Bank Ozk (OZK) 2011 Q3 法說會逐字稿

Good day, everyone, and welcome to today's Bank of the Ozarks third-quarter earnings conference. All lines have been placed on mute to avoid background noise. After the speakers' remarks there will be a question-and-answer session. (Operator instructions). Just as a reminder, today's call is being recorded. At this time I would like to turn the conference over to your host for today, Ms. Susan Blair. Please go ahead, ma'am.

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 third quarter 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 outlooks.

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 market, competitive, credit market and interest rate conditions; revenue growth; net income and earnings per share; net interest margin and potential for further improvement in our cost of interest-bearing deposits; net interest income; non-interest income, including service charge income, mortgage lending income, trust income, net FDIC loss share accretion income, other loss share income and gains on sales of foreclosed real estate covered by FDIC loss share agreements; 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, including growth in our legacy loan and lease portfolio through 2014; changes in the value and volume of our securities portfolio; the opening and closing of banking offices; our goal of making additional FDIC-assisted sale bank acquisitions, including achieving ongoing bargain purchase gains associated with such 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 recent 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. Thank you for joining today's call.

We are very pleased to be reporting excellent results for the quarter just ended. These results included record quarterly net interest income, our best quarterly net interest margin as a public company, record service charge income, favorable asset quality results and good growth in non-covered loans and leases. Even though we did not make an FDIC-assisted acquisition in the quarter just ended, it was nonetheless a very profitable, productive and busy quarter.

We continue to be very active in evaluating and bidding on failed bank opportunities. We completed the systems conversion on our two most recent acquisitions. We completed our annual round of regulatory examinations. We focus significant attention on new business development opportunities, including growth in our legacy loan and lease portfolio.

Our team's hard work is evident in our achievements, including achievement of our third-highest quarterly net interest income ever. Let's look at some details.

Net interest income, as you know, is traditionally our largest source of revenue and is a function of both net interest margin and the volume of average earning assets, both of which increased in the quarter just ended. This combination helped us achieve record quarterly net interest income of $44.3 million in the third quarter, giving us our fifth consecutive quarter of record net interest income. In fact, our third quarter net interest income increased $1.9 million or 4.4% from the immediately preceding quarter.

Over the last three years, we have had very favorable improvement in our net interest margin. This improvement continued in the quarter just ended as our net interest margin increased to 5.90%, up 10 basis points from the immediately preceding quarter and up 59 basis points from last year's third quarter. The 10-basis-point improvement in our net interest margin in this year's third quarter compared to this year's second quarter was primarily due to our lower effective rates on all three categories of interest-bearing deposits. This resulted in a 13-basis-point reduction in our overall cost of interest-bearing liabilities which more than offset a 4-basis-point quarter-to-quarter reduction in our yield on earning assets.

There appears to be some opportunity to further reduce our cost of interest-bearing deposits in the coming quarters.

Our significant net interest margin improvement over the past several years is the result of a team effort. Our deposit pricing committee has done an excellent job understanding our markets and our competition while focusing on profitability. Our retail banking team has done a great job in dramatically improving the mix and profitability of our deposit base.

On the other side of the balance sheet, our lending and leasing teams have continued to achieve good 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.

Over the last six quarters, our growth in average earning assets has primarily been due to loans acquired in our seven FDIC-assisted acquisitions. Of course, the vast majority of such loans have been covered by FDIC loss share agreements. We are very pleased with all of our acquisitions to date, and we certainly hope to do more FDIC-assisted acquisitions.

With that said, we are also diligently working on business development and growth in our legacy loan and lease portfolio. We were very pleased with the $61 million of growth in non-covered loans and leases in the third quarter. We are extremely well-positioned from both a financial and a competitive position, and we want to capitalize on our strong position to add new customers and build quality relationships.

Further, with our exceptional net interest margin we can afford to be somewhat more aggressive on pricing. With an increased focus on growth, we believe that we can achieve our goals, as previously stated, of net growth in our legacy loan and lease portfolio of $20 million per month on average in 2012, $30 million per month on average in 2013 and $40 million per month on average in 2014, all while adhering to our traditional conservative credit principles. Certainly, our results in the quarter just ended suggest that these are realistic goals.

As we have discussed in recent quarterly conference calls over the past two years, we have reduced the size of our investment securities portfolio as a result of our ongoing evaluations of interest rate risk and also to free up capital for FDIC-assisted acquisitions. We reduced the portfolio $60 million during the quarter just ended. Further reduction in our investment securities portfolio, if any, would probably be very limited in size since we are now approaching the minimum portfolio size we need to maintain our routine balance sheet management functions.

Of course, as we've said many times, we will be a buyer of investment securities when we believe that compelling values create a favorable buying opportunity and we will be a seller of investment securities when we believe it is time to sell.

Let's shift to non-interest income. Income from deposit account service charges is traditionally our largest source of non-interest income. Service charge income in the quarter just ended increased 3.2% compared to this year's second quarter and 18.3% compared to the third quarter of last year. Our third quarter results were particularly impressive considering that the new regulatory guidelines which became effective July 1 and, of course, which reduced NSF/OD fee income in various ways. We implemented measures to mitigate the impact of these regulatory changes on our service charge income, including expanding customer utilization of various fee-generating products and services and selectively increasing certain fees.

These actions, combined with our growth in core deposit customers, allowed us to achieve record service charge income for the quarter even after implementation of the new regulatory guidelines.

