Torry Berntsen – President David Brooks – Chairman and Chief Executive Officer Michelle Hickox – Executive Vice President and Chief Financial Officer.

Brad Milsaps – Sandler ONeil Brett Rabatin – Piper Jaffray Brady Gailey – KBW Michael Rose – Raymond James Steve Moss – Evercore ISI Kevin Fitzsimmons – Hovde Group Matt Olney – Stevens Michael Young – SunTrust.

Good day, ladies and gentlemen. Welcome to the Independent Bank Second Quarter 2016 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 be given at that time. [Operator Instructions] As a reminder, this conference call maybe recorded.

I would like to introduce your host for today’s conference, Torry Berntsen, President. You may begin..

Thank you and good morning. Welcome to the Independent Bank Group conference call to discuss financial results for the second quarter 2016. I 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 last night and a copy is posted on our website. We will be going over much of the release on this call. If you are having trouble accessing it, please call Peggy Smolen 214-544-4777 and we will e-mail 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 the release for additional information about the risks associated with these 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 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 the call. David will open with his thoughts regarding the second quarter results; Michelle Hickox, 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 everyone, and welcome to Independent Bank Group’s second quarter earnings call. This was another successful quarter for us and demonstrates our continued focus on consistent earnings performance. Here are few highlights. Our earnings reflect continued growth, both sequentially and on a year-over-year basis.

Quarterly core earnings were $13.8 million and represented 11.3% increase in core earnings from first quarter of 2016. We continue to make progress with respect to expense management as evidenced by our core efficiency ratio decreasing to 55%. Organic loan growth was strong.

Loans grew 11.8% on an annualized basis for the quarter despite a 34% decrease on our energy portfolio. Growth was focused in commercial real estate and non-energy CNI portfolios and occurred across all our markets. Total assets increased to $5.5 billion at quarter end, an increase of $1.1 billion over second quarter 2015.

We enhanced our capital position with the issuance of a $45 million of subordinated debt in June. This resulted in a total capital ratio of 11.35% at quarter end. Maintaining a strong credit culture continuous to be a fundamental principle of our company and we remain focused on asset quality.

Nonperforming assets decreased 0.34% at the end of the quarter primarily due to payoffs in the energy portfolio. Our credit metrics continue to be at historically low levels. As of quarter end, our entire energy portfolio was $122.1 million or 2.9% of total loans.

We are pleased to have positively resolved a number of our criticized and classified energy credits. That said, we are seeing some stabilization in the energy markets and we recently approved a significant, well-structured energy loan that is yet to be funded. We remain committed to the energy business.

Our Houston Region loan portfolio continues to perform very well with metrics and breakdown similar to previous quarters. The total portfolio is $1.2 billion and represents 28% of our total loan portfolio. At the end of the second quarter, Houston classified assets remain at 0.16% of the entire Houston portfolio.

With that introduction, I will now ask Michelle to go over more details on our second quarter operating results.

Michelle?.

Thank you, David. Good morning everyone. As noted in the earnings release, our second quarter core net income was $13.8 million or $0.74 per diluted share, compared to $10.5 million or $0.61 per diluted share for the second quarter of 2015, and $12.4 million or $0.67 per diluted share for the first quarter of this year.

Net interest income increased during the second quarter to $45.9 million, compared to $37.8 million for the second quarter of 2015 and $45.7 million for the first quarter of 2016.

The increase in net interest income reflects increased average loan balances resulting from organic loan growth and additionally on a prior year basis loans acquired in the Grand Bank acquisition.

We saw continued growth in net interest income despite a return to normal accretion income level from the unusually high level reported in the first quarter. Our net interest margin was 3.96% for the second quarter, compared to 4.10% for the prior year quarter and compared to 4.08% for the first quarter.

The decrease from the prior year is primarily due to decrease market rates and lower accretion income. Recall that the first quarter 2016 had unusually high accretion on acquired loans of $1.3 million, as well as collection of non-accrual interest and extension fees totalling $342,000.

These items added approximately 15 basis points to the first quarter margin. Our core net interest margin, which does not include accretion, was 3.94%, compared to 3.96% in the first quarter.

The core margin was fairly consistent on a quarter-to-quarter basis as non-accrual interest and the fee income mentioned previously added three basis points to the first quarter core margin. Total non-interest income increased $820,000 compared to the second quarter last year and increased $459,000 from the prior quarter.

The increase from the prior year is primarily related to increased mortgage fee income given the low rate environment in home purchase activity, in addition to an increase in earning credits on correspondent accounts.

