Bank Ozk (OZK) 2004 Q2 法說會逐字稿

Good morning. My name is Elizabeth and I will be your conference facilitator today. At this time I would like to welcome everyone to the second quarter earnings release conference call. (OPERATOR INSTRUCTIONS) This show also features streaming audio which allows you to listen to the show through your PC speakers. Thank you. Ms. Blair, you may begin your conference.

Good morning. I'm Susan Blair, Executive Vice President in charge of Investor Relations 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 results for the second quarter of 2004 and our outlook for the remainder of the year. Our goal is to make this call as useful as possible in understanding our recent operating results and 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, including the effects of the Company's efforts to increase variable-rate loans as a percentage of its total loans; net interest income; non-interest income, including service charge and mortgage lending income; non-interest expense; our efficiency ratio; asset quality; non-performing loans and leases; non-performing assets; net charge-offs; past due loans and leases; interest rate sensitivity, including the effects of possible interest rate increases on our net interest margin and net interest income; future growth and expansion, including plans for opening new offices; opportunities and goals for market share growth, loan, lease and deposit growth, and possible interest savings from the prepayment of trust preferred securities.

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 report 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 statement 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.

Good morning and thank you for joining our call as we report another record quarter at Bank of the Ozarks. This is our 14th consecutive quarter for both record net income and diluted earnings per share, and our 28th quarter of record net income out of the last 30 quarters.

Our second quarter net income was up 29.3 percent and diluted earnings per share were up 26.7 percent compared to last year's second quarter. This strong earnings growth was driven by strong balance sheet growth. During the last 12 months loans and leases have grown 23.7 percent, deposits 25.5 percent and total assets 26.9 percent. And most importantly, this was the kind of profitable growth that we want, resulting in second quarter annualized returns on average assets of 1.67 percent and average stockholders' equity of 24.63 percent. All this is a result of our continued implementation of the growth and de novo branching strategy we have been pursuing for almost 10 years.

During the first quarter of this year we had good loan and exceptional deposit growth. The roles reversed in the second quarter as we enjoyed good deposit growth and exceptional loan growth. If you look at this year's first 2 quarters on a combined basis, loans and deposits grew at very similar annualized rates of 25 percent and 24 percent respectively. This was at the upper end of our guidance range for both loan and deposit growth.

While we continue to report excellent loan growth, our second quarter asset quality ratios once again reflected our strong credit culture. We will discuss several of these ratios in more detail in a few minutes, but suffice it to say that our second quarter asset quality ratios were excellent and among the best ratios that we have ever reported.

In the second quarter we again invested for the future, sacrificing some short-term earnings to add 4 new banking offices. Specifically we converted our Frisco, Texas loan production office to a temporary banking office and opened three new Arkansas banking offices in Van Buren, Conway and Russellville. These additions give us a total of 5 new offices added in the first half of the year and keep us on track to achieve our full-year 2004 goal of adding 8 new Arkansas banking offices, converting our Frisco, Texas LPO to a temporary banking office, which we've already done, and relocating various other temporary offices to permanent facilities, several of which we've already done. While these offices, like all of our new offices, start off with more expenses than revenue, we believe they are important elements of our plans for continued growth and future profitability. We feel that in the second quarter we once again maintained a good balance between our short-term earnings goals and our long-term growth objectives.

In the remainder of today's call I would like to go into some more detail regarding some of the highlights of the second quarter and our expectations for the remainder of the year. First, let's talk about loan and deposit growth.

I've already discussed the growth rates for the last 2 quarters and the last 12 months, and those of you who follow our Company know that we have traditionally achieved strong loan and deposit growth rates. We view Bank of the Ozarks as a growth company, and our growth comes from adding new customers every day. We are keenly focused on that throughout the Company.

The last 2 quarters have been among our best ever for adding loan and deposit customers. This growth has been broad-based throughout the bank, with most of our officers contributing nicely to loan or deposit growth, or to both. And that's why we've seen the sort of annualized growth we've seen so far this year -- 25 percent for loans and 24 percent for deposits.

While our loan and deposit growth percentages will vary from quarter-to-quarter, we continue to expect that our loan and deposit growth rates for the upcoming quarters will average from the high-teens to the mid-20s in percentage terms. We have had 10 years of great results with our growth in de novo branching strategy, and we believe that our best opportunities are ahead.

