James Tippit - Head, Corporate Responsibility David Brooks - Chairman & CEO Michelle Hickox - EVP & CFO.

Matt Olney - Stevens Brad Milsaps - Sandler O'Neil Brady Gailey - KBW Michael Young - SunTrust Robinson Kevin Fitzsimmons - Hovde Group Brett Rabatin - Piper Jaffray John Warner - Macquarie.

Good day, ladies and gentlemen and welcome to the Independent Bank's Third 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 follow at that time. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to introduce your host for today's conference call, Mr. James Tippit, Head of Corporate Responsibility. You may begin, sir..

Good morning, everyone. Welcome to the Independent Bank Group third quarter earnings call. We appreciate you joining us this morning. We released our earnings press released last night. The release and the slide presentation can be accessed on our website at Ibtx.com.

Before we get started, I would like to remind you that remarks made today will include 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 or Page 2 of the slide presentation 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 beliefs 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 in Pages 15-17 of the slide deck.

I am joined this morning by David Brooks, CEO, who will give you some highlights and his thoughts about the quarter; and also Michelle Hickox, CFO, who will lead you through the quarterly operating results. At the end of their remarks, we will open it up for questions. I will now turn it over to David..

Thanks, James. Good morning, everyone, and thank you for joining us on the call this morning. Our third quarter results continue to demonstrate our focus on consistent, strong performance. Here are a few highlights. Our earnings continue to improve with this being our highest reported quarterly net income to date.

Third quarter core earnings were $14.8 million and represent a 7.7% increase in core earnings from last quarter. As indicated on Slide 6, our earnings continue to grow quarter-over-quarter and year-over-year.

We are getting results from the cost-save initiatives we implemented earlier this year with the material decrease in our core efficiency ratio to below 53%. Although loan growth slowed a bit from the first half of the year, it continues to be strong in all our markets with annualized growth of 10.2% for the quarter.

Total assets increased to $5.7 billion at quarter-end, an increase of $1.2 billion over third quarter 2015 and our credit metrics continue to be at historically strong levels and remain below state and national peers as shown on Slide 10.

As you know, maintaining a strong credit culture is a fundamental principle of our company and trends in this area remain favorable. Besides of our energy portfolio remains stable from last quarter to $126.5 million or 2.9% of total loans.

We continue results and problem credits in this sector as necessary, but we are pleased to note that we have had opportunities this quarter to participate in new deals as well. I will now ask Michelle to go over more detail on our second quarter operating results.

Michelle?.

Thank you, David, and good morning, everyone. Please note that Slide 5 of the presentation includes selected financial data for the quarter.

Our third quarter core net income was $14.8 million or $0.80 per diluted share, compared to $8.9 million or $0.52 per diluted share for the third quarter of last year and to $13.8 million or $0.74 per diluted share for the linked quarter.

Recall that we put the material reserve for the energy portfolio in third quarter 2015 that impacted earnings during that quarter. Net interest income remains stable during the third quarter at $45.8 million, compared to $45.9 million for the linked quarter. All interest income increased by $799,000.

It was offset by interest expense on the subordinated debt issued at the end of the second quarter, as well as a slight increase in the cost of deposits, primarily due to increased cost to public funds.

Our net interest margin decreased more than expected for the quarter at 3.66%, compared to 3.96% for the linked quarter and 4.08% for the same quarter last year. The decreases are due to lower yields on loans and securities, along with an increase in cost of money market and certificate of deposit accounts.

Although interest rate processing on new loans this quarter was generally consistent with processing in previous quarters this year, overall loan yields were negatively affected by lower fee income and the payoff of some higher yielding energy loans that were occurring at default interest rates.

In addition to those, there were several factors that contributed to the decrease of the margin from the linked quarter. We moved our excess liquidity from our clearing correspondent non-interest-bearing account to an interest-bearing money market.

The earnings credit on that account which are reported in non-interest income were offset by the additional interest we earned and had a neutral effect on net income, but diluted our margin by about 10 basis points. We also experienced a high level of calls in our investment portfolio during the third quarter.

Several municipal bonds at unamortized premiums that negatively affected the yields for this period. In addition, the interest expense on the recent sub debt offering decreased the margin by about five basis points.

Total non-interest income increased $1.1 million compared to the third quarter last year and was fairly stable compared to the prior quarter. The increase from last year is related to increased mortgage fee income, increased earnings on new BOLI policies and a decrease in loss on-premises and equipment.

For the linked quarter, an increase of approximately $88,000 in service charge income and $132,000 in BOLI income was offset by a decrease in mortgage income and correspondent earnings credits as mentioned earlier. Total non-interest expense increased $1.1 million from the third quarter last year and decreased $4.1 million from the linked quarter.

Overall increases in non-interest expense from the prior year are generally due to increased compensation, data processing and the FDIC assessment associated with the Grand Bank transaction.

