Prosperity Bancshares Inc (PB) 2008 Q1 法說會逐字稿

Hello, and welcome to the Prosperity Bank's first-quarter earnings conference call. All lines are in a listen-only mode. Please note this call is being recorded. Later there will be an opportunity to ask questions during our question-and-answer session. I would now like to turn the call over to Mr. Dan Rollins. Go ahead, sir.

Thank you. Good morning, ladies and gentlemen. Welcome to Prosperity Bancshares' first-quarter 2008 earnings conference call. This call is also being broadcast live over the Internet at 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. Here with me today is David Zalman, Chairman and Chief Executive Officer; Tim Timanus, Vice Chairman; and David Hollaway, our CFO. David Zalman will lead off with a review of the highlights of the first quarter of 2008; he'll 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 finally we'll 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, Katie, or you may email questions to investor.relations at ProsperityBankTX.com. I assume you have all received a copy of the earnings announcement we released earlier this morning. If not, please call Whitney Hutchins 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 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. good morning and welcome to our first-quarter 2008 conference call. I'm very pleased to report another successful quarter. Some of our successes this quarterly include -- our first-quarter earnings were up 13.4% to $22.9 million compared to $20.2 million for the same period last year. We reported diluted earnings per share of $0.52 for the first quarter of 2008 compared to $0.50 for the same period last year. Our return on average assets was 1.43% and our efficiency ratio was 45.06% for the three months ending March 31, 2008.

I am pleased to announce that on January 10th we completed the previously acquisition of six Houston retail bank branches from Banco Popular North America. All six locations are now operating as full-service banking centers of Prosperity Bank. We welcome all their customers and associates.

On February 7, we entered into a definitive agreement to acquire 1st Choice Bancorp Inc. and its wholly-owned subsidiary, 1st Choice Bank. 1st Choice operates two banking offices in Houston, Texas with one location in South Houston and another in the heights. We welcome all their customers, their shareholders, directors and associates and look forward to having them as part of our family. This transaction should close around midyear.

We are also excited to mention that we have moved into our new facility in San Antonio and are now operating a full-service bank while we completely renovate the facility. We could not be happier with the response we are receiving. Our success is due to Eddie Casseb and Frank Casseb who joined our team last year and whose family has been in San Antonio banking history for generations.

When comparing linked quarter deposits there was very little change. However, if you exclude the deposits acquired from Banco Popular you see a decrease in the deposits. As we noted in our year-end conference call, we experienced a large annualized increase of approximately 15% during the fourth quarter. At that time we commented this was more seasonal in nature and would normalize during the first half of this year.

Our net interest margin decreased to 4.03% in the first quarter from 4.12% last quarter. We were obviously impacted by the significant and frequent rate reductions that the Fed initiated. We are forecasting the margin to return as our deposits reprice. David Hollaway will provide more detail in a few minutes.

When comparing our March 31, 2008 loans to year-end December 31, 2007 loans we were pleased to see an increase in total loans. Our organic loan growth for the quarter was strong at 8.4% annualized when you exclude loans at the locations acquired in the past year.

I am sure everyone remembers, but just as a reminder, Texas United, which was our largest acquisition yet, had a very active mortgage lending department that generated traditional portfolio mortgage loans, held for sale mortgage products, one-time close construction loans and direct construction loans to builders on a contract and speculative basis. We decided very early last year to exit this line of business and are pleased with our decision even with the negative impact to our outstanding loans.

Our nonperforming assets to total assets at quarter end March 31, 2008 were 33 basis points, which compares very favorably to our peers and industry standards, especially in light of the current economic environment.

In wrapping up I would like to say, as I have mentioned before, we do not have any CDOs, SIVs or other esoteric products that are causing strain on liquidity in the markets. While we do offer traditional mortgage-related products, we do not operate a mortgage company, we do not have a factoring company or asset-based lending area; we do not participate in indirect lending programs and we do not participate in shared national credits. And finally, we are not involved in subprime lending.

Our management team has many years of experience, and if economic times change in Texas I feel very confident in the ability of our team and believe we will be able to navigate through any difficulties.

