Prosperity Bancshares Inc (PB) 2005 Q1 法說會逐字稿

[OPERATOR INSTRUCTIONS] I would like to turn the program over to your host Mr. Dan Rollins.

Thank you. Good morning, ladies and gentlemen. Welcome to Prosperity Bancshares first-quarter 2005 earnings conference call. This call is also being broadcast live over the Internet at our website, www.prosperitybanktx.com. And will be available for replay at the same location for the next few weeks. I am Dan Rollins, Senior Vice President of Prosperity Bancshares. And here with me today is David Zalman, President and Chief Executive Officer, H.E. Tim Timanus, Jr., Executive Vice President and Chief Operating Officer, and David Hollaway, our Chief Financial Officers. This morning David Zalman will lead off with a review of our financial results for the first three months of 2005. He will be followed by David Hollaway who will spend a few minutes reviewing some of our financial statistics. Tim Timanus will discuss our view on the economies in our area and our lending activities including asset qualities. And then I will provide an update on the progress of our recently completed acquisitions.

Finally we will open the call for questions. During the call, interested parties may participate live by following the instructions that will be provided by our conference call moderator Leo. Or you may E-Mail questions to investor.relations@prosperitybanktx.com. I assume you have all received a copy of the earnings announcement we released earlier this morning. If not you can call Jennifer Nouan at 713-693-9308 and she will be happy to 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 to be materially different from results, performance, or achievements expressed or implied by such forward-looking statements. Additional information concerning -- 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 Bancshares 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 the call over to David.

Thank you, Dan. And we would like to welcome and thank everyone that is listening and participating in our first-quarter conference call for 2005. Our most newsworthy event of the quarter was the completion of our acquisition of First Capital Bankers, Inc. and its Corpus Christi-based subsidiary FirstCapital Bank on March 1 of 2005. The operational integration started only a week later, and I am proud to announce that all 85 of our Banking Centers are currently running on our core data processing system.

FirstCapital Bank is one of our largest acquisitions with assets of $761 million as of December 31, 2004. And 31 offices from Kingsville south of Corpus Christi, northward to Houston. I am very pleased and excited with the cooperation and the addition of the FirstCapital associates to our team. Not only does this transaction increase our presence throughout the state, but it also brings with it a large number of very seasoned, successful bankers that should help us to build our franchise even more going forward. We now have 85 full-service banking locations. 33 in the Houston CMSA, 16 in the Corpus Christi area, 11 in the Dallas area, 7 in the Austin area, and 18 in communities south and southwest of Houston, generally along the NAFTA highway.

Now on to the other business. I am very pleased to again announce record earnings for the first quarter. Prosperity reported earnings of $10.554 million compared to $8.063 million for the same period in the prior year. Diluted earnings per share for the first quarter were $0.43 compared to $0.38 or a 13% increase from the same period in the prior year. As expected, our net interest margin continued to expand from 3.63% as of March 31, 2004 to 3.76% as of March 2005, which represents a 13 basis-point increase. The increase also represents a 6-basis point expansion in our margin from the prior quarter ending December 31, 2004.

Loans as of March 31, 2005 were $1.5 billion. A $729 million or 94.8% increase when compared to the same quarter last year. It is also important to note that our loan-to-deposit ratio for quarter-end March 31, 2005 is now 51.8% as compared with 37.9% at the quarter-end March 31, 2004. The higher ratio reflects our desire to continue building our loan portfolio. While internal loan growth for the first quarter did not equal the 11% annualized growth we experienced during the fourth-quarter 2004, we were pleased with the almost 6% annualized growth we achieved this quarter in light of the extremely competitive price environment we are experiencing.

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 compounded annual growth rates of 40.4% in deposits, 46.1% in loans, 39.9% in net income, and 19% in earnings per share. As you can see from these numbers, we have achieved significant growth in all categories. Over this time, we have built a larger, stronger, and more diversified Company. We will continue to focus on our primary objectives of improving shareholder value by increasing profits on a sustainable basis. Two, increasing customer satisfaction and retention with our three-point service commitment of greet 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 feel as long as we can continue our historic performance and earnings per share growth, our future will be bright and shareholders will benefit. The performance that 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.

We feel very good about the first quarter of 2005, and our outlook for the full year 2005 is very optimistic. We believe our earnings for the year will trend more to the higher end of current analyst estimates for full-year 2005. This is based on our belief that we will experience relatively stable or moderately higher interest rates and will not experience some tragic event around the world that might cause economic uncertainty. Thanks again for your support of our Company. Let me turn over our discussion to David Hollaway, our Chief Financial Officer, to discuss some of the specific financial results we achieved. David?

Thank you, David. Some additional detail behind the numbers. Net income did increase year-over-year 30.9%. Net interest income increased $5.2 million or 26.5% year-over-year and $2.3 million or 10.2% link quarter and these increases were primarily due to an increase in the average earning assets of 20.6% year-over-year and 8.3% linked quarter. Non-interest income increased 23.9% year-over-year and 4.8% linked quarter. A bulk of our fee income, over 80% comes from insufficient fees, debit ATM card fee income, and service charges on deposit accounts. There have been questions concerning the impact of higher rates on fee income generated from commercial accounts, and that impact on overall fee income growth. For us, that number is small as a percentage of total fee income. We generate about $125,000 per month off of about $200 million in commercial deposits that are on account analysis. To give another perspective, we generate roughly $135,000 per month in debit -- debit card income.

Non-interest expense was up 27.1% year-over-year and 13.2% linked quarter and these increases reflect the acquisition of the Austin banks last year and First Capital Bank this year. We also noted in the press release that we had about $1 million in one-time expenses this quarter for money surrounding our new advertising campaign for our new markets and some merger-related items. There were two other one-time items noted in the press release: Tax expense included a $540,000 tax credit adjustment associated with deferred CDI amortization from recent acquisitions and other income included a $225,000 distribution related to the Pulse EFT Association merger. As stated earlier, loans increased 44.9% linked quarter and same-store growth, those locations older than one year, increased an an annualized growth rate of 5.6%. The internal number is down a bit from the previous quarters and Dan Rollins will provide a bit more color on what caused the change.

