SIMMONS FIRST NATIONAL CORPORATION 10-Q
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q

QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
For Quarter Ended September 30, 2006 
Commission File Number 0-6253
 
SIMMONS FIRST NATIONAL CORPORATION
(Exact name of registrant as specified in its charter)
 
Arkansas
71-0407808
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification No.)
   
501 Main Street, Pine Bluff, Arkansas
71601
(Address of principal executive offices)
(Zip Code)

870-541-1000  
(Registrant's telephone number, including area code)
 
Not Applicable
Former name, former address and former fiscal year, if changed since last report
 
 
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.  x Yes  o No
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
o Large accelerated filer     x Accelerated filer     o Non-accelerated filer 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act.).  o Yes  x No
 
The number of shares outstanding of the Registrant’s Common Stock as of October 27, 2006 was 14,206,728.
 
 
Simmons First National Corporation
Quarterly Report on Form 10-Q
September 30, 2006
 
INDEX
 
   
Page No.
  
Part I:      Financial Information    
       
   
       
     
   
       
     
     
   
       
     
   
       
 
 
  
   
       
   
       
   
       
   
   
       
 
       
 
       
   
       
 
       
 
       
 
       
       
   


Part I: Financial Information
Item 1. Financial Statements

Simmons First National Corporation
Consolidated Balance Sheets
September 30, 2006 and December 31, 2005
 
ASSETS
 
   
September 30,
 
December 31,
  
(In thousands, except share data)
  
2006
 
2005
 
   
(Unaudited)
      
Cash and non-interest bearing balances due from banks
  
$
77,724
  
$
75,461
  
Interest bearing balances due from banks
    
19,599
    
14,397
  
Federal funds sold
    
49,340
    
11,715
  
Cash and cash equivalents
    
146,663
    
101,573
  
               
Investment securities
    
531,505
    
521,789
  
Mortgage loans held for sale
    
6,591
    
7,857
  
Assets held in trading accounts
    
4,574
    
4,631
  
Loans
    
1,788,517
    
1,718,107
  
Allowance for loan losses
    
(25,879
)
  
(26,923
)
Net loans
    
1,762,638
    
1,691,184
  
               
Premises and equipment
    
66,769
    
63,360
  
Foreclosed assets held for sale, net
    
1,413
    
1,540
  
Interest receivable
    
21,953
    
18,754
  
Bank owned life insurance
    
35,708
    
33,269
  
Goodwill
    
60,605
    
60,605
  
Core deposit premiums
    
4,406
    
5,029
  
Other assets
    
14,117
    
14,177
  
               
TOTAL ASSETS
  
$
2,656,942
  
$
2,523,768
  

See Condensed Notes to Consolidated Financial Statements.
3
 
Simmons First National Corporation
Consolidated Balance Sheets
September 30, 2006 and December 31, 2005
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
   
September 30,
 
December 31,
  
(In thousands, except share data)
  
2006
  
2005
  
   
(Unaudited)
      
LIABILITIES
          
Non-interest bearing transaction accounts
  
$
302,700
  
$
331,113
  
Interest bearing transaction accounts and savings deposits
    
745,649
    
749,925
  
Time deposits
    
1,100,127
    
978,920
  
Total deposits
    
2,148,476
    
2,059,958
  
Federal funds purchased and securities sold
              
under agreements to repurchase
    
85,535
    
107,223
  
Short-term debt
    
61,850
    
8,031
  
Long-term debt
    
82,173
    
87,020
  
Accrued interest and other liabilities
    
24,316
    
17,451
  
Total liabilities
    
2,402,350
    
2,279,683
  
               
STOCKHOLDERS’ EQUITY
              
Capital stock
              
Class A, common, par value $0.01 a share, authorized
              
30,000,000 shares, 14,188,008 issued and outstanding
              
at 2006 and 14,326,923 at 2005
    
142
    
143
  
Surplus
    
49,068
    
53,723
  
Undivided profits
    
208,200
    
194,579
  
Accumulated other comprehensive income (loss)
              
Unrealized appreciation (depreciation) on available-for-sale securities,
              
net of income tax credits of $1,691 at 2006 and $2,615 at 2005
   
(2,818
)
  
(4,360
)
Total stockholders’ equity
    
254,592
    
244,085
  
               
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
  
$
2,656,942
  
$
2,523,768
  
 
See Condensed Notes to Consolidated Financial Statements.
4
 
Simmons First National Corporation
Consolidated Statements of Income
Three Months and Nine Months Ended September 30, 2006 and 2005
 
   
Three Months Ended
  
Nine Months Ended
  
   
September 30,
  
September 30,
  
(In thousands, except per share data)
  
2006
  
2005
  
2006
  
2005
  
   
(Unaudited)
  
(Unaudited)
  
