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Simmons First National Corporation (NASDAQ:SFNC)

Q2 2014 Earnings Conference Call

July 17, 2014; 04:00 p.m. ET

Executives

George Makris - Chief Executive Officer

David Bartlett - Chief Banking Officer

Bob Fehlman - Chief Financial Officer

David Garner - Investor Relations Officer

Analysts

Tyler Stafford - Stephens

Michael Rose - Raymond James

Brian Zabora - Keefe Bruyette & Woods Inc.

Michael Rose - Raymond James

Operator

Good day ladies and gentlemen and welcome to the Simmons First National Corporation, second quarter earnings call and webcast. At this time all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time (Operator Instructions).

I would now like to turn the call over to David Garner.

David Garner

Good afternoon. I’m David Garner, Investor Relations Officer for Simmons First National Corporation. We want to welcome you to our second quarter earnings teleconference and webcast.

Joining me today are George Makris, Chief Executive Officer; David Bartlett, Chief Banking Officer; and Bob Fehlman, Chief Financial Officer.

The purpose of this call is to discuss the information and data provided by the company in our quarterly earnings release issued this morning. We will begin our discussion with prepared comments and then we will entertain questions.

We have invited institutional investors and analysts from the investment firms that provide research on our company to participate in the question-and-answer session. All other guests in this conference are in a listen-only mode.

I would remind you of the special cautionary notice regarding forward-looking statements and that certain matters discussed in this presentation may constitute forward-looking statements, may involve certain known and unknown risks, uncertainties and other factors which may cause actual results to be materially different from our current expectations, performance or achievements. Additional information concerning these factors can be found in the closing paragraph of our press release and in our Form 10-K.

With that said, I’ll turn the call over to George Makris.

George Makris Jr.

Thank you David and welcome everyone to our second quarter conference call. Second quarter was a landmark quarter for Simmons. We announced two acquisitions totaling approximately $3 billion in assets and today reported record core earnings and record core earnings per share for the quarter.

In our press release issued earlier today, we reported second quarter core earnings of $9.2 million and the increase of 42.8% compared to the same quarter last year. Diluted core EPS was $0.56 a share, a 43.6% increase quarter-over-quarter. Core earnings exclude $755,000 in net after tax earnings. Let me give you an overview of the non-core items from the second quarter.

First, we announced the acquisitions of Community First Bancshares in Union City, Tennessee and Liberty Bancshares in Springfield, Missouri. As a result of these acquisitions, along with previously announced Delta Trust & Bank acquisition, we recognized $823,000 in after tax merger related expenses.

Also we had net after tax gains of $1.2 million related to the sale of previously closed branches, which will offset somewhat by costs related to maintaining the properties. These were sales of branches closed during the first quarter, related to the integration of the Metropolitan National Bank into Simmons Bank. We also incurred $252,000 in after tax charter consolidation costs during the quarter. Finally, we recorded a $608,000 after tax gain from the sale of our merchant services business.

Including these non-core items, net income for the second quarter was $9.9 million or $0.60 diluted EPS, compared to $6.6 million or $0.40 diluted EPS or a 50% increase over the same period last year. Year-to-date core earnings were $16.6 million and core EPS was $1.02 per share, compared to $12.5 million and $0.76 last year. On June 30 total assets were $4.3 billion. The combined loan portfolio was $2.4 billion and stockholders’ equity was $414 million.

Net interest income for Q2 was $40.4 million, an increase of $10.8 million or 36.7% compared to Q2, 2013. This increase was driven by growth in our legacy loan portfolio and earning assets acquired through the Metropolitan transaction, offset by a decrease in accretable yield on acquired loans. Net interest margin for the quarter was 4.34%. Normalized for the accretable yield adjustment impact, net interest margin was 3.74% compared to 3.76% in Q1.

As discussed in previous conference calls, the interest income on acquired loans includes additional yield accretion recognized as a result of updated estimates of the fair value of the loan approvals acquired in our FDIC acquisitions.

In Q2, actual cash flows from our acquired loan portfolio exceeded our prior estimates. As a result, we recorded a $5.9 million credit mark accretion to the interest income. This was a $2.7 million incremental increase in accretion in the same quarter last year, which had a 19 basis point positive impact on margin.

Total accretable yield recognized during the second quarter was $8.2 million. The increases in expected cash flows also reduced the amount of expected reimbursements under the loss sharing agreements with the FDIC, which are recorded as indemnification assets. The incremental negative impact to non-interest income for Q2 was $3.3 million.

