Prosperity Bancshares Inc (PB) 2006 Q1 法說會逐字稿

Good day, and welcome to today's teleconference.

At this time, all participants are in a listen-only mode. Later, there will be an opportunity to ask questions during our question-and-answer section.

I would now like to turn the program over to your moderator, Mr. Dan Rollins.

Go ahead, sir.

Thank you.

Good morning, ladies and gentlemen, and welcome to Prosperity Bancshares first quarter 2006 earnings conference call.

This call is being broadcast live over the Internet at www.prosperitybanktx.com, and will be available for replay at the same location over the next few weeks.

I am Dan Rollins, President and Chief Operating Officer of Prosperity Bancshares, and here with me today is David Zalman, Chairman and Chief Executive Officer, H.E. Tim Timanus Jr., Vice Chairman, and David Hollaway, our Chief Financial Officer.

This morning, David Zalman will lead off with a review of our highlights for the first quarter of 2006. He will be followed by David Hollaway who will spend a few minutes reviewing some of our -- spend a few minutes reviewing some of our recent financial statistics. Tim Timanus will discuss our lending activity, including asset quality, and I will provide an update on the status of our recently completed 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 the instructions that will be provided by our call moderator, [Jennifer], or you may email questions to investor.relations at www.prosperitybanktx.com.

I assume you all received a copy of this morning's earnings announcement, if not, you may call Whitney Rowe at (281) 269-7220, 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 inform known and unknown risk, uncertainties, and other factors that may cause the actual results, performance, or achievements of Prosperity Bancshares to be materially different from future results, performance, or achievement 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's filings with the Securities and Exchange Commission, including forms 10-Q and Form 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 the call over to David.

Thank you, Dan, and I would like to welcome and thank everyone that is listening and participating in our first quarter conference call.

I am very pleased to report that the first quarter of 2006 was another record quarter for our company. Some of our successes of this quarter include record earnings.

We earned $12.9 million in the first quarter, compared to $10.6 million in the first quarter of 2005, an increase of 21.9%. We reported diluted earnings per share of $0.46 for the first quarter of 2006, compared to $0.43 for the same period in the prior year.

Return on average assets for the three months ended March 31, 2006, was 1.43%. Return on average common shareholders equity for the three months ended March 31, 2006, was 10.9%, and a return on tangible shareholders equity for the same period was 27.5%.

Our efficiency ratio improved to 46.8% for the three months ended March 31, 2006. We are especially pleased with our results when we look back at the past quarter and consider the strong head winds we were facing with the flat yield curve in a rising rate environment. As we look forward, our expectation is for a slightly improving net interest margin 12 months out, as we were able to reprice our assets.

We have been particularly successful at growing our demand deposits, also known as interest-free deposits. Our non-interest deposits increased almost 17% from March 31, 2005, to March 31, 2006, an increase of approximately $100 million.

At the same time, we have not felt the need to chase higher cost money and have let approximately $120 million of higher cost funds, much of which was public funds, leave the bank. This rebalancing of our deposit mix has helped our earnings.

Loans, excluding loans acquired as part of our Grapeland merger, link-quarter same-location loan growth was 5.7% on an annualized basis. While this is slightly below our organic loan growth goal of 10%, we are very pleased with this progress when considering the level of competition in Texas and the normally slow first quarter loan fundings.

We continue to focus on loan growth. Only two years ago, our bank had a 37% loan-to-deposit ratio. At March 31, 2006, this ratio had increased to 54%. When you include our acquisition of Southern National Bank into the numbers, the loan-to-deposit ratio will be approximately 57%. We would like to increase this ratio to somewhere between 65% and 75% over the next two to three years.

Regarding asset quality, nonperforming assets totaled $1.3 million, or four basis points of average assets, at March 31, 2006, compared with $3.4 million, or 13 basis points of average earning assets, at March 31, 2005.

Our asset quality is still considered to be the best of the best. We continue to focus on asset quality as we continue to increase the loan portfolio. We feel our asset quality has been, and will be, one of our major strengths.

On April 1, 2006, we completed the acquisition of SNB Banks shares, Inc. and its subsidiary, Southern National Bank of Texas, in a stock and cash transaction. Southern National Bank operated five full-service offices in the Houston metropolitan area, all of which became full-service banking centers of Prosperity Bank. In addition, Southern National Bank has a full-service banking center under construction that we plan to open in June of 2006.

We are very excited to be in Fort Bend County, one of the fastest-growing counties in the US. Population growth from 2000 to 2005 increased 26%, compared to approximately only 10% for Harris County and 6% for the rest of the US. The forecast calls for 27% population growth from 2005 to 2010, and we fully intend to be part of this dynamic growth.

In closing, I would like to say how gratifying it is to become the fourth largest Texas-based commercial bank upon the completion of our acquisition of Southern National Bank. We are proud of our past and intend to stay the course.

We plan to continue our focus on organic growth, and we also plan to continue to pursue accretive acquisitions. Our goal is to become the largest, or one of the largest, Texas-based banks in five years. Although we want to grow, we will not take our eye off the ball when it comes to asset quality and building shareholder value.

We intend to continue building our loan portfolio, focusing on our customers, rewarding people that produce results, and continue to build shareholder value, and we will continue to honor our service commitment by greeting the customer with a smile, calling the customer by name, and finding a way to say yes.

Thanks again for your support of our company.

Let me turn over our discussion to David Hollaway, our Chief Financial Officer, to discuss some of the specific financial results we achieved.

David?

Thank you, David.

Good morning, everyone.

Net interest income increased to 29.2 million for the first quarter '06, a 19.3% increase over first quarter 2005, and a 0.6 increase over fourth-quarter '05. The first quarter comparative increase was primarily due to a 19% increase in average earning assets.