The increase in the linked quarter is the result of the same factors mentioned earlier, offset by decrease in income distributions from small business investment funds. Total noninterest expense increased $6.6 million from the second quarter last year and $2.5 million from the prior quarter.

Overall increases in noninterest expense from the prior year are generally due to the increase in number of employees and operating costs resulting from the Grand Bank transaction.

The increase in salaries and benefits from the prior year is also due to the $2.6 million one-time charge related to the company’s recent senior leadership changes, including the expense associated with the former Houston Region Chief Executive Officer’s Separation Agreement.

Increased professional fee expense over the time period is due to greater legal fees on existing litigation inherited in the Bank of Houston transaction.

With respect to the linked quarters, salaries and benefits increased primarily, as a result of the restructuring referenced above and professional fees increased, due to litigation and workouts to the energy portfolio.

The increases in the quarter were offset by lower acquisition expenses, as most of the cost associated with the Grand Bank acquisition were taken in the first quarter. The provision for loan loss was $2.0 million for the quarter, an increase of $464,000 from the second quarter 2015 and a decrease of $874,000 from the first quarter this year.

Generally provision expense correlates with net loan growth and level of charge offs. Recall that we took an additional reserve for the energy portfolio in the first quarter 2016 and with the significant paydowns in the energy portfolio and stabilization in the energy markets we did not make a similar provision for energy in the second quarter.

As it relates to loans in the energy portfolio, for the second quarter, loans held for investment grew 2.9% from March 31, 2016 or 11.8% on an annualized basis. As David mentioned, we experienced growth across all our regions. Loans have grown 13.2% on an annualized basis from December 31, 2015.

Energy outstandings at the end of the second quarter were $122.1 million, versus a $185.9 million for the prior quarter end. The June 30 number represents 2.9% of the entire loan portfolio. The energy portfolio includes $72.9 million in working interest credits, $36.1 million in royalty credits and $13.2 million in oil field related service credits.

We participate in three SNCs agented by other banks. We currently have four nonperforming energy credits totaling $11.7 million and three performing classified credits totaling $20.5 million. Aggregate criticized and classified energy credits totaled $39.4 million, down from $67.3 million 1% of total loans.

The energy related allowance is now 6.8% of the energy portfolio. With respect to overall asset quality, total nonperforming assets represented 0.34% of total assets at June 30, 2016, compared to 0.37% at June 30, 2015, and compared to 0.62% at March 31, 2016.

The decrease compared to the prior period is primarily due to the payoff of a $17.1 SNC energy loan participation that was placed on non-accrual status in the first quarter. With respect to funding, total deposits were $4.21 billion at June 30, 2016, compared to $4.17 billion at March 31, 2016.

The average cost of interest bearing deposits was up slightly to 50 basis points for the quarter, compared to 0.47% for the second quarter 2015 and 0.48% for the first quarter of 2016. Our year-to-date rate on total deposits was 0.37%. Non-interest bearing deposits have remained consistent at 26% of total deposits.

There was a net increase in total borrowings of $133.4 million from the first quarter of 2016. These movements reflect proceeds from the issuance from our subordinated debt and the use of short term FHLB advances for liquidity purposes. As David previously mentioned, we issued $45 million of subordinated debt in June.

This represented an increase of our outstanding 2014 issue with a maturity August 1, 2024. This increased our total risk-based capital ratio to 11.35%. That includes my highlights for financial statements; I will turn it back over to David..

Thanks Michelle. Our solid results demonstrate again our ongoing commitment to consistence and strong earnings quarter-over-quarter. We remain focused on quality loan growth across our franchise and lowering our efficiency ratio. Asset quality remains a vital component of our success as it has for the last 28 years.

We are pleased with the progress we have made in our energy portfolio and the improvements in its metrics. As we have continuously stated, we are committed to being in the energy business and believe now is the time to add some high quality credits with solid structures and pricing to our portfolio.

I continue to have conversations with banks located in markets where we plan to grow. These conversations have picked up over the last few months as our stock price has improved. I believe that trend will continue to be the case and we remain optimistic about the possibilities on the M&A front.

In conclusion, we remain committed to our strategy and believe in our fundamental business and staff, the shrink of our asset quality and our ability to execute. We remain confident about the prospects for the remainder of the year, as well. With that, we will open the call for questions.

Operator?.

Thank you. [Operator Instructions] Our first question comes from the line of Brad Milsaps of Sandler ONeil. Your line is now open..

Hey good morning, Dave, nice quarter..

Thanks Brad, good morning..

