Bank Ozk (OZK) 2005 Q3 法說會逐字稿

Good morning. My name is Cynthia and I'll be your conference facilitator today. At this time, I would like to welcome everyone to the Bank of the Ozarks third-quarter earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. (OPERATOR INSTRUCTIONS). At this time, I would like to turn the conference over to Susan Blair, Executive Vice President. Ms. Blair, you may begin your conference.

Thank you. Good morning. I am 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 third-quarter results 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, 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 the relatively flat yield curve and intense competition, net interest income, non-interest income, including the 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 replacing existing offices and loans, leads 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 and thank you for joining today's call. In the third quarter, we achieved record net income and record diluted earnings per share for the 19th consecutive quarter. This was accomplished despite a very competitive environment and the continued challenge of operating with a relatively flat yield curve. We have now achieved record net income in 33 of the last 35 quarters.

Let's get straight to the details. Net interest income or spread income is our largest source of revenue. In the third quarter, we achieved our 18th consecutive quarter of record net interest income. This strong performance is a result of excellent growth in earning assets, primarily loans and leases. During the third quarter, loans and leases grew a record $109 million. We have a tradition of strong growth in loans and leases and our record third-quarter growth was very satisfying, particularly coming after loan and lease growth of 15.5% annualized in the first half of this year.

Of course, loan and lease growth will vary from quarter-to-quarter and accordingly, we feel that the best measure of our performance is to look at a longer period of time. Over the last four quarters, our loans and leases have grown 23.9%, which is toward the upper end of our guidance range. Throughout that period, we have stated that we expected loans and leases to grow from the high teens to the mid-20s in percentage terms and that continues to be our goal and our expectation.

While we were very pleased with our record third-quarter growth in loans and leases, we are even more pleased to report that this growth was accomplished while adhering to our traditional credit underwriting standards and without pricing below what we consider to be acceptable pricing levels. In our earnings calls and other public communications over the past several quarters, we have commented that we have seen an apparent easing of credit standards and unusually aggressive pricing for loans and leases by some competitors. We have stated that we were maintaining our traditional credit standards and we continue to do so in the third quarter.

We have worked very hard to achieve our excellent asset quality and we do not plan to reduce our focus on credit quality in order to achieve growth. While pricing for loans and leases continues to be intensely competitive in many of our markets, we are a little more optimistic regarding loan and lease pricing than we were three months ago. While we're still seeing loans and leases priced very aggressively and generally priced with thinner margins than we saw one or two years ago, in the third quarter, we did not see the pricing environment for loans and leases intensify further and it seems that some competitors may be moving slightly toward more favorable pricing.

Investment securities are our second-largest category of earning assets accounting for 27.9% of earning assets as of September 30. In the last earnings call, I stated we did not see many compelling values in investment securities and that we might therefore see little or no growth in our investment securities portfolio in the third quarter. Over the course of the third quarter, we had a couple of market pullbacks that provided what appeared to us to be reasonable opportunities to replace some of the investment securities that we are paying off and to increase our portfolio slightly, which we did from $506 million at the end of the second quarter to $514 million at quarter end.

Thus growth in investment securities contributed only slightly to our growth in earning assets during the third quarter. Over the last four quarters, our investment securities portfolio has grown 18.6% while our loans and leases have grown 23.9%. This is all consistent with our goal of maintaining our investment securities at 25 to 30% of total earning assets while maintaining loans and leases at 70 to 75% of total earning assets.

Our strong growth in loans and leases in the third quarter allowed us to achieve record net interest income even though our net interest margin contracted three basis points from 4.22% in the second quarter to 4.19% in the third quarter. In the July earnings call, we said that we expected some continued pressure on net interest margin in future quarters until we returned to a more favorable yield curve and a more normal competitive environment. The three basis point contraction in our net interest margin in the third quarter was consistent with our expectations and that guidance. We continued to expect that the relatively flat yield curve and intensely competitive environment would put further pressure on net interest margin in coming quarters.

Our goal will continue to be to achieve good growth in earning assets, which we hope will more than offset any compression in net interest margin and thus allow us to continue to increase net interest income from quarter-to-quarter.

Let me make a few comments about deposit growth. Over the last four quarters, our total deposits have increased 18.1%, which is toward the lower end of our high teens to mid 20s guidance range for deposit growth. We are not particularly concerned that our deposits have grown less than our loans and leases over the last four quarters. In late 2003 and through the third quarter of 2004, we maintained a fairly aggressive stance on deposit pricing and deposit generation. Our belief was that we were then at the beginning of a series of Fed interest rate increases and that that was the time that we should be aggressive in growing deposits.

Our strategy was to grow deposits aggressively when they were cheaper and then to become more conservative on deposit pricing in what we expected to be the second half of the Fed tightening cycle when typically of course deposit competition is more aggressive and deposits are more expensive. As a result of this strategy, our deposits grew 29.9%, almost 30%, for the full year of 2004; while we have achieved slower deposit growth in recent quarters.

In the past quarter, we became even a bit more conservative on deposit pricing and we are comfortable with the results. In the coming quarters, we expect our deposit growth rate will vary from quarter-to-quarter but we believe it will grow roughly in tandem with loans and leases over time. Therefore, we are reiterating our previous guidance for deposit growth averaging from the high teens to the mid-20s in percentage terms; the same as loan growth.

One of our goals is to maintain our loan and lease to deposit ratio between 85% and 95%. And as of September 30, we were near the middle of that range and 89.2%. For several previous quarters, we had been at or below the low-end of that target range for the loan and lease to deposit ratio.

