Welcome to the Prosperity Bancshares 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 telephone keypad. To withdraw your question, please press star then two. Please note, this 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, welcome to Prosperity Bancshares' third quarter 2018 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, Chairman and Chief Executive Officer, H.E. Tim Timanus Jr., Vice Chairman, David Holloway, Chief Financial Officer, Eddie Safady, President, Merle Karnes, Chief Credit Officer, Bob Benter, Executive Vice President, 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 David Holloway, who will review some of our recent financial statistics, 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 provided by our call operator, Michelle. Before we begin, let me make the usual disclaimers. Certain of the matters discussed in this presentation may constitute forward-looking statements for purposes of the federal securities laws, as such, may involve known and unknown risks, uncertainties and other factors which may cause 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, 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. I would like to welcome and thank everyone listening to our third quarter 2018 conference call. We are pleased with this quarter's results. First of all, let me share the good news that Prosperity will be increasing its quarterly dividend to $0.41 a share from $0.36. This represents a 13.8% increase in our quarterly dividend. Prosperity shareholders have enjoyed a 13% compounded annual growth rate from 2003 to 2017. We showed impressive returns on third quarter average tangible common equity of 16.1% annualized and third quarter average assets of 1.46% annualized. Our net income was $82,523,000 for the three months ended September 30, 2018, compared with $67,908,000 for the same period in 2017, an increase of $14,615,000, or 21.5%.
The net income per diluted common share was $1.18 for the three months ended September 30, 2018, compared to $0.98 for the same period in 2017, an increase of 20.4%. Loans at September 30, 2018, were $10,293,000,000. Our linked quarter loans increased $146 million, or 1.4%, 5.8% on an annualized basis from the $10,147,000,000 at June 30, 2018. We continue to see strong loan demand and borrower enthusiasm. Our total loan approvals are running higher and more consistent than in the last several years. However, we are still experiencing large payoffs. Our lenders are optimistic and are committed to continue to grow our loan portfolio.
With regard to asset quality, our non-performing assets totaled $16.7 million, or eight basis points of quarterly average interest-earning assets at September 30, 2018, compared with $45.8 million or 24 basis points of quarterly average interest-earning assets at September 30, 2017. $31.5 million or 16 basis points of quarterly average interest-earning assets at June 30, 2018. Our asset quality continues to improve as the non-performing assets at September 30, 2018, reflected a 63.4% decrease compared with the level at September 30, 2017, last year. Prosperity's asset quality is one of the best in the nation. I always say you will like us in the good times, but you will love us in the bad times. With regard to deposits at September 30, 2018, were $16.7 billion, a decrease of $173 million or 1% compared with $16.9 billion at September 30, 2017.
Our linked quarter deposits decreased $244 million or 1.4% from $16.9 billion at June 30, 2018. The decrease in deposits was primarily due to seasonality. As previously mentioned, we have over 450 municipal customers, such as cities, schools, and counties, that use the tax dollars they receive in December and January throughout the year, resulting in declining account balances throughout the year. Our farming customers also have declining balances as their crops have been harvested or are being harvested but have not yet been paid for. We also have experienced business people using their cash that in the past several years were keeping them as reserves. During the last several years, as rates were low, certificates of deposits decreased. However, the good news is that our average non-interest-bearing deposits for the third quarter of 2018 increased 5.3% year-over-year.
With regard to acquisitions, as we mentioned in the past, we've indicated in prior quarters we continue to have conversations with other bankers regarding potential acquisition opportunities. We remain ready to enter into a deal when it is right for all parties, and it is appropriately accretive to our existing shareholders. With regard to the economy, the economic fundamentals are strong in the communities we serve. The low national unemployment rate, together with a GDP that is stronger than we have seen in years, has resulted in interest rate increases that may continue over the next year. The increased interest rates have affected the rates we pay on deposits, the rates we charge on loans, and the rates we earn on bonds. We believe that the economy has provided an opportunity for the Federal Reserve to normalize rates and be ready to respond to any future economic downturn.
We expect the increased rates to help our bank. For example, we have $9.5 billion in investment securities with a 3.6-year duration at September 30, 2018. That generates approximately $1.8 billion in cash flow annually. If those cash flows were reinvested at today's rates, we should generate a yield approximately 1% higher than the current yield. Texas and Oklahoma should continue to prosper with no or low state income tax, a business-friendly political climate, and a tailwind from the energy sector. Further, Texas has four out of the top 10 fastest-growing MSAs in the United States, those being Houston, Dallas, Austin, and San Antonio. Texas has also garnered the best state for business by CNBC this year. Overall, we continue to see positive customer sentiment. I would like to thank all of our customers, our associates, our directors, our shareholders for helping build such a successful bank.
