Bank OZK
Q3 2008 Earnings Call Transcript

Published: 15 Oct 2008

[Operator:]

Welcome everyone to the Bank of the Ozarks third quarter 2008 earnings release conference call. (Operator Instructions)

[Susan Blair:]

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 2008 and our outlook for upcoming quarters. Our goal is to make this call as useful as possible in understanding our recent operating results and future plans, goals, expectations, and outlook. To that end, we will make certain forward-looking statements about our plans, goals, expectations, and outlook for the future, including statements about economic, housing market, competitive, and interest rate conditions, revenue growth, net income, net interest margin, net interest income, including our goal of achieving record net interest income in the final quarter of 2008 and into 2009, non-interest income, including service charge, mortgage lending, and trust income, non-interest expense, asset quality, including expectations for our net chargeoff ratio, and other asset quality ratios, loan, lease, and deposit growth, and changes in the volume and yield of certain portions of our securities portfolio. You should understand that our actual results may differ materially from those projected in any forward-looking statements due to a number of risks and uncertainties, some of which we’ll 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 at the management 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 statements 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.

[George Gleason:]

We are very pleased to be reporting our second consecutive quarter of record results for both net income and earnings per share. In the quarter just ended, we also achieved our seventh consecutive quarter of record net interest income, improved our net interest margin for the fourth consecutive quarter, once again achieved relatively good performance and asset quality, and added to our allowance for loan and lease losses. All things considered, we think we had an excellent third quarter. It probably goes without saying but it was another exciting quarter to be in the banking business. Despite all of the dramatic volatility and equity and credit markets and the jaw-dropping headlines from Wall Street and Washington, in most respects it was business as usual here at Bank of the Ozarks in the third quarter. However, it was a very busy quarter. We found ourselves constantly monitoring conditions in the economy, the credit markets, and throughout our industry, trying to detect any risk that might impact us, while also trying to identify opportunities created by this extraordinary environment. In addition, during the third quarter we had our regular state bank department, Federal Deposit Insurance Corporation, and Federal Reserve regulatory exams, I would characterize all those exams as retained but as always they required a significant amount of management time and attention. There were many important elements in accomplishing our record third quarter results, so let’s talk about some of those details. Net interest income is our largest source of revenue, accounting for approximately 83% of total revenue in the quarter just ended. In our conference calls this year we have stated that one of our goals for 2008 was to achieve record net interest income in each quarter. In the quarter just ended, our net interest income increased 25.1% compared to the third quarter of 2007 and it was up 4.3% from the second quarter of this year. This gives us our seventh consecutive quarter of record net interest income. We continue to believe that achieving record net interest income is a realistic goal for the final quarter of 2008 and that will continue to be one of our goals in 2009. To achieve this goal in the coming quarters, we will need to achieve good growth in earning assets and maintain our net interest margin at or near the current level or hopefully improve it somewhat further. In each quarter this year we have benefited from meaningful improvement in our net interest margin. Our third quarter net interest margin improved to 3.82%, up 5 basis points from the second quarter of this year. In our last two calls, we have discussed that our first and second quarter results benefited from our increased level of investments in certain tax-exempt investment securities, and we said that we expected the benefits of these investments would go away as conditions in the credit markets normalized and yields on these securities returned to more normal levels or as these securities were called away. As expected, our volume of these investments diminished in July and August as many securities were called and yields on other securities dropped below a yield that was beneficial to us. However, when credit market turmoil returned in September, we once again found many good opportunities to both increase our volume of these investments and our yields on them. In our last call we stated that we estimated that these securities investments added about 3 basis points to our second quarter net interest margin and we stated that we expected the yields on these securities to be lower in the third quarter. We therefore expected such securities to be dilutive to our third quarter net interest margin in percentage terms while still being accretive to our third quarter net interest income in dollar terms. That’s exactly what happened. We estimate that our investments in these securities reduced our third quarter net interest margin by approximately 3 basis points although they still provided a positive addition to net interest income in dollar terms. Our volume of these securities has declined from approximately $290 million at March 31 of this year to $170 million at June 30 and $119 million as of September 30. If this portfolio continues to pay off as expected, our total securities portfolio will continue to shrink. In the third quarter our total investment portfolio declined approximately $47 million which was roughly equivalent to our reduced volume of investments in these tax-exempt securities. During the third quarter, we also benefited once again from further improvement in our spreads between loans, leases, and other securities and our deposits and other funding sources. This is evident in the growth in our net interest margin from 3.77% in the second quarter when we estimate that our net interest margin benefited approximately 3 basis points from favorable yields on