Bank Ozk (OZK) 2005 Q2 法說會逐字稿

Good morning. My name is Melanie and I will be your conference facilitator. At this time, I would like to welcome everyone to the Bank of the Ozarks second-quarter earnings release conference call. All lines have been placed on mute to prevent any background noise. (Operator Instructions). Thank you. Miss Blair, you may begin your conference.

Good morning. I'm Susan Blair, Executive Vice President in charge of Investor Relations for Bank of the Ozarks. The purpose of this call is to discuss the Company's second-quarter earnings press release issued after the close of business yesterday, our results for the second quarter of 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 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 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 and increased competition, net interest income, non-interest income, including service charge, mortgage lending and trust income, non-interest expense, our efficiency ratio, asset quality, interest rate sensitivity, including the effects of possible interest rate changes, future growth and expansion, including plans for opening new offices, and loans, 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 statements 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. Thank you, Susan, and thank you for joining today's call. We're very pleased to be reporting another record quarter at Bank of the Ozarks. We've now reported 18 consecutive quarters of record net income and diluted earnings per share, and we have reported record net income in 32 of the last 34 quarters.

Our proven growth and de novo branching strategy, combined with a strong focus on the execution of that strategy, once again allowed us to achieve excellent results despite a challenging operating environment. In our last conference call, we pointed out two specific challenges -- a flattening yield curve and an increase in the level of competition for both loans and deposits. During the second quarter, these challenges continued. The yield curve flattened further, and intense competition for both loans and deposits continued, although competition does not appear to have accelerated from the first-quarter level.

While these two factors put some pressure on net interest margin and somewhat slowed our growth, we continued to find many opportunities. Let me point out four highlights of the second quarter.

First, growth in earning assets more than offset pressure on our net interest margin, allowing us to achieve our 17th consecutive quarter of record net interest income.

Second, our continued addition of new customers allowed us to post record income from service charges on deposit accounts.

Third, our dual commitment to revenue growth and controlling overhead helped us achieve a 43.86% efficiency ratio. This was our best quarterly efficiency ratio since we became a public company in 1997 and reflected a slight improvement from the record ratio reported in this year's first quarter.

And fourth, our excellent asset quality ratios, and particularly our six basis points annualized net charge-off ratio, resulted in a low loan and lease loss provision for the quarter.

These outstanding results reflect both the strength of our growth and de novo branching strategy and the excellent job our team is doing executing that strategy.

To get into the details, let me begin with our balance sheet growth. Over the last four quarters, our loans and leases have grown 19.6%. However, during the first six months of 2005, our loan and lease growth slowed to an annualized rate of 15.5%. Over the past four quarters, our deposits have grown 23.4%. However, during the first six months of this year, our deposit growth slowed to an annualized rate of 12.7%.

These growth rates for the first half of 2005 are below our guidance for growth, ranging from the high teens to the mid-20s in percentage terms. We continue to be optimistic about our long-term potential for loan, lease and deposit growth. We have a business strategy with a proven track record. We are in many excellent markets and have recently entered or plan to enter many markets with even better demographic and growth characteristics. In our opinion, the slower growth rates of the last two quarters do not reflect a fundamental change in our long-term prospects.

We have seen three factors adversely affecting loan and lease growth in recent months. One of these factors is the increased movement of loans on completed and stabilized projects to secondary market financing, or the sale of such projects to institutional or other investors. With the yield curve flattening and rates likely to rise somewhat further, we have seen some customers accelerate their movement out of their construction and many permanent loans on such projects into longer-term, fixed-rate, non-recourse secondary market financing.

With short rates rising and long-term rates holding relatively steady, customers are losing their incentive to stay in their short-term construction financing any longer than necessary. We have seen some customers take advantage of low appraisal capitalization rates to also justify the sale of projects.

The second factor affecting loan and lease growth is intense pricing competition. As I suggested we would do in our last conference call, we have become somewhat more aggressive on our pricing of loans and leases. However, we will not price at levels where we do not feel we are achieving an adequate risk/reward ratio.

The third factor affecting loan and lease growth has been competition related to loan and credit underwriting. While we will compete aggressively on price, we will not compete for business by sacrificing sound underwriting. Over the past few quarters, we've seen a number of transactions financed by competitors with what we consider to be inadequate down payments, inadequate guarantees and recourse provisions or other diminished credit requirements.

We've worked too hard to build excellent asset quality to jeopardize it with overly aggressive underwriting.

With respect to deposits, there has also been a lot of competition. Because of the significant deposit growth that we achieved in 2004, when our deposits grew 30%, our loans and leases to deposits ratio continues to be below our 85% minimum target, and accordingly, we are continuing to take a fairly conservative stance on deposit pricing. This has allowed us to be comfortable with the somewhat slower deposit growth we have experienced over the last couple of quarters.

While our growth has been slower over the past two quarters, our long-term plans and goals continue to be for higher growth rates than achieved in these quarters. Most banks would be very pleased with the 15.5% loan and lease and 12.7% deposit annualized growth we achieved in the first half of this year, and we're pleased that we have continued to add new customers every day.

With all that said, we believe it is realistic to maintain our goal of achieving loan and lease and deposit growth rates ranging from the high teens to the mid-20s in percentage terms. However, we believe that the current competitive and interest rate environment makes that a challenging but not unattainable goal for the next couple of quarters.

Before we leave the subject of growth, let me comment that we are expecting to add a total of approximately eight new offices for the full year of 2005. We have previously given guidance for eight to 11 new office openings this year. We had expected to open our new office in Jacksonville, Arkansas, this year, but our branch application has been contested by a competitor bank. I am told that this was the first contested branch application in Arkansas in about 15 years.

