Bank Ozk (OZK) 2010 Q3 法說會逐字稿

Good morning. My name is Michey and I will be your conference operator today. At this time I would like to welcome everyone to the Bank of the Ozarks third-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. Susan 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 third quarter of 2010 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, thoughts, beliefs, estimates and outlook for the future, including statements about -- economic; real estate market; competitive; credit market and interest-rate conditions; revenue growth; net income and earnings per share; net interest margin; net interest income; non-interest income including service charge, mortgage lending and trust income; non-interest expense; our efficiency ratio; asset quality in our various asset quality ratios; our expectation for provision expense for loan and lease losses; net charge-offs and our net charge-off ratio; our allowance for loan and lease losses; loan, lease and deposit growth; changes in the volume of our securities portfolio; the opening and closing of banking offices; and our goal of making additional FDIC assisted failed bank acquisitions.

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. Thank you for joining today's call. In the quarter just ended our two very profitable FDIC assisted acquisitions helped us make significant profits, but even apart from those acquisitions our third-quarter results were excellent. Our third-quarter net income and earnings per share exceeded our previous best by a wide margin and the details are even more exciting. Let's take a look.

Net interest income is our largest source of revenue. Of course, net interest income is a function of both net interest margin and the volume of average earning assets, both of which increased nicely from the second quarter to the third quarter. This combination helped us achieve record net interest income of $32.8 million in the quarter just ended which was $2.4 million better than our previous record quarter of net interest income.

Over the last three years we have had very favorable improvements in our net interest margin. This improvement continued in the quarter just ended as our net interest margin increased to 5.31%, up 21 basis points from the immediately preceding quarter and up 51 basis points from last year's third quarter.

A number of factors have contributed to the steady improvement in our net interest margin over the past three years and the latest boost was primarily attributable to the excellent yields on covered loans acquired in our two most recent acquisitions. Since these acquisitions occurred intra quarter on July 16 and September 12 the prospect of having these new covered loans on the books for the full fourth quarter bodes well for some further improvement in our net interest margin.

Another key factor contributing to our improved net interest margin in the quarter just ended is the 10 basis point reduction in our average rate on interest-bearing deposits from the second quarter to the third quarter. This is a result of the improved quality and profitability of our deposit base in recent years, a trend which continued in the quarter just ended.

In recent calls we've discussed that our non-CD deposits have grown significantly and our level of brokered deposits has been reduced significantly. Not only have these changes helped to improve our net interest margin, but they also have had favorable implications for business development opportunities and service charge income.

As we have acquired new banks we have moved quickly to eliminate wholesale and high cost deposits there and to increase the focus at those offices on lower-cost core non-CD deposits. We have already seen the benefits of this in our five North Georgia offices which we acquired in March of this year.

Specifically at the time of acquisition non-CD accounts provided only 41% of the acquired deposits in those offices. But at September 30, just six months later, non-CD accounts provided 55% of the deposits in those offices. Obviously this is one of the reasons why those offices have been so profitable for us in their first six months of operation.

Throughout 2009, and to a lesser extent year to date 2010, we have been a net seller of investment securities which has restrained or eliminated our growth in average earning assets in most quarters. We've previously stated that the reduction in our investment securities portfolio was undertaken primarily as a result of our ongoing evaluations of interest rate risk and also to free up capital for FDIC assisted acquisitions.

In the quarter just ended we benefited from good growth in average assets as a result of the addition of the covered loans with our two most recent acquisitions. The impact of this integrated balance sheet management strategy, which involves selling of securities and adding covered loans, was seen in our third-quarter net interest margin.

This rotation in earning asset mix, specifically the addition of a significant volume of higher-yielding covered loans in place of securities, sold earlier at much lower effective take-out yields not only reduced our interest-rate risk and improved our net interest margin, but it also resulted in nice gains on the sale of securities and nice bargain purchase gains on our three FDIC assisted acquisitions. It is hard to not like a strategy that generates income on your sales, income on your purchases and better margins with less interest-rate risk going forward.

Let's shift our discussion to non-interest income. Income from deposit account service charges is traditionally our largest source of non-interest income. We are very pleased to report record service charge income for the second consecutive quarter. For the quarter just ended service charge income was up 23.7% from last year's third quarter. For the first nine months of this year service charge income is up 22.6% from the first nine months of last year.

These increases reflect a number of factors including -- the significant organic growth in our number of core deposit accounts; the increased utilization of certain fee-based services by many of our customers; and the addition of core deposit customers as part of our three bank acquisitions this year. In addition, we think that we've benefited somewhat from better economic conditions generally this year as compared to last year.

As most of you know, August 15 was the effective date for new federal regulations that prohibit banks from utilizing overdraft protection programs to pay customers into overdraft for non-recurring electronic debit transactions, unless the customer has previously affirmatively opted in for such overdraft protection. There was a lot of speculation that this would significantly reduce bank service charge income.

For our bank the impact of this was not too severe, primarily because we had conducted a very well-planned and effective opt-in program. And despite what people in Washington think, most of our customers seem to want their non-recurring electronic debits paid even if they incur an overdraft fee for that service.

