Texas Capital Bancshares Inc (TCBIO) 2009 Q3 法說會逐字稿

Hello and welcome to the Texas Capital Bancshares third quarter earnings release. (Operator instructions) Please note this event is being recorded.

I would now like to turn the call over to Myrna Vance. Miss Vance, please go ahead.

Thank you very much, Amy. And thank all of you for joining us today for our third quarter conference call. As Amy said, I'm Myrna Vance, Director of Investor Relations and I would invite you to call me if you have any questions following our call. And you can reach me at 214-932-6646.

Before we get into our discussion, I was going 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 31, 2008 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 George Jones, our CEO, and Peter Bartholow, our CFO. As Amy said, after we finish our prepared remarks, she will facilitate a Q&A session for us. At this time, let me turn the call over to George.

Thank you, Myrna. Good afternoon, everyone. Earnings for the third quarter was $5.4 million or $0.15, down from Q2 by 17%. The reason for the decline was a provision for loan losses and ORE of $15.7 million compared to $11 million in Q2.

However, our core earnings power before provisions continued to improve with our net interest margin increasing 18 basis points to 4.06 from Q2 and 59 basis points from Q3 2008. We continue to be focused on credit quality during the economic downturn and we believe that credit issues are properly reserved to remain manageable. I'll discuss our credit performance in more detail a little bit later in the discussion.

Our growth in loans held for investment of 3%, demand deposits of 6%, and total deposits of 20% compared to Q2 proved to us that our business model is intact, producing increased core earnings.

We had great success in strengthening our market presence in all our locations in Texas. We have brought in Bill Wilson to be president of our Houston Region and he's hired four new corporate bankers. We have added new energy and new private bankers to that team also.

Our Austin team has attracted an excellent corporate banker in Central Texas, while Dallas, Fort Worth, and San Antonio continue to find great talent in their respective markets. We believe now is the time to be somewhat aggressive in attracting and hiring relationship managers because we see more availability of top talent today than ever before.

Texas continues to perform better economically than most of the nation, but it's not been immune to credit deterioration. Our increase of NPAs reflects the challenging environment, but our overall charge-offs remain low at $2 million in Q3. As we have demonstrated in the past, a larger quarterly provision provides reserves for potential loss exposure and does not necessarily translate into larger future losses. We will continue to grow the reserves in this economy, but believe that our actual net charge-offs will be substantially less and below those provisions.

Now I'd like for Peter to review the financials in more detail and I'll return in a moment to provide more information on our credit performance.

Thank you, George.

I think we did have very good results in core earnings under obviously very challenging conditions from which Texas is clearly not immune. We had very solid growth driven by market opportunity that George discussed. We've seen major improvement in core earnings in operating leverage reflected especially in growth and net revenue and income before the credit costs.

We had net income, as George mentioned, of $5.4 million or $0.15 a share. That does reflect much higher costs associated with the increases in reserves or loan and ORE losses. For the $13.5 million provision, a $2.2 million reserve for ORE reflected in non-interest expense, and net of $2 million in net charge-offs, we saw $13.7 million increase in total reserves.

As George mentioned, we saw a margin increase of 18 basis points. I'll complete comments about that in just a moment, but basically it results from dramatically improved funding costs, despite the shift we anticipated from borrowed funds to deposits, success of loan pricing initiatives, the exceptional DDA and total deposit growth, and growth in common equity after the offering completed in the second quarter. Benefits from these programs were offset in part of course by lost interest on non-performing assets, as well as the compression and spread between LIBOR and prime rates.

Turning to page five and asset quality we've discussed. We've had a provision of $13.5 million and a valuation reserve for ORE, again reflected in non-interest expense of $2.2 million. Didn't have a substantial increase in non-accrual loans. I think people have become accustomed to the fact that our business model can produce rather lumpy changes from quarter to quarter. As George commented, there is nothing about this that reflects significant exposure to loss or a lack of confidence in our ability to manage through these issues.

We have very strong coverage of our provision to the net charge-offs. Net charge-offs of just $2 million or 19 basis points. We have anticipated and I think effectively communicated our anticipation of higher credit costs and recognize, as I said, that we can see unusual changes between quarters without again, reflecting a view that there is a fundamental problem in the portfolio.

Loan growth has been more modest this quarter. It is seasonally a weak quarter for us. The deposit growth trend from the second quarter remained very strong. Saw DDA growth again of 6% in the quarter on an average basis, and 35% year-over-year. We saw a 20% growth in total deposits. The linked quarter actual growth rate, which I think is exceptional.

