Q2 2017 Bank of the Ozarks Earnings Call

Jul 12, 2017 AM CDT
OZRK.OQ - Bank of the Ozarks
Q2 2017 Bank of the Ozarks Earnings Call
Jul 12, 2017 / 03:00PM GMT 

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Corporate Participants
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   *  George G. Gleason
      Bank of the Ozarks - Chairman, CEO & President
   *  Greg L. McKinney
      Bank of the Ozarks - CFO and CAO
   *  Tim Hicks
      Bank of the Ozarks - Chief Administrative Officer and Executive Director of IR
   *  Tyler Vance
      Bank of the Ozarks - COO & Chief Banking Officer

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Conference Call Participants
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   *  Blair Craig Brantley
      Brean Capital, LLC, Research Division - SVP and Senior Equity Research Analyst
   *  Brian Joseph Martin
      FIG Partners, LLC, Research Division - VP and Research Analyst 
   *  Catherine Fitzhugh Summerson Mealor
      Keefe, Bruyette, & Woods, Inc., Research Division - MD and SVP
   *  Jennifer Haskew Demba
      SunTrust Robinson Humphrey, Inc., Research Division - MD
   *  Joseph Gladue
      Merion Capital Group LLC, Research Division - Research Analyst
   *  Matthew Covington Olney
      Stephens Inc., Research Division - MD
   *  Michael Edward Rose
      Raymond James & Associates, Inc., Research Division - MD, Equity Research
   *  Peyton Nicholson Green
      Piper Jaffray Companies, Research Division - MD and Senior Research Analyst
   *  Stephen Kendall Scouten
      Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research
   *  Timur Felixovich Braziler
      Wells Fargo Securities, LLC, Research Division - Associate Analyst

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Presentation
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Operator   [1]
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 Good day, ladies and gentlemen, and welcome to the Bank of the Ozarks Second Quarter 2017 Earnings Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded.

 I would now like to introduce your host for today's conference, Mr. Tim Hicks, Chief Administrative Officer and Executive Director of Investor Relations. Sir, you may begin.

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 Tim Hicks,  Bank of the Ozarks - Chief Administrative Officer and Executive Director of IR   [2]
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 Good morning. I am Tim Hicks, Chief Administrative Officer and Executive Director 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.

 During today's call and in other disclosures and presentations, we may make certain statements about our plans, estimates, strategies and outlook that are forward-looking statements. These statements are based on management's current expectations concerning future events that, by their nature, are subject to risks and uncertainties. Actual results and future events could differ possibly materially from those anticipated in our statements and from historical performance due to a variety of risks and other factors.

 Information about such factors as well as GAAP reconciliations and other information on non-GAAP financial measures we discuss is included in today's earnings press release and in our 10-K, 10-Qs and various other public filings and investor materials. These are all available on our corporate website, bankozarks.com, under Investor Relations. The company disclaims any obligation to update or revise any forward-looking statement based on the occurrence of future events, the receipt of new information or otherwise.

 Finally, the company is not responsible for and does not edit or guarantee the accuracy of our earnings teleconference transcripts provided by third parties. The only authorized live and archived webcasts and transcripts are located on our website.

 Let me turn the call over to our Chairman and Chief Executive Officer, George Gleason.

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 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [3]
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 We are very pleased to report our excellent second quarter results, which include our seventh consecutive quarter of record net income and other favorable financial results as well as a number of significant strategic accomplishments. My comments today will focus primarily on strategic matters before Tim, Greg and Tyler speak on the financial results.

 First, on June 26, we completed the previously announced merger of our holding company into our bank, with the bank continuing as the surviving corporation. We expect this corporate reorganization to contribute to future efficiency by eliminating redundant corporate infrastructure and the associated administration, accounting and duplicative federal regulatory oversight. Bank of the Ozarks, the surviving entity, continues to use our OZRK ticker symbol and the same CUSIP number, as previously used by Bank of the Ozarks, Inc.

 Second, on May 31, we closed a secondary common stock issuance resulting in net proceeds of $299.7 million. This increased our already robust regulatory capital ratios and provides capital for significant future growth. As most of you know, we expect to file our first Dodd-Frank Act Stress Test, or DFAST, submission in July 2018 based on our year-end 2017 financials. As part of DFAST, we will project our expected growth and performance under 3 scenarios known as the base case, adverse and severely adverse scenarios over a period of 9 quarters. With limited exceptions, you cannot include projected future capital raises in your DFAST projections. Based on our expected significant growth in the base case scenario, we determined that we would need to augment our regulatory capital ratios during 2017 to support the projected growth in 2018, 2019 and the first quarter of 2020. Our May 31 capital raise should provide that needed capital.

 Third, for some time now, we've been evaluating holding additional on-balance sheet liquidity to provide another tool in managing our liquidity position. During the quarter, we increased our investment portfolio by a net $631 million. This resulted from our purchasing approximately $728 million of highly liquid, short-duration government agency mortgage-backed pass-through securities. Because of the high quality and short duration of these securities, they yield only about 2%. So their purchase will be diluted to some of our performance ratios such as net interest margin and return on average assets. On the other hand, their purchase will be slightly accretive to other performance ratios such as our efficiency ratio. However, this balance sheet adjustment is not so much about the small incremental earnings as it is about the significant liquidity that purchase bonds will provide, including their monthly cash flow. These securities have a 20% risk rating for regulatory capital, so their purchase did not utilize significant capital. This gave us a very good liquidity position at June 30, 2017, including cash of $791 million and approximately $5.72 billion in other available secondary sources of liquidity, including unpledged investment securities.

 Fourth, our Forms 10-Q and 10-K reports in recent years have discussed 2 legal actions related to overdraft fees and the posting order of payments. During the quarter just ended, we reached a settlement in principle with Plaintiff's counsel on a settlement amount, and attorneys for both parties are now negotiating final settlement documents. The agreed-upon settlement amount has been fully provided for in our financial statements as of June 30, 2017. This accounted for $750,000 of our other operating expenses in the quarter just ended, in addition to amounts accrued in prior years. This matter originated in 2011 and has been the subject of numerous hearings and appeals. We look forward to having this resolved in the near future.

 Fifth, for years, we have been among the nation's top-performing banks. As we continue to grow, we've always focused on developing our products and infrastructure to allow us to continue to achieve high performance even as we become a much larger bank. We have previously discussed our increased focus on developing technology-based products and solutions through our Ozark Labs, which we think will be critical to our success in this rapidly evolving retail banking environment. We have also talked about our focus on expanding and enhancing our infrastructure for information technology, information systems, cybersecurity, business resilience, enterprise risk management, internal audit compliance, BSA/AML monitoring, training and other important areas as well as expanding our human and physical infrastructure to serve low to moderate income and majority and minority markets and customer segments. All these initiatives are important elements in our preparation for significant further growth, and we have already made significant progress. These initiatives have been and will continue to be an important emphasis for us throughout 2017 and into 2018.

 Sixth, as most of you know, Real Estate Specialties Group, or RESG, has been our largest growth engine for earning assets for many years. We expect it will continue to be our largest growth engine and will continue to increase its volume of originations and growth. However, for several years, we have been working on various initiatives to achieve greater contributions to our growth in earning assets from our other lines of business and product types other than commercial real estate. You can see the progress we are making in this regard in the quarter just ended, in which 56% of our growth in non-purchased loans and leases came from our other loan and lease teams. We continue to expand these other lines of business.

