Form 10-Q
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


FORM 10-Q

 


(Mark one)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2007

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             .

Commission File Number 0-22759

 


BANK OF THE OZARKS, INC.

(Exact name of registrant as specified in its charter)

 


 

ARKANSAS   71-0556208

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

 

12615 CHENAL PARKWAY, LITTLE ROCK, ARKANSAS   72211
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code: (501) 978-2265

 


Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Check one:

Large accelerated filer  ¨    Accelerated filer  x    Non-accelerated filer  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes   ¨    No   x

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practical date.

 

Class

 

Outstanding at June 30, 2007

Common Stock, $0.01 par value per share   16,770,940

 



Table of Contents

BANK OF THE OZARKS, INC.

FORM 10-Q

June 30, 2007

INDEX

 

     Page

PART I. Financial Information

  

Item 1.

   Financial Statements   
   Consolidated Balance Sheets as of June 30, 2007 and 2006 and December 31, 2006    1
  

Consolidated Statements of Income for the Three Months Ended June 30, 2007 and 2006 and the Six Months Ended June 30, 2007 and 2006

   2
   Consolidated Statements of Stockholders’ Equity for the Six Months Ended June 30, 2007 and 2006    3
   Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2007 and 2006    4
   Notes to Consolidated Financial Statements    5

Item 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    9
   Selected and Supplemental Financial Data    21

Item 3.

   Quantitative and Qualitative Disclosures About Market Risk    23

Item 4.

   Controls and Procedures    25

PART II. Other Information

  

Item 1.

   Legal Proceedings    26

Item 1A.

   Risk Factors    26

Item 2.

   Unregistered Sales of Equity Securities and Use of Proceeds    26

Item 3.

   Defaults Upon Senior Securities    26

Item 4.

   Submission of Matters to a Vote of Security Holders    26

Item 5.

   Other Information    26

Item 6.

   Exhibits    26

Signature

      27

Exhibit Index

   28


Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

BANK OF THE OZARKS, INC.

CONSOLIDATED BALANCE SHEETS

 

     Unaudited June 30,     December 31,
2006
 
     2007     2006    
     (Dollars in thousands, except per share amounts)  

ASSETS

      

Cash and due from banks

   $ 42,601     $ 41,283     $ 42,531  

Interest earning deposits

     356       212       203  
                        

Cash and cash equivalents

     42,957       41,495       42,734  

Investment securities – available for sale (“AFS”)

     575,433       655,631       620,132  

Loans and leases

     1,756,383       1,553,893       1,677,389  

Allowance for loan and lease losses

     (18,747 )     (17,332 )     (17,699 )
                        

Net loans and leases

     1,737,636       1,536,561       1,659,690  

Premises and equipment, net

     125,608       97,962       116,679  

Foreclosed assets held for sale, net

     2,685       391       407  

Accrued interest receivable

     17,367       16,053       17,384  

Bank owned life insurance

     45,172       43,294       44,229  

Intangible assets, net

     6,008       6,271       6,140  

Other, net

     27,679       22,939       22,005  
                        

Total assets

   $ 2,580,545     $ 2,420,597     $ 2,529,400  
                        

LIABILITIES AND STOCKHOLDERS’ EQUITY

      

Deposits:

      

Demand non-interest bearing

   $ 203,046     $ 157,301     $ 167,841  

Savings and interest bearing transaction

     532,355       537,242       519,427  

Time

     1,420,242       1,124,085       1,357,824  
                        

Total deposits

     2,155,643       1,818,628       2,045,092  

Repurchase agreements with customers

     45,063       55,230       41,001  

Other borrowings

     120,807       342,027       194,661  

Subordinated debentures

     64,950       44,331       64,950  

Accrued interest payable and other liabilities

     16,001       10,771       9,063  
                        

Total liabilities

     2,402,464       2,270,987       2,354,767  
                        

Commitments and contingencies

      

Stockholders’ equity:

      

Preferred stock; $0.01 par value; 1,000,000 shares authorized; no shares issued and outstanding

     —         —         —    

Common stock; $0.01 par value; 50,000,000 shares authorized; 16,770,940, 16,717,540 and 16,746,540 shares issued and outstanding at June 30, 2007, June 30, 2006 and December 31, 2006, respectively

     168       167       167  

Additional paid-in capital

     37,697       35,686       36,779  

Retained earnings

     154,863       130,589       142,609  

Accumulated other comprehensive income (loss)

     (14,647 )     (16,832 )     (4,922 )
                        

Total stockholders’ equity

     178,081       149,610       174,633  
                        

Total liabilities and stockholders’ equity

   $ 2,580,545     $ 2,420,597     $ 2,529,400  
                        

See accompanying notes to consolidated financial statements.

 

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Table of Contents

BANK OF THE OZARKS, INC.

CONSOLIDATED STATEMENTS OF INCOME

Unaudited

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2007     2006     2007     2006  
     (Dollars in thousands, except per share amounts)  

Interest income:

        

Loans and leases

   $ 36,347     $ 29,410     $ 71,027     $ 55,578  

Investment securities:

        

Taxable

     6,245       6,382       12,840       11,518  

Tax-exempt

     1,532       2,060       3,078       4,537  

Deposits with banks and federal funds sold

     4       2       11       3  
                                

Total interest income

     44,128       37,854       86,956       71,636  
                                

Interest expense:

        

Deposits

     22,224       15,040       43,049       26,912  

Repurchase agreements with customers

     437       306       898       544  

Other borrowings

     917       3,664       2,959       7,099  

Subordinated debentures

     1,259       859       2,510       1,658  
                                

Total interest expense

     24,837       19,869       49,416       36,213  
                                

Net interest income

     19,291       17,985       37,540       35,423  

Provision for loan and lease losses

     (1,250 )     (500 )     (2,350 )     (1,000 )
                                

Net interest income after provision for loan and lease losses

     18,041       17,485       35,190       34,423  
                                

Non-interest income:

        

Service charges on deposit accounts

     3,107       2,587       5,942       4,909  

Mortgage lending income

     817       779       1,548       1,382  

Trust income

     531       478       996       911  

Bank owned life insurance income

     478       455       943       898  

Gains on sales of investment securities

     —         27       337       1,858  

Other

     690       628       1,816       1,160  
                                

Total non-interest income

     5,623       4,954       11,582       11,118  
                                

Non-interest expense:

        

Salaries and employee benefits

     7,016       6,569       14,327       13,153  

Net occupancy and equipment

     1,967       1,738       3,938       3,398  

Other operating expenses

     2,893       2,710       5,749       5,526  
                                

Total non-interest expense

     11,876       11,017       24,014       22,177  
                                

Income before taxes

     11,788       11,422       22,758       23,364  

Provision for income taxes

     3,702       3,491       7,151       7,036  
                                

Net income

   $ 8,086     $ 7,931     $ 15,607     $ 16,328  
                                

Basic earnings per share

   $ 0.48     $ 0.47     $ 0.93     $ 0.98  
                                

Diluted earnings per share

   $ 0.48     $ 0.47     $ 0.93     $ 0.97  
                                

Dividends declared per share

   $ 0.10     $ 0.10     $ 0.20     $ 0.20  
                                

See accompanying notes to consolidated financial statements.

 

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Table of Contents

BANK OF THE OZARKS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

Unaudited

 

     Common
Stock
   Additional
Paid-In
Capital
   Retained
Earnings
    Accumulated
Other
Comprehensive
Income (Loss)
    Total  
     (Dollars in thousands)  

Balances – January 1, 2006

   $ 167    $ 34,210    $ 117,600     $ (2,574 )   $ 149,403  

Comprehensive income:

            

Net income

     —        —        16,328       —         16,328  

Other comprehensive income (loss):

            

Unrealized gains and losses on AFS investment securities, net of $8,474 tax effect

     —        —        —         (13,129 )     (13,129 )

Reclassification adjustment for gains and losses included in net income, net of $729 tax effect

     —        —        —         (1,129 )     (1,129 )
                  

Total comprehensive income

               2,070  
                  

Cash dividends paid

     —        —        (3,339 )     —         (3,339 )

Issuance of 52,900 shares of common stock for exercise of stock options

     —        408      —         —         408  

Tax benefit on exercise of stock options

     —        581      —         —         581  

Compensation expense under stock-based compensation plans

     —        487      —         —         487  
                                      

Balances – June 30, 2006

   $ 167    $ 35,686    $ 130,589     $ (16,832 )   $ 149,610  
                                      

Balances – January 1, 2007

   $ 167    $ 36,779    $ 142,609     $ (4,922 )   $ 174,633  

Comprehensive income:

            

Net income

     —        —        15,607       —         15,607  

Other comprehensive income (loss):

            

Unrealized gains and losses on AFS investment securities, net of $6,145 tax effect

     —        —        —         (9,520 )     (9,520 )

Reclassification adjustment for gains and losses included in net income, net of $132 tax effect

     —        —        —         (205 )     (205 )
                  

Total comprehensive income

               5,882  
                  

Cash dividends paid

     —        —        (3,353 )     —         (3,353 )

Issuance of 24,400 shares of common stock for exercise of stock options

     1      179      —         —         180  

Tax benefit on exercise of stock options

     —        224      —         —         224  

Compensation expense under stock-based compensation plans

     —        515      —         —         515  
                                      

Balances – June 30, 2007

   $ 168    $ 37,697    $ 154,863     $ (14,647 )   $ 178,081  
                                      

See accompanying notes to consolidated financial statements.

 

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Table of Contents

BANK OF THE OZARKS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

Unaudited

 

     Six Months Ended
June 30,
 
     2007     2006  
     (Dollars in thousands)  

Cash flows from operating activities:

    

Net income

   $ 15,607     $ 16,328  

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation

     1,615       1,469  

Amortization

     131       132  

Provision for loan and lease losses

     2,350       1,000  

Provision for losses on foreclosed assets

     36       33  

Net accretion of investment securities

     (517 )     (495 )

Gains on sales of investment securities

     (337 )     (1,858 )

Originations of mortgage loans held for sale

     (90,806 )     (81,811 )

Proceeds from sales of mortgage loans for sale

     91,602       78,629  

Losses (gains) on dispositions of premises and equipment and other assets

     12       (13 )

Deferred income tax benefit

     (155 )     (166 )

Increase in cash surrender value of bank owned life insurance

     (943 )     (898 )

Tax benefit on exercise of stock options

     (224 )     (581 )

Compensation expense under stock-based compensation plans

     515       487  

Changes in assets and liabilities:

    

Accrued interest receivable

     16       (2,251 )

Other assets, net

     (631 )     966  

Accrued interest payable and other liabilities

     2,976       (724 )
                

Net cash provided by operating activities

     21,247       10,247  
                

Cash flows from investing activities:

    

Proceeds from sales of investment securities AFS

     34,539       80,600  

Proceeds from maturities of investment securities AFS

     13,795       27,079  

Purchases of investment securities AFS

     (14,326 )     (206,899 )

Net increase in loans and leases

     (86,047 )     (181,464 )

Purchases of premises and equipment

     (10,909 )     (10,465 )

Proceeds from dispositions of premises and equipment and other assets

     3,113       747  

Cash received from (paid for) interests in unconsolidated investments

     1,001       (292 )
                

Net cash used by investing activities

     (58,834 )     (290,694 )
                

Cash flows from financing activities:

    

Net increase in deposits

     110,550       226,985  

Net (repayments of) proceeds from other borrowings

     (73,854 )     37,162  

Net increase in repurchase agreements with customers

     4,063       19,559  

Proceeds from exercise of stock options

     180       408  

Tax benefit on exercise of stock options

     224       581  

Cash dividends paid

     (3,353 )     (3,339 )
                

Net cash provided by financing activities

     37,810       281,356  
                

Net increase in cash and cash equivalents

     223       909  

Cash and cash equivalents – beginning of period

     42,734       40,586  
                

Cash and cash equivalents – end of period

   $ 42,957     $ 41,495  
                

See accompanying notes to consolidated financial statements.

