Q4 2015 Bank of The Ozarks Inc Earnings Call
Jan 15, 2016 AM EST
OZRK.OQ - Bank of the Ozarks
Q4 2015 Bank of The Ozarks Inc Earnings Call
Jan 15, 2016 / 04:00PM GMT
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Corporate Participants
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* Susan Blair
Bank of the Ozarks, Inc. - EVP of IR
* George Gleason
Bank of the Ozarks, Inc. - Chairman and CEO
* Greg McKinney
Bank of the Ozarks, Inc. - CFO and CAO
* Tyler Vance
Bank of the Ozarks, Inc. - COO and Chief Banking Officer
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Conference Call Participants
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* Michael Rose
Raymond James & Associates, Inc. - Analyst
* Jennifer Demba
SunTrust Robinson Humphrey - Analyst
* Matt Olney
Stephens Inc. - Analyst
* Joe Gladue
Merion Capital Group - Analyst
* Brian Martin
FIG Partners, LLC - Analyst
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Presentation
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Operator [1]
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Welcome to the Bank of the Ozarks Incorporated fourth-quarter earnings conference call. My name is Vanessa, and I will be your operator for today's call. At this time all participants are in a listen-only mode and later we will conduct a question-and-answer session. Please note that this conference is being recorded.
And it is now my pleasure to turn the call over to Susan Blair. You may begin.
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Susan Blair, Bank of the Ozarks, Inc. - EVP of IR [2]
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Good morning. I'm Susan Blair, Executive Vice President in charge of Investor Relations for Bank of the Ozarks. The purpose of this call is to discuss the Company's results for the quarter just ended and our outlook for upcoming quarters. Our goal is to make this call as useful as possible to you in understanding our recent operating results and outlook for the future. A transcript of today's call, including our prepared remarks in the Q&A, will be posted on bankozarks.com under the Investor Relations tab.
During today's call, and in other disclosures and presentations, we may make certain forward-looking statements about our plans, goals, expectations, thoughts, beliefs, estimates and outlook, including statements about economic conditions in the United states and globally, including the state of the current United States economic recovery and certain global economic and geopolitical risks, real estate market, competitive credit market and interest rate conditions, including expectations for further changes or adjustments in monetary and interest rate policy by the United states Federal Reserve, revenue growth, including the possibility for additional revenue growth in 2016 from reallocating overhead from less productive activities to geographies and areas of business which may be more productive, net income and earnings per share, net interest margin, net interest income, the expected impact of recent actions intended to reduce our costs of Federal Home Loan Bank, FHLB, borrowings, non-interest income including service charge income, mortgage winning income, trust income, bank-owned life insurance income, other income from purchased loans and gains on sales of foreclosed and other assets, non-interest expense including acquisition-related, systems conversion and contract termination expenses, our efficiency ratio including our goal for achieving a sub 30% efficiency ratio, asset quality, our various asset quality ratios, our expectations for net charge-offs and our net charge-off ratios, our allowance for loan and lease losses, loan and lease growth including growth from unfunded closed loans and growth from loans currently in the underwriting and closing processes, deposit growth including growth from existing offices, acquisitions and other sources, growth in earning assets, changes and expected cash flows of our purchased loan portfolio, changes in the value and volume of our securities portfolio, estimated cost savings in connection with the conversion of our core banking software, the opening, relocating and closing of packing offices, our expectations regarding pending mergers and acquisitions including our expectation that such acquisitions will enhance our community banking, loan administration and other business functions and provide capabilities in technology and innovation which will be transformational to customer experiences and operational efficiency, our goals and expectations for additional mergers and acquisitions in the future, the availability of capital, changes and growth in our staff, the timing and eventual impact of the Durbin amendment on non-interest income and expenses with regard to regulatory compliance, including the impact on non-interest expense from total assets reaching $10 billion.
You should understand that our actual results may differ materially from those projected in these forward-looking statements due to a number of risks and uncertainties, some of which we will point out during the course of this call. For a list of certain risks that may impact any of these forward-looking statements and other risks associated with our business, you should refer to the forward-looking information section of our periodic public report, the forward-looking statements caption of our most recent earnings release and the description of certain risk factors contained in our most recent annual report on Form 10-K, all as filed with the SEC.
Forward-looking statements made by the Company and its management are based on estimates, projections, beliefs and assumptions of management at the time of such statements and are not guarantees of future performance. The Company disclaims any obligation to update or revise any forward-looking statements based on the occurrence of future events, the receipt of new information or otherwise. Any references to non-GAAP financial measures are intended to provide meaningful insight and are reconciled with GAAP in our earnings press release.
Let me turn the call over to our Chief Executive Officer, George Gleason.
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George Gleason, Bank of the Ozarks, Inc. - Chairman and CEO [3]
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Thank you, Susan. And thank you all for joining our call today. In our 18-plus years as a public company we've reported many great quarters and many great years. But we believe our work in 2015 and particularly the fourth quarter of 2015 is by far our best yet. Of course, the year and the quarter just ended were notable for many record-breaking financial results, which Greg and Tyler will discuss shortly. But we believe our work in 2015 will be best remembered for how well we prepared and positioned ourselves for even greater achievement in 2016 and future years.
In today's call we hope to give you clear insights into both of these very important elements of our team's accomplishments in 2015, both the outstanding financial results and the highly strategic preparation for our future.
Let me start with a quick summary of financial highlights. Our fourth-quarter net income of $51.5 million was a quarterly record, providing a strong finish to our most profitable year ever. In fact, our record annual 2015 net income of $182.3 million was a stellar 53.7% increase over the previous record annual results in 2014.
During the quarter and year just ended, we achieved both quarterly and annual records for a large number of measures, including diluted earnings per common share, growth in funded non-purchased loans and leases, growth in closed and unfunded loans, net interest income, service charge income and trust income. Additionally, we ended the year with some of our best asset quality ratios as a public company, including our best past due ratio for non-purchased loans and leases.
