Bank Ozk (OZK) 2006 Q2 法說會逐字稿

Good morning. My name is Renell and I will be your conference operator today. At this time I would like to welcome everyone to the Bank of the Ozarks second-quarter earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (OPERATOR INSTRUCTIONS) Ms. Blair, you may begin your conference.

Good morning. I'm Susan Blair, Executive Vice President in charge of Investor Relations for Bank of the Ozarks. The purpose of this call is to discuss the Company's second-quarter 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 feature plans, prospects, goals, and expectations of Bank of the Ozarks.

To that end, we will make certain forward-looking statements about our plans, goals, expectations, and outlook for the future, including statements about economic and competitive conditions; our goals and expectations for revenue growth, net income, earnings per share, net interest margin including the effect 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 loans, lease, and deposit growth. You should understand that our actual results may differ materially from those projected in any forward-looking statements due to a number of risks and uncertainties, some of which we will point out during the course of this call.

For a list of certain risks associated with our business, you should also refer to the forward-looking information caption of the management's discussion and analysis section of our periodic public report, the general caption of our most recent earnings release, and the description of certain risk factors contained in our most recent annual report on Form 10-K, all as filed with the SEC. Forward-looking statements made by the Company and its management are based on estimates, projections, beliefs and assumptions of management at the time of such statements and are not guarantees of future performance. The Company disclaims any obligation to update or revise any forward-looking statement based on the occurrence of future events, the receipt of new information, or otherwise.

Now let me turn the call over to our Chairman and Chief Executive Officer, George Gleason.

Good morning and thank you for joining our call. It is our privilege today to report our second-quarter results which we think reflect good performance in a challenging environment. While we did not report record net income or earnings per share in the second quarter, thus ending our most recent streak of record quarterly earnings at 21 quarters, we are making important investments for the future.

During the second quarter, we continued to pursue the branching, corporate growth, and deposit initiatives we discussed on our last conference call. The effects of these three initiatives include a higher overhead and interest expense, which reduced our earnings in both the first and second quarters of this year. On the positive side, these initiatives contributed to our strong growth in loans, leases, and deposits and our growth in service charge, mortgage, and trust revenue so far this year. We are pursuing these initiatives because we believe they are in the best long-term interest of our Company and our shareholders even though such actions have reduced earnings in the short term.

I will comment further on these initiatives later in the call, but first let's look at some numbers.

Loan and lease growth could be considered the headline story of the second quarter. During the quarter, loans and leases grew $130 million, giving us our best quarter ever of loan and lease growth. Over the last four quarters, loans and leases have grown 27.2%, which is somewhat above the top end of our expected high teens to mid-20s growth range. Our ability to generate a good volume of quality loans and leases has been one of the hallmarks of our Company. These recent results reflect our efforts to continue to grow our lending team in both our established and newer markets. We expect continued good loan and lease growth in the coming quarters and we reiterate our guidance for such growth to average from the high teens to the mid-20s in percentage terms.

Deposit growth was also favorable in the quarter just ended. After a couple of years in which we have pursued a mostly defensive deposit pricing strategy, you will recall that in late January we launched what I have referred to as a deposit initiative. This initiative included repricing a number of deposit products and increasing marketing and public relations expense. We continue to be offensive minded in regard to deposit pricing in the second quarter.

In the five months since we launched this effort, we have seen good growth in our total number of deposit accounts and our total volume of deposits. In fact the past two quarters have been our best and fifth best growth quarters ever. This has increased our deposit growth rate to 24% over the last four quarters, which is near the top end of our high teens to mid-20s guidance range. We expect to continue our deposit initiative probably for the balance of this year and we reiterate our guidance for deposit growth to average from the high teens to the mid-20s in percentage terms in the coming quarters.

Our excellent second-quarter growth allowed us to fulfill a prediction we made three months ago. In our first-quarter earnings press release we stated that based on our expectations for loan and lease growth, we believed that second-quarter net interest income would once again reach a record level. Second-quarter net interest income was indeed a record, increasing 7% compared to the second quarter of 2005. However with loans and leases having grown 27.2% in the past four quarters, we are certainly not satisfied with this 7% increase in net interest income.

Obviously we are in a very tough margin environment which we attribute primarily to three factors. The first two are external, being the relatively flat yield curve between short-term and long-term rates and the very challenging competitive environment for pricing both loans and deposits. These two factors combined with our decision to more aggressively price a number of deposit products this year have put considerable pressure on our net interest margin. We expect this challenging margin environment will improve in time but we do not see net interest margin increasing in the next couple of quarters and in fact we expect some further pressure on margin.

As I have already mentioned, one of the strengths of our Company has been our ability to generate good growth in earning assets, primarily loans and leases. We will continue to seek to more than offset any further margin pressure with growth and earning assets and thereby hopefully achieve record net interest income in the coming quarters.

