Prosperity Bancshares, Inc.

Good day and welcome to the Prosperity Bancshares, Inc. first quarter 2020 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 touchtone phone. If your question has been answered and you wish to withdraw yourself, please press star then 2. Please note, today's event is being recorded. I would now like to turn the conference over to Charlotte Rasche. Please go ahead.

Thank you. Good morning, ladies and gentlemen, and welcome to Prosperity Bancshares' first quarter 2020 earnings conference call. This call is being broadcast live over the internet at prosperitybankusa.com and will be available for replay at the same location for the next few weeks. I'm Charlotte Rasche, Executive Vice President and General Counsel of Prosperity Bancshares, and on the call with me today is David Zalman, Senior Chairman and Chief Executive Officer, H.E 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 Carnes, 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. Finally, we will open the call for questions. During the call, interested parties may participate live by following the instructions that will be provided by our call moderator, Eric. Before we begin, let me make the usual disclaimers. Certain of the matters discussed in this presentation may constitute forward-looking statements for the purposes of the federal securities laws, and as such, may involve known and unknown risks, uncertainties, and other factors which may cause the actual results, performance, or achievements of prosperity bankshares to be materially different from future results, performance, or achievements expressed or implied by such forward-looking statements. Additional information concerning factors that could cause actual results to be materially different than those in the forward-looking statements can be found in Prosperity Bancshares' filings with the Securities and Exchange Commission, including Forms 10-Q and 10-K 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.

Thank you, Charlotte. I'd like to welcome and thank everyone listening to our first quarter 2020 conference call. Our merger with Legacy Texas was completed on November 1, 2019, and our management teams continue to find commonalities and strengths that we expect will benefit our company, our shareholders, and associates going forward. Our planned operational integration remains on schedule for June of this year. In our efforts to continue to enhance shareholder value, Prosperity repurchased 2,092,000 shares of its common stock at an average weighted price of $52.59 per share during the first quarter of 2020. The net income was $130 million for the three months ended March 31, 2020, compared with $82 million for the same period in 2019. Our earnings per diluted common share were $1.39 for the three months ended March 31, 2020. compared with $1.18 for the same period in 2019, a 17.8% increase. For the first quarter of 2020 on an annualized basis, return on average assets was 1.67%, return on average common equity was 8.86%, and return on average tangible common equity was 20.1%. Prosperity's efficiency ratio, excluding net gains on the set of assets and taxes, was 42.9%, where the three months ended March 31, 2020. Our loans at March 31, 2020 were $19.1 billion, an increase of $8.7 billion, or 83.7%, compared with the $10.4 billion at March 31, 2019. Lean quarter loans increased $281 million, 1.5%, or 6% annualized compared with the $18.8 billion at December 31, 2019. Our deposits at March 31, 2020 were $23.8 billion, an increase of $6.6 billion or 38.5% compared with the $17.1 billion at March 31, 2019. Our lead quarter deposits decreased $373 million or 1.5% from the $24.2 billion at December 31, 2019. A portion of this decrease was due to our planned reduction of higher cost and broker deposits assumed in the Legacy Texas merger. Excluding deposits we assumed in the merger and new deposits we generated at the acquired banking centers since November 1, 2019, deposits at March 31, 2020 grew $1 billion, or 6%, compared with March 31, 2019. and Drew 162 million non-basis points or 3.6% annualized compared with December 31, 2019. Our non-performing assets totaled $67 million or 25 basis points of quarterly average interest earning assets at March 31, 2020 compared with $40 million or 21 basis points of quarterly average interest earning assets at March 31, 2019 and 62 million or 25 basis points of quarterly average interest earning assets at December 31, 2019. The increase during the first quarter of 2020 was primarily due to the merger. During the first quarter of 2020, Prosperity increased its allowance for credit losses to $327 million from $87 million in the fourth quarter of 2019 after adopting Accounting Standard ASU 2016-13, also known as CECL. The amount of the allowance is based on our CECL methodology. We believe these additional reserves should help to insulate the company during these challenging and unprecedented times. Our allowance for credit losses to total loans excluding the Warehouse Purchase Program loans now stand at 1.88% compared with 51 basis points at December 31, 2019. With regard to acquisitions, as one would expect, conversations with other bankers regarding potential acquisition opportunities have subsided. However, we remain ready to enter into negotiations when it's right for all parties and is appropriately accretive to our existing shareholders. While today's challenges are certainly extraordinary, Prosperity has a deep management team with experience in navigating and adopting in difficult times. We enter this economic downturn from a position of strength with sound credit quality, robust capital and liquidity, and solid operating fundamentals. We believe that our team will see us through, and we remain confident in our long-term future. I would like to thank every associate at Prosperity. Throughout the past several months, while dealing with various personal challenges related to the pandemic, our retail team operated at full capacity, enabling us to keep our locations open and serve our customers' daily needs. Additionally, our operational staff and lending team were crucial in accepting, processing, and submitting thousands of SBA PPP applications and closing the loans, working around the clock to assist our customers. Thanks again for your support of our company. Let me turn over our discussion to Asylbek, our Chief Financial Officer, to discuss some of the specific financial results we achieved.

