Bank Ozk (OZK) 2007 Q2 法說會逐字稿

Good morning. My name is [Nakeisha] and I will be your conference operator today. At this time, I would light the welcome everyone to the second-quarter earnings release conference call. (OPERATOR INSTRUCTIONS). Ms. Blair, you may begin your conference.

Good morning. I'm Susan Blair, Executive Vice President in charge of Investor Relations for Bank of the Ozarks. The purpose of this call is to discuss the Company's results for the second quarter of 2007 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, goals, expectations and outlook. To that end, we will make certain forward-looking statements about our plans, goals, expectation 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 to inverted yield curve and intense competition, and our goal of maintaining and possibly improving net interest margin from the level achieved in the second quarter 2007; net interest income; non-interest income, including service charge, mortgage lending and trust income; non-interest expense, including the expected cost of FDIC insurance premiums, and our goals for decelerating our rate of increase in non-interest expense in 2007 as compared to 2006; asset quality, including changes in real estate market conditions, changes in residential mortgage market conditions; future growth and expansion, including plans for opening new offices, expanding existing offices, and replacing an existing office; 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 statement, due to a number of risks and uncertainties, some of which we will point out during the course of this call. For a list of certain risks associated with our business, you should also refer to the forward-looking information caption of the Management's Discussion and Analysis section of our periodic public report, the forward-looking statements 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.

Thank you for joining today's call. We're pleased to be reporting our second-quarter earnings. In our opinion, these second-quarter results reflect good progress in achieving a number of our goals for 2007.

We previously stated key goals for 2007, which are, one, accelerating our rate of revenue growth; two, decelerating our rate of increase in non-interest expense; three, maintaining our improving net interest margin; and four, maintaining good asset quality. Obviously, we want to see our profit metrics improve in 2007 after pursuing our significant deposit, branching and corporate growth initiatives in 2006.

Our second-quarter 2007 results reflect a continuation of the progress seen in the first quarter this year. Let me give you some specifics. Net interest income, which typically accounts for about three-fourths of our revenue, increased 3.1% in 2006 compared to 2005. During the first quarter of this year, 2007, net interest income increased 4.7% compared to the first quarter of last year. During the quarter just ended, net interest income increased 7.3% compared to the second quarter of last year. We have achieved record net interest income in both quarters this year. The acceleration in our rate of growth of net interest income this year is a result of a combination of growing earning assets, primarily loans and leases, and quarter-to-quarter improvement in our net interest margin during the first two quarters of this year. I'll comment further on balance sheet growth and net interest margin later in the call.

In addition to accelerated growth in net interest income, we've also seen acceleration in our rate of growth in revenue from some important components of non-interest income. Income from deposit account service charges is our largest source of non-interest income, and last year, this category of income increased 3.5% compared to 2005. During the first quarter of this year, income from deposit account service charges increased 22% compared to the first quarter of last year. During the quarter just ended, service charge income increased 20.1% compared to the second quarter of last year.

Income from deposit account service charges has been a record in both quarters this year. A number of factors contributed to this acceleration in our growth rate of service charge income in 2007, including enhancements made in 2006 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 service charge fee schedule this year.

Typically, mortgage lending income is our second largest source of non-interest income. During 2006, our mortgage income actually declined 3.8% compared to 2005. During the first quarter of 2007, despite slower housing market conditions, mortgage income increased 21.2% compared to the first quarter of last year. During the quarter just ended, mortgage income was up 4.9% compared to the second quarter of last year. In fact, mortgage income during the quarter just ended was our best quarter of mortgage income in seven quarters.

We were particularly pleased with these results in light of the well-publicized challenges facing the housing sector. As I noted in our last conference call, in 2007, we have seen some slowdown in housing activity in our markets, but apart from northwest Arkansas, the impact of this slowdown has been moderate so far. A large part of our growth in mortgage income during the first two quarters of this year is attributable to our expanding our core of mortgage personnel in the existing markets and adding mortgage staff in some of our new markets as part of last year's branching and corporate growth initiatives. We invested in our mortgage lending team last year, and that investment has produced good results so far this year despite the challenging market conditions.

Trust income is another important source of non-interest income for us. During 2006, trust income increased a very favorable 16.4% compared to 2005. During the first quarter of this year, trust income increased 7.4% compared to the first quarter of last year. During the quarter just ended, trust income increased 11.1% compared to the second quarter of 2006. A slowdown in new bond issuance in Arkansas and thus our acquisition of new corporate trust business has restrained our growth in trust income during the first half of this year. However, we have continued to see good growth in our personal trust an investment management business, and we expect growth in these areas to continue to drive overall growth in trust income in 2007.

Obviously, the higher 2007 growth rates for net interest income, income from deposit account service charges and mortgage income were the sort of results we had in mind when we articulated our goal for accelerating our rate of revenue growth in 2007.

