Prosperity Bancshares Inc (PB) 2011 Q4 法說會逐字稿

Good day, everyone. And welcome to the Prosperity Banks fourth quarter earnings call. 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. (Operator Instructions) Please note this call is being recorded. And I'll be standing by if you should need any assistance.

It's now my pleasure to turn the call over to Dan Rollins. Please go ahead, sir.

Thank you. Good morning, ladies and gentlemen. Welcome to Prosperity Bancshares year-end 2011 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'm Dan Rollins, President and Chief Operating Officer of Prosperity Bancshares. Here with me today is David Zalman, our Chairman and Chief Executive Officer; Tim Timanus, our Vice Chairman; and David Hollaway, our Chief Financial Officer. David Zalman will lead off with a review of the highlights of the recent quarter and our full year 2011. He will be followed by David Hollaway who will spend a few minutes reviewing some of our recent financial statistics. Mr. Timanus will discuss our lending activities including asset quality. And I will provide an update on our recently announced acquisitions. 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, Alicia. Or you may e-mail questions to investor.relations@ProsperityBankTX.com. I assume you've 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 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, 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.

Let me turn our call over to David.

Thank you, Dan. I would like to welcome and thank everyone for listening to our year-end 2011 conference call. We are very proud of our performance for 2011. We finished the year with record net income of $141.7 million, an 11% increase over 2010. For the full year, our loans increased 8.1% or $280 million, while our deposits also increased 8.1% or $605 million. Our entire team is honored to have been recognized by Forbes as the Best Bank in America in their 2012 rankings. This recognition is a result of the hard work and dedication of all our associates and reflects our industry-leading asset quality, our strong earnings, and continued focus on building shareholder value.

While our loan growth was seasonally slow in the fourth quarter, and our net interest margin was negatively impacted by increased amortization in our investment portfolio, we believe that Prosperity is well-positioned for continued growth. Some of our success in the fourth quarter and for the full year include an increase in earnings to $36.4 million in the fourth quarter compared to $32.8 million for the same period in the prior year, an increase of $3.6 million or 11% for the quarter.

Our diluted earnings per share were $0.77 for the fourth quarter of 2011 compared to $0.70 for the same period in the prior year, a 10% increase. The net income for the full year 2011 was $141.7 million, or $3.01 per diluted common share. That's up 11% from 2010's net income of $127 million. And up 10.3% from 2010 diluted earnings per common share of $2.73. The total net income and income per share for 2011 are the best we have ever reported.

Our Tier 1 leverage ratio has now increased to 7.89% from 6.87% just a year ago as a result of our strong earnings. We are pleased with the loan growth for 2011 of $280 million, or 8.1%. While our aggressive loan growth targets call for double-digit growth which we were able to accomplish for the first three quarters of the year, our fourth quarter loans increased at a slower pace of 3%. While the fourth quarter was substantially below target, we continue to target double-digit loan growth in 2012. We expect improving economic tail winds will help attain our growth target this year.

Our non-performing assets declined to $12.1 million or 14 basis points of average earning assets, from $15.8 million last year. We continue to see signs of improving loan quality. Our provision expense in 2011 was $5.2 million compared to $13.5 million in 2010. Given the current economic conditions, we expect loan quality will continue to improve in 2012. In fact, January 2012 is the first month in several years in which we experienced no foreclosures on any real property.

Our deposits increased 8.1% or $605 million to a total of $8.1 billion when compared to the same period last year. We continue to actively review and pursue acquisition opportunities. In the past six months, we have announced three smaller transactions. Texas Bankers, Inc. in Austin, Texas; East Texas Financial Services, Inc., in Tyler, Texas; and The Bank Arlington in the Dallas/Fort Worth metroplex. All of these transactions are located in markets we already serve. We expect our industry's current operating environment with higher regulatory scrutiny and higher operating costs emanating from the new Washington-driven legislative burdens, along with asset quality problems, will result in many Texas banks revisiting their strategic options, including sale to bigger institutions.

As we look forward we recognize the need to grow our balance sheet and, specifically, our loan portfolio to offset the negative pressures on our net interest margin. In 2012, we will continue to focus on loan growth, eliminate unnecessary expenses, grow deposits, and identify and make accretive acquisitions. Our management teams, along with our associates, are truly engaged and are working to achieve our goals. Again, I would like to thank our whole team for a job well done.

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 three months ended December 31, 2011 was $80.1 million compared with $79.5 million for the same period in 2010, an increase of $600,000 or 0.7%. Net interest income for the 12 months ended December 31, 2011 was $326.7 million compared to $318.2 million for the same period in 2010, an increase of $8.5 million or 2.7%. Non-interest income increased $160,000 or 1.2% to $14.1 million for the three months ended December 31, 2011, compared with $13.9 million for the same period in 2010. Non-interest income for the 12 months ended December 31, 2011 was $56 million compared to $53.8 million for the same period in 2010, an increase of $2.2 million or 4.1%. Non-interest expense for the three months ended December 31, 2011 was $38.4 million compared with $41.2 million for the same period in 2010, a decrease of $2.8 million or 6.9%. Non-interest expense for the 12 months ended December 31, 2011 was $163.7 million compared to $166.5 million for the same period in 2010, a decrease of $2.8 million or 1.7%. The efficiency ratio was 40.8% for the three months ended December 31, 2011 compared to 44.1% for the same period last year and down from 42.4% in the third quarter of 2011.