The net interest margin on a tax equivalent basis increased to 3.81% for the first quarter 2006, compared to 3.77% for the fourth quarter 2005, and I would mention here, again, as we are looking forward -- based on our 331 model and impact of SNB -- looking forward, I would tend to think that our net interest margin should run for the balance of this year in the mid-370s range, or using somewhere between 373 and 378, and then, beginning to expand as David mentioned in 2007.

Non-interest income for the first quarter 2006, increased 17.4% from first quarter 2005, and increased 2% from fourth quarter 2005. Insufficient check fees drove the first quarter-over-first quarter increase. Concerning a link quarter increase, it was driven by an increase in various fees, such as wire transfer fees, fees for purchases of money orders, cashing check fees, et cetera.

Non-interest expense for the first quarter 2006 was up 8.9% from the first quarter 2005, which reflects the increased operating costs associated with the additional banking centers acquired in 2005. On a linked-quarter basis, non-interest expense was basically flat, which helped produce an efficiency ratio of 46.8%, and this was slightly lower than the fourth quarter ratio of 47.1%.

Account on deposits, which were 2.9, 15 billion at 3/31/06, down 0.2% from year-end, and up 0.7% from 3/31/05. As mentioned earlier, we continue to improve our mix of money, which is reflected in our non-interest checking deposits, which were up 17%, comparing 3/31/06 to 3/31/05, and up 2.7% from year-end. This change is also reflected in the percentage of non-interest bearing deposits to total deposits, which increased from 20.5% at 3/31/05, to 23.8% at 3/31/06.

Final comment is concerning the bond portfolio -- the effective duration at 2.8 years with the weighted average life of 3.4 years.

With that, I would like to turn over the presentation to Tim Timanus for details on loans and asset quality.

Thank you, Dave.

Non-performing assets at quarter-end, March 31, '06, totaled $1,267,000, or 0.08% of loans and other real estate, compared to $1,408,000, or 0.09%, at December 31, '05, and $3,447,000, or 0.23%, a year ago at March 31, '05. This represents a decrease of $101,040 in nonperforming assets from year-end 2005, and a $2,180,000 decrease from the quarter-end March 31, '05.

The March 31, '06, non-performing asset total was comprised of $1,228,000 in loans, $2,000 in repossessed assets, and $37,000 in other real estate. 65% of these non-performing assets pertained to loans in the portfolios of banks acquired by Prosperity since January 1, '05.

Net charge-offs for the three months ended March 31, '06, were $11,000, compared to net charge-offs of $312,000 for the three months ended December 31, '05, and net recoveries of $106,000 for the quarter ended March 31, '05.

The average monthly new loan production for the quarter ended March 31, '06, was $66 million, compared to $47 million for the quarter ended March 31, '05. Loans outstanding at March 31, '06, were 1.561 billion, compared to 1.542 billion at December 31, '05. The March 31, '06 loan total is made of 39% fixed-rate loans, 39% adjusting as prime moves, and 22% resetting at specifics 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 before we take questions reviewing the status of our recently completed acquisition of SNB Bancshares.

As you know, we completed the acquisition of SNB Bancshares and its subsidiary bank, Southern National Bank of Texas, on April 1. I am pleased to report that the systems conversion is scheduled to take place within the next month. Our new partners in Fort Bend County, led by Harvey Zen and Dan Agnew, are doing a fantastic job of leading our newest partners and taking care of our newest customers.

I am very proud of our team of bankers. They are competing effectively in all of the markets we serve, and we are continuing to grow our customer base. Our team is customer-focused, and we continue to look forward to great things in the markets we serve.

Our organic, or same-store, loan growth, as we were talking about, was 5.7% on an annualized basis for the first quarter. Our loan pipeline is very strong, and our team is very focused on producing results.

As you've heard already, on the liability side of the balance sheet, we continue to make progress on rebalancing the deposit mix by growing our non-interest bearing deposits. We've been focusing on this for some time, and as David Hollaway said, on March 31, non-interest bearing deposits reached 23.8% of our total deposits.

We are very proud of our team's performance, and we're looking forward to our future opportunities.

At this time, I think we are ready to take questions.

[Jennifer]?

[OPERATOR INSTRUCTIONS]

We will take our first question from Brett Rabatin from FTN Midwest.

Go ahead, sir.

Hi. Good morning.

Morning, Brett.

Couple questions -- mostly wanted to talk about the deposits, was impressed with the DDA and a lot of banks this quarter are -- the title escrow deposits are lower and you guys had, in the period, 11% link-quarter annualized growth and the averages were up. Why are you guys being more successful than a lot of the other institutions out there in growing your core deposits like that?

Well, first of all, Brett -- David Zalman -- I don't think our bank really in the past, historically, has relied on higher cost deposits. As interest rates have gone up, I think you have seen the deposits that were really so interest-rate sensitive that other banks continue to pay higher rates on. I think we just didn't do it, and, again, we don't -- I think our clientele, with our good core funding, or core deposits, we're not as high. Not that people aren't sensitive to interest rates, because they are -- you can't be too much off, but, again, our -- our company and our -- and our customers are not just -- just completely banking with us just because of interest rates, in my opinion.

I think we are -- we are focused on relationships, Brett, and as we are talking with customers, we are telling customers on a regular basis, if you want us to pay higher rates on interest-bearing deposits, you need to move more free money and you need to have more relationship with us. So, when you are focused on those relationships, I think that builds core deposits.

I would make -- David Hollaway -- I will make one last observation, as we continue to evolve as an organization coming out of the rural areas, and being refocused to more urban-based and starting to add more larger commercial deposit relationships, that brings a lot of non-interest bearing money. It is just showing the fruits of the work that we have been doing in the past couple of years.

Okay.