 

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BANK OF THE OZARKS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Unaudited

 

1. Organization and Principles of Consolidation

Bank of the Ozarks, Inc. (the “Company”) is a bank holding company headquartered in Little Rock, Arkansas, which operates under the rules and regulations of the Board of Governors of the Federal Reserve System. The Company owns a wholly-owned state chartered bank subsidiary - Bank of the Ozarks (the “Bank”) and four 100%-owned finance subsidiary business trusts - Ozark Capital Statutory Trust II (“Ozark II”), Ozark Capital Statutory Trust III (“Ozark III”), Ozark Capital Statutory Trust IV (“Ozark IV”) and Ozark Capital Statutory Trust V (“Ozark V”) (collectively, the “Trusts”). The consolidated financial statements include the accounts of the Company and the Bank. Significant intercompany transactions and amounts have been eliminated in consolidation.

 

2. Basis of Presentation

The accompanying consolidated financial statements have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) in Article 10 of Regulation S-X and in accordance with the instructions to Form 10-Q and accounting principles generally accepted in the United States (“GAAP”) for interim financial information. Certain information, accounting policies and footnote disclosures normally included in complete financial statements prepared in accordance with GAAP have been condensed or omitted in accordance with such rules and regulations. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2006.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. In the opinion of management all adjustments considered necessary, consisting of normal recurring items, have been included for a fair presentation of the accompanying consolidated financial statements. Operating results for the three and six months ended June 30, 2007 are not necessarily indicative of the results that may be expected for the full year or future periods.

Certain reclassifications of prior period amounts have been made to conform with the current period presentation. These reclassifications had no impact on previously reported net income.

 

3. Earnings Per Share (“EPS”)

Basic EPS is computed by dividing reported earnings available to common shareholders by the weighted-average number of shares outstanding. Diluted EPS is computed by dividing reported earnings available to common shareholders by the weighted-average number of shares outstanding after consideration of the dilutive effect of the Company’s outstanding stock options. Options to purchase 238,650 shares of the Company’s common stock were not included in the diluted EPS calculation for both the three-month and six-month periods ended June 30, 2007, and options to purchase 125,700 shares and 113,700 shares, respectively, of the Company’s common stock were not included in the diluted EPS calculation for the three-month and six-month periods ended June 30, 2006 because inclusion would have been antidilutive.

Basic and diluted EPS are computed as follows:

 

     Three Months Ended
June 30,
   Six Months Ended
June 30,
     2007    2006    2007    2006
     (In thousands, except per share amounts)

Common shares – weighted-average (basic)

     16,769      16,716      16,764      16,705

Common share equivalents – weighted-average

     65      92      66      97
                           

Common shares – diluted

     16,834      16,808      16,830      16,802
                           

Net income

   $ 8,086    $ 7,931    $ 15,607    $ 16,328

Basic EPS

   $ 0.48    $ 0.47    $ 0.93    $ 0.98

Diluted EPS

     0.48      0.47      0.93      0.97

 

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4. Federal Home Loan Bank of Dallas (“FHLB”) Advances

FHLB advances with original maturities exceeding one year totaled $61.1 million at June 30, 2007. Interest rates on these advances ranged from 4.54% to 6.43% at June 30, 2007 with a weighted-average rate of 6.24%. FHLB advances of $60.0 million maturing in 2010 may be called quarterly. At June 30, 2007 aggregate annual maturities (dollars in thousands) and weighted-average interest rates of FHLB advances with an original maturity of over one year were as follows:

 

Maturity

   Amount    Weighted-Average
Interest Rate
 

2007

   $ 15    4.81 %

2008

     229    6.10  

2009

     33    4.81  

2010

     60,034    6.27  

2011

     31    4.80  

2012

     21    4.64  

Thereafter

     724    4.54  
         
   $ 61,087    6.24  
         

 

5. Subordinated Debentures

On September 25, 2003 Ozark III sold to investors in a private placement offering $14 million of adjustable rate trust preferred securities, and on September 29, 2003, Ozark II sold to investors in a private placement offering $14 million of adjustable rate trust preferred securities (collectively, “2003 Securities”). The 2003 Securities bear interest, adjustable quarterly, at 90-day LIBOR plus 2.95% for Ozark III and 90-day LIBOR plus 2.90% for Ozark II. The aggregate proceeds of $28 million from the 2003 Securities were used to purchase an equal principal amount of adjustable rate subordinated debentures of the Company that bear interest, adjustable quarterly, at 90-day LIBOR plus 2.95% for Ozark III and 90-day LIBOR plus 2.90% for Ozark II (“2003 Debentures”). The weighted-average interest rate on the 2003 Securities and the 2003 Debentures was 8.28% at June 30, 2007.

On September 28, 2004 Ozark IV sold to investors in a private placement offering $15 million of adjustable rate trust preferred securities (“2004 Securities”). The 2004 Securities bear interest, adjustable quarterly, at 90-day LIBOR plus 2.22%. The $15 million proceeds from the 2004 Securities were used to purchase an equal principal amount of adjustable rate subordinated debentures of the Company that bear interest, adjustable quarterly, at 90-day LIBOR plus 2.22% (“2004 Debentures”). The interest rate on the 2004 Securities and the 2004 Debentures was 7.58% at June 30, 2007.

On September 29, 2006 Ozark V sold to investors in a private placement offering $20 million of adjustable rate trust preferred securities (“2006 Securities”). The 2006 Securities bear interest, adjustable quarterly, at 90-day LIBOR plus 1.60%. The $20 million proceeds from the 2006 Securities were used to purchase an equal principal amount of adjustable rate subordinated debentures of the Company that bear interest, adjustable quarterly, at 90-day LIBOR plus 1.60% (“2006 Debentures”). The interest rate on the 2006 Securities and the 2006 Debentures was 6.96% at June 30, 2007.

In addition to the issuance of these adjustable rate securities, Ozark II and Ozark III collectively sold $0.9 million of trust common equity, Ozark IV sold $0.4 million of trust common equity and Ozark V sold $0.6 million of trust common equity to the Company. The proceeds from the sales of the trust common equity were used, respectively, to purchase $0.9 million of 2003 Debentures, $0.4 million of 2004 Debentures and $0.6 million of 2006 Debentures issued by the Company.

At June 30, 2007 the Company had $64.9 million of subordinated debentures outstanding and had an asset of $1.9 million representing its investment in the common equity issued by the Trusts. The sole assets of the Trusts are the adjustable rate debentures and the liabilities of the Trusts are the 2003 Securities, the 2004 Securities and the 2006 Securities. At June 30, 2007 the Trusts did not have any restricted net assets. The Company has, through various contractual arrangements, unconditionally guaranteed payment of all obligations of the Trusts with respect to the 2003 Securities, 2004 Securities and 2006 Securities. Additionally, there are no restrictions on the ability of the Trusts to transfer funds to the Company in the form of cash dividends, loans or advances.

The 2003 Securities and 2003 Debentures mature in September 2033 and the 2004 Securities and 2004 Debentures mature in September 2034 (the thirtieth anniversary date of each issuance). The 2006 Securities and 2006 Debentures mature December 15, 2036. All of the trust preferred securities and related debentures may be prepaid at par, subject to regulatory approval, prior to maturity at any time on or after September 25 and 29, 2008 for the two issues of 2003 Securities and 2003 Debentures, on or after September 28, 2009 for the 2004 Securities and 2004 Debentures and on or after December 15, 2011 for the 2006 Securities and 2006 Debentures, or at an earlier date upon certain changes in tax laws, investment company laws or regulatory capital requirements.

 

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6. Supplementary Data for Cash Flows

Cash payments for interest by the Company during the six months ended June 30, 2007 and 2006 amounted to $48.1 million and $35.8 million, respectively. Cash payments for income taxes during the six months ended June 30, 2007 and 2006 were $7.6 million and $8.3 million, respectively. At June 30, 2007 and 2006, the Company had accrued $4.5 million and $3.4 million, respectively, of unsettled investment security purchases.

 

7. Guarantees and Commitments

Outstanding standby letters of credit are contingent commitments issued by the Company generally to guarantee the performance of a customer in third party arrangements. The maximum amount of future payments the Company could be required to make under these guarantees at June 30, 2007 was $7.5 million. The Company holds collateral to support guarantees when deemed necessary. Collateralized commitments at June 30, 2007 totaled $5.2 million.

At June 30, 2007 the Company had outstanding commitments to extend credit of $352 million. These commitments extend over varying periods of time with the majority to be disbursed or to expire within a one-year period.

 

8. Stock-Based Compensation

The Company has a nonqualified stock option plan for certain key employees and officers of the Company. This plan provides for the granting of incentive nonqualified options to purchase shares of common stock in the Company. No option may be granted under this plan for less than the fair market value of the common stock, defined by the plan as the average of the highest reported asked price and the lowest reported bid price, on the date of the grant. While the vesting period and the termination date for the employee plan options are determined when options are granted, all such employee options outstanding at June 30, 2007 were issued with a vesting period of three years and expire seven years after issuance. The Company also has a nonqualified stock option plan for non-employee directors. This plan permits each director who is not otherwise an employee of the Company, or any subsidiary, to receive options to purchase 1,000 shares of the Company’s common stock on the day following his or her election as a director of the Company at each annual meeting of stockholders and up to 1,000 shares upon election or appointment for the first time as a director of the Company. These options are exercisable immediately and expire ten years after issuance. All shares issued in connection with options exercised under both the employee and non-employee director stock option plans are in the form of newly issued shares.

