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Texas Capital Bancshares, Inc. (NASDAQ:TCBI)

Update Call

January 14, 2008 5:00 pm ET

Executives

Mryna Vance, Director of IR

Joseph M. (Jody) Grant, Chairman and CEO, Texas Capital Bancshares, Inc.

George F. Jones, Jr., President and CEO, Texas Capital Bank

Peter Bartholow, CFO

Analysts

Andrea Jao - Lehman Brothers

Charlie Ennis - Sandler O'Neill Assessment Management

John Pancari - J.P. Morgan

Brent Christ - Fox-Pitt Kelton

Erika Penala - Merrill Lynch

Jennifer Demba - Suntrust Robinson Humphrey

Ron Peterson - Sterne, Agee & Leach

Robert Patten - Morgan, Keegan & Company, Inc.

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the TCBI conference call. (Operator Instructions)

I would now like to turn the presentation over to your host for today's call, Ms. Mryna Vance, Director of Investor Relations. Please proceed, ma'am.

Myrna Vance

Thank you, [Shaquanna], and thanks to all of you on the line for joining us on such short notice.

As Shaquanna said, I'm Myrna Vance, and if you have any follow-up questions, I'd appreciate getting a call at 214-932-6646.

And before we get into our discussion today, let me read the following statement:

Certain matters discussed on this call may contain forward-looking statements which are subject to risks and uncertainties. A number of factors, many of which are beyond Texas Capital Bancshares' control, could cause actual results to differ materially from future results expressed or implied by such forward-looking statements.

These risks and uncertainties include the risk of adverse impacts from general economic conditions, competition, interest rate sensitivity and exposure to regulatory and legislative changes.

These and other factors that could cause results to differ materially from those described in the forward-looking statements can be found in our annual report on Form 10-K for the year ended December 31, 2006 and other filings made by Texas Capital Bancshares with the Securities and Exchange Commission.

Now, let's begin the discussion. With me on the call today are Jody Grant, Chairman and CEO, George Jones, President, and Peter Bartholow, CFO.

As Shaquanna said, after our prepared remarks, she will facilitate a Q&A session.

Let me now turn the call over to Jody.

Joseph M. (Jody) Grant

Thanks, Myrna. Good afternoon, everyone.

We greatly appreciate your joining us for this conference call, particularly on such short notice. As you may have surmised, the purpose of the call is to advise you of a change in earnings guidance for 2007.

I believe the press release that we issued after the close of the market is self explanatory, however we want to give you an opportunity to answer questions, and we will be as forthcoming and transparent as possible.

We do hope to have accomplished one goal and that is for you to have an understanding of what our exposures are.

The change in guidance results principally from our exposure to a single commercial loan in the amount of $12,500,000. While complete financial results will be presented in our regularly scheduled call on January 30, we felt it appropriate to announce a revision in the guidance to a range of $30.5 million to $31.5 million from continuing operations, or a $1.14 per share to $1.18 per share. This produces an increase from 2006 of between 4% and 8%.

As you can appreciate, we cannot talk about any specific customer by name in order to protect the confidentiality of the nature of the relationship that we have with our customer. However, we will attempt, again, to be as forthcoming as we can given the circumstances.

We've reviewed the portfolio and have identified and accounted for all of non accrual loans discussed in the press release. In a few minutes, George will discuss those non-accruals in greater depth.

We have great confidence in our methodology for determining our provision and our reserve for loans and leases outstanding. We believe that this larger provision in the fourth quarter to bolster our allowance is prudent, particularly given the circumstances of the specific problem loan previously mentioned.

The increase in the provision and the allowance is normal and is an expected consequence of our business and is not indicative of further credit losses as most of our loans are secured by marketable collateral and the sound earnings capacity of our borrowers.

I want to emphasize that our growth story is still very much alive and well. We experienced growth in loans for the year and for the fourth quarter, and we continue to see improvement in other operating metrics. We also saw a strong increase in demand [inaudible] for the quarter.

