Bank Ozk (OZK) 2003 Q4 法說會逐字稿

Good morning. My name is Jeannette, and I will be your conference facilitator today. At this time, I'd like to welcome everyone to the Bank of the Ozarks' fourth-quarter 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. (OPERATOR INSTRUCTIONS) I would now like to turn the call over to Mr. Randy Oates, Director of Marketing with the Bank of the Ozarks. Sir, you may begin.

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 fourth-quarter earnings press release issued after the close of business yesterday, our results for 2003, and our outlook for 2004.

Our goal is to make the 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, mortgage lending income and trust income, non-interest expense, our efficiency ratio, asset quality, interest rate sensitivity, future growth and expansion, including plans for opening new offices and the possible conversion of existing loan production offices to full-service banking offices; opportunities and goals for future market share growth; loan lease and deposit growth; the possible prepayment of certain trust preferred securities and the effects thereof; the potential for realization of future benefits from state tax credits; and the recognition of future impairment charges related thereto. 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 will 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. Good morning. We are pleased to report record fourth-quarter results which capped off an excellent 2003 for Bank of the Ozarks. As reported in our press release, 2003 net income was up 40 percent from the prior year. Diluted earnings per share were up 35 percent. Our return on average assets was 1.69 percent, and our return on average stockholders' equity was 23.63 percent.

Loans and leases grew $191 million, or 27 percent for the year, and even excluding the $41 million of loans acquired in our RVB acquisition, 2003 loan and lease growth was $150 million, or 21 percent. Deposits grew $272 million, or 34 percent, and again, excluding the $50 million of deposits acquired in the RVB acquisition, 2003 deposit growth was $222 million, or 28 percent.

We increased our number of new banking offices in 2003 by 8 and our loan production offices by 2, giving us a total of 41 banking offices and 3 LPOs at year end. Our total number of offices increased 29 percent in 2003, yet we maintained our efficiency ratio below 50 percent and our asset quality ratios were excellent throughout the year. I could go on, but suffice it to say that the fourth-quarter and the full-year 2003 results were very good at Bank of the Ozarks by just about any measure.

However, our focus is now clearly on 2004. In the past year, we again invested heavily, sacrificing some short-term profits to pave the way for continued growth in the future. We feel that we are very well-positioned for 2004, and we are excited about the opportunities that lie ahead. Today, I want to focus my comments primarily on our plans and prospects for 2004.

First, let's talk about growth -- after all, Bank of the Ozarks is a growth company. Our growth comes from adding new customers every day. This, in turn, results in larger balances of loans and deposits, and this growth in loans and deposits is the primary driver of our growth in net interest income, or spread income, which accounts for about three-fourths of our revenue. Growth in customers also drives our growth in non-interest income, which is derived primarily from service charges on deposits, mortgages, and trusts. In 2003, we did a great job in acquiring new customers. We have excellent momentum in most of our markets, and we expect to again add large numbers of new customers in 2004.

Twice last year, in both our April and July conference calls, I increased our guidance for expected loan and deposit growth. In the July call, I stated that we expected loan and deposit growth to average from the high teens to the mid-20s per annum in percentage terms. I reiterated that guidance in our October conference call.

Our results have met or exceeded that guidance. Again, even excluding the effects of the RVB acquisition in 2003, our loans and leases grew 21 percent and our deposits grew 28 percent. Our fourth-quarter growth showed no signs of slowing, as loans and leases grew at a 23 percent annualized rate and deposits grew at a 27 percent annualized rate.

In 2004, we again expect loans and deposit growth to average from the high teens to the mid-20s in percentage terms. Now I know that some of you have a hard time getting comfortable that we can achieve that kind of growth year after year, even though we have done it for many years now. So in support of our favorable outlook for 2004, let me offer a few facts.

First, we have 29 more offices -- or 29 percent more offices at the start of this year than we did at the beginning of 2003. These offices include several new markets which we believe provide excellent growth opportunities. Among these are our first loan production offices in Frisco and Dallas, Texas, and our first banking offices in Cabot, which is the 24th largest city in Arkansas; Russellville, the 14th largest city in Arkansas; Benton, the 16th largest city in Arkansas, and Mountain Home, the 28th largest city in Arkansas. Our other 2003 new office openings include one additional office in Conway, Arkansas's 8th largest city; a new office in Bryant, Arkansas's 34th largest city, and a Little Rock suburb; one office in Little Rock, the state's largest city; and one office in Fort Smith, the state's second-largest city. In other words, we have more offices than ever before, and these offices are well located in larger markets where we can generate good loan and deposit growth.

Second, our offices opened prior to 2003 still have great growth potential. We believe that only seven of our 41 total banking offices are at substantially full capacity. While we expect these seven offices to grow on average at only an inflationary sort of growth rate, we have 34 banking offices, or 83 percent of our total banking offices, which we expect to grow on average for some time to come at a double-digit growth rate. In other words, we have more capacity for growth than ever before.