Thank you again for your support of our company. Let me turn over our discussion to David Holloway, our Chief Financial Officer, to discuss some of the specific financial results we achieved. Dave?
Thank you, David. Net interest income before provision for credit losses for the three months ended September 30, 2018, was $157.3 million compared to $156.1 million for the three months ended September 30, 2017, an increase of $1.2 million or 0.8%. The Net interest margin on a tax-equivalent basis was 3.15% for the quarter ended September 30, 2018, compared to 3.22% for the same period in 2017 and 3.28% for the quarter ended June 30, 2018. On a core basis, which excludes the loan discount accretion and the higher than normal collection on a non-accrual loan for last quarter, the core margin this quarter was 3.09% versus 3.11% last quarter and 3.07% for the same period last year. Non-interest income was $30.6 million for the three months ended September 30, 2018, compared to $28.8 million for the same period in 2017, an increase of $1.8 million or 6.3%.
Non-interest expense for the three months ended September 30, 2018, was $81.8 million compared to $77.5 million for the same period in 2017, an increase of $4.3 million or 5.5%. This was primarily due to an increase in salary expense for all associates following the enactment of the Tax Cuts and Jobs Act. The efficiency ratio was 43.5% for the three months ended September 30, 2018, compared to 41.9% for the same period last year and 43.9% for the three months ended June 30, 2018. The bond portfolio metrics at 9/30/2018 show their weighted average life of 4.07 years, effective duration of 3.62, and projected annual cash flows of approximately $1.8 billion. With that, let me turn over the presentation to Tim Timanus for some detail on loans and asset quality. Tim?
Thank you, Dave. Our non-performing assets at quarter end September 30th, 2018, totaled $16,777,000, or 16 basis points of loans and other real estate, compared to $31,585,000, or 31 basis points at June 30th, 2018. This is a 47% decrease from June 30th, 2018. The September 30th, 2018 non-performing assets total was comprised of $15,778,000 in loans, $110,000 in repossessed assets, and $889,000 in other real estate. Of the $16,777,000 in non-performing assets, $3,846,000, or 23%, are energy credits, all of which are service company credits. Since September 30th, 2018, $2,867,000, or 17% of the non-performing assets, have been removed from the non-performing assets list or are under contract for sale. There could be no assurance that those under contract will close. Net charge-offs for the three months ended September 30th, 2018, were $1,318,000 compared to net charge-offs of $2,636,000 for the three months ended June 30th, 2018.
This is a decrease of 50%. $2,350,000 was added to the allowance for credit losses during the quarter ended September 30th, 2018, compared to $4 million for the quarter ended June 30th, 2018. The average monthly new loan production for the quarter ended September 30th, 2018, was $277 million compared to $297 million for the quarter ended June 30th, 2018. Loans outstanding at September 30th, 2018, were $10,293,000,000 million compared to $10,147,000,000 million at June 30th, 2018. The September 30th, 2018 loan total is made up of 39% fixed rate loans, 37% floating rate, and 24% variable rate. I will now turn it over to Charlotte Rasche.
Thank you, Tim. At this time, we are prepared to answer your questions. Michelle, 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 telephone keypad. 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 Dave Rochester of Deutsche Bank. Please go ahead.
Hey, good morning, guys.
Good morning.
Good morning.
On the NIM, I had just noticed that you guys may have moved some of your money market rates up a little bit on your website, maybe at quarter end. Were those moves applied to the entire portfolio? Just given that, how are you guys thinking about that NIM guide going into 4Q?
You want me to start, Dave?
Yeah.
This is David Zalman. It's true, we did raise interest rates. I think that really, I would say they really just became more normalized. When I read a lot of reviews this morning, I saw that net interest income became a big issue. If you remember last time, we had a higher net interest margin, and we said that we're probably looking anywhere between 316, 3.16 and 3.18. I think we came in at 3.15. Again, part of the reason for the downturn in the net interest margin was last quarter, there was a recovery from a bigger accretion recovery and also some interest recovery at the same time. We didn't hit it, but at the same time, interest rates just went up higher than they normally. I think competition just went up.