Hey just wanted to see if you can talk a little more about loan growth, obviously some nice growth in the quarter, heard a little bit about the energy pay-downs, I know that’s the direction you wanted to see those go.

Just, what’s your outlook there and what does the pipeline look like now kind of relative to where you were at March 31?.

Yes, the energy paydowns have obviously been a large and they were a little greater, I think, in the second quarter than we expected, Brad, mostly related to the resolution of criticized and classified nonperforming credits which you saw those numbers come down dramatically.

One of the ways we’ve looked at it – if you took out the energy paydowns we’ve had in the first half of the year, including those 13% organic growth, if you took those out, we would be running at a 16%, 17% organic growth rate. We’re not expecting to see a decline in our energy portfolio in the second half of the year.

We will have some new credits being added. We have approved what I mentioned in the call. We are agenting a large credit that we expect to fund in the third quarter in energy and, then, we’ve got a pipeline of other energy credits we’re looking at now that we expect to get some business out of in the second half of the year.

So, we don’t expect net paydown of our portfolio and energy. In fact, we expect it to grow materially from the level it’s at now in the second half of the year. So, instead of having the big headwind, we will have some tailwind.

It looks like our pipeline for nonenergy loans is consistent with where it was at the end of the first quarter and so a midteens – we have felt like for the year a low teens, low double-digit number was because of these paydowns in energy which has turned out to be about right in the first half of the year with the paydowns we were at 13% organic growth.

I think it’s going to be better than that in the second half of the year, given the tailwind we’ve got in energy and the strength we have in the other markets. But we’re still cautious around that and still feel good with what we have said in the past..

Great, that’s helpful. And just one follow-up for Michelle. Appreciate the color on expenses. I know you guys have talked about the back half, maybe seeing some – potentially some late quarter declines in overall expenses. I see the professional fees piece of it.

Maybe you have some potential to go down there but just maybe other line items that you might view as potentially being able to go lower. I don’t know if mortgage banking had an effect on some of those lines this quarter, but just any color on what you’re thinking on expense trajectory might be helpful..

Yes. You are exactly right Brad. The mortgage fee income. We pretty much – I think we’ve said in the past, we retained about 80% of that, so as you see that income go up, there’s going to be about 80% that hits the expense lines as well, primarily in bonus compensation for those lenders and commissions.

So that has mostly to do with what the increases in comp, once you pull out those kind of one-time expenses for the restructuring. And you’re exactly right, professional fees was up more than what I expected, but that was primarily due to some of the energy workouts and I think that was about $250,000 of the increase in the number.

So I think if you pull those two things out, you get back to the run rate that I had said in the first quarter of about $27 million on a core basis..

Great thank you guys..

Thanks Brad..

Thank you..

Thank you. Our next question comes from the line of Brett Rabatin of Piper Jaffray. Your line is now open..

Hi good morning..

Good morning Brett..

Good morning..

Wanted I guess first to ask about thinking about the margin in your origination rate relative to the 485 level in terms of yield in 2Q and then – you are a little over 100% loan to deposit ratio now. I’m just curious.

If you anticipate funding some of the growth in the back half of the year with higher cost sources, how do you guys think about both those things?.

Yes, Brett, in terms of rate pressure, I will take the part of the question regarding new loan generations. We’re seeing that be pretty steady, pretty flat, and held flat basically in the second quarter, so not seeing much pressure there. The market seems to have leveled out here and has accepted lower for longer, whatever the thought process is.

So, not seeing downward pressure on that. I’ll let Michelle speak about the margin generally going forward, but I will speak to deposits. We did have a little bit of deposit outflow at the end of the second quarter that we – right at the end of the second quarter that we necessarily hadn’t expected.

We have a large vertical in title companies and that ends up having a lot of funds flowing around at the end of quarters, the end of months, and particularly the end of quarters is – a lot of larger real estate deals get closed at the end of the quarter. So it flowed out a little bit at the end of the second quarter more than we expected.

So we didn’t expect to be over 100%, but nonetheless we were. And we are continuing to focus on treasury efforts, continuing to focus on the possibility of some other verticals like the title company business that we’ve been successful with.

So continue to focus on that and also as we look at our M&A strategy focused on talking to banks with great core deposits and, maybe, with significantly lower loan to deposit ratios than we have that would average us down in terms of our loan to deposit ratio. So those are the active things we are thinking about.

I will let Michelle speak to margin and how she’s thinking about funding any shortfall in deposits in the second half..

Well, as you guys know, our loan to deposit ratio has floated right and around 100% for a while now.

