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Bank of the Ozarks, Inc. (NASDAQ:OZRK)

Q4 2009 Earnings Call

January 15, 2010 11:00 am ET

Executives

George Gleason – CEO

Susan Blair – EVP of IR

Analysts

Andy Stapp - B. Riley & Co.

Dave Bishop - Stifel Nicolaus

Matt Olney - Stephens

Kevin Reynolds - Wunderlich Securities

Peyton Green - Sterne, Agee

Andrew Boord – Fenimore Asset Management

Steven Russell – Emerald Advisors

Ryan Stevens - Philadelphia Financial

Joe Stieven – Stieven Capital

Doug Rainwater – Rodman & Renshaw

Ryan Martin – Unspecified Company

Operator

Good morning ladies and gentlemen and welcome to the Bank of the Ozarks, Inc. fourth quarter and full year earnings conference call. (Operator Instructions) Miss Susan Blair, you may begin your conference.

Susan Blair

Good morning. I’m Susan Blair, Executive Vice President in charge of Investor Relations for Bank of the Ozarks. The purpose of this call is to discuss the company’s results for the fourth quarter and full year of 2009, and our outlook for upcoming quarters. Our goal is to make this call as useful as possible in understanding our recent operating results and future plans, goals, expectations and outlook.

To that end we will make certain forward-looking statements about our plans, goals, expectations, beliefs, estimates and outlook for the future, including statements about economic, real estate market, competitive, credit market, unemployment and interest-rate conditions, including the potential effect on interest rates as recent US government monetary and fiscal policy, revenue growth, net income and earnings per share including our goal of achieving record net income in each quarter and for the full year of 2010, net interest margin, including our expectation of maintaining net interest margin in the first quarter of 2010 at a level slightly above or slightly below the level achieved in the fourth quarter, and prospects to increase net interest margin starting in the second quarter of 2010, net interest income, non-interest income including service charge, mortgage lending and trust income, non-interest expense, our efficiency ratio, asset quality in our various asset quality ratios, our expectations for provision expense for loan and lease losses, net charge-offs and our net charge-off ratio, our allowance for loan and lease losses, loan, lease and deposit growth including our expectation of achieving positive loan and lease growth no later than the second quarter of 2010, changes in the volume of our securities portfolio, potential savings from repayment of certain FHLB advances, the opening of new banking offices and the closing of the sales contracts for certain nonperforming assets during the first quarter of 2010.

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 of the management’s discussion and analysis section of our periodic public reports, the forward-looking statements caption of our most recent earnings release and the description of certain risk factors contained in our most recent Annual Report on Form 10-K, all as filed with the SEC.

Forward-looking statements made by the company and its management are based on estimates, projections, beliefs and assumptions of management at the time of such statements and are not guarantees of future performance. The company disclaims any obligation to update or revise any forward-looking statement based on the occurrence of future events, the receipt of new information or otherwise.

Now, let me turn the call over to our Chairman and Chief Executive Officer, George Gleason.

George Gleason

Good morning and thank you for joining us for today’s call. We’re very pleased to report another record quarter and our ninth consecutive year of record net income. For the past two years we’ve described the economic and operating environment as providing exceptional challenges in the midst of exceptional opportunities.

Our goal has been to capitalize on the opportunities. By doing so we achieved record net income in 2008 and again in 2009 in the midst of a very difficult economic and operating environment. It now appears that the economy is beginning to climb out of the deep trough that has become known as the great recession.

Based on our strong competitive and financial position, we are excited about our prospects going forward. Our optimism for 2010 including our goal of posting a tenth consecutive year of record net income is based on a combination of factors including signs of improvement in general economic conditions, our strong revenue generating capabilities, our favorable operating efficiency, our abundant sources of liquidity, our robust capital position, and our substantial allowance for loan and lease losses.

I’ll discuss some of those factors in more detail as we discuss our results for the quarter just ended and for the full year of 2009. Net interest income is our largest source of revenue and of course, net interest income is a function of both net interest margin and average earning assets. Over the last two years we have had very favorable improvement in our net interest margin.

This improvement continued in the fourth quarter as our net interest margin increased an additional nine basis points from the immediately preceding quarter to 4.89%. That’s a 37 basis point increase from last year’s fourth quarter. There were no significant unusual items effecting fourth quarter net interest margin, either positively or negatively and accordingly we expect net interest margin for the first quarter of 2010 will be slightly above or slightly below the fourth quarter’s 4.89% level.

All other things being equal starting in the second quarter of 2010 and thereafter, our net interest margin should get an additional boost from our repayment of our highest rate interest bearing liabilities, specifically in May, 2010 we have $60 million of FHLB advances maturing with a weighted average interest rate of 6.27%. We estimate that we will have annual savings of between $2.8 million and $3.6 million pre-tax when we repay these advances and replace them with new deposits or borrowings.

One of the factors contributing to our net interest margin improvement in 2009 was the improving quality and profitability of our deposit base. Although total deposits declined in 2009 as we adjusted our balance sheet primarily for the reduction in our investment securities portfolio, there were two very favorable trends regarding deposits.

First, our non-CD deposits grew significantly from year-end 2008 to year-end 2009. Total non-CD deposits grew $113 million and increased from 44.3% to 56.8% of total deposits. Second, broker deposits have been significantly reduced, decreasing $328 million from 16.4% of total deposits at year end 2008 to just 2.8% of total deposits at year end 2009.

Not only have these changes helped improve our net interest margin, but they also have favorable implications for business development opportunities and service charge income. Before we leave this subject of net interest margin, there is one other matter worth mentioning. During the quarter just ended we had further improvement in the spread between our yields on loans and leases and our rates paid on interest bearing deposits.

Specifically that spread widened another 35 basis points from 4.80% in the third quarter of last year to 5.15% in the fourth quarter. If one factors in non-interest bearing deposits, our spread between loan and lease yields and the average interest rate on total deposits is even wider. Some people have incorrectly assumed that our favorable net interest margin is a result of the good yields we enjoy from our investment securities portfolio, and not a function of what they describe as our core banking business.