INTEREST INCOME
                  
Loans
  
$
33,924
  
$
29,225
  
$
95,705
  
$
81,813
  
Federal funds sold
   
325
    
262
    
692
    
863
  
Investment securities
    
5,183
    
4,693
    
14,991
    
13,926
  
Mortgage loans held for sale
   
141
    
168
    
369
    
421
  
Assets held in trading accounts
    
14
    
25
    
58
    
74
  
Interest bearing balances due from banks
    
229
    
119
    
785
    
418
  
TOTAL INTEREST INCOME
    
39,816
    
34,492
    
112,600
    
97,515
  
                           
INTEREST EXPENSE
                          
Deposits
    
14,404
    
9,046
    
38,313
    
23,889
  
Federal funds purchased and securities sold
                          
under agreements to repurchase
    
1,152
    
815
    
3,320
    
2,088
  
Short-term debt
    
761
    
646
    
1,082
    
790
  
Long-term debt
    
1,122
    
1,113
    
3,364
    
3,306
  
TOTAL INTEREST EXPENSE
    
17,439
    
11,620
    
46,079
    
30,073
  
                           
NET INTEREST INCOME
    
22,377
    
22,872
    
66,521
    
67,442
  
Provision for loan losses
    
602
    
1,736
    
3,099
    
5,895
  
                           
NET INTEREST INCOME AFTER PROVISION
                          
FOR LOAN LOSSES
    
21,775
    
21,136
    
63,422
    
61,547
  
                           
NON-INTEREST INCOME
                          
Trust income
    
1,435
    
1,430
    
4,095
    
4,164
  
Service charges on deposit accounts
    
3,973
    
4,154
    
11,945
    
11,721
  
Other service charges and fees
    
596
    
472
    
1,846
    
1,511
  
Income on sale of mortgage loans, net of commissions
    
763
    
826
    
2,194
    
2,221
  
Income on investment banking, net of commissions
    
55
    
146
    
252
    
364
  
Credit card fees
    
2,755
    
2,619
    
7,912
    
7,543
  
Premiums on sale of student loans
    
413
    
295
    
1,808
    
1,572
  
Bank owned life insurance income
    
382
    
279
    
1,098
    
636
  
Other income
    
654
    
519
    
2,004
    
2,078
  
Gain (loss) on sale of securities, net of taxes
    
--
    
--
    
--
    
(168
)
TOTAL NON-INTEREST INCOME
    
11,026
    
10,740
    
33,154
    
31,642
  
                           
NON-INTEREST EXPENSE
                          
Salaries and employee benefits
    
13,298
    
12,703
    
40,269
    
38,231
  
Occupancy expense, net
    
1,612
    
1,483
    
4,673
    
4,314
  
Furniture and equipment expense
    
1,407
    
1,421
    
4,281
    
4,277
  
Loss on foreclosed assets
    
32
    
57
    
105
    
160
  
Deposit insurance
    
64
    
72
    
204
    
214
  
Other operating expenses
    
5,722
    
5,490
    
17,029
    
16,412
  
TOTAL NON-INTEREST EXPENSE
    
22,135
    
21,226
    
66,561
    
63,608
  
                           
INCOME BEFORE INCOME TAXES
    
10,666
    
10,650
    
30,015
    
29,581
  
Provision for income taxes
    
3,219
    
3,316
    
9,284
    
9,444
  
NET INCOME
  
$
7,447
  
$
7,334
  
$
20,731
  
$
20,137
  
BASIC EARNINGS PER SHARE
  
$
0.53
  
$
0.51
  
$
1.46
  
$
1.40
  
DILUTED EARNINGS PER SHARE
  
$
0.51
  
$
0.50
  
$
1.43
  
$
1.37
  
 
 
See Condensed Notes to Consolidated Financial Statements.
5
 
Simmons First National Corporation
Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2006 and 2005
 
 
 
September 30,
 
September 30,
 
(In thousands)
 
2006
 
2005
  
OPERATING ACTIVITIES
  
(Unaudited)
  
Net income
  
$
20,731
  
$
20,137
  
Items not requiring (providing) cash
              
Depreciation and amortization
    
4,104
    
4,052
  
Provision for loan losses
    
3,099
    
5,895
  
Net amortization (accretion) of investment securities
    
185
    
247
  
Deferred income taxes
    
864
    
(1,227
)
(Gain) loss on sale of securities, net of taxes
    
--
    
168
  
Bank owned life insurance income 
    
(1,098
)
  
(636
)
Changes in
              
Interest receivable
    
(3,199
)
  
(4,307
)
Mortgage loans held for sale
    
1,266
    
(171
)
Assets held in trading accounts
    
56
    
186
  
Other assets
    
61
    
106
  
Accrued interest and other liabilities
    
7,445
    
4,224
  
Income taxes payable
    
(1,444
)
  
(1,515
)
Net cash provided (used) by operating activities
    
32,070
    
27,159
  
               
INVESTING ACTIVITIES
              
Net originations of loans
    
(75,408
)
  
(144,918
)
Purchases of premises and equipment, net
    
(6,890
)
  
(7,573
)
Proceeds from sale of foreclosed assets
    
982
    
1,568
  
Proceeds from sale of securities
    
1,542
    
1,225
  
Proceeds from maturities of available-for-sale securities
    
78,503
    
58,757
  
Purchases of available-for-sale securities
    
(65,625
)
  
(60,671
)
Proceeds from maturities of held-to-maturity securities
    
18,841
    
24,071
  
Purchases of held-to-maturity securities
    
(41,620
)
  
(24,140
)
Purchase of bank owned life insurance
   
(1,341
)
  
(25,000
)
Net cash provided (used) by investing activities
    
(91,016
)
  
(176,681
)
               
FINANCING ACTIVITIES
              
Net increase (decrease) in deposits
    
88,518
    
88,532
  
Net proceeds (repayments) of short-term debt
    
53,819
    
90,374
  
Dividends paid
    
(7,110
)
  
(6,464
)
Proceeds from issuance of long-term debt
    
6,785
    
1,821
  
Repayment of long-term debt
    
(11,632
)
  
(9,488
)
Net increase (decrease) in federal funds purchased and
             
securities sold under agreements to repurchase
    
(21,688
)
  
(12,465
)
Repurchase of common stock, net
    
(4,656
)
  
(8,400
)
Net cash provided (used) by financing activities
    
104,036
    
143,910
  
               
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
    
45,090
    
(5,612
)
CASH AND CASH EQUIVALENTS,
             
BEGINNING OF PERIOD
    
101,573
    
153,731
  
CASH AND CASH EQUIVALENTS, END OF PERIOD
  
$
146,663
  
$
148,119
  
 
 
See Condensed Notes to Consolidated Financial Statements.
6
 
Simmons First National Corporation
Consolidated Statements of Stockholders’ Equity
Nine Months Ended September 30, 2006 and 2005
 
   
 
 
 
 
Accumulated
 
 
 
 
 
 
 
 
 
 
 
Other
 
 
 
 
 
 
 
Common
 
 
Comprehensive
 
Undivided
 
 
 
(In thousands, except share data)
 
Stock
 
Surplus
 
Income (loss)
 
Profits
 
Total
  
                       
Balance, December 31, 2004
  
$
146
  
$
62,826
  
$
(1,124
)
$
176,374
  
$
238,222
  
Comprehensive income
                                
Net income
    
--
    
--
    
--
    
20,137
    
20,137
  
Change in unrealized depreciation on
                                
available-for-sale securities, net of
                                
income tax credit of $1,394
    
--
    
--
    
(2,324
)
  
--
    
(2,324
)
Comprehensive income
                            
17,813
  
Stock issued as bonus shares - 5,620 shares
    
--
    
138
    
--
    
--
    
138
  
Exercise of stock options - 80,460 shares
    
1
    
1,112
    
--
    
--
    
1,113
  
Securities exchanged under stock option plan
    
(1
)
  
(775
)
  
--
    
--
    
(776
)
Repurchase of common stock - 341,995 shares
   
(3
)
  
(8,872
)
  
--
    
--
    
(8,875
)
Dividends paid - $0.45 per share
    
--
    
--
    
--
    
(6,464
)
  
(6,464
)
                                 
Balance, September 30, 2005 (Unaudited)
    
143
    
54,429
    
(3,448
)
  
190,047
    
241,171
  
Comprehensive income
                                
Net income
    
--
    
--
    
--
    
6,825
    
6,825
  
Change in unrealized depreciation on
                                
available-for-sale securities, net of
                               
income tax credit of $548
    
--
    
--
    
(912
)
  
--
    
(912
)
Comprehensive income
                            
5,913
  
Exercise of stock options - 25,960 shares
    
--
    
320
    
--
    
--
    
320
  
Securities exchanged under stock option plan
   
1
    
(213
)
  
--
    
--
    
(212
)
Repurchase of common stock - 29,458 shares
    
(1
)
  
(813
)
  
--
    
--
    
(814
)
Dividends paid - $0.16 per share
    
--
    
--
    
--
    
(2,293
)
  
(2,293
)
                                 
Balance, December 31, 2005
    
143
    
53,723
    
(4,360
)
  
194,579
    
244,085
  
Comprehensive income
                                
Net income
    
--
    
--
    
--
    
20,731
    
20,731
  
Change in unrealized depreciation on
                                
available-for-sale securities, net of
                                
income taxes of $924
    
--
    
--
    
1,542
    
--
    
1,542
  
Comprehensive income
                            
22,274
  
Stock issued as bonus shares - 10,200 shares
    
--
    
275
    
--
    
--
    
275
  
Exercise of stock options - 67,580 shares
    
1
    
992
    
--
    
--
    
993
  
Securities exchanged under stock option plan
    
--
    
(799
)
  
--
    
--
    
(799
)
Stock granted under
                                
stock-based compensation plans
    
--
    
69
    
--
    
--
    
69
  
Repurchase of common stock - 188,900 shares
    
(2
)
  
(5,192
)
  
--
    
--
    
(5,194
)
Dividends paid - $0.50 per share
    
--
    
--
    
--
    
(7,110
)
  
(7,110
)
                                 
Balance, September 30, 2006 (Unaudited)
  
$
142
  
$
49,068
  
$
(2,818
)
$
208,200
  
$
254,592
  
 
 
See Condensed Notes to Consolidated Financial Statements.
7
 
SIMMONS FIRST NATIONAL CORPORATION

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1: ACCOUNTING POLICIES

The consolidated financial statements include the accounts of Simmons First National Corporation and its subsidiaries. Significant intercompany accounts and transactions have been eliminated in consolidation.