 Finally, on June 23, we migrated from the Russell 2000 to the Russell 1000. Some of you probably noticed that this transaction -- transition created several days of volatility in our stock price and trading volume. We are pleased that our continued growth led to our increased market capitalization, which resulted in our graduating to the Russell 1000. In addition to all of this, our second quarter results included some exceptional financial performance. I will let the rest of the team tell you about that.

 Let me turn the call back to Tim Hicks who, you may have noticed, has a new title, Chief Administrative Officer and Executive Director of Investor Relations. The creation of this new position and Tim's promotion and expanded role reflect both his accomplishments and our efforts to further increase the depth and breadth of our senior management team. Congratulations, Tim.

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 Tim Hicks,  Bank of the Ozarks - Chief Administrative Officer and Executive Director of IR   [4]
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 Thank you, George. Our $20.1 billion in total assets at June 30, 2017, was a 63% increase from June 30 last year. This balance sheet growth translated into excellent income growth. Our net income for the quarter just ended was a record $90.5 million, a 66% increase from the second quarter of 2016. Our diluted earnings per common share of $0.73 for the quarter just ended were a 22% increase compared to the second quarter of 2016. In the quarter just ended, the funded balance of our non-purchased loans and leases grew $808 million, and our unfunded balance of closed loans grew another $625 million. This unfunded balance of closed loans was a record $11.9 billion at June 30, 2017, which will be instrumental in achieving our loan growth goals in the remainder of 2017, 2018 and early 2019.

 RESG accounted for about 44% of our growth in the funded balance of non-purchased loans and leases in the quarter just ended, and our other loan and lease teams accounted for 56% of the growth. As George mentioned earlier, we expect RESG will continue to be our largest growth engine, but we are pleased by the positive momentum and contribution from our various other loan teams.

 At June 30, 2017, the RESG portfolio accounted for 68% of the funded balance and 93% of the unfunded balance of our total non-purchased loans and leases. At quarter end, our average loan to cost for the RESG portfolio was a very conservative 49.1%, and our average loan to appraised value was even lower at just 42.0%. The extremely low leverage of this portfolio exemplifies our very conservative credit culture and is one of the many reasons we have such confidence in the quality of our loan and lease portfolio. Given the growth in our customer base, our robust pipeline of transactions currently in underwriting and closing and our largest-ever unfunded balance of closed loans, we continue to expect 2017's growth in the funded balance of non-purchased loans and leases to be between $3.1 billion and $4 billion, although it is not likely to be at the top end of that range. As we said in our January and April calls, we expect growth in non-purchased loans and leases in the second half of 2017 to be better than the $1.4 billion of growth in the first half of 2017.

 Let's turn to capital. As George mentioned, during the second quarter, we completed the issuance and sale of common stock for net proceeds of $299.7 million. We will continue to monitor capital market conditions, capital formation alternatives and our capital position, including our expectations for growth over the relevant 9-quarter DFAST time horizon, all with the goal of effectively managing our capital position for the maximum benefit of our shareholders while always maintaining well-capitalized status.

 Organic growth of loans, leases and deposits continues to be our top growth priority, and we have demonstrated our ability to achieve substantial growth apart from acquisitions. With that said, we believe M&A provides significant opportunities to augment our robust organic growth. Our last 15 acquisitions have been triple-accretive, being accretive to book value per share and tangible book value per share at closing and accretive to earnings per share in the first 12 months following closing. We expect to continue to be disciplined in our acquisition strategy and to apply this triple-accretive test to future opportunities. We remain active in identifying and analyzing M&A opportunities, and we believe this strategy will help us create significant additional shareholder value over time.

 Let me turn the call over to our Chief Financial Officer and Chief Accounting Officer, Greg McKinney.

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 Greg L. McKinney,  Bank of the Ozarks - CFO and CAO   [5]
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 At the company, we are focused on 3 disciplines: net interest margin, efficiency and asset quality. First, let me discuss net interest margin. In the quarter just ended, our net interest income was a record $202.1 million, and our net interest margin of 4.99% increased 11 basis points from the first quarter. In recent calls, we have mentioned that we have recently focused more on our core spread than our net interest margin. In the quarter just ended, our yield on non-purchased loans and leases increased 16 basis points to 5.42% while our cost of interest-bearing deposits increased 9 basis points to 0.67%, resulting in a 7 basis point increase in our core spread and continuing an improving trend over the last 5 quarters. Increases in LIBOR rates and the Federal Reserve's Fed fund's target rate have contributed, among other factors, to this improvement. As a result of our robust level of loan originations in the quarter, we had $47.1 million in net deferred credits at June 30, 2017; meaning, we had $47.1 million more in unamortized deferred loan origination fees than unamortized deferred loan origination costs. This, along with the $123.9 million valuation discount on our purchased loans at June 30, 2017, has favorable implications for future earnings.

 Let me switch to efficiency. Our efficiency ratio has been among the top decile of the industry every year for 15 consecutive years. In the quarter just ended, our efficiency ratio was an excellent 35.3% and, for the first 6 months of 2017, was 35.2%. While our efficiency ratio will vary from quarter-to-quarter, we have stated in recent calls that we expect to see a generally improving trend in our efficiency ratio in the coming years. There are several key factors, among others, needed to accomplish our long-term efficiency goals. First, we expect to ultimately utilize a large amount of the excess capacity of our extensive branch network, tapping billions of dollars of additional deposits through existing offices. This ability to achieve substantial deposit growth with limited additions of overhead has favorable implications for our efficiency ratio. Second, we expect to achieve further efficiencies over time from our ongoing deployment of technology applications from Ozark Labs.

 As George previously mentioned, as a larger and growing organization, we are constantly increasing our expenditures, building infrastructure in a number of important areas. The increase in cost for such enhanced infrastructure will be a headwind in our efforts to improve our efficiency ratio. However, we believe that our excellent organic growth will generate sufficient additional revenue for us to achieve both our important infrastructure enhancements and our long-term efficiency goals. Our guidance regarding an improving efficiency ratio in future years does not consider the potential impact of any future acquisitions.

 Our asset quality metrics through the second quarter are some of our best as a public company. For example, our annualized net charge-off ratios during the quarter just ended were 3 basis points for non-purchased loans and leases and 5 basis points for total loans and leases. At quarter end, excluding purchase loans, our nonperforming loans and leases as a percent of total loans and leases were just 11 basis points. Our nonperforming asset as a percent of total assets were just 23 basis points, and our loans and leases past due 30 days or more, including past due nonaccrual loans and leases, to total loans and leases were a record-low 0.15%. This was our sixth consecutive quarter of reporting a record-low past due ratio. These ratios reflect our long-standing commitment to conservative underwriting standards and excellent asset quality, which have resulted in our having asset quality consistently better than the industry as a whole. In our almost 20 years as a public company, our net charge-off ratio has averaged about 35% of the industry's net charge-off ratio, and we have beaten the industry's net charge-off ratio in every year. Our outperformance has been even better recently, as evidenced by the fact that our net charge-off ratio was just 13% of the industry's net charge-off ratio last year and just 10% of the industry's net charge-off ratio for the first quarter of this year.

