Prosperity Bancshares Inc (PB) 2006 Q2 法說會逐字稿

Welcome to today's teleconference. (OPERATOR INSTRUCTIONS). Please note that this call may be recorded. I will now turn the program over to Mr. Dan Rollins.

Thank you. Good morning, ladies and gentlemen. Welcome to Prosperity Bancshares' second 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 time for the next few weeks. I'm 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. We are pleased to have Don Stricklin, President and Chief Executive Officer of Texas United Bancshares, on the call with us this morning also.

David Zalman will lead off with a review of the highlights of the second quarter of 2006. He will be followed by David Hollaway, who will spend a few minutes reviewing some of our recent financial statistics. Tim Timanus will discuss our lending activities, including asset quality, and I'll provide some information about our proposed merger with Texas United Bancshares and 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; then, finally, we will open our call for questions.

During the call, interested parties may participate live by following the instructions that will be provided by our call moderator, or you may e-mail questions to investor.relations@prosperitybanktx.com.

I assume you have all received a copy of this morning's earnings announcement. If not, please 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 involve known and unknown risk, uncertainties and other factors, which may cause the actual results, performance or achievements of Prosperity Bancshares to be materially different from 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 and 10-K, and other reports and statements we have filed with the SEC. All forward-looking statements are expressly qualified in their entirety by these cautionary statements.

Now let me turn our call over to David.

Thank you, Dan. I would like to welcome and thank everyone for listening and participating in our second quarter conference call this morning. Obviously, we have a lot of big news to talk about with the proposed merger of Texas United Bancshares. However, I do not want this good news to overshadow a great second quarter and the success our team has posted for the quarter.

I am very pleased to report that the second quarter of 2006 was another record quarter for our company. Some of our successes this quarter include -- organic loan growth exceeding 15% on an annualized basis; record earnings. We earned 15.9 million in the second quarter, compared to 12.2 million for the same period in the prior year, an increase of 30.2%.

We reported diluted earnings per share of $0.48 for the second quarter of 2006, and that's compared to $0.44 for the same period in the prior year.

The noninterest income was up 16.2%. Our return on average assets for the three months ended June 30, 2006 was 1.4%. Our return on average common shareholders equity for the three months ended June 30, 2006 was 10.15%, and return on tangible shareholders equity for the same period improved to 34.81%.

Our efficiency ratio was 47.2% for the three months ended June 30, 2006. Considering the merger of SNB Bancshares was completed on the first day of the quarter, we are very pleased with this number.

Asset quality remains very strong, with nonperforming assets to average earning assets ending at a very low 0.03%, or 3 basis points. When we look back at the past quarter, I find myself particularly excited and proud of our team and our bank.

The majority of the operational integration with Southern National Bank was completed shortly after we completed the transaction on April 1st, 2006. The addition of the former SNB locations in the fast-growing Fort Bend County should provide excellent opportunities for our team going forward. In fact, Money Magazine recently named Sugar Land the third best place to live in the United States.

Strong loan growth, holding deposit rates in line, keeping expenses low, and the rapid integration of Southern National Bank all contributed to a very successful quarter. I would be remiss if I did not thank Harvey Zinn, Dan Agnew, and the entire team of former Southern National bankers for their help and cooperation in making this a very successful merger.

And now I am very excited to talk about the partnership of Prosperity and Texas United Bancshares. Before I discuss the strengths of the proposed merger, I would first like to say a few words about our experiences over the last few weeks as we visited many of Texas United's banking centers during our due diligence.

The bankers we met from La Grange to Dallas-Fort Worth were all very upbeat and professional. Their dedication to exceptional customer service was very evident, and leads us to believe this partnership will be very successful. I would like to thank Don Stricklin and his team at Texas United for being so helpful and accommodative through the process. We look forward to a long, mutually beneficial relationship with the directors, the associates and customers. We believe that our teams will fit together very well.

I'm also pleased that Don Stricklin will be joining Prosperity Bancshares' Board of Directors, as well as our bank board. Don's title will be Vice Chairman and Executive Vice President of Prosperity Bancshares, where he will become a member of our executive management team.

We believe the benefits of combining our organizations include -- creating a company with almost $6.5 billion in assets, resulting in the third-largest independent Texas-based bank; it increases our market capitalization to approximately $1.5 billion; it's accretive to GAAP and cash earnings per share within 12 months after operational integration, with 20% cost savings; it's relatively neutral to tangible book value; it improves our footprint in Dallas and Austin; and it provides market entry to Fort Worth and the Bryan/College Station markets; it gives us the number 11 deposit market share in Texas.

Our combined franchise will have 131 banking centers in Texas, the number three position of brick-and-mortar branches among independent Texas banks. The pricing of the transaction is consistent with other bank deals in metropolitan markets in Texas, we feel they are below execution risk, and it combines two dedicated and talented teams with a demonstrated track record of success.

As we look forward, our modeling suggests that our full year 2006 earnings will fall within the range of $1.92 and $1.94 per diluted share. Our modeling assumes relatively stable or moderately higher interest rates, along with our belief that we will not experience some tragic event around the world that may cause economic uncertainty.

In closing, I would like to say again how excited I am about our financial performance last quarter, the success of our integration of Southern National, our proposed merger with Texas United, and the growth and Prosperity I see for us going forward.

