Bank Ozk (OZK) 2014 Q2 法說會逐字稿

Please stand by, we are about to begin. Good day, everyone and welcome to the Bank of the Ozarks, Inc. second-quarter earnings release conference call. Today's call is being recorded. I would now 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 outlooks including statements about economics, real estate markets, competitive, credit market and interest rate conditions, revenue growth, net income and earnings per share, net interest margins, net interest income, non-interest income including service charge income, mortgage the lending income, trust income, net FTSE loss share accretion income and amortization expense, other income from loss share and purchase non-covered loans, and gains on sales of foreclosed assets including foreclosed assets covered by FTSE loss share agreements, non-interest expense, our efficiency ratio, asset quality in our various asset quality ratio, our expectations for 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, 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 mergers and acquisitions, and our goals for additional mergers and acquisitions in the future and changes in growth in our staff.

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 section of our periodic public reports, the forward-looking statements caption of our most recent earnings release and the description of certain risk factors contained in our most recent end 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. Any references to non-GAAP financial measures are intended to provide meaningful insight and are 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 second-quarter results.

Highlights of the quarter included record organic loan and lease growth and the mid-quarter closing of the Summit acquisition, which is our largest acquisition to date. We look forward to having a full quarter's contribution from this acquisition in our third-quarter results.

Let's go straight to the details and look at our second-quarter numbers. Net interest income is traditionally our largest source of revenue and is a function of the volume of earning assets and net interest margins. Of course, loans and leases comprise the majority of our earning assets.

In the quarter just ended, our non-purchased loans and leases, which excludes covered loans and non-purchased or purchased non-covered loans, grew a record $393 million. When you combine that with our excellent growth in the first quarter, non-purchased loans and leases have grown $539 million during the first half of this year.

Additionally, our unfunded balance of close to loans increased a sizable $418 million during the second quarter and now totals $1.83 billion. While some portion of this unfunded balance will not ultimately be advanced, we expect that the vast majority will be advanced. This, of course, has favorable implications for future growth in loans and leases for the remainder of this year and in 2015.

We are constantly striving to enhance our capabilities to produce increasing volumes of good quality, good yield and earning assets. As a result, we believe that we are strategically positioned for even stronger growth in earning assets in the years to come.

In previous conference calls, we have discussed our five engines for growth and earning assets apart from acquisitions. 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 in previous calls and presentations. We believe Real Estate Specialties Group will continue to be our strongest growth engine for organic growth and earning assets for some time to come.

With that said, we believe that our other organic growth engines will contribute more to growth and earning assets in 2014 and future years than they have in recent years.

These other growth engines include our vast network of community banking offices in seven states, our leasing division, our relatively new Corporate Loan Specialties Group and our investment securities portfolio, all of which made positive contributions to our growth in earning assets in both the first and second quarters of this year. We seem to be hitting pretty much on all cylinders.

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. 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 and earning assets in 2014, 2015, and beyond.

In our previous conference calls this year, we provided guidance that we expected non-purchased loan and lease growth of a minimum of $600 million in 2014. We emphasized in those calls that such guidance was for a minimum of $600 million.

Based on our excellent second-quarter growth, the large increase in our unfunded balance of closed loans, and the current robust pipeline for additional loans, we appear to be well on track to far exceed that minimum guidance.

We now expect non-purchase loan and lease growth of a minimum of $850 million for the full year of 2014. In 2015, our goal is to achieve growth in non-purchase loans and leases of a minimum of $900 million. Given our current momentum, we believe that is a reasonable goal.

While we were very pleased with our growth, we were even more pleased with the credit and interest rate risk profile of loans and leases we have booked in the first half of this year. We are operating in an intensely competitive environment in which some competitors have been, in our judgment, taking on excessive credit risk and excessive interest rate risk to generate volume. In contrast, we believe our lending teams have been maintaining sound pricing and credit 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. Variable rate loans now comprise 68.5% of our total non-purchase loans and leases. That is up from 64.5% at March 31 and 62.7% at December 31.

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

In regard to net interest margin, our second-quarter net interest margin on a fully taxable equivalent basis was 5.62%, which is a 6 basis point increase from the second quarter of 2013 and a 16 basis point improvement from this year's first quarter. The improvement in our net interest margin from this year's first quarter is primarily attributable to our increased yield on covered loans, which I will discuss in more detail later, and the increased volume of purchased non-covered loans from recent acquisitions which loans have favorable yields.

In our recent conference call, we provided guidance that we expected our 2014 net interest margin to decline, but that the expected year-over-year decline from 2013 to 2014 was expected to be less than the 28 basis point decline in net interest margin from 2012 to 2013. Last year for the full year of 2013, our net interest margin was 5.63%. And for the first half of 2014 this year, our net interest margin has been 5.55%, just 8 basis points below our net interest margin for the full year of 2013. Based on this, it appears that we are on track to come in well within our guidance range for net interest margin.

We continue to expect that our cost of interest-bearing deposits will increase slightly in coming quarters as we continue to accelerate deposit-gathering activities to find expected future loan and lease growth. We reiterate also that our net interest margin guidance does not take into account the effect of any future acquisitions.

Let's shift to non-interest income. Income from deposit accounts service charges is traditionally our largest source of non-interest income. Service charge income for the quarter just ended was a record $6.60 million, and increased 30.2% compared to the second quarter of 2013, and 17.1% compared to this year's first quarter.

Of course, acquisitions have been a significant contributor to this growth, but even excluding acquired deposits, we continue to grow core deposit customer relationships in the quarter just ended, adding approximately 1,973 net new checking accounts apart from acquisitions. Clearly, our good growth momentum is not limited to our loan and lease portfolio.

