Prosperity Bancshares' (PB) CEO David Zalman on Q2 2014 Results - Earnings Call Transcript

Jul.25.14 | About: Prosperity Bancshares, (PB)

Prosperity Bancshares, Inc. (NYSE:PB)

Q2 2014 Earnings Conference Call

July 25, 2014 10:00 a.m. ET

Executives

David Zalman – Chairman and Chief Executive Officer

David Hollaway – Chief Financial Officer

H. E. Tim Timanus – Vice Chairman

Randy Hester – Chief Lending Officer

Michael Epps – Senior Executive Vice President for Financial Operations and Administration

Charlotte Rasche – Executive Vice President and General Counsel

Analysts

Rahul Patil - Evercore Partners

Scott Valentin – FBR & Company

Brett Rabatin – Sterne Agee & Leach

Jon Arfstrom – RBC Capital Markets

Jennifer Demba – SunTrust Robinson Humphrey

Mikhail Goberman – Portales Partners

Gary Tenner - D.A. Davidson

Jefferson Harralson – Keefe, Bruyette, & Woods, Inc.

Operator

Good morning and welcome to the Prosperity Bancshares’ second quarter 2014 Earnings Conference Call. All participants will be in listen only mode. (Operator instructions) Please note this event is being recorded.

I would now like to turn the conference over to Charlotte Rasche. Please go ahead.

Charlotte Rasche

Thank you. Good morning, ladies and gentlemen, and welcome to Prosperity Bancshares' Second Quarter 2014 Earnings Conference Call. This call is being broadcast live over the Internet at www.prosperitybankusa.com and will be available for replay at the same location for the next few weeks. I'm Charlotte Rasche, Executive Vice President and General Counsel of Prosperity Bancshares. And here with me today is David Zalman, Chairman and Chief Executive Officer; H. E. Tim Timanus, Vice Chairman; David Hollaway, Chief Financial Officer; Randy Hester, Chief Lending Officer; and Mike Epps, Senior Executive Vice President for Financial Operations and Administration.

David Zalman will lead off with a review of the highlights for the recent quarter and an update on our merger and acquisition activity. He will be followed by David Hollaway, who will review some of our recent financial statistics; and Tim Timanus will discuss our lending activities, including asset quality. Finally, we will open the call for questions. During the call, interested parties may participate live by following the instructions that were provided by our call moderator, Betty or you may email questions to investor.relations@prosperitybankusa.com. I assume you have all received a copy of the earnings announcement we released earlier this morning. If not, please call Tracy Elkowitz at (281) 269-7221, and she will send 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 statements for the purposes of the Federal Securities Laws, and as such, may involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of Prosperity Bancshares to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Additional information concerning factors that could cause actual results to be materially different than those in the forward-looking statements can be found in Prosperity Bancshares' filings with the Securities 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.

Now let me turn the call over to David Zalman.

David Zalman

Thank you, Charlotte. I would like to welcome and thank everyone joining us for the second quarter earnings announcements. I am very excited and proud to be able to announce such positive results for the second quarter of 2014. In addition to our strong performance for the first half of 2014, we are flattered to be named the best bank in America by Forbes Magazine. In fact, we were recognized two out of the last three years as the Best Bank in America.

We posted earnings of $75,506,000 for the three months ended June 30, 2014 compared to $53,844,000 for the same period in 2013, ab increase in net income of $21,662,000 or 40.2%. Our diluted earnings per share for the quarter ended June 30, 2014 came in at $1.08, compared to $0.89 for the for the same period last year, representing a 21.3% increase in earnings per share.

Our asset quality continues to be one of the best in the industry, our nonperforming asset ratio of only 15 basis points and nonperforming assets of $28.521 million. Our allowance for credit losses was $73.266 million as of June 30, 2014 with nonperforming loans of $23.417 million as of the same date representing a healthy coverage ratio.

Loans at June 30, 2014 were $9.308 billion, an increase of $3.136 billion or 50.8% compared with $6.172 billion at June 30, 2013. On a linked quarter basis, loans increased $1.556 billion or 20.1% from the $7.752 billion at March 31, 2014. Looking at loan production on an organic basis excluding those loans acquired in acquisitions and new production at the acquired banking centers since the respective acquisition days, our Legacy loans at June 30, 2014 grew 8.4% when compared to June 30, 2013 and 3% or 11.8% annualized on a linked quarter basis. We are very excited about the higher level of organic growth this quarter and we are seeing more requests for new loans.