Non-interest income for Q2, 2014 was $15.4 million, an increase of $4.1 million or 36.5% compared to the same period last year. Included in non-interest income for the quarter were a couple of significant non-recurring items that I previously mentioned.

We recognized $2.3 million in pretax gains, in the sale of branches that were closed as part of our Metropolitan integration. We also recorded a $1 million pretax gain from the sale our merchant services business. We made a strategic decision to sell this unit. While we will have a reduction in revenue, the net financial impact of the company will be relatively unchanged with a significant reduction in risk exposure.

Another large item offsetting these gains was the $3.3 million increase in FDIC indemnification asset, amortization, normalizing for the non-core income and the incremental increase in the indemnification asset amortization. Non-interest income for Q2 increased by $3.9 million. The increase was primarily driven by the impact of service charge and fee income from deposit accounts acquired as part of the Metropolitan deal.

Pre-tax non-interest expense for Q2 was $39.8 million, an increase of $9.5 million compared to the same period in 2013. Included in Q2, non-interest expense were the following merger items:

Merger related expenses increased by $1.8 million from last year. We recorded pre-tax, branch right sizing expense of $300,000 associated with the maintenance of branches previously closed and held for sale. During May we consolidated three of our subsidiary banks into Simmons First National Bank and recorded $414,000 with charter consolidation costs mostly related to systems conversion.

Excluding the non-recurring, merger related, branch right sizing and charter consolidation expenses, non-interest expense increased by $7 million or 22.7% on a quarter-over-quarter basis, primarily due to incremental operating expenses of the acquired Metropolitan locations.

Our combined loan portfolio was $2.4 billion, an increase of $512 million or 27.3% compared to the same period a year ago. On a quarter-over-quarter basis, acquired loans increased by $293 million net of discounts, while our legacy loans increased $218 million or 13.2%. The legacy loan growth was driven by a $155 million increase in real estate loans and an $85 million increase in commercial loans, partially offset by a $22 million decrease in consumer and other loans.

When we make a credit decision on an acquired non-covered loan, the outstanding balance migrates from acquired loans to legacy loans. Our Q2 legacy loan growth includes $16.2 million in balances that migrated during the quarter.

Excluding the acquired loan migration, the legacy loans increased by $175 million or 10.6%, we are encouraged by the continued growth in our legacy loan portfolio during the second quarter. The double digit organic growth represents a significant improvement over the last three years and Q2 marks the seventh consecutive quarter with legacy loan growth on a quarter-over-quarter basis. During the second quarter we sold the majority of our student loan portfolio at par, which was approximately $24 million.

We continue to have good asset quality. As a reminder, acquired assets were recorded at a discounted net present value. Additionally, acquired assets covered by FDIC loss sharing agreements have provided 80% protection against possible losses by the FDIC loss share indemnification. Therefore all acquired assets are excluded from the computation of the asset quality ratios for our legacy loan portfolio.

It’s important to remember that the acquired non-covered loans are protected by a credit mark and the acquired covered loans are protected by a credit mark and 80% loss coverage by the FDIC. At June 30 the allowance for loan losses was $27.5 million; the loan credit mark was $88.8 million, for a total of $116.3 million of coverage. This equates to a total coverage ratio of 4.7% of gross loans. The allowance for loan losses equaled 1.47% of total loans and approximately 245% of non-performing loans. Non-performing loans as a percent of total loans were 60 basis points.

At June30, non-performing assets were $64.7 million, a decrease of $5.4 million from the prior quarter. The year-to-date annualized net charge-off ratio was 28 basis points. Excluding credit cards, the year-to-date annualized net charge-off ratio was 17 basis points.

Our credit card portfolio continues to compare very favorably to the industry. Our year-to-date annualized net credit card charge-offs to loans was only 1.17% through the second quarter. Our loss ratio continues to be more than 200 basis points below the Federal Reserve’s most recently published credit card charge-off industry average of 3.32%.

For Q2, the provision for loan losses was $1.6 million, up $694,000 compared to the previous quarter. Provision expense included a net $161,000 for acquired covered loans.

We’re still on schedule with our previously announced charter consolidation. We will merge and consolidate our remaining three subsidiary banks into Simmons First National Bank during August. During June we will receive Federal Reserve approval to acquire Delta Trust & Bank. We anticipate the merger will be completed during August 2014.

Regarding the Community First and Liberty acquisitions, the regulatory applications are in the process of being filed and we believe we are still on course for the Q4, 2014 closing.

In closing, we remind our listeners that Simmons First experiences seasonality in our quarterly earnings due to our AGRA lending and credit card portfolio. Quarterly estimates should always reflect this seasonality.

