Prosperity Bancshares - Q2 2023
July 26, 2023
Transcript
Operator (participant)
Good day, welcome to the Prosperity Bancshares Second Quarter 2023 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. To withdraw your question, please press star then two. Please note, today's event is being recorded. I would now like to turn the conference over to Charlotte Rasche. Please go ahead.
Charlotte Rasche (EVP and General Counsel)
Thank you. Good morning, ladies, and gentlemen, and welcome to Prosperity Bancshares Second Quarter 2023 Earnings Conference Call. This call is being broadcast live over the internet at prosperitybankusa.com, and will be available for replay for the next few weeks. I'm Charlotte Rasche, 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, Merle Karnes, Chief Credit Officer, Mays Davenport, Director of Corporate Strategy, and Bob Dowdell, Executive Vice President. David Zalman will lead off with a review of the highlights for the recent quarter.
He will be followed by Asylbek Osmonov, who will review some of our recent financial statistics, and Tim Timanus, who will discuss our lending activities, including asset quality. 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 the actual results to be materially different than those in the forward-looking statements can be found in Prosperity Bancshares' filings with the Securities and Exchange Commission, including Forms 10-Q and 10-K, and other reports and statements we have filed with the SEC. All forward-looking statements are expressly qualified in their entirety by these cautionary statements. Let me turn the call over to David Zalman.
David Zalman (Senior Chairman and CEO)
Thank you, Charlotte. I would like to welcome and thank everyone listening to our second quarter 2023 conference call. I'm pleased to announce that on May 1st, 2023, Prosperity completed the merger with First Bancshares of Texas and its wholly owned subsidiary, FirstCapital Bank, headquartered in Midland, Texas. FirstCapital Bank operated 16 full-service banking offices in six different markets in West, North, and Central Texas areas, including its main office in Midland and banking offices in Midland, Lubbock, Amarillo, Wichita Falls, Burkburnett, Byers, Henrietta, Dallas, Horseshoe Bay, Marble Falls, and Fredericksburg, Texas. For the second quarter of 2023, Prosperity's net income was impacted by merger-related charges.
Excluding those charges, our earnings remain strong but are lower than previous quarters, primarily because of the timing differences and that our cost of funds has increased faster than our earning assets have repriced. The good news is that based on our models, we show our net interest margin improving in a 12-month and 24-month time period to more normal levels. If rates increase more than we anticipate, this could change. Together with our model projections, our strong capital position, our liquidity, earnings, strong cost controls, and sound asset quality, we believe opportunities remain for our continued growth and expansion. I would like to welcome our new associates and thank our current associates for all the hard work and integrity they show every day taking care of our customers.
On a linked quarter basis, net income was $86.9 million for the three months ending June 30, 2023, compared with $124.7 million for the three months ended March 31st, 2023. The change was primarily due to the merger. Net income per diluted common share was $0.94 for the three months ending June 30, 2023, compared with $1.37 for the three months ended March 31st, 2023. During the second quarter of 2023, Prosperity incurred a merger-related provision for credit losses of $18.5 million and merger-related expenses of $12.9 million. Excluding these charges, earnings per diluted common share was $1.21 for the second quarter of 2023.
Excluding the merger-related provision and expenses net of tax, the annualized returns on average assets and average tangible common equity for the three months ended June 30, 2023, were 1.14% and 12.43%. Prosperity had strong loan growth for the quarter. Loans at June 30, 2023, were $21.6 billion, an increase of $2.3 billion, or 12%, from $19.3 billion at March 31st, 2003. Excluding the loans from the FirstCapital acquisition, loans increased $729 million, or 3.7%, 15% annualized. Excluding Warehouse Purchase Program loans and FirstCapital loans, the organic loans increased 8% annualized.
Our deposits at June 30, 2023, were $27.4 billion, an increase of $376.7 million, or 1.4%, compared with $27 billion at March 31st, 2023. Excluding the deposits from the FirstCapital acquisition, deposits decreased $1.1 billion during the quarter ended June 30, 2023, compared with the quarter ended March 31st, 2023. Historically, we generally experience a decrease in deposits in the second quarter, primarily due to public fund accounts using their funds. However, this year, we also saw a decrease in core deposits. However, over the last three weeks, the decrease in core deposits has stabilized. We have not purchased any broker deposits to offset the deposit loss, and we do not currently intend to do so.
Our bankers, our focus is on building core deposits. Our non-interest-bearing deposits represented 37.9% of our total deposits at period end June 30, 2023. Our nonperforming assets totaled $62.7 million, or 18 basis points, of quarterly average interest-earning assets at June 30, 2023, compared with $22 million, or 7 basis points, of quarterly average interest-earning assets at June 30, 2022, and $24.5 million, or 7 basis points, of quarterly average interest-earning assets at March 31st, 2023. Over $20 million of the increase was due to the acquisition. In prior transactions, the amount of nonperforming assets that would be reflected as a nonperforming asset was the loan balance net of the mark.
