Bank Ozk (OZK) 2005 Q1 法說會逐字稿

Good morning, my name is Jody, and I be your conference facilitator today. At this time I would like to welcome everyone to the Bank of the Ozarks first-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] Thank you.

I would now like to turn the conference over to Susan Blair, Executive Vice President, Bank of the Ozarks. Please go ahead, ma'am.

Thank you. The purpose of this call is to discuss the Company's first-quarter earnings press release issued after the close of business yesterday, our results for the first quarter of 2005, and our outlook for upcoming quarters. Our goal is to make this call as useful as possible in understanding our recent operating results and 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 statements about economic and competitive conditions, our goals and expectations for revenue growth, net income, earnings per share, net interest margin, including the effects of a flattening yield curve, increased competition, 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, nonperforming loans and leases, the adequacy of our loan and lease loss allowance, prospects for sale of an item of other real estate obtained in connection with the credit placed on non-accrual status in the fourth-quarter 2004, nonperforming assets, net chargeoffs, pass through loans and leases, interest rate sensitivity including the effects of possible interest rate changes and the flattening of yield curve on our net interest margin and net interest income, future growth and expansion, including plans for opening new offices and converting loan production offices to full-service banking 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 an 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 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.

Thank you, Susan, good morning and thank you for joining today's call. We are very pleased to be reporting another record quarter at Bank of the Ozarks. We have now reported 17 consecutive quarters of record net income and diluted earnings per share, and we have reported record net income in 31 of the last 33 quarters. While each quarter has different challenges and opportunities, our proven growth in de novo branching strategy, combined with a strong focus on execution of that strategy has allowed us to achieve excellent results in a variety of economic and competitive conditions. In the quarter just ended, this focus on execution was critical in producing our record results.

Let me point to three highlights of the quarter. First, good growth in earning assets, combined with a relatively stable net interest margin gave us our 16th consecutive quarter of record net interest income. Secondly, our dual commitment to revenue growth and controlling overhead helped us report a 43.96% efficiency ratio, our best quarterly efficiency ratio as a public company. And third, our excellent asset quality ratios and particularly our 7 basis point annualized net chargeoff ratio, helped us achieve a low loan and lease loss provision for the fourth quarter. These are the three highlights of another record quarter.

To get into the details, let me begin with a discussion of our first-quarter balance sheet growth. After growing at very good annualized growth rates of 23% and 37% respectively, in the fourth quarter of 2004 loans and leases and deposits grew at annualized rates of 15% and 4% respectively in the first quarter of this year. Of course, these growth rates tend to vary quite a bit from quarter to quarter as reflected by this comparison of results for these last two consecutive quarters. Two things are probably worth mentioning here.

First, the first quarter is often a slower quarter for loan and lease growth for us. For example, loans and leases grew at a 19% annualized rate in the first-quarter 2004 and at an annualized rate of 8% in the first-quarter 2003. So this year's first-quarter loan and lease growth rate of 15% is right in the middle of the prior two years first-quarter growth rates. At this point, our loan and lease pipeline looks very good for the second quarter, and we expect loan and leases to achieve high-teens to mid-20s percentage growth for the full year of 2005.

Secondly, for the full year of 2004, last year, loans and leases grew 25% while deposits grew 30%. This pushed our loans and leases to deposit ratio below our 85% minimum target. As a result, we took a fairly conservative stance on deposit pricing the first quarter this year, and that tended to slow our deposit growth sharply from the 37% annualized growth rate achieved in the fourth quarter of last year.

We expect deposit growth to resume high-teens to mid-20s percentage growth on average in coming quarters. Probably the best measure of our growth is our results over the last 12 months. From March 31, 2004 to March 31, 2005, our loans and leases have grown 24% and our deposits have grown 22%. These last 12-month results are well within our past and our present high-teens to mid-20s percentage guidance range.

Before I leave the subject, I would like to talk briefly about our progress in two other exciting areas. First, I want to discuss Northwest Arkansas, or more particularly Benton and Washington counties. These counties as you probably know are home to Wal-Mart, Tyson Foods, JB Hunt Trucking, and a number of other high-quality companies. In recent years they have comprised one of fastest growing MSAs in the country. For the past 18 months, we have been planning our entry into these markets, and we have now started.

