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IBERIABANK Corp. (NASDAQ:IBKC)

Q2 2014 Earnings Conference Call

July 24, 2014 09:30 AM ET

Executives

John Davis - SEVP, Mergers & Acquisitions & IR

Daryl Byrd - President and CEO

Anthony Restel - SEVP and CFO

Randy Bryan - EVP and CRO

Bob Kottler - EVP and Director, Retail and Small Business

Michael Brown - VP and COO

Jeff Parker - VP and MD, Brokerage, Trust and Wealth Management

Analysts

Christopher Marinac - FIG Partners

Ebrahim Poonawala - Merrill Lynch

Jennifer Demba - SunTrust

Catherine Mealor - KBW

Matt Olney - Stephens Inc.

Peyton Green - Sterne Agee

Michael Rose - Raymond James

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the IBERIABANK Corporation’s Second Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. (Operator Instructions).

I would now like to turn the conference over to your host, John Davis. Please go ahead.

John Davis

Good morning, and thanks for joining us today for this conference call. Joining me on the call is Daryl Byrd, our President and CEO who will cover the majority of the prepared remarks and Anthony Restel, our Chief Financial Officer. The rest of our team is available to answer in the Q&A session of the call.

If you have not already obtained a copy of our press release and supplemental PowerPoint presentation, you may access those documents from our website at www.iberiabank.com under Investor Relations. A replay of this call will be available until midnight on July 31. Information regarding that replay is provided in the press release.

Our discussion deals with both historical and forward-looking information. As a result, I will recite our Safe Harbor disclaimer. To the extent that statements in this report relate to the plans, objectives, or future performance of IBERIABANK Corporation, these statements are deemed to be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are based on management’s current expectations and the current economic environment. IBERIABANK Corporation’s actual strategies and results in future periods may differ materially from those currently expected due to various risks and uncertainties. A discussion of factors affecting IBERIABANK Corporation’s business and prospects is contained in the Company’s periodic filings with the SEC. In fairness to everyone listening to the call, we ask that you push the mute button on your telephone to limit any background noise that may occur during the call.

And at this stage, I will turn it over to Daryl for his comments. Daryl?

Daryl Byrd

John thanks and good morning everyone. We are excited to report a very solid quarter, consistent with our expectations. For the second quarter of 2014 we reported GAAP EPS of $0.60 and operating EPS of $0.96, the difference being primarily non-operating acquisition and conversion provided cost. We produced very positive operating leverage as operating revenues grew by $17.8 million, while operating expense growth was only $4.6 million. That margin improvement equated to a 26% efficiency ratio on growth in the quarter. Also from an operating perspective, our return on average assets for the quarter was 85 basis points, up from 66 basis points last quarter.

As we anticipated, our fee businesses accounted nicely this quarter. Residential mortgage originations were up $123 million to $436 million for the quarter. Also the pipeline of quarter end remained strong at a $179 million, up from $157 million at March 31. Title income, broker commissions, service charge income exhibited significant improvements, again as expected. From an expense perspective we believe our focus on containing and reducing expenses continues to show great progress. In our PowerPoint supplement we have outlined the components of the 10.7 million efficiency project we announced during the quarter. Similar to what we demonstrated last year, we intend to stay very focused on those we mentioned.

We had another very solid quarter from a client growth perspective. Period-end organic loan growth for the quarter was $382 million or an 18% annualized rate, covering the rundown in the FDIC portfolio about over four times. We are very pleased with this organic loan growth. It was balanced between all of our businesses. Our organic deposit growth was $156 million or 6% annualized rate.

Non-interest deposits ended the quarter at 25% of total deposits. Over the last year we’ve drawn non-interest deposits $751 million. As we've demonstrated over the last 15 years, this organic growth has not been at the sacrifice of asset quality. Our credit quality remains stellar, legacy non-performing assets edged up 4 basis points to 53 basis points. However much of that increase was a direct result of transferring closed and consolidated branch facilities into OREO until they are sold.

Noteworthy though is the fact that we had either contracts or letters of intents signed on 10 of the 22 locations sitting in OREO. Net charge-offs for the second quarter were only 4 basis points of average loans, down from our 5 basis point average over the last 10 quarters. Yet our loan loss provision more than doubled on a linked quarter basis. We have completed, converted and created the Teche Federal transaction and welcome our new associates and clients to our organization.

We also completed the First Private transaction and have recently recruited a commercial team leader in the Dallas market. We're very excited about our growth prospects in the Dallas market, the team we have in place and the exceptional client base. Our strong organic growth, in combination with these acquisitions resulted in a $1.8 billion increase in period-end assets to $15.3 billion.

We anticipate consolidation in the banking industry will continue for a while. We continue to see favorable opportunities across many of our current and targeted markets that we believe fed our strategy very well. Many of these organizations are high-quality with management teams that we respect. While we are hopeful that these partnership opportunities will come to solution, we are mindful of the importance of continuing to improve our operating performance and executing upon our high-quality organic growth.