Under the new accounting rules, the full loan balance of all acquired nonperforming assets must be reflected, regardless of the amount of the reserve. In this case, we have accrued an approximate 70% reserve for these acquired nonperforming loans. Additionally, there were two other loans totaling $14 million placed on nonaccrual status, one of which is under contract for sale. After the merger adjustments, the allowance for credit losses on loans and off-balance sheet credit exposures was $381.7 million at June 30, 2023, compared with $312 million at March 31, 2023. Further, the allowance for credit losses on loans to total loans, excluding the Warehouse Purchase Program loans, increased to 1.68%.
Our merger with Lone Star State Bancshares is pending regulatory approvals and is expected to close during the third quarter of 2023, although delays could occur. We continue to have conversation with other bankers considering opportunities. We believe that higher technology and staffing costs, funding costs, loan competition, succession planning concerns, and increased regulatory burden all point to continued consolidation. We remain ready to move forward in the event a transaction materializes and will be beneficial to our company's long-term future and will increase shareholder value. Texas and Oklahoma continue to shine as more people and more companies move to the States because of business-friendly political structure and no state income tax. Prosperity continues to focus on building core customer relationships, maintaining sound asset quality, and operating the bank in an efficient manner while investing in ever-changing technology and product distribution channels.
We intend to continue to grow the company, both organically and through mergers and acquisitions. I want to thank everyone involved in our company for helping to make it the success it has become. Thanks again for your support of our company. Let me turn over our discussion to Asylbek Osmonov, our Chief Financial Officer, to discuss some of the specific financial results we achieved. Asylbek?
Asylbek Osmonov (CFO)
Thank you, Mr. Zalman. Good morning, everyone. Net interest income before provision for credit losses for the three months ended June 30th, 2023, was $236.5 million, compared to $248.5 million for the same period in 2022, a decrease of $12 million or 4.8%. Loan and security interest income increased $93.9 million and $7.9 million, respectively, in the second quarter of 2023 compared to the second quarter of 2022. This was offset by an increase in interest expense of $114.7 million, and a decrease in PPP loan fee income of $2.4 million. During the second quarter of 2023, we recognized $18.5 million of day two accounting provision expense related to the FirstCapital acquisition.
The net interest margin on a tax equivalent basis was 2.73% for the three months ended June 30th, 2023, compared to 2.97% for the same period in 2022, and 2.93% for the quarter ended March 31st, 2023. Excluding purchase accounting adjustments, the net interest margin for the quarter ended June 30th, 2023, was 2.7%, compared to 2.97% for the same period in 2022, and 2.91% for the quarter ended March 31st, 2023. The current quarter net interest margin was impacted by an increase in deposit rates at the end of the first quarter of 2023, and an increase in borrowings.
Non-interest income was $39.7 million for the three months ended June 30th, 2023, compared to $37.6 million for the same period in 2022, and $38.3 million for the quarter ended March 31st, 2023. Non-interest expense for the three months ended June 30th, 2023, was $145.9 million, compared to $122.9 million for the same period in 2022, and $123 million for the quarter ended March 31st, 2023. The linked quarter increase was primarily due to merger-related expenses of $12.9 million and 2 months of FirstCapital Bank's operation.
For the third quarter of 2023, we expect non-interest expense to be in the range of $134 million-$136 million, which includes the additional operating expenses from the FirstCapital acquisition. This projection exclude one-time merger-related costs, estimated to be around $10 million-$12 million, and additional operating expenses from the pending acquisition of Lone Star Bank. The third quarter results will be impacted by day two accounting provision expense related to the expected Lone Star acquisition in the third quarter, which is estimated to be $10 million-$13 million. The efficiency ratio was 53.2% for the three months ended June 30th, 2023, compared to 43.1% for the same period in 2022, and 43.7% for the three months ended March 31st, 2023.
Excluding merger-related expenses, the efficiency ratio was 48.5% for the three months ended June 30th, 2023. The bond portfolio metrics at 6/30/2023 showed a weighted average life of 5.3 years and projected annual cash flows of approximately $2.17 billion. With that, let me turn over the presentation to Tim Timanus for some details on the loans and asset quality. Timanus?
H.E. Tim Timanus (Chairman)
Thank you, Asylbek. Our non-performing assets at quarter end, June 30th, 2023, totaled $62,727,000, or 29 basis points of loans and other real estate, compared to $24,485,000, or 13 basis points at March 31st, 2023. This represents a $38,242,000 increase in non-performing assets. $21,875,000 of which came from FirstCapital Bank of Texas. The June 30th, 2023, non-performing asset total was made up of $59,467,000 in loans, $153,000 in repossessed assets, and $3,107,000 in other real estate.
Of the $62,727,000 in non-performing assets, $8,294,000 are energy credits, $7,923,000 of which are from FirstCapital Bank of Texas. Since June 30, 2023, $11,360,000 in non-performing assets have been removed or are under contract to be sold. This represents 18% of the quarter end non-performing assets. Net charge-offs for the three months ended June 30, 2023, were $16,065,000, compared to net recoveries of $615,000 for the quarter ended March 31, 2023. $14,976,000 of the net charge-offs were from one loan that LegacyTexas Bank had in its portfolio when the bank joined us.