Now let's talk about interest margin. Our second quarter net interest margin was 4.43 percent, down 5 basis points from 4.48 percent in the first quarter. This was consistent with our recent guidance, which we reiterated in the past couple of quarters, and which we have stated that we were optimistic about our prospects for a fairly stable net interest margin in 2004. If you look at the last 4 quarters, our net interest margin has varied only 5 basis points from 4.48 percent in last year's third quarter, down to 4.45 percent, back up to 4.48 percent, and now to 4.43 percent in the second quarter.

Of course, a myriad of factors affect net interest margin, but a couple of factors affecting our second quarter net interest margin are worth noting.

First, during the second quarter we continued our efforts to increase the percentage of variable-rate loans in our portfolio. We've been increasing this percentage every quarter for more than 2 years, and we made excellent progress in the second quarter with variable-rate loans now accounting for 37.47 percent of total loans at quarter end. That's up 391 basis points from 33.56 percent of total loans at the end of the first quarter. Of course, we typically get lower rates on variable-rate loans than on fixed-rate loans, so this continued shift in our portfolio has the short-term effect of putting some pressure on margin. However, this shift tends to lower interest rate risk and should be very helpful in maintaining margins as rates rise.

Secondly, we prepaid our 17.3 million 9 percent trust preferred securities on June 18. This prepayment resulted in a pre-tax charge for $852,000 of unamortized debt issuance costs. And we offset a large portion of this charge with gains from the sales of investment securities. The investment securities sold were predominantly among our longer-term fixed-rate securities, and thus were also among our higher yielding securities. And the majority of those sales settled in April, causing us to lose the benefit of those favorable yields well before we prepaid the trust preferred securities on June 18.

The effect on our margin of the sale of these higher yielding securities early in the quarter and the benefit later in June from prepayment of the trust preferred securities are evident among other factors in the monthly net interest margin results within the quarter. In April, our net interest margin declined to 4.43 percent, and in May declined further to 4.36 percent, but in June, with the boost from the prepayment of the trust preferred securities and the benefit of higher loan yields for the month, the margin improved to 4.51 percent. This improved margin was a nice touch at the end of an excellent quarter.

The quarter just ended was our 13th consecutive quarter of record net interest income. With our cautiously optimistic outlook for a fairly stable net interest margin and our expectations for continued good earning asset growth, primarily in the form of loans, we believe prospects are favorable for continuing to achieve records in net interest income in each quarter of 2004.

With that said, let me comment on a closely related subject, interest rate risk. Of course, the long-awaited first Fed rate increase occurred on June 30th and it seems likely that more such increases, perhaps many more, are coming soon. If you look at the interest rate risk simulation model results contained in our first quarter 10-Q, it suggests that if rates rose 100 basis points our net interest margin would increase by 1/10 of 1 percent, leaving our baseline net interest margin virtually unaffected. The model projected that if rates rose 200 basis points our net interest income would increase by about 3.2 percent or approximately 14 basis points of net interest margin.

Of course, this is a complex model with many assumptions and our actual results may not be completely consistent with this or any complex model of interest rate risk. However, my point is this -- we believe that we have taken steps to get very close to a neutral interest rate risk position, and we do not think that our net interest margin will be affected significantly either way by the recent Fed rate increase or the several more that are likely to occur in the coming quarters.

On a related point, I should also note that our loan and lease portfolio is much more rate sensitive than one might think if he or she focused exclusively on the 37.47 percent -- basically 37.5 percent -- of variable-rate loans within the portfolio. In addition to our variable-rate loans, we have a substantial volume of fixed-rate loans and leases which mature or pay-down each year. If you look at the total loan and lease portfolio, 57 percent of all outstanding loan and lease principle is scheduled to reprice or repay in 1 year or less. This includes the variable-rate loans that reprice under their contract terms, fixed-rate loans that mature and are thus subject to being repriced, and the principal cash flow from regularly scheduled payments on amortizing loans and leases which can, of course, be re-loaned or released at new rates.

If you look at the two-year timeframe, 71 percent of all of our outstanding loan and lease principal balance is scheduled to reprice or repay, and that percentage goes to 83 percent for the 3 year timeframe. These percentages do not include unscheduled principal payments or early payoffs, which could push these numbers even higher. Thus, we believe that the repricing of our loan and lease portfolio is much more closely aligned with our expected repricing of deposits and other liabilities than one might assume considering only the percentage of variable-rate loans.

