Hello and welcome to the Prosperity Bancshares Third Quarter 2023 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] 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 third quarter 2023 earnings conference call. This call is being broadcast 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; Merle Karnes, Chief Credit Officer; Mays Davenport, Director of Corporate Strategy; and Bob Dowdell, Executive Vice President.

David Zalman will lead off with a review of the highlights for the recent quarter. He will be followed by Asylbek Osmonov, who will review some of our recent financial statistics, and Tim Timanus, who will discuss our lending activities, including asset quality. 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 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 our filings with the Securities and Exchange Commission, including Forms 10-K and 10-Q 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, and good morning to everyone. I would like to welcome and thank everyone listening to our third quarter 2023 conference call. I am pleased to announce that the Board of Directors approved raising the fourth quarter 2023 dividend to $0.56 per share from $0.55 per share that was paid in the prior four quarters.

The increase reflects the continued confidence the Board has in our company and our markets. The compounded annual growth rate in dividends declared from 2003 to 2023 was 11.5%. We continue to share our success with our shareholders through the payment of dividends and opportunistic stock repurchases, while also continuing to grow our capital.

Our tangible capital increased $243 million from September 30, 2022 to September 30, 2023. This is the amount Prosperity retained after paying $203 million in dividends and repurchasing $72 million of our common stock during this period, reflecting Prosperity’s stable earnings.

Prosperity reported net income of $112 million for the quarter ended September 30, 2023, compared with $135 million for the same period in 2022. Our net income per diluted common share was $1.20 for the quarter ended September 30, 2023, compared with $1.49 for the same period in 2022.

Prosperity’s earnings were primarily impacted by a lower than normal net interest margin. Although our net interest margin is lower than we would like, the good news is that based on our models, we show our net interest margin improving in a 12-month and 24-month time period to our more normal levels as our assets repriced to market rates.

However, if rates increase more than we anticipate, this could change. The net interest margin on a tax-equivalent basis was 2.72% for the three months ended September 30, 2023, stable when compared with 2.73% for the three months ended June 30, 2023.

Prosperity continues to exhibit solid operating metrics with annualized returns on tangible equity of 12.58% and on assets of 1.13% for the third quarter of 2023. Our loans were $21.4 billion on September 30, 2023, a decrease of $221 million or 1% from the $21.7 billion at June 30, 2023.

Our loans increased $2.9 billion or 15.8% compared with $18.5 billion on September 30, 2022. Excluding the loans acquired in the First Capital acquisition and new production by the acquired lending operation since May 1, 2023 and the warehouse purchase program loans.

Loans on September 30, 2023 grew $111 million or 2.3% annualized compared with June 30, 2023 and grew $1.4 billion or 8.2% compared with September 30, 2022. Interest rates have continued to increase, and there are signs of the economy slowing and loan growth moderating as intended by the Federal Reserve’s actions.

Deposits were $27.3 billion on September 30, 2023, a decrease of $68 million, or 2 basis points, compared with $27.4 billion on June 30, 2023.

Deposits decreased $2 billion, or 6.8%, compared with $29.3 billion on September 30, 2022, primarily due to a decrease in business deposits and public fund deposits partially offset by an increase in merger acquired deposits.

After a more challenging time in the first quarter of the year due to large bank failures outside of Prosperity’s markets, our deposits stabilized during the third quarter. Total deposits, excluding Public Funds, increased $260 million during the quarter. Importantly, this was achieved without the purchase of any brokered deposits.

Our noninterest-bearing deposits represented a strong 37.6% of total deposits.

Our non-performing assets totaled $69 million, or 20 basis points of quarterly average interest earning assets on September 30, 2023, compared with $62 million, or 18 basis points of quarterly average interest earning assets on June 30, 2023, and $19.9 million or 6 basis points of quarterly average interest earning assets on September 30, 2022.

The increase during 2023 was primarily due to the merger and an increase in other real estate. Our asset quality remained sound and the allowance for credit losses on loans and off balance sheet credit exposure was $388 million on September 30, 2023. As mentioned in our last conference call, the accounting for acquired loans has changed.

Under the new accounting rules, the full loan balance of each acquired loan is booked at closing and a reserve as needed is set aside. Our nonperforming assets include approximately $23.7 million from the First Capital acquisition. The bank appropriately reserved for these loans at closing based on day one accounting.

