Good day. Welcome to the Prosperity Bancshares, Inc. first quarter 2020 earnings conference call. All participants will be in 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. To ask a question, you may press star then one on your touchtone phone. If your question has been answered and you wish to withdraw yourself, please press star then two. Please note, today's event is being recorded. I would now like to turn the conference over to Charlotte Rasche. Please go ahead.
Thank you. Good morning, ladies and gentlemen, and welcome to Prosperity Bancshares' first 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, and on the call 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, Eric. 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. Let me turn the call over to David Zalman.
Thank you, Charlotte. I'd like to welcome and thank everyone listening to our first quarter 2020 conference call. Our merger with LegacyTexas was completed on November 1st, 2019. Our management teams continue to find commonalities and strengths that we expect will benefit our company, our shareholders, and associates going forward. Our planned operational integration remains on schedule for June of this year. In our efforts to continue to enhance shareholder value, Prosperity repurchased 2,092,000 shares of its common stock at an average weighted price of $52.59 per share during the first quarter of 2020. The net income was $130 million for the three months ended March 31st, 2020, compared with $82 million for the same period in 2019. Our earnings per diluted common share were $1.39 for the three months ended March 31st, 2020, compared with $1.18 for the same period in 2019, a 17.8% increase.
For the first quarter of 2020, on an annualized basis, return on average assets was 1.67%, return on average common equity was 8.86%, and return on average tangible common equity was 20.1%. Prosperity's efficiency ratio, excluding net gains on the sale of assets and taxes, was 42.9% for the three months ended March 31st, 2020. Our loans at March 31st, 2020, were $19.1 billion, an increase of $8.7 billion, or 83.7%, compared with the $10.4 billion at March 31st, 2019. Linked quarter loans increased $281 million, 1.5%, or 6% annualized compared with the $18.8 billion at December 31st, 2019. Our deposits at March 31st, 2020 were $23.8 billion, an increase of $6.6 billion or 38.5% compared with the $17.1 billion at March 31st, 2019. Our linked quarter deposits decreased $373 million or 1.5% from the $24.2 billion at December 31st, 2019.
A portion of this decrease was due to our planned reduction of higher cost and broker deposits assumed in the LegacyTexas merger. Excluding deposits we assumed in the merger and new deposits we generated at the acquired banking centers since November 1st, 2019, deposits at March 31st, 2020 grew $1 billion or 6% compared with March 31st, 2019, and grew $162 million, nine basis points or 3.6% annualized compared with December 31st, 2019. Our non-performing assets totaled $67 million or 25 basis points of quarterly average interest earning assets at March 31st, 2020 compared with $40 million or 21 basis points of quarterly average interest earning assets at March 31st, 2019, and $62 million or 25 basis points of quarterly average interest earning assets at December 31st, 2019. The increase during the first quarter of 2020 was primarily due to the merger.
During the first quarter of 2020, Prosperity increased its allowance for credit losses to $327 million from $87 million in the fourth quarter of 2019 after adopting accounting standard ASU 2016-13, also known as CECL. The amount of the allowance is based on our CECL methodology. We believe these additional reserves should help to insulate the company during these challenging and unprecedented times. Our allowance for credit losses to total loans, excluding the Warehouse Purchase Program loans, now stand at 1.88%, compared with 51 basis points at December 31st, 2019. With regard to acquisitions, as one would expect, conversations with other bankers regarding potential acquisition opportunities have subsided. We remain ready to enter into negotiations when it's right for all parties and is appropriately accretive to our existing shareholders.
While today's challenges are certainly extraordinary, Prosperity has a deep management team with experience in navigating and adapting in difficult times. We enter this economic downturn from a position of strength with sound credit quality, robust capital and liquidity, and solid operating fundamentals. We believe that our team will see us through, and we remain confident in our long-term future. I would like to thank every associate at Prosperity.
Throughout the past several months while dealing with various personal challenges related to the pandemic, our retail team operated at full- capacity, enabling us to keep our locations open and serve our customers' daily needs. Additionally, our operational staff and lending team were crucial in accepting, processing, and submitting thousands of SBA PPP applications and closing the loans, working around the clock to assist our customers. 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 March 31st, 2020, was $256 million compared to $154.9 million for the same period in 2019, an increase of $101.1 million or 65.3%. The increase was primarily due to the merger with LegacyTexas in November 2019 and $28.5 million in loan discount accretion in the first quarter of 2020. The net interest margin on a tax equivalent basis was 3.81% for the three months ended March 31st, 2020, compared to 3.2% for the same period in 2019 and 3.66% for the quarter ended December 31st, 2019.
Excluding purchase accounting adjustments, the core net interest margin for the quarter ended March 31st, 2020, was 3.36% compared to 3.16% for the same period in 2019 and 3.26% for the quarter ended December 31st, 2019. Non-interest income was $34.4 million for the three months ended March 31st, 2020, compared to $28.1 million for the same period in 2019. The increase in non-interest income was primarily due to the merger with LegacyTexas. Note, the debit card income from LegacyTexas is now impacted by the Durbin Amendment. Non-interest expense for the three months ended March 31st, 2020 was $124.7 million compared to $78.6 million for the same period in 2019.