Our deposits at June 30, 2014 were $17.281 billion, an increase of $4.7 billion or 38.2% compared with the $12.5 billion at June 30, 2013. On a linked quarter basis, deposits increased $1.821 billion or 11.8% from $15.460 billion at March 31, 2014. Looking at deposits from an organic basis, meaning excluding deposits assumed in acquisitions and new deposits generated at the acquired banking centers since respective acquisition dates, deposits at June 30, 2014 grew 6.1% compared with June 30, 2013 and decreased 1.5% on a linked quarter basis. The drop in organic deposits for the quarter is not unusual for us. In fact, if you go back to the prior year at the same time, at the same time you will see a similar situation. We have over 450 municipalities that do business with us and this time of the year they have less in their accounts until their tax dollars come in at the end of the year. We expect our organic deposit growth to be positive for the year at about 4% to 6%.

We completed our operational integration with the F&M Bank in Tulsa in the late second quarter. Tony Davis, Chairman, Eric Davis, Vice Chairman and Jeff Pickryl, President and many of the associates of F&M have worked very hard to make this a successful merger. And we really appreciate all of their time integrity and dedication. We expect F&M to add value to our organization and we look forward to them taking miniature pros in our company.

We could not be more pleased with how things are going with the First Victoria National Bank merger. We are already seeing them begin to grow loans and deposits in the latter part of the second quarter. Many of the First Victoria National Bank associates have taken leadership roles in our company and are helping us to build a bigger and better bank with more products and services for our customers. Again, we owe all of our success to our team of associates, our past associates and Board members who have helped grow the company from one location with $40 million in assets when I got there in 1986 to a $21 billion bank with 246 locations in Texas and Oklahoma today. We would also like to thank all of our customers for their business and loyalty to the bank. Thanks again for your support of our company.

Let me turn over our discussion to David Holloway, our Chief Financial Officer.

David Holloway

Thank you, David. Net interest income for the three months ended June 30, 2014 was $174 million compared with $118.7 million for the three months ended June 30, 2013, an increase of $55.3 million or 46.6%. The increase was primarily due to a 30.7% increase in average interest-earning assets.

The net interest margin on a tax equivalent basis was 3.83% for the three months ended June 30, 2014 compared to 3.43% for the same period in 2013 and 3.62% for the three months ended March 31, 2014. Excluding purchase accounting adjustments, the net interest margin on a tax equivalent basis for the three months ended June 30, 2014 was 3.31%, compared to 3.09% for the same period in 2013, and 3.33% for the three months ended March 31, 2014.

Noninterest income increased $8.7 million or 34.5% to $34 million for the three months ended June 30, 2014 compared to $25.3 million for the same period in 2013. This year over year increase was impacted by the F&M, and First Victoria National Bank transactions, an increase in trust and brokerage income, and gain from sale of assets and other real estate.

Noninterest expense for the three months ended June 30, 2014 was $88.7 million compared to $61.3 million for the same period in 2013, an increase of $27.4 million or 44.7%. Again the increase was primarily due to the F&M and First Victoria National Bank transactions. Additionally, the current quarter included one-time pre-tax merger expenses of $2 million, primarily related to the F&M transaction.

The efficiency ratio was 42.9% for the three months ended June 30, 2014 compared to 42.5% for the same period last year and 42% for the three months ended March 31, 2014.

The bond portfolio metrics at 630 showed a weighted average life of 4.27 years and effective duration of 3.89 and projected annual cash flows of approximately $1.5 billion.

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, Mr. Holloway. Our nonperforming assets at the end of the second quarter of this year totaled $28.521 million or 31 basis points of loans and other real estate. This is compared to $18.696 million or 24 basis points at the end of the first quarter of this year. This represents an increase of 53% in nonperforming assets from March 31, 2014. The change primarily results from two loans from acquisitions that are all in our books for a total of $11.062 million. The June 30, 2014 nonperforming assets total, consist of $23.417 million in loans; $11,000 in repossessed assets and $5.093 million in other real estate.

