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BancorpSouth, Inc. (NYSE:BXS)

Q3 2008 Earnings Call

October 21, 2008 11:00 am ET

Executives

Randy Burchfield - SVP

Aubrey Patterson - Chairman and CEO

Gregg Cowsert - EVP, Vice Chairman and CLO

Nash Allen - EVP, Treasurer and CFO

Analysts

John Pancari - JPMorgan

Kevin Fitzsimmons - Sandler O'Neill

Brian Klock - KBW

Gordon Hamlet - Philadelphia Financial

Charlie Ernst - Sandler O'Neill Asset Management

Dave Bishop - Stifel Nicolaus

Peyton Green - FTN Midwest Securities

Al Savastano - Fox-Pitt Kelton

Justin Harrison - Ramsey Asset Management

Operator

Hello and welcome to the BancorpSouth Third Quarter 2008 Earning's webcast. All participants will be in listen-only mode. There will be an opportunity for you to ask question at the end of today's presentation. (Operator Instructions). Please note, this conference is being recorded.

Now, I would like to turn the conference over to Randy Burchfield, Senior Vice President of BancorpSouth. Mr. Burchfield, please begin.

Randy Burchfield

Thank you, and good morning to everyone. As our normal practice we have with us, BancorpSouth's Chairman and CEO, Aubrey Patterson; Jim Kelly, President and Chief Operating Officer; Nash Allen, Chief Financial Officer; Gregg Cowsert, Chief Lending Officer; James Threadgill, Vice Chairman of Financial Services.

Before we begin, let me remind you that, during today's call, representatives of BancorpSouth may make certain forward-looking statements regarding future results or future financial performance of BancorpSouth. We caution you that actual results could differ materially from those indicated in these forward-looking statements, due to a variety of factors and/or risks. Information concerning certain of these factors can be found in BancorpSouth's Annual Report on Form 10-K for the year ended December 31, 2007.

Also, during the call, certain non-GAAP financial measures may be discussed regarding BancorpSouth's performance. If so, you can find a reconciliation of these measures to the GAAP financial measures on the Investor Relations portion of our website at www.bancorpsouth.com.

And now our Chairman and CEO, Aubrey Patterson.

Aubrey Patterson

Thank you, Randy, and good morning. Welcome to BancorpSouth's conference call for the third quarter 2008, and thank you all for being with us today. As usual, I'll provide a brief overview of our third quarter financial results and then other members of the senior management team and I will address any questions you have.

As an overview, I'll point out that BancorpSouth produced solid net income of $28.3 million, or $0.34 per diluted share for the third quarter in a very challenging environment for the services industry.

We maintain strong credit quality and enhanced our capital position and retain ample sources of liquidity. With a Tier 1 risk-based capital ratio of 10.57% and a total risk-based capital ratio of 11.82%, we are well positioned to weather the current economic environment.

During the third quarter, we continued the flow of credit in our markets expanded our portfolio of high quality loans by 5.9% compared with last year and that an annualized rate of 4.7% during the quarter. Our asset liability management strategies, again, produced a relatively strong net interest margin, which was 3.67% for the quarter and we achieved a modest increase in net interest revenue.

Finally, our financial performance benefited from 9.6% growth in non-interest revenue, including the third consecutive comparable quarter increase of more than 20% in our insurance commission revenues. In fact, according to a recent report by Michael White Associates and the American Bankers Insurance Association, BancorpSouth ranked 10th among all bank holding companies in the country for total insurance income for the first half of 2008.

When all the industry data from the third quarter is compiled, we believe our performance will again prove to be superior compared with our industry peer group. We have virtually no exposure to the issues affecting the subprime residential real estate market and we have no equity investments in the securities of Fannie Mae and Freddie Mac.

In addition, we've benefited by careful expansion focused in existing or contiguous markets that we understand and that have diversified the economies growing at a sustainable rate. Conversely, we've also benefited from decisions not to expand into the most speculative markets or in some of the higher risk forms of lending.

As our short-term and long-term results have demonstrated, we've maintained both our strong credit quality and capital position through a disciplined execution of conservative loan and investment policies.

These strengths have enabled BancorpSouth to mitigate the impact of the current economic and credit challenges that financial services industry faces, although, the environment obviously did affect our earnings and credit quality results of the third quarter. Depending on the magnitude and duration of these challenges, we would expect them to continue affecting the industry and our results to some degree in future quarters.

