Texas Capital Bancshares Inc (TCBIO) 2007 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Texas Capital earnings conference call, my name is Eric, I'll be your coordinator for today.

At this time, all participants are in a listen-only mode, we will facilitate the question-and-answer session towards the end of the conference.

(OPERATOR INSTRUCTIONS) I would now like to turn your presentation over to your host for today's call, Ms.

Myrna Vance.

Please proceed.

Thank you very much, Eric.

Yes, thank you very much for joining us today.

For our year-end conference call and fourth quarter.

If you have any follow-up questions, I would encourage you to give me a call at 214-932-6646.

Now before we get into discussions, let me read the following statements.

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 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 31, 2006 and other filings made by Texas Capital Bancshares with the Securities and Exchange Commission.

Now let's begin.

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

After a few prepared remarks, Eric will facilitate a Q&A session.

Let me turn the call over to Jody.

Thanks, Myrna, hi everybody.

I know many of you think this is probably anticlimatic since we spoke to you I think a little less than three weeks ago, but hopefully by the time we finish this afternoon, we'll have some new perspectives on the table and maybe some fresh new information.

Looking at it from the perspective of the year as a whole, we had a great year.

We recorded records in many, many of the metrics.

Just for example, net income at 31.4 million, was up 8.2% from the prior year.

EPS at $1.18 was up 7% from the prior year.

Loans held for investment at $3.5 billion were up 27.2% from the prior year and 4.5% linked quarter, total loans at $3.6 billion up 24.5% from the prior year, and 5.5% linked quarter, demand deposits, again, we said in the prior call that they were strong, we were up 3.1% for the year.

Importantly, linked quarter 12.4%.

Now, admittedly, I think you have to look at that in the perspective of the fact that just the last quarter usually is our strongest quarter in terms of demand deposits.

Total assets for the company were up 4.3 billion, that's 17.2% ahead last year, and 5.1% linked quarter.

These were achieved in spite of the fact that we had the large provision that we announced in the last call.

And reflecting on 2007, we had three great quarters and we had the fourth quarter, which was more challenging.

We expect 2008 to be challenging but I believe improving if we look to the latter half of the year.

I'm generally optimistic.

I'm optimistic for a number of reasons.

First I'm optimistic because at Texas Capital we're deep in experience.

We have conservative standards, which we haven't compromised in the face of what has been increasingly intensive competition.

And finally, we have a very disciplined centralized credit approval process, which assures us of good quality control.

I'd like to turn to the economy for just a few seconds and I want to go through this kind of quickly, except for the last part which I think is some new and interesting data.

Again we're extremely lucky to be in Texas, energy which is a problem in terms of prices for the rest of the country, continues to be a blessing in Texas.

The oil and gas industry is operating at the highest level since 1982.

One measure, that's a root count which was up in just one month from November to December, 4%.

Which means that it's extremely healthy.

Total employment's at an all-time high, even though our unemployment rate was up from 4.2% to 4.5% from November to December.

What this means is that we are experiencing workers moving into the state faster than we're able to absorb them into the labor market.

But this is good because we've got in migration and it means we've got the resources to fuel our growth in the future.

Personal income, and I only have third quarter data but it was an all-time high.

So the consumer in Texas seems to be poised to continue to spend.

And the data strongly suggests that we'll outperform the rest of the country.

I'd like to shift to the housing market.

I had the opportunity to spend probably the last hour talking to a fellow named David Brown, who heads a consulting firm called metro study that focuses on the housing markets and the health of those markets in Texas, and his focus is primarily Dallas-Fort Worth, that's where about 80% of our business is, so most of that will pertain to Dallas-Fort Worth, the rest I'll just make a couple of comments about other cities.

Housing starts in 2007 were down 35% and that we consider to be great news because it means that the inventory is lower as a consequence thereof.

Housing is now at a 6.8 months supply in terms of inventory.

The peak was 7.8 months, so we're making progress.

In 2007, starts were 32,000 units but we closed 39,000 units which means that we closed more units than we started.

Again, we're making progress.

The firm expects starts to be down about 10%, or 3,000 units in 2008, which means we should hit equilibrium in the third or fourth quarter.

The lot inventory deliveries were slow in 2007.

We have about a 34 months supply, 24 months is normal.

At that rate, it means we're probably hitting equilibrium in about 18 to 24 months.

That's pretty much the picture on Dallas-Fort Worth.

I think from our own perspective, the lenders would tell you, and I'm sure George will reemphasize this point, the customers are cautious.

They're being conservative.

And that's very good.

San Antonio, the experience is about the same as what I cited for Dallas.

Austin seems to be the healthiest economy in the state.

I just got a report, it was dated Friday, December 14, but I just received it.

This is a study that was done that shows that Austin ranks Number 1 out of 381 cities in the country in terms of economic vitality.

Looking again though at the housing markets, Austin was down 22% in '07, and Houston was down 23%.

So both of those cities seem to be a little healthier than Dallas-Fort Worth is at the present time.

David Brown in closing, he said well, if Florida, California, Arizona and Nevada have the flu, Texas has the sniffles.

Just a couple more data points, and then I'll move on to something else.

From another study, this is dated September '07, Texas ranked Number one in terms of job growth in the country, followed by California and Florida.

By SMSA, Dallas-Fort Worth was Number two, Houston Number three, Austin, Number 14, and San Antonio, Number 20.

So all of our cities are in the top 20 in terms of job growth.

That is terrific.

I'd like now to just turn to a couple of other reasons why I'm optimistic as I look to the future.

The principal reason for this relates to our strategy and focus.

As everybody knows, we're basically a commercial lender.

