Prosperity Bancshares Inc (PB) 2005 Q4 法說會逐字稿

Good day ladies and gentlemen and welcome to today's teleconference. Currently all sites are on-line in a listen-only mode. Please note this call may be recorded. Right now, I'd like to turn the program over to your speaker, Mr. Dan Rollins. Go ahead sir.

Thank you. Good morning, ladies and gentlemen, and welcome to Prosperity Bancshares year end 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 locations for the next few weeks. I'm Dan Rollins, Senior Vice President of Prosperity Bancshares and here with me today is David Zalman, President and Chief Executive Officer; H.E. Tim Timanus Jr., Executive Vice President and Chief Operating Officer; and David Hollaway, our Chief Financial Officer.

This morning, David Zalman will lead off with a review of our financial results for the fourth quarter of 2005 and highlights for the year. He will be followed by David Hollaway, who will spend a few minutes reviewing some of our financial statistics. Tim Timanus will discuss our lending activities, including asset quality, and I will provide an update on the status of our recently completed acquisition of Grapeland Bancshares and our proposed acquisition of SNB 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 instructions that will be provided by our call moderator. Or you may email questions to investor relations and ProsperityBankTX.com. I assume you have all received a copy of the earnings announcement we released earlier this morning. If not, please call [Jennifer Wynn] at 713-693-9308 and she will fax a copy to you.

Before we begin, let me make the usual disclaimers. Certain of the matters discussed in this presentation may constitute forward-looking statements for the purposes of the federal securities laws and as such may involve known and unknown risk, and 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 Forms 10-Q, 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 David.

Thank you, Dan. We would like to welcome and thank everyone that is listening and participating in our fourth quarter conference call. Without question, our fourth quarter and full-year 2005 results were the most successful in our history. Net income for the quarter was $0.45 per diluted share compared to $0.41 per diluted share for the same period in the prior year. This represents a 9.8% increase.

Net income for the quarter was $12.6 million compared to $9.3 million for the same period in the prior year. This represents an increase of 35%. Our full-year earnings increased $0.113 to $1.77 per diluted share from $1.59 in 2004. Net income for the full-year of 2005 was $47.9 million compared with $34.7 million in 2004. This represents a 37.9% increase.

Our team remains committed to building shareholder value. Over the past five years, I am pleased to report that diluted earnings per share had increased from $0.74 in 2000 to $1.77 in 2005, an increase of 139%. Our total assets have increased 410% from $703 million at year end 2000 to $3.6 billion at year end 2005.

We have grown our loan to deposit ratio from 39% in 2000 to 53% at year end 2005. On a pro forma basis, with our recently announced acquisition of Southern National Bancshares, our loan to deposit ratio should be approximately 60%. Net earnings have increased 496% from $8 million in 2000 to $48 million in 2005. We continue to control our costs, resulting in our efficiency ratio falling from 56.57% in 2000 to 48.91% for 2005. We believe this compares favorably to industry standards. While we continue to build and increase the size of our loan portfolio, we have maintained our focus on strong asset quality. At year end 2005, our non-performing assets totaled only $1.4 million, or 0.05% or 5 basis points of average earning assets.

Our year in reflection -- we had a very busy year. Our loan team produced over 6000 new loans with a total value of over $666 million. Debit cards in our customers' pockets increased over 28% to almost 54,000 cards. Users of our Internet banking product increased 37% to almost 32,000 users. During the first quarter, we completed our acquisition of First Capital Bankers, one of our largest acquisitions yet in asset size, and added 31 locations from Kingsville, south of Corpus Christi northward to Houston.

In November, we announced our proposed acquisition of Southern National Bancshares which operates five locations and two stand-alone motor banks in Harris and Fort Bend Counties. Southern National Bancshares also has another full service location under construction. At year end 2005, Southern National Bancshares reported consolidated assets of $1 billion. This transaction moves Prosperity into the number two deposit market share in Fort Bend County. This county has experienced 26.6% population growth over the past five years versus 10.8% for Texas and 6.2% for the U.S. Projected population growth in Fort Bend County for the next five years is projected to be 27.6%. In December, we completed the acquisition of First State Bank in Grapeland which operated two offices in Houston County, Texas, one in Crockett and the other in Grapeland, Texas.

We had numerous honors in the year 2005. We were named to the Keefe, Bruyette & Woods Inc. 2005 honor roll for achieving exceptional earnings per share growth for the past 10 years. We were named to the Sandler O'Neill & Partners 2005 Bank and Thrift Sm-All Stars. We were listed in U.S. Banker's August 2005 list of top 100 publicly traded mid-tier banks. We ranked number 2 out of 195 publicly traded financial companies in the 2005 Stephens Inc. bank and thrift performance matrix and we were named in the Houston Chronicle's top 100 list. We will also join the Standard and Poor's 600 Small Cap index.

Our goal for 2006 is to continue to deliver the high benchmarks that we have set for ourselves in previous years, deliver quality products, treat our customers to the highest standards, and increase shareholder value. Thanks again for your support of our Company. Let me turn over our discussion today to David Holloway, our CFO, to report some of the specifics financial results we achieved this past year. David?

Thank you. Net interest income increased to 110.9 million for 2005, a 35% increase over 2004. This was primarily due to a 28% increase in average earning assets and an improvement in the margin from 363 to 381. On a linked quarter basis, the increase in net interest income was minimal reflecting the challenges of the current interest rate environment and a slight decrease in total average loans to 1.507 billion. And I would like to point out, note the period and loans were 1. 542 billion, so going forward, that average loan number will be higher in the first quarter.

