Bank Ozk (OZK) 2004 Q4 法說會逐字稿

At this time, I'd like to welcome everyone to the Bank of the Ozarks fourth quarter earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer period.

[OPERATOR INSTRUCTIONS]

At this time, I would like to turn the conference over to Ms. Blair, Executive Vice President in charge of investor relations. Please go ahead, ma'am.

Thank you. Good morning.

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 the fourth quarter of 2004 and our outlook for upcoming quarters. Our goal is to make this call as useful as possible in understanding our recent operating results and the future plans, prospects, goals and expectations of Bank of the Ozarks.

To that end, we will make certain forward-looking statements about our plans, goals and expectations of future events, including about economic and competitive conditions, our goals and expectations for revenue growth, net income, earnings per share, net interest margin, including the effects of the recent purchase of additional bank-owned life insurance, and the increase in variable rate loans as a percentage of total loans, net interest income, non-interest income, including service charge, mortgage lending income and trust income, non-interest expense, our efficiency ratio, asset quality, non-performing loans and leases, the adequacy of our loan loss allowance for a credit recently placed on non-accrual status, and the expected impact of such credit on future net income, non-performing assets, net charge-offs, past due loans and leases, interest rate sensitivity, including the effects of possible interest rate changes 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 and loan, lease and deposit growth.

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 our Chairman and Chief Executive Officer, George Gleason.

Good morning, and thank you for joining our call.

We are pleased to report another record quarter at Bank of the Ozarks. The strong momentum of our growth in de novo branching strategy continued in the fourth quarter, resulting in one of our best quarters ever. As we stated in the press release, this was our largest quarter of deposit growth in Company history and our third largest quarter of loan growth.

In percentage terms, loans and deposits grew at 23 percent and 37 percent annualized rates respectively in the fourth quarter. This is very consistent with our growth rates for the full year of 2004 in which loans increased 25 percent and deposits grew 30 percent. And this was all internal growth accomplished without acquisitions. This growth helped us achieve record earnings.

The fourth quarter was our sixteenth consecutive quarter for both record net income and diluted earnings per share and it was our thirtieth quarter of record net income out of the last 32. Fourth quarter net income was up 24.9 percent and diluted earnings per share were up 23.5 percent compared to last year's fourth quarter. For the full year, net income was up 28.1 percent and diluted earnings per share were up 25.8 percent compared to 2003.

Our fourth quarter annualized return on average assets was 1.66 percent and our annualized return on average stockholder's equity was 23.6 percent, both consistent with our results for the full year. In the fourth quarter, we once again invested for the future, giving up some short-term earnings to add new offices.

During the quarter we opened 2 new full-service Arkansas banking offices, including our eighth banking office in Little Rock and our first banking office in Sherwood. In addition, we opened a loan production office in Bentonville, Arkansas, which is a forerunner to the banking office we expect to open there later this year. This gives us a total of 10 new banking offices opened in 2004, which exceeds the record number of 8 new banking offices we added in 2003.

We believe these offices are important elements of our plans for future growth in loans, leases, deposits and net income. As of today, we have 48 Arkansas banking offices, 3 Texas banking offices, and loan production offices in Bentonville, Arkansas and Charlotte, North Carolina. In 2005, we expect to add 8 to 11 additional banking offices.

Of course, we have traditionally achieved strong growth in both loans and deposits and most importantly, net income. That is why our deposit market share in the 16 Arkansas counties in which we operate, increased 140 basis points from 6.51 percent of deposits at June 30, 2003, to 7.91 percent of deposits at June 30, 2004.

Based on the deposit market share data recently released by the FDIC, in the 12 months time period covered by that data, we had almost twice as much organic internally-generated deposit growth as any other banking organization in Arkansas. Strong growth will continue to be an important focus in 2005 and our goal will be to continue to achieve the kind of high quality and profitable growth which will increase net income and earnings per share.

We continue to expect our loan and deposit growth for the upcoming quarters to average from the high teens to the mid-20s in percentage terms. Now let's talk about interest margin. Our fourth quarter net interest margin was 4.34 percent, down 13 basis points from 4.47 percent in the third quarter of 2004. On its face, that doesn't sound too good, but when you analyze this change, our fourth quarter net interest margin results were actually very good.

While there are a myriad of factors that affect our interest margin in any quarter, there were several factors that had a significant impact on our fourth quarter results. First, as we discussed in our last conference call, on October 1, we purchased an additional $18 million of bank-owned life insurance. The increases in cash surrender value from these policies are recognized as non-interest income.

This purchase resulted in $212,000 of additional tax-free, non-interest income in the fourth quarter. If we had not purchased this BOLI, these funds would have been invested in interest-earning assets. Shifting these funds from interest-earning assets to non-interest income-producing assets, had the effect of reducing our net interest margin in the fourth quarter.

Secondly, we have stated many times that our goal is to increase variable rate loans as a percentage of total loans. For several years, we had increased this percentage every quarter until the third quarter of 2004. As I mentioned in our last conference call, we felt that the third quarter decrease in variable rate loans was an anomaly.

In fact, variable rate loans increased from 35.2 percent of total loans at September 30, 2004, to 40.6 percent of total loans at December 31, 2004, getting us back on the right track with this ratio. This 540-basis point increase in our percentage of variable rate loans should help us reduce interest rate risk going forward, but it also has a cost. Typically we charge lower rates on variable rate loans than on fixed rate loans because we're eliminating the interest rate risk. So this shift cost us in the form of sacrificing some current net interest margin.

Third, as reported last quarter on September 28, we purchased $15 million of new trust preferred securities to provide additional capital to support expected future growth. The investment of these funds produced only a small spread, which tended to compress our net interest margin.

We believe all 3 of these actions are, and will continue to be, very beneficial to us. And considering their cumulative effect on net interest margin, our fourth quarter net interest margin of 4.34 percent was a very good result. We are particularly pleased with the substantial progress made in increasing our percentage of variable rate loans in the fourth quarter.

We continue to believe that we are close to a neutral-interest rate risk position, and we do not expect our net interest margin percentage to move up or down significantly if, as expected, there are several more 25-basis point Fed rate increases in the coming quarters. The quarter just ended was our fifteenth consecutive quarter of record net interest income. Strong growth and earning assets, primarily loans, more than offset the decline in our net interest margin.

With our cautiously optimistic outlook for a fairly stable net interest margin, and our expectations for continued good earning asset growth, we believe prospects are favorable for continuing to achieve improvements in net interest income in the coming quarters. Now let's turn to non-interest income.

Our fourth quarter non-interest income was up 6.5 percent compared to the fourth quarter of 2003, and was up 4.8 percent for the full year of 2004 compared to 2003. These are pretty good results, considering the significant fall-off in mortgage income from 2003 to 2004 as the great refi boom of last year receded into history and also considering the decline in mortgage volume in the third quarter -- or from the third quarter of 2004 to the fourth quarter of 2004.

In our last conference call, I stated that we would not be surprised to see a small downturn in mortgage income during the fourth quarter. We in fact did see a decline.

And as I've noted many times, home purchase activity in a number of our markets is typically better in the second and third quarters, than in the first and fourth quarters. We have a strong mortgage origination platform and we believe that our mortgage business will grow nicely over time, although this business will continue to be highly seasonal and cyclical.