This means we're not incurring the costs of competing in an overbranched and overcrowded consumer market.

I think we're good at what we do.

Our loss ratio since our beginning is 0.10%.

As I think everybody knows, we're primarily a secured lender, only 7% of our loans are unsecured.

For this reason, we've experienced a low percentage charge-offs relative to nonperforming loans since our existence.

We're well-diversified by line of business, by [C-code] by type of collateral and by geography.

In short, I think we're well-positioned for the future.

And we're particularly well-positioned to take advantage of a stabilizing and ultimately improving National and Texas economy.

This is because our organic growth machine remains very, very healthy, and I think the statistics that I cited earlier fortify that.

I'd now like to turn it over to George, and I think one of the things he's going to do is touch upon -- or rather to Peter first, who's going to talk about the numbers, and then to George, who's going to touch on some of the issues that we discussed in the January 11 conference call.

Then we'll come back for questions.

Peter?

Jody, thank you.

I will comment a little about it more detail obviously than we were able to do on January the 14, provide a little additional clarity, but I think everything came in at or slightly better than what we had announced at that time.

Net income was $31.4 million, as Jody commented, $1.18.

That's right near the very high end of the range that we provided as additional guidance.

We do think it's good result in light of the very large increase in the provision, 4 million in Q3, to -- excuse me, in 2006, to 14 million in 2007.

As indicated in the earlier call, the 14 million compares to 2007 guidance was a number incorporated in our guidance of approximately $8 million.

Substantial majority of the increase from the indicated levels receipts to a unique circumstance involving a single credit about which George will comment more.

Net charge-offs actually were better than the original guidance, $2.2 million instead of about $3 million incorporated in the guidance.

The final decision related to the provision, which we said earlier would be from 9 to $10 million.

It was $9.3 million.

That provision in Q4 was not affected by favorable developments about which George will comment in a moment.

Much improvement we saw throughout the year in operating leverage, about which I'll comment later.

We saw stability, as we said earlier, in net interest margin.

It was flat with Q3.

It was flat with Q4 of '06.

And for the year at 383, was 2 basis points below that level in 2006.

That's despite a lot of change over that time period in interest rates.

Stability of the margin clearly comes from the growth that we've experienced in DDA, a shift in earning asset composition has come from strong loan growth.

The speed of liability repricing that is the composition of funding which has become much more rate-sensitive, as we depended on interest-bearing liabilities to support growth, and obviously with rates where they are now, and are projected to go much stronger contribution from fixed rate and LIBOR-priced earning assets, all of these factors contribute to much less earning asset sensitivity.

We remain asset sensitive but by no means near the level that we were as rates began to rise.

Turning to Slide 7, very strong performance, as I've commented, in net revenue growth at 19%.

Produced strong improvement in operating leverage throughout the year.

We saw net income growth, net interest income growth also of 19% due of course to the 27% growth in average loans held for investment.

Both net growth obviously overcame the drag fixed rate earning assets throughout the year.

Noninterest income was up 16% despite significant weaknesses we commented about in the past in mortgage warehouse.

Conditions in the mortgage industry reduced the contribution of that group, which remains profitable, by approximately $0.05 after tax in the last half of 2007, compared to the first half.

Operating leverage is reflected in comparison by obviously in the rate of growth of net revenue to that of noninterest expense.

All categories of noninterest expense remain well-contained with expense growth of 13% for the year.

We did see an adjustment that we commented on in the call earlier of $2 million due to fourth quarter performance in the incentive accrual.

Before the effect of that adjustment, we would have seen 16% growth in noninterest expense, again, with net revenue still 300 basis points above the growth rate in noninterest expense.

Noninterest income and efficiency ratios are -- noninterest expense and efficiency ratios are excellent, a major effect, obviously, of reducing the incentive expense but the efficiency ratio would still have been just under 60% without that adjustment.

We do want to say, however, that that level is probably not sustainable if net interest margin should fall.

Even with expenses well under control.

Obviously, again, the stability of net interest margin was important throughout the year, a comment again, we remain somewhat asset-sensitive, but sharply less so than in years past.

Credit quality costs, as I said a minute ago, were approximately $6 million higher than the number incorporated in the guidance.

And with -- despite the increase in provision of Q4, ROA and ROE remained the 80 basis points and 11.5% for the full year, compared to 88 basis points and 12.6% in the prior year.

Turning to page 8, not much to say about this kind of growth.

It's all organic.

We had, as Jody commented, record growth in average balances of loans held for investment more than 660 million for the year, and Q4 to Q4 just over [718] million.

All growth, as I said, has been organic, reflecting much improved productivity of RMs, especially those who joined Texas Capital in the early years and especially even more in the last half of 2005 and '06.

You any it going to be hard to find pure growth anywhere in the United States that hits this level.

We have continued to see and will continue to see as long as the yield curve is like it is, strong growth in loans overcoming and improving the earning asset composition.

Total deposit growth year-over-year was 16% on average balances, again, all customer-based deposits link order growth of 16 million and DDA was up 3%.

Following the $12 million growth or 2.5% in Q3.

Though they were essentially flat for the full year.

All measures of DDA performance are counter and much more favorable than industry trends.

Composition deposits clearly continue to the shift the interest bearing liabilities as the industry experience as lot of difficulty in growing demand deposits.

Slide 9, again, strong growth through the end of the quarter.

We start 2008 in loans held for investment, 125 million or 4% better than the average for Q4 2007.

Loan held for sale volumes, obviously are more variable and down sharply.

Link order deposit comparisons are down because of unusual growth in loans that occurred in the last half of the last quarter.

And the maturity of transactions specific deposits.