Despite those possibility, we can also say with confidence that at the end of the third quarter, we remain well-positioned on an absolute basis and relative to our peers. To achieve our long-term strategy of consistent growth, we remain fully engaged in serving our markets and aggressively pursuing new well underwritten loan opportunities.

Now, let's turn to the specifics of our performance for the third quarter of 2008. Net interest revenue increased 1.6% for the quarter from the third quarter last year. Due to a significant decrease in interest rates during the past year, our results benefited from a greater reduction in average rates paid and in average yields in earnings assets.

In addition, net loans increased from 5.9% at the ends of the third quarter of 2008 from the same time the previous year and we continued our effective AL management strategies that we discussed with you for a number of quarters.

Among these, we have improved asset yields by partially funding our loan growth with maturing lower yielding investment securities. We've also lowered interest expense through conservative pricing of time deposits and the time when liquidity needs within many banks produced upward pressure on pricing.

While we expect to continue conservative pricing to help maintain our net interest margin, we are intent on preserving relationships with core customers. We don't believe our pricing strategy has significantly affected these relationships.

We've replaced much of the decline in time deposits through substantial growth and lower cost demand deposits, which increased by $563 million, or 11.5% for the 12-month ending September 30, 2008.

We also expended our lower rate short-term borrowings from the Federal Home Loan Bank. They increased by $125 million over the past four quarters. And to further mitigate interest rate risk, we increased long-term FHLB borrowings by $147 million from the third quarter of 2007 to the third quarter of 2008.

Through these strategies, we produced a net interest margin of 3.67% for the third quarter essentially even with the 3.66% of the third quarter last year. We are pleased with the relative stability achieved in net interest margin. While the third quarter is below the 3.79% level produced for the first half of 2008, it's actually equal to our average net interest margin for the previous six quarters.

Moving on to credit quality. There are a couple of principal points I'll make. First, our credit quality remains strong. Non-performing loans at the ends of the third quarter and annualized charge-offs for the quarter are relatively low on an absolute basis and strong by industry comparison. We have consistently adhered to our conservative credit standards.

Also, our veteran team recognized the early stage of the current cycle and tightened real-estate lending standards actually in late 2006. We, therefore, benefited by having virtually zero exposure to the credit issues affecting subprime residential mortgages and limited exposure to the non-owner occupied commercial market.

Second, with the continuation of the challenging economic environment, we did experienced deterioration in credit quality from the second quarter of 2008, but to levels that are entirely manageable.

The provision for credit losses was $16.3 million for the third quarter, up sequentially from $11.2 million for the second quarter. Non-performing loans of 0.68% of net loans for the third quarter increased sequentially from 0.49% and annualized net charge-offs increased to 0.45% from 0.30%.

Our provision for credit losses in the third quarter was $16.3 million, exceeding net charge-offs of $10.6 million for the quarter. Our allowance for credit losses have increased to 1.35% of loans at the end of the quarter, up from 1.24% for the same time last year and 1.30% at the end of the second quarter of this year.

We continue to have strong coverage of any expected losses in our loans with an allowance for credit losses that's twice the size of our NPL's at the quarter's end and three times the size of the annualized net charge-offs for the third quarter.

To summarize my comments on credit quality, the performance of our high quality loan portfolio has, in fact, remained fundamentally sound. While BancorpSouth is not immune to the challenges the banking industry is experiencing, their impact on credit quality has been manageable and as always, we will take decisive action to deal with any emerging credit issue. We expect to maintain credit quality as a differentiating strength of BancorpSouth.

Let's now turn to the noninterest revenue, which is 36.7% of total revenue for the third quarter continues to be an important source of strength for BancorpSouth. Noninterest revenue was $63.4 million for the third quarter, an increase of 9.6% on a comparable quarter basis. Consistent with our strategic goals, noninterest revenue continues to mitigate our exposure to any interest rate volatility in the traditional banking business.

Our expanding portfolio of noninterest products and services strengthens our relationships with our existing banking customers and it introduces new customers to the company. While serving an increasing portion of our customer's financial needs, we enhance customer service and we improve their satisfaction, increasing the stability of our core operations.

Among our sources of noninterest revenue, I'd again highlight our insurance business, which produced a 24.2% increase in commission revenue for the third quarter versus the third quarter of '07.

Insurance commission revenue has now increased to more than 20% over comparable quarter results for the last three quarters, primarily due to the combined impact of an agency acquisition in the third quarter of last year and two acquisitions in the first quarter of '08. We also produced a second consecutive quarter of double-digit growth in credit and debit card fee revenue.