Mortgage lending income for the quarter just ended decreased 31.5% compared to the second quarter of last year, but increased 18% compared to the first quarter of this year. Trust income for the quarter just ended was a record $1.36 million and increased 57.7% compared to the second quarter of 2013 and 3.6% compared to this year's first quarter. Our trust business grew substantially with the July 2013 FNB Shelby acquisition and we have continued to achieve organic growth. The recent Summit acquisition included a small book of trust business which should contribute modestly to future trust income.

Net gains from sales of other assets were $1.45 million in the quarter just ended compared to $3.11 million in the second quarter of 2013 and $0.97 million in this year's first quarter. In recent years, such net gains have been a meaningful contributor in every quarter. We expect that net gains will continue to be a significant income item for quarters to come, but by its nature this category of income will vary quite a bit from quarter to quarter.

As part of our FDIC assisted acquisitions, we recorded a receivable from the FDIC based on expected future loss share payments and we recorded a clawback payable to the FDIC based on estimated sums we expected to owe the FDIC at the end of the loss share periods. The FDIC 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, this category flipped to net amortization expense, so $0.74 million compared to net accretion income of $2.48 million in the second quarter of last year and net accretion income of $0.69 million in this year's first quarter. This change reflects the continued evolution of a phenomenon we have discussed at length in recent conference calls.

As we have more experience with our portfolios and covered loans and as these portfolios become more seasoned, we are increasingly revising upward the expected projected cash flows on certain loans where we originally expected an elevated risk of loss but no longer believe such loans have an elevated risk of loans. Of loss.

These are loans where principal reductions through amortization, unscheduled principal payments, provision of additional collateral improvement in the obligor's financial position and various other factors have in our view largely eliminated any elevated risk of loss. The effect of these upward revisions 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 the reason our net accretion income of our FDIC loss share receivable declined in recent prior quarters and the reason that it changed from net accretion income to net amortization expense in the quarter just ended. This is also the primary factor in the increase in our yield on covered loans last year from 8.93% last year's second quarter to 9.49% in the third quarter and 10.66% in the fourth quarter, and then further to 11.58% in this year's first quarter and most recently to 15.53% in the quarter just ended.

Based on the improving risk 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 estimates of future cash flows. The net effect of this, assuming it occurs, will be positive for net income since we will have an additional $1.00 and 25% -- $1.25 of interest income for every $1.00 of reduced non-interest income related to amortization of the FDIC loss share receivable.

In addition, non-interest income in the quarter just ended included other income from loss share and purchased non-covered loans of $3.63 million compared to $3.69 million in the second quarter of last year and $3.31 million in the first quarter of this year. This line item includes certain miscellaneous debits and credits related to accounting for loss share assets and purchased non-covered loans.

But it consists primarily of income recognized when we've collected more money from covered loans and purchased non-covered 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.

The significant income we continue to recognize (technical difficulty) reflects in large part the skills, the hard work and the achievements of the various teams we have developed to resolve and collect these problem assets. Needless to say, they are doing outstanding work.

Let's turn to non-interest expense. Our efficiency ratio for the quarter just ended improved to 44.6% compared to 46.3% for the second quarter of 2013. While our efficiency ratio will vary from quarter to quarter especially in quarters when we have significant unusual items of income or non-interest expense, we expect to see a generally improving trend in our efficiency ratio in the coming years. Our expectation for further improvement in our efficiency ratio is predicated upon a number of factors, including our expectation that we will ultimately utilize a large amount of current excess capacity in our extensive branch network.

Our expectation that our ongoing core software conversion projects will reduce software costs by approximately $2.75 million per year while providing greater functionality to our customers and employees and creating other opportunities for enhanced operational efficiencies through technology. And our expectation of achieving additional cost savings from our recent acquisitions. Our guidance regarding an improving efficiency ratio does not consider the potential impact of any future acquisition.

One of our long-standing and key goals is to maintain good asset quality. Economic conditions in recent years have made our traditional focus on credit quality even more important. The strength of our credit culture and the depth of our commitment to asset quality were both evident in our key asset quality ratios in the quarter just ended.

At June 30, 2014, our ratio of nonperforming, non-purchased loans and leases as a percent of total non-purchased loans and leases decreased to 58 basis points compared to 66 basis points at June 30, 2013, but increased compared to 42 basis points at March 31 this year. Similarly, excluding covered loans, purchased non-covered loans and foreclosed assets covered by loss share, nonperforming assets as a percent of total assets decreased to 62 basis points at June 30, 2014, compared to 66 basis points at June 30 a year ago, but decreased -- but increased, I'm sorry, increased compared to 57 basis points at March 31 of this year.

Finally, our ratio of nonperforming loans and leases past due 30 days or more -- I'm sorry, let me start over with that sentence since I messed it up.

Finally, our ratio of non-purchased loans and leases past due 30 days or more, including past due nonaccrual loans and leases to total non-purchased loans and leases decreased to 63 basis points at June 30, 2014, compared to 74 basis points at June 30 last year, and 75 basis points at the end of this year's first quarter.

Our annualized net charge-off ratio for our non-purchased loans and leases for the second quarter of 2014 increased to 19 basis points compared to 12 basis points in the second quarter of last year and 3 basis points in the first quarter of this year. For the first half of this year, our annualized net charge-offs for non-purchased loans and leases decreased to 11 basis points compared to 15 basis points in the first six months of 2013.