We went up on interest rates, but again, it doesn't change our perspective going forward. I would say this because I have a feeling that everybody's going to be asking the same question on net interest income. I'm just going to put it to bed right to start with is that we still feel very comfortable with net interest income and net interest margin going forward. I think that, again, we have a model, and our model shows with, especially with the amount of assets that we have, repricing over a period of time. Again, this is just an interest rate model, and models which the inputs you put into these models can change what the output is. Just be careful when I tell you some of this stuff. Going forward, we look at a 320 net interest margin in six months.
We look at 3.24% in 12 months. We look at 3.27% in 12 months, 3.40% at 3.48% in 24 months and 3.70% in 36 months. Again, that's with the 100 basis points move up in rates. Again, we're very excited where we're at. I know that people had the net interest margin at 3.20%, and we never kind of indicated that we would even be there, but I know that most analysts put us there. Going forward, we're very happy where we're at for this quarter. We hit our earnings per share, 5.8% loan growth. There are so many positive things. I just don't want it to get bogged down in this net interest margin, because going forward, that's a real plus for us where I think a lot of other banks, they've had their play. Most of their stuff is floating. Ours is yet to come.
I hope I didn't go into too much detail. Dave, you want to talk about it just a minute?
I'll just briefly say, from the money markets, it wasn't a specific account that we raised. We just normalized. From a liquidity position, as we came through the zero interest rate cycle, obviously, we didn't need that much liquidity. Now, as rates have come up, we just need to normalize our rates. We can't, from a competitive standpoint, just fall so far behind. That's all we did this past quarter, is normalize money market and CD rates.
I think if you look back before interest rates went so terribly low, banks like ours had anywhere from 20%-30% of their money in CDs. When rates went extremely low, we saw rates go to I think we have about 12% in CDs. What you will see, and what I've said in the past, you'll see that money will be moved out of certain money market accounts and be tied, and your CDs will grow more. That's just part of what happens in a rising rate environment.
That's a lot of good detail, guys. I appreciate it. I guess, your guide to 320 NIM over six months, that's obviously incorporating all the changes you guys have just made. I guess that incorporates not only the repricing up of the variable rate loans, but also sort of the roll-off of lower rate securities coming on at higher yields. I think you mentioned something close to like a 330-ish or maybe mid threes on the securities reinvestment rates right now. Is that right?
I think if you reinvest our rates today, yes, you'd probably see at least a full point above where we're at today, probably around three and a half. Yeah. Maybe a little bit more.
Okay, great. Just switching to expenses, how are you guys thinking about that $81 million-$82 million range going forward? You guys landed right in that range this quarter. Is it still good heading into the fourth quarter?
Yeah, I think so. I think, for the foreseeable future, that's the range we should be running in between 81 and 82.
Then you get that $2 million-$3 million benefit in one Q, I guess, from the surcharge rolling off.
I don't know. Do we believe it's rolling off in the first quarter?
At some point.
I would just say for us, again, we said $2 million-$3 million, that's the annualized. That wouldn't be in one quarter. If it takes effect, we'd get a quarter of that starting in the first quarter.
Yep. Great. Just one last one. I noticed you guys had some nice loan growth this quarter. CRE was pretty strong, I know we've just heard in the market some commentary that suggests that non-banks are very competitive in that space, not only on pricing, but structure. Can you just talk about what you're seeing there and why this growth is so strong and your outlook on that?
Sure. This is Tim Timanus. You're right. The competition is significant in pricing and structure both, that includes bank sources and non-bank sources. It just is what it is. I personally think we saw an increase in the competitiveness this quarter compared to the second quarter of the year. It ebbs and flows. Who knows what it'll be like by the end of this year. Your assessment is correct. It's been very competitive here lately.
Okay, great. Thanks, guys.
Agreed.
The next question comes from Geoffrey Elliott of Autonomous Research. Please go ahead.
Hi. Thanks very much for taking the question. I'm going to ask another NIM question, so apologies for that in advance. The yield on securities was pretty flat compared with 2Q, it was up a basis point. What held back the benefit from repricing? I guess it kind of feels like we get on these calls, we hear the message, the reinvestment of cash flows is at a much higher rate, but so far that hasn't translated into a significantly higher yield on securities this quarter. What kind of held it back this time?