The net interest margin on a tax equivalent basis was 3.82% for the three months ended December 31, 2011, compared to 3.99% for the same period in 2010 and 4.02% for the three months ended September 30, 2011. For the 12 months ended December 31, 2011, the net interest margin on a tax equivalent basis was 3.98% compared to 4.04% for the same period in 2010. And to add some color on the margin decrease, on a linked quarter basis, the major impact to the 20 basis points decrease was due to increased prepayment speeds and paydowns in our bond portfolio, which jumped from approximately $100 million per month to approximately $130 million per month, resulting in additional bond premium amortization expense.

The amortization expense on a linked quarter basis increased $2.1 million. And this impacted the margin by about 10 basis points, meaning that the margin would have been around 3.92% versus the 3.82% number. Additionally, the net loan growth for the quarter was not enough of a positive to support the margin in a meaningful way. The lower rate environment is also impacting our bond portfolio metrics. At 12-31, the portfolio shows a 2.6 average life, effective duration of 2.5, and projected annual cash flows of approximately $1.55 billion. Up from the earlier projection of $1.2 billion.

And a final comment, I would note that all of our capital ratios improved year-over-year. As of year-end 2011, the Tier 1 leverage ratio was 7.9%. The Tier 1 risk-based ratio, 15.9%. The total risk-based ratio, 17.1%, and the tangible equity, the tangible asset ratio was 7% compared to 5.9% at year-end 2010. And with that let me turn over the presentation to Tim Timanus for some detail on loans and asset quality. Tim?

Thank you, Dave. Our non-performing assets at year-end December 31, 2011 were $12,052,000, which is 0.32% of loans and other real estate. This is compared to $13,363,000, or 0.36%, at the end of the third quarter 2011 and compared to $15,842,000, or 0.45%, at the end of 2010. These numbers represent a decrease of 10% from September 30, 2011 and a decrease of 24% from December 31, 2010. The December 31, 2011 non-performing asset total was made up of $3,578,000 in loans, $146,000 in repossessed assets, and $8,328,000 in other real estate. At this time, $1,555,000 of the year-end 2011 non-performing assets are under contract for sale. As is always the case, we can give no assurance that any of these contracts will close.

Net charge-offs for the three months ended December 31, 2011 were $2,069,000 compared to net charge-offs of $368,000 for the three months ended September 30, 2011. Net charge-offs for the year ended December 31, 2011 were $5,190,000 as compared to $13,864,000 for the year ended December 31, 2010. $1,150,000 was added to the allowance for credit losses during the quarter ended December 31, 2011 compared to $950,000 for the third quarter of 2011. And $5,200,000 was added during the year 2011 compared to $13,585,000 for 2010.

The average monthly new loan production for the quarter ended December 31, 2011 was $100 million. This is compared to $98 million for the third quarter ended September 30, 2011. Loans outstanding at December 31, 2011 were $3.766 billion compared to $3.738 billion at 9-30-11, and $3.485 billion at December 31, 2010. The December 31, 2011 loan total is made up of 43% fixed rate loans, 25% floating rate loans, and 32% variable rate loans.

I'll now turn it over to Dan Rollins.

Thank you, Tim. As you all know, last night we announced our third acquisition since last fall. While The Bank Arlington may not be large enough to make a significant impact on our earnings, we believe the addition of Bill Allen and his team in Arlington will benefit our efforts in the Dallas/Fort Worth metroplex. Arlington is located between Dallas and Fort Worth, and provides a platform to help us grow our customer base in North Texas. We expect that we will be able to complete this transaction during the second quarter.

We completed the acquisition of Texas Bankers, Inc. on January 1. This transaction was accretive to tangible book and improved our market share in the Austin market. Gordon Muir and his group have joined our Central Texas team and should be able to help us continue our growth in that market. Finally, we're scheduled to close on our acquisition of East Texas Financial Services in Tyler, Texas, early in the second quarter. Derrell Chapman and the bankers at Firstbank significantly improve our visibility in East Texas. These three acquisitions together add approximately $300 million in assets and provide us additional resources to continue our growth in these markets. We continue to believe that additional acquisition opportunities are just around the corner.

As you have heard, we are very proud of our team and the effort they exhibit each day. Our loan and deposit growth plans are working and we believe we can continue to build shareholder value going forward. At this time I believe we're ready to take questions. Alicia, can you assist us with that?

(Operator Instructions) Dave Rochester from Deutsche Bank.

Before we hit the premium amortization discussion, can you talk about reinvestment rates? Are those generally in that 2% to 2.1% range you mentioned last quarter?

