Prosperity Bancshares Inc (PB) 2015 Q2 法說會逐字稿

Good morning and welcome to the second-quarter 2015 earnings conference call.

(Operator Instructions)

Please note that 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.

Welcome to Prosperity Bancshares' second-quarter 2015 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. Here with me is; David Zalman, Chairman and Chief Executive Officer; H.E. Tim Timanus Jr., Vice Chairman; David Hollaway, Chief Financial Officer; Eddie Safady, President; Randy Hester, Chief Lending Officer; Mike Epps, EVP for Financial Operations and Administration; and Merle Karnes, Chief Credit Officer.

David Zalman will lead off with a review of the highlights for the recent quarter. He will 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 will be provided by our call moderator, Cassia. 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 our second-quarter 2015 earnings announcement. For the three months ended June 30, 2015, our net income was $71.932 million compared with $75.506 million for the same period in 2014. Our net income per diluted common share was $1.03 for the three months ending June 30, 2015, compared with $1.08 for the same period in 2014.

Our net income was impacted by lower loan accretion income that obviously reduces as loans that were purchased in recent acquisitions pay off. Our core earnings, which are earnings excluding the purchase accounting adjustments, continued to grow. Net income for the quarter ended June 30, 2015, excluding the purchase accounting adjustments, was $63.800 million, an increase of $4.191 million or 7% compared with $59.609 million in net income excluding the purchase accounting adjustments for the quarter ending June 30, 2014.

Our asset quality continues to be one of the best in the industry with a nonperforming asset ratio of only 19 basis points or $35.119 million. Our allowance for loan losses was $80.972 million as of June 30, 2015, representing a very healthy coverage ratio. Loans at June 30, 2015 were $9.114 billion, a decrease of $193 million or 2.1% compared with the $9.3 billion at June 30, 2014. Our linked quarter loans decreased to $51 million or 6 basis points from the $9.166 billion at March 31, 2015.

Excluding the loans acquired and the recent F&M acquisition and the new production at the acquired banking centers since that acquisition date, loans at June 30, 2015, increased $228 million, or 2.9%, compared with June 30, 2014, and increased $7.7 million, or 1 basis points on linked quarter basis. Our deposits at June 30, 2015, were $17 billion, a decrease of $279 million, or 1.6%, compared with $17.281 million at June 30, 2014. Our linked quarter deposits decreased $559 million, or 3.2%, from the $17.561 billion at March 31, 2015.

Excluding the deposits assumed in the recent F&M acquisition and new deposits generated at the acquired banking centers since the acquisition date, deposits at June 30, 2015, increased $262 million, or 1.7%, compared with June 30, 2014, and decreased $403 million, or 2.5%, on a linked quarter basis. The drop in organic deposits in the second quarter is not unusual for us. We experienced similar situations in prior years.

We have over 500 municipalities that do business with us, and at this time of the year they have less in their accounts until their tax dollars come in at the end of the year. Further, our agricultural customers have most of their money tied up in fields until the harvest. We believe that our organic deposit growth will be positive for the year at about 4%.

As most of you are aware, we decide to take a self-imposed hiatus from acquiring banks until we make sure that we properly integrated all of the larger acquisitions that we made over the past several years. We are comfortable with where we are with the integrations and are again pursuing acquisitions.

Texas has been the top state in job creation for the past decade and continues to produce opportunities in growth and employment, despite the struggling oil and gas industry. Texas payroll is increased by 16,700 workers in June 2015, while unemployment fell to 4.2%. Refining, petrochemicals and service industries are offsetting job losses in the oil industry. Employment in the health services and education sectors has also been strong.

Austin continues to boom with an annual job growth rate of 6.6%. Texas is now America's top technology exporter, surpassing long-time leader, California. The Texas strategy of avoiding burdensome taxation and regulation continues to attract growing businesses and resulted in economic diversification.

Again, we owe all of our success to our team of associates, past associates and Board members who have helped grow the Company beyond our own expectations. 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 discussion to David Hollaway, our Chief Financial Officer.

