Bank Ozk (OZK) 2002 Q2 法說會逐字稿

Good morning. My name is and I'll be your conference facilitator.

At this time, I would like to welcome everyone to the Bank of the Ozarks' second quarter earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key.

Thank you.

Mr. Randy Oates, you may begin your conference.

Good morning.

I'm Randy Oates, Director of Marketing for Bank of the Ozarks. The purpose of this call is to discuss the company's second quarter earnings press release issued after the close of business yesterday. Our goal is to make this call as useful as possible in understanding the future plans, prospects and expectations of Bank of the Ozarks.

To that end, we will make certain forward-looking statements about our plans and expectations of future events, including statements about economic and competitive conditions, our goals and expectations for net income, earnings per share, net interest margin, net interest income, non-interest income, including service charge income and mortgage lending income, non-interest expenses, our efficiency ratio, asset quality, interest rate sensitivity, future growth and expansion and loan and deposit growth. To the extent we make these forward-looking statements, we intend to ourselves of the Safe Harbor provisions of the Private Securities Litigation Reform Act.

You should understand that our actual results may differ materially from those projected in any forward-looking statements due to a number of risks and uncertainties; some of which we'll point out during the course of this call. For a list of certain risks associated with our business, you should also refer to the forward-looking information caption of the management's discussion and analysis section of our public reports filed with the SEC.

Forward-looking statements made by the company and its management are based on estimates, projections, beliefs and assumptions of management at the time of such statements, and are not guarantees of future performance. The company disclaims any obligation to update or revise any forward-looking statement based on the occurrence of future events, the receipt of new information, or otherwise.

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

Thank you Randy, and thank you for joining us today for the conference call. We are very pleased to be reporting excellent second quarter results. If you've had a chance to look at the press release, I think you will agree that the quantity and quality of our second quarter earnings were very good.

On June 17th, we completed a two for one stock split, in the form of a stock dividend, which was effected by issuing one share of common stock for each share of stock outstanding on June three. All share and per share information we will discuss today has been adjusted to give effect to this stock split.

For the second quarter, net income was a record $3,435,000, and diluted earnings per share were a record 44 cents. That's a 55.2 percent increase in net income, and a 51.7 percent increase in diluted earnings per share, compared to the second quarter of last year, which was itself a record quarter at that time. We have now posted six consecutive quarters of record net income, and from a longer-term perspective, we have now reported 20 quarters of record net income, out of the last 22 quarters.

Our second quarter annualized return on average assets was 1.55 percent, and our second quarter annualized return on average stockholders equity was 22.41 percent. For the first six months of this year, our annualized return on average assets was 1.50 percent, and our annualized return on average stockholders equity was 22.15 percent. Let me mention a few of the highlights of the second quarter, which contributed to these good earnings numbers.

First, net interest income was up 47.1 percent, compared to the second quarter of last year, and up over nine percent from the first quarter of this year. This growth in net interest income was primarily attributable to a 19 basis point improvement in our net interest margin from the first quarter of this year, and a strong 111 basis point improvement from the second quarter of last year. This resulted in a 4.97 percent net interest margin for the quarter just ended.

For several quarters, we've been discussing the changes in our mix of earning assets and deposits during 2001, and to a lesser extent during the first half of this year. These changes have paved the way for the significant improvement in net interest margin that we achieved in 2001 and the first half of this year. We continue to actively manage and target our mix of earning assets and deposits, with the goal of maintaining or improving net interest income, while maintaining or reducing interest rate risk.

For example, in the second quarter, non-CD deposits accounted for 50.8 percent of total average deposits. That's an improvement from 47.0 percent of average deposits in the first quarter of this year, and 45.5 percent in the fourth quarter of last year. Another example, variable rate loans accounted for 16.4 percent of total loans at June 30 of this year, that's an improvement from 15.8 percent at the end of the first quarter and 14.4 percent at yearend.

Secondly, another strong contributor to our second quarter performance was improved non-interest income. Second quarter non-interest income was a record $2,709,000. That's a 41 percent improvement over the comparable quarter of last year, and a 24 percent improvement over the first quarter of this year. Our strong performance in non-interest income was primarily result of record growth and income from deposit account service charges. These were up 97 percent from the second quarter of last year and 20 percent from the first quarter of this year.

During the second quarter, we continued to have a very favorable response and very favorable results from our new bounce-proof security product, which we launched in early January of this year. In addition, we continue to enjoy excellent growth in our number of core deposit account customers, which contributed to our growth in deposit account service charge income.

