Bank Ozk (OZK) 2006 Q3 法說會逐字稿

Good morning and welcome to the Bank of the Ozarks' third-quarter earnings release. My name is Richard and I will be facilitating the audio portion of today's interactive broadcast. All lines have been placed on mute to prevent any background noise. (OPERATOR INSTRUCTIONS) This show also features streaming audio, which allows you to listen to the show through your PC speakers. (OPERATOR INSTRUCTIONS) At this time, I would like to turn the show over to Ms. Susan Blair. Please go ahead, ma'am.

Thank you. Good morning, I am Susan Blair, Executive Vice President in charge of Investor Relations for Bank of the Ozarks. The purpose of this call is to discuss the Company's third-quarter results and our outlook for upcoming quarters. Our goal is to make this call as useful as possible in understanding our recent operating results and future plans, prospects, goals, and expectations of Bank of the Ozarks.

To that end, we will make certain forward-looking statements about our plans, goals, expectations, and outlook for the future, including statements about economic, competitive, and interest rate conditions, our goals and expectations for revenue growth, net income, net interest margin, including the effects of the relatively flat to inverted yield curve and intense competition, net interest income, non-interest income, including service charge, mortgage lending, and trust income, gains on sales of investment securities, 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, replacing existing offices, chartering a new Oklahoma bank subsidiary, and converting loan production offices to banking offices, loan, lease and deposit growth, and changes in our securities portfolio.

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 published reports, 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. During the third quarter, we continued to successfully implement the deposit, branching, and corporate growth initiatives we discussed in our last two conference calls. While these three initiatives have resulted in higher interest and overhead expenses, we have pursued and continue to pursue these initiatives because we believe they are in the best long-term interest of our Company and shareholders. Even though these initiatives have reduced net income in the short term, we believe they will contribute to good balance sheet and income growth in the future.

Deposit growth is certainly one of the headline stories of the third quarter. During the quarter, deposits grew $190 million, giving us our best quarter ever of deposit growth. Over the last four quarters, deposits have grown 34.7%, well above our average long-term growth rate.

This exceptional deposit growth is attributable to our actions in three areas. First, you will recall that in late January of this year, 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. This initiative was in part intended to accelerate our growth in the number of deposit customers and deposit balances in existing markets.

Secondly, aspects of this deposit initiative were also intended to accelerate our growth in the number of deposit customers and deposit balances in the four new markets in which we are concentrating our expansion efforts in 2006.

In both existing and new markets, we have had success with our deposit initiative. During the first nine months of 2006, the growth in our number of deposit accounts was 179% of our growth in number of deposit accounts in the first nine months of 2005.

Third, in addition to these efforts to grow our local deposit base, we have also focused on growing and diversifying our other deposit and funding sources, including brokered deposits. This year, principally in the third quarter, we have added several new wholesale deposit customers and products both for CD and non-CD business. We believe these new deposit sources provide added depth to our funding capabilities.

During the third quarter, outstanding brokered CDs contributed $81.4 million of deposit growth. Growth in non-CD brokered deposits contributed $39.3 million to deposit growth.

As a result of this year's growth in diversification of deposit and other funding sources, we believe that we can be less offensively-minded in regard to deposit pricing in 2007. In fact, in recent weeks, we have already begun to make small reductions in our interest rates paid on some deposits and rates being offered on some new CDs. Also, we have recently seen a modest decrease in the cost of new brokered deposits.

One of our goals for 2007 is to utilize our many deposit and funding sources to achieve the best possible average cost of funds. We believe that doing this will allow us to slow the rate of increase in our average cost of funds in the coming months and achieve a stable cost of funds sometime in 2007. For the remainder of this year and in 2007, we expect deposit growth to average from the high teens to the mid-20s in percentage terms.

While we are on the liability side of the balance sheet, let me mention that on September 29 we issued an additional $20 million of adjustable-rate trust preferred securities at an interest rate of 90-day LIBOR plus 1.60%, adjustable quarterly. Our practice has been to issue additional trust preferred securities as growth in our equity permits us to include additional trust preferred securities in Tier 1 capital.

Approximately two-thirds of the securities just issued will count as Tier 1 capital, and the remainder will count as Tier 2 capital. The issuance of these securities will contribute to our maintaining a well-capitalized status for regulatory purposes.

Let's go to the other side of the balance sheet. Our ability to generate a good volume of quality loans and leases has been one of the hallmarks of our Company. Loans and leases have increased 19.9% over the last four quarters, although loan and lease growth was at a somewhat slower annualized growth rate of 10.6% in the quarter just ended.

We had a good volume of loan originations in the third quarter; but this was somewhat offset by loan payoffs and a lower usage by some builders and developers of credit due to slower housing market conditions. Of course, loan growth varies quite a bit from quarter-to-quarter, and it was not particularly surprising that our third-quarter loan growth was slower following our record second-quarter loan growth.

We expect continued good loan and lease growth in the remainder of this year and in 2007. We reiterate our guidance for such growth to average from the high teens to the mid-20s in percentage terms.

While we are discussing earning assets, let me also mention our securities portfolio, which continues to account for just under 30% of our total earning assets. Our securities portfolio has provided both a good source of earning assets and collateral necessary to secure our large volume of public funds deposits, which require collateralization of amounts in excess of FDIC insurance limits.

During the third quarter, we continued to add securities, principally early in the quarter. But later in the quarter, as the yield curve inversion steepened, we became a net seller of securities. In our opinion, the inverted yield curve between short-term and long-term rates later in the third quarter provided a better opportunity to sell securities than to purchase securities. We felt the bid conditions for some municipal bonds were particularly compelling. As a result, we realized $718,000 of security gains in the third quarter from the sale of $24.6 million of securities.

Our policy has been to maintain securities at approximately 25 to 30% of earning assets. We will continue to actively monitor our securities portfolio with a goal of finding relative value among the various investment products available from time to time. When we believe that available securities provide attractive spreads or favorable pricing, we will be a buyer; and when we believe it is more advantageous to sell particular securities, we will be a seller.

Given the recent inverted yield curve and the very low spread between securities yields and our marginal cost of funds, we do not see a compelling reason to buy many securities at this time.

That provides me an excellent segue to net interest margin. Obviously, we have been in a very tough margin environment all year. We attribute this primarily to three factors. The first two are external, being this year's relatively flat yield curve between short-term and long-term rates, which has recently become inverted, and the very challenging competitive environment for pricing both loans and deposits. The pricing environment for loans has become even more competitive as the yield curve has inverted.

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.

While 2006's margin environment has been far more challenging than we expected at the beginning of the year, we are becoming cautiously optimistic that this challenging margin environment will improve in time. We will not try to predict whether the Federal Reserve's next Fed funds rate change will be up or down. But it seems likely to us that we may be at or very near current interest rate levels for a while.