Again, building on the success we had at the end of Q2, with a planned shift from borrowings, which were utilized heavily during Q1 and Q2 to deposits as cost of deposits have come down dramatically. Obviously we're in a very strong capital position, with changeable common equity of 8.7%. And given first full quarter of inclusion of the proceeds of second quarter operating -- excuse me -- equity offerings, we've seen an 8% increase in the level of common equity.

Turning to the next slide. We have been focused on consistent improvement in controllable and variable operating costs, and improving operating leverage. Stronger core earnings power to mitigate the impact of the credit costs, which we acknowledge are higher and are likely to stay that way.

We saw net interest income growth 5% linked quarter and 35% from the year ago quarter. Increase in NIM with much more modest growth in loans produced this result. Non-interest income was down slightly due to the reduction in mortgage warehouse fees. And loan balances in the held-for-sale category were down this quarter from last.

Non-performing asset costs have obviously increased substantially. You'll see in our income statement not just the allowance for ORE losses, but the increased cost associate with managing those properties. The FDIC assessment costs are clearly and remain a significant drag on industry profitability.

Credit costs and non-performing asset expenses are obviously have a significant limiting effect on ROA and ROE. But the ROE is also limited by the very high levels of common equity.

Turning to slide seven, George commented we had a net interest margin of 4.06%, an increase of 18 basis points, 2003 -- excuse me -- Q3 2009 and 59 basis points from the year ago quarter.

The end of the second quarter we contemplated a relatively flat net interest margin for Q3 because we simply were unable to predict with confidence the magnitude of the deposit growth, the reduction in deposit cost, and the extent to which we would benefit from re-pricing in the loan portfolio. The benefit of re-pricing activities has offset spread compression between LIBOR and prime. Increased spreads to indices on new business and upon renewal are clearly taking hold. And with floors on a significant portion of portfolio at levels well above historical spreads to prime or LIBOR are producing significant results.

The pricing opportunity has reduced the effect of compression, as I mentioned, in spreads in certain categories of pricing, and it's overcoming impact of interest reversals on non-performing assets. The cost of carry of non-performing assets, which is obviously reflected in our NIM, is only about $250,000 a quarter, but the lost opportunity is roughly $1 million a quarter at these levels.

We saw substantial contraction -- further contraction in funding costs. We contemplated, as I've said, a shift from borrowed funds to deposits, and that has occurred in very significant measure. We did not anticipate or could not have anticipated the level of that growth. We had in Q3 very favorable conditions in terms of both pricing and the level of growth coming in significant part from treasury management products and focus on deposit growth in all regions and lines of business.

Despite the substantial shift of almost $700 million in borrowed funds, the deposits for the cost went from 40 basis points to an incremental deposit cost of something in just less than 75 basis points. We've seen a net decrease in costs.

Total funding cost, including DDA and equity, fell to just 80 basis points. Company interest Q4 in a very good position relative to pricing and to funding costs.

Turning to slide eight, as I said we had very modest growth in loans. Loans held for investment grew $139 million or 3% linked quarter, and 13% year over year. So our reduced contribution income and balances from loans held for sale, fraction due in significant part to the reduction in refinancing activity.

The total loans in the linked quarter grew only $23 million, potentially flat, with a year-over-year growth largely driven by the strength of loans held for sale of 18%. Next you can see the remarkable trend in DDA growth. Linked quarter again, 6% off of a very high level in Q2 and 35% from Q3 2008.

The growth in total deposits I mentioned at 20%. The trend from the last half of Q2, where we saw substantial growth, was continued and strengthened through the quarter. The planned replacement of borrowed funds as deposit loss came down was clearly evident. I mentioned the major commitment to treasury management and to deposit production in all lines of business has clearly produced this result.

Anticipated reduction in deposit cost, and that's been -- clearly been realized at even lower levels than anticipated. We see substantial growth in quarter -- turning to the next page -- quarter-end demand deposits, compared to the average. Total deposits are not up as high because of the very high levels evident at the end of Q2, and because some of the deposits had slightly higher costs that were put on in the last half of Q2 were allowed to either roll at lower rates or to mature.

Again, total loan growth certainly modest. We do have though at this point loans held for investment of $4.3 billion. Again, very attractively priced and producing very good margins. Of the following two tables just reflect again what George said. Clearly a growth model producing strong results. We have a market opportunity that's providing a very favorable environment for Texas Capital and that's in terms of access to key customers to improve pricing and strengthen underwriting for new business as well as recruiting.

George?

Thanks, Peter. Slide 12 shows our loan portfolio statistics. Collateral breakdown of the portfolio has basically remained the same over the last few quarters. With the exception of what Peter talked about in terms of growth of highly liquid assets. That's our mortgage warehouse, which has grown substantially since Q3 2008.

