Texas Capital Bancshares Inc (TCBIO) 2007 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the quarter two 2007 Texas Capital Bancshares Inc.

earnings conference call.

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

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

We will conduct a question-and-answer session towards the end of the conference.

(OPERATOR INSTRUCTIONS).

I would now like to turn the call over to Ms.

Myrna Vance.

Please proceed, ma'am.

Thank you, Paul, and good afternoon to all of you.

We are glad you could join us today to discuss our second-quarter results.

I'm Myrna Vance, Director of Investor Relations and should you have any follow-up questions, please give me a call after the 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 risks and uncertainty.

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 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 statements can be found in our annual report on Form 10-K for the year ended December 31st, 2006 and other filings made by Texas Capital Bancshares with the Securities and Exchange Commission.

That done, let's begin our discussion of the quarter.

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

And as Paul said, after our prepared remarks, he will facilitate a Q&A session.

Let me now turn the call over to Jody.

Hi, everyone, and thanks for joining us for the second-quarter conference call.

Really pleased to make this call today in that we've just concluded what I believe is a great quarter, particularly given the environment that we are in as we sit here.

I'm going to diverge a little bit and talk about the factors that drive shareholder value, particularly in the context of Texas Capital Bank before I turn it over to Peter and to George.

First, I want to refer to a study that was done by the American Bankers Association headed by Bill Ford, who was then their economist and later became the president of the Atlanta Federal Reserve Bank.

This was a study on high performance banking and they identified three characteristics of high performance banks and they were, in no particular order, organic growth, expense control, and credit quality.

We focus on these metrics as we run our organization and strive to be among the elevated, high performance banks.

And just to focus on these three metrics, organic growth, let's look at total loans.

For the second quarter, using linked quarter measurement, total loans were up 8% over the first quarter.

Year-over-year, they were up 28%.

On an average basis, total loans were up $232 million; in absolute terms, that is the best quarter that we've ever had.

And again, just emphasize that this is all organic growth.

Turning to expense control, we spend a lot of time concentrating on expense control and particularly the delta between net revenue growth and the growth in non-interest expenses.

Using the second-quarter statistics on a linked quarter basis, net revenue was up 8%.

Non-interest expenses were up 5.5% and there were some unusual factors in the non-interest expenses, which caused them to be a little bit higher than they normally would have been.

Turning to the next variable, credit quality, we had a stellar second quarter and that continues a long string of successes.

As it relates to credit quality, our net loss for the second quarter was $27,000 or next to practically nothing.

For the first half, we had net recoveries of $359,000.

So for the year, we're doing very, very well.

And based upon the visibility that we have today, the outlook remains very favorable.

I'm now going to fast forward from the basic study that was done in 1975, which has become sort of everyone's Bible to a study that was done March 27, 2006 by Jim McCormick of First Manhattan Consulting Group.

For those of you who are interested in this kind of thing, I will give you his e-mail address because I think this is something you might want to put in your files.

It's JMCteam@FMCG.com.

And the title of the article is "What Really Drives Shareholder Value?"

He did a regression analysis on 100 regions banks and studied 50 variables.

He found some interesting statistics really which confirmed what we believed all along.

One was that market prices and multiple of book values closely correlated to return on equity.

And if you look at the correlation data, it's 0.69%.

In other words, or 69%.

In other words, 69% of that ratio is accounted for by changes in ROE and particularly, of course, increases in ROE and the absolute level of ROE.

ROE is one of the major metrics by which we measure Texas Capital Bancshares.

We think that is the best indicator of how we are performing for our shareholders.

Our goal in the -- not in the second quarter, but over the long term is 14 to 15%.

In the second quarter, we were 12.59%.

This is versus 11.36% year-over-year.

And this is with the challenge of the inverted yield curve or flat yield curve, which, in our case, means that we are losing money on our securities portfolio.

Turning to another element of McCormick's study, he focused on total shareholder return over time, and by over time, he meant over a five-year period and found that it's heavily correlated to growth in EPS and changes in return on equity.

In other words, if your return on equity was going up, that was a multiplier as it related to the growth in EPS.

However, these are all outcomes, not drivers of what is causing the outcomes.

So the next element that he addresses in this study are the drivers of ROE and growth in EPS.

And, according to his research, he believes that there is one basic driver and that is same-branch or same-store organic growth, which he says is the key.

McCormick uses growth in deposits as a standard.

At Texas Capital Bank, we use growth in deposits and loans.

