Prosperity Bancshares Inc (PB) 2012 Q3 法說會逐字稿

Good day, everyone and welcome to today's program. (Operator Instructions). Please note, this call is being recorded. It is now my pleasure to turn the conference over to Mr. Dan Rollins. Please, go ahead.

Thank you. Good morning ladies and gentlemen. Welcome to Prosperity Bancshares third quarter 2012 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, Chairman and Chief Executive Officer; Tim Timanus, Vice Chairman and David Hollaway, our Chief Financial Officer. David Zalman will lead off with a review of the highlights of the recent quarter.

He'll be followed by David Hollaway who will spend a few minutes reviewing some of our recent financial statistics. Tim Timanus will discuss our lending activity, including asset quality, and I will provide an update on our recently announced mergers and 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, Victor, or you may email 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 Elkowitz at 281-269-7221 and she'll be happy to fax a copy to you now.

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 security 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 Dave.

Thank you, Dan. I would like to welcome and thank everyone for joining us for our third quarter earnings announcement. I'm very excited and proud to be able to announce such positive results for the third quarter of 2012, especially in a time when our industry is so challenged.

We posted earnings of $47.2 million for the three months ending September 30, 2012 compared to $36.4 million for the same period in 2011, which represents an increase of $9.8 million or 27%. Our earnings per share for the September 30, 2012 quarter came in at $0.82 compared to $0.77 for the same period last year, an increase of 6.5%.

While our earnings include adjustments related to our recent acquisition, the performance of our core bank remains strong. Our strong asset quality continues to be one of the core values of our bank with our non-performing asset ratio of only 11 basis points of average earning assets. Tim will provide additional information on the asset quality in a few minutes.

Our allowance for loan losses is $50.9 million as of September 30, 2012, with the total non-performing assets of $14.1 million for the same period, representing a healthy coverage ratio. Total loan growth was 35.9% or $1.3 billion over the past quarter -- I'm sorry, past year. Our organic loan growth was 4.4% over the same time period.

During the third quarter, two of our larger long-time customers sold their businesses, and therefore paid off their debt to our bank. These two relationships represented approximately $45 million in paid off loans during the quarter.

Another factor negatively impacting organic loan growth during the quarter was the operational integration of American State Bank. As part of our integration process, we sent over 250 bankers away from their regular jobs during conversion to West Texas to support our newest locations. During the quarter, we also believe consumer sentiment and business activity was muted due to political uncertainty.

We are actually making more loans than ever, but are seeing our loans pay back faster than ever. When loan pay-offs stabilize, we believe we will experience solid growth. Tim will also provide some additional color on this topic in a few minutes.

Our deposits increased $3.2 billion over the past year, representing an increase of 40.5%. Our organic deposit growth rate was 4.5% during the same period. We continue to have customers parking funds in their checking accounts while they wait on a clearer business environment.

Like our peers, with the low interest rates and such a flat yield curve, our net interest margin decreased to 3.52% as of September 30, 2012 compared to 3.55% last quarter. During the past quarter, we closed our merger with American State Financial Corporation in West Texas which added 37 locations in three new market areas; Lubbock, Midland-Odessa and Abilene. We are very excited about our new relationships and working together with their entire team. Our entire bank has worked diligently and tirelessly over the last month with the operational integration, and we thank them for their dedication and hard work.

We also recently completed our merger with Community National Bank located in Bellaire Texas, in the Houston metropolitan area. We're excited about this team joining us and increasing our presence in an area we already service. The management team and associates at Community National Bank will add to the already strong group of bankers we have in Houston.

We owe all of our success to our associates and board members who have helped grow the Company in the right direction with all of their insight and efforts and for that, I say thank you. We would also like to thank all of our customers for their business and loyalty to our bank.

On a final note, our Board of Directors is proud to be able to reward our shareholders with an increased dividend for 2013. The quarterly dividend will increase to $0.215 from the current quarterly dividend of $0.195, an increase of 10.3%. The annual dividend will now be $0.86 per share.

