Prosperity Bancshares Inc (PB) 2005 Q3 法說會逐字稿

Good day. Welcome to today's teleconference call. (OPERATOR INSTRUCTIONS). Please also note that this call may be recorded. Now I would like to turn the program over to Mr. Dan Rollins. Please go ahead, sir.

Good morning, ladies and gentlemen. Welcome to Prosperity Bancshares' third quarter 2005 earnings conference call. This call is also 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 am Dan Rollins, Senior Vice President of Prosperity Bancshares. And here with me today is David Zalman, President and Chief Executive Officer, (indiscernible) Tim Timanus, Jr., Executive Vice President and Chief Operating Officer, and David Hollaway, our Chief Financial Officer.

This morning David Zalman will lead off with a review of our financial highlights for the third quarter of 2005. He will be followed by David Hollaway who will spend a few minutes reviewing some of our recent financial statistics. Tim Timanus will discuss our lending activities, including asset quality. Then I will provide an update on our progress integrating FirstCapital Bank in our recently announced acquisition of Grapeland Bancshares.

I will also provide some information on our loan and deposit mix. 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 call moderator, Adam, or you may e-mail questions to investors.relations at prosperitybanktx.com. I assume you have all received a copy of the earnings announcement we released earlier this morning. If not, please call Jennifer Nguyen 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 federal securities laws, and as such may involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of Prosperity Bancshares to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Additional information concerning 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 its Form 10-Q and 10-K and other reports and statements we have filed with the SEC. All forward-looking statements are expressly qualified in their entirety by these cautionary statements.

Now let me turn our call over to Dave.

Good morning. Thank you for participating in our third quarter earnings conference call. We continue to be pleased with our financial performance, particularly considering the current interest rate environment. Without question our financial performance during the third quarter of 2005 was the most successful quarter in our history.

Some of the highlights include earnings per share increased 12.5% to $0.45 per diluted share compared to $0.40 per diluted share for the same period last year. Our net income increased $3.5 million to 12.5 million compared to 8.9 million for the same period last year. We are especially pleased to report a 1.43% return on average assets, a nice increase when compared to 1.37% for the same period last year.

We continued our progress of integrating FirstCapital Bank, resulting in a decrease since June 30 from 902 to 857 full-time equivalent associates. Our strong earnings growth is a result of our strict adherence to cost controls and continued strong internal loan and deposit growth. Loans at September 30, 2005 were $1,514,000,000, an increase of 506 million or 50.3% compared with the 1,007,000,000 last year.

Obviously, a large part of this increase can attributed to our recent merger with FirstCapital Bank. However, excluding FirstCapital, we are pleased to report strong internal loan growth of 7% on an annualized linked quarter basis. Deposits at September 30, 2005 were 2,879,000,000, an increase of $552 million or 23.7% compared with the 2,327,000,000 last year. Again, the majority of this increase can be attributed to our merger with FirstCapital Bank. Excluding deposits acquired with FirstCapital, we are pleased to report internal deposit growth on an annualized linked quarter basis of 5%.

Our commitment to asset quality has not changed. We are pleased to report non-performing assets to average earning assets of only 3 basis points at September 30, 2005 compared to 11 basis points at the same time last year. Our non-performing assets to loans and other real estate were only 6 basis points as of September 30, 2005 compared to 25 basis points at the same time last year.

On to some other business. This quarter we were very pleased to learn that we have been included in the S&P 600 Small Cap Index. Our shareholders should benefit as we expect an increase in average daily trading volume. After the announcement we experienced one of our busiest trading days with over 2 million shares worth 16 million in value trading on a single day. We're also flattered with the recognition we received this year. We ranked second out of 195 publicly traded companies in the 2005 Stephens, Inc. Bank and Thrift Performance Matrix. We were also named to the Sandler O'Neill 2005 Small Bank and Thrift All-Star list. For the second consecutive year we were honored to be included in the Keefe, Bruyette & Woods 2005 Honor Roll of High Performing Backs. We're recently listed in U.S. Banker Magazine's top 100 Publicly Traded Midtier Banks recognizing superior return on equity for three years. And finally, we were included in this year's list of the top 100 Houston companies published in the Houston Chronicle.

A little bit about the Texas economy. Obviously, the high cost of gasoline and the disruptions caused by Hurricanes Katrina and Rita are concerning consumers. However, the Federal Reserve Bank of Dallas recently released some very upbeat projections. Robert Gilmore, Vice President and Senior Economist, recently reported that indicators are clearly moving in the right direction for Houston and Texas. While the local economy has lagged the national economy, it is now making up for lost time. Per rig count is now growing rapidly, and oil service companies are sharing in high oil revenues. Chemical producers have cash flow to spend. Productivity gains are keeping Houston's job growth for 2005 below 2%, but don't take historically slow job growth as a sign that the economy is struggling. Output and production are growing rapidly.

In my opinion, all of these conclusions are very favorable for our economy. Despite the challenge of flat yield curve, our Board of Directors and our management team are very excited about the opportunities before us. We are located in one of the fastest-growing states in our nation, and should benefit from the vibrant Texas economy. In addition, we continue to see opportunities in the merger and acquisition market.