Mortgage lending income in the quarter just ended was up 52.4% from the third quarter of last year, but even after our excellent third-quarter results mortgage lending income is still down 10% for the first nine months of this year compared to the first nine months of last year. The recent drop in mortgage rates has had positive implications for refinancing activity in the quarter just ended and it seems likely that that will continue in the fourth quarter.

Our trust income increased just one/tenth of 1% in the quarter just ended compared to the third quarter last year, but for the first nine months of this year our trust income is up 14.6% compared to the first nine months of 2009.

Net gains from investment securities and sales of other assets in the quarter just ended were $837,000 compared to net gains in such categories of $91,000 in the third quarter last year. Net gains from investment securities and sales of other assets in the first nine months of this year were $4,550,000 compared to net gains in such categories of $20,625,000 in the first nine months of last year.

Our securities portfolio, although reduced in size over the last two years, continues to be an important component of our earning assets and a potential source for future gains. Not surprisingly, in light of market activity the favorable mark to market adjustment for our securities portfolio increased nicely in the past quarter.

Of course the 800 pound gorilla in our third-quarter non-interest income was our $16,122,000 in pretax bargain purchase gains from our two recent FDIC assisted acquisitions. For the first nine months of 2010 non-interest income included a total of $26,160,000 in pretax bargain purchase gains from our three FDIC assisted transactions so far this year. There were no such gains of course in 2009.

As beneficial as these gains are, we think that our third-quarter results excluding these gains make it clear that the ongoing benefits from these acquisitions may be even more significant than the day one gains.

In recent months there has been significant commentary from many sources suggesting that the opportunities for profitable FDIC assisted acquisitions are diminishing. The profitability metrics of our two third-quarter transactions suggest that very favorable acquisitions can still be made using our approach, which is to be very active in looking at opportunities while being very conservative in our underwriting and our bidding.

This strategy has resulted in us being the winning bidder on just under 13% of the opportunities on which we have performed due diligence. Like you, we have observed a number of recent transactions that seem to make very little financial sense and, frankly, we were significantly outbid on some of those transactions.

However, we've stated from the beginning that we would do our due diligence, maintain our discipline in underwriting and discipline in bidding and pursue transactions with a view to making profits both on the acquisition transaction and from the ongoing operation of the acquired assets. We are continuing to pursue this disciplined approach and we will continue to see, we believe, many additional opportunities.

Let's turn to non-interest expense which increased 52% in the quarter just ended compared to the third quarter of 2009. Our third-quarter non-interest expense was significantly impacted by several factors including write-downs totaling $2.74 million and the carrying value of certain items of foreclosed real estate.

In addition, non-interest expense for the quarter just ended included $1.67 million of unusual expenses related to our two acquisitions in July and September, preparing for the systems conversion of those two acquisitions in November of this year and January of next year and completing the systems conversion for our North Georgia offices acquired earlier this year. Non-interest expense also included the cost of ongoing due diligence efforts relating to other FDIC assisted bank acquisition opportunities.

Of course, for many years one of the strengths of our organization has been our excellent efficiency ratio and we expect that strength will continue to be evident in future results.

While we're discussing overhead let me mention that despite our current focus on FDIC assisted failed bank acquisitions we are continuing our growth in de novo branching strategy. This includes plans to open a third banking office in Benton, Arkansas, a suburban area around Little Rock here in central Arkansas later this year.

And in addition, we currently have contracts in place to purchase in December two former Wachovia/Wells Fargo branch buildings in the metro Dallas area which we expect to reopen as Bank of the Ozarks offices during the first half of next year. We are also in negotiations to purchase a third Wachovia/Wells Fargo branch down there Wachovia/Wells Fargo branch down there and we would open it also next year as a Bank of the Ozarks branch.

We expect de novo branches to continue to be an important part of our business strategy in future years, but our focus on such strategy will take a backseat for another year or two or possibly longer as we continue to focus on FDIC assisted acquisition opportunities.

During the past 17 years, we have achieved excellent results with our focused and disciplined de novo branching strategy. We are applying that strategy to the branches of our newly acquired banks. Among the things that we liked best about our first-quarter acquisition in North Georgia was the fine staff, the good locations, and the excellent branch facilities. As a result we retained all five of those branches as Bank of the Ozarks branches and we've been very pleased with each of them.

On the other hand, when we perform due diligence on Woodlands, which we purchased in July, we knew that their facilities would require a major overhaul, and that was factored into our bid. We are temporarily operating all eight of their offices, but on October 26 we expect to permanently close four of those offices and in December we plan to relocate two of the remaining offices to new enhanced facilities.

Only two of the original eight Woodlands facilities meet our minimum standards for a retail branch and we plan to continue to operate those facilities. But even there we have renegotiated our leases to reduce our operating cost by eliminating excess space. All of these changes will give us four well located offices, one each in Mobile, Alabama; Savanna, Georgia; Bluffton, South Carolina; and Wilmington, North Carolina.