We now have temporary offices open in Bentonville which is in Benton County, and Fayetteville which is in Washington County. By the end of April, both these offices should be serving as temporary branches. Currently one is a temporary branch and one is a loan production office, and both will be replaced later this year with permanent offices. By year end, we expect to have three permanent offices in Benton and Washington counties, and we expect to add four more in the year 2006, four more in 2007, and one to three in either 2008 or 2009. This should give us an expected total of 12 to 14 offices in this rapidly growing and important MSA. We already have six sites in the area, and we have three more under contract which should close this quarter. So we are well along with our site acquisition process.

We are very excited about our management team for this area. We have selected Doug Parker, one of our senior lenders to serve as Northwest division President. Doug had 11 years of experience in Northwest Arkansas prior to coming to work for us. He is an excellent banker, and is proving to be a good team builder. Doug has already hired some great local talent including three experienced Commercial lenders. These are great markets, and we are very excited about our opportunities and our initial progress that we are making with site acquisition, staff development, and early business development.

Secondly, I want to comment on Texas and North Carolina. While we still have approximately 31 Arkansas branches planned to open over the next four years, we are also moving forward with our plans for expansion in Texas and North Carolina. And we are very pleased with the progress. As you know, we currently are operating three temporary banking offices in Dallas, Frisco, and Texarkana Texas. In recent weeks we have broken ground on our first permanent Texas facility in Texarkana. We expect this office to open late this year.

In addition, we now own two sites in Frisco, Texas, and we expect to break ground on our first permanent facility there later this quarter with completion expected in the first quarter of 2006. We have recently hired our leader for the initial permanent Frisco office and the other offices we will develop around it. Although our Charlotte office is still operating as a loan production, we are also building our team there, having added another new lender in recent weeks. In short, we are making good progress with our development of sites, facilities and staff in Texas and in North Carolina.

And most importantly, even though we are operating out of temporary offices in all of these markets, we are having some good early results. As of March 31, our Texas offices accounted for 5.7% of our loans and 3.8% of our deposits. Our Charlotte LPO accounted for another 2.5% of our loan. So in total, these four relatively new temporary non-Arkansas offices accounted for 8.2% of our loans, and 3.8% of our deposits. And based on these early results, we see great potential in these markets. Before I leave the subject of growth, let me comment that we are still expecting to add a total of 8 to 11 new offices in 2005. This is consistent with our prior guidance on this subject, and, again, this is about the same number of offices we added in 2003 and in 2004.

Let's change subjects and talk about net interest margin. We were pleased with our first-quarter net interest margin of 4.33%, even though it was 15 basis points below our net interest margin for the first quarter of last year, and 1 basis point below our net interest margin for the fourth quarter of 2004. These results looked particularly good when one considers the flattening of the yield curve over the past year, and the highly competitive environment in which we operate, as well as several changes that we made in our balance sheet in recent quarters, such as our increase in variable rate loans a percentage of totals loans, our trust preferred securities issuance and [burley] purchases, all of which tend to push down net interest margin.

Let me give you a few further comments regarding net interest margin. First, we were very focused on our net interest margin percentage in the first quarter and frankly in retrospect, we were probably a little too focused on that percentage, because we set some relatively conservative pricing standards for loans and deposits in the quarter, we missed some good business opportunities. Secondly, competition has recently intensified in some of our markets resulting in very aggressive pricing of both loans and deposits. It appears to us that some bankers are struggling to find proper pricing levels in view of the recent fed rate increases. And some of our markets, competitors seem to be trying to price rationally, and make appropriate adjustments to changes in fed interest rate policy.

But on the other hand, in some of our other markets, including the metro Little Rock market, we have seen what we consider to be irrational pricing for both loans and deposits. In times like this, we are very glad that we operate in a broad cross-section of markets with a diversity of competitors. While we are not going to chase business with extreme or irrational pricing, we have concluded that we will need to be somewhat more aggressive in pricing in a couple of these ultra-competitive markets. Now we think this will all work out in a few quarters when some of these hyper-competitive bankers stop or look at, or calculate their net interest margin.

While we expect the flattening yield curve and competition in some of our markets will put some downward pressure on our second-quarter net interest margin, we still expect to report record net interest income in the second quarter. We expect that our strong growth in earning assets will more than offset any pressure on our margin. We have reported record net interest income in 16 consecutive quarters, primarily due to strong earning asset growth, and we don't see that trend changing in the upcoming quarter.

Now let's discuss non-interest income. Our first-quarter non-interest income was up 9.5% compared to the first quarter of 2004, and was almost unchanged compared to the fourth quarter of 2004. Our first quarter is typically a tough quarter for non-interest income, as evidenced by the fact that first-quarter non-interest income in both 2004 and 2003 was our lowest quarter of each of those years. Typically, the first quarter is a weak quarter for income from service charges on deposit accounts, and I have said many times that our mortgage business is typically much better in the second and third quarters, than in the first and fourth quarters, due to the seasonal cycle of housing activity in our area.