Quarter end DDA balances were up sharply from Q3 2007, again, reflecting the fact that we have such strong growth in the fourth quarter of each year.

A date statement, not average.

And on Slide 10, 3.83% net interest margin for the year, down 2 basis points from 2006.

Q4 was flat with Q3, and Q4 of the prior year reflection again, and much reduced asset sensitivity.

The company remains asset-sensitive, but again, growth in loans has produced a change in funding composition, composition of funding puts a limitation on net interest margin, but liabilities also now repriced much more rapidly.

The level of net floating rate assets funded by fixed rate and zero cost liabilities have decreased substantially as a percent of earning assets since rates began to increase.

Stated differently, the funding of earning assets made up of DDA and equity is still -- is now under 20% and it was 25% or greater in prior years.

And with that, I'll turn it over to George.

Thanks, Peter.

Slide11, again, showing the deposit and loan growth over the past six years.

As Peter mentioned, demand deposit growth is up following on a linked quarter basis but the CAGR 17%, with that average growth in Q4 of 16 million or 3% compared to similar increases in Q3, and as mentioned, a driver of the decrease in funding costs in Q4.

Total deposit growth over the six-year period was 21%, but again, as mentioned before we showed a decrease of $96 million, in average deposits in Q4, tied really to specific events related to some CDs that matured partially offsetting that decrease, we saw really good deposit growth from most of our lines of business, particularly energy banking, San Antonio, private banking and corporate banking here in Dallas.

The loans held for investment, again, showed a great growth of 28% over the six years and grew on average 142 million or 4% in Q4, and 27% over Q4 2006.

As you might suspect, C & I loans continue to be the driver.

They provided 54% of the overall loan growth.

And the regions outside of the DFW area provided 38% of the loan growth in Q4.

The balance coming from Dallas, specifically from our energy lines of business, corporate, lender finance, and private banking.

Slide12 reflects growth in income and expenses, again, over the past six years with revenue continuing to outpace the expense growth, noninterest expense, as Peter mentioned, declined sharply, reflecting the partial reversal of some incentive accruals, but if you exclude that, one-time event, linked quarter expense only increased slightly continuing, again, to reflect our efforts to reduce the expense growth in the company.

Slide13, we'll talk about credit for a few minutes.

Credit experienced as Jody mentioned, remains quite good.

Our net charge-offs of $2.2 million for 2007 really was after $2.5 million taken in Q4.

This represents just 7 basis points for the year.

I believe it's important to put Q4 results in context of our longer-term experience.

Even small losses compared to the industry look larger when compared to net recoveries or insignificant net charge-offs.

Our loss of 7 basis points is consistent with the previous two years.

Our net charge-offs since inception of the company just over $11 million, represents just approximately 10 basis points.

I think all of you will recall that we had realized a net recovery of 300,000 for year-to-date 2007 through Q3.

And actually, in five of the past eight quarters, we had either net recoveries for three-quarters, or net charge-offs of insignificant amounts for two quarters.

During the past two years, in quarters where we've had any net charge-offs at all, the average net charge-off ratio in those quarters was just under 14 basis points.

As we mentioned in our earlier calls, nonaccruals and ROE increased approximately $15 million to $24.1million in Q4 '07.

Let me give you, again, an update on the five credits that I discussed previously on that call that compose the majority of our nonperforming loan portfolio.

We have not received any reduction on the large $12.5 million loan that was added to our problem loan list or our nonaccrual list in Q4, but we have had positive movements over the past few weeks.

This loan was the primary driver, along with growth, of our larger provision in Q4, but it is not indicative of the condition of the rest of our loan portfolio.

This company acquired a business approximately a year ago resulting in leadership and financial control problems.

Texas Capital and the board of the borrower independently engaged, outside advisers to report on the control issues.

The results of which were not forthcoming until the fourth quarter.

The $2.5 million C&I loan in Houston that we previously took a $1 million charge-off in 2007 was paid this week.

We received the $3 million -- a $3 million payment and recorded a $500,000 recovery in January of '08.

The $2.2 million C&I loan in Houston to an individual now there's an agreement in place that should assist us in our collection efforts.

The $2.9 million commercial real estate loan in Houston that I mentioned earlier is moving toward foreclosure and based on an appraisal, an additional reserves allocated to this exposure, we believe a loss exposure is properly valued today.

And finally, the series of small credits that total 4.1 million that I mentioned earlier relate to the mortgage warehouse loans that are mark-to-market, reserved, and have been moved into the loans held for investment portfolio.

These loans were warehoused prior to the beginning of the mortgage crisis, and really didn't have the benefit of current underwriting and investor selection guidelines.

And I might take a minute to talk about the warehouse, give you a perspective of what we're doing, what we're doing today.

Beginning in April of 2007, and through August of 2007, we tightened our parameters dramatically for loans that would be accepted into the warehouse.

Since August, new guidelines have been implemented.

Let me give you an example of some of those guidelines.

We're primarily underwriting to Fannie, Freddie, FHA guidelines today.

That's the majority of our loans.

FHA loans must have a FICO score of 620 or better.

Nonagency loans must have a FICO score of 680 or better with a maximum LTV of 80%.

Jumbo loans require proof of investor approval.

Alt-A, stated income, no ratio, no dock loans are not acceptable.

And basically here handling those stand alone second liens.

We have completely restructured our list of improved -- of approved investors and our investors today are primarily large financial institutions like a City, Wells, Chase, GMAC, et cetera.

Again, the $4.1 million of loans were part of the bubble, so to speak, before these new underwriting standard took effect.

We monitor loan flow in the warehouse daily.

And we watch trends with certain aging groups.