Mortgage lending income in the quarter just ended was down 20.4% from last year's third quarter, but up 28.5% from this year's second quarter. Our volume of home purchase financing continues to reflect the relatively subdued housing market, but recent Federal Reserve actions have created an environment more conducive to mortgage refinancing. Increased refinancing activity largely accounted for the improvement in our mortgage lending come from the second quarter to the third quarter of this year.

Trust income increased 1% in the quarter just ended compared to last year's third quarter and increased 0.9% from this year's second quarter. Our sluggish growth in trust income this year compared to our growth in recent years is primarily due to a reduction in corporate trust income. A large portion of our corporate trust income is derived from fees earned for services in connection with new municipal bond issues. Municipal bond issuance has been at very low levels so far this year.

Net gains from investment securities in the quarter just ended were $638,000 compared to $570,000 in the third quarter of last year. For the first nine months of this year, net gains from investment securities were $989,000 compared to $4,319,000 in the first nine months of 2010. Of course, we were a much more active seller of investment securities in the first half of last year.

Net gains from sales of other assets were $1,727,000 in the quarter just ended compared to $267,000 in last year's third quarter. For the first nine months of this year, net gains from sales of other assets were $2,839,000 compared to $232,000 in the first nine months of 2010.

Net gains realized in the quarter just ended and the first nine months of this year were primarily attributable to gains on sales of foreclosed real estate covered by loss share agreements, or covered OREO, as we refer to it. When we acquire such foreclosed real estate and FDIC-assisted acquisitions, we mark those assets to estimated recovery values and we then 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 projected holding period of recovered OREO.

Because of this, a sale of covered OREO, if sold in a transaction producing net proceeds exactly equal to the proceeds expected will result in a gain on sale to the extent of the net present value discount. We've discussed this in recent conference calls and we mention this again to point out that, while gains on sale are normally considered an unusual item, we are very likely to see gains on sale in future quarters. This has been evident in each of the last five quarters and is in part because of the accounting associated with covered OREO, specifically the non-accretion of the related net present value discount.

In the quarter just ended, we recorded $2.86 million of income from accretion of our FDIC loss share receivable net of amortization of our FDIC callback payable. As part of our FDIC-assisted acquisitions, we record a receivable from the FDIC based on expected future loss share payments, and we record a clawback payable to the FDIC based on estimated sums we expect to owe the FDIC at the end of the loss share periods.

The FDIC loss share receivable and the related clawback payable are discounted to net present value utilizing a 5% per annum discount rate. The discount rate amounts are then accreted into income over the relevant time periods, and in the quarter just ended the resulting net accretion was $2.86 million, down just slightly from $2.92 million in the immediately preceding quarter.

This accretion income will be an ongoing income source 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.

In addition, non-interest income in the quarter just ended included other loss share income of $2.98 million. This line item includes certain miscellaneous debits and credits related to accounting for loss share assets, but it consists primarily of income recognized when we collect more money from covered loans than we expected that we would collect. We refer to these additional sums collected as recovery income. Since we tend to be conservative in the way we value covered assets, which is certainly appropriate given the uncertainty surrounding many of those assets, it is likely that this other loss share income will continue to be a recurring income item and potentially meaningful income item as it has been in recent quarters. Because it can be significantly impacted by prepayments on covered loans, other loss share income will tend to vary from quarter to quarter.

We believe that our accounting, including valuations for covered assets, in connection with all seven of our acquisitions, has been appropriately conservative. You can see our conservative philosophy in four line items of our income statement.

First, the 8.56% effective yield on covered loans in the quarter just ended reflects the substantial discount rates we utilize to determine the net present value of covered loans.

Second, the significant net accretion income on our FDIC loss share receivable reflects the 5% discount rate we utilize to discount those assets to net present value. Some banks are using discount rates as low as 2%.

Third, our other loss share income, mostly recovery income, as we have previously discussed, reflects the fact that our lending and special assets personnel have done a good job maximizing recoveries on some covered loans.

Fourth, our gains on sales of other assets for the reasons specifically discussed reflect the conservative accounting for covered OREO and the effective work of our staff in selling these assets.

The profitability metrics of our three FDIC-assisted acquisitions this year suggests that very favorable acquisition opportunities still exist and can be made using our approach, which involves actively looking at a number of opportunities while being very conservative in our underwriting and our bidding. We have been the winning bidder in approximately one out of every 10 opportunities on which we have bid, and we have only pursued transactions on which we thought we could make profits on both the acquisition and the ongoing operation of the acquired assets. We believe we will continue to see many opportunities for FDIC-assisted acquisitions.

Now let's turn to non-interest expense, which increased 34.9% in the quarter just ended compared to the third quarter of 2010. Our third-quarter non-interest expense included conversion cost of $1.2 million and write-downs of other real estate owned at $1.4 million. While our non-interest expense has increased significantly from the 2010 levels, we are pleased to have achieved a $3.4 million reduction in non-interest expense from the second quarter to the third quarter of this year. This quarter-to-quarter reduction is primarily due to a $3.4 million reduction in the amount of write-downs of other real estate owned. Each quarter, we review the carrying value of every OREO asset and we adjust those values downward as necessary to reflect reappraisals, reduced listing prices or deterioration in market conditions.

In addition, we have been systematically and aggressively writing down the carrying values of assets we think will have extended holding periods. In many cases, these write-downs have reduced carrying values to well below appraised values. Our philosophy is, if we expect to sell it over an extended period, we want to be carrying it at an extremely conservative valuation.