Thank you, David. Net interest income before provision for current losses for the three months ended June 30, 2015, was $158.2 million, compared to $174.1 million for the three months ended June 30, 2014. This change was primarily due to the decrease in loan discount accretion of $11.7 million.

The net interest margin on a tax equivalent basis was 3.39% for the quarter ended June 30, 2015, compared to 3.83% for the same period in 2014, and 3.57% for the quarter ended March 31, 2015. Excluding the purchase accounting adjustments, net interest margin on tax equivalent basis for the quarter ended June 30, 2015, was 3.13%, compared to 3.17% for the quarter ended March 31, 2015.

Non-interest income decreased $2.3 million to $30.3 million for the three months ended June 30, 2015, compared to $32.6 million for the same period in 2014, and on a linked quarter basis non-interest income increased $1.9 million. Non-interest expense for the three months ended June 30, 2015, was $79.7 million compared to $87.3 million for the same period of 2014, a decrease of $7.6 million and on a linked quarter basis, non-interest expense increased $273,000.

The efficiency ratio was 42.4% for the three months ended June 30, 2015, compared to 42.9% for the same period last year and 41.8% for the three months ended March 31, 2015. As of June 30, 2015, the Common Equity Tier 1 capital ratio was 12.91% and the Tier 1 leveraged capital ratio increased to 7.35%. The bond portfolio metrics at 6/30 reflected a weighted average life of 4.2 years and an effective duration of 3.8 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 June 30, 2015 totaled $35.119 million, or 39 basis points of loans and other real estate, which is basically equal to the March 31, 2015 total of $35.376 million at 39 basis points. The June 30, 2015, nonperforming asset total was made up of $32.140 million in loans, $173,000 in repossessed assets and $2.806 million in other real estate.

As of today, $2.154 million, or 6% of the June 30, 2015, nonperforming assets have been liquidated or under contract for sale, but there can be no assurance that those under contract for sale will close. Net charge offs for the three months ended June 30, 2015, were $491,000 compared to net charge offs of $1.049 million for the quarter ended March 31, 2015. $500,000 was added to the allowance for credit losses during the quarter ended June 30, 2015, compared to $1.250 million for the quarter ended March 31, 2015.

The average monthly new loan production for the quarter ended June 30, 2015, was $246 million compared to $216 million for the quarter ended March 31, 2015. This represents a 14% increase.

Loans outstanding at June 30, 2015, were $9.114 billion compared to $9.166 billion at March 31, 2015. The June 30, 2015 loan total is made up of 41% fixed rate loans, 36% floating rate loans and 23% variable rate loans.

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

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

(Operator Instructions)

Our first question comes from Ken Zerbe of Morgan Stanley. Please go ahead.

Great. Thank you.

I guess first question is just in terms of the loan growth, sort of a two part question. One, if you can address the organic loan growth side, ex F&M, what you are seeing, why it's been fairly weak over the last quarter or so? But also on F&M, generally speaking, the decline, if I look at it over the last year, I think it's something like 25%, 28%, down a fair bit again this quarter. How long does that runoff continue? Thanks.

Ken. This is David Zalman. I will take probably the second question first.

On the F&M, I think when we first started posting their numbers in June, we said there would be about $400 million to $450 million in loans that probably would be outsourced or that we wouldn't have in the bank. And I think that we are pretty spot on. If you looked at the time when we first announced the deal as to where we were with the first reporting date, there is a difference there too.

But you have to remember too that when we do the fair value accounting, there was probably about $100 million that reduced it and based on 2003 and the 2010 accounting -- I'm sorry, 1991 and 2003. You had $100 million there. And then, you had a lot of nonperforming assets that were still on the nonperforming asset list.

Today, probably over half, or 50% to 60%, of the loans on the nonperforming list are from F&M. As those get down those will still reduce too. Hopefully they'll reduce.

That said, I think that we are pretty stabilized right there. I think that we are in line in what we said.

Loan growth, when you look at our loan growth even from the first half of the year, I would say that basically there is probably things that we think would happen. Let me give you some color.

