Prosperity Bancshares Inc (PB) 2014 Q2 法說會逐字稿

Good morning and welcome to the Prosperity Bancshares second-quarter 2014 earnings conference call.(Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to Charlotte Rasche. Please go ahead.

Thank you. Good morning, ladies and gentlemen, and welcome to Prosperity Bancshares' second-quarter 2014 earnings conference call. This call is being broadcast live over the Internet at www.prosperitybankusa.com and will be available for replay at the same location for the next few weeks.

I am Charlotte Rasche, Executive Vice President and General Counsel of Prosperity Bancshares. And here with me today is David Zalman, Chairman and Chief Executive Officer; H.E. Tim Timanus, Vice Chairman; David Hollaway, Chief Financial Officer; Randy Hester, Chief Lending Officer; and Mike Epps, Senior Executive Vice President for Financial Operations and Administration.

David Zalman will lead off with a review of the highlights for the recent quarter and an update on our merger and acquisition activity. He will be followed by David Hollaway who will review some of our recent financial statistics, and Tim Timanus will discuss our lending activities, including asset quality. Finally, we will open the call for questions.

During the call, interested parties may participate live by following the instructions that were provided by our call moderator, Betty, or you may email questions to investor.relations@prosperitybankusa.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 will send a copy to you.

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

Additional information concerning factors that could cause actual results to be materially different than those in the forward-looking statements can be found in Prosperity Bancshares' filings with the Securities and Exchange Commission, including Forms 10-Q and 10-K, and other reports and statements we have filed with the SEC. All forward-looking statements are expressly qualified in their entirety by these cautionary statements.

Now let me turn the call over to David Zalman.

Thank you, Charlotte. I would like to welcome and thank everyone joining us for the second-quarter earnings announcement. I am very excited and proud to be able to announce such positive results for the second quarter of 2014. In addition to our strong performance for the first half of 2014, we are flattered to be named the Best Bank in America by Forbes magazine. In fact, we were recognized two out of the last three years as the Best Bank in America.

We posted earnings of $75.506 million for the three months ended June 30, 2014, compared to $53.844 million for the same period in 2013, an increase in net income of $21.662 million or 40.2%. Our diluted earnings per share for the quarter ended June 30, 2014 came in at $1.08 compared to $0.89 for the same period last year, representing a 21.3% increase in earnings per share.

Our asset quality continues to be one of the best in the industry, a nonperforming asset ratio of only 15 basis points and nonperforming assets of $28.521 million. Our allowance for credit losses was $73.266 million as of June 30, 2014, with nonperforming loans of $23.417 million as of the same date, representing a healthy coverage ratio.

Loans at June 30, 2014 were $9.308 billion, an increase of $3.136 billion or 50.8%, compared with $6.172 billion at June 30, 2013. On a linked quarter basis, loans increased $1.556 billion, or 20.1% from the $7.752 billion at March 31, 2014.

Looking at loan production on an organic basis, excluding those loans acquired in acquisitions and new production at the acquired banking centers since the respective acquisition dates, our legacy loans at June 30, 2014 grew 8.4% when compared to June 30, 2013, and 3% or 11.8% annualized on a linked quarter basis. We are very excited about the higher level of organic growth this quarter, and we are seeing more requests for new loans.

Our deposits at June 30, 2014 were $17.281 billion, an increase of $4.7 billion or 38.2%, compared with the $12.500 billion at June 30, 2013. On a linked quarter basis, deposits increase $1.821 billion or 11.8% from $15.460 billion at March 31, 2014.

Looking at deposits from an organic basis, meaning excluding deposits assumed in acquisitions and new deposits generated at the acquired banking centers since respective acquisition dates, deposits at June 30, 2014 grew 6.1% compared with June 30, 2013, and decreased 1.5% on a linked quarter basis. The drop in organic deposits for the quarter is not unusual for us.

