Prosperity Bancshares Inc (PB) 2004 Q4 法說會逐字稿

Good day and welcome to today's conference. At this time, all sides are on the line and in a listen only mode. Right now I would like to hand the meeting over to your host, Mr. Dan Rollins. Go ahead, please.

Thank you. Good morning ladies and gentlemen. Welcome to Prosperity Bancshares 2004 year end earnings conference call. This call is being broadcast live over the internet at www.ProsperityBankTX.com, and will be available for replay at the same location for the next few weeks. I'm Dan Rollins, Senior Vice President of Prosperity Bancshares and here with me here today is David Zalman, President and Chief Executive Officer, H.E. 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 results for 2004. He will be followed by David Hollaway who will spend a few minutes reviewing some of our financial statistics and providing additional details on the results. Tim Timanus will discuss our lending activities including asset quality and I will provide an update on our recently announced acquisition. Finally, we will open the call to questions.

During the call, interested parties may participate live by following the instructions that will be provided by our call moderator Melissa or you may e-mail your questions to investor relations at www.ProsperityBankTX.com. I assume you have all received a copy of the earnings announcement we released earlier this morning. If not, call Jennifer Nuan (ph) at 713-693-9308 and she will fax a copy to you.

Before we begin, let me make the usual disclaimers. Certain of the matters 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 risk, uncertainties and other factors which may cause the actual results, performance or achievements of Prosperity Bancshares shares to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Additional information concerning factors that could cause actual results to be materially different than those in the forward-looking statements can be found in Prosperity Bankshare's filings with the Securities and Exchange Commission, including Forms 10-Q and 10-K. 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. We would like to welcome and thank everyone that is listening and participating in our year-end conference call. Without question, 2004 was the most successful year in our history with net income reaching $34.7 million, or $1.59 per diluted common share, which is an increase in net income of $8.2 million, or 30.7% compared with 2003. The $1.59 earnings per diluted share for 2004 represents an increase of 16.9% over the $1.36 per diluted share we posted for year end 2003.

Our loans increased $274.6 million during 2004. More importantly, for the third consecutive quarter, we have been able to grow loans organically in excess of 11% on an annualized basis. We believe our strong and consistent performance is rooted in our strategy of expanding our customer base while maintaining strong asset quality and cost controls. Our growth strategy includes organic growth along with select acquisitions, which have helped to produce five-year compound annual growth rates of 34% in deposits, 36% in loans, 40% in net income, and 21% in earnings per share for the past five years.

Prosperity's total assets have more than doubled over the past three years. Over this time, we have built a larger, stronger and more diversified company. We will continue to focus on our primary objectives of, number one, improving shareholder value by increasing profits on a sustainable basis. Two, increasing customer satisfaction and retention with our three-point service commitment of greeting the customer with a smile, address the customer by name, and try to say yes instead of no, and three, to provide a working environment where our associates are excited and eager to come to work every day.

We are very proud of our past and believe we can build on our historic performance and continue our earnings per share growth into the future to continue building shareholder value. The performance we have been able to produce is a testament to the efforts of our entire team. I continue to be pleased at the dedication to customer service, our team of real bankers exhibit each day.

On August 1st of 2004, we completed the acquisitions of Liberty Bank and Village Bank and Trust in Austin and are now operating seven full-service banking centers in the Austin area. Austin is a market that we are excited about. We feel we have a good team there that has shown they can grow the bank organically and have a good understanding of their market. Eddie Safady is Chairman of the Austin area and Mike Meyer is President of the LakeWay Banking Center. Under their leadership, we are looking forward to a bright future.

Our Dallas-area banks performed very well last year, showing some of the strongest loan growth in the company for 2004. DK, President of the Dallas area and his team are making progress every day expanding our customer base in north Texas. I am very excited about our proposed merger with First Capital Bankers, Inc. and its Corpus Christi Texas Bank, bank subsidiary First Capital Bank. As of December 31st,2004, First Capital reported total assets of $761 million, loans of $499 million, deposits of $629 million and shareholders' equity of $61.7. Mike Hunter, First Capital's Chairman, will become Vice Chairman of the board of Prosperity Bancshares, and Steve Hives, First Capital's President, will become Chairman of the south Texas area for our bank.

Immediately following the merger, Prosperity will have a total of 86 banking centers serving most of the major cities in Texas, with 21 of those in 15 contiguous counties south and southwest of Houston, generally along the Nafta Highway.

Thanks again for your support of our company. Let me turn over our discussion to David Hollaway, our CFO, to report some of the specific financial results we achieved last year. David.

Thank you. As David Zalman had mentioned, the diluted earnings per share for the year was $1.59, an increase of 16.9% over the prior year and net income increased 30.7% year over year. Additionally, net interest income increased 27.1% year over year, an increase of $17.5 million to $81.967 million. This is primarily due to a year over year increase of 25.8% in average earning assets.

