Bank Ozk (OZK) 2014 Q1 法說會逐字稿

Good day and welcome to the Bank of the Ozarks Incorporated first-quarter earnings release conference call. Today's conference is being recorded. At this time I would like to turn the conference over to Susan Blair. Please go ahead.

Good morning, I am 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 quarter just ended and our outlook for upcoming quarters. Our goal is to make this call as useful as possible in understanding our recent operating results and outlook for the future.

To that end, we may make certain forward-looking statements about our plans, goals, expectations, thoughts, beliefs, estimates, and outlook including statements about economics, real estate market, competitive, credit market, and interest rate conditions, revenue growth, net income and earnings per share, net interest margin; net interest income; noninterest income including service charge income; mortgage lending income; trust income; net FDIC loss share accretion income; other income from loss share and purchased noncovered loans; and gains on sales of foreclosed assets, including foreclosed assets covered by FDIC loss share agreements, non-interest expense; our efficiency ratio; asset quality in our various asset quality ratios; our expectations for net charge-offs in our net charge-off ratios; our allowance for loan and lease losses; loans, lease, and deposit growth including growth in our legacy loan and lease portfolio through 2014; growth from unfunded closed loans; and growth in earning assets in 2014, 2015, and beyond; changes in expected cash flows of our covered loan portfolio; changes in the value and volume of our securities portfolio; conversion of our core banking software; the opening, relocating and closing of banking offices; our expectations regarding recent and pending mergers and acquisitions; and our goals for traditional mergers and acquisitions in the future; changes in growth in our staff, including our plans to build our corporate loan specialties group team and add new lease originators; other opportunities to profitably deploy capital; and our goal of improving on our 2013 earnings in 2014.

You should understand that our actual results may differ materially from those projected in these 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 risk of certain risks associated with our business, you should also refer to the forward-looking information caption of our periodic public report, 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 statement 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. Any references to non-GAAP financial measures are meant to provide meaningful insight and art reconciled with GAAP in our earnings press release.

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 are very pleased to report our excellent first-quarter results. Before we get into our usual details, we want to make a couple of general observations.

First, in our January conference call, we reminded our listeners that in most years the first quarter is a seasonally challenging quarter and we pointed out that we expected those seasonal challenges to be amplified in this year's first quarter, due to the number of staff additions associated with the expansion of our origination teams in real estate specialties group, community banking, and leasing as well as the addition of our corporate loan specialties group.

You can see the effect of those staff additions in our first-quarter non-interest expense, but you can also see some early signs of the benefit of these staff additions in our first-quarter growth in loans and leases.

Second, our results for the first quarter of 2014 include three significant unusual items. Because of the very good work done by both sides in our Bancshares and OMNIBANK acquisition in Texas, we ended up with a better-than-expected tax-exempt bargain purchase gain of $4.7 million on the closing of that transaction.

Offsetting that to some degree were after-tax acquisition-related expenses of approximately $0.4 million.

Finally, on the last day of the first quarter, we signed our contract with our new core software provider and issued contract termination letters to our existing core software providers. We incurred significant charges for early termination of our existing contracts, and these charges reduced our first-quarter earnings by about $3.1 million after taxes.

We expect to implement this new core software in a series of four conversions, starting in August of this year and concluding in the first quarter of 2015.

From an income perspective, these three unusual items had a net positive impact on first-quarter after-tax net income of approximately $1.2 million or $0.03 per diluted share. But far more important than the first-quarter income impact, we view the events generating these first-quarter unusual items as being extremely positive for our Company.

For example, the Bancshares OMNIBANK acquisition not only generated a good day one gain, but enhanced our presence in three of the best banking markets in the country. We are very pleased with our early weeks of operations there and we are already seeing an excellent loan pipeline developing.

Likewise, we expect our new core software to provide a quantum leap in our technology capabilities for many years to come, and once the last of our core systems is converted in the first quarter of 2015, we expect to see a reduction in our core system software cost of approximately $2.75 million annually. How many times can you achieve that outcome, greatly enhanced capabilities in combination with greatly reduced cost?

The six-month process of selecting our new core software was comprehensive and included over 60 team members in evaluating and comparing these three potential solutions. I am confident that this effort, led by Chief Operating Officer Tyler Vance and Chief Information Officer Sean O'Connell, resulted in our selection of the very best software solution for our Company and negotiation of the best terms possible.

The next stage of this process, actually implementing systems conversion, has already begun and is being pursued with the same structure, discipline, and comprehensive planning used in our software selection process and our contract negotiation process.

Let's get to our first-quarter results. Net interest income is traditionally our largest source of revenue and is a function of both the volume of average earning assets and net interest margin. Of course, loans and leases comprise the majority of our earnings assets.

In the quarter just ended, our loans and leases, excluding covered loans and purchased noncovered loans, grew $146 million. In our January conference call earlier this year, we introduced updated guidance that we expected loan and lease growth excluding covered loans and purchased noncovered loans of a minimum of $600 million in 2014.

