Prosperity Bancshares, Inc.
Q4 2008 Earnings Call Transcript

Published:

  • Operator:
    Good day and welcome to today’s Prosperity Bank’s Fourth Quarter Earnings Call. All lines are currently in a listen-only mode and later you will have the opportunity to ask a question during our question-and-answer session. It is now my pleasure to turn today’s program over to Mr. Dan Rollins. Please go ahead, sir.
  • Dan Rollins:
    Thank you. Good morning, ladies and gentlemen, welcome to Prosperity Bancshares’ fourth quarter 2008 earnings conference call. This call is also being broadcast live over the Internet at prosperitybanktx.com and will be available for replay at the same location for the next few weeks. I am Dan Rollins, President and Chief Operating Officer of Prosperity Bancshares and here with me today is David Zalman, Chairman and CEO; Tim Timanus, Jr., Vice Chairman; and David Hollaway, our Chief Financial Officer. David Zalman will lead off with a review of the highlights for 2008. He will be followed by David Hollaway who will spend a few minutes review some of our recent financial statistics. Tim Timanus will discuss our lending activities including our asset quality. I will provide an update on our integration plans for the former Franklin Bank locations, and finally we will open the call for questions. During the call, interested parties may participate live by following the instructions, which will be provided by our call moderator, Katie [ph], or you may email questions to investor.relations@prosperitybanktx.com. I assume you’ve 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 constitute forward-looking statement for the purposes of the federal securities laws and, as such, may involve known and unknown risk, 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 and Exchange Commission, including Forms 10-Q and 10-K and other reports and statements we have filed with the SEC. All forward-looking statements are expressly qualified in their entirety by these cautionary statements.
  • David Zalman:
    Thank you, Dan. 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 great year for our Company. Our performance during this difficult economic environment continues to be strong. With a challenging U.S. economy and industry-wide credit problems, we are pleased to be able to report stable, consistent earnings, and strong credit quality. As we have mentioned before, but certainly worth repeating, we do not have any CDOs, SIVs or other esoteric products that have been causing 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 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 subprime lending. In addition, our Board of Directors spent a significant amount of time during the fourth quarter considering Federal TARP program and ultimately decided not to seek Federal Capital Purchase Program funds. We are well capitalized under regulatory guidelines and we should be able to continue building our business and taking advantage of opportunities that arise during these uncertain times. We expect that our business and its earnings, as in the past, will provide the necessary capital for continued growth. In the event that a large acquisition opportunity arises where additional capital may be needed, we feel we have the ability to raise capital thru traditional sources. With regard to our 2008 operating results, we showed fourth quarter earnings per share of $0.49 on a diluted basis. This is $0.03 above the mean analyst estimates. We had annual net earnings for 2008 of $84.5 million or $1.86 per diluted common share. Excluding the non-cash impairment charge we recorded during the third quarter our net earnings would have been $93.6 million or $2.06 per diluted common share. On November 7th, 2008, Prosperity Bank completed the assumption of approximately $3.6 billion in deposits, from the Federal Deposit Insurance Corporation, acting as receiver for Franklin Bank. Approximately $1.6 billion was brokered money and have since exited the bank. We acquired certain assets from the FDIC including an approximately $350 million in U.S. Treasury and agency securities. In addition, we had the exclusive right to purchase any Franklin Bank loan we wanted at book value. After a thorough review of loans originated and managed in the Franklin Bank community banking offices, we purchased approximately $350 million of high quality performing loans. My next statement may be viewed as a bit naïve by some considering the times, but we are expecting improved earnings in 2009 based on a few factors. One, after a length time period of flat or inverted yield curves we are finally experiencing a true yield curve. Two, the acquisition of Franklin Bank franchise from the FDIC should be very accretive for us. We were fortunate to purchase over $2 billion in investment securities before rates dropped so dramatically. As we were purchasing in November the yield on the 10-year treasury was close to 4% while today, as you all know, it is much lower, currently around 2.5%. We do, however, expect our 2009 loan loss provision to be equal to or higher than our 2008 full year provision based on the economic times we are facing. With regard to asset quality, our nonperforming assets totaled $14.4 million or 20 basis points on average earning assets at December 31st, 2008. This is decrease from the December 31, 2007, total of $15.4 million or 30 basis points on average earning assets. Our provision for loan losses was $6 million for the three months ending December 31, 2008. The net charge-offs were $3 million for the same period. The additional provision during the quarter took into consideration additional loans purchased from Franklin along with deteriorating economic conditions as per our loan loss provision calculation. At December 31st, 2008, our securities portfolio totaled $4.1 billion with a total unrealized gain of $81 million. The effective duration on the portfolio is 2.96 years and the average life of the portfolio if 2.93 years. Talking about the economy a little bit, although the seasonally adjusted non-agricultural employment failed by 25,700 jobs in December the Texas economy added 153,600 during 2008 compared with job losses of 2.6 million nationwide. Texas seasonally adjusted unemployment rate rose to 6% in the December compared to 7.2% for the U.S. Houston employers created 57,300 new jobs in 2008, an increase of 2.2%. While unemployment claims for Houston and the State of Texas rose during December, we believe that Texas is feeling more of the national recession that until recently it had been immune to. However, we still feel that the Texas economy will outperform the nation in 2009 with a pretty good economy considering all factors. Without question, the full year 2008 results were very successful. Our team remains committed to building shareholder value. Since January 1st of 2000, I am pleased to report that the diluted earnings per share have increased from $0.74 in 2000 to $1.86 in 2008, a total increase of 151% or 12.2$ compounded annually. Our total assets have increased 1191% or 37.6% compounded annually from $703 million at year-end 2000 to $9.1 billion at year-end 2008. The net earnings have increased 956% or 34.3% compounded annually from $8 million in 2000 to $84.5 million in 2008. We continue to control our cost, resulting in our efficiency ratio being in the top of our peer group. Our goal for 2009 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. In the past, our bank has generally performed well during more challenging economic times compared to our peers and we expect this to be the case in the future. We hope to be able to take advantage of opportunities that arise from the disruption in the loan and deposit markets and to be prepared for the acquisitions – institutions needing assistance. Before I close, I would also like to thank and welcome all of the Franklin Bank associates who have worked and are working so hard retaining our great customers as well as helping in the operational integration of our two companies. Thanks again for your support of our Company. Let me turn over our discussion to David Hollaway, our CFO, to report some of the specific financial results we achieved this past year. David?
  • David Hollaway:
    Thank you, David. Beginning with deposits, deposits were at 12/31/08 were $7.3 billion, an increase of $2.4 billion or 47.4% from 12/31/07. On a linked quarter basis, deposits increased 43.4%. Backing out all the acquired bank transactions, deposits decreased $10 million year-over-year, and on a linked quarter basis increased 4.8%. I would note that on the linked quarter number that’s similar to previous years most of the linked quarter growth was seasonal and will be gone by the end of the first quarter in 2009. Net interest income increased year-over-year $27.3 million or 13.6% to $227.7 million. The tax equivalent net interest margin impacted by the Franklin transaction was 3.65% for the fourth quarter 2008 versus 4.15% in the third quarter and the margin was 3.96% for 2008 versus 4.06% for 2007. Non-interest income decreased 1% year-over-year from 552.9 million in 2007 to $52.4 million in 2008. This was primarily due to net losses on sale of ORE in 2008 and I would point out within the non-interest income category the positive [ph] on service charges line item is up year-over-year $4.8 million or 11.8%. Non-interest expense increased 13.4% to $143.8 million in 2008 compared with $126.8 million in 2007. In addition to the Franklin transaction the increase was impacted by the impairment of our remaining Fannie Mae and Freddie Mac preferred stock, which was a $4 million increase year-over-year. The efficiency ratio impacted by the Franklin transaction and does not include the preferred stock impairment charge was 48.6% for the quarter 2008 compared to 45.5% for the same period last year and 45.4% for the third quarter 2008. The year-to-date efficiency ratio for 2008 was 46.5% compared to 46.2% in 2007. Looking forward for 2009, based on our 12/31/08 asset liability model, we are projecting our net interest margin to be 5 to 10 basis points higher than the fourth quarter number. Factoring in the Franklin locations, we are modeling a 10% increase in non-interest income year-over-year. Projecting a specific target for operating expenses for 2009 is a bit more difficult due to the timing of the Franklin deal but another way to look at this we are targeting our efficiency ratio to be back to pre-Franklin transaction levels by year-end. On the balance sheet side, we are projecting a 5% to 7% loan growth number for 2009, and this is based on the idea that this is the opportunity to get the best of the best customers. And for deposits, we still expect $300 million to $600 million in high-rate CDs from the Franklin transaction to leave the bank and because of this we are assuming deposit growth for 2009 will be flat to slightly down. And with that, let me turn over the presentation to Tim Timanus for some detail on loans and asset quality. Tim?
