Prosperity Bancshares Inc (PB) 2009 Q4 法說會逐字稿

(Operator Instructions). Good day everyone, and welcome to today's program. At this time all participants are in a listen-only mode. Later you will have the opportunity to ask questions during the question and answer session. Please note this call may be recorded.

It is now my pleasure to turn the call over to Mr. Dan Rollins. Please go ahead sir.

Good morning ladies and gentlemen. Welcome to Prosperity Bancshares' fourth-quarter 2009 and year-end earnings conference call. This call is 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 am Dan Rollins, President and Chief Operating Officer for 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, and highlights of the recent quarter and the full year 2009. He will be followed by David Hollaway, who will spend a few minutes providing some of our recent financial statistics. Tim Timanus will discuss our lending activities including asset qualities. I will discuss the recently announced purchase of the three US bank branches in Texas, and 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@ProsperityBankTX.com.

I assume you have all received a copy of the earnings announcement we released earlier this morning. If not, please call Tracy [Schmidt] at 281-269-7221, and she will be happy to fax a copy to you.

Before we begin let me make the usual disclaimers. Certain of the matters discussed in this presentation may constitute forward-looking statements for the purposes of the federal securities laws and as such may involve known and unknown risk, uncertainties and other factors which may cause the actual results, performance or achievements of Prosperity Bancshares to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements.

Additional information concerning factors that could cause actual results to be materially different than those in the forward-looking statements can be found in Prosperity Bancshares' filings with the Securities and Exchange Commission, including Forms 10-Q, 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. We would like to welcome and thank everyone listening and participating in our fourth quarter conference call. 2009 was a very good year, and we are pleased to have been recognized recently in several publications for our 2009 performance. Prosperity Bancshares was included in the January 18, 2010 issue of Forbes magazine's list of good banks and bad banks as the fourth best bank out of the top 100 banks in the nation as measured by size. In addition, Prosperity was recently recognized by Morningstar for its strong performance in their article entitled Our Favorite Texas Banking Franchise.

We reported strong fourth quarter earnings per share of $0.65 on (technical difficulty) [or] $30.6 million. This was an increase in net income of $7.9 million or 34% over last year's $22.7 million, or $0.49 per diluted common share. We also reported strong net earnings for the full year of 2009 of $111.9 million, up 32% from 2008 net income of $84.5 million.

While we are very pleased with our performance, we incurred an extra $30.6 million in expenses above our 2008 level in two categories. First, we expensed $18.9 million in additional loan loss provision compared to 2008. And secondly, our first FDIC assessment -- I'm sorry -- our FDIC assessment increased $11.7 million over the 2008 assessment.

The two items alone represent a significantly greater burden on our bank above prior years. In light of the current state of our industry, we expect to continue to report higher FDIC assessments for several more years.

Loans at year-end were $3.3 billion, a decrease of $190 million, or 5.3%, from December 31 of 2008. Two factors affected our loan totals. One, we reduced our construction loans by $109 million, and second, loans that were acquired with the Franklin transaction paid down by $97 million.

Deposits at year-end were $7.259 billion, a decrease of $43 million compared with $7.303 billion at December 31, 2008. Our linked quarter deposits increased $140 million. When comparing the year-over-year deposits and excluding the runoff that was expected from the Franklin Bank deposit assumption, we recorded significant deposit growth for the year of $599 million or 11%.

Our nonperforming assets totaled $16.3 million or 22 basis points of average earning assets, compared to $21.9 million or 29 basis points of average earning assets at September 30, 2009. The allowance for credit losses increased to $51.9 million or 1.50% of total loans at December 31, 2009, compared to $37.0 million or 1.04% at December 31, 2008.

Looking forward, we expect our 2010 net charge-offs to stabilize and hopefully even fall from our 2009 level. We believe our nonperforming assets will continue to fluctuate between 25 basis points and 75 basis points of total loans, the same range we have discussed for the past several years. We expect employment in Texas to grow in the second half of 2010.

We feel comfortable with our consensus analyst estimates for our 2010 earnings-per-share. Obviously if the Texas economy takes a turn for the worse, a double-dip recession, we will change our view.

We will continue to consider the FDIC assisted transactions and other opportunities as some banks exit our markets. We will continue our focus on organic growth and continue to take advantage of opportunities that arise due to the extraordinary turmoil in the credit markets.

Thanks again for your support of our company. Let me turn over our discussion to David Hollaway, our CFO, to report some of the specific financial results we achieved this year, this past year.