The increase was primarily due to the merger with LegacyTexas. For the second quarter of 2020, we expect normalized non-interest expense to range around $120 million-$125 million. In addition to this, we expect $3 million-$5 million in one-time merger expenses related to upcoming June conversion. We expect to incur expenses related to SBA Paycheck Protection Program in the second quarter, which are not included in the normalized non-interest expense guidance. As we discussed in prior quarters, we expect to realize most of our cost savings from the LegacyTexas merger beginning in the third quarter of 2020, after the system integration that is planned for June.
To date, we have already realized some cost savings from the merger and eventually expect additional cost savings of approximately $8 million-$9 million per quarter. Combined, this will be in line with announced 25% cost savings. The efficiency ratio was 42.9% for the three months ended March 31, 2020, compared to 42.94% for the same period in 2019, and 58.07% for the three months ended December 31, 2019, which included $46.4 million in merger-related expenses. The bond portfolio metrics at March 31, 2020 showed a weighted average life of 3.08 years and projected annual cash flows of approximately $2.2 billion. With that, let me turn over the presentation to Tim Timanus for some detail on loans and asset quality.
Thank you, Asylbek. Our non-performing assets at quarter end March 31st, 2020, totaled $67,179,000, or 35 basis points of loans and other real estate. The March 31st, 2020 non-performing assets total was made up of $61,449,000 in loans, $278,000 in repossessed assets, and $5,452,000 in other real estate. Of the $67,179,000 in non-performing assets, $13,187,000, or 20%, are energy credits, $12,869,000 of which are service company credits, and $318,000 are production company credits.
Since March 31st, 2020, there have been no material deletions from the non-performing assets list. Net charge-offs for the three months ended March 31st, 2020, were $801,000. There was no addition to the allowance for credit losses during the quarter ended March 31st, 2020. The average monthly new loan production for the quarter ended March 31st, 2020, was $476 million. Loans outstanding at March 31st, 2020, were $19.127 billion. The March 31st, 2020 loan total is made up of 36% fixed rate loans, 36% floating rate loans, and 28% that reset at specific intervals. I'll now turn it over to Charlotte Rasche.
Thank you, Tim. At this time, we are prepared to answer your questions. Eric, can you please assist us with questions?
Thank you. We will now begin the question and answer session. To ask a question, you may press star then one on your touch tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. Our first question today will come from Jennifer Demba of SunTrust. Please proceed with your question.
Good morning.
Morning.
David, can you talk about what you see as your most vulnerable loan buckets over the near term as we're still kind of in the shutdown and things are reopening slower than we'd like?
Yeah. First, I would say that, W e haven't seen deterioration yet in the loan portfolio. Again, maybe that's because you extended a number of loans for that. I guess it's obvious that vulnerable would be the first thing somebody would pick out would be probably the oil and gas portfolio. However, when you really look at it, the majority of it is in production loans. Of that, again, Kevin can jump in and talk in a minute, but about 85% of that is hedged, the production loans that we got from Legacy, at about $50-$60 a bbl. That's hedged for this year and part of next year. He can probably go into more detail with you than that. There's a little over $200 and something million that we have in loans that are in the service industry.
The thing I would say about that is that most of those came from us, and those are customers that we've had probably for the last 20 and 30 years. We didn't put any new customers on there, and they have experience in this, and we made it through this with them back in 2016 and 2017 when oil went to $25 a bbl. I guess the next vulnerable thing would probably be your hotels and motels, and that's just going to be until people start coming back and traveling again. I always think that usually we don't make a bunch of restaurant loans, but all the PPP money that came out probably is going to help a lot of these hotel, motels, and restaurants, and stuff like that. Again, it was very helpful, and so we'll see how that goes.
I don't know that anybody really knows where we are at in the future, in, say, the third quarter or fourth quarter. I think a lot of it's going to depend on how fast we turn back on the economy, and I think Texas is planning on turning it on faster than some of the other states. I think this Friday we're coming on. It's not everything on. I don't know that the hair salons and the nail places, but even your restaurants are coming back on, and again, it's going to be at diminished capacity, maybe 25% and 50%. Your medical offices are coming back in. I think the faster we come on, the better it will be. Again, the thing I feel good about, again, I can't predict the future, but we've been through this before. Our underwriting has probably been better.
I don't want to say that, then something may go wrong, but our credit underwriting has probably been stronger than some of the other banks. We've not taken as much risk as some of the other banks, and hopefully, that should help carry us through this. Again, we don't know the future, but we feel pretty good where we're at. Long answer, Jennifer. I'm sorry. I just wanted to give you some color.
Yeah. That's okay. How much of your loan balances have been deferred overall, and specifically in that hotel and energy bucket?