With respect to the decrease in the linked quarter, recall that we had $2.6 million of expense related to the company's senior leadership restructuring in the second quarter. Our ongoing run rate on compensation was also reduced by these changes.

In addition, mortgage and lending-related on these accruals and commissions were higher in the second quarter and we also experienced the positive adjustment on our health and benefits expense during the third quarter. We increased our FDIC assessment accrual for the quarter by $254,000 compared to the linked quarter.

This increase was offset by lower professional fees which were down by approximately $260,000 due to lower legal cost related to the energy portfolio.

The provision for loan loss expense was $2.1 million for the quarter, which is comparable to the linked quarter and a decrease of $1.8 million from the prior third year quarter when we took additional reserves for the energy portfolio. Generally, provision expense correlates with net's loan growth and level of charge-off.

However, because we had previously made provisions for problem energy credit in 2015, $3 million charge-off we made this quarter did not result in additional provision expense. Note on Slide 11, our provision expense and charge-offs in each reported period. Loans held for investment grew 2.6% from June 30, 2016 or 10.2% on an annualized basis.

We continue to see growth across all of our regions. As illustrated on Slide 12, the energy portfolio was $126.5 million at September 30, 2016, versus $122.1 million as of the end of the second quarter and remain stable at 2.9% on total loans.

Due to those charge-offs mentioned earlier and improved metrics in the energy portfolio, the energy-related allowance has decreased to 4.7% of the energy portfolio at quarter-end. Non-performing assets improved compared to the linked and prior year quarters due to disposition of ORE, payoffs and the charge-off mentioned earlier.

Total non-performing assets represented 0.23% of total assets at September 30, 2016, compared to 0.34% at both September 30, 2015 and June 30, 2016. Deposit composition and cost are illustrated on Slide 13.

We experienced good deposit growth in the quarter with total deposits ending at $4.42 billion at September 30, 2016, compared to $4.21 billion at June 30, 2016. The average cost of interest-bearing deposits was up slightly to 0.51% for the quarter, compared to 0.48% for the third quarter of 2015 and 0.50% for the second quarter 2016.

Increases are primarily related to competitive pricing on public fund time deposits. Non-interest-bearing deposits have remained stable at approximately 26% of total deposits. Borrowing fees for liquidity and interest rate risk purposes as needed remains stable during the quarter. Note on Slide 14, our capital position as of September 30, 2016.

Our TCE ratio remains stable at 6.9% and our total capital to risk-weighted assets was 11.24%. All regulatory ratios remain in excess of well-capitalized levels. That concludes my comments this morning and I will turn it back over to David..

Thanks, Michelle. We are pleased with our performance this quarter. Our ROA over 1% and efficiency ratio of sub 53% were the best we have reported in our three and-a-half years as a public company.

We are beginning to see the benefits of our restructuring and cost-savings initiatives earlier this year and we remain confident and continuing our improvement in these areas in the quarters ahead.

Overall, I believe we are well-positioned to continue to execute the strategies we have consistently outlined since the IPO, robust organic growth, strategic acquisition growth, underguarded by a strong credit culture across all the major markets in Texas.

We have continued to add strength to our leadership team throughout the company which will allow us to continue our success as we grow the company. As I state in our Q2 earnings call, there has been an increase in M&A discussions. Our operating performance has led to a stronger stock price which makes for more possibilities in this area.

I'm optimistic that these discussions will lead to opportunities in the quarters ahead. With that, we will open the call to questions.

Operator?.

[Operator Instructions] Our first question comes from Matt Olney with Stevens..

Hey, thanks. Good morning, guys.

How are you?.

Hey, good morning, Matt..

Hi, Matt..

I want to start on the net interest margin. Michelle, you gave us lots of colors, all the moving parts in the quarter.

Can you give us an outlook of your expectations for the margin over the next few quarters?.

Yes. As you noticed, I'm not trying to give you guys a lot of all the different pieces of what happened with the margin this quarter because it was unexpected to me as well. But if you unnoticed, we had more liquidity over the quarter, primarily due. We had really good deposit growth.

Our loan growth came later in the quarter and so our average balances and liquidity were up, which while having overall average earning assets didn't really hurt our interest income, it did hurt the margin.

I think going forward, I would say we have some upside; I think our loan yields are going to stay stable, I think our investment portfolio yields will increase a bit, and what we're seeing as our deposit cost are probably going to be stable this quarter. I think stable to up a few basis points is probably a good run rate for now..

And within the loan fees, was 3Q a normalized level or is it usually low?.

No. I think our loan season in the quarter were lower than they have been at the beginning of the year and I would expect those to return to normalized levels this quarter as well..

Okay, that's helpful. And then on the expense side, David, you made the comment. I think you're seeing some good progress in the expense side, but there's still more opportunity to be had. How do we think about the expense levels from here? I know you talk about the efficiency ratio.

Maybe that's better context we should think about?.

Yes. We're quite pleased with that. When you make changes and structure and you know it pencils out on paper, but you kind of like to see it come through the income statement eventually and we're happy to see that happen this quarter.