Non-accrual loans were $85 million in Q3, up from $50 million in Q2. And ORE was $35 million net of the $2 million reserve established this quarter compared with $31 million in Q2. Total NPAs were up $39 million to $120 million compared to $81 million in Q2 2009. The increase in non-performing loans is basically represented in three credits. Let me describe them to you.

One is a residential product -- project on Lake Travis in Austin, Texas. $20 million. We have put a substantial reserve on this loan and will be taking a third of the units to auction in November. We believe any loss will be well contained within the established reserve at Q3. This is what happens when you have a drought and the water in the lake recedes. Lake Travis is down considerably and has hurt the marketing of this particular project.

A second loan is an apartment project in Houston that's in bankruptcy. $7 million. We believe that we have collateral that will repay this loan in addition to the project itself.

Three is a residential rehab company loan in the amount of $10 million. We expect this loan to be reduced by approximately $2 million by year-end and it carries the proper allocated reserve representing what we believe to be loss exposure on the balance of the credit.

All of these loans were previously identified as problems before Q3 and we believe that they're properly reserved at this time.

Our ORE category is currently property that came into this category valued at $46 million. Carrying value today on our books is $35 million, net of the reserve we discussed. These properties have a cumulative current appraisal value of $41 million.

Non-performing assets are 38% in the C&I loan category and 72% in the real estate category.

We'll turn to slide 13. Our credit experience remains consistent with our expectations. Net charge-offs were $2 million in Q3 and $11.5 million for 2009 year to date. These charge-offs were basically related to real estate loans, three of them, and were previously identified and covered with allocated reserves. The increase in our non-performing levels were larger than we have experienced in previous quarters. But the total level and future exposure is still very manageable.

Our loan loss provision of $13.5 million, as Peter mentioned, increased our loan loss reserve balance to approximately 1.6% on total loans held for investment. This was driven by our methodology with factors related to these challenging economic conditions.

Embedded in this methodology is the factor that increases the percentage of the reserve that applies to the past category in our loan portfolio. That factor has increased approximately 25 basis points over the past two years, thus driving an approximately $8 million to $10 million in additional provisions into the loan loss reserve to address the economic downturn that we're experiencing today.

Mentioned before, we did establish an ORE reserve of $2.2 million, making the total credit provisioning $15.7 million.

Texas Capital's earning power continued to increase because of margin improvement. It gives us the ability to help offset these higher credit costs. We believe these costs will remain high for the next few quarters, though also see tightened credit standards continue to remain in effect for some time due to the economic conditions we're experiencing.

Turn to slide 14. This reflects our credit experience over the past four years and our experience year to date 2009. You can see our excellent charge-off record extending well into 2009.

In closing, I'd like to emphasize our vastly improved core earnings power due to margin expansion and our management of controllable expenses. We have an excellent capital position with tangible common equity to total tangible assets of 8.7%. We have had excellent growth in loans and deposits that are consistent or really in some cases, well ahead of our plan. We obviously recognize the credit challenges that all banks are facing in this economy. But our level of charge-offs and non-performing assets remain manageable and are not unexpected in the environment in which we operate.

Lastly, and very important, our Company is well positioned to take advantage of market opportunities for people and for customers.

Thanks for your continued confidence and support. Myrna?

Yes. Operator, we're ready for our Q&A session.

(Operator instructions) Our first question comes from John Pancari at Fox-Pitt Kelton.

Good evening.

Hi, John.

Hi. Could you talk a little bit about your -- I know you indicated that you expect credit costs to remain high so that clearly means that you're going to keep that -- the reserve either at the current level or build it. So if you could just talk about that -- what your outlook for continual reserve additions are as well as your outlook for NPAs, given your expectation for credit costs remain high.

Well, John, we really don't give too much forward a look at that. But again, in the environment in which we're dealing, we expect credit costs that you mentioned to remain high, similar to where we've been in the last few quarters. And we will probably see NPAs at levels like we've seen again in the last couple of quarters. We're making progress on existing non-performing assets and the key obviously is to continue to make that progress and reduce over time your NPAs.

The reserve, as you said, the methodology in which we use is very good in our minds and does exactly what we want it to do, which provides provision and additions to the reserve prior to any charge-offs that we take. The methodology, as I mentioned before, because we have continued to increase the percentage that is on the past portfolio over the last two years continues to drive higher provisions during weak economic environment. And that's exactly what we want it to do. And as long as the environment continues to be weak, we think that will be for a few quarters, you're going to see that methodology drive higher provisions.

