Texas Capital Bancshares Inc (TCBIO) 2004 Q2 法說會逐字稿

Good day ladies and gentlemen and welcome to the Q2 earnings conference call. My name is Stephan and I'll be your coordinator for today.

At this time, all participants are in listen only mode. We will be facilitating a question and answer session toward the end of this conference. If that anytime during the call you require assistance, please press star followed by zero and the coordinator will be happy to assist you.

As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Miss Myrna Vance, Director of Investor Relations. Please proceed, ma'am.

Thank you Stephan, and good afternoon everyone. We're glad you could join us today to discuss Texas Capital Bancshares second quarter performance.

As Stephan said, I'm Director of Investor Relations, and should any of you have any follow-up questions, I encourage you to give me a call at 214-932-6646.

Before we began our call, I'd like to read our obligatory statement. Certain matters 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 impacts 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 10-K for the year ended December 31st 2003, and other filings made by Texas Capital Bancshares with the Securities and Exchange Commission.

And now let's begin the call.

With me on the call today are Jody Grant, Chairman and CEO, George Jones, President of Texas Capital Bank, Peter Bartholow, our CFO. After their prepared comments, our facilitating Stephan will facilitate the Q&A session.

Now I'll turn the call over to Jody.

Thank you very much, Myrna. Good afternoon ladies and gentlemen and welcome to the conference call for the second quarter. We're delighted to have you with us today, and we have a very strong quarter to report.

Before I get into the details on that, I'd like to just introduce you to Myrna Vance. Some of you have already met Myrna by telephone, but Myrna comes to us after retiring from EDS, where she was Director of Investor Relations for over 20 years.

Myrna and I had the privilege of working with each other for the eight years I was there as CFO, and Peter Bartholow was there with us as well, so we're particularly glad to have Myrna on our team here at Texas Capital Bank.

Let me now make a few comments about the quarter and then I'm going to turn it over to Peter Bartholow, whose going to cover the financials in more detail.

As I said, it was a very strong quarter. We came in at $0.17 a share, which is right on the consensus I believe. The quarter was typified by significant growth in earnings deposits and loans, which I'm going to get into and a little more depth in a minute, but also by a very significant improvement in credit quality, and we'll discuss that in more depth as well.

All of this is a result of a vastly improved Texas economy. We've seen some real traction in the economy over the course of the quarter. It really is embedded in quite a number of things, but if you just look at the unemployment rate in Texas, it has declined about 9/10 of a percent over the last year, and is at about the national average at 5.7 percent.

The leaders were Dallas and Austin, both of which scored extraordinary gains in employment. Dallas's unemployment rate, just to give you an example, over the last year, declined from 7.1 to 5.8 percent, which leads the state again with Austin. Austin's unemployment rate has declined from 6.6 to 4.3 percent over the course of the last year, which is exceedingly strong.

To reinforce our opportunity in Austin, we have just hired a veteran J.P. Morgan Chase banker named Merriman Morton (ph). Merriman was with Texas Commerce for 35 years before retiring. The previous 10 years, prior to his retirement, he was the CEO of Texas Commerce or Chase Austin.

After having been President of their lead bank in Houston and also President of their subsidiaries in El Paso and Corpus Christi, so we're delighted to have Merriman with us. He'll be Chairman of our Region and will work arm in arm with Kerry Hall, who is our Regional President.

I'd like to highlight in particular at this time the sequential growth from the first quarter to the second quarter in a number of categories, the first being net income, which grew 10.7 percent from the first to the second quarter on an annual basis. That's 42.9. Core loans grew 4.8 percent from quarter to quarter. Deposits, 8.5 percent.

And importantly, the demand deposit element of total deposits grew at a 9.4 percent pace. This gives us tremendous momentum going into the third quarter of the year, and I'm delighted to say that that is evidenced in our pipeline, which is very strong, and bookings of new loans in the first part of the third quarter also are very strong. So we do have a lot of momentum going into the second half of the year.

Importantly, our credit quality has improved significantly from the first quarter, and it was good in the first quarter. Our net charge-offs in the second quarter were $96,000, 0.03 percent of loans and leases. We think that's a great number, of course, and we wish we could say that we'll repeat that performance in the third and fourth quarters, but of course there's no guarantee that that will happen. However, at this point in time, our visibility on losses, looking at the third quarter is nil.