Normally, you would think with the oil and gas industry that Houston would have been probably the one that would have been most impacted. It was just to the contrary. Houston had the best production that we saw at around $74 million, an increase in business. So they did extremely well.

On the other hand, we have the West Texas market which would include Midland and Odessa and we lost probably through the first half, probably $60 million just in two credits. And again, one company was bought out by National Oilwell and of course, our customer did very well out of the deal. Then another customer had an equipment company and they were bought out. So we lost business there at that point. Then we lost business in Oklahoma City.

So the Houston market was great. Central Texas was okay. Dallas was okay. In south Texas, we lost in the south Texas which is more in the shale play too.

So because we are so diversified and throughout the state of Texas, I think we saw this different parts happening. When you go back too, again, at the first of the year, we started off good. Oil prices dropped to $45. Everybody got psychologically impacted. Then it came back up, and then you have the weather.

Again, I am not going to make excuses. We are not happy where we are at with the loan growth. I will say this, that we see a lot in our pipeline. I am excited about it.

We have been through this a lot of times and again, there is a lot of the terms and conditions that we are looking at a lot of stuff sometimes. We are not jumping into the market.

At our state of the game, and I have seen all the different markets, sometimes I think that, especially from a shareholder's perspective if you are not trading the stock on a day to day basis, sometimes you need to be cautious at different times in the market. And preservation of capital and income is just as important to us as growth sometimes. But again, it's just a perspective that you have. I hope that gave you some color.

It did. That was very helpful.

I think it was last quarter you may have mentioned I believe [ethanol] was 8% on an organic basis is kind of what you are targeting. That's excluding F&M. Do you still think that's a fair broad target to shoot for or just the environment might bring that down a little bit?

I think basically, excluding F&M was 8%. Right now I hate to make any promises because we didn't live up to what we said we were going to do this time. I would tell you that I don't know, again, trying to say that there is going to be 8% or even 5% would mean you know a 13% or 14% annualized in the second half. I don't know that that's realistic.

On the other hand, again, they still may not believe it, but the proof's going to be in the pudding in how we look to next third and fourth quarter. We're going still shoot for the 5%.

Got it. Last question on expenses.

It looks like very good expense control, mostly on salaries. Was there anything unusual on that? Is the $80 million expense number, is that a good go forward number?

Ken, this is Dave Hollaway. We talked about this in the last quarter. When we talked in detail I was guiding, you talked about and I think actually we guide to $82 million, $84 million and obviously, that didn't hold when we got to this quarter.

We had two quarters where we're running around $80 million. That would tell me fundamentally that we've got our hands around a number of things and we're running at full efficiency here. I will try it again and I'll say maybe the range going forward on a quarterly basis could be $80 million to $82 million instead of where we were at, the $82 million to $84 million.

Perfect. All right. Thank you very much.

Your next question comes from Dave Rochester of Deutsche Bank. Please go ahead.

Good morning, guys.

Good morning.

Just following up on that expense question. It looked like the other expense line was up a bit, around $2 million. What drove that increase and are you expecting that to drop back to the 1Q level?

Yes, I mean that's one of those moving parts. That's what I was kind of alluding to before. Because in that other, it's what you would think, other things. It could be legal expenses, professional fees, fraud on loss of a debit cards and on and on.

I think really this quarter that run rate -- again, my crystal ball doesn't tend to be the most pristine. But I would say this quarter, numbers should be more reflective of what we are doing going forward. I would say on an ongoing basis, that's a better number.

But again, one quarter here and there it can dip up and down just because of the nature of those kinds of expenses. They'll go up and down.

Sure. Understood. Thanks.

Can you just talk about the strength you saw in Houston that you were talking about? What loan types you were seeing that strengthened? Does your outlook assume that that strength continues?

This is David. I don't have a break down of just what category it is. I think it's probably all categories.

I do think that Houston will continue to grow. I think it's very dynamic what we are seeing in Houston today.

If you read so many different journals that Texas has seen of the world when you are really here things are still really going very good. Housing probably has a two month or three month supply, very low housing inventory, house prices still continue to go up. People are spending money and even though we don't like the price at the pump, that's probably really pushing other people.

