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Simmons First National Corporation, Inc. (NASDAQ:SFNC)

Q2 2009 Earnings Call

July 16, 2009 4:00 pm ET

Executives

David W. Garner – Senior Vice President & Controller

J. Thomas May – Chairman of the Board & Chief Executive Officer

David L. Bartlett – President & Chief Operating Officer

Robert A. Fehlman – Chief Financial Officer & Executive Vice President

Analysts

Matt Olney – Stephens, Inc.

Operator

My name is Amanda and I will be your conference operator today. At this time I would like to welcome everyone to the Simmons First second quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question and answer session. (Operator Instructions) Mr. David Garner, you may begin your conference.

David W. Garner

I am David Garner, Investor Relations Officer of Simmons First National Corporation. We want to welcome you to our second quarter earnings teleconference and webcast. Joining me today are Tommy May, our Chief Executive Officer; David Bartlett, our Chief Operating Officer and Bob Fehlman, our Chief Financial Officer.

The purpose of this call is to discuss the information and data provided by the company in our quarterly earnings release issued this morning. We will begin our discussion with prepared comments and then we will entertain questions. We have invited the analyst from the investment firms that provide research of our company to participate in the question and answer session. All other quests in this conference call are in a listen only mode.

I would remind you of the special cautionary notice regarding forward-looking statements and that certain matters discussed in this presentation may constitute forward-looking statements and may involve certain known and unknown risks, uncertainties and other factors which may cause actual results to be materially different from our current expectations, performance or achievements.

Additional information concerning these factors can be found in the closing paragraph of our press release and on our Form 10K. With that said I will turn the call over to Tommy May.

J. Thomas May

Welcome everyone to our second quarter conference call. In our press release issued earlier today Simmons First reported second quarter 2009 earnings of $5.5 million or $0.39 diluted EPS compared to $0.42 diluted EPS in Q2 ’08. The earnings decrease was primarily driven by a $2.4 million increase in FDIC insurance with a significant portion being the special assessment impacting the entire industry. The after tax impact was $1.5 million or $0.11 EPS, otherwise our Q2 earnings exceeded our expectations both on a link and a quarter-over-quarter basis.

For the six month period ended June 30, 2009, net income was $10.7 million or $0.76 diluted earnings per share compared to $14.8 million or $1.05 per share for the same period in 2008. I’d like to remind you that you will remember that during Q1 2008 we recorded earnings of $0.18 per share for non-recurring items related to the Visa, Inc. IPO. Normalizing for the 2008 Visa items and the 2009 FDIC insurance increases our six month earnings were flat.

On June 30, 2009 total assets were $2.9 billion and stockholders’ equity was $292 million. Our equity to asset ratio was a strong 10.1% and our tangible common equity ratio was 8.1%. The regulatory tier I capital ratio was 13.6% and the total risk based capital ratio was 14.8%. Both of these regulatory ratios remain significantly above the well capitalized levels of 6% and 10% respectively and rank in the 75th percentile or better in our peer group.

Obviously, our company remains well positioned with strong capital. However, since the national economy remains under considerable stress, we continue to focus on building our capital basis. As announced last week, Simmons First will not participate in the US Treasury’s capital purchase program or CPP. As you will recall, Simmons First was the 32nd bank in the country to be approved with funding to be at $60 million.

While we were among the first approved funding was delayed by our request for extensions. After careful consideration and analysis we believe there has been considerable improvement in the economic indicators since October, 2008. The Arkansas economy is doing well relative to many other geographic regions in our country and Simmons First continues to have strong asset quality, liquidity and capital. Accordingly, we do not believe participation in the CPP is necessary nor in the best interest of our shareholders. While we have chosen not to participate, we do believe the CPP has served the original purpose of the Treasury very well.

Net interest income for Q2 ’09 increased $625,000 or 2.7% compared to Q2 ’08. Net interest margin for Q2 ’09 increased four basis points to 3.71% when compared to the same period last year. Based on investment portfolio, maturities and call projections we continue to anticipate flat to slight margin compression for the remainder of 2009. Non-interest income for Q2 ’09 was $13.3 million, an increase of approximately $1.6 million or 13.6% compared to the same period last year.