As a result of the previous write-downs, we believe that our third-quarter OREO write-down expense of $1.4 million is a much better indicator of future OREO write-down expense than the $4.8 million incurred in the second quarter of this year. Excluding any increased non-interest expense resulting from additional acquisitions, we are targeting further reductions in non-interest expense in coming quarters from the level of the quarter just ended. Until we make another acquisition, we should have no more conversion cost, so in projecting a run rate for non-interest expense absent another FDIC-assisted acquisition, you can eliminate the $1.2 million conversion cost from the third-quarter non-interest expense.

In addition, we are closing two offices in Georgia at the end of October, and we have recently taken actions to improve the efficiency at our acquired offices.

One of our long-standing and key goals is to maintain good asset quality. Economic conditions have made our traditional strong focus on critical even more important. The increase in our ratios of non-performing loans and leases as a percent of total loans and leases and non-performing assets as a percent of total assets at September 30, 2011 as compared to June 30, 2011 was due to a single $10.5 million loan in Texas which is secured by land and an additional $1.8 million in cash collateral. There have reportedly been several offers for the land at prices in excess of our loan amount. Our loan has matured, and we have outlined to our borrower terms on which we would extend the loan. Our borrower is unhappy with those terms and has resorted to litigation and a bankruptcy filing to try to get more favorable terms. We expect to work through this matter without a loss, so we are not significantly concerned about the increase in those two ratios.

Excluding this one loan, our full-year of non-performing loans and leases and non-performing assets declined from June 30 to September 30 of this year. You can see evidence of the improving asset quality trend in our third-quarter net charge-offs and net charge-off ratio, both of which are the best we've seen in many quarters -- in the case of the net charge-offs, the best ratio in 12 quarters, and the same for the net charge-off ratio. And also, our 30-day past-due ratio was the best 30-day past-due ratio that we have had in five quarters.

Our asset quality has improved over the first three quarters of this year, as had been expected and consistent with the specific guidance that we gave in our previous conference calls this year.

Before we close today, we want to offer a few comments about the recent growth in our capital account, which has increased significantly through retained earnings in recent years. Specifically, our book value per common share increased 128% over the last 4.75 years, from $5.21 per share split-adjusted at December 31, 2006, to $11.87 per share at September 30, 2011. Essentially, all of this growth is through retained earnings. This would be a noteworthy accomplishment in normal times, but is particularly gratifying considering that we have been through the most severe economic downturn since the Great Depression.

Our common stockholders' equity to total assets ratio at the most recent quarter end was 10.35% even after making seven acquisitions in the last seven quarters.

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 in our legacy loan and lease portfolio, which we saw signs of in the quarter just ended. Our third opportunity will likely come whenever interest rates increase significantly and when we consider it timely to reload our investment securities portfolio.

The fourth opportunity we see for capital deployment relates to traditional M&A activity, an area in which we have not traditionally focused but which may provide significant favorable opportunities for us in the future.

In closing, let me state that our goal for the fourth quarter of 2011 -- and we believe it is a reasonable goal -- is to achieve net income exclusive of any bargain purchase gains and related costs from acquisitions in excess of $15.5 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 could result in significant bargain purchase gains and even higher quarterly net income results.

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

(Operator instructions) David Bishop, Stifel Nicolaus.

Is there any way to frame the good organic loan growth you saw coming from this quarter, maybe provide some color in terms of what regions, what loan segments there? And sort of a second follow-up question there -- obviously, commercial real estate is -- there is a lot of (inaudible) there in terms of that market segment there. But are you seeing good looks from some of the competitors out there who might have a concentration are starting to throw off some decent credit your way just because they don't have the capability and the capital to service those types of credits?

Well, we've originated a lot of loans for several years now that have come from competitors who had capital challenges or concentration of credit challenges, and we have seen a lot of opportunities to originate loans for customers that have been able to buy assets from those weakened competitors or acquire loans at a discount from those weakened competitors.

So, yes; that has been a source of loan growth for us in the quarter just ended, as it has been for the quarters over the last three years. So we are continuing to benefit from good take-away business. We are also continuing to benefit from some good growth opportunities for new business. Our growth in the quarter just ended was very much a combination of new business, new projects, new originations and take-away business.

I think the other sort of area you were addressing with your question is -- what does all that look like going forward? And we've got an excellent pipeline now. We are already in positive growth territory for the current quarter, although it's early in the quarter. We've got an excellent closing pipeline and an excellent underwriting pipeline going forward into Q4.

We devoted a substantial amount of time and attention in the month of May to really visiting with all of our legacy lenders and developing strategies for our legacy markets where we could generate positive loan growth in a very careful and strategically focused manner. Those efforts that were started and really push to a much higher level in May of this year bore fruit for us in Q2 -- or Q3. I think that Q3 momentum continues into Q4 and beyond at an accelerated rate.

So I'm hopeful we will have at least as much loan growth in Q4 as we did in Q3.

We talked about this at length in the last call, you know. I don't know when the last loss share of bank opportunity is. I believe that will be more likely 2013 or so than sooner. But we realize that if we were going to continue to have a strong positive quarterly earnings stream in a post-FDIC acquisition environment, we had to get good momentum in legacy loan growth growing now so that we could keep building on that momentum quarter to quarter and year to year going forward.

And that's the premise behind our guidance for $20 million of loan growth a month on average next year, $30 million in 2013 on average, $40 million a month on average in 2014. And I think we are on a good track to do that.

Great. And then one final question in the last part of the preamble about excess. What is your view in terms of the dollar amount, I guess, of excess capital to deploy? Are you sort of managing to set Tier 1 common, tangible common equity there? Just curious in terms of how you are framing maybe how much capital there is to deploy via acquisition or loan growth.