Of course, 2015 was another in a long string of excellent years, as evidenced by the fact that our 2015 return on average assets of 2.11% continued our exceptional record of having achieved returns on average assets in excess of 2% for six consecutive years.
As I already mentioned, our excellent 2015 results were just part of the story, and we believe the strategic preparation for 2016 and future years is even more important. Let me briefly discuss eight strategic highlights. I think you will find these items to be the most helpful part of today's call.
First, we continue to intensify our long-standing focus on credit quality and conservative underwriting standards. We think this is of critical importance.
Clearly, the current United States economic recovery has lasted for a relatively long time, but that recovery has never been robust and has seemed to require highly accommodative monetary processes to be sustained. From its beginning, we focused on the fragile nature of this domestic economic recovery, the relatively poor performance of many other economies around the globe and the myriad economic risks posed by a long list of global economic and geopolitical circumstances. All this is amplified our traditional focus on very conservative credit underwriting, causing us to focus primarily on transactions involving great projects, strong and capable sponsors, low leverage and defensive loan structures.
You can see this focus on credit quality in a number of metrics. For example, at December 31, 2015, excluding purchased loans our nonperforming loans and leases as a percent of total loans and leases was 0.20%. Our nonperforming assets as a percent of total assets were 0.37% and our ratio of loans and leases past-due 30 days or more, including past-due nonaccrual loans and leases, to total loans and leases were just 0.28%. These December 31, 2015 ratios for nonperforming loans and leases and nonperforming assets were our best since the third quarter of 2007. And our December 31, 2015 past-due ratio was our best ever as a public company.
For our construction loans with interest reserves, which is the majority of our construction loans, we don't have the data compiled at year end. But at September 30, 2015, our average loan to cost was an ultraconservative 51% and our average loan to appraised value was just 43%.
None of us can say for sure when the next recession will occur or when the real estate cycle will turn. But for years we have tried to be very conservative in our underwriting, structuring and portfolio management. And we think all that will serve us very well in times of future economic challenge, whenever they come.
Second, we carefully managed our balance sheet growth in the quarter just ended to maintain total assets under $10 billion. At December 31, 2015 our total assets were $9.88 billion. We have previously explained that reaching $10 billion in total assets will subject us to the Durbin amendment, which will result in a loss of some interchange revenue and will also subject us to increased regulatory compliance cost. By staying below $10 billion in total assets at year end, we delayed the impact of the Durbin amendment on our interchange revenue by one year, from July 1, 2016 until July 1, 2017.
Based on our current business volume, we estimate that the annual revenue loss attributable to the Durbin amendment will be about $5.35 million. So our net income in the second half of 2016 and the first half of 2017 should benefit noticeably from our staying below $10 billion at December 31, 2015.
Third, during the quarter just ended, we sold certain purchased loans with a carrying value of $12.5 million, recognizing a net gain of $6.3 million. The sales were motivated in part by our desire to maintain our year-end balance sheet under $10 billion and also by our desire to be defensive in maintaining asset quality. When we reviewed our portfolio of purchased loans, we concluded that these loans were among our most vulnerable purchased loans to an economic downturn.
Fourth, during the quarter just ended we sold $167.3 million of investment securities, recognizing a net gain of $2.9 million. These sales were motivated primarily by our desire to maintain our year-end balance sheet under $10 billion and, to a lesser extent, by our desire to reduce our investment portfolio's exposure to the uncertainty surrounding possible rising interest rates.
Fifth, at December 30 we prepaid $120 million of Federal Home Loan Bank, FHLB advances. These advances had maturities in September and October 2017 and had a weighted average interest rate of 3.80%. We initially replaced these long-term advances with overnight FHLB borrowings and, during the first week of January, the short-term borrowings were replaced with deposit growth. These prepayments resulted in penalties of $6.4 million in the quarter just ended, but this should significantly reduce our cost of FHLB borrowings in 2016 and 2017, and increase our FHLB borrowings capacity, which is an important secondary source of liquidity for us. For those of you updating your models, we now have just over $40 million of FHLB advances, half maturing in November 2017 and half maturing in January 2018 and with a weighted average rate of 2.85%.
Sixth, as you know, we focus intensely on efficiency and we always try to deploy our resources in the most efficient manner. In the quarter just ended, we reviewed the productivity of every lender and lending team in the Company, looking at production volume, quality, yield and other factors. That review resulted in our decision to consolidate our stabilized properties group and its remaining servicing team into real estate specialties group and, of lesser significance, to eliminate certain underperforming lenders and other team members in community banking.
This resulted in approximately $2.2 million in severance costs in the quarter just ended. While other divisions of our Company, notably Real Estate Specialties Group and most of community banking, were very successful in originating a good volume of good-quality, good-yielding loans in 2015, the Stabilized Properties Group business model was severely challenged to produce the needed volume, quality and yield in the current highly competitive low-yield environment for loans to its target customer segment.
Based on the significant overhead expenses attributable to Stabilized Properties Group and the lack of satisfactory production, we made a decision to wind down the New York loan operations of Stabilized Properties Group by December 31, 2015. The Stabilized Properties Group Florida staff was retained in its entirety and will continue as the servicing team for that portfolio and as an important special servicing unit for other portfolios.
These actions in the aggregate eliminated somewhere between $3 million and $4 million of annual overhead expense. But you won't see any overhead reductions in our results in 2016. That is because we are reallocating that overhead to grow our team and geographies in areas of business where we believe we can achieve much greater productivity. So we hope you will see the results of these actions in greater revenue growth over the course of 2016.
Seventh, on December 8 we issued 2.1 million shares of common stock at a price of $52.42 per share for gross proceeds of $110 million and expenses of approximately $20,000. The shares were offered to certain institutional investors in a registered direct offering conducted without an underwriter or placement agent. Immediately following the offering we made a capital contribution of $110 million to our bank subsidiary to support its expected growth in loans and leases.
Our thinking behind this offering is probably much more obvious in light of the substantial fourth-quarter growth in both the outstanding balance of non-purchased loans and leases and our unfunded balance of closed loans. Later in the call we will provide updated 2016 loan and lease growth guidance, which should divide additional clarity.