However, we are now doing a deeper dive into the collateral values and liquidation alternatives for these loans. If appropriate, charge downs to the allowance for credit losses may occur in the next several quarters. Again, these loans are fully reserved for. Our acquisition of Lone Star Bank shares is pending the receipt of regulatory approvals.

We are committed to the transaction and continue to work together with Lone Star in anticipation of the closing. The parties have extended the termination date in the merger agreement to March 31, 2024, and are prepared to complete the transaction as soon as possible following receipt of regulatory approval.

Our operational conversion date is set for second quarter 2024. We continue to have conversations with bankers considering opportunities. We believe that higher technology costs, salary increases, loan competition, funding costs, succession planning concerns, and increased regulatory burden all point to continued consolidation.

The Texas and Oklahoma economies continue to benefit from companies relocating from states with higher taxes and more regulation. This combined with people moving to the states requires additional housing and infrastructure, a driver for loans, and increased business opportunities.

Although, there are signs of the economy slowing and loan growth moderating, I believe our bank is located in two of the best states we can be for future growth and continued Prosperity. Thanks again for your support of our company.

Let me turn over our discussion to Asylbek Osmonov, our Chief Financial Officer to discuss some of the specific financial results we achieved.

Asylbek?.

Thank you, Mr. Zalman. Good morning, everyone.

Net interest income before provision for credit losses for the three months ended September 30, 2023 was $239.5 million compared to $236.5 million for the quarter ended June 30, 2023, an increase of $3.1 million or 1.3%, and compared to $260.7 million for the same period in 2022, a decrease of $21.2 million, or 8.1%.

The net interest margin on a tax equivalent basis was 2.72% for the three months ended September 30, 2023 compared to 2.73% for the quarter ended June 30, 2023, and 3.11% for the same period in 2022.

Excluding purchase accounting adjustments, the net interest margin for the three months ended September 30, 2023 was 2.68% compared to 2.7% for the quarter ended June 30, 2023 and 3.1% for the same period in 2022. Period end borrowings decreased $550 million during the third quarter 2023, primarily funded by cash flows from the bond portfolio.

Non-interest income was $38.7 million for the three months ended September 30, 2023 compared to $39.7 million for the quarter ended June 30, 2023 and $34.7 million for the same period in 2022.

Non-interest expense for the three months ended September 30, 2023 was $135.7 million compared to $145.9 million for the quarter ended June 30, 2023 and $122.2 million for the same period in 2022. The linked quarter decrease was primarily due to the merger related expenses in the second quarter related to the First Capital Bank acquisition.

For the fourth quarter 2023, we expect non-interest expense to be in the range of $134 million to $136 million. The efficiency ratio was 48.7% for the three months ended September 30, 2023 compared to 53.2% for the quarter ended June 30, 2023 and 41.4% for the same period in 2022.

The bond portfolio metrics at 9/30/2023 showed a weighted average life of 5.2 years and projected annual cash flows of approximately $2.1 billion. And with that, let me turn over the presentation to Tim Timanus for some details on loans and asset quality..

Thank you, Asylbek. Our non-performing assets at quarter end September 30, 2023 totaled $69,481,000 or 32 basis points of loans and other real estate compared to $62,727,000 or 29 basis points at June 30, 2023. This represents a $6,754,000 increase.

The September 30, 2023, non-performing asset total was comprised of $60,126,000 in loans, $35,000 in repossessed assets, and $9,320,000 in other real estate. Net charge offs for the three months ended September 30, 2023 were $3,408,000 compared to net charge offs of $16,065,000 for the quarter ended June 30, 2023.

This is a 79% decline on a linked quarter basis. There was no addition to the allowance for credit losses during the quarter ended September 30, 2023 compared to an $18,540,000 addition to the allowance during the quarter ended June 30, 2023 that resulted from the acquisition of First Capital Bank of Texas.

No dollars were taken into income from the allowance during the quarter ended September 30, 2023. The average monthly new loan production for the quarter ended September 30, 2023 was $398,000,000 compared to $565,000,000 for the quarter ended June 30, 2023.

Loans outstanding at September 30, 2023 were approximately $21.433 billion compared to $21.654 billion at June 30, 2023. This is a 1% decrease on a linked quarter basis. The September 30, 2023 loan total is made up of 42% fixed rate loans, 27% floating rate loans, and 31% variable rate loans. I will now turn it over to Charlotte Rasche..