Accordingly, we expect income from deposit account service charges and mortgage lending to have a favorable trend over the next couple of quarters. In regard to mortgage lending, I should add this caveat. To date, we have not seen mortgage rate increases have much effect on new home purchase activity. If rates continue to increase as is generally expected, it could have a dampening effect on our mortgage business in later months, if consumer tolerance for such rate increases diminishes.

First-quarter trust income was up 29.2% compared to the first quarter of 2004. We are very pleased with our trust department team, and we expect they will continue to add new customers and grow revenue at a healthy pace in coming quarters. Of course, this income category also tends to vary quite a bit from quarter to quarter.

Here is our bottom-line thoughts on non-interest income. While there is some uncertainty about how high interest rates will go and what affect this may have on our mortgage business, we are reasonably optimistic that like the last two years, the first-quarter level of non-interest income will be the low quarter of the year, and we will see improvements from that level.

Now let's talk about non-interest expense and our efficiency ratio. As you have probably heard me say many times, we are very focused on our efficiency ratio. Even though our efficiency ratio is well within the top decile of the 500 largest bank holding companies, we have the goal of improving it over time. We want to achieve this by achieving our dual goals of growing revenue and controlling expenses. Specifically, we want to grow revenue at a faster rate than non-interest expense, which will, of course, improve our efficiency ratio, again recognizing this number will bounce around from quarter to quarter.

In the first quarter, we achieved an efficiency ratio of 43.96%. This the best quarterly efficiency ratio that we have reported as a public company. We are very proud of this latest milestone in our ongoing quest for an ever lower efficiency ratio. This record was accomplished by growing first-quarter tax equivalent revenue at 16.7%, compared to the first quarter of 2004, while non-interest expense grew only 13.3% compared to the first quarter of last year.

Our attention to controlling overhead is clearly seen in this quarter's results. In the last 12 months from March 31, 2004 to March 21, 2005, our total assets grew 26%, and our total number of banking offices increased 29%, but our non-interest expense only increased 13.3%. This is a result of an ongoing effort to increase productivity and control costs while still growing revenue at an even faster rate.

Let me change subjects by discussing another area where we have a strong focus, asset quality. Our great attention to asset quality was very important in achieving our record first-quarter results. For the second quarter in a row, our provision for loan and lease losses was low. This is due to two factors. First, our chargeoff ratio continued to be very favorable. And second, the analysis that we use as our primary measure of the adequacy of our loan and lease losses, suggested that only a small addition to the allowance was appropriate.

Let me discuss several more noteworthy details about first-quarter asset quality. First our annualized net chargeoff ratio of 7 basis points for the first quarter is the second-best quarterly net chargeoff ratio we have reported as a public company. Second, our ratio of nonperforming loans and leases as a percentage of total loans and leases declined 21 basis points during the quarter, from 57 basis points at December 31, 2004 to 36 basis points at March 31, 2005. This decline is primarily attributable to our gaining title and possession to a large piece of improved real estate, which was in non-accrual loan status in the fourth quarter of last year.

We now have this asset in our other real estate-owned account, so it is still reflected in our nonperforming asset numbers. We have this property under contract for sale, with closing scheduled for mid-May. Having been in this business for 26 years, I can tell you that sometimes these deals close, and sometimes they fall through, but this looks like a good contract with a good buyer, and we presently expect it to close. But you can never be sure until the deed and the money changes hands. If this sale does close, we expect to record a pretax gain on sale of approximately $290,000. Such a gain would substantially offset our prior period charges to write-off accrued interest on this credit, pay delinquent property taxes, attorney fees and other loan collection and preparation-for-sale costs, as well as recover a small chargeoff amount.

In other words, the sale, if it closes, should make us almost -- not totally, but almost whole in this transaction. Also, this asset accounts for 14 basis points, approximately one-third of our 39 basis points of nonperforming assets at March 31, 2005. So closing this sale should have a very favorable impact on our ratio of nonperforming assets.

In summation as I have said many times our goal is to continue to improve net income each quarter. This means reporting record income each quarter compared to the proceeding quarter. We have now achieved this goal in 31 of the past 33 quarters, including the last 17 in a row. Of course, with each success the bar keeps getting higher, but from where we are at today 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 ask our operator, Jody, to once again remind our listeners how to queue in for questions.