$18,540,000 was added to the allowance for credit losses during the quarter ended June 30, 2023. This addition to the allowance resulted from the acquisition of FirstCapital Bank of Texas. The average monthly new loan production for the quarter ended June 30, 2023, was $565 million, up from $436 million from the prior quarter, for a 30% increase. Loans outstanding at June 30, 2023, were approximately $21.654 billion, compared to $19.334 billion at March 31, 2023. This is a 12% increase on a linked quarter basis. The June 30, 2023, loan total is made up of 41% fixed rate loans, 29% floating rate, and 30% variable rate.
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. Rocco, can you please assist us with questions?
Operator (participant)
Absolutely. If you would like to ask a question, please press star and one on your telephone keypad. If your question has already been addressed and you'd like to remove yourself from queue, please press star then two. Today's first question comes from Michael Rose at Raymond James. Please go ahead.
Michael Rose (Managing Director)
Hey, good morning, guys. Thanks for, excuse me, thanks for taking my questions. good morning. Maybe we could just start on the core margin, decline and, you know, what the expectations could be. Also, Bach, excuse me, if you can give us some color on what you expect the accretion to be, you know, with with the FirstCapital deal, you know, going forward, and what the other deal will, you know, add in terms of accretable yield, as we move forward. Thanks.
Asylbek Osmonov (CFO)
Yeah, if you look at talking about margin, you know, this quarter we were down 20 basis points, but it was the impact of several things, as we discussed in. You know, the announced increase in deposit rate that we announced in our call during the first call, earnings call, impacted or had full impact in the second quarter, and we had a little bit of more borrowing than we had in the first quarter. Those two items impacted our margin, because as we stated in the comments, Mr. Zalman said, you know, for our assets, it takes time to reprice. You know, it takes time to reprice our loan portfolio in securities. As you saw in our security, average yield on security was 2.07%, and average, our loans were 5.48%.
As time passes and those reprice, right now, related to specific security, we're not buying any security. That's why the yield is staying the same. We're using that cash flow. We have about $2.2 billion cash flow from the security, we're either using towards, you know, putting on the loans or paying down on borrowings, depending how it is. The second quarter, we had a strong loan growth, that which we used that funds toward loan growth. If you just look at it, Michael, from the, if we can reprice our security with generating 2.07% right now and putting our new loans, we're getting about 8%. I mean, that's almost a 6% spread that would help us.
Again, it's taking a time, and as we mentioned, you know, if you look at 12 months, 24 months or 36 months, those really look good. Near term, yes, we did have some compression on the NIM. I know I kind of talked big picture, but that's how we see our balance sheet structure.
David Zalman (Senior Chairman and CEO)
Yeah, Mike, I mean, I've always referred to as we're like the Queen Mary in here. It just takes time. Our models have been pretty good. Our models we've used for the last 30 years, 35 years, and they've always been, I think, very, very close and very spot on. What our models show is that in a 12-month timeframe, our net interest margin hits at around the 3% range, maybe a little bit better than that. In a 24-month time range, we go back to the 3.30%, 3.40% net interest margin. Again, it just takes time, and that's just the situation that we're in right now, and it's the amount of time it takes to reprice our assets.
Michael Rose (Managing Director)
Accretable yield.
Asylbek Osmonov (CFO)
The accretable yield on the, we expect about $3 million from the FirstCapital Bank on quarterly basis.
Michael Rose (Managing Director)
Okay, that's helpful. Then just following up on the, you know, bond repricing. I totally understand that, but what about on the loan side? I think if I look at your call reports, I think if I remember correctly, like 12% of the loans are expected to reprice in the next year. Can you just give us a sense for if that's correct, and then what the yields on, you know, the nearer term maturities kind of are? Assuming, you know, they would reprice somewhere where current yields are, I would expect that you would, you know, see some pickup there. I think it'd just be helpful if you could provide some greater color there. Thanks.
David Zalman (Senior Chairman and CEO)
I'll let somebody jump in, but your 12% number seems low to me.
Michael Rose (Managing Director)
That's based off straight off maturities.
David Zalman (Senior Chairman and CEO)
Okay.
Michael Rose (Managing Director)
As opposed to-
David Zalman (Senior Chairman and CEO)
Because our average life in our portfolio is about three years. That seems low. All new loans we're putting on are somewhere between 7.75%-8.5%. I think Tim mentioned the other day, we had one at 9%. Somewhere in that range, I think.
H.E. Tim Timanus (Chairman)
That's correct. The basic run on that is about, on the low end, 7.75%-8.5%.
Michael Rose (Managing Director)
Right.
Asylbek Osmonov (CFO)
If you look at our cash flow, where we analyze our annual cash flow. Within the next 12 months, we're going to get about $5 billion, either paying down, paying off a maturity of loans. I think our call report shows $6 billion, but there was some, including loans that's going to be, you know, have variable rate. The $5 billion for the next 12 months should reprice. Average rate you ask, when we calculate, it was very close to what our rate showing. Our margin is about 5.50%.
