Texas Capital Bancshares Inc (TCBIO) 2006 Q3 法說會逐字稿

Good day ladies and gentlemen, and welcome to your third quarter 2006 Texas Capital BancShares earnings conference call.

[OPERATOR INSTRUCTIONS]

At this time we'll turn the call over to your host, Ms. Myrna Vance, please proceed ma'am.

Thank you very much and good afternoon to all of you. We're glad you could join us today to discuss our results for the third quarter of 2006. As Jean said I'm Myrna Vance, Director of Investor Relations. Should you have any follow-up calls or questions give me a call at 214-932-6646.

Now before we begin our discussion today I would like to read the following statement. Certain matters discussed on this call may contain forward-looking statements which are subject to risk and uncertainties. A number of factors, many of which are beyond Texas Capital BancShares's 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 rate 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 statement can be found in our annual report on Form 10K for the year ended December 31, 2005 and other filings made by Texas Capital BancShares with the Securities & Exchange Commission.

Now let's begin our discussion of the quarter. 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, as we said earlier our operator Jean will facilitate a Q&A session.

At this time, I will turn the call over to Jody.

Thank you, Myrna, and good afternoon, everyone.

We believe we have had a very solid second-quarter, moreover we believe that it provides a base for a very good fourth quarter, which historically has been our best quarter of the year. I'm going digress slightly from the webcast.

Before addressing performance I would like to say a few words about some of the basic principals by which we run the Company. I'm going to enumerate these 1-9 just to keep them in order.

The first is that we are a very entrepreneurial company. This was initially evidenced when we raised $80 million in capital in 1998, which was the largest capital raised for a start-up bank in the history of the United States. We kept this spirit alive since then by incubating new ventures, we like to place small bets, we look for large returns, but we continue to invest and nurture these companies until they either meet or do not meet our expectations.

An example of this is Residential Mortgage Lending, RML, and I hope all you have seen the accompanying press release that came out today announcing our sale of RML to Transnational Financial Network, which is an American Stock Exchange based company.

We began RML in 2003 around basically two people. It grew to 27 offices in 18 states. Unfortunately, it never really reached the critical mass required to produce the kind of profitability that we were looking for, and given the outlook we believed that the best alternative was for us to enter this transaction. We're very pleased with our sale to Transnational Financial Network and we look forward to holding that stock. As the press release indicates, we received 1.130 shares of stock and then there is an additional 869,335 subject to earn-out provisions making a total of 2 million shares.

The second principle I would like to discuss is focus. We believe that the key to success for small cap companies competing against much larger companies is to find a niche, and the niche that we focused on is middle market businesses and affluent individuals. Our goal is to be best of class.

We try to remain within our core competencies that's one of the principle tenants. We will however on occasion open and nurture related or compatible operations. An example of that would be Tex Cap Insurance, which we began in late 2005. Tex Cap Insurance has lived up to our expectations so far, even though it's been slightly behind plan, we're looking for a very good fourth-quarter.

The third tenant I'd like to talk about is value creation. Our goal is to become a high performance bank which we would identify as a bank that consistently earns as measured by ROE 15% or let's say a 1% deviation around that number. This quarter we earned 13.83, certainly we hope to do better in coming quarters.

We are a well capitalized bank and we intend to remain a well capitalized bank. We believe in reinvesting our capital in that we think we can deploy that capital to finance future growth more effectively than we could by paying it out in dividends. We also believe in prudent leverage as evidenced by the $40 million in trust preferred that we issued in the last quarter.

The fourth principle that I would like to discuss is our target of a high rate of organic growth. Now this is something that we have believed in from the outset. We have always regarded Texas Capital Bank as a high growth bank and I think the most recent numbers that you are seeing continue to reflect that.

Just as an example, taking loans year-over-year, we're up 34%, linked quarter, 28%. For deposits year-over-year, we're up 32%, linked quarter, annualized 48%. Earnings per share, adjusted for 123 R we're up 11% year-over-year and linked quarter, again annualized 25%. Our peg ratio we think is low and that is something we follow although it isn't followed generally throughout the industry.