We were generally pleased with our levels of non-interest income in the second quarter. Of course service charges on deposit accounts are our largest source of non-interest income and second-quarter service charge income was a record, although it was up only fractionally from the results in last year's second quarter. Over the last five months as part of our deposit initiative, we have seen particularly good growth in our number of non-CD deposit accounts. Continued growth in the number of non-CD accounts should positively affect future income from deposit account service charges.

Mortgage lending income is our second largest source of non-interest income. In the second quarter, mortgage lending income increased 9.4% compared to the second quarter of last year. Our goal this year was to improve our mortgage income by gaining market share in existing markets and beginning to capture share in newer markets and it appears that we are having success in this effort.

Trust income is another important source of non-interest income for us. We have said for some time that this is an area of opportunity for us to grow our non-interest income. We have an excellent trust team with a demonstrated ability to grow this business as shown in the second quarter when trust income increased 21.3% compared to the second quarter of 2005.

Now let me make a few comments about expenses. Noninterest expense increased 10.1% in the quarter just ended compared to the second quarter 2005. While second-quarter non-interest expense was essentially flat compared to the first quarter of this year, the 10.1% rate of growth compared to the second quarter of last year was still above our rate of growth of noninterest expense experienced in 2005. To a large extent, this higher growth rate is attributable to our corporate growth initiative, which is our actions to build up staff to support future growth plans for years to come.

This corporate growth initiative includes adding more production staff such as loan officers, mortgage loan counselors, and private bankers at existing officers, adding a number of corporate staff members, and giving appropriate 2006 salary increases to help retain and develop our next generation of supervisors and managers. While a large part of this increased cost was reflected in our first- and second-quarter non-interest expense, there will be some additions to noninterest expense in the remainder of this year as a result of continued implementation of this corporate growth initiative.

In addition, we are continuing to pursue our branching initiative in 2006 which is our plan to open a record 12 new offices this year. We have opened three new offices so far in 2006 and our present plan is to open five offices in the third quarter. This planned new office group of five offices will be in Texarkana, Texas and in Texarkana, Fayetteville, Springdale, and Hot Springs, Arkansas. The planned Fayetteville office is a replacement for our present temporary facility there, so that leaves us four net new office additions which we are planning for the third quarter. In addition we are planning five new offices and one replacement office for the fourth quarter.

We expect that our corporate growth and branching initiatives will keep non-interest expense growing throughout 2006, however in our last conference call, we said that we expect that that rate of growth in non-interest expense to slow somewhat from the year's first quarter in which non-interest expense increased 17.5% compared to the comparable quarter of 2005 and that was borne out in the quarter just ended when non-interest expense grew a somewhat slower 10.1% compared to the comparable quarter of last year.

As we said in the last call by the first quarter of 2007, we hope to see our growth rate of non-interest expense return to a more moderate level, allowing us to once again start improving our efficiency ratio.

Suffice it to say that during the second quarter we continued to benefit from our strong credit culture and the resulting favorable asset quality. Nonperforming loans and leases as a percent of total loans and leases were a very favorable 18 basis points as of June 30, 2006 and nonperforming assets as a percent of total assets were just 13 basis points as of June 30, 2006. Both of these ratios tied our previous records for these measures.

Our ratio of loans and leases past due 30 days or more including past due non-accrual loans and leases was just 45 basis points at June 30, 2006, matching the mark achieved on June 30 last year. And our annualized net charge-off ratio for the quarter just ended continued to be very favorable at 9 basis points.

In closing, let me say that we like reporting record earnings much better than we like reporting less than record earnings. However, our second-quarter results reflected our continued investment in our deposit corporate growth and branching initiatives. While these expenditures have diminished both first- and second-quarter earnings and will affect earnings for the remainder of 2006, we continue to believe that the long-term benefits of these efforts will far outweigh this short-term impact.

Some years ago we had a streak of record quarterly earnings going and that streak ended at 14 consecutive quarters of record net income. We then had a two quarter pause before we started our most recent streak of 21 consecutive quarters of record net income. This most recent quarter was not a record and we most likely will not achieve record earnings in the third quarter; however, increased earnings is important to us and I assure you that we are working hard to get back to a record earnings level as quickly as possible while implementing the elements that we need to accomplish our long-term plans.

With that said, at this time let me entertain questions. I will ask Renell, our operator, to once again remind our listeners how to queue in for questions.

(OPERATOR INSTRUCTIONS) Barry McCarver, Stephens Inc.

George, exceptionally strong loan growth. I'm excited to see that. Could you talk a little bit about whether or not there was a big loan in the quarter that pumped that up and if not, kind of where the demand was coming from? And then secondly, the pipeline going forward.