As always, I’m very proud of the dedication and hard work of our associates in producing strong financial performance this quarter. Based on our financial forecast, we expect our financial results for balance of the year to result in full year 2014 operating EPS to be in the range of $3.65 to $3.70. Consistent with what we communicated in first-quarter earnings conference call, we expect our operating efficiency ratio will average 67% for the remainder of the year and we also expect to achieve the full run rate $10.7 million in efficiency enhancements announced and detailed in our PowerPoint presentation.

At this point, I’ll turn the call over to John to provide more details on our results. John?

John Davis

Thanks Daryl. My remarks will focus on an update regarding acquisitions and a quick explanation how our second quarter results differed from the sell side community’s projections. Our Memphis branch acquisition and whole bank acquisitions of Teche and First Private each received timely regulatory and shareholder approvals and no divestiture was required in the Teche transaction. On May 31st we closed Teche and subsequently completed the branch and systems conversions and integration. At the very end of the second quarter we closed First Private with the conversion integration scheduled for late in the third quarter. We estimate we will record about $4 million in acquisition and conversion related costs in the third quarter and a negligible amount may occur in the fourth quarter. So Teche is in this quarter’s balances share count and income statement for one month and First Private’s balances are only in the period-end balance sheet and share count.

As Daryl mentioned, we continuing to see some excellent merger partner opportunities that reside in our targeted footprint. Many of those situations fit very well from a strategic and financial perspective with solid synergies. Another intriguing aspect is many of these opportunities provide a solid cultural fit with our organization as well which is not always the case. Unfortunately we’re not seeing many opportunities in our home State of Louisiana as we would like but I suppose that’s a sign of the extremely robust nature of many of our Louisiana MSAs. Most local economies continue to exhibit some of the lowest unemployment rates and strongest housing statistics in the country.

I’ll now do a quick comparison of our first quarter results to the second quarter results through the consensus of the 12 sell side analysts to follow on something. Our margin of 348 was well within the guidance range of 345 to 350 but was 3 basis points below the average analyst margin estimate. Those margin estimates range from 345 to 360. In the earnings release we reiterated our 345 to 350 margin guidance range for the remainder of the year.

The income on the FDIC covered loan portfolio, net of the loss share receivable declined about $700,000 but it was about $600,000 better than what we projected during our last earnings call. Essentially better yields on the portfolio than we expected outweighed the lower volumes than we expected.

For the third quarter, we are projecting the FDIC income, portfolio income, to decline $1.2 million compared to second quarter. Despite that quarterly decline, our current projections for the remainder of the year are about $1 million better than the projections we’ve provided for the same period on our last earnings call. While off a few basis points on margin, our analyst expectations are right on top of our average earning asset volume in the second quarter which resulted in net interest income very close to the average estimates.

Our reported loan loss provision was generally $1 million to $2 million more than the analyst projections. The additional provision was the result of our strong organic loan growth we experienced during the second quarter. Analyst estimates of our non-interest income results were well below our results of $48 million in non-interest income, which were on average $9 million or 20% above the estimates. Mortgage income and capital markets will be likely the primary reasons for the variance and possibly the impact of cash as well.

Mortgage loan origination volume was up 39%, mortgage loan sales volumes were up 27% and the aggregate gain on sales, not best efforts basis beginning was 82 basis points on a linked quarter basis. Gains on sale grew $6 million. The market value adjustments include $1.7 million and servicing income was up slightly. Mortgage revenues jumped $7.8 million or 77% while mortgage commission expense, which is included in non-interest expense increased $1.3 million or 57% during the quarter.

On slide 15 of the PowerPoint presentation, we provide a look at the seasonality trends in our mortgage business as measured by the weekly locked pipeline on a common size starting position basis. In this slide you can see that the significant seasonality in the mortgage activity that typically occurs between fourth, first and second quarters. We expect to see continued positive seasonal influences through the summer and normal seasonal volume reductions beginning in the fall. In addition, we had a good quarter for customer derivative commission income associated with our interest rate derivative activity. And finally, cash added a significant retail deposit base to our Company in the final month of the quarter, which benefited our non-interest income as well.

So to wrap up, our non-interest expense increased $20 million on a reported basis and $4.6 million or 4% on an operating basis. On an operating basis those expenses totaled $110 million or about $3 million above average analyst estimates. I suspect there were probably two primary reasons for the variance. First, given the strength in the mortgage and capital markets businesses, the commission payments were probably higher than expected. Again, mortgage commission expense increased $1.3 million on a linked quarter basis. Second, the addition of Teche for one month on an operating basis added $1.4 million in operating expense during the quarter.

Overall, we’re very pleased with the operating leverage exhibited during the second quarter. And just as final note, just to remind everybody in the call that as demonstrated last quarter, some of our businesses have seasonal influences which should be considered into your expectations regarding our financial results. Again, we’re very pleased with the progress achieved on many fronts we exhibit this quarter.

I’ll now turn it over to Anthony for his comments.

Anthony Restel

Thanks John. I am going to start today with a quick update of the FDIC portfolio. From a performance perspective, the net income on the covered portfolio was better than expectations. At June 30th, indemnification asset was $120 million, down $21 million or 15% since quarter one. From an expectation standpoint, I expect the pace of the FDIC portfolio resolution to remain relatively brisk throughout 2014 and then expect the balance on the indemnification asset to decline below a $100 million by year-end.

