Prosperity Bancshares, Inc. (NYSE:PB) reported a robust second quarter for 2024, with net income reaching $111 million, or $1.17 per diluted common share. The bank saw a significant increase in net interest income and loans, largely attributed to its merger with Lone Star Bank. Non-performing assets saw a slight uptick, but the company remains confident in its business model and future prospects, including potential acquisitions and a targeted return on tangible capital of 15-16%.
Key Takeaways
- Net income stood at $111 million, translating to $1.17 per diluted common share.
- Net interest income before provision for credit losses increased by $20.5 million from the previous quarter.
- Loans grew by $666 million, primarily due to the merger with Lone Star Bank.
- Deposits rose by $552 million.
- Non-performing assets amounted to $89 million, a 6.87% increase from the previous quarter.
- The efficiency ratio was reported at 51.8%.
- The net interest margin improved to 2.94%, up from 2.79% in the previous quarter.
- Non-interest income included a notable $10.7 million net gain from Visa (NYSE:V) stock conversion.
- The company forecasts non-interest expenses for Q3 to be between $141 million and $143 million.
- Loan demand is expected to rise in the latter half of the year due to rate cuts and deposit stabilization.
Company Outlook
- The net interest margin is expected to hover around 3%.
- Loan demand is anticipated to pick up in the second half of the year, supported by rate cuts.
- The company plans to maintain a neutral position on the balance sheet despite potential volatility.
- Prosperity Bancshares is open to future mergers and acquisitions, with a changing regulatory tone noted.
Bearish Highlights
- Non-performing assets increased by 6.87% since the previous quarter.
- Net charge-offs for the quarter were reported at $4.4 million.
Bullish Highlights
- Loan production remained strong at $278 million for the quarter.
- Loans outstanding at quarter's end totaled approximately $22.3 billion.
- The company's loan portfolio is diversified, with a mix of fixed, floating, and variable rate loans.
Misses
- The company recognized a purchase accounting provision expense of $9.1 million related to the Lone Star acquisition.
- Fair value loan income was $7.2 million, which, while an increase from the previous quarter, reflects the cost of the acquisition.
Q&A Highlights
- Executives discussed the impact of rate cuts on loan yields and the stability of core deposits.
- There was a focus on the performance of the acquired portfolios and the stabilization of the loan business.
- The bank anticipates a return on tangible capital around 15% to 16%.
- Questions were raised about the average earning assets at the end of 2024, with the company expecting continued growth.
Prosperity Bancshares' second quarter earnings call painted a picture of a company navigating a complex financial landscape with a degree of success, bolstered by strategic growth initiatives and a strong focus on customer relationships. Despite some challenges, the bank remains optimistic about its ability to maintain a solid net interest margin and to explore further growth opportunities through acquisitions and loan production.
Full transcript - Prosperity Bancshares Inc (PB) Q2 2024:
Operator: Good day, and welcome to the Prosperity Bancshares Second Quarter 2024 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to hand the call to Charlotte Rasche. Please go ahead ma'am.
Charlotte Rasche: Thank you. Good morning, ladies and gentlemen, and welcome to Prosperity Bancshares second quarter 2024 earnings conference call. This call is being broadcast live on our website and will be available for replay for the next few weeks. I'm Charlotte Rasche, Executive Vice President and General Counsel of Prosperity Bancshares, and here with me today is David Zalman, Senior Chairman and Chief Executive Officer; H. E. Tim Timanus, Jr, Chairman; Asylbek Osmonov, Chief Financial Officer; Eddie Safady, Vice Chairman; Kevin Hanigan, President and Chief Operating Officer; Randy Hester, Chief Lending Officer; Mays Davenport, Director of Corporate Strategy; and Bob Dowdell, Executive Vice President. David 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. Before we begin, let me make the usual disclaimers. Certain of the matters discussed in this presentation may constitute forward-looking statements for the purposes of the federal securities laws and as such, may involve known and unknown risks, uncertainties and other factors which may cause the actual results or performance of Prosperity Bancshares to be materially different from future results or performance expressed or implied by such forward-looking statements. Additional information concerning factors that could cause actual results to be materially different than those in the forward-looking statements can be found in Prosperity Bancshares filings with the Securities and Exchange Commission including Forms 10-Q and 10-K and other reports and statements we have filed with the SEC. All forward-looking statements are expressly qualified in their entirety by these cautionary statements. Now let me turn the call over to David Zalman.
