Prosperity Bancshares - Q1 2024
April 24, 2024
Transcript
Operator (participant)
Hello, and welcome to the Prosperity Bancshares, Inc. First Quarter 2024 Earnings Conference Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on your telephone keypad, and to withdraw from the question queue, please press star, then two. As a reminder, this conference is being recorded. I would now like to hand the call to Charlotte Rasche. Please go ahead.
Charlotte Rasche (EVP and General Counsel)
Thank you. Good morning, ladies and gentlemen, and welcome to Prosperity Bancshares' First Quarter 2024 Earnings Conference Call. This call is being broadcast live on our website and will be available for replay 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, Senior Chairman and Chief Executive Officer, H.E. Tim Timanus, Jr., Chairman, Asylbek Osmonov, Chief Financial Officer, Eddie Safady, Vice Chairman, Kevin Hanigan, President and Chief Operating Officer, Randy Hester, Chief Lending Officer, Mays Davenport, Director of Corporate Strategy, and Bob Dowdell, Executive Vice President. David 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. 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 or performance of Prosperity Bancshares to be materially different from future results or performance expressed or implied by such forward-looking statements. Additional information concerning factors that could cause actual results to be materially different than those in the forward-looking statements can be found in Prosperity Bancshares' filings with the Securities and Exchange Commission, including Forms 10-Q and 10-K and other reports and statements we have filed with the SEC. All forward-looking statements are expressly qualified in their entirety by these cautionary statements.
Now let me turn the call over to David Zalman.
David Zalman (Senior Chairman and CEO)
Thank you, Charlotte. I'd like to welcome and thank everyone listening to our first quarter 2024 conference call. We are excited to announce that on April 1st, 2024, we completed the merger of Lone Star State Bancshares Inc. and Lone Star Bank, headquartered in Lubbock, Texas. The operational integration is scheduled for late October 2024, when Lone Star customers will have full access to our 288 full service locations. We welcome the Lone Star customers and associates to Prosperity and will work hard to win your trust. Prosperity continues to focus on long-term relationships and our customer success while maintaining strong asset quality and earnings and a fair return to shareholders.
Prosperity maintained a high tangible equity to tangible asset ratio of 10.33% for the first quarter of 2024, while sharing earnings with our shareholders. Prosperity repurchased 567,692 shares of common stock during the first quarter of 2024, in addition to the quarterly dividend. In 2023, Prosperity's total capital return to shareholders from dividends and share repurchases was $278 million. For the 3 months ended March 31st, 2024, the net income was $110 million, or $1.18 per diluted common share, compared with $95 million or $1.02 per diluted common share for the 3 months ended December 31st, 2023. The change was primarily due to higher interest income and lower FDIC assessments.
For the 3 months ended March 31st, 2024, the annualized return on average assets was 1.13%, and the annualized return on average tangible equity was 12.06%, and the efficiency ratio was 49%. The loans were $21.265 billion at March 31st, 2024, an increase of $84 million, or 40 basis points, to 1.6% annualized from the $21.181 billion at December 31st, 2023. The loans increased $1.931 billion, or 10%, compared with the $19.334 billion at March 31, 2023. The loans, excluding warehouse purchase program loans-...
Loans acquired in the merger of First Bank Shares increased $115 million, or 60 basis points, or 2.4% annualized during the first quarter of 2024. Our deposits appear to have stabilized, and core deposits have increased modestly. Deposits were $27.176 billion at March 31st 2024, a decrease of $4.3 million from the $27.180 billion at December 31st, 2023. Deposits increased $171 million, or 60 basis points, compared with the $27.004 billion at March 31st, 2023. Deposits, excluding public fund deposits, increased $109 million during the first quarter, with no broker deposits purchased.
The net interest margin on a tax equivalent basis was 2.79% for the three months ending March 31st, 2024, compared with 2.75% for the 3 months ended December 31, 2023. Based on our models, we believe our net interest margin should continue to improve to a more normalized level as our bond portfolio and loan portfolio reprice. Our average net interest margin from 2012-2022 was 3.37%, compared with our net interest margin of 2.79% for the first quarter of 2024.
Our non-performing assets total $83 million, or 24 basis points of quarterly average interest earning assets at March 31st, 2024, compared with $72 million, or 21 basis points of quarterly average earning assets at December 31st, 2023. Our non-performing assets are higher than our historical levels, primarily due to acquired loans. We expect to reduce our non-performing assets ratio to a more normal level within a year. The $2.4 trillion Texas economy is now the 8th largest economy in the world, larger than Russia, Canada, Italy, and others. Texas is the top state for Fortune 500 headquartered companies, currently at 55, and was named the 2023 State of the Year for Best in Nation Business Climate and Job Growth.
Texas added 369,600 non-farm jobs in 2023, the most in the nation. We believe the Texas and Oklahoma economies should outperform most other states. As previously mentioned, the merger of Lone Star State Bancshares was completed on April 1st, 2024, and the operational integration is scheduled for late October 2024. We're excited to have the Lone Star associates on the Prosperity team. We continue to have active conversation with other bankers regarding potential acquisition opportunities and hope to continue to grow through thoughtful mergers and acquisitions. Overall, I want to thank all our associates for helping create the success we have had. We have a strong team and a deep bench at Prosperity, and we'll continue to work hard to help our customers and our associates succeed and to increase shareholder value.
Thank you 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 that we achieved. Asylbek?