[OPERATOR INSTRUCTIONS] We will pause for just a moment to compile the Q&A roster. Your first question comes from Joe Stieven of Stifel Nicolaus.

Hi, George, good morning.

Hi, good morning, Joe.

A couple of questions. In the release you talk about opening somewhere between 8 and 11 banking offices this year. First of all, could you give us the geographic placement of those? How many will be in Northwest Arkansas? What about Texas? What about Carolina? I guess that is question number one.

Question number two has to do a little bit just with strategy. Due to some of the competitive items that you talked about, does the strategy that you very successfully used throughout Little Rock, et cetera, does that strategy change much in either Northwest Arkansas and/or Texas or Carolina? Number two.

And then number three is I think now about 7 or maybe 8% of total loans are in North Carolina and Texas. Where do you think that number could be and, you know, as you look out a year or two? And that's it. And George, again, great quarter.

Thank you, Joe, I appreciate it. All right, well, let me start at the beginning. Where will these -- where will these offices be located?

As I already mentioned including the Bentonville office that was in our first-quarter numbers that is temporary, that will convert to permanent. The Fayetteville LPO that we currently have operational as of last week, which we expect to convert to a temporary banking office later this month, and at least during the quarter if not this month, we will add one more in Northwest Arkansas. So we expect of the 8 to 11 offices, that 3 of them will be in Northwest Arkansas.

We actually now do not expect to add any new banking offices in Texas or North Carolina this year. We have three temporary offices in Texas now, and as I mentioned, we expect to replace the temporary Texarkana office with a permanent facility, but that will be a replacement by year-end. We will expect to add another Texarkana office next year on a site we have under contract in Texarkana, but that's next year. And we do not plan to proceed this year with full service banking operations in North Carolina. We expect to continue to operate this year in an LPO mode there, and will consider possibly as early as next year, seeking a thrift charter and operating on a full-service basis in North Carolina. So, again, 8 to 11 offices. Three of them will be in Northwest Arkansas, none in Texas, none in North Carolina.

We added offices in North Little Rock and Mountain Home in the first quarter, and we expect to add offices in Russellville, which is our third Russellville office, our initial office in Hot Springs which is Garland county here in Arkansas, and a second Benton office also later this year. And there are a couple more we have got on the drawing board. So -- the others are scattered around through our different Arkansas markets.

The question of strategy is a good question, Joe. And basically, you know, our strategy is very similar in every market with some subtle variations, but we would expect our Texas strategy and our North Carolina strategy, and our Northwest Arkansas strategy, to be very similar to what we've done in markets such as Little Rock, Conway, Fort Smith that we have entered.

The actual quantity of our loans out of state as of March 31 was 8.2% of loans have been originated through our Texas offices and North Carolina offices. We would expect that that percentage will grow, even given the temporary nature and the limited number of offices. Even as we are building out the rest of Arkansas and focusing most of our capital expenditures on Arkansas because of the teams that we have got in place in those markets and the strong natural growth rates of those markets, we would expect that 8.2 figure to escalate probably pretty much on a consistent quarterly basis over time.

Now I am not going to try to predict where I think we will be in those markets in total in one year or two years or three years, because that just depends too much on the ebb and flow of competitive conditions. For example, I mentioned right now competition is extremely intense in the metro Little Rock area, and we are getting much better pricing on the loans, comparable loans that we are originating out of our Metro Dallas office, Charlotte office, and Northwest Arkansas offices even, than we are out of the metro Little Rock area now. So al lot of where that growth will come from will depend on the ebb and flow of competitive conditions in those different markets.

The fact that we have this diversity of markets now, including our rural Arkansas markets is a source of great strength to us. It is allowing us to sort of shift away from some of these markets that are real competitive, and try to do more business and focus more attention on the markets where we are getting better pricing. So that's a strong positive for us. But we do expect that the Texas North Carolina, the non-Arkansas piece will grow in percentage pretty much every quarter going forward. I hope that answered all your questions.

Thanks, George.

Okay, thank you, Joe

Your next question comes from Barry Mccarver of Stephens Inc.

Hey, good morning, guys. Thanks for another great quarter.

Thank you, Barry.

A couple more specific questions on the margin, George. I know there are a lot of moving parts in there but looks like the yield in the securities portfolio increased pretty significantly. Can you give us an idea what is going on back there? And then secondly, you talked a little about the, you know, the pressure from the yield curve and from competition. In the past, you have kind of focused on a little bit of a range. I think around 15 basis points is kind of where you thought margin would move within. Are you still comfortable with something like that?