All adjustments made to the unaudited financial statements were of a normal recurring nature. In the opinion of management, all adjustments necessary for a fair presentation of the results of interim periods have been made. Certain prior year amounts are reclassified to conform to current year classification. The consolidated balance sheet of the Company as of December 31, 2005 has been derived from the audited consolidated balance sheet of the Company as of that date. The results of operations for the period are not necessarily indicative of the results to be expected for the full year.

Certain information and note disclosures normally included in the Company’s annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Form 10-K annual report for 2005 filed with the Securities and Exchange Commission.

On January 1, 2006, the Company began recognizing compensation expense for stock options with the adoption of Statement of Financial Accounting Standards (SFAS) No. 123, Share-Based Payment (Revised 2004). See Note 11 - Stock Based Compensation for additional information. There have been no other significant changes to the Company’s accounting policies from the 2005 Form 10-K.

Earnings Per Share

Basic earnings per share are computed based on the weighted average number of common shares outstanding during each year. Diluted earnings per share are computed using the weighted average common shares and all potential dilutive common shares outstanding during the period.

Following is the computation of per share earnings for the three and nine months ended September 30, 2006 and 2005.
 

   
Three Months Ended
 
Nine Months Ended
 
 
 
September 30,
 
September 30,
 
(In thousands, except per share data)
 
2006
 
2005
 
2006
 
2005
  
                   
Net income
  
$
7,447
  
$
7,334
  
$
20,731
  
$
20,137
  
                           
Average common shares outstanding
    
14,196
    
14,357
    
14,236
    
14,386
  
Average potential dilutive common shares
    
255
    
297
    
255
    
297
  
Average diluted common shares
   
14,451
    
14,654
    
14,491
    
14,683
  
                           
Basic earnings per share
  
$
0.53
  
$
0.51
  
$
1.46
  
$
1.40
  
Diluted earnings per share
  
$
0.51
  
$
0.50
  
$
1.43
  
$
1.37
  
 
 
8
 
NOTE 2: INVESTMENT SECURITIES

The amortized cost and fair value of investment securities that are classified as held-to-maturity and available-for-sale are as follows:
 
   
September 30,
  
December 31,
 
   
2006
  
2005
  
   
 
 
Gross
 
Gross
 
Estimated
 
 
 
Gross
 
Gross
 
Estimated
 
 
 
Amortized
 
Unrealized
 
Unrealized
 
Fair
 
Amortized
 
Unrealized
 
Unrealized
 
Fair
 
(In thousands)
 
Cost
 
Gains
 
(Losses)
 
Value
 
Cost
 
Gains
 
(Losses)
 
Value
  
                                   
Held-to-Maturity
                                  
U.S. Treasury
  
$
1,001
  
$
--
  
$
(4
)
$
997
  
$
1,004
  
$
--
  
$
(20
)
$
984
  
U.S. Government
                                                  
agencies
    
53,000
    
107
    
(115
)
  
52,992
    
28,000
    
--
    
(473
)
  
27,527
  
Mortgage-backed
                                                  
securities
    
161
    
3
    
(1
)
  
163
    
187
    
3
    
--
    
190
  
State and political
                                                  
subdivisions
    
116,481
    
314
    
(297
)
  
116,498
    
117,148
    
662
    
(1,298
)
  
116,512
  
Other securities
    
2,301
    
--
    
--
    
2,301
    
3,960
    
--
    
--
    
3,960
  
                                                   
   
$
172,944
  
$
424
  
$
(417
)
$
172,951
  
$
150,299
  
$
665
  
$
(1,791
)
$
149,173
  
                                                   
Available-for-Sale
                                                  
U.S. Treasury
  
$
6,792
  
$
--
  
$
(43
)
$
6,749
  
$
10,989
  
$
--
  
$
(102
)
$
10,887
  
U.S. Government
                                                  
agencies
    
336,545
    
--
    
(4,836
)
  
331,709
    
348,570
    
35
    
(7,615
)
  
340,990
  
Mortgage-backed
                                                  
securities
    
3,187
    
--
    
(92
)
  
3,095
    
3,392
    
9
    
(92
)
  
3,309
  
State and political
                                                  
subdivisions
    
1,360
    
13
    
--
    
1,373
    
3,014
    
39
    
--
    
3,053
  
Other securities
    
15,183
    
452
    
--
    
15,635
    
12,561
    
690
    
--
    
13,251
  
                                                   
   
$
363,067
  
$
465
  
$
(4,971
)
$
358,561
  
$
378,526
  
$
773
  
$
(7,809
)
$
371,490
  

 
The carrying value, which approximates the fair value, of securities pledged as collateral, to secure public deposits and for other purposes, amounted to $398,516,000 at September 30, 2006 and $411,580,000 at December 31, 2005.

The book value of securities sold under agreements to repurchase amounted to $70,610,000 and $67,778,000 for September 30, 2006 and December 31, 2005, respectively.

 
9

 
Income earned on securities for the nine months ended September 30, 2006 and 2005, is as follows:
 
(In thousands)
  
2006
  
2005
  
           
Taxable
          
Held-to-maturity
  
$
1,321
  
$
773
  
Available-for-sale
    
10,136
    
9,542
  
               
Non-taxable
              
Held-to-maturity
    
3,454
    
3,460
  
Available-for-sale
    
80
    
151
  
               
Total
  
$
14,991
  
$
13,926
  
 

Maturities of investment securities at September 30, 2006 are as follows:


   
Held-to-Maturity
  
Available-for-Sale
  
   
Amortized
 
Fair
 
Amortized
 
Fair
 
(In thousands)
 
Cost
 
Value
 
Cost
 
Value
  
                   
One year or less
  
$
19,459
  
$
19,377
  
$
102,837
  
$
101,962
  
After one through five years
    
54,952
    
54,831
    
161,855
    
158,704
  
After five through ten years
    
82,370
    
82,384
    
79,082
    
78,168
  
After ten years
    
14,792
    
14,988
    
4,112
    
4,092
  
Other securities
    
1,371
    
1,371
    
15,181
    
15,635
  
                           
Total
  
$
172,944
  
$
172,951
  
$
363,067
  
$
358,561
  

 
Gross realized losses of $0 and $275,000 were recognized for the nine-month periods ended September 30, 2006 and 2005. There were no realized gains over the same periods.