To the contrary, our spread between loans and leases and deposits is actually greater than our spread between investment securities and all other interest bearing liabilities. As a result of our favorable net interest margin we had another good quarter of net interest income although it was not a record quarter.

Specifically net interest income for the fourth quarter was $28.5 million, a decrease compared to both the fourth quarter of last year and the third quarter of this year. This decrease was attributable to our declining average balance of earning assets, which resulted primarily from our being a net seller of investment securities throughout 2009.

We have reduced our investment securities portfolio by $438 million during 2009 as a result of our ongoing evaluations of interest rate risk including consideration of the potential effects of recent United States government monetary and fiscal policy actions. This adjustment in our investment securities portfolio reflects our emphasis on long-term performance over short-term results. Let me explain that.

While our net sales of investment securities have reduced net interest income in the short-term, we expect interest rates will increase significantly at some point and we believe that we will benefit from being in a position to be a substantial net purchaser of securities in the future when we expect interest rates will be higher.

To get back on a record quarterly pace for net interest income, we will have to grow earning assets. In that regard loan and lease growth was a challenge in 2009 as recessionary conditions diminished both the demand for credit and the quality of many credit applications. Throughout 2009 we made many good quality new loans and leases, but such loan and lease originations were more than offset by loan and lease pay downs.

We have seen and continue to see new business opportunities including opportunities to take business from competitors and opportunities to refinance quality borrowers out of commercial mortgage backed securities. We had hoped to resume positive loan growth in the fourth quarter but once again good growth early in the quarter was offset by several large pay downs later in the quarter.

Considering our loan application volume and the early signs of improvement in economic conditions generally, we are cautiously optimistic that we will resume positive loan growth sometime in the first half of 2010 and at the latest, in the second quarter of 2010. Historically the second quarter has been characterized by good demand for loans and leases.

In addition to loans and leases investment securities comprise an important part of our earning assets. We stated many times that we will manage our securities portfolio with a view to maximizing our long-term total returns, buying when we believe it is advantageous to buy and selling when we believe it is beneficial to sell.

Therefore the volume of our securities portfolio may increase or decrease in coming quarters based on changes in market conditions, changes in our balance sheet, changes in our assumptions regarding interest rate risk, and various other factors.

Let me shift our conversation to non-interest income, income from deposit account services charges is traditionally our largest source of non-interest income. The quarter just ended was our second consecutive quarter of record income from services charges on deposit accounts helping us achieve record annual results in this category for the full year of 2009.

Mortgage lending income for 2009 was a pleasant surprise for the full year, mortgage-lending income increased 49.5% compared to 2008, and in the quarter just ended it was up 57.1% compared to the fourth quarter of 2008. While housing market conditions are still weak by historical standards, these signs of improvement are certainly welcomed.

Our trust staff continued to add new accounts and grow existing relationships throughout 2009. This growth increased fourth quarter trust income to a quarterly record for the second consecutive quarter and helped us achieve a fifth consecutive year of record trust income. Our trust staff continues to do an excellent job.

Our bank owned life insurance to BOLI program, has been in place for seven years and we currently have 92 individuals insured. During the fourth quarter of 2009 we recorded $1,253,000 of income from BOLI death benefits in addition to our regular BOLI income from increases in cash surrender value. This was only the second quarter in our company’s history in which we have recorded income from BOLI death benefits, and coincidently the other quarter was the fourth quarter of 2008 in which we recorded $2,147,000 of income from BOLI death benefits.

Net gains from investment securities and sales of other assets in the fourth quarter were $6,180,000. Specifically we had $6,322,000 of net gains on investment securities and $142,000 in net losses on sales of other assets. The net gains from investment securities were a result of our continued sales of investment securities to adjust our interest rate risk position.

During the fourth quarter we also sold numerous items of other real estate owned and repossessed properties with a total book value of $4.8 million which resulted in the $142,000 in net losses on sales of other assets. This relatively modest loss compared to the total volume of repossessed and foreclosed assets sold reflects the good job that our staff has done in estimating the ultimate liquidation value of these assets.

Let’s talk about non-interest expense which increased significantly in the quarter just ended compared to both the third quarter of 2009 and the fourth quarter of 2008. There were a number of factors which contributed to non-interest expense being unusually high in the quarter just ended. First as you know we have slowed our rate of branch openings over the past few years.

As a result of that we were in various stages of progress with architectural, engineering, and other pre construction work on five Arkansas branches. We had incurred capitalized costs totaling $639,000 related to the pre construction work on these five branches. At this time we are uncertain as to when or if we will proceed with construction of these five additional Arkansas branches, and as a result in the quarter just ended we wrote off that $639,000 of previously capitalized cost.

Second, we have one direct equity investment in a real estate development project and this project is selling at a slower than expected pace. As a result we concluded that it was appropriate to reduce our carrying value of this asset and accordingly we took a $1 million impairment charge in the fourth quarter to reduce our carrying value to $2.55 million, which equals the net present value of the proceeds that we expect to realize using a 15% compounded annual discount rate.

In addition to these two charges, our loan collection expense and repo expense which varies quite a bit from quarter to quarter was also unusually high in the fourth quarter. Notwithstanding our higher than normal fourth quarter non-interest expense our efficiency ratio at 43.2% for the quarter was very favorable compared to typical industry norms.

Of course for many years one of the strengths of our organization has been our excellent efficiency ratio and that strength was evident in our 37.8% efficiency ratio for the full year of 2009. Let me add one comment regarding development of new banking offices, despite our indefinite delay in constructing the five Arkansas banking offices previously mentioned, we are continuing our growth in de novo banking strategy.

We opened two new offices in 2009 including the new office we opened in Allen, Texas in the quarter just ended. We are also continuing with plans to open a third banking office in Benton, Arkansas in late 2010 and two additional metro-Dallas area banking offices in late 2010 or in 2011. We expect de novo branches to continue to be an very important part of our business strategy.

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

Over the past two years we have dealt with a number of asset quality challenges and we think we have been successful in handling those issues. Let me address a couple of specific matters, in our last conference call I reported that we had another real estate owned an apartment project in the metro-Dallas area on which we had an executed conditional sales contract. That contract failed to close.