 I want to make one final comment regarding our effective tax rate. During the second quarter, our effective tax rate increased due to our true-up of state income tax portion of factors. These adjustments were somewhat larger than normal due to our increased lending activity in higher income tax rate states to municipalities, principally New York state and New York City. We have recently enhanced our procedures to ensure our quarterly accruals are more precise going forward. We expect our tax rate for the remainder of this year to be in a more normalized range of 36% to 37%. Of course, significant changes in the mix of taxable and tax-exempt earning assets and changes in the mix of assets between states could affect the tax rate actually incurred.

 Let me turn the call over to our Chief Operating Officer and Chief Banking Officer, Tyler Vance.

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 Tyler Vance,  Bank of the Ozarks - COO & Chief Banking Officer   [6]
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 In regards to liquidity, we have long expected that we could accelerate deposit growth that's needed to fund our loan and lease growth. Our experience in recent years has validated that expectation. At least monthly and more often as needed, we update a comprehensive 36-month projection of our expected loan fundings, loan paydowns and other sources and uses of funds. These detailed monthly projections of needed deposit growth provides a goal for our deposit growth strategies. This has proven to be a very effective process.

 Currently, we have 41 offices in 28 cities in spin-up mode offering various deposit specials along with an enhanced level of marketing activity. Our branch network of approximately 242 deposit offices continues to have substantial untapped capacity. And we believe that capacity is sufficient to fund our expected loan and lease growth over the next several years. Planned de novo branch additions and possible future acquisitions should provide additional deposit growth capacity as needed for the future.

 At June 30, 2017, our total deposits were $16.2 billion, which was a $528 million increase from the previous quarter end. Because of our significant growth in organic deposits in the quarter just ended, we decreased our volume of broker deposits by $434 million from $2.00 billion at March 31, 2017, to $1.57 billion at June 30, 2017. That's a decrease from 12.8% of total deposits to 9.7% of total deposits. Of course, we're not subject to any regulatory limitations on our volume of broker deposits, and our internal policy calls for a 15% limit, which we are well below. But we are nonetheless pleased to see our percentage of broker deposits continue its recent downward trend. As a result of this shift in mix, our non-broker deposits grew a healthy $962 million in the quarter just ended.

 We consider net growth in core checking accounts as one of our most important deposit metrics. We achieved excellent organic growth in our number of net new core checking accounts with a record 6,339 net accounts added in the second quarter of 2017, bringing our total net new core checking accounts to 10,843 for the 6 months of 2017. Our excellent checking account growth has been an important contributor to our record service charge income of $11.8 million for the quarter just ended.

 Let me remind you that the Durbin Amendment started impacting our service charge income as of July 1, and we estimate it will result in a pretax reduction in service charge income of about $1.95 million per quarter based on our most recent transaction volume available.

 As Greg mentioned, our cost of interest-bearing deposits increased 9 basis points in the quarter just ended compared to the first quarter of 2017. Given our expectation that our growth in non-purchased loans and leases in 2017 will range between $3.1 billion and $4 billion, we expect to continue to grow deposits significantly this year. Based on this, combined with possible further increases in the Fed fund's target rate during the remainder of 2017, we expect additional increases in our cost of interest-bearing deposits this year. Our goal for 2017 is to hold the rate of increase in our cost of interest-bearing deposits below and hopefully well below the rate of increase in our yield on non-purchased loans and leases. As previously mentioned, we achieved that goal in the quarter just ended as our yield on non-purchased loans and leases increased 16 basis points compared to the 9 basis points increase in our cost of interest-bearing deposits.

 Now let me turn the call back to George.

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 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [7]
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 Next Monday, we will celebrate our 20th anniversary as a public company. Over those 20 years, we've grown from 13 offices with $309 million in total assets to 251 offices with over $20 billion in total assets. Our shareholders benefited greatly from our constant pursuit of excellence, as evidenced by our 22.5% compounded annual total return to shareholders over that 20-year period. Such exceptional and sustained results can only be achieved by an exceptional team. I want to thank our 2,459 employees, who, I believe, are among the best in the industry, for their hard work and great accomplishments as we celebrate our 20th anniversary as a public company. Well done. We look forward to continuing this success for decades to come.

 That concludes our prepared remarks. At this time, we will entertain questions. Let me ask our operator, Amanda, to once again remind our listeners how to queue in for questions. Amanda?

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Questions and Answers
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Operator   [1]
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 (Operator Instructions) Our first question comes from the line of Joe Gladue of Merion Capital Group.

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 Joseph Gladue,  Merion Capital Group LLC, Research Division - Research Analyst   [2]
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 And I guess, first off, I wanted to touch on some of the expense growth, I guess, particularly in the, I guess, the other noninterest expense category, which looks like it was up roughly 19% versus the first quarter. Wondering how much of that might be onetime related to the holding company activity and what else might be pushing that up.

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 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [3]
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 Well, as we commented -- as I commented in my prepared remarks, there was about $750,000 of cost in there related to the agreement on a settlement amount for the long-standing since 2011 deposit service charge lawsuit. So that was one unusual factor. There were some lesser sums related to the bank holding company merger, but those were not a significant-enough amount for us to quantify. As Greg mentioned in his remarks, we're continuing to build out this infrastructure. A good example of that is at March 31, we had 2,343.5 full-time equivalent employees. That number of employees had increased 51 FTEs by June 30, 2015 (sic) [June 30, 2017] to 2394.5 FTEs. And that reflects both a build-out of the various elements of risk management infrastructure we've talked about for several quarters now as well as a build-out of staff in our revenue-producing units from RESG, to community banking, to leasing. So it's a broad-based increase in staff there, and that is reflected in that.

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 Joseph Gladue,  Merion Capital Group LLC, Research Division - Research Analyst   [4]
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 Okay. Let me, I guess, move on over to, I guess, the unfunded -- growth in unfunded commitments. And I guess, that grew about a little over 5%, 5.5-or-so percent from the first quarter, which is a bit of a slowdown from the previous quarters. Is there some seasonality to that growth? And is some of that, I guess, slower paced related to the fact that more of the growth is coming from non-RESG units rather than RESG?

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 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [5]
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 Joe, I don't think, number one, there's any particular seasonality to it. To some extent, what we are probably seeing is the fact that 2 years ago, we had a really large year followed by an almost as large year growth in percentage terms in that unfunded balance of loans. And as you and I and others have talked about many times, the loans -- the larger loans sometimes take 2 or 3 years to construct a project. And being the very low-leverage, only senior secured lender in the transaction, it's often a year or 2 years before we're funding on the loan as all of the subordinated capital elements, equity and mezzanine debt and so forth are getting expended on project. So I think, to some extent, we had expected that, that rate of growth in the unfunded commitments would begin to slow over time as a lot of these big unfunded commitments from 2 years ago begin to fund up. We had a very robust level of originations at RESG in the quarter just ended, and I don't have that number, but I don't think there was any slowdown from our first quarter pace of originations at all. It was just more of those previously unfunded commitments funded, so it tended to minimize the impact of newly originated unfunded commitments. And I think you'll see that, to some degree. Going forward, I would expect the unfunded commitments to continue to grow but at a slower percentage rate of growth than we have seen in the previous couple of years.

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Operator   [6]
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 And the next question comes from the line of Jennifer Demba of SunTrust Robinson.

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 Jennifer Haskew Demba,  SunTrust Robinson Humphrey, Inc., Research Division - MD   [7]
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 Just had some questions on loan growth. You said you expect loan growth this year to be probably not at the top end of your guided range. Can you just talk about the dynamics you've seen in the last few months? Has demand slowed a little bit or higher paydowns? Or what are we seeing right now?