Non-interest income increased to 30 million and 2005, a 30% increase over 2004. On a linked quarter basis, we did see a decline in our fee income of about 7%. A majority of this decrease was in insufficient check fees, as we saw that our customers were not willing to incur these fees. Non-interest expense was up 33% 2005 versus 2004, which reflects the cost associated with the additional banking centers acquired this year. On a linked quarter basis, non-interest expense decreased 829,000 to 17.2 million.

The efficiency ratio for the year was 48.9% and it was 47.1% for the fourth quarter compared to 48.8% in the third quarter. The net interest margin on a tax equivalent basis was 381 for the year, up from 363 the previous year. It was 3.77% for the quarter compared to 3.81% for the third quarter. And again, this was impacted by one, the flattening yield curve, and two, a slight decrease in average loans in the quarter.

A positive to the margin both year-over-year and on a linked quarter basis was an increase in average non-interest bearing deposits. We saw $136 million increase year-over-year, which reflects a 29% increase and $39 million increase reflecting a 6.2% increase on a linked quarter basis. Looking forward, based on our 12/31/05 model, the projected net interest margin shows minimal movement over the next quarter -- next two quarters, and then expanding over the second half of the year and 2007. And I would point out that our model does not assume any loan growth, so a 10% increase in loans over the next year will be an additional positive to the margin.

With that, I would like to turnover the presentation to Tim Timanus for detail on loans and asset quality.

Thank you, Dave. Non-performing assets at year end December 31, 2005 totaled $1.408 million or 0.09% of loans and other real estate, compared to $840,000 or 0.06% at September 30, 2005 and $1.721 million or 0.17% a year ago at December 31, 2004. This represents an increase of $568,000 in non-performing assets [from] the end of the third quarter 2005 and a $313,000 decrease from year-end 2004.

The December 31, 2005 non-performing asset total was comprised of $1.143 million in loans, $26,000 in repossessed assets, and $239,000 in other real estate. 33% of these non-performing assets pertain to loans in the portfolios of banks acquired by Prosperity since January 1, 2005. And 61% pertain to acquisitions prior to January 1, 2005 for a total of 94%.

Net charge-offs for the three months ended December 31, 2005 were $312,000 compared to net charge-offs of $89,000 for the three months ended September 30, 2005 and net recoveries of $25,000 for the quarter ended December 31, 2004. Net charge-offs for the entire year ended December 31, 2005 were $410,000 compared to $484,000 for the year ended December 31, 2004.

The average monthly new loan production for the quarter ended December 31, 2005 was $67 million compared to $53 million for the third quarter ended September 30, 2005 for a 26% increase, and compared to $49 million for the quarter ended December 31, 2004 for a 37% increase. The average monthly new loan production of for each quarter of 2005 was -- first quarter 47 million, second quarter 58 million, third quarter 53 million, and fourth quarter 67 million. Average monthly new loan production for the entire year ended December 31, 2005 was 56 million compared to 44 million for the year ended December 31, 2004 for an increase of 27%.

Loans outstanding at December 31, 2005 were $1.542 billion compared to $1.036 billion at December 31, 2004 representing a 49% increase. The December 31, 2005 loan total is made up of 39% fixed-rate loans, 39% adjusting as prime moves, and 22% resetting at specific intervals such as quarterly or annually. I will now turn it over to Dan Rollins.

Thank you, Tim. I want to spend just a few minutes reviewing the status of our recently completed acquisition of Grapeland Bancshares and the progress towards our proposed acquisition of SNB Bancshares. As you know, during December, we completed the acquisition of Grapeland Bancshares and its subsidiary bank, First State Bank. I am pleased to report that the system conversion was also completed during December. Our new partners in East Texas, led by longtime banker [Walter Cook] are doing a fantastic job taking care of our newest customers.

I am pleased to report that we're making excellent progress on our integration plans for our proposed acquisition of SNB. We are on schedule and continue to believe that we will be able to complete the transaction early in the second quarter. We have filed all of our regulatory applications with the Texas Department of Banking and with the FDIC. We anticipate filing of the SNB proxy statement within the next few weeks. Our partners at Southern National, led by Harvey Zen and Dan Agnew, have embraced this relationship very well and are working diligently to ensure that the integration comes off without a hitch.

I'm proud to report that our team of bankers are competing effectively in all of the markets we serve. We have a great team of customer focused bankers across the state of Texas and continue to look forward to great things [in] our markets. Our organic or same-store loan growth was 6.4% for the full year 2005. At December 31, our commercial and industrial loans represented 14.1% of our loan portfolio. Construction and land development loans represented 13.4%. Commercial real estate increases to 40.2. One to four family residential declined to 20.3, and home equity loans increased to represent now 3.8% of our total portfolio. During the fourth quarter, as expected, our agricultural production loans fell by approximately 5.7 million.

Our pipeline remains strong. Our team remains focused on producing results. On the liability side of the balance sheet, I'm very pleased to report as David said, that we continue our progress towards our goal of rebalancing our deposit mix. During 2005, period end to period end, we experienced approximately 30.1% growth in non-interest-bearing deposits. At quarter end, our -- year end, our deposits consisted of non-interest-bearing deposits of 23.1%. Interest-bearing deposits -- interest-bearing checking accounts of 16.1. Money market and savings accounts, 25.1. And our certificates of deposits have declined to 35.7.

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

(OPERATOR INSTRUCTIONS). Brett Rabatin, FTN Midwest.

A couple of questions for you. First off, I wanted to ask you about the run rate for expenses going forward excluding SNBT next year. Can you talk about -- obviously the expenses were lower in 4Q from a personnel perspective. Going forward, is this a good base to runoff of, or are there any other mitigating factors you might see?

Yes. I would say, if I can jump in, that it probably is a good run rate and kind of talking big picture here, one of the things that drives our expense base is what's going on in the top line -- the revenue. If our revenue is performing above where we projected, then we tend to do something on the expense side where we will go in and do additional type PR or advertising or things that we can control.