Thank you, Tim. At this time, we are prepared to answer your questions. Our call operator MJ will help us with questions..

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Today’s first question comes from Brady Gailey with KBW. Please go ahead..

Hey, thank you, good morning..

Good morning, Brady..

I know in the past we’ve talked about the dynamic of the asset repricing pushing the net interest margin higher. I think previously you talked about a 3% margin within a year and like a 3.30% to 3.40% margin within a couple of years.

Is that still the right way to frame the amount of NIM upside you’re seeing going forward?.

Every time I answer that question, Brady, I get looks in the room from my General Counsel that I’m supposed to be cautious on this all the time, but the answer is yes. I mean, our numbers are still showing, again, we’re showing – we feel like we’ve kind of bottomed out where we’re at.

We feel there will be a decent increase in six months, 12 months and 24 months based on some of the numbers you just mentioned. And our models – we just ran our models again as of 9/30/2023, and we’re still showing that right now..

Okay. And you could get there tomorrow if you restructured the bond book. That’s such a big opportunity. And you guys clearly have the excess capital to consider doing something like that. I know it’s gotten more costly just with the tick up in rates that we’ve seen, but it also would be more EPS accretive if you pull the trigger.

So maybe just updated thoughts on how you’re thinking about a possible bond restructuring or just a partial bond restructuring..

Well, we’ve looked at it. I mean, again, you either hold the bonds for three years and you get your money back or you sell them right now and take your loss and you get your money back through an accounting accretion. But to me, that’s just kind of Voodoo Accounting, really.

It would take our earnings from where we’re at next year at $500 million to maybe $600 million and something million or $650 million. I mean, it would just propel the earnings. But again, those earnings would be propelled primarily from accretion numbers in.

More so than that, under accounting, you have to put your bonds either in available for sale or HTM. And since this bank has began, again, just because we were such an acquisitive bank, we always had to watch our capital. And so we never could take the chances, when we didn’t have that much capital to have a lot of big changes in our capital account.

So we pretty much put probably 90% plus of all of our securities in HTM. So you really couldn’t do it from an accounting standpoint. And if you did do it, once you did it, it would change everything. You couldn’t go back to the HTM..

That’s correct. And I can just add to his question. You said partially no. If you have to take the whole portfolio, you have to do the 100%.

So the decision would have to do, do you want to take the whole portfolio or not? And I think at that point, with the duration being short and we can get all the cash within three, four years, we determine just leave it and let it reprice and use the cash flows for paying off our borrowing..

Okay. And then finally for me, just a quick one on the provision. It looks like you booked about $3 million of net charge offs, you built reserve by about $6 million. So I would have thought the provision would have been like, $9 million or $10 million, but it’s zero. So there must be something going on there..

Yes. On the provision, Brady, we did put additional about $10 million for FCB, as we mentioned in our comments earlier. We’ll kind of dive in a little bit, and we put an additional $10 million that’s related to FCB, but the charge off $3 million was some of them were related to overdraft and loans. So it’s only $3 million..

It’s crazy the amount of – a lot of times it goes through that category, but probably a majority of a lot of that times, it’s just overdrafts and stuff like that..

Combination overdraft and loans. Yes. And $3 million being not material, we determined we don’t need to provision anything this quarter. And our model shows that we appropriately have allowance balance..

Well, you have $388 million in allowance for credit losses and $60 million in non-performing. So I’d say we’re covered pretty good, probably..

That’s pretty strong. All right, great. Thanks for the color, guys..

I will say that a lot of that money, I mean, some of that money was First Capital reserves. I mean, we put, again, I don’t know the exact numbers at $85 million or so in reserves for First Capital….

Including this – everything’s about $95 million..

$95 million?.

Yes. Including one-time….

But no matter how you look at it, $388 million, even if we decided to charge off – not charge off, but relook at some of those things, I think you still have $388 million or $60 million, it’s still a very strong position..

Great. Thank you..

The next question comes from Dave Rochester with Compass Point. Please go ahead..

Hey, good morning. Nice quarter..

Good morning, Dave. Thank you..

Appreciated the update on the longer term NIM outlook, and it’s good to hear the NIM has bottomed here, and that makes sense. Just given the repricing opportunity you guys have in the asset side.