  • Tim Timanus:
    Thank you, Dave. Non-performing assets at year-end December 31st, ’08, totaled $14,368,000 or 0.40% of loans and other real estate compared to $14,536,000 or 0.45% at September 30th, ’08, and $15,390,000 or 0.49% at December 31st, ’07. The December 31st, ’08, non-performing asset total was made up of $9,736,000 in loans, $182,000 in repossessed assets, and $4,450,000 in other real estate. As of today $1,938,000 of the December 31st, ’08 non-performing asset total have been removed. Net charge-offs for the three months ended December 31st, ’08, were $3,011,000 compared to net charge-offs of $1,805,000 for the three months ended September 30th, ’08. Net charge-offs for the year ended December, 31st, ’08, were $7,621,000, compared to $5,593,000 for the year ended December 31st, ’07. $6 million was added to the allowance for credit losses during the quarter ended December 31st, ’08 compared to $1,700,000 for the third quarter of 2008. And $9,867,000 was added during the year 2008 compared to $760,000 for 2007. The average monthly new loan production for the quarter ended December 31st, 2008, was $77 million compared to $80 million for the third quarter ended September 30th, ’08. Loans outstanding at December 31st, ’08, were $3.567 billion compared to $3.249 billion at September 30th, ’08. The December 31st, ‘08 loan total is made up of 44% fixed rate loans, 28% floating rate loans, and 28% loans that reset at specific times. I will now turn it over to Dan Rollins.
  • Dan Rollins:
    Thank you, Tim. I am pleased to report that our team is on schedule to complete our integration of the former Franklin Bank offices before the end of this quarter. We’ve identified 13 of the former Franklin Bank offices that we can consolidate into nearby locations. The net result for our bank after this integration will be an additional 33 full service banking centers, brining our statewide presence to 158 offices. The Houston area will continue to be our largest market with 51 locations. We’ll have 36 banking centers in Central Texas, including San Antonio, 12 in the Austin area, and 7 in the Bryan/College Station market. Our Dallas/Fort Worth footprint includes 24 locations and our East Texas area, including Tyler and Longview will have 20 full service banking centers. Finally, we will operate 27 locations in South Texas including Victoria and Corpus Christi. The Franklin transaction again looks to be very attractive for us. At this time, I think we are ready to take questions. Katie?
  • Operator:
    (Operator instructions) We’ll take our first question from the side of John Pancari of JPMorgan. Please go ahead, your line is open.
  • John Pancari:
    Good morning.
  • David Hollaway:
    Good morning.
  • David Zalman:
    Hey, John, how are you?
  • John Pancari:
    Okay. Can you give me just a little bit more color on the linked quarter expenses growth I mean excluding Franklin? I just want to get an idea of what the core number was there for expenses and then what we should think about in terms of the growth rate going forward?
  • David Hollaway:
    You know I think that’s what I was mentioning earlier. This is Dave Hollaway. You know there are so many moving numbers here with this acquisition to really pin this down and that’s why I kind of made the comment it’s easier to think about it from an efficiency ratio perspective because if we are controlling that expense and as we normally do in these acquisitions, we start reducing the expense base that we have. This transaction is a little more unique because it is a failed transaction, we only had to buy parts of the institution versus a normal type transaction where you take the whole thing and then you start working from that. So, kind of couple of things I would say on that is think about it in terms of efficiency ratio and the other way to look at this that you are trying to pinpoint a number which is no guarantee of a run rate in ’09, but when you are looking on our press release you look at the quarterly numbers and you are looking at the expense piece of it. You can kind of see the numbers moving from third quarter to fourth quarter. You can make the assumption that allows that extra expense that you see is coming from the Franklin transaction. Dan?
  • Dan Rollins:
    That’s right. I think we’ve talked about this a couple of times, John. You know we – the net increase here of 33 offices, you can take another stab at it, which is like opening 33 de novos. We didn’t acquire the company of Franklin Bank, we acquired bits and pieces of it from the FDIC. So you are really starting with a zero expense base and building expenses as opposed to taking on a whole company and then cutting expenses. So I think from my perspective I see we are adding 33 new offices and I would look at it as 33 de novos, so go back to the third quarter numbers when Franklin wasn’t there, we were operating 130 offices in that expense base and you can see we are going to lay 33 new offices on top of that.
  • David Hollaway:
    And plus the other thing to think about is we brought – this transaction happened in November 7, so it wasn’t there for the full year.
  • Dan Rollins:
    Yes, you had two-thirds of the quarter. It was there for most of two months of the quarter.
  • John Pancari:
    Okay.
  • Dan Rollins:
    Did that help you, John?
  • John Pancari:
    Yes, it does, that’s helpful. And Dan, can you – just one thing margin, can you give us some detail on the how much of the compression you could attribute to the Frank – (inaudible) the Franklin deposits and then Dan any others factors? I mean just the compression was a bit less than I had anticipated and expected an increase of – I know it is – and I know you expected an increase in ’09 over the 4Q levels. So I am just trying to get some understanding, some added understanding of the impacts on the fourth quarter per se.
  • David Hollaway:
    Yes, I mean I will jump in on that one first. I mean the reality is if you were able to kind of peel off the Franklin part of the business and the offset of the reinvestment of deposits for the quarter, the prosperity standalone actually that margin held steady from the third quarter, I mean we were able to maintain on the core business. It didn’t go backwards in the fourth quarter. So you can see it’s that assumption is holding then you can see that there was tremendous impact from the Franklin part of the acquisition.
  • Dan Rollins:
    And you have to remember that in November we took the full $3.6 billion in deposits and we have that money basically 20 or 25 basis points Fed funds for not the full month in November but it was late in November before that money started really going to work. So you had a much bigger – the volume was higher in November and the rate – the margin deterioration from that in November was pretty significant. December was relatively clean. Most of the brokered money was gone by the time we got to December and most of the money had been invested by the time we got to December. I think that’s what Dave’s telling you. I think in your comments you said you expected to see a 5 to 10 BP, right, increase in margin over this quarter going forward.
  • David Hollaway:
    But I mean the assumption is absolutely spot on that that huge margin compression is directly attributable to the Franklin transaction.
  • John Pancari:
    Yes. Okay then one last question actually on credit. Just can you talk a little bit about the jump in the past dues, almost doubled. I just wanted to see what that was largely related to.
  • Dan Rollins:
    You are talking about the over 90 days past due number – ?
  • John Pancari:
    Yes
  • Dan Rollins:
    That went from $3 million – $4 million to $7 million?
  • John Pancari:
    Yes
  • Dan Rollins:
    I think at the same time we were pleased to se that some of the ORE dropped down. I think we are still fighting the same headwinds that we’ve been fighting, John. I think that in Tim’s comments, Tim, you may want to jump in here, but we saw the NPA numbers basically turn over 50% or 60% from one quarter to the next, so it’s the same thing we’ve been fighting all – for the last year now is we are looking at predominantly acquired credits over the last two years and we are just fighting the headwinds of cleaning those things up.
  • Tim Timanus:
    I think that’s exactly right. I mean there is probably less volatility in our credit markets as compared to elsewhere in the country, but having said that, we have volatility and it’s moving around and there are signs albeit not significant signs, but there are signs of deterioration out there. So it’s not surprising to us to see that 90-day number move.
  • John Pancari:
    Okay. Alright, thank you.
  • Dan Rollins:
    Thanks for your questions.
  • Operator:
    (Operator instructions) We’ll take our next question from Jon Arfstrom of RBC Capital Markets. Please go ahead, your line is open.
  • Jon Arfstrom:
    Thanks, good morning guys.
  • David Hollaway:
    Good morning.
  • Dan Rollins:
    Hey, Jon.
  • Jon Arfstrom:
    Doing a nice job.
  • David Zalman:
    Thanks.
  • Jon Arfstrom:
    Question on the loan growth number that you talked about, David. I know you’ve been – become a little more optimistic on loan growth that I am curious to what’s changed over the last three or four months and really what you are seeing now to give you confidence to say that you can put up that kind of growth.
