Bank Ozk (OZK) 2007 Q4 法說會逐字稿

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

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 fourth quarter and full year 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, expectations and outlook for the future, including statements about economic, competitive and interest rate conditions, revenue growth, including our goal of achieving revenue growth at a rate in excess of our rate of increase in non-interest expense, net income, net interest margin, including our goal of maintaining and possibly improving net interest margin from the level achieved in the fourth quarter of 2007, net interest income including our goals of increasing net interest income in each quarter of 2008, and growing net interest income in 2008 at a faster rate than in 2007, non-interest income including service charge, mortgage lending, and trust income, non-interest expense and our goals for maintaining our rate of increase in non-interest expense below our rate of revenue growth and, thereby, achieving positive operating leverage, asset quality, including expectations for the timing of resolution of problem assets in the portfolio of a former loan officer, residential mortgage market conditions, future growth and expansion including plans for opening new offices and a new corporate headquarters, loan, lease and deposit growth, and changes in our securities portfolio.

You should understand that our actual results may differ materially from those projected in any forward-looking statements due to a number of risks and uncertainties, some of which we will point out during the course of this call.

For a list of certain risks associated with our business, you should also refer to the forward-looking information caption of the management's discussion and analysis section of our periodic public reports, 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.

Good morning, and thank you for joining today's call. At the beginning of 2007, we stated four key goals for the year, which were 1) accelerating our rate of revenue growth; 2) decelerating our rate of increase and non-interest expense; 3) maintaining or improving net interest margin from the level a achieved in the fourth quarter of 2006; and, 4) maintaining good asset quality.

We also stated that we wanted to get back on a record earnings pace by year-end 2007 after pursuing our significant deposit, branching and corporate growth initiatives in 2006. When I spoke to you last quarter, we announced record third quarter earnings and at that time I expected to be announcing record earnings in our call today.

However, due principally to losses from unusual and inappropriate activity related to the portfolio of one former loan officer, we are reporting fourth quarter results short of those expectations today. We will get into the details of that issue later in the call.

In our call today, I want to discuss our 2007 plan and how it played out, the unusual situation which led to our fourth quarter earnings shortfall, and most importantly, our plan and expectations for 2008. The good news is that our 2000 plan produced good results and we expect to pursue a very similar plan in 2008.

The first key goal of our 2007 plan was to accelerate our rate of revenue growth. If you only compared total revenue growth rates for 2007 and 2006, it doesn't appear that we achieved much acceleration. Total revenue for 2007, that's net interest income and non- interest income combined, increased 7.1% from 2006 and this was only slightly better than our 7% year-over-year growth rate for revenue in 2006. However, when you look at the quality and composition of our 2007 revenue growth, we are very pleased.

Let me give you some details. Net interest income is by far our largest revenue component, typically accounting for about three fourths of our revenue. In 2007, we achieved record net interest income in each quarter, with total net interest income for the year increasing a respectable 9.8% from 2006.

During the year, our loans and leases grew 11.6%, somewhat below our expectations, but still sufficient to give us good growth and earnings assets and, thus, good growth in net interest income. Our second largest revenue component and traditionally our largest source of non-interest income is service charges on deposit accounts, which increased 19.3% in 2007 compared to 2006.

Service charge income for the year of 2007 and the fourth quarter were annual and quarterly records, respectively. A number of factors contributed to this excellent growth in service charge income in 2007 including 1) enhancements made in late 2006 to our processes for applying and collecting service charges; 2) the large increase in our number of deposit accounts from our 2006 deposit growth initiative; and, 3) some small adjustments in early 2007 in our service charge fee schedule.

Trust income in the quarter just ended was our third largest revenue component and our second largest source of non-interest income. Trust income increased 14.2% in 2007 from 2006 and trust income for the year of 2007 and the fourth quarter were also annual and quarterly records, respectively. In fact, we've achieved quarterly records for trust income in both of the last two quarters.

Over the last two years, we've seen excellent growth in our trust business, especially in our personal trust and Investment management business. This good growth in net interest income, deposit account service charges and trust income was somewhat offset by a decrease in mortgage lending income which declined 8.6% in 2007 compared to 2006, and also by a lower level of net gains from sales of investment securities and other assets, which totaled only $1.007 million in 2007 compared to $3.827 million in 2006.

Now, obviously, we like mortgage income and would like it to be higher and we alway like to have gains from sales of investment securities and other assets, but these two sources of revenue are more cyclical, less predictable and less dependable than revenue sources such as net interest income, service charges on deposit accounts and trust income . Thus, we feel that the quality of our revenue growth in 2007 was excellent.

The second key goal of our 2007 plan was to decelerate our rate of increase in non-interest expense and we probably exceeded most everyone's expectations in this regard as our non-interest expense increased only 4% in 2007 from 2006. This was a significant deceleration from the 15.7% year-over-year increase in 2006.

Our third key goal for 2007 was to maintain or improve our net interest margin from the 3.22% level achieved in the fourth quarter of 2006. Our net interest margin showed a generally improving trend in 2007 and was 3.44% for the full year. We were pleased with our 3.47% net interest margin in the quarter just ended, which was our best in the last six quarters.

Therefore, in regard to each of the first three key goals of our 2007 plan, we feel that we accomplished our objectives very well. Now, let me give you the 2008 version of these goals. As I said in our press release, our key goals for 2008 include achieving further positive operating leverage by once again achieving a faster growth rate for revenue than non-interest expense.