In closing I would like to say thank you for your support and confidence. We have not changed our model. I am 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 the 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 build 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. Net interest income for the first quarter 2008 increased 12.8% to $51.9 million compared with $46.1 million in the same quarter last year. This was primarily due to an increase in average earning assets of 8.9% which was mainly impacted by the TXUI acquisition. Noninterest income increased 8.6% to $12.7 million compared with $11.7 million in the same quarter last year. This was primarily due to the increase in deposit service charges generated on the increased number of deposit accounts from the TXUI transaction and I would note as of 3-31 we have approximately 332,000 loan and deposit accounts compared to 256,000 total accounts a year ago.

On the noninterest expense side, first quarter '08 versus first quarter '07 we saw an increase of 6.8% to $29.1 million. Again, these increases were driven primarily driven by the TXUI acquisition. The tax equivalent net interest margin, as mentioned before, was 4.03% for the first quarter '08 versus 3.93% for the same period last year and 4.12% for the fourth quarter '07. And again, based on our 3-31-08 asset liability model, we do see that the margin should improve and expand over the next few quarters helped by the yield curve and our ability to continue to lower deposit rates, especially as we have the ability as our book of CD business starts to roll over.

The efficiency ratio was 45.06% for the first quarter '08 compared to 47.23% first quarter '07 and 45.45% fourth quarter '07. And our FTE or full-time equivalent count at 3-31-08 was 1,374 which includes the Banco Popular transaction. So taking out those FTEs related to the Banco Popular transaction, our FTE count was 1,326 which reflects a decrease of 33 from the year-end number, 1,359.

Our bond portfolio metrics at 3-31-08 did not change much from 12-31-07. The weighted average life was 3.97 years, effective duration 3.19 years, and the projected annual cash flow is approximately $450 million. One last note, the tangible capital ratio was 5.94% at 3-31-08 compared to 4.97% at 3-31-07. And with that let me turn over the presentation to Tim Timanus for some detail on loans and asset quality.

Thanks, Dave. Nonperforming assets at quarter end March 31, '08 totaled $17,554,000 or 0.55% of loans in other real estate compared to $15,390,000 or 0.49% at December 31, '07. The March 31, '08 nonperforming asset total was comprised of $5,816,000 in loans, $126,000 in repossessed assets and $11,612,000 in other real estate.

Of the $17,554,000 in nonperforming assets at quarter end March 31, '08, approximately $1,417,000 have now been removed primarily through the sale of other real estate and there is presently an additional $2,464,000 in other real estate under contract that may close.

Net charge-offs for the three months ended March 31, '08 were $1,643,000 compared to net charge-offs of $3,113,000 for the three months ended December 31, '07. The average monthly new loan production for the quarter ended March 31, '08 was $94 million compared to $110 million for the third quarter ended December 31, '07. Loans outstanding at March 31, '08 were $3,162,000,000 compared to $3,143,000,000 at December 31, '07. The March 31, '08 loan total is made up of 40% fixed rate, 32% floating and 28% resetting at specific intervals. I'm now going to turn it over to Dan Rollins.

Thank you, Tim. Katie, I believe we're ready to take some questions now if you can help us with that.

(OPERATOR INSTRUCTIONS). Barry McCarver, Stephens Inc.

Good morning, guys. Great quarter. I was wondering if we could start off just on asset quality and hear a little bit more color about your thoughts on just sort of what credits in Texas are looking like in general and what you think the rest of the year might have in store for just all the banks in Texas on credit quality in general?

Berry, This is David Zalman. It's hard to speak for all of the other banks. I guess I can speak more for our bank. Just looking at it right now I have a little bit of confidence that things should improve, that's my gut feeling just looking at where we're at today and looking at past dues and reviewing --

You're speaking for our balance sheet.

that's for our balance sheet, that's right. So I feel a little bit better about it, but at the same time we don't want to be cavalier about it at all. We're still planning and expecting to be almost the same as last year, that would be the downside. But overall my general gut feeling is that things do look like they're improving for us.