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 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [8]
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 Well, Jennifer, the first 2 quarters of growth were very much in line with what we had modeled at the beginning of the year. So we are tracking where we expected to be. There have been movements in a few of the parts. Our marine and RV business generated about $185 million growth in the second quarter. That was up from $134 million growth in the first quarter and a little more that we -- than we expected. I anticipate that some of the competitors we've been taking market share from are adjusting some of their marketing and business strategies. And I would be surprised -- not be surprised if that number pull back a little bit in Q3 and Q4. On the other hand, our funded RESG growth has been a little slower than we modeled it at beginning of the year. But net-net, we're within about $20 million or $30 million at the end of June of what we modeled for Q1 and Q2 at the beginning of the year. So we're running really close to projection. We have not changed our guidance, although Tim noted that we're probably more likely to be in the bottom half of that guidance, I think, was the implication of his comment, than the top half of the guidance range. So we feel like we're on track to do what we expected to do at the beginning of the year.

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Operator   [9]
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 And our next question is from the line of Timur Braziler of Wells Fargo Securities.

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 Timur Felixovich Braziler,  Wells Fargo Securities, LLC, Research Division - Associate Analyst   [10]
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 First question I have is on the purchased loan yields. It seems like they have been bouncing around quite a bit over the last 3 quarters. Any gauge as to what's driving that increase in the second quarter? And maybe help frame where you see expectations going forward there.

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 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [11]
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 In Greg's remarks, he mentioned we've got -- Greg, what was the number, $125 million?

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 Greg L. McKinney,  Bank of the Ozarks - CFO and CAO   [12]
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 $123 million.

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 Tim Hicks,  Bank of the Ozarks - Chief Administrative Officer and Executive Director of IR   [13]
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 $123 million.

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 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [14]
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 $123 million of remaining credit, non-credit NPV marks on that portfolio. And what causes those loan yields to bounce around, and we've talked about this for years since we've had significant purchased loans in the portfolio going back to 2010 now, is when you have prepayments of those loans, those unaccreted counter accounts drop into income as additional accretion income. So that is -- the number will be very volatile from quarter-to-quarter and will be largely dependent on and heavily impacted by the rate of prepayments and the mix of prepayments. If you have $100 million of loans paid off and they were at their natural maturity and there were no credit marks on them, then you'll have no unusual impact on accretion income from those prepayments. If, on the other hand, you have $100 million of loans payoff that there were meaningful credit marks or significant maturities left, meaning the significant maturity -- meaning that there's substantial unaccreted discount, net present value discount, on it, then those credits will drop into income, and that will cause your margin on that portfolio to increase -- your yield on that portfolio to increase. So it will be volatile. And that's one of the reasons that we have talked about in the last 4 or 5 calls that core spread, the difference between our yield on non-purchased loans and our cost of interest-bearing deposits, is really being a better indicator of the job management is doing and the effectiveness of our business plan in maintaining good margins. And that spread increased -- core spread increased 7 basis points in Q2 after increasing 6 basis points in Q1. We've had a 5-quarter improving trend in that core spread, as Greg alluded to. So our real focus at the management level is to keep improving that core spread and get our yield on non-purchased loans to go up more than our cost of interest-bearing deposits goes up as the Fed raises rates. And the NIM will bounce around quite a bit from quarter-to-quarter based on the prepayments in that purchased loan portfolio.

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 Timur Felixovich Braziler,  Wells Fargo Securities, LLC, Research Division - Associate Analyst   [15]
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 Okay. That's helpful. And then just circling back to the deposit cost conversation. How much of that increase this quarter was driven by promotional rates versus seeing higher deposit betas on your core accounts. And I guess, with now 3 consecutive rate hikes, is your expectation for deposit betas, is that expectation now moving higher starting here in the third quarter?

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 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [16]
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 I'm going to let Tyler address that.

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 Tyler Vance,  Bank of the Ozarks - COO & Chief Banking Officer   [17]
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 The increasing cost is really driven a lot by the need to fund our growth. And so we have seen some larger customers where we've made rate concessions. We've adjusted their rates in terms of this new rate environment. We've not changed any of our rack rates. Those have all stayed the same. We've adjusted some CD specials anywhere 10 to 15 basis points in those spin-off markets. So again, really the increase in cost is at the margin to fund the growth.

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 Timur Felixovich Braziler,  Wells Fargo Securities, LLC, Research Division - Associate Analyst   [18]
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 Okay. And then...

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 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [19]
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 Special related, right?. Go ahead.

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 Timur Felixovich Braziler,  Wells Fargo Securities, LLC, Research Division - Associate Analyst   [20]
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 And then one more if I could, just for you, George. Love to hear your updated thoughts on M&A. What are you seeing there as far as deal flow? And does the upcoming DFAST preparation, does that all -- does that at all hinder the ability or the willingness to announce acquisition at some point throughout the remainder of the year here?

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 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [21]
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 Well, our work on DFAST, which is ongoing and we're in the process now of doing our second dry run on DFAST, that is having no impact whatsoever on our appetite or interest in M&A transactions. As Tim mentioned in his remarks -- and Tim works most closely with Dennis James, our Director of M&A, on modeling and looking at opportunities out there. We continue to be active and continue to look, but we are committed to our long history of doing transactions that are triple-accretive, accretive to book value and tangible book value per share on day 1 and earnings per share in the first 12 months following the transaction closing. Obviously, seller pricing has gone up, and seller pricing expectations have gone up as a result of deals that have been announced in recent quarters. Our stock is not trading as high a mult as it was a year or 2 years ago. And frankly, I don't understand that, but it is the fact. So that's making the math of transactions less appealing and more challenging. With that said, we have continued to see several transactions in the first half of this year that would have met our triple-accretive test, but we looked at those through a lens of another test. And that other test is if we spend the same energy and effort and resources that we would devote to doing that transaction, can we generate more profitability and return for shareholders spending that same -- those same resources on our organic growth? And hence, we've not elected to pursue several transactions that would have met that triple-accretive test so far this year. But we continue to look; we continue to be active. And we continue to believe that M&A will be an important part of our future growth strategy, but we will be disciplined about it.

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Operator   [22]
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 And our next question is from the line of Michael Rose of Raymond James.

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 Michael Edward Rose,  Raymond James & Associates, Inc., Research Division - MD, Equity Research   [23]
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 Just wanted to start with the other non-interest income. It looks like it was up a little bit, and I just wanted to see if there was any sort of onetime kind of items in there.

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 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [24]
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 Greg?

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 Greg L. McKinney,  Bank of the Ozarks - CFO and CAO   [25]
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 Michael, it was really just a continuation of what we've seen from just a run rate standpoint. That has a little bit of a tendency to bounce around from quarter-to-quarter, but there's no really unusual onetime items in there that are diving the increase this quarter.

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 Michael Edward Rose,  Raymond James & Associates, Inc., Research Division - MD, Equity Research   [26]
------------------------------
 Okay. So that's a decent run rate going forward then.

------------------------------
 Greg L. McKinney,  Bank of the Ozarks - CFO and CAO   [27]
------------------------------
 That is correct.

------------------------------
 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [28]
------------------------------
 With the caveat, as Tyler mentioned, that the Durbin Amendment will kick in here in Q3 and as our number of customer transactions and core accounts has grown, and we've completed our acquisitions over time, that number has gotten bigger and it's about $1.95 million a quarter. So as your starting point, deduct $1.95 million in service charge revenue from Q2 and then project whatever you think it's going to grow at from there would be a good starting point.

