Bank Ozk (OZK) 2011 Q1 法說會逐字稿

Good morning. My name is take Lakesha, and I will be your conference operator today. At this time, I would like to welcome everyone to the first quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions) Thank you. I will now turn the call over to Ms. Susan Blair. Ma'am, you may begin.

Good morning. I'm Susan Blair, Executive Vice President in charge of Investor Relations for Bank of the Ozarks. The purpose of this call is to discuss the Company's results for the first quarter of 2011 and our outlook for upcoming quarters. Our goal is to make this call as useful as possible in understanding our recent operating results and future plans, goals, expectations, and outlook. To that end, we will make certain forward-looking statements about our plans, goals, expectations, thoughts, beliefs, estimates, and outlook for the future including statements about economic, real estate markets, competitive, credit market and interest rate conditions, revenue growth, net income and earnings per share, net interest margin, net interest income, non-interest income including service charge, mortgage lending, trust income, net FDIC loss share accretion income, other loss share income and gains on sales of covered ORE, non-interest expense, our efficiency ratio, asset quality and our various asset quality ratios, our expectation for provision expense for loan and lease losses, net charge-offs and our net charge-off ratio, our allowance for loan and lease losses, loan, lease and deposit growth, changes in the value and volume of our securities portfolio, the opening and closing of banking offices, our goal of making additional FDIC-assisted failed bank acquisitions, and opportunities to profitably deploy capital.

You should understand that our actual results may differ materially from those projected in any forward-looking statements due to a number of risks and uncertainties some of which we will point out during the course of this call. For a list of certain risks associated with our business, you should also refer to the forward-looking information caption of the management's discussion and analysis section of our periodic public reports, the forward-looking statements caption of our most recent Earnings Release, and the description of certain risk factors contained in our most recent annual report on Form 10-K, all as filed with the SEC. Forward-looking statements made by the Company and its management are based on estimates, projections, beliefs, and assumptions of management at the time of such statements and are not guarantees of future performance. The Company disclaims any obligation to update or revise any forward-looking statement based on the occurrence of future events, the receipt of new information, or otherwise. Now, let me turn the call over to our Chairman and Chief Executive Officer, George Gleason.

Good morning, and thank you for joining today's call. We're very pleased to report another excellent quarter. Highlights of the quarter include another big increase in net interest margin which was our best quarterly net interest margin as a public Company, record net interest income, our fifth FDIC-assisted acquisition, and favorable results for both service charge income and asset quality. We have a lot to talk about today so let's get right to the details.

Net interest income is our largest source of revenue. Of course, net interest income is a function of both net interest margin and the volume of average earning assets, both of which increased nicely in the quarter just ended. This combination helped us achieve record quarterly net interest income of $36.1 million, giving us our third consecutive quarter of record net interest income. Over the last three years, we have had very favorable improvements in our net interest margin. This improvement continued in the quarter just ended, as our net interest margin increased to 5.61%, up 26 basis points from the immediately preceding quarter and up 62 basis points from last year's first quarter. This notable improvement in our first quarter net interest margin was a result of increased yields on almost every category of earning assets and decreased effective rates on almost every category of interest-bearing liabilities.

Specifically, from the fourth quarter of 2010 to the first quarter of 2011, our yield on taxable investment securities increased 7 basis points, and our yield on tax-exempt investment securities increased 43 basis points. Now, part of this increase in securities yields is due to the fact that the first quarter is a 90-day quarter which tends to have the effect of boosting the yield on most securities as compared to other quarters with 91 or 92 days. But more importantly, our yield on non-covered loans and leases increased 2 basis points, and our yield on covered loans increased 41 basis points. All of this gave us a 22 basis point overall improvement in our yield on total earning assets.

At the same time, we lowered our effective interest rates on all three categories of deposits, giving us a 7 basis point reduction in our cost of interest-bearing deposits. Along with a 4 basis point reduction in our cost of repurchase agreements and a 3 basis point reduction in our cost of subordinated debentures. This resulted in a reduction of 7 basis points in our overall cost of interest-bearing liabilities.

Our noteworthy first quarter net interest margin is truly the result of a team effort. Our deposit pricing committee has done an excellent job understanding our markets and competition and focusing on profitability. Over the last several quarters, and really years, our retail banking staff has done great work in dramatically improving the mix and profitability of our deposit base. Our lending and leasing teams have continued to achieve excellent pricing on loans and leases in our legacy markets, and our teams working on FDIC-assisted acquisitions have added large volumes of covered loans with excellent yields.

Our volume of average earning assets increased $84 million in the first quarter of 2011, compared to the fourth quarter of last year. This growth was completely attributable to the $146 million increase in the average balance of covered loans, which was partially offset by a $17 million reduction in the average balance of investment securities and a $46 million reduction in the average balance of non-covered loans and leases. Of course, the increase in our average balance of covered loans is a result of our fourth and fifth FDIC-assisted acquisitions which closed in December 2010 and January 2011, respectively. As we've stated previously, we are very pleased with all of our acquisitions to date, and we continue to be very actively involved in evaluating opportunities, performing due diligence, and bidding. We certainly hope to do more FDIC-assisted transactions in 2011 and beyond.

