Zions Bancorporation, National Association (ZION) Q4 2007 Earnings Report, Transcript and Summary

Good day, ladies and gentleman, and welcome to the Fourth Quarter 2007 Zions Bancorp Earnings Conference Call. My name is Jacqueline, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of this conference. [Operator Instructions]. I would now like to turn the call over to Mr. Clark Hinckley, Senior Vice President. Please proceed, sir.

Good afternoon, and thank you for joining us on this quarterly conference call on January 24, 2008. If any of you do not yet have a copy of the earnings release, it can be downloaded from our website in pdf format, which is www.zionsbancorporation.com. A link to the release is found near the top of the page. During this afternoon's call, we will discuss the expected performance of the company. Such statements constitute forward-looking information within the meaning of the Private Securities Litigation Act. Actual results may differ materially from the projections provided in this call since such projections involve significant risks and uncertainties. A complete disclaimer is included in the press release and is incorporated into this call. I will now turn the time over to our Chairman and CEO, Harris Simmons.

Thank you very much, Clark, and welcome to all of you. I just want to introduce the call by saying that while we are disappointed by the aggregate level of this quarter's earnings, which were driven by securities write-down and reserves building, we also see in our numbers some real areas of strength, particularly in light of what is a very challenging environment that you are all very familiar with. I am going to turn the time over to Doyle Arnold, our Vice Chairman and Chief Financial Officer, to go through the number, and I’ll have some comments later.