This is David Zalman, Dave. And the answer is, today, yes. Two or three days ago, there's been some market fluctuations where the tenures dropped. Again a 10 year drop probably is in the 1.80% and today it's probably over 2%. That doesn't necessarily mean that the price or the yield fluctuations are going to change the same on a mortgage-backed security. But over a period of time they do correct. We've been able to buy more in the highs. So, the answer to your question is yes, I think those are still some of the same yields.

Okay, great. Then, also on the loan pricing, can you update us there on maybe that incremental production on the CRE and on the resi side, as well?

I would just tell you overall that the pricing, it's competitive. I think we always continue to look at pricing. But, again, we don't see a whole lot of change from where it is right now.

I think we're holding in there okay on that line.

Okay, great. Then, just switching real quick to the premium amortization. Just given the activity you saw in December and coming into this month, do you expect to see that activity remain stable or could you see a reduction in premium amortization going into the first quarter?

I'll start off by saying, quite frankly, I really thought the premium amortization has been too much for the last couple of months. On the other hand, it still continues to rise. Our portfolio -- Dave can add more color on this -- but our coupon is probably around the 4% coupon. So, you wouldn't think, even with the refinancing, that this would really be impacting this as much as it has. But it has. If it continues, we're prepared for that.

Yes, again, the best that we can tell today, until those projected pre-payment speeds, we need to see some change in that to be able to determine how that will impact our amortization one way or the other. Those reports don't come out until the end of this month. So, until we can see that, it's hard to make that call whether it's going to slow down, continue as is, or if rates could go down some more, then it could go the other way.

You gave some numbers though, Dave, on prepays during the month. Our prepaid went from $100 million a month to $130 million a month.

The paydowns.

Paydowns on the portfolio. If you extrapolate that into what should have happened to our premium amortization, there's a disconnect. The prepay moving up $30 million a month doesn't equate to the premium amortization moving up as much as it did. But the numbers are what the numbers are.

That's the other side of the equation is the prepayment speeds that they put into place which predicts -- in theory it's supposed to predict your cash flows coming back to you. When you look back over the fourth quarter they were going up significantly and it sure does show in those numbers.

Without getting complicated though, we base our prepayment amortization on CPRs, which is current prepayment speeds, rather than PSAs. Which, PSAs are a lot slower. So, hopefully this, in the long run, will turn out good for us. But we don't want to be caught where we see it not written down the amortization one day and come and announce to all you guys that we should have been amortizing more. So, if anything we should go on the right side of this if it does slow down.

Okay, great. Just one last one before I step back. I saw the comp expenses were down a little bit this quarter. Was that just a year-end true-up? Where should we expect to see those levels pan out for the first quarter?

I'm sorry, what was that?

The compensation, the salary line item. It slowed down, especially on a linked quarter basis. Then, the comment as to what we would look at in the New Year. Dan, you might have some color on that? I would just say the slowdown part of it is, as we were doing well for the first three quarters, we were able to get as close to compensation as we can. When you get to the fourth quarter and everything is shaking it out we are truing it up at that point.

Yes, I would call it a true-up to some extent. Remember, first quarter comp always is a little bit higher because we've got payroll tax items in there. So, I wouldn't think that would be a good run rate.

Okay, thanks, guys. Appreciate it.

Scott Valentin with FBR Capital Markets.

I think earlier you referred to the loan growth during the quarter, less than you had hoped for. I was just wondering, is that reflective of the economic environment or competition? Or maybe you could provide some color around why it came in a little less than you thought?

Let's paint that whole picture for you, Scott, that's a good question. Thanks. Let's get some guidelines out there. We grew loans in the third quarter $70 million-plus in the third quarter and $30 million-some-odd in the fourth quarter. But loan production actually went up from third quarter to fourth quarter. So, when you lay all this out, our loan production went from $98 million a month to $100 million a month third quarter to fourth quarter. But the portfolio grew substantially slower. But the reason for that is the paydowns in the fourth quarter picked up substantially. We think there's a mix of paydowns in there. There's some loans that we lost for pricing competition or other reasons where loans moved away from us.

But there's also, we believe, customers that are out there that are cash flush that are just using their cash to pay down lines and pay down loans. The net result is, we expected to see if you can grow -- if we can produce $100 million a month in loans, that's more loan production than we've ever had in the history of our Company. Yet our loan growth didn't stick to the bottom line. So, it's not a factor of production problem. It's economic winds of what's happening out there in the field. Are we having customers that are just ready -- they are cash flush and they want to hold cash and pay down loans?

Yes, I was thinking, and I would just add that any loans that we would have lost because of pricing was not significant. I would say it's in the $3 million to $5 million range. So, I would say the majority of the paydown is, if you have a lot of companies that are just really cash flush right now and that impacted us. Again, I'll reiterate that our production was actually higher in the fourth quarter than it was in the third quarter. It's just because of the paydown that we saw a decrease.

Yes. We think our team is doing well. If those paydown rate reduce back to what we saw in the second quarter, the third quarter, and we continue to producing the loans we're producing -- that's what David said in his conversation -- we believe we can produce good loan growth in our portfolio.

Okay, thanks for that color. It's very helpful. Then, on the M&A, you guys have been very active as of late. Maybe the deals have been a little bit smaller than historically what we've seen from you guys. Is that a reflection of what the market will give you that still makes economic sense? Or the big deals just aren't available yet -- bigger deals?