I want to emphasize that the information we are sharing with you this afternoon takes into full account the condition of our loan portfolio based upon the information that we have today.

In closing, I want to underscore that the fundamental earning power of the company increased with each quarter and was particularly strong in the fourth quarter. Consequently, we're entering the first quarter of 2008 in a very strong position.

I'll now turn the call over to Peter for a few comments, and then George will discuss credit quality in more depth, after which we'll be happy to answer your questions.

Peter?

Peter Bartholow

Thank you, Jody.

I do have just a few comments related to the change in guidance announced today, especially the incremental impact of the circumstances Jody mentioned about which George will comment in much great detail.

To reiterate, we believe we will report income from continuing operations of $30.5 million to $31.5 million, or as Jody said, $1.14 to $1.18 per share. This will represent an increase from the $1.10 reported last year from continuing operations.

The guidance provided earlier this year contemplated the following in comparison to what's being reported:

We anticipated provision expense driven by the methodology, consistently applied and resulting from substantial growth, of about $8 million. We anticipated net charge-offs for the year to be $3 million.

Instead, the revised guidance is based on a provision for all of 2007 that includes the $4.7 million through Q3 2007 of $13.7 million to $14.7 million, and net charge-offs for the year of $2.2 million.

The specific credit will represent the substantial majority of the difference between the provision incorporated in guidance and the actual results we're discussing today. The $12.5 million exposure also represents the substantial majority of the increase in nonperforming assets.

As has been seen over the last eight quarters and beyond, TCB's results in terms of credit cost vary, sometimes somewhat widely. It is simply a characteristic of the business model. That business model and its emphasis on sustaining strong credit quality have also produced excellent results over an extended time period.

It's important to put the Q4 2007 results in context of the longer credit quality experience. For us, even small losses compared to the industry look larger when compared to the net recoveries and insignificant net charge-offs in many quarters.

Net charge-offs in 2007 at about $2.2 million will represent 7 basis points, the same as net charge-offs for the trailing 24-month period. Net charge-offs since inception have been just under 10 basis points.

You'll recall that we had realized a net recovery of $300,000 for the year-to-date through Q3 2007. Actually, in five of the last eight quarters we have either had net recoveries in three quarters, or net charge-offs of insignificant amount in two quarters. And during the past two years, in quarters with any net charge-offs, the average net [charge-off] ratio in those quarters was just under 14 basis points.

I think all this points out not only that we have variability, certainly, in results, but the variability has not been adverse to our position.

Jody mentioned that we have seen improvement in key operating metrics over the past year. Specifically, we've seen significant improvement in operating leverage, and for us that means the growth rate in net revenue is substantially higher than the growth in non-interest expense.

We've seen improvements in the ratio of non-interest expense to earning assets reaching what I believe will be a new low in the fourth quarter.

The efficiency ratio, we will report under 60 basis points - excuse me, 60% - even before adjusting for the impact of things that are adverse to us in the mortgage industry today.

And with that, I'll turn it over to George for a more complete discussion.

George F. Jones, Jr.

Thanks, Peter.

I'd like to take a few minutes and discuss our $9 to $10 million proposed provision to our loan loss reserve, the reasons for it at this time, and a little more in-depth description of our non-performing assets at the end of 2007.

As mentioned in our release, the provision is driven primarily by a single commercial credit and by the effects of substantial growth in loans.

The single C&L loan that we talked about is a secured credit with exposure to Texas Capital Bank of $12,500,000. The loan is secured by all the assets of the company, and their management and their board are working with us to repay the loan.

Obviously, there are many moving parts in a loan workout situation such as this, and because of these uncertainties, we've provided additional reserves specific to this credit at this particular time.

The bank, as mentioned before, will show an increase in non-accrual loans and ORE - these are net of past-dues - of approximately $15 million. But I'd like to discuss the majority of the non-performing portfolio of approximately $24 million that we'll report at the end of the 2007. This number will be net, obviously, of proposed charge-offs and 90-day plus past-dues.