Decelerating our rate of increase in non-interest expense is another key goal for 2007. During 2006, we invested heavily in our branching and corporate growth initiatives, which contributed to the 15.7% increase in non-interest expense in 2006 compared to 2005. During the first quarter of 2007, non-interest expense increased 8.8% compared to the first quarter of 2006. During the quarter just ended, this rate of increase slowed further to 7.8% compared to the second quarter of last year. Clearly, this reflects that we're on track so far in accomplishing our goal of decelerating our rate of increase in non-interest expense in 2007.

For the first time in years, our second-quarter results included $210,000 for FDIC deposit insurance assessments. This cost is expected to increase to approximately $[310,000] in the third quarter and approximately $320,000 in the fourth quarter.

A third key goal that we set for 2007 is maintaining or improving net interest margin. Of course, this is closely related to our goal of accelerating our rate of growth in revenue and net interest income, which I've already discussed. However, net interest margin is so important that we think of it as a separate goal, and I want to talk about it separately as well.

We've now had two consecutive quarters in which our net interest margin improved on a quarter-to-quarter basis. During the first quarter this year, our net interest margin improved 13 basis points compared to the fourth quarter of 2006. During the quarter just ended, our net interest margin improved another 11 basis points compared to the first quarter of this year.

Now, I wish I could tell you that this net interest margin improvement was due to some fundamental change in our environment for pricing loans and deposits, but unfortunately competition continues to be very challenging for pricing both sides of the balance sheet. The improvement in our net interest margin over the last two quarters is primarily due to two factors. First, we've moderated our deposit pricing somewhat after our broad-based deposit initiative in 2006. Second, our loans reprice somewhat more slowly than our deposits. With the Federal Reserve now on hold for more than a year, our loan repricing is catching up with our deposit repricing.

While we've enjoyed significant improvement in net interest margin in the last two quarters, further improvement will likely be more difficult to achieve. At this time, our goal is to maintain net interest margin at the second-quarter level and hopefully improve it slightly over the next two quarters.

The fourth key goal for 2007 is to maintain good asset quality. Our second-quarter asset quality ratios are certainly consistent with this goal. As I said in our last conference call, the cumulative effect of 425 basis points of FOMC interest rate increases, higher energy prices and slower economic conditions in many sectors, among other factors, are having an effect on some borrowers.

With the exception of northwest Arkansas, economic conditions continue appear to be holding up relatively well in our market. In northwest Arkansas, the slowdown in residential lot and home sales is continuing as that market is working through an oversupply situation. The good news for northwest Arkansas is that there is by no means a cessation of residential lot or home sales and the area continues to be a growing and economically vibrant market, which in due time should resolve this significant oversupply of houses and residential lots now existing in some submarkets and some price points.

With that said, our strong credit culture and commitment to asset quality appear to be serving us well. Our asset quality ratios at June 30, 2007 were not as favorable as those at June 30, 2006. However, I should mention that our June 30, 2006 asset quality ratios were very favorable. In fact, a couple of the ratios from last year's second quarter tied previous records.

Although these ratios have increased since last year, our asset quality continues to be strong, and each of our reported asset quality ratios improved slightly in the second quarter of 2007 compared to the first quarter. At June 30, 2007, our ratio of nonperforming loans and leases to total loans and leases was 23 basis points. Our ratio of nonperforming assets to total assets was 26 basis points. Our ratio loans and leases past due 30 days or more, including past due nonaccrual loans and leases, as a percentage of total loans and leases was 53 basis points at June 30, 2007. Our annualized net charge-off ratio was 14 basis points for the second quarter of 2007. As of the end of the most recent quarter, our allowance for loan and lease losses equaled 466% of total nonperforming loans and leases.

In our last conference call, I stated that our first-quarter asset quality results reflected the normal ebb and flow of these various ratios in an environment where higher interest rates, higher energy prices and slower housing and real estate market conditions have presented challenges to some borrowers. I would make the very same comment about our second-quarter asset quality results. We view our second-quarter asset quality ratios as very good, particularly considering the more challenging economic conditions compared to recent years.

In summary, accomplishing our goals of, one, accelerating our rate of revenue growth, two, decelerating our rate of increase in non-interest expense, three, maintaining and improving net interest margin, and four, maintaining good asset quality, are critical elements in our favorable first and second-quarter results. More importantly, these four goals will continue to be key objectives for the remainder of this year.

Now, let me briefly turn to several other subjects. Growth in earning assets, primarily loans and leases, is certainly important in achieving our goal of growing net interest income. Loan and lease growth in both the first and second quarters of 2007 was below our goal for average quarterly loan growth. Now, typically, our first-quarter loan and lease growth has averaged only about 15% of our annual loan and lease growth, so our slower first-quarter loan and lease growth results were not unusual or unexpected.

The second quarter is usually a very good quarter for loan and lease growth, but our loan and lease growth in this year's second quarter was below expectations. In our last conference call, we adjusted our guidance for loan and lease growth to a mid teens to low 20s annual percentage range. At this point, it appears that we have a good pipeline for the third quarter, and we continue to believe that, in the coming quarters, our growth in loans and leases will, on average, be in the mid teens to low 20s annual percentage range. Obviously, that means we've got to pick up the pace from the second quarter.