Let me close my prepared remarks with a few comments about growth and acquisitions.

Organic growth of loans, leases, and deposits continues to be our top growth priority. And we have clearly demonstrated our ability to achieve substantial growth in these regards, apart from acquisitions. With that said, M&A activities continues to be another focus as we believe M&A provides significant opportunities to augment our healthy organic growth.

We are very pleased with the progress of each of our acquisitions to date, including our two acquisitions in the first half of this year. We continue to be active in identifying and analyzing M&A opportunities and we believe an active and disciplined M&A strategy will allow us to continue to create significant additional shareholder value.

This potential was evident in our Summit acquisition which, on a split adjusted basis, added $1.44 to book value per common share and $0.35 to tangible book value per common share and is also expected to be accreted to diluted earnings per common share by approximately $0.125 to $0.15 in the first full four quarters.

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

(Operator Instructions). Michael Rose, Raymond James.

Good morning. I wanted to get a sense -- obviously the quarter's growth was really strong. The growth in the unfunded balance of closed loans was even stronger.

I remember last quarter the Real Estate Specialties Group contributed about 76% of this quarter's growth. But I really wanted to get an update on some of the other initiatives like the Community Bank Group and the Corporate Loan Specialties Group and how much they contributed to this quarter's growth.

Yes. I will be happy to give you that. Real Estate Specialties Group as you surmised was the king of the hill, contributing $309 million to our growth in funded balances. Corporate Loan Specialties Group contributed $22 million. Our various community banking units had net growth of $55 million. Leasing contributed $6 million and our bond portfolio, apart from bonds acquired from Summit and sold out of the Summit portfolio, contributed $9 million to growth.

So all of them were in positive territory and generally with an increasing trend versus the first quarter, except leasing was a little bit less than its first-quarter growth and the bond portfolio was a little less than its first-quarter growth, about half.

Okay. And then, how should we think about some of the newer offices and the Real Estate Specialties Group? Where do they stand versus your expectations and are they expected to be growing contributors as we move forward? Thanks.

Yes. Be happy to give you that. Our New York office that accounted for $91 million of our loans at March 31 accounts for $209 million at June 30. So a sizable collection of booking and fundings there. Our LA office that we opened earlier this year has closed quite a few loans and went from zero at the end of the first quarter to $9 million outstanding at the end of the second quarter. Most of what they booked is future fundings.

Our Houston office that has had several very nice closings, all of that is in future fundings. They were essentially zero at the end of both quarters, but certainly doesn't reflect a lack of productivity there. Obviously they closed some loans they just haven't funded yet.

Our Austin office went from $70 million at the end of the first quarter to $86 million at the end of the second quarter. Our Dallas office went from $1.153 billion to $1.319 billion end of first quarter to end of second quarter. And Atlanta Real Estate Specialties Group office has had activity, but they were net funded $68 million at the end of both quarters. $69 million, $68 million end of both quarters.

So, quite a bit of activity in the new offices and they are beginning to get some funded balances on the boards.

All right, that is helpful. And one follow-up question, if I may. I noticed the legacy nonaccrual loans balances went up from about 11.8 to 18.4. Was there anything in there? Was there it just a couple of credits, anything we should read into there? Thanks.

We have got about $10 million, part of which went nonaccrual and the first quarter and the rest of which went nonaccrual in Q2 and a loan relationship here in Central Arkansas that is secured by property in both Arkansas and North Carolina. It's -- the relationship appears to be well-secured. The customer is experiencing some cash flow difficulties, obviously. There is a plan to get that credit back on track.

I don't know whether the customer is going to be able to execute that plan or not. That should play out pretty clearly over the next couple of months.

So, but that -- if you look at year end balances versus now essentially all of that growth is one credit relationship that is comprised of five, six -- four, five, six loans. I don't remember the exact number of loans in the relationship, but it is about $10 million.

So, again, I think we are well-secured, based on our most recent valuations, but we'll see how that plays out over the next quarter.

Great. Thanks for taking my questions, George.

Jeff Bernstein, Capital AH Lisanti.

Good morning. So please ignore my ignorance on this, but trying to understand a little bit more the P&L impact/cash flow impact on the funded balances on these construction loans. So, obviously the customer is funding some percentage of the equity, a significant part upfront. Then they take the draws, they are finishing the building.

You get paid out when either units in the building are sold or when a perm loan goes on to the finished building. And is that when you first start to get your interest income? And is there any difference between P&L and the cash flow?

Okay. Well, let me try to explain that and we may want to have a further discussion of details of this at a subsequent time. But at a high level, as of March 31 -- and I don't have the June 30 data yet -- but as of March 31, our average construction and development loan that had interest reserves, which is typically about [5, 6] of our construction and development loans, our average cash equity in those loans and cash equity can be comprised of borrowers equity or mezzanine financing or some sort of subordinated debt, but it is usually a combination of cash equity from the bar and mezzanine financing that is subordinated.

That equity behind our loan was on average 46% of the transaction. So our average loan to cost was 54% in those loans at March 31. And that gave us a loan to value ratio on those based on appraisal of about 47%. So our typical deal is almost half equity and half loan.

In 99% of our transactions, all of the subordinated debt mezzanine and equity pieces fund before we fund. So at a typical loan closing, we will book $1,000 to prime our mortgage legally of record and we will monitor the transaction on a monthly basis every expense item, CapEx item, until all of the equity is in and proven up, whether that equity is true equity or mezzanine or subordinated debt, and then we will start funding.