So -- what I would say directly is it probably is a good run rate. You might want to build a little bit of increase in there for things such as utilities, normal insurance and things like that normally increase year-over-year, but that should be a pretty close number.

Okay. And then on the accounting for the provisioning and acquisitions, I know that with the changes, it's difficult to bring overall the reserve, but yet in the case of Grapeland, it looks like the -- given the net charge-offs and the provisioning in the quarter and the increase in the reserve, it looks like you have even brought over more than 100% of their reserve. Is there something I'm missing in terms of the accounting you guys did with the reserve in the fourth quarter?

So you are saying -- the question is you see (technical difficulty) our reserve number and their reserve number when you add the two together it's actually more than the two (multiple speakers)?

Well, the reserve they had was about 350,000 and your charge-offs were 300 and your provision was 100, and the reserves increased about 200. So there's a $400,000 swing linked quarter and their reserve was 350. Is there something I was missing?

I don't -- we don't have those numbers in front of me. This is Dan. But we brought over the reserve that they had, so I think we're missing something in that look that you're running. We provisioned 120,000 in the quarter. Their reserve was approximately 400,000, and I don't have the period end numbers in front of me. (multiple speakers) there's nothing unusual in there.

Okay. Maybe we can clear that up after the call or we're missing something. And then lastly, you mentioned the service charges -- the NSF fees were lower. Was there -- was that the entire factor in the reduction linked quarter or was there anything else that --

No, that was the majority of it. Obviously, if you -- on the press release I think we broke out some line items. There was a loss on the sale of securities to the tune of about 79,000, but I would say the NSF fees was the overwhelming majority of it. And it's something worth looking at because normally when we study this, it's seasonally higher in the fourth quarter, not lower. And it's too early to tell (technical difficulty). As we look in two weeks into January, it's still kind of too early to tell what that trend is.

And we have gone back and looked. The bank as a whole has not done anything in terms of insufficient fees, in terms of changing the program or waiving more fees anything like that, so it's an interesting question. Is the mood of the consumer changing a little bit? I don't know the answer. It's something we really want to focus on as we go forward. It looks like that those fees are moderating up this quarter, but again, I would just say it's a little too early to tell.

All right thanks. I will let the other guys ask about the margin and loan growth. Thanks.

(OPERATOR INSTRUCTIONS). Kerstin Ramstrom, Bear Stearns.

I have a quick question for you on merger and restructuring charges. Did you take any Graceland?

No, ma'am.

Okay. And then in terms of loan growth, it seems like organically you guys are seeing very little. When I look at the breakout you did in the press release, you breakout how much you added for Grapeland and then you also included the First Capital information. But in looking at just -- excluding Grapeland, your loans were down quarter over quarter. Are the first -- I'm just trying to get a sense of what the situation is with First Capital, because that seems to be driving most of the decline. Is that just runoff from that portfolio or are these customers that are leaving, or is there another situation that's going on there?

Kerstin, David Zalman. Let me answer that. The amount of loans that have declined from First Capital, we feel that we're probably bottoming out. But it's not anything more unusual than what we first -- when we first looked at and did our due diligence. We anticipated the amount of loans that we were [outsourced] to be this number. So of course, having said that, there may be a few loans that we lost that maybe we didn't intend to lose. Maybe we gained -- we kept some that we didn't intend to keep. But for the most part, it's -- we're not experiencing anything more than what we decided we were going to have in our due diligence.

So this change has really been just a natural -- well, not runoff, but this has been controlled decline in this as a result of what you guys wanted to get out of that deal?

I think if you go back, that is the same message we've given quarter over quarter, that we expected to see some loans that didn't fit out of that portfolio move out over the first year. I think what David said was we think we're to the bottom of that. We think we're to the end of that, and that certainly is what is moving those numbers around. The other thing -- the other number that I threw out there is First Capital didn't have any agricultural production loans. During the cycle of an ag credit quarter that comes back in, and our ag credits -- production ag credits fell 5.7 million from September to December, so that's another piece of the puzzle.

Okay. Because I guess just when I look at your loan growth anyway, it just seems like it's pretty slow. You were saying that your organic loan growth was 6.4%, which compared to the other Texas banks we've been talking to for the year is pretty slow. And is there any particular reason for that?

Kristen, you know, you can make all the excuses in the world that you want, but again, our model really consists of two parts of the bank. One is an M&A model and the other part is the internal loan growth or internal growth in deposits and loans. When you look at as many banks as we do on the mergers and acquisitions side, we really don't hire any outside teams to come in and do the due diligence. We use our own team. So we announced two acquisitions during the year, but we probably looked at 4 or 5 larger deals that we didn't do. And to do that, it takes a lot of our people -- our key people -- sometimes as many as 25 and 30 people out of the bank for a week at a time that they have to go and do the due diligence on these banks.

And so -- I'm not trying to make an excuse. It's just part of our model. And we spend as much time doing -- a lot of time doing due diligence as we do internal loan growth. So you ask the question if you weren't looking at these other acquisitions and stuff like that and your lenders were really focused on just strictly internal loan growth like a lot of our competitors are, I think you would see something different. But it is what is.

Some of the other people are promising loan growth of 20 or 25%. That's not in our model.

Right. I was just also trying to figure out if there were any underlying economic changes that you guys were seeing in your markets that might not have surfaced at other banks that may be a little more aggressive with their loan growth that might become obvious through the numbers that you guys are reporting, but it sounds like that's not really the case.

No, I don't think there's any economic issues. I think we feel pleased with the economy in the markets we're serving. I think we're pleased with the way things are going. Again, when look at the model, our number that we've said all along is we want to be at 10% loan growth. We came in at 6.4. The answer is we didn't hit 10. We're not that far off of the number. If we told you we wanted to hit 20% and hit 6.4, that may be a different story.