I think we'll continue to see some progress in that regard and I expect our efficiency ratio to continue to come down slightly - Michelle - in terms of an ongoing quarterly run rate on non-interest expense..

Yes. I think we have been guiding towards that $27 million non-interest expense run rate. I think it's going to be a little lower than that. I think this third quarter is probably a good run rate for fourth quarter and going forward. As David said, we still have some opportunities. I think we still could get some benefit going forward as well..

Okay. That's helpful. And then last question for me as far as the loan growth, can you just talk about the growth to wrap the quarter and the pipelines at this point heading to the fourth quarter? Thanks..

Sure. Thanks, Matt. We had a good quarter - a little slower than the first half as I mentioned, but we have a good pipeline for the fourth quarter and as we look out into '17, continue to see our growth in that low double digits, 12% give or take a little on average.

We are 12.4% year-to-date to the first three quarters across those nine months and would expect that to be in line for the fourth quarter as well. And as Michelle said, I do think we're going to see a little bit of tailwind on the NIM as our fees return to a more normalized level.

Also as we're booking, we approved two energy loans in the third quarter. We funded one of those. One we'll fund in the fourth quarter and then we have some other deals in the pipeline, but looking at right now, given what has happened in that industry, we're seeing a little better pricing there than some of our other lines of business.

Anyway, I think on the NIM side, we'll see a little bit of tailwind on the loan side as well..

Great. Thanks, guys..

Hey, thanks, Matt..

Thanks, Matt..

Our next question comes from Brad Milsaps with Sandler O'Neil..

Good morning, Brad..

Hey, good morning. Hey, Michelle, just to get back to the margin for a moment, what drove the decision to make the change, to move the cash from non-interest earning assets to earning asset and then how quickly do you expect to sort of work that down? You guys are sitting on more than you might typically.

Just kind of curious what the plan would be there..

To be honest, Brad, we had some excess liquidity that we were holding in one of our corresponding accounts that the way we accounted for that is earnings credit. It was shown up in non-interest income and just to diversify our risk, we moved it to some other account corresponding accounts with other banks that are money market interest earnings.

As I tried to explain in the release, I know it's a little bit confusing. It was mutual, really to net income, but it was dilutive to our margin and it was really just a risk diversification decision for the most part..

And that was 10 basis points, Brad, of the decline in the NIM - was not really 10 basis points to our bottom line, it was just 10 basis points that was coming, flowing through as non-interest income and now flows through as interest income and do with the NIM..

Got it. Yes, I just was curious, kind of what the background, what drove the decision.

And then Michelle, maybe how quickly - is that where you want to be from a liquidity standpoint or how quickly do you plan to work that number down?.

No, we have more liquidity. I think if you look at our liquidity numbers historically, it's quite a bit more than what we typically have had. But like I said, we had good deposit growth this quarter.

We had a lot of pay downs in our securities portfolio that we have not been able to get reinvested by the end of the quarter, which we're currently working on. So I expect to see that come down some this quarter by the end of the year..

Great. And then, David, maybe just on the loan growth. Where are you seeing new loans getting approved in terms of pricing today? Kind of relative to where the current book yield and some of the pressure coming from a mixed change, maybe you're doing more variable rate loans versus fixed? Just kind of curious, any color there would be helpful..

Yes. Brad, what we've seen as it relates to the NIM has been a pay down of interview loans which were higher yield and some of those were in default and accruing high interest rates and we were able to collect that. That probably held our NIM up a few beeps higher than it would have been otherwise.

So that has resolved itself and as I said, I think as we add back view [ph] loans that will be positive. In terms of the rate, many premium real estate loans, three to five year have been very stable now for the last 12 months, so we haven't seen any pressure there.

What we're booking as Michelle said earlier, tends to look a lot like what's being paid off. One of the things that contribute to the liquidity that Michelle has been speaking about is we did have an extraordinary amount of pay downs in the third quarter.

I think I've heard some of our colleagues around the state say the same thing for whatever reason. A lot of assets seem to sell in the third quarter and again, they'll know if that's a trend or it's just a cyclical or seasonal.

We'll see, but even with all the energy pay downs we had for instance in the second quarter, our pay downs were really about the same level in the third quarter without the energy pay down.

The amount of loans we booked in the quarter was right in line for what we expected and probably would have seen loan growth in the 12%-13% range for the quarter, had it not been for a higher level than the payoffs that we've had in the past.

We have, Brad, been doing some more commercial loans, C&I loans that tend to be floating rate at ` plus, whatever and that has put a little bit of pressure on the NIM on the loan side.

But by enlarge, as Michelle did the analysis for the quarter, a lot of moving parts right, more paid out than we expected and we book some energy loans and we book some C&A loans, we book some real estate loan.

When you shuffle altogether and see what you got it was probably down a basis point or two, but the pressure really had been on the loan side..

Great thank you..

Okay, thanks, Brad..