In addition, mortgage lending revenue, excluding the valuation impact of the mortgage servicing asset increased by 29.5%, or nearly $1 million. While our mortgage volume of $198.6 million for the third quarter of '08 was 10% below the third quarter of last year. Mortgage volume increased 13.2% for the first nine months of 2008 compared with the same period in 2007.

Noninterest expenses increased 9.1% for the third quarter of '08 from the third quarter of '07, 3% of which was due to the three insurance agency acquisition discussed earlier. In addition salaries, employee benefits and occupancy expense rose as a result of the opening of new loan production offices and full-service branch bank offices.

BancorpSouth continued profitability with net income of approximately a $136 million for the last four quarters, has enabled us to expand our shareholder's equity by 6% since the third quarter of last year, which controlled growth in total assets at 1% for the same period. The company's equity to asset ratio improved to 9.34% from 8.91%.

BancorpSouth obviously remains a well-capitalized bank holding company as defined by Federal Regulations, which is the highest classification. To be defined as well-capitalized requires Tier 1 risk-based capital of 6% and total risk-based capital of 10%. As mentioned earlier, at the ends of the third quarter, our Tier 1 capital was 10.57% and our total capital was 11.82%.

We've also maintained ample sources of liquidity such as through our substantial capacity for additional advances from the Federal Home Loan Banks. In addition to traditional sources of liquidity, recent actions by the federal government to strengthen and to provide liquidity to the system offer us further opportunities, which we are in the process of evaluating.

As you know, any applications to the treasury for injections of this new capital source are due in November 14. We believe there maybe opportunity for well-capitalized banks such as BancorpSouth to take strategic advantage from this and we continue to evaluate that and our Board will make a reasonable decision in a timely manner.

In conclusion, we believe that today, BancorpSouth has continued to perform well in difficult economic conditions. We do not under estimate the potential for our prolonged or deep downturn which would affect all the companies in the financial services industry. We are therefore cautious in our outlook, expecting increased competition for high quality loans and continued pressure on credit quality and net interest margin.

As we've discussed with you consistently over the years, our performance is attributable to the conservative credit culture and operating strategies, which are designed to produce long-term and consistently profitable growth in an industry, obviously, subject to substantial volatility.

We believe BancorpSouth today is well-positioned relative to our peer group to manage in this current economic environment. Based on the strengths of our credit quality and capital structure as well as the diversification of both our revenue streams and our markets themselves across our mid-size franchise, we continue to expect to achieve long-term growth and earnings and to maximize shareholder value.

Thank you for being with us today. And operator, we would be happy to answer any questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from John Pancari at JPMorgan.

John Pancari - JPMorgan

Good morning.

Aubrey Patterson

Hi, John, glad to have you with us.

John Pancari - JPMorgan

Thanks for taking my call. Aubrey, can you give us more on the credit pressure this quarter? What did you see move on to non-performers and in terms of in which markets and by which types of loans and was it concentrated in the couple of large credits? Can you give us some more detail there?

Aubrey Patterson

Absolutely. I will call on Gregg Cowsert, our Chief Lending Officer, John to respond to those.

Gregg Cowsert

Yes, John, we continue to seek pressure in the residential, construction and acquisition and development area. That's primarily where our focus has been that's been the source of our increase in non-performers and our charge-offs. Our other portfolios, our consumer portfolio, commercial real estate portfolio, our leasing portfolio, and our credit card portfolios are holding up very well.

I will give you an example of the impact of three credits that we addressed in the third quarter in the residential construction and development area. Those charge-offs on the three credits totaled $6.4 million. So, without those three credits, our annualized net charge-off rate would have been 19 basis points. So an indication that, our problems continue to be located in our residential construction and development portfolio.

We anticipate that continuing going forward. We would anticipate our credit performance though to remain strong. And that our problems will be very manageable going forward.

John Pancari - JPMorgan

And in which markets were those, are you really seeing the pressure in the resi construction work and which markets were those exact three credits?

Gregg Cowsert

One was in the western market. One was in the Missouri market and one was in the Mississippi market. So, it was pretty well spread out.

John Pancari - JPMorgan

Okay. And what are the sizes of those non-performers?

Gregg Cowsert

The charge-offs or the non-performers?

John Pancari - JPMorgan

I know you gave us charge-offs total 6.4, how much is the remaining on non-performing related these two credits?

Gregg Cowsert

Okay. Hang on just a second.

Aubrey Patterson

While he is doing the math on that, John, that's a good question, because obviously we believe that those three credits and they are outliers from a granular portfolio more generally, but the values remaining in non-performance from those charge-offs, we believe are a good valuations.

