Bank Ozk (OZK) 2005 Q4 法說會逐字稿

Good afternoon. My name is [Takesha] and I will be your conference facilitator. At this time, I would like to welcome everyone to the Bank of the Ozarks fourth-quarter earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (OPERATOR INSTRUCTIONS)

Thank you. Miss Susan 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 fourth-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 at 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 service charge, mortgage lending and trust income, non-interest expense, including the cost of opening new offices and devoting increased resources to expand and develop staff, 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 loan, lease and deposit growth.

You should understand that our actual results may differ materially from those projected in any forward-looking statements due to a number of risks and uncertainties, some of which we will point out during the course of this call. For a list of certain risks associated with our business, you should also refer to the Forward-looking Information caption of the Management's Discussion and Analysis section of our public report filed with the SEC.

Forward-looking statements made by the Company and its management are based on estimates, projections, beliefs and assumptions of management at the time of such statements and are not guarantees of future performance. The Company disclaims any obligation to update or revise any forward-looking 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 our call today. In the fourth quarter we achieved record net income and record diluted earnings per share for the 20th consecutive quarter. In 34 of the last 36 quarters we have had record net income. 2005 was our fifth consecutive year of record annual net income and diluted earnings per share.

2005 presented many challenges. Competition and pricing pressures were intense all year. In 2005, the competition and pricing pressure seemed most intense early in the year for loans, and in the later quarters of the year, it appeared to us that competition and pricing pressures for deposits were more intense.

These competitive conditions, in combination with eight Federal Reserve interest rate increases during 2005 and a relatively flat yield curve, created a very dynamic and difficult operating environment. This makes our record fourth quarter and full-year 2005 results even more satisfying.

Let's get straight to some details. Net interest income or spread income is our largest source of revenue. In the fourth quarter we achieved our 19th consecutive quarter of record net interest income. This performance is a result of good growth in earning assets.

Loans and leases are our largest category of earning assets. During 2005, loans and leases grew $236 million, which was our largest annual increase ever for loans and leases. This growth rate of 20.8% was near the middle of our guidance range. Throughout 2005, we had 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 for 2006.

We are pleased to report that our growth in loans and leases in 2005 was accomplished while adhering to our traditional credit underwriting standards and without pricing below what we consider to be an acceptable level. As we have previously stated, at times during the year, we observed what seemed to us to be unusually aggressive underwriting and pricing of loans by some competitors. We've worked very hard to achieve our excellent asset quality and despite the intense competitive environment, we have not reduced our focus on quality in order to achieve growth.

While loans and leases are our largest category of earning assets, investment securities are our second largest category of earning assets. In the last half of the fourth quarter, we had several opportunities to purchase investment securities on terms we thought provided relatively good value. As a result, our investment securities portfolio increased from $514 million to $574 million during the fourth quarter.

This fourth-quarter growth increased our investment securities portfolio to 29.5% of earning assets as of year end. This was consistent with our stated goal of maintaining investment securities at 25 to 30% of earning assets.

During 2006, we may allow investment securities to grow above our current limit of 30% of earning assets, possibly into the low 30s in percentage terms. Because we have increased our percentage of variable rate loans and leases in recent years, we have more flexibility to increase investment securities, which are typically fixed rate.

For example, during 2005, variable rate loans and leases increased from 40.6% of total loans and leases to 44.0% and the percentage of our total loan and lease portfolio repricing or repaying within three years increased from 84% at the beginning of 2005 to 88% at year-end 2005.

We have commented on our investment securities portfolio in previous conference calls, and I want to make a few additional comments today. First, I would like to point out how effective our securities portfolio was in 2005 as a contributor to net interest income. Frankly, I didn't realize how well we were doing relative to some other financial institutions until Sandler O'Neill & Partners published a research report in November which stated that our third-quarter securities yield ranked number three out of 304 public banks and thrifts for which they had data available. Dan Rolett, our Investment Portfolio Manager, upon reading that report observed with a grin that that is 99th percentile performance.

Secondly, I would comment that despite 325 basis points of interest rate increases by the Federal Reserve in the last two years, we have incurred very little mark to market adjustment in our securities portfolio, all of which is held in the available for sale category. There are various reasons for this relatively small mark to market adjustment.

One is that we've received good monthly principal cash flows from our CMO portfolio, allowing reinvestment of the proceeds as rates have been rising. Another reason is that many of our investments were in portions of the yield curve that has seen relatively small changes due to the yield curve flattening as short-term rates have increased.

Let me make one final comment regarding our investment securities portfolio. While that portfolio is an important part of our earning assets, it is also an important element in managing the liability side of our balance sheet. State and local governmental entities and agencies in both Arkansas and Texas are required to collateralize their bank deposits in excess of the FDIC insured amount. Investment securities are the primary source of collateralizing these deposits.

In the past several years as we've expanded into more and more Arkansas communities and now into Texas, we have found ourselves unable to capture all of the public fund deposit opportunities available to us because we did not have sufficient collateral for all the available deposits. Accordingly, we have missed some opportunities which we would have liked to have pursued.