Yes. And then my last question is for Dave Holloway. In terms of your view of the net interest margin over the next year or so, what is the implicit movement of the Fed in that?

That's -- I think we're probably in line with this [general] deal where we think rates are going to -- again, I don't have a crystal ball so --

Right, but I figured you had to have plugged in some assumptions for the thoughts you had.

That's right. It's assuming that the Fed is getting close to the end of raising their rates, number one. Number two, we have a pretty much neutrally balanced gap, if you will, today because there has been -- there have been whispers that as you get into end the part of the year, I heard comments that maybe the Fed drops rates.

So we're kind of in this really gray area, so our assumptions are built kind of with all of those ideas in mind to say let's get neutrally positioned here. And if rates are going to move up another 50 basis points, if that is what is going to happen, so be it. Or if Fed turns around and drops them 50, that's fine too. We are building all those assumptions into the model to get there.

Again, having said all that, with the yield curve the curve the way it is, it's really tough to model that. Because the inverse -- how much of an inversion etc. does the long-term start moving or not? Does the short-term come back? But we have to make some educated guesses and we're making those assumptions. The way to get out of the box and what really helps us is as Dan just stated, if we're going to grow loans 10%, that's a positive for the margin as we go forward through the year.

Campbell Cheney, Sanders Morris Harris.

Good morning everyone. This is a bit off topic, but I was looking at the release for Southern National Bank that you published under your own letterhead. In the $47.5 million loan re-class -- can you guys provide some color on that? What type of loans were they? Why were they written down $7 million when it looks like they were performing type of loans? Just any color you could provide would be appreciated.

They can probably provide some additional information. You can talk to them. But what you look at, if you look at their non-performing number, all of their non -- or of the large majority of their non-performing is in that group and that is where the majority of the write-down came from. The rest of the loans that were in there, again, are just loans that for whatever reason didn't fit -- don't fit a model, could have interest rate risk, could be a multitude of reasons why it would have been put into that category. But it is something that we identified through the due diligence process that we wanted to see if we could move out.

Okay, so [it is] your identification -- is this something that doesn't fit into your profile?

That's right.

Adam Barkstrom, Stifel Nicolaus.

Real quick, you guys touched on I guess in the press release sort of talked about it a little bit here, but your overhead costs, you touched on the fact that you improve your efficiency ratio over the last year. Do you think that can continue and what kind of improvement going into 2006 and 2007 might we see in that ratio?

Let me take a shot at it, and I might want to answer it a different way. Driving that ratio down because we're going to cut expenses significantly more in 2006, that's -- that may be a tougher call, but what might impact it positively is just increasing our fee income and getting our margin to expand, because obviously those are other variables in that ratio. But if you're asking direct to how much more expense are we cutting, that's a tough call. I don't know that I would say we're going to materially move that thing down from an expense cutting perspective.

Got you. And then I guess I wanted to see if you could maybe give us some color on SNBT and how perhaps -- once you merge that in, is that going to materially affect your credit numbers, i.e. your level of loan loss reserve? And then would you anticipate your charge-off level from a charge-off ratio perspective, would you anticipate that going up at all or kind of sticking where it is?

Well, that's a crystal ball question. I think the real look would be if we identified the 40 some odd million dollars in loans that don't fit for whatever reason, I think you can assume that the large majority of problem credits are in that category. So what comes across should be very clean. Does that mean that there won't be more non-performings than we had in the past? When you're carrying 5 basis points on earning assets, that is not a number that is long-term sustainable when you're growing a loan portfolio from 500 million to 2 billion or 2.5 billion in a couple of years' time.

So is the number going to be higher than 5 basis points? Maybe. Is it going to be significantly higher? Is it going to -- I think our goal is to be an industry leader and lead our peers. And I think the way we structured the transaction and the way we are working forward now will allow us to be able to stay in that position.

Okay. And then the portion of loan loss reserve that is going to be acquired from them, is that going to -- will that keep your ratio kind of the [1 12] area or is that up or down or --?

Well, I don't know that we've run numbers that would say whether it's in the 1 12 or not. As we roll up towards the closing, we certainly have to go through all of that analysis and decide what's in the portfolio and how to bring that across. I don't know that we're ready to answer that question at this point.

Probably give us another quarter to analyze it.

Scott Alaniz, Sandler O'Neill.

You guys still celebrating the Rose Bowl victory or --? Good. Glad you took a few moments out from your celebration to jump on the call. A couple of questions. First, for Dave Hollaway, could you give us a little more detail on the sequential decrease in staffing expenses? Because as I look at it, it didn't appear that there was a big drop in headcount from the third quarter to the fourth quarter.

Yes, if you're going back and looking at -- and we actually have in the press release on page 13 I think it is, it [tells] employees' FTE, but what is interesting about it is you can see at year and we're at 859 and you're right; on 9/30 it's 857. But really what you're seeing is if you go back to March 30, 926 FTEs and fill this in as we're putting pencil to the paper, that 859 at year end includes 18 people -- 18 FTEs from the Grapeland transaction that happened on December 1.

So it's kind of misleading in a sense because you've got 18 extra people in there, but the end result of that is you're talking about a significant drop in FTEs that you're really seeing a full run rate in the fourth quarter -- (technical difficulty) all in the third quarter.

Okay, and would you expect a similar drop in FTEs in the first quarter?

No, if you kind of think about it -- again, if we've gone from 926 and take 18 out to 840, I don't know there's a lot more FTE reductions [to] happen absent some type of acquisition.

I guess I will come at it from a -- I think we would tell you that the cost saves in the First Capital transaction are in. The headcount reduction at Grapeland from 18 down is not going to move the needle enough. That's one or two people. So -- I don't see a headcount move from an acquisition -- the expense saves are all in there. That's a normal run number.