Obviously our results for both the first quarter and the second quarter of this year were driven by record net interest income and record non-interest income in each quarter. Achieving strong revenue growth is a key to the successful implementation of our branching strategy. As we open new branches, we continue to add additional overhead costs. Our goal is to add at least $2 of additional revenue for each dollar of overhead cost added, thereby maintaining our efficiency ratio below 50 percent.

Despite increased overhead costs in the second quarter, our efficiency ratio for the quarter was 46.6 percent. That's a 170 basis point improvement from our 48.3 percent efficiency ratio in the first quarter, and a 575 basis point improvement from our 52.4 percent efficiency ratio in the second quarter of last year. We are very pleased that our efficiency ratio has been below 50 percent in each of the past four quarters.

Although our ratios of non-performing loans to total loans and non-performing assets to total assets increased somewhat during the quarter from the first quarter level, our second quarter asset quality ratios were still very favorable. At quarter end, our non-performing loans equaled just 37 basis points of total loans. That's seven basis points higher than the second quarter of last year.

At quarter end, our non-performing assets were just 31 basis points of total assets. And that is six basis points lower than the second quarter of last year.

Our ratio of loans past due 30 days or more - and, again, this is a 30-day past due ratio, not a 90-day ratio, and it includes all non-accrual loans - as a percent of total loans with 69 basis points. And that's the lowest 30-day past due ratio at the end of any quarter since we went public in 1997.

Our net charge-offs were very favorable in the second quarter, with annualized net charge-offs equaling just 16 basis points of outstanding loans. That compares favorably to 20 basis points in the first quarter of this year and 24 basis points for the full year of 2001.

We are pleased to report that our allowance for loan losses increased to $9.6 million, a 1.49 percent of total loans as of quarter end. That compares well with $7.1 million, or 1.30 percent of total loans at June 30 of last year, and $9 million, or 1.45 percent of total loans at the end of the first quarter this year. The increase in our allowance for loan losses in recent quarters reflects our cautious outlook regarding the current uncertainty about economic conditions, as well as the change in the mix and the size of our loan portfolio. At quarter end, our allowance per loan losses was a strong 404 percent of our non-performing loans.

We are comfortable with the adequacy of our current allowance per loan losses at 1.49 percent of outstanding loans. While the reserve ratio may increase or decrease somewhat, depending on changes in economic condition, or the mix and quality of our portfolio, at this time we do not anticipate that the loan loss reserve will change materially, but will increase or decrease roughly in tandem with the size of our loan portfolio.

Given current economic conditions, and the asset quality challenges facing many banks, we're extremely pleased with our excellent June 30 asset quality ratios. As I've said before, we know that we are not immune to the impacts of the current economic slowdown, but we continue to be very pleased with the job our staff is doing in both credit underwriting and problem asset resolution. Like bankers in many parts of the country, we have seen some up tick in bankruptcy filings, layoff announcements and business closings, but to date these factors have not had a material affect on our asset quality ratios.

After sluggish loan growth in the first quarter, our loans grew $30.4 million in the second quarter. For the first six months of this year, our loans have now grown at an annualized pace of ten percent. We continue to expect our loan growth for the full year of 2002 to be in the high single-digits to the mid teens. Deposits grew roughly $31.2 million during the second quarter. Our deposit growth, again, moved roughly in tandem with our loan growth, in both the first two quarters of this year.

As we have stated previously, we expect deposit growth to generally move in tandem with loan growth, and therefore we are expecting deposit growth for the full year of 2002 to also range from the high single-digits to the mid teens. We want to maintain our loan to deposit ratio in the range of 85 percent to 95 percent. Let me give you some specific guidance regarding some other numbers, of course, again, all of our guidance is qualified in its entirety by our previous admonitions regarding forward-looking statements.

The second quarter net interest margin of 4.97 percent will probably be the highest of any quarter this year. Assuming no significant changes in our competitive environment, and only moderate increases in interest rates later in the year, we now expect to achieve net interest margin for the remainder of the year near the range achieved during the first two quarters. A significant acceleration in competition could adversely affect our margin, and even with the transformation of both sides of our balance sheet over the past year and a half, we are still somewhat liability sensitive, and therefore a rapid acceleration in interest rates could negatively affect our margin.