Our key goals for 2008 also include continuing to improve net interest income each quarter by maintaining or possibly improving net interest margin from the level achieved in the quarter just ended and achieving good growth in earning assets which will primarily be loans and leases.

Let me give you nine specifics regarding those expectations and those goals: 1) Notwithstanding that our loans and leases increased only 11.6% in 2007 and even considering that we expect a somewhat slower level of U.S. economic activity in 2008, we believe that for 2008, we will achieve growth in loans and leases from the low teens to the high teens in percentage terms. In other words, we believe that our lending and leasing teams will produce good loan and lease growth even in a slower economy;

2) In addition to loans and leases, our investment securities portfolio provides the second component of our earning assets. In 2007, our investment securities portfolio declined $42 million as the combined volume of sales, maturities, principal pay downs and call securities exceeded new purchases. At this time, we are not expecting substantial growth or shrinkage in the size of our investment securities portfolio in 2008. However, as I've said many times, we will be a buyer of securities when we believe it is an opportune time to buy and we will be a seller of securities when we believe it's the appropriate time to sell;

3) We expect to fund our growth in earning assets in 2008 primarily through deposit growth. Now, we will not pursue the same sort of broad based aggressive deposit initiative that we did in 2006, but in selected markets, we will also not be as conservative regarding deposit pricing, marketing and growth as we were in 2007;

4) In regard to net interest margin we believe that our goal of maintaining or possibly improving net interest margin from the 3.47% level achieved in the fourth quarter of 2007 is a reasonable goal. We continue to believe that we are close to neutrally positioned from an interest rate risk perspective and we do not believe that we will be significantly affected, either positively or negatively, by Federal Reserve interest rate changes, if such changes continue to occur in relatively orderly increments and intervals and don't go to extremes either way;

5) Accordingly, based on our expectations for good loan and lease growth, and stable to possibly improving net interest margin, we think that it is a reasonable goal to expect that we will achieve record net interest income in each quarter of 2008. In fact, our goal is to achieve growth in net interest income in 2008 in excess of the 9.8% growth rate of 2007;

6) We expect some growth in income from deposit account service charges in 2008, but we believe that growth rate will be well below the 19.3% growth rate achieved in 2007. We believe that most likely this growth rate will be in the mid single-digits. Also, let me remind you of the seasonality of this income over the last five years. On average, the first quarter has typically accounted for only about 22.5% of each year's income from deposit account service charges;

7) We expect continued good growth in trust income in 2008 and considering current economic and financial market conditions, our expectation is for that growth rate to be in the low to mid-teens percentage range, modestly below the level achieved in each of the past two years;

8) Our expectations for mortgage lending income in 2008 are very modest, given the low level of mortgage lending income achieved in the fourth quarter of 2007 and the significant challenges continuing to overhang the housing and mortgage finance industries in general, and, finally;

9) In regard to non-interest expense, we have a modest office opening schedule planned for 2008, just three new offices including our new corporate headquarters which will probably open late in the fourth quarter of 2008. Given the economic environment at this time, we expect to maintain a particularly strong focus on controlling non- interest expense in 2008.

While we will continue to carefully control non-interest expense, we also want to continue to grow and expand our franchise and this requires some increases in non-interest expense as we add new people and a few new offices and otherwise spend to operate and build our business. Accordingly, we are expecting this category of expense to grow in the mid single-digits in percentage terms in 2008.

Another of our key goals for 2007 was to maintain good asset quality, and except for the unusual circumstances related to the inappropriate actions of the single lender in the fourth quarter, I think we achieved that goal as well. Let me address that exceptional situation, and then I'll speak to our expectations for asset quality in 2008.

During the fourth quarter of 2007, we incurred approximately $1.046 million of net charge-offs, that's 47% of our total net charge-offs for the quarter from problems identified in the portfolio of a single lender. In addition, we had approximately $115,000 of interest income reversed related to these problems, approximately $265,000 of additional provisions for potential future loan losses associated with classified assets in this former officer's portfolio, and approximately $25,000 of related charges to general ledger accounts.

Accordingly, we estimate that the total negative impact of this situation on our fourth quarter results was approximately $1.450 million pre-tax. The inappropriate activity was discovered by our internal auditors in the routine performance of this, of their duties. This lender, upon being confronted about the inappropriate activity with certain loans, deposit accounts and general ledger accounts, resigned in lieu of termination.

Because the resolution of a number of these problems is ongoing and because we're still contemplating a possible bond claim related to some of these inappropriate activities, and other possible actions to mitigate our losses I'm going to limit the additional details provided at this time. With that said, in the period of approximately seven weeks between the mid-November discovery of this situation and year-end, a number of our talented and capable officers addressed this situation very effectively.

I believe that they've identified the significant problem loans in this former officer's portfolio, determined as best we presently can the magnitude of all current and potential losses from the portfolio, charged off all determinable losses that we could have identified as of year-end, and appropriately reserved for any potential loss exposure that was not fully determinable as of year-end. I believe that as of year-end, you are seeing the worst case scenario of the impact of this loan officer's portfolio. Let me explain what I mean by that.

By year-end, we believe we had identified and provided for substantially all the problem assets, but we had not yet had time to actually resolve and liquidate any of those problem assets. That process is now underway. This former officer's portfolio significantly impacted our various asset quality ratios as of year-end.