Third, we are currently operating in 16 of Arkansas's 75 counties. Our weighted average deposit market share in those 16 counties is just under 6.5 percent. Our long-term goal is to increase our weighted average market share in those 16 counties to somewhere between 15 and 18 percent. We believe that we can do this while adding only about 18 additional offices, which we expect to add over the next five years. The potential for doubling or even almost tripling our market share in existing markets while adding only 44 percent more offices shows the tremendous potential still within our existing branch network.

Fourth, we have not vigorously pursued deposit share growth in our northern and western division markets in recent years. If you study the county-by-county growth of our deposits both in dollars and market share over the last five years, you will see that the vast majority of our growth has come in the central division. Each year, we calculated the cheapest way to raise needed deposits, and each time in the past, we have determined the optimum solution did not include an offensive deposit strategy in our western and northern divisions. However, in the last few months of 2003, our higher estimates of future loan growth combined with changes in our deposit position in those markets suggested that it was time to refocus on deposit growth in our western and northern divisions. Accordingly, we have started to offer some of our newer products in those markets with excellent initial results. In fact, a good portion of our fourth-quarter deposit growth came from our western and northern divisions, and we expect that to continue in 2004 and for some years to come. We had one of our best quarters of deposit growth ever in the fourth quarter, and this shows in part the untapped potential of those markets.

Lastly, there are other factors suggesting that our future loan and lease growth will be very good. In the past two years, we have continued to add a number of experienced lenders in our established markets in addition to the new lenders hired for the offices we opened in 2003. We've also broadened our loan and lease product offerings. In early 2003, we started to more actively market consumer lending products in our central division -- previously, most of our consumer lending had been done in our western and northern divisions. For example, in early 2003, we rolled out our prime access home equity line of credit product. We had good success with this product in 2003, and we believe that we can do much more with it and our other direct consumer lending initiatives in the central division in 2004. The central division accounts for about half of our company, and we have only begun to scratch the surface of our direct consumer lending opportunities in this market.

In the last half of 2003, we also commenced operation of our new leasing division. This was in the planning stages for most of last year, as we discussed in our earlier conference calls. We are very pleased with the initial results. We have booked 113 leases, with total outstanding balances of $4.5 million. Our weighted average FICO score on these leases was 732, and our weighted average D&B CCS score was 474. Of course, CCS scores are really designed to estimate the creditworthiness of smaller companies rather than large ones, and if you delete one Fortune 500 company from our group of lessees, the weighted average CCS score for the remaining lessees is over 500. Our average residual is 6.45 percent of the lease value, and most of these residuals are guaranteed by the vendors. In fact, unguaranteed residuals, or what we refer to as "residuals at risk", are only 72 basis points on average of our outstanding lease values. These residuals are very conservatively valued, and we believe that we are more likely to have upside potential rather than downside potential from these. Our weighted average lease yield is well over 8 percent, and in fact, would continue to be over 8 percent even if all the at-risk residuals were worthless. In other words, we're getting excellent credit scores, taking very little residual risk, and getting excellent yields.

Before we started with our leasing program, we developed detailed financial models and goals for this program. And after test marketing this product for several months, we are meeting or exceeding those goals, and as I have stated, have already generated 4.5 million in leases. Based on initial results, we now expect to grow our leasing portfolio to over 20 million by year-end 2004.

Indirect auto lending was a third new product we introduced in 2003. Like leasing, we spent a number of months building our financial models and goals for this product and developing systems, processes, procedures, and contracts. Unlike leasing, we have not been able to hit our financial goals with this product. We actually originated loans totaling about $1 million on a limited test basis for two months, but we could not achieve our target return on equity. After monitoring the results weekly, we discontinued this program in the first week of January.

While this project did not prove successful, I'm very glad that we did it. The manager of this program and some of the automated decisioning models and systems that we built we think will have very useful application in our direct consumer lending programs.

In summary, our 10 new 2003 offices, the unused capacity within most of our other offices opened prior to 2003, the substantial opportunity for market share gains in most of the 16 counties in which we operate, our new focus on deposit growth opportunities in the northern and western divisions, our addition of a large number of experienced lenders, our new consumer lending initiatives in the central division, and our new leasing products all suggest that 2004 and coming years should see us produce very good rates of loan, lease, and deposit growth. It is important for you to understand that we have had nine great years of results with our growth in de novo branching strategy -- but we believe that our best opportunities are ahead of us.