the additional tax-exempt investment securities to a net interest margin of 3.82% in the third quarter when we estimate that our net interest margin was reduced approximately 3 basis points as a result of lower yields on the additional tax-exempt investment securities. At this point we believe it is reasonable to think that we will be able to achieve net interest margin for the remaining quarter of 2008 at a level approximately equal to or possibly somewhat above the 3.82% level achieved in the third quarter. This guidance assumes a slightly dilutive effect on our net interest margin in the fourth quarter from our continued temporary investments and tax-exempt investment securities. Growth in earning assets, both loans and leases and investment securities, also contributed significantly to our record net interest income in the first three quarters of this year although our average earning assets in the quarter just ended were slightly below the level of our average earning assets in this year’s second quarter. This was due to the lower average balance of the previously discussed tax-exempt investment securities in the third quarter of this year as compared to the second quarter of this year. Loans and leases at the end of the third quarter were up 13.2% compared to September 30, 2007. In the first three quarters of this year, our loans and leases grew 9.8% or approximately 13.2% annualized. This is at the low end of our 2008 guidance range for loan and lease growth which was for loans and leases to grow from the low teens to the high teens in percentage terms for the full year of 2008. With the slowdown in economic conditions nationally and operating as we are in a much more challenging portion of the credit cycle, one might be surprised that we are still achieving loan and lease growth at this level this year. Of course current economic and credit cycle conditions are making it harder in many respects to find good quality loans and leases. On the other hand, these conditions had led many competitors to withdraw from the market because of liquidity, asset quality, and other problems. There are still many good quality loan opportunities and the recent changes in the competitive landscape have given us many opportunities to originate loans with significantly better credit terms and pricing than in recent years. After several years of having to compete against very aggressive pricing and credit terms, these signs of significantly improved credit terms and loan pricing are very welcome and if they continue, they should have favorable implications for future loan growth, asset quality, and net interest margin. Let me shift quickly to non-interest income. We’ve provided a great deal of detail on non-interest income numbers in our press release so I’m not going to repeat any of those numbers. Let me just give you a little color. First, income from deposit account service charges was up slightly compared to the third quarter of last year and up nicely from the sub-par results of this year’s second quarter which we believe were negatively impacted by the economic stimulus checks distributed to most taxpayers. Mortgage lending income for the third quarter was at its worst quarterly level since the third quarter of 2001. Obviously this reflects the generally weak housing market conditions including negative market psychology, the effects of slightly higher mortgage rates as credit spreads have widened, and the more rigorous underwriting and appraisal standards being applied throughout the mortgage industry. Overall it’s a tough mortgage environment. Our trust staff continued to add new accounts and grow existing relationships during the third quarter as they have done all year. This has resulted in solid growth and trust income and each quarter of this year as compared to the comparable quarter of 2007. We continue to expect that trust income for the full year of 2008 will increase from the low teens to the mid teens in percentage terms compared to 2007. During the quarter just ended, we incurred net losses from sales of investment securities and other assets of $396,000. This was primarily attributable to the sale of our only two preferred stock investments which were in Citigroup and JP Morgan. While we have confidence in the long term prospects of these two companies, preferred stock in general was under considerable stress following the takeovers of Fannie Mae and Freddie Mac and accordingly we decided to liquidate these investments. I would emphasize that we have no preferred stock investments after the sale of these two. On a related matter I will note that we have had no exposure to Fannie Mae or Freddie Mac common or preferred stock and no credit exposure to Lehman Brothers, AIG, WaMu, or Wachovia. While everyone in our industry will likely experience some indirect impact from the recent turmoil on Wall Street and in Washington, we are fortunate to have avoided many pitfalls which have directly affected many other financial institutions. Non-interest expense increased 17.8% in the third quarter of 2008 compared to the third quarter of last year. For the first 9 months of this year, non-interest expense was up 12.3% compared to the first 9 months of 2007. This was in line with our most recent guidance which was that we expect non-interest expense for the full year of 2008 to be somewhere between 10% and 13% above non-interest expense for the full year of 2007. Although our third quarter efficiency ratio of 43.8% was higher than the record efficiency ratio we achieved in this year’s second quarter, it still represented a good improvement compared to the 45.1% efficiency ratio achieved in last year’s third quarter. Another of our key goals is to maintain good asset quality. Economic conditions nationally have weakened in recent quarters, making our traditional strong focus on credit quality even more important. Most of our markets in Arkansas, Texas, and the Carolinas generally appear to have been less severely impacted by this economic weakness than many other markets. The notable exception is Northwest Arkansas which is still wrestling with a significant oversupply of residential and commercial lots and homes in certain price ranges and submarkets. We’ve already worked through a number of challenges in this market over the past two years and we expect that we will have to work through some more challenges there until economic conditions improve, the excess supply has absorbed, and liquidity