Good day, and welcome to the Prosperity Bancshares second quarter 2019 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. Please note this event is being recorded. I would like to now turn the conference over to Charlotte Rasche. Please go ahead.
Thank you. Good morning, ladies and gentlemen, and welcome to Prosperity Bancshares' second quarter 2019 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 here with me today is David Zalman, Chairman and Chief Executive Officer, H.E. Tim Timanus, Jr., Vice Chairman, Asylbek Osmonov, Chief Financial Officer, Eddie Safady, President, Randy Hester, Chief Lending Officer, Merle Karnes, Chief Credit Officer, 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, Jake. 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 achievement 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 the 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 would like to welcome and thank everyone listening to our second quarter 2019 conference call. For the second quarter of 2019, we showed impressive returns on average tangible common equity of 14.82% annualized and on average assets of 1.46% annualized. Our earnings were $82.2 million in the second quarter of 2019 compared to $81.5 million for the same period in 2018, an increase of $661,000 or 80 basis points. Our diluted earnings per share were $1.18 for the second quarter of 2019 compared to $1.17 for the same period in 2018, an increase of 90 basis points. Our loans at June 30, 2019, were $10,587,000,000, an increase of $441 million or 4.3% compared with the $10,147,000 at June 30, 2018. Our linked quarter loans increased $173 million or 1.7%, 6.7% on an annualized basis from $10,414,000 at March 31, 2019.
We saw strong loan growth in the second quarter reflecting consumer and business confidence. Our deposits at June 30, 2019, were $16.888 billion, a decrease of $90 million or 50 basis points compared with $16.979 million at June 30, 2018. Our linked quarter deposits decreased $310 million or 1.8% from $17.198 million at March 31st, 2019. This quarterly decrease was primarily due to seasonality. Historically, our deposit balances in the second and third quarters are generally lower due to large customer income tax payments, farming customers having declining balances as their crops have been planted but not yet harvested, as well as public funds having lower balances from using their tax dollars throughout the year. When comparing the second quarter of 2019 to the same period in 2018, our core deposits are higher, but total deposits decrease slightly, primarily due to public funds investing in higher yielding investments outside of the bank.
It should be noted that when comparing quarterly average non-interest-bearing demand deposits, they increased 8.4% on an annualized basis when comparing June 30, 2019, to quarter end March 31st, 2019. We are excited about our pending merger with LegacyTexas Financial Group, the parent company of LegacyTexas Bank. LegacyTexas Bank operates 42 locations in 19 North Texas cities in and around the Dallas-Fort Worth area. We look forward to partnering with Kevin Hanigan and the entire LegacyTexas team to build their premier Texas-based bank. We had a number of opportunities, but believe that this strategic transaction provided the greatest opportunities for the combined organization at this time. With the addition of LegacyTexas, we will have a significant and competitive position in Texas' two largest metropolitan areas. Prosperity is fortunate to operate in vibrant and growing states.
We continue to see employment growth and a tailwind from companies expanding in and moving to Texas and Oklahoma due to a business-friendly political climate and lower tax rates. The Texas and Oklahoma economies continue to perform well with record low employment. Consumer confidence remains strong, as evidenced by increased credit card purchases, and businesses continue to do well, as reflected by increased sales tax rebates to most cities and small towns. We posted a 6.7% annualized increase in loans for the second quarter of 2019, also reflecting confidence from business and consumers. Prosperity continues to focus on building core customer 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's 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 Osmonov, our Chief Financial Officer, to discuss some of the specific financial results we achieved. Asylbek.
Thank you, Mr. Zalman. Net interest income before provision for credit losses for the three months ended June 30th, 2019, was $154.8 million, compared to $161.8 million for the same period in 2018, a decrease of $7 million or 4.3%. The decrease was primarily due to a lower loan discount accretion in the second quarter of 2019 and higher than normal collection on non-accrual loans in the prior year. The net interest margin on a tax equivalent basis was 3.16% for the three months ended June 30th, 2019, compared to 3.28% for the same period in 2018 and 3.2% for the quarter ended March 31st, 2019.