I think that probably covers the subject of growth. Now let's talk about interest margin. In our last conference call, I stated that we expected prepayments to slow in the fourth quarter, that we expected a small amount of margin compression in the fourth quarter, and that we were cautiously optimistic about our prospects for a more stable interest margin in 2004. Prepayments of loans and securities did slow in the fourth quarter, and we did experience slight additional margin compression. With prior results fully restated to comply with Financial Accounting Standards Board Interpretation No. 46, known as FIN 46, our fourth-quarter net interest margin declined 3 basis points from 4.48 percent in the third quarter to 4.45 percent. Our cautious optimism about the future also seems to be borne out, as our net interest margin actually improved within the quarter from 4.42 percent in October to 4.47 percent in November and December. Since we earn the same dollars of income on securities in a 30-day month that we earn in a 31-day month, the results actually suggest some improvement from November, when our securities income was spread over 30 days, to December, when it was spread over 31 days. We continue to be cautiously optimistic about our 2004 net interest margin.

We were actually pleased with our 3 basis points of margin compression in the fourth quarter. There were a couple of things that we did to put pressure on our margin. One was that we issued $28 million of trust preferred securities in the last week of September 2003. We reinvested the proceeds in investment securities with only a small spread which was well below our target spread. That contributed to a decline in our margin. In fact, that actually took 8 basis points out of our margin on a pro forma basis. Also during the fourth quarter, we continued our efforts to increase the percentage of variable-rate loans in our portfolio. We expect that rates will rise at some point, and we have been working diligently to increase our percentage of variable-rate loans for more than two years. We've made progress in that regard every quarter, and we continued to do so in the fourth quarter, with variable-rate loans accounting for 32.73 percent of total loans at year end -- and that's up 174 basis points from 30.99 percent of total loans at September 30. Of course, we typically get lower rates on variable-rate loans than fixed-rate loans, so this continued shift in our portfolio has a short-term cost in the form of slightly lower interest margin. This also tends to lower interest rate risk and should be very helpful in maintaining margins when the rates eventually rise. Considering the trust preferred security issuance and the increasing in variable-rate loans, the slight margin compression for the quarter coupled with the slight improving trend in November and December margins actually looks very good.

The fourth quarter was our 11th consecutive quarter of record net interest income. With our cautiously optimistic outlook for a more stable net interest margin and our expectations for continued good earning asset growth -- primarily in the form of loans -- we believe that prospects are favorable for our continuing to achieve records in net interest income in each quarter of 2004.

With that said, let's turn to non-interest income. Service charges on deposits are our primary source of non-interest income. During the fourth quarter, we had our third consecutive record in income from service charges on deposit accounts. Now this number will bounce around from quarter to quarter, and it's affected by many things, including the number of working days in a quarter and weather conditions. While there may be some volatility from quarter to quarter, we expect that service charges on deposit accounts will grow nicely in 2004. We believe this growth will come both from growth in customers and from improved pricing. Our business strategy involves adding new customers constantly, and this drives our growth in service charge income. In addition, we have not had a major service charge increase in four years. After reviewing competitive pricing, we believe that it is appropriate to implement some service charge increases in 2004. Accordingly, our goal is to grow deposit account service charges in 2004 at a rate equal to or exceeding our deposit growth rate.

Our second largest category of non-interest income is mortgage income. We stated in our last conference call that undoubtedly mortgage income would decline in the fourth quarter, as the refi wave receded from the high-water mark of the third quarter. We said then that we expected fourth-quarter mortgage income to reflect a more normal level of business. This guidance was on the mark, as this category of income fell sharply. We feel that the fourth-quarter results do reflect a fairly normal level of mortgage business. Refi activity accounted for 46 percent of our fourth-quarter mortgage volume, compared to 70 percent to 75 percent in the previous quarters of 2003. Normally, the first and fourth quarters are less favorable mortgage quarters due to seasonal factors, so in the past quarter we think we saw both a cyclical slowdown and the seasonality of this business.

We have a strong mortgage origination platform, and we are continuing to add to it. Obviously, mortgage income will not be as good in 2004 as it was in 2003, but we hope that the fourth-quarter numbers do reflect a normal level of business upon which we can continue to build as we expand our origination platform in the coming year.

Trust income once again set a record in the fourth quarter. During the last two quarters, we benefited from a high level of Arkansas municipal bond issuance which resulted in us being named as trustee on a number of new bond issues. Schools and other governmental entities are taking advantages of the low rate environment to issue new debt and refinance old debt. These favorable conditions have been very good for our corporate trust income. While the corporate trust business may not be as good in 2004 as in 2003, we hope to see continued growth in other aspects of our trust business which will hopefully offset any pullback in the corporate trust area.

Here is our bottom line on non-interest income. While we don't expect to achieve non-interest income in 2004 equivalent to the levels achieved in the second and third quarters of 2003 when the mortgage refi boom was at its absolute peak, we think that the fourth-quarter results are a good baseline number from which we hope to grow non-interest income in each quarter of 2004. This growth is expected to come primarily from improvements in deposit account service charge income.

