Bank Ozk (OZK) 2007 Q1 法說會逐字稿

Good morning. My name is Felicia, and I will be your conference operator today. At this time I would like to welcome everyone to the Bank of the Ozarks first 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). I would now like to turn the conference over to Susan Blair, Executive Vice President.

Thank you. Good morning. The purpose of this call is to discuss the Company's results for the first quarter of 2007 (technical difficulty) and our outlook for upcoming quarters. Our goal is to make the call as useful as possible in understanding our recent operating results and future plans, prospects, goals and expectations. 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, revenue growth including our goal of accelerating our rate of revenue growth in 2007 as compared to 2006. Net income, net interest margin including the effects of the relatively flat inverted yield curve and intense competition and our goal of maintaining and possibly improving net interest margins from the level achieved in the first quarter of 2007.

Net interest income, non-interest income including service charge, mortgage lending and trust income, gains on sales of investment securities, non-interest expense including our goals of reducing marketing and customer relations expense to substantially offset the increased cost of FDIC insurance premiums, and decelerating our rate of growth in non-interest expense in 2007 as compared to 2006, our efficiency ratio, asset quality including recent changes in residential mortgage market conditions, 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, loans, 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 public reports. The forward-looking statements (technical difficulty) 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. Thank you for joining our call. During the quarter just ended we achieved record net interest income of $18.2 million. This record net interest income was a result of both growth in earning assets and improvement in our net interest margin compared to the fourth quarter of 2006. The first quarter's growth in average earning assets was $42 million. This was a result of $75 million in first quarter growth in the average balance of loans and leases which was partially offset by a $33 million reduction in the average balance of investment security.

Although our first quarter 2007 net interest margin of 3.35% declined 49 basis points compared to the first quarter of 2006, it improved 13 basis points compared to the fourth quarter of 2006. As I noted in the press release, this was our first quarter of improvement in net interest margin in the last 10 quarters. Obviously we were very pleased with this first quarter net interest margin improvement, and recent conference calls I have stated our belief that our average interest rate on deposits was approaching its peak and that the rate of increase in our average interest rate on deposits was slowing. We now believe that our deposit cost peaked (technical difficulty) in March and, assuming the Fed funds target rate remains unchanged, we expect that our average deposit rate may decline a few basis points over the next couple of quarters. Of course unless we see the FOMC lower the Fed funds target rate, it is unlikely we will see a more significant decline in deposit cost. But even a few basis points of reduction in our average deposit rate would be helpful.

At the same time, our loan and lease portfolio, which has repriced somewhat more slowly than deposits over the last couple of years, is expected to provide opportunities for further slight improvement in earning asset yields. Given current competitive and yield curve conditions we have a relatively modest expectation for our ability to improve earning asset yields, but we do believe some modest improvement can be achieved as the repricing cycle of our loan and leased portfolio gradually catches up with the deposit repricing that has already occurred. Thus, we are cautiously optimistic that over the remainder of 2007 we can improve somewhat on our first quarter 2007 net interest margin.

In our last conference call I reiterated our goal of growing loans and leases from the high teens to the mid-20s in percentage terms in 2006. From December 31, 2006 year-end through March 31, 2007 our loans and leases grew $46 million or 11% annualized. During the nine full years that we have been a public company our first quarter loan and lease growth has averaged only 15% of our annual loan and lease growth. So our slower growth during the first quarter of 2007 was not unusual.

Over the last four quarters from March 31, 2006 to March 31, 2007 our loans and leases have increased 21% in the middle of our high teens to mid-20s percentage guidance range. Based on these results and our expectations for economic conditions, including generally slower real estate and housing market conditions, we are adjusting our guidance for 2007 growth in loans and leases to a mid teens to low 20s percentage range. Now we are still striving to achieve that mid-20s percentage growth goal, but we acknowledge that it will be a challenge to achieve that higher level of loan and lease growth given current economic and competitive conditions.

You may have noted that our securities portfolio was reduced $30 million from December 31, 2006 to March 31, 2007 as our volume of principle paydowns and sales of securities exceeded our volume of new purchases. In recent conference calls I suggested that we would be a seller of securities when we believe market conditions were conducive to selling securities and a buyer of securities when we believe market conditions were appropriate for buying. At times during the first quarter generally when the ten-year Treasury note was trading at or near 4.50% we felt that it was more appropriate to be a seller than a buyer of investment securities. You can see the results in the reduced size of our securities portfolio during the quarter just ended. We will continue to manage the securities portfolio with the same mindset, and you should not be surprised to see us purchase our sales securities based on our ongoing assessment of market conditions.

During the quarter just ended we achieved deposit growth of $125 million. Despite the fact that we were less aggressive in deposit pricing and advertising than during the major deposit initiative of 2006. Over the last four quarters from March 31, 2006 to March 31, 2007 our deposits grew 24.9% at the top end of our previous high teens to mid-20s percentage guidance range. Because of the significant deposit growth achieved in 2006 and in the first quarter of 2007 we found ourselves in an unusual position on the last day of the quarter just ended. On that day for the first time in years we had no overnight federal home loan bank Fed funds borrowings. Now we expect to continue to routinely utilize federal home loan bank and Fed funds borrowings in the future. In fact, we were only out of our overnight borrowed position for that one day. With the absence of such borrowings as of the end of the first quarter underscores the considerable flexibility that we now have in managing the liabilities side of our balance sheet as a result of our 2006 deposit initiative.

Our deposit growth goal for the remainder of 2007 will simply be to grow deposit sufficiently to fund our growth and earning assets. Let me summarize our thoughts and goals about growth and margin for the remainder of 2007. If we can achieve good growth in earning assets, primarily loans and leases in the coming quarters, and if we can maintain or increase somewhat our net interest margin from the first quarter 2007 level, then we have the necessary ingredients to improve net interest income each quarter. We think these are realistic goals for the remaining quarters of 2007.

