Good day, ladies and gentlemen, and welcome to the Bank of the Ozarks second quarter 2018 earnings conference call. At this time, all participants are in a listen-only mode. Following management's prepared remarks, we will host a question and answer session, and our instructions will be given at that time. If during our conference today you require operator assistance, press star then zero, and an operator will be happy to assist you. As a reminder, this conference call is being recorded for replay purposes. It is now my pleasure to hand the conference over to Mr. Tim Hicks. Sir, you may begin.
Good morning. I'm Tim Hicks, Chief Administrative Officer and Executive Director of Investor Relations for Bank of the Ozarks. Thank you for joining our call this morning and participating in our question and answer session. In today's Q&A discussion, we may make forward-looking statements about our expectations, estimates, and outlook for the future. Please refer to our earnings release, management comments, and other public filings for more information on the various factors and risks that may cause actual results or outcomes to vary from those projected in or implied by such forward-looking statements. Joining me on the call to take your questions are George Gleason, Chairman and CEO, Greg McKinney, Chief Financial Officer and Chief Accounting Officer, and Tyler Vance, Chief Operating Officer and Chief Banking Officer. We're very pleased to report our excellent second quarter results, and we'll begin by opening up the lines for your questions.
Let me ask our operator, Brian, to remind our listeners how to queue in for questions.
My pleasure, sir. Ladies and gentlemen, if you would like to ask a question over the phone lines, press star and then one on your telephone keypad. If your questions have been answered and you wish to remove yourself from the queue, simply press the pound key. Once again, ladies and gentlemen, to ask a question, that is star and then one. Our first question will come from the line of Ken Zerbe with Morgan Stanley. Your line is now open.
Great. Thanks. Good morning, everyone.
Good morning, Ken.
Why don't we start off on the core spread. I'm going to try to narrow this down a little bit, but just I would love your broader thoughts on this. You mentioned in the release that over time, going forward, you do think that core spread should eventually move higher. When I think about the pieces and sort of think about sort of a, let's call it, a rough mid-sixties asset beta or loan beta, then this quarter's deposit beta, which interest-bearing is 84%, how do we end up in a place where core spread actually expands? It seems that something would meaningfully need change. I suspect it's on the deposit beta side, but essentially, are you calling for core spread or the deposit beta to actually come down next quarter? Thanks.
Well, great question, Ken. Thank you for asking that. Our hope is that deposit betas will come down. We are reviewing, and have been reviewing in recent weeks, our results in that regard for the quarter just ended and looking at ways that we can fine-tune our approach to that. We have some actions and steps that we're taking in an effort to do that. We are not certain those will achieve the desired result, but we think they will achieve the desired result. I think the answer to your question really is two parts. One, yes, we hope to improve that deposit beta in the third quarter and the fourth quarter of this year. Number two is we hope that we'll get a little more lift on the loan side.
Our non-purchase loan yields improved 18 basis points in the first quarter of the year, I believe it was. Is that correct, Tim?
That is.
14 basis points in the second quarter. Obviously, that core spread would've diminished less than half of what it did if we'd gotten the same 18 basis point lift on the loan side. We hope we'll see better results on both sides.
Okay. Just to mix up the questions a little bit. In terms of the growth, one of, I guess, your comments in the release was that you're seeing competitors offer aggressive credit structures and pricing. I would love to get more detail on that. How broad is that? Is there any geographic concentrations on where you're seeing it? Thanks.
We've seen a number of new competitors enter the CRE space over the last year. That has been more or less broad-based. I would not say it's in every market with the same intensity and vigor. We've seen a clear increase in competition in a lot of markets on a lot of product types with competitors competing both much more aggressively on deal structure and on pricing. We have always said, no one should be surprised at our actions in this regard. We've always said that asset quality is the most important in the asset quality pricing growth equation for us. That growth is a tertiary consideration. The way we have approached it and will continue to approach it is we're going to hold very firmly to our longstanding asset quality standards. Those are not negotiable.
We will get as aggressive on pricing as we can to be competitive while still achieving our minimum return on allocated capital for each loan. Growth will be the variable that will adjust up or down depending on how market conditions play out. We're quite content to have less growth, unless we can get that growth on credit quality and pricing standards that make sense to us. I would hope that any thoughtful holder of our company stock would applaud that approach, that credit quality is just not something that you want to play with or take chances on. Return on equity is not something you want to get below a minimum target level, if growth suffers because you're being disciplined, then so be it.
This will be my last question, I guess just on the growth piece, the way you're describing it. I totally understand what you mean. I'm glad you're being conservative on credit, you mentioned that you're "less certain" that you can actually outgrow last year, it seems that what you're describing, it should be not just less certain, it should be just like growth could potentially come in meaningfully lower than the growth last year, given the increase in aggressive competitors. Is that a fair statement, is there some reason why growth should accelerate in the back half?