Thanks again for your support of our Company. I'm honored to be able to work with a fantastic management team and a great group of bankers. Now let me turn over our discussion to David Hollaway, our Chief Financial Officer, to provide some additional detail on our financial performance.

Just a little more detail behind the numbers in the press release. Net interest income increased 7.9 million to 28.9 million or 37.3% year-over-year, and 1.5% linked quarter. And again as we have stated in past quarters, the increase was primarily due to the increase in average earning assets.

Noninterest income increased 32.4% year-over-year, and 2.7% linked quarter to 8.1 million. And again as we said before, the bulk of this growth is coming just simply the deposit service charges on our deposit base, the regular service deposit charges. Noninterest expense was up 37% year-over-year and 1.4% linked quarter to 18.1 million. And the bulk of this increase, again, reflects the additional banking centers from recent mergers.

And I would kind of like to make a couple of points on this, if I could. One, when you're looking at our operating expenses this past quarter the number is probably a little polluted in that those cost phase that we were gaining from the recent acquisitions happened throughout the quarter. And if you're wanting to model what our expense run is on a normal quarterly run, I would suggest to you taking that number and reducing it somewhere in the range from between 2 to 3%, 2% conservative to 3% liberal. And you can run that number out. Of course the caveat that I add is acquisitions will tend to distort that number. And as you know, we do have one starting to close this quarter.

The efficiency ratio was 48.8% for the quarter compared to 49% in the previous quarter. The net interest margin on a tax equivalent basis was 3 .81% for the quarter compared to 3.62% for the third quarter '04, and 3.82% for the second quarter '05. Again, there are a number of factors affecting the margin. I kind of want to briefly touch on those. The obvious one is the flattening yield curve. But there is a couple of other items that we truly need to note to see what is impacting the margin.

The first was a linked quarter increase in average noninterest bearing deposits of $22 million, which had a positive effect on the margin. The second, the margin would have been slightly higher for the quarter if we had seen better overall average loan growth and the higher yields that come with it. So the point here is going forward increasing the percentage of loans to earning assets is key to increasing the interest margin.

And another thing I would point out affecting the margin is on our security portfolio, the current yield on the portfolio is 4.11%. And we generally use the five-year treasury as our base to invest. So having the five-year rate move up is a positive to us. So if you're looking at rates today, we're probably able to reinvest our excess cash flow closer to 5%, where if you were looking back 30, 45 days, 60 days, that reinvestment yield we were getting is probably somewhere 4% to 4.25%. So this -- the cash flow of 25 million per month this will take a little longer to get into our numbers, so it has a longer-term effect, but it would be positive.

The other thing that we will be looking at in '06 is our trust preferred issuances. We have the opportunity to look at a couple of them that we can call next year. We will certainly take a look at that from a rate perspective, as well as from a capital perspective, to see if that is something we want to look at, because that is obviously in the net interest margin calculation.

The last thing that I would note before turning it over to Tim, our capital ratios. Our leverage ratio was at 7.81%. Tier 1 was at 15.5%. Total risk base was at 16.5%. And intangible was up to 5.48% compared to 4.38% at year end. And with that, Tim, I will turn it over to you for some loan and asset quality discussion.

Non-performing assets at quarter end September 30, '05 totaled $840,000 or 0.06% loans, repossessed assets and other real estate compared to $2,738,000 or 0.18% at June 30, '05. This represents a decrease of $1,898,000 or 69% in non-performing assets at quarter end June 30, '05. The September 30, '05 non-performing asset total was comprised of $783,000 in loans, $16,000 in repossessed assets, and $41,000 in other real estate. 92% of these non-performing assets pertain to loans in the portfolios of banks acquired by Prosperity.

Net charge-offs for the three months ended September 30, '05 were $89,000 compared to net charge-offs of $115,000 for the three months ended June 30, '05. The average monthly new loan production for the quarter ended September 30, '05 was $53 million compared to $58 million for the second quarter ended June 30, '05. Loans outstanding at September 30, '05 were $1,514,000,000, compared to $1,520,000,000 at June 30, '05. The September 30, '05 loan total is made up of 38% fixed-rate, 43% adjusting as prime moves, and 19% resetting at specific intervals, such as quarterly or annually. I'll now turn it over to Dan Rollins.

I want to spend a few minutes reviewing our progress on our acquisition integration. As you know, during March we completed our systems conversion of FirstCapital Bank, our largest acquisition to date. Since March we have made excellent progress on our full integration plans. This was a large undertaking, and we are pleased with our progress. From a cost save perspective, we believe that we're on target and on schedule to achieve the savings we have projected. In fact, while we still have some work to do, we should be substantially complete before year end.

The recently announced Grapeland Bancshares acquisition is expected to close during the fourth quarter. While the acquisition is relatively small, we're looking forward to expanding into East Texas. I'm proud report that our team of bankers are competing effectively in all of our markets. We have a great team of customer-focused bankers in Texas, and continue to look forward to great things in our markets. Our organic, or same-store, loan growth was 6.9% on annualized basis for the third quarter. At September 30, 2005 our commercial and industrial loans represented 15.5% of our portfolio. Construction and land development loans represented 13.7%. Commercial real estate represented 39.8%. One to four family loans represented 19.6%. And home equity loans now represent 3.6% of our total portfolio.

