Bank of Ozarks Inc at Raymond James U.S. Bank Conference

Aug 22, 2013 AM EDT
OZRK.OQ - Bank of the Ozarks
Bank of Ozarks Inc at Raymond James U.S. Bank Conference
Aug 22, 2013 / 07:20PM GMT 

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Corporate Participants
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   *  George Gleason
      Bank Of The Ozarks Inc. - Chairman and CEO

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Conference Call Participants
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   *  Michael Rose
      Raymond James - Analyst

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Presentation
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 Michael Rose,  Raymond James - Analyst   [1]
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 All right everyone, we're going to get started. Next up is Bank of the Ozarks, which has a little more than $4 billion in assets. With us today from the Company is Chairman and CEO George Gleason, and I'm happy to have him here. So I'll pass it over to you.

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 George Gleason,  Bank Of The Ozarks Inc. - Chairman and CEO   [2]
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 Thank you very much, Michael. It's a great pleasure and honor to be here. I appreciate each of you attending.

 Please make note of our slide here regarding forward-looking statements. We tend to be a very transparent Company and we give a lot of information and comments about where we think things are going. All of those are qualified by the disclosures here regarding forward-looking information.

 You know Bank of the Ozarks is a Company that has a tradition of high performance, excellent performance. As you can see from this slide, which shows our net income each year since we went public, we've had record net income in 14 of our 16 years as a public company. And we have had positive earnings in every year under the current leadership.

 I became Chairman and Chief Executive Officer of the Company 34 years ago when it was $28 million in assets, tiny beyond compare. And we've never had a loss quarter in 34 years.

 You can see that high performance became very high performance in 2010 and 2011. Those were years in which our earnings were boosted substantially by bargain purchase gains on a total of seven FDIC-assisted acquisitions. The portion of our earnings attributable to bargain purchase gains in those years are noted by the slashed part of the bars. But even without those transactions, we had substantial positive earnings momentum in both of those years.

 In 2012 we made a small and single live bank acquisition. That transaction added slightly about $1 million to our earnings in 2012. Again, positive momentum in core earnings excluding the results of those acquisitions.

 And you can see this year our $40.4 million of earnings for the first six months of the year is a nice improvement compared to $37.1 million in the first six months of last year.

 We had no acquisitions in the first six months of this year, but on July 31 we did close what we think is a very nice acquisition of First National Bank of Shelby in Shelby, North Carolina.

 What I would tell you about our Company is basically three things -- that we work very hard, we are extremely disciplined and we've shown a proven ability to capitalize on opportunities. The slide shows our return on average assets and return on average equity in red compared to the industry metrics over the last seven years or so, which are shown in yellow. And as you can see from this slide, our ROA and ROE numbers have always compared favorably during this timeframe to the industry, and very favorably in the later years of this timeframe.

 In 2008 and 2009 when the industry earnings went to near zero, we were generating a 1.14% and a 1.23% return on assets, and a 16% and 14% return on average equity in those years. And you know those were years when a lot of folks thought we would have a lot of problems because we are a heavy CRE, heavy construction and development lender. Over 80% of our portfolio is real estate related.

 And we said going into this cycle that we believed we did real estate lending that vastly differently with a great deal of expertise, vastly differently than most banks did and that our portfolios would hold up relatively well during that timeframe, as they did. And we continued to be able to make loans in those time frames and generate positive earnings momentum. It set us up in a very good fashion to capitalize on great opportunities in 2010 and 2011 through failed bank acquisitions and more recently through additional live bank acquisitions.

 And you can see the way that has played out over the last four years. Our return on average assets has ranged from 2.13% to 2.70% to 2.04% to 2.07%. And our return on average equity has ranged from 21.6% to 27% to 16.8%, and for the six months of this year to 15.6%.

 Now 15.6% is certainly not the ROE that we want to achieve. But it's not bad considering that we are operating with almost 13% tangible common equity. So, given that, we feel good about that number.