Net interest income for 2009 was $307.1 million compared to $227.7 million in 2008, an increase of $79.4 million or 34.9%. This increase was primarily due to a 30.3% increase in average earning assets from $5.8 billion to $7.6 billion.

The tax equivalent net interest margin was 4.08% for 2009 compared to 3.96% in 2008. The margin for the three months ended December 31, 2009 was 4.24%, up from the third quarter number of 4.08%. The linked quarter increase was impacted by an improvement in the mix of our money. We saw increases in average interest-bearing demand deposits and money market deposits, which offset some of the decrease in average higher cost CDs, and our overnight Fed funds averages decreased from the third quarter of $[107] million down to $14 million in the fourth quarter of 2009.

Non-interest income for 2009 was $60 million compared to $52.4 million in 2008, an increase of $7.6 million or 14.8%. The increase was primarily due to a reduction on losses on sale of ORE.

Non-interest expense for 2009 was $169.7 million compared to $143.8 million in 2008, an increase of 18%. Excluding the $14 million impairment write-down on the Fannie Mae and Freddie Mac preferred stock (technical difficulty) non-interest expense would have been $129.8 million in 2008. As mentioned before, the increase in the non-interest expense was impacted by an increase in FDIC assessments and expenses associated with the banking centers acquired in the Franklin transaction.

The efficiency ratio was 42.44% for the three months ended December 31, 2009, compared to 48.60% for the same period last year and 44.46% for the third quarter 2009. The efficiency ratio for 2009 was 46.27% compared to 46.51% in 2008.

Bond portfolio metrics at 12-31-09 reflected a weighted average life of 3.0 years and an effective duration of 2.8 years. The cash flow coming off that bond portfolio continues to run at about $1.2 billion annually.

Finally, our capital ratios all increased from 12-31-08 to 12-31-09. Total risk based capital ratio increased from 11.2% to 13.9%, tier 1 risk based capital ratio increased from 10.3% to 12.6%, and the leverage ratio increased from 5.7% to 6.5%.

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

Nonperforming assets at year-end December 31, '09 totaled $16,356,000 or 0.48% of loans in other real estate, compared to $21,920,000 or 0.64% at September 30, '09, and $14,368,000 or 0.40% at December 31, '08. This represents a decrease of 25% from September 30, '09 and an increase of 14% from December 31, '08. The December 31, '09 nonperforming asset total was made up of $8,411,000 in loans, $116,000 in repossessed assets, and $7,829,000 in other real estate.

As of today, $2,467,000 of the December 31, '09 nonperforming assets total are under contract for sale. But of course there can be no assurance that any of these contracts will close.

Net charge-offs for the three months ended December 31, '09 were $3,949,000 compared to net charge-offs of $2,549,000 for the three months ended September 30, '09, for a 55% increase. Net charge-offs for the year ended December 31, '09 were $13,881,000 compared to $7,621,000 for the year ended December 31, '08. This represents an 82% increase.

$8,500,000 was added to the allowance for credit losses during the quarter ended September 30, '09, compared to $7,250,000 for the third quarter of '09. And $28,775,000 was added during the year 2009, compared to $9,867,000 for 2008.

The average monthly new loan production for the quarter ended December 31, '09 was $85 million, compared to $77 million for the third quarter ended December -- excuse me -- September 30, '09.

Loans outstanding at December 31, '09 were $3.377 billion compared to $3.406 billion at September 30, '09. The December 31, '09 loan total is made up of 40% fixed rate loans, 26% floating rate loans, and 34% that reset at specific times.

I'll now turn it over to Dan Rollins.

I'm sure you all saw our announcement on Tuesday afternoon that we reached an agreement to assume approximately $400 million in deposits from U.S. Bank at their three Texas branches. U.S. Bank took over the former North Houston Bank, Madisonville State Bank, and Citizens National Bank in Teague, Texas last October after the FDIC was named receiver of those three banks, along with the other banks owned by FBOP.

The addition of those -- of these three locations to our Texas franchise is a natural fit. As part of the transaction, we have agreed to purchase the banking facilities, and we have the option to purchase any Texas loans we want, however we are not required to purchase any loans. We expect to be able to complete this transaction before the end of this quarter. This should be a good opportunity for us to further expand within our Texas footprint.

At this time we are prepared to take your questions. Shannon, can you assist us with that?

(Operator Instructions). John Pancari, Macquarie.

