Bank of the Ozarks Inc. Q1 2008 Earnings Call Transcript

Apr.21.08 | About: Bank of (OZRK)

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

Q1 2008 Earnings Call

April 11, 2008 11 am ET

Executives

George Gleason – Chairman and Chief Executive Officer

Paul Moore – Chief Financial Officer

Susan Blair – Executive Vice President of Investor Relations

Analysts

Barry McCarver – Stephens Inc.

David Bishop – Stifel Nicolaus

Peyton Green - FTN Midwest Securities

Brian Martin - Howe Barnes Hoefer & Arnett Inc.

Chris Chouinard – Morgan Stanley

Andrew Stapp - B. Riley & Company, Inc

Charlie Ernst – Sandler O’Neill

Operator

I would like to welcome everyone to the Bank of the Ozarks’ First Quarter Earnings Release Conference Call. (Operator Instructions)

I would now like to turn the call over to Ms. Susan Blair of Bank of the Ozarks.

Susan Blair

Thank you and Good morning. I am 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 first quarter of 2008 and our outlook for upcoming quarters.

Our goal is to make this call as useful as possible in understanding our recent operating results and future plans, goals, expectations and outlook.

To that end, we will make certain forward-looking statements about our plans, goals, expectations and outlook for the future, including statements about:

Economic and housing markets;

Competitive and interest rate conditions;

Revenue growth, including our goal of achieving revenue growth at a rate in excess of our rate of increase in non-interest expense and thereby achieving positive operating leverage;

Net income;

Net interest margin, including our goal of maintaining and possibly improving net interest margin from the level achieved in the fourth quarter of 2007;

Net interest income, including our goal of improving net interest income in each quarter of 2008;

Non-interest income, including service charge, mortgage lending and trust income;

Non-interest expense, and our goals for maintaining our rate of increase in non-interest expense below our rate of revenue growth;

Asset quality including expectations for our net charge-off ratio;

Future growth and expansion including plans for opening new offices and a new corporate headquarters;

Loans, lease and deposit growth;

And changes in our securities portfolio.

You should understand that our actual results may differ materially from those projected in any forward-looking statements due to a number of risks and uncertainties, some of which we will point out during the course of this call.

For a list of certain risks associated with our business, you should also refer to the forward-looking information caption of the management’s discussion and analysis section of our periodic public report, the forward-looking statement 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 today’s call and allowing us to discuss our first quarter results, which reflect some significant accomplishments as well as the challenges posed by the current economic environment. We have a lot to talk about, so let’s get right to the details.

Net interest income is our largest source of revenue accounting for 80.9% of total revenue in the quarter just ended. In our January conference call, I stated that one of our goals was to achieve record net interest income in each quarter of 2008, and we continue to believe that is a reasonable goal.

We said that we expected to accomplish this goal primarily by doing two things. First, growing loans and leases from the low teens to the high teens in percentage terms; and second, maintaining or possibly improving net interest margin from the 3.47% level achieved in the fourth quarter of 2007.

Our first quarter results met or surpassed this guidance in all respects. Our net interest income in the quarter just ended increased 19.2% compared to the first quarter of 2007. And it was up 6.6% from the fourth quarter of 2007. This gave us our fifth consecutive quarter of record net interest income.

Since net interest income accounts for such a large percentage of our total revenue, achieving record quarterly net interest income is of paramount importance in achieving our larger goal of returning to a level of record quarterly earnings during 2008.

Improvement in our net interest margin was an important contributor to our record net interest income. Our first quarter FTE net interest margin of 3.69% was up 34 basis points from the first quarter of 2007 and up 22 basis points from the fourth quarter of 2007.

We were very pleased with this 22 basis point linked quarter improvement, which was exactly two times what our Board-approved, internal plan had projected.

Interestingly half of this improvement is a result of a favorable spread achieved on the unexpected addition of a large volume of tax-exempt investment securities, and half of the improvement is due to better spreads between our loans, leases, and our other securities and our deposits and other funding sources.

Our excellent growth in earning assets, both loans and leases and investment securities, also contributed significantly to our record net interest income. Loans and leases were up 15.0% compared to March 31, 2007, and up 5.9% compared to December 31, 2007.

The year-over-year growth percentage is right in line with our recent guidance for loan and lease growth to range from the low teens to the high teens in percentage terms. If you annualize our first quarter loan and lease growth you get a 23.8%, well above our recent guidance range.

Of course loan and lease growth tends to vary significantly from quarter to quarter, so annualizing one quarter’s results may not be particularly meaningful. However you look at it, our first quarter loan and lease growth met or exceeded guidance.

With the slowdown in economic conditions nationally and operating as we are in a much more challenging portion of the credit cycle, one might be surprised by this level of growth. Of course economic conditions and credit cycle conditions are making it harder in some respects to find good quality credit.

On the other hand these conditions have led many competitors to withdraw from the market because of liquidity, asset quality, or other issues. There are still many good quality loan opportunities and the recent changes in the competitive landscape have resulted in a normalization of credit terms and loan pricing in many cases.

For example, the vast majority of our first quarter loan growth involved transactions which included cash equity or subordinated debt invested by the borrowers or others totaling 35% to 45% of the total project cost. And these loans also had relative pricing 100 basis points or more above where comparable loans might have been priced just a few quarters ago.

After several years of having to compete against very aggressive credit terms and loan pricing, these signs of normalization of credit terms and loan pricing are very welcome. And if they continue they have favorable implications for future loan growth, credit quality, and net interest margin.

In addition to good loan and lease growth, our earning assets got a boost late in the first quarter from the addition of tax-exempt investment securities.

In our January conference call, I said that we were not then expecting substantial growth or shrinkage in the size of our investment securities portfolio in 2008, but that we will be a buyer of securities when we believe it is an opportune time to buy and we will be a seller of securities when we believe it is an appropriate time to sell.

In the last week of February and throughout March we found what we believe were unusually good buying opportunities for certain tax-exempt securities. The opportunity to acquire these high-quality tax-exempt securities at very favorable yields is due to the unusual market conditions in recent months.