The smaller deals, they're really out there. As you can see the pricing that we're buying these banks at are relatively good. We do think that we will be able to do bigger deals. We do see more action out there. There's more people talking. So, it's still our goal -- and I've told this to the whole market -- it is our goal to do a bigger deal and I still think that we'll do it.

Yes, I think when you look at the smaller transactions, Scott -- as David said and as I commented -- these are all end market transactions. They fill in for us. All of these transactions bring not only size and location for us. They also bring community bankers that fit. So, when you look at Gordon Muir and his team in Austin that we've already completed, Derrell Chapman and his team in Tyler that will be joining us, and Billy Allen and his team in Arlington, all of those community bankers benefit us. So, when we're looking at these smaller transactions, it needs to be a fit for us, and they need to be able to help us grow in the markets that we're in. We've been able to deploy our stock and our currency into this and it helps us in the markets with retail shareholders.

Okay, thanks very much.

Jennifer Demba with SunTrust Robinson Humphrey.

David Hollaway, you said that there was somewhat of an incentive payment true-up in fourth quarter. Can you quantify that at all?

I don't know if we can quantify it but when you look at the numbers, just the black-and-white numbers, that's going to give you a big chunk of what's going on. The numbers are giving you that story.

I can say, if I can just give a little bit of color, Jennifer. I think, as we're doing good and we make more money, we accrue more money for bonuses at year-end and stuff like that. If we're not making as much money, we don't accrue as much of bonuses and such. It's pretty simple, really.

Yes, our incentive comp is multiple hurdles. The first hurdle is the whole Company as a whole has to be performing for us to accrue out there. We had accrued in the first three quarters of last year, our incentive comp was good last year for our team. There's a little bit of a true-up in there.

I think the difference could be as much as $300,000 to $500,000 a month, really, at some points in time, depending on how we do. Again, that is really a function of how we perform really.

Okay. Second question for David Zalman. I know your goal is to try and grow earnings per share at a double-digit rate each year. Right now, the estimates don't indicate that. This is obviously a challenging rate environment. Can you just give us your thoughts on what you expect for this year and how much of it can come from acquisitions versus organic?

Again, it's pretty easy. You guys are doing the calculations right. You can see with the net interest margin decreasing to where it has, it's definitely more challenging. If you do the numbers and you plug in, you don't show that we have any growth, you don't see that we make as much as we did this year. Having said that, if we get not even to the growth that our goal is in loans, we feel that we can still have positive earnings growth. Will that be double-digit growth? No, but we can still see earnings growth. Now, if we do have a decent acquisition and a good-sized acquisition, then we can get to a double-digit earnings growth. But it takes a combination of everything. We are really focused on growing loans. So, if we grow loans and we grow deposits, we can definitely do better in income this year than we did last year. If we don't do anything, and we stay exactly where we're at, we'll go backwards. If we grow deposits and we grow the loans and we make an acquisition, then you could see a home run for everybody. So, there's probably three scenarios that I gave you there.

Which crystal ball are you using to determine that?

If you had known us, and you have, Jennifer, and you've watched us over the years, you know we're not going to stand by and not improve shareholder value.

When you look at your acquisition pipeline, are most of the companies that you're looking at of a similar size range to the last two deals you've announced, the tiny deals?

We're looking at everything. As was mentioned earlier, we've done some smaller deals. As Dan said, the smaller deals have added up to maybe $300 million or so. We still know to move the needle that, we have to do a larger deal. So, as you know, we've been working on deals and relationships with bankers around the state for years. So, we do think eventually that we will be able to get one of those bigger deals done.

Thank you.

Michael Rose with Raymond James.

Just wanted to get a little more context on the loan growth that you are seeing. I know that you mentioned that production was up quarter to quarter. Is there any geographic flare to that or is it widespread as it has been?

Michael, this is Tim Timanus. I would term it as not geographical. We're seeing similarities in all of our markets, so I don't think it's hinged on any one factor or any one geography.

That's right. Proportionately the numbers are similar across all the markets.

Okay. Then, on the C&I portfolio, I saw that was down again, quarter to quarter. I know that's not a tremendous focus for you all. We've seen strong growth out of a lot of banks this quarter. Any reason why we're not seeing those numbers go up?

Yes, I think my answer to that would be -- Tim jump in here -- but I think my answer to that is, is the customer base that we bank is cash flush at this point and not out there. I think when you look at the shared -- remember we have zero Shared National Credits and a lot of that C&I business is a Shared National Credit business. We're just not in that game. The customers that we're banking are cash flush and haven't deployed any new cash. Tim, you could add on to that?

I think that's essentially correct. In our opinion, our customer base is of a higher quality, so to speak. So, when they do have cash on hand, their borrowing demands are, a lot of times, not as significant as they would be otherwise. While our economy here is certainly good, if not great, compared to many other places in the country, having said that, it's not as robust here as it has been at various periods in the past. So, a lot of these companies are doing well, have cash, pay their loans down. But with all the uncertainty in the markets and the difficulties elsewhere, they are not necessarily expanding and doing new deals, so to speak. So, it's really a mixture of all those things.