I see, very good. Secondly, on the SNB acquisition, do you have a preliminary estimate of what the quarterly core deposit intangible amortization will be?

We do not.

Okay. I guess lastly -- a couple other -- what system does SNB use? What systems are they using? And talk a little bit about --

Core processing systems?

Yes, sir.

That's a good question. I will just in on that. Our conversion teams are actively working to do all of those conversions, Scott. They operate on an ITI premier system. ITI is the parent company of [IR Core Processing Company] Precision Computer Systems, so we're coming off of an ITI out there and onto PCS. And both of those, ITI and PCS are both Fiserv subsidiaries.

Got you. And I guess a little bigger picture question. I know you have to be opportunistic with respect to acquisitions. But when do you feel like you could do another deal -- another reasonably sizable deal -- 3, 4, 500 million in assets or larger?

I guess that is a question for me, Scott. I think we are ready right now.

I don't know that our team all feels that way.

I would say that the First Capital acquisition was probably a lot tougher acquisition or merger than say Southern National. And it was tougher because you had 31 locations and you had a distance all the way from Corpus Christi to Houston.

The Southern National Bank transaction that we're doing in the merger, it's just like in our backyard. The people have been very accommodating. The attitude is just unbelievable. And a lot of the integration that normally happens after the merger is actually happening before the merger and as we speak. And because of that, I think we're moving really expeditiously and it's just in easier deal. [Of course], I don't want to be coy about it, but it's a lot easier transaction for us.

Operationally, it's just people driven -- David's right. I think from a timing perspective, if something were come along now, it takes a while to cook these things. You got to put them on the stove and let them cook and simmer for a while. So I think in the process and the way things work, we could probably begin that process again knowing where we are in the timeline on Southern National.

Again, comparing the two as David did, when you look back, we had 650 people before the First Capital transaction, and it took 150 plus people on our side to integrate that team. We pulled 100 plus people out of their day-to-day jobs, put them into the integration team, sent them out into the field to the 31 new locations. That can be very disruptive to an entire organization, and it causes workloads and things get stacked up and home while you're out helping somebody else.

In this particular transaction, we're now carrying 850 people, and my guess is our conversion team during that week of conversion is probably going to run in the 50 people range, not 150 people range, because they only have seven offices and they're right in our backyard. We are not going to have to be away from home, so just -- it is an easier deal from that perspective.

And I will tell you the other side of that -- I have got to talk to about Harvey and Dan and Louise and the folks that are out there at Southern National -- wow, those folks are really doing a fantastic job of getting things lined out -- getting in front of all the issues that need to get taken care of. And with that kind of leadership going on out there, this will be very smooth.

Excellent. Last question. What is your sense of let's say seller expectations or seller sentiment in Texas? Do you feel like there are going to be more opportunities out there in 2006 than in 2005? Just talk a little bit about what you see in the marketplace.

Again, this is David, but there is -- there's a lot of opportunity out there. I'm sure it's for everybody, but especially for us. I still get phone calls and people are asking to meet with us and we discuss different things. And so I think there's a lot of activity out there. Again, you may meet with a lot of people and sometimes the price expectations are so great that you have lunch and you go and call back on them in five years or so. That's the way the deal works.

But what we see out there right now, it is still very, very active and it's just a matter for us is -- a question for us of how much we can do and do it right and integrate it properly. I don't see anything stopping us from not -- the opportunities are out there. That's not going to stop us. It will be us that will stop ourselves and we can only do what we can and do it right.

Our team goes in, rolls the sleeves up, and starts going to work. There's a work ethic that says we want to figure out to make this thing work that can be a benefit for both sides. And from a price expectation, I think David's right. I think everybody we talk to the first time, price expectations is - oh, 10 or 12 book will get it for them. No problem. It takes some talking to figure out what is a real number.

Barry McCarver, Stephens Inc.

I got on a little bit late, so most of my questions have been touched on. Back on the loan loss reserve very quickly, let me ask it this way. At the current levels before you add in the new acquisition, are you -- is your reserve about as high as it can go before the auditors start giving you dirty looks? Or do you still have some upside there? Just sort of where are you at?

I'll just take it, and I can only talk in generalities, not as specific as those Dave can. But we have continued to put money into the reserve for loan losses, and it's pretty easy to see when you look at our net charge-offs for the year was around $400,000 to $500,000. And you see $17 million in reserve, that's quite a few times coverage. So the long and short of it is I think we probably do have some room that if we don't want to -- or if it becomes really a question of an auditor question that we may not have to be as aggressive on the reserve for loan loss maybe for the next year. We haven't made that decision yet.

We had net charge-offs during the year of $410,000. We actually provisioned off the expense statement $480,000 for the year. So the actual provision expense in the net charge-off number was very close to the same number.

One of the things that we do, that again -- it's just like were dealing with the Southern National Bancshares deal. We try to get to the banks. We -- during our due diligence, we look at the loans, we look at the loans that we think may have problems going forward, and we try to address those upfront and try to outsource them pretty quickly. So that -- in the case of Southern National and again the 47 million that you see there, we'll try to move those out of the bank.

Again, we're not saying that they are bad loans one way or another, but again, they don't fit the criteria of the asset quality that we have, so if we can keep doing that, we shouldn't have to provide -- put a big provision for loan loss. In fact, we might be able to do something the other way really.

That's right. Under person purchase accounting, when you look at the Southern National transaction, they did put 47 million in available for sale category and marked them to market. Under purchase accounting rules, we would be required to mark them to market at closing if nothing happened between now and then. So I don't think the entries are any different whether the entry is made now or the entry is made in three months. If the market value of those loans is accurately reflected as the accountants require, then that is where we are.