Ken, let me tell you this. If our crystal ball was perfect and we knew exactly what growth was going to be, we would tell you and everybody else on this call what our growth number was going to be, there would be no uncertainty about it. We do live in a world that has uncertainty and variables and many customers and many competitors, it's a dynamic landscape. We have not thrown in the towel or don't consider it impossible for us to beat last year's number, it is a more competitive environment than we envisioned when we gave that guidance earlier this year and last year. That has created uncertainty about our ability to hit that number.
I think the more important reality that our shareholders ought to be focused on is whether we come in at 75% or 125% of last year's growth number. Even on the low side of that, we would be producing an organic growth rate that's twice probably what the industry is producing. Whether we're growing at two or three times the industry, we're still generating excellent growth. Certainly, with our stock trading where it is, you buy that growth at a deep discount relative to competitors. I think there's an excessive focus on are they going to be a little more than last year or a little less than last year, or a lot more than last year or a lot less than last year? The reality is that our growth is going to be at a very good metric versus the industry.
We don't know what it is going to be today. We'll know that in six more months. We think it's going to be very good growth, we're obviously not getting rewarded for it.
All right. Great. I'll get back in the queue. Thank you very much.
Thank you.
Thank you. Our next question will come from the line of Catherine Mealor with KBW. Your line is now open.
Thanks. Good morning.
Good morning, Catherine.
One follow-up on the growth. Outside of just the competition, would you say, George, that the flow of quality deals has changed as well, or is it really just more on the competition side of the equation?
I would tell you the flow of quality deals has changed. Cost of material for construction are going up, cost of labor for construction are going up, construction period interest costs are going up. That makes it more challenging for our sponsors to find and pursue viable projects that are going to meet their returns on their equity investments in the project in an environment where you're seeing very little increases in rental rates or sales rates. Most property types that we're seeing in most markets around the country, your rental rates or your sales rates are not materially different up or down than where they were a year or so ago. Your cost to produce the asset is higher. The value of the asset is up a little bit or down a little bit from where it was a year ago.
It is making it harder for sponsors to find deals that make sense, and we've seen sponsors shelf deals that didn't make their target equity requirements and so forth. You have an interesting dichotomy here in that you've got an environment where there are probably fewer deals that are going to meet our very rigorous credit standards, and you've got a lot more competitors in the space chasing those deals. Clearly it was a more favorable environment for us a couple of years ago when we could find more good deals than we could close that met our standards, and there was much less competition in the space. That dynamic has changed, and I think one of the great strengths of our company is our discipline and willingness to do what's right, even if it impinges on our growth numbers.
We would have had no problem achieving growth. I think our growth through the first six months of the year was about 2% ahead of last year's growth rate through six months. We would have had no problem achieving growth 20%, 30%, 40% ahead of last year's had we been willing to sacrifice our standards to do that. That's not the way we run this company and not the way that we have had better-than-industry credit metrics every year since we went public 21 years ago, and those credit losses over that 21-year period of time have averaged 32% of the industry's average credit metric. It's because we've been disciplined. We're not perfect, but we've been much better than average because we've been very disciplined.
Makes sense. That's really helpful. Thank you. Then maybe one other one is just on the indirect RV and marine portfolio. Can you just kind of give us some more detailed and updated background on that portfolio, given it's now $1.5 billion and with most of the growth this quarter, just kind of talk about some of the underwriting standards of that portfolio, the average size of credits, kind of profile of your typical customer yield on that portfolio, just kind of those things, and then how large you think that portfolio can get over time. Thanks.
Okay, great question. Thank you. One of the gems in the Community & Southern Bank acquisition that we did in July of 2016 predominantly in Georgia was the indirect marine and RV business. They ran the indirect marine, RV, and auto loan business. We looked at all of that and really did not like the auto loan business at all. Felt like there was a lot of risk there, and that it didn't yield a particularly high return by our standards. On the other hand, we really liked the marine and RV business because they were pursuing a very high-quality customer and were getting better yields for it. What I would tell you is, in recent quarters, the credit scores on our customers in that book have averaged, Tim, 780, 790?
Originations this year have averaged 792.
792 credit score on this year's originations. It's a high-prime, super prime type customer base. There's a strong emphasis on lifestyle customers, people who have owned multiple RVs and multiple boats before, so they understand what they're getting into. That combination of emphasis on high credit scores and lifestyle customers typically means that your customer base has high-income metrics and high balance sheet metrics. As we said in the management comments, we have grown really excited about this unit because it is a unit that allows us to get much more exposure and diversification of our portfolio to the consumer sector, while at the same time being true to our standards of high credit. Many ways that you would get exposure in the consumer credit environment, you wouldn't get that high credit, and you wouldn't insulate yourself from wide swings in credit performance in economic cycles.