The Board believes that as the Company's good fortune increases, the shareholders' should, also. Thanks again for support of our Company. But before I turn it over to David Hollaway, I would like to say -- I said a final note maybe a second final note.

I would like to mention that in our previous travels with analysts and institutional investors, there was always a lot of discussion concerning fair value accounting rules that we now have to live by. In our travels, we committed to everyone that we would try and make it as transparent as possible.

So we included two charts in the press release this time that simply tries to show, on a non-GAAP basis, what the earnings per share would have been if there were no fair value accounting for the securities or the loans. This may have created more questions than answers, but we can address in more detail during the question-and-answer period. And with that, let me turn it over to David Hollaway, our Chief Financial Officer.

Thank you, David. Net interest income for the three months ended September 30, 2012 was $106.9 million compared with $82.5 million for the same period in 2011, an increase of $24.5 million or 29.5%. The increase was primarily due to a 49.7% increase in average earning assets during the same period.

Non-interest income increased $9.2 million or 63.4% to $23.8 million for the three months ended September 30, 2012 compared to $14.6 million for the same period in 2011. The increase was primarily due to the American State Bank transaction and impacted multiple line items, as well as adding income from trust and mortgage origination departments.

Non-interest expense for the three months ended September 30, 2012 was $60.2 million compared with $41.2 million for the same period in 2011, an increase of $19 million or 46.4%. Again, the numbers were impacted by the American State Bank transaction that included one-time merger expenses of $5.4 million.

The efficiency ratio was 46.1% for the three months ended September 30, 2012 compared to 42.4% for the same period last year and 41.9% the second quarter of 2012. Excluding the one-time merger expenses this quarter, the efficiency ratio would have been 41.9%.

The bond portfolio metrics at September 30 showed an average life of 2.69 years, expected duration of 2.66 years and projected annual cash flows of approximately $1.9 billion. And with that let me turn over the presentation to Tim Timanus for some detail on loans and the [follow up]. Tim.

Thank you, David. Our non-performing assets at September 30, 2012, totaled $14.051 million which is 28 basis points of loans and other real estate as compared to $11.873 million, or 30 basis points, at the end of the second quarter of this year. The $14.051 million total represents an increase of 18% from June 30, 2012. The September 30, 2012 non-performing asset total was made up of $5.195 million in loans, $10,000 in repossessed assets, and $8.846 million in other real estate.

As of today, $3.275 million or 23% of the non-performing assets at the end of the third quarter are under contract for sale. But as we consistently say each quarter, we can make no assurance that any of these contracts will close.

Net charge-offs for the three months ended September 30, 2012, were $1.255 million, compared to net charge-offs of $1.860 million for the three months ended June 30, 2012. $1.8 million was added to the allowance for credit losses during the third quarter compared to $600,000 during the second quarter of this year.

The average monthly new loan production for the third quarter was $134 million compared to $125 million during the second quarter of this year. This represents a 7% increase. Loans outstanding at September 30, 2012, were $5.79 billion compared to $3.950 billion at the end of the second quarter of this year. September 30, 2012 loan total is made up of 45% fixed-rate loans, 32% floating rate loans, and 23% variable rate loans. I'll now turn it over to Dan Rollins.

Thank you, Tim. As you all know, we completed our merger with American State Financial Corporation, or American State Bank, on July 1 and we completed the operational integration late in the third quarter. W. R. Collier, Mike Epps and Tony Whitehead are our leaders in West Texas, and they're actively involved in helping Prosperity expand across Texas.

We closed our fourth merger of the year with Community National Bank in Bellaire on October 1, and expect to complete the operational integration there before the end of this year.

Finally, our pending merger with East Texas Financial Services in Tyler, Texas is working towards a closing early in 2013. These five transactions add approximately $3.7 billion in assets, and provide us with additional resources to continue to grow across the state.