Eighth, acquisitions were an important part of our story in 2015; and our two pending acquisitions, both announced in the quarter just ended, are, in our opinion, of particular strategic importance and value. Our pending acquisition of Community and Southern Bank, which we announced on October 19, 2015, will be our largest acquisition to date. Community and Southern provides us 47 strategically located and highly complementary Georgia banking offices and one Florida banking office, a large number of talented bankers, particular expertise in both direct and indirect consumer credit, and important loan operations group, two important loan and business analytics groups and numerous other team members and capabilities which will enhance our community banking, loan administration and other business functions.
Our pending acquisition of C1 Bank, which we announced of November will provide us 32 strategically located and highly complementary Florida banking offices including offices in some of Florida's highest growth and strongest economic markets. We believe that C1's unique culture and leadership in technology and innovation will be transformational in our quest to be an industry leader in best-of-class customer experiences and operational efficiency. Both transactions are expected to close in the first half of 2016.
In summary, we think the quarter just ended was remarkable not only for its record net income but as a quarter in which we further enhanced our already excellent asset quality, further reduced our exposure to possibly rising interest rate, avoided the adverse impact of the Durbin amendment on our interchange income until July 1, 2017, greatly reduced our FHLB borrowing costs, enhanced our secondary liquidity by freeing up FHLB borrowing capacity, enhanced our productivity by freeing up overhead from underperforming departments and reallocating it to increase our focus on more productive geographies and areas of business, raised new common equity to support continued growth and announced two strategic acquisitions, each of which provides a valuable and highly complementary branch network, many talented bankers and expertise in technology which we expect to have significant application throughout our combined enterprise, all of which has me more excited about the future of our Company than ever before, and that is saying a lot.
Let me turn the call over to our Chief Financial Officer, Greg McKinney.
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Greg McKinney, Bank of the Ozarks, Inc. - CFO and CAO [4]
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Net interest income is traditionally our largest source of revenue and is a function of both the volume of average earning assets and net interest margin. Our fourth-quarter 2015 net interest income was a record $106.5 million and our full-year 2015 net interest income was a record $382.2 million.
We enjoyed a very positive trend in net interest income in each quarter of 2015, as a result of excellent growth in average earning assets which more than offset the reduction in our net interest margin.
Of course, loans and leases comprise the majority of our earning assets. In the quarter just ended our non-purchased loans and leases grew a record $1.08 billion. This growth was $400 million more than our previous quarterly growth record, achieved in the third quarter of 2015.
Our unfunded balance of closed loans also increased by a record amount, $939 million, during the quarter just ended and at December 31, 2015 was a record $5.8 billion. While some portion of this unfunded balance will not ultimately be advanced, we expect the vast majority will be advanced. This has favorable implications for future growth in loans and leases.
Our growth in non-purchased loans and leases accelerated over the course of 2015 from $331 million in the first quarter of 2015 to $456 million to $680 million and finally $1.08 billion in the fourth quarter, resulting in record non-purchased loan and lease growth for the full year of 2015 of $2.55 billion.
In our October conference call we introduced guidance for the full year of 2016 growth in non-purchased loans and leases of at least $2.5 billion.
Based on the growth in our customer base, our pipeline of transactions currently in underwriting in closing and, as previously discussed, our largest-ever unfunded balance of closed loans, we are raising our 2016 growth guidance. We now expect growth in non-purchased loans and leases in 2016 of at least $3 billion.
On the deposits side, we have long expected that, within reasonable limits, we could accelerate deposit growth as needed to fund our loan and lease growth. In the first quarter of 2015 the excess cash generated from the Intervest acquisition provided sufficient funds to support our loan and lease growth. Likewise, our pending and any possible future acquisitions may be sources of liquidity to fund portions of our expected future growth. In the second and third quarters of 2015 we successfully utilized a combination of organic deposit growth and several good, low-cost wholesale funding sources to fund our growth in a cost-effective manner.
In the fourth quarter we deployed our deposits spin-up strategy to fund our record loan and lease growth. This spin-up occurred in 31 offices in 21 cities, primarily in Florida and Texas, where our capacity to raise deposits is significant and we enjoy a nice complement of offices. You can see this in our $365 million of deposit growth in the quarter just ended.
As George alluded to earlier, in an effort to make sure the excess deposit growth did not force us over $10 billion at year end, we restrained deposit growth in the last half of the fourth quarter, relying on short-term FHLB borrowings to bridge our funding needs. During the first week of January we loosened the restraints on deposit growth and we quickly generated sufficient deposits to repay all short-term FHLB borrowings we had at year end. We continue to believe we have substantial capacity for deposit growth in our existing branch network and from established wholesale funding sources, and we expect our pending acquisitions to augment our deposit growth capacity.
We consider net growth in core checking accounts as our most important deposit metric. In 2015 we achieved record growth in our number of net new core checking accounts with approximately 12,232 net new accounts added, and that does not include the addition of accounts from acquisitions. That's a 30.5% increase over the number added in the prior year.
This record net new core checking account growth, along with accounts acquired in our acquisitions, were key contributors to our record 2015 service charge income. Tyler and the entire retail banking team continued to do a great job in 2015 growing core deposits.
Even as we achieved substantial deposit growth, our favorable cost of interest-bearing deposits contributed to our net interest margin of 4.98% for the fourth quarter. Achieving a superb net interest margin continues to be one of our key goals, and although there has been pressure on our net interest margin in recent years, we've continued to be among the best in the industry in this important measure.
Our 2015 net interest margin on an FTE basis was 5.19%, a 33 basis point decrease from 2014. In our January conference call last year, (technical difficulty) toward a decrease in our net interest margin in 2015 of approximately 28 basis points. That guidance was based on our achieving $1.35 billion in non-purchased loan lease growth in 2015. We've said numerous times that greater non-purchased loan and lease growth would tend to put additional pressure on our net interest margin. A much higher than originally expected growth in non-purchased loans and leases was one of the most significant factors in our net interest margin declining 5 basis points more than we expected in January of last year. We were happy to trade the 5 basis points of net interest margin for the extra $1.2 billion of loan and lease growth.