There are no indications today in those aging statistics of any increases in volumes of problem loans in the warehouse.

And we feel comfortable with our portfolio at year-end.

Approximately 95% of our warehouse loans have been in the warehouse less than 25 days today, and 99% have been warehoused less than 45 days.

As mentioned before, our provision was 14 million for the year, 9.3 million in Q4 2007, and this provision increased our reserve balance to 95 basis points of loans.

The conditions in our industry today warrant intensified focus and tightening of standards.

And we are continuing to do so as we speak.

We believe that 2008 can be a very good year for us, but again, it will be challenging and we think, again, it will be a strong year for us.

If you turn to Slide 14, I won't spend much time on that, that really just reflects our net charge-offs to average loans since 2003.

And again, you can see that that performance has really been excellent.

Jody?

Thanks, George.

Let me make a few comments about guidance, and I'll begin by saying that the plan that we've put together for 2008 together with the guidance, I think, reflect a very conservative posture on the part of the bank and its management.

If we do have major assumptions which are listed on Slide 15, we expect our loan growth to be less than historical levels.

To put that into perspective, you'd have to extrapolate what normal would be in 2008, and we're predicting about half that.

Margin compression obviously rates doing what they're doing, given the action that the Fed took today, together with the action that they took several weeks ago, we're down 125 basis points from the beginning of January.

The results for the fourth quarter, when we reported a margin of 3.86, reflect largely the first 100 basis points in rate reductions that the Fed has imposed.

The last 125 basis points reflected in the guidance that we're providing to you now.

And you'll notice from the slide that we expect the Fed funds rate to reach a low of 2.5%.

That means we got 50 basis points to go, and for planning purposes, we have -- we have placed that reduction in the month of April.

And held it steady throughout the rest of the year at 250.

The provisions, obviously, the most significant variable.

And for provision purposes, we have assumed outsize provisions.

The guidance incorporates a low loss reserve ratio of 1%.

You can extrapolate into your own models and reach your own conclusions about what that specifically means in terms of the provision, and net charge-offs, we've assumed, at 15 to 20 basis points which exceeds our 10-year historical average of 10 basis points by a significant percentage.

We also expect improvement in noninterest income.

This comes in large part from the warehouse.

We feel that the way we operate that business, and George gave you some data points on that, but we think we operate it conservatively.

We've seen others step out of this business, so we believe there's an opportunity there for us to increase our market share.

And a lot of the improvement in noninterest income comes from that source.

We continue or we will continue to contain growth in our noninterest expenses, all though, again, that's going to be measured largely by the top line growth.

And the greater the top line growth, it does imply a concomitant increase in growth in the expense line.

Having said all that, the guidance that we're giving you today is $33 million to $35 million.

Doing it in terms of aggregate dollars is in keeping with what we've done in the past, and that, trying to predict the number of shares is sometimes difficult just based upon the fact that it is affected by the price of stock.

Therefore, we think we are going to have a good year.

We could believe that the first half is going to be slower than the second half.

The first quarter in particular will reflect the same dynamics that we've discussed in the last years of guidance that we've given you, that includes FICA expense and other nonrecurring type of expenses.

Now, we did have one extra day in the first quarter this year, it being leap year.

So any of those of you who got married on February 29th can celebrate your once every four-year anniversary.

With that, we will go to questions.

Let me just say before we turn it back over to the operator, that we've attempted to be as transparent as we possibly could be.

And we will try to answer your questions with the same degree of forthrightness and clarity.

But also within the bounds of good reason.

So with that, let me turn it to the operator and we'll be glad to entertain your questions.

Thanks very much.

(OPERATOR INSTRUCTIONS).

Your first question comes from the line of John Pancari with JPMorgan.

Please proceed.

Good evening.

Jody, can you just comment a little about it on the competition in your markets coming from the larger players.

Given that you do compete against some of the larger money center names there in Texas, obviously there's larger banks tend to, in times of credit downturn, pull back notably across their markets regardless of where it is, and since Texas is holding up just a little about it better, are you seeing some of those larger players pull back and that could be an opportunity to pick up share?

Well, we love to see those bigger banks have those knee-jerk reactions that emanate from New York and other places and filter down to our markets.

As you know, John, the biggest banks, they continue to be upscale in their targeting of commercial clients, targeted mostly on the fortune 1000, 2000, and also at the bottom end of the market, the branch activity continues to be pretty fornacic down here, although there are some signs that it slowed somewhat recently.

We also have a lot of new charters that, have been filed, and new banks that have been opened during the year which we have a hard time understanding.

But all of that having been said, the competition is keen.

The banks that are in our space are doing pretty well for the most part.

Cullen Frost had a pretty good report, the Bank of Texas, which surreptitiously operates under that name, is really the Bank of Oklahoma, but nonetheless they are good composition.

And, we're in the market case being prudently aggressive and I think there is a chance to increase market share.

And the stronger banks that are well-capitalized as we are and that have funding sources and excess capacity on their balance sheets which we have based upon warehouse of funds that we have at the holding company, plus a major facility that we have available to us, gives us dry powder.

So we think we're well-positioned for growth as the opportunity occurs, and we do think the opportunity will occur sooner here than it will in the rest of the country.

George or Peter, George in particular, might like to add some granularity to that, but that's kind of a 35,000 --

Right.

Right.

I think we will, John, have some opportunity in '08, no question about it.

We're positioning the company hopefully to be able to take advantage of whatever comes, but if some of the pullback does happen, we'd like to be right there.

Okay.

Okay.

Good.

And then secondly, George, if you could help here, I'm just looking at in terms of your loan growth, do you have how much of that growth on a linked quarter basis was in loan participations where Texas Capital had led the deal?