As our loan portfolio has become more rate sensitive and assuming that that trend continues, as we hope it will, we should be able to add some additional investment securities, which will increase our capacity to acquire additional public funds deposit business.

As I've already stated, our good fourth-quarter growth in earning assets allowed us to achieve record net interest income for the 19th consecutive quarter, even though our net interest margin contracted 17 basis points from the third quarter to the fourth quarter. This contraction in our fourth-quarter net interest margin was more significant than we had anticipated, but reflected in part our decision to accelerate deposit growth in the quarter. As the Fourth-quarter progressed we decided that we did not want to further increase our level of short-term borrowings at that time, and as a result, we issued additional CDs, including some brokerage CDs, and this put additional pressure on our net interest margin.

We continue to expect that a relatively flat yield curve and intensely competitive conditions will further pressure our net interest margin in the upcoming quarters. We hope that margin pressure will diminish as 2006 progresses, and we have two reasons to believe that that may happen.

First, in the latter months of 2005, we experienced better results in pricing new loans and leases, and we think this may have some positive implications for loan and lease yields in 2006. Further improvements in loan and lease pricing would be very helpful as we continue to experience intense competition for deposits.

Second, we believe the Federal Reserve is likely near the end of its series of interest rate increases. If this assumption is correct, we should see a deceleration in the rate of increases in deposits in the second half of 2006.

In summary, we expect that further downward pressure on our net interest margin will occur in 2006 and we may not see an improvement in net interest margin until we have a more favorable yield curve and a more normal competitive environment. Our goal continues to be to achieve good growth in earning assets, which we hope will more than offset any further compression in our net interest margin and thus allow us to continue to increase net interest income from quarter to quarter. We believe this is a reasonable and an achievable goal for 2006.

Let me also make a few comments about deposit growth. In 2005, our total deposits grew $212 million, or 15.3%, which was somewhat below the lower end of our high-teens to mid-20s guidance range. As I have previously reported, we pursued a fairly conservative deposit strategy in 2005 after deposits had grown 29.9% for the full year of 2004.

We will resume a more aggressive deposit gathering approach in 2006 and we expect deposits in 2006 to grow roughly in tandem with loans and leases. Therefore, we are reiterating our previous guidance for deposit growth averaging from the high teens to the mid-20s in percentage terms.

Our strong growth in loans, leases and deposits over the last 11 years has resulted from implementation of our growth in de novo branching strategy. Continuing this strategy, we now expect to add as many as 12 new banking offices in 2006 and relocate two temporary banking offices into new permanent facilities. This total includes two office openings which were originally planned for 2005.

Of course, 12 new office openings would be a record number for us in a single year. These new offices reflect a major expansion into four important new markets in both Arkansas and Texas. The largest number of our new office openings in 2006 is planned for Benton and Washington Counties, which are part of the one of the fastest-growing metropolitan statistical areas in the U.S. These two northwest Arkansas counties are home to several Fortune 500 companies, including Wal-Mart, Tyson Foods and J.B. Hunt Transport Services, and they are Arkansas' second and third largest counties in terms of bank deposits.

We opened our first temporary offices in these counties in 2005 and by year end, we had three offices there, including our first permanent office, which opened in November, a temporary banking office and a loan production office. By year-end 2006, we expect to have as many as nine permanent banking offices serving these two counties.

And over the next several years, we plan to increase that number of offices even further, possibly to as many as 13 offices in total. As one of Arkansas' largest and fastest-growing banking markets, these counties represent a particularly important element in our plan for further growth in Arkansas.

The Texarkana market, both Bowie County, Texas and Miller County, Arkansas, is expected to be another important new market for us. We entered this market in late 2004 with the opening of our first temporary office in Texarkana, Texas. Last month, we relocated that to our first permanent office in the market and we now plan to add one additional office on each side of the state line in 2006, giving us a total of three Texarkana offices by year end.

We are also excited about our plans to open our first two banking offices in Hot Springs, Arkansas, the largest city in Garland County, during 2006. Garland is the sixth largest Arkansas County in terms of bank deposits, and it is a natural extension of our existing footprint in central Arkansas. We expect to add one or two additional Garland County offices in future years.

Frisco, Texas is a rapidly-growing city in Collin County, which is part of the Metro Dallas area. We opened our first temporary banking office in Frisco in 2004, but it offered only limited banking services there to date. In 2006 we expect to replace this temporary office with two permanent Frisco offices and begin offering a full range of banking services. This will be our first real retail banking effort in the metro Dallas area.

We feel that we have assembled an excellent staff for each of these markets and we are very pleased that that staff includes a number of very experienced and talented bankers, many with close ties to the communities. We have an excellent branch location -- multiple excellent branch locations, in fact, in each market. This combination of a great team of bankers and great locations should make us a serious competitor in each of these important markets. Because these are new markets for us, we will initially be somewhat more aggressive in deposit pricing in these markets and that is one of the reasons we expect further pressure on our net interest margin in 2006.

As part of our growth in de novo branching strategy we have always sought to balance our number of new offices and the related cost of opening such offices with our revenue growth. Our strategy has been to always invest for the future, while also being attentive to our goal of consistently increasing earnings. We certainly have our work cut out for us in 2006 given our aggressive plans for branch openings and the tough competitive and yield curve conditions currently prevailing.