During the first quarter of 2011, we continued to be a net seller of investment securities to a small extent which once again restrained our growth in average earning assets. As has been the case in the past two years, the reduction in our investment securities portfolio was undertaken primarily as a result of our ongoing evaluations of interest rate risk and also to free up capital for FDIC-assisted acquisitions.

We were a bit disappointed by the $46 million reduction in the average balance of non-covered loans and leases in the quarter just ended, compared to the fourth quarter of last year. As has been the case in a number of quarters during the past two years, we originated a good volume of new loans and leases in the quarter, but our origination volume was once again offset by high level of payoffs. We currently have an excellent pipeline of approved loans and loan applications, but we acknowledge that our first quarter results have diminished our optimism regarding our ability to generate substantial growth in non-covered loans and leases this year. We continue to believe that our best source of growth and average earning assets this year would be covered loans from additional FDIC-assisted acquisitions.

Let's shift to non-interest income. Income from deposit accounts service charges is traditionally our largest source of non-interest income. In most years, the first quarter has historically provided our lowest quarterly level of service charge income due to seasonal factors. Service charge income in the quarter just ended increased 19.9% compared to the first quarter of last year. This is a testament to the success our retail banking team is having in adding large numbers of new core deposit customers over the last year, both through organic growth and acquisitions, as well as increasing customer utilization of various fee-based services.

In the second half of 2011, we will once again face regulatory and legislative headwinds in regard to service charge income. We've discussed this previously. The FDIC has issued guidance which will tend to reduce NSFOD fee income beginning July 1 of this year. In addition, the Durbin Amendment dealing with debit card interchange income and the Federal Reserve's recently proposed rule limiting debit card interchange charges by banks may affect us at some point. On its face, the Durbin Amendment applies only to banks of $10 billion or more in size as does the Fed's proposed rule, but there is widespread concern that interchange income for all banks will ultimately be diminished.

We are monitoring developments on both fronts. Our retail banking and compliance staff are working to implement the new FDIC guidance on NSFOD charges, which takes effect July 1st, and they are also working to develop and implement measures to mitigate, at least in part, the impact of these and other regulatory and legislative actions on our service charge income. Today, our focus has been on expanding customer utilization of various fee-generating products and services and preparing to selectively increase certain fees. But these actions will not fully offset the revenue we are likely to lose. We are also evaluating possible overhead reductions. Our goal is to fully offset any lost revenue, but frankly, it remains to be seen if that can be achieved.

Mortgage lending income in the quarter just ended was up 29.2% from the first quarter of last year although it was down significantly from the fourth quarter of last year. Mortgage lending income is another category which tends to be affected by seasonal factors, and all other things being equal, the first quarter tends to be the lowest or one of the lowest quarters for mortgage lending income each year. I stated in the last conference call that, quote, the recent increase in mortgage rates combined with the large volume of mortgages that have already been refinanced nationally will likely reduce the level of refinancing activity going forward, end quote. Our first quarter results certainly are consistent with that prediction.

Our trust income decreased 15.2% in the quarter just ended compared to the first quarter of last year, primarily due to a reduction in corporate trust income. A large portion of our corporate trust income is derived from fees earned from services provided in connection with new municipal bond issuance. As you are probably aware, municipal bond issuance was at extremely low levels nationally in the first quarter.

Net gains from investment securities in the quarter just ended were $152,000 compared to $1.697 million in the first quarter last year. Of course, we were a very active seller of investment securities in last year's first quarter, and we were a more modest seller of investment securities in this year's first quarter. Net gains from sales of other assets were $407,000 in the quarter just ended compared to net losses of $73,000 in last year's first quarter. The net gains realized in the quarter just ended were primarily attributable to gains on sales of covered other real estate assets. When we acquire OREO assets in FDIC-assisted acquisitions, we mark those assets to estimated recovery values, and then we discount those estimated recovery values to a net present value utilizing an appropriate discount rate. Unlike covered loans, the net present value discount on our covered OREO is not amortized into income over the expected holding period of the covered OREO. Because of this, a sale of a covered OREO asset if sold in a transaction reducing net proceeds exactly equal to the proceeds that we expected will result in a gain on sale equal to the amount of the net present value discount.

I mention this to point out that while gains on sale are normally considered an unusual item, we are very likely to see a fairly steady stream of gains on the sale of covered OREO assets in the coming quarters and over the next several years because of the unique accounting associated with covered OREO and the non-accretion of the related net present value discount. This has been evident in each of the last three quarters when our gains on sales of other assets have been $267,000, $571,000, and $407,000, respectively.

In the quarter just ended, we recorded $2.0 million of income from accretion of our FDIC loss share receivable, net of amortization of our FDIC clawback payable. As part of our FDIC-assisted acquisitions, we record a receivable from the FDIC based on our expected future loss share payments. And we also record a clawback payable to the FDIC based on estimated sums we expect to owe the FDIC at the end of the respective loss share periods. Each of the receivable and the related payable is discounted to a net present value utilizing a 5% per annum discount rate, and the discount amounts are accreted over the relevant time periods into income and expense. This accretion in both the FDIC receivable and the FDIC clawback payable is netted out, and in the quarter just ended, the resulting net accretion income was $2.0 million. This accretion income will be an ongoing source of income for us as long as we are under the loss share agreements. Of course, as loss share winds down over time, the amount of net accretion income will tend to diminish each quarter. But the $2.0 million recognized in the quarter just ended is a reasonably good starting point for estimating this number for the next several quarters.