These four offices will cost much less to operate than the original eight Woodlands offices and, even more importantly, these enhanced offices will be much more effective in serving our customers in building the type of retail banking operation we want in those markets.

We are currently evaluating the four Horizon offices that we recently acquired in Florida with the same goal of ensuring that our final complement of offices will be the best possible solution for our customers and for our operating efficiency.

One of our long-standing and key goals is to maintain good asset quality. Economic conditions have made our traditional strong focus on credit quality even more important. Over the past several years we've dealt with a number of asset quality challenges and we think we've been relatively successful in handling those issues.

In our last four conference calls, we've stated our belief that we are past the midpoint of the current credit cycle and therefore we believe that our allowance for loan and lease losses ratio has already peaked. As you will recall, the recent high point in our allowance ratio was 2.19% of total loans and leases at June 30, 2009, a little over a year ago. We continue to believe that that 2.19% allowance ratio was the peak for the current credit cycle.

I also stated in our January call earlier this year, and reiterated in our April and July calls, that while we expect our net charge-off ratio, our net charge-offs, and our provision expense to vary from quarter to quarter this year, 2010, we believe that on average these metrics will show improvement in 2010 compared to the results achieved in the fourth quarter of 2009. In each quarter this year, our actual results for all three metrics have shown improvement compared to the results in last year's fourth quarter, which was the benchmark for our guidance.

Specifically pertaining to the quarter just ended, our annualized net charge-off ratio was 88 basis points compared to 108 basis points in the fourth quarter of 2009. Our net charge-offs in the quarter just ended were $4.2 million compared to $5.3 million in the fourth quarter of 2009, and our provision expense in the quarter just ended was $4.3 million compared to $5.6 million in last year's fourth quarter.

The guidance we gave in January of this year regarding our expectation for these three asset quality metrics has proven to be right on target for the past three quarters and we expect it will still apply to the final quarter of 2010.

For the past two years, we've regularly stated our expectation that this economic recovery would be very subdued. Unfortunately, that prediction seems to be on target as well. Notwithstanding the relatively weak recovery in 2011, we expect stable to modestly improving results in our net charge-off ratio, our net charge-offs, and our provision expense compared to 2010.

The magnitude of improvement will depend to some degree on the strength of the recovery over the coming quarters. Our guidance in this regard assumes that the United States does not experience a double dip recession and continues to have some degree of economic recovery.

In closing, let me state that our goal for the fourth quarter of 2010, and we believe it is a reasonable goal, is to achieve net income exclusive of any bargain purchase gains and related cost of acquisition and additional FDIC transactions in excess of $11.5 million. In our view, that is now a minimum level of quarterly earnings we would like to achieve.

Of course we certainly hope to do more FDIC-assisted loss share transactions and if we can do more such transactions may result in significant bargain purchase gains and even higher quarterly net income results.

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

(Operator Instructions). Andy Stapp.

I missed your comment on your net interest margin guidance. I apologize, but could you repeat that please?

Yes, I'd be happy to do so. In of course the current quarter we had two factors that really pushed our margin wider. One was a 10 basis point reduction in our cost of interest-bearing deposits from Q2 to Q3. That appears to be very sustainable to us based on what we're seeing at the current time. And number two was the significant boost in yields on the covered assets that we acquired in the Woodlands and Horizon transactions.

And I commented that since we made those two transactions intra quarter and basically have five-sixths of a quarter of the Woodlands benefit in our numbers and about one-sixth of a quarter of our Horizon's benefit in the numbers, that we expect that having that larger volume of higher-yielding covered loans on the books for the full fourth quarter would give us some additional prospects for margin improvement in Q4.

Okay, got you. And that -- the increase in your yield on covered loans was pretty substantial. Just curious, was the accretable yield in your two deals this quarter -- why was that substantially higher than your first deal?

Well, the way that we determine the discount rate on each loan is based on how those loans are graded out and risk rated in our system. As we acquire these banks, what we do is literally go in the first week and take a team of people in there and work with the local lenders and loan assistants and re-grade and re-evaluate every loan and apply our enhanced and expanded grading system to those loans.

And then we assign a discount rate based on the -- to each loan based on the risk allocated to that loan. For example, a three rated loan in our system might have a 6.5% discount rate assigned to it, a six impaired C loan might have a 9.5% discount rate assigned to it. So the higher accretable difference or discount rate just reflects the relative risk profile of those loans.

And of course, the credit -- there's a non-accretable difference. The credit mark also is reflective of the difference. So we had in both transactions higher credit marks and higher discount rates on average than the Unity transaction because the portfolios were a little rougher.

Got you, it makes sense.

And we expect, because they're going to be a little rougher, that they're going to be a little more challenge to work out and also they're going to be more profitable for us. We priced accordingly. None of that was a surprise to us.

Okay, and your last category in non-interest income, the other non-interest income was up quite a bit. Were there any notable non-recurring items in that line item?

There were no notable non-recurring items. There are some new items in there. And as you know, when we value these assets we mark them down to a net present value of expected future recovery proceeds discounted to a net present value and we set up a receivable from the FDIC for what we [think] the loss share receivable will be related to those loans.