Barry, the demand was fairly broad-based. We saw growth at offices throughout our footprint, Texas offices both Dallas and Frisco offices continued to contribute nicely. Our North Carolina office contributed nicely. Northwest Arkansas contributed nicely. We had some good growth in the Metro Little Rock area and a number of our smaller offices saw positive growth numbers during the quarter. So it was a broad-based effort.

Again we saw a slight increase or more rapid increase in our lending outside of Arkansas than in Arkansas and I will give you those numbers. Texas at the end of the quarter, our three Texas offices, Dallas, Frisco and Texarkana accounted for 5.7% of our loans. That is up basically 0.25 points from 5.45% of loans at March 31. North Carolina accounted for 3.66% of our loans, up 16 basis points from 3.50% at March 31. And our Arkansas loans were down to 90.63% compared to 91.05%, so down 42 basis points in Arkansas as a percentage, but we had growth across the board.

In regard to the pipeline for the third quarter, that looks very good. So we are optimistic about our continued ability to generate loan growth as evidenced by our restatement of our guidance for high teens to mid-20s percentage loan growth going forward.

And the other part of your question was there a large loan in there? We do a lot of lending above $10 million to particular customers. There were several loans in that category in there in the quarter and those loans we feel very good about.

So enough large loans in the quarter that that probably accounted for a little bit of that growth that we might not expect run rate going forward? Is that fair?

I don't know that that is a fair statement. I think the mix of large and small and medium-sized loans was probably a pretty typical mix for us. There was not anything unusual I think as far as contribution to fundings from a particular loan. It was a pretty normal quarterly mix as far as the size of the loans go, I think.

Okay. A couple of things that caught me by surprise that were really to the upside of earnings was the expense levels and also the loan loss reserve. Let me tackle expenses first. Just thinking out the next couple of quarters given that we've got nine branches to open by year-end, you said five in the third quarter and for me to look at expenses in the third quarter, how much have you staffed up? How much of those buildings obviously are already in play? Is there going to be a tremendous ramp in the third quarter I guess is my question?

As I said, Barry, in my prepared remarks, the opening of additional offices and some further elements of our corporate growth initiative will add to headcount and will add to non-interest expense in the third and fourth quarters. But as I said in our last conference call, the majority of the heavy lifting as far as the more highly compensated individuals that we will be adding this year and the majority of the raises impacted and we're seeing in the first-quarter and thus in second-quarter results. So yes, we have got some pretty good headcounts to add as we open nine additional offices. There will be typically probably five on average and I'm sort of guessing at that number but approximately five additional people to add per office beyond what we've got now. And there will be some other additions to staff. So there will be some growth in non-interest expense, but we expect revenue growth as well.

How difficult is it --? I would single out northwest Arkansas because I know you're going to have some branches open there and that is a competitive market and just finding branch personnel is tough. Are you really having to pay up there? Is there any chance of that slowing down the initiative to find good people in northwest Arkansas?

Barry, it is always a challenge to find the right people, the best people, really good people in any market for any office. That is always a considerable effort. I have commented a couple of times in the past publicly and particularly in our conference calls that we have been very, very pleased with our team building ability in northwest Arkansas. We expected to be more difficult to attract talented personnel up there than it has been and I think we've assembled a good initial team. They are continuing to do a very good job.

Wage rates vary from market to market. We are in some very rural markets in Arkansas, towns of less than 1000 and some very metropolitan markets such as Metro Dallas and Charlotte, and then some more middle-sized markets such as Little Rock and northwest Arkansas. Wage rates vary from market to market and we factored that in our plans and projections. So I don't think that is an item that is going to affect the feasibility of our branches or make it particularly more difficult for us to get up and running and get those branches operating in northwest Arkansas. So your question was, do I see that posing some risk to execution of our plan? And at this time I would say no, I do not.

Okay, then just lastly and I'll let somebody else ask some questions, but probably the biggest surprise particularly given your very strong loan growth was that the provision was flat with the first quarter and by my calculation took your reserve ratio down to about 112 basis points. Can you comment a little bit on that and your comfort level there?

Certainly we are comfortable with the reserve. As you know, we use a formula methodology as the principal indicator of our reserve adequacy and one of the benchmarks by which for years we have managed that is that our unallocated reserve, which we maintain, is maintained at somewhere between 15% and 25% of our total reserve. When we calculated that at March 31 and it will take some time to actually have a June 30 calculation, but at March 31 we were about 24.8%. So we were bumping against the top end of what we feel is an appropriate unallocated level and what our auditors feel is an appropriate unallocated level. We are certainly within that range, so we are very comfortable with that.

You know, I have commented a couple of times in previous calls that our loan loss experience in recent years has been very favorable and that was certainly continued in the last quarter for example in 2004, our charge-offs were 10 basis points; in 2005, our charge-offs were 11 basis points; year-to-date, I think the two quarters have been 10 and a 9 basis point and I think that actually rounded down to a 9 for the year-to-date, didn't it, Paul? So our charge-off experience the last 2.5 years has been particularly favorable and has been even very favorable to industry if you go back five or seven years.