Although most of these securities were on our books for only the last month or so of the quarter, they provided a nice boost to net interest income and net interest margin.

We know that a portion or perhaps a majority of these securities will be called or paid off during the second quarter. If this occurs our securities portfolio could shrink back toward the December 31 level.

On the other hand if we can continue to find unusually good purchase opportunities, our securities portfolio might stay at or near the March 31 balance or even increase further.

We are just pleased that the recent market turbulence is allowing us to own, even if for only a short-term, a good volume of high-quality assets with unusually favorable yields.

Let me shift quickly to non-interest income, which in the aggregate was down 14.0% compared to the first quarter of 2007 and down 14.2% compared to the fourth quarter of 2007.

The adverse comparison to last year’s first quarter is due primarily to two things. First in the quarter just ended, we had net losses of $73,000 from sales of investment securities and other assets, compared to net gains of $372,000 in the first quarter of 2007.

Secondly, in the first quarter of last year we benefited from $500,000 of other non-interest income from the settlement of a contested branch application.

The adverse comparison to the fourth quarter of 2007 is also due primarily to two factors. First, income from service charges on deposit accounts and trust income were lower in the first quarter just ended compared to the fourth quarter of 2007, as is typically the case in the first quarter of each year due to seasonal variations.

Second, in the first quarter of 2007 net losses of $73,000 from sales of investment securities and other assets compared to net gains of $567,000 in the fourth quarter of 2007. More importantly however, if you look at our three main components of non-interest income in the quarter, our results were modestly favorable.

Specifically, service charges on deposit accounts, which are our largest source of non-interest income, increased 1.3% in the quarter just ended compared to last year’s first quarter. But principally due to seasonal factors, decreased 9.6% in the quarter from the record achieved in the fourth quarter of 2007.

Our initial 2008 guidance for service charges on deposits was that they would increase in a mid single digit percentage range. Based on our first quarter results we’re revising our guidance for service charge income slightly to a low to mid single digit growth rate in 2008.

Not surprisingly, first quarter 2008 mortgage income was down 8.1% from the first quarter of 2007. However, it increased 27.8% from the fourth quarter of 2007, as we benefited from a higher level of refinancing activity in the quarter just ended.

While we gave no specific guidance for mortgage income in 2008, our first quarter results were somewhat better than we had projected internally.

Trust income continued to be a very positive line item for us as it increased 29.9% in the first quarter this year compared to the first quarter 2007, although it decreased 8.6% from the quarterly record set in the fourth quarter of 2007.

At this point we will stick with our earlier guidance for trust income growth in 2008 to range in the low teens to the mid teens in percentage terms. Non-interest expense increased 6.1% in the most recent quarter compared to the first quarter of 2007 and increased 3.0% compared to the fourth quarter of 2007.

Our previous guidance suggested that this category of expense will grow in the mid single digits in percentage terms in 2008. Our first quarter non-interest expense was moderately higher than we expected and accordingly we are revising our expectations and guidance somewhat to suggest that this category of expense will grow in the mid to high single digits in 2008.

Our expectation for growth of non-interest expense in 2008 reflects in part our plans to open only three new banking offices this year. During the first quarter we opened a Dallas area banking office in Louisville, Texas. This gives us 4 Dallas area banking offices and a total of 6 Texas banking offices.

During 2007, our Texas offices contributed the vast majority of our growth in loans and leases and we expect that to continue to be the case in 2008. Specifically, loans from our Texas offices accounted for 22.0% of our total loans and leases at the end of the most recent quarter, up from 16.9% at year-end 2007, and 10.1% at March 31, 2007.

With our recently expanded retail banking presence in Dallas area, we expect our Dallas area offices to also contribute more significantly to 2008-deposit growth. Our Texas offices accounted for 8.5% of our deposits at March 31, 2008, up from 6.5% at year end 2007 and 4.4% at March 31, 2007.

Another of our key goals for 2008 is to maintain good asset quality. Economic conditions nationally have weakened significantly in recent quarters. While our markets in Arkansas, Texas and North Carolina appeared to be less significantly impacted by this weakness than some other markets, we are obviously not immune to the effects of slower economic conditions and particularly the slowdown in housing activity.

As a result, our ratios of non-performing loans and leases, non-performing assets, passed due loans and leases and net charge-offs were all higher in the first quarter. While these measures are all elevated compared to our experience in recent years, they are not outside of the range we have experienced in similar credit cycles in the past and our ratios still compare very favorably with recent results for the industry as a whole.

We had expected our ratios of non-performing loans and leases, non-performing assets and passed due loans and leases to increase during 2008, but the increase in such ratios in the first quarter was a bit more than we had expected.

These first quarter increases are not due to a specific customer or a specific market, but are a result of a number of credits spread across most of our footprint. Our credit practices dictate that the larger the loan, the more stringent are the credit standards applied.

As one would expect, softening economic conditions therefore typically affect our smaller credits more adversely than our larger credits, as these smaller credits are not underwritten to the more rigorous standards applied progressively to credits of larger size.

That is exactly what we’ve seen in recent months as smaller consumer loans, business loans, and real estate loans to various customers had been adversely impacted by deteriorating economic conditions.

The increase in our ratio of non-performing loans and leases is also due in part to a number of smaller less well-capitalized builders for whom we financed a small number of home construction loans typically ranging from 1 to 5 homes.

During the first quarter of 2008 we have been very aggressive in conducting thorough impairment analyses on all non-accrual loans and leases. The majority of the anticipated loss exposure from non-performing loans and leases was written off in the first quarter, which led to a higher net charge-off ratio for the quarter.

Accordingly, we feel that our non-performing loans and leases at March 31, 2008, will not significantly impact future net charge-offs or operating results since such assets have been thoroughly evaluated and the majority of the expected losses have already been recognized.

Over the last 5 years and 10 years, our net charge-off ratios have averaged 27% and 34% respectively of the net charge-off ratios for all FDIC insured institutions as a group. We believe that our asset quality will continue to compare favorably to the industry as a whole and accordingly we expect that in 2008 we will enjoy a favorable net charge-off ratio compared to the industry average.