David Zalman: Thank you, Charlotte. I would like to welcome and thank everyone listening to our second quarter 2024 conference call. We want to welcome the customers and associates from Lone Star State Bank of West Texas and are excited about our partnership. As previously announced on April 1, 2024, Prosperity completed the merger of Lone Star State Bancshares Inc. And its wholly owned subsidiary Lone Star Bank headquartered in Lubbock, Texas. Lone Star Bank operated five banking offices in the West Texas area. For the three months ended June 30, 2024, net income was $111 million or $1.17 per diluted common share compared with $110 million or $1.18 per diluted common share for the three months ended March 31st, 2024. Net income and net income per diluted common share for the second quarter of 2024 were impacted by an increase in net interest income and a gain on the Visa Class B-1 stock exchange net of investment security sales of $10.7 million and partially offset by a merger related provision for credit losses of $9.1 million and merger related expenses of $4.4 million, an FDIC special assessment at $3.6 million and an increase in non-interest expenses related to three months of Lone Star State operations. Excluding the merger related provision and expenses, the gain on the Visa Class B-1 stock exchange net of investment security sales and the FDIC special assessment each net of tax net income was $116 million or $1.22 per diluted common share for the three months ending June 30, 2024. And our annualized returns on average assets were 1.17% and our annualized return on average tangible at the common equity was 12.34% based on those numbers. We are also pleased that our net interest income before provision for credit losses was $258 million for the three months ended June 30, 2024 compared with $238 million for the three months ended March 31, 2024, an increase of $20.5 million or 8.6%. In addition, our net interest margin on a tax equivalent basis was 2.94% for the three months ended June 30, 2024 compared with 2.79% for the three months ended March 31, 2024 and 2.73% for the same period in 2023. As mentioned on prior calls, these are the results that we expected and we anticipate these tailwinds should continue to be positive for the near future. Our loans were $22.3 billion at June 30, 2024, an increase of $666 million or 3.1% when compared with $21.6 billion at June 30, 2023. Our linked core loans increased $1,056 million or 5% from the $21.2 billion at March 31, 2024. Loans increased primarily due to the Lone Star merger. Excluding loans acquired in the Lone Star and First Capital acquisitions and new production at the acquired banking centers since the respective acquisition dates. Loans at June 30, 2024 decreased $37 million or 2 basis points, when compared to last year, June 30, 2023 and an increased $63 million or 3 basis points compared with March 31, 2024. Excluding these acquisition-related loans and warehouse purchase program loans at June 30, 2024, loans decreased $152 million or 8 basis points compared with March 31, 2024. Our deposits were $27.9 billion at June 30, 2024, an increase of $552 million or 2% compared with $27.3 billion at June 30, 2023. Our linked core deposits increased $757 million or 2.8% from the $27.1 billion at March 31, 2024. The increases were primarily due to the Lone Star merger excluding deposits assumed in the Lone Star and First Capital acquisitions and new deposits generated at the acquired banking centers since the respective acquisition days, deposits at June 30, 2024 decreased by $470 million or 1.8% when compared to last year June 30, 2023, and decreased by $298 million or 1.2% compared with March 31, 2024. Historically, our deposits are seasonally lower in the second and third quarters and increased again in fourth quarter. We have not purchased any broker deposits to offset the deposit loss and we do not currently intend to do so. Our bankers focus is on building core deposits. Our net interest bearing deposits represented 34.7% of our total deposits at June 30, 2024. Our non-performing assets totaled $89 million or 25 basis points of quarterly average interest earning assets at June 30, 2024 compared with $83 million or 24 basis points of quarterly average interest earning assets at March 31, 2024 and $62 million or 18 basis points of quarterly average interest earning assets at June 30, 2023 with a significant portion of the balance for each period attributable to the acquired loans. At June 30, 2024, the allowance for credit losses on loans was $359 million and allowance for credit losses on loans and off balance sheet credit exposure was $397 million. The allowance for credit losses on loans was 4.02x the amount of non-performing assets. With regard to acquisitions, we continue to have conversations 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 increased shareholder value. We are optimistic about the future and confident in our ability to create meaningful long-term value for our shareholders. Over the last 12 months, we have returned $284 million to shareholders, $74 million through share repurchases and $209 million through cash dividends. With regard to the economy, CNBC recently announced that Texas was voted the third best state for business in 2024. However, we believe we should have been number one. Sorry, that's Texas humor. It's just the right trying to correct the wrong. Texas continues to shine as more people and companies move to the state because of the 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 for changing technology and product distribution channels. We intend 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 the discussion to Asylbek Osmonov, our Chief Financial Officer to discuss some of the specific financial results we achieved. Asylbek?
Asylbek Osmonov: Thank you, Mr. Zalman. Good morning, everyone. Net interest income before provision for credit losses for the three-month end of June 30, 2024 was $258.8 million, an increase of $20.5 million compared to $238.2 million for the quarter-ended March 31, 2024, and an increase of $22.3 million compared to $236.5 million for the same period in 2023. The increase was partially due to operation of Lone Star Bank acquired on April 1, 2024. During the second quarter of 2024, we recognized purchase accounting provision expense of $9.1 million related to the Lone Star acquisition. In addition, fair value loan income was $7.2 million for the second quarter, compared to $1.9 million for the first quarter of 2024. The net interest margin on a tax equivalent basis was 2.94% for the three-month end of June 30, 2024, compared to 2.79% for the quarter-ended March 31, 2024 and 2.73% for the same period in 2023. Excluding purchase accounting adjustments, the net interest margin for the three-month end of June 30, 2024 was 2.86%, compared to 2.76% for the quarter-ended March 31, 2024 and 2.7% for the same period in 2023. Non-interest income was $46 million for the three-month ended June 30, 2024, compared to $38.9 million for the quarter-ended March 31, 2024 and $39.7 million for the same period in 2023. Higher non-interest income during the second quarter 2024 includes a net gain of $10.7 million, resulting from Visa stock conversion, partial offset by the loss on sale of investment securities. Non-interest expense for the three-month ended June 30, 2024 was $152.8 million, compared to $135.8 million for the quarter-ended March 31, 2024, and $145.9 million for the same period in 2023. The lean quarter increase was primarily due to merger-related expenses of $4.4 million, three months of Lone Start Bank operation and FDIC special assessment of $3.6 million. For the third quarter 2024, we expect non-interest expense to be in the range of $141 million to $143 million. The efficiency ratio was 51.8% for the three-month ended June 30, 2024, compared to 49.1% for the quarter-ended March 31, 2024 and 53.2% for the same period in 2023. Excluding merger-related expenses, FDIC special assessment and net gain on sale of securities, the efficiency ratio was 49.1% for the three-month ended June 30, 2024. The bond portfolio metrics at 6/30/2024 have a modified duration of 4.1 and projected annual cash flows of approximately $1.9 billion. And with that, let me turn over the presentation to Tim Timanus for some details on loan and asset quality. Timanus?
