Good day, everyone, welcome to the Prosperity Bancshares' second quarter 2020 earnings conference call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. Please note today's event is being recorded. At this time, I'd like to turn the conference call over to Charlotte Rasche. Ma'am, please go ahead.
Thank you. Good morning, ladies and gentlemen, and welcome to Prosperity Bancshares' second quarter 2020 earnings conference call. This call is being broadcast live over the internet at 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. Here with me today is David Zalman, Senior Chairman and Chief Executive Officer. H.E. Tim Timanus Jr., Chairman. Asylbek Osmonov, Chief Financial Officer. Eddie Safady, Vice Chairman. Kevin Hanigan, President and Chief Operating Officer. Randy Hester, Chief Lending Officer. Merle Karnes, Chief Credit Officer. Mays Davenport, Director of Corporate Strategy, and Bob Dowdell, Executive Vice President. David Zalman will lead off with a review of the highlights for the recent quarter.
He will be followed by Asylbek Osmonov, who will review some of our recent financial statistics, and Tim Timanus, who 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 will be provided by our call moderator, Jamie. 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.
Thank you, Charlotte. Good morning to everyone. I would like to welcome and thank everyone listening to our second quarter 2020 conference call. We are pleased with our second quarter 2020 results, and with completing the operational integration of Legacy on schedule in early June. The team members from Legacy, now Prosperity, have been excellent, and we could not have achieved such a smooth integration without their commitment and efforts. I want to thank all of our team members who worked many hours to make this happen. We remain excited about the combination and look forward to continuing to build the best bank anywhere. For the second quarter of 2020, we showed impressive returns on average tangible common equity of 19.98% annualized, and on average assets of 1.61%.
Our earnings were $130.9 million in the second quarter of 2020, compared with $82 million for the same period in 2019, an increase of $48.6 million or 59.1%. Our diluted earnings per share were $1.41 for the second quarter of 2020, compared with $1.18 for the same period in 2019, an increase of 19.5%. The second quarter 2020 earnings per share of $1.41 includes a $0.22 income tax benefit, a $0.06 charge for merger-related expenses, and a $0.03 charge for the write-down of fixed assets related to the merger and some CRA funds. In summary, there was $0.22 in benefit to earnings and $0.09 in deductions, mostly related to the merger. Loans at June 30, 2020, were $21,025,000,000, an increase of $10.4 billion or 98.6%, compared with $10,587,000,000 at June 30, 2019.
Our linked quarter loans increased $1,898,000,000 or 9.9% from the $19,127,000,000 at March 31st, 2020, of which $1,392,000,000 were SBA Paycheck Protection Program, sometimes referred to as PPP loans. Mortgage Warehouse loans also increased $843 million in the second quarter of 2020 compared to the first quarter. Our core loans, excluding held for sale and the warehouse purchase program and the PPP loans, decreased $311 million. A portion of this decrease resulted from loans that were intentionally removed that were identified in our due diligence of Legacy. We saw strong loan growth in the first part of the second quarter, but that slowed as business shut down or reduced operations in response to various government orders. Our deposits at June 30, 2020, were $26,153,000,000 an increase of $9,265,000,000, or 54.9%, compared with $16,888,000,000 at June 30, 2019.
Our linked quarter deposits increased $2,326,000,000, or 9.8%, from the $23,826,000,000 at March 31st, 2020. Historically, our deposits are lower in the second quarter of the year compared with the first quarter, and then begin to increase in the third and fourth quarters for us. This year, second quarter deposits are higher. A large portion is from the PPP loans, as well as reduction in customer spending and customers saving more right now. With regard to asset quality, it has always been one of the primary focuses of our bank and always will be. I have always said, you will like us in the good times, but love us in the bad times, and this is playing out to be true again during this pandemic and oil price downturn. Non-performing assets totaled $77.9 million, or 28 basis points of quarterly average interest-earning assets at June 30, 2020.
We continue to provide relief to our loan customers through loan extensions and deferrals when possible. For the second quarter of 2020, net charge-offs were $13 million. Of these charge-offs, $12.4 million were related to PCD loans with specific reserves of $28.5 million that we acquired in the merger. Further, $16.1 million in specific reserves were released to the general reserve in addition to the $10 million provision for loan losses for the second quarter. M&A activity has subsided during this pandemic, although there are some conversations and probably a few deals working. We believe that the M&A activity will start to pick up as businesses reopen and economic activity increases. Size does seem to matter now, especially with lower net interest margins, the need for increased technology, and the potential for additional regulatory burden if there's a change in the administration.
An example is the increased volume at our customer call center, with many older customers wanting to set up online and mobile banking that have previously not been interested in doing so. The economy, the Blue Chip consensus forecast estimates that fourth quarter 2020 GDP will end at a -5.6% compared with the fourth quarter of 2019. They are forecasting a +4.8% GDP for the fourth quarter of 2021 compared with the fourth quarter of 2020. They are also forecasting an unemployment rate of 9.4% for the fourth quarter of 2020, compared with unemployment rate of 6.9% for the fourth quarter of 2021. Based on these estimates, 2021 looks bright. We are positive about our company's future. While our operating environment and economy is changing frequently, we remain focused on addressing whatever comes our way and taking care of our customers and associates.