That loss share receivable is discounted to a net present value and I think, Greg, we're using a 5%, 5.5% type discount rate on that and -- as that discount is accreted into income. So the non-interest income results for the second quarter included the net present value discount accretion for the FDI receivables on Unity and Woodlands. Of course, there was very little for Horizon because it was acquired late in the quarter.

And also, as we recover more on loans and recover things faster really on loans than were expected, that results in some incremental income there. And we've been pretty conservative in valuing these things and pretty conservative in our timing estimates on the receivables, just commensurate with our normal conservative view.

So we recovered more on assets and recovered those amounts faster than we had modeled, and that created non-interest income in that other non-interest income category. I expect that will vary somewhat from quarter-to-quarter, but I expect that it will be a regular and recurring amount of income. And in my view the third-quarter number probably represents a pretty indicative amount of what that will be.

Of recoveries or the total amount?

Both.

Okay -- even though there should be a full quarter effect of that -- the FDIC receivable in your -- in Q4?

Yes, I would say that, all things being equal, there would tend to be a slight upward bias to that on the fact that we would have a full quarter effect to the recent acquisitions. Yes, I agree with that.

Okay. And one last question and I'll get into queue. Are there any encouraging signs with regard to loan demand or do you think everybody is just on the sideline until there is more clarity on tax rates, healthcare costs, the economy, etc.?

I certainly think that the considerable degrees of uncertainty on the political landscape about taxes and what government policy is going to be and the outcome of the elections -- I think that does have people in many sectors, business and consumer, taking a wait and see attitude.

And I wish that our political folks in Washington understood that if they keep tinkering with all the mechanisms of our economy that the tinkering may be well intended but the uncertainty created from that tinkering is causing people to just stand aside and wait. I wish we could get that message to Washington. So I agree that is.

Yes, I would say in response to your question we do see some live modestly encouraging signs. We did have positive on growth in Q2. We commented in the last call that our magnitude of our pipeline going in to Q3 was not as encouraging as the pipeline going into Q2. I would say going into Q4 we see a better pipeline than we did at the time of the July call, probably not as good as we did at the time of the April call. But I'm taking that as somewhat positive compared to the last quarter.

So we're still hopeful that we will generate positive loan growth on a quarter-to-quarter basis. I can't guarantee you we get there this quarter or next quarter. But I think it's very likely that we're going to have positive quarters interspersed with flat to slightly negative quarters of loan growth. But I do think we're in a more positive situation in that regard than we were certainly this time last year.

Okay, thank you.

Thank you.

Bain Slack.

Good morning. A quick question I guess with regard to the NIM and looking at the full impact of the covered loans. You had interest income of $6.205 million in the quarter; is there any way to estimate or guesstimate what that would have been assuming those banks were there in the entire quarter, in other words that being annualized?

Bain, I've not actually put a pencil to that. I'm actually looking at our daily numbers, but I've not pro forma calculated that. So you've got the dates we acquired Woodlands and the dates we acquired Horizon and you can derive some estimates from that. And the Woodlands deal was about twice the size roughly the Horizon deal as far as the loans. So we had -- as far as the growth in covered assets, we had about I guess -- Greg, is that right? Woodlands was roughly two-thirds?

Yes.

So we had five-sixths of a quarter roughly on two-thirds and one-sixth of a month roughly on one-third. So you can project and extrapolate from that.

Okay, great. I think earlier you had said that the 10 basis points of lower deposit cost was sustainable. I guess I just wanted to interpret what you meant there. Was that meaning that we see another further type of reduction or just where we are as sustainable with regard to the cost?

Well, that's a good question, I apologize for the ambiguity. What I meant was the number that we generated in Q3 appears sustainable. That 10 basis points we gained from Q2 to Q3 I'm not seeing a situation where we give that back.

Got it. Okay. If I could just also just jump to the tax rate, which in the last couple quarters, I think because of these transactions, have been a bit higher. Is there kind of an outlook of what that could be on a normalized basis, maybe -- I don't know if you could look at it from a 4Q perspective or maybe just kind of 2011 as we look out into the future.

I think if you go back to our tax rate in Q2, which was --.

24?

Yes, Q2 was a quarter with no significant securities gains or bargain purchase gains. I would say that tax rate is probably going to be pretty indicative of a quarter in which we do not have significant unusual income or expense items. And obviously in Q1 and Q3 where we had big bargain purchase gains, those are all taxable gains so that tends to skew the tax rate higher proportionately based on how big those gains are.

And my hope is that we're going to -- we're very actively looking. For example, in the three weeks following the Woodlands acquisition we bid additional banks each of those deals, and the week following the Horizon acquisition we bid a bank the week following that. So we're fully engaged in the process of looking at additional opportunities, so I hope we're going to have a really high tax rate because we make lots of acquisitions and make big profits on them.

Got it. And just the last question before I go. I think you had referred to a $2.7 million OREO cost. I was wondering if we could get kind of an update of I think there are three particularly large pieces in there, if we could get an update on those three?