Asylbek Osmonov (CFO)
Thank you, Mr. Zalman. Good morning, everyone. Net interest income before provision for credit losses for the three months ended March 31st, 2024, was $238.2 million, compared to $237 million for the quarter ended December 31st, 2023, and $243.5 million for the same period in 2023. The net interest margin on a tax equivalent basis was 2.79% for the three months ended March 31st, 2024, compared to 2.75% for the quarter ended December 31st, 2023, and 2.93% for the same period in 2023.
Excluding portfolio accounting adjustments, the net interest margin for the three months ended March 31s, 2024, was 2.76%, compared to 2.71% for the quarter ended December 31st, 2023, and 2.91% for the same period in 2023. The first quarter increase in net interest margin was primarily due to repricing to higher yielding earning assets. Non-interest income was $38.9 million for the three months ended March 31st, 2024, compared to $36.6 million for the quarter ended December 31st, 2023, and $38.3 million for the same period in 2023.
Non-interest expense for the three months ended March 31st, 2024, was $135.8 million, compared to $152.2 million for the quarter ended December 31st, 2023, and $123 million for the same period in 2023. Beginning the second quarter of 2024, we expect the run rate for non-interest expense to be in the range of $141 million-$143 million. The expected increase is based on the acquisition of Lone Star State Bank on April 1st, 2024, and Prosperity Bank's annual merit increase in the second quarter 2024.
Additionally, during the second quarter 2024, we expect one-time merger-related cost of $6 million-$8 million and additional FDIC special assessments of approximately $3 million-$5 million. Further, second quarter results will include purchase accounting provision expense related to the Lone Star acquisition. The efficiency ratio was 49.1% for the three months ended March 31st, 2024, compared to 55.6% for the quarter ended December 31st, 2023, and 43.7% for the same period in 2023. The bond portfolio metrics at 3/31/2024 have modified duration of 4.1 and projected annual cash flows of approximately $2.1 billion. And with that, let me turn over the presentation to Tim Timanus for some details on loans and asset quality. Mr. Timanus?
Tim Timanus (Chairman)
Thank you, Asylbek. Our non-performing assets at quarter end, March 31st, 2024, totaled $83,811,000, which is 39 basis points of loans and other real estate. This is compared to $72,667,000, or 34 basis points at December 31st, 2023. This represents a 15.34% increase. Since March 31st, 2024, $7,425,000 of non-performing assets have been removed or put under contract for sale. The March 31st, 2024, non-performing asset total was comprised of $81,510,000 in loans, $97,000 in repossessed assets, and $2,204,000 in other real estate.
Net charge-offs for the three months ended March 31st, 2024, were $2,143,000, compared to net charge-offs of $19,133,000 for the quarter ended December 31st, 2023. This is a $16,990,000 decrease on a linked quarter basis. There was no addition to the allowance for credit losses during the quarter ended March 31st, 2024. Also, there was no addition to the allowance during the quarter ended December 31st, 2023. No dollars were taken into income from the allowance during the quarters ended March 31st, 2024, and December 31st, 2023.
The average monthly new loan production for the quarter ended March 31st 2024, was $308 million, compared to $300 million for the quarter ended December 31st, 2023. Loans outstanding at March 31st 2024, were approximately $21.265 billion, compared to $21.181 billion at December 31st, 2023. The March 31st 2024, loan total is made up of 41% fixed rate loans, 28% floating rate loans, and 31% variable rate loans. I will now turn it over to Charlotte Rasche.
Charlotte Rasche (EVP and General Counsel)
Thank you, Tim. At this time, we are prepared to answer your questions. Our call operator will assist us with questions.
Operator (participant)
Thank you very much. To ask a question, you may press star, then one on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. Today's first question comes from Peter Winter with D.A. Davidson. Please go ahead.
Peter Winter (Managing Director and Senior Research Analyst)
Good morning.
Tim Timanus (Chairman)
Good morning.
Peter Winter (Managing Director and Senior Research Analyst)
First, I just want to congratulate you guys on closing Lone Star. I can't imagine the level of frustration, just given how long it took to close. But I was just wondering, given that experience, are you still interested in bank M&A or kind of on pause for a little while?
David Zalman (Senior Chairman and CEO)
Well, it's a good question. We have to ask ourselves that all the time. As you know, it was very difficult closing the Lone Star transaction. First, it was held up by the DOJ, took quite a while. We spent a lot of money trying to get it out of there, and then we had a time getting it from the FDIC approved until now. But we, you know, we thought about it a lot. I don't it was hard. I think things have changed in Washington. There's no question about it. It is hard to get deals done. You probably really have to think about the deals you want to do. But the answer to the question is yes, we're still, we're still.
We're still into the M&A world, and we'll probably still do more. It's just, I think that it'll be more, it'll be really thoughtful before we, you know, determine the transactions that we want to do. You know, I don't know that people can just do all the transactions that they used to do. I don't know that the climate is even right for that right now. But, the answer is still yes, we are interested in M&A.
Peter Winter (Managing Director and Senior Research Analyst)
Got it. And then just separately, it's nice to see the increase in net interest income sequentially. I'm just wondering, can you talk about what the impact with Lone Star is in the second quarter to net interest income and just kind of your outlook in the second half of the year?
Asylbek Osmonov (CFO)
Yeah, Peter, we looked at our, you know, impact of Lone Star on our book, and from there, I'll talk about a little bit margin. When we run our models, it's accretive to the margin and net interest income. So the, I think it's gonna be a few basis points on margin. So, but considering, Lone Star will be positive in the long term as the assets reprice ours and theirs.