Excluding purchase accounting adjustments and the higher than normal collection on non-accrual loans last year, the core net interest margin for the quarter ended June 30th, 2019, was 3.14%, compared to 3.12% for the same period in 2018 and 3.16% for the quarter ended March 31st, 2019. Non-interest income was $30 million for the three months ended June 30th, 2019, compared to $28.4 million for the same period in 2018. Non-interest expense for the three months ended June 30th, 2019, was $80.8 million compared to $83.6 million for the same period in 2018. The efficiency ratio was 43.74% for the three months ended June 30th, 2019, compared to 43.95% for the same period in 2018 and 42.94% for the three months ended March 31st, 2019.
The bond portfolio metrics at 6/30/2019 showed a weighted average life of 3.64 years, an effective duration of 3.25, and projected annual cash flows of approximately $1.9 billion. With that, let me turn over the presentation to Tim Timanus for some detail on loans and credit asset quality.
Thank you, Asylbek. Our non-performing assets at quarter end June 30th, 2019 totaled $41,558,000, or 39 basis points of loans and other real estate, compared to $40,883,000, or 39 basis points at March 31st, 2019. This is an increase of $675,000 from March 31st, 2019. The June 30th, 2019 non-performing asset total was made up of $38,883,000 in loans, $670,000 in repossessed assets, and $2,005,000 in other real estate. Of the $41,558,000 in non-performing assets, $16,595,000, or 40%, are energy credits, all of which are service company credits. Since June 30th, 2019, $1,443,000 in non-performing assets have been sold. Net charge-offs for the three months ended June 30th, 2019 were a negative $115,000, compared to net charge-offs of $1,049,000 for the three months ended March 31st, 2019.
$800,000 was added to the allowance for credit losses during the quarter ended June 30th, 2019, compared to $700,000 for the quarter ended March 31st, 2019. The average monthly new loan production for the quarter ended June 30th, 2019 was $287 million, compared to $284 million for the quarter ended March 31st, 2019. Loans outstanding at June 30th, 2019 were $10,587,000,000, compared to $10,414,000,000 at March 31st, 2019. The June 30th, 2019 loan total is made up of 38% fixed rate loans, 38% floating rate, and 24% variable rate. I will now turn it over to Charlotte Rasche.
Thank you, Tim. Before we take questions, we wanted to provide you with a brief update on our pending merger with LegacyTexas. Last week, we filed the required regulatory applications with the FDIC and Texas Department of Banking. We expect to file with the Federal Reserve in the next week or so. We have also begun our operational integration efforts with the team at LegacyTexas. To date, we have had multiple meetings between the managers and key employees of various departments at both companies to discuss current processes, including deposit operations, loan operations, compliance, risk management, mortgage origination, and IT and information security. We are impressed with the LegacyTexas team members and look forward to working with them. We expect to close the merger in the fourth quarter of 2019, although delays could occur. At this time, we are prepared to answer your questions.
Jake, can you please assist us with questions?
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. At this time, we will pause momentarily to assemble our roster. The first question comes from Brady Gailey with KBW. Please go ahead.
Thank you. Hey, good morning, guys.
Good morning.
Good morning.
I know last quarter we talked about the net interest margin kind of being flat, if not up a little bit. We saw it slip a little bit this quarter. Looks like it's from lower bond yields and some higher deposit costs. As we look forward, and I know we're now looking at a couple of rate cuts and the yield curve is doing what it's doing, how do you foresee the net interest margin trending?
This is David. Brady, again, the numbers I'm going to give you is really based on the bank as we are today. A lot of this is going to change when Legacy and us merge together. If you just took it and sliced it and looked at the bank the way we are today, I'll give you three scenarios. With no changes or interest rates stay where they're at, we still see a net interest margin that increases pretty significantly, more significantly in the 24 and 36 month time frame.