Our focus on reducing credit risk and interest rate risk also contributed to our decline in net interest margin in 2015. In recent years we've been focused on decreasing our loan to cost and loan to value on loans to reduce credit risk, and we have focused on originating more variable-rate loans and fewer fixed-rate loans to lower interest rate risk. While we believe these actions have significantly reduced our risks, they have also lowered our average yield on new loans.
With the Federal Reserve's recent rate increase and economic conditions as volatile as they are, we believe being more defensively positioned is worth giving up some margin. At December 31 we had increased variable-rate loans to 79.0% of our total non-purchased loans and leases. And we anticipate further pressure on our net interest margin in 2016.
As part of our guidance provided at 2015, we said we expected our costs of interest-bearing deposits would increase between 1 and 5 basis points in each quarter of 2015 as a result of our deposit-gathering activities to fund loaned and leased growth. Our cost of interest-bearing deposits has been consistent with that guidance in each quarter, having increased 2 basis points in the first quarter, none in the second quarter, 2 basis points in the third quarter and 4 basis points in the fourth quarter.
We believe that our cost of interest-bearing deposits will increase between 3 and 7 basis points in each quarter of 2016, due to the recent Fed rate increase and further Fed rate increases we anticipate this year and our expectation that we will need to accelerate our deposit-gathering activities in 2016 to fund the expected volume of loan and lease growth.
Now let me turn the call over to Tyler Vance.
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Tyler Vance, Bank of the Ozarks, Inc. - COO and Chief Banking Officer [5]
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Traditionally, we have been among the most efficient bank holding companies in the US, and the improvement in our efficiency ratio this year compared to 2014 further enhances our excellent standing among the nation's most efficient banks.
Our efficiency ratio for the quarter just ended was 37.1%. For the full year of 2015, our efficiency ratio improved to 38.4% compared to 45.3% for the full year of 2014.
While our efficiency ratio will vary from quarter to quarter, especially in quarters where we have significant unusual items of income and non-interest expense, we have stated in recent conference calls that we expect to see a generally improving trend in our efficiency ratio in the coming years. This is predicated upon a number of factors including our expectation that we will ultimately utilize a large amount of the current excess capacity of our extensive branch network, our expectation that our core software conversion and improvement projects over the past two years will provide greater functionality for our customers and employees, creating opportunities for enhanced operational efficiency, our expectation of achieving additional productivity gains by reallocating resources from Stabilized Properties Group and a few underperforming community banking elements to more productive geographies and areas of business, and our expectation that we will achieve significant efficiencies from our pending acquisitions, including efficiencies from the adoption of Community and Southern Bank's consumer lending platform and the deployment of numerous technology applications from C1 Bank's C1 Labs Innovation Group.
We are hopeful by fully leveraging these factors, among others, we can achieve our goal of a sub 30% efficiency ratio over the next several years. Our efficiency ratio results for both the fourth quarter and full year of 2015 were significantly impacted by unusual items of non-interest income and non-interest expense. During the quarter just ended we have incurred $6.4 million in penalties for prepaying FHLB advances, $2.2 million of severance costs associated with the consolidation of the Stabilized Properties Group and approximately $1.0 million of acquisition-related and system conversion expenses, offset by $2.9 million of income from gains on sales of investment securities and $6.3 million of gains on sales of certain purchased loans.
For the full year of 2015, we incurred $8.9 million in penalties from prepaying FHLB advances, the $2.2 million of severance costs associated with the consolidation of the Stabilized Properties Group, approximately $6.7 million of acquisition-related and system conversion expenses and $1.0 million of software and other contract termination charges, offset by $2.3 million of tax-exempt income from bank-owned life insurance death benefits, $5.5 million of gains on sale of investment securities and $6.3 million of gains on sales of certain purchased loans.
In the financial tables accompanying our earnings release, we included a calculation of a core efficiency ratio effectively excluding the various items of income and expense we just discussed. We believe this calculation provides additional insight into the level of efficiency we are achieving.
Based on these calculations our core efficiency ratio was 32.3% for the fourth quarter of 2015 and 35.7% for the full year of 2015. We will incur additional unusual items of non-interest expense in future quarters, including non-interest expense related to the closing and core system conversions of acquisitions.
As for our two pending acquisitions, Community and Southern Bank and C1 Bank, we can expect acquisition-related and system conversion expenses to be incurred in each quarter of 2016. We expect both transactions will close in the first half of 2016 and we anticipate both core systems conversions will occur in the second half of 2016.
As we have previously discussed, we have been adding staff and taking other actions in recent years to prepare for the additional regulatory and compliance burden associated with exceeding $10 billion in total assets. We are pleased with our progress and preparations to date and we have detailed plans for further staff additions and other preparatory actions. All this will add additional non-interest expense in future quarters and years.
We expect our annualized additional compliance costs, including cost of staff additions, to increase compared to our annualized costs for such items in the quarter just ended by about $3.4 million in 2016, an additional $1.9 million in 2017 and another $0.3 million in 2018. Our guidance regarding an improving efficiency ratio in future years considered the impact of our ultimately exceeding $10 billion in total assets and the two pending mergers. But it does not consider the potential impact of any future acquisitions.
Let me provide updated guidance on asset quality and a few comments about growth in acquisitions. In our January conference call last year, we said we expected our 2015 net charge-off ratio for total loans and leases would not be significantly different from the range of net charge-off ratios we had experienced for total loans and leases in 2013, which was 26 basis points, and in 2014, which was 16 basis points. Our 2015 net charge-off ratio for total loans and leases came in at 0.17%, toward the lower end of our guidance range. We think our overall asset quality is even better than a year ago, so we are introducing a slightly lower guidance range of 10 to 25 basis points for our 2016 net charge-off ratio for total loans and leases.