Based on his research, McCormick advises bank management to measure organic revenue growth.

We do this monthly, quarterly, and yearly by the relationship manager and by the business unit as well as for the whole bank.

And how each person does and how they are rewarded depends upon how they perform against these measures.

He also says compare your growth to that of your competitors.

We do this on an ongoing basis.

And I'm going to give you some statistics through March 31 because we don't have statistics obviously through June 30 for all of our competitors, but the competitors included in this analysis are Cull and Frost, the Bank of Texas element of Bank of Oklahoma, Sterling and Prosperity.

For Texas Capital Bancshares, our loans held for investment grew 623 million or 28% from the prior year over the year.

Our competitors, their gross loans grew 717 million, just slightly more; this is an aggregate for all of them.

And their percent increase is 0.05%.

For total deposits, coincidentally, our deposits grew the same as our loans held for investment, 623 million.

That was an increase of 25%.

Our competitors in aggregate grew 441 million, or 2%.

McCormick concludes the study by stating, if you have a good story to tell about organic growth communicated to the investment community, which is a good lead-in to the rest of this presentation.

I might ask you to turn to Page 3 very briefly, again, before I turn this over to Peter.

It's obviously we had another successful quarter.

A principal driver behind this is the Texas economy.

We operate in what I think is the strongest economy in the United States today.

This is verified by any of the indicators you want to look at.

The leading indicator is at its highest level since August of 2000.

The unemployment rate for the state is 4.1% versus 4.5% the last time we spoke to you.

All of the cities, Austin, Dallas/Fort Worth, Houston, and San Antonio have unemployment rates below 4% with Austin being at the bottom at 3.2, Dallas/Fort Worth and Houston all at 3.9%.

And those are all substantial decreases from the last time we spoke about the performance in these cities.

Total employment for the state is up 3.1%.

The rotary rig count is the highest since it has been since September 1984.

The durable goods manufacturing index is the highest since 2001.

Housing permits in the latest month available, which is May, were 17,570.

That is the highest level since June of 2006.

And it is substantially above the average for 2005 of 17,060 and is about right on the average for '06 of 17,582.

The bottom line of that being we really haven't seen the housing debacle in Texas that has appeared in other parts of the country.

And one reason for that is that while the state experienced a moderate 24.2% rate of increase in house prices over the past five years, the nation, as a whole, increased 55.2%.

So we didn't have the bubble that occurred in some of the other states.

Let me now turn this over to Peter, who is going to go into more depth as it relates to the numbers and then he will turn it to George, who is going to talk about growth in some of the business metrics as well as credit quality.

Jody, thank you.

Turning to slide 4, it's obvious that the performance of this quarter is marked by exceptional growth in loans.

Core deposit growth before what we knew to be a reductions from business transactions, DDA growth 4% linked quarter and very strong gross compared to the averages at the end of the quarter.

And unusually I think for the industry, net interest margin expansion by 5 basis points, driven by DDA growth, again, and the improvement in cost structure of interest-bearing deposits as well as utilization of our cash balances.

George will talk about very strong credit quality and all of this wraps up, of course, with very strong earnings per share growth.

Turning to slide 6.

I have additional comments about performance.

We had net income of $8.4 million, linked quarter growth of 11% and year-over-year growth of 33%.

This very strong performance is reflected, as Jody commented, in net revenue growth of 8%.

It's a major improvement in operating leverage, reflected in the comparison of growth of net revenue to the 5.5% growth rate in non-interest expenses.

A substantial majority of the growth in non-interest expenses accounted, was accounted for in two major items, neither of which reflects any weaknesses in our core operating strengths.

The growth in non-interest income we experienced related to the brand-new FDIC assessment.

which will be an ongoing expense we just have to live with and represents about 1%, excuse me, $0.01 per share per quarter and there's a little heavier weighting of that in Q2.

Salary and benefit expense, which results from the normal growth that we've experienced plus a significant increase in the variable performance-based expense.

All other categories are extremely well contained.

Adjusted for these major items, expense growth for linked quarter was less than 2% in the quarter.

I mentioned the noninterest -- net interest margin increase of 5 basis points.

Very significant in light of the growth and the flat yield curve alluded to by Jody.

Exceptional loan growth and impact on earning asset composition was also very powerful.

The loan growth for the quarter was record with 200 million in loans held for investment and over 230 million in total loans.

Those are average balances.

We had success in reducing deposit costs in key categories and more effect use, as I mentioned, of our cash balances.