As of today, $1.526 million of the June 30, 2014 nonperforming assets total are under contract for sale, but there can be no assurance that any of these contracts will close. This represents 5% of the nonperforming assets at the end of the second quarter that are under contract for sale at this time.

Net charge offs for the three months ended June 30, 2014 were $155,000 compared to net charge offs of $786,000 for the three months ended March 31, 2014.

$6.325 million was added to the allowance for credit losses during the quarter ended June 30, 2014 compared to $600,000 for the second quarter of this year.

The average monthly new loan production for quarter ended June 30, 2014 was $241 million compares to $223 million for the quarter ended March 31, 2014. This average monthly new loan production for the second quarter of 2014 was an 8% increase on a linked quarter basis.

Loans outstanding at June 30, 2014 were $9.308 billion compared to $7.752 billion at March 31, 2014. The loan total at the end of the second quarter of 2014 was made up of 44% fixed rate loans, 34% floating rate and 22% variable rate loans.

I’ll now turn it over to Charlotte who will coordinate your questions.

Charlotte Rasche

Thank you, Tim. At this time, we are prepared to answer your question. Betty, can you assist us with questions?

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from John Pancari of Evercore. Please go ahead Sir.

Rahul Patil - Evercore Partners

Yes, this is Rahul Patil in for John. A question on your loan demand. I know the agricultural loans are relatively a smaller book. Are you seeing any spillover effect from the drought conditions in Central Texas on your loan demand in other areas?

David Zalman

I think the answer to that is essentially no. It does obviously directly affect certain agricultural operations, but it doesn’t seem to have had any significant adverse effect on our customer base up to this point in time. And some of the second home sales on lakes and rivers they are having water problems have diminished. So there is not as much economic activity in that regard. But once again that really hasn’t affected our loan growth and our loan portfolio.

Rahul Patil - Evercore Partners

Okay, thanks. Just a question on your loan yield. If I exclude the purchase accounting impact, it looks like the core loan yields were down 10 bps. How should we think about the loan yield pressure going forward excluding the noise in purchase accounting? And are you any stabilization in your new loan spreads that are coming in as of second quarter?

David Zalman

I don’t think you’ll see any dramatic change in what you’ve just described. What we are seeing is a lot of aggressive lending in the marketplace especially, when it comes to the extending fixed rates out over long periods of time. This competitive situation makes it difficult on us needless to say, but we’ve had it for a while and I think we are going to continue to have it. But having said all of that, I don’t think you are going to see any significant increase or decrease in what you’ve just said in terms of our loan yields.

Operator

And our next question comes from Scott Valentin of FBR & Company. Please go ahead sir.

Scott Valentin – FBR & Company

Good Morning, thanks for taking my question. I’m just trying to tease out a core noninterest expense run rate. I know there is obviously a lot of noise and you mentioned merger expense in there. I’m just trying to figure out looking forward as some of the expenses from the mergers go away, how should we think about a core one rate for noninterest expense?

David Hollaway

This is Dave Hollaway, I think when you look at our numbers the one major piece if you want to adjust is just remember that in our second quarter numbers you’ve got $2 million of onetime merger fee. Obviously going forward, that will fall away. Other than that, I think you are going to probably want to run -- we probably are going to run our overall expense base of that run rate for the next few quarters

Scott Valentin – FBR & Company

Okay and then in the press release you guys called out I think a gain on the sale of a building and a gain against your receipt of benefits from some life insurance policy. Can you quantify that amount?

David Hollaway

Yeah. I think what you see if you’re looking at our press release, you see a number of things on there. One you see related to that you see $1.3 million and $1.4 million. I don’t have them correctly in order, but one is a gain on sale of some assets and gain on sales ORE. And then yes, and then there were some benefits from some life insurance that I think it in the other category and that’s about $1.5 million too. So you add a $1.3 million and a $1.4 million, $1.5 million that will get you those kind of onetime items.

Operator

Our next question comes from Brett Rabatin of Sterne Agee. Please go ahead sir.