In regard to growth in acquisitions, organic growth and loans, leases and deposits continues to be our top growth priority. And we have clearly demonstrated our ability to achieve substantial growth apart from acquisitions. M&A activity continues to be another focus for us as we believe M&A provides significant opportunities to augment our healthy organic growth. We will continue to be active in identifying and analyzing M&A opportunities, and we believe an active and disciplined M&A strategy will allow us to continue to create significant additional shareholder value.
Now, let me turn the call back to George Gleason.
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George Gleason, Bank of the Ozarks, Inc. - Chairman and CEO [6]
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We have traditionally reminded listeners in the January call that our first-quarter results are often affected by numerous seasonal factors. For example, lower post-holidays consumer transaction volume typically results in lower service charge income. Home sales are often lower in the first quarter, resulting in less mortgage income. Business disruptions due to winter weather are not uncommon. And our annual immune increase for health insurance and a majority of our salary increases take effect in the first quarter.
You should consider these seasonal factors in establishing your quarter-to-quarter estimates for 2016, which we expect to be another record-breaking year for Bank of the Ozarks.
That concludes our prepared remarks. At this time we will entertain questions. Let me ask our operator to once again remind our listeners how to queue in for questions. Operator?
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Questions and Answers
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Operator [1]
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(Operator Instructions) Michael Rose, Raymond James.
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Michael Rose, Raymond James & Associates, Inc. - Analyst [2]
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Just a couple of quick questions. Maybe we can just start off with a housekeeping question. The severance costs, if we are looking to back that out from the run rate, should we back that out, out of salaries and employee benefits? Or should we back it out of other operating costs?
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George Gleason, Bank of the Ozarks, Inc. - Chairman and CEO [3]
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Salaries and employee benefits.
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Michael Rose, Raymond James & Associates, Inc. - Analyst [4]
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Okay. So that gets to my second question, which is, what drove the big sequential decline in that line item this quarter?
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Greg McKinney, Bank of the Ozarks, Inc. - CFO and CAO [5]
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In part was the staff reductions. Our total FTE headcount at 12/31/2015 was 1,641 employees compared to 1,653 employees at September 30. And in addition, we had a lower accrual for our performance-based bonuses. We have been accruing, over the course of the year, assuming that we were going to hit 100% of those bonus targets. We did not achieve maximum performance objectives and one of the criteria for the bonuses. So that resulted in our earned bonuses being 94% of the maximum. And we had lower accrual in Q4 as a result of that.
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Michael Rose, Raymond James & Associates, Inc. - Analyst [6]
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Okay, that's helpful. And then if I can dig into the loan growth outlook for the year, obviously you raised it a decent amount, pipeline looked good.
George, can you talk a little bit about the deals that you are putting on the books now and those leverage levels you are using? And have you started to do larger deals because you've now exceeded the growth, the loan growth in the pipeline for nine consecutive quarters? I just want to get a sense for if you are moving upstream or if you are just seeing a lot more deal activity.
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George Gleason, Bank of the Ozarks, Inc. - Chairman and CEO [7]
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Yes and yes, on both respects. Every year, we have increased the size range of transactions that we are doing because our balance sheet is growing and our capital account is growing. And that has allowed us to look at larger transactions. So that has been helpful.
And yes, we are, as Greg alluded to in his comments, adding new customers, in some cases very substantial new customers that we've never done business with before, getting substantial volume there. And we are getting increased deal flow from existing customers. So the growth is coming from a variety of sources, which is very encouraging, very pleasing to us.
I think the reason that we are getting this growth from so many different fronts is that our reputation for being able to execute in a very effective, timely manner for our customers is growing. The market is becoming more aware of that. And that is, I believe, making us the lender of choice for many customers for their commercial real estate transactions. Our expertise in execution is definitely paying dividends for us.
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Michael Rose, Raymond James & Associates, Inc. - Analyst [8]
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Okay, great. And just one more for me. I know you gave us some of the pieces but I don't think you actually gave an initial NIM outlook for the year. Would you care to comment on that?
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George Gleason, Bank of the Ozarks, Inc. - Chairman and CEO [9]
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I would be happy to comment on that. And we didn't give a NIM outlook on that. And there are a variety of reasons for that. One is -- and I think part of the guidance that Tyler gave on the cost of interest-bearing deposits was predicated upon two Fed rate increases is what Tyler is modeling or Greg is modeling on the deposit cost side.
But frankly, with the volatility in the economy, I don't know whether we have zero Fed rate increases or four Fed rate increases next year, or if it's one, two or three. So there's considerable uncertainty in our minds about how that plays out. The rest of you guys may have it all figured out. If you do, please send me an email giving me the answer. But we are confused about that.
And then the magnitude of our growth over the course of next year -- we are working with a fairly wide range of outcomes there that start with a $3 billion minimum growth in non-purchased loans and leases. And then the two very substantial acquisitions, the CSB and C1 deal, have total assets of $6 billion, adding to our $10 billion -- almost -- balance sheet. And until we actually get in and do our final market pricing on those loans, valuations on those loans, we won't know exactly what the yields of those portfolios are.
So there's just -- there are so many variables at play there that we elected to not try to give precise guidance.
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Michael Rose, Raymond James & Associates, Inc. - Analyst [10]
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Understood. Thanks for taking my questions.
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Operator [11]
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Jennifer Demba with SunTrust.
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Jennifer Demba, SunTrust Robinson Humphrey - Analyst [12]
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Just wondering if you could get your specific thoughts on the commercial real estate cycle and where you think we are in that cycle at this point. I think that during the last earnings call, in October, you said we could be coming towards the end but you didn't have any real conviction, I don't think, on that point of view. Can you just give us more color?
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George Gleason, Bank of the Ozarks, Inc. - Chairman and CEO [13]
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Well, the hazard of making statements like that is sometimes they get interpreted differently than you intended. I think exactly what I said was not that we were coming to the end or could be coming to the end of the real estate cycle but that we may be in the later stages of the real estate cycle.