Thank you, Mr. Zalman. Good morning, everyone. Net interest income before provision for credit losses for the three months ended March 31, 2020, was $256 million, compared to $154.9 million for the same period in 2019, an increase of $101.1 million, or 65.3%. The increase was primarily due to the merger with Legacy Texas in November 2019 and $28.5 million in loan discount accretion in the first quarter of 2020. The net interest margin on a tax-equivalent basis was 3.81% for the three months ended March 31, 2020 compared to 3.2% for the same period in 2019 and 3.66% for the quarter ended December 31, 2019. Excluding purchase accounting adjustments, the core net interest margin for the quarter ended March 31, 2020 was 3.36% compared to 3.16% for the same period in 2019 and 3.26% for the quarter ended December 31, 2019. Non-interest income was $34.4 million for the three months ended March 31, 2020 compared to $28.1 million for the same period in 2019. The increase in non-interest income was primarily due to the merger with Legacy Texas. Note the debit card income from Legacy Texas is now impacted by the Durbin Amendment. Non-interest expense for the three months ended March 31, 2020 was $124.7 million compared to $78.6 million for the same period in 2019. The increase was primarily due to the merger with Legacy Texas. For the second quarter of 2020, we expect normalized non-interest expense to range around $120-125 million. In addition to this, we expect $3-5 million in one-time merger expenses related to upcoming June conversion. Further, we expect to incur expenses related to SBA Paycheck Protection Program in the second quarter which are not included in the normalized non-interest expense guidance. As we discussed in prior quarters, we expect to realize most of our cost savings from the Legacy Texas merger beginning in the third quarter of 2020 after the system integration that is planned for June. To date, we have already realized some cost savings from the merger and eventually expect additional cost savings of approximately $8 to $9 million per quarter. Combined, this will be in line with the announced 25% cost savings. The efficiency ratio was 42.9% for the three months ended March 31, 2021. Bancshares, Inc., David Zalman, H.E Timanus, Edward Safady, Charlotte Rasche J.D., Robert Dowdell, Annette Tripp, John Mays Davenport, Perry Johnson 3.08 years, and projected annual cash flows of approximately $2.2 billion. And with that, let me turn over the presentation to Tim Timanus for some detail on loans and asset quality.

Tim Timanus Thank you, Asylbek. Our non-performing assets at quarter end March 31, 2020, totaled $67 million. $179,000 are 35 basis points of loans and other real estate. The March 31, 2020 non-performing assets total was made up of $61,449,000 in loans, $278,000 in repossessed assets, and $5,452,000 and other real estate. Of the $67,179,000 in non-performing assets, $13,187,000, or 20%, are energy credits, $12,869,000 of which are service company credits, and $318,000 are production company credits. Since March 31, 2020, there have been no material deletions from the nonperforming assets list. Net charge-offs for the three months ended March 31, 2020, were $801,000. There was no addition to the allowance for credit losses during the quarter ended March 31, 2020. The average monthly new loan production for the quarter ended March 31, 2020 was $476 million. Loans outstanding at March 31, 2020 were $19.127 billion. The March 31, 2020 loan total is made up of 36% fixed rate loans, 36% floating rate loans, and 28% that reset at specific intervals. I'll now turn it over to Charlotte Rasche.

Thank you, Tim. At this time, we are prepared to answer your questions. Eric, can you please assist us with questions?

Thank you. We will now begin the question and answer session. To ask a question, you may press star then a one on your touchtone phone. If you are using a speakerphone, Please pick up your handset before pressing the keys. To withdraw your question, please press star then 2. Our first question today will come from Jennifer Ambar of SunTrust. Please proceed with your question.

Good morning.

Good morning.

David, can you talk about what you see as your most vulnerable loan buckets over the near term as we as we're still kind of in the shutdown and things are reopening slower than we'd like.

Yeah. First, I would say that, you know, we haven't seen deterioration yet in the loan portfolio. And again, maybe that's because, you know, you extended a number of loans for that. But I guess it's obvious that vulnerable would be You know, the first thing somebody would pick out would be probably the oil and gas portfolio. However, when you really look at it, the majority of it is in production loans, and of that, again, Kevin can jump in and talk in a minute, but about 85% of that is hedged, the production loans that we got from Legacy at about $50 to $60 a barrel, so that's hedged for this year and part of next year. He can probably go into more detail with you than that. There's a little over 200 something million that we have in loans that are in the service industry. The thing I would say about that is that most of those came from us and those are customers that we've had probably for the last 20 and 30 years. We didn't put any new customers on there and they have experience in this and we made it through this with them back in 16 and 17 when oil went to $25 a barrel. So then I guess the next thing would be vulnerable would probably be your hotels and motels, and that's just going to be until people start coming back and traveling again. I would think that usually we don't make a bunch of restaurant loans, but all the PPP money that came out, probably is going to help a lot of these hotels, motels, and restaurants and stuff like that. Again, it was very helpful, and so we'll see how that goes. I don't know that anybody really knows really where we are at in the future in, say, the third quarter or fourth quarter, but I think a lot of it's going to depend on how fast We turn back on the economy and I think Texas is planning on turning it on faster than some of the other states. I think this Friday we're coming on, there'll be almost, it's not everything on, I don't know that the hair salons and the nail places, but even your restaurants are coming back on. and your, again, it's going to be a diminished capacity, maybe 25% and 50% your medical offices are coming back in. So I think the faster that you, the faster we come on, the better it will be. And again, I, you know, the thing I feel good about, again, I can't predict the future, but we've been through this before. We have, probably our underwriting has probably been better. I don't want to say that then something may go wrong, but as you know, our credit underwriting has probably been stronger than some of the other banks. We've not taken as much risk as some of the other banks, and hopefully that should help carry us through this. But again, we don't know the future, but we feel pretty good where we're at. Long answer, Jennifer. I'm sorry. I just wanted to give you some color.

