Prosperity Bancshares, Inc.
Q1 2009 Earnings Call Transcript

Published: 17 Apr 2009

[Operator:]

Welcome to the Prosperity Bank first quarter earnings conference call. (Operator Instructions) It is now my pleasure to turn the call over to Mr. Dan Rollins.

[Dan Rollins:]

Good morning ladies and gentlemen. Welcome to Prosperity Bancshares first quarter 2009 earnings conference call. This call is also being broadcast live over the internet at Prospertitybanctx.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. Here with me today is David Zalman, our Chairman and Chief Executive Officer, Tim Timanus, our Vice Chairman and David Hollaway, our Chief Financial Officer. David Zalman will lead off with a review of the highlights of the most recent quarter. He will be followed by David Hollaway who will spend a few minutes reviewing some of our recent financial statistics. Tim Timanus will discuss our lending activities including asset qualities. I'll provide an update on the integration of the former Franklin Bank locations we acquired from the FDIC and finally, we will open the call up for questions. During the call, interested parties may participate live by following the instructions that will be provided by our call moderator, Elizabeth, or you may email questions to [e-mail]. I assume you've all received a copy of this morning earnings announcement. If not, please call Whitney Hutchins at 281-269-7220 and she will fax a copy to you today. Before we begin, let me make the usual disclaimers. Certain of the matters discussed in this presentation may constitute forward-looking statements 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 Form 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. Let me turn the call over to David.

[David Zalman:]

I'm very pleased to be able to announce the results of one of our most successful quarters in the history of our bank. Some of our successes this quarter include record earnings. Our first quarter earnings were up 11.1% to $25.5 million compared to $22.9 million for the same period last year. Our diluted earnings per share was up 5.8% to $0.55 compared to $0.52 for the same period last year and up 12.2% on a linked quarter basis from $0.49. Our non performing assets declined again to 16 basis points of average earning assets, among the lowest in our industry and a true indicator of our strong asset quality. Our tangible common equity increased to 4.61%. Our total risk based capital increased to 11.34% and our return on average assets for the quarter was 1.15%. Our return on average tangible equity was 28.52%. Our efficiency ratio was 49.47% for the quarter. While we realize this ratio is very good when compared to our peers, we should be able to improve on this in future quarters and return to levels before the FDIC assisted Franklin Bank transaction. Deposits at March 31, 2009 were $7.2 billion, an increase of $2.2 billion from March 31, 2008. This increase was impacted by the deposits assumed from Franklin Bank and deposits assumed in the acquisition of First Choice Bank. On a linked quarter basis, we saw our Legacy deposits or deposits at locations that were not part of our recent acquisitions, increase $32 million. We find more and more customers are valuing the relationship and the knowledge of their bank and their banker. When comparing Legacy loans as of March 31, 2009 or loans at locations that were not part of our recent acquisitions, to year end Legacy loans, we experienced a $14 million increase when you exclude the $23 million reduction in our construction loans. Additionally, we continue to be able to price our credit at a higher spread. Tim Timanus will provide additional detail concerning loans in a few minutes. With regard to asset quality, we are pleased we were able to reduce our non performing assets and increase our provision expense while showing record income. Our non performing assets totaled $12.5 million or 16 basis points of average earning assets at March 31, 2009. That's compared with $17.6 million or 33 basis points of average earning assets at March 31, 2008. The allowance for credit losses was 1.12% of total loans at March 31, 2009 compared with 1.01% for the same period of 2008. To talk a little bit about the Texas economy, the Texas economy is the second largest in the nation and the 12th largest in the world. Texas is home to 102 of the country's largest 1,000 companies and 56 of the Fortune 500 which is more than any other state. While we began experiencing signs of a slowing economy in 2008, we did not actually see evidence in numbers until the last quarter. As expected, the first quarter of 2009 produced a slower economy than the first quarter of 2008. The area economists are projecting employment to fall 2.8% or 296,000 jobs in 2009. This type of job loss is consistent with the rise in the Texas unemployment rate to about 8%. At the same time, improvements in world financial markets and overall economic growth should enhance our State's growth prospects, particularly in the second half of 2009. While the first quarter outlook was weaker, longer term prospects remain healthy. Job growth, low business and living costs and a young, fast growing labor force remain positive that will help in the recovery. Texas is a very big and diverse economy. While we acknowledge a slower economy than we have experienced in the recent past, we feel out future is very bright and we feel optimistic looking forward. We believe the fear of Texas returning to the terrible economy we lived through in the 1980's is very remote. Having said that, it would be imprudent not to recognize the risk and continue to increase our loan loss reserves. Additionally, higher loan charge offs can be expected with higher unemployment. We believe we have taken all of this into consideration in our business planning and believe we are well positioned in the current environment. Thanks again for your support of our company. Let me turn over our discussion to David Hollaway, our Chief Financial Officer to discuss some specific financial results we achieved.