Tim Timanus: Thank you, Asylbek. Our non-performing assets at quarter end June 30, 2024, totaled $89,570,000 which is 40 basis points of loans and other real estate, compared to $83,811,000 or 39 basis points at March 31, 2024. This represents a 6.87% increase. Since June 30, 2024, $2,517,000 of non-performing assets have been removed or put under contract for sale. The June 30, 2024 non-performing asset totaled was comprised of $84,497,000 in loans, $113,000 in repossessed assets and $4,960,000 in other real estate. Net charge offs for the three months ended June 30, 2024 were $4,368,000 compared to net charge offs of $2,143,000 for the quarter ended March 31, 2024. This is a $2,225,000 increase on a linked-quarter basis. There was a $9,066,000 addition to the allowance for credit losses during the quarter ended June 30, 2024, resulting from the Lone Star State Bank of West Texas acquisition. No dollars were taken into income from the allowance during the quarter ended June 30, 2024. The average monthly new loan production for the quarter ended June 30, 2024, was $278 million compared to $308 million for the quarter ended March 31, 2024. Loans outstanding at June 30, 2024, were approximately $22.321 billion compared to $21.265 billion at March 31, 2024. The June 30, 2024, loan total is made up of 41% fixed rate loans, 30% floating rate loans, and 29% variable rate loans. I'll now turn it over to Charlotte Rasche.
Charlotte Rasche: Thank you, Tim. At this time, we are prepared to answer your questions. Our call operator will assist us with questions.
Operator: [Operator Instructions] And the first question will come from Peter Winter with D. A. Davidson.
Peter Winter: Really nice margin expansion this quarter even if I exclude the purchase accounting accretion. Can you just give an update on that NIM outlook by fourth quarter? It seems like you can do better than the 3% and how you're thinking about the NIM into next year.
Asylbek Osmonov: I think we have to look at our NIM, what happened in the second quarter. So we had two things happening, right? It was our organic growth on NIM that we expected, plus we had a Lone Star acquisition that helped. So those two combinations gave us pretty good lift in the margin. So if we look at our model, I think it's still showing improvement on the margin, continuous improvement on the margin going forward. And for the fourth quarter, I think we expect being a little bit better, but right now we say that our exit margin will be around 3% as we guided, so it has not changed since then, but we expect for better as we hopefully continue to grow loans and manage our deposits.
David Zalman: I think, Peter, I could probably give you a little bit more reassurance or at least I feel like I can. I think the net interest margin, at least from the models that we have, shows that -- again, I think we'll hit what we said. The Queen Mary is turning around in the driveway out there. I think that we're going to be able to hit what we have said we'll hit by the end of the year. I think maybe even, like you said, maybe a little bit better. But our six-month, 12 month and 24 month net interest margins really show that we should continue to increase, up or down 200 basis points in our model. So I think that we're definitely on the right track. I think in 12 months, we're showing about a 3.2% net interest margin. This is just a model, this is a static model. I mean, loans stand where they're at, deposits stand where they're at and 24 months, I mean, we start getting back up. I'm not going to put what our model says because I think it looks too high, but I'd say we'll still be maybe back to what our normal net interest margin is. Historical is probably about 3.4 to your length. And that's what we're shooting for right now. And I think that's the way it should go. As far as net interest income, that may be another issue. I mean, we like seeing the net interest income go up, but again as interest rates, if interest rates do drop, that would be pressure on the net interest income. But it'll take time to re-establish what the interest expense will be. And also goes into consideration what's rolling off at the same time that we have and repricing, so all of that goes. So what I'm saying is there could be some noise in those numbers short-term, but long term, I think this model is correct. And I've seen it go when we started talking last year at 273 to almost read where we're at today. And I think I see it going forward, so.
Peter Winter: And then just one more question, just loan, can you just talk about loan demand, maybe provide an update on the competitive landscape for lending? We did see some pressure on period end loans from legacy prosperity and then also just continued runoff from First Capital. Are we getting closer to the bottom there?
Kevin Hanigan: Yes. This is Kevin. I think we are, Peter, I think it's going to be aided by the prospect of rate cuts, which I think is going to both stabilize deposits. In fact, we were talking earlier in the week that is with the prospect of rate cuts that a lot of money that moved off the banking industry's balance sheet into treasuries will work its way back into the bank. I think we were talking about that on Monday and loan behold yesterday, we had a client move back in the process of moving back in about $20 million out of treasuries back into a money market account here at the bank. But it'll also aid in the way people are thinking about growing their business. So I think going back through our guidance so far for the year, we started off the year with 3% to 5% growth in core loans. Q2, we backed that off a little bit saying that probably towards the lower end of back end loaded and that's where we sit today. It's still very, very competitive out there for almost everything we look at. And so it's still a knife fight when it comes down to rates and things of that nature, but I'd say in the last couple of weeks, we've seen particularly in our middle market customers who in the short run are more likely to be borrowing more as construction projects we approve may not fund for six or nine months from now. Some renewed optimism in where the economy is going and some inventory builds and some folks in fact expanding plant and equipment. So I think the second half is going to has the prospect of being much better aided by the general belief that rates are going to moderate.