We have now obtained both state and FDIC approval for this branch, but the protestant has appealed this matter in court. We continue to be optimistic we will ultimately prevail, and as a result, we now expect to open this branch in 2006.

We had also planned to add an office in the Heights neighborhood of Little Rock this year, and we had purchased a site for that facility. However, we also needed adjoining property, which we were ultimately unable to acquire. As a result, we sold this site during the second quarter and are now looking for an alternate location. This has indefinitely delayed this planned branch.

Finally, the design and development and permitting processes for our first Frisco, Texas permanent office have taken longer than expected, causing that branch opening to be rescheduled for 2006. Accordingly, we are now expecting eight office openings this year, and we continue to expect eight to 11 new office openings in 2006 and in future years.

Let's change subjects and talk about our net interest margin. In our last conference call, we said that we expected the flattening yield curve and competition in some markets to put some downward pressure on net interest margin. We also stated that we expected our growth and earning assets to offset any pressure on net interest margin, thus allowing us to report another quarter of record net interest income in the second quarter.

That guidance was accurate. The yield curve flattened, competition continued to be intense, our net interest margin declined 11 basis points from 4.33% in the first quarter to 4.22% in the second quarter, and most importantly, our good earning asset growth allowed us to achieve positive growth in net interest income and thus report our 17th consecutive quarter of record net interest income.

During the last conference call, I stated that we may have been a little too focused on net interest margin in the first quarter, and this may have caused us to miss some good business opportunity. In the second quarter, we became slightly more aggressive on both loan and deposit pricing. This no doubt hurt our margin a bit, but we believe this was a necessary and appropriate response to the current competitive environment.

With the substantial flattening of the yield curve that has already occurred, we probably only have a little farther to go with that process. Competitive pressure seemed to have stabilized in the second quarter, but I don't expect to see those competitive pressures diminish until some of our competitor banks study their margins and conclude that they are not happy with their results.

In short, we expect some continued pressure on the net interest margin over the next few quarters until we return to a more favorable yield curve and a more normal competitive environment.

Our goal in the current quarter will be the same as last quarter. We hope to achieve growth in earning assets, which will more than offset the effects of any pressure on our net interest margin, thus allowing us to achieve another record quarter of net interest income.

Last quarter, this growth in earning assets came in part from loans and leases and in part from investment securities. We were fairly active purchasers of municipal bonds during late March and the first half of April, when the yield on the 10-year treasury was in the 4.25 to 4.5% range. As 10-year treasury rates dropped in the second quarter, we found it much more difficult to find what we consider to be value in the bond market, and thus we substantially reduced new purchases.

We continue in that mode today. Apart from isolated transactions that we believe have particular value, at this point, we do not plan to purchase many bonds until the market gives us a better entry point. Based on Bloomberg consensus prepayment projections, we are expecting about $31.4 million in CMO paydowns this quarter, so our securities portfolio may actually decline this quarter unless we find better purchase opportunities than we see today. That means we are looking for strong loan and lease growth this quarter to more than offset any decline in our securities portfolio, if there is any, and to help us achieve the earning asset growth that we desire. We are cautiously optimistic about our ability to achieve this growth as third-quarter loan growth is off to a good start so far.

Let me make a few comments regarding non-interest income. In our last conference call, I noted that the first quarter is typically a weak quarter for income from service charges on deposit accounts. I know that some of you were concerned about the industry-wide low numbers for service charge income for the first quarter, so I'm particularly pleased to report that we achieved a record level of income from service charges on deposit accounts in the second quarter.

Despite the very competitive environment, we added net new customers in each month of the second quarter. We expect to continue to add net new deposit customers in the third and fourth quarters, and we believe this will contribute to a generally improving trendline for income from deposit accounts service charges.

We are also optimistic about growing trust income. Trust income in the first two quarters of this year was up 18.8% compared to the first half of 2004. While this category of income will vary from quarter to quarter, we expect trust income to grow over time at a very good rate.

Second-quarter mortgage lending income was up from the level achieved in the first quarter of this year. As I've said many times, 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 market activity in our area.

We saw the impact of this seasonal cycle in our second-quarter results. Based on our closings and application volumes so far in July, it appears that mortgage lending is off to a good start for the third quarter.

Now, let's talk about non-interest expense and our efficiency ratio. As you probably know, we are very focused on our efficiency ratio. Even though our ratio is well within the top decile among the 500 largest U.S. banking companies, we have a goal of improving it further over time. Specifically, we want to focus primarily on growing revenue and secondarily on controlling our growth in non-interest expense.

In the third quarter, we achieved an efficiency ratio of 43.86%. This was the best quarterly efficiency ratio we've reported as a public company and reflected a slight improvement on the 43.96% efficiency ratio we reported in the first quarter.

We're very proud of these milestones in our ongoing quest for an ever lower efficiency ratio. This latest record was accomplished by growing second-quarter tax equivalent revenue by 11.3% compared to the second quarter of last year, while non-interest expense grew only 4.1% compared to the second quarter of last year.

Our asset quality results for the second quarter make me extremely proud of our lending and credit personnel. Our focus on asset quality was very important in achieving our record second-quarter results. For the third quarter in a row, our provision for loan and lease losses was relatively low. This was due to two factors. First, our charge-off ratio continued to be very favorable. And second, the analysis used as our primary measure of adequacy of our allowance for loan and lease losses suggested that only a small addition to the reserve or allowance was appropriate.

There are several noteworthy details about second quarter-asset quality. First, our annualized net charge-off ratio of 6 basis points for the second quarter is the second-best quarterly net charge-off ratio we have reported as a public company and was just 1 basis point from our best. Second, our ratio of non-performing assets to total assets of 21 basis points was our best-ever ratio of non-performing assets since becoming a public company in 1997.