[David Hollaway:]

Net interest income for the quarter ended March 31, 2009 increased 42.5% to $74.1 million compared to $52 million for the same period last year. The increase was primarily due to a 45.2% increase in earning assets. The tax equivalent net interest margin was 3.98% for the three months ended March 31, 2009 compared to 4.03% for the same period in 2008 and up from the fourth quarter number of 3.65%. The late quarter margin expanded at a much greater pace due to multiple factors including the ability to lower deposit pricing at a faster pace than projected and I would note that the yield on the savings in money market accounts decreased from 1.74% in the fourth quarter of '08 to 1.36% in the first quarter of 2009. Non interest income increased $2.3 million or 18.4% to $15 million for the three months ended March 31, 2009 compared with $12.7 million for the same period in 2008. This was primarily due to the Franklin transaction. The Franklin transaction also was the primary driver in the change in non interest expense which increased to $44 million for the three months ended March 31, 2009, a 51.2% increase compared to the first quarter of 2008. Finally, the bond portfolio metrics at 33109 reflect a weighted average life of 2.9 years and an effective duration of 2.8 years and the projected annual cash flow is approximately $1.2 billion. And with that, let me turn over the presentation to Tim Timanus for some detail on loans and assets.

[Tim Timanus:]

Non performing assets at quarter ended March 31, 2009 totaled $12,525,000 or .36% of loans and other real estate compared to $14,368,000 or .40% at 12/31/08. This represents a 13% decline. The March 31, 2009 non performing asset total was made up of $2,964,000 in loans, $427,000 in repossessed assets and $9,134,000 in other real estate. Approximately $4,100,000 or one third of the March 31, 2009 non performing asset total are at this time under contract for sale. Of course, there can be no assurance that any of these contracts will actually close. Net charge offs for the three months ended March 31,2009 were $3,857,000 compared to net charge offs of $3,011,000 for the quarter ended December 31, '08 for a 28% increase. $6,125,000 was added to the allowance for credit losses during the quarter ended March 31, 2009 compared to $6 million for the fourth quarter of 2008. The average monthly new loan production for the quarter ended March 31, 2009 was $64 million compared to $77 million for the fourth quarter ended December 31, 2008. Loans outstanding at March 31, 2009 were $3,501 million compared to $3,567 million at 12/31/08. The March 31, 2009 loan total is made up of 42% fixed rate loans, 27% loans that float and 31% variable loans resetting at specific intervals. I'll now turn it over to Dan Rollins.

[Dan Rollins:]

Let me just add a couple of statistical numbers on the loan side and then we can talk about Franklin. One of the things we've talked about many times is the granularity in our overall loan portfolio and we've talked about that in a couple of ways. We did disclose today a little more information on the non performing assets and I think you'll see that the average size of the non performing assets at March 31 was $120,000, 104 credits representing $120,000 on average. That's down a little bit from $146,000 average at year end, but let me remind everybody the overall portfolio, the full $3.5 billion that average loan size is still sitting right on top of $100,000 and when you look at the individual parts of that portfolio, our commercial real estate portfolio, the largest piece of our loan book, the average loan size in that portfolio is $385,000. The second largest average loan size piece is the construction piece that Tim talked about a little bit and the average loan size there is $254,000. We believe that granularity in the portfolio is a big plus for us and will continue to help us manage through the process that we're in. I am pleased to report that our team completed the integration of the former Franklin Bank offices on March 1. They have our signs up. They're on our systems and they're operating well today. Our newest associates are doing a great job of taking care of customers and in fact, we're beginning the process of winning back some business that they had lost over the most recent past. Today, we have 158 full service locations across Texas. The Houston area is our largest market with 51 offices representing a little less than half of our total loans and our total deposits. We have 36 banking centers in the Central Texas market including Austin, Grand College Station and San Antonio. Our Dallas/Fort Worth footprint includes 24 locations and we're operating 20 locations in the East Texas markets including Tyler and Longview. Finally, we operate 27 locations in the South Texas market including Victoria and Corpus Christi. Overall, our Texas footprint covers about 75% of the total population of the state of Texas. At this time, I'd like to take some questions.