As you have heard, we are 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, we are prepared to take your questions. Victor, can you assist us with this?

(Operator Instructions). We will take our first question from the site of John Pancari with Evercore Partners. Please, go ahead. Mr. Pancari, your line is open.

This is [Raul] on behalf of John. I have a question regarding the -- (technical difficulty)

We can't hear you, John.

We're not able to hear.

Hi. This is [John]. Hello? Can you hear me?

Hello. We can hear you.

Okay, good. This is Raul on behalf of John. Got a question on the loan yields. Excluding the loan discount accretion of around $11 million this quarter, the loan yields came in at 5.34% which was down 29 bps linked quarter. I was just wondering if you could talk about that and give us a sense of the current loan pricing competition that you're seeing and where new loans are being priced at; rates on the CRE, single family and C&I. That would be great.

Tim, you or I can take it. But I think that what you're seeing in the market today, I think you're seeing people continue just like on the home loans. I think you're seeing people continue to refinance. I don't know, some people may agree or disagree with me even in this room, but even though we are seeing refinancing, I don't know that ours is as strong as maybe a lot of other peoples who are refinancing.

Most of the loans that we have, we've set up for longer periods of terms, and they have maybe some longer term fixed-rate. So even though we're seeing it, I don't know that it may be as strong as you may see it other places. But again it's still very competitive. Tim, you want to --

It is still very competitive. Having said that, we try very hard not to price anything lower than prime, which is 3.25% right now. So the spread really is from that number up to maybe 5.5%, 5.75%. It's very difficult to get 6% or anything above that on any loans at this point in time

I don't remember seeing 6% in a long time, if ever.

I don't know how to spell 6% anymore. So it is competitive and we don't see any reason that's going to change overnight.

Okay. All right. That's helpful. And then on the loan demand, if I basically take out the $1.1 billion that was added from the ASB deal, the organic loan growth was essentially flat this quarter at around $3.9 billion. Could you just discuss the status of the loan demand in your markets in what areas you've seen improving demand and in what areas, just by loan type or by industry, and where you are seeing increased competition.

Loan demand -- first of all Texas is probably doing better than most other states. So we have an extremely good economy, especially as it pertains to the oil business down in south Texas and we have a lot of other industry. But a lot of the other industries right now are still -- they have a lot of money on the sidelines, and again I think that they really want to see a lot of it maybe just because of the political situation that we're in.

I think before anybody's willing to pull the trigger, I think people are wanting to see a more clearer picture of what the economy is going to be like going forward. And having said that, you saw that our loan demand for this quarter was flat. Again we don't like to make excuses. But I will say that probably a couple of our companies did so good that they got bought out, which reduced our loans in this one quarter. These two were approximately about $45 million in size, which would have made a difference.

The second variable is if you followed our Company for a long time, you always knew that when we're in the middle of mergers and acquisitions, it's not as easy to grow the loan portfolio as it is when we're not. A year or so ago when we weren't doing the M&A, in fact we went a whole year before we did any M&A, you saw us getting close to double digit increases in loans. But again, make no doubt about it, as you do do M&A it does require people. And I think, as we said in the press release, we had as many as 250 people.

We had 250 people in the West Texas area during this period of time. A lot of those factors come into play. Going forward, I think there will be more clarity. I think after the election, there will be more clarity, and I do think that you should see loans pick up again.

If you go back and you look at our loan production performance throughout this calendar year, it's something that we feel reasonably good about. The average production for the first quarter was $106 million. The average production for the second quarter was $125 million a month. And then as I said, earlier today, the average for this third quarter was $134 million. So it's been steadily growing.

What we obviously don't have much if any control over is unanticipated paydowns and pay-offs. And as David mentioned earlier in the call, we had approximately $45 million pay off during this third quarter that we were not anticipating.

