Prosperity Bancshares, Inc. (PB) Earnings Call Transcript & Summary

Good afternoon, everybody. I'm Ken Zerbe, the mid-cap banks' analyst at Morgan Stanley. I just want to welcome you to the 2020 Morgan Stanley Financials Conference. Before we begin, I do need to tell you that for important disclosures, please see Morgan Stanley research disclosure website, which I'm sure you will, at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales rep. So our -- the panel that we're doing today right now is with Prosperity. We have David Zalman, Senior Chairman of the Board and CEO; Eddie Safady, Vice Chairman, Area Chairman of Central Texas; and Kevin Hanigan, President. Very excited to have everyone with us today. And for everyone who's on the line, I do want to remind you that if you do have any questions for any of the management of Prosperity, please just fill out the question right in the Morgan Stanley conference portal, and I'll see it very shortly thereafter. All right. With that, let me take it over to David for some intro remarks, and then we're just going to go right into Q&A. So David?

Okay. Thank you, Ken, and thank you for having us. Let me just start off and give you some highlights from our first quarter, and then we'll -- let's move into the Q&A. But for the first quarter, our earnings per share were $1.39. It was about a 17.8% increase when you compare it to the first quarter of 2019. Our net income was $130 million. Our loans increased $281 million or 1.5% during the first quarter, was about 6% annualized. Our allowance for credit losses on loans and off-balance sheet credit exposure, we went from $87 million to $357 million. Our allowance for credit losses to total loans, excluding the warehouse purchase program loans, was 1.88%. We still had nonperforming assets still remain very low at 25 basis points. Our return on first quarter average assets were 1.67%. Our return on tangible common equity was 20%, and we also repurchased about 2 million shares during the first quarter of 2020. I think it priced around $52 a share. So with that, Ken, let me go ahead and turn it over to you, and we'll go into the Q&A.

Great. Perfect. I think a good place to start is just really talking about the Texas economy. Obviously, I'm up in the New York region, and I think we're sort of the epicenter of the pandemic for the last couple of months. How are things in Texas? How is the economy? How are the people? How are businesses?

Well, for Texas, again, like you said, it's probably we are living in really 2 different worlds right now. I think when I look at Texas, where all of our banks are opened back up right now, we have -- for the first quarter, we had -- you saw the loan growth. We saw loan growth in the first part of the second quarter right now. And at the last half of the second quarter, we see a downturn in core loans. When I say core loans because I'm not counting PPP loans, which we made $1.4 billion of those. And we have the warehouse mortgage. That's kind of running higher right now at about $2 billion, which there's a lot of mortgage business. But overall, I think things look pretty good. We have all of our locations open. We're operating. I know our highways when I try to get back on the freeway to get back on the road in Houston, I would say it's may not be exactly close to where it was when this all started, but people are really out there. They're really moving around. I think you can find different parts of the state doing differently. I know Eddie's here with me. And again, we were talking about it earlier in Austin. In Austin here, they're not quite back to where they were. I mean there's some industries like I think restaurants are open at about 50%. Depending on which restaurants you go to, some people put more than 50% into them. I think people are really taking care. I know when I got my hair cut a couple of weeks ago, I had to knock at the door and wear a mask and then the barber giving me the haircut, she had a mask on. So there's some things that are still slowing down. But people, for the most part, are still just is really active. I think Houston is probably more active and probably more of a cowboy than, say, Austin is. And Dallas, I think, there's -- I think Kevin can give us some input on that, but I think they're probably a little bit more reserved and refined than we are down here. Kevin, what do you see over in the Dallas market?

Maybe just in my neighborhood, David. Look, Dallas has been pretty active as well. My wife and I are probably personally not all that worried about this. So we've been going out to dinner since the first day restaurants opened up almost 3 weeks ago, I guess. A better part of 3 weeks ago, almost 4 weeks ago. And the initial reaction was a little slow. I can tell you the last couple of nights, restaurants have been packed. I'm quite certain that the restaurant we were in the last 2 nights, 2 different restaurants were well beyond their 50% capacity. Virtually every table was taken. So I see a lot of activity come back on the restaurant side. I think restaurants open up across the state to 75% capacity this Friday. So that will be a further improvement. Gyms are back open. Traffic is up. We had our system conversion, the Legacy-Prosperity conversion that occurred over the weekend. I think Charlotte and Bob Dowdell were driving up here. I talked to both of them about how traffic was from Houston to here. They said traffic was pretty heavy from what they saw. There was a lot of 18-wheelers moving, which I think is a good sign. Some people say maybe that we should be worried. There's been a slight tick up in a number of cases in Dallas County. But I think that's mostly attributed to more testing being done. If there's a worry about that slight uptick in cases, we certainly haven't seen it as it pertains to the restaurant I was in last night or the place I went to lunch today. So I think we're coming back pretty well.