Okay. So, just finally, piggybacking on that, I know you have this goal to grow loans on a net basis by $1 billion by the end of this year. You'd need about $650 million in net growth this year. Is there any update to that? Do you have a plan for that and through 2013? Any updates there would be helpful. Thanks.

I think the goal is out there. We have not changed the goal. Our team is focused on growing loans. $650 million for the year is a lot, as you can testify to. When you look at production numbers for us, we've climbed that production ladder. Our production has gone up quarter over quarter over quarter. We're continuing to add what we think are good quality lenders to the team that can continue to help us grow loans. We need some economic tail winds to help us.

I think that's true, Dan. Again, it's not like we're not producing loans. We're producing $100 million a month. So, if we can get some of the slowdowns and paydowns to slow down, we can see the economy to where, as they mentioned earlier, our customers are a little bit different than some of the other banks. A lot of the people we bank are really flush. So, if they feel the economy is doing better, that politics are where they want to be, we can really see -- I think that we can really see some good growth this year. That's just my personal opinion. We're really focusing on that and we're going to push for that.

Okay, thanks for the color.

Brett Rabatin with Sterne, Agee.

I wanted to ask, as you're waiting for a larger transaction, I know I've asked in the past about the rate volume tradeoff. Can you give some color around -- everyone's focused on the margin -- can you give some color around just spread revenue growth? Maybe you'll use a bigger balance sheet to give into the margin pressure. Any thoughts on focusing more on the aspect of spread revenue as opposed to the margin?

I don't think there's any question -- David Hollaway will probably jump in here in a minute -- but we were really focused at year-end not to be over $10 billion in size. So, we've managed our balance sheet. You'd say why wouldn't we want to be over $10 billion in size. It's primarily because of the Durbin Amendment where instead of getting $0.40 a transaction on the debit card we get $0.20, and it saved us $5 million. Having said that, this first month -- and Dave will probably give you better numbers -- in December we were at $10.2 billion, Dave?

January.

I'm sorry, in January, $10.2 billion. So, you can see that we are already building the balance sheet and we'll continue to build the balance sheet to help us achieve the net income. You may see the net interest margin still down or staying down a little bit. At the same time we're hoping to grow assets for the balance sheet and to really grow income. Even though the net interest margin is down we're still hoping to build it the other way.

I think that's absolutely right. We're growing the balance sheet, obviously. Just to reiterate what David said, deposits are up yet another $200 million on average already in January. So, what also should happen here is it will be accretive to net interest income dollars, and that concept is probably dilutive to the net interest margin itself. So, we are concentrating on the dollars.

You called it spread income. We're looking at NII. The margin can swing around widely, based upon several things but NII is what drops EPS to the bottom line. Dave said it, deposits are up. Our team is actively growing the Bank in multiple ways. I think our team of calling officers is doing a good job. We've grown free money quarter over quarter over quarter. While growing free money is a negative to the margin, it's a positive to net interest income and to the income of the Bank.

Okay. Good color there. Just going back to the topic of M&A. What is the near term impediment to larger bank -- I don't want to say large bank M&A in Texas but -- like a $500 million to a $1 billion bank maybe in Texas selling? Is it because their expectations are still too robust? Or they still have classified assets that need to get cleaned up? Or what's holding those kind of transactions from transpiring?

My personal feeling -- Dan may want to jump in here in just a minute -- but, again, I think the bigger deals -- the smaller deals, it's just as obvious as it can be. It can be a $100 million bank in today's market and with the regulatory burden and the compensation you're having to pay, and what you have to do under the new guidelines of everything to comply, they can barely make money. I would say that in Metroplex they can't make money at $100 million, maybe not even $200 million. In a smaller rural community they might be able to make some money. So, that's driving your smaller banks to look for partners right now. The bigger banks, in the past they've not been willing -- they still remember banks selling at 3 times book and 20 times earnings. I would tell you that, that is changing. You're starting to see some of the bigger banks to realize that, that is going to change. I think you're going to see, and we're starting to see people talking, that they understand, and I think you'll see some action happening.

Yes, my adding to that, Brett, as you know, David and I spend a lot of our time on this subject. There are a lot of bankers out there. There is some bid-ask spread as part of the issue. I think that there's opportunities out there. Your comment about asset quality or regulatory burdens or all those other things that are out there, I think the answer is all of the above. Remember, Texas still has 500 or 600 or 700 banks, and in that group you've got some banks that have absolutely excellent asset quality, as good as ours or better. You've got some of the banks in there that have absolutely terrible asset quality. You've got banks that have great reputation and relationship with their regulators, as we do. You've got banks where the regulators are all in their shorts. I think, every one is a little different and what causes a seller to make the decision to sell is different. We're actively working that. As David said, I think we do believe that there's opportunities for us, as I said, just around the corner.

Okay, great. Thanks for all the color.

Bill Young with Macquarie.

Just to tack on a little bit on the M&A question. Has your stance on doing any out-of-market or out-of-Texas deals changed, in terms of M&A?