Our investment securities portfolio is another source of earning assets. As you will recall, during the first quarter, we were a net seller of investment securities and we have found very few investment securities we thought were compelling values this year. This has been the primary factor in the $45 million decrease in our investment securities portfolio this year. As we have said a number of times before, we will be a seller of securities when we believe market conditions are conducive to selling and a buyer of securities when we believe market conditions are more appropriate for buying. We will expect to continue to manage the securities portfolio with this same mindset and with a view to the overall interest rate risk of our total balance sheet.

As stated in our last conference call, our deposit goal for the remainder of 2007 is to grow deposits sufficiently to fund our growth in earnings assets. After record-setting deposit growth in 2006 and very strong deposit growth in the first quarter of 2007, our deposits actually declined from March 31 to June 30. We do not view this as a trend or a reason for concern. We continue to expect that deposits will grow to the extent that deposit growth is cost-effective and needed to fund our growth in earning assets.

Our goals in the coming quarters include continuing to achieve good growth in earning assets, primarily loans and leases, and maintaining or perhaps increasing slightly our net interest margin from the second-quarter level. If we can achieve these goals, then we have the necessary elements to continue to achieve improvements in net interest income each quarter. This is a critical part in our achieving earnings growth.

During the (technical difficulty) quarter, we continued our growth in de novo branching strategy, opening our first new office of 2007 in Hot Springs in Garland County, Arkansas, Hot Springs is one of our 2006 expansion markets, and this newest office is our third office there. During the third quarter of 2007, we expect to replace our original temporary office in Frisco, Texas, with our second permanent office in that city. This new Frisco office will be the headquarters for our Retail Banking operations in the Metro Dallas area. Also, in the third quarter, we expect to open our second banking office in Fayetteville, Arkansas, and in the fourth quarter, we expect to open our third banking office in Rogers, Arkansas. Given the fact that 53% of our banking offices have been opened in the past 4.5 years, including the record number of new offices in 2006, we believe that we can maintain good growth rates while opening fewer offices in both 2007 and 2008.

In our last conference call, I reported that our pending Oklahoma bank application had been placed on hold while we reconsidered plans for our leadership there. After further evaluation of potential leadership and opportunities in Oklahoma during the quarter just ended, we discontinued our plan to establish a new bank subsidiary in Oklahoma and closed our Tulsa, Oklahoma loan production office. Since we were planning to use this Oklahoma charter as a vehicle to ultimately branch into North Carolina, this may delay our plans to expand our North Carolina loan production office to a full-service banking operation.

In closing, we believe our second-quarter results were another step forward in achieving our 2007 goals. If we can continue to accelerate our revenue growth compared to 2006, decelerate our rate of increase in non-interest expense compared to 2006, maintain or possibly improve our net interest margin from the second-quarter level and maintain good asset quality, we believe we will be successful in our efforts to achieve record quarterly earnings once again by year end.

That concludes my prepared remarks. At this time, we will entertain questions. Let me ask our operator [Nakeisha] to once again remind our listeners how to queue in for questions.

(OPERATOR INSTRUCTIONS). Charles Ernst.

Can you talk a little bit about the period-end deposit numbers, and in particular what the level of non-interest bearing deposits was?

Yes, I can give you a little color on deposits in general. On an average basis, Q2 versus Q1, our deposits were actually up, but as we have already commented, at the end-of-period basis, they were down somewhat from the end of the first quarter. As I said, we're not particularly concerned about that. There was a minute shift in a favorable direction in our deposit mix in the second quarter versus the first quarter. And it's very minute. The first quarter, our non-CD deposits, on average, were 32.3% of deposits. We were up basically 49 basis points to 32.8% of deposits on an average basis in Q2, so -- and the end-of-period numbers were actually a little more favorable. End of period Q1, I think we were 32.7 non-CD deposits, and that went up about 130 or 140-something basis points to 34.1% of deposits at the end of period June 30, so a very slight shift to the positive in mix of deposits, both on an average basis and end-of-period basis in the second quarter. I guess after the successive of quarters of negative shift in that mix that have gone on for quite a while now, even a slight improvement is a welcome sign.

We were more conservative in our deposit gathering efforts in the first half of the year. That is somewhat reflected in our deposit growth. Of course, we were very aggressive in 2006 and articulated from the outset of the year that we would be less aggressive this year.

There were also some shifts of public funds and other deposits that tended to move that number around. But I think, going forward, our expectation is that we will be able to grow deposits quite adequately as needed to fund the growth in our earning assets. The negative March 31 to June 30 point-in-time numbers on deposit growth is not any sort of trend or not anything that is concerning to us.

George, can you say what the balance was of the non-interest bearing deposit account at quarter end?

I think we've -- non-interest-bearing at June 30 was 203 million.

How much?

203 million. Is that right, Paul?

Versus an average of 175 in the second quarter?

Yes, that's correct.

Why is that account up so much in the last (multiple speakers)?

Those accounts move around quite a bit on a day-to-day basis. They are transaction accounts, and there tends to be considerable variation in them on a day-to-day basis. So, I wouldn't read too much into one day's numbers.