Specifically, it accounted for 27% of the increase in our past due loans and leases from September 30 to December 31, 2007. It accounted for 46% of the increase in our non-performing loans and leases in that quarter, and 38% of the increases in our non-performing assets in that period. While each of these ratios would have been up in the fourth quarter even without the unusual circumstances associated with this former officer's portfolio, such increases would have otherwise been much more in line with the normal ebb and flow of our asset quality ratios.

Over the next several quarters, we expect to resolve and liquidate a large portion of the problem assets from this loan officer's portfolio. This should help us return our various asset quality ratios to more normal levels during 2008. Our Company has a history of maintaining excellent asset quality and even with the higher level of charge-offs in 2007, and particularly in the fourth quarter, and the higher levels of non-performing loans and leases, non-performing assets and past due loans and leases as of year-end, I believe that our asset quality results for 2007 will still compare favorably with results for the industry at the current time and considering the current economic environment.

Our key asset quality goals for 2008 include basically two things. First, we want to quickly resolve the unusual and unexpected problem assets from this former officer's portfolio. We expect it will take several quarters to whittle down the problems to a level which will no longer noticeably impact our overall asset quality ratios, and, second, we want to continue to otherwise maintain strong asset quality.

We have a great group of lenders, a strong credit culture and a long history of excellent asset quality results. The misconduct of one former loan officer should not unduly reflect on our remaining team of outstanding and professional bankers.

Let me share one additional thought before I leave this subject. We have a track record and a reputation for achieving excellent financial results, and that's a good thing. But it is far more important to me and I believe far more important to most of our staff that we maintain our reputation for impeccable character, unquestionable honesty and unwavering integrity. I believe that every member of our staff realizes that the conduct of each one of us reflects on the others. As we've been dealing with with the problems created by this former loan officer in recent weeks I've been greatly encouraged by knowing the deep committment of our other team members to matters of character, honesty, and integrity.

We started 2007 on a quest to get back on a record quarterly earnings pace by year-end. We accomplished that goal in the third quarter only to have our plans for another record quarter in the fourth quarter derailed by an unusual event. Notwithstanding this situation, during the fourth quarter we continued to have good revenue growth, improved our net interest margin, and continued to do a good job controlling non-interest expenses.

We believe this strong momentum puts us in an excellent position to get back on a record quarterly earnings pace during 2008, and hopefully we will accomplish that goal earlier in 2008 rather than later in the year, but I should remind you that the first quarter is always a challenging quarter. With that said, I assure you that our entire management team is focused on building long-term shareholder value.

We are committed to achieving earnings growth in 2008, and returning to a level of record quarterly earnings as soon as possible. That concludes my prepared remarks today. At this time, we will entertain questions.

Let me ask our operator, Miranda, to once again remind our listeners how to queue in for questions. Miranda?

(OPERATOR INSTRUCTIONS) Your first question comes from Barry McCarver from the company of Stephens Corporation.

Good morning, Barry.

Good morning, George. George, I know you don't want to talk too much about this particular situation, but I was wondering if you could tell us kind of the extent to the unusual activity? Are we talking about fraud here, or just serious activity outside the lines that you laid fourth?

Well, Barry, I used the term, I think in my prepared remarks, unusual and inappropriate, and you know in our politically correct society we use the term "inappropriate" to describe all sorts of grossly improper behavior, and I'm going to stick with that terminology.

As I said in my prepared remarks, because the resolution of a number of these problems is ongoing and because we're still contemplating a possible bond claim and other possible actions to mitigate our losses, I'm going to be somewhat limited in the additional details I provide. You know, the purpose of our call and our public disclosures in my view is to provide useful information to understand our historical financial results and our prospects for the future, and I've already stated what I believe is important in that regard that we've identified the significant problems in this former officer's portfolio.

We believe we've determined as best we presently can the magnitude of all current and potential losses from the portfolio. We've charged off all of those determinable losses as of year-end, and we think we've appropriately reserved for any potential loss exposure that it was not fully determinable.

I've also disclosed the aggregate fourth quarter impact on earnings at approximately $1.450 million pre-tax. So that's, I think I've said what I need to say to give us the information to understand the fourth quarter results and the prospects. I'll add a few more comments to that.

First, I'll comment that our internal audit function performed very well in identifying this problem. However, I can also tell you that the sensitivity of both our internal audit and loan review functions to the types of inappropriate transactions involved in this situation has been heightened. Second, I know that all observers of the financial service industry are carefully monitoring construction and development loan portfolios and I can tell you that this former officer's portfolio was very diversified and not predominantly focused on construction and development and the same is true of the problems that we identified in his portfolio.

They're predominantly not construction and development issues. It's a very diversified little group of loans that contributed to the problems. Third, I also know there's significant attention being given to loan portfolios in Northwest Arkansas and while I'm not going to identify the officer or the office involved, I will say that the loan officer was not located in Northwest Arkansas and none of the problem assets, or at least nothing significant that we've identified in this portfolio were in Northwest Arkansas.

And finally, I would comment that while many of the loans that became problem assets were originated earlier, the vast majority of the unusual and inappropriate transactions which led to our significant losses in this situation occurred in an approximate six-month period through mid-November of 2007. These losses materialized rapidly when, for example, additional credit was improperly extended by the loan officer, based on collateral already securing existing loans, unsecured loans were extended in inappropriate circumstances.