What are you guys expecting at this point for NIM more near-term? Any way to put some parameters around that expansion that you’re expecting here in 4Q and in the next year?.

Yeah, if you look at – I would say, for the fourth quarter, we have probably moderate increase as we – based on what we look at our balance sheet, we see third quarter, we believe is bottomed on the NIM perspective.

So now we’re going to – as we continue optimize our balance sheet from the standpoint, we’re using our bond portfolio cash flow to pay off higher borrowing. As you saw, we paid off $550 million right now in the third quarter. So we’ll continue to do that optimization and balance sheet that will be NIM accretive for us.

And as we continue to grow the loans that will reprice over time, that should help us from that standpoint. So I would say moderate increase in the fourth quarter with all what I described right now with balance sheet optimization..

Yes. And then 4Q is normally a pretty good quarter for deposit growth, right? I mean, you normally see some seasonal strength there that should help pay down some more of those borrowings, potentially..

It will. So we usually see the public fund growing in the fourth quarter, because of the tax payment. It’s usually end of the fourth quarter, like in the end of December and January.

But I think more the impact we’ll see in the first quarter and what we’re also seeing that public funds, they’re not – probably not keep their deposit as longer they used to be, because they’re moving to some tax pool or other areas. But we’ll see the benefit of it in the fourth quarter.

But I don’t know how much of a significance we’ll see, but we usually see about $400 million to $500 million deposit increase due to tax collections from the public funds..

But again, just cautionary, they left that money with us a lot of times, but now that they can get 5% and 6%, they may move it quicker, too..

I agree. I think the timing of the keeping is probably very short. Once they collect it, they’ll be moving out to the higher yielding export..

That expansion you’re talking about at 4Q isn’t dependent on that kind of growth, it sounds like. That’s more from the asset repricing and stabilization of the core deposit side..

That’s correct. Especially, what we said on bond portfolio, we have $2.1 billion cash flow with paying off our – and if you look at our loan portfolio, we have about $5 billion of cash flow from the loan portfolio that’s going to reprice. But you have to keep in mind on the loan portfolio that out of $5 billion, about 65% is fixed to variable loans.

That probably at 5% and 5.5% yielding. So they’re going to replace to 8% and 8.5% right now, but the 35 already floating, so we’re not going to get a benefit out of that. But yes, based on what we see, and we see modest increase in the fourth quarter..

Great. You’re saying new loan yields are still in that 8% to 8.5% range..

That’s what we’re seeing. It is..

Great. Maybe just one more on capital. You’re just about back to 50% Q1 right now. Was wondering what your thoughts were on the buyback here with the stock near 50%, seems like you’ve got a lot of excess capital here that you could deploy. I know some of that will go to the deal closing coming up, but 15% gives you a lot of flexibility there.

So I just want to get your updated thoughts..

We do have a lot of capital. I know a lot of people is questioning why we’re not doing more. At the same time, there’s a lot going on. I think that, again, I’ve always said that we like to use our capital for primarily mergers and acquisitions and also increasing dividends. At the same time, we truly are building capital.

You can see that even not one of our best years, we still retain quite a bit, even after dividends and share repurchases. But one thing that we’re looking at right now is with the regulatory agencies looking on what their new requirements are, we’ve been hesitant.

I mean, right now would be, like you mentioned, you couldn’t be a better time to be buying our stock, at least in my opinion. This is one of the cheapest things I’ve ever seen, trading under ten times next year’s earnings. So it would be a time.

I think right now we’re really trying to see from a regulatory standpoint what their new requirements are going to be, how they’re going to consider losses in the bond portfolio. They consider that part of your capital, not part of your capital. However, ours is an HTM right now. It doesn’t seem like it’s on the block for any change on that.

It does look like if you have your bonds available for sale, that is going to be part of your capital calculation. At least right now, things could change, but we’re just waiting to see that. And we do think there’s going to be a number of opportunities out there right now with everything happening. So having excess funds is not a bad place to be.

It’s a high class problem right now..

Great, agree. Thanks, guys..

The next question comes from Michael Rose with Raymond James. Please go ahead..

Hey, thanks for taking my questions. A lot have been asked and answered, but Kevin, while I have you on here, could you just comment on the warehouse? Your guidance last quarter was pretty much spot on and just wanted to see how your crystal ball is looking as we think about that business over the next couple of quarters..