Well, we are not giving any specific guidance -- on the margin, and we haven't historically given any specific guidance. You know I -- I would point you back to the comments that I made is that even though we do expect a little bit of pressure on the margin, principally because of -- because of the intensification of competition and some very aggressive pricing, our sense is that we will still put up a nice improvement in the net interest income number. So I think you will see a little compression on the margin, but that will be more than offset by the increase in the volume.

In regard to the securities portfolio, let me -- let me give you a couple of comments on that. I think there were a couple of things, and there are a lot of moving parts, as you accurately said, Barry. But in the -- in January, February and March, we had $23.7 million in principle paydowns on our CMO portfolio. Most of those paydowns came from CMOs that were purchased at various times and in probably 2003 and 2004 in a lower rate environment. To that $23 .7 million that came in, in principle cash flow, allowed us to redeploy those assets in either new CMOs or municipal securities, tax-frees, which we predominantly bought tax-frees -- or bought a lot of tax-frees in the quarter. So we were repricing those assets at higher yields.

I know there's been a number of questions asked about our CMO portfolio, and the fact that it is a pretty strong-yielding CMO portfolio and people have questioned how that CMO portfolio would react as rates rose. I thought I would give you, if someone asked that question a little bit of data, and you got close enough to it, so I will give you this data anyway. In the third quarter of last year we had $17.5 million in principle cash flow from our CMO portfolio, fourth quarter, October, November, December, $17.5 million of principal paydown on that CMO portfolio.

In the first quarter of this year, January, February, March, $23.7 million, and in April, of course we don't have these payments yet, some will be coming in on the 15th and some the 25th, but we already know the amounts. We will get 10.7 million in a single month, which is more than we've gotten in any other month in the last six months of principal paydown on that CMO portfolio.

So while the obvious intuitive thought would be rates are rising prepayments on mortgages, refinancing of mortgages are slowing, and it will slow down the cash flow, and the models would suggest that, the actual results of that portfolio over the last quarter and the current month of this quarter, actually show an acceleration in the cash flow, principal cash flow from that portfolio. So that's good if that continues in that it will give us more lower rate assets to reinvest at a better -- better yield.

Okay, thanks, George, that was perfect.

Thank you very much.

Your next question comes from Charlie Ernst of Sandler O'Neill Asset Management.

Good afternoon.

Good morning, Charlie. How are you doing?

I am doing just fine. Nice quarter.

Thank you.

Interesting, the cash flow commentary. Do you think that will continue? And why do you think it has accelerated like that?

Well, Charlie, I will give you a couple of comments here. While we don't do our own projections, we look at a variety of projections. And the Bloomberg estimate of cash flow from that portfolio this quarter is $29.7 million. So that -- if the Bloomberg estimate is accurate, and we know the April number is an actual, so we are adding in the estimates from May and June then, yes, that trend would continue with $6 million more in prepayment this quarter than last quarter.

The second thing I would tell you is, you know, as I've discussed before typically, what we buy is sort of that first support traunch past the various pack structures in these CMO [structions], and we don't typically go out and buy whatever is on market. We do quite a bit of study of these things, and we try to identify the support traunch structures that are going to have predictable and consistent prepay characteristics that would like more like a -- a pack type structure than a support traunch, and we try to get paid the support traunch yield on a support traunch because of the history of the product, and the way it is structured we think is going have a pretty predictable yield. Now, that is a tough thing to do.

It probably is like trying to be the judge of a beauty contest in a dimly-lit room, it is not a perfect science, but we look at them. We study them. And we try to buy things that have relatively high predictability and relatively good yield for that predictability and see if we can do some extra -- extra work and generate some extra value there. So I think we have done a good job purchasing product that is probably behaving better in the rising rate environment than would have been predicted by the typical generic models that look at it, and we are getting paid for that.

George, can you comment on what the bond premium amortization expense was during the quarter?

I don't have that number for the quarter at hand. We can -- I think we can dig it out here. Let me tell you where we are at the end of the quarter, though. I do have that number.

At the end of the quarter, we own CMOs that had outstanding premiums of $541,000. We own CMOs that had outstanding discounts of $2,424,000. So there was -- we have approximately a 5:1 or between a 4:1 and a 5:1 ratio of discount to premium. And we do not ourselves calculate and account for that premium or discount amortization.

We outsource that function to FTN Financial, which, you know, has significant expertise in bond accounting, and we just don't want the responsibility for trying to project the assumptions, and make the assumptions that go into how quickly you amortize those premiums or accrete those discounts. So we -- we utilize their independent accounting sources for that, and they drive those numbers.