Substantial inappropriate overdrafts of customers of this former loan officer were allowed. Insufficient actions were taken to protect and secure existing collateral and pay-offs were misapplied to loan customers' checking accounts as opposed to being applied to pay off the loans. I think that probably, with the comments I've already given, gives you guys a pretty clear picture and tells anyone running a model of our earnings what they need to know as far as that, and with that said, I'm going to limit my comments to that point. Thank you for the question.

George, you got a bunch of my questions there. I appreciate the extra detail.

Okay.

I guess just in terms of asset quality trends, outside of this one event, it certainly sounds like a small uptick in the fourth quarter outside of this event, but you're not immediately concerned about kind of what's out there on the horizon, is that a fair thought?

Well, I can can give you and -- let me just give you some general comments, numerous comments, I guess, and expectations regarding asset quality and what we expect to see ahead. You know, despite the unusual situation that impacted our fourth quarter asset quality results we're actually cautiously optimistic about asset quality for 2008.

Yes, our past due and non-performing ratio certainly increased in the fourth quarter and I've already noted that, and a substantial portion of that increase was related problems in this former officer's portfolio, and those ratios would have increased even without those unusual circumstances. But as I've already said those increases would have been much more in line with the normal ebb and flow of asset quality ratios.

Over the last quarter, we have seen economic conditions slow somewhat, but we continue to believe that our markets are doing better than many markets throughout the country, and in particular, we're positive about our Texas operations which accounted for most of our loan growth this past year. At the beginning of 2007, our Texas offices accounted for 7.5% of our total loan and lease portfolio and that number had increased to 9.4% to 16.9% of our total loan and lease portfolio as of year-end. So Texas was most of our growth last year.

Now, job growth, population growth and home sales in the metro Dallas area have slowed in the past year, but these statistics even recently continue to reflect very favorable economic conditions. Most places would be happy to have those conditions, even in good times.

The same is true to a large extent of our North Carolina markets which, of course, are principally in the metro Charlotte area. North Carolina also has been a good growth market for us in 2007. It increased over the course of the year from 4.3% of our total loan and lease portfolio to 5.0% of our total portfolio as of year-end.

Similarly, market conditions in our Central Arkansas markets and rural Arkansas markets have slowed. No doubt about that, but I would still characterize conditions in these markets as generally healthy. Our principal source of concern economically continues to be Northwest Arkansas as it was throughout 2007 and ironically, this is still a market with very positive population and job growth. The most recent data that's just, I think, a month or so old, shows that the two-county area is still creating about 470 net new jobs a month and having a population growth of about 900 a month.

So this is still a very positive market economically, but it's still as we all know, it's been well publicized now, suffering from a significant oversupply of houses and residential lots. That market seems to be moving in the right direction, but it's still got a good ways to go before it reaches a normal supply/demand equilibrium.

More recently, in Northwest Arkansas, we've also seen a slower level of activity in commercial real estate as well. However, Barry, I'd tell you we continue to be cautiously optimistic regarding our portfolio in that market. Frankly, I feel better about the Northwest Arkansas portfolio now than I did a year ago. I guess to summarize that, I think we're benefiting from being in moderately healthy markets at a time when many other states are seeing significant property value declines, higher vacancy, and inventory rates run so homes escalating foreclosures and so fourth.

With that said, anyone who reads newspapers certainly realizes that economic conditions throughout the U.S. are slowing and we're not naive enough to think that we would be immune from the impact of that. Our net charge-off ratio in the fourth quarter was 47 basis points, and for the full year of 2007 was 24 basis points.

If you adjust those charge-off ratios by subtracting out the $1.046 million of losses associated with the portfolio of that former loan officer, our net charge-off ratio for the fourth quarter would have been 25 basis points, and for the full year of 2007 would have been 18 basis points. So those are up from where they've been in recent years certainly reflecting even on an adjusted basis a higher level of charge-offs.

Given prospects for generally slower economic conditions in 2008, it seems unlikely that we can do much better than probably that adjusted 18 basis point charge-off. That's equal to our net charge-offs last year excluding the fourth quarter losses from that one loan officer's portfolio. On the other hand, the adjusted fourth quarter net charge-off ratio of 25 basis points, again excluding the losses from that loan officer's portfolio, seems like a high number to me.

Accordingly, my expectation is that our net charge-off ratio in 2008 will probably be somewhere in a range between those two numbers of 18 and 25 basis points, and take that the with a grain of salt because actual results will ultimately depend on how much the economy slows and our assumption is that in our markets we will see moderate, but not severe slowdowns in economic activity and declines in property values. That's sort of all of our thoughts, I think, summarized on asset quality.

Okay, George, thanks, you also tackled my loan growth question as well so I appreciate that. Thanks a lot.

Thank you, Barry.

Your next question comes from Charles Ernst, from Sandler O'Neill.

Good morning, guys.

Good morning, Charles.

A question on the loan growth expectations. A year ago, you guys gave guidance and you came out a little bit below that, the actual number in '07, and it looks like the economy right now is expected to be weaker in '08, and so I was just wondering if you could talk a little bit about why you are still pretty optimistic on your overall loan numbers?

Charlie, I'd be happy to address that, and again, the low teens to high teens number is the number we've given and that is a deceleration from our guidance previously given, just in response to the fact that we just didn't get there in 2007. But I'm pretty optimistic about our growth for next year, I guess, because we've got a very good pipeline and a lot of our competitors have been sidelined with some fairly significant asset quality issues.

So, and a lot of the people that the were doing really aggressive stuff are out of the market and have maybe permanently gone away from the lending business, particularly non-bank competitors that we saw doing some pretty aggressive stuff a year ago or so, but those guys funding sources and so fourth dried up.