This concludes our prepared comments and we would like to now open the phone lines for questions from our analysts and institutional investors. Let me ask the operator to come back on the line and once again explain how to queue in for questions.

Question-and-Answer Session

Operator

(Operator Instructions). The first question comes from Matt Olney from Stephens.

Tyler Stafford - Stephens

Hey, good afternoon guys. This is actually Tyler Stafford in for Matt, how are you doing?

George Makris

Hey Tyler, how are you?

Tyler Stafford - Stephens

I’m doing well, thank you. I wanted to start on the loan growth. It looks like you had some nice loan growth within your legacy portfolio even outside of the seasonal strength of the Ag portfolio. Can you talk about the trend that you’re seeing within that Legacy book and what markets are driving that growth?

George Makris

Tyler, I’ll start and then I’ll turn it over to David Bartlett for a little more detail. I would tell you that our growth is coming from virtually every market we serve and we are seeing some of the new lenders that we hired about a year ago, our Kansas and Missouri markets starting to really have some production success up in those markets. But I’ll turn it over to David and ask him to talk about the trend that we see and maybe a little more detail about some of the markets.

David Bartlett

Hi Tyler, David Bartlett here. Thanks for the question and quite frankly we’re seeing some nice loan growth in the core areas, primarily in St. Louis, Kansas City and Wichita. Little Rock, Central Arkansas is still driving some nice long growth for us as well in the Legacy portfolio. Now we anticipate around a 7% to a 10% growth in that portfolio going forward. So that’s pretty well where see our legacy growth portfolio to advance.

Tyler Stafford - Stephens

And what about your pipelines as they stand today?

George Makris

Tyler, as David mentioned, if everything comes through that we see in the pipeline, that 7% to 10% growth rate ought to be pretty easy to attain. So, I would say they are pretty sturdy with what you’ve seen over the last two quarters at least.

Tyler Stafford - Stephens

Okay, and then switching over to M&A and just kind of a bigger picture question if you will. So you’ve got three pending bills now, how do you balance the pipeline of additional M&A opportunities with everything that’s on your plant with the integration of the existing deals. Can you give any color on that?

George Makris

Sure. I will tell you, our focus right now is clearly on the integration of these deals. We’re spending a lot of time talking to our newest friends at Liberty Bank and First State Bank and Delta Trust, to make sure we understand how to integrate their successful lines of business with ours and we’re well down the road of understanding some of their product lines that we didn’t previously have with Simons and are getting even more excited about that opportunity once we get to roll those out across the entire franchise. So that’s a high priority for us right now.

I will tell you that because of our pending size and that is about $8 billion, we are going to have to spend a little time vesting with regulators about how things will change for us once we pass $10 billion.

As we take a look at out of state opportunities, we would like those acquisitions to be big enough to be a standalone region on their own, so for us that means about $1 billion or more. I will tell you that we continued to have a keen interest in the states that we are in and filling in the footprints and also win some other contiguous stats we’ve mentored before, like Oklahoma and Texas.

We are going to defer any serious discussions until at least the end of this year and probably into the first quarter of 2015. Go through our books between now and April of 2015 with regard to closings and conversions, so anything we would do would have to occur after that timeline.

Now I’m not speaking of any relatively small deal that we may run across in the meantime and that would make a strategic sense for us. For instance, some very specific line of lending or very compressed geographic coverage area that would fill in very well. We might be able to handle something like that, but any large acquisition we think is a 2015 project.

Tyler Stafford - Stephens

Okay, that’s helpful George. I appreciate it.

George Makris

Sure

Operator

The next question comes from Brian Zabora from Keefe Bruyette & Woods Inc.

George Makris

Hi Brian

Brian Zabora - Keefe Bruyette & Woods Inc.

Hi, good afternoon.

Bob Fehlman

Hi Brian

Brian Zabora - Keefe Bruyette & Woods Inc.

One question I had on the gains that you recorded. You said something about the merging gain. Was that in other income, other fees or does that flow through another line item. I just want to double check where it came from.

Bob Fehlman

Other income Brian from the income statement, the non-interest income category.

Brian Zabora - Keefe Bruyette & Woods Inc.

So credit card fees, that’s all organic, that was pretty strong. Can you give a sense – are you expanding your operations to maybe Metropolitan or maybe talk about a little bit of the spreads of the credit card fee line item.

George Makris

I’ll tell you first, the credit card income was really up about 4% or so. That was really a re-class related to the Metropolitan after the conversion, and if you look up in other service, charges and fees, that was down about that like amount. So yes, it looks like it’s up about 30%, but that’s really a re-class after the conversion.