Our loan pipeline remains strong, and our team is focused on producing results. On the liability side of the balance sheet I am pleased to report that we're making progress toward our goal of rebalancing our deposit mix. We experienced a good noninterest bearing deposit growth for the quarter. At quarter end our deposits consisted of noninterest bearing DDA balances of 22.2%, interest-bearing checking balances 16.2%, money market and saving accounts 25.8%, and certificates of deposit declined to 35.8%.

Again, we're proud of our team's performance and are looking forward to future opportunities. At this time I think we're ready to take questions.

Brett Rabatin.

A couple of questions for you. First off, I was curious if you anticipated anymore run off in the acquired FirstCapital loan portfolio? And it sounds like your average monthly production is a little slower than 2Q, but still pretty strong. And so if there isn't anymore run off would a mid single digit to high single digit loan growth rate being sort of you guys' guess going forward?

Let me try to address that. If you look at the average production number for the quarter that I mentioned a little while ago, which was 53 million, you have to take that in context of really what happened in September. If you average July and August, those two months averaged 60 million in new loan production. September dropped all the way down to 39 million. And candidly we feel the primary reason for that was hurricane Rita. Several of our banking centers were closed for a few days at the end of the month, and business was certainly not conducted as usual for the entire last week of that month. So it caused loan production to suffer a bit, and it also caused a number of loans that would have normally been booked, documented and booked in September, to be held over into October. Those were booked in the first week in October. So September is skewed a bit by that.

And back to the FirstCapital question. Since we acquired FirstCapital, about $40 million approximately in loans have been left that portfolio. Those loans primarily had been assets that did not fit our model. I would suspect that there would be some additional run off, but certainly not of that magnitude. So we really expect that loan production will continue to increase in a reasonable fashion.

That's great color. And then I wanted to ask on the efficiency ratio and the point (ph) expenses out of the past acquisitions, if you could talk about -- if you guys could talk a little bit about the FT count going forward, and if you are looking for some additional improvement in the efficiency ratio in the near-term for exclusive of any potential margin expansion or what have you?

Dave will jump in here also. But from a headcount side, obviously we've got an acquisition that will close in the fourth quarter that will move that needle also. But excluding the acquisition that we expect to close this quarter, I think we're relatively there. There are some people in there, but it is a relatively small number of people that are still in the headcount that need to be reduced out. And when you load on the new folks that are coming onboard from the Grapeland transaction, my guess is that you're going to see a net number up for this quarter, but that is going to be driven off of the acquisition. Your question on the efficiency ratio and how much lower can we go, Dave, you can jump in and jump on that one.

I don't know if I can give you a specific number, but what I would say is, again, when you look at the third quarter and you see that efficiency ratio it has not seen the full impact, again, of all the cost saves occurring throughout the quarter. I would tell you again without putting the acquisition in, and as you say, down don't feel the net interest margin in one way or the other, but we would see it move down a little bit more. I wouldn't say significantly.

The noninterest expense base?

The efficiency ratio.

The efficiency ratio. Okay.

And then this last question. If you could give a commentary on competition levels relative to where they have been in the past couple of quarters in terms of rate competition on lending, and any kind of crazy pricing on deposits, particularly in the Houston area?

The Houston market on the deposit pricing is very competitive. The Austin market on deposit pricing is very competitive. The deposit pricing across the state I think is competitive. There are some in our opinion irrational players out there on the deposit side. Loan competition is tough. There are people out there that are fixing rates for ten years or longer. There are a lot of nonrecourse deals floating around out there. So competition has always been there and will always be there, but I think our team is performing well. I think we are pleased with where we are.

The thing that helps us -- this is David Zalman -- but collaborating on Dan's comments, you can probably look at our numbers and see that our CD in that area remains in state pretty flat this quarter. Where we really picked up ground is really in our noninterest deposit accounts, noninterest bearing deposit accounts, and more business, commercial and that type of account. So what that really says is the rates really are, as Dan mentioned, are really competitive out there. We are seeing some really aggressive rates on CDs, especially from startup banks that really don't have a real good core deposit funding. And they are paying really up on money market accounts and deposit rates. And they have to do that to try to get their money in for funding sources. We are really in a good or unique situation in that we, again, we're competitively pricing our deposits, but again we don't have to be the leader of the market and that really help us at this point in time, because we have such liquidity and so much core funding.

Those answer your questions?

Yes, thank you very much. Good quarter guys.

Thanks for your support.

Kerstin Ramstrom of Bear Stearns.

It is Kirsten Ramstron. Just to follow on to Bret's questions a little bit. In terms of loan growth by region, it gets a little muddy of course when you have got the FirstCapital loans running out, but where have you seen the most strength in loan growth geographically in your footprint?