We're getting opportunities to do business with some very high end customers, substantial net worth people who have substantial equity sources for their transactions and bring a lot of money to the closing table on deals that gives us a lot of comfort.

And our underwriting standards, we did not loosen our underwriting standards in the course of a very favorable and aggressive lending environment that existed in much of '06 and much of '07. And as some of the more aggressive lenders have developed problems and have gone to the sidelines, we're finding that our standards for equity contributions to deals and guarantees on transactions are much more acceptable to customers than they were 12 months or 24 months ago when somebody would finance it with little or no equity contribution and limited or no guarantees and we were requiring substantial equity contributions and substantial guarantees.

So I think the market as far as deal structure, pricing terms, equity requirements has come back to our standards considerably and a number of competitors have gone away, and we believe that's going to help us get more business in 2008.

Okay, and you've said a lot about this lender and I apologize for asking yet another question, but can you just say whether the lender was in or outside of Arkansas?

The lender was in Arkansas.

In Arkansas. And I think you alluded to the fact that there were some policy changes. Is that a fair assumption to take from your comments?

Oh, no, actually, there are no policy changes. What I said was that the sensitivity of our loan review and internal audit functions to the types of, specific types of transactions that resulted in these losses has been increased. I would point out that internal audit uncovered this.

They uncovered it pretty quickly, really, within six months of the time it actually began to really get going in a significant way. So I think our internal audit function performed very well in this regard and we've not significantly changed any of our routines and controls there, but I guarantee you that the guys who actually perform that are in the broad array of transactions that internal audit looks at and the broad array of things that loan review looks at.

I will guarantee you that as they've post-mortemed this problem situation, they are looking even more closely at those sort of transactions and entries and so forth than they were previously, although these were all things that were on their review list before. So there's not really change in policies, it's just a heightened awareness that this was a very unusual situation and it was executed in a very unusual and complex way and the sensitivity to making sure it doesn't occur again is heightened.

Okay, and then with regards to the margin, George, it sounds like you're probably a little bit liability sensitive. Is that fair to say?

Well, as I said, I think we're about as close to neutral as we can get. We ran our budget for 2008 and when we stressed that budget with various rate changes up and down 200 basis points, I think our net interest margin, Paul, moved 6 or 8 basis points up or down from what's in the budget, and the budget is based on just one additional Fed cut and then a stable environment.

That's probably not exactly right, but when we ran that and we ran a plus and minus 200-basis-point step to rate scenario from the Fed, I think we were 6 or 8 basis points up and down was the full range of net interest margin scenario. So we think we are very close to neutrally positioned.

Okay, and you mentioned though in your comments that you talked a little bit about sort of a big change in rates and that that would have other effects. Could you just add a little bit of color as to what those effects would be?

Well, what I was envisioning, obviously, if the Fed instead of cutting in quarters and halves cut in 100-basis-point increments, and I've been doing this 29 years so I remember Paul Volker, when rates moved a point at a time. But if the Fed moved in 100-basis-point increments, that would cause some distortions short-term.

We -- 49.8% of our loan portfolio is variable rate as of December 31. Now, 29.7% of that 49.8%, so basically about almost 15% of the total portfolio is at a floor rate, and we put floor rates on a lot of our variable rate loans, and because we've had 100-basis-points Fed cuts a lot of those loans have hit their floors. Very few of those loans, I think, 3% of that 49.8% approximately are at a ceiling rate, 3.6% are at ceiling rates.

So with a Fed cut that is also accompanied by prime rate cut, roughly 35% of our loan portfolio is going to adjust down in rates pretty quickly assuming LIBOR and prime both move. So it takes us, typically with a quarter point Fed cut, it takes us about six to eight weeks, six weeks I think is sort of the average to reprice enough CD's and core accounts to offset that increase.

After that six weeks, we actually get some slight benefit from that. So if the Fed came in and dropped rates 100 basis points at once, it might elongate that six weeks somewhat further. We would have to run some scenarios on that. But if the Fed came in and did 300-basis-point cuts or something, then there would be such an unpredictable set of ramifications, how customers and competitors would respond to that, that it would be hard to predict.

But I think if the Fed keeps moving in quarters or halves that our models are pretty good and our assumptions are pretty tight on how that would play out.

Okay, and then can you just generally say the overall deposit assumption in the rate scenario analysis, are you assuming that the mix doesn't change a lot over the year or what are you doing there?

We are assuming probably a slightly higher reliance on jumbo deposits over the course of 2008. Is that accurate, Paul?

Yes, that's right. (inaudible)

And as Paul mentioned there, I don't know if you could hear him or not, but he commented that the plan and the budget and the marketing plan for all next year are predicated upon funding the earning asset growth principally with deposit growth. I think I mentioned that in my prepared remarks.

As I said also in selected markets aren't going to be quite as conservative on deposit pricing as we were this year. That should help us achieve a higher deposit growth rate, but that's not going to be hyper aggressive and it's not going to be a widespread adjustment in strategy, and, hence, we think the broker deposits and other jumbo pieces of our deposit portfolio will probably slightly outgrow the rest of the portfolio next year as a growth percentage.

Okay, great. Thanks a lot, you guys.

Okay, thank you.

Your next question comes from Peyton Green from FTN Midwest Securities.

Yes, George, I was wondering if you had identified the total size of the portfolio of the lender or the loans that moved to 30 days plus in terms of the exposure there?