The significant improvement in our non-performing asset ratio from the end of the first quarter was due primarily to the sale during the second quarter of an item of other real estate. You will recall that we had thoroughly discussed this property and related matters in our last two conference calls.

This sale not only helped us achieve a record level of non-performing assets, but it also generated a nice gain on sale. This gain allowed us to effectively recover almost all of the interest written off and the loan collection and repo expenses incurred in connection with this credit.

From the time this loan was placed on non-accrual status to the date of sale of this asset was about six months, and I'm very proud of the job that our team did in resolving this matter. Even with the strongest credit underwriting, every lender will eventually have some problem loans, and the ability to quickly resolve and liquidate problem assets at near-full value is a very important skill set in our business. The speed and efficacy with which our staff resolved this matter was very satisfying to me.

Thirdly, as of June 30, our ratio of loans and leases past due 30 days or more, including past-due non-accrual loans and leases, as a percentage of total loans and leases was just 45 basis points. This is the second-best past-due ratio we've reported as a public company and just 1 basis point from the best.

For all of these excellent asset quality results, I want to publicly say congratulations and well done to our loan and credit personnel.

In summation, as I have said many times, our goal is to continue to improve net income each quarter. This means reporting record net income each quarter compared to the preceding quarter. We've achieved this goal in 32 of the past 34 quarters, including the last 18 in a row. Of course, with each success, the bar keeps getting higher, and given the flattening of the yield curve, the competitive environment in which we're operating and the lack of value we see in current securities purchase opportunities, we're clearly operating in a challenging environment. But from where we stand today, we believe this is still a reasonable goal for the upcoming quarter, and we look forward to the challenge of working to achieve another quarter of record results.

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

(Operator Instructions). John Rodis, Stifel Nicolaus.

Good morning, George. Congratulations on a nice quarter. First off, you talked about, right at the end, the sale of the foreclosed assets. Was that the entire 335,000 during the quarter -- the gain on sale?

The gain on sale of that transaction was about $316,000, and that was literally within a few thousand dollars, and I don't remember whether it was plus or minus, John, of what we would have recognized as interest income had the loan stayed in performing status and recovering the taxes -- property taxes and other cost of sales associate with it. So we basically -- while that looks like an extraordinary item, and is, if the loan had continued to perform, we would have had about the same earnings almost exactly as we ended up by recognizing the gain.

The other aspects of that -- we had a small final payment from sale of our interest in the Pulse network. We had -- and I don't remember on the sale of that branch that I mentioned in the Heights, there was a few thousand dollars gain or loss, and then we had a negligible gain or sale on several other items of OREO and smaller repossessed assets. So, pretty normal, other than that one deal.

You'll note, if you look at our supplemental quarterly financial data, that we've reported some gain on the sale of assets in each of the last eight quarters, and I think that just reflects the generally conservative mindset that we have regarding value and repo and other real estate items.

With credit quality being obviously so strong, can you just talk a little bit about maybe what you're seeing on the watchlist trends, kind of behind the scenes a little bit?

John, I would tell you that our list of classified assets is the lowest in percentage terms, as a percent of capital, that it has been in a number of years, and we feel very good about the asset quality. The reserve percentage over the last five, six, seven quarters has come down from about 1.52% of loans to 1.37% of loans, and that is simply a reflection of the fact that the mathematical formula that we use to calculate the adequacy of our reserve is not allowing us to keep as high a reserve as we were. We're bringing that down because the formula is requiring us to bring that down. And that is reflective of a general underlying positive trend in asset quality, and we've certainly seen that in the last few quarters' charge-off numbers.

Okay, that makes sense. One or two other questions. On salaries and benefits, I guess that line item was up on a linked-quarter basis about 400 -- a little over 400,000 during the quarter. Was that just basically related to the continued growth of the bank?

Two things. Continued growth -- obviously we had more offices -- it takes more people. And the other thing is our bonus accrual in the second quarter was about $150,000 higher than our bonus accrual in the first quarter.

I'm sorry, you said 150,000 higher?

$150,000 higher than the first-quarter bonus accrual.

Okay. And my final question, George, is I guess at the beginning of the call you talked a little bit about loan and deposit growth, and you kind of gave three reasons why loan growth had maybe slowed a little bit in the first and second quarter. Were you more referring to Arkansas, or Arkansas and Texas, or can you kind of break that out a little bit, what you're seeing in the different markets?

Well, we're seeing different aspects of competition and different intensity of competition in our different markets. I think one of the strengths of our Company now is that we do have some diversity even within our Arkansas markets and the addition of Texas and North Carolina that are helping us ride out the storm. If we were limited to just a couple of the markets that we're in, where we've seen very intense competition, I think we would have a much more challenging margin and growth environment. But we've got some areas that are not as significantly impacted.

I'll give you some color on the volume of our deposits and loans out-of-state. We did that for the first time last quarter. And rounding off just to one decimal place, if you'll let me do that, last quarter, our out-of-state deposits, which of course are in Texas, were 3.8% of total deposits. Texas now accounts for 4.3%, so a 50 basis point -- a half percent improvement in the Texas share of our total deposits on a linked-quarter basis.

Texas loans grew at almost exactly the same rate as our total loan portfolio, and at the end of the first quarter, Texas accounted for 5.7% of loans, as it did at the end of the second quarter.

North Carolina saw a good growth in their portfolio as we're building our staff and presence there, and North Carolina grew from 2.5% of loans at the end of the first quarter to 3.3%, so an 80 basis point, 8/10s of 1% increase in their share of our total loan portfolio.