In addition, non-interest income in the quarter just ended included loss share income of $1.0 million. This line item includes certain miscellaneous debits and credits related to loss share accounting, but it consists primarily of income recognized when we recover more money from covered loans than we expected to recover. We refer to this as recovery income. Since we tend to be conservative in the way we value covered assets, which is appropriate given the uncertainty surrounding many of those assets, it is likely that this other loss share income line will continue to be a recurring and potentially meaningful income item in future quarters because it can vary significantly and be significantly impacted by prepayments on covered loans. Other loss share income will tend to be somewhat volatile from quarter to quarter.

During the quarter just ended, we benefited from a pre-tax bargain purchase gain of $3.0 million on our fifth FDIC-assisted acquisition. During the first quarter of last year, we enjoyed a pre-tax bargain purchase gain of $10.0 million on our first acquisition. The smaller gain in this year's first quarter as compared to last year's first quarter reflects in part the smaller size of this year's acquisition. In addition, we believe that our valuations for covered assets in connection with the most recent acquisition were particularly conservative because very little credit information was available to our staff during the loan valuation process. When critical information is missing, caution mandates conservative assumptions. Over time, however, this latest acquisition could prove to be just as profitable as our first acquisition.

There has continued to be significant commentary to the effect that the opportunity for profitable FDIC-assisted acquisitions has largely passed. The profitability metrics of our two recent transactions suggest that the very favorable acquisitions we've enjoyed can still be made using our approach which involves actively looking at numerous opportunities while being very conservative in our underwriting and bidding. This strategy has resulted in us being the winning bidder in about one out of every eight opportunities on which we have bid. Like you, we've observed a number of recent transactions that seem to make very little financial sense. And frankly, we were significantly outbid on some of those transactions. However, we stated from the beginning that we would do our due diligence, maintain our discipline in underwriting and bidding, and pursue transactions with a view to making a profit on both the acquisition and the ongoing operation of the acquired assets. We are continuing to pursue our disciplined approach, and we believe we will continue to see many opportunities for FDIC-assisted acquisitions.

Before we leave that subject, I would like to discuss the franchise we are building in our five new states and share several thoughts in regard to FDIC-assisted acquisitions. First, let me remind you and note again that we have looked at acquisitions in Arkansas, Texas, Oklahoma, Kansas, and Missouri, Tennessee, and in the Southeast from Virginia, North and South Carolina, Georgia, Florida and Alabama. By looking at 12 states, we have seen many opportunities, and thus, we have been able to be very conservative in our bidding. This has allowed us to purchase all five of our acquired banks at prices that have generated initial gains and operating profits from the first business day following acquisition. If we were concentrating on a single state or just a couple of states, we would have either made fewer acquisitions or we would have had to have been much more aggressive in our bidding.

Second, we can be profitable and efficient with a single office or a small number of offices in a market. For example, we've operated a single office in Charlotte, North Carolina for more than a decade, and it has been a profitable and important piece of our Company. The same could be said for the two offices we initially operated for several years in the Metro Dallas area.

Third, we are already starting to connect some of the pieces. Our first acquisition in March of last year consisted of five Georgia offices, and our fourth acquisition in December of last year consisted of four Georgia offices. These two groups of offices are separated by the width of a single county. And they can ultimately be connected as a single cohesive unit with just one or two additional offices. Likewise, the Georgia office that was part of our second acquisition last year could easily be connected with the two Georgia offices from our fifth acquisition in January of this year as they are just 71 miles apart. While all of our acquired offices can be successful as they currently stand, it is more likely that we will ultimately connect our current individual offices, or groups of offices, into larger, cohesive groups or networks through additional FDIC-assisted acquisitions, or subsequently, through de novo branching and traditional M&A activity.

The final point that we want to discuss relating to FDIC-assisted acquisitions is our focused approach to instill in our new staff at these offices not only our proven processes, procedures, policies, and practices but also our commitment to excellence, ethics and integrity. We want each of our acquired offices to perform at the same high level that we expect of each of our legacy offices. To achieve both the desired evolution in business practices and the revolution in culture, we are spending significant resources on both training and cultural integration of these new offices. These efforts have added to the increase in our non-interest expense over the last year, but we believe these expenditures will produce great returns in the future.

Let's turn to non-interest expense which increased 50% in the quarter just ended compared to the first quarter of 2010. Our first quarter non-interest expense was significantly impacted by several factors. First, we incurred $1.4 million in acquisition and conversion cost in the first quarter of 2011, compared to just $0.3 million in the first quarter of 2010. We have now completed systems conversions on four of our five acquired banks, and we plan to complete the fifth system conversion over the weekend of May 6.

