Bank OZK (OZK) Q2 2012 Earnings Report, Transcript and Summary

Well, good day, everyone, and welcome to the Bank of the Ozarks Second Quarter Earnings Conference Call. Today's conference is being recorded. And at this time, I would turn the conference over to Ms. Susan Blair. Please go ahead, Ms. Blair.

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 net interest income, including our expectation for net interest income to increase in coming quarters; 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 assets, 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 ratios for both non-covered loans and leases, and covered loans; our allowance for loan and lease losses; 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; other opportunities to profitably deploy capital and our positioning for future growth and profitability. 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'll 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. We are very pleased to report our excellent second quarter results. We accomplished just about every goal that we set for the quarter except for our desire to make one or more additional FDIC-assisted acquisitions. Net income in the quarter just ended was our third best ever. In fact, in each of the 2 previous quarters in which we have reported higher net income, we had 2 FDIC-assisted acquisitions with significant bargain purchase gains. Of course, those quarters were the third quarter of 2010 and the second quarter of 2011. Highlights of the quarter just ended were numerous, consistent with our prior guidance, growth in non-covered loans and leases was evident in a big way, although it occurred toward the end of the quarter. Asset quality, which has been one of our traditional strengths, got even better, as seen in the further improvement in our asset quality ratios to the best levels in 4 or 5 years. Our net interest margin continued to be among the best in the industry. We had excellent results in almost every category of non-interest income and our non-interest expense declined for the fourth consecutive quarter. While our second quarter results were stellar, we are even more pleased by how well-positioned we are for future growth and profitability. Let's look at the details. Our excellent growth in non-covered loans and leases in the quarter just ended was heavily concentrated in the last 2 weeks of the quarter. As a result, this growth contributed very little to second quarter net interest income, which decreased slightly 0.4% in the quarter just ended compared to the second quarter of 2011, and decreased 3.5% compared to the first quarter of this year. Based on our recent growth in non-covered loans and leases and our expectation for further growth, we expect net interest income to increase in the coming quarters from the level achieved in the quarter just ended. Let me explain that. Of course, net interest income is a function of both the volume of average earning assets and net interest margin. As a result of our growth in non-covered loans and leases, earning assets increased to $3,109,000,000 at June 30, 2012, and this was higher than the average balance of earning assets and either of the first 2 quarters of this year. Starting from this higher base of earning assets and given our expectations for strong growth in non-covered loans and leases in the coming quarters, we expect increases in net interest income from higher levels of average earning assets. Let's talk a little more about the recent and expected loan growth. In the quarter just ended, our non-covered loans and leases grew $89 million. Obviously, that's a great result for the quarter, but our loan and lease teams did an even better job than that number reflects. In the last 2 conference calls, we have pointed out that our unfunded balance of closed loans almost doubled from $166 million at year-end 2010 to $313 million at year-end 2011. Because of the large volume of loan closings in the first 2 quarters of this year, our unfunded balance of closed loans increased another $78 million during the first quarter and $163 million during the second quarter to a June 30 total of $554 million. This growing volume of closed loans still to be funded, coupled with the excellent top line of loan requests on which we are currently working, suggest to us that we will achieve our goal of a minimum $240 million of net growth in non-covered loans and leases in 2012, a minimum of $360 million in 2013, and a minimum of $480 million in 2014. We are reiterating that prior loan growth guidance for all 3 years. This growing volume of unfunded loan balances is due to a couple of factors. First, most of you know, we get a lot of cash equity in most of our loan transactions. As noted on Page 38 of our most recent 10-Q, we had weighted average cash equity of 45% in our construction and development loans, which had interest reserves as of March 31. Of course, that included the majority of our construction and development loans. Those of you who have followed the 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 45%. Getting this much cash equity in transactions tends to make for great asset quality. But it also delays loan funding since cash equity is almost always put in first. This has definitely contributed to the build up in our unfunded balances of closed loans. Second, despite the highly competitive markets, we are finding many opportunities for good quality, good yielding loans. Because our lending teams are maintaining such excellent pricing and credit discipline and getting so much cash equity in our new loans, I believe that the loans we have originated in recent quarters are among the highest quality loans we have originated in my 33 years as CEO. In regard to net interest margin, 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 6.05% to 5.80%. Our first quarter net interest margin was 5.98% and our second quarter net interest margin was 5.84%, both within the guidance range. The 14-basis-point decline in our net interest margin from this year's first quarter to the second quarter was consistent with our expectations. We continue to believe that the 6.05% to 5.80% guidance range is appropriate for the remaining quarters of 2012, and that our third quarter net interest margin should be close to our second quarter net interest margin. Our 5.84% net interest margin is among the best in the industry and it is truly a result of the team effort. Our deposit processing 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 average cost of interest-bearing deposits by 9 basis points to 0.39%. Further improvements in our average cost of interest-bearing deposits are expected, but those improvements should be more modest as we grow deposits as needed to fund the expected loan growth. 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. 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 in our legacy markets. In the quarter just ended, the yield on our non-covered loans and leases was 5.78%, giving us an enviable 5.39% spread between our yield on non-covered loans and leases and our average cost on interest-bearing deposits. Of course, our teams working on FDIC-assisted acquisitions have given our net interest margin an extra boost with the excellent yields on our covered loans. Let's shift to non-interest income. Income from deposit account service charges is traditionally our largest source of non-interest income. Service charge income for the quarter just ended was our second best ever and increased 7% compared to the second quarter of last year. Service charge income for the first 6 months of this year increased 14% compared to the first 6 months of 2011. 