Not much.

Not much at all.

Most of this, again, is organic growth from within the existing marketplace that, falls into that category, so to speak, that 2 to 10 or $15 million category that really is our sweet spot.

Our focus is not on agenting very large credits and putting agenting groups together.

We do have some of that in our portfolio, but that certainly is not our focus and has not been our real growth engine in the company.

Okay.

All right.

And then lastly, on the credit side, the charge-off expectations, are up notably from your historical trends as you indicated, and anything specific there that you're looking at outside of just a general deterioration that you're seeing in certain parts of your portfolio in for the broader credit environment?

John, let me just make a comment.

What we gave you in terms of guidance is what it is.

It's what it's intended to be, that is guidance.

It's not a projection of charge-offs.

Obviously, we hope our experience is going to be much better, but in terms of giving guidance and in terms of planning, profit planning, we are being very cautious.

So, just be careful not to take guidance as being a projection of fact and something that's going to happen and that is written in concrete.

Because that definitely isn't true.

Essentially, the 33 to $35 million would accommodate net charge-offs of that magnitude and still be able to maintain a reserve of 1% or better.

Okay.

And--

John, just one other thing, the way we operate this company in terms of, booking profits and handling our finances as the year progresses, we'll take another look at this the end of the first quarter, and we will determine our provisioning based upon the experience in the first quarter, and, if it's in keeping with the guidance we've given you, that's with a we'll do.

On the other hand, if it's better than our results are going to be better.

And we continue to calibrate and recalibrate as the year progresses.

Okay.

Okay.

And then one more quick thing and then I'll hop off after that.

Just in terms of your mortgage warehouse, I know you indicated the 4.1 million that's on -- that's in MPA there.

How much do you have left in the warehouse that is similar to those types of credits that were originated before the new guidelines were implemented?

We believe, John, that we have cleared all those out at this point in time.

And what's in the warehouse today is, we believe, under the new guidelines, readily sellable to those institutions that we have approved or really most any other mortgage investor in the marketplace.

And that's the key.

You want to be sure and underwrite because if some of these investors choose not to buy, you have an opportunity to sell it in the marketplace to other investors.

But we believe, as I mentioned today, that the aging, based on the agings we see and track daily, that we see the trends being very positive in the warehouse, and we don't expect a lot of additional problems there at all.

I mentioned to you also that, , the agings in the warehouse are certainly very acceptable, 95% of the portfolio at -- in the warehouse at 25 days or less.

Pretty good

Okay.

All right.

Thank you.

Thank you, John.

Your next question comes from the line of Andrea Jao with Lehman Brothers.

Please proceed.

Good afternoon.

Andrea Jao.

Hello everyone.

Hello Andrea.

Begin your pipelines and given the business conditions that you see, do you think [medium] loan growth is possible in 2008?

What areas, what types of businesses will be weaker, what types of businesses, what areas will remain good?

Well, this is George.

As we mentioned before and we've mentioned on virtually, I think, most of the conference calls, C&I growth continues to fuel the growth of this company.

We see a slowdown in the real estate area so you will probably see from our perspective, single-family construction, lot development, even some commercial real estate products slow in 2008.

And the focus will be on strong C&I business on a go-forward basis.

We are not necessarily picking industries, we pick management teams and we pick specific companies that have performed well in the past and have a good opportunity to perform well in the future.

But we think that, again, we're reflecting a slowdown in our projected numbers and so we obviously think that energy is going to be a very, very strong participant in our growth in 2008.

Professional service companies, those kinds of industries.

But again, we're looking at management teams and potentials.

Okay.

On the deposit side, do you think it will easier to grow noninterest bearing deposits, low-cost deposits as interest rates fall?

Well, that certainly was the experience when the fed funds rate fell from 6.25 to 1%.

And during that period of time, Andrea, we had demand deposit growth that was generally exceeding the growth of total deposits.

That of course came to an end when interest rates started rising from the 1% level.

In this environment, intuitively, you would have to think that that would be the case.

The proof is in the pudding.

We'll be able to tell you more at the end of the first quarter.

Okay, great.

Thank you very much.

Thanks, Andrea.

Your next question is from Brent Christ with Fox-Pitt.

Please proceed.

Good afternoon.

Hello.

Just a follow-up on the loan growth topic.

Could you give us a sense of obviously it sounds like a little about it of moderation, how much of that is a function of you guys kind of just pulling back a little about it versus just what's going on in the market?

Well, I think it's a combination of both.

We have consistently reminded our lenders.

I've seen memos going out to the lending staff that have urged moderation, have urged more prudence and more conservative underwriting standards.

We also think that the size of the credits probably will be a little larger than the average as we, are in a new environment.

And I think the projections that we've given you are conservative based upon, again, the Texas economy and the prospects for the Texas economy.

I do think that, we're going to have kind of a hockey stick in terms of this growth, and it's going to be more back-end loaded toward the second half of the year.

And that's why, in my comments, I said that the first half of the year in comparison to '07 , we are expecting growth in terms of net income and all the other metrics, but it's going to be more back end

Okay.

And then switching gears for a second, in terms of the margin it was good to see you were able to hold the line this quarter, and just wanted to see to what extent the roll-off of some of the CDs had in terms of booing the margin this quarter and how you're thinking about the recent Fed cuts flowing through in terms of order of magnitude in terms of how much pressure that could cause you near-term.

Brent , it did have a favorable effect.

We also were able to, while these were not determine deposits, we've been very successful in ratcheting down the cost of the other categories, such as Euro dollar deposits.

We do not expect, though, to be able to maintain that kind of margin with rates falling to as low as 2.5%.