Most of the state and political subdivision debt obligations are non-rated bonds and represent small, Arkansas issues, which are evaluated on an ongoing basis.
 
10
 
NOTE 3: LOANS AND ALLOWANCE FOR LOAN LOSSES

The various categories are summarized as follows:
 
   
September 30,
 
December 31,
 
(In thousands)
 
2006
 
2005
  
           
Consumer
          
Credit cards
  
$
133,607
  
$
143,058
  
Student loans
    
86,875
    
89,818
  
Other consumer
    
146,039
    
138,051
  
Real Estate
              
Construction
    
267,600
    
238,898
  
Single family residential
    
364,657
    
340,839
  
Other commercial
    
494,514
    
479,684
  
Commercial
              
Commercial
    
175,576
    
184,920
  
Agricultural
    
103,301
    
68,761
  
Financial institutions
    
576
    
20,499
  
Other
    
15,772
    
13,579
  
               
Total loans before allowance for loan losses
  
$
1,788,517
  
$
1,718,107
  
 
As of September 30, 2006, credit card loans, which are unsecured, were $133,607,000, or 7.5% of total loans, versus $143,058,000, or 8.3% of total loans at December 31, 2005. The credit card loans are diversified by geographic region to reduce credit risk and minimize any adverse impact on the portfolio. Credit card loans are regularly reviewed to facilitate the identification and monitoring of creditworthiness.

At September 30, 2006 and December 31, 2005, impaired loans totaled $11,961,000 and $14,804,000, respectively. All impaired loans had either specific or general allocations within the allowance for loan losses. Allocations of the allowance for loan losses relative to impaired loans were $4,060,000 at September 30, 2006 and $3,868,000 at December 31, 2005. Approximately $297,000 and $313,000 of interest income was recognized on average impaired loans of $13,133,000 and $15,984,000 as of September 30, 2006 and 2005, respectively. Interest recognized on impaired loans on a cash basis during the first nine months of 2006 and 2005 was immaterial.
 
11
 
Transactions in the allowance for loan losses are as follows:
 
 
 
September 30,
 
December 31,
 
(In thousands)
 
2006
 
2005
  
           
Balance, beginning of year
  
$
26,923
  
$
26,508
  
Additions
              
Provision charged to expense
    
3,099
    
5,895
  
     
30,022
    
32,403
  
Deductions
              
Losses charged to allowance, net of recoveries
              
of $2,266 and $3,305 for the first nine months of
              
2006 and 2005, respectively
    
2,618
    
5,074
  
Reclassification of reserve related to unfunded commitments (1)
    
1,525
    
--
  
               
Balance, September 30
  
$
25,879
    
27,329
  
               
Additions
              
Provision charged to expense
          
1,631
  
               
Deductions
              
Losses charged to allowance, net of recoveries
              
of $511 for the last three months of 2005
        
2,037
  
               
Balance, end of year
        
$
26,923
  
 
(1)
On March 31, 2006, the reserve for unfunded commitments was reclassified from the allowance for loan losses to other liabilities.

NOTE 4: GOODWILL AND CORE DEPOSIT PREMIUMS

Goodwill is tested annually for impairment. If the implied fair value of goodwill is lower than its carrying amount, goodwill impairment is indicated and goodwill is written down to its implied fair value. Subsequent increases in goodwill value are not recognized in the financial statements.

Core deposit premiums are periodically evaluated as to the recoverability of their carrying value.

The carrying basis and accumulated amortization of core deposit premiums (net of core deposit premiums that were fully amortized) at September 30, 2006 and December 31, 2005, were as follows:
 
   
September 30,
 
December 31,
 
(In thousands)
 
2006
 
2005
  
           
Gross carrying amount
  
$
7,246
  
$
7,246
  
Accumulated amortization
    
(2,840
)
  
(2,217
)
               
Net core deposit premiums
  
$
4,406
  
$
5,029
  
 
12
 
Core deposit premium amortization expense recorded for the nine months ended September 30, 2006 and 2005, was $623,000 and $622,000, respectively. The Company’s estimated amortization expense for the remainder of 2006 is $207,000, and for each of the following four years is:
2007 – $818,000; 2008 – $807,000; 2009 – $802,000; and 2010 – $698,000.

NOTE 5: TIME DEPOSITS

Time deposits include approximately $436,022,000 and $364,177,000 of certificates of deposit of $100,000 or more at September 30, 2006 and December 31, 2005 respectively.

NOTE 6: INCOME TAXES

The provision for income taxes is comprised of the following components:
 
   
September 30,
 
September 30,
 
(In thousands)
 
2006
 
2005
  
           
Income taxes currently payable
  
$
10,148
  
$
10,671
  
Deferred income taxes
   
(864
)
  
(1,227
)
               
Provision for income taxes
  
$
9,284
  
$
9,444
  
 
The tax effects of temporary differences related to deferred taxes shown on the balance sheets were:
 
 
 
September 30,
 
December 31,
 
(In thousands)
 
2006
 
2005
  
           
Deferred tax assets
          
Allowance for loan losses
  
$
8,655
  
$
8,329
  
Valuation of foreclosed assets
    
63
    
74
  
Deferred compensation payable
    
1,230
    
1,109
  
FHLB advances
    
64
    
97
  
Vacation compensation
    
757
    
727
  
Loan interest
    
140
    
241
  
Available-for-sale securities
    
1,691
    
2,615
  
Other
    
393
    
363
  
Total deferred tax assets
    
12,993
    
13,555
  
               
Deferred tax liabilities
              
Accumulated depreciation
   
(867
)
  
(1,128
)
Deferred loan fee income and expenses, net
    
(771
)
  
(657
)
FHLB stock dividends
    
(847
)
  
(740
)
Goodwill and core deposit premium amortization
    
(5,044
)
  
(3,852
)
Other
    
(880
)
  
(807
)
Total deferred tax liabilities
    
(8,409
)
  
(7,184
)
               
Net deferred tax assets included in other
              
assets on balance sheets
  
$
4,584
  
$
6,371
  
 
 
13

A reconciliation of income tax expense at the statutory rate to the Company's actual income tax expense is shown below:
 
   
September 30,
 
September 30,
 
(In thousands)
 
2006
 
2005
  
           
Computed at the statutory rate (35%)
  
$
10,505
  
$
10,353
  
               
Increase (decrease) resulting from:
              
Tax exempt income
    
(1,389
)
  
(1,422
)
Other differences, net
    
168
    
513
  
               
Actual tax provision
  
$
9,284
  
$
9,444
  
 
NOTE 7: SHORT-TERM AND LONG-TERM DEBT

Long-term debt at September 30, 2006 and December 31, 2005, consisted of the following components:
 
   
September 30,
 
December 31,
 
(In thousands)
 
2006
 
2005
  
           
Note Payable, due 2007, at a floating rate of
          
0.90% above the one-month LIBOR rate, reset
          
monthly, unsecured
 
$
2,000
  
$
4,000
  
FHLB advances, due 2006 to 2024, 2.58% to 8.41%
            
secured by residential real estate loans
    
49,243
    
52,090
  
Trust preferred securities, due 2033,
             
fixed at 8.25%, callable in 2008 without penalty
    
10,310
    
10,310
  
Trust preferred securities, due 2033,
             
floating rate of 2.80% above the three-month LIBOR
             
rate, reset quarterly, callable in 2008 without penalty
    
10,310
    
10,310
  
Trust preferred securities, due 2033,
             
fixed rate of 6.97% through 2010, thereafter,
              
at a floating rate of 2.80% above the three-month
              
LIBOR rate, reset quarterly, callable
             
in 2010 without penalty
    
10,310
    
10,310
  
               
   
$
82,173
  
$
87,020
  
 
At September 30, 2006 the Company had Federal Home Loan Bank (“FHLB”) advances with original maturities of one year or less of $59.7 million with a weighted average rate of 5.30% which are not included in the above table.