[Operator:]

(Operator Instructions) Your first call comes from Jon Arfstrom – RBC Capital Markets.

[Jon Arfstrom:]

Dave Hollaway, in terms of the margins, is everything baked in? Does that fully reflect the repositioning of Franklin deposits and Solomon Securities portfolio also so that we have the potential to see something more stable going forward?

[David Hollaway:]

I think that's absolutely right. That fourth quarter everything was still in flux and it was hard to get a good read on it but absolutely true. On the asset side everything has been fully invested specific to Franklin, and so now on a go forward basis, it's just a matter of what we always do with these acquisitions, it's try to get their mix of money to reflect more of our mix of money. What I mean by that, our CD percentage as a total of deposits is generally lower than these transactions that we take over so we'll start seeing some of that going forward so you might get some efficiencies on the CD's continuing to re-price down, and that's a bank level statement. But the other side is, we have to focus on what's going on in the asset side because again, we have a big percentage of our money in a bond portfolio and as that cash flow comes off, what are we going to be reinvesting in? Is it going to be loans? Will it be chasing off CD's, high cost CD's and it pays that off or do we try to stay short because we have to cognizant longer term of extension risk. We don't want to do something in the short term on the security portfolio side that causes us pain going forward and so what that means, bottom line is, we may have to stay shorter if the money goes back into the security portfolio meaning less yield there. So I think it's a long way around to say you're absolutely right. I think the margin will probably be a lot more stable at least over the next six months.

[Jon Arfstrom:]

In terms of the commercial real estate balances, they were stable sequentially and they were stronger than the other categories and I'm just wondering if you could talk a little bit about impressions of the Texas real estate market and in terms of what you're avoiding and what you might be attracted to in that category.

[Tim Timanus:]

Commercial real estate is obviously where folks are focusing today and that's what I was trying to say a few minutes ago. You first have to start with our bread and butter and obviously $1.3 billion or $1.4 billion or whatever is in that category is the biggest part of our loans. But the granularity in there with an average size of $385,000 says we're making loans today in the $1million, $2million, $3million, $4million, $5 million dollar range. We're seeing those on a regular basis. They run the gamut from A to Z, one to 99. If you can dream it up it's probably in there and some of the markets that we're in ranging from building a veterinary clinic, the small manufacturing plant, the new law office, just if you can dream up a small project in the $5 million or $10 million down, that's probably things that we're seeing today, and I think we're really focusing on more of the owner occupied, the folks that have the wherewithal to play in the game. We're not focused on a whole lot of investor or speculative properties at all. But our commercial real estate book is very diverse and again, spread across the state from the bigger Houston, Dallas markets to many others.

[David Zalman:]

I would say that going back as far as two years ago where a lot of people were really taking in any and every commercial real estate they could for getting the points and we really got out of the market. Of course I would say we really never did participate in that type of market to begin with, but we were never really keen on bringing people in that weren't really core customers of the bank, meaning dry relationships; people that were just moving loans and going based on price. We always looked at every type of loan whether it's a commercial real estate loan or a commercial loan to be a full relationship where the customer banks with us. They have their checking account with us. And so just sitting in on loan committees and looking at watching non performing. I don't see the amount risk in our portfolio that maybe some of the other people do in the commercial real estate side because the kind of loans we make, we make loans to individuals who bank with us. They needed it for their offices or we didn't really do speculative deals and just hoped that they would fill out. Having said that, we bought some banks that did take more risk and the good part about that is, we over the last couple of years have been outsourcing those type of loans and really getting them out of the bank when the market was still good. So I really don't see the amount of risk in the commercial real estate in our bank that some people might have.