We saw an improvement in the ratio of earning assets to total assets to now more than 95%.

That is a meaningful increase compared to the number a year ago.

We saw an improvement in DDA balances, as we expected following the weak first-quarter results, with DDA growth linked quarter of 4%.

I think that's a trend or that's countertrend to what we can expect to see in the industry.

Credit costs were -- credit quality costs -- were obviously well contained, though the provision increased to $1.5 million from $1.2 million, driven by the growth that we experienced.

Deposit growth actually was quite good.

We experienced a number of anticipated maturities, tax payments, and so forth, which had the effect of reducing deposits, actual levels of average deposits.

We saw a healthy increase, however, compared to the average deposits that I will mention at the end of the quarter.

Profitability, we obviously saw improvement in all key measures of performance.

Turning to page -- slide 7, net interest margin again increase was obviously important to the improvement in key performance measures.

Improvement by 4 basis points in ROA and 50 basis points in ROE and we still have capacity to improve that by employing additional leverage of our equity.

The yield curve continues to represent a significant constraint for us, not just because of the impact of the carry on our securities portfolio, which by the way is now only 13% of earning assets, but because it affects rates on leases.

It affects rates on our held for sale portfolio and limits our ability to maximize net interest margin or optimize net interest margin.

Just to put it in perspective, the net interest margin represents 87% of our net revenue and just a simple move to 4%, which we have seen in a rate environment which was not converted, which would have a powerful effect on ROA, ROE and efficiency ratios.

All of these -- not to say that we're not doing extremely well, but we have to understand what that opportunity cost represents to the Company.

Net revenue growth I mentioned was very strong.

Net interest income up 9% linked quarter.

Non-interest income up 3% off of quite strong numbers in Q1.

Operating leverage growth, operating leverage was very strong with expense growth 250 basis points below net revenue growth.

Again, the FDIC assessment of $0.01, staffing expense including specialty variable performance-based expense was quite high.

Again, those numbers adjusted for -- expense numbers adjusted for just those two items would have been up 2%.

We saw an efficiency ratio improvement of 160 basis points in the quarter.

Turning to slide 8, I'm not going to repeat or read growth numbers to you, but suffice it to say, we had a major shift in earning asset composition resulting from the growth in the effects of the yield curve, meaning that we just simply cannot make investments in securities.

Loans have now reached 87% of earning assets.

That composition shift will continue with securities running off at 15 plus million per quarter.

Mentioned DDA growth of 4% on a linked quarter basis.

That's significant growth and counter to industry trends.

We expect DDA growth to continue and we expect it to represent not only a challenge for the entire industry, but will be a major factor obviously for a high-growth bank in net interest margin.

Total deposits were reduced, I mentioned, by the anticipated effects of the tax payments and certain business transactions.

They are already being replaced for new transactions and new customer relationships, which George will speak to more completely.

Slide 9, we had very strong growth that continued through the end of the quarter.

We saw beginning balance in Q3 of loans held for investment now, 4% ahead of the Q2 average, annualizing now at a rate of greater than 30%.

Loans held for sale volumes are obviously more variable and down from the very strong levels that we experienced at the end of Q1.

DDA balances for the reasons cited are down on a linked quarter basis, but were 8% at the end of the quarter above the average for Q2.

So we ended the quarter quite strong compared to the average levels.

Total deposits, $144 million or 4.9% greater than the Q2 averages at the end of the quarter.

To slide 10, again, net interest margin expansion by 5 bps, DDA growth 4%.

We saw a reduction in the cost of interest-bearing deposits by 5 basis points.

We saw a rational pricing of key categories, including especially our Eurodollar accounts.

The growth in borrowings we saw resulted from anticipated deposit transactions and positioning to carry loans held for sale.

The rate on borrowings increased from 5% to 5.25% in the quarter due almost entirely to the effect of the maturity of a large portion of what remaining lower rate repo's that we had.

Despite the effects of competition, we saw a yield on loans held for investment only 2 basis points below Q1 levels.

Despite again, competition and the magnitude of growth that's quite remarkable.

Yields on loans held for sale are more variable and are more directly tied to the yield curve.

Earning assets, as I mentioned, are now over 95% of total assets.

At quarter end, they averaged just under 95% for the quarter.

More effective use of cash and the elimination of the intangible assets associated with the discontinued operations were quite important.

Again, despite the growth of the loan portfolio and the impact on funding composition, total funding costs for the Company increased by only 2 basis points from Q1.