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 increased 109.5% from the second quarter last year. Mortgage lending income for the first 6 months of this year increased 84.7% compared to the first 6 months of 2011. A number of factors have -- or a number of our markets have seen increased volume of home purchase activity and we have continued to build our mortgage team particularly in our new Southlake, Texas office. Trust income in the quarter just ended increased 10.6% from the second quarter of last year. Trust income for this first 6 months of this year increased 4.9% compared to the first 6 months of 2011. We have continued to see growth primarily in personal trust income. Gains from sales of other assets were $1 million -- $1.40 million in the quarter just ended compared to $0.71 million in last year's second quarter. Net gains from sales of other assets increased to $2.95 million for the first 6 months of this year compared to $1.11 million for the first 6 months of 2011. Net gains realized in the first 2 quarters of this year 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 transactions, 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 of covered OREO for some time to come. This has been evident in each of the last 8 quarters. In the quarter just ended, we recorded $2.04 million of income from accretion of our FDIC loss share receivable net of amortization of our FDIC clawback payable. As part of our FDIC-assisted acquisitions, we recorded receivable from the FDIC based on expected future loss share payments and we record a clawback payable to the FDIC based on estimated sums we expect to owe the FDIC at the end of the loss share periods. The FDIC loss share receivable and the related clawback payable are discounted to a net present value utilizing a 5% random discount rate. The net discount amounts are then accreted into income over the relevant time periods. And in the quarter just ended, as I said, the resulting net accretion income was $2.04 million, down from $2.31 million in the immediately preceding quarter. This accretion income should be an ongoing income source for us as long as we are under the loss share agreements. Of course, the amount of net accretion income will tend to diminish over time as loss share winds down and you can see this trend over the last 5 quarters. In addition, non-interest income in the quarter just ended included other loss share income of $3.20 million. This line item includes certain miscellaneous debits and credits related to the accounting for loss share loans, but it consists primarily of income recognized when we collect more money from covered loans than we expected that we would collect. We refer to these additional sums collected as recovery income. Since we tend to be conservative in the way we value covered assets, which is certainly appropriate given the 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 of covered loans, other loss share income will vary quite a bit 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 in our income statement. First, the 8.61% effective yield on our covered loans in the quarter just ended reflects the substantial discount rates we utilized 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, primarily recovery income as we've discussed already, reflects the fact that our lending and special assets personnel have done a great job so far in maximizing our recoveries on covered loans. And fourth, our gains on sales of other assets for the reasons previously discussed reflect the conservative accounting for covered OREO and the effective work that our staff is doing in selling those assets. You will note from our press release that we had $2.0 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 $1.40 million of gains on sales of assets, mostly covered OREO during the quarter, and our $3.2 million of other loss share income during the quarter, mostly recovery income, you can clearly 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. We are also continuing to actively pursue additional FDIC-assisted acquisitions and we continue to maintain our discipline in pricing and our goals for profitability both in the short term and the long term for these transactions. Given the processing discipline we are maintaining, it is hard to handicap our prospects for making additional FDIC-assisted acquisitions, but we remain optimistic. If, however, we don't make any additional FDIC-assisted acquisitions, we believe that our organic loan growth will be sufficient to support positive earnings momentum. We've been working for quite a while now to achieve the loan growth momentum needed for a post FDIC-assisted acquisition environment, and our second quarter results make clear that we are achieving that momentum. Of course, any additional FDIC-assisted acquisitions would be icing on the cake. Let's turn to non-interest expense, which decreased $7.9 million or 22.5% in the quarter just ended compared to the second quarter of last year. Of course, non-interest expense for the second quarter of last year included approximately $2.9 million in pretax acquisition and conversion costs related FDIC-assisted transactions. We have said for several quarters that we expected our non-interest expense to return to a more normal level as our newly acquired offices began to perform more like our legacy offices. Consistent with that guidance, our non-interest expense has now declined for 4 consecutive quarters. There may be some further room to decrease non-interest expense from the level achieved in the quarter just ended, but we believe that the more significant goal is to now improve our efficiency ratio by growing our balance sheet and thereby increasing revenue significantly while maintaining non-interest expense at or near the second quarter level. Of course, additional acquisitions, either FDIC-assisted or via traditional M&A, could result in increased non-interest expense. We are continuing to grow and expand. As previously reported, in January, we opened an expansion office in Austin, Texas for our Real Estate Specialties Group, and in February, we opened our 9th Metro Dallas area office in The Colony, Texas. On July 2, we opened our 10th Metro Dallas area office in Southlake, Texas, and another expansion office in Atlanta, Georgia for our Real Estate Specialties Group. Later in the third quarter, we expect to open our second office in Mobile, Alabama. In the fourth quarter, or early next year, we expect to relocate our longtime Charlotte, North Carolina loan production office to a new full-service banking office we are now building. Later this year, we hope to relocate 3 offices from our current leased facilities to new improved facilities we will acquire in Bluffton, South Carolina, Wilmington, North Carolina and for our original office in Mobile, Alabama. Obviously, these new offices in Texas and the Southeast reflect both the growing importance of Texas to our company and our shifting to a more offensive-minded business strategy in our southeast markets. One of our long-standing and key goals is to maintain good asset quality. Economic conditions in recent years have made our traditional strong focus on credit quality even more important. The strength of our credit culture and the depth of our commitment to asset quality are both evident in 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 improved to 0.18% for the second quarter this year compared to 0.85% for the second quarter of last year, 0.69% for all of last year, and 0.44% for the first quarter of this year. This was our best net charge-off ratio for non-covered loans and leases since the third quarter of 2007. At June 30, 2012, excluding covered loans, our ratio of nonperforming loans and leases to total loans and leases was 0.50%, which is an 11-basis-point improvement from March 31 of this year, and a 20-basis-point improvement from year end. This was our best ratio of nonperforming loans and leases since the fourth quarter of 2007. At June 30, 2012, excluding covered loans and foreclosed assets, our ratio of nonperforming assets as a percent of total assets was 0.63%, which is a 14-basis-point improvement from March 31 of this year, and a 54-basis-point improvement from year end. This was our best ratio of nonperforming assets since the second quarter of 2008. Similarly, excluding covered loans, our ratio of loans and leases past due 30 days or more, including past due nonaccrual loans and leases, was 0.75%, which is an 11-basis-point improvement from March 31 of this year and an 81-basis-point improvement from year end. This was our best past due ratio since the third quarter of 2007. 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 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 higher provision expense 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 second quarter, pushing our ratio of common equity to assets up to 12.21% and our ratio of tangible common equity to tangible assets up to 11.95%. 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. Our second quarter loan growth, both in outstanding balances and unfunded balances of closed loans, clearly highlights the potential magnitude of this capital deployment opportunity. The second most immediate opportunity for capital deployment is additional FDIC-assisted acquisitions. The third opportunity relates to traditional M&A activity, an area on which we have recently increased our focus and which may provide favorable opportunities for us. The fourth opportunity will likely come when interest rates increase significantly and we consider it timely to reload our investment securities portfolio. In closing, we feel that the quarter just ended was an excellent quarter with its net interest income of $19.1 million. Our goal, which we believe is a reasonable goal, is to improve on our second 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, Kelsey, to once again remind our listeners how to queue in for questions. Kelsey?