In our January conference call, I stated our expectation that our net charge-off ratio for 2008 would be in the 18 to 25 basis-point range. With a first quarter net charge-off ratio of 38 basis points we would like to average approximately 20 basis points of annualized net charge-offs for the remainder of the year to hit the top end of that earlier guidance range.

While we continue to believe that that is a possibility, in light of the uncertainty about economic conditions and the higher than expected level of our first quarter net charge-off ratio, it seems prudent to revise our guidance for our net charge-off ratio to a mid to low 30s basis point range for the full year of 2008.

In closing, let me repeat our statement that our paramount goal for 2008 is to once again return to a record quarterly earnings pace, building on the significant growth in earning assets in the first quarter and the improvement in our net interest margin in the first quarter, I believe we are well positioned to accomplish this goal in the coming quarters.

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

Question-and-Answer Session

Operator

Your first question comes from the line of Barry McCarver – Stephens Inc.

Barry McCarver – Stephens Inc

Hi, good morning George. Great quarter.

A bunch of questions, let me just get a few and then I’ll let somebody else get on. Starting off with margin, I did see where the rate you’re paying on deposits has dropped pretty dramatically, can you talk a little about what’s driving that? It certainly sounds like it’s an easing up of competition there.

George Gleason

Certainly we’re working hard on that and we are being very attentive, Barry to seek deposits in the most cost-effective manner, which is leading us to be more active in certain types of deposits in certain markets and less active in other markets where competition continues to pay a very high rate.

So we were pleased to some degree with our success in lowering deposit rates in the first quarter. But I’ll be honest with you, we did not achieve as much success as we had hoped to in lowering rates.

Deposit rates continue to be more sticky than I think they should be as a result of fundamental economic conditions and I think part of that is just the result of the fact that liquidity markets of all sorts nationally are gummed up and I think that’s creating a higher demand for deposits and keeping rates somewhat sticky and somewhat higher.

What helped us really offset the stickiness in that deposit cost was two things. One I’ve already addressed, the normalization of credit pricing. On new loans we’re originating, we’re probably getting 100 basis points and in many cases a lot more than that, better rate and by rate I mean relative rate, not absolute rate, than we would have gotten on those loans 6 months or 12 months or 18 months ago.

And secondly, while 53.8% of our loan portfolio is variable rate, we started several years ago really trying to get floor rates in a lot of those loans, anticipating that if we got in a situation where the Fed was reducing rates again that we might find deposit cost to be somewhat more sticky than normal.

As a result of that at the end of the first quarter 49% of that 53%, almost half of our variable rate loans were at their floor rates. So the combination of floor rates on our variable rate loans and normalization of credit terms have helped us mitigate the impact of the stickiness on deposit costs and led in part to that improvement in the net interest margin in the first quarter.

As I mentioned about half of that 22 basis point improvement, in fact exactly half of it, was a result of just fundamental improvements in our relative pricing of assets and liabilities, and half of it was due to the unusually good spreads that we picked up on the addition of those tax-exempt securities.

Barry McCarver – Stephens Inc

Now, you mentioned on those securities that there may be a portion that comes off in the second quarter, are you thinking a third, half or what do you mean by a proportion?

George Gleason

Barry, it is difficult to know. We are getting large numbers of call notices on those securities. I would guess that we already have indications of call notices that are either issued or coming on probably 20% to 25% of those securities and that’s right now, and we’re just getting started in the quarter. So we’re expecting that a lot of those securities will be refinanced or paid off during the quarter.

Barry McCarver – Stephens Inc

What I am trying to get at here, George, if that’s the case and those securities did give you the benefit to some at the margin, if they roll-off and you don’t see the credit rate of deposits like you did this quarter, is there a potential to give some of this margin gain back in the second quarter?

George Gleason

Barry that is certainly a potential. I’m not sure that it is the likelihood, but there is certainly a potential and that’s why in our prepared remarks we talked about the fact of that 22 basis point margin gained compared to Q4 of 2007, 11 of it was normal.

Barry McCarver – Stephens Inc

Yes.

George Gleason

From just improvement in the relative mix of things, and 11 of that 22 basis points was from this securities addition. So if we give back some of that top 11, the question is will we be able to make that up by further improvement in the normalized deals.

With the repetity of Fed movements, and the uncertainty about future Fed action, and all of the turbulence in all these markets, that is difficult to give you real precise guidance. So I’ll just tell you those are all the sort of things we’re looking at.

We continue to believe, we said it in our January call, that we expected to maintain or be able to improve our margin in each quarter of 2008 from the 3.47% level of the fourth quarter of last year, certainly that looks like very good guidance at this point and we certainly stand by that guidance.

Our hope is that we’ll be able to maintain the margin at or close to the level of the first quarter and hopefully build on it as the year goes on. But I’m not giving you that guidance because there is just a lot of unusual moving parts in the liquidity aspects of our economy out there and competitive situations.

But we are very encouraged by what we see as a massive normalization of credit terms and loan pricing. In fact, I would say we probably have gone beyond normal and have even better than normal credit term environment and better than normal loan pricing environment because the pendulum has swung from a very aggressive environment in both respects to what looks like a much more conservative environment in both respects.

So I think, as I said in my prepared remarks, that has some favorable implications for our ability to grow loans and our asset quality going forward and our margin going forward.

Barry McCarver – Stephens Inc

Okay. That’s very good information. The last line of questioning, moving over to loan growth, particularly strong growth in 1Q. Could you give us a little color on where those loans came from and what type of loans they are, that nature?

George Gleason

Yes. Most of those loans came as I’ve already said from our Texas offices and most of that came from our real estate specialties group, which is our metro Dallas office or in the Preston Center area of Dallas.

The real estate specialties group handles our larger commercial credits; most of these were construction and development loans. But the two largest credits I think we closed in the quarter had 45% approximate cash equity from the borrower in them, and so we were loaning about 55% of the capital structure on the bill.

These were ongoing projects that have sales histories and we can look at the trends of where sales have been going in recent years and recent quarters and where prices have been going in recent years, in recent quarters and they’re excellent projects.