So loan demand is decent. I wouldn't call it great. I don't see anything that would make it deteriorate significantly. Although, I would say a lot of business people are watching this election very, very closely, and that's one of the reasons that they haven't moved forward with projects. And depending on what happens with this election, things could take a spurt up or could head down. We'll just wait and see.

All right. And then just lastly, I know earlier you mentioned that when the pay-offs essentially stabilize for [Prosperity] you will see some solid loan growth going forward. And the last quarter, your paydown activity was around $108 million. And I think you just mentioned there was $45 million this quarter. The monthly average.

No, that's not the number he was giving.

No, the actual total paydown rate exceeded the loan production rate just barely. Basically it was flat. $45 million was just an example of two loans that were unanticipated that paid off.

The lower the total paydowns, I think he didn't catch that.

About $135 million. (multiple speakers)with the burn rate.

So it was actually a little bit in excess of the production.

$134 million production; $135 million pay off.

That's correct. The production was at record high, but unfortunately the burn rate was high also.

Record highs also.

You've got two record highs, that's right. One good, one bad.

All right. That's helpful, thank you.

Thank you.

Thank you. We'll take our next question from the site of Jefferson Harralson with KBW. Your line is open.

I was going to ask you about the loan mark. I think originally you were talking about doing just the reserve, basically as a mark, which was about $24 million the last time I had seen American State's reserve. And it looks like it's $104 million loan mark or about 8%. Can you just talk about what changed and what's the implications of that going forward?

Well, as you know Jefferson, under fair value accounting in today's world, what we want and what we do are two different things. But under fair value accounting, we're required to go out and get bids on both the securities and the loans, and if you saw -- that's why we did the chart.

The securities actually, they had probably about an $80 million to $90 million gain in the securities. We had to reduce the yield on the securities which actually reduced the goodwill, as you know. But it also reduced the yield going forward.

On the loan side, we had to go out and get a valuation, which we hired independent people to go out and value the portfolio. Those are the numbers I think that we came up with about $75 million in loans. $75 million. I used to call it SOP 91. I know there's a new name for it, right now.

And then the other $20 million or $30 million was [2003]. So they broke it up into two categories. The first category is a category that really goes against the whole bucket of loans that basically reduces as the loans pay down and the speed and renewals and stuff like that.

The other portion of that is really directed toward just specific loans. It kind of it is what it is and that's why we really wanted to do the charts in the press release, Jefferson, is to show that if there wasn't this fair value accounting where you wouldn't have had to adjust the loans, the securities or the loans, what would the earnings per share have been? And that's kind of why we wanted to show this. There wouldn't have been a whole bunch of change, but this is just something we have to do.

All right. Thank you. It was a really nice expense quarter. How much of the -- you're mentioning 20% cost savings you're expecting of American State's expenses. How much of that 20% do you think is in the numbers already, or should we expect a lot of that to still come? How much is it from here, I guess, is the question?

This is Dave Hollaway. Again you're spot on. When we come into it, we said if we could cut 20% of the expense base, that's usually a target that we have. To give you an exact number, how much of that percentage is this past quarter and how much is coming, that's going to be kind of difficult.

Obviously, this bank was well run, as we were, and they were working with us in this first quarter, so we were able to achieve some things, now. But I would agree with you there will be more cost saves to come, but to give you an exact number, I don't know we can get you there.

Okay. Thanks, guys.

Without the one-time cost, efficiency ratio would have been 41.9%.

42%

How much lower can you drive that, Dave?

Again, we've been talking about the acquisition, specifically. Again, there will be some efficiencies there, but there's all kinds of other things going on. Again, the bank itself and the things that are happening in terms of talking efficiency ratio, 42% when you back out that one-time charge, that's where we've had -- in the last few quarters we've been about 42%, so the question can be, how much more could you drive that efficiency ratio down. I don't know that we would drive it down materially much more from here.

Are you making some investments in that American State side too, that would offset any expense saves that you expect to come there?

I think you're asking from a fee income perspective?

Either, either.