That is actually a good lead-in to my second question, which is maybe a little tougher, so forgive me. But -- and I have not had a chance to go through Southern National's entire press release this morning with a fine toothed comb, but clearly, they're taking some steps I would guess heavily directed by you guys as to what they want -- what you want them to look like when you close the deal.

I'm wondering if you to give us just in broad strokes on the asset side, the [reject] on the liability side, the same way. What do you hope that they're going to look like early in the second quarter when you get ready to close the deal?

I think most of the changes are in place today. And really, I think this is a partnership. We're not telling them what to do. I think the decisions that are being made are what's right for the balance sheet and what is right for the shareholders. And when you look at the balance sheet restructuring that they did, I think Harvey would tell you today that was in their plans with or without us being a part of the team.

So where they are today, your question is what is it going to look like. At a billion dollars in size and very little leverage, I think that's what it will look like. Their loan team is producing business and is growing loans and is continuing to do that. The loans that didn't fit for whatever reason, you can see their NPA number spiked up a little bit. We want to clean some of that up, but I think that what you see today at a period end balance sheet is going to be close to what you should see at closing. Do you agree with that Dave?

Well actually, that is our hope that there won't be a leverage strategy on the balance sheet when we close, which when they did their press release on 12/31, I think that's what came through on it. I think when you are looking at also their 12/31 balance sheet, again you can see that their deposits have gone way up, and that is a seasonal thing. So again, by the time we get to the point where we're together, that will probably be gone because those deposits are seasonal in nature and they're quite expensive actually.

So again, we call it -- maybe it's not accurate. We think of it as a leverage situation. It's really not. There's a lot of different moving pieces. You have to do certain things depending on the type of deposit. But again, the direct answer to the question is [they] will probably be a little smaller from asset perspective and their margin will be probably a lot better than it has been in the last few quarters.

That is very helpful, thanks guys.

Kevin Reynolds, Stanford Group.

Good morning gentlemen. I have a multipart question that gets to loan demand, the monthly loan production. And you can be as detailed or as brief as you like because I know we have been here for a little while. But could you comment on loan demand in each of your major Metro markets, which markets might be leading versus lagging? And then second, can you comment on the competition in those markets and how that's impacting terms and pricing today?

Kevin, this is Tim Timanus. Approximately 40, 45% of our loans are in the Houston market. And we don't see that ratio changing in relation to the other markets. The demands in each market seem to be stable. We really don't see any kind of a roller coaster effect in any of those marketplaces.

The competition is very difficult, has been for quite some time and we assume is going to continue to be. There are a lot of lenders out there that are extremely aggressive in pricing, in down payment requirement, in credit quality that clears their hurdle, etc. and we have to compete with that every day. And that's not going to change in our opinion. I don't know whether that fully answers you or not.

Does that answer your demand question? When I look at -- in my mind Tim sits in the loan meetings, I watch some of that, it looks to me like what we're seeing is we're seeing more loan demand out of Houston than other markets, but I think that is probably a factor of we've got more lenders on the street in Houston than other markets. But from a location to location, the Austin team is producing loans very well. The Dallas team, loans grew in Dallas. The Houston team is performing well.

I would say -- if I could summarize, this is David again. Houston by far is one of our best markets. And again I think it's because we haven't had a lot of transition or integration in the Houston market. We have been [here] for awhile now -- quite a few years. I would say secondly, probably the best performing area would be -- probably the Austin area. It seems to be really good. And then I would probably put Dallas in the third category for us.

And then again, South Texas with Victoria and Corpus Christi in that area, because they are so new, they're not really even on the plus side yet. They are still trying to get through the loans that we have identified during their due diligence, which we think they are about there, so usually that takes about a year to get to where we want to be. We think they're almost there, so we do look for some good things hopefully from the Corpus and Victoria market going forward in the next year also to kick in.

Okay. And then I guess a -- maybe a follow-up to that, and in the loan demand that you are experiencing, is there any particular industries -- defined as broadly as you want, but can you sort of drill down say we're seeing good growth economically in these type industries versus others?

Kevin, this is Tim again. We're really seeing it across the board. All segments of the economy seem to be strong right now. Needless to say, the oil and gas sector is extremely strong, but real estate continues to do well. Really every sector that we see seems to be stable and doing well.

Eric Roth, Hovde Capital.

I had a couple of questions some were answered so I will just pick a few here. Can you talk about the average monthly loan production by month first of all in the quarter?

If we have monthly number -- you got your quarter numbers you went through --

Yes, I have got the quarter. I don't have it handy.

I don't know if you could hear that, Eric. Basically, we have them more on a quarterly basis and not on a monthly basis.

Okay. I apologize for the noise here, by the way. We have some heavy construction going on next-door -- putting up some condos here.

Sirens in the back so you're okay.

Right. Not yet. What -- can you give us a sense at least as far as a trend if you don't have that stuff handy -- how the quarter was looking -- was October stronger? Was December stronger?

I would say that the quarter improved as it went by. The average number of 67 million -- [we're hopeful] that's a good minimum level number going forward. Obviously, we don't have a Crystal ball on that, but we hope to improve on that number and we don't see any reason -- it's obvious to us why we don't have a good chance of doing that.

How would do say the hurricanes -- I know you talked last quarter about the hurricanes, and it sounded like there were some delays there that were going to get pushed into this fourth quarter. I would have thought October would have been pretty strong given that dynamic and is this -- you still feel pretty good with this 67 million like you just mentioned it sounds like. You are pretty comfortable about as a core number even though that may have had some extra stuff from the hurricanes left over from the third quarter.