Now let's talk about non-interest expenses. The fourth-quarter non-interest expenses were up $226,000 from the third-quarter level. In our last conference call, I suggested that non-interest expenses would be flat to down in the fourth quarter instead of up. We expected this figure to decline even as we incur the expense of opening new offices because we expected variable salary and benefit costs to decline as our mortgage volume declined. We indicated at that time that variable compensation expense in our mortgage division, consisting of commissions, incentives, and bonuses, was running at about 33 percent of mortgage income. As expected, mortgage income declined, and mortgage variable compensation declined with it. Notwithstanding this, non-interest expense was still up, and the primary reason was the $320,000 impairment charge taken as part of the transaction that generated $556,000 in tax benefits, which we discussed in our press release. Excluding this unexpected impairment charge, non-interest expenses would have been down as we suggested in the last conference call.

During the fourth quarter, we also had an unusual item in other operating expense. This item totaled approximately $400,000, and it resulted from a failure in our trust division to properly implement established balancing and reconciliation procedures. We have already taken corrective actions to prevent this situation from occurring again. While a portion of this amount may ultimately be recovered, we are taking the conservative position at this point in time and assuming no recovery. This actually had only a small effect on our fourth-quarter results because we elected to reduce our planned bonus accruals to offset about two-thirds of this amount. Thus, the majority of the impact of this item was just shifted from one category of non-interest expense to the other.

The large tax credit effect in the fourth quarter, the related impairment charge, this charge in trust, and the related reduction in bonus expense all created what our analysts refer to as noise in our fourth-quarter numbers. I have done the math on these items, and if you assume that we took only one-fourth of the impact of the tax credit and impairment charges in the fourth quarter -- in effect, spreading this item ratably over the entire year, as we expect to happen with our carryover tax credits in 2004 -- and if you net out the unusual tax expense and the related reduction in our bonus accrual, fourth-quarter earnings would have been reduced by slightly less than six-tenths of 1 cent -- In other words, the net effect of all these items combined was very small. For this reason, we feel that the fourth-quarter numbers are ones upon which we can build in the coming quarters.

As I stated many times before, our goal is to continue to improve net income each quarter. This of course means reporting record income each quarter compared to the preceding quarter. We have achieved this goal in 26 of the past 28 quarters, including the last 12 in a row. Of course, the target gets higher each quarter, and we like that, because it keeps us working very hard for our shareholders. Despite the higher bar, we believe this is a reasonable goal for each quarter of 2004.

Now with that said, let me add one caveat and note of caution. As discussed in the press release, and we mentioned this last quarter in our conference call, we will likely prepay our outstanding 9 percent trust preferred securities either late in the second quarter this year or early in the third quarter. This should generate significant interest cost savings and give us a nice bump in our net interest margin if and when we do so. These trust preferred securities are prepayable, with Federal Reserve approval required on or after June 18 of 2004.

This prepayment will result in a pretax charge for approximately $852,000 of unamortized debt issuance cost. The after-tax cost would be about $518,000. Assuming a 2 percent marginal cost of funds with which to prepay these securities, it would take us approximately 8.5 months for this prepayment to generate interest savings equal to the debt issuance charge. So assuming we effect the prepayment early in the third quarter, which is a good possibility, we would expect to offset roughly three-eighths of that charge with interest savings in that quarter. That leaves us roughly five-eighths of the charge to make up with improved earnings from other sources.

Now while we're optimistic about our prospects for 2004, we realize that growing earnings enough to cover this charge in a single quarter is a very tall order. And I assure you that we will work extra hard to achieve our goal notwithstanding this item. But we simply may not be able to maintain or improve earnings in the quarter in which we take this charge. Of course, this prepayment will substantially benefit earnings in subsequent quarters.

While we're talking about trust preferred securities, we all know the recently issued FIN 46 was revised in December to clarify its application to trust preferred securities. As a result, the accounting treatment for the trust through which trust preferred securities are issued has changed. Accordingly, there's a possibility that the Federal Reserve may change the capital treatment of trust preferred securities. While we can't predict the final resolution of this issue, we do not expect it to have a material effect on our future plans or prospects in any event. Our key capital measure is tangible common equity. And as I have stated in our last conference call, our desire is to operate with a tangible common equity ratio in the range of 6 percent to 7.5 percent. At December 31, 2003, this ratio stood at 6.67 percent, well within our target range. So even if all of our trust preferred securities were not counted as capital, we anticipate that we would still be well capitalized and this would not affect our future plans for growth or expansion.

I would be remiss in closing our call without some discussion of asset quality. Although our ratios of nonperforming loans and nonperforming assets were above the comparable ratios for year-end 2002, both ratios have improved over the past two quarters. With nonperforming loans and leases at 47 basis points of total loans and leases, and nonperforming assets at 36 basis points of total assets, we continue to feel very good about asset quality. We have made good progress over the last two quarters bringing the asset quality of the acquired RVB portfolio closer to our normal standards, and we expect this progress to continue over the next couple of quarters.