Non-interest income increased 36% year over year, an increase of $6.1 million to $23.1 million and the majority of the income comes from our deposit account base. Non-interest expense was up $9.7 million, a 23.1% year over year increase, and the bulk of this increase is reflecting the acquisitions in Austin in '04, and full year operations of the 2003 fourth quarter Dallas acquisitions.

For the year, return on average assets was 1.36%, return on average equity was 14.2% and return on tangible equity was 33.4%. Loans increased 34.5% year over year to 1.036 billion on an annualized link quarter basis, loans were up 11%, as David had mentioned, and this loan growth helped move our loan deposit ratio to 44.7% at year end, compared to 37% at year end 2003.

Deposits were up 11.2 year over year, an increase of 233 million to 2.3 billion, and on a link quarter basis, deposits were down $10 million and the majority of this decrease was related to the Austin locations in a couple of areas where former owners took out money and the bank chose not to renew higher rate deposit accounts. If you back out or remove the Austin locations, the same-store growth on a link quarter annualized basis was about 4%.

The efficiency ratio was 49.2% for both the fourth quarter and 2004. The net interest margin and tax equivalent was 3.63% for the year. The margin was 3.70% for the fourth quarter compared to 3.64% in the third quarter, and the increase in the margin reflects our asset sensitive position and the impact of the recent Fed hikes and the continuing growth in our loan portfolio.

Our asset liability model at 12-31-04 shows that we are still asset sensitive and projection expansion in our net interest margin over the next 12 months based on rates moving up 100 to 300 basis points. And I would note in our model, we are using a flattening curve scenario where short-term rates are rising faster than the rates at the long end. The effect of duration on our securities portfolio at 12-31-04 was 3.3. We have approximately 14% in the AFS category, which produced a net after tax unrealized loss in the equity section of $3.1 million at 12-31-04, that's compared to $1.9 million at 9-30-04.

One last point to make concerning the tangible equity ratio. We mentioned in previous conference calls that by year end this ratio would be at least 4.25%. We actually ended the year at 4.38%. And going forward, this ratio will continue to expand absent any acquisition activity. And with that, I would like to turn over the presentation to Tim Timanus for some details on loans and asset quality.

Thank you, Dave. Non-performing assets at year-end December 31st, 04 totaled 1,721,000 or 0.17% of loans and other real estate, compared to $2,563,000 or 0.25% at September 30, '04, and $967,000, or 0.13%, a year ago at December 31st, '03. This represents a decrease of $842,000 in non-performing assets from the end of the third quarter, 2004, and a $754,000 increase from the year end 2003. The December 31st, '04 non-conforming asset total was comprised of $1,380,000 in loans, and $341,000 in other real estate. 99% of these non-performing assets pertain to loans in the portfolios of banks acquired by Prosperity.

Net recoveries for the three months ended December 31st, '04, were $25,000, compared to net charge-offs of $295,000 for the three months ended September 30th, '04, and net charge-offs of $172,000 for the quarter ended December 31st, '03. Net charge-offs for the year ended December 31st, '04, for $484,000, compared to $1,618,000 for the year ended December 31st, '03.

The average monthly new loan production for the quarter ended December 31st, '04, was $49 million, compared to $43 million for the third quarter ended September 30th, '04, for a 14% increase, and compared to $26 million for the quarter ended December 31st, '03, for an 88% increase. Average monthly new loan production for the year ended December 31st, '04, was $44 million, compared to $25 million for the year ended December 31st, '03, for an increase of 76%.

Loans outstanding at December 3 1st,'04, were $1,35,513,000, compared to $770,053,000 at December 31st, '03, representing a 34% increase. The December 31st, '04 loan total is made up of 37% fixed rate, 41% adjusting as prime moved and 22% resetting at specific intervals such as quarterly or annually. I will now turn it over to Dan Rollins.

Thank you, Tim. I'm very pleased to report that we are on track to complete our previously-announced merger with First Capital Bankers within the next few months. Both of our companies have scheduled shareholder meetings for February 23rd , to vote on the proposed merger, and we expect to have received the final regulatory approvals required before that date. Our new partners at First Capital Bank all share our desire to provide a level of banking service that is not often found in today's society. During the past few months, we have been preparing for this merger and are pleased with our progress. We are on target and on our time line.

This is the largest transaction in our history, and provides an opportunity for future growth. In January, 2003, or just two years ago, our bank was pre-dominantly a south Texas bank with 42 locations, and over 56% of our deposit base in the Houston area. Within the next few months, Prosperity Banc will have 86 full-service banking centers with significant operations in and around Houston, Dallas, Austin, Victoria and Corpus Christi. Upon completion of the transaction, we will become the second largest Houston-based bank and fifth largest Texas-based bank.