However, these are four excellent new markets; we have outstanding teams onboard for each market and excellent branch locations. In our view, the short-term challenges resulting from this aggressive expansion are more than outweighed by our longer-term potential from these markets.

Let me make a few comments about noninterest income. Service charges are our largest source of noninterest income and increased 4.2% to a record $9.9 million in 2005. This increase was primarily due to our continued growth in core deposit customers. Of course, service charge income will vary from quarter to quarter due to a variety of factors.

It should be noted that first-quarter service charge income has in recent years been noticeably lower than in any other quarter of the year. You can see this pattern in the eight quarters of data shown in the supplemental quarterly financial data schedule which is attached to our press release. We expect that service charge income will continue to vary from quarter to quarter, but we expect that it will grow over time as we increase our number of core deposit customers.

Mortgage lending income is our second-largest source of noninterest income. Mortgage lending income declined 7.8% to 3.0 million in 2005. Interestingly, our 2005 volume of origination of mortgage loans available for sale was $175 million, down only 1.4% from $178 million in 2004. However, when mortgage originations fall, competition for the smaller overall volume of business usually intensifies, which has the effect of cutting profit margins. That seemed to be the case in 2005.

Housing market conditions continued to be generally favorable in our markets in 2005 and our volume of mortgage loans for home purchases actually increased slightly in 2005 to $107 million compared to $102 million in 2004. However, the volume of loans for refinancing fell somewhat, from 76 million in 2004 to 68 million in 2005. Refinancing activity accounted for 39% of our total mortgage origination volume in 2005 compared to 43% in 2004.

As I've said before, the second and third quarters are typically better quarters for home sales in the mortgage business in our markets than the first and fourth quarters, so we were not surprised to see a somewhat lower level of mortgage lending income in the fourth quarter of 2005 compared to the third quarter.

In 2006, we hope that we will see growth in our mortgage lending income, in part as a result of our entry into the four new markets I've already discussed. In fact, in the past month, our head of secondary market mortgage lending relocated to northwest Arkansas with a goal of building a substantial mortgage origination team in this important and rapidly-growing market.

There are excellent opportunities in this market and we are cautiously optimistic about our ability to capture a meaningful portion of these opportunities. In addition, we hope to add originators in existing markets and in the other new markets that we are entering in 2006.

Trust is our third largest contributor to non-interest income. In 2005, trust income increased to a record $1.7 million, a 13.3% increase compared to 2004. We have an excellent team in the trust area, and our goal is to achieve an equal or better growth rate of trust income in 2006.

If higher interest rates slow the volume of municipal bond issuance in 2006 that may create some headwinds in the area of corporate trust. However, we believe that growth in personal trust and investment management services should more than offset this, providing good growth in overall trust income in 2006.

In each of the last 15 quarters, net gains on sales of securities or other assets have made a positive contribution to noninterest income. In the fourth quarter of 2005, our gains on sales of securities and other assets total $71,000. Over the last eight quarters, such gains have averaged $225,000. We hope we will continue to achieve some gains from sales of securities or other assets.

Let me make a few comments about noninterest expense. Our fourth-quarter noninterest expense of $10.3 million was up moderately from the prior quarter and was our highest level of noninterest expense ever. However, our rate of revenue growth in 2005 exceeded our rate of growth in noninterest expense, allowing us to achieve a record efficiency ratio in 2005.

While our long-term goal continues to be to grow revenue any rate exceeding our growth rate for overhead and thus improve our efficiency ratio in the long run, we are not expecting to improve our efficiency ratio in 2006. In fact, we will probably see that ratio increase 100 to 200 basis points in 2006 compared to 2005.

There are two reasons for this. First, we are planning to open a record 12 new banking offices in 2006. Opening new offices involves start-up expense for marketing and other costs and the ongoing expenses of staffing and operating each facility.

Secondly, in our annual staff budget meetings during December, we made decisions to add a number of new staff members in various departments and to continue to provide competitive salaries and many full-performance increases to our high-performing staff members. These decisions were made based on our long-term plans for staff development and corporate growth.

While these actions will increase our overhead cost in 2006, they are important elements in light of our growth plans for many years to come. We hope to resume an improving trend in our efficiency ratio in 2007.

It's a great pleasure to discuss asset quality. While several of our asset quality ratios are somewhat off the record pace of the ratios achieved in September, our asset quality ratios at year were once again excellent. At December 31, our nonperforming loans and leases as a percentage of total loans and leases were 25 basis points; our nonperforming assets as a percent of total assets were 18 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 our total loans and leases, was 39 basis points. These ratios are a tribute to the fine job our loan, lease, credit and special assets personnel have done.

Our annualized net charge-off ratio for the fourth quarter was 12 basis points, which is roughly in line with our net charge-off ratio of 11 basis points for the full year of 2005.

As a result of our excellent asset quality and our evaluation of loss exposure within the loan and lease portfolio, our allowance for loan and lease losses as a percentage of outstanding loans and leases at December 31 was 1.24 percent, 18 basis points lower than at the end of 2004.