Prosperity continues to focus on building core relationships, maintaining sound asset quality, and operating the bank in an efficient manner while investing in ever-changing technology and product distribution channels. We intend to continue to grow the company both organically and through mergers and acquisitions. We want to develop people to be the next generation of leaders, make every customer experience easy and enjoyable, and operate in a safe and sound manner. I want to thank everyone involved in our company for helping to make it the success it has become. Thanks again for your support of our company. Let me turn over our discussion to Asylbek, our Chief Financial Officer, to discuss some of the specific financial results we achieved. Asylbek?
Thank you, Mr. Zalman. Good morning, everyone. Net interest income before provision for credit losses for the three months ended June 30th, 2020, was $259 million compared to $154.8 million for the same period in 2019, an increase of $104.1 million or 67.2%. The increase was primarily due to the merger with Legacy Texas in November 2019, and loan discount accretion of $24.3 million in the second quarter of 2020. The net interest margin on a tax equivalent basis was 3.69% for the three months ended June 30th, 2020, compared to 3.16% for the same period in 2019, and 3.81% for the quarter ended March 31st, 2020. Excluding purchase accounting adjustments, the core net interest margin for the quarter ended June 30th, 2020 was 3.33%, compared to 3.14% for the same period in 2019 and 3.36% for the quarter ended March 31st, 2020.
Non-interest income was $25.7 million for the three months ended June 30th, 2020, compared to $30 million for the same period in 2019. The current quarter non-interest income was affected by $3.9 million in write-down of certain assets and general impacts of COVID-19 pandemic. Non-interest expense for the three months ended June 30th, 2020 was $134.4 million, compared to $80.8 million for the same period in 2019. The increase was primarily due to the merger with Legacy Texas and one-time merger related expenses of $7.5 million due to the core system conversion that occurred in June. In addition to these merger related expenses, the second quarter result reflected elevated expenses related to increased mortgage activities.
With the core system conversion and operational integration process behind us, we do not anticipate any significant merger related expenses going forward, and we expect to start realizing the remaining cost savings beginning in the third quarter of 2020. We expect these additional savings to be about $7 million- $9 million per quarter. This, combined with the savings realized in the first and second quarter, will be in line with our previously stated 25% cost savings in non-interest expense. The efficiency ratio was 46.56% for the three months ended June 30th, 2020, compared to 43.74% for the same period in 2019 and 42.9% for the three months ended March 31st, 2020. Excluding merger related expenses of $7.5 million, the efficiency ratio was 43.97% for the three months ended June 30th, 2020.
The bond portfolio metrics at 6/30/2020 showed a weighted average life of 2.69 years and projected annual cash flows of approximately $2.3 billion. With that, let me turn over the presentation to Tim Timanus for some detail on loans and asset quality. Tim?
Thank you, Asylbek. Our non-performing assets at quarter end June 30th, 2020 totaled $77,942,000, or 37 basis points of loans and other real estate. The June 30th, 2020 non-performing assets total was made up of $71,595,000 in loans, $187,000 in repossessed assets, and $6,160,000 in other real estate. Of the $77,942,000 in non-performing assets, $12,173,000, or 16%, are energy credits, $12,073,000 of which are service company credits, and $100,000 are production company credits. Since June 30th, 2020, $15,786,000 has been removed from the non-performing assets list through the sale of collateral. This represents 20% of the non-performing assets dollars. Net charge-offs for the three months ended June 30th, 2020 were $13,001,000. $10 million was added to the allowance for credit losses during the quarter ended June 30th, 2020. The average monthly new loan production for the quarter ended June 30th, 2020 was $871 million.
This includes a total of $1,430,000,000 in PPP loans booked during the quarter. Loans outstanding at June 30th, 2020 were $21.025 billion. The June 30th, 2020 loan total is made up of 39% fixed rate loans. 36% floating rate loans and 25% loans resetting at specific intervals. The fixed rate percentage increased somewhat due to the inclusion of the PPP loans. I'll now turn it over to Charlotte Rasche.
Thank you, Tim. At this time, we are prepared to answer your questions. Jamie, can you please assist us with questions?
Ladies and gentlemen, at this time, we'll begin the question- and- answer session. To ask a question, you may press star and then one using a Touch-Tone telephone. To withdraw your questions, you may press star and two. If you are using a speakerphone, we do ask that you please pick up the handset in order to ensure the best sound quality. Once again, that is star and then one to ask a question. We'll pause momentarily to assemble the roster. Our first question today comes from Dave Rochester from Compass Point. Please go ahead with your question.
Hey, good morning, guys.
Good morning.
Good morning.
You guys did a good job hitting the NIM range this quarter ex accretion. Just wondering what your thoughts were on that going forward, as well as the accretion trend, in the back half of the year, if you can. It seems like you guys have a lot of room to move deposit costs lower, just looking at where you were pre-rate cycle. Just was curious to get your thoughts there too.
Yeah. I'll probably let Asylbek take it. I think our accretion was higher than we normally gave guidance for. I think, Asylbek, we're looking, what, about $11 million-$13 million.
That's right.
this quarter.
Yeah, going forward, I think next quarter we're looking at $11 million-$13 million. It's a little bit elevated because some of those PCD loans were working out, which they had discounts in them. Those being paying off, bringing additional fair value income this quarter. If you're looking going forward, we're projecting $11 million-$13 million based on what our model shows right now.
I think on the second part of the question, Dave, is we have kept our rates a little bit higher than we really had to. I've always said that sometimes in really good times, people pay more than we do, and then when things get a little tougher, we kept our rates a little higher than everybody else. We are looking at it right now to reduce our rates a little bit, and we should probably do that this week, probably sometime.