I don't know that I have it broken. I don't think that I have them broken down. Somebody else can jump in a minute. There wasn't as much in March, but as if you looked as of yesterday, we had 5,643 loans that we did have an extension on out of 66,000 or almost 67,000. That would be about 7%, a little over 7.7% of our loans. The dollar amount that we extended were $66,829,000.
David, I might add that, Jennifer, it's really a function of time. If things start to normalize relatively quickly, I suspect we're not going to have that many severe loan problems. If this gets drawn out more and more and more and more, then obviously, that could be a different story. As David mentioned, Texas is starting to come back online this weekend. Restaurants are allowed to open this weekend at 25% capacity, and then depending on how things go, they're going to go to 50% capacity by mid-March.
Then once again, based on how things go, they could be at full capacity by the end of May. I said mid-March, I meant mid-May. There are a lot of things happening. Medical offices are already reopened. Their client flow is obviously less than what it normally has been, but the important thing is they're open for business, and people can go see doctors now and not have to talk to them over the phone. There are a lot of positive things in play that we're hoping will allow our customers to get back online fairly quickly. We'll have to just wait and see.
Kevin, you want to jump in on the oil and gas at all? Or the?
Jennifer, as you know, and as Tim just said, a lot of this is about duration, particularly in oil and gas. Low prices are one thing, but low prices for a long time can be very destructive. Our portfolio, which is now $719 million, or 3.8% of the loan portfolio, it's pretty well hedged, as David said. If we look across the producing portfolio on the gas side for this year, 88.5% of the PDP is hedged at a weighted average price of $50.93. That rolls into next year, that we have 63.2% of the PDP hedge at $50.24. These hedges have, not only for us, because the industry kind of moved a lot more in the way of hedging in 2015. I don't think we're unique in this regard. We might be unique in that we're reporting it, how much we have. It's buying us time.
Not much works, in fact, nothing works at $20 oil. There can be stress within the portfolio. As we talked about in the January call covering our fourth quarter results, because of the marks we had back then, which are now poured into CECL, we've got 12.2% of our energy portfolio reserved. We've kept pretty tight looks at everybody else who's got an energy portfolio, and I don't think anybody's got that kind of reserve up. There's a couple that are now starting to approach it. I think I heard a call yesterday where somebody had approaching 8%, we've got a pretty healthy reserve up against it. We're working really hard on the former energy credits we had at Legacy. We had identified about $200 million of those we wanted to get off the books.
If I just look at that portfolio back in September, that reserve base portfolio was $511 million. It's down to $355 million. Out of all those resolutions, they've all come at or below the marks that were put on them. In fact, every one but one has been well within the mark. I think we have one this quarter that we got out exactly on top of the mark on. We haven't gone negative of the mark in all of these resolutions. I think we're making great progress on what's in front of us.
We'll see what duration brings, but I think we've got a good 18 months of hedging with pretty darn good counterparties built into our portfolio. Counterparties are basically, or mostly BP and Cargill, so pretty good counterparties on the other side of these things. Our clients are actually doing pretty well with these hedge volumes. It's up to us, and we're instituting MCRs, or monthly commitment reductions, on all of these guys to capture some of these cash flows that they're benefiting from and reducing the debt.
Thank you. One more question, David. Are you inclined to suspend buyback activity right now, or are you still active?
I think if it were up to me, I'm probably pretty bold. I would probably do it. On the other hand, I know the regulators right now, while they haven't said that you can't do something, that I think they would like us to make sure that you build your capital. I'd say for the most part, I've committed to them that it's not in anything formal, but just talking to them, unless our stock just went really through the bottom or something, we probably wouldn't be buying stock back right now. That's just kind of where we're at.
Thank you so much.
Thank you. Our next question will come from Brad Milsaps of Piper Sandler. Please proceed with your question.
Hey, good morning, guys.
Good morning.
David, I know one of the big aspects of when you bought Legacy was right-sizing their balance sheet, running off some of their loan portfolio to kind of meld the two together. Just kind of curious where you are in that process, kind of what this environment might do to sort of change the timing of some of that, or do you kind of have the balance sheet in terms of the left and right side kind of where you would want it at this point?
I'll let Kevin answer in a minute, but I think we're right on schedule. I think when we first said this, we thought there'd be about $400 million in loans or $500 million in loans, and those guys have just done a fantastic team over there. David Montgomery and Sam Duff, they're cleaning up the port. I wouldn't say cleaning up. They're outsourcing some of the loans that we didn't necessarily want there. As Kevin said earlier, the marks that we had on them, actually this quarter, if you look at our ALL, or whatever they want to call it now, the CECL calculation, we took about,also like how much was it, $13 million?
We had $13 million.
$13 million that was really related to, we took it out of PCD.
Yeah.
Put it into the regular allow loans. Everything so far has worked out really good. Knock on wood, I don't want to just say everything's perfect in the world, but I think we are where we want to be. I was a little bit leery on were we going to stay in the Warehouse Purchase Program. I think we've gotten more comfortable with it, and we were even able to, there are some customers that we probably picked up a couple of customers because they were so strong that they couldn't get financing somewhere else, and probably outsourced a couple that we weren't making as much money on.
