Bank Ozk (OZK) 2009 Q3 法說會逐字稿

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 third quarter of 2009 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, beliefs, estimates and outlook for the future, including statements about economic, real estate market, competitive, credit market, unemployment and interest-rate conditions, including recent changes in US government monetary and fiscal policy; revenue growth; net income and earnings per share; net interest margin, including our expectation of maintaining net interest margin in the next few quarters at a level slightly above or slightly below the level achieved in the past two quarters; net interest income; noninterest income, including service charge, mortgage lending and trust income; noninterest expense; our efficiency ratio, including our long-term goal of reaching and sustaining a sub-40% efficiency ratio; asset quality and our various asset quality ratios; our expectations for provision expense for loan and lease losses and net charge-offs in the next few quarters; our allowance for loan and lease losses, loan, lease and deposit growth; changes in the volume of our securities portfolio; potential savings from repayment of certain FHLB advances; the opening of new banking offices and the closing of the conditional sales contracts for certain nonperforming assets.

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. We're pleased to report another good quarter of both net income and diluted earnings per common share, although it was not a record quarter. There were a number of significant positives in the third quarter, including our 4.8% net interest margin, record income from service charges on deposit accounts, record trust income, a reduction in our noninterest expenses as compared to this year's first and second quarters, and a favorable 41.2% efficiency ratio.

The quarter just ended was very busy as we continued to work hard to achieve good earnings while addressing the various challenges posed by current economic conditions. During the quarter, we also had our regular annual joint bank examination by the State Bank Department and the FDIC. We have an excellent working relationship with our regulators based on mutual respect and common goals, and I would characterize our recent examination as routine and positive. As is the case almost every year, the list of classified assets which we provided examiners at the beginning of the exam was substantially the same as their list of classified assets at the conclusion of the exam.

While current economic conditions continue to pose challenges, we are optimistic about our future prospects. In fact, our optimism increases each quarter as we resolve specific asset quality problems while also generating excellent earnings and building substantial capital through retained earnings. We believe that our demonstrated revenue-generating capabilities, combined with our 9.29% tangible common equity ratio; our 2.03% allowance for loan and lease losses ratio; our relatively good asset quality, favorable deposit base, abundant sources of liquidity and essentially neutral interest rate risk position all prepare us to perform well in the coming quarters and equip us to capitalize on numerous opportunities which we believe will arise.

We have a lot to talk about, so let's get to the details. Net interest income is our largest source of revenue, and of course, net interest income is a function of both net interest margin and average earning assets. Over the last two years, we have had very favorable improvement in our net interest margin. Our third-quarter net interest margin was 4.80%, which was a 98-basis-point increase from last year's third quarter and equal to the 4.80% net interest margin we achieved in this year's second quarter. That was exactly what we had predicted for third-quarter net interest margin.

Our favorable net interest margin was achieved even though we charged off the accrued interest on several large credit relationships which went into nonaccrual status and ultimately moved into other real estate owned during the quarter.

As a result of our favorable net interest margin, we had another good quarter of net interest income, although it was not a record quarter. Specifically, net interest income for the third quarter was $29.2 million. That is an 18.8% increase from the third quarter of 2008, but a decrease from this year's first and second quarters. This decrease was attributable to a declining average balance of earning assets over the past three quarters, which has resulted primarily from our being a net seller of investment securities so far this year.

We've reduced our investment securities portfolio by $299 million over the first three quarters of this year as a result of our ongoing evaluations of interest rate risk, including consideration of the potential effects of recent United States government monetary and fiscal policy actions. This reflects our emphasis on long-term performance and long-term objectives over short-term results.

To get back on a record quarterly pace for net interest income, we will have to grow earning assets or continue to improve our net interest margin, or a combination of both. Let me share our thoughts on the prospects for growth in earning assets and net interest margin.

First, earning assets -- loan and lease growth has been a challenge in recent quarters as recessionary economic conditions have diminished both the demand for credit and the quality of many credit applications. Over the last four quarters, our loan and lease portfolio has actually declined 6%.

Despite the environment, we are still making many good-quality new loans and leases. We are seeing opportunities to take business from competitors, and we are seeing good loan applications from borrowers refinancing out of commercial mortgage-backed securities.

Notwithstanding these opportunities, our loan and lease paydowns have exceeded the volume of new originations in recent quarters. We are cautiously optimistic that we will resume positive loan and lease growth sometime over the next one to three quarters.

In regard to investment securities, we've stated many times that we will manage our securities portfolio with a view to maximizing our long-term total returns, buying when we believe it is advantageous to buy, and selling when we believe it is beneficial to sell. Therefore, the volume of our securities portfolio may increase or decrease in coming quarters based on changes in market conditions, changes in our balance sheet, changes in our assumptions regarding interest rate risk, or various other factors.

Second, in regard to net interest margin, our 4.80% net interest margin in each of the past two quarters appears to be reasonably sustainable. Accordingly, we expect the net interest margin in the next few quarters will be slightly above or slightly below that 4.80% level.

If our net interest margin is relatively stable in the coming quarters, then our ability to get back on a record quarterly pace for net interest income will depend on how quickly we can effectively grow our earning assets. And that will, of course, depend on loan and lease demand, investment opportunities for bonds, and balance sheet management steps which we may take to manage interest rate risk.

One of the factors contributing to our favorable net interest margin has been the improving quality and profitability of our deposit base. Although total deposits have declined in recent quarters as we have adjusted our balance sheet, primarily for the reduction in our investment securities portfolio, there have been two favorable underlying trends regarding deposits.

First, our non-CD deposits have grown significantly. From September 30, 2008, to September 30, 2009, total non-CD deposits grew $106 million, an increase from 38.5% to 48.5% of total deposits. And second, brokered deposits have been significantly reduced. Specifically, over the last four quarters, our total brokered deposits have decreased $373 million, from 19.6% of total deposits at September 30, 2008, to just 3.8% of total deposits at September 30, 2009. At the same time, our total nonbrokered deposits have increased $116 million and accounted for 96.2% of our total deposits at September 30, 2009.