The $12.5 million loan makes up the majority of the $15 million increase, but there are really four other loans that comprise most of the balance of the non performers. Let me take a minute and work through those particular loans.

The first is a $2.9 million commercial real estate loan in Houston, Texas secured by a commercial development site that is supported by an appraisal on that property. We have additional reserves allocated to that loan in excess of the appraised value.

The second one relates to a $2.5 million commercial C&I loan that you'll recall we have discussed previously. This is a loan we took a $1 million charge-off on last year. Of that amount, we've recovered $400,000 from the sale of other real estate, leaving $600,000 of charge-off and $2.5 million left on the books to collect. We've agreed to a transaction with a payment from collected accounts receivable, hopefully in the first quarter of 2008, to recover all but $100,000 of our charge-off. But we also have reserves allocated to this credit in addition to our proposed collection efforts.

The third series of credits total $4.1 million, and these are mortgage warehouse non performing loans that have been marked-to-market and moved into the loans held for investment portfolio that we believe have small additional exposure. But also, we have additional reserves allocated over and above that mark-to-market allocated to those specific loans.

The fourth credit is a $2,250,000 commercial loan in Houston to an individual. We're currently trying to receive $750,000 in liquid assets as collateral, and this individual has signed a sale-leaseback agreement on various real estate properties that will generate enough cash to pay us off if it closes. But today, we have a substantial reserve allocation on that particular loan.

Turning for a minute to the ORE portfolio, our other real estate portfolio totals approximately $2.7 million at year end, with about half of that total representing lots and houses foreclosed on in Q4 from just one small homebuilder. A charge off was recorded at the time of foreclosure, and we believe our ORE portfolio has been marked down appropriately.

With this provision that we've discussed earlier and our current reserve, we believe we have provided appropriate reserves for our loan portfolio. This provision would increase our loan loss reserve from about 0.8% to almost 1% of average loans held for investment at December 31, 2007.

Jody?

Joseph M. (Jody) Grant

Thanks, George.

We've tried to make this overview as brief as possible to allow plenty of time for questions so at this time, Shaquanna, would you please ask for questions?

Question-and-Answer Session

Operator

Yes, sir. Thank you. (Operator Instructions)

Your first question comes from the line of Andrea Jao, with Lehman Brothers. Please proceed.

Andrea Jao - Lehman Brothers

Good evening. Andrea Jao from Lehman Brothers. How are you?

Joseph M. (Jody) Grant

Hi, Andrea.

Andrea Jao - Lehman Brothers

Well, it looks like operating trends are better than expected, you know, loan growth strong and demand deposits actually turned out to be strong.

Why not kitchen sink more potential losses given that trends are strong right now, or do you feel that, after a look at your loan portfolio, it's totally not necessary?

Joseph M. (Jody) Grant

Andrea, we have looked at the portfolio in depth and based upon the status of every loan in that portfolio today, we believe we have adequately accounted for and reserved for any possible contingencies.

Andrea Jao - Lehman Brothers

Okay. Now, as you looked at your loan portfolio, what kind of assumptions did you have for 2008? Are you assuming a stable economic scenario in Texas in 2008 versus what it is now?

Joseph M. (Jody) Grant

Andrea, obviously Texas has changed over the years, and we are somewhat more vulnerable to the national trends.

However, as we've stated previously, we didn't experience the housing bubble in Texas that the rest of the nation experienced. And I think I've cited these statistics before, wherein, in the five-year period ended at the end of last year - last year meaning '06 in this case - the median price of homes in Texas increased 22% versus 55% in the rest of the country.

Now, we've experienced what the rest of the country has experienced in terms of the slowdown in housing starts, slowdown in housing permits, and the slowdown in the resale of existing homes. I think the good news in all of that is that prices have held up reasonably well and, in fact, in homes over $200,000, they've actually gone up a little bit.

George should comment on our lot exposure and our exposure to homebuilders as well. And I'll just remind you, we don't bank any of the major big homebuilders that have made most of the news.

George F. Jones, Jr.