Fourth quarter service charge income slipped somewhat after 7 consecutive record quarters. We believe this is primarily due to the way the weekends fell on the calendar in the fourth quarter and may have also been affected by several days of bad weather just before Christmas.

Service charge income tends to vary somewhat from quarter to quarter, but generally we would expect service charge income to grow over time at roughly the same rate as our growth in core deposits.

Trust income was very good in the fourth quarter. In fact, it was our best quarter of trust income in 2004 and our third best quarter of trust income ever. We seem to have good momentum in trust, with the right team in place. We're very pleased with the progress we've made in this area and we are optimistic about our prospects for good growth in trust income in 2005.

Now let me make a few comments regarding non-interest expense. Non-interest expense was up 11.2 percent in the quarter just ended, compared to the fourth quarter of 2003. It was up 17.5 percent for the full year of 2004, compared with 2003. However, we once again achieved our goal of growing revenue at a faster rate than overhead expenses.

Our total revenue was up 16.3 percent in the fourth quarter compared to the fourth quarter of 2003, and it was up 19.1 percent for the year of 2004 compared to 2003. This allowed us to achieve an efficiency ratio of 46.5 percent in the fourth quarter, compared to 49 percent in the fourth quarter of 2003. And our efficiency ratio improved to 46.2 percent for the full year of 2004 compared with 47.5 percent for the year of 2003.

The efficiency ratio for 2004 was our best for any year as a public company. While this ratio will vary from quarter to quarter, one of our important goals is to continue to improve our efficiency ratio over time.

Our year-end ratio of non-performing loans and leases, as a percentage of total loans and leases was 57 basis points. Our ratio of non-performing assets as a percent of total assets was 39 basis points, and our ratio of loans and leases past due 30 days or more, including past due non-accrual loans and leases, stated as a percentage of total loans and leases, was 76 basis points at December 31.

Each of these ratios increased from the very low levels achieved in the prior quarters of 2004. While these ratios did jump noticeably at year end, we are not alarmed about this increase and at this point, do not see anything which indicates this as the beginning of some sort of adverse trend.

Let me put these numbers in perspective 2 ways. First, the increase in these ratios put us roughly in the same position we were at at year end 2003. At that time, our non-performing loan and lease ratio was 47 basis points, moderately better than the 57 basis points at year end 2004.

Our non-performing asset ratio at year end 2003 was 36 basis points, which is only slightly less than the 39 basis points at year end 2004. And our 30-day past due ratio at year end 2004 was 76 basis points, almost unchanged when compared to 77 basis points at year end 2003.

Secondly, this increase in our year end 2004 asset quality ratios from the prior quarter is primarily attributable to the impact of 1 credit relationship totaling about $2.7 million, which became past due during the fourth quarter, and was placed on non-accrual status at quarter end.

We have substantial collateral securing this credit, and our current belief is, that the proceeds from the liquidation of the collateral, assuming liquidation becomes necessary, will be adequate to pay off the balance we currently have on our books.

This credit consists of 2 loans, which were originated in 1998 and 2000. And although these loans did not become 30 days past due or go on non-accrual until late in the quarter just ended, they were both originally placed on watch status in 2003 and the larger loan was placed on substandard status at year end 2003, and the smaller loan was place order substandard status in early 2004.

Now, when we place a loan on substandard status, we typically establish a 15 percent allowance for that loan and we believe that this 15 percent loss allowance allocated to these loans will be fully adequate to cover any loss exposure, should a liquidation of collateral bring less than we expect.

Accordingly, we do not expect this credit to have a material effect on future net income. At this point, it's unclear what action the borrower will pursue. For many months our customer has pursued the sale of our real estate collateral and another transaction which would involve the sale or recapitalization of his business. During the first half of the fourth quarter it appeared that both these transactions might close imminently.

However, the borrower was ultimately unable to accomplish these transactions, and it now appears unlikely that they will occur. If the borrower voluntarily surrenders the collateral to us, as requested, and as now seems very likely, we would expect to have this credit liquidated in somewhere between a few months and a few quarters. If those discussions break down and the borrower ultimately seeks bankruptcy protection, final resolution of this credit could take much longer.

Even with this credit, our asset quality ratios continued to be excellent in the fourth quarter. We feel that our strong credit culture and focus on asset quality is evident in our charge-off ratio for 2004, which was 10 basis points, and our fourth quarter charge-off ratio of 9 basis points.

Our allowance for loan and lease losses appears to be very adequate and even with the higher ratio of non-performing loans and leases, our coverage ratio is still a very strong 248 percent.

Our record fourth quarter performance validates the strenth of our growth in de novo branching strategy. It also confirms our belief that we can achieve strong financial results through executing this strategy, which includes competitive products, delivered with a highly personal touch, by community bankers, operating in good local markets.

In summation, as I've stated many times, our goal is to continue to improve net income each quarter. This means reporting record income each quarter compared to the preceding quarter. We have achieved this goal in 30 of the last 32 quarters, including the last 16 in a row. Of course with each success, the bar keeps getting higher, but from where we stand, we believe this is a reasonable goal for the upcoming quarter and we look forward to working to achieve it.

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

[OPERATOR INSTRUCTIONS]

Joe Stieven from Stifel Nicolaus.

Good morning, Joe.

Good morning, George. First of all, good quarter. I've got one question, then I think Johnny Rodis will have a couple. My first question is, your deposit growth was much -- I mean was fabulous, much stronger than I anticipated, even stronger than you guys had talked about. George, I guess -- and I also did your cost of funds -- your cost of funds was, had moved quarter-to-quarter a certain degree.

Tell me how you were gaining so much in deposits and did that have an impact on your cost of funds end-year? Again, good quarter, George and John will probably follow up with some other stuff when you're done with that.

All right, well thank you very much. Yes, obviously it was a record quarter as far as deposit growth.

I would, I guess, first I should start off by saying that all of this was locally generated deposit growth. We did not issue 1 dollar of brokered deposits during the quarter, so this all came from our various local sources.

I should probably also mention that in Arkansas, property taxes are payable, due on or before October 10, so typically our various tax collectors have large in-flows of tax dollars from the property tax collections that occur in the quarter. We have a number of governmental deposit customers and certainly a large portion of our deposit flows in the quarter were from those governmental accounts, Joe.

Now this, is a normal kind of ebb and flow of deposits that occurs at that time of the year, so it's not anything particularly different than we've experienced in past years. It was just an extremely strong deposit growth quarter both in the public funds and in the non-public funds sector for us.

In regard to the cost of funds, obviously our cost of funds continue to go up with the Fed increasing rates and pushing short-term rates up. The cost of funds that we incurred in the fourth quarter were almost exactly what we had projected in our model for the quarter. We had assumed the Fed increases that did occur and we had projected those cost of funds and those numbers were very consistent with our expectations.

As I have mentioned in the last conference call, over the last 6 months as the Fed has been raising rates, we have seen the competition a little bit different than what we had expected. We had expected some more significant increases on administered rate deposits and a little bit less aggressiveness on the CD side. I mentioned this deviation from our expectations in the last call. That's continued in the current quarter.

