Bank OZK (OZK) Q1 2012 Earnings Report, Transcript and Summary

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

Good morning. I'm Susan Blair, Executive Vice President, in charge of Investor Relations for Bank of the Ozarks. The purpose of this call is to discuss the company's results for the 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 future plans, goals, expectations and outlook. To that end, we will make certain forward-looking statements about our plans, goals, expectations, thoughts, beliefs, estimates and outlook for the future, including statements about economic, real estate market, competitive, credit market and interest rate conditions; revenue growth, net income and earnings per share; net interest margin and potential for further improvement in our cost of interest-bearing deposits; net interest income; non-interest income, including service charge income; mortgage lending income; trust income; net FDIC loss share accretion income; other loss share income and gains on sales of foreclosed asset, including foreclosed assets covered by FDIC loss share agreements; non-interest expense; our efficiency ratio; asset quality and our various asset quality ratios; our expectations for provision expense for loan and lease losses; net charge-offs and our net charge-off ratio for both non-covered loans and leases, and covered loans; our allowance for loan and lease loss; loans, lease and deposit growth, including growth in our legacy loan and lease portfolio through 2014 and growth from unfunded closed loans; changes in the value and volume of our securities portfolio; the opening and relocating of banking offices; our goal of making additional FDIC-assisted failed-bank acquisitions; and other opportunities to profitably deploy capital. You should understand that our actual results may differ materially from those projected in any forward-looking statements due to a number of risks and uncertainties, some of which we will point out during the course of this call. For a list of certain risks associated with our business, you should also refer to the forward-looking information caption of the Management's Discussion and Analysis section of our periodic public 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 statements and are not guarantees of future performance. The company disclaims any obligation to update or revise any forward-looking statement based on the occurrence of future events, the receipt of new information or otherwise. Now, let me turn the call over to our Chairman and Chief Executive Officer, George Gleason.