So we are seeing opportunities because of the liquidity issues in large segments of the market, in fact that a lot of financing vehicles are gone. We’re seeing opportunities to do credits for really high quality borrowers on high quality projects with large amounts of cash equity in them at what standards of recent years is very favorable pricing.

So we think that while the economy certainly providing challenges for everybody that it’s also creating some excellent opportunities and we were fortunate to be able to take advantage of some of those opportunities in first quarter.

Barry McCarver – Stephens Inc

George is one of the large deals you mentioned there, is that the one you talked about on our field trip that was in Nevada, I believe?

George Gleason

Actually we did a deal in California that’s right across the line from Nevada.

Barry McCarver – Stephens Inc

Okay.

George Gleason

The other transactions were all done for our Texas based borrowers but all done out of that office.

Barry McCarver – Stephens Inc

Did that deal, was that fully funded in the quarter?

George Gleason

Not fully, but substantially.

Barry McCarver – Stephens Inc

Okay. So, if there’s a couple of big deals in the quarter, how much of the growth came from just those two big deals? I’m just trying to get an idea of the run rate for the second quarter that you can see.

George Gleason

I would say somewhere between 40% and 50% of growth came from a couple of larger transactions. I think that’s a pretty good estimate, but I haven’t calculated that specifically.

Barry McCarver – Stephens Inc

Okay, George. Thanks a lot. I’ll let somebody else ask some questions.

Operator

Your next question comes from the line of Charlie Ernst – Sandler O’Neill.

Charlie Ernst – Sandler O’Neill

Can you just clarify again your thoughts as to where the investment balances stabilize? I know it’s a a guess at this point, but the period and numbers were so much higher than the average that there is a lot of room there.

George Gleason

Charlie I know there is a lot of room there and I’m certainly not trying to be evasive, but the answer to your question is no I can’t say any more than I’ve said because I don’t know any more than I’ve said.

We had a bunch of growth in the first quarter. We feel good about that. We’ve already had a number of call notices on a lot of those, a lot more will be called. We are at the same time looking for new opportunities.

As you know the markets are very dysfunctional in some respects right now, and you can find opportunities to buy things that are high-quality assets from high-quality issuers at either very low prices or very high rates relative to where those things would have been priced in the past.

So, we’re looking for those opportunities but we also know a lot of the stuff we bought is going to be called. So I really can’t tell you where we’re going to be at the end of the quarter.

Charlie Ernst – Sandler O’Neill

Right. Okay. And were a lot of those new issues that are now getting called because rates have improved?

George Gleason

I’m sorry, I’m not sure I understand.

Charlie Ernst – Sandler O’Neill

Were a lot of the munis that you are saying are getting called, were those new issues that you bought?

George Gleason

No. They were bought in the secondary market.

Charlie Ernst – Sandler O’Neill

Okay. And then can you say what the margin was in March?

George Gleason

Charlie, I don’t have that number with me.

Paul Moore

It was 3.91%.

George Gleason

That margin was, I will tell you though, disproportionately affected by the addition of those tax exempt securities, which we just really started adding them in the last part of February. So they were in there really only in the month of March in any significant volume.

Given the fact that we expect a lot of those to be called, the March number may not be a good number for you to use for your run rate going forward.

Charlie Ernst – Sandler O’Neill

Right. Okay. And then George can you just talk about the drop off in service charges? Given that earnings credit rates have come down obviously a fair amount and we had an extra day, I was a little surprised to see that number come down so much.

George Gleason

It was a little light for our comparisons. We expected that instead of being up from the comparable quarter year ago 1% and change. We had expected that to be up more in the 4% to 5%, 6% range. Those numbers tend to bounce around a bit.

I’m not going to read too much into one quarter’s results, but the fact that we were a little surprised by the run rate on that compared to the first quarter of ‘07, did lead me to slightly adjust our guidance from a mid single digits guidance to a low-to-mid single digits guidance because we were a little surprised by it.

Charlie Ernst – Sandler O’Neill

Right. So, there wasn’t any one particular component that you felt was more disappointing than the rest?

George Gleason

No.

Charlie Ernst – Sandler O’Neill

And then the other expense line was up a fair amount in the quarter. Can you add some color there?

George Gleason

Not really any more than I have added; there were lots of pieces of that. With our mortgage volume being up a little more than we had expected, most of our originators, they’re based on incentive comp, some of our incentives for some of our lenders were a little higher than we had expected because of growth in volume, and improvement in spread on new product that they where originating.

So there were things like that that contributed to our position, so it’s not any one big thing, it was a bunch of little things.

Charlie Ernst – Sandler O’Neill

Okay. And, then I’m guessing the tax rate is just going to float around inversely with what you’re doing with your mortgage backs?

George Gleason

Tax exempts.

Charlie Ernst – Sandler O’Neill

I am sorry, your munis.

George Gleason

Yes, exactly.

Charlie Ernst – Sandler O’Neill

Okay. Great. Thanks a lot.

Operator

Your next question comes from the line of Andrew Stapp - B. Riley & Company, Inc.

Andrew Stapp - B. Riley & Company, Inc

Good morning, nice quarter.

I missed the upper end of the guidance range you gave for net charge-offs. Could you repeat that please?

George Gleason

What we said was a mid-20s to low-30s basis points range for the full year of 2008. And that guidance takes into account the 38 bps in Q1.

Andrew Stapp - B. Riley & Company, Inc

Okay. And how much did construction development loans account for total loans at quarter end?

George Gleason

Construction and development accounted for 39.5% of total loans at the end of the first quarter.

Andrew Stapp - B. Riley & Company, Inc

Okay. And would you happen to have the average loan to value of construction development loans?

George Gleason

No. I don’t have that number. I would again tell you that the growth that we originated in that category in Q1 was principally volume-wise was in credits that had 35% to 45% cash equity or subordinated equity debt in them.

Andrew Stapp - B. Riley & Company, Inc

Okay. Do you happen to have how much of construction development loans were housing related?