Our IA balance related to the NSF portfolio was $21 million at the end of the second quarter. As customary we have provided updated projections for the portfolio in the supplemental PowerPoint presentation on Slide 37. Although hard to believe, we have finally reached to the last quarter of loss share coverage on the capital side of non-single family portfolio. I can personally tell you that I’m glad to be moving into the later innings related to loss share accounting.

Overall I would describe our resolution progress as on track. We are not expecting any significant issues as we work the last couple of quarters of non-single family coverage. As a reminder, once loss share coverage ends in the non-single family portfolio, there is a reimbursement period for three years where we share recovery on the same proportional basis with the FDIC as we share the losses. And we have five more years of loss share coverage on the single family portfolios.

As disclosed in our 8-K filing on May 13, the Company’s next cost savings revenue enhancement initiative program started at the end of the first quarter, and is included within our forecast for the remainder of the year. I will cover our forecast in a moment, but let me touch quickly on the new initiative. Similar to the 2013 initiative with targeted run rate earnings improvements of 20.5 million, the 2014 initiative is targeted to produce run rate earnings improvements of $10.7 million by year-end.

Details of this year’s initiatives are presented on Slide 6 in the supplemental PowerPoint presentation. Approximately 93% of the initiatives are expense reduction related items and I am pleased to say that we stand at approximately 65% completion of these initiatives as of Monday of this week. We expect to realize savings this year of approximately $5.7 million, with the bulk of these savings coming in the third and fourth quarters, and the full benefit being realized in 2015.

Regarding the earnings guidance we provided last quarter, I’m pleased to provide the following updates. Our current forecast indicates the operating EPS for full-year 2014 will be between $3.65 and $3.70 which is slightly ahead of our forecast for the first quarter. We expect the tangible efficiency ratio, adjusted for non-operating items to be approximately 67% for the remainder of the year. Tangible operating efficiency ratio excluding non-operating items was 68.3% in the second quarter. And finally, we also expect the margin for the full year to be between $3.45 and $3.50.

The following major assumptions are embedded within our current forecast. The current forward curve projection on interest rates, no significant change in credit quality, no significant change to the preliminary marks assumed on the most recently completed acquisitions, no significant cash flow or credit changes on the non-single family target portfolios or related OREO, that we complete achieving the $10.7 million and recently disclosed earnings enhancement initiatives, and we have updated our mortgage and title projections to reflect the current environment and expectations.

Like all forecast, things will change and evolve through the remainder of the year. Like last year, we will change and adapt as things evolve throughout the remainder of the year. We will provide updates to the current forecast if things change materially.

And finally, a few housekeeping items. Expected savings expected to be realized in the Teche transaction will exceed our original cost savings estimates we provided of $19 million or 50% plus. Our commercial loan pipeline at quarter end was $660 million. The Company’s interest rate risk provision modelled at June 30 indicates that Company remain asset-sensitive post the Teche and First Private acquisitions. The Company’s Tier 1 leverage ratio for the quarter was based on an average asset number and I will put some transparency on expectations for the third quarter. We estimate that Tier 1 leverage ratio would have been 9.16% for the second quarter, if you looked at the ratio based on end of period assets instead of average assets.

As a reminder our 109 million of trust preferred securities remain included in Tier 1 capital today. The loan to deposit ratio was 91% at the end of the quarter. Excluding the acquisition, the -to-deposit ratio would have improved to 89%. And finally we expect our marginal tax rate to be approximately 28% in the third and fourth quarters of 2014.

Now I’ll turn the call back over to Daryl

Daryl Byrd

Anthony thanks. We are proud of the progress we achieved in the second quarter and I want to again thank our associates for their efforts making these results possible. We make sizeable investments and engaged in meaningful initiatives over the last several years. We are delighted to see continued progress in that regard and appreciate our shareholders patience while we executed on those opportunities. Finally I want to again welcome our new shareholders, clients and associates from the Teche Federal and First Private combinations.

At this point I will turn the call for questions. Cici [ph]?

Question-And-Answer Session

Operator

(Operator Instructions) And our first question comes from Christopher Marinac from FIG Partners. Please go ahead.

Christopher Marinac - FIG Partners

Daryl just want to talk about I guess some of the operating perspectives, sort of where you see directionally the return on assets heading? Is there a goal that you have to reach in that certain time frame or I guess I thought just get closer to next year?

Daryl Byrd

I think historic was up would be continued good direction for us. Yes, we’re very focused on that, enjoyed the operating leverage this quarter. I think we have opportunities continue to develop in that regard. Some of the fee businesses that we built over the last few years continue to come online for us. Anthony, any comments there on ROA?

Anthony Restel

Chris, I would just tell you, if you look at our long term goals that we’ve got out there, so obviously we’re kind of into the first year of potentially redefining those goals. If you look at that return that we’ve got out there and then you kind of back up, if you look at our tangible equity leverage ratio today which is about 12% that number can’t move dramatically higher from there. So which that naturally implies, the ROA is going to be moving up. And so I guess as implicit since we’re not telling anything different on the long term goals we’re telling you that the ROA needs to go up.