improves in that market. During the quarter just ended, the trend of our various asset quality ratios was mixed compared to our ratios for this year’s second quarter. On the positive side our ratio of non-performing loans and leases to total loans and leases at September 30 was 70 basis points which is 4 basis points better than such ratio at June 30. Our third quarter annualized net chargeoff ratio of 27 basis points was 6 basis points better than this year’s second quarter ratio. On the negative side, our September 30 ratio of non-performing assets to total assets was 66 basis points which was 7 basis points higher than such ratio at June 30 and our 30 day past due ratio at September 30 was 94 basis points, which was 2 basis points higher than such ratio at June 30 of this year. Given that all 4 of these ratios are only slightly changed from our second quarter ratios, 2 are up and 2 are down compared to the second quarter results, one might ask if we have reached an inflection point in regard to asset quality. Certainly we’ve seen a slowdown in the rate of emergence of new asset quality problems in the last month or two, but the growing angst about economic conditions nationally in recent weeks suggests that it is premature to declare a turning point in asset quality at this time. While no one can say for sure, we will repeat what we’ve said for the past several quarters, that you may see one or more or even all of our asset quality ratios increase somewhat further, but we think such increases if they do occur will not seriously affect our ability to generate a good level of net income or even a record level of net income in each quarter. In support of that statement, let me point out that the increases in our various asset quality ratios and provision expense during the first three quarters of 2008 have not prevented us from posting good earnings in each quarter, including record earnings in the last two quarters. Earlier this year we provided guidance that we expected our net chargeoff ratio for the full year of 2008 to be in a mid-20s to low 30s basis point range. Based on our annualized net chargeoff ratios of 38 and 33 basis points respectively in the first and second quarters of this year, in our July conference call we stated that it seemed likely that our net chargeoffs for the full year of 2008 would be toward the top end of such guidance range. Our third quarter annualized net chargeoff ratio of 27 basis points brought our year to date results for the first 9 months of 2008 to an annualized ratio of 33 basis points. We continue to believe that our net chargeoff ratio for the full year 2008 will be toward the top end of our earlier mid-20s to low 30s basis point range. During the quarter just ended, we made a $3.4 million provision to our allowance for loan and lease losses. With net chargeoffs of $1.4 million for the quarter, this resulted in a $2 million increase in our allowance for loan and lease losses in the third quarter. For the first 9 months of 2008 our provision to the allowance for loan and lease losses have totaled $10.7 million and net chargeoffs have totaled $4.9 million resulting in a $5.9 million increase in our allowance for loan and lease losses so far this year. This growth increased our allowance to 1.24% of total loans and leases at September 30, 2008 compared to 1.05% of total loans and leases at December 31, 2007. We believe this 19 basis point increase is appropriate considering all relevant factors including the continued uncertainty regarding economic conditions in general and market conditions in Northwest Arkansas in particular. In our last conference call we provided extensive details regarding some of our practices for accounting for and structuring loans, practices which we consider to be very sound and conservative. We are not going to repeat all of that again but it is probably appropriate to summarize a few key points. First, we have been very aggressive in promptly conducting thorough impairment analyses on non-accrual loans and leases and regularly re-evaluating the carrying values of foreclosed and repossessed assets. Our general practice has been to quickly write off any identified loss exposure from non-performing loans and leases and foreclosed and repossessed assets. During the quarter just ended, we continued our practice of aggressively re-evaluating the carrying values of foreclosed and repossessed assets and we recorded approximately $228,000 of non-interest expense during the third quarter to write down the carrying value of foreclosed assets to reflect changes in market value. Accordingly, we feel that we have little or no loss exposure from our existing non-accrual loans and leases and foreclosed and repossessed assets as of September 30. Second, we have been very aggressive in placing loans and leases on non-accrual status when we believe doubt exists regarding the ultimate collection of payments. Because of this conservative accounting practice, at September 30 we had some loans on non-accrual status which were still making payments, including some loans that were not past due. Third, in regard to a couple of other subjects which were discussed in detail in our last conference call, I would just remind you that we consider our practices regarding interest reserves for construction and development loans and capitalization of interest on loans as very conservative. If you have any questions about these two items, I encourage you to listen to the replay of our second quarter earnings conference call which was held in July and is available on the Investor Relations section of our website. In closing, let me repeat that our paramount goal for 2008 was to once again return to a record quarterly earnings pace. We have accomplished that in each of the past two quarters and we now want to continue to improve on that level of earnings. We are operating in the most challenging environment in many years but with our good growth and earning assets and the improvement in our net interest margins so far this year, and with our relatively good asset quality, sound capital position, and abundant sources of liquidity, we think we are in a reasonable position to capitalize on numerous opportunities and achieve modestly improved earnings growth in the coming quarters. That concludes my prepared remarks and at this time we will entertain questions. Let me ask our operator to once again remind our listeners how to queue in for questions.