Can you talk a little bit more about the margin outlook in terms of the expansion that you saw here and the sustainability of it going forward over the next few quarters here?

Yes, John. I'll jump in first on that. Again, one of the things to point out is on a linked quarter basis, again, from third quarter to fourth quarter you saw it come up a lot, a little bit more than what we would've anticipated. But again, there's so many moving parts to this thing, and it can't be understated, on the -- and the deposit growth that we saw in the fourth quarter was -- were lower interest rate type accounts, money markets and interest-bearing checking, offsetting what we were losing on the CD side, which was high cost CD money.

And then again, we weren't as liquid in the fourth quarter versus the third quarter. We had -- in this low rate environment we are taking -- we're being opportunistic in terms of having to redeploy that liquidity for the low cost money.

So all of these factors come into play. It's what saw our margin come back in the fourth quarter.

If that dynamic continues to play, at least over the next couple of quarters, that margin will tend to hold right there. But again, the hard part to this is you don't know what these inflows and outflows of new money ultimately will be, and you can see that it can impact that margin.

And again, we've also got to be kind of aware of what are we investing this excess liquidity in. If we stay very liquid over night, you're getting basically nothing in terms of investment. That has impact on your margin. That's kind of our conservative way we look at it, because inevitably rates are going to turn up. Now, probably everybody agrees, maybe not for the next 12 months. I mean, who knows? You just don't know with everything being so volatile.

So we are walking a fine line here. It's a long-winded answer, but these are all kind of the things that we have to look at.

I think I'll jump in. Looking at our net interest margin, and it looks -- it's pretty stabilized. I mean over the year it looks pretty good. On the other hand, it's what David Hollaway said, we have a lot of money that comes off of our bond portfolio. And that margin really depends on whether or not we reinvest it right away or we wait.

And right now we are considering, with the government pulling out of the mortgage-backed security market by March, we may want to take a position where we are not reinvesting everything right away over the next month or so. And those are the things that can cause the net interest margin to maybe change good or bad. But right now it looks pretty stable.

That's helpful. And I guess on that line of questioning as well, just in terms of the loan demand you're seeing, can you talk a little bit about demand and whether we could see kind of a resumption of loan growth here over the next couple of quarters, particularly maybe around the small business or C&I side?

We see really a continuation I think of the status quo on loan demand. I don't think there's any reason to think it's getting ready to spike up significantly, certainly not from overall economic reasons. We've mentioned before in prior calls that a lot of our competition is not necessarily doing very well these days. And a lot of them have had to pull back on their loan desks, and that has created opportunity for us to pick up new customers that maybe we wouldn't be able to do things with otherwise. We see a continuation of that scenario, but once again, I don't think there's anything that we see on the economic horizon that tells us that loan demand is getting ready to take off and spike upwards.

So all that stirred together to me says that we are not getting ready to see a significant change one way or the other in loan demand.

That's appropriate. Didn't you say during your comments, Tim, that the production during the fourth quarter was better than the third quarter?

It was. I don't know that that's indicative that it's just going to absolutely be significantly better next year, though.

Yes. We talked about it, Tim, and really the increase came from a couple of bigger deals where it's taken advantage of situations where some -- maybe a couple of bigger loans were being financed through other ways when the economy was different, and now we are getting offers, and if you just look at some of those special situations, because some of those other alternatives from borrowers aren't out there, and so that's kind of what helped us I think in the last quarter (multiple speakers)

And we hope to continue to be able to take advantage of those opportunities (multiple speakers)

That's right. And there will be some of that. That's the good news.

And can I add one more thing. I know, David Zalman, you had mentioned not long ago about FDIC assisted deals, your interest outside of the state. We are aware of some of the larger names in some of the adjacent states there that have some C&D orders and are struggling. Can you talk about -- give us an update on what your thoughts are there in terms of FDIC assisted deals?

Well, we -- as you know, we are looking at everything. We are on the FDIC list, and, gosh, we probably get three to five a week, I guess. So we are looking at a lot. I would tell you up to this point in time, though, that a lot of the banks that we are seeing are banks that we're not necessarily interested in, simply because when we look at them, they were banks that were started in the last five to 10 years and 60% and 70% of their money is C&D money. But if we ever find a bank that's really a good core bank with a good core relationship that's been around for a long time that fits into that category, we will certainly consider it.

And it's going to be compelling from a financial perspective from our side (multiple speakers)

Absolutely.