------------------------------
 Michael Edward Rose,  Raymond James & Associates, Inc., Research Division - MD, Equity Research   [29]
------------------------------
 Perfect. And then maybe as a follow-up, if you guys can touch on post the capital raise, where are your CRE and construction concentration levels are relative to the guidelines and if the capital raise in any part was contemplated by any sort of regulatory conversations.

------------------------------
 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [30]
------------------------------
 The capital raise was not a result of any regulatory conversations whatsoever related to CRE or otherwise. And frankly, I don't know -- Tim, do you know what our CRE ratios are afterwards? I haven't -- we haven't looked at that.

------------------------------
 Tim Hicks,  Bank of the Ozarks - Chief Administrative Officer and Executive Director of IR   [31]
------------------------------
 No. We don't have those available this time although they're obviously -- the capital raise will obviously benefit those ratios, and we'll have to calculate that with our -- considering growth in the quarter as well.

------------------------------
 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [32]
------------------------------
 So we haven't even calculated that, and that the CRE ratios were not at all a consideration in the capital raise. The capital raise was a result of the fact that under our first dry run of our DFAST stress test. And as we extrapolated those first dry run results to our projections for growth in the future as they've evolved and so forth, we are expecting such significant growth in 2018, '19 and the first quarter of 2020 in the base case that will outrun our ability to generate capital organically. So if you're retaining -- retained earnings at a 13% or 14% rate of retained earnings, but you're growing the balance sheet at 30% per annum plus or minus, you've got to have more capital. And as I said in my remarks, you can't project those capital rates as over your 9 quarters of the DFAST stress test with limited exceptions. You've got to have it on your balance sheet at the balance sheet measurement date, which in our case here for the first test will be December 31, '17. So it was all about the DFAST test and the projected base case growth we expect in the DFAST test. And the capital raise had nothing to do with our CRE ratios.

------------------------------
 Michael Edward Rose,  Raymond James & Associates, Inc., Research Division - MD, Equity Research   [33]
------------------------------
 Okay. Then maybe just one final broad question just on the RESG business. George, you and I talked about your thoughts on what that -- what the industry growth looks like over the next few years. You talked about it potentially slowing and then your pass-through rates increasing a little bit. Can you just give some color on the market pricing? If that's improving for you, guys, given competitors have pulled back, and kind of your thoughts and expectations just for that business line over the next few years.

------------------------------
 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [34]
------------------------------
 Yes. We do have the expectation that construction nationally across all product types and all markets across the country is likely to pull back a little bit. And whether that number is 10% or 20%, I don't know. But in talking with our customers as our RESG guys do, and they're passing that feedback along to me, cost of labor and materials in some markets are going up significantly. Cost of construction financing is going up. Cost of feds moved interest rates now 4x and probably spreads on construction financing at least in our experience it had gone up over the last 18 months to 2 years. So it's costing more in labor materials and capitalized construction period interest for our customers to build things. And we're working against a period of years coming out of the Great Recession where supply did not keep pace with demand and supply of product and a lot of product types has caught up with demand now in a lot of submarkets. So there are a lot of markets around the country where you might have had 5 projects coming to market a year ago, but there's really only a need for 2 more projects coming to market this year. And that is slowing volume to some extent. But as we've talked about, we do a very, very low percentage of the transactions that we see. And historically, that number has kind of been 6% to 8%. We feel like it's even a lower percentage now. So if the pie nationally shrinks, we would still expect our volumes to be very good. And as Tim mentioned, and I think I mentioned in my remarks, we expect RESG to continue to be our biggest growth engine and its business to grow over time. So we still expect by just getting a little higher pull-through rate on our transactions that we can keep our volume positive even if the industry contracts a little bit. And that contraction is actually a very healthy thing. It's very encouraging to us that developers are paying close attention to supply-demand metrics and are really being careful to only build things where there's a very good reasonable sound expectation that the demand is going to be there for the product being built. So we think all that's working out in a very healthy and constructive way.

------------------------------
Operator   [35]
------------------------------
 And our next question comes from the line of Stephen Scouten of Sandler O'Neill.

------------------------------
 Stephen Kendall Scouten,  Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research   [36]
------------------------------
 Maybe a follow-up on a growth question, if I could. Maybe it's kind of two-part question around growth. You mentioned the RV and marine as a contributor on the non-RESG percentage but that number was kind of -- and a lot more impressive than I would have expected this quarter. Can you give other color into that? And then as it pertains to the RESG hires that you mentioned, have you added any new whole teams there? Or where do we fall on the amount of teams you have for RESG?

------------------------------
 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [37]
------------------------------
 Yes. We've continued to add new team members to RESG, but we've never have gone out and hired a team of people. We're -- what we do there is very disciplined and very focused and requires a very high level of expertise and confidence and understanding. So we've never tried to go out and lift the team out from any place else and put them in RESG. We hire individual team members that we believe have the aptitude, the skill set, the experience, the knowledge, the work ethic, the discipline to be part of RESG; and bring them in, and one at a time, make sure those individuals really are performing in our culture consistent with the high standards of our culture. So we're continuing to add that. I don't know exactly what the headcount is there. I think we're at 100-something now, maybe as high as 108 or 107, something like that. So the RESG team is growing but it's not by adding teams. It's one person at a time based on the unique skills and ability of that person. The marine and RV team is an excellent team. They were one of the real jewels from a talent and competence and unique skill set perspective in the CSB acquisition that we closed last July. And John Redmond and Dennis Poer and the guys that worked with them in that team have just continued to do an excellent job. They are veterans in the business and, hence, they have very broad-based comments or contacts and a lot of relationships that go back decades there and their ability to take their expertise and capitalize on their market knowledge and relationships and bring in businesses has been the reason that, that line of businesses ramped up as effectively as it has for us.

------------------------------
 Stephen Kendall Scouten,  Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research   [38]
------------------------------
 Okay. And just from some of the color you've given, I'd presume you wouldn't expect the same level of contribution from the non-RESG businesses in the next couple of quarters? Is that fair to say?

------------------------------
 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [39]
------------------------------
 I would expect, as I said, it may be hard for the indirect marine and RV guys to replicate that $185 million of growth from Q2. That was an outstanding number, and I think they've certainly ruffled feathers among some of our competitors there. And so there's likely to be a little competitive pushback that slows their momentum just a bit in the short run. I do expect them to be a significant positive contributor, I'm just not sure they can hit $185 million again. We expect continued increases in the volume of growth from community banking. Our community banking group actually contributed about $210 million or $211 million to our Q2 growth. And we had positive growth in leasing, and our Corporate Loan Specialties Group got a little bit of traction with about $57 million of growth in the quarter. So I would expect in future quarters, we would continue to see additional contributions at an accelerating volume from the non-RESG groups with the possible exception we may have a flat to slightly down quarter or 2 for indirect. And I would expect an accelerating volume of funded growth from RESG starting this quarter.

------------------------------
 Stephen Kendall Scouten,  Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research   [40]
------------------------------
 Okay. That makes sense. And if I could jump to the interest-bearing deposit costs again, it seems like the same amount of offices and regions are in spin-up mode as they were last quarter. Would you anticipate the need for any changes there? Any major differential in terms of the deposit composition for this quarter versus last?