The next key measurement that I would like to talk about is high credit quality. We believe that one of the keys to high performance banking is high credit quality. As an example of how we run that part of our operation, our net charge-offs over the last two years have averaged three basis points.

We are a conservative lender in the space in which we operate. We attempt to identify early problems that may be occurring or that we may have and we try to move them out of bank we have had a great deal of success in doing that. We also believe in prompt loan loss recognition.

We charged off last quarter $1.5 million in two loans, one $0.5 million, the other $1 million and I'm pleased to say that in this quarter we recovered on the $500,000 loan approximately $430,000. This is all driven by the loan process that we follow, which we believe in and George may want to comment on that more extensively later on in the Q&A period.

The sixth item that I would like to talk about is expense control. Again, we think that is one of the keys to high performance banking. As an example, over the course of the last four quarters beginning with the fourth quarter of '05, expenses have increased at 9.9%, first quarter of '06, 10.9%, we went up slightly. The second-quarter of '06 5.1% and in this quarter, 2.7%.

This is going to be a principle focus in the fourth-quarter and throughout 2007. However, I would remind you that the first-quarter is usually an anomaly for various reasons that we have discussed in the past.

The second principle I would like to discuss is balance sheet integrity. We believe in investing our asset as fully as we possibly can. We have no real estate on the books as of September 30th, 94% of our assets were invested in earning assets.

Our securities portfolio we hold for sale. In other words, what you see is its true value. It's mark-to-market. We also believe in minimizing intangibles, you will see that we have $13 million on the books. Mostly as a result of acquisitions of insurance operations and insurance agents.

That $13 million in intangibles is out of total assets of $3.5 billion roughly. Our loan loss reserve at $28.8 million is 2.5 times our accumulative loan losses since we started the bank nearly eight years ago.

The next item I would like to talk about is acquisitions. We believe in build versus buy. The principle reason for that is the delta between current expectations and what we would be willing to pay.

I think as everyone on the call knows banks in Texas have been selling at four to five times book value. There is no way we believe that we can make an acquisition at those levels, and realize an accretive transaction in any reasonable time. We're not opposed to acquisitions, but we are very sensitive to price, and accretion. An example of an acquisition we made is Bank Direct Capital Finance which we acquired in the summer of '05 and has been accretive from the very first quarter that we acquired it.

Finally I would like to talk about pay for performance. We believe in hiring seasoned bankers, bankers who can bring skills and relationships to us at the very outset. In our planning process we create a bonus pool and that bonus pool is based upon planned profitability. We maintain on a monthly, quarterly and yearly basis a full balance sheet in P&L on each relationship manager and they are rewarded at the end of year based upon their contribution to profit.

These are just some of the principles and values that we use in running the Company. They're core to our culture and we think they count for the success that we have enjoyed since our inception.

I'm now going to turn it over to Peter to talk about the numbers in more detail and look forward to Q&A later on. Peter?

Jody, thank you.

If you'll flip to slide 4, performance summary we had $8 million in net income from continuing operations, it's an increase of 29% from the previous quarter, and 8% from the year-ago quarter. EPS growth of 25% on a continuing basis and up 11% when adjusting 2005 third quarter results for the impact of 123 R.

Loans held for investment 32% over the prior year, very strong growth. 11% in demand deposits which I will speak to more in a moment. Total deposit growth 32% over 2005 quarter averages and an increase of 12% on a linked quarter basis Q3 versus Q2.

We've seen net interest margin for the first time presented on a continuing operations basis and I will spend more time on that in a moment. We did see an increase over the prior year, but a seven basis point decrease from the second quarter of '06, again I will speak to more issues related to net interest margin in a moment.

Credit quality Jody addressed a moment ago we had a net recovery of $445,000, and we had an increase--a decrease from the second quarter level of provision, but a provision of $750,000 driven primarily by the growth in the portfolio.

Turning to slide 6, again, we have had strong growth in net interest income and very good growth this quarter in non-interest income and as Jody mentioned we saw non-interest expense at the lowest growth level in percentage and dollar terms on a linked quarter basis in some time. This again is all based on continuing operations.

You see income from discontinued operations in this presentation and I will comment on that. That is a reflection of several things.