Yeah, that's okay. How much of your loan balances have been deferred overall and specifically in that hotel and energy bucket?

I don't think that I have them broken down. Somebody else can jump in a minute. There wasn't as much in March, but if you looked as of yesterday, we had 5,643 loans that we did have an extension on out of 66,000 or almost 67,000. So that would be about 7%, a little over 7%, 7.7% of our loans and the dollar amount that we extended were $66,829,000.

You know, David, I might add that it's, Jennifer, it's really a function of time. If things start to normalize relatively quickly, I suspect we're not going to have that many severe loan problems. If this gets drawn out more and more and more and more, then obviously that could be a different story. But as David mentioned, Texas is starting to come back online this weekend. Restaurants are allowed to open this weekend at 25% capacity, and then depending on how things go, They're going to go to 50% capacity by mid-March, and then once again, based on how things go, they could be at full capacity by the end of May. I said mid-March, I meant mid-May. So there are a lot of things happening. Medical offices are already reopened. Their client flow is obviously less than what it normally has been, but the important thing is They're open for business, and people can go see doctors now and not have to talk to them over the phone. So there are a lot of positive things in play that we're hoping will allow our customers to get back online fairly quickly.

But we'll have to just wait and see. Kevin, do you want to jump in on the oil and gas at all?

Yeah, I mean, Jennifer, as you know, As Tim just said, a lot of this is about duration, particularly in oil and gas. Low prices are one thing, but low prices for a long time can be very destructive. Our portfolio, which is now $719 million, or 3.8% of the loan portfolio, it's pretty well hedged. As David said, if we look across the portfolio, Producing portfolio on the gas side for this year, 88.5% of the PDP is hedged at a weighted average price of $50.93. That rolls into next year that we have 63.2% of the PDP hedged at $50.24. So these hedges have, not only for us, because the industry kind of moved a lot more the way of hedging in 2015, so I don't think we're unique in this regard. We might be unique in that we're reporting it, how much we have. It's buying us time. Not much works. In fact, nothing works at $20 oil. So there can be stress within the portfolio. As we talked about in the January call covering our fourth quarter results, because of the marks we had back then, which are now poured into CECL, we've got 12.2% of our energy portfolio We've kept pretty tight looks at everybody else who's got an energy portfolio, and I don't think anybody's got that kind of reserve up. There's a couple that are now starting to approach it. I think I heard a call yesterday where somebody had approaching 8%, but we've got a pretty healthy reserve up against it. We're working really hard on the former energy credits we had at Legacy. We identified about 200 million of those. We wanted to get off the books. So if I just look at that portfolio back in September, that reserve-based portfolio was $511 million. It's down to $355 million. And we haven't, out of all those resolutions, they've all come at or below the marks that were put on them. In fact, everyone but one has been well within the mark. I think we had one this quarter that we got out exactly on top of the mark on. So we haven't gone negative to the mark in all of these resolutions. So I think we're making great progress on what's in front of us. We'll see what duration brings, but I think we've got a good 18 months of hedging with pretty darn good counterparties built into our portfolio. Counterparties are basically are mostly BP and Cargill, so pretty good counterparties on the other side of these things. And our clients are actually doing pretty well with these hedge volumes. It's up to us, and we're instituting MCRs or monthly commitment reductions on all of these guys to capture some of these cash flows that they're benefiting from and reducing the debt.

Thank you. One more question, David. Are you inclined to suspend buyback activity right now, or are you still active?

You know, I think if it were up to me, I'm probably pretty bold. I would probably do it. On the other hand, I know the regulators right now, where they're not, you know, they haven't said that you can't do something, that I think they would like us to make sure that you build your capital. And so I'd say, for the most part, I've committed to them that Not in anything formal, but just talking to them. Unless our stock just went really through the bottom or something, we probably wouldn't be buying stock back right now. But that's just kind of where we're at.

Thank you so much.

Thank you. Our next question will come from Brad Millsaps of Piper Sandler. Please proceed with your question.