Traditionally, our first quarter has been our most challenging quarter for loan and lease growth. So our strong first-quarter growth compels us to reiterate our earlier 2014 loan and lease growth guidance and emphasized that such guidance was, for a minimum, of $600 million in 2014.

Our unfunded balance of closed loans increased another $206 million during the first quarter and now totals $1.42 billion. While some portion of this unfunded balance will not ultimately be advanced, we expect that the vast majority will be advanced. This has favorable implications for future growth in loans and leases outstanding.

We are very pleased with the growth in both our funded and unfunded balances of loans and leases during the quarter just ended. But, frankly, we are even more pleased with the credit and interest rate profile of the loans and leases we booked. We have been operating in an intensely competitive environment for some time -- an environment in which some competitors have been, in our judgment, taking on excessive credit risks and excessive interest rate risk to generate volume.

In contrast, we believe our lending teams have been maintaining sound credit and pricing discipline.

During the quarter just ended, we obtained large amounts of cash equity and most new loans continued to require appropriate risk-adjusted pricing and actually increased our percentage of variable-rate loans, excluding covered loans and purchased noncovered loans to 64.5% of total loans and leases, again excluding covered loans and purchased noncovered loans from 62.7% at year-end 2013.

It takes hard work and great discipline to achieve loan and lease growth while adhering to stringent credit and interest rate risk standards. Well, we believe that discipline will distinguish us in a very positive way in the future from banks which have disregarded conservative credit and interest rate risk standards in order to achieve growth.

In regard to net interest margin our first-quarter net interest margin on a fully taxable equivalent basis was 5.46%, which is a 17 basis point decrease from our net interest margin for the full year of 2013. In our conference call earlier this year, we provided guidance that we expected our 2014 net interest margin will decline, but that the year-over-year decline from 2013 to 2014 will be less than the 28 basis points decline in net interest margin from 2012 to 2013.

Included in this guidance is the expectation that our cost of interest-bearing deposits will increase slightly in coming quarters as we continue to accelerate deposit-gathering activities to fund expected future loan and lease programs.

We also noted that such guidance did not take into account the effect of the then-pending or any future acquisitions. There are a number of variables that can and will affect our net interest margin in coming quarters.

For example, our earlier margin guidance was predicated upon us achieving only our minimum $600 million in loan and lease growth, excluding covered loans and purchased noncovered loans. If loan and lease growth exceeds that minimum, our net interest margin could decline somewhat further from that projected in our recent guidance.

The vast majority of our first-quarter loan and lease growth occurred in the last few weeks of the quarter, so this growth contributed very little to first-quarter net interest income. Because of the late quarter timing of most of our first quarter loan and lease growth, the decline in our net interest margin from last year's fourth quarter to this year's first quarter and the two fewer days in the first quarter compared to the fourth quarter, net interest income actually decreased 5.2% from the fourth quarter of 2014 -- 2013, excuse me -- to the first quarter just ended. We expect to be back on a record quarterly net interest income pace in the second quarter.

In recent years, we have demonstrated an ability to grow loans in a slow growth economy. While doing this, we have constantly strived to enhance our future capabilities to produce increasing volumes of good quality, good yield earning assets. As a result, we are strategically positioned for even stronger growth in earning assets in the years to come.

In our most recent conference call in January, I discussed briefly our five engines for growth in earning assets apart from acquisition. Currently, the strongest of these five organic growth engines is Real Estate Specialties Group, which has contributed the majority of our organic growth in recent years and did so again in the quarter just ended. This unit is well known from our numerous discussions and previous conference calls and public presentations.

The growth capabilities of Real Estate Specialties Group have expanded in recent years with the continued growth and development of our team in Dallas and the opening of additional Real Estate Specialties Group offices in Austin in January 2012, Atlanta in July 2012, New York City in July 2013, and the long planned opening of a Houston office in early January this year, and the opening of a Los Angeles office in February of this year.

We believe Real Estate Specialties Group will continue to be our strongest engine for organic growth in earning assets for years to come.

In our January call, we stated our belief that our other organic growth engines will contribute more to growth in earning assets in 2014 in future years than they have in recent years. Our second most important engine for organic growth in earning assets is our vast network of community banking offices in seven states. Our community banking offices have delivered only modest earning asset growth in recent years. In many of our markets, we have faced intense competition from competitors offering long-term fixed low rate loans often on very aggressive credit terms.

With the recent uptick in rates and the beginning of Fed tapering, some of these competitors should be rethinking their long-term fixed low rate strategies. Similarly, a number of our community banking offices are from our seven FDIC-assisted acquisitions and only recently have we begun to see meaningful increases in new loan opportunities in these markets.

Accordingly, we believe that our community banking offices will be a much more meaningful growth engine in 2014 and beyond. To capitalize on this opportunity, earlier this year we promoted Matt Reddin to Director of Community Bank Lending and John Carter to Deputy Director of Community Bank Lending. These individuals are our offensive coordinators, providing additional leadership and maximizing good quality loan growth opportunities through our community banking offices.