Again, different parts of the state when you look at Dallas, is not nearly affected as much and Austin is a world all to its own. It continues to grow and it's extremely bustling.

I think overall, you will still see growth in Houston, Dallas, Austin and Central Texas. I think you'll still probably will see a slowness probably naturally, and depending on oil prices, but we are not forecasting them to go up any time soon or great guns. So I think you'd still see a more slower area in West Texas, South Texas and probably Oklahoma City. Tim?

That's all correct. I would clarify that the growth in all categories in the Houston market really does not include direct energy loans. There were very few, if any, direct energy loans made in the Houston market.

That's a good point.

It was all categories other than direct energy lending.

Got you. Understood. That makes sense. I appreciate the color.

Then switching to your deposit growth guidance you were just talking about. I just want to make sure I heard you right that you are expecting 4% deposit growth for the year for 2015 including the runoff that you have seen from F&M? Or is it excluding that?

No. Excluding F&M.

Got you.

Perfect. Just a little housekeeping. Can you give us the amount of accretion that came from the [03] loans this quarter?

Yes, that breakdown was roughly $13.6 million for the quarter and of that, $10 million of it was related to what we call 91 so the balance would have the 03 items.

Great. Alright, thanks guys. Appreciate it.

Your next question comes from Jennifer Demba of SunTrust Robinson Humphrey. Please go ahead.

Thank you. My question was just asked. Thanks.

Jennifer, your line is open.

They just covered my question. Thank you.

Oh okay, sure. The next question comes from John Moran of Macquarie Capital. Please go ahead.

Hey. Good morning, guys.

Good morning.

I just want to circle back, a followup on the persons carrying accretion in the NII. I think last quarter you guys were saying total would run $16 million to $18 million or so based on what you were seeing per quarter over rest of 2015. Is that still a good number going forward or does the $13.6 million change the look there?

This is a point that we do really want to be very clear on. You are right. We were guiding higher in these past quarters but as you have seen on the loan side where we have this intense discussion about these loans reducing at the acquisitions. This is the other side of it. As those loans are giving out that's what, in one sense, is pumping those numbers.

Absolutely, this will slow down because from one perspective, we've been cleaning out the portfolio. I do want to be clear on this because we are certainly not guiding forward at that higher level. There is no way. It was $13.6 million in total this quarter.

But I would tell you is we need to look forward and that number needs to come down to around $10 million to $10.5 million going forward. We are just not getting the same amount of fair value discount accretion on these loans. A lot of them are paid off and gone.

So you would expect it to hit the $10 million to $10.5 million back half of this year? Or is that into 2016 and we'll have I guess a glide path down?

I think again, we don't have the -- these crystal balls can only be so crystal. I would tell you what we think today based on what we are seeing is that $10 million to $10.5 million -- what's happening because it's slowed down is that we extend longer. If you look at our press release, I think in the $91 million, there's still roughly $68 million. 2016's bad as a guide. If it's $10 million a quarter, you're talking seven quarters. I don't know if it would be linear, but we should be in that ballpark as we go forward.

Got it. That's helpful. Thanks.

Maybe a just quick update on what you guys are seeing in the energy book, what that stands at today? And I assume that SNC exam results are incorporated in Q2's print here?

I will start off. Again, the numbers that we give sometimes in March may be a little bit different than they are in June. And the reason being, as we get into this and we get the stratification even done closer, I think last time in March, we gave you a number of about $212 million in E&P loans. And in the service industry, I think we gave you a number around $301 million.

In that $301 million, included businesses that do business with the oil industry or have over 30% of their income from the oil and gas industry. Today, we're going to break it out a little bit better for you and continue to break it out and refine it just a little bit better.

Today, we have $218 million in E&P loans, $215 million in the service industry. So that's $433 million right there.

We have another $69 million in what I refer to as businesses that deal with the oil industry that maybe have over 30% of their income from the oil industry. I think that's a pretty conservative number that $69 million. I mean 30% is pretty conservative.