Most of our competitors have made small, if any moves in their administered account rates and have put most of their emphasis on the -- on the CD pricing. And the net-net of that for us is about the same as far as net interest margin, because that has changed how we responded to competition a little bit.

But the net result has been about the same increase in our cost of funds as we projected, but it has tended to skew our deposit mix a little bit, toward a little bit more CD-oriented mix and a little less core deposit mix. And I think it's probably done that for most, if not all of our competitors as well, just because the premium pricing on CDs is tending to have a slight effect of cannibalizing other deposits. So, that's about how we see the deposit and cost of fund issue for the quarter.

Okay. George, thank you.

Thank you.

Hey, George, it's John. How are you doing?

Doing fine, John.

Quick question, on your percentage of floating rate loans up to 41 percent during the quarter, what percent of those loans would reprice within approximately 1 year?

Virtually all of them. There's a tiny fraction of them that probably don't reprice within a year, but virtually all of them would reprice within a year, and the vast majority of them reprice instantly with prime. The vast majority of them are daily floaters at prime.

Okay. And then one final question, just on the tax rate. The tax rate was down a little bit during the quarter. Could you just maybe give some details there?

John, we continue to invest in some of these tax credits and that -- we have made some additional investments this quarter.

And the municipal bond portfolio grew a little bit as a percentage of earning asset.

Continues to be a larger portion of our net income, our taxable income.

Okay. Thanks, guys.

Thank you.

Barry McCarver from Stephens, Inc.

Hi, good morning, guys and congrats on the quarter.

Thank you, Barry. Good morning.

George, could you just comment in general on your margin a little bit? What we should expect going forward. I know we have the shift downward this quarter because of the variable rate loans. Do you expect that to continue in future quarters?

Barry, I think there is, is a natural downward bias of a very slight nature related to that, and I -- I'll give you kind of an example.

If we're charging, say, 150 basis points more on a fixed rate loan for 2 or 3 years than a variable rate loan, and we shift from a fixed rate loan to a variable rate loan, 1 percent of our loan portfolio, then that would tend to, all other things being equal, have about a 1.5 basis point downward pressure on net interest margin per each percentage point shifted from 1 -- from fixed to variable, roughly. And that's an estimate.

That 150 basis points is an arbitrary assumption. So I think that does tend to put a little bit of natural downward pressure on our margin as we -- we shift that portfolio.

Now, what we have been trying to do is to offset that shift in prior quarters with more effective pricing on variable and fixed rate loans, just getting a little more yield across the board where we can to try to offset that shift in the portfolio.

We had been pretty successful in doing that in prior quarters where we had had a 1 percent or 0.5 percent or 1.5 percent movement in the quarter from fixed to variable. Obviously when you have a 540-basis point shift in 1 quarter, as we did this last quarter, that becomes a much harder differential. So, I think that bias is there. We're going to try to offset that with just more effective, efficient pricing. I can't tell you whether or not we're going to be able to do that.

Our general expectations that we have for margin and the plan that we've run and our model that we've run for next year, that includes several more Fed increases in the model, would lead us to believe that our margin for the year is going to be very close to a stable margin, bouncing around a fairly small number of basis points up or down from quarter to quarter.

Okay. And then lastly, I notice the loan loss provision was quite a bit lower in the fourth quarter. Could you go through what triggered that?

Okay. Yes, I would be-- I would be happy to do that.

As you guys know from prior calls, our principal method for determining how much loan loss we need is a mathematical formula. And that formula assigns a grade to every loan, 1 of 7 grades we use other than consumer and residential 1 to 4s, which we assign into grade groupings based on past due status and so forth.

We then calculate, periodically, a 3-year and a 5-year historical loss experience for each loan grade or type of loan and category of loan. And we then multiply basically that loss experience factor times the number of loans, the volume of loans in each grade, to determine what is the appropriate reserve for the Company. About annually, we will typically update those loss experience numbers. I think we last did it in the second quarter of '04 -- early in the second quarter of '04 and we'll do it again probably in the second quarter of this year. And we annually update those historical 3 and 5-year trailing loss factors to determine what the appropriate loss coefficient should be for each grade of loans.

When we sum all that up, we come up with a -- what we consider a required reserve. And then because of the fact that our portfolio has a high growth rate, and because of the fact that we have some degree of concentration of credit to various borrowers and because we've issued, or introduced some new products such as leasing in recent years, we believe, and our auditors have concurred, that it's appropriate for us to maintain a certain unallocated reserve over and above that minimum reserve. And our policy, which is approved by our board of directors says that that reserve can be between 15 and 25 percent of our total reserve.

When we ran the calculations at year end and did all of these calculations, it was necessary for us to reduce our reserve to stay within that 15 to 25 percent unallocated band (ph). If we had left the reserve at the same reserve level as we had in prior quarters, we would have been over and outside of our policy and I doubt our auditors would have signed off on it, but we would have been excess-reserved based on our formula -- calculation methodologies.

The -- reducing the reserve to 1.42 percent of total loans, as we did in the quarter, had the effect of leaving us with about a 23.97, basically 24 percent unallocated. So we're still very much at the top end of our range of unallocated reserve there.

So the answer is, the reason the provision wasn't more and the reason the reserve percentage came down slightly in the quarter is simply our formula dictated that it had to come down. And that's based on the -- the underlying trend, which is an improving trend in the grades of the loans and portfolio. And I'll give you a number that may add a little bit more color to that, that normally we don't disclose until the 10-K. But in addition to our non-accrual and OREO and repos, which we consider substandard assets that we, and I'm sure every other bank in the country has other substandard loans that are classified internally as substandard, but are accruing.

At December 31 of '03, a year ago, our substandard accruing loans were $5.533 million. That number is in the 10-K. At December 31, '04, our substandard loans that were still accruing interest had dropped by more than half and were $2.626 million.

So despite the fact that we had this little bump in non-accruals, there is actually an underlying trend that's moderately favorable in the grade of the whole portfolio over that period of time.

And that trend, coupled with the fact that our loss experience has been getting better and better, is putting some downward pressure on that reserve ratio. And, I'll point out that 3 years ago, 4 years ago now, I guess, our loss ratio was 24 basis points. Then it declined to 22 basis points. Then it declined to 20 basis points. And then in '04 it was 10 basis points.

So, when we recalibrate our loss coefficients, which will probably, as I mentioned, do in the second quarter of this year, all other things being equal, that's probably going to suggest at that time that that reserve ratio might go a little bit lower, just simply because the -- the historical loss experience has been getting better and better. So we're going drop off a year out in the 5-year calculation and a year in the 3-year calculation that have higher loss experiences than the10 basis-point year we're going to be adding for '04. And that's going to mathematically suggest that reserve should be a little lower. Again, all other things being equal, assuming the quality is stable and doesn't have an adverse trend.

So if I understand what you're saying, even though your growth is going to continue to be really strong, if the quality remains high, your provision should continue to be low, or lower than it was last year?

I think -- I think that is very possible, Barry. You know, there are a lot of variables.

The loss experience, the quality, the underlying quality trends of the portfolio, the growth rate. But I -- I think given our loss experience, that it is possible that we could have strong growth and lower provisions necessitated by the -- by the formula calculations. I think that's possible.