In the coming quarters, we expect to continue to grow our number of core deposit account customers. We expect service charges on deposit accounts to grow roughly in tandem with our deposit growth rate over time. Of course these service charges will vary a bit from quarter to quarter, but we do not expect further growth of the magnitude that we've achieved in the first two quarters of this year.

As expected, second quarter mortgage lending income was down from the level of last year's second quarter, but it was still a very respectable $498,000. In fact, that was actually a slight improvement from $494,000 in the first quarter of this year. As we've noted previously, this sector is very rate sensitive and significantly impacted by refinancing activity. During the quarter just ended, 47 percent of our mortgage loan volume was for home purchases, and 53 percent was for refinancing. It's difficult to predict mortgage lending income, but I will share two thoughts on this subject.

First, our mortgage pipeline for July looks good, which is probably due in large part to the more favorable interest rate environment than we had expected at this point in the year. And secondly, our goal continues to be to increase our market share in the mortgage business in 2002 with the hope that this will offset some or all of the expected decline in the overall level of originations from the very favorable level of 2001.

Our non-interest expenses increased in both the first and second quarters for several reasons, including new office openings, preparation for additional new office openings, higher bonus accruals, higher marketing expenses and an increase in losses in deposit accounts due to our new bounce-proof security product. We expect non-interest expenses to continue to grow throughout 2002 as we open additional offices.

In addition to the two offices, which we opened in the first quarter, we expect to open three offices in the third quarter. These offices include our second temporary office in Conway, which we opened earlier this week; a new grocery store branch in Hot Springs Village; and our sixth Little Rock office in the new Cantrell West Office Building on Cantrell Road. We estimate that these offices will add approximately $125,000 pre-tax to our third quarter overhead cost. This will increase to approximately $215,000 pre-tax in the fourth quarter, when these three offices are opened for the full quarter.

We do not now expect to open any additional offices during the fourth quarter. These openings will give us a total of five new offices in 2002, and that's consistent with our earlier predictions of four to six new offices opening in 2002. We expect roughly the same number of new office openings in 2003.

In addition, the growth in non-interest expenses from new office openings we expect to incur approximately $130,000 of additional pre-tax cost in the third quarter, related to staff training and conversion to a new check imaging system. This system should have favorable long-term effects on our overhead cost, but it will create a noticeable increase in our third quarter overhead, as we expense the cost of conversion and training of personnel. Given our expectations for revenue growth in the third quarter, our goal and expectation is that we will still be able to achieve an efficiency ratio below 50 percent for the third quarter, notwithstanding the opening of three new offices and implementation of this check imaging system.

Our oft-stated goal is to improve net income each quarter compared to the preceding quarter. With the 44 cents of diluted earnings per share for the second quarter, we have certainly set a high level of performance to match.

The quality of our second quarter earnings was excellent. And assuming that economic interest rate and competitive conditions remain fairly stable, we believe that we can improve modestly on the second quarter results in this current quarter. However, I will point out that this is a challenging goal, given the expected cost of new office openings and check imaging conversion this quarter. But that is our goal; we believe it is a reasonable and achievable goal. And, once again, we're very excited about the opportunity to pursue it.

At this time, we will entertain questions. Let me ask to once again remind our listeners how to queue in for questions.

At this time, I would like to remind everyone, in order to ask a question please press star, then the number one, on your telephone keypad. We'll pause for a just a moment to compile the Q&A roster. Your first question comes from .

First of all George, another very, very good quarter. Let me ask you one question, loan growth was a very, very healthy for you guys. Can you give us a little feedback or thought on is it, you know, where is it coming from as far as geographically, and is there any type of, is it more on the business side, and sort of a mix of it a little bit?

OK. Good question. We were very pleased with the loan growth after a very nominal growth figure in the first quarter, the 30 million plus in second quarter was very encouraging. And it was particularly encouraging to us because it was very broad based. It came fairly evenly from our different offices, both rural offices and urban offices contributed in a nice way to that growth. And it came from both the consumer sector, the mortgage sector and the commercial sector, it appears at this point that it was very broad based and diversified.

Of course, as I've mentioned in previous calls, we continue, because of our more significant expansion in recent years in urban areas, to see the percentage of our portfolio in residential and consumer lending decline as the percentage in commercial and commercial real estate lending increases. And that's just a reflection of the trend of opening more offices in more urban markets that have more commercial business. But for the quarter it was actually, the growth came from all categories, and we're very pleased with that.

Great George. Thank you.

Thank you .