Now let's turn to non-interest income. Service charges on deposit are our primary source of non-interest income. The second quarter was our fifth consecutive quarter of record income from service charges on deposit accounts. In fact, service charge income was up 23.2 percent compared to the second quarter of last year. While there may be some volatility from quarter-to-quarter, we expect that service charge income will continue to grow in 2004 as a result of growth in customers. Our goal is for this category of income to grow at a rate roughly equal to our rate of growth in core deposit customers.

Our second largest category of non-interest income is mortgage income. Of course, mortgage income is well below last year's record levels achieved during the great refi boom, but we were pleased with our second quarter mortgage results, which improved from the first quarter level even as mortgage rates moved higher from much of the second quarter. This improvement from the first quarter level is primarily attributable to seasonal factors as home purchasing activity in our markets is usually much better in the second and third quarter than in the first and fourth quarters. During the quarter just ended approximately 55 percent of our home mortgage originations were for purchases, and approximately 45 percent were for refinances. We have a strong mortgage origination platform and our goal is to increase our market share in this business over time, even though we realize this business will be volatile due to seasonal and cyclical factors.

Our third largest contributor to second quarter non-interest income was gains on sales of investment securities, which totaled $752,000. This is, of course, an unusual item. These sales were made for two purposes -- first, we wanted to generate some gains to offset a portion of the $852,000 charge taken in connection with prepayment of the 9 percent trust preferred securities; and second, for interest rate risk purposes. With the payoff of those long-term fixed-rate borrowings, the trust preferred securities, we also wanted to shed some of our longer-term fixed-rate securities, and these sales allowed us to accomplish both those goals.

Now let me make a few comments regarding non-interest expense. We were very pleased with our level of non-interest expense in the second quarter. While non-interest expense was up 23.9 percent in the second quarter compared to the second quarter of 2003, $852,000 of that increase, or approximately 46 percent, was due to the write-off of the deferred debt issuance costs in connection with the prepayment of those 9 percent trust preferred securities. This resulted also in an increase in our second quarter efficiency ratio. Excluding this unusual item, we achieved our goal of growing revenue at a faster rate than overhead expenses. Even with this charge, our second quarter efficiency ratio was 46.9 percent. While this ratio will undoubtedly vary from quarter-to-quarter, 1 of our most important goals is to continue to improve our efficiency ratio over time.

Lastly, I want to brag on our lenders and our credit personnel for the excellent asset quality ratios they achieved in the second quarter. Our June 30th ratio of non-performing loans and leases as a percentage of total loans and leases was 25 basis points, down 11 basis points from the end of the previous quarter. Our ratio of non-performing assets as a percent of total assets was just 21 basis points, down 7 basis points from the end of the previous quarter and tying the best non-performing asset ratio that we've ever reported as a public company. Our annualized net charge-offs ratio for the second quarter was 16 basis points, up from a record low 5 basis points in the first quarter, but still a very favorable ratio. Our ratio of loans and leases past due 30 days or more, including past due non-accrual loans and leases, as a percentage of total loans and leases was 44 basis points, less than 0.5 percent at June 30th, which is the lowest past due ratio that we have ever reported at the end of any quarter as a public company.

When you look at these numbers in conjunction with our loan growth rates over the last decade and our net interest margin, we think that our team is doing a pretty darned good job of underwriting, pricing and growing the loan portfolio, and I want to publicly recognize and congratulate them for that.

In summation, Asian, let me say that we believe the second quarter results are results on which we can build in the upcoming quarters. As I have stated many times, our goal is to continue to improve net income each quarter, and this means reporting record income each quarter compared with the proceeding quarter. We have achieved this goal in 28 of the past 30 quarters, including the last 14 in a row. With each success the bar keeps getting higher, but we believe this is a reasonable goal for each quarter 2004.

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

(OPERATOR INSTRUCTIONS) Barry McCarver, Stephens Inc.

I will just say congrats on a great quarter.

Thank you, sir.