Deposits were up 24.9% linked quarter and same store deposits were slightly down linked quarter less than 1%. The major factor behind the internal growth number was not having the need to chase higher cost deposits. The efficiency ratio was 51.06% for the quarter up from the fourth quarter which was 49.19%. This reflects the impact of FirstCapital, and as the year progresses, we should trend down to the target rate of 50%. As stated previously, the net interest margin tax equivalent expanded for the third consecutive quarter to 3.76, up from 3.63 in the first quarter, 3.70 in the fourth quarter. And based on our asset liability model as of 3/31/05, we should continue to see expansion in the margin over the next 12 months in an interest rate environment that sees rates holding steady to one where rates can increase another 200 basis points. This assumes an orderly movement of rates over the next 12 months which allows management time to -- time to manage the balance sheet as rates change. The security portfolio as of 3/31/05 saw the effective duration decrease slightly to 3.2 years. One last point, the tangible ration now stands at 4.86% up from 4.38% at year-end. And with that I would like to turn the presentation over to Tim Timanus for some detail on earnings and asset items. Tim?

Thank you, Dave. Nonperforming assets at quarter end March 31, '05 totaled $3.447 million or 0.23% of loans and other real estate compared to $1.721 million or 0.17% at December 31, '04. This represents an increase of $1.726 million in nonperforming assets from year-end 2004. The March 31, '05 nonperforming asset total was comprised of $2.727 million in loans and $720,000 in other real estate. 96.7% of these nonperforming assets pertain to loans held at the time of acquisition in the portfolio of banks acquired by Prosperity.

Net recoveries for the three months ended March 31, '05 were $106,000, compared to $25,000 for the three months ended December 31, '04. The average monthly new loan production for the quarter ended March 31, '05 was $47 million, compared to $49 million for the fourth quarter ended December 31, '04. And $27 million for the first quarter of 2004. Loans outstanding at March 31, '05 were 1.5 billion compared to 1.36 billion at December 31, '04. The allowance for credit losses were 1.13% at March 31, '05 compared to 1.27% at December 31, '04. While the percentage decreased over the quarter the dollar amount of the allowance increased from 13.1 million at December 31, '04 to 16.9 million at March 31, '05.

A portion of FirstCapital Bank's allowance was utilized to facilitate the sale of approximately $17 million in loans that Prosperity requested be taken out of the bank prior to closing our acquisition. While the allowance at 1.13% appears to be adequate at this time, we are focused on making necessary adjustments if the condition of the loan portfolio in the future justifies such action. The March 31, '05 loan total is made up of 39% fixed rate, 42% adjusting as prime moves, and 19% restating at specific intervals such as quarterly or annually. I will now turn it over to Dan Rollins who will give us a status report on the completion of our acquisition of FirstCapital Bankers ,Inc. Dan.

Thank you, Tim. I want to spend a few minute reviewing our progress for acquisition integration. During March, we completed the operational integration of FirstCapital Bank. Keep in mind this is our largest acquisition in size, asset size and number of locations that we have attempted to date. This was a large undertaking, and we are very pleased with the progress we have made so far. As David said, the computer conversion piece of the puzzle, which is the first -- the first step and the largest step in the process was completed on March the 18th.

As we speak, we are working to complete the rebranding of all of the new locations. That should be completed within the next few weeks. Steve Hipes, our South Texas area Chairman and Bob Koon, our Corpus Christi area President and their team have done a remarkable job of laying a very strong foundation in Corpus Christi, Victoria, and other communities in Texas that will support our future growth objectives. We have a great team of customer focused bankers in South Texas and we are looking forward to great things in these markets.

Our organic loan growth was 5.5% on an annualized basis for the first quarter. While this was below our stated goal of 10%, we are pleased with our progress in light of the extremely aggressive loan pricing competition that we are facing in the Houston area. Including the FirstCapital loans, we experienced loan growth in our commercial real estate portfolio, our commercial industrial portfolio, and our construction portfolio. At March 31, our commercial and industrial loans now represent 16.2% of our loan portfolio. Commercial real estate loans represent 38.9% of our portfolio. One to four family loans have decreased and now only represent 20.4% of our portfolio and construction loans increased to represent 13.0% of our total portfolio. Our loan pipeline remains strong. Our team remains focused on producing results. At this time I think we're ready to take questions.

[OPERATOR INSTRUCTIONS] We will take our first question from the site of Barry McCarver of Stephens, Inc.

Good morning, guys, great quarter.

Hey, Barry, how are you today?

Great, especially since I saw your numbers.

Thanks.

A couple of higher level questions and then a couple of housekeeping questions to start off with. You talked about the large number of seasoned lenders you got with the FirstCapital acquisition. Can you give us an idea, any specialty or any particular product they are better at that might complement your existing business?

I think that -- that the community bankers that FirstCapital had are very similar to the community bankers that we have. They have got some folks that are very good commercial real estate lenders. They have got a couple of very good construction lenders. They have got some good commercial and industrial lenders, and they have got some good consumer folks. I think it is a very good fit across the board, Barry, with what we already had. When you look at the number of producers. We had 70 some odd lenders give or take prior to the FirstCapital transaction. We now have 100 and some odd lenders that includes consumer lenders, home equity-type lenders also. If you look at it from a commercial standpoint, we had roughly 50 commercial lenders in the past, and today we will have somewhere around 75 commercial lenders.

Dan, I would point out that probably in the Houston area, a little bit of a specialty is the -- one of the lead guy force FirstCapital is Jack Thompson here in the Houston area, and a little bit of his specialty was prior with the old First Citigroup and some of the guys that worked directly for him really have a lot more big bank experience and Jack himself really specializes in a lot -- one of his primary deals was correspondent banking and deals with a lot of higher-end executives at other banks.

Professional executives lenders.

Right, right.