Michael Rose (Managing Director)
Okay, so some potential upside there. Okay, great. Then maybe just finally for me, this the loan growth has been pretty good. I know you guys have talked about, you know, previously, you know, being a kind of not a lender of last resort, but certainly given some of the other competitors, have slowed down a little bit because they're, you know, full in terms of, you know, loan-to-deposit ratio, things like that. It seems like that is good. Any sense for kind of pipeline and just the healthier markets? Then, Kevin, if you could just provide some comments on the warehouse, just given you've had two competitors, kind of exit the space and, you know, looks like the, you know, the average balances were a little bit higher than what you got it to. Thanks.
Kevin Hanigan (President and COO)
Sure. Let me do the warehouse first, Michael. There have been a couple of competitors that have exited the space, I think, you know, first reaction might be they would scramble to get capacity elsewhere. With the shrinkage of the overall business, there haven't been many requests for increases where we had common clients. There might have been one or two, but not to the extent you might otherwise think. I think the increase in volume, which was nice for the quarter, I think we had indicated we thought on average, the warehouse might run $800-$850 for the quarter. It ran almost $900, ran $899. It was a little better than we thought, but that I would say that's more seasonal.
you know, May was okay, June was really good, April was pretty soft. I would expect going forward, July has been pretty good so far. To give you an idea, through last night, we've averaged $1.062 billion in the warehouse, so July has been pretty good to us. I suspect August will also be pretty good, then September tends to weaken up a little bit with people returning to school and coming back off of vacations and things moderate down a little bit. For Q3, Michael, I'm going to say on average, $950 million-$1 billion. So we're a bit around $1.062 billion right now.
I think, net-net, we might give a little bit of that back, and on the top side, maybe average $1 billion for the quarter. That covers the warehouse. David, you want me to take loan growth? Loan growth has been strong. If we go back to January, when we talked about what we expected for the year, you know, we said high single digits, and we've been running high single digits for the first six months. We cautioned that if we elected to begin selling mortgages in the secondary market rather than holding them, that number would go down.
We have made a decision, in fact, we made the decision probably a month ago, maybe a little longer than a month ago, to position ourselves to start selling some mortgages in the secondary market and take the gain on sales. That's strictly just the rate they're coming on the books at versus the gain on sale. We think the gain on sale is a better proposition for us now, and we've got other uses for the cash, even if that's paying down borrowings. Either way, it's good for the organization. You know, that takes a while to put in place, and I'd say where we sit today is probably 30% of our origination volume is available to be sold. We're packaging that up, and we'll begin the sales process.
We had to get back in front of all our secondary market participants and let them know we were back, and re-grease those skids. As a result of that decision, I think loan growth will moderate a little bit for the remainder of the year. We'll feel some of that impact probably in the latter stages of Q3 and the full effect of it in Q4 as we prepare to sell more of those mortgages that we originate. Going forward, maybe second half of the year, what we said in January was if we did that, we might grow at 5%, 6%, kind of mid-single digits versus high. I think that's probably a safe number for the second half of the year.
Michael Rose (Managing Director)
Thank you. Thank you, guys. Appreciate it.
H.E. Tim Timanus (Chairman)
I would add, the rest of the loan portfolio, in other words, other than warehouse and mortgage, it's really interesting to see how reasonably steady the demand has been. What has fallen off seems to be the very large, expensive real estate projects. They're not quite what they were. But the rest of the loan market seems to be reasonably steady in spite of higher interest rates and talk about recessions, et cetera. I guess we attribute that to the economy in Texas and Oklahoma, which are two economies that David has mentioned, have maintained their steady growth. So far, we see loan growth being pretty doggone decent.
Michael Rose (Managing Director)
Thanks, guys. Appreciate it.
Operator (participant)
Thank you. Our next question today comes from Peter Winter at D.A. Davidson. Please go ahead.
Peter Winter (Managing Director and Senior Research Analyst)
Good morning. I just want to follow up on Michael's question about the loans maturing over the next 12 months, if we exclude the floating rate book. Just do you have a sense how much actually will mature in the next 12 months in the fixed rate book and what those yields are?
Asylbek Osmonov (CFO)
I think when we looked at it, we looked at it in general, when I said the $5 billion are going to be maturing next 12 months. I think more than half is going to first six months and later. The rate, like, when we calculate the rate, it was 5.5%, 5.6% average on those. I know that we have mentioned, what, 41% fixed mortgages. I think it's, I would say around 41 would be fixed that's going to be maturing next 12 months. I don't have any specific, but we can get back with you on specific on that, on the sixth.
Peter Winter (Managing Director and Senior Research Analyst)
Okay. You know, it's likely the Fed will increase rates today and then on hold. What's the outlook for the margin in the second half of the year? Do you see, you know, that you'll need to do another kind of deposit rate increase?