Let me make a few comments about noninterest income. Our continued growth in core deposit customers during the third quarter allowed us to achieve another record quarter of service charge income. While service charge income will vary from quarter-to-quarter depending particularly on how the quarter or the calendar falls within a particular quarter, we expect the service charge income will have a generally upward trendline growing roughly in tandem with our growth rate in core deposit customers over time.

Our third-quarter mortgage lending income was the best that we have reported in the last five quarters. Housing market conditions continued to be favorable in our markets. Even as refinancing activity has continued to be a lower percentage of our total origination volume, we have seen a good volume of new home loan purchases and mortgage business resulting from those purchases. As I have said many times, our second and third quarters are typically better quarters for home sales and thus our mortgage business in our markets than the first and the fourth quarters. So we would not be surprised to see a somewhat lower level of mortgage income in the next two quarters due to seasonal factors.

Over the next year, we hope that our growth in our new northwest Arkansas markets, our entry into the Hot Springs market, the opening of our first full-service offices in the Metro Dallas area, along with continued growth in existing markets will provide excellent opportunities to increase mortgage lending income.

In the third quarter, we had gains on sales of securities of $211,000 and gains on sales of assets of $33,000. Over the last eight quarters, we have had gains on sales of assets and/or securities in every quarter averaging $218,000 per quarter over that period. Thus, the current quarter's results were roughly in line with this eight quarter average.

Let me make a few comments about noninterest expense. Our third-quarter noninterest expense of $10,270,000 was our highest level of noninterest expense ever. And as I have said many times, our growth in de novo branching strategy necessarily requires the addition of new offices and people and other things and this increases non-interest expense. Our goal is to grow revenue at a rate in excess of our growth rate and non-interest expense and thus become more efficient over time. We have a good track record of accomplishing this goal as evidenced by the fact that we have achieved record efficiency ratios in each quarter so far this year. We were particularly pleased with a record 43.0% efficiency ratio achieved in the third quarter. While our efficiency ratio will vary from quarter-to-quarter and not every quarter will be a new record, our goal continues to be to grow revenue at a rate exceeding our growth rate for overhead and thus maintain a generally improving trend for our efficiency ratio over time.

While I'm talking about overhead, I should probably discuss the details of our growth in de novo branching strategy. The third quarter was unusual in one respect. We opened no new offices in the quarter. This was not intentional but simply resulted from construction delays and delays in the permitting processes on a few projects. In the third quarter, we did complete an expansion of our Marshall, Arkansas office. This office was originally opened in February of 1995 and was the second office that we opened as part of our growth in de novo branching strategy, which we launched in November of 1994. We have been at maximum capacity for staff in the Marshall office for a number of years and despite our inability to add staff, the Marshall office has continued to generate impressive growth. Additional growth opportunities appear to exist in the market and as a result, we elected to take the unusual step of expanding this office.

We opened five new offices in the first half of this year and we expect to open one office in the fourth quarter. This will give us a total of six new offices for the year, which is short of our most recent guidance of approximately eight offices to be opened this year. Again, let me emphasize that we are not intentionally trying to slow down our branch opening process but we have just encountered minor delays on several projects.

In the fourth quarter, we expect to complete construction on permanent facilities to replace our present temporary offices in Bentonville, Arkansas and Texarkana, Texas and open a third banking office in Russellville, Arkansas. Despite a reduction in our number of branch offices in 2005, we're targeting a record pace of branch openings in 2006. In 2006, we're planning to add approximately 12 new banking offices, replace two present temporary banking offices with permanent facilities and possibly replace one of our original banking offices with a new facility.

Our 2006 office additions are expected to include approximately seven new offices in northwest Arkansas, two new offices in Texarkana with one being in Texas and one on the Arkansas side, two new offices in Hot Springs, Arkansas and a second office in Frisco, Texas. We have acquired all these sites. A number of these offices are currently under construction and the others are moving through the development process in an orderly manner.

It is a great pleasure for me next to discuss asset quality. We are very pleased needless to say to report our strong focus on credit quality has once again allowed us to achieve new records in regard to a number of asset quality ratios. At September 30, our nonperforming loans and leases as a percentage of total loans and leases were a record low 18 basis points. Our nonperforming assets as a percent of total assets were a record low 13 basis points and our loans and leases past due 30 days or more, which includes past due nonaccrual loans and leases, as a percent of total loans and leases were a record low 38 basis points. These ratios are attributed to the fine job that our loan, credit and special assets personnel have done.

Our annualized net charge-off ratio of 20 basis points for the third quarter was somewhat higher than our recent results. This follows two quarters in which our net charge-off ratio had been extremely low at seven and six basis points respectively. Our charge-off ratio will vary from quarter-to-quarter and we believe that our year-to-date annualized charge-off ratio of 11 basis points is fairly reflective of our loan and lease portfolio quality. And this is also about the same as our 10 basis point charge-off ratio for the full year of 2004.

Because of our higher level of loan growth and our slightly higher level of charge-offs in the third quarter, we increased our provision expense to 800,000 for the quarter from $500,000 in each of the previous three quarters. Because of our excellent asset quality and our evaluation of loss exposure within the existing portfolio, our allowance for loan and lease losses as a percent of total loans and leases at September 30 was 1.27%, 10 basis points lower than at the end of the previous quarter. While our allowance has come down in percentage terms over the last couple of years, in each quarter, we have made provisions to the allowance for loan and lease losses in excess of our net charge-offs and thus the allowance has increased every quarter. As of September 30, our allowance for loan and lease losses was 700% of total nonperforming loans and leases.

Our strong credit culture combined with our strong focus on our efficiency ratio have been particularly helpful this year. These ratios have been very important in our continuing to post excellent operating results in a very competitive and challenging yield curve environment. We have made these issues a priority for a number of years because we realized their importance, particularly in more challenging operating environments such as the current environment.