Yeah, I think we've mentioned in the past that our starter home portfolio is roughly in the $20 million range, and there are about seven builders that relate to that particular side of our business. So it's very little exposure from our standpoint.

From an overall perspective in terms of single-family construction and single-family lot developers that we call market risks, so to speak, that need to be sold or refinanced actually to get paid, we've got about 8.4% of our portfolio related to those single-family home construction builders and lot developers. And that's a fairly reasonable, small number in terms of concentrations, we believe.

One thing that again we think is very positive in those numbers is about 95% of those loans are in Texas, and as you might imagine, the preponderance of those are in DFW and in Houston and, to a lesser extent, San Antonio, and that portfolio to date has held up pretty well.

I mentioned to you before we had the one small homebuilder foreclosure, but that was just a little bit over - we're carrying that a little bit over $1 million in our ORE portfolio, again, which is fairly small, and we've marked that to market before we took it into our ORE portfolio.

We would never say there would never be any future problems in our homebuilding or lot development portfolio, but we feel pretty good about the quality as it stands today.

Peter Bartholow

The only other thing I would mention, Andrea, is that we are witnessing a degree of caution on the part of our customers. They are voluntarily pulling back on their own development and plans.

I read in the paper just over the weekend in a report about new housing starts that it's anticipated that starts will be much lower in the first half of this year, and that in the second half of the year, we should have eaten our way through the inventory and be on an upward path again.

But that's speculation on the part of analysts who are looking at the specifics of the marketplace, and we won't know until we get there.

Andrea Jao - Lehman Brothers

Great. Thank you.

Operator

Your next question comes from the line of Charlie [Ennis] with Sandler O'Neill Assessment Management. Please proceed.

Charlie Ennis - Sandler O'Neill Assessment Management

Good evening, you guys.

Joseph M. (Jody) Grant

Hi, Charlie.

George F. Jones, Jr.

Hey, Charlie.

Charlie Ennis - Sandler O'Neill Assessment Management

Can you - I think that this credit was discussed a little bit on the last quarter, and you guys seemed to have a fair amount of comfort with it.

Can you guys in generalities discuss what changed with the credit?

Peter Bartholow

You're talking about the large C&I credit mentioned up front?

Charlie Ennis - Sandler O'Neill Assessment Management

Yeah.

Peter Bartholow

You know, Charlie, just the natural progression of a company that just struggles a little bit in the economy.

Without getting really too specific - as Jody mentioned earlier, we really can't get into too many of the specifics for the sake of our customer relationships - so digging a little bit deeper than that at this point in time would be a little more difficult for us to do.

Charlie Ennis - Sandler O'Neill Assessment Management

Okay.

Joseph M. (Jody) Grant

Charlie, I won't elaborate much except to say that when we had the conference call after the third quarter, this was all in the process of developing. We didn't have a lot of information at that time. Today, we have much, much more information and feel like we've got a good handle on the credit that George spoke of plus the rest of the credits that he spoke to.

Charlie Ennis - Sandler O'Neill Assessment Management

Okay. Can you make any comment as to the collateral that you've got left in the credit?

Peter Bartholow

Yeah. Basically, we just have all the assets of the company behind the credit.

Charlie Ennis - Sandler O'Neill Assessment Management

Okay. And then, in terms of the quarter, can you say how the margin did in the quarter?

Peter Bartholow

We're trying to hold most of that, Charlie, to the end of the month when we make our full release, but I will say that despite the fact that we've been constrained by the yield curve and we've now been exposed to several Fed rate decreases, that the margin has been quite stable.

Charlie Ennis - Sandler O'Neill Assessment Management

Okay. Can you make a general comment, then, as to - the efficiency ratio you said was at or below 60% in the quarter and last quarter I think it was around 62%, so a big improvement.

Are there gains in there included in that or, if not, why did it show such a big improvement?

Peter Bartholow

There are no gains or any other kinds of transactions. In fact, as George mentioned, we actually have charges in that number relative to the mortgage warehouse business line.