Let me make a comment or two about Houston and residential mortgage lending. At the time of the last conference call, reporting the first quarter, we advised that the startup of both these operations, which commenced I might add for residential mortgage lending in June of 03, and for Houston, in all reality in October of ‘03.

As I advised in the first quarter, those operations cost us $0.02 a share. We've narrowed that by a half penny in the second quarter, and in terms of the prospects for the third quarter and the rest of the year, we think they are very good for both of those operations, with a very good possibility that they will pass breakeven in the third quarter.

That's a short summary of the highlights, looking at the quarter. Let me now turn it over to Peter Bartholow, whose going to talk about the financials in more depth. Peter?

Thank you Jody. I will say once again, as I've said many times, that the numbers really speak for themselves. We have a very simple and we believe very efficient business model that can produce what we believe are strong and very sustainable results. We've had net income growth of $4.4 million during the quarter.

As Jody mentioned, it is consistent with what we had in our plan and with full year guidance. This represents an 88 percent increase from the second quarter of 2003, and I will speak mostly in terms of adjusted numbers, and for the adjustments, I'll refer you to the footnote in the press release, which adjusts out the effects of tax benefits and the loss from restructuring of repurchase agreements.

We had an increase in net income of 11 percent in the first quarter of this year. That $0.17 of earnings per share up 55 percent on an adjusted basis, and that's after giving still the effect of a 22 percent dilution from the IPO in the second quarter. Excuse me, early third quarter of last year.

For the first time, we've seen ROE increase to something just above 10 percent on an adjusted basis. That's the first time in the history of the company. It reflects an improvement in ROA, which was up to 77 basis points.

Growth in core loans on an average balance were up 24 percent from a year ago. Very solid growth, as Jody mentioned, just under five percent for the second quarter from first quarter levels.

And June 30th outstandings, you will note in the financials, were actually three percent greater than the second quarter average, again, reflecting what Jody mentioned as strong growth starting in the third quarter.

Loan growth total was still up 15 percent, despite the 51 percent decrease in loans held for sale. Those loans held for sale did increase slightly from first quarter levels to second quarter.

We saw stability this quarter in net interest margin at 3.23 percent. The second quarter margin was exactly equal to first quarter. I will say that it would have been higher except for the effect of refinancing that caused prepayment adjustments to securities yields during the quarter. We had an increase then of 45 basis points over the very low levels of a year ago.

We had substantial improvement in earning asset mix, with growth in loans. Interest sensitivity during the quarter remained high, and increased compared to the first quarter, given that the growth rate of interest sensitive earning assets was much greater than the levels of securities during the quarter.

We do remain positioned for substantial improvement in margin as we get a further increase in interest rates. I'll comment of course, that with the rate increase that occurred on June 30th, we had no benefit that occurred during the second quarter.

We also, during the quarter – if you’ll switch to the next slide - demonstrated improved efficiency in what we believe, again, is our model of producing very high-quality earning asset growth, with efficient operations. We had a 44 percent growth rate in net revenue compared to a 30 percent year over year growth in net interest expense.

Net interest expense -- excuse me, non interest expense grew only 1.2 percent on a link quarter basis, compared to a 7.4 percent growth rate in net revenue, again, on an as adjusted basis compared to the prior year and -- excuse me, to the first quarter.

Measured by net interest, non-interest expense to earning assets, the efficiency improved from the first quarter levels, and again, our traditional measure -- the traditional measure of the efficiency ratios continues to be effective for us by low interest margins in a low rate environment, and the extent of the buildouts still underway at Texas Capital.

Jody commented at length on credit quality improvement. Net charge-offs decreased only $96,000 or three basis points on average core loans. Nonaccrual loans decreased to 47 basis points.

Total nonperforming loans decreased to 0.79 percent, and of the 4.4 million in past due loans, 1.1 million is guaranteed as to principal and interest by the United States government. An additional $3 million reduction was achieved earlier this month, since June 30th. So we've had now a substantial additional reduction in the level of total nonperforming loans.

The improvement in overall credit quality resulted in a reduction in our provision for loan losses to 363,000 despite that the reserve increased to 18.3 million or 1.3 percent of core loans. We also evaluate our reserve in terms of what coverage it has of multiple year -- multiple quarters and years of total charge-offs, and for us, that number remains very high.