Yeah. We did reduce the rates. Absolutely right. We reduced rates in the second quarter, but we're looking, managing further in the third quarter-
Right.
...reducing it. If you look at our deposits, our CD is at the higher rate right now, but we're waiting for them to be repriced.
Right.
I think based what we see, we should have about $2 billion being repriced next 12 months.
Right. I think the biggest, we still have a lot of money, like in our premier money market account, that we're still paying 40 basis points if it's a $1 million+ . We have some room to come down a little bit.
Additional, there are some broker deposits. We still have about $100 million to get repriced.
About $100 million.
Yes, next 12 months. There will be some movements in the deposit cost.
Great. Appreciate that color. Just given all those opportunities, where do you think the NIM goes from here ex the accretion?
For the next quarter, our model show that our core margin to be relatively stable, given the current economic conditions. However, we do expect to see some additional pressure on NIM because of loan repricing. If you look at for next quarter, we could see decline in the amount somewhere in mid-single digits, I would say. There's a lot of moving pieces. How the PPP forgiveness going to work, and we have, as every bank experience right now, quite a lot of liquidity coming into the bank because of the PPP program we had and the government stimulus.
Yeah. We never like to give evasive answers, there are so many moving parts now. There's $2.3 billion in extra deposits that came in. A lot of people thought $1 billion of that was probably from the PPP loans. You'd have to think, or I have to think that if that money we put out on PPP, they should have used half of that or more. Some saying they didn't spend it because they're waiting to see if I don't know what the reason is. I think there's going to be more liquidity than we anticipate. So you have that, you have the PPP loans. We do have some room on the deposit side. I would still say to be careful. You'd still see some, probably mark getting some decline of maybe mid to single digits probably.
Yeah.
Just to be careful on everything, I think.
Okay. I guess some of that pressure, to your point, is from just higher liquidity levels?
Higher liquidity levels and repricing of loans.
Loans, yeah.
included, so.
Yeah. But we'll be-
Again, when we give you that, we're not showing any increase in loans. If we increase loans, that changes things. If we buy some securities, which we've been reluctant to do because they've been so low, that changes things. There's a lot of moving parts on this this time.
Yeah.
There's probably more noise this time than ever before for us, I think.
That's right.
Understandable. Appreciate all that. Just switching to expenses, just based on your comments on the cost savings, are you guys still feeling good about that previous expense guidance for, I think it was $115 million-$116 million for 4Q? Or are you thinking you may come in a little bit higher than that?
Yeah. I think we still believe that we're going to get $7 million-$9 million cost savings next few quarters. Remember, like in my notes, I said that we have elevated mortgage activities, which has some expenses related to that. With the current environment, with the rate being so low, we see a lot of Getting new loans or mortgage loans. That could keep up the volume, which would increase the expenses. If you look at our current expense for the second quarter, if you take out the one-time expenses and reduce that amount by $7 million-$9 million, that's what we believe going to be on the next quarter.
What do you think about $118 million plus another $2 million in mortgages?
No, I think it'll be around $118 million , $119 million , including the mortgage.
That includes the $2 million.
Including mortgage activity. Yes, sir.
Okay.
Okay, that's for 3Q, the $118 million-$119 million ? All in?
Yes.
Okay.
Assuming the mortgage level's going to continue as we saw in the second quarter.
Yep. Got you. Perfect. Maybe one last one on credit or on capital. You guys obviously have a lot of it, and I was just curious how you're thinking about the buyback here, if you're hearing anything from the regulators on that front, and if there's any willingness to reengage there at all.
I think right now we do have a lot of capital. We're making a lot of money. We like to milk money, no question about it. I think that regulators at this point in time, I think if we bought back stock, we have no agreement with them. I would think they would look at negatively if you're buying back stock right now until we see further what the pandemic is doing. I don't see us buying stock back unless there's some really downturn in the stock, really strong or something like that. For the immediate future, I think it would be frowned upon, as they would say, I think, by the regulators if we bought some stock back right now, probably.
Got you. All right, great. Thanks, guys. Appreciate it.
Our next call comes from Jennifer Demba from SunTrust. Please go ahead with your question.
Thank you. Good morning.
Good morning.
Good morning.
Question for David. David, what do you see as the most stressed borrowers in your portfolio right now? What kind of business trends are they seeing right now, and what kind of loss content do you think could potentially arise in the next year or so?
Boy, those are all hard questions. Probably if you had asked me some time ago, we would've said the oil and gas department was the toughest. I think oil and gas we're used to right now. I think the prices where we're at are a lot better. I think we've learned to live with that. Although, having said that, from what they tell me at some of the meetings I'm at, they still say that oil and gas companies, there's still a large amount of bankruptcies to come from that. I feel pretty good where we're at. I think the most stressed that I would see, looking at our portfolios, we have, again, I'm talking off the top of my head, what, about $300 million in motel loans?
$380 million.
380. I think the businesses that are most affected by this pandemic are really the hotel/motel loans, which we have about $380 million in that, and then restaurant loans are about a little over $200 million. Again, we feel pretty good where we're at with most of our customers. I don't want to be Mr. Happy, but I don't want to be a downer either. I think that we have given some extensions. I think that we've extended or are at forbearance on, again, I'm going to give you some numbers. I'm going to let somebody else jump in this in a minute, We extended about 6,700 loans. That's about 9.5% of our loans outstanding. On the other hand, out of that 6,700, approximately 4,800 of those already started being repaid. Don't take those for exact numbers. I'll let somebody give you the exact numbers.