We were fortunate to have several additional interested parties and we now have the property under contract again. The buyer has $100,000 of hard earnest money with us. This contract appears likely to close this quarter with net proceeds expected to slightly exceed our book value.

Also in last quarter’s conference call we discussed a 60-acre track of land just south of the Dallas central business district. This is a valuable track and a key piece of future development plans for this area. In the last call I reported that we had an executed conditional sales contract on this property with a cash buyer.

That contract has been terminated and we are currently in negotiations with several additional interested parties. I visited this track last month and I continue to be very optimistic about our prospects for ultimately marketing this track at a price equal to or exceeding our current book value.

During January and February we have conditional sales contracts on various properties which we expect to close which account for 15.86% of our total non-performing assets at year-end. Such contracts are in the aggregate expected to result in net proceeds slightly in excess of the company’s book value of such assets. We have been very effective in selling our foreclosed and repossessed assets. This is evidenced by the fact that we sold $4.8 million of such assets in the quarter just ended with an aggregate net loss of only $142,000.

In addition it is noteworthy that we have not allowed these assets to linger on our books as only $315,000 of our foreclosed and repossessed assets have been on our books more than 15 months. In our last conference call I stated our belief that we are past the midpoint of the current credit cycle and therefore we believe that our allowance for loan and lease losses ratio has already peaked.

As you will recall the recent high point in our allowance ratio was 2.19% of total loans and leases. We continue to believe that the 2.19% allowance ratio was the peak for the current credit cycle. And I should also say we continue to believe that we are past that midpoint. I also stated in our last call our belief that our provision expense and net charge-offs in each of the next few quarters would likely would be well below the levels of the third quarter of last year.

Obviously our fourth quarter results were consistent with that expectation. While our fourth quarter annualized net charge-off ratio of 1.08%, our fourth quarter net charge-offs of $5.3 million and our fourth quarter provision expense of $5.6 million, were all still elevated compared to historical norms they do represent significant improvement from the results of recent quarters.

While we expect our net charge-off ratio, our net charge-offs, and our provision expense to vary from quarter to quarter in 2010 we believe that on average these metrics will show further improvement compared to the results achieved in the quarter just ended. We have stated many times our belief that any increases in various asset quality ratios would not seriously effect our ability to generate a good level of net income or even a record level of net income in each quarter.

Obviously we’ve taken a few hits in the asset quality arena in the past two years, but we have still posted record earnings in six of the last seven quarters and in each of the last two years. Because of our strong revenue generating capabilities we will restate our prior guidance that we believe that we will continue to generate a good level of net income and possibly a record level of net income in each of the coming quarters.

Before we close I should probably comment on capital and our TARP repayment. Our tangible common equity ratio stood at 9.71% at year-end and is very strong and we are well capitalized by a wide margin by all applicable regulatory measures. As a result of our strong capital position and common equity position, we were able to redeem our series A preferred stock, and repurchase our common stock warrant from the United States Department of the Treasury during the fourth quarter without raising new capital.

No one can be sure how long the effects of the great recession will linger. As we’ve come through the recession we’ve increased our allowance for loan and lease losses substantially. We have achieved good increases in net income and earnings per common share. We have significantly increased our tangible common equity through retained earnings. We have successfully managed through a lot of challenges including higher net charge-offs.

And more importantly we have capitalized on many of the opportunities resulting from the same economic turmoil that has caused many challenges. We think that’s what a good management team should do. In closing, we think we are in an excellent position to continue positive earnings trends by achieving good earnings and hopefully record earnings in each quarter of 2010.

That will be our goal and we think it is a reasonable goal. That concludes my prepared remarks. At this time we will entertain questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Andy Stapp - B. Riley & Co.

Andy Stapp - B. Riley & Co.

As you alluded to in your prepared remarks the spread between your yield, the spread in your loans was up quite a bit. Some of that was driven by the remix on your deposit side, but I noticed that your yield on loans is also up sequentially. Is that due to a reduction in interest reversals or what would that be.

George Gleason

It may be partly due to that. I didn’t actually look at our cumulative interest reversals for non-accrual loans in the quarter versus prior quarters. There may have been some variation in that. But predominantly I think its just a result of repricing opportunities. We’re still getting to reprice some loans that were priced in the 2006, 2007 timeframe when competition was extremely intense and loan-pricing margins were fairly thin and we are seeing continued improvement for that.

And we also achieved further improvements in reducing our cost of funds in the fourth quarter. And as a result that spread as we noted between loan and lease yields and deposits widened another 35 basis points compared to the third quarter. So that was just a very positive trend and it is a real trend and we think the 489 number is a good baseline number from which to project forward.

Andy Stapp - B. Riley & Co.

How about just pricing on new loan opportunity, is that continuing to improve.

George Gleason

I don’t know that it is continuing to improve beyond where it was in the second, third quarter or the first quarter, obviously all year spreads have been much wider than they were in the hyper aggressive 2004 to 2007 period. So we are continuing to enjoy very good spreads on new business that we’re booking and excited about those opportunities to roll off older loans that were lower priced and either renew those loans at current pricing levels, current spread levels or originate new volume at current spread levels.

So there’s probably a little more room for improvement there as older lower margin assets get repriced.

Andy Stapp - B. Riley & Co.

You touched on this somewhat, but the other non-interest expense, the last line item in your non-interest expense category was up quite a bit even if you back out the one-timers you discussed. Do you know what was driving that.

George Gleason

Yes, as I said in my prepared remarks it was primarily higher loan collection and repo expense. At the end of the quarter we always do a review of all items and other real estate owned and reevaluate the values. We don’t necessarily reappraise them, but we look at our marketing efforts and the marketing results, the interest and look at market data on various properties and we were pretty aggressive in the fourth quarter in writing down a number of those assets.

Its, 2009 has been a noisy year and there was some sentiment there certainly to look hard at those assets and try to get the values on them where we could them marketed without further hits in the coming quarters. To quantify that I would, I haven’t really looked hard at this but intuitively and knowing what I know about the numbers just scanning, I would guess that that line item probably was $0.5 million to #1 million high relative to the average quarterly results for the year in that loan collection and repo expense category.