George, back to your discussion on the margin, you said you ended June at about 4.51 percent. I guess assuming that -- I guess basically you're saying that regardless of what the Fed does you're not going to be affected to great extent either way, but going forward do you expect that to be kind of flat in the next couple of quarters or what would be a decent run rate to assume there?

Yes, Barry, we want to reiterate our previous guidance that we are expecting a fairly stable margin in '04. And we have been bouncing around, as I said, between 4.43 and 4.48 over the last 4 quarters. The expectation that we have is that we are very, very close to a neutral interest rate risk position. The Fed move, we do not think, will impact our margin significantly either way. So our guidance continues to be that we expect a fairly stable margin for the remainder of the year.

You may have kind of already answered this question, but on the deposit side I know that if I'm thinking correctly you have been a little bit more aggressive in the past, and probably had a pretty good rate out there versus some of your competitors. Is that still the case or are you taking a little bit of that back with the first 25 basis points we got here?

Actually, Barry, because we can afford to do so we're staying in a fairly aggressive mode, at least for this quarter. And we feel like we can afford to do that, so we're keeping the pressure on and continuing to push forward on that side. So we're fairly optimistic about our prospects for deposit growth, particularly given our competitive position there.

Great. I Noticed in the press release you said you're moving your Cantrell location into the new Wal-Mart Supercenter. That's, to my knowledge, the first kind of in-store branch you have.

Actually, it's the third in-store branch we have. We have a in-store branch in all Wal-Mart Supercenter and Bryant, Arkansas that's been operating for a couple of years and has done very well, and in-store branch in a grocery store on the East Gate side of Hot Springs Village. And that has also performed very well. So we've got two other in-store branches a couple of years old or more that are performing in a very satisfactory manner to us, so we're pretty optimistic. And of course this Wal-Mart Supercenter in West Little Rock that we're moving into here in a month or so is at a very strategic intersection of Chenal Parkway and Highway 10, Cantrell Road. And we're very optimistic that that's going to be a very good performing branch for us.

The Cantrell West branch that we're closing and relocating to the Supercenter has actually been the poorest performing branch that we've ever opened. We deviated from our normal principles regarding ingress, egress, and this was in a small suburban office building that had a pretty large floor plate, and thus it was a pretty good little trip around the building to get to the drive-ins. And it just deviated from our normal pattern of doing business in several ways. And our experience there has proven to us why sticking with our principles for opening branches is a good thing and deviating is not. So we were very fortunate to be able to sell out of that. We have sold that back to the landlord who is selling it to a competitor with a 60 day dark period on the branch, and we actually come out at an insignificant gain on the transaction.

Just very lastly, more out of curiosity than anything, in your new Frisco branch, I didn't hear you say whether you opened it the first of the quarter or the end of the quarter, but have you taken any deposits there yet?

Barry, that's a good question. We opened in April, early to mid-April, when we acquired that little charter. And honestly, you've got to buy the charter when you find it to get the entry into the state, and we really got that charter about 3 to 6 months before we really wanted to. So basically in the second quarter we just ran a little bit of expense down there every month, took in a very nominal level of deposits, and we just had -- the baby came before we had the room ready. And we're getting ready really this month to begin to ramp up kind of a more typical start of opening operation there in temporary quarters where we've been occupying with our LPO. So we will begin to really get started there to in earnest this quarter with that operation.

Thanks a lot.

John Rodis, Stifel Nicolaus.

Congratulations, George, on a great quarter. Quick question on your growth in the adjustable-rate loan portfolio. You said it was about 37.5 percent in the second quarter. Do you have any sort of target going forward? What do you think is reasonable to assume out a couple years or what are you projecting?

John, as I have stated several times, our goal is to increase that percentage at least 100 basis points -- 1 percent a quarter. Of course we had exceptionally good results in the current quarter with a 391 basis point increase. So the 1 is a minimum we hope to hit every quarter. We would love to see some more result that looked like 2 and 3 and 400 basis point-type numbers. But I think realistically we've probably been averaging around 2 percent a quarter; sometimes closer to 1 and sometimes as high as 3. This 391 basis point improvement was exceptionally good will be hard to repeat. Obviously that's a big transition in the portfolio each quarter. We are continuing to push that direction and expect to get that portfolio more rate-sensitive in the coming couple of quarters.

When we look at the second quarter loan growth, you said it was once again pretty much broad-based. But just because it was stronger than the last few quarters, was there any 1 big loan in there or was it -- was there really anything out of the ordinary?