And then, secondly, the other question on deposits, and that is the cost of liabilities for SNB was down 5 basis points link-quarter. I know you guys have been changing the mix of their funding, particularly the borrowings, et cetera. What -- do you have the cost of what the CDs were this quarter? I know they were 388 last quarter, which was about 37% of their funding.

No, I think -- one line above that shows their average cost of total deposits, and it actually went up.

What you are seeing there is the reduction in their borrowings. In the fourth quarter, they averaged quite a bit of borrowings you can pick that up out of the Q -- or the K -- and in the first quarter, those borrowings were gone.

Right, but I wouldn't say their CD rates were necessarily above-market, but they were previously above yours. Is there any thought to their CD portfolio mix being a little longer duration and maybe it doesn't reprice as fast?

No.

I think you could make the observation -- I don't have the exact rates -- but I think you can make the observation that their CD rates that they were paying were a little higher than -- than ours in the past, but they are now adopting our rate structure going forward, and those CDs are not longer maturities compared to ours.

Okay.

You can probably make an observation of some of their deposits and -- I think your analogy that they were more tied to interest rate sensitivity. You know we may see a drop in their -- in their deposits a little bit because of that probably.

But I think it is important to emphasize they have a number of core relationships, just like we do.

Right.

That those deposits are tied to loans and other products, and we don't see those moving or leaving.

That's right.

Okay.

And then, last question -- on the margin guidance, I believe you gave the 370s to maybe 378 for the rest of the year. Is that a function primarily of the repricing billion or so of CDs moving upward, or is that the primary factor in that, or there other things because it looks -- when I look at what you are doing, at least in the first quarter, you could argue that moving securities into loans and continuing to grow core deposits, you could be more optimistic if you were assuming certain things continued?

I think that's right. You could, but the counter-piece to that is the SMV. You are hitting on it from the CD. When you look at the press release, their cost of funds is obviously a little higher than ours and recall, even after they delevered -- before they delevered, they were hugely liability-sensitive, and when they restructured back in fourth-quarter -- end of the fourth quarter, they were still not quite where we need them to be in terms of asset-sensitive. So, carry this all forward, and we continue to rebalance their balance sheet. I think you are seeing it correctly. We could be a little more optimistic, but we're trying to be realistic in the short-term in saying there's probably a little bit work here before we can get there, and that's why we don't want to get ahead of ourselves if that makes sense.

David, did you want insert a comment then?

No. I think, David, you hit the nail on the head.

It has taken us a while to restructure their balance sheet, and again, we don't want anyone to be overly optimistic. We are going to get there. I think your analogy that it should improve over a period of time is accurate, but, again, we don't want to jump the gun on it.

Okay. Fair enough. Great.

Thanks, guys.

Thanks.

We will take our next question from Adam Barkstrom from Stifel Nicolaus.

Go ahead.

Hi, guys. Good morning.

Good morning.

We're going to touch on the deposit market as well, and I guess Brett was right, you guys -- from a lot of our companies, we're are really starting to see -- I guess in other areas -- the DDA starting to run-off here -- pretty significantly -- and you guys have benefited from yet another sequential quarter of growth in that bucket. Just curious, overall, with the entrance of -- with Capital One now, and Hibernia buying Coastal -- any pick-up in the competition for pricing of deposits you are seeing, or is it the same environment that you've been seeing for the last year?

I think that it's been -- David Zalman again -- I think it has always been competitive. It is still a very competitive market. I don't know if you have seen any new players jump into the market. I just think it is highly competitive, and, again, we -- we are still relying on the customers that we have, which are really core-based customers. We are not going after the interest rate-sensitive customer. If we were, I mean, you would have a lot bigger balance sheet, but we just won't be making the money. We are after relationship-banking.

It's easy to grow deposit, you just pay up on the money.

This is Tim Timanus.

One of the things that I do on a day-to-day basis is work with our banking center managers and presidents on their deposit issues, and that typically translates into trying to deal with the customers that want the higher rates. We really don't see any change in that environment over the last quarter, in '05, for example. It is still very competitive, but we focus on the core relationships and those customers that have more business with us than just CDs. We tend to be reasonably successful in keeping those customers, and working with them. So, I don't think there has been any change.

Okay.

Looking at your margin outlook, I guess you said mid-70s range for the remainder of '06. You guys closed the margin first quarter at 381, so let's say mid-70s, 375, for second quarter. Is that just the S&P effect, or just the effect of continued yield curve pressure?

And then, secondly, do you think you are going to get some relief in '07? Is that a -- a structural balance sheet / pricing issue for you guys, or do you think you're going to get some -- or is your outlook for yield curve really going to drive that relief in a sense?

Part of that can be explained on the last page of the press release, Adam. There is some information in there on the First -- on the Southern National margin at the quarter, so that will help you model out some of that, and David will talk about where we are going in the future from there.

That observation is well taken.

The margin that SNB brings to the table does impact it somewhat, and the continuing flat yield curve is still a headwind, but I think the -- the answer to your last question probably builds -- builds a bridge. You were talking about '07, why we look at an expanding margin, absolutely true to your observation.

We have a securities portfolio throwing off 300 million in cash flow, and our loan portfolio today, David, is what -- it has an average life of three years. Cash flow coming off of that is significant.

As time wears on, we are giving opportunities to reprice these assets. So, when we look at our model, at a point of time, at 3/31, and you look at this cash flow going forward, it allows our asset repricing catch up, which then, absent something crazy going on in the future, it gives us tremendous opportunity to start expanding our margin.

I think it is two things, David.