Our best guess, just to be open about it, would be that we could be exposed from Q4 levels to a 10 to 15 point erosion in market over the course of 2008.

Part that have coming simply from relatively strong growth necessarily being funded with interest bearing liabilities as opposed to DDA.

Not strictly as a function of

Brent, just to remind you that what we experienced in the last cycle of rate declines was that even though our margins were declining, that was the more than offset by the growth in our loan portfolio.

So, it's the rate volume game and the volume was overcoming the rate.

Just another point of clarity, a lot of the slowdown in growth that we anticipated receipts to our desire to be more stringent in terms of credit quality.

So it doesn't mean that there isn't loan demand out there, because it's there.

But we're going to be selective.

Sure.

Makes sense.

And then the last question I had was just looked like you still continue to have a little about it of noise related to the discontinued operations and just want to get a sense of, how long we could potentially see that persist into the future.

Well, we think most of it's behind us.

It will have been a year at the end of March since we exited this business.

We exited it once, then we had to renegotiate the deal, and the renegotiation took place and was effective March 31 of '07.

And so we've had, really not 12 but 18 months expire since we first exited the business.

And as a consequence of that, we've seen a tremendous slowdown in loans that have been put back to us.

And, I would expect it would be modest as we go forward.

And is that really what's the pressure point as loans being put back?

Because I didn't think you had much --

They allege fraud or something like that, and they attempt to put these loans back to us.

Our initial reaction is to reject them, and fight them, and sometimes we end up in some kind of settlement.

They keep the loan, but we, pay them $25,000 or something to keep them.

So I really don't think that's going to be an issue of any significance as we go forward.

Brent, what we did at year-end was provide in that discontinued operations category a reserve, the number, the bottom-line number you see is after that, a reserve that we estimate to be our maximum level of exposure on those kind of issues that have been put back to us as of 12/31/07.

So we tried to take a fairly conservative approach in terms of what that loss number might be, and hopefully, and our experience is, it will probably do better than that.

So you could potentially recoup some of that.

Well, we're not banking on that, but there's a possibility.

Okay.

Thanks a lot.

Yes.

Thank you, Brent.

Your next question comes from the line of Erika Penala of Merrill Lynch.

Please proceed.

Have you started to see the Fed cuts meaningfully impact deposit pricing in your marketplace?

Absolutely.

We've seen that in every month since it started.

As I mentioned, euro dollar deposits are running 54-plus basis points, that's December average, does not reflect what's current today, 54, 50 to 60 basis points below levels of Q3.

Whether it will manifest itself in dramatic increases and DDA and other lower-cost deposit categories is yet to be seen but because of the repricing, it has been very sensitive to the decreases.

Okay.

And could you give us a little about it more color on earlier stage credit indicators as you see them at year-end, in terms of delinquencies and classifications?

Really, reflected in what we've reported.

That's about it.

With some improvements that George noted already occurring in Q1.

I think we've spoken to that with clarity, and we've been comprehensive in what we've said, Erika.

Okay.

Thanks for your time.

Thank you.

Next question comes from the line of Brad Milsaps with Sandler O'Neil.

Please proceed.

Hi, Brad.

Hey, how are you guys doing?

Doing well.

Most of my questions have been answered regarding the discontinued ops, but I did want to ask you a question regarding your current deposit rates, it looks like you've cut all your money market rates below 3%.

Does that reflect obviously last week's cut, but I mean, is it your sense that you're going to be able to push those even lower?

Certain categories you can't push lower.

I mean, they're already so low that realistically, they can't go that much lower.

But nothing you've seen of course reflects any of the adjustment that occurred with 75 basis points earlier this month.

Yet to be seen, but we are able to reprice again much more rapidly than we had historically been able to.

Okay.

Great.

Thank you.

Next question comes from the line of Jennifer Demba with SunTrust.

Please proceed.

Hi, Jennifer.

I'm just wondering if you could give us a sense of what the loan growth was by market for you in 2007?

And where you ended up the year in loans in Houston in particular?

Yes.

The-- as I mentioned, Jennifer, the 38% of the loan growth in Q4 really came from the markets outside of Dallas.

We've had good growth in -- in particularly in San Antonio, and Houston, in terms of loan growth.

Austin has been and will continue to be a good market for us primarily in deposit generation.

And that continues to be a good market for us there.

Dallas obviously making up the difference, and I think I mentioned the four or five areas within the company in Dallas that provided pretty substantial growth.

Where did you guys end up the year in loans in Houston, George, and what was your year-over-year growth for all --

Let me check that for sure.

Well, it was about 400 million --

About 400.

Something like that.

While George is looking for that answer, Jennifer, San Antonio we were able to increase our loans there by 50% last year, just on the order of 50%.

It was an extraordinary year.

You never know where this loan growth's going to come from, and it intuitively, it would seem like San Antonio would be maybe the least likely place.

But it was a great year for us there, and the guys down there did a great job.

Jennifer, the Houston loan portfolio is approximately $408 million at the end of '07, and that was about a 44% increase over 2006.

So they've done well.

Okay.

Thanks so much.

Okay.

The next question comes from the line of Bain Slack with KBW.

Please proceed.

Hey, Bain.

Good evening.

I had a quick question with regard to the guidance that you all gave for '08 and what the rate cuts, I know y'all have been letting the security portfolio run off, if you can give us color how you think about that going forward, in terms of will the runoff continue, what needs to happen to the yield curve to enable you all to start putting money back there?

We don't -- it would have to be a lot different than with a we see it, but we anticipate during the year that it will simply continue to run down.

Ran off 68 million during the year, and that implies a rate of, 5 to $6 million a month.