We feel like this business really gives us a high net worth, high income, high credit score customer that will be resilient in economic downturns and is a good exposure and a good diversification of our portfolio toward the consumer sector. The question about yield, the net of the amortization of premiums that you pay for that paper, we do pay a premium for that paper. Net of the amortization of that premium over the expected useful average life of those loans, the yields on the portfolio are just very close to the yields on our total portfolio of non-purchase loans. It's not dilutive or accretive in any meaningful way to our yield on non-purchase loans. It's really tracking right in line with the average on that. It's a good yielding portfolio with high credit quality in our view. How big can it get?
We think that has a significant growth trajectory. As you can see on, I think it was page seven of our management comments. There's a graph at the top of that that shows the growth trajectory of that and the growth in the number of RV and marine dealers that we're doing business with across the country. We expect both the volume of the portfolio and the number of dealer relationships to continue to grow. You noted that it was a lion's share of our non-purchase loan growth in the quarter just ended. I would note and caution you to not expect Q2's growth to necessarily be repeated in Q3 and Q4 because it is somewhat of a seasonal business. In most years, we would expect that the second quarter, based on seasonal factors, would be the largest quarter of growth for the portfolio.
Really helpful color. Thank you.
Thank you.
Thank you. Our next question will come from the line of Timur Braziler with Wells Fargo Securities. Your line is now open.
Hi, good morning.
Good morning.
My first question is around the deposit base. Looking at betas versus growth this quarter, would love to just hear any more color on what was driving the beta, specifically in Q2. Was that all posted rates? Was that all negotiated rates? Kind of any color behind that would be helpful.
Tim, I don't know that I can give you a lot of meaningful color. I would tell you it was in part negotiated rates, part RFP rates. We had some relationships that we have had public funds and other relationships that were under RFPs from earlier dates that those cycles of that business came up to reprice that, rebid that. We got a little push in our cost of funds from some of those. Then it was in some markets on some product types, posted rates as well. It was really a combination, and I don't have a breakdown. Tyler, I doubt you have a breakdown at your fingertips on that.
I don't have the breakdown, George.
That's about all we can tell you. It was kind of a combination of factors.
Okay. Going back to Ken's question and your answer about looking at different strategic initiatives currently to try and lower beta going forward, any additional color you can provide on that? What's the opportunity to really tap some of the more rural markets, and align the deposit market share closer to the branch market share?
Well, certainly, I think there's a tremendous capacity to align our market share in line with our branch infrastructure over time as we need to do that. That really is what I would say about the second part of that question. The first part of that question, the answer is yes, I could give you a lot of details about actions that we're taking or initiating to try to reduce that deposit beta in Q3 and Q4, I'm not going to do so for competitive reasons, if you don't mind. I would rather be effective in doing what we're doing and implement that without telling all of our competitors exactly what we're doing, as opposed to telling you about it and then have trouble getting the results we want from it. We do have a plan of action about how we're approaching that.
We were not pleased with our deposit betas in Q2. We feel like we can refine some of our approaches and strategies in that regard. Not changing them in any broad wholesale way, but just tweaking how we're doing that and get better results in the coming quarters. As I told Ken, there's no guarantee about that, but we think we've got an approach that will be helpful.
Okay. That's understandable. Just one more for me, just circling back on the indirect RV and marine portfolio. As you think longer term, obviously credit's been phenomenal for the bank as a whole, but as you think longer term for this product set going through the next cycle, whenever it may be and how severe it might be, just can you give us some color around just broader allowance methodology, allowance trajectory? Should we expect to see kind of continued build with allowance as that portfolio gets bigger, or are you thinking the inherent loss profile there isn't going to be very different than what you've seen at the bank as a whole?
Well, obviously the loss profile on that portfolio will be probably more like our other consumer small business portfolios and less like our RESG portfolio. To give you a perspective on that, I think at June 30, when we did our modeling calculations on that portfolio, we had a 1.07%. Am I remembering? Yeah, we had 1.07% allowance for that portfolio, and that compares to a 0.74% allowance for the total portfolio. Obviously, there are two factors that play into that. One, those are longer duration loans on their contractual face amount. So we're holding more allowance for the longer duration of those. Two, just consumer credit is going to have a slightly higher loss profile than our RESG portfolio, even if it's high prime, super prime type credit, we believe based on our modeling.
It's a relatively modest difference, but not concerning to us at all. Again, I think the key to the pursuit of this line of business for us is we believe it gives us diversification and exposure to the consumer segment, and we said this in the comments, in a way that's consistent with our commitment to excellent credit quality.
Understood. Thank you.
Thank you.
Thank you. Our next question will come from the line of Jennifer Demba with SunTrust. Your line is now open.
Hey, Jennifer.