Naturally, when things get like this and we're below plan, you have to take a hard look at the incentive accruals, but there is nothing of any consequence other than just better expense management and good results.

Charlie Ennis - Sandler O'Neill Assessment Management

Okay, great. Thanks a lot, you guys. Appreciate it.

Joseph M. (Jody) Grant

You bet.

George F. Jones, Jr.

Thanks, Charlie.

Operator

Your next question comes from the line of John Pancari with J.P. Morgan. Please proceed.

Joseph M. (Jody) Grant

Hi, John.

John Pancari - J.P. Morgan

Sorry about that. I just wanted to ask about the concentration or the granularity of your portfolio.

If you can just give us an idea of the average loan balance as it stands now in your commercial real estate book, and how many other credits of this magnitude do you have in your portfolio at this point?

Joseph M. (Jody) Grant

Charlie - I'm sorry, John; I'm back on the previous question - the granularity of the portfolio hasn't changed from comments we've made in the past. It's essentially the same.

We've got about 70 companies that have commitments over $10 million, and the last time I looked, those commitments averaged about $14 million apiece and we had about $8 million outstanding under each commitment, something along that.

George F. Jones, Jr.

Yeah.

Joseph M. (Jody) Grant

So anyhow, that's reasonably close.

George F. Jones, Jr.

We have a house limit, John - this is George - of $15 million. We obviously have a few exceptions to that that we think are unusually good credits that will exceed that, but not a heck of a lot. So with a limit of well over $40 million at this point in time, we try to be conservative in terms of concentrations of credit.

You asked about the commercial real estate side, we've got about 27% of our loan portfolio in what we would consider market risk real estate. In that number, the 8.4% that I mentioned in single-family builders and lot developers fall within that 27%.

The commercial real estate portfolio has held up really pretty darn well, and frankly, our homebuilder portfolio and lot developer has held up pretty well.

We are not oblivious to what's going on out there in the marketplace today. We're not saying that we won't see some weakness on a go forward basis. But we feel that our loan loss methodology is sound and if there is weakness, future weakness, our methodology drives provisioning, just like you saw us do this time when our classifications - not necessarily our losses, because you can see our losses are at 2.2 - but if you see our methodology, that will drive provisioning.

So we feel comfortable in that vein.

Peter Bartholow

John, stated a little differently, while we have - obviously for a company of our size you're going to have a number of credits in the $10 to $15 million range. I don't think in terms of the broad portfolio things have changed much.

We have a huge percentage of our total portfolio in sort of the $2 to $6, $2 to $7 million range, and that really hasn't changed very much.

John Pancari - J.P. Morgan

Okay. And then can you just talk about your watch list credits. Did they change materially this quarter given that you pointed to the deterioration or the change in this one credit here. I know that Charlie asked about what happened during the quarter. It was just a natural progression of the deterioration in this borrower's credit.

Assuming we saw that type of progression across your portfolio to an extent, I mean, can you talk a little bit about where you're seeing - what the watch list is looking like at this point?

George F. Jones, Jr.

Well, in a softening economy, your watch list is going to increase a little bit. It doesn't mean they're criticized. It doesn't mean they're classified.

But we certainly will be more conservative in terms of how we review and look at the portfolio, and just because we put something on the watch list doesn't mean it's a bad credit.

But we'll take into consideration those kinds of things, the economy. In fact, our loan loss provisioning methodology takes into consideration a number of issues like that, like an economy, like a more difficult economy nationwide and state wide.

Joseph M. (Jody) Grant

John, most of the increase in the watch list was reflected in the loans that we've talked about this afternoon.

John Pancari - J.P. Morgan

All right.

Joseph M. (Jody) Grant

In other words, we've given you very, very full disclosure as it relates to the increases.

George F. Jones, Jr.

And the real conditions we're talking about in the larger credits, as you mentioned, are somewhat unique and really not indicative of the balance of our loan portfolio, if that's the question you're really asking.

Joseph M. (Jody) Grant

Or even of the watch list.

George F. Jones, Jr.

That's right.