Yes. All right. That's great to hear.

That's great to hear. Now David, you mentioned very briefly, you said you had a downturn or downtick in core loans. Could you just dive into that a little bit more? I assume that you were talking about second quarter specifically, correct?

Probably when you look at overall loans, you may still see an increase because of the PPP loans. I mean we made $1.4 billion of those. And so -- and the warehouse -- mortgage warehouse loans are up, too. So when you look overall there, you still may see an increase. What I call core loans are the loans that really aren't mortgage warehouse or I don't consider the PPP loans. So we started at the beginning of the year where we said that we're going to try to shoot for a 5% to -- 5% to 6% organic growth rate. Legacy, we said no because we're trying to get outsourced about $400 million or $500 million of their loans, but we thought we would try to shoot for 5% on our existing loans for Prosperity. And so we were doing really good, I think, in the first quarter, in the second quarter, but we've seen a downtick of several hundred million. And I think that probably a good portion of that is because of the -- we saw some energy credits that we got out of and that Legacy, we also saw some of the, what I call, structured commercial real estate loans that were non-personally guaranteed at Legacy. Those loans are really paying down, and we haven't been putting more of those loans back on, and those do pay off pretty fast. And again, I guess with COVID-19, I don't know that you want to finance a bunch of retail centers and stuff like that right now. So that's kind of died down. But overall, I would -- I think that I would say that I still feel good where we're at. I'm in loan committee, and we start off at 10:30 in the morning, we stay till 5 in the afternoon. So we're seeing a lot of action on the other hand. I guess some of the loans that drew up in the first quarter, people might have been drawing up because they were panicked and making sure they're going to get money. Now maybe they don't feel as panicked and paid back down. So we don't know everything. There's -- again, like I said, there's a lot of money in the banks, I mean [ $2 million ] extra in core deposits this quarter, probably $1 billion is related to the PPP. But -- so people aren't spending all the money. But I still feel pretty good. But I would say probably, if you had to ask me after what I've seen the second part of the second quarter, would I stick with the 5%, the 6% organic growth rate? I would say no, that we would probably have to go lower, maybe 2% to 3% organic growth -- organic loan growth, and that's on the Prosperity side. I don't think you'll see the growth on Legacy because we are getting in and out of some of their credits that we established that we want to.

Yes, Ken. On the oil and gas side, we had a loan that had a pretty good-sized mark on. It was about $21 million loan with a $7 million credit mark and about a $3 million fair value mark on. And believe it or not, it's an oil and gas producer. That was recently resolved at par, which is a really good sign. So that was one we were glad to see roll off the books. And as David said, on the flip side, I wouldn't say we are seeing outsized payoffs on the structured CRE portfolio. It's normal, but what we're not seeing is much in the way of new originations.

And I'd say also...

No. Sorry, go ahead.

I would say also, Ken, when we're looking at credit, too, and I don't know if this is going to be another question that you might have had, but you're probably interested in. I talked with Randy Hester, who's our Chief Lending Officer. And I asked, I said we're going with this Morgan Stanley virtual conference today. And I said, "Have you seen any upticks in people not paying the credit, we see deterioration in credit?" And he said no, that we're not, that -- again, I said, "Was that because we're extending everybody?" jokingly. And again, we did extend, I think, at the end of the first quarter, 7% of our loans. And I think it's ticked up a little bit to around 8% through the second quarter. But most parties said no. In fact, he said that we had a motel loan that we're actually working in Oklahoma on the sale. And I think that -- I don't know that it'll be off by the end of the second quarter, but it's going. We had another big credit in the Permian Basin, again, very strong guarantor that started off at $30 million. He's paid it down to $15 million, and he did -- came the other day and asked that we would release certain collateral he paid it down to $6 million. So we're even actually working through some. May not -- it may not happen by the second quarter, but in the third quarter, we're trying to see unless something else pops up. But overall, we feel pretty good where the credit is.