[Operator Instructions] We'll hear first from Matt Olney with Stephens.

Hey, good to see the loan growth accelerate in 2Q, I know it's something you've been talking about that for a while, so that's definitely good to see. Do you know what percent of this growth came from your Real Estate Specialties offices versus your traditional offices? And do you have a breakdown of loan type?

I can give you some color on that, yes. The majority of the growth came as we projected it would from our Texas offices, and our Real Estate Specialties Group office in Dallas led that. As we predicted in January, the second largest contributor to growth in the quarter was our Little Rock offices. And the third largest contributor was Charlotte. And we said at the beginning of the year that our Texas offices would contribute most to the growth this year, Little Rock would be a strong second, Charlotte would be a strong third, and that's exactly the way it played out in the quarter. Our -- at June 30, our nonresidential, non-foreign loans, our CRE loans were 39.8% of the portfolio, that's up about $44 million from 39.3% at March 31. Our construction and land development book was 26.3% of the portfolio, up from 25.8% at March 31, that's a $33 million contributor to our growth there. Multifamily was down about $11 million, Agri [ph] was down about $3 million, residential 1-4s were up a couple of million and our C&I portfolio grew about $22 million and accounted for 6.6% of the portfolio at June 30 from 5.8% of the portfolio at March 31. So those are sort of the big movers in the numbers. And as expected, the construction and development in the CRE book were the largest 2 pieces, but we did have a nice contribution to growth of $22 million from our C&I book, which was not something we had expected would be a big contributor this year, so we got an extra, extra contribution there.

And then on the margin side, the compression in 2Q was a little bit more than what I was expecting. It looks like the core loan yields have came down pretty heavy in the second straight quarter, was there something unusual in the quarter that caused that because the momentum of those core loan yields suggest that the overall margin could be below your guidance. That sounds like you're maintaining your guidance for the next few quarters.

Yes, that did come in and it was a result of just a lot of a little unusual impacts there. Included in those yields are light fee incomes, prepayment fees on loans that flow into income, just accounting adjustments on loans, charge-offs, nonaccruals, there's a whole bunch of adjustments. And if you go through all of those kind of odd pieces that are not just interest rate, they all came in on the low side and we're kind of down for the second quarter. And in our projections for the third quarter, just assuming a normalized combination of those factors, suggest that if you factor all those things in, I actually think we've got a pretty good shot of having the margin actually increase a little bit, maybe 1, 2, 3 basis points in the coming quarter. I would say my personal opinion after studying all this and looking at it over the last few days is as if we're more likely to have margin go up in Q3, 1, 2, or 3 basis points from the Q2 margin level than we are likely to have it go down a little bit. But we think we're still right on track for our guidance for the year.

Moving on to Michael Rose with Raymond James.