Okay. Then in terms of the loan mix, can you say what the balance of construction loans and commercial real estate loans are?

Yes, I can give you that. At June 30, total non-farm non-residential and total commercial real estate was 425.7 million, which was 23 -- or 24.3% of the portfolio. That was actually down about 9 million and down a full 1% of the portfolio from March 31. Construction and land development was 562.2 million, which is 32% of the portfolio, so that's up 2% from March 31 as a percent, from 30% to 32% of the portfolio. Total real estate actually declined 30 basis points from 81.3% of the portfolio at March 31 to 81% at June 30.

Is there any geographic -- so linked-quarter construction was very strong. Is there any geographic concentration in terms of why that was so strong? Was it Texas? Was it Arkansas? North Carolina?

Texas and North Carolina, as we indicated we expected them to do, continue to contribute disproportionately to our growth. At June 30, our Texas offices accounted for 11.63% of our total loan portfolio. That's up from 10.12%. Our Texas office has gained 151 basis points, percentage-wise, of our loan mix in the quarter. North Carolina went from 5.05% of our loans at March 31 to 5.25% at June 30, so a 20 basis point increase in the share of our total deposits in North Carolina. So, that had Arkansas going from 84.83% to 83.12%, a 161 basis point decline in our Arkansas portfolio as a percent of the total. As I have said before, our Metro Dallas area markets where most of our Texas lending is, certainly not all of it, but most of it, and our Metro Charlotte markets, where most of our North Carolina lending is, are markets that we consider to be very good markets with good demographic and economic momentum. We view continued increases there as a positive for our company.

My last question, George, is -- are you guys accruing bonuses?

We accrued $100,000 for a targeted bonus pool in the second quarter, which is the first such bonuses we've accrued in well over a year. My goal is that we will grow earnings sufficiently that I can begin to accelerate those bonus accruals and get back to paying our deserving staff members bonuses some time before midyear next year. So, that's a goal that I personally set because I feel like it's an important thing for our staff and our company.

Based on kind of the run rate that you're on for the year and kind of the way things look right now, that wouldn't require heavier accruals between now and the end of the year?

Well, I hope we will have heavier accruals between now and the end of the year, certainly.

Great, thanks a lot.

Barry McCarver.

Good morning, George. Good quarter. Just carrying on a little bit of Charlie's question about your construction and development balances, do you have a concentration with any particular either residential or commercial product in any of your neighborhoods or markets that appear to be -- have a little oversupply that you think might cause some concern in the near future that you would be looking at?

Barry, the only area that we have any present concern about of significance is the northwest Arkansas market. That market accounts for approximately -- and I don't know this number exactly -- but approximately 9% of our total loan portfolio is in northwest Arkansas. We feel very good about a lot of those credits and feel like we've certainly identified our present problems, and those are reflected in our numbers there. But there's considerable softness, as you know, in that market, so we're looking at everything that we do there very carefully, whether it's a new credit or a renewal, to make sure that we are doing what we can do and need to do to mitigate any risk from the present market conditions there. As I said in my prepared remarks, I think that market will work itself out in a reasonable period of time, but there's considerable oversupply there.

Okay. Secondly, on your discussion about expenses, they certainly were very impressive in the quarter. I noticed a lot of that benefit came out of the salary and benefits line, which is not normally an item I would expect, dollar-for-dollar, to be down quite that much. Is there anything in there slightly unusual in the second quarter? Is that a pretty good base to start for next quarter?

Barry, in the whole quarter, the results, overall, I would say they were pretty clean results. In any quarter, you have some extra items of expense or extra items of income, and we had some extra items of income and some extra items of expense, but they were all pretty small in magnitude and they pretty much offset each other, so it was a pretty clean quarter.

One of the things that we did benefit slightly from in the quarter was, when we changed our 401(k) service provider last year, we had a glitch in capturing the forfeitures from terminated employees, which go as a credit toward our matching contributions for the 401(k) plan. So, we actually accumulated and did not properly credit ourselves for 401(k) forfeitures, which offset our 401(k) costs for a couple of quarters. That came in to reduce salary expense, and that was $100,000 or something, $120,000. But we had a couple of other expenditures in the other categories of non-interest expense that were about the same magnitude, so all of that stuff really pretty much washed out. On balance, it's a pretty clean quarter all the way around, I think.

Okay. Secondly, you mentioned earlier that the loan pipeline into the third quarter looked pretty healthy. Anything in particular in there that you might want to talk about product-wise?

Well, we continue to be predominantly a real estate lender, so a lot of that business is real estate, and a lot of it is business that is related to our North Carolina and Texas markets. Texas I probably should've said first because that's the predominant source and North Carolina secondly. Then central Arkansas also, we've got some good opportunities that are either approved and pending closing or going through the underwriting and approval process from our central Arkansas offices.

So those are the three markets where significant growth opportunities exist. Of course, in a lot of our smaller markets, we've got a lot of smaller growth opportunities there. We're not seeing much growth opportunities out of northwest Arkansas. If anything, given market conditions, that area may be a source of shrinkage. So the pipeline that we're looking at is very consistent with what's on our books and where our growth has been coming from, as we've articulated that in recent quarters.