Houston and Dallas. Well, Austin was -- we broke out the Austin numbers. The loan growth in Austin for the third quarter you see that in our press release. And on an annualized basis that was almost 14%. Houston and Dallas continue to perform well.

In terms of deposit pricing you said that Houston and Austin were very competitive. Are they getting more competitive or has kind of the level of competition flattened out a little bit?

This is David Zalman again. No, I think that it is as competitive or even getting more competitive. I think that for whatever reason I think some bankers have probably felt that interest rates will rise and that they are probably trying to get ahead of the market maybe and being the leaders in it. But the bottom line is it is still just as competitive or more competitive, and I don't see that easing up any really.

I agree. I don't know that I could say it is more competitive, but it is certainly not any less competitive is it?

That is about the same -- you would say that the trend of the same to a little more competitive would remain across your entire footprint? You are not seeing it changing in any of the markets?

I don't. I don't see it changing at all. I see being as competitive, yes.

I agree.

One other question. Where do you guys stand with energy exposure in your loan portfolio?

I don't have the numbers in front of me, BUT it would have to be minuscule.

What are you including in energy exposure -- direct oil and gas loans?

Yes.

Very, very low.

I would say we really don't have any direct production loans. If we are exposed to any at all, and Tim can step in on this, it is more in the oil service industry -- service industries that may have -- like a set service to work over rigs and the drilling rigs, vacuum trucks, mud companies -- work over, some stuff like that. And again we don't have the numbers, but really it is minuscule.

That is correct. Our exposure in terms of direct exposure is immaterial. What is there is in the service sector. Of course, we have indirect exposure, given the marketplace that we operate in.

Brent Christ with Fox-Pitt Kelton Inc.

A couple of quick questions. One, could you touch on what was kind of the driver behind the strong demand deposit growth in the quarter?

This is Dave Hollaway. I think it is a couple of things. One is just the seasoning of all the accounts that come on with these acquisitions where we get them set up so they are service charging correctly. The other thing -- I don't have this fact in front of me but my belief is there were probably a couple of extra days in the quarter also that contributed to that strong growth.

You're talking on the fee side?

The free income side service (multiple speakers).

He is talking about the deposits.

Yes, the deposits, the balances.

He is talking about the balance side. What growth did deposit balance increase?

Go ahead, Dan.

I think historically -- this is David again -- historically the third quarter of the year we start seeing deposits as a -- it is kind of a natural occurrence, our deposits start building in the third quarter, and even increase in the fourth quarter. It is just historically that has been the nature of our Company really.

I think you continue to see the rebalance. As you look back over history, as we have done acquisitions that have been more CD driven institutions -- you know, FirstCapital was a thrift charter. They really were operating as a commercial bank. So I think you have seen us over the past, when you look back at where we are today at 22.5 or 22 -- 22.2 and a DDA balance -- if you go back to before the FirstCapital acquisition, that is about where we were. The fourth quarter a year ago we were at 22.7% of deposits on a DDA or free money spot. Today we are at 22.2. And we dropped as low as right under 19 at March. So we continue to move back towards the spot where we wanted to be. And I think that is just part of the business model that we are in, and the business customers that we are tracking.

That's what we focus on too. That is -- our bank has always focused on good core deposit relationships. And with some of the other banks joining us, that is one of our primary goals is to get those people going our way and trying to build those core deposit relationships, and maybe let some of the time money roll off. And I think that is what is happening.

The business model has been very consistent year after year in the target based customers that we're trying to attract.

In terms of the margin, it is pretty stable this quarter. Is that the outlook going forward even with the securities yields coming on the books a little bit higher than the current portfolio yields?

I think it generally speaking, yes. Again the wild card is what kind of net loan growth will we have going forward. Because you can see, if you start playing with numbers and modeling it, you will see that has the biggest impact going forward.

In terms of the hurricane, do you guys have any estimate or opportunities going forward in terms of some of rebuilding efforts?

No, we were lucky that the hurricane really hit to the east of us. And I think I had talked to some of you folks on what impact was earlier. When you look at where the storm struck, the Texas/Louisiana border, we have -- two counties were impacted significantly out of this, Liberty County and Chambers County. We have five offices in those two counties. They represent 7%, given or take, of our deposit base. Less than 3% of the loan book is in those two counties. Certainly there is some opportunity for rebuilding over there. All of our locations opened up the day -- on Monday morning after the storm. Four of the five locations in those two counties operated for most of the week without electricity in the building. But you know the customers certainly were appreciative that our folks were there. We were taking care of business. And there will be some opportunities, but I don't know that they would be anything that would move the needle.

Again, I can't be factual on this, but just our proximity to Louisiana and New Orleans where the big storms hit, it will be a massive rebuilding. And I'm almost certain that a lot of the labor and the construction and people -- it will probably come from our area. And in that respect I think it will be a great opportunity for the Houston business, because I think you will see a real increase in business for the people rebuilding. They just don't have that in Louisiana. They will have to come probably more toward the Houston area.

And we are addressing what is happening in the area of the storm. Part of your question may have been addressed towards what is happening to the Houston economy with the influx of people. And I think the housing market, the apartment market has certainly tightened up. The office market, when you talk to some of your realtor friends, all of that is tightening up. So there has certainly been an influx of people in Houston, but how long is the question.