Good morning, and thank you for joining today's call. Our first quarter results are an excellent start for 2012. Our solid first quarter earnings and significant improvement in asset quality ratios are a result of hard work and meaningful contributions from team members throughout our company. We've got a lot to talk about today, so let's get to it. Net interest income was -- is traditionally our largest source of revenue, increased 21.5% in the quarter just ended compared to the first quarter of last year. But it decreased 4.4% compared to the fourth quarter of last year. Of course, net interest income is a function of both net interest margin and the volume of average earning assets. In the quarter just ended, both our net interest margin and volume of average earning assets increased significantly compared to the first quarter of 2011 specifically in this year's first quarter compared to last year's first quarter, net interest margin increased 37 basis points and average earning assets increased 11.9%. On the other hand in the quarter just ended, net interest margin decreased 7 basis points and average earning assets declined 1.4% compared to the fourth quarter of last year. In our January conference call, we stated that we expected our net interest margin would fluctuate over the course of 2012 in a range of from 6.05% down to 5.80%. Our 5.98% net interest margin in the quarter just ended was within the upper 1/3 of that guidance range. We continue to believe that the 6.05% to 5.80% guidance range is appropriate for the remaining quarters of 2012. Our first quarter net interest margin of 5.98% is outstanding and is truly the result of a team effort. Our deposit pricing committee has done an excellent job understanding our markets and our competition while focusing on profitability. For example, in the quarter just ended, they reduced our cost of interest-bearing deposits by 4 basis points, and they expect to see additional improvement in our cost of interest-bearing deposits in the coming quarters. Our retail banking team has done a great job in adding large numbers of core deposit customers and dramatically improving the mix and profitability of our deposit base in recent years. That mix improved even further in the quarter just ended. On the other side of the balance sheet, our lending and leasing teams have continued to achieve good pricing on loans and leases on our legacy markets. In the quarter just ended, the yield on our non-covered loans and leases was 6.03%, giving us an enviable 5.55% spread between our yield on non-covered loans and leases, and our average cost of interest-bearing deposits. Of course, our teams working on FDIC-assisted acquisitions have given our net interest margin an extra boost and the excellent yields -- with the excellent yields on our covered loans. In the quarter just ended, our non-covered loans and leases grew $8 million from the balance at the beginning of the year. Notwithstanding this modest first quarter growth, we still expect to achieve our full-year growth targets for loan and lease growth. The commitments and contingencies footnote contained on pages 98 and 99 of our recently-issued annual report reflects that our outstanding loan commitments almost doubled from $166 million at year end 2010 to $313 million at year end 2011. Since we seldom issue loan commitments, this $147 million increase during 2011 was almost all due to the increased volume of closed loans not yet funded. Because we closed a number of additional loans in the quarter just ended, that commitment amount increased another $78 million to $391 million at March 31. This growing volume of closed loans still to be funded, coupled with the excellent pipeline of loan requests on which we are currently working suggest to us that we will achieve our goal of a minimum of $240 million of growth in non-covered loans and leases in 2012, a minimum of $360 million or $30 million a month on average in 2013, and $480 million or $40 million per month on average in 2014. We are reiterating today our prior loan growth guidance for all 3 years. This growing volume of unfunded loans is due to a couple of factors. First, despite the highly competitive markets, we are finding many opportunities for good quality, good yielding loans. And second, as most of you know, we get a lot of cash equity in most of our transactions. As noted on Page 22 of our recent annual report at December 31, we had weighted average cash equity of 41% in our construction and development loans which had interest reserves. Of course, that included a majority of our construction and development loans. Those of you who have followed this statistic in our periodic reports over the past several years will realize that this cash equity percentage has increased from the high 20% to low 30% range when we first started reporting this number some years ago, up to the current 41% cash equity figure. Getting this much cash equity in transactions tends to make for great asset quality but it also delays loan funding since our cash equity is almost always put in first, meaning that we are funding our loans later in the development process. We have a growth pipeline that is flowing robustly as evidenced by the $78 million increase in closed but unfunded loans in the first quarter, and we fully expect to see loan and lease growth materialize consistent with our guidance. Let's shift to non-interest income. Income from deposit account service charges is traditionally our largest source of non-interest income and historically the first quarter has typically accounted for about 22% of our annual service charge income. In the quarter just ended, service charge income increased 22.3% compared to the first quarter of last year and reflecting normal seasonality was down 4.9% from the fourth quarter of last year. Obviously, our growth in core deposit customers has had, and should continue to have, favorable implications for income from deposit account service charges. Mortgage lending income in the quarter just ended was up 61.7% from the first quarter of last year. Typically, our first quarter mortgage lending income is adversely affected by seasonal factors, but our mortgage lending income in the quarter just ended was down only 4% from the fourth quarter of last year. Our excellent first quarter mortgage income results likely benefited from the unusually mild weather in a number of our markets combined with modest improvement in housing market conditions. A number of our markets have seen some increased volume of home purchase activity over the course of the quarter. Trust income in the quarter just ended was down 1% from the first quarter of last year. We're continuing to see growth in personal trust and employee benefit trust income, but corporate trust income has decreased. Most of our corporate trust income has derived from fees earned for services in connection with new municipal bond issues, and municipal bond issuance has been at very low levels for more than a year. Net gains from sales of other assets increased to $1.55 million in the quarter just ended compared to $0.41 million in last year's first quarter. Net gains realized in the quarter just ended were primarily attributable to gains on sales of foreclosed assets covered by loss share agreements which we refer to as covered OREO. When we acquire such foreclosed assets and FDIC-assisted acquisitions, we mark those assets to estimated recovery values and then we discount those estimated recovery values to a net present value utilizing an appropriate discount rate. Unlike covered loans, the net present value discount on our covered OREO is not accreted into income over the expected holding period of the covered OREO. Because of this, we are very likely to see net gains from sales in future quarters for some time to come. This has been evident in each of the last 7 quarters. In the quarter just ended, we recorded $2.30 million of income from accretion of our FDIC loss share receivable net of amortization of our FDIC callback payable. As part of our FDIC-assisted acquisitions, we record a receivable from the FDIC based on expected future loss share payments, and we record a callback 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 related callback payable are discounted to a net present value utilizing a 5% per annum discount rate. The net discount amounts are then accreted into income over the relevant time periods and in the quarter just ended, the resulting net accretion income was $2.30 million, down slightly from $2.36 million in the immediately-preceding quarter. This accretion income will be an ongoing source of income for us as long as we are under the loss-share agreement. Of course, the amount of net accretion income will tend to diminish over time as loss share winds down. In addition, non-interest income in the quarter just ended included other loss share income of $1.98 million. This line item includes certain miscellaneous debits and credits related to the accounting for loss share assets, but it consists primarily of income recognized when we collect more money from covered loans than we expected that we would collect. We refer to the additional sums collected as recovery income. Since we tend to be conservative in the way we value covered assets, which is certainly appropriate given the uncertainties surrounding many of those assets, it is likely that this other loss share income will continue to be a meaningful income item for many quarters to come. Because it can be significantly impacted by prepayments on covered loans, other loss share income will vary from quarter-to-quarter. We believe that our accounting, including our valuations for covered assets in connection with all 7 of our FDIC-assisted acquisitions, has been appropriately conservative. You can see our conservative philosophy in 4 line items of our income statement. First, the 8.60% effective yield on our covered loans in the quarter just ended reflects the substantial discount rates we utilize to determine the net present value of covered loans. Second, the significant net accretion income from our FDIC loss share receivable reflects the 5% discount rate we utilize to discount those assets to net present value. Some banks have used discount rates as low as 2%. Third, our other loss share income, mostly recovery income as we've previously discussed, reflects the fact that our lending and special assets personnel have done a great job so far in maximizing recovery on covered loans. And fourth, our gains on sales of other assets for the reasons previously mentioned reflect the conservative accounting for covered OREO and the effective work of our staff in selling these assets. You will note from our press release that we had $1.53 million of provision expense in the quarter just ended for covered loans. Obviously, that number reflects covered loans where we were not conservative enough in our estimates of cash flows. However, if you consider that number in the context of our $1.55 million in gains on sales of assets, mostly covered OREO, and our $1.98 million of other loss share income, mostly recovery income, you can see the overall conservatism with which we have valued these acquired portfolios. We continue to be very pleased with the current performance and future prospects of all 7 of our FDIC-assisted acquisitions. Although the pace of bank closings has slowed noticeably in recent months, we continue to expect that there may be a couple of hundred more failures over the next 2 or 3 years, and we continue to be actively pursuing such transactions. Let's turn to non-interest expense which increased 9.2% in the quarter just ended compared to the first quarter of last year. In our last conference call, we noted that with our systems conversions completed and the follow-up training done for all 7 of our acquisitions, our non-interest expense in the first quarter of 2012 should reflect a more normal level. Consistent with that guidance, our non-interest expense in the quarter just ended declined for the third consecutive quarter. Excluding any increase in non-interest expense that might result from any additional acquisitions, we expect some further reductions in non-interest expense in the next couple of quarters compared to the quarter just ended. With that said, we are certainly continuing to grow and expand. For example, in January -- on the 3rd of January, we opened an expansion office in Austin, Texas for our Real Estate Specialties Group. In February, we opened our 9th Metro Dallas area office in The Colony, Texas. In the third quarter, we expect to open our 10th Metro Dallas office in South Lake, Texas; our second office in Mobile, Alabama and an expansion office in Atlanta, Georgia for our Real Estate Specialties Group. In the fourth quarter, we expect to relocate our long-standing Charlotte, North Carolina loan production office to a full-service banking office we are building, and we are also working on potential fourth quarter relocations of our offices in Bluffton, South Carolina and Wilmington, North Carolina from our current leased facilities to new improved facilities which we hope to acquire. Obviously, these new offices in Texas and throughout the Southeast reflect the growing importance of Texas to our company and our shifting to a more offensive-minded business strategy in our newer Southeast markets. One of our long-standing and key goals has been 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 the significant improvement in our asset quality ratios in the quarter just ended. Our annualized net charge-off ratio for non-covered loans and leases was 44 basis points for the quarter -- for the first quarter of this year compared to 72 basis points for the first quarter of last year and 69 basis points for all of last year. At March 31, 2012, excluding covered loans and covered foreclosed assets, our ratio of nonperforming loans and leases to total loans and leases was 61 basis points, which is a 9 basis point improvement from year end, and our ratio of nonperforming assets to total assets was 77 basis points, which is a 40 basis point improvement from year end. Similarly, excluding covered loans, our ratio of loans and leases past due 30 days or more including past due nonaccrual loans and leases was 86 basis points, which is a 70 basis point improvement from year end. In our January conference call, we stated that in 2012, we expect to see some further improvement in our net charge-off ratio compared to 2011. But we also stated that we expected provision expense to go up in 2012 because of the strong growth we are projecting in non-covered loans and leases. That guidance continues to reflect our expectations for the full year of 2012. Of course as we said in January, we don't mind incurring provision expense at a higher level if the increase is due to growth in our portfolio of quality loans and leases. In recent years, we have accumulated a sizable war chest of capital through retained earnings. Our excellent earnings and resulting capital growth continued in this year's first quarter, pushing our ratio of common equity to assets up to 11.54% and our ratio of tangible common equity to tangible assets up to 11.26%. We believe that we will have numerous opportunities over the next several years to profitably deploy our accumulated capital and that the most immediate capital deployment opportunity we foresee is growth in our legacy loan and lease portfolio, which we've seen signs of in each of the last 3 quarters. The second most immediate opportunity we foresee is additional FDIC-assisted acquisitions. A third opportunity relates to traditional M&A activity, an area on which we have not traditionally focused, but which we think will provide more favorable opportunities for us in the future. And the fourth opportunity will continue to come from whenever interest rate increases occur in a significant way, and we consider it timely to reload our investment securities portfolio. In closing, the quarter just ended with its net income of $18 million has provided an excellent start to the year. Our goal, which we believe is a reasonable goal, is to improve on our first quarter earnings in each succeeding quarter of 2012. That concludes my prepared remarks. At this time, we will entertain questions. Let me ask our operator to once again remind our listeners how to queue in for questions. Operator?