And it's been relatively consistent in terms of percentage of the -- the percent the portfolio's declined.

Okay.

So I guess -- I didn't know how that played into this guidance in the sense that that one off kind of continues?

It assumes in run off continues, we were not able to make, in the kind of securities and maturities that would fit us, any new investments.

Okay.

Great, I appreciate that.

No free money, Bain.

Right, okay.

Thank you.

Thank you.

Your next question comes from the line of Andy Stapp with B.

Riley and Company.

Please proceed.

Hi guys.

Hi, Andy.

Obviously, most of my questions have been answered, but I was wondering if you could tell us the balance of construction and development loans at year-end?

Yes, let me give you a little perspective of that, maybe on our commercial credit, real estate credit, our market risk real estate that we talk about.

That's 27% of the portfolio.

Are you interested in the breakdown between single-family and lot developers?

Yes.

Or commercial real estate, kind of -- try to answer the question you're interested in.

The total -- what you gave is, includes commercial.

That's correct.

If you're specifically looking for single-family construction and lot development loans, that's about 8.4% of the overall portfolio.

Roughly how much is that as residential versus lot development?

Lot development is about 5% and single-family construction is about 3.4%.

Okay.

Of that number.

And --

And that's been fairly consistent.

Those percentages have been like that for some time.

And then overall construction development was how much of total loans?

I'd have to check that specifically.

I can get back to you specifically on that.

One thing that we think, Andy, is really positive as it relates certainly to the single-family side and the lot development side is that 95% of that is all in Texas.

Right.

So you can break it down by market, but that makes us feel pretty good in today's environment.

We're just not doing much outside of Texas.

I might add one thing I failed to mention, in the conversation I had with David Brown that I related to you, he did say that Texas, unlike the other markets around the country that he follows, we've seen very little price erosion in terms of sales.

Now, that doesn't mean that, you know, developers aren't cutting special deals and providing incentives and so forth, but the prices have remained pretty flat and they've held up pretty darn well.

That's encouraging to us.

Okay.

Thank you, I appreciate it.

We'll get back to you on the construction number.

Sure.

Your next question comes from the line of John [Langstone] with (inaudible) Capital.

Please proceed.

Hi guys, I want to congratulate you on your loan growth for the year.

We certainly encouraging to hear you mention the things you had to say about the Texas economy, I certainly think nobody around here thinks what we're seeing now parallels what we saw in the mid-'80s, but I wanted to see if there are any comparisons whatsoever you could draw from what's going on now to what happened back then in the early to mid-'80s?

Now, that's a question I can field with great certainty.

There's absolutely no connection between what's going on now and the mid-'80s, early to mid-'80s.

We had the perfect storm of economic and political events that led to a complete melt-down in the Texas economy and the Texas real estate markets during the '80s, and as you know, we lost nine of the ten largest banks either to failure or acquisition, and we lost 94 of the top 100 savings and loans.

And there's absolutely no indication that we have any bank in the state, that I'm aware of, that's got any significant problems.

And the underlying economy, we have one area of weakness, and that's housing.

And this is the first time in my recollection and I really begin, in terms of how I look at the economy, kind of post-world War II, but it's the first time since then that I know of that a decline in the economy's been led by housing.

And this whole deal with sub prime lending, I think for those of us who weren't involved in it, we didn't see it necessarily, it wasn't that visible, and fortunately we didn't participate in it.

And the type of borrower that we finance isn't in that segment of the market necessarily.

So this is just a complete and entirely different situation.

There's no, absolutely no parallel, no correlation, you couldn't draw any -- I look for a rebound sometime in the second half of the year.

I'm not saying it's going to be a sharp rebound, but I think it's going to be a turnaround.

If you take housing away, the rest of the economy, looking at Texas, looks pretty darn good.

As I said our total employment is up in the state.

Total construction employment is up, interestingly.

And a lot of that relates to public works, it relates to commercial construction.

And each month, when we've had this housing problem that has been the big bugaboo we've seen monthly increases in construction employment.

So it indicates that the Texas economy, again, taken as a whole, is pretty darn healthy.

And I might just add one other data point for you.

That is out of the total employment in Texas, construction employment, and that includes state, federal, private, everything, is less than 6% of total employment.

Now, you know housing's still a significant part of the economy but we're going to get through this and we're going to get through it in pretty darn good shape.

And I think we'll be strongly positioned to take advantage of the opportunities that will exist as the recovery begins.

Does that --

Yes, that's great.

Thanks for the color.

Your next question's a follow-up question from the line of Andrea Jao with Lehman, please proceed.

If you think that the growth will be much better in the back half of the year, do you think that credit will be toughest and, therefore, net charge-offs higher in the early part of the year?

Well, Andrea, that's a hard question to answer, and all we can do is give you an answer based upon what we know today.

And we've disclosed everything that we know today.

If we had anything else that we were, terribly concerned about, it would be out there as part of the public record.

And, we are being more cautious.

George indicated, that one of the loans that was a real problem for us has been paid, we've actually -- are going to incur a $0.5 million recover.

The largest loan that is a catalyst for our preannouncement, as George indicated, we have seen progress there and we're hopefully optimistic.

But we've got a way to go and we hope we'll be able to give you better news.

But there's no certainties in this world and we take it one day at a time.

But we think we've got our arms around this portfolio.

We got, in addition to our own in-house staff, I'll just remind you that we bring in for loan review a outside consulting firm consisting of OCC examiners, and in this is kind of deja-voo, and I'll tell you why in this context.

It relates back to the last question, when I was at Texas America Bancshares in the '80s, our principal OCC examiner is the same person who does our internal loan reviews today.