John Pancari - J.P. Morgan

Okay. And then lastly, could you just talk to us a little bit about your outlook here on the credit side, just what you're seeing so far going into '08 in terms of either a charge-off level or your reserve levels.

Are you comfortable that with your reserves sitting there still below 100 basis points of loans that that's where you think you need to be as you go through '08 or just given these trends that you're seeing?

Joseph M. (Jody) Grant

John, the first thing we should say is that we are still in our planning cycle. We haven't put to bed our 2008 plan. We're not ready to discuss it. We will give you guidance when we announce our earnings at the end of the quarter.

The customer, as I mentioned earlier, is being more cautious, which puts a governor itself upon the potential deterioration in credit quality and credit conditions, and we think our customers are acting in a very prudent way.

It's my belief that, at least based on our portfolio, a lot of this is going to be self-correcting as the inventory of lots and homes is absorbed.

We've seen reports recently that show that we're not out of line with the rest of the country, and, in fact, we're in far better shape than the hot spots such as Miami and the San Diego area, Phoenix, Las Vegas, and other places.

So we don’t feel - we're not looking a 2008 from a gloom-and-doom point of view. We're looking at it optimistically.

John Pancari - J.P. Morgan

Okay. All right. Thank you.

Operator

Your next question comes from the line of Brent Price, with Fox-Pitt. Please proceed.

Brent Christ - Fox-Pitt Kelton

Good afternoon.

Joseph M. (Jody) Grant

Hi, Brent.

Brent Christ - Fox-Pitt Kelton

Could you talk a little bit about how much of the provision this quarter was specific to the single commercial credit.

And then as a follow-up to that, you mentioned four separate kind of lumpy non-performers. Could you talk about how much in reserves you have set aside for each of those, and the extent that those are new this quarter versus were on non-performing last quarter?

George F. Jones, Jr.

Brent, that would get into a complete and probably very lengthy discourse about our methodology. And let me just say that our methodology has been looked at by everybody under the sun who possibly could look at it and has been signed off on.

We think the reserves that have been allocated to each of these loans is in keeping with the severity of the problem associated with those loans, and also is indicative of any potential charge-off that we might expect on those loans.

Beyond that, I think it would be an exercise in futility for all of us to get into trying to parse this thing and to breaking down our 100 basis points and allocating it across our entire portfolio.

But we're very comfortable with the reserve as it's been reported to you today.

Peter Bartholow

Brent, I'll cover something I mentioned earlier and say generally, the methodology requires reserves against the portfolio that are multiples of the experience we've encountered over the last two years, five years or 10 years.

The other thing I said is we contemplated in the guidance provision of $8 million. We're at $13.7 to $14.7, and I said a minute ago that the credit we're talking about represented a majority of the difference between guidance and the actual result.

So that's about all we can do.

Brent Christ - Fox-Pitt Kelton

Okay, so I can back into it there.

And then the second part of the question was just with respect to the four other non performers, which ones of those were new this quarter versus - obviously the C&I credit that you've taken some losses and recoveries on in the past is old, but how about the other three?

George F. Jones, Jr.

Right. Really, most of that relates to that $4.1 million of mortgage warehouse loans, and we have some of that in the non-performing portfolio. We added to that slightly in Q4, but really the balance of those have been here, have been around and aren't necessarily new to Q4.

Brent Christ - Fox-Pitt Kelton

Okay.

George F. Jones, Jr.

One thing I wanted to mention also in addition to the question you asked first, remember, in my discussion of these particular credits, a number of those have been taken into the portfolio with a marked-to-market mentality going in, and then there are additional reserves, once they're in the portfolio, against those particular loans.

So we certainly anticipate and hope that that is the right number, but we've tried to take a fairly conservative approach in terms of provisioning and reserving.

Brent Christ - Fox-Pitt Kelton

Gotcha. Okay. And the reason I asked is just that it seems like a little bit more granularity than you've given in the past.

George F. Jones, Jr.

Right.