The following table summarizes stock option activity for the six months ended June 30, 2007:

 

     Options    

Weighted-Average

Exercise

Price/Share

   Weighted-Average
Remaining
Contractual Life
(in years)
  

Aggregate
Intrinsic

Value

(in thousands)(1)

Outstanding – January 1, 2007

   489,550     $ 23.43      

Granted

   12,000       30.36      

Exercised

   (24,400 )     7.32      

Forfeited

   (8,700 )     22.57      
              

Outstanding – June 30, 2007

   468,450     $ 24.46    4.6    $ 2,945
                        

Exercisable – June 30, 2007

   214,200     $ 14.82    3.6    $ 2,945
                        

(1) Based on closing price of $27.87 per share on June 29, 2007.

Intrinsic value for stock options is defined as the amount by which the current market price of the underlying stock exceeds the exercise price. For those stock options where the exercise price exceeds the current market price of the underlying stock, the intrinsic value is zero. The total intrinsic value of options exercised during the six months ended June 30, 2007 and 2006 was $0.6 million and $1.5 million, respectively.

Options to purchase 12,000 shares of the Company’s common stock were granted during both six-month periods ended June 30, 2007 and 2006. The weighted-average fair value of those stock option grants was $8.18 and $10.01, respectively, for the six months ended June 30, 2007 and 2006.

 

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The weighted-average assumptions used in the Black-Scholes option pricing model for the six months ended June 30, 2007 and 2006 were as follows:

 

     2007     2006  

Risk-free interest rate

   4.56 %   4.89 %

Expected dividend yield

   1.32 %   1.17 %

Expected stock volatility

   22.5 %   27.1 %

Expected life (years)

   5.0     5.0  

The Company uses the U.S. Treasury yield curve in effect at the time of the grant to determine the risk-free interest rate. The expected dividend yield is estimated using the current annual dividend level and recent price of the Company’s common stock at the date of grant. Expected stock volatility is based on historical volatilities of the Company’s common stock, and expected life of the options represents management’s estimate of the period of time the options are expected to be outstanding.

The total fair value of options to purchase shares of the Company’s common stock that vested during the six months ended June 30, 2007 and 2006 was $98,000 and $120,000, respectively.

Stock-based compensation expense for stock options included in non-interest expense was $0.3 million for each of the quarters ended June 30, 2007 and 2006 and $0.5 million for each of the six-month periods ended June 30, 2007 and 2006. Total unrecognized compensation cost related to nonvested stock-based compensation was $1.1 million at June 30, 2007 and is expected to be recognized over a weighted-average period of 1.8 years.

 

9. Comprehensive Income

Unrealized gains and losses on investment securities available for sale, net of income taxes, are the only items included in accumulated other comprehensive income (loss). Total comprehensive income (which consists of net income and unrealized gains and losses on investment securities available for sale, net of income taxes) was $(3.0) million and $(2.0) million, respectively, for the three months ended June 30, 2007 and 2006 and $5.9 million and $2.1 million, respectively, for the six months ended June 30, 2007 and 2006.

 

10. Income Taxes

The Company adopted the provisions of Financial Accounting Standards Board (“FASB”) Interpretation No. 48 (“FIN 48”) “Accounting for Uncertainty in Income Taxes,” on January 1, 2007. The adoption of FIN 48 resulted in no adjustment to opening retained earnings. The Company has no unrecognized tax benefits and does not anticipate any increase in unrecognized benefits during 2007 relative to any tax positions taken prior to January 1, 2007. Should the Company determine that any penalty and interest be accrued as a result of current or future tax positions taken on its returns, such penalties and interest will be accrued in its financial statements as other non-interest expense and as interest expense during the period in which such determination is made.

The Company and the Bank file consolidated federal and state income tax returns. These returns are subject to examination by taxing authorities for all years after 2002.

 

11. Recent Accounting Pronouncements

In February 2007 the FASB issued Statement of Financial Accounting Standard (“SFAS”) No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value with an objective of improving financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. The provisions of SFAS No. 159 are effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. Management is currently evaluating the impact, if any, that adoption of SFAS No. 159 will have on the Company’s financial position, results of operations and liquidity.

In September 2006 the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements, with the intent of increasing consistency and comparability in fair value measures and providing financial users with better information about the extent to which fair value is used and the effect of fair value measures on earnings for the periods reported. The provisions of SFAS No. 157 are effective for fiscal years beginning after November 15, 2007. Management is currently evaluating the impact, if any, that adoption of SFAS No. 157 will have on the Company’s financial position, results of operations and liquidity.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

GENERAL

Net income for Bank of the Ozarks, Inc. (the “Company”) was $8.1 million for the second quarter of 2007, a 2.0% increase from net income of $7.9 million for the comparable quarter in 2006. Diluted earnings per share were $0.48 for the quarter ended June 30, 2007, a 2.1% increase from $0.47 for the quarter ended June 30, 2006. For the six months ended June 30, 2007, net income totaled $15.6 million, a 4.4% decrease from net income of $16.3 million for the first six months of 2006. Diluted earnings per share for the first six months of 2007 were $0.93 compared to $0.97 for the comparable period in 2006, a 4.1% decrease.

The Company’s annualized return on average assets was 1.27% for the second quarter of 2007 compared to 1.37% for the second quarter of 2006. Its annualized return on average stockholders’ equity was 17.8% for the second quarter of 2007 compared to 21.1% for the comparable quarter of 2006. The Company’s annualized return on average assets was 1.23% for the first six months of 2007 compared to 1.46% for the first six months of 2006. Its annualized return on average stockholders’ equity was 17.5% for the first six months of 2007 compared to 21.7% for the comparable period of 2006.

Total assets increased to $2.58 billion at June 30, 2007 from $2.53 billion at December 31, 2006. Loans and leases were $1.76 billion at June 30, 2007 compared to $1.68 billion at December 31, 2006. Deposits were $2.16 billion at June 30, 2007 compared to $2.05 billion at December 31, 2006.

Stockholders’ equity was $178 million at June 30, 2007 compared to $175 million at December 31, 2006. Book value per share was $10.62 at June 30, 2007 compared to $10.43 at December 31, 2006. Changes in stockholders’ equity and book value per share reflect earnings, dividends paid, stock option transactions and changes in unrealized gains and losses on investment securities available for sale.

Annualized results for these interim periods may not be indicative of those for the full year or future periods.

ANALYSIS OF RESULTS OF OPERATIONS

The Company is a bank holding company whose primary business is commercial banking conducted through its wholly-owned state chartered bank subsidiary – Bank of the Ozarks (the “Bank”). Accordingly the Company’s results of operations depend primarily on net interest income, which is the difference between the interest income from earning assets, such as loans, leases and investments, and the interest expense incurred on interest bearing liabilities, such as deposits, borrowings and subordinated debentures. The Company also generates non-interest income, including service charges on deposit accounts, mortgage lending income, trust income, bank owned life insurance (“BOLI”) income, other charges and fees and gains and losses on sales of investment securities and other assets.

The Company’s non-interest expense consists primarily of employee compensation and benefits, net occupancy and equipment and other operating expenses. The Company’s results of operations are also significantly impacted by its provision for loan and lease losses and its provision for income taxes. The following discussion provides a comparative summary of the Company’s operations for the three and six months ended June 30, 2007 and 2006 and should be read in conjunction with the consolidated financial statements and related notes presented elsewhere in this report.

Net Interest Income

Net interest income is analyzed in the discussion and the following tables on a fully taxable equivalent (“FTE”) basis. The adjustment to convert certain income to a FTE basis consists of dividing federal tax-exempt income by one minus the Company’s statutory federal income tax rate of 35%. No adjustment has been made in this analysis for income exempt from state income taxes. The FTE adjustments to net interest income were $0.8 million and $1.1 million, respectively, for the quarters ended June 30, 2007 and 2006 and $1.7 million and $2.5 million, respectively, for the six months ended June 30, 2007 and 2006.

Net interest income (FTE) increased 5.3% to $20.1 million for the quarter ended June 30, 2007, compared to $19.1 million for the quarter ended June 30, 2006. Net interest income (FTE) increased 3.5% to $39.2 million for the six months ended June 30, 2007 compared to $37.9 million for the six months ended June 30, 2006. The Company’s growth in average earning assets, primarily loans and leases, offset in part by declines in net interest margin (FTE), contributed to the increase in net interest income (FTE) for the second quarter and first six months of 2007 compared to the same periods in 2006. Average earning assets increased 10.0% in the second quarter and 13.1% in the first six months of 2007 compared with the same periods in 2006.

 

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Net interest margin (FTE) was 3.46% for the quarter ended June 30, 2007 compared to 3.61% for the comparable quarter in 2006, a decrease of 15 basis points (“bps”). Net interest margin (FTE) for the six months ended June 30, 2007 was 3.41% compared with 3.72% for the same period in 2006, a decrease of 31 bps. Yields on earning assets increased 36 bps for the quarter and 42 bps for the six months ended June 30, 2007 compared to the same periods in 2006, while the rates on interest bearing liabilities increased 57 bps for the quarter and 78 bps for the six months ended June 30, 2007 compared to the same periods in 2006. The relatively flat to inverted yield curve between short-term and long-term interest rates and the competitive environment for pricing loans and deposits were significant contributors to the decline in the Company’s net interest margin (FTE).

Loan and lease yields increased 40 bps for the quarter and 50 bps for the six months ended June 30, 2007 compared to the same periods in 2006. This increase in loan and lease yields is attributable to overall increases in general interest rate levels as a result of the Federal Open Market Committee (“FOMC”) raising its federal funds target rate through a series of four 25 bps increases during the first half of 2006. The Company’s variable rate loans and leases as a percentage of total loans and leases were 46.7% at June 30, 2007 compared to 44.1% at June 30, 2006. Variable rate loans and leases benefit the Company when interest rates are increasing by allowing it to more quickly reprice its loan and lease portfolio.

During late January 2006 and continuing throughout much of 2006, the Company implemented a more aggressive deposit pricing and growth initiative, resulting in its repricing a number of deposit products in most of its markets. This adjustment in deposit pricing, particularly the repricing of time deposits at higher rates as a result of the FOMC increases in its federal funds target rate, contributed to the Company’s increase in rates on interest bearing deposits throughout 2006 and 2007 and the decline in its net interest margin (FTE) in the second quarter and first six months of 2007 compared to the same periods in 2006. The aggregate rate paid for the Company’s time deposits increased 83 bps for the quarter and 105 bps for the six months ended June 30, 2007 compared to the same periods in 2006. Also, such time deposits, which generally pay higher rates than its other interest bearing deposits, increased to 73.1% and 73.2%, respectively, of the Company’s average interest bearing deposits for the second quarter and first six months of 2007 compared to 66.6% and 66.5%, respectively, for the second quarter and first six months of 2006.