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 December 31, our allowance for loan and lease losses was 502% of our total nonperforming loans and leases.

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 34 of the past 36 quarters, including the last 20 in a row. Each record achieved sets the bar higher for future performance.

Despite the current challenging operating environment and our ambitious expansion plans for 2006, from where we stand today, we believe improving net income is still a reasonable goal for the upcoming quarters in 2006 and we are cautiously optimistic about our prospects for achieving that goal.

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

(OPERATOR INSTRUCTIONS) Barry McCarver.

Good morning, George. A couple of questions. First off, looking at the margin and, more specifically, down into the interest rate analysis, I guess the loan and deposit pricing on some of your faster growth markets and a point specifically to Texas, which is significantly becoming a bigger piece of the portfolio, and then northwest Arkansas, what does the environment up there look like relative to some of your bigger markets, like around Little Rock?

Barry, actually I would say we are getting equal or better loan pricing in both Northwest Arkansas and in the Metro Dallas market compared to Little Rock. At this point, Little Rock is certainly one of if not the most competitive of the markets that we are in.

What about on the deposit side?

I would say that is true on the deposit side as well, again, for reasons that are not altogether clear, other than the competitive makeup of the market; the Little Rock market is intensely competitive. Our sense is that we're actually getting better margins in the other markets.

Now of course, we are so new on the deposit side in Northwest Arkansas, having opened our first permanent office there just in November, that we're really just beginning to roll out retail deposit gathering efforts in a significant way in Northwest Arkansas. So my comments there are based on very preliminary experience in that market in a real retail sort of environment. But I certainly don't think it is anymore competitive and might be slightly less so than the Metro Little Rock area at the present time.

And then secondly, could you provide just a little more detail on the timing of the branch rollout for 2006, maybe giving us an idea of what we can expect in the first quarter and the second quarter?

The plan right now is to open two offices in the first quarter -- that would be our first office in Rogers, Arkansas, which is in Northwest Arkansas obviously, Benton County; and our first office in Hot Springs, which is in Garland County. We would expect to open three offices in the second quarter -- that would include our second Bentonville, Arkansas office in Benton County, which is our headquarters really for Northwest Arkansas; our second Texarkana, Texas office; and our Texarkana, Arkansas office.

And then in the third quarter, we expect to move from our temporary to our permanent facility in Fayetteville, opened our first Frisco, Texas permanent facility that would a replacement of our temporary office there; our first Springdale, Arkansas office; our second Hot Springs office; and our first Bella Vista office, which again is in Benton County. And then in the fourth quarter we would open our second Bella Vista office, our second Fayetteville office, our second Frisco office and our second office in Rogers, Arkansas.

So if you are counting and you're ignoring the relocations, that's two new ones in the first quarter, three new ones in the second, four in the third quarter and three in the fourth quarter. So based on the way they are laying out on the calendar right now, a fairly equal allocation of branches.

I will tell you we are already -- in the last two months, 60 days or so, have already begin to build large numbers of the staff for some of these offices, even offices that will be opening in the second quarter. We are getting people in early, we are training them.

And these are very important markets to us, and the thing that I am most excited about for the future -- it's expensive in the short run, but it's very exciting for the future -- is we have been able to assemble some of the best teams of lenders and veteran bankers that we've probably ever had for startup new offices.

So that certainly added to our cost in the fourth quarter as we begin to bring a lot of these people on board, and it's going to add to our cost in each quarter of '06 because we are hiring a lot of people and some veteran, very experienced people. But I think that poses really good prospects for the long-term success and potential of these offices.

Refresh my memory, but I think in Northwest Arkansas -- it's either and Rogers or Bentonville -- aren't you opening -- it's a building a little bit bigger than a branch, as part of a regional headquarters?

Yes, we are. The Bentonville office -- that will be the second Bentonville office we're opening; we already have the first one open -- is really a regional sort of headquarters. And the building -- I'm not sure of the exact size but it is probably about an 8 to 10,000 square foot two-story building there and it is a more substantial facility. And that is, as I've already mentioned, scheduled to open in the second quarter and specifically expected to open in May.

That will have the greatest number of employees too, obviously then, right?

Yes, it will. And the office that we are opening in Fayetteville in July, early in the third quarter, which will be a relocation from our facility, will be a somewhat larger office. It will be larger than a normal branch. And, again, I don't recall the exact size, but probably somewhere in the 5 to 6000 foot range. And that will be our preeminent office in Washington County. And we will have -- and already do have on staff -- in addition to our head guy over both those counties, we have a designated leader for each county and, again, very fortunate to have assembled an excellent staff in those markets.

And then just lastly, and I'll let somebody else get on, when you mentioned the 100 to 200 basis point increase in the efficiency ratio over 2005, were you pointing towards the fourth quarter efficiency ratio or were you just talking in general for the year?

That number is a 2005 number versus a projected or expected 2006 annual number. And even though we are adding the branches at a fairly even pace, I think it is probably fair to say that a relatively large part of that expense growth will be reflected in the first-quarter results.