[Operator:]

(Operator Instructions) Your first question comes from Matt Olney.

[Matt Olney:]

I wanted to ask you about CD repricing. It seemed like it was very favorable during the quarter. Can you give us kind of a rough idea of the pricing of some of the CDs that will be maturing during the remaining part of the year and what’s the pricing on some of the new CDs that will be replacing some of the old CDs?

[George Gleason:]

We’ve got CDs maturing Matt at all sorts of pricing from very low pricing to very high pricing and we will be replacing those with CDs that will be pricing from very low to moderately high pricing. Generally there are a few phenomena going on that probably merit a comment in that regard. Number one is we still have quite a few CDs that were issued 12, 15, 18 months ago that we’ll be rolling off in the fourth quarter and even the early part of 2009 that should, based on where CDs are pricing today, should result in those CDs repricing at a lower level. So the trend that we’ve experienced should continue to occur to some degree of higher pricing CDs rolling down to a lower level of pricing. The second force that is muting the benefit of that somewhat at this time and I think will continue to mute the benefit of that in Q4 and into the first part of ’09 is we’ve seen a number of institutions who appear to be significantly stressed for liquidity and as a result are pricing up very aggressively and I saw another banker making a comment about Countryside and of course with them going away and WaMu and with them going away, hoping that some of the guys that have been under more significant stress for funds would moderate that pricing. But with commercial paper markets seized up as they are and other sources it seems like even a lot of the large banks, we’ve seen a lot of the large national banks in regionals being very aggressive on pricing CDs and that is tending to hold up the cost of CDs and not give us further relief that I would have hoped we would be getting at this point. So our general expectation is that we think the cost of funds will continue to go down somewhat because of repricing older, higher rate deposits down, but I don’t think we’re going to get as much of a bump there as we would like to the margin just because I would think there is a very aggressive need for deposits out there. Now what is helping us really good in that regard is even though 54.8% of our loan portfolio is variable rate, at September 30, 56.8% of those variable rate loans, a little more than half of those variable rate loans that we had, are at their floor rate so over half of our variable rate loans did not adjust downward in rate as a result of the last move in the Fed funds target rate and prime rate and a large percentage of those loans that were not at their floor rate are LIBOR based loans and LIBOR hasn’t moved too much and in fact has moved in a positive spread, so it is a very dynamic market in trying to manage and predict what’s going to go on with your net interest margin because there are a lot of unusual forces at play there but with all that said, we feel pretty comfortable with the guidance that I just gave that we think our Q4 margin will be in the 3.82% range or somewhat higher and that takes into account what we think will be a somewhat dilutive effect on our net interest margin this quarter from the remaining balances of our temporary investments and tax exempt securities.

[Matt Olney:]

George, do you think your margin guidance would have been any different had we not had the 50 basis point cut recently?

[George Gleason:]

Very little, if any difference. The quantity of loans that are not at a floor or not being impacted by the unusual spreads on LIBOR are almost identical to the quantity of [immediately borrowings] that we have so the 50 basis point cut appears in at least the short run to be pretty much a non-event as it impacts our margin.

[Matt Olney:]

Okay. I want to shift over to the credit quality. We’ve heard more and more concern about the credit quality in Texas as some would say the next shoe to drop. Can you compare what you’re seeing today in the Dallas-Ft. Worth market to what you saw in Northwest Arkansas maybe a year or two ago in terms of underwriting standards and the amount of excessive speculation that went on during that time?

[George Gleason:]

Matt, I don’t think there is a comparison. I believe Northwest Arkansas is compared to Texas is in a league of its own as far as the level of excess and supply that developed there. I believe the supply and demand metrics and metro balance are much much closer to an equilibrium supply and demand situation, so I view that as a very different situation.

[Matt Olney:]

What about as far as the actual underwriting standards in Dallas. Are those concerning at all to you?

[George Gleason:]

You know, there was a massive difference in loans that are done for the most part, or that we’ve done in Texas and stuff that we’ve seen done in Northwest Arkansas and I’ve commented many times publicly that Texas is such a capital rich state and has so many private equity sources within the state that it is very common for transactions there to be done with a lot of equity and most of the deals we’ve done there have had, if it was a really skinny deal, 15% to 20% cash equity in most of them, that’s been fairly atypical, and a lot of them have been done with 30, 40, 50, or even more cash equity than that. In Arkansas I’ve commented a number of times that while there are a lot of very wealthy people in Arkansas, that even if you’re doing a deal for a wealthy person because of his strong financial statement, that person expects to pretty much borrow out on the transaction, so there were an almost countless number of transactions that were done by our competitors in Northwest Arkansas that were done with no equity in them and that’s just not the norm in Texas and we’ve always even though we’ve required equity on almost all of our Arkansas deals have very few exception bucket transactions that didn’t have a minimum regulatory mandated level of equity in them. In Texas we’ve almost always gotten considerably more equity because it’s the norm down there and the stronger capital and wealth position of that state makes that the norm, so I don’t see any significant parallels in Northwest Arkansas and in Texas. I think that’s... Whoever’s saying that I think it’s ill-conceived. Now there was some guys that probably got individual institutions that got overly aggressive in parts of the Texas market and did some things and I’ve commented that our loan growth in 2007 was our lowest annual loan growth in a number of years because we saw a lot of business lost to guys who were doing it on more aggressive credit terms that we wouldn’t do, and we lost some deals in Texas that were done with much less equity than we would have required in those transactions and the institutions that did those deals and that sort of deal may be having some problems from that, but again I think that’s not the norm in that market.