I mean actually that's something trying to point out in the numbers. Again if you look into those numbers, notice, and we mentioned this earlier, that the ASB brought some interesting initiatives with it from the fee side, particularly the trust area, what they call the home loan center. There's a few other things.

Absolutely, we're going to try to leverage that to the rest of the bank, which kind of works in conjunction with whatever we're doing on the expense side and therefore will impact that efficiency ratio, so absolutely on that side. I'm not sure I followed you on the expense.

I was asking that you were saying that efficiency ratio can't go lower, yet we have some expressed cost savings that are coming out. So I was wondering if there would be some other expenses that you were going to be adding on, kind of putting into the American State to invest in when there's new products or branches or other things that might not [get a little extra] at the bottom line.

I don't know that we would be materially doing it on the ASB side, but maybe on the bank-wide side to give you a very specific example. Again, we've talked about all the new rules and regulations coming our way and they're massive.

That's going to require us to add some expense next year just on the bank, generally. It's intimidating the amount of rules that are coming our way, and we're going to have to bulk up our compliance area and things like that. So that's the kind of expense I was looking at.

Okay. Thanks, guys.

Thanks, Jefferson.

Thank you. We'll now go to the site of Brad Milsaps with Sandler O'Neill. Your line is open.

Hi. Good morning.

Hi, Brad. How are you?

Good. Just to follow up on Jefferson's question on the expenses. It looked like American State's averaged around $18 million in operating expenses kind of quarterly for the last few quarters. Yet on a net basis you guys were up about $12 million, excluding the merger expense, OREO costs, CDI. I know you guys are some of the best in the business in extracting the cost saves, but even that seems really aggressive.

And looking back at AFS, it looks like they preloaded a lot of expenses before the deal closed. So I was just curious, any additional color there? It would seem to me that a lot of the expense saves ran, but it seems to me that you're indicating there may be some more to get.

I'd come off of head count. When you look at head count, there still were people that we are working through the integration piece that will continue to drop off. I think what you said is right, though. I think the folks at ASB did a great job of helping us eliminate some costs prior to the July 1 closing.

So when you're trying to dial in an expense save off of what they've been doing in the past when they had already done some of the lifting for us before we got to July 1, part of what you're seeing from a run rate is the good job that they did on their side of the aisle before closing. And both David Hollaway and I, are both sitting here telling you there's still additional costs to come out, just off of people in head count.

Okay. And then more specifically on the CDI number, maybe up about $400,000 linked quarter. I was maybe looking for maybe a more substantial increase. Is that kind of the run rate going forward, about $2 million a quarter?

Yes. I mean obviously that's being impacted by the American State Bank transaction, but yes, I'm thinking about the -- call it CDI -- but think about it this way, $2 million a quarter is right. But as we're looking forward, that includes all the banks we've acquired over the years, and the way it works on a CDI, remember, it's kind of a double declining balance concept, if you will.

CDI tends to be higher in the earlier years and then as time wears on, it's usually over eight to ten years, it starts to fall off. If you're looking year-over-year, you can see how, prior to the ASB deal, that core deposit and tangible expense was trending downward. That's going to continue to be that way outside of the ASB transaction. If that makes any sense.

Sure, absolutely. Final question. I appreciate the disclosure that you guys gave on the purchase accounting. If I just kind of look at the individual, sort of the three components, the one related to loan book and then the two on the securities portfolio, is it fair to assume since the $2.7 million piece was related to a specific sale of securities that won't be in the run rate going forward, while the other two pieces will continue to accrete in over time. I was just curious what you guys were assuming in terms of the timing of how those would accrete in? Is it a 18-month, 24-month period, or something less or more than that? Thanks.

I'll take first shot at that and I'll give kind of the overview -- the others can jump in. It's three pieces, obviously, moving in. One, the first one, obviously the first issue is the loan accretion. What will that do over time? I'll let the other guys jump in on more specific detail on that.

