Prosperity Bancshares, Inc.
Q4 2007 Earnings Call Transcript

Published: 28 Jan 2008

[Operator:]

Good day and welcome to today’s teleconference. At this time all participants are in a listen only mode. Later there will be an opportunity to ask questions during our Q&A session. I will now turn the call over to Mr. Dan Rollins. Please go ahead sir.

[James D. Rollins:]

Good morning ladies and gentlemen. Welcome to Prosperity Bancshare’s fourth quarter 2007 earnings conference call. This call is also being broadcast live over the Internet at www.ProspertyBankTX.com and will be available for replay at the same location for the next few weeks. I’m Dan Rollins, President and Chief Operating Officer of Prosperity Bancshares and here with me today is David Zalman, Chairman and Chief Executive Officer, H.E. Tim Timanus, Jr., our Vice Chairman and David Hollaway our CFO. David Zalman will lead off with a review of the highlights of the fourth quarter of 2007. He’ll be followed by David Hollaway who will spend a few minutes reviewing some of our financial statistics. Tim Timanus will discuss our lending activities including asset quality and finally we will open the call to questions. During the call interest parties may participate live by following the instructions that will be provided by our call moderator, Curtis, or you may email questions to [e-mail]. I assume you have all received a copy of the earnings announcement we released earlier this morning. If not, please call [Whitney Hutchins] at 281-269-7220 and she will fax a copy to you. Before we begin let me make the usual disclaimers. Certain of the matters discussed in this presentation may contain forward-looking statements for the purposes of the Federal Securities Laws and, as such, may involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of Prosperity Bancshares to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Additional information concerning factors that could cause actual results to be materially different than those in the forward-looking statements can be found in Prosperity Bancshares’ filings with the Securities & Exchange Commission, including Form 10Q and 10K and all other reports and statements we have filed with the SEC. All forward-looking statements are expressly qualified in their entirety by these cautionary statements. Now let me turn our call over to David.

[David Zalman:]

We would like to welcome and thank everyone that is listening and participating in our fourth quarter conference call. It is a pleasure to report another record year for our company. Our performance in this tough economic environment continues to be strong. With a challenging yield curve and industry-wide credit problems, we are pleased to be able to report a stable net interest margin and relatively strong credit quality. We do not have any CDOs, SIBs or other esoteric products that are causing some strain on the liquidity markets. While we do offer some mortgage-related products, we do not operate a mortgage company. We do not have a factoring company or an asset-based lending area. We do not participate in indirect lending programs. We do not participate in shared national credits and, finally, we are not involved in sub-prime lending. With regard to loan growth, I’m very pleased with our organic loan growth for the quarter. Loan growth at our legacy banks, the locations that have been a part of our organization for more than one year, was 9.1% annualized for the fourth quarter. If you were to exclude the former Southern National Bank locations from the loan growth calculation, our loans grew on an annualized basis over 17% during the fourth quarter. While we recognize that our non-performing assets to total asset ratio of 30 basis points and our non-performing assets to total loans and ORE ratio of 49 basis points is strong within our industry, it remains elevated when compared to our historic performance. As I have mentioned during our past earnings conference calls, due to our recent acquisitions of the Southern National Bank of Texas and Texas United Bancshares which, by the way, was our largest ever, we expected our non-performing assets to total loans and ORE ratio to range from 25 basis points to 65 basis points. We feel we are on the last leg of the Southern National Bank of Texas’ loan issues. In the past we have said it should take us 12 months after an acquisition to get the acquired portfolio to the quality level we expect. In dealing with these larger banks, it appears to be taking approximately 18 months. We expect this to be true with the Texas United acquisition also. We believe our loan loss provision is adequate for our current loan portfolio. While our net charge offs were in excess of our provision expense, this was expected as many of the losses we recorded came from our recent acquisitions and were specifically reserved for in our loan loss provision. Without the question, the full year 2007 results were the most successful in our history. Our team remains committed to building shareholder value. Since January 1, 2000 I’m pleased to report that our diluted earnings per share have increased from $0.74 in 2000 a share to $2.09 in 2007. That’s an increase of 182% or 16% compounded annually. Our total assets have increased 810% or 37% compounded annually from $703 million at year end 2000 to $6.4 billion at year end 2007. We have grown our loan-to-deposit ratio from 39% in the year 2000 to 63.2% at year end 2007. Our net earnings have increased 1,032% or 41% compounded annually from $8 million a year in 2000 to $90.6 million in 2007. We continue to control our costs resulting in our efficiency ratio falling from 56.57% in 2000 to 45.45% for 2007. We believe all of these statistics compare favorably to industry standards. In other business, we currently own $15 million in Fannie Mae Preferred Stock and $9 million in Freddie Mac Preferred Stock held in our available for sales securities portfolio. The Fannie Mae and the Freddie Mac Preferred Stocks are investment-grade, variable-rate securities with a current tax equivalent yield of 6.28% for the Fannie Mae Preferred Stock and 4.93% for the Freddie Mac Preferred Stock and are rated AA- by S&P and AA3 by Moody’s. The rate on the Freddie Mac Preferred Stock resets every five years with the next reset date in December of 2009 and the Fannie Mae Preferred Stock resets every two years with the next reset date in March, 2008. The Preferred Stocks continue to perform according to their contractual terms and all dividend payments are current. The recent market volatility which has occurred over the last two months, or three, and turmoil in the credit markets coupled with the issuance by Fannie Mae and Freddie Mac of higher-yielding preferred securities have resulted in a decrease in the market value of Fannie Mae and Freddie Mac Preferred Stocks. Prior to recent events, the market value of these Preferred Stocks moved in accordance with market rates with some price deviation due to events at Fannie Mae and Freddie Mac. There are multiple factors considered in determining whether a decline in the market value of a security is in other than temporary impairment. These include, but are not limited to, the condition of the issuers, Freddie Mac and Fannie Mae, prosperity’s liquidity and capital position, prosperity’s intent and ability to hold the Preferred Stocks for a reasonable period of time sufficient for a forecast and recovery. We intend to continue to review the additional data and assumptions concerning the decrease in market value of the Fannie Mae and Freddie Mac Preferred Stocks as of December 31, 2007. Based on such review, should we determine that these securities are other than temporarily impaired, we will be required to take a non-cash impairment charge as of December 31, 2007 of approximately $10 million pre-tax and $6.5 million after tax. Such a charge would decrease net income but would have no affect on our shareholders’ equity, tangible equity or regulatory capital. Currently the decline in the market value of these Preferred Stocks is recorded as an unrealized mark-to-market loss in available for sales securities and is already reflected as a reduction to our shareholders’ equity through accumulated other comprehensive loss. At December 31, 2007 Prosperity’s securities portfolio totaled $1.9 billion with a total unrealized loss of $7.4 million including the securities mentioned above and had an effective duration of 3.2 years with an average life of 4.08 years. In response to the recent FED action as of today our $1.9 billion portfolio has an unrealized gain on securities of $24 million including the securities mentioned earlier and has an effective duration of 3.04 years and an average life of 3.68 years. Our goal for 2008 is to continue the high performance that we have delivered in previous years, provide quality products, treat our customers to the highest standards and increase shareholder value. Thanks again for your support of our company. Let me turn over our discussion to David Hollaway, our CFO, to report some specific financial results that we achieved this past year.