Thank you, Harris. Good afternoon and good evening, everyone. Earnings per share for the quarter were $0.39. I think most of the major items impacting earnings adversely this quarter have already been disclosed in the 8-Ks that we issued in December. Included in those and included in the results were $0.89 per share of impairment and valuation losses that were previously disclosed. We had previously disclosed information about these litigation settlements. The final number as we got our arms around several different cases was little bit higher and had a $0.05 per share impact on the quarter. So earnings of $0.39 with $0.89 of impairment charges and $0.05 a share of litigation reserves related to these. Some credit measures were maybe slightly worse than earlier guidance, but I think broadly in line and not materially different. Non-performing assets increased $87 million, somewhat less than the increase of $101 million in the third quarter. Net charge-offs were $26.7 million or 0.28% of average loans. This was an increase of $8.6 million from the third quarter. And the provision of $70 million was up from… it was up $14.6 million from the $55 million in the third quarter, perhaps little bit higher than our guidance, but it did include $43 million of provision in excess of losses. The net interest margin declined 17 basis points during the quarter, probably a bit more than some of you were expecting. A third of that resulted from our support during the quarter of Lockhart Funding, which I will discuss more in greater detail later. Loan growth was remarkably strong. It was net $1.3 billion during the quarter and nearly $1.5 billion before subtracting the $169 million of loans that were sold in conjunction with the sale of branches. The growth came largely as it has the last couple of quarters from Zions Bank here in Utah and Idaho, Amegy Bank in Texas, and Vector Bank in Colorado. All of those banks are operating in states where the economy remains relatively robust. In a turnaround from prior quarters, average core deposits showed some solid growth expanding by about $800 million. A significant part of this, however, seems to… appears to have been seasonal in nature and the growth was largely concentrated in more market-rate types of deposits. The combined loan and deposit growth were sufficient to offset the decline in net interest margin, and net interest income actually increased slightly from the prior quarter. The efficiency ratio, if you simply exclude the valuation and impairment losses on securities, was 56.6%, which we’re reasonably pleased with. In summary, net earnings were negatively impacted by the impairment and valuation losses related to securities that were previously disposed. Credit costs did increase, but remained within historical levels and not inconsistent with the guidance that we gave. Loan growth was very strong in the Intermountain West and Texas, areas that constitute about 60% of our asset base and where the economies are… while softening somewhat are… still remain pretty strong. And deposit growth was better than prior quarters, expenses remained well controlled. In sum, we think the fundamentals of the quarter remained reasonably strong. What I’d like to do now is, as we usually do, go through some of the numbers in the tables attached to the press release page. The tables are numbered in the upper left-hand corner. And I'm first going to call your attention to page 12, and the number I'm going to point to first there is just at the end of the average balance section, the very last line, weighted-average shares outstanding, 106.9 million, a decrease of about 1 million shares from the third. That is purely a reflection or the effect of the lower stock price on the treasury method of accounting for stock options. We did not buy back any shares during the quarter and we do not expect to do so in the near future. Near the bottom of the page, fourth line from the bottom in the left-hand most column of numbers, you see the tangible equity ratio. At quarter-end, that number was 6.17%, down from the 6.40% in the prior quarter and slightly below our target range of 6.25% to 6.5%, but still very strong. We’ve previously disclosed and discussed a number of investor presentations and in one-on-ones and Q&A sessions that if all of our QSPE Lockhart Funding came back on our balance sheet, GAAP capital ratios would be impacted by about 40 basis points. Effectively, between securities that we repurchased from Lockhart at the end of the quarter and our support of Lockhart by purchasing its commercial paper during the quarter and at the end as well, we had at the end of the quarter about $1.6 billion of Lockhart-related assets on our balance sheet or a bit over half of the assets that we disclosed on balance sheet at the end of the third quarter. So we basically brought half the assets back and you see about half of the total impact of… that we’d previously discussed, if it all came back. So about 20 basis points to 21 basis points of the 23 basis points of tangible equity decline, you can, if you choose, attribute to the previously discussed impact of Lockhart on our balance sheet. On page 13, consolidated balance sheet, next page. Just note, first of all, interest-bearing deposits and commercial paper were up about $213 million. That's the second line of numbers on the page. That’s compared to the third quarter, and again a lot of that increase reflect… represents the average commercial paper issued by Lockhart and owned by Zions during the fourth quarter. On average, that amount was $763 million for the quarter. The next line I'll call your attention to is under investment securities available for sale, $5.1 billion. That's an increase of about $585 million from the third quarter. It basically reflects the purchase as disclosed in December of $895 million of securities from Lockhart. That was two individual securities that were downgraded to below AA minus by an agency during the quarter and then $840 million of assets that we bought out to reduce the CP funding needs of Lockhart. And then you have paydowns and so forth, which net out of that so that the net increase was $585 million. Moving on down the page, you'll see there $39.25 million of loans for unearned discount and allowance, up $1.3 billion from the prior quarter. And again we did close the sale of 11 branches in California that were originally part of the Stockmen's acquisition. This reduced loans by 169 – $169 million of loans were sold with those branches along with their deposits. In the deposits section, you'll see that non-interest-bearing demand at $9.6 billion was up $296 million during the quarter after having dropped significantly in the third quarter compared to the second. Finished the year still below where it was a year ago, and we still really haven't seen any strong consistent rebound in non-interest bearing demand deposits. The core deposits at period-end were up $1.3 billion, but as you can see as you glance through here, a lot of that was in large core deposits and more expensive form of core deposits such as the Internet Money Market and the foreign line, which for us are almost exclusively suites of commercials deposits into Cayman [ph] accounts. We still see the growth in deposits being very sensitive to the interest-bearing accounts. Core deposit growth was concentrated in Zions Bank and Amegy Bank and was weakest in National Bank of Arizona and Nevada State Bank, reflecting the continued weakness in the economies and homebuilding and in all kinds of residential related activities in those states, including title and escrow accounts. And then finally, again because of the strong loan growth, Federal Home Loan Bank advances during the quarter increased another $1.1 billion. If you will now turn to page 14, consolidated statements of income, as previously mentioned, net interest income before provision at $479 million was actually up slightly from the prior quarter. As previously discussed, and I’ll talk a bit more about provision, we did increase from $55 million to $70 million during the quarter. So net interest income after provision was down. Service charges and fees on deposit accounts continued their steady increase consistent with previous quarters. Loan sales and servicing income, which was down this quarter, did have an impairment charge of $3.3 million of retained interest from loan securitizations. There was no impairment charge in the third quarter as you recall, and in the second and first quarters there were $5.1 million and $4.2 million of such charges respectively. About half the 3.3 million reflected greater credit losses and then the other half was a combination of pre-payments and changes in discount rates. Trust and wealth management income continued its increase, up another $1.1 billion from the third quarter. I would just note that comparing fourth quarter '07 to fourth quarter '06, that is a 26% increase in one year in that line reflecting the investments and emphasis that we have made in those kinds of businesses over the last several years. Growth was all organic, no acquisitions during that period. Income from securities conduit was weak. This is the fee income that we earned from Lockhart. It is strongly driven by the difference between the cost of funding Lockhart and the earnings on its assets, and while the spreads over LIBOR have improved they are still quite... recently during the quarter, they were still quite high relative to historical averages. So that line remains weaker and it will remain weaker going forward because Lockhart now has only $2.1 billion of assets in it, down from the over $3 billion a quarter ago, reflecting paydowns and the purchasers of securities out of Lockhart. And once repurchased, they’re unlikely to go back in. And then finally, the last big line to point to there is the impairment losses on securities of $158 million, which we had previously disclosed. Under non-interest expense, I’ll note that the salary and employee benefit line is actually down $13.3 million. That largely reflects lower accruals and reversal of accruals for various long-term cash incentive plans, profit-sharing plans, and discretionary bonuses, reflecting the weaker financial performance of the company. So we trued up those accruals to reflect what we think will actually be paid and then that was actually a large decrease. All other expenses remained well controlled. The other non-interest expense line includes the $8.1 million accrual for Visa litigation as well as increases in FDIC deposit insurance expense as more of our banks began to eat through their credit and are in a position of having to actually pay that insurance. Final note… note that the income tax line is a net benefit, not a tax… of net benefit of $11 million. This reflects two things, one, most of the income after the impairment charge are larger… much larger proportion of income after taking the impairment charge was coming from non-taxable or tax advantage revenue sources. And during the quarter, a number of statute limitations or audits were passed on various tax positions for which we had reserved and we reversed about $11 million of reserves… tax reserves and took those into account. The result of those two things was a negative provision of $11 million. As I… in case I forget to mention it during the guidance section, certainly don't factor that into your tax rate for your models in 2008, but year rates should be consistent with what it has been in prior more normal quarters. Turning now to page 17, credit quality, non-accrual loans did increase to $258 million from $174 million. I think that's reasonably consistent with our guidance. Restructured loans and OREO were essentially flat. So the increase in NPAs reflects the increase in non-accruals. And accruing loans past due 90 days also crept up a bit more. The largest increases in non-performing assets, as you would probably expect, were in our National Bank of Arizona and in Nevada State Bank, and were in the commercial real estate area mostly related to residential housing construction land and development. It’s already mentioned that charge-offs were $26.7 million against a provision of $70 million. As a result, the reserve increased by $43 million on top of the $38 million in the prior quarter. The ratio of the allowance for loan losses to net loans outstanding then increased another 7 basis points on top of the 8 basis points in the prior quarter. And we’re please that at 28 basis points, we think our net charge-offs are still comfortably below industry and peer averages as they have been through previous cycles. We can't say how high they may reach, but we think as historically has been the case that our underwriting standards portfolio mix and geographic diversifications should enable us to continue to outperform peer banks on this measure. And then finally, at the bottom of the page, the total credit related reserves including the allowance for unfunded commitments was at 1.23%, also up 7 basis points from the prior quarter and 14 basis points from two quarters ago. I am going to ask… Harris, would you like to make any additional comments on the credit quality before we move on to some other things?