Not only have these changes helped improve our net interest margin, but they have also had favorable implications for business development opportunities and service charge income.

Before we leave the subject of net interest income and net interest margin, there are two other matters worth mentioning. First, during the quarter just ended, we had further improvement in the spread between our yield on loans and leases and our rates paid on interest-bearing deposits. Specifically, that spread widened another 8 basis points, from 4.72% in the second quarter of this year to 4.80% in the quarter just ended. If one factors in noninterest-bearing deposits, the spread is even wider.

Some people have incorrectly assumed that our favorable net interest margin is a result of the good yields we enjoy from our investment securities portfolio and is not a function of what they describe as our core banking business. To the contrary, our spread between loans and leases and deposits is greater than our spread between investment securities and all other interest-bearing liabilities.

Second, we have benefited in recent quarters from lower costs on interest-bearing deposits and liabilities. We believe there is still some additional room to lower the cost of our interest-bearing deposits. In addition, in May of 2010, we have $60 million of FHLB advances maturing with a weighted average interest rate of 6.27%.

These are our highest-costing interest-bearing liabilities. And we estimate that we will have annual savings of between $2.7 million and $3.6 million when we repay them and replace them with new deposits or borrowings. The anticipated payoff and replacement should benefit our net interest margin in the final seven months of next year.

Let's shift to noninterest income. Income from deposit account service charges is traditionally our largest source of noninterest income. We're very pleased to report that service charges on deposit accounts were a record $3.2 million in the quarter just ended, which was an increase of 4.3% compared to the third quarter of last year. As a result, service charge income was up 1.6% in the first nine months of 2009 compared to the first nine months of 2008.

Mortgage lending income has been a pleasant surprise this year. Although mortgage lending income for the quarter just ended was less than achieved in each of the first two quarters of this year, it was still up 42.1% compared to the third quarter of 2008. Mortgage lending income for the first nine months of 2009 was up 47.7% compared to the first nine months of last year.

We are encouraged by the increase in the percentage of our mortgage loans for home purchases as compared to mortgage loan refinancing. In this year's first quarter, only 23% of mortgage originations were for home purchases, but that increased to 34% in the second quarter and 54% in the third quarter. Obviously, this is a positive and hopeful sign for the housing industry and the economy in general in our markets. Of course, housing market conditions are still weak by historical standards, but these signs of improvement are welcome.

Our trust staff has continued to add new accounts and grow existing relationships this year. This growth increased third-quarter trust income to a quarterly record $801,000, which was a 23.4% increase compared to the third quarter of 2008. Trust income for the first nine months of 2009 was up 16.8% compared to the first nine months of last year. Our trust staff continues to do an excellent job.

Our third-quarter noninterest income was not significantly affected by net gains or losses on investment securities or from sales of other assets. Specifically, we had $142,000 in net gains on investment securities and $51,000 in net losses on sales of other assets. Combined, these two line items resulted in net gains of $91,000.

During the third quarter, we sold numerous items of other real estate and repossessions with a total book value of $8.2 million, which resulted in $51,000 in total net losses on sales of other assets. This relatively modest loss of $51,000 compared to the total volume of assets sold at $8.2 million reflects the good job our staff did in estimating the ultimate liquidation value of these assets.

Let's talk about noninterest expense, which increased 12.1% in the quarter just ended compared to the third quarter of 2008. We were very pleased to be able to reduce noninterest expenses from the levels achieved in each of the first two quarters of this year.

Of course, one of the strengths of our organization in recent years has been our excellent efficiency ratio. And that strength was evident again with a 41.2% efficiency ratio in the quarter just ended. Our third-quarter efficiency ratio was not significantly impacted by unusual items of revenue or expense. Accordingly, it would seem to be a good starting point for projecting our efficiency ratio going forward. We've stated many times our long-term goal of reaching and sustaining a sub-40% efficiency ratio, and we will continue that quest.

Another of our longstanding and key goals is to maintain good asset quality. Economic conditions have made our traditional strong focus on credit quality even more important. Although most of our markets appear to have been less severely impacted by the recession than many of the other markets in the United States, the duration and depth of the global and national recession have had negative impacts almost everywhere.

Over the past two years, we have dealt with a number of asset quality challenges, and we think we have been successful in working through those issues. During the quarter just ended, we had three significant credits go on nonaccrual status and transfer into other real estate owned. We have talked about all three of these credits in previous conference calls or public filings, so they were not new issues.

Let me discuss each one of them. First, we have a 476-unit apartment project in the metro Dallas area which we have discussed in previous conference calls. As you may recall, we were of the opinion that the project had not been well managed. And we had worked with our borrower to develop a plan to improve operating performance.

This loan was still on accrual status at June 30, 2009, but it was past due and it was included in our June 30 ratio of loans and leases past due 30 days or more. During the quarter just ended, we concluded that our borrower was unlikely to either successfully turn the project around or achieve a sale of the property to a third party. As a result, we took title to the property, and we now have an executed conditional sales contract for sale of this property for $11.5 million, which is equal to our September 30 OREO book value. We expect to close this sale before the end of the years. In the interim, we are operating the property and working to improve the occupancy and operating results.

Second, we have previously discussed a large land loan just south of the Dallas central business district. This 60 acres is a valuable tract and a key piece of future development plans for this area. This loan was past due at year-end 2008 after our original borrower became unable to make monthly payments. We discussed this loan in our January conference call, including the fact that our original borrower and its equity partners had $12 million of cash equity in the project.

We reported in our April conference call that the loan had been assumed by a new borrower, who made an initial equity contribution and committed to make additional future equity contributions. The new borrower did not follow through with the subsequent equity contributions, and as a result we took ownership of this property in September. Our September 30 OREO book value of $17.9 million equals the expected net proceeds from an executed conditional sales contract that we have on this property with a very capable cash buyer. We expect this contract will close in the first quarter of next year.

The two conditional sales contracts on the two properties I've just discussed account for 35.3% of our total nonperforming assets at September 30, 2009. If these sales close as expected, this will have a significant positive implication on our future nonperforming asset ratios in coming quarters.