Andy Stapp - B. Riley & Co.

And is my understanding correct that the one real estate project you discussed is the only project that you have equity investment in.

George Gleason

That’s correct, it’s a single one.

Andy Stapp - B. Riley & Co.

And when you talked in the past about FDIC assisted deals, if I understood you correctly I perceived you as having sort of a lukewarm interest as you’re somewhat skeptical if you could find a deal that is both attractive both in terms of the short-term accounting dynamics and the long-term franchise value, is this still the case or has your appetite changed.

George Gleason

I would say our appetite post repayment of the TARP has significantly increased. We would have and we looked at and bid on one deal pre TARP repayment that we thought made sense. We were an unsuccessful bidder for that, or let me say we were a successful non-winning bidder. We bid what we thought it was worth to us and didn’t win.

But after we repaid the TARP we widened our strike zone considerably on deals that we’re looking at and our logic for that was is we were afraid if we made an acquisition it might diminish our ability to repay the TARP. We kept the TARP until we had accumulated enough capital through just common retained earnings to be able to really widen, to go after an FDIC deal. Then we repaid the TARP and with that repaid we widened the strike zone considerably.

So we bid on one transaction in the fourth quarter. We were not the winning bidder on that. Our due diligence teams have already underwritten two additional transactions that we’re considering at this time and we are looking at other opportunities. So we are very active and vigorously looking in that arena because we think there will be some attractive opportunities among what we suspect will be numerous opportunities in 2010.

Andy Stapp - B. Riley & Co.

And the regions that you’re interested in, are they the same as you mentioned in last quarter’s call.

George Gleason

I’m going to give somebody else a chance, I will answer that question. But let’s give someone else a chance to answer a question.

Operator

Your next question comes from the line of Dave Bishop - Stifel Nicolaus

Dave Bishop - Stifel Nicolaus

You alluded to the conditional sales track contract, some of the properties getting extended, remarketing, maybe give some flavor in terms of what happened from a borrower perspective. Was that just not able to obtain some financing there, that the global cash flow stretched somewhere else and give us maybe an update, a little bit more granularity in terms of the status of those contracts.

George Gleason

Yes I can, on the apartment project our understanding is that our buyer was unable to put together the required equity on the project. We had a substantial equity requirement and he was unable to meet that equity requirement and as a result could not close.

The new buyer on that project would also be a borrower. The new buyer apparently we understand has his equity done and the equity requirement on that’s actually more favorable to us than on the earlier project. There is a signed contract. That contract is in all practical forms unconditional. The only outs are is if we are unable to agree on material terms of the loan documents and all they actual deal terms have been agreed.

So unless his lawyer and our lawyer get in a fight over some technical issue, that does not seem to be a meaningful out. Or our inability to deliver clear title and the title commitments have already been done. Our survey issues and those issues have already been addressed earlier. So it looks to us that that is about as firm a firm contract is as you can get to one that’s closed. We do have a $100,000 of hard earnest money from that buyer sitting in our bank.

So I think he is committed and the scheduled closing on that is expected to be within the next 30 days. So we think we’ve got the apartment complex sold. As I mentioned in the call we have a number of smaller pieces of OREO also, so when the apartment project plus others we’ve got pending contracts that should close or expected to be closed in January and February that I think covered I think 15.7%, 15.8% of our total year end non-performing assets.

So historically the first quarter has been kind of a hard time to move problem assets. It tends to be a slower time of activity in a lot of our markets so we’re pretty encouraged with the volume of contracts that we already have in place to sell things and as I said in the call those contracts in the aggregate should result in net proceeds slightly in excess of the book values that we’re carrying those assets at as of year end. So we’re feeling pretty good about our ability to move this stuff.

Dave Bishop - Stifel Nicolaus

And the, sort of the out sized growth in the repo and collection efforts you mentioned this quarter, was any of that related to the three problem credits you had mentioned last quarter, or was that more organic in nature I guess so to speak.

George Gleason

It was related to all the way across our book of OREO items. We probably I would imagine we took valuation write-downs on 20 to 30 different properties that we reviewed and thought we need to [dink] the value a little here, a little there to get these things sold and be right on them. As I say it was a, the fourth quarter was a noisy quarter in a noisy year and there was a mindset of let’s try to put as many issues in the past as we can.

Dave Bishop - Stifel Nicolaus

And then you noted that at the beginning part of the quarter had a decent amount of loan growth application so to speak, where are you seeing that come from. Is it still being led by any particular product or loan region, market share gain, maybe some commentary from that.

George Gleason

We booked some assets across the franchise and interestingly enough most of the new opportunities that we booked were construction and development deals. Our construction and development loan portfolio that was $587 million at September 30 was $600 million at December 31. So we had a number of pay downs in that portfolio but net growth of about $13 million and change in the portfolio end quarter.

We had some fairly significant pay downs in our CRE book that went from $636 million to $607 million so doing the math in my head that looks like a $29 million net pay down in the CRE book. We specifically had a large payoff on a shopping center that went into probably one of the few CMBS deals that got done last year. I think it was a JPMorgan deal and we had a big payoff on a long-term acute care facility in [inaudible] that our customer elected to sell and take his profit on.

So there was some shifts in the book and I would have gotten that all wrong at the beginning of the quarter. I would have told you that our construction and development book would probably shrink during the quarter and the CRE book would probably grow and the opportunities just came in the opposite direction there.

But we really like what we booked. We were sad to get paid off on the assets that got paid off because they were very good assets as well.

Let me address Andy’s question that he asked and that is in regard to FDIC assisted acquisitions, what markets would we be looking at, and certainly our primary desire would be in Arkansas, Texas, North Carolina, and South Carolina where we already have a presence, but there are probably not going to be ton of opportunities in Arkansas and Texas and we’ll look carefully at things in the Carolina’s.

But we would also look much more broadly in the markets that we think would be beneficial to our company over the next decade or two consistent with our much longer-term 10 or 20 year plan for the company and that would include markets such as Tennessee and Virginia, Georgia, and Florida, certainly Missouri and Oklahoma and their proximity to Arkansas and even possibly Kansas might be markets at which we would look.