And they are two reasons for that, Barry, and let me amplify on my comments I've already made. One is we're opening a lot of offices this year and we're staffing up for that. But we have been doing a lot of longer-term -- 3-, 5- and 10-year planning -- with a goal of building the human resource infrastructure in place to maintain high-teens to mid-20s growth rates on a compounded annual basis for years into the future. That is a goal that we've talked about a lot. We went to maintain the same sort of growth rates that we've historically had.

And what we are encountering is situations where we need to add a person here and a person there and a person in this department and that department to accomplish that in the manner of excellence that we went to accomplish that.

A good example would be in our corporate finance office area, Paul Moore, our Chief Financial Officer, is sitting across the table so I'll pick on his department. We have a number of talented people down in that area and two very senior people in Paul Moore, our CFO and Chief Accounting Officer, and Greg McKinney, our Controller.

But as we are projecting forward over the next several years, what we realize is that we need a third very senior person with either big public company, SEC company experience, or serious banking experience in there that can contribute at a very high level and be a legitimate contender to be a backup for one of those guys in the future.

And as we go through our Bank, as we went through our planning session, in department after department where we've got two really senior people, we realize we needed to add another one. Or maybe we've got really only one very senior person and we realized we needed to add another one.

So we are putting in place in 2006 a lot of human resource infrastructure that is going to be really critical not to just accomplishing 2006 -- in fact, we could just skinny by and do without those people in 2006. But we're putting them on because of what we realize are going to be our needs in '07 and '08 and '09, and we don't want to wait too late to add these people.

So '06 is really a year of building for the future for us, and we are adding some cost doing it -- not just going into these four new markets that are very important, but also building the infrastructure to sustain growth way beyond that. So that means that we're going to add a higher rate of overhead growth in '06 than we've added in the past few years.

And I would normally take that in stride if we were in a better yield curve and a better competitive environment, but we certainly have our challenges set out for us to continue to achieve the kind of earnings growth we want to achieve in '06, given the ambitious expansion and staff development plans that we have for the year.

Okay. Thanks, George.

Andy Stapp.

Good morning. Just wondering if you could shed some color -- the linked-quarter compression in net interest margin, which was the biggest culprit in that, the competitive pressures or the flat yield curve?

Andy, I don't know that I can say which one is the biggest culprit in that. They are sort of inextricably bound together, I think. I think there is a nexus between those two things.

Certainly, the flat yield curve has been challenging all year long. We have had large quantities of payoff from our loan portfolio and from our bond portfolio. Our cash flows from, example, our CMO portfolio have been equal to or better than what we had projected all year long. So we've had plenty of assets with opportunities to reprice during the year.

The flat yield curve has simply meant that we were repricing those assets at less of an increase than the increase in short-term rates by the Federal Reserve. For example, a lot of the CMOs that we had rolling off were probably in the 5 or very low 5% range, and as we reinvested those, they were reinvested at a 100 to maybe 200 basis point better tax equivalent yield than what was rolling off. But we were in a situation where the cost of funds were up 300 or 325 basis points now, by virtue of the Fed increases.

So that has certainly posed a challenge. The fact that the yield curve has been flat and a lot of lending is priced off of the longer end of the curve has also tended to keep us from getting as good of an increase in loan rates as we would have liked.

We did see in really the last weeks of November and December a far better improvement in our loan and lease pricing than we had seen at any other time in the year. Whether or not that will translate through into continued improvement in '06 remains to be seen. But it did give us a faint bit of optimism on the loan and lease pricing front.

The deposit competition in the last couple of quarters of the year got extremely brisk and seemed to continue to intensify even toward the end of the year, and I think that is fairly normal. The Fed tightening is intended to decrease liquidity in the banking system, and that is supposed to raise the cost of funds and create a bit of a liquidity scramble among financial institutions and other financial intermediaries. And I think it has certainly having that effect and we are seeing that in the aggressive pricing on deposits. And that also has pressured the margin over the last year. So I think it is a combination of the two.

Okay, that is helpful. And I noticed that there is a linked-quarter declined in compensation expense. Can you comment on that?

Yes, I can comment on that; that is a good question. We had made modest accruals for our various bonus programs in the first, second and third quarters of the year. Our fourth-quarter earnings -- the way we do our bonus program is we have an internal goal which we set -- and I've set it for next year, I set it for last year -- we don't disclose it because it is too much of a forward-looking specific guidance to disclose it.

But if we make that we accrue bonuses; if we don't make that, we don't accrue bonuses. And we did not make that goal in the fourth quarter sufficient to accrue bonuses. And in fact, fell short of our goal in the fourth quarter and actually reversed part of the prior quarter's accruals. So as a result, we are not paying bonuses as part of our general cash bonus program this year.

Now we have some employees that have specific incentives based on specific performance and so forth, and those are contractual and paid. But our general cash bonus program -- this is the principal bonus program for all the members of our staff -- is not being paid based on 2005 results.

And we will do the same thing in '06. We have set criteria that we believe is a minimum level of earnings that we need to return to shareholders. And if we produce that minimum level of earnings and exceed it, we will put initially a large part of the excess in the bonus pool. And then if the excess grows even bigger, that will be split more toward shareholders and less toward employees as we exceed that.