I don't think we've changed our idea on that, Bill. If there's opportunities out there that make sense for us and are compelling, we're continuing to look at opportunities wherever they may be because we have to be opportunistic. Clearly, in Texas is our focus -- I jumped on David as he was getting ready to say something -- but clearly the message hasn't changed. If you look at our top 10 list, I've said this for the last couple years, 1 through 9 is anything in Texas, and 10 would be some compelling reason for us to move to another state or another area. Again, we've looked in Oklahoma, we've looked in Arkansas, we've looked in Louisiana, we looked in New Mexico a year ago. We certainly have had opportunities out there but Texas just continues to be our home and where we want to try and grow.

I would just add that Texas is really where we're focused on. We like it. At the same time, as Dan mentioned, we're not opposed to crossing the lines to Oklahoma, New Mexico, Louisiana. In fact, a lot of these places, we're probably only 10 miles to 15 miles away from their boundary lines right now. So, if there's an opportunity and we can really enhance shareholder value. When I say enhance shareholder value, we're not going to move across state lines to do a $200 million or $300 million deal. For us to move across state lines, I would say it needs to be a minimum of $1 billion, and we would like to see a bigger deal.

If we can do that, find an opportunistic acquisition or merger that's very accretive to earnings, we're going to do it. We're not opposed to that at all. But again, let me just say this -- Dan I'm sorry. You're not going to find us, probably, in Florida. You're not going to see us in New York, Michigan. (multiple speakers) But stuff that's close to us we'll definitely look at.

We've certainly had a lot of great publicity from the Forbes recognition that we received, when Forbes named us as their Best Bank for 2012. I had a call yesterday from California. The guy tells me all about how we need to be in California, and he's unhappy with his bank and he would like to have a bank like us in California. It's flattering and nice, but we need to be focused close to home and we want to be opportunistic on our M&A.

Great. That was helpful, guys. Then, could you just talk about, you mentioned the pick up in monthly loan production. Has the mix of the loan products changed at all? Are you seeing increased demand in maybe resi mortgage versus commercial real estate, et cetera?

Bill, this is Tim Timanus. The mix really hasn't changed in any significant way. The pieces of our portfolio still move forward in about the same percentages as they've been in. So, there's no substantial change there.

Okay. Could you just talk about what the mix has been trending like?

If you look back historically at our portfolio, our commercial real estate's usually 35%, 40% of our portfolio. Our one-to-four family's around 25%, sometimes 30%. Construction 10% to 15%. C&I, 10% to 15%. Then, about 10% spread out among things like consumer loans, agriculture loans and home equity. Those percentages are still essentially true and what comes into us goes into those buckets about the same way.

Okay. My last question is, do you feel you have any other levers left on the margin front to offset what's going on, in the security side, if things don't trend your way?

This is Dave Hollaway. Again, just in a big picture comment, to reiterate what was said before. Obviously, the one lever is to continue to grow the loan portfolio, is really key. That's a big deal in terms of impacting the margin. I guess the other question is, what can you do on the funding side. There's a little bit more room to go there but at some point we would hit diminishing returns on this. To be more specific, if you look at the CD yield, if you look at the press release and the CD yield, I don't have it in front of me, but Dan?

CDs are still 92. That's where I was pointing. There's still some funding cost improvement. We've got $2 billion in CDs, or $2.1 billion in CDs at an average cost of 92 BPS. That's down from 99 BPS in the third quarter. I think we'll continue to see that category fall.

It will come down because, obviously, we're not paying those rates. But that's what I mean by diminishing return. As it keeps rolling over, over the next one to six months, it just takes a little bit more time to get that. There will be a little positive from that.

I think we continue to try and move all of the opportunities that we have. We can continue to lower our funding cost, we can continue to deploy dollars into the loan portfolio, and the wild card is how fast. If we're producing $100 million a month in loans, and that production in the third quarter helped us grow loans almost $100 million in the quarter. We produced more loans in the fourth quarter, and what stuck to the balance sheet was two-thirds less than that -- clearly the paydown environment is driving that. Our hope is, is that, that paydown environment will mitigate or slow, and we can continue to post those dollars to our balance sheet. If we can grow loans $100 million a quarter, and we can reduce our funding cost on the CD side, I think we can hold margin pretty well. Dave is shaking his head, I think.

Great, thanks. One last housekeeping item. I apologize. I missed the numbers on OREO sales and what's under contract.

About $1 million, $1.5 million, Tim?

Yes, right now it's $1,555,000 that are under contract.

Great. Thanks a lot guys.

Jefferson Harralson with KBW.

You guys mentioned the incentive reversal this quarter. Which reminded me to ask a question of, what constitutes your incentive plan. What do you guys need to get to, to get a full payout or a strong payout? What ratios are those based on?