Gregg Cowsert

Total on the remaining nonperformance is 8.7 million on those three credits.

John Pancari - JPMorgan

Okay. And what is the total size of your resi construction portfolio across your markets?

Gregg Cowsert

Which portfolio?

John Pancari - JPMorgan

The resi construction and the A&D portfolio.

Gregg Cowsert

Our residential acquisition and development portfolio was $553 million. Our total construction and acquisition and development portfolio, which that's the hardest 1.671 million.

John Pancari - JPMorgan

Okay.

Aubrey Patterson

Thank you, John.

John Pancari - JPMorgan

All right. Thank you.

Operator

Our next question comes from Kevin Fitzsimmons of Sandler O'Neill.

Kevin Fitzsimmons - Sandler O'Neill

Good morning, guys.

Aubrey Patterson

Good morning, Kevin.

Kevin Fitzsimmons - Sandler O'Neill

I was wondering I know you talked about the margin, Aubrey, but I was wondering if you could, and if I missed it, I apologize, but if you can give a little more color on what drove the link quarter decline in the margin.

As you guys historically have done, you have been focused on taking the CD balances down and replacing that with more core deposits and in this quarter looks like you did replace it with some to Federal Home Loan Bank advances also and use maturing securities as well to confirm loan growth and you have been able to really keep a pretty steady margin last quarter.

So, just want to see what was driving that and then B, your comment about expecting continued pressure. Does that mean more modest kind of compression than what we saw this quarter or is the margin just going to get more volatile? Thanks.

Aubrey Patterson

I will respond to that forward looking some in and I'll refer to Nash Allen will give you a little more color on the break down between asset deals journey, liability cost that occurred. But what we are obviously seeing, Kevin and no surprise for you, is that a number of institutions within, we complete throughout the southeastern region, have had liquidity issues they had to deal with and even in the face of continuously reducing yields on the asset side and particularly a variable rate lending rates. Their liquidity pressures are forcing them to be very aggressive. And CD, retail CD pricing and that's what we are facing.

We have been willing and I made a reference to this in my comments earlier. We have been willing to see some shrinkage in that as we have seen some growth and healthy growth in our demand deposit segment of the liabilities for the company. But certainly, we expect the pressure to continue. If and as these other regional banks continue to try to solve their liquidity problems with more aggressive CD, retail CD pricing.

Nash, would you comment on that breakdown on the third quarter spread check?

Nash Allen

We had a vision. We had a fair decline. We are basically our loans most for our loans were prime based and prime rate. That brought loan dues down. In addition to that, I think it is more out of abundance of caution, we made some term borrowings from Federal Home Loan Banks, which cost us a little bit on margin and we thought it was a good idea relative to the condition of the banking industry was finding itself in and solving liquidity so many what drying up last month, in the month of September.

But other than that, the other deposit cost seems to have hit a floor for current period of time. It may prove to be a temporary situation. We will have to wait and see. But we have not seen decline at retail type deposits to the extent that you have seen rates drop for the wholesale markets.

And I think that's basically the reason and in fact that loans while we did experience some modest growth in loan portfolio, we are not seeing higher yielding assets going on the books to extend that they were in the prior periods. So, that's primarily was contributing to a decline in the margins.

Kevin Fitzsimmons - Sandler O'Neill

Okay. And separately Aubrey, on the whole issue of tarp, I know you are evaluating it and there could be advantages, but assuming you guys did get capital, can you just look at it in terms of what you may do with it if you can just hold the entire capital for tougher environment you can be more aggressive in the near-term and write-down issues in your loan portfolio or you can go out and use the capital and either expand into other markets or be ready to make strategic acquisition as they become available and how do you look at those opportunities?

Aubrey Patterson

Well, you cataloged it pretty well. We are evaluating all of the above and we are really not quite yet ready to make a recommendation to our board of directors as to what we think is the strategic and most valuable thing on the issue and hold, and till the war chest obviously has implications for dilution, leveraging it significantly, obviously, takes away from the potential strategic M&A value.

And on the other hand, we do believe that there will be significant opportunity for well capitalized strong institutions like BancorpSouth to make strategic moves in this environment and treasury preferred stock opportunity may give us even more strength to take full advantage of that.

We're not really ready to go on record as saying how we evaluate that. We're always mindful, regardless of the source of capital or the terms of acquisition opportunities. We're always mindful of dilution and our shareholders returns. And that's going to be a serious central point of consideration as we go through this.