We have been very effective in selling our foreclosed and repossessed assets. This is evidenced by the fact, as I've already stated, that we sold $8.2 million of such assets in the quarter just ended, with an aggregate net loss of just $51,000. In addition, it is noteworthy that we have not allowed these assets to linger on our books, as only $172,000 of our foreclosed and repossessed assets have been on our books more than 16 months.

The third credit relationship that impacted our results this last quarter is the Northwest Arkansas relationship disclosed in our June 30 Form 10-Q and discussed in yesterday's earnings release. As noted in the earnings release, the lawsuit involving this credit relationship has been dismissed, and we have obtained title to all of our collateral, excepting one track that we received cash consideration of equivalent value for.

Our collateral consists, and now other real estate items consist of a number of houses, townhouses and duplexes, a small commercial building, and various commercial, residential and duplex lots. These properties had a combined September 30 OREO book value of $11.4 million. We are cautiously optimistic that we will have good success in liquidating the $3.3 million of houses, townhouses, duplexes and commercial building over the next several quarters. The $8.1 million of various lots may take longer to sell.

More than half of our net charge-offs in the quarter just ended relate to the previously mentioned metro Dallas apartment project and the Northwest Arkansas credit relationship. In prior quarters, we had identified these two credit relationships as potential problems, and we had established $5.1 million of special allocations within our allowance for loan and lease losses for the estimated exposure on these two credit relationships.

Because a large portion of our third-quarter charge-offs had been previously provided for with special allocations within our allowance for loan and lease losses, our provision expense for loan and lease losses in the third quarter was less than our net charge-offs. This resulted in a decrease in our allowance for loan and lease losses from 2.19% of total loans and leases at June 30, 2009, to 2.03% at September 30.

We view this as positive, since the lower allowance ratio reflects our opinion that we are past the midpoint of the current credit cycle, and therefore we believe our allowance for loan and lease losses ratio has already peaked. This is consistent with the comment we made on our last conference call in which we stated our opinion that we were then probably approaching the end of the process of increasing our allowance for loan and lease losses for this recession. Accordingly, we believe that our provision expense and our net charge-offs in each of the next few quarters will likely be well below the levels for the quarter just ended.

While the addition of these three credits to other real estate owned increased our ratio of nonperforming assets to total assets to 2.88% as of September 30, 2009, our other asset quality ratios continued to be favorable. Specifically, our ratio of nonperforming loans and leases to total loans and leases at September 30, 2009, was 1%, and our 30-day past-due ratio, including past-due nonaccrual loans and leases, was 1.77% as of September 30, 2009.

We have said in the past that we try to focus on quality projects, and we strive to get substantial cash equity in most transactions, particularly in larger transactions. The relatively good performance of our loan portfolio over the last few years is largely attributable to our underwriting principles, including our cash equity requirements. While good collateral and substantial cash equity may not avoid a loan going into nonaccrual status or other real estate owned, they do facilitate resolution of problems and help to minimize any loss exposure.

In our July 2008 conference call, we provided extensive details regarding some of our practices for accounting for and structuring loans, practices we consider to be very sound and conservative. We are not going to repeat all that again, but it is probably appropriate to summarize a few key points.

First, we have been aggressive in promptly conducting thorough impairment analyses on all nonaccrual loans and leases and regularly reevaluating the carrying values of foreclosed and repossessed assets, making adjustments when necessary to reduce the carrying value of those assets. We also look at performing loans which we think may become problems in the future, and we establish what we believe to be appropriate special reserves for such loans. This proactive approach meant that we had already established significant special reserves for a number of the charge-offs we accrued this past quarter.

Second, we had been aggressive in placing loans on nonaccrual status when we believe significant data exists regarding the ultimate collection of payments.

Third, we consider our practices regarding interest reserves for construction and development loans and capitalization of interest as very conservative. We have stated for many quarters our belief that any increase in our various asset quality ratios would not seriously affect our ability to generate a good level of income or even a record level of income in each quarter. Obviously, we have taken a few hits in the asset quality arena in the last few quarters, but we've still posted record earnings in five of the last six quarters and good earnings in the quarter just ended. Because of our strong revenue-generating capabilities, we will restate our prior guidance that we believe we will continue to generate a good level of net income and possibly a record level of net income in each of the coming quarters.

Our 2.03% allowance for loan and lease losses ratio is strong, and I'll repeat what I've said earlier -- we think we are probably at or near the end of the process of increasing our allowance for loan and lease loss ratio for this recession.

Our 9.29% tangible common equity ratio is very strong, and we are well capitalized by a wide margin by all applicable regulatory measures, even without the TARP preferred stock. Accordingly, we have no plans to raise new equity. And if we repay the TARP preferred stock, we have room to do so without raising new equity. Also, we think our earnings generation capabilities are excellent, as evidenced by our favorable net interest margin and good momentum in service charge mortgage and trust income. All this gives us a very solid financial position.

No one can be sure how long the effects of the recession will linger. As we have come through the recession, we have increased our allowance for loan and lease losses substantially. We have achieved good increases in our net income and earnings per common share. And we've significantly increased our tangible common equity through retained earnings. We have successfully managed through a lot of challenges, including higher net charge-offs. And more importantly, we have capitalized on many of the opportunities resulting from the same economic turmoil that caused the challenges. We think that's what a good management team should do.

We are continuing our growth and de novo branching strategy, although we have slowed the pace of new office openings in recent years. In September, we opened a new banking office in downtown Little Rock. In the fourth quarter, we expect to open a banking office in Allen, Texas, and also close a small office in North Little Rock, Arkansas, where the leased space is no longer available to us.

In our last conference call, we stated our opinion that we're closer to the end of the recession than the beginning, and we have grown more confident in that view over the past quarter. Based on this, we are continuing plans for future branch development. Specifically, we're moving forward with the development of a third branch in Benton, Arkansas, and branches in McKinney and Sachse, Texas, both suburbs of Dallas.

While we have owned these sites for some time, their development schedule has been uncertain. But we are now targeting these branch openings for the last half of 2010 and in 2011.