Our third growth engine for organic growth in earning assets is our leasing division. Our leasing division is operated as a small but consistently high-performing and important part of our Company since 2003. Scott Hastings founded that division for us and continues to lead it. Prior to joining our Company, Scott ran an $800 million lease portfolio for a major national company.

We believe 2014 is the year to make leasing a more important part of our balance sheet. We think we can grow leasing from its current $93 million in outstanding balances to several times its current size over the next five years. That magnitude of growth will depend on a variety of factors, including economic and competitive conditions and, most importantly, our ability to hire quality originators.

A 25% compounded growth rate would triple our lease portfolio site in five years and a 35% compounded annual growth rate would increase that portfolio to about 4 1/2 times its current size in five years.

As evidenced by our very low loss rates on leases during the downturn, we have been very conservative with our credit underwriting for this portfolio and we expect to continue to be conservative. Our growth is expected to come by adding originators and expanding our customer base and not as a result of changes in our credit or pricing standards.

Our fourth and newest engine for organic growth is a new part of the Company. For some time we have been searching for a leader around whom to build a non-real estate lending team equivalent to our Real Estate Specialties Group. As a result of this search, Manish Raj joined our Company earlier this year as President of our newly created Corporate Loan Specialties Group based in Frisco, Texas.

While this unit will focus on non-real estate lending, its business strategy is very similar to the business strategy we have utilized with great success in our Real Estate Specialties Group for the past 11 years. Corporate Loan Specialties Group will pursue complex transactions in which our modeling, structuring and execution capabilities, combined with a deep expertise of the team we will build, should allow us to achieve very favorable returns while adhering to conservative credit standards. Much like Real Estate Specialties Group we expect Corporate Loan Specialties Group to start slowly and build over time in a very careful and methodical way.

Our fifth engine for organic growth in earning assets is our investment portfolio. And as we said many times in recent years we have been very defensive in managing our investment portfolio and we have maintained its size near the minimum level needed to effectively manage our balance sheet.

We have said repeatedly that we expect to significantly increase the size of our investment portfolio at a time when interest rate conditions and market conditions make it advantageous to do so. We continue to think that we may be one to three years away from an advantageous opportunity to significantly grow that portfolio. But we continue to believe that higher interest rates will provide an excellent entry point for portfolio growth at some point in the future.

A great deal of work has gone into building the talent and the infrastructure needed to make all five of our organic growth engines effective. We are very pleased to report that all five of these growth engines made positive contributions to our first-quarter earnings asset growth.

The geographic and product diversity of our different growth engines are significant factors in our optimism regarding our ability to achieve increasing levels of growth in earning assets in 2014, 2015, and beyond.

Let's shift to noninterest income. Income from deposit account service charges is traditionally our largest source of non-interest income. Service charge income for the quarter just ended decreased 19 -- or, I'm sorry, increased 19.4% compared to the first quarter of 2013, but decreased 6.5% compared to the fourth quarter of 2013.

Our linked quarter results appear to reflect our normal seasonality of this income item. We continued to grow core deposit customers in the quarter just ended adding approximately 1,891 net new checking accounts excluding accounts acquired in our Bancshares OMNIBANK acquisition. You may have also noted a very favorable shift in our deposit mix during the quarter.

Mortgage lending income for the quarter just ended decreased 45.2% compared to the first quarter of 2013 and 1.3% compared to the fourth quarter of 2013. These percentage declines appear to reflect a combination of factors, including the increases in mortgage interest rates over the past year and a normal seasonality of this business.

Trust income for the quarter just ended was a new record level and increased 49% compared to the first quarter of 2013 and 2.1% compared to the fourth quarter of 2013. Our trust business grew substantially with the July 31, 2013 acquisition of the former FNB Shelby and its trust business.

Net gains from sales of other assets were $0.97 million in the quarter just ended compared to $1.97 million in the first quarter of 2013 and $1.80 million in the fourth quarter of 2013. In recent years, such net gains have been a meaningful contributor in every quarter.

In most quarters, these net gains have been primarily attributable to net gains on sales of foreclosed assets covered by loss share agreements. We expect that net gains will continue to be a significant income item for many quarters to come, but by its very nature this category of income will vary quite a bit from quarter to quarter.

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 values and such discounts are accreted into income over the relevant time periods.

In the quarter just ended, the results in net accretion income was $0.69 million, a decrease from $2.39 million in the first quarter of 2013 and $0.9 million in last year's fourth quarter. Of course, this category of income is expected to decrease as we collect and reduce our FDIC loss share receivable.

The decrease in this net accretion income in recent quarters also reflects another phenomenon. As we have more experience with our portfolios of covered loans, and as those portfolios become more seasoned, we are increasingly revising upward the projected cash flows on certain loans where we originally expected an elevated risk of loss, but on longer believe that such loans have an elevated risk of loss. These are loans where principal reductions through amortization on scheduled principal payments, provisions of additional collateral, improvement in the (inaudible) financial condition or other factors have in our view, largely eliminated the elevated risk of loss.