You take another scenario and you look at, say, interest rates go down 50 basis points, we see a slight dip of about two basis points in the six and 12 month categories, but increases back in the 24 and 36 month category. If you looked at interest rates down 100%, you would see that we would have a net interest margin of about three basis points, maybe three or four. Again, this doesn't count any increase in loans, loan-to-deposit ratio, but if everything just stayed exactly like it is, maybe three to four basis points. All in all, not a real big change. Our best scenario, of course, is interest rates staying where they're at or going up. That helps us the most. Even going down 50 basis points in the longer term, we're still positive.
Having said this, when you merge LegacyTexas Bank and our bank together, you should see some pretty significant net interest margin increase.
Yeah, I would agree. This is Asylbek. I want to add on a little bit. If you look at for second half of the year, our loan or core loan yield is at 504. Right now, we're putting the new loans at about 550. That would definitely help us on the margin aspect going forward. The wild card would be, of course, deposits, which cost of deposit went up by 3 basis points, and that impacted our quarter. What we saw this quarter that the cost of deposits stabilizing a bit, and we're seeing the slowdown in terms of the increases in cost of deposits compared to prior quarters. That should help us going forward. Like Mr. Zalman mentioned, based on the model, our NIM should improve.
Yeah, I think overall, the pace at the rate that deposits increased over the past couple of quarters surprised everybody. I think we have seen a stabilization in those. Again, I think that two things working for us is when we put loans on, we're getting a better yield than where they're at right now. When you're putting securities on, our securities yield today is still only 2.36. If we're reinvesting a bond today, you'd probably be getting closer to 270. We have some gains in both categories. I think that we're probably better positioned than a lot of the other banks. It could be good or bad. I would say that we're more balanced. If we were strictly a commercial portfolio with floating rate loans, we definitely would be impacted more.
It looks like we have about a third, a third, and a third, a third fixed rates or a third floating, 30 fixed plus variable. I think we're pretty balanced overall.
Exactly. Okay, also the net premium amortization for security was a little bit higher this quarter versus Q1. I think Q1 was relatively low compared historically. Going forward, I would expect really the same level with on third quarter.
Yeah. Again, you saw a lot more refinancing this quarter with interest rates going down. That's just natural to expect, I think.
All right. That's helpful. I know last quarter, we talked about de-levering the bond book a little bit. It looks like the bond book continued to come down again in the second quarter. Do you see that continuing to trend down, or are we to the point where those balances should be roughly stable going forward?
There's probably an answer. There's two parts to that question. One, how much do your loans grow? Because that's where your money would come from your bond book. How much do your deposits grow? We're historically and seasonally low in this quarter and the third quarters. Historically, our deposits grow 2%-4%. They were less the last year or so. There's two things that are going on in that category. I would say that if you look at it historically, you probably should still see both grow a little bit, I would think. I think you should see some growth in loans, and you should still see the balance, the securities book grow also a little bit.
That's exact correct because we want to invest in loans if possible. The decrease in the investments is in line with the decrease on the other borrowing because our overnight rate is like 258 right now.
Right.
That's the reason we're running off a little bit our bond portfolio, and that's you see the decrease in the both line items.
I don't think it makes a lot of sense. We talked about this earlier, borrowing money at 2.5%.
Exactly. Correct. It helps our margin as well too.
Right
in that management of balance sheet.
All right. That's helpful. Then just finally for me on the buyback, you repurchased a little over 1% of the company. If I look at the price per share, the $64.50, it looks like you repurchased it kind of late in the quarter, maybe even after the LegacyTexas deal was announced. Maybe just thoughts on future buybacks going forward in the back half of the year.
