Texas Capital Bancshares Inc (TCBI) 2005 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to Quarter 2-2005 Texas Capital Bancshares Incorporated Earnings Conference Call.

My name is Angela and I will be your coordinator for today.

At this time, all participants are in a listen-only mode.

We will be conducting a question and answer session towards the end of this conference.

If at any time during the call you require assistance, please press star followed by a zero and a coordinator will be happy to assist you.

As a reminder, this conference is being recorded for replay purposes.

And now, I would like to turn the presentation over to your host for today's call, Ms. Myrna Vance, Director of Investor Relations.

Please proceed, ma'am.

Thank you very much, Angela, and good afternoon to all of you.

I'm glad you could join us today on our Q2 Earnings Call.

If you have any follow-up questions or want to discuss this further with me after the call, my direct line is 214-932-6646.

Now before we begin the call, I need to read a prepared statement.

Certain matters that are discussed on this call may contain forward-looking statements which are subject to risks and uncertainties.

A number of factors, many of which are beyond Texas Capital Bancshares' control, could cause actual results to differ materially from future results expressed or implied by such forward-looking statements.

These risks and uncertainties include the risk of adverse impact from general economic conditions, competition, interest rates sensitivity and exposure to regulatory and legislative changes.

These and other factors that could cause results to differ materially from those described in the forward-looking statements can be found in our annual report on form 10K for the year ended December 31, 2004, and other filings made by Texas Capital Bancshares with the Securities and Exchange Commission.

With that done, we're ready to begin our call.

With me on the call today are Jody Grant, our Chairman and CEO, George Jones, President of Texas Capital Bank, and Peter Bartholow, our CFO.

After our prepared remarks, our operator, Angela, will facilitate our Q&A.

With that, let me turn the call over to Jody.

Thank you, Myrna.

Good afternoon, ladies and gentlemen, and thank you very much for being with us today.

In our opinion, we just completed what we regard as truly an outstanding quarter which positions us to continue to achieve superior results, we believe, for the rest of the year and beyond.

This is all occasioned by our continued execution with regard to our strategy in a very, very strong Texas economy.

The Texas economy in particular is strong in the five markets that we serve, Dallas, Ft. Worth, Austin, San Antonio and Houston.

We think the Texas economy is hitting on just about all cylinders, even manufacturing is beginning to perk up, that index having improved rather materially over the course of the last year.

Of course, oil and the activity in the [Barnett Shell], oil and gas that is, activity in the Barnett Shell continue to be a hot spot and we continue to benefit from that, both in the area of loans and deposits.

The financial highlights are on the press release that we issued earlier today.

However, let us just elaborate on a few of those things before I turn it over to George and to Peter.

Specifically, we earned $6.6 million in the first quarter, that's 25 cents a share.

Our business remains exceptionally well-positioned for 2005.

We would repeat the guidance that we've given you earlier of $26.5 million to $28 million in net income for the year.

That equates to approximately $1.00 to $1.05 a share.

We're particularly proud of the continued high quality of our loan portfolio.

This is evidenced by the recoveries that we sustained in the two quarters of this year, $17,000 in the first quarter followed by $59,000 in the second quarter.

And, you know, as far as we can see, the outlook for credit quality remains very, very good, if not excellently superior.

We've continued to experience good growth in all lines of business, in particular, I'd like to highlight our Residential Mortgage Lending Group.

You'll recall that we have previously stated that it was our belief that Residential Mortgage Lending would become breakeven in the second quarter.

It actually did better than that.

Not only did we pass breakeven during the quarter, but we actually recorded a profit for the quarter.

Particularly encouraging is the fact that the progression during the quarter in terms of profitability was very encouraging in that we lost money in April, we made a little money in May and we made more money in June.

So the outlook there, we believe, is again very good.

Loan production totaled close to $49 million for the quarter, and that was up from, or it was double from previous periods.

Actually, it was $49 million for June and that's double the level of about a year ago.

Houston likewise was extremely gratifying.

We are very solidly in the black there.

That has been strategically a move for us.

It has paid very, very large dividends to the Company.

Our loan production there, as well as our deposit growth, are exceptional.

We have close to a $200million bank looking at the asset side of the balance sheet, and I'll just remind you that to achieve that, we spent about $1.5 million in startup costs in that market.

Particularly notable in this conference call is the announcement that we made at the close of business yesterday that we created a new line of business, Bank Direct Capital Finance, to provide premium finance and other financial services within the insurance industry.

This opportunity was occasioned by our acquisition of Premium Finance Holdings.

Premium Finance Holdings is a company that is based in Dallas, Texas but operates throughout the United States.

We bought the company from three principals, one of whom had been the leader of the company and decided that he wanted to pursue additional opportunities in the political arena and, therefore, the owners believed that it was time to seek a new owner.