[Operator Instructions] We'll go first to Michael Rose at Raymond James.

My first question relates to the drop in the non-covered loan yield. Just a sense of what you're seeing on pricing. I assume most of the quarter's growth, although it was somewhat muted -- this quarter is coming from Texas, can you talk about the competitive trends there where new loan spreads are?

We're seeing very competitive conditions in a lot of -- a lot of our markets. And Little Rock is probably one of the most competitive markets. So we've seen really tough pricing comparisons and banks doing things on credit terms that we would just consider foolish. So we're not going after tons of really cheap business. We're not going after anything that we think has gotten overheated on the credit front. But one of the great assets of our company is the fact that we have such a strong origination platform in our Real Estate Specialties Group in Texas. Those guys last year saw $8 billion of loan applications. I think that number will be 25% to 50% higher than that this year based on what deal flow they're seeing. We screened that $8 billion and did thorough comprehensive underwriting on about $2.5 billion to $3 billion of that. And the closings in that office last year were approximately just rounding off $320 million. So basically, those guys closed about 4% of the loans that they looked at last year. I expect that number will be somewhat higher than that this year just because we continue to refine and improve our processes. But if you're looking -- if you're closing 4% or 5% or 6% or even 7% or 8% of the loans that you -- opportunities you look at, then you're able to screen out all of the loans that don't meet your super high credit standards, and you're able to screen out lots and lots of loans that would be really good credits but they're just priced too cheap to have an appropriate risk-adjusted reward. So because we are seeing so many opportunities particularly in that office, but in a few other locations as well, we're fairly confident about our ability to continue to get yields on our loan originations that are better than the average bank can get on their loans. And that's why we've given guidance that we think the margin this year, even with the runoff in some of the covered loans and so forth, will range from that 605 of the fourth quarter of last year down toward that 580 of the third quarter of last year. And the first quarter seems to sort of validate that assumption. So having a little margin compression is not surprising, but it's hard to not be really excited about having a 598 margin. I mean, that is a world-class margin. So yes, we are seeing a lot of competition, but we are seeing a lot of volume and we think that that's going to translate into really good growth over the course of the year without too much erosion in the profit margin.

And, George, can you discuss what the core margin is excluding the accretion and what it was last quarter?

Yes, I gave that in my remarks. If you take our yield on non-covered loans and compare that to our yield on interest-bearing deposits, the spread was 555 this quarter, and I think that number was 573 last quarter. And that 8 -- I think it was an 18 basis point quarter-to-quarter swing, but you could read more into that than should be read into that. There were various and sundry factors that affected that. I don't think you'll see much movement in that spread over the next couple of quarters, actually. I think that swing -- Q4 was probably an unusually high spread, and Q1 probably is a more normal spread. I don't think you'll see much compression in that. As I said in my prepared remarks, we expect our cost of interest-bearing deposits to continue to decline over the next couple of quarters. I would guess we'll see some decline in the yield on the non-covered loan portfolio as well. But I think our cost of interest-bearing deposits for the next couple of quarters will be a significant mitigating factor offsetting that.