The trust preferred securities are tax-advantaged issues that qualify for Tier 1 capital treatment. Distributions on these securities are included in interest expense on long-term debt. Each of the trusts is a statutory business trust organized for the sole purpose of issuing trust securities and investing the proceeds thereof in junior subordinated debentures of the Company, the sole asset of each trust. The preferred securities of each trust represent preferred beneficial interests in the assets of the respective trusts and are subject to mandatory redemption upon payment of the junior subordinated debentures held by the trust. The common securities of each trust are wholly-owned by the Company. Each trust’s ability to pay amounts due on the trust preferred securities is solely dependent upon the Company making payment on the related junior subordinated debentures. The Company’s obligations under the junior subordinated securities and other relevant trust agreements, in aggregate, constitute a full and unconditional guarantee by the Company of each respective trust’s obligations under the trust securities issued by each respective trust.

14
 
Aggregate annual maturities of long-term debt at September 30, 2006 are:
 
   
 
  
Annual
  
(In thousands)
  
Year
  
Maturities
  
           
     
2006
  
$
3,244
  
     
2007
    
10,154
  
     
2008
    
12,939
  
     
2009
    
5,767
  
     
2010
   
2,446
  
   
Thereafter
    
47,623
  
               
   
Total
 
$
82,173
  
 
NOTE 8: CONTINGENT LIABILITIES

The Company and/or its subsidiaries have various unrelated legal proceedings, most of which involve loan foreclosure activity pending, which, in the aggregate, are not expected to have a material adverse effect on the financial position of the Company and its subsidiaries. The Company or its subsidiaries remain the subject of two (2) lawsuits asserting claims against the Company or its subsidiaries.

On October 1, 2003, an action in Pulaski County Circuit Court was filed by Thomas F. Carter, Tena P. Carter and certain related entities against Simmons First Bank of South Arkansas and Simmons First National Bank alleging wrongful conduct by the banks in the collection of certain loans. The plaintiffs are seeking $2,000,000 in compensatory damages and $10,000,000 in punitive damages. The Company has filed a Motion to Dismiss. The plaintiffs have been granted additional time to discover any evidence for litigation. At this time, no basis for any material liability has been identified. The Company and the banks plan to vigorously defend the claims asserted in the suit.

On April 3, 2006, an action in Johnson County Circuit Court was filed by Tria Xiong and Mai Lee Xiong against Simmons First Bank of Russellville and certain individuals alleging wrongful conduct by the bank in the underwriting and origination of certain loans. The plaintiffs are seeking an unspecified sum in compensatory damages and $1,000,000.00 in punitive damages. Discovery is in process, and the suit is pending, with no court date set. At this time, no basis for any material liability has been identified. The bank plans to vigorously defend the claims asserted in the suit.

On June 22, 2006, an action in Johnson County Circuit Court was filed by Wa Khue Moua and Maycha Moua against Simmons First Bank of Russellville alleging wrongful conduct by the bank in the underwriting and origination of certain loans. The plaintiffs were seeking $275,000.00 in compensatory damages and $500,000.00 in punitive damages. On October 6, 2006, an Order of Dismissal was signed in Johnson County Circuit Court dismissing the case without prejudice.
 
15

NOTE 9: CAPITAL STOCK

On May 25, 2004, the Company announced the adoption by the Board of Directors of a stock repurchase program. The program authorizes the repurchase of up to 5% of the then outstanding Common Stock, or 733,485 shares. Under the repurchase program, there is no time limit for the stock repurchases, nor is there a minimum number of shares the Company intends to repurchase. The Company may discontinue purchases at any time that management determines additional purchases are not warranted. The shares are to be purchased from time to time at prevailing market prices, through open market or unsolicited negotiated transactions, depending upon market conditions. The Company intends to use the repurchased shares to satisfy stock option exercises, payment of future stock dividends and general corporate purposes.

During the nine-month period ended September 30, 2006, the Company repurchased 188,900 shares of stock under the repurchase plan with a weighted average repurchase price of $27.54 per share. Under the current stock repurchase plan, the Company can repurchase an additional 355,167 shares.

NOTE 10: UNDIVIDED PROFITS

The Company’s subsidiary banks are subject to a legal limitation on dividends that can be paid to the parent company without prior approval of the applicable regulatory agencies. The approval of the Comptroller of the Currency is required, if the total of all dividends declared by a national bank in any calendar year exceeds the total of its net profits, as defined, for that year combined with its retained net profits of the preceding two years. Arkansas bank regulators have specified that the maximum dividend limit state banks may pay to the parent company without prior approval is 75% of current year earnings plus 75% of the retained net earnings of the preceding year. At September 30, 2006, the bank subsidiaries had approximately $12 million available for payment of dividends to the Company, without prior approval of the regulatory agencies.

The Federal Reserve Board's risk-based capital guidelines include the definitions for (1) a well-capitalized institution, (2) an adequately-capitalized institution, and (3) an undercapitalized institution. The criteria for a well-capitalized institution are: a 5% "Tier l leverage capital" ratio, a 6% "Tier 1 risk-based capital" ratio, and a 10% "total risk-based capital" ratio. As of September 30, 2006, each of the eight subsidiary banks met the capital standards for a well-capitalized institution. The Company's “total risk-based capital” ratio was 13.35% at September 30, 2006.

NOTE 11: STOCK BASED COMPENSATION

Prior to January 1, 2006, employee compensation expense under stock option plans was reported only if options were granted below market price at grant date in accordance with the intrinsic value method of Accounting Principles Board Opinion (APB) No.25, "Accounting for Stock Issued to Employees," and related interpretations. Because the exercise price of the Company's employee stock options always equaled the market price of the underlying stock on the date of grant, no compensation expense was recognized on options granted. As stated in Note 1 - Significant Accounting Policies, the Company adopted the provisions of SFAS 123R on January 1, 2006. SFAS 123R eliminates the ability to account for stock-based compensation using APB 25 and requires that such transactions be recognized as compensation cost in the income statement based on their fair values on the measurement date, which is generally the date of the grant. The Company transitioned to fair-value based accounting for stock based compensation using a modified version of prospective application ("modified prospective application"). Under modified prospective application, as it is applicable to the Company, SFAS 123R applies to new awards and to awards modified, repurchased, or cancelled after January 1, 2006. Additionally, compensation cost for the portion of awards for which the requisite service has not been rendered (generally referring to non-vested awards) that were outstanding as of January 1, 2006, will be recognized as the remaining requisite service is rendered during the period of and/or the periods after the adoption of SFAS 123R. The attribution of compensation cost for those earlier awards is based on the same method and on the same grant date fair values previously determined for the pro forma disclosures required for companies that did not previously adopt the fair value accounting method for stock-based employee compensation.