David Zalman (Senior Chairman and CEO)
I would also say, Peter, that the net interest margin did show the improvement. It probably would've showed more improvement this quarter, but the regulators are requiring most banks to keep more liquidity on their books. In the past, you know, we always had a line of credit because we borrowed in front of what our runoff of our $2 billion in bonds that rolled off every year. We also just organic growth of 2%-4% of deposits gave us almost another $1 billion. So we would always borrow in advance, not leave a lot of money on the sidelines. In today's world, the regulatory agencies really are pushing to keep more liquidity on hand.
And again, if we wouldn't have had to do that and build that up, we would've paid our loan down and our borrowings down, and our margin would've been somewhat higher.
Peter Winter (Managing Director and Senior Research Analyst)
Just if I could follow up. Just what is the outlook then going forward on the margin? You, you've given us some guidance in the first quarter. I'm just wondering what the outlook is.
David Zalman (Senior Chairman and CEO)
I think that we're on. We're right there. I mean, I think that everything that we had said, we're still on course to do what we said we would do.
Asylbek Osmonov (CFO)
I agree, and with the addition of Lone Star, I think the projection is, so we increased our NIM projection a little few points higher than we're projecting. So that's been, NIM accretive.
David Zalman (Senior Chairman and CEO)
I'll just be glad to get back to where we were much more.
Asylbek Osmonov (CFO)
So I think the guidance we provided, 24 months, 3.30, 3.40, I think we can maybe estimate about 3.40-3.50 in 24 months.
David Zalman (Senior Chairman and CEO)
But just looking in the short term, though, I think that we're, it, the goals we had given to you guys in six months being somewhere around 3% and a little bit better than that at year-end. So I think everything that we've said.
Asylbek Osmonov (CFO)
Mm-hmm.
David Zalman (Senior Chairman and CEO)
It seems to be going in the direction that we gave guidance for in the previous earnings announcement. So I think the model, again, something can always change, but I think that we're on course.
Peter Winter (Managing Director and Senior Research Analyst)
Thanks, David.
Operator (participant)
Thank you. The next question comes from Michael Rose with Raymond James. Please go ahead.
Michael Rose (Managing Director and Equity Research)
Hey, good morning, guys. Thanks for taking my questions. Just a few on Lone Star, maybe for Asylbek. I think you guys had talked about kind of a day two provision addition. I know this is going back like a year of around, I want to say, $12 million. I just want to see if that holds and then what the accretable yield addition will be as it relates to Lone Star. Again, I think things have changed. Appreciate the margin guidance, but was just looking for those. Thanks.
Asylbek Osmonov (CFO)
Michael, related to Lone Star, we're still working on the valuation of their loan portfolio, and I would say we're getting the preliminary, but it's subject to change as we finalize. I think day two accounting could be between $8 million-$12 million. I know we provided guidance between $10 million-$12 million, but I think it could be between only $8 million-$12 million. So it's might be decreasing, but we're working toward that, on the day two provision. On accretable yield, it was also a preliminary number, but I think initially it will be around between $1.5 million-$2 million fair value income on loans per quarter. That's what we're estimating. That's gonna be 10 to, what? Nine to $12 million.
Michael Rose (Managing Director and Equity Research)
Okay, that's very helpful. Maybe just as a follow-up, I think Kevin's in the room. I would ask the warehouse question came in a little bit better, you know, this quarter. Just wanted to kind of see the outlook maybe for the, for the second quarter now that we're entering kind of a more seasonal pattern, but understanding that mortgage rates have gone up and there's a lack of supply. Thanks.
Kevin Hanigan (President and COO)
Yeah, it's been moving around, Michael. It's, you know, for Q1, it started off pretty bad and rallied really nicely in late February and throughout March, to pull that average up probably $60 million or $70 million more than we were thinking, when we talked back in January. I'd say for Q2, I'd peg a number of around $900 million on average for the quarter. You know, through last night, we're somewhere in the 870, 873, 874, average so far for the quarter. Rates have ticked up. I might have gone a little higher than 900, but with this ticked up, I think 900 is probably a safe average number.
Asylbek Osmonov (CFO)
[crosstalk] So no, I just want to correct when I say, yeah, for the Lone Stars of $1.5 million-$2 million, that's annualized would be only $6 million-$8 million, not $12 million. I said, just want to correct that.
Yeah, yeah, yeah.
Kevin Hanigan (President and COO)
I was going to say, how far out are you taking that?
Asylbek Osmonov (CFO)
I was thinking about total. A Lone Star, that will be $6 million-$8 million annualized.
Michael Rose (Managing Director and Equity Research)
Got it. Okay, helpful. And then maybe just finally for me, also, Bob, I appreciate the expense guide for the second quarter, but, you know, as those cost savings are realized, you know, I think, you know, more in earnest in the fourth, once you get past operational conversion, is it plausible that, you know, non-interest expenses would kind of stay in that, I think you said $141-$143 range, kind of through the end of the year? Is that fair balancing the kind of the puts and takes on the cost savings with just normal expense growth? Thanks.
Asylbek Osmonov (CFO)
Yeah, I would agree. I think that, right now, sitting and projecting our cost, I think $141-$143 quarterly, I would say throughout the year will be good guidance unless something changes.
Michael Rose (Managing Director and Equity Research)
Great. Thanks for taking my questions.
Operator (participant)
Thank you. The next question comes from Dave Rochester with Compass Point. Please go ahead.