Second, write-downs on other real estate owned total $2.6 million in the first quarter of 2011, compared to just $1.6 million in the first quarter of 2010. Every quarter, we review the carrying value of every OREO asset, and we adjust the carrying value downward as necessary to reflect reappraisals, reduced listing prices, or deterioration in ongoing market conditions. In addition, we have been systematically and aggressively writing down the carrying values of assets which we think will have extended holding periods. And in many cases, these write-downs are reducing carrying values to well below current appraised values. Our philosophy is very simple. If we expect to sell it over an extended period, we want to be carrying it at an extremely conservative valuation. Non-interest expense also included the cost of ongoing due diligence efforts related to our other FDIC-assisted acquisition opportunities and the increased cost of having 94 offices at March 31 this year versus 78 offices at March 31 last year.

While we are discussing overhead and number of offices, let me mention that despite our focus on FDIC-assisted failed bank acquisitions, we are continuing our growth in de novo branching strategy. During the quarter just ended, we opened a new office in Plano, Texas in January and in Carrollton, Texas in February, and we plan to open a new Keller, Texas office later this month. We expect de novo branching to continue to be an important part of our business strategy, but our focus on de novo branches will continue to be secondary to our focus on FDIC-assisted acquisition opportunities for the time being.

One of our long-standing and key goals is to maintain good asset quality. Economic conditions have made our traditional strong focus on credit quality even more important. For the past 18 months, we've stated our belief that we are past the mid-point of the current credit cycle, and therefore, we've stated that we believe that our allowance for loan and lease losses ratio peaked at 2.19% of total loans and leases as of June 30, 2009. For the past seven quarters, that ratio has stayed just under the 2.19% level, but over the course of 2011 we expect to see that ratio begin to decline further.

In this year's January conference call, we stated that although we expect our net charge-off ratio -- our net charge-offs and our provision expense to vary from quarter to quarter in 2011, we expect these three metrics on average would show improvement in 2011 compared to the results we achieved in 2010. In 2010, our net charge-off ratio was 81 basis points. In January of this year, we stated that we expect that our net charge-off ratio for 2011 to be less than 81 basis points although it may be more than that in a particular quarter or quarters. In the first quarter, our annualized net charge-off ratio was 72 basis points in line with our guidance.

Our provision expense in 2010 was $16 million, or $4 million per quarter on average. In January of this year, we stated that we expected our provision expense would average less than $4 million per quarter in 2011 although it may be higher than that in a particular quarter or quarters. Our provision expense in the first quarter was $2.25 million in line with our guidance.

Our net charge-offs in 2010 were $15.4 million, or $3.85 million per quarter on average. In January of this year, we stated that we expected our net charge-offs would average less than $3.85 million per quarter in 2011 although they may be higher than that in a particular quarter or quarters. Our first quarter net charge-offs were $3.3 million in line with our guidance. We continue to believe that the guidance we gave in January for all three metrics is appropriate.

In January, we stated our belief that the magnitude of the improvement in these three metrics will depend to some degree on the strength of the recovery over the course of this year. Our guidance continues to assume that the United States does not experience a double dip recession, and that our country continues to have some degree of economic recovery. Our provision expense in the quarter just ended was $1 million less than our charge-offs for the quarter, but our allowance for loan and lease losses at both December 31 of last year and March 31 of the quarter just ended held steady at 2.17%. We expect positive growth in our loan and lease portfolio over the final three quarters of the year, and therefore, our allowance level is not expected to decline further because of portfolio shrinkage. On the other hand, we expect asset quality will show an improving trend over the course of the year which could result in some reduction in the overall level of our allowance for loan and lease losses.

Before we close today, we want to offer a few comments about the recent growth in our capital and capital ratios which have increased significantly through retained earnings in recent years. For example, our book value per common shares increased 88% over the last four and a quarter years from $10.43 per share at December 31, 2006 to $19.58 per share at March 31, 2011. This would be a noteworthy accomplishment in normal times but is particularly gratifying considering that we've been through the most severe economic downturn nationally since the Great Depression.

As a result of our substantial retained earnings, we have surplus capital. Our common stockholders equity to total assets ratio as of the most recent quarter-end was 10.0% --10.06%. We believe that we will have numerous opportunities over the next several years to profitably deploy our accumulated capital, and that the most immediate capital deployment opportunity is additional FDIC-assisted acquisitions. The second most immediate opportunity is expected to be positive growth from our loan and lease portfolio which we hope to see very soon. The third opportunity will likely come when interest rates increase significantly, and we consider it timely to reload our investment securities portfolio. Over the last couple of years, we have reduced our investment securities portfolio to both free up capital for the most profitable opportunities and in anticipation that higher interest rates would eventually return. At some future point, we will likely feel comfortable resuming investment securities portfolio growth.

The fourth opportunity we see for capital deployment relates to traditional M&A activity which may provide favorable opportunities for us in the future. Presently, however, we believe that FDIC-assisted acquisitions are more attractive relative to traditional M&A transactions.

In closing, let me state that our goal for the second quarter of 2011 -- and we believe it is a reasonable goal -- is to achieve net income exclusive of any bargain purchase gains or related costs from acquisitions in excess of $12.5 million. In our view, that is now a minimum level of quarterly earnings we would like to achieve. We certainly hope to do more FDIC-assisted transactions, and if we do more, such transactions may result in significant bargain purchase gains and even higher quarterly net income results.

That concludes our prepared remarks. At this point, we will entertain questions. Let me ask our operator to once again remind our listeners how to queue in for questions.