Obviously, a result of DDA growth and of course, the growth in stockholders' equity.

George?

Thanks, Peter.

If you will turn to slide 11, let's look at the last five years regarding loan and deposit growth.

Loans held for investment growth is 28% and that compares favorably with our Q2 year-over-year percentage of 28%.

Average loan growth, Q2 versus Q1, as you've heard before, was 8%.

The strongest loan growth on a linked quarter basis came from corporate banking in Dallas, Houston, San Antonio, and Fort Worth.

As you can see, regions outside of Dallas contributed 43% of the average growth in loans held for investment in Q2.

Houston posted 20% of the total loan growth and we continue to be very pleased with our progress in that particular market.

C&I loans were responsible for 57% of the loan growth, total loan growth, with real estate and loans held for sale, which is basically our mortgage warehouse operation, comprising the balance.

85% of the loan growth came in loans held for investment and 15% of the growth came in loans held for sale.

Even with our RM hiring slowing somewhat as we've become more selective, as Jody mentioned, we are still getting the loan growth we have achieved in the past really because our organic growth is improving dramatically.

And this is because we continue to use excess capacity of our existing RM's.

Our demand deposit growth for the past five years is 18% and you have heard previously that our linked quarter average growth was 4%.

And in this environment, we're really pleased with that number.

Total average deposits declined slightly on a linked quarter basis primarily because of expected withdrawals of a few large customers.

However, we have knowledge of additional large deposits that should arrive in the third and the fourth quarters.

In fact, we have seen one of those deposits, well over 100 million, come in the door.

Outside of those, again, expected withdrawals, as Peter mentioned, we had good deposit growth from our energy group, Austin and San Antonio regions.

In fact, at the end of Q2, 100% of our loans held for investments were funded by customer deposits.

If you'll move to slide 12, we have talked about that.

I would just briefly touch on operating revenue and net interest income.

Again, the growth continues to be strong at 28 and 29%.

Noninterest income grew at the 22% level and Q2 was fueled by increased trustees, service charges, loan and lease fees.

And Jody mentioned, I believe, also, we have mentioned before that lowering noninterest expense growth is a priority.

Peter talked about controllable expenses.

Those are in line.

But again, however, all banks are dealing with new FDIC assessments in 2007, so that's included in that particular line.

If you will turn to slide 13, I will talk about credit quality.

Credit quality, as you can see, remains exceptionally strong with net charge-offs of only 27,000 in Q2.

But year-to-date, as you can also see, we post net recoveries of $359,000.

You'll also note that net charge-offs for the past two years equal only $1,400,000 or just 3 basis points.

And only $35,000 was charged off over the past 12 months.

Our provision of $1.5 million in Q2 was driven almost exclusively by loan growth and we saw a number of key measure improvements of credit quality, particularly in the nonaccrual loans and ORE move from 37 basis points in '06 to 28 basis points year to date in '07.

Our ratio of loan loss reserve to historical net charge-offs also is strong at 17 times trailing two-year charge-offs and 2.8 times all charge-offs the Company has taken since inception.

The reserve year to date to nonaccruals is 2.8 times and reserves to non-performing loans 2.3 times.

In Turning to slide 14, I won't go over that again.

That really graphs what we've just been talking about.

Again, another excellent quarter with regard to credit quality for our bank with improved metrics from 2006.

We believe that the credit quality outlook continues to remain favorable.

Thanks, George.

Just turning to earnings guidance on page 15, in the last quarter conference call, we were asked why we didn't increase our earnings guidance and at that time, we felt it was just too early in the year that we didn't have the clarity and vision on the rest of the year that we now have.

It pleases me to be able to give you new guidance today.

We're moving the bottom of the range from $32 million to $33 million and the top of the range from $33.5 million to $34 million.

We don't like to talk about this in terms of earnings per share simply because on a per-share basis, every time the price of the stock goes up, more shares are included in that calculation, and it's difficult for us to know and to predict exactly what's going to happen with regard to the price of the stock.

Now, don't misunderstand me.

I'm not trying to jawbone the price of the stock down because that certainly isn't our objective.

But it is a dynamic that we have to deal with.

Suffice it to say, I think this range puts us at the middle point of the range, pretty close to what the consensus for the year is.

So we feel very good about this.

The economic outlook, as indicated earlier, is strong.

It remains very strong and the outlook for Texas for the remainder of the year, I believe, is very, very good.