Okay. And can you talk a little bit about your earlier stage delinquencies? So 30 to 89 day past dues, if you have that number, as well as trends in your watch list?

Yes, it's approximately $30 million in the 30 to 89, which is down somewhat I think from where it's been in past quarters. The watched list continues to reflect the economy in terms of where we operate. We are much more cautious today. We are much more interested in putting things on the watch list so that we can stay on top of credit concerns. So we're pretty conservative in terms of the way we look at increasing names on that watch list. But it's about where we've had it. It's not outsized by any means.

But does your -- like for example, your potential problem loans, did they increase in the quarter?

The potential problem loans did increase and we file that in the 10-Q. We really stated in the 10-Q that possible credit problems of those certain borrowers cause us to have doubts as to their ability to comply with the present repayment terms. That total will reflect about $78 million.

We've diligently reviewed each loan on that list. And we've allocated reserves to that certain -- those certain credits that we feel that there is a current loss exposure to. Our review places -- I'll tell you, our review places a very small amount of reserves on these loans. We think that our loss exposure is quite low. While some of the borrowers may struggle in the future to meet all the terms and conditions placed on them, we feel there is manageable exposure and the current exposure should produce a small loss potential on these loans to the Company the way we see it today.

Okay. And then lastly just -- did any of the moves we saw this quarter in terms of non-performers or your provisioning, was that any of -- any of that prompted by a regulatory review or anything?

No, not at all. We are current on our regulatory review. Our reputation and working relationship with the regulators is great. And we have no regulatory issues at all. They -- there was no financial impact to the most recent OCC exam to the Company in any form or fashion. It was a very good exam.

Okay, thank you.

Your next question comes from Brett Rabatin at Sterne, Agee.

Good afternoon.

Brett.

Wanted to first ask it sounded like there might -- you kind of had a little foreboding to some maybe some specific charge-offs with a few credits. Can you elaborate any on maybe a dollar amount? Or just generally speaking it sounded like there may be some of the reserve was being set aside for a few credits. Can you elaborate any further on --?

We did. I think I mentioned the large housing project on Lake Travis in Austin.

Yes.

We have put a fairly decent sized reserve on that particular credit just because of the market in which we operate today and where we are in the economy. But we'll have a much better feel for that pretty soon because we're going to take about a third of those units to auction and we'll see.

So, how much -- maybe I missed it. I'm sorry. How much was the actual reserve for that particular --?

We didn't state what it was, but it was a decent size to protect us we think from future loss.

Okay. All right. And then I was curious of the potential problem loans that you were talking about earlier. Or maybe even your watch list that you had indicated more caution on. Can you give us some color perhaps on whether those -- is it across the board? Or is it more isolated in certain portfolios or types of credits?

Well, we're still seeing real estate weaken in the overall portfolio. And it's probably -- we've seen the non-performers on the C&I side and the real estate side in the last quarter increase pretty much on an equal basis. The overall NPA portfolio is about 75/25 in terms of real estate. But we're seeing a few commercial -- or C&I credits come into play, but nothing very unexpected or nothing in our minds out of the ordinary in dealing in the economy in which we're dealing.

Okay. And then as it relates to that, some lenders have made more cautious commentary regarding energy related credits. Maybe more on the service side. But was curious to hear your thoughts on energy, the exposure you have and then just generally shared national credits would also help too.

Sure. We have no service business. We do not finance any service providers in the energy business. We're basically financing drillers with -- that are exploring for the product and we're loaning money on the -- on production. We have very few energy problems today. We don't consider that a big risk factor in our portfolio today. We do plenty of review on it. We think our underwriting, our price deck, and the way we review these credits, and require hedging for so much of the portfolio that we're really not concerned about the energy portfolio at this point in time. Even with gas prices a little lower than all of us would like it.

Okay.

The SNC portfolio is about -- oh, at $450 million in terms of outstandings today. We have a very few criticized or sub-standard, or classified SNC credits in the portfolio. It's about a third energy. We agent a number of these SNC credits. Probably about a third. And we think the portfolio is performing really quite well in an environment in which we're dealing today.

Okay. And then just last quick question. Obviously credit spreads have widened out nicely. Is there -- are we almost done with that in the relative environment? Or do you see that potentially still being --

I'm sorry. I missed the first part of your question.

Yes, I'm sorry. The credit spreads. Do you see those continuing to widen out? Or is that something that's been more of a factor in the past two quarters and is not as meaningful going forward?