And while we did see some pressure on funding costs at the beginning of the year, right after the Fed raised rates, I think after everyone kind of figured out that they weren’t going to raise rates again, we haven’t seen those requests like we were at the beginning of the year.

So our cost of deposits has bumped up a little bit, but the stuff that we been putting on more recently, we haven’t seen that pressure. I think – you know what I had said about the margin, I think it’s going to be fairly stable for the rest of the year.

If you had pulled out that – there was some non-accrual interest and some extension fee interest in the first quarter, the core margin actually would have gone up a basis point this quarter. And so I think it’s going to trend in about that range for the rest of the year..

Okay. That’s great color. And then the other thing I was curious about was obviously the energy trends are better.

Can you talk about just thinking about polar provisioning? If oil stays in this 40 to 45 range, would it be fair that your expectations are to continue to not have to make any specific provisions for the energy portfolio going forward? Or how do you think about the energy book in terms of the $39 million of criticized loans?.

Yes, as we look at it now, Brett, with the total energy portfolio being less than 3% of our outstanding loans and we’ve got almost a 7% reserve against those remaining loans. And as you noted, we resolved that the majority of our classified criticized assets in the second quarter.

So we do not anticipate – we did not take an additional energy provision in the second quarter and we do not expect to take one – any additional energy provision for the balance of this year..

Okay, congrats on the results, thanks..

Okay, thanks Brett..

Thank you. Our next question comes from the line of Brady Gailey of KBW, you line is now open..

Hi good morning guys..

Good morning Brady..

How did you get this level of energy shrinkage? Was this just paydowns or did you actually sell some credits? This is a notable decline. I’m just wondering how this came about..

Yes it was just really the result – we expected it really more spread over the first quarter and second quarter. And some of the ones that we had planned for and expected in the first quarter, I think we mentioned at the end of the first quarter got pushed into the second quarter.

So in our view, we kind of got the whole first six months worth in the second quarter and its all resolutions. Brady, we didn’t sell any energy credits in the second quarter and that has not been our MO in terms of resolving these. They have been all just in the field people.

Really, what happened in the second quarter from a big picture – maybe to answer your question is, the capital markets opened up, there was equity – private equity coming in.

Some of the second lien and subordinated debt holders – to protect their position, made equity investments or loaned more sub debt in order to pay down the first right sized – the first lien debt.

So it was a combination of equity primarily and then some sales of assets that had been in the works and just with the stabilization of prices in the 40s – mid 40s, upper 40s for most of the quarter, we saw some deals actually close where – and in fact the deal that we just approved here early in the third quarter that we expect to close in the third quarter is the transaction where a group is buying a significant piece of assets from one of the major companies that is downsizing their portfolio.

So we’ve seen that with our portfolio, just people going, look, we’ve got this one field or this one set of assets that are not necessarily core to our long-term strategy or in some cases they just decided to get out of the business. So we have seen that.

So, no loan sales 100%, just resolution by our credit and energy lending team in the field dealing with our customers one-on-one..

Actually that $17.1 million alone, Brady, was just – we had originally anticipated that it might be paid off in the first quarter and even at the end of the year, so David is spot on in terms of what is going on with that trend being pushed back..

Yes, and we predicted the end of the first quarter that energy prices would stabilize. Our customers would be able – bars will be able to execute on their plans which we’ve been working on for the last 18 months and sure enough, that’s what happened..

And ideally, where do you want your energy exposure to stand? 3% of loans sounds like it’s going to be a low point.

Ideally, do you want that number at 5% of loans, 10% of loans, or is it a percent of capital? How do you all think about the max you want to bring energy back up to?.

Yes, we had peaked out at upper 7s, just under 8% at the peak when energy prices started down. Brady, I think our policy – internal policy was 10% was our max exposure at the time that we went into this downturn and I agree with what you said, 3%, a little under 3%.

We expect to be our low-water mark and I think in the foreseeable future, we would love to get that back in the 5%, 5% to 7% range feels like a good level for us.

But you know again, it will be conditioned upon our ability to generate credits that meet our bar and we’ve learned like everyone has during this downturn, we’ve tweaked our policies and strengthened where we needed to strengthen and – so it will just be contingent upon the markets providing us opportunities, but – if you said hey, just pick a number where you would love to be, I think 5% to 7% feels right to us..

Okay.

And then can you update us, where do you guys stand commercial real estate as a percent of capital in 2Q?.

I think we ended up Brady post the additional capital, the $45 million of sub debt that we put in, we were in the – around 380% of capital in total CRE. And then we were in the I think mid-100s – 150-ish on the – maybe a little less than 150% on the construction loans. So on the ratios everybody pays attention to, less than 150% and 380% I believe..