Christopher Marinac - FIG Partners

Great, thanks for that. And I guess Daryl what’s the likelihood that you do no acquisition I guess for the next year? Is there a scenario where nothing comes to life?

Daryl Byrd

Chris, the fair answer to that is we are seeing a fairly interesting amount of kind of inbound calling and we’re seeing a lot of opportunity as I mentioned in my remarks. So, you never know but I think we have kind of unique opportunities. And as I mentioned, we’re seeing some really high quality management teams and high quality companies which is pretty exciting. And it’s fairly broad from a market perspective and in the target markets that we historically talked about. So, I don’t want to handicap a one year timeframe but based on what we’re seeing, I think we’ve got a lot of nice opportunities out in for all of us. John any comments from you?

John Davis

Yes, the only thing I would add to that, Daryl described from the inbound calling perspective. But I would say also from an outbound calling perspective we found quite a bit of receptivity to our story and I guess given what's happening in the industry what we’re providing. But I’d remind you as I remind everybody, we’re very disciplined in our approach from a financial perspective. From a strategic perspective our level of interest is really narrowly scoped. We really know who it is we think would fit very well with us and there are many exclusions, because they just don’t necessarily fit strategically with where we like to go. So again I think we’ve got a pretty unique approach to the M&A process and I think that we’ve shown in the past our discipline in the pricing side. So again, very good environment right now. I think an upgrade from what we’re trying to accomplish.

Daryl Byrd

Chris, I think John’s dead on. We’ve been very disciplined. We miss on transactions, we missed on a lot of FDIC transactions when those were in vogue and we’re okay coming in second on stuff if it’s just not right for us. I will say from a risk management perspective we’ve invested heavily over the last three years and we feel very good about our risk management capabilities and our ability to convert, manage, bring-in, bring in the line kind of get like an acquisition when we do one. So I'd feel pretty strong about that.

John Davis

I do have one more thing to add Chris. I do think as we’ve mentioned probably starting about six months ago, we had assumed very good quality fits to what we’re trying to do. It hasn’t always been the case. And that’s a good positive I would say.

Operator

Thank you. And our next question comes from Ebrahim Poonawala from Merrill Lynch. Please go ahead.

Ebrahim Poonawala - Merrill Lynch

I guess, just a question I guess -- Michael is on the call as well -- on loan growth as we can sort of give a sense of trends that we are seeing on loan growth broadly speaking in terms of we are near pretty solid rate this quarter. Should we anticipate that momentum continuing or is there any reason why we should expect a slowdown as we look into the back half of the year? And secondly, just tied to that, if you can comment on the traction on the small business lending side, again this was a pretty good quarter there too. And is that still sort of in the early stages of maybe see a ramp up in that business as well?

Daryl Byrd

Ebrahim, Michael is right here and I know he's very excited to take the question on loan growth and I am sure he’ll talk about the balance in the portfolio as it developed this quarter.

Michael Brown

Yes, I was actually going to. To your question, we had good loan growth during the quarter. That has been a consistent theme of this calls for us which is obviously very important. And I think a direct function of the investments that we’ve made over the last few years, the good things relative to the quarter were that the growth was diversified. It wasn’t simply driven by our commercial business. Yes, commercial was a large part of the growth and it was in a number of individual markets. It wasn’t just dominated by one. And we also saw good growth in our consumer businesses, which was very good to see. And as you know, we saw good growth in our small business franchise. We feel good again about the investments we’ve made. The market seems to be very receptive to rewarding us for those investments relative decline growth. We don’t foresee that that will change going through the rest of the year into ’15, et cetera.

Ebrahim Poonawala - Merrill Lynch

And I guess if you could -- obviously your guidance is very clear on improving operating leverage through the rest of the year. I was wondering Anthony, in terms of when we look at the $110 million core expense this quarter, how should we think about that going forward in terms of just Teche expenses coming on board, plus you will get some cautionary out of that. Add to that your own efficiency initiatives. Is there anything that you can sort of help frame, that would be helpful.

Daryl Byrd

Ebrahim, its Daryl. I'm going to ask Anthony to expand your question a little bit and give a little bit of color in terms of the timing of the 10.7 and kind of how that played out this quarter. So I think it might be helpful as well, and how that looks for the year. Because that’s really a run rate number for the year and Anthony, you’ve got the expenses on quarter as well.

Anthony Restel

So a couple of things about the expenses. Obviously when you pullback and you get into the press releases, and you look at the operating expense increase on a quarter-over-quarter basis, that number is just shy of about $5 million. You got a couple of components. So you’ve got a month of Teche embedded. Obviously there is -- as we saw, the seasonal businesses pickup both in mortgage and in ICP. Those are heavy commission driven businesses, and so a portion of that increase comes from those businesses. And then finally --

Daryl Byrd

That’s just commission?