  • David Hollaway:
    Jon, we think that Franklin, the Franklin transaction is a different than say the other transactions with the 1st Choice and Texas United, and Southern National in that when we bought those banks, we were probably outsourcing as much or more loans that they had in their portfolio than we were making. In this particular case, we got to buy just the loans that we really thought were really good loans, and so we don’t see a tremendous amount of roll off of loans from the purchase to begin with. And then, number two, I think with the dislocation of the markets, the way they are right now, we are kind of opposite of what everybody else is doing in the market; we usually always are. But when everybody else was really jumping into the market increasing their loan volumes by 20% a year you didn’t see us growing that much in the last couple of years. I think we are really finally getting an opportunity to see some credit that normally are coming back to traditional banking that probably were out in the markets and the commercial markets and the securitization market. So we are getting some opportunities to see those and we are looking at them because we are getting – we are not doing them like the securitization market, but we are getting to get personal guarantees again, we are getting to get rights. We are getting reasonable down payments and so all of those are coming back into the banking field and that’s what’s encouraging to me that we should see some – maybe some loan growth and pickup in this kind of time when other people are – really are in a position to do that.
  • Jon Arfstrom:
    So, you are saying that we can cherry pick the best customers that are out there from the banks that are not treating their customers the way they should be treated?
  • David Hollaway:
    Well I just think that everybody knows the economic times are different and whether banks sometimes want to loan, sometimes they can't loan just because of the situation that they are in. We’re in a very good position. We have a lot of liquidity and so we are just in – we are in the right place at the right time right now.
  • Jon Arfstrom:
    Okay. And funding for that growth I am assuming that cash flow off the securities portfolio may be some run off –
  • David Hollaway:
    Yes.
  • Jon Arfstrom:
    – relative to the loan growth?
  • David Hollaway:
    Yes. We have tremendous cash flow off of the portfolio. This year is probably over a billion dollars, probably a billion three, billion four, maybe.
  • Jon Arfstrom:
    Okay. Okay, and then in terms of the Franklin loans, are you completely through the portfolio and that process is over?
  • Dan Rollins:
    Yes, the process – the purchase of assumption amount with the FDIC gave us a 30-day exclusive right on those loans that was expended out to a 60-day exclusive right, which terminated on January, 5th, and we are outside of that one though now. We are still talking to some customers over there. We saw the ability to make those customers a loan, but we won't be purchasing anymore loans from the FDIC.
  • David Hollaway:
    And, Jon, I would also emphasize that Franklin, they had a lot of different types of loans. They had the loans that were in there what we call their retails banking centers and then they had another group that was a commercial group and several other groups. The only loans that we’ve really looked at were the loans that were made in their retail locations and those are the loans that we actually cherry picked on those.
  • Dan Rollins:
    That’s right. That is Franklin operated 45 community bank offices across the State of Texas and Central Texas and predominantly Central and East Texas and those 45 office had originated and were managing somewhere around $650 million in loans that are similar in process the way we do our lending, so you had customers in the field and you had lenders in the field taking care of that. Out of that $650 million in community bank credits, we looked at those as if we were making new loans for those customers and purchased $350 million, give or take, of those loans.
  • David Hollaway:
    Yes, and again and loans to individuals and companies and businesses, not – they are not wholesale, they are not wholesale loans or anything like that.
  • Dan Rollins:
    And the types of loans that we purchased I think that was a question whether you are asking or not, somebody will, especially the same types of loans that you see on our current portfolio. So we disclosed in there that the $52 million of that $350 million was in the construction category that was in the press release. The rest of it is probably proportionally spread across the rest of the categories of loans fairly similar to what we had coming into the quarter.
  • Jon Arfstrom:
    Okay. And then just a quick question on the accounting. You said you purchased these loans at book value so I am assuming it’s book value plus a reserve or do you end up marking that after you purchased or how does that work?
  • David Hollaway:
    Multiple answers there, one, yes, you are right, the TNA [ph] says purchase on that book value but ultimately they have to be brought over for accounting purposes at market value.
  • Dan Rollins:
    Now there is no reserve attached to them.
  • Jon Arfstrom:
    And that – so all of that would be – any marks would be reflected in the current quarter number?
  • David Hollaway:
    Well, I think the additional reserve that you saw in this last quarter where we actually reserved a provision $6 million for loan losses, we only incurred about $3 million, so there was additional $3 million in provision and that had – most of that had to deal with primarily the loan loss reserve calculation, which took into consideration these new loans basically.
  • Jon Arfstrom:
    Okay. Perfect. That’s what I was after. Thanks guys.
  • Dan Rollins:
    Thanks, Jon. Appreciate your help.
  • Operator:
    And our next question will come from the side of Ken Zerbe of Morgan Stanley. Please go ahead, your line is open.
  • Ken Zerbe:
    Thanks. I guess first of all just, dealing just a little bit more on the Franklin expenses in terms of the branch openings, I – so given what you said, the $5 million roughly is two-thirds of the – for the quarter, two-thirds of your total expenses, which imply total sort of Franklin run rate of around $8 million, given that you’ve taken on those 44 branches originally and I think you are going to close roughly 10 or 11 of those, is there any incremental or any integration cost or any kind of closing expenses that would probably be viewed as one-time as you close those branches or lay off any people associated with those branched that you did take on?
  • David Zalman:
    Not in the fourth quarter.
  • Ken Zerbe:
    But in the first quarter?
  • David Hollaway:
    I will jump in. Yes, I mean there is a lot of moving parts here and that’s the key to it because one of the things to point out is right now this Franklin of the business, they are still running on their data processing system, which is – which will be increasingly these costs significantly and I think that’s kind of where you are heading like if you are looking in this fourth quarter what are some of these one-time extra cost that are happening now versus as we go out into 2009 those start disappearing. I mean I think that’s absolutely right. Now trying to pinpoint what that number is, that’s going to be a little more difficult but the thought is correct that the expenses are a lot higher in this – for these two months and into the first quarter. And then by the time we get to the second quarter we’ll start streamlining this process. Dan, do you agree with that?
  • Dan Rollins:
    That’s exactly right. Your numbers were close. There were 45 – Franklin really operated 46 offices, but one of them was not a – so 45 banking centers and keep 33 of those coming forward.
  • David Zalman:
    I think Ken’s – the other part of the question was that do we foresee going forward any I guess may be Dave one-time charges as closing this and I would answer that Ken, this is David Zalman that we’ve taken all of that into consideration. There will be obviously integration cost and closing to that, but we don’t expect any of that to be extraordinary or any one big-time – one-time charges or anything like that.
  • Ken Zerbe:
    Understood. Okay, so maybe all of that expenses in the first quarter and they are slowly coming down as –
  • David Zalman:
    That’s right.
  • Ken Zerbe:
    New systems and –
  • Dan Rollins:
    Yes, that’s right. And I think we answered that in the – look at the efficiency ratio, we want to turn back towards where we were.
  • Ken Zerbe:
    Fair enough. The other question I had, just on the – you commented about the impact of where oil is in that overall Texas economy. I think you guys mentioned in your comments that Texas was starting to weaken a little bit. How such is that driven by oil? I understand that the economy did not build itself out around $140 per barrel of oil, but I am sure it had some impact.
  • David Zalman:
    I will take that, Ken. I think that oil does have an impact. It was starting to have a bigger impact. I think I mentioned in previous conference calls that what we started seeing really – first of all, let me say that if you looked at January’s oil price last year at this time, and January at the beginning of the year it was $60 a barrel. It wasn’t $140 a barrel. So let’s start from there. But we did see – as the price of oil started reaching these triple digits, we did start seeing commercial real estate rents, especially from our perspective, as we started re-milling probably two or three leases that we had on eight properties especially in the Eastern market, we saw that our leases that usually would run $25 or $26 a square foot, as we were starting to renew some of those leases, they were asking anywhere up to $30, $35 to $38 a square foot. So we started seeing prices really escalating. Now, we moved out of those building, two of those buildings, so we didn’t pay that. But I think that’s what the oil started to do. The good side of this is that the prices have come down but on the other hand from a perspective of housing in Texas the housing market and the prices never went up as considerably as it did in the rest of the nation. So will it impact us? It probably will. I mean you are seeing jobs right now that aren’t only from oil, it’s from all the other industries at the same time. But at the same time if you are talking just specifically about the oil industry, I don’t think that you are going to see any major layoffs like you did previously and the reason is last time that the oil companies did that trying to re-hire and get these people to know what they are doing, it was almost a virtual impossibility. So even if you see oil stay where it’s at or go down to some degree, I think that the oil companies are being lot loss fast to reduce staff when compared into the past. And that’s just a personal opinion, but overall we think there is a slowdown. We see it. Obviously the unemployment rate is going up, but having said that, we’ve taken all of that into consideration or calculation and because our real estate prices and almost all the other prices didn’t get out of hand over here, we still it’s going to be a pretty good economy compared to the rest of the U.S.