I'm talking off of the top of my head, we really feel pretty good where we're at. Those loans that we charged off this quarter were probably the $12.4 million were loans that came over through the Legacy merger, and we fully had reserved on those. In fact, we had $28 million reserved on that, so we were able to put another $16 million into the general reserve plus $10 million that we put. I feel like we have a real good quarter. Again, I don't want to be a Pollyanna and say things are great, but I feel we're probably one of the best banks to be with in these kind of times. Kevin, you may want to jump in on some of the oil and gas. What's your feelings on that too?
Yeah, I agree with David. If we look at stress areas, it's things that be on your top of mind. It's probably hotels, although I don't think we have any of them past due at the moment. I don't think we have any office buildings or retail centers past due either. Some of those are in deferral periods, and we can talk about that as a separate issue. On the oil and gas front, obviously the stress is less now with prices closer to $40 than it was when we saw single digit and worse kind of oil and gas numbers. Our portfolio continues to work its way down. If you just look quarter-over-quarter, the portfolio shrunk $80 million over the quarter. Unused commitments shrunk from, I don't know, $390 million to $277 million, and that's largely due to redetermination time.
It was us cutting commitments at redetermination time and putting everybody on MCRs. A little over $54 million of that $80 million decline in oil and gas was from former Legacy clients that had marks on them. That's where a lot of the loss content we reported came from. Just in terms of loss content on that $54 million, it was about 18%, but we had close to 48% reserves up against that. If you think about the reserve level prior, called the mark, that was put on this 18 months ago, it was pretty prescient of the Prosperity team to put big marks on that portfolio because we had over $28 million of that $54 million was marked, and we had loss content in it of about $12.5 million.
Overall, I think the portfolio, energy-wise, is in good shape, A, because of the marks, B, because of the hedging, and C, because we continue to strike it down, and we were pretty aggressive during redetermination time about putting monthly commitment reductions in every deal. I think we're managing the risks around that portfolio as good as could be expected.
Yeah. I would just say that, again, we have almost 1.9% in reserves when you exclude the PPP, I think I'm talking from the top of my head, and the Mortgage Warehouse. We've never really ever had that in reserve before. I feel really good where we're in. Tim, you wanted to comment too, didn't you?
I think I can maybe give a little help on the hotel and the restaurant question.
Right.
Obviously, none of us can firmly predict the future. We can only talk about with certainty where we are today, but it's a lot better than one would probably think it would be. As of June 30th, on the non-performing assets list, we only had two hotels. Each one had a balance of about $7 million. We had a total of about $14 million. One of them has already sold. $7 million has come off the list, and it's part of that number that I gave, that total number that's come off the list since the end of June. There's only one remaining hotel in the non-performing asset list, and it's got a balance of about $7 million, and it's actually current right now. They've resumed payments, and they've kept it current for a while.
To be conservative, we left it on the list at the end of the quarter, and we're going to watch it month by month going forward. The good news is it's current right now. There was only one restaurant on the non-performing asset list at the end of the quarter, and it had a relatively moderate balance of about $43,000. It happens to be SBA guaranteed, and we've already filed a claim with the SBA to get them to honor their obligation as it relates to that loan. If you look at the total hotel portfolio, about $52 million of that portfolio carries an SBA guarantee. On the restaurant side, about a little over $10 million of the portfolio carries an SBA guarantee. Right now, things are reasonably stable, as it relates to our hotel, motel, and restaurant loans. We'll just have to see how the future plays out.
I would think that's a good color, Tim. I would say the restaurant loans, we really aren't doing a bunch of mom-and-pop restaurant loans. These are customers that have maybe 30 stores or franchises or something. They're usually bigger customers. Did we give you too much color, Jennifer?
Not at all. It was great. I have one more question on credit. On one of your slides in your deck, it just calls out medical loans. I'm just curious, are you seeing any stress there, or you just decide to strip that out for us?
I'd have to ask Cullen, but I didn't know. I didn't look at it. No, we're not seeing any stress in the medical side. I think it's just something people have asked us for, and investors have asked us for to break out, and that's just the reason we broke it out primarily.
Okay. Terrific. Thank you.
Thank you.
Thank you.
Our next question comes from Brad Milsaps from Piper Sandler. Please go ahead with your question.
Hey, good morning.
Good morning.
Good morning.
Thanks for taking my questions. Just curious, trying to figure out the impact of the PPP loans in the quarter. I was curious if you might be able to disclose the average balance and then the level of interest income, including fees and the coupon you recognized in the quarter. Any benefit maybe from FAS 91, deferred loan origination costs that might have been on expenses in the quarter.
Yeah. This is Asylbek, I'll give you a little bit of color. We recognized about $4 million on the fee income during the second quarter, with about $2 million per month. We deferred all the fees, including fees and deferred some direct expenses over 24 months. As you know, once those loans are going to get forgiven and paid off, we can recognize that income at that time. For time being, it's on the deferral for the 24 months. I think the average balance, I believe, for the second quarter was about $750 million or so on PPP loan. If you calculate including the 1% interest income, we're generating about 2.5% yield on those loans right now.