Well, Peyton, you can can calculate that from the percentages that I gave you in the call. I don't have those numbers, but as I said in the call, 27% of the increase in our past dues from September 30 to December 31 were related to his portfolio; 46% of the increase in our non-performing loans and leases from September 30 to December 31 was related to his portfolio and if you add in (inaudible) repos and non-performing loans, 38% of the increase in our total non-performing assets.

Great, I'm sorry I missed that. Okay, and then in terms of your usage of brokered CDs, historically, you all have used those or [borrowings] depending on what the lower cost source was, to what degree were you using them at year-end and where is your most favorable opportunity if deposit growth is a little more difficult to come by?

Okay, as of year-end, December 31, 2007, our total brokered CDs, let me make sure I'm reading this right, yes, $331 million in total brokered CDs as of year-end.

Okay, so I guess that was up a little from the prior quarter?

Yes, actually, up a bunch from the prior quarter. At the end of the prior quarter that number was $253 million.

Okay.

And, frankly, the reason for that increase, that was, I'll also give you another point, that number was $281 million, or $282 million at December 31, 2006, so it actually was about a $49 million increase, if I'm doing the math right, over the course from beginning of year-end '07 to the end of year-end '07.

And our increased use of those, although it was fairly modest during the course of the year, just simply reflected the fact that we could get brokered CDs cheaper than we could get incremental CD deposits in a number of our markets. There have been several articles recently in the Wall Street Journal and American Banker talking about the high cost of deposits and the deposits have not come down commensurate with the reduction in the Fed funds target rate, which, of course, has moved 100 basis points so far, and so far we've been able to move our deposit cost down about 70 basis points.

Now, if the Fed quits moving and we continue to reprice CDs lower, we would ultimately catch up to that 100 basis points, but it's certainly a challenge.

I know there's also been some articles recently that the possible acquisitions of Countrywide and WaMu who have been very aggressive, national CD depositors may help rationalize that situation, and certainly, the aggressive national CD pricing from competitors who have a vast need for funds and have had some of their other funding sources perhaps go away, has certainly kept deposit costs higher. So I think we'll see some rationalization of that in 2008.

Okay, and then with respect to your CD pricing, if my calculations are correct, you saw about an 18-basis-point linked quarter decrease in your overall cost of CDs versus only about a 14-basis-point drop year-over-year.

I was just wondering, was there anymore of a pronounced repricing move on you all's part over the back half of the quarter that might benefit you more in the first quarter or have you changed your pricing subsequent to year-end?

No. We have not.

Okay.

Either way.

Okay.

Nothing unusual in the back half of the quarter from the front half of the quarter and no real change in strategy in the first half of the year.

Okay, and then on the C&D portfolio, what percentage of the total loans was that at year-end, and then, I guess, if you could give any color on how you all are monitoring that portfolio compared to how you might have looked at it six months to a year ago and any signs of stress you're seeing?

Okay, the construction and development portfolio at December 31 was 36.6% of our total portfolio, that's up 3.6% from September. The commercial real estate non-farm, non-residential portfolio was 23.8% of the total portfolio, that's down 0.4%. The construction and development portfolio, of course, everybody is monitoring those things very carefully, and that has been a big source of growth for us, continues to be, and, Peyton, I expect it to continue to be.

We're doing a lot of transactions there with very well healed regionally or nationally prominent developers that are coming to the table with 25%, 30%, 35%, 40% equity in a lot of these deals and we're doing a lot of transactions that are sizeable transactions with what the we would consider very much A-list players who have substantial equity sources and are putting a lot of equity in these transactions.

And we realize that we're in a slowing economy and doing construction and development lending in a slow economy has certain risks, but if you got people that are very skilled at what they do, they've got very good projects and very good locations, with lots of equity and in many cases high levels of pre-leasing and pre-sales then we think that's good business.

And that portfolio has held up very well for us because we've had and have stuck to our strong underwriting standards, and we think it will continue to perform very well for us because we're committed to those underwriting standards and if you got the right people and the right project and lots of equity, even in a slower economic environment, we think that's good business.

Okay, and then anything that you're seeing, I guess, in terms of the watch list that -- I mean are there more issues that you're monitoring or have you still seen things move out as things move in?

You know, our watch list and our classified asset ratios will be up as of year-end. Of course, a big chunk of that is related to this one situation with this former loan officer's portfolio. But those ratios would be up notwithstanding that, and where we have seen further stress is primarily sort of been on the low end of our portfolio, in our more rural markets, actually our more traditional markets where people are not as well heeled and don't have as much equity and thus don't have as much staying power.

And then a handful of small builders, the guys that do just a few homes, those guys typically don't have the same level of financial resources and wherewithal, so as home sales have slowed, you see a continued attrition of a few more of those guys along the way falling out and we've ended up with a few more properties from that sort of customer, and would expect to continue to end up with a few more properties. The good news there is we've had good success in marketing those properties.

You know, we had a little bit of surge in the fourth quarter of last year because, and I don't remember whether it's four , five, or six builders up in Northwest Arkansas, they were all small builders and all had one to a few homes, I think the largest one we've had any trouble with up there so far was six, six homes, and that sort of surged our non-performing ratios at the fourth quarter of last year and we've had very good success liquidating those.