For our balance sheet -- I think when you're looking at the markets that we serve, I think the same things that everybody else is talking about apply to us. I think that across the state the housing market continues to be not as in good a shape as it has been for the last few years, especially on the lower end of the market. Commercial real estate -- there's some strain in some of the commercial real estate. Some of the folks that I talk to in the real estate market, Barry, are watching the liquidity markets and they're basically saying we're going to sit on the sidelines for four or five months and wait and see what happens.

Barry, again, this is David. It's probably our -- we're colored a little bit because the loans that we're working and the asset quality issues that we're working through, probably 70% or more of them are from banks that we've acquired over the last couple years. So if we weren't having to work that I'd probably be jumping up and down right now. But we're still working through that. And I would say, again, if we didn't have that and we ran our normal deal that things still look pretty good really.

Okay. And just so we don't get caught off guard, when you guys bring 1st Choice on the books midyear is there going to be any significant level of NPAs there that might bring your overall numbers up a little bit?

No, keep in mind we've got a $3.1 billion or a $3.2 billion loan portfolio, they have $180 million, give or take, in loans. So this isn't the same type transaction that Southern or Texas United was just off of the size line. And then as a part of the transaction, as we have done in our past multiple transactions, they're disposing of some assets that will help us as we move into the combined merger.

And overall, just looking at banks doing our due diligence, their loan quality is pretty good.

Okay. Another question really moving over to thinking about deposits. I see where average rate did come down a little bit for your deposit accounts. Is that a trend that you're seeing accelerate in Texas at all or is it still pretty tough out there?

I think it is. As rates have dropped we've been able to drop rates also. And again, what's impacting our market, as David Hollaway said earlier, we still have -- our CDs are still yielding, what, Dave?

It shows it -- if you look in the press release the last quarter 4.45.

4.45, and so we're probably paying for the same CD rate today 2.65. So we should be some significant improvement right there. I mean it's still competitive, but I think people really do realize that there's probably two or three other companies that we all know that are paying a lot higher rates and they have to pay those higher rates for liquidity. But I think most people know that and if they're keeping money with them they're really keeping maybe $100,000.

The competition is still there. I think that you see that. I think our story and our model has been consistent for a long time. You see that with the deposit flows. We are not out actively bringing in deposits, we're protecting the deposit base we have and we're watching the cost on those deposits.

That's good information. Thanks a lot, guys.

Brent Christ, Fox-Pitt.

Just a follow-up on the credit quality. You mentioned that you have one of your larger ORE properties under contract, but could you just give us a sense -- I know there are a couple of lumpy credits in there, could you give us a sense in terms of the workout progress for those foreclosed properties?

Tim's flipping pages here. I can tell you in the ORE properties there are four -- four properties represent $8 million plus of the $11 million and one of those is under contract, another one of those -- a piece of it has been sold. Tim, have you got your answers to some of that?

If you look at the ORE at the end of the quarter, quite a bit of it was in four major blocks, two of which are retail centers and about $2 million each -- one of those is under contract and we're hopeful it's going to close. One obviously never knows until you get the money. The other two that total approximately $4 million are residential related and we have offers going back and forth, nothing under firm contract.

So I think if you look at the nonperforming that we had at this quarter end compared to the year end, there's good news and bad news there. The total number obviously went up, but there weren't that many new additions to the list. About 70% to 72% of what is on the list now was also on the list at the end of December of '07.

So we didn't really add substantially that many new credits to the list which is the good news. The bad news is a quarter has gone by and we weren't able to move all of them out. So it's taken us a little bit longer to move them out than historically it has. But we see light at the end of the tunnel in that regard.

All four of those big pieces were there at year-end and through various excuses and issues, none of them came off during the quarter and we had expected one of them to go away and it didn't. Some of them are under contract, we're working them through, I think we'll make progress this quarter.

And I guess with that in mind and kind of your somewhat optimistic backdrop in terms of the credit quality picture, is it fair to think that this could potentially be your near-term peak level in nonperformers?

It's hard for us to say that. We've been very hesitant, I think we've been very consistent and said that when we did the two transactions over the last couple of years we said we could get to 60 or 65 basis points. And I think it's -- I don't think it would be right for us to say this is the peak.

