Prosperity Bancshares Inc (PB) 2007 Q2 法說會逐字稿

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 Q&A session. Please note this call may be recorded.

I will now turn the program over to your moderator, Mr. Dan Rollins. Go ahead, sir.

Good morning, ladies and gentlemen. Welcome to Prosperity Bancshares' second-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 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; David Hollaway, our Chief Financial Officer; and Randy Hester, our Chief Lending Officer.

David Zalman will lead off with a review of the highlights of the second 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 some of our lending activities including asset quality; and I will provide an update on our progress towards 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, Marcia. Or you may e-mail questions to investor.relations at prosperitybanktx.com.

I assume you have all received a copy of the earnings announcement that we released early this morning. If not please call Whitney Rowe at 281-269-7220 and she will fax a copy to you today.

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 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 second-quarter 2007 conference call. I'm very pleased to report that the second quarter of 2007 was another record quarter for our Company.

Some of our successes this quarter include records earnings. We earned $23 million in the second quarter compared to $15.9 million for the same period in the prior year, an increase of 44.7%. We reported diluted earnings per share of $0.52 for the second quarter of 2007. That is compared to $0.48 for the same period in the prior year, which represents an 8.3% increase in earnings per share.

Our return on average assets for the three months ending June 30, 2007, was 1.47%. Our return on average common shareholders equity for the three months ending June 30, 2007, was 8.54% and return on tangible shareholders' equity for the same period was 32.04%.

I am pleased to announce that we completed the operational integration of Texas United Bancshares and its subsidiary banks, State Bank, Gateway National bank, GNB Financial and North West Bank. This was our largest integration ever. While all integrations are stressful, I am pleased with our progress and believe we performed better than expected. The combined Prosperity and Texas United team performed very well and accomplished our goals in a very short time.

I would like to congratulate them for all of their outstanding efforts. Our bank has more than doubled in size in just over two years. This could not have been done without a dedicated and talented team of people. I'm very proud to be part of this team.

Deposits as of June 30, 2007 were $4.8 billion, a decrease of $152 million when compared to the March 31, 2007. $73 million of the decrease was attributable to the former Texas United locations.

As I have discussed in the past, we are focused on rebalancing our deposit mix. By lowering our dependence on higher cost CD funding, another $40 million was from the former Southern National Bank locations. Again, this was expected as Southern National Bank paid higher rates to attract money to fund their loan portfolio.

Fortunately, we are not under funding pressure like many of our peers. We have elected to let higher cost deposits, primarily large CDs, roll off if we could not make a reasonable return. In short, we sacrifice growth of higher cost deposits in a very competitive market to maintain our net interest margin.

We continue to focus on core deposits. That is lower cost deposits that create a better margin for us.

Our net interest margins improved to 4.09% for the quarter ended June 30, 2007 compared to 3.93% for the previous quarter. As shareholders we believe growing earnings is more important than growing assets just to say that we grew.

Having said that, we certainly do not intend to shrink our balance sheet and we are confident that our team can perform well in this environment.

Loans decreased during the second quarter by $66 million to $3.2 billion. $53 million of this decrease was from the former Texas United subsidiary Banks and was expected as we managed to outsource some of their loan that did not fit our credit culture. We also experienced a $45 million decrease in the former Southern National Bank locations.

So if you take into consideration the rest of the bank grew organically about $31 million. Our loan demand is strong at an average of $95 million in monthly loan production. As the loan portfolio stabilizes from our recent acquisition, we expect to see a 4 to 5% organic loan growth going forward.

Our nonperforming assets to loans totaled $11.2 million or 35 basis points compared to $4.3 million or 13 basis points as of March 31, 2007. Again this was not unexpected. Our loan portfolio is largely comprised of credits that were originated by institutions that we have acquired over the past few years. As we have mentioned in the past, we expect to work through these credits over a period of time and improve the quality.

Tim will go into more detail in a minute but we do have a good handle on these assets. In fact approximately $7.3 million of these nonperforming assets should be extinguished in the next 30 days.

I feel very confident that the nonperforming ratios you all are accustomed to seeing from our bank will be back in a short period of time. It should be noted that our reserve for loan loss ratio is higher today at 1.14% when compared to the previous quarter of 1.12%; and our net charge-offs to average loans is the same for the current quarter as it was in the previous quarter at 2 basis points.

