Torry Berntsen – President and COO David Brooks – Chairman and CEO Michelle Hickox – EVP and CFO.

John Pancari – Evercore Brad Milsaps – Sandler O’Neill Matt Olney – Stephens John Moran – Macquarie.

Presentation:.

Good day, ladies and gentlemen, and welcome to the Independent Bank second quarter 2014 earnings conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions) As a reminder, this conference may be recorded.

I will now turn the call over to your host, Torry Berntsen. Please go ahead..

Thank you and good morning. Welcome to the Independent Bank Group conference call to discuss financial results for the second quarter 2014. I am Torry Berntsen of Independent Bank and would like to thank you for joining us this morning.

I will go over a few housekeeping items and then hand it over to David Brooks, our Chairman and CEO to lead the presentation. We issued our earnings release this morning and a copy is posted on our website, www.ibtx.com. We will be going over much of the release on this call.

If you are having trouble accessing it, please call Eileen Ponce, 469-742-9437469-742-9437 and we will email or fax you a copy. Some of the remarks made today will constitute forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995.

We intend such statements to be covered by the Safe Harbor Provisions for forward-looking statements contained in the act. Please see Page 4 of the text in this morning’s release for additional information about the risks associated with these forward-looking statements.

Please also note that if we give guidance about future results, that guidance will only be a statement of management’s beliefs at the time the statement is made. Predictions that we make may not continue to reflect management’s belief and we do not publicly update guidance.

In this call, we will discuss a number of financial measures considered to be non-GAAP under the SEC’s rules. Reconciliations of these financial measures to the most directly comparable financial measures calculated and presented in accordance with GAAP are included in our earnings release.

At the conclusion of our remarks, we will open the telephone lines for questions. At that time, we will provide instructions for submitting your questions. With those reminders out of the way, I would like to outline the agenda for this call. David Brooks will open with his thoughts regarding the second quarter results.

Michelle Hickox, our Chief Financial Officer, will lead you through the quarter’s operating results and some balance sheet highlights. David will then close the presentation and open the phone lines for questions. I will now turn it over to David..

Thanks, Torry. Good morning and welcome to Independent Bank Group’s second quarter 2014 earnings conference call. We are pleased with our results from the second quarter and our continued strong momentum. We are also excited about closing the Bank of Houston deal earlier than expected on April 15th and the successful integration to date.

It is a real tribute to our staffs and advisors at both institutions and to our interactions with the regulators. We are also delighted to have announced the Houston City acquisition in the second quarter. Our presence in the dynamic Houston market continues to grow.

Overall, we intend to continue to be an active acquirer, looking to build out the Houston region and add to our footprint in the major markets across the state. With that said, a few highlights include the following. Core earnings remain solid, increasing sequentially and on a year-over-year basis through both organic and acquisition growth.

We expect improvement in core earnings with increasing loan volumes throughout the remainder of the year. Our organic loan production continues to be strong with loans held for investment increasing at an annualized growth rate of 25.6% during the second quarter.

We continue to see increased loan demand and are particularly pleased with our growth in energy lending. Our downtown Dallas and Austin locations had another robust quarter. Asset quality remains strong. We fully understand the need for conservative underwriting and effective credit administration during periods of strong loan growth.

The second quarter asset quality ratios continue to reflect our strong credit culture and are at historically low numbers. We are very encouraged with the improvement in our efficiency ratio. On a core basis, it was 56.9% for the second quarter.

We also completed our core [Jack Henry] [ph] system conversion that will support and augment our growth for years to come. We have also further strengthened our technology efforts by adding a very experienced Chief Information Officer to our team. Finally, we recently executed a successful subordinated debt offering strengthening our capital base.

And we are also very pleased with the achievement of an investment grade rating with respect to our debt. As I will summarize at the end of the call, we feel very good about 2014 and the first six months of the year. Now, I’d like to ask Michelle to go over second quarter results..

Thank you, David. Good morning, everyone. As noted in the earnings release, our second quarter net income was $9 million or $0.57 per diluted share compared with first quarter net income of $5 million or $0.39 per diluted share. I would like to highlight a few things regarding earnings.

Net interest income increased during the second quarter to $31.4 million compared to $22.1 million for the first quarter. The increase in net interest income reflects increased loan volume, both organic and from the Bank of Houston acquisition. Our net interest margin was 4.26% for the second quarter compared to 4.17% for the first quarter.

The increase is primarily due to a decrease in excess liquidity and the benefit of Bank of Houston’s lower cost of deposits. Our percentage of demand deposits relative to total deposits has increased as a result of the acquisition. The yield on interest earning assets was 4.76% for the second quarter compared to 4.74% for the first quarter.