We anticipate continued strong loan growth.

The pipeline looks full at this point in time.

I don't know if it's, in terms of past experience, I think it compares very favorably.

Deposits, as George has already indicated, we know of deposits that we expect to receive in the near future.

Our credit experience, as just indicated, remains very strong and our visibility on credit experience from this point, of course, is very, very good or it would be reflected in the numbers that you're looking at.

The margin we think will remain essentially flat.

We don't expect the federal reserve to make any significant moves in interest rates either upward or downward, so we're projecting 5.25% fed funds rate for the remainder of the year.

With that, that concludes our formal presentation.

I'll now turn it back to the operator for Q&A.

(OPERATOR INSTRUCTIONS).

John Pancari, J.P.

Morgan.

Good evening.

I wanted to just see if we can get a little bit more detail on the deposits -- how much of the linked quarter decline in the other balances was the anticipated rolloff in deposits?

Just wanted to see if we could get some quantification.

Going to let George answer that one.

Yes, there are about three specific withdrawals that we knew about.

One was a large tax payment.

Another related to a withdraw by a large customer in effect.

Related to specific business --

Specific business transactions.

And we were also an escrow holder of some deposits for a company that had gone public, so we moved those down.

We knew we were going to move those down and we have two specific areas that we know we're going to increase deposits significantly.

One of those has already happened, with a large deposit inflow.

Another will be coming in over the third and fourth quarter.

So we're very pleased to see that and we think that we will continue to see good growth in the third and fourth quarter as far as the deposits are concerned.

Do you have any other quantifications around that, around how sizable those withdrawals were and then how sizable that deposit relationship could be that you expect to come in in the third or fourth quarter?

John, this is Peter.

The total deposit change resulting from what George described was well in excess of $200 million.

And the offsetting amounts existing in anticipated are comparable.

Comparable to that.

Okay.

We're on a major one which has already occurred actually.

So.

All right.

And then separately on the loan side, just wanted to see if we can get some additional detail on the types of loans in terms of where did you really see the solid strength on the C&I side, I guess by the types of borrowers or anything?

And what are you seeing on the homebuilding and construction side, of what type of demand there?

Yes, primarily North Texas is a service-related economy.

We are seeing good organic growth in our service-related companies.

We are seeing reasonably good growth in our energy customers, both in south Texas and in north Texas, out of Dallas.

We see some of our real estate loans being made on the commercial side.

We, on the commercial side of our business, we see real strength.

It looks good.

As Jody mentioned, the pipeline remains good.

57%, as I mentioned, of our loans are C&I loans.

The balance being real estate with a small component being made up of our loans held for sale, which is our mortgage warehouse group.

John, I might just elaborate for a second.

What we've seen in Texas is a real surge in the basic economy, manufacturing, for example, which was flat for a long time.

And as this economic growth has continued, our customers are prospering and their demand for working capital loans is improving and over half the increase that we experienced was in the C&I category.

Real estate was also strong, particularly on the permanent side.

Okay.

And I believe you had -- so basically on the real estate, on the construction side, you are not seeing, I know in your prepared comments you had mentioned that the markets are holding up relatively better than the other parts of the U.S., so generally, you would characterize demand there as relatively healthy still in terms of construction?

I think it's -- compared to the rest of the world, I would have to say it's excellent.

And I would cite an economic study that was released June 1 by an economist at Texas A&M and he said, and I quote, in Texas, the year is already off to a good start.

The state median existing home sales price has already increased by 3%.

He looks for Texas to be -- to buck the national -- the title of the article is "Texas to Buck National Housing Trends." And we see no reason to argue with this learned professor.

Okay.

And then on that housing point, just on the credit side, I know there was some discussion during the quarter about exposure to Grandview.

Any comment there on your exposure that you could have and expected loss content?

No, but that is not an issue for us.

I think that was a comment that was made in the Austin market.

Our Austin market is incredibly strong.

In fact, that's one of our strongest markets in the single family area.

We have virtually no issues, no problems in our single family residential builder portfolio in the Austin area.

And frankly, that could be a comment across the board, John, as it relates to our single family residential construction and/or lot development portfolio as far as the bank is concerned.

We are extremely pleased with it.

We have watched it for the last 18 months because we saw some of these things happening, and we're very comfortable where we are today in virtually every one of our markets.

Just reemphasize, we had zero exposure to that particular borrower that you spoke of.

Okay.

That's very helpful.