Yeah, you're exactly right. After we announced the Legacy deal, our stock took a dive, and we felt that it was underpriced, and we jumped in really and bought the maximum that we could buy almost every day until the day that we couldn't buy because of our earnings announcement. We just felt that the price of the stock really should be more, and we jumped in, and if it happens again, we'll do the same again. We like it. We have a lot of capital, and if the stock ever becomes disproportionate to where it should be, we'll be back in again.
All right. Got it. Thanks, guys.
The next question comes from Jennifer Demba with SunTrust. Please go ahead.
Thank you. Two questions. First, how does the new rate environment expectations now impact your accretion assumptions for the LegacyTexas transaction? My second question is, what's your appetite for more M&A over the near term? Thanks.
I'll probably turn the first question, Jennifer, to Asylbek, because he's done some calculations on what net interest margins should look like and how they may affect it. I'll take the second question with regard to appetite of more mergers.
Yeah. Regarding accretion to Legacy, you're right. With the rates decreasing, probably we're not going to see much of a discount that we had in previous acquisition. That will definitely impact the accretion going forward. Again, if you're talking about the SOP of credited discount, as we've spoken, I think previously, that under CECL, that the discount on the credit becomes the allowance just starting January 1st. Going forward, we should not see any of those accretion income from the credit side of it. With the rate environment slowing down or going down, I think the discount will be less than we had previous acquisitions.
I think probably going a step further, I think Legacy on their own with rates going down would probably see a lower net interest margin. Again, we have such a great opportunity because they have a chunk of money that's more, I guess, purchased money from the Federal Home Loan Bank one. Number two, they probably have $800 million or so in what we call CDs.
Broker CDs.
Broker CDs. I think that we can replace that money with our core deposit. Our core deposits, our cost is what right now? Our total cost.
Cost of deposit is 62 basis points.
62 basis points where their overall is over 1%. Overall, the combination of our two banks together is real beneficial to both because it increases our net interest margin, but it also helps them dramatically. Then I'm going to move to the second part of the question about our appetite for more mergers and acquisitions. I don't want to scare anybody, but as I mentioned earlier, this is our first and foremost that we want to focus on, us and LegacyTexas together, and make sure that everybody feels comfortable and that we're going forward. As mentioned earlier, too, I think that Kevin feels this way the same that I do, we want to build a premier Texas bank. I think that we were looking at a couple of other transactions before we did the deal with LegacyTexas.
It just seemed Legacy was the right deal to do at this particular time. There's still more stuff out there, and I think that you will see us back in the market again.
Follow-up to the first question. When you announced Legacy, you said you thought 2020 earnings accretion would be a little over 10%. You still feel that's achievable with some offsets?
We do feel that it's going to be achievable, and it's only improving with the acquisition of the 800,000 shares that we bought already in stock. That helps our accretion as well, too, and that's why we like going out. If you remember, too, we wanted to really put about 25% cash down on the transaction. Legacy really only wanted us to give them about 10%. I think we settled somewhere in the 15% category of cash down. We do have excess money, and if we can buy in the market, the more we can buy in the market will only add to that accretion. I feel like the cost saves that we gave, they were real, but we always seem to do pretty good on that end, too.
Yeah, that I agree. 10% accretion, 10 plus accretion, assuming the full savings. In 2020, probably we're going to realize 50% savings, and 2021 will be 100% savings.
Oh, you're just saying by the time the integration happens.
Yeah, integration.
You're just making a point that we won't get 100% the first year.
Yeah, exactly. That's why I just want to clear that 10% accretion.
Just not the full amount.
not going to happen in 2020, but 2021.
Right.
Right.
Okay. Thank you.
Thank you.
The next question comes from Michael Rose with Raymond James. Please go ahead.
Hey, guys. Just looking at the Legacy side this quarter, looks like they had some negative migration this quarter. I guess what I'm asking is, looks like some of those loans are going to be resolved potentially by the time the deal closes. Could we expect the credit mark to actually come down?