Flipping now to Page 7, slide 7, I won't comment on length, I think again, the numbers speak for themselves. Strong growth in assets. Deposits, Jody commented on. A special enhancement in both demand deposits and in total funding. Loans held for sale did decline sharply from a year ago. On an average basis, they were actually slightly up during the quarter.

Quarterly net income, I mentioned, of $4.4 million, and again, return on equity for the first time exceeding 10 percent.

On Page 8, again, nothing specific. I will comment however on what we call net revenue growth, which is net interest income after provision for loan losses, plus non-interest income. At $20 million, grew 48 percent over the adjusted number for 2003, and was strong as well compared to the first quarter of this year.

On Page 9, securities you'll see grew by only $8 million on an average basis. The level at quarter end was slightly higher, but not significantly. Loans held for sale, up 12 1/2 percent, down sharply however, 51 percent from the prior year. Loans held for investment, again, quite strong.

Page 10, nothing specific to comment. Maybe non-accruals at $6.4 million, representing 47 basis points. And with the 3 million reduction and a $1.1 million guaranteed portion of past due loans, our net exposed nonperforming loans today are less than 50 basis points.

On slide 11, you've all seen the compound growth rate slide. Very strong growth, obviously, from the beginnings of the company.

On Page 12, we've had no significant shift in portfolio composition. We remain very small in all aspects of consumer lending. Real estate lending, there's some level of paydowns in fixed-rate loans became a slightly lower component of total loans. We had strong growth, as we commented throughout the period.

Slide 13, again, just a graphic depiction and more information about credit quality, which as Jody commented on is doing extremely well.

And Jody, I'll turn it back to you.

Thanks Peter. Let me just close the formal part of our comments by saying that being halfway into the year, we have much greater visibility with regard to 2004 as a whole. We continue to be extremely interest sensitive, as Peter mentioned, with 90 percent of our loans tied to either Prime or LIBOR, and 85 percent of that 90 percent tied specifically to Prime.

Peter also mentioned the fact that we did not benefit from the rate increase which occurred June 30th, but we look forward to benefiting from that in the third quarter, and also to an environment of rising interest rates.

Given the visibility that we have at this point in time, you know, we can reaffirm our guidance that we'd previously given at 18 million to $20 million net income for the year, and do that with much more assurance than when we originally gave that guidance that the beginning of the year.

With that, Steve, let's commence with the Q&A period. So, I'm going to turn it back to you at this point.

Ladies and gentlemen, if you wish to ask a question, please press star followed by one on your touch-tone telephone. If your question has been answered or you wish to withdraw your question, please press star followed by two. Questions will be taken in the order received.

Again, that is star one if you would like to ask a question. And our first question comes from Andrea Chow (ph). Please go ahead.

Good afternoon gentlemen.

Hi Andrea.

Hi. Great quarter, very good trends.

Thank you.

Quick question though on OCI, just kind of talk about the swing in sales occasions (ph) of going from a positive 8.3, if I'm not mistaken, in the last quarter to a negative 24 this quarter. And I'm sure it's changed by now, so ...

Andrea, if you could just elaborate OCI, what ...

I'm sorry, the other comprehensive.

Andrea, this is Peter. That reflects the mark to market of the securities portfolio that existed from June -- excuse me, March 31, that you mentioned, to the end of the year -- excuse me, the end of the quarter. We have had in pretax terms a reduction in value of the portfolio of about $20 million. We had some improvement, obviously, with rate changes since then. That reflects about 2.5 percent of the average portfolio.

OK.

The portfolio is of extremely short duration. We look at having no significant maturity extension risk, and we have, as I commented on, lower than hoped-for yields on the portfolio due to the level of prepayment that occurred during primarily the month of May.

Great. Just one follow-up. Any outlook on prepayments going to the third quarter, and kind of what was the impact of premium amortization second, and if you can, share an outlook of that going to the third.

I can do that Andrea. Our amortization on our portfolio has declined dramatically over the course of the year. That amortization going from about 3.2 million, if you go back into the third quarter of last year.

In the current quarter, it was a million 389, and we saw favorable trends, as you look from March to June, and as a consequence, we believe that the amortization, which is driven of course by the prepayments, will be at a -- or probably the lowest it's been in certainly the last probably eight quarters or so in the third quarter. So that's encouraging to us.

Now, I might just in that context say that, you know, while we benefited tremendously from that, we have -- that has been offset in a negative sense as a result of the prepayments as that has impacted the mortgage warehouse, which Peter alluded to, and the balances in the warehouse, of course, have declined by about 100 million over the course of last year.