Fair enough. And one more if I can, just on how you're looking at capital at this point. Obviously, if you see it almost 11.3%, the payout ratio here is still in kind of the low 20% range, have you given any thought to giving a more material increase to the dividend?

Well, I think we will as I said in my prepared remarks. I think we'll have ample opportunities to profitably deploy that capital. And you may have noted in my remarks that I shifted the order of priority of those 4 things that I think will ultimately result in us deploying that capital. And I shifted organic loan and lease growth to number 1 from number 2 and dropped FDIC acquisitions from 1 to 2 because obviously the pace of those resolutions by the FDIC, while it's -- I think there's still a lot of them coming, the pace has slowed. So -- and but the positive thing about that shift in order is we are seeing a tremendously accelerating top line of opportunities for loan and lease originations. So I'm not only reiterating the guidance of $240 million in non-covered loan and lease growth this year, but I emphasized in my prepared remarks the word "minimum" because I think that really is a minimum number. And we're getting so much equity in so many transactions now that a lot of loans that we're closing this quarter and that we closed in the first quarter won't have material funding or any funding until 2013, or really late 2012 but at the same time, we've also got a huge pipeline. We've got the best pipeline of loans today in queue for closing that we have ever had in the history of the company. And when I'm talking about loans and pipeline in queue for closing, I'm talking about loans that are approved that the customers have agreed to, documentation has been prepared and they're lined up waiting to be closed as the lawyers finish preparing the loan documents and so forth. We're at an all-time high in that. So we're feeling pretty optimistic about our ability to really generate the loan growth in 2012, 2013 and that -- a lot of those deals, the larger more complex transactions, will have funding that will drag all the way out into 2014. So we are really seeing that pipeline of future growth build. Because we are getting so much equity in most of those transactions, again, it's some quarters out after you close them before they actually start funding in a lot of cases. But that growth is coming. So we think that's going to be the preeminent vehicle and the most profitable vehicle for capital deployment.

We'll move next to Dave Bishop with Stifel, Nicolaus.

In terms of that -- the closed loans you had funding, has there been any sort of change in terms of the tenure, the other lending types of loans here or they're still predominantly, as you alluded to, construction type of commercial real estate loans that you have yet to fund?

That would be correct, yes. They're predominantly construction and development, commercial real estate loans. Exactly.

And then in terms of -- you said in terms of the outlook for expense growth, you mentioned some realignment in terms of both North Carolina and Atlanta. Obviously, a lot of the growth is still dominated by that Central Texas region, Arkansas. What are you seeing out there in the sort of the hinterlands of the franchise yet? Any sort of inklings in demand especially in Atlanta?

We are actually seeing a few opportunities. And one of our long-standing lenders from Central Arkansas here who, when we started making acquisitions, took over as one of the 2-person teams overseeing 2 of our acquired banks in Georgia has been evolving her role in the company over the last several months into a role with Real Estate Specialties Group. So we expect her to relocate to Atlanta probably around the end of June or the 1st of July, and we will open it -- what will probably be our 28th Georgia office at that time in Atlanta. And that will be a satellite office of our Real Estate Specialties Group team utilizing their screening capabilities, their underwriting capabilities, their closing and servicing capabilities to allow us to look at larger commercial real estate and construction development transactions in Georgia. Now the real estate economy in Georgia is still severely oversupplied in almost every category. But we are seeing for some really national credit tenants, some opportunities to do some build-to-suits on stores' locations that they want to open. And ìn very carefully selected locations on really marquee primo properties that have really strong tenant basis and good tread on the leases and so forth, we're seeing some opportunity. So it's a market we've really got to be careful because it is, in a general sense, oversupplied across almost every category of product in the market. But there are selected properties, selected projects with particular tenant profiles and locational advantages where you can do some good business. So we want to start getting in and really carefully cherry picking and mining some good business opportunity. So that location of that new office and the realigning of how those Georgia offices have previously handled real estate lending to really bring it into our highest level of underwriting documentation and servicing standards is an important step to us getting more offensive-minded in Georgia. And of course, the opening of our second office in Mobile, Alabama later this year, the relocation of those Bluffton, South Carolina and Wilmington, North Carolina offices to new, expanded and enhanced purchase facilities that we've got under contract and the relocation of our Charlotte loan production office into a full service banking operation in a new facility we're building there, all reflects the fact that we think there is really good potential in the Southeast and that's going to be a really important growth area for us in the future. That's going to be much more 2013, 2014, 2015 than it is 2012 growth. But you've got to put the platforms in place and build what you need to capitalize on those future opportunities now.

We'll move next to Matt Olney with Stephens.

Going back to your organic loan growth commentary, it seems like the unexpected paydowns were a problem in 2011, was this also an issue in the first quarter? And what are your thoughts on this in 2012 given many of your competitors are getting very aggressive on pricing and in some cases, getting very aggressive on structure?