Well, I'll jump in first, but just on a linked quarter basis, it's a dynamic of mathematics, right? The cash flows that we reinvest, I don't have the specifics as to how much cash we reinvested this quarter, but at best, $200 million-$300 million at the higher rate is just not going to move that overall yield on the portfolio. It's just mathematics. The point would be well taken to say, if we can reinvest at 100 basis points higher than what the overall portfolio yields, we certainly should begin to see some dramatic effect on it as we move out 6, 9, and 12 months.
Yeah, I don't think you have to be a mathematician or a scientist. Take $9.5 billion, reprice it at one point above it. You can do the math. Anybody can put a tax effect on it, you still have about $75 million more. It's not always that simple as it seems because you have moving parts and you have rates moving all the time. I guess you'd have to say, okay, on a static basis, what would happen if things stopped today? What would happen? To me, it doesn't take a math genius to figure that out.
You're looking at cash flow.
That's right.
If you could roll over 12 months and we're doing, let's just do $1.8 billion, but you got to average it out because it doesn't happen on day one, cut that in half and then average 100 basis points up. It'll begin to move that overall.
I think that it wouldn't work like that if tomorrow we said, okay, our money market accounts were too low, and we're going to raise them a 400 basis points or something like that. Staying in a relatively moderate market and you're moving up, things should happen that way. It is. I know everybody would like to see them move faster, myself included, this is just the way it is. Again, I think a lot of our net interest margin is always sometimes harder. I don't want to get real deep into it, but when you have this accretion income coming this way and that way, it'd be interesting just looking at it without any accretion, what did the net interest margin do one way or another? Having said that, I don't want to get extremely technical.
I think it still boils down to rate stop, take the $9.5 billion, reinvest it at a point or point better, a little bit more than a point, and you can do the math. It's pretty easy.
Then just one other quick detail. Non-interest income was a bit stronger this quarter, and in particular, the other non-interest income line. Were there any kind of one-offs or episodic impacts that boosted non-interest income, particularly the other component?
The answer is yes to that. We had some one-offs there. When you look at that overall number, there's probably eight to $900,000 of what we would call extraordinary one-offs in there.
Great. Thanks for taking the questions.
The next question comes from Brady Gailey of KBW. Please go ahead.
Good morning.
Morning.
Morning.
I know Prosperity has a buyback in place. You guys have not been active on that anytime recently. If you look at how the stock is trading, do you think it's to a level where a buyback might be more of a possibility for Prosperity?
This is David Zalman. I'll answer that. We have a buyback plan that's already been passed by the board of directors. I think that we're allowed to buy, Charlotte may jump in, we can buy up to 5% of our stock. At this point, we have not bought any of our stock back. As you mentioned, our stock looks pretty cheap in my opinion. When you're looking at the $60 range, you're not talking about on 2019 earnings a little over 12 times. It's something we will really consider. We're not committing one way or another, it's something that we really consider, and we're prepared that we're making a lot of money. We have a lot of capital, it's not out of the question.
Okay. Just a little more on M&A. I know your stock price being lower is not helping on that front. In the past, you've talked about it's really not a pricing issue for you guys. It's more of a what's for sale issue. I know you guys like to buy very old institutions that have good deposit bases, and there hadn't been many of those for sale recently. Is that still the dynamics on the M&A front for you guys, or has anything changed recently?
That's still the dynamics, those are the deals that we're working on right now, and it's like a fine wine. Sometimes it takes a little bit longer. We're focused on that, and I think that we're continuing on that path, and I think over some period of time you'll see us. Again, it's got to be the deal that we like. It's not something, you said it earlier, the type of banks that we really like to look at. It doesn't mean that it's the only type of bank that we'll look at, but it's banks that have been around for a longer time. Again, we really believe that the real value in any bank is in the deposit base, the core deposit base. That's really what we focus on, and that's the kind of banks we're talking to as we speak.
Got it. Thanks for the color, guys.
The next question comes from Jennifer Demba of SunTrust. Please go ahead.
David, I think that the last time you repurchased stock was when the price went down following the price of oil. If I recall right, the Prosperity price got into the low 60s or mid-60s. Do you have less interest in repurchasing stock right now for some reason than you may have back then?
No, my memory may be wrong, but I think the stocks, when the oil crisis and everybody thought we were bottoming off in the Gulf of Mexico, the stock went into the 30s.
Oh, you're right. I'm sorry, 30s. I got the number wrong. I apologize.