We're not excited about the flatter inverted yield curves that we have had in recent months, but we see the Fed's recent pause in interest rate increases as a step towards stabilizing our cost of funds. Let me explain what I mean.

Since the Fed has paused in its steady progression of interest rate increases, we have seen marginal cost of new and renewed CDs from both retail and wholesale sources stop increasing -- and actually decrease in some cases. Our average cost of funds will likely continue to go up for a while; but the rate of increase should slow.

While CDs originating six months or more in the past are still repricing at higher rates, they are not repricing at rates higher than the rates at which we put on new CDs in the last several months. Accordingly, we expect that our cost of funds will essentially stabilize sometime over the next couple of quarters, assuming the Federal Reserve does not resume its campaign of rate increases.

On the other side of the balance sheet, loan pricing has already become so challenging that it is hard for me to envision an even more competitive environment than exists today. It seems to us that many of our competitors have been pricing loans as if there were little or no credit risk. If some credit risk emerges in the industry, at some point we might see an industrywide move toward more favorable loan pricing.

Our best expectation on net interest margin is that we will see some further margin compression in the remainder of 2006; but that we will see net interest margin stabilize and hopefully begin to improve in 2007. Of course, any improvement will depend on stabilizing our cost of funds and achieving more favorable yields on earning assets. Of course, competitive conditions and Federal Reserve monetary policy, among other factors, may significantly affect our actual results.

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 continue to strive to more than offset further margin compression with growing earning assets and thereby hopefully achieve record net interest income in the coming quarters.

Let's turn our attention to non-interest income. Service charges on deposit accounts are our largest source of noninterest income. During the quarter just ended, although we have continued to grow our deposit base, service charges on deposit accounts actually decreased 1.2% from the third quarter of 2005.

For the first nine months of this year, income from service charges on deposit accounts was up a mere 1.5% from the first nine months of 2005.

Our 2006 service charge income results have been well below our expectations. The nationwide trend toward fewer checks may be affecting these results, and the higher interest rates are resulting in higher earnings credits for commercial customers on account analysis. Additionally, in recent years our growth has been primarily in our more urban markets with more favorable customer demographics. This may be impacting the growth of overdraft and insufficient fee income in proportion to our overall growth rate of the number of checking accounts.

We are reviewing this area and developing plans of action which are expected to help us achieve better growth in deposit account service charge income in 2007. Ultimately, continued growth in our number of non-CD accounts should also have a positive effect on deposit account service charge income.

Mortgage lending income is our second-largest source of non-interest income. Despite the fact that third-quarter mortgage lending income was our best so far this year, our results were still down 10.8% from the third quarter of last year. Mortgage lending income for the first nine months of 2006 was 4.2% below the level of the first nine months of last year.

Our goal this year has been to improve our mortgage lending income by gaining market share in existing markets and beginning to capture share in newer markets. We believe we have had some success in both those respects. But we have not been able to generate enough market share gains to fully offset the headwinds from a generally slower mortgage market.

We will continue to focus on gaining market share. Whether or not that will translate to increases in mortgage lending income will to a great extent depend on market conditions.

Trust is another important source of non-interest income. We have said for some time that this is an area of opportunity for us to grow non-interest income. We have an excellent trust team with a demonstrated ability to grow this business, as shown in the third quarter, when trust income increased 8.5% compared to the third quarter of last year. For the first nine months of 2006, trust income increased 13.5% compared to the first nine months of 2005.

Now let me make a few comments about expenses. Non-interest expense increased 14% in the quarter just ended compared to the third quarter of 2005. For the first nine months of 2006, non-interest expenses increased 13.8% compared to the first nine months of 2005. To a large extent, our higher non-interest expense growth in 2006 is attributable to our corporate growth and branching initiatives.

As previously discussed, our corporate growth initiative includes adding more production staff, such as loan officers, mortgage loan counselors, and private bankers at existing offices, 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. All of these actions are intended to build up staff to support growth plans for years to come.

Our branching initiative in 2006 includes our plan to open a record 11 new offices this year. We have already added seven offices so far in 2006, including four in the quarter just ended. In addition, during the quarter just ended we relocated our temporary Fayetteville office to a permanent facility and established a new loan production office in Tulsa, Oklahoma.

We expect to add four offices in the fourth quarter. These plans include two new offices in Bella Vista and another in Rogers, all in northwest Arkansas; and our first permanent Metro Dallas office in Frisco, Texas. In addition, during the fourth quarter, we expect to relocate the retail banking activities at our main Ozark, Arkansas, office to a new permanent facility.

During the fourth quarter, we also expect to file an application for a new Oklahoma bank subsidiary to be located in Tulsa. Assuming this application is approved, we expect to combine our Oklahoma loan production office, which we recently opened, with this new charter and engage in full-service banking operations in Oklahoma during 2007.

Because Oklahoma and North Carolina permit reciprocal interstate branching, we ultimately expect to use this new Oklahoma subsidiary to expand our North Carolina loan production office to a full-service banking operation, most likely during 2008.

Our corporate growth and branching initiatives have kept our non-interest expense growing throughout the first three quarters of 2006. We expect that growth to continue in the fourth quarter, considering the four new offices and office relocation planned for this quarter. During 2007, we expect to see growth in non-interest expense -- or at least our growth rate -- return to a more moderate level than in 2006.

We now expect to open approximately eight new offices in 2007, which is at the low side of our previously announced expectations for eight to 11 new offices. Assuming we add the four new offices that we expect to add in the fourth quarter of this year, 52% of all of our offices will have been opened in the last four years. With the substantial capacity of all these new offices, we believe we can accomplish our growth goals while opening only eight new offices this next year.

Suffice it to say that during the third 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 favorable 21 basis points as of September 30, 2006. Nonperforming assets as a percent of total assets were just 15 basis points.

Our ratio of loans and leases past due 30 days or more, including past due non-accrual loans and leases, was 60 basis points at September 30. Our annualized net charge-off ratio for the quarter just ended was a favorable 14 basis points.

In closing, let me reiterate that our third-quarter and year-to-date results reflect our substantial investment in our deposit, corporate growth, and branching initiatives. While these expenditures have diminished each quarter's earnings this year and will affect the fourth quarter of this year, we continue to believe that the long-term benefits from these efforts will far outweigh the short-term impact.

Our strategy for getting back on a record earnings pace is very simple. We believe that we will continue to achieve meaningful growth in earning assets, primarily loans and leases. We believe that in 2007 we will see our net interest margin stabilize and then hopefully begin to improve. In combination, these two factors, among others, should provide accelerating revenue growth.