In addition to that, they had been in a position where they were generating substantial premium financings, but were having to direct the loans to lenders throughout the United States.

And they believed that this opportunity could best be optimized by placing this company within the hands of a banking institution that had available funding.

We were fortunate enough to be able to buy the company.

We paid $6.6 million for it, $5 million of that was in the form of the purchase price for Premium Finance Holdings, and in addition to the $5 million, there is a $4 million contingent payment based upon production levels in the coming years.

In addition to Premium Finance Holdings, we were fortunate enough to be able to acquire a group of individuals and a back office operation in Lake Forest, Illinois.

The total employment in the entire company is 23 people currently, but remember, they work through agents in the field to generate their product.

As indicated in the webcast, which you may have before you, we believe that the loan production from this activity should equate to more than $400 million a year.

They actually produced collectively in excess of $600 million in 2004.

We would expect that the average loan outstanding would be 30 to 40% of that number, and as a matter of fact, we have recently bought $80 million, $10 million before the close of the quarter, and $70 million after the quarter, from another financial institution and have migrated those loans to our books.

So we're starting out really with a real jump-start in this business.

This wasn't something we actually anticipated, but it's very gratifying that we had this opportunity.

Getting back to just some other metrics before I pass this over to Peter to discuss the income and statement balance sheet in more detail, I might just highlight the fact that we had solid growth in every category of our business except for securities; and in the securities portfolio we've actually continued to experience a decline quarter over quarter.

This extends back to before the beginning of 2005.

We peaked out at about $822 million in our securities portfolio.

As you've been able to see from the numbers, we're down to about $725 million.

We would expect this number to continue to decline simply because we're not going into the market and replacing securities that run off or – securities have run off in this interest rate environment.

It just doesn't pay for us to lock in longer-term securities and rates and carry those with floating rate instruments.

So, we're being very disciplined about this.

We're obviously sacrificing income over what we have thought we would be experiencing at this time because we actually had planned for the portfolio to, if not remain flat, perhaps grow a little bit during the year, but the interest rate curve has not allowed that, the yield curve.

With that, let me pass it over to Peter who will hit the highlights of the financial statement and may want to make some more remarks about Bank Direct Finance.

Peter?

Jody, thank you.

Turning to page eight in the financial review webcast, Jody commented we made $6.6 million in the quarter, 25% [link] quarter change, and the 51% increase over the prior year.

Non-interest income and expense [indiscernible], along with the growth in the portfolio, coupled with the expansion in the margin, but the continued build out of our business base.

It made it very consistent in our investment and opportunities to grow one's business and with very strong near term impact on growth in deposits, growth in loans, and of course, expense levels as well.

The benefits of this strategy, we believe, are clearly demonstrated by the growth in the second quarter of this year.

Co-loans link quarter 10% on average growth.

Net revenue 12.9%.

We believe that same store expense growth normalized increase at just under 4% link quarter Q2 versus Q1.

So we saw very substantial increase in margin.

A 27 basis point increase results from growth in demand deposits, very strong loan growth, the rising rates and their effects on a highly interest sensitive balance sheet, and the expansion of stockholders' equity.

So very strong performance in our [judge] money.

Turning to page nine, margin improvement has also had a direct impact on net revenue, obviously coupled with the growth in our portfolio.

Return on assets reached 97 basis points for the first time and exceeded in ROE terms 13% for the first time.

Our efficiency ratio still reflects a very high level of build out as I commented.

Actually, Bank Direct Capital Finance and RML and n the general banking expansion have had and continue to have a significant effect on this ratio.

Investment in our business as I said, we believe is reflected in the core loan and net revenue growth by clearly benefiting from the investments and build out expense that we've incurred.

Excluding the build out, as I mentioned, we believe that link quarters same store expenses are roughly up by 4%.

The earning asset composition and the level of earning asset to total assets, we believe, clearly demonstrates the efficiency of our business model and our balance sheet.

We did with the transactions and the creation of Bank Direct Capital Finance increase intangibles by $6.4 million, still an extremely low level.

We have seen some slight increase in the leverage ratio, but only slight.

And we have, as I mentioned, ROE exceeding 13% for the first time.

We do expect BDCF (Bank Direct Capital Finance) to have a positive effect, if not – we expect it to be positive in earnings contribution for the remainder of 2005, but perspectively should have a significant affect on ROE and ROA.

To slide nine, prolonged growth, obviously, very strong.

That number does include at quarter end only $10 million from the Bank Direct Capital Finance portfolio.

But we saw strong seasonal growth in both mortgage warehouse and in Jody's comments referring to the growth in R&L production.

Those put loans held for sale well above the average for the quarter.

Until we see appropriate returns as Jody mentioned on investment securities, we will not have purchases there.

They will continue to decline as a percent of earning assets from today's level of about 27%, average about 28% for the quarter.