Yes, I think particularly given the environment we are in it would be interesting to you to just briefly to talk about credit quality in some of the non-CRE non-commercial real estate, particularly non-residential construction portfolios. At the end of the year, our… for example, our delinquency on our commercial loan portfolio or C&I portfolio was less than 1%. It was 0.95%, which is very consistent with where we have been in prior quarters and remains we think in exceptional shape. I think perhaps most notably in our consumer loan portfolio, total delinquencies were 81 basis points at year-end. In the home equity credit line portfolio, which has been a source of some concern around the industry, our delinquency was 20 basis points, 0.2%, consisting of 44 accounts out of 38,000 that were over 30 days past due. And again, it reflects the fact that we have been quite conservative not going beyond 80% loan-to-value in our policy, and we think that's quite an extraordinary number in today's environment. If you look at our mortgage loan portfolio, mortgage… residential mortgages that we have on our balance sheet, the delinquency was 0.72%. Our bankcard portfolio is a small portfolio with a delinquency of 1.53%, which as you know compared to industry standards is exceptional. I was looking the other day on our home equity credit line portfolio. Our losses last year were 1.5 basis points, net charge-offs on that roughly $1.5 billion portfolio. So to the extent of that is symptomatic of the underwriting going into this cycle, I think it's a reason that we believe that again we will make it through in a at reasonably good shape despite the fact that we are clearly seeing some stress with homebuilders and developers. But at this point the increased levels of problem assets that we are seeing is really very much concentrated in that category.