And then the last question. You mentioned some of the loans lagged, in fact, over related to the hurricane. Could you quantify that amount?

I don't have a number today. We talked about, and really we're working with our lending team. We talked to all of our lenders during and after that time. And they all had one or two or three deals that didn't close at quarter end because of the storm. And when you put it altogether, as Tim was saying, it could have been 10 million, it could have been 7 million, it could have been 15 million. We don't have a number. But there were loans that were moved from third quarter closings to fourth quarter closings.

Scott Alaniz with Sandler O'Neill.

A question for Tim first. On the -- looking at the loan, the monthly production numbers, which were I guess a little bit north of 50 million per month, when I compare that to the amount of loans -- of average loans that actually went on the books, going from June to September, it would suggest that you all had a fairly significant amount of pay downs? Is that correct?

You have to look I guess primarily at the FirstCapital situation. As I indicated earlier, since FirstCapital joined us those loans have dropped a little more than 40 million. So we have had pay downs at more rapid pace because of moving those assets out.

It would look like there was probably 50, 60 million in pay downs on top of the FirstCapital?

I think our burn rate can easily be 50 million at times.

This is Dan. We do calculate what we call a burn rate through the portfolio. We can actually calculate on a per person, or poor lender, basis. Burn rate is what is the normal amortizing payments or payoffs that are coming through your portfolio. And you need to remember that the large majority of our portfolio is an amortizing portfolio, just like the bond portfolio. The turn rate on the entire loan portfolio is less than three years. So just the natural principal payments and payments are coming through the amortizing loans that we have on the books, you're right, there is significant pay down that comes through that. When you look at the C&I piece of the book, and I am flipping pages to try and get to it. But C&I, which is maybe where there may be a little less amortizing credits, you are really only looking at 15.5% of the total portfolio is in that category.

Second question, on asset quality. A big drop in the non-performing scheme in the 90 days past due category. Was that just a couple of loans that were brought current or was there something else there that caused that big drop?

It is really a mixture. There were very few loans of significance in that mix. It is really a combination of a number of loans. We try to move them out and fix them as quickly as possible. So I really think that decrease represents business as usual. It could go up the current quarter, and then fall back the first quarter of next year. It is not really anything unusual.

With respect to the rebalancing of the deposit mix, I think, Dan, you mentioned it earlier. Did you have some target metrics that you are looking at, i.e., CDs as a percentage of total deposits, or could you help us out with what you're trying to do?

I don't know that we have a target number that would say we want to have X% in CDs and X% in DDAs. I think we continue to tell the team we want to be growing the commercial deposits and the free money. We want to continue to grow the transaction business and the relationship business. And we want to continue to be less dependent upon CD funding. And that has been the same story all along. I don't know that we have a target that says if we get to 25% are we going to be happy? The answer is we want to continue to improve on that. And we track ourselves and continue to work towards that goal.

You wouldn't -- I'm just adding for you, because you would book CDs if they were priced right?

Absolutely.

When I look at your CDs about 70% repriced in less than a year. And I am just wondering what your strategy is? Do you try to link them -- is it your goal to try and link them -- the duration of those or to raise pricing on the money market a little bit and move those to money market savings? What are you trying to do over the next year or so as those reprice?

I think we want to protect the customer relationships that we have. Every customer is a little different. Some customers are lengthening because they want to pick up some rate. Other customers are taking the opposite side of that. We think rates are going to move up so we want to stay short. I think we want to play on both sides of that game, and we want to take care of the customers with the relationships that we have. Keep in mind that we don't have wholesale CD funding. We don't have brokered CD funding where we could be making one decision and saying, we want to lengthen the CD portfolio so we are going to go out and offer some rate on a certain long-term CD, and pick up a bunch of money in a brokered CD market. We don't have that. Ours is just customer money in the different locations that we hold.

You could add one of the strategies we have done in the past, again this is just historical information, is on the CDs where we had to step up, what you call a step up. It is a strategy where they book a longer-term CD. But you think rates are going up, they have the opportunity to come in and reprice it one time.

We have all the products that everybody else out there has. I think that what our team does a good job of is counseling with customers to be sure that we're accomplishing their goals.

Along the lines of what you mentioned, if you look at our CD customers, the vast majority of them have transaction accounts with us also.

David again. I don't think there's a particular strategy to move them from say six months maturities to one year or five year maturities. For us again, as Tim said, most of our relationships are relationships where they have more than just a CD relationship with us. We are primarily offering all the products out there and trying to help the customer pick what they want, not really trying to put them -- not trying to -- us thinking rates are going to go one way and move them into a longer term or shorter term, because we just really don't know. So our primary goal is to have all the products on a competitive basis and give the customer the best we can really, not call the rates really.

We hear comments occasionally from customers that go into other institutions where they are forcing people into something that they may not want, and we're not playing that game.

Charlie Ernst with Sandler O'Neill.

Just to confirm one thing, did you lose any days in branches before the storms?