Asylbek Osmonov: I think it's also I could say that where deposits have been and now the competition has been, we have had opportunities to increase our position and some shared credits that we've had. But again, I think our terms and conditions we kind of toughened up a little bit to holding that we really want to keep we still want to build customers that have true relationships with us. And I think that's held us back a little bit too. But that's by design we kind of pulled back ourselves, hoping and waiting till we see the turnaround in deposits and all that stabilize and come back to the bank. Tim, did you say?
Tim Timanus: Yes. I think everything you guys are saying is absolutely correct. What's been encouraging to me is when we talk to existing customers and potential new customers about prospective future loans, they all have things that they want to do. They have projects that they want to start. So there's a fair amount of enthusiasm about trying to get things moving and do things. And they're all sitting there waiting for a rate cut is the bottom line. And I think any rate cut at all will make them feel better. I think if you get as much as 100 basis points rate cut, which won't happen day one with a cut, I wouldn't think, but maybe it would. I think you'll see some projects coming off the desk and moving forward. So I'm reasonably optimistic that things are going to be better as we move forward in the year -- certainly into next year.
Operator: The next question will come from Manan Gosalia with Morgan Stanley (NYSE:MS).
Manan Gosalia: On either loan yields or NIM, are you able to separate out how much of the expansion came from the core Prosperity portfolio and how much came from the Lone Star acquisition?
Asylbek Osmonov: Yes. If you look at our margin expansion and I was going to talk the core NIM improved from 276 to 286. Our organic was very similar, maybe a basis point better than what we did from Q4 of last year to Q1 and the rest of them came from Lone Star acquisitions. So I think if we looked at it like 50-50 increase was between Lone Star and organic.
Manan Gosalia: And that organic expansion is coming from the fixed rate asset repricing?
Asylbek Osmonov: Yes. The repricing story continues and we expect it to continue from here.
Manan Gosalia: And then maybe if you can just speak to some trends on the deposit side, what do you think on NIB excluding what you got from Lone Star? And just as you're thinking about downside deposit betas and rate cuts from here, how should we expect the deposit portfolio to behave?
Asylbek Osmonov: I don't know about the best answer on this, but I'll give it a shot and you guys can tag in. I think as we look at the month of July, I'd say it's still fierce out there. I mean, we still get some requests for modifications off of rate sheet, but stabilization would be the word I would use. I mean, through Tuesday anyhow last time, having looked at the balance sheet for today, deposits -- core deposits outside of public funds are actually up, not very much, but they're up. There wasn't brackets around it and that was encouraging for us to see. So I think stabilization and to the extent we do have rate cuts, I think that will improve even more so.
David Zalman: I think that's exactly right. I mean, that's what I'm seeing is stabilization. I think that we also will see deposits as we quick competing against the government and the treasuries and interest rates come down. I think you'll see more people coming back into the bank. So I think we see that. Just I always keep in mind though, this is a quarter for us where we, you can go back historically and we've always lost deposits this quarter and next quarter seasonally just because of our public fund. So keep that in mind. I think overall, our overall feeling is that deposits are we never really went out and bought broker deposits. We really weren't to stay where we're at. And so I think we all feel about the same.
Kevin Hanigan: But we didn't, like a lot of banks that had higher loan deposit ratios had the need to go chase deposits with rate. We just never really chased through rate. I think we've maintained our money market -- stated money market rate at 3% on the high end. And there's been some exceptions above that. But -- and you could say, well, that decision cost us to lose some deposits over the last couple of years, not a ton, but we've lost a couple of quarters. I think I may view it on the other side of it. We found out just how strong the core deposit franchise is with people sticking with us. If you just look at our overall cost of funds, you guys got it for the universe of banks out there. Our cost of funds is significantly better than most of our peers.
David Zalman: And I think you hit a high point there when you mentioned people staying with us, sticking with us. When I talk to customers and potential customers, they're into treasuries for the obvious reason to yield. But their preference is to have the money with us. And they'll say that. They really prefer not to have all their money with the federal government for whatever reason. That's their own decision. But it's good to hear that dialogue and how many of them say, we really want to start moving money back to you guys. Now proof is in the pudding whether they do or they don't. But I think there is a desire to do so. And if the treasuries weaken some more, I think you'll see more money coming our way.
Operator: The next question will come from Dave Rochester with Compass Point.
Dave Rochester: Maybe just to round us out on the loan discussion, it looked like the First Bank (NASDAQ:FRBA) loans were down maybe almost 25% since the deal closed. But it sounds like that's stabilizing here. How are you thinking about the potential runoff at Lone Star? Is there anything in that book that you want to get rid of? And then outside the core loans on the warehouse side of things, how are you thinking about that trend from here? It looks like you guys saw some good seasonality this quarter, so we get to hear what you're thinking on that front going forward. And are you still adding clients to that business or is it steady state right now?