Demand deposits, as Jody mentioned, were very strong at quarter end, 17% link quarter, 32% year over year.

Total deposits at quarter end were down slightly due to some runoff in the very large deposit that created the liquidity position during the first quarter – created a huge surge in deposits.

The growth in net income reflects margin expansion I've mentioned, coupled with the loan growth, 25% year over year, excuse me, link quarter, 50% year over year.

Page 11, we did see in the quarter loan growth much more evenly spread through the quarter than we had as you'll recall from quarter one.

Average balance increased 10% late quarter, 32% over the year over year basis in the total loans.

No impact on the averages from the Bank Direct Capital Finance creation.

We saw, as I said earlier, on an average basis as well, noteworthy growth in demand and total deposits.

Next slide, number 12.

Late quarter change, when we think of growth in demand.

Important growth in core loans, seasonal growth in the loans held for sale.

Very strong contributors.

Earning asset composition contributed to improved margins.

We did see, as Jody mentioned, a reduction in securities portfolio.

We believe that that reduction versus original planned levels equates to an after-tax per share impact of approximately one cent per quarter.

Core loan and earning asset yields, we saw a 51 basis point increase in both of those.

Earning assets year over year were up 148 basis points.

Loans, 161 basis points, while the cost of interest bearing liabilities increased by only 29 basis points during the quarter and 105 basis points year over year.

Total cost of funding, including the benefit of the substantial growth in [ADA] was only up 22 basis points link quarter.

We have had some improvement in net interest margin that results from an increase in the degree of our asset sensitivity.

When we have this much loan growth and imploding rate loans as we've had and no security growth, by definition we have seen increases in asset sensitivity.

Slide 13, you've seen these slides before.

I will note that the recent growth in core loans and total deposits is actually better than the [Kagger] despite the fact that the Kagger benefits so much from the low volumes in the early periods.

On slide 14, again, growth and net interest income and net revenue were actually currently running ahead of Kagger.

Slide 15.

Asset sensitivity, as I had mentioned, increased due to the growth in floating rate loans and the reduction in fixed rate assets.

Our growth in equity and demand deposits have also created significant benefit in this measure.

The efficiency of our balance sheet has an affect also on improvement of margins and we see that the asset sensitive differential has increased to $598 million, that's versus $551 million at the end of the first quarter.

This again is largely a result of the growth in earning levels – floating rate loans and the growth in demand deposits.

George, I'd like to ask you if you would to comment on the changes in credit quality.

Thanks, Peter.

As we talked about, we've showed 32% loan growth Q2 04 to Q2 05, and our credit quality continues to remain exceptionally strong.

We've had net recoveries for three of the last four quarters.

Our net charge offs for the last 12 months are less than one basis point.

Net charge offs for the trailing two year period is less than five basis points.

And our reserve coverage of MPLs and our net charge offs from inception are quite good if you can see the chart above, we've got a multiple reserve of 13.8 times trailing two year charge offs and ten times current MPLs and a multiple of 2.6 times net charge offs from inception of the Company, which is quite good, we believe.

Shortly after the end of the second quarter, our position improved dramatically.

Despite the growth of loans, unallocated reserve has increased each quarter for the last five quarters in dollars and as a percentage of the total reserve.

It is substantially greater today by three times over the non-performing loan totals and it's a substantial percentage of net charge offs since inception, almost 90% since inception our charge off total.

Reduction in non-performers by 3.8 after the end of the quarter bringing our non-performing loans today to only $1.9 million, or .1% of core loans.

And our reduction in classified loans again, subsequent to the end of the second quarter, have been reduced by 39%.

We have excellent coverage of our MPLs and our trailing period net charge offs.

If you'll turn to the next page, 17, again, the slide depicts consistent improvement in credit quality, particularly over the last two and a half years.

The chart itself has a footnote that shows subsequent quarter end numbers, but just so that you'll remember MPLs to loans, year to date 2005, .1 an allowance to MPLs 10 times.

Jody?

Yeah, thanks, George.

The last slide on the webcast is one entitled "Confirming Guidance" which I did in my previous remarks, let me just say that in terms of margin, we've had an exceptionally good experience with margin now being 388.

There are four more meetings planned for the fed the year and Chairman Greenspan said this morning that based upon the desire to continue to contain inflation and to promote growth that the fed will require – will continue to renew monetary accommodation, which effectively means they're going to continue to increase interest rates.

We had originally forecast three and a quarter.

I think that the best guess now is that rates this year might end the year at 375 or something like that – 375 to four.

Nobody really knows but it does seem pretty certain that they'll continue to go up.

We will benefit from the last rate increase which occurred on June 30 which, of course, really didn't affect the second quarter.

And again, we expect to be able to capture 25 to 40% of the rate increase in the form of increased net interest margin.