Okay. Great. Thanks a lot, George.

Okay. Thank you.

Scott Alaniz from Sandler O'Neill.

Hi.

Good morning, Scott.

Good morning. First question, are you close, or where are you in the time line of finding a suitable candidate for North Carolina?

Scott, honestly, that has not gotten a lot of attention this quarter because we are -- we're sort of evaluating our internal options.

You know, we had a gentleman hired there and there was a mutual agreement for him to go his separate ways back in the third quarter. And after that, the lady that had pioneered that office as a loan production office came to us and asked us for the opportunity to be considered for that position. We have given her that opportunity.

After extensive discussions with her, she has already added one additional lender to her team and is looking for an additional add or 2 . So, at this point in time, we are giving her the opportunity to see how far she can elevate her performance and the performance of that office. While we're doing that, we're basically going to stay in a loan production office mode.

We've not been looking for -- actively looking for a charter or sites there, and just letting her try to ramp up and take that loan production office to a little bit higher level of performance and a higher volume and build a team there. If she is successful in that and we think that's very likely she will be, then she could end up being the individual that is our leader in North Carolina.

If it becomes apparent in future quarters that she is not going to be able to take us to another level there beyond where we are in the LPO (ph) now, then we will that search and look for a leader for North Carolina.

Honestly, we've got so much going on in Arkansas and Texas, that we -- we're fairly content to let that situation in North Carolina play out, see how that develops over the next couple of quarters, because we've got a full agenda of things on our plate as pertains to our Texas and Arkansas expansion.

I see. And with respect to the variable rate loans and your growing that as a percentage of total loans, do you have a target that you could share with us in terms of where you would like that percentage to be, perhaps by the end of '05?

Scott, our stated goal in the past has been to increase that percentage by about 1 percent a quarter . We rocked along there for a number of quarters and we were somewhere between 0.5 and 2.5 percent a quarter. Then we went backwards a couple of points in the third quarter and now forwards 5.

So, I think realistically moving that number somewhere a percent or 2 percent a quarter is probably a realistic and achievable goal. I'll give you a little more information on the portfolio, in addition to our variable rate loans, we have a sizable bulk of maturities of fixed rate loans and principal payments that are made on our fixed rate loans, so we've -- we've routinely in the past disclosed data on how much of our loan portfolio reprices in a 1 and a 2-year and a 3- period of time.

And, I've got that data and let me go ahead and give it to you.

Okay.

In the -- counting variable rate loans and the principal that either matures or cash flows as principal payments off the fixed rate loans, 61 percent of our loan portfolio reprices in 1 year now. 73 percent reprices in 2 years and 84 percent reprices in 3 years. Those numbers are quite a bit higher than the numbers we had a year ago, so we've had very good success in making this loan portfolio more -- much more rate sensitive than it was a year ago.

Our goal is to continue to do that overcoming quarters. Now, I'll be honest with you. In forward-looking with you, at some point, we'll probably get out here and reach a point in the rate cycle, which I think we're quite a ways from now. Where we think, gosh, you know, we probably got more variable rate loans than we really want because the next direction is probably down. And our focus there will probably shift at that point. But for the moment, and I think foreseeable future, over the next few quarters, our goal is to make that percentage go up and not down.

I see, and then lastly, with respect to the non-accrual loan, the large loan, the large relationship, I assume that you don't have a great deal of confidence in the borrower's ability to return to accruing status since you've asked for the collateral?

That is correct, and the borrower, I would say, has done an extraordinary job of trying to overcome the challenges his business has faced and I think he's just reached a point that he does not have any options left, really.

I think he's -- he's worked hard and he's been diligent about it and has done as good a job as anybody could have done with the challenges that he's faced in his business, but I think he's reached a point where liquidation is his only viable option left at this point.

What's the nature of the business, the challenges?

Small community here, so I don't want to get too specific. I would say he is in the manufacturing business and leave it at that.

Okay.

But we're in substantial negotiations with him and I think have an agreement in principal for a voluntary surrender and orderly liquidation of the assets. And if that continues to be the case, if that works out as we expect it will, and you know these things are challenging negotiations, but if that works out as we expect, I think we will have possession and control of the collateral and be in a mode of liquidating that in an orderly manner pretty quickly, in a matter of months.

Terrific. Thank you.

Thank you.

Charlie Ernst from Sandler Asset Management.

Good afternoon.

Good afternoon, Charlie. How are you doing?

Doing well. Couple questions, first, is could you just comment on the salaries line this quarter? Is there any change in bonus accruals or what's driving the line item down a little bit?

Yes, that was -- that was kind of an anomaly that our salaries went down. There are a number of factors in there Charlie, that -- that kind of skewed that. There were some things that pushed the third quarter salary number up in an unusual fashion and I'll mention those and then there was an item that pushed the fourth quarter down in an unusual fashion.

In the past year, we determined that our 401(k) plan was top heavy, and it became top heavy because of the appreciation in our Company stock.

Company stock is one of the options, investment options under the 401(k) plan and a lot of our senior executives have a large part, or if not all, of their 401(k) in Company stock and because the stock went up, it increased the value of their accounts so much, more than we had frankly considered when we looked at top heavy at year-end '03, that we became top heavy in the plan, which means that we're going to have to make an additional contribution to the plan to bring all employees in the Company up to -- for 2004, up to our maximum match amount, whether or not they participated in the plan. So we'll make that contribution in, Paul, what, October '05?

By year end.

By year end '05. But it relates really to '04, so we went ahead and accrued that. We identified this problem in the third quarter, so we accrued three-fourths of our total liability for this extra contribution in the third quarter since we were 3 quarters into the year and accrued the other one-fourth in the fourth quarter.

In addition, we had a couple of hiring bonus items and a severance item that added to our cost in the third quarter. In the fourth quarter, we actually ran a little lower bonus accrual than we had in the prior 3 quarters. We had run an equal bonus accrual in quarters 1, 2 and 3.

We lowered that a little bit in the fourth quarter, and the reason for that is we had a check fraud situation that hit us in the fourth quarter that we've reserved $200,000 for, which is our maximum possible exposure on it.

At this point, we're not sure whether we're going to recover sufficient amounts to reduce that exposure or not, but we fully provisioned $200,000 in other operating expense for this check fraud exposure. And because of that, the way that played out, we felt like that it was appropriate to reduce our bonus accrual somewhat for Q4 because of the -- of that fraud issue. So that's the reason that bonus item went down in Q4.

Okay. Could you talk about the December margin for the month, what that was?

The -- hang on. I've got it.

Fine.

You're going to send me to -- the -- to research. The December margin was 4.36 percent.

4.36 percent, okay.

And I'm looking at the average trends over the last couple quarters and if I look at your loan yield is up about 21 basis points and most of your deposit categories are up by more than that, and so I guess I'm just wondering, why doesn't that trend continue, especially if -- I mean my guess is that if anything, deposit costs are going to accelerate.

Charlie, I don't know that -- I don't know that that is true on your assumption on deposit costs. I can't tell you it's not true, but our -- the best information that I can give you is that we've modeled this thing pretty thoroughly and given it a lot of consideration. And our best estimate is that we're in a mode that is going to have us at a fairly stable margin environment and that's fairly stable really throughout the whole year.