And that was pro forma for the sub debt?.

Yes, that was with the sub debt..

Okay. And I know you all have raised sub debt here a couple times. But your comment – are your TC ratios still – I know it’s within the guidelines that you also said and it’s where you all have always brought it, but it still screens as less than peers. And you all over the – I know it’s not a rule, but just kind of guideline for CRE and construction.

Are regulators changing the way that they look at your capital base related to TCE or are they even [indiscernible] there at all?.

And we don’t – we haven’t seen a focus from the regulators so much on the TCE ratio. It tends to be more focus of the investors and analysts looking at returns on equity and those type of things.

The regulators tend to be focused on the total capital ratio and particularly the total risk-based capital ratio at the underlying bank and that’s what we’ve managed to in the past. Our total TCE – I’m sorry, our total risk-based capital at the Company was, I believe, 1.135, at the end of the quarter. We generally wanted that number north of ##%.

And as it relates to CRE, I know that’s been a topic and that seems like the next topic up post the energy commodity price challenge we’ve had the last 18 months. We understand that.

I’ll just say that for 28 years we have been a community bank that is slowing down real estate, we’ve been in growth communities, we are still in growth communities in Dallas, Austin, Houston, and a lot of what we’ve done has been real estate. It is granular, it is a lot of owner-occupied.

Our whole positions are, I think, less than most banks our size. So we part of our credit strategy has been diversification of risk across different property types, different industries, and we are big believers in real hard equity. We are not big appraisal lenders, so we want our borrowers to have cash equity in their deals.

That has really protected us in the downturns, and if over the last 28 years, Brady, at our performance versus peers in Texas, versus our peers nationally during every major economic downturn and most recently in 2008, 2009 and 2010.

If you look at our numbers, we are a fraction in terms of our classifieds and charge-offs, a fraction of what our peers in Texas, and a smaller fractions of what our peers across the country had to deal with.

So again, that’s not to sound overly confident, but we are very good real estate lenders and our policies and the way we have done real estate lending last 28 years has not changed. We got the same credit, Chief Credit, Chief Risk Officers, the same credit team we had during that time, and we feel good about our current portfolio and exposure.

And we understand there is a higher bar for banks that run at the level that we run at, and we’ve always been able to meet that bar in the past with our regulators and we have a – continue to have a strong relationship and a good dialogue that goes back that goes back and forth monthly and quarterly.

So that said, we’re aware of the attention it’s getting today. And we intend to do with it accordingly. .

Great. Thanks for the color, guys..

Thanks Brady..

Our next question comes from the line of Michael Rose of Raymond James your line is now open. .

Hi good morning guys how are you. .

Good morning Michael..

I just wanted to follow up on that line of questioning on CRE. So you guys are about 52% CRE. Some banks this past week have talked about scaling back commercial real estate.

How do you envision this whole conversation playing out? Would you expect your mix to change? Would you maybe look to focus a little bit more on C&I just kind of at least keep the concentration levels near where they are? Any sort of change in your thought process as you move forward on this issue? Thanks..

Certainly we are continuing to monitor and manage that exposure the way we have and continuing really to try to be relationship based lenders. We don’t buy a lot of large share national credits. In fact, very, very so we continue to be relationship-focused, so that hasn’t changed, Michael.

Certainly the ability to in our minds make good, well structured energy loans will help the diversification a bit going forward, we do continue to focus on C&I and we have hired a few C&I lenders the last couple of years. And really going into this downturn so we’re starting to see the results of that here in the first half of the year.

We are seeing some growth in our non-energy C&I portfolio as well. So, we are going to pay attention to it and we’re also focused on just opportunities to be in different verticals or lines of business.

But I think overall, our focus and heavily owner-occupied focus on a real estate again, relationship-based owner-occupied credits mitigates our risk when you just look at those total numbers so..

Okay and maybe just as a follow-up to that, how does this play into your thought process around future acquisitions? If I look at some of your markets, some banks that I would screen as maybe potential candidates for you are also over that – over those guidelines.

Does that play into your thought process at all when you look at potential deals?.

Sure it does and we are looking for the best managed, best run banks with great deposit bases and clearly as we look across the whole market place with all the potential candidates other banks that are running 100% loan to deposit ratio might not be as attractive to us today as banks that are running 70% loan to deposits.

But again, it is much bigger than just that, but to answer your question, yes, we’re paying attention to that as well..

Okay, that’s helpful. Then maybe just one more for me. You kind of mentioned that energy portfolio going through here. Obviously we’ve seen some players pull back in the space and not being willing to commit to growing the portfolio, I think you guys are obviously one of the banks that will.