That, together with the acquisition and creation of Bank Direct Finance, and also the very robust growth in our core business, gives us reason to be confident about our outlook for the remainder of the year and very optimistic for overall 2005, the last half of 2005 and 2006.

We do believe that we'll reach substantial benefit from the creation of our new line of business.

We also believe that our Residential Mortgage Lending operation should continue to yield improving results, that of course depends upon the vagaries of the marketplace, and we don't know, and nobody does, what's going to happen in the housing markets, but where we are in the housing markets through Residential Mortgage Lending at the bottom of the market, in terms of the average mortgage and the price of the house that we're financing, gives us reason to believe that that market should remain fairly active through at least the foreseeable future.

With that, let me turn it back over to the operator and we'll begin the Q&A session.

Thank you, sir. [CALLER INSTRUCTIONS.] And our first question comes from the line of Andy Collins with Piper Jaffray.

Please proceed.

Good afternoon, guys.

Just wondering about the loan to deposit ratio.

I guess, loan [startout] strip deposits a little bit here this quarter.

I'm just wondering, given your guidance of margins continue to go up, just wondering where you are to go to kind of source those loans at an ever increasing kind of margin, if you will?

Sourcing loans, you mean sourcing deposits?

Yeah.

Well, I mean, getting – paying for your – funding your loan growth, should I say.

Andy, we maintained access, we've had exceptional growth, obviously, among our customer base.

There are, unfortunately, no wholesale sources at demand deposits.

And, we maintain access to basically every, every type of funding.

We have, only for the first time in the last several quarters, gone to a brokerage CD in anticipation of the purchase of the $80 million in premium finance loans.

We did that very modestly and now we'll start backfilling with customer deposits.

We have had – I think you're referring probably to a lot of discussion about competition, of the rates in deposits?

That's right.

I will say that we still have not seen that in significant measure.

Right.

One of the –

We expect to be able to maintain certainly in that line of business especially very strong spreads over any cost of funds that would be available to us.

Great.

Can you kind of give us some feel for what the premium finance business might do financially?

Is it accretive, diluted?

And with the revenues and expense what [indiscernible] might look like?

It will definitely be accretive in the last half of the year.

Jody mentioned having an $80 million portfolio gives us a jump-start.

That's a business that traditionally has produced returns on assets of more than 2.5% after tax.

And returns on equity of well north of 20, maybe even 30%.

Jody mentioned the book of business that we have today has a capacity to generate a substantial amount of loans.

We will continue to avail ourselves of relationships with other financial institutions whether it's been purchasers of those loans and maintain those relationships.

We do expect a high level of conversion of relationships, but again, we will through participations and sales of loans continue to avail ourselves of that funding.

Great .

Thank you very much.

You're welcome.

Thanks, Andy.

Next question.

And your next question comes from the line of Jay Cunningham with Southcoast Capital.

Please proceed, sir.

Good afternoon, how are you?

Hi, Jay.

Tell me a little bit just with a couple of the line items in expenses and there seems to be a lot of variability there, you probably know which ones I'm talking about, so can you kind of just hit those real quick if you could?

Jay, RML, because a lot of their production and income generates commission, RML combined with BDCF, Bank Direct Capital Finance, represented more than 50% of the link quarter increase in expenses.

And obviously, most of that was from RML.

We also saw in both cases substantial contributions in non-interest income.

So we do have with RML the reality that that has a significant affect on our expense base and we do see it on the other side, substantial growth and non-interest income as an offset.

You'll remember, during the first quarter we had substantial increases in FICA expense –

Right.

The expense related to the restricted stock vesting we obviously did not have those in this quarter.

But even giving us adding those back to the expense base, RML and BDCF represented roughly 50% of the total expense increase.

The rest of it's just basically associated with the larger business base, the growth in our business, and we are building out in other areas of the Company as well.

RML and BDCF are the two most pronounced examples, but it's occurring throughout the rest of the Company.

That's why I said it's kind of – there's no pure way to do this, but same store expense, late quarter, was roughly 4% growth.

So, if we look at such as some of these like the occupancy that's at a better run rate and I guess that then you can look over then on the balance sheet and see the increase in PK&E, so that those relate and then is advertising, is that a better run rate or was there some mild or something in that?

There's always some lumpiness – there is some lumpiness in those.

We expect some improvement in level expense through part of our business, but the rest of our business continues to grow.

We expanded in Houston [rentals] during the quarter.

R&L expanding through the quarter and a number of other minor activities.

Okay.

Help me a little bit on the yield in the held for sale portfolio.

I don't know – I'm just a little slow, I just don't understand how that [ASSI] and continues to go up and I guess it appears that you kind of pull this back down to yields you've realized late last year.

That probably added somewhere 15 to 18 [bips] to the [nail] in this quarter.

So I'm just – I mean, help me understand how this is, again, how this is so hard.

All held for sale are mortgage loans.