In fact, if you go back to the prior year at the same time, you will see a similar situation. We have over 450 municipalities that do business with us, and this time of the year they have less in their accounts until their tax dollars come in at the end of the year. We expect our organic deposit growth to be positive for the year at about 4% to 6%.

We completed our operational integration with the F&M Bank in Tulsa in the late second quarter. Tony Davis, Chairman, Eric Davis, Vice Chairman, and Jeff Pickryl, President, and many of the associates of F&M have worked very hard to make this a successful merger. And we really appreciate all of their time, integrity and dedication. We expect F&M to add value to our organization and we look forward to them taking leadership roles in our Company.

We could not be more pleased with how things are going with the First Victoria National Bank merger. We are already seeing them begin to grow loans and deposits in the latter part of the second quarter. Many of the First Victoria National Bank associates have taken leadership roles in our Company and are helping us to build a bigger and better bank with more products and services for our customers.

Again, we owe all of our success to our team of associates, our past associates and board members who have helped grow the Company from one location with $40 million in assets when I got there in 1986, to a $21 billion bank with 246 locations in Texas and Oklahoma today. We would also like to thank all of our customers for their business and loyalty to the bank. Thanks again for your support of our Company.

Let me turn over our discussions to David Hollaway, our Chief Financial Officer.

Thank you, David. Net interest income for the three months ended June 30, 2014, was $174 million compared with $118.7 million for the three months ended June 30, 2013, an increase of $55.3 million or 46.6%. The increase was primarily due to a 30.7% increase in average interest earning assets.

The net interest margin on a tax equivalent basis was 3.83% for the three months ended June 30, 2014, compared to 3.43% for the same period in 2013, and 3.62% for the three months ended March 31, 2014. Excluding purchase accounting adjustments, the net interest margin on a tax equivalent basis for the three months ended June 30, 2014 was 3.31% compared to 3.09% for the same period in 2013, and 3.33% for the three months ended March 31, 2014.

Noninterest income increased $8.7 million or 34.5% to $34 million for the three months ended June 30, 2014, compared to $25.3 million for the same period in 2013. This year-over-year increase was impacted by the F&M and First Victoria National Bank transactions, an increase in trust and brokerage income, and gains on sales of assets and other real estate.

Noninterest expense for the three months ended June 30, 2014 was $88.7 million compared to $61.3 million for the same period in 2013, an increase of $27.4 million or 44.7%. Again, the increase was primarily due to the F&M and First Victoria National Bank transactions. Additionally, the current quarter included one-time pretax merger expenses of $2 million primarily related to the F&M transaction.

The efficiency ratio was 42.9% for the three months ended June 30, 2014 compared to 42.5% for the same period last year, and 42% for the three months ended March 31, 2014. The bond portfolio metrics at 6/30 showed a weighted average life of 4.27 years, an effective duration of 3.89, and projected annual cash flows of approximately $1.5 billion.

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

Thank you, Mr. Hollaway. Our nonperforming assets at the end of the second quarter of this year totaled $28.521 million or 31 basis points of loans and other real estate. This is compared to $18.696 million or 24 basis points at the end of the first quarter of this year. This represents an increase of 53% in nonperforming assets from March 31, 2014. The change primarily results from two loans from acquisitions that are on our books for a total of $11.062 million.

The June 30, 2014 nonperforming asset total consists of $23.417 million in loans, $11,000 in repossessed assets, and $5.093 million in other real estate. As of today, $1.526 million of the June 30, 2014 nonperforming assets total are under contract for sale, but there can be no assurance that any of these contracts will close. This represents 5% of the nonperforming assets at the end of the second quarter that are under contract for sale at this time.

Net charge-offs for the three months ended June 30, 2014 were $155,000 compared to net charge-offs of $786,000 for the three months ended March 31, 2014. $6.325 million was added to the allowance for credit losses during the quarter ended June 30, 2014, compared to $600,000 for the second quarter of this year.