We run multiple incentive programs. The executive team is a laundry list of items that includes growth in the balance sheet, growth in earnings, net charge off numbers, efficiency ratio, growth in dividend payout, growth in loans. Total return is in the number. So, when you look at the 10 or 11 things that are in the formula for the executive management, the five named executives, that's a formula deal that's got a laundry list. It's hard to get all of them in there. They're certainly out in our proxy and you can go through that. The big piece of our incentive comp, clearly is the side that covers the team that's out there pulling the plow and pulling the wagon for us. Clearly, growing the balance sheet, growing their personal loan portfolio, asset quality, all of those things are there. I think our team did very well from an incentive comp basis last year.

That's why I was asking because you had 11% EPS growth and 7% loan growth. I'm just surprised to see a reversal on some of the numbers, are some of the strongest in the industry.

I think that would be that we had put some good numbers in, in the first three quarters.

So, I ask a follow-up. Now, for next year, it's going to be a lot tougher to have similar EPS growth. I guess the loan growth will be there but are we starting behind for next year? Or do you amend your EPS growth expectations or lower that as a percentage or how does that work?

I wish our comp committee would consider that, but I don't think they are.

I would just say, Jefferson -- and Dave may want to jump in -- but we really look at this on a monthly basis. We really look how we're doing, are we meeting our goals, and what will we have to pay out in incentive comp. We adjust the incentive comp based on where we're at.

At real time. It's a real time model.

It's a real time model. You could ask the question, why wasn't it real time in the last quarter. I think it's just because we probably accrued more in the previous quarters than we probably needed. It was just an adjustment. But it's definitely real time.

Okay, thanks, guys, I appreciate it.

Maclovio Pina from Morningstar Equity Research.

Thank you, good morning, and congratulations on both the quarter and the recognition. You already have a very good efficiency ratio. But in the comments you mentioned that you'd be looking to cut unnecessary expenses. So I'm curious to know, where would you look to get those expenses? And if you have any estimates for that.

I don't know about the estimates. I'll jump in ahead of David on this. But in today's low rate environment, until we get rates come up off the ground again, it's a whole new dynamic here. So, in terms of looking at expenses, and we make the comment we'll try to keep them low, that means we have to look at everything. I know that's not a specific answer for you but we look at every single thing.

Yes, that's what I would say. David's comment was we're going to continue to challenge our expenses, and that means every item, every bill gets looked at, for -- is this expense driving additional income or additional loans or additional customers into our Bank. If this expense is not producing the results that we want, we challenge it. That's how we hold the efficiency ratio to where it is.

We look at staffing, we look at compensation, we look at contracts.

Look at utility, look at legal bills.

We look at our locations, are they being run efficiently.

Vendor relationships. We go down the list.

There's a lot of places you have to continue to fight and look all the time.

Okay, understood. Now, turning on to provisions, you obviously have a very good NPL ratio and excellent coverage ratio. So, I'm wondering if you have any run rate guidance for provisions, perhaps as a percentage of loans or something, where you know you would be comfortable?

I don't know that we've got any crystal ball in that regard. But having said that, right now, we don't see anything on the horizon that would indicate we're going to have any increased provision for next year. That obviously could change on us.

We've really never given guidance on the provision. So, giving any kind of guidance or indication is hard. I think you've heard a couple of things today that can help you color in between the lines. David said in his comments, and I think it probably bears repeating, January was the first month in two-plus years, maybe almost three years, where we had zero foreclosures on real estate, or real property in the month. So, clearly our asset quality continues to improve. You saw our provision expense drop from 2010 to 2011 by over 50%. We're not giving any guidance going forward but our asset quality looks good.

I would say, just to add a little bit of color, I know where you're coming from. I would say that based on what we're seeing right now, you may not see as much in provision as you did in 2011. On the other hand, probably somebody is trying to ask the question, right in back of you. The next question -- well, you have so much coverage in there compared to what you have in non-performing assets, will you start pulling money out? I would say, again this is all driven based on our model and you have to look at all that. But everybody needs to remember, where a lot of other banks are pulling this money out of the provision, if we want to continue to grow and we want to continue to build our loans, I wouldn't expect to pull money out of provisions. It wouldn't be prudent.

Growing loan portfolio is another factor in that model.

Okay, excellent. That's exactly where I was going, towards a coverage target of some sort.

We don't have a target.

Okay, understood. Thank you very much for the color.

Dave Bishop with Stifel Nicolaus.

Most of my questions have been answered but I have a question for Dave. In terms of the outlook for acquisitions, I think you properly termed it, the most recent ones, to infill the existing footprint within Texas. As you look across the state, maybe more western there, would you potentially consider -- I don't know how to term it -- outfield type transactions in some of the more suburban areas?

I don't know that I understood the question.

I think what you're really asking, Dave, is, are we going to go outside of our existing footprint. The way I would want to say that is when you look at Texas today -- and you're right, we cover that I-35 corridor which runs from Corpus to San Antonio to Austin to Dallas and we're not west of there. We've got a couple of offices west of there but not many. Any time we move outside of an existing footprint, the size of the transaction has to be large enough to justify that move. So, whether that's in Texas or whether we're moving to some other state somewhere else, to move outside of an existing footprint, the size matters.

Got you. I think, Dave, you'd said that in terms of the paydowns this quarter, most were due to customers flush with cash. I think you'd enumerated some amount where others had gone to competitors. What was that dollar amount in terms of the breakdown?