In closing, we think we're in an excellent position to continue a positive earnings trend by achieving good earnings and hopefully record earnings in each of the next few quarters. That will be our goal. We acknowledge that we are operating in one of the most challenging environments in decades. But with our fine staff, our revenue-generating capabilities, our substantial allowance for loan and lease losses, our relatively good asset quality, robust capital position, favorable deposit base and abundant sources of liquidity, we think we're in an excellent position to continue to effectively manage through the challenges ahead and capitalize on new opportunities.

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

(Operator Instructions). Andy Stapp, B. Riley & Co.

In your earnings release, you talked about conditional sales agreements. What conditions are there in these agreements?

Andy, these are typical due diligence requirement type agreements. We feel pretty good about both contracts. All indications are that these are very financially capable borrowers. The buyers, they appear to be very serious buyers and interested parties in the properties. But these are big properties and they have all the normal complexities that you would have with a big property. So the contracts are subject to typical standard due diligence requirements.

I will emphasize what I've said in the call, that one of the contracts, the contract on the apartment project, is for $11.5 million. That project will require us to provide some financing. But the terms of the contract provide the buyers putting in over $3 million of cash equity. The second contract, which is for $18 million and change and should net us about $17.9 million, is a cash contract without any financing requirements. So until they close, they are not closed. But we think they're pretty good contracts as these things go.

Okay. And do you have the balance of construction and development loans as of quarter end?

I do have that balance.

And also the amount of land loans in that amount.

Well, I don't have it broken down. But our total construction and land development loans at September 30 were $587 million. That's down about $31 million from $618 million the prior quarter. Construction and land development loans in the previous quarter were 31% of our total loans. At September 30, they were 30.4% of total loans, so a modest decrease in those balances.

Okay. And on the Trinity project, why did the borrower not put in additional cash equity?

You know, Andy, I can't comment on his motivations. I'm not in his head. But we had expected he would continue to do so, and he did not do so. So I can't tell you any more. I'm surprised he didn't do so.

Okay. And I missed the dollar amount of FHLB borrowings that are occurring in May.

It's $60 million.

Six-zero?

Yes, six-zero million. And the weighted average interest rate on this is 6.27%. So I gave you a range of estimated savings, and one was based on our average cost of deposits. One was based on a Fed funds rate. So depending on how we replace them and refund them, we expect $2.7 million to $3.6 million a year in savings from that.

Okay. Let me ask one other question. The effective tax rate, what you expect that to be in coming quarters?

The effective tax rate was lower this quarter than it was last quarter by a couple of percentage points. Probably a better proxy for future quarters would be the tax rate from last quarter. Of course, that's going to bounce around quite a bit, depending on the change in tax-exempt and non-tax-exempt securities and BOLI income and a variety of other things. But if you're looking forward at next year, I would suggest that most likely, the effective tax rate that we incurred last quarter is a better proxy of future numbers than this quarter's effective tax rate.

Okay. I have some other questions, but I will let other people get on.

Matt Olney, Stephens.

The OREO expense of just $51,000 was very impressive. I think that's the lowest quarterly amount in quite some time. As you look at your portfolio of the substandard credits, do you think that level of OREO expense is sustainable in the next few quarters?

Well, the $51,000 was net gains and losses on sales of OREO and repossessions. We have some OREO and repossession items that sold at a gain in the quarter and some that sold at a loss. And net-net, that was $51,000 on the net.

That number will bounce around. In quarters in the past, we have had gains in that account. In other quarters, we have had losses in that account. It is going to vary Matt. I can't tell you for sure. But I think what it does -- I think there are two factors that I think are worth noting there. One is in the last quarter we sold $8.2 million in OREO and repos. As I've said in the call, we are moving this stuff pretty quickly. And number two, we sold it with just a nominal net loss in the aggregate, which suggests we've done a pretty good job valuing the stuff. So it will be whatever it is in the future, but we are trying to be very accurate in how we value these things.

And also, in your prepared remarks, you mentioned something about provision and charge-off in future quarters being lower than 3Q levels. What was your exact wording on that topic?

Well, I think we said they would be significantly lower, or well below, I think was the exact wording that we said. In our view of the world, our charge-offs and provision expense the last several quarters are the high watermark of this recession if things play out as we expect them to do so. So we think we will see noticeably lower provision expense and net charge-offs in the coming quarters. And I think that probably gets better, tends to get better each quarter if the economy is regaining its footing, as it appears it is.

Okay. And lastly, George, can you give us an update on Northwest Arkansas, including your exposure there, and maybe also your reserve allocation within that market?

Matt, I actually don't have many numbers on it. With the Combs credits and the Lazenby credits in OREO and the write-downs that we have taken on those credits, we've got pretty much the -- anything that is of any consequence that has any issues has been totally resolved, or resolved to the extent of getting it into OREO.

So our exposure up there is pretty nominal as far as loss exposure, I believe. I've mentioned in previous calls that our high watermark in that market was $180-something million, $190 million; I don't remember the exact number. And my guess is, with the assets that have been transferred into OREO, and I haven't actually seen these numbers, so I'm guessing at them, but I would guess our exposure in that market is under $60 million now.

What is left is largely performing in a very satisfactory manner, except for a few isolated credits that are already on nonaccrual and had been written down. So there's just not anything else there, I expect, that is going to give us any unusual problems.

And Northwest Arkansas has been by far the toughest market. And certainly you could -- someone could argued with that here in the current quarter and say, well, you've got two Texas properties for $11.5 million and $17.9 million in OREO. But the strength of that market is evidenced from that fact that those things went into OREO in September, and I've already got sales contracts on both of them.

So resolving the problems in Northwest Arkansas to the point that we have, which suggests that we've got very, very little additional exposure up there in the future, gives us a lot of comfort, because that has certainly been our most challenging market.

Jordan Hymowitz, Philadelphia Financial.

Thanks for taking my question. A couple things. One, your capital is 9.3%. You're rapidly approaching 10%. Why don't you guys just go ahead and repay TARP? What is the vote from the Board?