I think our model is the same as it's always been. Certainly we are looking for opportunities, but it's going to have to be the right opportunity, and we are not feeling any pressure to go do anything immediately. We're going to study it and look at it and be prepared when the opportunities present themselves.

We know that a lot of banks have been out there and they've raised money and they're looking for deals like this. And I think it could be very easy to jump into something just to say you did it. But we really feel there's going to be a lot of opportunities throughout the whole year. So we are really trying to pick the one that really makes us the most money and we can handle the best.

Thank you for taking my questions.

Brett Rabatin; Sterne, Agee.

I wanted to ask two questions. One is just a little more clarity on the expenses. The salary line was a little light this quarter vis-a-vis the past few quarters. Can you talk about is that a normalized level going forward? Or was there anything unusual, reversals in that line? Is $20 million kind of a good run rate?

Yes. I would just jump in and say, not only that line item, but you could probably use that whole fourth quarter as a jumping off point for annualizing in the new year, plus say at 5%, because we just have some natural increases that we'll have to build in for the new year.

Okay. And then secondly, you indicated you thought charge-offs would be lower in 2010, and if you talk to certain people in Texas, it sounds like they are somewhat cautious on Texas and saying they are seeing the effects of the recession. On the other hand, the Texas index of leading indicators is positive, and you guys don't sound necessarily ebullient, but you do sound somewhat optimistic for the economy. Can you reconcile all that for us and if you think there's a chance the Texas economy kind of lags in 2010? Or give us a little more color on why you think some people are a little concerned about the recession in Texas?

Well, I -- for such a long period of time most people thought that Texas was immune to the recession. And we found out last year that we weren't. In our particular case we are making that comment based on what we are seeing in this first month of this year, where our charge-offs seemed to be somewhat lower.

But again, we don't want to be just overexcited and jubilated and say it's going to happen. From our perspective things do look a little bit better. But having said that, it's hard to reconcile because nobody really knows. So much of it depends on the economy and the political [deal] out there. But from what we see and in reading what some of the local economists have said, they are expecting Texas to start employment increasing by the second half of this year.

Having said that though, some of the economists -- or if you read some of Forbes magazines or Fortune, they're still projecting some home values in Texas to decrease this year. Houston I don't think is very bad, they're looking at about 1.7% I think. And then some other parts of the state get up to 2% and 3%.

But again -- so you're having to deal with that, but overall we still think it's going to be good for us. I can't say it's going to be good for everybody because everybody's situation is different. Just looking at our portfolios, we are a little bit excited about it. We think we're going to have a good year.

I think that when you look at Texas and the Texas economy -- we are not economists, and we read all the stuff that everybody else is. I think it's a psychology issue, the way I would look at it. But whether the home prices fall 1% in Houston or not -- I mean, some people are telling you they're going up, some people are telling you they are going down.

But what I see and hear when you're out in the communities that we serve, whether that's Dallas or Austin or Houston or anywhere in between, there's a lot of people that are sitting still. They are not really ready to do anything.

We can name customers that have decided it's in their best interest just to pay down debt and sit and be still and wait and see what happens. So as long as everybody is waiting to see, that just continues to depress or hold down economic activity in the state.

Now, I think there's a lot of money out there chasing things around, but from what I can tell, the money that's chasing things, it looks like it's chasing things they can steal. It's bottom fishers. So I think we need to see some normal economic activities before we can tell you that Texas has turned the corner.

But still, Texas is not hurting. Things are doing good. I went to dinner last night on a Thursday night, and I had to wait 20 minutes to get a table at a restaurant. I was shocked.

It is a bit ironic, because on one hand you have some people in our overall economy, compared to the rest of the United States, is doing really good. But at the same time you have some people that are really hurting and declaring bankruptcy and that. So you have a real mix. It's really unusual. You've got some people doing good, but then you're having some people that have problems too.

I think the psychology of it is part of it. The rest of the nation was feeling -- they got to the party before we did, they've digested the feelings that we are having in Texas earlier, and maybe they are seeing that things are getting better, and we haven't recognized that yet.

Most economists -- again, everybody can read what they want to read. But most economists are projecting and predicting that Texas will come out of this before anybody else will.

That's right.

Thanks for all the color, and nice results in 4Q.

(Operator Instructions). Jon Arfstrom, RBC Capital Markets.

Tim, you mentioned a number that I missed, and I think that was NPAs under contract for sale after quarter end.

Yes.

Can you give me that number again?

$2,467,000.

Okay.