That's worked out real well with us. I think the other portfolio was that commercial real estate portfolio. We really haven't seen a lot of growth in that portfolio yet, or a lot of loans. Again, it's just paying down like it is. I hope that gives you some color. Kevin, you may want to jump in.
No, I think David covered it pretty well. If anything, I think we're ahead of schedule. We still have about $50 million on the energy side we'd like to work our way out of, at least going back to those original numbers. Where we sit today, we'd probably like to work our way out a lot more than just $50, but we're ahead of schedule, Brad.
Got it. Even just away from credit, what about in terms of the liabilities, remixing the deposits, and how does that impact, in addition to what's gone on with rates, impact some of your thoughts around the NIM? I think, David, you mentioned last quarter kind of getting into that 335 range, which you did this quarter. Just kind of curious what the environment does, and then kind of what you're in addition able to do with Legacy's portfolio of deposits as well.
This is Tim. I can give you a little insight on that. I've been working with Mays and others on the Legacy's side to reduce some of our interest expense. I think we're having good success. We're trying to do it in a, what I would call, a considerate fashion, because we don't want to run off customers that have the capability of being core customers and staying with us over time. We're taking a, I guess you could call it, somewhat of a relaxed approach, but yet focused and determined on lowering these rates.
I think we're having good success. Mays can maybe add to it, but I'm not aware that we have lost any customers that we feel like are on the core customer side. Some that are more on the hot money side just inevitably will end up going somewhere else. We're very focused on it. We have been. We continue to be. All the interest costs are going down, obviously. The high price ones go down just like the low price ones, although there is a differential there. I think we're having good success. I feel good about it.
This is Asylbek. I would like to add that related to the brokerage CDs that we have, we have about at least $250 million at 2.5% that we're planning to reprice hopefully soon. There is that one, and also we have $125 in subordinate debt that we are going to pay off by the end of the year in December. That's definitely going to help us with the repricing of the high cost deposits.
Really deposits, I know even though they might have been down from the Legacy's side, this month, I guess, probably in the last month, our deposits have increased probably $1 billion. Again, some of that's probably because of the PPP. Usually in times like this, normally our peak deposits come in the fourth quarter and first quarter, now is not a time, and this month we saw, in April, a $1 billion increase. When we went back and looked, this happened in 2008, when times get a little tougher, we tend, more people put more of their money with us. Is that right, Asylbek?
That's right.
If you've done that, yeah.
The flight to safety, you can see that.
As far as the net interest margin, I think that Asylbek will probably tell you this. I asked him, he feels comfortable in projecting anywhere from a 3.45- 3.55 net interest margin going forward on a total. If you want net interest margin without the accretion, what did you have, three? What is it?
Yeah, probably low to mid $3.30s. That would be without accretion. When we provided range of $3.45-$3.55, based on the about $13 million-$15 million fair value income that we expect in the second quarter.
Right.
Related to the margin, I can speak a little bit. The way our balance sheet is structured, I think is very better insulated in this time environment because if you look at our total interest earning assets, 31% is in the bond portfolio with fixed rate.
Right.
Also we have about 35% of loans in fixed rate. That's definitely help us to maintain, I would say, our margin definitely going to stay flat. I think the wild card in this environment is our SBA PPP program.
Right.
That is depending on the timing of forgiveness, timing of the funding, it could impact the margin in the second quarter. It's going to be dilutive little bit to the margin, but if you look at from the EPS or bottom line, it will be very accretive to us.
It probably wouldn't be dilutive if you could take the whole premium that you're getting, the three or five percent that you're getting in. That wouldn't be dilutive, but you have to take that from what you're telling me over a two-year period.
Yes. Exactly.
There's a lot of money that'll be coming in from that PPP Program. I think once it's all said and done, we'll have $1.5 billion- $2 billion in PPP loans, depending if we get them all approved or not.
Yes. That's going to definitely impact our bottom line and EPS in accretive way.
Great. Thank you, guys. I'll hop back in the queue.
Our next question will come from David Rochester of Compass Point. Please proceed with your question.
Hey, good morning, guys. Nice quarter.
Thanks.
Hey, on the energy book, you guys gave a lot of great detail on that. You look pretty well protected at this point, but was just wondering how far along you were in the spring redeterminations and what you're seeing from the standpoint of line reduction, and then what you're baking in for oil prices in your new decks.
We're well into the redeterminations. It's an ongoing process. The customers are fully aware that that process is underway and appropriate and called for. We haven't had really any resistance to the process. Obviously, some people don't like the fallout of the numbers, but they are what they are. We haven't had any, what I'd call declared defaults so far in the process. We seem to be working well with virtually all the customers. We understand where they are, they understand where we are.