Well, I think we've got room to, in making acquisitions -- Greg, probably 2.5, something like that?

Yes.

Yes.

: Net of shrinkage, yes.

Yes, $2.5 billion of acquisitions net of shrinkage. So we probably -- honestly, we probably -- looking at how we historically have managed these acquired assets and shrunk them down and focused on what we wanted to keep and so forth, my guess is we've got more capital than we probably will need to make acquisitions. Because, even if we made a $1.5 billion acquisition or something, that would shrink fairly quickly and we would get to use that capital again. And hopefully, we wouldn't make an acquisition that's not going to generate gains, and those gains would further support capital formation.

So I think we've got the capital that we need which, coupled with the growth in earnings and retained earnings that we expect, will allow us to accomplish all of our goals for FDIC-assisted acquisitions over the next several years, plus our goals for organic growth. If we grew to the point that we needed more capital, that would probably be such a positive scenario, no one would be disappointed about that. But I don't think we're going to outgrow our capital, given the substantial amounts we've accumulated.

Great, thanks, George.

Andy Stapp, B. Riley & Company.

Congratulations on a nice quarter.

Thank you, Andy.

I noticed that, as you mentioned, loans were up on an end-of-period basis. But on an average loan basis, they were down a tad. Was that just a matter of your work you have done and to set yourself up for loan growth started to really kick in towards the end of the quarter?

Absolutely, it is. The last two weeks of the quarter accounted for significant closings, and all the growth came in the last two weeks of the quarter.

Okay. And how does your confidence level with regard to doing more FDIC deals compare to this time last quarter?

It's lower than it was last quarter because I'm three months further down the road and haven't made one. And I say that sort of facetiously, you know. We have said from the beginning that we thought that we would miss a lot of these and that our initial guidance before we ever got one is that we would average about 1 out of 10. And that is pretty much where we stand today; we're getting about 1 out of 10 we bid on.

So, honestly, my views on that have not changed one iota since last quarter. My comment -- you miss 10 in a row or 15 in a row, and you think -- you can either look at that two ways and say I'm due, or, gosh, I'm never going to get another one.

But I don't really think anything has changed. Our bidding philosophy has not changed. We got two on one day at the end of April, and statistically you wouldn't expect to get two on a single day the way we bid. And these things tend to be just sort of random in the way they occur. So I'm about as optimistic, honestly, as I was last quarter or have been at any point in time about our ability to do more transactions.

Okay. And when did the Park Avenue and First Choice conversions take place?

First Choice converted in mid-August and Park Avenue converted in the first half of September, mid-September, I guess, so both of them -- August-September.

Okay, all right, thank you, I'll hop back into the queue.

Matt Olney, Stephens.

I want to go back to the organic loan growth -- good to see that return again in Q3. Previously you have talked about the competition from bigger banks that was the problem. So was that competition not there in Q3, or did you guys just get more aggressive on pricing yourselves?

Well, we probably got a little more aggressive on pricing on transactions that we thought were really, really high-value relationships and high-value targets. And I think the competition from the big banks subsided a bit. As you know, probably, there were a couple of commercial pools that got put together and sold by the big banks early in the year, and I think maybe one late last year. And my understanding is that some of the banks have -- some of the big banks had originated a lot of stuff with the idea that they were going to come to market with another syndication, another CMBS deal, and that they now are stuck with a lot of that on their balance sheets because they were unable to get deals done and marketed on the terms they thought.

So it appears to us that some of the big tank guys that were sopping up some of the most attractive credits at extremely low long-term fixed rates and trying to put them in a CMBS product are gummed up a little bit. And that is typically the way that happens. The guys get a few deals off and they get irrationally exuberant about it and put a bunch of stuff on their books and then get stuck with it.

So I think those guys are sidelined a little bit. That helped us on probably one or two transactions this quarter. And I think our getting a little more aggressive helped us, too. We sort of looked at it, and our view is that our investors are going to be better served with us having $300 million of growth between now and the end of next year and a 5.70 or so margin than us having zero growth and a 5.90 margin. So we are willing to give up 10-20 basis points of margin to get some really meaningful growth if that's what it takes to do it, as long as we are focusing on high-quality business.

And what about in terms of geography of these new loans? Are they indicative of your current footprint, or are they more weighted towards your Texas market?

The growth in the last quarter and, really, what we've got in the pipeline for the current quarter not surprisingly reflects the three metropolitan markets that we are in, in our legacy portfolio -- Texas/Little Rock, Dallas/Little Rock and Charlotte. Those -- our offices in those three metropolitan markets are actually originating the vast majority of our growth. With the economy the way it is, our more rural offices just do not seem to be seeing a lot of growth business. That will come back in time, but it's not there now. But Dallas, Little Rock, Charlotte, probably in that order, will be the keys to our growth for the remainder of this year and next year.

Now, actually in the current quarter, you could flip that. The quarter just ended, the third quarter, you could flip that. And Little Rock actually, I think, originated more than our Dallas guys did in Q3. Charlotte was third. But I think that will flip back around in Q4 and next year with Dallas, Little Rock and Charlotte being the one, two and three producers for us.

All right, thanks, George.

Kevin Reynolds, Wunderlich Securities.

Great quarter. I wanted to ask a little on -- you mentioned a potential for open bank M&A down the line providing some opportunities. I was just curious; we have focused a lot on FDIC-assisted deals here recently. But what do you think the nature of open bank M&A might look like down the line? Are there going to be strong banks that might be good strategic fits? Are there going to be trouble banks with board fatigue that might recognize that it's time to partner up with someone like you that's stronger? What type of target might that be?