Basically, it is what you said -- taking in SNB does effect the net interest margin initially, but it's even in our own bank. If you look at our bond portfolio, as you said, we have maybe $300 million in cash that rolls off 400 million that reprices -- and I don't have the numbers in front of me -- but again, if you look at our duration of 2.7 years and our yield on our portfolio now is about 4.4 -- is that right -- and you compare with probably with re-investing in today's world of 5.4.

There is a lot of pick-up, and it is just -- our bank has never been -- if we were more tied strictly just to loans, you would have seen our income increase probably a lot more dramatically that we are all on floating rates, but, again, we never try the call rates, and so, as interest rates rise, our income rises slower. But, again, if rates go down, our interest -- our -- our income goes down slower on those -- on those particular bonds, and we just -- we just try to take a middle-of-the-road approach.

So, the bottom-line effect of what you are saying is you see our margin -- in the short term, our margin is not moving much, but once you get further out, it's starts to seem bigger and bigger.

Right.

But in the next quarter, the biggest impact is the Southern National transaction, and you see again -- their margin in the first quarter was 364, our margin was 381. So, you've got some information that can help you model off of that.

Got it. Got it.

With the SNB transaction, I guess that -- that transaction closed a little bit earlier than originally anticipated. Is that -- am I thinking about that right?

I don't think so.

We have said all along we were going to close early second quarter. Maybe some folks didn't think early second quarter meant the first day of the quarter--.

That's what I am saying, yes.

When we put the transaction out in November of -- of '05, there were some people who were questioning why we couldn't close it before the end of the first quarter, so we've -- I don't know that we were too far ahead of schedule. We were right on the schedule we had put out all along.

I guess the point of asking is there any positive -- I guess early second quarter means maybe the beginning of the second month of the second quarter -- but anyway, first day of the second quarter--.

We certainly get a full quarter of the acquisitions. So, from a modeling perspective, for you and from us, we get a full three months in there, it is not a partial quarter.

Right.

It would make it harder for you to work from, and the other piece of the puzzle that we want to talk about today is where we are in the integration process along the way, and let me walk back through the process.

When we made the announcement back in November, we immediately began the integration process, and I have to say the team here in Sugarland has been fantastic. Harvey Zen and Dan Agnew, and I could name 10 or 15 others, have been fantastic on helping build the bridges and put the pieces of the puzzle together, so that we are well down the path and are on-schedule to do our systems conversion here in the next month. The brand sign changes will happen in the next month. The teams are working together every day.

We have been meeting on a weekly basis now since the beginning of December, putting these plans together, so I think, from an operational integration standpoint, where we are in the process, we feel very good that we are on-schedule and moving forward.

Which is really when -- when you talk about -- you know it is not the signing of a legal document necessarily on April 1, it is the conversion process that's going 30 days later. So, you are still on a time schedule that you laid out.

That's right.

The closing date is no magical date and really doesn't change anything from an operational perspective. The first time we get to make any real changes in the process is when we do the systems conversion because that's when we put the loan teams together and the deposit teams together, and wire transfer and accounting, and everything else comes together, and that is where we really begin to see some of the financial benefits that come with acquisition.

So, those really are probably 30 days past.

Okay.

If I could, one last question -- your credit just continues to be very, very strong. Just curious -- I mean, this can't last forever, obviously. Any particular areas in the portfolio -- maybe not your portfolio, but in the industry that perhaps you are kind of taking a -- a little bit closer look at or not get concerned about, but just take a closer look at -- any particular loan types, areas in the industry?

Our credit teams -- Randy Hester is the Chief Lending Officer, and Chris Bagley is the Chief Credit Officer -- those guys are very focused on a relationship customer-by-customer basis. We really don't have a silo approach to lending. We don't have a commercial real estate team. We don't have a C & I team. We don't have a construction team.

We are purely focused on a customer-by-customer relationship, old-fashioned community banking. I don't think we have a red marker that says we don't like this type of credit or don't like this type of credit. However, I can tell you as we are going through the process, we are certainly looking very closely at credits that are coming in areas that we feel may be stressed, and we want to make sure we have got equity, that we have got good borrowers, that we have got cash flow capacity. That we stress those loans. I don't know that we are red-lining anything.

Dan, I don't know if you are red lining anything.

On the other hand, it is really just a matter that interest rates are rising, and probably -- I would say that, you know, there's been a lot of demand for a new retail centers that have been going in, and there's been a ton of hotel-motels.

We don't really do downtown office buildings or anything like that, but when you start looking at the retail strip centers that are being built in mass, and the amount of motel and hotels being built, a lot of those are going to be hard if you stress them at from the rate that we are. Even -- they are probably at max right now, and if you put another two points on them, it is really going to be stressed. So, I think those are areas you have to be cognizant of.

Okay, gentlemen.

Thank you.

Thanks.

Thank you.

We will take our next question from John Martinez from Cohen Brothers & Company.

Good morning. Thanks for taking my call.

Hi, John.

Hi.

Just a couple of questions here -- looking in the period, it looks like the commercial real estate and consumer loans were just off a bit. Any concern there, or any inclination as to -- I mean did you have expectations for better growth this quarter?

No -- I think that number -- you are looking at a point in time number. I think if you had looked at that number a week or two before quarter-end, you may have seen that commercial real estate is up some, and by the time we got to the end of the quarter, a couple of big properties that we have financed and just sold and just paid off. I don't think we have any concern on that side from one type or another at all.

Consumer credits continues to be challenge because we used to do a whole lot of car paper, just in the retail locations, and that process has significantly changed over the past few years.

Okay.

Similarly, on the positive side, your commercial loans, as well as the construction loans seem to be up. Any particular strengths there, or just business as usual?

No. Hi, John.

I think it is really business as usual. I think, as the banks grow, and Dave made mention earlier, as we are moving more into a urban market, I just think that is the type of loans that are probably continue to increase the fastest.

Okay.