Dave Rochester (Managing Director and Director of Research)
Hey, good morning, guys. Congrats again on the deal close. Just wanted to go back to your comments on the margin. You gave a lot of good color on the accretion, and the 6-24 month look. There are a lot of moving parts of the deal coming in, and just with everything baked in, what do you think is a good range for the NIM for 2Q at this point?
Asylbek Osmonov (CFO)
Well, 2Q, I think, what we see past few quarter, our margin accelerating. So I would say probably, sitting right now with the information we have, another 4-5 basis point increase in margin in the second quarter.
Dave Rochester (Managing Director and Director of Research)
Okay. Is the idea to continue to run the securities book down and use that liquidity to fund either loan growth or a reduction on the borrowing side?
David Zalman (Senior Chairman and CEO)
Go ahead, Kevin.
Kevin Hanigan (President and COO)
Yep. Longer term, yes. We are still building a little cash, as David said, at the onset for regulatory purposes.
Dave Rochester (Managing Director and Director of Research)
Yep.
Kevin Hanigan (President and COO)
They'd like to have a little higher cash. We're getting closer on that cash build, but longer term, that's the use of the bond proceeds. We pay down the debt, if it's not being chewed up by loan growth.
Dave Rochester (Managing Director and Director of Research)
Yep. And then, how much cash do you guys think you need ultimately?
David Zalman (Senior Chairman and CEO)
It's a work in progress. I think what makes the regulators happy that, you know, our gut is somewhere around.
Asylbek Osmonov (CFO)
$1.5 billion-$2 billion. I think that's the range we're working on right now.
Dave Rochester (Managing Director and Director of Research)
Okay. And then switching to capital real quick. I think you've only been above a TC ratio of 10% for more than 1 quarter, maybe once, that I can remember, and that was about 5 years ago, right before you announced another deal. So I was curious, it sounds like you're still interested in deals. What do you think your prospects are over the next year at this point, just given where rates are and whatnot? You know, what are the conversation levels like today? And do you still think you need to build capital from here to do a potential deal, or can you just maintain these ratios here and maybe start returning a little bit more capital through a more regular buyback?
David Zalman (Senior Chairman and CEO)
There's quite a few questions in there. I'll try to take the first one. There still are conversations. We had conversations going, even working, trying to coast through Lone Star. I would say, you know, we did. Sometimes you just get frustrated with all the hard work that you have, and you wonder, should you keep doing it? But the truth of the matter is, yes, we are. We'll continue. We'll probably start pursuing it more than we had. I think we wanted to get, you know, we wanted to get Lone Star done, and we still, even right now with Lone Star, we're trying to get it put together, talking about the operational integration, and then we'll start working harder on some of the deals that we have been working on.
But the odds are good that we will be able to enter into something. I don't think there's any question about that. It's just, again, I think before we do something, we just really want to be thoughtful what we do, and it does, it's accretive to the bank, to the shareholders, and it adds to the value of our franchise. So those are just the considerations that we're looking at.
Dave Rochester (Managing Director and Director of Research)
In terms of the buyback, what do you think about that?
David Zalman (Senior Chairman and CEO)
Okay. You know, the buyback, we do have a lot of money now. I think things have stabilized. You know, everybody. After the Silicon Valley Bank and the Signature Bank and Republic Bank, I think everybody was worried about everything. I think things are becoming more stable right now. People are starting to feel better. And with that, I think if our stock price becomes, you know, if it goes down, you saw how many shares we bought in the first quarter, and I think that, I think we'll continue to be buyers of our stock, too. I think we do have, we do have a high-class problem with a lot of capital, but, you know, we'll use it when we think it's a real opportune time to buy our stock back.
Dave Rochester (Managing Director and Director of Research)
All right. Great. Thanks, guys.
Operator (participant)
Thank you. The next question comes from Catherine Mealor with KBW. Please go ahead.
Catherine Mealor (Managing Director in Equity Research)
Thanks. Good morning.
David Zalman (Senior Chairman and CEO)
Morning.
Asylbek Osmonov (CFO)
Good morning.
Catherine Mealor (Managing Director in Equity Research)
Just to follow up on the dynamics between building the excess cash and borrowings. Do you see a follow-up on just the margin outlooks. Do you still believe that even with having to hold a little bit more liquidity, you still see a path in your margin towards the end of this year to still get back near that 3% range? Or is that margin line a little bit lower, but, you know, the balance sheet is maybe a little bit bigger, so NII, maybe ends up the same, but, you know, it's a balance between those two?
David Zalman (Senior Chairman and CEO)
I'll start off and say yes, but Osmonov may want to correct me.
Asylbek Osmonov (CFO)
No, I think the guidance phase is three because of two dynamics. First of all, we're still repricing our securities from 2% to 5.40%. We're getting on the cash with excess cash we're having. That's dynamic still working out. And also, with the addition of Lone Star, as I mentioned, that helps us. So I think with those things, I think three should be still reasonable assuming, but the wild card is a deposit, right? So how we manage deposit. But so far, we're able to manage deposits. So if it continues as we go, I think three should be still the guidance we stick by by end of the year.
David Zalman (Senior Chairman and CEO)
Yeah, I mean, I think that's true.
Catherine Mealor (Managing Director in Equity Research)
Okay, great.
David Zalman (Senior Chairman and CEO)
I mean, the deposits do seem to have stabilized, but again, if something like that change or there was some other black swan out there that happened, you know, that can always change the dynamics.