We can actually sit at the same table and have a civil conversation.

But she is tough.

And she covers about 60 to 65% of the portfolio.

She samples the portfolio from top to bottom.

Obviously to get that kind of coverage she's looking very carefully at the largest exposures.

And, I think our processes together with this scrutiny we get from externally from the consultant that I've just described to you, I think it's as good a process as any bank, certainly in Texas has, maybe any bank in the country has.

Okay.

And remember, we've been through this before and we are deeply experienced in identifying early identification and an attempt to move out these loans before they become problems.

And we've had a great deal of success in doing that.

The heated competitive environment that we have in Texas is a big plus for us in that context.

Because, a loan that we look at that we might not look upon that favorably, may look really golden to somebody else who doesn't have the deep experience and perspective that we do.

Okay.

Fair enough.

Thanks again.

Let me go back quickly to the question that was asked about construction loans as it relates to our overall portfolio and try to give as much color on that as I can.

36% of our loan portfolio today is real estate loans.

Overall.

Of all real estate loans, 43% are real estate construction, i.e., the other 57% are what we call permanent loans.

Of the construction loans that we have in the company, about 89% are commercial or market risk real estate loans.

So hopefully that gives some color to the previous question and if there's additional need to discuss it, please call us and we will.

Your next question comes from the line of Charles Ernst with Sandler O'Neil Asset Management, please proceed.

Hi, Charlie.

Hi guys, how are you today?

Doing well.

Can you just real quick say what the attitude of the energy companies is right now, whether they're actually borrowing money or if they're just using there are cash flow and investing that on their own?

No, they're borrowing, and obviously, pay-downs are -- come more rapidly and in bigger amounts than they used to.

The big thing about this energy play in Texas is that, the Barnet Shale just continues to be a gold mine for those looking for the gas play.

And, because it has been -- the operators have been so successful, it encourages new entries into the marketplace and we've got more opportunity than we can say grace over.

Are you seeing much growth, on a net basis, Jody?

Yes.

Yes.

Absolutely.

In other words, new loans, new loan growth is exceeding payoffs and by some pretty significant margin.

Okay.

And then I know that you guys are probably careful about what you can say on this credit, but you did make a comment that there was some positive movement and so can you comment on that and also, is there any sense that you can give us as to the collateral behind the credit?

I don't -- Charlie, the problem with talking about any credit and particularly one where we're involved with a consortium of banks, the negotiations are delicate.

And we have to be very circumspect in whatever we say.

And I think it behooves us, and we're going to have a better result in the final analysis, if we say less rather than more about this particular situation.

Okay.

Fair enough.

Thanks a lot, you guys.

Your next question comes from the line of Michael Rose with Raymond James.

Please proceed.

Can you guys talk a little about it about your hiring plans for the year and maybe if you see some opportunities to pick up some lenders from competitors?

Yes, and yes.

We definitely see opportunity out there.

Well, the history of our company has been to take the opportunistic and take advantage of what's out this in the marketplace today.

I think there will be more opportunity in 2008.

We're very selective.

We're not in the marketplace trying to fill offices, we're trying to find the absolute best people we can find to join our company and grow our portfolio.

But in times like these, we typically find very good people looking for other opportunities.

So our goal would definitely be to find the premium players in each one of our marketplaces, and bring them all on.

Now, we do -- and we always have had and have told you we've had some capacity in the company today for growth, and we want to keep that capacity because that's the way you compete in a very competitive marketplace if you have capacity with your players to really get out there and hit the long ball.

But again, a list of people that are excellent and can produce for the company.

Great, thank you.

We have no more audio questions in queue at this time.

That being the case, let me just make a couple of ad lib closing comments.

I'm a little about it by the question related to the '80s, I almost started having facial ticks, tremors and vapors, but looking at 2008 in the current environment, makes me feel very, very good.

I'm relaxed, I sleep well at night.

And I'm really comforted by the processes, the team that we've got, and the economic environment in which we're operating.

Obviously, energy is a great underpinning to this economy, it is the fastest growing segment of our business.

When you look at all of our lines of business and our geographical markets.

So we believe that we're in as good a place as we could be in, given the circumstances in which we're operating today.

And certainly, there are uncertainties about the economy, but I think we'll get through this housing problem that the country faces, I think we'll get through it and I would certainly hope that most of the big hits have been taken as we look at the large financial institutions.

There's no certainty of that.

But, again, we have been scrupulous in trying to limit our exposures and to be very circumspect in terms of who we bank.

That having been said, we hope we'll be reporting very good quarters in the first half of the year, and even better quarters in the second half of the year.

We look for a solid 2008.

We've given you guidance which we think is conservative.

On the other hand, if the year unfolds as we have suggested, we're not going to be disappointed.

We'd like for it to be a lot better but we're just going to conduct our business as best we can and continue to operate in a conservative, sound manner and the chips will fall where they will.

With that, let me thank everybody on our team who's participated in this call, a lot of work goes into these calls, getting ready for them.

We've tried to be as transparent as we could possibly be today.

I think we've given you more information and more detailed information than we've ever given you before, both as it relates to already reported results, plus guidance and what that guidance is built upon.

I encourage you to call us if you have further questions, direct those calls to Myrna.

She'll find the appropriate person to answer them if she doesn't feel comfortable in answering them herself.

With that, we appreciate everyone who follows the company, all the analysts, we obviously particularly appreciate our investors who continue to stay with us and whom we value very, very highly.

So it's time to bring this call to a close.

We'll join you in toasting the new year and we look forward to it being a very good year.

Thank you very much.

Thank you for your participation in today's conference.

This concludes our presentation.

You may now disconnect, and have a good day.