Yes. We had 3 significant paydowns in Q1. One of them was a multifamily project that we had done the development on and it was a 50% loan to cost project. It was a Texas property. We really liked the project. They had built it, they got it stabilized and doing really well. While we really liked the project, what they wanted to do, they wanted us to basically refinance out their -- their equity and increase our leverage in the project. And while the project was a great project, the financial profile of the borrowing entity on that just was not one that we were comfortable in taking out their subordinate debt piece and reloading the thing with a higher leverage. The numbers worked fine on it at a higher leverage, but we just had some concerns about doing that so we let that business go. We had a pretty sizable C&I loan, $12 million or $13 million loan that we got paid off on in the Southeast or really I guess mid-Atlantic area. That was a nice piece of business, but our risk-adjusted pricing model on it for just -- was a lot higher pricing than where they got it refinanced. And we liked the customer and liked the piece of business, and I'm sure we'll do business with that customer in the future but when they showed us quotes they got from a couple of the mid-Atlantic competitors, we just said, wow, those guys really want the business and when we put our risk-adjusted pricing on it, it just didn't fit. So we thanked them for the opportunity and let that go, and we'll look for new opportunities to do business with those guys in the future. And then we had one other loan that at the moment is escaping me. It was a $10 million-plus -- yes, yes, yes. We had a large timberland loan that was down in -- I guess that would have been in the Igraph [ph] loan book that got refinanced. That was a pricing deal, and there were some relational attributes to that, that affected that opportunity. So we lost that piece of business, but we're already having dialogue with that customer and we've actually introduced that customer to a couple of other really good business opportunities that we just knew about from other customer relationships we've have in another state. And we've introduced that customer to those opportunities and we're already having dialogue with them about 1 or 2 new opportunities there. So it was nothing problematic and I don't think it's anything that would indicate a wave of payoffs. I think a lot of the things that were going to pay off and refinance have done that and my guess is the first quarter probably had -- will probably be -- could be the high point of the year as far as sort of unexpected payoffs on things.

All right. And then just shifting over to on the credit quality side, the OREO balance is just now $18 million, can you give us an idea of what's in that OREO balance?

A lot of stuff. It is an assorted menagerie of stuff. We had an exceptionally good quarter in selling OREO. We sold about 100 properties in our loss share covered OREO book. We sold 74 properties for $7.5 million. Of course, we put a whole bunch more in there as well but had some really nice liquidation. We sold that large land tract we talked about in Texas in several previous calls and we sold quite a few other smaller properties. We had close to, counting covered OREO and non-covered, we had close to 100 sales in the first quarter. And I would guess that we're on track to have that many or even more sales in Q2 from the number of OREO sale case studies that I've read and signed off on. There is -- there is a lot of work being done on that and we're seeing a lot of activity out there. So that, we view that as very positive.

And then lastly, do you have the OREO write-down amount for the first quarter?

It's about $900,000 -- $994,000. So last time we almost hit $1 million. But I suspect that number obviously with these OREO balances getting less and less and us having very aggressively written down lots of these assets, our philosophy is we have them and if they don't sell, we write them down and if they don't sell in the next couple of quarters, we write them down. We just keep adjusting values until we get them down to where we can push them out. So I would expect that number will have a declining trend most likely and that's part of the reason for our guidance that we expect non-interest expense will decline over the next couple of quarters, even further from that Q1 level because we're expecting a moderation in that OREO write-down cost.

We'll go next to Kevin Reynolds at Wunderlich Securities.

Rather than focus on sort of next quarter, next couple of quarters, I want to ask you kind of a bigger picture question. You talk about loan growth, offering guidance in round numbers out through 2014, I'm assuming that between now and then, we'd probably get higher rates. You've mentioned your core margin here in the near term hanging in there because you got some flexibility. What do you think your margin does in round numbers over the sort of 3- to 5-year period from a kind of a 6-ish level? And then I guess, if the assumption is that it doesn't go a lot higher and may come down a little, I don't mean to put words in your mouth, but if it offsets the efficiency ratio, I think you're running a little higher than you have in the past before you made acquisitions. How low do you think you could bring the efficiency ratio down and still maintain service levels now that your footprints -- sort of a larger multistate footprint than it has been in the past?

Well, let me tell you as far as giving 3- to 5-year guidance on margin, I'm not prepared to try to do that. I didn't consult my Ouija board, of course, I don't have a Ouija board but I think I might have to buy a Ouija board to try to give you 3- or 5-year guidance on margin. We're in such extraordinary times with the unprecedented monetary and fiscal policy initiatives of our federal government and just changing world landscape with China and what's going on there and what's going on in Europe -- and the deficits we have both from a budget and a trade point, it is really hard to know. So our philosophy is that we're not smart enough to know what's going to happen to interest rates long term, so what we try to do is just maintain our balance sheet as close to a neutral interest-rate risk position as possible. So if rates go up 500 basis points, we're still making really good margins and if rates went down further, which is hard to figure that out. But whatever happens to rates we've got a fairly consistent net interest income number that has not moved significantly one way or the other by increases or decreases in rates. And I think that the interest rate world that we're going to be in longer term is going to be more volatile even than it's been in the last 15 years. So we're paying more attention to interest rate risk management than we probably ever have and what is amazing to me is how many banks are extending the duration of their portfolios out of desperation for yield and earning assets, and I think taking extremely high levels of interest rate risk based on my estimates of what some of these other banks are doing. So we're going just the opposite way and trying to be more judicious than perhaps we've ever been before in controlling interest rate. So I would say that. The second big picture thing that I would tell you is that if you look back at a 15-year history of our company since we went public. Back in the 2000 range, our margin got beat up in there and our margin got beat up in the kind of '05, '06, '07 timeframe, I guess. And one of the reasons that our margin got beat up in those 2 timeframes was we were so CD oriented. Our deposits were 70-plus percent CDs, and we just didn't have this powerful, very profitable core deposit banking franchise and Tyler Vance and the retail banking team really started to reengineer all of that in the first quarter of 2008 and our entire retail banking team has just done a phenomenal job. And now -- and I keep thinking we can't get it any better but in the last quarter our non-CD deposits at period end were 70.65% of total deposits and on an average basis for the quarter were 69.21% and both those numbers were 1% plus better or about 1%, 90 basis points and 184 basis points better than they were in the fourth quarter. So the guys just keep improving the mix of the deposit base, and you can see that in not only the fact we're continuing to take cost out of our interest-bearing deposits and as I alluded to in the prepared remark, we expect to continue to do that. But you can see that in the fact that even with the new service charge regulations on overdrafts and so forth that went into effect July 1 of last year, our service charge income is just having really nice growth and that reflects this more valuable deposit base. So I don't think that deposit costs gyrating wildly and particularly CD cost deposit gyrating wildly will create the challenges for us in maintaining a net interest margin that we're real happy about in the future like it has in the past, because we're just a different company from a deposit perspective now than we were 5 years ago. And that gain in the profitability of our core franchise is also a significant reduction or a significant factor in reducing the volatility of our margin going forward. So I think we're going to be a lot better off than we would be if we didn't have this deposit base transformation. So let me leave your 3- to 5-year margin question with just those sort of 2 general comments and as we get further out, we'll have more commentary on where we think those numbers are going to be.