  • Dan Rollins:
    Yes, it’s also a positive for the consumer, Ken, when you look at the cost of gas. Over half the vehicles on the roads in Texas are SUVs and trucks that probably aren’t the most fuel efficient miles per gallon, so when you look at the – what the run up in cost of gas did and then the run back down, I think the average household – I think (inaudible) today the average household is somewhere between $150 and $250 a month increase in disposable income from the peak of the gas price. So there is a positive on the consumer side with a fall in gas prices.
  • Ken Zerbe:
    Understand. Alright, thank you very much.
  • David Zalman:
    Thank you, Ken.
  • Operator:
    And we’ll go to our next question from the side of Charles Ernst of Sandler O'Neill. Please go ahead, your line is open.
  • Charles Ernst:
    Good morning, guys.
  • David Zalman:
    Good morning.
  • Dan Rollins:
    Hi, Charlie.
  • Charles Ernst:
    Can you just talk a little bit about the balance sheet change? You had a large amount of money go from short-term running assets on the average balance sheet to basically nothing at quarter-end. And just talk about – it looks like it went into the bond portfolio. What were you buying? What kind of yields?
  • David Hollaway:
    Okay, I am not – you are talking about –
  • David Zalman:
    I will jump in as I think David will provide similar color. Probably what you are seeing is we were – had a lot of liquidity and Fed funds coming right up before the transaction, the Franklin transaction, because we knew it was coming and then that’s what I think David was saying earlier on. He took that – a lot of that liquidity and then jumped in and bought securities to offset the deposits coming. So –
  • David Hollaway:
    Ask your question again, Charles, I don’t if I quite understand.
  • Charles Ernst:
    The average for the fourth quarter in short-term running assets was $451.5 million and it was at 71 basis points on the balance sheet and – but if you look at the year-end balance sheet, the Fed funds was at $16.5 million.
  • Dan Rollins:
    Yes, the difference is – I kind of walk through that. We took – through the Franklin transaction we got three-point-something billion in cash basically on November 7th. All of that money went into a short-term investment until it could be deployed. And so that’s what’s driving that average for the quarter way up. We took in $3.6 billion in total deposits. A billion six of that was brokered money that stayed in short-term investment the whole time those brokered monies were here, which was basically a month. So you can take one month out of the quarter, three to four weeks. So you had a billion sic in there for three or four weeks of the quarter that was in short-term until that money went away and the other two billion that came in on the first of November stayed in short-term until it could get fully invested in the settlements on the bonds that David talked about buying. We bought $2 billion in bonds is November. And it took time for those to settle out. So that’s all the difference you are seeing.
  • Charles Ernst:
    So, can you just talk about what you are buying and what kind of yields were on those bonds?
  • David Hollaway:
    Yes, Charles, basically, we bought this really plain vanilla Freddie Mac and Fannie Mae mortgage-backed securities that generally had about 3.5% – I mean I am sorry, 3.5 year average life that would extend in the event interest rates went up 300 basis points. It may extend at least 100 probably from 3.5 years to maybe 4.5 years and most of our yields were in the – somewhere between 4.75%, 4.85%, 5% range for the most part. And again, if you look at our total duration, when we talk about earlier in my comments, right now basically our whole total portfolio right now has about 2.93, 2.96 average life and duration right now when you mix everything together.
  • Dan Rollins:
    You can also see that the averages – the average for the investment securities for the quarter was $3.2 billion and we finished the quarter at $4 billion, so you can see the difference where those numbers came from, Charles.
  • David Hollaway:
    Yes, I would comment that basically we did this deal on November 7th, but for the most part, we are a bank – if you want to try to put this together, we didn’t make any money off of the investments for that whole – for the month of November, basically. I mean basically we were purchasing the bonds and most of them didn’t – we did settle on some, but most of them didn’t really start settling until we – the full effect of the purchases were probably is starting in December. And I remember too that we had $1 billion probably in these brokered deposits that basically took us three weeks to get out of. We started 7th, and we kept that in the Fed funds right at what 25 basis points (inaudible) basis a point somewhere between 25 and 100 points. So we were doing our best just to offset. That’s not costing us anything really.
  • Dan Rollins:
    If your question is modeling out going forward should you averages or should you use period end balances you need to start with the period end balances.
  • Charles Ernst:
    Okay. So my ultimate question on this subject is if you just do the math about looking at the average versus the period end, and you move the $400 million into a yield that you guys were talking about, a 475-type yield, then just that shift causes the margin to go up by over 20 basis points. But your guidance says that the margin is only going to 5 to 10 basis points higher. So is it just conservativism on your part or what else should we be thinking about what other dynamic is impacting the margin?
  • David Zalman:
    Well, one of the dynamics is and I think somebody said this earlier is that cash flow off the bond portfolio. I think so much there is a billion, billion two range for this upcoming year and you have to ask the question where is that money going. If we don’t lend it out we have to take the conservative approach and say we are going to reinvest in the bond portfolio. Well today you’d have to ask the question what kind of reinvestment rate would you be getting on that. And I don’t think it’s 4.85% or 5% in the bond portfolio.
  • Dan Rollins:
    Well you’ve got another – you know there is a whole bunch of moving parts in there, Charlie, but when you go down to the CD line, there is – it shows an average of the quarter of $2.8 billion. That includes that billion six in brokered money. We put those brokered monies on for the whole time they were here at 25 basis points. So that held the cost of that money while it was here down.
  • Charles Ernst:
    Right.
  • Dan Rollins:
    So that is negative to your number. I think you are a little high on your calculation.
  • Charles Ernst:
    Well, the math is that if you just move – if you just did what you said you guys did on the short-term running assets then I mean that adds a lot, but I appreciate the comment about the cash flow rolling off so – and just to be clear the expense guidance that you guys are loosely giving, the efficiency ratio you are talking about is a GAAP efficiency ratio in kind of the that mid-45% range?
  • David Hollaway:
    Yes, I would say again we said by the end of 2009, so for starting at the – our number, we are showing 48%. Yes, I would say we are going to drive that thing back down into the 46 to mid-45 range, but that would be by year-end. So you have to average that thing out over the year.
  • Charles Ernst:
    Okay. And then my last question is in terms of earning assets if I look at the period end balance sheet it sounded like you are going to run off some ordered funding so that means that bonds will probably shrink a little bit, but you are also going to grow loans, so is it fair to assume sort of a flattish average earning asset balance throughout the year off of the period end numbers?
  • David Hollaway:
    Yes, I think I do. It’s because again if deposits – to see some numbers I guess to say if we lose $500 million in CDs we can fund that with some of the security cash flow then we are actually do (inaudible) on the loan side again the cash flow can do that so I think that’s a good assumption.
  • Charles Ernst:
    Okay. And – I apologize – one last question. So you guys think that the Franklin deal basically did not earn anything – add anything to earnings per share this quarter, is that quite sure?
  • David Hollaway:
    For November it didn’t. I think we started seeing things come in December.
  • David Zalman:
    I mean it might have added just a little bit. I mean it’s not going to be significant if that’s what you are seeing.
  • David Hollaway:
    Well, yes, Dan, if I can get point of view too. If you count the provision in there, we probably didn’t.
  • Dan Rollins:
    Yes. I mean on the core business, if you were just trying to run a core and try to back into it, I mean we are not talking anything significant here in the fourth quarter.
  • Charles Ernst:
    Okay, great. Thanks a lot you guys.
  • Dan Rollins:
    Thanks, Charlie.
  • Operator:
    And we’ll take our next question from the side of Jennifer Demba, SunTrust Robinson. Please go ahead, your line is open.
  • Jennifer Demba:
    Thank you, good morning.
  • David Zalman:
    Good morning.
  • Dan Rollins:
    Good morning.
  • Jennifer Demba:
    My question is about the construction portfolio, which I guess is about $666 million now. Can you give us a sense of what kind of loss content you see in that portfolio this year and what your current NPA level is out of that portfolio?
  • Tim Timanus:
    Jennifer, this is Tim. I don’t think that we foresee really any change in the loss in that portfolio. (Inaudible) there is no given in that regard, but based on the credits that we have and our assessment of those credits, we just don’t see a large swing there.
  • Jennifer Demba:
    Do you have any non-performing assets in that portfolio right now?
  • David Hollaway:
    We do –
  • Tim Timanus:
    I don’t have a breakdown of exactly how much that is.
  • Dan Rollins:
    We don’t break the NPA by type like that. But, I think we had non-performing in the construction portfolio for the whole year.
  • Tim Timanus:
    That’s correct. It’s safe to say, Jennifer, that I don’t think it’s significantly a higher percentage now than it has been, if that answers your question.
  • Jennifer Demba:
    Okay. Thank you.