Your next question comes from .

Well good morning. Nice numbers.

Thank you very much.

Couple of questions. Could you talk first a little bit about your market share gains, which markets those seems to be coming from? And then I'll ask the next question.

OK. Well on the, as I said in response to question, in the loan category, the market share gains seem to be fairly broad based across the, across the franchise, with a number of offices contributing to the loan growth. In the deposit categories, and I haven't studied this number in as much detail, , but I'm fairly comfortable saying that the majority of our deposit market share gains are probably in our urban markets.

We continued to have very strong growth in those markets, and of course that's Littlerock north, Littlerock metropolitan area, which we entered in 1998, and the Fort Smith area, which we entered in 1998 and most recently the Conway market, which we have just entered with two temporary offices this year. So I think those urban markets are contributing most significantly to the deposit growth. But we have had growth, pretty much across all the markets this year on the deposit side. That was one of the most encouraging things early in the year, is that we had growth in net numbers of new accounts in almost every market in which we operate. So it is broad-based, but the growth there on the deposit side seems to be concentrated in the urban markets.

And secondly, you're planning for another four to six new locations in 2003. What's your expectation as to how those are going to be sequenced throughout the year? Meaning one a quarter or a little more front-end loaded or back-end loaded or how are you looking at that?

We would probably expect a couple in the first quarter, and then probably, you know, about one a quarter going forward.

OK.

And those offices would primarily be concentrated again in and around the metropolitan Little Rock area and Conway and Fort Smith. We'll probably open one more in Fort Smith, one more in Conway and two or three or four around the metro Little Rock area, most likely.

All right. Terrific - thanks again.

OK. Thank you.

Your next question comes from .

Good morning, George. Can you comment - where are you seeing the deposit growth come from? Are there any particular competitors? And you mentioned also that - or at least you alluded to the fact that conditions might get more competitive. Did you see anything in the second quarter that indicated that?

Well, good question. First, where is it coming from, as far as our competitors, let me answer that. I think, again, we're benefiting from some business from a large number of competitors. And, , as I've said several times, I think we're very well positioned in the market to compete both against the larger competitors and the smaller competitors.

We have the products and services that really let us compete with the big guys, but a deep commitment to a very high level of personal service that lets us look a lot like the small guys from a service perspective. And that has let us gain market share. That combination has let us gain market share from both sides of the competitive landscape there.

Probably the majority of our market share gains are continuing to come at the expense of the larger out-of-state banks. And I'm not sure, frankly, whether that's because we compete with those guys than we do the small banks, or it just may be a reflection of the fact that our concentration of our branch expansion efforts from 1998 to the current period have been in the metropolitan markets, where those guys have much larger market share than the smaller banks. It's probably a combination of those two factors.

Your second question, have we seen much of a change in competition over the last quarter, and, , I would say no. That the level of intensity of competition for both loans and deposits has probably, in my view, been roughly stable throughout the first six months of this year. We've not seen a particular acceleration in competitive pressures or a moderation in those pressures.

As I've said many times, we operate as I guess almost all banks do in this day and time in what seems like a very competitive environment. And I think we're learning to deal with that and price appropriately and compete prudently in that kind of environment, and I think we'll be in that kind of environment for a long long time.

OK. And then just one last follow-up. How do you feel about mortgage going into the third quarter?

Well again, to reiterate the comments I made on that, really two things. One, it looks good but in mortgage lending you have the ability to see about three weeks down the pipe. So July looks good, and, you know, the July results would suggest that, you know, we're on track to do a level of business consistent with what we did in the first couple of quarters, but that could get better or worse in a heartbeat, as the mortgage business tends to do.

I'm very pleased that we seem to be accomplishing our goals of capturing more market share in the mortgage business, we're continuing to add originators there, and have added a couple just in the past few weeks. And we think that we are going to be successful in increasing our market share in the mortgage business, and that's been one of the goals.

We were expecting a more challenging mortgage environment this year than we've actually incurred, because at the beginning of the year the expectation for higher rates seemed more ominous than it does at the current time. And our goal at the outset of the year was to build our market share enough to offset any declines in the overall size of the origination pie. We knew that was going to be a challenging goal, but we do seem to be gaining some ground in market share.

OK, great. Thank you.

Thank you. Do we have another question?

Your next question comes from .

How are you gentlemen, good morning.

Good morning .