So there are other markets other than four markets in which we have some presence or connection right now that we are looking at for acquisitions and even beyond those markets if an extremely favorable transaction appeared in another market we would look at that.

Operator

Your next question comes from the line of Matt Olney - Stephens

Matt Olney - Stephens

On that last topic of FDIC deals, hypothetically if you don’t get an FDIC deal in 2010 is there some kind of backup plan as to how the excess capital can be deployed in a creative manner or do you have a pretty high degree of certainty that you think you can get an FDIC deal in the next year or two.

George Gleason

I don’t know that anybody can accurately predict what the probability is that they’ll make an acquisition of an FDIC loss share transaction. We are vigorously in the hunt and are very serious about our efforts in that regard. We are optimistic that they will bear fruit. But one never knows. It’s a like trying to get a wife. You just never know that you’ve got it done until she shows up at the alter and says yes.

So we’re looking to make an acquisition in that regard or multiple acquisitions in that regard and vigorously working that direction but the transaction has to make sense. We’re not going to go do something that doesn’t make sense and you know we’re pretty conservative so if we do a transaction we’re going to do it on terms so that all of us don’t have to get together on the phone and try to figure out if it was a good deal or a bad deal.

We’re going to do it on terms that everybody can look at it and allow for the margin for error that is inherent in these things and say that’s a good deal. So within those parameters I’m optimistic that we will be successful. I think there will be a number of opportunities. If in the event that we don’t make an acquisition we certainly got a lot of capital.

And I guess I would say two things in that regard, unlike a lot of would-be acquirers that are also looking as we are, we didn’t go out and raise a lot of capital and dilute existing shareholders to do it. Its capital we earned and number two, we’ve not been a highly acquisitive bank in the past and we have historically been able to deploy capital very effectively through organic growth and if we don’t make an acquisition in 2010 or 2011, I think there’ll still be acquisitions being made from FDIC transactions in 2011 most likely.

If we don’t I think we are probably in as good or better position than just about anybody else in the industry based on our history and experience in being able to deploy that capital through organic growth. So the fact that its our capital that we raised through retained earnings and not an offering in the fact that we’ve historically been good at deploying that capital I think are positives in our prospects for the capital that we have.

Matt Olney - Stephens

And switching gears, you talked previously on other conference calls that the cost structure of the bank is finally getting to a level that you think the efficiency ratio could be sub 40% and sometime over the next year or two I believe, can you give us any more details as to what has to happen for you to achieve that goal and when you think that could happen.

George Gleason

Well the only thing that would be required to achieve that goal given our current revenue structure and current cost structure would be just to normalize the loan collection and the repo expense to normal levels. If you normalize that we would be solidly in the 30’s. Two years ago I would have said our margin, the ultra competitive margin environment we were in was keeping us from getting that goal, and right now the challenge is the higher loan collection and repo expense.

So if we can maintain our margins anywhere near current levels and I think we’ve actually got some more upside as I alluded to starting in the second quarter of this year on the margin and normalize that loan collection and repo expense to what would be historically normal levels we will be solidly and well into the 30’s on that ratio.

Operator

Your next question comes from the line of Kevin Reynolds - Wunderlich Securities

Kevin Reynolds - Wunderlich Securities

You started out by, and this may not be a quote but a paraphrase that its clear that the economy is climbing out of the deep trough, and I wanted to kind of go back to that if we could rather than focus on the specific details of the numbers but what is it that you see that gives you confidence. I know that you’ve sort of felt that way I guess here that we were improving in the last couple of quarters but do you see the national data that causes you to think that or are you seeing some signs of life at the street level in your markets that cause you to feel a little bit more confident as we look into 2010.

George Gleason

Well to clarify what I said, the word clear was not used. I said it now appears and I apologize if my poor southern diction made the word appears sounds like clear. But I do think that we are seeing signs certainly in the national data that are positive. We are seeing signs locally as well and one piece of data that I can point to is our, the last month that I have this data for home sales in Arkansas was October but home sales were up 24% state wide as far as number of units versus October of 2008.

Now the average price was still down year over year 5.5% throughout the state. But we are seeing more activity. We are seeing as evidenced from the fact that we’ve got some new fairly sizable new projects in our construction and development portfolio that I alluded to in response to Dave’s question.

We’re seeing folks taking projects that had probably been shelved or mothballed for a little while in the planning stage and beginning to resume those projects because they’re confident enough about the future and leasing and tenant conditions are such that they can do that. So I think there’s still a lot of issues to be dealt with in the economy and the industry. We’ll have some more issues and so forth but I think we are seeing in a lot of our markets small signs of activity resuming here and there and things are slowly getting better.

I wouldn’t say it’s the flood gates are open but I think there’s a steady trickle of new things getting done that make us optimistic and they create to us the appearance that we’re beginning that process of climbing out of a deep trough.

Kevin Reynolds - Wunderlich Securities

I know we’ve talked about the overall pricing and deposit gathering dynamics out there but, loan generation and deposit gathering dynamics, but can you talk more specifically about the competitive nature in your small bank versus big bank, like say without naming names, within your core markets. Is it getting easier to have conversations with customers and are you finding it easier to get them to move their business over to you or have the bigger banks out there started to do a better job of holding on now that we’ve gotten a few quarters beyond the absolute meltdown out there.

George Gleason

Let me answer that I’ll sort of give a glancing blow to answering that question and not step on too many of my competitors in the process, but we are very encouraged and have been very encouraged all year long about what we think is a really fundamental improvement in customer acquisition and growth in our balance sheet.

We’ve been very conservative in deposit pricing all year long and as a result what you might characterize as hot money or even quasi hot money, has gone from our balance sheet and what we have now I think is the best deposit base that we’ve had in the aggregate probably since we started our growth in de novo branching strategy in 1994.