So, if you add Texas and North Carolina, they went from 8.2% of loans at the end of the first quarter in total to 9.0% of loans at the end of the second quarter. So the more aggressive competition that we have seen has been in Arkansas, and that's helping us to see these out-of-state markets, even though we're still operating in temporary facilities in all of these markets, actually contributing a higher percentage to our total growth.

Thanks, George. Nice quarter.

Barry McCarver, Stephens Inc.

Just quickly, going through on the margin again, kind of make sure I understand your thoughts there, it sounds like in terms of loan and deposit competition, much like we expected last quarter, we could see a little bit of contraction in the margin as a result of that, which you hope to make up with potentially some strong asset growth. And then on top of that, it sounds like maybe some rolling out of the securities portfolio, which you'd have to have even stronger asset growth to make up for, and whether or not that occurs, maybe even a little bit more margin compression. Is that a fair assumption?

I don't think the rollout from the securities portfolio has much impact on the margin number, Barry. I don't see that being anything that moves the margin, you know, more than a basis point or two. That real change in mix -- I do think you're going to have that significant a shift. And you know, I don't want to overemphasize that, because obviously, rates have been rising on the 10-year for the last week or so, and if that trend continues, we may find another occasion in this quarter where we feel like there is some value and we may buy some securities.

So, if on the other hand, rates get lower in the 10-year sector from here, we're not -- when we're down around 4% on the 10-year, we're not finding that to be a particularly compelling value equation for us. So we're just not buying bonds.

We typically tend to be a little bit of a contrarian, and we look for significant pullback opportunities, normally, to buy bonds, which is why we were very active the last few days of March and the first 10 or 12 days or so of April. There was a pretty good selloff in the 10-year in that time frame, and we felt like it was a good buying opportunity, so we went out and bought a lot of munis, and those have turned out to be very good purchases for us.

So, if we find a good buying opportunity, we will buy. If we don't, we'll let that securities portfolio shrink a little bit.

In regard to the margin, yes, you've got it right. We are expecting some further pressure on the margin this quarter, just because of the flattening of the yield curve and the competitive pressure. And we believe that it's a realistic goal to think that we can generate earning asset growth, whether it's from loans or a combination of loans and securities that will allow us to offset that, and that's our strategy for the quarter.

I will mention another item in the very late first quarter and early second quarter. We decided that we were unhappy with this continuous shift in our deposit mix to more CDs and less non-CD deposits, and that was being driven because our competitors, over the last year, as rates had been going up, it really concentrated heavily on CD deposit pricing and they had not moved their core rates very much. So we went in, and I don't remember whether we did it the last week of March or the first week or two of April, but decided we were going to try to turn that tide and go against the competitive grain there, and we pushed up some of our rates on our non-CD accounts.

And in retrospect, I'm not sure that was a very successful strategy. We did turn the tide just a little bit, but such a negligible way that it, for example, CDs accounted for 58.0% of our average deposits in Q1. They accounted for 57.9% of our average deposits in Q2. So, an insignificant improvement in mix there. And that cost us a little bit on the margin. We spent several basis points of margin in that effort to try to shift that tide, and I don't know if we had that decision to make over again today we would do that. My guess is we probably wouldn't. We would probably just go with the flow and follow the aggressive trends that persisted throughout the first and second quarter on CDs and let that mix shift a little bit.

But we did make an effort to stop that, and the costs and the benefit of that probably did not work in our favor. But that tended to dink our margin a little bit in the second quarter.

Okay, thanks. Just secondly, in terms of the new branches in Northwest Arkansas, it looks like there's a lot of startups going on up there. Are you finding it more difficult to hire people, and is it any more expensive in that marketplace for future branches?

Barry, we're actually surprisingly pleased with our ability to acquire staff up there. We've put together an excellent team. We've got a great leader and a number of guys that we've got a tremendous amount of confidence in on our lending team there. So, we're very encouraged. We know what a competitive market that is, and the demands on the talent pool in that market, and we've been very pleased with the team we've been able to put together, and I think I may have even commented on that in our last conference call. I know I did at our stockholders' meeting. And so, surprisingly pleased with that. Yes, it is a competitive market, but there still is tremendous growth there, and we're very optimistic about that market.

Scott Alaniz, Sandler O'Neill & Partners.

A couple of questions. George, first, could you elaborate on the degree of stretching, if you will, on credit quality terms, conditions and so forth by certain of your competitors -- maybe give us a sense of which markets that's in and whether or not this is isolated with respect to a handful of competitors, or if it's a little more widespread than that?

Well, Scott, one, I'd rather talk about what we're doing than our competitors. But I understand your desire to know that information and need to know, so I'll address it generally. It's certainly not a universal throwing in of the towel, in our view, from our competitors on credit underwriting. But what I think you're seeing is a lot of competitors having margin pressure because I don't think they are pricing properly, in my view, and that's my prejudiced, humble opinion on the subject.

And I think their solution to that is run out and try to get more growth to offset some pressure on their margins, and to get the growth, then, they are sacrificing both margin and credit quality. But, to give you examples, we've seen quite a few projects that we were working on or bidding on where we would have normally required, even given the strength of the guarantors, a minimum 10% or more cash equity infusion, and we've seen those projects being done at 100% finance. We've seen projects where we would typically require joint and several guarantees, and some of those projects being done with no guarantees on a non-recourse basis.

So, I would say it's not universal. It is isolated. But it is not isolated to one or two competitors. There are more than a normal amount of folks out there doing some -- what we consider ill-advised bets on credit underwriting.

Is that North Dallas, East Texas or Arkansas?

