Prosperity Bancshares Inc (PB) 2002 Q4 法說會逐字稿

Good day. All sites are now on the conference line in a listen only mode. At this time, I would like to turn the meeting over to your host, Mr. Dan Rollins.

Thank you. Good morning, ladies and gentlemen. Welcome to Prosperity Bancshares fourth quarter, 2002, earnings conference call. This call is also being broadcast live over the Internet, at www.prosperitybanktx.com, and will be available for replay at that same location for the next few weeks. I'm Dan Rollins, Senior Vice President of Prosperity Bancshares, and here with me today is David Zalman, President and Chief Executive Officer, H. Tim Timanus, Jr., Executive Vice President and Chief Operating Officer, and David Hollaway, our Chief Financial Officer.

This morning, David Zalman will lead off with a review of our financial results for the fourth quarter and the full year of 2002. He will also address some of the key factors impacting our performance, along with the significant milestones of the past year. Tim Timanus will spend a few minutes on the local economy, as we see it. He will be followed by David Hollaway, who will spend a few minutes reviewing some of our financial statistics. Tim will discuss our asset quality, and I will provide an update on the progress of the operational integration of our recently completely acquisitions, along with some details on our marketing and sales efforts. Finally, we will open the call up for questions.

During the call, interested parties may participate live by following the instructions that will be provided by our call moderator, Erin. You may also email questions to contactus@prosperitybanktx.com.

I assume you have all received a copy of the earnings announcement that we released earlier this morning. If not, please call Cara Smart at 713-693-9308, and she will be happy to fax a copy to you.

Before we begin, let me make our usual disclaimers. Certain of the matter discussed in this presentation may constitute forward-looking statements for the purposes of the federal securities laws, and as such, may involve known and unknown risks, uncertainties, and other factors which may cause the actual results, performance, or achievements of Prosperity Bancshares to be materially different from future results, performance, or achievements, expressed or implied, by such forward-looking statements. Additional information concerning these factors that could cause our actual results to be materially different than those in the forward-looking statements can be found in Prosperity Bancshares' filings with the Securities and Exchange Commission, on forms 10Q and 10K. All forward-looking statements are expressly qualified in their entirety by these cautionary statements.

Now let me turn our call over to David.

Thank you, Dan, and I would like to welcome everyone joining us today for our fourth quarter and year-end earnings announcement. We have some very exciting news to share with you today. I am very pleased to report that 2002 was the best year in our company's history. We had record earnings, we made five acquisitions, we continue to focus on superior asset quality, we focus on strong cost controls, and we have a growing team of professional bankers that come to mind as I reflect on 2002.

The foundation of our company remains remarkably stable. Our quality associates continue to turn out quality banking as well as quality earnings. Our non-interest income continues to grow, and expense controls are in place. Exceptional asset quality continues to be a core strength of our company.

Our earnings per share were up 37% over the same period last year. Our diluted earnings per share were 33 cents for the quarter, compared to 24 cents in the same quarter last year. Our return on average equity was an astounding 18.66%.

During 2002, our total return to shareholders, according to SNL Data Services, was 42.64%, while the S&P index decreased 22.1%.

Our three-year return, according to SNL Data Services, compared to a decrease of 40% for the S&P.

Prosperity continues to grow internally, as well as through a series of questions. Prosperity completed five deals during 2002. All of the deals so far have been fully integrated into our system, with the exception of Bank of the Southwest in Dallas, and it is slated for operational integration during the second quarter of 2003. Our bank has seen remarkable growth this year; our assets at year-end 2002 were at $1,822,000,000. This represents an increase of 44%. Our loans at year-end 2002 were at $679,000,000, and this represents a 60% increase over the level at December 31, 2001. Our deposits grew over 41% from last year, and we ended up with more than 100,000 and loan accounts.

Our bank is in the last phases of bringing in-house all of our data processing systems. By mid-year, we will be processing all of our checks and deposits, and doing our own statement rendering, imaging, and other data processing functions in-house. In the past, this was all outsourced to a third party. This should save us money going forward, as well as being an improvement in customer service and also quality control.