Anthony Restel

That’s just commission driven. And then finally the other thing I’ll just point out is IBERIABANK does annual raises in March, and so for what it's worth, the whole company, we absorb all the increase in pays starts basically for one for the company. And we put on a great job on the expense. Relative to what I would expect to see, clearly as we kind of expect our seasonal business to hold in fairly strong going through the summer months, I would expect the expect number to be fairly consistent quarter-over-quarter with the exception of some incremental expense related to having the full load of Teche on and First Private for full quarter. That will be offset somewhat by the earnings improvements that we got. So if I had to handicap it on a net-net basis, I think it will probably be in line to possibly slightly down.

I will tell you though, as we continue to see activity in different things and opportunities, my goal the way that I'm thinking about it and trying to help manage inside the bank is all about maintaining expenses. And at the same time just to make sure that our revenues significantly outpace our expense growth. So I hope that helps on your trends question. Obviously as we head towards the end of the year, we'll see the commission businesses slowdown and the expense side will come down reflecting just lower commissions as well as expense initiatives we're are working on taking hold. To Daryl's point, what I would say is, I guess I'm going back to Daryl and say give me a little bit more. So yes, we got the 10.7. We talk about -

Daryl Byrd

What got implemented in the quarter? how much actually hit during the quarter?

Anthony Restel

So we had about $350,000, to $400,000 of those initiatives. So the 10.7% run rate actually hit in the second quarter. And so what that implies is we've got about 5.3 or so for the remainder of the year and I would say if you had to ballpark it, you could split that between really the third and fourth quarter.

Operator

And our next question comes from Jennifer Demba from SunTrust. Please go ahead.

Jennifer Demba - SunTrust

A question on M&A front. Daryl, we’ve seen some companies get sidelined for a while as they deal with compliance and fair lending issues. So I'm wondering how you feel IBERIA is situated there? Do you feel completely up-to-date on those items?

Daryl Byrd

Jenny, compliance, risk management, CRA, all areas, that we tried very seriously, our Board is very focused on it, our risk management team is very focused on it. And as I said a few minutes ago, we've kind of paid our dues in that regard over the last few years. We have invested heavily in a number of different systems, whether it’s risk writing systems, ALLL systems, stress test systems, DSA systems. We’ve been investing over the last several years and I think we're in great shape. And I'd be very confident in our capability in that regard. Randy, anything you'd add to it?

Randy Bryan

Jenni, I think I would add, as a growth oriented company, we have a pretty firm understanding of our need to stay ahead of all those issues, compliance and risk management. It is our overall infrastructure. And we really look to kind of manage these things, not just a percent of our current asset size but kind of looking forward as we continue to grow. And as Daryl said we’ve invested in a lot of these things. We also invested in a lot of people, a lot of high-quality people, people that have been in these parts of the business, have a lot of experience, and we will look at it as a kind of strategic advantage to us as we continue to grow, as this environment becomes challenging, maintaining our focus on all of the things that you just described and keeping a sharp internal focus and keeping a good dialogue with all the regulators, and others in the industry. That’s what’s going on. It’s a very fundamental part how we look at our ability continue to grow the company.

Operator

Our next question comes from Catherine Mealor from KBW. Your line is open.

Catherine Mealor - KBW

Can you continue to the mortgage a little bit and just talk about the increase in the gain on sale margin? What’s driving that increase and maybe the fluctuations that we’ve seen over the past couple of quarters? And then do you believe that’s higher level gain of sale margin is sustainable for such the rest of the year?

Daryl Byrd

Bob Kottler is here and Bob is going to talk about it and Anthony is going to jump in and help out as well. I would start -- I think the first thing you focused on when you’re running a mortgage operation is the quality of the origination force that you have. And we’ve invested, we’ve grown, we’ve developed that sales force over the last several years and we’re very proud of the quality of the people we have from that perspective.

It’s very interesting and we’ve mentioned this several times in the past, our refis compared to the industry are pretty low. I think we came in at about 13% and Bob I think the industry was at about 49% still on refis. So that points to our strong kind of purchase money capability and the quality of what our originators do. Bob, Anthony, on the gain on sale.

Anthony Restel

Yes, so a couple of thoughts for you, Catherine really related to the mortgage business. I'm going to go out at it I guess from three different angles and then I’ll let Bob kind of fill in with the qualitative cover on the business itself. So going back to just talking about volumes and if you think about the mortgage performance really tied, in the easiest most simplistic way, you’ve got, volume times margin gets you the income when you kind of peel the onion back. So we spent a few minutes talking about volume. Daryl mentioned heavy purchase relative to refi. I think it’s pretty clear and I think you can go back to history and see that the purchase activity, regardless of the interest rate environment actually continues and that's actually pretty steady if you go back and look at it.

So we feel pretty good that we’re going to return just basically to the seasonal trends that we saw before the last refi wave and again expecting to have even reasonable volumes relative, just alone to the purchase activity. So, we feel really good in terms of our forecast and what we think the level of activity is going to go. Margin, itself largely driven by movement in interest rates. Obviously the 10 year treasury probably has the most impact relative to our mortgage business and if you think about it, the 10 year treasury has been kind of range bound between 250 and 275 but they were at the lower end of that.