Brian Zabora - Keefe Bruyette & Woods Inc.

Great, okay, that makes sense. And then could give us a sense on how much accretion interest income did you receive from Metropolitan this quarter compared to last.

George Makris

Well, let me just give you the total numbers. For this quarter our accretable yield was $8.2 million versus about $10.1 million in the first quarter, and if you look at in the press release we give you the e numbers for the quarter. The excess that we have to accrete and write-off there, we have a non-interest income. Our excess, we accreted the income $5.8 million, while our indemnification asset went down $6.4 million. So we actually had a negative impact to the P&L this quarter related to that. Metropolitan, their accretable yield was relatively flat from this quarter to the first quarter.

Brian Zabora - Keefe Bruyette & Woods Inc.

Okay. So with the margin, I mean I know there’s some seasonality, but how do you think about the margin going forward. In the second half of the year I know you got acquisitions, potential closing in the fourth quarter, but just any thoughts around the margin would be helpful.

George Makris

Well, I think first off I think when you look at us first, you need to look at what the core margin is and that takes out of this accretable component of it. But we were at 374 compared to about 375 in the first quarter, so relatively flat.

Third quarter will pick-up. That will be our highest yielding for seasonality. As we put more assets, as these loans we talked about going from 7% to 9%, 10% loan growth, as we move that from the lower costing funds and Fed funds, that yield will go up. So I would say on a core basis of the 375 will be improved from those numbers. The top number, that reportable number will be kind of volatile as we go up and down with the accretable yield over the next couple of quarters, but I would say that 435 is going to be in that anywhere from the 420 to 435 range.

Brian Zabora - Keefe Bruyette & Woods Inc.

Okay, that’s helpful. And then just lastly, the business that you saw, can you just give us a sense on may be the annual revenues and expenses, just for modeling purposes.

George Makris

Well, I’ll tell you. First off, we think the revenue down. I don’t have that number, but it’s going to be down $1 million or so, but on net side the expenses that go with it, it’s basically a wash.

What we’ve done here is we were able to get out of this line of business and take off a lot of liability off the books and yet keep our revenue and we’re having revenue sharing going forward. So revenue and the increase going forward, we think will be about a wash if we were in the business line.

Now on the gross side we will see little at a time. But in our size income statement, it will be relatively negligible in there.

Brian Zabora - Keefe Bruyette & Woods Inc.

Sounds great. Thanks for taking all my questions. I’m sorry, go ahead.

Bob Fehlman

Hey Brian, this is George. Just a little bit more on merchant services sales. It’s always hard to make a decision to get out of them, a service area. This one was not as difficult for two major reasons. One is, in 2015 the conversion to the chip credit cards is coming into play, which means that many, many merchants are going to have to convert their card readers. That is a huge capital expense and we were looking forward to it. We don’t have that expense now going forward.

And the second thing is, Bob mentioned it, is the risk associated with merchant services businesses. All that has left us at this point. We still have a great marketing agreement, so we still have a great revenue stream coming in and we can focus on what we do well and that is sales to our customers and providing that service through a third party, who quite honestly over time is going to be much more proficient at proving that service than we were going to be able to do.

Brian Zabora - Keefe Bruyette & Woods Inc.

I really appreciate all the color.

George Makris

Sure.

Bob Fehlman

Thanks.

Operator

(Operator Instructions). The next question comes from Michael Rose from Raymond James.

Michael Rose - Raymond James

Hey, good afternoon guys. How are you?

George Makris

Hello Michael.

Michael Rose - Raymond James

Hey, just wanted to get your thoughts on the provision from here. One of your instate competitors today just reiterated the fact they are going to build reserves, as the banks that they’ve acquired move from a loss – they are not loss share accounting, but switched accounting basically to more of a core basis and are building reserves because they are adding about three deals or a fair amount of assets here. How should we think about the absolute level of reserves as those deals are layered in as we move into 2015 and what provisioning can look like?

George Makris

Michael, we’re experiencing the same thing as we’re moving loans from our acquired bucket to our legacy bucket, we have to start accounting for those loan losses in a traditional manner. So you can see that we have differed income of about $6.5 million for the differential between the accretable yield and the indemnification assets, but a lot of that – not all of it, but a lot of that’s going to be taken up in the addition to our provision as all those loans migrate into our legacy portfolio.

You can expect a similar process with our pending acquisitions. Even though the marks aren't quite as substantial, who knows, as you have been used to seeing with our Metropolitan acquisition and certainly nothing like the marks we had on the loan portfolios of the FDIC acquisitions. But yes, you’re going to start seeing that mark go down and our provision go up as those loans move into our legacy portfolio.