Our next question comes from Brady Gailey with KBW..

Good morning, guys..

Good morning..

Good morning, Brady..

Maybe David just talk a little bit about the hold [ph] of commercial real estate, in Texas especially on the of the city of Houston and then where you guys finish the quarter on CRE [ph], capital that ratio..

Okay. Good questions Brady. We are really stable in Houston with where we have been. Total CRE portfolio around $875 million. About 41.2% of that is owner occupied, so you invest real estate 575 million somewhere in that range.

So, that's very stable with what we've been all year, we're continuing to book real estate loans there that replaced the payoffs. Again, that portfolio is largely what was there when we purchased the two banks we purchased in Houston, so very small pieces, very granular continues to hold up extremely well, we've seen no head wind at all in Houston.

In fact, our loan growth for the quarter was strongest in Austin and followed by Houston. And then we had a lot of pay down in the Dallas area and again that's our oldest most season [ph] portfolio.

So we weren't surprised, we did speak pay down that they came in - we're in North Texas where we had a book business that we built a lot during the '08, '09, '10, through '12 kind of timeframe when our customers were buying distressed real estate; and they since made a lot of money on that real estate by turning it around and selling it into a stronger market, so that's kind of what happened there.

In terms of CRE broadly, now I know that the topic that's getting a lot of conversation around the country, we certainly have been a real estate lending bank for 28 years and we've we have shied away from that we think we do it very well, if you look at our - Just a reminder if you look at our performance of our portfolio in the most recent downturn, but the numbers would be similar going back 28 years in in every downturn.

That our real estate portfolio CRE portfolio. We were to give you a relative number of Brady, we were in the mid 500 in 2008, 2009 going into the big downturn and if you look at our numbers are classified any way you want to measure it. Past due loans, classified loans, substandard nonperforming charge offs.

We had a fraction of what the other Texas banks had, and half of fraction of what the National Bank has. So, again that's not to say we - where they say past performance not in indicative of the future at results but we feel good about. We got the same team, the same policy, the same philosophies, the same types of loans.

And we have really changed the way we do business over the years, we've just gotten bigger and some of the numbers are a little bigger, but that philosophy of big cash equities and real borrowers, Real projects, not a lot of speculative, not a lot of land, and not a lot of C&I and - and so we built a very good about that, our number is and remains an access of the regulatory guidelines.

That 300, 100 Brady but we have a policy in place approved by our board. We just finished our annual exam. The real estate portfolios, you can imagine got to a good looks since our energy portfolio has become less than 3% of our total loans.

And so we feel good about where we are, we continue to make real estate loans, we intend to continue to make real estate loans. We're not slowing down we're going to continue to abide by our policy and our targets and everything.

Our CRE portfolio again is very diversified geographically and one of our guiding principles of credit philosophy here's been don't take big bits, don't take big pieces and our whole limits and whole targets on loans, I think are materially less then you know lot of banks that are our size that had the same limits that we do.

Again now, one might argue what you leaving earnings on the table and you'd have a better NIM and all that you guys took bigger pieces and we just don't think that's the right philosophy long term.

So, we feel very strong about where we are, very good about where we are, our exam in our ongoing dialogue and not just our recent examine, but ongoing dialogue with the regulators, it’s real, it's good, it's substantive they know exactly how we think about things.

And they are always encouraged by our board involvement and the fact that the way we monitor and all that. So - and look I know, some bank have gotten push back from their regulators I can only speak to what- - what our situation is but I do think it counts and I don't think that analysts and investors.

Brady, have been as discerning as they should be about the differences between institutions and history and there what happened to those institutions over the last three or four or five downturn. What is the management group look like had they changed their philosophy around what types of loans what types of commercial real estate they're doing.

We remain largely owner occupied in our portfolio and we've been at it and doing it for a long time, and so I couldn't believe in the point but I think we are a real estate lending bank and we continue to do that, it's a core competency of ours we do it well and we're going to continue to do it..

Okay, and so next quarter.

I mean you're over the 300, 100 did they change much like, I think I remember they were actually a little over 400% last quarter, was that roughly unchanged like 4.10 roughly?.

Yes, were up slightly from that a few bases this point, I don't have a calculation from the Brady, but it was like 4.10 and were up a few bets from that but..

Okay.

And then you mentioned that M&A comment again David, can you just remind us, what size you're interested in acquiring, what markets you like and just what--sort of bank do you like? what would your next deal going to be more kind of funding focused given you have good loan growth, and your loan deposit ratio is 100% or just what's--what is the characteristics of what you would be interested in on an M&A front..

Sure. Continues I said to see a lot of discussions some were involved in, others I see others involved in across the state. So, I think there is a lot of activity if you will.

That we think will result in partnerships and mergers and deals over the next few quarters will - that all deals are hard to do and it's hard to get them to the finish line as my colleagues know across the state.

The broadly the size that we've talked about Brady, has been $500 million to $3 billon, is the size that - well anything less than $500 million is not that helpful for us at this point, anything above $3 billion would kind of - in our mind move that toward a merger of equal type discussion.