 There are three secrets to our -- and I guess they are really not secrets, three components of our stellar financial performance. One is we generate a very high net interest margin. Two, is we are very efficient and three is favorable asset quality.

 And I'll give you a few data points on those. This slide shows our net interest margin, and as you can see, it was unspectacular back in 2006 and 2007, a time that was very competitive and a time when about 75% of our funding came from CDs. We decided starting early in 2008 that we were going to fix and rectify the poor structure of our deposit mix and we embarked on a substantial campaign to improve the mix in the profitability of our deposit base. And I'll give you a few more data points on that in a minute. But as a result of that, we've really flipped that over and now 75%, roughly, of our deposit base is non-CD and our cost of funds been greatly reduced.

 We've also layered over that FDIC-assisted acquisition loans that included some very high yields and we have a very high performing bond portfolio. I'll give you a few more data points.

 You can see the first bullet point here is the current mix of our deposits -- 75.6% non-CD. Obviously that's quite a transition from where we were six years ago. The second bullet point really talks about our legacy loan and lease portfolio. In the second quarter this year that portfolio yielded 5.50%. That's roughly in line with 5.55% for the industry overall.

 Our cost of interest-bearing deposits was a mere 23 basis points in Q2 compared to an industry number of somewhere around 65. So as a result, if you look just at our non-loss share and non-purchased loans and compare that to our cost of interest-bearing deposits, we've got about a 37 basis point better margin in Q4 and a 54 basis point better margin in Q1 than the industry did in the first part of the year.

 But if you layer over that our outstanding yield on our covered loan portfolio, these are the loans acquired in our seven FDIC-assisted acquisitions, those loans are yielding almost 9%, contributing to part of the significant outperformance in our net interest margin.

 And if you look at our investment portfolio we've always been very strategic in the way we manage that investment portfolio. And for the first six months of this year, the tax equivalent yield on our investment portfolio was 5.82%. If you compare that to an industry average of 2.36%, you will see that that is a significant contributor as well to our much better than industry net interest margin.

 Here you go -- you can see the mix in our deposits, the way that has evolved over the last six years, 6.5 years. We've gone from 69% or 67% non-CD. If we went back one more year, that would be about 75% CDs to 24% CDs.

 And we've gone, obviously, on non-interest-bearing deposits from just below 8% to almost 20%. And interest-bearing non-CD deposits have gone from about 25% to 56% of our total deposits. So, all of those things combine in tandem to give us a very strong net interest margin.

 In regard to efficiency, you can see for the first six months of this year, our efficiency ratio was 46.5%, 12.4% better than the industry average of 58.9%. And our 46.5% efficiency ratio we actually think is an abysmal number. If you look back in 2008, 2009, 2010 we were -- 2011, we were running or just over a 40% efficiency ratio and we have great aspirations to get back to a sub 40% efficiency ratio. And we think ultimately we've got a mathematical possibility of hitting a sub-30% efficiency ratio.

 The reason we believe that will happen is right now we're running with 132 branches. The data that contributed to this was really 118 branches. We picked up 14 more in the Shelby acquisition. But that 118 branches at June 30 was probably 40 to 50 more branches than we need to fund our existing balance sheet.

 As part of our FDIC-assisted acquisitions, we picked up a lot of branches and a lot of deposit-gathering funding capacity that we don't need. So we've simply been keeping deposit rates very, very low, driving off any deposit that had any sort of rate sensitivity to it. And we can get those deposits back with very minor adjustments in our cost of funds we believe.

 So our expectation is that running with basically a $4 billion balance sheet at June 30, that ignoring the effect of acquisitions -- both the Shelby and other potential acquisitions, that we can get -- with our 118 offices at June 30, we can get to somewhere between a $7.5 billion and $8 billion balance sheet with probably no more than four or five additional branches at along the way.