Just wanted to get a little context on Matt's question on the margin. When you laid out your initial guidance of 5.80% or 6.05%, did that kind of incorporate the tenure where it is? And I wanted to get some color around where you’re booking those new loans at and if competition's starting to pick up a little bit.

Okay. Yes, it did contemplate that we would be in a very low-rate environment and we didn't give guidance of 5.80% to 6.05%, we gave guidance of 6.05% to 5.80%, and the order in which we gave that was intended to communicate that we expected we would move over the course of the year towards that 5.80% level by the end of the year. So the order in which we gave that was intended to be indicative of the trend that we thought we would see. The loans that we are booking, we're getting what I think are very good yields on it. Certainly, it is a very competitive environment and we're having to get very competitive on certain pieces of business. But none of the competition we're experiencing is inconsistent with our expectations when we gave our guidance. We have a philosophy here that we're not going to work for free and we're not going to book assets that have such low yields that we don't get an appropriate risk-adjusted return for our shareholders consistent with a high teens to low 20s ROE. So we're very disciplined about that and we're continuing to hang on to that discipline. We could've had much more loan growth in the quarter just ended in the first 6 months of this year had we not been as disciplined as we're being on credit quality, first, and pricing, second. And we could be a much bigger bank than we are and just have average results. The buy goal for our buying, for our staff, and this is our goal that our staff shares, is to not be good. We don't even want to be great, we want to be excellent. And if you're going to be excellent, you've got to maintain your discipline on credit quality and you've got to maintain your discipline on pricing and keep those margins fair. So I think we're getting far better yields on average than most banks are getting out there. And I think we're getting appropriate risk-adjusted returns for the credit risks that we are taking, which I think are very minimal credit risks. But I still think we're getting very good risk-adjusted returns on the loans we're booking. So we feel good about that and nothing is really much different than what we expected at the beginning of the year.

Okay, and just as a follow-up if I can. On the liability side, more specifically on the deposit complexion, it seems that you do have some room to continue to shift mix and lower your funding costs maybe for another couple of quarters. But with the loan to deposit ratio here at about 96%, I mean, how should we think about deposit growth and the impact that could have on the margin in future quarters?

As I said in my prepared remarks, I think we've got some further improvement to come over the next quarter or 2 in our average cost of interest-bearing deposits, which is 0.39% for Q2. But we think those levels of improvement, I think that improved 9 basis points, wasn't it, Greg, in the quarter just ended. And we think further improvements will be more modest, less than 9 basis points a quarter because we are becoming a little bit more offensive-minded because that growth is beginning to land on our balance sheet in a fairly significant volume. And I've got to grow my deposits to fund those loans. So I still think we do that with some downward movement in our cost of interest-bearing deposits over the next couple of quarters, and so I think we still got some room to go there. But that rate of descent will slow in this quarter and probably the next quarter because we will be putting a little more focus on offense and growing that deposit book to fund this volume of loans that we've already funded, that we expect to fund this quarter and that are sitting in unfunded balances that we'll fund over the next couple of years.

[Operator Instructions] We'll now hear from Jennifer Demba with SunTrust Robinson Humphrey.

George, could you just elaborate, give us some color on your strategies if you wanted to get more aggressive in the southeast. You've opened up an Atlanta office, and you said you're going to open a Mobile office. Are you hiring locally? Are you bringing people over from other -- your existing offices? Do you have any specific volume goals for these offices? If you could just give us some color there.

My volume goal for every office in the company is for every lender to make every good quality, good yielding loans that they can make consistent with safe, sound improvement banking practices. And that's always been our goal for every office. I mean, we want to book every loan that we can book that is high quality, good yielding and that we can handle in accordance with all applicable standards of safe, sound, and prudent banking practices. Our guys have got to be able to understand it, they've got to be able to underwrite it, they've got to be able to document it, they've got to be able to close it, they've got to be able to service it, all at the highest standards of the industry. And if we can't do that, then we don't want to book it. So we are getting more offensive minded in the Southeast. When we made each acquisition, we acknowledged privately and publicly that those portfolios in those 7 acquired banks were challenged portfolios and our guys are going to have to play mostly defense for the first year or 2. You can see, if you look at the volume of covered OREO, the volume of loans in those portfolios, that the number of things we're needing to address defensively are going down every quarter and we're having really good success and had particularly good success in Q2 resulting a lot of the more challenging issues in some of those portfolios. So we're feeling really good about that. As my teams in those markets spend less time and energy on defense, they get to spend more time and energy on offense and what we are constantly doing now is reminding those guys, hey, it's a good thing you resolved that problem, we're really glad to have that problem credit gone. What you've got to do now is go out and find good new business to replace it and it's going to be high quality and it's going to be appropriately priced and we've got to go get new business. So we are seeing that and our Real Estate Specialties Group office, which we opened July 2 in Atlanta, is intended to bring the strong underwriting discipline credit structure from our Real Estate group in Texas to the Atlanta market. Now Atlanta is a profoundly overbilled, oversupplied market, but there is good business even in a market with the high vacancy rates and the millions and millions of square feet of vacant space that exist in the Atlanta market. There are good business opportunities to be had in those markets on properties that are key properties: strategically located, high-quality properties that have strong leases and so forth on them and long duration on those leases and that's what we're doing. Because of that focus, July may be the first month in which our growth in Georgia of new loans exceeds the runoff in our loss share loans. We've got several things in queue, in the pipeline that are super high quality pieces of business that fit. If we can get them closed, we got a legitimate shot this month in July of having originating more new loans in Georgia than the payoff on our existing loan portfolio there. You mentioned staffing, we're certainly looking to hire local staff in a number of our southeastern markets, but we've also transferred some key lenders over there. For example, our Real Estate Specialties Group has been run by a young lady who was one of our best credit underwriters for several years here in Little Rock. When we made the first few acquisitions in Georgia, she was one of the 2 member teams that has run 2 of those acquisitions, then she spent a lot of times in the last 6 months in our Dallas office as part of our Real Estate Specialties Group. So she transfers over there with a strong credit background from working with us in Little Rock, a strong background of spending some time over the last 6 months with our Real Estate Specialties Group in Dallas and a good knowledge of the Georgia market from having been one of the 2 member teams that oversaw the operation of 2 of our acquired banks in Georgia. So we're getting -- we're not going to have a massive amount of growth come out of those markets for a while because the markets are really challenged and you've got to be really careful. But the momentum is beginning to shift in those markets and we're very excited and optimistic about that.