Brett Rabatin – Sterne Agee & Leach

Hi guys. Good morning. I wanted to ask I guess first just going to F&M and just thinking about that portfolio and I know you’ve talked about it in terms of potential runoff, but just any updated thoughts around F&M and then if you think about the other ones Victoria, Coppermark, if runoff of those portfolios are close to being over or if we might see some additional decline from those past deals as well.

David Zalman

Sure. Going back from probably the last one, Coppermark, we do think that we’ve seen them stabilize and probably too will start going forward. The First Victoria – this is David Zalman -- and the First Victoria National Bank started doing just right. We’re ready to see them increase deposits and loans in the late second quarter. You saw a little bit of a decrease, a part of the decrease you saw from last quarter to this quarter with Frist Victoria National Bank, they’re also an add lending banks. So the first quarter you see the loans that they have are not as much as they are probably in midyear in June as it crops in as their customers are drawing on the deal.

So, we’re really seeing a good increase from them. F&M again we knew that there would be a certain amount to runoff just simply because the amount of shared national credits and even cost syndications or club deals that they have. I mean when you really look at it, I think that the shared national credits at F&M Bank had at the end – probably at the end of June were $290 million in shared national credits and in club or syndication they had about $43 million. Down from where they were when we first looked at them, and again the legacy shared national credits that Prosperity had that rule that came through some of the other acquisitions we had, we had $82 million. So we do think that there will still be some downward pressure on F&M for a period of time, but again it’s nothing unusual compared to other banks that join us like that.

Brett Rabatin – Sterne Agee & Leach

Okay, that’s great color, David. And I guess the other thing I was hoping to get maybe I thought on is just there’s been a lot of talk this quarter about being a bigger bank and not necessarily CCAR, but just being north of $10 billion -- north of $20 billion actually. I was just curious if you were seeing any increased costs? I know you’ve talked a lot about people you’ve had to add as you got bigger. But do you think you’ll be hoping to add anymore infrastructure back office, what have you to appease the regulators as you continue to grow your asset base?

David Zalman

I think the bird hit us in the head about two years ago. I’m still ringing and seeing stars. Once we crossed the $10 billion dollar mark it was a – I think I mentioned in prior calls, the examination process just changed dramatically. And so I think it was almost shocking to us especially after the American State Bank Acquisition I think we had $13 billion. I think that we have gotten our arms around it. We are getting our arms around it. Again the regulatory burden is so much more intense than I would have ever even imagined. Having said that, where we used to be regulated primarily on a regional basis and using the regional guide, we can make a lot of the decisions. What we’re seeing today in our examination is that you have regional people here, but so many of the people that come in are experts from different parts of the nation, Washington, Philadelphia, for every different type of deal that you have. I think it takes them a while and us a while to learn what they’re looking for and for us to get up to speed where we’re at. But I feel like we’re doing a good job. Your last question I think you had, what do you think going forward? I have to be careful. They’re probably on the line, but form a regulatory standpoint you can never have enough people. So, there’s probably a balance between – there’s probably between a balance between what they want and what we want. So I think what Dave said earlier though, but run rate and the expense rate if you use that what we have I think that’s pretty ….

David Hollaway

Yeah. That’s – I’d just add a little color to that. When we’re looking at run rate, if we didn’t have all those regulatory – these hurdles that we have to overcome and build up infrastructure staffing, yeah I think you could see us drive down our operating expense. But with these challenges for $20 billion plus bank, that’s probably just not going to happen. I equate this, the analogy on this, the way I look at this whole thing is, up until a year and a half ago we were asked to run a three-mile race and we were very good at it. Then overnight, because of our size, they come in and say starting tomorrow you need to run a marathon. It takes a little time to train up from three miles to a marathon and that’s where we’re at today. We’re just ongoing process of upgrading people’s infrastructure, whatever it is. We’ve been doing it now for -- David it’s been going on 18 months.

David Zalman

Yeah. In the past as you know, we focused and we always felt that from a regulatory standpoint that the asset quality of the bank and the earnings and our efficiency ratio and the fundamentals are what really counted. And what we’ve found out as I’m sure like others have found out, as you get larger, those are probably still important. But they’re more impressed with policy than procedures and things of that nature.

Operator

And our next question comes from Jon Arfstrom of RBC Capital Markets. Please go ahead sir.