The average monthly new loan production for the quarter ended June 30, 2014 was $241 million compared to $223 million for the quarter ended March 31, 2014. This average monthly new loan production for the second quarter of 2014 was an 8% increase on a linked quarter basis.

Loans outstanding at June 30, 2014 were $9.308 billion compared to $7.752 billion at March 31, 2014. The loan total at the end of the second quarter of 2014 was made up of 44% fixed rate loans, 34% floating rate, and 22% variable rate loans.

I will now turn it over to Charlotte who will coordinate your questions.

Thank you, Tim. At this time we are prepared to answer your questions. Betty, can you assist us with questions?

(Operator Instructions). John Pancari, Evercore.

Yes, hi, this is Rahul Patil in for John. A question on your loan demand. I know the agriculture loans are relatively a smaller book, but are you seeing any spillover effect from the draught conditions in central Texas on your loan demand in other areas?

I think the answer to that is essentially no. It does obviously directly affect certain agricultural operations, but it doesn't seem to have had any significant adverse effect on our customer base up to this point in time. And some of the second-home sales on lakes and rivers that are having water problems have diminished, so there is not as much economic activity in that regard. But once again, that really hasn't affected our loan growth in our loan portfolio.

Okay, thanks. And then just a question on your loan yields. If I exclude the purchase accounting impact, it looks like the core loan yields were down 10 bps. How should we think about the loan yield pressure going forward, excluding the noise and purchase accounting? And are you seeing any stabilization in your new loan spreads that are coming in as of second quarter?

I don't think you will see any dramatic change in what you have just described. What we are seeing is a lot of aggressive lending in the marketplace, especially when it comes to extending fixed rates out over long periods of time. So this competitive situation makes it difficult on us, needless to say. But we have had it for a while and I think we are going to continue to have it.

But having said all of that, I don't think you're going to see any significant increase or decrease in what you've just said in terms of our loan yields.

All right, thank you, guys.

Scott Valentin, FBR & Co.

Good morning. Thanks for taking my question. I'm just trying to tease out kind of a core non-interest expense run rate. I know there is obviously a lot of noise, and you mentioned the merger expense in there. I'm just trying to figure out looking forward as some of the expenses from the mergers kind of go away, how should we think about a core run rate for non- interest expense?

Yes, this is Dave Hollaway. I think when you look at our numbers, the one major piece if you wanted to adjust is just remember that in our second-quarter numbers, you have got $2 million dollars of one-time merger fees. So obviously, going forward, that will fall away.

Other than that, I think you are going to probably want to run -- we are probably going to run our overall expense base at that run rate for the next few quarters.

Okay. And then in the press release you guys called out, I think, a gain on a sale of a building and a gain against your receipt of benefit from life insurance policy. Can you quantify that amount?

Yes, I think what you see if you are looking at our press release, you see a number of things on there. One, you see -- related to that you see $1.3 million and $1.4 million. I don't have them correctly in order, but one is a gain on sales from assets and gain on sales of ORE.

And then, yes, and then there were some benefits from some life insurance that I think is in the other category, and that is about $1.5 million too. So you add $1.3 million, $1.4 million, $1.5 million, that would get you to those kind of one-time items.

Okay, great. Thanks very much.

Brett Rabatin, Sterne Agee.

Hi guys, good morning. Wanted to ask, I guess, first just going to F&M and just thinking about that portfolio, and I know you have talked about it in terms of potential runoff, but just any updated thoughts around F&M. And then if you kind of think about the other ones, Victoria, Coppermark, if runoff of those portfolios are close to being over or if we might see some additional decline from those past deals as well.

Sure. Going back from probably the last one, Coppermark, we do think that we have seen them stabilize and probably soon will start going forward. The First Victoria -- and this is David Zalman-- then the First Victoria National Bank, they are doing just great. We are already starting seeing them increase deposits and loans in the late second quarter.