It's Arkansas. We've seen it a little bit in the Texas market as well -- the North Dallas market as well, and, you know, more isolated cases of it elsewhere. But the important thing for our investors to understand is that we are not going down that road. We are requiring what we would normally require as down payments, what we would normally require as guarantees and recourse. We're not underwriting our loans or structuring our deal terms any differently than we were a year or two years, three years, four years ago, and you see the asset quality results that that has produced for us, and we want to continue to have very favorable asset quality.

Now, that may diminish my growth a little bit in the short run, but that is the smart thing to do, and we're running this Company for the long run, so we're not going to go, to make our growth objectives for a quarter or two or three quarters, we're not going to go chase and do crazy underwriting. We're going to stick to our fundamentals and our principles of running this business, and that will serve us very, very well in the long run.

I understand. I believe that you -- the Company updates annually its historical loss experience -- I believe also over the last three years and five years, and you do that by loan category and grade. And I think you stated in the fourth quarter that you were going to -- that the Company was going to do that again in the second quarter. So, the first question is, did you update the historical loss experience?

We did that in the first quarter, and we're doing it annually, so that's a first-quarter deal that we look at every year. And we look at it on both a three-year and a five-year basis. And both the three-year and the five-year data is calculated into our resetting of the required reserve levels for each category of risk-rated loans.

And George, is the unallocated reserve still near the top end of the Board's policy limits of 15 to 25% of the total reserve?

That's a good question, and yes, it is, and as I commented in response to John's question in a more general sort of way, we are having to bring the reserve down because we are constantly bumping at the 25% unallocated figure, which is we think the sort of the maximum that is reasonable and appropriate. So that formula is continuing over the last four or five quarters, and I'd have to look back to tell you, but it is continuing to require us to lower our reserve percentage.

We are not lowering our reserve because we need a lower provision to make earnings numbers. We're lowering our reserve because of the mathematical formula that determines how much we need to be in the reserve, is just requiring us to bring that reserve down. I will comment on that if you -- because I know some of you have noted that over the last three quarters, our provisioning has only been 500,000 a quarter, and while that is by historical standards a relatively low provision, it is exceeding our charge-offs by a two or three to one margin each quarter, so our reserve is still going up, and we're just deriving the benefits from a very strong commitment to asset quality that we've had over the last four or five years.

Andy Stapp, Cohen Brothers & Company.

Congratulations on another nice quarter. It looks as though that the -- your decline in net interest margin was due more to the flattening yield curve than competitive pressures, given that the spread on investment securities declined more than the spread on loans. Is that a fair statement?

Andy, I don't -- I don't think it is, actually. Certainly, the flattening yield curve is a significant factor, but competitive pressures are also a significant factor, and I will point to just one example of how that is playing out.

As we are renewing variable-rate loans or setting up new construction loans or loans that we would've done variable rate last year and two years and three years ago, and we're doing them variable rate this year, in a lot of cases, to retain that business, we're having to renew those loans with a margin to prime that's 50 or 25 or 75 or 100 basis points less than the margin to prime at which we would have renewed those loans in prior years.

And we have a sizable chunk of our portfolio that either reprices or rolls over annually, so that increased competitive pressure, and we've really been seeing that on the prime floating loans for a couple of three quarters now. It has put some pressure on those margins. It's not changing the margins on the prime loans that were already on the books, but it is -- one construction loan pays off and a new one comes on, in certain markets on certain types of credit, we are just having to price those more aggressively than we did six, 12, 18 months ago. That is a factor.

Let me add one thing there, and a piece of data that I normally give in our call that I didn't mention today, and I mentioned the rollover in our loan portfolio, and some of you will want this data. If you take variable-rate loans or principal payments or maturities on fixed-rate loans, 62% -- as of June 30, 62% of our loan portfolio either pays off or reprices in one year, 75% in two years and 86% in three years, and our variable-rate loan percentage at June 30 was 42.2%, up 99 basis points from 41.21% the prior quarter.

So our goal is to increase variable-rate loans 1% a quarter, and we almost got there. We were 99 basis points. And if we hit all of our goals 99% of the way, we'll be (multiple speakers)

Doing pretty good.

Yes. So, if you look at that with 62% of the portfolio either repricing or renewing or repaying in one year, 75 in two and 86 in three, we don't have a lot of duration exposure in the loan portfolio. The challenge is not an asset/liability mismatch. The challenge is flattening yield curve and the competitive environment.

Well, what should we expect some greater linked-quarter margin compression if the yield curve doesn't move, given that that'd be the full-quarter effect of the flattened yield curve?

Well, the curve, of course, has been flattening for a year now. And as I said in my prepared remarks, we think we're most of the way, although not all of the way through that flattening process. And obviously, further flattening is for us, and probably the vast majority, if not all other banks in the country, a more challenging environment and a steeper yield curve, which would -- for almost everybody would be more favorable.

We have run our assumptions and our plans for the next quarter, and, you know, again, the guidance we've given and -- about as precise as I can be is to say, yes, we think we'll have a little more pressure on the margin over the next couple of quarters, but we believe certainly for this next quarter that we're going to generate earning asset growth that will offset that. That's our plan and our strategy, and we think that's a very reasonable plan. We've got to go do it, but (multiple speakers) plan.

Last question, could you provide me the duration of your estimate securities?

Yes, I can, and I can give you a little information along that. As of June 30, according to our good friends at FTN Financial, who do the accounting for our bond portfolio, the average life of our bond portfolio -- and this includes estimated consensus prepayment speeds on the mortgage-backed part of it -- the average life was 3.7 years; the modified duration was 3.13 years.