Our next question will come from David Bishop with Stifel, Nicolaus.

George, a follow-up on Jen's question. In terms of the tenor of sort of the commercial developer base out there, obviously Texas is still going strong. But are you seeing sort of the pipeline build behind for this unfunded commitments with any sort of growing optimism out there within the development community, given a little bit more risk appetite for some of these projects or they still remain very sort of markets specific.

Dave, I think there is a modest improvement in the sentiment and the optimism of folks out there. I think it's cautiously optimistic, though, and that's certainly the way we want to -- that's the type of people we want to do business with. People who are not euphoric, but people who are cautiously optimistic. I think that's the appropriate attitude. So the projects that we're working on, of course, we're requiring a lot of equity in them. It's not probably the average deal we closed in the second quarter, and I haven't actually seen the numbers yet, but just looking at the deals and improving them as they came through, I would guess that our average cash equity as a percent of the total project cost was probably about 45%, probably about where we were at the end of Q1. So people are putting a lot of equity in these deals and our developers realized that having a lot of equity in the deal allows them a fair degree of latitude if economic conditions get a little more bumpy going forward. So I think folks are optimistic in that they're doing things and they're doing a few more things than they were doing, but they're also cautious in that their optimism and they realize it could get rocky and if Europe unravels in an ugly way or whatever and to make sure their projects survive and thrive in a more rocky environment if that materializes, they need a lot of cash equity in them, they need to have less leverage. So the guys that we're doing a lot of business with understand that a lower level of leverage is a lower risk scenario for both them and us, and they're willing to do that. That's why we're growing this portfolio in a very deliberate, disciplined manner because we are cautiously optimistic about the future, but we realize we could see a very negative downturn if world economic events turn out adversely. So we're underwriting the portfolio to do very well in either scenario.

Moving onto Kevin Reynolds with Wunderlich Securities.

You may have addressed this, I apologize, I've been sort of a little bit distracted, so my fault, not yours. But when you talk about the outlook for M&A activity and FDIC and the open bank and ways to use capital, has anything been changed there? I know we've seen sort of headline deterioration in the economy. Do you get the sense that bankers that might be target, acquisition targets, are starting to sort of realize that the growth may not be there that they would like to see, and so they're starting to more seriously consider their alternatives?

Kevin, I don't know that I have a real good feel for that. There are certainly a lot of banks out there. If they could get a deal at one price or another would like to sell. I mean, there are a lot of bankers, and this is no secret to anybody that would like to not have to fight the battles and deal with the challenges that are on the industry now because of this lackluster economy and the regulatory challenges -- it's a tough -- you got to really love this business to be excited about coming to work and fighting all of these challenges that face our industry today and everybody knows that, that's nothing new. So there are a whole bunch of bankers that would like to sell. And we created a Director of M&A position early this year and we've been barraged with that announcement with banks that would like to talk to us and so forth and we're trying to prioritize those things and look through them and find things that make good economic sense, where we can do a transaction that is undoubtedly beneficial for our shareholders and still do it on terms that would be satisfactory to the guys on the other side. So we're approaching that with the same discipline that we have our FDIC-assisted transactions, the same cautious conservatism and I still think we're going to find, over the next several years, lots of opportunities to do some things that will make sense there. I think whether or not the expectations of sellers and mass are changing, I don't know that, but I'm sure every negative headline affects some sellers, some place, some way and if these are already inclined to sell and the headlines continue to pressure them, whether it's a regulatory-related headline or an economy-related headline or a margin-related headline or whatever, there are a lot of reasons that folks would want to sell a small bank and not continue to fight this, unless you really love this job.

Okay. And a couple of other follow-ups. As I recall, recently, maybe in the last quarter or so, you have said that you had bid on something around 75, 80 FDIC-assisted deals and we're sort of winning 1 in 10 or somewhere around those numbers, and you expect the same sort of success rate although maybe not the same volume on open bank deal. Do you think -- has there been any change to your outlook on those kinds of -- that kind of analysis between open bank and FDIC-assisted? And then another question, do you -- how do you view your footprint when you look out over these few years? Do you see yourself getting more and more dense within it or do you see yourself perhaps expanding it out into the frontier a little bit from where you are right now?