The effect of these upward revisions and projected cash flows is to accrete into interest income over the remaining life of the loan the previous non-accretable difference, and to amortize against accretion income over the remaining life of the loan or the remaining loss share term, whichever is shorter, the related FDIC loss share receivable.

This is one of the reasons for the decline in income from accretion of our FDIC loss share receivable in recent quarters. This has also been the primary factor in the increase in the yield on covered loans from 8.93% in the second quarter of last year to 9.49% in the third quarter, 10.66% in the fourth quarter, and 11.58% in the quarter just ended.

Based on the improving risk file -- profile and greater seasoning of many of our covered loans, we expect to identify additional loans in the current and future quarters for which it will be appropriate to upwardly revise our estimated cash flows. The net effect of this will be positive for net income, since we will have an additional $1.25 of interest income for every $1.00 of reduced non-interest income related to amortization of the FDIC loss share receivable related to these loans.

Of course, if this plays out as expected, and as we discussed in recent conference calls, income from accretion of our FDIC loss share receivable will tend to decline in the current and future quarters with the corresponding increase in yields on covered loans. We have seen that phenomenon at play in recent quarters.

In addition, non-interest income in the quarter just ended included other income from loss share in purchased noncovered loans of $3.31 million compared to $2.16 million in the first quarter of 2013 and $4.83 million in last year's fourth quarter. This line item includes certain miscellaneous debits and credits related to the accounting for loss share and purchased noncovered loans, but it consists primarily of income recognized when we collect more money from covered loans and purchased noncovered loans than we expected we would collect. We refer to these additional sums collected as recovery income.

It is likely this will continue to be a meaningful income item for many quarters to come. Because it can be significantly impacted by loan prepayments, other income from loss share and purchased non-covered loans will vary from quarter to quarter.

Let's turn to non-interest expense. Our efficiency rates show for the first quarter of 2014 increased to 49.8% compared to 46.8% in the first quarter of 2013 and 45.5% in the fourth quarter of 2013. Of course the elevated efficiency ratio for the quarter just ended was significantly impacted by the unusual pretax noninterest expenses in the quarter, specifically $5.0 million in charges for terminating existing core banking software contracts and $0.7 million for acquisition-related costs. Our efficiency ratio in each of the final two quarters of 2013 was approximately 45.5%, reflecting modest progress toward achievement of our longer term goals.

While our efficiency ratio will vary from quarter to quarter, excluding the effects of such unusual items, we expect to see improvement for the full year of 2014, again excluding the effects of unusual items as compared to 2013. This guidance regarding our efficiency ratio does not consider the potential impact of any pending or future acquisitions.

One of our long-standing and key goals is to maintain good asset quality. Economic conditions in recent years have made our traditional strong focus on credit quality even more important. The strength of our credit culture and the depth of our commitment to asset quality are both evident in our key asset quality ratios in the quarter just ended. At March 31, 2014, excluding covered loans and purchased non-covered loans, our nonperforming leases as a percent of total loans and leases increased to 42 basis points compared to 40 basis points at March 31, 2013, and 33 basis points at December 31, 2013.

Similarly excluding covered loans, purchased non-covered loans and foreclosed assets covered by loss share, our nonperforming assets as a percent total assets increased to [57] basis points at March 31, 2014, compared to 50 basis points at last year's third quarter end and 43 basis points at last year's fourth quarter.

Finally, excluding covered loans and purchased non-covered loans, our ratio of loans and leases past due 30 days or more including past-due nonaccrual loans and leases to total loans and leases increased to 75 basis points this quarter, compared to 56 basis points for last year's first quarter and 45 basis points for the fourth quarter of 2013.

We are very pleased to report that our annualized net charge-off ratio for non-covered loans and leases for the first quarter of 2014 decreased to 2 basis points compared to 19 basis points in the first quarter of 2013 and 12 basis points in the fourth quarter of 2013. Our annualized net charge-off ratio for all loans and leases including covered loans for the first quarter of 2014 decreased to 5 basis points compared to 45 basis points in the first quarter of 2013 and 18 basis points in the fourth quarter of 2013.

In recent years we have accumulated a sizable war chest of capital through retained earnings. We believe we will have numerous opportunities over the next several quarters to profitably deploy our accumulated capital. And the most immediate capital deployment opportunity we foresee is organic growth in our loan and lease portfolio. A second opportunity relates to traditional M&A activity in an area which continues to be a significant focus as evidenced by our first-quarter announcement of our definitive agreement to acquire Summit Bancorp and its Summit Bank subsidiary here in Arkansas.

And we continued be active in identifying and analyzing M&A opportunities and expect this to be an important part of our business going forward. We are also optimistic about our prospects for one or more additional [live] bank acquisitions in 2014.

The third opportunity for capital deployment will likely come whenever interest rates increase significantly and we consider it timely to reload our investment securities portfolio.

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

(Operator Instructions). Jennifer Demba, SunTrust Robinson Humphrey.