And so as that number is moving around with our hedging and other things we have the ability to see some increase in margin flow through. What I can tell you is through where we are in July, we believe that the margin is holding relatively flat, what we saw in the second quarter which is very positive. On a longer term basis because I can’t tell you exactly where interest rates are going, I would tell you that again it’s an interest rate driven dynamic and it will tell us where the margin will go. But we feel pretty good about that. And then the third thing it hadn’t done a lot of color -- clearly as we came out of the refi ways, we’ve been focused on our earnings initiatives and expense reduction efforts.

The mortgage company has really played an instrumental role in trying to right size our business for the expectation of a lack of refi activity. And therefore we saw lot of change in the staffing size in order to be more efficient organization. So I think we’ve got three good things here working for us. As I mentioned as part of the assumptions we do have embedded within our current forecast, but we believe it reflective of current expectations for the mortgage business as of today. So I’ll turn it over to Bob for color.

Bob Kottler

Thanks Anthony. So Catherine I will give you some color on the business itself. You may remember that Chuck Quick who has run that business for a while retired a few months ago and Bill Edwards, who had been our production manager took over with David Bryles. And they’ve been very focused really on a number of thing. From a margin standpoint we constantly look at where we have opportunities and pricing and you saw some of that in the quarter. But really what we’ve done is our mortgage company if you may remember primarily has been strong in Louisiana, Arkansas and Memphis and Southeast Louisiana, Fayetteville and Memphis have been our top markets.

But we’ve also started to make investments from Texas and Florida. We brought in a new -- recruited a new mortgage market president in Florida which we think will be very good. And then we also have brought in teams in San Antonio and Houston, as well as the top producer in Memphis. So we’re very focused on making sure that we continue to have quality originators. At the same time, our originators that had been very good having their own customer basis and we have a concerted effort going to partner them up with the branches as well.

From an expense standpoint, we’ve been very focused there as well. We closed two offices out of our core markets; one in Swansea, Illinois and one in Rome, Georgia. And then we also, if you look at our staffing in the mortgages business, in spite of the fact that we’ve added some new originators, our staffing is down 3% in the quarter and 9% since the beginning of the year. So I think the mortgage team is doing a very good job of focusing on margin, focusing on volume, focusing on cost and I think you’re seeing some of the benefits of that.

Catherine Mealor - KBW

It’s very helpful. Thanks guys. And maybe one follow up. I want to see if you could talk a little bit about the small business lending book and your opportunities there. And more on that the opportunities for your NIM, how that can benefit from more growth in the small business portfolio over time? Thanks.

Daryl Byrd

Since in the last question I think the Anthony and I didn’t really give Bob a lot of time to talk.

Bob Kottler

We had good small business growth in the quarter. It was fairly broad based across our markets. One of the things that Michael and I’ve been very focused on is continuing to increase productivity of our existing banker group and I think you saw some of that. The margins are better. One of the things is that you continue to see is -- we have seen some increase in demand and so it’s been generally good from there. Michael you want to talk a little bit about this one?

Michael Brown

Yes, I mean, so the good thing about that business is really just two distinct things. One is granularity. It’s obviously a smaller loan size, so natural from a risk-management perspective offset to our larger to sort of lumpier commercial business. Two as Bob said, it’s got good returns. And that’s a function of both, the absolute rate on the loan, but also the broader relationships. We're seeing the business banking client hold a larger level of deposits relative to loan size versus our commercial client. So good growth in the quarter. We’ve seen good growth thus far this year. We still view the potential for that business to be significantly greater.

It will continue to grow as a percentage of our loan portfolio book. One of the things that's worth noting is as we acquire, small business plays a component part to that. Teche for example was really a mix of retail and small business and our expectation is that we’re going to continue to benefit from the investment in that franchise from a small business perspective. It will help us out a great deal in Acadiana from a momentum perspective. So between my comments and Bob's, I hope you get a sense for our enthusiasm for that business. It’s going to be very, very important for us, as we move forward.

Daryl Byrd

Catherine, its Daryl. I've got one more point that I would bring to the table on this one. As a company, something that we're pretty proud of is the geographic diversity of the different markets that we're in. Our dispersion across the South, Southeast, I guess significant, particularly compared to many of our peers and that gives us an ability to get kind of manage -- and kind of think it from a concentration perspective. I always say we try not to put too many eggs in any one basket. And so we’ve got a variety of markets that we’re able to grow.

We also have now a variety of businesses and while we've talked about our commercial pipeline, Bob’s talking about our business banking and small business efforts, we also have -- we have a strong consumer effort and that came in pretty strong in the quarter. So what I like is the balance. We're not landlocked to any individual market or any individual loan type. We have a fairly diverse basket of opportunities for the Company. I think that’s important.

Operator

Thank you. Our next question comes from Matt Olney from Stephens Inc. Please go ahead.

Matt Olney - Stephens Inc.

I wanted to go back to loan growth. Some of your peers, especially in Texas have talked about a higher level of pay downs in the energy book in the second quarter. Is that something you've got experience in 2Q and what’s the overall outlook for energy lending?

Daryl Byrd

Michael.