So you know, we've had to offset that decline in loan balances with other loan growth, which we've done and done successfully, but we kind of got a built-in hedge as it relates to the amortization against the securities portfolio, with the offsetting impact on the mortgage warehouse.

OK, great, thank you.

You're welcome.

Next?

Our next question comes from Andy Collins. Please go ahead.

Good afternoon guys.

Hi Andy.

Just wondering I guess at one point your net interest income was sensitive to the tune of about 9.3 million on a 200 basis point move. Just wondering kind of if you could give us the equivalent number in today's terms.

Andy, we're still in the process of -- you know, our Q hasn't been finalized yet, and we're still working on the number. Of course, you know, it's impacted by the assumptions we make with regard to the outlook for the remainder of the year, and given our experience early in the quarter this quarter, we're going to need to go back to the drawing board to do a little bit more work on that, but I would just say that, you know, there's no significant change based upon the early indication as it relates to the interest sensitivity of the company.

And you know, looking at it in the context of at least our peers in the Southwest, we are far more interest sensitive than any of our competitors. And I would think that we'd be hard-pressed to find a bank in the country that had more to gain as a result of rising interest rates than we do.

OK.

Andy, one simple supplement to that is that we had very good growth in loans (inaudible) on an average basis and essentially no growth in securities. We had great growth in both fixed-rate deposits, as well as demand deposits. So on a link quarter basis, there clearly was improvement.

That's great. One other question, was just wondering about the average earning assets. I guess that's why it showed a little bit of slowing now, a lot of growth in securities book. Would we expect that average earning assets to accelerate to you know kind of the more normal or better levels in the third and fourth quarter?

I would think so because you also have the impact of the warehouse, the reduction in the warehouse, Andy.

Right.

And we believe we've hit a low as far as the warehouse goes, so it should be -- everything should be headed north from here.

Great, thank you.

Thank you, appreciate it.

Your next question comes from Scott Ollenoff (ph). Please go ahead.

Good afternoon gentlemen.

Hi Scott.

Hi, a couple of questions. Jody, you mentioned earlier -- referenced earlier one higher, in Austin. We're there any other -- or maybe you could talk a little bit about what other highers you may have made during the quarter or subsequent to the quarter.

Let me just say that we have a significant number of offers out in the marketplace right now. One of them is to a group of individuals that really would be bringing in a whole team of people, a small team, but an effective team. We'd be adding a minimum of five and probably more like seven or eight people when we round out that group.

We have received their acceptance letters. They have not left their current employer at this point in time, but this was not in the plan. Would be an addition to plan, and will give us a tremendous boost in 2005 should we be able to land this group, and we're you know 80 percent confident that we can at this point, but you never are 100 percent until they're actually you know in the office working with you.

In terms of our overall goals with regard to new hires in the RM category, I'd say we're right on track with our plan. The team I just spoke of would be in addition to plan, and the plan for the year hasn't really changed, so we feel very good about this. And you know, in spite of the new entrants into the marketplace, and the increased competition, we seem to be a preferred employer and are doing very, very well in that context.

Excellent. OK, a couple of housekeeping questions. What is the duration on the securities portfolio?

3.9 years.

OK, and in the mortgage business, what was the volume of loans originated during the quarter?

During the quarter? We can give you that. Hold on just a second, George has got it.

Yes, Scott, in the mortgage business, monthly production on an average basis for June was 20 million.

OK, and lastly, could you talk a little bit about deposit composition in terms of broker deposits, public funds or ...

Broker deposits have -- we started the year at about 150 million, and we have about half that on the books at this point in time. That has been rolling off. We have no plans to put any broker deposits on the books at this point, and as the existing portfolio matures, it's maturing at significantly higher rates and we'll be able to either roll those deposits in to replace them as CDs or other liabilities at a much reduced cost. So you know that will help our margin in the third quarter and future quarters.

OK, thank you.

You're welcome. Thank you.

Your next question comes from Jay Cunningham. Please go ahead.

Hi Jay.

Yes, good quarter guys.

Thank you very much.

Let's see, can you just elaborate a little bit further on the deposit growth that we had this quarter? I mean we've seen pretty good numbers from some competitors, but this is certainly a good high first quarter.

I don't think there's anything seasonal in the numbers. We did have a very nice growth in particularly our demand deposits, which is gratifying to us of course, because those are lower-cost deposits. Beyond that, our deposits from the public sector remained pretty flat. You know, it's really core growth that you're seeing.