Hey, good morning, guys. Good morning. David, I know one of the big aspects of when you bought Legacy was right-sizing their balance sheet, running off some of their loan portfolio to kind of meld the two together. Just kind of curious where you are in that process, kind of what this environment might do to sort of change the timing of some of that, or do you kind of have The balance sheet in terms of the left and right side, kind of where you would want it at this point.

I'll let Kevin answer in a minute, but I think we're right on schedule. I think when we first said this, we thought there'd be about $400 million in loans or $500 million in loans, and those guys have just done a fantastic team over there. David Montgomery and Sam Duff, I mean, they're cleaning up the port. I wouldn't say cleaning up their outsourcing some of the loans that we didn't necessarily want there. As Kevin said earlier, the marks that we had on them, actually this quarter, we actually, if you look at our ALL or whatever they want to call it now, the CECL calculation, we took about, Asylbek, how much was it, 13 million? So we'll have 13 million related to that. 13 million that was really related to that we took it out of PCD, is it PCD? Yeah. And put it into the regular allowance. So everything so far has worked out really good. I mean, knock on wood, I don't want to just say everything's perfect in the world, but I think that we're really, I think we are where we want to be. I was a little bit leery on the, you know, where are we going to stay in the warehouse lending program. I think we've gotten more comfortable with it, and we were even able to, there are some customers that we probably picked up a couple of customers that because they were so strong that they couldn't get financing somewhere else and probably outsource a couple that we weren't making as much money on. And so that's worked out real well with us. I think the other portfolio was that commercial real estate portfolio. We really haven't seen a lot of growth in that portfolio yet or a lot of loans. And again, it's just paying down like it is. I hope that gives you some color. And Kevin, you may want to jump in.

I think David covered it pretty well. If anything, I think we're ahead of schedule. We still have about $50 million on the energy side we'd like to work our way out of, at least going back to those original numbers. Where we sit today, we'd probably like to work our way out of a lot more than just $50 million, but we're ahead of schedule, Brad.

Got it. Even just away from credit, what about in terms of the liabilities, remixing the deposits and you know sort of how does that you know impact in addition to what's going on with with rates impact sort of your thoughts around the NIM I think David you mentioned last quarter kind of getting into that 335 range which you did this quarter but just kind of curious what the environment does and then you know kind of what you're in addition able to do with with legacies portfolio deposits as well this is Tim I can give you a little insight on that I've been working with

and others on the legacy side to reduce some of our interest expense. And I think we're having good success. We're trying to do it in what I would call a considerate fashion because we don't want to run off customers that have the capability of being core customers and staying with us over time. So we're taking a, I guess you could call it somewhat of a relaxed approach, but yet focused and determined on lowering these rates. And I think we're having good success. Mays can maybe add to it, but I'm not aware that we have lost any customers that we feel like are on the core customer side. Some that are more on the hot money side just inevitably will end up going somewhere else. So we're very focused on it. We have been. We continue to be. All the interest costs are going down, obviously. The high-priced ones go down just like the low-priced ones, although there is a differential there. So I think we're having good success. I feel good about it.

This is Asylbek. I would like to add that related to... to the brokerage CDs that we have. We have about at least $250 million at 2.5% that we're planning to reprice hopefully soon. So there is that one. And also we have $125 in subordinate debt that we're going to pay off end of the year in December. So that's definitely going to help us with the repricing of the high-cost deposits.

And really deposits, I know, even though they might have been and a number of others. When we went back and looked, this happened in 2008, when times get a little tougher, we tend more people put more of their money with us. Is that right, Asylbek? That's right. If you've done that, yeah. Flight to safety, you can see that. And as far as the net interest margin, I think that Asylbek will probably tell you this. I asked him. He feels comfortable in projecting anywhere from a 3.45 to 3.55 net interest margin going forward on a total if you want net interest margin without the Without the accretion, what did you have, three?

Yeah, probably low to mid-330s. That would be without accretion. And when we provided range at 345, 355, we, based on the about 13 to 15 million fair value income that we expect in the second quarter. Right. And related to the margin, I can speak a little bit. The way our balance is structured, I think, is very, you know, better insulated in this time environment because we have, if you look at our total income Interest Earning Assets, 31% is in the bond portfolio with fixed rate. And also we have about 35% of loans in fixed rate. So that definitely helps us to maintain, I would say, our margin definitely going to stay flat. But I think the wild card in this environment is our SBA PPP program, that depending on the timing of forgiveness, timing of the funding, it could impact the margin in the second quarter. I mean, it's going to be dilutive a little bit to the margin, but if you look at it from the EPS or bottom line, it will be very accretive to us.

It probably wouldn't be dilutive if you could take the whole premium that you're getting, the 3% or 5% that you're getting in, that wouldn't be dilutive, but you have to take that from what you're telling me over a two-year period.

Yes, exactly.

There's a lot of money that will be coming in from that PPP program. I think when it's all said and done, we'll have A billion and a half to two billion dollars in PPP loans, depending if we get them all approved or not.