The day we start funding we earn interest, we accrue interest on amounts that we fund and we continue to accrue interest every day on every dollar of loan outstanding as long as that is an accrual loan. And there is negligible income impact when those loans get paid off.

Now -- and I will explain what that negligible income impact is. On every loan we defer in accordance with generally accepted accounting principles, certain origination costs and we defer all loan fees. And those deferred origination costs and those deferred loan fees, debit and credit, are netted out and the net differential is amortized into income -- or amortized against income or accreted into income over the life of the loan. And at the end of the most recent quarter, we had on our book $6.73 million of net credit. So we had deferred $6.73 million more in loan fees than deferred loan origination costs.

So, the majority of loans because we have net credits on the majority of loans, at least in dollars, the majority of loans will generate some additional income when the loan pays off if it pays off prior to maturity. Because that unamortized net credit will fall into income. If it happens to be one of the loans where the deferred costs are more than the deferred fees, then the payoff of the loan will result in a small net debit.

So that is the accounting for them. Does that answer your question?

It does. And a quick follow-up. In a rising rate environment, you -- the rates on these loans go up and your recognition of that accreted income goes up linearly with that over the course of the loan payoff.

No. The recognition of the deferred fees and deferred loan origination costs would not be impacted by the fact that it is a variable rate loan.

Right.

We calculate that, what would give us a constant yield of maturity on the loan at the time of origination and set up an origination or an amortization or accretion pattern for those expenses and fees that are deferred, and that pattern holds true over the life of the loan, no matter what happens to the interest rates on it.

Got it. And in terms of the accruing interest, it just rises whenever the remeasurement of interest rate occurs.

Yes. If the rate adjusts on the 16th of the month and the accrual changes to the new rate on the 16th of the month.

Got you. Great. Thanks so much.

I will take that as your last question, but since you touched on variable rate loans, I will point out that -- repeat that 68.54% of our non-purchased loans and leases were variable at June 30, basically a 400 basis point increase from the prior quarter. And if you look at cash flows of our loans and adjustable-rate loans, 77.1% of the total portfolio is adjustable within a one-year timeframe. 82.4% within a two-year timeframe and 88.3% of the portfolio is adjustable through either adjustable rates or maturities or cash paydowns, principal paydowns expected, 88.3% in the first three years of the portfolio's life.

Thank you for that detail.

Matt Olney, Stephens.

Good morning. I want to drill down on the loan yields. Do you have what the average yield is on your new and renewed originated loans in 2Q?

I wish I did have that data, but I don't. Don't have that available.

Obviously, the new loans we are booking are at a lower rate than the average of our legacy loan yields on the books. And you saw that again and I don't remember what the quarter-over-quarter decline in yields was on our legacy non-purchase loans. I think it was a couple of basis points. Greg, do you? 3 basis points. So it was fairly small.

But we are in a very competitive environment, as we have talked about for a couple of years. And we do expect some continued erosion in that loan yield just because of competitive circumstances.

So, and that is why we gave the guidance that we expected our net interest margin this year to decline albeit at a lower rate of descent than the 28 basis points decline last year. I think we said in the prepared remarks that first half of this year versus last year was down 8 basis points. So we are doing a good job, but that trend is downward.

Okay, thanks. Secondly, can you remind us what the average size is of your loans within your Real Estate Specialties Group?

I can't remind you because I don't know. I would like to give you that (technical difficulty), but I don't know that information. I don't have that average number in my head or in front of me.

What about just a typical deal of the sweet spot that you guys try to target within that group?

Matt, it varies a lot. We are routinely looking at transactions across a broad size range where you occasionally have loans in from Real Estate Specialties Group that are in the $1 million, $2 million, $3 million range for existing customers that we have multi-transaction relationships. And then we are looking at transactions much larger, $20 million, $30 million, $40 million, $50 million transactions. We have got a handful of relation -- of relationships for transactions in the $60 million and $70 million.

The largest credit we have ever approved in committee was a $100 million transaction that was extremely low leverage. So, it --. The size varies dramatically across the spectrum there.

One rule of thumb we follow is the larger the transaction, the better the quality has got to be. So if you see us going up the food chain sizewise, we would expect commensurate increases in the quality and credit metrics of the transaction, appropriate for taking on that additional concentration risk.

Thanks, George.

Kevin Reynolds, Wunderlich Securities.

Good morning. Great quarter. I jumped on a little bit late and I think right at the tail end of some comments you were making about your expectations for loan growth. So I wanted you -- if you could, I apologize for this, could you go back over what your minimum expectations are for 2014 and 2015 organic loan growth?

Yes. We have revised our guidance for growth in non-purchased loans and leases for 2014 to a minimum of $850 million and we've introduced growth guidance for 2015 for the first time. And, again, non-purchased loans and leases, minimum growth, minimum growth for 2015, a minimum of $900 million.

Okay. And that compares to -- on the $850 million, if you will refresh my memory for 2014, compares to what number?

Well, the previous guidance we had articulated in Q1 and Q2 was a minimum of $600 million. As I pointed out in my prepared remarks, we had emphasized that was minimum and we are certainly thumping, knocking on the door of achieving that number at June 30. So the upper guidance is clearly justified.

Our optimism, as I said in the prepared remarks for that, is based on one, the growth we have already had. Two, the significant growth in our unfunded close loan balance, and three, the pipeline that we are looking at at the current time. We have a very robust pipeline currently we are working on.