In summation, let me say that our goal is to continue to improve net income each quarter while also building our organization to increase long-term shareholder value. Our goal of reporting record net income each quarter has been achieved in 33 of the past 35 quarters, including the last 19 in a row. Each record achieved of course sets the bar higher for future performance and today's flat yield curve and the current intensely competitive environment are providing extra challenges. But from where we stand today, we believe in proving net income 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 our operator, Cynthia, to once again remind our listeners how to queue in for questions. Cynthia.

(OPERATOR INSTRUCTIONS). John Rodis, Stifel Nicolaus.

Good morning, George. Nice quarter. Can you maybe provide a little bit more detail on the strong loan growth you had during the quarter, maybe what you saw in Arkansas versus maybe Texas, North Carolina, maybe some of the -- I assume primarilt commercial driven? If you could just provide a little more detail?

Would be happy to do so. In response to your first question, at the end of the third quarter, September 30, Arkansas loans accounted for 90.5% of our total loans. That was down from 91% at the end of the previous quarter. Now Arkansas loans increased considerably in that period of time but still shrunk percentagewise. Texas was pretty much unchanged, actually down a tenth of a percent. Texas went from 5.7 to 5.6% of the portfolio and again, while they had very nice growth in Texas, they declined percentagewise. North Carolina actually rose from 3.3 to 3.9% of the portfolio. So Texas grew slightly but the growth there was mitigated by several pretty large payoffs that we had in our Texas portfolio. North Carolina had nice growth.

The majority of the growth was in Arkansas in dollar terms even though the Arkansas percentage declined and a significant portion of that growth, probably the most notable portion, came from our Benton and and Washington County offices, new markets where we've opened loan production and then temporary banking offices this year and we are off to an excellent start there. The composition of that growth was primarily commercial, commercial mortgage and construction development type lending as is consistent with what you have seen in the growth in our portfolio over the last couple of years. So there was no particular unusual change in the mix.

And again what I am most pleased about and I'm very pleased about the $109 million in loan growth. But what pleases me the most is that we did that while sticking to our normal credit underwriting standards and without just going crazy on pricing. We feel pretty good about the volume and the quality and the pricing and it is just a tribute to the job that our lenders did. They know they are in a very competitive environment where a lot of our competitors are being very aggressive on both credit and pricing and to get the results that they achieved we just had to go out and really work hard to do it and our guys did a great job.

George, you typically breakout I guess the percentage of fixed and floating within the loan portfolio. Can you do that to?

Yes, I can do that and last quarter, I believe our variable rate part of the portfolio was 42.6% at June 30 and we have stated a number of times over the last several years that our goal is to increase that percentage approximately 1% per quarter. We were successful in doing that in the third quarter. At September 30, variable rate loans accounted for 44.0%. So we were actually up 1.4%, 140 basis points, in variable rate loans over that period of time. I have also, John, in the past given information on what portion of our portfolio would reprice in one year, two years and three years and those percentages typically went up. If you look at principal repayments and maturities on fixed-rate loans plus variable rate loans, in one year, 63% of our portfolio will reprice. That is up from 62% a quarter ago. In the two-year time frame, 75% of our loan portfolio reprices. That is flat to 75% at the end of the second quarter and in the three-year time frame, 88% of our portfolio reprices. That is up 2% from 86% at the June 30 quarter. So we are continuing to accomplish our goal of getting a slightly higher level of rate sensitivity in that loan portfolio each quarter and feel good about the results there.

Thanks, George. Just two final questions and then I'll hang up. Just your comments on the overall health I guess of the Arkansas markets that you are in as far as the economies and so forth. And then my final question, just your ability to continue to hire good seasoned loan officers, kind of your comments on that. And I will hang up and listen and congratulations on a nice quarter.

Well, thank you very much. Well, first we continue to be very pleased with the economic conditions and the level of activity in the various markets that we are in in Arkansas as well as North Carolina and Texas. Of course Arkansas matters a lot more than North Carolina and Texas so I'll limit my comments to that. But we continue to see good activity. We continue to see good growth in a number of markets we are in. Inventories of housing and lots continue to seem to be at fairly manageable levels. We are not seeing a particular slowdown in sales activity that is concerning to us. We don't think there is a housing bubble in our housing markets. I think Susan Blair who is with me today commented and reported some information in our last call that indicated that housing prices in Arkansas were up somewhere in the 7 plus percent range year-to-year and that is reasonably consistent with the cost of constructing those and doesn't seem to be irrationally accelerating or unsustainable to us. So we feel very good about the economic conditions in the markets in which we are operating and feel that those conditions are stable at this time.

As pertains to our ability to hire seasoned lenders and other banking personnel, obviously that is a constant challenge and we continue to be able to hire good people. And we're very thankful for that. We work very hard on that. You know the challenge there is as our company grows, if we maintain, in the future, growth rates consistent with those we have had in the past then certainly we need a lot of new people. And that number of new people that we need each year continues to go up.

The flip side of that is that we have a lot more resources as a company. We have a good track record, a good reputation, I believe and that is making it somewhat easier to hire the people that we want than perhaps it was five years ago when we were not as well-known and did not have as a significant and noteworthy a track record as we have now. So it is harder because we have to hire more. It is easier because we have better momentum that is helping us accomplish that. That is obviously the key to the future success of our company though. We are a people driven company and being able to hire the right people is critical for our future. We are optimistic. I guess the lawyers would probably want me to say cautiously optimistic about our ability to do that. But we have not seen an inability to accomplish that yet.

Barry McCarver, Stephens Inc.

Another good quarter.

Thank you, sir.