[Operator:]

Your next question comes from Peyton Green.

[Peyton Green:]

You all had a great deposit gathering quarter on the savings and interest bearing transaction side. I was just wondering if you could comment where the momentum came from. Is it out of your own CDs or is it something where you’ve been visibly able to grab more deposit share and what your outlook for the future is on that.

[George Gleason:]

There was a noticeable improvement. The end of the quarter our non-CDs were 38.45% of deposits which is the best ratio I think we’ve seen since you probably go back to like December of ’05. We were pleased to see that. We’re seeing good deposit growth in a number of our markets and one of the things I mentioned in the press release is that because we have abundant sources of liquidity, we have not had to compete with some of the more aggressive deposit getting efforts from some of the big national and regional franchises that have been very aggressive in deposit pricing. We were able to pick from a menu of liquidity options to fund our balance sheet and fund our growth and that let us pick some of the lower cost options. So we had a good quarter. I guess I would say that there are two things that I would say are noteworthy about our deposits in the quarter and one is that we picked some markets where we wanted to gain some share and thought we could gain some share on a reasonably cost-effective basis. We were relatively aggressive in those markets and accomplished some good growth. The second side of that first point is that there were markets where we had competitors paying very high rates and we didn’t chase those rates and we lost some share on those markets just because it was just way too expensive to pay up for those deposits. So the fact that we had a lot of options on liquidity and deposit gathering helped us significantly. One other thing that shifted that interest or CD/non-CD mix in the quarter dealt with broker deposits. At the end of both quarters I think we had about 19% of our total deposits in broker deposits but the shift in the third quarter was that a lot of brokerage CDs rolled off and we were able to replace that with a lot of much less expensive non-CD broker deposits so our broker deposit level I think was more or less flat for the quarter on a total basis but a lot of that shifted away from higher cost CDs to much lower cost non-CD broker deposits and when I’m talking lower cost, I’m talking in the low 2s range on the non-CD brokers so that helped our margin. I think that mix going forward we expect in the fourth quarter to roll off a number of additional brokerage CDs and replace those with non-brokered locally generated deposits in Q4 because we think we can do that in a very cost-effective way. So that’s really what’s going on the deposit side, but we’re viewing that as pretty positive. We could have grown deposits a lot more in the quarter had we been willing to sacrifice a little more margin to do it but we had a lot of options so I think we chose wisely from those options improving the fundamental mix of our deposit base while at the same time doing it in a way that also let us improve our margin.

[Peyton Green:]

I guess going forward is there... Do you care if you... Is your preference to reduce the brokered deposit side down to zero or is it just one of many options to fund the balance sheet and you view it against the other alternatives still?

[George Gleason:]

It’s one of many options to fund the balance sheet and we will use it when it’s appropriate and cost-effective to do so. Now we have changed our policy just because we read the American Banker and Wall Street Journal just like you do and we know that the regulatory winds have shifted on broker deposits so reading some of that literature back in the late second quarter or early third quarter we modified our policy to limit our broker deposits effective December 31 of this year to a maximum of 15% of our total deposits so we’re at about 19.47% at the end of the third quarter so we are expecting to roll of a chunk of those in Q4 and replace them with locally generated deposits from various markets. We see no problem doing that and at this point we can do that pretty close on a dollar per dollar basis on the cost. So we will lower that level not because we think there’s anything problematic or wrong with broker deposits but we just realize the regulatory winds have shifted and you try to cater to those regulatory winds where you can. If on the other hand I could get broker deposits at 2% and non-brokered would cost me 4%, then we would ignore the regulatory winds and run the bank for the benefit of the shareholders.

[Peyton Green:]

What was the mark to market on the securities portfolio at the end of September?

[George Gleason:]

The total in the capital account was a negative $10,384,000. That was a couple million additional negative mark compared to the June 30 number and that’s the tax affected number in the capital account.

[Peyton Green:]

Considering kind of your competitors’ issues, is there any opportunity to broaden our loan growth and are you seeing more opportunities on the owner occupied real estate side or C&I side?

[George Gleason:]

Almost all of our growth in the last quarter came in the commercial real estate book. It went up $47 million on what we call non form non residential, the commercial real estate book. The construction and land development portfolio dropped a million. [Agro] was up $2 million and change. Multi-family was up a couple million. Otherwise it was very small change. It was almost all the growth and the change in the portfolio was in the commercial real estate book and with... There was a time there a couple of years ago when almost every project, once it was built and completed, went into some sort of commercial mortgage backed security whether it was a good project or not and we lost a lot of good business that we would normally do for deals where we would do two year, three year, five year loans for a customer on a completed project, amortizing loans, and that was a good source of business for us and a lot of that business went away because of the commercial mortgage backed securities markets and with those markets basically blown up, we’re getting a chance to keep a lot of that stuff and put a lot of that stuff on our books now and that’s traditionally been excellent business for us so we’re glad to see it return.