Asylbek Osmonov (CFO)
Mm-hmm.
David Zalman (Senior Chairman and CEO)
So just keep that in mind, so.
Tim Timanus (Chairman)
Yeah, I think, you know, finalization of the cash buildup has been taken into consideration in the margin as, you know-
David Zalman (Senior Chairman and CEO)
Mm-hmm
Tim Timanus (Chairman)
aspect. So, that's in there. That's built in there.
Catherine Mealor (Managing Director in Equity Research)
Yeah, that's great. And that, and that 3% too, is also without any rate cuts, and it might be easier to get there if we see some rate cuts. Is that a way to think about that?
Asylbek Osmonov (CFO)
Yeah, so this is the model is on the static balance sheet with no rate changes.
David Zalman (Senior Chairman and CEO)
But again, even if it changes, our model shows it would be just a few basis points, a couple of basis points. I mean, even if-
Asylbek Osmonov (CFO)
Yeah
David Zalman (Senior Chairman and CEO)
If it went down even 200 basis points, which I don't think it is, it still would only be 3 or 4 basis points as a difference than what we're modeling.
Asylbek Osmonov (CFO)
That's correct, because we are very neutrally positioned.
David Zalman (Senior Chairman and CEO)
If interest rates went up 100 basis points, actually our it would improve by 5 basis points, 4 basis points.
Asylbek Osmonov (CFO)
Mm-hmm, that's correct.
Catherine Mealor (Managing Director in Equity Research)
Great. Thank you for that. And then on growth, I think you had said before about a 3%-5% growth rate for the year. I know this quarter was supposed to be slow. It's been slow for everybody. How are you thinking about growth for the back half of the year?
David Zalman (Senior Chairman and CEO)
Kevin, you want to?
Kevin Hanigan (President and COO)
Yeah, we said 3-5. You know, first quarter was a bit challenging. We squeaked out a little bit of growth. April's been equally challenging, so we haven't seen any spurt in growth rate. So, if we said 3-5, I'd for the year, I'd say we're probably on the lower end of the 3-5. I don't know if you agree, David.
David Zalman (Senior Chairman and CEO)
Yeah, I do. I mean it's, when you, when you turn on CNBC and you see unemployment so low and inflation just every, the economy so good. But when you really squeeze down, you talk to some of your customers, you see that your commercial customers are pulling back, waiting to see what interest rates are going to do. You, I think the, you know, when you talk to some of our customers who are in wholesale, they, they see, they see slowdowns in trying to get their, the supply chains are full, and so they're not able to sell as much, so they're concerned.
And even when you talk to a lot of our customers who works sometimes on the plants on the Gulf Coast, where you can talk to them, and they're laying where they send crews in to do turnarounds on these big plants, they're not doing as many this year, and they're still laying people off. So I think there is a delay in the economy. I think it will slow down, and most business people are watching. I don't think that we're in any chance of a recession, but the economy, I don't think it's as good as everybody says it is either.
Catherine Mealor (Managing Director in Equity Research)
Very helpful. Thank you.
Kevin Hanigan (President and COO)
I just add, one of the things we've got that maybe is a little wind at our back potential is our unfunded commitments. On unfunded portions of construction loans are still running at somewhere in the $1.6 billion range, I think $1.6 billion-$1.65 billion. So, we still have a lot of fundings. As you know, we require all the equity go in before we start funding up. So, you know, that's been a relatively stable number and but I do think there's some opportunity for growth through just unfunded commitments, finally funding up.
Catherine Mealor (Managing Director in Equity Research)
All right. Perfect. Thank you for all the color.
David Zalman (Senior Chairman and CEO)
Mm-hmm.
Operator (participant)
Thank you very much. The next question comes from Brandon King with Truist. Please go ahead.
Brandon King (Treasury Sales Analyst)
Hey, good morning.
David Zalman (Senior Chairman and CEO)
Good morning, Brandon.
Asylbek Osmonov (CFO)
Good morning.
Brandon King (Treasury Sales Analyst)
So saw that we had some non-interest bearing outflows in the first quarter. So could you just characterize what you're still seeing within your deposit mix? And when do you think those DDA balances will stabilize?
David Zalman (Senior Chairman and CEO)
Let me get my crystal ball here on the table, and, I'll ask it. But there's, you know, it, from what we can tell, Brandon, it's- it does seem to be stabilizing, but again, to give exact dates and how much it would go down, would just- it would be unrealistic for me to come up with that number. All I can tell you is from what we see, they, you know, it does seem to be stabilizing, where there's still, you're still seeing in the bank where some of your non-interest bearing deposits and your lower interest-bearing deposits are moving sometimes more to money market accounts and to CD. So you're still seeing that transition. I think that'll continue.
But for the most part, we think it is stabilizing, barring that there's no bank deal that gets announced, some bank deal failure or something like that. We do think that we're on the road to stabilization.
Asylbek Osmonov (CFO)
I agree, and, as we mentioned earlier, our core deposit that excluding public funds, has increased in the Q1. But what we see dynamics, like Mr. Zalman mentioned, that some people taking their non-interest bearing to putting into CD, which, special CD programs we have. So we're not losing customers, just repricing, so we're still seeing lag effect on that, on those deposits, but overall, we feel good where we are on deposits, at currently.
David Zalman (Senior Chairman and CEO)
But on a percentage of deposits on CDs in our bank, we're probably still at 10% or 12%? What is it?
Asylbek Osmonov (CFO)
I believe at 14% now.