[David Hollaway:]

Net income for the fourth quarter 2007 was $23.6 million or $0.53 per diluted common share compared to $16.6 million or $0.50 per diluted common share for the same period last year, an increase of 42% and 6% respectively. Net income for 2007 was a record $90.6 million or $2.09 per diluted common share compared to 2006 net income of $61.7 million or $1.94 per diluted common share, an increase of 47% and 8% respectively. Net interest income for the fourth quarter 2007 increased 42% to $51.6 million compared with $36.4 million in the same quarter last year. This was primarily due to an increase in average earning assets of 31% which was mainly impacted by the TXUI acquisition. Net interest income for 2007 increased 45% to $204 million from $138.1 million in 2006 and again this was primarily due to the increase in average earning assets of 36%. Comparing fourth quarter 2007 versus fourth quarter 2006 non-interest income increased 61% to $13.2 million and for 2007 non-interest increased from the prior year 56% to $52.9 million. These increases were primarily due to the increase in deposit service charges generated on the increased number of deposit accounts that came from the additional banking centers acquired in 2007. On the non-interest expense side the fourth quarter 07 versus fourth quarter 06 comparative saw an increase of 53% to $29.4 million and for 2007 an increase over the prior year of 50% to $116.9 million. Again these increases were primarily driven by the TXUI acquisition. Total loans increased year-over-year 44% to $3.1 billion and on a link quarter basis they were up 2% on an annualized basis. As David had mentioned earlier, excluding acquisitions, loans on a link quarter basis increased 9% on an annualized basis and the additional comment here is that this organic growth was across the franchise and not specific to any one market. Deposits increased year-over-year 33% to $4.97 billion and on a link quarter basis increased 15% on an annualized basis. Excluding acquisitions, deposits on a link quarter basis increased 5.4% or 21.6% on an annualized basis. And I would note here that a lot of this growth that you see in the fourth quarter is seasonal. This occurs every year. If you went back and looked last year, you would see the same trend and a lot of this is seasonal and will begin to flow out of the bank in February. Adjusting for the seasonal impact, our linked quarter organic growth was more in line with our annualized target of 3%. The cash equivalent net interest margin was 4.12% for the fourth quarter versus 3.79% for the same period last year and 4.07% for the third quarter 2007. Looking at the linked quarter increase there was positive impact due to the yield on interest-bearing liabilities decreasing more than the yield on earning assets, 22 basis points versus 15 basis points. The cash equivalent net interest margin for the year was 4.06 versus 3.80 for 2006. As we stated before we tend to stay as neutral as possible from an asset liability perspective and so looking out over the next six to 12 months, the margin should be relatively stable based on our 12-31-07 asset liability model and it can move a few points down or up, especially on a quarter-to-quarter basis depending on balance sheet growth, specifically loan growth and the market’s reaction to the recent FED cuts in terms of deposit pricing. The deposit pricing is a big variable given that over the last few months we continue to see high rates offered out in the marketplace. Finally, the efficiency ratio was 45.5% for the fourth quarter down from 46.4% in the third quarter and the capital ratios at year-end were 5.87% tangible capital ratio. The tier-one leverage capital ratio was 8.09%. The tier-one risk base capital ratio was 13.12% and the total risk base capital ratio was 14.10%. And with that, let me turn over the presentation to Tim Timanus for some detail on loan and asset quality.