[Peyton Green:]

When you look at a loan like that, what does it look like today compared to what it would have looked like a year ago?

[George Gleason:]

It’s got a lot more equity in it and it has a lot higher rate on it.

[Peyton Green:]

Is that stuff that’s floating or are you doing some fixed?

[George Gleason:]

Most of that stuff is floating. We do some fixed but most of it is floating.

[Operator:]

Your next question comes from Dave Bishop.

[David Bishop:]

Payton and the other fellows hit a lot of my questions but sort of circling back to [30 second blank audio]

[George Gleason:]

- - projects and you know they’re very good projects. One of them is a facility here in Little Rock that comes to mind that the facility basically just went into final completion a quarter or two ago of their second phase. We had the original facility financed. They were totally out of space. So they needed a second facility so the expansion, they basically doubled the size of it. We financed that for them. It moved, it was in our construction loan book until they completed that and got their Certificate of Occupancy and their licenses on the expansion and then it moved to our CRE book. It’s a large group of local doctors that’s a multi practice, multi discipline surgical inpatient facility and does very well. We’ve got an [L-tach] facility, long term acute care facility in the Dallas area that again has a large group of local doctors there that own that facility, and there’s several other lesser loans in there but that book of business is doing very well we think.

[David Bishop:]

As we think about into ’09 and the loan pipeline, relative to what we’re seeing from the broader economy there, what are some of the maybe expectations in terms of loan growth for next year?

[George Gleason:]

We will probably have a similar expectation for loan growth next year as we have had in ’08 and a low teens to a high teens sort of growth rate. We’ll give some more guidance on that in our next call in about 90 days after we’ve really completed our ’09 planning process but just the general sense that I have in talking with our guys and looking at pipelines and so forth is that’s probably what we will be looking for. I’ll give you an idea of the magnitude of opportunities. In the month of September we fielded about $3.8 billion in loan applications. We did a quick scan on all of those in 10 minutes a pop type deal and narrowed that down to about I think $140 million or $150 million that we actually worked on and somewhere between a third and half of those will probably ever get approved and closed. So the credit markets are fairly seized up and guys that have a good contact base as we do and have done business with a lot of folks, we’re seeing what for us is an almost infinite level of opportunities and what we’re trying to do is just wade through that avalanche of opportunities real quickly, real efficiently, and narrow it down to a universal project that look like they are either extremely good projects in a target zone that we like and a geographic area that we like or projects that just have extraordinary support from the sponsors and guarantors and hopefully both and pick the cream of the cream to work on.

[David Bishop:]

$3.8 billion?

[George Gleason:]

That’s correct. That’s September. Obviously we’re not going to work on that many loans, we’re not going to make that many loans, but that just gives you an idea of the level of opportunities that are out there and my guess is we’re doing a good job, we’re probably throwing loans in the shredder that most other banks in the country would love to have.

[Operator:]

Your next question comes from Brian Martin.

[Brian Martin:]

Just on that loan piece, the loan growth this quarter, were there a lot of smaller credits? Were there any larger size credits in there? It sounds like there was more the smaller variety this quarter without the construction stuff. Was that the case?

[George Gleason:]

Brian, I’d have to go back [blank audio for 30 seconds]. Sorry, I’m not sure what happened. We lost you there for a moment. I’m not sure what happened but Brian, in response to your question, I’m not sure if any of that answer got through or not, but the question was, was there any large credit that contributed to our growth and the answer is none really comes to mind that stands out. There may have been something in there but I’d have to dissect that to really give you that, but no, I think it was pretty much --

[Brian Martin:]

Pretty broad based. Okay, in the Texas and the Arkansas breakdown on the loan and deposit side, do you have that?

[George Gleason:]

I do and once again Texas accounted for pretty much all of the growth. At September 30 our Texas loans were 27.0% of our portfolio and when I say this, it’s not necessarily loans in Texas, but loans originated by our Texas offices. Our Texas offices accounted for 27.0% of the portfolio. Our North Carolina offices accounted for 4.6% of the portfolio, and the Arkansas offices were about 68.5% so Texas was basically up about 3.2% from June 30. Our Texas deposits also were a significant source of growth. They grew from 11.3% of deposits at June 30 to 12.1% of deposits at September 30 so Arkansas went down from 88.7% of deposits to 87.9% of deposits at June 30.

[Brian Martin:]

Just a shift in the credit quality for a second, you talked about some of the non-performing that are still paying or still performing. Has that percentage changed or has it been pretty constant for you here?