You saw a little bit of a decrease -- a part of the decrease you saw from last quarter to this quarter with First Victoria National Bank, they also had -- they're an ag lending bank. So the first quarter you've seen the loans that they have are not as much as they are probably in mid year in June, as the crops and as their customers are drawing on the deal. So we are really seeing a good increase from them.

F&M, again, we knew that there would be a certain amount of runoff just simply because the amount of Shared National Credits and going to cost syndications or club deals that they have. I mean when you really look at it, I think that the Shared National Credits that F&M Bank had at the end of -- probably at the end of June were $290 million in Shared National Credits. And then club or syndications, they had about $43 million.

So down from where they were when we first looked at them. And again, the legacy Shared National Credits that Prosperity had that really came through some of the other acquisitions we have, we have $82 million. So you know we do think there will be some downward pressure on F&M for a period of time. But again, nothing unusual compared to other banks that join us like that.

Okay. That's great color, David. And then I guess the other thing I was hoping to get, maybe a float-on, is just there has been a lot of talk this quarter about being a bigger bank and not necessarily CCAR, but just being north of $10 billion -- north of $20 billion actually, and was just curious if you were seeing any increased costs.

I know you've talked a lot about people you have had to add as you've gotten bigger, but do you think you'll be having to add any more infrastructure, back office, what have you, to appease the regulators as you continue to grow your asset base?

Well, I think the bat hit us in the head about two years ago. I am still ringing and seeing stars. Once we crossed the $10 billion mark, it was a -- as I think I mentioned in prior calls, the examination process just changed dramatically. So I think it was almost shocking to us, especially after the American State Bank acquisition when I think we had $13 billion.

I think that we have gotten our arms around it. We are getting our arms around it again. The regulatory burden is so much more intense than I would've ever even imagined. And having said that, where we used to be regulated primarily on a regional basis and usually the regional guy could make a lot of the decisions, what we are seeing today in our examination is that you have regional people here, but so many of the people that come in are experts from different parts of the nation -- Washington, Philadelphia -- for every different type of deal that you have.

So I think it takes them a while and us a while to learn what they are looking for, and for us to get up to speed where we are at. But I feel like we are doing a good job.

The last question I think you had, well, what do you think going forward? Well, I have to be careful; they are probably on the line. But from a regulatory standpoint, you can never have enough people. So there is probably a balance between -- there is probably a balance between what they want and what we want.

So I think what Dave said earlier, though, the run rate and the expense rate if you use that what we have, I think that is pretty --.

I mean, you know, I would just add a little color to that. So when we're looking at our run rate, if we didn't have all this regulatory -- these hurdles that we have to overcome and build up infrastructure staffing, yes, I think you could see us drive down our operating expense.

But with these challenges for a $20 billion plus bank, that is probably just not going to happen. I equate this -- the analogy on this, the way I look at this whole thing, is up until a year and half ago we were asked to run a 3-mile race and we are very good at it. And then overnight because of our size, they come in and say, well, starting tomorrow you need to run a marathon.

Well, it takes a little time to train up from 3 miles to a marathon, and that is where we're at today. We are just an ongoing process of upgrading people, infrastructure, whatever it is. We have been doing it now for -- I mean, David, it has been going on 18 months.

Yes, I mean in the past as you know, we focused and we always felt that from a regulatory standpoint that the asset quality of the bank and the earnings and our efficiency ratios and the fundamentals are what really counted.

And what we have found out, as I am sure like others have found out, as you get larger those are probably still important, but they are more impressed with policies and procedures and things of that nature.

Okay, I appreciate all the color. Thank you.

Jon Arfstrom, RBC Capital Markets.

Thanks, good morning. Just a follow-up on that. It is a great topic to explore with you, given the fact that maybe some of the efficiencies from F&M might be off set a bit with bigger regulatory burdens. And I guess, Dave Zalman, for you, does this change your acquisition appetite at all, or does it make you think a little bit differently about the future of the Company? Or is it still the same as it has been over the last couple years?