This is David Zalman again. Where we feel good about it, again I think it would be premature and it would almost be Cavalier on our part to say this is the bottom. I'd like to just stay where we said -- that we operate within those ratios that we gave. Although having said that I think it could be better than that.

Sure. And then maybe switching gears for a second. You guys obviously added a fair amount of deposits from the Banco Popular acquisition this quarter and it looked like the securities balances at the end of the period also moved up fairly considerably. I'm just curious, I'm assuming you used most of those deposits and purchased securities and if that's the case could you give us a sense of what you were buying?

Two items. Yes, one, we had $120 million or so of deposits from Banco Popular. But we also had a lot of money in overnight Fed funds that really -- we were just waiting for the right products to buy. The mortgage department got, we feel, a little overblown and the product that we were buying really didn't -- we didn't feel that it was yielding us.

Once the market hit a point that we wanted to buy at we really jumped in and probably bought 300 million (multiple speakers) and bottom line we're still buying product that's -- not generic -- but it's all -- I'm going to have to say it's all 100% Fannie Mae, Freddie Mac mortgage-backed security with an average life of around 3.75 years that has a yield today of about 480 to 490, I don't know what the 10 year is right now. Basically very little life extension -- even if interest rates go up 300 basis points most of the property we bought would not increase their average life over one year.

Got you. And then the last question, you mentioned the potential for a little bit of a rebound in the margin here over the next couple quarters as deposits reprice downward. Could you give us a sense in terms of how much in CD's you had rolling off over the next couple quarters?

When you look at our book of business most of our CD's tend to be short maturity. So we're probably looking at over the next six months 50% of that book turning over.

Got you. Okay, thanks a lot, guys.

Brett Rabatin, FTN Midwest.

Good morning. A couple questions. First off, on service charges, I was curious. They were a little softer this quarter and I was just curious if there was any color on just the performance there?

Yes, we looked at that because you're absolutely right, and I fall off and I don't know when we looked at it that there's any clear answer here. The historic trend, normally you see the service charges expand in the fourth quarter because of the Christmas season, and then you normally see them drop off in the first quarter. I don't know if I can attribute that today.

Again, when we look at it and you look at -- is it really digging into our fee income -- the biggest line item is service charge on deposit accounts. And the biggest piece of that is basically NSF charges and they've just fallen off. And as a bank we haven't changed anything, done anything, raised the per item charge, lowered it. So I don't know what the answer is unless it's a macroeconomic thing where people are knowing that they've got to look at every dollar and can't afford doing the overdraft anymore.

Your theory is that that's a lot of -- we don't know if it's right or wrong, but when you go and fill up your car with gasoline and you're paying $3.50 a gallon, we feel people may be strapped a little bit more and they're watching for overdraft charges (multiple speakers).

Yes, and just speaking to that point, because it's counterintuitive to a sense. But I was talking to one of our banking center presidents out in our southern region of the franchise and I didn't prompt him to say that but he brought that up himself. He said, yes, I'm seeing my customers not being quite where they're willing to write a hot check and have to pay that, whatever it is, $29, $30, whatever it is. They're just watching every penny, so that may be part of it. It will be interesting to watch in the next quarter to see if this trend continues, especially against the backdrop of high energy prices, high gas.

Okay, go figure, consumers getting smart. I wanted to talk about the reserve too. I know you guys are great credit managers. I guess I was surprised the reserve was a little lower this quarter. And so I'm just curious to hear some thoughts on your methodologies and I know it's not a black and white answer, but I guess I was surprised your relative reserve level was a little lower this quarter so I didn't know if you wanted to give any color around that as well?

David Zalman again. You know, it's not black and white. In the old days you used to say you wanted 1% in reserve and you'd put the 1% in there. In today's world you have to have this elaborate methodology that takes into consideration a number of things -- cash charge-offs, the amount that you have on your watch list, specifically economic -- there are so many variables that go into that. And basically we've been just really following the methodology that we have there.

So it's not something -- we've had a number of questions and people ask us about that, but we can't just arbitrarily anymore just because we want to increase more and put more into there, we have to follow the methodology. And from your perspective and our perspective, probably a year ago people were saying that we had too much in our reserve loss for the amount of loan charge-offs that we had.