With that said let's switch subjects and talk about noninterest income. Income from deposit account service charges is traditionally our largest source of non-interest income, and we were very pleased with the record level of service charge income achieved in the quarter just ended. The first quarter has typically been our worst quarter of the year for deposit account service charge income. In fact, over the last five years on average the first quarter has produced only about 22% of our service charge income each year. The seasonality of this income makes us particularly pleased with our record first quarter result. We believe these results are due to several factors, including enhancements in our processes for applying and collecting service charges, the large increase in our number of deposit accounts from our 2006 deposit initiative and some small adjustments in our fee schedule.

Since our first quarter results have historically been below average for each year, we are optimistic that income from deposit account service charges will be even better in the remaining quarters of 2007. Despite slower housing market conditions our first quarter mortgage lending income was up 21.2% compared to the first quarter of 2006, although it was down slightly from the fourth quarter of 2006. Because of seasonal factors our mortgage lending income is often at or near its lowest level of the year during the first quarter. As a result, we were pleased with the first quarter results. Now we read the newspapers and listen to the news broadcast, and obviously the housing sector faces challenges. We have seen some slowdown in our markets, but apart from northwest Arkansas the impact of the slowdown in our other markets seems moderate so far.

I have said in the past that we can predict mortgage income accurately for about three weeks, so I am not going to make any bold predictions here either direction on that subject. However, I will point out that our branching and corporate growth initiatives last year included expanding our core of originators in existing markets and adding originators in some of our new markets. We invested in our mortgage lending team last year and we believe that investment contributed to good first quarter results this year. This team worked hard to produce good results in less than ideal conditions in the first quarter.

Trust income was up 7.4% in the first quarter this year compared to the first quarter of last year, a slowdown in new bond issuance in Arkansas and thus our acquisition of new corporate trust business restrained our first quarter trust income. However, during the first quarter we continue to see good growth in the personal trust and investment management business, and we expect growth in these areas to drive overall growth in our trust income in 2007 even if opportunities for new corporate trust business are limited by market conditions.

Non-interest income for the quarter just ended included $337,000 in securities gains and $35,000 in gains on sales of other assets. While these gains were a nice contributor to first quarter earnings, they were small in comparison to the $1,833,000 of such gains in last year's first quarter. During the first quarter of 2007 we sold a site previously acquired for a Jacksonville, Arkansas branch, the First Arkansas Bank and Trust and subsequently withdrew our contested branch application for this site. We recognized a gain of $17,000 on the sale of the site and $500,000 of other non-interest income related to the settlement of the contested branch application. Among other things, this settlement and payment reimbursed us for our expenses incurred in previous quarters related to such branch application and included an agreement by us to not pursue a future branch application in the present city limits of Jacksonville.

After being delayed over two years by litigation protesting the approval of our branch application, we believe that the timing of the Jacksonville opportunity is no longer optimal for us. We also believe we now have better opportunities in another market. Selling our branch site and concluding this matter allowed us to book some income, eliminate the cost and distraction of this litigation and refocus on better opportunities elsewhere.

Let's talk about non-interest expense. During 2006 we spend a lot of money on our branching and corporate growth initiatives. In our last conference call we noted that we would pursue a much slower pace of branch expansion in 2007 and that we did not need to duplicate in 2007 the same sort of corporate growth initiatives we pursued in 2006. We noted that this combination of adjustments in strategy should allow us to decelerate our growth rate of non-interest expense in 2007 as compared to 2006. The first quarter results certainly reflect that.

Now there are several ways to look at this, and the easiest is to note that our first quarter 2007 non-interest expense was actually below the level of non-interest expense in the fourth quarter of 2006. A more analytical approach is to note that in each quarter of 2006 non-interest expense increased at a double-digit rate compared to the comparable quarters of 2005 and for the full year of 2006 non-interest expense increased 16% compared to 2005. In the quarter just ended non-interest expense increased only 9% compared to the first quarter of 2006.

This deceleration and our rate of non-interest expense growth was very helpful in the first quarter, and our goal is to maintain non-interest expense growth in 2007 well below the 16% rate of growth in 2006. With that said, as a result of the FDIC resuming deposit insurance assessments on the banking industry, we will be paying FDIC insurance premiums in 2007 for the first time in many years. As previously disclosed these expenses will start in the second quarter after our credits for prior assessments are fully utilized. We expect these premiums will be approximately $210,000 in the second quarter, $310,000 in Q3 and $320,000 in Q4. Also as previously stated our goal is to substantially offset these cost reduction in marketing and public relations expense.

While we are talking about non-interest expense, let me also discuss our growth in de novo branching strategy. We opened no new offices in the first quarter of 2007. During the second quarter we expect to open a new office in Hot Springs in Garland County, Arkansas. Hot Springs is one of our 2006 expansion markets, and this will be our third office there. During the last half of this year we expect to add two new offices in northwest Arkansas and replace our original temporary office in Frisco, Texas with a new permanent facility. That will be our second office there, and that office will serve as our headquarters for our Metro Dallas expansion.

In addition, we may convert our Oklahoma loan production office to a temporary full-service banking office later in 2007. However, we have asked that our pending Oklahoma branch application be placed on hold temporarily while we reconsider plans for our leadership in Oklahoma. After the plethora of office additions in 2006 this is a modest list of new office openings for 2007. But given the fact that 52% of our banking offices have been opened in the previous four calendar years we believe we can maintain good growth rates while opening fewer offices in 2007 and 2008.

Now let me turn to asset quality, and I want to start with a hot topic which we think has little or no direct impact on us, and that is the recent turmoil in subprime mortgage market. First let me comment that we do not own any CMOs or other mortgage-backed securities which are backed by subprime mortgage assets. All of our mortgage-backed securities are AAA rated U.S. government agency securities.