I think the story there is basically the same as it's been quarter after quarter. Our team is very focused on moving things through quickly. The NPAs were down, and we feel really good about that. But I told somebody a little while ago, I said, I'm not sure I'm writing home to mama about it, because it could just as easy go up $4 million or $5 million or something if another big credit kicks on there. But certainly we think we are doing a good job on that front.

Well, the good news (technical difficulty) is that we are selling the stuff out of ORE and nonperforming loans. We probably -- you might have $2 million or $3 million going in, but you also have $2 million or $3 million going out. It seems like we've actually had more going out than coming in. So I think that's a good sign that we are able to get rid of this stuff.

It's getting to the point where you're going to have to do an acquisition to give you guys something to do.

We just did. What are you talking about? We did on Tuesday.

Got to give them some more loans to work on.

That's right. Well, there's no loans in that deal. I guess we can look at some. Somebody said the other day -- you're probably right -- our team likes to eat red meat. They are ready to do something. They need activity.

Yes. We're getting to that point.

On the deposit growth, I think I know the answer to this, but I'll ask it anyway. Have you done any advertising or promotion, or is there any specific driver to that deposit growth?

None at all. What we saw is -- again, if you look at our numbers -- Dan, you may -- you look like you wanted to jump in -- but the bottom line is, we knew that we were going to lose a lot of the higher rate CDs out of the Franklin deal, which we ended up losing 500 and something million dollars, but a good thing that helped our net interest margin that Dave was talking about, we increased so much in regular checking accounts and money market accounts and things like that, that are at a lower cost.

The advertising we are doing is just name, [rank and serial number] (multiple speakers)

That's what I was going to say. We certainly are doing advertising, we did more advertising and more marketing in 2009 than we did in '08, and we're budgeting to do that much or a little more in 2010. But it's image marketing, it's name recognition marketing, we are not advertising any particular deposit product, and we're certainly not advertising any rates. So I don't think our advertising is driving specific deposit products.

But I will tell you, we all think that our name advertising has done a good job for us in opening doors and helping us get into some businesses and calling on customers that we had not done before. So -- and I don't know how you quantify that, but our advertising we think is doing well, but we are not advertising specific products.

On the deposit front, I just want to echo what David said. I think when you look back a year ago, this call in January last year, we were talking about what our expectations were in the way of the Franklin deposit runoff, and I think we've been right on target for that all year. So you can see that. We probably won't break out Franklin any further. We typically break that out for four quarters, this is the fourth quarter. So you can see we are at basically $1.4 billion in Franklin deposits, and that's right in the range of I think what David told you, $1.2 billion. I told you $1.5 billion four quarters ago. So I think we are right in between the numbers where we thought we would be.

Dave said yesterday that he still feels there may be $100 million or so (multiple speakers)

That could be.

Just where we are at in the rate environment, right? (multiple speakers) You have rates coming down, and again, we have to ask ourselves the question from the liquidity perspective, we can't be paying up on CD rates today (multiple speakers)

Right.

What would you invest in?

That's right.

Thanks for the color, guys, appreciate it.

Bain Slack, KBW.

Good quarter. Just wanted to see if I could dig a little bit into the USB transaction. I know it's pretty de minimis in sort of its size. But just wonder if you all had any pro forma numbers on the impact to the tangible common equity or what the expected accretiveness is.

No, we talked amongst ourselves. I don't have any ratio numbers to give you. It's going to be minimal, as you said, the size of the transaction. It's $400 million in deposits. We did not put out the deposit premium because U.S. Bank doesn't want to talk about that. But you can assume it's a relatively small number, and with our earnings capacity you can assume that it's not going to negatively impact our numbers in any big way.

When you look at the EPS side of the deal, in today's rate environment I guess there's a positive and a negative. It's good core low-cost deposits, or relatively low-cost -- they are higher than ours but not way out of line. But when you look at the EPS accretion off of that, I think we would want to guide you on the smaller side in that, remember that we are going to get a wire transfer basically for $400 million, and David is going to put that to work in our bond portfolio at somewhere around 3. So the ability to make a large ROA on that book of business is probably not there on the front side.

Long-term, clearly we think we can do well on that. So -- and if you dial in 50 basis points ROA maybe on that money, I think that would be a realistic expectation.

And I guess kind of like with Franklin, is there some runoff expectation color that -- from that 480?

There is. It's 420. There was -- in December they had about $420 million in deposits. Our expectation is that that will drop between now and closing, and our -- we think the real number there is somewhere between $300 million and $350 million.