  • Dan Rollins:
    Thanks.
  • Operator:
    And we’ll take our next question from the side of Erika Penala, Banc of America. Please go ahead, your line is open.
  • Erika Penala:
    Thanks. I just wanted to clarify a number that was mentioned during the prepared remarks. How much in run-off do you expect for the run-offs in the Franklin assets portfolio?
  • Dan Rollins:
    Franklin deposits?
  • Erika Penala:
    Yes.
  • Dan Rollins:
    How much run-off do you have from the run off – ?
  • Erika Penala:
    Yes, how much further run-off do you expect?
  • David Zalman:
    Again, as we said coming in, we are talking about their higher priced CDs and so we are in the in the range anywhere from $300 million to $600 million because of – what does it show on the 12/31 about $2 billion in bonds – ?
  • Dan Rollins:
    $2 billion, yes. You know when you look at what Franklin was, Erika, their community banks that they had acquired going back to 2002 forward I think that we looked at that transaction as roughly a billion five in true core lower cost sticky core funding. And then over the last year or so they had paid some higher rates on some retail deposits and balloon that balance sheet up to the current $2 billion number. So our expectation is that those customers that are rate choppers and rate sensitive that ballooned up $500 million give or take in new deposits over the last year or so where probably not going to be competing for the rate chopper high rate deposits going forward. And as that matures a part of that will probably move out. That’s where Dave comes back to the $300 million to $600 million number.
  • Erika Penala:
    Well, could you – go ahead.
  • David Hollaway:
    Having said that, again is that monitoring what we are monitoring right now, though, we don’t seem to seeing as much of a run off as we thought that it would be too. Now just you know it’s probably too early to tell, but that’s just a little bit of color too.
  • Erika Penala:
    Could you give us a sense in terms of that – those deposits you are targeting that could potentially run off with roughly the cost of deposits are right now?
  • Dan Rollins:
    Well, I don’t know that we have a number to tell you, the average cost of those deposits because let me – I will walk you through the process here again. They are not on our computer system. We can’t slice and dice numbers the way we would normally be able to do if we had converted them onto our computer system. So we are running kind of with our arms tied behind our back. But I can tell you the weekend that Franklin failed, they were running full ads the Saturday and Sunday after they failed on Friday, at 4.25 for CDs. So, you know the market at that time was three or less so the answer is they had a higher base to start from than what we certainly had it all.
  • Erika Penala:
    Going back to some of the comments that were made, I think I am – I don’t know if I understand it correctly. You mentioned that when oil prices were going up, commercial real estate rents were rising in kind. Were you talking about your own needs or were you talking about color from your commercial real estate borrowers?
  • David Zalman:
    No. This is David Zalman. When I was referring – I was referring to as our leases had started maturing, and we started looking at new leasing prices, the prices we were being quoted was affecting us. So –
  • Dan Rollins:
    For our own needs.
  • David Zalman:
    For our own needs basically, but I am sure that was starting the impact to everybody else’s –
  • Dan Rollins:
    Yes, but that applies to the whole market.
  • David Zalman:
    Right.
  • Erika Penala:
    And do you expect in your term commercial real estate portfolio in ’09 for some asset classes as some of the leases come off, do you expect some of the rents to start coming down, renegotiated lower?
  • David Hollaway:
    You know, we – Tim can answer this, but our portfolio probably doesn’t consist of any major buildings that $150 million buildings, that’s not our portfolio. So I don’t think that we ever got to that point really. Tim you may want to add.
  • Tim Timanus:
    That’s exactly correct. We have virtually no large office buildings or complexes in our portfolio. So, from an office perspective, we are not directly impacted by that in an extremely significant way. And really the same thing is true on the retail side. We have very few big box retail sites that we have financed. There are some, obviously, but they are not that many, and we are all cognizant of the difficulty that many of these large retailers are experiencing right now. So, we don’t see an immediate direct impact from that either. Obviously there is fallout from any negative economic activity that occurs. So indirectly we could be affected by all this at some point in time, but we don’t see it starting us in the face right now.
  • Dan Rollins:
    Remember, Erika, our portfolio is very granular. The average credit size in that commercial real estate box or the commercial real estate bucket is still in the $400,000 range. So, lots and lots of relatively small credits. Tim’s right. We have some bigger credits in there, but we also have some smaller credits in there.
  • Erika Penala:
    And my last question. Can you remind us what your direct lending exposure is to the energy sector?
  • Dan Rollins:
    We really don’t break out a sector exposure like that. When you are talking about energy credits per se we’ve discussed amongst ourselves with our Chief Credit Officer and our Chief Lending Officer and the four of us in this room and we don’t break it out that way but I can tell you from an exploration and production standpoint, we don’t have an exploration and production department. We probably do have a few credits that are secure by producing oils, insignificant amount and we probably have some credits that are secured to oil field service type companies for equipment or trucks or tanks or whatever. Again, a very, very small part of our portfolio.
  • Tim Timanus:
    That’s correct. It’s not a significant portion of our lending.
  • Erika Penala:
    Thank you.
  • Dan Rollins:
    Thanks. Erika.
  • Operator:
    And we’ll go to our next question from the side of Chris Marinac of Fig Partners. Please go ahead, your line is open.
  • Chris Marinac:
    Thanks guys. I just want to understand about the goodwill change in the quarter end. To what extent you may be able to revisit that as you have further runoff on the deposits from Franklin.
  • David Hollaway:
    Chris, I don’t think there will be any goodwill impairment. When we bid on – and this is what you are getting at – when we made the bid we really didn’t anticipate – our bid was based on what we thought we would end up with in deposits, not what’s running off right now.
  • Dan Rollins:
    I guess I want to make sure I understand your question, we went from 811 in goodwill to 876, that’s what you are saying, Chris?
  • Chris Marinac:
    Right. Exactly.
  • Dan Rollins:
    Okay, and yes, the – that’s basically the premium on the Franklin transaction.
  • David Hollaway:
    And again, we didn’t – we never bid based on the deposits being – those deposits that were there. We made on our bid based on what we thought we would end up with.
  • Dan Rollins:
    Right.
  • Chris Marinac:
    Okay. So the premium dollars and dollars is what ultimately gets booked in the goodwill and that will be fixed in –
  • David Hollaway:
    That’s right.
  • Dan Rollins:
    Correct.
  • Chris Marinac:
    Got you. Great. Thanks guys. Appreciate it.
  • Dan Rollins:
    Thanks, Chris. Appreciate you.
  • Operator:
    And we’ll go to our next question from the side of Andy Stapp of B. Riley and Company. Please go ahead, your line is open.
  • Andy Stapp:
    Good morning. Nice quarter.
  • David Zalman:
    Good morning.
  • Dan Rollins:
    Hi, Andy.
  • Andy Stapp:
    Could you tell me how your 30-89 delinquencies faired quarter-to-quarter?
  • Dan Rollins:
    I think the answer is they were actually a little bit better in the fourth quarter. Tim, I don’t know if you’ve brought any of those numbers with you, 30-89 past due.
  • Tim Timanus:
    No, I don’t have it broken down, but there was not significant deterioration.
  • Dan Rollins:
    And I think we actually finished the fourth quarter better than we did at the third quarter, but again not a material number change.
  • Tim Timanus:
    Yes, I think, Andy, for your purposes it was flat.
  • Andy Stapp:
    Okay. And would you happen to have what your net interest margin was in the month of December?
  • David Hollaway:
    Yes, we do and that’s where we are coming – you know when I talked about earlier, when we were talking about look at our margin expanding, that’s kind of the range that our December margin was in. We already had seen improvement from – as I think you said earlier, November just we did move fast enough to get all that money reinvested, but once December rolled around, we did some expansion in that margin, so that’s where we are coming from when you talk about that.
  • Andy Stapp:
    Okay. And do you expect any deposit run off from the Franklin branch closures or they are just being rolled into nearby offices?
  • Dan Rollins:
    Yes, they are all being rolled into the nearby offices. Obviously, we are expecting to see some runoff in the hot money or the high cost CD money, but the offices that are being consolidated, eight of those offices are literally a block or less apart. So they are very close, so – we are not abandoning a big block of deposits by closing an office if that’s your question.
  • David Hollaway:
    And they are most of them CD –
  • Dan Rollins:
    Yes, they are mostly CDs, yes.
  • David Hollaway:
    Hot money bond anyway which is part of our number.
  • Dan Rollins:
    That’s right.
  • David Zalman:
    I think it’s probably important to point out that while we still anticipate a runoff of some of that higher priced money, I think that the sensitivity to the risk where people have their money is heightened at this point in time.
  • Dan Rollins:
    That’s right.