We are proud of our past, we intend to stay the course, we plan to continue our organic growth, and we 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 growing loans, focusing on our customers, rewarding people that produce results, building shareholder value, and 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 (technical difficulty)

(technical difficulty) other high points in the quarter. Net interest income increased to 36.6 million for the second quarter of '06, a 28.5% increase over second quarter '05, and a 25.3% linked-quarter increase. These increases were primarily due to a 28.7 and 23.9% increase in average earning assets, respectively. And I would note that at period end -- at period end 2Q, loans as a percentage of earning assets was 57%, compared to 50% at the end of the first quarter.

The net interest margin on a tax equivalent basis for the second quarter '06 was 382, compared to the first quarter '06 of 381. [Kind of] explanation here -- this rate was a lot better than we projected, and it's kind of coming from three factors. The first one was the additional improvement in the margin on the SNB portion of the business. Additionally, strong loan growth provided higher asset yields. And number three, generally we weren't as competitive on rates for new deposits. However, the flip side of holding deposit rates down is that overall organic deposit growth is muted year-to-date. So what we're looking at is going forward, because of where the market is, we're going to have to be more competitive in the market in terms of rates. This should help our organic deposit growth, but that will potentially offset further margin expansion coming from loan growth.

Noninterest income for the second quarter '06 increased to 9.2 million, up 16.2% from second quarter '05 and 19.4% from first quarter '06. I would just point out within the noninterest income category, the line item that says service charges on deposit accounts, which is truly our core service charges from our deposits -- that was up 13.9% to 7.2 million on a linked-quarter basis.

Noninterest expense for the second quarter '06 was up 20.1% from the second quarter '05. This reflects the increased operating costs associated with the additional banking centers acquired in the SNB acquisition. The Southern National acquisition also impacted the linked-quarter increase of 24.1%. And as David mentioned earlier, it moved our efficiency ratio up from 46.8% in the first quarter to 47.2% this past quarter.

With that I'd like to turn over the presentation to Tim Timanus for some more detail on loans and asset quality.

Thank you, Dave. Nonperforming assets at quarter end June 30th '06 totaled $1,171,000, or 0.05% of loans in other real estate, compared to $1,267,000, or 0.08% at March 31st '06, and $2,738,000, or 0.18% a year ago at June 30, 2005. This represents a decrease of $96,000 in nonperforming assets from quarter end March 31st '06, and a $1,567,000 decrease from the quarter ended June 30th '05.

The 6/30/06 nonperforming asset total was comprised of $1,094,000 in loans and $77,000 in other real estate. 61% of these nonperforming assets pertain to loans in the portfolios of banks acquired by Prosperity since January 1, 2005.

Net charge-offs for the three months ended June 30 '06 were $206,000, compared to net charge-offs of $11,000 for the three months ended March 31st '06, and net charge-offs of $115,000 for the quarter ended June 30th '05.

The average monthly new loan production for the quarter ended June 30th '06 was $100 million, compared to $66 million for the quarter ended March 31st '06, and $58 million for the quarter ended June 30th '05.

Loans outstanding at June 30th 6 were 2,205,000,000, compared to 1,561,000,000 at March 31st '06. The March 31st '06 loan total is made up of 43% fixed-rate loans, 39% that adjust as prime moves, and 18% that reset at specific intervals, such as quarterly, semi-annually or annually.

I'm now going to turn it over to Dan Rollins.

Thanks, Tim. I want to spend just a few minutes talking about this week's announcement of our proposed merger with Texas United Bancshares, and then I will review the status of our recently completed acquisition of SNB Bancshares.

As David mentioned, we are very excited about our future with Texas United Bancshares. We are viewing this as a four-in-one transaction. With four banks and their team, we will be able to properly schedule all four integrations over the next year, to allow for the most efficient use of our time and our associates' time, and to minimize any customer inconvenience.

Earlier this week we were able to have supper with some of the senior managers from Texas United. I am confident that we will be able to achieve our goals with the strong leaders that TXUI adds to our team.

As you know, we completed our acquisition of SNB Bancshares and its subsidiary, Southern National Bank of Texas, on April 1st. I'm pleased to report that the systems conversion was completed on schedule on May the 1st. Today, all six former Southern National Bank locations are operating as full-service banking centers of Prosperity Bank. Our new partners in Fort Bend County, led by Dan Agnew, are doing a fantastic job of leading their team and taking care of our newest customers.

I'm very proud of our team of bankers. They are competing effectively in all of our markets and continue to grow our customer base. We have a great team of customer-focused bankers in Texas and continue to look forward to great things in our markets.

Our organic, or same-store, loan growth was 15.3% on an annualized basis for the quarter, as David had mentioned. If you look at it for year-to-date, it's approximately 10% organic growth for the first half of 2006, on an annualized basis. Our loan pipeline remains strong and our team remains focused on producing results.

On the liabilities side of the balance sheet, I am pleased to report that we continued our progress towards our goal of rebalancing the deposit mix by growing non-interest-bearing deposits. At June 30, 2006, non-interest-bearing deposits were 23.1% of our total deposits.

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

(OPERATOR INSTRUCTIONS). Brett Rabatin, FTN Midwest.

A couple of questions for you. First off, I heard you mention talking about being more aggressive on deposits. I know like [Citi] is paying 6% in Texas. How much more aggressive are you guys intending to be, and can you give us some deposit goals that you guys have for this year, in terms of thinking about how much more aggressive you might be to grow the deposit base?