In my opinion, one of the biggest successes of the year is the retention of the quality associates that joined us from our bank mergers and acquisitions. These people will help propel us in the future with their knowledge, experience, and can-do attitude. Just to mention, some of these people are Peter Fisher, now vice chairman of Prosperity Bank, and Jay Porter, our regional president, North Houston, and their entire banking center presidents, who joined us from Paradigm Bank, Houston. Lonnie Goodman, president in Dallas, and Cindy Swindle, head of our operations in Dallas, who joined us from Bank of the Southwest in Dallas. Andy Dow, president of City West, and Jackie Calhoun, banking center manager, Memorial, who joined us from Texas Guaranty Bank, Houston. And Jack Conner, Matagorda County banking president, and Wayne Buss, head of compliance, who joined us from the First National Bank of Dade City. And lastly, Ollie Klumpel president of the Meadville banking center, who joined us from the First State Bank of Meadville. All of these people bring a tremendous amount of experience and knowledge to our bank, and should help propel us in the years going forward, with their experience and customer contacts.

As expected, our non-performing assets increased to $2,564,000, or 0.38% of loans, and other real estate, at December 31, 2002, compared with $1,000, or 0% of loans and other real estate, at December, 2001. All of the non-performing assets were originated by the banks we acquired during 2002, and were identified as potential problem loans during our due diligence process, and Tim Timanus, our Chief Operating Officer, will discuss that in a few minutes in more in-depth.

Looking forward, after reviewing our fourth quarter results and looking forward, we believe our earnings for 2003 will fall within the range of $1.32 and $1.35, in line with analyst estimates. Again, this is based on the belief that we will experience a relatively economy, and that we will not experience some event around the world that could cause economic uncertainty. And with that, I'm going to turn over the program to our Chief Operating Officer, Tim Timanus.

Thank you, David. In looking at the Texas economy, our primary focus is on the Houston area, with additional consideration to Dallas. Over the last 15 years, the Texas economy has become more diversified, with less dependency on the energy sector. As such, the Texas economy is clearly affected by national issues, such as recession, consumer confidence, terrorism, and more. The key to improvement in the Texas economy is improvement in the overall U.S. economy, and continued strong energy prices. Major aspects of the Houston economy are the Texas Medical Center, which is the world's largest health care complex, employing 140,000 people and creating six billion dollars in regional spending, the airport system, employing 90,000 people and having an $8 billion impact, the Port of Houston, which is the world's eighth-largest port and ranked first in the U.S. in foreign tonnage, and the Johnson Space Center, employing 16,000 people, creating a $1.2 billion economic impact. Also, it should be mentioned that Houston is second only to New York City in the number of Fortune 500 companies with offices in the area.

Job growth in Houston in 2002 was flat, but predictions for jobs added in 2003 range from flat, again, to plus 40,000. Houston-area new home sales set a record in 2002, with approximately 33,000 homes sold, a 14% increase over 2001. It should be noted that this strong statistic for 2002 was based primarily on sales of homes costing less than $300,000, with softness persisting in the market for expensive homes and town-homes. Unless there is an improvement in the national economy, the prediction is that Houston could see a decline of 5 to 10% in 2003 new home sales off of 2002. Due to slowdowns in telecommunications and aircraft and semiconductor manufacturing, Dallas trailed Houston in 2002 in most areas of the economy. For example, office vacancy rates in Houston are approximately 15%, which is the national average, while the average for Dallas is 22%. As with Houston, Dallas should benefit from an improvement in the national economy. For example, Dallas is forecasted to have an increase in total of population of approximately 11 percent over the next five years, which outpaces the State of Texas as a whole.

I'm now going to turn it over to our Chief Financial Officer, Dave Hollaway, who will go over some of the numbers for us.

Thank you, Tim. In regards to earnings, again, net income improved 64.5% year-over-year, and 46.7% on an operating basis, which is adjusting for the merger-related expense that we had in 2001. Diluted earnings per shared increased 54.4% year-over-year, or 38.6% on an operating basis. And some of the metrics that were driving the earnings numbers -- net interest income increased 14.7% in quarter and 34.6% year-over-year, and one of the major factors driving these numbers was an increase in average earning assets of approximately 19% in-quarter and 22% year-over-year. Non-interest income increased 43% in-quarter and 34% year-over-year, and Dan will be providing some additional detail on some of the items that are driving this increase later in the presentation. Non-interest expense increased 14% year-over-year, or 24% on an operating basis, and this increase basically is reflective of all the acquisition activity that we had in 2002.