No, Jon, it is too late, we are already pregnant. We know where we're at, we know what we have to do. I think that basically we said probably even a year ago that -- we mentioned this to all the associates and the staff and everybody that our game plan was to -- over the last 18 months to two years, we have grown from a $10 billion bank to a $20 billion bank.

And basically we've said that our goal was to get both banks operationally integrated. We did that here in June with F&M. And I would say that we said basically from last year at the end of the year, there would be about a year before we would really be in the market for probably trying to purchase or doing another bank deal.

And I think for the most part -- I am sure we have a lot of our own associates listening; if I said anything different, they may come in here and kill me. But I think from -- truly, though, I think it is the right thing to do. We have really grown a lot.

It is really important right now to make sure that our back room, that our operations get up to speed with the size that we are. And that just doesn't happen overnight. When you double in size, it really takes a lot of work there. It takes a lot of work to make your IT piece work, your note areas work, that the regulators are happy with everything that you have.

So I think unless there is something that is extremely sexy out there, you know, that it is a deal of a lifetime, I think we are still on that schedule to go out toward the end of the year and really not make an acquisition.

Okay. Good, that is helpful. I am not sure who will answer this, maybe Tim, but you talked about seeing more requests for new loans. Can you give us an idea maybe of what or where is the strongest?

Well, it is really across the board. We are seeing, for example, more requests for large Class A apartment projects in major metropolitan areas. In fact, we have seen so many that we are a little bit concerned about the growth in that area and whether or not the absorption is going to be there in the future to make those projects work.

We are seeing continued office and retail requests on the real estate side. All of our bread-and-butter loan types continue to have requests come in. So I think it is spread across all sectors. But it does seem like the largest request, and it is simply by virtue of the nature of the projects, are the large residential projects. And those are primarily apartments as opposed to condominiums for sale.

And then we are seeing some large office buildings change hands; not necessarily new office buildings but existing ones change hands, and those are high-dollar loans. So it is business as usual, but we are seeing more larger requests from the high-dollar residential and the office side.

Tim, I think you could also make an analogy that we are seeing larger credits coming to us, simply because of our size and our dominance in Texas and Oklahoma, and probably some other relationships that might have had a relationship with us but because they were so big, they might have shared some of their loans or seen some of the customers increase what they've had with us and coming more toward us too, I would think.

That is exactly correct. I mean once upon a time, we really weren't big enough to see these kinds of credits or be able to do much with them, other than act as a participant. Now we are big enough where we can actually generate credits, and if we want to be a participant we can take a larger share, obviously. So you are right, a lot of this is a result of our size.

Okay. Then just one small one, the construction and development increase, over $100 million. How much of that was acquired versus organic, in terms of that sequential jump?

I do not have a hard number for you on that, but Randy Hester just said he thought 50% acquired, 50% organic, and I would say that it's going to be pretty close to right.

Yes, okay. Okay. All right, thank you.

(Operator Instructions) Jennifer Demba, SunTrust Robinson Humphrey.

Thank you. Following up on topics we have already discussed, David Hollaway, how much of the F&M cost savings have you guys realized through the end of Q2?

Yes, I think in the big picture, we have recognized quite a bit of it. Again, I think that run rate is pretty close. And again, when we get to third quarter, you'll take out that $2 million one-time charge; we are pretty good there. The other expenses you see coming out of the first quarter, the second quarter, is just a lot of this other stuff going on.

You know, we have done our job pretty much for the acquisition, but we have got all this regulatory stuff, expenses, that we need to deal with. We also have, as you'd note on our fee income side when you see it, you see our trust and brokerage, our lines of business. You see the fee income increasing. Well, that doesn't come out of thin air. There is expense behind it.

So they are beefing up those areas, so that is some of that expense also that you are seeing in the linked quarter grow.