Okay. Great. And I'm sure credit will come up a little later in our conversation. But just really quickly back on the loan side, you said core loan is down several hundred million dollars. It sounded like both the energy and the structured credit -- sorry, structured CRE loans were due to LegacyTexas. Was that part of the original $400 million to $500-ish million of loans that you expected to run off? Or is that in addition to those loans?

I think...

So the energy loan was up on the expected to run-off basis, and there was about $50 million of the remainder, which is in CRE, which was on the run-off list, Ken. So about $75 million of what amounts to, David, I saw a number this morning, maybe I'm wrong on this, about $240 million of runoff off of the Legacy portfolio for the quarter. So $75 million of it was on the list, Ken, and the other was just normal payoffs.

Yes. Got it. Okay, perfect.

I would say that probably had some -- some of that was due to us, too, where we had people drawn up and pay down too. So -- but that -- I think he's probably hit the nail on the head, Kevin has. It sounds like he had better information than I did this morning.

Can you guys talk just a little bit about the mortgage warehouse business? I'm just kind of curious how that's trending, just given the pandemic and interest rates.

Yes, it's been really strong in the quarter. We predicted it to be strong in the quarter, at least for the first 75 days of the quarter and then I thought it might trail off a little, Ken, as the purchase volumes slowed down just because of the pandemic. That's a nationwide business for us. And there will be a temporary slowdown in the purchase volume. But it's running pretty strong. It's been running at about -- I think we closed out last night. There's $2 billion in there. It's averaged a little less than that. Volume's been really high. Turnover of the, just based on day, how long things stay in our line is down from what was 17 days to closer to 12. So what's on there is turning really fast. There's been some dislocations in the market as some folks have maybe realized they have too much of this and might be exiting part of the business or trying to shrink their portfolios. We've taken that opportunity, and we've added 2 really nice clients that just started bringing their volume on, both large. They would beat our 2 largest clients. Both really strong. I mean they came through loan committee, and they would be the 2 strongest credits in the portfolio. One of them was a friend of David's that he's known for a period of time. And we weeded out a couple of our smaller clients or lower-quality clients or clients who were less willing to pay us the spread we were looking for to make room for those clients. So we didn't -- we're trying to hold the business, hold the line on the business being at about, its peak, about a $2 billion business, $2 billion, maybe $2.1 billion. We're pretty firm on that. So we've taken this dislocation as an opportunity to improve the customer base within the portfolio. And the friend of David's is really a good one.

Yes, I believe.

Okay. Sure. I guess switching gears. So you mentioned that the operational integration with Legacy happened over this last weekend. How did that process go? Anything surprising come out of it?

I'll start off.

I think that may -- yes, go ahead, David.

Okay. I'll start off the -- generally, you're always worried about an operational integration. This was the weekend that we actually converted our core operating systems together. And you're generally always worried about did the people get their -- excuse me, their debit cards? Were they able to log on online? Were they able to transfer money from one to another? You're always worried about the commercial center, the cash management group because most of those customers have to be handled with white gloves. It's just really taking care of. And by 11:00 on Monday morning or 10:30, I called, over 50% of the people had already activated their debit cards. There was already about 3,000 or 4,000 people that had made transfers within their accounts, one to another. So they were really -- things really look good. I think that all of our -- I think if there were any issues or issues still today we have where people -- they were calling -- supposed to be able to call the banking center, and then the banking center didn't answer. It was complicated. The long and the short of it is that we have problems with the banking centers and getting phone calls, and that was a little bit. But for the most part, I think we've done really a great job. I mean when we look at social media, we see about 40 to 60 people that weren't happy because they couldn't get through, had longer wait times. On the other hand, you had some people saying, too, that stick with it. They've been through this before. You'll really love it later. But the ones -- we try to contact everybody. And then generally, even I had probably 3 calls -- 3 e-mails over the last few days. And they're really angry when they call. You don't know what you're doing, what did you all do and so forth and so on. And usually, I'll get them some help in about 10 minutes, and they're my best friends after that. So it can really take an opportunity to make a customer happy and getting to know you, too, at the same time. But I think we're good. I think it's gone really well. Kevin, you want to jump in?