Well, I'm not going to say about a lot about TARP today. On our last conference call, we said we were going to revisit this subject before the end of the year. And, Jordan, your comment is certainly well taken.

Over the last several quarters, both our management and Board have talked extensively about when and if to repay the TARP preferred stock. As you have noted, our common equity ratio is increasing a lot, and we've got a lot of capital. And as I've said in the call, we can repay the TARP preferred stock without raising additional common equity. And when we do so, that will be our plan to do so.

Let me just leave it this way, that if and when we repay the TARP preferred stock, we're going to make an appropriate announcement at that time. And I think given the fact that we have discussed this at length before and said we would revisit this issue before the end of the year, I think that's about all I can add to that right now.

When is your October Board meeting?

We have a Board meeting next Tuesday.

Is it on the agenda?

There are a lot of things on the agenda on that, Jordan. Let me just leave it at that. When we repay it, we will make an announcement about it.

Next question is, your 30-day and over NPLs are dropping like a stone down to 77 basis points. You'd previously talked about 70 basis points of charge-offs. When you look forward, do you still think that is a good number? You didn't mention that number this call.

Jordan, I intentionally didn't mention that number because I've been off base in the guidance I've given you in the last two quarters, and I've given publicly in the last two quarters on that, so I didn't mention that number. But I am comfortable in saying that we think our net charge-offs and our provision expense will in future quarters be well below where they were in the third quarter.

And I think that is enough to say about that. I have said in my prepared remarks we think we're past the midpoint in dealing with all the issues from this recession, and we feel like we're on the downhill side of this thing. And there will be some more challenges out there, but I think they will be less significant than what we have dealt with over the last couple of quarters. So I think we have come through the hardest part of this.

So for next year, is 70 basis points a reasonable guess in your mind, or you don't want to go there?

Without adopting that guidance, Jordan, I would say that I don't think that is an unrealistic number to achieve.

And final question is, what is the earliest you see yourselves doing a sub-40% efficiency ratio?

That is going to depend significantly on getting some growth in earning assets. I would think that we've got a very legitimate shot of getting there by the third quarter of next year, Jordan. And part of my premise for that is I think we are very likely -- you know, I said in the call that I think we're going to get positive loan growth somewhere in the next one to three quarters. I think the latest that we actually get our loans growing in a positive way is in the second quarter of next year, because that typically is a time when we have a resurgence in activity in a lot of our markets and the real estate sector.

I think the economy is going to be doing quite a bit better by then, in my view. And we're going to get a pretty good lift or support for our margin at that point in time from the repayment of those FHLB advances that are very high-costing. So I could fairly reasonably pencil out a model and a scenario that would get us sub-40% in a really sustainable sort of way, midyear, third quarter next year.

Thank you. I will get back in the queue.

Kevin Reynolds, Wunderlich Securities.

A couple of questions, and one I'm probably going to tackle a different way. I hope that you don't notice that and you're able to answer it. And that is, in the past, I think you have said TARP repayment would be sort of a function of opportunities to deploy the funds, because the costs are already fully baked in and all that, and you obviously don't need the capital from a ratio perspective.

Today, do you -- what are your thoughts on FDIC-assisted deals, perhaps? Are you seeing more or less out there right now, in general terms, of the stuff that fits your criteria of what you are looking for? And do you think you are more or less likely to participate in something going forward right now, based on sort of what you see and how the economy is shaping up, knowing that troubled banks tend to be a little bit of a lagging indicator?

That is a great question, Kevin, and I would say two things on that. Number one, I think there are going to be a number of additional opportunities. And my guess is that there are going to be more opportunities in front of us than there are that have gone behind us. And I would say that our interest and appetite in participating in those transactions is probably marginally higher than it was even a quarter ago.

Okay. And then I guess another question -- with what looks like pretty sizable, at least at quarter end pretty sizable unrealized gains in the securities book, and with the Fed backing away from the support they have given to the marketplace, what are your thoughts now, I guess subsequent to quarter end, on harvesting gains before they really move away and before rates move up, and I guess it's less a pure rate move decision and more just sort of about their participation in the marketplace?

Well, we are certainly monitoring that closely. We started dialing in on that issue in late February and early March and started shrinking the portfolio then. And I think we were focused before a lot of folks were focused on the potential interest rate risk scenarios that may arise as a result of the fairly unprecedented government both monetary and fiscal policy intervention in the economy. And we're continuing to monitor that.

Our overall policy is to maintain a neutral, essentially neutral interest rate risk position. Of course, we never hit exactly dead zero on neutral. We are always plus or minus a little bit. But we will continue to run our interest rate risk models, determine what we believe is a neutral interest rate risk scenario, and adjust our balance sheet accordingly. And as we also run non-neutral scenarios, we run extreme scenarios, and as the probability for an extreme scenario of uprights, if that increases, then that would affect our decision on how many securities we wanted to hold.

So there are also shifts that we have got ongoing at any time within that book of business. For example, we originated -- we had some gains and some losses in the investment portfolio that we recognized in the third quarter, and there were some assets that we liquidated because we thought it was best for quality of the portfolio to liquidate. There were some assets that we liquidated that we thought it was best to liquidate because we thought they had reached a point where they were actually overvalued or fully valued, and we could replace them with assets that were not fully valued.

So there is a constant movement and management of that portfolio that goes on every day. But the aggregate size and aggregate risk profile of that portfolio will be adjusted over time to reflect our evolving assumptions about interest rate risk for our total balance sheet and interest rate risk as it relates just to the portfolio, based on monetary and fiscal policy and other economic indicators.

Okay. And then I guess one last question. You talked about earning asset growth and the ability to resume positive loan growth, I guess on a net basis, over the next one to three quarters. Is that, in your mind, is that a function of a firming economy and additional demand for credit over and above what you see today, or is that a function of fewer paydowns, or a combination of both? I'm just trying to get a better feel for how we get to going from a minus sign to a plus sign.

I think it is a combination of both. We have got a lot of folks that are in our builder and developer book that have been paying down inventory and reducing loans and not doing new things and producing new inventory. And I think the rate of those paydowns subsides and folks get reenergized, and instead of paying their lines down, they think, okay, it's time to rebuild.