We've probably liquidated two-thirds of those assets that went on the non-performers at year-end last year went into OREO in the first or second quarter of last year. We've probably sold two-thirds of that stuff. We've added a few more along the way, but we're having pretty good success liquidating those things, but with that said, I'll be honest with you, a house that a year ago or two years ago we would have moved in 30 to 90 days may take two or three quarters.

Okay, all right, great.

It's just taking longer to move stuff out of the pipe.

Sure, and then I promise last question, switching back to the deposit side and I guess the overall competitive landscape, do you see a material improvement as kind of, I guess, on both sides from the irrational loan pricing that have pushed spreads way down, and then also on the deposit side, the tendency was for people to pay up. Have you seen any material change in that in the last 30 to 60 days?

I would say that we have seen a very favorable trend in loan pricing, and even more particularly than pricing in deal structure and equity requirements and so forth from a lot of our competitors. As I said earlier, a lot of the guys who were doing really crazy stuff are gone now, or at least not active in the market at this point in time. So that is allowing us to get business that we were not getting because we were not deviating from our equity requirements and guarantee requirements and so forth a year or two years ago.

We've stayed where we thought we needed to be on those sort of requirements and the market has come back to us, and, as I told Charlie Ernst, that's one of the reasons we're optimistic about our loan growth potential for next year. We have not seen as much improvement and if anything, it's been very marginal improvement on the deposit side, and there are a lot of guys out there that need deposits. Again, the Countrywide and WaMu's of the world would be good examples of that, that are being very aggressive on deposit pricing.

And there's some local guys in different markets that, honestly, I'm not sure they've read a newspaper since the Fed started cutting rates. They don't seem to be pricing their deposits like they've read a newspaper since the Fed started cutting rates. So and that's been well documented a number of, Wall Street Journal and American Banker and other articles talking about the stickiness of deposit costs and that's a problem for the industry, but we've been able to improve our margin notwithstanding that.

We feel pretty optimistic that we can maintain or slightly improve that margin further in 2008, even given those conditions.

Okay, great. Thank you very much.

Thank you.

Your next question comes from Andy Stapp from B. Riley & Company.

Hi, guys.

Hi, Andy. Good morning.

Most of my questions, as you could imagine, have been asked. One question I do have is do you have any idea how long it's currently taking to absorb the housing inventory in Northwest Arkansas?

Andy, I don't have market data on that. I will tell you what one phenomenon that we're seeing, and one of the largest builders that we finance has operations there, as well as operations in a number of other markets, and very profitable, very successful builder, high profit margins, excellent sales results, and we're still financing houses for him in that market and there aren't a lot of guys getting houses financed in that market because of the over supply. But we're still financing houses for him and those are still selling like hotcakes.

And we've got another subdivision that we've got financed up there that is sort of a middle price range subdivision, and it's done very well and those guys continue to, they're averaging lot sale probably about every month. They've got three builders building in there and that thing is just moving along like clock work.

So if you've got the right product and the right neighborhood at the right price range, new stuff is still getting built and it's still getting sold and certain subdivisions, certain price points, certain product up there is moving very well. And that's a reflection of the fact that even the most recent data that we've got that I think is less than a month old is suggesting 470 jobs a month being created up there and 900 or so monthly population growth, so the economy is good.

There is sectors of product, though, that because it's the wrong price range and the wrong location, or it doesn't have the amenities that you really need is very dead. So there may continue to be statistically an oversupply of lots and houses up there for a long time because you've got some areas and some products that are just totally stagnant, whereas, in other areas and other product ranges, there's new stuff being put up and it's selling in a very orderly and effective manner and people are moving into the area and jobs are being created, so these new houses are being occupied and marketed quite efficiently.

It's not a market that you can really or phenomenon you can really understand just by looking at the headline statistics and saying, yes, there's 13 months of housing and it ought to be six. It's more complicated than that, and we've been very fortunate to not have too many houses or too many lots in places that the have not done okay.

The other phenomenon is theres a difference between Washington County and Benton County. The average home prices in Washington County, for example, in November of this year compared to November of last year were up 3.49%. The average home prices in Benton County from November this year versus November of last year were down 3.1%.

So there's the product that you've got in Washington County for the most part, on average and, again, they're unique exceptions for different price points in different locations, but on average, Washington County is doing a lot better than Benton County.

Okay, that's helpful, and I think you might have mentioned your level of residential construction loans to total loans at year-end and 9/30. If you did, I missed it. Could you --

I didn't mention residential and I don't have that data. Our total construction in land and land development loans at December 30 was 36.6% of our portfolio.

Yes, I got that.

That compares to 33% as of September 30. I don't have a breakout on the residential. I will tell you that the residential certainly didn't grow significantly and hasn't grown significantly in several quarters and may have actually even shrunk.

What we are seeing is a lot of commercial properties that are under construction and development, and these things include shopping centers with good pre-leasing, medical office, other medical type facilities, quite a few apartment opportunities that the we're seeing. So it's, the growth in the construction and land book is principally related to commercial type projects that are under construction as opposed to residential developments increasing.

Okay, great. Thank you.

Thank you.

Your next question comes from David Bishop at Stifel Nicolaus.

Good morning, Dave.

Good morning, George. Circling back to the deposit pricing front, in terms of some of the local banks that you're seeing are acting sort of crazy there, is there any sort of a commonality without naming names or any of these banks facing issues on the credit quality front that might lead you to believe that they're sort of trying to raise money to put that to work into new loans to sort of stave off the inevitable?