Just real quickly, back to that loan growth. Were there any bigger deals that closed in the quarter that made that growth look a little extra strong?

You know, Barry, we close larger loans routinely and I would say there was nothing particularly unusual about the size of loans that we closed this quarter. We have frequently large relationships with very substantial creditworthy customers that we have got a tremendous amount of confidence in and that has been part of our practice for the entire time we have been a public company and even before. So I don't think on a relative basis to our size and capital there was anything unusual about the results in regard this quarter.

I guess jumping over to the de novo expansion. Can you give us just a little bit more color on kind of what the holdup was? I know you said that you thought that it was more of a temporary situation. Sounds like you expect to be back on plan or better next year. Can you give us just a little bit more color on what was holding you up in the quarter?

I can give you some nitty-gritty detail on our Hot Springs, Arkansas site. We encountered quite a bit of rock that just simply slowed us down while they chiseled that stuff out and prepared the site. And that has moved that office opening from one quarter to the next, to the first quarter of next year. In Fayetteville, Arkansas, our first permanent office there is a property, a rare example of where we are actually building on a leasehold property and the property shares an access with an adjoining property and the landlord from whom we are acquiring the property is developing some adjoining property and the city is requiring certain aspects of that to be looked at collectively instead of just dealing with our little part of it separately. And that has complicated the approval process. They are going through the city. I think they have a fairly methodical approval process there anyway and it has pushed our Fayetteville office opening a quarter or two later than we expected just because it has taken us a long period of time to run through the traps.

Similarly in Frisco, Texas, we got two offices working there. One of which we had hoped to open this quarter that will actually slide to next quarter. Again, it's just a much slower, more involved permitting process there than what we are accustomed to. I've mentioned in a previous call that our Jacksonville, Arkansas office was the subject of a protest of our branch application, which was approved by the State Bank Department, the FDIC and is now on appeal through the normal court process. We expect to ultimately prevail on that. But that has moved that branch from being a 2005 branch to a most likely a 2007 branch by the time we get all the way through the appeals process, prevail and get to let our contracting start on that.

Other than the Jacksonville branch, which we think has probably jumped from '05 to '07, all of the other delays have simply pushed projects from '05 to '06 and hence, we're looking at a pretty intense branch opening schedule in '06 of 12 new offices, plus two relocations from temporary quarters to permanent quarters, plus possibly replacing one of our original older banking facilities with a more modern facility. So we have got a busy schedule. Next year, we have -- in fact, I met yesterday with our staff who handles all of this. We discussed the progress on each of these projects and we're confident that we can get that done next year.

That was very helpful, George. Thank you. I guess the natural question then is record efficiency ratio in the third quarter, how much of that could have been related to the fact that you only opened one branch?

Well, obviously that provided a little boost to the efficiency ratio because if we had opened two or three, there would have been additional opening costs related to those branches. So that no doubt helped the efficiency ratio. I think we still would have been in or very near record territory even if we had opened a couple of more branches though. We are continuing to work on our long-term goal of improving that efficiency both by working on the revenue and the overhead side and I think we are having satisfactory results in that regard.

And then just lastly and I'll get off the subject and let somebody else ask a question. Is the fact that you're having a slower second half of the year, does it bother you at all in terms of future asset growth since you're only going to have a couple of new branches in the second half of '05?

No, Barry, that really doesn't. And it is an interesting correlation probably that we opened zero branches and had the record loan and lease growth that we have ever had in the same quarter. And the opening of these offices does not particularly affect our growth in the short run. The opening of these offices has implications for the long run. The offices we open this year and next year are key drivers to earnings and growth, particularly sort of three to seven years down the road -- years down the road. So the fact that we opened a few less offices this year than we had planned and we are opening a few more next year than we had planned, I think that just all evens out. I don't think it makes a ripple in either our short-term results or our long-term results. It may move 100 or $200,000 of opening expenses from one year to the other but that is not a big-ticket item and it doesn't affect our long-term plans whatsoever.

Andy Stapp, Cohen Brothers & Co.

Congratulations on another nice quarter.

Thank you, Andy.

Were there any timing issues with loan growth such that some loans that you were anticipating booking in the fourth quarter were accelerated into third quarter?

Not really. We pretty much booked everything in the quarter that we expected to book. Didn't have really an acceleration or delay in closings or payoffs on anything. And we have maintained an ongoing funding forecast that includes all major expected loan fundings. whether it is new loans closed or advances on existing lines or loans and all payoffs. And we were tracking pretty close to that as we updated at various times through the quarter. The interesting thing was our growth was weighted toward the end of the quarter while we had excellent July and August. In fact July and August alone would have been a record quarter. September was the largest month of loan growth that we have ever had. In fact, it approached record quarter status on its own. So our growth in the portfolio was sort of skewed to September but that just dealth with the timing of closings and not really an acceleration of anything that we had expected to close later.

That's really all I had. All my other questions were already asked.

James Ellman, Seacliff Capital.

Could you give us a little bit of detail or insight into what you think might happen to the net interest margin if the yield curve continues to flatten and potentially even inverts and inverts significantly over the next year? Thank you.

Well, I have said many times over many years that the flatter the yield curve and particularly if it goes inverted is a more challenging operating environment than a steep yield curve. And the guidance that we gave today, which suggested that because of the yield curve environment and the very competitive environment that exists in which we are operating today, we think we are going to see some continued pressure on that margin in the coming quarters. We are expecting that and planning for that and James, I assure you we are working constantly to try to mitigate and minimize the further pressures on the margin. We felt like even though we lost another three basis points of margin in Q3 compared to Q2, we were actually pretty pleased with that. We felt like we did a very good job of working our loan pricing as effectively as we could have given the competitive environment in which we are operating and we think we did a good job of minimizing our cost of funds.