Jon Arfstrom – RBC Capital Markets

Just to follow on that, it’s a great topic to explore with you given the fact that maybe some of the efficiencies from F&M might be offset a bit with bigger regulatory burns. And I guess Dave Zalman, for you; does this change your acquisition appetite at all or does it make you think a little bit differently about the future of the company? Or is it still the same as it has been over the last couple years?

David Zalman

No, John. It's too late. We’re already pregnant. So we know where we’re at. We know what we have to do. I think that basically we said, probably even a year ago that we mentioned this to all the associates and staff and everybody that our game plan was to – over the last 18 months to 2 years, we’ve grown from a $10 billion bank to a $20 billion bank. And basically we’ve said that our goal was to get both banks operationally integrated. We did that here in June with F&M. And I would say that we said basically from I think last year at the end of the year that it would be about a year before we would really be in the market for probably trying to purchase or doing another bank dealt.

And I think because the most part I'm sure we have lot of our own associates listening. If I said anything different, they might come in here and kill me. I think from --truly so I think it's the right thing to do. We’ve really grown a lot. It's really important right now to make sure that our back room, that our operations get up to speed with the size that we are. And that just doesn’t happen overnight. When you double in size, it really takes a lot of work there. It takes a lot of work to make your ITPs work, your node areas work, that the regulators ae happy with everything that you have. So I think unless there’s something that’s extremely sexy out there that we know that it's a deal of a lifetime, I think we’re still on that schedule to go out toward the end of the year and really not make an acquisition.

Jon G. Arfstrom – RBC Capital Markets

Okay. Good. That’s helpful. I'm not sure who will answer this, maybe Tim. But you talked about seeing more requests for new loans. Can you give us an idea maybe of what or where is the strongest?

Tim Timanus

It's really across the board. We’re seeing for example more requests for large class A apartment projects in major metropolitan areas. In fact, we’ve seen so many that we’re a little bit concerned about the growth in that area and whether or not the absorption is going to be there in the future to make those projects work. We’re seeing continued office and retail requests on the real estate side. All of our bread and butter loan types continue to have requests come in. I think it’s spread across all sectors, but it does seem like the largest request and it’s simply by virtue of the nature of the projects are the large residential projects and those are primarily apartments as opposed to condominiums for sale. And then we’re seeing some large office buildings change hands, not necessarily new office buildings, but existing ones change hands and those are high dollar loans. So it’s business as usual, but we are seeing more larger requests from the high dollar residential and the office side.

David Zalman

And I think you could also make an analogy that we seeing larger credits coming to us simply because of our size and our dominance in Texas and Oklahoma and probably some other relationships that might have had a relationship with us but because they were so big they might have shared some of their loans. We are seeing some of the customers increase what they’ve had with us and coming more toward us too I would think.

David Hollaway

That’s exactly correct. Once upon a time we really weren’t big enough to see these kinds of credits or be able to much with them other than act as a participant. Now we are big enough where we can actually generate credits. And if we want to be a participant, we can take a larger share obviously. You’re right. A lot of this is a result of our size.

Jon G. Arfstrom – RBC Capital Markets

Okay, and then just one small one, the construction and development increase, over $100 million. How of that was acquired versus organic in terms of that sequential jump?

David Hollaway

I don’t have a hard number for you on that but Randy Hester, just said he thought 50% acquired, 50% organic and I’d say that’s going to be pretty close to right.

Operator

(Operator Instructions) And our next question comes from Jennifer Demba of SunTrust Robinson Humphrey. Please go ahead.

Jennifer Demba – SunTrust Robinson Humphrey

Thank you. Following up on the topics we’ve already discussed, David Hollaway, how much of the F&M cost saving have you guys realized through the end of 2Q?

David Hollaway

Yeah. I think in a big picture I think we’ve recognized quite a bit of it. Again, I think that run rate’s pretty close and again we get to third quarter you’ll take out that $2 million onetime charge, we are pretty good there. The other expenses you see coming out of first quarter, second quarter is just a lot of this other stuff going on. We’ve done our job pretty much for the acquisition, but we’ve got all these regulatory expenses that we need to deal with. We also have as you’ll note on our fee income slide you see our trust and brokerage, our lines of business. You see the fee income increasing. That doesn’t come out of thin air. There’s expense behind it. They are beefing up those areas. So, that’s some of that expense also that you are seeing in a linked quarter growth.