Does that mean moving upstream in terms of the size of credits that you do and the opportunities that you look at, obviously, the balance sheet is a little bit bigger than it was a year or two ago.

So how should we think about the types of credits that you are going to look at in the energy space as we move forward?.

So not necessarily we would be moving dramatically upstream. I think we have felt good with holds in the $10 million to $25 million range and some of the credit sizes, the total facility and the $40 million to $70 million range, so still deals that can be club deals with two or three or four banks taken $15 million, $20 million a piece.

That tends to be on the upper end of what – where we like to be and the opportunities we’d like to see. We did learn during this downturn that sometimes there’s more risk in a $5 million deal than there is in a $50 million deal.

So I would say would be – one of the things we have tweaked is to be a little more cautious about some of the very small end credits and going forward, we will probably be more attuned to those to making sure we have personal guarantees and we usually do on credits that size anyway.

But more of a hard-line maybe on the structure on those smaller deals. It would be one of the lessons that we’ve learned in this downturn. But certainly, we are a bigger bank just our philosophy, it just goes 28 years deep is to keep, hold smaller pieces, not bet the ranch on a credit by taking $35 million, $50 million pieces of deals.

It’s not, hasn’t been our style..

Okay, that’s great color. Thanks for taking my questions. .

Hi thank Michael..

Thank you our next question comes from the line Steve Moss with Evercore ISI. Your line is now open. .

Hi, good morning..

Good morning Steve..

I just wanted to follow-up on the energy credits.

Wondering how much better are the terms today – how much lower is leverage and how much better is pricing?.

Yes, so I do think there was a bit tighter structure in what we’re seeing today.

The biggest probably risk mitigator is just that all the pricing deck and models in everything today are based upon the current pricing in the 40s as opposed to when we were making credits before, making loans before when prices on oil were $100 and the price deck was $83. So I think that mitigates a lot of the risk.

And there is a lower leverage – I will say there’s more equity, so you have the lower price deck and you’ve got more equity coming into transactions then we saw back in 2013 and 2014 and then also being very particular around hedging today and making sure that those hedges were in place and so.

Yes a tighter structure and you see it, we saw it in real estate in 2010 and 2011 and 2012. The real estate deals are getting done at more equity. They were tighter structures, higher rates. So yes, we are seeing those same kind of trends in the energy business. .

Okay and also David, just kind of wondering in terms of M&A here, what is the typical type of deal size you’re thinking these days and any particular focus in terms of market? Does it remain more Dallas, Austin and Antonio rather than Houston?.

Not necessarily Steve, we think Houston has done really well during this downturn. Our numbers as we’ve said have been fantastic in Houston in terms of really no issues at all and some of the best credit performance across our Company has been in Houston during this downturn.

So, I’m not – we’re not opposed at all to partnering with the bank in Houston if we find the right partner there. There tend to be more opportunities right now properly in the Dallas Fort Worth area and in Austin and Houston behind that a little bit. Size wise, it is consistent with where we’ve been.

I think $500 million on the low end to $3 billion on the higher end in terms of an acquisition. I think bigger than $3 billion, you get up in the $4 billion to $8 billion is more of in our view a merger of equals type proposition. So in terms of just outright acquisitions, $500 million to $3 billion is a good spot for us.

$1 billion to $2 billion which is kind of the middle of that would be very comfortable for us. And we continue to see lots of opportunities, lots of dialogue, and I think a lot of banks, now that we are coming out of this energy downturn here in Texas for at least seeing stabilized prices in the mid-40s – I don’t want to sound too optimistic.

I don’t think anyone sees prices racing up anytime soon, but anyway, just now that we’ve seen some stabilization of people. We’ve got a little bit of the real deep concern about what’s going to happen to banks and in the market behind this that I think we are seeing more opportunities to have conversations.

And I think people are – owners of bank groups are more just being thoughtful around who do we want – if we are not going to get – realize our price expectations we had, based upon maybe what banks are selling for before the great recession, then how do we get there and do we find a partner who is running a company that we want to be a part of and whose stock, we think, has an upside.

And I think that’s one of the things we hear from groups who are considering strategic options is we want to make sure we pick the right partner here. We want to make sure that they are really studying us hard and I think our other peers across the state hard to see who they want to partner with..

Thank you very much, David, I appreciate it. .

Hey thanks Brady..

Thank you, our next question comes from the line of Kevin Fitzsimmons of Hovde Group. Your line is now open. .