And then, have you -- has there been any, as far as you can tell right now, any movement in terms of bid-ask spread between buyers and sellers question? Are sellers starting to finally recognize that probably the days of ridiculously high prices are probably not coming back?

Kevin, I'm not the best person to answer most of those questions about the broader market because we've been focusing virtually all of our attentions in the acquisition arena right now on the FDIC-assisted transactions. So we have not spent enough time noodling around with the market for live bank deals to really give you a lot of color on what is happening out there.

But I think there are several ways that this could play out well for us in the future. I think the regulatory environment, the economic environment that we expect our industry is going to be operating in for a number of years is likely to create a high fatigue level, to use one of your phrases there, a lot of fatigue among some bankers. And I think there will be some opportunities that will present themselves to us because of that. And hopefully, as a well informed and thoughtful seller looks at the universal potential buyers, they will look at the long-term track record of our Company and say, gosh, even if these guys don't give me a better price than the other guys, that's the stock I want to own long-term. And our track record, I think, would make us an attractive acquirer from that point of view.

What I would see us looking at primarily would be acquisitions that would be nice adjuncts or fill-ins to our existing franchises. We are getting spread out over a lot of geography. That doesn't bother me or concern me at all; I'm very comfortable with where we are going with our acquired offices and our legacy offices and how that is all developing and moving forward. But if we don't fill in some of the blanks between offices and connect things as much as we would like to in an optimal scenario, then certainly it would be profitable to us to look at some opportunities if we can make them at the right price to do some fill-in in the future with a live bank M&A situation.

So we will just see how that plays out. But we will be very opportunistic. We would expect to do stuff predominantly that's either overlapping or provides a nice augmentation and expansion of our existing franchise that sort of connects some of the dots, perhaps.

Okay, thanks a lot.

Jennifer Demba, SunTrust Robinson Humphrey.

Your net charge-off levels came down quite a bit from second quarter. Just wondering if you think that's sustainable, or are we looking for more lumpy trends?

I would say that -- my expectation is that the trend is downward over time, but in a saw tooth pattern. I don't think it's a straight line down. Probably the Q3 level of charge-offs was pretty benign. I would guess that what we would see going forward would sort of be somewhere for the next several quarters, maybe through next year, would be somewhere around the Q3 level as being the bottom of the range. There may be a little more downside there in a particular quarter or so. But probably an absolute minimum in a quarter would be $1 million a quarter over the next, say, five quarters, and the top end of the range would kind of be where we were in Q1 or Q2 of this year. So I think we are going to be somewhere between, mostly, typically, between the $1.5 million and $3.5 million range on a he quarter-to-quarter basis would be my guess.

We've got a sort of a lumpy portfolio, so these results tend to be a little lumpy from time to time as a result of that.

Okay. I know you had some conversion costs in the third quarter, but your occupancy expenses went up quite a bit sequentially. Is the third quarter level a good run rate going forward, or was there something unusual in there?

Jennifer, I don't -- Greg, do you want to try to --

Yes, Jennifer, I think that's a pretty good run rate for going forward. We had the addition of the Park Avenue and the First Choice branches during the second quarter. So we only had those for a couple of months during the second quarter. We've had those for a full quarter now. Obviously, from the utility side of -- the occupancy expense is a little higher in the summer months with the heat here in the South. But I think the third quarter is a pretty good run rate for what we would expect going forward.

On occupancy expenses, yes.

Yes.

And we did mention in the prepared remarks that there was $1.2 million of conversion cost in there. And of course, until we make another acquisition or if we make another acquisition, however I'm supposed to say that correctly, that number won't repeat until we have another acquisition and more conversion costs. So you can take that out. We are closing a couple of offices, and with the systems conversions completed on the last two acquisitions, some of the retail operating back-office staff that operated those systems are gone now. So we are actually trying to sort of get the acquired banks in a little more efficient mode going forward. And we addressed a lot of that toward the end of the third quarter that will help us a little bit in Q4.

Okay, thank you very much, nice quarter.

Michael Rose, Raymond James.

Just to follow up on Jennifer's question about the expenses -- I think in your prepared remarks, you mentioned that you are implementing some ways to cut costs. A, what is the lowest-hanging fruit? Is it the FDIC-assisted deals? And, B, what are the other areas in which you are looking or where you can cut loss? Thanks?

Yes, and I don't want to make that -- I don't want to hit the ball too hard on the cost-cutting deal. As I mentioned in response to Jennifer's question, the staff reductions that we've got going and really the ones that I think are realistic is to -- the staff reductions that have already been made, eliminating the back-office operating staffs at First Choice and Park Avenue facilities where those systems, we're now consolidated. And we did elect to keep all of the loan ops staff at Park Avenue because there was such a talented group of folks, and we came up with a very good scheme for how to use that loan op staff creating a southeast regional loan op center for us at Park Avenue. So we've already done that and kept those folks. But the folks who were running the core processing system; they are now gone post-conversion, as you would expect, and as they expected.

And those cost saves will be evident in our Q4 numbers. They are not a huge number, but they will help a bit. And then eliminating the two branches, one out of the First Choice franchise, one out of the Park Avenue franchise. And those were closures that we identified and specifically carved out the right to close those two offices in our bids on those two banks, as an exception to the continuing business continuity requirements of the P&A.