Good morning. Your provisions in net charge-offs were obviously unusually low this quarter. Do you think that's sustainable over the next few quarters? What are you seeing in general and asset quality trends?

Well, Jennifer, obviously a 2 basis point charge-off ratio on legacy loans is very low and 5 basis points in aggregate is very low. I don't know if that particular number is sustainable, but from where we sit today, I would expect that our charge-off ratio on both metrics for the full year of 2014 would show a noticeable improvement from 2013 even though 2013 was an excellent set of numbers. We are feeling very good about asset quality at this point.

What do you think will occur once Fed funds start to go up in terms of your net charge-off rate? Do you run a lot of sensitivities?

Yes. We stress particularly all of our larger loans and most of our smaller loans that are veritable rate loans, looking at what happens to the debt service coverage on those credits as rates rise 100, 200, 300, 400, and 500 basis points. And the vast majority of loans that we originate still generate positive debt service coverage and an up 500 rate scenario. We have a few that we close and originate that may be a .97 or a .99 and then up 500 basis point scenario. But we get comfortable closing those loans based on the liquidity and financial strength of the guarantors and credit enhancements in those transactions.

So, yes, we are very focused on the fact that we think rates are going to rise substantially in coming years. And we are stress testing the portfolio at an individual loan level basis based on that assumption.

Thank you so much.

Michael Rose, Raymond James.

Good morning. You spent some time, obviously, talking about some of the new initiatives. I wanted to get a sense if you can quantify how much of the new initiatives contributed to the growth this quarter and then to the unfunded balance of closed loans or if that just relates to the Real Estate Specialties Group?

Let me give you some details. Of our loan growth in the quarter, $111 million came from Real Estate Specialties Group. $7 million came from Corporate Loan Specialties Group. $7 million came from leasing. $21 million came from community banking.

The growth in our bond portfolio, we had about $18 million growth in our investment portfolio. $7 million of that was a result of additional bond purchases. And we find occasional bonds that we think have relative good value and make sense.

So we were able to actually buy a few more of those.

The other $11 million just came from a positive swing in the mark-to-market adjustment on that portfolio from year end. So all of -- all five of our growth engines contributed.

As I said, Real Estate Specialties Group was the dominant force there contributing roughly 2/3 of the overall growth in earnings assets. Community banking provided a solid second compared to its results in recent years. And the other guys all put up some positive scores as well.

Now, your question was how much of that is really coming from new hires and, say, our Houston office and our LA office that were new in the quarter and addition of lease originators, very little of it came as a result of staff additions that we made in Q4 and Q1. I think those are going to be significant sources of contributors. But for example, in leasing, most of that $7 million in growth was done by originators we already had on staff earlier and not by the guys that we hired in late December and then subsequently in January and February. Although I think they will be good contributors to future growth, they didn't really get much on the Board in Q1. Corporate One Specialties Group got on the Board with $7 million, but that is a small sum. I think that will increase.

And I think some of the initiatives we have implemented in community banking will lead to more growth in later quarters.

So I think we saw, as I said in my prepared remarks, early signs of the expansion of these origination themes. But I think much more will be evident in future quarters.

Okay. And then as a follow-up, obviously the Bancshares deal closed this quarter. Their margin was quite a bit lower than where yours is today. I wanted to get a sense for how much of the margin decline this quarter could be attributed to them, given the early March closing.

None. None is attributed to them. In fact they were slightly accretive to our margin on a -- based off the valuations we put on those assets on day one in the transaction. So that was accretive about 3 basis points for the quarter and of course we only had about three weeks impact on it.

So, as we spread that over a full quarter's impact, that should help us with net interest margin in Q2 and following.

Okay and then, any update on your most recent acquisition and is that still on track to close this quarter?

Yes, it is on track. We have effectiveness of our registration statement. We have received FDIC and Federal Reserve approval. The state banking board that has to approve the transaction meets April or this Thursday, meets this week, and they are at a meeting that they have called to consider that we expect no problems there. Proxies have been sent out, shareholder voting is coming in on the transaction.

We expect tentatively to close that transaction on May 16, right on the earliest possible timeline we had indicated in our earlier guidance on that. So all that seems to be proceeding very well.

Great. Thanks for taking my questions.

Brian Zabora, KBW.

Good morning. A follow-up question on the loan discussion. Your yield on the originator portfolio was down about 30 basis points in the first quarter compared to fourth. I know in the fourth quarter there were some unusual benefits, but maybe talk about what you saw in the first quarter. Is that an indication of loan pricing pressures and could we see it further decline going forward?

Well, I think you observed and we commented in the January call that we got a lift in net interest margin in Q4, compared to Q3 of last year because of some unusual items. We have yield maintenance on certain loans and prepayment penalties. And we have at the end of the last quarter of the year, we had about $4.2 million of net deferred credits. We defer all fees on loans and we defer origination costs and the fees -- we have got about $4.2 million more in deferred fees than deferred origination costs. So prepayments of loans drop those deferred fees and deferred costs into income as yield adjustments.