Following our substantial investment in this year's initiatives, we expect that we will be less aggressive in deposit pricing in 2007; that we will add fewer offices than we have added in 2006; and that we will not need to make the same level of additions to corporate staff as in 2006.

If these things occur as expected, we should see a decelerating rate of expense growth. That is what we are seeking -- accelerating revenue growth combined with decelerating expense growth.

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

(OPERATOR INSTRUCTIONS) Andy Stapp, Cohen & Company.

First off, your growth in deposits obviously outpaced loan growth by a considerable margin. Could you provide some more insights as to your strategy here?

Yes. What we're trying to do is be very aggressive in our deposit growth both locally and in our new markets, and also diversify those sources of deposits. One of our goals in the long term is to develop a much more diverse and broad deposit and other funding sources base.

As you noticed, what we're doing with this growth in deposits that is outpacing our growth in earning assets is paying down our borrowings considerably, which really refills our borrowing capacity bucket with the Federal Home Loan; and that is a secondary source of borrowings to us. We would like to have that bucket used less and be less dependent on that, so that we have got a more robust form of secondary borrowing capacity there.

That bucket filled up, along with our Federal Reserve borrowing capacity, and our [Feds lines], lines of credit and other borrowing facilities we have, provide us considerable secondary sources of liquidity, which we want to keep in place.

We have also, in the third quarter particularly, established several new I guess what you would consider brokered or institutional deposit sources that we can access, both for brokered CDs and non-CD deposits. We did fund up a portion of those, as I mentioned in my prepared remarks. Some of those are more costly, slightly, than probably other marginal cost of funds such as Federal Home Loan Bank borrowings. We will work those more costly sources back down.

But we did want to establish those, develop those. We expect to use them at fairly minimal levels when they are not a cost-effective solution in the future. But to retain them as available secondary sources of liquidity.

We just think as our Company grows and expands, and our balance sheet becomes a little more complex, that we need a much broader and deeper repertoire of funding sources that we can go to both primarily and secondarily.

So that has been the big focus this year. It will continue to be somewhat of a focus in the fourth quarter, although probably less significantly than it has been in the first three quarters. Our focus, really, in that regard in the fourth quarter will continue to be strong emphasis on locally-generated deposits, including the new markets we're going into.

Okay. You had provided to us the amount of non-CD brokered deposits that you generated. I missed that. Could you --?

Yes, let me find that in my prepared remarks. The non-CD brokered deposits were $39.3 million. That is a new source of deposits to us, for us, in the quarter. So that is the growth number in the quarter and the total number that we have in that category, because these several -- I think there are actually four of them, three or four -- arrangements that we have established are new deposit sources for us.

On the CD brokered, what type of maturities did you gather?

Typically six to 12 months. We maintain a fairly staggered portfolio of those, that stagger out over the next four quarters.

Okay. The effective tax rate was a little bit lower than what I expected. Do you know what a good run rate might be going forward?

That number has bounced around a couple of percent this year. My best suggestion to you there would be to probably average the three quarters of this year. That is probably a pretty good proxy for the run rate on that.

Okay, great. Thank you.

David Bishop, Stifel Nicolaus.

A quick follow-up in terms of the brokered CDs. I think you said six to 12 months in terms of duration. What sort of rates are we talking about in terms of that bucket?

I guess in general, in terms of the remaining, just looking at your -- I guess the average balance sheets on the disclosure there -- in terms of the other time deposits there, within your markets, what sort of repricing potential in terms of, I guess, interest rate differential are we looking at there? In terms of current rates being paid in your market.

Well, David, I think -- and I'm not going to be exact in this; so understand that these comments are not precisely right. But I believe at the beginning of the quarter, the rates that we were seeing on brokered CDs were more in the 550, 560 type range for 12-month brokered CDs. That is an all-in cost for those.

As the quarter progressed, and so far this quarter, for six-months brokered CDs we are seeing all-in cost of around [5.25]; and for 12-month brokered CDs, all-in cost of about 530.

As I alluded to in my prepared remarks, we have seen over the last quarter the cost of those brokered CDs come down a little bit. That has favorable implications. Now, obviously, brokered CDs we issued six months or 12 months ago are still repricing as we replace those. The same is true for local deposits issued six to 12 months; they are still pricing up.

But because we are in an environment now where our CDs we are issuing the last two months were actually at a lower average cost for new and renewed CDs than the CDs we issued in July. So we are seeing a slight moderation and at least a stabilization in that escalation of new deposits.

So as we continue to roll the remaining CD portfolio that is repricing up to current rates, we don't see that -- at least at this point -- don't see that rate accelerating. So we get to a point where ultimately we have got ourselves up to a stabilized level.

We think we are not there yet, certainly won't be there in the fourth quarter. But that rate of increase in deposit costs should slow in the fourth quarter and should slow down significantly early in '07, and at some point in there stabilize.

But in terms of -- I think you alluded to you saw some, was it, paydowns that sort of masked strong origination growth.

We had excellent originations in the third quarter. We did have some unusual large paydowns, particularly in our Metro Dallas portfolio. In fact, the Metro Dallas portfolio as a percent of our total portfolio actually went down a couple of tenths of a percent in the third quarter, because we did have some pretty good paydowns down there.

Some of those were sales of property. I think we had one transaction that was refinanced. But there were some good sales that just occurred a little faster than we probably thought they would have.

The other thing that we have seen that has provided a little headwind is our builder and developer customers, and we have quite a few of those, are being, I think, appropriately cautious given slower housing market conditions.

Guys that hypothetically might have had 10 spec house loans going last year may have three or four or five going this year, just being more cautious about the market. Guys that might have done two or three lot developments last year might be doing one this year.

So we are seeing some of our existing customers borrowing quite a bit less, because they are just carrying a little bit less inventory of houses and lots that we think is appropriate. If they weren't coming to us and voluntarily slowing down, we may be having that conversation.

So we have been able to offset those headwinds by continuing to build new customer relationships, add new lenders. Of course entering these new markets is helping us to have new opportunities. So there are some headwinds to the deposit growth, but given our origination capabilities, the team we have, the new markets we are entering, we think we have still got the potential to achieve a high-teen to mid-20 sort of growth rate in loans over the coming year. Hence, we are reiterating that guidance level.

One final question, and I will hop off. I think in the past you provided some commentary about, I guess, the northwest Arkansas housing market. In terms of there are some pockets of weakness and strength. Maybe some supply versus demand inefficiencies or imbalances there. Can I [ask you] provide some commentary what's the outlook or if the environment has changed at all in that market?

There continue to be some indications of oversupply up there. Now, the most recent numbers that I have seen looked like there was approximately six months of housing inventory available in the market, based on the most recent data we have seen for household creation up there. There are a lot of people moving into the area. That continues, and we don't have any indication that has slowed.