[H.E. Timanus:]

Non-performing assets at year-end December 31st 07 totaled $15,390,000 or .49% of loans and other real estate compared to $9,499,000 or .30% at 9-30-07 and $1,120,000 or .05% a year ago at December 31st 06. The December 31st 07 non-performing asset total was comprised of $5,127,000 in loans $56,000 in repossessed assets and $10,207,000 in other real estate. 72% of these non-performing assets pertain to loans in the portfolios of our last two major acquisitions. Of the $15,390,000 in non-performing assets at December 31st 07, approximately $4,100,000 or 27% have been paid off, sold or are under contract to be sold or are otherwise resolved. Net charge offs for the three months ended December 31st 07 were $3,113,000 compared to net charge offs of $1,313,000 for the three months ended September 30th 07. Net charge offs for the year ended December 31st 07 were $5,593,000 compared to $771,000 for the year ended December 31st 06. The average monthly new loan production for the quarter ended December 31st 07 was $110 million compared to $84 million for the third quarter ended September 30th 07 and compared to $72 million for the quarter ended December 31st 06. Average monthly new loan production for the year ended December 31st 07 was $92 million compared to $80 million for the year ended December 31st 06 for an increase of 15%. Loans outstanding at December 31st 07 were $3,143,000,000 compared to $2,177,000,000 at December 31st 05 representing a 44% increase. The December 31st 07 loan total is made up of 41% fixed rate, 31% floating and 28% resetting at specific intervals. I’ll now turn it over to Dan Rollins.

[James D. Rollins:]

I’m pleased to report that we have completed the acquisition and systems conversion of the six former Banco Popular locations in Houston that we purchased in January. We believe these locations are a natural fit with our existing Houston presence and they will do well for us. Houston is a very diverse economy and we are excited about this addition to our team. At this time I’m ready to take questions.

[Operator:]

(Operator Instructions) Our first question comes from Barry McCarver of Stephens Inc. Your line is now open.

[Barry McCarver:]

My first question is probably for Tim on the asset quality aspect. I didn’t catch all your comments regarding the $10 million in foreclosed assets. Can you give us an idea of what that is and kind of your thoughts on the timing of that to roll off?

[H.E. Timanus:]

It’s primarily about four different credits. One is a shopping center, it’s about $2 million. There’s another large shopping center in there. There’s a mobile home park. All those are located in Houston. We’re working diligently on trying to move those out. We’ve had some offers on them already. None that have been acceptable, but some that have been close. The exact timing to move them out, Barry, is pretty difficult to give any assurance on. Our target I can tell you is to move them out by the end of the next quarter.

[James D. Rollins:]

It’s a total of 22 properties and four of them are over a $1 million that Tim’s talking about.

[David Hollaway:]

Historically we’ve had them out of here within a six-month timeframe. Sometimes faster, but I’d rather – If you have to go one side, I would say the side of six months on the outside.

[James D. Rollins:]

Out of the 22 that are in there only a couple were here at September 30th. So we’re turning them pretty fast.

[David Hollaway:]

I was going to say if you looked at our non-performing last quarter the majority of all of those have been gone.

[James D. Rollins:]

That’s right.

[Barry McCarver:]

That was going to be my next question. Is there anything to read into the timing that several of these big ones hit all in the fourth quarter given that they did come from acquisitions?

[H.E. Timanus:]

I don’t think so. All of these came from the Southern National Bank acquisition and it was just their type of lending. Some people have said this in the past some types of credits might astound the books of other banks where we take a position if they have a harder time, if they can’t pay interest, then we really don’t go into renewals or we do a terms and conditions, so I don’t – To answer your question, I don’t think so.

[James D. Rollins:]

I don’t read anything in there, Barry. I think it’s just as we’ve said all along, this is just the stuff working its way through the system.

[Barry McCarver:]

Is there other things similar to this that we might see hit in the near future, looking out towards the first and second quarters?