Another area -- just coming back to questions about the SNB deal having closed now. Do you have any strategic expectations as far as adding to that business, maybe focusing or growing that faster by adding lenders or adding staffing here during the year?

Our game plan has been to always add good people when we can find good people that bring results to the bottom line. That's one of the things that David had commented on was that we want to reward people that produce results.

In the last quarter, we did add what I would consider to be a great producer in the Dallas market. We -- we brought over -- brought over another guy in Dallas to join our team up there that is a senior lender that has been in the market for a long time. We continue to look for people that fit our style of community banking -- customer-relationship banking.

As far as focusing specifically on Fort Bend County or the Southern National part of the franchise, I don't think they get treated any different than anywhere else. If we find good people, whether they're Dallas, Austin, Corpus Christi, or Houston, or Fort Bend County, we want those people on the team, and we will try to make it happen. Certainly, the economy in Fort Bend County gives us opportunity to grow that book of business that's here, and that's why I think with Harvey Zen and Dan Agnew and the loan team that's here, we have great opportunity in front of us in Fort Bend County.

I just might add, Dan, that it is hard to beat the reputation that Southern National Bank had in Fort Bend County because they are considered the bank in Fort Bend County, so this is where -- this is it basically.

When you go down the list of folks who are out there calling on customers today, you are going to see, as you look at their numbers because they are out there, they've got a lot of construction loans. They are very well known in that market. They have got some great people doing that business. They got good people on the commercial real estate side.

This is a very good fit. We want to make sure that we are giving those folks tools to do business.

Our biggest challenge is to make sure that they are happy and we retain and keep these people because they are the best of the best in this area.

That's right, and let me talk about future growth.

One of the questions we saw last year was we saw some noise in the loan portfolio for First Capital. I would not expect to see great growth out of Southern National for the next quarter. We have got noise in the process here. We are in the middle of doing a systems conversion. They are all learning new customers. They are all out calling -- new customers? They are learning new computer systems. They are learning how to do things a little different, and at the same time, they are focusing on retaining the business we have and calling on the existing customers to make sure those customers are secure and that they are taken care of through the changes that are coming on.

Okay.

And then, just one last question associated with the acquisition there -- looking on a link quarter basis, it looks like the occupancy expense was down a little bit. I know you got a lot of square footage there that -- at the Sugarland location. As we look to model in some of these -- the addition of SNB -- do you anticipate any cost saves at that line item here in '06, or any plans to migrate more people to those buildings?

That is a yes and a no.

David is shaking his head no to the first part of your question, and then, the second part, we are calling you today from Sugarland, Texas. We're sitting in one of the Southern National buildings here in Sugarland, and absolutely, through the systems conversion, our deposit operations team will be here in Sugarland. A large part of our accounting team will be here in Sugarland. Our item processing team has already moved to sugarland. Our information technology team has moved to Sugarland, so certainly, you are right, John. These are great facilities, and these are allowing us to consolidate some of our operations that have been spread out across South Texas into one area.

Dave was shaking his head no on the do we expect big cost saves.

Well, I was thinking from a SNB perspective, we are going to occupy what they have, but there may be some opportunities going forward of some of the other locations that we have where we are moving people away from there. That is where we might see some savings.

I hope that answered your question.

Yes, that is what I was looking for. I appreciate the answers, guys.

Thank you.

Thank you.

We will take our next question from Jennifer Demba with SunTrust Robinson.

Good morning.

Good morning, Jenny.

Hi.

I think you've probably already addressed it earlier, Dan, but I will ask it. In the SNB financial highlights you put at the back of the press release, the loans and deposits went down. Was that still part of the M&A transition?

Yes, the deposit -- well, there are two different answers, and I am glad you asked because I don't know we have been clear on that yet. Let me talk about loans first.

Loans dropped from 652 to 598. As a part of the transaction, Southern National exited about 40 million, give or take, in loans sometime in January, and that was a part of the transaction that was virtually all of the non-performing assets that were on their balance sheet plus some other assets. So, really, what you saw from a -- from a normal perspective was you saw about 12 million in -- in drop in loans from December to March, and I really attribute that, Jenny, to just -- we've had these folks focused on learning new computer systems and playing defense and not playing offense and the natural process that that comes through. So, it is really pretty close to flat when you look at the 40 million that was sold.

On the deposit side, I think you have to look at their history, and Southern National has a large part of their business was in the public fund market where they bank multiple public entities, counties, and school districts, and cities down here, and the normal process here is that money comes in on December 25, 26, 27, 28, 29, 30, 31, and then, that money begins to start flowing out. It was here through January, and as we rolled into February and March, that public fund money all has been deployed and invested. I think if you look back at their last year December number and their last year March number, you will see a similar change in deposits to this.

So, I think, that is, again, just a natural part of their business.

Okay.

Could you remind us again what you guys are assuming in terms of cost savings from SNB and how that should flow in through the next few quarters?

I think it will flow in, in the same way that it has done in the past. We run -- we run pretty fast trying to get the cost saves in. It takes a year from integration to get them all in, and we are just finishing up the First Capital numbers, and I think that is part of what you saw in this quarter was the tail-end of that.

You should see the big majority of the cost savings in the first six months after acquisition, and then, a much smaller part trails off in the next two quarters. I think the number was 29% was the cost save number off of their expense base that we were looking for in cost savings. Again, you will have a full quarter run in the second quarter, and like I was talking to Adam a little while ago, the cost saves really don't start until we get into the integration piece of it that we are still a month or so away from.

So you won't see -- some expense, I guess where I am going, will be in this quarter. We should be ready to start the third quarter in pretty good shape, and when you see the third quarter numbers, you will probably see some pretty good cost saves in there, and when you see the fourth quarter numbers you should see the lion share of those cost saves all dialed in.