So those were planned reductions and not anything particularly unusual. But they will help lower the borrowing cost a little bit and get rid of some offices that would not have in profitable for us, I don't think, for a long time.

Okay, and then just a secondary question -- I think you mentioned that you had some opportunities to lower deposit funding. Is that more effective of CDs coming up for maturity, or kind of your expectations for continued mix shift, i.e., checking account deposits rolling in?

It's a combination of CDs that are rolling over. We are repricing those at lower rates. Obviously, the low rate environment we are in makes that competitively possible. We have also been able to, over the course of the quarter, particularly late in Q3, cut the cost on some non-CD deposit products, and we are continuing to work hard on the shift in the mix to less CDs, more non-CDs and more non-interest-bearing deposits.

So we've got several things going on there in our funding base that suggests to us that we can get several more basis points out of our cost of funds. And who would have ever imagined five years ago that we would be looking at the cost of funds level we've got and saying we can get some more out of that? It's extraordinary times that we are in, but we certainly think it's prudent to continue to very diligently manage that part of our balance sheet.

All right, thanks a lot, guys, I appreciate it.

Derek Hewett, KBW.

Good morning and good quarter. My first question is, what is the duration of the bond portfolio, given the movement we saw in the balances this quarter?

What we sold this quarter was predominantly some more of those short to medium Ginnie Maes that we had acquired in the Park Avenue acquisition. I mentioned in the last conference call, I think, that we had acquired something in the Park Avenue acquisition, something like $130 million or so. Greg, is that about right?

(multiple speakers) $125 million-$130 million.

And we sold $30 million or $40 million of those late in Q2, and we sold another $40 million or so early in Q3 and got that down to where we wanted to do that. The modified duration of the whole portfolio at September 30 was 6.57 years.

Okay, great, thank you very much. And is there any sort of update on the large OREO property in Dallas?

I've got it under contract for sale again -- or I say I do; our guys that are managing that asset do. And that transaction, if it closes, would close on -- is scheduled to close on March 15 next year. The contract is slightly more than we've got the asset on the books for, so we book a very modest gain on it if we get it closed. But as you know, we have had that under contract several times previously and have been unable to get it closed. So I'm not going to jump up and down -- having it under contract doesn't excite me as much as it used to. I now say let's get it closed and then I'll celebrate with you. But we do have it under contract and a very reputable buyer that we know very well, and he has certain due diligence outs that would allow him to exit the contract without any penalties if he wanted to do so. But he is a serious and very qualified buyer; we do know that. So that's very positive.

The other thing is, you know, that track has been in -- really, there's a large area of down -- south area of downtown Dallas that would be in the floodplain if the Trinity River levees were not certified as being adequate to protect the city. And they have been going through a recertification process of the levees, and there's been a lot of back and forth between the city and the Corps of Engineers. And it has put a cloud over all that area. And to give you an idea, there's, I think, $8 billion or $9 billion of improved commercial real estate that has kind of an asterisk on it related to floodplain status until they get this levee deal worked out, including a bunch of very high-profile buildings that you would know the buildings.

So that process, between the city and the Corps of Engineers I have been monitoring correspondence and other things recently going back and forth there. And there seems to be good movement, and they seem to be moving toward a resolution that will resolve that and take that question out of the equation, which -- that has certainly been one question that has made it difficult for us to get that property sold.

Great, that's great color. And then my last question is, do you have any longer-term ROA goals? Right now you are at 1.9%, but there is the noise from your successful FDIC deal. So just trying to get a sense of what your expectations are maybe 3 to 4 years out when the FDIC opportunities are -- pretty much have run their course through your balance sheet.

We have not established an ROA goal for four years out. Maybe that's something we ought to address. But our goals historically have been to try to generate return on asset numbers in the 150 or higher range and return on equity numbers in the high teens to low 20s. And that will -- I don't see us having a change in our philosophy about what we think are acceptable return numbers. So I would assume we are going to continue to try to work toward that sort of ROA/ROE numbers indefinitely into the future. Our philosophy hasn't changed about that.

Okay, great, thank you very much.

Andy Stapp, B. Riley & Company.

Any color you could provide on the watch list, how it fared over the quarter?

Actually, I think are classified and watch list in total migrated a bit lower over the course of the quarter. I don't have those numbers in front of me, Andy, but my impression is that they had a positive movement to them.

Okay. And could you also talk about the linked-quarter decline in the yield on covered loans?

That number was 880 in Q2, I believe or -- what am I saying? It's around 880 -- and tends to bounce around a little bit. There are some things that move that number around, so the -- what was it this last quarter?

856.

856. The 856 number was not terribly surprising there. I think we're somewhere in that kind of range. Most likely going forward in the high 8s type range is what I would expect that to continue -- mid-8s, mid -- 850 type of range. And it will bounce around a little bit from quarter to quarter.

That number will be more volatile from quarter to quarter than our legacy loan book yield numbers, just because there are a lot of moving parts and discount payments and various things that move that somewhat, late fees and so forth.

Okay, thank you.

Brian Martin, FIG Partners.

George, just one question -- the new loans you booked at the end of the quarter you mentioned -- can you talk about what the pricing was, how the pricing looked on those relative to what it has in the past, talking about maybe being a little more aggressive, and maybe just where you think -- as you look to be more aggressive over the next 12 to 15 months here, kind of where you see that kind of a floor on your legacy loan yields? I think this quarter they were around 6.154 or somewhere in that range.