Morning, George. Question for you. You said that demand has slowed a bit for the RESG loans. I think you said it wasn't geographic in any way. Has there been any difference in demand in product type that you've noticed?
Nothing appreciable, no.
Okay. One more question on the marine and RV loans. What is the average size of those loans?
It's roughly around $100,000.
Okay. How comfortable as a percentage of the total loan portfolio are you comfortable growing that to over time?
Jennifer, I think it will grow. We haven't set any sort of growth limits on the portfolio. While these loans tend to be longer term, fixed rate loans, the reality is they're probably somewhere between three and four years in average life because of the fact that being high income, high net worth borrowers predominantly, these customers tend to trade up on a fairly frequent basis, and they tend to have the capability to pay off these loans fairly quickly. It's really sort of three to four year average life product. What I would tell you is you probably see us continuing to have pretty good percentage year-over-year growth in that product category for the next couple of years.
As that portfolio gets to more of a mature state, two or three years out, where we're having a lot of payoffs in that portfolio and a lot of trade ups in that portfolio, the growth probably gets then to more of a long-term sustainable growth rate. I think we've got a pretty good runway for a nice percentage growth of that portfolio over the next couple of years.
Thanks very much.
Thank you.
Thank you. Our next question will come from Stephen Scouten with Sandler O'Neill. Your line is now open.
Hey, good morning, guys.
Hey, good morning.
You guys have always taken a pretty long-term view on the stock, which I appreciate. I'm wondering if, given where the stock is currently trading and the fact that you mentioned you're no longer subject to DFAST and the capital raises I think we were all kind of expecting would need to occur to meet those hurdles. Do you think about a share buyback of a material proportion at this point, or is the dilution there, day one dilution, something you'd be hesitant to undertake? If so, I guess, what's the delimiting factor in terms of a capital ratio for you guys moving forward?
Stephen, good question. I would tell you all options are on the table for consideration at any time in how we manage our capital position. Obviously, we expect, as we've said in the past, to achieve good growth in the future. We'll have times when that growth will be higher than others. If history is a guide, the times when we'll have the highest growth are times when other competitors have pulled back from various spaces and provide us an opportunity to really do thoughtful, intelligent things in a meaningful way and volume. We expect to continue to need some of the excess capital we've got over what's well capitalized or adequately capitalized, plus capital conservation buffers to date. If you look at the management comments, Tim, what page was that we put that on, 30?
34. Figure 32.
Yeah. Page 34, the management comments, figure 32. We had a very nice increase in our capital ratios in the quarter just ended, and part of that was because of the reduction in capital allocated for unfunded loans as that unfunded balance went down. Part of that was the new DFAST or the new HVCRE clarifications that came as part of the Senate Bill 2155 that was signed into law. Part of that was just our organic growth and retained earnings and capital retention after the dividend. We have a generous capital position. We would expect to maintain a good cushion over what will be the fully phased-in Basel III standards for well-capitalized or adequately capitalized, plus the capital conservation buffers. Within the limits of those constraints, we've got options to consider all alternatives.
One alternative that could possibly be considered would be issuing some other form of capital to replace some common stock to some extent that would be accretive to our EPS. We're looking at that. We'll continue to look at that and make what we think are the appropriate decisions, balancing all factors.
Okay. Makes sense. Your view would be, you wouldn't necessarily bleed that 11.9% CET1 down to 10.5%. It would be more of a replacement in the capital stack with some other form of capital?
Again, there are a lot of variables and a lot of options there.
Okay.
One option would be to replace some common equity if we did a stock buyback with either sub-debt or preferred or some other form of capital, the swapping of which would be net accretive to EPS. We're not saying we're going to do that. We're just saying we're evaluating all options.
Yep. Makes sense. Okay. Maybe thinking back about the core spread, one question I had on just the moving parts there, was there any sort of material impact within the non-purchase loan yields from deferred origination fees kind of quarter-over-quarter? I know that was somewhat of a negative impact last quarter in expenses and other things. I was wondering if, even though it moved up 14 basis points, was some of that quarter-over-quarter impacted by the deferred origination charges and just with that seeming dislocation between the move in LIBOR and Fed funds. I guess, how can you help me think about that? Or am I just making something that's not really there?
Stephen, I don't think there was a material impact one way or the other from prepayments in the non-purchase loan portfolio or the impact of cost deferrals or anything. That was all both quarters at a fairly normalized rate, I believe. We do have impacts every day, to some degree, a few thousand dollars or a few hundred thousand dollars some days, plus or minus from loans that prepay sooner, that paid early in the life of the loan, whether we're deferred fees or deferred cost or a net of those credit or debit that impacts earnings. Both Q1 and Q2 were pretty typical in that regard.
Okay, great. Last question for me, and I apologize if I missed it in here somewhere, but the amount of offices in spin-up mode, did you give a number for that or where we are relative to where you were maybe last quarter?