Well, I think whether we get more dense or expand into new frontiers really depends on the opportunities. What we're doing -- what we're looking to do with any transaction we do is to try to generate growth in our franchise that would generate a high teens to low 20s return on equity, assuming a 7% capital allocation to that piece of business. And if I can find a 22% opportunity -- 22% ROE opportunity, that's a little bit on the frontier and only an 18% ROE opportunity when you factor in cost saves [ph] and everything that would increase my density, I'm going to be like Daniel Boone and constantly looking for the frontier. If on the other hand, and it's probably more likely that deals we would do would increase our density because of cost saves [ph], if I can get a 22% ROE on a deal that enhances density and only 18% on the frontier, then we're going to stay very close to home. So it really will be very opportunity driven. We're going to go where we can generate the best returns for shareholders, most likely because of efficiencies and cost saves [ph] that's going to tend to be something closer to home than something in the end market as opposed to something farther from home and out of market. But again, it will just depend on the numbers.

Matt Olney with Stephens has the next question.

Hey George, just a follow-up on the loan growth discussion. I think you disclosed that the unfunded balance of closed loans continues to increase, so the pipeline looks very good. Is there a typical lag that you think of as to when these deals close versus when these deals fund? Or how should we be thinking about that?

That $550-plus million of closed and unfunded loans that was on the books at June 30, some of those loans will have fundings in July, some of those loans will have fundings -- their first fundings in September, some of those loans will have their first fundings in the first quarter of next year. It really just depends on how much equity is in the transaction and what the land and upfront costs were. If we do a deal that has got 45% cash equity in it and the land cost is 15% and they've got to fund 30-more percent toward construction draws. If we do a deal that has a much higher percentage of land cost in it, then we'll be funding into that loan more quickly. The second factor that affects that if it's a bigger, more complex project, it may have a 2-year build out or development phase, then it's going to fund up more slowly than a 1-year. So I would guess that probably those unfunded balances that were on the books at June 30, and this is just from head knowledge and not from really doing a scientific analysis on this, but I would guess that something just over 90% of those balances will ultimately fund, that something less than 10% of those balances would never fund, that something over 90% of them would fund and I would guess that 60% to 70% of that funding would occur in the next 12 months, and 30% to 40% of that funding would occur in the second 12 months. It would just be a guess, but I think it's probably a pretty good off-the-cuff guess.

Okay. That's helpful. And then also, I want to ask on the expense side, your expenses continue to come down, and for a while, your expenses were elevated from due diligence on failed bank M&A or even integrating some of the deals you've already closed on. So as it stands today, do you still have elevated expenses from these deals or those are all behind us now?

We still have a bit of elevated expenses from these deals and it's primarily in the loan collection and repo expenses, the number one thing now. We had a lot of work to do to integrate and streamline and generate the efficiencies in the acquired offices that we needed to get them to where we are. We had a ton of training expense, I mean, we were spending large amounts on training and really cultural orientation to get these acquired staffs culturally and philosophically ingrained into our culture and philosophy so they would understand how we do business and function and operate like we function and operate in our legacy markets. And all that was kind of an optional expense, but I thought it was the most important money we've ever spent. So most of that sort of stuff is behind us now, but we still are because we still got $60-something million of covered OREO at carrying value and $700 million of covered loans, a lot of which are troubled credits, they were troubled when we acquired them, then we're working them out. We still are spending a lot more on loan collection and repo expense than we will over the long haul. So I think that loan collection and repo expense line and OREO expense line continues to go down over time. I think there are some other efficiencies that we can continue to wring out of these offices. It wouldn't surprise me if our non-interest expense went down another quarter or 2. But the further improvements in that are probably going to be more modest than you've seen over the last 4 quarters when we really brought that number down big time. And we projected that that would happen. We said right after we made those acquisitions that non-interest expense ought to decline in the coming quarters, it has and declined significantly. We're back down to a 45% efficiency ratio. I'd like to keep grinding that efficiency ratio down and get back to the high 30s to the 40%, 41% type ratio. And the biggest key to that is not really cutting expenses so much more, but the biggest key to that is getting the revenue going. We've got 115 offices today. That's about 50 offices, 45, 50, 55 offices, more than we really need today. I'll need all those offices to generate deposits and so forth as we get this loan machine going even better than it is, and I think it is gaining momentum. So with all that, I think we'll need all these offices, and that's how we get back to a 40% efficiency ratio. It's not so much cutting the expenses, and I really do think we can improve them another quarter or 2, but longer term, the key is revenue growth and begin to more fully utilize this vast network of offices we built. And I think we're well on our way to making that a reality over the next couple of years.

And that loan collection and repo expenses, you mentioned that could eventually come down. That's something about $2 million per quarter. I did not see that disclosed in the press release. Is that about what it was in Q2, you think?

I don't have that number in front of me, but we'll have it in the Q and I would guess it was not terribly dissimilar in Q2 to Q1. But again, I've not looked at that number specifically.

Moving onto Brian Martin with FIG Partners.