So if we're thinking about acquisitions in and merger partners, we think $500 million to $3 billion; the typical deal Brady that we would - that I would be looking at today, in any of the major markets, so we haven't changed our philosophy around Dallas-Fort Worth, Austin, St.

Antonio in Houston, and that triangle in Texas being where we want to build our bank, and build that over time within a lot of room to grow in those markets, a lot of banks I think will be sold or partner up over the next few years.

So there is plenty of opportunity to grow in that triangle of the four major metro areas in Texas, so we intend to stay there. And then a lovely deal for us, Brady, would be a deal that was a strong core deposit bank, so emerged entity would result in more liquidity and lower loan deposit ratio, they might - may result in a lower CRE ratio.

So if we found a bank that maybe didn't work C&I, or was strong in SBA, or some things that we have historically not done as much of would be helpful. And then if it was a merger that resulted in a little bit higher capital ratio coming out the other side, that would be a positive for us as well.

Again, we said we feel comfortable with our capital ratios, where they are, but as we continue to grow and if we picked up some capital strength as a part of a merger, that would be a positive as well.

I've said in the past, we have a lot of control over that if we do a merger in terms of how much stock, how much cash we do and the fact that our stock is done relatively well this year, I think gives us a good position as we talk to potential partners about making sure we meet their liquidity requirements and everything, but also would expect that any deal we do, we'd be using a lot of our stock as a part of that - which again will help enhance our post-merger capital ratios.

So, good deposits, maybe a more diversified lending platform and stronger capital ratios, all those things would be good if we continue to think about - it's not rocket science, we're looking for strong earnings accretion and we're not wanting to take any more tangible book guide dilution than we actually have to and if we do take tangible book guide dilution, we want to earn back in a relatively quick basis and our mindset around that hasn't changed at all..

Okay, great. Thanks for the color..

Hey, thanks, Brady..

Our next question comes from Michael Young with SunTrust Robinson..

Hey, good morning..

Hey. Good morning, Michael..

Hi, Michael..

I just wanted to take all your comments on the CRE in the context and maybe think about how we should think about growth going forward, kind of 9% growth this quarter. You mentioned you have your paydowns assume that wasn't CRE.

But do you think we could sort of return to more of a historical 20% to 30% growth rate there or should we expect it to be a little slower for the next couple of quarters?.

Well, Michael, we've been pretty consistent in saying this year that it was low double-digit. Take that as 11%, to 13%, or 12% or however you want to think about it. Our growth for the quarter was 10.2%.

I'm not sure - you said 9%?.

Just CRE; I'm just talking about the CRE books..

Okay, got it. As we think about this quarter and going forward, I still think the lower double-digit is a good number for us. I think that we had historically grown our loan book 20%, but that was when we're a much smaller bank and so I don't expect that we're going to see loan growth rates in the 20% range.

I think that would certainly raise a lot of attention from a lot of people including our board of directors if we start to grow on the loans 20% at this point.

But I do think we're a growth bank, organic growth bank, the markets are really strong, we expect Dallas, Fort Worth and North Texas to bounce back this quarter and Houston continues to do extremely well.

As I mentioned, they were our second leading growth market in the third quarter; and Austin, we had a really good competitive position in Austin and we seem to get a look at the really good deals in Austin generally and a lot of those are our good customers.

So we're going to be able to continue to grow, Michael, in that low double-digit range for the foreseeable future.

Depending what obviously, is somewhat driven by the economy, driven for a successful making acquisition in some point here, how that changes the shape of our lending platform, but we're going to continue to do what we've done well for 28 years and what we've done for three and-a-half years as a public company.

As I mentioned on my comments, what we do is not really complicated. We're an organic growth company, we make strategic acquisitions, we do it in the umbrella of a strong credit team and a strong credit policy and a strong credit history. We're going to keep executing that..

Okay.

And do you have an in-house limit on CRE concentration as a percent of the capital?.

We do. The board has reviewed it and we have a policy and we will adhere to that policy..

Okay, great. And then just last....

If the point of the question, Michael, is that internal limit going to cause us to have to slam on the brakes, the answer is no..

Okay. So you have plenty of ceiling on that. Okay. And then just lastly for me. You mentioned better opportunities in Houston to lend with other shying away.

Is there an increase in pricing in that market as well?.

No. Just stable pricing and very consistent with what it's been really since we purchased the bank two and-a-half years ago..

Okay. And actually one more if I can. Just within the own and/or occupied portfolio there, you mentioned good stability. Obviously we're hearing headwinds that this is more at the top end of the market to class A space.

Can you just give us a feel for what is in that portfolio for you guys?.

Sure. Happy to give you some details. We've shared this before and it really hasn't changed much, Michael.

But if you look at our office down there for example, of the $870 million of CRE we have down there including own or occupied, Michael, $78 million of that was office building and so less than 10%is office and that's up from $74 million a year ago if that helps. We're basically flat in that.