Okay. And two questions that may tie into that. The next question is, how do you feel about the level of economic activity or your outlook for the economy? I know we had that minus 3 percentage-ish GDP number in Q1 and the expectation, or at least hopes, that it gets better in Q2. Which -- where do you think we are if you took the pulse of your lenders out there on the Street and your clients? Are we closer to a minus sign than we are to a 2% or 3% or 4% GDP number? Are we right in the range, or do you know?

Well, the sense that I get in talking with customers and in talking with our lenders who are talking with customers even more than I am on a daily basis, is that the economy is getting better. It is, as we expected, and as talked about for several years, getting better at a really slow rate. But that it is getting better.

In our real estate sectors, for several years, real estate -- even though the economy was getting better very slowly -- real estate suffered from a significant overhang of supply that had been built in the prior boom that got ahead of itself. In a lot of our markets it appears that that supply is largely, if not entirely, soaked up and that supply/demand metrics are largely in equilibrium again. There is as much demand as -- at least as there is supply and in some markets more demand than there is current supply.

Hence, we are seeing a lot of our customers who are very well-capitalized and very sophisticated, seasoned developers with decades of track record in real estate, finding very viable projects to build and develop.

So, our view is fairly constructive on the economy. I don't think we are in boom times again, but I do believe and my lending teams believe that economic conditions are improving at a slow pace pretty broadly in the markets with our --.

Okay and one last question. Looking at your footprint and your acquisition experience, the Summit deal was an end market deal, fits very, very well with you and I know is going very, very well.

If you -- where you are today as a $6 billion bank, high performer, high probability, very skilled at organic loan growth and bidding share. Do you sense now that your acquisition opportunity as you go forward is less of the end market nature, traditional bank nature? Do you think that your footprint will expand to match your lending expansion that you've had out of your specialty divisions? And not necessarily become nationwide, but do you feel like you have outgrown the Arkansas opportunity and now any significant opportunities will be in markets that you might -- that might be considered quote new markets to you?

That's a good question. I don't think there is a yes or no answer to that. I think the proper answer to that is to state what we've stated about acquisitions all along and that is that we are looking to do transactions that will achieve basically a 20% return on equity assuming an 8% tangible common equity allocation to that franchise.

We want to do things that add to shareholder value. We are continuing to look at transactions from the $300 million to $500 million on these small size up to $2 billion on the large size. So we are looking across a very broad spectrum of acquisitions.

We continue to look in Arkansas and Texas, as well as North and South Carolina, Georgia, Florida, and Alabama, the seven states where we already have a retail presence. We continue to look in the peripheral states to those -- primarily Virginia, Tennessee, Missouri, Oklahoma, Louisiana. And we would, as we have said we would, look beyond those 13 or so states.

As we have commented many times, we are going to be probably less competitive as a bidder for an acquisition in a more remote state just simply because we are not going to have to cost save synergies that an end market acquirer in that state might have. We are not going to be able to service that with our existing -- if it is an hour time zone to the West, or two hours to the West, we are not going to be able to service it with our existing timelines for data centers and call centers. If it is a state that has complex consumer financial regulations or whatever, we are going to have to build in that additional compliance function.

So, in states that are far away where we will incur additional costs and where we won't get the cost synergies that an end market bidder might get, we are going to be hard-pressed probably to be able to put a price on a transaction that is going to satisfied the seller and achieve our 20% ROE criteria.

So I certainly think the most likely scenarios for acquisitions over the next several years would be in the markets we are either in or very nearby to them, but we are looking. And we may find special situations here, one here or one here that are outside of that geographic footprint that work for us economically because we are a uniquely good match to that franchise.

So, when we look beyond those 12 or 13 core states we are looking at, those are the sorts of transactions that we would look to consider would be transactions where we thought we are such a uniquely good match for this company, and they are such a uniquely good fit within our Company, that even though we are going to incur some costs that another acquirer might not incur in that market, it fits us so well we are still going to be competitive.

Okay. Thanks a lot, good quarter.

Thank you very much.

Jennifer Demba, SunTrust Robinson Humphrey.

Good morning. Just curious as to if you could go over the cost savings you have been able to achieve from your most recent two transactions through the end of the second quarter, George.

Yes, well, let me talk about what we haven't done first. And we still have not consolidated either company's core operations. We expect to consolidate Omni in September -- October, first week of October -- and Summit in the second week of November. So we will achieve some significant benefits at the time that we get those back office consolidations done.

We have pretty much done all of the staff rationalization other than a couple of positions there at Omni. And the Summit deal, we have got quite a ways to go there because we are operating at least nine branches now -- seven of Summit's and two of ours that will most likely not make the cut longer term. So we will not -- we obviously can't consolidate any branches until we get the core systems on the same system so that we can serve customers at each branch.

So we would expect to have some branch cost reductions that you will see in our Q1 results. We have skinnied down staff at all these offices just through our offices and their offices where there is overlap just through normal attrition. Just as people move or leave or retire or whatever, we have not replaced any position that we could suck it up and get through without replacing so that we would have minimum impact on our staff when we do consolidate those branches.

And we are going to be -- because we really like the staff that they have and we really like the staff that we have, we are going to be very slow to work out some of that overlap. I may end up with a couple of dozen surplus people that we really don't need, but we will try to work them in through attrition just because we have so much respect for the people and their skills and abilities on both sides of the equation.

So I think you'll see a pretty good wave of cost savings from branch consolidation in our Q1 operating results. And the rest of that in our Q2 operating results. We will consolidate the Shelby operations in February of 2015. That lets us get a little more efficient there.