I think 90 days ago, we said we’d probably average about 950 we did just a shade better than that. Michael, through last night, the average is down from that $972 million for the quarter, it’s down to $816 million, so it’s dropped off pretty significantly. We closed yesterday at $740 million almost exactly out in the warehouse.

So I think for the quarter, not too unlike last year’s fourth and first quarter, we’re probably looking more in the neighborhood of $725 million on average.

So any kind of shortfall we would have gotten out of the public funds in terms of excess liquidity coming in the fourth quarter, we’re going to have a couple of hundred million here come off the warehouse that we’ll use. If there’s loan production, it’ll go to loan production. If there’s not, it’ll go to pay down the Federal Home Loan Bank borrowings.

So it’ll be down. We’ve got some uses for it..

Helpful. And then maybe just on the production, you guys have had pretty decent growth this year, I think some of the dislocations in your Texas markets, especially for some of your competitors, but seems like some of those competitors are starting to get a little bit more aggressive on growth and just wanted to see where that leaves you guys.

And should we consider kind of a mid single digit growth rate for next year, kind of what you’ve got to do for this year. Thanks..

Yes. I think, Michael, I would tell you low to mid and off from what I said was mid last quarter. And just by recapping part of that is our decision to sell mortgages rather than to portfolio them. And that’s brought us into that mid range. We’ve seen some relatively weaker loan demand, I’d say, over the last month or so.

And there’s a lot of things that don’t pencil out real well at these rates or take so much equity into a deal, it’s just harder to get deals done. So, look, if it’s – on the lower side, that’ll be more money that can be used to pay down the borrowings, and if it’s on the mid side, that’d be great. So I’m just looking forward, I’d say low to mid..

And a lot of it has, as Kevin, don’t you think, when we were just flush with deposits, we were looking at all kinds of loans, whether people had relationship with us or didn’t have relationships with us. And now with deposits not being in the banks and everybody’s trying to reduce their borrowings.

We ourselves kind of restricted loans a lot, because some loans that we would normally have made six months ago, we don’t make today because we’re not getting a complete deposit relationship. So some of this is by our own making, too. So I guess, we were at one end of the spectrum, we went to another end of the spectrum.

And I guess, it depend where we finally how the dust settles, where we all end up..

There’s a lot of pluses and minuses, right? There’s a lot of people really restricted. They basically have shut down, which you think creates opportunity. And I think we’re into that period where the market’s adjusting and borrowers are getting used to having to pay up.

And our requirements of, hey, while you might have done this historically with bank XYZ, if you’re coming here, you need to move your deposits from XYZ to us or we’re not interested. So we’re going through that adjustment period as we speak. And if people are willing to pay up and move us deposits, we’ll be there for them, but….

I just told yesterday, like, one of the lenders came to us and said that one of the deals that they’re in, two or three of the banks that are participating in their line of credit are not willing to participate anymore and ask if we would participate. And I asked what the rate was and it was still, I think, SOFR plus.

Anyway, the total rate was about 7.5. And this guy’s always wanted to – good customer has always wanted to do business with us, but we’ve always been about a half a point short. So the lender has said he would really like to come back, he like us to do it. And he says, you’re always about a half a point higher. And I said, well, we still are.

So if we do see the pricing where it becomes better and that we may take more risk also, I think, at the same time..

Totally, got it. Great color. And maybe just one final one for me, David, you threw out a lot of potential drivers for M&A as we move forward. Just broadly speaking, how do you think this all plays out? And then if you could just give us kind of a quick update on the Lone Star deal and maybe what’s holding it up.

I know you talked about it last quarter, I just want to see if anything has changed. Thanks..

Well, I was hoping if some of the FDIC people were on the line, maybe they could answer that about the approval on Lone Star. But we are still working with the regulators to get approval on the Lone Star deal.

I’m hoping, it’s just times – all I can say is times are a lot different than when they were a year ago, but we’re still completely committed to it, we’re trying to get it done. And hopefully, if we can get that thing done and approved, hopefully, there will be some more opportunities out there that we’re looking at.

We’d like to move forward with those also..

Great. Thanks for taking my questions..

The next question comes from Peter Winter with D.A. Davidson. Please go ahead..

Thank you. Tim, I just want to go back to the comment about selling resi mortgages. You had talked about that last quarter, but resi mortgage was a pretty strong quarter for loan growth this quarter. And I’m just wondering is that kind of happened towards the end of the quarter and it’ll accelerate from here in terms of originate and sell..