There was quite a bit of that sort of flux in Q4 and we commented on that. That did contribute to an unexpected upturn in margin in Q4 so we gave that back in Q1, not unexpectedly and because of competitive pricing environment did give up some more margin.

If we only hit our minimum $600 million growth number for the year we think our guidance we gave in the January conference call is still good for 2014. If, on the other hand, we exceed that in a meaningful way, obviously new loans we are booking are generally at somewhat lower yields than the loans that are rolling off the books. And new loans in larger volumes dilute down to higher-yielding covered loan components of the portfolio.

So exceeding the $600 million growth by a meaningful number would further dilute margin.

We have discussed this for a long time, that there is a trade-off. The more growth we get in this environment, the more it is going to tend to dilute margins down. We would love to have a lot more growth and suffer a little more dilution in margin.

Last year in the January call, we gave guidance for the year based on $360 million in growth. We said in that January 2013 call that we would have 5 more basis points of margin dilution if we had another $120 million of growth. We actually exceeded that $120 million of additional growth by a small margin, $40 million or $50 million, I think and suffered the full 5 basis points of additional margin dilution as a result of that.

So, similarly this year, if we get more growth than the $600 million minimum, which seems like a very plausible outcome given the excellent growth in Q1, we would suffer a little more margin compression likely than what we described in the first quarter.

That's very helpful. Then maybe on the core systems that you are -- the new core systems, maybe talk about is there increased capabilities or maybe what the potential is for some revenue potential with this new system along with the cost savings that you outlined starting in 2015.

Yes. We believe that the -- let me give you a little color first on the selection process. I mentioned in the call just briefly that more than 60 members of our team participated in this process. And what we did is we invited in the three vendors who each had a possible solution to our core software. We provided each of those three vendors in and gave them two days with our 60-person team to just ask questions about our business and our processes and our needs and so forth. So we didn't ask any questions for two days. They got to ask all the questions.

Then after they thoroughly evaluated what our needs and current capabilities and systems were and so forth, business processes and all, they went back and developed a presentation and a proposal. Took them about 30 days each to do this, to address how their system would meet our needs. And then they came back and had two days of meetings with all of our staff on those and did that in large groups and then broke down into subgroups. And in that two days, our guys got to ask all the questions. They didn't get to ask any questions.

So we scored every one of the vendors that presented, based on how their system met our requirements; did it exceed our requirements; what their industry thought leadership was; what their level of professionalism was; and the relative degree of quantum leap in technology for us, for both our internal and external users of our software.

We had each of our 60 members assigned numeric grades based on a scoring system we developed for each vendor in that regard. And then we looked at those grades based on each of the three vendors, based on the entire team that graded them and, then, we looked at it based on the loan team, the mortgage team, the deposit team, and the corporate finance team, and based on subgroups of our team that looked at them. And the winning service provider won every single composite score, both on the -- across the team and on every individual subgroup basis. So the -- and won by a decisive margin over the second-place finisher and the third-place finisher.

So we are very confident based on a six-month process that involved extensive mutual evaluation of each other that we are going to achieve a quantum leap in technological capabilities, both for our internal users of our core systems as well as our external users of our core systems. So we think this is going to create tremendous additional benefits to our staff and our customers going forward and allow us to do a lot of things productwise with customers that we do not have the capability to do at this time.

In addition, because of the fact that we are taking what right now is a bunch of sort of cobbled together different systems that we've put together to run our current bank software and we are getting a much more streamlined efficient system by upgrading to our new software, and because we've negotiated a very good contract on this software, we expect that our core software cost is going to be about $2.75 million a year less, $2.75 million a year pretax cost savings versus what we are incurring today.

And our future conversion costs are not built into that number, Greg, is that correct? And the arrangements we have negotiated for future conversion costs are going to be much less costly on future acquisitions than conversion. And as our Company grows, our rate of growth on our existing contract in our software charges will be much less than our rate of growth would be on our existing contract.

So just on a flat apples-to-apples current comparison we are going to say $2.75 million a year. We will save additional as a result of lower conversion costs. We will save additional as a result of less escalation in cost and we are going to have a tremendously better system.

We really shook up our operations and IT staff August of last year when we launched this process. And I cannot tell you how pleased I am with the work that our Chief Information Officer, Sean O'Connell, Chief Operating Officer, Tyler Vance, Chad Necessary, Jeff Starkey, the other members of our IS, IT team have done. They have really stepped up and done some incredible work on the core software selection, the contract negotiations and I think they are going to do equally good work in executing the conversions.

We are scheduled to convert our legacy system the weekend of August 15. We will convert the OMNIBANK systems the weekend of October 3. We will convert the pending Summit acquisition, assuming we get that transaction closed the weekend of November 7. And our Carolina Foothills Group, the former First National Bank of Shelby, will convert those guys on February 13 of next year.

And all those processes are in motion and very detailed planning and execution strategy and teams have been developed for all of those.

That's great. Thank you for taking my questions.

(Operator Instructions). Matt Olney, Stephens.