  • David Zalman:
    So, as David mentioned earlier, we actually haven’t seen quite as much of it run off yet as we thought although it’s early in the game, but it may be that some of these people are looking at bank and realizing that we are probably not getting ready to go out of business and therefore their money is safe. So the rate may become somewhat of a secondary issue (inaudible).
  • Dan Rollins:
    Yes, we are still thoroughly in the game. We are less than 90 days in. The rebranding process is just on the very early stages of – it will be – by the end of this quarter everything will be rebranded, everything will be competitor conversion, changeover and we’ll all be on one platform by the end of this quarter and we’ll have a much clearer picture of kind of what’s happening at that point.
  • David Zalman:
    Dan, you may want to – one of the other guys asked a while ago and we probably didn’t go into it about the – closing some of these offices and stuff like that. You might want to mention that. We are only having to take the offices.
  • Dan Rollins:
    That’s right.
  • David Zalman:
    You might want to go into that just a little bit.
  • Dan Rollins:
    Yes, somebody was asking on the expense side, under the purchase and assumption agreement with the FDIC, the way that works is we only purchase or assume the leases on the locations that we want to keep. So the offices that we are not taking, we don’t really have to do anything to close those offices or vacate those offices. The nice part of this transaction is that, that becomes the FDIC’s problem and if we don’t want to keep it we move out and it becomes theirs to either dispose of or re-lease or whatever they have to do. So that’s a positive from the expense run side.
  • Andy Stapp:
    And these will all be closed in the first quarter?
  • Dan Rollins:
    Yes.
  • Andy Stapp:
    Okay, thanks.
  • Dan Rollins:
    Thank you.
  • Operator:
    And we will go to our next question from the side of Maclovio Pena [ph] of Morningstar Equity. Please go ahead, your line is open.
  • Maclovio Pena [ph]:
    Morning, guys.
  • David Zalman:
    Good morning.
  • David Hollaway:
    Good morning.
  • Maclovio Pena [ph]:
    Looking at your tangible common equity ratio, it fell from about 6.28 to 4.18 between September and December. A large part of that was driven by the intangibles there from Franklin, and you did mention that in the case you were interested in acquiring something you would raise some equity by the traditional means. But without any acquisition, how comfortable are you with this ratio so low?
  • David Zalman:
    Well, obviously – this is David Zalman. If you go back in time and in history, starting at the end of last year was probably the highest capital ratio that we ever had. I would first point out that our Tier-1 ratio is 5.66%. Now, that does take into consideration $100 million of preferred stock at 4.18% or whatever tangible capital ratio didn’t have. But if we didn’t have – if we were running at 75% or 100% loan-to-deposit ratio like a lot of the other banks, first of all, it is not sustainable. And if you didn’t have the credit quality or asset quality that we have now or ever had over the last 20 years, that’s not sustainable. But again when you are running the asset quality that we are, it is lower. On the other hand, our earnings – just our natural earnings that I think the analysts have is at about $2.13 the mean this next year. If you just take that number and add back by year-end, what we’ll have in just a straight tangible capital ratio after dividends is going to be well over 5%. So, we have very, very strong earnings that helps compensate for the lower ratio.
  • Dan Rollins:
    We really look at it as a risk model, and that’s what David is talking about. If you paint with a broad brush and you are looking for the low tangible numbers, my guess is we will be in that group. But I think you have got to look at it in the context of the full balance sheet, and with a 50% loan-to-deposit ratio, $4 billion of the assets predominantly in agency mortgage backs and 20 BPs of non-performing on average earning assets, I think we feel very comfortable.
  • David Zalman:
    If you can feel comfortable in today’s. I don’t know that it would be realistic to say that a bank like ours would have the same capital ratio as of one that had a different profile than ours. I mean, I know a lot of people right now are almost in a cynical position in saying that everybody should have 8% or 9% capital. It is nice, and it would be nice to have, but again, I don’t think you can paint everybody with the same brush.
  • Dan Rollins:
    That’s right. That’s right.
  • Maclovio Pena [ph]:
    Okay. Thanks for your time.
  • Dan Rollins:
    Thank you.
  • Operator:
    And we will take our next question from the side of David Bishop from Stifel Nicolaus. Please go ahead, your line is open.
  • Dan Rollins:
    Hi, Dave.
  • David Bishop:
    Hey, question in regards to the outlook for loan growth next year. Just curious where you think – what sort of segments are you seeing yourselves get compensated from risk adjusted basis or do you think that’s going to be more sort of market share transfer from some of the other regions that might be struggling from liquidity or capital?
  • Dan Rollins:
    I only heard two questions in there, David. Where are the loans coming from, is it new credits being generated in the economy or is it stealing credits from other players. And two, what types of credits do we think we are getting properly rewarded for on the risk. I guess what you are really asking is if we want to add more CRE or more construction loans. I think David answered a part of that earlier when he was saying that the market today is allowing more traditional credits the way they were years ago where the borrowers that had the financial wherewithal are now – they are signing personally again, where for a while the personal guarantees went away. The equity requirements and credits that for all practical purposes went away over the last few years, now there is a requirement that they have real cash equity back in the transaction. So I think the risk side, I think it is good.
  • David Zalman:
    Yes, to answer your question, yes, I think the loans come from two places, the super regionals that where making loans that have these 100% loan-to-deposit ratios, whether they want to or not they have to cut back. The Streets make them and everybody else, at least until they get their loan losses into a more stable environment and their loans into a more – until we get into a more stable economy. The other part is what Dan is saying, the loans are coming – probably we're getting new opportunities where people in the past were going after the securitization market. Those types of people are coming back in and are willing to do what we said earlier, sign personal guarantees, put real money down, and we are getting an interest rate. But also, I would like to say that we are not doing that for everybody. This is a time when you can really pick and choose and we're going with people and companies that have been around not one year ago, not five years ago, but people that have been around in business and we know them for the last 20 or 30 years. We are looking for that type of opportunity where people – we couldn't get those credits in the past because they weren't willing to pay the rate, they weren’t willing to do the terms and conditions like we want. Those are the kind of companies that we are going after right now. Tim, do you have any comments on that?
  • Tim Timanus:
    I think that is all exactly correct. We hope that we are looking at all loans closely, regardless of the segment and that certainly holds true for all real estate loans. But it’s a reasonable guess that not every homebuilder is going to go out of business, for example, and if we can pick up somebody that has been in that industry for a long time that we have known and watched, and been unable to do business with because they’ve gotten lower rates and less down payment requirement historically, we are trying to embrace those kinds of credits. And they come from all segments of the economy. So, the growth, if it comes, will be from all sectors, probably less real estate than others. But it will come from all sectors.
  • Dan Rollins:
    Does that help you, Dave?
  • David Bishop:
    Yes. And then maybe one housekeeping item. The dollar amount of the FDIC deposit insurance premium this quarter, I know that it’s not there going forward –
  • David Hollaway:
    Yes, that thing is significantly increasing. I mean, per monthly this past quarter is like $250,000, which was significantly higher than prior quarters, and then if we're into the new year, that number is on an annualized basis, you are somewhere in the $7 million range.
  • Dan Rollins:
    So third quarter it was running at about $100,000 a month, and the fourth quarter, it was $250,000 a month, and you are expecting it to be $500,000 plus a month going forward?
  • David Hollaway:
    Yes, on an annualized basis, $7 million.
  • Dan Rollins:
    $7 million.
  • David Bishop:
    Right. Thanks.
  • Dan Rollins:
    Pretty significant jump. Thanks, Dave.
  • Operator:
    Thank you. We will go to our next question from the side of Bob Patten of Morgan Keegan. Please go ahead, your line is open.
  • Bob Patten:
    Hey guys. That FDIC question was the last one I could come up with, but I will ask you – and this has gone on too long, so I will let you guys go. And just a thought process, when you guys did the third quarter, oil would come down from $145 to like $93 at the end of the third quarter, then it closed in the fourth quarter at $33. What kind of shock testing do you go through when you look at your portfolio? I understand that you are not big in energy directly, but it’s a whole ancillary issue with a lot of different businesses.
  • David Zalman:
    Are you talking about shock testing for oil and gas production loans?
  • Bob Patten:
    Well, not only that, but you know, jobless, when you saw oil go down that quick, obviously you guys had to be looking at what the net effects were to your overall market in terms of loans across various spectrums.
  • David Zalman:
    First of all, Bob, though you have to say that oil went up pretty quick. I mean if you looked at last January, oil started at $60 a barrel.
  • Bob Patten:
    Absolutely, yes.