Hey guys, most of my questions have been answered here but just one quick one. It sounds like you are definitely more comfortable getting back on the offensive. But carefully and energy, and I’m just curious what is driving curious what is driving that.

Is that more fact of the activity just coming back, and there’s – so with activity, there is opportunities for loans. Is it more matter of your own comfort with oil prices having stabilized and you getting some resolutions of your criticized and classified credits or some kind of combination of that? Thanks..

Yes to all that, Kevin. Yes to all that. We’re just really seeing opportunities now. There were certainly opportunities during the last few quarters and I know some of our peers were able to make significant size loans during the last couple quarters.

We just, at least in our customer base, weren’t seeing the opportunities that we felt good about and we are seeing those opportunities now that we’ve got a good pipeline of opportunities we’re looking at and it is partly that prices have stabilized and we feel good about our balance sheet.

And I go back and I’ll give the analogy again to the real estate crisis and the great recession of 2008, 2009 and 2010.

In 2008 and 2009, everybody was just looking at what they had to make sure that we hadn’t made mistakes, and once we were comfortable that our portfolio was in good shape and once we were comfortable that we had resolved any significant problems, then we went back on the offensive and we were a very material lender and had very material growth in 2010 to 2013 in our real estate portfolio because we really saw that as a great time to make loans, transactions were happening.

And same thing, I think, is going on in energy now is their assets changing hands, there are people who have come through this downturn that are now looking around and raising a little equity and putting together a loan facility and beginning to look for assets to acquire. And we’re still not seeing – some companies, I guess, are still drilling.

We are not seeing a lot of drilling activity in our portfolio but properties are trading at attractive prices and equity is willing to step up, so..

Okay, that’s all I had, thanks guys..

Okay, thanks Kevin..

Thank you. [Operator instructions] Our next question comes from the line of Matt Olney of Stevens. Your line is now open. .

Hi thanks, good morning guys. .

Good morning, Matt. .

Hey, David, going back to the energy discussion, I’m curious within the overall energy allowance, how much of that is allocated towards specific energy credits versus just a general energy allowance? I’m just trying to get a better idea of how much more incremental charge-offs that they could see in energy book from here..

I think we have maybe half of that remaining. 7% is allocated against specific credits, Matt, and in terms of actual charge-offs going forward, I think we’ve got the one small nonperforming loan that we’ve had for – gosh, since early in this downturn that we think has got a couple of million dollars of charge against it.

And so $2 million to $4 million would be a range, I would say, if you said hey, pick a specific number but we will probably have a couple of million dollars of additional charge-offs to go here but $2 million, $3 million is probably where we are..

Okay, that’s helpful. And then on the Houston market commentary, I believe you said in the prepared remarks that about 1.6% of the entire Houston market is now classified.

Did I hear that correctly and is that any change at all from last quarter and can you just follow that up with any kind of general commentary about the Houston market and specifically with your exposure in the multifamily and office space down there?.

It’s still – 16 basis points is the sub classified amount in Houston. And that’s flat with where it’s been, Matt, the last quarter or two, I think..

Yes, it was actually 16 last quarter and 17 basis points the quarter before. So it’s been a very consistent trend line in the metrics. As David pointed out, the metrics and breakdown are very similar to the path, so the portfolio is holding up stellar..

And end of your question, Matt, I’m sorry I missed..

It was about your specific exposure to the commercial real estate markets. What you are seeing there and I guess from a macro perspective, we are hearing still some negative things on the multifamily and office market.

I know your exposure there is pretty minimal but can you just kind of update us on what you are seeing in Houston CRE?.

Yes, in our CRE portfolio, again, seeing zero issues at this point. We continue, as you do, to hear that some of the large office and the large multifamily projects are still struggling and struggling with decreasing lease rates and increasing occupancy. And our – I don’t know how many kind of layers down our portfolio is.

I don’t want to make an analogy about that other than just to say that we have not seen it affect our customers, our investors, the families that we bank, the family offices, people who have these investments in neighborhood office and neighborhood apartment complexes, we just haven’t seen pressure there on rates and occupancy.

So continue to see really good performance there. Continue to pay close attention to it, but we just haven’t seen anything. And we’re seeing nice opportunities in healthcare down there.

We had good growth in the second quarter there, and they are – the lending teams we have down there are encouraged about the second half of the year, so they are seeing opportunities with their customers.

We are continuing now, especially, Matt, to – because we closed on the Bank of Houston and then the Houston Community Bank in 2014 and of course immediately went into this energy commodity price decline that caused everyone including us, to get cautious in and around Houston. But as we had hoped, it’s held up really well for us.