16
 
Stock-based compensation expense for all stock-based compensation awards granted after January 1, 2006, is based on the grant date fair value. For all awards except stock option awards, the grant date fair value is the market value per share as of the grant date. For stock option awards, the fair value is estimated at the date of grant using the Black-Scholes option-pricing model. This model requires the input of highly subjective assumptions, changes to which can materially affect the fair value estimate. Additionally, there may be other factors that would otherwise have a significant effect on the value of employee stock options granted but are not considered by the model. Accordingly, while management believes that the Black-Scholes option-pricing model provides a reasonable estimate of fair value, the model does not necessarily provide the best single measure of fair value for the Company's employee stock options.

As a result of applying the provisions of SFAS 123R during the three and nine months ended September 30, 2006, the Company recognized additional stock-based compensation expense related to stock options of $18,773 and $69,112. The increase in stock-based compensation expense related to stock options during the three and nine months ended September 30, 2006, resulted in no change in basic or diluted earnings per share.

Stock-based compensation expense totaled $18,773 and $213,341 during the three and nine months ended September 30, 2006 and $0 and $116,691 during the three and nine months ended September 30, 2005. Stock-based compensation expense is recognized ratably over the requisite service period for all stock-based awards. Unrecognized stock-based compensation expense related to stock options totaled $306,387 at September 30, 2006. At such date, the weighted-average period over which this unrecognized expense is expected to be recognized was 2.11 years. Unrecognized stock-based compensation expense related to non-vested stock awards was $437,456 at September 30, 2006. At such date, the weighted-average period over which this unrecognized expense is expected to be recognized was 2.48 years.

17

The following pro forma information presents net income and earnings per share for the three and nine months ended September 30, 2005, as if the fair value method of SFAS 123R had been applied.
 
   
Three Months Ended
  
Nine Months Ended
  
(In thousands, except per share data)
  
 September 30, 2005
  
 September 30, 2005
  
Net income, as reported
  
$
7,334
  
$
20,137
  
Add: Stock-based employee compensation included
              
in reported net income, net of related tax effects
    
--
    
73
  
Less: Total stock-based employee compensation
              
expense determined under fair value based method
              
for all awards, net of related tax effects
    
(65
)
  
(269
)
Pro forma net income
  
$
7,269
  
$
19,941
  
Earnings per share:
              
Basic - as reported
  
$
0.51
  
$
1.40
  
Basic - pro forma
  
$
0.51
  
$
1.39
  
               
Diluted - as reported
  
$
0.50
  
$
1.37
  
Diluted - pro forma
  
$
0.50
  
$
1.36
  
 
The Company’s Board of Directors has adopted various stock compensation plans. The plans provide for the grant of incentive stock options, nonqualified stock options, stock appreciation rights, and bonus stock awards. Pursuant to the plans, shares are reserved for future issuance by the Company, upon exercise of stock options or awarding of bonus shares granted to officers and other key employees.

The fair value of each option award is estimated on the date of grant using the Black-Scholes option-pricing model that uses various assumptions. Expected volatility is based on historical volatility of the Company’s stock and other factors. The Company uses historical data to estimate option exercise and employee termination within the valuation model. The expected term of options granted is derived from the output of the option valuation model and represents the period of time that options granted are expected to be outstanding. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. Forfeitures are estimated at the time of grant, and are based partially on historical experience.

18


The table below summarizes the transactions under the Company's stock option plans for the nine months ended September 30, 2006:
 
   
 
 
Weighted
 
 
 
 
 
Average
 
 
 
 
 
Exercisable
 
(In thousands, except per share data)
 
Shares
 
Price
  
           
Outstanding, January 1, 2006
    
609
  
$
14.77
  
Granted
    
60
    
26.19
  
Forfeited/Expired
    
(27)
 
  
13.50
  
Exercised
   
(68)
 
  
14.68
  
               
Outstanding, September 30, 2006
    
574
  
$
16.03
  
               
Exercisable at September 30, 2006
    
509
  
$
14.79
  
 
Total intrinsic value of options exercised for the nine months ended September 30, 2006, was $913,682.

There were 59,700 options granted during the nine months ended September 30, 2006. The weighted-average fair value of options granted during the nine months ended September 30, 2006 was $5.01. The following weighted-average assumptions were used to estimate the fair value of options granted during the nine months ended September 30, 2006:
   
Expected dividend yield
2.67%
Expected stock price volatility
17.74%
Risk-free interest rate
4.84%
Expected life of options
5 - 10 Years
 
As of September 30, 2006, there was $743,343 of total unrecognized compensation cost related to nonvested share-based compensation arrangements. That cost is expected to be recognized over a weighted-average period of 2.33 years.

NOTE 12: ADDITIONAL CASH FLOW INFORMATION
 
   
Nine Months Ended
 
 
 
September 30,
 
(In thousands)
 
2006
 
2005
  
           
Interest paid
  
$
43,552
  
$
29,019
  
Income taxes paid
  
$
9,865
  
$
9,732
  
 
19

NOTE 13: CERTAIN TRANSACTIONS

From time to time the Company and its subsidiaries have made loans and other extensions of credit to directors, officers, their associates and members of their immediate families. From time to time directors, officers and their associates and members of their immediate families have placed deposits with the Company’s subsidiary banks. Such loans, other extensions of credit and deposits were made in the ordinary course of business, on substantially the same terms (including interest rates and collateral) as those prevailing at the time for comparable transactions with other persons and did not involve more than normal risk of collectibility or present other unfavorable features.

NOTE 14: COMMITMENTS AND CREDIT RISK

The Company grants agri-business, commercial and residential loans to customers throughout Arkansas, along with credit card loans to customers throughout the United States. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since a portion of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Each customer's creditworthiness is evaluated on a case-by-case basis. The amount of collateral obtained, if deemed necessary, is based on management's credit evaluation of the counterparty. Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, commercial real estate and residential real estate.

At September 30, 2006, the Company had outstanding commitments to extend credit aggregating approximately $214,882,000 and $443,950,000 for credit card commitments and other loan commitments, respectively. At December 31, 2005, the Company had outstanding commitments to extend credit aggregating approximately $194,614,000 and $429,442,000 for credit card commitments and other loan commitments, respectively.

Letters of credit are conditional commitments issued by the Company, to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. The Company had total outstanding letters of credit amounting to $6,339,000 and $4,573,000 at September 30, 2006 and December 31, 2005, respectively, with terms ranging from 90 days to three years. At September 30, 2006 and December 31, 2005 the Company’s deferred revenue under standby letter of credit agreements is approximately $62,000 and $43,000, respectively.

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

BKD, LLP
 
Certified Public Accountants
200 East Eleventh
Pine Bluff, Arkansas
 

Audit Committee, Board of Directors and Stockholders
Simmons First National Corporation
Pine Bluff, Arkansas

We have reviewed the accompanying consolidated balance sheet of SIMMONS FIRST NATIONAL CORPORATION as of September 30, 2006, and the related consolidated statements of income for the three-month and nine-month periods ended September 30, 2006 and 2005, and the related consolidated statements of stockholders’ equity and cash flows for the nine-month periods ended September 30, 2006 and 2005. These interim financial statements are the responsibility of the Company’s management.