Michael Brown

Yes, so, we got into the -- our principal way to fund it is the E&P business because that’s the largest part of our energy book. We got into that business if you think about it three to five years ago and anytime you have a portfolio for that amount of time, you’re going to see some level of seasoning. The second quarter of that portfolio saw additional clients, which saw a net reduction in outstandings. Now why the reduction outstandings? It came from a couple of things. We had one of our larger clients. So again that’s not usual in that portfolio seasoning process. So we define it as churn. We also saw some of our clients tap the capital markets. That's natural and it’s actually very good if you think about it from a portfolio perspective.

So those are the clients that work with Jeff in the capital partners business and create opportunities for us for fee income. Now they go back to operating their business and they draw their lines back down again as they spend money on capital expenditures for drilling or for acquisitions et cetera. So long story short, yes, we saw some reduction in the energy portfolio, though I think that’s indicative of the future decline. I think where that industry is at this particular point in time, it naturally will be spending money to invest and we will continue to see that business grow. Jeff, our future is in your….

Daryl Byrd

Yes, Michael, I'm going to jump in and make a comment. One thing I am very, very proud of is the high quality nature of our Houston team. We have a very solid group in Houston. Particularly on the energy side it's a very strong team and I would expect them to do very well regardless of the activities in the market. I think they’ll get at least their fair share, probably more, just some quality of the people that we have and very proud of their accomplishments over the last several years and their contribution to this company. Jeff, any thoughts?

Jeff Parker

Matt, I think I would just let go some of what Michael just mentioned. We continue to have opportunity during at Texas. We continue to have opportunity to work with the lot of very seasoned management teams that have very good assets, have a lot running room in terms of growing to be done. The reserve base lending that Michael is focused on is something that is very much in the middle of our fairway that we’re comfortable with. Frankly I think that there are and continue to be an enormous number of opportunities out there. So you may have seen some pay downs in some other places. We may have had a pay down or two that Michael reflected on. We did see that acquisition of EPL, which occurred this quarter and you’re going to see some more of that. But I think there's an enormous number of opportunities out there.

Matt Olney - Stephens Inc.

Okay, that’s great commentary. And then going back to the net interest margin, I guess Anthony, can you talk about the impact of Teche on the margin in 2Q and obviously just one month impact. But I'm trying to get better feel for what the full quarter impact is going to be in 3Q just from Teche?

Daryl Byrd

Anthony will comment on that. Obviously not a lot of impact, given just the short time.

Anthony Restel

Matt, at this point, I'm not expecting much impact really from the Teche. I think relative to the decline that we saw in the first quarter really driven by two items, one obviously holding more liquidity on the balance sheet, which is going to carry call it 25 basis points of yield. So liquidity kind of played a little bit into that. And then conversely on our non-covered acquired loans, a little bit of a dip in the yield on those portfolios. I'm optimistic that that could rebound next quarter and again. But we’ve got all of this factored into the guidance we’ve provided.

Daryl Byrd

Yes, so we've got guidance that we’ve provided you.

Operator

And our next question comes from Peyton Green from Sterne Agee. Please go ahead.

Peyton Green - Sterne Agee

I was wondering -- I wanted to make sure you got the right base for the Teche acquisition. They had fees I guess of about -- deposit fees of about $9.2 million annualized and other fees of about $6.4 million. So they had expenses of about $35 million to $36 million annually. John, just as a refresher or Anthony, how close was the conversion done and then how much of a lag is there between expense saves that you might get that might fall in throughout the different timing of the third and fourth quarter, but still quite honestly with an acquisition that size, still a very tight integration.

John Davis

Yes, so couple of things Payton. Let's just start with the revenue. Obviously you're quoting kind of the Teche numbers. I’ll remind you that as a bank, over $10 billion in size we have some natural haircuts, that benefit of being so large accretes to us in the form of reduced income that we might get on interchanging a few of the things. So don’t forget the fact and I think we gave some color on that as part of the original numbers. Relative to how fast things kind of move from a conversion, post conversion. I would tell you that basically within one quarter. So I think while the last little bits of, I'll call it remnant, I guess the non-recurring items relative to Teche that are going to away, should be going within the third quarter. If I had to say how does it play out in the third quarter, I'd say maybe just kind of ball parking, it just comes down on a linear fashion through the third quarter.

Peyton Green - Sterne Agee

Okay, and then what’s a fair run off rate on the deposit side or loan side for Teche? Because I know they were in businesses and operated in a way that you all wouldn’t operate necessarily on your own?

Anthony Restel

We've got a couple of things; unlike some other businesses because Teche is such a consumer driven business, they're granular accounts. We’re not really expecting to see anything too significant out of either portfolio. Of course they’ll be -- Peyton, there'll be some depositors leave. I'll tell you that we’re running deposit campaigns. And so quite likely we could be sitting here telling you in Acadiana, we’re actually grown our number of deposit accounts. But from an overall perspective, we’re not expecting anything dramatic. Daryl do you want to add?

Daryl Byrd

Yes. Peyton, the comment I would make to you is we’ve got a fairly significant market share in branch distribution coverage in the Lafayette marketplace and in Acadiana which would be that region. And we’ve got a great team of people and really the combination between our legacy company and the Teche people that came across. So we’re pretty optimistic that we’ll do very well from a client perspective as ongoing in those markets. And as Anthony mentioned, we would expect to see fairly nominal impact.