Alright. Thanks.

One more question, I think, for David Hollaway.

Dave, do you have the end-of-period securities balance and borrowings balance for SNB at the end of the first quarter?

I don't have it in front of me, but I can give you a ballpark.

Okay.

That's good.

I looked at it earlier in the week. They are around, in securities, around $200 million roughly.

And borrowings virtually nothing--.

Borrowings -- yes, if you want to go the other side -- overnight -- all they have is overnight borrowings. That was about 10 or 15.

Almost nothing. Okay.

Virtually nothing, and when you look back at their cost of interest bearing liability, that is what drove that number down was reduction in all those wholesale borrowings.

Let me interject just another piece to that too. The 200 million in securities, they probably have -- I want to say maturing out of that 200 million, probably about 50 million maturing in April, and the reason -- what's magical about that balance is, at 3/31, they still roughly had about 200 million in public funds. When you have public funds you have to collateralize them with security, so that's why those numbers exist when they did.

Thank you very much.

Thank you.

We will take our next question from Campbell Chaney with Sanders Morris.

Good morning, everyone.

Good morning, Campbell.

This is a follow-up to the securities question on SNB. Dave, do you know what the yield was on that securities portfolio, and can you give us an idea what the margin impact will be from the purchase accounting?

Good questions.

You know I don't know if I can be absolute factual with you. The yield -- when they got rid of probably half of their securities back in December, it helped their securities yield. I don't have the number in front of me. You could probably back into it off the last page of the press release because we give the overall yield on earning assets and yield on loans. You can probably bank into that knowing they have roughly 200 million.

Can you give us an idea what you are going to write the security yields to with the purchase accounting?

Yes.

On purchase accounting you have the mark-to-market, and we will certainly go out there and look at that number. Again, I don't have it in front of me to give you an exact number, and I know what you are asking because, obviously, when you mark them down, you have to accrete that loss back into income, so it will improve the yield -- whatever the yield they were currently getting.

Again, like Dave just said, 50 million of that is going to mature in the next month.

I can -- I can maybe call off-line with that.

Moving on -- can you give us an idea what the pro forma tangible equity would be at 3/31, if you had closed the SNB deal on that date?

As of -- which date are you looking for?

3/31, the pro forma--.

Again -- maybe I can answer that in a different way for you. The way we look at that is we model out and say what will it end up being at 6/30, as an example.

Okay. That's fine.

It should be around, roughly 4.5% at 6/30, and then, if you keep looking forward, our anticipation is, by the end of the year, it'd be back over 5%. So, we think the earnings stream for the rest of the year, absent any other deals or anything like that, it will improve back to over 5%, but I will interject into that, we certainly don't have a target of 5%. I don't want to leave that impression. Again, if you look at our historic numbers, we have consistently run a little over 4%.

When you look -- when you look back, year-end '02, we were at 4.7; year-end '03, we were at 4.17; year-end '04, we were at 4.38; and Dave was saying he expects us to be in the 4.5 range in June with the combined companies, and at the end of this year, we were significantly higher at than that at 581.

It might be worth repeating, at 581, at 3/31. That's as high as we have been for years.

A long time--.

If you go back and look, historically -- historically, we have always fallen down in the fours when we make an acquisition, and then, we are always back at 5 and above within a very short period of time just because of the amount of earnings that we have.

Does that answer your question, Campbell?

Sure does.

One final question -- are you going to have to file regulatory reports, Qs, call reports, Y-9s, on SNB since it close April 1, or can you escape that burden?

Yes, there's no filing requirements.

Okay. Terrific. Great.

Thank you very much.

There's no SEC filing requirement, but I think a call report filing requirement.

So you have to file a call report then?

I think that's right.

Thank you.

We will take our next question from Brent Christ from Fox-Pitt.

Hi, guys.

Another question on the same topic -- could you talk a little bit about how much additional run-off you expect, both in termites of loan portfolio as well as the securities portfolio? I know you mentioned 50 million maturing, but just how much shrinkage do you expect from the Southern deal going forward?

I will answer that.

I don't think it will be as substantial as -- as, for example, maybe our First Capital, because a big chunk of the -- the -- the -- what we did during the closing, we made so many of the transactions -- they made so many of the transactions before we close with regard to the securities.

So, again, what you see there -- the 200 million or so -- besides what's holding off here pretty soon next month, it's probably going to be pretty much like that. And from the loan side, we don't see -- right now as we see it, we don't see $50 million or $70 million additionally come out of the loan portfolio like we might have on the -- on the First Capital deal. There may be some run-off just because there is -- through this transition period that Dan had talked about earlier, it's just hen people are trying to focus on a new computer system, and so, you lose a little business, but, again, we don't think it is going to be as dramatic.

You heard David talk about the folks here. They have got a great team of production folks. They have got a great team of customer relationship folks. That's huge -- very, very important to us.

Yes, I mean there might be some, but we don't look at big -- we don't look at big changes here.

Brent, I think it is important to make sure that we go back and talk about what happened prior to closing. Prior to closing, we had run-off, or reduced about 230-some odd million dollars in their borrowings and in their bond portfolio. That happened really in the fourth quarter, and we sold 40 million, a little over, in loans prior to closing also. I think we made a large majority of the changes in the balance sheet prior to closing.

Yes, when you start going forward, looking at security portfolios specifically, again, with the cash flow coming off our side of things that we put another 150 million into what we have, it will probably all net out by the time we get to the end of the year.

Okay.

And then, I -- I apologize if you addressed this earlier. Can you just talk a little bit about your appetite for additional deals going forward?

We haven't talked about that, but I am sure David would like to answer that.

I don't think I am. I get into trouble every time I answer that question.