Kevin Fitzsimmons - Sandler O'Neill

Okay. Thank you very much.

Operator

Our next question comes from Brian Klock at KBW.

Brian Klock - KBW

Good morning.

Aubrey Patterson

Good morning, Brian. Glad to have you.

Brian Klock - KBW

I guess, Aubrey, I know you did talk about the margin and maybe Nash could give some color too. I guess just wondering on deposit side, you did talk about the sort of remix into deposit side of time and into the demand. Maybe you can talk about, I guess, reasons for the strong interest-bearing demand growth in the quarter and what you think your outlook is in the next few quarters if you think the growth can continue at such a strong pace? That's my first question on deposits.

Aubrey Patterson

Well, the strong growth that we've had would indicate that we've been able to outperform general economic trends in that regard. We have had a very effective, continuously effective marketing effort with corporate clients as well as retail.

And I think our being the J.D. Power Customer Satisfaction award winner from the Southeast has been a good springboard for generating retail deposit growth as well throughout this period. So, as to whether it can continue at the same pace or not, that's hard to say.

Customer behavior is obviously being affected by concerns for stability. And we believe that we have reason to believe that our clients feel very good about their depository relationship with BancorpSouth for obvious strong capital learning performance reasons.

How that's all have going to shakeout going forward is a little bit unclear. I do think that we are well-positioned from a liquidity point of view. We have very, very significant available lines with the Home Loan Bank for what has continued to be relatively low cost funding.

Nash made the point that we at the recent time, when it was clearly evident that the entire system has had liquidity issues, we deliberately extended some maturities in our Home Loan Bank advances system to assure ourselves that we would not be victimized in a short-term spike or emergency condition. That was a deliberate move, which had a price attached to it.

We think that we will be very competitive and continue to be effective in maintaining core deposit relationships. And I am hopeful that some of the liquidity pressures on some of the extremely large regionals will be mitigated by current events and current programs that are going to be available to them and the new affiliations that are present in those acquisitions and mergers that applies.

Brian Klock - KBW

Okay, great. I guess, Nash, on the margin. From what you said, it sounds like it was a lot of prime based loan on the balance sheet. You said that deposit costs may have floored currently?

Nash Allen

Well, the lower you get on deposits as we have experienced in other cycles, the more compression there is. When you are down in the low 100% range on your sweep accounts and your commercial relationships, there is just not a lot more room to make up that. And then when you have a 50 basis points move downward and variable rate loans on the asset side, there is going to be a natural compression. We hope to make up some of that with volume.

Brian Klock - KBW

Okay. Okay. And I guess should we expect a similar sort of runoff in the securities portfolio. I guess going forward here down about $200 million each quarter.

Nash Allen

To the degree that we can, we are currently evaluating the FDIC insurance expansion to see how that affects us in this particular area. But, yes, to the degree that we can.

Brian Klock - KBW

Okay. And then, I guess my last question, I'll let someone else get back in. On the NPLs, Gregg, last time, you gave us sort of a breakout of, I guess relative to collateral type where that $33 million of non-performing loans was spread across. Do you have that for the third quarter?

Gregg Cowsert

Yes. $16.5 million of that is in construction, acquisition and development. $400,000 of that is in true commercial real estate and $14.4 million is in all other type loans. That covers about $33 million I believe.

Brian Klock - KBW

Okay. And I guess, but maybe just quick follow-up on that. In that on other, last quarter and the C&I portfolio, again, still non-performers were pretty low at only about just under $3 million. Have you seen any sort of contingent into commercial or how is the C&I book holding up?

Gregg Cowsert

It looks very good and we've not seen any deterioration in that portfolio.

Brian Klock - KBW

Okay, great. Thanks guys.

Aubrey Patterson

Thank you, Brian.

Operator

The next question comes from [Gordon Hamlet] from Philadelphia Financial.

Gordon Hamlet - Philadelphia Financial

Hi, guys. Most of my questions were answered. My only question is can you describe the credit quality within Mississippi and one of the charge-offs within Mississippi, but just the overall Mississippi, but what areas are stronger, weaker? I know there is some deterioration around the Memphis area. How is the panhandle area holding up and link to that area?

Aubrey Patterson

Yeah. I'll make a general comment. Of course Mississippi continues to be over 40% of our franchise, so your question is apt. And as you know, by being the base of our [real estate] operation we have a long history in the state of Mississippi and most the Mississippi markets are holding up well. We have such strong, long-lasting relationships that that's a great source of strength to us.