In specific response to your question, Paul Moore tells me that we had premium amortization during the first quarter of $121,000, and discount accretion of $335,000. So as you can see that is not even quite a 1:3 or 3:1 ratio there, even though we have between a 4:1 and 5:1 ratio in the discount and premium.

For some reason we noted that the FTN guys seem to tend to be prone to amortize premiums faster than they accrete discounts, which is fine with us because we think that is a fairly, reflects a fairly conservative bent in their accounting for that. So, you know -- that bodes well for conservatism is a good thing we think.

So the yield of the net interest margin, I guess, was supported a little bit by the accretion of those discounts this quarter? If that's how the math works there.

Yes, it was, and should continue to be. And, again, we didn't have quite a 3:1 margin of discount accretion to premium amortization. $335,000 discount, $121,000 of premium amortization. And the actual ratio of what is left unamortized and unaccreted is 2.4 to 4 million versus $541,000. So between a 4:1 to 5:1 ratio there. So that -- at least in a relative ratio sense, that -- that number over time ought to get better instead of worse.

Can you also add a little more color to the expense line? It seemed to me last quarter you all felt expenses were a little below average or kind of a normal quarter, so I guess a little bit of a surprise to see expenses down so much this quarter. Were there any -- were there full bonus accruals, or anything else we should be thinking about there?

Well, you know we did have a bonus accrual in the first quarter, whether or not it was full or not, would be depending on your perspective on that. We did have a bonus accrual. Frankly, I would have liked to have accrued more bonuses for our people. I think our guys worked hard, and they probably deserve more than we accrued. And I would hope that strong earnings momentum in future quarters will allow us to accrue a little bit more. But really the first-quarter results were -- were fairly stable, normal results, I think. We have been working very hard to trim some expense items, and be more efficient and more productive in some of the things we do, and I think you are seeing some success in that.

You know, we did have some items that -- that tended to push up our expenses, particularly in the second and third, -- or third and fourth quarters last year. As I had mentioned in I think our conference call in October, you know, we had several severance payments that pushed up employee benefit cost in the third quarter. We hired some folks that we paid some hiring bonuses to, to compensate them for some incentive comp and options and other things that they walked off and left at some of the places that they came from. They tended to push our third-quarter of last year compensation expenses up somewhat higher than normal.

And I think I mentioned -- I know I've mentioned in a couple of previous calls that our 401(k) we determined last year, that it was top heavy and that ended up costing us a pretty good chunk of money, that we had to accrue to make an extra contribution to employees under that plan. And about 3/4 of that we identified that in the third quarter of last year, and 3/4 of that expense hit in the third quarter, and a 1/4 of it because it was for the full year and we just identified it in Q3, so we caught up the accrual then, and then 1/4 of that hit in the fourth quarter of '04. So we fixed that problem by pulling the top-heavy, The folks that were causing that plan to be top heavy out, and putting them in a deferred comp plan that is very similar in its cost and structure. It takes them out of the 401(k) and keeps it from being top heavy.

Another thing you will recall in the fourth quarter of last year, we did have a $200,000 provision for a situation where we had some alleged fraudulent endorsements of some checks that we had processed and we took a charge for what we thought was our maximum exposure on that, and that tended to run up our fourth-quarter costs on that by $200,000. Now following up on that item, we have recovered about $75,000 of that money in the first quarter, and are still working and think that we've got a better-than-even shot of recovering the remaining $125,000 or so, plus interest and attorney fees, in either of second or the third quarter. Probably that is most likely a third-quarter opportunity as we are going through court proceedings in that direction. We have got some property tied up, that we think we can either get a lien on, or get liquidated to cover that deficiency. The $75,000 we recovered in the first quarter, you would think, well, that lowered your first-quarter expenses, and yes, it did.

We also had kind of another unusual item. Our Jacksonville Arkansas branch application has been contested. It is the first branch application that has been contested in Arkansas in 17 years. And we incurred a bunch of extra cost in legal fees and financial consultants and economics experts and other folks preparing our response, and doing the things we needed to do to go through the administrative process of that. And that figure, I don't have exactly, but was probably somewhere in the $70,000 to $80,000 range, it virtually was an identical offset almost for the recovery in the check proc (ph).

When you sort of wash those out, it is a pretty normalized quarter. Yes, I would have liked to put some more money in the bonus pool, but we have a policy that we have minimum infernal targets for earnings and then above that, we split the money above that between our bonus pool and our shareholders.