[H.E. Timanus:]

I hate to say one thing and then something else happens, but I’ve talked with Randy Hester, our Chief Lending Officer and he and I talked about it because over the last two or three quarters we really – most of this stuff has really come from the Southern National Bank acquisition and we’re looking at Texas United going forward and he and I view things differently. He always takes a more conservative approach, but I kind of think that we’re still going to have charge offs this year. Will they be the amount that we charged off last year? I don’t want to tell you less, my gut check is that it’ll be less and we’re coming toward the end of it, but a lot of that depends on the economics and what’s out there at the same time. We feel we’re on the downside of this, we feel like we’re moving on to the Texas United and we should be through with this in a reasonable period of time. I don’t know if you were listening to my comments. In the past, we always said that most of the banks that we acquire we usually do have them cleaned up – not cleaned up, usually we get their portfolios to be more in the conformity of what our portfolios are within a 12-month timeframe and it appears that these larger banks, both Southern National Bank and Texas United, both were two of our largest acquisitions ever and probably the 12 months on these billion dollar deals, it’s not as reasonable to say they’ll be cleaned up – not cleaned up – but the portfolio will be the same as ours in 12 months. It’s probably going to take more of an 18-month timeframe it appears going forward.

[Barry McCarver:]

I hear you on that, it’s just a little bit bigger spectrum than we’re used to seeing in Prosperity, but you can kind of see that trend as well.

[H.E. Timanus:]

The only thing I would ask everybody to see, Barry, is that when we did both of these transactions and you can go back to prior conference calls because I had somebody look it up and read them to you. We pretty much commented that these ratios would be in the range that we’re talking about and these charge offs. The good thing is none of this not unexpected, I guess.

[Barry McCarver:]

One thing that did surprise me a little bit and it’s kind of a final question here related to assets, was the loan loss provisions, particularly given a little spike here and then what appear to be very strong gross new loan production. I’m surprised you let it come down to 104.

[H.E. Timanus:]

A lot of the money – I say a lot of the money. Monies that were in the provision for loan losses, you have to remember, some of that money in the provision were for the loans that we saw on the books of Southern National Bank and Texas United and the methodology – in the old days, as a banker you would go across the board and say if you had a clean bank you’d have a 1% reserve requirement, if you had a clean bank. In today’s world, and I’m sure you’re aware of this, regulators and Securities & Exchange Commission and state regulators and national bank regulators, they won’t allow you to do that anymore. The methodology that’s used is it probably takes days to complete and it takes all things into consideration and if you don’t follow their guidelines, they just don’t like that. So, it’s really a methodological approach and you almost have to follow the methodology that you have set out really.

[James D. Rollins:]

And this is purchase accounting on these two portfolios that we’ve acquired and you’ve got to follow the purchase accounting rules for the potential losses in there. So, there’s a lot of factors that are playing in there. I think when you look back, Barry, our loan loss reserve had been in the 10 something range a couple of years ago prior to doing these two big acquisitions. So all that makes sense to us.

[Barry McCarver:]

And then I guess just two final short, short questions. Can you give us any color on the increase in that new loan production? It seemed to come up quite a bit in the fourth quarter, just beyond natural increases in headcount.

[James D. Rollins:]

I think there’s multiple factors involved there. We’ve said all along we want to get the team with some traction going. When you look at where the loan growth is coming from it was across the state. There was loan growth in every area across the state, some doing better than others. I think that we did a couple of bigger credits in the quarter. I don’t know that there’s any one factor that does that. I think it’s the same thing we’ve been saying all along. The biggest impact is not that we did that much better in production, it’s that we did a better job of not letting the stuff run out the back door while we were bringing it in the front door.

[H.E. Timanus:]

Honestly, I’d make a point that I really didn’t see the production increasing that much. We just kept on dwelling on everybody to keep on harping that we don’t need to worry about anybody else, we just need to bill at our portfolio and do what we do best and keep pushing. I think the general comment I would make is that everybody contributed to this because it wasn’t any one big deal that we saw or anything like this. I think the whole team throughout the state really contributed with us kind of creeping us and letting us see this as the numbers came in.

[James D. Rollins:]

It’s really easy for everybody to get caught up in the talking heads and the economy and the this and the that. We continue to talk amongst ourselves and to our team, we’ve just got to do our job, guys, we want to be out there on the front lines, we want to be building relationships with customers, we want to take advantage of the situations that are in front of us and I think our team is doing that.

[Barry McCarver:]

Great, and then just lastly a question for Mr. Hollaway. Can you give us some expense guidance in on 1Q for the six new branches? Any thought there?

[David Hollaway:]

It’ll impact it a little bit, but bringing on six new branches, about $125 million in deposits, it’s going to bump it a little bit, but there’s multiple things moving through there. We’re still at the end of getting our arms around the TXUI thing, just kind of how we phrased it out last quarter. I would tell you if you’re trying to model it out, look at it holding it steady is probably not unrealistic.

[Operator:]

Our next question comes from Brent Christ with Fox-Pitt. Please go ahead.

[Brent Christ:]

A couple of quick follow-ups on credit quality. Could you give us a sense to the extent that how much in reserves there is left specifically for the Southern National and Texas United portfolios that were set aside with the deals? I guess what I’m driving at is the dynamic between provisioning and charge offs going forward, if we’ll see the reserve continue to trickle lower from here.

[David Zalman:]

We don’t have those numbers in front of us and, again, it’s in the methodology and it’s in the specific provision section of the methodology. All I can tell you is that we feel that it is reserve and if we go past the reserves, we will naturally add to the provision. Again, a lot of it’s methodology, but we understand where we need to be and that the provision doesn’t need to draw but, again, we still have to follow the guidelines of the methodology.