In closing I would like to say thank you for your support and confidence. I know bank stocks have taken a beating in the past quarter but I assure you we have not changed our model. I'm very confident in our model and our continued success. We have a great group of bankers and we will continue to grow and prosper. 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 of 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. Thank you. David.

Thank you, David.

Looking at income statement items and some financial ratios, net interest income was $51.3 million for the quarter ended 6/30/07 -- an increase of 40.4% over the same period last year and 11.4% on a linked quarter basis. As was mentioned earlier the net interest margin on a tax equivalent basis for the quarter ended 6/30/07 was 409 compared to 382 for the same period last year and 393 for the first quarter '07.

One point here. Taking out the impact of the TXUI acquisition, the margin for the rest of the bank in the second quarter was 3.85% compared to 3.79% in the first quarter. Noninterest income for the quarter ended 6/30/07 was $13.8 million, an increase of 51.2% over the same period last year and 18.6% on a linked quarter basis.

Noninterest expense for the quarter ended 6/30/07 was $30.1 million, an increase of 40.5% over the same period last year and a 10.3% increase on a linked quarter basis. Reflecting our ongoing effort of consolidating the TXUI transaction, the efficiency ratio decreased from 47.2% in the first quarter to 46.2% this past quarter. The tangible equity ratio increased from 4.97% in the first quarter to 5.48% at the end of the second quarter.

And finally a quick comment on the bond portfolio at 6/30/07. It reflects an effective duration of 2.9 years with a weighted average life of 3.9 years. The projected cash flow is approximately $500 million over the next 12 months.

With that let me turn the presentation over to Tim for some detail in loans and asset quality.

Thank you, David.

Nonperforming assets at quarter end June 30th '07, totaled $11.2 million or .35% of loans and other real estate compared to $4.3 million or .13% at March 31, '07. This represents an increase of approximately $6.9 million in nonperforming assets since quarter end March 31, '07. The June 30, '07 nonperforming asset total was comprised of $7,481,000 in loans, $75,000 in repossessed assets, and $3,637,000 in other real estate.

Approximately $7.3 million in nonperforming assets which is 65% of our nonperforming asset total, should be resolved by the end of this month, primarily through other real estate and collateral sales and loan paydowns -- some of which have already occurred. Net charge-offs for the three months ended June 30 '07 were $531,000 compared to net charge-offs of $635,000 for the quarter ended March 31, '07. This represents a decrease of $104,000.

The average monthly new loan production for the quarter ended June 30, '07 was $95 million compared to $79 million for the quarter ended March 31, '07. This represents an increase of $16 million.

Loans outstanding at June 30, '07 were $3.100 million -- excuse me $3.181 billion compared to $3.248 billion at March 31, '07.

The June 30, '07 loan total is made up of 40% fixed rate loans, 33% adjusting as prime moves, and 27% resetting at specific intervals such as quarterly or annually.

I will now turn it over to Dan Rollins.

Thank you, Tim. I want to spend just a few minutes talking about integration process of our recent merger with Texas United Bancshares and our plans to grow into the San Antonio market. We are very excited about our new team in San Antonio.

As you all know, we have not historically opened many de novo locations. We believe in relationship banking and prefer to build our bank around good solid bankers. Fortunately we have had two very experienced relationship bankers with deep roots in the San Antonio market join our team. We have already opened a loan production office there and are actively looking for the right place to open our first full-service banking center in that market.

As David mentioned, we continue to be excited about our future. I'm pleased to report that we have completed the systems conversion of all former Texas United subsidiary banks and all former Texas United locations have been rebranded as Prosperity Bank.

I am extremely proud of our team and the job they have recently completed in less than 120 days following our merger. Today, we have 124 full-service banking center locations across the great state of Texas; and our associates are fully engaged in providing excellent customer service to our customer base.

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

(OPERATOR INSTRUCTIONS) Brett Rabatin with FTN Midwest.

Two questions for you. First off, just wanted to ask on the attrition of the past acquisitions, deposits and loans, if that is over or if you think you'll see some more modest atrophy from those franchises in the next few quarters? And then maybe it looked to me like on the deposits side maybe $40 million or so was from Prosperity. Any thoughts on what you call Classic Prosperity as well?

I will take that. Basically again I would have to go through my numbers to answer the first part of your question, Brett, is I think you still will see some probably some more runoff. I think that it is stabilizing, but again in mentioning that when you look at the Southern National Bank acquisition probably paid a lot higher rates than even the Texas United Group did.