We are pleased with our organic loan growth and are proud to report another annualized growth over 10 million, as you hears. We experienced growth in our commercial real estate portfolio and our construction portfolio for the quarter while our AG portfolio experienced expected pay downs. At December 31st, our commercial industrial loans represented 13.9% of our portfolio. Commercial real estate represented 35.6% of the portfolio. One to four family residences represented 22.5% and construction loans now represent 10.6% of our port folio. Our pipeline remains strong and our team remains focused on producing results.

As you've heard from David while our deposits appear to be slightly lower than they were at September 30th, we are pleased to report that organic growth for locations that have been a part of our bank for one year or more was approximately 4% on annualized link quarter basis.

On the consumer product front, I'm pleased to report continued strong growth in our consumer fee based products along with our Internet banking products. Debit cards outstanding increased 19% over the past year while our debit card income has more than doubled. Our popular royal checking product continues to grow and is continuing to generate significantly to the income. In closing, our team is on task and producing results, both on the loan side of the bank and on the fee income side. At this time, I think we're ready to take questions. Melissa.

Thank you, Mr. Rollins. [Operator Instructions]. We will take your first question from the site of Brad Rattenen (ph) with FTN Midwest Research. Go ahead please.

A couple of questions. First, I wanted to get a little more detail on margin thoughts. Obviously you are looking for the margin to move up a little bit. I know that the end of three Q from the re-pricing perspective, including First Capital, you had about $400 million more of assets re-pricing in the 90-day bucket. Can you just talk about re-pricing with FCB in the next couple of quarters, and, you know, if the majority of the margin expansion is re-pricing or if there is also a piece of movement from securities to loans.

I will jump in before and then David Zalman can make a comment. There is another perspective on it. Off the security portfolio today, it's throwing off roughly somewhere to $275 to $300 million in cash flow annually, which obviously gives us re-pricing opportunities from that perspective, so if rates are going up, we are going to be able to reinvest at a higher rate. You are right when you look at the buckets. The models we look at, the reports we look at, we see about 46% -- 45%, 46%, you know, if you are adding the loans and the securities, have the opportunity to re-price in the next year. so it gives us great opportunity to take advantage of rising rates and that's when we look at the model, we do see our margin expanding because of that very fact and the opportunity to reinvest in those funds.

And so you are still saying the $300 million or so of cash flow?

I will say somewhere, you know, you can look at it month by month, but somewhere -- when I talk about that cash flow specifically, I'm talking about the bond portfolio.

Right.

Somewhere between $275 to $300 million, absolutely.

Brad, this David Zalman, I think [inaudible - background noise] Dan probably has these numbers but about 62% of our loan portfolio is either a variable rate or it floats on a daily basis. That's one issue. The second issue is, as the latter banks that we bought, the banks in Austin, Lakeway, Austin and Lakeway and now with First Capital, both of those banks had real high loan to deposit ratios and their makeup of their loans is somewhat different than our loans. It's probably more commercial oriented and most of them are floating. So I think as rates go up, we probably will see a better marketing of margin expansion because of the banks that joined us, and especially First Capital, in addition to what David just said about the bond portfolio.

That's where I was going to go. When you look at us, the stand alone, we are expensing margin expansion and we are more asset sensitive today than we have been, as David said, for many reasons, including recent acquisitions. You lay over First Capital's asset sensitivity, which is very high, and their margin is running a little larger than ours now, you know, that will be a benefit for us going forward into '05.

Probably, too, Brad, I didn't mention, but toward the end of last year, and you can probably see it in our numbers, we really felt interest rates were going to increase, and of course, we saw the increase on the very short end in the Fed number the prime rate, but the part of the curve that we buy in, in that three-year curve, we saw more of a flattening yield curve, and so we left probably $100 million more in liquidity than we normally leave, expecting this to be able to take advantage of this situation, and of course that hasn't happened, so as we start reinvesting that, that should improve our margin as well.

Okay. Great.

Does that answer your question, Brad?

Yes. And then you mentioned the same-store sales, 4% in the fourth quarter. A number of banks in Texas have basically said, look, it's single-digit deposit market from here. Can you talk about the outlook for deposit growth and if single digit is a fair assessment for the future?

I think that's a fair assessment. This is Dan. The other guys can jump in here. As we look forward, I think we're sitting in a pretty nice position. We've got a loan to deposit ratio that is less than some of our brothers and sisters out there, which means we're not feeling the pressure to chase some of these high-rate deposits. We're not having to chase deposits as rates move, and so we have been a little more diligent in paying attention to our funding costs because we're in a position where we don't have to be paying those high rates. But yes, I think we all are expecting deposits to be harder to come by, but we're still expecting to grow those deposits in the single digit range this year.

Okay, great. Well, one last question, if Tim could just give net versus gross net charge-offs in the quarter.