Let me take a minute to discuss the items that have impacted non-interest income. First, service charges on deposit accounts increased by $881,000 or 23.9% in Q2 ’09 compared to Q2 ’08 due primarily to an improvement in our fee structure and core deposit growth. The second item would be the income on the sale of mortgage loans increased by $604,000 or 79.5% compared to last year. This improvement was primarily due to lower mortgage rate lending to a significant increase in residential refinancing volume. Our Q2 mortgage production volume was $72 million, double from the same period last year. Obviously, the largest increase comes from refis but existing purchases were up approximately 3%.

The third item would be income from investment banking operations that increased by $477,000 or some 240% compared to last year. This improvement was primarily due to a volume driven revenue increase in our [daily] bank operation. Non-interest income was negatively impacted by two items, first was our trust income which decreased by $227,000 or 15.7% in Q2 ’09 compared to Q2 ’08. Generally, trust fees are based on the market value of customer accounts, because of the depressed market values and the declines in the overall stock market, trust fees have declined accordingly.

Premiums on the sale of student loans also decreased by some $221,000 which is actually a timing issue. During Q3 ’09 we expect to sell the remaining loans originated during the ’08/’09 school year. Looking to the third quarter, we expect to record the remaining premium on the sale of approximately $60 million in student loans. The premium now estimated to be at $1.8 million. We will continue to evaluate the profitability and viability of this strategic business unit going forward. Currently there remain too many uncertainties concerning the roles of government, the secondary market and the private sector to make any long term decisions.

Moving on to the expense category, non-interest expense for Q2 ’09 was $27 million, an increase of $2.8 million or 11.4% from the same period in 2008. This includes the previously mentioned $2.4 million increase in deposit insurance. Excluding the impact of the FDIC assessment, non-interest expense increased by a modest 1.3%. Looking forward we estimate the deposit insurance expense run rate to be approximately $750,000 per quarter not including possible additional special assessments.

Let me move to our loan portfolio; as of June 30, 2009 we reported total loans of $1.9 billion, an increase of $35 million or 1.8% compared to the same period a year ago. The growth was attributable to a 20.9% increase in consumer loans primarily in the student loan portfolio. Student loans increased by $64.6 million. Our credit card portfolio increased by $6.8 million and other consumer loans increased by $6.7 million.

The real estate loan portfolio was relatively flat with a migration from C&D to CRE and one to four family portfolio due to permanent financing of completed projects. Considering the challenges in the economy it is important to note that we have no significant concentrations in our portfolio mix. Our construction and development loans represent only 10.2% of the total portfolio and as we have mentioned before, we have no subprime assets in either the loan or investment portfolio.

Like the rest of the industry, our loan pipeline remains very soft. As a matter of information, we expect to sell approximately $60 million of our student loans in September and we anticipate funding an additional $30 million through our normal funding process during Q3 ’09.

Now, let me give a brief update on credit cards; we continue to see an increase in the number of new accounts. During the first six months of 2009 we have added 9,400 net new accounts and this compares to 3,500 during the same period last year. Let me remind you that we have not changed our underwriting standards as reflected in our approval rate of approximately 16% in our credit card application flow. As such, we believe the increase in applications represent a movement from of the larger credit card companies that have become much more aggressive in their interest rates, fee structures and lower credit limits.

Although the general state of the national economy remains unsettled and despite the challenges in the Northwest Arkansas region, we continue to have relatively good asset quality. At June 30, 2009 the allowance for loan losses equals 1.29% of total loans and 126% of non-performing loans. Non-performing assets as a percent of total assets were .86%. Non-performing loans as a percent of total loans were 1.02%. While these ratios compare very favorably to the industry, they are up slightly from prior periods and somewhat affected by student loans.

Let me explain; with the turbulence in the secondary market and because the government program only purchases current year production, we are required to service loans that have converted to a payout basis. Historically those loans would have been sold in the secondary market. Under existing rules, the Department of Education will not purchase the payout loans until they have exceeded a 270 day past due status. As such, while they remain fully guaranteed they will impact our non-performing asset ratio.

With this said, these ratios include approximately $2.4 million in government guaranteed student loans over 90 days past due. When these loans exceed 270 days past due the Department of Education will purchase them at 97% of the principle and accrued interest. Excluding these past due loans, the allowance for loan losses to non-performing loans was 143%. Non-performing assets as a percent of total assets were .78% and the non-performing loans a percent of total loans were at 90 basis points. As you can see, while slightly elevated, we continue to enjoy good asset quality.