No, it really wasn't. Our lending team just did an exceptional job with the quarterly growth numbers. And of course, our first quarter growth was 19 percent and change annualized; our second quarter growth was just under 30 percent annualized, so that gets you to that average for the first 6 months at 25 percent. As we did note in our last conference call, the first quarter growth tends to be a little subdued, although we had the best first quarter growth we'd ever had this year. But that tends to be a slower growth quarter. So we're sticking by that high-teens to mid-20s guidance in hope that we can continue to push toward the upper side of that.

If I just switch real quickly to the asset quality numbers, obviously they're very strong. And your reserve as a percentage of loans was down a little bit to, I guess, about 1.48 percent. Is there a number you're targeting in there?

We're targeting what is an adequate reserve. And let me comment on that, John, and that's -- I'm going to take a minute to comment on that because it's a big question.

As you probably recall from looking at our Qs and Ks, we have got three criteria that we used to evaluate the adequacy of the reserve -- objective criteria, as well as a number of subjective criteria. The primary formula that we rely on is a calculation that assigns a loan grade to every commercial loan and to every similar group of consumer and residential loans based primarily on type of loan and past due status. Then based on our historical loss experience, we assign a reserve percentage to each of those loan grades or loan groupings and then multiply those percentages times the volume of loans in each grade and grouping and sum all that up to get what is the reserve required for loans based on our historical loss experience. Because of the growth rate in our portfolio, and our entry into new markets, and the fact that we're offering new products, and other factors, we also keep an additional unallocated reserve equal to 15 to 25 percent of the total reserve. And when you add that unallocated in, the grand total of all that is what we consider to be an appropriate reserve level.

Now, to give you a little historical perspective, starting back in 2001 we began to increase our reserve as a percentage of outstanding loans because we perceived that the general economic conditions were getting more uncertain and weaker at that time. And as you will remember, there were a number of potential signs of weaknesses in '01 and those became much greater concerns after September 11th. Over the next year or so, we built the reserve up to that 1.52 percent of outstanding loans level where it stayed for a number of quarters -- in fact, until this past quarter.

In the second quarter just ended we went through and we updated our calculations of 3 and 5 year historical loss experiences for all loan categories and all loan groups. And based on those historical numbers, we then had to update our reserve percentages, as we do periodically, for each loan grade and each loan group. And the purpose of all that was to recalibrate the formula and to make sure that the data we were using to build the formula was current and that it was a good indicator of an adequate reserve amount.

As you know, our numbers have been getting better. In 2000 our charge-off ratio was 36 basis points, in 2001 it was 24 basis points, in 2002 it was 22 basis points, last year it was 20 basis points and over the last 3 quarters it's been below 20 basis points annualized. Since that charge-off ratio has actually gotten better over the last few years -- in other words, our loss experience has gotten better, notwithstanding the economic condition -- when we plugged all this in, it changed our formula. And that change in the formula, coupled with the apparent improvement in economic conditions and our very favorable asset quality ratios, suggested to us that the 1.52 percent ratio was no longer justified. And in order to maintain that unallocated percentage within that target 15 to 25 percent range at the end of the quarter we had to reduce our reserve ratio to the 1.48 percent.

We think the current 1.48 percent is adequate but not excessive. Obviously, as you noted, it has given us still a very, very favorable coverage ratio. And I would point out also, John, that the 4 basis point decrease in the reserve in the second quarter didn't decrease the dollar amount of the reserve. In fact, the reserve is up $653,000 for the quarter, which is a result of $1,045,000 provision during the quarter, which are fairly typical normal numbers for both our provision and the increase in the reserve in dollar terms.

That makes sense. George, just one final question. Just if you could give us an update on the competitive landscape in some of your newer markets. Is anybody doing anything out of whack? Is there anything that worries you right now on the competition side?