Thanks a lot.

Thank you.

[OPERATOR INSTRUCTIONS] We will pause for just a moment to compile the Q&A roster. Your next question comes from Peyton Green of FTN Midwest.

Good morning.

Good morning, Peyton. How are you doing?

Doing great. A question -- I think you have done a great job of explaining the expense side, but are there any particular -- is there going to be any particular lumpiness to it as you bring the branches on over the balance of this year? Do you have bigger branches coming on in the second half of the year, versus smaller ones in the first half, if you can just kind of give a little qualitative perspective on that.

Peyton, I don't think you will notice any particular lumpiness caused by the addition of personnel or construction or opening of facilities. Now we do have more offices scheduled for third quarter and fourth quarter than second quarter. And that's not an intentional plan.

That is just because weather, site acquisition, branch approval, architectural design, just construction and development issues have just delayed some of these things that we would have liked to have gotten done Q2 to Q3, and from Q3 to Q4. So the opening schedule tends to be pushed a little out farther this year, but we are already acquiring talent and training people and, you know, doing things that we need to do for the opening of those branches, so, you know, realizing it won't be perfectly linear, I think you'll see our expense growth related to staffing and facilities issues. It will be pretty much on a linear basis through the year.

Okay. And then what was the percentage of variable rate loans out of the total portfolio?

I am glad you asked that. We did increase that percentage again this quarter. You recall at December 31 it was 40.6%. And we pushed that percentage up to 41.2% this quarter. So we -- we gained another 0.6%. I had hoped that we would be able to increase it a full percent, but we did not. But I had a conference call yesterday or two days ago, I can't remember which, with all of our lenders and I reiterated to them again, the importance of booking variable rate loans versus fixed rate loans, and also the importance of putting a floor rate in those loans at the start rate.

You know we -- we certainly think rates are going up, but we also realize that there is always the potential for some sort of cataclysmic event, like a 9/11 event or something like that, that would lead to a sudden reversal of fed policy. We also realize that it is very possible that with the energy costs and the drag that that is likely to put on the economy, and the fed increases already, that there is a real possibility that the fed could overdo it in here, and we could be going other way before too long. So we are trying to protect against that eventual turn in interest rates whenever it may come by trying to put some floor rates in these loans pretty much at the start rate.

Okay. Then -- I know you all relied a little bit more on -- on wholesale borrowings to fund some of incremental earning asset growth and the fourth quarter was a particularly strong deposit quarter so I guess a move to kind of where you were in the third quarter. But can you talk about what your appetite is on the borrowing side going forward or what your capacity is? And then also, you know, what timeframe did you use from the borrowing perspective. Thank you.

The borrowings we used were predominately 7 days to overnight borrowings over a very short term. I noticed the piece you wrote this morning, and you accurately predicted that or estimated that in your notes that you wrote up. And I think you will see the borrowings continue to grow. And those will grow probably pretty much in tandem with our overall balance sheet growth rate. I don't think you will see them growing significantly as a percentage of our total -- total funding sources. But pretty much growing in tandem from this point forward with our deposits. We do expect deposit growth to resume a nice pace this quarter.

I will tell you also -- you know I probably should have mentioned this in our prepared remarks, but we are also making a concerted effort to break a cycle that our competitors have set in motion here. And I've mentioned over the last couple of calls that most of the increases, and the most aggressive deposit pricing that we have seen is on the CD side, and that's taken our mix of CD and nonCD deposits a little higher than we would like. We were actually at the end of March, well, I guess our quarterly for the March quarter on an average basis, our CDs were 58% of total deposits and nonCDs were 42.

And, you know, at one point a year or two ago those numbers were about 51 or 52 for CDs, and 48 or 49 for nonCDs. Very close to a 50/50 mix. And we would like to see that getting back to a more nonCD. And basically what we have done over the last year or so, nine months as the fed has raised rates -- is work on optimizing our margin -- and that has basically meant doing very little in rate increases on your nonCD deposits and playing a very carefully calculated, competitive game on the CD deposits. Not being out there too far, -- but being in the right place.

So that's cannibalized some of our nonCD deposits, and we are as of late March, we are adjusting our strategy just a little bit, and we are trying to get this nonCD category growing at a little higher rate and slow down the growth of that nonCD category. That may cost us a little in our margin for the quarter, but I think we will make it back in the long run.

So I am not going to say a lot more about that because I don't want to tell our competitors exactly what we are doing. But we are trying to shift our strategy just a little bit to see if we can get this mix going back the direction we would like to go, instead of letting our competitors drive the agenda, and just push that CD percentage higher and higher and higher.