Our annualized net charge-off ratio for the fourth quarter was a very favorable 11 basis points, bringing our net charge-off ratio for all of 2003 to 20 basis points. This ratio is very consistent with -- and, in fact, a slight improvement from -- the 22 basis points of net charge-offs incurred in 2002 and the 24 basis points of net charge-offs incurred in 2001.

We also have an excellent past-due ratio. Our ratio of loans past due 30 days or more -- and I remind you, this is a 30-day past-due ratio, not a 90-day ratio -- including past due non-accrual loans and leases as a percentage of total loans and leases was just 77 basis points at December 31, 2003. We increased our allowance for loan losses, loan and lease losses to $13.8 million during the fourth quarter, which keeps the allowance at 1.52 percent of outstanding loans and leases. At year end, our allowance for loan and lease losses was a very healthy 326 percent of total nonperforming loans and leases.

There are several other exciting things that I would like to discuss today, but in view of the time, at this point I think we should probably entertain questions. Let me ask our operator to once again remind our listeners how to queue in for questions. Janet?

(OPERATOR INSTRUCTIONS) Joe Stieven, Stifel Nicolaus.

Hi, George. First of all, it was a great quarter again. You actually almost hit about everything, but one thing I want to ask about is a little bit on the margin. There is a lot of economists -- and not that we're in this camp, but a lot of economists are starting to say they could see rates ticking up. And without trying to sit here and make interest rate predictions, talk a little bit about the impact on you guys -- because you typically do it each quarter -- if rates start to increase -- and give us your sensitivity to, you know, what an up 25 might look like to an up 100 rate scenario could look like? Again, great quarter, George, and thank you.

Well, thank you. Joe, as I mentioned, one of the steps that we have been taking for over two years now is to increase the percentage of variable-rate loans. As you know, following our company very closely, we have significantly increased that percentage from low double digits a couple of years ago to almost a third of the portfolio now. And our goal is to continue to increase that percentage at least 1 percent a quarter. And we're actually doing better than that. We're giving up a little margin to accomplish that goal. But that, plus the fact that a lot of our loans have significant cash flow and the fact that a lot of our loans have balloon maturities on them, gives us the opportunity to re-price a substantial portion of our loan portfolio in fairly short order. Also, we feel like that we have some room in some of our depositing products -- the pricing there -- that would give us a little cushion as rates rise, because we are being fairly aggressive and have been throughout last year on some of our pricing of some of our core deposit products that would not cause us to have to increase those proportionately as rates rose. As a result, we feel like we're in pretty good shape whether rates fell a little bit or rose a little bit.

Now the last simulation model that we did was a September 30 simulation model. And the way we do this simulation model is we calculate a baseline net interest income assuming that rates do not change and the shape of yield curve doesn't change, and assuming a myriad of assumptions which we work very hard on to try to make as accurate as possible. That simulation model said that if rates went up instantly 100 basis points and stayed up 100 basis points, and if the yield curve shifted in a parallel fashion, that our net interest income would be about 1.5 percent lower in that rates-up-100-basis-points scenario than in the baseline scenario. So if you look at that in terms of margin -- with our margin at roughly -- let me use 4.5 percent, just for round calculations -- then you're talking about 7 basis points or so of margin.

In an immediate and sustained parallel shift of up 200 basis points, the net interest income on our most recent simulation model would decline 3 percent. So in that case, you're talking about 14 or 15 basis points of margin compression.

Now that assumes an immediate and sustained parallel shift, and not since the days of Paul Volker have we seen the Fed raise rates 100 basis points in a day. So assuming that there is some time to adjust to that higher rate scenario, we think the impacts would be less in a rate environment where rates went up a quarter a month for four months, or a quarter every other month for eight months, or something like that. Does that answer your question?

Barry McCarver, Stephens Incorporated.

Good morning, everybody, and congratulations on a great quarter, again. George, one thing you didn't hit on -- and if you did, maybe I missed it, was -- you talk a little in the press release about converting your loan production offices outside the state into full-service branches. Can you go into a little more detail about that? That was a kind of a little surprise to me -- and kind of what you're expecting there.

I would love to, Barry, and we're excited about the opportunity. You know, we're in 16 Arkansas counties now with 41 offices. As I did mention in my prepared remarks this morning, we expect to ultimately add 18 more offices in those 16 counties. So if you do the math, that will get us to 59 Arkansas offices in those 16 counties.

We have done an extremely exhaustive planning process that has basically evaluated every one of our Arkansas's 75 counties based on a number of -- population, income, growth demographic numbers. And we have determined that there are eight additional Arkansas counties which we think would be optimal for us to de novo branch into.

We have also done the math and believe that we will need 24 offices to achieve our optimal return on equity in those eight counties. So that would get us to a total of 83 Arkansas branches in 24 counties -- meaning that there are 51 counties in Arkansas that, based on this very detailed analysis we spent a lot of time doing in the fourth quarter -- that we don't really feel like it would be optimally efficient for our shareholders, in terms of return on equity, to branch into.