That's going to definitely impact our bottom line in EPS in a creative way.

Great. Thank you, guys. I'll hop back in the queue.

Our next question will come from David Rochester of Compass Point. Please proceed with your question.

Hey, good morning, guys. Nice quarter.

Thanks.

On the energy book, you guys gave a lot of great detail on that. You look pretty well protected at this point, but I was just wondering how far along you were in the spring redeterminations and what you're seeing from the standpoint of line reduction and then what you're baking in for oil prices in your new decks.

We're well into the redeterminations. It's an ongoing process. The customers are fully aware that that process is is underway and appropriate and called for. We haven't had really any resistance to the process. Obviously, some people don't like the fallout of the numbers, but they are what they are. We haven't had any what I'd call declared defaults so far in the process. We seem to be working well with virtually all the customers. We understand where they are. They understand where we are. I think it's like everything else that relates to our loan portfolio. It's really a matter of how long does it stay weak. Right now, I'm not overly concerned about it. If prices are bad a year from now and two years from now, we're probably going to be more concerned about it. So I feel good about where we are in the redeterminations. You know, people have the option of pledging additional collateral, the option of paying us down. Sometimes we need to give certain customers a little more time, and we're willing to be considerate of that and look at it. So it's a viable process. It's not a process that has broken down in any way at this point in time.

This is Kevin. I would just add to that. We're about halfway through at this stage of the game. General sense in terms of what's happening is commitment reductions of anywhere from 40% to 50% across the board and heavy usage. Almost, I think, every client we've instituted MCRs on.

Okay. And in terms of the oil price you guys are using in your decks now?

Yeah, somewhere between $25 and $30.

Okay. Yeah, I think, Kevin, Murrow's in here. Murrow said that we're probably using in the 20s. Murrow, is that right? Well, we're starting out in the low 20s.

We're probably averaging into the mid-20s.

Yeah, we have a stress case that we're running, and it takes it down to high teens, low 20s.

I don't know if that's a good term for that.

That's great, Kyle. I appreciate that, guys. And then I guess in terms of your loan growth outlook, just if we get some thoughts there. I know in the past you guys have typically put together some decent loan growth when the environment is tougher because all the other banks tend to tighten their underwriting standards, and you guys are already operating with tight standards. So I was just wondering what your thoughts were on that as you're seeing that unfold today.

I think it's the same as what you just said. I think it's going to keep itself as though. Again, I think it's exactly what you said. I think that we'll probably do better in these kind of times than maybe some of our peers because we're in a better position probably.

Yeah. Okay. And then just switching to the margin, which is curious where you're seeing securities reinvestment rates these days. And if you guys were buying to replace any of the runoff you were talking about, I know you talked about some decent cash flow coming off that, or if you're just planning on working borrowings down a little bit.

Really, we haven't... Probably last month we might have bought because we got around, we bought a couple hundred million dollars because we got around that 2.4, 2.4%. Right now, really, with rates where they're at, we're just paying it down and taking the money and putting it back in instead of borrowing from the Federal Home Loan Bank, using that as a substitute and putting it back into the loan side. On the warehouse? Warehouse receipt deal, yeah. I'm not warehouse receipt, warehouse mortgage.

Just one last one on M&A. I appreciated the thoughts you just gave earlier. I was just curious if you'd still be interested in FDIC-assisted deals if those were to pop up over the next year or so, depending on how bad things get, and if you'd go for only in-market deals or if you'd go outside the market for those types of situations.

If you look back, some of our better deals we've gotten, even like the Franklin deal, when it has been at times like this, and yes, we did jump in, and that's generally when we can get things at a pretty reasonable price. And so we would be interested in it naturally. We would be more interested in an in-market deal. Having said that, from a shareholder standpoint, depending how sexy it was, if we could make some money, we'd consider that too.

Yeah. All right. Great. Thanks, guys.

Our next question will come from Brady Gailey of KBW. Please proceed with your question.

Hey, thanks. Good morning, guys. Good morning. I wanted to follow up on the SBA's PPP program. What's the average fee that you're seeing currently?

This is Eddie. You know, in the first tranche, we had about $630 million in approvals over 2,700 loans, and I think if you take the average fee on that, it was close to about 3.2% on average, or right around 3% on the fees on that. We're, of course, you know, early on into the second phase right now, and as of this morning, we've had about 3,000 approvals, totaling about $500 million in and we have a lot more to work through. So we really haven't analyzed the fees on that. I will tell you that the average size loan has come down in this tranche. You know, it started about $190,000. What we're looking at on the average through this morning was closer to $150,000.

Probably if you had to make an assumption, you'd probably be more, what, about a 3% fee?

About 3% on average because these are all in that lower level. Right.

So if you guys end up doing $1.7 billion of P3 loans at a 3% fee, that's $50 million of pre-tax earnings that could potentially flow through the margin over the next couple of quarters as most of these loans are forgiven. That would be a nice tick up to the margin. Is that the right way to think about that?