But that is the way we've always done our bonus pool. We've paid our general cash bonus program six times in the last nine years; we've had three years when we either didn't make our internally targeted earnings or we made it by such a slim margin that we did not pay the bonuses. And that was the case for the full year of '05; we made our number, but by such a very slight margin that we didn't pay the general cash bonuses.

Has your bogey for the 2006 bonus, has that been lowered to reflect the fact that you're investing a lot in infrastructure?

No, it has not.

Okay. Go ahead.

It is not. We are investing a lot for the future in '06, but we still have goals, as I articulated in my prepared remarks, of putting up improved earnings on a quarter-to-quarter basis. We've got our work cut out for us to do that, but that is our goal and we think it is a reasonable goal.

Okay. And I also noticed that there is linked-quarter decline in other noninterest income, the last catchall category.

Andy, you may have me on that one.

Just a general lumpiness in that number.

There is not anything that strikes me as particularly noteworthy.

Okay. No large (indiscernible) occurring type thing then?

I'm looking at that and it's in the quarter was 545,000 versus 549, 453, 527 -- it's pretty much.

I thought it was like 200,000 higher linked-quarter. Maybe I'm --

Are you talking about other noninterest income?

Yes.

No. It was 545,000 in the fourth quarter versus 549,000 in the third quarter. So it was a very small change (multiple speakers).

Okay. Maybe I misread something. And lastly, can you give us any -- has there been any change in the duration of your investment securities since what you had disclosed in the last call?

Not a tremendous change. I can give you that data. We've continued to buy principally longer municipal bonds. And we did in December found some mortgage-backeds, some CMO product, that we liked and thought had a relatively good value and we purchased some of that.

As of December 31, the average life of the portfolio was 5.8 years and the modified duration of the entire portfolio was 4.5 years. The average life on the CMO part of the portfolio with those new purchases was 5.2 years.

So a slight increase in the overall duration and the average life of the portfolio. And that is probably -- or primarily result of slower expected prepayments from the mortgage-backed portfolio, the CMO portfolio in 2006 and purchase of longer municipal bonds, primarily.

What we have tried to do, Andy, in the management of the bond portfolio -- and I think it has served us exceedingly well -- is to find sectors of the curve and bonds of a particular type and specific bonds within those types that have relative value. We've invested in the CMOs a couple of years ago and we invested in longer municipal bonds last year, in 2005, principally because we believe that those sectors offered relative value to other portions of the curve.

And a number of very intelligent, sophisticated, well-trained bonds people urged us to take on more defensive strategies for our portfolio in view of the expectation over the last couple of years that the Fed was going to raise interest rates significantly. We shared that belief and thought that we would see about 300 basis points Fed increase.

But in our view, the relative value and the best place to be was the areas that we went on the curve. And I don't know whether we are that good or just like lucky or a combination of both, but as it turned out the sectors on the curve that we have been have yielded us a very good return on the portfolio and it depreciated very little as the curve has flattened.

And we've looked at some of the defensive -- supposedly more defensive strategies that some folks suggested to us a year or two years ago. And had we invested in those defensive strategies, we would have yielded a much lower yield on our portfolio and actually had more significant mark-to-market adjustments because those bonds would have been in the shorter end of the curve, where there's been the biggest change in rates.

So we're continuing to search all types of investments and all areas on the curve and to look for relative value compared to all the risk associated with that. And that is what we're trying to do, is constantly buy the best relative risk-weighted value that we can find in the curve.

Okay, thank you.

Scott Alaniz.

Good morning. A couple of questions. First question he is what type of inflation, if you will, or wage increase are you planning on in 2006?

I don't want to disclose that because it is different for different people. Obviously, we don't give the same sort of wage increases. But I will give you a window into our process. We spend about two weeks each year in December and we go through a series of meetings, and Mark Ross, our President and Chief Operating Officer, and I, and Diane Hilburn, who is our Director of Human Resources, literally meet by telephone with every manager, every supervisor in the Company and review their employees and their staffing needs for the next year and receive a very brief performance evaluation of every employee.

And we talk about the future of that department, what the expectations are for the next year, where we expect the staffing and needs of that department will be longer term, and what we're going to do to build the staffing within that department to achieve our short-term and our long-term goals. And then based on the performance of those people and our need to build staffing, we award raises and determine how many additional people we're going to add and in what month they're going to be added and what the approximate salary range for those people are.

So that is the way our process works. Some people, obviously, based on their performance, get much larger increases than others. Our goal is to accomplish a couple of things. Number one, to be externally competitive with the other employers in the markets with which we compete for employees.

Two is to be internally equitable so that if you sorted out all of the employees in our Company that there is a reasonable dispersion of those people and a prioritization of those people based on their overall contribution and performance.

And thirdly is to make sure that we are building the human resource infrastructure that is necessary to support our growing operations into the future. And that final aspect was one of the key focuses of our process this year, because we just realized we've got the infrastructure to run a 2 billion or 2.5 or maybe a $3 billion bank. But at a high-teens to mid-20s growth rate, we very quickly over next couple of years get to 3 billion and then very quickly get to 4 billion.