Internet deposits were up a little bit, but nothing dramatic, so you know we’re very gratified that we continue to gain traction in the marketplace, and you know we've grown to be the largest independent bank in the Dallas-Fort Worth area and in North Texas over the course of our five plus year history.

And that has been typified by sort of a catch-up in terms of deposits. You know, we lead with our lending capabilities and our borrowers become depositors, and I think you know with the passage of time, we're going to continue to have a great experience. Austin and Houston in particular have been very strong this quarter, and it looks like that strength is continuing. We're significantly ahead of plan in Houston with regard to deposits, and we're significantly ahead of plan in Austin as well. And all of this of course is great news to us.

And then can you help a little bit, just on what we might expect on the (NEM) expansion this quarter due to the Fed fund cyc (ph)?

Jay, this is Peter. Certainly, I think we've talked to you about not being that good on very specific model building questions, but obviously with the 25 basis point improvement, that affects the entire quarter, plus whatever may happen in the month of August.

We expect for reasons Jody commented upon, for an improvement in the securities portfolio yield this quarter. There are no apparent downdrafts in the term rates that would drive another refinancing boom, that they seem stable in the 450, 460 level, which is good for us. And you'll see our yields creep up in that portfolio. Loan portfolio has remained a very good.

We're seeing good production and good yields in both mortgage warehouse and of course in the RML groups. They're relatively small, but helping in this environment. No specific guidance on a quarterly net interest margin.

OK, and then just finally, what was total headcount and then total RMs at quarter end?

Total headcount was 390 people, and RMs was 71.

Great. Thanks a bunch, good quarter.

We ought to point out, with regard to the headcount, that -- George, how many commission people are in that number?

Yes, that's something that does need to be pointed out. We have 93 people in our residential mortgage-lending group. Of that, 65 people are commission people, so they're not fixed salaries. We only have 28 people in that amount that are salaried.

I might ask George to just comment, while we're on the subject of residential mortgage lending, about -- you know, he did mention we have 93 people, but George, you might talk a little bit about the expansion that we've seen geographically in particular with that group.

Yes, actually, we started booking mortgages in October of 03, and that's gone from a monthly production of almost 3 million to June, we've got $20 million in production, and as Jody and Peter mentioned, we are very close to break even in the term there. Since that third quarter of 03, we've opened 15 branch locations for our residential mortgage group, 5 have been retail offices and the other 10 are net branch offices.

Net branch is obviously, as you know, -- we don't have the liability for the lease or for trailing fixed expenses, but we do have income produced from those branches. We've opened two additional net branches since June 30th, so we're 17 today. And we're -- in Texas, obviously, we have good diversification in Dallas, Houston, San Antonio. We're also in Las Vegas, Denison Texas and then the branch offices range from the Texas region, Georgia, Massachusetts, Virginia, Minnesota. So we have good, good locations and what we think are the best retail locations in the country, and that's the way we're going to continue to open offices. Again, focused mainly with people on commission as opposed to fixed salaries.

Let me just get back to the question on the headcount. If you exclude the commissioned people that George spoke of, our full-time equivalence increased from 310 in the first quarter, the end of the first quarter, to 324 at the end of the second quarter.

And I might just add further that you know we are a growth company so when you look at our non interest expense, it is going to be driven largely by salaries. And you know we expect it to grow, but not grow as rapidly as revenue or net income, but it will grow and you know that is something we carefully manage, but we need to keep the growth engine alive, so we're adding people and our emphasis is on production people, relationship managers.

Let's go to the next question.

Next question comes from Campbell Cheney. Please go ahead.

Hi guys. Where was your margin at June 30th?

Well, it was 323 for the quarter.

Right, where was it at period end on June 30?

That's a question I don't think we're prepared to answer. Campbell, if you'll -- we can probably do some work on it if you get back to us, we'll do our best to get a number for you.

OK, fair enough. And then the government guaranteed non-performer, was that an SDA loan or a U.S ...

Campbell, this is George. It's a USDA government guaranteed. We have about a $40 million portfolio of USDA guaranteed, and that is principal and interest guarantee, so there is no risk of principal or interest on the credit.

Great. Thanks a lot. All my other questions have been answered.

Thank you.

Your next question comes from Charlie Ernst. Please go ahead.