Tyler, do you have that?
I do. Total bank-wide currently, I see under 44 offices. About 18% of the total offices that are in spin-up today. The specials we're offering in those offices range from 13 to 15 months from a 2.01% APY to a 2.30% APY.
Okay. What was that number? I'm trying to look it up. Was it like 37 offices last quarter that were in spin-up mode or?
Yeah, it's pretty close to that.
Pretty close. Okay.
It's been in that range for several quarters now.
Okay, great. Okay, thanks, Tyler. Thanks, George. Appreciate your color, guys.
Thank you.
Thank you. Our next question will come from the line of Arun Ghosh with Citi. Your line is now open.
Thanks. I was just thinking in terms of potential slowdown in loan growth, what your ability to dial back your operating expenses. Are there any kind of levers around that to help maybe offset some of that from an operating leverage perspective?
I would say that is fairly minimal. We, of course, operate with probably an efficiency ratio already that's probably in the top 1% or 2% of the industry. We don't have a lot of fat. We pay our lenders to make loans, and we pay our lenders to not make loans. By that, our lenders are instructed to make every good quality, good-yielding loan they can make consistent with safe, sound, and prudent banking standards. We articulate eight rules for them. We say that if you can't achieve all eight of those objectives on every loan, don't make a loan.
If we've got a lender who's operating in an environment and he looks at 100 loans over the course of this year and makes zero because competitive dynamics have made it impossible for him to make loans and meet all of our standards, then we're going to reward that guy for his discipline and his hard work in creating 100 opportunities and not punish him because he didn't produce any loans if he worked hard and went out and pursued our standards. You don't want to cut that person just because he didn't make any loans this year if he's doing his job well and following our standards because next year or the year after, he may be the guy that makes 30 of those loans.
We do take a very long-term view of this, and our Lenders understand when volume is a tertiary consideration and quality is number 1 and profitability is number 2, you have to be consistent in the way you approach your lenders on that, because they've got to understand that not hitting a certain volume metric is okay as long as you're doing the work, you're working hard, you're producing opportunities, and you're not hitting the volume metric because you're adhering to our standards for quality and profitability. That's inherent in our culture. There's not a lot of variable cost we're going to take out if our loan growth is 75% of last year's number or 125% of last year's number. It's going to be pretty much the same cost structure.
Okay. Thank you. In terms of the competition for RESG, are you seeing it more on pricing or structure? I'm just trying to get an idea. There's been some concern from investors that the return hurdles may start to go down a bit because of the giving back some of the benefit from tax reform. Just kind of curious if you're seeing it more on the pricing side.
Both. As we said in our management comments, we've seen increased competition on both structure and pricing.
Okay. Just a quick modeling question. Do you happen to have the purchase accounting accretion for the quarter, how much that was?
Yeah. It was roughly the same as it was in the first quarter, which was $12.6 million recognized during the quarter.
Got it. Okay. Thank you.
Thank you. Our next question will come from the line of Michael Rose with Raymond James. Your line is now open.
Hey, good morning, guys.
Good morning.
Hey, wanted to get back to this quarter's provision and reserve and how we should think about it as we move forward. I assume, obviously, you're building in a higher level of reserves for the RV and Marine business, and that was a good portion of this quarter's growth. As we get through 2019, how should we think about the trend in the reserve ratio, assuming that you still have pretty solid growth in that business and maybe RESG is a little bit slower? And then if you can give us your initial thoughts on what the impacts of CECL will be for you. Thanks.
Well, it's too soon to comment on CECL, I think, Greg, would you agree with that? I mean, we're doing work on that, but that's.
Yeah
1/1/2020.
Yeah, I think from a CECL standpoint, I'll let George talk to the first question. On CECL, I would say that wherever that ends up, whether it's the same allowance, less allowance, more allowance, and we're still working through that analysis, and trying to determine where that's going to be. We're probably still three or four quarters before we really begin to have some modeling results from that, Michael. Regardless of where that ends up, that's kind of a one-time, in our minds, kind of reset of the allowance, as a % of that portfolio. I think our thoughts are at this point in time, as you think about that moving forward, though, from that point, once you implement CECL, I don't anticipate there being a material change to our quarterly provisions.
I don't think CECL is going to require us all of a sudden to start booking significantly more or significantly less provision, assuming all else is the same. I think it's kind of a one-time implementation adjustment, assuming it is an adjustment. I think the ongoing provision is, again, all things being equal, not going to be materially different than where we've been running over recent quarters.