The disposition as of September 30th of all assets of RML and associate--assets associated with RML, computer equipment, software and so forth. It reflects an allowance for all identifiable expenses associated with the disposition and any contingencies that we've been able to identify in connection with the sale.

It also incorporates the fair value of the consideration that we have received in the tradition, as well as the operating results during the third quarter, so on an after tax basis all of those things combined was a negative $167,000. Turning to page 7, net revenue growth I mentioned was 5.4% from the second-quarter. Net interest income growth, as you will see was driven basically by exceptional loan growth once again.

We saw net interest margin decrease and margins continue to be constrained by the impact of rapid growth in loan portfolio on the funding position of the bank. The effect of the loan and lease mix is also a factor. We have seen very good growth in the lease portfolio.

We have seen exceptional growth as you will notice in the loan held for sale category. That is a category that is very important to us. It's a very successful business, but it's yields are generally constrained by market rates on long-term mortgage loans. We also get fees on that, which I will comment on again in a moment.

Operating expense growth was 2.7% from second quarter, that represents only half of the net revenue growth. When I speak of "Net revenue growth," the 5.4% and that excludes the pickup or the improvement that comes from the reduction in the provision for loan loss.

The expense growth has really been nominal from continuing operations when you exclude the effects of depreciation in the operating lease portfolio and more normal expense levels within our company. A FAS 123 expense remain unchanged in Q3, it was $0.02 and the same number in 2000--in Q2.

Insurance services and the leasing lines of business are still in growth and development phase, but they have improved dramatically in the third-quarter. The RML sales effective as I said at the end of Q3 and will from now on be reflected as discontinued operations.

Turning to slide 8, these graphs show the differences in key performance ratios between continuing and consolidated operations. In terms of net interest margin you'll see that since year end 2004 there will be more about this at the end of presentation.

RML's contribution to net interest margin has averaged more than 20 basis points. The portfolio is relatively small and declining as a percent of total loans, but the fee component produces a very--produces very high yields, generally in excess of 25%. The net interest margin from continuing operations has demonstrated the same trend as the overall margin with rising interest rates, but with less variability.

As Jody mentioned the principle issue here is that RML has never been a big drag. It's never produced a significant contribution and it just has not kept pace with the success of the rest of our businesses.

The efficiency ratio despite very favorable impact on net interest margin, the impact on the efficiency ratio is quite negative, they're generally 400 basis points, four full percentage points higher with RML than for continuing operations. It also has essentially a very high cost associated with its gain on sale.

Also very important and directly related to this, it contributes 20 to 30 points--basis points to the ratio of non-interest income to earning assets. But that is offset by more than 50 basis points on average in the ratio of direct non-interest expense to earning assets, and this ratio significantly understates the expense impact, total expense impact given the relatively high cost of support in HR, IT, financing, etc.

For all the reasons stated RML's impact on ROE---ROA and ROE has been slightly negative in 2005-2006. No real prospect unfortunately for consistent contribution without a significant change in the scale of this operation, which realistically is not going to be available through TCB. Relative to its size, RML's skews results widely and has made understanding of our core profitability more difficult.

RML is, in our judgment, very well -managed and we believe it can contribute to its new organization and give us an opportunity to share in the upside there with no meaningful exposure to loss from the carrying value of the securities we've received.

Turning to page 9, loan growth has been again exceptional. We saw very strong growth in the mortgage warehouse line of business and its results in loan sales for sale. Earning asset composition, clearly more favorable with securities now at quarter-end just under 17%. Continuing operations, loan category depicted on this slide excludes approximately $27 million in loans held for sale associated with RML.

The comment as I mentioned on demand deposits. The trend has been very good compared to industry peers at 11% year-over-year, and these are all average balances. DDA growth is more variable in the TCB business model. We saw 25% growth from Q1 '05 to Q4 '05. These are average balances and that annualizes at more than 30%.

That does make, because of the strength of the growth in the last half of '05, makes last half of '06 comparisons quite difficult. We saw a 3% increase--decrease, I'm sorry from Q4 to Q1 of '06 and then a 5% linked quarter growth from Q2 to Q1, and followed by a 1% decline in Q3. Needless to say, demand deposit composition of total funding is a very powerful driver of net interest margin as it especially was in 2005 where we benefited from improvements plus the effect of rising interest rates.