 And we believe we can generate the loans similarly with very modest additions of infrastructure. We will have to add some personnel along the way. But obviously if we can execute that model over a number of years and grow our balance sheet where to we think we can grow it, we believe that it is very plausible that in a couple of years will be at a 40% efficiency ratio, and probably three or four or five more years out from there we've got a mathematically plausible possibility of getting to a sub-30% efficiency ratio.

 Again charge-offs, asset quality are the third leg of our financial strength. You can see our net charge-off ratio every year throughout the cycle compared to the industry as a whole. Obviously in 2009 we had a high level of net charge-offs.

 We still made record earnings that year even with 175 basis points of net charge-offs. And obviously that situation has corrected fairly quickly as our charge-off ratio went to 81 bps, 69 bps; 30 bps last year and year to date we're running with an annualized charge off ratio of 15 basis points, which is roughly one-fifth or so of the industry average, a little less than one-fifth of the industry average for year to date.

 So, while we are a heavy construction and development and CRE lender, we do that in the very disciplined way that has resulted in very, very few losses. One of the disciplines we follow is to get a lot of cash equity in our transactions, if you look at our construction and development loans that have interest reserves, which is basically all of them, or almost all of our construction and development loans.

 In 2007 and 2008 that pool of loans would've had somewhere between 25% and 27% cash equity in the transactions. If you look at that at June 30 quarter end just ended, we had 41% average cash equity in those transactions. And if you look over the last say six quarters we've been bouncing somewhere between 37% weighted average cash equity and 44% weighted average cash equity quarter to quarter.

 So we get a lot of cash in our transactions. We do a lot of very large, complex transactions with a great deal of sophistication. And we've got a lot of borrower skin in the game or sub debt or mezzanine debt behind us in those transactions. And that has certainly contributed to this excellent asset quality.

 We're an Arkansas-based institution and have I think 66, 68 offices in Arkansas, but Texas is the most rapidly growing an important part of our company. We have 13 Texas offices. That's -- at June 30 was 11% of our total offices, yet those offices account for 48.2% of our total loan and lease portfolio excluding purchased and covered loans, and 13.1% of our deposits.

 The disproportionate performance of our Texas offices really reflects the diversity, strength and depth of the Texas economy. We believe it is the best state economy in the United States and is a very positive place. So we expect it is going to continue to be the most rapidly growing part of our Company on a pound for pound basis.

 You can see what we describe here is a brief history of Texas, which for us started in 2003, 10 years ago when we opened our first office there, which was our real estate specialties group that continues to be main loan engine of the Company. And as you can see we've added offices fairly regularly in the ensuing ten-year period. Last year we added three offices, the year before added three.

 What really is interesting about this disproportionate impact of our Texas office is six of the 13 are less than two years old. So that gives you an idea of the real performance of the older Texas offices.

 We have also, complements of the FDIC, developed a significant emerging Southeastern franchise. As I said, we made seven acquisitions there from the FDIC; we made a small acquisition in the last day of last year in Geneva, Alabama in a live bank deal, and then the First National Shelby transaction which gave us 14 more branches in North Carolina.

 So where we stand today is we have 28 offices in Georgia, 16 in North Carolina. We're about to close one of the Shelby offices. We're going to retain the other 13. That will close in September, and then sometime probably in the first half of next year will open an additional office in Cornelius, North Carolina just north of Charlotte. So we are at 16. And after closing and opening offices we'll be back at 16.

 Florida we currently have four offices, one under construction, to expand our franchise there to five; and then a trio of offices in Alabama, and one loan office in South Carolina. One might look at these fairly scattered group of offices and say well, wow, one office in Bluffton and one office in Wilmington. What can you do with those? And certainly it is true we don't have the critical mass of business in those offices to make them highly efficient in a conventional sort of strategy.