(Operator Instructions) Our first question comes from the line of Derek Hewett.

Good morning.

Good morning, Derek.

Hey, quick question about your OREO. In terms of that Dallas OREO property, any update on potential contracts to sell that piece of property?

Well, we do actually have it under contract again. This is the third time that we have had the property under contract. The contract that exists on it today we feel pretty good about, but again, it's subject to the borrower raising their equity -- required equity money in it and a due diligence period. Our sense is that the borrower is well-versed and knowledgeable about the property, and we are also told that the equity money is raised although that's never a done deal until it's a done deal. The scheduled closing date on the transaction if it does close is June 15. So we won't really know anything until very close to the end of the second quarter.

But that continues to be a property in which there is a lot of interest. It is a very valuable piece of property and whether we get this deal closed or not, we expect to sell it at a price approximating our book value in the property at some point. So we are not terribly concerned about it. I am probably a little more optimistic about the prospects of this transaction closing than we have been the other two. But again, there's still quite a few conditions on it. Obviously if we get that closed, that asset accounts for more than 40% of our OREOs so it would make a really nice improvement in our non-performing asset ratios.

Okay. Great. Thank you very much. Could you talk a little bit about the yield on the covered loan portfolio, and why we're seeing such a significant increase in the first quarter?

Well, as I've said many times before, we continue to be very conservative in the way we value those assets. Both from a credit mark perspective, so we are carrying them at a low expected recovery value, we think -- a conservative recovery value. And we put significant discount rates on them. The best of those loans that we would consider a one or two grade loan, I think, are carrying discount rates of 6%. The more problematic credits are carrying discount rates as high as 9.5%. So we're conservative both in our credit marks and our net present value discount rates, and we assume pretty extended holding periods on the recovery.

So the three ways that you could be conservative, we are conservative in the way we value them. And as a result, they tend to generate high yields. And as I mentioned in my prepared remarks, they've tended to also generate a fairly decent stream of recovery income which is in that other loss share income line item. So there is considerable uncertainty about the assets. So very conservative valuations of them are appropriate.

Okay. Great. Thank you very much.

Thank you.

Our next question comes from the line of Dave Bishop.

Dave, good morning.

Hey, good morning, George. Following up Derek's question there, he hit a topic I wanted to touch upon because I know it's getting more focus and a bigger part of the income stream. Obviously, it's sort of arcane. I know there's a lot of moving parts. But even though it's probably a conservative expectation, but assuming there was no more deals -- any sense of the duration of those acquired loans in terms of what the roll-off period was, would be? And I guess what the depletion of that accretion would be on a quarterly basis? I'm just trying to get a sense of what the margin effect is.

Yes. Well, some of those assets will have tails on them that will go out ten years -- or odd little pieces even longer into the future. But what we've said in our previous communiques and conferences and conference calls on this is, it appears to us from the first deal -- and I think it's been true on the others. That it looks like those assets are rolling off on about a five-year basis. If you just take the monthly cash flows that we're getting off those and assume that's a straight line deal -- and of course, it won't straight line, it will be a -- have a nice curve to it. But if you just in a very simplistic fashion assumed a linear straight line runoff, I think a five-year assumption would be a pretty decent rough approximation of what we're expecting.

Okay. And then the -- I think you alluded to the fact also in some of the other loss share income, any more granularity you can provide there in terms of what was driving that this quarter?

We've got five acquired banks instead of three acquired banks that we had basically affecting last quarter's numbers, the December and January acquisitions. So as we get paid off on loans that we ascribed a lower than full value to, which I don't think we have any loans that we've said are worth 100 cents on the dollar. So as payments come in in excess of what were projected on those loans -- as the carrying values go to zero on them -- all future payments go to income as loss share recovery income.

So that's really the driver. The increased volume of assets is really the driver in the increase in that line item, as is the case for the increased FDIC accretion income. We've got a bigger receivable net of clawback that we're accreting into income. So those last two acquisitions in December and January have been the key factors really driving those increases.

One follow-up question. Back to -- in the past, obviously, you had talked about expectations for further margin improvement here. The 5.61% obviously a new high watermark. Any sense as we look out into next quarter, you can sustain this or even build upon that even further?

Well, when you're at 5.61%, you're hesitant to be optimistic about being able to build on that. That's a pretty heady number. But if we can continue to make additional FDIC-assisted acquisitions -- certainly as you observed -- if you looked at our margin schedules that were attached to our press release. Our covered loans are our highest yielding component of earning assets, and if we can add more of those at comparable yields to what we've added, that tends to blend the yield on earning assets up with every group of those that we add. So that could be helpful. And there is still some room for small further improvements in our cost of funds.

Now, that actually may bounce around. As we acquire banks, we may end up temporarily with some higher cost deposits very short-term from acquisitions. But over the long haul I think we can. If rates stay stable, we can get a few more basis points out of our cost of funds. So there are scenarios that are very plausible that we could assume further improvement on the cost of funds and additional acquisitions that push the margin up. I think the margin in the range between where we were in the fourth quarter and where we are now is very plausible to think we stay in that range for a number of quarters. And there's some possibility for some upside.

Thanks, George.

Thank you.

Our next question comes from the line of Matt Olney.

Good morning, Matt.