Okay, that's very helpful. Just I guess just lastly, on your decision to close the Tulsa office, I know that was going to be key in branching into North Carolina, and you mentioned it might postpone that. That's been a great loan market for you for some time. How eager are you to get a full-service branch in North Carolina? Is that something we could see a new plan articulated in the next quarter or two?

Well, I can articulate what the plan is to do that now. I just can't possibly tell you when it might happen. I think there are two ways that we could get to North Carolina at this point. One is to buy North Carolina Charter at some point, and something like that could happen anytime between now and never. The other possibility is to change the Arkansas branching laws, which would basically have Arkansas opting into receptacle interstate branching as opposed to opting out, which would put it among the 17 states, the 18th state I guess that would have reciprocal interstate branching. And that's something we would support. I don't know that anyone else would support that, but we would certainly support that. So there are ways I think we can get to North Carolina in the future, but honestly, with our plan to basically open three new offices this year, and what we've generally articulated as a slower rate of office openings next year that's probably three, four, five type offices next year, we had more offices lined up and more sites lined up to open than we're going to now be opening in '07 and '08. As a result of pushing some of that out, we own sites that will open in 2009 and 2010, based on our current schedule. So some things are having to go by the wayside, and we're having to prioritize the office openings we want.

Last quarter, we announced that we were not going to be opening and had reached a resolution and disposition of that branch site in Jacksonville on very favorable terms. That reflected a trimming of our future branch plans in part based on just prioritizing and realizing we're not going to be opening as many branches now as we thought we might have been a year or 18 months ago. This Oklahoma thing reflects a similar deal. If you can't open everything that you've got on the board to open, you start prioritizing the things that are most important and leave them on the board and things that are less important, you take off. That's simply what we did here.

That's helpful too. Thank you very much, George.

Joe Fenech.

(technical difficulty) questions, but the only one I have left here -- the migration within the problem asset segments during the quarter, can you talk about that a little bit? I know earlier this year and late last year, you talked about a few housing related problem loans in northwest Arkansas. I think there are about four of those. Could you just address the status of those and what, if any, credits may be replaced and where they were within the footprint?

Yes. Well, as you noticed, there was a slight downtrend in the nonperforming loans, and some of that stuff moved through into nonperforming assets, which also had a downtrend. But it was some of the stuff moved through the pipe.

The problems that we had talked about I guess in our January call in northwest Arkansas, which was roughly 4 or so credits to home builders on spec houses and lots, or rent houses, those have pretty much all moved through into the OREO category. They're out of loans now and into OREO. We've had a couple of other builders -- again, very small credits -- join those guys and move through the pipe. Also, we've still got one or two houses maybe that are in non-accrual loan status that will move to OREO. Everything that we've got that's in foreclosure up there, plus the ones that are in OREO now, would bring me to a total of 14 houses and 12 lots in northwest Arkansas. So, the vast majority of our other real estate is all concentrated in that one market. At this point, that's what we've got on the radar screen as being problematic up there.

As I mentioned in my prepared remarks, the good thing about northwest Arkansas is there is not a cessation of activity there. We sold a house in June, sold two lots in June, and have active prospects working on a couple of houses up there right now that could result in sales within the next 30 to 45 days. So, it's an active market; the population is still growing; jobs are still being created. There's just an imbalance in supply and demand because of significant over-development and over-building. But things still are getting sold, and we're still, for selected customers, having new business opportunities up there that are good. But we've probably got more of the portfolio running off there than is being added to it at this point in time.

Thanks, George.

David Bishop.

Good morning. A question for you, sort of in light of that last question there in terms of the real estate market and we are seeing obviously some weakening and maybe more in the upper part of the Midwest and other markets of the country. Are you guys being -- are you able to be more [confident] in terms of loan pricing there? Are you seeing any sort of an improvement or pricing in terms of spreads there to sort of reflect I guess (inaudible) macro risk factor there in terms of loan pricing?

Boy, that sounds logical, Dave, but in all honesty, there continues to be -- and I addressed this in my prepared remarks -- very competitive pricing on both sides of the balance sheet. I still don't think, as a banker of 28+ years, I still don't think that our industry has seen adequate pricing for credit and interest rate risks that is being taken on most loans being made today. It's a tough pricing market, and we've seen isolated and sporadic instances of small improvements in that pricing, but nothing general and broad-based.

Even in a market like northwest Arkansas, which is overbuilt, there are still a lot of banks chasing business up there. So, your really good customers, which are the guys that we try to do business with and of course other banks try to the business with them also, those guys are demanding as good a pricing as ever because, where some banks were filling their buckets with loans that shouldn't be made and obviously we put a few of them in our basket too up there, as I've got 14 houses and 12 lots that I'm looking at owning, or own, as those marginal borrowers get marginalized and people don't want to loan to them anymore, there's even more demand to loan until you're really highly creditworthy borrowers. It is still a very tough pricing environment out there. I'm not sure exactly how or when that's going to change, but we would welcome that.