I would say no, because the loans that you're seeing right now that have been reserved for or being charged off were loans that First of all, they might have identified them, but more so than that, we identified them also in our due diligence. Those were all identified in the due diligence, and those were marked appropriately. I guess you could say it like this, I guess the mark would come down overall if they're charged off. From our perspective, it really hasn't changed from what the original mark was. I guess I don't know if I'm being very clear, but if they are charged off, yeah, then your mark will be down because it's already been taken into consideration.
I think the thing to emphasize is in the overall, we haven't seen anything, and Legacy has not seen anything that would change the overall aggregate mark that we were talking about initially.
Right. I think that everything that we're seeing right now and that what we know that they have, I think they're aware of and we're aware of at the same time. There's nothing that was unexpected in this.
Understood. Maybe just one more question as it relates to them. They had a pretty nice bump in their mortgage warehouse this quarter. We've kind of seen that across the industry.
David, what's your view on that line of business? I know you guys haven't historically been in it, but would just love any thoughts on what you would expect to do with that business once the deal closes. Thanks.
Yes. I think as you get bigger, you take on different lines of business sometimes. I think that we've always been more conservative in nature. I think that Legacy is taking more risks than we have. I think going forward, warehouse mortgage lending, Kevin feels very comfortable with it, and so we're looking at it, and I think that when we went into this deal, it's part of something that we're going to keep. I can't tell you that we're going to expand it from a billion and a half to two and a half billion or something like that, but where it's at right now, we feel comfortable with it.
Okay. Thanks for taking my questions.
Again, if you have a question, please press star then one. The next question comes from Matt Olney with Stephens. Please go ahead.
Hey, great. Thanks. Good morning, guys.
Good morning.
Morning.
I want to circle back to the discussion around the margin. I believe you said the new loan yields are coming on around 5.5%. Can you just clarify, is that the average rate of the new and renewed loan yields in 2Q, and has that changed at all over the last few quarters?
The 550 that we mentioned, that's what the average we're putting on our books. If you look at past few quarters, I think Q1 was on average also 550. It has not changed significantly. With the expected rate change, we're not sure how it's going to impact. Right now, what we see in our books putting it at 550.
I would say this, Matt, too, that even when rates dropped extremely low, there was still kind of a base on what we were charging, especially on loans that we would fix rate for three and five years. I don't know that we really ever dropped below 5% on a fixed rate. Randy, you might have some comments about it.
We were probably in the mid-fours, 4.5% when rates were at their lowest.
At the lowest.
We've been above five for a while.
Yeah. I think who knows what rates are going to be. I don't want to forecast that, but as you say, I think that we're well positioned where we're at both because we have a certain amount of fixed rates and a certain amount of variable rates, too.
Right. On the liability side, deposit costs still look great, especially versus peers, I was surprised to see incremental pressure on the CD cost. I think they were up 16 basis points sequentially. Just trying to appreciate, is that incremental pressure in the metro markets that you guys serve, or is this new and more emerging pressure in the rural markets that you've avoided for the most part over the last few years?
That's probably because of me. I saw that our CDs when I started in banking or when the bank started, we probably had around a 30%-35% ratio of CDs, and if we look today, we just have really dropped to what, 10% or 12%?
12%, yeah.
12% of CDs, and we really felt like, okay, that's enough. Again, we're not leading the market. You didn't see us go out and offer 2.5 or 3% on a one-year CD, but we did offer 2% on a one-year, and that was to try to keep our existing customers and not to lose not that we're trying to go after the higher rate CDs, but we didn't want to lose more from where we were, and I guess it was maintaining where we're at, not going backwards more on the CDs.
Yeah.
Let me add to that a little bit, David.
Michael.
We're seeing it across the board in all markets. I will say in the major metropolitan markets, we're not seeing it from the very large banks. It's virtually all financial institutions other than the very large ones. We're seeing it in the smaller markets, we're seeing it in the larger markets both. It's just not coming from the Chases and the Bank of Americas and people like that.