[Brent Christ:]

Outside of the couple of acquired portfolios, are you seeing any broader pressures in your legacy prosperity loan book?

[David Zalman:]

There’s a lot of talk out there. I think there’s more hype than anything else, in my opinion. I’m probably going to talk more in a broader global sense because overall the Texas economy is still doing very well. Has there been a slow-down in the economy? Yes. Is it still good? Yes. We still have good employment figures and I’ll just give you some numbers here. The Texas adjusted non-agricultural employment grew by 18,600 jobs in December and Texas employers now added 218,000 jobs over the past 12 months. That’s an annual growth rate of 2.1%. That’s more than double the national growth rate of 1%. I can go on and on with these statistics. The December statewide adjusted unemployment rate increased to 5.4% up from 4.2%, but when you look at the markets that we’re in, for example Austin and Round Rock, their unemployment rate is 3.6%, the College Station, Bryan area is 3.3%, Dallas, Forth Worth at 4.2, Houston, Sugarland at 4.2%, San Antonio 4%, Victoria 3.6%. The highest unemployment rate that we have is in the Corpus Christi area at 4.4. But, I guess my point that I’m trying to make is, yes, there’s less building permits today than there were last year at this time. On the other hand, the permits that are out there and the new construction that we’re seeing is still as good as it was maybe two years ago which was still a very good economy. I think as long as we have still an employment growth, I think that we’re going to be fine. I think it’s overblown. There’s a lot of people saying that there’s so many – that nobody can get loans and nobody can get mortgaged and I just have to tell you that is just the farthest thing from the truth that it could ever be. We want loans, we’ll do mortgages, but it’s got to be the mortgages and loans that are to people that are willing to bring in tax returns and financial statements. If you’re someone that wants to get refinancing, you want to bring in some kind of payroll stub or somebody said you made something, there’s not a whole lot of money for that. Otherwise, if you have really good financial statements or tax returns and you’re legitimate you can get all the money you want and there’s a good economy over here.

[Brent Christ:]

Last credit question. As you work through some of these problem assets, what type of haircuts are you typically having to take on some of them to move them off the down sheet? I know it varies depending on the credit, but just generally.

[James D. Rollins:]

That’s all over the board and it’s really dependent upon how the credit was written at the beginning. We’ve had some, you saw last quarter, we had some gains coming back in. We’ve had some where there’s no haircut at all and you’re taking a gain. We’ve had others that, for whatever reason, it was done incorrectly at the beginning and there’s some issue and we’re taking a pretty significant deal. It’s hard to speak with broad brush and tell you, no the average is 10% or 15% when that’s just not the case. We look at each credit on a case-by-case basis and I can assure that our team is aggressively working through those.

[David Zalman:]

Tim, what do you think the maximum deduction is we take on anything? Has it been 20%?

[H.E. Timanus:]

I’d say 20 is the outside. Most of them are going to fall in the 5 to 10% range.

[David Zalman:]

I don’t know if that adds any color for you.

[Brent Christ:]

That’s helpful.

[David Zalman:]

Probably the worst one we took was probably a 20% hit, but as Tim said it’s probably falling in the 5 to 10% range.

[Brent Christ:]

That’s very helpful. My last question, you mentioned that the Fannie and Freddie review. In terms of timing, when would you expect that to be complete?

[H.E. Timanus:]

We’re not going to carry this on forever. David and I talked about it and the team, we’re going to make a decision within 30 days. The market has been just so volatile. If you would have told me three days ago that our stock would have came up 20% in two days, if you would have told me the ten-year Treasury would have went from 370 last week to 330 and back up to 370 today, I don’t know what it is this morning – The market is so volatile right now that we think there’s panic and hysteria in there. We don’t want to make the wrong decision. We’re not selling the security. To only give you my feelings, I don’t think Fannie Mae or Freddie Mac is failing. I don’t think anybody does, but at the same time, we have accountants and there’s accounting rules that we have to abide by even though, when things get out of hand like this.

[James D. Rollins:]

So you think we’re 30 days out?

[H.E. Timanus:]

Yeah, I think 30 days.

[David Zalman:]

Max.

[H.E. Timanus:]

Dave feels 30 days out max.

[Operator:]

Our next question comes from Jennifer Demba with Suntrust Robinson Humphrey. Your line is now open.

[Jennifer Demba:]

I was just wondering if you guys could give us some detail. What’s the size of your total residential construction development portfolio and do you have any NPAs out of that portfolio right now

[James D. Rollins:]

The answer is on our call report. We show construction includes the full 600 and something million dollars that’s out there. I think if you look at just one to four-family, it’s somewhere in the $200 million range.

[David Hollaway:]

It’s actually about 500.

[James D. Rollins:]

500?

[David Hollaway:]

Right.

[David Zalman:]

He’s talking to the –

[James D. Rollins:]

One to four-family?

[David Hollaway:]

Right.