They have fees associated with the origination and sale of those loans, and they generate, basically, the faster you get them out, the higher the yield.

The fees that are associated with it get booked over the life of that loan on our books.

Average life of two to three weeks.

So, then has that changed at all?

I guess you're telling me that's changed?

Because it continues to go up every quarter.

Well, rates have risen a little bit.

The volumes have increased.

We saw very substantial increases in loans held for sale near the end of the quarter.

That means that most of that, of course, is mortgage warehouse.

It's generating very high yields in that held for sale portfolio.

So, going forward then, if the expectation as for rates – you know, to increase at whatever pace, should we look at this to be in north of 15% in a given quarter ahead?

I can't – I don't – there's no way to project that number.

I'm not arguing that it could be right, we're just not going to get into that.

Okay.

Okay.

And then just two other things – can you give us what the ending rate in the quarter was for other borrowings?

The ending rate for other borrowings – I – no, I don't have that, actually.

Okay, and then, last one on yield, I was a little surprised to see the 51 [bip] increase in loan yields.

Yeah.

It's driven mostly by core loans as you can see.

But that was a huge – the delta versus first quarter was huge.

So, help me understand that.

Remember in the first quarter we had what we described as some non-interest yield variables that affected us by seven or eight basis points.

So the link quarter growth in margin on an apples to apples basis, might be closer to 20 basis points, you'll remember from that first quarter discussion.

And you're saying that's applicable to loan yields?

It was applicable – long yields were a portion of that in the first quarter, yes.

Okay.

Okay, very good.

Thank you very much.

Thank you, Jay.

And your next question comes from the line of Campbell Chaney with Sanders Morris & Harris.

Please proceed.

I have a couple of questions on your premium finance business.

Yes, sir.

Can you give us an idea how the loans are priced, what index they're tied to?

Almost all lending in that business is done on an add on rate basis.

Can you explain what that means?

Yeah, it's like old car loans.

You pay – the rate is a percentage of the premium financed, and then that gets paid, for book purposes, it gets amortized over the quarter.

It's generally time based.

The average yield – total yield would be north of one and a half over prime.

Maturities are roughly five months with a substantial early payment.

The balance over nine months produces an average maturity of right at five months or just below.

Okay.

And then, so I take it you're going to hold these loans.

You're not going to try – I think that – did I hear you right that sometimes you sell a portion of this to other banks?

The company that we acquired, Premium Finance Holdings, here in Dallas, was essentially a broker.

It sold 100% of its loans.

Then in 2004, it generated total loans in excess of $350 million, between $350 and $400 million in loans generated.

Those were sold to financial institutions that participated in that market and we expect that to continue.

I will migrate significant portion of that business to our balance sheet.

The other portion of the portfolio that we acquired, that enterprise did loan participations and some loan sales as well.

We'll, of course, be analyzing what parts of that we will continue.

We do expect loan participations and sales to continue.

Okay.

And then, did I hear – I didn't quite get how you funded the initial $80 million in July.

Did you go to a wholesale channel?

Did I hear that right?

It is a little bit of wholesale funding for that at the end of June and early July.

Okay, and then one more question –

Average of about four-month return.

Four months?

Okay.

It's kind of match funded a little bit?

Yes.

Basically, that's the only way we can go to market and attempt to do something that looks like match funding.

Okay.

And then your strong DDA growth period end versus average?

Right.

Was there any seasonality in – at the end of the quarter or maybe the balances were inflated a bit or was that kind of a good starting point for the second quarter – the $475 million in DDA?

The average was less, of course, than the – the growth rate and the average is from first quarter. second quarter was less than that from period end to period end.

And that reflects to some degree a fairly typical pattern of growth in demand deposits as we've seen in our bank.

We have, as we've stated in the past, a fairly large number of title companies, Campbell, and those balances, extra balances tend to build up toward the end of the month.

Okay.

And then, loans held for investment there in the quarter, can you give us an idea where you saw the best traction – what types of loans you were making?

57% of the quarter over quarter loan growth was commercial loans.

Approximately 37% was growth in real estate.

That was broken down – 26% of that was permanent real estate, 11% was interim construction.

We're seeing good growth in our C&I portfolio.

Okay.

How about the 57% commercial, how much of that would be in I and how much in commercial real estate listing?

Well, that was C&I loans.

So that's all C&I?

Yeah.

Okay.

Were these term loans or people drawing on lines of credit?

Little of all of that.

You know, some were term loans, some, obviously line of credit, equipment financing, etc.

Okay.

And was – can you give us some color on how much of it was prime base versus libor based?

It probably – Campbell, I don't have that specifically, but it probably tracks the rest of our portfolio, its' sort of an 80/20 prime libor base.

Okay, so basically –

But again, basically again all – most all floating rates.

Okay.

Terrific.

Thanks a lot.

Very good quarter.

Thank you, Campbell.

Next.