John, I would say that the average level of competitive intensity has not changed. As you often do when interest rates are moving, you see some aberrations in pricing on both the loan and deposit side. I think while we are being fairly aggressive right now on the deposit side because we can afford to do so and we think we've got a competitive advantage, in a few of our markets we have a competitor or 2 that is really out there doing some things that we just don't think make any sense. But that's often the case and particularly the case when rates move. And then, at the same time I think we've seen a handful of deals that we thought were significantly under-priced given the credit and the structure of the transaction and so forth, and felt like our competitors had just not moved their pricing to match the 93 basis point move in the 5 year treasury during the second quarter or the 70 basis point move in the 10 year treasury during the second quarter. We think some of these things are just not right on market pricing. But we typically see in a quarter some aberrant deals, both on the loan and deposit side in spot market situations, and I think we're seeing that, maybe a slight bit more of that now just because rates are moving and people are trying to figure out where they ought to price. But generally, I would say there's not any material change in the competitive landscape.

Thanks, George. Nice quarter.

Arielle Whitman, Sandler O'Neill.

Great job George. Phenomenal quarter. My questions have largely been answered with the expansion plans into Texas and the Carolinas, so thank you.

James Ellman, Seacliff Capital.

I just wanted to ask if you could give us an idea about your expected changes in the composition of your earning assets going forward. As the refi boom ends and as C&I lending starts to ramp back up, can you give us an idea where the percentages is now in terms of mortgage related assets as a percentage of your earning assets? And how do you expect that mix to shift in the next couple of years?

Let me give you several pieces of guidance on that and information, James.

One of the balance sheet management principles that we follow and have been pretty diligent, and expect to continue to be diligent about following, is we want loans to comprise 72 to 78 percent of our earning assets, which means that investment securities portfolio is going to provide 22 to 28 percent of our earning assets.

Within that loan portfolio -- and if you just assume a 75, just to make the numbers 3/4 of our earning assets loans -- within that loan portfolio, as of June 30th 23 percent of our loan portfolio was residential 1-to-4 family mortgage loans. And that number has typically been going down about 1 or 2 percent a year of the total portfolio. Now it continues to increase in aggregate dollars, but because our franchise is becoming more and more an urban franchise after we entered much more urban markets in 1998 and later, that residential 1-to-4 piece of our portfolio as a percentage is declining 1 to 2 percent a year.

Those residential 1-to-4s are A Grade loans predominantly -- they were all intended to be A Grade loans -- that are booked primarily in our rural markets where a lot of loans do not go to the secondary market. In our rural markets the normal situation is that the vast majority of loans stay in the local banks and stay in portfolio either on an ARM or a 2, 3, 4 or 5 year balloon-type loan set up on a long-term amortization that balloons periodically for repricing purposes. A good chunk of those are ARMs. And they're good quality loans and we want to keep that business, and we want to grow it as much as we can because typically we get commercial or better pricing on those loans but they have the quality profile and characteristics of typical 1-to-4 A Grade mortgages, so very favorable.

On the securities side of the portfolio, which is, say, 25 percent plus or minus 3 percent of our earning asset, probably 2/3 to 3/4 of that now is mortgage-backed assets of one kind or another. And we just shift that portfolio around based on where the relative value equations are at various times, and I would expect CMOs and other market mortgage-backed assets to continue to comprise a substantial part of that portfolio. I think you'll probably see, if we can get Arkansas muni supply available (ph) you will probably see the muni part of that portfolio grow proportionately a little bit more than mortgage-backed portion, but I don't think it's going to be material change in the composition of that portfolio. At least we don't plan one at this time.

Bottom-line is we don't think that changes in the mortgage origination levels are going to have a significant effect on really either 1 of those portfolios or our growth rate, either at the loan or the securities portfolio. Did that answer your question?

Yes. Could you just comment in terms of other consumer loans; what's the percent right now in terms of auto and home equity and how is that expected to change going forward?

Total consumer loans, which includes the auto and the home equity, were 6.9 percent of our portfolio at the end of the second quarter. That's down from 7.1 percent at the end of the first quarter. Now, we actually added $3 million in that category in the second quarter, but because it grew at a slower rate than the rest of our portfolio the percentage actually went down. We don't expect that basically 7 percent plus or minus mix of consumer loans to change very much. And we are growing that part of the portfolio, but it is a fairly small portfolio.

I did mention in a couple of conference calls back that really starting last year we really began to focus on originating some consumer lending in our urban markets, which we had really not heretofore done. Predominantly in the past our consumer lending was primarily in our rural markets, and our urban offices were much more commercial and commercial mortgage and mortgage-related in their lending focus. But as we have built out our branch networks in those urban markets, it's made sense for us to develop and add (technical difficulty) products in those markets. We've done that, and that is the primary focus and source of that consumer loan growth, such as it is.

