Tim Hicks - Chief Administrative Officer and Executive Director, Investor Relations George Gleason - Chairman and Chief Executive Officer Greg McKinney - Chief Financial Officer and Chief Accounting Officer Tyler Vance - Chief Operating Officer and Chief Banking Officer.
Joe Gladue - Merion Capital Group Jennifer Demba - SunTrust Robinson Timur Braziler - Wells Fargo Securities Michael Rose - Raymond James Stephen Scouten - Sandler O’Neill Matt Olney - Stephens & Company Catherine Mealor - KBW Peyton Green - Piper Jaffray Brian Martin - FIG Partners Blair Brantley - Brean Capital.
Presentation:.
Good day, ladies and gentlemen and welcome to the Bank of the Ozarks’ Second Quarter 2017 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to introduce your host for today’s conference, Mr. Tim Hicks, Chief Administrative Officer and Executive Director of Investor Relations.
Sir, you may begin..
Good morning. I am Tim Hicks, Chief Administrative Officer and Executive Director of Investor Relations for Bank of the Ozarks. Purpose of this call is to discuss the company’s results for the quarter just ended and our outlook for upcoming quarters.
During today’s call and in other disclosures and presentations, we may make certain statements about our plans, estimates, strategies and outlook that are forward-looking statements. These statements are based on management’s current expectations concerning future events that by their nature are subject to risks and uncertainties.
Actual results and future events could differ possibly materially from those anticipated in our statements and from historical performance due to a variety of risks and other factors.
Information about such factors as well as GAAP reconciliations and other information on non-GAAP financial measures we discuss is included in today’s earnings press release and in our 10-K, 10-Qs and various other public filings and investor materials. These are all available on our corporate website, bankozarks.com, under Investor Relations.
The company disclaims any obligation to update or revise any forward-looking statement based on the occurrence of future events, the receipt of new information or otherwise. Finally, the company is not responsible for and does not edit or guarantee the accuracy of our earnings teleconference transcripts provided by third-parties.
The only authorized live and archived webcast and transcripts are located on our website. Let me turn the call over to our Chairman and Chief Executive Officer, George Gleason..
We are very pleased to report our excellent second quarter results, which include our seventh consecutive quarter of record net income and other favorable financial results as well as a number of significant strategic accomplishments.
My comments today will focus primarily on strategic matters before Tim, Greg, and Tyler speak on the financial results. First, on June 26, we completed the previously announced merger of our holding company into our bank with the bank continuing as the surviving corporation.
We expect this corporate reorganization to contribute to future efficiency by eliminating redundant corporate infrastructure and the associated administration accounting and duplicative federal regulatory oversight.
Bank of the Ozarks, the surviving entity, continues to use our OZRK ticker symbol and the same CUSIP number as previously used by Bank of the Ozarks Inc. Second, on May 31, we closed a secondary common stock issuance resulting in net proceeds of $299.7 million.
This increased our already robust regulatory capital ratios and provides capital for significant future growth. As most of you know, we expect to file our first Dodd-Frank Act Stress Test, or DFAST submission in July 2018 based on our year end 2017 financials.
As part of DFAST, we will project our expected growth and performance under three scenarios known as the base case, adverse, and severely adverse scenarios over a period of nine quarters. With limited exceptions, you cannot include projected future capital raises in your DFAST projections.
Based on our expected significant growth in the base case scenario, we determined that we would need to augment our regulatory capital ratios during 2017 to support the projected growth in 2018, 2019, and the first quarter of 2020. Our May 31 capital raise should provide that needed capital.
Third, for some time now, we have been evaluating holding additional on balance sheet liquidity to provide another tool in managing our liquidity position. During the quarter, we increased our investment portfolio by net $631 million.
This resulted from our purchasing approximately $728 million of highly liquid short duration government agency mortgage-backed pass-through securities. Because of the higher quality and short duration of these securities, they yield only about 2%.
So, their purchase will be dilutive to some of our performance ratios such as net interest margin and return on average assets. On the other hand, their purchase will be slightly accretive to other performance ratios such as our efficiency ratio.
However, this balance sheet adjustment is not so much about the small incremental earnings as it is about the significant liquidity to purchase bonds will provide including their monthly cash flow. These securities have a 20% [ph] risk rating for regulatory capital, so their purchase did not utilize significant capital.
This gave us a very good liquidity position at June 30, 2017, including cash of $791 million and approximately $5.72 billion in other available secondary sources of liquidity, including un-pledged investment securities.
Fourth, our Forms 10-Q and 10-K reports in recent years have discussed two legal actions related to overdraft fees and the posting order of payments. During the quarter just ended, we reached a settlement in Principal with plaintiff’s counsel.