So with 41 offices already in Arkansas, and 83 to go -- and assuming we continue to build out our Arkansas offices at about the same rate that we did last year, roughly adding eight full-service banking offices in Arkansas a year, you know, we've got about five more years to really build out the total of our Arkansas franchise. This growth in de novo branching strategy has achieved sizable compounded double-digit returns for us, both in net income and deposit growth and loan growth.

And we want to continue the strategy. We don't want to get out five years and say, gosh, there's no place else really to go in Arkansas that's optimal. So we certainly don't want to go into sub optimal markets with this strategy. So what we realized is this strategy is clearly transferable to other markets, and probably even works better in higher-growth markets.

So assuming that we finish out our Arkansas franchise in 2008, we don't want to be in a situation in 2009 where we say, okay, we're going to open 10 branches, and we're going to go out of state and open 10 branches, and we've never been out-of-state before -- because in case it doesn't work exactly like we think in Texas or North Carolina or Tennessee or wherever, we want to know that and make appropriate adjustments in an orderly manner beforehand.

So what our strategy is -- is to probably this year seek to convert our existing three out-of-state LPOs -- or at least a couple of them -- into full-service banking offices; experiment on a very calculated, measured basis with our de novo branching strategy in a couple of non-Arkansas markets; probably add one or two out-of-state branches a year over the next five years as we're continuing to build out the Arkansas franchise, so that in 2009 or 2010, when we are really dependent upon out-of-state offices to continue to generate the growth in loans, deposits, and earnings for us, we have proven to ourselves and to the market that we know how to operate in those markets and can continue to implement our growth and de novo branching strategy in those markets with the same level of effectiveness that we have done so over the last nine years in the Arkansas markets.

So that's the strategy. It's going to be a very cautious, very slow, very measured approach, just as we have taken with the loan production offices -- taking small steps with them and making sure we knew what we were doing before we put a few more chips on that office. Does that answer your question?

Yes, perfectly. And just a secondary question as to the timing of when we can see these three new de novos come out -- I guess three new conversions from the LPOs? You know, I know in the past we've seen that you kind of had some assets already based around new areas where you opened up a new branch, and as a result, they became profitable -- I believe -- much more quicker than the normal, say, U.S. de novo branch. Are these loan production offices at that level, that you can achieve similar results by turning them into full-service branches? Or are you expecting to see a little bump up in expenses sometime during the year as you convert those?

Barry, we do have a good volume of business in those existing offices -- in the form of loans, of course, only. We can't do deposits there. But we feel like that the opportunities are there to ramp those offices up on pretty much the same timetable toward profitability as we would normally try to achieve for an Arkansas branch. So I don't think the numbers are going to look much different for those branches than they do in Arkansas branch.

Okay, thanks a lot.

Okay. Thank you.

Peyton Green, FTN Midwest Research.

Hi, good morning, George. A couple of questions. One -- how are competitive pressures changing in your footprint? Are you seeing any particular changes in Fort Smith or Little Rock with some of the larger regional competitors? And then secondly, are you seeing any change in customer behavior with respect to what they're doing with their deposit balances or existing customers on their loan request activity?

Well, Peyton, we've said many times in the conference call that we think we're in a very competitive environment. And we continue to think that. We have not seen any really sort of systemic change in competitive conditions over the last quarter or two, or three, really. You know, you will see your outlier deal that is priced by somebody that you wonder if they slipped a digit on their calculator or something when they priced it. And you know, you have an occasional competitor jumping up and doing something very aggressive on the deposit side or on the loan side.

But we have not seen any really fundamental systemic change in the competitive environment. It's pretty much your occasional crazy deal here and your occasional crazy deal there, and an occasional special here and there from competitors -- which is basically the same sort of stuff, really, we have seen for the last year-and-a-half to two years. It is still a very competitive market. We are working very hard every day. And we're winning a lot more battles than we're losing, as is obviously evident from the fact that our loans and deposits are growing at rates in the mid-20 percent range over the last quarter. So we feel very good about that.

I would also comment that our pipeline for portfolio loans looks very good. And that's continuing to make us very optimistic about our loan growth opportunities in the coming couple of quarters.

Would you say it's better than it was 90 or 180 days ago?

The pipeline?

Sure.

Yes, I would.

Okay. And then any change on existing customer behavior on the deposit or loan side?

Peyton, not really. You know we had -- we've had a lot of changes in the players in a number of our markets. But most of those changes were several quarters or even a couple of years back. And we seem to have sort of stabilized at our current level of competition. We hope that continues.

Okay, great. Thank you very much.

Thank you. Good question.

Julia Kazareno (ph), Prospector Partners.

(technical difficulty) if you could explain to me what happened with that $400,000 charge that you took in the trust department?