The cost of interest bearing liabilities, including borrowings, dropped to 0.64% for second quarter 2014 from 0.715 for first quarter of 2014 and 0.93% for second quarter 2013 due to a lower cost of deposits and FHLB advances and the repayment of indebtedness over the last year.

Total non-interest income increased $785,000 compared to the first quarter. The increase is attributable to increased mortgage fee and service charge income and an increase in the cash surrender value of bank owned life insurance related to the Bank of Houston transaction.

Total non-interest expense increased $9.3 million compared to the first quarter. This increase is primarily related to the Bank of Houston transaction. Total merger and acquisition costs for the quarter were approximately $5.5 million, including $4 million for compensation and bonus expense related to the transaction.

The provision for loan loss expense was approximately $1.4 million for the quarter, an increase of $126,000 compared to the first quarter. The increased provision is reflective of the loan growth experienced during the quarter.

I should also reiterate the point that loans acquired in the Bank of Houston transaction have been recorded at an estimated fair market value as of the date of the acquisition and do not have an allowance as of June 30, 2014. As you review the balance sheet, there are a few things to note regarding loans.

For the second quarter, organic growth of the loans held for investment were 6.4% from March 31, 2014 or 25.6% on an annualized basis. In addition, we added $787 million in loans from the Bank of Houston transaction. The composition of the overall loan portfolio continues to diversify, as projected. C&I now represents 19.9% of the portfolio.

Our energy outstandings were $199 million as of June 30, 2014 and we believe this will continue to be a growing area of our loan portfolio. Our Houston energy presence added to our lending in the second quarter and is expected to be a revenue synergy from the acquisition. As loans continue to grow, we maintain rigorous focus on asset quality.

Total non-performing assets represented 0.39% of total assets at June 30, 2014 compared to 0.51% of total assets at March 31, 2014 and 1.27% at June 30, 2013. Additionally, total non-performing loans represented 0.37% of total loans at June 30 compared to 0.39% at the end of March and 0.43% a year ago.

We continue to focus on attracting and growing our core deposits. Total deposits were $2.85 billion at June 30, 2014 compared to $1.89 billion at March 31, 2014 with $821 million of this increase through the acquisition of Bank of Houston.

The average cost of interest bearing deposits decreased by two basis points during the second quarter to 0.49% compared to 0.51% for first quarter 2014 and decreased by nine basis points compared to 0.58% during second quarter 2013. We benefitted from Bank of Houston’s lower cost of funds.

That concludes my outline of the highlights of our financial statements and I’ll turn it back over to David..

Thank you, Michelle. As noted in my earlier remarks, we feel like we accomplished a lot during the second quarter. We continue to believe in our business and footprint. Loan demand is up and the growth across our franchise remains strong.

The M&A environment in Texas continues to be very active as evidenced by our recent announcement of our intention to acquire Houston City, the parent of Houston Community Bank. I regularly have conversations around cities and areas that we are interested in and where we envision our growth.

We intend to continue building out our footprint as strategic opportunities arise. However, we will remain disciplined in our approach to these acquisitions.

In conclusion, we know that there are competitive challenges ahead but we believe that our strong financial position and commitment to our proven business model, communities and employees will yield positive results and enhance shareholder value. With that, we will open the call to questions.

Operator?.

Thank you. (Operator Instructions) Our first question comes from John Pancari with Evercore. Your line is open..

Good morning..

Good morning, John..

Just wanted to get a little bit more color on the drivers of the loan growth in the quarter.

Can you just talk about how much of the - or what you’re seeing in C&I versus CRE and maybe a little bit more of the regional color as well?.

Our most active areas, John, have been Dallas and Austin. Obviously we had a partial quarter of Houston there continuing to see good growth there as well but so more the metro areas. Because of that, we’re seeing a nice mix of C&I. Our C&I portfolio now is up to 20%....

It’s actually at 20% right now, John..

Which was our target we mentioned a year ago. 15 months ago we went public with that we wanted to get C&I up to 20%. About half that's energy… it’s not quite half energy at this point but energy has been a strong driver of the growth.

I would say more general C&I has also participated in the growth and then on the CRE front, a lot of I would say user real estate, owner-occupied real estate and then some investment type real estate as well, John, if it helps..

John, it’s Torry. I think it’s really across the board in terms of CRE and C&I and, again, as David pointed out the component of the Energy side and then some of those metro areas are really seeing the most significant growth overall..

And then one other area, John, I would mention, we’re seeing terrific growth on the home construction, interim construction lending as well..

Okay, all right.

And what’s the size of the Energy book as of the end of the quarter?.

We had about $330 million in commitments outstanding, some of which we had [inaudible] participations off. Our total outstanding energy loans in the quarter were about $200 million..

Okay, good. And then in terms of loan growth, just how we can think about the outlook, your end of period balances came in well above the average loan balance. Now, I know there could be something impacted by the merger but not too much since you closed the merger in April.