[Dan Rollins:]

I think there's a couple of factors that I'd want to tag onto. David's exactly right. The pluses in that commercial real estate book for us is remember, our bank is more of an amortizing type credit originator so when you look at that commercial real estate book, those are amortizing credits. They've been on the books for awhile. We're getting principal payments or principal reductions on a monthly basis on a majority of that. The LTV that's in that book, we started at 80 and moved down from there. So when you look at the overall commercial real estate book today, and the amortizing nature of that book, you've got credits that have been on the books for three to five to ten years or more. Those loans are paid down significantly, so the overall LTV in that commercial real estate book is relatively low. I think you can see that when you look at the net charge off information that we provided this morning that shows that over the last 15 months, we're in a net recovery position in the commercial real estate book. So again, we all understand the focus that's on the commercial real estate today. I think what David was saying, what I'm saying is, I don't think that's where we're the most concerned today.

[David Zalman:]

And again, we'll get off of this subject but it seems to be a topic of interest for everybody. Our bank really never jumped into making real estate loans, short term real estate loans that ultimately were supposed to fill up and then be sold on the secondary market. We never participated in that type of lending. I don't think that we ever made a loan or originated a loan from our bank that we didn't intend to keep.

[Tim Timanus:]

There's no high rise office buildings, there's no huge credits in there. There's certainly no shared national credits in there. These are our customers that we take care of, and again, you can see that on the average loan size.

[Operator:]

Your next question comes from Brett Rabatin – Stern Agee.

[Brett Rabatin:]

I wanted to ask obviously the credit metrics are really strong. I wanted to ask on the construction side, was there any geographic centrification you say on the construction stuff? Was it more in Austin or was there anything in particular that stood out? Were any of the charge offs related to some stuff from past acquisitions? I know you've got $50 million or so from Franklin in the construction book.

[David Hollaway:]

The answer to the first part of the question is that the problems were really spread geographically among all of our markets. There was really no concentration in any particular area. There weren't any Franklin credit to speak of in there. There were credits from other acquisitions, TXUI, Southern, First Choice, etc. but I don't believe there were any from Franklin at all.

[Tim Timanus:]

Zero. The Franklin loans we bought remember, we cherry picked the best of the best Franklin loans. There's not a problem in that book of business.

[David Zalman:]

And we're really not seeing any of our mortgage deteriorating more than another one so to speak. Everything seems to be relatively flat cross the board from that standpoint.

[Brett Rabatin:]

Do you see them all kind of being the same?

[David Hollaway:]

So far, that's correct.

[Brett Rabatin:]

I wanted to go back to the question about the margin and just the balance sheet. Is it fair to assume that you guys might shrink the balance sheet a little bit this year assuming the reinvestment rate risk and the securities portfolio and not growing that fast?

[Dan Rollins:]

I'll let Dave jump in on the balance sheet perspective. Let me talk from the retail perspective on the front line. Let me remind everybody when we acquired the Franklin deposits through the FDIC transaction, there were $2 billion in community bank deposits in that book of business and we said last November coming up on six months ago, that we really expected that number to shrink because some of that money was what we would consider to be hot money or rate shopper CD money. While we can discuss internally whether it's going to drop $400 million over the next year or $600 million to $700 million over the next year, we certainly expect that hot money to fall and you see that in the numbers. I think the total Franklin deposits were down $120 million give or take from quarter end in December. I think our expectation is that we will continue to see that hot money move away. The caveat in there quite frankly, I think we're maintaining more of it than we thought we would because the rate pressures and the rate competitors are not out there as much and as David said in his comments, I think our customers, or many customers have become more focused on bank quality of who they're doing business with and today's rate environment, maybe that's gone away a little bit. But we certainly expect the high cost CD money to do one of two things; either to go away and shrink the balance sheet or it's going to re-price at our rates, and when you look at, Dave will talk about specific numbers, but you can see our rate that we were paying is significantly down and will continue to fall. The growth on the loan side question, we certainly want to continue to cherry pick the best of the best credits that are out there. Our team is focused. Tim gave you some loan production numbers. Our production was off in the first quarter. I think it's important to recognize in the first quarter we integrated what was 46 that we kept 33 banking centers out of. We had our team very focused on bringing that across. It has always been our process. We work very aggressively and very quickly to integrate new folks and that is somewhat disruptive to the existing bank and the core franchise and the production that's out there because we've got lenders literally in other offices for weeks on end to bring those guys across to the new team. So all that being said, I'm hopeful and I'm optimistic that we can continue to find good credit in the market and we can continue to take business away from our competitors that are in the penalty for whatever reason, and I think when you look at what's out there today, we certainly have the ability to win some business away. Let me remind you also though, we face a head wind quarter over quarter. You saw our construction loans shrink $23 million from December 1 to March 31, and our expectation is that we're sailing straight into that head wind again and we should see $20 million plus shrinkage in that construction book this quarter and next quarter moving forward. So for us to grow loans, everything else being equal, we've got to fill up the $20 million construction bucket first and then grow. I think that's a possibility but I don't know that you're going to see growth numbers. Dave, the question was on net interest margin, can you address that?