Okay, 3 to 350. Great, thanks. And I guess just last question, if -- on the loan side, I guess, can you maybe give some characteristics of what you guys might be looking for?

Are you talking about loans from USB or loans in general in the state of Texas?

No, no, no. The cherry picking from this UBS transaction.

Yes. They -- this was a part of a big holding company that was spread from California to Chicago to -- Texas was the smallest piece of it. I guess that's why USB didn't want to stay here. I don't think we have any interest in participations or parts of credits outside of our market. We like in-market credits with customers that walk in the door and bank with us. And so that's clearly where our focus would be, and I think, while I don't have numbers for you, our expectation is that that's a very small part of their loan book. So I wouldn't expect that we are going to see a large loan purchase here as a part of this transaction.

Great. And just last question, if you could help remind me, the -- going to the fee income, was there something in the third quarter that caused the deposit account service charges to sort of be higher than what we have seen I guess previously and in this quarter?

Yes. It was down a couple hundred thousand this quarter.

Right. No. I mean, again, nothing -- there was no extraordinary anything, nothing season -- nothing unique. It's just what it was.

Okay. Yes, I just was going back to the second quarter and the third, it just looked like the third quarter was just high for some reason. And I couldn't recall if you all had discussed that before.

Yes. Again, nothing unusual in there. Just assume the customers -- the big bulk of that is driven by insufficient income. So assume people wrote more hot checks that quarter.

Okay. Well great. Well thank you all very much.

David Bishop, Stifel Nicolaus.

A quick question for you. In terms of more of a macro question there. You guys have obviously been through these cycles before. In your opinion, do you think the small business customers, the commercial customers you service entered this recession I think better prepared to -- from a cash flow perspective, relative to the last recession? What are you seeing there in terms of the resilience of your business book?

The accounting probably in Texas, you have to break it down, comparing the '80s to where we are at today in the 2000s. In the '80s so many of the small business people were relying so much -- they were relying heavily on oil and the oil prices, and they got just creamed on it. So from the oilfield patch, I would say that, yes, everybody this time is so much more prepared. You don't see the people just leveraging up and thinking there is no tomorrow. In fact most of those customers tend to -- they realize that they still have scars on their backs, so they were a whole lot more prepared for that.

With regard to housing, I find it a whole lot different right now, the construction business too, and some of the builders that we have right now, we still have some really good builders. And just in loan committee yesterday one of the officers, we looked at a builder, and he had maybe $15 million in September when we looked at -- in inventory. And we all said, even though he is extremely good, that still looks like a lot for this builder. And our officer went back and talked to the builder, and the builder listened to him, which is -- which a lot of times that doesn't happen, but they said, you know, we thought about it and another banker told us this --and today they're down to $3 million or $4 million.

So I think the people are a lot more prepared. I really do. On the other hand, some of the real small, small customers, the really mom-and-pop shops, I think they are probably having a more difficult time, the people that had not been through this in the '80s. So I -- that's where I see a lot more of the weakness right now, not in the guys that have been there in the '80s in the homebuilders and the oil business. I see it more in the -- in more in the mom-and-pop shops that have not experienced this and have kind of overleveraged.

And then Dan, sort of turning back to the USB transaction, I guess following up on Bain's question, I think you guys talked about operating expenses maybe building about a 5% maybe run rate increase for this year. Does that include the effects of the branch purchase?

No, no. We were talking organic. I think when David Hollaway was talking, he was saying take your 4Q numbers and dial out 4Q plus 5% for just natural growth and expenses on the legacy or existing book of business that's there. And any acquisition changes, USB or any others, would be on top of that.

Any guidance you can give us there in terms of potential (multiple speakers)?

I think it's easier for us to come back at it from a big picture way, from a guidance -- when you look at the number of offices that we run, I don't think any of these three offices are going to be more expensive or less expensive than the other 158 that we've got. So I think I would look at it as -- take our expense base and assume we're going to pick up 1/158 for each one of those offices, and run forward from there.

Got you. Great, thank you guys.

Jennifer Demba, SunTrust.

A question on the reserve. Looks like loan growth will be minimal this year. You said net charge-offs will be down, NPAs have been going -- have gone down. Do you expect to build the reserve much more from here? I know you wanted to hedge yourself, but --

Again, we are supposed to say all this depends on the methodology that we use. And that's the examiners and regulators really in today's world, they really want you to use your methodology. So even sometimes with what we feel, what we want to do, we have to go based on the methodology. And the methodology, as you know, has so many different factors in it. One of them is the economy, one is our peers, what they are charging off. There's probably 10 factors in there. So that's really going to determine what we do to increase our provision for loan losses.