 But as we're looking at our balance sheet and realizing that we have the capacity to grow loans hundreds of millions of dollars a year in the future, and can -- want to fund those loans at the lowest possible cost of funds, what we have basically done is go in into a market segmentation strategy on our entire franchise. We've looked at each market that were in, each office that we have, the deposit mix and volume of that office versus the deposit mix and volume of the entire market it serves. The relative competitive strengths, weaknesses and pricing levels that exist within that market among all of our competitors to determine which offices we can spin up first as positive offensive deposit-gathering offices, and generate the most deposits possible at the lowest cost of funds while cannibalizing deposit rates on the leased percentage of our existing deposits.

 Basically to determine which office is the most profitable to raise deposits in, or the least costly to raise deposits in for our whole franchise. We have done this. And as we mentioned in our July conference call, we are in the process now of beginning to spin up those first few offices because we've used up our spare cash and we need deposit growth to fund what we expect will be nice loan growth in the coming quarters.

 And we commented that because of this very disciplined and thoughtful market segmentation strategy, we think will be able to generate the deposits we need over the next few quarters with minimal impact on our cost of interest-bearing deposits.

 For example we're expecting, based on our loan guidance, on average $100 million-plus a quarter in loan growth. We think we can achieve the deposits we need to achieve and move our 23 basis points cost of interest-bearing liabilities only a basis point or two a quarter for the next several quarters. So the isolated and somewhat random scattering of some of these acquired branches, which would seem to be a shortcoming and a liability, we actually think we've got a good strategy to turn that into a valuable asset and benefit.

 You can see the live bank acquisitions, I've talked about those. The status of those is -- the first one was really small, about $127 million in deposits. First National Bank of Shelby just acquired is about $600 million of deposits. We have already got their surplus liquidity.

 They had a pretty good bond portfolio we also inherited, so we've really put ourselves pre-acquisition in a borrowed position in our legacy banks. So we would have the capability to sop up their excess cash day one in that acquisition. So it worked out really nicely the way we planned that.

 And then you can see our seven FDIC transactions that range from March of 2010 through April of 2011 as well. Those transactions as of June 30 still accounted for $481 million in carrying value of covered loans. That's about half where we were. We were just under $1 billion at the high point.

 Our FDIC receivable related to those at June 30 was about $113 million. Seven quarters earlier that was $357 million. So we're doing a really good job of working through those loan portfolios, recognizing our losses, turning in our claims. We said in the July conference call that based on about $20 million, $21 million in FDIC receivable that we expect to collect in July and August -- this month basically -- from our claims related to losses recognized and certified to the FDIC in the second quarter that we thought that receivable would be down to about $92 million, $93 million by the end of the month of August. And that number is bearing out.

 And then covered OREO -- that's about $46 million. We are generating gains on about 95% of our covered OREO sales and we have been selling about 100 properties a quarter. I feel like a realtor.

 $818 million of deposits from those seven acquisitions; all of these banks, when we acquired them, had about 75% CDs. All of them have now about 75% non-CDs. So we've instilled in the acquired banks and pretty much fully conformed them to our disciplines on deposit pricing and mix.

 You can see here the fairly linear run rates on the loans on the blue line and the FDIC receivable on the yellow line. The OREO is running down less slowly and that's because we sell four pieces and put four more in there. It's an interesting process to work through such large and troubled portfolios.

 This has been very profitable for us. Of course you saw in the margin we are generating about a 9% yield on the loans. If you look at this slide, it shows you some other quarter to quarter metrics.

 The first column of data there is provision expense, and this is situations where we were too optimistic in our projections regarding what we could cover on these loans. So we've had provision expense subsequently. That's $9.6 million.

 The second column is a good column, and that is where we've had other loss share income which is an assortment of things. But mostly it's recovery income, where we've collected more on a loan than we thought after we gave the FDIC credit for their 80% of that excess collection. This is our 20% differential there.

 We generated $23.6 million of positive earnings from those portfolios as a result of that. And as you can see, that number is holding up very well on a quarter-to-quarter basis.

 And then gains on sales of foreclosed assets, this is covered OREO. As I told you, we are generating gains on 90%, 95%, maybe even as high as 96%, 97%, 98% of those transactions because we value these things pretty conservatively. So that's generated $14 million in cumulative gains.