And then actually one last question on the loan side.

Any growth -- did you see any growth in the quarter in loans related to any form of shared national credits?

I don't think we had any to speak of.

We've got -- we have a small participation in the building that we are building where we're going to be a tenet and hopefully we're a good credit for that particular building.

So we feel pretty comfortable with that one.

We're not doing a lot of shared national credit business, John, as it relates to our loan portfolio.

Typically, when we participate in a syndication like that, there is some real reason for us to do so as opposed to just a blind participation.

We either try to get the treasury management business, the deposit business, we know management they bank with us.

Some reason to be in that particular market and it's not a big line of business for us.

Can you remind us of the size of that portfolio?

I'm sorry, I didn't hear that.

Can you remind us of the portfolio.

Yes, the size of it.

Credits.

[I don't] it's, again, small compared to the overall loan portfolio.

All right, fair enough.

Thank you very much.

Brent Christ, Fox-Pitt Kelton.

A couple of quick questions.

First, in terms of your Eurodollar deposits, I know you guys have been working to kind of gradually lower the rates that you are offering on those and just wanted to get a sense of where you are in that process, if you think you have a little bit of additional flexibility going forward or if most of the reductions there are kind of in that deposit base right now.

We do have additional room.

We have had good success in the second quarter I think overall we've reduced the interest expense by about 5 basis points.

A little more than 5 during the quarter.

And then they are not -- those deposits are not subject to the new FDIC assessment.

How has the retention been in terms of when you've tried to reduce rates for certain customers?

Have you seen --?

We've had no issues.

Got you.

None of these anticipated withdrawals had anything to do with rate.

They were all withdrawals for special purposes, tax payments and other things.

Okay.

And then the next question, and you mentioned a couple of somewhat lumpy deposits, fairly large.

Could you give us a sense of maybe how many relationships you -- deposit relationships you may have of that magnitude, say $100 million plus?

Are these kind of the exceptions or do you have a number of relationships that big?

The transactions were exceptions and I think as we have already commented, one of them under the same control has already returned, so it's not -- that's a variable we know we have to deal with in our business.

We have one deposit from Dallas County which is over 100 million.

We've had it from the get go.

It's been consistently on the books almost from the day we started the bank.

Okay.

And then, the last question, just on the loan growth again, obviously very strong again this quarter and you mentioned earlier in the call kind of your cumulative growth being on par or your growth being on par with that cumulative of your peers.

And it sounds that, like underwriting and pricing are still pretty intense at this point.

I'm just wondering have you had to get more aggressive either in terms of structure or pricing to keep up the growth trajectory?

Well, this is George, Brent.

We obviously compete on price first, and that, again, as you say, is intense.

But as Peter talked about, the yields on our portfolio have held in there quite well.

We feel very good about our yield participation across the portfolio.

Structure, also, is becoming an issue as the marketplace continues to be competitive.

And we will, occasionally, accommodate a customer or a new prospect in that vein, but we're very cautious and we usually have some mitigate as it relates to giving up one piece of the underwriting, we will get a mitigate for another.

That's where, if you deviate very much in that vein, you can have a problem.

That's where banks have problems.

So we try very hard to stay with our underwriting standards and compete more on the price side.

Okay.

Thanks a lot.

Charlie Ernst, Sandler O'Neill.

Can you guys -- your margin guidance, is that more related to the third quarter or is that sort of in the foreseeable future?

And if it's not over the next say three to four quarters, do you care to make any guesses or predictions as to how the margin falls out?

The guidance that we gave is through the end of the year.

Okay.

We have not made any comments about interest rates in the first half of next year.

But I think the comment that I made related to the second half of the year is that the Fed, from everything that I read, and I try to read a lot about this, I don't think they're going to move rates significantly one way or the other.

The soothsayers on Wall Street are all looking for upward pressure, and that's stimulated by inflationary expectations.

Well, we all know those numbers can change and change pretty dramatically over a short period of time.

We've been very lucky.

Inflation, if you look at the core numbers, has remained relatively flat.

At times, I guess if you look at year to date, it's higher than the Fed would like for it to be, but they've kept a steady hand on the throttle and I don't think anybody wants to create a recession before an election that is looming closer all the time.

I guess, I'm just kind of looking at the dynamics over the last year and I'm looking that non CD deposit growth or deposits are basically flat to down.

And so and if we look at the loan to deposit, to kind of non CD deposits are way up.

Where do you get your comfort that your margin is going to be so stable?