Hi guys.

Hi Charlie.

Couple of questions. Are there escrow deposits in the non-interest-bearing line and if so, could you break out what the contribution is?

There are escrow deposits in the non-interest-bearing line. Again, I'm not prepared to give you the exact number. We haven't typically you know disclosed that. The escrow deposits here are significant. We are the favored depository for title companies, particularly in North Texas. We've got great relationships with the title companies.

One of the thrusts of your questions may be with the slowdown in refis, have we've seen a diminution in those deposits, and the answer is not really, and you know, whatever diminution there has been, has been offset by growth from our other customers.

OK. Is there any ballpark sense that you can give us or that's what you're giving out?

Ballpark relates ...

Just idea in terms of size.

I would say you know that it's in the neighborhood of -- you know, probably north of 75 million, but you know, again, I don't have an exact number.

OK. And in looking at the yield on the held for sale portfolio, it seems pretty high, over 8 percent now. I was just curious as to you know what types of loans you all are -- well, I know they're mortgage loans, but what types of mortgage loans you all hold in that portfolio.

Well, in the first place, that portfolio is very short. You know, typically the loan is not in the portfolio, either if you talk about the mortgage warehouse or the residential mortgage lending group, for over three weeks. 20 days I think is the average length of time for the mortgage warehouse, and those loans are single-family residential mortgages that have been either presold in the case of the mortgage warehouse or in the case of residential mortgage lending, they've been locked in. The rate's been locked in, and you know, our burden is to deliver the loans unencumbered. In other words, with full documentation. George, do you want to add something?

Just we sell everything, servicing, release. You know, no servicing issues as it relates. It's all sold.

I think when the portfolio is not growing and you have high turnover, then the fees enhance the yield.

That's why Peter's here to answer those difficult questions.

OK, and then just generally speaking, I know that you all are in kind of a buildout phase of the mortgage business, so you'll probably buck the trends a little bit, but what's your outlook for the warehouse season, also the gain on sale mortgages?

Outlook in terms of ...

You know, I mean more -- originations are obviously slowing since the first half of the year ...

Well, we are in a build out phase. The residential mortgage group, as I mentioned, we started at about 3 million and originations we're up to 20 today. That number is going to continue to grow. We've got you know projections that show that on the mortgage warehouse inside. What we're doing, and I think we've mentioned this before, while the business is down, we are adding new accounts on a daily basis. So we hope to bottom out and continue to grow that business, primarily in this slower time with new accounts.

So you think that it's still going to be up from here over the second half and early part of next year?

We certainly hope so. Again, our plan would be to continue to -- we believe strongly the residential mortgage group will continue to grow, and we believe that the mortgage warehouse group, by adding the accounts that we're talking about, can improve our outstandings.

And we don't have to go very far to hit breakeven from where we are, Charlie, in terms of monthly production. I may just add to what George has said, in terms of the refis, in the mortgage warehouse in June, they were only 17 percent of the total volume of loans that we processed.

And in the residential mortgage-lending group, the number was 30 percent. So you know, we think we're getting close to the bottom of the barrel as it relates to refis, and we feel pretty comfortable with where we are in terms of our production capabilities and you know, we're not depending upon refis to drive this thing is the point that I'm making.

And those are all retail originations, no wholesale in there?

Yes, that is right.

And no retained mortgage servicing rights.

Right, OK. And then, you know, looking at the reserve the loans, I know that credit's looking pretty good these days and the loan growth is very strong. What do you feel like you know the bottom for the reserve is? I mean what you're comfort level?

Well, the first place, the reserve is driven by the methodology that, you know, we have developed here in the bank based upon -- and that methodology is based upon our history and of course we don't have but five years of history at this point, but it also takes into account industry trends and peer group comparisons. Given the fact that it is driven by the methodology, you know, we don't have a bottom necessarily that we have targeted.

We do need to always be mindful of the peer group comparisons, and we what's not only the Southwest peer group that we developed for ourselves, but banks of a similar size across the country. We don't want to be an outlier as it relates to peer group comparisons. On the other hand, you know, what's really relevant is the quality of our own portfolio, and you know, looking at the net charge-offs that we've had so far this year, and particularly considering that the charge-offs in the first quarter were impacted by a settlement of a long-standing negotiation that we had with one customer, and ...

In leases.