It's actually Tyler in for Matt. With the five years expiration of the loss share coming up in early 2015, on a few of your failed bank acquisitions, how should we be thinking about the associated fee income in covered loan runoff in 2015?

Well, if you -- what I would suggest you do is take our covered loan runoff history, look at that, and you can extrapolate that number forward, would be my best guess.

Now that is going to tail off at some point because we have got basically one year to go on our shortest bank; two years and a fraction to go on our longest banks; on the 415 B loss share, the commercial asset loss share. But the 415 A, the residential parts of that, we have got six years and seven years roughly to go on those banks.

So there's a lot of clock left on the residential part. And not insignificant, we have got 20%, 40% of the clock left on the commercial parts still.

So we have still got a lot of time to resolve these assets and we are doing a great job doing that. We don't see any problem with the clock running out and leaving us in a jeopardous situation on any of these assets.

But, yes, the portfolios are running down. They are going to continue to run down. I think that rate of rundown diminishes because we get a lot of the B stuff out and we get down to the A assets that are longer lived assets. The FDIC receivable is running down. That is going to continue to run down. So the accretion income with that will continue to run down.

But the flipside of that is while we are losing a lot of those loss share assets, we are making additional acquisitions and we are adding very good yielding assets and much higher quality assets in those acquisitions. So we think we are well-positioned to manage part of our business, the loss share part of that business, running off and replacing it with other business that will let us continue to put up a very positive earnings trend.

Thanks, that's helpful. Secondly, do you have the mortgage production amount and then the refi versus new purchase mix in 1Q?

Yes. I do. We had $38.8 million of originations, and 73% of that was purchased and 27% of that was refis. And I don't have last year's numbers, but I would guess the purchase refi percentage is probably about flipped from last year.

Okay. Thanks, George.

Peyton Green, Sterne, Agee.

Good morning. I was wondering if you would -- could reveal who your new systems provider was going to be.

Fiserv Premier.

Okay. All right. With regard to -- I apologize if I missed this earlier, but maybe your outlook -- just as you talk to customers and are involved in the underwriting process, how do you see activity today in customer outlook today compared to six months ago or even a year ago? Has there been any lift or is it just you all getting more opportunities to sit down at the table?

I think it is a combination of those things. I think we are getting a lot more opportunities to sit down at the table, but in talking with our customers, talking with our lenders, interacting with various people in the markets that we are in across the country, I think there is a slightly more positive outlook in pretty much everyone's perspective.

Nobody is under the delusion that the economy is great or is getting a lot better a lot faster, but I think as we suspected it would for several years, it is getting better. And it is getting better slowly and it is not an overwhelming sort of thing, but, yes, I think the tone is just slowly getting a little bit better as we go forward.

And I would tell you in our -- some of our loss share markets it is getting a lot better. Because those guys hit bottom, hit hard, and a lot of them have laid at the bottom for a long time and some of those markets the -- not all of them, but some of those markets, the surplus capacity and inventories of houses and lots and so forth are beginning to get absorbed now. There are places in Georgia where there are enough lots to last the next 150 years and so forth, but there are a lot of markets also where inventories have really run down to normal levels and production of new inventory is back in vogue. So, I think the economy is getting a little bit better and we expect it will continue to just slowly get better.

Okay. Then in terms of covered OREO, I know there has been some lumpiness to timing of sales and the like. Would you expect both second and third quarter to be maybe a little more active?

I would. We talk about seasonality of our business and a lot of that seasonality is driven by weather. And I think, certainly, we had tough weather and that is just part of Q1; and our Q1 OREO sales were much less than what I would expect we would average on a quarterly basis this year. And you saw that in the gain on sale number which was under $1 million slightly. And we would expect that gain on sale number and our volume of sales and the reductions in those portfolios to be more significant in Q2 and Q3 than they were in Q1.

Okay, great. And then last question, any -- do you still see M&A as a bigger opportunity than it has been or what do you see on the M&A landscape?

As I said, we are optimistic we will make additional acquisitions including, we would hope, another additional acquisition or two in the current year. So, we are actively engaged in that. We think it continues to be a significant area of opportunity. I think this OMNIBANK transaction we closed this quarter, it is obviously a really nice deal and it generated enough gains for us to more than offset all of our charges for our new software conversion. That was a great outcome and coincidentally it nicely happened to all fall in the same quarter.

And I think the run rate, the future performance of that bank, the potential it affords us in Houston, Austin, and San Antonio is going to make the day one impact of that, which was very nice just seem pale and insignificant because those are great markets.

The Summit acquisition here in Arkansas as we've commented previously, we think, is just a hand in glove fit with our franchise and we think that is going to be a very positive acquisition. I just -- I need to find more OMNIs and more Summits that are transactions that are as meaningful to us as we think those transactions are going to be.

That's great. Thank you.

Brian Martin, FIG Partners.

Hello. Can you talk about all the staff you have added recently and I guess what are the needs still remaining, just the impact on expenses prospectively, is it much less significant going forward? It sounds like the leasing areas I know you are focused on, but sort of other staffing and ramp-up. Where also are you still in need, I guess, if you will?