That's okay. Again, we weren't making the kind of money we're making right now. You're showing $4.98 to $5, I guess, for 2019. I think that the stock looks very attractive. Again, we keep building a lot of capital. We're making a lot of money. I've always said that I want to keep our capital more for growing the bank and making acquisitions. Again, when you start seeing the stock at this price, it's something that we need to consider.
Okay. Thank you.
You're welcome.
The next question comes from Peter Winter of Wedbush Securities. Please go ahead.
I guess sticking with the margin, if I look at the core margin quarter-over-quarter and I strip out that seven basis point benefit from the elevated interest recoveries, I guess I was a little bit surprised that even though it was still down, and I'm just wondering if you could talk about that a little bit, especially with having good loan growth.
I wish I would've won the lottery and didn't have to talk to Peter today. I guess I didn't, so I'm here. Dave, you want to answer?
That's just a reflection. When you look at it, we've kind of said this on lots of conference calls. It's the dynamic of our balance sheet and where we're at today. Let's kind of go back through it. For this quarter, why you see what you see is we did normalize our money market and CD rates a little bit. We need to be competitive. We can't just shrink the bank forever. We normalized those rates a little bit. When you raise rates like that, it takes just a little bit longer for our assets to reprice: our loans, our securities. One quarter to the next, you've heard us say this on prior calls, we can't see what all the variables are that are moving, but it might move our margin a few basis points.
It might be stable, it might go down a couple, it might go up a couple. In this case, it went down a couple. When you look at year-over-year, if you look at the core margin year-over-year, we went up a couple basis points. It should've been a little bit more, but again, as we stabilize our core pricing, I think we'll be okay. I just reiterate what David was saying. Let's instead of looking at the next quarter, let's look out 6 to 12 months, using the balance sheet we have today. Again, I don't know what that specific David quoted some numbers. I don't know what that specific percentage could ultimately be, but what it does tell us directionally is we should do better. Let's just use the mathematics on that. Why would we do better?
Well, it's simple. We've got $1.8 billion of cash flow coming from the bond portfolio at 229. It'll go back in at least 100 basis points better. On the loan side, that average life in our loan portfolio today is pretty short. I think we're running about $3 billion of cash flow there. You would be able to reinvest that at current rates, which if the prime, help me out here, it's five and a quarter is the rate.
Right
the rate. We could do a little bit better than that. You're reinvesting that. Remember, when we look at the model, it's a static model. It doesn't account for growth. It looks at where we're at on that day. The other piece of this is if we continue to do what we've done these last couple of quarters in terms of growing our loan portfolio, we're booking those dollars at higher rate, all that would support our model that says our margin should expand as we go forward. The wild card on this is your funding costs and how fast they go up. I think, again, we're core funded. I think if you looked over since rates have been going up, our betas on our deposit costs have been pretty reasonable compared to a bank that's wholesale funded.
David, you want to jump in with some color on that?
Peter, I think everything that Dave is saying is accurate, and I understand where you're coming from on this. At the bottom line, I think anybody could see that banks that were paying 10 and 20 basis points on their money market account and leaving them there forever, it wasn't going to work. Yes, I think not only our bank, probably all banks really had kind of a normalization of rates. When you have a big jump like that, I think if you would've been in times past when rates were moving up all the time, you were moving rates up probably when prime went up, you changed it every time. I think all banks got to a point where nobody was raising rates, so we didn't. Then we woke up one day, and everybody was real high.
I think you went to a normalization of rates. I think when you have a normalization of rates like that, everything is not going to reprice. Your liabilities go up immediately, but your assets don't. I don't know if I'm being very clear on that, That's just a point. As David said, you have to look at where we're going and where we're going to be, and our models show, again, they're just models, and things can change. Our models look very good, and we're very excited where they're at, and we should be making a whole lot more money. Again, I think if you're an investor for three months or six months, you're probably not as excited, but if you're a longer-term investor for a year or two, you got to be terribly excited where we're at from what we're looking at.
Okay. Thank you. I guess just on that, I guess interest-bearing deposits increased about 12 basis points this quarter. With the increase in the money market accounts towards the end of the quarter, how much do you think your interest-bearing deposits will go up in the fourth quarter?
I don't have that information. Do you?