Second, let me comment that we do not have any mortgage loan products targeting subprime borrowers for origination of mortgage loans for our portfolio. And third, let me add that we do originate a small volume of subprime mortgage loans for resale on the secondary market; we originated $1 million of such loans in 2005 and $12 million in 2006. Now we have binding commitments for the resale of such loans as they are originated, and in fact they are payable funded by the parties that are buying them, and we don't even fund them ourselves. And such loans are sold on a nonrecourse basis with servicing relief. Based on all these factors we believe that we have no direct credit exposure to the subprime mortgage market and changes in this business sector will have no material direct effect on our future financial result.

Of course, no one can predict with certainty if or to what extent problems in the subprime mortgage market will spill over and effect other sectors. Our first quarter of 2007 asset quality ratios in our judgment continue to be very good. Several of those ratios were somewhat higher than in recent quarters, but they are still at very acceptable levels. These increases probably reflect that 425 basis points of FOMC interest rate increases, higher energy prices, slower economic conditions in some sectors, among other factors have affected some borrowers with the exception of northwest Arkansas, economic conditions appear to be holding up relatively well in our market. In northwest Arkansas there has been a noticeable slowdown in lot and home sales but by no means a cessation of such activity. Northwest Arkansas continues to be a rapidly growing and economically vibrant market, but it is dealing with a significant oversupply of houses and residential lot at this time.

Our nonperforming loans and leases as a percent of total loans and leases were 25 basis points as of March 31, 2007, almost unchanged from 24 basis points at March 31, 2006 and actually down 9 basis points from 34 basis points as of December 31, 2006. A higher ratio of nonperforming loans and leases at year end, December 31, was primarily due to several credits secured by homes and lots in northwest Arkansas, which were placed on nonaccrual status during the fourth quarter of 2006. During the first quarter we made progress toward the ultimate resolution of these credits and several moved to the other real estate account and one house was sold and closed toward the end of the quarter. The movement of some of these credits from loans to other real estate was the primary reason for the 9 basis point decline in our nonperforming loan and lease ratio from year end to March 31.

Nonperforming assets at a% of total assets were 27 basis points as of March 31. That is up 10 basis points from a year ago and 3 basis points from year end. Our thirty-day past due ratio was 84 basis points at the end of the quarter just ended. That is up from 63 basis points a year ago and 60 basis points at year end 2006. Our annualized first quarter net charge-off ratio was 16 basis points compared to 10 basis points in last year's first quarter and 12 basis points for the full-year of 2006. This moderately higher net charge-off ratio although still favorable, was one of the factors that contributed to a higher provision to our allowance for loan and lease loss in the first quarter. As of March 31, 2007 our allowance for loan and lease losses equaled 421% of total nonperforming loans and leases.

In our view the first quarter asset quality results reflect the normal ebb and flow of these various ratios in an environment where higher interest rates and higher energy prices and slower housing and real estate market conditions are presenting challenges to some borrowers. Let me summarize my prepared remarks by reminding you that in our last conference call I explained that our priorities for 2007 include accelerating our rate of revenue growth and decelerating our growth rate of non-interest expense compared to 2006.

I also stated our belief that we were near the point where we could stabilize and then begin to improve net interest margin. Accelerating our rate of revenue growth, decelerating our rate of growth in non-interest expense and improving our net interest margin are three important elements in achieving our overall goal of returning to record quarterly earnings later in 2007. I am pleased to report that our first quarter results reflect a good start in achieving our 2007 goals.

Now that concludes my prepared remarks. At this time we will entertain questions. Let me ask our operator Felicia to once again remind our listeners how to queue in for questions. Felicia.

(OPERATOR INSTRUCTIONS) Barry McCarver.

Good morning, George. Good quarter. My first question revolves around the assets in loan growth and your comments about lowered guidance just slightly. Could you give us a little color on some of the particular product lines and what you are seeing there in the market on both for the retail and commercial lending?

Yes. On the retail side you know I don't think there is particularly much change going on there. On the commercial lending side obviously home builders are pulling back somewhat and folks who do lot development are pulling back somewhat. And of course that process has been ongoing for the last year as wise customers took a little bit more conservative assessment of the market. But we've seen a little continued pullback in that area, and there are obviously not going to be as many homes built and as many lots developed this year as last year. And that was not as numerous as the year before. So I think there is a prudent retrenchment there in the volume expectations of some of our clients, and I think there is just a little bit more conservative tone out there among our borrowers as to their enthusiasm for various projects.

We've also seen customers selling, a lot at our customers selling projects. We had some pretty good paydowns in the first quarter. We had a customer who had a large portfolio of office buildings that we had financed for them over the years that were leased to the government service administration, and he decided that at the cap rates that he could sell that portfolio for, it was time to liquidate it. So we had a sizable paydown from that portfolio. We had another customer that we had financed a shopping center, a mall that he had purchased several years ago. And he got an excellent cap rate and sold that at a substantial profit. So we are anticipating some other projects that we've got financed being sold by the borrowers, by our customers sold to noncustomers at the favorable cap rates that are existing on a lot of projects now and that that will provide a little headwind, as well.

Okay, and as it relates to that just thinking about the kind of loan production you did in this quarter, really in order to hit your low 20s to midteens type of range you would have to pick up the pace for the year; you would have to pick up the pace in the next couple of quarters. Is that the way we should look at that? Are you comfortable with that?

That is accurate. And you know as I commented historically since we've been a public company only 15% of our loan growth has come in the first quarter. So if you apply that percentage to our first quarter growth it would extrapolate to a, I think about an 18% growth rate for the year. And of course these growth rates are going to vary considerably from quarter to quarter. So extrapolating one quarter's numbers, any quarter forward is going to lead you to strange results possibly. We feel comfortable with the midteens to low 20s sort of guidance for the year, and the quarters will vary considerably from that if you annualize any one of them I would suspect. But I think for the year that is a realistic goal for us to shoot for.