Total deposit growth of 12% linked quarter and 32% year-over-year, I think is remarkable. Deposits grew more than $130 million more than loans, and it's obvious that that kind of growth would have to come in the form of interest bearing deposits. I will add that during that quarter we also saw a reduction, a pay down of our broker deposits, broker CDs by additional $50 million and that balance outstanding today is less than $5 million, a remarkable improvement in the core funding of this company over the last several years.

Turning to page 11, the Company remains significantly asset sensitive, but given the growth and some of the issues confronting the industry and us, that impact of being so sensitive has become lower. First of all, the loss on RML loans at 32% has had a big effect on net interest margin, but has been more than offset with a reduction in expense. Growth in loans, of course, has driven a shift in funding composition. EDA growth has been good, but clearly could not maintain this pace.

Loan composition also is having an effect on current rates--effect at the current rates. Rates are higher and reached levels that are higher faster than our plan and therefore guidance anticipated and the higher rates have obviously hurt spreads on fixed rate assets more than we anticipated. Q3 average deposit growth is much greater, as I said than loan growth, but all the growth did occur in interest bearing deposit.

In loan composition the yields on the floating rate fortunately have held up extremely well. We have expansion of loans held for sale on an average basis effective actually very favorable effect on net income, not as favorable effect on net interest margin, because as I mentioned earlier, yields are compressed because they are tied to note rates, which are a function of the negatively sloped yield curve. Fees that we generate in Mortgage Warehouse categorized as non-interest income do represent about five basis point equivalent in net interest margin if it were classified in that category.

Leasing has been good for us, we're expanding there, it's a very well-managed business. It does compress net interest margin by several basis points, especially because fixed operating leases have a negative spread in their early life with the classification of the asset not as an earning asset and income from rental classified as non-interest income with obviously the funding cost to support that activity reflected in interest expense.

On page 12, as I said very strong deposit growth in the third quarter. Growth in customer deposits is now replaced as a mentioned all but $4 million in brokerage CDs, composition of funding has obviously had an adverse affect on net interest manager, but the growth in loans has offset the impact on net interest income.

On net interest income from continuing operations indicates a contraction by 7 basis points as I mentioned and the major categories or components of reduction are loan growth and shift in funding, the drag of securities portfolio and fixed rate loans and loan mix with some yields constrained by the negatively sloped yield curve.

With that overview of the financial results I'll ask George to comment on the growth in the bank.

Thanks, Peter.

Slide 13, as you can see our growth numbers for deposits and loans are exceptional. However, as Peter just mentioned, our demand deposit growth has slowed near term primarily related to higher interest rates with higher return options available to the depositor. Most of our deposit growth in Q3 came from money market and Euro dollar accounts with the Dallas Corporate Banking unit and the regions outside of Dallas showing the best growth.

On a linked quarter basis our strongest loan growth came in the C & I portfolio of approximately 48% of that growth. The real estate portfolio made up 22% and our Mortgage Warehouse portfolio 30%. We saw excellent loan growth in the Dallas Corporate Banking Group. Our Bank Direct Capital Finance Group, as you recall that's our insurance premium finance subsidiary and in Houston and in Austin.

On slide 14, our revenue and income growth numbers are strong as can you see. Our expense growth as we have talked about previously, primarily because of our continued build-out in new lines of business remain high also, but this quarter on a continuing operations basis after the sale of RML, linked quarter expense dropped to 2.7% and as mentioned before, one of lowest increases we have seen in a long time. As Jody mentioned we're actively working to reduce expense growth on a quarter-by-quarter basis.

If you'll turn to slide 15, we'll talk about credit quality for a moment. A strong quarter with net recoveries of $445,000 or 7 basis points. As mentioned before, this would make our net charge-off ratio for the last 12 months only 5 basis points, and total net charge-offs for the past two years of 3 basis point or a little over $1 million.

We did provide the $750,000 provision to the reserve in Q3 primarily to support loan growth, and we have been consistent with our methodology since inception of the Company. Our reserve position remains high as a multiple of historical net charge-offs and non-performing loans and our NPO ratio, as you can see, remains low at 25 basis points.