On the securities side that is in the numbers, and the bigger question for those two line items is really the question of two things here. Going forward what do we all believe the amortization from the prepayment and cash flow coming back to us, what's the prepayment speeds? What will that amortization do?

Don't really have that crystal ball. If it stays where it is today, you can use those numbers. Again, if it trends down, better for us. So yes, it's making the numbers, but it's all about prepayment assumptions and how that's going to impact that amortization, along with when you step back into this big picture, what are we doing in terms of growing our loan portfolio and soaking up some of this cash flow coming out of the bond portfolio, instead of reinvesting it at today's rates, where we are at today versus where we were at a little.

I've got to believe we're reaching kind of a base line here where the yield on portfolio and what we are reinvesting is getting close. But I'll let anybody else jump in on the loan side of this equation?

I would say on the loan side on the accretion part, again, this is something that we really hired out to an independent firm to come up with what this should be. You saw there was $11 million in accretion for the quarter. I would say that going forward, that's probably -- my gut feeling is that's high.

That's probably something more realistic would be, probably, we think anywhere between $2 million to $2.5 million a month, which would be $6 million to $8 million a quarter in accretion. Again, that's including the American State Bank and all the other banks that we bought at the same time.

So going forward, it was stronger this month again, but again a lot of that, the accretion just like the bond portfolio, depends on the speed and the renewals. Again I think you'll see that there's probably more accretion in the front end, and there will be a declining balance going farther out up until it's probably four years out.

But it's fair -- thanks, that's great color. It's fair to assume that the $2.7 million piece on the securities portfolio, that's not going to be there, right? Because that was a specific transaction from the securities that were sold, correct?

That's correct. It's in the number.

Perfect.

It's in there today. That will now just get washed as we go forward in reinvesting the cash coming off the portfolio going forward.

Great. Thank you, guys. I appreciate it.

Thanks, Brad.

Thank you. We'll now go to the site of Jennifer Demba with SunTrust Robinson Humphrey. Your line is open.

Good morning, everybody.

Hi, Jen.

Two questions. One is what are your feelings on the trajectory of the manager's margin over the next several quarters? You obviously, have some purchased accounting impacts right now. That's my first question. And two, I'm just wondering, David Zalman, what you're seeing now in the merger discussion arena, right now.

Okay. Two good questions. The first question I think is what's on everybody's mind is the net interest margin question, and I think a lot of people asked the question, we are not unlike anybody else and can we increase loans enough to offset margin pressure? I guess what I would say the answer is yes. We can continue to increase loans.

But like other banks, there's still margin pressure, and we continue to focus on increasing earnings per share both through the loan growth and the asset growth. But make no doubt that our goal is to continue to build earnings with the resources we have.

I guess, in short, what I'm saying is there will be continued margin pressure, maybe not as much as some of the other banks have, I think. We saw margin pressure starting, probably, two quarters ago where the other banks didn't see as much margin pressure.

I would think that's probably because they have probably got more loans than we had, so we took the brunt of the margin pressure earlier than anybody else. So I would say that we probably won't see as much as -- there will still be margin pressure but not as much as anybody else.

But again, we continue to focus on trying to increase earnings per share. We're not making a statement and saying, "Okay, net interest margins are going down so things are going to go down." We continue to focus and in order to do that, we'll have to build loans and we'll obviously have to continue buying banks and increasing our asset base.

You're saying, just to inject here, we need to focus on net interest income in addition to net interest margin, because it's the dollars that drop to the bottom.

That's the way an accountant would say it, yes.

Number two, the second question is the M&A. The M&A is hot and furious, we think. Dave mentioned earlier, I think too, Tim. Everybody else mentioned that the rules and regulations -- always need to be careful because I know they're listening on the other line too, our regulators, but I would have to say that the world has really changed in the banking environment.

When we have an exam right now where asset quality used to be first and foremost, and I think it probably still is for most banks, we spend very -- there's not quite the amount of time that's spent on the asset, I guess maybe because of our asset quality. We may spend two or three weeks during an examination process. We spent five months over the last year or so on a fair lending exam.