Yeah. Michael, what I would tell you on the provision expense, if you look back on page 13 of the material that was part of our press release, where we've got that eight quarters of data. Our provision expense in the quarter just ended was $9.6 million. That is not the highest in the last eight quarters. The highest was Q4 of 2016, $9.855 million. We had another $9 million quarter in Q4 of 2017. Those numbers have kind of varied from just under $5 million to just over $9 million. I think quarter to quarter, those are probably indicative of ranges we would expect to see. We're not expecting a fundamental change in economic conditions or portfolio conditions that would dictate a wide variation in that provision expense.
To George's earlier point, the RESG portfolio, we've got the history there. We understand. We've been doing that for years and years. The allowance we carry for those loans, those very low leverage loans, is at the low end of the loans we carry for be it consumer, small business, other sectors of the portfolio, just because we have the knowledge, the history, the performance there. The Marine and RV is a little newer sector for us, and we feel really good about the credit quality of that sector as well. We do carry a little higher allowance as a percent of loans in that sector.
Okay, that's helpful. Then maybe back to the expense question that was just asked. I know you guys have spent some money to build out systems and things of that sort to become a much bigger Bank OZK. Where do we stand with that? Could we see some expense leverage in the back half of the year? Is the money that you've spent over the past few quarters, will that be spent in other areas, meaning that we shouldn't expect to see kind of a net reduction as we move forward? Thanks.
Yeah, Michael, I think the comment we gave on that in one of our previous calls recently was is that we would expect to see a continued build of human infrastructure to some degree. Most of that's in place in our company, but we will continue to add some people doing some things related to this build-out of IS/IT, cybersecurity, all the elements of risk, credit review, internal audit, and so forth. We've got a few more people to add in those disciplines and other similar disciplines. We do hope that those additional cost increases will be offset by reductions in our consulting expenses.
We've been spending a lot of money on consulting work, building out a lot of this infrastructure. We expect and hope that that's going to moderate as we get more of our own people in place doing those functions and get them more effective and have less of that infrastructure build.
Okay, that's helpful. Maybe just one last one for me, just on the growth in the securities portfolio. If I remember correctly, I thought you guys were just about done with that. The commentary implies that there could be more to do. Any sense for magnitude?
No, not really. Part of that will be based on opportunity. I'm sure our regulators would always like us to hold more liquidity. Our shareholders would like us to hold less liquidity because the margins on that liquidity are not as good as other elements. It's a balancing act of achieving management and shareholder desires in regard to returns and meeting our internal requirements and regulatory expectations regarding liquidity. As our balance sheet grows, we will have to keep additional liquidity on balance sheet. We know that, expect that, and the magnitude of that is not as clear to us, we know the direction is toward having more liquidity on balance sheet.
Okay, maybe just one last quick one for me. I'm sorry. Back to Stephen question about shareholder value and unlocking it. Given where you guys are trading, would you ever consider a sale? Does that ever come into play? You're at a point where a valuation where somebody could actually make the math work, particularly in light of your growth. Just as we think about unlocking shareholder value, is that in the cards at all?
Well, it's certainly not a focus that we have, Michael. At the same time, we're a publicly traded company, and we've got to do the right thing for shareholders, and we understand that. If offers came our way and somebody offered us a substantial premium, our board would have no choice but to fairly and thoroughly consider the option. That's not a direction we're pursuing, not a direction that I think we'd go. Again, our board's got an obligation to consider all options, just as we would consider all options regarding the components of our capital structure.
Great. Thanks for taking my questions.
All right. Thank you.
Thank you. Our next question will come from the line of Brocker Vandervliet with UBS. Your line is now open.
Good morning. Thanks for taking my question. George, if we could just circle back to the growth issue, maybe you could talk about the unfunded commitments, because it seems like that it's such a massive number that should kind of carry the day, carry the rest of the year. I'm curious what's happening there. Is that what you're talking about in terms of transactions just don't pencil given higher expenses as people now look at them? Or what's happening there in terms of that pull-through?
Brock, I'm not sure I understand your question, let me try to intelligently respond to it even if I don't understand it. The unfunded balance of our construction loans, which is about 97%, probably, of our unfunded, 93% of that's RESG, and there's probably another 3% or 4% of community bank that's construction loan. The other minute part is other types of lines of credit and so forth. The vast majority of that unfunded is construction loans. In the typical loan, the vast majority of the loans were the last dollars in the transaction and the first dollars out. If we have a $50 million loan on a $100 million transaction, all of the $100 million of equity or mezz or whatever the other capital components will typically be in the loan before we fund, and we'll fund the last dollars in.
If you've got a construction loan on a project that's simple and small and easy to build, that construction loan may fund up in nine months or 12 months or 15 months. If you've got a construction loan on a really large, complex mixed-use project, and we're at 30% or 40% of the cost of that, we may not fund till the second half of year two or year three, or even beyond. The reality is that, I think your point is, why, if you got $12 billion in unfunded commitments, that's going to take care of your growth for the year. The reality is that $12 billion will not all fund. Probably somewhere 85% to 90-something percent of it is going to fund.