I think overall, Brad, we brought in around $50 million in fee income and probably at about $5 million or $6 million in expenses. Again, we'll amortize that over a 24-month period. As those get forgiven, we'll bring it back into income right away. I think the average loan, you may be wrong on that, the $750 million. What's the average loan size about? $350,000? I don't know.
Well, we booked 12,000 loans in round numbers.
What do you think, Eddie?
The average loan size is below $200,000.
Below $200,000. I would say our average fee was probably closer to around 3%, probably, or not?
Right at it.
I think that's what you're trying to get at, Brad, isn't it?
Yeah. Sorry, I was giving the average balance for the quarter.
Right
for total PPP loans.
He may be right. Sorry, I missed that. Fees were, yeah.
Yeah, we booked essentially a total of $1,430,000,000, and that was spread out over 12,000 loans, in round numbers.
Yep, that's right. Did we get you what you need, Brad?
Yeah, that was great. Just to be clear, Asylbek, that the FAS 91 adjustment wasn't a huge number in the quarter, and you still feel comfortable getting down to the kind of expense numbers you talked about earlier, even with that adjustment?
Yeah. Those fees, the PPP fee, yeah, we deferred it. All the direct expenses, we also deferred it, but it's part of the interest income part of it, the way it's how GAAP is done. It's not going to be impacting our non-interest expense, Brad.
Got it. Okay. Thank you. Just as a follow-up, maybe for Kevin. Obviously, a great warehouse quarter. What's your crystal ball say over the next 90 days in terms of average? Noticed the yield was down there maybe more than some of your peers. Just kind of curious thoughts on that competitive landscape and ability to hold onto pricing.
This is Kevin, Brad. I'll take that one. Obviously, the quarter was really strong, averaging $1.843 billion, I think, and ending at much higher numbers, almost $2.6 billion. That ending June month-end balance gives us a great running start going into July because those balances carried on for much of the month. Based upon what we're hearing from our clients, we expect the end of this month to be really strong again. That comes to us by virtue of them asking for over lines or extending facilities at larger levels to get them through this really robust period of time. What's particularly interesting to me is that the turn days, despite all that volume, the turn days, which typically run for us and the industry at about 17 days, only ran at 14 days this quarter.
When you think of that in terms of the amount of activity that have those level of balances with that quick a turn days, it's pretty remarkable. I've been around this business a long time, and typically, we would average in a month 20 or 23,000 to 25,000 files. Q1 was a new record. We did 41,000 files, and we did almost 82,000 files in Q2. The amount of volume going through there is pretty high. That volume does produce throw-off levels of fee income. We're collecting, I calculated this morning, about $37 a file that we touch in fee income. I think, Q3, and again, who knows beyond where we sit today.
If rates stay reasonably stable where they are, I think Q3 is going to be even stronger than Q2 was by, if we average $1.8 billion, I wouldn't be surprised if we average $2 billion or $2.1 billion for the quarter. We'll just see how it plays out from here. All pretty strong. Finally, on rates, I think rate pressure has kind of subsided, finally. I would tell you that all of our loans have LIBOR floors in them. Every loan that we have, and we have 39 customers now, has a LIBOR floor of LIBOR being 1%. Any moves in LIBOR from where we are now won't impact pricing like it has in the past.
Great. That's helpful. Thank you, guys.
Thanks.
Thank you.
Our next question comes from Brady Gailey from KBW. Please go ahead with your question.
Hey, thanks. Good morning, guys.
Morning, Brady.
Morning.
I wanted to ask about the need or lack thereof of future provisioning. You had a zero provision last quarter, $10 million this quarter. David, as you said, your reserves are almost 2%, and you guys are known as having one of the cleanest loan books in the industry. Do you think that there will be a need for future provisioning, just given how clean your book is and how strong the reserves are currently?
Well, this time, again, when I say this, something may go wrong, but even the $10 million provision that we made this time, under CECL or any other type of calculations you have, you can either be at the high end, the mid end, or the low end. Even to get the $10 million that we had this time, we had to really try to be on the high end of our provisioning. My gut feeling is, unless something changes, I don't see us provisioning. I just don't see it right now. I'm sure Every year, I'm looking at Merle and the credit guys always, they look, they'd always like to have everything in the world in there. The bottom line is, again, I see it as highly provisioned.
When we do these stress tests, I remember when we had the DFAST test, even under a stress test, the most that you would lose over a two-year period, compared to what the stress tests say, if they're right, I don't see it. The question is, what do regulators, going forward through this pandemic, until we get some guidance to see what we have. I think the 1.9% in reserve for loan loss is too high for a bank like ours. Having said that, I think the regulators want to see that. I think your Chief Credit Officer wants to see that. I think that $354 million that we have in there, I don't think we've lost that since I've been in banking.
If you added all the years together, I bet we haven't lost $100 million or $80 million, and that's with some of the banks we bought. God help us, I hope we don't get there, but in my lifetime, I've never seen us giving close to what we have in there, what we would use. That's just me. Having said that, I know we have to be careful. We don't know when this will all end and when everything will open back up. I don't know. I'll throw it out there. I don't see it. I think it's too much, but it is what it is, and we have these calculations, and we have to go with the calculations, and it's not just me running the bank. There's the credit people and the regulators and everybody else, but I think it's extremely high, really.
Well, where we are as an individual bank right now is relatively stable. Things are arguably a lot better than a lot of people would assume they would've been. Clearly, there's a lot of instability in the economy out there.
Right.