[David Hollaway:]

You mentioned one thing that I think is a dynamic we saw over the last 60 days and it's worth repeating. One of the things we're seeing is customers are seeking out stronger banks and good management teams. We're getting core deposits coming in because a good customers are seeking that. The direct answer is these higher priced CD's. We certainly don't want to keep them. They either roll out of the bank or they're going to re-price down to what we do, and so depending on what happens, the answer is yes. If they're higher priced CD's they'll probably roll out of the bank and some of that cash flow will pay it off. If they re-price at the right correct level, then we'll keep those deposits and we'll have to reinvest some of that cash flow back into the bond portfolio if we're not increasing our loan business. That's absolutely correct.

[David Zalman:]

Overall though, I would say that what we are seeing especially in the Franklin deposits with regard to their CD's, it turning out much, much better than we ever anticipated. I think a sure sign is the $100 million that we lost in the Franklin deposits, the majority of it, over 90% had to be with the CD's. Where we thought that we could possibly lose $400 million to $500 million of those deposits, I don't thing that's going to happen now.

[Dan Rollins:]

That's also just a perspective, that's because there's a lot less players out there, these crazy players that were paying way above market.

[David Zalman:]

And having said that, a lot of this stuff is re-pricing over the next couple of months too where these things are 3%, 4%, so there's no question we'll lost more. I think that we're probably going to end up retaining a whole lot more than we ever anticipated.

[Operator:]

Your next question comes from Andy Stapp – B. Riley & Company.

[Andy Stapp:]

Your deposit service charges are down almost $1 million despite full quarter of Franklin Bank. Can you provide some insights there?

[David Zalman:]

You're talking about service charges on deposit accounts? The short answer is, and what we tend to see is, it's a seasonal thing. And I realize these acquisitions when you do them at year end really tend to change the dynamic, but within that service charge on deposit accounts, a big chunk of that is the NSF fees and it always goes up. What I would always do is go back and look at the third quarter because what you see happen is third quarter, fourth quarter jumps way up because of the seasonal aspect of it all, and then it always comes back down in the first quarter and that's exactly what happened in '08 to '09. And again, I understand some of that is muddled up with the Franklin. It should have brought more feast to the table, but that dynamic was in place not only for our book of business but the Franklin book of business we bought. I don't know if there's anything else systemic under there other than that seasonality thing. There's nothing else that I'm aware of that changes that.

[Tim Timanus:]

It's down $832,000 is the down number on that line. I think the Franklin piece, they were less focused on that side of the deposit book than we have so that's one of the things we work on, is on the retail core deposit, free money side for them.

[David Zalman:]

Basically when we took Franklin, they had a different overdraft policy than we did. As something went into the overdraft there, they would actually collect a service charge and it would turn the overdraft into a loan. And I think when we first took that over it created a lot more service charge income whereas when you're in the overdrafts with us, we either charge it off if you can't pay the overdraft charge. But we don't turn it into a loan. And I think that had some bearing on it also.

[Dan Rollins:]

I agree with Dave. I think it's almost all seasonal.

[Andy Stapp:]

And you have what your 30 to 90 days delinquencies were at quarter end?

[David Hollaway:]

I don't have the number on that. We talked about that yesterday a little bit. I don't think it's materially different than it was at year end. At year end it was roughly $40 million in the 30 to 89 category and I think when you talk to our guys, we're focused on that.