And that is our goal, is to continue that kind of growth rate. And we realized that we had to add some people to accomplish that long-term goal and we had to build some more seniority and depth in some of our back office areas to have the people that we could accomplish that kind of growth with three and five years from now.

A good example -- one of the important parts of our company is our operations, our back office center that is all centered in Ozark, Arkansas, a very small community there. We've done a 10-year staffing plan for what it takes in Ozark to support the growth rate of our Company over the next 10 years.

And as we have looked at that, we've realized that we have got to build a staff of people in that community over a number of years to support the growth that were expecting five and seven and 10 years from now. It's a small market, it's a very efficient operation with relatively low turnover. But we've got to attract and retain higher caliber people in the lower echelon positions there to build that next generation of future leaders that I'm going to need five and seven and 10 years from now.

So there were some fairly robust raises given to some people in a half dozen departments there that we expect to be very important elements of our future growth and that we went to grow and develop and build in the future. So that is the sort of process that we go through each year in those meetings.

I see. So it sounds like the general level of wage increases in 2006 would be above that level of wage increases in 2005. Is that a fair --?

That is exactly correct, yes.

And the second part is, how many people do you need? As you look at the need to build the infrastructure for the out years, how many senior and middle level type additions do you need to make in 2006?

Scott, I don't have an exact count on that. But there are people scheduled to be added in the CFO's office and the General Counsel's office, in the marketing department, in the investment area, a number of other areas in the Bank. Now I can give you what our expectations for total headcount are.

Okay.

At December 31 we had 662 total employees and a lot of those are part-timers. And if you calculate those on an FTE basis, that was 629 FTE employees. We are projecting, based on our expansion and putting this infrastructure in place for the future, that our headcount at December 31 of '06 will be 823 employees and the FTE count would be about 779.

So basically, we are looking at adding 150 FTE employees in 2006. A large number of those, of course, are associated with the 12 offices we will open in '06 and some of that headcount is even associated with offices that would be opened in early '07, would be late-year additions for '07 offices. But a goodly portion of those are intended also to just strengthen our overall infrastructure as we get ready for a next major growth push that we expect to pursue over the next four to five years.

I understand. Do you happen to know what the FTE headcount increase was in 2005?

Yes, I do. It was 68 people who were -- our FTE headcount at December 31 of '04 was 561 people.

Okay, thank you very much.

(OPERATOR INSTRUCTIONS) Brian Martin.

Hi, George. I wanted to just get your -- you gave a little color on the last question regarding the staff additions. But if you can comment a little bit about the six offices you opened in '05 relative to the number of commercial lenders you added versus the number of commercial lenders you anticipate adding in '06 with the 12 branches, likely.

And I guess just the other part of the question is what level of comfort -- I guess are you able to find those lenders pretty successfully at this point and is that expected to be a challenge in '06?

I don't expect it to be any more of a challenge in '06 than it has been in any previous year. In fact, as I've already sort of touched on in some of my comments, we have been extremely pleased with the number and quality of staff members and particularly commercial lenders that we've been able to hire for new offices such as our offices in Texarkana and Northwest Arkansas and Garland County. We've had very, very good success in building the teams for those offices.

And while I certainly don't underestimate the challenges we face in '06, I am extremely excited about the longer-term potential of the markets we're going in, the locations we have and the staff in those markets.

We basically a have a rule here on hiring commercial lenders, and that is that will hire every commercial lender that we can find that meets our standards for experience and ability and our expectations for being able to produce business. I would hire 50 commercial lenders tomorrow if I could find 50 that met our model and we thought could be productive and profitable lenders for us.

So we are constantly looking for those folks and constantly looking to add those folks pretty much in any market. We would add another commercial lender anyplace, anytime that we could find a quality individual that we wanted to add to the team and thought could come in and be very productive for us.

So I can't give you a number of how many commercial lenders we have in the budget for '06 versus how many we added in '05. I would tell you we do have a number of additions budgeted, both in existing markets and new markets. I would tell you also that we have a large number of mortgage lenders -- mortgage loan counselors as we call them -- budgeted based on our expectations for growth in that part of our business in our new markets. In fact, probably a more than doubling of the number of those mortgage lenders because of the opportunities that we perceive in those markets.

So a lot of these people that are budgeted are producers, business development people or trust people or commercial lenders or mortgage lenders -- you know, other people that are out there producing business. And obviously, we're expecting those guys to generate a lot of growth for us. That is about as much information as I can give you.

Okay. How about just one more big picture question, and that is, when you looked at the growth as far as the number of branches you're adding in '06, I guess when you look even further out, since it sounds like you guys have done some pretty detailed budgeting, what is the outlook for '07 at this point as far as the branch expansion?

Do you take the increase in the expenses this year and grow into the branches that you've added? Do you keep adding fairly aggressively or is this a kind of -- I guess letting some of these bear fruit before you continue aggressively growing again?