So we are very comfortable with that reserve, feel that it is appropriate and obviously if we continue over time to maintain charge-offs level as we have maintained particularly in the last 2.5 years in that 10 basis point range, it would be impossible in the long-term to justify reserve at the current level if we have that kind of loss history going forward.

Okay, George. Thanks a lot. That's very helpful.

Thank you. Barry, also you wrote something this month that I want to comment on and it was regarding the departure of our northwest division president. We did have a change in guard there and I want to comment on that. Doug Parker, who had been the foundational guy in our northwest division left. He left to pursue a very lucrative offer outside the banking industry that involved him being the CFO of a company and having an ownership position in that company. He did not go to a competitor bank. Doug was a great leader for us in northwest Arkansas, but we are very fortunate to have had Shannon White there who was a designated successor in our management succession plan and had been one of I think perhaps Doug's first hire there and had really helped Doug build our team there.

So while any company that loses a guy like Doug Parker loses something and there is not enough good employees in the world for any company, we certainly had an excellent person step up in his place and Doug's departure did not I think in any way reflect adversely on his assessment of our prospects in northwest Arkansas, but simply reflected the fact that he had a very, very good opportunity that he felt he needed to pursue outside the banking industry.

So I know there has been some question would Doug's departure slow the progress, development, or prospects of our northwest Arkansas offices? We certainly do not feel so because we have got tremendous confidence in Shannon White being able to step in and lead that division and he is our designated permanent replacement for that division. So I did want to clarify that and comment on that a little bit while we're on the phone today.

Charles Ernst, Sandler O'Neill Assets.

A couple of questions for you. George, can you talk about the muni portfolio? I saw that it was down in the quarter and I guess down maybe a little bit more than I would have guessed. So what is driving that trend? Are you still looking around to add some or has the market moved away from you? Just add some color there that would be great.

I would assume when you say it was down it is on an average basis and as you know and as we reported, we sold quite a few municipal bonds in the first quarter and on an average basis that lowered the balance in that portfolio. We talked at length in the last call about our strategies for those sales. We are looking to add municipal bonds to the portfolio when appropriate opportunities present themselves and appropriate pricing occurs. With this very flat yield curve, we are less excited about some investment opportunities than we certainly would be if the curve were steeper and these things had a little higher coupon on them.

But that change in average balances is really a result of the activity that occurred in the first quarter which was thoroughly discussed in the last call. We did actually add a few selected munis that we found in the second quarter and expect to continue to do so in the third quarter.

Okay. And do you all happen to have the detail behind the monthly margin trends? So that we --

Yes, I do. Not absolutely my hand but close by, so I can give you that. Here we go. The margin in April was 365. The margin in May was 357. The margin in June was 362.

Okay. Then in terms of capital, your tangible capital looks like it fell below 6%. Where do you start to get a little less comfortable with your tangible capital ratio?

Well, when we calculate tangible capital for purposes of determining in our comfort level, Charlie, we throw out the mark-to-market adjustment on available for sale securities because in our view that is a temporary thing. And in my personal view it is a screwball thing because I realize it is GAAP accounting but your marking to market one piece of your balance sheet and ignoring all the rest, and we do like the regulators. We throw that out as far as calculating capital.

So our stated policy has been and will continue to be to operate with a tangible common equity excluding any effects of the mark-to-market adjustment between 6% and 7.5% of assets. We are within that -- we are about 6.60 something now -- 6.50, 6.60 something range now if you throw out the mark-to-market adjustment. So we are pretty much in the center portion of our target range there and quite comfortable with that.

Do you have the dollar amount handy of the mark?

Yes, I do. The mark-to-market adjustment is $16.832 million. (multiple speakers)

Is there anything else in kind of the fee lines that are gain related or anything like that? I mean other fees look like they are up about $100,000. Is there anything like that or is it pretty clean on that side?

It is pretty clean on that side. I can give you a little color on those other fee items if I can put my hands on it. I thought you might ask that, Charlie. I actually brought that into the meeting. Okay, here I have got. What that other fee item line consists of is just various sorts of commissions and fees we earn, securities, sales, gains from -- we've got a little broker/dealer affiliate that is in our offices. It is a third-party provider and we benefit from their commission income. Safety-deposit box rentals, and just a variety of miscellaneous items are in there and that number tends to move around a little bit. But there was nothing of particular consequence. I think it was just kind of the normal ebb and flow of those numbers.

Okay. Then on the salary side, are you all accruing full bonuses right now?

We have not hit our bonus targets in either the first or second quarter, so we are not accruing anything under what we would describe as our sort of general cash bonus program.