------------------------------
 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [41]
------------------------------
 Well, that's under constant review by Tyler and his team. And the reason we didn't put more offices in spin-up mode or do more adjustments to our rate on the spin-up offices was simply a result of the fact that the -- if you ignore the runoff and broker deposits, our non-broker deposits were up -- Tyler what was that number?

------------------------------
 Tyler Vance,  Bank of the Ozarks - COO & Chief Banking Officer   [42]
------------------------------
 $962 million.

------------------------------
 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [43]
------------------------------
 Yes. $962 million. So his retail banking teams and the retail banking teams in the community bank that work for John Carter and the deputy directors of community banking and those market division president just did an excellent job growing deposits. And Tyler mentioned we had over 6,000 net new core checking accounts added. By far, the largest quarterly total we've ever had. So they just got a really good quarter of deposit growth without having to increase our number of spin-up officers or significantly adjust the rates in the spin-up offices. And that's just good, hard handwork in the way we brought in those deposits by our entire team. So real proud of the accomplishments of our Tyler and the entire retail banking team and community banking team on that. There was a lot of hard work went into that and we're pretty optimistic that we'll only make probably minor adjustments in the spin-up offices this quarter, if any, and still get some pretty good results. We've got a lot of momentum going on the deposit sides. We're feeling very positive about that. But as I said, spin-up is under daily review. As Tyler contemplates the 36-month forward funding forecast that Tim and his team provides to Tyler based on the constant review and update of loan commitments and closings and fundings and so forth, Tyler is constantly evaluating what is happening competitively and growth-wise, volume-wise on the deposit side. And he's matching that. So it's under constant review.

------------------------------
 Stephen Kendall Scouten,  Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research   [44]
------------------------------
 Okay. And then maybe just one last question. It maybe a little bit of an abstract question, but you mentioned you're a little frustrated or surprised by where your evaluation is today and that could be inhibited in M&A. Do you think there's anything that you guys can do specifically to kind of further demonstrate the core of your franchise, the strength of the quality, the results of the franchise and maybe dissipate some of these concerns around RESG or the size of those loans? Anything that you guys are considering to make things more clear for people, that maybe apparently, it's not clear for today?

------------------------------
 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [45]
------------------------------
 The answer to that is no. I mean, we've been incredibly transparent regarding our RESG portfolio and really all of our business for that matter. And if people can't understand that, then I don't know anything else we can do to help them understand that. But the results over the long term clearly speak to the quality of that portfolio. And the thing that people ought to be able to very easily understand is that our competitors, many of whom have lower CRE ratios than we do, maybe 20 or 30 points or 40 points higher leverage on their CRE than we are at 49% loan to cost and 42% loan to appraised value, which is the fully funded LTCs and LTVs for the RESG portfolio, assuming every loan is fully funded. I mean, those are amazingly not low numbers, and we're the most conservative party. The only senior secured party and the cap stack on every transaction we do. And if you look at our level of leverage versus the industry as a whole, we're probably the most conservative CRE lender in the entire industry. The numbers from our historical loss experience certainly tell a compelling story. The LTV, LTC numbers tell a massively compelling story, and you would think people would be able to understand that. But -- and I think more and more people are understanding it as time goes on. But it's an outstanding quality portfolio, and we have absolute confidence in it.

------------------------------
Operator   [46]
------------------------------
 And our next question comes from the line of Matt Olney of Stephens Inc. Company.

------------------------------
 Matthew Covington Olney,  Stephens Inc., Research Division - MD   [47]
------------------------------
 I wanted to circle back on the acquired loan book. It looks like that the paydowns continue there at a pretty high level. No real slow down from the first quarter. Any commentary you guys can provide as far as the pace of the paydowns on that acquired loan book?

------------------------------
 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [48]
------------------------------
 We were a little surprised by that. If you look at Q4 of last year when we would've expected elevated paydowns because of the C1 and the CSB acquisitions were fairly freshly minted, we had a $442 million decrease in that loan book in Q4, which was 8.2% of the beginning of Q4 balance of that. That slowed as we expected it would in Q1 to $378 million or 7.6% of the beginning balance of Q1. And we would've expected that number would've gone down from $377 million or $378 million and down from the 7.6%. That would be our normal experience as the rate of paydowns from these portfolios would slow. But to your point, it actually reversed the other direction in Q2. We had $421 million in paydowns, which was 9.2% of the beginning of quarter balance. So my best guess at this point in time and when people pay their loans off is a hard thing to predict, but my best guess at this time is that the Q2 increase in paydowns both in dollar and percentage was an anomaly, and I would expect and there are certainly no guarantees on this, but I would expect that dollar amount of those paydowns and the percentage to decrease in Q3 and decrease again in Q4 and decrease again each quarter. It's not going to perfectly go in a straight line, but we would think the trend would be to have lower dollar amounts and lower percentages prepay over time. So.

------------------------------
 Matthew Covington Olney,  Stephens Inc., Research Division - MD   [49]
------------------------------
 Okay. And then circling back on the operating expenses, I appreciate the commentary on the infrastructure build that's required in order to become a larger bank. Is there more color you can give us on the operating expense growth rate? And how should we be thinking about the -- what percent of the infrastructure build that's required is now in the run rate as of 2Q?

------------------------------
 Tim Hicks,  Bank of the Ozarks - Chief Administrative Officer and Executive Director of IR   [50]
------------------------------
 Matt, let me take a stab at this. George mentioned the high to low that had about the -- that settlement of that piece of litigation, had about $700,000 onetime -- $750,000 onetime impact. We did have the merger transactions, special shareholders' meetings. I mean, there were a little bit of legal fees, some proxy, preparation and printing, filing, middle-man expenses associated with that. So that is a run rate there, a onetime item as well. Our annual Director Stock Grants that we grant to directors, they're not employee directors, every year at the Annual Shareholders' Meeting that hits in Q2, that was about a $700,000 impact to other operating expenses in the quarter. That's a onetime annual charge. That's not in the -- would not be part of the run rate. The other couple of items I mentioned, and this is kind of in lieu and along the lines of the build out of the infrastructure, we have engaged third parties to help us with some of the DFAST model builds that are required to run the various -- and prepare the DFAST submission. Those expenses have been in the run rate for the last 3, 4, 5 quarters and will probably continue to be there throughout the remainder of this year. My expectation is that those expenses would begin to slow down in 2018 as we have that DFAST, the models entirely built and all those models validated. So I think that probably remains a little bit elevated for the remainder of 2017. George's comment indicated that we would expect those infrastructure costs to continue through '17 and into, to some extent, 2018. So I think those will begin to ebb as we move into the remainder of this year, particularly into 2018. And then the one final piece I'll mentioned is as of March 31, we are now part of the large bank deposit, insurance and processing from FDIC. Those rates are higher for large bank versus the community bank. And that had a little over $1 million impact on our deposit insurance cost in Q2. And that will be -- that will basically be ongoing as we look into the future.

------------------------------
 Matthew Covington Olney,  Stephens Inc., Research Division - MD   [51]
------------------------------
 Okay. That's helpful, Greg. And then Greg, since you're there, with respect to the decrease in income that goes through the NII output that was about $9 million in the first quarter. Do you have that number for 2Q?

------------------------------
 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [52]
------------------------------
 Actually, that was ... looks like that was...