What does fund is going to fund some this quarter, some next quarter, some each quarter of next year, some each quarter of 2020, and there'll be little tails that will run out even beyond that. It is a long-term realization of those balances being on our books. At the same time, we've got a constant rate of payoffs. Constant may be the wrong word, an ongoing rate of payoffs that was near $1 billion in Q1, I believe, and $1.4 billion in Q2. That's just from the RESG portfolio. That doesn't count the other portfolios. There's $1 billion to $2 billion of loans getting paid down every quarter as you fund up your unfunded balances on those construction loans that are already booked and as you make new loans to create new volume.
We've got a very detailed process for managing and projecting that. At the RESG, it's a loan-level projection of how much funds every month, when a project should stabilize, when it should pay off, what the sellout rate will be on it, and so forth. We're showing on the loan level at RESG on closed loans and loans expected to be closed, what the funding on those is, what the paydowns on those are expected to be. Based on pools of loans from elsewhere in the company, we're looking at that on a portfolio and pool level of loans. We have pretty good intel that tells us how much liquidity we're going to need in any given month for the next 36 months to fund that.
Those projections are not perfect, obviously, they're much better over the next three months than they are in months 12 through 15, and 12 through 15 are much better than months 24 through 27. We're constantly re-projecting that number, looking at a 36-month forward funding forecast. Hopefully, that answers your question about how that unfunded works.
It does. Thank you very much. Is there anything you can share with us in terms of the granularity of the RESG portfolio in terms of 10 largest commitments or X% of the entire portfolio or something like that?
I don't have that data at hand. I think our average loan size last year was about $10.77 million. Is that right? $80 million?
I think the average originations was around that. The average in the portfolio is closer to $60 million.
Okay. There's approximately in the RESG portfolio today, approximately 350-ish.
Correct
loans, plus or minus, in that portfolio.
Okay.
When we're saying $77 million or $60 million as an average origination and a portfolio average, that's funded and unfunded balance.
Correct. Got it. Okay. Thank you.
Thank you. Our next question will come from Matt Olney with Stephens. Your line is now open.
Hey, thanks. Good morning, guys.
Hey, good morning.
George, I want to stick with Brock's questions on the RESG portfolio and the dynamics behind it. I think it'd be helpful to put some numbers behind it so we can understand some of the puts and takes. I believe you disclosed that the RESG paydowns were $1.4 billion in Q2. Could you also disclose what the amount of originations were from RESG in Q2? What the level of RESG advances were in Q2 as well?
Tim, you want to take that?
Yeah, Matt, the advances were roughly $34 million, more than the repayment.
That was the net growth.
That's the net growth.
Yes.
They had roughly over $1.2 billion of originations during the quarter.
Tim or George, that $1.2 billion of originations, you talked about how your sponsors are being more selective on some of the deal flow. How does that $1.2 billion compare to the previous quarters?
Q1 was Tim, what was Q1?
Q1 was right at $1 billion.
Yeah.
The average last year was over $2 billion.
Got it. Okay.
If you look at that, you can say, okay, we're running at about half the origination volume at RESG we were a year ago, and on an average basis, that would be true. The reality is, a higher percentage of our originations occur typically in the fourth quarter of each year, and that's certainly been true the last two years. We would expect some boost in that origination volume as we go through the year. Part of that is, a lot of the competitors that we deal with get annual allocations. They've got $700 million of apartment loans or $1 billion of office building loans they're going to make, and their originators are paid bonus based on achieving their goals. A lot of our competitors come out of the chute very aggressive early in the year.
They get their quotas, they get their allocations built, and they tend to go by the wayside. Our volumes in Q3 and Q4 have traditionally benefited from the fact that a lot of our competitors get out of the space after they fill their allocations. Our guys work 7 days a week, 365 days a year, and we run through the tape at the end of the year, so we tend to get an extra boost in volume into Q4. Hopefully, this year will be that way again, as it has been in prior years.
That's helpful, George. As far as the $1.4 billion of RESG paydowns, I know we've been talking about paydowns for well over a year it seems like, but how does that number in 2Q compare to the more recent quarters?
As I said, it was $1.4 billion in Q4 of last year. It was $1 billion roughly in Q1 of this year. I think $1 billion was sort of the high end before Q4 of last year. We have hit a higher number, and that just reflects the fact that we've had a lot of growth in that portfolio in recent years. A lot of those projects that we booked two or three years ago, to sort of put some color on Ken Zerbe's question and Brock's question, a lot of those projects we booked two or three years ago are stabilizing now and are either refinancing to the permanent market or if they're condos or other sorts of development loans, are selling out.