On slide 16 we'll continue to look at the credit quality numbers. Again our net loss year-to-date 2006 is 6 basis points, following a net recovery year in 2005. Our reserve to loans is 0.82%, slightly up from Q2, but again, after absorbing well over $120 million of loan growth in Q3.

Our NPL plus ROE to loans is 0.29% and we have a relatively small ORE portfolio with almost 90% of that portfolio under contract with no loss projected for the bank, and as you can see coverage ratios of reserves to non-accruals and NPLs remain very good. We believe it was a very good credit quality quarter.

Jody?

Okay, George, thank you very much. I think as everybody can see from the comments that I made, plus those of Peter and George that we are continuing on a very strong growth trend. We believe that this will continue into the fourth quarter although there are some early indications that the Texas economy is weakening somewhat.

Fortunately it does not seem to be weakening in the lines of business where we're most predominant. In fact, we're optimistic about the Texas economy. I think one has to realize in assessing the outlook that we're coming off of all time highs, the economy has been absolutely hitting on all cylinders. There may be some slowdown in energy, but the rig count in the month of August was at an all-time high since the crisis that we had back in the 1980's.

So we're confident about the economic outlook as it relates to Texas. Likewise we're confident about the outlook for our company. We look forward to a strong fourth quarter again and we look forward to a very, very good 2007.

We'll now be delighted to entertain your question and we'll turn it back over to the operator.

[OPERATOR INSTRUCTIONS] We have a question from Andrew Collins of Piper Jaffray, please proceed.

Hello. This is Peter [Fralick] for Andy Collins.

Hello Peter, H.

How are you doing? Just a question on the demand deposits, I noticed you highlighted that on an average basis they are down 1% linked quarter, but on the period end it's down 12%, is that due to the effect of the RML sale or what else might be going on there?

RML has no effect on that number, it's just the variability of what can happen on a particular date. There have been no fundamental changes in the nature of business activity with our customers, it's just what happens as I said at the end of a quarter. We also had a very high level at the end of second quarter and high average levels during the second quarter.

Okay. And then one more aspect of the deposits, I noticed that the branches (inaudible-technical difficulties)--845 up, (inaudible-technical difficulties) could you give us a little more color what is go on there?

You remember at the end of the second quarter we said that we had a very substantial--one of our customer's sale of his business and a substantial increase in the deposit levels at June 30. That transaction occurred on June 29th and we have been fortunate to maintain that relationship or a significant portion of it over the entire quarter or for most of the quarter. George do you have anything?

Nope, that is right. We had obviously some other growth in the Euro dollar deposit category, but as Peter mentioned that was a significant deposit that we maintained for sometime.

All right, thanks, guys.

I'll take our next question from Charlie Ernst with Sandler O'Neill Management, please proceed.

Good afternoon.

Hi Charlie.

Can you just--couple questions first the premium finance balances in the 90 day past due, do you have that handy?

That number has been the same for three-quarters.

Okay and then in terms of the loss that you show in discontinued operations, can you add some detail between what is the gain, if there have any and what is the ongoing loss?

Yes, and I didn't mention during the--I mentioned vaguely the last two slides of the presentation show a lot more detail on the differences between continuing and consolidated operations and details by category of RML. We put a big discount on for an illiquid position based on an appraisal of the securities we received in the sale. So we got a very small exposure to that as an investment. I think the rest of it you can see on slide 19, shows the adjustments to Q3 results.

Okay, I'm sorry does that show exactly what the gain is and what sort of the ongoing loss is?

It shows all of it. The gain, it's all reflected there. The gain--the value of the securities we received is just under $600,000.

Okay, and you are not going to hedge, it's not worth hedging I guess?

There is no way to hedge it.

Okay and then, do you have, I don't know if I saw it anywhere on the balance sheet what the pro forma earning asset level is on average.

Yes, $27 million. It shows up on slide number 11.

That is all that comes out of the balance sheet, Peter?

That is all that comes out the balance sheet,

Okay, great.

There were no intangibles that have ever been booked, there were no meaningful assets, it was literally computers, furniture and things like--and software.