Okay and then last question I promise is on the deposit side. Do you think that we will continue to see similar repricing adjustments assuming the Fed keeps going? How are you feeling about that right now? In terms of the move up in deposit costs?

Obviously, Charlie, if the Fed keeps moving the Fed funds target rate up, I think certainly that is going to continue to escalate deposit costs and it will also give us some escalation in the asset yields as well. Perhaps the stress and strain on the industry of that will lead to a little more rational pricing or a little more favorable pricing -- rational may not be the right word -- favorable pricing of certain loan and deposit products. But yes, if the Fed continues to move rates, no doubt deposit costs will continue to go up.

If the Fed does not continue to move rates and we are sort of in the camp now that we think they're probably one more sometime in the next quarter and done for awhile. And assuming that scenario, deposit costs will continue to go up just because CDs will roll over that have not already been repriced at current rates and you'll pick up additional incremental cost on those. But we would expect that escalation in deposit costs to slow.

Of course the flip side of that is we have also got fixed-rate loans that roll over and if the Fed moves again, variable rate loans that will move and those should price up also as well. We have got principle cash flow from our securities portfolio that will reprice. So hopefully we can keep earning assets moving up in yields close to if not in tandem with any further Fed increases and continued escalation in cost of funds. We are expecting a little more margin pressure, but I think we're going to reach a point here where that margin story is going to stabilize and then I think there will be happier days ahead in some quarters in the future, although I don't think we are there yet.

Okay, great. Thanks a lot, you guys.

Andy Stapp, Cohen Brothers.

You just implied if I understood you correct that the margin pressure should be less severe in the second half of the year and just curious what your thoughts are in that regard?

Well, again our thought in that regard is probably that we think the Fed is going to take some pauses in here. We certainly think that the Fed should take some pauses in here and that that will slow the rate of escalation of deposit costs. I think that will if the Fed does take that action I think it leads to a little more manageable situation as far as maintaining that margin. We do think that there is some further escalation of course that is just going to -- in deposit costs that will occur just as I said from CDs that were fixed-rate instruments that repriced before the last Fed or two or three or four Fed moves that will roll over and we will reprice at higher levels than those levels at which they were originated three, six, nine, 12, 15 months ago.

But if the Fed does slow the pace of its increases, that rate of acceleration and deposit costs should begin to taper off and that should let us begin to catch up on the earning assets side and hopefully at some point there we'll actually start gaining a little ground on it, but I think we are a ways from any positive margin [news].

Isn't it more the flat yield curve that's causing your compression rather than Fed increases?

Yes, I would say the flattening of the yield curve has certainly been a big contributor. As I commented in my prepared remarks, Andy, we think three primary reasons for the margin pressure. One is the flat yield curve. Two is very intense competition for loans and deposits. And it seems to us and I don't think this is limited to our markets, I think it is probably an industrywide or at least a very prevalent throughout the industry trend is as margins are getting pressed at a lot of institutions, the goal is to make it up on volume. And we have been very fortunate and been able to do that throughout the Fed timing cycle even as margins have pressed down a little bit. And then more severely this year, we have been able to make it up on volume and are forced into have a large and very proven loan originations capability to do that.

I think some of the banks that may not have that as much loan origination capability are using more pricing to achieve those volume growth metrics and as a result, they are pressing down traditional loan pricing models across the industry, and we are certainly seeing that and have seen that for sometime in our markets. I think it is not just a local phenomenon. I think it is to a great extent a national phenomenon that people are just pricing more aggressively. And the combination of the flat yield curve and loans tend to be priced more off longer-term sectors of the curve and deposits tend to be priced more off short-term sectors, so the flattening of the yield curve, the acceleration of compression as earnings hungry banks look for more volume to make up what they are losing on margin has led to a very tough pricing environment.

We knew that coming into the year and yet we made a decision to accelerate our aggressiveness on deposit pricing knowing that it would cost us some money, knowing that it would cost us some margin in an already challenging margin environment. But we did that very intentionally and with a great deal of thought because we believe that doing so in this market provides us an excellent opportunity and that decision was made based on where are competition is, the markets that we are entering, the opportunities we see in those markets, and we are very pleased with the results of that. I know the street may not be particularly pleased with our first and second quarter results, but we are very pleased with the results we are achieving and the plan that we are executing and we think it is going to have very favorable long-term results for us.

And as an example of that, I would point to the fact that in both the first and the second quarter, we opened over 3000 net new deposit accounts each quarter and that number is almost equal, in fact I think I haven't added it up but we are either right at and I believe we are slightly more net new deposit accounts in the first half of this year than we opened in all of last year.

Okay. When the Fed rate hike cycle comes to an end and we are still in a flat to inverted yield curve, do you think the margin pressure would be less severe than it has been in the first half of the year?