We have maybe a slightly better profile, we think margin-wise in the later quarters of the year than early. But I mean it is so slight that it's -- it's just negligible difference, so our belief is that we are in a fairly stable margin situation.

Now, there, are a million variables that go into that, including everything from Fed action and competitive situations, to the shape of the yield curve that are very difficult to predict, but we're cautiously optimistic about our prospects for holding that margin pretty flat throughout the year.

What is the overall assumption in terms of the steepness of the curve? Are you all assuming fairly static from here or further tightening?

We are assuming further tightening for sure.

Well, I guess tightening between the long end and the short end.

We're assuming that the curve stays fairly stable from its current, somewhat flattened position going forward is our assumption.

Okay.

And the variable -- the 41 percent variable loans, how much of those are hybrid ARM-type products versus truly floating product?

What do you mean by saying a hybrid ARM, a fixed --?

Well, the single family hybrid product that everybody's putting on the books that is kind of a 3 or 5-year fixed rate, and then --

You know what? Everybody's not putting those on the books because we don't have a single one of them.

Okay.

Everything that we've got is a floater.

Okay, great. All right. Thanks a lot.

Okay. Thank you.

Cory Shipman from Stanford Group.

Good morning, gentlemen.

Hi, good morning, Cory.

Most of my questions have been answered but, I do have couple. And one is really just a data point, if you could give me a period in balance (ph) for non-interest deposits.

Okay. We'll -- Paul is scampering to get that number for you. What else do you have?

While he's doing that, really just a follow-up on a previous question. Notwithstanding the -- your company policy in regards to the reserve and provisioning levels, can you give an indication of, is there a level of total loans, the reserve to total loans that you feel completely uncomfortable going below? I mean I know there, is but -- ?

You know, Cory, I don't know how to answer that. We're going keep an appropriate reserve under what we believe is any circumstance and, we're very comfortable with the 1.42 percent reserve we have at the end of this quarter.

Again, it reflects our fully allocated calculated reserve and a 24 percent additional -- or 24 percent of the reserve is unallocated to allow for unexpected bumps in the road that might occur as a result of the rapid growth rate of our portfolio or our introduction of new products, or related to the fact that we probably have a little bit more concentration of credit issues in our portfolio than -- than some banks do.

We've got 65 credits plus or minus in the bank of $2.5 million or more. And we used 2.5 million to kind of assess concentration levels, since that's roughly 10 percent of a year's earnings. So we've got 65 percent of credits that -- 65 credits in number that would kind of breach that 10 percent threshold.

Relationships.

Relationships, not loans and a lot of those are composed of highly diversified credits on different properties and some with different borrowing groups and so forth, so we feel real good about all of those, but there is a concentration issue and hence we keep this additional unallocated reserve. We feel very good about that.

If you look at the last FDIC and Federal Reserve peer group data on banks in our peer group, their reserve ratios are down in the 130s. We're at 142. Our coverage ratio is good.

We feel very good about the ratio and we'll keep it adequate to try to -- on a speculative basis say at any point in time where a minimum would be on that ratio is hard to do. We're -- our intention is not to run it down to the minimum.

Our intention is to maintain it at a very adequate level and to buttress our commitment in that regard and our thoughts in that regard I would point you to the fact that we're at 24 percent of unallocated and our parameter targets are 15 to 25.

So we tend to be conservative and be toward the high end of the range there. And I would expect us to continue to be conservative, but appropriate in the level of reserve we maintain.

Let me give you that number. Paul tells me that our demand non-interest bearing deposits at the last day of the month, last day of the year were 142,947,000. 142,947,000.

All right. Thank you very much.

All right. Thank you.

Jordan Hymowitz from Philadelphia Financial.

Hey, congratulations on a very good quarter.

Good morning. Thank you, Jordan.

Quick question, if you didn't buy the BOLI but obviously still had the variable rate loans, what would your margin have been in the quarter?

Jordan, we didn't calculate that number, so I'm not totally sure of -- the guidance that we gave in our last conference call was that we expected the BOLI to have about a 7-basis point effect on our margin in the quarter. I haven't recalculated that at the end of the quarter.

Of course there -- there are a myriad of different ways you could calculate that. You could take the BOLI yield and tax effect that, and throw that in the interest income or you could go out and make a variety of other assumptions of what you would have bought if you didn't buy the BOLI. But our -- and again, I didn't calculate that for this quarter, but we had projected that we thought it would have about a 7-basis point negative effect on the margin. So that's the best data I could give you right now, and, again there are a variety of ways you could calculate that.

Okay. Thank you very much.

Thank you.

Peyton Green from FTN Midwest Research.

Hi, good morning.

Good morning, Peyton.

Just a couple follow-up questions. A lot of the ones I had have been addressed. But, just in terms of thinking about the net charge-off rate going forward, what do you see in terms of that?

I know historically a 20-basis point number was a pretty good number for you all and that's ratcheted down to about 10 basis points. How should we think about that going forward in '05?

Peyton, that's a really good question.

You know, when we had the 11-basis point charge-off ratio 5 quarters ago in the fourth quarter of 2003, I think I made the comment that that was an unsustainably low margin. And as I made investor presentations in the first quarter and the second quarter of last year, I repeated that guidance, that it was unsustainably low.

Having been proved wrong now, in subsequent quarters since we are sort of sustaining that, I quit saying that about 6 months ago.

Honestly, I -- I'll give you sort of a schizophrenic sort of answer to that, and that is that from my experience and belief, it seems like a 10 or 11-type basis point ratio is unsustainably low.

But at this point, looking at our general population of our loan portfolio, I feel very good about the credit quality of that portfolio and I think that it's possible that that portfolio could support a lower than 20-basis point charge-off ratio. So I think it seems like a tall order to think we could maintain that or sustain that, at or close to that 10-basis point level, but again, the portfolio we're feeling pretty good about.

Now, this 1 credit that we did put on non-accrual at year end could have an effect on that charge-off ratio. I've got a 15 percent reserve for that credit, so I've got over $400,000 reserved for it, we have real estate collateral. We've got equipment. We've got fixtures. We've got inventory. We've got accounts receivable. We've got the whole ball of wax collateral-wise on this thing and some of that collateral is going to be difficult to know what it's going to market for, when we actually get it into an auction or sale-type of setting.

So there could be some charge-offs beyond our book value on that loan, but I've got $400,000-plus reserved for it and we believe that that is adequate to cover any misestimation we have in the value of the collateral. So that credit could lead to kind of a bump in that charge-off ratio. But it won't -- shouldn't affect net income because we've got that 400,000 reserve.

The flip side of that is if that credit doesn't lead to a bump in the charge-off ratio and I'm able to liquidate it for what it's on the books, then I've freed up $400,000 in reserve from that credit that could then be used to cover other credits or growth. So, it's difficult to know.

I would say that bottom line is we think the 10-basis point number is probably unsustainably low, but we're still optimistic about the portfolio, not being in a situation where it's going to generate a much higher ratio.

Okay. And I guess just to follow up on that, in terms of your going through the 30-day past dues on a monthly basis, you still feel really good about how things look based on the last couple months worth of reviews, is that fair to stay?