So I think we have to stick -- you have to stick to the model that you have and follow that model. But I guess (multiple speakers) but I think the reassurance that I want to give you is that we're not going to just fabricate something. If that reserve needs money it's going to go into it.

I think we believe that our methodology is accurate and sound and I think we want to continue to follow the process that we've got in place.

Okay, great. And then just one last quick one on loan growth which was on a core basis pretty strong this quarter. I missed if you guys gave it, the monthly production and just where you saw those trends going and just generally your loan growth expectations?

The monthly production for this past quarter averaged $94 million and we see it, I believe, as steady going forward in the last handful of weeks. We haven't really seen a significant drop-off in loan requests, nor have we seen a significant increase. So it seems to be basically holding steady.

I'd like to add something to that, also, Tim. It looks more favorable to me also in sitting in loan committee where say a year ago, maybe even six months ago, we're seeing loans now though that we're getting an opportunity to look at and bid on and being able to price it better than what we saw even six months or a year ago.

Six months, a year ago when there were so many entities out there lending money that could just issue commercial paper and make loans it was so competitive, not to say that it's not as competitive, but things in my mind or the way I see things seem to really be stabilizing, getting back to a real credit market with a lot of the other players that were in there that really didn't have core deposits, they're getting out of the business. Do you see that, Tim?

Yes, I think David is accurate in what he is saying. It appears to us that a lot of these lenders that in the recent past did not factor risk into their pricing are having to do so now. Unfortunately not all of them do it, but more and more seem to be doing that. And it is enabling us to get a little better rate structure in what we're doing.

That's good to hear. Great. Thanks, guys.

Erika Penala, Merrill Lynch.

Hello. I just wanted to follow-up on the question on the reserve. Are you getting or are you hearing from your peer banks about the regulators getting more fussy and perhaps encouraging -- or becoming less methodology intensive when it comes to the reserves?

Erika, this is David Zalman. Probably -- there are different levels of regulators and I would say the people that examine us that come in once a year at the FDIC and the state-level, I don't think that they've ever changed. I think that they wanted you to have as good and as big of a reserve as you could always put in.

Six months ago or a year ago on a higher level their bosses in Washington and SEC because of GAAP was being so cautious that banks were being -- that they were over reserving. So I still don't think that it's changed on the level that we're being examined on. I think that they want to see as much as we can and want us to put as much as we can and we still have not heard that though from some of the higher levels. Dan, do you want to jump on that?

Erika, we just finished our annual exam here in the last month and we have great relationships with the examiners, the examiners are very pleased with the processes that we follow. We have no issues at all, I think there's good respect on both sides of the aisle. And so as David says, maybe the regulators are putting out different messages from the Washington headquarters to the field, but I think from where we are today and our methodology and the processes that we go through, we feel very comfortable that we're on target.

And I wanted to ask a question about M&A. What are your thoughts in terms of doing more small deals in '08 versus capital preservation and are pricing expectations getting any better?

Yes, I wish that were true.

I think it is -- well, let me say, you've asked probably two questions.

Sorry.

That's okay. The environment of M&A I think was the first one and then number two, price expectations. You know, we really -- we have done some smaller deals like the Banco Popular and the 1st Choice and probably are looking still at some smaller deals. At the same time we have not been as aggressive this year as we've been in other years primarily because we took on two very large transactions, the Southern National transaction and also Texas United, just three years ago. We're at about $2.6 billion today, we're about $6.4 billion.

So we really wanted to get our hands around what we had and make sure that our back rooms, that our operations, that our lending controls and everything was in place. Because of that we actually have pulled back from being as aggressive on the M&A.

With regard to pricing, I think when you first start talking to buyers out there, they haven't changed, but in the back of their mind they do realize that pricing has changed and changed significantly. I think that -- I'm sorry, the sellers -- the sellers, I think they do realize that. The real question is will they be selling or will they just be waiting out until the market may change? I don't know.

I think what you have with us, Erika, is the same thing that I was talking about earlier. I think we've got a process that we go through in our model, we've not deviated from that. I think we're very opportunistic. We look for transactions that benefit and that are wins for us and if those opportunities come along we want to look at them. If they're not priced appropriately we're not interested. If they're bigger or smaller, as David said, I think we kind of felt like we needed to kind of keep our head down and do our job, but when opportunities present themselves we're interested in looking.