Those loans price to -- there were a lot of different loans with a lot of different characteristics and profiles to them in that originated -- pool of originations in the last quarter. So I'm reluctant to get in and say, well, this loan priced at this and that loan priced at that. But I think, as we have already said, we were a little more aggressive for really primo pieces of business that were exceptional pieces of business.

One reason that we felt comfortable being a little more aggressive on that is I had a big payoff in the last quarter which was probably the worst-priced loan I ever priced in my entire 32 years. And I had been living with it for five years and hating myself monthly for it, if not daily, because I just priced it horribly badly. And it was a big deal, and it paid off. And everything we originated in the last quarter was a whole lot better yielding than that. So I think the yields on the loans that we did last quarter were appropriate. They were a little more aggressive than we would historically have been, but we targeted just -- rifle-shot targeted some really primo pieces of business that we wanted to pick off, and we are glad to have that business even if we had to do it a little cheaper than we would historically have done it at.

I don't think it will have a significant effect on our overall margin, as I've already alluded to. Obviously, if you've got a 6.14 yield on your legacy loan portfolio, and the longer we stay in the sort of environment that we are in, it would be reasonable to assume that that portfolio will give a little ground on yield. We are -- prime is 3.25%, and LIBOR is all down next to nothing and Fed funds rates are down next to nothing.

So if we stay in this sort of low-rate environment and target $300 million or so of growth as we are targeting over the next five quarters, then we will give up a little of our legacy loan book yield in the process of doing that. But as I have already alluded to, I think we've got opportunities to further improve our cost of funds. So our goal is to not give up much, if any, in the net interest margin arena to achieve the $300 million or so of growth we want to achieve over the next five quarters in that loan book.

So that's the challenge we are working on now, is to get the growth and maintain the margin at or as close to current levels as we possibly can.

Okay. How about just -- on the covered OREO sales in the quarter, can you just talk about what you have got in the pipeline, or just how to think about that? I guess it could tend to be a little bit lumpy. But as you look at over the next four to eight quarters, is that something that's going to be somewhere in the range? Or just give any color on that, that component.

The reduction in the covered OREO during the quarter?

Yes, the gains that come from that through the fee income line.

Well, I think that will tend to be very lumpy. But I was pleased; we sold, I think, about $10 million of covered OREO in the quarter, and it may have been more than that. I know we were $8 million and change in July and August, and just knowing about transactions that I knew about specifically, I would guess we probably got to $10 million at least through the end of September, and maybe more.

So we are having good success selling a lot of the stuff. Of course, we moved a lot of stuff from non-performing covered loans into covered OREO. So you didn't see a $10 million reduction in the quarter-to-quarter balance of that. But we are working through that stuff pretty expeditiously. I've actually been real pleased with the way our guys are moving those assets.

And we had gains on not every one of them but, I would say, 90%-95% of the covered OREO sales generated gains, and that's largely due to two things. Number one, we were pretty conservative in how we value them. And number two, as I explained in detail in the prepared remarks, that net present value discount doesn't get amortized. So you are carrying them at value less the discounts you don't amortize. So they all should generate gains unless you have misestimated your values up front.

So I think it will be lumpy. It's hard to predict what that is going to be quarter to quarter, but I think in the vast preponderance of quarters we will show gains from sales. And in some quarters it will be very substantial numbers, I would guess, just because the way you account for that OREO under gap.

And when you say very substantial, would you consider this quarter's level in that very substantial category?

Yes.

Okay. And then maybe two other questions, maybe one of them I missed. Just the loan growth this quarter -- can you just talk about by segment what that was mostly made up of, as far as construction or commercial real estate?

And secondly, just talking about the FDIC deals, can you just talk about or maybe just give a little color on how many deals you guys actually bid on this quarter relative to -- not seeing any, but did you bid on a significant number in the quarter?

You know, I don't have it broken down by the quarter. But since the two acquisitions we made at the end of April, we bid on 15, Greg, 18, something like that -- yes, 15 or more, probably at least 15 since then. And we are still actively bidding and we are going to be conservative. We are going to stick to our discipline. Sort of as I said in response to Andy's question, it doesn't surprise me that we have missed 15 in a row. We hit two in one day. It wouldn't surprise me if, on any given Friday, we hit one or two or three. So we are actively bidding and we're just going to stick to our discipline. And I think we will be rewarded for that again multiple times.

In response to your question about loan growth, our residential 1 to 4 portfolio from June 30 to September 30 went up $6 million. Our commercial real estate portfolio went up $29 million. Our construction and land development and lots portfolio went down $26 million. Our multi-family portfolio went up $32 million. And what will probably be a surprising number to you is our C&I portfolio went up $25 million. And our consumer portfolio dropped $9 million.

So there was a lot of movement in the portfolio, and C&I, multi-family and commercial real estate went up, as did residential 1 to 4s, and construction and land development and consumer went down -- were sort of the big swings there. And you guys know that we are not traditionally a big C&I lender, but we did book one really large C&I loan in the third quarter that contributed the majority of that growth. And it is an outstanding credit that has, really -- to a governmental-related entity -- that is higher-quality credit we've got in our portfolio. If I could book a lot of C&I loans like that loan, we would be a big C&I lender.

All right, I appreciate the color, George, thanks very much.

(Operator instructions) Peyton Green, Sterne Agee.