Brett, I would just answer it like this and say that, our bank, from the beginning of time, has always had a motto of two things, and that is organic growth, hopefully, 5% to 10% on the loan side, and annually, about 6% on the deposit-side, and the other part o our model is acquisitions. We still feel that we have a great deal of opportunity to grow this bank to be one of the largest Texas-based banks in Texas within a short period of time. We feel there are people out there who would like to join us and be part of what we have. They like the style that we have. They like the asset quality that we have, so we just feel like we have a lot of opportunity.

I don't think I would answer that any differently, Brett.

I don't think our model has changed. The same game plan that we have been playing for some time is still here, and we think we can continue to be successful.

Probably the thing that you can always count on us about is that we are not -- we are not going to hear a conference call where we promise all this huge growth or promise one thing after another, but one thing that you can probably go back and look at our numbers, and that is that we are always consistent. We are always moving. We always grow, and it's just consistent and good growth. You are not -- generally, you don't see numbers where we made $5 million more one quarter than we made in a prior quarter and stuff like that. It's generally, pretty consistent growth.

Are you hearing more willingness in terms of sellers and any change in expectation? I know you just recently had a deal announced in your neighborhood.

Yes, I -- there's -- I think you are. There is more -- there is more noise out there. There are more people that are wanting to do something. On the other hand, sometimes I would tell you that we -- we let probably two deals go -- smaller deals this quarter -- just because the price expectations were so high that we just couldn't get there.

So somewhere -- but then again, you look at the deal that was announced here in Houston this -- this quarter, and the multiples -- there is no question they are in never, neverland. So, probably every bank that you deal with thinks that they ought to be getting these multiples, and you know there are some banks that deserve very huge multiples because they serve very specific needs for a very specific buyer, and there are other banks that don't have that allure. So, it is just the way it is.

I think that the market is -- lots of talking about on out there. Price expectation -- everybody got their own feelings. So, we are going to continue to play the game.

Okay.

Thanks a lot.

Thank you, Brett.

[Jennifer]?

We will take our next question from Christopher Marinac from FIG Partners.

Hi, guys. Good morning.

I had a question on construction lending. It looks like SNB, in the past, had slightly different profile than you all did, not dramatic. I am curious on your tolerance on with construction as an opportunity for loan growth going forward?

I think that is people-driven again. I think my position would be that their construction-part of their portfolio, or the size of it relative to the whole portfolio, was somewhat dependent upon where they are in the Houston market, and Fort Bend County is on fire and a lot of construction going on out here They've got a couple of lenders who are very good construction lenders, Kathy King and others, and I think we like what we see. They are doing it in the same way that we are doing it. I think when you take care of customers -- there is some customer overlap in there, but not a whole lot. When you take care of customers and deal with each deal on a stand-alone basis, we'll continue to do that business.

It's really a, Christopher, it is a hard situation because when you look at national news and you see that there are slowdowns in parts of the country, and then, you come back into a loan committee and start pounding on the desk. We are trying to make sure that we are doing what we are supposed to do.

We're not over-building, but then, again, I have to say, on the local front, business is still as good as ever over here, so you have to ask your question. It is now, but what does it look like going into the future. So, we are looking at all -- we are looking and asking ourselves those questions all the time.

We think we have got a great team of construction lenders, and they are going to continue to produce results.

Great.

A follow-up question -- just back to the margin discussion a while ago. The amount of the loans that reprice in the next 12 months, would that have been a lot different at the end of March for you, Prosperity stand alone, or SNB?

I am not sure I am following the question. You're asking for what percent is floating--?

No, I'm actually looking at just the repricing of the loan portfolio 12 months forward.

What is the burn rate. No, I think our portfolio is on a three-year run, and I think that Southern National is running on about the same pace.

Great.

Thanks, Dan.

Thank you, Chris.

We will take our next question from Kerstin Ramstrom from Bear, Stearns.

Hi, guys. How are you doing?

Good, Kristen.

A question for David Hollaway -- you guys have some trust preferred that matures at the end of July. What are your thoughts on that? Are you planning on calling that like you have done over the last few, or have you made any decisions on that?

I think we will look hard on that. There are always a lot of variables that go into it, and I can honestly say, as we sit here today, the decision hasn't been made one way or the other on that. Not only do we want to look at this one, but I think if you look out in '07, there's a couple more.

Yes.

And the new rules kick in as far as what can be counted -- counted as tier 1, so we will start looking at a lot of things.

Here we are today, I can't give you a definitive answer on yes or no.

Okay.

Thank you.

Thank you.

Appreciate your help.

[OPERATOR INSTRUCTIONS]

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

Good morning. How are you doing?

Great.

How are you?

Great.

Just a quick question on the deposit service charges -- you are probably one of the only companies that has been flat link quarter. I know that in the third and fourth quarters, you had a little bit of a down-tick there. Can you tell -- I guess what -- what held it off, and what changes are you seeing and is that a function of the deposit mix changing, or something else going continue to that held link quarter?

Yes, link quarter -- it went up a little bit. Is that what you are saying?

Yes.

Yes, I mean -- I think if you recall back in the -- in the last conference call, when with he did the year-end fourth quarter, our income had dropped off compared to third quarter, which was unusual than what you normally see. And what you normally see -- and what you normally see is seasonality. Normally, you would see the fourth quarter spike up, and then, when you look at first quarter, link quarter it will generally drop from the fourth quarter.

The long-winded answer is I think, with great planning in December and all that, it wasn't a very big transaction. I think the fee income you see is just us recovering from whatever happened back in December and just our normal traction that you get in fee income. It was all over the board.

I would make this income on the service charges on deposits line item, which if you were looking from one period over the other, it was flat. But what we are seeing is NFSC still are kind of flat, but starting to see our debit card income and some of the other things I mentioned, they're all still growing, and that's kind of where we want to be -- Grow these other fee-related things that we have versus relying strictly on insufficient income.