On a settlement amount and attorneys for both parties are now negotiating final settlement documents, the agreed upon settlement amount has been fully provided in our financial statements as of June 30, 2017. This accounted for $750,000 of our other operating expenses in the quarter just ended in addition to amounts accrued in prior years.
This matter originated in 2011 and has been the subject of numerous hearings and appeals we look forward to having this resolved in the near future. Fifth, for years, we have been among the nation’s top performing banks.
As we continue to grow, we have always focused on developing our products and infrastructure to allow us to continue to achieve high performance even as we become a much larger bank.
We have previously discussed our increased focus on developing technology-based products and solutions through our Ozark Labs, which we think will be critical to our success in this rapidly evolving retail banking environment.
We have also talked about our focus on expanding and enhancing our infrastructure for information technology, information system, cyber security business resilience, enterprise risk management, internal audit compliance, BSA/AML monitoring training, and other important areas as well as expanding our human and physical infrastructure to serve low-to-moderate income and majority minority markets and customer segments.
All these initiatives are important elements in our preparation for significant further growth and we have already made significant progress. These initiatives have been and will continue to be an important emphasis for us throughout 2017 and into 2018.
Sixth, as most of you know, Real Estate Specialties Group, RESG has been our largest growth engine for earning assets for many years. We expect it will continue to be our largest growth engine and will continue to increase its volume of originations and growth.
However, for several years, we have been working on various initiatives to achieve greater contributions to our growth in earning assets from our other lines of business and product types other than commercial real estate.
You can see the progress we are making in this regard in the quarter just ended, in which 56% of our growth in non-purchased loans and leases came from our other loan and lease teams. We continue to expand these other lines of business. Finally, on June 23, we migrated from the Russell 2000 to the Russell 1000.
Some of you probably noticed that this transition created several days of volatility in our stock price and trading volume. We are pleased that our continued growth led to our increased market capitalization, which resulted in our graduating to the Russell 1000.
In addition to all of this, our second quarter results included some exceptional financial performance. I will let the rest of the team tell you about that. Let me turn the call back to Tim Hicks who you might have noticed has a new title, Chief Administrative Officer and Executive Director of Investor Relations.
The creation of this new position and Tim’s promotion and expanded role reflect both his accomplishments and our efforts to further increase the depth and breadth of our senior management team. Congratulations Tim..
Thank you, George. Our $20.1 billion in total assets at June 30, 2017 was a 63% increase from June 30 last year. This balance sheet growth translated into excellent income growth. Our net income for the quarter just ended was a record $90.5 million, a 66% increase from the second quarter of 2016.
Our diluted earnings per common share of $0.73 for the quarter just ended or a 22% increase compared to the second quarter of 2016. In the quarter just ended the funded balance of our non-purchased loans and leases grew $808 million and our unfunded balance of closed loans grew another $625 million.
This unfunded balance of closed loans was a record $11.9 billion at June 30, 2017, which will be instrumental in achieving our loan growth goals in the remainder of 2017, 2018 and early 2019.
RESG accounted for about 44% of our growth in the funded balance of non-purchased loans and leases in the quarter just ended and our other loan and lease teams accounted for 56% of the growth.
As George mentioned earlier we expect RESG will continue to be our largest growth engine, but we are pleased by the positive momentum and contribution from our various other loan teams. At June 30, 2017, the RESG portfolio accounted for 68% of the funded balance and 93% of the unfunded balance of our total non-purchased loans and leases.
At quarter end our average loan to cost for the RESG portfolio was a very conservative 49.1% and our average loan to appraised value was even lower just 42.0%. The extremely low leverage of this portfolio exemplifies our very conservative credit culture and is one of many reasons we have such confidence in the quality of our loan and lease portfolio.
Given the growth in our customer base, our robust pipeline of transactions currently in underwriting and closing and our largest ever unfunded balance of closed loans, we continue to expect 2017’s growth in the funded balance of non-purchased loans and leases to be between $3.1 billion and $4 billion, although it is not likely to be at the top end of that range.
As we have said in our January and April calls, we expect growth in non-purchased loans and leases in the second half of 2017 to be better than the $1.4 billion of growth in the first half of 2017. Let’s turn to capital. As George mentioned during the second quarter we completed the issuance and sale of common stock for net proceeds of $299.7 million.
We will continue to monitor capital market conditions, capital formation alternatives and our capital position including our expectations for growth over the relevant nine quarter DFAST time horizon, all with the goal of effectively managing our capital position for the maximum benefit of our shareholders, while always maintaining well-capitalized status.