[George Gleason:]

Brian, I don’t track that percentage so I don’t know. My sense is that it’s a smaller portion. It’s less than half of the non-performers. I don’t even know what the percentage is but it’s a smaller subset of those non-performers that we’ve got on non-performing status but they’re still paying, they’re not past due, and the reason we’ve got them on there is we just don’t have confidence that they’re going to continue to perform long term.

[Brian Martin:]

Last quarter you talked about just the unallocated portion of the reserve. Can you tell us where that stands this quarter?

[George Gleason:]

It went up just a touch farther. Last time I think I said it was 28% and we actually rounded up from like 27.8% or 27.9% to 28% and this time that number is I think, I don’t have the number right in front of me, 28.3% I believe unallocated. We’re just continuing to build that a touch just because it’s a crazy world with such uncertainty out there.

[Brian Martin:]

Then just a couple last things. On the non-performing side, I guess specifically on the non-accrual side, was there a... You know that number was pretty constant second quarter, third quarter. Was there a lot of inbound and outbound kind of activity in there? Is it kind of as constant as it looks there? I know that you have the chargeoffs and you had some stuff moved to OREO but just kind of those non-accruals.

[George Gleason:]

Brian, there is a lot of activity in and out of that portfolio and I give you an example on that. In the first two weeks here of this month, I keep a little notepad on the side of my desk just to keep track of these things and we’ve had $636,000, not a huge number, but kind of gives you an idea of the velocity in and out. We’ve had $636,000 of non-accrual loans, OREO, or repo items either sold or paid off and pulled, fully, finally liquidated and the net impact of those transactions was a plus $28,000 to either recovery, to reserves, or income, so there’s several hundred thousand dollars a week typically going in and out of those accounts. So the percentages may be very similar quarter to quarter. The composition of the assets comprising those is quite different. I think we sold in the last two weeks of September I think we had three or four items sold and that... I know of at least three and there may have been four liquidated out of the OREO account alone that probably approached $1 million.

[Brian Martin:]

And the largest non-performing asset at this point is how large? Ballpark?

[George Gleason:]

Brian, I have no idea.

[Brian Martin:]

All right. Just a last thing. Do you know what the FDIC or FDIC insurance cost was for the quarter?

[George Gleason:]

We’ve been at 5 basis points for... It’s $288,000. That’s 5 basis points and of course everybody in the first quarter of next year, the whole industry is going up 7 basis points as I understand it. 212. So we’ll be at 12 basis points in Q1 and we’ve already been modeling and based on our preliminary models and the formulaic calculations that would apply, we would expect, if we pro-forma’d our existing ratios to a second quarter of ’09 we’re looking at a 10 to 11 basis point range there. Somewhere above 10 and below 11 basis points.

[Operator:]

Your next question comes from [Allan Fortel]

[[Allan Fortel]:]

Two questions. One, I don’t have the whole press release in front of me, but your risk based capital ratio, where is that and where do you like to keep it, that’s one question. The other is, when the stock tanks so much, I guess it was during the third quarter, where there short sellers doing that or where there particular sellers who had to bail out or where there particular rumors?

[George Gleason:]

Allan on the... Let me give you the capital ratios first and the leverage ratio at September 30 was 9.36% which was up from 9.01% at June 30. The Tier I risk based capital ratio was 11.34% at September 30 which is up 14 basis points from 11.20 at June 30 and the total risk based capital was 12.35% which was up 20 basis points from 12.15% at June 30. Now the only time I ever look at those ratios is when I’m reviewing the draft of the Q or the K. Otherwise I don’t pay any attention to those ratios. The way we manage the company from a capital position is number one, we are going to make sure that all of those ratios are within well-capitalized status, that’s a long stay to go to maintain regulatory well-capitalized status. But the way we really manage day to day is we’re looking for tangible common equity excluding the mark to market adjustment on the securities portfolio that we think is just paper forming. We’re looking for our tangible common equity ratio to be not less than 6% and not higher than 7.5% and Paul, we’re probably about two-thirds of the way up, 6.86%. So we’re a little above the mid-point of that target range as of September 30. As for what the activity in our stock was about there in June I think it was when the real volatility in our stock really took a hit, I don’t know, I’ve told many people that I don’t pay attention to who owns our stock. The only time I ever know that is when an investment banker tells me somebody owns our stock and I usually promptly forget that. I don’t know who buys our stock, I don’t know who sells our stock. We don’t monitor that and I don’t mean to hurt anybody’s feelings by saying we don’t care, but our focus is simply to run the company and we try to run the company, manage our affairs day to day, and let the stock take care of itself. I don’t know what all that activity was about in June. I’m glad it’s over. It was distracting.

[[Allan Fortel]:]

You do admit it was distracting. Thanks.

[Operator:]

Your next question is a follow up from Peyton Green.