Well, I'd say a couple things to that when you're looking at recall again, remember how our balance sheet works. We have all these public fund entities. I would guess when we get to the end of the quarter and you're looking at our period-end interest-bearing piece of the puzzle, that's going to go up just simply because the public funds come running in.
All funds coming in at year-end.
Yeah.
You just have a bigger increase in funds at year-end.
Peter, when you look at us, you just see this huge inflow coming in. To the question to where we need to be in terms of growing our deposits, let's just say overall, if we can kind of revert back to normal, we should be growing our overall deposit base when this is all said and done, and you adjust for all the seasonality 3%-4%. Don't misunderstand what I'm saying. I'm not saying we would grow that 3%-4% in the fourth quarter. That's an annualized number. You've got these two dynamics at work. We should grow 3%-4% annually, and in the fourth quarter of every year, we have this huge inflow of deposits coming in. It will make all those balances a lot higher when we get to the end.
I think you are. I think that deposits, and again, I don't know that I think we probably have a better core deposit base than anybody does, you had so many of these deposits that people just left in checking accounts, as they saw that they could go get 2% or 2.5% in other places, they started moving that money. You also had the dynamic that businesses weren't using their money. They were just using them as reserves in the bank. Now you have businesses buying capital equipment. They're using their money, and you have this dynamic of interest rates moving. Having said all of that, I still think that we're one of the better-positioned banks to contend with all of that.
Just finally, if I look at the fourth quarter, do you think the run rate for the reported margin would be back to that 3.16, 3.18 level?
He says he's not going to tell you anything anymore, that is history.
Are you comparing that to the 3.09 number? Is that what you're doing?
No, reported. The reported number, so it would be the
Yeah. Again
3.15
With the best crystal ball we have, is it possible we could be at 3.16, 3.17? Yeah. Is it possible we could be at 3.15? Yeah. Is it possible we're at 3.14? Yeah. I get where you're going, but the trend line would say we should do a little bit better, but I can't guarantee that because there's too many moving parts.
I wish we wouldn't have to look at quarter to quarter. I wish you could look at the dynamics of the bank and what our models say. Our models are showing that, again, these are just models, but in six months, we're looking at 3.20, in 12 months, 3.27, in 24 months, 3.48, and at 36 months, 3.70. You can do the math on that. I think these models, we've been running this model for 20 something or 30 something years, and we're pretty close. I don't see these changing really.
Okay. Thanks very much for taking the questions.
You're welcome.
The next question comes from Jon Arfstrom of RBC Capital Markets. Please go ahead.
Hey, good morning.
Morning.
Morning.
It's a question on loan growth. You've had pretty good numbers the last couple of quarters. I know there's some competition as well, but how do you feel about the current pace of growth? Give us an idea if you're doing anything different than maybe you were a year ago.
I think, Tim, you may want to jump in, or you want me to start off?
Well, you can start.
Okay. I'd say, Jon, the bottom line is the fundamentals when you look at the economy are extremely good. The last couple of weeks or so, I don't know what happened. Whether it's the geopolitical issue of one losing the House or not losing the House, or is it interest rates that may be bothering? There's a couple of deals out there. I don't know the answer to what's causing that deal, but when you look at the fundamentals, the fundamentals are still very good. They're still very strong. When I think we get out of this psychological aspect, what people think about interest rates or who's going to be leading the House or something like that, I think if things don't change, we should still see the good growth that's out there. I think this is a blip, and I think fundamentals are very good.
Having said that, we're always subjected to some large loan payoff, but we are working harder to make loans. We focused on our organic growth. Tim, you may want to jump in.
I think what you're saying is correct. The economic fundamentals from our perspective are still strong. The softness that we saw in loan production during this most recent quarter, I personally don't think has anything to do with a softness in the economies that we serve. Having said that, I agree with David. As we've gotten closer to these midterm elections, I think we've noticed a little bit of a decline in requests for new fundings. I think people are just nervous about what might happen with these elections. We'll know one way or the other in a couple of weeks on that, so it's not going to be an unknown for very long. As I mentioned earlier in the call, the biggest problem that created a little bit of a decline in our production is competition.
We looked at a lot of loans, and we approved a lot of loans. We continue to have competitors out there in the marketplace that from a pricing perspective and from a structure of the loan perspective are willing to do things that candidly, we just don't think are in the best interest of our shareholders. Below-prime pricing is prevalent, and that doesn't do anybody's margin any good. When you take extreme risk in the structure of a loan, long term, that doesn't seem to work very well for very many lenders. We're trying to keep an equilibrium and watch it week by week. I think the competition was clearly the biggest problem for the quarter. We'll see how that plays out going forward.