But it is a challenging environment, no doubt. One of the most challenging yield curve environments I have ever seen when you consider that in the context of the competitive conditions. And I think it is going to stay flat and perhaps get flatter and very possibly go inverted for a brief period of time. Fortunately, historically, inversions are fairly short-lived. And there is usually better times on the other side of the inversion from an interest rate risk point of view. So we think this is just a challenging environment we have got to work through. And as I said, the fact that we've got excellent asset quality and an excellent efficiency ratio are really helpful when you are dealing with this kind of an environment to let you continue to post some very, very good results.

Thank you. One other quick follow-up. Could you give us an idea as to what we should expect in terms of loan loss provisioning against new loan growth? It seemed to drop a little bit in the most recent quarter.

Well, you know it did drop and that loan loss reserve or allowance as a percentage of total loans and leases has been declining for a couple of years and it has been declining because our charge-off ratios have been declining and our evaluation of the quality and loss potential of our portfolio has been improving. And we are going to put in the reserve or in the allowance, make a provision in whatever amount our formulas and our analysis tells us is necessary to maintain an adequate reserve.

I have indicated in detail, James, in previous conference calls and you may or may not have heard this and some may so forgive me for repeating myself but because of the fact that we are constantly entering new markets and adding new lenders, we believe that it is reasonable and our auditors have agreed with this that we maintain a portion of our portfolio unallocated. We have a formula methodology that allocates reserve requirements for each loan based on a risk rating of that loan and other characteristics of that loan.

And we sum all that up to determine what is an allocated reserve and then our auditors have agreed and we have maintained an unallocated reserve of 15 to 25% of the total reserve. That is sort of the limits up and down that we can maintain. We have not yet done the analysis at September 30 but based on the August 31 analysis, we were just under 24% unallocated and my sense is that we are probably at about the same -- right around 24% unallocated at September 30. So the reserve that we made was made to cover our losses, to cover our growth.

The provision we made to cover losses and growth and was sort of topped out by maintaining that unallocated reserve in that 15 to 25% band. So I took great pains in my prepared remarks to point out that even though the reserve has come down as a percentage of total loans that we have made a provision every quarter in excess of our losses and thus it continued to increase the reserve. But where it goes in the future will be guided purely by what the quality of the portfolio is, our analysis and evaluation of that and what the math then results as a required reserve.

Scott Alaniz, Sandler O'Neill.

A couple of questions. First, do you have handy what the employee headcount was at the end of the quarter?

No, I don't. I apologize for that.

We will move on then. On the funding side, many of your competitors in Arkansas have been extremely aggressive on CD pricing.

You've noticed that.

Yes, I have. I have noticed that. In looking at your CD, Bank of the Ozarks CD structure, it appears that a great percentage of those will be maturing or repricing within the next twelve months and I would like to get a sense from you as to whether or not you are starting to see some of those depositors extend their duration if you will, number one, and then we'll go to the next question.

Well, Scott, I am not dealing with that personally daily like Dan Rolett, Susan Blair and some of our other folks, particularly Dan Rolett. But from the information I have, which is a limited view of that, we have not seen much of a shift there. Typically, in our markets, CD customers have a propensity to stay from six or seven months on the short side to 12 to 13, 14 months on the longside and the vast majority of your deposit customers want to stay in that time frame. You have a few that always want to go as long as they can go and get as high rate as they can get but that is a minority. So to the best of my knowledge and information, which is not mathematically or analytically based on that, I don't have a sense that we are seeing much of that duration extension yet on the deposit side.

As you look into 2006 and where short-term rates have been headed, what is your strategy, funding strategy to combat depositors moving to higher yielding products?

There's certainly a propensity of customers -- a tendency for customers to do that and if you look at our non-CD deposits on an average basis, last quarter, non-CD deposits accounted for 41.5% of our total average deposits in the third quarter and CDs accounted for 58.5%. That compares to a year ago in the third quarter of last year, non-CDs were 44.8% and CDs were 55.2%. So you have a 330 basis point shift away from non-CD to CD deposits over the last year on an average basis, which is the best measure to do that. There is no doubt that the way the competitive environment is played out with banks not moving their core pricing very much and moving their CD pricing a lot that there has tended to be some cannibalization of our own and eachother's core deposits moving to higher yielding CD product.

Frankly, that 330 basis point shift given the way competition is priced, core deposits and CDs and thus shaped our pricing of core deposits and CDs over the last year, I am actually pleased that that mix is as good as it is right now. My guess is that we will see a slight further shift towards CDs and away from non-CD products just simply because of that phenomenon you're talking about and that is CD yields are getting very high.

Over the last two quarters, if you look at first quarter of this year versus third quarter, there has been -- we have seen a 50 basis point shift basically from non-CDs to CDs. My guess is that based on the fact that the aggressive CD rates now -- being paid now are about as aggressive on a relative basis as CD rates being paid two quarters ago or three quarters ago, our competition keeps raising the rates as the Fed moves up. But they have been relatively pretty aggressive throughout that whole period of time. My guess is that what we have seen in shift in that deposit base over the last year or six months is probably indicative of what we will see over the next year to six months if all this continues.

Secondly, I believe in the last quarterly conference call you mentioned that you were expecting CMO paydowns to be a little north of $31 million. For this third quarter, did they come in at approximately that range?

Yes, they did. In fact, north of that. We had projected 31.4 million and the actual results were 39.8 million. So we actually had about 8.3 million more in paydowns than we expected. We know that for the month of October that the numbers are already out. We are going to have 10.5 million for the month of October. We are projecting between 7 and 8 million a month in November and December based on Bloomberg projections. So that would give us 26.3 million for the quarter if those Bloomberg projections are right and whether or not they are I don't know. If the last quarter is any indication, the Bloomberg projections are low but rates are rising a bit and that may have the effect of slowing prepayments a little bit. But right now we are projecting 26.3 million for the current quarter and that compares with 39.8 million last quarter.