I would just add, Jennifer, that generally you'd probably even see more, but sometimes it is overcome by the amount of regulatory costs we have or regulatory burden with the new people we have to add all the time.

And the lines of business.

And the lines of business, yes.

(multiple speakers) And private lines we're getting up to run.

David Zalman, you mentioned you think you are still on the sidelines for more M&A until late this year, early next year. Are you trying to get through another exam cycle before you contemplate announcing something? Or is there some certain date you're trying to get past?

Well, I don't know that we have an exam cycle anymore. They are here all year long. So they are here 42 out of 52 weeks. (multiple speakers). That is a year cycle. If we are doing something wrong, we know pretty quick. And probably the good part of that is you get a chance to correct it right away, and so suffice to say they are here.

But I don't know necessarily that we're waiting for an exam cycle as much as just waiting for our people to catch up and catch their breath. And again, making sure -- IT, for example, I mean we really took on a lot, making sure that is working. And when you turn on your computer the little circle doesn't go around, that you do get the Outlook email when it pops up.

And fundamental stuff like when you're trying to make a loan where they don't have to wait two weeks to get it processed. It is fundamental stuff that really as you grow, you have some issues and you have to work through those issues and make sure that you are the best at it. So that I would say it is really getting our back rooms in shape to service our front end, basically.

It is a timing thing, right? I mean as we just closed the last transaction in June, it takes about 90 days from our operations to deal with the aftermath and ensure everything is moving forward correctly. And then once they have signed off on all that, then their attention can turn back to infrastructure, whatever they need to do. And it is just a timing thing. So I think we are on schedule of what you laid out, David.

Yes, I think that is right. I think from a repertory standpoint, I mean I feel like we are doing everything that they want us to do. Who knows, we may get a bat in our head, but from right now I think that we are -- again, I don't see anything dramatic there, really.

And I might add to what Dave said, I think F&M is an important factor in this. We need to get F&M squarely on board and make sure everything is functioning properly there. You know, that is happening, but it takes a few months to do that. So we need to complete that process.

One more follow-up if I could. BSA, AML, fair lending, seem to be under greater scrutiny now. How do you feel specifically about your processes related to those areas?

Well, I would probably go back to a prior comment that I've said a while ago, I mean 18 months ago or two years ago when we crossed the $10 billion mark, it was unbelievable. The BSA where we might have had a few people in BSA, I think within six months we had to increase that to probably 15 or 18 people.

So I think we are doing pretty good. Maybe I'm wrong, but I feel like right now our BSA is doing pretty good. Do you feel any different Charlotte, or anything?

No.

I mean, I think we are okay.

Okay, thank you very much.

Mikhail Goberman, Portales Partners.

Good morning, gentlemen. Quick question about capital, tangible common equity ratio of 616 right now. Do you have any sort of target ratio that you wanted to rise to before you indeed pulled the trigger on another deal? And is that an internal target, or is there anything regulatory related with respect to that?

I don't -- you know, again, we generate a lot of capital. I think that our earnings projection to you guys or the analysts have are about $300 million a year. And even after we pay close to $1 on a dividend, we are still retaining over $230 million a year in capital.

So we almost grow 1%. That 6%, for example, would turn into 7% with a one-year timeframe. So I think that we are okay with 7% today. Today is well-capitalized, but again it is always the thing that we are always looking in, we are cognizant of at the same time.

I'd also say that when we do deals, generally for the most part that we've seen, the banks that join us are willing to take our stock. So we may pay some percentage in cash, but most of the time they are willing and wanting to take our stock.

All right, that is very helpful. Thank you. And just real quick from a competitive landscape sort of perspective, in which direction are things moving down there in Texas and Oklahoma? Is it continuing to get more competitive and crazy pricing, or is it starting to level off a little bit?