First of all, when we say that we're going to be a little bit more aggressive, comparing it to paying 6% -- we're not even in that league.

I just throw them out since they're just off the chart.

When we're talking about being more aggressive, we're talking about maybe raising six-month CDs and one-year CDs maybe by 25 basis points or something like that, to be a little bit more aggressive. Our bank really has never gone for hot money. Again, we've always tried to create relationship banking. And again, we're looking for a total relationship. We really don't have a lot of customers with the dry relationship that -- what I would call just have a CD with, because that's really not what we're looking for. But at the same time, we're -- in the past couple of quarters, if somebody wanted us to raise and be more competitive by raising it a quarter to a half, we have not been. And I would say going forward for us to keep our deposits and not let it run off, we'll have to be a little bit more aggressive on the CD rate. And that's really what we're referring to, something like that.

We tell our team that if somebody is looking for the highest rate in the market, we're probably not the bank for them. If somebody is looking for the absolute lowest loan rate in the market, we're probably not the right bank. We're relationship-driven. We want the full benefits of both sides of the customer's relationship.

That's great color on deposits. On the lending side, obviously, loans were very strong this quarter. I'm looking for, if possible, some additional color on if that was some pent-up demand that you guys finally pushed through the tube, so to speak, or can you give any additional color on the growth in the second quarter, and if it's logical from you guys' perspective that double-digit loan growth from here is probably a good number to use.

We really didn't do anything any different. We're still treating the customers the same way we've been treating them. We're treating the lenders the same. There are more lenders on our team. We've continued to add people into the fold. We've been pleased to add a couple of producers into our South Texas area in the last few months. We continue to look for people that want to do relationship banking. I don't know that it was pent-up demand, I think it's just that sometimes you get it all at one time, sometimes you don't. We really don't look quarter to quarter. The fact that the second quarter was higher than the first quarter is not really that important to us. The issue is we're on target to hit the goals that we've set out there for ourselves.

I think when you look from a regional standpoint, we are competing better in some markets than others. Dallas year-to-date, our loan growth in the Dallas market year-to-date is over 20% up annualized. That's right; thanks, Dave. Our loan growth in the Houston market year-to-date is up almost 18%. So when you look at the two major markets that we are in, we're seeing very strong loan growth in both of those markets. But as we've said before, we also cover some lower-growth markets that pull the overall number back. So year-to-date, we're looking at a 10% loan growth number, and I think that's where we intend to be.

I would also add that (indiscernible) I don't that think this was a pent-up demand. I just think this is just something that's consistent. We have more lenders out in the field. We've been able to spend more time out there. I think we can continue this, with one caveat. Probably the last three to four weeks, we spend a lot -- again, we don't hire teams to go out and do the due diligence. And we pulled probably 30 to 40 of our top lenders out of the market, and had them doing due diligence with the Texas United deal. So, having said that, that will affect probably -- possibly could affect next quarter to some degree. Let me just say that.

I know the SNBT deal was not as involved as integrating First Capital, but the growth you guys had this quarter was excellent nonetheless. Last question on securities -- was just curious about cash flow in that portfolio going forward. And obviously it sounds like we might expect balance sheet growth to be a little slower than your total loan growth going forward, i.e. you fund a portion of your loan growth with securities.

Again, our securities portfolio is generating anywhere from 3 to $400 million a year in rolloffs. So we have plenty of liquidity, and look forward to moving from the securities portfolio more toward a loan portfolio.

Thanks for your questions.

Adam Barkstrom, Stifel Nicolaus.

On Brett's last point, I want to make sure I heard that right. 3 to 400 million per year in cash flow runoff? Or was that per quarter?

That's annually, average.

Good. You talked about the efficiency ratio, and that bumped up a little bit on a linked-quarter basis, I guess, with SNB coming on. Do you anticipate that's going to trickle-down a little bit more in 3Q, or are we at a pretty good run rate here as far as efficiency goes?

I guess (indiscernible) if I rephrase the question, what it really comes down to is how far along are we on the expense savings (multiple speakers). And Dan can jump in, because this is his pet (indiscernible), but I think there's some more out there. I think the number could move down maybe a little bit. But to say it would move significantly, I don't know that we could make that assumption.

I agree. I think there's a little bit there, but the facts are the Southern National transaction has been running ahead of schedule really since -- out of the box. And we can attribute that to the fact that it was five or six locations, all very close to us, all right here in our backyard; great attitudes on the team that came across. So I think we've been running ahead of schedule, from a cost save perspective and an integration perspective, on that transaction all the way up and down the line. And you're seeing that in our numbers. I think we're close to there. There's a little bit more improvement we can do, but I think we're there.

What about the service charge line? A nice increase. Linked-quarter, obviously, that reflects SNB. Any differences in composition of the deposit base? In other words, if you looked at -- if you took deposit fees and divided that for deposits for both SNB and for Prosperity, would there be a significant difference in that number; i.e., did they have a higher fee structure, or --?

They had a much lower fee structure.

You can answer the question directly, Dan, but let me just put some color into it. A couple of observations on it is that fee income is just all of the above lines increased dramatically. But what is really driving it is just -- it's just the end result of all these acquisitions and all the accounts that come with it. Once we get them into our deposit relationship concept and start focusing in on the fee income side (technical difficulty) start generating this additional increased fee income. So I think it's just a natural thing. There's nothing that we did differently this quarter. Some of it's got to be seasonal (multiple speakers) go back and look sometimes. You get into the summer, it tends to be a little bit more seasonal. But it's just pure -- again, we're a retail -- on the deposit side, we're a retail bank, basically. And that's what you're seeing.

We said at the beginning we really don't look at revenue enhancements to drive a number when we're doing acquisitions, but we knew coming into the transaction that Southern National's fee structure, or fee income, was relatively low compared to ours. Their deposit base is a little different than ours. It may never get to the same level that we are on their customer base and the type of customers that are out there. But we certainly think there's room for improvement over the next six or nine months.

And then on the credit front, any particular sectors you guys are potentially taking a closer look at for heightened attention to? Given your credit numbers, I would kind of feel a little silly asking that question. But nonetheless, any areas that might be softening a little bit in your markets anywhere?

We don't really see any softness. When you ask about what areas we might be paying a little extra attention to, I would say the entire real estate secured area would be one, simply because prices of all real estate have continued to go up year after year for some time now. And while we don't see any evidence of any crack in the wall, so to speak, anytime you see escalation in prices year after year on a continuing basis, you have to periodically take a step back from it and ask yourself the question -- where are we and where is it going? So we do that on a consistent basis. We try to maintain our requirements for down payments and good credits, and move forward in the process. But we are looking at real estate loans closely, if that answers your question.

Let me ask -- if I could follow up and then I'll hop off and let somebody else on. Residential real estate in Texas in general, the appreciation rates have kind of trailed -- certainly trailed some of the hotter markets, just because there's plentiful supply. Is there kind of a mismatch between that and commercial real estate?

One could make that argument. We consistently see people from out of state coming to Texas to look at real estate, be it commercial or residential. Because on a relative basis, they see what you're just describing, that prices seem to be less here. The numbers are what they are. But even though they may be less compared to a place like California, for example, they have been continuing to go up. So I don't -- I don't think that's in and of itself an issue for us. We continue to see a lot of activity in both the commercial and the residential sectors, and we don't see any significant softening in either place. But to say that the residential market here has a lot of upside, just simply because it may be proportionally less to somewhere else in the country, I don't know that that really holds true. I don't think we would underwrite on that [basis].

John Martinez, Cohen Brothers.

A couple of questions here. Maybe you can outline for us which markets you saw to be your strongest. I know you just mentioned there, Dan, the exceptional loan growth year-to-date in Dallas. Just if you could maybe prioritize where you're seeing the strongest growth. And obviously, no real weaknesses going on their in Texas. But again, just a quick question if you have any concerns in the markets.

Let me go back through what we talked about earlier. Year-to-date -- we're talking year-to-date loan growth, not quarterly here. Year-to-date loan growth, Dallas is winning the charge for us at this point with north of 20% annualized loan growth. Houston is running at just a shade under 18% annualized loan growth. Austin is running right at a little less than 10% annualized loan growth. The rest of the markets are running a little less than that.

When we look at it on the deposit side, the Houston market is growing deposits, and we've had some changes in the balancing on our deposits as we've talked about locations. We look at -- remember, we run today 88 independent banks, and we run 88 -- each one of them sees their own balance sheet. So the locations that have been interest-bearing dollars or higher levels of CD deposits in the past, those locations may be seeing some of their deposits shrink a little bit. Because as David said, we've been holding the line on deposit rates. Locations that are in more commercial markets or more transaction-based markets -- they've seen their deposits increase through this process as we've been working towards that. Does that answer your question?

Sure does. Another question I would have is you gave the figure as far as loan production coming out of this quarter at about $100 million. If you could maybe share with us what the first quarter number was. I don't recall that from the last call.

60 -- the first quarter (multiple speakers) '06. First quarter '06. I think it was 65 or 66 million.

66 million.

66 million a month versus 100 million this month this quarter. That reflects more lenders on the team, the larger portfolio that Southern National brought to the team, and improved production.

I'll try to keep this to two more short quick questions. Regarding the Texas United deal, maybe you could characterize what type of opportunities you feel are in place for the new -- expansion into the Dallas and Austin markets, as far as increasing your footprint there, where do you hope to benefit from, other than just obvious deposit growth?

The Dallas market is the biggest change on our side. We run from 11 offices in Dallas to 29 offices in Dallas. We've got great opportunity to improve our presence in the Dallas-Fort Worth metroplex across the network up there. We pick up some great lenders in the Fort Worth market on the construction side. We pick up some great commercial lenders on the commercial side in Dallas. They've got a fantastic team of leaders up there in that Dallas-Fort Worth area that we're looking forward to partnering with.

When you look at the State Bank operation in South Texas, which includes the Austin market and their locations here in Houston, again, some great lenders. They're producing great business, and they're doing business the same way we're doing it. Don is on the line with us. Don, do you want to take a stab at that?

I was just thinking about that. I think, John, we also bring to the table some new markets like the Bryan/College Station market that's been an excellent loan market for us. We have some strong lenders in Austin, I think, that will ratchet up the growth they're already seeing in Austin. We have good complement in North Houston. We had a -- really had a chance in Dallas to get all those banks up to speed as far as ability to generate more business, but what they were doing on their own is fairly significant. So I think we bring a really good team of middle-market, small commercial-type lending and real estate to the team to complement the 11 locations that they already have there.

Keep in mind, John, this is July, and it's going to take us four or five months to get all this put together. But the opportunities in front of us are really bright.

You might point out too, Dan, John, Dave, that Texas United has a 90% loan to deposit ratio or more. So it tells you that they really can help provide us and help take us to another level of loan deposit relationships, too.

Let me talk about Texas United. I don't know if everybody knows. We updated -- if you have not been out to our Website and pulled the investor presentation down about the Texas United/Prosperity merger, I would invite you to do that. We updated that presentation today to include 6/30 numbers for both Prosperity and for Texas United. And there's some very interesting information in there . You also might want to pull the Texas United earnings announcement for the quarter that came out recently. Their margin expanded to a little over 5% -- theirs being Don and Texas United.

In the investor presentation we outlined the cost of deposits. There were some questions about that, so we outlined that a little closer into the investor presentation. For the three months ended June 30th, the second quarter, cost of deposits here at Prosperity Bank was 229, 2.29%. That excludes our cost of any borrowings, that excludes our cost in any repos, that excludes our cost from any trust preferred. We're talking purely the blended cost of all deposits was 2.29. The blended cost of all deposits at Texas United, about 1.3 billion, was 2.04. So they are running their bank very similar to the way we are, or their banks I should say. They've got a great cost of funds, they've got a great loan machine; the opportunities in front of us are very bright.

Let me also point out that as of June 30 '06, our loan to deposit ratio was 60.6%. The loan to deposit ratio for Texas United Bancshares as of June 30th '06 is 94.9%. So when you combine those and look at those as a pro forma, the loan to deposit ratio combined takes us to about 69.7%, which is -- if you've been following us for a long time, that's a long way from the 35 to 40% that we were at not that long ago.

Dan, can I say one more thing? John, also funding is starting to be a problem for Texas United, because we've maintained the same pricing philosophy that Prosperity is maintaining now. We're relationship-oriented. We don't go out and pay up on CDs just to say we have the best CD rate trying to grow that part of the business.

When you look at our deposit base, you can see our DDA balance is pretty significant to balance sheet. So what we've been doing as a strategy is we've been borrowing on a short-term basis on seven-day advances primarily from the Federal Home Loan Bank and Fed fund lines, to fund this loan demand. So I think the beauty of this merger is we're going to be able to absorb some of the liquidity and the funding capacity that Prosperity has and, obviously, (indiscernible) those borrowings are pretty expensive. And even in spite of that, we've been able to increase the margin at the same time.

Thanks, Don. Don brought up a very good point. Looking at the deposit mix, the deposit mix at Texas United, they are running 28.5% free money or non-interest-bearing DD&A to our 23% non-interest-bearing money. So you can see they're doing a very good job of balancing their deposits. John, we appreciate your support.

Jennifer Demba, SunTrust Robinson Humphrey.

I was wondering -- a few questions, first for David Hollaway. David, given that you guys are going to be raising your deposit rates slightly here in the second half of the year, what kind of margin compression are you expecting?

And that's kind of what we're kind of giving the pieces to; that's kind of what we were trying to get to. Obviously, my crystal ball is not as sharp as it needs to be, because when we looked into the first quarter, our model said we would be mid 70s, high -- 370 to the high mid 370s, and we came in a little better. But what we're trying to get the point across here is you can see when you're modeling this out, with loan growth and the repricing opportunities in our securities bond portfolio, those can be very positive things for a margin. But really what we're seeing today -- and with the flat yield curve the way it is, let's reiterate; that's a very challenging thing for financial institutions. And going forward, it continues to last longer and longer. And as somebody mentioned earlier, the deposit pricing competition out there is just getting more and more aggressive from a lot of these mom-and-pop shops and other type nonfinancial institutions. We can't just sit on the sidelines and ignore what the market is doing.

Now, as David said earlier, there's no way we're going to be the leader in paying rates on the deposits; that's not going to happen. But this is a long-winded answer to say that we do think we're going to be able to be more proactive on the deposit side, and that's going to offset a lot of this tremendous benefit we're getting on the asset side. And so as David had given guidance from an EPS perspective, what that would all infer, when you put it in the model and go back, is what you're looking at for the rest of this year -- we think that that margin is going to be pretty stable. It might move a couple basis points one way or the other, it's truly dependent on what the loan growth will be going forward and what we're doing on the deposit side.

And we're really hoping (indiscernible) we're really hoping that as our securities reprice at $300 million a year, that will really help offset the increase in the rates that we're paying on the CD. Because as you can see (indiscernible) on the bond portfolio is about 4.6, 4.5. So we're picking up -- reinvestment there may be 100 basis points; where we may be just (indiscernible) CDs, maybe 25 basis points. So we're hoping -- we realize there's a lot more repricing on the CDs and the securities, but the difference is quite dramatic, too.

I have a couple of other questions, if that's okay. Wanted to ask Don Stricklin why he chose to seek a merger partner right now.

Obviously, if you look at our first quarter and our second quarter, the strategic plan that we laid out a couple of years ago is working. So it's not something that we had to do. But at the same time, I was given direction by the Board back in '02, when we became a public company, that we're going to do what's best for the shareholder. And obviously, they aligned my interest for that same fact.

Back in November, the first part of last year, when we were doing -- this year when we were doing some strategic planning, we started looking at our capital levels, which we had strained pretty well with the last three acquisitions that we put together. And our investment banker advised us to kind of look around for some strategic partners to align with; at least explore that option. He had had a long relationship with Prosperity, and I had known David Zalman for 10 years. And he said I've sold this company, I've sold Prosperity four or five banks, all the management teams that are still there that they joined them in the merger, and everybody I like that I talk to after they joined them have been very happy. So we started having some conversations with David and Dan. And the more I looked at it, the more I realized how much our companies were alike, whether -- as far as customer service. And at the beginning David talked about people, talked about customer service, and employees. And when you spend time with someone over the last 90 days, and you get to know them and you see the similar philosophies, after putting the banks together and looking at the footprint, from the perspective of the shareholder it made sense, and from a customer standpoint it made sense, and from our employees it made sense. So it was something we felt like was the right time to do. And we wanted to keep it in Texas, and this was the best choice, we think, for everyone, and a real win-win situation.

One more question. Dan, your assumptions for accretion within the first 12 months after integration, I'm assuming that includes some exiting of some loans.

Yes. When you look at what our past track record has been, we've tried to exit any nonperforming assets through the process. In this particular case we don't have an identified list that says this is what we're going to do as we've done in the past. But I think you can certainly assume that certainly the nonperforming assets would be on the list that we would not want to bring across if possible.

Bain Slack, KBW.

I just had a quick question on -- I guess with the closing of SNBT this quarter, was there any merger expense or anything sort of in a non-recurring nature in the expense line item this quarter?

When you're talking about -- when you say non-recurring, I'm not sure -- just a onetime charge or something?

Either a onetime charge or just expenses involved in the integration that wouldn't necessarily be there for the remainder of the year.

I don't know if you could say that. Again, it's kind of backing up. It's just the overall expense carry from the acquisition itself. It's all of the above lots of items that, as we go through with these acquisitions, we start integrating them into the structure that we have in place. So I don't know that I could say that there's some specific item we could point to.

I think when we look back, my guess is that you're remembering when we did the First Capital transaction March a year ago. In the first couple of months we had some excess travel expenses, in particular in the process. They have 33 locations. 15 of those are more down in the Corpus Christi area where we really didn't have a presence. And we had a large number of people that we put up in hotels for weeks on end through that process. That wasn't the case here. This is in our backyard. Our folks were staying at home doing their business right here. So I don't think we had to expense some of those funds this time that we did last time.

I guess I want to double-check some numbers I think I missed when you all were talking earlier. The loan production this quarter on a monthly basis, I thought I heard 100 million, versus 66 last quarter?

Correct.

I guess the last question is just with loan growth looking like it's coming a little bit higher than traditionally that you all had on an organic basis, the tax rate has kind of been coming up over time, 34.4, I guess, this quarter is what we've got. Just kind of wondering, is that -- within the assumptions of the guidance, is that kind of what you all are looking at at this level?

Yes, absolutely.

Bain, congratulations on your new baby girl.

Thank you very much.

Campbell Chaney, Sanders Morris.

David, I'm just trying to get the correct calculation of your net interest spread, excluding your non-interest-bearing deposits. I came up with 3.09, down about 5 basis points for the quarter. Is that math right?

That sounds right. You're taking all interest expense over the base, right, not just deposits themselves?

Correct.

That's probably right. I think what's probably impacting that, if we back up -- if you're kind of looking at your notes, remember SNB had a lot of high-cost money on their balance sheet. And we are in that process of trying to rebalance that thing. You can't get it all done in three months. We've done quite a bit of it. But when you're looking at the balance sheet, that's primarily the impact you're seeing as we're getting that part of our balance sheet reoriented here.

Terrific. I guess this is for Don Stricklin, and maybe Dan, too. Looking at kind of how the companies are managed -- Dan, you mentioned earlier that you run your company with 88 different balance sheets. Is Texas United managed the same way kind of with the silo approach where every branch is tracked the way that Prosperity does? And if it's not, could that become somewhat of a challenge to incorporate that into the operating model going forward?

Don. I'll let you go first.

Campbell, yes, especially on the State Bank side, obviously, because we've been operating as one bank longer in South Central Texas. The banks that we purchased up in the metroplex, we have not had a chance to integrate them into our system yet. So we're actually operating on four different back-room systems. So each one -- we have a 232 -- $230 million bank and a $130 million bank, and they are on their own separate system. And they manage their P&L for their collective bank, as well as on a branch level. The P&L that we generate for each banking center at the State Bank side is similar to what Prosperity is doing. So, obviously, when we get them all into one back room, it will be their system. And I don't think that's going to be much of a challenge at all. I think it will be a very positive thing.

And the banks in Dallas are, again, very -- you've got five locations in one, six in another. This is not foreign to what they're used to seeing at all?

No, no.

I guess I was trying to get not so much the back-office integration, but just the way the branch managers operate. Are they going to -- now that they're going to be kind of having their own P&L, do they manage their businesses, if you will, a branch manager at Texas United, as a separate business from a branch perspective, like Prosperity does?

Yes, they do.

So there shouldn't be any cultural challenges, I guess, is the way I would characterize it?

No. And even the way Prosperity's banking centers are set up and organized is very similar to way that ours are organized as well.

That's right. This is a good cultural people fit. That's one of the things we've spent quite a bit of time on. I was talking a minute ago -- we had an opportunity -- my days are running together here -- to have dinner with 40 some-odd folks from Texas United, I guess, on Wednesday night in Austin. And I think culturally this is a very good fit. They've got some great leaders. We want to take care of customers. We want local decision-makers. This will do well.

One final, I guess, clarification is when you talked about increasing your deposit rates in the back half of the year, is that more of a defensive position just to keep your current depositors there, and keep attrition levels low?

Let me answer it this way. Obviously, the overall level of deposit cost has been heading upwards, especially in the CD area. But our retail folks that are out there all day, every day, really dealing with the customers have historically done an excellent job of making those customers comfortable with the overall relationship that they have with us. And as a result of that, we haven't really been called upon so much to meet the highest rates in the communities that we serve. And we're hoping and trusting that that is going to be the case going forward. Having said that, we obviously can't ignore what occurs in the marketplace, and we do anticipate some additional cost. But if we're successful going forward the same way that we have been historically, we really don't think it's going to be that big of an issue. We think we can absorb it in our system (technical difficulty) really turn out to be any kind of a negative (technical difficulty)

Thanks for your support.

Brent Christ, Fox-Pitt.

A couple of quick questions. I guess first, on the loan to deposit ratio, going into the Southern National deal, I think you guys are somewhere down in the 57% range. And now it looks like pro forma, after the Texas Unite, you're going to be closer to 70%. And I think historically you've mentioned kind of targeting a 65 to 75% level. How do you think about the use of securities to fund loans kind of over the near-term before you get the Texas United deal? And has your target changed in terms of the loan to deposit ratio?

I guess it's -- we've always said that really our goal would be to be somewhere between 65 and 75%. I think with this combination, we're going to be close to 70%. Even, as Jennifer mentioned earlier, there will probably be some loans that may not fit exactly what we want. There may be some rolloff of that, so that will give us some room. But I think where we see it right now, our goal is still to be at 75%, and I think that still gives us some room to grow. And I would think that the Board of Directors will probably revisit it, revisit that number when we get the 75%, and make a decision whether or not to go to 85% or not.

Keep in mind, though, that the move from 70% to 75% on a pro forma company, you're talking about growing loans 300 million or more to do that. So you're still talking a pretty big loan growth number to get there.

And you have to bear in mind also that as we grow, the liability side of the balance sheet, that provides us additional money to make loans with also, and keeps the ratio about the same.

But all else being equal, there is still some leverage there to shift that make, even with the addition of Texas United? You can do it organically (inaudible)?

Absolutely.

The next question is on the deal, and kind of your thoughts, or maybe how long this puts you on the sidelines for in terms of potentially looking at more acquisitions.

I guess that would be directed at me. I have to be careful, because my guys have some duct tape right here. Obviously, this is one of our largest mergers that we've had, and it will be one of our most challenging, in my opinion, simply because of the number of locations and the number of systems or computer systems that they're on. So to jump off tomorrow and say we're going to do a real huge deal, I don't think that would be possible.

At the same time -- at the same time you know that we are opportunistic. If we feel that we have things under control, we will always look if there's something out there. But I would have to say right now, our first and primary goal is to get this thing behind us, put it to bed, and make sure that we feel comfortable before we jump off into something else.

Remember, this is a four-in-one deal. We're getting really four acquisitions in one.

My last question is just you mentioned accretion in 12 months. Is there anything more surrounding that you could share with us, in terms of quantifying that, or talking about the timing of the cost savings?

I think as you look at timing of the cost savings, I think -- again, our crystal ball and our timing schedule never seems to be perfect. It would be nice if we were more than 48 hours past an announcement. We've spent several weeks, several -- many hours for the last few weeks kind of doing due diligence. But as we look forward, we really don't have a lot of those plans finalized. We're beginning to talk about some of that, but this really has to be a partnership. We've got to establish a partnership with the folks on the TXU side of the aisle, and we've got to lay some of those schedules out so that we create the least disruption as possible for our customer base. And I think when you look at that, [beginning] with four acquisitions, it's going to take us longer to get our cost save number in line, because there's four acquisitions or four integrations to go through, than certainly took place here at Southern National. Southern National, probably two opposite situations. You've got five or six locations all right here, close; everything falls into place perfectly for us here. If everything falls into place perfectly, the way we would want it at Texas United, it's just going to take longer, just because it's spread and there's four computer conversions and four operational integrations to put together.

Barry McCarver, Stephens Inc.

Barry had to step out. This is Matt. I wanted to follow up on kind of the integration questions, talking about. We consider kind of the integration of SNB kind of high-risk, given their balance sheet and what they'd gone through the last few quarters before the announcement. How would you classify the integration risk of Texas United, comparing it to SNBT?

I think -- again, from an integration standpoint -- from an operational integration standpoint, I don't think that the balance sheet integration we were looking at at the Southern National side the way -- the same way you were. Operationally, Southern National, again, operated very similar to the way we operate. They had decision-makers in the locations. They take care of customers. Their customer service skills are fantastic. So from an operational integration standpoint, and all five or six locations right here close to us, we view the Southern National transaction to be a less risk operational integration maybe than you did. You were looking at it from a balance sheet perspective, and I think we saw coming in that the balance sheet rebalancing was probably easier to do than maybe the street believed it to be. And I think that the results that we've now posted kind of prove that up.