Analysis of Net Interest Income

(FTE = Fully Taxable Equivalent)

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2007     2006     2007     2006  
     (Dollars in thousands)  

Interest income

   $ 44,128     $ 37,854     $ 86,956     $ 71,636  

FTE adjustment

     838       1,130       1,686       2,486  
                                

Interest income – FTE

     44,966       38,984       88,642       74,122  

Interest expense

     24,837       19,869       49,416       36,213  
                                

Net interest income – FTE

   $ 20,129     $ 19,115     $ 39,226     $ 37,909  
                                

Yield on earning assets – FTE

     7.73 %     7.37 %     7.70 %     7.28 %

Rate on interest bearing liabilities

     4.54       3.97       4.55       3.77  

Net interest margin – FTE

     3.46       3.61       3.41       3.72  

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Average Consolidated Balance Sheets and Net Interest Analysis – FTE

 

    Three Months Ended June 30,     Six Months Ended June 30,  
    2007     2006     2007     2006  
    Average
Balance
  Income/
Expense
  Yield/
Rate
    Average
Balance
  Income/
Expense
  Yield/
Rate
    Average
Balance
  Income/
Expense
  Yield/
Rate
    Average
Balance
  Income/
Expense
  Yield/
Rate
 
    (Dollars in thousands)  

ASSETS

                       

Earnings assets:

                       

Interest earning deposits and federal funds sold

  $ 316   $ 4   5.11 %   $ 225   $ 2   2.99 %   $ 283   $ 11   7.51 %   $ 232   $ 3   2.84 %

Investment securities:

                       

Taxable

    453,876     6,245   5.52       456,441     6,382   5.61       466,202     12,840   5.55       418,888     11,518   5.54  

Tax-exempt – FTE

    132,221     2,358   7.15       180,401     3,170   7.05       133,218     4,734   7.17       199,833     6,979   7.04  

Loans and leases – FTE

    1,746,889     36,359   8.35       1,484,649     29,430   7.95       1,722,082     71,057   8.32       1,433,912     55,622   7.82  
                                                       

Total earning assets – FTE

    2,333,302     44,966   7.73       2,121,716     38,984   7.37       2,321,785     88,642   7.70       2,052,865     74,122   7.28  

Non-interest earning assets

    228,929         205,022         228,923         196,838    
                                       

Total assets

  $ 2,562,231       $ 2,326,738       $ 2,550,708       $ 2,249,703    
                                       

LIABILITIES AND STOCKHOLDERS’ EQUITY

                       

Interest bearing liabilities:

                       

Deposits:

                       

Savings and interest bearing transaction

  $ 538,518   $ 3,739   2.78 %   $ 543,036   $ 3,579   2.64 %   $ 522,787   $ 7,085   2.73 %   $ 522,332   $ 6,295   2.43 %

Time deposits of $100,000 or more

    964,287     12,424   5.17       704,744     7,813   4.45       939,047     24,040   5.16       678,924     14,245   4.23  

Other time deposits

    497,076     6,061   4.89       378,558     3,648   3.86       491,667     11,924   4.89       356,026     6,372   3.61  
                                                       

Total interest bearing deposits

    1,999,881     22,224   4.46       1,626,338     15,040   3.71       1,953,501     43,049   4.44       1,557,282     26,912   3.48  

Repurchase agreements with customers

    46,286     437   3.79       38,118     306   3.22       46,966     898   3.86       36,142     544   3.03  

Other borrowings

    83,859     917   4.39       300,946     3,664   4.88       126,540     2,959   4.72       300,458     7,099   4.76  

Subordinated debentures

    64,950     1,259   7.78       44,331     859   7.77       64,950     2,510   7.79       44,331     1,658   7.54  
                                                       

Total interest bearing liabilities

    2,194,976     24,837   4.54       2,009,733     19,869   3.97       2,191,957     49,416   4.55       1,938,213     36,213   3.77  

Non-interest bearing liabilities:

                       

Non-interest bearing deposits

    175,066         156,608         168,286         150,924    

Other non-interest bearing liabilities

    10,182         9,867         10,300         9,002    
                                       

Total liabilities

    2,380,224         2,176,208         2,370,543         2,098,139    

Stockholders’ equity

    182,007         150,530         180,165         151,564    
                                       

Total liabilities and stockholders’ equity

  $ 2,562,231       $ 2,326,738       $ 2,550,708       $ 2,249,703    
                                       
                                       

Net interest income – FTE

    $ 20,129       $ 19,115       $ 39,226       $ 37,909  
                                       

Net interest margin – FTE

      3.46 %       3.61 %       3.41 %       3.72 %

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Non-Interest Income

The Company’s non-interest income consists primarily of (1) service charges on deposit accounts, (2) mortgage lending income, (3) trust income, (4) BOLI income, (5) appraisal fees, credit life commissions and other credit related fees, (6) safe deposit box rental, operating lease income, brokerage fees and other miscellaneous fees and (7) gains and losses on sales of investment securities and other assets. Non-interest income for the second quarter of 2007 increased 13.5% to $5.6 million compared to $5.0 million for the second quarter of 2006. Non-interest income for the six months ended June 30, 2007 increased 4.2% to $11.6 million compared to $11.1 million for the six months ended June 30, 2006.

The Company’s service charges on deposit accounts, which is its largest source of non-interest income, increased 20.1% and 21.0%, respectively, for the quarter and six months ended June 30, 2007 compared to the same periods in 2006. This increase is attributable to several factors including enhancements made in late 2006 to the Company’s processes for applying and collecting service charges, increases in the Company’s number of deposit accounts from its 2006 deposit initiative and small increases in some of its deposit account service charges.

Mortgage lending income increased 4.9% and 12.0%, respectively, for the second quarter and six months of 2007 compared to the same periods in 2006. During 2006 the Company pursued branching and corporate growth initiatives that included expanding its team of mortgage loan counselors in both existing and new markets. This increase in mortgage personnel during 2006 contributed to increases of 4.6% and 11.0%, respectively, in the volume of originations of mortgage loans for sale in the second quarter and first six months of 2007 compared to the same periods in 2006.

For the quarter and six months ended June 30, 2007, trust income increased 11.1% and 9.3%, respectively, compared to the same period in 2006, primarily due to continued growth in the Company’s personal trust and investment management business.

In the quarter ended June 30, 2007, the Company had a net loss on sales of investment securities and other assets of $47,000 compared to a $38,000 net gain in the second quarter of 2006. For the six months ended June 30, 2007, net gains on sales of investment securities and other assets were $0.3 million compared to $1.9 million in the first six months of 2006.

During the first quarter of 2007, the Company sold a site previously acquired for a Jacksonville, Arkansas branch to a competitor and subsequently withdrew its contested branch application for this site. The Company recognized a gain of $17,000 on the sale of such site and $0.5 million of other non-interest income related to the settlement of the contested branch application. Among other things, this settlement and payment reimbursed the Company for its expenses incurred in previous quarters related to such branch application and included an agreement by the Company not to pursue any future branch application in the present city limits of Jacksonville.

The following table shows non-interest income for the three and six months ended June 30, 2007 and 2006.

Non-Interest Income

 

     Three Months Ended
June 30,
   Six Months Ended
June 30,
     2007     2006    2007     2006
     (Dollars in thousands)

Service charges on deposit accounts

   $ 3,107     $ 2,587    $ 5,942     $ 4,909

Mortgage lending income

     817       779      1,548       1,382

Trust income

     531       478      996       911

BOLI income

     478       455      943       898

Appraisal fees, credit life commissions and other credit related fees

     131       145      248       256

Safe deposit box rental, operating lease income, brokerage fees and other miscellaneous fees

     305       262      583       589

Gains on sales of investment securities

     —         27      337       1,858

Gains (losses) on sales of other assets

     (47 )     11      (12 )     13

Other

     301       210      997       302
                             

Total non-interest income

   $ 5,623     $ 4,954    $ 11,582     $ 11,118
                             

 

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Non-Interest Expense

Non-interest expense for the second quarter of 2007 increased 7.8% to $11.9 million compared to $11.0 million for the comparable period in 2006. Non-interest expense for the six months ended June 30, 2007 increased 8.3% to $24.0 million compared with $22.1 million for the comparable period in 2006. This increase is the result of a number of factors including the ongoing costs of facilities and staff added as part of the Company’s 2006 branching and corporate growth initiatives, costs from the resumption of FDIC deposit insurance assessments and cost of the Company’s continued growth and expansion efforts. At June 30, 2007, the Company had 68 banking offices compared to 59 at June 30, 2006. The Company had 686 full time equivalent employees at June 30, 2007 compared to 666 at June 30, 2006. The growth in Company employees is primarily the result of growth in the Company’s number of offices during the past twelve months and the addition of certain corporate staff members and other personnel at existing offices to support its continued growth and expansion.

The Company’s efficiency ratio (non-interest expense divided by the sum of net interest income – FTE and non-interest income) was 46.1% for the quarter ended June 30, 2007 compared to 45.8% for the quarter ended June 30, 2006. The Company’s efficiency ratio for the six months ended June 30, 2007 was 47.2% compared to 45.2% for the same period in 2006.

The following table shows non-interest expense for the three and six months ended June 30, 2007 and 2006.

Non-Interest Expense

 

     Three Months Ended
June 30,
   Six Months Ended
June 30,
     2007    2006    2007    2006
     (Dollars in thousands)

Salaries and employee benefits

   $ 7,016    $ 6,569    $ 14,327    $ 13,153

Net occupancy and equipment

     1,967      1,738      3,938      3,398

Other operating expenses:

           

Postage and supplies

     395      420      816      919

Advertising and public relations

     225      356      533      839

Telephone and data lines

     351      395      767      765

Professional and outside services

     305      248      602      422

ATM expense

     174      143      329      294

Software expense

     302      250      591      499

FDIC insurance

     210      —        210      —  

FDIC and state assessments

     153      157      319      306

Other real estate and foreclosure expense

     105      7      143      65

Amortization of intangibles

     66      66      131      132

Other

     607      668      1,308      1,385
                           

Total non-interest expense

   $ 11,876    $ 11,017    $ 24,014    $ 22,177
                           

Income Taxes

The provision for income taxes was $3.7 million for the second quarter and $7.2 million for the first six months of 2007 compared to $3.5 million for the second quarter and $7.0 million for the first six months of 2006. The effective income tax rate was 31.4% for both the second quarter and first six months of 2007 compared to 30.6% for the second quarter and 30.1% for the first six months of 2006. The decline in the Company’s tax-exempt income, primarily as a result of selling a portion of its tax-exempt securities during 2006 and the first quarter of 2007, contributed to the increase in the effective tax rates for the second quarter and first six months of 2007 compared to the same periods in 2006. Income exempt from both federal and state income taxes includes earnings on certain investment securities, loans and leases with state and political subdivisions, increases in the cash surrender value of BOLI and returns on an investment in a low income housing limited liability company. Certain U.S. government agency securities are exempt from state income taxes but are subject to federal income tax.