And I’m really liking what I see going on with the acquisition of new customers and cross selling other services to those customers and I think it reflects the fact that we’re making money, we’re strong, we’re still able to invest in our customers and quality service and there’s a flight to quality. And customers are responding to our strong balance sheet and our strong earnings position and the quality of service that we’re still delivering, you know while we’ve been fighting a lot of challenges, one of the challenges that we’ve been fighting throughout the last two years is our relentless pursuit of improving the quality of service to our customers and just being a better bank for our customers.

And I think we’re winning that battle and constantly improving and I like where we are on that. And on the other side of the balance sheet I really like where we are in our securities portfolio. We’ve done not only a lot of shrinking the portfolio this year but we’ve also significantly in the fourth quarter reduced the taxable mortgage backs part of our portfolio that would not only be effected by higher interest rates but would be prone to extending duration in higher interest rate and we’ve reinvested a lot of money in certain munis so I think we’ve really gotten what we think is a much more defensive posture there for what we expect to be a higher interest rate environment going ahead.

So a lot of the things that are not apparent from just the aggregate number of deposits or the aggregate level of securities, I think we’re really feeling pretty good about the qualitative condition of our company and the prospects that gives us going forward.

Operator

Your next question comes from the line of Peyton Green - Sterne, Agee

Peyton Green - Sterne, Agee

On the interest rate risk component, most banks have reported negative loan growth which is not too surprising but I think also everybody is trying to prepare for higher rates and I was just curious with customers continuing to de-lever what do you think the odds are that rates go up this year and how have you prepared Ozark to deal with that and then separately, the mix change on the earning asset side has certainly favors loans more now than it probably ever has in your history and also on the deposit side the non-CD, the low cost deposit component is higher than its been in a long, long time. How sustainable do you think that is going forward if we get into a rate change environment.

George Gleason

As I really, I guess, that’s just a follow-on to the closing comments that I made to Kevin’s questions and you may have been offline and couldn’t hear that but we are really excited about the deposit base. We’ve acquired a lot of new customers. Our non-CD deposits rose to 11% at the end of the quarter. That is a result of a lot of focus on acquiring non-CD and non-interest bearing deposit customers, and 11% non-interest bearing is probably the highest our non-interest bearing deposits have been in a long time.

So we think we have been doing a very good job focusing on our retail banking customer development and relationship building. The flight to quality has made us a bank of choice in this environment. I think we get to keep those customers a large percentage of them, even in a return to more normal times.

And certainly as far as preparing for interest rate risk I don’t know where the rates are going to go up in the second half of 2010 or whether rates are going to go up in 2011 or I can imagine a scenario that rates don’t go up until 2012 because we have such persistent high unemployment that the Fed’s hand has stayed for a considerable period of time.

On the other hand, when the Fed unwinds, starts unwinding all the stimulus and balance sheet expansion and even ceases to buy mortgage backs and treasuries and agency bonds after March 31, I can also envision a scenario where spreads widen even beyond the historically wide [point] that they are today even further on the long end because of lack of demand and support for the massive amounts of treasury debt and other debt being issued out there.

So I don’t know where interest rates are going but we have, since we don’t know we have positioned ourselves on the assumption that they rise sooner rather than later. That may be a totally bogus assumption but we don’t want to be wrong on positioning. We’ve shrunk the size of our bond portfolio and shifted the composition of the bond portfolio significantly to what we think is a much more defensive posture.

So we’ve gone a long way if not all the way to where we need to be to position for a rising rate environment.

Peyton Green - Sterne, Agee

And I guess that was part of the question I was asking, historically you’ve always been fairly long on the investment side and so you say that there’s been some shortening and as you’ve paired it down also.

George Gleason

Well not necessarily and I’ll just tell you, we’ve probably sold and I don’t know the exact number but we’ve probably sold 60% of our taxable mortgage backed securities because we believe those securities were the most vulnerable to rising rates because you have both the [inaudible] effect of rising rates and the extension risk that you have with mortgage backed securities.

We replaced those with munis to some degree, obviously not fully because the portfolio shrunk a lot but we are looking to buy munis that we believe will be less likely to depreciate. Now certainly when rates rise all fixed income securities tend to depreciate but our premise is really twofold and one is the munis seem to still enjoy a historically wide spread to taxable’s so we think that tends to mitigate the potential depreciation effects on them.

And two, I think we’re going to have higher tax rates and higher tax rates will tend to made tax exempt securities more valuable which also we think will tend to mitigate the depreciating effects as rates rise. So we believe that the real value is longer out the curve and not on the very front end of the curve so we’re tending to go longer out but we’re looking for individual securities and structures that we believe will tend to depreciate less and yield a lot more.

Peyton Green - Sterne, Agee

On the borrowing side, I know about 20% of your borrowings reflect the $60 million in FHLB advances that are rolling off, are you doing any, are you extending your borrowings at all.

George Gleason

No.

Peyton Green - Sterne, Agee

So the increase linked quarter and the cost of borrowings was more likely due to just the FHLB advances being higher percentage of the mix, is that—

George Gleason

I haven’t looked at that so, Paul is nodding his head across the table at me affirmatively and saying yes, that’s accurate.

Peyton Green - Sterne, Agee

If rates were to rise, how much do you believe the loans or [earn] the money in terms of the floors.

George Gleason

Well as you we reflected in our last 10-Q that we would incur some margin compression in a rising rate environment and you can look at the Q, and we basically said in a plus 100 environment we would lose about 2% of our net interest income versus the baseline base case scenario and in a plus 200 we would lose about 1.1%. So I think because a lot of our loans are variable rate loans but the formulas calculate a rate that is below the floor rate today, those loans have to rise 50 or 100 or 150 or 200 or 250 basis points before they get in the money and start adjusting upward.

And that does give us a tenancy, even though if you just look at, if you count those are rate sensitive assets and look at them in the first couple of hundred basis points up in rates we do lose a little net interest income and a little margin but if we’re running close, just for round number purposes, 5% on the margin, and we lose 2% of that then that’s still like a 490 margin.

So we think we are vulnerable there a few basis points, whether that’s five or eight or 10 basis points I don’t know, but not significant.

Peyton Green - Sterne, Agee

I missed the loan guidance going forward, did you revise that.