Our compliance, Bank Security Act and Anti Money Laundering exam took probably three months. I can go on with Sarbanes-Oxley and this risk committees and risk management and everything else. Dave mentioned that we'll probably be hiring at least five more people in the regulatory piece that will create 25 people just that deal, just with regulatory burden.

So having said that, I'm telling you all this because I don't really see how smaller banks can really make it going forward, especially with the net interest margins and the spread on money. I think you're going to continue to see a great deal of banks trying to merge and consolidate going forward.

We're still looking at some. We're busy. Our first goal, however, is to really digest what we have first with American State Bank. It's a big deal for us and we're really focusing on trying to get that done. But having said that, we're still looking at other deals, and I think that you're going to continue to see a major -- if things stay like they are right now, you'll continue to see a major consolidation in banking.

The question will be, who can buy them or who can they merge with? Because there's only a certain amount of buyers, and so you have to ask the question, how will this all get consolidated?

Thank you very much.

You're welcome.

Thank you. We'll now go to the site of Scott Valentin with FBR Capital Markets. Your line is open.

Good morning and thanks for taking my question. Just with regard to loan originations, you mentioned that on a monthly basis you're seeing record originations. Can you maybe give a breakdown of where the activity is? Is it residential mortgage? Is it commercial real estate?

There's probably less commercial real estate right now than anything else. And what I'm referring to is, I guess, what I would describe as specialty projects. Owner occupied real estate is still somewhat active, people that own businesses, buying and building new facilities.

But large commercial projects, either residential or commercial, either one, that doesn't seem to be very active right now. Everything else that we're involved in seems to be steady. And I don't see much change in that going forward.

One thing that we pick up with the American State Bank acquisition is the locations in the Permian Basin in the Abilene area in Texas. And those areas are more active in oil and gas than we are traditionally used to. So I think we're probably going to see, as long as that sector remains healthy and it certainly is healthy right now, we expect to see some additional production out of there. But other than that, I think it's business as usual for us.

Okay. And just with regard to the statement about net interest income, assuming if the loan portfolio stays relatively flat going forward, if prepayments remain high, it implies growth in the securities book. I'm just wondering how you think about capital levels going forward. Did Tier 1 leverage capital ratios down, I guess, from 7.7% at June 30 down to 6.9%? I'm just wondering how you think about where capital should be, given that it's being kicked around by the regulators?

I'll let Dave jump in in just a minute but, again, from a capital standpoint, I know that we talked about this at our last conference call. They talk about Basel III, and I think we've done some projections going forward, and we seem to be fine to be -- again and all our projections show us to be in good shape going forward, even under the Basel III going forward. Dave, do you want to comment on that?

No. That's correct. Well capitalized. We would meet that threshold. The example that they use are adequately capitalized. But even under the new rules for us, even if you think about the bond portfolio, it's all Fannie and Freddie. That risk weighting is not changing so we should be fine.

And then again you add the amount of earnings that we're earning going forward, it's huge compared to -- even after the dividend that we pay, we're probably retaining 75% of our earnings. So it builds up pretty quick, almost 1% a year.

Okay. So, you're not concerned by capital, at all, in terms of growing the balance sheet or the securities portfolio?

Not at all.

Okay. Thank you very much.

Thanks, Scott.

Thank you. (Operator Instructions). And we will now go to Matt Olney with Stephens. Your line is open.

Hi, Matt.

Hi, guys. Good morning.. Going back to the M&A discussion. In 2013 your home state of Texas is going to have a small handful of mutual conversions that will reach their three-year anniversary date, and there's speculations those guys could sell. I don't think Prosperity has been historically very active in terms of acquiring former conversions. How should we think about your appetite for this type of acquisition that has strong deposits but just not very profitable?