------------------------------
 Greg L. McKinney,  Bank of the Ozarks - CFO and CAO   [53]
------------------------------
 Yes. Close to $20 million in the first quarter. It was $22.5 million in the second quarter. So a little bit elevated in the second quarter. If you're referring to the line item on our cash flow statement that outlines that, it was a little elevated. Obviously, the denominator was a little bit lower as well on the purchase loans, so that did have a little bit bigger of an impact this quarter. And that again, that goes back to George's comments and Greg's comments just on the -- from previous calls on the mix of payoffs and those purchase loan portfolios and how much accretion -- accretable differences remaining on those loans that pay off in that particular quarter.

------------------------------
Operator   [54]
------------------------------
 And our next question comes from the line of Catherine Mealor of KBW.

------------------------------
 Catherine Fitzhugh Summerson Mealor,  Keefe, Bruyette, & Woods, Inc., Research Division - MD and SVP   [55]
------------------------------
 Just to follow up on maybe first on the expense side. It sounds like if we take out the $750,000 associated with the Durbin charge, it feels like it's still directionally linked quarterlies -- from here to the back half of the year, we should still see an increase in the expense base but perhaps at a less -- or perhaps at a slower pace than we saw in the second quarter.

------------------------------
 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [56]
------------------------------
 Catherine, I would think that's correct and Greg you jump in here. But as Greg just enumerated on the previous question, there was the $750,000 legal charge in the non-interest expense, and there was the $750,000 or $700,000 roughly director's cost. So those will drop out, but we continue on this infrastructure bill. So I think your assumption is probably a reasonable assumption that yes, non-interest expense will go up in future quarters but at a lower rate than the rate of increase from Q1 to Q2. Greg, is that...

------------------------------
 Greg L. McKinney,  Bank of the Ozarks - CFO and CAO   [57]
------------------------------
 Yes. And I would actually expect that other line item to be down in Q3 versus Q2. I think probably somewhere between Q1 and Q2 is where I would expect that. I mean, I think we've got probably close to a couple of million dollars of onetime-type items that hit that line item, Catherine, in Q2. So I would expect that line item to be down somewhere between the Q1 and Q2 amounts as we look into the back half of the year, particularly third quarter.

------------------------------
 Catherine Fitzhugh Summerson Mealor,  Keefe, Bruyette, & Woods, Inc., Research Division - MD and SVP   [58]
------------------------------
 Okay. That's helpful. One then one thing, to circle back to the margin, just thinking directionally about the margin. In reading -- in what about you were saying George at the beginning of the call and the impact that you think that the securities build is going to have under the margin directionally. Do you still feel like kind of a normalization in the purchase accounting and then the impact from the securities build should still be probably enough that we're going to see directionally a lower margin even as your non-purchase loan yields continue to move higher?

------------------------------
 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [59]
------------------------------
 Yes. I think that's true because we added $700 million plus of mortgage-backed securities that are very short, and they're going to yield right at about 2%. And so that's going to be dilutive to our margin, dilutive to our yield, on our securities portfolio. And as I said, the -- we're going to have some small incremental amount of earnings from that, so it will be positive in a slight sense to net income. But the purpose of that securities portfolio adjustment and strategy is all about giving the funding guys just one more tool in their arsenal of tools to manage balance sheet liquidity. And we probably got adequate tools already, but those are the sorts of things. You'd just like to have multiple tools on the toolbox to use if you ever got in a situation where you need them. So it will be dilutive to our margin to do that. The thing we're focused on, though, as you alluded to, is that core margin. Keeping that increasing over time. And if we do that, I think we'll put up very good results for our shareholders.

------------------------------
Operator   [60]
------------------------------
 And the next question comes from the line of Peyton Green of Piper Jaffrey.

------------------------------
 Peyton Nicholson Green,  Piper Jaffray Companies, Research Division - MD and Senior Research Analyst   [61]
------------------------------
 I was wondering maybe if you could comment with regard to the non-purchased loan yield. Basically, spread started to widen, if I recall correctly, in the second half of '15, and then the first half of '16 relative to spreads on -- from prior Real Estate Specialties Group loans. And given the time line of those fundings, would you expect the non-purchased loan yield to get a little benefit as those loans fund in the second half of '17 and into the first half of '18?

------------------------------
 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [62]
------------------------------
 Yes. We would. And we talked about that starting really in the, probably, the April call last year, that we were getting better spreads because a lot of folks had vacated the space. So we were able to even push our leverage lower and get our spreads a little wider than they might have previously been, and that we would begin to see the benefits as those loans originated last year and earlier this year began to fund in future quarters. So we're still thinking that that is some element of positive for us going forward. It's hard to quantify that, but we do think there's some potential there for that to continue to help us boost the core spread.

------------------------------
 Peyton Nicholson Green,  Piper Jaffray Companies, Research Division - MD and Senior Research Analyst   [63]
------------------------------
 Okay. And then the June rate hike. That should also help, that non-purchased loan yield comp in the third quarter, which I would expect you probably have minimal floors that are in the money to move through at the end of June. Is that fair?

------------------------------
 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [64]
------------------------------
 Yes. I think we've got about $800 million of loans that are at a rate. And you would say, "Oh, gosh. Why is that so large with 4 Fed increases already done?" And the answer to that is some of these loans are annually adjustable or semiannually adjustable. And they're not all daily immediately adjustable. So we still have some loans that will adjust when they hit their adjustment date. That will help us. And obviously, we got part of the quarters impact from the Fed move in Q1. And since so many of our loans are LIBOR-based, our most dominant index is 1-month LIBOR, and 90-day, 3-month LIBOR is the second most dominant index. So those indexes began to anticipate this last Fed increase, so we began to get some build up as we got closer to the date of those increases and those margins. But we'll have a full quarter's benefit of that in Q3. So that should help us continue to keep non-purchased loan and lease yields moving in the right direction.

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 Peyton Nicholson Green,  Piper Jaffray Companies, Research Division - MD and Senior Research Analyst   [65]
------------------------------
 Okay. And then last question for me. Is there -- overall, we'll call it kind of other earning asset to earning asset mix, I guess everything non-loans, that you would be targeting towards over the next couple of quarters or year or 1.5 years that we should be mindful of?

------------------------------
 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [66]
------------------------------
 We're not. Our securities portfolio right now is at a very low percentage of earning assets compared to where we were, say, 7 years ago or 10 years ago. And we would like to be in an environment where that securities portfolio could become a much higher percentage of our earning assets. We are unfortunately not in an environment today where we feel like we can add a lot of securities for yield purposes. We did add securities last year that we retained a lot of the kind of short-, medium-term mortgage-backed securities and other short-term securities from the CSB acquisition for liquidity. And then we added securities as we've talked about at length on this call and the last quarter for liquidity. So we're keeping the liquidity element of our securities portfolio where we feel like it needs to be. But as far as really investing a much higher percentage of our earning assets and securities because we love the risk-reward profile from an interest rate, risk perspective we're a long way from that at this point.

------------------------------
Operator   [67]
------------------------------
 And the next question comes from the line of Brian Martin of FIG Partners.

------------------------------
 Brian Joseph Martin,  FIG Partners, LLC, Research Division - VP and Research Analyst    [68]
------------------------------
 Say, most of my stuff's been answered, George. Maybe just a couple of quick things. And maybe just one more for Greg. But on the fee income side, just that other line, Greg, that you kind of talked about. I mean, it's up about 50% since fourth quarter at least kind of the run rate. I'm just curious, and it sounds like it's sustainable. What are the biggest? Are there bigger components in there? I guess, maybe if you just -- you were talking about the other expenses and kind of breaking things out. Just on those other fees, are there any larger components in there that you can isolate or just point to on that line item?