Okay. Thank you, Harris. I’ll turn to page 18 now, if you will. We’ll look at composition of the very strong loan growth. Note that commercial lending was up $873 million to $17.9 billion, and most of that was concentrated in the pure commercial and industrial line. The commercial real estate was up $215 million with all of that being in term lending. Construction and development lending balances actually declined slightly during the quarter. They actually rose through most of the quarter, peaked in early December, and have been kind of trending downwards since. And we would expect that to probably be the case going forward for quite a while. And then finally, consumer lending rose $157 million, as you can see, with the home equity credit lines and consumer real estate as well as mortgages and bankcard all posting increases. As you might expect, the strongest loan growth was in stronger economies, Zions Bank in Utah and Idaho; Amegy Bank, Texas; Vector Bank, Colorado; and smaller dollar amounts for good percentage increase also coming out of the Commerce Bank up in Seattle, Washington. So that's a quick look at the loan growth. Net interest margins, as I mentioned it decreased 17 basis points from prior quarter, primarily driven by a combination of very strong loan growth, growth in earnings assets related to Lockhart Funding, continued deposit pricing pressures, and the growth in higher cost funding accounts. In line with our guidance last quarter, the Fed rate decrease in the third quarter had a negative impact on NIM as deposit costs continue to be very sticky. We hope that perhaps the acquisition of some trouble players in the market may relieve some of their liquidity-induced pricing pressures over time. There is some evidence that that has already begun to happen, but time will tell. There’re various ways one can do a rate volume analysis on what drove what, but I will offer the following. As I said, about 6 basis points of the decline can be attributed to the purchase of commercial paper by our banks and by Zions Bancorp from Lockhart Funding, of course commercial paper. Even though LIBOR spreads widened and the spread over LIBOR widened for that type of paper, the effective yield over funding cost was very low. So that had about a 6 basis points depressing effect on the margin. The very strong loan growth was largely funded with federal home loan bank borrowings and more market… closer to market rate deposit accounts. DDA did not grow in line with loan growth on a percentage basis. Therefore, the funding mix of incremental growth was more expensive than the average on the balance sheet. That accounted for about 8 basis points of the decline, simply that DDA does not grow in line with loan growth, leaving about 3 basis points to be attributed to deposit pricing pressures and other things. We would expect some additional decline in the margin in the coming quarter, which I will discuss in the outlook section. Since I have now mentioned Lockhart a couple of times in connection with the NIM and the balance sheet, let me just kind of briefly recap what it is, why it is, etcetera, and what's there now. We created Lockhart in the year 2000 as a Qualified Special Purpose Entity, a QSPE that is sponsored by Zion's Bank. And from 2002 through 2007, Lockhart paid Zions nearly $185 million in fees in that line that we discussed a few minutes ago. From its inception, it was designed to hold only very high-quality assets. All of the assets purchased by Lockhart must be either Government issued or Government guaranteed or be rated AAA at the time of purchase. Zions Bank has a liquidity agreement with Lockhart. Liquidity support from the bank is triggered by either of two things. If any security owned by Lockhart is downgraded below AA minus by any rating agency that rates it, Zions Bank must buy that security from Lockhart at face value, and it then books it at fair value and the difference if any is taken as a charge against income, and we had two such charges during the quarter. The other is if Lockhart is unable to sell sufficient commercial paper to fully funded self to Zions by sufficient securities from Lockhart in a predetermined order, we don't get the cherry-pick… pick and choose. Anyway, we buy enough securities to enable it to meet its funding needs. As you're all aware, the total amount of asset-backed commercial paper declined globally from 1.2 trillion in July to 780 billion at the end of December or about 34% decline. Zions… Lockhart was not immune from that withdrawal of funding. Our affiliate banks have purchased commercial paper issued by Lockhart over several months during the mid-to-later part of the third quarter and all through the fourth quarter. In late December, the markets really got tight again as the players were very reluctant to go beyond year-end. And Lockhart was unable to meet its funding obligations, and Zions did not have capacity to prudently purchase additional Lockhart commercial paper. As a result, the second trigger of the liquidity agreement was triggered, and Zions Bank purchased $840 million of securities from Lockhart. As previously disclosed, we recognized a $33 million pretax write-down on this transaction. During the quarter, two securities owned, as I mentioned were downgraded below AA minus by one rating agency. We purchased those two securities at a face value of $55 million and recognized a $17 million pretax loss. Interestingly, both of those securities continue to be AAA rated by the other agency that rates them. As a result of normal repayments and these purchases, at year-end Lockhart had total assets of $2.1 billion, down about $1 billion from three months previous, and with a fair value that was $22 million less than book value. So we recognized $33 million loss on the $840 million and… plus another $17 million on the $55 million of specific securities. All of the rest had a haircut of $22 million left. So kind of further evidence that we could not and did not cherry-pick securities. On average, the lesser quality ones have come out, but there is still pretty high quality. They are all AAA rated by at least one agency and most of them by two. Over 95% of that assets remaining are AAA rated by two agencies. Unlike a SIV, which I’ve been talking about a lot lately, Zions does not have discretionary over Lockhart. That is, we cannot arbitrarily make a decision to liquidate it. And we have gotten questions about that, why don't you just shut it down, why don't you just make it go away. All the actions were determined by agreements pertaining to Lockhart that were set up in the year 2000 when it was established. We can only purchase assets from Lockhart under the conditions mentioned, when an asset is downgraded or Lockhart cannot fund itself. And we do have one discretionary action we can do. At our discretion, we can and have purchased commercial paper issued by Lockhart in lieu of buying securities from Lockhart. Our ability to do that and our willingness to do that does have limits and is subject to any other needs that the company may have, but we have exercised that discretion quite a bit over the last five months. If at anytime, Zions owns 95… over 90% of the commercial paper by Lockhart, Lockhart would dissolve and we would have to then repurchase all remaining securities from Lockhart and consolidate. But in summary, we can’t arbitrarily just collapse it, bring it on to our balance sheet. But at anytime, market conditions or rating changes could bring additional Lockharts on to our balance sheet and we are prepared for that contingency, both from a capital and from a funding standpoint. That kind of concludes the review of the quarter. I would like to end prepared remarks by giving you guidance for the next few quarters of 2008. It’s a difficult year for me to do that. It’s clearly got to be a difficult year for you analysts and investors because each of you has to