On the balance sheet side, as mentioned before, deposits at year-end were $1.587 billion, which is up 8% in-quarter and 41% year-over-year. Non-interest bearing deposits were 21% of total deposits, and our non-interest bearing deposits were up 74% year-over-year. Loans were $680 million at year-end, which is up 4.9% in-quarter and 60% year-over-year. Our average loans increased 28% sequentially, and 25% year-over-year. Looking at the ratios, our return on average assets was 1.45% for the year, compared to 1.09 in 2001, or 1.22% on an operating basis. Our return on average common equity was 18.7%, compared to 15.2% last year, or, again, 17% on an operating basis. The efficiency ratio for the year was 50.4%, as compared to 60.1 percent in 2001, or again, 55.1% on an operating basis. The net interest margin tax equivalent for the year was 4.16%, compared to 3.86% in 2001. For the quarter, it was 4.08%. And the bank is currently in an asset-sensitive position, and one of our biggest challenges is margin compression, due to reinvestment of the security portfolio cash flow. We believe if rates remain the same for the whole year, we would expect our margins to run in a range of 3.95% to 4%.

In summary, the significant increase in assets, loans, and deposits, basically, our balance sheet, have helped deliver a 54% earnings per share growth for the year. With that, I'll turn it back over to Tim for some comments on asset quality.

Thank you, Dave. At December 31, '02, non-performing assets totaled $2,564,000. This amount was made up of $219,000 in other real estate, and loans of $2,345,000. These loans represented 0.35% of loans outstanding. All of these non-performing assets belong to banks acquired by Prosperity in 2002. Of the $219,000 in other real estate, $165,000 is under contract to close by the end of January, '03, and we have a viable offer on a property booked at $40,000 that most likely will go to contract. No additional writedowns are anticipated on these two properties. All loans making up the $2,345,000 are secured, with one loan at $1,053,000, secured by two office warehouse projects, and another loan at $1,100,000, secured by a parking facility at the primary Houston airport. We are working as quickly as possible to reduce or eliminate these non-performing loans through collection efforts, foreclosures, and repossessions, and potential sale of certain loans to third-party investors. I will now turn it over to Dan Rollins.

Thanks, Tim. Let me just take a couple of minutes and throw some other color on Dave's comments on our fee income. Fee income in the fourth quarter has always historically been higher than the rest of the year for us, and fourth quarter, 2002, was no different. There are some things that are driving that fee income growth -- just to put some quick numbers out. Our debit card/ATM income, year-over-year, was up 67%, our Royal Checking, or our all-inclusive checking product income, year-over-year, was up 26%, our trust and investment fee income year-over-year was up 50%, and we continue to see growth on our sales efforts.

Just to give you a little additional information, on our products per customer, many of you may recall, we've talked about this before, we track produce per customer number -- we were at 2.47 at year-end '01. Today, we are at 2.61, which is an increase. Without this year's acquisitions, we would have been at 2.69. The acquisitions, all five of the acquisitions in 2002, equate to a 2.33 number, and just keep in mind, our goal is four, and we continue to be focused on putting additional products in our customers' hands.

On the loan production side, loan production, or loan funding, continues to be a challenge for us, for a couple of reasons. You know, fourth quarter is always a reduction in our AG out-standings and our AG loans quarter-over-quarter about $5.5 million from September to December, and then in addition to that, we've talked throughout the year on the opportunities that have been missed from rate situations, and we've since gone back and we can identify -- we've added $79 million in loans that we have missed the opportunity to either keep on the books, that have actually paid off because of a longer-term fixed rate product that we would not match, or that we had committed to make and ultimately did not fund because we could not match a lower rate that was out there. So, you know, those two issues continue to put some pressure, or give us some challenges, on the loan production. The positive, on the other side of that is, is as we've rolled through these acquisitions, today, we have 66 producing lenders on the street, our sales and marketing program for 2003 is out of the gate and off and running, and it will be much more vigorous than we have had in the past, and I think our team is up to the challenge on that front.

On our operational integration, as David had mentioned, four of the acquisitions that we completed last year, we are totally on board, all-in, on the computer side, operational integration side, we still have some cost savings to dial in, in a couple of different areas as we roll forward into the new year, but four of the are complete. Our Bank of the Southwest acquisition in Dallas, we actually collapsed the charter of the two banks on January the 1st, and we are all now one bank, and but we won't actually run through an operational conversion, or a data processing conversion, until early second quarter, and that has to do with the other piece of what David had mentioned on our DP/IP conversion this year. As we bring everything in-house from our outsourced third party provider, the first step of that is the first step of the data processing conversion, will be early second quarter in Dallas, and we anticipate completing that project in July, when we bring the rest of the bank on to our new process. That whole back room shop and bringing it in-house, number one, it saves us some money, number two, the quality and the control that we can put in place, we believe, is much better than the service we've been providing. And number three, that's a scalable process that we believe we're scaled up, to where we can grow that shop to $5 billion to $10 billion fairly easily, as we continue to grow through our model of internal growth and acquisitions.