David Zalman

Yeah. I would just add, Jennifer that generally you probably even see more, but sometimes it’s overcome by the amount of regulatory course we have or regulatory burden with the new people we have.

David Hollaway

And the lines of business.

David Zalman

And the lines of business, yeah

David Hollaway

And private lines we are getting up to runs.

Jennifer Demba – SunTrust Robinson Humphrey

David Zalman, you mentioned you think you are still on the side lines for more M&A until late this year, early next year. Are you trying to get through another exam cycle before you contemplate announcing something or is there some certain date you are trying to get past?

David Zalman

I don’t know that we have an exam cycle anymore. They are here all year long. So they are here 42 out of 52 weeks. That’s a year’s cycle. If we are doing something wrong we know pretty quick. And probably the good part of that is you get a chance to correct it right away. And so I’d say they are here, but I don’t know necessarily that we are waiting for an exam cycle as much as just waiting for our people to catch up and catch their breath. And again like making sure IT for example, we really took on a lot, making sure that’s working and when you turn on your computer the little circle doesn’t go around, that you do get the outlook email when it pops ups and a fundamental step like when you are trying to make a loan so that I don’t have to wait two weeks to get it processed. It’s fundamental stuff that really as you grow you have some issues and you have to work through those issues and make sure that you are the best at it. I would say it’s really getting our backrooms in shape to service our front end basically.

David Hollaway

It’s a timing thing, right? I mean as we disclosed the last transaction in June, it takes about 90 days from our operations to deal with the aftermath and ensure everything is moving forward correctly. Then once it’s signed off and all that, then their attention can turn back to infrastructure, whatever they need to do and it’s just a timing thing. So I think we’re on schedule with what you laid out, David.

David Zalman

Yeah, I think that’s right, I think from a regulatory standpoint I feel like we’re doing everything that they want us to do. Who knows, we may get a bat in our head. But from right now I think that we’re -- again I don’t see anything dramatic there really.

Tim Timanus

I might add to what Dave said, I think F&M is an important factor in this. I mean we need to get F&M squarely on board and make sure everything is functioning properly there and that’s happening. But it takes a few months to do that. So we need to complete that process.

Jennifer Demba – SunTrust Robinson Humphrey

One more follow up if I could BSA, AML, fair lending seem to be under greater scrutiny now. How do you feel specifically about your processes related to those areas?

David Zalman

I’d probably go back to a prior comment, but I’d say a while ago, I mean 18 months ago or two years ago when we crossed the $10 billion mark, it was I think within six months we had to increase it to probably 15 or 18 people. So I think we’re doing pretty good. Maybe I’m wrong, but I feel like right now our BSA is doing pretty good. Do you feel any different Charlotte or anything?

Charlotte Rasche

No.

David Zalman

I mean I think we’re okay.

Operator

Our next question comes from Mikhail Goberman of Portales Partners. Please go ahead sir.

Mikhail Goberman – Portales Partners

Good morning gentlemen. A quick question about capital, tangible common equity ratio of 6:1:6 right now. Do you have any sort of target ratio that you wanted to rise to before you indeed pull the trigger on another deal? And is that an internal target or is there anything regulatory related with respect to that?

David Zalman

Again we generate a lot of capital. I think that our earnings projections to you guys or the analysts have are about$300 million a year and even after we pay close to $1 on a dividend we’re still retaining over $230 million a year in capital. So, we almost grow 1%. That 6% for example would turn into 7% within a one year timeframe. I think that we’re okay with 7% today. Today is well capitalized, but again it’s only the thing that we’re always looking in. We’re recognizant of it. At the same time I’d also say that when we do deals generally for the most part that we see the banks that join us are willing to take our stock. And so we may pay some percentage in cash, but most of the time they are willing and wanting to take our stock.

Mikhail Goberman – Portales Partners

That’s very helpful. Thank you. And just real quick, from a competitive landscape sort of perspective, in which direction are things moving down there in Texas and Oklahoma? Does it continue to get more competitive and crazy pricing or is it starting to level off a little bit?