Absolutely, we did. The entire South Texas area, which is -- over 60 of our locations were closed all day Thursday, all day Friday. That is not true, let me go back. Let me give you the facts. We had 65 or 66 locations closed on Thursday all day. As the storm track moved north and east, we were able to reopen 10 locations in the Corpus Christi area on Friday. We opened a couple of more for Saturday hours, so we probably had 12 or 13 of the 60 some odd that were closed Thursday reopened by Saturday. And we were 100% open on Monday morning.

But really us being closed and how that impacts business is two different things. It is interesting in talking to our lenders we had closing scheduled that week on Tuesday and Wednesday -- documents at the Title Company, things ready to happen, where the buyer or the seller, neither one, ever showed up. And I think what you saw was that storm was in the Caribbean, or wherever it came across the Florida -- the south of Florida on the weekend before. And everybody was watching it all the way through. It really peaked out in strength on Wednesday. So Monday, Tuesday, Wednesday everybody was paying attention to that storm even though we were only closed on Thursday.

Thanks a lot you guys. Nice quarter.

Campbell Chaney with Sanders and Morris.

David Zalman, I would like to follow-up on one of the comments you made on the aftermath of hurricane Katrina and the possible pick up of business in the Houston area at let's call it a staging ground for the rebuilding. Are you getting any word from your business clients about increasing lines of credit, commitments, or even drawing on your lines of credit? Has that started yet at all?

Candidly, I sit in loan committee and at this point in time the people that really what I call that do things like this drywall people, construction people, we truthfully at this point time have not seen requests or large requests come in. But just been talking and getting a feeling from our customer base, and saying what is happening around here, again it is not a factual deal, but really believe that you will see a real uptick in that line of business for this the people. And I think you will see increases in loans for these kind of people and there will be a lot of -- it will be a pick up in business.

I am familiar with three or four customers that have contracted with FEMA to do some cleanup work. There is some of that work out there.

I expect there is. I just want to kind to get a timeframe of when that can really start to kick up some traction. Most of my questions have been answered, but one other point on your cash flow and your securities portfolio funding your loans, any thought of -- I guess it is still continuing to take down the securities portfolio. Any thought of where we can model out a base or where you think the securities portfolio will come to rest where you are no longer going to bleed down the portfolio?

You mean without having to reinvest excess deposits back into the security portfolio?

Correct.

That's a tough question. I don't know that we have a target number for something like that. Dave.

I think it is really dependent on our model. Our business model again it could be real technical, but it really is so dependent -- we do so much M&A activity, and again I guess if you said we're not going to have any more mergers and acquisitions, at what point in time will your -- what percentage will you have been in securities and what percent would you have in loans? And I would tell you, again, not a basis for this but again, I don't think this will ever happen, because I think we're always going to be in the M&A business unless something happens. But if we weren't and things just continued to go the way they were and we increased our loans 7 to 10% say a quarter -- or a year like we have been, you will probably see ratios like 65 to 75% loan to deposit ratio and the rest in the securities portfolio.

Just kind of saying that in a different way. You're right, if you can get net loan growth up 150 million a year in theory against holding deposit steady, you would see the security portfolio go down by a corresponding amount. But of course in real life it doesn't quite work like that, because we're going to assume we are having deposit growth, and if that strips the loan growth it has got to go somewhere.

I think the other variable in this also it is where you see a 7% loan growth, as you mentioned earlier, Dave, as you do an acquisition. And probably the majority of all of our acquisitions, with the exception of may be Austen, we normally do -- we do see a runoff of loans or loans that don't actually fit in our portfolio, and that part rolls off and then you have an increase on what we're doing internally at the same time. So all of those factors really come into play really.

I would make one last statement. If you are asking the other way the question is, we're absolutely wanting to drive down that ratio. We want a larger loan deposit ratio which would infer that we are reducing the securities as a percentage of overall earnings assets.

I would come in from the loan production team, we've got 90 plus lenders, 100 lenders that are out there, and they are all charged with growing their loan portfolio. They're all charged with producing business for us. A large number of that team, one-third -- 25% to one-third of that loan team has really only been a part of our organization for seven months. We always have said that it takes a year's time for people to get comfortable in a new organization, people to understand the processes in a new organization, and we're only seven months into that process with 25% of the production team. I think we're clearly focused on producing loans.

Would it be fair to say that you would probably start to run off -- if loan growth starts to surge, you would be more likely to run off the securities portfolio than go out and try and fund a quickie CD campaign or wholesale borrowings (multiple speakers). I am just trying to put your comments earlier about the CDs and the deposit composition into perspective, so --.

We have said we certainly want to be competitive in the deposit market and we do not want to get caught up having to pay the high rates that are out there, but we've got to be competitive. We don't see the need to be wholesale funding any of the balance sheet when we've got the excess funding that we have now.

That clears things up. Great. Thanks a lot. Good quarter.

Joe Stieven with Stieven Capital Advisors.