There are a lot of jobs being created in the area. We don't have any indication that has slowed.

Normally, you would think of a six-month or so housing supply as pretty much in equilibrium. But there are some types of inventory, higher-end homes, that I think there's much more than six months of inventory. The lower-priced homes seem to be selling very briskly up there. So there are a few issues in that market; and there is a considerable overhang of lot inventory in that market, ahead of supply.

But again, that is a very positive market with population growth, strong demographics, job creation, so those things will work their way out. At this point, we're not seeing those issues as problematic for any of our customers in the market. Our customers are doing well. The projects we have are selling well. The houses that we have financed, we're not seeing any unusual aging of inventory or accumulation of inventory there.

So we continue to feel like our guys are doing a good job, picking viable projects and good customers in that market. And that is the key. Good projects are getting done, they're selling well. Projects that are not as well conceived or do not have quite the amenity (inaudible) so forth are laboring to get done.

Great, thank you.

Barry McCarver with Stephens Inc.

George, I wonder if you could -- just a little bit more color on, I guess, the loan side in terms of production. I wonder if you can give us kind of the number of paydowns, or the gross production in the quarter, just given that it was $41 million in net versus the $130 million in the second quarter.

I'm sorry, I don't have those gross numbers available to me. You know, I will tell you, obviously, we came off a record second quarter in which I think we generated $130 million in growth. I think somewhat our slower growth rate in the third quarter was just a result of the fact that we got lots of things closed and funded.

Our lenders did a lot of work on that stuff in the second quarter. Our customers did a lot of the things that they were doing in the second quarter. I think there was a little aggregation of that. I think that did provide a little bit of an impact on the third-quarter results.

But origination of new deals was good. We saw still good projects across the spectrum of our loan portfolio that looked good. Certainly, that level was not up to the second-quarter level, though.

Pipeline for 4Q looked pretty good?

I'm sorry, the pipeline?

Yes.

Yes, it does. We are, at this point, we feel pretty good about that. It is consistent. The pipeline that we see today is consistent with the high-teens to mid-20s annualized growth rate guidance we have given now. We have got to get them closed and funded, but the pipeline looks good at this point.

Speaking about the margin again, just real quickly, with such deposit growth this quarter, I know a lot of it was brokered money. Below the deposit ratio fell, I think, to about 78%. That is the lowest it has been in a while. I am a little surprised on your comments about the potential for another decline in the fourth quarter.

Are you focusing more on just what the market has given us with the yield curve or -- do you see what I'm saying? With such strong deposit growth this quarter, I would be surprised that you couldn't put a little bit more to work in the fourth quarter and might even see a little bit more stable margin.

Barry, I understand that, and that is probably something that could be achieved, but probably not something we are going to achieve. And I mentioned we are going to continue to be aggressive on the deposit front in our local markets and our new markets in the fourth quarter, even though we have ratcheted back a little bit on some products in some markets.

And the reason for that continued aggression is we have opened four offices this quarter, moved from temporary to a permanent office in a fifth. So I have got basically five new offices opened in the third quarter. I'm going to add four more in the fourth quarter.

And our typical strategy is to be pretty aggressive on deposit pricing in new offices to get those customers in there and get the flow of transactions and flow of volume in those offices going.

So, you know, yes, I think we could moderate our strategy and probably stabilize our deposit cost in Q4 if that had been our plan. But our plan is to continue to be aggressive because we think it is important to get these new offices off to a good start and generate a lot of activity in these new offices.

So we will continue to be aggressive in those offices through Q4, and since some of them are opening late in Q4, that will continue to play over into Q1 of next year. And if that doesn't contribute to me getting back on a record earnings pace by being aggressive, but I certainly think it is the right long-term decision for our company.

And we are very interested in short-term results, but we are even more interested in doing the right thing for the long-term.

In terms of the new offices, the 12th office you had targeted for '06, is that still going to be early '07, maybe January?

That office has actually slid into, I think, the second quarter of next year. That office has moved around, Barry. That's a hard question to answer because when we had 12 posted early in the year, that office was our second Frisco, Texas office which is, because of some approval problems with the city down there which we have now got all worked out is, I think, slated for 2Q of '07.

But when that fell out, we had also identified our staff member for Oklahoma, and our thought was that Oklahoma we would have our branch application filed soon enough and would be approved to actually have our first full-service Oklahoma office open in temporary quarters by the end of the year.

That application process is taking a little longer than we anticipated. We now expect to file it this quarter and have that functional in a temporary office as a temporary banking office as opposed to an LPO, probably in first quarter.

So, you know, there work two 12th offices this year, and one has slid to the first quarter and one has slid to the second, which is probably more than you wanted to know but the only way I can honestly, completely answer your question.

That's helpful. I didn't catch all of your comments about the new headquarters. Could you tell us when the expenses for that groundbreaking should fall in '07?

There should be no expenses related to our new headquarters building here in Little Rock in '07. That is an '08 project.

Okay. Then just lastly, George, I will let somebody else get on. Do you see anything maturing big in the fourth quarter on the loan side that might have some other runoff?

Barry, not at this point. I am not aware of any significant trends, unusual transactions. We have obviously tens of millions of dollars of runoff from the portfolio every month, and that is just -- but at this point in time, I don't see anything that would be out of the ordinary affecting that runoff level.

Let me clarify one comment I made about the headquarters building. Certainly, we will be under construction on that building in 2007, and thus we will have capital expenditures that will be capitalized in our FF&E account for that facility, and those will continue into 2008. But as far as things that go through the expense statement as an income or expense item, there won't be anything related to that building until 2008.

Okay. Thanks, George.

Charlie Ernst, Sandler O'Neill.

A couple questions for you, George, on the margin. I want to add a little bit of -- try to get a little bit more color in terms of your expectations. I am assuming you're not anticipating any more hikes. Then in 2007, are you anticipating any cuts?

Charlie, you know, I don't know the answer to that. You know, I read guys that think we are going up 100 basis points; and I read guys that think we're going down 100 basis points. I certainly can't add anything to that debate.

In our comments we said we don't know which way the Fed is going to go next. Our sense is, and it could be totally wrong, our sense is that we are probably going to be about where we are on the Fed funds rate for a while.

In terms of your margin guidance, though, I am assuming you have to make an assumption there. In thinking your margin would stabilize and maybe even improve out later on in the year, would that take cuts in order to see the improvement? Or do you think just as long as we kind of [stock] going up --?

My comments were predicated on the assumption that we're going to be pretty much where we are for the next several quarters.