David Zalman

I’d probably answer two ways. Unemployment is what we probably have is better here in Texas and Oklahoma than almost anywhere else. Population growth is I think 200 cars a day in use and probably 200 cars a day in Dallas, 100 in Austin. I mean the growth is just unbelievable. So from a growth standpoint and economic standpoint we’re seeing loans and people really starting to come in for more. In fact, Tim, I don’t know when the production was or how much production we had, but it’s really growing. So from that perspective I think it’s really good.

The negative that we see is probably the competition, the willingness to lower the terms and conditions on credits. I guess everybody is looking for loans so much and the rights that they’re willing to do that and fix that and stuff like that. So that’s probably the negative part that we see. It’s almost extreme, so extremely competitive that we feel sometimes we wish that everybody – and of course they probably say that about us too that when we’re looking at other deals we wish that the other banks would try to keep up their margin a little bit and put reasonable rights fixed for a certain period of time. There’s terms and conditions overall really.

Tim Timanus

I might add a little to that with a specific example. We found out yesterday that one of our competitors in Texas approved the loan that we had looked at a commercial real estate loan and they agreed to fix the rate at 3% for 20 years. I think that gives you a little clue as to what’s going on out there in the marketplace. It’s extremely difficult from a competitive standpoint and if history repeats itself, which it normally does, these financial institutions that are doing those things are going to have a real problem at some point in time down the road. And we are trying to keep a balance and continue to add to our loan portfolio, but not fall into those traps. It’s just part of the landscape that’s out there and we deal with it every day and we’ll get through it.

David Zalman

Yeah. I think that I looked at the loan in Oklahoma. It was a municipality last week or a couple of weeks ago. Again a lot of these are smaller banks so they are not held -- they are probably not as -- looking at everything the same way we would look at it, but they offered a fixed rate to a municipality for five years at 1.75%. That wasn’t tax free. 1.75% by time it costs your overhead of over 1% and you have any risk at all, it’s virtually not making anything on it basically.

Operator

And our next question comes from Gary Tenner of D.A. Davidson. Please go ahead Sir.

Gary Tenner - D.A. Davidson

Good morning. just thinking about the increase in purchase accounting benefits this quarter to the loan yields, is it reasonable to think of the amount of share national credits and club deals at F&M and thinking that some of those benefits could be a little front loaded as you work off some of those loans or is there some other driver this quarter over the increase?

David Hollaway

Multiple -- I think there’s probably multiple answers to that question. Let me take the last one first. Yeah, in the quarter there was -- in the loan side there was roughly $25 million of purchase accounting on the loans. And of that, $7 million of it was related to 03 type credits which these are credits we’ve been able to work our way out of from the deals over the last two years. So that was a little higher than normal. And on the second part of that question, I’ll let somebody answer in more detail, but yeah, I think that if you are working your way out of some of these loans, you call them outsourcing them or if they leave us or we are touching them or whatever the terminology is, and they’ve got a fair value discount attached to them and then they leave us, you are absolutely right, that would be front loaded. It could be that fair value comes to us quicker.

David Zalman

Yeah, but I’d hate to say that it’s front loaded. I think the mark that we put on the loans I think we are talking about the 03 loans. We think they are realistic and fair. We are not trying in any form or fashion of front end loading them and put a lot more in. In fact if we recover, for example on an F&M deal for example if we add a $2 million or $3 million 03 provision for that loan and we collected it in the next three or six months, we wouldn’t take that through income. We would take that back to goodwill. Wouldn’t we Dave? That would be more of a happening in a short period of time.

David Hollaway

No, on 03, well to get in the weeds though, 03 if you do better than what your mark is, it will come back to you in income

David Zalman

But none of it happens right away, will it? It’s a question I guess you have to debate it. But again I think overall the front end, we really don’t try to front end load stuff. We really try to put realistically what we think the …

David Hollaway

What he means by front load is that these loans pay off, mature whatever just in the general way. You are collecting that discount.

Tim Timanus

Right. I think maybe the best way to answer it …

David Zalman

From the 91, yes. Interesting.