In the leasing portfolio, and we've got that behind us. If it hadn't been for that, we would have had net net recoveries in the first quarter. So 2004 has been typified by excellent credit quality and our trends are looking very, very favorable.

As I mentioned earlier, we have visibility right now on zero losses in the third quarter, but recognize that we're very early in the quarter.

Actually, the charge-offs for year to date period are all leases, which is a portion of the portfolio that there's a much higher allocation of course.

And just to add another bit of granularity to that, all of our recoveries have been out of the lease portfolio as well year to date, so we're pretty aggressive in taking those charge-offs, and we are getting down to the bottom of the barrel as it relates to the lease portfolio. You know, it today is a seasoned portfolio. We've got about $11 million left on the books, and you know, our goal is to work them out of the bank.

And my last question is kind of a follow-up to Andy's question on the earning asset level. Do you expect to grow the bond portfolio at a similar rate to loans going forward or should we see the mix kind of shift down, as -- you know, given the strength of your loan growth?

Our original plan called for an increase in the bond portfolio from this level, but given the surge in loan demand that we've seen in the early part of this quarter, I expect that the mix will change, tilted toward the loan portfolio, increasing as a percentage of the total, relative to bonds, but you know, whenever we see an opportunity to lock in a spread that is in keeping with our goal, we will take advantage of, you know, market timing so to speak to add assets, and you know we have a practice that we've followed now for you now our short history of taking those bonds, repoing them and locking in a spread for at least a twelve-month period of time.

Great, thanks a lot.

Thank you.

Our next question comes from Michael Turner (ph). Please go ahead.

Hi, this is Jennifer Demba.

Hi Jennifer.

Hi. I was wondering if you could give us an update on the Houston operation, and also you said you had 71 RMs in the second quarter. Could you just remind us how many you had in the first quarter?

Yes, I will answer the RM question in a second. Let me address Houston first, and this is kind of a general answer to your question, we are about -- well, specifically, we're 49 percent ahead of plan on deposits year to date, and that's post June 30. We're 30 percent behind plan on loans in Houston. We had a very aggressive loan plan for Houston, Jennifer.

I would say if you look at the total operation down there, you know, and you balance the very, very favorable experience we've got on the deposits side, that we're about where we thought we would be in the whole.

We're very gratified with regard to our overall experience in Houston and in the quarter just ended, they made a positive contribution to margin before allocations. And we fully expect them to be breaking even in the third quarter.

Again, we're very pleased with what we've been able to accomplish in that market. With regard to the RMs, at the end of the first quarter, we had 69. We added a couple of people in the second quarter, but you know a lot of this it's like booking a loan. You know, trying to hire a person can drift over from one quarter to the next and it's a matter of timing. By the end of August, with a little bit of luck we will have added you know five to seven more RMs.

And how many do you want to have by the end of the year?

(inaudible)

We're opportunistic, Jennifer. This is George. Our plan, basically, is 82, but again, as we've always said and as it relates to the four or five new RMs that Jody talked about earlier, we're opportunistic. If we find the opportunity with an individual or a group, we'll have them join the company, and move on.

And the team that you mentioned earlier that you think you're likely to hire, what market are they in?

We'll be getting a press release out on that, Jennifer, and hopefully, that will be forthcoming within two weeks.

OK.

I'd rather, you know, not be more specific about that until we have handcuffs on these guys.

Fair enough, thanks.

OK, thank you.

Good quarter.

Thank you very much.

Thank you.

We have a follow-up from Andrea Chow. Please go ahead.

I have a follow-up on the theme that wasn't -- if you're hiring, that wasn't part of your plan. What kind of expense dynamics and mix (inaudible) ...

We would expect to spend approximately half million dollars before they reach breakeven, and that will be for the course of this year would be you know -- and the breakeven is about eight months out, so it will be mostly this year, but will affect next year as well.

And you know when we gave our guidance earlier, we did that considering this added expense, which I might add was not in the plan. As George said, we're very opportunistic and we will -- you know, if we see a great opportunity like this, we'll take advantage of it, even though we know it will cause us to spill a little red ink in the short term.

OK great, thank you.

Thank you.

We have a follow-up from Jay Cunningham. Please go ahead.

Yes, just on the unrealized loss position, can you comment what that is today?

I don't have a number since the end of the quarter, I just know that the rates -- long-term rates have declined since quarter end. We saw, as we expected, strengthening of bond prices following the Fed's announcement.