For example, one of my guys in Dallas sent me an article that was in one of the publications down there, I guess, over the weekend that pointed out that the Dallas market now has a three-month supply of new homes and that there's a shortage of homes developing in the Dallas market. And I think we are seeing folks beginning to step back in and think about rebuilding a little bit of inventory because they are seeing sales volumes picking up, and market inventories are down, and there really is a need for some new inventory. And then I think part of it is new opportunities on totally new relationships and new deals. So I think is a combination of both those things.

Mike Bronzino, Bronzino Capital Management.

Great quarter. And all of my questions were answered by previous questioners. Thank you.

Dave Bishop, Stifel Nicolaus.

Most of my questions have been answered as well. But I think you spoke about the success in terms of pure core deposit generation there. And maybe you can just give us an update what you are seeing on the market, Arkansas versus Dallas, there, what you are seeing on the pricing side of the ledger there in terms of deposit competition. Have you seen some of the backing off from some of the bigger [uglies] putting the pedal to the metal, or is it becoming more rational?

Dave, I don't have a whole lot to say about that, honestly. And the guys that are managing that process for us every day might have some additional comment on that that I don't have. But I'm not aware of any significant change in the competitive landscape for deposits out there over the last quarter.

And obviously, we have been able to continue to lower our deposit cost on a quarter-to-quarter basis. And I indicated in the prepared remarks that I think there is more room for us to do that. That comment is based on what we have seen so far this quarter and the daily results that we are seeing coming out of our offices.

So I don't think there has been an acceleration of aggressiveness for deposit pricing. And the Feds pretty much flooded the world with liquidity out there. And given the scarcity of good loan opportunities and so forth, there just doesn't seem to be much impetus to get very aggressive for deposit generation right now.

One housekeeping item. Maybe I missed it in the release, but the dollar balance of total equity?

That is a really good question. You'd think we would know that. Paul and I are both looking at each other. Total stockholders' equity quarter ended, $273,658,000.

That is common equity?

Common stockholders' equity, $273,658,000. And it is in the selected consolidated financial data, about five or six pages back in the press release.

Brian Hagler, Kennedy Capital.

Most of my questions have been answered, but just to follow on on the FDIC question earlier, George, could you just talk about maybe what regions you would be more interested in or less interested in, or does it depend on more on where the opportunities are?

I would be happy to, Brian. Of course, the paramount opportunities for us would be in Arkansas, Texas, and North Carolina and South Carolina, where we already have some presence and some business and some activity. So it would be much easier, particularly in Arkansas and Texas, to a lesser extent the Carolinas, to acquire something and integrate it and manage it effectively and so forth.

But in the longer-term view of where we want our Company to be 10 and 20 years from now, there are other markets that would be interesting. And we may have a once-in-a-generation opportunity to get a good franchise in one of those markets at a really good deal. That would include places like Tennessee and Virginia, as well as the Carolinas, where we only have a loan operation now, and even Florida and Georgia.

And I say that realizing that those economies are so badly battered by the downturn there that you would have to factor in a very long recovery period for those general economies and factor that into your pricing. But there may be some exceptional opportunities that do arise in those markets. And of course, right here next, Arkansas, mentioned Tennessee, but Missouri would also have some interest to us.

So there are places that we either are now or would want to be in the next 10 to 20 years that if the right opportunity came along, we would look at it. And frankly, we are looking at opportunities there, and we will continue to do so.

I appreciate that. And the last question from me, I know we talked earlier about the securities gains, and you guys run a lot of modeling as it relates to interest rate risk. But do you have any idea kind of roughly how much of additional gains you could harvest and still maintain that neutral position?

You know, I think that there is considerable opportunity there, Brian, for us to do that, and also to do that and do it in a way that is not detrimental to our ability to maintain a fairly decent level of earning assets.

We could shrink the portfolio in some respects and reduce interest rate risk. There are also other ways to reduce interest rate risk in the portfolio without shrinking it, by just rotating securities from one sector to another that might be -- you might be selling a security that is relatively fully valued and buying a security that is relatively undervalued. And you might even be able to improve, in some scenarios, your interest rate risk profile. And there have been a few situations we have been able to rotate some securities around and really improve the yield and interest rate risk profile of the portfolio in doing that. So, again, we're working on little things and big things every day to do that. So you try to actually achieve both.

All right. Thanks for your time.

Walker Forehand, Hovde.

Great quarter. Just two quick questions. First, I was just wondering if you could comment a little bit on kind of where the bank is in the regulatory cycle and when you were expecting the next regulatory exam.

In my prepared remarks, I commented, we just completed our annual state and FDIC exam about a month ago, a month and a half ago. And we thought it was a very routine and very positive exam.

One of the things we always try to do is (technical difficulty) have our classification list and our writedowns and valuations in line with where our regulators would have us have them if they came in and looked at our books that day. So our typical exam, we provide the regulators in advance of the exam a classified list. In almost every exam, and it was true this year, the list that they end up classifying at the end of the exam after they've looked at our books is virtually the same, substantially identical to the list we give them at the beginning of the exam. So, no surprises, and we thought it was a positive and routine (multiple speakers).

Got it. I'm sorry, I was having trouble connecting when the call first started, so I must have missed that.

No problem. I don't mind repeating that.

Thanks so much. That's all I have.

Thank you. Yes, Paul is commenting, we do have an exam every year on a 12-month cycle because of the size of our bank. And it is always a joint exam with the State Bank Department of Arkansas and the FDIC. And again, because of our size and the fact that we are one of the larger banks that they examine in this region, they always do it on a joint basis.

Thank you. Next question?

Peyton Green, Sterne, Agee.

A couple questions for you, George. I was just wondering, what kind of rolloff is there in the securities portfolio over the next year? The taxable yields and I guess the tax-free municipal yields are still relatively high compared to where they have been historically. I just didn't know if there was any risk of prepayment on those securities.

Peyton, there is. The guys that run the bond portfolio are in my face all the time about that, because they like to buy bonds, which is understandable. They are in the business of managing and building the portfolio. And they are constantly pointing out to us the rolloff on that portfolio.