You've correctly identified the corner of Northwest Mississippi as being part of the Memphis market is generally healthy, but obviously has excess inventories and has to be absorbed. And I'll let Gregg to make a comment about our relationships in that market and also, if he would like to comment about the Gulf Coast.

Gregg Cowsert

Okay. The Northwest Mississippi market, which is contiguous to the Memphis market, continues to be weak and in the area of residential real estate. That's one of the markets that Aubrey talked about; we started pulling back in late '06. And that portfolio, also even though its experience the market, it experienced a lot of weakness, the portfolio for us today has performed extremely well as a result of our pullback out there.

The Mississippi Gulf Coast, this is still not developing strongly. There is some insurance issues down there that probably impact that to a large expand. And it will take a while for that market to, again, to develop in a strong way.

Operator

Okay. Our next question comes from Charlie Ernst of Sandler O'Neill Asset Management.

Charlie Ernst - Sandler O'Neill Asset Management

Good morning, guys.

Aubrey Patterson

Hello, Charlie. Welcome.

Charlie Ernst - Sandler O'Neill Asset Management

Thanks. Can you just comment whether there are any sorted extra items in the other fee and expense lines?

Aubrey Patterson

Nash?

Nash Allen

The other expense line, one of the larger amounts in there, we did have some real appraisal from other real estate and that was $979,000 a quarter. We wrote it down, other income, not a material amount.

Charlie Ernst - Sandler O'Neill Asset Management

Nash, it seems like its sort of $1 million or $2 million below the run rate of the last, I don't know, year or two on a quarterly basis?

Nash Allen

Well, the reason is that the prior quarters had unusual items and they were absent here in the third quart.

Charlie Ernst - Sandler O'Neill Asset Management

Okay. And then lastly, can you just comment on the MSR, what happened with the amortization of the MSR versus the change in the fair market value?

Nash Allen

Okay. I'll give you a synopsis of what happened. We had a pay downs for the quarter $1.4 million. Our market adjustment was 407,000. Therefore, the total MSR valuation change was a million and 9,000 per quarter. We generated servicing and origination income of $4.3 million. And the origination volume, I think somewhere [historic] comment was down 10% to 198.6 million. And the servicing asset value at the end of the quarter was $39.1 million.

Charlie Ernst - Sandler O'Neill Asset Management

Great. Thanks a lot. I appreciate that.

Operator

Our next question will come from Dave Bishop at Stifel Nicolaus.

Dave Bishop - Stifel Nicolaus

Hi. Thanks, gentlemen. A lot of my questions have been answered. But Aubrey or Jim maybe can handle this. In terms of what you saying in early stage delinquency maybe you can give some commentary there in terms of maybe watch the strength?

Aubrey Patterson

Okay. I will ask Gregg Cowsert to respond to that one.

Gregg Cowsert

Well, an indication being a past due ratio with the end of the quarter, 30 day past dues were only 1.1% and our 90 day plus past dues were 5/10 of 1%.

Aubrey Patterson

I think this is particularly remarkable. Given the state of the general economy, I think Gregg and his staff and most especially our community bank presidents and their colleagues have done a remarkable job controlling and holding our delinquencies to this dramatically low level.

Dave Bishop - Stifel Nicolaus

And as you look out across the footprint their maybe outside of Mississippi, maybe some commentary from and in regard perspective what you're seeing maybe in Arkansas, Missouri and Texas market?

Aubrey Patterson

Well, obviously, the Texas market continues to be strong, and our Louisiana markets continue to generate it. We're seeing good loan opportunities in those markets. They are not really as affected by the general economic slowdown. The urban markets where you've had some residential older building and inventory overhang are obviously areas where we and others are experiencing slowdown.

But I think Mississippi's economy as best we can tell is mildly effected by the slowdown and state tax revenues are moderately, and I think 2% below the expected levels, so that that gives you some indication of general economic activity.

But one of the fundamental strengths of the company is diverse markets and granular portfolios and that continues to be the case. And we have focused on expanding in the micropolitan markets. Our sweet spot, as you know, is the county seats and larger micropolitan markets as I say such as, the Jackson, Mississippi, Little Rock, Arkansas, Baton Rouge, Louisiana Shreveport, those kinds of markets and they're holding up, I think, very well under the circumstances.

Dave Bishop - Stifel Nicolaus

Great, thanks, Aubrey.

Operator

Our next question comes from Peyton Green at FTN Midwest Securities.