[James D. Rollins:]

Including commercial construction?

[David Hollaway:]

No.

[James D. Rollins:]

Does that help you, Jennifer?

[Jennifer Demba:]

Yeah, and do you have any non-performers out of that portfolio right now?

[James D. Rollins:]

Absolutely.

[David Zalman:]

And some of the loans that are in the non-performing right now are from that.

[David Hollaway:]

That’s right. One of the OREs is – A couple of OREs probably in there. And again on the ORE deal, you’ve got 22 credits, four of them are over $1 million in size and a couple of them are probably coming out of the construction side. I don’t think we see any blaring holes in that area that says there’s an issue, if that you’re what you’re question is.

[Jennifer Demba:]

My question is are a disproportionate number of your non-performers coming out of that portfolio?

[David Zalman:]

The answer is no, Jennifer. It’s spread fairly evenly between commercial properties and residential properties. When you say – without me saying the wrong thing – when you say if we’re seeing any – where some of this is occurring was primarily where Texas United had a mortgage department and we’re seeing that in some of their interim construction loans –

[David Hollaway:]

Some of the smaller ones.

[David Zalman:]

Smaller loans.

[James D. Rollins:]

That’s correct. Our two largest blocks of non-performing on the residential side, one is from Southern National and the other is from TXUI and one of them is about a million and a half from Southern National involving a handful of properties and the one from TXUI is less than that in dollars. But those two blocks represent the majority of it. And if you back and look at – To readdress the question earlier from Barry – if you go back and look at the other real estate that we have right now that $10 million in other real estate is essentially all made up of four different properties, only one of which is residential.

[Jennifer Demba:]

Question for David Zalman. Just wondering how you feel about acquisitions right now in this environment and what the level of interest has been from potential sellers at this point.

[David Zalman:]

This will probably sound crazy because usually when most of the investment bankers or analysts are so high, I try to bring them down and when they’re so low, I go the other way. This is kind of a time that I feel is very exciting for us. I think there’s a lot of opportunity out there right now. It’s kind of crazy but when prices are at their highest, a lot of people that feel what the value of their bank is, they always want another 20 or 25% and they’re just not going to sell or do anything unless they get that. What’s kind of crazy as the prices drop like they have dropped, then they’re anxious to sell right away. We’re seeing a lot of opportunity out there. We’re not going to move quick on anything but what’s happening and what’s happening in the market is really presenting us with some good opportunities. I would say that Prosperity made, the majority of its real easier money or money that we made is in the earlier years and the very hard times in the 80’s and the 90’s. I’m pretty excited right now about all of that. We’re looking at some opportunities, we’re getting calls and, again, we’re just waiting to see how the market is. There will be some acquisitions, they’ll be at prices that are not what they were, what you saw a few months ago. It’ll be pretty much dramatic difference really.

[Operator:]

Our next question comes from Bain Slack with KBW. Please go ahead.

[Bain Slack:]

Follow up I guess on the pickup and the organic loan growth that we saw during the quarter, I want a little more color on what the function is behind that. I know that in the past when you all are involved in a lot of M&A it does pull lenders off the front lines. I’m assuming part of it is them being back on the street knocking on doors, but I also wonder if you could give us some color on competitors. Obviously we’ve come off of several years of which some of your other competitors have been growing along at a fairly fast clip. We saw one peer have a credit quality issues that they pre-announced on. Is there a more conservative or has some of the underwriting changed that allows Prosperity to get more deals and not leave as much money on the table as maybe you all have in the past?

[David Zalman:]

The answer is yes, yes and yes, Bain. For so long – Say a year ago when everybody was dwelling and harping on us why aren’t you doing more, why aren’t you being more competitive and we continually said, we’re not going to go into the market and make loans that they don’t have the proper terms and conditions and rates and we just were not going to do that. In this last quarter, I don’t want to call it a market meltdown, all of these lenders that had another job six months ago that were now lenders on every street corner and brokers, those people have fallen out and we are getting opportunities now to make loans at more realistic prices and at terms that are competitive and reasonable and I think that’s exactly what’s helping us.

[Bain Slack:]

So is the sense that the competition is coming more to the frustrated style of underwriting?

[David Zalman:]

I think it’s just that the other guys are not there anymore. You had so many people in our business that were making loans, selling to the secondary market, packaging and selling them. Even the credit scrutiny wasn’t on there. They had formulas and models in the commercial loans and if they did this and met this, then they did and they packaged them and sold them. When there wasn’t anymore liquidity to the market and it dried up, those lenders weren’t out there. So now, we’re getting opportunities to see that. I think that you’re seeing probably even maybe some of the other lenders becoming more in line with the kind of thinking that we’re at too right now where a lot of them were just – A lot of people were growth, growth, growth was everything under any terms and conditions. I think people are starting to say, okay we need growth but it has to be a balanced growth.

[James D. Rollins:]

Prudent.

[Bain Slack:]

So, under the scenario that we’re starting to see unfold, I guess growth would – Looking at the last quarter it would easily be in the previous ranges. You all have always given us what your targets are, but would there by any opportunity for it to be above that or still limited in that upper single digit range?