Okay. And then I guess secondly, you talked about your locations now across the state. Any -- any gaps in the state or any particular MSAs that you don't have the presence you feel like you need that you're going to be filling in in the next couple of years? Not any particular way of filling in, just -- I'm talking about acquisitions, just in general.

I think when you look at our footprint today across the state. One, we are very pleased with 85 locations that run from Corpus Christi north to Houston and include Dallas and Austin. We hit the fringes of San Antonio with the FirstCapital acquisition. We are now 30 miles or 40 miles outside of San Antonio. Certainly the San Antonio market is one of the top ten markets in the nation. It is appealing to us. The Dallas/Fort Worth metroplex with 11 offices and lots of independent banks appears to be a great place that we could continue to expand. That doesn't mean that we wouldn't look for great opportunities to continue to expand our footprint in the Houston market in South Texas.

Okay. Fair enough. Just a couple of quick housekeeping. I know you just said the allowance was adequate. It is still quite a bit below the levels you guys have carried in the past. On a long-term trend are we going to see it moving slowly back up to where it was?

Go ahead, David.

This is Dave Hollaway. I will take a shot at that. Again when you are looking at the overall loan portfolio, you can't really -- in today's world, you can't just say we want to be at a certain percentage, because first of all, I don't think the regulators would allow such a thing. So what it is is an ongoing analysis of the portfolio. The first big point is, we are growing our commercial piece of the portfolio, and historically it has been one to four families. Not as much risk in the past. So direct answer to your question as we go forward, we have got to continue to analyze it. Are we as of today uncomfortable with the 113? Probably not based on what we have in the portfolio. As we go forward and continue to grow it, we'll continue to look at it. And if we're growing our loan portfolio significantly and we are doing analysis on it, we may have to move that up. But we will have to kind of judge this as we go forward.

When you look at the -- at the regulators and the auditors review today of this, it is a little different than it used to be. I think part of the issue there, Barry, is when you build on what Prosperity had premerger and add on the FirstCapital piece a piece of the loan loss reserve that was in the FirstCapital Bank prior to merger was -- was used as a part of the cost of divesting the $17 million that was divested prior to closing.

Barry, we look at it monthly and we will make adjustments as those become apparent.

Okay. Fair enough. Thanks a lot, guys.

Thank you, Barry. Appreciate it

We will move next to the site of Brett Rabatin of FTN Midwest Research.

Hi, guys, good morning.

Good morning.

One question for you I was impressed with the link quarter minimal increase in the cost of interest bearing funds. You guys obviously focused on that during the quarter with some higher cost stuff rolling off. Can you give us any thoughts on volume mix, trade-off, and deposit pricing as you guys see it going forward?

David Zalman. What we saw this last quarter, again, we were -- it is a very competitive market out there, especially with new -- some of the larger banks moving into the market. And with us not absolutely necessary needing to have liquidity, we took the position that we really were not going to chase the high deposits, and when you look at our numbers, basically it was about a $28 million drop from the last quarter, and the $28 million, if you want to -- really want to break it down more, you can probably even see in our press release, came specifically or at least $15 million of that from the Austin banks that we acquired back in -- in -- in '04. And we knew that that money was going to leave. It was higher cost money. In fact there may even be some more.

The other 13 million or so we feel was really seasonal. If you look at the quarter last time at this same time last year, we had the same effect, and in fact if you look at our deposits today, I hope I am not saying something wrong, Dave, but when we looked at them a day ago when we were doing this conference call, preparing for it, the deposits had already been up over that 13 million that we lost.

Yes. Just kind of adding some color to that, that being what David is saying. It is interesting. I mean, when you project forward, becoming more of a commercial-type bank doing more commercial credits, so, yes, the thought process going forward is you'll see the higher cost monies not sticking with the bank but the Non-interest bearing monies probably on average will increase, and that's what David was alluding to in the first quarter on average, it seasonally tends to go down a little bit and it will start coming back over the next few quarters. Another example of high-cost rates, this goes all the way back to an acquisition we did in the fourth quarter of 2000, I believe it was. CDs on the books at 7% for five years. Those -- those were coming off this past quarter. But those were people simply chasing rate. Again, it wasn't a significant amount of money, maybe talking 5, 6, $7 million. But those people were chasing rate, we didn't need to keep those deposits so that's partly what was affecting the numbers.

And having said all of that, not that we are not going to chase money but at the same time, we don't want to shrink the bank either but it's a real fine line and it's a balancing act what you need to do and what you don't really.

Does that help you Brett?

That does. Then just one quick follow-up. You are talking about chasing money. I was curious to hear your thoughts on Houston. I have been hearing a lot of people talking about chasing credits in the Houston area, and was curious if you felt like your loan growth was somewhat restrained given some competitors chasing credits in Houston.

That's a wonderful question. I think that is a very soft serve on the tennis court. We will be happy to answer that one back. You have hit the nail on the head, Brett, you know. Our loan team is very focused on producing business, and they're bringing great loans in through -- through the pipelines that are being approved. We identified just in a very short period of time over the last few days talking about what's happening to our loan production team. We identified 25 to $30 million in credits that we approved, that we talked with the customer on, that we are working toward closing with the customer on, that we did not close because of very aggressive pricing on the loan side with some of our competitors.

When you look at our bank today, we have -- we have six loans on the books under prime. Six. We have tried to make a loan under prime this past month, and we missed by 75 basis points. You know, we have seen pricing at prime minus one. We have seen pricing at LIBOR plus 1.75 on commercial credits and we have just not been feeling that we needed to chase those loans at that price level because that would be damaging to our margin.

Good for you. I have heard of those kind of similar pricing trends too. Thanks, guy

Thank you.

We will move next to the site of Joe Stieven of Stifel Nicolaus.

Good morning, guys. First of all, good quarter

Thanks, Joe.

Most my questions have been answered. But can we drill down on the margin for a second. Your margin in the quarter was very good. But can you just sort of give us some color on the margin without the -- the acquisition of FirstCapital? How did that impact the quarter. What would of the old Prosperity margin have looked like.