OK. And just to maybe deal with the net interest margin in a little different way, Peter, I think in the first quarter call, you had kind of walked through by saying you know 100 basis points shift would cause the efficiency ratio to fall to X. Are we still pretty close to those parameters today?

Yes.

OK. And then can you take that a step further than and suggest where ROE might end up?

End up when?

Well, going about it the same way, if we had 100 basis points shift tomorrow, efficiency went to X, you could expect ROE to go to where?

To Y.

Y, yes, that'd be fair.

Maybe 2 x Y. we still think year-end, which has in our original plans said that the rate increase would come a little sooner than it did, and end up at about two percent Fed funds rate by year-end. Treasury markets are telling us that's about right, although we were about a one-quarter delay in the increase that we received. So we gave guidance that said we might be 13 to 14 percent exit rate 2004. That has to be very close, but we could be off a little bit by the effect of the quarter delay in the Fed funds rate increase.

OK.

The good news is we're moving in the right direction, and you know each month is better than the month before.

Great, thanks again.

With an improvement -- anything we would call a normalized margin with whatever you think that is in Fed funds, and take out just the identifiable components of our build out, if what you're getting to is we're already in the low 50s, making those kinds of adjustments on efficiency ratios.

Got you. OK, thanks a lot.

Thank you.

We have a follow-up from Scott Ollenoff. Please go ahead.

Hi, two quick follow-ups. First Peter, could you remind us what the composition of your other borrowings figure is, the number -- that 575 million specifically what portion, if any, is fixed versus floating?

I don't have in front of me the details. The average maturity is about a year. It basically all carries the securities portfolio. So in terms -- it's not necessarily matched in terms of duration, but it's matched in terms of source and use of funding.

I see. Secondly, Jody, you had mentioned in response to another caller's question about a surge in loan demand after -- early this quarter. Could you talk a little bit more about what you're seeing there, if that is customers returning, if that's a surge in demand in any particular market or two or could you help us out there?

I would attempt to answer that question, but George can do it better than I, Scott, so I'm going to let George elaborate on that.

Hi Scott. That's two questions really. In terms of where do we see loan demand coming from, if your question was are we seeing it from our existing customers, are we seeing it from business we're taking from our competition, I would tell you today we're still taking the greater portion of our growth away from our competitors.

We still haven't seen much organic growth from existing customers. Again, that we look at as a positive. As the economy improves we're going to see organic growth from existing customers, coupled with our continued strong take away business from our competitors.

Secondly, you're talking about what are we seeing, what kinds of loans. Actually, about 65 percent of our growth for the second quarter has come in the commercial loan portfolio, CNI loans, followed secondly by good commercial real estate loans.

We think that's really good core business from our core customers. We're competing again, very favorably in Houston, Austin and Fort Worth. Not only is Dallas, you know, one of our great contributors and really from a corporate standpoint where we started the company, we're now getting great participation by Houston, Austin, and Fort Worth also. And San Antonio has always been a good strong market for us.

The other thing I would add to what George has said is more macro in nature, and that is if you look at the manufacturing indexes, manufacturing is still very flat in the state of Texas. So is the industrial production index. Activity in those areas would drive CNI loans and increase in demand for CNI loans, and we really haven't seen that in the last couple of years.

In fact, we've seen you know the indexes headed in the other direction. So the fact that they've stabilized and should turn up you know as the economy continues to improve, I think that'll give the CNI portfolio a boost as well.

OK, thank you very much.

Thank you.

And there are no further questions at this time.

That being the case, let me just say in closing that you know we are very gratified with the quarter just concluded. We are extremely optimistic about our outlook and the outlook for the Texas economy in general.

We think we're located in the best places, being in the five major markets, which I can tell you about 13 million people, pretty good-sized country under themselves, and we have no plans to change the direction of the company in any way whatsoever.

We remain focused on these markets and on the things that we do and do best. So we enter the last half of the year with a lot of optimism and considerable traction, and we expect to conclude a very good year in 2004, and for that momentum to continue into 2005.

We appreciate everybody being with us today.

Again, I would encourage you, if you have follow-up questions, to call Myrna Vance. She gave you her number once, but let's repeat it one more time.

Absolutely, Jody. My number is 214-932-6646.

With that, we will bring this call to a conclusion. Thanks for all the great questions, and we look forward to hearing from anybody who has further questions and to continuing to stay in close contact with our analysts and our investors. Thank you very much.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a good day.