David Zalman (Senior Chairman and CEO)
14%. So that, that'll probably still continue to grow? I don't know.
Asylbek Osmonov (CFO)
Yeah, it continued to grow, but, being a short term, I mean, we can reprice it within-
David Zalman (Senior Chairman and CEO)
Right.
Asylbek Osmonov (CFO)
If you look at our CD portfolio, 65% get repriced within 6 months and 90% within 1 year. So it's very short-term duration for those, CDs.
Tim Timanus (Chairman)
What, what does appear to have calmed down is the concern over FDIC insurance.
Asylbek Osmonov (CFO)
Mm-hmm.
Tim Timanus (Chairman)
I mean, that could change tomorrow if something came out in the news that, that disturbed people. But, just in my conversations with existing customers and potential new customers, they, they don't ask about the insurance to the extent that they did, you know, going back 6-9 months ago. There's still a lot of rate competition, but the, the insurance issue has waned a bit. So that has resulted in some stabilization of deposits.
Brandon King (Treasury Sales Analyst)
Okay. And with the NIM outlook, what does that assume from a deposit standpoint?
Asylbek Osmonov (CFO)
So if you look at our deposits, I think if on March, our period-end deposit cost was 1.42%, I think if we, in our model, it ticks up a little bit, but it's around 1.45%-1.50%, cost of deposits. And on the loan side, I think we put up loans blended rate in January, February, March, around 8%-8.50% on average. So that's what's taking into account in the model.
Brandon King (Treasury Sales Analyst)
Okay. And, and it stays at that level, I guess, through the rest of the year. Is that kind of what you're assuming?
Asylbek Osmonov (CFO)
Yeah, we do.
David Zalman (Senior Chairman and CEO)
It's a static model.
Brandon King (Treasury Sales Analyst)
Okay, got you. Then just lastly, sorry if I missed this, but I think you referenced the step up in NIM, but could you share the step up in NII in the second quarter? Just helpful, just given the noise around the deal.
Asylbek Osmonov (CFO)
I don't think we have specific numbers, but we'd... Let's see.
David Zalman (Senior Chairman and CEO)
You got to do some of your own work, Brandon. We can't do it all. But we can get back to him on that.
Asylbek Osmonov (CFO)
Yeah, we'll get back.
Brandon King (Treasury Sales Analyst)
Okay. I'll step back. Thank you.
Operator (participant)
Thank you. The next question comes from Manan Gosalia with Morgan Stanley. Please go ahead.
Manan Gosalia (Equity Research Analyst)
Hey, good morning. You know, before you put that crystal ball away, I have one more on deposits. Do you think that with the change in rate expectations and the fact that you're seeing a little bit of a slowdown on loan demand, you know, would any of your existing customers revisit their surplus cash balances and see if they can put more money to work elsewhere, especially on the commercial client side?
David Zalman (Senior Chairman and CEO)
I don't know if I understood the question exactly, but my gut, I think what you're asking is, you know, will our commercial customers take money out and put it somewhere else with things slowing down? I would think if rates, this is just my feeling, usually when rates come down, the customer is not using their money, they're not, they're not, they're not pushing it, trying to find something to do with it every minute, they, they leave more in their accounts. I would think as interest rates come down, you're probably, you'll probably, we'll probably have an easier time with commercial customers keeping their balances up. I, I think when, as interest rates stay where they're at right now or even higher, and they can see that they can get 4% or 5% somewhere, they're really trying to work that money.
But again, I think that if the short-term interest rates come down, it'll probably be easier on us.
Kevin Hanigan (President and COO)
Yeah, Manan, this is Kevin. I think most of that has already occurred. You know, they were using excess money to pay down lines of credit, so we saw unfunded commitments rising through this period of time as they took, you know, DDA balances and paid off loans. And then, to the extent they still had excess money, they were calling one of us asking for a special rate or a some kind of rate bump. It's not all the way over yet, but I don't think it's gonna get, I don't think it's gonna accelerate from here unless something really odd happens.
David Zalman (Senior Chairman and CEO)
I think it's a good point, Kevin. We talked about that before. Most of that has happened already, where they're starting to use their money, on money.
Manan Gosalia (Equity Research Analyst)
Got it. Yeah, that's helpful. I was thinking about it more from the point of view of if we get fewer rate cuts this year, do people just put their money elsewhere? But yeah, you know, the color you gave is helpful. And, you know, maybe to follow up on the loan growth question, you know, is it just a function of rates? You know, is it a lot more pressure that you're seeing on the economy, too? And, you know, the reason I ask is because a lot of your peers are looking for a major inflection in loan growth in the back half of the year, even without too many rate cuts. So I was just hoping to get some more color from you on what you're seeing on the loan growth side.
Kevin Hanigan (President and COO)
Yeah, we agree back. I'd say back half, but and that would be to get us to that 3%-5% range, and it might, all I'm saying is it might tend towards the lower side of the range based upon what we're seeing today. But I think it could be more back half related. And a lot of this is related to rates. A lot of new construction, in particular, call it multifamily, or whatever else, retail. It's hard to pencil these things out at these rates. If you're gonna charge them any kind of premium, you know, you're getting 8.5% or 9%, it takes so much equity to make that deal pencil out to our underwriting, that people are just waiting.
It's either put in, you know, 50 or 40, 50, 52, 55% equity to make the deal work, and then your return on equity kind a gets so muted, and your return on cost is not that great. People are just holding off. I mean, but for the most, we still see a trickle of, you know, hey, somebody wants to build a strip center every now and then, and they've got it pre-leased, and we're doing a little bit of it, but not as much as we were.