------------------------------
 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [69]
------------------------------
 Brian, let me clarify. You're talking about other income or other expense?

------------------------------
 Brian Joseph Martin,  FIG Partners, LLC, Research Division - VP and Research Analyst    [70]
------------------------------
 The Other -- so within the fee income, just the Other line.

------------------------------
 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [71]
------------------------------
 Okay.

------------------------------
 Greg L. McKinney,  Bank of the Ozarks - CFO and CAO   [72]
------------------------------
 Yes. There's a -- we have some asset servicing fees that RESG charges. That's a decent sized component within that line item, Brian. We have really began trying to charge customers for the value we bring to the transaction. And so those fees have been increasing the recent quarters. So that's part of the driver there. There's a little bit of underwriting that are also in that, that are -- they also end up in that line item. That's not a big number, but it's really those types of fees and income items that we're able to generate. We've been more successful with the ability to -- for better pricing, better other fees associated with some of those transactions. So that's a big part of what has driven the increase in that other noninterest income line item in the last 2 or 3 quarters.

------------------------------
 Brian Joseph Martin,  FIG Partners, LLC, Research Division - VP and Research Analyst    [73]
------------------------------
 Okay. Perfect. That's helpful. And then just on the securities. They were purchases this quarter, I guess. Fair to assume that not much impact on the margin this quarter from that purchase as they occurred late in the quarter. Is that fair?

------------------------------
 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [74]
------------------------------
 That entire block of securities, as you know, mortgage-backed securities tend to settle on a regular way on a single settlement date, which I think was the 18th or 19th of June. So you're exactly right. There was 11 or -- 10 or 11, 12 days of impact on the margin this quarter from those security purchases. They were all settled on that regular way, June settlement date.

------------------------------
 Brian Joseph Martin,  FIG Partners, LLC, Research Division - VP and Research Analyst    [75]
------------------------------
 Okay. Perfect. And then just the last few things. Maybe if you can talk about just on the RESG growth this quarter geographically, maybe just the -- if you have an idea of where the larger growth was coming from. And then, maybe just one other question on the margin on the non-purchased loan yields and just -- wondering how much of the -- you've talked about the better pricing, George. Just wondering how much of the pickup in that non-purchased loan yield in the quarter is driven off of the rates versus the better pricing. I guess, I assume it's more of the rate side with some incremental or some piece to better pricing. But just those 2, and that's all I have.

------------------------------
 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [76]
------------------------------
 I don't know that I can break that out in any meaningful way for you. With the variable rate loans, obviously, a big part of that increase in yield was a result of that. And I can't quantify how much of it's because we got better pricing on the loan than we might have gotten a year ago. But we were pleased with the positive directionality of that. On the RESG originations, we had about $746 million of net new loans originated in the quarter; and New York MSA, we had about $324 million of net new originations; and Miami, Florida MSA; Los Angeles MSA, we had about $306 million of new originations. And these are funded and unfunded balances. Orlando, we had about $148 million; Metro Atlanta area, about $94 million; Metro Boston area, about $80 million; Metro Chicago, where we're about $76 million; Metro Philadelphia, about $56 million. And then, everything else was below $50 million and that included: San Francisco MSA; Summit Park, Utah; Madison, Wisconsin; Minneapolis, Minnesota; Dallas, Texas; Portland MSA; Austin MSA; Denver MSA. Yadda, yadda, yadda. A lot of geographies involved.

------------------------------
Operator   [77]
------------------------------
 Your next question comes from the line of Rob [Sanderson] of UBS.

------------------------------
 Unidentified Analyst,    [78]
------------------------------
 A lot of these has already been kind of aired out, but I would just going to ask on the funding side. Your cost of interest-bearing deposits has risen somewhat faster here in the second quarter than it did in the first. Not surprising consistent with industry trends, I would imagine we see, but you also had some changes in the component parts. You called out the decline in the broker categories. Do you think the mix savings time, other time continues to move and shift versus what we saw here in the second quarter? Or do you think that's going to be pretty stable from here?

------------------------------
 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [79]
------------------------------
 I was looking at a -- Tim, was that a 12-month graph of that I was looking at the other day, yesterday?

------------------------------
 Tim Hicks,  Bank of the Ozarks - Chief Administrative Officer and Executive Director of IR   [80]
------------------------------
 It was a 12-quarter graph.

------------------------------
 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [81]
------------------------------
 12-quarter graph of that. And that number has just not moved very much over the last 12 quarters. I think we were about 29% time and 54% non-time interest bearing and 17% noninterest-bearing in real round numbers at the end of the last quarter. And those numbers, I would say, are slightly better than they were a quarter or 2 quarters ago for the most part if time being a lower percentage is better. But they haven't moved within 2 basis points -- 2 points -- 2 percentage points on any of those numbers, really, over the last several years. So pretty stable mix. And I think that will continue.

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 Unidentified Analyst,    [82]
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 Are you sensing that customers are becoming much more sensitive to rates whether it's savings or time? And you're having to fight for -- fight harder for the deposits that you are pulling in?

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 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [83]
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 I would say, and Tyler, you may want to comment on this. But I would say, yes. There is some increased sensitivity. I mean, obviously, we've had 4 Fed fund rate increases, so most deposit customers sort of fell asleep for years because there was no activity on deposit rates. And certainly, 4 rate increases by the Fed, it got folks looking at that. And that's reflected in the increased cost of deposits in the last quarter.

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 Tim Hicks,  Bank of the Ozarks - Chief Administrative Officer and Executive Director of IR   [84]
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 Yes. I think, George, on the CD side, we have seen that. And we've made a few adjustments, as I mentioned, on our deposits, CD specials. But that's primarily where we've seen it. It's on the CD side.

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Operator   [85]
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 Our next question comes from line of Blair Brantley of Brean Capital.

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 Blair Craig Brantley,  Brean Capital, LLC, Research Division - SVP and Senior Equity Research Analyst   [86]
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 Just a real quick question. On the fee income side, is there any change in your strategy to maybe add some more? I mean, you've got -- with the Durbin kicking in, and then obviously, the benefits from some of the acquired loans or what not, that should be following. Is there any change in philosophy or maybe adding some other lines to that fee income segment?

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 Tyler Vance,  Bank of the Ozarks - COO & Chief Banking Officer   [87]
------------------------------
 This is Tyler. For some time, we've been focused on improving debit card usage in our marketing teams and others, our community banking team that George referenced earlier. They're all focused on getting cards in customers' hands as they leave the branch and in improving usage. But other than that, there are no other efforts underway.

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 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [88]
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 We're not looking at adding any new lines of business. Particularly, we were very focused and engaged on all the things, all the initiatives we already have going on. So there are no present plans, Blair, for us to get into any other fee generating lines of business to augment our existing portfolio of products and services.

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Operator   [89]
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 And at this time, I'm showing no further questions.

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 George G. Gleason,  Bank of the Ozarks - Chairman, CEO & President   [90]
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 Thank you, guys, for joining the call today. We greatly appreciate your participation. There being no further questions, we're done. We look forward to talking with you again in about 90 days. Have a great day. Thank you.




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