It probably will flatten out somewhat on a go-forward basis. We have 54% of our floating rate loans with floors that exceed 5%. We have a number of credits that we've re-priced in terms of moving forward. We don't see the increases that we've seen in the past on a go-forward basis to the extent that we've seen them in the past. And I -- we've actually seen some competition coming back in the marketplace today from some of the stronger players. So Texas is still a very good place to be and we see some activity beginning to pick up.

Okay, great. Thank you for all the color.

You're welcome.

The next question comes from Bob Patten at Morgan Keegan.

Hi, Bob.

Hi, guys. How are you doing? Most of my questions have been answered. Can you give us some thought process about how OREO or how we should look at OREO expense going over the next few quarters as we do over real estate exposure and some growing OREO?

Sure.

I'm not asking for guidance guys. I'm just trying to get a feel for this becoming a growing number with a lot of banks as they get titles to these things and try to dispose of them.

We've said in the past that the movement we're going to see is from the NPA loans into the ORE portfolio and we'll probably continue to see that to a certain extent. We have, as I've mentioned, all our ORE properties basically with current appraisals today. We've set up the reserve for where we feel there's some softness in those appraisals. We again appraise them every year. We think that -- and the number I gave you -- pardon me -- the number I gave you I think was on an absolute basis, a combined basis, $35 million in value and $41 million in appraised value.

Now, in an environment like we're in today, when we continue to get current appraisals, we've seen some declines. And that again is why we put the reserve up and that's why we charge some down. The charge-offs we had in Q3 all really -- most all came from writing real estate loans down and moving them into the ORE portfolio. So I think that is still a current risk we're going to deal with, but we're trying to be proactive, provide plenty of provision ahead of time, and protect us on the downside.

Okay. Then just two short questions. Your unallocated reserve was around $18.4 million at June 30. Where is that today?

No, I don't think we ever gave that number out at all. That was not right.

Okay.

We have not in the past given that number out in terms of truly unallocated reserve. We work very hard to accurately assess the risk and the weaknesses in any of our potentially problem credits. So we're allocating reserves everywhere we can.

I think that was the problem and watch list number I just gave you. And then just also, the loan credit you guys are getting, obviously other banks would kill for it, we talked a lot about line borrowings being at all-time lows. Are you getting cycle replenishment, inventory replenishment? Are you getting equipment financing? What types of financings are you guys seeing?

Really what we see is exactly -- and what we've done is exactly what we've done since we started the Company 10 years ago. It's taking market share away from the competitors. We don't see much growth and expansion financing going on in this market at all. But there are people that need to borrow money to run their businesses. We've been we think very successful in being able to move that business from our competitors.

Again, in this environment, we are only taking the best. The highest quality clients only. We're able to underwrite it and price it, quite frankly, in a very effective way. Today, as I've mentioned before, is a very good time to find people and to find customers because out of all this chaos, we do see opportunity. And we have hired -- you didn't ask for this, but we've hired 13 relationship managers in Q3. And these are excellent senior experienced relationship managers that are going to do a great job for us we believe. And it's just been a real wonderful opportunity in terms of finding top quality talent.

Okay, thanks guys.

The next question comes from Brad Milsaps at Sandler O'Neill.

Hi, Brad.

Hey, guys. How are you doing?

Good.

Just to follow up, George, on your comment there about the 13 relationship managers you hired in the third quarter. I'm going to see if you guys could talk a little bit about some of the personnel expenses. I guess they've certainly moved higher throughout the year I guess as you've hired others. But I assume that a lot of those hires maybe came later in the quarter. Didn't know if you could talk about how you feel about that line item going forward and didn't know if that includes a full sort of incentive accrual. I know in years past you've typically trued that up in the fourth quarter. Just trying to get some more color there.

Sure, well and I'll let Peter take that one on. But as I think we've mentioned to you before, Houston has been a priority for us and for the last quarter or two, we have put a lot of time, effort, and resources into -- and I think I mentioned in my comments -- increasing our task force in Houston. And we've been extremely fortunate to do that with a new president and about six or seven new senior relationship RMs. So we are going to have a little bit higher expense cost related on a go-forward basis to Houston, but I think it's going to pay big dividends in the future.

These are all senior people that are well known in the marketplace. We think growth is going to be great. We're definitely upgrading a number of individuals in all our regions and all our markets today. And we're seeing that really improve our ability to take market share from the competition.

Brad, this is Peter. We've had -- because of the success of the mortgage warehouse, very substantial increases in mortgage warehouse fees that you know about. What's embedded in salary and benefit expense are commission dollars and that functions well. And those are up significantly.