Kevin Hanigan: Yes. Let me I guess there's two parts to that question. And as it pertains to Lone Star very, very different bank than First Capital, really good credit quality loans we really like underwritten the way we like to underwrite them. So I don't expect much runoff out of that portfolio, really clean. I mean, when we did due diligence, it's not often for Randy Hester to say this is a really clean bank and he led the due diligence team and he came back, but this thing is clean. So I don't think we'll have a ton of runoff of that portfolio. It's a really good bank, really love the people. It's a good deal for us. Warehouse, let me answer the customer question first. We've actually let a number of customers go over the last 15 months. I think our peak customer count in that business was either 43 or 44 customers and we're down to I think 32. And a lot of that was either rate and or more recently performance where they might not have been doing as well and we either reduced our exposure to them or eliminated it. So we -- it's not that we were losing customers, it's we flat out fired a bunch of them. Now the customers we've got have been really good to us. As you said, we're into the seasonal period of this business which seems to be lost in all the years of refi and echo refi booms and all the other things. We're back to business as usual. And I got to tell you, when I said we'd average $900 million for Q2, at the end of May, I was a little worried we weren't going to get there. April, May were pretty weak, and then June was very strong. The strength of June has continued into July through last night. The average for July is $1.105 billion, so I expect that to continue through August and maybe moderate just a little bit seasonally in September. And part of that will be what happens with rates. I'm not saying September may not moderate as much as usual if rates abate a little bit. So if I had to put a number on where I think we average for the quarter, I'd say on the very low side, just to be conservative $975 million but more likely in the $1 billion to $1.25 billion range.
Tim Timanus: I would add. You look at the comparison between Lone Star and First Capital, for example, in our non-performing assets as of June 30, about $36 million is First Capital, in other words, about 40%. On the Lone Star side, it's about $2 million about 2%. And I think that's indicative of what Kevin mentioned about the difference in the quality of the portfolios. I would be surprised if we had big drops in loans outstanding from either one of them at this point in time. I think we've pretty well identified the problems at First Capital. There's always surprises down the road, but I wouldn't think they would be overly material. So I think we're seeing some stabilization there.
Dave Rochester: And maybe switching to M&A. Appreciate all the opening comments there on that front. I was wondering what the conversation level was like at this point? Has that picked up at all with stock prices moving in the right direction here to levels possibly closer to where seller expectations would be? And what do you think the chances are? You do get a deal done here over the next year? And then absent the deal, how do you guys think about buybacks going forward with the stock trading where it is, but with capital likely continuing to grow at a fairly decent clip here over the next year?
David Zalman: There's no question, I think. I think if you saw the conventions and all the political stuff that's going on right now, there was a lot of optimism a week or so ago about if there is a change in administration or there is a change that would be more favorable to banks. And I think that's true. I think if you saw a change of administration, you would see more M&A going on. And I think that it even -- it stirred up a lot of people. We do have more costs coming in. I think it's the last week or so and the last few days or so, it's kind of mitigated a little bit, nobody really knows which way it's going. But I think if you do see a change in administration, you definitely will see a big uptick in the M&A market.
David Rochester: On the buybacks?
David Zalman: Yes. I think that you're right. We seem to be making good money and even it shows that we’ve even continue to make more and more money. But when our stock does go down like it did, it was unfairly. We felt it was an unfair price. We're going to probably always jump in and buy back.
Operator: The next question will come from Catherine Mealor with KBW.
Catherine Mealor: I just wanted to follow-up on the margin conversation. You mentioned targeting maybe with some upside of 3% margin by year end '24 and then maybe hitting around [320] by mid-'25, and that's what you've told us before. How should we think about the kind of initial downside to margin once we start to see cuts? I know you mentioned that there might be some volatility. Is there a scenario where the margin declines? Or is there still enough back book asset repricing to where the margin still is going to continue to move up throughout '25? Just maybe not at as high of a pace as we factor in the cuts?
DavidZalman: Again, I don't have exactly what the exact numerics that you're looking for. But I would say that basically goes back to what I said, there will probably be noise in it. But I think the numbers that we gave to you should -- we should end up there by those periods of time. So it just may be noisy until you can get things readjusted. But we really feel comfortable with this model. It's -- I've been here. So it's -- we have a lot of confidence in it. So we think we will get there. But again, I think it could be noisy. We'll try to look in more to what you're asking, the actual numerics. There could be short-term changes like when the prime drops like that, and we don't get to change the interest rates immediately or it takes time or there's the asset that's repricing. So I know exactly what you're asking and it's a good question for us, too, and we'll work more on that.
Asylbek Osmonov: Yes. And just to add to that. Our balance sheet has been neutrally positioned when we looked at it and we run some models.
David Zalman: Up and down.
Asylbek Osmonov: Yes, up and down. So when we run some models down 50 basis points. Our model still shows that at the end of the quarter or end of the year at exit, net interest margin still holds up around 3%. So even with that, we feel confident where we are.
David Zalman: As a good point, I see that even if we had 50 basis points, we still end up with 3 basis points.
Asylbek Osmonov: Yes because of the neutral position and we still have a tailwind of our security repricing from 2%. We have repriced that 5%-plus, that's our tailwind that's helping us. So with that, I don't think that there's much change even with 50 basis points. But personally, I believe we're going to have maybe one cut rather than two cuts.
David Zalman: Well, in a caveat, this is a static balance sheet. I mean the loans dropped dramatically or increase, either one way, that all affects this. When we talk -- we're talking about really a static balance sheet analysis.
Catherine Mealor: And can you remind us, do you have the dollar amount of fixed rate repricing maybe in the back half of this year and then into next?
David Zalman: I don't know if we have the next year. Historically, we've said we have about $2 billion in bonds that are repricing. And on the loan side, we had, how much for?
Asylbek Osmonov: So loans or cash flow, we'd say about $5 billion, but out of $5 billion, fixed is about 40%. And so that's going to be repricing on the loan side and $2 billion of securities.
Kevin Hanigan: Yes. I think the fixed is closer to -- the fixed and variable is closer to 60%.
Asylbek Osmonov: Okay. Yes. My bad. 60% on the fixed -- on the loan side.