Organic growth of loans, leases and deposits continues to be our top growth priority and we have demonstrated our ability to achieve substantial growth apart from acquisitions. With that said, we believe M&A provides significant opportunities to augment our robust organic growth.
Our last 15 acquisitions have been triple accretive, being accretive to book value per share and tangible book value per share at closing and accretive to earnings per share in the first 12 months following closing. We expect to continue to be disciplined in our acquisition strategy and to apply this triple accretive test to future opportunities.
We remain active in identifying and analyzing M&A opportunities and we believe this strategy will help us to create significant additional shareholder value over time. Let me turn the call over to our Chief Financial Officer and Chief Accounting Officer, Greg McKinney..
As a company we are focused on three disciplines; net interest margin, efficiency and asset quality. First, let me discuss net interest margin. In the quarter just ended, our net interest income was a record $202.1 million and our net interest margin of 4.99%, increased 11 basis points from the first quarter.
In recent calls we have mentioned that we have recently focused more on our core spread than our net interest margin.
In the quarter just ended our yield on non-purchased loans and leases increased 16 basis points to 5.42%, while our cost of interest paying deposits increased 9 basis points to 0.67% resulting in a 7 basis point increase in our core spread and continuing an improving trend over the last five quarters.
Increases in LIBOR rates and the Federal Reserve’s fed funds target rate have contributed among other factors to this improvement.
As a result of our robust level of loan originations in the quarter, we had $47.1 million in net deferred credits at June 30, 2017, meaning we had $47.1 million more in unamortized deferred loan origination fees than unamortized deferred loan origination costs.
This along with $123.9 million valuation discount on our purchase loans at June 30, 2017 has favorable implications for future earnings. Let me switch to efficiency, our efficiency ratio has been among the top decile of the industry every year for 15 consecutive years.
In the quarter just ended our efficiency ratio was an excellent 35.3% and for the first six months of 2017 was 35.2%. While our efficiency ratio will vary from quarter-to-quarter, we have stated in recent calls that we expect to see a generally improving trend in our efficiency ratio in the coming years.
There are several key factors among others needed to accomplish our long-term efficiency goals. First we expect to ultimately utilize a large amount of the excess capacity of our extensive branch network tapping billions of dollars of additional deposits through the existing offices.
This ability to achieve substantial deposit growth with limited additions of overhead has favorable implications for our efficiency ratio. Second, we expect to achieve further efficiencies over time from our ongoing deployment of technology applications from Ozark Labs.
As George previously mentioned as a larger and growing organization, we are constantly increasing our expenditures building infrastructure in a number of important areas. The increasing costs for such enhanced infrastructure will be a headwind in our efforts to improve our efficiency ratio.
However, we believe that our excellent organic growth will generate sufficient additional revenue for us to achieve both our important infrastructure enhancements and our long-term efficiency goals. Our guidance regarding and improving efficiency ratio in future years does not consider potential impact of any future acquisitions.
Our asset quality metrics during the second quarter are some of our best as a public company. For example our annualized net charge-off ratios during the quarter just ended were 3 basis points for non-purchased loans and leases and 5 basis points for total loans and leases.
At quarter end excluding purchased loans our non-performing loans and leases as a percent of total loans and leases were just 11 basis points.
Our non-performing assets as a percent of total assets were just 23 basis points and our loans and leases past due 30 days or more including past due non-accrual loans and leases to total loans and leases were a record low 0.15%. This was our sixth consecutive quarter of reporting a record low past due ratio.
These ratios reflect our longstanding commitment to conservative underwriting standards and excellent asset quality, which has resulted in our having asset quality consistently better than the industry as a whole and our almost 20 years as a public company, our net charge-off ratio has averaged about 35% of the industry’s net charge-off ratio and we have beaten the industry’s net charge-off ratio in every year.
Our out-performance has been even better recently as evidenced by the fact that our net charge-off ratio was just 13% of the industry’s net charge-off ratio last year and just 10% of the industry’s net charge-off ratio for the first quarter of this year. I want to make one final comment regarding our effective tax rate.
During the second quarter our effective tax rate increased due to our true up of state income tax portion of factors. These adjustments were somewhat larger than normal due to our increased lending activity and higher income tax rate states and municipalities, principally New York State and New York City.
We originally enhanced our procedures to ensure our quarterly accrual to be more precise going forward. We expect our tax rate for the remainder of this year to be in a more normalized range of 36% to 37%.
Of course, significant changes in the mix of taxable and tax-exempt earning assets and changes in the mix of assets between states could affect the tax rate actually incur. Let me turn the call over to our Chief Operating Officer and Chief Banking Officer, Tyler Vance..
In regard to liquidity, we have long expected that we could accelerate deposit growth as needed to fund our loan and lease growth. Our experience in recent years has validated that expectation.