We will try to add a little bit of that -- color to that. As I've already said, Julia, we had a failure to properly implement some of our balancing and reconciliation procedures. This occurred over a period of time, and really went undetected until a problem arose in December that alerted us to it. And we put our internal audit people on it, and they began to identify the situation. For the last four weeks, we've had a number of personnel from internal audit and our CFO's office reviewing all accounts and all balancing and reconciliation procedures.

It appears that the magnitude of the problem is the 400,000 that we have taken. We've expensed that full amount. We hope to recover a portion of that in subsequent periods. But as I said in the prepared remarks, there's no certainty that we can do that. So we've taken what we think is the conservative and appropriate course of action by writing that full amount off at this time.

Who would you recover from? And did you have to reimburse customers that $400,000 amount, or --?

Well, again, I will answer a few of those questions. Yes, we did have to make some adjustments to customer accounts. And some of the errors did occur in customer accounts where we had misposted assets from one account or the other. And obviously, part of the problem there is that some of the moneys that were posted to at least one account were disbursed and are unrecoverable. It was posting and reconciliation problems. And these things were just not properly followed through on and detected.

There are also some entries that lead us to believe we may have some out-of-balance conditions with some of our settlements on some securities purchased for some accounts. Again, we've provided for those amounts that have been identified and assumed, therefore (ph), a loss, but there may be some recovery there. And we're asking our counterparties to those transactions to also review those transactions and confirm our beliefs on those things. So we're dealing with all of that. We have again provided for the maximum amount that we believe is at issue here.

We certainly have a heightened level of attention to these matters in our trust department. In addition, personnel from our CFO's office and internal audit are now monitoring these matters on an ongoing basis and will continue to do so.

In addition, let me add that we had already scheduled to add another member to our trust operations staff in 2004. And we sort of changed that job description now, and are looking for an individual with very strong accounting training or experience. This is a situation that, frankly, should have never occurred. And we are taking the steps necessary to ensure it never occurs again.

Let me again comment -- it has a minimal impact on our numbers, particularly in view of the fact that, because of this, we felt like it was appropriate to reduce what we were otherwise going to pay in bonuses to our management team. We reduced that and offset about two-thirds of that loss with a reduction in bonuses.

I will add -- and I should add -- that there is no evidence in anything we have found at this point that indicates there is any employee fraud or intentional misconduct. It was just simply oversight and failure to effectively implement established balancing procedures.

Okay. And can you explain to me the impairment to -- the $320,000 impairment charge --?

Yes, I would be happy to. We invested in two LLCs that were facilitating the development of low- to moderate-income housing. And to explain the transactions, let me -- I'll just try to explain them as best I can. Under an Arkansas statute that encourages this kind of development, we get a state tax credit equal to one-third of our investment in those enterprises, with the proviso that it cannot reduce our state taxes by more than 50 percent in any one year. And to -- I'm going to use round numbers here, but they're reasonably close. If you looked at our investment and you said, okay, the bank is investing in this LLC at 118 cents on the dollar -- the 18-cent premium goes to cover transaction costs and a grant that is made to the developer who is developing these low- to moderate-income housing.

So we put 118 cents in an LLC. 18 cents went to cover the transaction cost and this grant to the developer. And then the other 100 cents is invested by the LLC in an Arkansas municipal bond that is guaranteed by HUD and Ginnie Mae, so it has two AAA guarantees on the bond. And that bond, along with the grant money and money from other grant sources that the developer receives, goes to accomplish these developments.

So we basically wrote our investment down to the portion that was equal to the AAA-rated municipal bond that is inside the LLC. And the LLC would exist for a period of time -- roughly five years -- at which time it will distribute the bond to the investors. And we will hold that municipal bond at that time.

What happened in the quarter that prompted the write-down? What changed the value?

Well, we put 100 -- we made the investment for 118 cents. And we wrote it down to 100 cents on the dollar -- that's the value of the AAA-rated bond. So the only value that's still on our books is the value of the underlying AAA-rated municipal bond.

I will comment, also, because I had a question from someone this morning -- in the press release, we mention that there's $556,000 of tax benefits and a $320,000 impairment charge. The $556,000 is the tax credits and the full tax effect of the transaction. So that includes the tax effect of the $320,000 impairment charges included in the $556,000 tax effect. So the net effect of the whole transaction was a positive $236,000. And as I mentioned also, we have roughly the same number of tax credits and impairment charges which we will take next year. And that will be spread ratably as we incur state tax liability next year. So you could take that $236,000 difference, divide it by 4, and that's roughly the quarterly effect -- a positive quarterly effect net that we expect in each quarter of 2004.

Okay. The impairment charge that you took -- did you have to take it in this quarter? Or did you choose -- you just chose to take it --?

I think it was the proper accounting treatment to take it, because the money was put in the LLC, that 18 cents went to cover transaction cost, and it went to cover this grant to the developer. So what is left in the LLC is the municipal bond, which is secured by the project and, again, a HUD and a Ginnie Mae guarantee. So, yes, I think we had to take it. I think it was the proper accounting for the transaction.