Yes. I mean in the overall scheme of things, given the size of what we did, the problems we have are really relatively minor. The phone system, which was just -- if your line didn't get picked up when you called the banking center because they were busy, it was supposed to transfer over to our call center, and it wasn't. So some people got lost in that shuffle. And if they got to the call center, the wait times were extended as people were confused about how to activate debit cards or how to get a new PIN number. That's what most of the calls were. And Dave and I both talked to clients yesterday, and they said, "Well, we didn't know this was coming." That just shows -- you can't tell them we've sent you 6 e-mails and 6 mailings, and you just didn't see them. That doesn't get you anywhere. You just fix their problem and move on. So it's -- to have 44 people who were mad at us after the first half of conversion is a really low number when you consider the number of households that we converted.

Yes.

So how are you guys thinking about expense saves from here? I mean now that, that's done. Obviously, I was a little bit worried that the pandemic could have pushed that out a little bit, but it doesn't. Seems like everything was on track. Are you guys still comfortable with, I think it's like roughly $115 million of core expenses or total expenses in fourth quarter?

Yes, Ken, $115 million, $116 million, we're still comfortable with it. We had a lot of folks who are scheduled to depart after the conversion on Sunday. And when I tested my debit card at about 3:00 and it worked. And I went on online banking and that worked. And I paid some bills and that worked. I called the guy who was letting those folks go and said it's a go. Go ahead and finish out the conversations, and let's arrange their severance. We'll keep a few people through the end of this week and a couple through the end of the month just to sort out some of these last couple of minor issues. But a big part of the expense saves will be done by the end of the month.

Got it. And how much flexibility -- sorry, please go ahead.

Just want to add a little bit more to that. Most of the savings that we were indicating, that comes from the conversion part of it, which we successfully completed the conversion this weekend. So we should get some savings. Most of the savings in the third quarter, but there's some outstanding items. For example, we want to sublease one of the location, which would give us $2 million savings annually. That's a little bit postponed due to COVID-19. So -- but eventually, we're going to definitely get out all the savings we'd announced, but majority will be in the third quarter.

And the real savings comes from this operation of the core because that's about $2 million a month really that once we get off of it, we'll be -- that's a lot of savings.

Exactly. So we're comfortable that the $115 million, $116 million would be our normal run rate once all the savings comes in.

Right.

All right. Perfect. And then, I guess, just along the same lines with expense -- or with the expenses, when we think about, say, 2021 because obviously, if I take the $115 million roughly, annualize it, you're at $460 million. Like how are you thinking about? Is there any room for additional expense savings beyond the fourth quarter? I think you mentioned the one thing. I forgot, there's something about the $2 million I just heard, but I was wondering if there's any opportunities there.

We always look for opportunities. I would say every time, we don't -- we've not just settled onetime savings. We evaluate all the processes and procedures we have. So we'll definitely look for it, but I don't think there'll be anything dramatic savings on top of what we already announced. But we definitely will be looking for opportunity to do more savings as we go on and improve on our processes and consolidating some of those systems smaller.

Yes. I've always noticed that we always seem to do better than what we think we are. So hopefully, that will be the case here, too.

Fair enough. In terms of deposit growth, David, I think you said you had $2 billion of deposits coming in, $1 billion from the PPP. Obviously, those tend to be fairly large numbers, I guess given your core deposit base. Like what are you doing with those deposits right now? Like how are they being allocated or invested?

Believe it or not, if you look at our balance sheet today, we don't have any Federal Home Loan Bank borrowings. We've paid off everything. So we've taken the excess funds and just paid off the Federal Home Loan Bank borrowings. And I mean, I can make a long story, but that's just what we did, basically. And it's been great. I mean we've been able to take core money and pay everything. Our balance sheet is bigger, but you still, again, don't have the Federal Home Loan Bank borrowings.

If you look at the first quarter balance sheet, we've had $1.3 billion on borrowings. As of right now, we have 0.

Right. And again, I don't know how long the money is going to stay, but it looks like -- it's amazing how that much money can come in at one time. And you would have thought that PPP -- we figured part of that or half of it to the PPP money. You would think that they would have spent the majority of that by now, but again, they look like they're saving. And it looks like people aren't, I guess, not going out. They're not spending money either or else they're scared and brought money back into the bank. So it's interesting to see.

So is it fair to assume that if you're using presumably very low-cost deposits, and I'm not sure what you were paying on the FHLB funding, but is the $2 billion broadly of sort of the excess $1 billion ex the PPP, is that actually NIM dilutive or NIM accretive to you? How should we think about the impact on NII and NIM from those excess deposits?