I think that's correct. As I indicated earlier, the third quarter average monthly number was 53 million. So it went all the way up from 53 million to 67. It had been 58 in the second quarter. And there's no question that the two hurricanes that affected -- from a geographical standpoint that affected our marketplaces did have an effect on our loan production. Things were stagnant and simply not happening for at least two weeks, and really one could make a case as long as a month after those storms came in. So there's no question that had an effect on it. And we believe that the catch up did take place in the final quarter of the year.

Okay. Also, you talk about the -- maybe if we could talk a little about the securities portfolio. I am trying to understand a little bit about the cash flow per month that is generating. I think you talked in the past around -- I think it was around $300 million per year -- about 25 million a month. Is that still about the case?

Yes, as of today, that is what we are still seeing. If you're looking over the next twelve months, it is probably a little under 300 million. Then when you roll into year two, it's a little over 300 million on annualized basis.

I want to make a comment that probably actual cash flow is important, but also you need to look at the effective duration. It probably has come down. Good or bad I don't know, but it's down to about 2.87 years right now.

Okay. How do you see that given the runoff and given the 10% organic loan growth expectations or internal goal that you guys have, the way that I look at it in looking at your loan base now, it's about $150 million in loan growth organically on an annual basis with about double that in securities -- the cash flow from the securities. So is that -- where do you go with the remainder there with the proceeds? Are you -- do you have to go into other securities then? Is that part -- how did that affect -- how is that affecting the margin this quarter?

Dave will have to answer the question about the margin. But yes, if you have 300 million rolling off, you are hoping that 150 will go into the loan portfolio. And the other 150 will be reinvested in securities with kind of an average life of -- [as to] what we've been doing, which the reinvestment should be higher than the yield that we have right now. So that should do the good for the margin and probably even 150 million if we get the loan growth that we want to get, that should impact the net interest margin positively.

I would just add obviously the best scenario is lend all that money out. And put it back into the security portfolio. We all agree with that.

We don't want any losses there with that though.

The other direct answer to your point is -- it's an interesting point that you bring up, because if you look at the quarter and say -- if we are saying we're growing 10% organically and you use that number and say that makes it 2.5% for the quarter, if you apply that logic to this past quarter, you can do this in your model, you'll see that would have had a positive effect on the margin. That would have actually probably have made the margin -- and again this assumes everything else is static, but not reinvesting it into securities and having it in the loans, you're probably looking at something like a 3.80 margin instead of a 3.77.

Okay. And then, let's see -- I think I had one more. How about -- can you talk about how the margin looked on a -- similar to my other question about the monthly production -- on a month by month basis?

I don't know that I have that information to be able to really answer that accurately.

Okay. Maybe I'll follow up another time then. And the last comment just on the service charge in deposits which you briefly touched and we are seeing this at a lot of banks this quarter, what do you think is going on there? Any more that you can say there or any thoughts as far as the weakening consumer? And where do you see that going?

I think I'm asking the same question as -- we're analyzing that now because it's a trend that we haven't seen before. And again, the first question is, did we as a bank do something different? The answer is no. And the next question is, well, are you waiving a lot of fees? The answer is no. The bank has not changed anything. So it comes to the point of your question, is something happening out in the marketplace now with the consumer? And again, I don't know that -- we haven't been able to discern anything yet within -- maybe the next three months will tell the tale, but I don't know -- David or Dan if you have a perspective on that.

Well, (multiple speakers) historically in that area, I would tell you that usually it -- the economy didn't effect the service charges and things like that. It looked like people who wrote insufficient checks wrote insufficient checks and it didn't matter. They just kept doing it. It is usually not even tied to if you increase the price that you put on an insufficient check. It's really remarkable because as you do that, you would think that you would lose some business, and over the years I've been in the business, even as you raised prices on insufficient charges, you generally never lost the amount of charges that you had or the number of transactions that you had. So this is puzzling a little bit.

So is it a macro question that -- is this a kind of a crystal ball look into the future that the consumer is starting to --

That is what I'm wondering, and I guess the other question is, how do you think the regulators and the increased disclosure requirements have played in? Do you think that is [having] part of the effect too or do you think it's just a macro weakening consumer or tied maybe to housing prices and real estate? Or what do you -- (multiple speakers)

I can answer in the first part. I mean from our bank's perspective, we have always disclosed -- even before the regulators jumped in, we always did appropriate disclosure, so that didn't change for us. But the second half --

I was going to say the same thing. From a disclosure perspective, we've been ahead of that curve, so we're not -- with all of the new rules that have come out, it's not required us to change anything of any significant matter that would be hitting somebody in the face that hey, stop, think about this. That's always been there on our side. So it comes down to -- I think your question is in the big picture world out there, consumers in general, what's changing this and we're such a small piece of that, we're looking to you guys to help figure that out and tell us.

Maybe it's the Suze Orman show on CNBC and they're all listening to her not to write hot checks.

God I hope not. Okay. Thank you very much guys.

[John Martinez], Cohen Brothers & Co.

Most of my questions have been answered. Just maybe two short, quick questions. David, you mentioned -- I think you said on a pro forma basis, the loan to deposit ratio with the SNB acquisition would be in the 60% range.

Right.

And given the restructuring they reported today, is that reflecting that number as well?

I have to get my number guys, but they're saying -- they're shaking their heads.

I guessed as much, but I just wanted to double check. And thanks for kind of breaking out your markets and where you're seeing loan production and given that ranking, is there any market that you're in now between your markets that you'd like to either further expand your presence, either through additional lenders or additional branches? Where do you think your best opportunities are to maybe improve that organic growth a little bit?

Well, Houston is just a vibrant, vibrant market, so I think we have opportunities here for internal growth as well as merger and acquisition. Dallas, by far, has the best -- should have some of the best potential for M&A because there are just so many independent banks out there. We should still be able to experience good internal growth in Dallas as well. Austin can have good internal growth. I don't think you will see a bunch of M&A in that market because there's just not -- there's not that many banks in that market.