Hey, good morning, George. Can you hear me?

Yes, certainly can.

All right. I hopped on this call a few minutes late so I apologize if you already addressed some of my questions. But the pace of failed banks has slowed down in recent weeks especially in some of your target markets in the Southeast. So what's your outlook for the pace of failed banks? Have we hit a temporary low here? Are we just going to see fewer deals at this point in the cycle?

Well, you see the same FDIC problem bank list that I see, and I think it's as large or larger now than it's been at any time during the economic downturn. So that would suggest that there are a lot of banks still to be resolved. I think that goes on throughout 2011, throughout 2012, and probably continues into 2013. There's a lot of work that the FDIC's got to do.

The other comment I would make on that is having been involved in this process for over a year now, these things tend to seem to come in waves. And that's -- I don't know the reason for that, but there seems to be a lot of opportunities on the calendar. And then there seems to be not much for a little while, and then there seems to be another wave. And that just is what it's looked like historically to us, and those waves tend to move around the country geographically. And again, I think that's just the randomness of the whole process.

So I expect there's going to be a lot of opportunities out there, and we are vigorously and actively looking at them. I think we bid six transactions since we made the January acquisition. So I think we bid one the following week. So we've continued to be very active in looking, very conservative in our bidding, and we're working hard on that and have high hopes of making a number of additional acquisitions before this cycle is over.

Okay. And then another question, circling back on the Dallas OREO property you discussed a few minutes ago. Would the current contract result in any kind of meaningful gain or loss from your current book value?

No, very negligible. Within a few thousand dollars one way or the other.

Okay. Last question. You mentioned in prepared remarks the expansion strategy has been -- resulted in some higher expenses. And historically, you've been able to get efficiency ratio around 40%. Is that still reasonable to assume once these get fully integrated? Or now since your footprint's a little more spread out, is that going to be not realistic down the road?

I don't think that the geographic diversity of our offices will impair our ability to achieve our historical efficiency ratio that we, say, have experienced over the last two or three years in the future at all. And I did comment on that in my prepared remarks. That we think we can operate one office or three offices or two offices or five offices as a group very profitably and very efficiently just as we've operated isolated offices in the past very efficiently.

We are, as I mentioned in my prepared remarks, spending an intense amount of time on training. And not just training in the sense of processes, procedures, practices, and policies, and we're certainly immersing our newly acquired staffs in that. But we are really focusing really hard on our standards of excellence. Our standards of fair dealing business practices, honesty, integrity, ethics, those things, and that cultural transformation is every bit as important to us as the business practices transformation in these offices. And we're just spending a lot of money on it. I would guess -- I haven't calculated exactly, but I would guess we're spending probably as much as a half million dollars per acquisition on cultural development of our staff and training and business practices development of our staff because we are really -- we're going to be in these markets long-term. We expect to be in all these markets permanently. And we've got to get these people fully on-board at the acquired offices with the same culture that has made us very efficient, profitable, and successful in the past.

And I will tell you that process is going very well, and I really like the teams at each of our five acquired institutions. They -- the people that we have left there -- that we've retained at those institutions seem really willing and enthusiastic about embracing not only our business model but our culture and being a part of our Company.

So I think this is certainly adding to the cost right now, and I'm a little embarrassed by 50% range efficiency ratio. That's certainly not where we want to be long-term. But I think the money that we're spending here in the short run to do these things is going to pay great dividends for us in the future. So I think you'll see our efficiency ratio two, three, four years from now be much more back in line with where we were a year ago, two years ago.

Great. Thanks for the color, George.

Thank you.

Our next question comes from the line of Peyton Green.

Good morning, Peyton.

Good morning, George. Certainly a very strong quarter again. I was just wondering if you could comment a little bit. The 30-day past due number has kind of crept up over the better part of the year. Just wondering where you're seeing past dues, and what makes you comfortable about the improved credit outlook given the past dues.

Since I'm personally involved in the working of that list with our lending team at a very detailed level, I'm disappointed in that result as I know our lending team is. We work those past due ratios really hard and work really hard to get payments and if loans need to be renewed, get them renewed. So we're disappointed that that ratio migrated up. I don't think it has -- I'm not terribly disturbed about it. I certainly am disappointed in it because I would like for that ratio to go down every month and every quarter. But I'm not terribly disturbed about it, and as you noticed, I painstakingly in my prepared remarks reiterated our January guidance for charge-offs and net charge-off ratio and provision expense. And the modest uptick in the past due ratios does not in any way cause us to alter or deviate from our earlier guidance in regard to those metrics. So it's not where I wanted the ratio to go, but I don't think it has any particular negative connotations to it either.

Okay. Great. With regard to the loan growth, that's something that probably has been the most disappointing thing to you over the last year has been -- I guess in terms of looking at the guidance that you've given, that's probably the one that's been more wrong than not. The payoffs that you're seeing, is it payoffs from completion of projects or sales? Or is it completion from others refinancing loans away due to competitive conditions? If you could give a little color on that, it would sure be great.