Okay. Then, I guess the tailing off in the margin pressure, is that basically because the deposits you are putting on right now --? Your balance sheet costs, your deposit costs are moving up, and so the difference between the new funding you are putting on is less than it was maybe a couple quarters ago?

That is exactly right. The marginal cost of putting on CDs this month is actually a little less than the marginal cost -- or let me say the marginal cost of putting on new CDs in September was actually a little less than the marginal cost of putting on new CDs in July.

So we actually have seen a little bit of pullback there, as the market perception became -- gosh, the Fed may be through or is through, and we don't need to price any more increases in the CD pricing. So that has pulled back a little bit.

So as we continue to roll over things to current rates, the quantity that we are increasing them becomes less; and the volume that we are increasing becomes less. We think that that will lead to a stabilization of that cost of funds out here pretty quick.

Coincident with that, at some point in each market -- and ultimately, probably, in most of our markets -- we will pull back to a little less aggressive, little less offensive-minded position than we have maintained throughout this year. We have done that on selected products in selected markets, so far.

But we will do a little more of it, or expect to do a little more of that in the coming quarters, and that should also help to moderate that cost.

But you still have to deal with kind of the negative mix shift on the funding side. I would guess that is part of the compression assumption. Is that fair?

That is true. Certainly, we have got less non-CD deposits, because aggressive CD pricing by the whole market, it seems like -- not just us, but many, if not all other competitors -- has led to a cannibalization of non-CD deposits. Those non-CD deposits now comprise about 38.1% of our total deposits, which is considerably less than we would like that percentage to be.

So one of the focuses that we have got with our managers this next year is to really work hard to try to grow that non-CD deposit category. I am not sure we can improve the percentage, but we're going to try.

Right. George, just conceptually it seems like a lot of the growth has come from the sort of higher-cost, more wholesale-oriented areas. Why not just make a decision that you're going to slow asset growth instead of putting on these deposits that at the end of the day probably don't have a lot of value to the franchise over the longer run?

Well, certainly, the brokered deposit sources are not something that you would assign a core franchise value to. But the loan customer side that we are funding with those is a valuable part of our franchise, the relationships we are building there.

So we are going to continue to grow loans as quickly as we can, adhering to our traditional credit underwriting standards and minimum standards of profitability for those loans. We are going to continue to grow that part of our balance sheet as quickly as we can, because we think that is a valuable thing to do.

In terms of your Oklahoma initiative, maybe I missed it before; but is this something new? Is the big driver there the reciprocity laws with North Carolina? Or what is driving that?

Yes, yes, and yes to all the questions. It is something relatively new. We have had our loan production office in North Carolina for quite a while, and it is really blossoming and doing well. In fact, in the quarter just ended it went from providing 3.7% of our total loans to 4.8%. So it increased its percentage of our total loan portfolio 1.1% in the quarter just ended.

We want to get to full-service banking operations in North Carolina. I have got to have a charter there to do that. I cannot form a de novo charter under North Carolina laws. But because North Carolina is reciprocal with Oklahoma, and I can do a de novo charter in Oklahoma, then that provides me an opportunity to turn my North Carolina offices ultimately into full-service offices and grow that franchise.

We also like Oklahoma. Obviously, we would not have gone to Oklahoma if it wasn't someplace that fit our much term longer-term plan for Company growth. We have got an individual there that we believe is going to be an excellent leader for us in Oklahoma. We think that we can both do very good things in Oklahoma and use that charter as a vehicle to engage in full-service banking operations in North Carolina.

My last question is, can you give me the dollar amount of the construction loan book? I think in the second quarter I had it at $437 million.

Yes, you are correct. At June 30, it was $437 million. It is $449 million at September 30. It went from being 28.1% of the portfolio in end of Q2 to 28.2% at the end of Q3. So a little bit of growth there.

Great. Thanks a lot, you guys.

Chris Kelley, Commissum Capital.

You made reference earlier in the call that some of the pricing you're seeing on loans has gotten pretty excessive. Maybe those are my words or not yours. But can you give us any color where you see people making the biggest concessions, rate or term?

Then further, does that break down very cleanly among some product types? I.e., we really don't like residential construction anymore because people have gone crazy; or market specific, are there just some markets where you just cannot get these numbers to work any more.

So sort of any color there -- where you're seeing the most competitive pricing; and frankly what you still like and perceive as pretty good business for the bank.

Chris, the scope of our conference call does not allow me to adequately address that question. I think in the context of our conference call, what I what tell you is that the competition that we have seen over the last several quarters -- and I guess particularly the last couple of quarters -- has been surprisingly aggressive.

It has been very broad-based. We have had to adjust pricing on loans not just because of our typical small bank competitors and typical large regional bank competitors; but we have seen a very aggressive pricing from captive manufacturing finance companies, from finance arms of petroleum companies, and even large money center banks that affected our pricing on various deals and cost us a lot of money to keep business that we either already had or otherwise would have gotten.

So it is -- there seem to be more lenders out there, not just bank, but non-bank lenders, chasing more good deals than there really are. That has led to a very competitive environment.

I think, as I said in my prepared remarks, that part of the problem is the credit environment has been so benign for so long that I think a lot of guys are pricing loans as if there is no credit risk in them. That is just not true. There is always some risk.

Understood.

(multiple speakers) priced in. I think one of the ways that we get out of this pricing environment is that some of those credit risks begin to manifest themselves; and people say -- oh, gosh, look what I have gone. Why did I do that, that cheap, and take all that risk?

My analogy for that is insurance companies, when there is a hurricane, they do two things. They write less policies and they charge more for them.

Right, right.

I think a little storm in credit quality will have that effect on the loan business. So we are -- we think that storm will probably come someday nationwide, industrywide. What we are trying to do is adhere very diligently to the established credit principles that we have followed for a number of years.

Not sacrifice credit underwriting to achieve our growth, but we willing to give up some pricing to retain customers that we believe are important, valuable, long-term customers and we can still get a minimally satisfactory pricing on. So we are trying to be aggressive where -- as aggressive as we have to be within reason on price, without sacrificing sound credit principles.

Great, that's actually very helpful. I appreciate it.

Brian Martin, Howe Barnes.

Just a question on the non-CD deposits. That would be, linked-quarter they were relatively flat. Just hear you comment about maintaining that percentage and kind of growth expectations, what growth expectations do you have for that component of the portfolio? Since you have kind of talked about some of the other initiatives as you look to '07 at this point.

Well, Brian, I will be honest with you. We do not have a numeric target for that. We have, over the last several months, have been steadily escalating the dialogue about that part of our balance sheet and about the need to improve that part of our balance sheet with our division presidents and profit center managers. Trying to escalate the focus on deposits to a level equal to our traditional long-term focus on loans.