We have got it at all points in times some unfilled staffing requisitions that we are looking for talent, but the vast majority of the adds that we are going to significantly affect our cost relate to some staff additions in Real Estate Specialties Group where we beefed up our legal team, our servicing asset management teams in Dallas, in our origination teams, which we added in LA and enhanced a little bit in New York. And then our Corporate Loan Specialties Group where I have still got a few team members to add, but most of what we need to add is going to be added.

Now, as my leasing originators -- I think we hired three in December and a few more in January, February, and March -- as those guys kick in we will add some more lease originators over the course of the year. But the heavy increment of costs is pretty much reflected in our Q1 numbers.

Okay. All right and maybe I missed this, but jump down on the margin if I might, if you take any color on your margin outlook and kind of the impact Summit may have to it and then secondarily as rates head higher, wondering how you are thinking about stress testing the cost of funding, if it is still your outlook that it is a minimal impact to that cost of funds, if can we spin off base options terms or whatnot?

Yes, well, I and not going to give any guidance on Summit because I am not going to really know exactly how that is going to play out until we complete our final valuation on all their assets. And we are scheduled to do that the first two weeks of May. We have got all our asset valuation teams gearing up and ready to go down there and spend two weeks valuing every individual asset in their portfolio.

So we will do that first two weeks in May and in anticipation of a May 16 tentative closing date on that transaction. So I am not quite sure how that does play out.

As far as our ability to spin up offices and grow deposits as needed with minimal impact on our cost of interest-bearing liabilities, yes, I think that is very achievable and we are pretty optimistic about that, just because of the tremendous progress that we are having in growing deposits without raising rates or spinning anything up. We added almost -- excluding acquisitions we added almost 2,000 net new checking accounts in the quarter just ended. And if you look at our mix of deposits, our non-interest-bearing deposits jumped from just over 20% to almost 23% of deposits in the first quarter. And our total non-CD deposits jumped from 75.9% to 78.8% the first quarter. So our costly CD part of our deposits went from a little over 24% down to just a little over 21%. Dropped about 3 points in the quarter.

So we are having really good success, continuing to improve the mix of the deposit base and continuing to grow a lot of checking accounts. So I think -- and we have got a lot of cash. So I think we are in really good position to achieve significant balance sheet growth in loans, fund it with existing cash, fund it with incrementally grown deposits without making much of a dent at all in our cost of funds. As I have said, I said last year I think we were 23 basis points cost of interest-bearing deposits in Q2 of last year.

We spun off some offices and went to 22 basis points in Q3 and Q4 of last year. I think we were flat, Greg, in Q1? So we were flat in Q1 and we achieved substantial deposit growth of the types we wanted in those periods. So, we feel pretty good about that.

Perfect. Then two last housekeeping ones. On the loan growth, the real estate loan growth, what was the mix of that between construction, commercial real estate this quarter? Was there any significant [plan] one way or the other?

Yes, if we -- if you look at last quarter residential one to fours were up $3 million. CRE was up $40 million, construction and development was up $74 million. Agra and real estate was down $1 million. Multifamily was down $13 million. C&I was up $13 million. Consumer was down $2 million. Leasing was up $7 million. Agra and non-real estate was down $1 million or $2 million. And other, the other category was up about $37 million.

And just your thought on the credit -- where you have got your credit metrics and the slight uptick, I mean the OREO that sits out there today, I guess maybe, what is your expectation as far as seeing that move out in a relatively short period of time. Would that be your thought at this point?

It is our house. That is what we are working for every day. The increase in the OREO, the non-loan share OREO was virtually all attributable to OREO we acquired in the OMNIBANK acquisition. I think our legacy Bank of the Ozarks OREO actually went down slightly less than $1 million, but we had a net decrease in our legacy OREOs. So all of the increase in noncovered OREO plus a little bit was attributable to OREO acquired in the OMNIBANK acquisition.

They don't have -- I think they have got about seven or eight pieces. One of them is a fairly substantial piece in Austin and they have got things working on several of those.

So we are hopeful that we will whittle that back down to our level that we were at the end of the year over the next several quarters.

And then the growth in the nonperforming loans is primarily related to one credit here in Arkansas that went nonaccrual. We think that customer has got a plan to get that caught up in return to accruing status. We are monitoring that real closely, but that is really a single Arkansas-related credit that really moved that ratio.

So if you look at the details of it, there's nothing significant going on there. And certainly the overall and the best metric of credit quality in my view is net charge-offs and that number pretty much says a lot.

Yes, okay. Thanks very much.

(Operator Instructions). Blair Brantley, BB&T Capital Markets.

Good morning, Blair. Blair?

And it appears Blair has disconnected. And we have no further questions in queue.

All right. If there are no further questions at this time, thank you very much for joining the call. We appreciate your interest in our Company and we look very forward to talking with you in about 90 days.

Thank you very much. Have a great day.

That does conclude today's conference. Thank you for your participation.