Okay. Great.

Thanks.

Thank you.

We will take our next question from Barry McCarver with Stephens, Inc.

Good morning, guys.

Hi, Barry. How are you?

My question hasn't been answered this late in the call -- must not be a very good question, I guess.

Really, most of it has been touched on -- you talked a couple of times about what the SNB team producers are going to be doing over the next few days as they keep up with their old customers and learning the new systems. I was just curious a little bit on the time frame about what are you expecting in this first quarter as being part of the team, and then, secondly to that, obviously, SNBC had what, I consider top-quality producers. Certainly, their growth rates were very strong on the loan side to the extent they are folded into your existing team. How do you feel like that does for the entire team going forward together?

Well, I think there is no question they have got some very strong players down here that we are very excited to be partnering with. I think we have said for a long time that the mix of the Fort Bend County economy, the mix of the Southern National Bank team that is very strong. It's a great partnership for us. I think, going forward, you heard us say we are here in Sugarland today, this becomes a big part of our operation. I think we can learn a lot of how to grow the loan book and how to continue to improve.

Barry, David Zalman.

I sit at loan committee and the Sugarland SNB bankers have been coming into loan committee for the last couple of months or so. There are certain things -- you can have all the numbers in the world, and then, sometimes it boils down to gut feel, and I will tell you the gut feel just feels real good with these guys. They just -- it's just a real good feeling.

There's a bunch of ladies too, but--.

Guys mean both, guys and girls.

So, it feels real good.

Thanks, Barry.

Thank you.

Thank you.

We will take our last question from [Leo Harman] with Fidelity Management.

Hi. Good morning, guys.

Good morning.

Sorry, I had to step off the call, but if you have already answered this, just let me know.

I am trying to get a better idea of what is the biggest constraint right now behind the organic loan growth, whether or not it is pricing, whether or not it is terms and conditions, and if you could, relate it to what you are seeing in your run-off portfolio, both organically and from the acquisition side, whether or not a lot of those loans that you are letting running off, would you have kept a proportion of those loans if could you have gotten a right price in its structure and what portion of those loans are just being run-off because you don't want those relationships?

I think maybe we are not using -- thanks for the question, Leo.

I think the terminology is not clear for everyone. When we are talking about loan run-off, I think we are talking about just natural things that happen in the market. When look at our day-to-day loan numbers, in the middle of March, we are showing a much higher loan growth than we were at the end of March. We were thinking gee this is looking very good, and in a week's time, we had 30-some odd million in pay-downs on loans. That's run-off in our book or what we are telling you, but not loans we wanted to go anywhere. When you looked at that, that was about 6 credits, and I looked at all six of those credits and all of them were just natural events that took place. We had $1 million airplane finance that sold, and when the plane sold you got paid off. We had a construction loan that was quite large, that had funded up and moved out to some long-term permanent financing. It was just natural things that happened in the portfolio. So, I don't think that it's -- that we are intentionally running off credits today, and we we are not keep some credits off of price in terms, as you said.

When you look at structure, how many -- how many loans do we miss or do we lose because we won't lower the rate to a prime minus something or because we won't remove the personal guarantees that are there? Well, there is certainly a piece of that. The competition is very, very strong in the markets that we are in today, and I think we have said all along, we want to play the game prudently, and if we have to give up the shop to get the deal, we might not be willing to do that.

Leo, I probably understood you to ask another question -- two different questions basically.

One being -- you might be referring to the amount of credit that didn't -- that we sold or that Southern National Bank sold between the time we took over in the end of the year. If it is, those are credits that our due diligence team identified and for some reason, whether with terms and conditions, or interest rates or something, it was something we felt we would rather not have in the bank. So, that's one category.

Half of those loans were non-performing.

But half of them were non-performing, but then, again, another half might -- you know--.

It didn't fit.

It didn't fit some way.

The other part of the question that I interpret that you asked was, our own portfolio has about a three-year average life, and our loan portfolio is so much different than other loan portfolios in that the majority of all of our loans are amortizing loans. A lot of banks have a lot of credit where the loan -- a Commercial credit and it's maybe was secured with an operating line and it renews and is looked at on an annual basis. Where the majority of all of our credit that we have on our books are amortizing, so, we are having $500 million a year right now that is just paying down naturally that we have to replace.

Did we answer your questions multiple ways for you, Leo?

Yes, and particularly, from current organic loan growth -- just trying to get a better idea whether pricing is the bigger issue or whether credit is the bigger issue, or do you look at those in equal terms at this point?

Organic loan growth is -- I think, Leo, that a lot of people -- there is certainly a number of analysts and people who would like the loan to deposit ratio from, say, 57% to 75% within one year. I will tell you that is not going to happen the way we do business.

Again, we grew from two years ago at 39% to -- at the year -- in March -- 50 -- I forget what it was -- 54 or something, 53%, it's been 57% with this bank. We are going to do it, but we are going to do it under the terms and conditions that we can accept, that we can be profitable at, that we can grow at, and that we can get the asset quality that we are not going to put all at one time despite what it does to our net interest margin and just to get the loans and say we grow the loan. We just don't do things like that. We do it to be profitable, and we are probably longer-term players.

Again, I think if you want to go out and grow loans and pricing is not important to you and your margin is not important to you, you can grow loans and see the margin go backwards. That is not what we are trying to do.

Okay.

Thank you, and congratulations on both Dan and Dave on your new roles at the company.

Thank you very much.

We have no further questions.

Alright.

Thank you all very much for participating in our call today. We appreciate everything that you are doing in the support of our bank.

We will talk to you all soon.

Thank you.

This concludes today's teleconference.