[James D. Rollins:]

I think our expectation is to stay where we’ve always thought we would be, Bain. Again, we’re longer-term lookers here, we don’t look quarter-to-quarter. We’re not going to get excited if David quoted a 17% number excluding SNB in the number. That’s good and we’re pleased about that, but if this next quarter that number is 9 or 8 or 25, that’s all okay with us. I think we just want to take case-by-case, day-by-day. I think the number that we put out there for our long-term future growth is where we think we can be and to promise something bigger than that I don’t think is right.

[David Zalman:]

Let me just add on too. You have to keep in mind where we weren’t looking at really big acquisitions in this last quarter too. Your previous statement, when we’re looking at some bigger deals, that does take people out of the banks and it’s a big deal for us. Having everybody in the bank that can really perform makes a huge difference for us.

[Operator:]

Our next question comes from Erika Penala with Merrill Lynch. Your line is now open.

[Elena Kim:]

Actually this is Elena Kim calling for Erika. I just wanted to bring the conversation back to the Texas economy. I know that you had mentioned that employment growth and overall growth has slowed down but it’s still out-performing the nation and now that the Texas economy is less dependent on oil like it was back in the 80’s and 90’s, I was wondering what you thought about the national recession and how that might affect the local economy for the next 12 months or so.

[David Zalman:]

Throughout last year when everybody was saying – not everybody, but the general consensus was – Texas is not going to be affected by the national economy. I think if you go back to our past conference calls, I think that we always said that no matter how good the Texas economy is, we will be affected by what the national economy is to some degree. It may not hurt us as much, it may not help us as much, but it’s going to be affected. So, I would say that the national economy – Again, we don’t live in Michigan or some of these other states that are having a very difficult time, the top industries that they’re in. Unless you live in those places – I just know when I talk to analysts sometime they almost sound demoralized when they get off of earnings conference calls and talk [inaudible 00

[James D. Rollins:]

Elena, you and I talked a couple of times earlier. When you look at the Texas economy today, David hit on the hot buttons, affordability is big, job growth is big, the Governor has been out talking about the diversity in the economy across the state, job growth across the state. The Texas economy, as you know, is quite large. If Texas were its own country, we’d be one of the top ten gross products in the world. The Mayor was speaking a couple of weeks ago, the Houston Mayor, and he said that job growth in Houston alone in the last 12 months exceeds job growth in 47 states combined. The economy here is clipping along relatively well compared to other areas and I think a lot of that’s driven off the affordability and what David said. We didn’t see the run-up in prices that everybody’s talking about having to come down.

[Elena Kim:]

I guess just a follow up then, how you mentioned earlier that of course Texas is going to fare well in comparison to that of the nation, but if it is slightly affected by the national economy, I was just wondering if you’re going to be looking more closely at certain loan segments in terms of credit performance for 2008?

[David Zalman:]

Well, we’re going to look at it. I guess when I say what happens in the rest of the country’s economy affects us to some degree. You can look at the Fannie Mae and Freddie Mac scenario that we have on our books. Two months ago, these things were trading very close to par. It’s nothing that we did, but all of a sudden you had this liquidity issue and some of your larger banks had to start issuing preferred stock at 9% because there was this crisis for capital. Those are the kind of things that really impact us when I refer to that. Probably one of the loans that we have on the non-performing list is an individual that actually brought a property here, used 1039 exchange money, put 25% down and it had good cash flow. He almost just had to let it go. We weren’t willing to reduce the terms and conditions and the interest rate and this guy had so many other properties in the other parts of the region, California that he just couldn’t keep it. So, that’s the kind of stuff that really impacts the lending side. But I will tell you that we generally don’t do that kind of stuff for that much out-of-state people coming in and buying like that.

[James D. Rollins:]

We look at each customer individually. Your question was are we going to specifically look at one area or another area differently. I think the answer is we look at each credit and there’s a merit. If it doesn’t make sense, we’re not going to do it. We don’t get in and out of industries or loan types just because the wind’s blowing a different direction. Quite frankly, we’re contrary to that. Sometimes when times are tough, there’s some real opportunities in some of those markets. Our bank style is not to sit in the ivory tower and say, oh my goodness we’re worried about X, Y and Z so we’re going to stop doing that tomorrow and send a memo out to the troops. That’s not us.

[David Zalman:]

I think that’s a good point, Dan. We don’t have these mathematical models with a bunch of guys with Master’s degrees. We look at each and every customer individually and make the decision based on that customer really.

[Elena Kim:]

One last question. You had mentioned that as far as the margin goes, that is going to be dependent on the deposit pricing in your area and I just want to know when you expect the Fed cuts to meaningfully enter into the Texas market.