It is. I mean, there are some expenses that need to come out of that a little bit. But, you know, these loans are 24-month amortizations, but the forgiveness period will start eight weeks after. They can start applying eight weeks after their first funding. And the rate at which they will be retiring that debt is yet to be seen. We can conceivably see the lion's share of that coming up in the next 12 months.

Having said that, though, too, I think this is money that we really weren't counting on and if our model would let us, our methodology, I would like to see if we could put some of that money, again, increasing our allowance for loan losses if possible. So I wouldn't want you to count it just extra found money. Just caution you on that. If we can and the model will allow us, I don't know that you can ever have too much money in reserves. Okay.

And then on that topic, It's odd to see a zero provision this quarter, but totally understandable given the credit quality of prosperity and where your reserves are already at. Do you think that you could see a zero provision going forward from here as well?

I would say that I would like to take extra money that we have coming in. and try to put some, again, Merle's probably going to look at me because this is all based on a methodology, but in the methodology there's, what is it called, the economic? Environmental. Environmental deal where maybe you have some flexibility. I would like to put more of this extra found money. We have not only that, we have some other things coming in that are above what our normal budget is and we would like to maybe put some of that. So if there's a provision, it would be with this extra money, I would say, and if the methodology allows it.

And once again, right now we're not faced with obvious defaults. That could change. That could get worse. And if it does, then our model will address it appropriately.

But again, it would be nice to just say, here's another $40 or $50 million you have in income that you didn't count on, but it would be nice if we could put some of that away, in my thoughts.

Yep, that makes sense. And then lastly for me, looking at the energy reserve of around 12%, I think that is excluding another $21 million of fair value marks. So once you bake that into it, it's more like a 15% energy reserve. Is that the right way to think about it?

That is a fair way today, but that what we call interest mark is going to bleed off over time. So over the next 18 to 24 plus months, that

We went back to look and, you know, when oil went to $25 a barrel, first I asked them to go back and tell me how much money have we ever lost over a two-year period. And so, I think the two years, and this might be in the slideshow that we did, I think it was in 16 and 17, in over a two-year period, We lost about $35 million, and $25 million of that, or $24 million of that, was oil and gas, and the majority of that was from a bank that we bought in Oklahoma. So most of those losses came from that. But again, we were smaller at that size, so if we go through something like that, again, I can't say that's what our total loss is. It could be, who knows, it could be $80, it could be $90, who knows, but again, that just gives you some Some flavor of where it was when oil went to $25 last time, what we charged off over a two-year period.

Yeah, David, that's right. That went from about mid-June of 2016 through the first quarter of 2018. So it was half a year, 16, all of 17, and the first portion of 18. So that's exactly correct.

As far as reserves, and again, you never can say you have too many, but in my lifetime as a banker, I've never been at 1.88%. This is a whole new dimension for me, so I hope we don't need it, but that's more than I've ever... I've never been in a bank where capital ratios we used to operate when we first started off, if we had 5%, we thought we were in great shape, but now we have capital ratios of 10%. You've got I know we're in this situation right now, but I don't know that really the banking industry has ever gone into a downturn where we're at right now as strong as most banks are right now also.

Got it. Thanks, David.

Our next question will come from Ibrahim Unawa of Bank of America. Please proceed with your question.

Good morning.

Good morning.

Most of my questions have been answered. Just one, I guess, for Kevin. To the extent you can, how do you see the mortgage warehouse business playing out both in terms of just the demand over the next few months or over the next couple of quarters and what you're seeing on the and many more.

And notably, it was a pretty big quarter in terms of refi. Purchase refi volume was 51% purchase 49 refi, so a lot of refi volume in the quarter. I actually think that warehouse volumes this year are going to peak in mid-May. So we're not too far away from what I think will be peak volumes. It'll be somewhere between May 15th and May 20th by my math. And for us, that peak could be somewhere between $2 billion and $2.3 billion, and we've said we'd like to kind of keep this at $2 billion. We've got a lot of bulge facilities out there to get folks through volume. Just keep in mind, volume that comes onto our balance sheet is usually an application that was taken by one of our customers six weeks ago. So what I do expect post, call it May 20th, is that purchase volume is going to drop pretty dramatically. And we're going to see a much lower balance from May 20th to June. And when that purchase volume returns, I don't know. And once it starts returning, realize we have another six weeks of lag before that application gets back on the line. It may be a couple of months of lower volumes in the June-July period, which is normally when we're at the peak. So this year is going to be a little bit different, in my opinion, and just based upon all the facts we're looking at. So my crystal ball isn't all that good past July, and it will all depend then on whether the purchase volume goes back. If people put their houses back on the market, if there's traffic, if there just isn't much foot traffic today, That also extends over into the purchase market. I think home builders are going to have a tough quarter in Q2. They all had pretty good quarters in Q1, record kind of quarters through February, and then some bust-outs started to occur on contracts in March. There will be pockets of the United States in home building in Q2 where you will see some home builders, and I'm not talking about the national guys for the most part, that will actually have negative sales volume in Q2. There will be more bust-outs than they have in new contracts. So this will be temporary, but both for home builders and I think for the warehouse it's going to be – and more.