If you add all of them together you're $502 million. If you want to look just at E&P and the service industry direct loans to the industry it's $433 million.

Okay. Then I guess of the $433 million, how much of that is SNC and was the SNC exam in -- you guys have the results of that incorporated in Q2 numbers here, right?

Yes. Again, one of our primary goals when we do acquisitions is to try to get out of most of the shared national credits or a lot of the shared national credits and participations that we don't feel as comfortable with. I think we did go through the Shared National Credit exam. I don't think anything really was a whole lot different.

There is two loans. One was classified. We had it classified and reserved already. Then there was another small loan.

Merle, you want to jump in to help me?

There were two loans in the Shared National Credit exam that were oil and gas that were classified in the exam. We already had them on our watch list as classified credits. One of them was an acquired loan where we have about a 73% mark against that loan.

The other one is -- well we had one loan -- both the second relationship we have two loans. One of which we had a mark on, the other of which we have specific reserve against. The combination of the mark and the specific reserve were about 35% of the loan amount.

What do you think both total balances were on both loans? Wasn't very much.

$6 million or $7 million.

Does that include the reserve we have on it or it's after reserve?

That's after reserve.

So take the reserve out.

That's what's on our books now.

So it's about $4 million on the books.

$4 million left on the books.

That's after the mark. When he is talking about these two loans, that's about $4 million.

And the rest of the Shared National Credits were all passed.

Right. I would say that when we look in the service industry, we did downgrade one loan out of the West Texas market in the service industry. And again, it's not nonperforming, but we did downgrade it by one notch. That was a $30 million credit. Is that right?

Correct.

Thank you very much for the color there. I really appreciate it.

The next question comes from Brett Rabatin of Piper Jaffray. Please go ahead.

Hey guys. Good morning.

Good morning.

I wanted to just follow up a little bit on that if you guys had any color around you talked some about the energy and what -- you'd been to the SNC review. How much of the portfolio at this point if you have it as classified or how do you guys view your watch list in that area?

I think we just went over that. Were you listening a minute ago?

I am just curious on a percentage basis of the portfolio, how much of it would be classified if you had that number?

On the Share National Credits? All Share National Credits, I think you just mentioned it. Wasn't it $4 million. I think it's $4 million.

So those are the only loans -- that's the only loans that are on criticized or classified, are the portfolio?

This is Merle. Let me see if I can help you with some numbers.

We have about $35 million in total nonperforming assets. I think about $32 million to $33 million of that is nonperforming loans. And of the nonperforming loans, oil and gas represents about $13 million.

That's correct. If you look at our $35 million in NPAs, about $13 million of that are energy credits. And that's broken down basically about $11 million in exploration and production credits and about $2 million in service company credits.

Would it be fair to say most of that is from acquired banks?

Yes. And virtually all of it is. Absent that number relating to the $35 million nonperforming assets, we really don't have any significant additional dollars quote on the watch list out of the energy portfolio. To date, most of those credits are performing.

That's what I was looking for. Sorry for my confusion on that.

I can understand it. It was a good question.

I just want to add another piece of perspective. Of that portion of the acquired oil and gas loans that are on the nonperforming list, the vast majority of those have 03 marks against them.

That's a good point too.

That's right. On average those marks are -- what Merle? About 50% to 60%.

Overall.

I am talking about overall.

In the total portfolio as it relates specifically to oil and gas. I don't have that number right off the top of my head but it would be similar.

Then I guess the other thing I was just curious about was just thinking about your past acquisitions and obviously loan growth is a bit of a struggle right now. But I know have done some acquisitions that included some trust operations and maybe some fee income generation potential. And I was just curious if you guys could give any update on maybe if you can bolster the fee income gross side of the equation and any thoughts on some of those businesses on that side?

This is Mike Epps. As you know with the ASB acquisition, we acquired the trust department. And we also acquired another piece of a trust department when we acquired First Victoria.

Those two combined departments have done extremely well for us and we continue to grow. If I look at the overall growth of our trust department since the combination of ASB and First Vic together on that, I think we have grown at about a 5% to 6% rate. And we are in the process of expanding that department throughout our footprint on a very select basis but doing that so we can get -- it will be more throughout our whole banking system.