One question, George. On the -- just given your comments about the credit quality and the new loans you're putting on, the quality that they are and looking at the charge-offs this quarter at such a low level, is it fair to think about things going forward that the charge-off type of levels ought to be sustainable at this type of lower level given the quality of steps you're putting on at this point?

Well, I don't know quite how to answer that. I guess I haven't prepared to answer that and I haven't thought about that in that context. But I would tell you that I think the loans that we are booking -- the loans we booked in the last 6 months or the last 12 months are probably, on average, on the aggregate, the best quality portfolio we've ever booked. And part of that is our philosophy has been different from a lot of banks. We see a lot of our competitors whose philosophy seems to be while the recession is over, we can go back to doing loans the way we did them before the recession. And so we're seeing a lot of really high-leverage, low-equity stuff that's done at very competitive rates and in some cases, what our competition is doing looks like 2007 all over again. And our philosophy is very different. We spend up to the beginning of the recession, I spent a 28-year career building a set of credit standards that we'd strive to follow with a high degree of adherence. And in the last 5 years, through the slowdown in the economy, we've learned a lot of lessons that have caused us to go back and say, "Wow, our credit standard was really good in this regard, but it wasn't good enough for this situation, or that situation or the other." So we have incorporated in our credit policy, now, 33 years of my credit experience. Our prior credit policy incorporated all of the lessons we have learned in 28 years and we've now got 5 years of more lessons from a very challenging economy. So we have incorporated all of those risks, and our philosophy is we're never going to go back to doing business the way we did in '07. We don't want to go back to doing business the way we did in '07. We want to do business based on all of the things that we've learned from this severe economic downturn that afflicted our country for a period of time there. So our credit standards are permanently different and I think that, that does have positive implications for our net charge-off ratios in the future.

Okay. And can you just give it a little color, George, on the level of opportunities you're looking at in -- maybe in Texas, kind of year-to-date versus where you're at a year ago? I mean, how much more magnitude of opportunities are there in Texas, if maybe you can just give a little color on?

I would say that the level of opportunities we're seeing, the pipelines that we're looking at on just flow of opportunities is running well over 50% ahead of the level of opportunities that we were looking at a year ago. And the other thing that I would tell you about that is the quality of those opportunities are better. So not only is the volume is better, but the quality is better. And there are 2 reasons that the quality is better. And one is fairly a marginal reason, and that is the economy is a little bit better. But the second thing is more unique to us and that is that a lot of customers and prospective customers that were showing us transactions a year ago did not really understand our equity requirements and our strike zones, so the deals that we're seeing today, the opportunities we're seeing today tend to come from customers and prospects who much more understand what our equity requirements are going to be and what our pricing requirements are going to be, so they're showing us opportunities that fit what we're doing a little bit better. So we're seeing a lot more applications and I would say, better applications than we were seeing a year ago.

Okay. And do you know what the applications were last year that you looked at on this? So if we look at that 50% increase, how much was it in 2011?

In 2011, our Real Estate Specialties Group, I have -- that's our biggest office, so I have a lot of breakdown on that office, but that office looked at $8 billion of loan applications last year. And I don't know, I haven't looked at the data. We've got the data, I just haven't had time to look at it. But I know through April 30, the first 4 months of this year, they had looked at over $4 billion of applications. So instead of running -- they were running over 50% ahead in volume, ahead of where they were last year and on a monthly average. And my sense is that has probably done nothing but accelerate in May and June and July. And again, I don't -- I haven't looked at that data, but just from the number of -- I talk about every loan those guys do with them, and just discussing with them in my regular calls with them, all the opportunities they're seeing, my sense is that they're running over 50% ahead of last year's application volume and that the quality is better.

Peyton Green with Sterne Agee has the next question.

George, I was wondering if you could comment a little bit on the covered loan portfolio, just maybe give a little bit of an idea of what you would expect to run off to be on that over the next 18 months or so.

Well, again, we started out saying we thought that was kind of a 20-month -- or 20-quarter run rate on the portfolio, and then we evolved that in the quarter and in the last couple of quarters, the pay rate has been about 1/18 or 1/17 a quarter. And I think given the pay downs in the portfolio and the aging of the portfolio, it's probably realistic to assume that it's kind of a running 16, 17, 18 quarter run rate on that portfolio and a rolling run rate. So if you decide to use 17 quarters, Greg, what was it last quarter? Was it at 17? So if you use 17 quarters, I'd take the ending balance and divide it by 17, and that would be sort of what I would project the runoff would be in the next quarter, and then the next quarter take the ending balance and divide it by 17 again. Because there is, particularly in the residential parts of those portfolio, there'll be a long tale on a lot of that, and a lot of that business is good business. So there'll be a pretty significant tale of that that will stay around. But I think for your projections for the next 24 months, next 8 quarters, probably just assume a 17-quarter run rate, that's a rolling run rate. So you just keep dividing by 17 at the end of each quarter and projecting out. That's probably a pretty good estimate.

Okay. And then certainly, I mean, the other income in terms of the FDIC activity, it seems like the number is still quite strong. Is there anything different from one quarter to the last or even a couple of quarters ago that you're finding about the recovery process that makes you a little bit more optimistic about the recovery income or even the OREO gains? I guess I'm thinking more from have property values improved any or are there more buyers for these types of properties, or what's going on there?