I think a lot of that growth that you’re seeing was already in the pipeline. It’s not unusual to take 60 to 90 days from the date of application to getting a loan actually closed and funded. So a lot of what you’ve seen for this quarter was really a carryover from the prior quarter.

And I think you’ll see more moderation going forward, if that makes sense..

Yes, no, it does. Thank you. And then, can I just ask about what you’re seeing in terms of credit quality within commercial real estate, particularly multifamily and office, there has been a number of articles talking about office pressure, particularly in the Texas market..

We have seen very few problems up to this point in time, really almost none. And I think there are a few obvious reasons for that. If you take office first, we typically have done owner-occupied as opposed to non-owner-occupied. And the projects that we’ve been involved in have been reasonably small, two to three-story type facilities.

So we’re really not in the large non-owner-occupied office market, really never have been. So that has insulated us somewhat from the problems that you’ve referred to in office. And in terms of multifamily, we’ve always tried to be very careful, obviously with any loan, but certainly with multifamily.

And I think our way of weeding through those opportunities and checking them out has benefited us. So far, the developers that we’ve done business with have got pretty decent projects and are holding their own. There continues to be growth in our markets in terms of population. So that certainly hasn’t hurt the multifamily piece of it.

So I think it’s stable right now and I don’t see any reason to think that that’s going to change overnight. Obviously, from a macro standpoint, out there in the world, so to speak, there are a lot of disconcerting things. But most of those really don’t directly affect the markets that we’re in, in Texas and Oklahoma.

And we just don’t see a big change in that anytime soon. So we think it’s pretty stable going forward..

Okay. Great. And there’s one last question, just credit obviously is very strong.

You have nice reserve coverage to non-performing loans, but is there – how much longer can you take a zero provision expense, do you think?.

Well, I’ll make a quick comment. A lot of that reserve is based on what we call environmental factors. And I mentioned it just a minute ago in what I was saying. There is some weakness out there in the world and there’s some things to be concerned about.

And do those end up affecting us more than they have today? Who knows? But that possibility is there. You asked about, and I mentioned the office market. It’s a pretty good example. If you look at the statistics, they’re not good. And does that tend to creep into other segments? We don’t know.

But we’re trying to be prepared for the future in a reasonable way. And we think that per our models and all of our calculations, we think where we are right now on the reserve is appropriate. And I wouldn’t see any significant change anytime real soon on that. So we’re not expecting to take money out of the reserve.

We don’t see any huge additions to the reserve either based on what we see right now. So I think we feel comfortable with where we are and we think it’s steady as it goes for a little while..

I think most banks, Peter, probably there’s not many banks probably carrying a remount reserve like us at 1.7% reserve, compared to the losses that we’ve had historically.

So I think when Tim’s referring a lot to the environmental factors, probably there’s probably a big piece, and there is a larger piece in our reserves for the environmental factors. So we’re – a number of banks a year or two ago were pulling money out of the reserve and putting back into income. We never did that. We’ve left that money.

So we really don’t like to play with that taking money in, putting money out at different times. We like to be pretty consistent. So we do feel we’re well-reserved. And we shouldn’t, I don’t see putting money in unless something catastrophic happens, I don’t see us putting money in for the next 12 months, such as May..

Okay, great. Thanks, David..

The next question comes from Brandon King with Truist Securities. Please go ahead..

Hi, good morning..

Good morning..

Good morning..

So, industry is experiencing a softer revenue growth outlook next year, although not as much the case for Prosperity. But I just wanted to get your thoughts on how you’re thinking about expense growth next year. I know a lot of other banks are announcing initiatives and restructurings.

But I just want to get a sense of what you’re thinking about how you want to manage expenses going forward..

So, Brandon, in the short-term I’ll talk about the fourth quarter. I think it’s going to be in line with what we had in the third quarter, as I mentioned. It’s $134 million to $136 million. But if you go out for 2024, I think with the inflationary environment we are right now, and we do our merit increases annually.

So I would expect for next year probably 2% to 3% expense growth, but we have a lot of initiative. We’re trying to automate a few things, but nothing significant that would – but we’re trying to mitigate the cost.

But if I had to get guidance for next year, that would be 2% to 3% increase, but that’s not including the special FDIC assessment that’s going to come in, in the first quarter, that’s excluding that special assessment. So I would say 2% to 3%..