The annualized net charge off ratio for Q2 ’09 was 44 basis points down, 29 basis points when compared to the first quarter. Excluding credit cards the annualized net charge off ratio was .22% or 22 basis points compared to 56 basis points for the first quarter. The preponderance of the charge offs in the first quarter were associated with the challenges in Northwest Arkansas where we have been very aggressive in the identification, quantification and resolution of the problems.

Concerning our credit cards, we continue to see some pressure relative to the past dues and charge offs. However, our portfolio continues to compare very favorably to the industry. Q2 ’09 annualized net credit card charge offs were 2.83% compared to 2.64% during the previous quarter and now more than 750 basis points below the most recently credit card charge off industry average of 10.62%.

One of the real strengths that we have in our credit card portfolio is our geographic diversification with no concentrations in any state other than Arkansas where we have 45% of our portfolio which is good. We are very conscious of the potential problems associated with high levels of unemployment and we continue to reserve accordingly. We are currently reserving at a level of 3% for our credit card portfolio.

During Q2 ’09 the provision for loan losses was $2.6 million, an increase of $408,000 from the same quarter in 2008. The increase is the result of a special provision for the Northwest Arkansas region and additional provisions for the credit card portfolio. Bottom line, quarter-over-quarter we experienced a slight margin expansion of four basis points, increased provision expense in Northwest Arkansas and credit cards but, good asset quality corporate wide compared to the industry, a continuation of relatively low credit card charge offs at 2.83%, exceptional non-interest income growth of 13.6%, modest normalized non-interest expense growth of 1.3% and most importantly, strong capital with a 10.1% equity to asset ratio.

Like the rest of the industry, we expect the remainder of 2009 to be a challenge relative to meeting our normal growth expectations. However, Simmons First is well positioned based on the strength of our capital, asset quality and liquidity to deal with the challenges and opportunities that we face throughout the year. Our conservative culture has enabled us to engage in banking for 106 years. We rank in the upper core tile of our national peer group relative to the capital asset quality and liquidity.

There has never been a greater time to have these strengths. We continue to believe that the Arkansas economy will better sustain the economic challenges because as primarily a rural state we have not and likely will not experience the same high and lows that will challenge much of our nation. However, we will not be lulled to sleep since there is always some concern relative to a lag affect occurring in a major economic downturn.

Now, this concludes our prepared comments and we would like to now open the phone line for questions from our analysts. Let me ask the operator to come back on the line and once again explain how to queue in for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Matt Olney – Stephens, Inc.

Matt Olney – Stephens, Inc.

I think your prepared remarks answered a lot of my questions but I had a few here I want to go over. As far as the securities portfolio, it looked like there was some movement in to the held to maturity out of the available for sale along with some minor securities gains. What was the strategy behind some of those movements?

J. Thomas May

If I recall, probably six months ago we were moving towards 75% in our AFS and 25% in the HTM, that’s where we’ve been moving the last three or four years. What we have done is that we have decided with the interest rates as low as they are and certainly with the expectations that interest rates will move up over the next two years and looking at our high levels of liquidity that we don’t need those dollars in AFS and we know when the interest rates go up that that’s going to have a mark-to-market issue and if we’re all looking at capital growth or capital preservations it was just a strategic decision relative to that.

The liquidity actually makes that all possible. Like I said, we have been relatively successful in making those moves because we have, as you well know, a high level of short term maturities as well as a high level of cost.

Matt Olney – Stephens, Inc.

As far as the credit, it looked very good in Q2, the reserve rate shows it was relatively flat. I think you said in the past you don’t target the reserve to loans you look at reserve to NPLs. I think the bogie that you talked about before has been 150 on reserves to NPLs and we’re about there in 2Q. Is that still a fair bogie that you guys look at? And if so, what’s the outlook for the reserves going forward?

J. Thomas May

I think probably we’re running about a 126 or 127 right now and as our denominator has grown somewhat with the credit card operation then a lower level is more acceptable. But even more so, with this big increase in our student loan portfolio which is carrying about $70 million more than normal and that being a government guarantee then obviously we don’t think we would need that same ratio. As those loans are sold off in September, you’ll see a little bit more of a movement in that particular direction.

Matt Olney – Stephens, Inc.