Okay. And then going to sort of the efficiency ratio and some of your comments about your ability to monitor interest rates and that volatility and protect the balance sheet started me thinking down the path of a lot of smaller banks out there that may not have the expertise or the resources to do that as well as you. Do you think -- this is actually kind of a branch question as well -- I mean, you've got 113 offices now and a footprint that extends from Texas over to Florida. How many offices do you think you probably need long-term to really exploit the opportunities there? And do you think you'll be having opportunity to pick up some small banks that don't see this interest rate risk coming ahead of them or don't have the resources to more effectively manage it like you might be able to?

Well, I think the smaller you are in the industry, particularly once you get below $1 billion, the interest rate risk environment, the challenges of being able to produce earning assets, the growing regulatory burden on small banks, the complexity of accounting within our industry, there are just a whole lot of reasons that it takes a really special few people to effectively run a really small bank, and I think there will be a lot of small bankers that will tire of the challenges of successfully managing a small bank or find it impossible to any longer generate earnings they are happy with as a small bank. So I think there will be a significant wave of consolidation coming in, and we would hope that we could find transactions that would be very lucrative for our shareholders that we can get done. So yes, I think that exists. Now, the more important question, I think, is your question about, guys we've got 113 branches, how many do we need and how many will we need and I would answer this, today, I need about 60 of those branches. We could fund our balance sheet with 50-something less branches today and be immensely more profitable. But I believe in 3 years or 4 years, with the growth that I think will actually materialize in our franchise and the opportunities that I think are before us, I'll need 120 branches. And in 5 years we'll need 130 or 140. So we've built 4 or acquired 4 new branches in the Dallas Metroplex in the last year and all 4 of those were acquired Wachovia, Wells Fargo, duplicate branches. Wells Fargo and Wachovia both had great branch networks in the Metro Dallas area that largely overlapped each other, and we bought as many of those branches as we could that they own. They only owned about 7 of them, the rest of them were leased. But I think we bid on 7 and got 4 of the 7 branches we bid on. And they're great facilities. And the last thing in the world I need now is another branch and the overhead of another branch because I've got more branches than we need to fund the balance sheet we have today. But here's the deal on that. In Metro Dallas area it's very difficult to buy strategic locations. Most developers when they develop big power shopping centers or whatever, big development projects, they won't sell the out parcels because they want to lease them, and keep that constantly-growing income stream for decades or centuries to come. So you can't buy the really primo locations in a lot of cases, which is why 80% of those Wachovia and Wells Fargo duplicate branches we looked at were leased instead of owned. And we like to own our real estate because it's much more cost-effective for us, much more efficient for us to own the real estate. So number one, by buying those branches, I'm buying branches and locations that I may never -- if I pass this opportunity, we may never be able to buy those sites again in my lifetime or the lifetime of Greg McKinney and Tyler Vance and other managers in our company who will probably live longer than me. They may never have another shot at those. And number two, buying them in this economy, we're probably in those at 60%, 70% of what it would cost us to reproduce them if we could reproduce them, if we could acquire a site and build them. So I'm looking at it with a mindset that we're getting highly strategic locations that may be truly irreplaceable in the future, and I'm buying them at a 30% or 40% discount to replacement cost. So if I buy them now but really don't need them for 3 more years, I'm still doing something that is really good for my shareholders. So that's our focus on that.

We'll go next to Derek Hewett of KBW.

I might have missed this in your prepared comments but did you discuss any sort of goal of increasing your earnings on a linked-quarter basis like you typically comment on?

We said that we expected to. Our goal was, we thought it was a reasonable goal to improve on our first quarter earnings and each succeeding quarter of 2012. Our first quarter earnings were obviously just a little change over $18 million, so our goal is to improve on that number each quarter.

Okay, great. And then could you also talk about the timing of your minimum loan growth goal for this year? Is it something that we will be able to kind of see the path towards that minimum growth rate of $240 million in the second quarter or is it going to be more backend loaded?

Well, I think it will be more backend loaded, but I think you'll certainly see progress in Q2. And I think to really look at this, we give that contingency and commitment footnote disclosure. We give that in our Qs, don't we, Greg, in addition to the annual? Yes. So that's in there. Look at the footnotes in the annual report, and that number is again it was $313 million at December 31, it was $391 million, $78 million increase in Q1. I think you will see that number escalate significantly when we release or announce the June 30 number. I think you'll actually see the balances of loans on the books increase in Q2 as well, and I think you'll see an accelerating trend in the balances on the books, the amount of increase quarter-to-quarter-quarter this year and my guess is, you'll actually see that commitments number increase quarter-to-quarter-to-quarter this year because we're building a lot of momentum for growth and doing a lot of really low leverage deals. We've had 4 deals in the pipeline recently that are substantial size deals and just to give you a perspective, one of those deals is like 55% loan to cost. One of them is a 48% loan to cost, one of them is a 25% loan to cost and one of them is a 22% loan to cost. The 22% loan to cost transaction is not actually yet approved, but its term sheet. All the others are approved. The 22, that commitment will appear once that loan gets closed assuming it does, but we won't fund anything on that loan until 2014 because there's massive amounts of equity, 78% of cost of projects coming in, in equity ahead of us and they'll fund virtually all of that before we fund anything. So you'll see that commitment number building and I know if you were -- in a lot of banks if they were giving you a 2014 loan growth number, they would just be guessing but we actually have models and reasons and things that we're working on that give us a lot of basis to actually think about and give you a intelligent estimate for 2014.