The rest of it is made up of about the same amount of industrial and manufacturing warehouse type space, is another 10% of the portfolio; office warehouse about 10% of the portfolio; single family residential about 20% of the portfolio; shopping centers, retail shopping centers are about 15% of the portfolio; and then healthcare makes up another 10% to 12% of the portfolio.

Hopefully those and the rest are just diversified everything from churches to own or occupied type projects, dental offices, healthcare, etcetera. So it's very diversified, very granular; the average loan size in that portfolio remains $911,000, it's the average theory [ph] loan size in Houston across that whole $900 million portfolio..

Okay, perfect.

So not a lot of class A in there?.

No..

I'd say it's a little more expensive, generally than $900,000..

That might be direct payment for a year..

Right. Thanks, guys. I appreciate it..

Okay. Thanks a lot, Michael..

Our next question comes from Amar [ph] with Raymond James..

Hey. Good morning, David, Michelle..

Good morning, Amar.

How are you?.

Doing well, thanks. I wanted to get some color on the provisioning this quarter. We've heard your peers talk about their provision reflecting the reasons in Snick exam in early October.

Does your provision reflect that guidance at all and what are you hearing from regulators on your Snicks?.

Yes, so it does reflect that which is basically nothing. We didn't have a fact from Snick exam in the third quarter.

Again, Snicks are a very small part of what we do, Amar and the ones that we have now a year ago or a few months ago, maybe in the Spring - I can't remember the exact time frames, but we had a small oil field service credit in Houston that was a piece of our oil field service portfolio - a few million dollars - that was downgraded in a Snick exam, but it since paid off, resolved itself.

But no, we haven't seen any pressure on Snick provision - we haven't had any Snick downgrades, I guess is the easy way to say that..

Okay, great. And then one more for me on the allowance. That was down a few basis points in the quarter, the 68 basis points.

What does that number look like when you add back the marks on the acquired loans? And how well do you see that allowance going here in the next few quarters?.

Yes. When you add back the marks - and it went down by the way, Amar, because we took the $3 million charge against an energy loan in the quarter that have been provided for. We've been talking about it for two years, but we have provided for and we finally took the charge-off in the third quarter.

So that lowered the gross amount in our loan loss reserve and lowered that ratio a few bips but including our marks on acquired loans, we're right around 90 basis points today and we've said historically and we continue to have this philosophy and policy as to put in 1% of our loan growth plus any losses we have during the quarter.

That number will trend up over time because it's 68 basis points. If we're putting in 1% of the growth, that averages it up overtime.

But I think in terms of provisioning going forward, as we look at our low double-digit growth, asset quality numbers, we're at historically strong levels so we're not expecting any outsized provisions - certainly not for energy and we don't see it on real estate at this point. That said, I think the run rate, I think we've been consistent.

I believe Michelle, this quarter, we've put in $2.1 million every quarter this year, I believe? So that's our pretty good indication of what our run rate is at the current growth level and so we don't expect any changes up or down from that.

Even though our energy portfolio still has a 5% reserve against it, we have continued to work through that, but we think that's more than adequate, but last quarter someone asked about if we saw in the future an ability to negative provisioning - we don't see that either out of energy or anywhere else.

And with our growth rate, it would be unusual for us to back down our provisioning just because we intend to continue to grow as I mentioned earlier..

Okay, that's great. Thanks a lot and then maybe one last real quick if I could. The reserve is also down, you talked about that charge-off and better as a quality trend in general and energy down to 4.7%.

I wonder if there is any more color there and how much of that 4.7% has on specific credits?.

Most of 4.7% is general reserve against the portfolio, so we don't have any more big credits or big provisions like that when we got a few hundred thousand here and there, I think against them. But almost 100% of it is general reserve and we think it's more than adequate.

As I said earlier, our portfolio is about $125 million and we resolved over $150 million of difficult credits, companies or groups that were over-levered two years ago going into the downturn and we had a portfolio of almost $300 million over the course.

I might point that the total losses we've had, a little over $4 million, actual charge-offs we've taken amount to about 1.4% of the total loans in that portfolio going into the downturn in '04.

So if you take a look at our losses and relate that back to the portfolio we had to deal with going into the end of '04, we lost our total charge-off, severity fuel was about 1.4% of those loans. We're not expecting any other losses at this point - let me put it that way. That's why we think that 5% reserve is good.

If we had another problem or something we feel like we're going to lose money on, we'd have it specifically reserve and we don't have any of the loans specifically reserved..

All right, that's great. Thank you, both..

Hey, thanks much..

Our next question comes from Kevin Fitzsimmons with Hovde Group..

Hey, good morning, everyone..

Hey. Good morning, Kevin..

Hi, Kevin..

Hey, Michelle, this one is probably for you. Just another question on the margin, but looking out a little longer, I know you said stable, but maybe up a little up in fourth quarter.