Our reserve is based on a lot of things. Obviously, a very important part of it is where we are as a bank, but also there are economic factors that go in there, and a lot of those are not trending well right now-
Right.
for obvious reasons. It's just very hard to say. I'm inclined to agree with you, David. It's hard to imagine that our portfolio is going to fall apart overnight-
You never know.
the world is what it is, and anything can happen.
Kevin, I don't know if you want to add to that at all?
No, I think you've got it covered pretty well.
I think that's it.
Did we answer Brady? I don't know if I answered it, but that's just my overall feelings of that.
Yeah, no, that was great. My second question is, the 9.5% of loans that were modified?
Right.
What is that as of today? I'm guessing that's come down some, and any idea how much of those initial modifications will need a second modification?
I can give a little more-
Go ahead.
certainty to that. Obviously, we can't give 100% certainty. As has been previously mentioned, we extended some payments on, to be precise, it was 6,727 loans. The total aggregate outstanding balance of those loans together was $3,626,000,000. That's extending at least one month. Most of them were two or three months. There have been a few, not many, that has gone as far as four months being extended. Really, the vast majority of those were two or three-month extensions. Out of that 6,727,000, 4,864 of those loans have already resumed making normal payments. The aggregate total balance of those 4,864 that have resumed payments and are still paying, that balance is $2,283,000,000. How long those that have resumed payments continue to do so, obviously, we can't say with certainty.
Those customers are implying to us that they have reasonable stability in their business right now. We still continue to extend a payment here or there for a few customers, but not near as many as we did in April and May. Everything seems to have stabilized a bit, but obviously, there are just no guarantees.
Yeah, I think 4,800 loans resuming payments out of 6,727 loans that we extended is pretty good. I think that shows you that the customers that we have are really good customers, I think.
Great. Thanks, guys.
Our next question comes from Ken Zerbe from Morgan Stanley. Please go ahead with your question.
Thanks. Were the PCD loans that you guys took charge offs on this quarter, were they sold in the quarter? I'm just trying to figure out how you also were able to release the $16 million of other reserves on those back into the general portfolio or general reserves.
The loans were moved out of the bank. We were paid off.
Got it. Okay. You took a charge on those as they?
I'm sorry.
Got it. Okay. Just, I just want to make sure I got the math right on this. I understand, David, you certainly think the reserves are very high, and you struggle to get the $10 million of provision. If you moved the $16 million of specific reserves into general reserves, is it a fair way of looking at it that your provision expense this quarter, based on what your CECL model said, your CECL model says you should have booked a $26 million provision? You had $16 coming from the specific, and then $10 million is coming from regular provisions.
You're hitting the nail on the head, I think. We actually put $26 million into the general reserve this month, basically. You have a wide range in there, and we were at the upper end of that range. If he's asking, would we have been required to put $26 million in there if we hadn't got that? No. That's wrong. I see what you're saying, yeah. No, we took the upper range of what we could be in. The bottom line is, technically, we increased the general reserve by $26 million this quarter, basically.
Got it.
The difference between the $28 million we had in reserve and what we collected, there was $16 million more in specific reserves that, in the old days, that $16 million before you had this new accounting, that $16 million would've come through the income statement. It doesn't. It used to be called SOP 03-3 or something like that. In today's world, it doesn't come through the income statement. Well, I guess, if we wouldn't have added to the other reserves, it might have, but we put it to the reserves, the general reserves.
It doesn't automatically go into income the way it used to.
No. I guess if you could say-
Got it. Yep.
I'm trying to put from a technical standpoint, I'm learning something myself. I guess if we would've just said also that we couldn't put that $16 million into the general reserve, I guess that might've been pulled back into the income statement, I guess.
Yeah. Technically, in the old ways, you would take that $16 million as a SOP 03 fair value income. Technically, if the model, we decide not to go with the upper end, you could technically take it as a provision income because once it releases, you could take a provision income. Based on the model and our discussion, we believe that just leaving it as a general reserve was more appropriate.
It wouldn't be prudent in today's world to bring something back into income, I don't think, with the pandemic and not knowing where everything is going to eventually settle out at, I don't think.
Yeah. In a perfect world-
Right.
technically should have taken it as a provision income.
In a perfect world, if we weren't in a pandemic and all that, we probably wouldn't have even put the $10 million in, and we might have even taken the $16 million back into-
As a provision income.
general fund.
Okay. Just last question, just in terms of fee income, are you seeing any rebound in deposit service charges? Just more broadly, how do you see fee income trending over the next quarter or two?
Go ahead. You can jump in also, but I have seen this last month, finally our service charges picked up over $1 million this last month, just general overall service charges. What you were going to say?
No, that's exactly because those fee income we saw down in the April and May month, and we saw some bounce back in June. If we continue that way, I believe the fee income will go up. You are right on, Mr. Zalman.
I think as the economy opens up, really the service charge income and people really just weren't spending money. They're saving money and they're not doing things. I think we did see this last month, I saw that the service charge income did do pretty good, almost $1 million.
One wild card I would just throw out there, we just have to be conscious that there's a second stimulus package they're talking about, passing it. If they're going to give the stimulus money to people, they'll have access liquidity there too, that could impact. It's just a wild card.
Yeah. I think you could see another round of big deposits come in, probably increase this quarter with the stimulus package and all that. You probably could, yeah.
You also have to take into consideration that during the worst of it for us, which were the months of April and May, we specifically waived a number of service charges for customers to help them out.
That's right.