And at this time, Erin, I think I'd like to turn the call over to questions, and we'll be happy to entertain the questions that may be there.

Very good. At this time, if you would like to ask a question, please press the star and the one on your touch-tone phone. You may withdraw your question at any time by pressing the pound key. Once again, if you would like to ask a question, press the star and one on your touchtone phone at this time. We'll take our first question from Scott Alanez of Stephens. Go ahead, please.

Good morning, gentlemen. Nice quarter. A couple of things, just kind of talking about loan demand. Could you talk a little bit about what you're seeing within Houston versus what you may be seeing, the level of activity you may be seeing in some of the perimeter markets? The markets around Houston?

We'll take turns on this. You know, obviously, we think that the Houston market is where there is a lot of opportunities for us. We continue to produce good loans and good volume of loans in several of the outlying markets, or the community banking centers. Those are kind of- you have to look at each one individually, to look at the economy in those local communities, to see which ones have the opportunity to produce and which ones have less of those opportunities, but we continue to do well in some of those markets. When we look at our per banking center numbers, year-over-year, any of those markets actually see loan growth up, year-over-year. We also track our loan out-standings per lender, on a year-over-year basis, and many of the lenders in the outlying markets have increased their funding year-over-year.

OK, good. I guess secondly, kind of moving over to the securities portfolio and I guess what I'd like to know is, kind of what your thoughts are in terms of you're positioning the portfolio for 2003? I mean, I would imagine you're going to have a pretty significant amount of cash flow from that portfolio, and really, you know, sort of tied into that, I'd kind of like to get a sense of how asset-sensitive, exactly, that you all are at this point?

So Scott, those are good questions -- basically is, it's probably just like all the other banks right now, are having a tremendous amount of pay-downs in their portfolio. We have such a-- we have over a $900 million bond portfolio, and a good percentage of that bond portfolio are mortgage-securities, and just to give, for an example, we used to have about $150 million a year that would roll off of the portfolio. Right now, currently, under these interest rates, and these market conditions, we're having $300 million a year, a little over $300 million a year, rolling off, and so you have to ask the question, what to do with that? And our guys, rightly or wrongly, we're kind of like the Internet bubble, we said for two years it was going to bust, and it never did, and it finally did, and we're sticking to the story -- we still think interest rates will eventually go up, and because of that, we've been staying extremely short. Our effective duration is 1.99 years. Our weighted average life is about three years, and of course the difference between the weighted average life and the effective duration is simply because we have a lot of floating rate securities. But going forward, we, you know, we're probably having to take some positions, because we've become so asset-sensitive. We're about 8% asset-sensitive right now, and if interest rates go up, you know, we stand to do extremely well. I mean, extremely well, if interest rates go up. Our real- our real challenge right now if rates go down, continue to go down, and it doesn't really affect us this year as much as it will affect us in '04, so we're having to take a position right now to buy- We're probably, right now, what we're buying are some, it's kind of a dirty word in some cases, but we're buying some really short, agency CMOs that have an effective average life right now, under current market conditions, of about two- to three-year average life, and probably have an extension to five to five and a half years, if interest rates go up 300 basis points. And even-- we've done some rate analysis and some shock analysis, and even if we take everything that's rolling off of that right now, this year, and invest it, even if interest rates go up 300 basis points, we would still be an asset-sensitive bank, so we're going to have to take some of those positions this year, just to, you know, protect ourselves from a downside in the year 2004. I don't know, that might have been too winded, but I was trying to answer your question.

No, that was perfect. Thank you very much.

Thanks, Scott.

We will take our next question from Sam Wooten of Investment Counselors of Maryland. Go ahead, please.

Yeah, hello gentlemen. Terrific quarter.

Hi.

Hi. One of the things that I wanted to get -- maybe I missed the answer, on loan growth, do you all have an internal loan that you recorded the is year, excluding the acquisitions, and your expectations for next year, and the same for your core deposit numbers, growth numbers?