It's a variety of things. Right toward the end of the quarter -- the last week of the quarter we had a pay off of -- I think it was $9.8 million, somewhere just under $10 million. And this was a deal that was a very good customer, and we were totally comfortable with the transaction. But the customer advised our lender that they had been accumulating cash just because of the economic uncertainty and just building large cash reserves, and they were just sitting on a lot of cash. And they're getting more comfortable with the economy so they decided to just pay down some of their loans with their surplus cash. And I thought when I got that report from my lender how ironic that is. You would think that normally when customers are feeling better about the economy, they're going to borrow more money and more good things are happening. But this customer's been accumulating cash out of concern, and now that he's more comfortable with the economy he's paying down debt instead of sitting on cash.

So there are a lot of reasons. We had some loans where projects were just completed and paid off as they should have been, and our new volume was not added to replace it. We had situations like that where customers had a lot of cash and just simply getting more comfortable with the economy and paying down debt. And we lost some opportunities that were in our pipeline that we really thought we would get closed. We had term sheets out and were pretty far along in negotiations with customers, and we lost a couple of really, really fine, high quality deals to bank competitors that priced them on a long-term fixed rate that just makes no economic sense to us.

So it's a variety of things. But again, we did close a lot of loans in the quarter that we feel really good about. And we've got a really good pipeline of approved deals now, and we've got pending deals. So we're seeing lots of opportunities and getting a lot of them closed. I'm not terribly concerned about it, but I am very disappointed that we had negative growth for the quarter, particularly of the magnitude we did. But I don't think that's necessarily a harbinger of things to come. As I said, I think we will have positive growth over the remainder of the year. But after getting shellacked on the growth story in January like we did, I'm a little less optimistic about that than I was just because you have a negative quarter like that on growth, and it tends to subdue your optimism.

Sure. And then in terms of the -- this will be my last question. But the Oglethorpe acquisition was one where I guess less information was known the day you got the bank. You've been there 90 days now, give or take. More of the mark would have been used to reduce the carrying value of the loans. Have you seen anything that would lead you one way or the other in the first 90 days in terms of that mark?

We're very pleased with the acquisition. We're very pleased with our team there. But to provide a little more color on that comment, the senior lender at the bank left the Company about a week or two before the acquisition. And he was really the guy that had underwritten the vast majority of the credits there, and the culture at the bank was just not one of maintaining a lot of information in the pile. So when this guy walked out, a lot of the credit information really went out in his head.

And so we've got a really sharp group of lenders there. Young guys -- they are working hard. They are really embracing what we're doing. But when we went in the week of acquisition -- the week after acquisition -- and were asking these guys about the loans, a lot of the loans they had just inherited from the acquired lender. And we just assigned them to them, and they just frankly didn't have a lot of head knowledge. And there wasn't a lot of information in the file. So as we're dealing with renewals or past due situations, we're building the informational files on those loans. And that process will take a year. So it's really too early to comment on that.

But the way our loan valuation and loan review guys do is if there's an absence of information they tend to fill in any missing blanks with fairly dark negative scenarios. So I think it did lead to some pretty gruesome credit marks on some of those assets, and I was concerned enough about it that when I saw the numbers -- because I thought wow, these are really gruesome marks. Did our due diligence guys really miss this or what? So I went through personally, probably -- I don't know, 150, 200 of the assets, and after I did that I understood exactly where we came to it. It may not necessarily be that the assets are as bad as we marked them, but I couldn't disagree with the fairly adverse marks that our guys put on them given the information that was available in the files.

So I think we'll do better than our initial valuations on that over time and probably have a wider margin of do better on that than we do in our typical deal because normally we're conservative. I think we were extremely conservative -- exceptionally conservative in that bank because of the lack of information.

Thank you very much.

Thank you.

Our next question comes from the line of Michael Rose.

Hi. Good morning, everyone.

Good morning, Michael.

Most of my questions have been answered. But I wanted to get a little bit more color -- kind of where you are on repricing the deposits specifically at your two most recent FDIC acquisitions. Looks like your all-in cost of funds is 85 basis points. But drilling down into the deposit and the CD cost, where are you in the life cycle of kind of working that down?

Well, Michael, we repriced deposits. We are entitled to break rates.

Yes.

At the time of acquisition, and we repriced our acquired deposit portfolios on Monday following the acquisition. So the CD repricing occurs immediately. The core deposit repricing -- interestingly enough, we've done very little of that because most of the acquired banks have had core deposit pricing that was consistent with where we would have priced your non-CD deposits or not significantly inconsistent.

So we've typically left the core stuff alone. We've repriced the CD stuff right down to where we would have priced it. And that has led to significant shifts in the deposits. If you notice at the end of the last quarter, our non-CD deposits, I think, were about 65% or 66% of our total deposits. Typically, in these acquired institutions, they're about -- that number's about 25% to 35%. Somewhere around 30% non-CDs and 70% CDs. And as a result of our repricing, I think the acquired institutions now are about 60% non-CD and 40% CD.

So we're shifting their deposit mix by losing the high cost deposits. And of course, we lose the brokered deposits and the Internet deposits. The non-local wholesale funding stuff we lose real quickly because we price it down radically. But what is encouraging to us is that we are retaining in the acquired institutions very high percentages of the non-CD accounts. So we're keeping the business that makes sense with our business model and trying to grow on that business and lose the high cost wholesale CDs that don't really fit our business model.