Okay, great. And then in terms of that 60 acres of land in Dallas that was OREO property, what percentage of that was related to -- or what percentage was that of the total OREO decline?

Well, that number was essentially the amount of the decline. Now we sold another 20 or so pieces of non-covered OREO in the quarter, but we had other items that left nonaccrual loans and went into non-covered OREO that pretty much offset that. So that -- there was a lot of movement in that book of business or book of assets in the quarter. But the net change in that book of assets was essentially the sale of that Texas property.

Okay. And did you guys finance that sale?

We did provide some financing for that sale, yes we did. There is substantial equity in the transaction. I think it's 30-plus percent cash equity went in, but we did finance the rest of it, which we're very comfortable doing.

And we'll go next to Jeff Bernstein at AH Lisanti.

Couple of additional questions on lending activities in the quarter, so it sounds like you're doing still a fair amount of construction and development, can you give any kind of breakdown on how much investor CRE you did and maybe any owner-occupied CRE that you did kind of as a percent?

I don't have that -- we have that information available. I don't have it at my fingertips, but I'll make a comment on that. There is a sentiment out there that investor properties are not as safe as owner-occupied properties. And that is a broad brush generalization that I would tell you is how banks that don't understand real estate think about properties. Owner-occupied, it must be good. It's not owner-occupied, it must be risky. We don't really -- I mean, we keep data on that and break the portfolios down by that, and we look at that. And I'll tell you how this plays out. We lost a piece of business a few weeks ago to one of the big regional competitor banks we compete with that was owner-occupied, and it was an okay piece of business but it was just okay. It was not great. And they priced that thing through the roof, just I mean, super, super, super cheap to get that piece of owner-occupied business. The same timeframe and it may not have the same week but within a week or 2 of that, we took away a piece of business from that same bank that was non owner-occupied, and it was a great piece of business, a really primo piece of property and a great location with great tenants. But the mindset at that bank is we want to run off non owner-occupied property. We're going to move them out, and we want to do all owner-occupied. So they would trade a mediocre owner-occupied piece of property that they're going to get a 375 yield on and run off a really premium quality asset, non owner-occupied piece of property they could have gotten a 5.5 yield on. And what we try to do is not focus on is it owner-occupied or is it non owner-occupied, is it a great asset, does it have great leases, does it have great debt-service coverage, does it have a long life to it. We try to understand the real estate and underwrite that and actually think instead of using just gross generalizations and say, well, this is bad and this is good. It's like people, you can't make generalizations about people. You got to know their character and integrity, and what sort of human being they are and the generalizations don't apply. You got to meet every one of them and really know who they are and you got to do the same thing with real estate loans. You've got to really understand the project and all of the dimensions and metrics of it and then you can make a smart decision.

I appreciate that color. In the investor CRE and owner-occupied, is this still essentially refi-takeaway business or is there some transactions actually going on?

It's a lot of both. We're doing a lot of transactions, obviously, a lot of stuff in the construction and development book. My allusions to closing loans that are going to fund over the next year or 2 years, or 3 years, those are construction deals. A lot of those are built to suit as for specific tenants or owner occupants in some cases of those properties. So we're seeing a lot of that. Certainly the best volume of that we've seen in probably 3 or 4 years, probably 4 years. And we are continuing to see a lot of business opportunities to take away business from competitors or stuff that is moving out of special servicing-type environments where our customers are buying those properties. A good example -- a lot of our customers -- we have a number of customers who go out and buy assets from special servicers and our typical structure on those deals is our customer's buying the asset at about 50% more or less of the prior loan basis, and then they're putting in 50% equity and we're loaning 50% of their purchase price. So in those deals, we're typically in it at about 25% of the basis that the prior lender was in on that.

So, George, I keep getting this feeling like you got one foot on the gas and one foot on the brake, that you are cherry picking these loans to such a degree that -- I mean, is that where the visibility comes from in part that there's plenty of pretty good business to do, but you're not settling for that? Is that how I should be thinking about this?

I think that's an excellent characterization of where we are. We are very much keeping a foot on the brake and we're very much pushing the accelerator at the same time. And we're looking at lots and lots and lots of business to find things that we are really comfortable with that we can make a good profit margin on and that we think will stand up to the rigors of what I think is going to be a really bumpy economy for many, many, many years to come. I sort of see our U.S. economy as, to use a -- if you were a power boater, you'd use the term porpoising. I kind of see our economy porpoising along, we kind of get the nose out of the water and we're going to hit a bump and get the nose back down and we're going to get the nose up again and I just see the economy sort of bouncing along in that fashion for many, many years to come.

Okay. So you would agree with me that sort of good loans are made in bad times, but you are wearing a belt and suspenders here?

Well, I'll tell you what. Some of the stuff that I see being done today by some other banks, and I don't know how widespread it is, but I'm seeing bad loans made today that are going to come back to haunt people. They are being way too aggressive because they're desperate for business, and I would much rather produce within our capabilities to produce and not have the growth and go stretch on credit terms and put a lot of interest rate risk on our books right now to get it. So we're in a very fortunate situation that I think we can stick to our very rigorous credit standards and generate a lot of growth and stick to appropriate profitability standards, margin standards and still generate a lot of growth and think we're in a unique situation with the ability to do that. There are certainly a lot of other banks that can do that, but I think there are a lot of banks that cannot do that.

We'll take our next question from Brian Martin at FIG Partners.