But I guess an overall flavor that I would say, Dan, is that maybe a year ago or two years ago, if there was a deal out there we were a heck of a lot more aggressive than we are today. When we start negotiating today, if something seems unreasonable we're really not spending a whole lot of time on it really.

That's right.

And one housekeeping question. Could you give us an update on how your construction book breaks down in terms of raw land versus resi construction versus commercial construction?

Well, our total residential construction portfolio, which would include lots, land development and houses being built, is about 15% of our total loan portfolio.

It's really not changed much in the last quarter. You can see total construction was down a little bit quarter over quarter, but the breakdown is about the same as it was.

Okay. Thank you so much for your time.

[Carl Dorf], [Dorf] Assets.

Good morning, guys. Good quarter. I'm just trying to back a little bit more look at the reserving situation in a little different way. And would you guys by any chance have a figure for your watch list at the end of this quarter and what it was last quarter?

Carl, I didn't know you were still alive. Good to hear from you.

Still kicking and breathing, thanks. I still have my original stock from you guys.

I don't have that number as far as the number that you're looking for. The watchlist, we've never published it. Again, I don't have it here in front of me, but I don't think it's increased or decreased a whole lot. I think it's pretty much like it is. I know you like real direct answers and I don't have one for you, but that's about as good as I can give.

Okay, just thought I'd try.

Jennifer Demba, SunTrust.

My questions have actually been asked. Thanks.

David Bishop, Stifel Nicolaus.

Following up on the reserve questions here, how should we interpret the increase in the loan loss provision this quarter? Is that more symptomatic of, Dave, what you were talking about in terms of some of the macro inputs that you're seeing that would compel you guys to book that provision, or is that some deterioration in loan rating or -- and just maybe give us some color on that?

Again, it's an elaborate methodology and where we used to take five minutes and do it, it probably takes five hours. But I think the answer to your question is it's a combination. I think it's taking into consideration actual stuff that -- for example, when you put a certain loan in a watchlist category you classify it and based on what it's classified whether or not you have a reserve for it or not.

And so as those lists change and the numbers change your reserve is going to change based on that. But it's also -- there's an economic variable in there too and you have to consider the economic variable that the economics are out there and, you're right, that deal did kick up on us because we can't -- even though we live in Texas it would be imprudent to ignore what's going on in the rest of the country.

A lot of the loans that we have that came over from acquisitions, basically there were higher loan reserves that those banks had and they had higher loan reserves specifically because the type of loans that they had were more at risk. And so we're using that, but again, it's a two answer questions. It's that plus the economics have come into play. So the bottom line is this is not something that just popped up on us I guess. It's something that we were very aware of. It's nothing new I guess.

Thanks. In terms of -- just another housekeeping item -- the pure other expenses category, the line item, that looked to have about a -- when I calculate it, about a $700,000 decline. Any sort of color? Is that just more clean-up from TXUI or (multiple speakers)?

That would be spot on. Like we've been saying over the last few quarters as you recall, back last quarter if you remember, we said as we're getting this TXUI transaction more efficient we wouldn't see as much expense in the fourth quarter, we'd start seeing it more into the first quarter. That's what you're seeing. You're just seeing getting this thing finally towards its end.

And I'd like to add something to that -- on that question. Also recall we've always said on these transactions it takes us a full year to get our benefit out of this from operational integration and I just want to point out that, remember on the TXUI deal, that half that bank wasn't converted until like, May.

So I guess what I'm saying is we're still working on that and there should be a little bit more. But any cost saves going forward that we'll get in the next quarter will probably get offset by just the general expenses like insurance and merit raises and things like that. So I think we're getting to a neutral position on expense reduction.

Got you. And then finally commercial real estate is still showing some good growth there. What types of projects are funding these days? Is it still the tried and true local smaller credits here or has there been any sort of change in the types of loans that are being booked here?