David Zalman (Senior Chairman and CEO)
In general, too, I think banks may say they wanna have a lot of loan growth, but most of the majority of the banks have a pretty high loan-to-deposit ratio right now. And with the emphasis on liquidity and from the regulatory agencies, I think all banks are gonna have to monitor how much growth they really do wanna have in loans and have liquidity. Unless the dynamics change, where we start having organic growth in deposits. But those are all gonna have to be taken into consideration, and that'll really determine a lot of, you know, the turf right there, basically. I don't know if I'm being very clear on that.
Manan Gosalia (Equity Research Analyst)
No, that, that, that's helpful. And, you know, I was surprised by, you know, the stress and focus on liquidity, even for a bank of your size. So maybe if I can just follow up on the liquidity point, is it—do you have to keep a certain level of cash on your books? Or eventually, can you move that out to other sources of HQLA, like Treasuries or Ginnies?
David Zalman (Senior Chairman and CEO)
I think basically, they want, it's crazy, because in a bank like ours, we have $16 billion in available funds. We can pick up the phone and call. We, those lines are at the Federal Home Loan Bank and also at the Federal Reserve. And so we've always borrowed money because we've always had that position. But the regulators are, they are becoming more insistent, and I think that they're really gonna want you to keep that cash overnight on hand. So it's a, it's crazy, but it is what it is.
Manan Gosalia (Equity Research Analyst)
Great. Thank you.
Operator (participant)
Thank you. The next question comes from Jared Shaw with Barclays. Please go ahead.
Jared Shaw (Managing Director and Senior Equity Research Analyst)
Hey, good morning. Thanks. I think most of mine were hit, but maybe just a little more detail on energy lending. You had good growth there. What's the appetite for that to continue to grow and maybe grow as a concentration as well?
Kevin Hanigan (President and COO)
I don't see it growing to a much larger percentage of our total loan book than it is now. The growth in the quarter was one particular transaction. It was large. It was to a customer that keeps, I think, $150 million on deposit with us.
David Zalman (Senior Chairman and CEO)
It's as much borrow on deposit as they can borrow.
Kevin Hanigan (President and COO)
It's as much or more on deposits with us than they borrow. They were making an acquisition and gave us the opportunity to loan them some money. It was a pretty large deal and accounted for all the growth in the energy book.
David Zalman (Senior Chairman and CEO)
Right. Yeah, I think it's safe to say that we're not afraid of energy, but we're trying to be particular.
Kevin Hanigan (President and COO)
Particular. We remain particular.
David Zalman (Senior Chairman and CEO)
Right.
Jared Shaw (Managing Director and Senior Equity Research Analyst)
Okay, that's good color. Thanks. And then, going back to the question on DDAs, you know, if we look at average versus end of period, it feels like you had some good growth in DDAs going into March. Was there anything unique about that, or is that the type of pace you think that potentially we could start seeing resume?
Kevin Hanigan (President and COO)
Yeah, I was gonna say earlier in that overall discussion, but I kept my mouth shut for a change. Pretty odd. We did see a pickup in DDA and deposits in March. It continued through tax day. And then like every year, tax day, it takes a pretty good-sized dip, so we were feeling great, you know, right up to the sixteenth. And then we woke up to a whole lot of money flowing out of DDA at the bank to make tax payments. And we were looking back at it this morning. It's not abnormal as to what it has been in other Aprils, in other periods of time. And when we looked, we excluded the COVID period because everything was so wonky then.
So we looked back over a bunch of years to say: Is that typical of April or not? It's been pretty typical. We'll see whether it returns the way it has typically returned in May or not. But we're a little bit excited, I guess, relieved, to see the uptick towards the end of March and into April.
David Zalman (Senior Chairman and CEO)
Mm-hmm. Yeah, historically, we, it does recover. Usually, it, but again, it happens primarily in the last quarter of the year. Isn't that right, HOSS?
Kevin Hanigan (President and COO)
Mm-hmm.
David Zalman (Senior Chairman and CEO)
Most of the, we have a really good first quarter usually, then we kind of the second quarter's kind of middle, and then third quarter is our tough, tough quarter with us.
Kevin Hanigan (President and COO)
Yeah.
David Zalman (Senior Chairman and CEO)
Fourth quarter is when we historically have always shown our growth in deposits, basically overall for the year, so.
Jared Shaw (Managing Director and Senior Equity Research Analyst)
Okay, thanks. And then just finally for me, you know, as we look at your deposit funding, it's been great. Any expectation for where peak cumulative deposit beta is will, will top out?
Asylbek Osmonov (CFO)
Yeah, I mean, we do see a little bit lag, but what we see that the increase in the rate is decelerating, so this is very positive. But as we mentioned, that we still see some customer moving their non-interest-bearing deposit to interest-bearing deposit, which is driving up the cost. I think there'll be still lag effect, but it's at a smaller pace.
Jared Shaw (Managing Director and Senior Equity Research Analyst)
What, what are we at, 37-38?
Asylbek Osmonov (CFO)
Yeah, so Q1 cost of deposits was 1.37.
Jared Shaw (Managing Director and Senior Equity Research Analyst)
No, I mean, beta.
Asylbek Osmonov (CFO)
Beta is 37 basis points, yeah, 400 up. So we do expect a little bit increase, but it's at slower pace.