George Gleason

We really didn’t. We said we expect to be back on a positive loan and lease growth track some time in the first half of the year, not later than the second quarter and included implicit in that assumption, included in that assumption is our belief that we will continue to see slightly improving economic conditions over the course of the year.

Peyton Green - Sterne, Agee

Historically the first quarter has always been your toughest in terms of loan growth, do you think its different this year just because 2009 was such an off year or—

George Gleason

No I don’t think, first quarter is a tough quarter in two respects, one loan growth, two mortgage and really I guess three, service charge. We normally historically have collected about 22% of our service charge income in the first quarter of the year and I think the first quarter is subject to all those normal cyclical influences this year, seasonal influences I guess.

Operator

Your next question comes from the line of Andrew Boord – Fenimore Asset Management

Andrew Boord – Fenimore Asset Management

The construction growth you’re seeing, is that coming more from commercial real estate projects or are we talking home construction projects again.

George Gleason

I don’t have that number broken down but I would tell you my gut is that the majority of it is coming from commercial projects.

Andrew Boord – Fenimore Asset Management

And is that more Arkansas versus Texas or the Carolina’s or is it, do you have that detail.

George Gleason

I don’t have the detail on how that growth was split out, I can give you the overall breakdown of our loan book based on office of origination. At December 31 year end, 33.8% of our loans were originated by our Texas offices, that’s up from 32.6% at the end of the prior quarter, 5.9% of our loans that were originated by our Carolina offices versus 6% the prior quarter so a one-tenth of one percent drop.

And what’s interesting there is we had a very large payoff in the Carolina’s that was offset by new growth so it looks like there was almost no change one-tenth of one percent, but there was a pretty sizable shift in their portfolio. And then 60.3% in Arkansas versus 61.4% the prior quarter. Texas at year-end accounted for 14.5% of our deposits and Arkansas accounted for 85.5% and as was the case with loans where the Texas percentage increased 1.2% in loans it also increased 1.1% in our total deposits from the September 30 number.

So we saw new business in all of our markets, Texas was a net grower, Arkansas and North Carolina were offices were net down as a percent of the total but as I alluded to in North Carolina we had a big payoff and a lot of new business booked. That was true also in Arkansas we had several smaller payoffs, not as large new business booked and one of the big payoffs we had was a big Texas deal but our Texas growth out ran that.

So Texas continues to be probably the best growth engine for us. And there were new construction and development projects in all three of those markets, the Carolina’s, Texas and Arkansas in the quarter.

Andrew Boord – Fenimore Asset Management

On the securities portfolio, I appreciate what you’re doing there and I’m glad to see it, don’t get me wrong, I’m trying to get a sense for how much further, how much more could you shrink that before you start worrying about too much impact on earnings or too little liquidity or any of those other aspects.

George Gleason

Well that’s a good question and I think we’re very close to doing what we want to do there. I wouldn’t mind rotating a few more of the taxable’s off and rotating some more munis on because those one are better yielding, and two I think they’re more defensive for the reasons I’ve already enumerated and we are trying to be opportunistic and look for opportunities to make new investments.

One of our sort of our targets and signals to be a seller is when the 10 year basis got into the 320 range and we expected that we would visit the 320 range on the 10 year several times during the year and our strategy was to be a net seller in and around that range and we were pretty diligent about doing that and we got in that range 320, 330 range, in December early and we were a net seller and then obviously traded back up to a 380 basis right around the end of the year there.

So I think our timing in adjusting the size of our portfolio has been good and I think we will see opportunities this year where we’ll have an opportunity to add securities at favorable prices at favorable times and I think you’ll see some quarters this year where that securities portfolio will grow with more advantageously priced securities added to the mix.

Operator

Your next question comes from the line of Steven Russell – Emerald Advisors

Steven Russell – Emerald Advisors

As far as the land that you brought in as a result of the lawsuit in Northwest Arkansas was that land reappraised when you brought it in and are you seeing any land sales in that area, and if you can give us some color on the pricing of land lots in that market.

George Gleason

Yes I can, it was, it had all been reappraised within a year if not at the time of our acquisition so we have current market appraisals on all of it at the time we put it in and we continue to reevaluate that. And we really took, where there were two different lawsuits up there and we have sold some pieces already and have some pieces under contract of the land that we acquired in connection with each of those lawsuits.

So we are continuing to work on liquidating that. We’ve had some small successes in that regard and have several deals in the pipe that are working that would also liquidate part of that. Some of those I would say were pretty, we’re being pretty successful with. Some of them, its proving difficult to liquidate in what is a very tough market up there.

But I think we’re in pretty good shape on most of it. We may have a few pieces of it that we end up being short on. On the other hand we’ve got a few pieces that we’re going to end up being under valued on. For example, one of the large subdivisions that we took in as the first lawsuit I think our current carrying value is about $26 or $27,000 a lot.

\We sold eight lots in there last year at an average basis of right at about $50,000 a lot and we’ve got 10 more in a pending sale now that because it is a booked sale, we’re discounting them somewhat and those will be at about $40 to $43,000 I think, $43, $44, somewhere in that range, $40 to $44 say per lot and that compares pretty well to our $26, $27 a lot basis.

Sp the sales were accretive and we’re not booking any gains on transactions like that. Our accounting there is to just use the cost recovery method of accounting so we take every dollar of proceeds and apply it to our balance which makes the sales even more accretive and reduces our average value on remaining lots.

So we will probably when its all said and done, come up a little short on a few of those deals. We’ll probably come up a little long on a few of those deals. I think on average we’re pretty well valued on them.

Operator

Your next question comes from the line of Ryan Stevens - Philadelphia Financial

Ryan Stevens - Philadelphia Financial

Just parsing through your credit commentary is your expectation that the loan loss provision could actually be down next quarter.

George Gleason

Well what we said was that if you take fourth quarter provision expense net charge-off expense and our net charge-off ratio, and if you take the results that we expect for all four quarters of 2010 and average those results we think on average they’re going to be less than the fourth quarter results. So we think we’re going to have less charge-offs, less provision expense, and a lower net charge-off ratio for the full year of 2010 than we did in the fourth quarter.