That being said, I guess philosophically or more functionally, as you go to your (inaudible) offices there, has there been any sort of change I guess in the compensation or bonus matrix I guess the year versus past in terms of how they're getting rewarded and compensated from a variable rate basis?

No.

That's all I had.

Peyton Green.

Just a question to follow up on the extension of credit and also to some degree the administration of credits that you already have -- what is changing in terms of how you're managing the Company in terms of whether you focus on looking at credits that may not be non-accrual by any stretch, but how intensively are you managing existing loans where you are starting to see signs of weakness? Then also, how are you changing your underwriting criteria on new deals that you are getting a look at?

Very good questions, and I guess I would start out by telling you that we have not changed our underwriting criteria at all. I have said this a number of times, privately and several times publicly, but we have underwriting standards that we've developed over my 28-year career in the Company. Those standards are standards that we have adopted and memorialized in loan policy and that we train our people on because, in our view, these standards result in the kind of asset quality we want. We don't change those standards in good times, and we don't change those standards in bad times.

Now, there's a constant refinement process that goes on where we're trying to make them permanently better, but we don't loosen standards when things are really good and try to load the boat and then tighten standards when things are tougher and try to empty the boat because, if you've got standards, the standards ought to be standards that serve you well in good and bad times. That's what you should have standards. If you loosen in some economies and tighten in others, you're just following the lemming over the cliff every time. We try to adhere to very sound, consistent principles. I think that helps us in maintaining customer relationships, because a customer that does business with our bank for a period of time understands that we're not going to be hot and cold; we're going to be consistent. If it was a credit that we would've underwritten, a bad debt service coverage with that tenant base, with those kind of leases on that kind of deal last year, we're likely to do the deal almost exactly the same this year and next year and the next year.

Now, with that said, we take into account and market valuations, we take into account absorption rates and so forth, so a guy that might have qualified for ten spec loans two years ago and may have the same exact financial condition now that he did two years ago, may only qualify for five spec loans today. But that is not because we're underwriting any different; it's because we're underwriting in such a way that the goal is for him to have an equilibrium amount of inventory out there. If the absorption rate is half what it was two years ago, then for him have an equilibrium volume of inventory, he needs half the inventory that he had two years ago.

Our underwriting standards have not changed. Our process for administering credit has not changed. I am -- share with Darrel Russell, the Chief Credit Officer role in the Company, and with C. E. Dougan, who is president of our Western division as sort of the Chief Credit Administration Officer who oversees our folks that do that. And there have been almost no changes in the way we manage problem assets or past dues or oversee that process. We're continue on -- every year, we try to look at our loan review process and figure out ways that we can refine it or improve it or have those guys be more effective and do the same thing with our credit process. But we've not made any changes in those things as a result of a change in the environment. I don't think we need to because, if you look at our asset quality metrics over a considerable period of years, our track record is good in slow times and fast times. We just want to continue to do that.

Now, I will tell you that more time and attention was devoted to asset quality issues in the second quarter of 2007 than in the second quarter of 2006 just simply because there were more issues to be addressed, as evidenced in our ratios that we reported for the second quarter. They were higher than they were in the second quarter last year. But that increased time and attention is not the result of our change in our processes more systems for managing; it is just the fact that there were more issues to address.

The last thing I would comment is that we constantly try to prune the portfolio. One of the things that whittled into our loan growth statistics for the second quarter was a couple of pretty sizable credits that we've pruned out of the portfolio. These credits were not credits that were problems; they were generating positive debt service coverage and they were adequately collateralized. But we did not like the trends that we (technical difficulty) as we analyze the borrower's operations month-to-month, quarter-to-quarter and year-to-year. We could have kept that business, but we elected to price that business and encourage customers to move that business out of the Bank. That's not anything new; we always do that. There's an ongoing process of identifying customers that just simply are not performing like they used to perform, or not performing like they were expected to perform, and that underperformance raises the risk profile of the credit. If it raises the risk profile of the credit to a point that you're no longer comfortable with it, then we try to move it out while it is still performing, let somebody else have the fun of dealing with it down the road.

Sure. I guess, to follow-up on that, is it something that you assess just on kind of a renewal type situation, or is it something that is constantly ongoing as you have dialogue back and forth? How do you best kind of I guess resolve these issues where you see trends?

Well, they are identified in a variety of ways. Our credit risk management functions certainly include an active review by officers with various levels of loan authority, or the loan committee at times of new credit extension or renewals. They also include active review by our loan review function, which is one of the departments that we expanded significantly over the last 18 months, as part of our corporate growth initiatives was to increase and expand our staff and internal audit and loan review departments, our risk management team. They get looked at by me and division presidents as part of a monthly past due process. Loan officers do, in the process of managing their individual customers, particularly if it's a type of customer that has accounts receivable inventory financing that's on a borrowing base, those sorts of customers are looked at on a monthly basis by the account officer. So it's the approving authority officers, whether that's a loan committee or below loan committee level of authority, it's loan review, it's the monthly past due review and management process, and it's the account officer's review of those things. So there are a lot of different people who look at our credit quality from different angles and write reports on it and made recommendations and try to identify problems. Hopefully, if all those things are working well, you identify a lot of problems and work them out before they ever become the sort of problems that hit your ratios.