So we have made some good progress, which will be evident in our Q3 results, but these cost saves are going to be achieved serially and incrementally over the course of four quarters. And that is why we have said that the EPS accretion from the Summit deal which we had pegged at $0.25 to $0.30 before we split and now $0.125 to $0.15 on a split adjusted estimate of EPS accretion, that is a 12-month number and that ought to get better as the quarters roll on over that first four quarters. Because we will ultimately get to the full implementation of cost saves.

Thanks, George.

Brian Martin, FIG Partners.

Hello, George, nice quarter.

Thank you, Brian.

George, you just talked about the pipeline, right now you talked about being very robust. Assuming that is still the Real Estate Specialties Group and what areas are really driving that pipeline at this point? Is it commercial real estate and construction pretty equally? Is one better than the other or one market better than another?

Our business model for Real Estate Specialties Group is such a national model that we are seeing lots of opportunities across a broad spectrum of geography. Obviously, with the office established in Los Angeles now, we are seeing more California opportunities, Washington state opportunities, Arizona and Nevada type opportunities. More West Coast things than we might have seen.

And the same is certainly true with the office in New York which we established a year plus ago. We are seeing more opportunities from the tri-state area there than we probably would have otherwise seen.

So the additional offices are helping us to not only underwrite and service customers in those markets, but also get some additional opportunity from developers, builders, and property owners we would not have otherwise met. So, it is very broad. And I was pleased that our Community Banking unit in Q2 generated $55 million of our growth up from $21 million in Q1. And leasing was positive and Corporate Loan Specialties Group got $22 million of growth versus $7 million in Q1.

So, we seem to be gaining some momentum in our Community Banking Group and our Corporate Loan Specialties Group. While those are small numbers relative to Real Estate Specialties Group, the positive momentum is a very welcome sign for us. It reflects the work of our team, and it reflects the improving economic conditions in a lot of these local markets we are in as well.

Okay, that's helpful. And to last things. The level of deal activity, how would you characterize the opportunities you are seeing today versus a quarter or two ago? Are there more opportunities, less opportunities, or any kind of pricing expectations? Any change on that front?

I would give you the same answer to that I have probably been giving for 18 months or two years now. And that is that we continue to see more opportunities than we have time to analyze and evaluate. So, we are continuing to go through the same routine I have described in previous calls where we periodically prioritize those and try to focus on what we think are the top one or two or three priorities at a potential sort of particular time and dig deep enough to make very intelligent informed decisions on what we are taking a serious look at.

Okay and maybe the last thing, on the margins, the guidance that was out there, a little bit less than last year. I guess that included the upward revisions you are seeing with the covered portfolio and the benefit of the Summit deal. I guess that was all included in the numbers. I realize the future potential acquisitions aren't, but it just seems a bit conservative not knowing how much below the 28 basis points, but just want to make sure those numbers were included in there and that seems fair.

Well, yes, they are. And if the guidance seems conservative, you -- Brian, you have known us and you and I have talked a number of times. You know we tend to be conservative in the way we think about things and I am glad we are. I like being conservative.

I hear you. Okay. Thanks a lot.

Blair Brantley, BB&T Capital Markets.

Good morning. Couple of questions for you. First, what is the spread on those -- for the floors for the variable rate loans? That you are putting on right now or are you putting on floors?

Yes, we are. Most of our loans, not all of them, have floors in it. And, hang on, let me -- what have I done? There it is. I am setting my -- I don't have all of this information in my head. I rely on sheets of information around here. So, let me tell you where we are on the floors.

Obviously, we don't get as high floors as we used to, which is one reason our yield on legacy loans has been coming down. But the upside of not getting as high floors as you used to is they react faster in a rising rate environment.

So if you looked today, and, again, 68.5% of our portfolio is variable rate. Of that, 93% of that 68.5% is at a floor rate. If we go up a 1/4 point, only 61% is at a floor rate. If we go up a whole 1% in rates, only 37% is at a floor rate.

So 66% of our variable-rate loans, or really, I guess, 73% of our variable rate loans will adjust by the time rates have gone up 100 basis points.

We have no loans at ceilings today. Not surprisingly. And if rates went up 400 basis points, only 9.1% of our loan portfolio would have hit a ceiling rate -- or 13.2% of our variable rate loans would have hit a ceiling rate in an up 400 basis point environment.

I think we disclosed in our last Q that we are somewhat asset-sensitive in an up 100, 200, 300, 400 basis point environment. The last models that I looked at showed that sensitivity growing as rates rose. We get more -- we are more asset-sensitive in an up 300 or 400 basis point environment than we are in an up 100 or 200. Greg, is that still correct?

And that is because we are a lower and lower percentage of variable rate loans are affected by the floors as rates rise. And the fact that we increased our variable rate loans as a percent of our legacy loan portfolio over 400 basis points in the last quarter, a big increase in variable rate loans as a percentage of total non-purchase loans and leases. That was a big move. That should make us even slightly more asset-sensitive.

Now, the Summit portfolio tended to have more fixed-rate loans in it. So we will have to -- we are still running models, simulation models, taking into account the data in their portfolio and the data in ours to see how that plays out. But, generally, I think we are probably even with the acquisitions probably tending to get slightly more asset-sensitive as we continue to increase that percent of variable rate loans and the non-purchased loan and lease portfolio.

Okay, thank you. Also, in terms of the purchase loans whether it is the covered or noncovered, how do you see that trending over the next year and a half or so? Are we getting to a point where some of these covered loans are going to stay on the books here? Is the pace picking up? Or what are you going to see there?