[Andy Stapp:]

Is there much room for your cost of funds to continue to trend downward, through the re-pricing of your legacy liabilities?

[David Zalman:]

There's no question that our cost will go down. They should go down. On the other hand we always have to keep in mind what David Hollaway mentioned earlier, we still have a big bond portfolio and so as our deposits come down in price, and they should, we don't get to put the money back into loans, we have to put it back into reinvestment of bonds, reinvest at a lower rate than what we did. We just really hit a home run when we bought the Franklin deal in that we purchased about $2 billion worth of bonds and again, we generally bought product that had an average life of three years and we yielded probably about 4.8% on it. All agency things like Freddie Mac paper, so we really did real good, and you can see that in our 10-Q, the game that we have in the portfolio which is over $120 million. So we're benefiting from that but at the same time as this stuff does re-price we have to reinvest it at lower rates too, so it's probably, I would say we're probably going to do a little bit better, but not a whole lot better on the margin.

[David Hollaway:]

Right, which projects more of a stable margin in the short term.

[Operator:]

Your next question comes from Erika Panela – Bank of America Securities, Merrill Lynch.

[Erika Panela:]

You mentioned you're not, term is not at the top of your concern list, but if you are watching one loan segment most closely what would that be?

[David Hollaway:]

The question is we said that the commercial real estate book because of its amortizing nature and lower loan to value is not the top of our worry list. She's asking us what we worry about.

[David Zalman:]

You worry about everything, let me say that to begin with. If you had to pick your first and foremost, and this is just mine. Tim may feel differently. He's as much in the loan committee side as I am, I think the construction portfolio, the one family residential construction and land development. That seems to be where the slowness is and I think it's more reflective of a national trend where a lot of people felt that Texas wouldn't see that trend. It's not as bad here as it is everywhere else, but that's still the trend over here right now that I see.

[Tim Timanus:]

That's right. There's some positives out there right now. I think for the last three months or four months, I need to get Randy to run to that side of the collection piece for us, but I think we foreclosed on properties every month for the last few months and we've brought those properties in. Some of them are turning pretty fast. Let me remind you, when you look at quarter over quarter MPA number, there's 104 on there this quarter, but less than half of those were there last quarter. So we're turning that MPA group pretty quickly. But Randy was telling just yesterday, this month, the April foreclosure day we showed up at the courthouse and there were buyers for that property at the courthouse we never even got it. We went to foreclose it, and somebody else bought it before we could foreclose on it and get a foreclosure sale. So there are certainly buyers out there on that one to four family stuff and we think we're in pretty good shape.

[David Zalman:]

The good news is, just again relaying what Randy is relaying to us, when we do get homes back and they're completed, we're not taking that big of a loss on them when we're selling them, maybe 10% to 15%. So the real loss does come though if you have a development or a home that's not been completed and you can end up with a 30% loss on that.

[Dan Rollins:]

Completed properties are worth a lot more than uncompleted properties.

[David Zalman:]

The good news is that we're rotating them. We're flipping them and we're selling them and that's the good news.

[Tim Timanus:]

There's a market out there.

[Operator:]

Your next question comes from Jennifer Demba – Suntrust Robinson Humphrey.

[Jennifer Demba:]

A follow up question on the construction book, you've got $300 million or so in lots, raw land, land development. Can you tell us what you've been experiencing when you've foreclosed on those loans?

[Tim Timanus:]

It's a pretty small piece of it, but we've had some. I don't know if we've done any land development.

[David Hollaway:]

We haven't foreclosed on any significant land developments. What lots and pieces of land we have foreclosed on, we really haven't seen a buyer response to those. It's much different than what we just described. We've been able to sell them. I don't know if easily is the right description, but we've been able to sell those and move them along. So up to this point in time, that raw land piece of it doesn't really jump out as being a significant issue apart from the overall real estate picture.

[Jennifer Demba:]

What kind of severity are you seeing when you have sold? It hasn't happened very often, but.

[David Zalman:]

I don't know that we really, I'm going to jump on what Tim said. We really haven't seen big losses. We've come close to maybe foreclosing on some but somehow they get a development check and we get pulled out of the deal. We get out of it. I just don't think that we've seen, we just haven't seen it. We really haven't it. I guess if we had to throw a number out there, and it's not a, once again, it's not based on a lot of volume in terms of our experience but between 10%, 20% to 30%. I don't think it's any worse than that.