We will continue to escalate that dialogue. Our goal is to do the very, very best we can do in that regard. But as long as CD pricing is as high as it is, it is going to be very hard to achieve significant growth in those non-CD account categories. Because any time anybody accumulates significant money in one of those accounts, given the rate differential on CDs, there is a strong impetus to move that.

So it is an -- improving that mix in the short run is going to be very challenging. But we are focused on trying to at least garner every new account we can in that category and increase it however we can.

Honestly, as I said in my earlier comments, I think it is going to be very difficult to move that percentage up. It would probably be a pretty successful achievement if we could just maintain that percentage in tandem with the additional CD growth we expect. So it is a big project.

Okay. How about just your comment about maybe becoming a little bit less aggressive on the pricing next year? Just trying to understand that, in the sense that this year -- I guess you made the comment earlier that the new branches you put in place you would like to be a little bit more aggressive as you -- to get people in the door.

If you're not going to slow down the branch production all that much next year, I guess what does that say about your strategy as far as being --? Are you not going to be aggressive on the pricing with the new branches you look to next year? Or were you referring to being less aggressive somewhere else?

Well, the majority of the offices that we are opening next year are concentrated in a couple of markets. I think we will be able -- we have different pricing for different products in different markets. I think we will be able to companywide on an average basis be less aggressive, while still be appropriately aggressive in our markets that we have opened this year, particularly later in the year, and the new markets we are opening next year.

It is an office by office, market by market decision that our profit center managers or division presidents will have considerable control over that. But I think the general mindset is to be generally less aggressive. But we will still -- and always have done this -- been relatively more aggressive in the newer offices.

Okay. When you say less aggressive or more aggressive, can you just quantify that a bit? This year, what is more aggressive? Is it 25 basis points, is it 50? I guess in general terms, maybe looking on the CD side, since that seems like where there has been a lot of the growth (inaudible).

I would say that certainly is the range. Probably 25 to 50 basis points would be in our mindset the difference between a moderate strategy and a very aggressive strategy, would be in there someplace. So, yes, that is (multiple speakers).

Fair enough. Okay, how about the other side of the balance sheet. On the loan side, can you give any color as far as -- you talked a little bit about the North Carolina adds this quarter. The growth by state, can you give a little color there as far as the 60 that was added?

Yes, I can actually do that, yes. Our Texas -- and I can give it to you in percentage terms, and you can do the math if you want the dollars.

But our Texas office at September 30 accounted for 5.5% of total loans compared to 5.7% at June 30. Our North Carolina office accounted for 4.8% compared to 3.7% at June 30. Our Arkansas office accounted for 89.8% as opposed to 90.6%, which is kind of an interesting milestone. For the first time, Arkansas accounted for less than 90% of our loan portfolio.

I think all those offices had dollar growth, but the relative strong growth in our North Carolina office versus Texas and Arkansas resulted in a shift in those percentages.

So you know, I actually think that is a positive. I will tell you if we had a much higher percentage of our assets in Texas and North Carolina right now, our margin would be considerably better than it is. Because we are generally getting better yields, particularly in Texas. Texas is probably the best; North Carolina second; Arkansas is third. So I think our continued focus on growth and diversification in Texas and North Carolina is a positive, long-term plan for our Company.

Okay. How about two last questions? That was, going forward, is it difficult -- or maybe there is a reason you guys haven't done this in the past -- as far as giving a breakdown of the loan portfolio, like you do on the deposit side? Is that something that is difficult to include in the release that you guys put out? Or is there a reason you guys don't do that rather than --?

We provide a breakdown of the loan portfolio in the 10-Q.

Right, I guess just when the earnings come out, rather than asking questions about it, I guess it seems to open -- maybe give us a few more points of interest, if you guys can do that, if that is not a problem.

I am not sure that we -- you know, you have to draw the line someplace. We have a lot of information, and to -- by the 13th day of the month have a printed press release with several pages of schedule data to it, and prepare for the conference call, and hopefully prepare enough information to answer all of your questions, it's --. You know, you have to draw the line someplace.

With the quick filing dates on the Qs now, we would hope you would allow us to continue to just include that info in the Q. We have just got to draw the line somewhere on how much information we include with the press release.

Okay. How about the staff additions you talked about for the initiative this year? Outside of the branch personnel, which I know can flow based on how you guys are adding the branches, but as far as the support people, the HR type people, do you anticipate the number you gave earlier in the year -- that all of those people will be added in '06? Or will there be some spillover, because you haven't found people, that goes into '07?

We are down to a very few, and I am somewhat reluctant to give you a headcount on that. But I think as far as corporate additions go, we are down to like three or four people that are still (inaudible).

So, mostly be done this year?

Yes. Of course, as your loan portfolio grows you're always going to add one more loan guy. There are -- there will be ongoing additions. We won't go from a $2.5 billion to a $10 billion Company without adding a few more people along the way.

Right, I am just talking significant numbers. That was all I was trying to quantify.

The onetime really revamp of our staffing structure and all that is all in the '06 numbers. Will be in the '06 numbers, and I alluded to that. We expect to have significantly less additions next year in that kind of category than we have in '06.

Since you asked the question, our FTE headcount at 9/30 was 697. That compares to 666 at June 30. It was about midway, I think, to where we projected we would be at the end of the year when we were asked that number June 30. So I think we were projecting 720 something. That number is in the last Q. I don't have it at hand here.

But those staff additions in Q4 will be three or four, two, or three, or four more kind of corporate or production level people in existing offices; and the staff for these four new offices we're open that we didn't already have on hand at the end of the quarter.

Okay, I appreciate your time. Thanks, George.

Leo Harmon with Fiduciary Management.

Can you talk a little bit about liquidity at least as measured by loan or deposits, and how we should think about that going forward? It seems certainly that you guys have a lot of liquidity on the books currently. If I should think about loans growing slightly faster than deposits, or if I should think about loans and deposits growing in tandem -- where should I think about that liquidity level on a forward basis?

Well, our ideal corporate model is have a loan to deposit ratio of 85 to 95%. We have certainly pushed well below that 85% number somebody commented on earlier. Mr. Harmon, I don't know if it is reasonable to think we will get back within that guideline next year; or if that is a longer-term deal. But I think over time, whether it's '07 or '08 or '09, you will see us probably get back toward that or in that 85 to 95% loan to deposit ratio guideline.

You know, that would have favorable implications for our net interest margin if we -- as we do that.

I will comment; that brings to mind a further comment that I would make. We are sort of at the top of our securities portfolio guideline now, 25 to 30%. I think that there is a good possibility that you will see us in coming quarters let that securities percentage of earning assets move from 25 to 30% of earning assets; kind of the 30 side of that; down into the middle; and maybe over time even to the lower end of that range.