Charlie, this is Peter.

I think the context was flat rate environment absent significant new growth would produce a flat margin.

If we continue to have the kind of loan growth that we have experienced, we will continue to have the shift in funding composition and some tightening of margin.

So the status quo without growth, we would see a flat margin.

With growth and without substantial changes in what we see in the industry for demand deposits, we would expect some weakening of the margin.

Charlie, my earlier comments really were strictly confined to the Fed funds rate, not to our margins.

Okay.

And when you say flat, I think no growth or you said flattish growth, does that mean a slowdown to kind of high single-digits or does that truly mean flat?

No, no, no, I think there's a communication issue.

If we did not expect growth, we would be flat on margin.

We do expect substantial growth, and that will cause some weakening of the margin, offset, hopefully, by continued improvement in DDA balances.

Okay great.

Thanks a lot, you guys.

Andrea Jao, Lehman Brothers.

As deposits come back, do you expect the runoff in the securities book to kind of taper off?

And if runoff continues, at what level does this kind of stop?

Runoff is fairly consistent on a percentage basis, Andrea.

We're now at about 490 million at the end of the quarter.

It's running off at about 5 to $6 million a month, so you can extrapolate that on out to the end of the year, assuming things remain constant as -- and they have been predictable if we go back over time.

I'll just remind everybody that portfolio at its peak was about $850 million.

Now down to $490 million, we have benefited from being able to shift those funds into higher yielding earning assets in the form of loans.

And to the extent we got another 30 or $40 million from that source by the end of the year, obviously that benefits us as well.

Longer-term, what percent of earning assets or total assets do you want to hold securities at?

Well, we don't really look at it quite that way.

We look at our pledging requirements and I don't think the world in general looks at what used to be called secondary reserves in the form of securities as a source of liquidity.

They look at other funding sources really as major sources of liquidity.

So we believe we could take that portfolio down closer to the 3 to $400 million range and we would be very comfortable.

And it's going to continue to run off.

At times, we will have to buy modest amounts of securities to meet specific pledging requirements.

But generally, that trend is going to continue until something differently happens in the marketplace and changes the dynamics with regard to the level of the yield curve.

Okay.

Regarding loan growth, could you give a bit more detail on how much of that was from new clients, how much from that was from older clients and utilization ramping up?

And kind of what utilization rates are you seeing at the moment?

Let me make a general comment, then I will let George answer.

I'm not sure we heard the last part of your question, but.

Generally speaking, we are a much more mature bank today than we were three or four years ago when almost all of the loans that were coming on the books were being transferred from other banks as new RMs came into our employment.

Today, we are seeing with the traction that we have in the marketplace -- and I believe particularly in Dallas, we are the preferred middle market lender by most customers -- we are seeing a lot of traction in the marketplace and we're seeing organic growth, as it relates to existing customers.

So the major portion of the loan growth this year has been from existing customers.

That would include commitments on real estate loans, of course, being drawn as well as increases in drawings under existing lines of credit.

And it would include new customers that we have gone out and solicited, not necessarily by new RM's.

But as stated earlier, we believe we've got a lot of capacity among our existing RM's.

We're being a lot more careful in terms of how many RM's we hire.

We are screening them a lot more carefully than we were before and we're really looking for star quality among these people.

So the number of RM's we hire per year is not as good an indicator today as it was three or four years ago.

Utilization rates under the lines, I'm not sure I can give you a number, but I can give you this number for example, which may be helpful to you.

We have at last count, 56 commitments over $10 million and the average of those commitments is about $14 million and the average outstanding is about 8 to $9 million.

Okay, great.

That is helpful.

Last question, longer term, how do you think of the reserve to loan ratio?

Just credit is really good, but at the same time, it's fairly low.

Well, we can probably all chime in on this.

Let me make a general comment and then we may get some specific comments from George and Peter.

But we are driven by the methodology that we use.

And it's very hard for us to justify increasing the unallocated portion of our reserve given the coverage we have as it relates to charge-offs, nonperformers, loans 90 days past due and still accruing interest or not accruing interest.

And if you look at those coverage ratios, and I think if you look at one of your competitors, we recently made their top 23 Allstar accounts and one of the criteria was credit quality.

And the absolute ratio of reserves to loans and leases wasn't even included as basic criteria.

It all related to coverage of the variables that I spoke of before.

Okay.

This is helpful.

Thank you very much, and nice quarter.

Jennifer Demba, SunTrust.