Okay, great. Thank you very much.

Charlie Ernst.

George, two quick questions. The loan sale, or the loan origination range that you've given, do you think the higher end or the lower end is more likely, based on what you're seeing?

Charlie, that's why we give you a range, is because we don't know. I would like to hit the high end but based on our second-quarter results, I guess we wouldn't feel too terribly bad about hitting the low end. But our belief is that while this will bounce around from quarter to quarter, that if you take like the next four quarters and annualize them, I think we will be somewhere in that mid teens to low 20s growth range for loan growth. That's about as precisely as I can get.

Okay. Then there are a couple of borrowing categories on your average balance sheet, look like the pricing was down in the quarter. Is there any color you can add there?

You know, Charlie, I haven't studied that enough to give you any color. I apologize.

Not a problem. Thanks a lot.

Brian Martin.

Just a few questions here. You talked about the mortgage this quarter and just the investment you made last year, kind of seeing some dividends being paid. Can you just comment a little bit on the -- you also invested last year in the C&I. I guess just wondering, given that the construction was up a little bit this quarter and commercial real estate was down, can you just talk a little bit about what your expectations are? Is that just a little bit slower to develop at this point? Is it developing as you expected? Kind of what your outlook is on the C&I exposure?

The C&I piece was a positive growth piece. From March 31 to June 30, our C&I book when from 162 million to 172 million, so it went from 9.4 to 9.8% of our portfolio, so that was good growth. Those guys actually had to overcome about a $12 million pay-down. We had a credit that we had originated for a customer that we knew wasn't going to be a real long-term credit, but it ended up being about a 40-day credit, and we had thought it would be a six-month to a year credit. The customer just simply didn't need the credit facility anymore. They had to overcome a $12 million headwind with a payoff there.

So the C&I guys and our increased focus on that category of business is I think a positive. It's still going to be a smaller part of our business because we've got a whole legion of guys that are basically veteran real estate guys in the Company. So, it's going to take a while to see that number become a bigger percentage.

But if I look at December of '05, C&I accounted for 8%. December of '06, it accounted for 8.9% of our loans. June 30 this year, it accounted for 9.8% of our loans. So if I can keep that going 10, 11, 12, 13 over the next year or two, that would provide a meaningful, meaningful chunk of growth to us. We are pleased with that, very pleased with that.

Okay. Then, I guess you touched on a little bit the pay-downs in the quarter. The first quarter, you had mentioned you had a handful -- you just mentioned one now. I guess when you look at the second half of the year, do you see much in the way of payoffs, or is it pretty normal relative to what you see in the first half? Can you give any color there?

Well, I hope that our level of large loan payoffs, which we've had three or four pretty good chunks of loan payoffs in both the first and the second quarter, I hope that level of payoffs will slow a little bit, but you just can't predict those things. A lot of times, you don't know about those sort of things until they are imminently upon you. So, it's impossible to predict that. I would hope that the level of paydowns that we've had from sales of property and so forth would be less in the second half than in the first half. But I can't assure you that would be the case. A lot of our customers have elected to sell some pretty good-sized properties or pretty good-sized portfolios of properties or refinance them, really long-term non-recourse secondary market long-term fixed-rate things that our balance sheet management just doesn't allow us to do. So we've had some payoffs, particularly from sales of property in both Q1 and Q2, that provided some headwinds to our growth. We've got them. We've got to pick up the pace and find good new business and overcome that.

Not to beat a dead horse up on the construction piece of the business, but you talked about where the concentration was of the growth. But when you look at that portfolio geographically, of the entire portfolio, can you give a little color where the greatest geographic exposure is?

We've got -- our portfolio is broken into submarkets and stratified by 99 collateral codes over all of those submarkets. We get a very detailed report that I don't have in front of me right now that prints out -- that stratifies that portfolio based on that. To print it out, you print it in almost microscopic little print that old guys like me have trouble reading on four legal pages. Then you can lay them into a quad and see the whole report all at once. Then we stratify the portfolio by geographic market and product type based on risk rating so that we can assess any migrations of risk ratings in different markets and different product types. I don't have all of that information in front of me, and it's voluminous and not something you carry around in your pocket.

I would tell you that Texas accounts for a large part of the construction and land development portfolio, particularly the Metro Dallas area. We are fairly comfortable with that book of business. As we are really with our construction land development and CRE portfolio in general, again with the considerable asterisk there about Northwest Arkansas being a market that, particularly on residential lots and residential home construction, is overbilled -- but generally, we feel very good about the portfolio.

Just the last two -- the last quarter, you mentioned that there were no construction or lot development loans that were added to the nonperforming loans in the quarter. Was that the case this quarter as well, or did you see some movement to that area?