Kevin Hanigan: So $3 billion a year, $1.5 billion in the back half of the year.
Asylbek Osmonov: And $1 billion from the security in six months.
Catherine Mealor: And then maybe just one more margin question. You've talked about excess cash building to $1.5 billion to $2 billion. That's still your plan for the back half of the year or are we kind of coming back on the lower end of that range?
David Zalman: That would be a yes, unless I can convince the Federal Reserve to change their opinion of what's liquidity. Again, I can talk with them. It's really crazy because we have $15 billion of lines of credit between the Federal Home Loan Bank and the Federal Reserve. And we really consider that, a phone call and it can drop this. So we used to run with not a lot of liquidity because we could just draw on our lines. But again, after the Silicon Valley deal and Signature and all that, I mean, everything changed and they came up with this deal. But the truth of the matter is you had $1.5 billion on hand. And there was truly a real run that wouldn't be enough. You have to draw on these lines. And we probably have more liquidity. We have probably more lines available than anybody in our average accounts like $30,000. So I'm hoping we can convince them to change. It probably will over time if this probably won't be right away.
Catherine Mealor: And especially if you're considering M&A, maybe to be on the high end is a safer place to be?
David Zalman: Say that again at the high end?
Catherine Mealor: Especially if you're considering M&A, having excess liquidity is a safe place to be.
Kevin Hanigan: We've come a long way in building the cash already. I mean it's -- part of this was the security sale in the quarter that helped.
Asylbek Osmonov: And the cash flow from our investment portfolio.
Operator: The next question will come from Brett Rabatin with the Hovde Group.
Brett Rabatin: Wanted to ask the M&A question in a different way. I feel like the regulators have some idea they'd like to see deals announced that are out of market, low branch closures. And so I wanted to ask if you're thinking about M&A, do you have to get on a plane to have talks or can you still drive a car, i.e., in Texas? Any comments today you would have on whether in state or out state might be more likely for you?
David Zalman: Well, I think it goes back to my conversation. If there's a change in administration, I don't think it's going to matter if it's in Texas or in other state. Right now, I think that you're probably right. They'd like to see something. I mean, the whole philosophy. And again, this is coming down from the upper administration, not just the heads of the FDIC or the OCC. That's really coming up from their bosses upstairs. The FTC and everybody, they'd rather see stuff that you're not closing down something. But again, I think there’s a change -- and I can even tell the tone. I probably have some of them listening and they'll probably call me in a minute after we all get through. But I think the tone is changing. I think that they are looking now that we do have to have some M&A. And my gut feeling is it will unless the administration doesn't change then I think we're back to where we were -- I could say we're back to where we were. But even -- I don't even know that I would go that far. I do think that the tone of the regulators is changing. I think when you add Silicon Valley Bank close, you had Signature, Republic, I mean all of that, it may all the regulatory agencies unnerved. And I think it's taken them a little bit of a while just to get a handle on where all the banks are and where they're comfortable. I think that is happening. So I think either way, there will be somewhat better. The tone will be somewhat better. But if the administration changes then, I think you're going to have like a little mini boom probably.
Kevin Hanigan: And Brett, keep in mind, it's a 10-hour car drive from Houston to Far West Texas.
Brett Rabatin: The other question I wanted to ask was this quarter, you had a provision. Last year, you had one quarter with a provision. How should we think about any thoughts on thinking about provisioning from here? And I know that obviously depends on if loan growth reaccelerates, what have you?
David Zalman: How should I answer in a minute, but the provision this time was just solely based on our CECL calculation and because of the merger. But I mean, really, we have $350 million, I’m talking from top of my $359 million in reserve, $397 million if you count what's in our other reserve for unfunded loans, and we have $80 million something loan. So we have over 4x the amount of reserves is what we have is non-performing. Yes. So I think we're pretty good right there.
Kevin Hanigan: Yes. But the only reserves we've put up in the last couple of years have been acquisition related to the day one CECL numbers. So the 2 points in time you're referencing were both acquisition related.
Asylbek Osmonov: Well, second quarter of last year and second quarter both related first. Last year was our First Capital Bank acquisition. This quarter's Lone Star per CECL rules and GAAP rules, you have to put provision expense on the loans you're bringing over, that's a rule change and but there was no provision on ourselves.
Kevin Hanigan: Yes. I think it's safe to say unless something changes materially, and we look at this every quarter when we run our models. But in our minds, things would have to change pretty materially for us to be thinking about posting provision this year, outside of the acquisition.
Brett Rabatin: And maybe just lastly on the expense guidance, $141 million to $143 million in the third quarter. Is that net of expense savings? Can you maybe give us a little more color on how you get to that number in 3Q?
Asylbek Osmonov: Yes. Just this quarter, we had a little bit higher because of the extraordinary items and we had some projects we had. So that's why we came a little bit higher. But $141 million, $143 million is including the Lone Star operation we're going to have, and that's in combination. We're going to still continue to have some savings from the Lone Star acquisition, but we're working on some project that's going to run up the expenses. So the net-net, it's kind of offset each other. That's why our guidance did not change from $141 million to $143 million, and we feel pretty confident about that on the third quarter.
Operator: Next question will come from Michael Rose with Raymond James.
Michael Rose: Just wanted to clarify on the -- sorry to go back to the margin, but the exit rate for the fourth quarter. Can you guys hear me? Sorry about that. So the exit rate for the fourth quarter, is that on a core basis or would that include the accretion income? And just separately also back, what would you expect to -- what's the schedule accretion for the next couple of quarters?