I think it's like everything else that relates to our loan portfolio. It's really a matter of how long does it stay weak. Right now, I'm not overly concerned about it. If prices are bad a year from now, and two years from now, we're probably going to be more concerned about it. I feel good about where we are in the redeterminations. People have the option of pledging additional collateral, the option of paying us down. Sometimes we need to give certain customers a little more time, and we're willing to be considerate of that and look at it. It's a viable process. It's not a process that has broken down in any way at this point in time.
Yeah, Tim, this is Kevin. I would just add to that, we're about halfway through at this stage of the game. General sense in terms of what's happening is commitment reductions of anywhere from 40%-50% across the board. Heavy usage, almost, I think every client we've instituted MCRs on.
Yep. Okay. In terms of the oil price you guys are using in your decks now?
Yeah, somewhere between $25 and $30.
Okay.
Closer to $20.
Yeah, I think Kevin, Merle's in here. Merle said that we're probably using in the $20s. Merle, is that right?
Well, we're starting out in the low $20s. We're probably averaging into the mid $20s.
Yeah, we have a stress case that we're running, and it takes it down to high teens, low $20s. Yeah. I don't think anybody's going to argue from that.
That's great color. Appreciate that, guys. I guess in terms of your loan growth outlook, just if we get some thoughts there. I know in the past, you guys have typically put together some decent loan growth when the environment is tougher because all the other banks tend to tighten their underwriting standards, and you guys are already operating with tight standards. Was just wondering what your thoughts were on that as you're seeing that unfold today.
I think it's the same as what you just said, Kevin. I think it speaks for itself. Again, I think it's exactly what you said. I think that we'll probably do better in these kind of times than maybe some of our peers because we're in a better position probably.
Yeah. Okay. Just switching to the margin, was just curious where you're seeing securities reinvestment rates these days, and if you guys were buying to replace any of the runoff you were talking about. I know you talked about some decent cash flow coming off that, or if you're just planning on working borrowings down a little bit.
Really, we haven't. Probably last month, we bought up $200 million because we got around that 2.4%. Right now, really, with rates where they're at, we're just paying it down and taking the money and putting it back in instead of borrowing from the Federal Home Loan Bank, using that as a substitute and putting it back into the loan side.
On the warehouse.
Warehouse receipt, yeah. I meant warehouse receipt, warehouse mortgage.
Got you. Maybe just one last one on M&A. Appreciated the thoughts you just gave earlier. I was just curious if you'd still be interested in FDIC-assisted deals, if those were to pop up over the next year or so, depending on how bad things get. If you'd go for only in-market deals or if you'd go outside the market for those types of situations.
If you look back even to when some of our better deals we've gotten, even like the Franklin deal when it has been at times like this, yes, we did jump in, that's generally when we can get things at a pretty reasonable price. We would be interested, naturally, we would be more interested in an in-market deal. Having said that, from a shareholder standpoint, depending how sexy it was, if we could make some money, we'd consider that too.
Yeah. All right. Great. Thanks, guys.
Our next question will come from Brady Gailey of KBW. Please proceed with your question.
Hey, thanks. Good morning, guys.
Morning.
Morning.
I wanted to follow up on the SBA's PPP program. What's the average fee that you're seeing currently?
This is Eddie. In the first tranche, we had about $630 million in approvals over 2,700 loans. I think if you take the average fee on that, it was close to about 3.2% on average, or right around 3% on the fees on that. We're, of course, early on into the second phase right now. As of this morning, we've had about 3,000 approvals totaling about $500 million, and we have a lot more to work through. We really haven't analyzed the fees on that. I will tell you the average size loan has come down in this tranche. It started about $190,000. What we're looking at on the average through this morning was closer to $150,000.
Probably if you had to make an assumption, you'd probably be more, what about a 3% fee?
About 3% on average because these are all in that lower level.
Right.
If you guys end up doing $1.7 billion of P3 loans at a 3% fee, that's $50 million of pre-tax earnings that could potentially flow through the margin over the next couple of quarters as most of these loans are forgiven. That'd be a nice tick up to the margin. Is that the right way to think about that?
It is. There are some expenses that need to come out of that, a little bit. These loans are 24-month amortizations, but the forgiveness period will start eight weeks after. They can start applying eight weeks after their first funding. The rate at which they will be retiring that debt is yet to be seen. We can conceivably see the lion's share of that coming up in the next 12 months.
Having said that, though, too, I think this is money that we really weren't counting on, and if our model would let us, our methodology, I would like to see if we could put some of that money, again, increasing our allowance for credit losses, if possible. I wouldn't want you to count it just extra found money. That's just caution you on that. If we can, and the model will allow us, I don't know that you can ever have too much money in reserves.
Yep. Okay. On that topic, it's odd to see a zero provision this quarter, but totally understandable given the credit quality of Prosperity and where your reserves are already at. Do you think that you could see a zero provision going forward from here as well?
Well, just, I would say that I would like to take extra money that we have coming in and try to put some. Again, Merle is probably going to look at me because this is all based on a methodology. In the methodology, there's What is it called?