Basically every single one of my questions has been answered, but I will ask one sort of as a follow-up. I guess probably for David Zalman, David Zalman. When you're talking about East Texas it sounds like you are awfully excited about it. Is that because -- and not that all your markets aren't competitive -- but it is it slightly less let's say competitive as far as the number of big banks out there looking to do deals and things like that? That is just trying to get a sense of -- because you seem awfully optimistic about that market. That is really it. Thanks guys.

I don't know if I'm as excited as Dan Rollins is. I may turn it is over to Dan Rollins. Dan, you may want to jump on that question I think.

I think that we do well in community markets. The East Texas markets that are out there are very good markets. We've got some locations -- we're not in East Texas really to speak go. I guess we could be, depending on how you call our Corsicana and Ennis markets, we are performing well in those markets. In fact, Corsicana is one of our -- the top performers from a return on asset perspective. So you can do very well in the smaller markets. The loan growth and the demand for a larger credits is not there. But at the same time you've been a good core customer base and you have got a good solid base to work from. As you said, the competition is going to be more local base to competition, not the big boys that want to come into Houston and pull gloves off and fight with you. I think it is a good mix. I think that is one of the strengths of our Company is we've got a good mix of small town community banks, and we've got a good mix of metropolitan, high growth commercial locations.

I think that the bottom line is is that it will probably never be our major growth machine, the East Texas market. At the same time, we have been extremely successful operating in markets like East Texas. And some of these markets have been some of our most profitable banks. And I think what Dan is saying, and he is even focused on acquiring some of these banks, it is a market that may not be as competitive. And it may not be as -- it is not as sexy as some of the other ones, but yes, it is a market that may be underserved from other banks and we can be competitive and make good money in those markets. And that is the excitement.

Let me talk about Grapeland and Crockett, Houston County, while that is a $50 million deposit franchise up there, Walter Cook, who is the CEO there, Walter has been in that market for a lifetime. The folks that are there are good, solid performers. Their loan book is clean, a good solid deposit base. The market that we are in there is a fairly vibrant, small town market. Grapeland and Crockett are 30 to 45 miles southeast of Corsicana, which would be our closest location there. It is kind of a natural fit for us between the Houston and Dallas market to allow us to continue to expand into that area.

Thank you. Good luck. Good quarter again.

Michael Printer (ph) with SunTrust Robinson.

It is Jennifer Demba. David Zalman, can you give us some perspective on the M&A environment right now, and what you're hearing from potential sellers?

Again, the M&A market for us is very active. We see probably -- it is probably busier. We're getting more calls today than we did I would say in the beginning of the year. I would venture to say that you will probably see more announcements this last quarter than you did the first part of the year. All in all, if I had to make just an average statement, I think it is busy or busier than ever really.

I agree. It's hot.

Lastly, David Hollaway, could you give us your perspective on options expensing in 2006?

Yes, I think if you're just using today's numbers, it probably -- if you're going forward and wanting to annualize, it is probably a good number to use is somewhere in the 60 to $65,000 per month.

And you'll begin that in January?

Yes, that is actually -- that will be our run rate in that fourth quarter.

Barry McCarver with Stephens, Inc.

Much like Joe I waited so late to get in the queue that I think all my questions have been answered. The only thing I did have was a question for David Hollaway. In putting things back into the securities portfolio, what instruments are you looking at there?

I'm going to let David Zalman answer that, because he has got one actually he is purchasing right now. But you know -- two year (indiscernible)?

You know, in the past what we have tried to do is to average a three-year duration or an effective duration. And what that meant probably at the beginning of year and midyear, we're buying products like ten-year fully amortized mortgages, which had about the 3.5-year life on them. And if interest rates went up 300 basis points, you could see maybe a year extension on those. Currently we're a little bit -- as Chairman Greenspan said, a conundrum, because it has become attractive right now where we kind of -- I'm not saying I am going to stick to this, but right now we have kind of moved back and shortened our maturities to probably some 2 and 2.5 year maturity callable products that were yielding 4.9 to 5% on them today.

And so it will probably be -- we will probably have a mix now, where overall -- again, if you listen to me what rates are doing, you have been wrong for two years. So don't count on this. So we don't try to call rates. And so it just seems the right thing, or the most practical thing, to do right now is to just maybe stay a little bit shorter. There's not -- you are not getting a reward that much by extending the portfolio right now, unless you really believe that this is -- that these interest rates are not going to stay where there at and they are going to go back down, and then you're making a mistake. But if you think that the interest rates are more stable where there at now, or going to possibly increase, they are just not that much more of a reward to extend for longer periods of time.

Jon Arfstrom with RBC Capital Markets.

A couple of questions. If you guys remember back about a year ago you were questioned pretty aggressively on your tangible capital levels, and they've grown quite nicely over the last several quarters. I am just wondering if you could give us an update as to where you would like that capital ratio to be, and could we expect that to continue to build?

I will jump in first. This is Dave Hollaway. Again, we do not have a target number. And I know David Zalman is going to jump in here. But we don't have a target number. You are exactly right when you look back a year, it has increased. But having said all of that, it was low because of all the acquisitions we have done historically. And that is not to say going forward if something comes up and there's a need to draw that tangible ratio down, we would certainly consider it. My short answer is there's not a target number. And, David, do you want to add to that?