I have the loan side. David, you might want to get the deposit side. The loan side -- Sam, that's a good question -- on a year-over-year basis, internally, we were basically flat on loans. We were actually down less than 1 percent, or right at 1 percent, year-over-year, and that comes back to what I was talking about on the loan funding. When you look at the $79 million that we've missed the opportunity because of an unwillingness to lock longer-term rates, and then you also look at our AG pay-downs, or the reduction in our AG portfolio, fourth quarter, 2002, versus fourth quarter, 2001, there's kind of the answer on the flatness of the portfolio for this year. I would tell you, our target for the year going forward is 8% growth this year in our loan portfolio, and we feel that's achievable for a couple of reasons. As we've talked--

That's internally.

Internally -- yeah, internal growth of 8%. You've got-- we now have 66 producing lenders out on the street, throughout the communities that we serve, and that number is significantly up from year-end last year, because of some of the acquisitions, and as we've rolled through these acquisitions this year, I'm not big into making excuses, but I think some of the lenders maybe took their eye off the ball there for a month or two or three, as we were kind of going through these operational integration features and functions, and we're past that, for the most part, and we've got a sales force that's out there today, knocking doors, and are going to bring some business in.

OK.

And on the deposit side, interestingly enough, the internal growth ended up being right around 6% for the year, which is, historically, we've pretty much run in the 5 to 6% range internally, and that's kind of what we modeled out, looking into the new year, about a 6% internal deposit growth.

And then--

Sam, can I just jump in one minute?

Sure.

I'm sorry-- I would say part of the responsibility for the flat loan growth probably has to do with me. As Dan mentioned earlier, you know, we probably missed out on about $75 million, $79 million on loans, and it's because-- I personally, and we-- not just me, but a group of us felt that we still think interest rates were going to go up, and probably we should have locked in into some of those locked-in rates, and so, you know, one guy answered the question at one time, ``well, what if rates go down?'' and that's entirely a possibility, and so probably, you know, there's a mixed bag on that, but--

All right. Great. And then two other questions. One, on your reserve, with respect to the percentage to loans, I guess you guys, I forget where you are right now?

We're at 141.

141 -- could you just comment on--

That's right where we were a year ago this time.

Great.

The number has been 141, you know, a year ago, all the way across the board, basically. We dipped down a little bit in the third quarter with some acquisitions, and you can see we provisioned, again, in order to make up for that. And you can see Tim talked about the NPA numbers, spiking up to that $2.5 million. We think we're adequately reserved.

OK. So, 141 is what we should expect in the-- in the new year as well? In other words, keeping it at the 141 level?

I think that has to do with where we are with on some of those NPA numbers and how we feel about the portfolio as a whole. As Tim said, you know, while we have $2.5 million out there in Naps, or 38 basis points, every one of those are secured, and we believe that there is not a whole lot of loss in that, but if things were to change, or if the acquisition model that we continue to operate off of, of buying acquisitions, would require a change in that, we would continue to review that on a quarter to quarter basis.

Well, I would say, too, we put $500,000 into the reserve for loan loss at year-end, and that was specifically for these two credits that we have, and what we've been doing, in the market, most people didn't get to see this, but we've already cleaned up probably about $2 million to $4 million of the loans from these banks that we've taken in, and the $500,000 [inaudible] only $5 million, we've already outsourced or sold the loans, and we're planning on-- we're trying to [inaudible] doing that with these other two large loans, so part of the 500-- most of the $500,000 that was put in at year-end will be if we do go ahead and sell these loans off, so-- that'll reduce that.

OK, so if that occurs, sort of-- do we expect it to be in the 135 to 140 range? Is that what you're-- I just wanted to get an idea of where you guys--

I would say yes, unless loan quality-- unless the loan quality gets worse or something, and we'll pump it up, but probably right now, it's a very good number.

I think we're comfortable where we are, and David brought up another point that I missed on our U.S., on the internal loan growth numbers. David is right - out of these acquisitions, we actually have sold just a shade under $5 million in loans, where we've out placed some customers, where we've-- they didn't fit, for one reason or another, and customers have left because we-- they didn't fit our model. But we also have actually sold another $5 million in loans that would also cause our loans to be flat.

Great. And-- that's fine. And then the final question I had is, on M&A activity, you guys did a terrific job this year. What's the outlook for the upcoming year? Is the pipeline-- going to give a little color on the pipeline, as you see it?

I think we're close to getting ready to take some of that duct tape off David's mouth and let him go back to work. You're right, our model of acquisitions and internal growth has been working well for us, and David can address the pipeline.