Asylbek Osmonov: Okay. I'll answer the second question first. So our expectation that normalized accretion for the third quarter will be $4.5 million for third quarter. And so when we gave guidance of being a 3% of exit, that's including the normalized, say, run rate or fair value income.
Michael Rose: So that's inclusive of the purchase accounting accretion. Okay. That's perfect. And then separately just -- I noticed that the trust fees were down this quarter. I just want to see if there's anything in there. I think most banks have actually seen that up a little bit. So any color would be great.
Asylbek Osmonov: Yes. I think our trust income kind of stay the same as we are -- we did not lose any customers. What happened in the second quarter, we had some one-off ordinary income in the second -- I'm sorry, on the first quarter, we had some extraordinary income came in. There was a trust. I think sale or not sale. Yes, state fee came in. That's why it was unusual in the first quarter. But while we have $3.6 million, that's a normal run rate. And if you look at Michael, from the last year to this year and six months, our trust income up by more than $1 million. So it just looks like it went down, but it was unusual event happened in Q1.
David Zalman: In fact, our trust assets continue to grow year-over-year. A lot of the deposits that were in the bank are in the trust department.
Michael Rose: Yes, that's what I was asking. Also just last for me, just in the other expense or other income that was down about $2.2 million Q-on-Q. And I know bumps around a little bit, but that's the lowest level we've seen in a while. Anything happened this quarter or offsets or anything we should consider?
Asylbek Osmonov: Yes, there was nothing unusual. Usually, we have one-off income every quarter here and there, and we had a significant one-off income happened in the Q1, which we did not see this one. But I think the run rate, what we had of I thought $36 million to $38 million, that will be a normal run rate, and we should be expecting that in the Q3 and Q4.
Operator: The next question will come from Brandon King with Truist Securities.
Brandon King: So I wanted to follow-up on expenses. I think you mentioned how there are some investments being made. So just how are you thinking about expense growth beyond the third quarter? And what are you expecting also from an inflationary standpoint in your expense base?
Asylbek Osmonov: So I think looking like fourth quarter, I think the expense should stay stable. I don't think -- I don't see anything increasing significantly in the fourth quarter. And going beyond, I mean, it's kind of hard to say, but we don't see anything significant. I know we're working on some projects that will have increase in expenses for maybe '25. But I don't see anything significant, let's say that.
David Zalman: And you've been accruing for some of those additional expenses, haven't you? A little bit that we'll be facing later on.
Asylbek Osmonov: Incurred, yes. The incurred expenses, we had not paid that. We accrued it in the -- that was the second quarter additional expenses. But I think I gave guidance on maybe like 2% to 3% increase in year two or three. So that probably happens. But right now, I can't think of anything.
David Zalman: Brandon, it's always hard to come up with something like that. But again, if we don't -- we've been very good at bringing our costs down and find a way to cut the cost if we don't have the income to come in to increase the expense. So we -- historically, we found ways to keep it where it's at.
Brandon King: And then a question on loan growth. I know before you mentioned how you've been holding more resi loans, production on the balance sheet instead of selling it. But any updated thoughts there and how you're thinking about whether keeping more residential production on the balance sheet or maybe being more opportunistic in the secondary markets?
Kevin Hanigan: I'd say more opportunistic in the secondary markets. We have largely curtailed the growth in that portfolio. We do have -- I mean we do take care of our core customers. We do have some onetime close products that continue to fund up and complete. But in terms of new originations, they're down. And it was more a matter of balance sheet size in our case. The category got to be 33%, 34%.
David Zalman: Correct.
Kevin Hanigan: Of the balance sheet. We just think that's a comfortable level for us and a high end of the comfortable level. So we've set pricing in that category to get paid for what we are going to produce and what we will produce. We hope, in many cases, it will be available in the secondary market, and we can generate some fee income through loan sales.
Brandon King: And then lastly, also going back to your comment on, I think purchase accounting accretion being $4.5 million. Is that just for Lone Star or is that total purchase accounting accretion for?
Asylbek Osmonov: That is total, including the Lone Star, FCB and all other acquisitions. So it's in total.
Operator: The next question will come from Jared Shaw with Barclays (LON:BARC).
Jared Shaw: Just looking at the discussion around loan growth as well as the cash and securities, where do you think a good exit rate for average earning assets is for the end of 2024?
David Zalman: What was the exit rate?
Kevin Hanigan: What will the average earning yield be?
Jared Shaw: Yes. Average earning assets at the end of the year.
Asylbek Osmonov: Yes. I think as we look at our model, we continue to see growth in that area. I don't know if I can pinpoint exactly what's it going to be. I mean, right now in the second quarter, we had [468]. I think is going to be continuing to increase.
David Zalman: It's hard because, I mean, the Fed does come down rate cuts related. I mean on a static basis, there's no question it would continue to go up. I think that would change if the rates are less. That's just a really hard question.
Jared Shaw: Just in terms of using cash flow from securities to fund loan growth versus deposits, just trying to see where an exit rate could be, given the loan or with expectation?
David Zalman: Bad to ask on something like that, but again, it's going to be a lot really theoretical, I think. But we can look at it.
Kevin Hanigan: And even the runoff of the securities, even to the extent we put it in cash, we're getting overnight, [540]. So we're going from [2 to 540] even in those cash holding. So it's well lost opportunity to the extent it could have gone into loans at something higher, it's still, we're picking up 340 basis points.