We've also had a major project underway in mortgage warehouse to drive a complete change in the technological base from which they operate. And that has been just recently completed. Where we've been incurring a lot of cost, the contract labor and other costs associated with that initiative. A lot of temporary staffing.

Officer salaries year-to-date are actually down. Just base salaries. We have in the second quarter a very modest increase. We have had with the new hires that George mentioned some signing bonuses. Certainly not significant in the scheme of things, but have all really shown up this quarter.

And then we pick up with some of these individuals as well because we're taking them out of their bonus opportunity. We pick up some guarantee bonuses for which we're having to true up our bonus accrual.

Now as you said, we will always get that trued up in this fourth quarter.

Okay. And just a follow-up on your comments there on mortgage banking. Looks like the period-end loans sale-for-sale were slightly higher than the average balance for the quarter, but lower than the second quarter, I suppose, which is not a big surprise. Just -- I know you've made a lot investments there. Is this you think kind of the core business? Somewhere maybe around $500 million going forward? Or do you think it's somewhere lower, higher than that?

I think it could be higher than that.

Brad, this is George. Let me make a quick comment about that because it is a significant line of business for us today. You did see on an average basis it came down from the $650 million in the previous quarter to average about $540 million in Q3 or about 18% decline. It's still up though as you might imagine well over 80% from the same time last year. The mini refi boom has slowed down from Q2. And that's some of the decline that you've seen on a go-forward basis.

But again, we continue to add new accounts. And we see the reverse mortgage business increasing for us. So we do see some modest increases expected on a go-forward basis. You have some normal seasonal softness in the fourth quarter obviously in terms of home buying or refinancing. But this is a good business for us. It is going to continue to be a good business. We think we're going to have a competitive edge at least for the next 18 months to two years. We have, as Peter mentioned, completed a fairly sophisticated software conversion and we're really positioning the Company to again take advantage of what's out there.

Remember, we've said too that in this environment today we're able to insist that our mortgage warehouse customers put balances with us also. And we have somewhere between $150 million and $200 million worth of balances related to the mortgage warehouse business too. A great portion of that being demand deposits. So it is been extremely good for us and we believe it will continue to be a good business for us.

Okay, great. Thank you.

You're welcome.

The next question comes from Andy Stapp at B. Riley & Company.

Andy?

Hello. How are you?

Good.

CRE and C&I tend to be laggards in developing asset quality issues. Just curious how much heartburn do these loans give you going forward?

Well, wish we had a crystal ball and we could look about 12 months into the future. We think the issues, Andy, are welcome pains in our Company. We're going to continue to see some softness on the real estate side. We'll continue to see some softness on the C&I. But our underwriting has been conservative for the last seven or eight years and we feel like we're better able to handle those particular problems when they arise and then maybe others at times.

We don't have any major concentrations in our loan portfolio at all. Our C&D loans are about $700 million. They are not a significant portion of our book. The market risk portion is even a little bit less than that. We pretty much diversify across the board in geography, in collateral, industry. We think we're pretty well positioned to deal with the issues. We're going to have some more. There's no question about it. The economy is not -- has not righted itself at this point in time. But again I think based on our people, and our credit, and our credit process, we'll deal with it as well or better than most.

Okay. And was the increase in NPAs related to older credits or newer ones as well?

I don't think there was any systemic problem in terms of originations of those credits in terms of time or people. It was a smattering of each. Mostly I guess you'd say credits that have been on the books for a while. These -- we don't see a lot of brand-new credits popping up and causing us problems. Again, this is economy driven. It's really not underwriting driven. And it's something that this entire industry's going to have to deal with.

Okay. Thank you. The rest of my questions have been answered.

Okay.

The next question comes from Jennifer Demba at SunTrust Robinson Humphrey.

Hi, Jenny.

Hi, how are you?

Good.

Question on the technology upgrade for the mortgage warehouse business. Can you just give us some color about what was done and what the technology does for you that you didn't have before?

Well, it -- for one thing, we have increased the business pretty dramatically as you can see. And we just needed more capacity. More bandwidth. That's the big benefit. Another thing it will give us the ability to do is reduce our cost of processing. We think from an automated standpoint that you'll see a lot of this cost in that business come down. That's number two.

Number three, we think that this business can grow about as much as we want it to grow, so we need a capacity and software to be able to handle the ability to participate out these types of credits. Again, that's good for us; it's also good to diversify to keep the concentration down within our portfolio. Because we've always said we don't grow the portfolio just because it's there. We plan everything from the top in terms of concentrations and diversifications. We think it'll give us the ability to be able to more positively provide a participation product.

Those are some of the things that we see beneficial.

Okay, thank you.

You're welcome.