Your next question comes from the line of Jennifer Demba with SunTrust Robinson Humphrey.

Please proceed.

Thank you.

Good afternoon.

I was just wondering if you could give us a flavor of your loan growth by market?

Sure, Jennifer.

We saw, again, quarter over quarter we saw the corporate banking group in Dallas about 44% of that loan growth was our corporate banking group in Dallas.

Houston grew 20% of that and our energy group in Dallas grew 15%.

If you break it down between north Texas, Dallas and the regions, you saw about 65% of the loan growth in Dallas, about 35% in the other regions.

You'll recall we talked about this after the end of first quarter and it was a little bit reversed.

We had 54% of our loan growth in the outer regions and the balance in north Texas.

So we're getting a good blend really across the board in terms of loan growth.

We're very – as Jody mentioned, very proud of Houston doing a great job.

Our other regions are growing nicely.

And the regions actually from deposit growth standpoint do exceptionally well.

Austin, in particular, kind of hit the ball out of the park on deposits which relates really, Jennifer, I think to the strong economy here.

They've driven their unemployment rate down to about 4.5% in Austin and as you know, Dell is the biggest corporate employer there and they're doing exceedingly well.

Okay.

Thanks.

And question on RML, Peter indicated that about half of the operating cost increase was related to that operation or the bip operation.

How many people did you have in RML in second quarter versus first quarter?

And did you hire more people?

Well, there are 227 at the end of the second quarter.

And at the end of the first quarter there were 192.

Now remember also that the break is about 70/30 commission to salary.

So heavily weighted to commission.

Did you hire people in a new market?

Yes.

Yes, we've opened a couple of new markets.

We do that on a quarter-by-quarter basis.

Okay.

So are you still – are you planning to expand this further in the second half of the year?

I think we will, Jennifer.

Probably within the net branches.

We've opened five net branches.

We've also closed three branches in Seattle.

So, net we're up just a little bit, but yes, they're looking for opportunities in growth markets to pick up additional production.

Okay.

And one final question.

I won't ask what your net interest margin by month was but can you indicate to us whether it increased throughout the quarter?

Yes, it did.

In terms of what we would describe as the normalized portfolio yield, yes.

Okay.

Thanks a lot.

Good quarter.

Thank you very much.

Your next question comes from the line of Faye Elliott-Gurney with Lehman Brothers.

Please proceed.

Hi.

Thanks for taking my call.

Hi, Faye.

Hi.

Can you give us an idea of the calling efforts during the quarter and what kind of loan pipeline you might be seeing for the third quarter?

Yes, Faye.

We have a good pipeline.

Again, we don't break it down much more than that, but we're continuing to be very optimistic in terms of loan growth and relationship growth in the third quarter.

We think we'll have good growth.

Compared to – you probably gave more information last quarter to speak of really the funding mismatch, but should we be as optimistic, do you think, this quarter, as we were going into the second quarter?

With regard to –

[indiscernible] growth.

At the end of the quarter given the loans hadn't grown as much during the beginning of the quarter in the first quarter you guys were saying that the second quarter should be pretty strong based on March outstanding and so forth.

Do you think that we should have the same outlook going into 3Q?

Well, you remember we acquired $70 million in loans post-second quarter, closed.

Right.

So we got a pretty good start on that and we've got, as George just mentioned, a good pipeline, so we'll have to let you draw your own conclusions, but we're optimistic that we're having a good experience and that it should continue for the remainder of the year.

Okay.

Great.

And then also can you comment on whether the allowances and I realize that allowed levels came down, coverage of MPAs was great, do you include in your reiteration of guidance another decline in the allowance level?

They never – Faye, this is Peter.

They've never given any indication about that on a quarterly level as we discussed many times as driven by the methodology.

The original plan had losses, we expected some losses during the year as any bank would.

That's not come about.

And we look forward every period to see what we can – what looks like it might be on the horizon, and as George commented, in this case, we were optimistic that we were to have what he described was the substantial reduction in non-performing and classified loans.

Okay.

And as you mentioned, very high coverage of levels.

Ten times now on the non-performing loans and I think on a trailing 12-month basis, which is something we monitor carefully, we've had recoveries three of the last four quarters.

Great.

And, Faye, remember, we have, as I mentioned, continued growth even with our loan growth, continued growth in our unallocated preserves.

Okay.

Thank you very much.

Great quarter.

Thank you, Faye.

Your next question comes from the line of Kerstin Ramstorm with Bear Stearns.

Please proceed.

Hi, everyone, how are you?

Fine, Kerstin.

I've got just a couple of questions for you.

First, back to Faye's question on the loan pipeline, Jody, when I saw you about a month ago, you had indicated that it was – looked spectacular.

Good doesn't quite sound like spectacular and I was wondering if you wanted to put any more color around that.