David Zalman (Senior Chairman and CEO)
We've talked about, you know, increasing rates, right? You know, right now, probably the highest that we pay on our money market account, unless it's, you know, there's always some bigger customers have a negotiated type of deal. For the most part, we pay 3%, and that's if you have over $250,000. The rest of our CD rates are pretty low. I think that we have come up with a CD special rate for 7% that's, I'm sorry, seven months, that's 5%. We do have that. You would think that a lot of money would have flown into that account. I think it's probably about $1 billion. I would have thought that more money would have gone into that.
You know, our cost of funds right now, our total cost of funds when you add everything into it, and that's Federal Home Loan Bank borrowings, Federal Reserve borrowings, interest on deposits is 1.55%. When you look at just our total deposits, our cost of funds are 0.94%. When you look at just the interest on deposits, not including the Federal Home Loan Bank and not including the non-interest-bearing deposits, it's 1.51%. Our cost of funds are extremely low. We have a good core business, I think.
I heard also back in Cullen talked a while ago, about 85% of our business is consumer in accounts, but it probably on a percentage basis of deposits, also that coming from.
Asylbek Osmonov (CFO)
53% of the dollar-wise is the.
David Zalman (Senior Chairman and CEO)
And then-
Asylbek Osmonov (CFO)
consumer and 47% commercial.
David Zalman (Senior Chairman and CEO)
Yeah, the commercial represents about 15% of our accounts.
Asylbek Osmonov (CFO)
Accounts, yeah, only forty-.
David Zalman (Senior Chairman and CEO)
47% of the deals. Our mix of money is good core. We haven't chased the money. I mean, it could have been very easy for us to increase, like some of the other banks, $1 billion or $2 billion by going out and buying broker deposits this quarter. We didn't do that. Our true intent is to try to pay down Federal Home Loan Bank to a certain amount. You know, we talked about a while ago, reducing maybe the amount of home loans that we're keeping on our books and selling. It's our goal to really reduce some of the higher cost money, and our real focus is deposits, and that is to go out where the last two years, all we really hammered in everybody's mind was loans, loans.
What we're hammering right now are deposits, deposits. As this thing turns around, our goal is really to reduce some of our borrowings and to really go after core deposits. It's a long, it's a long answer around a question: Are you going to raise rates, with a, with a 25 basis points increase? I guess the answer is, right now, we probably just would be watching it. It didn't say we wouldn't, but we feel like our deposits have stabilized over the last three weeks. We, you know, we don't see much change, $100 million, maybe lower at the end of the week, and $100 million, $150 million gain at the beginning of the week. We really don't see a whole lot of changes.
Really a lot of it just depends, as long as our deposits stabilize, that's where we're at. We've never really run after hot, you know, higher cost money. I think it's hard once you do, to get out of it. We really don't want to jump into that. That's, that's kind of our story.
Peter Winter (Managing Director and Senior Research Analyst)
Just based on that, the outlook for the margin in the second half of the year?
David Zalman (Senior Chairman and CEO)
You know, I looked at the model, and I looked at 12 months. I can probably pull my notes out and see what it does in six months. In 12 months, we do know that it does go more toward a 3% net interest margin. I'd have to look and see in six months what it is.
Asylbek Osmonov (CFO)
Yeah, the other thing that's kind of hard to answer specifically, we have the loan, pending Lone Star acquisition coming in with, you know, with their loans, so that's going to impact, too. Like, if we were saying, you know, in 12 months, definitely up. I would say in six months, flat and maybe half, but it all depends on Lone Star as well. Peter, I know you asked me about the fixed versus variable asset on my information. So we have a little bit more than 50% of fixed going to reprice out of $5 billion fixed rate loans. It's right about 50%, a little bit.
Peter Winter (Managing Director and Senior Research Analyst)
Over the next 12 months?
Asylbek Osmonov (CFO)
Yes. Out of $5 billion, that we said that the cash flowing.
David Zalman (Senior Chairman and CEO)
I found some numbers, Peter, on the six months. Our six-month projection is to go to around. Again, this probably isn't exactly accurate because and this is flat. That's no growth in deposits, or, I mean, no growth in loans, deposits, or anything like that. This is just straight.
Asylbek Osmonov (CFO)
Static.
David Zalman (Senior Chairman and CEO)
It's about a 2.86% in six months.
Asylbek Osmonov (CFO)
That's not including Lone Star.
David Zalman (Senior Chairman and CEO)
No, that's 2.86%. I'd say 2.86%, 2.90%, and Lone Star should improve and help us a little bit.
Peter Winter (Managing Director and Senior Research Analyst)
Thanks, David.
Operator (participant)
Thank you. Our next question today comes from Dave Rochester with Compass Point. Please go ahead.
Dave Rochester (Managing Director and Director of Research)
Hey, good morning, guys.
Asylbek Osmonov (CFO)
Good morning.
Dave Rochester (Managing Director and Director of Research)
Just to make sure I heard you right, it's 2.86% NIM, six months from now. That includes the rate hike, but no Lone Star. Is that right?
David Zalman (Senior Chairman and CEO)
Let me see if that includes the rate hike. I think it does. It does not include Lone Star. It doesn't include Lone Star. It does include the rate hike.
Dave Rochester (Managing Director and Director of Research)
It does. Okay. Just one hike and no cuts or anything like that? That's the only change in the Fed funds?