Very good. Thank you.

(OPERATOR INSTRUCTIONS) Peyton Green, FTN Midwest Research.

A question just to kind of go forward on the loan to earning asset mix on an average basic basis. It's trended down over the last year from 74.2 percent down to about 71.2 in the second quarter on an average balance basis, but it seems to have ended the quarter at about 73 percent or a little over that. Is that a more suitable rate going forward or will you continue to add securities based on the recent -- or I guess the treasury market more recently has rallied, but as interest rates go up or do you want to really book more loans going forward?

Basically, Peyton, again we want to keep that mix, and that mix is in our management of our balance sheet, we believe, an ideal strategy. So if we achieve $60 million in loan growth in a given quarter, just to use a totally hypothetical number, we would expect to grow securities approximately $20 million to basically maintain that 75-25 mix, plus or minus 3 percentage points.

I guess what I'm trying to figure out is was the second quarter exaggerated a little bit because of the trust preferred issue and will it move back up a little bit going forward?

Peyton, I don't think the trust preferred issue had much of an impact. Let me tell you that 1 thing we do, and we've done this for many, many quarters, that may exaggerate your ratios, our target ratios are really quarter end ratios that we're working to. And we will pre-fund -- we calculate -- for example, in June we calculated what we thought would be our needed securities purchases for the third quarter, and we did that very early in June, and we always do this. So a month before a quarter starts we calculate what we think is going to be the roll-off from our CMO portfolio in that quarter and what our loan growth is going to be, and take 1/3 of the loan growth number as a target for securities growth, and add to those 2 numbers any securities maturities we will have and come up with a number that we think is the securities purchased that will be required in Q3 in order to achieve the earning asset mix we want at the end of the quarter. We then agree on that number with the guys that manage the portfolio, and we say, "okay, we're 3 or 4 weeks away from the beginning of the quarter; we want to add this many securities in the quarter to cover our roll-offs and pay-downs and maturities and growth, and we want you to look for an optimal entry point to do that." And frequently that optimal entry point is somewhere around the end of that quarter or early in the next quarter. But we want to try to look for an optimal entry point in the market to make those purchases, so we sum that up. And occasionally, as it did in the second quarter and did again in the third quarter, we felt like that point was very early in the quarter, and that tends to skew the ratios on average asset basis for the quarter. But we're always working back toward basically that 72, 78, 22, 28 mix range at the end of the quarter is what we're looking for.

On a 90 day basis -- not within 1 year, but on a 90 day basis -- in terms of your interest rate sensitivity with the increase in variable rate, does that give you a little bit of a boost in the third quarter above and beyond the benefit from excluding the trust preferred interest expense?

We think that, again, that number is not going to move much either way in a quarter. And, yes, obviously a chunk of our loans repriced up a quarter on July 1 with the effective increase in the funds rate and that prime rate. But, at the same time we did move deposit pricing on a number of products very, very shortly after that, again realizing that we had that additional revenue stream to work with on an offensive side on the deposit side. We're trying to maintain a pretty good balance there.

Would you say overall, though, that it might lag the loan side a little bit?

Peyton, I would stick by my earlier guidance that we don't think the Fed quarter point increase or the next quarter or the next quarter or the next quarter -- you know, we're thinking there are 3 or 4 more this year -- we don't think those are going to move that margin much up or down. I think it's pretty neutral situation.

Just to clarify on the loan growth, were there any particular categories that were maybe outsized in the second quarter versus what we should look for going forward?

Nothing unusual there. And of course, our commercial mortgage piece continues to be a strong source of growth, as does the construction and development categories of lending that we do and have done for a long time. As we get into more urban markets, those parts of our portfolio tend to grow percentage-wise at a faster rate than the residential 1-to-4s and the consumer pieces. So the portfolio just continues every quarter and every year to get a little bit more urban and a little bit more commercial as a result of that.

Good enough. Thank you very much.

At this time you have no further questions.

All right. With there being no further questions, we're going to adjourn the meeting. Thank you for joining us. We look forward to talking with you again next quarter. Thank you for participating today.

Thank you. That does conclude today's conference. You may now disconnect.