I don't think there's really too much significant change, David. We've always looked at a variation of real estate loans. I think if there's any softness at all in the markets we serve from a commercial standpoint it seems to be more on the retail side than elsewhere, but it's not pronounced. The office building market still seems to be very strong in Houston and in most of our markets. Mini storage still seems to work, most industrial properties still seem to be doing okay.

And we have historically looked at all those sectors and loaned into them. So I don't think there's a huge amount of difference right now. I would say we're probably being a little more cautious when it comes to looking at retail shopping centers as compared to the other categories. But once again, it's not pronounced.

I think the model, again, hasn't changed. We're smaller credits probably been many of the guys that are our size or bigger. We're still playing in the $1 million, $2 million, $3 million, $4 million, $5 million range. We see a lot of credits in there.

Thanks for the color.

[Lozen Alexander], Fig Partners.

Good morning. I have a couple of questions. First of all with regards to FAS 157 and 159, can you tell us if you designated any of your securities portfolio to level 3?

FAS 157 and 159 level 3 is the stuff that's not trading.

I'd just back up because we don't have a trading bond portfolio. Everything is classified as either held to maturity or available for sale and the bulk of it is in HTM. Is that what you're asking?

Yes, yes.

Again, not being in a trading type environment, it really doesn't have any impact for us.

And the products we're buying are all highly marketable AAA (multiple speakers).

We don't have any nonmarketable level 3 stuff that he's talking about.

And then on the -- it seems like you had some gain in other accumulated other comprehensive income. Can you tell us a little bit more about that?

I'm sorry, we had what?

A gain this quarter also compared to the previous quarter on the other comprehensive income -- accumulated --?

You're probably referring to -- there's nothing specific, but I think what you're referring to is on the AFS portfolio, the unrealized gains and losses.

Sure.

And again, if there's an increase, that's just the unrealized gain on the AFS security. Just because of the rate drops, our overall portfolio, maybe that's something we could talk about is -- you can see it in the comprehensive income line, you see we actually have a gain because rates have dropped and made our portfolio more valuable. But let me just add some color to that. Our overall portfolio, if you were looking at everything, AFS and HTM, that we have -- as of 3-31 the gain in that portfolio is $30 million, a little over $30 million today in that and we (inaudible) three months ago, a couple quarters ago and there wasn't a gain in it.

It was just flat, yes, about even.

So it's a reflection of where rates are today.

But we're not trading in that portfolio. We don't have a trading portfolio.

I just wanted to make sure that there is nothing unusual there, that it was just the plain rate impact. Guys, that's it for me. Thank you.

Jon Arfstrom, RBC Capital Markets.

Good morning, guys. I love hitting clean up. David, a question for you. It seems like the banks that have capacity to grow seem to have better loan growth opportunities right now, and you alluded to that earlier. And I guess the question is are comfortable enough with some of the pricing and the terms and the structures that you're seeing now where we might see a little greater loan growth over time assuming it stays the way it is?

Yes. I could elaborate but, yes, my gut feeling is, yes. I think there are some real opportunities and possibilities. I guess we could probably be deviated. When we're not doing acquisitions we're really focused on building loans and it was always hard maybe for outsiders to see or maybe even believe that when we did a lot of these acquisitions it took so much of our own manpower because we didn't really hire outside consultants to go in and do the due diligence or to train the people or anything else.

And so, growing the way we did we used a lot of our manpower for the acquisitions where when we don't have the big acquisitions it's much easier -- those people are in their offices and they're building loans.

Okay. And then I guess the other related question is -- I remember covering you when you had a loan to deposit ratio of 38 or 39%.

35, Jon.

35, All right.

We have changed a little.

You've changed a little and I guess the question is how high do you feel comfortable taking that loan to deposit ratio?

Probably it's not just the way I feel about it, our directors are pretty -- they have some strong feelings about it because most of the directors are directors that lived through the '80s and they saw the banks that survived through the '80s in Texas were banks that had reasonable loan to deposit ratios. So I don't think you'll never see -- you should never say never I know, but I don't think you'll ever see us at a 95% or maybe even 85% loan to deposit ratio. I think probably for the high side you'll see from us is probably 75% probably, maybe 80% but probably more like 75%.

Okay. Great, thanks.

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