That is actually very helpful. Thank you. And just staying on that, do you see any risk or concern that any of these independent mortgage companies could run into trouble because of what's going on with the market and deferments, et cetera, where they are stuck with borrowers who might be deferring right at the onset after taking the loan?

Yeah. We haven't seen that yet. As we look at our portfolio, and that's really all I've got a window into, the volumes that might have a deferment on it in the short 17 days that we've held it has been less than 1%. And it does seem like there's, if you track this here in the last week, we've had some of the GSEs agree to buy those things if there are deferments on them, which is going to free up that market a bit. If there's going to be issues for mortgage warehouse companies, it would have been during that period of time where they were getting hit with some MSR write-downs for those guys, those who have maybe big MSRs. And there were some that were caught on hedging and they had to settle up on some hedges that were some meaningful dollars there for a period of time in March. Our clientele made it through that, I'm not going to say unscathed, but without any real liquidity concerns or anything else. We looked across our portfolio pretty hard during that period of time. And in fact, we stopped accepting jumbos without identified takeouts, probably in the second week of March, just because the jumbo market also slowed down in terms of getting them off the line. I think we took all the appropriate steps, and we're just keeping an eye on MSRs and hedge volumes.

That's helpful. Thank you. And just one question, David, as a follow-up on M&A. Given what you talked about in terms of, at least for now, being in a little bit of a capital build mode until things set down, does it suggest that for the near term, and I guess near term is whatever, like three to six months, It's highly unlikely that you enter a deal or you entertain any M&A transactions until you get the integration piece complete and until we get to some form of the other side of the lockdowns.

I think I understood your question, but it was a little bit muffled a little bit. I think you're asking what do we see in M&A or what we're going to do. Our thought is the operational integration is first and foremost. The June operational integration. Having said that, I mean, if an opportunity really came up, we would probably really consider it because this is what we wait for are these kind of times. We're there all the time, but these are the kind of times that we really are in a good position to do what we need to do. So if that comes up, and I feel really good with the legacy team and Kevin and Mays, and the whole team has just been remarkable, and they've just been fantastic. Some of the greatest partners we've ever taken on and the business we've kept and what we thought we could do, we did. And so I feel very comfortable where we are with our teams. And so if that happened, we would do it.

Got it. That's all I had. Thanks for taking my questions.

Our next question will come from Michael Rose of Raymond James. Please proceed with your question.

Hey, guys, just two quick ones. First, I understand the comments around the buyback. If I look back to kind of the great financial crisis, you guys, you know, still continue to increase your dividend. You guys got strong, you know, ROA, pre-tax, you know, earnings trends. Any reason to think that you'd slow on annual dividend increases from here?

I hope not. My kids need milk money, so I hope they'll continue. The only thing, from what we see right now, I don't see that being an issue, but again, I can't tell you that something would jump up in the third or fourth quarter and it's an automatic either, but it's certainly, I hope that's not the case. If you ask me which way we're leaning, it would be more for dividend increases, especially with the increase in earnings that we're projecting.

Got it. I appreciate the comment, very similar to what Johnny Allison said, but in a different way. One other question, just as it relates to the timing of cost savings, have any of them been pushed back? Is systems conversion still on track to go as planned? Anything we should think about there? Thanks.

No, I think this plays with what is already in process. So we're waiting for our June conversion. After the June conversion, we should start seeing the savings. Our June, you know, because so close to the quarter end, our conversion, it might be a little bit delay on realizing the cost. But as we said, we already realized about $2 to $3 million cost savings this quarter, and we're planning to do another $8 to $9 million. in future quarters, so it gets us to 25% cost savings. But we're hoping to do more than that, but definitely we'll achieve our 25% cost savings that we announced. All right.

Thanks for taking my questions, guys.

Thank you. Thank you.

Our next question will come from Gary Tenner of D.A. Davidson. Please proceed with your question.

He might have dropped off.

Mr. Tedder, your line is live into the conference.

I'd move to the next one. It's probably off.

All right. Our next question will come from Kevin Zerbe of Morgan Stanley.

Please proceed with your question. Hey, Ken Zerbe.

Just a really quick follow-up on the expense comment that you just made. The $2 to $3 million and then the $8 to $9 million of additional that you're going to get, is the $2 to $3 million already included in the $120 to $125, such that kind of like the normal run rate after everything's said and done should be close to like $114? So I'll make sure I got my numbers right. Thanks.

Yeah, so... Clarification. So, yes, the $2 million to $3 million cost savings already baked in in the $120 million to $125 million range I provided. So, if you take another $8 million to $9 million, I think we run rate, assuming everything stays the same as we're thinking right now, is going to be around $114,000 to $116,000.

You have the tax effect, the $8 or $9 million, right?

No, we're talking about expenses. Yeah, not the net income, the expenses. So I would say between $114,000 to $116,000 will be run right after all the savings we realize from the conversion.

Got it. Okay. Thank you. Our next question will come from John Armstrong of RBC Capital Markets. Please proceed with your question.