At the same time, my personal preference is, if we had it, look, if there is a factor for influence on that methodology, it's to continue to build it if we can.

All right, thanks a lot. Good quarter.

Chris Marinac, FIG Partners.

Just wanted to follow up, David, on your comments earlier on M&A. Do you think there are opportunities this year to do sort of regular way or non-assisted transactions? And do you have to be even more tough on negotiations than you normally would be?

(multiple speakers) Well, that's a hard question and a (multiple speakers)

Well, opportunity (multiple speakers)

We are hoping that there is. I know where a lot of -- most -- a lot of banks are focused right now strictly on FDIC transactions. We are focused on that, but we are really looking at things where other banks may be in our area or in Texas that may be wanting to exit for some reason. We'd also like to look at some banks that may be having a little bit more difficult time, that perhaps with what we can offer in -- as far as efficiency ratios and some of the others on the loan side, that maybe we can team up with somebody like that.

Is pricing any different in this environment than it normally would be as you look at a deal?

Absolutely. It's day and night difference than a year or two years ago, for sure. It's day and night difference. Usually the people that you're talk -- first of all, I think somebody that's really healthy right now, I don't know, and they're wanting a price that was a year or so ago, that deal is just not going to happen. We've had some people that have called us, and they are still expecting prices that were available two years ago. That's really not out there.

The deals that you're probably going to do right now, and they probably aren't going to sell, the deals that you're looking at right now are special situations where it's mutually beneficial for both parties to do something.

That's right. We certainly have had some discussion. Part of our job, mine and David's in particular, is we spend a lot of time talking to other bankers, and there's other banks out there that are healthy, doing well. We've visited with some banks that are doing very well, that maybe they want to see what they could do to partner up and get some liquidity. The problem is, the valuation that they thought they were going to have two years ago is not there today, even though their bank is very healthy and very stable. So what you're seeing is distressed situations more often than not.

Right.

If you are healthy and you can hold, there's really no reason to sell at a depressed price today.

On the other hand, I would probably make a comment that would say that if times stay like they are over the next year or two years, you'll probably see healthy banks do sell --

That's right.

-- and sell at a more realistic price or be willing to accept a more realistic price based on where we are at today.

That's right.

Great. Thank you so much. Appreciate it.

(Operator Instructions). Andy Stapp, B. Riley & Co.

Nice quarter. How did early stage delinquencies in the watch list compare to Q3?

Dan, is that you?

I probably have that number.

It can be me. The delinquencies have gone up a bit, which is not surprising given our experience in these kind of economic times. When you go into difficult economic situations, the weak credits fall out immediately. And hopefully we didn't have very many of those.

So what that means for us is that a lot of what we see in deterioration is lagging. And by that I mean, you have good customers that continue to pay, but as conditions continue to be weak or even worsened, some good customers can hold on only so long. And as hard as we try to keep current financial information on all of our customer base, sometimes there are surprises out there. And there are people that have paid on time for years, and all of sudden they run out of gas, so to speak.

And if in fact we see a continued situation of delinquencies going up a bit, I think it's because of that. And that's just the kind of portfolio we have. And that's the kind of experience that we have all seen in these economic times. So it's very hard to predict if and when somebody that's been good for years all of a sudden becomes not quite so good. But I think that's what we are faced with.

Probably a couple of things I'd add to that, Tim, and I -- again, I haven't seen the list completely. But again, when you have the amount of loans that we are talking about compared to some of the other banks, you can get two or three bigger loans that might have been past due for an extended period of time for special reasons because of negotiations, or they might have wanted a cheaper interest rate because everybody else is giving it to them and we are not willing to give it to them, which affected these numbers.

And as well, we still have some agricultural credit that this is the time of the year that they renew, and until they get their government payments and things like that in, we can't really renew them until we get their complete situation and understand where they are at.

So I think a couple of factors added to that this quarter.

I think that's right. There is certainly some seasonality when it comes to the agricultural piece of it, no doubt about it.

Ag loans were also down quarter-over-quarter about $10 million, which was a part of the shrinkage in the loan portfolio.

Okay. And could you provide some more color on how you are positioned for eventual Fed rate hikes, including the impact of interest rate floors?