Well, you actually noticed if you look at covered loans quarter to quarter, the rate of paydown on covered loans decelerated in the quarter just ended. And that was a phenomenon I had expected us to see some quarters earlier than that. But we finally did see a deceleration in the rate of paydown on those. And I think you -- I think that continues. I can't be sure, but I think it continues and the reason I think it continues is we are getting through most of the nonresidential parts of those portfolios. And those portfolios are getting increasingly more residential.

And you have got two phenomena at work there. One, the loss share on the residential pieces is 10 years, not five. So, you have longer to resolve the problem residential credit than you did problem commercial credit. And number two, just by their very nature, the amortization terms on residential loans tend to be longer than the amortizations of commercial loans. So those loans tend to be stickier longer term on the balance sheet.

So I think we probably see the -- we continue to see those portfolios decline, but at a decelerated pace as indicative probably of our second-quarter rate of decline going forward. The purchased loans that are not covered, the non-loss share loans from the live bank acquisitions, I think you see runoff in those portfolios and those decline. And really for two reasons.

One is, there are credits in those portfolios that don't meet our standards. And we are going to very purposefully in a very orderly manner try to work those credits out to get the portfolios all up to our standards.

And secondly, loans just pay off and customers refinance and we will have customers who have a loan that is a purchase loan that will come in and want to refinance that, or change the terms, or change the borrowing entity or substitute collateral, or draw new money, or whatever, and we will refinance that as a legacy loan. And it will move from the purchase loan book to the legacy loan book.

Now we haven't seen a ton of that so far. I would guess in all the quarters we are going, there's probably only, Greg, $40 million, $50 million, $60 million of loans at the most that have either moved from loss share or purchase loans that have been refinanced into our legacy book. And that is over several years of loss share and a year plus, a year and a half plus of purchased loans. We have not moved a lot of things over.

But we have had some where customers come in and been at very low leverage and another bank was offering to refinance them at a higher leverage, or they wanted to combine properties, or do one -- move it from one entity to the other and to keep the business. It was good business. To keep it we had to refinance it. So it didn't move out of the purchased category into the non-purchased category.

So you'll see some of that happened, but over a longer term, all those portfolios will go away, either by loans paying off or the loans getting refinanced from purchased into non-purchased. But that is a long-term deal for them to all go away.

Okay. Thank you very much.

Any more questions?

Peyton Green, Sterne, Agee.

Good morning. Congratulations on a very strong quarter. With all the moving parts I am sure you have got to be very pleased with how everybody is executing.

A question maybe on the noncovered, acquired loans. What do you think a reasonable run off rate is? Is it -- there is a little bit of varying degree from one portfolio to the next on your live bank M&A. Certainly it won't be like the covered books, but is that something that you would think would be absent any other M&A, would be a little bit of a headwind going forward? Or not necessarily so?

Peyton, certainly it will be somewhat of a headwind because, as I mentioned, there are some loans in all of those portfolios that don't meet our standards that we will want to work out. So there is business in every one of the portfolios that we will want to work out. That is obviously going to be less of a factor in a portfolio like Summit, as compared to a portfolio like the Geneva portfolio. The Summit portfolio was much more closely aligned to our standards of underwriting and credit than any of the previous acquisitions. And that is a good thing because is the largest one and we paid the premium for it. So paid goodwill for it. So it ought to have been much more closely aligned.

But there will be some headwind. Those portfolios because they are all, even our most challenge purchase portfolio is vastly better than the loss share portfolios. The best of the loss share portfolios. Because of that quality differential from the live bank acquisitions, I would expect a much higher retention rate longer term from the customers for those.

So, it will be much less of a headwind than the runoff of the covered loans from the loss share portfolios has been.

And we have talked about this now for 3 1/2 years or 3 1/4 years that our ability to generate positive earnings momentum was challenged by the fact that there was a headwind from the runoff of the covered loan portfolios and then, more recently, parts of the other purchased loan portfolios. But 3 1/2 years ago, 3 1/4 years ago, on this conference call following earnings releases, we talked about the fact that we had a business model, a business plan in place that would generate significant organic loan growth and that we felt we would be able to put up very positive earnings trends notwithstanding the potential runoff from those portfolios.

And in July 2011, after our last two acquisitions, which we -- FDIC acquisitions -- which we didn't think were the last two, but we said if those were the last two, we still think we have positive earnings momentum notwithstanding the headwinds from running off of these portfolios. It is much easier to see the evolution of that business strategy after the growth we have achieved in recent quarters and the last year or two organically. But that continues to be our strategy.

We are running the Company as if any acquisition was our last. We don't ever think it is, but if the last acquisition -- Summit was the last acquisition we ever make and I actually don't think it is, but if it was, we think we have got the organic growth vehicles, capabilities, infrastructure, personnel in place that we can continue to put up very positive earnings trends going forward. And that is our business plan and goal.

Okay and what was the loan yield at Summit? Maybe date of acquisition and then what was the yields- in the second quarter or the fair value adjusted yields?

Peyton, I don't think I have that broken out. The -- you are going to have to look at the purchased non-covered loans and look at Q1 which included everything through Omni and just a part of a quarter for Omni and then look at Q2. And obviously that category of loans more than doubled as a result of the Summit acquisition. And the impact on the yield there is largely going to be attributable to having one-half quarter and it was almost exactly a half quarter of the Summit results embedded in that.

All right. Is there any difference in the duration of their portfolio versus yours? Is it -- I would expect it to be a little longer lived maybe than yours.

Yes. It is. And their portfolio has more fixed rate loans in it than our portfolio does. Not nearly the percentage of variable-rate loans. There's -- hours is basically two thirds variable and one third fixed. A little more variable than that.