George, congratulations on, again, a very strong quarter. A question for you in terms of the interest rate/risk management side. I know everybody is now pretty convinced that long-term rates are going to stay low forever. But at some point, do you see you all shifting to maybe putting on some long-term borrowings, now that the long end of the curve has come in so much? And you are, I guess, thinking about your legacy or non-covered loan portfolio, your yield on that portfolio versus your total cost of deposits, the spread has widened to about 560 basis points from 540 basis points a year ago. And I guess just from an outcome perspective, how are you compared to where you were a quarter ago? Are you seeing more variable-rate, more fixed-rate? And what kind of term on the fixed-rate loans are you committing to?

Well, that's a great question and a lot of questions, really. We are slightly more variable rate in the loan portfolio now than we were a quarter ago. I think that number is up about -- a little over 2%. At the end of the June quarter, 54.6% of our loan portfolio was variable. That number is 56.7%, so the preponderance of our new originations were obviously variable rate loans. And we are seeing pressure from some customers to do fixed-rate loans. We are keeping those, typically, as short as we can and we are not going out on longer-term fixed-rate loans terribly far, almost nothing beyond five years. And we are only going there where we feel like we are getting adequately paid for the interest rate risk.

Our philosophy is that we are in an environment where everybody thinks rates are going to stay low forever, which we -- when everybody thinks something, I tend to get really nervous about the conclusion that that total absolute mass of humanity is coming up with and tend to think, gosh, if everybody is thinking it, it's got to be wrong at some point and badly wrong. So we think that there are a lot of fundamental issues with the US economy that suggest we could have a lot of rate volatility and much higher rates at some point down the road. Just -- it's hard to imagine that we can maintain the hyper-accommodative monetary policies we are maintaining and have our dollar in the fragile position it's in and not have that work out to a situation where we have much higher rates at some point down in the future.

So we're trying to, A, make a great profit in this very low rate environment; and, B, keep ourselves protected in case this thing unwinds rapidly into a different rate scenario two years, 18 months, 30 months down the road. We are being very -- we're spending a lot of time running our simulation models and trying to keep ourselves protected on the interest rate risk side, which was one of the reasons we got that bond portfolio ratcheted down to about as small as we can get it and still run the size balance sheet we have today. We don't want a lot of exposure out there.

Okay, great. And then just another question -- on the reinvestment in the FDIC-assisted banks that you acquired, in terms of getting them up to Ozark levels -- when do you see the cost of doing that maybe stepping up a notch compared to really getting them rationalized down to the lowest common denominator after the conversions and into a growth position? I know they are in pretty damaged markets, but there should be an opportunity for being a clean bank in a damaged market. I'm just curious if you could comment on that.

Well, and yes, there is the opportunity. And we are already generating some growth at these markets. It has been fairly modest volumes so far. But I would say every quarter it's not going to be, gosh, we are in cleanup mode and then you shift out of reverse and you put it into drive, and all of a sudden you're going forward in these markets. It's going to be a very subtle shift as the cleanup modes get less and less and less every quarter and the offensive momentum should get more and more and more every quarter. And it's just a very gradual shift from one to the other, and we are in the process of making that shift.

And I would tell you that I think we were more offensive-minded in our new markets in Q3 than we were in Q2. I would think we will be more offensive-minded in Q4 than we were in Q3. Your observation is very on point, that a lot of these banks, most of them, are in very damaged markets. So there's just not a ton of room to be safely offensive out there. But we are working to try to create those opportunities. And again, I used the term earlier rifle-shot targeted approach. We are approaching and soliciting business on a rifle-shot basis from customers that we think are high-value, high-quality, very strategic customers in those markets. And there's some business to be gained that way.

Okay, great, thank you, George.

David Bishop, Stifel Nicolaus.

George, just a follow up in terms of the fee income initiative you have implemented to sort of buck the trend that probably would have been expected. Can you give maybe a little bit more color in terms of what sort of pricing changes you made, what sort of product rollouts you reemphasized there in terms of augmenting that growth? And can you expect that acceleration to continue?

The guys to do that for us, Tyler Vance, Susan Blair, the folks who worked on that project for us -- they exceeded my expectations. And I'm not one that is noted for having low expectations. And they tweaked several prices on different products and services. They went out and looked particularly in our acquired banks at services that we offer in our legacy bank that are fee-generating services that were not offered in some or all of the acquired banks, and put a full-court press on doing that and, of course, just continued to focus on getting more core customers in.

And I didn't -- I'll tell you, everybody is probably surprised that we reported record Q3 service charge income. I was surprised we reported record Q3 service charge income. The challenge that they were given many, many months ago was find ways to offset this revenue loss that will come from the new regulations. And I didn't think they could totally close the gap, but they -- to my surprise, to their credit -- did so. And I'm very proud of them for doing it.

I would rather not get into a discussion of specific pricing changes and specific product changes. I think the overall results speak for themselves and address the issues that need to be addressed.

Great, thanks, George.

Derek Hewett, KBW.

A quick question -- do you guys have -- did you guys see any material change in your TDRs for this quarter, given the change in accounting guidance?

No. And all of our TDRs are in non-accrual status. We don't break them out separately; we just stick them all in non-accrual. And as you could see, apart from the one $10.5 million loan that is well secured, I think there's no loss in that, which increased our non-accrual numbers. Non-accruals apart from that went down nicely. So no, no change there.

Okay. And what was your TDR balance for this quarter?

I don't have that number. It's all in the non-accrual number, though.

Okay, all right, great, thank you very much.

And it appears we have no further questions at this time. I would like to turn the conference back over to our speakers.

Thanks very much for joining the call today. Since there are no further questions, we will look forward to talking with you in about 90 days. That concludes our call. Thanks very much.

Thank you. Again, that does conclude today's conference. We thank you all for joining us.