Okay, and then just lastly George and I will let somebody else get on, you usually talk a little bit about your other markets outside of Arkansas, kind of their growth relative to Arkansas. Could you go into that a little bit? How did Texas and North Carolina do?

Texas and North Carolina as we expected are continuing to contribute larger pieces of the puzzle, and we think that is very healthy. At March 31, Texas accounted 10.1% of our loan portfolio, and North Carolina accounted 5.1% of our loan portfolio. So that means that of our total loans and leases 84.8% of them were originated by our offices in Arkansas. So we expect that all three of those states will continue to grow their portfolios over time but that the growth in Texas and North Carolina will be at a relatively more rapid pace. And that will provide us even more geographic diversification of the portfolio.

Okay, George. Thanks a lot.

Joe Fenech.

Most of my questions were answered, George, in the prepared comments and then Barry had some of them too. But the increase in the thirty-day delinquency specifically, is that more of a general issue throughout the footprint, or was there a geographic concentration where maybe you're seeing the uptick there?

Actually about two-thirds of that increase is related to a single credit. And it is a credit we've had on the books for about eight to ten years; it is a medical clinic, and we financed two clinics for this doctor. And he subsequently expanded to a third and a fourth clinic sort of against our wishes. He really got himself over expanded, and he has been a customer that we've dealt with periodically on the past due list for several years. He is trying to retrench from his expanded mode back to his more traditional operation and he ended up in that past due ratio at the end of the quarter. He has been on there intermittently for the last couple of years intra our quarter and has just never hit our quarter end numbers. I think that will -- that aspect of that will work out, but even if you factor that out, that number is probably in the high 60 basis point range. So it is up a little bit, and we are seeing as I alluded to in my comments, just small impact of the tougher interest rate environment on customers, the tougher energy cost environment.

In any month, Joe, or quarter, we have loans that become problems and loans that get resolved and fall off the other side. Sometimes those nonperforming ratios look very static from quarter to quarter, but the pool of loans that comprise those is never static, it's always sort of constantly changing and evolving. And to give you a picture of the economy from our point of view, we did not actually I don't think add any construction or lot development loans into that problem list last quarter. We had several of those fall in there in the fourth quarter and I have already mentioned we made some good progress in moving some of those through the pipe into other real estate and even getting one sold out on the other side.

We saw a turkey farm loan go in there. We saw a (technical difficulty) loan go in there. We saw a couple of customers that are in the dirt excavation business go in there. And some of those have been liquidated and worked out, but there is just a kind of an attrition, if you will, grinding away a slow gradual grinding away on the ability of some customers to service higher levels of debt and deal with higher energy prices and slower economic conditions. And that is really -- it is just kind of hitting some of those marginal customers.

And as I commented in the last call, a lot of times it is not just the higher energy cost or the higher interest rates or the slow economy, but you have customers are then hit by extraordinary events. Like in the fourth quarter of those several little construction loan relationships, one of those guys have had a serious health problem and you have these external events that hit folks in there in a stressed position and it puts them over the edge. So that is sort of the thing we are dealing with. It is not any sort of cataclysmic shift. It is just affecting those customers on the margin.

Thank you.

Charlie Ernst.

Good morning. A question on the expense side. Did you all accrue for bonuses this quarter?

We did not. As I commented in the last quarter, we are going to have to really do an extraordinary job on the earning side if we are going to be accruing our traditional cash bonus program this year. I certainly hope we will get there but we are going, as I think I said in the last call, if we do that everybody will be happy with our earnings. We did not do so in the first quarter.

Is there any kind of range of performance that you can provide for us that will cause you to then start accruing?

You know, we have not disclosed that in the past, and I am reluctant to go down that road at this time.

And then other expenses were pretty late in the quarter. Is there anything going on in that line or is this a good run rate? How do you view it?

I think it is -- I don't think it is significantly affected by any unusual items one way or the other. It is pretty clean representation of quarterly results. We were down from the fourth quarter results. There were a few things that were heavy in Q4, for example we opened a very large number of offices. I think it was four new offices in our relocation in Q4. And we probably had an extra (technical difficulty) hundred thousand dollars or so of supplies expense in Q4 just related to stocking all those new facilities. And then we had some larger than normal fees for what we call outside services fees, we paid third parties, and that was probably $150,000 to $200,000 heavy in Q4 and about $125,000 of that was related to a programming fee that we paid to write new software to help us more effectively administer our charge assessments on NSF and OD checks. And that improvement enhancing our processes there kicked in the fourth day of December, and of course was effective throughout the full first quarter, and that was one of the significant factors, the most significant factor in the improved service charge income in Q1. So that was obviously a very good expense.

Can you tell us what the construction balance was in -- at the end of the first quarter?

The total construction in land development loans? Is that what you're asking?

Yes, in the K it was a $515 million number at year end.

$517,659,000, which was 30.0% of the portfolio. You know, we added one interesting phenomenon that our real estate actually went down as a percentage of our portfolio in Q1; went from 81.6% to 81.3%. And that was not particularly by intent or design, but as I commented in I think the last call, one of our efforts as part of our corporate growth initiative last year was to add new teams of lenders focused on the C&I lending and professional and executive lending. And those guys did some good work in Q1, and I think are going to continue to do good work. And as a result, the C&I piece of our portfolio jumped to 9.4% of our portfolio in Q1, which was very favorable. It's not an area where we have had a lot of growth before; we want to get some growth there to A, contribute to our overall portfolio growth and B, help us diversify somewhat that portfolio.