Well, I would put it like this. Never say never. But I think you hit the nail on the head. The deals that we look at, it's not to say that we won't change at some point in time if it makes sense. Because if it always makes sense and we can make a lot of money out of it, we'll always consider it.

We're really focused on teaming up with banks that have been around for a long time, that have a real good core deposit structure, not necessarily time money but more transaction money, and that has a business, it's a business of loans. Again, I notice some of these companies have worked very hard to convert their mutuals to banks, and they're trying. And I think they're doing a good job, and maybe as they convert more into a banking type of environment, we may be more interested in something like that.

But right now there's so much on our plate, which is good, good banks, that we have more than we can say grace over, right now, with just real core banks, really.

All right. Thanks, guys.

Thank you, Matt.

Thank you. It looks like we have a follow-up question from Jennifer Demba from SunTrust Robinson Humphrey. Your line is open.

Okay. Two questions.

You can't ask. You already asked two.

I'm going to ask two more if you'll take it.

Okay.

American State's, given that revenue generation is so difficult for the industry right now, can you talk about what businesses that bank has been in or done better than Prosperity that you think you can particularly leverage?

Well, I think they've done better than us at quite a few things, quite frankly. First of all, they had a lot better service charge income than we did. We've looked at their service charge income. Instead of changing them to us, we're adapting to more of what they had than what we had.

They have a trust department, and it's about a $1 billion in size, and it makes good money. And I think going forward, if we can all get comfortable, we would like to expand their trust and wealth department into other areas, into Dallas and Houston and other parts of the state.

They also have a mortgage banking department that we didn't have. And of course mortgage banking right now is hot, and they do a real good job with it. It's just us trying to get our hands around it.

Our bank has about $1 billion in portfolio in one to four mortgage portfolio home loans, and of course you have got to be real clear on the fair lending side. How do we mix to not lose our 15-year product or our variable rate product to a mortgage company? They add a lot of income right there.

They have credit cards where we have not had credit cards, and so I think that again, this is going to take time. But gosh, if we can get 5 % or 10% of our customers to use the credit card system that they have, I think that could be a good chunk of change. They have a thing that's called ISO, Dan, you're going to have to help me with the ISO, where they actually act as a sponsor of ATM machines for how many customers?

Oh, [635] or 40,000 ATM machines.

So one of the biggest in the [ISO]. So I guess I can go on and on, but this is a great company, and if we can keep everybody together and working together, I think we can really build something with it. I consider this a real great opportunity for us with them. They're really good people, everybody out there.

And the ATM business, that falls into other income?

Yes, that's where it is this quarter.

Okay. And how big is that per year?

Dave, do you have a number on that? I don't know if we pulled out a number.

Big meaning?

How many dollars. She's wondering how many dollars in other income was in that category?

Talking about $1 million, $2 million a year. Something like that?

Per year. Not per quarter.

Something like that.

I think we're $1.5 million give or take a year and growing.

Okay. And this question's been asked a lot during the call so I'm going to try and take another crack at it. If my numbers are right, your current total expense run rate's around $60 million. Would you see that growing significantly over the next several quarters or staying relatively flat or down?

As close as I can get to it, probably relatively flat, a little bit one way or the other. But again crystal ball today with all the moving parts, it's hard to make that call, to give you the real clarity that you need. I mean using maybe a flat run for the next couple quarters, maybe.

It may be down a little bit. I think Dave is trying not to get everybody's expectations too high, because it's easy that you can make a lot of assumptions, but everybody has to keep in mind there's margin pressure.

And so we don't want to get anybody extremely excited because there's still margin pressure out there at the same time. I think Dave is trying to mitigate everybody to maybe look at it like it is, maybe on a flatter basis or a little bit better.

That's very helpful. Thank you very much. Thanks.

Thanks, Jenny.

(Operator Instructions). It appears we have no further questions over the phone.

All right. Thank you all very much. We certainly appreciate everyone participating in our call. We look forward to visiting you as we're on the road in the next few months. Thank you very much for calling in.