  • David Zalman:
    It went to $140, so it went up real quick. Do we do testing? The answer to that is yes. All of our commercial real estate is tested and it is tested on several factors – Tim, you may want to jump in – but – and again Chris Bagley is our Chief Credit Officer, does this for us. And they look at it as basically on a collateral basis, on a valuation basis and valuations drop and where we are at and – I don't have the exact numbers, but I was really impressed by what our average valuation to value was, and Tim, I don't know if you remember that. It can drop pretty dramatically and we are still covered. Was it 50% range, I don't want to give you a number that’s not accurate.
  • Tim Timanus:
    Well, I'm not sure it was that good.
  • Dan Rollins:
    You are talking real estate, he is talking C&I, but –
  • Bob Patten:
    I am talking everything.
  • Dan Rollins:
    So, yes, I think the answer to your question is as we review all of the portfolios, but to put a number out there for you, I don't think that we can do that today, but I think the part of the portfolio that’s directly tied to energy we believe is very, very small, very, very small and then we are all tied to it. When you get down here, we all drive cars that use the gas and Texas does have a big part of the state tied to oil and gas production, more gas certainly than oil, you know I think we missed that part of the puzzle here.
  • David Zalman:
    But Bob is making a good point too and I think something that may give you a little bit of a comfort level that we do, that I don't know that all banks were doing, were a lot of banks would make loans based on a certain asset or the asset itself and the cash flow from that asset. We have always done what’s called a global cash flow. So we take a borrower's total indebtedness, what they have, and their total income where they bring in everywhere, and we stress that when we're making the loan to determine if there are certain changes, if there are certain deals that go bad, can that customer still continue to pay, where I think in the past a lot of banks haven't done that and we have done that since we have been in business really.
  • Tim Timanus:
    I think it is important to point out that a) as we have said, we don't have a significant direct exposure to the energy industry, but b) what exposure we do have by and large is to credits that have been out there in the marketplace for quite some time. A lot of these companies went through the depression in the oil field in the ‘80s, and the price of oil and gas actually right now is very attractive on a relative basis to where it was back then and those people learned a lesson and the lesson they learned was that debt is not a good thing. And as a general rule, they are not extremely leveraged. So that helps them during these periods when the price of their commodity dips. So there is no guarantee that the energy sector is going to stay healthy, but my point is that a lot of these companies in terms of the structure of their balance sheet are much better off this time around than they were last time around. There is just not as much leverage out there.
  • David Zalman:
    I would also go a step further in saying that the banks, they didn't put everybody in business the way they did in the prior boom and gain that boom – if you want to call it a boom on the asset for very short period of time, so you didn't see a bunch of new people jump in but banks in general didn’t –
  • Dan Rollins:
    Because they were busy putting people in the homebuilding –
  • David Zalman:
    I guess (inaudible) but in the 80s, everybody that have gone to work over rigs, started the vacuum truck service or oil and production and that didn't happen. In fact, to the contrary, we have had a couple of our customers, believe it or not, that are in the oil and gas service industry call us and they have reserves built up and wanting to buy something like we do that may be having a hard time. So it’s much different. I think the oil industry this time is much stronger than your – if you saw the weakness, I think it’s more – as Dan has pointed out and I joked him away, but I think everybody was putting every home – everybody in the homebuilding business – they were putting them in the oil and gas business.
  • Bob Patten:
    Yes.
  • Dan Rollins:
    Thanks, Bob.
  • Bob Patten:
    And then one other quick question. We talked about capital, are you guys really or highly confident, would you say, modestly confident that you guys could raise common in this current environment?
  • David Zalman:
    Well, I can only – the reason I want to be cautious on this, I don't want to be sued one day because you say automatically that you can just automatically raise it, but we have had a number of different investment firms that have contacted us and have told us that we have the ability if we needed to raise $200 million or $300 million in a very quick fashion –
  • Dan Rollins:
    From a position of strength.
  • David Zalman:
    From a position of strength. And we maintain the position of strength that we're in today. You know, our asset quality stays where it is, and our income stays where it is and we should be able to raise money. They’ve reassured us that we can raise money where we are at, and also if we ever find a bigger acquisition that there will be money available for a large acquisition as well. Again, if we stay in the position that we are in, you know, things change on a daily basis it seems like today.
  • Dan Rollins:
    Our model continues to be very simple, Bob. Keep it simple, take care of the simple things, we have not invested in esoteric products. We want to keep simple plain vanilla type loans on the balance sheet where we can watch the credit quality. Our investment portfolio is that way. So asset quality continues to be a core strength. And then I think on the expense side, I think in today’s market, we have got to watch the dollars that we're spending and Dave Hollaway does a great job of that for us and I think that is part of what makes us be successful.
  • Bob Patten:
    Thanks guys, appreciate it.
  • Operator:
    Thank you. We will take our next question from the side of Ariel Scosche [ph] of Omega [ph]. Please go ahead, your line is open.
  • Ariel Scosche:
    Hi guys, how are you? This is probably a good follow-up to that last question, but I wanted to discuss more. If you could review – what are your criteria for doing deals and if you could just review both what your criteria would be for buying a bank as well as what your criteria or what are the metrics you use when thinking about doing an assumption transaction like an FDIC-type transaction?
  • David Zalman:
    Well, Ariel, this is David Zalman. The criteria that we use is everybody in this room probably has a majority of their net worth tied up in our bank’s stock. So unlike somebody else, we have egos, we have only meant that we don’t have egos, but to say that we want to do a deal just to be $2 billion, $3 billion, $4 billion or bigger has never made me very enthusiastic. The criteria for doing deals and from what our perspective is, is are they accretive? Can they make us extra money? We have always been – we have always looked at earnings per share from the time we started this and we saw some of the numbers what we started off in 2000, when we were making $0.76 a share, and today we made $1.86 a share. We are always focused to shareholders on continuing earnings and the earnings per share growth for us in building capital and getting a cash machine. So in the past, we didn’t have the FDIC deals. The FDIC deal, there is no question, they are very, very nice because they exempt you and take all the litigation away from you. You can buy things right now reasonably. But, having said that, this is how we got our start back in the ‘80s. This is what we did, we bought FDIC deals. Now, having said that, once the market turns, sometimes those deals get more expensive than a regular conventional deal. So, I wouldn’t rule out a regular conventional deal that is not an FDIC deal if it made a lot of sense that maybe it can enhance our capital position, but it’s always got to increase earnings per share and basically, we have never done a deal yet that has not been accretive to the bottom line.
  • Ariel Scosche:
    In what time period?
  • David Zalman:
    One year.
  • Ariel Scosche:
    In one year. You know, you sort of alluded to this, I mean my next question was if you could just reflect on your experience so far with Franklin. Have you learnt things in that transaction that make you more or less willing to do future transactions and suddenly, have you – in your ongoing discussions with the FDIC, do you think that they feel too that it was a good transaction for them and that they will be willing to do – you know, come to you when other ones perhaps are available?
  • Dan Rollins:
    We are still early in the process with the FDIC on this transaction, but the simple, easy answer, Ari is that from our standpoint, you know, I can’t speak to whether it is a good transaction for the FDIC or not, I mean, I think they hoped that banks would never fail. But from an acquisition standpoint, I think David hit the nail on the head. When we have looked at banks in the past that wanted to partner up with us, if they had asset quality issues that can create us a problem because we don’t want to bring that across, we want to divest the asset quality problems prior to closing. That is a harder thing to do in today’s market. The litigation piece just is huge and so the fact that you come into this transaction clean and you took the deposits, you got the cherry pick the very few loans that we did, the assets that came with it were government securities, treasuries of agencies, and then we can hand pick or cherry pick the best locations that we want to occupy, be them theirs or ours that there is overlap. And all those things make this a very, very attractive situation for us. I don’t know if there is a whole lot of those opportunities out there. You know, there just aren’t that many that would be a good fit like this for folks. But certainly, if there were other opportunities out there, I think our relationship with the regulators is excellent.
  • David Zalman:
    Let me just say we are on the list and we see things weekly as we are right now.
  • Ariel Scosche:
    One other question is – you know, in terms of your capital levels, I would imagine that the level that both you and your regulator would allow is from a comfort standpoint of your minimum level, it is probably higher than it would have been a couple of years ago when looking at transactions. Do you have a sense or do you have a benchmark in your head for what those levels would be, so if you did a larger transaction or a transaction that is more expensive then it would cause you to want to do a simultaneous capital raise?