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ANALYSIS OF FINANCIAL CONDITION

Loan and Lease Portfolio

At June 30, 2007 the Company’s loan and lease portfolio was $1.76 billion, compared to $1.68 billion at December 31, 2006 and $1.55 billion at June 30, 2006. Real estate loans, the Company’s largest category of loans, include all loans made to finance the development of real property construction projects, provided such loans are secured by real estate, and all other loans secured by real estate as evidenced by mortgages or other liens. Total real estate loans were $1.42 billion at June 30, 2007, compared to $1.37 billion at December 31, 2006 and $1.26 billion at June 30, 2006. This increase is primarily attributable to the Company’s growth and expansion in markets with significant commercial and residential real estate development including northwest Arkansas, Dallas, Texas and Charlotte, North Carolina. The amount and type of loans and leases outstanding at June 30, 2007 and 2006 and at December 31, 2006 and their respective percentage of the total loan and lease portfolio are reflected in the following table.

Loan and Lease Portfolio

 

     June 30,    

December 31,

2006

 
     2007     2006    
     (Dollars in thousands)  

Real estate:

               

Residential 1-4 family

   $ 276,840    15.8 %   $ 277,772    17.9 %   $ 281,400    16.8 %

Non-farm/non-residential

     425,734    24.2       427,853    27.6       433,998    25.9  

Construction/land development

     564,065    32.1       437,408    28.1       514,899    30.7  

Agricultural

     94,595    5.4       78,034    5.0       88,021    5.2  

Multifamily residential

     61,580    3.5       41,649    2.7       50,202    3.0  
                                       

Total real estate

     1,422,814    81.0       1,262,716    81.3       1,368,520    81.6  

Commercial and industrial

     172,051    9.8       136,245    8.8       148,853    8.9  

Consumer

     85,787    4.9       82,322    5.3       86,048    5.1  

Direct financing leases

     51,438    2.9       47,253    3.0       49,705    3.0  

Agricultural (non-real estate)

     22,727    1.3       23,245    1.5       22,298    1.3  

Other

     1,566    0.1       2,112    0.1       1,965    0.1  
                                       

Total loans and leases

   $ 1,756,383    100.0 %   $ 1,553,893    100.0 %   $ 1,677,389    100.0 %
                                       

Nonperforming Assets

Nonperforming assets consist of (1) nonaccrual loans and leases, (2) accruing loans and leases 90 days or more past due, (3) certain restructured loans and leases providing for a reduction or deferral of interest or principal because of a deterioration in the financial position of the borrower or lessee and (4) real estate or other assets that have been acquired in partial or full satisfaction of loan or lease obligations or upon foreclosure.

The Company generally places a loan or lease on nonaccrual status when payments are contractually past due 90 days, or earlier when doubt exists as to the ultimate collection of payments. The Company may continue to accrue interest on certain loans or leases contractually past due 90 days if such loans or leases are both well secured and in the process of collection. At the time a loan or lease is placed on nonaccrual status, interest previously accrued but uncollected is generally reversed and charged against interest income. Nonaccrual loans and leases are generally returned to accrual status when payments are less than 90 days past due and the Company reasonably expects to collect all payments. If a loan or lease is determined to be uncollectible, the portion of the principal determined to be uncollectible will be charged against the allowance for loan and lease losses. Income on nonaccrual loans or leases is recognized on a cash basis when and if actually collected.

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The following table presents information concerning nonperforming assets, including nonaccrual and certain restructured loans and leases and foreclosed assets held for sale and repossessions at June 30, 2007 and 2006 and at December 31, 2006.

Nonperforming Assets

 

     June 30,     December 31,
2006
 
     2007     2006    
     (Dollars in thousands)  

Nonaccrual loans and leases

   $ 4,022     $ 2,784     $ 5,713  

Accruing loans and leases 90 days or more past due

     —         —         —    

Restructured loans and leases

     —         —         —    
                        

Total nonperforming loans and leases

     4,022       2,784       5,713  

Foreclosed assets held for sale and repossessions(1)

     2,685       391       407  
                        

Total nonperforming assets

   $ 6,707     $ 3,175     $ 6,120  
                        

Nonperforming loans and leases to total loans and leases

     0.23 %     0.18 %     0.34 %

Nonperforming assets to total assets

     0.26       0.13       0.24  

(1) Foreclosed assets held for sale and repossessions are generally written down to estimated market value net of estimated selling and holding costs at the time of transfer from the loan and lease portfolio. The value of such assets is reviewed from time to time throughout the holding period with the value adjusted to the then estimated market value net of estimated selling and holding costs, if lower, until disposition.

Allowance and Provision for Loan and Lease Losses

Allowance for Loan and Lease Losses: The following table shows an analysis of the allowance for loan and lease losses for the six months ended June 30, 2007 and 2006 and the year ended December 31, 2006.

 

     Six Months Ended
June 30,
    Year Ended
December 31,
2006
 
     2007     2006    
     (Dollars in thousands)  

Balance, beginning of period

   $ 17,699     $ 17,007     $ 17,007  

Loans and leases charged off:

      

Real estate

     271       127       314  

Commercial and industrial

     669       369       872  

Consumer

     413       308       709  

Direct financing leases

     92       22       63  

Agricultural (non-real estate)

     36       15       107  
                        

Total loans and leases charged off

     1,481       841       2,065  
                        

Recoveries of loans and leases previously charged off:

      

Real estate

     22       7       13  

Commercial and industrial

     52       40       47  

Consumer

     99       119       234  

Direct financing leases

     5       —         13  

Agricultural (non-real estate)

     1       —         —    
                        

Total recoveries

     179       166       307  
                        

Net loans and leases charged off

     1,302       675       1,758  

Provision charged to operating expense

     2,350       1,000       2,450  
                        

Balance, end of period

   $ 18,747     $ 17,332     $ 17,699  
                        

Net charge-offs to average loans and leases outstanding during the periods indicated

     0.15 %(1)     0.09 %(1)     0.12 %

Allowance for loan and lease losses to total loans and leases

     1.07 %     1.12 %     1.06 %

Allowance for loan and lease losses to nonperforming loans and leases

     466 %     623 %     310 %

(1) Annualized.

 

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Provisions to and the adequacy of the allowance for loan and lease losses are determined in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 114, “Accounting by Creditors for Impairment of a Loan,” and SFAS No. 5, “Accounting for Contingencies,” and are based on the Company’s judgment and evaluation of the loan and lease portfolio utilizing objective and subjective criteria. The objective criteria utilized by the Company to assess the adequacy of its allowance for loan and lease losses and required additions to such allowance consists primarily of an internal grading system and specific allowances determined in accordance with SFAS No. 114. The Company also utilizes a peer group analysis and an historical analysis in an effort to validate the overall adequacy of its allowance for loan and lease losses. In addition to these objective criteria, the Company subjectively assesses the adequacy of the allowance for loan and lease losses and the need for additions thereto, with consideration given to the nature and volume of the portfolio, overall portfolio quality, review of specific problem loans and leases, national, regional and local business and economic conditions that may affect the borrowers’ or lessees’ ability to pay, the value of property securing the loans and leases, and other relevant factors.

The Company’s allowance for loan and lease losses was $18.7 million at June 30, 2007, or 1.07% of total loans and leases, compared with $17.7 million, or 1.06% of total loans and leases, at December 31, 2006 and $17.3 million, or 1.12% of total loans and leases, at June 30, 2006. The Company’s allowance for loan and lease losses was equal to 466% of its total nonperforming loans and leases at June 30, 2007 compared to 310% at December 31, 2006 and 623% at June 30, 2006. While management believes the current allowance is appropriate, changing economic and other conditions may require future adjustments to the allowance for loan and lease losses.

Provision for Loan and Lease Losses: The loan and lease loss provision is based on management’s judgment and evaluation of the loan and lease portfolio utilizing the criteria discussed above. The provision for loan and lease losses was $1.3 million for the second quarter and $2.4 million for the six months ended June 30, 2007 compared to $0.5 million for the second quarter and $1.0 million for the six months ended June 30, 2006.

Investment Securities

The Company’s investment securities portfolio provides a significant source of revenue to the Company. At June 30, 2007 and 2006 and at December 31, 2006, the Company classified all of its investment securities portfolio as available for sale (“AFS”). Accordingly, its investment securities are stated at estimated fair value in the consolidated financial statements with the unrealized gains and losses, net of income tax, reported as a separate component of stockholders’ equity and included in accumulated other comprehensive income (loss). The table below presents the amortized cost and fair value of investment securities AFS at June 30, 2007 and 2006 and at December 31, 2006.

Investment Securities

 

     June 30,   

December 31,

2006

     2007    2006   
     Amortized
Cost
   Fair
Value(1)
   Amortized
Cost
   Fair
Value(1)
   Amortized
Cost
   Fair
Value(1)
     (Dollars in thousands)

Mortgage-backed securities

   $ 376,819    $ 354,532    $ 402,110    $ 375,744    $ 406,611    $ 397,964

Obligations of state and political subdivisions

     139,883      140,654      190,794      191,232      133,255      135,149

Securities of U.S. Government agencies

     75,908      73,323      71,907      70,009      75,875      74,530

FHLB stock and other equity securities(2)

     5,880      5,880      15,349      15,349      11,489      11,489

Other securities

     1,044      1,044      3,167      3,297      1,000      1,000
                                         

Total

   $ 599,534    $ 575,433    $ 683,327    $ 655,631    $ 628,230    $ 620,132
                                         

(1) The fair value of the Company’s investment securities is based on quoted market prices where available. If quoted market prices are not available, fair values are based on market prices for comparable securities.
(2) FHLB stock and other equity securities consist of securities that do not have readily determinable fair values. These securities are carried at cost.

The Company’s investment securities portfolio is reported net of unrealized losses of $24.1 million at June 30, 2007, $27.7 million at June 30, 2006 and $8.1 million at December 31, 2006. Management believes that all of its unrealized losses on investment securities AFS at June 30, 2007 and 2006 and at December 31, 2006 are the result of fluctuations in interest rates and do not reflect any deterioration in the credit quality of its investments. Accordingly management considers these unrealized losses to be temporary in nature. The Company has both the ability and the intent to hold these investment securities until maturity or until such time as fair value recovers above cost.

 

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The Company had no net gains from the sale of investment securities in the second quarter of 2007 compared with net gains of $27,000 in the second quarter of 2006 from the sale of approximately $1 million of investment securities available for sale. During the first six months of 2007, the Company generated net gains of $0.3 million from the sale of approximately $34 million of investment securities available for sale. Net gains on sales of investment securities available for sale for the six months ended June 30, 2006 were $1.9 million from the sale of approximately $79 million of investment securities available for sale. The Company also purchased approximately $8 million and $82 million, respectively, of investment securities during the second quarter of 2007 and 2006 and approximately $14 million and $207 million, respectively, during the six months ended June 30, 2007 and 2006.