[Peyton Green:]

I was wondering if you could comment on the role in your construction and development portfolio over the next 3 months and 12 months and what degree of lumpiness that there is there and how you evaluate if somebody has a project that needs to take longer to sell out. What happens at that point when they can’t pay off the loan but it’s still a worthy credit?

[George Gleason:]

Well Peyton the way we handle that, if it’s a worthy credit and if the customer is capable of continuing to pay interest and is working the project in an appropriate manner then we will renew the credit and continue to work with them, and that’s not an uncommon thing. Projects all the time get underwritten on the assumption that they’re going to be a 24 month project and they become a 36 or 48 month project and the key is to have a borrower who has the financial wherewithal to weather that and the additional interest and taxes and other costs that it takes to see that project to fruition so and if we’ve got customers that simply have run out of ability then that’s what we’ve got in our non-performing loan book now. Customers who had construction projects, home loans, or development loans or whatever and they simply ran out of resources and ran out of ability to make their payments and could no longer financially support the project or managerially support the project and as a result we’re in the business. So our sense is that most of our customers are pretty solid and doing pretty well. Hence we’ve continued to give the guidance we’ve given about net chargeoffs and loan losses. As far as what matures in the next 30 days or 60 days or 90 days, I couldn’t really give you any color on that. Our lenders and division presidents are monitoring that and working that stuff. I’m aware of things that we consider to be either problem credits or watch credits and we’re working those and we have all those in mind when we’ve given you our guidance here on chargeoffs. I think it is business as usual here as I’ve said earlier in the call. Certainly I will comment and it should be no surprise to anyone but even really good projects in this economy are taking longer to develop and play out then they would have been in a more robust economy. I mean it’s tough out there in the overall economy and that affects everybody, even your good projects, but we are very fortunate that we have chosen sponsors and guarantors and capital structures that have lots of equity and resources behind the vast majority of our projects so they can withstand that without a hiccup and that’s why we get to have business as usual.

[Operator:]

Your next question comes from Andy Stapp.

[Andrew Stapp:]

I think you mentioned that you had $3.8 billion of applications in September. What’s a normal run rate there?

[George Gleason:]

That is abnormal and we’ve been running at abnormally high levels for several quarters and it’s getting higher and it’s just simply a fact that so many of the large institutions, particularly that we compete with on larger transactions, are pretty much seized up as far as being able to fund anything. So that’s an extremely high number.

[Andrew Stapp:]

Obviously. Also, there’s been a lot of speculation that CRE is the next shoe to drop. Can you tell us what you’re seeing there?

[George Gleason:]

I think there probably is a lot of exposure in CRE as a broad universe but again it depends on how particular CRE credits are underwritten and if you’ve got appropriate leasing and pre-leasing on those projects and you’ve got appropriate tread on the leases and you’ve got appropriate equity in the projects, I think those are the key elements there. What do you really have in your CRE portfolio? Dave Bishop was asking about our medical credits and we’ve got those transactions structured where either the doctors jointly and severally or pro rata guarantee the loans or jointly or severally or pro rata guarantee an operating lease that is a sign to us that basically guarantees the cash flow to repay the debt. We’ve competed against a lot of guys and lost a lot of medicals project loans to other lenders that required no guarantees from the doctor groups that did those projects or very short guarantees that burned off in a year or two years or whatever so it’s all a matter of structure. If the transaction is properly structured your CRE portfolio is going to perform pretty well. If the transactions were overly aggressively underwritten and you didn’t have adequate equity into the projects or adequate guarantor support or adequate takeout commitments, then your CRE portfolio is not going to perform very well, so it’s all a question of underwriting.

[Operator:]

Your next question is a follow up from Matt Olney.

[Matt Olney:]

You discussed loan pricing in recent conference calls as been very favorable compared to previous years. Do you think your outlook on loan pricing could change given some of the recent government intervention that [blank for 5 seconds] design to help encourage other banks to lend more?

[George Gleason:]

Matt, who knows. Every day you read these audacious headlines of stuff that’s being conceived in Washington and you just shake your head and wonder what the heck is next. At his point a lot of the big banks have so many problems, I don’t know if you buy $700 billion of their bad assets or if you put $125 billion of capital in the big banks, I don’t know that it puts them back in business. There’s a higher business model is I would describe basically, there are three key elements of our business model. One of those elements is to have adequate capital and Allen asked about that and I said 6% to 7.5% tangible common equity and one of our elements of our business model is to have a diversity of reliable and dependable funding sources including at the head of that list a broad deposit base that is locally originated and is a true relationship with us. The other side is to be able to generate really good quality assets in large volume based on thorough underwriting documentation and servicing and relationships with our customers. The big investment banks on Wall Street and even the big commercial banks don’t have any of those three things. Their capital accounts were leveraged 20 or 30

[Operator:]

There are no further questions at this time.

[George Gleason:]

There being no further questions, that concludes our call. Thank you guys for joining us today. We look forward to talking with you in about 90 days. Thank you. Have a good day.