Peyton Green - FTN Midwest Securities

Good morning. I have couple of questions. Just one, to what degree are you willing to utilize the wholesale borrowing to continue funding the quality loan growth opportunities that you're seeing. And then to what degree has pricing changed on the commercial? And certainly with prime going down, I have seen a fairly significant move down in the overall low deal, but to what degree booking new paper with higher spreads?

Aubrey Patterson

I'll let Gregg comment on the pricing issue as it relates to the downward movement.

Gregg Cowsert

Well, I'd really think we're seeing some tightening on the price and some better opportunities on pricing on credits. I would expect that to probably continue. Not where it should be. There is still some pressure out interest for real quality credits. There is still competition. There are funding issues across the board though. And in many cases, we're seeing better opportunities of prices.

Aubrey Patterson

With respect to sources of funds as we've indicated earlier in like we know this we obviously have a diverse source of funds mix. We have been concentrating on expanding our demand deposit base. And as you have heard, we've been enjoyed some success in doing that. And we've been able to get favorable pricing on our Federal Home Loan Bank advances and we continue to see that as a primary source of funding. We have an extremely strong overall liquidity position. And don't anticipate any liquidity needs to access all the markets at this time.

Peyton Green - FTN Midwest Securities

Okay. So, I mean, there's no line in the sand in terms of loan to deposit ratio?

Aubrey Patterson

Not really, we're still well below our peer group in terms of loan to deposit ratio and we have note discomfort given that we have readily available on a very significant sources of liquidity.

Peyton Green - FTN Midwest Securities

Okay. And then the follow up on the very solid, non-CD deposit growth. To what degree was that existing customer balances or new customer balances? Do you have any insight there?

Aubrey Patterson

Not sure, I can break that out for you right now.

Peyton Green - FTN Midwest Securities

Okay.

Aubrey Patterson

We'll get back with you.

Peyton Green - FTN Midwest Securities

Okay. Thank you.

Operator

Our next question comes from Brian Klock at KBW.

Brian Klock - KBW

Thank guys. Just a quick follow-up. And Gregg, I wanted to ask if I wrote this down right. In answering John's earlier question I think on the residential acquisition development you said there is $553 million of loans outstanding at the end of the quarter. So total construction in A&D was $1.670 billion, is that was you said?

Gregg Cowsert

$1.670 billion. That includes all the family construction, condos, one-to-four family construction, recreational lands, commercial construction, commercial A&D and residential A&D.

Brian Klock - KBW

Okay. As the same number from the second quarter of $1.578 billion is that on ample to ample basis.

Gregg Cowsert

That's correct.

Brian Klock - KBW

Okay. Can you comment little bit one the growth that you're seeing in that portfolio, within I guess, from the non-residential piece?

Gregg Cowsert

It's primarily in the US non-residential piece from commitments we've got in the commercial side that are funded.

Brian Klock - KBW

Okay, great. All right, thanks guys.

Operator

Our next question comes from Al Savastano with Fox-Pitt Kelton.

Al Savastano - Fox-Pitt Kelton

Good morning, guys. How are you?

Aubrey Patterson

Hi, Al, welcome.

Al Savastano - Fox-Pitt Kelton

Thank you. Your thoughts on the loan loss reserve ratio going forward. We are going to see a material increase in the reserve levels or kind as you go?

Aubrey Patterson

Well obviously, that's not something that we make arbitrary or non quantitative adjustments too. It is based on our actual analytical process of the portfolio and the probabilities there in. And that's what you've seen in the movement from the 1.30 to the 1.35 based on the breakdown of non-performers that we already described to you.

We are certainly well-reserved. We feel that it adequately reflects the risk in relative to the non-performers, the ratio of the reserve to non-performers and ratio of reserves of net charge-offs that I referred to earlier. Those numbers are significantly greater than others that I am familiar with. So, I hesitate to use the word comfortable, but we certainly think that we are extremely, appropriately and well reserved. And we would anticipate making the same kind of calculations as circumstances dictate in subsequent quarter and that's about all I could say to that in response.

Al Savastano - Fox-Pitt Kelton

Okay. And then just a follow up. Can you talk about the change in overall risk ratings in the portfolio and was there anything that may be surprised you or did you feel like you had most of them identified.

Aubrey Patterson

We have a lot of process as we go through. To stay on top of the portfolio. And we feel like we are on top of problems. And obviously, we got a strong methodology for calculating the adequacy of the loan loss reserve, is primarily driven by the migration of our internal ratings and our FAS 114 impairment process. So, we feel good about the process.