Okay. And then lastly, from kind of your perspective as CEO and when you call on customers. Economically, what are you learning about the economy in your footprint?

Peyton, that's a good question, and, you know, I continue to get pretty good reports about the condition of the economy. It is not running away with, you know, runaway growth that would be concerning from an inflation and overheating perspective, but it seems to be pretty stable in the housing market sectors and so forth, and growing decently in other sectors. I was out to dinner with my wife last night, and ran into one of our customers who was very, very positively talking about significant new growth opportunities that they have, and market share opportunities that they are picking up from some competitors, and they have a fairly national scope of business.

And, you know, I think it's -- I think it's positive but not just an absolute boom type situation. What we have been very encouraged by is that the 175 basis point increase in short-term rates, which I realize haven't translated through to that level of mortgage rates, but even with the higher mortgage rates, we don't see any our builders that are having excessive build-up of house inventory, or light inventory, the absorption of those things tend to be continuing at a fairly good pace.

So I would say we are fairly positive about the economy, and I think it's at a good middle point, where it is not too hot and not too cold.

Okay. Great. Thank you very much.

All right, Thank you.

Your they question comes from Charlie Ernst of Sandler O'Neill Asset Management.

Little bit of a light call today.

Okay.

Just wanted to ask you a couple more. George, can you add more color to the mortgage sector, I mean as you know, first quarter tends to be the seasonal low quarter, so a little bit surprising to see revenue pretty flat in the quarter. What can you say there?

Well, I can tell you we are working hard and we had a dismal January in mortgage. A decent February, a pretty good March. It got better in the quarter. You know we -- the $64,000 question on mortgage -- is how long is the consumer going to be tolerant to a little bit higher rates and, you know, what is going to happen to mortgage rates as the fed continues to push up short-term rates, and I think we have got a little ways to go on that. So, you know, those are the big questions. And I really can't give you any more color, Charlie, than that.

The pipeline and mortgage is about three or four weeks long. The pipeline, you know, looks pretty good and is consistent at this point with the guidance that I made, we would expect mortgage to be better in the second quarter and the third quarter than the first quarter, but you know about as far out as we can look with our binoculars on, mortgage is three to four weeks and you just have got to get those customers every day to add another day to that ability to predict and project. So I can't really add anything beyond what we've already said.

And in talking to your clients about, I guess, floors on loans, on the adjustable rate loans that you are getting. Are they -- are they asking you in turn for caps, and how successful are you in getting floors?

Well, we are being pretty successful. I would say we are getting them in more than half the loans that we're booking that are on variable rates, and probably well more than half. For example, 18 -- we had $18.9 million of loans at the floor rate, which is 1.6% of our total loans were at their floor rate at March 31. And, you know, those were, I think, probably almost all loans that had been originated and were still at their start rate and the floor rate was at the start rate. Of course we are frequently asked for caps. We've got caps in a lot less of our loans than we do floors, and you are know, to give you an indication on that, at March 31 $7.8 million of loans were at their cap rate, which is 0.7% of our total loan portfolio.

So most customers seem to be not too resistant to floors now, because they think rates are going higher. So they are not too concerned about the floors. And you know we -- are doing a pretty good job, I think, of making customers understand if they want a cap rate, they need to pay more and get a fixed rate. If they want a variable rate with a lower initial rate, than they don't get a cap with it.

Okay, lastly, can you comment on the amount of the bond portfolio in held maturity today and what the OCI mark was for the quarter?

There is none of the bond portfolio in held-for-maturity, and it is all in available-for-sale and we have been there for, Paul, a year or so.

Couple, three years.

Probably two years and we busted our held-to-maturity category a couple of years ago -- one two years ago because we wanted to reshuffle some things in the portfolio that were held for maturity that we didn't want to keep. So we moved everything to the AFS part of the portfolio, and which, of course, means it is all mark-to-market through capital through the end of each quarter.

And what would the market have been for the quarter? Do you have that number?

Well, let's see, the -- the total mark through the capital account was $4.8 million at quarter end. And it was $1.8 million at December 31. So $3.0 million -- $3 million.

After tax.

After tax, that went through the capital account.

Thanks.

Thank you. Any other questions?

No, sir, at this time there are no further questions.

If there are no further questions, That will conclude our call thank you for being with us and we look forward to talking to you in 90 days

Thank you. This concludes today's Bank of the Ozarks conference call. You may now disconnect.