make numerous assumptions about what you think the environment and the economy will bring. We’ll try to give you reasonably clear picture of where we stand today and we will try to give you our crystal ball outlook on some of the key drivers as we always do, but I do hasten to add, we not in the business of economic forecasting and we’re subject to the same uncertainties about just what the economy does over the next few quarters as you are. Our job is to try to manage the business in a way that navigate through the successful under any of a wide variety of scenarios that may unfold from here. Loan growth, loan demand remains very strong out there across much our footprint, not in the southwestern states, but in a lot of other places. However, we do plan to proactively manage balance sheet growth and to hold total loan growth and total asset growth to be less than $1 billion in the first quarter. With the sluggish deposit growth, the expensive funding, and the very, very expensive capital out there we are going to restrain balance sheet growth back to where it was kind of in the middle of last year, second, third quarter averages, not the 1.5 growth that you saw in the fourth quarter. We think loan growth will continue to come from the commercial loan portfolio more than the CRE portfolio. It will be concentrated in Texas, Utah, and Colorado, and be relatively flat or declining in California, Arizona, and Nevada. And as I mentioned previously, we would expect residential construction and land development balances in the aggregate to trend downward, although in some markets they may continue to grow. Texas might be an example. Deposit growth, very hard to forecast, but it is not impossible to think that in a slowing economy and sharply lower market interest rate environment over the next few quarters may improve both deposit pricing and balances. Historically, that's what happened when the economy slowed, at least in the case of our balance sheet, and we would suspect that it might happen again, but the timing of that is as uncertain as the actual direction of the economy at this point. With regard to the margin, loan growth in excess of deposit growth coupled with a continued comparative deposited environment is likely to keep some pressure on the margin in the near feature. In addition, the purchase of the securities from Lockhart near year-end and continued purchases of its commercial paper will probably reduce the margin this quarter by another 6 basis points or more, all by itself. And as always, the behavior of DBA balances will remain a significant factor in the margin. We did see some improvement in the net interest spread in December, but particularly with the vary rapid Fed rate declines, it’s probable that the margin will compress in the near term before the loan pricing and deposit pricing sort themselves out. We would expect that that may begin to have a positive impact on the margin at some point later in the year. Credit quality, we are at a point in a cycle where it is very difficult to predict future credit quality. Out best outlook is that conditions will continue to soften and home prices will continue to decline somewhat over the next few quarters. But the deterioration may not be as rapid as we saw in some markets during the last couple of quarter. At this point, we believe that while non-performing assets and net charge-offs will continue to be at or above their current levels for the next few quarters, the provision could remain relatively flat, somewhere around the last quarter and this quarter average, perhaps plus or minus. Reports from our executives in our various banks indicate that while some borrowers are clearly becoming more pressured, the loss content in our portfolio including the residential land construction and development portfolio remains relatively moderate. We expect the general economic conditions are likely to slow somewhat in the Intermountain West and in Texas, but that those state will continue to perform better than most of the country. And the one caveat on all of this that’s unknown to us is everybody else is... widespread weakening in the economy more than currently being forecast, it was broadbased throughout our footprint, could result in weaker credit and higher credit cost. But most economic indicators today remain relatively strong in the majority of our markets when compared to the other areas of the country. In the end each of you will have to make your own assumptions about the direction of the economy, but we believe that we are positioned to outperform the industry and most of the likely scenarios. Efficiency ratio, we expect that adjusted for any unusual writedowns, if there are any, that we would… that the core efficiency ratio will remain pretty stable over the next year. As we… you build your models for 2008, we remind that FDIC expense will increase. During the fourth quarter, it increased $2.6 million. Our best estimate is that they will add about an additional $11.5 million pretax of expense in 2008 or $7 million after-tax. Further more, salary and benefit expense in the first quarter could be about $25 million higher than the fourth quarter. The reversal of the bonus and incentive plan accruals in the fourth quarter that I mentioned accounted for about… would account for $14 million of that change, i.e., we won't be reversing those again in the first quarter. So that's a snapback of $14 million compared to the third. And the remainder is primarily due to the normal increase in payroll taxes and 401(k) contributions that always happens in the first quarter. We expect to keep base salaries under good control. As I mentioned, your tax rate assumption should be similar to the rate used in prior quarters and ignore the fourth quarter tax rate. Finally, a comment about capital, we plan to maintain strong capital ratios and to limit share repurchases as a matter of balance sheet prudence in what is still an uncertain environment. We do expect to go to the debt markets for some types of funding this year, senior debts, sub-debt, depending upon the market in moderate amounts and with a lot of discretion about when we do that depending upon how the market is performing. Note that aside from the impairment and valuation charges, the fundamental earnings power of the company remains very strong even at current provision levels, which are substantially higher than they were a year ago. So we do not see a need to raise any form of common equity capital including convertible issues at this time. I will note that our 2006 DRD preferred stock issue was uniquely designed so that it could be re-opened. Depending on market conditions and needs we may consider auctioning additional amounts of that instrument in 2008. Not a new issue, just re-opening an old issue and offering it for sale at current spreads. So, in conclusion, the quarter was marked by the impact of the turbulent financial markets, particularly with regard to securities writedowns. Some decrease in credit quality driven largely by land and residential construction development activity, again in Arizona, Nevada, California. Strong loan growth in other geographies, but continued weak… cheap deposit growth and well controlled expenses. Credit quality, while it has softened, remains very manageable and we continue to see revenue growth in many of our markets. Finally, I want to remind you that we will be hosting our biannual investor conference in Salt Lake City on February 14, Happy Valentines Day. We hope that you can join us in Salt Lake, I know that a number of you are. For those of you can’t, it will be webcast and we will try and address whatever is on anybody's mind at that event. We will have essentially the whole executive management team including all of the Bank CEOs present and many of them will be speaking. With that, I will close, and we will be happy to address your questions. Question and Answer