[David Hollaway:]

That’s a good question. It seems to be an issue –

[James D. Rollins:]

What’s your crystal ball say, Dave? [Laughs]

[David Hollaway:]

Crystal ball. Send things like that to the crystal ball. I think the only point to be made is, and I’ll kind of reiterate what Dave had said earlier, where the markets rates were over the last few months, you certainly didn’t see a lot of our competitors in the race they were offering, it was just nonsensical and we understand liquidity needs drive a need to pay off on these rates, but what we’re trying to say is with the Fed cutting these rates so significantly and the possibility next week of another one, you’ve got to think that our competitors can’t continue to pay 5 and 5.5%. It just doesn’t make sense and so some if discipline enters the market again going forward, if everybody gets on board and starts tracking what the market is telling them –

[David Zalman:]

Which we’re starting to see.

[David Holloway:]

Correct. – and we start to see it, that helps us because then based on the last few months, we’ve been a little more competitive in deposit rates, but if everybody gets into the flow and follows the norm, that helps us and then we’re not having to pay up a little bit and so that helps our margin going forward. But that’s a huge variable. I don’t have a crystal ball to say everybody’s going to follow in line this week, but as David said, maybe we’re beginning to see that. I don’t know at this point.

[David Zalman:]

And I would say if it does happen like we hope it happens, you probably will see some positive responses in the margin but again I wouldn’t count on that for a six-month period. If you get some relief, it would probably show up six months from now.

[Operator:]

Our next question comes from David Bishop with Stifel Nicolaus. Your line is now open.

[David Bishop:]

Hey Dan, I was wondering if maybe, getting back to the margin and maybe the spread-out look here, walk us through maybe the loan portfolio positioning in terms of fixed versus variable and maybe some of the [inaudible 00

[James D. Rollins:]

I’m going to let Tim answer that because he had those numbers in his comments and he can get to them quicker than I can.

[H.E. Timanus:]

David, right now we’re about 41% fixed rate, 31% floating and that means any time prime changes, those rates change and then 28% resetting at some kind of interval, that might be annually, it might be semi-annually. Typically not more than annually. So really there’s only 41% fixed rate in there.

[James D. Rollins:]

Then your question was margin driven. Hollaway you want to jump on the margin side somewhere?

[David Hollaway:]

Again, as you’re looking at it on the margin again we’re neutrally positioned as we have been over the last few quarters, few years and if you’re thinking about it, yeah, you’re looking on the loan side drop the rates, how much of that variable merely falls off. Then we have our security portfolio, a major earning asset of ours, that thing – as David mentioned earlier – is roughly 3.1 I think you said on effective duration, but the cash flow coming off that thing even as of today is roughly $400 million on an annualized basis and then obviously if you’re in a decreasing rate environment, you’re reinvesting at a lower rate, however, as David said if we’re going to get this yield curve back that actually may help us tremendously going forward and then it’s just a matter of - When you look on the deposit side which, again I would repeat this, it’s a key variable. If we can roll our CDs over at lower market rates, that’ll have tremendous impact for us. But when you’ve got every guy in the market, as they were a few months ago, paying 5% when rates should be 3.5 it creates a headwind for us.

[David Bishop:]

Circling back to the other real estate owned in-flow, were those credit that were identified on the wash list from the Southern National acquisition or is that – I sort of missed some of the conversation there – are those credits that had deteriorated relatively quicker inter-quarter?

[James D. Rollins:]

No, nothing deteriorated relatively quickly. I don’t think anything that we’ve seen has been a surprise. I think when you go back – David Zalman has been very specific and open, you’ve got to go all the way back to the first quarter of last year when we were doing the Southern National deal – we’ve said from the very beginning that there were issues out there that we were going to be dealing with and that we could see the NPA numbers move and I think that the timing of it is what we don’t control and that’s kind of where we are. We certainly don’t come in and just automatically pull the plug on everybody that we have a question about, we want to give people a chance to do what they can do to resolve issues, but at the same time, we’re not going to take all the risk on our side so when the game is over, we foreclose on a property, we’ll bring it into ORE and we’ll move it out and I think that’s what you’re seeing happen is just normal, natural stuff.

[David Zalman:]

I think if you go back in the conference call, I think I even gave some numbers back then. I said that we probably sold $70 million before we closed the deal, somewhere in that area and I said we probably owe another $50 million that’s on the books and we’ll have to work out of over a period of time, either outsource the loans get them more at the terms and conditions that we’re in favor of. I think it’s pretty much been like that.

[David Bishop:]

Just one housekeeping item. I noticed the amounts declining on the salaried employee benefits. Anything related to that? Production related or some sort of seasonal true-up?

[James D. Rollins:]

The mortgage department was closed out in the fourth quarter and was there all of third quarter so that could be a piece of it. You saw headcount go down just a little bit. There’s nothing unusual at all in there David. You had some mortgage people that were more highly compensated and commission driven that are no longer with us because we don’t have a mortgage department as David said earlier. That would probably be the only thing that’s part of it.

[Operator:]

(Operator Instructions) It appears at this time, sir, there are no further questions.

[James D. Rollins:]

We’ve run out of everybody’s time. Thank you guys very much. We’re looking forward to 2008. Appreciate everybody’s support of our company and we’ll look forward to seeing you when we’re out on the road. Thank you all very much.