Thank you.

Question.

Peter, the FDIC assessment you mentioned, was that included in your first-quarter results?

No.

I mean, we have some assessment always, but the big increase was in Q2.

So what was the sequential increase from 1Q to 2Q?

I don't have the exact number, but it was just in excess of the 300 -- we're now on a 300,000 per quarter increment.

Which is about 3/4 of a $0.01 --

From Q1 levels, not from now sequentially increasing.

But that's about 3/4 of $0.01 per share and we have included that in our guidance -- new guidance that we've given you.

Okay.

Just a question, Jody.

It sounds like the Texas economy is still really good, but given the fact that you are hiring fewer RMs, when do you anticipate, and I know this is a hard thing to predict, when your loan growth might slow a bit to maybe under 20%?

No, I can't predict that because, again, I think we do have a lot of capacity and one of the things we are doing, we're bringing a lot of -- I say a lot, that's probably not a good term to use, but we are bringing younger people in who are being mentored by the experienced rainmakers.

They help the rainmakers service these loans; that frees up the capacity of the really star quality people we have to go out and bring in new relationships.

So we've got some internal dynamics that you can't really quantify just in terms of headcount.

But I do anticipate that the Texas economy is going to remain very strong.

We don't believe that -- and the statistics bear out the fact that energy is not the factor it was years ago, but that notwithstanding, it is creating tremendous amounts of wealth, and I think it is driving the Houston and the Dallas and the Fort Worth economies to a considerable extent.

And we don't think that's going to abate anytime soon.

Aside from that, I don't think anybody is predicting a national recession except maybe some wild-eyed soothsayers that you might see on some of the TV talk shows, the talking heads, so to speak!

So I just am very optimistic about the foreseeable future.

Now, how far does that crystal ball, what's the clarity into the future?

The farther you get out the less clarity there is.

And in my experience, you can be pretty accurate looking 12 months down the road.

You get beyond that and the degree of accuracy falls off pretty rapidly.

Okay.

Jennifer, this is George.

Let me just make a comment to slowing the loan growth based on the capacity of the RM's.

We've talked about this.

This is a dynamic process.

It's really a line of business for us.

We're not -- you can't turn the machine on and off too easily.

We look at this a year at a time, certainly not a quarter at a time.

And when we feel we get close to that capacity level as it relates to some of these really strong RM's, we are back in the marketplace again.

So, from our standpoint, we are really not going to run the capacity level down to zero before we start hiring again.

And we're looking at this 12 months at a time and it's, again, a dynamic process.

We felt we had certainly in '07, the excess capacity that we have all talked about.

We're going to use some of that.

But when that gets close and we feel it might slow our growth at some point in time, we will be back in the market.

Okay.

One more question for Jody.

You mentioned you feel good about the health of your real estate portfolio.

Can you just talk about the real estate market in Austin and what you are seeing right now?

I can tell you what I have learned from our people who are in that market.

And also, the study that I cited cites Austin as being -- San Antonio and Austin -- as being the strongest residential real estate markets in the state.

But our people, specifically, on the residential side in Austin, they see a little slowdown in activity, but inventories have not lengthened, and houses that are being built are being sold.

The market is very, very strong.

The unemployment rate in Austin is 3.1%, which means essentially there is no unemployment in Austin, Texas.

It is a remarkable market, and we've seen excellent results out of our bank in Austin over the course of 2006, and into 2007.

And, as a matter of fact, in the second quarter, those results strengthened over the first quarter.

So, Austin continues to be a bright spot for us.

It's one of those markets where we are the beneficiary of having deposits there that exceed our loans; it's a net provider of funds.

Thank you.

Nice quarter.

(OPERATOR INSTRUCTIONS).

We have no further questions.

I would like to turn the call back to management for closing remarks.

If there are no other questions, we just would like to extend our thanks to all of our followers.

We really appreciate the analysts who write about us.

We appreciate the investors who follow us and their analysts.

We look forward to a very, very good remainder of 2007 and we will look forward to talking to you at the third-quarter conference call and I'm sure we will be seeing some of you at conferences in the interim.

If you have any questions related to today's call and wanted additional information, please call Myrna Vance.

All of us are available also to speak with you, but if you direct your calls through Myrna, that makes it a little bit more efficient for us.

Again, just an extended thanks to everyone.

We think we've had a terrific quarter and we will bring this particular call to a close.

Thank you for attending today's presentation.

This concludes the conference.

Have a great night.