No, I think that probably more regional and smaller banks more than anybody else, their loan-to-deposit ratios are just at a max of 100%, and they're doing whatever it takes to get money into the bank and paying very, very high rates.
That's correct. I will say for a while, we were seeing a fair amount of competition offering CD rates from one year going out, I guess, to as long as five years in the 2.5%-3% range. Every now and then, one a little over three. We're not seeing much at three anymore, two and a half is commonplace. I see it every day. It's still out there.
Overall, I think I'm making a statement like this, I don't know that I can base it on stuff except for Asylbek's comments as well, that we do see somewhat of the pressure on rates stabilizing and maybe coming down, I think. A few months ago, like you said, Tim, you would see ads in the paper for paid 3% plus, and you're not seeing that anymore, I don't think.
That's correct. For a while, I was probably getting 10 to 20 emails a day from banking centers having problems with customers wanting to move money to some of these very high rates. That's dropped down to maybe three or four or five a day. It's still there, but it's not as prevalent as it was. That's exactly correct.
Okay. Thank you, guys.
The next question comes from Jon Arfstrom with RBC Capital Markets. Please go ahead.
Thanks. Good morning, everyone.
Hey, Jon.
Good morning.
Question for maybe David or Tim, just on loan growth. You had a big picture, good overall loan growth quarter. Does this feel like a good pace of growth for you, or would you call out anything as unusual in terms of the increase that you saw?
As of this moment in time, I wouldn't say that there's anything unusual. From what we can tell, things are stable. I don't see any reason to expect any large swings, we all get surprised in the business world, so there are no guarantees. Everything is still healthy in our markets. If there's any softness, it's typically in the office occupancies in Houston and Dallas, for example. Those are stable in terms of where they've been. I think it's business as usual moving forward for a while.
I think overall, when you look at consumers and businesses, everything looks pretty healthy. I was going to qualify and say, when I looked at the first few days of the quarter, it looks like we were getting off to a slow start. When I looked last quarter, it started the same way. We actually were a slower start, and we really came through at the end. I don't see a whole lot of change.
The pipeline's still good.
The pipeline's still good.
The pipeline is still good. Sometimes there's a bit of seasonality in the summer when everybody's on vacation, it drops off. This past quarter was reasonably decent for us. We didn't see as much of a drop-off as we have in some years. As of this moment, there's no reason to think it's not going to be stable and hopefully improving going forward.
Okay, good. Thank you for that. Most of your loan categories look like they increased, but this is a small category in energy, but it looks like it was down a bit. I'm not necessarily asking about the growth there, but curious if you are seeing some opportunities and how you feel about the overall health of energy in general.
I don't know that we're seeing significant additional opportunities. There certainly are some. I guess our take on energy is one of caution. Energy lending can be fine, but it is what it is. It's cyclical, always has been. I'm sure it always will be. You just have to be careful, and not get overly enthusiastic when things look like they're improving a bit, because before you know it, they'll deteriorate a bit. We're still in the energy business. We're still making loans out there. I would anticipate that that portfolio would be stable for a while. I don't see it declining significantly, and I don't see it growing significantly either.
Okay, good. David or Asylbek, just in terms of the securities portfolio, you've talked about them a little bit, but the rate environment obviously changed a bit over the last quarter or two. I'm just curious if you're thinking about doing anything different with the portfolio, or is it just the same methodical approach that you always take?
I would say the same methodical approach. If anything, we're really reducing the bond portfolio and putting the money into bonds, really. I mean, into loans for the most part. With rates being lower the last month or so, there hasn't been any need to go out and try to borrow money at Federal Home Loan Bank or even pay higher rates for CDs or anything. I think we're just sticking with the same strategy.
I agree.
Okay. Thank you.
This concludes our question and answer session. I would like to turn the conference back over to Charlotte Rasche. Please go ahead.
Thank you, Jake. 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 for attending today's presentation. You may now disconnect.