So if we just take this quarter's reported earning asset level back out 27, that is a good run rate?

That is correct.

Okay, and then lastly, in looking at the profitability metrics for the RML business I was actually surprised to see that it wasn't wider between the consolidated numbers and the broken out numbers and it makes me wonder because you all said it was $0.05 in the first half of '06, the drag of all four of those businesses and it makes we wonder how big in ranking RML was versus the other business?

No, we never said it was $0.05 in the first half, we said that was the--a principle factor in the change in the guidance for the full year. It has a very aggressive plan coming into 2006. The mortgage industry is soft in the first quarter, we saw improvement in the second quarter as you can see in the results, but nowhere near enough to come to the aggressive plan that they had for the balance of year and their year was heavily back end load because of first quarter weaknesses.

Okay great. Thanks a lot.

I'll take our next question from Brent Christ with Fox-Pitt Kelton

Good evening, guys. A couple quick questions, first in terms of the margin, this is really kind of the first quarter of any notable contraction whether you look on a core or a pro forma basis. Could you talk a little bit about what type of spread you are adding additional assets to the balance sheet at and kind of how that plays into your thoughts on the margin going forward?

The loan growth has been very good and most of the growth continues to be in the floating category. As I have said, we've had good growth in the Mortgage Warehouse. that is technically a fixed-rate loan of short duration, but literally less than three weeks or four weeks, but it's got a yield that is constrained by, as I mentioned, the slope of yield curve.

The rest of the yields have held up very well. We have increased a little bit of fixed-rate lending and leasing activity, which is in this market a near term negative in terms of margin.

Okay. I guess the question was kind of, the spread you are seeing of the new assets coming on, I'm assuming from the sound of things those are coming on at lower rates than your current blended margin, is that fair to say?

No, it's really not. As I mentioned certainly the Mortgage Warehouse loans come in at lower than our blended average margin, but we pick up another five basis points in overall margin, not just that category because of fees in that business.

Okay. A couple more quick ones. First, you mentioned some initiatives that could potentially spoil the rate of expense growth. Is there anything specific in terms of actions you are taking there?

No, not really. We're seeing more what I would describe as operating leverage in our business. We see net revenue growth at twice the rate of expense growth. That is a good thing.

I think another element there is we spent a lot building up Tex Cap Insurance and that rate of build up slowed during the third-quarter and we looked for the fourth quarter to reap the benefits of that.

Then the last question is on the credit quality, it seemed like your loan loss reserve ratio stabilized and was actually up 1 basis point this quarter, but I guess you did have the net recovery in the quarter and kind of how should we think about the reserve ratio, as well as provisioning going forward?

Well, as we have said before, in today's environment, we have a very, we believe, a very good methodology in terms of loan loss reserve adequacy and we follow that very carefully. If problem assets increase, there is an automatic increase built in for the provisioning based upon that methodology. We'll continue to use that methodology and certainly as we grow we'll have to continue to provide provision to the loan loss reserve and if we can't do what we think we can do, which is keep credit quality pristine, we can be adding to the reserve to support growth as opposed to any problem asset.

Okay. Last question. You guys had some guidance in your last quarter presentation and I noticed that it wasn't in there this quarter. Any change to that or any reason?

No, we don't give quarterly guidance, and we have narrowed the guidance over the course of the year, so we feel comfortable with the range that is out there right now and don't really see any compelling reason to change that guidance in any way.

Okay, thanks a lot.

Thank you.

I'll take our next question from Andrew Collins of Piper Jaffray.

Hi guys,

Hi, Andy.

Just on the net interest margin, if that continues to come in, what we're hearing is that you'll manage it through better expense control, is that essentially what is going on here?

Well, that is one element. In terms of income, you play growth against yield, and we have been very successful in offsetting any diminishment in margin by growth.

If you look at back 2002-2003 we were increasing net income as rates were declining and declining very rapidly. So I think, just the very nature of the kind of business that we're in, the growth that we have been able to generate organically provides a built-in cushion and buffer against any kind of lowering in interest rates or diminishment in interest rates that could be reflected in net interest margin.

Andy, the growth itself is caused the reduction in net interest margin.

Certainly , the makeshift.

Correct.