They had run a bunch of special rates and both of those banks had very high loan to deposit ratios close to 100%. So they were really in a position to go after some higher rate jumbo CDs and pay higher rates which we just elected not to do.

So I think that you probably still will see some roll off. I don't know that it will be as dramatic as it has been, but I do think you'll see some more. Can I give you an exact number? Probably not.

Then on the the Classic Prosperity, it sounds like maybe there's not any going to be there going forward?

No I don't think, I think -- again I want to go back and look at my notes. Was talking in my part of the conference call here, but I think that when you look at the other part, if you pulled out the part that was really -- that left from Southern National Bank most of it was from Southern National Bank's deposits not necessarily Prosperity's deposits. It might have been a very small amount.

It's just that other category that is considered other still includes the Southern National Bank because it's been over one year. So we put it together with all the others, but most of those deposits were really run off from Southern National Bank.

Then, secondly, what I call liquidity securities and Fed funds sold average in the period was down about $55 million. And I think Tim mentioned the $500 million rolloff for the next 12 months in the securities portfolio.

Should we be modeling from a margin perspective the same kind of atrophy in the securities portfolio the next two quarters? Or can you give us any thoughts on just movement from securities to loans and then just managing liquidity?

Yes. I think the way to draw that picture is, the question would be how much of that liquidity gets reinvested back into the securities portfolio? And obviously that would be tremendously impacted by the loans and what they're doing. This past quarter with -- we've seen the net loans down. If there's nowhere to lend them back out you put it in security.

So if you are thinking about going forward our hope is that we lend some of that excess liquidity out, which would obviously have a better positive impact to the margin than just putting it back into the security portfolio.

So maybe a little faster pace going forward?

Right.

Erica Penala with Merrill Lynch.

I just wanted to get a little bit more clarity on the nonperformers. Of the $6.9 million increase quarterly, how much of that was related to Texas United? Also what -- can you give us a sense of the loan bucket in that $6.9 million increase?

I can respond to that. I don't have the exact number on Texas United, but I can tell you that of that total almost $5.6 million pertain to Texas United, Southern National and a little bit of hangover from First Capital. The majority of the $5.6 million was Texas United. But I don't have the exact precise number on that in front of me. But $5.6 million came from those three banks. Once again the majority from TXUI.

Does that answer your question? I'm not sure I fully understood your question.

Also I was just wondering, I guess the better way to frame this question is, there has been some buzz in the market about worries with your residential construction portfolio. Could you give us a sense on either credit rating migration within the book and whether you saw some of that going into nonperforming?

Randy Hester is here today too. The question that we've heard about the NPAs on the construction business -- in particular in the Austin market -- we look down, there's 88 credits in that NPA book which says that the average is what $100,000 and some. We have a very granular loan portfolio. The biggest piece of that that's in there is a land development project here in the Houston market that is not something that was unexpected in our processes. We've been working through it.

Then, we've got some other commercial credits in the Dallas-Fort Worth market. I don't think that we are seen any big chinks in the armor on the residential construction side. I think there was a lot of talk but no facts.

Dan, let me add to that. The lot development loan that Dan just referred to is one that we have foreclosed on. And it represents about $3.3 million of our other real estate. So it is the bulk of our other real estate.

We do have it under contract for sale and there is hard earnest money behind it. We anticipate that that sale will close before the end of this month. One might question why a residential subdivision would be taken back at this juncture. And while it might be considered by some as evidence of softness in the market, we candidly see it as a little more of a management issue as it related to this particular borrower possibly.

I guess what deserves to be pointed out is that we have had a lot of interest in that property since we took it back. Once again we do already have it under contract and anticipate that it will close.

There's never an absolute guarantee that any real estate sale will close, but we think that this one is headed in that direction. So once again we have had a lot of interest in this property.

I don't think our model has changed at all from what we have talked about in the past. We certainly have a lot of loans on our books today that we did not originate that we continue to come through and try and improve the quality to the standards that we would want. But I don't think that we are seeing anything out there that is any different than we've talked about in the past.

Just one more question. Can you give us a sense on what we should expect with the expense run rate, and whether you are on schedule to realize cost savings from Texas United?