So our funding was -- I think it's going to be neutral because the borrowing was at 50 to 60 basis points and our deposit base is a little bit lower. So it will help us a little bit, but nothing significant. So the guidance we provided initially of the first quarter, I think, is still stays as we speak, including the PPP program.

I thought you mentioned that the -- with the PPP loans, that would bring our margin down maybe just a little bit. Is that right?

Yes, it will. But when we provided the guidance, we've had that in mind. So from the margin perspective, we're still aiming -- core margin aiming around low 3.30s to mid-3.30s for the core. And with including all in fair value, we said 3.45%, 3.55%, assuming $13 million to $15 million fair value income in the second quarter.

Well, I know the deposits we're getting in are really core deposits. I mean it's like noninterest-bearing checking accounts or checking accounts that pay 10 basis points and some money market because we haven't built CDs in the last 10 years. So it's going back. So I mean, it's really all good core money, really.

That's great. I guess maybe switching gears again to acquisitions. Obviously, something probably near and dear to your heart, as you've done quite a few acquisitions over time. At this point, obviously, you're a bigger bank now than you were. I think when I first started covering you, you had a -- it feels like it was just a few billion dollars of assets in total. Now it's -- you're definitely over $30 billion. At this point, like what are you looking for? Like, I mean, I know I'm sure COVID is -- and the pandemics kind of put a damper on bank M&A in total. But how do you think about M&A longer or from this point forward?

I think exactly what you're saying. I mean I -- we built the bank. I mean I got here in 1986, and the bank was $40 million in size with about 10 people. So we built the bank in good times and bad times. I mean we -- it looks like sometimes we do better in the harder times than we do the good times. But I think that from the beginning and the earlier years when the bank was smaller, we were able to grow the bank on loans, 8% to 10% organically and the rest came through M&A, which gave us a really good double-digit number of growth. On the deposit side, we were growing deposits. Sometimes when it was smaller, 6% to 8%. Now we're back down to 3% or 4% organic deposit growth. Our -- and so it's harder to grow. But I think you'll still see organic growth, but I think you'll still see -- the deal with Legacy has just been fantastic. Kevin's on the other end, he can comment. But really, it was a surprise, I guess. You could -- I wouldn't say a surprise, but we've done a number of these things. And I guess one we did before kind of turned me cold to ever doing a deal again. This has been -- Kevin and his team have been so great and the additional help they've given us and the management that they bring to the table and some of the new products that -- we took on a little bit more risk with the Legacy deal. On the other hand, they cut a lot of risk that they had. It probably met both of our goals that we have. And with the management team that we have and getting this out of the way, this operational integration, when we were working with Kevin, I was working on another deal at the same time, about the same size. And I always said, you've got to do this, we're going to go one way or another. And I don't know that the other team ever believed me, but -- so there are several of those deals that are still out there that they're probably not active right now and may not even be active until maybe the fourth quarter. Most people, that's not on their mind. Generally on an M&A in this kind of time, we get something that we never anticipated. It's something that comes to us that hasn't happened yet, but that's why we usually grow at a time like this. But I think you'll still see us growing in the future, using the same thing, an organic growth approach and M&A at the same time. But again, I would always tell you that our -- this has been a little bit different, and it's been helpful because they had the loans. We didn't have as many. We took a little bit more risk with the mortgage warehouse. We took a little bit more risk with the structured CRE. On the other hand, we still bring everything down to core deposits. And I've always said the core deposits are the mother's milk of the bank. As long as you have that, you can do just about anything. And so I think our bank is extremely strong when you look at it. We went into this downturn with really strong asset quality, strong capital, and we had strong liquidity. Overall, strong operating fundamentals. And so I think that we will benefit through this time. And it wouldn't surprise me if something did happen. I'd tell you now, I don't have anything on the table right now. But when some -- in these kind of times, something can just always happen, sometimes overnight, you just never know it. But we'll still be back in the game, and I think that we're in a good position to do all of that.

That's good to hear. All right. With that, looks like we've come to the end of our time. David, Eddie, Kevin, I want to thank you very much for participating in the Morgan Stanley Financials Conference. I thought this was very -- you were very, very helpful. For everyone on the line, thank you for participating. Have a good day. Thanks.

Thank you.

Thank you.