Really there is only one particularly large piece in there at this time, the others have been whittled down considerably, and that's an $18 million asset in Texas. It's a 60 acre tract right by the central business district in downtown Texas. And I was a little reluctant to mention it, but since you asked the question I will.

We actually have that tract under contract. We're carrying it -- we'll net basically our book value on it. The contract is conditioned upon the purchase or raising a considerable amount of equity money. He is in the process of doing that. It's a tougher market to raise equity money on real estate bills now than it was two or three years ago, three years ago probably.

So my assessment is that there's a 50-50 chance that deal gets done. And because it was a 50-50 probability I wasn't going to mention that unless someone specifically asked me about it. So we're hopeful that that asset will be gone this quarter with essentially a breakeven transaction. And if it is obviously that would be a 40 plus percent reduction in our volume of other real estate assets, so that would be a very nice thing to get done.

We've also got a couple of million dollars of other pieces of that OREO under contract in transactions that would essentially be a breakeven. And so if all of those get closed this quarter we've got a shot. And again, all of those are subject to getting closed, but if we get them close we've got a shot of cutting our OREO in half this quarter.

Great, good news. Okay, well, that's it for me and good quarter.

Okay, thank you very much.

Ben Harvey.

Good morning. George, in terms of the increase this quarter in the salary line item, I guess I have two questions there. The first, should we expect to see a further increase again in 4Q kind of from the full quarter effect of the two recent acquisitions? And then secondly, how much was in there from that $1.7 million associated with the acquisition expense?

There was a pretty good line item in there associated with that because we paid -- we deploy teams of people to work on these and we have -- we pay our people who work on and successfully complete these conversions and do the preplanning, we pay them bonus comp for that.

So of the $1.7 million, probably about $530,000 of that was for bonuses related to either guys who were working due diligence or guys who were on our deployment teams or guys who were working on the conversion processes related to those transactions. So roughly one-third of it was related to those items. And of course, if we make more acquisitions you'll see more of that in future line items if we don't make another acquisition and that will not be reflective in future line items.

We have, of course, increased our headcount as a result of the Woodlands and the Horizon acquisitions; we picked up a number of employees there. And as a result our number of FTEs that was 763.5 at June 30 was 837.5 FTEs at 9/30. So in the quarter we basically added, what is that, 74 net new FTE employees as a result of that.

And most of that was at Woodlands and Horizons offices that we required. We added another person in the accounting department. We added -- to handle the loss share accounting we added another person in our general counsel's office and five other people in operations and so forth to handle the acquisitions and to prepare -- to stay ahead of the curve in preparing for future acquisitions.

It's possibly, I guess, too early to ask this question for Horizon and maybe even Woodlands, but I guess what do you guys think in terms of asset runoff from the acquisitions compared to your original outlook?

We are hitting our targets or doing better than we expected. And obviously we've got a very disciplined and structured way that we run our company that has achieved really good results for us for a long, long time. And these franchises that we're acquiring have elements that work within our model and then they have elements that are not consistent with our model.

So we're very deliberate in what we're doing and we're very straightforward with the staff in these offices. We meet with them over the first weekend and we explain what our model is and how it works and what their model has been. And we basically explain that the first step in dealing with these new acquisitions is to deconstruct all of the parts of their business model that don't fit our business model, get their buy in on that and we take it apart and get rid of that stuff and then start building back with our business model.

And at the Unity deal we've basically been involved for seven months in deconstruction and we are now really just this quarter getting very offensive minded. Now I will say we actually had positive deposit growth there in August; I haven't seen the September results, they're in, I just haven't looked at them yet from Unity. But we really started reconstructing their deposit base after the deconstruction early on and we're doing that same process at Woodlands and the same process at Horizon.

So for example, today if you look at our capacity to make additional acquisitions, we've got very comfortably, and kind of the level we could make $1.4 billion -- between $1.4 billion and $1.5 billion of additional acquisitions. But that would allow us actually to probably make $2 billion to $2.5 billion of acquisitions because the deconstruction process and the process of getting rid of things in these companies that don't fit our model is going to rapidly shrink them down.

So we're looking at acquisitions that could be as much as $2 billion to $2.5 billion, realizing that in a fairly quick order of deconstructing the pieces that don't work before we start building back, we could probably get them down to $1.4 billion, $1.5 billion which is really the capital capacity that we've got at this point to make acquisitions.

And we really like the way this is working and what has been really helpful to us is the staff at these things have -- we've been able to communicate effectively to them what our business model is and why it works. And we've had a real high degree of buy-in from those guys, of giving up their plan and jumping on our plan.

Great. And one quick last question. Do you guys have your regulatory ratios for the end of the quarter?

Capital ratios?

Yes, sir.

No, we don't have those yet. The risk rated and all of that, no, I don't have that.

Okay. Thank you for taking my questions.

All right, thank you.

Kevin Reynolds.

Good morning, George.

Good morning, Kevin.

Great quarter.

Thank you, sir.

Most of my questions have been answered, but I wanted to sort of talk about -- I think you actually just answered most of them with the talk about gross versus net acquisition capacity going forward. But has anything changed in terms of the size that you might look at? I know most of the ones that you so far -- or all the ones so far have been just a few hundred million dollars.

Is there any thought that you might be able to actually acquire something that's more sizable than that? And then second, has there been any change to the markets that you might be targeting for these as you do the work on potential bids? And if not, could you just remind us what those markets are that you're looking at?

I absolutely would be happy to. Nothing has really changed and, yes, the acquisitions that we've made have been small to lower moderate sized acquisitions. We bid on a number of acquisitions as large as $700 million -- $600 million, $700 million, $800 million, even $1 billion, north of $1 billion.

Our size range that we're basically looking at is anything from basically $150 million up to $2 billion and we would even edge over with the formation of capital and the change in the risk profile of our balance sheet we would even edge a little bit over $2 billion now.

We are continuing to focus primarily on the states where we have offices and, of course, that list is growing. Arkansas and Texas would continue to be our favorites, but there aren't many opportunities there -- North Carolina, South Carolina, Georgia, Florida. And because we now have a presence in Alabama we would add Alabama to that list as well. And of course, we're still looking in other sort of peripheral states to that -- Virginia, Tennessee, Missouri and Oklahoma and Kansas in certain respects would be places that we were looking at.

So there's not really any change, I guess, other than the fact that having picked up an Alabama office in Mobile as part of the Woodlands deal, we previously said Alabama really wasn't on our target list, but if something came along that fit with what we're doing there, what we've learned and know about Mobile, we actually like that market now so we would consider that as an additional state. But otherwise no change.

Okay, a couple of other questions on that. Has your appetite improved as the economy has stabilized with respect to possible open bank transactions? Would you be more willing to do something like that? I know we've seen a couple of wounded competitors find a savior here recently in the South. That's one question, and another is if you added another $1.5 billion, $2 billion or so, how do you staff for the integration, the workout and all those sorts of things? That's a very different bank and a set of opportunities and risks than what you have today?

We're just continuing to develop our staff constantly with that in process. Each order this year we've added staff members in certain key positions whether it's our legal guys that help us on workout stuff or whether it's accounting folks that handle loss share or operational people that are involved in the integration process.

We're very fortunate to have a really, really deep team of people and that's probably the one thing about our company that is most misunderstood and it's because when we present in public and I go on investor trips I almost always go solo and people read that in -- oh man, this is a one-man company. Nothing could be further from the truth.

We've guys here in the Company that could run it in my absence. We've got a fantastic team of people that I would match against any team in the country. I'd take my top 10 guys and match them against JPMorgan Chase's top 10 guys and feel pretty good about our chances of winning that battle. We've got a really sharp team of people and a lot of depth and capacity, so if we make $2.5 billion of acquisitions and shrink them down to $1.5 billion and that's added on top of what we've got I'm very confident in our ability to handle it.

We'll work hard and there will be some guys that will be here nights and weekends that might have been someplace else nights and weekends, but we can handle that and do it with excellence. And boy, that's what we're preaching to our new staff on the opening weekend right out of the gate is, guys, we're not interested in just getting the job done, we're interested in doing it with the utmost level of excellence in every respect.

And that's a different culture that we're having to impart. But as I said earlier, we're getting tremendous buy-ins from our new employees and our new offices and they are quickly embracing our culture and our focus on doing everything with the highest degree of ethics and integrity and the utmost standards of excellence.

Okay, thank you.

Thank you.

Joe Stieven.

Good morning, George. First of all, excellent quarter.

Thank you.

Kevin just asked one of my questions, but let me take a different angle. It's obviously impossible to predict when you're going to win FDIC deals, but tell us how busy your teams are as far as the volume of things that they're looking at now compared to what they were looking at three and six months ago?

There seems to be a little bit of a lull in activity right now in the pipeline of stuff we're seeing from the FDIC. Now we've got another due diligence team going out next week to look at another deal and -- but I have no doubt that there are many, many, many more deals going and I'm trying to figure out what the FDIC's strategy and reason for the timing on these things is.

They seem to come in waves and it's hard to understand why they're doing that and I'm assuming it relates to workload issues that they've got and staffing issues that they've got. But we seem to be right now this week today sort of between one wave and I would believe another one is coming. So -- and I think the FDIC is being fairly strategic in realizing that if they deal with this very deliberately over an elongated period of time a few deals will get recapped and a few deals will get bought like the deals that were mentioned earlier by one of the questioners.

And if they don't flood the market it tends to keep their prices better and reduce loss to the fund. So I'm thinking now when we started into this process earlier this year I was thinking this was a 2010-2011 deal. But as I'm looking at the relatively slow ramp up in economic growth and the relatively slow rollout of these things from the FDIC I'm thinking this is a 2011-2012, and maybe even a little beyond, window of opportunity. And we're staffing and adjusting accordingly.

George, with that as a backdrop, you've pretty much said you're focusing almost exclusively on FDIC stuff and not, let's say, buying wounded situations like we just saw in Mississippi just recently. I mean, does that mean that you might start looking at wounded companies selling at 50%, 60% of book on a healthy bank basis to a higher degree? Or are you just going to stay on the FDIC stuff?