David Zalman (Senior Chairman and CEO)
Six, our six month is we're projecting the prime to be 8.5%.
Asylbek Osmonov (CFO)
We don't expect any cuts for the, at least the next six months.
Dave Rochester (Managing Director and Director of Research)
Gotcha. This time next year, or maybe 3Q of next year, back half of next year, you're thinking 3%+ on the margin. Is that right?
Asylbek Osmonov (CFO)
We are.
Dave Rochester (Managing Director and Director of Research)
Okay.
Asylbek Osmonov (CFO)
We are.
Dave Rochester (Managing Director and Director of Research)
Great. Appreciate that. On expenses real quick, appreciate all the guidance there. Was first wondering if you thought that 3Q range, the $134 million to $136 million, was good for 4Q as well, ex the Lone Star deal. Then, what are you guys expecting for the size of that Lone Star expense base that you're going to bring in?
Asylbek Osmonov (CFO)
On the $134 million, $136 million, I think that's a good run rate because we're going to have full three months of FirstCapital Bank when it. If you look at, I think that's going to stay the same for the fourth quarter. I mean, it might change a little bit, but I think that's going to be same guidance for the fourth quarter. On the first, I'm sorry, on Lone Star, I know we're going to have one-time expenses. I think the Lone Star brings additional on the quarterly basis, around, I think between $7 million-$10 million quarterly expenses, before we get the some savings.
Dave Rochester (Managing Director and Director of Research)
Okay, great. Just one on capital. How are you guys thinking about the buyback here at the current stock price, which is a little bit higher than where you were buying this past quarter? Then just giving your thoughts on M&A and growth going forward, are you thinking this 2Q pace for buybacks is more what you would expect, or could you accelerate that just given you've got a whole lot of excess capital here? Thanks.
David Zalman (Senior Chairman and CEO)
Yeah. Well, if you saw, we have for the last two quarters, bought back how many? About 1 million share-.
Asylbek Osmonov (CFO)
$1.2 million.
David Zalman (Senior Chairman and CEO)
Million 200,000 shares. We definitely think.
Asylbek Osmonov (CFO)
Yep
David Zalman (Senior Chairman and CEO)
... the stock is too cheap. At the same time, you know, we're always focused on, we wanted to increase dividends, and we still want to do some mergers and acquisitions. I think a lot of it depends on our activity in M&A. You know, if we don't do the M&A, you'll probably see more of the, probably the buybacks. If you're seeing M&A, you know, that may not be as much.
Dave Rochester (Managing Director and Director of Research)
Okay. Maybe just on M&A, what are you guys seeing in terms of conversation levels or activity in the market at this point? I know, you know, some folks see, you know, purchase accounting marks as a big headwind. You guys list a lot of reasons why banks are going to want to combine. Was curious, you know, what's the opportunity set you're looking at right now and how active are those, you know, banks in conversations and whatnot that you're seeing?
David Zalman (Senior Chairman and CEO)
I think, M&A activities increased significantly.
Dave Rochester (Managing Director and Director of Research)
Okay, great. Thanks, guys.
Asylbek Osmonov (CFO)
Thank you.
Operator (participant)
Thank you. Our next question today comes from Brady Gailey with KBW. Please go ahead.
Brady Gailey (Managing Director)
Hey, thanks. Good morning, guys.
Asylbek Osmonov (CFO)
Good morning.
Brady Gailey (Managing Director)
I just wanted to ask about credit quality. You know, we saw some noise there in the quarter, but all the numbers are still very low. I know a lot of the noise related to acquisitions, and you know, previously acquired loans as well. When you take a step back and look at, you know, credit quality for Prosperity, are there any concerning trends, or are you guys still pretty confident on where you stand with credit quality?
David Zalman (Senior Chairman and CEO)
I would say we're confident. Most of what deterioration you've seen is a result of loans that joined us, and there may be a bit more of that to go. Not an overwhelming total by any means, but there might be a bit more. We've actually been a little bit surprised how well the quality has held up, once again, given the higher interest rates and the earning pressure that puts on borrowers. We see it as steady right now. We don't see really any red flags.
Kevin Hanigan (President and COO)
Yeah, Brady, this is Kevin. The loss we took was on a legacy deal, the former structured CRE portfolio that you're pretty familiar with. It was in an office building located here in Dallas, a $32 million loan that lost several tenants, a couple within the quarter. We moved to foreclose and sell that loan in a hurry, figure in the first loss was the best loss. We ran a process and settled on a buyer that paid $17 million for it, so it was a $15 million loss. That structured CRE portfolio, which was at one point above $2 billion in total, is now down to $305.7 million. It's come down materially.
The amount of office exposure left out of that portfolio is $126.3 million. It's not much left in terms of office exposure, and the remaining office exposure that we do have is all current and paying. At this point, it seems like an outlier. That doesn't mean something can't go wrong somewhere. If somebody said, where do you think the risk is in this $40 billion balance sheet? I'd look right into that $126.3 million worth of former legacy structured CRE portfolio, even though it's still performing well. Class B office is not a great place to be. Fortunately, we've worked it down to the $126 million, outside of that...