Bob Fehlman

Michael, one of the follow-up as I say too is, as we move and just for clarification, those loans that are impaired will stay in the acquired bucket and those are the ones that have the substantial mark against them. And as long as they are on the books, until they either payoff or we resolve them other ways, those marks will stay with them, but the unimpaired loans will be accreting those marks to income under FAS 91 type rule and as George said, those will migrate to our legacy portfolio.

And as they migrate, well, I will say those loans on average will have about a 1.5% allowance if it’s typical to the rest of our portfolio, whereas the higher percent is allocated to those impaired loans.

And so for example, this year we had $16 million of Metropolitan’s loans migrate from their acquired bucket to the legacy bucket in this quarter and I think it was 25 in the first quarter. We probably have somewhere in the $50 million for the balance of the year that will migrate, and as we move into the other acquisitions, those numbers will substantially increase.

These accounting rules that we are under now, related to the loans makes it a challenge for you all on the outside to look at what are the exceptions on the provision and that allowance change, but that’s the rules we are under right now.

Michael Rose - Raymond James

Okay, so maybe the way to think about it is, as more of these loans migrate and you also have a pickup in your legacy portfolio and stuff, the trim lines are relatively good. We should not only expect the dollar amount of provisioning to go up, but also the reserve to loan ratio to move up as well as. Am I thinking about that correctly?

George Makris

Exactly, you hit it.

Michael Rose - Raymond James

Okay, and then just a follow-up. You mentioned potentially starting a plan for crossing that $10 billion threshold and obviously these three deals (inaudible), they been a lot closer. Have you kind of quantified or can you quantify any sort of incremental cost that would come or that would be required and then what would the potential Durbin hit be for you and how long do you think it would take you to be able to replace those revenues? Thanks.

George Makris

Well I’ll tell you the Durbin hit could be substantial for us in the $4 million range. So that’s going to be a big hit for us. We don’t have a timeline for making up that revenue. I will tell you this, also that most of the banks that we’ve talked to, who are currently over $10 billion, we were over $10 billion when the rules went into effects, so they sort of had the shock effect, all at one time.

I’m sure that we have ramped up considerably over that period of time and we are absorbing a lot of that cost now, not all of it. So one of our objectives is to be able to quantify what that additional cost from the increased scrutiny and regulation is going to be and particularly things like the Durbin amendment that’s going to be a huge impact on us. So, we are not quite there yet. We know it’s going to be an impact, but we can’t put a dollar amount with it.

Michael Rose - Raymond James

Okay, and then in terms of infrastructure, compliance cost, do you have any sort of outlook for what that may be incrementally?

George Makris

We really don’t – we do what I consider to be an excellent job in the compliance arena now, and we are picking up excellent compliance people in the Liberty and Delta Trust and the First State acquisitions. So as far as trained personnel, I don’t have any problem with being able to ramp up in that area. What that means with regard to how much more we have to do internally than we’re currently doing, well that’s one of the big questions that we have to answer. So I really can’t tell you right now.

Michael Rose - Raymond James

Okay, no problem. And just one final one if I could; any change to the expected closing timelines for any of the three deals?

George Makris

The only change will be the Delta Trust closing date. If you recall, I think we announced a couple of weeks ago that we made an agreement with Southern Bancorp for the sale, well actually the gift of a current Delta location in Eudora, Arkansas. That was a branch that caused us an anticompetitive issue that took us a little longer to resolve than we expected on the front end. We didn’t have any other issues with the application, we just had to get the resolved before we could get regulatory approval, and of course this requires the Delta shareholder approval, so that timeline got pushed back until we got the regulatory approval.

So all that’s on track now, just got pushed back a little bit. We had originally anticipated that the closing would be at the end July. It’s now going to be the middle of August. I would tell you that we have filed the S4 for the Delta acquisition this week. We expect to file the S4’s for the Liberty and First State acquisitions before August 1. So we are actually ahead of schedule with regard to our regulatory filings.

Michael Rose - Raymond James

Okay, great. Thanks for taking my questions.

George Makris

Sure.

Operator

(Operator Instructions). And there appear to be no further questions. I would now like to turn call back over to George Makris for closing remarks.

George Makris

Okay, thank you very much. I want to clarify one comment I just made. We will file the S4 for Delta this week. It has not been filed as of today.

I appreciate everyone listening in today, and if we don’t have an occasion to talk to you, in another three months we will look forward to talking to you then. Have a great day.

Operator

Ladies and gentlemen, that does conclude the conference for today. Again, thank you for your participation. You may all disconnect. Have a good day.

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