We're seeing a number of opportunities. As you can imagine, I'm getting calls almost daily, at least weekly, and one or more every week from somebody that's showing some live bank deal and most of them are deals that you think after you take 10 minutes and listen you think I'm likely to see that deal (multiple speakers).

(multiple speakers) Six months later.

Yes. And some of them are deals that the bank probably doesn't get closed, but is probably sufficiently damage in regard to capital and other attributes that it will be years before they recover. And I mean we've seen a couple of deals that we've run a little bit of numbers on and just table topped. And we thought that deal would actually make sense.

But then when you compare those opportunities to an FDIC assisted deal, in the FDIC assisted deal you can take or reject the branches; you can break rates on the deposits day one; you can hire and not hire who you want; you can have the benefit of loss share on all the loans.

There are just so many pluses, it is so much easier and quicker to get a broken bank profitable in the FDIC situation than it is in a takeover of a live bank situation because in the live bank situation you've still got all the problems, you've still got all the branches, you've got all the contracts, you've got all the locked in rates on the deposits.

And every one we've looked at that seemed like it would make a little sense we've come down and said, guys, it's just not worth messing with, let's just keep focusing on the FDIC deals because they continue to be relatively compelling. So that's where we are. I'm not saying we won't do an open bank live deal at some point and we're looking at lots of them. I'm just telling you every time we've thought we had one that looked like it made sense and we've actually run numbers on it, we've said, gosh, the FDIC deals are just tons better.

George, thank you and great quarter again.

Thanks, Joe.

Dave Bishop.

Good morning, George, how are you doing?

Doing fine, Dave. Good morning.

In terms of just a fine tooth comb here -- most of my questions have been answered -- but in terms of the new non-accrual loan formations this quarter, any sort of commonality there? I guess as we take questions from clients there in terms of the commercial real estate and the construction book there, where do you get a sense in terms sort of to watch those trends there and how your clients are holding up from a global cash flow perspective there? Just (multiple speakers) some color just in terms of what's going on for those underlying trends there?

Of course there was the change in our non-performing loans excluding covered loans that are (technical difficulty) by loss share. If you exclude the covered loans the change in our non-performing loans was a very minimal slight increase I think in the quarter from the prior quarter, but a very slight number.

And I would tell you that I think there was not any noteworthy change in composition or location or anything of that. It's just the normal ebb and flow of those numbers. And as we said in the first conference call this year, we expect we'll have some quarters that will be better than other quarters over the course of the year, that it's not going to be a straight line down, but that the asset quality trend we believe the trend line is improving.

We continue to believe the trend line is improving. I continue to believe that there will be quarters our ratios will go up a little from the prior quarter and quarters they'll go down a little. But I think they're going to oscillate up and down along an improving trend line in the fourth quarter and the four quarters of next year.

I think things continue to get better and that's a reflection of two things. Number one, I think we are just well through the process of dealing with -- way along in the process of dealing with credits that have suffered damage as a result of the economic downturn, the recession. And the other thing is I think we do have an economic recovery, albeit extremely slow.

I started saying four, five, six quarters ago that my view is that the economy had fallen from a 10 story window and hit the sidewalk and that my view of the recovery was that the economy crawled down the sidewalk. And I said that when the economy probably was at the first floor and still falling and our view of the recovery has not changed.

It's just going to be slow and gritty and our country has fundamental long-term problems of global competitiveness and currency issues and deficit issues that have got to be dealt with and until those issues get constructively and properly dealt with we're not going to have much of a robust long-term recovery.

So we're just adjusting our business practices to be successful in the context of a very sluggish slow recovery for a number of years. But I do thank asset quality, notwithstanding that fairly subdued view of the economy, gets progressively better as we go forward in our balance sheet.

Thanks, George.

Thank you, Dave.

Andy Stapp.

I think your securities are down to 13% of assets. How much lower are you willing to reduce securities?

I think Payton Green asked in the last call was there room to further reduce them. And I think I said at that point, yes, there was. And I don't remember exactly the number, but I probably said $100 million to $200 million and, of course, I think we reduced them $50 million or so million, real round numbers, in the most recent quarter.

There is room -- we could take that number down another $100 million to $150 million from where we were at September 30. I don't really have any present intent of doing that, but if we made some really big acquisitions or a really big acquisition and pressed the capital ratio we could free up a little more capital by further shrinkage of the securities portfolio. We're happy with where it is right now, but we could shrink it $100 million to $150 million if we needed to.

Okay, thank you.

Thank you.

Brian Martin.

Brian, good morning.

Hey George, great quarter. I'll make it quick since you're getting tired here. The loan book in the quarter, you talked about it obviously being soft or a little bit down, but the outlook being maybe a little bit more positive than it has been maybe a year ago. But can you just give a little color on what the originations versus the paydowns this quarter were and just the activity in Arkansas and Texas, how that's trending in each of those markets?

One of the things that has just really been a blessing and benefit to our company has been the relative good economies in Texas, particularly the metro Dallas area where we have a lot of assets, and in Arkansas. And that continues to be the case and we continue to see modest what I would consider positive improvements in economic activity and volume of business in Arkansas and Texas.