I'll jump in and work backwards on it. I do agree we are on schedule as far as realizing the cost saves. And when you are looking at the second quarter versus the first quarter, even though there was a 10% increase you can pretty much -- if you are looking back on prior quarters -- see that it was truly impacted by the recent acquisition. But as we continue to go out over the next few quarters, we will continue to realize additional savings. We are on target to do that.

Bain Slack. KBW.

Good quarter. I wanted to -- I guess actually the question I was planning to ask was just asked but I guess to put a nail in this coffin with regard to Grandview Homes, did you have any exposure to this bankruptcy?

This is Randy Hester. I'm the Chief Lending Officer. I can tell you we have no loans to that borrower at all.

Great. Thank you. I appreciate that and the color from the previous question. Thanks.

Brent Christ with Fox-Pitt.

Just -- I had a question on your outlook for organic loan growth. I think you mentioned targeting 4 to 5% growth over time. I think in the past you had expressed expectations or hopes that you could do something closer to the line of double digits. And I just wanted to see if there was a change in thinking there, if it's a function of being more conservative in a tougher lending environment?

I just said that because our Chief Lending Officer wanted me to say that. No, we probably -- truthfully we hope to do better but then, again, maybe we are just reading all the headlines everywhere where the headlines say there is -- we are coming into a soft landing that the Fed wanted us to come into. So maybe we're -- maybe we're pulling back a little bit.

Truthfully we hope to do better than that but we don't want to give somebody false expectations either.

Just two other quick ones. A follow-up on the cost savings question. Is it fair to assume that the quarterly expense run rates should move lower relative to second-quarter levels and the back half of the year? Maybe can you give us a sense of how far along we are in terms of what we saw in cost savings in the second quarter?

Yes. I'll jump in. Yes, absolutely, we should expect it to continue to see cost saves compared to this past quarter over the next few quarters. I think we are probably halfway where we need to be. I don't know that I can give you a specific number but when you look at the absolute dollars you can kind of get a good view of what is going on.

The only thing I would caution is, don't expect the same kind of dramatic change third quarter, second quarter. These remaining cost saves that we have we will continue to recognize them over third, fourth quarter and there will even be some into the first quarter next year.

I think that just painting a picture around the timing of all this we closed the transaction in the first quarter and you had two months of TXUI in the first quarter numbers. We had a full three months of TXUI in the second quarter numbers but we also carried expenses heavier on the TXUI side, all the way through May. Because that is when we were completing all of our integration puzzle and during that same time period you need to recognize that the integration of their 40 some odd locations was a project that really well over 250 people that work for our company were actively involved in on a day-to-day basis for several weeks, if not months.

And so, that's people that are in the core PRSP franchise ahead of time that were not doing their jobs as much as we were integrating the TXUI side. So you'll certainly see that continue to trail off as Dave said because we carried those expenses longer into the second quarter than we would have normally done in past acquisitions.

That makes sense. Then just last question in terms of the $7.3 million in NPAs that you indicated you are in the process of resolving, how much of that actually has been either brought back to performing status or sold at this point versus is in the process of being sold?

It's less than half of it that's already occurred. Most of it we anticipate will occur between now and the end of the month.

(OPERATOR INSTRUCTIONS) David Bishop with Stifel Nicholas.

In terms of the lift out from -- or the hiring of the San Antonio team there, any sort of color you can get in terms of potential loan book those guys can bring over and types of relationships? Is that going to look different than the historical loan mix?

You hate to put numbers out like that, David. On the other hand I would just tell you this that we normally will not do de novo locations. That is just not our type of business unless we can really get some really good bankers to join us and we really believe in the bankers.

And when I talked to both these guys -- Frank and Eddie -- their commitment is that they can really build us a really nice sized bank there in the San Antonio market. But as far as giving you exact numbers I would just I would hate to do that but I would tell you that we don't take it lightly, opening up a de novo, unless we have a lot of -- we really feel strong that they can do it, we wouldn't be doing it.

We talked to lots of people in the market as we were talking about making the change or growing into that market and these guys have a very good reputation as very good relationship bankers. I think that is what we are excited about.

Yes. Their family -- their father had a bank there. They work for the bank and they work for other banks so they have a great reputation. They come from a banking family and their reputation in that market is impeccable, I think.

One follow-up in terms of the recent rise in interest rates there, despite what is happening in the backdrop today in the market. Any further commentary and potential benefit from a net interest margin impact of redeploying those investment securities?