So what I can tell you is that we are seeing tremendous transaction volume. We are underwriting that transaction volume very thoroughly and very carefully. We are paying tremendous attention to the economics and competitive market data on every significant transaction we are doing. And the transactions we are doing, we believe, have exceptional economic viability. And if we didn't think the supply/demand metrics in particular markets justified particular projects, we certainly wouldn't be approving them.
And we are being very conservative about that because there is a lot of turbulence and uncertainty about the economy and where we are in the real estate cycle. So, caution is merited. Really, extreme caution is merited, I think, given the uncertainty about the economy, globally and nationally.
So, we are doing things that make sense. And as I've said in my prepared remarks, our focus for several years has been trying to find the best projects in a massive universe of projects that are getting done out there, focus on the best sponsors -- and by that, I mean sponsors that have significant proven capability to manage development and to not only produce them but to manage that through a variety of cycles and sponsors that have very strong balance sheets and very strong liquidity, and then to be very low leverage in these transactions.
And I know some lenders trying to grasp yield are going to hire leverage. We are going in the opposite direction and willing to absorb a little attrition and yield to be more defensively positioned. And I mentioned that at September 30 our average loan to cost in our construction book with reserves was 51% loan to cost, and our average loan to appraised value was 43%.
To put that in historical perspective, those numbers are 20 points or more lower than they were in 2007. So, we are being very defensive from a leverage position and we are using very defensive loan structures.
For example, if we are doing a multiphase project, we may have very rigorous performance criteria, either pre-leasing or sales criteria, on the early phases of the project for you to get to the subsequent phases, so that we make sure that our developers don't get ahead of themselves in developing product that there's no market for and end up with too much supply.
So I think all those things position us extremely well for a continued boom in the real estate cycle or a bust in the real estate cycle. And that's what we are trying to underwrite for is we will be fine if things get better, we will be fine if things get worse, because I don't know what the exact timing of a turn in the real estate cycle is or the exact timing of a recession.
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Jennifer Demba, SunTrust Robinson Humphrey - Analyst [14]
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Can I ask one follow-up? Has the competitive landscape for lending in these projects -- has it changed at all in the last three to six months?
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George Gleason, Bank of the Ozarks, Inc. - Chairman and CEO [15]
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Not in any material sense. There is a continuous ebb and flow of competitors in and out, and what different folks are thinking at different times. But there has not been any material change in that landscape.
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Jennifer Demba, SunTrust Robinson Humphrey - Analyst [16]
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Thanks so much for the color.
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Operator [17]
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Matt Olney, Stephens.
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Matt Olney, Stephens Inc. - Analyst [18]
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Given the uncertainty of the national economy that you keep bringing up, I'm curious which markets today you feel still have strong fundamentals that would allow you to continue some growth. And within that closed but unfunded balance, any commentary you can give us as far as the mix by geography?
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George Gleason, Bank of the Ozarks, Inc. - Chairman and CEO [19]
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Well, the mix by geography is gravitating more toward New York and California. I haven't seen the data yet but my guess is that New York probably jumped over Arkansas in the total geographic distribution of loans at 12/31. At September 30, Arkansas was $1.28 billion of funded loans, and New York was about $100 million less at $1.174 billion. And I would guess those numbers flipped over in the quarter just ended. I would guess that California, which I think was sixth or seventh in our, I guess, fifth among our states and loans, possibly pushed up into fourth position, surpassing the Carolinas.
And clearly, the economies of metro New York City area and a number of the California MSAs are very vibrant, and a lot of things are going on.
There are a number of other very good economies. We continue to see good activity in the Dallas area. Austin is another good economy. Denver is a very good economy. Seattle, another very good economy.
So there are a lot of markets that are enjoying very favorable economic results for this period of time. And as I said in response to Jennifer's question, we are very thoroughly underwriting and stress testing supply/demand metrics, rental rate metrics, sales metrics in all these markets where we are doing business. And I should also probably throw Florida in there as a state where we are seeing a lot of activity.
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Matt Olney, Stephens Inc. - Analyst [20]
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Okay. That's helpful, George. And as a follow-up, I'm curious on your -- a bit of thoughts on capital. Obviously, you raised capital in December. And it looks like you deployed a pretty good chunk of that during the fourth quarter. So I'm curious what the scenarios are or what we could see additional actions to bolster tier 1 or tier 2 capital sometime in 2016.
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George Gleason, Bank of the Ozarks, Inc. - Chairman and CEO [21]
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Yes, our calculation is that we've still got somewhere around $1.3 billion, $1.4 billion of growth capacity in our balance sheet with existing capital, as of December 31. And that, of course, is based on the fully phased-in January 1, 2019 BASEL III capital standards including the capital conservation buffer.
So fully phased in with the buffer, we've still got $1.3 billion to $1.4 billion of growth capacity. Our needs for additional capital in the future will be guided by the same factors that drove our decision last time. And that is, are we going to see another acceleration in loan growth that would utilize that capital cushion that we have now and get us closer to our standards? And we won't get all the way down to our standards before we would take action to make sure we maintain plenty of capital.
The capital issuance we did in Q4 was heavily debated internally within our Company. There was a camp of our officers that thought that that would be a better choice, a camp that thought that equity would be the preferred choice, common equity. And after some discussion, we elected to do the capital raise through common equity because we felt like we were getting very good execution on the transaction.
I would guess that with that done, the next time we need to tap capital markets that you would probably see that done with tier 2 capital in the form of subordinated debt is the most likely thinking on that here. But we have no precise times or plans for that. And again, that creation of additional capital would be dependent and the choice of means for that would be dependent upon the circumstances at that time.
Sounding like the Fed, aren't I? We are data dependent down here. But that's our current thinking on that subject.
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Matt Olney, Stephens Inc. - Analyst [22]
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Okay. Thank you, George.
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Operator [23]
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(Operator Instructions) Joe Gladue, Merion Capital Group.
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Joe Gladue, Merion Capital Group - Analyst [24]
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Let me follow up a little bit on the geography question. On the last conference call you mentioned that you still weren't seeing a whole lot of stresses in the Texas markets. Just wondering if you would update that, if anything changed.