George Gleason

Andy, I’m sorry, I don’t have that information.

Andrew Stapp - B. Riley & Company, Inc

Okay.

George Gleason

We have it; I just don’t have it with me.

Andrew Stapp - B. Riley & Company, Inc

All the other questions I had have been asked. So thank you.

Operator

Your next question comes from line of Chris Chouinard – Morgan Stanley.

Chris Chouinard – Morgan Stanley

I had a couple of quick questions on the securities portfolio. First on the tax exempt portfolio and I apologize if this was in the release somewhere, but I saw that the average balance in the quarter was $229 million, but it sounds like it was the growth was really back-end loaded. What was the balance of the tax exempt portfolio at March 31?

George Gleason

Chris, we will get you that number while we are on the call here.

Chris Chouinard – Morgan Stanley

Okay.

George Gleason

I’ve got the whole portfolio but I don’t have the breakdowns. Paul if you could get that. You are correct in your assumption that it was back-end loaded principally in the month of March.

Chris Chouinard – Morgan Stanley

Okay. And the second question was just, your yield on taxable securities also went up linked quarter despite the fall in short-term rates, did you go longer duration in the quarter or was there something that pushed up that yield, because that was up about 40 basis points linked?

George Gleason

Chris, there were a couple of things that shifted the composition of that and affected the yield of that a little bit. One was very early in the quarter and I don’t remember the exact numbers but we had $30 million or so of callable agency securities that were among our lower yielding securities in the taxable part of the portfolio called away.

Frankly I wasn’t disappointed to see those called away; we were glad to lose those. Actually if you’d asked me for guidance on the securities portfolio at the end of January and I had the liberty to address that subject with you I would have told you our securities portfolio was going to be down from the quarter because of those securities getting called away. Obviously that changed in late February and March as we bought a bunch of tax exempts.

The second thing that affected the yield on the taxable part of the portfolio, we do have a bunch of mortgage-backs in there. These are AAA-rated, A paper mortgage-backed securities guaranteed, issued by Fannie Mae and Freddie Mac, so they’re high quality mortgage-backs. But we own those with substantial discounts in them, and I say substantial discounts, I’ll give you the numbers.

At the end of the quarter, our discount on those securities was $8,857,000 versus premiums on a few of those securities of $160,000. So about a $8.7 million net discount on those securities and there was a little refi boom for a short period of time there in Q1 that increased refinance activity and resulted in a little bit of an accelerated rate in the recognition of the discount accretion on those securities. So that contributed a bit to yield on those.

The volume of total tax-exempt municipal obligations at the end of the quarter was $388.8 million.

Chris Chouinard – Morgan Stanley

Got it, got it. That’s helpful. And just last thing. Was there a drag at all from the increase in non-performers on net interest margin this quarter or was that not noticeable?

George Gleason

There was some drag on it, yes. Obviously, when you are I think pretty aggressive in putting loans on non-accrual status and when you do that you of course write-off previously accrued interest on them as well as ceasing to accrue interest going forward. So, yes, there was an element of drag from that.

Chris Chouinard – Morgan Stanley

Okay. Great, thank you.

Operator

Your next question comes from the line of David Bishop – Stifel Nicolaus.

David Bishop – Stifel Nicolaus

In terms of the loan loss provisioning for this quarter, maybe walk us through that. Is that more attributable to what you saw in terms of the new non-accrual inflow or is that just positioning for maybe what you’re seeing in overall macro deterioration?

George Gleason

The non-accrual loans and leases contributed to the amount of our provision really to the extent of the net charge-offs, that you saw.

As I’ve said in my prepared remarks we were very diligent in doing an impairment analysis on almost every non-accrual loan and lease at the end of the quarter and there were a few small ones that come late in the quarter that you don’t have time to do in your impairment analysis. And there are a handful − like less then 10 − consumer type loans that are in bankruptcy that the indications are that the bankruptcy plan will provide for full repayments.

So we didn’t do an impairment analysis on those. But probably 97%, 95%, 98% somewhere in that upper 90 percentage range of the loans that were on non-accrual status at the end of the quarter. We did a thorough impairment analysis in accordance with FASB 114 and those loans were written down to the estimated net recoverable value during the quarter.

So, as I said in my prepared remarks we expect little additional charge-offs to come from the loans that are non-accrual on March 31. But we obviously did have a higher level of charge offs in the quarter as a result of those and certainly we put enough in the reserve to cover the charge-offs plus about $1.5 million of reserve building in the quarter.

That reserve building is principally a result of two things. One is the fact that we had very favorable loan growth in the first quarter, so because of the loan growth we added a chunk to the allowance. And the modest additional over and above charge-offs and the addition to the allowance for growth is a reflection the macroeconomic conditions.

David Bishop – Stifel Nicolaus

Got you. And then, maybe there’s a lot of teeth gnashing about the Northwest Arkansas area there. Any update on what you’re seeing there in terms of the housing market?

George Gleason

That market continues to be challenging. It’s a strange thing in that as markets in Arkansas go that two county area probably still has the best job and population growth metrics of the entire state of Arkansas.

So you’ve got a very favorable economic environment that is obviously just seriously over-built. And we added a few more non-accrual assets in that market; in the quarter it was not a disproportionately large contributor to our non-performing assets but we added a few, we were fortunate at the same time to liquidate a few up there.

So it continues to be a challenge with the continued employment growth and population growth assuming that does continue and it seems plausible to believe it will, we’ll get to a point where that market will be at an equilibrium supply again. But it is proving to be a very challenging market and I think the correction up there is lasting longer than most of us expected it would.

David Bishop – Stifel Nicolaus

When you do move to liquidate the loans you have built upon there, what sort of discounts are you seeing there relative to what you’ve written down to, or are you realizing what the realizable value you put them on the balance sheet for?

George Gleason

We went through all of our non-performing assets up there in the first quarter and I actually took additional write-downs on them. But I think were actually about $110,000, $120,000 and that went through non-interest expense as amortization of other real estate.