We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our reviews, we are not aware of any material modifications that should be made to the consolidated financial statements referred to above for them to be in conformity with accounting principles generally accepted in the United States of America.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet as of December 31, 2005, and the related consolidated statements of income, stockholders' equity and cash flows for the year then ended (not presented herein), and in our report dated February 15, 2006, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 2005, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
 
  /s/ BKD, LLP
  BKD, LLP
 
Pine Bluff, Arkansas
November 6, 2006
 
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Item 2.     Management’s Discussion and Analysis of Financial Condition
            and Results of Operations

OVERVIEW
 
Simmons First National Corporation recorded earnings of $7,447,000, or $0.51 diluted earnings per share for the third quarter of 2006, compared to earnings of $7,334,000, or $0.50 diluted earnings per share for same period in 2005. This represents a $113,000, or 1.5% increase in the third quarter 2006 earnings over 2005. From September 30, 2005 to September 30, 2006, quarterly diluted earnings per share increased by $0.01, or 2.0%. Annualized return on average assets and annualized return on average stockholders’ equity for the three-month period ended September 30, 2006, were 1.13% and 11.70%, compared to 1.15% and 12.05%, respectively, for the same period in 2005. The increase in earnings for the quarter over the same period last year is primarily attributable to an increase in non-interest income, a reduced provision for loan losses resulting from fewer credit card charge-offs, and a minimal increase in non-interest expense due to the Company’s emphasis on the budgeting process.

Earnings for the nine-month period ended September 30, 2006, were $20,731,000, or $1.43 per diluted share. These earnings reflect an increase of $594,000, or $0.06 per share, when compared to the nine-month period ended September 30, 2005, earnings of $20,137,000, or $1.37 per diluted share. Annualized return on average assets and annualized return on average stockholders’ equity for the nine-month period ended September 30, 2006, were 1.08% and 11.13%, compared to 1.08% and 11.29%, respectively, for the same period in 2005.

The non-performing assets ratio (the sum of non-performing loans and foreclosed assets divided by the sum of total loans and foreclosed assets) was 69 basis points and 58 basis points at September 30, 2006 and December 31, 2005, respectively. Non-performing loans to total loans were 61 basis points at the end of the quarter, compared to 49 basis points at December 31, 2005. The allowance for loan losses equaled 239% of non-performing loans as of September 30, 2006, compared to 319% as of year-end 2005. The allowance for loan losses as a percent of total loans equaled 1.45% and 1.57 % as of September 30, 2006 and December 31, 2005, respectively.

Annualized net charge-offs to total loans for the third quarter of 2006 were 20 basis points. Excluding credit cards, annualized net charge-offs to total loans were 13 basis points. The credit card annualized net charge-offs as a percent of the credit card portfolio were 1.10% for the quarter ended September 30, 2006, more than 300 basis points below the most recently published industry average of 4.23%. Credit card charge-offs increased during the fourth quarter of 2005 due to a new bankruptcy law that went into effect in October of 2005. While bankruptcy filings have declined significantly from the high levels of the fourth quarter of 2005, the Company does not expect the year-to-date results to be maintained during 2007. The Company anticipates credit card charge-offs will gradually return to the Company’s historical level of approximately 2.50%.

Total assets for the Company at September 30, 2006, were $2.657 billion, an increase of $133.2 million, or 5.3% from December 31, 2005. Stockholders’ equity at the end of the third quarter of 2006 was $254.6 million, a $10.5 million, or 4.3% increase from December 31, 2005.
 
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Simmons First National Corporation is an Arkansas based financial holding company with eight community banks in Pine Bluff, Lake Village, Jonesboro, Rogers, Searcy, Russellville, El Dorado and Hot Springs, Arkansas. The Company's eight banks conduct financial operations from 84 offices, of which 81 are financial centers, located in 46 communities.

CRITICAL ACCOUNTING POLICIES

Overview

Management has reviewed its various accounting policies. Based on this review management believes the policies most critical to the Company are the policies associated with its lending practices including the accounting for the allowance for loan losses, treatment of goodwill, recognition of fee income, estimates of income taxes and employee benefit plans as it relates to stock options.

Loans

Loans which the Company has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding principal balance adjusted for any loans charged-off, any deferred fees or costs on originated loans and unamortized premiums or discounts on purchased loans. Interest income is reported on the interest method and includes amortization of net deferred loan fees and costs over the estimated life of the loan. Generally, loans are placed on non-accrual status at ninety days past due and interest is considered a loss, unless the loan is well secured and in the process of collection.

Discounts and premiums on purchased residential real estate loans are amortized to income using the interest method over the remaining period to contractual maturity, adjusted for anticipated prepayments. Discounts and premiums on purchased consumer loans are recognized over the expected lives of the loans using methods that approximate the interest method.

Allowance for Loan Losses

The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to income. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

The allowance is maintained at a level considered adequate to provide for potential loan losses related to specifically identified loans as well as probable credit losses inherent in the remainder of the loan portfolio that have been incurred as of period end. This estimate is based on management's evaluation of the loan portfolio, as well as on prevailing and anticipated economic conditions and historical losses by loan category. General reserves have been established, based upon the aforementioned factors and allocated to the individual loan categories. Allowances are accrued on specific loans evaluated for impairment for which the basis of each loan, including accrued interest, exceeds the discounted amount of expected future collections of interest and principal or, alternatively, the fair value of loan collateral. The unallocated reserve generally serves to compensate for the uncertainty in estimating loan losses, including the possibility of changes in risk ratings and specific reserve allocations in the loan portfolio as a result of the Company’s ongoing risk management system.
 
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A loan is considered impaired when it is probable that the Company will not receive all amounts due according to the contractual terms of the loan. This includes loans that are delinquent 90 days or more, nonaccrual loans and certain other loans identified by management. Certain other loans identified by management consist of performing loans with specific allocations of the allowance for loan losses. Specific allocations are applied when quantifiable factors are present requiring a greater allocation than that established using the classified asset approach, as defined by the Office of the Comptroller of the Currency. Accrual of interest is discontinued and interest accrued and unpaid is removed at the time such amounts are delinquent 90 days, unless management is aware of circumstances which warrant continuing the interest accrual. Interest is recognized for nonaccrual loans only upon receipt and only after all principal amounts are current according to the terms of the contract.

Goodwill

Goodwill represents the excess of cost over the fair value of net assets of acquired subsidiaries and branches. Financial Accounting Standards Board Statement No. 142 and No. 147 eliminated the amortization for these assets as of January 1, 2002. While goodwill is not amortized, impairment testing of goodwill is performed annually, or more frequently if certain conditions occur. The Company did not record impairment of goodwill in 2006 or 2005.

Core Deposit Premiums

Core deposit premiums are being amortized using both straight-line and accelerated methods over periods ranging from 8 to 15 years. Such assets are periodically evaluated as to the recoverability of their carrying value.

Fee Income

Periodic credit card fees, net of direct origination costs, are recognized as revenue on a straight-line basis over the period the fee entitles the cardholder to use the card. Origination fees and costs for other loans are being amortized over the estimated life of the loan.