Well, for the year, we charged off, what, about $950,000.

We're all flipping through numbers.

$465,000 approximately.

Overall, you all can look at the numbers but from my recollection or memory, we had $400,000 more. We increased the provision for loan $400,000 more than what we charged-off. That's based on what we provided and also what we recovered. That's not exact, you probably have data --.

Total charge-offs were somewhere just shy of a million dollars last year and then we had some recoveries that shrank the number over the year to just under$500,000 in net charge-offs for the year. As David is saying, we positioned $880,000 during the year, about 180% of net charge-offs. We're looking forward to this year and some of the loans that are still on the books that we expect to have to work through.

Okay, great. Thanks, guys.

Thank you. We will take our next question from the site of Michael Crooner (ph) with SunTrust Robinson. Go ahead please.

It's Jennifer Demba. Good morning. Are you expecting any further deposit attrition in the Austin Banks, and then I have a follow-up question?

No, I wouldn't expect significant changes, you know. I think we have been through some of that, but it wouldn't be surprise me to see some of moving around over the next quarter. As you know, Jennifer, it always takes a little time to let some things settle. As we look out on the CD maturity schedule, you know, surprisingly, there is still some very high-cost CD's on the books today from acquisitions that we did back in 2000, and 2001 on some long-term CD's, so that's just part of business as deposits come and deposits go. From a re-pricing standpoint, we have obviously made the re-pricing in Austin, and I think we've seen what the results of that have been.

I would add Jennifer -- this is David. I would have to add a little bit more than that, because I mentioned to Dan and Dave and Tim earlier this morning that I'm really surprised we haven't lost more than -- especially at the Lakeway banking center, because it was more of a startup bank and it is not that old, and some of the rates that they were paying were, as much as 100 and 150 basis points over the market. So I thought when we re-price them that we would actually lose more than what we have lost. I still think you could see some runoff at the Lakeway banking center. I don't know that we saw all of it that we should, really.

It shouldn't be significant.

Okay. My follow-up question, your organic loan growth has been very good over the last few quarters. Can you kind of talk about how broad based that's been across your lending force? I mean, has it been concentrated among, you know, smaller group of lenders, or would you say you have the productivity up where you want it to be?

I'll answer that one real quick. We're never happy. I think we can always do better, but the answer to your question is yes, there has been good spread, not only across the lenders, but across the footprint of the bank. You know, when you look at where the loans are coming from, we have more offices in Houston, and we have more lenders in Houston, and we have been in Houston longer, so Houston is doing well for us.

The other side of that is Dallas. You know, we've been on the ground in Dallas over a year now, in all of our locations and early Dallas locations have been up and running for right at two years and Dallas is really beginning to come onboard. Several of the largest credits we have in the bank that we have approved recently are coming out of the Dallas market. Those lenders in those locations are performing, you know, quite well, so we're seeing, you know, loans out of Dallas, loans out of Houston.

Loans out of some of our south Texas markets. Austin is too new to really see. Loans are still there. If you use a same-store loan growth number, just like we were giving you same-store deposit growth number, excluding the acquisitions in '04, which excludes the Austin acquisitions, our loan growth year over year was more than the 10% that you are seeing. It was closer to 15%.

I would add Dan, you have to admit it is very encouraging with the Dallas group being one of our biggest producer this year, and probably even more encouraging to me Austin. Normally when you bring a bank in and a new bank in and it's joining you, you really see a pretty significant roll-off of loans in the beginning. It's just because the lenders sometimes slow down until they really understand the format, the way it has to be presented to the loan committee. It just takes six months to a year before they really turn on the speed again, and I would have to say that in the Austin market, really, they have really been very good. I've not seen that much of the loan slowdown. I would say they're still going. They're at 90%, anyway or 95, and I think they're doing really well, I think.

We're pleased with the execution, Jennifer, I think is the answer to your question.

Thank you.

Thank you. We will take our next question from the site of Campbell Chaney with Sanders Morris.

I have a clarification math question. I think your pro forma on your First Capital acquisition, is my math correct that the tangible equity ratio would go up something in the neighborhood of 5.3%?

No.

That's not right? Okay.

This is Dan, Campbell. You know, our calculation on tangible equity with the first capital transaction on the pro forma basis shows that we should see 15 to 20 basis point pickup in tangible ratio because of that transaction.

Okay. I will review my math. Sorry. And then the second question on the composition of the earning assets -- I'm sorry, loans and securities. I noticed it picked up a percentage point when you added the Austin banks and it is up about five percentage points in the year. Where do you think you could be 12 months from now?

From the loan to deposit ratio?

No the earning asset composition, loans & securities.

Oh, loans to securities.

Loans as a percent of earning assets is about 40 -- let's see -- I have you at -- I lost it.

While you're looking for that, I mean one of the things that we model out and maybe it is hard to predict, especially adding first capital into this, but you know, we project out from a modeling perspective or budget prospective growing that loan portfolio at least 10%. So I don't know how that moves the number between the percentage of securities to total assets and percentage of loans to total assets. The wild card there is, you know, deposit growth, because we can't lend all that money out. We're going to put it into the security portfolio at the end of the day.

Pro forma with first capital, we moved very close to a 50% loan to deposit ratio from the current 40-some-odd percent.

I had you close to 50 as well.

That's right on a pro forma basis and if you model out the 10% loan growth, you could be in the low 50's, 51, 52% loan to deposit and then we can back into a loans to earning assets if that was your question.

Yes, that was it. Okay. That helps, thank you.

Dan, we appreciate your help.

Thank you, we will take our next question from the site of Eric Ross with Hugbuy Capital. Go ahead, please.

Eric Ross, hello David how are you?

How are you, Eric?

Good. Just a couple of questions, most of them have been answered. Can you first talk about some of the fee income lines, and they're not big line items but the gain on sale of assets, what that is comprised over those loans and what that is, and the bank service fees, how much did that contribute this quarter, and then the other question on the income statement is your non-interest expenses were up about 6% sequentially. I'm curious what the makeup was there. I imagine some of it might be related to the two deals that closed in August, having a full quarter of those deals and I don't know if you have some Sarbanes-Oxley or other stuff going on there.

Yes, this is Dave. Let me see if I can work backwards here. There are a number of issues going on. The operating expenses up lean quarter basis, the comments -- your comment is on that. Part of it is having those Austin locations in for the full quarter. That's part of it. The other thing is we were looking, as management, we have asked all of our locations to turn in their budgets, their projections for '05 and the things they wanted to do. What we are looking at, a lot of stuff came back and they said we need to do repairs and maintenance on this, that and the other thing. We responded back saying, guys, looking at this, you need to repair whatever and get it done now. Why are we going to wait until'05 we can go ahead and do it now, so we made that commitment. The other one was we did some additional public relations-type stuff, including CRA donations, so that's also in there. All three of those things play into it.

As we look up from an infrastructure standpoint, as we look forward from moving from 50 some odd locations to almost 90 locations here in the next few months, you are seeing some of that infrastructure build also.

And then kind of working backwards, the fee income, the gain on other-I guess the gain from the sale of other assets, that's specifically when we acquire the Dallas banks, all of them had taken the position with the Texas independent bank in Dallas, they had to buy stock to participate in whatever programs that that bank offered. Well, when we acquire these banks, we don't really utilize that program, so we were able to take that stock and sell it as we have a need for it and that's where the bulk of that came.

That was half of it. We had $81,00 so in gain on sale. Half of it was that and the other half was we had a $30,000 some gain on the sale of OR-E.

What about the gain on the sale of loans, which you were selling in the mortgage company, will that add to it?

That was not hardly a number at all. And then I think the other question was, just a general comment on the fee income, and that, the rest of it is just purely derived from our deposit accounts. A lot of it comes from NSF fees being generated off this increased deposit account base.

And you had all three months of the Austin locations in there this quarter.

Right. That was one question we missed.

What did we miss there?

Just the banking-related service fees, can you just quantify what that was?

Banking-related service fees.

It was about $260,000 last quarter.

Oh. It was $269,00 in this quarter.

Okay. The other question was, can you talk little bit about what you are seeing from your competitors? I know you talk about how you're not going to chase deposits. We've talked in the past about higher earning. Maybe we can discuss what you are seeing from them or other competitors from the pricing standpoint, both on loans and deposits, more so on deposits. What are you seeing there? Are you seeing pricing more fierce than a quarter ago or about the same?

I don't think we want to throw rocks at our brothers and sisters.

Sure.

But there continue to be banks in all of our markets that are being very aggressive and pricing certain deposit products significantly higher than what the market would bare. We are seeing some 3% money market rates in some markets, we are seeing some exceptionally higher CD rates in some markets. And there is no and there are some bigger players doing that and there's a whole lot of smaller players doing that. That's just part of the banking business.

I would comment to say that we make comments like there are so many people doing it. I wouldn't say that there is that many people doing it. I think it is a handful of banks, and it is probably the same banks in the market in Austin, is the same banks in the market in Houston or Dallas. You can count them on one hand, and some of them are entering the market and they are offering some teaser rates that are trying to attract new business, and trying to get some of the business that maybe leaving them, but again, I wouldn't say it is the majority by any stretch of the imagination. I think it is a handful of four or five companies that are doing this basically.

I think your comments, in part, most of them are either new startup banks that are entering the market on that basis or larger banks that are coming into a market for the first time.

Right.

And we have seen this historically over time, and it usually works this way, and it comes and it goes.

Right.

Are you seeing more of the fierce pricing in Houston?

I think that you are seeing more of the fierce pricing in Houston with regard to the loan portfolio. I think there is more fierce pricing there. On the deposit side, I don't see it as dramatically. I see more of it in the more price sensitive with regard to deposit accounts; I think maybe more so in the North Texas area basically than Austin.

There are players in every market doing that. Maybe we're experiencing a little more in one market over another, but there are players out there. There is not a whole lot, but when they start banging the airwaves with something off the wall, that causes everybody to sit up.

Yes. The last question, I think, that you may have mentioned. I missed it, when you were giving the loan mix, what was the CNI percent of loan mix this quarter?

CNI was 13.9.

13.9. Okay, great. Thanks, guys.

Thank you, Eric.

Thank you. We will take our next question from the site of Joe Stieven with Stifel Nicolaus. Go ahead please.

A couple of my fundamental questions were answered but I want to drill back on the loan to deposit ratio. It sounds like you guys have a lot more flexibility than anybody else on deposit pricing because of your exceptionally low, you know, but very advantageous loan to deposit ratio, and I guess when you sort of model it out going forward, but it sounds like your loan to deposit ratio even though you have 10% loan growth really isn't going to change too much going forward. So I guess, just to talk about it, is it conceptional that you should be maybe a little more -- let's say more conservative on pricing? I guess that's question number one. Question number two, is you give an M&A updates outlook both on the state and how things are looking for you guys. That's really it.

How about if I start with your questions backwards?

Okay.

On the M&A side and David can jump in here, we have spent a lot of time and effort on the first capital transaction that's happening as we're speaking. It's happening behind the scenes, but there are still opportunities out there in the last couple of weeks. I know we have seen multiple opportunities that are being talked about, kicked around. I think there will be some. I see some smaller transactions. Again, you know when you are looking at Texas; there are so many banks under $100 million or under $150 million. I think there is a lot of talk in that range, and price expectations are still there. That's nothing new. I don't think anything has changed. People want a lot, and, you know, I think from our side, as you know, we're pretty disciplined at wanting a partnership. If it's just purely a sellout, that's not as appealing to us as when we can build a partnership with bankers and share holders that want to be a part of a winning and a growing organization.

So there is opportunity for us, and I think the opportunities are Houston, Dallas and other parts of the state, just as they have always been.

Your other question was loan to deposit ratio, and, you know, we may have a different view than some others on that, you know. It just plays back to the M&A question. I know David will jump in here in a minute. When we are looking at banks and we are modeling out acquisitions and where we are, you know, we believe we make money off of the deposit base. We believe that's where the value in a franchise is in the deposit base, and so, you know, holding deposits and growing deposits are important to us. I think you're right. I think we are sitting in a great spot where we don't have to chase high-cost deposits. We don't have to feel pressure to fund up. Quite frankly, that's exactly what was happening with some of the Austin acquisitions where they were fully loaned up, and to fund their loans, you know, they had to have deposits, and so they paid up on their deposits.

Right.

But we don't have to do that, and you see the results of that. We're not doing it, and we've lost some of those deposits, but the losing deposits as a general rule, I don't think anybody on our team feels comfortable about losing deposits.

I agree with you. That makes sense, too.

David, do you want to chime in?

I think you pretty well covered the M&A deal. I think Joe, bottom line is, this first capital deal; we spend a lot of time for a transaction of $750 million or so. But nevertheless, we still have had probably four or five opportunities so far this year. I don't think that we're going to get any of them. They might be a little out of our league on the deal, but it's definitely -- the acquisition or, you know, it's just a part of our model. We do look at acquisitions, so I think you will be seeing more from us. We will probably start working harder on it now in this second quarter.

With regard to the deposits, we basically it's a little bit harder for an analyst to see, but we do let from the -- especially from some of the new banks that have joined us, throughout the year, we left the CD's or the higher certificates for a loss and you can go and see by year end or a certain amount of time after we take these banks in, we generally, the ratio of transaction accounts to CD changes pretty dramatically. In some of these banks that we may buy may have a 40% or45% CD ratio compared to transaction accounts, and the probably within a year to two year's time, those bank's CD's will drop to maybe 30%. That's just an evolution of the way it works. We do let those CD's run off.

That's a great comment.

One thing I believe to be focused in on is that we don't walk away from customers lightly with regard to their deposits. One of the things that I do daily with our banking centers is to coordinate with them in that regard, and if they have a chance to pick up a new customer that, in their opinion would be a good one, and a deposit rate is an issue, we discuss that. If they're having problems with an existing customer regarding the deposit rate, we discuss that. We try to make a reasonable judgment as to how valuable that customer is to us in the long run, and we really look at it sometimes on a case-by-case basis, so we look closely before we let one walk out the door.

I think that ties back sometimes we kind of take it for granted but everybody understands that we have decision makers in every market and every location. We do give a lot of autonomy to those folks to make smart customer decisions. We want relationships. We want to build those relationships, and as Tim said, we don't want good relationships to walk out the door. The reverse of that is if all we have is hot money and we don't have a relationship, we're not chasing that very hard.

Right.

Does that help you out, Joe?

No, it does. Actually, I think it's a pretty good answer. Thank you, guys.

[Operator Instructions]. We will take the next question from the side of Barry McCarver with Stevenson, Inc.

Congratulations on the quarter, guys. I think most of my questions have already been answered. The only thing we didn't touch on was the loan pricing and competition there. Are you seeing any particular type of level and can you comment on that, please?

Loan pricing is kind of like acquisition pricing. You know, I think it's tough out there. Obviously we are in a rising rate environment. Prime has moved up. Customers are paying attention. We're seeing again, maybe not the same players as on the deposit side, but there are a handful of folks that are pricing loans very aggressively, as David said earlier, I think we're experiencing it more so in Houston, because we have a bigger presence here. We're not experiencing the same level of loan pricing competition in Dallas that we are in Houston or in south Texas that we are in Houston. Or Austin, to some extent. Austin may be in the middle there, but there is certainly loan pricing competition out there.

Barry, it's important to emphasize that we do the same thing on the loan side that we do on the deposit side. We look very closely at the borrower and the overall relationship, and we try to make a reasonable decision relative to that loan pricing based on who that entity is, who that borrower is, and it is difficult. A lot of the banks in Houston are willing to accept pricing that, in our opinion, is not particularly favorable, but we deal with it daily, and we'll continue to do so.

I would add Barry, that, so many banks, especially banks that occurring to growth mode and maybe some of the smaller banks, especially, they are so focused on the loan side of the balance sheet that they're willing to price underneath the market because they tied up a bunch of these of lenders and the lenders have come over. I think they feel compelled that they have the lenders -- that they have to get up to the 85 or 95% loan to deposit ratio and in so doing, they have pretty much just really cut rates very dramatically. Having said that, that's part of the business. It's been like that forever, and as Tim said, we look at the good customers of people trying to undercut us and if it's a dry relationship, we generally will let that other company or competitor have it.

Dry being no deposits?

Right. If it is a true relationship and the customer is borrowing a half a million or a million dollars and they have $200,00 so or $300,000 in the bank with it, we will be very competitive and try to match it.

Just to clarify, kind of what I'm looking at here is that I'm thinking if you guys were willing to give up a little bit on margin, your loan growth probably would have been significantly stronger. Is that fair to say?

I would say significantly stronger.

If you want to cut the price, there is plenty of loans out there. You know, we look to be rewarded for the risk that we're taking. You know, when you look at a loan, and if there's lower risk in the loan, we're willing to price the loan lower.

It's really ironic, Barry, because some of the same banks that have joined us now are merging with this. They are the guys that beat us on the loan, so it's, you know, some of those loans did go to those places, so, if we can really see, you know, where this did go and how they get them, it is because of the price they gave.

We have a lot more feet on the ground from a loan production side than we have had in the past. Again, when you look back over a relatively short period of time, you know, we've doubled the bank in three years. In two years, we're going to have gone from 50 some odd locations to almost 90 locations. Well, the same thing holds true on the number of lender feet on the ground, so the number of people out there calling is providing opportunities for us, and our model of letting -- putting decision makers in the field. We don't have an ivory tower, I am sure you have been to our office, we have folks that are all pulling the wagon together.

Okay. Thanks, guys.

Thank you. We will take our next question from the site of Eric Ross with Hugbuy Capital. Go ahead, please.

Hi, guys. Sorry about that. I have two other questions. Can you talk about what you are expecting to net interest income with a rise in rates and assuming your flattening curve scenario for a 100 bit increase and 200 bit increase? Do you have a particular asset size goal in mind in the next few years?

Zalman's answer is, much bigger than we are today. You know, we are obviously trying to grow. We want to grow organically. We want to grow through strategic acquisitions to expand our footprint and fill in our footprint. We've certainly told our team, you know -- we went public in 1998 as a $300 million bank, give or take, $400 million. At that time Zalman told The Street that we wanted to be over a billion dollars in five year, and we're six years into that mission and we're $3 billion. He told our team last year, he said, you know, we're doing well but really in the next three or four five years we need to be well over $5 billion in size. The challenge is out there in front of our team to make it happen.

I'm going to jump in before David responds. I don't know that we have an exact number to give you in terms of exact interest income. We want to work at it at a different way to say --. I wanted to come at it in a way to where we are projecting out from an earning asset perspective and kind of, you know, if we can give a range from where we think we will be from a net interest margin perspective. From there, I think you could back into the actual number.

He has taken the wind out of my sails. [indiscernible] points increase in 12 months but I think I've been spanked. I better not.

Did we try to answer your question, Eric?

Yes, to some degree. I'm still not sure I got it there.

The bottom line is, and again, I don't think we want to get the specifics out exactly, but in a 100 basis point increase in interest rate and in a 200 basis point increase in interest rates over a 12 month time frame, you should see some net income expansion.

Net interest margin expansion and dollar expansion.

That's right.

Okay. Thanks.

Thank you. We will take our next question from the site of Jeb Allen (ph) with SilverCrest Assets . Go ahead, please.

Yes, just a quick question about First Capital.

Sure.

In the past, you guys have cleaned up the loan portfolios of your acquired banks after you have closed the deals. I'm just wondering if we should expect some of the same with First Capital.

We've done loan acquisitions in a couple of different ways. Some have been post acquisition, some in part of the acquisition. As part of the transaction, First Capital is actually divesting not a big number, but, $11, $12, $13, $14 million, maybe as many as $17 million in loans. The majority of those are on their non-performing list today. It takes the worst piece of the non-performers out prior to close. Post closing, you know, there will be some loans, as there is in any transaction, there will be some things that don't fit our model, just like we're talking about where the deposits have moved off a different model. I would expect to see that take place over the next six months to a year.

Okay. Also, could you just comment on the mix of net interest income to non-interest income in the revenue base?

They are very high. They are loaned up. They have got $500 million give or take in loans, $630 million in deposits. Their fee income is not as high as a percent as ours is. Their net interest margin is a little higher than ours. We don't have all of their final closeout year numbers for their financials yet to put out. We do have some of it. We know that from a margin perspective, you know, we're expecting -- their margin is a little higher than ours. So that will be a benefit to us.

What you're saying is absolutely true. They went up, so most of their income is generated off the margin.

Their fee-based products. They have not been as successful. All that comes back to history. I don't think successful would be the right word. They were a thrift.

(multiple speakers) I would say also their push, where our push is building through acquisitions and internal organic deposit growth, their whole push was to build the loan portfolio, so I don't think that they really put the emphasis on different transaction accounts and fee income and other income like that. It was strictly driven to be a commercial bank.

Yes, to change their focus, you know, when you look at First Capital, the roots of First Capital are really in two savings and loans or south Texas thrifts that were put together and they have done a fantastic job of changing those facilities and that bank from a thrift-based model with high CD's into a commercial bank model where they have reduced the number of CD's. They do have some transaction accounts but as David said their primary focus was to get into the commercial loan market and they did that.

So is building the fee revenue an opportunity or is it just a different animal?

No, no. I think there is opportunity there. I think we've got to get -- we're picking up 20 some odd locations. I think we've got to bring those people onboard, explain how the products work, what we're looking for in sales, institute some sales culture. They have a great group of folks that are all very focused on taking care of their customers. There is an education process that we go through. Quite frankly, it starts today, it's the first day of some product training as we roll up towards putting these two banks together. We are, today is actually the first day of training for some of their staff on products and sales and how to make that happen, so certainly there is opportunities, and it will take us some time to put all of that together.

I think, Dan, it is going to be a lot of opportunity. But, again, it's going to be changing the way they do business right now. Currently right now, a lot of their -- if you have a problem or you have an issue with your checking account or any type of issue with the bank, you have to call a call center and so you are entering a call center, and in our world, basically we go back and we retrain the people at every banking center location to address the problem and take care of the customer where they bank at, and that's going to give that banking center an opportunity to really cross sale but again, as Dan said you are looking at about a 12-month process there probably.

Okay, great. Can you just remind us what was the next biggest acquisition you guys have ever done?

Sure, really from a size perspective, this is the largest acquisition we have done. From a percent of our size, as we are today, at $2.5 billion company acquiring a half billion dollar company, on a percent basis, this is the third largest transaction. In dollar size, at $600 or $700, million, this is the biggest. The second biggest would have been the commercial banks or Heritage Bank transaction that Tim Timanus joined us and that was announced late in 2000 and closed in 2001. They were a $400 million location plus when we were just barely over a billion. (multiple speakers). That was a much bigger -- that was the largest transaction we have ever done on a relative size basis, and the second largest transaction just off pure size.

This is more a, what, 20%? (multiple speakers). It looks big with numbers just because of the size we're at on a percentage basis or it is scaled to our biggest transaction. This is really not that big. It is not as big as Heritage, for example, in commercial Bancshares.

Thank you very much.

Okay. There are no further questions at this time, so I'd like to hand it back over to our presenters.

Thank you, ladies and gentlemen. We very much appreciate the support that you guys are showing in our company. We appreciate your interest in us and we would be happy to discuss further with you if you would like to call us. Thank you very much. We will talk to you again in April.

Thank you very much for joining us today, ladies and gentlemen. This concludes today's conference.