Peyton Green - Sterne Agee

Okay, but just to put some numbers around it, it’s fair to say that if they’re generating $36 million in annual expense, you had about $3 million of it in the second quarter and then with the cost saves you indicated it would be greater than $19 million, your original guidance. So that $3 million run rate should drop to about $1.5 million a month pretty soon, I guess by the end of the third quarter. Is that fair Anthony?

Anthony Restel

I don’t recall what the specific Teche run rate was, but that all -- that sounds reasonable. Again I'm not, unfortunately Peyton, I'm not working back with from a Teche financial statement. But again I think what you're putting forth sounds reasonable.

Peyton Green - Sterne Agee

Okay. No I guess I am just trying to look back at the expense numbers because the expense low mark was in the fourth quarter and variable comp wasn’t up that significantly versus the first quarter and expenses were up about few million from the fourth quarter to the second. I know there is seasonality in it but just trying to make sure -- there is a lots of volatility about the numbers when you have cost saves like John targeted. So just trying to make sure we have a good base. Daryl maybe you can comment about the loan growth or Michael, how do you see customer behavior changing maybe relative to where it was 90 days ago or six months ago?

Daryl Byrd

Peyton, one comment I'll make is we’re seeing a little bit more of an increase in land utilization, which is I think a very good sign economically. Michael?

Michael Brown

I think there is more enthusiasm within in our clients or confidence within our clients relative to where we are economically. They are not expecting the economy to boom per se. But I think there is a belief that there is a level of stability that’s there. So it’s given them the confidence to go ahead and make some level of investment. And I think that’s showing up in increased opportunities with the existing clients as well as prospects and as Daryl noted, these lines are starting to higher utilization, which I think is a function of working capital draws to basically accommodate increased sales. Again, one of the things that was very good see was the pickup in consumer activity that you would normally see in the second quarter.

To me that’s another good sign. That would be indication that consumers are back out spending again. Obviously that will ultimately lead to activity on the commercial side as companies manufacture goods et cetera. So I'm not so very positive relative to what I'm seeing right now in terms of customer behavior.

Operator

(Operator Instructions) Our next question comes from Michael Rose from Raymond James. Please go ahead.

Michael Rose - Raymond James

Can I get a little comment or some color on the comment that you made about non-covered loan yields maybe stabilizing a little bit here, obviously down 8 basis points quarter-over-quarter, what’s going to drive that?

Daryl Byrd

A couple of things. So obviously we go through periodic re-yield exercises, look at not only the performing portfolio but the portfolio that’s actually not performing and then you start to getting into collectability of loans, collateral values and all. So as we kind of see the economy improve and just kind of looking at the trends from the most recent re-yield that we’ve gone through the last few years, and my expectation would be, one, we’ll start to see a benefit from improved collateral value on distressed properties that we have to deal with.

The second thing, quite honestly is, as we move through time just like in the FDIC portfolio, we’ll have pools close out. And my expectation is that we’ll benefit from people paying us, who we didn’t expect to pay. And again just realization of better collateral values will drive some profits. So the only caveat to that statement, it could open the OREO gain number relative to the margin, but I think there's some upside there for us.

Michael Rose - Raymond James

That’s helpful. And maybe for Michael, the commercial loan pipeline was down a little bit quarter-to-quarter. Obviously the growth -- the funded growth was very strong this quarter. Anything that you see looking out here that could drive that pipeline high over the next couple of months? Thanks.

Michael Brown

Yes, it was down a little bit. We came into the second quarter with that first quarter build, which isn’t that unusual. I'm not seeing anything out there that would indicate that we’re going see a slowdown in commercial activity. Obviously it is a lumpier business and it kind of moves around a little bit, but our general momentum across our individual markets is good. To Daryl’s point earlier and I think I had mentioned it at the end of the first quarter, we’re seeing some good activity coming out of our Florida markets and that’s an area of the country that we haven’t talked a lot about, but there is a lot more confidence in Florida today than there was last year, a year before et cetera. And I would expect we’re going to continue to see a pickup in the Florida business and which is more towards commercial and our private banking segments.

Michael Rose - Raymond James

Okay and then one follow-up question, if I could. Your asset sensitivity increased maybe a little bit more than I might have thought quarter-to-quarter. Should we expect to see that increase overtime and are you comfortable with the balance sheet positioning? Thanks.

Daryl Byrd

Michael, what we’re actively cognizant of right now is not putting on long-term fixed rate exposure. So we obviously have our derivative slops into the things that we’re working pretty aggressive to make that we don’t create, let's just call it excessive balance sheet risk. Obviously, always want to be where I can be given where interest rates are. And I'm not opposed to being more asset sensitive. I will tell you that as a corporate position, we generally try to maintain a neutral posture. And so I feel very pretty very good where we are.

Operator

Thank you. (Operator Instructions). And we have no more questions in queue. You may continue.

Daryl Byrd

I want to thank everyone for listening today and for your confidence in our organization. Again, everyone have a great day. Thank you all for attending.

Operator

Ladies and gentlemen, this does conclude our conference for today. Thank you for using AT&T for your participation. You may now disconnect.

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