We are entering the spring selling season; typically things in Arkansas sell well from about May through the summer and that’s your best selling season typically. And I told our guys that what I wanted to do is thoroughly evaluate every OREO asset we have up there based on the most recent market comps and I want to write it down and lower our asking price to an asking price that is designed to result in the sale of the property in the next six months; in the second and third quarter selling season.

So, when we did that, we were determined that we were probably higher than we needed to be on about half a dozen assets or 8 or so assets up there, single-family homes and lots typically, and we wrote those down accordingly.

So we think that the revaluation of those assets in Q1 gets us pretty much there on the assets in that market. Now, that assumes that the recent comps that they were using to establish sales price continue to hold up. We’ve seen quite a bit of retrenchment in pricing those assets up there over the last year.

I think the current market values ought to pretty much hold, but if they slip further then we’ll have to take another valuation adjustment on those assets to liquidate them. But we think at this point we’re pretty close to where we need to be, we’re certainly trying to be there.

And what we did is, took our expected sales price, discounted it 5% and then discounted that number further 7% for closing cost as part of the methodology we use. So I think closing cost and commission, I think we’ve been pretty reasonable in what we have done there.

David Bishop – Stifel Nicolaus

Ok, thanks for the color George.

Operator

Your next question comes from the line of Brian Martin - Howe Barnes Hoefer & Arnett Inc.

Brian Martin - Howe Barnes Hoefer & Arnett Inc.

Just a quick question, a couple here. The non-performings in the quarter, the increase, was there any concentration by category as far as whether they’re development loans or C&I commercial real estate?

George Gleason

No, there really was not. As I said in my prepared remarks it wasn’t a single market, it wasn’t a single customer. It was principally spread across that bottom-ish line of your more marginal credits at the bottom of your portfolio. And everybody’s portfolio has a bottom edge and a top edge and this was stuff that was knocked off the bottom edge of the portfolio, typically smaller credit.

If there was anything that you would parse out of that and say ‘well that was more prominent than the other’ and I address this again in my remarks, we had a number of small builder guys for whom we finance typically 1 to 5 homes that they just ran out of gas.

The pressure on house pricing has cut the margins for those guys and home sales were definitely slower in the fourth quarter and the first quarter, and that’s due to in part seasonal factors here. Fourth quarter and first quarter are typically slower times aggravated by macro economic conditions nationally, and bad press psychologically nationally for house sales.

And some of these guys facing lower profit margins on their house sales and a few contracts falling out on various deals and longer holding periods, the interest rate carry just ate up their liquidity and they reached a point that they couldn’t continue.

So we’ve seen a handful of those small builders blow up in the first quarter. But there were also consumer loans, car loans and various enterprises of various kinds and a variety of consumer loans. While I pick on the small, less well capitalized home builders in my remarks there, it was not solely in that category.

Brian Martin - Howe Barnes Hoefer & Arnett Inc.

Your loan exposure up in Northwest Arkansas, can you give how big that portfolio is up in those markets?

George Gleason

I can give that. I don’t have that handy.

Brian Martin - Howe Barnes Hoefer & Arnett Inc.

I can wait if you get it before the end of the call.

George Gleason

Paul, can you…?

Brian Martin - Howe Barnes Hoefer & Arnett Inc.

A lot of the growth you talk coming out of the Texas franchises, real estate group. Some of that being out of state lending. Can you give some color as far as what percentage of the loan book is out of state lending at this point?

George Gleason

Our Washington and Benton County offices, let’s say March, have total loans of about $147 million.

Brian Martin - Howe Barnes Hoefer & Arnett Inc.

Okay.

George Gleason

And I could be off $1 million or so; I am adding up the column and numbers in my head but about $147 million.

Brian Martin - Howe Barnes Hoefer & Arnett Inc.

Okay.

George Gleason

I’m not sure where necessarily you mean by out of state. I don’t know if you are calling Texas out of state.

Brian Martin - Howe Barnes Hoefer & Arnett Inc.

No, what I’m saying is the loans you are doing with the Texas borrowers that are working on projects in Nevada, in California, that type of...

George Gleason

Actually we don’t have any in Nevada. We’ve got the one in California that Barry mentioned that’s across the line from Nevada. So I don’t think we have any assets in Nevada. We have assets in other states for our builders in Texas, a lot of developers in Texas.

A lot of the guys that we do business with in Texas are performing at a regional or national level. And they develop projects regionally and nationally. Some of those guys are among the top 10 or so in their field. They are very good at what they do.

So we do have some assets in others states. We just looked at our loan concentration report and no other state accounted for a significant part of that.

But we do have some deals in South Carolina, part of that is because we do business in South Carolina out of our Charlotte office, it’s just north of the South Carolina state line. Part of that’s because a large shopping center developer that we do business with has a shopping center in South Carolina not to far from Charlotte.

So we have some business there; we’ve got some business in Louisiana because of the Texas developers that do business in Louisiana. We’re in other states, but there is not a concentration of that and it’s principally with people that we know and do business with.

Brian Martin - Howe Barnes Hoefer & Arnett Inc.

Okay. The nonperformings: can you give some color as far as the breakdown between Arkansas and Texas on those non-performings? Is it proportional?

George Gleason

Probably pretty close, yes, I would guess it is. I haven’t looked at that actually to break it down proportionally but I would say that it is probably pretty much proportional.

Our nonperformers in Texas consist of I think two or three residential construction loans for small builders and they were not originated by our real estate specialties group which handles our large credits. They were originated at the retail level by our Frisco, Texas banking office.

Not anything unusual there, and the same would be true for North Carolina, pretty much in proportion to our assets there.

Brian Martin - Howe Barnes Hoefer & Arnett Inc.

Okay. And just lastly, given the future growth, from your perspective in Texas. Can you just talk a little bit about how that market is currently versus maybe where it was a year ago, kind of economically and competitively as you look at it now? Has there been any significant change with the macro slowdown?

George Gleason

Yes. There has been. But the economy there continues to be very good. I was traveling the other day to a banking conference which I spoke at, as I was going through the airport I was watching the TV while I was waiting for the plane, and one of the reports on the news was that of the 10 fastest growing cities in the United States, four of them were in Texas. And I think Charlotte was one of the others.

So we feel like we’re in pretty good places. I was told the other day, I haven’t independently verified this number that, that 12 County Dallas/Fort Worth Metroplex created 88,000 net new jobs last year and that was up from 70 something thousand in 2006 and down from almost 100,000, 90,000-something thousand in 2005.

So the economy in Texas, at least in the metropolitan markets in which we’re doing most of our business, seems to be very favorable, and it’s top of the heap, certainly in that top echelon among economies nationally.

We are finding that for the larger commercial real estate credits that we do, that there’s been a significant fallout from a lot of guys that were very aggressive originators in recent years that have had problems and have thus exited the market, and of course a lot of the secondary market financing vehicles for things have totally gone away.

So we’re finding that the way we do business, the type of customers that we do business with, that there is less competition than there was and that has led to as I described earlier the normalization of price and credit terms, that we think is very favorable.

So we certainly realize that we’re in a challenging macroeconomic environment and a challenging portion of the credit cycle. But we’re seeing lots of opportunities that look very compelling and we think it’s time to deal with challenges on the one hand and try to capture good opportunities on the other.

Brian Martin - Howe Barnes Hoefer & Arnett Inc.

Thank you very much for the color.

Operator

Your next question comes from the line of Peyton Green - FTN Midwest Securities.

Peyton Green - FTN Midwest Securities

I was wondering if you could give a little bit of color just in terms of the pay-offs that you received in the quarter. Are you still seeing a fair amount of pay-off volume or are you starting to see more inventory type loans with respect to real estate deals, where maybe projects don’t get completely sold out?

George Gleason

Peyton we did see a good stream of pay-offs in the quarter, some of them we were glad to see and some of them we were not glad to see. We got paid off from two things I wish we hadn’t gotten paid off, but we had a good enough volume of new stuff in the pipeline that it mitigated that.

So I think your question is probably are we seeing lot sales and commercial projects or home sales get gummed up for lack of sales velocity that would be a problem, that would lead our balances and our loan portfolio to grow, but not the type of stuff you want. And the answer to that is other than a small number of the smaller home builders we are not seeing that.

The commercial stuff seems to be moving through the pipe very well and in a very orderly fashion. Of course particularly the larger stuff that I’m looking at day-to-day, typically got a lot of pre-leasing or pre-sales activity and very substantial borrowers behind that. So we’re not seeing any problem there.

The issue I would say is with the smaller home builders who just are having trouble adjusting their finances to a lower margin, slower sales velocity market. Our large home builders that we finance seem to be doing very well at that.

And I say large, we don’t finance the guys like Lennar and KB and Horton, the super big guys. But kind of the middle sized guys that we finance seem to be continuing to generate good sales velocity and good profit margins.

It’s the smaller guys that are not quite as well run and didn’t start off with as good a profit margin or marketing plans in the first place that seem to be adversely affected and you pretty much see the results of that in our Q1 non-performers.

Peyton Green - FTN Midwest Securities

Okay. And then with respect to balancing the challenges and the opportunities, how long do you think that the pendulum stays swung in your favor in terms of really clinically being able to look at new opportunities and take advantage of them while others are somewhat shell-shocked?

Do you think it will last throughout this year or from your historical perspective, what do you think is most appropriate to view it?

George Gleason

Peyton I have been doing this job 29 years, and I’m not sure that 29 years of historical perspective qualifies me to answer that question there. We’re certainly in unusual market conditions and we are in unusual market conditions following a period of very unusual market conditions.

We got to a point and you heard me complain about this in road shows and investor meetings for several years where it just seemed like so many of our competitors were ignoring interest rate risk and ignoring credit risk and just getting so high progressive and working for such thin margins that in many cases it made no sense to us.

It cost us a lot of volume and while we tried to be somewhat aggressive with them, there were always people out there that were a lot more aggressive than we were both on pricing and credit terms. I think that was an unusual environment and I hope we don’t ever return to that as a norm in the future.

The pendulum as I had suggested in my earlier remarks has probably swung past normal to conservative underwriting standards. We’re looking at a deal now, an opportunity for a customer that the customer approached us and is proposing what would be about a 60% cash equity with about a 40% loan in the transaction.

That’s not something that you would see in normal times and deals with 45%, 50%, 60% cash equity, those are not deals that would normally happen. So we swung in a lot of transactions to the other extreme and I think that’s a great opportunity to really book some high quality business.

Whether we are in that sort of environment in another quarter or another year is going to depend on macroeconomic conditions and you’re in a better position to gauge that than I am.

Peyton Green - FTN Midwest Securities

Okay. And then with respect to the loan to earning asset mix, historically on an end of period basis you use to run at a 70% level very consistently and it got up to about 76% in the fourth quarter and back down to around 71% at the end of the first quarter of 2008.

Do you think with bond yields or the spread that’s back and bond yields do you stay closer to what you’ve done historically or do you think it was just a very short-term opportunity to take advantage of the market’s disruption?

George Gleason

Peyton that’s asking Charlie Ernst’s question in another way, and the answer is I just don’t know. A lot of that will depend on how many of these municipal securities get called and refinanced and what else we find in the way of opportunities and I just don’t know. I can’t give you any guidance that’s going to help you.

You’re just going to have to take the same middle of the road guess on that that Paul Moore has taken here when he updates my plan and projection month to month. He’s asking the same question. I said Paul ‘I wish I knew the answer.’

I can pretty much tell you what it’s going to look like next week, but three months out is a little harder. So we’ll just see what the market gives us. If the market gives us great opportunities that are just slam dunks, we’re going to try to take them and if not you’ll see that portfolio drift back down.

Peyton Green - FTN Midwest Securities

Okay. And then last question. Do you think there are going to be any more M&A opportunities? I know you have very tight criteria on how you look at deals but do you think the environment is moving more that way where an M&A opportunity might be more of a possibility then it has been?

George Gleason

Certainly there’re going to be banks and are banks out there that are experiencing a lot of discomfort and stress; they would probably love for somebody else to deal with all that discomfort and stress for them.

There’re going to be some more motivated sellers than there have been at the past and there may even be some sales bank opportunities that might provide chance to pick up some deposit basis or something. So, yes, I think there are more opportunities.

The countervailing factor there and you know this, is with bank stock multiples down as a multiple of book or a multiple of earnings from where they have been, that your small non-public companies who are, might be, want to be sellers, there are lot of those potentially in Arkansas, because it’s still a very fragmented banking market.

Those guys probably have not adjusted their expectations about sales multiples as much as the market has adjusted the trading multiples of publicly-traded companies.

So, apart from the highly motivated sellers who are feeling a lot of stress and are ready to get out of it and seek some safe haven, there may be more disconnect than there’s even been in the past between sellers’ expectation to value and buyers’ ability to deliver that expectation.

So, I don’t know that we’re entering into a fundamentally favorable M&A environment. My guess is it’s limited to transactions that are under some level of distress and duress. I was reading something while I was traveling the other day and I think it was in American Banker that said that 8 or 9 acquisition deals that already unraveled so far this year and it may be a tough market in which to do a lot of M&A.

Peyton Green - FTN Midwest Securities

Okay, good enough. Thank you.

Operator

You have a follow-up from the line of David Bishop – Stifel Nicolaus.

David Bishop – Stifel Nicolaus

Loans that are 30 to 89 days past due, I don’t know if you could provide that number at this standpoint.

George Gleason

Loans 30 to 89 days pass due?

David Bishop – Stifel Nicolaus

Yes.

George Gleason

No, I don’t have that. The number I can give you is loans 30 or more days past due. It was 130 basis points at the end of the quarter and that includes non-performing loans that are past due. And, not all my non-performers are past due.

We put some loans on non-performing status even though they’re technically current. But most of the non-performers are past due. So, if you take that 130 basis point total past due ratio and subtract out the non-performers that would give you some information. It would not necessarily be a particularly a proxy for loans less than 90 days past due because some of the non-performers were less than 90 days past due.

We put a loan on non-accrual status. I’ll tell you this, as soon as we believe there’s a serious doubt as to the collectability of interest. And so a lot of times they’re on non-accrual status before they ever hit the 30 day list and nothing over 90 days is on accrual status. If it’s over 90 days by policy, and our system’s hard wired, it puts it on non-accrual even if we don’t hit 90 days, past day.

Operator

Your next question comes from the line of Barry McCarver – Stephens Inc.

Barry McCarver – Stephens Inc

Hi George, just a couple of quick follow-ups. Number one, in the fourth quarter you had an issue with a particular lender who I believes is no longer with the bank. Are any of the nonperformers or charge-offs in 1Q related to that issue? I’m just trying to get sense of where we’re at there?

George Gleason

Yes. We said in the fourth quarter conference call, in addition to the charges we took in Q4, that we had reserved an extra $265,000 for potential charge-offs on that portfolio that we had estimated, but had really not had a chance to do a thorough evaluation or impairment analysis on those assets.

And we of course did all that in Q1 and I don’t have the exact numbers but when we finally got through doing the impairment analysis and evaluations on the credits, we had not had time to thoroughly evaluate that $265,000 loss number was low, $400,000.

Paul Moore

Yes.

George Gleason

And Paul is telling me that our total charge-offs from that portfolio in Q1 were north of $400,000 somewhat. So we missed that by $150,000 or so on that. All that has been addressed, so his portfolio was, again, a fairly significant contribution to the Q1 charge-offs.

And we’ve been through everything there; filed our bond claim with our bonding company on that and are waiting to hear back from those guys. They’ve had it several weeks now. I think that will be a protracted process working through that with those guys.

But that issue is, I think, behind us in the extent that everything’s been evaluated and all the charge-off have been taken as of Q1, everything that I think is going to be a nonperformer there is in nonperforming, and we actually started selling and sold several of the assets from that in the first quarter.

But as I said in the December conference call we think it will take us about three quarters probably to totally liquidate the various problems from his portfolio. Quite a few of those now we’ve started the foreclosure process and they’re working through the normal legal hoops that those things work through, it takes a quarter or two.

Barry McCarver – Stephens Inc

So, I just want to make sure I understand, any of the increase in nonperformers over 4Q, was any of that related to the guy?

George Gleason

Probably to the extent that there was an increase in nonperformers from the portfolio, it was more than offset by the charge-offs. So actually if you’re looking at Q4 non-performers and March 31 non-performers related to his portfolio, they’re probably actually down and I didn’t actually run that number.

But our charge-offs probably exceeded any smaller additional things that we found that we added to the non-performers. And then we did sell several of the properties there that also started whittling away.

So I would, I’m pretty confident in saying that the level of non-performers related to his portfolio were probably down slightly from December 31 to March 31 as I think through that.

Barry McCarver – Stephens Inc

Okay. And then just lastly in terms of the loan loss provision, I know you touched on this quite a bit already, but if we’re assuming a little bit higher production levels in loans for 2008 versus the last several quarters, and I’m certainly not suggesting the level that we saw in 1Q necessarily, but the NPAs are going to be little bit elevated and a little bit higher loan production, is it safe to assume that you may push that reserve ratio little bit higher?

George Gleason

That is really all going to depend on what our formulas dictate internally. And our reserve at the end of March included our formula calculations plus unallocated percentage of 22% and change. And we typically reevaluate the various factors that would justify the unallocated percentage quarterly.

Our most recent determinations in that regard is that based on softer macroeconomic factors and concentrations of credit and all other factors that we looked at in that we think an unallocated percentage of 15% to 25% is appropriate. So we are in the upper half of that range and what that actually is a little higher unallocated than we’ve had in the last several quarters and that’s a reflection of slightly softer, or moderately softer macroeconomic environment nationally.

Barry McCarver – Stephens Inc

Okay. Thanks a lot George.

Operator

There are no further questions at this time.

George Gleason

There being no further questions, let me thank you all for joining our call today and tell you we very much look forward to talking with you again in July. Thanks for tuning in. Bye-bye.

Operator

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

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