And we’re now – I think our lenders being been able to circle back and go out with our existing customer base there where Bank of Houston was a $1 billion bank and really did, I think, their average loan size was $2 million, $3 million, $4 million.

We are able now to go out back to the same customers and the ones who are doing well, and have held up well during this downturn and get a larger wallet share if you will by refinancing properties that they may have financed at other banks, or they are now making new investments and looking for distressed opportunities in Houston and we’re able to finance those.

So the strength of – both of the banks we bought in Houston had really deep core relationships in the Houston market. And we probably weren’t able to take advantage of that as much, given what’s gone on in energy in Houston and concern around the Houston market overall. But we remain confident in Houston.

Continue to remain confident in Houston, and we’re seeing our team down there do a really great job of cultivating new relationships, as well as expanding existing relationships. So those are where we are seeing opportunities there..

Thank you..

Hey, thanks, Matt..

Thank you. And our next question comes from the line of Michael Young of SunTrust Robinson. Your line is now open..

Hey, good morning..

Good morning, Michael..

I wanted to ask Michelle’s commentary for kind of a stable margin outlook from here.

Is that driven by any expansion and pricing in either CRE, Houston, and energy? Is that offsetting other pricing pressure in other areas?.

Well I think, as far as our – the loans that are coming on, the ones that have been coming on more recently are coming on really close to where our current yield is on loans. So I don’t believe we’re really seeing any pressure on pricing in our loan book..

I agree with that. Our pricing in the market seems to be pretty stable and not seen pricing there and not really – with what is going on with the Fed, we’re not expecting any material changes here in the next couple of quarters..

Okay, great. And one other one, just on the general reserve outside of energy is down to kind of 55 basis points and obviously you’ve acquired a lot of your loan book recently, so there’s a mark on that.

But just what should we think about in terms of rate of provision on new loan originations at this point?.

Well, I think that – you know what we’ve always said is that we generally think about that that we’re going to put away 1% of our net loan growth plus charge-offs. So if you look at the trend of our allowance over time, it will get down when we do an acquisition. The biggest change is we acquired Bank of Houston in early 2014.

But then that will trend up until we do another acquisition. So I think you’ll see it trend up over time. If you add back our – the fair market value adjustment for our acquired loans, it’s closer to about 93 basis points..

Okay, thanks, that’s helpful. And just last one. Mortgage fee income, obviously very strong this quarter given the market and you guys highlighted that in your comments, but just wanted to get sort of a sense of outlook from here.

Do you think there’s more market share gain opportunity that’s going to offset maybe a less robust market or what are your thoughts there?.

Well, we are seeing continued strong activity on the construction side and so I think that’s what will drive the future, Michael, as much as anything. I just don’t know how much lower rates can go and how many more refinancing booms we can have, so we certainly don’t have that in our plans, but we do bank a lot of homebuilders across the state.

And so, that feeds naturally into our mortgage business as those homes are sold and continue to be optimistic about that.

But as Michelle pointed out, and it is something to notice, because we are not a mortgage warehouse lender, our mortgage activity is really just brokerage basically passed through correspondent lending kind of things and while we had terrific revenue there, it is a low margin business for us on a relative basis.

So that – as Michelle said earlier, that is what drove our operating costs to look a little higher than we really think the core is just because if you get $1 increase in our mortgage revenues, 80%, 82% of that is expense. So that drives up our cost by 80%. Look, we are terrifically pleased with the mortgage business.

We think we’ve got A plus teams across all three markets in mortgage. We think that’s what’s driving it is our ability to serve our customers well.

But just no really way to know, but that business has a very – our model in the mortgage business has a very flexible business model, meaning that as revenues go down on that, the expenses go down dollar for dollar with it. So our margin is pretty well locked in at that 17%, 18%, 20%.

And if revenues go in half, we will still make roughly that same amount of money. So meaning the same margin.

So while we love the mortgage business for all the synergy it has and the way we do it – synergy it has with our core business, a falloff of 20% in mortgage revenue or volume in the second half of the year would have a pretty nominal impact on our overall bottom line..

That’s great color. Thanks..

Okay. Thanks, Michael. Thank you and I’m showing no further questions at this time. I would like to have a call back over to David Brooks for any closing remarks..

Terrific. If that’s all the questions, really appreciate everyone’s interest in Independent Bank, feel great about the quarter, and looking forward to the second half of the year. Hope everyone has a great day..

Ladies and gentlemen, thank you for participating in today’s conference. That does conclude today’s program. You may all disconnect. Have a great day everyone..