We also acquired by ISO sponsorship program with ASB and that is where we sponsor various entities into the MasterCard Visa network. On an overall basis they have consistently provided us with revenue. And where the growth of that has been kind of flat, mainly because the consolidation in industry. It continues to still produce at levels that have been extremely good from an overall fee generation standpoint.

Also finally, the last two things as you know, with ASB, we also had a small credit card department that we have continued to grow and expand throughout our footprint also. It has done well for us.

What else? Am I missing anything?

To add maybe a little more correction and color to it, Mike, correct me if I am wrong, and these are just approximate numbers now. But for this current fiscal year, Mike, I would anticipate that the trust department would bring to the bottom line at least $2.5 million, maybe $3 million.

Yes, Sir.

Then credit card?

It would be a little over $1 million.

Probably be about $1 million. Maybe a little over. ISO, same thing. A little over $1 million, about $1 million.

Our home loan center which is our mortgage operation that sells product into the secondary market, a little over $1 million there. Then our brokerage, $900,000 to $1 million. Those are just rough numbers.

That's rough ballpark and that's after tax numbers.

Right. Who knows whether that will hold or not but that's kind of our guess right now.

Okay. Great. Appreciate the color.

The next question comes from Brad Milsaps of Sandler O'Neill. Please go ahead.

Good morning.

Good morning.

Dave or David, I just wanted to follow up on credit quickly. Particularly as it relates to the provision. Maybe a little lower the last quarters relative to your two or three before that.

I know organic growth been a little slower. Any thoughts around your provisioning levels going forward? You guys have probably the best credit metrics in the business but just a little lower than I had been looking for and any thoughts going forward would be helpful?

Let me see here. We have $35 million in nonperforming assets and we have $80 million something in provision. That's maybe 2.5 to 3 times.

I guess we could have five or six. I don't know. I am being a little bit facetious. I think that we're well reserved.

If anything, as I mentioned before in prior conversations, it's hard for us. We still have accountants and we have this methodological -- it's something that's methodology that we go by and we have to follow. And even that sometimes, we go around and around even with our accountant and stuff. Sometimes maybe we have too much in it.

We feel we're real good. In fact, I think that, again, when you look at $35 million and you look at $80 million in provision, I don't know that there is any other bank that has a deal like that.

Our net charge offs for quarter averaged 2 basis points.

Absolutely. I mean you guys have some of the best in the business. Just it was much higher last year and there had really been no change. Which is one to followup on --.

I think last year too, again, we made some bigger acquisitions and we had a lot of clean up to do and a lot of work so we were using a lot of that too at the same time. I hope and I feel that we are toward the end of that.

Great. Thank you, guys.

The next question comes from Scott Valentin of FBR Capital Markets. Please go ahead.

Good morning, everyone. Thanks for taking my question.

Just in regard to, I guess they call it core margin ex accretable yield. Dave, I appreciate the color on the accretable yield but it was down a little bit linked quarter. Do you foresee, barring any change in interest rates, do you foresee that continuing to grind lower or do you think it can hold out where it is?

I think as we mentioned earlier, we definitely want to look at that number. It was higher last quarter, it was $13.6 million this quarter. That's exactly what we were saying is we do need to look at that coming down. We are saying between $10 million and $10.5 million per quarter.

Scott, maybe I was confused. Were you comparing the core earnings to core earnings from quarter-to-quarter. Is that what you're comparing?

Yes, I'm sorry. I was thinking core NIM. I think the core NIM was down 3 basis points from this first quarter. Just wondering -- those are rates that are going to go up or down, but if we keep the current environment, is that core NIM ex accretable yield, is that core NIM kind of stay here or does it grind a little bit lower?

Oh okay. That makes more sense. I think that's right.

I think we're in a stable -- I think what we say over the next three quarters is stable to a few basis point lower. Just depends on what's going on with two things here. One, what are we doing growing our loan book?