[Operator Instructions]. And your first question comes from the line of Steven Alexopoulos, with J.P. Morgan. Please proceed.

Hi, everyone.

Hello, Steve.

In terms of the comment to limit loan growth to $1 billion, it’s about a third of reduction where we were this quarter. Can you walk us through how you plan to restrict growth? Is it just make pricing less attractive, tighten approvals, how are you thinking about that?

We’ve had a number of discussions with our bank executive teams explaining to them how expensive capital is these days. Basically saying, if you grow too fast we are going to charge you for it, we are going to… we’ve developed other internal incentives to make sure that we are taking adequate account of the current spreads in the marketplace and loan pricing in terms of the incentives we are giving to them. And I’ll just say, we already have evidence that it’s beginning to take effect. We see… we’ve gone from discussing the matter at considerable length and frequently internally over the last six month to actually putting in the case a number of sort of internal pricing mechanisms to we hope give the right incentives there, and we think we will be successful. We don't want to shut it off. We don't intend to shut it off. We just want to make sure that we are continuing to underwrite very high quality credits, only high quality credits, and get paid accordingly. And then we turn away the easier stuff, if you will.

Can you talk about the environment for funding Lockhart earlier in the first quarter, maybe an outlook on for Lockhart for '08?

I would say it is pretty difficult. The ABCP market continues to contract the spreads over LIBOR… of course, LIBOR itself has come down. As you know, the spread of LIBOR over… relative to Fed funds rates or other things has improved over the last few weeks. Spreads over LIBOR had come down somewhat as well. They are still much wider than historical, probably 30 basis points, 40 basis points wider to LIBOR and LIBOR itself is still somewhat wider. But the funding availability shows no signs of loosening up. It’s still very, very tight out there. And there is a reasonable possibility that that will eventuality trigger a decision to buy additional assets in lieu… out of Lockhart in lieu of little of buying commercial paper from Lockhart.

And just one final question, at this point have you gone through all the bank, the re-review the residential construction book?

Let me see, how many times, how do I tell--. Yes, we have… I think all the banks probably went through the bulk of their major points of concern in their portfolios, particularly those in the southwest, a couple of times even just during the third quarter… fourth quarter.

As of regulator, certainly.

Okay. Thanks, guys.

And your next question comes from the line of James Abbott with Friedman, Billings, and Ramsey. Please proceed.

Hi, James

Hi, good evening, a couple of questions. One on the C&I loan growth, I was wondering if you could give us a little color on the geographic region? I guess you did give from general guidelines, but if it was heavily concentrated in Texas maybe. I'm also interested in the utilization rates, are people… are these new relationships or are these existing relationships trying further on lines of credit?

Second question… answer to the second question first. No, we have seen no meaningful change in line utilization rates. On average across all types of loans, they kind of continue to be in the 40%, plus or minus a few percentage points range, and it's been within that range for quite some time. So we don't see run-ups in utilization reach indicating kind of stress borrowing if you will. So most of the increase represents draws on new credits, new fundings, and yes, it is… probably Texas has been the biggest single dollar source followed by the Utah Bank followed by the Colorado followed by the State… the Washington bank.

Okay, and as far as the underwriting on commercial business credits, what changes have been made to that over the past, say, six months, just to kind of give us a perspective as to how you are shifting things around?

No changes. We didn’t loosen the standards when things were easy and we haven't tightened them now. I guess the major change would be they were encouraged real pricing discipline, make sure we are being compensated for the credit extend rather than dramatically changing the actual underwriting criteria.

Okay. And last question on the construction delinquencies, are you seeing any trend at all to suggest that commercial construction is beginning to weaken? We've seen some articles, The Wall Street Journal and properties in Las Vegas and stuff like that going back. What’s your sense there? Are you seeing any trends?

Only very slightly, nothing major… kind of I will make a comment and Jerry or Harris can jump in or refute me, but the stresses you are hearing about, some of them are related to trophy kinds of properties, very high-end properties are having trouble of getting takeout financing or refinancing or things like that, very large projects. Our commercial activity is more concentrated in middle… for lack of a better word, middle market type credits, not big trophy office buildings or casinos. And so we are not seeing some of the stresses that you are hearing about.

I think you are right on target with that comment.

Yes.

Okay. Thanks for your time.

And your next question comes from the line of Manuel Ramirez with KVW. Please proceed.

Hi, Manny. Manuel Ramirez - Keefe Bruyette & Woods: Hi. Good afternoon, guys. On credit, I was wondering if you could give some general comments on kind of what indicators you're looking out to get this your visibility for yourself on where credit is going? I would wholeheartedly agree that this is about as tough as it’s ever been to figure out where the economy of credits going. So I’d just like to hear your perspective on kind of the last few months, on what to look for, and what you're focusing on going forward to that? And then on the $70 million [ph] provision this quarter, roughly what amount of that was attributable to sort of additional deterioration of residential construction versus all the other factors you are doing without?