George, can you comment at all within your overall balance sheet/loan assumption for the year what your expectations are for that kind of construction and commercial real estate portfolio?

Well, I think it will grow, but I don't think it is going to grow as much as it has in the past just because I think particularly the residential area, I think we are going to see less new deals done and less inventory carried by a lot of our builders. Who might have been comfortable two years ago with ten homes and may have scaled that back to six or eight last year and they may be thinking, gosh, four or five is all I want to have this year. I think we'll see some scale back there. We are seeing a lot of medical office, [helpack] commercial, retail type of projects that are being done and seem to be very feasible, viable projects. So I think that will provide us a good area of growth in that sector, in the construction land development even as housing pulls back a little bit. And I just can't -- I can't really predict, Charlie, exactly how that is going to play out. But we've got a lot of good markets we are in. There are a lot of good project still getting done out there. We've got the diversification capabilities from the C&I guys we added last year and the P&E guys we added last year. I think they are going to help us get the growth. So that is where we still think midteens to low 20s in the loan growth for the year, loan and lease growth.

Can you remind me when you all lowered your savings rates; did that happen at year end, right?

No. We've made some investments in various deposit rates, but I don't think we've moved our savings count rate.

Just in looking at your average balance sheet it looked like the, I think it is a savings line item is down about 20 basis points versus the fourth quarter.

I tell you what that probably is, Charlie, and I don't think we've moved our product pricing there, but as you guys know we price different products differently in different markets, and I think we can probably add some governmental or public funds deposits in savings accounts that had a special negotiated price. And it is just a shift in the mix of that bill. It is not a change in our rate structure on savings accounts.

And lastly with regards to the margin if you are thinking that construction will be a smaller part of your growth this year, do you have any concerns about the positive effect that FAS91 fees have on the margin historically? And that could kind of cause your expectations for margin improvement maybe be a little aggressive?

We've factored all that into our expectations.

And the assumption you're using behind the rate cuts or hikes this year?

The guidance I gave is basically predicated on no change in Fed rate. I think we are stuck here for a while.

I agree with you.

That may not necessarily -- that is not the most pleasant scenario I could come up with, but it's the most realistic scenario. It seems that there is enough inflation pressure out there to keep the Fed from easing and enough softness probably to keep the Fed from raising rates, and I think we are stuck with the present landscape for the foreseeable future.

I appreciate it.

Andy Stapp.

Good morning. Great quarter. Your effective tax rate was up. I presume that is just because of the reduction in tax-free income.

That is. As you know, we sold a considerable chunk of municipal bonds in the fourth quarter, and I think that is the biggest factor in that. Paul, do you want to address that?

Yes, and of course the biggest driver in the change of our tax rate is the percentage of municipal income as a percentage of our pretax income. Last year on the average we had about 19% as a percentage of the pretax. First quarter it is about 14%, and that changed in and of itself is about 1.5% increase in effective tax rate.

Okay, great.

That's the primary driver.

Okay. That's what I thought. And can you give us some color on how your loan pipeline compares currently versus a year ago?

It is less robust than it was a year ago as reflected from the fact that we just lowered our guidance for loan growth by two or three percentage point.

Okay, I just want to confirm that you're already seeing that. Okay. And on the commercial real estate loans that you are originating, how are they being structured, especially with the terms -- are you looking at five-year resets or what?

Andy those are all over the board. A large percentage of them are floaters, and our preference is still for variable rate loans, and I am actually quite surprised in the shift in variable rate loans in our portfolio. As of the end of the quarter, 47% of our variable rate loans were or 47% of our loans were variable rate. And that is total loans and leases were variable rate, 47%. And interestingly enough, we've managed to work that up to where we've got as many loans almost as we've got floor rates as we have loans that are at cap rates. So I think that has worked out fairly well. And the rate sensitivity of our loan portfolio has actually accelerated a little bit; if you look at a number that I've given before. An either our variable rate loans that repriced or fixed rate loans that mature, our principal payments on fixed rate loans 66% of our loan portfolio will reprice in the next twelve months. That number goes to almost 80% in two years and 89% in three years. So that loan portfolio has actually gotten to my surprise a little more variable than it was even a quarter ago.

I've heard some banks are going out as long -- fixing rates on commercial real estate like out 10 years. You're not doing that, then?

Well, I would not say that we are not doing that, because if I said that I am sure that somebody could dig around in the portfolio and find an example or two or three where that has been done. But our normal mindset is to keep those balloon intervals as short as possible. Most of the things that we do that are fixed rate have three and five-year balloons. There are rare exceptions for specific customers that have specific deposit relationships and that pay an appropriate rate for us to go longer that we do go longer for. But those are more unusual situations. There are not a lot of them, and the fact that 89% of our loan portfolio at March 31 reprices in three years or less gives you a pretty good feel for what is out beyond three years.

That's it for me. Once again, great quarter.

Peyton Green.

George, good morning. I'm wondering if you could talk a little bit about what you are seeing in terms of I guess your interest-bearing deposit costs settled down nicely in the quarter. I guess you are paying for that in a flat rate environment. Is there more opportunity compared to a year ago when you were in an obvious growth mode to kind of reign in the cost of funds side? And then also do you see on the other side of the balance sheet, do you see the credit spread starting to come back into loan pricing? Thank you.

Let me address the deposit question first. You know there are a lot of things at work there. And one was this last year when we were opening 11 new offices and entering four new markets we were more aggressive in those new markets particularly then we become after a period of time, as we become more established in those markets. When you get in a new market you've got to get customers in the door, so you tend to be more aggressive. The other thing was is we were on a considerable mission in the last year to build the deposit side of our balance sheet, what we refer to as the deposit initiative. And, of course, blew through last year with very large deposit growth and as a result paid down borrowings, I think a couple hundred million dollars from the beginning of last year through the end of the first quarter or so of this year. So we are not going into new markets and not opening as many offices.