That's why we said we expect in Q3 and Q4, our run rate of paydowns and payoffs to continue to be elevated, as we've got a lot of projects that are going to CO over the next two quarters and sell out. We know that exists there. We'll have to overcome that loss of volume with new originations and fundings on the existing loans. That's why we've given the guidance we've given. Some of those projects are selling faster and are tending to move to permanent financing faster than in the past. That is tending to accelerate the realization of those paydowns.
Understood. Thank you.
Thank you.
Thank you. Our next question will come from the line of Brian Martin with FIG Partners. Your line is now open.
Hi, George.
Hi, Brian.
Hey, just one question back to that payoff question you just talked about. The payoffs, I guess if you look at the next two quarters where you've got maybe more visibility on those payoffs, and you've talked about this in the past, I just don't recall, but I guess if you look at next year and how you guys are thinking about payoffs, is there any impact from rates going up that slows down the payoffs? Or is it just based on when you book these projects and kind of how you see them unfolding? Just trying to get a gauge for how we should think about payoffs in 2019 with a little bit more color behind kind of what's going on there.
Yeah. Brian, our thought is, and our history seems to have borne this out as being about our thought is, but our thinking is that as long as rates are expected to go up, sponsors on income-producing properties are going to try to refinance as soon as they can. The reason being, if you're paying us 6% on a construction loan, you can get permanent financing that's twice as much money at 5% today that's fixed long-term. You want to get out of our 6% loan and get to the 5%, and you want to do it as quickly as possible because you think rates are going to go up next quarter and the next quarter and next year. The 5% permanent loan may become a 5.25% and a 5.5%.
The fact that the expectation is that rates are going up is encouraging sponsors to refinance long-term fixed rate faster than if they thought rates were going to fall. When we get to what we think is the peak of cycle, we would expect loans to stay on books longer because then a sponsor may be paying us 7% on a construction loan, may be able to go, again, at twice the dollar amount at 6% on a permanent loan. He's thinking, "Wow, if I wait three more months, permanent loan rates are going down.
I can get refinanced at five and three quarters, or if I wait nine more months, permanent rates may be five and a half." When we reach a point where the expectation is that rates are going down, the assets will tend to stay on our book longer because the sponsors will want to maximize their exit into their permanent financing. Now, if you're talking about condo sales or lot sales or single-family home sales, those are not going to be affected much one way or the other by rate expectations.
I got you. That's helpful. Most of my other stuff was answered. Just maybe one other thing, just going back to expenses for just one question, and that was, when you look at it, last quarter, there was the deferred cost you talked about being an impact, obviously, and then the infrastructure build, which appears to be slowing or at least kind of being remixed a little bit. Would you consider this quarter's expense run rate a pretty clean level? I understand you're still investing in the company and getting some benefit on the consulting side, but just where it sits today, was more representative or kind of a cleaner quarter from an expense standpoint and how we think about it?
I would say yes, absolutely.
Okay. All right.
Hey, Brian.
Yep
Professional fees are still a little elevated in the quarter. We would certainly hope that we can continue to pull those back down, they will likely be replaced with additional headcount and resources as we kind of swap the consulting and professional fees for personnel. I do think that the overall level of overhead is a pretty good starting point to move forward. Yeah.
Yeah. Okay.
A little bit.
Okay. I appreciate the color, guys. Thanks.
All right. Hey, Brian, I like the quote on your firm's daily note today. Thank you.
All right. Thanks, George.
Thank you. As a reminder, ladies and gentlemen, if you would like to ask a question over the phone, press star and then one on your telephone keypad. Our next question will come the line of Blair Brantley with Brean Capital. Your line is now open.
Good morning, George.
Hey, good morning, Blair.
Hey, just a couple of quick questions. Everything else has been answered. Going back to pay downs. On the purchase book, are these pay downs as expected, or are you expecting a $25 million-$50 million drop each quarter, kind of where it's been trending? How should we think about that in the view of net loan growth?
Yeah. Hey, Blair, this is Tim Hicks. Hard to predict, obviously, on those, but obviously, our portfolio of purchase loans is going down. The dollar amount of that should go down. Whether we have 10% per quarter or 12% per quarter pay down, I don't know that the percentage decline changes that much. Obviously, the dollar amount of that change should decline as the portfolio declines.
Okay, great. Thanks. Just on the fee income side, was there anything that kind of was non-recurring this quarter?
No, not really. No. We're always going to have recovery from purchase loans. We're always going to have OREO gains. Those are all one time in nature. We have a lot of those that we'll have. No, I think it seems like a pretty good run rate.
Even on the loan service and maintenance side of it, there's nothing, that's going to bounce around as well a little bit?
Well, we're getting more and more of those fees in the deals that we do today at RESG. That has had a tendency to grow over time. Nothing meaningful from a one-time item in that particular line item.
All right, great. Thank you.
Thank you. I'm showing no further questions in the queue.
Hey, thanks.
it's my pleasure to hand it--
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