  • David Zalman:
    You know, I’m not going to give you a direct answer because if these leaked back in the ‘80s, depending on how bad things got or – almost every deal is a different deal and your negotiations with the FDIC and your primary regulator is on a one-on-one deal. And sometimes, just like we look at loan customers, they look at us and they look at other banks at the same time and they value the management, they judge the management, they judge what your past record has been, they judge your asset quality, and all those things come into consideration when they are looking at what a capital ratio is. In the ‘80s, we thought they let us go extremely low one time and gave us some dispensation to catch up over a 12 month period. So, I really can’t tell you what their core numbers are going to be. I think it is really – their job is to get the best deal at the best time and they have got to make that decision to see who is the best group for it and who is going to make it happen and they don’t it want it back again.
  • Dan Rollins:
    The regulators here both on the safety and soundness side that we deal with, but in particular, we have been dealing with them on the resolution and recovery department that they have that is doing the failed transactions. They have had nothing but nice things to say. They are good folks, they are working hard, and I think they think they are overworked a little bit, but they are good folks and they are trying hard to do the right thing for the FDIC.
  • Ariel Scosche:
    Do you get the sense that the TARP funds for the banks that perhaps were more likely to look for outside solutions, you know, how does the TARP lifeline change the dynamics of what sellers want to do and how they look at their options?
  • David Zalman:
    You know, I may be wrong at this but the people that really took the TARP money in my opinion, and this is probably not 100%; they took the TARP money because they had specific needs for it and that is one to boost capital or they are at a 100% loan to deposit ratios and they need to make more loans. I think that anybody that really was in a good position, you wouldn't have taken TARP just to take it, because somebody said it is cheap if you really looked at all the variances and things about it. But I think the bottom line, I think the people that took it out the banks that took it, took it for a specific reason, and I don't think that is necessarily for acquisitions.
  • Ariel Scosche:
    Very good. Thank you, guys.
  • Dan Rollins:
    Thanks, Ari.
  • Operator:
    Thank you. (Operator instructions) We will go to our next question from the site of Jordan Hymowitz of Philadelphia Financial. Please go ahead, your line is open.
  • Jordan Hymowitz:
    Hey guys. Thanks for taking my call. Do you break out your reserve related to just construction loans?
  • Dan Rollins:
    No, sir. We really don't break the reserve out based upon loan types.
  • Jordan Hymowitz:
    Okay. Let me ask the question in a better way. Your bank's credit has been excellent by a mile, but a year ago was also excellent and you had the reserve at this level. My question is, will you take the opportunity to increase the reserve now that you can, now there is no more regulators breathing down your neck to keep the reserves low or do you want to just keep it at this level until you have actually chosen deterioration?
  • Dan Rollins:
    So you will come out of the back and spend 104, 105 now for four or five consecutive quarters?
  • Jordan Hymowitz:
    Yes, and a year ago, everybody was at that level. So even if you wanted to double it to be pretty, you couldn't do it but now that everybody is substantially higher, due think you might – forgetting what the actual losses are, you think you might take the average unit and boost it up just to be conservative?
  • Tim Timanus:
    Jordan, this is Tim Timanus. We have a very clear methodology which we employ in looking at the reserve and monitoring reserves and it is a methodology that regulators have deemed acceptable, our auditors have deemed acceptable, and more importantly, it is one that we think actually works. And right now, following that methodology in how we evaluate it, we think our reserve is fine. We have a formal recalculation of it quarterly; we actually look at it monthly. If at any point in time the factors change and if circumstances change and we feel like we need to add to it, we're going to add to it. So it is not a matter of being predisposed one way or the other about it. We're going to be flexible and we're going to adjust to circumstances and we will add to it we need to.
  • David Zalman:
    I think that is a good point, Tim. You know, when times are really good, everybody was adjusting or dealing going down. As times got back, everybody is going the other way. I think just doing it based on what you methodology says and being consistent is more important than just trying to change the numbers for our earnings a lot of times.
  • Jordan Hymowitz:
    But the magnitude concerns the frequency and severity of losses and if you look at just the Houston Feds site, things have deteriorated pretty rapidly in the past three or four months, so whatever assumption you have has got to be worse now than it was a year ago.
  • David Zalman:
    I think that is true, I mean, I think that is why you saw – in our last quarter, you saw that we made a $6 million provision and we only had $3 million in charge-offs and one of the primary forces driving that decision is you have a number of different factors that influences what that calculation should be and one of them is economic factors and that was probably one of the things that really boosted that reserve for this last quarter.
  • Tim Timanus:
    That is exactly correct. That is one of the pieces that we look at continuously, and we will continue to do so and obviously, it is not the only piece, but we intend to react to it on an as-needed basis.
  • Dan Rollins:
    That help you, Jordan?
  • Jordan Hymowitz:
    Yes, thank you.
  • Dan Rollins:
    Thank you very much.
  • Operator:
    And we will go to our next question from the side of Daniel Cardenas of Howe Barnes. Please go ahead, your line is open.
  • Daniel Cardenas:
    Hi, guys. Thanks for all the color on the quarter. Just one acquisition related question. As you look at deals going forward, are you going to try to stay within your Texas footprint or is it time to expand into other states?
  • Dan Rollins:
    Texas is pretty big.
  • David Zalman:
    Dan, this is David. You know, for the most part, we were really trying – Texas is a big state and a lot of number of banks out there. Again, buying a bank on the regular conventional basis right now or at least last year wasn’t as good as a deal as buying an FDIC bank, there is no question. But going forward, I think that you're still going to see probably more banks this year starting to look to partner up and again, you know, for the most part, we're looking and trying to stay in Texas. On the other hand, you know, I would tell you that we are always looking at a great opportunity. But again, it is not in the cards. I want to make sure that I have said this once before in the home markets that we're going out of the state. I don't want to say that. I'm just saying we are looking at all the opportunities but our main focus is primarily in Texas right now.
  • Dan Rollins:
    Does that help you?
  • Daniel Cardenas:
    Yes, thank you.
  • Dan Rollins:
    Thank you, Dan.
  • Operator:
    (Operator instructions) We will take our follow-up question from Jennifer Demba of SunTrust Robinson. Please go ahead, your line is open.
  • Jennifer Demba:
    This has gone on so long; I think I have forgotten my question. The income, you said I think was going to grow about 9% or 10% this year. Just wondering what you see as the drivers there?
  • David Hollaway:
    Year over year and that is coming straight from all the acquisitions, you know, all the extra accounts that we have added, not only from Franklin, but from First Choice et cetera.
  • Tim Timanus:
    The First Choice piece came in the mid year and then the Franklin piece came in at the end of the year. So this number of accounts drives the fee income.
  • Jennifer Demba:
    Okay, thank you.
  • Operator:
    (Operator instructions) And we will take our next follow-up question from David Bishop of Stifel Nicolaus. Please go ahead, your line is open.
  • David Bishop:
    Thanks gentlemen. I think in Jennifer’s camp they are not sure what I was going to ask, maybe it was about what is for dinner tonight, but maybe one small question on the charge-offs this quarter, maybe some color there on what was driving the uptick this quarter?
  • Dan Rollins:
    On the charge-offs?
  • David Bishop:
    On the charge-offs, yes, the 30 basis points (inaudible).
  • David Zalman:
    I will answer that if I can, and Tim, you may want to jump in, but we had some stuff that was on the non-performing list for probably over one quarter, maybe two quarters, Tim, and it was stuff like maybe more than a commercial real estate part of it, I think and we just made the decision that we were going to sell it and get it off of the books and I think that added to the additional charge-offs.
  • Tim Timanus:
    Well, that was a piece of the ORE loss. We took the loss on the ORE and then on the charge-offs side there was a handful of loans that we took a write-down on to just exit out and get out. Some was residential and some was commercial real estate.
  • David Zalman:
    Most of it was real estate related and quite a bit of it was continuing to clean up some of that Southern National portfolio.
  • Tim Timanus:
    That is right.
  • David Zalman:
    But the main part is we have made a decision that we are not going to hold property once we foreclose on it on ORE too.
  • Tim Timanus:
    We are not in the real estate business.
  • David Zalman:
    And other loans too, not only just real estate that we are going to sell it what it is worth and get out of it. We have always been successful in doing that and we had made that decision to do it. If something stays in there for a period longer than we think it should, we are going to sell it for whatever the market asks.
  • David Bishop:
    Thanks.
  • Operator:
    And it appears as though we have no further questions at this time.
  • Dan Rollins:
    Great. Thank you all very much for participating. I think that we have gone a little long today, but we certainly appreciate you support. We will continue in 2009 to try and build shareholder values, watch credit quality, and watch our expenses. Thanks again for you help and your support. Thank you.
  • Operator:
    This concludes today’s teleconference. You may disconnect at any time. Thank you and have a great day.

Other Prosperity Bancshares, Inc. earnings call transcripts: