Prosperity Bancshares Inc (PB) 2007 Q1 法說會逐字稿

Good day and welcome to Prosperity Bank's first quarter earnings conference call.

All sites are in a listen-only mode. Later you will have an opportunity to ask questions during our Q-and-A session. And please note this call is being recorded.

I would now like to turn this program over to Dan Rollins. Please go ahead, sir.

Thank you. Good morning, ladies and gentlemen.

Welcome to Prosperity Bancshares first quarter 2007 earnings conference call. This call is also being broadcast live over the Internet at www.prosperitybanktx.com and will be available for replay at the same location for the next few weeks.

I'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. David Zalman will lead off with a review of the highlights of the first quarter of 2007, he will be followed by David Hollaway, who will spend a few minutes reviewing some of our recent financial statistics.

Tim Timanus will discuss our lending activities including asset quality, then I will provide an update on our progress toward completely integrating the former Texas United Bancshares locations. 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 or you may e-mail questions to investor.relations at www.prosperitybanktx.com. I assume you have all received a copy of the earnings announcement we released earlier this morning. 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 law and as such may involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of Prosperity Bancshares to be materially different from future results, performance, or achievements expressed or implied by such forward-looking statements.

Additional information concerning factors that could cause actual results to be materially different than those in the forward-looking statements can be found in Prosperity Bancshares' filings with the Securities and Exchange Commission including 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 to our first quarter 2007 conference call. I'm very pleased to report that the first quarter of 2007 was another record quarter for our Company. Some of our successes this quarter include record earnings. We earned $20.3 million in the first quarter, compared to $12.9 million in the first quarter of 2006. This represents an increase of 57.3%.

We reported diluted earnings per share of $0.50 for the first quarter of 2007, compared to $0.46 for the same period in the prior year, which represents an 8.7% increase in the earnings per share. Our return on average assets for the three months ending March 31st, 2007 was 1.4%, and our return on average tangible shareholders' equity for the first quarter was 31.24%.

Our efficiency ratio has increased to 47.7% for the three months ended March 31, 2007, compared to 43% for the quarter ending December 31, 2006. The increase is attributable to the acquisition of Texas United Bancshares on January 31st, 2007, our largest acquisition yet in size. Dan will provide some additional detail in a few minutes.

But in short, we integrated and rebranded Gateway National Bank, GNB Financial, and Northwest Bank, three of Texas United's four operating banks, onto our systems during the quarter. We are planning the integration and rebranding of State Bank, Texas United's largest subsidiary, next month. State Bank operated over half of the 43 total banking centers under the Texas United umbrella. We are confident that our efficiency ratio will continue to improve upon completion of the integration of Texas United.

Deposits at March 31st, 2007 were $4.9 billion, an increase of $2 billion or 69%, compared with $2.9 billion at March 31st, 2006. This annualized increase was obviously impacted by the Texas United and Southern National Bancshares merger.

Our linked quarter organic growth was basically flat. We sacrificed growth of higher cost deposits in a very competitive market to maintain our net interest margin. We do not believe it makes sense to pay over 5% for a deposit and not have a place to reinvest it profitably. When the yield curve corrects itself and the Bank is able to invest at higher rates, we will become more aggressive on our deposit pricing.

We continue to focus on core deposits, lower cost deposits that create a better margin for us. Our non-interest bearing deposits increased $26 million in the month of March from February alone this year.

Loans at March 31st, 2007, were $3.2 billion, an increase of $1.7 billion or 108%, compared with $1.6 billion at March 31st, 2006. The annualized loan growth was impacted by the loans acquired as a part of the Texas United and Southern National Bank mergers. On a linked quarter basis, loan growth was flat.

It is a very competitive market, and in an effort to maintain fundamentals and discipline, we elected not to make certain requests or renegotiate some existing loans on the books currently. At this point in the economic cycle, we are willing to accept flat organic growth.

With regard to asset quality, our non-performing assets totaled $4.3 million, or 9 basis points of average earning assets at March 31st, 2007. That's compared with $1.3 million, or 4 basis points of average earning assets at March 31, 2006. The increase is almost entirely related to the acquisitions of Texas United and Southern National Bancshares.

Even with the increase in our non-performing ratio, our Bank remains stronger in asset quality than most, if not all of our peers. We expect the higher ratio to remain and maybe increase for a period up of to 12 months as we go through the loans that were acquired in these acquisitions.

The allowance for credit losses increased to 1.12% of total loans, compared with 1.1% at March 31st, 2006. We will continue to focus on our loan growth. Only six years ago our Bank had a 39% loan-to-deposit ratio. At March 31st, 2007, this ratio had increased to 66%. A goal that we achieved even with our most favorable forecast.

In closing, I would like to say how gratifying it is to become the third largest Texas-based commercial bank. We are proud of our past and intend to stay the course. We plan to continue our organic growth, and we plan to continue to pursue accretive acquisitions.

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 loans, focusing on our customers, rewarding people that produce results and 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 specific financial results we achieved. David?

Thank you, David.

Just a couple quick comments on income statement items and a couple of financial ratios. Net interest income was 46.1 million for the quarter ended 3/31/07, an increase of 57.9% over the same period last year. The net interest margin on a tax-equivalent basis for the quarter ended 3/31/07 was 3.93%, compared to 3.81% for the same period last year and 3.79% for the fourth quarter '06.

And so what's interesting, if we can back out the impact of the TX/TXUI merger, our margin in the first quarter was unchanged from the fourth quarter. It was at 3.79.

If we're looking forward, based on our asset liability model at 3/31/07 and we're looking forward, we -- it shows that our margin should expand as we move forward, due to the full impact of TXUI for three months and continued management of our balance sheet.

Non-interest income for the quarter ended 3/31/07 was 11.7 million, an increase of 52% over the same period last year and 41% on a linked quarter basis. These increases were primarily driven by the last two acquisitions.

On the non-interest expense side for the quarter ended 3/31/07 we were at 27.3 million, an increase of 58.1% over the same period last year, and a 42% increase on a linked quarter basis. Again, these numbers were impacted by the last two acquisitions and should decrease as we recognize additional cost saves from these transactions.

And just to reiterate a point that David had mentioned, the efficiency ratio was at 47.7% for first quarter compared to 43% in the fourth quarter. And as we continue to integrate the TXUI transaction, over time we would expect this ratio to trend back down to the low -- into the low 40s.

Final comment concerning the bond portfolio. At 3/31/07 our portfolio reflected an effective duration of 2.6 years, with a weighted average life of 3.4 years. And the projected cash flow is approximately 600 million over the next 12 months.

And with that, let me turn over the presentation to Tim Timanus for detail on loans and asset quality.

Thanks, Dave.

I'd like to give some emphasis to some of the points that David Zalman previously went over. Non-performing assets at quarter end, March 31st, '07, totaled $4.314 million or 0.13% of loans and other real estate, compared to $1.120 million or 0.05% at December 31, '06, and $1.267 million or 0.08% a year ago at March 31st, '06. This represents an increase of $3.194 million in non-performing assets from year end 2006 and a $3.047 million increase from the quarter ended March 31st, '06.

The March 31st, '07, non-performing asset total was comprised of $2.138 million in loans, $37,000 in repossessed assets, and $2.139 million in other real estate. $3.481 million or 81% of these non-performing assets pertain to loans in the portfolios of our last two acquisitions.

Net charge-offs for the three months ended March 31st, '07, were $635,000, compared to net charge-offs of $247,000 for the three months ended December 31st, '06, and net charge-offs of $11,000 for the quarter ended March 31st, '06. The average monthly new loan production for the quarter ended March 31st, '07, was $79 million, compared to $72 million for the quarter ended December 31st, '06, and $66 million for the quarter ended March 31st, '06.

Loans outstanding at March 31st, '07 were 3.248 billion, compared to 2.177 billion at December 31st, '06 and 1.561 billion at quarter end March 31st, '06. The March 31st, '07, loan total is made up of 40% fixed rate loans, 34% loans adjusting as prime moves, and 26% resetting at specific intervals such as quarterly or annually.

I'll now turn it over to Dan Rollins.

Thank you, Tim.

Let me spend just a few minutes talking about the status of our recent merger with Texas United Bancshares. As David mentioned, we continue to be very excited about our future. I am pleased to report that we are well down the road toward the integration of all four of the Texas United Banks.

Sometimes when I'm talking about our integration planning and implementation, it sounds easy and not hard work. Let me assure you this undertaking has been monumental for our organization, and I'm extremely proud and pleased of our team.

During the first quarter, we completed the computer conversions and the rebranding of Northwest Bank, GNB Financial, and Gateway National Bank, all in the Dallas/Fort Worth area. Today we have 27 banking centers in the Metroplex, and our associates are fully engaged in providing excellent customer service to our combined customer base there.

To accomplish this goal we had some of our associates away from home for over 45 days during the first quarter. This level of dedication is what sets our team apart from our competition. Before the end of next month, we will complete the process of integrating the remaining TXUI locations into Prosperity Bank.

The State Bank conversion is scheduled for late May and represents over half of the Texas United locations. So we're a little less than halfway there today. Our team is actively involved at this time, and we continue to be proud and pleased of our progress. I am confident that we will be able to achieve our goals and minimize any customer inconvenience with the strong leaders from Texas United that have joined our team.

At this time, I think we're ready to take questions. Tasha.

[OPERATOR INSTRUCTIONS]

Our first question comes from Brett Rabatin from FTN Midwest.

Hi, good morning.

Good morning.

Couple questions for you. First off, can you give us detail on -- you mentioned that you elected not to renegotiate some loans.

Can you give us some color on how much that would have been to give us some idea what -- obviously you gave us loan production numbers, but what piece of the portfolio you didn't elect to renegotiate.

Brett, I don't have an exact number. It's just -- again, probably it's because I see the larger loans. We've had some larger loans, for example.

I'll just use a $10 million loan, for example, on one. It's more of a club, but it's a real dynamic -- it was a good earning asset. It was a good loan, and basically, where we might have been earning a prime rate or a little bit under prime rate, they came back to us and wanted no guarantees and a lower rate, and we didn't do it, and they actually ultimately went to an insurance company and got it financed, the $10 million credit, without any personal guarantees for probably 6.5% for 20, 25 years, 6% to 6.5%.

So it's those kind of deals that I'm referring to.

I've been hearing some of that, too.

It may not necessarily be from other banking companies on these larger credits, but maybe more from different -- other types of financial companies.

Okay.

And then as it relates to that it sounds like you're probably going to manage the balance sheet pretty flat, given the competitive pressures on rates and other people being aggressive. Is that -- and in trying to manage the margin upward to the extent you can.

Is that a fair statement?

I would say that we are trying to manage the margin. We're probably not going to overpay for something that if we can't take and make money on it. Having said that, we were flat this quarter, and we were watching our margin.

But I -- this, for the first quarter, usually it's -- we have more of a flat quarter on deposits and loans, it's more seasonably, but I think going in to the rest of the year you will see some organic growth. It just may not be at the same levels that maybe historically everybody would like to be at.

Our team is focused on growing, Brett. I mean, we hear what you're saying, but to say that we're not -- that we're not modeling in or expecting no growth I don't think is a true statement. The team we have in the field, they're all compensated on production, and they're compensated on performance, and they are fully focused on growing their locations and growing their individual portfolios, both deposits and loans.

Having said that, we're watching the pricing of those, and we're watching the structure, and we don't think we need to give up quality just for growth.

I would say the first quarter, Dan that we probably may have had more flat organic growth in the deposit side but, on the other hand, we really have continued to let some of the higher cost money run off, and we've built our more core deposits, basically, what we focused on this quarter.

that's right.

Okay. That's good color.

The other thing I was curious about was the -- I'm sorry, Tim, I missed the number on MPAs that were -- that you had from prior acquisitions what the total was at the end of the first quarter, so if could you give that number again.

And then with -- as you work through sort of MPAs that you've acquired, I was curious if you feel like there's probably going to be some cleanup there and charge-offs might be a little higher and how that might reflect on your provisioning as well.

Okay.

The 81% of non-performing assets that I mentioned was a total of $3.481 million. And all of that came from the last two acquisitions.

Right.

If you add to that total an aggregate number from the last four acquisitions, it kicks that percentage way above 90%. So while there are a few assets in our total at quarter end that go back some time from Prosperity locations, the vast majority of it does pertain to acquisitions.

And we do see more of this coming. We certainly can't give an exact number on that. It's impossible to do so.

But based on the portfolios of the last four banks that we acquired and the things that we have seen evolving over the last several months, I think it's safe to say that our non-performing will be up for some reasonable period of time going forward, at a level beyond which you normally have seen from us.

I don't anticipate that it's going to get out of hand, so to speak, and we're very optimistic, given the reasonably decent level of the economy here that we can work through these assets in a timely manner, and that's certainly been the history to date.

But you will see some more of this.

Thanks, Brett.

Okay. Thank you, guys.

Our next question comes from Brent Christ from Fox-Pitt.

Good morning, guys.

Hey, Brent.

Quick question on the deal related cost savings, I guess. Could you try to give us a sense of kind of what the new annual expense base you kind of view at Texas United, given that you exited a few of their businesses and kind of how you're thinking about the cost savings levels now and maybe where we are in terms of that progress?

Let me answer that. This is David Zalman.

You know, when you're viewing the expenses and comparing them to what Texas United's were, a quick response would be to assume, wow, why isn't Prosperity showing even a larger increase in earnings. But as mentioned in previous conference calls, Texas United -- Texas United's expenses were much greater than Prosperity's, relative to their size.

They also have, a lot of top-line income from business like you'd like the mortgage factoring and asset based lending, that we either downsized significantly or in the case of the factoring and asset based lending exited completely, simply because we were not comfortable with it.

The net effect of these actions, while reducing top-line income, and expenses, had little effect on net income, and in turn, reduced risk and volatile earnings significantly.

Is there any numbers you can kind of put around that, though? I guess because if I think about before you exited some of those businesses, I believe the Texas United expense base was somewhere in the mid-70 million on an annualized basis.

How do you think about that number now and the cost savings opportunities?

This is Dave Hollaway.

My comment or viewpoint on that would be to kind of bring us back full circle to exactly how we've laid this out. If you recall, when we first went into this, we said we'd get 20% cost saves. Then we also said, guys, there's going to be noise. As David has just mentioned, some of these businesses were exiting with the gross revenues and there will be expenses related to that. That kind of gets confusing.

What I would tell you when you're looking at the numbers as of 3/31 and you're looking forward, I think you can come back and assume that 20% cost saves on the new expense run rate of the TXUI transaction. I think it will bring you right back to the way we laid it out a few months ago.

Okay. Could you give us a sense of how much maybe the cost between the legacy Prosperity and Texas United what they were in this particular quarter?

Well, I mean, what I would tell you, when you're looking at our press release what you'll pick up on, if you're looking at it on a quarter by quarter basis, the expenses, look at the absolute dollars, you'll see that our total expenses in the fourth quarter were roughly 19 million and some change, and then when you look at the first quarter you see that our expenses were 27 million and some change.

So if you assume that the majority of that came from the TXUI transaction and remember they were on our books for two months, not the full quarter, so if you -- if you're modeling the numbers and you got to three months, and you assume 20% of that, and again, these were just estimates, I think that will give you a good sense of where we're at today and where we're headed as the year wears on.

Okay. One more unrelated question.

You mentioned the securities cash flow this year of about 600 million and also a little bit focus on kind of managing the margin. How are you thinking about, you know, redeploying that cash flow? Are you going to reduce the size of the bond portfolio?

Obviously, I think the ideal situation would be to put that into loans, but just talk about the trajectory of the bond portfolio.

I'll jump in first, then I think David probably wants to have a comment. Obviously, first and foremost is we would like to lend that cash flow out. That's always the goal that we have.

But if it doesn't happen, then if we're not -- if it's being funded by core deposits, obviously we're not chasing off deposits, we would just reinvest that excess cash flow, if you will, back into the bond portfolio, keeping it short right now, and that should provide benefit to us, because when you're looking at our press release again you see the quarterly yield on our security portfolio, like 463, something like that.

You would have to assume, if we have to reinvest some of that excess cash, we should be getting at least 5, 5.25, something like that. So that would have a positive effect whether we lend it out or not.

Okay. Thanks a lot, guys.

Thanks, Brent.

Our next question comes from Matt [Ulney] from Stephens, Incorporated.

Hi. Good morning, guys.

Hi, Matt.

First off I want to get your take on the tax rate. It was down a little bit in the first quarter. I didn't know if that was a good tax rate to go off of in the future or not.

I think typically a lot of times when you close out year end there's some noise that runs through the tax entry, but it's -- if we're modeling this out I think we need to be back at that 34% level. I think that's really a better run rate.

Some of it is noise coming from TXUI in that first quarter.

So that's going to gradually happen over the next few quarters?

That would be my expectation, yes.

Okay.

And then on the loan mix, it was a question that was asked earlier. The loan mix changed slightly with the integration of TXUI. Higher construction loans, and you mentioned you're going to be exiting certain loans.

Is the loan mix kind of returning to where it was 12/31, or are we comfortable with the overall mix the way it is right now?

Talking about the mix between commercial loans, real estate loans, one to four's, that mix?

Yes, and specifically construction loans.

I can make a few comments about that.

I don't think we're uncomfortable about the level as a percentage of where we are. The uncomfortableness comes on a loan-by-loan basis when we see some of the aggressive things transpiring out in the market.

So I don't think we have a specific policy of necessarily increasing were we are in one particular area or decreasing where we are in one particular area. It's a matter of trying to be prudent and disciplined as we add assets on.

The change you're seeing, Matt, on the construction line went from 20% at December 31st, '06, to 23% at March 31st. And that's all TXU acquisition driven. The construction portfolio in the TXUI banks and the construction portfolio in the Prosperity banks is very similar.

We're not banking the big national nationwide track builders. These are local builders that we manage on a pretty tight basis.

Okay. Thank you.

Thanks.

Our next question comes from David Bishop from Stifel Nicolaus.

Good morning, gentlemen.

Hey, David.

Further acquisitions what's the outlook in terms of cherry-picking some of the local competitors in terms of lending and what's the environment in terms of the current market for senior lenders?

David this is David Zalman.

You know, historically, our bank is really not gone and raided other companies, even during a transition period. Now, it's true that we have people that have come over to us from some of the acquisitions that have been recently made, and we've hired some good people, but for the most part, we really don't go and just make a big deal to run out a bunch of people in a transition time.

Having said that, I think going forward with the big transactions that you've seen with BBBA and Compass and some of this stuff, there will be movement in the market, and so there should be opportunities.

Great. Thank you.

Our next question comes from Jennifer Demba from STRH.

Actually, this is Lauren [Johnson] for Jenn. Can you let us know if you have any stated goals on FTE reductions?

Lauren, we're having a hard time hearing you what. Did you say?

Is that better?

Much better.

Okay. Do you have any stated goals on FTE reductions for 2007?

Full-time equivalents?

Yes.

Dave can jump in behind me what.

I would answer, you need to look at the track record and put the two together. When we made the announcement last July -- if you take the June TXUI numbers and the June PRSP numbers and you roll forward to today, combined, we're down about 160 headcount. I think the majority of that is in -- the large majority of that is in the lines of business that Texas United had divested or that we divested post-closing.

So then coming forward from where we are today, I think there is some reductions. I don't know that we have a number.

Do you have a number, Dave?

I don't know that we can be specific, but I think it's a good -- it's a legitimate statement to say we probably expect some headcount reduction as we move forward.

That's right.

And is that going to be on your side, or has there been any unexpected attrition at Texas United?

I think one of the things is and maybe that's good point, because some of this that's going on, a company our size, you just have natural attrition where people are turning over, and so at the pace we're moving, we're able to leverage that. So as people are going, if we perceive, quote unquote, extra people in one department we can see if we can move them from one department to another.

So headcount down, whether it's their side, our side, I think we're all one at this point, and we just look it at it in a big picture way.

Again, I don't think that we're looking at any terminations or anything like that. This is simply through the attrition.

When you start having 1400 and 1500 people, and say you had a 3% rate or 4% rate of people leaving, all we really have to do is reshuffle people and not hire new people but keep the people that we have.

She also asked about unexpected.

I don't think we've had any -- certainly people move and they -- a family gets transferred. I don't think we've had any big disruptions that we're not aware of.

Okay. And lastly, when did y'all shut down the ABL factoring business? Was that immediately upon close some.

Yes. It happened in late February.

Okay. All right, that's it. Thanks so much.

Okay, thanks.

Our next question comes from Jon Arfstrom from RBC Capital Markets.

Morning, guys.

Hey, Jon.

Maybe a question for Tim or David.

Just in terms of your markets, which markets would you say have better lending opportunities, and which ones are nearly impossible from a risk/reward perspective? And I guess what I'm interested in is rural versus urban.

Is there regional by city? Can you give us a little more color there?

I will tell you that there's no question that your major metropolitan markets, like Houston and Dallas, are probably growing the fastest. Austin is really growing very fast, too, although Austin is a very competitive market, and again, trying to stay disciplined in a market that has such growth like that is very difficult.

But we still see growth in the Corpus south Texas markets as well, and we're growing even in some of the outlying areas, but just not as fast as you are in your major metropolitan markets, basically. We're just growing -- we're growing much faster in Fort Bend, Harris, Dallas, Plano, in those areas, than you are in some of the outlying areas.

Dallas and Houston continue to be the leaders in our team, Jon.

Jon, I would add to what David said.

I don't think any of the markets are impossible, so to speak, but probably the most aggressive market in terms of liberal activities that we see is the Austin market. We see more difficulty there in that regard than the others.

Okay. And then wondering if you could comment a little bit on some of the M&A trends that you're seeing, obviously without naming names, but how does the market look in terms of pricing and the number of banks for sale? Higher or lower pricing and more or less banks for sale?

The M&A activity is always -- from the time we -- I've mentioned this before. From the time we started, it's always very competitive, and people wonder, how can you pay so much. But overall the M&A activity is very strong.

We're being presented with a lot of opportunities. The majority of those opportunities, as we are right now, are usually smaller in size. At this point, it's just a matter of how many we can do and the people that we have. We will probably do some smaller deals this year, but probably not any one large deal.

Our main focus this year, of course, is to successfully integrate the Texas United acquisition.

And I guess a follow-up on that, given the size of your franchise now, is there a deal size that's too small for you, or if it fits the parameters, will you go ahead with the smaller deal?

Probably there's a mixed of opinions on that, even with our own group, but usually we acquiesce, and if does it make concern, it's in one of our markets where we can expand in a market that we're in, even if it's a $100 million deal, or $70 to $100 million deal, we'll probably do it.

Now, if we -- if it's in a market that is 200 miles away, or across the state, we're probably not going to be interested in something like that.

All right. Thanks. Appreciate it.

Sure.

[OPERATOR INSTRUCTIONS]

We have a follow-up question from Brett Rabatin from FTN Midwest.

Hi, guys.

I just wanted to ask -- kind of a housekeeping issue. Dilution factor going forward. Is 700,000 or so a good number to use, or can you guys give us any color on that?

The dilution factor -- talking about shares outstanding?

Dilution factor for options. Like your period end shares are 43.7, and so I was just curious if 500 or 600,000 shares on a dilution factor would --

I think that's right. Maybe I can answer it a different way.

If you're looking on a modeling run forward, when you take the basic shares plus the dilution piece of it, using 44 million total, that's probably a pretty good number actually.

Okay. All right. Great, thank you.

It appears that we have no further questions at this time.

All right. I appreciate everybody participating today.

Thank you all for your interest and time. We will look forward to talking to you all soon.

This concludes today's teleconference. You may now disconnect your lines, and have a great day.