So is the end of period balance indicative of what we should expect where loans can trend from here?.

I think so, John. Obviously we had a really strong first six months in organic loan growth but our pipeline’s still good. We indicated our goal short and mid-term has been to grow 18% to 20%. We’re on the outside the top end of that and we feel good about where we are and for the balance of the year..

Okay, good. And then lastly, just on the margin quickly, just wanted to get a little bit of color given how competitive it is in Texas, I wanted to get a little bit of color around where you’re bringing on new loans in your portfolio in terms of the average new origination yields by C&I and CRE possibly. Thanks..

I think our - we’re still seeing the CRE loans, John, in the 4.25 and 4.75 range with these, so pretty good yields on those.

We’re seeing energy loans generally in the threes, mid threes, mid to upper threes with fees and fees on use from generally leading those credits and getting deposits and so we’re getting some treasury management and other type opportunities there. And then so, yeah, floating rates in the 3.5 to four range and real estate loans in the 4.25 to 4.75.

It’s very competitive out there, John, as you alluded to, especially on the price side and we just see a lot of banks obviously hungry for growth and there’s a lot of growth going on in Texas, so it’s a great place to be.

There’s a lot of business out there but we’re also seeing some of the larger banks come down market a little bit where they can get better yield, so that’s putting some pressure more in that $10 million to $20 million type originations. We’re seeing some of the banks in that space that we hadn’t seen before.

So it’s going to continue to be difficult from a pricing standpoint. We’re going to continue to see pressure on loan pricing..

John, the C&I stuff is typically prime plus a spread, so obviously it’s floating in with shorter maturities..

Okay. All right, thank you..

Thanks, John..

Our next question comes from Brad Milsaps with Sandler O’Neill. Your line is open..

Hey, good morning..

Good morning, Brad..

Just wanted to see if you guys can make some comments around expenses. I know with the Bank of Houston deal closing things are a little muddled, linked quarter.

But just curious how successful were you in implementing some of the cost savings into the run rate and what do you feel like you got to continue to pull and just try to get a sense of run rate expenses as you move into the back half of the year..

Great question.

Michelle, would you take a shot at that, first?.

Sure. Hi, Brad. I think it was a really noisy quarter as you alluded to and there were a lot of expenses related to the acquisition on Bank of Houston.

But we really haven’t gotten the benefit of all of our cost saves yet because we actually are going to do their conversion this coming weekend, so really it’ll be closer to the end of the third quarter before we start really getting at least most of the compensation cost benefits out of that deal.

So really I expect our expenses, the run rate to improve at least related to Bank of Houston for the end of the year. And I think if you back out kind of the expenses we pointed out as non-core for the quarter that should stay fairly consistent through the remainder of the year..

Okay.

So 3Q might be relatively consistent with the core and second quarter and then you would start to see it maybe fall off from there?.

We would really get the benefit in the fourth quarter. You will really see the benefit in the fourth quarter..

Yeah, we’ll have most, Brad, I think of the cost efficiencies that we’re getting from the Bank of Houston deal you’ll see fully implemented in the fourth quarter.

The computer conversion, as Michelle said, is this weekend, so we’ll begin once we get their IT system online with ours and consolidated, then you’ll begin to see some of the personnel saves that we talked about and so you get part of it in third and then fully see it in the fourth..

Okay. Okay.

And then just to follow up on John’s question regarding the NIM and I’m sure we’ll see this when you file the 10-Q but just curious how now that you have Bank of Houston on the balance sheet, I know you guys have talked about this previously but how your sensitivity to higher interest rates may or may not have changed now that you’ve got almost a full quarter with those guys on your books..

Michelle?.

It really hasn’t changed much, Brad. I think first quarter on a Pro Forma basis we were - well, actually, Independent Bank alone was just a little bit liability sensitive but really neutral. When we did the Pro Forma with them, we were slightly asset sensitive but still pretty neutral and I think that’s going to be about the same as the end of June..

Okay, great..

It hasn’t really changed..

Yeah, so we’ve moved neutral to just very slightly liability sensitive to slightly asset sensitive we think now, Brad, with the floating portfolio of Bank of Houston..

And that comes with having that C&I portfolio, Brad, be close to 20% right now..

Great. Thank you, guys..

Thanks, Brad..

Our next question comes from Matt Olney with Stephens. Your line is open..

Hey, thanks. Good morning, guys..

Good morning, Matt..

Hey, I wanted to ask about if there’s any update on the hiring of new commercial lenders. I know that’s been an important part of the story over the last few years and didn’t know if there was an update there..

Yes, good question, Matt. We hired five new senior lenders that we talked about in the first quarter. So the pipeline on that slowed down a little bit in the second quarter and that was really as much by design.