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George Gleason, Bank of the Ozarks, Inc. - Chairman and CEO [25]
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Well, that continues to be the case. And obviously, the market in Texas where we have some substantial business that would probably be the most interesting to talk about is Houston. And I actually was on the phone with our RESG guy in Houston and our South Texas Community Bank Division President in the last couple of days, just asking about specific loans and progress in leasing and sales and so forth on specific assets we have in the market, and then getting a general update on market conditions.
And I'm very pleased to report that, as we reported last quarter, we are really not seeing any stress in our portfolio down there as a result of the oil and gas price declines and the impact that that is having in a variety of markets.
The good news about our portfolio there is predicated in large part on the fact that we really have no meaningful direct exposure to oil and gas through either exploration or development companies or oil service companies, just no meaningful direct amounts at all. Nor do we have significant indirect exposure in the form of those guys being tenants in buildings that we have the financing on and so forth.
So our exposure to the oil and gas economy is really at the macro level, how is that affecting just the general demand for apartments, condos, office, retail space in affected markets, including Houston.
And the interesting thing about Houston -- certainly, there have been a lot of oil and gas industry layoffs there in the last year. And no doubt there will continue to be some, given where oil and gas prices are. When I left the house to come to work this morning, I think WTI had broken $30 and was at a $29-something price. So clearly, that's not good for Texas.
But if you look at the Houston employment data, the last data I looked at was from the October month-end data, job growth in the Houston MSA had broken 3 million jobs for the first time ever. And jobs in Houston were up about 1.1%, I believe. Maybe I am wrong on that; it's close. They were up roughly 1% on the year-over-year basis.
So even with all of the loss of jobs in exploration and development, oilfield services company, Houston has managed to eke out positive job gains at least through October. And the projections in October were that there would be more positive job gains in November and December, followed by normal Houston cyclical downturn in jobs on an unannualized basis in January and February and then a resumption in job growth.
So that 1%, plus or minus, job growth compares to numbers that were 3%, 4% and 5% a couple of years ago. But it's still positive job growth. And I think the prevailing sentiment is that that we will be in that 0 to 1% job growth rates down there probably this next year. If the oil and gas situation gets even worse then maybe we've got some modest brackets around job growth numbers. But all in all, that market is doing pretty well, considering the adversity there.
And there are multiple dynamics at work there. Part of it is you've got a lot of job losses on the upstream side, in the exploration, production and servicing business. But you are having -- and that's on the west side of Houston. On the east side of Houston, where the chemical companies are, you are having significant jobs created because of the lower price of oil and the benefit to the downstream side of that equation.
And then, despite the fact that people are probably going to talk less about it in 2016 than they did in 2015, the Houston economy is much more diversified now than it was historically. And that's resulting in job creation.
So we are looking at it and feeling really very good about where we are in that market and the projects we have in that market.
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Joe Gladue, Merion Capital Group - Analyst [26]
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Okay. Thank you and just one other question -- the estimate of the impact of the Durbin amendment, the $5.35 million -- I just want to make sure that that wouldn't include any impact on the revenues of the two pending acquisitions, does it?
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George Gleason, Bank of the Ozarks, Inc. - Chairman and CEO [27]
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No, it does not include that. So to the extent they have got additional -- we get additional benefits from that, that number would be bigger.
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Joe Gladue, Merion Capital Group - Analyst [28]
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Okay, thank you. That's it for me.
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Operator [29]
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Brian Martin, FIG Partners.
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Brian Martin, FIG Partners, LLC - Analyst [30]
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George, can you just talk about the $1 billion in growth this quarter, just break out by your five or six growth buckets there, just the real estate specialties and what not?
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George Gleason, Bank of the Ozarks, Inc. - Chairman and CEO [31]
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Well, clearly Dan Thomas, who runs Real Estate Specialties Group for us and is, of course, our Vice-Chairman of the Board, Dan and his team were the lion's share of that growth. I don't actually have the breakdowns, but Community Banking contributed a pretty nice number. I think they were $100 million plus of the growth in the quarter. And again, I've seen those numbers but I've seen a lot of number since I saw them, so I could be off on that. But I think they were $100 million plus. But clearly, the lion's share of it was Real Estate Specialties Group.
It was broad-based across product types. Our residential 1 to 4 family loans actually went up about $23 million. Our CRE loans went up about $202 million. Our construction and land development loans went up about $402 million. Agri credits went up $20 million. Multifamily went up about $143 million. C&I dropped about $20 million. Consumer and leasing were ready much unchanged. And other loans went up about $315 million or so. So it's pretty broad-based contributions based on product type and different units in the Company.
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Brian Martin, FIG Partners, LLC - Analyst [32]
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Okay. And then just the seasonality you mentioned as far as first quarter -- in the past it seemed like you guys had the seasonality on the loan side and then more recently it sounded as though that was less likely. Does that seasonality comment also apply to the loan growth in the first quarter? Do you still expect that to be a little bit lower than the other quarters?
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George Gleason, Bank of the Ozarks, Inc. - Chairman and CEO [33]
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I appreciate you listening closely and noted that I omitted loan volume from the seasonality factors. And the reason that I did that -- obviously, with this massive is probably not an overstatement volume of loans that we've got close that are not funded, which is what, Greg? 5 -- ?
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Greg McKinney, Bank of the Ozarks, Inc. - CFO and CAO [34]
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$5.8 million.
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George Gleason, Bank of the Ozarks, Inc. - Chairman and CEO [35]
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-- $5.8 million now. Those loans are going to fund up on a predictable manner, and they are already closed. And they're in the pipeline.
Now, I think there will be some seasonal impacts. And part of that is people who do large transactions and complex transactions tend to take off at the end of the year. So there's always a bit of a lull to some degree in the pipeline of new deals that flow in because everybody sends you everything they've got before they go on a Thanksgiving or Christmas or New Year's vacation. And then you have a little lull of a few weeks after they come back to work before they get the next deals queued up.