Yes, I do, and we feel like we've got a strong credit culture. We're -- it's a constant tending, refining process to try to improve that. But, I think one of the -- one of the best numbers that I can give you in support of that is I talked about that substandard accruing and substandard non-accrual and you -- you -- I gave you the substandard accruing numbers, but if you take year-end '03 and year-end '04 and you add the substandard accruing, the substandard non-accrual and the OREO and repo, all your classified assets, that number went from 9.114 million at year-end 03, 9.114 million to 9.280 million at year-end '04. Which is, just almost no growth, less than a 1 or 2 percent growth at the same time that our loan portfolio grew 25 percent.

Sure.

So clearly a significant improvement overall in the portfolio performance in '04.

And that improvement, I think, was reflected in that charge-off ratio.

Okay. And then the $2.7 million relationship, you mentioned had 2 different loans. 1 was a larger which you said was in the substandard in '03 and 1 that went -- the smaller 1 went on substandard in '04. How big were the -- what was the size of the larger 1 just in terms of figuring out the change year-to-year on the substandard still accruing?

Okay. The larger one was -- it's about 1.8 million round numbers and it is real estate-secured and the other credit that's about $900,000 plus or minus a little bit, is cross-collateralized with a second mortgage on the real estate and secured by all equipment -- furniture, fixtures, equipment, inventory, accounts receivable.

Okay. Great. And then, separate question, but on the -- kind of thinking about the margin change late quarter. It seemed to me like you actually took the excess deposit growth and paid off wholesale fundings by an order of magnitude of about 40 to $45 million in the quarter.

What, in terms of the CDs -- the jumbo CD growth that you had, what was the nature of the maturity in that kind of stuff versus what you paid off on the wholesale side? Is that -- ?

Well, obviously the wholesale borrowings are overnight or 7-day is about as far as we go out on that borrowing, so the -- the maturity on the CDs typically ranges from about 30 days to a year predominantly, and I guess really in this environment, 30 days to really 13 to 15 months is the predominant maturity on those.

And the CDs do cost more than the wholesale borrowings, so that also is one of that myriad of other factors that pushed the margin up or down or around in the quarter. We would have had a better margin, frankly, had we relied more on short-term wholesale deposits and not had as much, say, CD growth within that deposit growth in the fourth quarter.

But at this point in time, we don't mind adding a little duration to the liability side of our balance sheet there. And I don't mind paying a little more and getting some CDs and having a little bit more fixed rate on that part of the balance sheet. So, that was another factor that pushed on that margin a little bit.

Okay, and then in terms of the kind of seasonal tax money that you get in the fourth quarter, when you think about the overall deposit number, how much of that, if there was a $40 million number paid off on the wholesale, how much of that reverses out in the first or second quarter of the year? Is it before second quarter or do you think tax money sticks around a little longer in the first quarter?

In different counties, it's handled differently. In some counties, the treasurer keeps the money and dolls it out to the various entities over the year. In some counties, within a month or 2 of its collection there are large payments that go out. The payments that come out of the county treasurers' collection receipt, large chunks of that go to school districts and other agencies, so it moves from one governmental pocket to the other and we have relationships with a lot of those guys also.

So there will be some runoff from some of those public deposits that were garnered during the fourth quarter, but, a lot of it runs into individual accounts, a lot of it run into his other agency accounts, so I don't think it's -- it's a huge item there. 20 or 30 million of the money might go back out or something like that, Peyton.

Okay. Then the non-interest bearing, is that ballooned up because of the tax money, or is that related to other, more, I guess customer-related issues other than municipalities.

Peyton, I would guess that -- I would guess that there is a little bit of non-interest treasurer deposits that might have been inflated by that, I guess, and I haven't really broken this data down, so I'm sort of speculating here. I am speculating, but my speculation would be that most of it's not related to that.

Okay. Great. Thank you very much.

Thank you. I appreciate it.

Scott Jaggers, BAX investment.

Thank you.

Good morning, Scott.

I have just a couple of real quick questions on the securities portfolio. First, just wondering if -- does the securities portfolio continue to be basically entirely in available for sale and then related to that, the equity at the period end seems to be about a half million higher perhaps than the net income and the dividends would indicate, and I was just wondering if that difference was from a positive mark on the securities portfolio or if there's something else going on in there.

All right. Scott, I'm not sure that -- I'm not sure I understand your last question. Could you repeat that? Could you also speak up? I'm having difficulty hearing you.

Yes. I'm sorry.

Just the equity account seems to be a bit higher than I would have expected. It seems to be up. It's up more than $6 million and the net income after dividends wouldn't get you quite there, so I'm wondering if the difference is in the available for sale portfolio hitting through the other comprehensive income or if there is something else going in there.

Okay. Actually I think probably the most significant thing going on there apart from income and dividends is the exercise of the options.

We did have a considerable number of options exercised by employees during the quarter and that and the tax benefit that goes into the capital account as a result of those options provided a boost to the capital number in the quarter. So I think it's -- I think it's options rather than the mark-to-market adjustment.

Okay. So do you have a mark-to-market adjustment number?

Yes. Hold on just a second.

The options for the year. I don't have it for the quarter, but for the year, the options would have been in the neighborhood of -- ( inaudible ).

For the full year of '04, the option benefits would have been about $3.5 million, approximately. That's cash received from exercise of options and tax benefits and, Paul, were there a total of 262,000 shares exercised during the year? And the -- do you have the mark-to-market at 9/30 and the mark-to-market at 12/31? We'll get you that, Scott. I'm --

Mark-to-market at 9/30 was 1 million -- 1.2million.

Is that after tax?

Yes.

The mark-to-market adjustment at September 30 was 1.2 million after tax and that's a negative, right?

Yes.

Negative 1.2 million after tax. And that number at December 31--

Negative 1.8 million.

A negative 1.8 million. So, there was actually a $600,000 negative swing in the mark-to-market adjustment on the AFS securities portfolio in the fourth quarter and -- so option exercises, if you plug that in, you can back into your option exercise number for the fourth quarter.

Thanks.

Okay. Is that all your questions?

That will do.

Okay. Thank you.

I might comment, since Scott mentioned the securities portfolio, that you recall from our last conference call that we had gotten our securities a little high as a percentage of our earning assets. We ended the third quarter at 29.02 percent of our earning assets in the securities portfolio.

We said we would get that back in line in the fourth quarter, and we did so by pulling that down to 27.66 percent of earning assets, which is back within our 22 to 28 percent target range. So we reduced the securities portfolio from 9/30 to 12/30 about 136 basis points of earning assets.

Didn't buy a ton of securities in the fourth quarter because we didn't like the value equation. We liked that yield curve better a couple of quarters back when it was a lot steeper, and we don't have expectations for adding a lot of securities this quarter unless the yield curve gets more favorably inclined toward us.

Are there any other questions?

Daniel Guerra ( inaudible ).

Good morning, George. Great quarter.

Thank you.

Any future thoughts on your role with the company? Daniel, I'm -- I just signed a new 3-year contract with the Company and my commitment continues to be that I'm going to be here as the Chairman and CEO as long as I'm the best solution for the job.