Okay. That's really helpful. I appreciate the color. One additional question. Looks like the legacy loan portfolio is down six out of the past seven quarters. I know you talked about the guidance on a go-forward basis. When do some of these markets that you've kind of stepped into through these FDIC-assisted acquisitions -- when do you think they start to become accretive to the overall business mix? And when do you really start to see some material growth?

Well, one of the reasons that each of the five banks we acquired failed is because their markets have suffered probably a disproportionate amount of economic upheaval compared to the nation on average as a whole. So the high unemployment rates and excessive over-building and the economic challenges that are existent in those markets make it fairly difficult to find a lot of high quality loan opportunities. But -- and you couple that with the fact that you're acquiring an institution that has a considerable degree of challenged assets, and you want to focus on those and get those things on effective workout plans that will either move them out of the bank or rehabilitate them and get them in a proper structure that we're happy with. When you factor those two things in, the first quarters and maybe even year or so in these banks tends to be very defensively oriented because you're just trying to fix all the things that need fixing. The growth will come later.

Now, we've originated some new loans at the acquired institutions already. We're certainly receptive to originating new loans at the acquired institutions. But frankly, I don't see those being markets of great opportunity for positive loan growth for several years. Just because of the distress that exists within those markets that contributed to the failure of those banks.

That answers my question. I was trying to figure out from your perspective, assuming no other deals, when those headwinds actually start to become tailwinds to your portfolio.

I think before we see meaningful growth in most of our acquired offices -- I think you're talking two or three years. You will see some growth, and we're certainly -- in fact, I'm planning on making a personal tour in the next 90 days to every one of the acquired offices and one of the themes I'm going to talk about is, yes, we're doing a great job fixing our problems. But we also need to be growing our customer base and looking for quality opportunities where we can add assets. That's part of the theme and mission of my tour.

But as a practical matter, I'm pretty realistic about the expectations there. That they're not going to be contributing meaningfully to our growth numbers for a couple of years just because of the economy there.

Perfect. Thanks.

Thank you.

Our next question comes from the line of Brian Martin.

Hey, George.

Hey, Brian, good morning.

Just one follow-up on the loan pipeline. You talked about it being maybe -- it sounded like stronger than it has been in the past. Just wondering if that is the case? If it is stronger than last quarter, the quarter before? And then just what markets -- I guess in particular -- I guess my assumption would be it would be Texas? But is that correct?

That is correct. Most of the opportunities that we are seeing, of course, are from Texas. We've got several nice deals working in Arkansas and a couple of deals working in our North Carolina office as well. But the majority of the opportunities we're seeing are coming out of our Texas offices.

Okay. And the pipeline is relative to fourth quarter, maybe the third quarter -- is there more optimism? I guess is that -- just on getting the growth turned around?

Well, I would say this. In our -- I think I was actually too optimistic in the January call, and I didn't mean to be. But I was too optimistic because we had several large deals in the hopper that we were fairly optimistic we were likely to get in and get closed that we lost, as I mentioned, because a couple of the big national banks -- one in particular -- just priced these things at a pricing level that made no sense to us. And our understanding is what they're doing is originating these loans at long-term fixed rates. Putting them on their books with the expectation that they're going to syndicate them and roll them out into some sort of CMBS product. And that sounds a whole lot like 2007 to me.

So that business model is -- that strategy just made no sense to us so we lost $50 million to $100 million of stuff that we were looking at down the road in our pipeline that just went away because we just couldn't compete with those terms and would never try. It was just -- it's not prudent pricing. So if you take those deals out of what I was looking at in January, yes, our pipeline for Q2 looks better than our pipeline did in Q1, ex those couple of opportunities. It's still not as good as we would like it to be, but it is better. And we've got -- from one of our Dallas offices -- we've got 15 transactions. I got a list from them yesterday, that are lined up to close. Hopefully, this quarter. And if we can get them all closed -- those transactions. I don't remember the exact number, but it's about $40 million, and then we've got probably a similar number of applications from there. So we've got a lot of things we're working on if we can just get them closed and not have -- not get a bunch of stuff prepaid we don't want to get paid off, we'll be okay.

Okay. And then just the last thing was in the K, you gave some disclosure regarding the substandard credits. Was there any material change in that number this quarter? Or do you -- would you have that number available?

I don't have that number available. I don't think there's a material change in it, no.

Okay. Okay. Thanks very much, George.

You noticed our non-performing asset ratio, I think, was up 2 basis points from December to March which really is a function of the slight shrinkage in the portfolio over that period of time and the actual non-performing loan number, which was up 2 basis points -- the actual number in dollars was pretty much flat, I think. And then of course, the non-performing asset ratio was down because OREO was down $2.5 million or so.

Right. Okay.

Okay.

Thanks, George.

Thank you.

(Operator Instructions). We do have a question from the line of Kevin Reynolds.

Good morning, George.

Hey, good morning, Kevin.

All of my questions have been answered by now, but great quarter. Keep up the good work.

Thank you, sir. I appreciate it.

And sir, there are no further questions at this time.

All right. There being no further questions, that concludes our call today. Thank you for joining us. We look forward to talking with you again in about 90 days. Thank you very much. Have a good day.

This concludes today's conference call. You may now disconnect.