This is Harris. Let me talk a little bit about credit further and then Jerry might have some comments as well. I think that… I mean one of the things that we do is every other month as a management team we go through quite a lot of granular detail, every deal that is criticized or classified of any size at all. And yes, there’s a pretty good feel for not only in the aggregate but what is going on at the very micro level with a lot of these credits. And I think that what we're seeing is, we are continuing to see a lot of weakness in land values. And so as we look at the residential construction book, A&D portfolio, the greatest strains are in the development round in that the A&D portfolio where you have land or undeveloped lots or even developed lots, or you’ve had lot of builders who have bailed out, they’ve locked on options, etcetera, and that’s… there’s just clearly a lack of demand for land at reasonable prices today, reasonable at least relative to what we have seen six months ago. We know there's a lot of money out there waiting for a bottom to be there and at the end of the day we think there will be a market for that land, but we don't think we have seen the bottom of it yet. So we are still watching, but we are getting… continue to get new appraisals process… a process that has been going on really now for… that is always going on, but a bit more… in a more accelerated fashion since kind of the beginning of September. Manuel Ramirez - Keefe Bruyette & Woods: Maybe you can get Fannie Mae to start buying [inaudible] securities?

That's a great idea. But I think that… so with respect to that portfolio, I mean we are taking quite a granular look through it at a very senior level. With respect to other parts of the portfolio, I mean obviously we have an ongoing credit exam process internally that is looking for problems. But as I indicated earlier, so far we are just not seeing any real demonstrable issues in the C&I or the consumer portfolios or for that matter in the non-residential commercial real estate portfolio of any real magnitude at all. It tends… it does appear to us at this stage to be reasonably isolated. So I think that the risk of recession I think is quite high and I do expect we’ll see more fraying in other areas as this proceeds. But I also think that we are coming into it reasonably strong. Manuel Ramirez - Keefe Bruyette & Woods: Okay.

Gerry, anything you’d--?

This is Gerry Dent, for the transcriber, speaking now. Thank you. The review that Harris was referring to is basically at an executive level, and as he’d pointed that’s a fair amount of detail. But I would also point out that in addition to looking at… as far as the management of their own portfolios in each of our institutions, in addition to looking at our problem credits, we are on a regular basis going through the rest of the portfolio, not only the… primarily focused on the residential market, but also the other aspects of commercial real estate construction. When we started end of the process, our concern was primarily with respect to the residential land and other types of land loans, and obviously that's where the first weakening started and that's where the biggest concern has been. We're watching other areas of the portfolio. We are watching closely the retail segment as well as the office and industrial type properties. So we're trying to stay on top of them.

You asked about the provision and how much of that is attributable to residential, and I don’t know if we have the exact number. Manuel Ramirez - Keefe Bruyette & Woods: A ballpark obviously--.

It’d be… the bulk of the increase would be because of that. It's also driven obviously just by loan growth, but our… in turn we have basically a range from low to high that we try to remain with them. We have been determined to try and make sure that we are not sagging in that range as problems develop, but most of it would be attributable to residential. Manuel Ramirez - Keefe Bruyette & Woods: Okay.

Let’s say close to two-thirds of the provision is accounting for increases to [inaudible]. Manuel Ramirez - Keefe Bruyette & Woods: And then your charge-offs this quarter… I'm sorry the composition?

The largest portion of that would also be related to residential land acquisition and development coming out of California and Arizona and Nevada. Manuel Ramirez - Keefe Bruyette & Woods: Okay. Thank you very much.

And your next question comes from the line Todd Hagerman with Credit Suisse. Please proceed.

Good afternoon, everybody.

Hi.

Doyle, I just want to go back to the reserve for just a minute. I'm just trying to get a better sense of the adequacy, the $459 million is essentially as you referenced before, loan loss content at this stage of the game, comfortable LTVs for the most part, thorough updated appraisals and so forth. I'm trying to get a better sense of what you guys are doing in terms of… in general with the risk migration within the portfolio, how much generally you are allocating towards the problem with residential construction portfolio? Or maybe a better way to say it is what is kind of the average kind of write down that you guys are taking in the charge-offs that we have seen in the last couple of quarters? Could you kind of give us a sense of how much cushion you’ve kind of built in to this portfolio at this stage of the game?

Jerry, Danne’s is going to take the first crack and then I may… at an answer, then I may chime in.

The majority of the charge-offs that we've had on commercial real estate loans have been really quite small percentage-wise, I would say around 5% to 10% at the most. The extreme example I would give you is we have had one credit during this quarter on which we had a 25% write-down on it, but that's a singular credit and it’s the worst of the whole group.

Can you give us, Jerry... that's helpful. I mean could you give us a sense, I mean going in when you initially established a reserve or make an allocation against one of these credits, just generally speaking say it’s a substandard credit, how much is generally already reserved on one of these typical credits going into this process with the incremental write-down?

You mean, if it's downgraded from something to substandard, how much more is put away at that time?

Right, I mean you’ve got the 5% to 10% average write-down on top of an X percent of reserves that has been allocated against that credit.

The additional reserve would be set aside and the most substandard would be approximately 10%.

Okay.