There is less of this sort of hyper offensive pricing of deposits to get started in new markets. We are not looking to achieve the same kind of quantum leap in deposit growth that we did last year and that is helping to moderate that. The other thing is when deposits sort of peaked around June or July of last year, the second quarter and early third quarter of last year and even at the end of third quarter people were being extremely aggressive on deposits because there were still sentiment in that time that the Fed may be going up further, and people were trying to get deposits before they went up further. And now we are at a point where we are repricing pretty good sized chunks of that stuff or will be repricing over the next couple of quarters pretty good sized chunks of that stuff that was put on the books in April, May, June, July, August, September of last year when we sort of hit in that middle of that time frame that high point in rate.

And the fact that that stuff will be rolling over we hope at rates about where they are today suggests to us that is the reason we think we can get a few basis points reduction in our cost of deposits, average cost of deposits over the next couple of quarters. We put on stuff then that was 15, 20, 30, 40, even 50 basis points higher than where things are pricing today. So that is part of that.

And then the other factor, and I mentioned this in my prepared remarks, is the fact that we have reduced our borrowings so much gives us considerable flexibility to utilize borrowings to fund part of our balance sheet, if deposits became more costly than borrowings. Because we've got all of our capacity at the Federal Reserve. We've got much greater capacity at the Federal Home Loan Bank. At the end of the quarter we are not using any of our Fed funds line, so we were really in very good shape deposit wise and have all the tools in the arsenal with considerable flexibility to manage the liability side of our balance sheet. So our expectation is that we can use those things to this year to manage our cost of funds more effectively than we did when we were in a very offensive mode a couple ways last year.

And then on the loan side with respect to the credit spread.

Yes, thank you for reminding me. Boy, I would like to say yes, we see credit spread being priced more appropriately, and I will tell you we see some occasional examples of that, but credit is still not in my view being nearly priced appropriately in the market. And I think that is a real problem for our industry, and I'm not quite sure how we get out of that and the most likely scenario is enough folks have enough problems that people begin to price credit spreads back in there. But I don't think risks are being adequately priced, no, and we are not seeing much improvement in that.

I see a few deals here and a few deals there that seem to be priced more appropriately, and I get hope that its the sign of better things to come, and they turn out to just kind of be more isolated examples than the real norm. And that is why I said in my prepared remarks that even though our loan portfolio, which is pricing more -- repricing more slowly than our deposit portfolio ought to give us a lift in earning asset yields. Because I've got loans that are repricing now that were booked a year or two or three years ago that still should price up a little bit to catch up with the deposit repricing that is already occurred. And I think I will get that, but I am not optimistic that that is going to just give us a gigantic boost in margin like it really should because credit is being priced so aggressively and so competitively right now. So I think we do get some enhancement in yields on the earning asset side. I just think it is modest because of the credit pricing and competitive environment.

Okay, and then last question on that point would be, have you seen credit spreads widen at all in northwest Arkansas given the slowdown there or not at all?

Yes, we have seen credit spreads widen there. The flip side of that is there is not a ton of new business coming from there. So folks that to a considerable extent pulled in their horns up there until this oversupply of lots and houses and sort of gets sorted out, which is a good thing.

Sure, absolutely. And then lastly, the watchlist, how could you characterize that in the context of the thirty-day past due increase?

The watchlist and internal substandard list, I don't have those numbers in front of me, and they will be in the Q, but those lists have increased. They have increased as the past due list has increased and as your nonperforming ratios have increased. That level of increase is not alarming, and it is what I think you would expect to see given the magnitude of rate increases, the deposit costs and slower economic conditions. So yes, customers as I said earlier, customers that are on the fringes of your credit portfolio are getting stressed by the ongoing challenges of the economic environment.

Okay, great. Thank you very much.

David Bishop.

To beat a dead horse a little bit more here, turning back to the margin I just have a quick question. As we look to the other borrowings line that is still on the book there at year end, it looks like you paid a lot of those down end of the year, that $64 million. Are those still primarily the borrowings that are over one year in terms of maturity in that (inaudible)?

Yes, those are primarily. The other borrowing line is the federal home loan bank, the longer fixed-rate. Those are detailed; the rates and so forth on those are detailed in our Q and annual report and so forth. So you can -- $63 million, I think of those.

Those are also the fixed-rates or is it variable?

They are fixed, and fixed at rates that are too high. But every day I get a day closer to paying them off, and if you've been on this call for six years, you heard me lament the fact that we fixed them when we did. We would rather have just taken that risk ourselves, and we'd been better off. But yes, they are fixed rates. Now if you look at the rates in the -- Paul, is that where our capitalized interest --?

Yes, I was going to say there is a pretty big difference.

If you look at the rates in the Q on those, you will see a 6-something rate, and the rate in the reported is what, Paul?

It's 4.88.

4.88, and what goes in there, as you know, we capitalize interest on construction projects in accordance with generally accepted accounting principles. We are required to do that. And that capitalized interest on our construction projects has to go as an offset to some interest cost item, and we dump that in that account.

That is footnoted in the 10-Q.

Yes, there is a footnote in the Q that explains that and gives you the difference, what impact that had on the interest.

Do you know the impact first quarter offhand, or was there one?

Certainly there was one and -- let's see -- I can't give it to you. There are too many other things in there. You've got those fixed-rate borrowings in there and various other liabilities that are in there. But you will have to look at the Q for that, David, sorry.

That being said I am just trying to get a sense in terms of as you sort of look at the funding decision here between the marginal cost of deposits, marginal cost of short-term borrowings -- maybe not taking (indiscernible) of an absolute number but as you go forward what is sort of the going market rate in terms of that decision there in terms of --

Obviously we are -- Federal Home Loan Bank advances or Fed funds are basically about in the 525 to 530 range so pretty much Fed funds target rate for that.