Just wanted to go back to the loan growth, and question. Could you give us a sense of, is a lot of the new loan growth coming from the new offices? And how quickly are these new offices sort of coming up to speed, in terms of a breakeven and/or being profitable? Say take the last three or four you opened?

Well the last three or four we opened are not yet profitable of course, but they do seem to be moving right along fairly consistently with our expectations . And yes, the Conway office, for example, that we opened in the first quarter, and the office that we opened in the first quarter of this year, are neither one at breakeven yet, but they are adding customers at a very good clip, and particularly on the deposit side in , that is not particularly a loan office, but primarily a deposit focused office there. And Conway, which is very much focused on both of them is proceeding very well, in line with our expectation.

We're not really seeing any particular change in the, in our ability to open these offices and ramp them up to a, to a level of profitability, from what we've seen in the past few years. They are continuing to operate and open in a very consistent manner with what we've done in the past. So we're very encouraged .

And your expectation in terms of profitability, in terms of number of years, is what? For those, as well as the ones you're going to open up this year. You said two or three, I believe.

We are looking to basically get those things to a breakeven level of operation somewhere plus or minus around the 12-months timeframe.

That's for the ones you recently opened or the ones you're going to open over the next year or so?

That would be for all of them. For all that category. You know sometimes it takes a little longer than 12 months. We have had some of them also get to breakeven before 12 months. So that's a fairly good timeframe.

You know, at this point, , the - and probably a good place to comment on this - our branching strategy is, as far as its impact on the total financial position of the company, is a fairly mature strategy at this point. And I don't mean it's a mature strategy in that it doesn't have legs that can go on and on into the future. But it's a fairly mature strategy in that we've been doing this now since the first office opened in November of 1994.

So we have branches that are really in all stage of maturation; that have been opened over the last eight years or seven and a half years. Some of those offices have reached capacity and are sort of mature offices. And instead of really trying to grow them now, we're just working on improving performance from cross-selling, and, you know, growing them at sort of an inflationary rate.

Some of those offices are 60 or 80 percent of capacity, but still have a lot of growth potential. And, you know we are looking to continue to grow those, as well as to generate more profitability out of it. Some of them are just at breakeven or shortly past breakeven. And we've got a tremendous amount of growth potential.

So I say all that to say that I don't think future office openings are going to create much ripple one way or the other in our financial results. I think, you know, the sequence of these things is they're coming in at a fairly orderly rate. Going forward, we expect to continue to pursue this strategy in a very orderly basis.

So I don't think you have to worry about us opening four or six offices in a year, and that blowing our overhead up or disrupting our earnings . Because I've got contributions to our earnings performance coming from a lot of offices that are not yet at capacity that had been opened. And the full cost has been there for, you know, a year or two or three or four years in our structure.

And just one final question. I might have missed it. You talked a little bit about the second quarter in terms of earnings projections. Did you talk about the year at all?

Well, again, I would reiterate our goal of increasing earnings on a quarter-to-quarter basis. And as I mentioned, the third quarter we're going to have a fairly significant influx of overhead related to this check imaging system. And opening three offices in a quarter, which is a little unusual for us to open three in a quarter.

But we still think it is a reasonable goal to think that we can improve on that 44 cent number in the third quarter, and certainly our goal would be to improve on the third quarter number in the fourth quarter. So we think that is a reasonable goal. As I mentioned with 44 cents in Q2 and a 22.4 percent return on equity, we're setting the bar pretty high, but if we continue to execute our business plan well, as we did in the second quarter, we think we can improve on those numbers, albeit modestly in Q3.

Just, sorry, I'll get back in queue. Thank you.

OK. Next question.

Your next question comes from .

Good morning .

Mr. , your line is open.

Good morning George. Are you there?

Yes.

OK. Sorry, I had a technical difficulty here. With respect to credit quality, it look like you commented on the non-performing loans sort of coming up this quarter. Would you characterize that as company specific or sort of a more general deterioration, and do you think that this number may be a peak or is there possibly more to come down the line, just with the general economic conditions in your markets?

I wouldn't characterize it as either company specific or a general deterioration. It's definitely not company specific, there's no one credit or, in there that contributed to that. And I don't really think it reflects a deterioration in our, in our portfolio. Yes, those numbers are somewhat higher than at the end of the first quarter, which was a very favorable set of numbers for non-performing loans and non-performing assets, but they're very consistent with our numbers of 12 months ago.