 So if you look over the last three years, basically, we've had $28 million of net other income pretax as a result of the difference in recovery income, plus gains on foreclosed assets that were covered by loss share, minus the downward adjustments for provision expense on assets that we were too optimistic on the value. Obviously we have been pretty conservative in how we value these portfolios. What we like about it is that every month we've had a net-net positive.

 And we commented back in 2011 because people are saying why, you have got good income here, but what's going to happen in the future years? We said we think 2012 will be better than 2011. 2013 will look a lot like 2012. It will start tapering down in 2014 and more so in 2015.

 Obviously, as you can look at a couple of months here so far in 2013, they are actually doing much better than 2012. And that is reflection of the fact that market conditions are improving better than expected in the Southeast and we are getting higher sales prices and higher recoveries on some of these loans than we modeled, because we factored and almost no potential for recovery in our initial valuations on these.

 So that has the potential to actually possibly make 2013 better than 2012 in this regard, and get a little more legs to recovery potential in 2014 and 2015.

 You can see that we really call these just beachheads in these markets, although we've got 400-plus employees in these states now, including 132 at our FNB Shelby transaction. We're really beginning to move off the beachhead become more offensive-minded in these markets; had really good loan growth in Georgia and North Carolina particularly last quarter.

 We've opened a real estate specialty group satellite office in Atlanta, July of last year. We relocated our Bluffton office to a new facility, opened a second office in Mobile, relocated Wilmington office to a better facility, relocated our original Mobile office to a better facility. We're really trying to improve what we're doing there to give our customers the services they need.

 We've talked about some of these other things, but as you can see it is a very important market for us in the Southeast, even though I don't think it has the growth potential Texas does. If you add North Carolina and Georgia together they have about the same GDP as Texas, and Texas I think has a better economy than those two states long-term. So we're optimistic the Southeast is going to be good for us; not quite as good as Texas.

 We did open a real estate specialties group office in New York. We've over the years done a lot of transactions for our Texas and other customers where the equity money, the mezzanine debt, the sub debt pieces of the transaction were done by New York money sources. As a result we built a ton of relationships, some of them forged in the heat of battle with those guys where we fought over terms vigorously but have developed a mutual respect with those guys, and that has given us the opportunity to do more and more business with those.

 A lot of times we might have a sub debt player for one of our big Texas borrowers on a deal, and then they would contact us and say well we've got a deal in the South or Southeast or Texas. We worked well with you guys in the past. We want you to come in and be the prime mortgage on it and put a 40% first mortgage on it, we'll put a 40% sub debt with a 20% equity on the deal.

 So we started doing more and more of those sort of pieces of business with our New York contacts. The result of it is a New York office seemed to be a logical evolution of what we were doing.

 I think I've gone too slow in this and run out of time. We feel like we've got a lot of opportunities. We are growing loans significantly. You know we had [200 and] -- Michael? -- [80-something-million-dollars] of growth in non-loss share, non-purchase loans last quarter.

 It's a robust quarter. We warned people that's not a run rate number, but some substantial growth is in our future. This is one data point I'll leave you and then I'll be quiet.

 This is our balance of loans that are closed on the books. This is the unfunded balance of those. And over the last three years that went from $166 million to $313 million to $769 million. And from year-end 2012 to June 30 six months that went up another $166 million to $935 million.

 These are construction and development loans that are closed on the books. But because we get so much equity, remember 40% or so equity average in these loans, a lot of these loans get closed, we fund $1000, the customer may put $30 million in the project before we put our $30 million in. All the equity typically comes in first. So this big balance of unfunded loans reflects some of the potential inherent within our bank to grow loans in the future.

 I'm going to stop there. Michael do I have a minute for questions? We'll take a couple minutes if any of you have any questions? Anybody? Michael?