Okay so the difference there (inaudible) capitalized interest. Okay. Turning back to credit quality I think you referred to this -- the loan loss provision has elevated (inaudible) sort of fading in and out here. Was that related to the increase in charge-off or is that sort of also a function of what you're seeing just the conservatism in terms of the overall macro credit environment, economic environment?

That number was driven by primarily by our formula calculation of loan loss reserve adequacy. And certainly the charge-off number impacted that, as did changes in the watchlist loans, substandard loans from past dues and so forth. So it is a combination of factors that drove that, including all of those.

Brian Martin.

Nice quarter. A question, you mentioned the I guess the pause in Oklahoma, the change in leadership and I guess I just wonder if you can elaborate a little bit on that and what the thought process is there on timing.

Good question. Yes, I think we had reported we hired a gentlemen to lead our Oklahoma charter efforts in August. We did all the due diligence, did all the interview processes everything that you would do there, and we just were not as time wore on we realized that that was not working out the way we envisioned that was going to work out. And guys who had done well in different settings in the past sometimes that skillset and performance does not translate in a different environment, and we were just -- it became evident that we were just on different pages regarding credit and other managerial issues and so forth. And we elected to put our application on hold (technical difficulty) our office there and start over. And we will take however long it takes to find an individual that we are confident can lead that office. We hire a lot of people and not all of them work. Anybody who hires a lot of people would have to admit that. They are not all the stars you thought they were when you hired them. So we are looking for new leadership there. Our application is on hold. If we find the appropriate leader for our Oklahoma operation tomorrow we will be back moving forward on that. If we don't find that person until this time next year, then we will move forward then. And we are going to be very diligent about looking and very diligent about underwriting that person, and we will go forward when we find the right person.

Okay, and secondly, the growth in Texas this quarter appears to I guess just wondering is that the best growth kind of record growth in Texas in a quarter? It looks like it was most of the net loan growth in the portfolio -- last quarter I thought you were about 7.5, and now you are -- I thought you mentioned earlier you are 10%, which maybe in the neighborhood of 45, $50 million. Is that record growth? And I guess can you just give a little color as far as what type of run rate -- was anything unusual in that large credits, or is that just a direct function of the people you hired, or whatever you can offer there.

I can't give you a run rate specifically for Texas. I can tell you that we did have good growth there. It was a meaningful contribution. I apologize I don't have at my fingertips here the percentage of where that was at the end of last quarter, but I think you're right, it is up considerably from last quarter. And it is a very vibrant, very dynamic market. And we've got a couple of -- well, three good teams of folks there. We've got our real estate specialties group that operates out of Dallas, and then our Metro Dallas group that operates out of Frisco and our Texarkana Texas group that is operating there on the east border of Texas and Arkansas. So we've got three good teams there.

They are doing a good job. It is a very dynamic, positive market down there. Now even there home sales and home construction have slowed, but what is interesting the last couple of months down there the sales have exceeded the new starts. So there is even an adjustment going on in that market, but it is still a very healthy and very good market and a lot of opportunities. And I expect Texas will continue to be proportionately the larger contributor to our loan growth as compared to North Carolina and Arkansas. That our growth rates will be faster there and hence it will account for more and more of the portfolio. And again, we think that is a very positive development.

You ask if there were large loans there. Yes, our real estate specialties group in Dallas is the unit in our company that handles our larger commercial real estate loan credits of various kinds and construction development pieces. So the biggest loans in the Company in most quarters are posed in that office, and so yes, it is a bit of a chunky portfolio there and hence it is real hard to give you any sort of run rate from quarter to quarter because they may close several large deals and then there may be a pause before the next one is closed.

Okay. Last two things. Just the growth in deposits this quarter looked like it was primarily in the CD area and I was just wondering do you have a breakout of what the brokered CD number was at quarter end?

You're correct our growth in this quarter was primarily in the brokered CD category although we did have a pretty decent run rate on adding new checking, savings and other local accounts. Our number of new accounts was really running probably about our 2005 level for new accounts. We did almost 185% of the 2005 level in '06 as far as addition of accounts and with no new offices and a more conservative strategy, we were sort of back to that '05 level. But still a pretty good rate of adding new accounts considering that we didn't open any new offices. Our total brokered CD's were about $370 million at the end of the quarter. So that was about 16.8%, 16.7% range of our total deposits at March 31.

One last question. You talked last quarter I believe was about the marketing expense, and you hoped to ratchet that down this year, and just wondering if you can give us where that number was at for the quarter, what the next (indiscernible) was?

I think we were actually in Q1 about flat to Q4, weren't we? (multiple speakers) And I don't have that number. It is in the annual report.

That's fine. I was just wondering what it was relative to the fourth quarter.

It was about flat to Q4, and our marketing guys realize they've got to dial that back as these FDIC insurance premiums kick in this quarter and the ensuing two quarters. Susan Blair who introduced the call and did our forward-looking statement disclosure is head of marketing also, so I am looking at her and she is nodding affirmatively that she knows her budget is wacked for the next few quarters.

And last question and I'll hang up and listen, the variable-rate loans in the quarter, you talked about them I thought saying 47% and last quarter I had written down that they were 43.7 or 44%. You talked a little bit about that earlier. This level at 47% you're kind of drooling about being a little surprised and you think this level is kind of worth being stabilized? Or I mean just seemed like it was the biggest percentage change, 300 basis points in the quarter that you've seen in some time and just wondered if you see that trend continuing or just stabilizing and I'll hang up and listen. Thanks.