No, in Austin, every bank is opening a de novo office on every corner.

I would say the Corpus Christi market that we probably will try to expand our market share in that area, going toward the San Antonio market through M&A as well that we haven't focused on as much. But since we're there now and have such a big presence, we'll probably start to focus more in that area as well.

Thanks guys. That's a big help. I'm just kind of following up with your conversations there about NSF fees. As an observation we saw in another bank in the Midwest, one of their comments was that their volume of check processing was down and that they felt that was part of their story as to why their NSF fees were also down. Do you think you might have experienced any of that as well?

It's a possibility. Something else we can throw out is -- just in a general big picture, the other thing that we see that is interesting is the use of debit card. Maybe this -- (multiple speakers) [answers it] indirectly, but the use of the debit card transactions is skyrocketing.

I was the comment that was coming out of this bank in Michigan, so I was just curious if you might have had a similar experience.

Yes, and we've seen that I guess, but I guess what is puzzling to us is, is there a correlation between using the plastic a lot more and then not overdrawing your account?

Maybe people don't understand that they can still use the debit card and overdraw the account. Maybe they think they have to have money in it. I don't know. We need training obviously.

I'm looking at item volumes, John. Our item volumes are not dropping off at the same pace that the debit card volume is increasing, so I don't see it as a volume issue.

I understand. Thanks a lot guys. I appreciate it.

Kerstin Ramstrom, Bear Stearns.

I'm sorry, my other question has unanswered.

Jennifer Demba, SunTrust Robinson.

Obviously everybody is trying to get the disconnect between your increase in your monthly -- or your quarterly loan production and the fact that you didn't really have any internal loan growth this quarter. Did you have any significant paydowns in the quarter?

This is Tim. I think I can address that. If you look at our burn rate for the entire year 2005, and a conservative burn rate number is 55 million a month. And the reason I refer to that as conservative is because included in that calculation are all of the First State Bank and Grapeland loans that came over, which is 44 million -- 45 million. They didn't come over until December 1, so they really were not in the mix for eleven months.

And then also included in the calculation are all of First Capital's loans that came over, which was some 461 million in loans. And they were only in the mix for I guess 10 months out of the year, and you really have to look at the paydowns on the First Capital side. As we've already indicated earlier today, there have been a large number of loans that have paid off from the First Capital portfolio that were in that group of loans that we identified as not fitting our model -- as many as $60 million worth. So we don't think the normalized burn rate going forward is going to be 55 million. But that is what it was approximately for 2005.

What do you think the burn rate will be next year or this year?

Well obviously, we don't know for sure, but I think -- we think it could be -- $8, $10 million a month less than that possibly.

When you look at this year's full numbers, kind of big picture, (indiscernible) in the numbers, 56 million burn rate -- is that what you just said?

55.

55 million in our average production for the year was 56 give or take a million, so there's your -- that puts back to where we were for the year. And what that answers your question I think is -- is what really is the normalized burn rate and we think production is good. We've got to reduce the burn rate.

If we are right that we in essence outsourced all that we need to out of First Capital, that's as much as a $60 million annual swing in that number. So it's significant.

Does that help you?

Yes, thanks.

[Lozen Alexandroff], FIG Partners.

Good morning. I just wanted to ask you to comment a little bit on what you see on the market for deposits? Do you see the competition [sitting] up a little bit? And also, now with (indiscernible) for time deposits at higher levels, we use the customers preferring and switching accounts from other types to bank deposit accounts?

I think what I heard was what is the competition for deposits in our markets?

Yes.

The deposit competition is red hot. I don't think it's changed in the last quarter. In my mind really I don't think it gotten any less competitive, nor do I think it has gotten any more competitive, but it's hot. There are players in all the markets that we serve that are paying very high deposit rates. You got some players that are paying money market rates that are not far off of a Fed funds rate. You have got folks that are paying CD rates that are very high. And in different markets, different banks are doing different things. So the competition is still there.

I would say that Dan, this is David jumping in. We've never -- our customer base -- we've never really focused on that part of the market where the hot money (multiple speakers) and it's real competitive that is going to change for us 25 or 50 basis points. We've never really focused on that market.

The other part of your question was, are we seeing a shift from transaction accounts to time accounts to pick up more yield? And I don't know that we're seeing that. Again, I think it depends on the customer base. I don't think we've seen that. In fact, the other way -- our total CD money is actually -- as a percent of total deposits is actually declining.

Yes. I guess I wanted to see if you see any trends on the market as a whole, maybe not only at your bank.

I don't know that I can answer for the market as a whole. (multiple speakers) It depends on -- here in Houston money market seems to be the thing. In Austin, money market seems to be the thing. In the Dallas -- I have seen Dallas and Corpus with some huge CD rates being published. So I think every bank has got a model that they are following, and there are some banks out there that for whatever reason are paying big prices on CDs and they're attracting money that way. And there's other banks that are paying really big prices in our eyes on money market accounts.

With the exception -- and this is just an analogy, with the exception of the credit card banks that are really having to pay extra high money to -- higher rates to get the money in, after you leave that area, then you're probably focusing on more of the startup banks that really have the loans but they don't have the CD -- or they don't have the deposits. And they're really focusing on paying a lot higher rates on the CD. So that is probably the second part of the group that is trying to get the money.

Yes, most of the banks that we see paying up in all the markets are having funding pressure to support their loan growth.

At this time we have no more questions.

Fantastic. Folks, I certainly appreciate everybody participating with us today. Thank you very much for your time listening to our call. We ran a little over an hour today. We will try and do a better job at being more precise next time. Talk to you all soon.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect at anytime.