Tim Timanus

I think my numbers are close to being correct. On the 03 side the number of F&M loans that have an 03 mark are really only about a third of that total portfolio that David mentioned, the shared credit et cetera. It would be a mistake to assume that that total portfolio that our credits, we are not saying they are bad credits, but they are outside of our normal box. Some will stay with us, some won’t. But it would be a mistake to assume that there’s a mark associated with all of those that would come into income because that’s not the case.

David Zalman

Right. And I would also say the amount of accretion that we had this quarter because of the 03, I don’t think you can count on that. I think some of this is more reflective in a quarterly accretion basically it would probably be more like $16 million or $17 million, Dave?

David Hollaway

Yes, you could take $16 to $18 million

David Zalman

$16 to $18 million

David Hollaway

Of which -- we say on every conference call, you can’t consider 03s as part of quarterly flow. That’s just a reflection of how you work out of your loans eventually.

David Zalman

Yeah, I think, and I know it’s hard for everybody that’s watching this. There’s so much noise in here because we had a large accretion number and we had a gain on the sale of some ORE. At the same time we took a much larger provision for loan loss. So I think when you consider everything that went on, the additional accretion that we got, the initial gains that we got on the sale of ORE and some life insurance and you offset with the additional provision that we made and the additional cost with the F&M deal, we had a– I think a really damn good month. I mean our quarter it was really impressive and I think we did better than we had anticipated.

Operator

(Operator instructions). Our next question comes from Jefferson Harralson of KBW. Please go ahead sir.

Jefferson Harralson – Keefe, Bruyette, & Woods, Inc.

Thanks. I wanted to ask about the F&M loan market. It looks like the loans of F&M were a $1.7 billion at the end of Q1 and $1.5 billion at the Q2. Is the lion’s share of that the mark?

David Zalman

I’ll try to answer this, and Tim or somebody else can jump in. But again you had a $1.7 billion to start off with or so. Our mark was right around $100 million, $130 million total. Basically the decrease in the loans came from about $100 million in pay downs more in the shared national credit area and then the rest was the mark.

Jefferson Harralson – Keefe, Bruyette, & Woods, Inc.

So in combination it was a mark off so it heavily moved towards those shared national credits to where the $400 million that we had at Q1, is that down to like $250 million now the shared national credits at F&M?

David Zalman

The shared national credits at the end of June were $290 million and they also had some syndications or called club credits of about $43 million. But the shared national credits were down to $290 million.

Jefferson Harralson – Keefe, Bruyette, & Woods, Inc.

Okay and then finally on the accretable yield you expect to go through over time, it seems like that had a big increase this quarter. Was that due to F&M or just some things moving from non accretable to accretable or what happened there?

David Zalman

I don’t know that I understood that question.

Tim Timanus

We have a total of $224 million in fair value accounting spread out between the 03 and the three 1020s. It’s more than just F&M, if that answers your questions.

Jefferson Harralson – Keefe, Bruyette, & Woods, Inc.

Yeah. So I would say in that -- I guess in the last quarter the remaining accretion to go through was about $77 million. Now it looks like its $123.3 million. And I was thinking you also had the $23 million dollars run through. It looks like the number increased, but we can also talk about that one offline if you want to.

David Hollaway

No, I think that’s right. There was about $65 million and 91 discount coming from F&M. And so that’s a little higher than on these past bills. If you’re tracking history that would infer that the 91 going forward is a little higher. Now I think if we recall we were projecting based on what we knew at the time, we thought maybe $13 million a quarter was good. But it looks like this past quarter is running about $18 million and that some of that is going to be F&M obviously that’s driving that for a majority of it actually.

David Zalman

But again we’re not the ones really putting the mark on that. We hire an outside group to come in and give us that mark and again they called it higher than we anticipated it to.

David Hollaway

What that infers is your go forward number should be a little higher, because you’re starting at a higher number.

David Zalman

Yeah, right.

Operator

This concludes our question and answer session. I would like to turn the conference back over to Charlotte Rasche for any closing remarks.

Charlotte Rasche

Thank you, Betty. Thank you ladies and gentlemen. We appreciate you taking the time to participate in our call today. We appreciate the support that we get for our company, and we will continue to work on building shareholder value. Thank you.

Operator

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect your lines.

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