Yes, Joe. Dave Hollaway. Absolutely, first off, FirstCapital was only in the quarter for the 30 days and bringing color to that, looking at the 3.76 margin, if we were able to back out FirstCapital, that would probably have left the margin on the quarter down 2 or 3 basis points. Their margin was just a little bit higher than ours was on a stand-alone basis. But to really give you a good specific looking forward, in March -- let's just pull March out separately and what was the margin then because that had FirstCapital in it. We were running at about 3.80. You can see we have got very good positive trends on the upside. Looking at our bank in January and February, we were running about 3.75.

Okay. And second, on the pricing in Houston, is it really -- I mean is it the biggest -- is it starting from the top down with some of the biggest people? Or where is the pricing pressures really coming from.

Are you talking on the loans.

On the loan side, yes.

On the loan side. Because deposit pricing is certainly an issue too. But on the loan --.

We can go into that next. [ LAUGHTER ]

On the loan side of the equation there is a lot of folks out there that are promising results and promising loan growth, and they are doing it as smaller banks, growing, feeling like they have to grow loans and it's larger banks that are feeling like they have got to grow loans and they are willing to cut the price to do that. So I think we've seen that competition in regional banks. We have seen that competition in big super regional banks, and we have seen that competition in local banks.

Okay. So pretty much across the board.

Pretty much across the board. On the deposit side, it is probably closer to a larger super regional leading the charge on the deposit rates than it is the local guys.

I would say it is even bigger than the super regionals. It's the super regionals plus even some of the new --.

The nationals.

The nationals that have entered into the market. For example, we had a -- Mike Myers from our Austin location E-Mailed me the other day, Joe, and said that the guy that bought (INAUDIBLE) Citicorp are offering a 3% money market rate as long as you open up another checking account. It is a teaser, right, but it is still pretty significant and that's the kind of stuff that we are seeing out in the market.

Okay. That's -- that's tough to compete with. Okay, thanks, guys.

Thanks for your questions.

Our next participant is Jennifer Demba of SunTrust Robinson Humphrey.

Thank you. David, I was just wondering -- David Zalman, wondering what you are seeing in the M&A environment right now. We haven't seen many deal announcements here in the first quarter, and I was just wondering what you are seeing from your perspective.

Jennifer, we are still seeing deals out there. We are still looking at deals. Probably some of the deals that we looked at so far, one I can say that we are out of it. We got beat pretty good on the pricing. We are still -- we are still -- we are still looking at other deals. We have the FirstCapital -- FirstCapital Bank in front of us that is really -- we are really -- our primary interest right now is to make sure that we operationally integrate FirstCapital which I think is doing fine. At the same time, though, we are still looking for other deals, but, again, pricing is very competitive and we are not going to overpay for deals, but I think you are still going to see deals you might not have seen the deals during the first quarter. But I think by year end, you will see some deals happen. Not necessarily with us, but overall, I think they're out there right now.

There is certainly a lot of talk going out there based on margin pressures, based on compliance and regulatory pressures. When they make the decision to go, we can't control that.

But, again, I think there were -- there is a considerable number of people considering it right now, especially when -- you know Sarbanes-Oxley and the regulatory environment that we are in. I think a lot of people are considering or were considering it. And I think you will see some deals start happening this year.

But we continue to talk to lots of bankers on a regular basis.

Right, right.

One housekeeping question for David Hollaway. You mentioned your deposit service charges and the amount that you had from commercial accounts. Can you go over those figures again?

Yes. One of the questions that comes up -- because apparently a lot of banks are reporting with rates going up that it affects the earnings credit on commercial accounts that are on account analysis so, therefore, it significantly impacts their fee income.

Right.

That question has been lobbed at us a number of times so we've actually pulled it out and we have got about $200 million in commercial deposits that are on account analysis today that gain about $125,000 a month. So, again, in the overall scheme of things, as a percentage of our fee income is not as significant as maybe some banks that are 100% linked up with a lot of commercial deposits.

Or a pure commercial bank that doesn't have the consumer and retail deposits that we carry.

Sure. One other housekeeping question, David Hollaway. The tax rate was obviously positively impacted this quarter. It will go back to more of a 34% type level in the future quarters?

Absolutely. It should be in the range of about 33.5 to 34%.

Okay. Thank you very much.

Our next participant is Kevin Reynolds of Stanford Group.

Good morning, everyone.

Good morning, Kevin.

To follow up on Jennifer's question on the tax rate. As I look at that as a one-time item obviously to get to a core run rate if we can this quarter because the noise from the acquisition, it is probably 2, 2.5 cents or so that comes out, and you allude to merger-related items as extraordinary items in the expense structure, but you really didn't break them out this quarter. Can you do that right now just so we can see what the net of those two things might be.

In the verbiage in the press release, Kevin, we talked a little bit about, there is really three items that are in there. The biggest of which is some new branding advertising in some new markets. And keep in mind, advertising is a purely discretionary item. We've always felt that we can advertise when we have the funds, and if we don't have the funds, earnings are important. That is certainly something that we can control. So the ability to do some -- some branding in some new markets is important us to. That is the biggest ticket item that's in there.

Then you are also looking at some incentive compensation. There's more players on the game today. We have got to true up where we begin the year. So there is an additional incentive compensation that would be a one-time item in there. And the smallest piece of the puzzle would be the travel and lodging and keeping our team around. In the past, as we have done, acquisitions and we have integrated these banks into our team, we have had people that are out on the road and we will send out 10 or 15 people and they will be out for a week two and they will make sure everything falls into place, and you have never seen those numbers before.

This particular time with 27 new locations, we had 100 people out staying in hotels and eating and driving and flying and doing all of the other things that had to get done to get them into our system, and that was a bigger cost this time, but the smallest of the three items we've just talked about. So the net effect is, you have got about $1 million in extraordinary expense in the quarter, and if you tax effect the tax credit or the tax piece of it along with the $225,000 Pulse income, you have got roughly $1 million in extraordinary income.

Okay, but -- but it sounds to me like -- again, it may be a choice to rebrand, but we have seen other people in your local market choose to rebrand as well. And, again, it is not something that you back out of the equation to get to a run rate going forward. I mean it's -- it sounds like something you feel like you need to do given the opportunities that are there. So I am just trying to figure out, I mean --?

No, advertising is a one-time expense. That is over and above our normal advertising run rate.

Okay, but if you choose to advertise over and above that in coming quarters, should we also consider that a one-time expense? I guess that is what I am trying to get to.

I would say, Dan, the expense that we took this time was in preparation for the rest of the year.

My answer would be, no, you shouldn't have one-time advertising costs that are extraordinary on an ongoing basis.

Okay. Thank you.

Our next participant comes from the site of Greg Lapin of Saronet (ph) Capital.

Good morning. Can you offer any color on the commercial real estate side in terms of customer reactions to rising interest rates.

Tim, you want to take a stab -- I think the question, Greg, is how are our customers reacting to the rising interest rates. Are they doing more deals, less deals. I think everybody would like to lock longer term rates, but Tim, maybe you can kind of talk about that from the loan approval process.

I think from a practical standpoint, we haven't seen really any effect at all yet. People that are in the real estate business are still out there looking at deals and trying to do deals. When we look at a loan, we always do a stress test on the rates. Typically take it up by 300 basis points. Obviously at some point in time if rates continue to rise, some people in the industry are going to be pinched a bit. But we don't see it in their profit numbers yet, and we don't see it yet in their desire to do deals.

Yes, I concur with Tim. This is David Zalman. I sit in the loan committee also, and I don't see that it has really stopped anybody from doing commercial real estate deals yet. I think overall people still feel that the rates where they are at right now are still considered pretty low, but, again, as it moves up, it probably will affect the future, I would think.

If it continues to move up. There will be a break point in there somewhere. We don't know exactly where it is, but it always works that way, and it will work that way again, but once again, to date, we have seen no -- no pulling back from -- from the desire to do transactions and no adverse effects really in terms of profitability.

Okay. One more question. On your guidance, which is predicated on 10% loan growth. If we assume that the commercial lending, underwriting standards in the market continue to deteriorate and follow that trend, What leverage do you have available to reach the bottom-line for that plan? It appears that the net interest margin is doing better than your plan so far. So that helps.

Well, first of all, Craig, our future projection or what we think we are going to make is not predicated on a 10% loan growth. So we are not required to have the 10% loan growth to hit the number.

Okay. That's -- that's helpful. Would you consider any modifications in your lending strategy if it did get more competitive?

Modifications by, in other words, lowering rates to play in the game?

Lowering rates or considering giving credits for other relationships, the holistic management?

Greg, that's a -- I would tell you that we have been doing this for a long time, and I would tell you, whenever it gets to the point that we can't make the margin that we need to off of the loan side and we are not being rewarded for the risk for making the loan, we generally will go ahead and put the -- put -- put the asset in a security because we would make just as much and not have the risk. Now having said that, I am sure you'd lose some type of business on the other end whether it is a checking account or stuff like that. I would tell you to date and as long as I have been at the bank, we have not done that. If we reach a point where we can't cover the cost of the lender, the servicing and make a fair return and take into consideration the risk in the loan, we generally won't do that and I don't see that changing going forward.

Thanks.

Does that help, Greg?

That is helpful, thanks very much.

Thank you.

Our next participant is Scott Alaniz of Sandler O'Neill.

Good morning.

Hi, Scott.

I want to follow up that Burt and Joe and Greg talked about pricing on the loan side in particular. And as I look at it and what I want to you to talk about is, how in the world is it going to get any easier? I really don't see it getting any easier out there. And if you were to look out a year, I mean, how -- how challenging of an environment could it be from a loan pricing standpoint?

I think that -- that there's multiple parts. I think you have a lot of moving parts here. Let's talk about some of the loan transactions that we are looking at that we've missed. We have historically been a under-the-radar-screen lender. We are looking at smaller credits. When you look at our loan portfolio today, let me give you some numbers we haven't talked about. We've said from the very beginning of time our average loan was a little less than $100,000 when you lay on the FirstCapital Group our average loan today is $108,000. So we didn't move the needle very far.

When you drill further into the portfolio, the largest loans we have are in the commercial real estate transaction category. Average commercial real estate loan today is right at $400,000. The pricing on a $400,000 commercial real estate transaction is not in the same ballpark as a multimillion dollar transaction. So where we've been not playing the game as well or not playing the rate game as aggressively as some of our peers in the market has been in the multimillion dollar category, and when you look at the five or six loans that we missed that totaled up to a little less than $30 million the question comes back should we have made those $30 million loans at a lower rate, basically the same rate as we can get in the bond portfolio or are we better off not making those loans and keeping that money in the bond portfolio and continuing to work with the lenders to find the loans that we can get a better rate on.

Got you.

There are loans out there -- we are making loans. I don't remember the number that Tim threw out, but roughly 50 million a month is the average loan production number. We are making loans at the higher rates. We are just not feeling the need to chase those loan rate loans just like we are not feeling the need to chase the low rate -- or the high rate deposits.

So you haven't seen the same degree of competition on your bread and butter type, the 100 to $400,000-type loans.

Not as much and you normally would not. It is the larger more what I will call sophisticated commercial loans where you see the focus of that aggressiveness.

And again, we are a relationship lender. So when we are working with the owner-operators, or the small investors that want to build a relationship with a lender that they have confidence in, that they know can take care of what their needs are those transactions aren't going to move over a 10-basis point move in the rate, where your multimillion dollar transaction, you are going to have more players in the game up front and it is really not a relationship. It is a you buy the business.

Dan, it may help to give Scott a little color of the type of loan that we didn't get or didn't compete with. And I will give you one example. We were looking at a $6 million credit. And it was -- the credit was not an issue. It was more of a charge. And it was -- it was a branded one. It was not even an issue as far as credit, if they could pay or not, very large. What we -- we tried to get the credit because we knew it was a relationship that we could probably get other business from. The lender asked if we could price it at prime minus a quarter and take the collateral. Take the charge as collateral, we said, yes.

Keep in mind we have six under prime loans on the book. So this is pretty aggressive.

We really thought we were going to get the deal, Scott, and it finally got funded as an unsecured loan at prime minus 1. So that's the kind of stuff you are seeing and I think that it's more -- Dan probably has some more examples, I think there were four or five that we talked about that came up to the $30 million. But these are -- this pricing pressure is really the pricing pressure from credits at probably $2 million or above.

Okay. Good. Very helpful.

Thanks, Scott, appreciate it

We will take our next question from the site of Campbell Chaney of Sanders Morris Harris.

Good morning, everyone. Kind of following up on those good answers you have given. Are you seeing the bigger banks come down and giving that kind of pricing like the loan you just mentioned, the prime minus 1, or is it the smaller banks -- your competitors who are coming in with those kind of pricings?

It's both, Campbell. We have got super regional banks that are playing in the game, and we have got some of our peer banks in the same group that we are in playing in that game, and to some extent we have seen some smaller, newer banks that are feeling like they have just got to do this or they are not going to be in business. So you really got competition on all three sides.

Is it relatively new to see the super regionals coming down into, I think you classified off under the radar?

Let me make sure we are all on the same page. The loans -- we're -- the loans we are talking about are multimillion dollar large credits that all of the bigger banks have been playing in all along. The size of the credit has not changed. We do not see a lot of competition from the big super regional banks and my term under the radar loan size. If you are talking a loan size under $1 million, you know, those guys, while they will look at them, they are not out actively looking for that kind of a relationship.

Okay. That's good to hear. And then also, how about -- give us some color on attrition from employees and also maybe some business with the FirstCapital deal and then also maybe some opportunities to poach commercial bankers with seeing-eye type books from some of the deal activity we see such as Hibernia and maybe some of other banks. How are those opportunities for you?

I think there are multiple questions in there. Let me try to take those backwards and David jump in here, the opportunity to bring lenders onboard. What we consistently are looking for the right fit for our community banking team. You know we talk to lenders a lot. We have hired some lenders here and there. We have got two or three that have come on board in the last six months or so. We have got a couple of others that we are talking to now. I don't see us out looking to bring in a huge number of people from somewhere else while that could be an opportunity for some folks. The --.

I would say, Dan, that FirstCapital was a little bit different than we are in that they had primarily -- even though they had 31 locations, they had 3 primary loan centers, and those loan centers were really Corpus Christi was their primary lending center. Then they had another one in Victoria, Texas. And then, of course, the -- the next one was the Houston, Texas market. And when we looked at the loans, those loans were all pretty much distributed equally among the three locations. I would say as far as the people -- it's -- I think it is great. It has been overwhelming. We have not lost anybody as far as -- I think the primary we lost two people. Primarily, one in the Victoria market. So I still consider that really good.

I think the competition for people is always going to be out there. You also were asking about attrition, which I think is more of a FirstCapital what's happening with our headcount.

Headcount and also maybe some loans leaving, refinancing or something.

Well, certainly we have said all along just like you see on the loan chart that we put in the press release from Austin, that -- that there is always going to be some loans that will not fit. That will leave. Some that we are happy to see. Some that we are not happy to see, that's a piece of the puzzle. Any time there is an acquisition, there is going to be -- that's a destabilizing effect on the book of businesses that's there. There will be some of that. From a headcount perspective, I have lost my number, where were we, 920 something, give or take at quarter end. We would certainly expect that number to decline over the next quarter. We have not come in and laid people off. That's not been our style. But with 1,000 people out there just through normal comings and goings, we are going to be able to see that headcount number decline as we move forward.

I guess I am trying to get -- you haven't seen a real spike outside what your expectations were?

Oh, no. I think from an on plan. Where we are let me back up again. When we put together banks and we're merging institutions together, we certainly try to put a road map in place prior to doing the transaction that is laid out. Where we want to be. What we are going to try and accomplish on multiple fronts, and that includes certainly the people piece of that. And I think on all fronts on the FirstCapital, keep in mind it's -- it's very early in the game. We are 45 days past convert, past acquisition, and really less than 30 days past computer conversion. It is early in the game. But today I think we feel very comfortable that we are on plan in most areas and ahead of plan in a few.

That sounds great. Thanks a lot.

Thank you.

We will move next to Bain Slack of KBW.

Good morning. Most of my questions have been answered. I guess in light of the -- a lot of the questions on the Houston pricing, what other market or markets outside of Houston is offering you all the best opportunity to get better loan growth with the pricing that you are looking for?

Well, you know, Bain, David Zalman. I think it is competitive everywhere, quite frankly. But if you are asking me where we get better pricing at, at least in our Company right now, it is true that we get better pricing in the Dallas market. Austin market is probably not -- not as good as Dallas but yet it's better than Houston. And I would say the Corpus market. So almost all of the other major markets that we are in, we are getting better pricing than we are in Houston. It is very competitive in the Houston market.

So the better pricing in the other markets, just due to a competitive difference, in your opinion?

I think that it is just so competitive in the Houston market and there is such a desire to build a loan portfolio that it is just more competitive here. People are willing to take less.

We also cover some 20 some odd communities outside of the major metropolitan markets and while those communities don't have the huge potential for loan growth, we are certainly making loans in those markets and the pricing is not the same as in the metropolitan area.

That's probably our best pricing wouldn't you say, Dan?

Yes.

Great, hey, thanks.

Thank you.

Our next question could from Eric Ross of HOVD (ph) Capital.

How are you.

Good Eric, how are you?

Very well, thank you. I have a series of questions and maybe I will hit some of them and then step back in the queue later. Can you first tell us what your one-year cumulative GAAP is now with the acquisition included.

Cumulative GAAP you mean from an asset liability, asset sensitive perspective?

Right.

331 we were about 9%. And that's really when you go back and look at the fourth quarter that is not too terribly different if I recall correctly we were about 7% at the end of the year.

I would say the last quarter of the year we were in the 7% range and I am looking at the number right now, it's 9.3% positive, cumulative GAAP right now, 180 days to 1 year out.

Okay. Great. Speaking of competition again. Two questions there. First, on the deposit side. Is Austin still the toughest market that -- in terms of pricing?

I would say in my personal opinion, it is. Austin is. But having said that, I think it is very competitive in Houston, too.

We see it across the board, but Austin is -- is the worst.

From a deposit side.

Everybody wants to be in Austin. Everybody needs a place in Austin. It is a wonderful place to be.

And, also, on the competitive front. You talked briefly with Hibernia. I'm just wondering what are your thoughts on the Capital One, Hibernia situation how do you think that's going to play out and what effects do you think that's going to have on yourself and your competitors?

That's a hard question at this point. We are focused on taking care of the customers that we have. We certainly expect that there would be some disruption on their side of the table just as there is disruption on our side when we do acquisitions. That is a hard question to kind of have any factual information on. As I said a minute ago, we are relationship-driven, our bank has always been focused on growing relationships, and when you do acquisitions, that is disruptive to the whole field. Just like we are competing with the FirstCapital side I think they're going to compete to hold their business.

Yes, Dan, I would say that no matter when do you a deal like this, there is some disruption. Not everybody is going to be happy, but for the most part, I think that they have done a good job in keeping their people and being competitive.

Today but it is early in the game.

That's right.

And just some other questions getting away from the competitive front. On the expansion front, you talk about Dallas perhaps, San Antonio perhaps. Any thoughts as far as out of state?

Our -- our acquisition model -- David and I spent a lot of time talking to a lot people -- has always been focused first on shareholder value. Shareholder value, increasing earnings and there is not really a fence line that says if it is outside this fence, we are not interested. Certainly there is lots of opportunity here in our back yard. But if an opportunity were to present itself somewhere else that made great sense from a shareholder perspective, that made great sense from our banking philosophy perspective, I don't think there is any rules or -- or policies or thoughts in our Company today that would say we would not look at something just because it was over a fence line somewhere.

I think that's true, Dan. I'll just -- the only thing that I will add is we -- we are probably different than some other financial companies where they are just willing to be in a Dallas market or a Houston market or a San Antonio market. We have never done that. If it makes sense for the shareholder and it increases shareholder value and when we are talking like that, we are talking about earnings per share. I don't think that we would limit ourselves whether it would be in state or out of state, and if it is making sure it is something we could handle on top of that.

Are there particular cities or MSAs in particular out of state that would be of interest to you that you care to mention?

No. Well, obviously -- I would just say this, obviously the closer states in the South that are related -- or closer to us would actually be your preference but, again, I don't think you should limit it just to that.

Again, this is going to be an opportunity that would come along that would make sense for us to look at. We don't know where those opportunities are. We are certainly not out actively courting and meeting bankers and other markets outside the state. There are plenty of bankers for us to get to know and build relationships with in the state of Texas right now.

Okay. Also, if you can talk a little about deposits. I was wondering if you could give us more of a breakdown on the end of period deposit mix and also -- you mentioned the 15 million, I guess, from Austin that left after the two deals that we saw last quarter. Do you think you will see some of that from the FirstCapital acquisition as well?

I will answer that question. They are going to give you some more specific numbers, but this is David Zalman. Yes, I think you are probably not through seeing it completely even in Austin. One of the banks that we purchased there, the Village Bank & Trust where incentive had $100 million in deposits. A good chunk of the deposits were probably brokered CDs. Not a good chunk but 15 or 17 million. I don't have the exact number. It had some and then they had some higher yielding certificates. I think you may still see some more runoff in the Austin area a little bit. And I think that even FirstCapital, it is hard to call. I think there is always some initial loss, but then generally after a period of time you get it back.

On the specific breakdown, Non-interest bearing was about 20%. Interest bearing transaction accounts were about 18. Money markets were about 18, savings was about 5, time less than 100,000 was about 20%, and kind in excess of 100,000 was about 18%. So those are just approximate percentages.

Okay, that is very helpful. One last question actually -- I think this wraps most of them up. On your capital levels, any target or where you -- where you see that shaken out throughout the year or at the end of the year?

Are you talking maybe in reference to the tangible ratios?

That's right.

Yes, you can see -- if you're looking at the ratio over the last few quarters, you can see how it's been expanding absent any acquisitions that would have been by cash, as an example. So obviously we always use the caveat going forward, you can see that if we don't do any more acquisitions impacted by cash, that thing is going to go over the 5% level pretty quickly. When we get to the end of the second quarter it will be over 5%. It will continue to increase, but we always add the caveat to it that if there is a deal, that can change that ratio.

You know, Eric, when look at our deposit mix today kind of circling back around, David is right. There have been some brokered CDs in some of the banks that we have acquired. Today we don't have any brokered CDs in the bank at all today. FirstCapital, in their early infancy, was really a savings and loan or a savings bank. So they had a higher part of CDs that are out there. But I think they did a fantastic job of converting their deposit pricing from a savings model to a commercial bank model. I don't think that the rate structure that FirstCapital had on the table and ours was very far apart.

No, I agree with that, Dan.

The last question is on your securities portfolio, anything to comment on there? Any changes there as far as percent of -- of the total that's of -- that are mortgage backs and CMOs or percent held to maturity versus available for sale. Anything changing or different going on there? What are your thoughts there.

The only comment that we would make is obviously when we acquired FirstCapital, they had probably 140 million in securities themselves and so when that was brought over, part of it goes into HTM, part of it goes into AFS, but at the end of the day, the bottom line is it moves the number a little bit we put a big chunk of their variable rates mortgage backs in our available for sales. What that does at the end of the day is moves that percentage from about 14% of total portfolio to about 18 to 19%. So not a material change.

Okay. Thanks, guys.

Thank you, Eric.

Our final question comes from Charlie Ernst of Sandler O'Neill.

Hey, guys.

Hi.

Sorry to belabor this point but I just wanted to ask the loan question a little bit differently and given the concerns that you've cited. Are you a little bit less optimistic then on loan growth than maybe what you were a quarter or two ago when you were kind of chugging along at the 10% mark?

I don't think we are. We are all looking at each other here. I think we feel like the loan pipeline is there. The business is there. I think we have got opportunities in front of us.

I know that there's a lot of questions that are being asked about the competitiveness, but I have to tell you, I have always felt that it has been very competitive. I don't really see -- I don't see that it has changed that much. It is getting maybe more competitive, but it has always been very competitive and I think with the bank and the size that we are at today some of the stuff that we are seeing becomes more competitive because as you get to these larger credits, just naturally they're more sophisticated and they are going to shop it more. I think that is the area that you are seeing right there as being competitive but I think it is still opportunity for us that we didn't have in the past.

I don't think our lenders are discouraged. I think that they are out there every day in the batter's box swinging and I think we have got the opportunity to continue to grow at the same rate we were growing last quarter.

As outsiders looking in, do you think that we are getting a little bit too over excited about the competition? Because everybody is writing about it. And, I mean, I know that I have been concerned about it for a while. But it seems to me that you all are a little bit more comfortable with the situation than kind of what we are thinking.

Well, I'll answer that. In fact I will start off by answering that. This is David Zalman. First of all, there is a lot of people writing about it, and, again, in the past, I don't think you can dismiss it. I think that you have to pay attention to it, because if somebody is saying something like that, a lot of times we, as insiders, can't see it and then it eventually happens. So I think you have to pay attention to it. On the other hand, and I don't want to be coy about this or take it lightheartedly, but I think it has always been like that. It has been a fight from the time we were $40 million to be $3.5 billion. And it has been competitive. It has been competitive. This bank didn't start 100 years ago. We started probably in the late '80s and it was built into the 3.5 billion today and it's been a fight the whole way. So I really don't see it changing the way we do things quite frankly.

I think if you are -- when you talk to other bankers, Charlie, we are talking about deals that we missed that we don't understand why they did what they did. My guess would be that there are other people out there that would look at some of things we have done and say we don't understand why they did what they did. That is just the nature the beast that we are in and what we are supposed to do as management for our bank is be sure that we have got our eyes open and that we are paying attention to what's happening, that we are prepared to manage through whatever environment comes along.

But in my experience, Charlie, I would add is that, you can whine about something and say something is bad or else you can go out and change it. And our experience has been -- we even see this in lenders. Some lenders will whine about it, the others will say well we just got to change focus and go after it. And almost always the people that say we can do it. It does happen. The people that whine and say you can't do it because of that, then it doesn't happen. I am very positive with regard to that.

Okay. And then just getting back to kind of trying to core out the quarter a little bit. I guess you have these three different items and you are saying that those added up to about a million; is that correct?

Yes.

Would those specifically related to the merger and you absolutely think that they are going away out at the run rate next quarter?

Yes, we absolutely do believe that, that it was discretionary. In other words, if we are looking into the second quarter, let's use the advertising as an example, we will step back as the quarter unfolds, see how well we are doing in terms of overall bank. How are we doing in the FirstCapital transaction. And if we are able -- and if the loan growth were to double or whatever it is, the point I am making is, if we trend better, we will step back as management and say, well, guys, did the advertising as an example that we did up to this point do we need to do some more and if we have extra money on the table, we may make that decision, but the point that I would drive home is that is a discretionary thing. We will only make that decision to spend that money if we are hitting our earnings targets.

Okay. And there weren't any other kind of severance expenses or anything like that in the quarter?

No, there were none of that.

Great, thanks a lot, you guys.

Thank you, Charlie.

We have follow-up from Eric Ross of HODV Capital.

Sorry, we almost made it off there but I just thought of one other question. Just to follow-up on that last question on the advertising expenses. Just out of curiosity, does that start before the deal closes? Meaning is there some of that branding going on in January and February or is it all in March once the quarter -- once the acquisition had closed. And if so, would a month be enough of that or wouldn't there be -- it seems to me just from a business standpoint that you would probably be doing some advertising and branding for more than a month at least for a couple of months.

That's right. Dan is chomping at the bit to answer that. This is David Hollaway. I just want to kind of step back again to be very clear here. We do advertising ongoing where we spend a couple hundred thousand dollars a month ongoing and that would include -- that would include some of these newer locations, newer markets. What we are talking about here today is additional dollars over and above this. Where we're going to hit the cable news waves. We are going to hit the radio. We are going to hit the billboards. These are additional dollars and an additional kind of perspective of advertising. We did it last year, as some of the people might recall. I think last year we talked about doing this branding --.

That was two years ago.

Two years ago doing a branding of our entity because we had grown so much. We had been doing advertising but we went over and above what we normally do. That applies here again today. So could we spend more dollars on it? Absolutely. Can we do with what we have today? Probably so. I don't know where that bright line is in terms of what -- what should those final advertising dollars be if that's the example we are using. Dan, you wanted to jump in?

I just kind of want to repeat what you just said. You are seeing this as -- this is normal advertising. Our normal advertising budget is several hundred thousand dollars on an ongoing monthly basis. That's not what we are talking about here. That money is still out there. Keep in mind you have got 27 new locations that are coming on board that -- and 16 or 17 those are in a market that has never seen our name before at all. So just in a normal ongoing run rate environment we're going to have regular advertising going toward. The thought here was, was we could come out and do a big splash to get some name recognition because the funds were available to us. Quite frankly, that was not in our -- our long plan -- say, okay, wait, we have got an opportunity here that we can maybe better ourselves and maybe give a little kick start as we get out of the gate.

Okay, thanks, Dan. Thanks, Dave.

Thanks

There are no further questions at this time.

Thank you all very much for participating. We are looking forward to finishing out 2005. We think the opportunities in the future look very bright for us. Thanks again for your participation and your support of our Company. Good afternoon.