Thank you.

And the Financial Accounting Standards Board's guidelines on this require that you take the impairment charge in a transaction like this in proportion with the recognition of the tax credits. So as we take the additional tax credits next year that are carried over to next year, we will take a proportional amount of the charge at that time. And again, that will leave us with approximately a net after-tax benefit in -- assuming we recognized it equally in the four quarters next year -- of roughly $60,000 a quarter net after-tax benefit.

(OPERATOR INSTRUCTIONS) Arielle Whitman, Sandler O'Neill.

Hi, George and crew -- great quarter. George, most of my questions have been answered and, you know, resided around the tax situation. The only follow-up question I have is you commented -- you know, you have tax credits going through '04. Do you know at what point these run out? Or you know, are these what we should call quote-unquote sustainable tax levels?

That's a very good question, Arielle. The transactions that we engaged in that produced the tax credits -- under the rules, we can carry those tax credits forward for three years.

Three years (multiple speakers) from '04?

Yes, three years from the date of the transaction (multiple speakers) would be '04, '05 and '06. We do not have enough tax credits, assuming we continue to earn the type of earnings that you've got us projected to earn, to last more than in '04. So we would expect to utilize all those credits in '04.

This particular program in which we participated expired at year-end of '03. So we could not make an invest (multiple speakers) in '05 that would generate comparable tax credits. But one thing that we are keenly focused on is that we have done a really good job running a lot of the different parts of our company, but we have not been as focused on controlling and minimizing our tax liability as we probably should have. And there are other tax credit opportunities under different programs that are available out there, both federal- and state-wise. And we intend to look a little more diligently and vigorously at those things in the future than we have. And we hope that we will do a better job managing our tax liability in the future than we have in the past. So we hope this is the first step toward producing a little better returns for our shareholders by being more focused on that tax position.

Mark Anthony (ph), Dorian Ethan Assessment (ph).

Good morning. Let's focus for a moment on your leasing efforts. I infer that you're continuing to make a push in this business component and counting on that to meet your growth targets. Could you expand your strategy here? Are you focusing on industry types, or conversely, avoiding any industries?

And one other question in an entirely different nature -- you mentioned your loan production offices in Texas and North Carolina -- but you mentioned Tennessee. Where are those -- do you have a facility in Tennessee? Or is that on the planning stage?

No, we don't have a facility in Tennessee. And we have no specific plans for Tennessee. That was just a random comment that, you know, we may -- there may be other states that we are interested in in the future. And no one in Tennessee should imply that as any plans that we have to come to Tennessee right now.

The Texas operations that we have, Mark, we have been very, very pleased with. And of course, we opened both of them earlier in 2003. And our mortgage operation in Frisco has done very well. Our commercial mortgage office in Dallas is doing very well. And if you just look at the Dallas-Fort Worth SMSA, the banking market in that -- I think it's an 11- or 12-county area there -- is about 2.5 times the size of the banking market in the state of Arkansas. So if we go down, and those initial offices in Dallas-Fort Worth as we convert them to deposits -- Dallas and Frisco, I apologize. As we convert them to full-service offices, if they do well and we continue to expand down there -- and you know, our Charlotte office has done well. If we convert that and continue to expand there, Charlotte and that Dallas-Fort Worth SMSA are such large markets, we may spend the rest of our banking careers just trying to mine the opportunities there. But at the same time, we do not rule out the possibility of going to other states.

Now let me answer your question on the leasing. Yes, we feel very good about that. We were able to hire a gentleman with tremendous experience in this business that has basically built -- helped build a company that got up to about 200 million, and then was sold. And then he led it for another company that bought it up to about 400 million. And then it was sold again, and he led it for another company that took it to about $800 million. And he led that operation for them. So this individual has very strong capability.

What we are primarily focusing on is small ticket leasing, although we are doing a few larger ticket transactions for very creditworthy folks. We are staying primarily within the geographic footprint of our franchise, primarily looking at places and customers that are in areas where we would make loans to, basically, and focusing on credit to the extreme. We want this to be a very high credit operation. As I said in the initial conference call when we discussed this, you know, I think a lot of banks have customers that don't qualify for loans, and they send them down to leasing. And that's not our business strategy at all. Our focus is that we won't do anything on a lease that we would not also do that same customer in a credit transaction on a loan. They're just structured differently.

So primarily, it's small ticket leasing, primarily in our existing footprint, with a strong emphasis on credit quality.

At this time, sir, there are no further questions. Are there any remarks?

Let me thank each of our listeners for joining our call today. We appreciate your interest in our company and thank you very much. We look forward to talking with you next quarter. That concludes our call.

This concludes today's Bank of the Ozarks' fourth-quarter conference call. You may now disconnect.