I think when the Fed tightening cycle (technical difficulty) end or when the Fed starts taking a pause, it will alleviate somewhat the pressure. I don't think we get better until we see a change in the shape of the curve particularly. But I think the end of the Fed tightening cycle will be helpful at this point.

Okay. Where did you stand at June 30 in terms of FTE employees?

We had 666 FTE employees. That was up 10 from 656 at March 31.

And you still expect to have approximately 779 by year-end?

I don't have that number handy and I actually think that 779 may be a total employee headcount. I don't think that's an FTE number and I apologize for that. Paul, that number we won't put a forward number in the Q will we? We can include that number in the Q if you would like to see it. So if you would, Paul, make a note and we will include that.

The excellent loan growth that you had during the quarter I presume you didn't have to sacrifice pricing to get that type of growth?

Well, if we had raised the price on it we probably wouldn't have had the growth, Andy. I will say that. We were comfortable with the pricing that we received on those loans. Obviously loan pricing is not as favorable as it was 12 months or 24 months ago for competitive reasons that I've already addressed. We are seeing loans priced more cheaply than they have been priced in the past and that has certainly been a factor. Those competitive conditions have certainly been a factor in our margin compression.

We would have liked to have seen better pricing on those loans, but I think the deals that we did we did on reasonable pricing and I would say that and then I will tell you there is one caveat to that and there was a loan that I personally priced and I mispriced it and I priced it the way too cheap, but other than that I think our lenders have done with the exception of that one loan I think our lenders have done excellent job in pricing, given the competitive conditions.

Okay, that's all for me. Thank you.

Scott Carmel, Philadelphia financial.

Most of my questions have already been answered. My only quick question is just can we quantify the magnitude of the margin compression going forward? In other words if I try and reprice your CDs close to 5% by the end of the year, it seems to be that the margin will probably going to end around 340. Is that a good guess?

Scott, I cannot quantify it for you. There are too many variables there for me to really be able to give you a number that I am comfortable publicly putting out. And in the past we have given guidance on general direction, but we have not ever tried to quantify the magnitude, so I'm sorry I'm going to have to leave that ball in your court.

Okay, thank you.

Brian Martin, Howe Barnes.

One question just pertaining to the loan growth. You guys have quantified by market or comments a little bit by market that it was good across most of the footprint, although it looks like the last two quarters the bulk of the growth has been in the construction and land development category. I guess I am wondering is that trend continue this quarter so if it sounds like there at least a handful of larger loans in there. And I guess can you just comment a little bit about the mix of that portfolio, how it has grown since maybe two years ago when it was in the 21% range versus 29-ish now?

I'd be happy to, Brian. In my presentation that I have shown in recent years either in the front part of presentation or in the supplemental slides, I've shown a slide that compares the breakdown of our loan portfolio with the most recent quarter end compared to December of 1997 and that is going back away, but if you look over the history of our Company going back December 1997 was sort of the pinnacle of our Company as a primarily rural franchise. And subsequent to that, we entered Little Rock, North Little Rock, Port Smith and have now of course entered the Charlotte market and the Dallas market and northwest Arkansas.

And as we are entering these faster growing markets where there is a lot of population growth, a lot of job creation, enhance a lot of housing construction, lot development and commercial construction, better demographic markets on the whole certainly than the earlier markets that we ran. There has been a lot more construction loan opportunities, a lot more commercial real estate opportunities, a lot more development loan opportunities. Over the years those portions of our portfolio have outpaced other portions of our portfolio. We have had growth in single-family and multi-family and consumer and so forth, but those portions have grown much more rapidly than other parts of the portfolio every year. And what you have seen in the last couple of quarters is just a continuation of a trend that has been ongoing for quite some time in our portfolio.

I know there's a lot of focus on construction and development lending and a lot of focus on commercial real estate lending now and I will tell you I am not scared of those sectors per se because we are being very cautious and being very careful in what we do. I believe that we are good underwriters of those loans, that we are good originators and servicers of those loans, that we have a very good portfolio of borrowers and a very good portfolio of projects. We are -- that part of our portfolio I expect to continue to grow. We are not pulling away from construction development or commercial real estate lending because the markets that we are in are generally healthy in that regard and we feel doing a good job picking the right borrowers and the right transactions, structuring those with proper equity and secondary and primary sources of repayment and that the credit quality is good there.

So I guess for this quarter -- I guess ultimately what I'm getting at is do you have a stated level that you won't let the construction go beyond or what you're comfortable with letting that portfolio grow to? I guess going back to just this quarter, did that same trend as far as I think it was almost all of the growth from the third quarter to fourth quarter was construction and land development and then it looked like in the first quarter maybe 85% of it was that. Is it to that extreme this quarter or is it more diversified? Just I guess kind of that percentage relative to the total if you could give us a little color on what you're comfortable with.