From a Texas United standpoint, I don't think we view this to be a high-risk transaction, I think we view this to be a low-risk transaction. Again, the reason for that is you've really got four banks. So when we talk about the four banks, and the integration that we have to work through to integrate the four banks that are out there, three of those banks are in Dallas; we're already in Dallas. We have a presence there. We have good folks. You have already heard us say that Dallas is leading the charge on loan growth year-to-date for us. With four relatively small banks up there, those individual integrations should be relatively easy.

From the State Bank side, the biggest of the four banks on the Texas United side, that bank in itself is smaller than the First Capital transaction that we did a year ago. First Capital had 33 some-odd locations spread out all over. State Bank has 25 locations in Austin, Houston, and in between those two. So I think we see this as a relatively low-risk play; it's just going to take us longer to get there because we can't do them all at one time. We're going to have to stage them out over the months coming up. (multiple speakers)

Yes, that helps. Back on organic loan growth second quarter, can you give us an idea of how much of that organic loan growth was from the SNBT lenders that came on at the [end of the] quarter?

I don't think we have it broken out by lenders that way. When you look at the loan book from Southern National in our press release, we started the quarter -- or let me say that a different way -- we ended the first quarter -- SNB ended the first quarter with 598 million, give or take, in loans. And we ended the quarter with 585 million in loans in that book. I think we've said all along that in the first six months or so after an integration, the expectation is not to see great growth there. The expectation is we're playing defense. And I think Dan Agnew and the lenders here from -- the former Southern National lenders are absolutely doing a fantastic job. They are certainly producing business. They are producing business at a pretty good clip, but they're playing more defense and trying to hold customers, and they're not as focused on the growth side as they may have been in the past, which is exactly what we've asked them to do. We think they're doing fine.

We might add that we will have that number, but bringing Southern National in wasn't that long ago. And our focus at this point in time hasn't been to break that down. But we will be doing that. We always do that.

And historically, I would say that whenever we do a merger with somebody, historically the first year, the lenders have been more in a -- more of a position to retain the business they have and solidify the customer relationships that they have. We generally don't see loan growth as -- for the most part from new acquisitions until after 12 months, usually.

John Arfstrom, RBC Capital Markets.

I hate to belabor the call here to keep it going, but just a couple of quick ones. Dan, you talked about the four-in-one acquisition. What do you plan to do with the names at Texas United? Do you change them all it once? Do you do it with your integration? How do you think through that?

We typically do that with the integration. Again, the idea here is it's very important that we have the -- that we minimize disruption for our customers, and that's just key critical for our process. So it could be disruptive if we're trying to change names and not have our integration at the same time. Typically the name process would roll in as we do each integration. That's our past history. Again, no decisions have been made on this process. We really don't even have our teams in place yet to make some of these decisions, but historically that's what we've done.

Just a bigger-picture question on Texas M&A. You guys keep your finger on the pulse of that, I think, as well as anyone. And to the extent you can comment, is everyone acquired, or do you expect M&A activity to pick up or slow or remain the same over the next 12 months? Any commentary would be helpful.

You listen to our past -- you listen to our past conference calls, and I try to imply or insinuate last time that there's going to be a lot of deals coming down in Texas. And most of those deals that I knew about have come down. But I will tell you, having said that, there's still 700 banks in the state of Texas, and there's still a lot of deals out there. There's a lot of -- I would say there's not as many big deals left, but smaller deals for ourselves. We probably walked away from two to four deals in this last quarter, simply because we were working on this larger deal, which if we wouldn't have had this, we probably would have went with some of the smaller deals. I would tell you that I think that there is still a lot of activity, it just may not be in the size that you've seen here in this last quarter.

Great. That's helpful. Thank you.

Adam Barkstrom, Stifel Nicolaus.

Sorry to hop on here again, but just one quick follow-up. For the acquisition of TXUI, what -- I was looking through the presentation -- what have you guys actually said for '07 earnings, once they're merged in? Is that going to be dilutive for '07? Is it going to be flat, or slightly accretive?

The presentation shows that we believe it will be slightly accretive to '07 earnings.

Secondly, David, early on in the call you mentioned that you felt this deal presented low execution risk. And then later, I guess you were pointing to a little bit more challenging given the size and number of locations, and that you're dealing with four back-office systems. I wonder if you could just sort of take a minute and reconcile those two thoughts.

When I said the low execution risk, I guess when I think about execution risk, I think about execution risk as really is there -- could there be a real problem in earnings or something that would be more global that could affect the model that we've been doing. And so when I look at it from a global perspective, I don't see that there's much risk as far as putting the banks together, the balance sheets, their people. As mentioned earlier, they have banking center presidents like we do and lobby managers. They let each bank kind of know what they're doing like we do. So from a global standpoint, I don't see that there's the real (technical difficulty) the risk of really messing up the balance sheet or messing up the model. But on the other hand, as far as an operational integration, it still will be one of our most challenging just because of the number of locations they have and the different computer systems. That's kind of what I was trying to -- I'm glad you asked the question; we did clear things up, too.

It appears at this time we have no further questions. I will turn it back over to you, sir.

Appreciate it. Thanks everyone. We certainly appreciate the support. Great questions this morning. We look forward to talking to all of you soon. Thank you for participating.

Ladies and gentlemen, this does conclude today's teleconference.