Part of the reason for that is the size of our securities portfolio, which is almost all fixed rate, is dictated to some degree by the rate sensitivity of our loan portfolio. We are having a strong demand for fixed rate loans now. A lot of customers who are doing projects say -- I can't afford to have rates go up a couple of hundred basis points, if they do; and I have got to have a fixed rate project or loan for a period in order to viably do my deal.

Because we think we are toward the end of a Fed timing cycle, we are fighting that less than we would have a year or two years ago. As a result, for the first time in a long time, in the third quarter our percent of variable rate loans fell from 44.1% of the portfolio to 43.1% of the portfolio.

If that trend continues and that number moves into the 42s or 41s level, we will -- to maintain the interest rate risk profile that we want to maintain as a Company, we will probably need to [walk down] the securities portfolio a little bit, just to balance that out in our simulation model.

So it wouldn't surprise me terribly if you didn't see the securities piece go down a little bit, which is one of the variables that could also lead us to get that loan to deposit ratio back a little higher. That would have a favorable implication for the margin.

Okay. Then how much flexibility do you have in reducing your other borrowings line on the liability side going forward, as well?

Well, you know, one of the things that is in the other borrowings, and I think it was at about a $50 million item at September 30, is our customer repurchase agreements. Our commercial customers who have large dollar deposits and want to sweep those into an interest-bearing deal, we use repurchase (inaudible). Paul, how much was it? It was $51 million.

That category of borrowings we would expect to continue to grow as we do more commercial loan business and have more commercial customers. So that category of borrowings is really not -- we don't really view it as borrowings. It is really the equivalent of deposits that have to be structured as borrowings to allow us to pay those customers a rate of interest and keep those funds in-house, as opposed to moving them out for the customers. So that is not -- .

And the rest of the borrowings are intermittently some Fed funds borrowings and typically FHLB advances. We have been reducing the FHLB advances and may continue to reduce that down a little bit. Because we like having all that big secondary borrowing capacity from the Federal Home Loan as a real liquidity safety net. We're trying to beef that safety net up.

Joe Fenech with Sandler O'Neill.

George, I have some, stepping back, some big-picture questions for you here. But first, in terms of what I am trying to get at, with you being less offensively-minded with respect to deposit pricing in '07; you're slowing the pace of expense growth; I'm just trying to quantify as best I can the earnings levers that you seem to have available to you in '07.

I understand conceptually what you're trying to do. But I am just trying to get a sense of some -- put some numbers behind that as best I can. So first on the margin, have you done an analysis of what the expansion has cost you in terms of the margin this year?

In other words, your margin is down 68 basis points from the fourth quarter. I'm just trying to get a sense of what it might have been, excluding the deposit initiative and the aggressiveness you showed in some of your newer markets. You obviously would have seen some margin compression with what we have seen from the yield curve. But can you parse that out for us as best you can?

Joe, I am sorry. I cannot intelligently respond to that and give you meaningful data. I apologize for that.

Okay. How about same question on the expense side? With the 11 new branches, the incremental increase related to the corporate staffing initiative that you have. Can you break that out in dollar terms? I know you have broken it out in terms of the number of employees you have added. But in dollar terms? You [have a] dollar amount in operating costs related to the expansion this year?

Well, I think a good way to -- a good piece of guidance I could give you on that is if you went back to '05 and looked at our non-interest expense growth in '05, and compared that to our noninterest expense growth in '06 --.

Difference there?

The difference there is really a reflection of opening a few additional offices, and making some significant adjustments in compensation, and adding significant chunks of new people to the corporate team. You know, our goal is to move that expense growth number back much closer to the growth rate of expense that we saw in '05 than the growth rate of expense we saw in '06.

Okay, so growth rate in '07 relatively similar to what we saw in '05?

And I will tell you we have not completed the '07 budget; but I can tell you conceptually that is where we are hoping and trying to get to.

Now, we are in the budget process and the staffing process. All that is going to be coming together over the next two months. But we have a pretty good sense and a pretty good direction that what we're trying to do is get that overhead expense growth rate sharply lower versus the '06 percentage growth rate, and back down toward the fairly benign growth rate that we had in '05.

Okay. Then I guess just back to the margin question, I know it is difficult to estimate. But from a big picture, if you just get it in the ballpark, is it two-thirds of the margin compression, maybe one-third, is it half? In those -- can you take a stab at it from just a ballpark perspective?

Joe, I will tell you this. I think, by far the worst quarterly numbers are behind us. I think we have some more margin compression in the fourth quarter. We are hopeful that will be at a more moderate impact. We are hopeful that we can get out there in '07 and that the stabilization of that margin will curve sooner rather than later in '07, and we can begin to see some positive movement in that margin.

You know, the keys to our revenue growth, which has just been -- with the margin pressure we have had this year and all the initiatives we have had, we have had a hard time getting a lot of revenue growth this year.

The key certainly is to keep growing earning assets, which I am reasonably confident we can do. Stabilize and hopefully started improving that margin. And begin to get some lift from some of these fee categories, in addition to trust which has given us a little positive momentum this year. We have got to get that out of service charge. We are looking at that, and we have several planning -- several initiatives we have planned there that we think will help us in regard to that as 2007 progresses.

In addition to the push that we ought to get from just the continued growth in our number of new accounts. So we think we will get some revenue lift there as well.

Who knows? I wouldn't even venture a guess on what to tell you about mortgage, because it is so dependent on housing market conditions. Who knows what is going to happen there?

But we also realize that we have got to really slow that expense growth next year, so that is a big focus.

Okay, thanks.

Peyton Green with FTN Midwest Securities.

A couple of questions. Watch list trend. How has that been over the past quarter? I guess is there any deterioration in the watch list that might give you hope that maybe a credit spread comes back in?

I think the numbers on nonperforming loans and so forth and past dues and so forth are pretty indicative of our asset quality. We are not seeing any significant erosion. You know, obviously the NPL, NPA, and past due ratios were all a little higher than they were at June 30. But the June 30 ratios for nonperforming loans and nonperforming assets I think tied our record low ratios for those numbers.

If you look back at the supplemental breakdown at the back of the press release, you know, we give those numbers for the current quarters. Those numbers are pretty much in the middle. There are higher numbers and lower numbers over the preceding seven quarters for each of those numbers.

So our sense is, at this point, that asset quality is stable. We are not seeing anything at this point that would indicate a material change in the loss profile of our portfolio. Now, obviously, there are a lot of dynamics going on in the economy; and I don't know that we can accurately predict and foresee all of those things. But at this point in time, we're continuing to feel pretty positive about the asset quality side.