Can you give us any more of an update of what you’re seeing in Northwest Arkansas in terms of maybe your loans in particular and then the overall broader market?

J. Thomas May

I would tell you that, and I’ve got Mr. Bartlett here and I’ll let him add on, I would tell you that we continue to see a challenge in Northwest Arkansas but we continue to deal with it aggressively. I think we’re starting to see some improvements in the market but it’s still got a long way to go. If you go beyond Northwest Arkansas in to the other regions of Arkansas where we have a presence, they continue to fair very, very well in all categories. Needless to say, there are some challenges there, we’re seeing some asset quality issues but very, very minor. David, do you have anything to add on Northwest Arkansas?

David L. Bartlett

I’d have to tell you in general I think just the economic conditions, I don’t see the depth getting worse, I see the breadth getting wider. A few more of the support companies, some of the things that have historically not been affected are starting to get brought in to the economic challenge. I agree with what Mr. May has said, I think we’re still two years out.

J. Thomas May

I think David’s right, probably a couple of years out there’s going to be some cleanup in that time frame and to expect any more than that is just probably burying our heads in the sand which we don’t do. But, our people are dealing with it very effectively as you can see when we make a special provision. We’re not beyond making special provisions on a quarterly basis to allow them to be aggressive in this identification, quantification process.

I know David meets with them regularly, monthly, going through that. I would add one thing as far as the broader scope. Needless to say our credit card operations fall in to that broader scope and as we have reported we are up a little bit to about a 2.84% or 2.83% charge off ratio comparing to the industry of 10.6%, you can feel pretty good about that. But again, I’m not worried about the industry I’m more interested in our portfolio.

I think we’re very positive about where we are especially when you consider that we’re reserving at a 3% level. In fact, we are at a 3% level and as we mentioned in our prepared remarks we have I think at the end of June we increased our provisions slightly to even add to that reserve. We continue to grow the credit card portfolio and as I have mentioned to others, when you hear that that might create a little chill bumps up your spine under normal situations but we’re not a normal credit card bank.

What we’re seeing is so far year-to-date we’ve had a 9,400 net new accounts compared to 3,400 net new accounts this time last year. And, as we have said in our prepared remarks, the bulk of those we’re very comfortable are coming from some of the much larger credit card companies that have gone through a process of very aggressively increasing interest rates and fees and its created some anxiety and we’ve gotten the benefit of that. Quite honestly, the average FICO score on those are running somewhere above 720.

I think we feel very good about the growth we’re getting not only in the quality of it but we feel very good of it that the quality of it is adding to our existing portfolio that is strong in quality but creating some diversification age wise and otherwise. So, I think we see it as a positive. Only time will tell. But, that would be the other part as far as the scope of the credit situation.

Matt Olney – Stephens, Inc.

So staying with that credit card theme, what’s the early read on the charge off outlook next quarter? How are the past dues looking? Do you still think we’ll be around the 2.80 level going forward?

J. Thomas May

I will tell you that I’m not sure about the past due numbers in June versus the previous three months but what I can tell you is the charge off ratios have only elevated slightly. For example, in April the level was 2.74 and then there was a decent jump to 2.92 in May and it remained pretty much the same at 2.83 in June. So, it went from 2.74 to 2.92 back down to 2.83. We have seen an increase in bankruptcy filings but the number has held very well at that.

I guess from a historical perspective, we would guess that probably we’re still going to be between that 2.80 and 3% range in the next quarter. When you look at what’s happening relative to the national unemployment and elevating above the 10% range, I would not be totally shocked to see it go a little bit more than that. But, if it does, we will reserve accordingly.

Robert A. Fehlman

You asked a little bit on delinquencies, our total credit card past dues they were about 140 first quarter and they’re about 129 at the end of June 30th. We actually saw a slight improvement, we don’t believe that is a trend that it’s an improvement but for us it’s a key that there just wasn’t a big uptick in that number.

J. Thomas May

So I guess the answer to your question would be we would not be surprised to see it in the 280 range but likewise we wouldn’t be surprised to see it where we have it reserved at the 3% range.

Matt Olney – Stephens, Inc.

I think you’ve said in the past if the charge off level does go to the 3% range then you would increase your provision accordingly at that time. Is that far?

J. Thomas May

That’s right. I would point out one other thing, Matt in the past due piece of it that little blip that we saw from 2.92 to 2.83 probably has a little bit to do with the denominator going up.