You know, Dave, I think the motivation of some of our competitors that are pricing in what we would think would be an extremely aggressive or almost irrational fashion is probably quite varied. We've got some guys that I'm seeing out there that have just a few branches and they've opened another branch or two and they're just really trying to make an inroad and they 're being exceedingly aggressive in that. There may be some guys that are being very aggressive just because of liquidity needs.

I would tell you that from the comments that I've heard our state Bank Commissioner make and have read and these are all public comments, I'm not giving away any secrets here, but from the commentary that we're hearing from those guys, it wouldn't seem that anybody is, even in Northwest Arkansas where there are some considerable problems for r some banks up there, I don't think anybody is in a failure type situation that I'm aware of, so I don't remember exactly how you worded your comment, but it implied that they were desperately hanging on.

I don't know that that's the case with anybody that I'm aware of, and the state Bank Commissioner's comments would not suggest that's the case with anybody.

Okay, and then finally, just circling back to the CD book there, any sense of how much that book reprices in the next six months to a year?

Pretty much all of it we'll reprice in a year.

Okay.

And way more than half of it we'll reprice in six months. I don't have the break down. Our ALCO guys have that down to the minute, I think, but I don't have that break down. But most of our public funds CDs, and we have a substantial public funds book of deposit, strong relationships with a lot of those customers is less than six months and most of that tends to be 30 to 90-day type deposits.

Most of the brokerage stuff we have is on a fairly laddered scale, out over a year typically. The retail deposits customers typically tend to gravitate from a six to a 13-month maturity, and most customers tend to go to the shorter end of that spectrum rather than the longer, so it's going to be heavily weighted to the front end.

Got it, thanks.

Okay, thank you.

Your next question comes from Brian Martin with Howe Barnes.

Good morning, Brian.

Hi, George, I'll keep it short, I'm sure you're getting kind of tired here. The easy things, I think you already answered this, on those NPAs greater than 30 days, not withstanding that increase relating to the lender, did you say that there really wasn't any concentration concerns within that increase in the quarter?

I don't think I said on that subject one way or the other. I'm trying to --

I guess, can you give any color as far as if there are concentration concerns within that bucket?

And you're asking about our non-performing assets?

No, no, the 30-day past due bucket.

Oh, the 30-day past due bucket.

Right.

Well, that ratio was, Paul, what was it, a 1.12?

1.14.

1.14, it was 1.11%.

Okay.

1.14%.

1.14%, 1.14%, and --

I think it was like 45 basis points last quarter.

Yes, yes. You know, no, I don't think there's any concentrations there and I'll give you a couple of pieces of little details that will give you some color on that and I'll tell you I was very disappointed in that ratio, but, there's a, we have a 10% of those past dues, the total actually 12 basis points of that 1.14% was associated with a single loan and this is a medical office building loan that we've actually talked about in a conference call a year or two ago because it went past due and it kind of skewed our numbers then.

It's a customer we've had on the books for years and years. It's a owner occupied medical office building and the guy made half of his payment the last day of the year and the other half two days after the end of the year, so if that the guy made the whole payment at the end of the year instead of two days later, that past due ratio would have been 1.02%, I guess, or 1.03% instead of 1.14%.

We had another very wealthy customer that had a pretty large loan in there that accounted for five or six basis points of that past due and he had paid, the loan came up for renewal in December. He had paid his December payment and had paid his January payment, but he was on vacation with his family and was carrying our loan documents around, I think, all over the state that he was vacationing in and just couldn't find the time to sign them and return them until after the first of the year.

So it was just that kind of quarter. You just couldn't quite seem to get anything to work just right. And we're working hard on the past dues and trying to get that ratio back down, but there's not any concentration, particularly in that past due book, either geographically or product wise that is alarming to me.

Okay.

Of course, being a credit guy, every loan that's on there is alarming to me individually, so we're working on them.

Okay, and last two things, the new banking offices in '08, are those more Texas? Are they more Arkansas or just undetermined at this point?

The first one we'll open will be in Louisville, Texas, which is a Dallas suburb. The second one that we'll open will be in Rogers, Arkansas, and the third one and the final one that we'll open next year will, I'm sorry, not Rogers, it's, give me the list. The third one will be our corporate headquarters here in Little Rock. We are replacing our existing corporate headquarters with a larger, new facility.

Right.

I've got folks out in a couple of leased spaces now. We're just totally out of space and have been totally out of space for a couple of years here and we are developing that headquarters. So that will open late in the fourth quarter, we think that's either late November or early December move-in to that facility.

Okay, and, well, while you're looking for that, the last question was, and I'll hang up then, the loan growth in '07 was all primarily Texas like you said. I guess just wondering your thoughts and you look to '08, would you expect a similar type of pattern or would it surprise you if it was all Texas in '08, or just whatever color you can offer there?

Well, we had a little bit of growth in Arkansas, a bit of growth in North Carolina and a lot of Texas and I think it will be exactly that same sort of situation next year. So in a lot of respects, we're expecting that '08 is going to look like sort of a continuation of the trends and plans that we implemented in '07.

Okay, here is this office opening. Louisville, Texas is expected to open late February. A Little Rock downtown branch here in Little Rock, Arkansas is expected to open in August, and our headquarters, they've now, the most recent schedule from our building guys is early December of 2008, so that's the plan for next year.

Okay, thank you very much.

Thank you.

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All right, there being no further questions let me thank you all for your time and attention today. We look forward to talking with you in about 90 days. That concludes our call. Thank you very much.

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