Yeah, they're letting me take the duct tape off, so there's probably a good possibility that you'll see us in the market this year again, maybe not as-- maybe not five, but you'll probably see some activity this year again.

OK. All right, great job.

Thanks.

Thanks for your interest.

We will take our next question from Ron Peterson of Sandler ONeill and Partners. Go ahead, please.

Good morning. On the expense side, I found it, you know, pretty impressive that you were able to drop your efficiency ratio down to 49 percent, given the merger activity. What do you see, going forward? Obviously, that included all of Bank of the Southwest's, full quarter of that. The only thing that wasn't in there was the full quarter for First National Bank of Bay City, but that was a rather small acquisition. So what do you see going forward on the expense side?

I think kind of as a rule of thumb-- go ahead, Dan.

Ron, let me just kind of correct one of your assumptions, before he gets into the numbers. While you're right, we did acquire Bank of the Southwest on October 1st, through our acquisition structuring, we typically have the target payout, you know, where they're paying all the bills, where there's not outstanding accounts payable at closing, and so what that really does is, when you're looking at a coming forward basis, September-- excuse me, October, for Bank of the Southwest, was not a normal run month for expenses, so you really didn't have a full quarter in Bank of the Southwest's numbers. You really had only two months there, and you only had one month, for all practical purposes, on the Bay City numbers, just from the way we structure of acquisitions. And then David can go into details on where we are.

Yeah, I would say, you know, when you're tracking this and doing some modeling on it, it's very difficult when you have all these acquisitions coming in, but what I would tell you is, looking at the fourth quarter operating expense number, you could probably take that number and annualize it, and increase it a couple of percentage points, because there's a number of things going on here. One, there's still efficiencies to be had fro the acquisitions, but then you offset some of that with just the natural year-over-year increases that one would have in terms of annual salary reviews, medical insurance, things of that nature.

OK. And at year-end, your tangible equity asset ratio was down to 470. Are you comfortable with that range, or where would you like to see that, or where do you envision that being, say, by the end of '03?

Well, I'll answer part of it, and I think David will answer the other half, but you know, you're right, that is where our tangible ratio is, about 470-something, and we've run in this range before. And of course, that's a reflection of all the acquisition activity that we had. And if you were to make the assumption that we weren't doing any more cash deals, as an example, our ratio would get back over 5% by the second quarter. But again, it's going to be reflective of just ongoing M&A activity.

Yeah, there's not a whole lot I can say; it's been like that from the time I started.

I think when you also look at that tangible equity asset ratio, you also have to look at the asset quality that's out there behind that -- I think that's a piece of that puzzle. The asset quality can play into where we're comfortable with a lower tangible-to-equity.

Well, it's true, but I think we, our bank, is really always-- we've been a very acquisitive bank, and if you're doing deals with cash, and not all stock-- I mean, if you're asking me going forward, yes, I mean, our goal is always to maintain at least 5 percent, and that is our goal and we'll get right back up to that, simply because our earnings are so strong. But I do think that we're probably going to be living in these kind of ranges, really.

OK. Even if you do a stock deal, is-- will that kind of still limit your ability to do deals, as well as-- especially the number of deals you did in '02?

No, if we do stock deals, I mean, a lot of times, I mean, truthfully, you can do a stock deal and actually your tangible capital figure can improve, you know, depending on what you-- depending on how you cut the deal, really.

Right. I think those are getting harder and harder to come by, but yes.

But we-- I mean, truthfully, we've been pretty successful. I mean, I really look, going forward, we're looking-- we think there's still-- I didn't answer the other person's question, but there's really a lot of deals out in the pipeline. I think it's just, for us, it's just a matter of how much manpower we have and how much we can take on, because the deals are really out there for us, at least they are for us.

OK, thank you.

Thanks, Ron.

We will take our next question from Carl Dorff of Dorff Asset Management. Go ahead, please.

Good morning, gentlemen, nice quarter.

Good morning.

I've got no complaints, so don't misunderstand my question, but I was just wondering in terms of potentially ramping up loan growth and getting your loan deposit ratio to grow, what would you say you might run at, let's say, and which would you say is the most-- biggest drag on it? Is the lower interest rate environment holding you back from making fixed-rate loans, or the weak economy? And if they both improve, what kind of loan growth might you guys be able to turn in?