I've been doing this job now 25 years and actually this March it will be 26 years. I'm committed to be here for a long, long, long time if I'm the best solution.

At the same time that I say that, this is a very demanding job, even though we're a small company, we work really hard here. And if I'm not the best solution, I've got a lot of other things I'd like to do in life and I would turn it over to the guy that is a better guy for the job if that guy came along and it became evident to do so.

At this point, though, I'm very committed to this and expect to continue to be here and I have a personal 25-year plan for the company. So I -- I don't think my retirement or departure is anything you need to worry about, because I'm committed to be here for a long time and the only thing that would change that commitment was if my health or something became an issue, which it's certainly not now. Or if someone came along that was just clearly a better guy to lead the company and I felt like I had gone as far as I could go, I would hand it off in a very orderly, smooth transition to that next generation leader and get out of the way. Sure. Sure. Great. Great quarter. Thanks.

Thank you.

You have a follow-up question from Cory Shipman, Stanford Group.

Hi, George. This is actually Kevin Reynolds. How are you doing?

hi. Fine. How are you doing?

Doing okay.

I've got a quick question on your -- for you on your expansion and then sort of how it flows through the numbers and I guess maybe what the expectations -- or maybe the pace over the longer term could be.

As I look back, it seems that the branch count increased last year approximately 24, 25 percent, thereabouts in terms of total offices, but occupancy expense was up about 17 percent, so you're doing a better job of holding in those occupancy expenses as you expand, it would seem.

I'm wondering, A-- how you that, and what the expectation is going forward as more and more banks, particularly in places like Dallas start to open new branches. And, then the second question I've got is more from a cash flow perspective, it looks like going back to the September Q -- it looks like your -- the outlays for premises over the first 9 months of the year, a little over $9 million and approximately 50 percent of net income.

Is that sort of the benchmark as you go forward, 50 percent of what you earn is what you can spend to expand or is there some other way of looking at that?

Well, those are good -- those are good questions, Kevin, and I appreciate you asking them.

Let me -- let me start off with the last question and state that we do not specifically tie our expenditures to a percentage of earnings and we were in the mode last year of acquiring a lot of sites. We're in that same mode this year. In fact, over the next quarter or 2, I think we will complete the acquisition of a number of sites that we won't use until 2006 and 2007, just because we've realized that it becomes paramount to get ahead of the curve on acquiring these sites and we invested a tremendous amount of time and energy last year working on sites to really complete our plan.

This year we expect to open 8 to 11 new offices. We have 8 on the board that are pretty solidly in the numbers for next year and in planning. We think there's a possibility that could, on the high side, swell by 3 to eleven 11, but the 8 number looks very solid.

We would expect to open somewhere in that same range of offices in 2006, 7, 8 and 9. So as you mentioned, our number of offices last year was about a 25 percent more or less addition, some where in that range roughly. We would expect that percentage addition of offices to slow down each year going forward.

Now, you could be -- if you were projecting a 5 and a 10 and a 15-year model for our company, you would say, well, gosh, that's going have adverse implications 5, 10 and 15 years out because if they are only opening 20 percent new offices this year and if that number becomes 17 the next year and 14 the next, the number of offices going down is going to imply that, in 5, 10 years, these growth rates that the company hopes to achieve would -- would inevitably slow down.

And, the way we're trying to counteract that, and our strategy for that, is to open offices that are bigger offices in markets with better demographics. Basically to open offices that will grow much bigger and grow much longer than the offices we've opened in the past. And we think by doing that, that we can achieve our long-term objectives for substantial year-over-year growth in loans, leases and deposits and net income while opening fewer offices in percentage terms each year.

They just got -- those offices have all got to produce more, so we're focusing on markets that have better demographics. We're spreading those offices a little farther apart physically, geographically than we have before, so that they serve a little bit larger market radius without overlap, and we're building bigger offices.

When we started this, our idea was that an office got to $50 million, that that was just -- that was just top of the world sort of go. And a 30 to $40 million office was a good to a great office and 50 million would just be, that would just be full expectation goal for an office.

A lot of the offices we're opening now, we have expectations they will get to 100 million and north of that, and our kind of our idea now is a minimum goal for an office is $50 million. So, we're just focusing on better demographics, putting those offices in a situation where they can grow bigger, longer. And we think that will solve the -- will solve the problem for us.

Did I answer your questions, Kevin? You probably had more than that.

Well, you went a good bit down the path and I guess circled back to the first question on the occupancy expenses. Again, as you add more and more branches and you make those branches larger and then also it would follow if you're putting them in more demographically favorable markets that the competition for those sites and the cost of real estate would be a bit more expensive as well.

So how is it that you manage to keep that pace of growth and occupancy expenses so far below the number of openings and that a trend that we can expect to continue -- how much control over that do you have, I guess is the question that I'm really getting to?

Well that, is a good question, and let me answer the second part of that and then I'll try to come back to the hard part, and that's how do you control that.

The offices that we will open in, say, the metro Dallas area, will be more costly offices than the offices we've opened in Arkansas. We expect those offices to cost us about twice as much for land and building as our typical branch in Arkansas and almost twice as much to operate as our typical branch in Arkansas.

The flip side of that is, is from our limited experience in those markets, we're getting much better margins on our loans and deposits there than we are in Arkansas.

We're getting much better origination income on our mortgage loans that we're doing there than we are in Arkansas, and there appears to be about 3 times as many deposits per branch in the markets we're looking at in Texas as there are in the markets in Arkansas.

So our thought is that we're going to get better profit margins and a lot more business in those Texas offices than we do in Arkansas and that that's going to more than justify the additional cost of those offices.

We'll see how that plays out as late this year and early '06 we get the first couple of those full-service Texas offices up and running. We'll be able to give you a little more color on that in '06.

As far as controlling that occupancy expense, 1 of our key focuses, Kevin, as you know, is the efficiency ratio. And to make that efficiency ratio get better and better and better, which is our goal, we've got to keep our expense growth at a rate below revenue growth. And we focus primarily on the revenue growth side to make that efficiency ratio work, but we also give a strong secondary emphasis on the cost side, and we're monitoring those costs closely.

We are trying to manage all of those costs very, very shrewdly and efficiently, and I don't know if we can continue to do it or not, honestly. On keeping the occupancy cost of expense growing at a rate well below our growth rate of new offices. That's a good goal.

It's going to be a very challenging goal to achieve going forward, but I think it's an important goal. It's not a critical goal. But if we can do that, it's one thing that will help us achieve our goal for making that efficiency ratio get better year-to-year and I can't give you a lot more detail on it than that. I'm sorry.

Oh, no, that was a very good answer. Very good answer.

Then I've got one last question. This should be a little easier to explain than that.

Again, I apologize for asking something that required so much discussion, but given the jump in floating rate loans you saw this quarter and the progress you've made over the last couple of years relative to fixed, would you say that that is more a function of your lenders doing a better job of selling a floating rate product to a customer base and, I guess maybe taking market share to some extent from others? Or has there been a change in -- I recall a few years ago we talked about Arkansas borrowers tending to have kind of a cultural bias for fixed rate product? Has there been a change now that the usuary law's been -- goes further and further in the rear view mirror and should we expect to see more of that as we go forward?