Nothing has changed about our expectations really at all in that regard. And we were talking in the second, third and fourth quarters of last year and saying that we expected recovery income would -- and gains on sales of foreclosed assets would bounce around from quarter-to-quarter because it's so transaction deal driven. Loans paying off, foreclosed assets being sold, it creates quarter-to-quarter volatility in that number. But we said that we thought that number would probably tend to be -- have to an upward bias in 2012 and -- or I'm sorry, yes, 2012 and into 2013 that those numbers would probably tend to get higher before they went lower. And the reason that we think that's true on recovery income is you book these loans with discounts and as they credit marks and you don't accrete those credit marks, and as the loans pay down, your carrying value gets lower and lower because all the payments that come in are applied to your carrying value and then you get the loans where maybe you marked them at day 1 to what you thought your collateral value was and 2 years later, the customer's made 2 years of payments and now, your carrying value is way below your carrying values. So when that loan gets to 0, every dollar you collect from there on is recovery income. And we're getting more and more loans, it seems like, that tend to fall into that situation, or if the customer comes in and pays the loan off, you've got a big recovery income, even bigger than you would have if they paid it all on day 1 because your carrying value has gone way down. So we had expected and we said that one of the things that would mitigate the declining rate of interest income off those loans as the portfolio shrunk was, that we expected the recovery income and the gains on sales of assets would tend to be higher in 2012 and probably 2013 than they were in 2011. And that that would give us a nice boost in the non-interest income line that would support earnings while we were growing our non-loss share portfolio and reaching the point which I think we're now at, where our forward earnings momentum is driven by our legacy loan portfolio. So this is all working out so far very much as we expected it would. And I continue to think we'll have high levels of recovery income and gains on sales of foreclosed assets the remainder of this year and next year and that that will be a strong contributor to our earning.

And we'll now hear from Michael Rose with Raymond James.

I just have one follow-up, housekeeping question if I could. On the FDIC loss share receivable income, I think back in the fourth quarter, you said borrowing in the FDIC deals, that would essentially run to 0 over a 10-quarter period. Is that kind of an outlook? Am I understanding that correctly still?

On the FDIC loss share receivable?

Yes, in the fee income?

Yes. Well, let's just deal with the loss share receivable. The fee income, the other loss share income, the gain on sale of assets, the interest income, all of those pieces of the loss share deals have a much longer time horizon, but the FDIC receivable -- Greg, where were we within the end of that quarter? $208 million -- we were $208 million and I think 2 quarters ago, we collected about $45 million a quarter. Last quarter, we collected about $40 million. When we turned in our loss share search for the quarter just ended, which will collect in Q3, that's about $35 million. We're accreting a couple of million dollars a quarter into that. So that number is going -- that $203 million -- $208 million, that $208 million is going up a couple of million a quarter from accretion, but it's going down tens of millions of dollars a quarter through collection of those receivables. And I think the fact that our receivables, our collections were $45 million, $40 million, $35 million, pretty much reflects the trend of our collections. So I would hope in another 10 quarters, plus or minus, that we've pretty much collected the majority of the FDIC receivable. So that accretion income should go away over the next 2 to 2.5 years. Now we have conservatively accounted for that accretion income, so my hope is we get to a point out there where we've got our receivable to 0, but we're still collecting sums from the FDIC, which would all the income then. So we may have a different form of income that kicks in, in a couple of years, 2, 2.5 years or so, 3 years, when we're still collecting sums from the FDIC, but because we were conservative in the way we value that receivable, we've taken the receivable to 0, we still collected income. The operative percentage, we have loss share agreements that have higher and lower percentages and different tranches, but the operative percentage right now for essentially all of our FDIC deals is 80% loss share. And I think we're carrying our receivable at about 60%, roughly, of the credit mark -- or the total credit and MPV marks on our assets instead of 80%. And we've got a cushion built into that because we realize you could get to the end of loss share and not collect everything that -- you might not collect for every loss that's in the portfolio. So we're not carrying the receivable of the full 80%. And at the rate we're collecting it, there's a real possibility that in 2014 or 2015, we could be collecting sums from the FDIC that we don't even have on our books right now.

And we'll move on to Derek Hewett with KBW.

I just have a housekeeping question. Do you guys happen to know what the remaining accretable yield is? And did we see any sort of material movement from non-accretable to accretable this past quarter?

Greg says we don't have the final numbers on that. My impression, Derek, is there was probably no material change in a percentage basis. The portfolio went down 6% of whatever and I don't think there was any significant change in that. So I guess the way I can address that, probably, that would be more helpful to you is say we don't foresee a major change in the yield in percentage terms. The effective net interest yield on the covered loan portfolio, I think, it was 8.60% [ph] in Q1 and 8.61% [ph] in Q2 and I think we had like an 8.39%[ph] a quarter back last year. I mean I think we stay in that mid- to slightly higher-age range going forward as far as the effective yield on that portfolio.

We have no further questions. George, I'll turn the conference back to you for closing or additional remarks.

All right. Thank you all for joining the call today. We greatly appreciate your time and interest in our company. Have a good rest of the day and we look forward to talking with you in about 3 months. Thank you. That concludes our call.

And again, ladies and gentlemen, that does conclude our conference for today. Again we do thank you all for your participation.