But how should we think about the trajectory over 2017 over say, several quarters and not assuming rate hike? Is the way to think about that 10 BP impact from the shifting where cash is being allocated, that's more of a permanent impact to the margin? And then on the other 20 BPs, some of that is obviously pressure on loan yield, some of it is excess liquidity? So should we think of it as maybe some as that excess liquidity gets to put the work? Loan growth picks up a little from what we saw on third quarter? There's room for that margin to actually creep higher over the course of the year and where do we get to? Thanks..

Right. I think that's accurate, Kevin. I think that's a good way to look at it. If you look at our margin over the last couple of years, it bounced around a little bit, but generally within about a 10 basis point range depending on our accretion, which you noticed we had very little accretion this quarter.

So I think a good way to look at it is I do expect it will turn up a few basis points over the next quarter next year.

Again, I don't think at this point it's going to get back up to the level it was, but I do think we intend to keep that liquidity in the money markets where we have it now, so I do think for the time being, that's going to be a permanent change. You can look at it that way..

Okay, but all things equal, you probably have room for a low single-digit type of basis point expansion on any given quarter looking out?.

I think yes. A few BPs each quarter is probably a good way to look at it..

Okay, great. And David, just one for you. I know there has been a lot of question about M&A and on the CRE threshold.

I just want to kind of connect those two issues, because I think one thing you pointed out that's kind of critical is that your regulators - or you get the sense that your regulators are very comfortable because I've heard other banks say that even though they're comfortable with their own commercial real estate concentration, it's just not worth the risk to be so much above the concentration limits for when they go for approval for acquisitions.

So I'm assuming from your commentary, your regulators are very comfortable and you wouldn't expect any surprise when you guys go to get deals approved?.

Well, I think it's always risky ground, Kevin, to jump out there and say what your regulators are going to do. I continue to say we've had a very good, very open relationship with our regulators over long decades, period of time.

Obviously they still hold us accountable and we still feel like they're there as a part of how we think about the future of the company. But no, we haven't had any indication that a merger application would be negatively impacted by the fact that our CRE ratio is above the guideline and would not expect that.

But that said, as I mentioned earlier in the call, as I look at acquisition partner candidates, the fact that a blended balance sheet might lower that ratio materially and/or might give us other proven platforms of C&I, and SBA lending - those would all be positives.

You don't get everything you want in any bank and I'm sure if anybody were looking at us, we wouldn't be anyone's perfect dream candidate because we are a particular bank. We do things a certain way. We think we got a lot of strengths. Do we wish we had a robust C&I platform, a little more robust than we do? Sure, we do.

But that said, if loss severities and C&I historically when things get difficult, haven't been that great either. So that's receivable inventory and that type of collateral doesn't always hold up that well in a downturn either.

But we are communicating well with our regulators about CRE, we continue to talk to them about our merger and acquisition strategies, but we are mindful. So let me say it this way, we're mindful of the level, as I mentioned earlier, going into the dives downturn, we are 550%.

Part of that as a result, too, Kevin, and the fact we do run our bank leanly capitalized, and so - again, I think all that gets taken into consideration, but we think over time, we will see that number reduce.

Whether it's organically as we continue to focus more - part of what has set us back a bit has been this energy downturn because we had had seen some nice C&I in interview loan growth there in 2012 through 2014 and we were able to lower those ratios of bit.

And then we dealt with that over the last couple years, but we are also focused on doing more owner occupied, been focused a little bit on that as well as the C&I side. But those things take time, right, over time our culture is and has been we're real estate lending bank, we do it really well.

To be over simplistic about this, when we hire lenders we talk across our company and say, well, we'd rather have account receivable inventory - as inventory than a garden office building down around the corner, intuitively sometimes that's just hard pitch [ph] to make.

We understand the value diversification, and we expect and intend to bring that theory ratio down over time by diversification of our landings. So not by slowing down lending, but by diversifying the lending that we're doing.

We're actively working on that now, but again we don't - it's going to take some time we could help it with an acquisition, but otherwise we're going to continue to do it organically, and we continue to communicate well with the regulars about that..

Great, thanks, David. One quick follow up, just you've mentioned that the pace of conversations is very active, is it just a matter of enough time going by with oil prices being higher and more stable. Some of these would be sellers getting comfortable, is it also just the higher stock prices for, would be sellers that are public.

Is it just a matter of comfort on both the buyer and seller front that you see this gradually the pace of conversations getting more active..

Yes well said, Kevin. I think it has to do with all those things you mentioned, but I think as much as anything it has to do with especially the larger banks that have been around for a long time deciding they want pick a partner, that's a very intricate decision for them as the board and the management team and shareholder group to make.

And they want to make sure they get it right and so, more than ever and we've been buying banks for a long time, we made our first acquisition in 1988.

I would say more than any time in our history of buying banks, we're seeing a lot of analysis by the seller of our company, if you will, and not only us but of our peers and our competitors who are also trying to buy banks in Texas.