So there is an element of that that affects closings and initial funding on loans. And then, to the extent that adverse winter weather affects loans in certain markets, so you have weather conditions that affect the progress of construction that will slow your construction advances.
So I say all that. I think the bottom line is there will still be some seasonal impacts on loan volume. But because of the significant volume of closed unfunded loans that have been closed over the last six quarters that are funding up, that seasonal impact will be more muted than in past years, where we had a lower volume of closed unfunded loans that we were funding up upon.
So it is still somewhat of a factor, I think, less than in the past.
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Brian Martin, FIG Partners, LLC - Analyst [36]
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Perfect. Thank you for that. And then just maybe you talked about the reallocation from the stabilized property group to other areas. Can you point to any -- is that markets or just areas you are focused on as far as that reallocation goes?
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George Gleason, Bank of the Ozarks, Inc. - Chairman and CEO [37]
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Yes. We are looking to increase our RESG staff in New York, simply because the RESG staff has been much more effective in producing quality volume and meeting our standards than the Stabilized Properties Group has. We are also expecting next month to open a RESG office in San Francisco. We are looking at other staff additions to RESG and existing offices and we are making some Community Bank additions in Charlotte and certain other markets where we believe that there's significant opportunities for growth.
So it is just a look that we took to determine who was not producing to our standards on volume, quality and price, and could we either remedy that insufficiency or did we need to lose those resources and redeploy those resources into markets and products, business segments where we felt like we could achieve much greater productivity.
I view myself as a coach with a professional team. And my annual aspiration is to win the national championship. And if I've got -- since it's basketball season now, if I've got a guy that's giving me 8 points a game in 12 minutes of playing time, I'm thinking that's not what I need, I need 12 points from that guy in 12 minutes of playing time and I need better defense at the same time and more hustle and better attitude, then you know you've got to make the player trade that you need to make to put a championship team on the championship course.
And some of the changes we made were wonderful individuals who were working really hard and trying to do a good job; they just were not getting the ball into the basket for us. And we've got to have guys that perform at a high level if we are going to put up the high-level results that you guys expect.
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Brian Martin, FIG Partners, LLC - Analyst [38]
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Perfect. Okay, and just the last things -- maybe one for Greg on the tax rate, if you could just give any sense on that? And then maybe just one last one -- George, you have talked in the past or I guess just the regulatory guidelines, if you will, on commercial real estate concentrations maybe not being a big issue, given the diversity within your book. Does that still hold? Or I guess, any closer look at the concentration of commercial real estate? Or just any thoughts on that would be helpful.
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George Gleason, Bank of the Ozarks, Inc. - Chairman and CEO [39]
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We continue to believe that the conservatism with which we underwrite commercial real estate loans, the very low leverage based on loan-to-cost and loan-to-value basis that we do that, the diversification of the portfolio across a number of geographies, really 41 states, the diversification of the portfolio by product type across all of those geographies and the intense servicing that we do of assets post-closing so that we are monitoring and managing those assets on an ongoing, continuous basis while they are on the books -- we believe that the strength of that whole credit culture and process is such that it gives our regulators substantial comfort that our portfolio is much less risky than the average bank's CRE portfolio and that that gives us a fair degree of latitude.
We understand that to continue to enjoy that privilege means we've got to continue to be very conservative. We've got to continue to be very expert. We've got to continue to underwrite with extreme attention to detail. We've got to continue to close and document. We've got to continue to service these loans with extreme attention to detail and make sure that we know what we are doing and how they are going to work out, hence the focus on best projects, best sponsors, low-leverage transactions. So all that is just -- it's part of an overall holistic culture that gives us comfort and, I think, gives our regulators and obviously our shareholders comfort that we have a lot of expertise in what we're doing and are going to do it in a very safe and defensive manner.
Greg, do you want to comment on the tax rate?
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Greg McKinney, Bank of the Ozarks, Inc. - CFO and CAO [40]
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Yes. I'll be brief, Brian. But when you look at the tax rate, the biggest drivers that may change that would be really in the tax-exempt income, primarily the municipal bonds we've got and the BOLI that we've got. Those earnings are tax-exempt. With the shrinkage of that municipal bond portfolio as a percentage of our total assets, just mainly through the significant growth in our loan portfolio, a much greater percentage of our asset base and our earnings on those assets was taxable today than it might have been two, three, four, five quarters ago or more. So as long as that's the case, the tax rate will be at or have a tendency to work its way up just slightly over the course of 2016.
On the flipside, if opportunities present themselves in the bond markets, if we were to further leverage our balance sheet and add new BOLI, both of those types of transactions would have the tendency to mitigate any increase or potentially allow that tax rate to work its way down just slightly.
So I don't see a lot of movement in that rate as we look into 2016. But again, to the extent that we see opportunities either to substantially grow our balance sheet, opportunities within the municipal bond market or BOLI transactions, those would certainly have some impact on our tax rate on a go-forward basis.
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George Gleason, Bank of the Ozarks, Inc. - Chairman and CEO [41]
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But Greg, your thought is that the bias is slightly upward?
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Greg McKinney, Bank of the Ozarks, Inc. - CFO and CAO [42]
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Slightly upward; that is correct, yes.
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Brian Martin, FIG Partners, LLC - Analyst [43]
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And slightly upward from the fourth quarter, Greg, or just on the annual number?
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Greg McKinney, Bank of the Ozarks, Inc. - CFO and CAO [44]
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More so from the annual number. The fourth-quarter number, though, too, was probably a little less so than on the fourth quarter number. But yes, up on both.
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Brian Martin, FIG Partners, LLC - Analyst [45]
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Okay. Thanks very much.
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Operator [46]
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I see no further questions at this time.
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George Gleason, Bank of the Ozarks, Inc. - Chairman and CEO [47]
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All right. Thank you very much. We appreciate you joining the call. There being no further questions, we will conclude the call. We look forward to talking with you again in about 90 days. Have a good day. Thank you.
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Operator [48]
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And thank you. Ladies and gentlemen, this concludes today's conference. We thank you for participating and you may now disconnect.
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