Well we had $130 million of growth in the second quarter and $41 million of that was construction and development. So that is less than one-third of it. And that caused our construction and development lending to rise from 28.9% of our portfolio at March 31 just 0.2% to 29.1% as of June 30. So I am not alarmed or concerned at all by that trend in the quarter, so I don't see that as being a problem.

Now I will tell you longer-term as we look out and in our ten-year planning process and we do quite a bit of planning based on a ten-year process and we understand clearly that given the markets that we are in if we're going to achieve high teens to mid-20s loan growth over a ten-year period of time on a compounded annual basis, that it is going to require diversification of that portfolio to include other things and we are taking actions to do that. For example we have a very strong leasing unit that right now just has about $50 million in outstandings but we've taken that very slow. We have had only one charge-off loan in over three years. They typically have zero past dues. It is a high-quality leasing operation. Actually we may be the only bank in the world that has a better performance metrics on our lease portfolio than we do on our loan portfolio, which itself has high performance metrics.

But we look for leasing to become -- based on this platform we have built and tested and perfected, we look for it to become a more significant contributor to growth in the future. Our Dallas market guys, actually our Frisco Metro Dallas market guys are focusing their efforts while our Dallas office per se is focused primarily on commercial and development real estate lending and construction. Our Frisco office is focusing primarily on C&I and P&E lending and we expect some significant growth in that category from that office.

So we understand that we do have a high level of commercial real estate and a high level of construction and development as of June 30. They comprised 56.7% of our portfolio. We are quite comfortable with that. We are good at that. We have got an excellent customer base in that we're not going to run away from that, but at the same time that we continue to grow that, we really want to push up our C&I, P&E lending and the leasing part, lease financing part of our portfolio, which we think will help us diversify that and will help us accomplish our ten-year growth plan.

Okay, that's helpful. Thanks. I guess just two last questions. The fixed-rate versus variable-rate loans in the quarter, can you just comment on what those are?

Yes, I can. 44.1% of our portfolio was variable rate at June 30, and that is actually down. I think it is the first quarter in a while it has been down from 44.6% at March 31. And of that 44%, 666 basis points of it had hit their cap rate because when we really started pushing fixed-rate loans, a lot of those had 200 and 300 basis point cap rates and with 425 basis points and Fed increases, some of those had begun to hit their cap rate. And only 48 basis points of that were at their floor rate.

If you look at the total portfolio fixed and variable and look at principal repricing in one year, that was pretty much unchanged compared to the first quarter at 63.5% and in two years 75.4% of the portfolio, loan portfolio were repriced. And in three years 87.4% of the loan portfolio were repriced. So those percentages were actually down a fraction of a percent each from the prior quarter and obviously as rates have risen, we have had customers desiring a little more protection on the upside from rate increases. So demand for fixed-rate loans has been a little bit more intense than in the past. And given where we think we are in the rates cycle, we are not -- our preference is certainly still to generate variable-rate loans, but we are not finding it as hard as we might have thought 12 or 24 months ago on doing some fixed-rate financing here if it is absolutely necessary to keep a piece of business.

Okay, last question I promise here. In the quarter the other borrowings line was up, at least the period end balances were up pretty significantly which I think is a different story than the average balances which were essentially unchanged. Just wondering if you can comment on what transpired there, just kind of the timing of things and I'll hang up and listen.

I think the reason for the variation between the average for the quarter and the end of quarter results is probably reflective of a couple of things. Let me give you some color on our loan growth during the quarter. We had about $60 million plus of loan growth in April. We only had a few million of loan growth in May and then we had another $60 million plus of loan growth in June. Some of that June loan growth came somewhat late. And I think our investment securities portfolio, I think we had some purchases very late, right at the end of June and I am not sure of that and that is probably not a big number any way. So it is probably due to the timing of the loan growth, which June was a very, very significant loan growth month.

Okay, thanks a much.

Peyton Green, FTN Midwest Securities.

Just to try and give a little bit more balance to where you think you are from a margin perspective, when we look back historically this is about as low as the margin has been since I guess 1999 or on the way down and then probably 2Q '01 on the way up. How do you feel that the balance sheet is going to act differently or are the customers and competitors acting differently now than in that rate cycle when we had more of a flat to inverted curve and had a little bit of deposit to center mediation coming back in or actually a lot of back then? I guess if you can just talk also conceptually on what you are willing to accept in managing the business over the long term versus pricing actions you'll take over the short term to grow the customer base? Thanks.

Gosh, Peyton, I am not sure I can answer any of that to your satisfaction and I am not trying to be evasive. Certainly as I suggested in my comments that 27% growth in loans and leases paralleled with a 7% growth in net interest income and it is certainly not reflective of the kind of results that we want to achieve or we expect to achieve in the long term. Again I would reiterate what I said that we have made a very conscious decision this year to be more aggressive on deposit pricing and we know that is costing us some in margin this year. I know that it would be a whole lot easier to do these calls if I wasn't pursuing that decision, but I don't get paid to make the calls easy. I get paid to run the Company in the best possible way for shareholders over the longer period of time.