Environmental
Environmental deal where maybe you have some flexibility. I would like to put more of this extra found money we have, not only that, we have some other things coming in that are above what our normal budget is, and we would like to maybe put some of that. If there's a provision, it would be with this extra money, I would say, and if the methodology allows it.
Once again, right now we're not faced with obvious defaults.
Right.
That could change.
No, that could change. Yeah.
That could get worse. If it does, our model will address it appropriately.
Again, it would be nice to just, hey, here's another $40 or $50 million you have in income that you didn't count on. It would be nice if we could put some of that away, in my thoughts.
Yep. That makes sense. Lastly from me, looking at the energy reserve of around 12%, I think that is excluding another $21 million of fair value mark. Once you bake that into it's more like a 15% energy reserve. Is that the right way to think about it?
That is a fair way today, what we call interest mark, is going to bleed off over time. Over the next 18 to 24 plus months, that piece of what you call reserve is going to deplete.
It'll still be at 12%.
It'll still be at 12%. Everything over 12% is depletable.
We went back to look. When oil went to $25 a bbl, first I asked them to go back and tell me how much money have we ever lost over a two-year period. I think the two years, and this might be in the slideshow that we did, I think it was in 2016 and 2017. Over a two-year period, we lost about $35 million. $25 million of that, or $24 million of that was oil and gas, and the majority of that was from a bank that we bought in Oklahoma. Most of those losses came from that. Again, we were smaller at that time, so if we go through something like that, again, I can't say that's what our total loss is. It could be, who knows? It could be 80, it could be 90, who knows?
Again, that just gives you some flavor of where it was when oil went to $25 last time, what we charged off over a two-year period.
Yeah, David, that's right. That went from about mid-June of 2016 through the first quarter of 2018. It was half a year of 2016, all of 2017, and the first portion of 2018.
Right.
That's exactly correct.
As far as reserves, and again, you never can say you have too many, but in my lifetime as a banker, I've never been at 1.88%. This is a whole new dimension for me, so I hope we don't need it, but that's more than I've never been in a bank where capital ratios, we used to operate, when we first started off, if we had 5%, we thought we were in great shape, but now we got capital ratios of 10%. You've got allowance for credit losses of almost 2%. I know we're in this situation right now, but I don't know that really the banking industry has ever gone into a downturn or where we're at right now as strong as most banks are right now also.
Got it. Thanks, David.
Our next question will come from Ebrahim Poonawala of Bank of America. Please proceed with your question.
Good morning.
Morning.
Most of my questions have been answered. Just one, I guess, for Kevin. To the extent you can, how do you see the mortgage warehouse business playing out, both in terms of just the demand over the next few months or over the next couple of quarters, and what you're seeing on the pricing side in terms of lending spreads?
Yeah. Lending spreads have been pretty stable, after years of being beaten down on margin there. I think you saw in the Q, our weighted average coupon for the quarter was 362 on the Warehouse. Notably, it was a pretty big quarter in terms of refi. Purchase refi volume was 51%, purchase 49% refi. A lot of refi volume in the quarter. I actually think that Warehouse volumes this year are going to peak in mid-May. We're not too far away from what I think will be peak volumes. It'll be somewhere between May 15th and May 20th, by my math. For us, that peak could be somewhere between $2 billion-$2.3 billion, and we've said we'd like to kind of keep this at $2 billion. We got a lot of bulge facilities out there to get folks through volume.
Just keep in mind, volume that comes onto our balance sheet is usually an application that was taken by one of our customers six weeks ago. What I do expect post, call it May 20th, is that purchase volume's going to drop pretty dramatically. We're going to see a much lower balance from May 20th to June. When that purchase volume returns, I don't know. Once it starts returning, realize we have another six weeks of lag before that application gets back on the line. It may be a couple of months of lower volumes in the June, July period, which is normally when we're at the peak. This year's going to be a little bit different, in my opinion, and just based upon all the facts we're looking at.
My crystal ball isn't all that good past July, and it will all depend then on whether the purchase volume goes back. If people put their houses back on the market, if there's traffic, that there just isn't much foot traffic today. That also extends over into the purchase market. I think home builders are going to have a tough quarter in Q2. They all had pretty good quarters in Q1, record kind of quarters through February, and then some bust-outs started to occur on contracts in March.
There will be pockets of the United States in home building in Q2, where you will see some home builders, and I'm not talking about the national guys, for the most part, that will actually have negative sales volume in Q2. There'll be more bust-outs than they have in new contracts. This will be temporary. Both for home builders and I think for the warehouse, it's going to be a different Q2 than we've ever seen before.
That is actually very helpful. Thank you. Just staying on that, do you see any risk or concern that any of these independent mortgage companies could run into trouble because of what's going on with the market and deferments, et cetera, where they are stuck with borrowers who might be deferring right at the onset, after taking the loan?
Yeah. We haven't seen that yet. As we look at our portfolio, and that's really all I've got a window into, the volumes that might have a deferment on it in the short 17 days that we've held it has been less than 1%. It does seem like there's, if you track this here in the last week, we've had some of the GSEs agree to buy those things if there are deferments on them, which is going to free up that market a bit. If there's going to be issues for mortgage warehouse companies, it would've been during that period of time where they were getting hit with some MSR write-downs, for those guys, those who have maybe big MSRs.