Robert A. Fehlman

A few basis points, yes.

J. Thomas May

And I think again, your assessment is right on that we’re going to be very proactive relative to the trending of the charge offs.

Matt Olney – Stephens, Inc.

Then I guess the last question on the credit, maybe David Bartlett can give some more comments on what he’s seeing in credit outside Northwest Arkansas, if there are any other markets of concern that have risen over the last few weeks or months.

David L. Bartlett

That’s a good question Matt. We’ve seen a slight uptick in some markets where we’ve historically had outstanding credit. One of those has been our Hot Springs market, because of the size of that bank we’ve got one or two loans that have gotten past the 90 days and put on non-accrual that will be cleaned up by the end of this quarter. South still remains very, very strong in asset quality. Northeast Arkansas still remains very strong.

I’m going to tell you that outside of Northwest Arkansas and what Mr. May talked about was some of our issues here [inaudible] and the student loan portfolio creating some increase, the rest of the state still looks pretty strong in my opinion.

Matt Olney – Stephens, Inc.

Some of your Arkansas peers, public banks, have talked about the improved pricing power on the loan side. Is that something that you guys are focusing on in terms of improving your loan yields as some of these loans come up for renewal?

J. Thomas May

I think so. I think we’re all very conscious and sensitive to not only the margin but we’re equally as conscious and sensitive to risk pricing and the truth of the matter is that the risk is different today than it is at other times and it carries with it increased reserves thus, it should carry with it making sure you’re getting that the loan pricing right. So yes, I think we would agree with that assessment that we are being very conscious looking at risk pricing versus opportunity pricing I think is what I would say.

We’re going to look at relationships, if we have really good relationships on the deposit side that gives us the yield, we’ll give them the benefit of the loan pricing. If we don’t have the relationship then I think we’re going to be more aggressive in getting the higher price relative to the loan and we might not have done that in the past because competition might have kept us from doing that. But, I think we’ve all learned a little bit in that process.

I think another thing is that there comes a point in the institution in which the rate shouldn’t go below a certain point and [Glen Randon] the President of the lead bank and David Bartlett have worked together and come up with a pricing model that basically has a floor of 5%. We believe anything below that is just simply not where it ought to be. So, we are in fact using some of those things in our pricing structure.

Matt Olney – Stephens, Inc.

What about as far as capital levels? Your capital is very strong, as high as its been in quite some time. What are your thoughts on your comfort range, where you want your ratios to be and what ratios do you look at? And, what are your near term thoughts about deploying that capital?

J. Thomas May

Well obviously we’re at 10.1 equity to asset ratio, we’re an 8.1 tangible ratios. Obviously, from a business model standpoint those are very important to us. From a regulatory standpoint we’re significantly higher than the regulatory well capitalized and I don’t have those numbers immediately in front of me but I can tell you that we’re very comfortable with those.

Now, what do we mean we’re comfortable? Well, we obviously believe those capital levels are more than sufficient to allow us to manage normal growth. We believe they’re more than sufficient to allow us to manage this company during these turbulent times and that’s exactly why we opted not to go ahead and draw down the CPP money.

The going forward, as opportunities are created and we believe they will be created, we still are very interested in finding merger partners. Obviously, if we were to find the right partner, in the right location, at the right time with the right culture then that common equity would possibly not be sufficient to do what we would want to do there so we’re constantly in our planning process thinking about what, when and where relative to making sure that we do have sufficient resources to handle that merger when and where it happens.

On the regulatory side, we’re just in very, very good shape, 9.33 on the tier I leverage. They’ve put it in front of me, I didn’t just all of a sudden remember it obviously. 9.33 on the tier I leverage that is regulatory at 5 tier I. Risk based, regulatory at 6, we’re at 13.58 and total risk based at 10, we’re at a total of 14.84. So again, strong capital, more than capable of sustaining any growth that we have in the immediate near future, more than sufficient to enable us to continue to manage through these turbulent times which is the reason we did not decide to go ahead with the CPP money.

Then I think certainly more than sufficient to meet the expectations of our various regulators. I think from a strategic standpoint going forward though we’re going to be again looking very carefully to see if and when and at what time we would want to add to the common, primarily based on merger opportunities.

Operator

At this time there are no further questions.

David W. Garner

Thank you very much.

Operator

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

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