Now, I said in my prepared remarks that that will vary from quarter to quarter so we may have an individual quarter or two quarters that are higher than that but on average when you factor in all four quarters and average it out for the year, we have pretty good belief that we’re going to be below those fourth quarter ratios. That’s consistent with the guidance we gave last quarter which is we expect, we said then we expected the fourth quarter and the coming quarters to be well below the second quarter and third quarter last year levels. Certainly the fourth quarter results were consistent with that and I think the trend while not a straight line, it will be a choppy trend line but I think the trend is for continued improvement.

Ryan Stevens - Philadelphia Financial

On the FDIC assisted opportunities, referencing your one bid and then subsequent diligence you’ve done, what kind of accretion are you seeing. What’s the hurdle parameter that you’re seeing on some of these deals.

George Gleason

Well the hurdle parameter varies from deal to deal and to go back to the earlier question in that regard, there are two types of deals. And one deal is a what you think buried within the pile of rubble is a really sound franchise that has a lot of long-term value and certainly we would try to make less short-term profits on a deal that we thought had a really sound fundamental franchise underneath it, albeit it may be a shadow of the total enterprise.

If there’s a real fundamental franchise there that is a long-term fit and we think we can make money out of in a significant way for years to come, then we’re going to be much more aggressive bidding on that than we are a deal that has much less long-term franchise value. If its just a deal we’re going to have to make a lot more money up front than if it’s a long-term franchise.

Our preference is certainly to buy a franchise but I jokingly said at one of the conferences I spoke at last quarter that if we get a good franchise as part of the deal we only want to make a mountain of money and if there’s not a really great franchise as part of the deal, we would want to do a deal that we made two mountains of money on.

And that’s kind of a joke but it does really reflect our philosophy. The less franchise value there is the more up front profit we’re going to be wanting to make as part of the deal.

Operator

Your next question comes from the line of Joe Stieven – Stieven Capital

Joe Stieven – Stieven Capital

I’m going to ask you what the definition of a mountain is, but I won’t even do that, but thank you, nice quarter.

George Gleason

Ask my guy from St. Louis, you guys have to come down to the Ozarks and we’ll show you what mountains look like.

Operator

Your next question comes from the line of Doug Rainwater – Rodman & Renshaw

Doug Rainwater – Rodman & Renshaw

I just wanted to stay in the queue and say congratulations on a good quarter.

Operator

Your next question comes from the line of Ryan Martin – Unspecified Company

Ryan Martin – Unspecified Company

But just two things I wanted to touch on, just the cash equity you’re getting on these new construction projects you put on, can you just give a little color on that and then maybe just the other question was in the past you’ve talked about most of the challenges from here on out even though we are on kind of the downhill side of the cycle are going to be coming from the C&D book and not from the CRE and CNI, they’ll probably be a little bit more isolated, just wondering if that still seems the way you feel, just wanted to hear that from yourself.

George Gleason

Yes, I would say that’s still the case. Certainly we’ll have some challenges from our CRE book but as I’ve said a number of times, we continue to expect those to be very isolated and not terribly problematic. I think most of the challenges we’ve had and most of what probably remains to be addressed as challenges will come from the C&D book.

But again I do think we’re past the midpoint in that process and I think we have a lot more visibility now. When we were doing this call a year ago or 15 months ago, nobody quite knew what in the world was going to happen. At that point it looked like a large number of the top banks might fail and Fannie and Freddy and no one knew how those things were going to be rescued or resolved and while there is still a lot of questions, the whole world falling off an endless cliff into a bottomless pit, that sort of scenario is over and we have I think some pretty good definition on what’s going to happen to the economy.

Although there are still a number of questions. We think the range of outcomes there has narrowed quite a bit and we’ve got a lot more visibility on our loan book now. We thought we knew who would come up with additional money if deals need to be capitalized and who wouldn’t. We thought we knew what projects would work even in a stressed environment and which ones wouldn’t but that’s become much more clearly defined to us.

There’s still questions out there but the questions are much less numerous than they were a year, 15 or 18 months ago and the range of potential outcomes is much more defined. Although it may still be a range of outcomes as opposed to very defined results. So we’re feeling much better about our ability to predict those sort of things going forward.

Ryan Martin – Unspecified Company

And then just the cash equity requirements on the new C&D—

George Gleason

Well certainly we’re being pretty demanding on cash equity and it varies from deal to deal but I would say the majority of the transactions that we are doing in the construction and development book now, the cash equity is typically ranging from 30 to 50%.

Operator

Your final question is a follow-up from the line of Andy Stapp - B. Riley & Co.

Andy Stapp - B. Riley & Co.

Just curious what your thoughts are of the impact of the Fed rulings on NSF charges.

George Gleason

Certainly that, there’s going to be a big impact for the industry and it really depends on how effective we are in selling our customers on the benefits of opting in as opposed to opting out on having electronic Reg E transactions paid into overdraft instead of returned or rejected. And of course my understanding is is this comes into play on August 15 for our existing customers. So the first quarter and the second quarter of 2010 will be business as usual. We will develop our strategies for how we’re going to do our opt in marketing campaign to our customers and once we, and we’ll launch that probably in early July in anticipation of that August 15 change in procedure date.

And we’ll vigorously try to get customers to opt in and I think a vast majority of our customers, well I don’t know, I shouldn’t say that. I think a large number of our customers will opt in and there’ll be no change in the way their accounts are handled at all. And so whatever impact there will be will be an impact starting in the third quarter and the fourth quarter, certainly that will put some downward pressure on service charge income.

We’ve already factored in what we think is an estimate in our budget and built that into our assumptions and that is included in our comment that we think we’ve got a legitimate shot of putting up record earnings in every quarter next year and if in any quarter we don’t put up record earnings we feel, still think we’re going to put up very good earnings.

Operator

There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.

George Gleason

Thank you guys all for joining the call today. I appreciate it and we’ll look forward to talking with you in about 90 days. That concludes our call.

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Source: Bank of the Ozarks, Inc. Q4 2009 Earnings Call Transcript
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