I don't remember the adjective "spectacular" but if you say I said that then I guess I did, maybe in an unguarded moment because normally I try not to use those kind of superlatives, but nonetheless, you know we did have a great experience in the second quarter.

The actual expectation from Bank Direct Capital Finance is high.

In addition to the $80 million that we bought from another institution, $10 million before the end of the quarter and $70 million after the beginning of this quarter, we've also are beginning to see production coming from the field.

So, given – and honestly, $70 million in any one quarter makes pretty good quarter onto itself.

So, you might say that anything to get above that is pretty darn good.

But that's new, so I guess what I'm wondering about is the core underlying growth.

Jody Grant;

The core underlying growth has been very, very solid and we would expect it to continue to be solid but you know, it always is lumpy.

We can go through a quarter, we've experienced this.

And we have what you might consider to be modest loan growth and then it's succeeded by a blowout quarter.

And a lot of –

Quarter or month.

Or month.

And a lot of it depends upon timing.

You know, we've always got a significant number of deals in the pipeline.

When we close them is a matter of – it's not often in our hands, it's usually in the hands of lawyers, but – The Texas economy is very, very strong.

We expect to get more than our fair share of the growth and, as also I indicated later – earlier, the underlying strength of the economy is beginning to show up in the form of increases in the manufacturing index.

That's something we haven't seen in a long time.

So, I'm inclined to be more optimistic looking at the near term future than even in the past.

Also, the activity in the energy arena is pretty exceptional.

And we're seeing that not only in Dallas/Ft.

Worth area as result of the Barnett Shell, but we're also seeing it coming out of our Houston office and with the continued high level of prices, we should continue to seem more and more activity.

The rig count, just as a matter of interest to you, we had 608 operating rigs at the end of the quarter and that's double where we were about a year and a half ago.

So there's a lot going on here.

Clearly.

My next question is on RML.

You had indicated that you opened offices in a couple of new markets.

What were those new markets?

Well, one of them was in Texas, in Burleson, Texas.

In where?

In Burleson, Texas.

It's south of Ft. Worth.

It's really a suburb of Ft. Worth.

I can't tell you precisely where the others are at the top of my head.

There's a lot of movement in that arena and it's kind of hard to keep up with it on a day-to-day basis.

Okay.

And then one last question.

You mentioned that there was the potential for $4 million in contingent payment for BDCF and I was wondering if you could provide some more detail about what the hurdles are for that and what the timing is for the potential payouts on that?

Well, we really can't provide any detail with regard to the hurdles.

Suffice it to say that we hope that we'll have to make those payments.

Absolutely.

Because that means that the acquisition has lived up to not only the seller's expectations, but our expectations as well.

The term of the contingent payment is a three-year term.

So would that be payable in one lump sum at the end of the three years or is that periodic?

It's graduated so that the payments would probably be spread over the course of the three-year period.

Is that yearly, is that quarterly, are we going to see a big hit from that?

You'll never see a hit.

It couldn't pass through the income statement.

So, what you would see would be an increase in intangibles.

Okay.

And it's on anniversary date basis and based on achievement of very high levels of loan production.

I think the important issue here is that we are accretive in this business, almost from day one, and we – the outlook for continued accretive profitability is strong.

We paid what we considered to be a fair price, but a price that enables us to produce solid, good profits in 2005 and 2006. $9 million, even with the contingency payments, is not an overly aggressive price for the book of business and the production capabilities that we've acquired.

The payment to date, Kerstin, is roughly – it's about 1% of annual production.

And annual production, the renewal rate or the repressed rate of customers historically has been extremely high.

Okay.

Just as a matter of comparison, I can't recall anybody buying a bank of any size for even $9 million that had this kind of production capability.

Okay.

No, that sounds great.

Thanks so much.

Great quarter.

Thank you.

Your next question comes from the line of [Brent Christ] from Fox Pitt.

Please proceed.

Hi, Brent.

Hey, guys.

Want to go back to the question posed earlier about the yield on the loans held for sale.

It's still a little bit unclear as to what's driving that big increase.

Is it just getting more loans in and out the door quicker?

And where are you going to see that yield going from here?

It's all driven by the level of production and how fast they get out the door.

You do have, in the second quarter, seasonally high activity in the mortgage industry.

We do have, I think George, the vast majority of the business is not [refast] which is helpful.

That's right, that's right.

And then in the case of RMLs to some degree, they've been growing through the seasonal trend.

Okay and would you expect that to continue in terms of the length of time you're keeping these on your balance sheet where you might see a yield go higher?

There's no indication that it would stay on more or less.

Still, it's a production business.

And it's our practice to get them out the door, basically, as soon as we can.

I think, you know, it's – you need to understand the components of income.

One is the yield on the portfolio that is on the books, the loans that are on the books during the life of those loans, which is very short, but we're carrying these loans at prime plus, so based upon our net interest margin, that's one component of the income.