You followed us for I don't know how many years, but probably since we have done our IPO, and you can see sometimes our tangible capital ratio go down as well as 4%. We might have even gone under that. The thing that really helps us is the amount of earnings that we had. If you looked at our tangible capital at the beginning of year Dave, what was it?

438.

438. And what is it right now?

450.

The bottom line is we have gone from 438 to 5 something -- 548 in a very short period of time. And so it all happens because a lot of the merger and acquisition. And I would say that where we were likely to have a higher tangible capital ratio I just -- it is hard to say that we would maintain that 5.5 or 6, because I think that we really look at the deals that are out there, and if they make sense and they can really increase earnings to the bottom line and earnings per share, we will probably do deals. And that in turn will make that number probably fluctuate between 4 and 6%.

Does that help you?

That helps. By the way, I think with Joe Steven on the buy side ideas I guess that Grandpa will work the coverage (ph). The other question is typically you guys provide an update on guidance. And I think last quarter you said the high end of the 174 to 178 range. And I guess my question is, is that just an oversight? Do you feel like maybe Rita maybe cost you a penny?

Let me answer your today. The answer is, yes, we're still -- based on that same comment, we still -- as I think the comment we made last quarter, we should still be on the high side between $1.74, $1.78. Is that right?

I think I heard Jon say, or is there some impact from the hurricane that would --.

I don't think that it will affect that number, no.

Eric Ross with was Hobbs Capital.

All the questions have been answered. Thank you.

Scott Alaniz with Sandler O'Neill.

David, I think maybe you or Dan mentioned earlier there's a lot of -- it is a pretty active M&A market, are you sensing that pricing is beginning to come down or up?

I will answer that. I think on some of the smaller deals -- Dan has been working on some of smaller deals -- and it is probably not as pricey on some of the smaller deals. But I would tell you that if you are dealing in the major metropolitan markets of Dallas or Houston, Austin, it is just as pricey or pricier than ever. It is still -- you'll have to hold your nose.

The price expectations are sky high everywhere. When it comes down to doing a deal, I think there are some sellers that are motivated for multiple reasons that could cause prices to be more reasonable than we have seen. But the price expectation coming out of the chute, I have not seen anybody that hasn't got thought it was very high.

I really think though that if it breaks down -- it is hard to get a paintbrush and say that everything is at one price, because it is not. If you're dealing on really some smaller things, some mom-and-pop shops that are say $100 million in size, or anywhere from 50 to $200 million in size, the market is not out there for real high, real high multiples. But again if you are in a major metropolitan market and you are starting to see a bank that is 300, $400 million in size, and it is in a major metropolitan market, you're going to really pay up for it.

And that is what we have been seeing. David is exactly right. But the sellers, the first time they decide they want to sell they are going to take the high watermark that has been coming across the desk and say, that is what I think we need to do. And then they've got to get out there. That is why this process takes so long. That is why transactions and relationships have to be build and trust has to be there. It is takes time to build and can find partners that want to partner and do banking that fit with us.

I think that is one of the deals I see. Where we start working on a deal, a lot of times we will have lunch or dinner or something like that, and gosh, when we get through we just think we have wasted the whole night or the whole lunch, because the expectations where the seller is and where the buyer is are so far off that -- generally you almost think, well, the deals are going to go away. But then something happens over a period of time. They go out and find out what the market really is, and even though it is still pretty high, everything gets probably more reasonable. There is kind of a middle road between what you're willing to look at and what their willing to want. And generally you get that middle of the road prices generally.

Terry McEvoy with Oppenheimer & Co.

Actually all my questions have been asked and answered.

Our last question comes from John Rodis with Stifel Nicolaus.

Most of my questions were answered too, but just one quick question on the securities portfolio. What are you guys seeing as far as runoff there on a quarterly basis?

You mean cash flow?

Yes.

We're still there. It hasn't -- just looking at 9/30 numbers it hasn't really changed much. We're still in the 25 million per month, or 300 million annualized.

And then maybe just one other question on M&A outlook. What are your thoughts on the San Antonio market?

We would love to be in San Antonio. There is just so few available targets over there. David, you can jump in there. You know, we look at what is -- we look at the banks in Texas list on a regular basis and are looking to see what is there. There is just very, very few independent banks in the San Antonio market today.

Yes. The San Antonio market has been different than the Dallas and the Houston or Austin, Corpus market. Again, there is not as many sellers. And going forward I think that if you're going to be a Texas bank you need to be in the San Antonio market. Needless to say, we would like to be in the San Antonio market. And if you ask me the question do you think we will be there, will there be more banks, and eventually selling in the San Antonio market, I would say yes. I would think that market will eventually break as well. I do.

There is very few banks that are headquartered in San Antonio. There are opportunities with banks that are headquartered outside of San Antonio that had branched into the suburbs of San Antonio and have presences in San Antonio that could at some point be partners for us.

There appears to the no further questions at this time. I would like to turn the program back to Mr. Rollins.

Thank you all for participating today. We certainly appreciate your interest in our Company. And we look forward to visiting with you all again soon. Thank you.