Al Savastano - Fox-Pitt Kelton

Okay. Thank you.

Operator

Our next question comes from [Justin Harrison] at Ramsey Asset Management.

Justin Harrison - Ramsey Asset Management

Good morning, guys.

Aubrey Patterson

Good morning.

Justin Harrison - Ramsey Asset Management

The 1.1% on the 30 day delinquencies could you just remind us, where that was at the end of the second quarter?

Aubrey Patterson

Yes, just a second. You said 30 days…

Justin Harrison - Ramsey Asset Management

Yes, the one over 30 days of 1.1…

Aubrey Patterson

It was also 1.1 at the end of June.

Justin Harrison - Ramsey Asset Management

Okay. So, flat.

Aubrey Patterson

Yes.

Justin Harrison - Ramsey Asset Management

And on a kind of asset liability sensitivity. What kind of effect if the Fed were to cut another 50 basis points. What kind of effect that could have for you guys?

Aubrey Patterson

Immediate term, we would see a compression of net interest margin and net interest revenue. Overtime, we think we have a situation which we can manage without a relatively short period of time. I can't quantify…

Gregg Cowsert

Obviously, the scenario you described would be history repeating itself when we got Fed rates down to 1% previously. And there is a natural construction and spread opportunity, when you have an inability to reduce rates as you approach 1% levels potentially.

In the short run, we would definitely see some tightening as we have in previous similar circumstances. In our six month timeframe, we have the capacity to adjust, and certainly our models demonstrate that we're well within regulatory guidelines, any diminution of net interest income based on those changes in margins. So, the closer it gets to zero, the tighter it gets, but we're very well positioned as retail based depository.

Justin Harrison - Ramsey Asset Management

Okay. All right, thank you.

Operator

Our next question comes from John Pancari of JPMorgan.

John Pancari - JPMorgan

I just have a quick follow-up question. I know you had one construction credit that you highlighted in that, can you comment a little bit more on the Florida panhandle exposure and what you are seeing there?

Aubrey Patterson

Absolutely. We can, John. Good question. Greg?

Gregg Cowsert

We've got very little exposure down there. Our total portfolio in Destin is about $27 million total. And this is really the only problem created being material size, we've down there.

John Pancari - JPMorgan

Okay. So, when you say it's the only problem in credit material. So, everything else is essentially, not delinquent or on the watch list to anything in that portfolio?

Gregg Cowsert

Generally, yes. We probably got some small problems that particularity down there, but let's say the materials there is nothing material as it relates to credit of this size.

John Pancari - JPMorgan

Okay. And then in Missouri, is that, got to assume that it's an acquired relationship that you're seeing some pressure there?

Aubrey Patterson

That was an acquired relationship and that was a subdivision development that got in trouble.

John Pancari - JPMorgan

It's okay.

Aubrey Patterson

It was in St. Louis.

John Pancari - JPMorgan

Right. Okay, my last question. You indicated, I believe, Aubrey in your prepared comments that you're willing to take decisive actions in dealing with mapping issues as they come up or if they come up on the credit fund. Would that included any type of bulk sales of MPAs and have you had the opportunity to look into that and if so, what type of pricing have you seen, when you've done so?

Aubrey Patterson

We don't feel we have any need to do so, John. And we haven't looked into it.

John Pancari - JPMorgan

Okay. All right, thank you.

Operator

Our next question comes from Dave Bishop of Stifel Nicolaus.

Dave Bishop - Stifel Nicolaus

Yeah, Nash, just a quick housekeeping. Its look like the effective tax rate bounced down a little bit, below trend, anything you can come men on there?

Nash Allen

Basically, reflective of the result before the net taxable income decline. And reflect the net charge-offs exceeding what we've had in prior periods. There's also a decrease into it.

Dave Bishop - Stifel Nicolaus

Great, thanks.

Operator

At this time, we show no further questions. Would you like me to repeat the instructions?

Aubrey Patterson

No, if you have no further questions, well.

Operator

Would you like to make any closing remarks.

Aubrey Patterson

Yes, I would. If you are sure there are no further questions.

Operator

I show no other questions.

Aubrey Patterson

Thank you. I thank all of you for your questions this morning and for your support. If you've got any need for additional information or if something comes up other questions in your mind, don't hesitate to call myself or Jim Kelly or Nash Allen. Otherwise, we look forward to speaking with you again on our fourth quarter conference call.

Have a good day.

Operator

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.

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Source: BancorpSouth, Inc. Q3 2008 Earnings Call Transcript
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