At least monthly and more often as needed, we to update a comprehensive 36-month projection of our expected loan fundings, loan pay-downs and other sources and uses of funds. These detailed monthly projections of needed deposit growth provide the goals for our deposit growth strategies. This has proven to be a very effective process.
Currently, we have 41 offices in 28 cities in spin-up mode, offering various deposit specials along with an enhanced level of marketing activity.
Our branch network of approximately 242 deposit offices continues to have substantial untapped capacity, and we believe that capacity is sufficient to fund our expected loan and lease growth over the next several years.
Planned de novo branch additions and possible future acquisitions should provide additional deposit growth capacity, as needed for the future. At June 30, 2017, our total deposits were $16.2 billion, which was a $528 million increase from the previous quarter end.
Because of our significant growth in organic deposits in the quarter just ended, we decreased our volume of broker deposits by $434 million from $2.00 billion at March 31, 2017 to $1.57 billion at June 30, 2017. That’s a decrease from 12.8% of total deposits to 9.7% of total deposits.
Of course, we are not subject to any regulatory limitations on our volume of broker deposits and our internal policy calls for a 50% limit, which we are well below; but we are, nonetheless, pleased to see our percentage of broker deposits continue its recent downward trend.
As a result of the shift in mix, our non-brokered deposits grew a healthy $962 million in the quarter just ended. We consider net growth in core checking accounts as one of our most important deposit metrics.
We achieved excellent organic growth in our number of net new core checking accounts with a record 6,339 net accounts added in the second quarter of 2017, bringing our total net new core checking accounts to 10,843 for the six months of 2017.
Our excellent checking account growth has been an important contributor to our record service charge income of $11.8 million for the quarter just ended.
Let me remind you that the Durbin Amendment started impacting our service charge income as of July 1, and we estimate it will result in a pre-tax reduction in service charge income of about $1.95 million per quarter, based on our most recent transaction volume available.
As Greg mentioned, our cost of interest-bearing deposits increased 9 basis points in the quarter just ended compared to the first quarter of 2017. Given our expectation that our growth in non-purchased loans and leases in 2017 will range between $3 billion and $4 billion, we expect to continue to grow deposits significantly this year.
Based on this, combined with possible further increases in the Fed funds target rate during the remainder of 2017, we expect additional increases in our cost of interest-bearing deposits this year.
Our goal for 2017 is to hold the rate of increase in our cost of interest-bearing deposits below, and hopefully well below, the rate of increase in our yield on non-purchased loans and leases.
As previously mentioned, we achieved that goal in the quarter just ended as our yield on non-purchased loans and leases increased 16 basis points compared to the 9 basis points increase of our cost of interest-bearing deposits. Now, let me turn the call back to George..
Next Monday, we will celebrate our 20th anniversary as a public company. Over those 20 years, we’ve grown from 13 offices with $309 million in total assets to 251 offices with over $20 billion in total assets.
Our shareholders benefited greatly from our constant pursuit of excellence, as evidenced by our 22.5% compounded annual total return to shareholders over that 20-year period. Such exceptional and sustained results can only be achieved by an exceptional team.
I want to thank our 2,459 employees, who I believe are among the best in the industry, for their hard work and great accomplishments, as we celebrate our 20th anniversary is a public company. Well done. We look forward to continuing this success for decades to come. That concludes our prepared remarks. At this time, we will entertain questions.
Let me ask our operator, Amanda, to once again remind our listeners how to queue in for questions.
Amanda?.
Thank you. [Operator Instruction] Our first question comes from the line of Joe Gladue of Merion Capital Group. And your line is open..
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Thank you. And the next question comes from the line of Jennifer Demba of SunTrust Robinson..
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Thank you. And our next question is from the line of Timur Braziler of Wells Fargo Securities..
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Thank you. And our next question is from the line of Michael Rose of Raymond James. Your line is open..
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Thank you. And our next question comes from the line of Stephen Scouten of Sandler O’Neill. Your line is open..
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Thank you. And our next question comes from the line of Matt Olney of Stephens & Company. Your line is open..
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Thank you. And our next question comes from the line of Catherine Mealor of KBW. Your line is open..
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Thank you. And our next question comes from the line of Peyton Green with Piper Jaffray. Your line is open..
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Thank you. And the next question comes from the line of Brian Martin of FIG Partners. Your line is open..
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Thank you. Our next question comes from the line of [indiscernible] of UBS. Your line is open..
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Thank you. And at this time I am showing no further questions..
Thank you, guys for joining the call today. We greatly appreciate your participation. There being no further questions we are done, we look forward to talking with you again in about 90 days. Have a great day. Thank you..