Of course the size of our portfolio is getting considerably smaller as you would expect with almost 40 million in paydowns this quarter. And I think we added 10 million or so in new CMO purchases in the quarter. We found one structure that we liked and bought a big chunk of it and that is the only CMO purchase we made in the quarter.

You were able to add to the muni bond portfolio, which I think is now about 40% of the total. Do you have or does the company have limitations on how much in munis as a percentage of the portfolio that you could own?

We do and I apologize I can't tell you those. They are very liberal limitations and we are not presently approaching those limitations. I would give you some additional information on the portfolio if you would like because we did add munis and those typically were longer munis. It stretched the average life of our portfolio at September 30 and this is based on projected prepayment speeds on the mortgage-backed part the portfolio but the average life is 4.9 years and the modified duration of the portfolio, the exposure of the portfolio to interest rate changes is 3.9 years. So we are still well within our tolerance and limitations for average life and duration of the portfolio.

What would that look like excluding the munis?

It would be much shorter excluding the munis because the majority of our munis -- we tend to follow the curve out to a longer duration on those municipals. So it would be considerably shorter than that on the munis. I don't have the details of that. For example, we have got -- I can give you one component of it. The $250 million -- almost half the portfolio is still in CMOs and the -- I think the duration and average life on that is something like 1.5 years or so and that is not an exact number. So don't put too much stock in that number. But it is considerably shorter than the municipal part of the portfolio.

And then lastly on credit, obviously very impressive. Just with the new bankruptcy law and the rush for I guess consumers -- those that are going to have to file to try and file early, there has been a big jump in bankruptcies in Arkansas. Would you expect even a blip in some of your credit metrics in the fourth quarter related to that or --?

Scott, I would tell you that my sense is and first let me say I don't know for sure but our sense from the preliminary reports and data that we are getting from legal counsel and from our lenders is that we think there will be a small uptick in personal consumer bankruptcy filings. I don't think it is going to make a meaningful difference in our numbers. I think it is going to be small loans and a very small number of customers. And I don't think it is going to have a significant effect on our numbers.

Joe Stieven, Stieven Capital Advisors.

Hi, guys. It is actually Kevin O'Keefe. Congratulations on a great quarter. All of our questions have been answered.

Thank you, Kevin. We appreciate it.

Charles Ernst, Sandler O'Neill Asset Management.

How are you guys doing today?

Fine, Charlie,. How are you doing?

Well, thanks. Could you just comment on what the discount accretion was on the bond portfolio this quarter?

Yes, I think I can give you that number. For the third quarter and this is on our agencies only, the muni discount accretion is not as meaningful, but for the agencies we had a total of $325,000 in discount accretion, actually 326 discount accretion and $66,000 in premium amortization. So the net difference between those two was a $260,000 net discount accretion. If you look at what is unamortized, we have 1.902 million in unamortized or unaccreted discount and 383,000 in unamortized premiums. So just looking at it real quickly and I'm not putting a calculator on this but just doing it in my head. It looks like our discount to premium ratio was about 5 to 1 that we accreted or amortized in the quarter and basically we have got about a 5 to 1 ratio on the books. So we were recognizing those at pretty close to an equivalent sort of rate. Greg, is my math right on that?

George, earlier you observed that credit -- the pricing and also the terms are getting more challenging. Are you at all concerned about being able to maintain sort of the higher levels of growth rate in the loan portfolio given those observations?

Well, certainly, Charlie, it is a challenging environment and as I have said, we have got to go out and do it everyday and the way we did it in this last quarter was not by cutting quality or cutting price but just by going out and working hard and building new relationships and capitalizing on opportunities for business that exist in in the markets we are in and particularly our newer and more rapidly growing markets.

The guidance that we gave I think is good guidance for loan growth in the high teens to the mid-20s. We said that we thought our best measure of growth was looking at a four-quarter average. That is 23.9% growth for loans and leases. That is to the upper end of that guidance range. So it has been very competitive for the last year, particularly the last two or three quarters, or three or four quarters I guess, intensely competitive. And yet we still managed last quarter to put up a record loan growth, which if you annualized a quarter and doing that you can get you some pretty absurd results. But it was a spectacular quarter for loan growth and we did it in a very tough environment and that pleases me very much.

I think we will have quarters that look sluggish on a relative basis and by sluggish I mean like the first and second quarter where we were growing about 15 to 16% per annum and that is sluggish by our historical patterns. I think we will have quarters where we have exceptionally good loan growth and my guess is that those are going to average out to the high teens to the mid-20s consistent with our guidance.

And lastly I just had a question about the reserves and I understand that the regulatory environment isn't friendly to holding more reserves but given your comments on past calls and I think generally people's views that credit costs are low and at some point heading higher, is there any thought to maybe just holding more capital for a period of time until you can maybe put that back into the reserve down the road?

Charlie, no, we have not had that specific discussion connecting those two dots together. We feel very good with our capital position. It is toward the kind of the upper two-thirds of our range for maintenance of capital. We feel very good about our reserve position with about plus or minus a little bit, 24% of the allowance being unallocated and with our coverage ratio at 700% of nonperformers. We feel very good about where we are. We're very comfortable with that.

Great. Thanks a lot you guys.

Thank you. We had a question earlier regarding our number of employees. At quarter-end, we had approximately 643 total employees. A lot of those are part-timers. If you calculate an FTE basis, we estimate and this has been quickly calculated, that it is approximately 586 FTE employees, full-time equivalent employees. So hopefully that will respond to that question. I think Scott Alaniz asked that question.