I would probably answer two ways. Unemployment is -- we probably have -- it is better here in Texas and Oklahoma than almost anywhere else. Population growth is I think 200 cars a day in Houston, probably 200 cars a day in Dallas, 100 in Austin. The growth is just unbelievable.

So from a growth standpoint and an economic standpoint, we are seeing loans and people really starting to come in for more. In fact, Tim, I don't know when the production was or how much production we had, but it is really growing.

So from that perspective, I think it is really good. The negative that we see is probably the competition, the willingness to lower the terms and conditions on credits. I guess everybody's looking for loans so much, and the rates that they are willing to do it at and fix that and stuff like that. So that is probably the negative part that we see.

It is almost so extremely competitive that we feel sometimes -- we wish that everybody -- and, of course, they probably say that about us too, but when we're looking at other deals, we wish that the other banks would try to keep up their margin a little bit and put reasonable rates fixed for a certain period of time, and just terms and conditions overall, really.

I might add a little to that with a specific example. We found out yesterday that one of our competitors in Texas approved a loan that we had looked at, a commercial real estate loan. And they agreed to fix the rate at 3% for 20 years. So I think that gives you a little clue as to what is going on out there in the marketplace.

It is extremely difficult from a competitive standpoint. And if history repeats itself, which it normally does, these financial institutions that are doing those kinds of things are going to have a real problem at some point in time down the road.

And we are trying to keep a balance and continue to add to our loan portfolio, but not fall into those kinds of traps. So it is just part of the landscape. It is out there and we deal with it every day, and we will get through it.

Yes, I think that -- I looked at a loan in Oklahoma, it was a municipality last week or a couple weeks ago and -- again, a lot of these are smaller banks so they are not held. They are probably not as looking at everything the same way we would look at it, but they offered a fixed rate to a municipality for 5 years at 1.75%. That wasn't tax-free, 1.75%.

Well, by the time it cost your overhead of over 1% and you have any risk at all, it is virtually not making anything on it, basically.

All right, I see. Thank you very much.

Gary Tenner, DA Davidson.

Thanks, good morning. Just thinking about the increase in purchase accounting benefits this quarter to the loan yields. Is it reasonable to think of the amount of Shared National Credits and club deals at F&M, and thinking that some of those benefits could be a little frontloaded as you kind of work off some of those loans? Or is there some other driver this quarter of the increase?

Multiple -- I think there is probably multiple answers to that question. Let me take the last one first. Yes, I mean in the quarter there was -- in the loan side there was roughly $25 million of purchase accounting on the loans. And of that, $7 million of it was related to 03 type credits, which these are credits we've been able to work our way out of from the deals over the last two years. So that was a little higher than normal.

And on the second part of that question, I will let somebody answer in more detail but, yes, I think that if you are working your way out of some of these loans, you call it outsourcing them or if they leave us or we are touching them or whatever the terminology is, and they have got a fair value discount attached to them and then they leave us, you are absolutely right. That would be frontloaded. And I think that fair value would come to us quick.

Yes, but I would hate to say that it's frontloaded. I think the mark that we put on the loans -- I think we're talking about the 03 loans -- I mean we think they are realistic and fair. We are not trying in any form or fashion to front-end load them and put a lot more in.

In fact, if we recover -- for example, on an F&M deal, for example, if we add a $2 million or $3 million 03 provision for that loan and we collected in the next three or six months, we wouldn't take that through income. We would take that back to goodwill. Wouldn't we, Dave? I mean that would be more of a happening in a short period of time.

No, on 03 -- well, to get in the weeds, though, 03 if you do better than what your mark is, it will come back to you in income.

Well, but not if it happens right away, will it? It is a question, I guess, that you have to debate it. But again, I think overall the front end -- we really don't try to front-end load stuff. We really try to put realistically what (multiple speakers).

Well, what he means by front-load is if these loans pay off, mature, whatever, just in a general way, you are collecting that discount (multiple speakers).