Well, we certainly hope they will certainly be bearing fruit well before '06 is over and into '07. Our plans for '07, '08, and '09, which is as far out as we have fairly detailed plan, all project 8 to 11 offices per year in each of those years. And that is a sizable number of offices, but would be a considerable step back from '06 in percentage terms. It's one to four offices less per year, but in percentage terms, as that number of offices outstanding or existing grows, that is actually a pretty good reduction in percentage terms.

We believe that, as I've already said, that we will resume an improving trend in our efficiency ratio in '07. I don't think we'll see any record efficiency ratios in '06 unless we just outperform my expectations on the revenue side. The expense side is fairly predictable within reasonable tolerance there. So unless we really have an outperformance from our expectations on the revenue side, I don't think we'll see a record efficiency ratio in any quarter of '06. But we would hope to get back onto that improving trend in '07.

And we still have a long-term goal over the next four years or so of getting that efficiency ratio sub 40, which may not be achievable; it is certainly an audacious goal, I've always said it was. But we are getting closer and closer to it, and I think it is a goal that is a realistic goal for us to shoot for over, say, about a four-year period.

Okay. And then maybe just a last housekeeping question -- and I apologize if you guys already talked about it. The period end balances on the loan side between Texas and North Carolina and Arkansas, can you give a little color there?

I'm sorry, I don't have those numbers. We will get those numbers in the annual report though. Texas and North Carolina continue to contribute nicely. My sense is they -- and again, I don't have the numbers; I'm just giving you an intuitive feel from watching the portfolio and individual loans close or pay off over the quarter -- my sense is they probably are accounting for about the same percentage of our portfolio as they did at the end of the third quarter. I don't think we saw a major shift one way or the other over the quarter. But obviously, Texas particularly and to a lesser extent North Carolina are very important elements in our future growth plans.

Okay, I appreciate it. Thanks very much.

Peyton Green.

Just a follow-up on the asset liability. Could you refresh for us what the variable rate loan mix was at the end of the year, and then how the cash flow would look from loans less than a year, two years and three years?

Yes, I can give you that. The variable rate loans were 44.0%, and that was -- statistically, I guess, if you're rounding off to the nearest percentage was actually unchanged from September 30 when it was also 44% -- but it was actually a fraction of a percent better, more variable at December 31 -- so 44.0.

In one year, 64% of our loans and leases will either reprice or repay. That is up 1% from the last quarter when it was 63%. In two years, the number is 75% and in three years the number is 88%. And both those numbers are the same as the prior quarter, 75 and 88%, but both were up a fraction of a percent. So we just saw a very minute increase in the rate sensitivity of the loan portfolio in the fourth quarter.

Okay. And then just to follow up. You indicated that you expected the loan -- I guess the securities to asset ratio to actually increase going forward. So do you expect continued improvement in the variable rate loan mix? I mean, would it be kind of on a dollar-for-dollar basis or (multiple speakers) leaning in a direction?

We do you expect a continued improvement. As you know, these various ratios are up about 4% from the beginning of '05. And our stated goal is to increase the variable rate percentage by 1% a quarter on average. So we accomplished that, although we only got a fraction of a percent increase in the fourth quarter. For the year, we averaged 1% a quarter, and that is our goal and we would expect to continue to strive to do that. And that does give us some more flexibility.

Now, Peyton, I can't tell you for sure that you're going to see securities at a figure north of 30% of earning assets. And we're going to watch this market and if we find opportunities that we think are good buying opportunities, then we will buy securities. If we think the market is just obscenely overpriced at any particular point or there are better relative values in one sector than another sector, we would sell bonds in one sector and rotate to another sector. Or if we think the whole market is overpriced, we would sell bonds in general.

But I did want to prepare you for the possibility that that number might be -- sometime during 2006 -- might be 31 or 32 or 33% since we've previously stated that our policy is to stop at 30%. And if we were going to violate that policy and thought that was a possibility, I would want to give you a heads up on it if I had the opportunity. So that is why we mentioned that today.

Okay. And then just from a funding perspective, you indicated a preference to boost the deposit growth in '06. How much of that can you do from, I guess, an authorization perspective from brokered CDs versus having to rely on kind of the battle-weary Arkansas market for CDs?

Well, we could do a lot. At year-end, brokerage CDs and financial institution CDs in total were 10.66% of our total deposits. And our policy is to keep that under 15. And putting that in perspective, those total bank and financial institution CDs were 8.82% of deposits at year end '04. So we were up 184 basis points in that category as a percent of deposits for the full year of 2005.

So we have considerable room, 434 basis points more of growth potential in that. And we don't mind tapping that. And sometimes on an incremental basis, that is cheaper than raising deposits locally. At this point in time, given where that market is, I think that we've got some opportunities to raise considerable deposits locally at better pricing.

Okay.

So that is going to be -- our expectation at this point is that the primary focus on that growth is going to be in end-market retail deposit. And if relative pricing levels change, that may change during the course of the quarter or the course of the year. But that is our present thought based on relative pricing levels today.

Okay, great. Thank you very much.

There are no further questions from the phone lines at this time.

All right. Well, thank you very much for joining our call today. We appreciate your attention and your questions. We look forward to visiting with you in about three months. Thank you very much. That concludes our call.

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