Just 2 last things. The classified loans in the quarter, what was the trend you saw there? I mean, I know the OREO went down which impacts classified assets, but just the classified loans, were those about stable similar to the nonaccrual loans in the quarter?

Brian, actually I haven't looked at that number. I've looked at the nonperformers and so forth, but I haven't looked at the classifieds and Greg is looking as blank as I am on that. So I don't think there was -- yes, I think any move on that was to the positive -- certainly the classified assets with that $14 million, $15 million reduction in the OREO book are going to show a very favorable trend. The loans -- I've not actually broken that down and looked at that yet, but I think it would be positive. Our nonperforming loans went down I think 7 or 9 basis points from the prior quarter end, our past dues went down like 70 basis points from the prior quarter end. So all of that would suggest to me that there was probably something of a favorable trend in that number. But again, I haven't actually looked at that.

Okay. And how about just one other thing and that was on the loan mix. I know there wasn't much change in the uncovered balances this quarter, but when you look at the growth that you guys are expecting, I mean, I guess could you give a little bit of color on where you think the construction book and the CRE book play out with some of this growth that you see materializing as far as better limits, as far as how high you'll take the construction portfolio on a relative basis in the commercial real estate book, if you could just give a little color on how you guys look at those, that measurement?

In the quarter, our commercial real estate book went up $30 million in Q1. It went from 37.6% of the portfolio at year end '11 to 39.0%. Our construction and development loan book went up $10 million from 25.4% of the total portfolio to 25.8%. Our multifamily went down $10 million and part of that was we had about a $15 million payoff in that book that I mentioned. Our C&I went down $12 million. I talked about that credit and our real estate loans went down $14 million. We talked about that credit. So the commercial real estate and the construction and development book both grew in the quarter, and I would expect that's going to be just the way it is. That's where we -- that's what we do best. I've said a number of times, we could generate more consumer loans and I could generate more C&I loans and I would expect my losses on consumer loans and C&I loans to be 4 to 6 to 8x the charge-off ratio that I would expect from our well underwritten, documented and servicing -- service CRE and construction and development loan book. We're really good at that and that's what we're going to continue to do and that's where most of our growth is coming. Now certainly, if we generate the growth in that book that I would expect over 2012, '13, '14 and probably continuing beyond that, we'll have a really high concentration of those types of loans. And we totally understand that. But we are looking at it within those categories. We're looking at broad-based diversification of the portfolio based on geography, broad-based diversification of the portfolio based on product type, tenant, users and the real key is not how much of it you have, the real key is how well underwritten is it. And one of the mantras that I've been preaching, I was in Dallas yesterday at our Real Estate Specialties Group office all day and I stressed to those guys, as I do constantly, we're going to have more and more and more of these loans and they got to be better, better, better loans. So that's why you're seeing us looking at so many loans that have 45 or 55 or 52% cash equity in them is customers who have the wherewithal to put that kind of cash in the projects and the sophistication to have accumulated that kind of cash are generally customers that make things work and if they don't, then we've massively mitigated any exposure we would have by having so much cash in those transactions. So, we're going to live in a world and if you're a shareholder in our company, you're going to be investing in a company that is a construction and development and CRE lender. We're really, really good at it, and we know we're heavily concentrated in it. We're going to diversify that portfolio within those types as broadly and effectively as we can, and we're going to mitigate the risk by underwriting these loans extremely well, servicing them to the highest standards in the world and documenting them to the highest standards in the world and getting lots and lots of cash in them, so that our risk is greatly reduced.

We'll go next to Peyton Green at Sterne Agee.

My question comes -- I apologize if I missed this earlier, but to what degree do you see the live bank or traditional M&A market playing out over the next couple of years in the context of y'all's approach?

Well, we're certainly looking at that. Dennis James, who has taken the position and moved within our company into that Director of M&A role, Dennis has been traveling extensively. He's going to -- he may accumulate more frequent flyer miles than anybody in the company. Obviously, there are -- for all practical purposes, almost unlimited opportunities out there for that. So our philosophy on live bank M&A is just like our philosophy on failed bank transactions and that is we're only going to do transactions that we thoroughly understand and are going to be very profitable for our shareholders. And I think there will be a lot of those. My guess is we'll look at 20 or 30 deals for every one we'll do. And when I'm saying looking, I'm not talking about sitting at the desk, looking at somebody's financials, I'm talking about actually going to look at a bank. So I think that will be very much like our experience with the FDIC transactions. We're going to look a lot. We're going to be very conservative in the way we approach them, and we're going to get the ones that we can get, that we can make a really good profit on and have a really accretable yield situation for our existing shareholders and the ones that get into very competitive bid situations and everybody wants it and everybody's willing to pay up for it, those are not going to be our deals.

Okay, I guess as a follow-up, I mean do you see the activity becoming more likely in the next couple of quarters or is it just too episodic to peg a timeframe?

I would go with your choice of too episodic to predict a timeframe. When we find the right deal, we'll have a deal and that could be next week, it could be 5 years from now. And I'm not aware of an opportunity next week. Hopefully, we'll hit one more than 5 years, so hopefully my comment there was extreme but it's hard to predict. It's hard to know. But the important thing is not when we're going to get one. The important thing is that we're going to stick to our discipline and if we get one that makes really good sense for shareholders and it's clearly obviously advantageous to our shareholders to do it, we're going to do it. And if we don't get one that meets that criteria, we're not going to do one. So the -- what we're going to do is more important than when we're going to do it.

And at this time, we have no further questions. I'll turn the conference back over to management for any closing remarks.

All right. Thank you, guys, all very much for joining the call today. We appreciate your attendance on the call. We appreciate the good questions. We look forward to talking with you again about 90 days. Have a good day. Thank you. That concludes our call.

And again, that does conclude today's conference. Thank you for your participation.