Well, I'll jump in there, and David you can -- I guess basically you're asking, what is that going to really do to us if we have interest rate hikes? Is that the question?

Yes.

What part of our portfolio has floors?

Oh. Somebody else has to answer the question about that. I can talk more specifically about the $4 billion bond portfolio. Our average life on that is probably a little bit less than three years. Our duration is a little bit less than three years, two point something. David, you've got the (multiple speakers)

It's 1.8.

1.8.

2.8.

2.8. 2.8 is our duration. So right now we have a big gain in our bond portfolio, probably around $140 million, $150 million, something like that (multiple speakers)

In the total portfolio (multiple speakers)

Total portfolio (multiple speakers)

Including healthy maturity.

Including healthy maturity. So what will probably happen, if interest rates go up say 300 basis points -- and if they went up on a parallel shift is one thing. If they usually -- if they don't go up strictly straight parallel, meaning that if interest rates go up 300 basis points, the three-year that you've been buying that you were getting 3 or 4 on is going to go to 7. Usually there's somewhat of a change.

But we see from going, a gain in our portfolio to a loss in that bond portfolio. And again, it's still a very short portfolio, about as short as you can get, so for a year to two years. Our ship kind of takes a while to turn around. So we see that.

It will impact the margin to a certain degree. We are thinking our margin will be impacted by -- there are some things we can do to change that margin, but again, we will still see a decrease in the margin say with a 200 or 300 basis points of -- Dave, 10, 15, 20 basis points?

Say 10 to 15 out -- if you're going out 12, 18 months (multiple speakers)

12 to 24 months out, yes (multiple speakers)

Assuming a parallel shift up 300 basis points?

Right, right.

Yes. And that's the whole reasoning to keep the bond portfolio short and why we continue to talk about, do we actually put all our liquidity into the bond portfolio? Because eventually when rates move up, we've got to stay short. It's (multiple speakers)

I think when you're talking about a bank like ours, where a lot of other banks might have 80% or 100% loan to deposit ratio, we don't. So when interest rates go up for a bank that's got a very large loan to deposit ratio, if they don't have a lot of fixed rates in there, their income is going to skyrocket up and shoot right away. (multiple speakers) Vice versa, when it goes down --

If rates aren't so far below the floor (multiple speakers)

Right.

The floor is also a negative on that (multiple speakers)

Right. Then if rates go down, then a bank like ours -- so I always call our bank, it's more like the Queen Mary trying to turn around on the highway out here. It just doesn't happen, you can't do it. It takes us about 18 months in one of these cycles to change with it. You're never going to see real big increases in income or low -- or decreases in income. It just -- it's about an 18 month period where we make this change all the time.

So they are talking about the $4 billion loan portfolio (multiple speakers)

That'd be loans too.

Well, it's a $4 billion bond portfolio. When you look at the $3.5 billion loan portfolio, we are still basically in the same shape today we have been in for multiple quarters. It's 20/40/40. 20% of the loans are floating, and most of those are at the floor, or it will take -- the rate will have to come up for us to move those rates up. And 40% is fixed, and 40% is variable. But on some, reset date less than daily, so it could be a monthly reset, could be a quarterly reset.

So our portfolio, the loan portfolio, turns and the effective duration there also is less than three years. So the whole thing turns pretty fast.

So the answer is yes. We have to be prepared because rates, if they go up [vertically] (multiple speakers)

They are not going down. (multiple speakers)

-- [They're not quickly] and say 300 basis points. It will impact us, and as David said, it takes us about 12 months to turn the ship around (multiple speakers)

Maybe even 18, 12 to 18 (multiple speakers)

That's a chance -- 12 to 18 months to turn it. And if you're looking for historical comparison, just go back to the last rate cycle when they dropped rates all the way down to 1%, and then they turned back up. The exact same environment that we are in today. We had to navigate our way back up again.

But we can do it, you just wouldn't see us like some of the banks that 100% went up and the total went down. They'll see positive impact like that. For us, it just takes a little longer.

That help you, Andy?

Oh yes. Great color. That's all I have, thank you.

Thanks Andy. Appreciate it.

(Operator Instructions). It does appear that there are no further questions at this time.

All right. Well, thank you all very much. We appreciate your participating in our call today. We certainly look forward to catching up with you all when we are out on the road again in the near future. Thank you very much for your support of our bank, and we will talk to you soon.

This does conclude today's teleconference. Thank you again for your participation. You may disconnect. And please enjoy the rest of your day.