Yeah, I would say competition's always been tough. It will always be tough. As Tim says, it may be tougher now, in the long run, we've always had that in banking my whole career. Usually the people that are doing that kind of stuff, they usually don't last out there very long, or they want to join us or it's just a lot of times it's a secondary market that we're competing against, too. That never lasts in the long run. As long as we're consistent, we keep our head to the ground, we have our sleeves rolled up, and we continue doing what we're doing, it will be fine.
I think that's right. If you look at our discipline over many, many years, it has clearly paid off. That doesn't mean that we shouldn't look at credits on a credit-by-credit basis and try to be as flexible as we can, because we, in fact, do that. At the same time, we try not to do things that are just plain stupid. That's the way we've always run things, and I think it's paid off for us.
Okay. Good. That's helpful. Just back on the capital question, it's probably annoying to you, your capital keeps growing, and you're at a 10% TCE. It's probably the highest you've ever been. It's kind of a luxury, at what point does it just get too high, and it kind of forces your hand to do something like return the capital or really step on the gas on a buyback?
Well, Jon, you could never annoy me. You've been around too long, let me say that. Talking about the capital at 10%, believe it or not, before the last election, regulators were almost getting you to say that 10% is the norm where they wanted you to be. We don't think that's the issue right now, and we are building a lot of capital even after the increase. You saw us increase dividends, so that addresses part of it. I think you'll see us continue to increase dividends. I think our annual increase has been over 13% over the last number of years. I read those in my comments earlier. I think there's two things. We're going to make a deal. At some point in time, you can look at our history. We've had 42 acquisitions, and that's not going to change.
I can promise you we're going to use the money.
Okay. All right. Thank you.
All right.
The next question comes from Ebrahim Poonawala at Bank of America ML. Please go ahead.
Good morning, guys.
Hi.
Just a quick follow-up on deposits. We've had pretty significant seasonality, as you said, close to $900 million in deposit growth, fourth quarter of last year. Should we expect a similar magnitude of growth this year as well? Is the majority of that growth going to happen in interest-bearing deposits?
You want to start off?
No, go ahead.
I'll start off. Basically, no. The $900 million was above and beyond what we normally get in at year-end. I think we normally get in around $400 million-$500 million, and that's kind of what we're anticipating probably this year. I think a lot of it is interest-bearing, but again, I don't have the exact numbers because, again, you have so many dynamics happening. You have businessmen that start bringing money back in, getting ready for their quarterly federal income tax. You've got farmers and people like that that have sold their crops. You've got public funds where they're bringing in tax dollars. The majority of it is tax dollars a lot of times. You have so many dynamics happening. Dave, do you have a better answer than I do?
No, I think it'll be all the above. It'll be interest-bearing and non-interest-bearing.
Yeah. Probably lean more toward interest-bearing, I'm sure.
Again, if you were looking at last year, non-interest-bearing increased a couple hundred million-
Yeah
in the fourth quarter. It's going to be all the above.
I just don't know. Yeah. I guess the thing that we can answer is no, we're not expecting the $900 million at the end of this year.
Understood. That's helpful. Just going back to sort of deposit pricing, you mentioned, obviously, it's picking up. You're trying to defend your share. When you look at the loan-to-deposit ratio today at 62, it's up year-over-year. Is it your best guess that given that 2%-3% outlook that you've laid out for deposit growth over time, loan-to-deposit ratio should continue to trend higher?
I'll answer that first. It should trend higher, I guess, in this case, the mathematics may work against us. I'm going to do this off the top of my head, if we grew, let's say, deposits 3%, that's going to be somewhere in the $500 million range. If we grew loans at 5%, that's somewhere in the $500 million range. If you were growing the bank, they would both be going up, and I don't know you could gain on that loan-to-deposit ratio necessarily. The way you could gain is if somehow we could take the cash flow coming from the securities while growing a deposit and reinvest that somehow in the loans. It's mathematics. That's why I just caution you on that. We can't just jump to 70 if we're growing our deposits.
By the way, that's the best scenario of all of the above, grow your deposits and grow your loans.