Income Taxes

Deferred tax assets and liabilities are recognized for the tax effects of differences between the financial statement and tax bases of assets and liabilities. A valuation allowance is established to reduce deferred tax assets if it is more likely than not that a deferred tax asset will not be realized.

Employee Benefit Plans

The Company has a stock-based employee compensation plan. In December 2004, FASB issued SFAS No. 123, Share-Based Payment (Revised 2004), which requires all companies to measure compensation cost for all share-based payments (including employee stock options) at fair value. As discussed in Note 11 - Stock-Based Compensation in the accompanying condensed notes to consolidated financial statements included elsewhere in this report, the standard requires companies to expense the fair value of all stock options that have future vesting provisions, are modified, or are newly granted beginning on the grant date of such options. SFAS 123R became effective and was adopted by the Company on January 1, 2006.

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NET INTEREST INCOME

Overview

Net interest income, the Company's principal source of earnings, is the difference between the interest income generated by earning assets and the total interest cost of the deposits and borrowings obtained to fund those assets. Factors that determine the level of net interest income include the volume of earning assets and interest bearing liabilities, yields earned and rates paid, the level of non-performing loans and the amount of non-interest bearing liabilities supporting earning assets. Net interest income is analyzed in the discussion and tables below on a fully taxable equivalent basis. The adjustment to convert certain income to a fully taxable equivalent basis consists of dividing tax-exempt income by one minus the combined federal and state income tax rate of 37.50%.

The Company’s practice is to limit exposure to interest rate movements by maintaining a significant portion of earning assets and interest bearing liabilities in short-term repricing. Historically, approximately 70% of the Company’s loan portfolio and approximately 80% of the Company’s time deposits have repriced in one year or less. These historical percentages are consistent with the Company’s current interest rate sensitivity.

Net Interest Income Quarter-to-Date Analysis

For the three-month period ended September 30, 2006, net interest income on a fully taxable equivalent basis was $23.2 million, a decrease of $502,000, or 2.1%, from the same period in 2005. The decrease in net interest income was the result of a $5.3 million increase in interest income offset by a $5.8 million increase in interest expense.

The $5.3 million increase in interest income primarily is the result of a 75 basis point increase in yield on earning assets associated with the higher interest rate environment, as well as a $57 million increase in average interest earning assets due to internal growth and seasonal increases in the loan portfolio. The growth in average interest earning assets resulted in a $1.2 million improvement in interest income. The growth in average loans accounted for a $1.4 million increase, offset by lower average balances in other interest earning assets. The higher interest rates accounted for a $4.2 million increase in interest income. The most significant component of this increase was the $3.3 million increase associated with the repricing of the Company’s loan portfolio that resulted from loans that matured during the period or were tied to a rate that fluctuated with changes in market rates. Historically, approximately 70% of the Company’s loan portfolio reprices in one year or less. As a result, the average rate earned on the loan portfolio increased 75 basis points from 6.88% to 7.63%.

The $5.8 million increase in interest expense is the result of a 107 basis point increase in cost of funds due to competitive repricing during a higher interest rate environment, coupled with a $54.8 million increase in average interest bearing liabilities generated through internal growth. The higher level of average interest bearing liabilities resulted in a $510,000 increase in interest expense. More specifically, the higher level of average interest bearing liabilities was the result of an increase of approximately $89.4 million from internal deposit growth, offset by a reduction of $27.2 million in federal funds purchased and short-term debt, along with a $7.4 million reduction in average long-term debt due primarily to scheduled repayments of FHLB borrowings. The higher interest rates accounted for a $5.3 million increase in interest expense. The most significant component of this increase was the $3.4 million increase associated with the repricing of the Company’s time deposits that resulted from time deposits that matured during the period or were tied to a rate that fluctuated with changes in market rates. Historically, approximately 85% of the Company’s time deposits reprice in one year or less. As a result, the average rate paid on time deposits increased 128 basis points from 2.92% to 4.20%.

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Net Interest Income Year-to-Date Analysis

For the nine-month period ended September 30, 2006, net interest income on a fully taxable equivalent basis was $68.9 million, a decrease of $986,000, or 1.4%, from the same period in 2005. The decrease in net interest income was the result of a $15.0 million increase in interest income offset by a $16.0 million increase in interest expense.

The $15.0 million increase in interest income primarily is the result of a 74 basis point increase in yield on earning assets associated with the higher interest rate environment, as well as a $50.3 million increase in average interest earning assets due to internal growth and seasonal increases in the loan portfolio. The growth in average interest earning assets resulted in a $3.7 million improvement in interest income. The growth in average loans accounted for a $5.1 million increase, offset by lower average balances in other interest earning assets. The higher interest rates accounted for an $11.4 million increase in interest income. The most significant component of this increase was the $8.8 million increase associated with the repricing of the Company’s loan portfolio that resulted from loans that matured during the period or were tied to a rate that fluctuated with changes in market rates. Historically, approximately 70% of the Company’s loan portfolio reprices in one year or less. As a result, the average rate paid on the loan portfolio increased 73 basis points from 6.70% to 7.43%.

The $16.0 million increase in interest expense is the result of a 103 basis point increase in cost of funds due to competitive repricing during a higher interest rate environment, coupled with a $48.7 million increase in average interest bearing liabilities generated through internal growth. The higher level of average interest bearing liabilities resulted in a $1.2 million increase in interest expense. More specifically, the higher level of average interest bearing liabilities was the result of an increase of approximately $64.3 million from internal deposit growth, offset by an $8.3 million reduction in average long-term debt due primarily to scheduled repayments of FHLB borrowings. The higher interest rates accounted for a $14.8 million increase in interest expense. The most significant component of this increase was the $9.5 million increase associated with the repricing of the Company’s time deposits that resulted from time deposits that matured during the period or were tied to a rate that fluctuated with changes in market rates. Historically, approximately 80% of the Company’s time deposits reprice in one year or less. As a result, the average rate paid on time deposits increased 126 basis points from 2.61% to 3.87%.

Net Interest Margin

The Company’s net interest margin decreased 19 basis points to 3.91% for the three-month period ended September 30, 2006, when compared to 4.10% for the same period in 2005. This decrease in the net interest margin was primarily due to the increase in the cost of funds resulting from deposit repricing, coupled with the effect of the inverted yield curve between short-term and long-term interest rates. The Company also completed a corporate-wide time deposit promotion during the quarter based on its projected liquidity needs for the balance of the year. The approximately $43 million of new deposits from this promotion, along with the transfer of funds to these accounts by existing customers, caused some additional margin compression. The Company expects to see continuing competitive pressure in deposit repricing in the short term, and anticipates flat to slight margin compression for the fourth quarter of 2006.
 
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Net Interest Income Tables

Table 1 and 2 reflect an analysis of net interest income on a fully taxable equivalent basis for the three-month and nine-month periods ended September 30, 2006 and 2005, respectively, as well as changes in fully taxable equivalent net interest margin for the three-month and nine-month periods ended September 30, 2006 versus September 30, 2005.

Table 1: Analysis of Net Interest Income
(FTE =Fully Taxable Equivalent)
 
   
Three Months Ended
 
Nine Months Ended
 
 
 
September 30,
 
September 30,
 
(In thousands)
 
2006