The next question comes from Michael Rose at Raymond James.

Hi, Michael.

Hey, good afternoon guys. How are you?

Good.

I just had one follow-up question on the 13 RMs that you hired this quarter. Did you say where -- what markets they were in?

I'm sorry. Again?

Did you say what markets the RMs that you hired this quarter were in?

A number of them were in Houston, as I mentioned before. But really we're getting a great bandwidth across the Company in every region. I mentioned we had a senior -- great senior RM hired in Austin. We're looking at another one right now. We've had good success in Dallas in our business banking hires, our corporate hires. San Antonio, Fort Worth, we're going to add to the Fort Worth operation.

So I think -- also, if you look at the new RMs, you really need to look at what we've done internally. There were seven RMs that are no longer with us also in the fourth quarter. So what we're doing is dramatically reviewing and in some cases upgrading where we need to. So it's been a very positive expense. We've not just simply going to add people to the bottom line. We're doing a pretty in-depth review in terms of performance levels within the Company and when we add, we're looking to see if we can't improve where we are today.

Okay, that's helpful. That's all I had. Thanks.

Okay.

Our next question comes from Kyle Cavanaugh at Palisade Capital.

Hello.

Hi, good afternoon. I have a few questions. And the first one is I just was wondering if you can help me think about the lumpiness that you speak about? In terms of provisioning and related to the lumpiness. You're building up your provisioning purposefully and systematically, yet there's still a lumpiness that you speak about. So I was wondering, how do you think about that internally in terms of preparing for future quarters?

And then how do we as -- from an outside observer kind of -- how would you suggest that we look at it from the standpoint because if you have 3, 4 credits popping up every two or three quarters, it's hard to get a handle on which way -- trend they're going. So I was wondering if you can comment on that a little bit.

Okay. Well, I'll take a stab at it. And lumpiness is just that. I mean it goes up, but it also goes down. And if you look at our history in the past, you've seen exactly that. The methodology drives what we do in terms of provisioning. And the methodology drives provision prior to the need to charge off credit. And it's doing exactly what we want it to do in an environment and an economy that is difficult. It is driving more provision and growing the loan loss reserve. We're not just simply saying we like the loan loss reserve to be X and put it -- put money there. It's as driven by a very -- in our minds very accurate methodology.

Charge-offs continue to be low. And as I've mentioned before, just because you provision large amounts, and some of the credits that you have exhibit weakness, doesn't mean that the end result will be a charge-off. And I think the values of certainly commercial real estate in the State of Texas and the economy being somewhat better has helped us in terms of the ultimate charge-off. But again, that will be lumpy to a certain extent also. And as you've seen that in the past.

I wish I could give you a formula that would help you plan exactly what's going to happen every quarter. We don't have one frankly. What we do have is in my mind a great credit process, a very strong methodology that is proven with the OCC, proven with the SEC, proven with Ernst & Young, our accountants, and our outside loan review. All feel very good about the way we provision and the way we reserve. And that's what we're going to have to do. And I wish there was a specific formula that we could tell you the way it was going to be for the next three or four quarters.

Okay.

That's just the granularity in the portfolio.

Could you just remind me again what's the average loan size?

The average loan size really is about $3 million. We've got -- and I say about $3 million because we have a number of smaller loans if thrown into the mix bring that average down. But really that's not our true sweet spot or our customer. If you really look at where we play, so to speak, it's in the $2.5 million to $3 million range. And that's the average size of borrowing and customer that we approach. Raw average is probably about -- if you throw those smaller loans in there, about $700,000 to $800,000, but again our sweet spot is that $2.5 million to $10 million range.

And I also have a question about the hires, the relationship manager hires. I was trying to get a sense -- at what point do you kind of saturate your market lines? Because a CRE relationship manager with a strength in CRE, you don't need sometimes the same guys go after the same credits and you'll be seeing a large swath of the opportunities out there through one person rather than double hiring. So how do we think of it from that standpoint? (Inaudible) saturation.

What we've always said in the past and what really has played out, even in the third quarter this year is it's opportunistic. I wish we could hire exactly when we want to hire. But we can't do that because the people that we want become available. There's very few of those, by the way, but become available when they want to become available. So we believe in the way we operate that we're opportunistic and in some quarters we won't hire anyone. And in other quarters, we'll have an exceptionally good hiring quarter like we had in Q3.

It is not a size, it is an art. And we believe that to attack a market that will be coming back that you need some dry powder. We're positioned with a lot of capital, we're positioned -- and are positioning our Company to really take advantage of this marketplace. We're in five of the best growth markets in the State of Texas. And while depressed, they won't be depressed forever. And so we -- if we have to warehouse a person or two to get who we need and who we want for the long-term, we'll do it.