Brent Christ - Fox-Pitt Kelton

Just a follow-up question in terms of - could you kind of talk about your thought process in terms of the workout for this larger credit, and how important is it that they have up-to-date and viable financial statements as you kind of work through?

And maybe touch on what you consider plausible outcomes from a timing perspective?

Joseph M. (Jody) Grant

We really can't, and the reason we can't relates to the fact that this is a national shared credit.

And it's just - it's delicate. We just don't talk about our customers, and we hope for a good result here. We're working hard, and that's about all we can say about it.

George F. Jones, Jr.

As I mentioned also in my comments, there are many moving parts in a situation like this and, as Jody mentioned, it would take probably this afternoon and tomorrow to talk through all those particular uncertainties.

And that's, again, why we put up the additional reserves that we think are appropriate.

Brent Christ - Fox-Pitt Kelton

Okay. Thanks a lot.

Operator

Your next question comes from the line of Erika Penala with Merrill Lynch. Please proceed.

Erika Penala - Merrill Lynch

Good afternoon. I just wanted to clarify a comment that you made on the call earlier.

You mentioned that the margin is looking relatively stable. Does that include the potential negative effect from the higher NPAs in fourth quarter?

Peter Bartholow

It does include any reversals in interest income during the fourth quarter.

Erika Penala - Merrill Lynch

Okay. And Jody, I just want to - you made some comments about how Texas may not be as immune to a national slowdown as it has been in the past. Could you expand on that a little bit in terms of what you're looking for in the local economy for '08?

It's a rather broad question, but I just wanted to get a feel on how to think about, I guess, credit performance looking past the fourth quarter.

Joseph M. (Jody) Grant

Well, it is a broad question, and one that's kind of difficult to answer. We're looking at trends over a period of time, and over that period of time, things have changed slowly.

But we have a much, much more diversified economy today than we've ever had before, and even though oil and gas is only a fraction of what it used to be in terms of its impact on the economy, there's been a huge wealth effect that's resulted from the energy business and the benefits that have accrued to the Texas oil and gas operators and energy companies.

So we have that, which sets us apart from, I think, every other state in the Union. Houston is still regarded as the energy capital of the United States, and I don't think that's going to change anytime soon.

Recently, it was announced that a consortium of refining companies are building the biggest refinery in the United States on the Gulf Coast. We continue to have things like that. That operation is supposed to employ about 10,000 people.

We have all kinds of things like that going on, and if you just look at the cranes in Dallas, Texas alone, there's more activity here than there has been in the last 20 years, and it seems to be very solid activity. New projects continue to be announced, and particularly at the higher end they seem to be successful.

Erika Penala - Merrill Lynch

And will the positive trends, in your opinion, in oil and gas be enough to offset any potential slowdown from housing, even if the housing slowdown is better than the hot spots or the national trends?

Joseph M. (Jody) Grant

Well, it certainly helps offset it. And it would be difficult for me to say that because I haven't attempted to analyze it in this respect, but we'll put it in another context for you and that is, whereas employment for the housing sector in particular is down for the state as a whole, employment for construction overall was up about 6%.

So there's a lot going on other than the housing industry.

Erika Penala - Merrill Lynch

Okay. All right. Thank you for taking my questions, gentlemen.

Joseph M. (Jody) Grant

You bet.

Operator

Your next question comes from the line of Jennifer Demba, with Suntrust. Please proceed.

Joseph M. (Jody) Grant

Hi, Jennifer.

Jennifer Demba - Suntrust Robinson Humphrey

Hi, there. My questions have been asked. Thanks a lot.

Joseph M. (Jody) Grant

Okay.

Operator

Your next question comes from the line of Ron Peterson with Sterne, Agee. Agee, I'm sorry. Please proceed.

Ron Peterson - Sterne, Agee & Leach

Thanks. Good afternoon.

Joseph M. (Jody) Grant

Hi, Ron.

Ron Peterson - Sterne, Agee & Leach

In just going through some of the numbers, you said your prior guidance was based on provision of $8 million. That's now up to $13.7 to $14.7 million. Now, obviously that's a pre-tax number.