Okay, so it sounds like from the interest rate risk modeling that you would have done nine months or a year ago, the real breakdown has been on how your variable rate loans repriced. Or I guess in effect, they didn't reprice. Because it sounds like captives and others have been, I guess, eliminating the credit spread from how you would have underwritten the loan or repriced the loan, just on a normal renewal. Is that fair to say?

I would disagree with that a little bit. Let me tell you the way I see that. Number one is, our cost of funds behaved about like we thought they would, given the Fed's interest rate increases and our deposit strategy.

Number two, our variable rate loans repriced just in accordance with their contracts. But you know, in addition to our variable rate loans, we have lots of loans that roll over, lots of fixed-rate loans that mature every year, and lots of new loan originations.

What we saw is a loan that might have been made when rates were 200 basis points lower came due; and you would expect to get 200 basis points of lift in that loan; and competitive conditions just did not allow us to do that. Maybe on average we got 100 basis points of lift.

You know, I mentioned competition from a large vendor finance arm, and competition from a finance arm of a large petroleum company. We have had non-bank competitors as well as bank competitors trying to come in and steal some of our customers by offering them what we thought was below-market financing rates. We either had to match that or get close to it or lose the customer.

We have had an unusually large amount of that sort of thing to deal with this year. It has just provided considerable headwind. So what we didn't calculate and anticipate was that so many of the loans that we had on the books that weren't maturing, we would have to reprice because of very aggressive competitive conditions, and that we wouldn't get the lift on rates on a lot of loans that were maturing -- that we would think we would get given the relative movement in all other rate indexes.

So the competition for loans has been what is -- we started the year knowing that our margin was going to go down, or thinking it was. And we gave guidance to that effect. But we got almost as much margin compression in Q1 as we expected for the whole year; not quite, but almost. The rest of it has really resulted from inability to get what we think is appropriate pricing on the loans.

But I think all of that will work out in time. Certainly, we would rather it work out sooner than later.

Sure. Then the last thing on the expense side, I don't remember you all paying a bonus accrual or taking a bonus accrual in '06 -- or in '05, rather. Has there been one in '06 to date?

There has not. We have a threshold of earnings that we have to make in order to pay our general cash bonuses. We did not make that in '05. We are vastly short of to our threshold for doing that in '06. So I can tell you that barring some sort of miracle in earnings of biblical proportion, we will not have a bonus in '06.

Okay. Is it an absolute situation? Or is it something where, because you have had two years that have reflected a lot of investment in the franchise, that the third year the expectations come in a little bit? Or how should we think about that for '07?

Well, let me -- I don't know that I can answer that without -- are you asking me about the bonus accrual?

Yes. No, I mean I guess my question is, is it geared off an ROE level that you're just not (multiple speakers)?

It is geared off a net income level.

Okay, okay.

Income level.

That is good enough.

We have certainly got -- for us to pay a bonus in '07 we have got to generate substantial improvement in our net income. If we can do that, I'm not going to do decline to quantify that, but if we generate substantial improvement in net income then we will be back on track to pay a bonus. If we don't we won't.

I think most of our shareholders, if we pay a bonus, they will be real glad we are paying a bonus.

No, I just was curious. Okay, thank you.

David Bishop with Stifel Nicolaus.

I just had a follow-up on credit quality. In the past, I think you have talked about your unallocated reserve percentage, I guess, was bumping up against your targeted threshold maximum there. Are we still bumping along near that ceiling?

You know, our policy is to maintain an unallocated reserve between 15 and 25% of the total reserve. The last -- we look at that, David, at the month prior to the end of the quarter to make sure we are on track with where we need to be. So as of August 31, which was the last date that all that has been compiled and reviewed, I think we were at about 20 -- between 20 and 21% unallocated. So we were slightly above the midpoint of that unallocated range for the unallocated reserve.

Okay, so that was down from I guess the second-quarter level, when I think you were 24-plus, right?

I think we were around 24%, if I recall. I don't have that number at hand, so I am going from memory and I could be wrong on that. But I think it was about 24%. Paul?

This is the lowest quarter it has been (multiple speakers).

One final question. I don't know if you have these numbers on hand. Regulatory ratios without doing the trust preferreds, maybe give us a sense of what they are with and without, in terms of bumping near the well-capitalized minimum?

I do not have those ratios at hand. I will tell you, I think we are -- our expectation is we are certainly well within the bounds of well-capitalized. So the June numbers are in the Q, and I don't think -- we are certainly well-capitalized. I am confident we are there.

Fair enough.

All right. Any other questions?

Dan Quirk with Seacliff Capital.

I had to hop off the call, so I apologize if I've missed it. But can you give a little color on the securities book? Specifically the high yields you have been able to maintain, and you have been adding to the securities portfolios despite the inverted yield environment.

Well, you know, Dan, yes, we have been adding. We have been keeping it within the 25 to 30% of earning asset guideline that we have. I think we were just below the 30% threshold.

I commented earlier that that number may tend over the next several quarters, next year or so, may tend to migrate down from the 30s to the middle or lower side of that range. I wouldn't be terribly surprised to see that, because we have had a slight downshift in the percentage of our loans that are variable-rate. To offset that in our simulation model, that typically means a lower percentage of securities or a shorter duration on those securities.

So you know, the shift toward a little bit more fixed-rate loan portfolio may drive that securities piece down. In our prepared remarks, we said that we will be opportunistic on the securities portfolio. We will buy when we think it's a good time to buy. We will sell when we think it's a good time to sell. We certainly thought it was a good time to sell at the -- right toward the end of the third quarter. We booked some nice securities gains and got a good boost there.

With the converted yield curve, it is hard to find things that look like they have great relative value here, which also suggests that that securities book may come down a piece.

What has contributed to high yields is -- to that securities portfolio is we have got a lot of munis, and we have got good yields on those; and we have got a CMO portfolio that has performed well and given us relatively high yields. We have taken some extension risk in that portfolio. I think we have been very well rewarded for doing so.

We feel like the securities portfolio is a part -- an important contributor to our earnings, as well as providing a necessary collateral pool to secure the public funds deposit customers.

Great, thank you. Those munis, are those mostly Arkansas munis, or are they nationally?

Mostly Arkansas. I think there is a considerable Texas component, as we are in Texas and we can use Texas munis to pledge as collateral to the Texas state treasurer. That is a large deposit customer of ours. There are some more nationally focused munis, but principally Arkansas and Texas.

Thank you.

Thank you.

Mr. Gleason, there are no further questions. Do you have any closing remarks?

All right, there being no further questions, let me thank you for joining the call. We look forward to talking to you in about 90 days. Thank you very much. Have a good day. That concludes our call.

That concludes today's Bank of the Ozarks' third-quarter earnings release. You may now disconnect.