And also, I was just --

And we have a very small market share here in each one of our markets. So it's hard to say. We could be saturated at any point in time. We're less than 5% in any one of our markets. The markets are huge. And we have, give or take, about 100 relationship managers that are lending managers in markets that are very, very large.

And also, I just -- going back to the provisioning. Maybe you could clarify because I forget. I think it was two or three quarters ago there was also a little lumpiness and like this quarter, the average loan of those three credits is probably, call it $10 million. And a few quarters ago it was on the larger size. Is there a difference in kind of your larger loans versus the average $3 million credit? Is there some sort of a different credit profile?

No. They're really not. I mean we underwrite to the transaction and to the relationship. If you take that credit I talked about, the larger credit today, we underwrote that pretty conservatively. There was a lot of -- a ton of equity on the front end going in. And the economic circumstances in the environment today made that a problem. And it was well sponsored, well structured, and it's really very tightly underwritten. And that's the way we have operated for the last number of years.

Everything is underwritten for specific conditions. We don't score like some smaller banks or that have smaller customers. We underwrite everything through our credit area. The relationship managers have virtually no lending authority. It's all managed through the credit policy area. And we're pretty darn conservative.

Thank you.

You're welcome.

Our next question comes from Bob Patten at Morgan Keegan.

Guys, I don't want to keep this -- this call's going on and on for you. But a real quick question. If you had to break out the impact of the warehouse deposits and fees, what was the net impact on the margin? Have you ever done that?

On the warehouse specifically you're saying?

Well, yes. Two things, the warehouse business has become very profitable for you guys. Obviously with Colonial and others pulling out of the business, you guys are just scaling it a little better. Technology helps improve that too.

Right.

There's got to be a direct benefit to the margin, because we're watching the margin just -- on top of your balance sheet changes.

That's right.

I was just curious what the impact to -- of the warehouse business is.

It's average -- the average -- you can look on the last page of the release. Average rate earned in the warehouse -- it's very similar to that for the rest of the portfolio. It does have a good balance, but it's not disproportionate in terms of any characteristic relative to the funding of the rest of the portfolio. So it's not -- I'd look at it more in the context of average balance linked quarter was down about $100 million. And today that costs us about $1 million.

The interesting thing in the warehouse, we're getting about three terms a months in the warehouse. We're processing almost $1 billion of loans per month. So you're getting three kisses at the pig so to speak in terms of fees and leverage on that portfolio. And it's -- that's why it's, particularly on the fee side, very profitable for us.

And do you guys think at some point three years, five years from now you could double that business? Or is that -- is it right size where it is?

Well, that's probably not a bad estimate.

Okay. Thanks, guys. Appreciate it.

You're welcome.

Our next question comes from John Pancari at Fox-Pitt Kelton.

Yes, sorry to hop back on as well. I just -- one more question around the margin. Can you talk about -- a little bit about the general sustainability of the margin that you expect? I guess to an extent, where do you see the margin going near-term here following the sharp jumps that you've seen over the past few quarters? Thanks.

John, this is Peter again. I think last quarter we thought it would remain relatively flat to be up or down a little bit. We thought that because as I mentioned the shift from borrowed funds to deposits. We knew that would cost us some. We also could not know how effective the re-pricing would be through the course of the quarter. And then we obviously can't predict the level of demand deposit growth. That's obviously a huge factor.

In terms of what happened during the quarter, customer deposit growth was substantially greater on an average basis than we would have been willing to predict. And it came in at a cost that was below what we would have looked at for marginal pricing from other sources.

So if you factor those things together, they overcame the effect of reversal of interest income and the compression, which we talked about between 90-day LIBOR and prime rate, or Fed funds rate, or other funding costs.

So, based on that you view that the margin where it stands now is relatively sustainable.

It's based on what we know about the balance sheet, as it exists today. That's correct. Q3 was the first full quarter -- and there's no first full quarter completely of loans that are re-priced, because loans re-price at maturity. Loans are priced according to new standards. When they're made if they're a new relationship. And Q3 was the first full quarter of the significant majority of re-pricing through the renewal process.

Okay. Thank you.

(Operator instructions) We show no further questions at this time. I would like to turn the conference back over to management for any closing remarks.

Well, thanks very much. We appreciate your attention on the call today. Let us be sure and assure you that we are working on behalf of our customers and our shareholders. And we will continue to do that even in a difficult environment. We think we're managing that environment very well and we appreciate your support. Thanks so much.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.