[Jennifer Demba:]

I assume these types of loans are not showing up more on your watch list?

[Tim Timanus:]

No, I don't think there's been any surprises coming along the pipeline. We continue to manage the portfolio the way we always have. I think that we're continuing to watch all of those. We're small enough we can in a few days time we can look at every credit out there if we needed to. So I don't think we're seeing any glaring headlights coming at us out of the windshield.

[Operator:]

Your next question comes from Thomas Alonso – Fox-Pitt Kelton.

[Thomas Alonso:]

On expenses, I know March 1 you closed the Franklin. Is this quarter's run rate I would assume is probably a little bit elevated or is that a good base to work off of?

[David Zalman:]

It is elevated because we did do the data processing conversion on March 1 and so there's a lot of expense that surrounds that and carrying all these extra people and they're probably all in through the end of the quarter. So it is elevated and we expect to see some improvement on that as we go throughout the year.

[Dan Rollins:]

Let me jump in on the people side of that for you. When you look at the head count quarter over quarter you see down 50. My gut tells me that that 50 dropped off late in March so I think we carried those people almost all the way through the quarter.

[Thomas Alonso:]

I just want to make sure I heard your comments earlier on the Texas economy. You're expecting a bit of bounce back in the second half of this year? Is that better growth in the second half of this year?

[David Zalman:]

I think if the rest of the national economy does come back I think that we should see a better second half.

[Thomas Alonso:]

Would that translate into long growth for you guys as well or is that just sort of you're still going to kind of play it close to the vest this year.

[David Zalman:]

I'm hoping that we should see some loan growth.

[Operator:]

Your next question comes from David Bishop – Stifel Nicholaus.

[David Bishop:]

In terms of the impact of the decline in energy prices when you sort of serve your clientele, your small business customers there and sort of look at the landscape from a commercial perspective, anecdotally any sort of turn that in fact you are seeing in terms of rental rates, vacancies among the greater Houston area?

[David Zalman:]

The price is down, but again at $50 a barrel, that's still a pretty good price. If you're seeing any place where it's slower you have seen the service industries that are related to the oil companies. I mean if you look at the rig count, yes it's down and you see some of the service industries, people that take mud to the rigs or soft water, you'll see that they have reduced staff a little bit. But at the same time, almost everybody that's in the game right now in Texas in that part of the business has lived through the 80's. So they're not going to hire too many. They're not going to let too many go because as times come back, they'll need those people. So there is somewhat of a little bit of an impact but I think the overall gas prices being down at the pump far exceed any downturn or layoffs that we see in the oil industry. It's the stimulus is just phenomenal. With regard to real estate, there's no question about that. As the oil was getting to $130 and $140 a barrel, we actually moved out of two or three of our buildings because the rate they were going up on the commercial real estate to us, we couldn't bond. They were going from rate where we were paying $22.00 to $26.00 a square foot for a space, they were going up to as much as $38.00 plus, plus. So that seems to have changed now. We were working on one lease that we didn't think we would be able to compromise. We thought we would have to move out. We did I think come close to a compromise on that. So we are seeing people become more realistic from the commercial side also, But I think if you would have saw the $140 stay up there, Texas really would have had a bubble and it would have been a real estate bubble based on the oil industry because there were so many people that were expanding, getting new office space and bringing people in. It would have been a tough situation. So I think when you're talking $50, $60, $70 that's more where we need to be and it's a good place.

[Operator:]

Your next question comes from Terry McEvoy – Oppenheimer.

[Terry McEvoy:]

Could you just talk about your outlook for M&A multiples in Texas going forward in light of the discussion all morning about the Texas economy and whether you think that's going to result in lower acquisition multiples again in the future?

[Tim Timanus:]

The biggest investment banking firm right now working the bank business I think is called the FDIC and they're setting the price.

[David Zalman:]

When you look at our situation, and again I can't speak for everybody else, where we were very acquisitive and buying, I think all of us right now are saying do you want to buy a bank and take on the challenges of those existing banks that are out there if they haven't. So overall, the price is not where it was last year, probably won't be for some time. If you're looking at us, we're probably more interested in looking at opportunities from banks that are having more difficult times than even from the FDIC. We think that's where the opportunities for us lie really going forward. We think that we can make a whole lot more by participating in that type of market than acquiring other banks basically.