Kevin, it is a combination of both of those factors, yes. And for those on the call who are not familiar with it, until the passage of the Gramm-Leach-Bliley Act that contained a usuary override that effectively overrode Arkansas's usuary law as it pertained to FDIC-insured institutions, Arkansas had one of the most stringent usuary laws in the country. And one of the anomalies of that usuary law was that the maximum rate in effect on the date the loan was made controlled for the life of the loan. And as a result, the law did not really allow for floating rate loans.

First mortgage residential loans were exempted, so other than first mortgage residential and very short-term loans, almost all Arkansas loans were done on fixed rates because the rate can float down, but it couldn't float up, so the bank didn't have much incentive to make variable rate loans.

With Gramm-Leach-Bliley, we imported the usuary law of every state that has a banking presence in Arkansas into Arkansas and basically have very little, if any usuary limitations left in Arkansas and hence, floating rate loans are very permissible now in Arkansas.

And that really started in 2001 after the test case in federal court validated that usuary override. And since time we have been pushing to get that variable rate loan percentage up every quarter and have done so. And part of it has been a process of our lenders getting better at doing that and getting more accustomed to doing that and breaking their bias of primarily doing fixed rate loans with a balloon all their career and part of it's been getting customers acclimated to that and I think both sides of that, Kevin are getting better.

Our customers are getting much more accustomed to variable rate loans as being a norm in our environment here, and lenders are getting much more accustomed to selling that product. S, think it's a combination of both. And I, I--

Okay.

I think that makes it easier for us to continue to push that variable rate loan percentage up.

Okay. Thank you very much.

Thank you. Good questions.

Dane Unger from Neuberger Berman.

Hi, good morning, George. Good morning. Although it's already afternoon here. We've been on the phone for awhile. Have I one question on the investment security portfolio.

Yes, sir.

You have -- it's been stable, but it's a very high yield on your portfolio relative to most the other banks I look at, maybe 100 basis points higher in general, or maybe even a little bit more.

Could you just tell me what have you in there and why the yield is so high and maybe what the duration is on that portfolio?

I could.

Let me just give you the hard numbers first. As of December 31, the average life of the portfolio using Bloomberg consensus prepayments fees is 3.7 years and the modified duration of the portfolio is 2.98 years. A large part of the portfolio is CMOs. And Dane, we will typically buy the first traunch of those CMOs in that support structure. Instead of buying the pack 1 and the pack 2s and the vidames(ph)and the lower yielding and more defined structural products out of the CMOs. We'll typically go for that first support traunch and we look at a large number of these things to try to find a support traunch that has prepayment characteristics under a wide range of scenarios and assumptions that are fairly close to the prepayment characteristics and predictability that you would get if you bought back up in the pack ranges.

And we, we look for a lot of these things. We look at a lot of them. We run a lot of numbers on them and as a result, we think we can find product out there in that securities portfolio that has a higher yield than if we just came back and bought in the pack ranges, buy wide margin, but does not have significantly different prepayment characteristics.

It's a lot of shopping and a lot of looking to try to find something that got a little more yield, but -- and more yield than it really ought to have to justify the increased extension risk and so forth. Now, there is some extension risk in that portfolio and I want to be honest with everybody about that and we have been.

When we -- when the yield curve was steep and the 10-year rates jumped up close to 5 percent in the second quarter, the -- the duration on our portfolio, depending on which model, and we ran it using 3 different models and methodologies for calculating duration, but that average life, for example, jumped from, I think about the current 3.7, I think then the range was about 3 to (inaudible) years when --

How much was it?

About 5 and a half years.

Okay.

When that -- and it ranged from in the 3-year range, say 3 and a half roughly to 5 and a half. And I don't have those numbers anymore, but we ran it using 3 different methods and depending on how you calculated it, the average life was somewhere in that kind of 3 and a half to 5 and a half-year range.

So with that, basically at that point, 100-basis point boost in -- in the 10-year, which of course has all come back now, or pretty much, most of it, there was some extension, but we believe that we get paid very well for that little bit of additional extension risk.

The rest of the portfolio is primarily municipals and we would like to increase that municipal part of the portfolio over time because certainly we've got the tax situation that would let us use that. And given our tax situation in municipals, would be a very advantageous piece to add to the portfolio.

It takes time to build a municipal portfolio in Arkansas because Arkansas is a very small state. We have a very thin municipal bond market and to find value in that market and to find anything that's got any size and quantity to it, it just takes a long time to build that portfolio. But one of our goals for this year is to, as we can find attractively priced Arkansas municipal product, to add a pretty good chunk of it to the portfolio, but I think you'll continue to see a large CMO piece of the portfolio as well.

Okay, and I guess it's the case that in your modeling for your margin, you're assuming that there will probably be some extension risk in this security portfolio.

Absolutely. We model and up -- and up 100, and up 200 in addition to a stable environment and all that extension risk is modeled into the portfolio in those scenarios.

Okay. Thank you very much.

Thank you, Dane.

You have a follow-up question from the line of Peyton Green with FTN Midwest Research.

Thank you. Dane got a couple of them, but just in terms of the loans on the floor, George, do you have an idea what the percentage was at the end of the quarter?

Hold on just a second. Let's see if I can -- I actually have that information if I can find it for you here.

Okay.

3.74 percent of our variable rate loans were at their floor at the end of the quarter and 96.26 percent of the loans were not at their floor.

Okay. So you ought to see more adjustment in the first quarter from the past rate moves.

Yes.

And future rate moves, okay, good enough. When you all think about the securities book, what is your cash flow that you should get from it in '05 due to maturity?

I'm sorry. Peyton, I didn't understand that.

Sure, sure. The cash flow that you think you'll get from the securities portfolio, just from maturing securities in '05, do you all think about it that way?

Well, I don't have an '05 number. Let me -- let me tell you about what we're expecting. We're expecting -- looks like about somewhere between 8 and $12 million a month in cash flow from the CMO part of the portfolio in the first quarter.

Okay.

Just looking at those numbers there. So, 10 million a month plus or minus is expected CMO cash flow in the quarter.

Okay, and then in terms of the muni mix, it's about 35 percent of your securities book right now.

As the variable rate loan mix goes up, how high would you let the muni number drift up?

There's certainly a tradeoff there, and we would like to see that muni number go up. I don't think the muni number is going to be constrained by our asset liability limitation as much as it is by our -- our ability to find Arkansas muni product that is -- that meets our risk and pricing profile. So, I would hope that we could get that muni portfolio to go up in the next year as much as it went up in the last year and -- 26 percent.

It's at 26 percent of the portfolio now and we would certainly like to see it contribute a larger share of the growth this year. But, again, I think there's just not a ton of municipal issuance going on in Arkansas now and because there's a scarcity of product, sometimes it gets priced really ridiculously. And we want to buy value and be patient and buy quality and I think the constraint is not going to be our appetite for the product, but just the ability to find it this year.

Okay. Great. Thank you very much.

Thank you.

Thank you. At this time there, are no further questions.

All right. Well, thank you all, for your participation and all of the good questions. We appreciate it and we look forward to talking with you in about 3 months. Thank you very much. That concludes our call.

Thank you. This concludes today's Bank of the Ozarks fourth quarter earnings release conference call.