While Holloway is thinking about that let me make one more piece of comment about San Antonio. We are close to San Antonio now. I don't know that we fully colored all that. We are in New Braunsfel, which is between San Antonio and Austin, already. We are in Pleasanton which is just south of San Antonio and we are in Seguin, on the east side of San Antonio. So, really, we get very close to San Antonio and there are people in all three of those markets that actually commute in to San Antonio to work.

So being in San Antonio is just a natural fit for us as we continue to grow and these guys are going to be great for our team. Now talk interest rates, David.

Sure. I know Zalman wants to jump in but I will jump in first. Yes you know when you see that spike and using the 10-year as an example and you see it spike up a little bit that it did, obviously, if we have cash flow coming off that bond portfolio and we're not lending it out and we can reinvest it at those rates spike up like that -- that is obviously a very positive thing for us. So yes we don't mind that when you see that 10-year, David, and you want to -- and you get to see a [520].

No. In fact, we were looking for that. In fact we're planning on that because everybody -- our -- what's the yield on our portfolio right now, Dave? 489 or something like that.

So obviously the $500 million being reinvested if it doesn't go into the loan side gets reinvested probably somewhere between 5.75 to 6%. So it is a good hit.

Now the only thing I would want to mitigate there is that, even though we've taken a strong position and we've let larger CDs run off from some of these banks that we acquired you still don't want to let your balance sheet just wipe away. So I'd want to reserve some of that and say, you know we might have to you know we might have to be a little competitive if we see -- if we saw money leaving that we would not want to leave.

But, overall, it is a very positive thing for us.

Yes just to answer your question you'll get quarter of the yield on the bond portfolio was 479.

479.

One final question regarding pricing, maybe more on the loan side and in terms of conditions, any sort of improvement you have seen there? I know some of your commentary the past couple of calls is sort of pessimistic on that front. Anything that gives you a glimmer of hope that things are improving there?

It's still very competitive. We are -- our main focus is asset quality, but the marketplace is still very competitive as far as interest rate and terms on loan.

Jon Arfstrom with RBC Capital Markets.

Nice job. I just have more of a bigger picture question for you. I think you handled most of the fundamental stuff, but I just got off a call from a Michigan bank and it was pretty demoralizing. What I just wanted to ask you is when you have your feelers out across most of the Texas market and when you just think about the economy do you feel like it is still stable? Is it fraying at all?

Is it stronger in Texas because it just seems like Texas is the one market in the country that is stronger than any other. And I am just curious if you have any thoughts directionally on some of your markets?

If you turn the TV off and the headlines, you have a whole different picture. I guess when you are watching the headlines -- and so much of the rest of the country seems to be having a more difficult time -- it makes you more cautious because even though our economy still looks extremely good. Is it slowed a little bit? I would say I think it has done exactly what the Federal Reserve had wanted it to do when they started the increases in the interest rate they caused to have a soft landing.

And I think that is exactly what Texas is having, is a soft landing although having said that our unemployment is very low. We are still creating tons of jobs. People are still moving here. When I say it is a soft landing it just may not be where you had Star Trek at warp speed where we couldn't find help to build homes. We couldn't -- there was nobody to really -- the prices were going up so rapidly.

So overall I think we still have a very, very strong economy in Texas and probably -- you don't want to rely on this -- but probably some of that has to do with the oil industry. Probably [50%] of the companies in Houston still are related to oil and gas and that's, gosh, $75 a barrel just doesn't hurt us really.

Overall I'm the kind of guy that wants to tell you even the downside if there is a downside. I'd like -- I don't want to, but I would tell you that if it was really going backwards I would tell you but I just still think we have a very strong economy. The only thing that I hesitate on is when I read all the headlines everywhere else it makes you pause and say, "Well, if it's over there, could it happen to us?" You know?

I think we feel that we are positioned very well for whichever direction we move. I think that one of the things that we like the most about where we are today is, we think we are positioned into a spot today where if the economy slows, we will perform well. If the economy continues to hum along at its current pace we are in good shape there, too.

We appear to have no further questions at this time.

Thank you all very much, ladies and gentlemen. Thank you for participating in our conference call for the second quarter of 2007. We will look forward to seeing you again on our travels soon. Thank you very much.

This concludes today's teleconference. Thank you for your participation and you may disconnect at any time.