That portfolio is still doing just fine today, but I think that's where the risk lies.
David Zalman (Senior Chairman and CEO)
I think what Kevin is saying is real accurate. I'd also say that, you know, again, this loan never even hit the past due sheet or, you know.
Kevin Hanigan (President and COO)
It's never past due.
Asylbek Osmonov (CFO)
Never past due.
David Zalman (Senior Chairman and CEO)
Even on our deal. I think that probably some other banks would have taken it and held out and maybe tried to sell it over a year or two years. You know, we're just not like that. We took it, we sold it, we got what we thought we could get for it, and we usually try to get all of our non-accruals or non-performing off of the books. Just like the, we saw a $62 million in non-performing this time increased significantly. Over $20 million came from First Capital, we intend to get that off.
The other two loans, of the $18 million that we talked about, probably we already have a contract on a deal that's going to take out most of that, the majority of it, 2/3 of that. We already have a contract on that. You know, we sell it and get out of it.
Kevin Hanigan (President and COO)
Yes.
David Zalman (Senior Chairman and CEO)
By the way, it won't be that kind of loss on that. Just to warn you, so, but we did have.
Kevin Hanigan (President and COO)
Nowhere near that kind of loss. As David said, this was an intra-quarter event. This went from losing enough tenants to us, foreclosing and us running a process and getting it moved off the books and within a 90-day period of time, inside of the 90-day period of time.
Brady Gailey (Managing Director)
All right. That's helpful. You know, Lone Star has been pending regulatory approval for a while, I think. In the press release, y'all talk about hoping to close that this quarter in 3Q. What's been the hold up with getting regulatory approval for that deal?
David Zalman (Senior Chairman and CEO)
Up until this point, it really had been held up at the Department of Justice. Primarily, it was based on a on one of their banking centers or branch banks that they felt like that they didn't know if they were going to let us keep or not. This was really a branch bank in a town of how many?
Asylbek Osmonov (CFO)
$9,000.
David Zalman (Senior Chairman and CEO)
9,000. We fought that for the longest time, and we finally, what, two weeks ago or a week ago, finally got clearance on that the DOJ let us go through with it. Really, from that point, it was at the FDIC. You know, our contacts with the FDIC, we felt that, you know, we really would get it done in just a few days. It's taken longer than that because now most everything, even though the size of it and the small size of it still has to go to Washington. You know, I don't know, maybe they were dealing with the PacWest deal last night and the week before, I don't know. You know, we're really hoping to get it. We should get it. We don't know.
We don't know of anything that why it shouldn't be, let me say that.
Brady Gailey (Managing Director)
Okay, great. Thanks, guys.
Kevin Hanigan (President and COO)
Mm-hmm.
Operator (participant)
Thank you. Our next question comes from Manan Gosalia with Morgan Stanley. Please go ahead.
Manan Gosalia (Executive Director and Senior Equity Analyst)
Hi, good morning.
Asylbek Osmonov (CFO)
Morning.
Kevin Hanigan (President and COO)
Morning.
Manan Gosalia (Executive Director and Senior Equity Analyst)
I apologize if I missed it, but can you talk about what your models assume for terminal deposit betas, as well as the mix of NIB deposits?
Asylbek Osmonov (CFO)
Yeah, our beta for the interest-bearing deposit is 36 basis points. That's what we use in the model. If you look at our deposit over this interest rate cycle on interest-bearing deposit was 27 basis points. We're running below the model that we what we have for the deposit, interest-bearing deposit betas.
Manan Gosalia (Executive Director and Senior Equity Analyst)
Got it. And the NIB mix?
David Zalman (Senior Chairman and CEO)
Non-interest bearing.
Asylbek Osmonov (CFO)
None. I think it's the same.
David Zalman (Senior Chairman and CEO)
I don't think we show a decrease in it, probably.
Asylbek Osmonov (CFO)
On the model, no.
David Zalman (Senior Chairman and CEO)
It's just flat where it is. In fact, really, our non-interest bearing, as a percentage of deposits, has really gone up.
Asylbek Osmonov (CFO)
Mm-hmm
David Zalman (Senior Chairman and CEO)
this quarter, hasn't it?
Asylbek Osmonov (CFO)
Yeah, compared to the first quarter, yeah, it went up to 37.9%.
David Zalman (Senior Chairman and CEO)
Actually, our non-interest bearing has really held up better than most of our other accounts.
Manan Gosalia (Executive Director and Senior Equity Analyst)
All right. Perfect. Maybe just to approach some of the prior questions in a different way. On deposit betas, I think you've always had a significantly lower deposit beta than your peers. Maybe you can talk about if rates stay higher for longer, what do you think about your ability to keep that spread relative to your peers? Or, you know, as rates stay higher for longer and loan growth continues, do you see that spread compressing?