It just takes a while to integrate those teams as they come on from a cultural and just a logistical standpoint, finding them places to be and getting them all set up and integrated in the technology, et cetera. The teams we hired in the first quarter were particularly productive. That’s part of the growth story for the second quarter.

They not only started in the first quarter, they were producing and moving a lot of business over in the second quarter.

But we hired two new lenders in the second quarter, primarily replacement and younger lenders, so we didn’t hire any new teams or anything in the second quarter but we continued those discussions and expect that part of our story to remain the same for the balance of the year that we’ll continue to hire some teams between now and the end of the year..

And as far as the M&A initiative, I think some of your peers have had some problems getting their deals to the finish line and, obviously, this hasn’t been a problem for you guys.

But any update in your overall M&A appetite?.

As we mentioned, we closed Bank of Houston. We are on track to close Houston Community Bank. Houston City’s the parent, so you’ll hear us using those interchangeably but the Houston City parent company, we expect that to happen in the fourth quarter. No indications at this point that there’s any problem with that timeline.

We’ve been fortunate in our dealings both with sellers and with the regulators to be able to put together clean deals and get them through the system and improved.

But we are obviously aware of some of the challenges from a regulatory standpoint and we’re paying very close attention to that and doubling down our efforts to communicate well with our regulators. And I think part of it has to do with size as well and under $10 billion and we’ve got a lot of run room between here and $10 billion.

I think you have a little more flexibility in getting things done. When you get through the $10 billion and approaching $25 billion or greater than $25 billion, it just gets a bit more difficult apparently from our observation. But that said, we’re not in any way feeling like that we’re special. We just have to keep working hard and doing things.

But from an appetite standpoint, no, we continue to be active in the market, having discussions. We want to do strategic deals. We want to do smart, strategic deals. There seems to be a movement away, which is our view, away from tangible book value multiples which are always important and that is the multiple that people look at and think about.

But capital levels vary so much and how strategic a deal is varies a lot.

We’re really focused on earnings as the primary thing as we model and think about our acquisitions and that is what’s the current bank earning, what are the potential earnings as a part of our system and we value accordingly and that’s sometimes difficult when people are used to thinking, well, jeez, I can get two times the book or 2.5 times the book.

But if that’s 25 times trailing earnings, that’s a hard deal to do..

Matt, on the other point as a follow up to David on Houston Community, we should have that fully integrated into our… or the plan is to have that fully integrate into our computer systems or core system by the end of the year as well, so everything will be on one platform at that point..

Okay. And then last question for me as far as the tax rate, I guess the press release mentioned some of the 2Q expenses weren’t deductible.

What kind of effective tax rate should we be looking at for the rest of the year?.

Michelle..

It should be consistent what it’s been historical, Matt. It runs about 32.5% to 33%..

Okay. Thanks, guys..

Thanks, Matt..

(Operator Instructions) Our next question comes from John Moran with Macquarie. Your line is open..

Yes..

Good morning, John..

How’s it going? Maybe just real quick we could touch on the… and I know it’s a small piece of the overall pie, but on the fee side of things.

A pretty good outcome on mortgage I assume, just seasonally strong and then any sort of forward look that you could provide once Houston City comes in, if memory serves, they had some or may have had some other fee streams that would be additive. Thanks..

Thanks, John. I think fees were seasonally strong in the second quarter. We’re seeing obviously a lot of deal flow on the mortgage side. We’re starting to see some benefit from our focus on treasury and our focus on wealth management.

Initiatives were in the very early stages, so we’re hopeful that the back half of the year we’re going to see some production out of those areas that are net positive to the bottom line. And then as you mentioned, Houston Community’s done a good job in their fee lines of business and so we’ll see.

We don’t know when in the fourth quarter we’ll be able to close that so I don’t think that’ll… I don’t expect that to have a lot of impact on this year’s earnings but certainly we, as Torry mentioned earlier, we expect to get them integrated both technology and overall into our system in the fourth quarter, so we expect to see a full year of the benefit in 2015 of the fees and the cost savings on the Houston Community deal in full year ‘15..

Perfect. That’s helpful. Thanks, guys..

Thanks, John..

And I’m showing no further questions at this time. I will now turn the call back over to management for closing remarks..

Okay, good. Thank you very much. We had a busy second quarter. All things, though, moving in the right direction in our view and so we’ll continue to work hard.

We’re Pro Forma with the Houston Community acquisition, if we successfully close it in the fourth quarter, it’ll put us at the yearend around $4.2 billion to $4.3 billion in assets, so we’ve had a significant growth in the last 1.5 years and we’re optimistic that we’re going to be able to execute our strategy, so we’re excited about the back half of 2014 and really looking forward to 2015 as well.

So appreciate everyone’s support and we’ll be available if anyone needs anything else. Thank you..

Ladies and gentlemen, that does conclude today’s conference. You may all disconnect and everyone have a great day..