Jared Shaw: And then just the last for me, just circling back to something, David, you had said in your comments. If we look at lower rates, I think you had said margins should still be neutral, but that could spur deposits coming on to the balance sheet as well as some loan growth but NII could be under pressure. I guess just trying to square that, how are you still seeing good growth with stable margins? You would think that would be driving better NII?
David Zalman: Yes. Well, again, I don't have the model in front of me. Just -- you would think that the net interest income would be harder to grow because interest rates are coming down. So to look at continued really increases in net interest income maybe tougher to do. Our net interest margin does show us with interest rates coming up or down 200 basis points, still increasing over the next 6, 12 and 24 months timeframe. And that has to do with the existing assets that we have as well as lowering the deposit expense that we have, too. So you have a lot of moving parts in there. If you don't models trying to square something like this in your head is pretty hard. But I do feel very comfortable where we're at with these models.
Kevin Hanigan: Yes. I think what David -- let me try to put another cut on maybe what David was saying because I do think NII is going to continue to grow. But there will be a period of time when our floating rate book moves down with rates overnight. And deposits won't move as fast.
David Zalman: Exactly.
Kevin Hanigan: So when he talks about some little blip in the short run, like over a six month period of time, it will be dampened a little bit because the deposit rates move down as fast as our floating rate loans move.
David Zalman: That's exactly what I'm trying to say, that's the noise that I meant.
Kevin Hanigan: That's his version of the noise.
Operator: Your next question will come from Jon Arfstrom with RBC (TSX:RY) Capital Markets.
Jon Arfstrom: David, maybe another way to ask some of these margin questions. What -- you kind of alluded to it earlier, but what do you think a normalized margin is for Prosperity? I know it's a tough question, but you talked about 3.40. We're trying to get all these little nuances about what happens if rates go up or down. But what do you think?
David Zalman: It's a good question. I think historically, we went back and looked in our historical net interest margin. I’m looking to cut him because he did this for me, here this stuff. If I'm wrong, jump in. But normally, a normal net interest margin for us historically has been around 3.40. There's been some highs and there have been some lows, but historically, that's where we would end up at.
Jon Arfstrom: And do you think -- we had these liquidity discussions in a quarter or two ago. Do you think, is the balance sheet any different? Or do you think that we can eventually get there?
David Zalman: Absolutely. Yes. I mean I think that -- again, I feel very comfortable with these numbers. They're not just made up. This is a model that we've used for the last 25 or 30 years and I really do believe in them. I mean, the only caveat I would say is like there is a big change in loans up or down or big change in deposits up or down. So I see both of those as positive. I think that we've gone -- after COVID and the money drop into the banks, we just have so much money come in. We really didn't even pay much attention to it, and then the last 1.5 years or 2, I mean we've really been sucking win with interest rates going up and deposits going out the other way. I really think that what happens is supposed to happen. I think that we're -- it's moving in our favor. I think that as interest rates come down, we do think that money that was outside the bank will come back in. That's from treasuries and people feeling better about it. And so that will also provide more money for loans because people would do more loans because interest rates are going down that they put on hold right now that Tim mentioned a while ago. So I think it's all positive. But having said that, it's a crazy world, Things could go to other way. You never know. Just looking at it from common sense, it should -- we should be in a positive mode over the next two years, for sure.
Kevin Hanigan: I don't know if this will make any sense or not. But I'd say, we are always confident in this NIM numbers we’ve been given here and we've hit them consistently throughout the year. No delays, nothing else. We've been right on the mark. If anything, we become increasingly confident.
David Zalman: Yes. I think so for me.
Jon Arfstrom: How about return on tangible normalization? I mean you can see it in the charts, right? I mean, obviously, it seems like it's a margin issue and you alluded to it, David. But what do you think is an appropriate return on tangible for your company?
David Zalman: I think before, again, before the loss in earnings because of the net interest margin and the spread, I think we used to hit again, jump in Kevin if you want to also. I think we see about 15% or 16% return on tangible capital. And I think that's fair, and I think that's where we want to go again. But keep in mind, too, that we have a higher tangible capital than most banks. I mean, a lot of banks are 7% and 8%. We're over -- our leverage ratio is over 10%. So again, we could probably be criticized for keeping so much capital. But again, it's been nice to have when we've been able to buy stock back. It's been nice to have in pursuit of an acquisition. So we can make that number even a lot higher right now, but we elected to keep that capital high. So I think it is -- it's just we run that kind of bank. I mean we've tried always -- we're always covered. It's like my wife said, you always have pairs of socks and underwear that you haven't used, why keep buying? But that's why we have extra capital.
Jon Arfstrom: That's a new one for me, David. I have a follow-up story for you, David, off the call. Just one more last one. Not a big deal on credit, obviously, it looks good, but you guys show your non-owner occupied commercial real estate. Can you just talk a little bit about what you're seeing there when things come up for renewal and maybe the overall health of that book?
Kevin Hanigan: I'd say that books really strong competitive. We were looking at something the other day, and our lender who brought in a relatively for us a lower rate than we would have liked. I think he was talking [799] or something. He was highlighting all the banks on owner occupied who have special deals going that are somewhere between [700 and 750]. So it's a competitive side of the market right now because it usually comes with a full wallet. You end up getting the company's revolver. You get the treasury management business, and it's been competitive. It's holding up very well.
Operator: This concludes our question-and-answer session. I would like to turn the conference back over to Ms. Charlotte Rasche for any closing remarks. Please go ahead, ma'am.
Charlotte Rasche: 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: The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
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