[David Hollaway:]

Unfortunately I think if a bank is healthy and they want to sell today, unfortunately, I think the environment that we're in is going to severely restrict any multiples compared to what they could have been in the past. Certainly there may be some good banks out there that may be good opportunities and partners for us, but I think the multiples and the prices are significantly reduced from where they had been.

[David Zalman:]

That doesn't mean that we're out of the market either. If there's a bank that we can really enhance our position in, in a major market, or strategic market that we're in, we're definitely going to be interested in that, and of course that type of bank would draw more than some $100 million bank in the world market or something like that.

[Operator:]

Your next question comes from Erika Panela – Bank of America Securities, Merrill Lynch.

[Erika Panela:]

I know you talked about the granularity of the term portfolio. Could you tell us about your top concentration by collateral type ex owner occupied?

[Tim Timanus:]

When you look at the overall portfolio again and you talk about we really don't have any big concentrations, but when you look at the whole portfolio and you look at credits, pick a number, above $10 million, we've got less than 10 credits above $10 million, less that 30 credits above $5 million. Our loan limit is $160 million. So we just don't, I don't have a number. I can't give you an industry because it's so granular, I don't think we can answer that.

[David Zalman:]

I don't think we can. We can look but I just don't think we can. It wouldn't have any meaning, it's so diversified. It's really spread out.

[Erika Panela:]

I think the one for income producing, the one property type that concerns a lot of folks is retail. Is that also the definition of that is too broad?

[Tim Timanus:]

The answer is yes because here's the problem when you're looking at retail. We saw the big retail that filed bankruptcy yesterday, the big mall, we don't have any big shared national credits. We don't have any big box, when you look at the value of those things, whether it's the centers that have the retailer that just filed bankruptcy, Circuit City. The Circuit City boxes, I certainly see those boxes sitting empty. We've got one right next to Tim's office over there. Those transactions are above the level that you're seeing on our portfolio. Do we have some retail centers? Sure we do. The question is how do we account for those. I can name three where we've got a retail shopping center in the largest tenant in there is our customer and they bought the center for themselves and then they rent out other space on it.

[David Zalman:]

I would think though Dan if you wanted to highlight something, probably we were probably ahead of the curve when the Southern National Bank had probably more retail centers than any other bank we ever acquired and we are feverishly trying to get those things out of the bank or get them on a performing basis. And I think we did a pretty good job. We were probably ahead of the curve. We're not seeing the weakness in that area right now. I think we saw the weakness, somebody asked the question awhile ago, more of the weakness I think is in the construction part of it.

[Tim Timanus:]

We're trying to dig for numbers for you. When you look the retail that's out there the way that we class it, we show less than $150 million in total in that category.

[Operator:]

Your next question comes from Daniel Cardenas – Howe Barnes.

[Daniel Cardenas:]

Just a quick question on your intangible common equity ratio, moved in the right direction this quarter. How long do you think it's going to take to get to the pre Franklin levels?

[David Hollaway:]

Everything going along the way it is now it will be over 5% by year end. I think we were at 6% pre Franklin.

[David Zalman:]

Where we are now though, shouldn't we be closer to 5.5% at year end?

[David Hollaway:]

It depends on balance sheet. Remember we shrunk some this quarter. If we continue to experience the shrinkage, we could be at 5.5% plus at year end. If we don't shrink, the answer is, we've got great earnings power and I think we're certainly headed in the right direction. Remember, the 6.28% that we were at on 9/30 a year ago was the highest level I think in our company's history so I think when we look back, it's the 5.5% number, the 5% number. We don't have a target for that but we certainly think we can be into that range relatively quickly.

[David Zalman:]

I think it's easy to calculate. I mean you just look what the end expectations are and take out our dividends it's going to get you there pretty quick by year end. Again, assuming everything else is stable.

[Operator:]

That was our last question. Do you have any closing comments?

[Dan Rollins:]

I just want to thank everybody again. We really appreciate all the good questions and all the comments. We look forward to visiting with folks as we're out visiting with investors. Thank you for your support of our bank. We'll talk to you soon.