So we are achieving things that we think we need to achieve this year to accomplish our three-, five- and ten-year goals for the Company. And I think we are doing the right thing. I think we're doing it very well. I realize that just from the tone of a couple of the items that have already been written this morning that I have read that maybe the sentiment about the second quarter is not as good in the eyes of analysts as it is in my eyes. I feel very good about our second quarter and in fact although we did not make as much money as we did in the first quarter, I thought our second-quarter results on the whole were much better than our first-quarter results. And feel like that they reflect positive accomplishment of the things that we are trying to accomplish and bode well for the future.

We have really taken 2006 and said this is going to be a platform building year. We are going to sacrifice a little bit of margin and we are going to sacrifice a little bit of our efficiency ratio and spend some money and build some customer bases and get some relationships that we could not get if we did not price more aggressively and do some franchise billing in a significant way to try to set ourselves up for good, favorable future results.

I would address in your question specifically and I am trying to -- having a better margin in the future is certainly a goal. We don't want to be at long-term at the margin levels at which we performed in the second quarter of this year. We are not happy with that level of margin and you observed it is the lowest level of margin we have had since I think you said 2001. I have not gone back and looked, but we certainly are doing what we are doing in the expectation that it is all going to play out in a way that leads to better earnings and hopefully also better margin in the future.

Okay, good enough. I guess do you get any sense that the competitive aspect is abating a little bit or is it still pretty intense?

I would like to get that sense, but I'm not seeing that, no.

Great. Thank you very much.

Dean Ungar, Neuberger Berman.

I just wanted to follow up on the question about the construction lending. The growth has been very strong. If it wasn't a huge piece in the second quarter, it was a big piece. But is that more because you're taking marketshare or has there just been a lot of land development and construction going on in your areas? Or is there any particular areas where it is going on more? I guess what do you think in general -- I know you said you are comfortable with it. How do you look at the risks with rates going up and how does that impact the potential risks in the construction portfolio?

Certainly escalation of rates and higher long-term borrowing costs do pose a risk to construction and development lending. If you are building houses for sale, the ability to qualify buyers for those houses and their appetite to buy them at higher mortgage rates is certainly diminished. If you are leasing commercial rental space or office space or other types of space and the long-term financing rates are higher, the rental rates have to be higher, which disqualifies some potential users of those facilities. So we clearly understand that higher interest rates and potentially a slower economy both pose some risk in that lending.

The markets in which we are primarily doing construction and development lending are primarily in the Metro Little Rock area and northwest Arkansas, Benton and Washington Counties, the Metro Dallas area and Metro Charlotte area. We have construction and development lending going on all the time at our smaller market and offices, but those four metro areas are the principal places that that is going on and the market conditions are healthy there. By and large we're not seeing significant dis-equilibrium between supply of lots and demand for lots, supply of houses and demand for houses. And absorption rates are generally continuing to be very good. We are not seeing any issues there.

I would comment about northwest Arkansas, Benton and Washington Counties, and that market is probably in some respects overbuilt. But in those two counties, the last data that I have seen is you have got about 1300 net new people per month moving into those two counties because they've got job creation in the hundreds of net new jobs per month in those counties. So it's an unusual situation.

In my 27 years in this job I have seen the bad markets and I have seen good markets and it is a rare thing to see a bad and good market all at the same time. What you have got there is an overbuilt market with rapidly growing demand. When you have that phenomenon you end up with an unusual situation. You have got transactions that are losers and transactions that our winners because there's so many people moving to the market and there's so much job creation up their that there is a robust demand for product. There is just more product out there than can sell and it is like a sideways stockmarket I guess or something like that where you have to be a good stock picker because everything is not going to go up or everything is not going to go down. You have to pick the winners and the losers.

And our team I think has the requisite skill set to be able to identify which projects have the right location and are at the right price points in the market and have the right quality of development and the right package of amenities to be successful and which are poorly done or mislocated or mispriced or don't have the amenities to be competitive. We are seeing some projects that are not our projects that have languished for a year or two up in that market and yet the projects that we are doing and have done so far have had excellent sales results.

So I think there are some risks in commercial real estate and development lending right now, but we feel very good about our borrowers. We feel very good about our projects. We feel very good about the markets we are in and at this point, we don't see any deterioration in portfolio quality as a result of a slowing economy or rising interest rates.

Okay, thank you very much.

There are no more further questions or comments at this time.

All right, thank you so much for all of you participating in our conference call today. If there are no further questions at this time, that concludes our call and we will look forward to talking with you next quarter. Thank you very much.

This concludes today's Bank of the Ozarks second-quarter earnings release conference call. You may now disconnect.