I had mentioned in the last conference call that we were expecting CMO paydowns in the second quarter of 29.7 million. That number actually ended up being 29.1 million. So the paydowns were 98% of what we had projected. And again, this quarter, we're projecting 31.4 million in paydowns, and the July number is 9.7 million, and we already know that -- that's an actual number. So, if you add the actual number that we know for July to the August and September estimates, it's 31.4 million.

Peyton Green, FTN Midwest Research.

George, I just want to follow up on the deposit issue, because it seems to me, looking at the change in the cost of funds on the interest-bearing and money market or savings balances, that those only went up 20 basis points linked-quarter and the CDs went up to a wider degree, and yet you maintained the same balance on a relative basis of the lower-cost funding. Do you think that you could do better if you raise the cost of your savings and interest-bearing deposits versus what you did on the CD side, or is it just the competition on the CD side is higher than where you are and so it's pulling money out of the bank?

Peyton, we're going to meet -- is it, Susan, later this week? We're actually meeting tomorrow our deposit pricing folks to actually really crunch through the nitty-gritty details of the second-quarter deposit results office by office, product by product, and refine our strategy for the third quarter on that. So that's a good question, and I don't know the answer to your question. I'll know a whole lot more about that after we really meet and grind through that.

I've not personally been through that data, but Dan Rolett and Susan Blair and their team of people are studying all that. So we're looking at that and what we will try to do is exactly what you're suggesting here, is arrive at a revised marketing strategy that accomplishes what we want to accomplish on deposit growth and does it at the lowest weighted-average overall cost to accomplish that.

And you know, I did mention in my earlier remarks that we put some extra rate on some of our non-CD deposits and really had hoped to have a little better result with that than what we had had. We stopped the trend toward more CDs in the quarter, but only reversed it to the extent of 1/10 of 1%, and that was not as good a result as we were hoping for with that strategy.

And we'll just have to analyze that in detail tomorrow and arrive at a conclusion of whether or not that really was a good strategy or not, and if it was, we'll push that strategy a little farther. If not, then we'll go with the flow, as most of our competitors have done. So I really can't answer that at this point. I'm sorry.

Okay, and then just a follow-up. Is there anything you can do on the customer repo side to maybe get more balances on that line? I know it's a very small line for you, but it's at a significantly lower cost than your other borrowings, or really, frankly, any of your interest-bearing deposit accounts, and I just didn't know if there was any opportunity there that might help you with the margin in the third and fourth quarter.

Peyton, nothing other than our normal business development efforts that I'm aware of at this time that would help us.

Great, and I guess any sense on anecdotally in terms of like -- customer complaint may be too strong of a word, but versus what your pricing -- what you wanted your pricing to be and what you had to give in on on the deposit side in the second quarter? Was that more intense, about what you expected, or how does that compare to where you were in the first quarter?

I'm sorry, I'm not sure I understand the question.

Oh, just kind of like -- I mean, beyond the posted rate for your CDs and transaction accounts, when customers came in, was there more customer activity trying to negotiate your rate up versus the first quarter due to what the guy down the street was willing to pay versus the first quarter?

Peyton, my impression of that is it's about the same.

Okay, good enough. Thank you very much.

Charlie Ernst, Sandler O’Neill.

My first question is just a numbers question. Can you tell me what the other comprehensive income marked to equity was this quarter?

We can -- Paul Moore can give that number to us quickly. He is shuffling through papers here to give --

Okay. I'll go ahead and ask my second question (multiple speakers)

Wait just a second. We have that answer, so the marked was a positive 1,625,000 margin.

No, that's the balance.

Oh, that's the balance, I'm sorry. Okay. The balance was 1,625,000, would be the difference here.

Okay. So it's about a $3.5 million swing, quarter to quarter?

No, it's (multiple speakers)

3 million.

Is this the balance at March 31? I'd add those two together, so -- it's about a 6.4 million -- we went from a negative 4.8 to a positive 1.6 million.

But that's an equity number. That's an after-tax effect.

And what that reflects, Charlie, is as I mentioned, we were a buyer of securities significantly right at the end of the first quarter and early in the second quarter, because rates were quite a bit higher in the 10-year sector at that point, and obviously we had a significant swing to much lower rates in the 10-year sector. I think it was about a 50-basis-point swing from quarter-end to quarter-end in that 10-year sector of the curve, and that obviously swings that mark-to-market number around.

And this is a little bit of a follow-up to some of the discussion you were having with Peyton, but I'm just trying to think through the margin like everybody else, and if you are having to fund your excess loan growth, meaning your loan growth kind of above your deposit growth, and you're not able to have as much of an impact with pricing on the cheap deposit side, and you don't really want to chase the CD side, then doesn't that argue that you've got to either pursue higher-cost other funding or you've got to be more aggressive than you want to be on the funding side?

Well, we would actually be comfortable having a higher level of borrowed funds than what we currently have, and that's one reason we've been fairly conservative on our deposit pricing. And the marginal cost of CDs in our market is well above the Fed funds rate, so we're trying to achieve a balance there, Charlie, of keeping some decent policy of momentum in the deposit side because we want that grow over time, but also, we're not going to be too disturbed if our deposit growth rate stays fairly slow until we get back up into that 85 to 95% loan-to-deposit ratio that is an optimal ratio for us.

We could have funded our balance sheet much more cheaply in the second quarter using borrowed funds than pushing the envelope on the CD categories of deposits. But we want to move, to use the Fed terminology, as at a measured pace in moving these ratios around and not jump from one extreme to the other. So I could have reported better margin if we had done it all with borrowings in Q2 than going after the CD rates that exist in our Arkansas deposit markets at this time. It's a pretty aggressive CD environment out there. We didn't do that.

A couple of other statistical numbers. Premium amortization, you cited that last quarter. Do you happen to know what that was this quarter?