Hey, thanks. Good morning.

Good morning, John.

Good morning. Hey, quick question. Most of this stuff has been handled, but can you touch a little bit on West Texas and the kind of activity you're seeing there, you know, non-energy related, I guess, in terms of your thoughts on stresses in the real estate portfolio or housing? You know, I know you have some exposure to the Permian, you know, probably Eagleford as well. Just give us an idea what you're seeing there.

I'll start off. I mean, I don't, you know, Midland, Odessa is kind of a crazy market to begin with. When oil and gas prices are at their at, there's really no, there's not enough housing, there's not enough people, restaurants. and a number of others. I think it's probably a lot, not only oil and gas, but it's probably agricultural related to some degree. And again, based on a college town, you have retail. And Merle, you've lived there, and you may have some comments on what you see in West Texas or how you feel about it.

Lubbock's economy is pretty stable, both upturn and downturn. There's not much upside in Lubbock, but there's not much downside in Lubbock. It's pretty much a 2% to 3% annual growth rate. Middle of Odessa, I think David's right. The thing has been so stretched, there's some absorption it can take just to get back to normal. There'll be some job loss, but they can redeploy some of those people. I think net-net, there's going to be a lot of stress. You're going to see some stress in the hotels. because a lot of those hotels have been, number one, fully occupied. They're not going to be fully occupied whether it's by COVID or by oil and gas workers. So there'll be some stress there. But we don't have much hotels exposure, hardly any.

And we didn't do any over there, did we?

I think we've got one.

We might have one, yes.

I think it's an older hotel. I think it's break-evens around 30% occupancy.

That's good. On the other hand, I would tell you that oil and gas, The price is really going to depend on the economy coming back. You know, when I talked, we talked earlier about the E&P loans being hedged at least 85 or 80-something percent on the ones that we had from Legacy. We also had some from the West Texas area. And most of the people we lent to over there, we didn't require them to hedge because, you know, we lent one guy $80 or $90 million. He paid it back down to $20 million or $30 million and has $120 million dollars. on deposit in the bank. We have another family we have a loan to, but they've got $60 million in the bank and the trust companies. I think what you're going to see is you'll see production really come down. I think the guys that are hedged are going to keep on producing it, because why not if they can get that kind of money? But everybody else that we talk to, they're really pulling back, and they're not going to produce at these levels until the market comes back. And when the economy comes back, you'll see the oil and gas prices come back, too.

I think it's important to note that, to use the old Texas saying, this isn't the first rodeo out there. These people are used to boom and bust. That's the way it's always been. And I think we've been, personally, I think we've been rational and conservative in our loan approvals. And most of our customers that are out there have been through these ups and downs before. As you just said, we don't have many hotels. We don't have many restaurants. Real estate values clearly are not solid right now. But our customers have been through these hard times before, and right now they're holding in there. So I'm as comfortable as I can be right now.

And fortunately, we didn't finance any drilling companies. That's always good.

We don't have any drilling rigs financed. Well, we might have one. We still have that one, maybe? Well, the service. It's a...

He produces... Pooling units and stuff. Yeah, no, I'm talking about drilling. Yeah, those are work over... Drilling rigs. You'll have to have those work over rigs to... Yeah, we have some service companies.

But once again, these are people that have been in business for quite some time.

Also, we don't have any pipe. and we don't want to make it sound like we're not free from any sin, you know, and we don't know really what the future, but we do feel comfortable where we're at and we'll be able to get through all of this, we think, so. Okay.

That's fair. Tim, maybe to you, you know, periodically I ask about the average monthly production numbers, but I'm assuming If you take out PPP late March and kind of April today, it's pretty weak. Just curious what, you know, if that's true and kind of the activity you're seeing and then what is the kind of corporate prosperity message to the lenders? Is it, you know, keep your customers close or is it go and take some market share? Just curious what you're telling your lenders to work on.

Well, I think new loan applications probably have dwindled a little bit, but in actuality, not all that much. Our loan committee meetings are still reasonably robust, so there hasn't been a marked slowdown in new requests, but there has been some once again. We try to stay, when it comes to lending, Always in the middle of the fairway. Good times or bad times. We try to adhere to discipline and principles. We try to lend into cash flow and good collateral and borrowers that have experience and are honest. And that's always been our message to our lenders, and it really hasn't changed. As was mentioned earlier in this call, if things really start to deteriorate and get bad, We suspect some lenders are going to freeze up and quit lending or certainly slow down considerably their lending activities. And historically, that's always been an opportunity for us to pick up good customers that we haven't had before. So that's always a possibility. We're not hoping that that happens, but it could. So there's no different message to our people. Our approach is the same. Thank you. Thank you. Thank you.

This will conclude our question and answer session. I would now like to turn the conference back over to Charlotte Rasche for any closing remarks.

Thank you, Eric. Thank you, ladies and gentlemen, for taking the time to participate in our call today. We appreciate the support that we get for our company, and we will continue to work on building shareholder value.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.