There were some that were caught on hedging, and they had to settle up on some hedges that were some meaningful dollars there for a period of time in March. Our clientele made it through the, I'm not going to say unscathed, but without any real liquidity concerns or anything else. We looked across our portfolio pretty hard during that period of time. In fact, we stopped accepting jumbos, without identified takeouts, probably in the second week of March, just because the jumbo market also slowed down in terms of getting them off the line. I think we took all the appropriate steps and we're just keeping an eye on MSRs and hedge volumes.
That's helpful. Thank you. Just one question, David, as a follow-up on M&A. Given what you talked about in terms of, at least for now, being in a little bit of a capital build mode until things settle down, does it suggest that for the near term, and I guess near term is whatever, the next three to six months, it's highly unlikely that you enter a deal or you entertain any M&A transactions until you get the integration piece complete and until we get to some form of the other side of the lockdowns?
I think I understood your question, but it was a little bit muffled a little bit. I think you're asking what do we see in M&A or what we're going to do. Our thought is the operational integration is first and foremost, the June operational integration. Having said that, if an opportunity really came up, we would probably really consider it because this is what we wait for, are these kind of times. We're there all the time, but these are the kind of times that we really are in a good position to do what we need to do.
If that comes up, and I feel really good with the Legacy team and Kevin and Mays and the whole team has just been remarkable, and they've just been some of the greatest partners we've ever taken on, and the business we've kept, and what we thought we could do, we did. I feel very comfortable where we are with our teams. If that happens, we would do it.
Got it. That's all I had. Thanks for taking my questions.
Our next question will come from Michael Rose of Raymond James. Please proceed with your question.
Hey, guys. Just two quick ones. First, I understand the comments around the buyback. If I look back to kind of the Great Financial Crisis, you guys still continued to increase your dividend, and you guys got strong ROI, pre-tax earnings trends. Any reason to think that you'd slow on annual dividend increases from here?
I hope not. My kids need milk money, so I hope we continue. The only thing, from what we see right now, I don't see that being an issue. Again, I can't tell you that something would jump up in the third or fourth quarter and it's an automatic either, but I hope that's not the case. If you ask me which way we're leaning, it would be more for dividend increases, especially with the increase in earnings that we're projecting.
Got it. Appreciate the comment. Very similar to what Johnny Allison said, but in a different way. One other question, just as it relates to the timing of cost savings. Have any of them been pushed back? Is systems conversion still on track to go as planned? Anything we should think about there? Thanks.
No, I think it's already in process. We're waiting for our June conversion. After the June conversion, we should have start seeing the savings. Our June, because so close to the quarter end our conversion, it might a little bit delay on the realizing the cost. As we said, that we already realized about $2 million-$3 million cost savings this quarter, and we're planning to do another $8 million-$9 million in future quarters, so it gets us to 25% cost savings. We're hoping to do more than that, but definitely we'll achieve our 25% cost save that we announced.
All right. Thanks for taking my questions, guys.
Thank you.
Thank you.
Our next question will come from Gary Tenner of D. A. Davidson. Please proceed with your question.
He might have dropped off.
On mute, maybe.
Oh, mute.
Mr. Tenner, your line is live into the conference.
I'd move to the next one. Yeah. He's probably off. Yeah.
All right. Our next question will come from Ken Zerbe of Morgan Stanley. Please proceed with your question.
Hey, it's Ken Zerbe. Just a really quick follow-up on the expense comment that you just made. The $2 million-$3 million and then the $8 million-$9 million of additional that you're going to get, is the $2 million-$3 million already included in the $120 million-$125 million, such that kind of the normal run rate after everything's said and done should be closer to about $114 million? Just want to make sure I got my numbers right. Thanks.
Clarification. Yes, the $2 million-$3 million cost savings is already baked in in the $120 million-$125 million range I provided. If you take another $8 million-$9 million, I think we run rate, assuming everything stay the same as we're thinking right now, is going to be around $114 million-$116 million going.
You'd have the tax effect, the $8 or $9 million, right?
No, just we're talking about expenses.
Okay.
Yeah, not the net income. Yeah, expenses. I would say between $114-$116 will be run rate after all the saving we realize from the conversion.
Got it. Okay. Thank you.
Our next question will come from Jon Arfstrom of RBC Capital Markets. Please proceed with your question.
Hey, thanks. Good morning.
Good morning, Jon.
Good morning.
Hey. A quick question. Most of the stuff has been handled. Can you touch a little bit on West Texas and the kind of activity you're seeing there? Non-energy related, I guess, in terms of your thoughts on stresses in the real estate portfolio or housing. I know you have some exposure in the Permian, probably Eagle Ford as well. Just give us an idea of what you're seeing there.