David Zalman (Senior Chairman and CEO)
You know, I don't think so. I mean, we've been pretty consistent. If anything, you know, our models, really, after 12 months or after 24 months, show really some crazy stuff, you know, some really high net interest margins. I would say if that becomes true, you know, we may give more of that back to the customer. But basically, from what we're seeing in the, in the time horizons of 12 and 24 months, I pretty much think we are where we are.
Asylbek Osmonov (CFO)
Yeah. I mean, another way of saying it, as we reprice our loans and officially reprice our bond portfolio at $13 billion, generating 2.07%, that would help us from the assets, interest-earning assets. We could increase the our cost of deposit, but save the margin, protect the margin. You know, it's just this timing issue for us, as we improve on the asset side, we could give a little bit on the deposit side, but still protect the margin.
Kevin Hanigan (President and COO)
Right. We need a Fed pause.
Manan Gosalia (Executive Director and Senior Equity Analyst)
Got it. Got it. makes sense. maybe last question, just as we think about the securities book, should we think about that yield remaining flat as you repurpose those securities into loans? As more of the back book sort of runs off at a lower rate, should we still see that weighted average rate on those securities rise in the coming quarters?
Asylbek Osmonov (CFO)
Yeah, I think that if you look at security, we're not buying any new securities, we're not repricing those securities to higher yield. Only what we've discussed, we're using that cash flow, first of all, getting higher yielding loans, or if we have any, you know, funds available, we're going to be paying down. Both of them very accretive to the net income and the margin from our standpoint. From the rate on the security, I don't think it's going to significantly change what we see right now.
Manan Gosalia (Executive Director and Senior Equity Analyst)
Got it. Perfect.
David Zalman (Senior Chairman and CEO)
All the repricing, when you look at what our yield is on securities and look at what our yield is in loans, you look at what the yield, what we're getting today, you can see how significant that is. It just takes us time to turn the ship around a little bit.
Asylbek Osmonov (CFO)
Yeah. I mean, the spread we're getting on every dollar we get from in security on the loans, we're getting 5.5%, 6.5% spread on if we put it on new loans.
David Zalman (Senior Chairman and CEO)
You just pay a Federal Home Loan Bank up.
Asylbek Osmonov (CFO)
That's why we're getting.
David Zalman (Senior Chairman and CEO)
You're saving over 3% right there.
Asylbek Osmonov (CFO)
Yeah, 3.5%.
Manan Gosalia (Executive Director and Senior Equity Analyst)
Great. Thank you.
Kevin Hanigan (President and COO)
Thank you. Our next question comes from Brandon King at Truist. Please go ahead.
Brandon King (LDP Credit Analyst)
Hey, good morning.
David Zalman (Senior Chairman and CEO)
Morning, Brandon.
Brandon King (LDP Credit Analyst)
Morning. Yes, could you give us some commentary on what you're seeing in regards to prepayments in your CRE book? It seems like with this interest rate environment, in this interest rate environment, the average life of loans could be extended, just given the dynamics around that.
David Zalman (Senior Chairman and CEO)
Well, I think that's right. We're not seeing excessive prepayments on loans.
Kevin Hanigan (President and COO)
I think what we'll continue to see is multifamily deals that stabilize because the inversion of the curve can go out to the agencies and get a lower, longer-term fixed rate loan than they might have had from our floating rate perspective. We'll continue to see some pay down there. Tim's absolutely right. As we look across the entire book, it's a slowdown of the more traditional kind of deals. These big multifamily deals have an option to go out and lock up non-recourse debt off the inverted curve.
David Zalman (Senior Chairman and CEO)
Correct. I still think once all these rates quit rising, it always comes back around. There always becomes competition. Everybody starts trying to undercut you and trying to get better rates from different, maybe even non-banks. I think you'll see that in the future as rates stabilize and maybe even consider coming down next year or year. I don't think rates are going to go down as much as everybody else thinks are going to go down. I think rates are going to stay higher for longer. However, there's always that competition, and things always turn around. That's just the way it is.
Brandon King (LDP Credit Analyst)
Got it. Do you think that potentially limits the benefit of the fixed rate repricing? Just given how, you know, we have the contractual maturities in place, but obviously, you assume a certain weighted average life for those loans. Do you think that dynamic could kind of limit that benefit, at least over the next year?
Kevin Hanigan (President and COO)
No, the maturities are still the maturities. It's an opportunity for a rate increase.
David Zalman (Senior Chairman and CEO)
I think so, yes.
Brandon King (LDP Credit Analyst)
Okay. Going back to the NIM guidance, I believe you said 2.86% to 2.90% in six months. What are you assuming as far as paying down borrowings within that math?
Asylbek Osmonov (CFO)
I think in our guidance, it's, our borrowing stays flat in our model.
Brandon King (LDP Credit Analyst)
Okay, no benefit there is kind of the way you think about it, right?
Asylbek Osmonov (CFO)
Yes.
Brandon King (LDP Credit Analyst)
That's all I had. Thanks for taking my questions.
David Zalman (Senior Chairman and CEO)
Thank you.
Operator (participant)
Thank you. Ladies and gentlemen, this concludes our question and answer session. I'd like to turn the conference back over to Charlotte Rasche for 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)
Thank you. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.