The non-performing loan ratio is up seven basis points from 12 months ago, but the non-performing asset ration went the other way, being down six basis points from a year ago. The past due ratio that is a, you know, typically probably a pretty good leading indicator of where your non-performers are going to be at some point in the future, actually was the lowest past due ration that we've reported at the end of any quarter since we went public. It's 69 basis points, and our annualized charge-offs for the quarter were just 16 basis points, which is a very, very good number.

And that number was achieved even though we very aggressively went through all the non-performers at the end of the quarter, and very aggressively valued everything in that non-performing category of any consequence. And if we felt like we had any exposure on it at all, we wrote it down. So I don't think there really is any deterioration in the quality of the portfolio. These numbers at the end of the quarter are, you know, within the range that we've experienced over the last five or six quarters, which are very good numbers, and we feel like the quality of our portfolio is as good today as it was at the end of the first quarter. The ratios just move around a bit.

This is, I would characterize it as just the normal ebb and flow of managing the process of asset quality and problem asset resolution.

reynolds? OK. And then one other question not specifically related to that. But we've talked about loan demand being pretty strong for you this quarter. And you talked about gaining market share with some of your newer branches. Absent those new branches and more mature offices, are you seeing pickups in loan demand, and would you carry that as takeaway business? Or has there been a general improvement this quarter, say relative to the prior quarter?

Yes. We are seeing demand at our offices that have been open, you know, a year to five years or six years or seven years, as I've indicated in response to the first question. The loan demand and loan growth was very broad-based this quarter across a number of our offices, which is very favorable there.

I'm sorry, what was the second part of your question?

It was just to characterize it as more takeaway business, or is it just strengthening in loan demand broadly in the markets that you're in.

I don't think we've seen a particular strengthening of demand. I think a lot of our business is takeaway business. We have benefited from a lot of customers who feel a certain disaffection for the larger out-of-state banks that have moved into the market. And we have continued, and I think will continue, for quite a while to benefit from that trend.

If we continue to work hard and provide a high level of service and get better and better at what we do, and, you know, gain service advantage and relationship advantage over our competitors, I think we can continue to grow our business from taking market share from competitors. We are seeing a fairly healthy market over here, though. Not all of our business is takeaway business. There are new projects being done and customers coming in with new deals that they're doing and want to do every day. And we're very pleased to handle that business, too.

OK. Thank you very much, guys. Good quarter.

Thank you, .

, if I could interrupt for just a minute. George, we had a - this is Randy Oates. We had a call earlier today with a question kind of as a follow-up to . And that was that - the caller asked about allowance for loan losses continued to increase in this quarter, and could we explain why it continued to increase? And did we see that as a trend. And I thought that might be...

OK.

(CROSS TALK)

That's probably a good time to answer that question. The allowance did increase during the quarter. And there are really a couple of reasons for that. The first and simplest reason is our loans grew $30 million plus. And just to maintain the allowance at the Q1 level, given that level of growth, that requires us to increase the reserve something between $400,000 and $450,000 just to keep on track with our growth.

And this is one of the challenges, of course, of growing your loan portfolio at a strong rate, as we've been doing for many years. Because you have to keep the reserve in tandem with the loan portfolio's growth, and you have to expense a lot of money as a provision for the reserve to do that. Secondly, we have a methodology that we use to calculate reserve adequacy. That methodology employs various measures and one is a formula system based on the risk rating of loans, and an assignment of a reserve allocation in accordance with that risk rating.

In view of the uncertainty about economic conditions, I think we're probably grading loans a bit more harshly than we probably would have graded loans a year ago, or two years ago, and because of that, that methodology is suggesting the need to increase the reserve from the 1.45 at the end of the last quarter to 1.49 at the end of this quarter. And again, I think we're taking a very cautious and very conservative approach to looking at asset quality, and a very cautious and conservative approach to evaluating loans for the purposes of that reserve.

So we feel the reserve is very adequate and appropriate at this time. Again, I would mention it is 404 percent of our non-performing loans, which is a very favorable reserve coverage number. And I would also reiterate the previous guidance that I gave , and that is that we would see that reserve on a go forward basis moving roughly in tandem with growth in the portfolio. We have no expectation or predisposition that we're going to increase or decrease the reserve from 1.49 percent.

We're going to do what our methodology tells us we need to do, and at this point, we don't have any suggestion or insight that it's going to suggest a further increase or a decrease in the reserve from that level. So the best guidance I could give is we'll probably move pretty much in tandem with portfolio growth going forward.