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Questions and Answers
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 Michael Rose,  Raymond James - Analyst   [1]
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 You know after the Shelby deal was closed, you had this big [multi-buy]. And how critical was it for you to -- when you look back initially for (inaudible) volumes, what appears to be pretty robust?

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 George Gleason,  Bank Of The Ozarks Inc. - Chairman and CEO   [2]
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 You know, it's not critical at all. I mean we could literally with what we have got fund our balance sheet to the $7 billion, $8 billion, and with the Shelby acquisition even above $8 billion with no additional branches or only a handful of additional branches. But we believe that there are opportunities to do transactions.

 You know our bogey for an acquisition, any acquisition, is to generate to be able to generate a 20% ROE on a sustained go-forward basis from the acquired businesses, assuming an 8% capital allocation. And we certainly think we'll get there in 12 to 24 months on Shelby, that it -- you know, it's a $600 million acquisition. So at 8% capital you are talking $48 million in capital allocated. So we think we'll get to a point where we can generate a 20% ROE on that pretty reasonably in that acquisition.

 So we would love to do more acquisitions. Each of those acquisitions is likely to bring with it the capability to generate more deposits that it can generate loans, which puts more onus on our real estate specialties group and other guys in our lending team that are in markets that are net loan generators. And we have a few markets where we generate more loans and deposits.

 So it puts more responsibility on those guys to make good business decisions and make good loans and grow their portfolios. But we think that is inherent within that ability, and potential is inherent within our Company. So we think making additional acquisitions, even if we don't need the branches for two or three years, makes heck a lot of sense if we can buy them where they generate good ROE numbers for us.

 Any other questions? Yes sir?

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Unidentified Audience Member   [3]
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 Could you comment on future FDIC transactions? Are those opportunities changing?

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 George Gleason,  Bank Of The Ozarks Inc. - Chairman and CEO   [4]
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 Certainly, the flow of deals from the FDIC has diminished greatly. Our view is there still a few hundred banks that ought to be closed, but the FDIC seems to be very reticent about closing anything now. And the deal flow that has come in the last several quarters has been a lot of really small deals mostly.

 And the FDIC is giving these guys so much latitude to try to work out of their problems that some of the deals we've seen in the last year have been so decayed and deteriorated from wear and tear on the franchise, that it's really hard to put together a transaction that makes any economic sense because the franchise has just been hanging there in a fairly bad state for so long, that they've had so much attrition in good customers and good staff and other factors.

 And those things tend -- you leave them out there are long time, they tend to get more complicated and more messy instead of less so. So we are still looking at FDIC transactions, but I think the probability of us doing more FDIC transactions has gone down a lot just because they're going to be a lot fewer of them and what's going to be there is probably going to be very small and very messy.

 Yes?

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Unidentified Audience Member   [5]
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 Outside of Texas, what states in the Southeast are you looking to go into?

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 George Gleason,  Bank Of The Ozarks Inc. - Chairman and CEO   [6]
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 Well, we really like North Carolina. You know, we've had a loan production office in Charlotte that's been a very profitable, very good office for us since 2001. So we've had 12 years history in that state and we sort of learned how to do business there in a way that works well for us.

 With the substantial franchise that we acquired with First National Shelby, that was 139-year-old bank and had a really dominant market share particularly in Cleveland County. They are in three other counties, but Cleveland is really the dominant part.

 So we've got enough infrastructure there and people and systems and business that we could really very efficiently grow off of that. Even our loan production office in Charlotte has been a real help in managing the integration operationally and culturally of the Shelby transaction. So that is probably market number one.

 Georgia, where we have 28 offices scattered pretty much across the state, is probably market number two of interest to us. North Carolina is in better shape than Georgia economically, a little further along in working throughout the problems and issues. Had a lot less bank failures there, so that's probably the reason for the one-two order there.

 And then the other states we have a small very small presence we would love to expand on that if 20% ROE opportunities present themselves.

 All right, thank you guys, I appreciate your time.






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