In the last quarter, I think our CMO paydowns from just the taxable part of the portfolio averaged about, oh, somewhere between $10 million and $11 million a month. So $32 million in the taxable part of the portfolio rolled off in the last quarter. And I'm okay with that in one respect, in that we are replacing those taxable yields in some cases with much better tax-exempt tax-equivalent yields on a tax-exempt portfolio pieces we are replacing.

But the other side of it is, for pledging for public funds and a lot of our deposit customers that are public funds customers require US government or agency securities as collateral for their deposits. So as those run off, it diminishes my pledging base that I can use to pledge for public funds.

So that is just one more complexity in managing that portfolio. It not only serves as an important earning asset and a ballast that we use to adjust our interest rate risk of the total balance sheet up and down, but it also serves as an important foundational piece, collateralizing a lot of public funds, repurchase agreements and other things. So you have to manage it with a multiplicity of goals in mind as you are managing the portfolio.

But we've got all that factored in, and we project and anticipate the rolloff of those securities and the replacement of those securities. So that is all built into our models and the guidance we gave today on a relatively stable net interest margin of 4.80%, plus or minus.

Okay. And then I guess toward that, would you just consider allowing the FHLB borrowings, which I think you said were at a yield of 6.27%, would you consider just letting those roll off and take some gains through the portfolio and kind of have -- it probably ends up improving the margin. I mean, it's not necessarily -- it's good for net interest income, but is that something you might consider if securities aren't out there to be bought at the right yields or spreads?

Well, certainly, if securities aren't out there to be bought at yields or spreads that we are comfortable with and think don't pose significant risk to us, we let them roll off and not replace securities, yes, I'm sure.

Okay. And then, it's a strange quarter or even year with deposits and loans both shrink for you all. And I know that a good chunk of the deposit drop in the last two quarters has been as you've shifted out of brokered CDs. But just conceptually, I don't know that we've ever seen both coexist at the same time. What do you think that says about the real economy, maybe ignoring some of the headlines about the low end of the housing market? But do you see customers less willing to kind of engage in doing business, given all the stuff that is going on, or what do you really see going on in client calls, I guess?

Well, we're adding new deposit customers routinely, daily. We're adding new loan customers routinely. So I don't think it says a lot about our ability to grow our franchise longer term.

What we have seen, and I've talked about this a lot, is certainly our construction and development book. You've got folks that just need less inventory there. They are doing less in the vein of new construction and new development. You are seeing a reluctance, I think, for folks to do new commercial projects. So most of the growth in our CRE book that we're having, or new business in our CRE business, is refinancing away from CMBS or other competitors.

So I think we're just in a period where the types of business we do, and really, all types of business, probably are just -- demand for loans is muted. And we're taking advantage of the fact that we're shrinking our balance sheet by selling securities and so forth to really work on improving our deposit base and roll off all the brokered deposits, at the same time continuing to add new checking and savings, money market accounts and other core deposits from local customers.

So we really feel a $2.8 billion balance sheet may be better than a $3.1 billion balance sheet. We may have better quality in $2.8 million than we had in $3.1 million as far as all the components and pieces. So I feel pretty good about all that.

Okay. And then lastly, on the CMB book, I think you mentioned there was about $587 million in total construction and development at the end of the third quarter. How much of that do you expect to pay off over the next year?

Well, I hope it will grow over the next year, actually. A lot of it will pay off. I don't know whether that is $100 million, $200 million or $300 million. A huge portion of it will pay off. And we're making new loans in that category on a regular basis. So I am hopeful that we will stop the downdraft of that portfolio, the shrinkage in it, and hit a bottom here where it is going back the other way and we are getting some growth out of that portfolio.

We've certainly had some challenges in our construction and development book, and it's been the most challenging book of business, for reasons that are obvious to everybody. But we've got a ton of good customers, and we make a lot of money out of that book of business. So we're anxious for economic conditions to get to the point where we can see resumed growth in that book of business.

The comment I made from the article in Dallas about there being a shortage in supply of new homes there now versus the sales velocity, that's a positive sign that suggests that we're getting to or below an equilibrium level of supply, where new construction is feasible and profitable.

And then, I promise, last question. What is the direction of the watchlist or classified list? I mean, are you still seeing that list grow? And I guess what would give you more confidence about a lower provision and charge-off rate?

Well, let me say this, and I'm going to be a little bit off on these numbers, so forgive me for that. At June 30, going back a whole quarter, somewhere around, in round numbers, $1 million of our provision was for nonaccrual loans and leases. And I've said this a number of times. When we've got something on nonaccrual, it in almost all cases, with a few minor exceptions, has already been written down to the FAS 114 impaired value.

So our reserve, which was $43 million, roughly, at June 30, about $42 million of that was for loans that were not nonperforming, and only about $1 million, more or less -- it could've been $1.5 million; it could've been $0.5 million; I don't remember the exact number -- was for loans that were nonperforming.

So the vast majority was for performing credits. And what that reflects is the way we calibrate that reserve, is we are looking forward and looking at loans that may become problems in the future. We had a couple of them this quarter that certainly did, and we had already provisioned for those.

So the reason our reserve went down in the last quarter is, as we are looking forward and provisioning for things that we think may become problems in the future, that provision level dropped in the last quarter. So we didn't see as many things on the horizon that looked like they could become problems, and ergo, we needed to establish a special provision for them, as we did in the previous quarter.

And I think that is a very positive thing. And I think that says that, in my mind, that tells me that we have reached a tipping point where things are getting better instead of getting worse. Now, there will be more loans that are performing that become nonperforming in the future, but I think we've got pretty good visibility now and we sort of know who that is, and we've provided for those, hopefully fully, and if not fully, significantly. And as a result, I think our charge-offs and our provision expense are both on a downward track in future quarters.

Joe Stieven, Stieven Capital.

George, all my questions have been thoroughly vented by now. So I appreciate a good quarter again.

Thank you. Appreciate it. Have a good day.

Andy Stapp, B. Riley & Co.