Again, please don't put this as an exact amount because we were just talking about it before we started the meeting. Off of the cuff, I would say no more than $3 million to $5 million probably.

Got you. Great, thank you.

Bob Patten with Morgan Keegan.

Bob? We might have lost Bob. Are you here?

Matt Olney with Stephens.

All my questions have been addressed, so thank you.

Thanks Matt.

Richard Reach with RLR Capital.

Given the sharp decline in the price of natural gas, I'm a little concerned about possible exposure to drillers or E&P companies which might face some kind of financial strain, or worse if they're unable to meet their debt obligations. Would you review Prosperity's lending exposure, if any, to such businesses? Thanks.

Tim may want to jump in here in just a minute. This is David Zalman. We're not heavy in the oil and gas lending business. We do have some production loans, and Tim can probably give you more specifics. I doubt that those production loans are $50 million. Maybe less than $50 million. We do make some loans to the service industry, like vacuum trucks or mud tanks and some stuff like that. Again, I would say overall we are not just real heavy in oil and gas. Tim, would I be out of school saying we have $100 million in maybe total?

I think we ran those numbers and I think exposure, both in the service side and the direct exploration and production side, is less than 1% of the portfolio.

On the other hand, I think your point is well taken. If there's going to be a slowdown in oil and gas production, that does affect the overall economy. In that way it would have an impact. Because people that stay in motels and eat at restaurants and all that, that does impact that.

I think everything both of you have said is 100% accurate. I don't think that we, in my opinion, I don't think we have a significant direct exposure. It's not a huge piece of what we do. Most of our customers are smaller service companies that have been around before the recent shale oil boom, for example.

Most of our customers in that industry.

Exactly. So, they're not newcomers that have all of a sudden appeared because of what's going on. They've seen gas prices fall before. While it's clearly not a positive, when the price of natural gas is soft the way that it is and has been, I don't see a significant direct effect on us at all.

Richard, let me color for you the way we run our loan platform. We do not have siloed up departments for loans. We do not have an oil and gas or an E&P production team or loan team. I'd tell you all of our lenders are basically generalists and they would do whatever walks in their door. So, we're not out actively pursuing these oil and gas transactions with a team of lenders. If we do some of those in the markets that we're in with the customers that Tim was describing, they've been around for a long time, they bank with us. We have no Shared National Credit exposure in oil and gas.

Okay, thanks so much for your help.

Christopher Marinac with FIG Partners.

Dan or David, I wanted to ask about the profitability on a per loan basis. As you look at your internal pricing models, do you have to adjust those given where interest rates as well as your competitive environment is? Or are you looking at it same way you always have for the past several years?

You're talking about loan pricing specifically?

Yes, correct.

Again, Tim may jump in. We really haven't changed the model at all. We have a group of us, that actually yesterday we sat around a table, probably seven or eight of us. We look at every type of loan that we have, whether it's a commercial real estate loan, whether it's a car loan, whether it's a home loan, rental property, farmland.

What we do is we look at what the market is out there and we try to be competitive as to what the market is. We may not be the highest rate. We may not be the lowest rate. Again, we set rates all the time. Now, having said that if a customer, a good customer that has $20 million in the bank and we're posting one rate and he says he can do better than that, sometimes we make adjustments. Tim?

I think that's all correct. I think our approach is disciplined. Our approach is the same essentially that it always has been. The variables that we have to deal with, obviously, change over time. We have to look at, number one, what it takes for us to make money and have a proper return. We have to look at whatever interest rate risk might exist for us on down the road. We can't ignore the competition, so we have to look at what they're doing. So, we constantly review those three factors, as well as any curve ball that may come our way, something that's unforeseen. The approach, I think, is unchanged, and it's served us well over time and we've stuck with it.

Great. My follow-up just has to do from a different angle about M&A. Dan, I know these last couple deals are small in totality. If you are to do something more meaningful, can that, after credit marks, really be another way of getting a higher yielding earning asset on the books, which therefore helps margin in the bigger picture for the Company?

Yes. People ask us if we're out looking to go buy loans. Certainly you could do that, and if you do a bigger transaction and you put all of the current accounting rules on it, that can move the number. The issue for us, though, Chris, is, again, we're more opportunistic. Remember, the average Texas bank is not loaned up. We're probably in the wheelhouse of what an average Texas bank looks like even through we're only at a 50% loan to deposit ratio. So, finding banks that are 100% loaned up is not an easy fix in Texas. If you find somebody that's 100% loaned up, my guess is that they probably have more problems.

That's helpful. Thanks very much guys.

Brad Milsaps, Sandler O'Neill.

You have more than covered everything. I appreciate all the color, thank you.

Joe Stephens with Stephens Capital.

My last question was on the M&A side, and you got that. Congrats again for both a great quarter and a great year, you guys.

We have no further questions in queue.

All right. Ladies and gentlemen, thank you so much for your participation today. We look forward to catching up with you as we're out on the road on our Investor Relations trips. Thank you for support of our Bank.