Jared Shaw (Managing Director and Senior Equity Research Analyst)
Okay, thank you.
Operator (participant)
Thank you. The next question comes from Jon Arfstrom with RBC Capital Markets. Please go ahead.
Jon Arfstrom (Managing Director and Associate Director of US Research)
Hey, thanks. Good morning.
Asylbek Osmonov (CFO)
Good morning.
David Zalman (Senior Chairman and CEO)
Morning.
Jon Arfstrom (Managing Director and Associate Director of US Research)
We haven't touched on fee income, I guess. It looks like a pretty typical quarter to me, but anything you would note on fee income trends and expectations from here?
Asylbek Osmonov (CFO)
I think fee income is, you know, I would say normal. We saw good uptick in a little bit trust income. We had one good, fees on the trust income. I would say, wouldn't be probably non-recurring related to some oil, services we did. But overall fees, I would say is normal. I mean, that's what we expected. Nothing unusual.
David Zalman (Senior Chairman and CEO)
Yeah, I mean, you just, you have to be cognizant of what the CFPB is always out there and what they're saying, so all of that stuff can change. But, you know, if there's some rule that comes down, of course.
Jon Arfstrom (Managing Director and Associate Director of US Research)
Yeah. Yeah, they don't like fees, that's for sure. Tim, you talked about bringing down NPAs, and you gave us a number, and it looks like you've moved a chunk since quarter end. But can you talk a little bit about what you expect for bringing those balances down and how material that might be?
Tim Timanus (Chairman)
Unless we get significantly surprised in a negative way, I don't see it growing substantially above where it is. In essence, about almost 50% of our non-performing assets came from the First Capital acquisition. We think that that's going to, well, it may tick up a little more. We think it's more headed towards leveling out, and our people are doing a pretty good job of collecting these and working through some of these non-performing assets. So I would be very surprised if it went up dramatically from here.
David Zalman (Senior Chairman and CEO)
And as Randy mentioned to me, that the two of those loans, which total about $20 million, are really acute care centers, and they were having a problem with people leasing them, and then they did get them leased. And even during that period of time, the investors have about 35%, real, real cash into the deal. So I think it'll, as the lease matures and they can get it, they'll be able to get it and sell it out into the secondary market. But that takes a while, where they can show some performance, because they'll want their money out, too.
Tim Timanus (Chairman)
Yeah.
David Zalman (Senior Chairman and CEO)
So we have a couple of bigger, larger deals that they're working it. It'll just take us some time to get them out.
Jon Arfstrom (Managing Director and Associate Director of US Research)
Okay. Okay, good, that's helpful. And then just one, one smaller item. On, in, on your deck or in your deck, on slide 15, you highlight the non-owner-occupied office CRE. It's only about $500 million, but just out of curiosity, how, how is that book performing, for you? And, you know, I'm curious if it's any worse than or better than any other CRE performance. Thanks.
Kevin Hanigan (President and COO)
Over a very long period of time, that's been a pretty good performing book for us and really a lot of other banks. It's, you know, those businesses, that's their lifeblood. It's the last thing to go for them. It's, you know, they've got to really be in trouble to not keep the real estate going because they need it to generate all the other revenue in the business. So, and I'm talking about over 20, 30, 40 years, it's been a really good book of business, and it's been particularly good here. It's well underwritten and it's rare to see, even on a watch list, one of those loans.
Those are the customers that they wanna own their building.
Yeah.
They don't have a CFO saying, "Leverage up." They, they wanna own their building and pay it off.
Yeah.
Yeah, good effort.
It's been a really good book for us.
Jon Arfstrom (Managing Director and Associate Director of US Research)
The non-owner-occupied piece, I guess, is the question for me.
The non-owner-occupied.[crosstalk]
Yeah.
Yeah, sorry. Yeah.
Kevin Hanigan (President and COO)
Yeah. Heard that wrong. I'm sorry. It's performed very well. You know, it's been stress-tested and, you know, we, I think we all, these days, stress test for up 300, but, we don't stress test for up 500, 550. We've been pretty fortunate in that book, A, that it be really low, as you know, really low loan-to-cost lenders, which puts us in a really good position. There's so much equity in these deals. And being in a market where there's been a lot of population growth, a lot of in-migration from other states. And so occupancy in those things has been pretty good, and it's. Up until recently, it's driven rents up to help withstand some of the rate increases. But, it's rare.
I think maybe back in January, Jon, we ,I talked about a deal we had that was coming back in. It was gonna be repriced, and I thought it was too low. I think we had it at, like, 8.25 or something, and I'm like: Yeah, this, we're gonna have to move the rate on this thing. And then I got back to the back of the package for the cash flows and realized that it could only get us a 1.25 coverage at 8.25, but we were going from, like, a 5.60 on the rate to 8.25. And while we would have loved to have gone for 8.5, it would have put some stress on the cash flows.
That's as close to a difficult situation as I've seen.
Jon Arfstrom (Managing Director and Associate Director of US Research)
Okay. Okay, very good. All right. Thank you. Appreciate it.
Yeah.
Operator (participant)
Thank you. This concludes our question and answer session. I would now like to turn the call back over to Charlotte Rasche for any closing remarks.
Charlotte Rasche (EVP and General Counsel)
Thank you. Thank you, ladies and gentlemen, for taking the time to participate in our call today. We appreciate your support of our company, and we will continue to work on building shareholder value.
Operator (participant)
The conference is now concluded. Thank you for your participation. You may now disconnect your lines.