You discussed the charge-offs related to the two credits, which I think accounted for roughly half of net charge-offs. Could you provide some color on the remainder of the charge-offs, including what you are seeing in C&I loans?

Yes. The $3.1 million of the remainder of the charge-offs related to the 60-acre tract on the Trinity River there in the south of the central business district in Dallas. And honestly, I'm not sure that was a charge-off we should have taken. But we have three appraisals on that property in the last year, and the lowest of those three as-is appraisals was -- Paul, 26.5, is that right?

The average (inaudible -- microphone inaccessible).

No, the lowest was 26.5. The lowest of those was 26.5. We had the asset on the books, just in real round numbers, around $21 million, and we charged it down $3.1 million to $17.9 million. And that asset went into OREO in September. And a very, very capable cash buyer came along and made us an all-cash offer for the property. And it was a lowball offer. And we made the decision, because of the size of the asset and because of the fact that he was a cash buyer and we wouldn't have any fuss or muss in the future if we sold it to him, to sell the thing substantially below what we really thought it was worth.

And honestly, I don't know if that was a good decision or not, but it, I think, reflects our psychology of moving a big asset quickly and getting it gone and getting it off the books. So that was, if you look at that plus the charge-offs on the other two loans that we had largely provided for, that gets you to $8.2 million of the total charge-offs. So the rest were just odds and ends and so forth.

Okay. So you're not really seeing any bleed-over into C&I or CRE?

You know, the rest of those charge-offs were really from across our book of business (multiple speakers) C&I and kind of the whole gamut. But I would say this -- most of the challenges that we have had have been with our construction and development portfolio. And I know that there is a prevailing sentiment out there in the press and investment world that CRE is the next shoe to drop.

I can just state with great confidence my belief and opinion that our CRE portfolio will not be the next shoe to drop, and that we've had problems in our construction and development book. The further problems that we'll have going forward will be out of our construction and development book, for the most part. And anything out of the CRE book I think will be isolated and relatively minor compared to the challenges we have had in the C&D book.

So I don't see our CRE portfolio -- and I know that portfolio pretty well -- I don't see that portfolio as generating an unusually large number of problems. I think our challenges have been and will continue to be in the construction and development book, for the most part, and I think we are on the backhill side of that now, headed downhill.

Okay. And your weakest market in terms of the local economy are the Carolinas. Have any concern or heartburn related to that market?

Well, certainly the latest unemployment data, I think, had North Carolina at about 10.8% and South Carolina at somewhere around 11.5%. I don't remember the exact number, but 100 to 170 basis points more than the national average. And the unemployment conditions in the Carolinas are certainly disturbing.

But what we did is really shrink our book of business over there for awhile. And in the most recent quarters, we have actually started building our business back over there because we are seeing some excellent low-leverage opportunities to book really high-quality new business there. And there are enough battered banks over there that there is not much competition and not much financing available for really good borrowers on good projects. And as a result, I think we're getting an abnormally good look at opportunities over there.

So we have actually started building that portfolio back. We addressed some things that we thought we needed to address. We've got a couple more things over there that we will probably have to address. But they are largely provided for already in our provisions. And we think that now has become a market of opportunity more than a market of challenge. So we think we're going the other way in the Carolinas now.

Our timing in shrinking our book of business over there was good, and now seems like a very good time for us to start building it back.

Understood. And last question, just talk a little bit about what you are doing or your mindset regarding cost controls. For example, to what extent are you willing to invest in new lenders, or are you just hunkering down and controlling costs? Just whatever color you could provide in that regard.

We are hiring new lenders as we can find quality team members to add. In fact, I got an e-mail this morning right before I came into this meeting from one of our market presidents who has two new lenders he wants to extend offers to, and he wants to review the terms of those with me later today. So, yes, we are building the franchise, just as we are opening the new office in downtown Little Rock this last quarter and a new office in Allen, Texas, hopefully late next quarter -- this current quarter, fourth quarter, and planning three more office openings that have sort of been in limbo, but we are turning those loose to actually start the development process on Benton, Arkansas, Sachse and McKinney, Texas.

So we are viewing the environment in which we are operating and our opportunities as being favorable. And we're beginning to build the infrastructure, both facilities and people, to take advantage of what we think are going to be good opportunities out there in the future. So we are not cutting costs to be conserving capital or trying to improve our earnings by cutting costs. We are spending money, as we always have, judiciously to achieve future growth. And if we're cutting a position or a team member, it's because it's a position or a team member that we don't think is producing for us like we wanted. And we're going to be adding more team members or new positions that we think are productive. So we are growing the Company for the future and expect to continue to grow.

Okay, great. Thank you.

Jordan Hymowitz, Philadelphia Financial.

Two very quick things. One, between Texas, Arkansas and North Carolina, can you break out the NPLs by region?

Yes, I can. Would you like --

I guess I would like loan balance and NPL by region.

Okay. Let me give you the loan balances by state, and this is state of originating office. Texas was 32.6% of our loans. North Carolina is 6% and Arkansas is 61.4% of our loans at September 30. Deposits, Texas was 13.4% and Arkansas was 86.6% of deposits at September 30. Now, our nonperforming loans, Arkansas was $12.9 million. North Carolina was $0.9 million. South Carolina, $3.8 million, Texas, $1.6 million, and all others were $0.1 million. And that is $19.3 million of loans and leases.

Do you want the --

No, that's exactly what I was looking for. Second question is -- not that you're going to endorse this number, but if your margin stays flat and if you hit a 40-basis-point efficiency ratio by the third quarter of next year, and if the charge-offs go to 70 basis points, it seems to me you've got about $2.80 of earnings power. Is that thought process reasonable, again, without endorsing that number?

Jordan, you're a good guy at running models and probably as good as anybody in the industry. And I'm going to tell you what I've said in the call, and I'm going to let you guys run your models and come up with your own numbers on that.

Thank you.

(Operator Instructions). And you have no further questions at this time.

Thank you very much. There being no further questions, that concludes our call. Thank you for your participation and interest in our Company. We look forward to talking with you in about 90 days. Thank you. Have a good day.

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.