Peter Bartholow

Correct.

Ron Peterson - Sterne, Agee & Leach

But your net income numbers, the range is only down $2.5 million. I would have expected that number to be down a little bit more based on the guidance you gave.

Is that just due to - is there some gains in the quarter?

Peter Bartholow

No, there are no gains in the quarter. It's just we're a little reluctant at this point to be as specific about every other line item. We're going to have to wait for the end of the month on that, Ron.

Ron Peterson - Sterne, Agee & Leach

Okay, great. Kind of a normalized tax rate, no gains, so it's just basically strength in the rest of the business that's offsetting that?

Peter Bartholow

That's correct.

Ron Peterson - Sterne, Agee & Leach

All right. Thank you very much.

Operator

(Operator instructions)

Your next question comes from the line of Robert Patten with Morgan, Keegan. Please proceed.

Robert Patten - Morgan, Keegan & Company, Inc.

Hey, guys. Most of my questions have been answered.

Just in follow-up on that other question, did I hear you guys right? Operating or efficiency is going to be below 60% for fourth quarter?

Peter Bartholow

That's correct. That is correct.

Robert Patten - Morgan, Keegan & Company, Inc.

Is that a first time?

Peter Bartholow

That's a first.

Robert Patten - Morgan, Keegan & Company, Inc.

Are you guys holding off on the expenses just to be cautious or is there going to be catch-up later on, just so I can understand some of the moving parts here.

Peter Bartholow

I don't see any catch-up to speak of. We are still, as Jody mentioned, in a growth phase. We are still hiring, so there are no kinds of adjustments like that.

I did mention that, in a market like this, when you miss guidance or miss plan that the incentive accrual comes down. It's geared to the overall profitability, so that shouldn't surprise anybody.

Robert Patten - Morgan, Keegan & Company, Inc.

Would it be sort of, I guess, a forward objective to keep it in this line? Obviously, it's a revenue versus expense number, but what's your thoughts about going forward?

Peter Bartholow

Well, a lot of it is - at least two-thirds of the margin for us - excuse me, of the efficiency ratio - is margin, and we are looking obviously at a Fed inclined to decrease rates.

So while it has been stable, as I commented, we are not ready to project what will happen to it during 2008.

But back to some of the earlier conversations, we see the effect of rate decreases, substantially less than they were when there were increases on the other side, and it's come simply from the fact that we are more naturally balanced. Funding composition has changed to the point that we don't have the swings that we used to.

If you'll remember my comment that it really hasn't changed on the upside since the Fed funds rate went above 4. So that's part of what we're experiencing, and we have become less sensitive by far than we were at the time when the rate did go above 4, if that makes sense.

Joseph M. (Jody) Grant

One thing, very clear, and that is we have not deferred any expenses into '08, nor do we contemplate that there's anything that we haven't accounted for that isn't in the books and that we haven't made transparent to you today.

So as far as I'm concerned, we're starting '08 with a clean slate. Now, it's a clean slate given the environment we're in, and there are uncertainties in the environment.

But we're generally positive about '08 and think we'll have a very, very good year.

Robert Patten - Morgan, Keegan & Company, Inc.

Thank you, guys.

Peter Bartholow

Thank you, Bob.

Operator

At this time, there are no further questions.

I would now like to turn the call over to Jody Grant for closing remarks.

Joseph M. (Jody) Grant

Well, just let me thank everybody for being with us this afternoon. We obviously never like to have to preannounce anything and if we did, we'd much rather it be an upside surprise rather than something on the downside.

Given the circumstances, however, we feel that we've come through 2007 in very, very good shape. We regret that we have a couple of credits that are problems for us, but as George indicated, we've fully reserved and accounted for those problems, and I believe that as 2008 unfolds, we'll get more clarity on these situations. And we're quite hopeful that the results will be favorable.

With that, I'll bring the call to a close. Thank everybody again for being with us. Remind you to call Myrna if you have any questions, and we'll do our best to respond.

Thank you so much.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect.

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