The Company invests in securities it believes offer good relative value at the time of purchase, and it will, from time to time reposition its investment securities portfolio. In making its decisions to sell or purchase securities, the Company considers credit ratings, call features, maturity dates, relative yields and other relevant factors.

At June 30, 2007 the estimated modified duration of the Company’s investment securities portfolio is approximately 6.6 years. Modified duration is considered a measure of bond price sensitivity to changes in yield.

Deposits

The Company’s lending and investment activities are funded primarily by deposits. The amount and type of deposits outstanding at June 30, 2007 and 2006 and at December 31, 2006 and their respective percentage of the total deposits are reflected in the following table.

Deposits

 

     June 30,     December 31,  
     2007     2006     2006  
     (Dollars in thousands)  

Non-interest bearing

   $ 203,046    9.4 %   $ 157,301    8.7 %   $ 167,841    8.2 %

Interest bearing:

               

Transaction (NOW)

     413,916    19.2       436,200    24.0       400,578    19.6  

Savings

     26,625    1.2       27,809    1.5       24,588    1.2  

Money market

     91,813    4.3       73,233    4.0       94,261    4.6  

Time deposits less than $100,000

     503,929    23.4       392,763    21.6       479,952    23.5  

Time deposits of $100,000 or more

     916,314    42.5       731,322    40.2       877,872    42.9  
                                       

Total deposits

   $ 2,155,643    100.0 %   $ 1,818,628    100.0 %   $ 2,045,092    100.0 %
                                       

As of June 30, 2007, the Company had outstanding brokered deposits of $395 million compared to $309 million at December 31, 2006 and $180 million at June 30, 2006.

LIQUIDITY AND CAPITAL RESOURCES

Growth and Expansion. At June 30, 2007 the Company, through its state chartered subsidiary bank, conducted banking operations through 63 offices in 34 communities throughout northern, western and central Arkansas, five Texas banking offices, and loan production offices in Little Rock, Arkansas and Charlotte, North Carolina.

The Company expects to continue its growth and de novo branching strategy in 2007 by adding three new banking offices. During the second quarter of 2007, the Company opened its third Hot Springs, Arkansas banking office and, in the remainder of 2007, it plans to add new banking offices in Fayetteville and Rogers, Arkansas. The Company also plans to replace a temporary banking office in Frisco, Texas with a new permanent facility.

During the second quarter of 2007, the Company discontinued its plan to establish a new Oklahoma bank subsidiary and closed its Tulsa loan production office. Because the Company planned to use this Oklahoma bank subsidiary as a means to ultimately branch into North Carolina, this may delay plans to expand the Company’s Charlotte, North Carolina loan production office to a full-service banking operation.

Opening new offices and replacing temporary banking offices with new facilities are subject to availability of qualified personnel and suitable sites, designing, constructing, equipping and staffing such offices, obtaining regulatory and other approvals and many other conditions and contingencies that the Company cannot predict with certainty.

 

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During the first six months of 2007, the Company spent $10.9 million on capital expenditures for premises and equipment. The Company’s capital expenditures for the full year of 2007 are expected to be in the range of $19 million to $25 million including progress payments on construction projects expected to be completed in 2007 and 2008, furniture and equipment costs and acquisition of sites for future development. Actual expenditures may vary significantly from those expected, depending on the number and cost of additional sites acquired for future development, progress or delays encountered on ongoing and new construction projects and other factors.

Bank Liquidity. Liquidity represents an institution’s ability to provide funds to satisfy demands from depositors, borrowers and lessees by either converting assets into cash or accessing new or existing sources of incremental funds. Generally the Company relies on deposits, loan and lease repayments and repayments of its investment securities as its primary sources of funds. The principal deposit sources utilized by the Company include consumer, commercial and public funds customers in the Company’s markets and brokered deposits. The Company has used these funds, together with Federal Home Loan Bank of Dallas (“FHLB”) advances, federal funds and other sources of short-term borrowings, to make loans and leases, acquire investment securities and other assets and to fund continuing operations.

Deposit levels may be affected by a number of factors, including rates paid by competitors, general interest rate levels, returns available to customers on alternative investments, general economic and market conditions and other factors. Loan and lease repayments are a relatively stable source of funds but are subject to the borrowers’ and lessees’ ability to repay the loans and leases, which can be adversely affected by a number of factors including changes in general economic conditions, adverse trends or events affecting business industry groups or specific businesses, declines in real estate values or markets, business closings or lay-offs, inclement weather, natural disasters and other factors. Furthermore, loans and leases generally are not readily convertible to cash. Accordingly, the Company may be required to rely from time to time on secondary sources of liquidity to meet loan, lease and deposit withdrawal demands or otherwise fund operations. Such sources include FHLB advances, secured and unsecured federal funds lines of credit from correspondent banks and Federal Reserve Bank (“FRB”) borrowings.

At June 30, 2007 the Company had substantial unused borrowing availability. This availability was primarily comprised of the following four sources: (1) $457 million of available blanket borrowing capacity with the FHLB, (2) $14 million of investment securities available to pledge for federal funds or other borrowings, (3) $37 million of available unsecured federal funds borrowing lines and (4) $164 million from borrowing programs of the FRB.

The Company anticipates it will continue to rely primarily on deposits, loan and lease repayments and repayments of its investment securities to provide liquidity. Additionally, when necessary, the sources of borrowed funds described above will be used to augment the Company’s primary funding sources.

Capital Compliance. Bank regulatory authorities in the United States impose certain capital standards on all bank holding companies and banks. These capital standards require compliance with certain minimum “risk-based capital ratios” and a minimum “leverage ratio.” The risk-based capital ratios consist of (1) Tier 1 capital (i.e. common stockholders’ equity excluding goodwill, certain intangibles and net unrealized gains and losses on AFS investment securities, and including, subject to limitations, trust preferred securities (“TPS”) and other qualifying items) to risk-weighted assets and (2) total capital (Tier 1 capital plus Tier 2 capital, including the qualifying portion of the allowance for loan and lease losses and the portion of TPS not counted as Tier 1 capital) to risk-weighted assets. The leverage ratio is measured as Tier 1 capital to adjusted quarterly average assets.

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The Company’s and the Bank’s risk-based capital and leverage ratios exceeded these minimum requirements at June 30, 2007 and December 31, 2006, and are presented in the following tables.

Consolidated Capital Ratios

 

     June 30,
2007
    December 31,
2006
 
     (Dollars in thousands)  

Tier 1 capital:

    

Stockholders’ equity

   $ 178,081     $ 174,633  

Allowed amount of TPS (subordinated debentures)

     63,000       59,851  

Net unrealized losses on AFS investment securities

     14,647       4,922  

Less goodwill and certain intangible assets

     (6,008 )     (6,140 )
                

Total tier 1 capital

     249,720       233,266  

Tier 2 capital:

    

Remaining amount of TPS (subordinated debentures)

     —         3,149  

Qualifying allowance for loan and lease losses

     18,747       17,699  
                

Total risk-based capital

   $ 268,467     $ 254,114  
                

Risk-weighted assets

   $ 2,071,005     $ 1,991,570  
                

Adjusted quarterly average assets for leverage capital

   $ 2,556,223     $ 2,485,450  
                

Ratios at end of period:

    

Leverage

     9.77 %     9.39 %

Tier 1 risk-based capital

     12.06       11.71  

Total risk-based capital

     12.96       12.76  

Minimum ratio guidelines:

    

Leverage (1)

     3.00 %     3.00 %

Tier 1 risk-based capital

     4.00       4.00  

Total risk-based capital

     8.00       8.00  

(1) Regulatory authorities require institutions to operate at varying levels (ranging from 100-200 bps) above a minimum leverage ratio of 3% depending upon capitalization classification.

Capital Ratios of the Bank

 

     June 30, 2007     December 31, 2006  
     (Dollars in thousands)  

Stockholders’ equity – Tier 1

   $ 224,762     $ 196,816  

Leverage ratio

     8.81 %     7.95 %

Tier 1 risk-based capital ratio

     10.92       9.94  

Total risk-based capital ratio

     11.83       10.83  

Dividend Policy. During the quarters ended June 30, 2007 and 2006, the Company paid a dividend of $0.10 per share. On July 17, 2007, the Company’s board of directors approved a dividend of $0.11 per share to be paid during the third quarter of 2007. The determination of future dividends on the Company’s common stock will depend on conditions existing at that time. The Company’s goal is to continue at approximately the current level of quarterly dividend with consideration given to future changes depending on the Company’s earnings, capital and liquidity needs.

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CRITICAL ACCOUNTING POLICY

The Company’s determination of the adequacy of the allowance for loan and lease losses is considered to be a critical accounting policy. Provisions to and the adequacy of the allowance for loan and lease losses are based on management’s judgment and evaluation of the loan and lease portfolio utilizing objective and subjective criteria. Changes in these criteria or the availability of new information could cause the allowance to be increased or decreased in future periods. In addition, bank regulatory agencies as part of their examination process may require adjustments to the allowance for loan and lease losses based on their judgments and estimates. See the “Analysis of Financial Condition” section of Management’s Discussion and Analysis contained in the Company’s 2006 annual report on Form 10-K for a detailed discussion of the Company’s allowance for loan and lease losses.

FORWARD-LOOKING INFORMATION

This Management’s Discussion and Analysis of Financial Condition and Results of Operations, other filings made by the Company with the Securities and Exchange Commission and other oral and written statements or reports by the Company and its management include certain forward-looking statements including, without limitation, statements about economic, competitive and interest rate conditions, plans, goals, expectations and outlook for revenue growth, net income, earnings per share, net interest margin including the expected effects of the relatively flat to inverted yield curve between short-term and long-term interest rates and intense competition, net interest income, non-interest income including service charge, mortgage lending and trust income, gains on sales of investment securities and other assets, non-interest expense including the ongoing cost of opening new offices and continued growth and expansion efforts, efficiency ratio, asset quality including changes in real estate market conditions, nonperforming loans and leases, nonperforming assets, net charge-offs, past due loans and leases, interest rate sensitivity including the effects of possible interest rate changes, future growth and expansion including the plans for opening new offices, replacing existing banking offices with new facilities and converting loan production offices to banking offices, opportunities and goals for market share growth, loan, lease and deposit growth, changes in our investment securities portfolio and other similar forecasts and statements of expectation. Words such as “anticipate,” “believe,” “estimate,” “plan”, “expect,” “intend” and similar expressions, as they relate to the Company or its management, identify forward-looking statements. 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.

Actual future performance, outcomes and results may differ materially from those expressed in forward-looking statements made by the Company and its management due to certain risks, uncertainties and assumptions. Certain factors that may affect operating results of the Company include, but are not limited to, the following: potential delays or other problems in implementing the Company’s growth and expansion strategy including delays in identifying satisfactory sites, obtaining permits, designing, constructing and opening new offices, replacing existing banking offices with new facilities or converting loan production offices to banking offices, obtaining regulatory and other approvals and employing additional personnel; the ability to attract new deposits and loans and leases; interest rate fluctuations including changes in the yield curve between short-term and long-term interest rates; competitive factors and pricing pressures; general economic conditions including their effect on investment securities values, the creditworthiness of borrowers and lessees and collateral values; changes in legal and regulatory requirements; adoption of new accounting standards or changes in existing accounting requirements; and adverse results in future litigation, as well as other factors described in this and other Company reports and statements. Should one or more of the foregoing risks materialize, or should underlying assumptions prove incorrect, actual results or outcomes may vary materially from those described in the forward-looking statements.

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SELECTED AND SUPPLEMENTAL FINANCIAL DATA

The following tables set forth selected consolidated financial data of the Company for the three and six months ended June 30, 2007 and 2006 and supplemental quarterly financial data of the Company for each of the most recent eight quarters beginning with the third quarter of 2005 through the second quarter of 2007. These tables are qualified in their entirety by the consolidated financial statements and related notes presented elsewhere in this report.

Selected Consolidated Financial Data

Unaudited

 

     Three Months Ended
June 30,
   

Six Months Ended

June 30,

 
     2007     2006     2007     2006  
     (Dollars in thousands, except per share amounts)  

Income statement data:

        

Interest income

   $ 44,128     $ 37,854     $ 86,956     $ 71,636  

Interest expense

     24,837       19,869       49,416       36,213  

Net interest income

     19,291       17,985       37,540       35,423  

Provision for loan and lease losses

     1,250       500       2,350       1,000  

Non-interest income

     5,623       4,954       11,582       11,118  

Non-interest expense

     11,876       11,017       24,014       22,177  

Net income

     8,086       7,931       15,607       16,328  

Share and per share data:

        

Earnings – diluted

   $ 0.48     $ 0.47     $ 0.93     $ 0.97  

Book value

     10.62       8.95       10.62       8.95  

Dividends

     0.10       0.10       0.20       0.20  

Weighted-average diluted shares outstanding (thousands)

     16,834       16,808       16,830       16,802  

End of period shares outstanding (thousands)

     16,771       16,718       16,771       16,718  

Balance sheet data at period end:

        

Total assets

   $ 2,580,545     $ 2,420,597     $ 2,580,545     $ 2,420,597  

Total loans and leases

     1,756,383       1,553,893       1,756,383       1,553,893  

Allowance for loan and lease losses

     18,747       17,332       18,747       17,332  

Total investment securities

     575,433       655,631       575,433       655,631  

Total deposits

     2,155,643       1,818,628       2,155,643       1,818,628  

Repurchase agreements with customers

     45,063       55,230       45,063       55,230  

Other borrowings

     120,807       342,027       120,807       342,027  

Subordinated debentures

     64,950       44,331       64,950       44,331  

Total stockholders’ equity

     178,081       149,610       178,081       149,610  

Loan and lease to deposit ratio

     81.48 %     85.44 %     81.48 %     85.44 %

Average balance sheet data:

        

Total average assets

   $ 2,562,231     $ 2,326,738     $ 2,550,708     $ 2,249,703  

Total average stockholders’ equity

     182,007       150,430       180,165       151,564  

Average equity to average assets

     7.10 %     6.47 %     7.06 %     6.74 %

Performance ratios:

        

Return on average assets*

     1.27 %     1.37 %     1.23 %     1.46 %

Return on average stockholders’ equity*

     17.82       21.13       17.47       21.72  

Net interest margin – FTE*

     3.46       3.61       3.41       3.72  

Efficiency

     46.12       45.77       47.26       45.23  

Dividend payout

     20.74       21.08       21.48       20.45  

Asset quality ratios:

        

Net charge-offs to average total loans and leases*

     0.14 %     0.09 %     0.15 %     0.09 %

Nonperforming loans and leases to total loans and leases

     0.23       0.18       0.23       0.18  

Nonperforming assets to total assets

     0.26       0.13       0.26       0.13  

Allowance for loan and lease losses as a percentage of:

        

Total loans and leases

     1.07 %     1.12 %     1.07 %     1.12 %

Nonperforming loans and leases

     466 %     623 %     466 %     623 %

Capital ratios at period end:

        

Leverage

     9.77 %     8.76 %     9.77 %     8.76 %

Tier 1 risk-based capital

     12.06       10.92       12.06       10.92  

Total risk-based capital

     12.96       11.85       12.96       11.85  

* Ratios annualized based on actual days.

 

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Supplemental Quarterly Financial Data

Unaudited

 

     9/30/05     12/31/05     3/31/06     6/30/06     9/30/06     12/31/06     3/31/07     6/30/07  
     (Dollars in thousands, except per share amounts)  

Earnings Summary:

                

Net interest income

   $ 17,460     $ 17,845     $ 17,438     $ 17,985     $ 17,774     $ 17,523     $ 18,249     $ 19,291  

Federal tax (FTE) adjustment

     1,247       1,357       1,357       1,130       1,196       912       848       838  
                                                                

Net interest income (FTE)

     18,707       19,202       18,795       19,115       18,970       18,435       19,097       20,129  

Provision for loan and lease losses

     (800 )     (500 )     (500 )     (500 )     (550 )     (900 )     (1,100 )     (1,250 )

Non-interest income

     5,164       4,804       6,164       4,954       5,680       6,434       5,959       5,623  

Non-interest expense

     (10,270 )     (10,306 )     (11,160 )     (11,017 )     (11,707 )     (12,506 )     (12,138 )     (11,876 )
                                                                

Pretax income (FTE)

     12,801       13,200       13,299       12,552       12,393       11,463       11,818       12,626  

FTE adjustment

     (1,247 )     (1,357 )     (1,357 )     (1,130 )     (1,196 )     (912 )     (848 )     (838 )

Provision for income taxes

     (3,483 )     (3,460 )     (3,545 )     (3,491 )     (3,187 )     (3,196 )     (3,449 )     (3,702 )
                                                                

Net income

   $ 8,071     $ 8,383     $ 8,397     $ 7,931     $ 8,010     $ 7,355     $ 7,521     $ 8,086  
                                                                

Earnings per share – diluted

   $ 0.48     $ 0.50     $ 0.50     $ 0.47     $ 0.48     $ 0.44     $ 0.45     $ 0.48  

Non-interest Income:

                

Service charges on deposit accounts

   $ 2,570     $ 2,537     $ 2,322     $ 2,587     $ 2,540     $ 2,768     $ 2,834     $ 3,107  

Mortgage lending income

     888       763       603       779       792       744       731       817  

Trust income

     448       442       433       478       486       550       465       531  

Bank owned life insurance income

     465       446       443       455       463       471       465       478  

Gains on sales of investment securities

     211       3       1,831       27       718       1,341       337       —    

Gains (losses) on sales of other assets

     33       68       2       11       42       (145 )     35       (47 )

Other

     549       545       530       617       639       705       1,092       737  
                                                                

Total non-interest income

   $ 5,164     $ 4,804     $ 6,164     $ 4,954     $ 5,680     $ 6,434     $ 5,959     $ 5,623  

Non-interest Expense:

                

Salaries and employee benefits

   $ 6,221     $ 5,945     $ 6,584     $ 6,569     $ 6,993     $ 7,360     $ 7,310     $ 7,016  

Net occupancy expense

     1,632       1,673       1,660       1,738       1,732       1,900       1,971       1,967  

Other operating expenses

     2,351       2,622       2,850       2,644       2,917       3,182       2,792       2,827  

Amortization of intangibles

     66       66       66       66       65       65       65       66  
                                                                

Total non-interest expense

   $ 10,270     $ 10,306     $ 11,160     $ 11,017     $ 11,707     $ 12,507     $ 12,138     $ 11,876  

Allowance for Loan and Lease Losses:

                

Balance at beginning of period

   $ 16,745     $ 16,915     $ 17,007     $ 17,175     $ 17,332     $ 17,340     $ 17,699     $ 18,128  

Net charge-offs

     (630 )     (408 )     (332 )     (343 )     (542 )     (541 )     (671 )     (631 )

Provision for loan and lease losses

     800       500       500       500       550       900       1,100       1,250  
                                                                

Balance at end of period

   $ 16,915     $ 17,007     $ 17,175     $ 17,332     $ 17,340     $ 17,699     $ 18,128     $ 18,747  

Selected Ratios:

                

Net interest margin – FTE*

     4.19 %     4.02 %     3.84 %     3.61 %     3.34 %     3.22 %     3.35 %     3.46 %

Overhead ratio*

     2.10       1.97       2.08       1.90       1.88       1.99       1.94       1.86  

Efficiency ratio

     43.02       42.93       44.71       45.77       47.49       50.29       48.44       46.12  

Net charge-offs to average loans and leases*

     0.20       0.12       0.10       0.09       0.14       0.13       0.16       0.14  

Nonperforming loans and leases/total loans and leases

     0.18       0.25       0.24       0.18       0.21       0.34       0.25       0.23  

Nonperforming assets/total assets

     0.13       0.18       0.17       0.13       0.15       0.24       0.27       0.26  

Loans and leases past due 30 days or more, including past due non-accrual loans and leases, to total loans and leases

     0.38       0.39       0.63       0.45       0.60       0.60       0.84       0.53  

* Annualized based on actual days.

 

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

Interest rate risk results from timing differences in the repricing of assets and liabilities or from changes in relationships between interest rate indexes, including changes in the yield curve between short-term and long-term interest rates. The Company’s interest rate risk management is the responsibility of the ALCO and Investments Committee (“ALCO”), which reports to the board of directors. The ALCO oversees the asset/liability (interest rate risk) position, liquidity and funds management and investment portfolio functions of the Company.

The Company regularly reviews its exposure to changes in interest rates. Among the factors considered are changes in the mix of interest earning assets and interest bearing liabilities, interest rate spreads and repricing periods. Typically the ALCO reviews on at least a quarterly basis the Company’s relative ratio of rate sensitive assets (“RSA”) to rate sensitive liabilities (“RSL”) and the related cumulative gap for different time periods. However, the primary tool used by ALCO to analyze the Company’s interest rate risk and interest rate sensitivity is an earnings simulation model.

This earnings simulation modeling process projects a baseline net interest income (assuming no changes in interest rate levels) and estimates changes to that baseline net interest income resulting from changes in interest rate levels. The Company relies primarily on the results of this model in evaluating its interest rate risk. In addition to the data in the gap table, this model incorporates a number of additional factors. These factors include (1) the expected exercise of call features on various RSA and RSL, (2) the expected rates at which various RSA and RSL will reprice, (3) the expected growth in various RSA and RSL and the expected interest rates on new RSA and RSL, (4) the expected relative movements in different interest rate indexes which are used as the basis for pricing or repricing various RSA and RSL, (5) existing and expected contractual ceiling and floor rates on various RSA and RSL, (6) expected changes in administered rates on interest bearing transaction, savings, money market and time deposit accounts and the expected impact of competition on the pricing or repricing of such accounts and (7) other factors. Inclusion of these factors in the model is intended to more accurately project the Company’s changes in net interest income resulting from interest rate changes. The Company models its change in net interest income assuming interest rates go up 100 bps, up 200 bps, down 100 bps and down 200 bps. For purposes of this model, the Company assumes that the change in interest rates phases in over a 12-month period. While the Company believes this model provides a more accurate projection of its interest rate risk, the model includes a number of assumptions and predictions which may or may not be correct and may impact the model results. These assumptions and predictions include inputs to compute baseline net interest income, growth rates, expected changes in administered rates on interest bearing deposit accounts, competition and a variety of other factors that are difficult to accurately predict. Accordingly, there can be no assurance the earnings simulation model will reflect future results.

The following table presents the earnings simulation model’s projected impact of a change in interest rates on the projected baseline net interest income for the 12-month period commencing June 1, 2007. This change in interest rates assumes parallel shifts in the yield curve and does not take into account changes in the slope of the yield curve.

 

Shift in
Interest Rates
(in bps)
   % Change in
Projected Baseline
Net Interest Income
 
+200    1.5 %
+100    0.8  
-100    (0.4 )
-200    (0.9 )

In the event of a shift in interest rates, management may take certain actions intended to mitigate the negative impact to net interest income or to maximize the positive impact to net interest income. These actions may include, but are not limited to, restructuring of interest earning assets and interest bearing liabilities, seeking alternative funding sources or investment opportunities and modifying the pricing or terms of loans, leases and deposits.

The Company’s gap analysis is shown in the following table. The table is not intended to present repricing dates based on contractual maturities, but management’s best estimate of when RSA and RSL may be repriced based on prior experience and future expectations. Significant assumptions are used which are described in the narratives following the table. At June 30, 2007 the cumulative ratios of RSA to RSL at six months and one year were 76.16% and 69.37%, respectively. A financial institution is considered to be liability sensitive, or as having a negative gap, when the amount of its RSL maturing or repricing within a given time period exceeds the amount of its RSA also maturing or repricing within that time period. Conversely, an institution is considered to be asset sensitive, or as having a positive gap, when the amount of its RSL maturing and repricing is less than the amount of its RSA also maturing or repricing during the same period. Generally, in a falling interest rate environment, a negative gap should result in an increase in net interest income, and in a rising interest rate environment this negative gap should adversely affect net interest income. The converse would be true for a positive gap. Due to inherent limitations in any gap analysis and since conditions change on a daily basis, these expectations may not reflect future results. As already noted the Company believes the earnings simulation model results presented above are a more meaningful estimate of its interest rate risk and sensitivity than a gap analysis.

 

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RATE SENSITIVE ASSETS AND LIABILITIES

 

     June 30, 2007  
     RSA(1)    RSL   

Period

Gap

    Cumulative
Gap
    Cumulative
Gap to
Total RSA
    Cumulative
RSA to
RSL
 
     (Dollars in thousands)  

Immediate to 6 months

   $ 975,552    $ 1,280,883    $ (305,331 )   $ (305,331 )   (13.1 )%   76.2 %

Over 6 – 12 months

     190,117      399,571      (209,454 )     (514,785 )   (22.1 )   69.4  

Over 1 – 2 years

     276,252      70,000      206,252       (308,533 )   (13.2 )   82.4  

Over 2 – 3 years

     202,830      62,427      140,403       (168,130 )   (7.2 )   90.7  

Over 3 – 5 years

     176,826      962      175,864       7,734     0.3     100.4  

Over 5 years

     510,595      369,574      141,021       148,755     6.4     106.8  
                            

Total

   $ 2,332,172    $ 2,183,417    $ 148,755        
                            

(1) Certain variable rate loans have a contractual floor and/or ceiling rate. Approximately $94.2 million of loans were at their floor rate and approximately $54.0 million of loans were at their ceiling rate as of June 30, 2007. These loans are shown in the earliest time period in which they could reprice even though the contractual floor/ceiling may preclude repricing to a lower/higher rate. Of these loans at their contractual floor, $91.9 million are reflected as repricing in the immediate to six month time period, $1.8 million in the over six to 12 month time period and the remaining $0.5 million are reflected in various time periods exceeding 12 months. Of the loans at their contractual ceiling, $52.9 million are reflected as repricing in the immediate to six month time period and $1.1 million in the over six to 12 month time period.

The data used in the table above is based on contractual repricing dates for variable or adjustable rate instruments except for non-maturity interest bearing deposit accounts. With respect to non-maturity interest bearing deposit accounts, management believes certain of these deposit accounts are “core” to the Company’s banking operations and do not reprice on a one-to-one basis as a result of interest rate movements. At June 30, 2007 the Company estimates the co-efficient for change in interest rates, assuming a 100 bps increase in interest rates, is approximately 50% for its interest bearing money market account balances, approximately 30% for its MaxYield™ account balances, approximately 25% for its other interest bearing transaction account balances and approximately 5% for its savings account balances. Accordingly the Company has included these portions of the non-maturity interest bearing deposit accounts as repricing immediately, with the remaining portions shown as repricing beyond five years. Management evaluates and when appropriate revises its estimates of these co-efficients for change periodically based on its ongoing assessment of competitive conditions, its relative level of interest rates paid compared to the rates paid by competitors, its expectations and strategies for adjusting its rates paid as market rates change, and other factors.

Fixed-rate callable investment securities or borrowings are scheduled on their contractual maturity unless the Company has received notification the investment security or borrowing will be called. In the event the Company has received notification of call, the investment security or borrowing is placed in the time period in which the call occurs or is expected to occur. Collateralized mortgage obligations and other mortgage-backed securities are scheduled over maturity periods utilizing Bloomberg consensus prepayment speeds based on interest rate levels at June 30, 2007. Other financial instruments are scheduled on their contractual maturity.

This gap analysis gives no consideration to a number of factors which can have a material impact on the Company’s interest rate risk position. Such factors include among other things, call features on certain assets and liabilities, prepayments (except collateralized mortgage obligations and other mortgage-backed securities which are scheduled over maturity periods utilizing Bloomberg consensus prepayment speeds), interest rate floors and ceilings on various assets and liabilities, the current interest rates on assets and liabilities to be repriced in each period, and the relative changes in interest rates on different types of assets and liabilities.

At June 30, 2007 total outstanding loans and leases repricing or repaying within one year, two years and three years totaled approximately 66.7%, 80.2% and 88.6%, respectively, of total outstanding loans and leases. These loans and leases repricing or repaying include variable rate loans that may reprice, fixed rate loans and leases that are maturing and principal cash flows from regularly scheduled payments on fixed rate loans and leases during each of the respective time periods.

 

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Item 4. Controls and Procedures

 

  (a) Evaluation of disclosure controls and procedures.

An evaluation as of the end of the period covered by this quarterly report was carried out under the supervision and with the participation of the Company’s management, including the Company’s Chairman and Chief Executive Officer and its Chief Financial Officer and Chief Accounting Officer, of the effectiveness of the design and operation of the Company’s “disclosure controls and procedures,” which are defined under SEC rules as controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files under the Exchange Act is recorded, processed, summarized and reported within required time periods. Based upon that evaluation, the Company’s Chairman and Chief Executive Officer and its Chief Financial Officer and Chief Accounting Officer concluded that the Company’s disclosure controls and procedures were effective.

 

  (b) Changes in Internal Control over Financial Reporting.

The Company’s management, including the Company’s Chairman and Chief Executive Officer and its Chief Financial Officer and Chief Accounting Officer, has evaluated any changes in the Company’s internal control over financial reporting that occurred during the quarterly period covered by this report and has concluded that there was no change during the quarterly period covered by this report that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

(The remainder of this page intentionally left blank)

 

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Table of Contents

PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings

The Company is party to various litigation matters arising in the ordinary course of business. While the ultimate resolution of these matters cannot be determined at this time, management of the Company does not believe that such matters, individually or in the aggregate, will have a material adverse effect on the future results of operations, financial condition or liquidity of the Company.

 

Item 1A. Risk Factors

There have been no material changes to the risk factors disclosed in Item 1A. Risk Factors in the Company’s 2006 annual report on Form 10-K filed with the Securities and Exchange Commission on March 12, 2007.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

The Company had no unregistered sales of equity securities and did not purchase any shares of its common stock during the period covered by this report.

 

Item 3. Defaults Upon Senior Securities

Not Applicable.

 

Item 4. Submission of Matters to a Vote of Security Holders

Reference is made to Part II, Item 4 of the Company’s quarterly report on Form 10-Q for the period ended March 31, 2007, filed with the Securities and Exchange Commission on May 8, 2007.

 

Item 5. Other Information

Not Applicable.

 

Item 6. Exhibits

Reference is made to the Exhibit Index set forth immediately following the signature page of this report.

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SIGNATURE

Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

    Bank of the Ozarks, Inc.
DATE: August 9, 2007    

/s/ Paul Moore

    Paul Moore
    Chief Financial Officer and Chief Accounting Officer

 

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Table of Contents

Bank of the Ozarks, Inc.

Exhibit Index

 

Exhibit
Number

   

3 (i) (a)

  Amended and Restated Articles of Incorporation of the Registrant, dated May 22, 1997 (previously filed as Exhibit 3.1 to the Company’s Registration Statement on Form S-1 filed with the Commission on May 22, 1997, as amended, Commission File No. 333-27641, and incorporated herein by this reference).

3 (i) (b)

  Articles of Amendment to the Amended and Restated Articles of Incorporation of the Registrant dated December 9, 2003 (previously filed as Exhibit 3.2 to the Company’s Annual Report on Form 10-K filed with the Commission on March 12, 2004 for the year ended December 31, 2003, and incorporated herein by this reference).

3 (ii)

  Amended and Restated Bylaws of the Registrant, dated March 13, 1997 (previously filed as Exhibit 3.2 to the Company’s Registration Statement on Form S-1 filed with the Commission on May 22, 1997, as amended, Commission File No. 333-27641, and incorporated herein by this reference).

31.1

  Certification of Chairman and Chief Executive Officer.

31.2

  Certification of Chief Financial Officer and Chief Accounting Officer.

32.1

  Certification of Chairman and Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2

  Certification of Chief Financial Officer and Chief Accounting Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

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