Right. It seems like there are other banks who've allowed the loan-to-deposit ratio to trend higher without raising deposit rates, but doesn't sound like that's the case with you, where you do want to retain your customers. You are sort of adjusting pricing to bring in deposits as opposed to just letting this ratio move considerably higher relative to where it is today.
I would be cautious and say we're trying to keep our core customers. You can pick up the paper, and I don't even need to name the banks. Everybody can tell you their loan-to-deposit ratios are 100%, and so they're paying anywhere from 2.5%-3%. We're not doing that. At the same time, we don't want our core customers that we know some of our customers can get paid more somewhere else, but We don't want to be the highest, but we want to be fair to them. Let me just say that. We don't want to lose our core customers, and so you can't be paying 25 basis points on a money market account if somebody else is paying 80 or 90. There are some banks that are paying 200 or 225.
I guess the point that I'm trying to make, we're trying just to keep our good customers, our core customers that are somewhat cognizant of pricing, but again, not totally based with us just on pricing.
No, that's understood. Just, David Holloway, one last follow-up question on the tax rate. 21%, it seems like we are trending closer to 20% for the year. Is 21 still the right way to think about tax rate going into 2019?
Yeah. When we looked at it earlier in the year, all the changes, our best guess estimate was we should run around 21. Apparently, we've been able to take advantage of a few things in the new tax law. Got us to about 20.5%, I don't think I'd go down to 20. If somebody wanted to put in 20.5%, that's fine. That probably works for next year.
Got it. Thanks for taking my questions.
Again, if you have a question, please press star then one. The next question comes from Matt Olney of Stephens. Please go ahead.
Thanks, guys. Good morning.
Morning.
Morning.
Tim, you provided some really good commentary on loan competition that you guys are seeing. I think investors generally have a concern that newer loan yields that are being put on are pressuring the overall loan yields and really starting to impact the overall loan betas with higher rates. Any color you can give us as far as the newer loan yields? Tim, you gave us the new monthly loan production. Can you give us some yields that go along with that? Thanks.
Sure. Just across the board, as a comment about the average, what we're booking now on the low end is prime at this time, 5.25, and at the high end, six or just a little above. If you want to say the bulk of it is falling in the 5.5%-5.75% range, that would be pretty much accurate.
Got it. Okay.
Having said that, we've lost a lot of stuff because people priced it a lot less than that.
Well, there's plenty of pricing way below prime out there still, which just doesn't make any sense to us. Whatever works, I guess. That's still been out there, that's right.
Do you feel like some of the banks in your marketplace are taking advantage of the corporate tax cut earlier this year and starting to compete that away within loans and deposits so far this year?
Well, I think there's probably some of that. My personal opinion is they're building their banks to sell them. They're trying to put as many assets as they can on the books, and they're going to try to sell their institutions. I don't know that for a fact, but that's how we see these things play out historically. Doesn't mean there's anything wrong with it, or it doesn't mean there's necessarily anything good about it. Just is what it is. The tax rate, I think makes people feel better, and it frees up some funds, and does create some flexibility in the market from that standpoint. I wouldn't call that the primary driver.
I have to agree with you, Tim. That's a good analogy.
Okay. I guess separately, thinking about loan paydowns, I think in the past you've talked about loan paydowns can ebb and flow. Help us understand, was the third quarter a relatively higher or a lower quarter for loan paydowns versus the first half of the year?
It was lower. There's really not much way to predict that. Earlier this year, we had a few very large loans pay off because they were tied to essentially real estate projects, and the owners of those projects received some very good offers, and they decided to sell what they had. That can happen, doesn't tend to happen in a real poor economy, but in a decent economy, that's a good thing, and it happens. We did have a lower burn rate, if you want to call it that, on our loans. We didn't have as many payoffs. That could turn around and be different the last quarter of the year. A lot of times things, as we know, happen during the fourth quarter because people want to take profits, what have you, during this calendar year as opposed to pushing them into the next.
I really can't make a firm prediction, just kind of is what it is.
The last question from me, thinking about your overall deposit franchise, how do you guys think about it in terms of what portion of the deposit franchise is retail in nature versus more commercial in nature? Thanks.
I don't know that we have the exact number. Historically, it's been about 50/50. We've had about half of our deposit base has been retail, and the other 50% has been commercial.
Thank you guys.
This concludes our question and answer session. I would now like to turn the conference back over to Charlotte Rasche for any closing remarks.
Thank you, Michelle. Thank you, ladies and gentlemen, for taking 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. Thank you.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.