Well, I think if they both improve, you know, I think you could, instead of looking 8% internal loan growth, I think you could, you know, I think you could see over 10, a little over 10. When the economy is good and the number of lenders that we have out in the field right now, we're really poised to really-- to hit a home run. And as Dan mentioned earlier, a lot of it being flat this year was simply because of our unwillingness to lock in to longer-term rates. So as the economy starts moving up, people are more willing to take variable rates, and that's what the market is, and that's what everybody is offering, and there's not so much cut-throat rates out there as there is right now, and so I-- again, I think going forward, if there's a good economy, I think we could expect over 10%.

Carl, when you talk to our lenders, they've all set some internal goals. We've gone through a goal-setting, budgeting process, and they've all set some what I would consider to be pretty aggressive goals for themselves individually. If the lenders hit their goals, as David says, we could do much better.

Yeah, our budgets-- I mean, their-- when we look at their budgets, we ask-- I think, Carl, you're familiar with our system, that we have every banking center give us a budget every year, and they really get a balance sheet and a P&L statement monthly, and we ask them to give us what they want to do this year, and their, probably total loan growth, they're showing us about 15%, but again, we're not telling the Street that. We're still sticking to the 8%. But if they should ever hit something like that, I mean, it would be really good. They never have in the past, so don't count on it.

I'm not, and you know, you guys are doing a good job with this. This is just like icing on the cake. Another question -- are you going to be running any back-up, and will that increase costs temporarily when you bring a lot of these programs, back office, in-house, and what kind of risk is there in terms of doing that?

You're talking about running dual systems for a while on a back-up?

Yeah.

No. Part of the-- let me kind of go through our process for you, Carl. We've-- we've-- we obviously think that we've got this computer conversion model built into place. We've done, you know, four last year, and 18 in the last couple of years over these acquisition trails. But bringing the process in-house, one of the advantages to the way we're structured right now is by using the Dallas deal, we're going to actually bring the Dallas transaction on to our new in-house data processing shop, in front of the rest of the bank, and that will allow us to kind of get up and running, learn the system, figure it out. We think that our team is fully ready to go, but instead of trying to, you know, jump into the hot grease on day one, ramping on in early second quarter in Dallas is going to give us an opportunity to kind of maybe take baby steps before we learn how to run. But we won't be running back-up systems with 100,000 accounts and, you know, $2 billion in assets. That's not a feasible process.

OK, thank you.

Dan, you might also add that our IT manager is an expense-employee of the system provider, and he knows it very, very well.

Did you catch that, Carl?

I caught. That should obviously help.

OK.

Thank you.

Thank you.

We will take our next question from Bain Slack of KBW.

Hi, great quarter, guys. Most of my questions were answered, but I guess I'll take the opportunity just to ask about what you all are seeing on I guess the M&A scene. I know you've got the duct tape on, but probably have still been looking. Are prices kind of getting better, getting worse, and what are the differences of the two markets rights now, I guess, Houston versus Dallas?

Well, Bain, it looks like, you know, our deals usually are deals that just don't happen right away. Usually, as I think I explained earlier, we usually see a deal and we'll put it-- in some cases, recently what's been happening, we'll put a price out there, and they don't take it, and then they say, generally there's two or three other people interested in a deal, and most of the time, those deals fall through, and then they come back to us and we get back to the original price that we put out there. But this is a process that sometimes takes anywhere from six months to two years sometimes, so we have deals in the pipeline that we've been working on for a quite a long time, and it seems like when everybody gets through with the deal and everybody gets through looking, it seems like the deals finally come back to us and we get them at the price that we originally wanted them to be at. And our pipeline still looks pretty good this year.

Your question on Houston and Dallas -- obviously, Bain, Dallas is a target-rich environment. We continue to see potential opportunities in Dallas. We have, you know, some opportunities in Houston, but there's just going to be more opportunities in the Dallas market, and relatively speaking, I think what David was saying is that pricing right now is not going to be a whole lot different than we've been seeing in the past.

Yeah, I don't think it really is. You know, our biggest issue, and we're going into banks right now, saying, quite frankly, and it's in some of the smaller banks, is the asset quality. The asset quality has just been-- it's just not as good, and so that's probably taking a lot of our time in negotiations and dealing with the asset quality of the banks that we're looking at, so we're having to make deals where we sell the loans off or somebody, the parent company or somebody else, takes these loans, but that's been the biggest issue in negotiating recently. The pricing, I don't think, has changed a whole lot.