I think things are doing well there on a relative basis, have done well and continue to do a little bit better as we go on. So we're positive about that. We are having paydowns and loan pay off every quarter, every month and we are originating new loans as well. Obviously the second quarter of this year our originations benefited from a couple of larger loans that we originated that were we think the best quality loans we've got in the whole portfolio and that gave positive loan growth in Q2.

Our paydowns slightly exceeded our originations in Q3 so we had a very slight negative growth in Q3 apart from the purchase of covered loans. And as I said, I think we'll have up quarters and down quarters for a while, but I think we're a little more optimistic now about having up quarters in loan growth than we probably were in the July call. We had a weaker pipeline for going into Q3 than we have for Q4.

Now I've got to get the stuff we've got in the pipeline closed and we've got a good application pipeline and we've a good approved pipeline for Q4, but I'll still have -- I'll still incur some paydown. So that's why I think it's questionable as to whether we'll have growth or shrinkage in a particular quarter, but I think going forward we'll have more growth quarters than we do shrinkage quarters.

Okay. Thank you very much.

Payton Green.

Congratulations on a very strong quarter. A question on what you saw customer wise from I guess a behavioral aspect with the NSF fees in your accounts. I mean the deposit fees certainly were very solid in the quarter. I'm just curious what anecdotally you could share with us on that. But do you think -- has there been any regulatory push back on NSF practices and the like?

Okay. Well, first what we saw is obviously we had some reduction after August 15 in our level of NSF OD fee income from non-recurring electronic debit transactions, debit card transactions primarily. But it was a fairly well contained and well controlled reduction and the credit for that goes to Susan Blair and Tyler Vance and the folks who developed and worked on our opt-in program.

And to continue to pay customers into overdraft if they used their debit card the customer had to affirmatively opt-in in a written document. And we were very targeted and strategic in the way we did that. We determined that a very small percentage of our deposit customers accounted for a very high percentage of our non-recurring electronic debit income.

We specifically targeted those customers with personal calls and personal visits to discuss that. And 90% of those what we would describe as heavy users opted-in. Then we had a less intense program for other users and non-users to opt-in, but we had a very high opt-in rate overall. And the key was getting -- the key to not having a lot of attrition in that number was to getting a 90% opt-in rate from the heavy users. And I think the heavy users accounted for about 85% of our related fees on that.

And people were very anxious to make sure that we continued to honor their electronic debit transactions for the most part. And what was interesting is some of the people in the first few days after August 15, I'd say the next two weeks, we had a fairly high number of customers call that had not opted in and wanted to be opt-in because they went to Wal-Mart or Penney's or wherever and pulled out their debit card and the transaction got rejected. And when that happened they suddenly realized that they didn't like that outcome and they wanted to opt-in, so we had another wave of opt-in there.

So I think -- my guess is that our guys did a really excellent job in handling that process and that we'll have better results in that regard than others and it continues to be an ongoing process. Our guys are going back to the folks that didn't opt-in and some of those folks have experienced having their charge rejected at this point. And we're continuing to try to increase that overall opt-in percentage focused primarily on the heavy users, secondarily on the other users, and a really tertiary focus on non-users who may be users occasionally in the future.

So it's just an ongoing process of getting that opt-in. Now the FDIC, as you're probably aware, has proposed new regulations that -- the status of that I don't think is known and it's still in a comment period -- that would basically require opt-in for all overdrafts, not just non-recurring electronic debits.

But what I think the FDIC is going to find out, if they'll back off and look at what's happened with this opt-in on non-recurring electronic debits is the bureaucrats in Washington think the overdrafts are -- and the political guys in Washington think that the overdrafts are some sort of abuse by banks. But if they get out here and do what we're doing and talk with customers they're going to find out that the vast majority of customers who use the program want the program.

And so our regulators and our political folks are basically trying to address what they consider a problematic practice that is really, if you ask the customers, not problematic for the industry, it's something that people want and are willing to pay for.

Now what's interesting is the people who don't want it and the people who are not willing to pay for it are the people who never use it. So if you took a poll of all bank customers in the country you'd probably have a majority say, no, I don't want to be charged and if I'm overdrawn I don't want to be paid into overdraft and I don't want to be charged for it.

But if you stripped out the people who are non-users of the service and you polled just the users of the service, I would tell you that the users, or 80% to 90%, would say, yes, I want it and I want to be paid into overdraft and I'm willing to pay for it to have that service.

So there's a political rhetoric and posturing related to this that is disconnected from the reality of what customers want. And that's what we've got to communicate to the FDIC as an industry and avoid further issues. But if they do the same thing on all overdrafts that they did on the non-recurring electronic debits I think we'll have about the same results on an opt-in for that. We'll just have to do the program again. More than you wanted to know I'm sure.

(Operator Instructions). There are no questions from the phone line.

Concluding our questions that will wrap up our call. Thank you for joining the call today. We appreciate it. We look forward to talking with you again in about 90 days. Thank you very much.

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