Right, I think maybe the best way to answer it --.

(inaudible) 91, yes, I see what you are saying.

I think my numbers are close to being correct. On the 03 side, the number of F&M loans that have that 03 mark are really only about a third of that total portfolio that David mentioned of shared credits, etc. So it would be a mistake to assume that that total portfolio that our credits that-- and we're not saying they are bad credits, but they are outside of our normal box.

Some will stay with us, some won't. But it would be a mistake to assume that there is a mark associated with all of those that would come into income, because that is not the case.

Right. And I would also say the amount of accretion that we had this quarter because of the 03s, I don't think you can count on that. I think something that is more reflective in a quarterly accretion basis would probably be more like what, $16 million or $17 million, Dave?

Yes, you could take $16 million to $18 million.

$16 million to $18 million.

But we say that on every conference call, you can't consider 03s as part of the quarterly flow.

No.

That is just a reflection of how you work out of your loans eventually.

Yes, I think -- and I know it is hard for everybody that is watching this; there is so much noise in here because we had a large accretion number and we had a gain on the sale of some ORE at the same time. We took a much large provision -- provision for loan loss.

So I think when you consider everything that went on, the additional accretion that we got, the additional gains that we got on the sale of ORE and some life insurance, and you offset with the additional provision that we made and the additional cost with the F&M deal, we had I think a really damn good month -- I mean quarter. It was really impressive, and I think we did better than we even anticipated.

All right guys, thanks for addressing the questions.

(Operator Instructions) Jefferson Harralson, KBW.

All right, thanks. I wanted to ask about the F&M loan market. It looked like the loans at F&M were $1.7 billion at the end of Q1 and $1.5 billion at the end of Q2. And is the lion's share of that the mark?

I will try to answer this, and Tim or somebody else can jump in. But again, you had $1.7 billion to start off with or so. Our mark was what, around $100 million?

$130 million.

$130 million total.

$134 million.

So basically, the decrease in the loans came from about $100 million in paydowns, more in the Shared National Credit area, and then the rest was the mark.

So in combination, was the mark also heavily moved towards those Shared National Credits to where the $400 million that we had in Q1, is that down to like $250 million now, the Shared National Credits at F&M?

The Shared National Credits at the end of June were $290 million. And then they also had some syndications or called club credits of about $43 million. But the Shared National Credits were down to $290 million.

Okay. And then finally on the accretable yield you expect to go through over time, it seems like that had a big increase this quarter. Was that due to F&M or just some things moving from non-accretable to accretable, or what happened there?

I don't know that I understood that question.

Well, we have a total of $224 million in fair value accounting spread out between the 03 and the three 1020s. So it is more than just F&M, if that answered your question.

So I was saying that, I guess at end of last quarter, the remaining accretion to go through was about $77 million. Now it looks like it is $123.3 million. And I was thinking, you also had the $23 million run through. So it looks like the number increased, but we can also talk about that one offline if you want to.

No, I think that is right. There was about $65 million in 91 discount coming from F&M. So that is a little higher than on these past deals. So if you're tracking history, that would infer that the 91 going forward is a little higher.

I mean I think if you recall we were projecting, based on what we knew at the time, we thought maybe $13 million a quarter was good. But it looks like this past quarter it was running about $18 million. Some of that is when to be F&M, obviously, that is driving that, or a majority of it actually.

Again, we are not the ones really putting the mark on that. We hire an outside group to come in and give us that mark, and again, they called it higher than we anticipated it too, basically.

What that infers is your go-forward number should be a little higher because you are starting at a higher number.

Right.

Thanks guys, I appreciate that.

This concludes our question-and-answer session. I would like to turn the conference back over to Charlotte Rasche for any closing remarks.

Thank you, Betty. Thank you, ladies and gentlemen. We appreciate you taking the time to participate in our call today. We appreciate the support that we get for our Company, and we will continue to work on building shareholder value. Thank you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.