That's a good question, Brian, and obviously since I gave my opinion last quarter that I thought we were probably stuck at last quarter's number and then we have the largest quarterly increase in that number in years, my guidance on that may not be very good. What we preach to our lenders is we don't have many long-term fixed-rate deposits so to maintain proper asset liability management that we need to get as many variable-rate loans as we can. And our preference is always for a variable-rate loan and that if we do a fixed-rate loan we need to keep the repricing intervals as short as possible to help our guys that are trying to manage this aggregate balance sheet interest rate risk.

And I said in the last call that a lot of customers are doing transactions that the feasibility of which would be challenged if rates rose 100 or 200 or 300 basis points. We are having a lot of customers that would've tolerated a variable-rate loan two years ago coming in and saying I just can't afford the risk of rates rising on me, and I have got to have a fixed-rate loan for the first year, the first three years, or the first five years of this project. And I commented in that call, and I've done this several times that since we think we are more likely in a scenario where we are near the top of the interest rate cycle than bottom, we're not fighting that as hard as we did two or three years ago. But our preference is still for variable-rate loans because that is what we really need to manage our balance sheet risk, interest rate risk and our balance sheet.

And the guys surprised me and did a much better job in adding variable-rate loans in Q1 then I thought possible, and we will continue to preach that same message to the troops, and I hope they will continue to get this variable-rate percentage up even higher. But I can't honestly tell you if they can do that. I didn't think they could do what they did this quarter in that regard. I am very surprised at it. And we had had three or four quarters in a row where we were within 100 basis points one way or the other on that ratio, and it looked like our ability to improve it to increase that variable-rate percentage had pretty much hit a wall and all of a sudden they jump up here. So I can't really tell you where that is going except to tell you that our goal is to continue to push that percentage a little higher every quarter but I don't know that we can do that.

Thank you very much.

Troy Ward.

Troy Ward, A. G. Edwards. I apologize if I missed this earlier on the call but I was wondering if you could provide some color on a topic we've heard quite a bit about in the first quarter, and that is the early adoption of FAS 159, the fair value option. Do you guys evaluate this? And if so, can you give us a little color on that decision process?

Let me just shorten that and say we did evaluate it, and we decided to not do it, and the basic premise for that is we thought it would add too much variability to earnings by marking various things to market. And a lot of these market value adjustments from quarter to quarter to quarter don't mean a whole lot in the grand scheme of things. But it would create considerable volatility in earnings, and we just thought it was the wrong thing to do. And we know that there are people that are making a lot of noise and touting selectively adopting it for certain assets or certain categories of assets, that you could gain some sort of short-term earnings advantage by doing that. We looked at that and just it was just had a significant element of gimmickry to it and just didn't feel like it was something we needed to do. So we are not early adopting it.

Appreciate the comments. Thanks, George.

Leo Harmon.

Good morning, George. Can you talk a little bit about how your loan growth translates into earning asset growth and particularly given where your liquidity ratios are, your preference for funding that loan growth even with the investment portfolio or with incremental borrowings?

Well, our first preference to fund the loan growth would be with locally generated deposits. Our second preference to fund the loan growth would be either for borrowings or brokered deposits, whichever was marginally the cheapest. Whether or not we fund any loan growth with the securities portfolio or whether securities portfolio is actually a user of funds because we purchase additional securities is really an unrelated issue. And that is based on what we think about the relative value in the securities market at a given time. As I said, if we think there is value in securities and it is beneficial to be an owner we will buy them and use funds for it.

If we don't think there is a relative value and when we look at our needs for securities for collateral and for deposits for public funds customers, repurchase agreements and trust customers or other needs that we need securities for, we can liquidate securities we will do what we did in Q1 and sell securities and then that becomes a source of funds. But we don't really look at the securities portfolio and evaluate where we want it to be in the context of funding loans. Yes, it may be a user of funds or it may be a source of funds, but that decision is made on whether or not we think its a good opportunity for us to buy securities or sell securities, and the loan funding decision is made separately.

Thank you.

David Bishop.

Quick follow-up. Just remind us is there any seasonality in terms of deposit inflows related to public funds? Looks like sometime in the first quarter typically you a have a little bit of (indiscernible) there for three of the past four years.

David, not that has caught my attention. And that's a good question, and we will do some looking at that. But to my mind there is not a particular seasonal aspect to our deposits one way or the other. Now we do have individual customers that have seasonality, for example property tax in Arkansas are due by the 10th of October, and we have County Treasurer's accounts in a number of counties, and those particular customers get very flush with cash in the September/October timeframe when they collect all their property taxes. Then some months later they distribute that to all the recipients of that, such as school districts. And if it happens to be a county where we have a number of school district deposits, which we do in a lot of counties, then those accounts get pretty flush. But all this money seems to sort of move around one way or the other. I don't think there is a particular seasonality to our deposits. I think it is really more in the aggregate more a function of whether we are being conservative or aggressive in the way we are pricing deposits at particular times what our particular strategy is, how many new markets we are going in new offices and those sort of factors. But I'm going to look at that, and that is my impression; I'm going to do a little research and make sure that is really right.

Appreciate that.

Thanks for the question.

One quick follow-up in terms of the $500,000 of reimbursement in terms of branch application were any of those reflected unusually heavy in the third or fourth quarters last year through (technical difficulty) was that sort of spread evenly over the past year or so?

We had about $175,000 of expenses and that number is pretty loose, David. Plus or minus probably $10,000 or $20,000 there either way of expenses related to our branch applications and the appeals of the branch applications. And the request for rehearings and all that stuff that went on related to that, and that was spread out over various quarters of 2005 and 2006. So it was in '05 and '06.

Thank you.

Felicia, are we done?

Yes we are; there are no further questions at this time.

All right. Thank you very much. There being no further questions, that concludes our call. Thank you very much for your active participation in listening today, and we look forward to talking with you in about 90 days or so. Thanks very much. Have a good day.

Ladies and gentlemen this concludes today's conference call. At this time you may disconnect.