Peyton Green, FTN Midwest.

Good morning, George.

Hi, Peyton. How are you doing?

Doing great. A question on the other noninterest expense was down about 223,000 linked quarter and down about $540,000 year-over-year. Is there anything that -- I don't recall anything being in the third quarter of last year that was unusual. Is there -- should we expect that number to go up and is a lot of that related to I guess the timing of the branch openings or what happened there?

In the third quarter of last year, we had -- we did have some unusual costs and you are taxing my memory here, Peyton. You always ask hard questions. But if I recall, I think we reported that last year our 401(k) plan -- we determined it was top-heavy and we had to make an extra contribution for the year 2004 to all of the non-top highly compensated employees. And we made that determination and discovered that problem in the third quarter of last year. So we accrued three-fourths of the expense -- additional expense for that 401(k) contribution in the third quarter of '04 and the other one-fourth of it in the fourth quarter of '04.

I think also in the third quarter of last year and I believe we addressed this in the conference call that we had some incentive compensation payments that we made for some new employees that we hired, some upfront incentive fees that were paid and some severance benefits that were paid that also pushed our personnel cost up in that quarter. And there was some similar expenses I think that also fell in last year's fourth quarter, which is why those noninterest expense items were a little higher. So yes, there were some other operating expenses in there. I don't remember all the details of them but we publicly disclosed those and I can go back in the last year's Q and give you some color from the Q from last year.

But probably more to the point, the third quarter of '05 expenses, we felt were fairly baseline level of expenses. I don't think there were anything particularly unusually good or bad there as I think Barry questioned the fact that we opened less offices saved us a little money and yes, that did. We would've had a little more other operating expense in there related to promotion and just all the cost of opening a couple of more offices had we opened them. But apart from that, it was a very baseline sort of quarter without a lot of unusual items as far as I can identify.

So no reversals that you would reference in the numbers. Good enough. And then the loan yield increased about 31 basis points linked quarter. And your interest-bearing deposit costs only increased by 26 basis points. And I guess the two balances were pretty comparable to one another. So it has got to make you feel pretty good about the repricing of that part of the balance sheet. Was there any particular benefit from prepayments that stuck out or was it just now that you have gotten the variable rate component up to 44% it just moves better?

Well obviously the variable rate component helped considerably since the Fed did increase rates in the quarter. As I said, I think we are -- I think we did a good job pricing loans. I think we did a good job playing defense on the deposit side. It would have made me feel a whole lot better if the net interest margin hadn't of contracted. I would've really said we did a great job if we could have held it stable in this environment. But it is a challenging environment for both pricing loans and deposits and I don't want to minimize that. We have got our work cut out for us to continue to try to manage through what I think is going to be probably several challenging quarters until we get to a more normal environment. I am not sure when that is going to be. So we are focused on it and we were -- we did feel like we did a good job as I've already said in the quarter. We have just got to go do it again and again and again until we get to a more favorable yield curve and competitive environment.

Sure. I guess maybe my point maybe is just that that is the first time at least through the last eight or so quarters that you have actually had a favorable change in your loan yield versus your interest bearing deposit costs.

And I appreciate you pointing that out and I'm keenly aware of it and I didn't make a big deal out of that with my staff. In the prior quarters when that comparison was unfavorable, they heard about it. So maybe all that talking has finally had some results but we still have got to work really hard in this environment to try to get even more favorable results or at least minimize further damage from this environment.

And then last question, how high will you let the borrowings go as a percentage of earning assets or nonequity funding or how do you view the usage of wholesale?

Well, that is a good question and we have a number of limitations. And basically the -- kind of the nexus -- our balance sheet is driven by loans and rule number one at the bank is to make every good quality, good yielding loan you can make. And that loan growth determines the size of our balance sheet. And as I have said today, we want loans to be 70 to 75% of earning assets. So conversely securities are 25 to 30% of earning assets and that defines the debit side of our balance sheet.

The nexus to the credit side of the balance sheet is we want the loan to deposit ratio to be 85 to 95%. We have some restrictions on deposits. Those are primarily locally generated deposits. We want our total brokered deposits and other financial institution deposits, which we have a number of, to not exceed 15% of our total deposits. So that assures us that 85% or more of our deposits are going to be locally generated organic deposits.

And then the balancing figure is borrowings of various kinds and the limitation on borrowings, Petyon, is simply this. We want to maintain a 75,000 unused blanket borrowing capacity with the Federal Home Loan Bank at anytime. So we have got $75 million instantly that is available. We maintain various secured and unsecured Fed funds borrowing capacity that typically adds to that considerably and then we have got a substantial reserve borrowing capacity with the Federal Reserve primary care credit facility, which we have never tapped. Except I think we tapped it one time one day just to make sure it worked and that we really could borrow from just to prove it. But that facility is, Greg, what, 100 to $200 million. In excess of $100 million. So we keep in excess of $200 million of available borrowing capacity at anytime.

So the limitation on borrowings is simply driven by an 85 to 95% loan to deposit ratio and how that makes our whole balance sheet fit and then the various constraints about keeping various surplus unused borrowing lines available out there.

Okay. And I promise I will quit after this one. But the brokered level was what at the end of the third quarter? And then also how much capacity did you have on your FHLB?

The brokered capacity was -- brokered CDs as a percent of total deposits was 8.63% at the end of the third quarter. And we had something on the order of $95 million of unused borrowing capacity at the home loan at the end of the quarter. So still that number is $20 million plus or so -- around 20 million plus or minus over our minimum safety net that we like to keep. Pretty good room there.