And just in terms of RML it certainly was somewhat dilutive to your attention and I'm wondering was it somewhat dilutive to earnings as well and I guess would get a little bit of upside from that going forward from not having that drag?

Andy, let me make a general comment and then I will turn it over to Peter and George to be more specific, if they choose, but the numbers that we have shown you have been without overhead basically. And the overhead that we have spent and allocated to RML has been as precise as we could make it, but it's put a tremendous strain because of the geographic breadth of that operation on such operations as information technology, human resources, accounting, and we could go on.

So we think that it has been a burden on the Company that is hard to really quantify and we hope we'll reap the benefits of that as we go forward. Certainly we're going to be able to redeploy a lot of those assets more productively than in the past and as a matter of fact, we're going to be looking carefully at the ability to reduce some of those staff operations as it seems appropriate.

George, Peter, do you have anything to add? Next question.

I'll take our next question from Andrea Jao with Lehman Brothers

(Inaudible-technical difficulties)--and backing away from mortgage as one of the results, hoping to get some more color on your thoughts on the other business lines.

Well, as far as and again we'll let additional color come into play here, but the other business lines are doing well. We have already talked about Tex Cap Insurance and our expectations for the fourth quarter. Our C & I loan growth has been very, very robust. energy has been good, but has perhaps slow a little bit. We're seeing good growth in the regions.

Austin has particularly been robust over the course of the last six months including the last quarter. Houston continues to turn in good results. San Antonio we had a big paydown in loans there at the first of the year or late last year. I can't recall exactly which quarter it fell in, but they have been refilling that pot. They have been doing a good job of it.

We have good deposit growth across the board. George, you might want to comment on real estate in particular because that is a hot topic today, particularly with the housing markets being what they are, and there has been a--if you just look at the numbers as reported by the fed or whoever you want to look to, there has been a decline in housing starts. It was about 12% in the Dallas-Fort Worth area for example from the second-quarter to the first-quarter.

That notwithstanding housing starts in Texas if you look at it overall are tremendously robust compared to prior years, and we continue to benefit from an influx of people and job growth.

So George, you want to talk more specifically about it.

Yes, realistically the real estate market in Texas appears sound. While the national housing market is softening some and some of the information that Jody gave is certainly accurate. Our markets and where we're located, housing has remained pretty strong.

We still have good job growth, as Jody mentioned and really no apparent bubble like you're hearing in the rest of the country or in some parts of the country. The office product is well located and remains good. Industrial and retail are holding up well. Even multi-family in North Texas has been particularly strong. There is just not enough product out there and we have seen the highest average rents we have ever seen in multi-family in Texas today.

We're cautious, we're careful, we underwrite very cautiously, very carefully. Our real estate portfolio in the Company has declined since about 2003 and that is a symptom of being more selective and growing other parts of our business, but it's about 37% of the portfolio, down from 46%. But we believe the commercial real estate market in the state of Texas is pretty healthy and we're participating in that.

The only other thing I might add is that we have scrupulously avoided the higher risk elements of the market, such as high rise condominium, we have none of those on the books. High rise office buildings, the typical segments of the real estate market that you would associate with greater risk in a declining market, we have learned by experience to try to stay away from those.

Our real estate product that our loans that we make really look like our middle market business too. As Jody mentioned, we're not in big power centers, we're not in skyscrapers, we're in that middle market product, that low rise office warehouse, small strip centers, those kinds of projects that we underwrite the developer very carefully. A lot of equity in the project and we have been very pleased with our commercial real estate portfolio.

Thank you very much.

I'll take our next question from Ron Peterson with Sterne Agee, please proceed.

Thank you, good afternoon.

Hi Ron.

I have a question regarding the Mortgage Warehouse lines, you talked about the strong growth, you're going in there. Going forward with the softer housing markets do you think that kind of growth can continue or what do you see going on there?

Let me tell you why we're experiencing good growth even in maybe a softer mortgage market today and why it really differs a little bit from our R&L project. About a year ago we decided that we wanted to expand our business, but add additional customers to do that. So we have approximately five regions outside of the state of Texas that we're participating in the Mortgage Warehouse business.