Thank you sir.

Other questions?

You have a question from .

Hi. I was wondering if you could talk a little bit about your fairly aggressive net interest margin expansion? Perhaps expand a little bit about how much might be attributable to loan mix change, the interest rate curve and any other factors? And as a result, you did state you are liability sensitive, what implications that might have when the interest rates start to rise?

All right. Good, very good question. Let me tell you that our first, I don't think that the, we have changed the quality of our loan portfolio, or investment portfolio at all, you know, a lot of times if you, if you take more risky loans, or make more risky investments, you can improve your margin, and we certainly have not done that. In fact, 96.7 percent of our loans are loans to customers in Arkansas, the 3.3 percent that are to non-Arkansas folks are to customers of ours, and it's not purchase loans, or syndicated loans or large national credits.

We very focused on lending to people we know in the markets we know, and it's not really changed. Our credit underwriting standards in recent years, to the negative at all, if anything have tightened up on that. On the securities side, 95.3 percent of our securities portfolio is triple A rated, and we've actually been shortening maturities as I've commented in several calls, in the securities portfolio, and taking substantial amounts of interest rate risk out of the securities portfolio at the same time that we've enjoyed significant margin improvement, which is a very rare thing. There are very few times in my 23-year banking career that I can say we've actually been lowering risk and improving our profit margin. Those things typically are contradictory.

We have, as I have reiterated in previous conversations, over the last 18 months been extremely on shifting the mix of our deposits. And we've grown from just about 20 percent more or less of our deposits in non-CD deposits to, in the quarter just ended, slightly over 50 percent of our deposits were non-CD deposits.

The yield on our assets in the last year, , has dropped about 111 basis points in asset yield. Is that correct? About 100 basis points. And our cost of funds during that period of time have dropped well over 200 basis points. And that has contributed to significant growth in our margin.

And this has been a result of a very conscious and very focused effort on getting away from higher cost and more rate-sensitive certificate deposits, and building substantial core customer bases in lower-costing, less volatile categories of deposit. And that really is where that margin has come from. And we believe that that change is a thoroughly permanent change in our deposit side of our balance sheet. And, therefore, we believe that the levels of net interest margin that we've achieved over the last couple of quarters are fairly indicative of levels of margin that we would hope to be able to achieve on a go-forward basis.

So I don't think that we have - I don't think that this growth in our margin is a temporary or transitory sort of thing. I believe it reflects a real permanent change in our balance sheet. And particularly the funding side of our balance sheet, that has given us a less rate-sensitive and much lower costing source of deposit trends there. And, frankly, that has all come about as a culmination of all this branch opening work and market share work and relationship-building work that we've been doing over the last four or five years in our branch program.

And then the second question you asked is how exposed are we if rates start to rise. Again, we have been over the last 18 months - and we've talked about this a number of times - moving to a much more neutral interest rate risk position, and continue to do so even in the current quarter. We are somewhat liability sensitive, but I believe now that we are very close to neutral. I think it would probably cost us a little bit of margin if rates rose; particularly if they rose a lot and quickly. But I don't believe that would have a real profound impact on our earnings results.

OK, thank you.

Thank you.

George, if I can interrupt one more time as a follow-up to that question. We did have a caller earlier today ask about - comment that the net interest margin was very good. Can we get it above five percent?

Well, again as I, as I've said in the prepared remarks, we think that the 4.97 percent is probably the highest number that we will put up for the year. It is not out of the question that we might see a small increase in that, but I think that that's probably the highest number of the year. Could we get it above five percent, yes, I'm confident that we could push the net interest margin above five percent. But I don't think we want to do so.

Obviously we'd like to have more margin than less, but to, it would be fairly easy if we took on more interest rate risk, or fairly easy if we took on more credit risk, to probably push that margin out nicely above five percent. But the margin is only one of many financial ratios that we're looking at to measure our performance, and our goal is to achieve maximum shareholder value over the long haul.

And following our disciplined credit approach, and continuing to try to reduce interest rate risk and get very, very close to a neutral interest rate risk position, we probably will not see that number over five percent. We might, if we execute our business plan extremely well, might get there, but I really don't expect that.

Thank you.

Other questions? We have time for one more.

There are no further questions.

All right. Thank you very much for your participation in the call, and we'll look forward to talking with you in about three months. Thank you very much.

Thank you for participating in today's Bank of the Ozarks second quarter earnings release conference call. You may now disconnect.