Another component is the gain on sales securities at the time that we sell – or the gain on sale of loans at the time that we sell the loans, and then the other relates to fee income.

And as Peter said, the faster these loans turn over – if we could shorten the cycle from three or four weeks if they're on the books to two weeks, we'd increase that yield substantially.

And really, all that's depending on the buyers of those loans.

I mean, sometimes we can deliver them quicker, sometimes it takes longer from the standpoint of the purchaser, not certainly from our end.

Let me just get back quickly to an earlier question you asked where are our new locations.

There were four.

One in Missouri, one in California, one in Arizona, and the Burleson one in Texas that Jody mentioned a minute ago in the second quarter.

Being Texas centric to Burleson is what I remember.

Exactly on terms of the NTA to pay down essentially at the end of the quarter, was that just one credit or was that multiple?

The NTA was one particular credit that we'd had on the books for quite some time.

Actually, we had recovered substantially but was paid off a couple of weeks after the end of the second quarter.

It was a real estate credit, $3.8 million.

And then lastly, in terms of your guidance, is that still predicated on rates going up to 3.25 or is that now –

Well, we've already reached the rate levels that we had anticipated at the beginning of the year when we first gave that guidance.

So that's now based on 375?

Well, it was based [briefly] on 3.25, and we hope we'll see increased rates throughout the year and to the extent we do, we should benefit from that.

Okay, but that guidance does it factor in anything more than 3.25?

No.

Okay.

Thanks a lot, guys.

Thank you.

Next question.

And your final question comes from the line of Scott Alaniz with Sandler O'Neill.

Please proceed.

Good afternoon.

Hi, Scott.

Quick question on the premium finance business.

Can you describe who the actual end customers are in this business and what size pieces that production is coming in – coming across to you all?

The end customer – these are medium sized companies which fits the profile of our targeted customer, located throughout the country who need property and casualty insurance.

So it's business?

It's all business.

It's all commercial.

No individuals, Scott.

No individual lines.

And incidentally, we hope that there will be other business that we're able to generate from these customers, both deposit business as well as other type of lending opportunities.

Well, that was my next question.

Are there any deposits – does this business bring on any deposits?

Well, it should.

There haven't been here before because the business wasn't incorporated as a bank and they had not place to put these deposits.

But we regard that as an opportunity going forward.

We also think, Scott, there's some fee income possibilities on the treasury management side of this business.

I see.

And what about a reserve?

What type of a reserve is typical in this type of a business?

It's being evaluated.

The portfolio we purchased has been active in renewing every year for three years plus.

It's over – it started out and it's production is in excess of $200 or $250 million.

So, it equates to, as Jody mentioned, 35 to 40% of production is what shows up as average balance.

In the portfolio we purchased has a life average loss rate of less than 10 basis points.

But the experience of both the entities, the one that we acquired and then the one basically that came to us through other sources, they're loan loss experience has been excellent.

I see.

And what size pieces does this come into you, $1 million, $.5 million increments, or –

The range in size is $20,000 or $30,000 all the way up to $3 to $5 million.

It's a highly automated business.

It's basically a cash secured business, properly

And then, in terms of the loan portfolio, your core loan portfolio, where do you all stand on credit concentration?

I mean, could you give us a sense of how many large credits you have, maybe over $5 million or $10 million?

Well, there's 31 the last time I looked, credits over $10 million.

And the average loan outstanding was about $8 million.

Average commit was, I think, about $11 million.

Of those particular credits.

Of that subgrade.

Yes.

Average loan, obviously in the portfolio, totally is a lot less than that.

Right.

All right.

Very good.

And in terms of industry concentration, [it depends] on material changes from what we've told you in the past, Scott.

Scott Alaniz;

George, did you say what your energy was?

About 10%.

It's about 10% of the portfolio.

Okay.

All right.

Very good.

Thank you.

Scott, thank you.

We appreciate it.

And ladies and gentlemen, at this time we have no further questions in the cue.

Okay, in terms of closing remarks, let me just thank everybody for their participation in today's conference call.

Obviously, all of us are available to answer questions.

We would appreciate your funneling those through Myrna Vance, who gave you her phone number earlier.

We are extremely gratified over the quarter that we've just completed, but that doesn't in any way temper our enthusiasm for the rest of the year.

We think that we're in a great economy.

We believe we've got the right combination of resources, both in terms of people and products to optimize our opportunity in this market and we're going to continue to do that.

We're also going to continue to try to be innovative, do things that you might consider to be a little bit out of the docks, but we're interested in making money for our shareholders and incurring very, very low risk while we do that.

So we're working hard on your behalf and we appreciate, again, your participation this afternoon and look forward to hearing from you.

Thank you very much.

Thank you for your participation in today's conference.

This does conclude your presentation and you may now disconnect.

Have a wonderful day.