Nothing of huge significance. The most significant item and probably the only item that would even merit discussion is we had a customer in northwest Arkansas that we took back six houses on, that went from performing the nonperforming to OREO in the quarter. In fact, the last day of the quarter, we got the deed to the properties. So, they went all the way straight through in those six houses. I mean, these are very entry-level houses. Our total credit exposure there is like $640,000 in the aggregate. So, that's the only thing of any consequence in the construction and land development portfolio that went into non-accrual or OREO status that was performing at the beginning of the quarter. As far as I can recall at this moment, that's the only one of significance.

Okay, because of northwest Arkansas, you mentioned there were certain price points and subsets that were I guess more concerning or more problematic. Is that the lower-end stuff or is it the higher-end stuff?

Well, it depends on the markets. We've got customers in other submarkets there that are still actively building and actively selling product in that price range. This particular builder got way out over his skis. We had a small credit line with him that allowed him to build those six houses. My understanding is that he had 50 to 60 houses with another bank, and 5 with a third bank. So we were glad to be a small part of that problem instead of the large part of that problem. But the submarket where these houses are is not as vibrant as the same price range houses in another submarket. But with that said, we've got a buyer -- we've had him in OREO two weeks. We've got a very active buyer that we think will convert to a contract for one of those houses within the next week or two. So, again, I'm not terribly concerned about any of that. I think all of those properties up there have been pretty adequately written down and I think we will basically be at about a breakeven on the liquidation of that portfolio. We've been pretty conservative in our valuations and discounting those to net present value based on some pretty conservative assumptions, I think, about holding periods and so forth.

We've seen some news regarding some fraud in the North Carolina market. Is that anything you guys have noticed with -- as you've been study your underwriting and just the credit administration -- have you guys seen any type of increase there?

No, we have not.

Lastly, can you just comment -- and I'll hang up and listen and let someone else ask a question. With your long-term or longer-term expectation, you talk about a little bit more focused on the margin, given where your margin is at now in the last two quarters and the competitive forces in the market, can you give some color or just some thought as far as where you think, once we get a little steeply into the yield curve here, what type of margin is approachable over the next maybe 18 months or 2 years, you know, where you can get that number back up to and maintain?

I cannot give you any color on that. There are just too many variables and too many circumstances that are totally outside of our control and unknowable and unforeseeable by us to try to predict that. What I can is reiterate the guidance that I gave a couple of times in my prepared remarks. That is that our goal for the remainder of this year is to hold that margin at the 2Q level or improve it slightly. I would repeat that I said further improvement in it is going to be more difficult to achieve than the advances that we gained in Q1 and Q2. But our goal is to try to improve it slightly or hold it at the second-quarter level. That's all I can intelligently say on the subject.

I appreciate your time. Thanks, George.

Adam Parker.

Morning, boys. George, nice quarter there. I just have a very quick question related to the sales of investment securities and other assets. Are there any loan sales included in that other assets category?

No, there are not.

Would that be something you would think about, going forward, related to the mortgage lending?

We sell all of our mortgage loans. When we commit to the customer, we have a commitment on the other side. We don't portfolio any of our available-for-sale mortgage loans. In our rural markets, we originate mortgage loans for portfolio, and we have occasional loans that originated for portfolio based on our in-house pricing metrics. But the true mortgage stuff that's 15-year, 30-year type stuff is originated by our secondary mortgage department. The available-for-sale loans, all of that stuff is committed when we commit to the customer; it's locked when we lock with the customer. That stuff is closed in our name, goes through and two to four weeks after closing, it's shipped and paid off by the investor who is previously committed (inaudible). So we take no market risk on that.

I got you.

-- no credit risk and sell it on a non-recourse servicing release basis. The mortgage income line item of our reports includes fees we originate on the -- earn on the origination of those loans; it includes our premium or discount on the sale of those loans. Depending how the loan is priced, sometimes they are sold at a premium, sometime at a discount. It includes the service release -- income from the sale of it. So in essence, gain on sale of the mortgage piece is all recognized in that fee income line.

Great. What have you experienced in terms of the pricing just over the past quarter? Has it been improving, been more or less what you saw in Q1 in terms of gain on sale?

Since we have them -- we're working really for a targeted margin on every loan. Since we are not holding the things in portfolio and accumulating them and then selling them, we don't see considerable variation in our gain-on-sale income like some financial institutions and mortgage companies that accumulate them in large chunks and then sell them and may have a big gain or may not have a gain, depending on what's happening to the market in the interim. Ours are committed on both sides when we do it. So what I think we've seen is a minute improvement in our overall profit margin on. It's like 1 or 2 or 3 basis points. I don't remember that number exactly, but it's low single digit improvement in our profit margin. That's just part of our mortgage guys' efforts to try to tweak the margins ever so slightly. It is extremely slight. So basically, you could say no change and you would pretty much be on-point there.

Great. That's all I was looking for. Thanks, George.

There are no further questions at this time, sir. Do you have any additional closing remarks?

Thank you very much for joining our call today. We appreciate it. Since there are no further questions, that concludes our call. We look forward to talking with you in about 90 days. Thanks much. Have a good day. Bye-bye.

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