That's a good point, Mr. Zalman.
We're not seeing the necessity right now to do as much of that. I forgot about that. That's a good point. Some of that decrease is because we waived service charges.
We purposely waived the service charges for a number of customers to help them out. The necessity for that, of course, could come back, but right now we're not seeing it.
Right.
I think that by itself is going to create some addition going forward.
That's a good point.
Compared to where we were during this last quarter.
All right, perfect. Thank you.
Thank you.
Our next question comes from Peter Winter from Wedbush. Please go ahead with your question.
Good morning. I wanted to ask about the loan trends, the core loan trends. I was just curious, how much is left in terms of the runoff of Legacy, and then secondarily, what's the loan demand like in the core portfolio, ex the Mortgage Warehouse?
Okay. Let me, I'm trying to read my notes here that they wrote for me. I think we started off with about $400 million in loans. I think we started off around $400 million in loans from Legacy that we decided that we thought that we would try to outsource out of the banks. I think so far we've moved out in the first quarter and the second quarter, about $131 million of those loans. Still about $283 million left there. We'll have to get through that. As far as loans go, again, we had tremendous growth in the PPP. We had tremendous growth in the Mortgage Warehouse.
We actually saw a decrease. I think if you looked at our core loans this quarter, I think I said, I'm talking from the top of my head again, so forgive me if I'm wrong, but I think around $311 million, $312 million less in core loans. Out of those core loans, I would say that about $65 million of that was really made up of these loans that we talked about earlier, that we got out of them. We had some recoveries on them, so that was about $65 million. I would say probably just some of the other loans, from Legacy, the merger, and the CRE product. We're not putting on as many of those particular loans naturally in this type of economy, doing commercial real estate. On the retail side, it's not something we would jump into.
Having said that, if you look just at core loans, I think we were down about, if you take out the $65 million, I think that was about 1.6%. Of course, you'd have to annualize that, but 1.6% for the quarter, we were down. Really, when I look at everybody else, that was considered pretty good. I think going forward, to give a number of loan growth going forward, I think it's hard. Like I said before, the shutdowns, we were having great growth both in the first quarter and the first part of the second quarter. As the shutdowns came, we saw things contract.
With us having to get out of still a couple hundred million in loans, $280 million in loans at Legacy, and looking at the pandemic where it's at, I would have to forecast that probably the best you could hope for us, would probably be anywhere from a 0%- 3% growth rate this time, I think. That's just me talking. Somebody else may want to jump in. Kevin, you want to jump in on that and see?
No, David, I agree across the board. We're still seeing deals in loan committee every Thursday. Some new things are getting approved, but I think you can all understand this is a really tough time to underwrite a loan. The retail center comes in and what do you do? How many of these people are paying? How many of these people are going to be able to continue to pay? How many are being deferred? Same in a commercial office building. What's the future of commercial office buildings? It would have to be a pretty spectacular amount of equity and a really strong guarantor to do a retail deal or a commercial office building deal. That's an already constructed office building. Forget new construction for the most part, unless it's, again, a really unusual situation. On one hand, I could say it's a really tough time for underwriting.
I could tell you it's really easy. There's a lot of things you're just not going to touch during this period of time. While loans shrunk, I guess, to the $312 million number, and a good portion of that was running off some stuff out of the Legacy portfolio we didn't want to keep. It's going to be tough in this environment, and I'm not worried about not producing loan growth right now. I'd like to see a little more clarity as to what underwriting looks like across the board. I think we all would before we'd feel better about producing a whole lot of loan growth.
I think that's right, and I think also you could say the loans that we're looking at now, if you're coming to us for a multifamily project or an office building where we might have been willing to get 40% down, 35% or 40% down in the past and go with somebody lease it, we're probably going to ask for some guarantee support and other global support more than just the project itself. I think your underwriting, we're toughening up right now. We'll lose it as things turn around, but right now, we're able to get a little bit better comfort if we're doing stuff. We're able to get a little bit better collateral support and guarantor support, I think.
The only sector really that doesn't appear to have slowed down a bit is home building.
Right.
Most of our home builders are still selling their houses and building their houses. We haven't seen a big drop in demand from our home builders.
Good point.
Everything else has slowed a bit.
Right.
Not a screeching halt, but has slowed a bit.
Right.
We had already slowed our approach to apartments and office buildings before the virus, anybody ever knew anything about it.
I think that's right. There should be an opportunity for us, though, where other banks, do anything I don't think, where us, I think that we can be more optimistic on something and maybe we can get better.
Terms.
Better terms. We may be able to do it where some of the other banks can't. At least we have in the past.
In the past, that's exactly been the case.
Right.
When things have gotten bad, especially really bad, and other banks have been crippled and found themselves in a position of really being unable to loan, we've been able to get some customers in that are good customers because they can't find financing the way they have wanted it in the past.
Right.
Our conservative terms become more acceptable to them.
Right.
It has worked that way almost every time.
Did we answer, Peter?
Yeah. Above and beyond. That's very helpful. Just a follow-up question on earning asset yields. Can you talk about how much is cash flowing in the securities portfolio and what you're reinvesting that rate at? Secondarily, the yield is still fairly high on the loans held for investment. I'm just wondering what the new loans, or reinvestments are going on the loan portfolio as well.