Theirs is probably about the opposite of that. They didn't do a lot of long-term fixed-rate loans, but they did do some fixed-rate loans and they would tend to do more five-year deals where we would tend to do more two- or three-year deals. So that helps the stickiness of their portfolio in that those loans don't naturally come up for renewal or modification as quickly as they would if they were in our portfolio.

Sure. That's perfect. Then what type of special does it take to drive deposit growth? I know you have talked about priming two or three or four handfuls of branches to grow interest-bearing deposits in markets where you don't have such significant share of that don't want to really notice. But in the aggregate you could drive some pretty meaningful deposit growth. Is there a loan deposit type ratio that when you hit that you are more worried about? Or is it just simply trying to stay out in front of the funded loan growth? How should we think about that?

It is very simply, we have got to fund the loan growth. And we have 10, Greg, 10, nine, 10, 11, 12 offices in spin-up mode right now?

I think that number at -- let's just say 10 approximately, Peyton, and that will be one or two off and we started early in Q2 spinning up probably the first four or five or six and added a couple of more and then added a couple of more. So we have got a fair number of offices now.

I was very pleased we were able to accomplish some pretty significant organic deposit growth in the quarter without moving our cost of interest-bearing deposits. I think it was flat from Q1 to Q2, wasn't it, Greg? But I think what you will see is a 1 to 2 basis point a quarter. A small uptick in our deposit cost going forward as a result of spinning up these offices.

If I have to generate another $200 million, $300 million or $400 million a quarter to fund growth going forward, we are going to have to get a little more aggressive to accomplish that. But our spin up strategy, which is a very strategically designed market segmentation strategy, is working well. It is helping us to grow deposits as we need them without materially moving our overall cost of funds. So we are real pleased with that strategy.

We first tested that strategy in Q2 and Q3 last year after a big Q2 loan growth number. And we clearly identified, as we were looking at funding forecast potentially for this year, that we were going to have to get back in it early Q2 and accelerate it throughout Q2. We expect to probably further accelerate it in Q3.

It is working like it was designed to work. Helping us grow as we need to at a minimum cost, incremental cost of funds. 20

And is it a CD-oriented grab, or is it a combination of CD and transaction account? What -- ?

It is a combination.

Okay. Great. Thank you very much, George. Appreciate the color.

Next question.

Brian Zabora, KBW.

Good morning. A question on the loan loss provision expense in the quarter. Obviously with a strong loan growth you expect that to be higher in the quarter. Is there any metrics we should look at going forward as far as maybe reserve to loan ratio or the provision as a percentage of originations that we should keep in mind as we think about the loan growth continuing?

Brian, we have got a model that we follow and follow it religiously. We are going to go wherever that model says we go. Now, obviously the new loans we are booking have very favorable risk ratings, so they are -- you obviously don't make loans that are going to have special reserve or special allocations assigned to them at the get-go or loans that are going to have adverse ratings that you are going to assign higher allocations to.

So, the total overall percentage of allowance for loan and lease losses as a percent of non-purchased loans and leases has been declining over the last several years and declined in the last quarter. And that simply results from the fact that we had a big bunch of loan growth last quarter. The risk ratings assigned to those new loans, because we think they are very high quality, was lower than the average overall risk rating of the total portfolio.

At the same time, some loans that we had that we had specific allocations for resolved, or were charged off. And those allocations went away in the last quarter and the result was that the required allowance percentage went down from where it was at the prior quarter.

So, we are going to continue to follow that model. We think it is a very good prudent model. If we can continue to improve asset quality in the loans that are already on the books and have diminished specific allocations or have risk rating on loans improve so that less allowance is allocated to those loans, and if we continue to book new high-quality loans and have lower allocations for those than the average what is on the books, then that percentage will blend down.

If on the other hand, we start having adversity, which I don't think we will, but when it looks like the portfolio is getting better, not worse, but if economic conditions turned and we started having specific allowances for loans that increased, then that percentage would increase. So we are going to follow the model and if we keep doing a good job of evaluating credit quality and booking good quality loans and cleaning up things that are still in the portfolio that we have got specific allocations and reserves or high risk ratings on and we can improve them to a more favorable risk rating. That should have favorable implications for that reserve, that allowance level and the percent -- allowance allocation percentage level in the future.

Great. And on the leasing group, you talked about expanding that group. I wanted to see if you provided an update of hires or where you stand and if you maybe should -- you will be likely making additional hires throughout the year.

I think they are all the time looking to hire quality people and our model for that is a very disciplined and structured model. So we are looking for guys that can operate in a very specific environment. You hire a half-dozen of them, you do a good job hiring, you are probably going to get four or five guys out of that half-dozen that can make it and be part of the team. And you have got one or two or three that for some reason don't pan out, and can't achieve what we want them to achieve.

So it's a constant process of refining the team and making sure the guys you have got on the team are doing a good job. And it is like if you are playing for a national championship in basketball and you have got a guy on the team and he can't score, you have got to put that guy on waivers or cut him and find a guy that can produce. And so, there is a constant building of the team, refining of the team.

But the long-term objective is to continue to grow the leasing division. So they are looking to be a net higher, a net adder of loan originators over the course of this year and that, we expect that to continue next year.

Thanks for taking my questions.

You have no further questions.

All right. There being no further questions at this time, that concludes our call. Thank you so much for your time and attention today and your good questions. We look forward to talking with you in about 90 days. Thank you so much.

This does conclude today's conference. We do thank you all for your participation.