There's a real - I get a real sense that sellers are obviously a big component of any ones decision to sell has to do with price and value, but I would say that the distinction is a number of the sellers, especially quality banks are thinking of this in terms of picking a partner for the long term.

Especially if they going to take a big stock component, they care not only about the announced price of the deal, but they're really looking to make sure they partner with the right company, that has the right culture is going to do well in their communities after the fact, and that has a high probability that their stock is going to do well over the next few years.

I think that that's encouraging to me both for the likelihood of deals getting done.

But it does take a little longer Kevin, if folks are only focused on the sticker price and so they put themselves up for auction and take the highest sticker price offer, but we're finding the sellers, I've always been thoughtful about and found even more thoughtful recently around going gosh [ph] we know it's not rocket science who the buyers are out there, and they understand the importance of having - the buyer having a good stock price.

But it's more than that it’s going not only what's the price today and what the currency look like today, but a lot of investigation about; independent bank where your earnings look like the next two or three years, and are the regulars asking you about theory and all those things.

So, we're getting a lot of very good dialogue up from people who seem to be quite discerning these days about picking a partner. In the long run I said this for 3.5 years of school of public starting on the road show in the spring of 2013 that I think that the more discerning the sellers are, the better that is for us.

We got a 28-year track record of our team, our ownership group, our management group and we'll stand by that..

[Operator Instructions] The next question comes from Brett Rabatin with Piper Jaffray..

Hi, good morning..

Good morning, Brett..

David, I wanted just to ask on the fee income side of things, could you guys give us an outlook for guys who think about the coming year and then maybe any commentary on mortgage banking and results there versus what we've seen with some of players having more robust activity this quarter..

Yes, we had a good quarter in mortgage, Brett. And we are having a good year in mortgages well keep in mind we don't have - we do not have a mortgage warehouse, but we do a lot of just mortgage origination and expecting that to be a record year for us this year.

In terms of the total numbers of total contribution of bottom line it's important - it's a very important business force, because it's so integrated into our construction business, in our home construction business and into our other products and services that we offer.

I think that a good - a good regional community bank needs to do mortgage well, and I think we do. But in terms of contribution to the bottom line it's not a 10% or 20% contributor to our bottom line, it's a few percent of what we do every year. If they're up 20% that might move our number of 1% of our bottom line.

It is important an extremely important to strategically. But it's not going to drive a $0.05 out performance next quarter in our - in our earnings if you will. So just wanted to give you a relative view for the percentages of what we do. The other part of your question, Brett..

Just kind of an outlook for fee income as you think about the coming year, I know fee income is kind of big like you mention a big contributor to overall pretax income but I was just curious if you have initiatives on that further faster..

We are paying attention to that the addition of Jim White [ph] our new Chief Operating Officer up at the bank level has been important for us in that regard, to come in and really take a look at our structure and how we can drive additional revenue and top line growth, and we're in the midst of a number of projects on that front, we think that's going to see some of that showing up in 2017 as we go forward.

And the fee income on loans really can be a bit cyclical depending on what types of loans we booked, and the more in construction lending we're doing, the more fees we tend to generate, that's a good fee business for us.

And it's a bit cyclical, I do think as Michelle said earlier that we'll see that rebound to a more normal level, more normalized fourth quarter. And then to your other question, I think it can grow into '17 and beyond; and we're working on that and focused on that..

Okay, great. Thanks for the color..

All right, thanks Brett..

Our next question comes from John Warner with Macquarie..

Good morning, guys..

Good morning, John..

I am - mostly said, I just have one kind of key [ph] one on the margin to go back to, I think you guys said that the fees has some interesting recovery stuff that created some noise in Q2, but there was basically none of that in 3Q.

Do you have the by chance that dollar amount, or the basis point contribution to margin from Q2 verses Q3, and then what would be like a more normal quote - unquote level for that to run at..

I don't have that number John; I can't give that to you and right this minute. But I think like I said earlier I think our - the current yield on the loan portfolio is going to be stable going forward and have some upside, if our fee income gets back to more normal level..

John, then just think about that as up a couple basis points like you guys said..

Yes, right, I think that's right..

So try not to split the adam [ph] on it..

Okay..

Yes, I think it could be over the next year five to ten basis point of upside there John, of what we saw in third quarter, but as Michelle said I wouldn't think about that necessary as five to ten basis point in the fourth quarter but that - we depending on how things go, we get that over the course of the next four quarters..

Okay, got it, thanks very much. The rest of mine are all taken care of..

Thank you, John..

And I am not showing any further question this time. I'd like to hand the call back over to our hosts..

Great, well we appreciate everyone dialing in this morning and interest, we continue to be encouraged about 2016 being our best year ever, and encouraged about 2017, the Texas economy still seems to be good, unemployment numbers have continued to drop, and we're seeing great activity across the market including Houston.

So, all positive and thanks for your interest in Independent Bank, and feel free to reach back out if there is anything we can do. Have 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..