Yes. On our securities portfolio, we recognized $318,000 of discount accretion and $93,000 of premium amortization. So the net positive there between the discount and the premium was $225,000 for the quarter. And to give you -- that is a 3.43 to 1 ratio of discount accretion to premium amortization -- $3.43 of discount accretion for every dollar of premium amortized.

But what's interesting in that mortgage-backed portfolio, that CMO portfolio, we have 2,106,000 of unamortized discount at the end of the second quarter and $449,000 of unamortized premium. So we have $4.69 of discount unamortized for every dollar of unamortized premium. And if you compare those ratios, you can see that our friends at FTN Financial that determine what for us -- they do our bond accounting and determine for us what is the appropriate amortization and accretion each month -- they are amortizing the premiums and continue to do so at a faster rate than the discount. And I've alluded to that in a previous conference call, I know, and probably several times in previous conference calls. And I think that's just a conservative mindset for accounting for that.

So, if the paydowns from our CMO portfolio continue to accelerate as they have over the last three quarters and as they are projected to do so this quarter, ultimately, that's going to be recognized in that accounting and we're going to see a higher -- a more rapid increase in the percentage of discounts versus the premiums being amortized. So that should actually have some favorable effects at some point potentially on the yield from that part of our securities portfolio.

Okay. And on the municipal portfolio, on the new muni bonds that you're buying, what is the average maturity of those bonds? It can be rough.

I would guess 15 to 20 years.

15 to 20 years. And how do you (multiple speakers)

Explain to you why we're going that far out on the curve, and the reason we're going out there is our simulation model tells us that we need more duration in our securities portfolio than we have because the CMOs are paying down faster and the increase in variable-rate loans in our loan portfolio is creating a situation where we need more duration in the bond portfolio to maintain our neutral interest rate risk position. And that is somewhat of anunaccustomed position for us to find ourselves in, but it's because of the significant increase in the percentage of variable-rate loans over the last couple of years that we are actually needing more duration in the bond portfolio to balance.

Okay. And when you think about funding those loans, what part of the curve do you tend to fund it on?

Funding those loans?

I'm sorry, the municipal bonds.

We're not specifically match-funding any of those, Charlie. We're funding them with our normal deposit flows, and we're assuming that's going to be anywhere from very short-term to -- typically you don't have many deposits that go beyond a two-year maturity. And we're not looking at saying this liability funds this asset. And I know in the old days, bankers did that. Well, this part of my balance sheet funds this part, and this part funds this part, and we lump it all together and do a simulation model analysis on the whole thing and try to balance the whole thing. So we're not specifically tying any funding source to any asset.

Brian Martin, Howe Barnes Investments.

George, just a kind of a quick question. Most of the deposit questions I had were answered. But I was wondering if you could just comment a little bit about the Arkansas economy from a -- I guess the rural markets or the more metro markets as far as competition. And secondly, just with the growth in the de novo branches over the last 10 years, I'm just wondering if you can comment on maybe some level of branch rationalization at some point -- if all the branches are performing as you guys are expecting, or is that something you guys have entertained or have given any consideration to?

At this point, we're very pleased with our branch strategy and the number of branches that we have, and our plans, as we've articulated many times over the last year and a half to two years, to finish out this branch network in Arkansas over the next four years or so. There will be a branch here and a branch there that I'm sure we plan to open that for some reason we want to open because of changes in competitive situations or inability to find a site or whatever. There, I'm sure, will be another branch or two beyond what we currently have planned that we probably will find a need to open.

But, in general, I think our prior guidance on that is right on track, and we're very pleased with the way our branch network is playing out and the way those branches are performing, and they are still coming up and developing as we expect them to develop. So, we're very pleased with that.

As you know, from our past history, we will close a branch if it doesn't meet our expectations. We closed one last year and relocated it several miles down the road because it wasn't meeting our expectations. We've got no pride of ownership there that would make us leave one open if it wasn't performing, but we've only had one branch that we've opened in the last 10 years that has not met at least minimum expectations for performance and been one that we were happy to own. So, we closed that one, and if another one develops that does that, we will do the same with it.

As far as the Arkansas economy goes, I think we're generally very pleased. You know, we're focusing on Northern, Western, Central Arkansas, that is the part of the state that has better demographics than some other parts of the state. And Susan, I know you've been looking at some of that. Do you want to comment on a few things there?

The Arkansas economy is very strong at this point. The first quarter of 2004 -- excuse me, 2005 -- was the fourth consecutive quarter of year-over-year employment growth in the state. The per capita income grew fourth-quarter 2004 compared to the fourth quarter in 2003 approximately 6.8%. Home prices grew over that same time period, about 6.7%, which gave us a good measure of housing affordability. We saw the number of real estate loans in the state increasing 16%, when you looked at the first quarter of 2005 compared to the first quarter of 2004. And that's attributed to the improving state economy and the favorable interest rate environment.

Single-family housing permits increased 16.5% in the first quarter of 2005 compared to first-quarter 2004. The population trends in Arkansas are good. We recently got updated information that compares the population growth from the first of April in year 2000 to July 1, 2004, and we've seen nearly a 3% population increase in the state. It was 2.96%. Of course, Northwest Arkansas is growing much more rapidly and is contributing a great deal to that boom.

In the Central Arkansas area, where Little Rock is located, that population is holding its ground, and of course in the eastern part of the state, in the southern part of the state, in the delta area, the population trends are down. So it's much of what we've expected, and it fits very well with our branching plans and our branching experience over the last several years. In the top 10 population growth areas of the state, we're located in every one of those or have plans to open in every one of those markets except for one.