I'm going to start from the top of my head, and again, I'm not reading from anything. Again, we haven't been buying any securities. We've let all of our borrowings run out, and we've taken that money and really just funded the Mortgage Warehouse deal now. We're having some liquidity right now. We still haven't bought anything, probably about $400 million or $500 million. We'll probably go in and buy some securities that'll probably be a mixture of some floating rate stuff with some 15-year mortgage-backed security. It'll be somewhere in between. As Kevin mentioned earlier, we hope that some of the liquidity is going to be taken up by the Mortgage Warehouse financing toward the end of the quarter or in the next few months. We'll probably still have to buy some. Again, we've been letting it run off.
I think, gosh, I'm talking from the top of my head, we have probably over $1 billion a year that rolls off of.
Our annual cash flow right now is projected about $2.3 billion.
It's gone up.
Yeah, it's going up significantly because all the refinances and the new mortgage. Yeah, for the second quarter, we didn't buy any of those securities. We used all the money toward the warehouse and paying down the borrowing. Now we're looking into the-
Yeah, I think we'll be forced to buy some securities this quarter, probably. Again, I don't know if that'll be $300 million or $500 million, but we'll probably be forced to do something like that.
On the yield question, on the average, I'd say most of the new loans we're booking now are about 4%. That's about where we are.
I think the fixed rate, we're probably getting a little bit better than-
Yeah, I'm just saying across the board.
Yeah, across the board.
Across the board.
Yeah.
That's pretty close to what it would be.
Okay, great. Thanks for taking my question.
Sure.
Thanks.
Our next question comes from Michael Rose from Raymond James. Please go with your question.
Hey, guys. The two loans that were the PCD loans, I'm sorry if I missed them. Were they energy loans?
It was more than two loans, but yes, they were energy loans.
Yeah, Michael, I think it was four loans totaling $54 million, roughly.
That's correct.
Okay. What was the haircut on what you guys sold that?
Oh, I'm sorry. It was an 18% discount off the principal balance, whereas we had about 48% or 49% of specific reserves up against it.
Okay, thank you. Kevin, what's the go-forward outlook for the energy business for you guys? I know it's obviously a bigger piece at Legacy, but given that things have changed, is it still a business that Prosperity has a real interest in being in any sort of size or capacity?
Yeah, I should kick that to David. I would say our position is cautious. We're in Texas. I think our intention is to remain in the business, to stick to our knitting in terms of underwriting. Now that we've gone through a redetermination period under the Prosperity loan policy, all of the Legacy loans are now more conforming with the Prosperity loan policy in terms of advance rates and how we view engineering and things like that. The portfolio will probably continue to shrink, Michael, before it gets any bigger because we're being particularly cautious right now, and I think we'll remain that way. I don't see us as a Texas bank exiting the business.
We've got it at a little over 3%, between 3% and 4% of our total loan assets, and that's probably not a bad place to be, maybe a shade lower than that in the near term.
Okay. Maybe just one.
I'd have David weigh in on that.
Yeah. I agree with everything you're saying. I think when Kevin and I first talked, and we put these deals together, I think Kevin said didn't care if we were ever in the oil and gas business again.
I did.
Well, we are in Texas, and we will be in the oil and gas business. I think it'll just be different. It'll be a difference in underwriting. Again, I think probably not as many deals with shared credits and private equity and stuff like that. It'll be the oil and gas field will be primarily more to core customers that can show in the underwriting whatever they buy, that that particular deal can pay itself back in four or five years, and that's the way we would structure it, basically.
Okay. That's helpful. Maybe one final one for you, David. We're 90 days past the last earnings call. We're past the conversion for the Legacy deal. What have you learned at this point, and has your views on potential M&A partners changed, just given what you've learned maybe in the past 90 days? Thanks.
Yes. I'm back in love again with M&A after our bromance with Kevin. He may not be in bromance with me. I don't know. His back's hurting right now today.
I still love you, David.
Okay, good. No, it's just been great. I lost some of the love of M&A after one of the deals that we did. Everything that was said was just kind of the opposite, but this has been really good. Not only Kevin, his team. When I talk with the team, I really couldn't tell would we really be interested in this Mortgage Warehouse, and it's really turned out. It's really felt a great need with interest rates going as low as they have. Having the option of doing this, and I feel better with it because I feel good with their team. Their team, the Mortgage Warehouse team, really knows what they're doing, and I have a lot of confidence in them. I really feel good with that piece of the business.
Really almost everybody that I've worked with at Legacy, all the people are very professional, very astute. I couldn't be more pleased. Let me just say that.
Going forward, any updated views on M&A for you guys?
Yes. I think I mentioned that M&A probably right now, where we've had a lot of call-ins in the past when things are good. Everybody's called. Not everybody, but usually, we have two or three deals working at any given time. That's probably not the case right now. Having said that, generally what happens in times like this is generally we get a deal that we would never have been counted on. It's a deal that somebody's in that has some issues, and they have to get out of it. I wouldn't be surprised if we get. A lot of it depends on this pandemic and how long it lasts, but I wouldn't be surprised if something like that comes to us.
We've had deals, even some really good deals come to us right now, but again, the price that they want right now and where they're located wouldn't be what we want to do exactly right now.
Great. Thanks for taking my question.
Sure.
Ladies and gentlemen, at this time, we'll end today's question- and- answer session. I'd like to turn the conference call back over for any closing remarks.
Thank you, Jamie. Thank you, ladies and gentlemen, for 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.
Ladies and gentlemen, with that, we'll conclude today's conference call. We do thank you for joining. You may now disconnect your lines.