And here is what is interesting too. We haven't covered this topic yet, but if you look at where the 10-year yield is these days, it is a lot better than where we were at six months ago or five months ago. Six months ago, we were getting 180, 170, and we're having to go back in and buy.

If we are going forward to do that, we are actually in a better position. David can jump in here but I think 220, 225.

I think one less. Not long ago we had 237. So it's a lot better.

That will help us as we move forward. It's interesting as we sit here today, it looks like things are becoming clearer in terms of how we see things going forward. I think from that aspect with the 10-year going up and the stuff that we buy we can get a better yield on it.

Right. But we still forecast about a $1.5 billion to roll out over the next 12 months from the securities portfolio, right?

Yes.

Okay, thanks. That's helpful.

Then quick housekeeping. The Mercer payment, the $1.5 million, is that related to the ISO or is that something else?

No. That was related to an agreement with one of the credit card companies. It was not related to the ISO sponsorship.

We're talking about a $1.5 million and I know that some people have talked about that. But there is probably not a quarter that goes by that we don't have a few million dollars in either a gain on sale or loss on sale or something like that. I don't think that's really too extraordinary really.

Fair enough. Then on Houston, one of the concerns people have, I think the primary concern when talking to investors is the Houston office market. And there's concerns about vacancy rates increasing and obviously pressure on rents and values.

Just wondering in terms of your Houston exposure, do you have break out? What percent of that is of the commercial real estate would be in office?

Do you have anything?

I don't have a specific number for you but I can tell you it's very, very little. We have very very small exposure to office. We have, obviously, some owner occupied office loans but in terms of non-owner occupied, it's not material.

I think that's right. I think that probably the office space may have maybe more of a harder time. On the other hand, we see some of the projects that might have been going on switching to probably multi-family or retail. So we are seeing a change in what people are really building now to.

Okay. One more final question on the M&A segment. Any preference on geography?

I know you guys are obviously in Oklahoma now. How does the economy and impact of energy affect your decision on M&A in terms of geography?

You are the first guy that asked the M&A question. Congratulations, today.

M&A, we are going to -- again, if we are in Oklahoma, we are in Texas, surrounding states like Louisiana and things that are contiguous to us. We were only, before we went into Oklahoma, 10 miles away from the Oklahoma border. We're probably still only 10 miles from the Louisiana border.

We like Texas. We still think there is a preference here in Texas and if we can build in Oklahoma that would be a preference too.

I think if you are going to see us, there will be more opportunities. I don't know that we'll land the well deals that we would like to deal. But our goal is to increase our assets in M&A by at least 10% of our assets a year which would be around $2 billion. But that might be made up of one or two acquisitions a year.

Okay. Does the current environment -- you mentioned certain geographies in Texas. I think you mentioned Oklahoma City not doing as well because of energy and I think it was Odessa Midland not doing too well because of energy. Are those geographies off the table in terms of M&A or is there a price you would look at that and kind of look past the current witness because of energy?

I think quite to the contrary. It may provide opportunities for us when times are like this.

So in terms of people more willing to sell, but the environment, I guess the outlook for potential credit quality problems or credit deterioration, that wouldn't dissuade you from doing a deal in those weaker markets or more energy dependent markets?

No. We grew from a few years ago from $10 billion to over $20 billion. And I would say that we did due diligence and we looked at almost 90% to 100% of all the loans on the banks that we buy. We don't really send other people in there. We do it ourselves.

I would tell you that out of everything that we looked at, even going into this crisis situation with -- I say crisis. Looking at oil and gas where it's went today, I think we might have missed one loan in West Texas. It wasn't an oil and gas loan. It was a loan on a campus on a nursing home.

At the time we looked at it, I think that it was good. It's just one of those big contributors pulled out.

I have confidence that we do know what we are looking at. I know a lot of times when we go into a bank and on our final days when we meet with Management and we go over the loans, I wouldn't say it's a hostile environment, but there is a lot of controversy going on. So most of the time it's nonbelieving. Generally, I would tell you I don't know that we have ever called it wrong really.

Okay. Thanks very much.