Right. And I guess just a follow-up -- a lot of banks have obviously been talking about de novo around Texas. Is that something that you all have looked at? I mean, I think I know the answer to it, but is this something that you all may be looking at in the future, or--

You know the answer to that question, and you're right, we see that de novo activity going on down here. Our model works best with people to people, customer-focused bankers, and to open a de novo office, unless we had somebody walk in the door that said, you know, ``I really want to come to work for you guys and I can bring business'' in a specific area, that fits our model, I don't see de novos, you know, as being a big part of where we're going.

Great. Thanks. Great quarter.

Thanks.

We'll go next to John Arstrun of RBC Capital. Go ahead, please.

Good morning, guys. Good work again.

Good morning.

One follow-up on M&A. Of the five deals you did last year, and those that maybe have come to you recently, is there a common theme as to why these targets put themselves up for sale? Is there any way you can--

Let me kind of walk you through the five we've had last year, and then we can kind of go from there, but the five last year, you know, you've got to go back and pick up where we were. Texas Guaranty was owned by an Oklahoma holding company that was kind of changing their focus and needed to get out of their-- they were refocusing into their core market. They had never been able to really get going in Texas, and corporate restructuring, I guess, on their end--

And the bank wasn't making any money.

The bank was not performing.

It was a $100 million bank wasn't making money.

The bank in Meadville was family owned and operated for a long time. It was small. When you talked to the ownership there, they just felt like to be successful in the banking business, they couldn't continue to provide the services and the products and be as profitable at the size they were, so you know, you had a size issue in Meadville.

The Paradigm Bank Texas Group, you've heard Peter Fisher talk before. He's sitting in the next room, with us right now, but you know, Pete's comment was, their ownership wanted to grow, wanted to play, wanted to grow the bank, but they didn't want to be dilutive and they didn't want to put any more money, and they saw, you know, this is an opportunity for them to partner up with a really good fit and the rural/metropolitan mix, so that was more of a choice, I guess, on their part.

And a size issue, too. They saw with computers and their efficiency ratio the way it was, they were staffing up, as Bain asked earlier, they were one of the banks that just put a bunch of locations out there and had a lot of overhead, and they couldn't-- they really weren't making the return on capital, so teaming up with somebody like us really allowed them to stay in the game and really grow and still get the earnings and help-- we helped them get their earnings that they needed.

Bank of the Southwest in Dallas was more of, you know, pick-your-partner dance, and it was an estate. The primary owner had passed away a few years ago, the owners of the bank were interested in making sure that they continued to provide the high-touch, distinctive service that they had provided in the past, and they picked-- they kind of interviewed to pick, and so that's kind of interesting situation there, and we were a fit for them.

And finally, the First National Bank in Bay City, again, you had a corporate owner that wanted to come out of a position that didn't fit, and it fit very well for us. So, you know, you got two that kind of fit for us, one, you know, you've got a deceased owner, the other two kind of partnered up because of a size-growth issue. And I think we're seeing-- David, don't let me put words in your mouth, but when we look at the deals that are in the pipeline, they're all kind of are in the same range of from-- it could be any reason why they're for sale.

Yeah, I think those are all good comments, yeah.

OK, thank you, guys.

Once more, if there are any questions, press the star and one on your touch tone phone at this time. We'll go next to Lee Cassel of Acadia. Go ahead, please.

Hello. Nice job.

Thank you.

I had a question, a quick one, about the commercial mortgages. Over 2002, I noticed that grew nicely in your loan portfolio, and I was wondering if it continued to grow nicely in the fourth quarter, and if you could give a few examples of what types of loans were real strong this year in that category?

That's primarily acquisition-driven. That came out of the Paradigm acquisition. They were a large commercial lender in the Houston area. You know, as we've talked before, it increased our presence in the Houston market. But we're seeing in that is kind of a little bit of everything. Again, there's no one type of loan in that commercial portfolio or commercial real estate portfolio. They run the gamut from doctors offices to mini-warehouses to office/warehouse/retail. You name, it's in there.

OK. Good. Thank you.

There appears we have no further questions at this time. I'll turn it back over to your hosts.

Thank you, Erin. Thank you, everybody, for participating. We really appreciate your interest in our company. As always, we're available to take your calls and answer your questions, and we look forward to hearing from you all soon. Thank you very much.

That does conclude our conference call for today. You may now disconnect your lines. Thank you for participating, and have a wonderful day.