Jed Gore, Sunova Capital.

You know, George, at this point an hour and 15 minutes into the call, I think I'll call you offline.

Jed, go ahead. And in case you ask an FD question I can't answer privately, go ahead and ask.

What I was going to say is that you run below your 85 to 95 loan to deposit rate target because as you point out last year you ginned up a lot of CDs and have used them basically this year. What's your comfort level with going above 95%? I guess what I'm coming around is asking should we be surprised to see wholesale borrowings grow a little bit in the next couple of quarters just given the level of competition that for example Scott was talking about?

Jed, I don't know. That would depend on the relative costs of wholesale borrowings and our various capacity limitations alluded to in response to Peyton's question and further competition goes. At this point in time, it is not our plan to exceed the 95% limitation on loans to deposit but I could envision scenarios where our ALCO committee would look at it and say the relative cost and reliability of funding is such that it just make sense to exceed that limitation temporarily. And we have the capacity to make an exception to policy and do that as long as we document our reasoning and logic for that. But that is not our plan. And at this point, not our expectation.

Because in the quarter, your time deposits are 100K or more, cost of funds were up 38 bits and your borrowings were up 27 bits. So it was actually cheaper at the margin to borrow.

It is cheaper at the margin and even if you factor in Fed rate increases, as Scott Alaniz pointed out and he is very familiar with this market, it is a very aggressive deposit market and we can typically borrow from a variety of sources even factoring in expected Fed increases and/or used brokerage CDs many times cheaper than we can obtain additional CD deposits in a lot of our local markets' marginal cost of funds. But yet we want to maintain 85% or more of our deposits.

Philosophically, that is not how you want to run your business but in a pinch you might be there. Okay. Thanks, George.

Brian Martin, Howe Barnes Investments.

Just a couple of quick housekeeping questions here and first of all, you talked about the branch expansion next year. I was just wondering if you could give a little color as far as quarter-by-quarter how do we expect the 12 branches or what you are envisioning right now and then just I guess the other two questions were -- with the sale of assets and securities gains the last eight quarters running at 200,000 or so, is that something that you guys are expecting or projecting going forward? That should probably take care of it.

Okay. Well let me comment first on the gain on sale question. We never -- when we are doing our internal budgets, we never project in a gain on sale or a loss on sale unless we have a specifically identified transaction that is going to result in a gain or loss on sale. So for our internal projections for this quarter at this point I am not aware of any single transaction that is going to generate a gain or loss and hence, we have got zero in both securities and non-securities gains and loss categories projected for the quarter.

However it seems like we always have some sort of activity. Our securities gains last quarter came as a result of the fact that we found several pretty sizable issues of Arkansas municipals that we were able to buy and we sold some non-Arkansas municipals to make room for those Arkansas municipals. We bought a lot of non-Arkansas municipals late first quarter, last week of the first quarter and first couple of weeks of the second quarter earlier this year and we replaced some of those and then another chunk of those gains came when we had some bonds that we owned that were called away prematurely at a premium price and that generated a gain on sale on that cost. So these things happen, gains or losses unexpectedly each quarter. And at this point, we're not projecting any for the quarter. My guess is that we will have some gains or some losses and probably some of both over the course of any given quarter.

Typically, those have worked out to be gains for us as they have consistently over the last eight quarters. And part of the reason for that is the gain on sale of assets is typically a result of the fact that when we take assets into repossession, foreclosed assets, I think we have sort of a native conservatism in the way we value those and that tends to lead to gains. And that was the case in this quarter where we had 33,000 in gains on sale of assets. We had a lot of gains and a lot of losses that were small gains and losses that pretty much offset eachother but we had one OREO property that we sold that we actually netted 33,000 over and above where we had it booked, or actually it was a little more than 33 and that was the reason for the net 33 gain in that category. So I don't have any specific guidance except to say that there probably will be some.

Okay.

And your other question on the branches and what I can give you here is the number of office openings that we are expecting and sort of tell you how I think that is going to play out. I think of the 12 new offices, we would expect to add three of those probably in the first quarter. We would expect to add three or four of those in the second quarter and then two or three of them in the third quarter and three in the fourth quarter of next year.

And I would put a big asterisk on that and say it wouldn't surprise me if those numbers moved around one a quarter or something as one accelerated and moved up a quarter or one slowed down and moved out a quarter from what we're projecting. But pretty much an even pace. Opening 12 new offices, relocating two, temporaries to permanent facilities and replacing one office is a 15 facility opening year for us and the 12 new offices is about the outer limit of what we can open new office wise and do all the training and all the setup and manage that. So we are pretty much -- because we are behind a couple of offices this year, we are pretty much pushing to the limits of our capacity to open offices next year. But we are comfortable we can do it. It is just a full load.

Okay. And how about just one last question? If you can't comment, that's fine. The CD repricing schedule over the next 12 months, is it pretty even by quarter or are there certain quarters where you will have a little bit more repricing than others?

I don't know the answer to that. I have not personally seen that repricing schedule in detail. I have seen summaries of it but I cannot recall that information. I think probably the best guidance that I can give you is to tell you that I don't think our CD repricing schedule over the next quarter or two or three is going to look much different than it did over the last quarter, two or three in relative percent basis. Those ratios -- and one reason I don't look at them a lot is they tend to be fairly consistent and stable over long periods of time. So we're not anticipating any unusual aberrations there.

Okay. Nice quarter. Thanks.

Thank you very much.

At this time, there are no further questions.

Thank you for joining our call. If there are no further questions, there are not. Thank you. That concludes our call. We look forward to talking with you next quarter.

Thank you for participating in today's third-quarter earnings release conference call. You may now disconnect.