Generally, I think the economy is stable here. It's not overheated, but it's very, very strong. And I will also comment, I guess, of a general demographic thing. I know there's been a lot of interest in the base realignment and closing commission findings and recommendations, and net-net, we've done pretty well with that. Jacksonville, Arkansas, which has a large C130 base, is actually a significant winner in that. They are going to get a total of about 3898 new jobs and another 77 C130 cargo planes that are going to be moved from other bases, based on the recommendations of BRAC, and that's about 3600 military jobs and a little over 300 civilian jobs that that will mean.

That is the most significant base in our market area as we plan to be in Jacksonville -- we've got two offices just to the North in Cabot, four just to the south in Sherwood and North Little Rock, and that base has a significant economic impact on the metro Little Rock and Pulaski County area, where we've got another dozen-plus offices.

So it is -- that is the most significant-based impact on us. We are a substantial winner if that happens as expected. And I know they're already moving people and planes there. So that looks like a done deal.

We were not unaffected on the other side, though. The Fort Smith market is going to lose about 670 jobs because the 188 Fighter Wing there is going to be scuttled. But again, we have much less branch infrastructure and a much less significant customer base and business base in Fort Smith. Now, we had scheduled more facilities for Fort Smith, but we have reallocated the timing of those to allow us to assess the impact ultimately of this loss of the 188 Fighter Wing before we open those branches. So other branches have moved up in our future plans and those branches have moved down the timeline until we can reassess this.

And the other deal that affects us -- of course, there's various gains and losses on recruiting centers and other things that have negligible impact -- but in the Texarkana, Texas market, they are losing the Red River Arsenal and the Lone Star Arsenal, but again, we have a very small presence in Texarkana at this point. So, net-net, we came out as a pretty solid winner on the overall impact of the BRAC Commission results.

Okay, and just I guess more specifically, with regard to kind of the rural Arkansas markets as opposed to metros, is the competition still just significantly more intense in the metro markets, or I guess that was the other part of the question, and I will just hang up and listen to it.

Well, I think it varies from market to market. We have some rural markets and some metro markets where our competition is still being what we would consider very reasonable and orderly and competitive efforts. We've got a few rural markets, and we mentioned in our last call the metro Little Rock area, where competition is very intense. So it varies from market to market depending on who the competitors are and what their agenda is at a particular point in time. But we think all that will sort out to a normal level of competition over a period of several future quarters.

(Operator Instructions). Scott Alaniz.

How many sites have you acquired this year and where is that relative to your target?

Gosh, Scott, that is a question I don't know the answer to. I would guess that we have acquired -- and this is a guess, I would say the numbers fall six to eight, something like that. Eight to 10, something like that, and that is on track for our plans. We've acquired -- in six months, we've acquired more than six months' worth of sites. But that's because we were doing -- in the last half of last year, we were doing so much site development work in Northwest Arkansas and we were trying to acquire the initial dozen or so sites pretty much in one acquisition effort so we could really coordinate those locations as precisely as possible. So we've had a disproportionate number of site acquisitions, but it was consistent with our plan and our strategy. So we're not running into any unusual circumstances in site acquisitions that are delaying us there.

We've had capital expenditures of about 12.4 million for the six months. Of course, that would include sites and buildings, fixtures and so forth.

I see.

Is that a net number, Paul?

That's a (multiple speakers)

Net increase.

Right.

That's a net increase in capital assets.

And what was the nature of the delay in Frisco? Was that solely due to permitting?

Well, the site there is a complicated site, and it is part of a development being looked at by the city as part of a much larger development that is occurring on that corner and in that area. There are shared access agreements and a variety of other issues. And it just takes longer to permit these things. Plus it is our first Texas office. We actually worked on the design, although Texarkana is actually under construction now and being built. The design that we are developing for Texas delayed us for a little while in getting our plans finished because we are doing a redesign of our standard -- you know, we use a standardized architectural format for our branches, and we're redoing that stylistically for Texas.

And we -- that delayed us initially, and then the common access agreements and various things we're having to work out with the city there related to the adjoining property -- it's just been a slow tedious process. The planning at our Texas branches will take us an extra 90 days or so each to develop, just because the bureaucratic process is there a little slower and more involved than we've encountered in most of our Arkansas markets.

I see. At the end of the first quarter, the bank had 95 million in brokered deposits. Can you share what that number is or was at the end of the second quarter?

Hang on just a second. I don't have that number handy, Scott. There was a comparable number. There was some increase in it. But it was a fairly normal increase amount. I'm going from top of my head here with those numbers, but I believe that our brokered deposits were about 7.3 or 7.4% of total deposits, and I'm pulling that number off the top of my head, but I think that's an accurate number at the end of the quarter.

Okay. And lastly, the drop in the tax rate -- in the reported tax rate from the first quarter to the second quarter, is that due mainly to the increase in the municipal securities portfolio?

It is, primarily.

All right. Thank you very much.

There are a couple of other CRA-type investments that generate tax credits that also contributed to that decrease in the effective tax rate, but, based on our muni purchases, you will continue probably to see that tax rate diminish a little bit in future quarters -- not a ton, but just a little bit.

And Scott, I have the answer now. One of my associates who was listening to the call tells me that our brokered deposits at June 30 were 7.44% of our total deposits. My 7.3 estimate was a little bit off. So, 7.44% of deposits were brokered deposits at June 30.

(Operator Instructions). At this time, there are no further questions. Mr. Gleason, are there any closing remarks?

Thank you very much for joining our call today. We appreciate your interest in the Company and all of your excellent questions. Thank you very much. We look forward to talking with you again in about 90 days. That concludes our call.

This concludes today's conference call. You may now disconnect.