We have reps in five different locations covering the country, and about 50% of our business today is outside the state of Texas. So it gives us good diversification, it gives us the ability to add a number of customers and offset a softer market with adding more customers to your customer base, and that has worked very well for us.

It's taken us nine months to a year to really get some traction on that program, but it's beginning to work and I think we're going to continue to see good production out of our Mortgage Warehouse group.

Thank you.

I'll take our next question from Jennifer [Binmore], please proceed.

Good afternoon. I have a few questions starting with your average loans held for investment, it looked like that growth slowed. It's still obviously very strong from second quarter to third quarter, but it was slower than it had been in the previous three or four quarters. Was that deliberate or demand based?

Well, I think one of answers relates to just the third quarter August occurs in the third quarter and a lot of people--

Every year.

--every year and a lot of people are on vacation and it just typically is not the most robust quarter of the year as it relates to loan growth and business activity in general.

I also think if you look at the increase from the first quarter to the second quarter it was extraordinarily high and we may have borrowed some growth or stolen some growth, so to speak from the third quarter in the second quarter. But I don't think, Jennifer, you should look at it as any indication of a trend toward significantly lower loan growth.

You also see, Jennifer, the end of quarter balance was a lot higher than the average.

Right. Question on the fee income growth. Obviously very strong sequentially. Do you feel like--it sounds like you do, you feel like the run rates on the insurance side are pretty good going forward?

We believe so. At least based upon our early read and what the people who run that side of our business are telling us. We'll be able to tell you more at the end of the quarter.

Okay. What about on the trust side? Was there anything driving that increase?

Jennifer, we're beginning to get to that critical mass standpoint with our wealth management group and we have added some fairly significant customers over the last six months to our wealth management opportunity and we have grown our top line revenue quite well. So yes, we think that that nice profitability increase should continue.

Okay. Thank you.

Thanks, Jennifer.

I'll take our next question from (inaudible-technical difficulties) with Morgan Keegan.

Thank you, all my questions have been asked or answered, but I have one question with labor cost rising in Texas and that is obviously attributed to a lot of the larger banks [dinovoing] and having to hire away management, are those the savings that you'll get from R&L and sort of the redirection of those employees, how are you going to control the labor cost side of the P&L?

That is a good question and I think the first answer is that is a large element of our labor cost is in the form of bonus.. I mentioned pay for performance earlier and we tie bonuses very directly to profit contribution on the part of every RM.

I also believe that we're not going to have the build up in labor next year that we have experienced in the last couple of years simply because we don't have new lines of business that we envision. Starting in the near future, now I can't guarantee you that something won't come along during the course of the last quarter or during the course of 2007 that we might find inviting and enticing, but right now we have no plans to start any new operations.

So I think we're in a period of consolidation and leveraging off of what we have already got and that should keep our labor costs more in line with what you would expect of a more maturing company.

Any thoughts about an efficiency ratio target over the longer term?

Yes in the core bank, that number is already in pretty good shape. It's obviously a little bit lower-- mean a little bit higher than we would like, partly because of the effect of the net interest margin. What we have seen, as you have notice and commented on earlier, very good growth in non-interest income.

Non-interest expense if we're successful in the insurance business will have great growth in non-interest income and will also have high growth in non-interest expense because of the commissions. The commissioned nature of that business.

That business will never be--have a low efficiency ratio, because a really well run agency has roughly a 30% profit margin--25 to 30% margin. So that business, if it's really successful will have a 75% or so efficiency ratio compared to a 60% or below ratio for the rest of the bank.

Thank you, guys.

Any other questions?

I'm showing no questions at this time.

[OPERATOR INSTRUCTIONS]

And I'm showing no questions at this time, we'll turn the call back over to the presenters for closing remarks.

I would like to thank everybody for being on the call today. Again, we feel that we had a very good quarter. We look forward to continued success in the future. We continue to work hard for our shareholders, and obviously those of us in the bank have a keen interest in this because we're shareholders ourselves.

So again, thank you for being with us this afternoon. We very much appreciate it and look forward to continued conversations. I will just remind you if you have additional questions, please call Myrna Vance.

She would be delighted to answer those questions or redirect them within the organization. That having been said, thanks again.