Sort of reiterating, that we send our own team in and you look at the portfolio whether there's an energy issue or not. We look at it. We go in and if it doesn't look right, we walk from the deal.

That's right.

Appreciate the color. Thank you.

The next question comes from Steve Moss of Evercore ISI. Please go ahead.

Good morning.

Good morning.

I guess I want to followup one question on the M&A topic here. If you could give color around the level of M&A discussions you are having today verses three or six months ago.

I don't know that I understood the question, Steve.

Level of discussion.

Are you having more discussions?

I wouldn't say more discussions. I think that we have been pretty active the last three to four months when we got back into it. I think it's about normal.

Okay. Then with regard to Brad's question about the loan loss provision, just wondering if you have any thoughts about the potential for credit migration from the energy portfolio and how that might impact provisioning going forward?

As we mentioned earlier, the migration that we saw was one service industry loan that we went from -- it wasn't substandard, it was a $30 million credit. So far, based on what we see right now, we again, knock on wood, and I am not saying it will always be like this, but right now, everything looks pretty good. Even in the industry where it is today. I don't see a whole lot of changes, if that's trying to come up with the answer.

Got it. Okay. Thank you very much.

(Operator Instructions)

The next question comes from Ebrahim Poonawala of Merrill Lynch.

All my questions are asked and answered. Thank you.

The next question comes from Gary Tenner of D.A. Davidson. Please go ahead.

Thanks. Good morning. Just a quick question on the loan production.

Tim, you ran through the monthly production numbers for second quarter verses first quarter. Any way you could break those out through Texas verses Oklahoma production?

I don't have that hard number, but I think it's safe to say that most of that was Texas.

Well, right, which I would have figured. But as you kind of look at your friends in Oklahoma with having been there now for over a year through the first half of this year and now, about a year with F&M, what's the trend there in terms of production in the Oklahoma market?

Well just in terms of overall trend, Oklahoma City is rebounding a bit and our people there are starting to bring in more new loans to look at. So it's not as strong as we would like but it has turned around an they are bringing more in.

That even holds true for Tulsa. They have not turned the corner to the extent that Oklahoma City has, but we are starting to see some new loan production. And it is typically the case for the last year, Tulsa was focused on holding onto existing customers. As they should be. But we are starting to see a little turnaround on that.

Neither one of the primary Oklahoma markets are where we want them to be right now but they're improving and their production is improving. Most of what you see is still coming from Texas.

Okay. Thanks very much.

Next question comes from John Arfstrom of RBC Capital Markets. Please go ahead.

Good morning.

Good morning.

I have a follow up to a follow up to a follow up on M&A. Just maybe David Zalman. I guess why do you think you haven't been able to announce a deal?

Is it just you have been back in the market for a couple quarters and it is just a pipeline issue? Or is there something else that is going on that makes you nervous? Is the pricing too high? What are the barriers that you are seeing?

Again, I don't know that we have been out looking for two quarters but I would say that at least in the last three to four months we really have gone back out and pursued it. I think you will see something.

Okay. So it's not a question of if, it's when? And it is more of you are seeing some things that are attractive to you and it's the potential to be back on the trend?

Generally, deals don't happen. I mean, as you know. You are in this business.

Even once you make first contacts and start contacting people, it's deep at best, at best, once you even make a deal you are talking about romancing and kissing and all that stuff and that takes a while. Then you start due diligence and that takes a while. Then once you do the due diligence -- excuse me a minute. There is something on.

Then you have due diligence. Once you have due diligence, then you talk about the loans. Then after the loans, everybody talks about the contracts that they want. Under best scenario, I think it takes three months once you even make the hard contact.

Okay. It's not really an issue of price or regulatory or anything like that. It's the pipeline takes a while to gestate?

Stay tuned.

Good. You have kind of touched around this on Houston. Are you essentially saying the Houston growth potential really hasn't changed at all at this point?

I do think it's changed. I think it's better. I think it's good.

We are really seeing Houston really, at least based on the last quarter, it's been the shining star for us. It continues to grow and get better all the time for us.

Okay. All right. Thank you.

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.

Thank you, Cassia. 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.