I'll start off. Midland, Odessa is kind of a crazy market to begin with. When oil and gas prices are at their ebb, there's not enough housing, there's not enough people, restaurants, maybe work one shift instead of two. I see a lot of that becoming more normalized, that's in the Midland, Odessa area. I think that the Lubbock area is more really based, and the West Texas area is really based more on a college town with Texas Tech University. We really didn't see big increases or decreases in the market over there. I think it's probably a lot, not only the oil and gas, but it's probably agricultural related to some degree. Again, based on a college town, you have retail. Merle, you've lived there, and you may have some comments on what you see in West Texas or how you feel about it.
Lubbock's economy is pretty stable, both upturn and downturn. There's not much upside in Lubbock, but there's not much downside.
That's been what it's been.
It's pretty much a 2%-3% annual growth rate. Midland- Odessa, yeah. I think that David's right. The thing has been so stretched, there's some absorption it'll take just to get back to normal.
Yeah.
There'll be some job loss that they can redeploy some of those people. I think net, there's going to be a lot of stress. You're going to see some stress in the hotels, because a lot of those hotels have been, number one, fully occupied. They're not going to be fully occupied, whether it's by COVID or by oil and gas workers. There'll be some stress there, but we don't have much hotel exposure, hardly any.
We didn't do any over there, did we?
I think we've got one.
We might have one, yeah.
I think it's an older hotel. I think its breakeven's around 30% occupancy.
That's good.
Yeah.
On the other hand, I would tell you that oil and gas, the pricing is really going to depend on the economy coming back. When we talked earlier about the E&P loans being hedged, at least 85% or 80-something percent on the ones that we had from Legacy. We also had some from the West Texas area, and most of the people we lent to over there, we didn't require them to hedge because, we lent one guy $80 million or $90 million. He paid it back down to $20 million or $30 million, and has $120 million on deposit in the bank.
We have another family we have a loan to, but they've got $60 million in the bank and the trust companies. I think what you're going to see is, you'll see production really come down. I think the guys that are hedged are going to keep on producing it because why not if they can get that kind of money. Everybody else that we talk to, they're really pulling back, and they're not going to produce at these levels until the market comes back. When the economy comes back, you'll see the oil and gas prices come back too.
I think it's important to note that, to use the old Texas saying, this isn't the first rodeo out there. These people are used to boom and bust. That's the way it's always been. Personally, I think we've been rational and conservative in our loan approvals. Most of our customers that are out there have been through these ups and downs before. As you just said, we don't have many hotels. We don't have many restaurants. Real estate values clearly are not solid right now. Our customers have been through these hard times before, and right now they're holding in there. I'm as comfortable as I can be right now.
Fortunately, we didn't finance any drilling companies. That's always good too.
We don't have any drilling rigs financed.
Well, we might have one, two.
We still have that one maybe.
Well, the service.
produces-
Pulling units and stuff
Yeah, no, I'm talking about drilling.
Yeah, those are workover.
Drilling rig.
We still have to have those workover rigs to serve people.
Yeah, we have some service companies.
Yeah.
Once again, these are people that have been in business for quite some time.
Yeah. We don't have any pipe.
We don't have any pipe.
Don't have any pipe.
Again, we don't want to make it sound like we're not free from any sin, and we don't know really what the future, but we do feel comfortable where we're at and that we'll be able to get through all of this, we think.
Okay. Good. That's fair. Tim, maybe to you, periodically I ask about the average monthly production numbers, but I'm assuming if you take out PPP, late March and kind of April to date is pretty weak. Just curious if that's true and kind of the activity you're seeing, and then what is the kind of corporate Prosperity message to the lenders? Is it keep your customers close, or is it go out and take some market share? Just curious what you're telling your lenders to work on.
Well, I think new loan applications probably have dwindled a little bit. In actuality, not all that much. Our loan committee meetings are still reasonably robust. There hasn't been a marked slowdown in new requests. There has been some, once again. We try to stay, when it comes to lending, always in the middle of the fairway. Good times or bad times. We try to adhere to discipline and principles. We try to lend into cash flow and good collateral, and borrowers that have experience and are honest. That's always been our message to our lenders, and it really hasn't changed.
As was mentioned earlier in this call, if things really start to deteriorate and get bad, we suspect some lenders are going to freeze up and quit lending or certainly slow down considerably their lending activities. Historically, that's always been an opportunity for us to pick up good customers that we haven't had before. That's always a possibility. We're not hoping that that happens, but it could. There's no different message to our people. Our approach is the same yesterday, today, and tomorrow. Just be conservative and try to bring in good customers, and it's really not any different right now. I think it goes back to my old saying, you'll like us in the good times, but you'll love us in the bad times.
I've never heard you say that before, ever. Just kidding. All right. Thanks a lot. Appreciate it.
Thank you.
Thank you.
Thank you. This will conclude our question and answer session. I would now like to turn the conference back over to Charlotte Rasche for any closing remarks.
Thank you, Eric. 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, we will continue to work on building shareholder value.
The conference is now concluded. Thank you very much for attending today's presentation. You may now disconnect.