Of the loan balance. So every loan has some reserve applied to it no matter how good, but the change from a pass rated credit to substandard is about an incremental 10% on an average. It could be a little more, it could be a little less. And then you look at… and particularly in the real estate area, you are clearly looking in the collateral values, you are going to go get a reappraisal of the property, see what 's your loan balance is against… compared to the appraised amount. If your loan balance exceeds the values of collateral, you are going to charge it down. You are still going to have a reserve on the rest. So the charge-offs generally are essentially coming from when the collateral value has declined such that it's less than what would fully support the loan balance you are charging off the balance, that’ what’s driving a fair amount of the charge-offs.

Right. In noting that, kind of in this first round anyway, the… as we’ve said before, we came into this cycle with pretty strong equity and deals, and so far that equity has precluded larger charge-downs, and you might have seen it in prior cycles. Clearly, if this gets a lot deeper and goes on longer, that could increase the size of the pretty write downs there were taken on these-.

Just to quantify what Harris just said, this is Doyle again, let me remind you that as we have discussed a number of times and disclosed in these eye-popping charts that we sometimes disclaim, our standard maximum loan-to-value ratio on just raw land unless there is some other strong source of support was no more than 50%, meaning there is $1 of equity in the deal for every dollar of land value.

That's very helpful. I appreciate the color.

[inaudible] land value, excuse me. We are lending a dollar and there is a dollar out there.

Maybe we should have done a dollar for dollar.

Yes, I would have.

Terrific. Thanks a lot.

Yes.

And your next question comes from the line of Ken Usdin with Banc of America Securities. Please proceed.

Good afternoon.

Hi, Ken.

Two questions. First of all, just on credit, Doyle, to your point of run rate provisions being somewhere between third and fourth, call that in the low-60s, whatever, I just want to understand a little bit between what you expect to be providing versus what you expect to be charging off. So as you move ahead here and given all the comments you have already made about loss content, will we see more of a tighter band between provisions and charge-offs or would you still expect to also be adding towards… adding to the reserves due to the migration trends and etcetera?

Right now, we don't see a sharp increase in charge-offs. I don’t seen them declining, but I don't see reason that they are going to sharply increase. So somewhere in the 20s for lack of a better guess on the charge-offs, and so yes… but we do expect to continue to provision well on excess of charge-offs for a while as we see where the economic cycle does unfold. So embedded in that were some of the years a fair amount of reserve strengthening.

Okay. That's helpful to understand. And then my second question is just on the margin, I just want to make sure I heard you right, Doyle. Can you walk us back again through what of the margin negatives from this quarter are already in the run rate? And then what are the incremental builds that impact the margin going forward?

What was in this quarter's run rate were three items and then from biggest to smallest they were, very strong loan growth funded almost entirely with relatively expensive sources of funding, in particular DDA did not come close to keeping pace with the run rate. So the averaging back and to the existing portfolio diminished the overall margin by 8 basis points. If we had no loan growth and no change, there would be no change in funding mix in the next quarter. There would be no change in margin from where it was. But to the extent there is further loan growth and it’s funded with market rates sources, not cheap sources, that will… all else being equal that will compress the margin. I have already suggested to you that we are going to try to hold loan growth to at least a third less than it was. So the impact probably shouldn't be quite as strong. The next biggest was Lockhart Funding. The average amount of assets on the quarter had an impact of 6 basis points on the margin, but a lot of those assets came on at the end of the quarter. The fact that they are there for the whole quarter means the margins will start out at 6 basis points lower still this quarter, simply because we had… we go in to the quarter with far more than what we averaged in the way of Lockhart assets last quarter. If we buy more, there will be a further depressing effect. I mean so it is probably… it is 6 to maybe 12 basis points. That doesn't mean we are not earning a positive spread on those assets, but it does mean that the margin diminishes and a few basis points were just due to pricing pressures. And now, kind of the wild card is what does the… what is in this quarter in my view is… kind of when the Fed is moving deposit rates 75 basis points off cycle and maybe another 50 on cycle, clearly in response to liquidity crisis and everybody scrambling for funding, loan pricing we adjust immediately or very quickly because a lot of our loans are prime and LIBOR-based as you all know.

Yes.

We’ve hedged a lot of that, but not to the degree at which the rates are moving in this very abnormal environment. What we don't know is when and how quickly and how much the deposit pricing will finally start to break. I've got to believe that it will at some point and it will significantly, but the near-term effect could be some compression there. And that I wouldn’t even try to quantify at this time because I just don't know.

Right. Okay, great. That is really helpful. Thank you.

There are no more questions queued up, but we will pause here. If anyone has one, now is your chance or save them up to February 14 or some of you I’ll be seeing next week at an IR conference in New York and we look forward to more of you. Anybody else right now?

And your next question… no, there are no questions in queue at this time.

Okay. Then I guess I will wrap it up. Again, I would say thank you for your attention. It's clearly very interesting times. As always we’ve tried to be as candid as we can, tell you what we know and what we don't know. You know that the interesting thing is there are still a lot of positives out there in a very tumultuous environment. We’ll look forward to chatting with you in the coming weeks. With that I guess we will sign off.

Thank you for your attendance in today's presentation. This concludes today's teleconference. You may now disconnect. Good day.