And how much is that FDIC?.

So I think based on our initial calculations, above – going to be $10 million annually..

$10 million annually?.

Yes, on the FDIC, special FDIC assessment. In addition to that we already had assessment in 2023, which is costing another $10 million..

So really, you’re talking about an extra $2.5 million or so a quarter..

Yes, $2 million to $2.5 million, yes, per quarter expenses. That’s on the FDIC assessment..

Okay. That’s very helpful.

And then lastly for me, I’m sorry if I missed it already, but what are you expecting for security cash flows and maturities over the next 12 months?.

So our cash flow, it’s about $2.1 billion in the next 12 months..

That’s on the security….

On the security….

…on the loans..

I’m sorry. On the loans, it’s about $5 billion..

All right. But again, some portion of that will....

Okay. Sounds good. Thanks for taking my questions..

Your next question comes from Manan Gosalia with Morgan Stanley. Please go ahead..

Hi, good morning..

Good morning..

Thanks for taking my question. Can you give us some more detail on the fixed rate loan repricing dynamics that you’re expecting from AR? I know you mentioned 65% is fixed to variable rate loans reprising about 3-ish percentage points higher.

But how much of the loans are in dollars or in percentage are set to repay between now and the end of next year.

And how does the increase in duration as a result of higher long end rates impact that re-pricing dynamic?.

So then when we looked at the $5 billion that is including all the duration we have already in our loan portfolio. And from the cash flow, I would say maybe a little bit higher in the first half than second half, but essentially the cash flow would be evenly.

If you look back in the – I would just give you numbers what’d happened last three quarters, and maybe that gives you some information, Manan. It’s like in the Q1 we had $1.3 billion, in Q2 we had $1.5 billion, and in Q3 we had $1.4 billion.

So, based on that cash flow, you can see that the actual cash flows, you can see that that’s on – that’s going to be evenly distributed over 12 months..

And that’s loans re-pricing about 3-ish percentage points higher?.

On the fixed and variable loans, yes, that’s out of – that 65% out of $5 billion, that’s the re-pricing by additional 3%, but floating is floating, so it’s….

Already re-priced..

Yes, it’s already re-priced..

Sorry, I meant the numbers you gave for the last three quarters were all of those re-pricing three percentage points higher, or was it only half of that, or can you help us think through that?.

I think that’s the same percentage as what we said….

65% of that $1.4 billion, $1.5 billion is fixed or variable, that is re-pricing higher. The other 35% is….

Floating..

…is floating. So….

Yes. The composition is very similar to that, what we had experienced cash flows and what we expect..

Got it.

As we think through your model for NIM to improve over a 6, 12 and 24 month timeframe, how much of that improvement is coming from the securities maturing and pay downs in higher cost funding versus re-pricing in loans?.

I would say this Manan, our – the model that we disclosed, that’s a fixed balance sheet….

Static, yes….

Static balance sheet, what we have that’s getting – we have $2.1 billion on the bond portfolio and $5 billion on the loan. And that’s assuming also just make sure that model assumes that deposit static stays flat and there is no significant re-pricing in the bond – I am sorry in the deposit cost.

But with the competition and all that, you don’t know where we’re going to be, but that’s our model. So that’s a variable we use..

I mean, basically what we’re saying is everything is static, the amount of money in Federal Home Loan Bank, amount of loans, amount of deposits, this is just re-pricing and duration changes that bring this net interest margin up..

That’s correct..

Got it. That’s very helpful. And if I could just get a clarification, I think in the prepared comments, you mentioned that if rates increase more than you anticipate, that NIM trajectory could change.

Does that mean that if rates are higher than you anticipate, then the NIM would be higher because of the re-pricing dynamic or would it imply it would be lower either because of duration or because of deposit re-pricing?.

I mean, our balance sheet, we are pretty neutral on that standpoint. So if longer rate stays higher is a benefit for us because it’s longer time for our assets to re-price.

But on the deposits, I think we assume what we have right now is a little bit just re-pricing of maturity CDs, but other than that, we don’t have any additional increases in the deposits in our model..

I can make an overall statement that higher rates or lower rates, we still have the three – still a significant increase in net margin where it does affect you, at least what I’m looking at in the model is more in the short term on the 6 and 12-month time horizons. So if you look at a 12-month, you actually might do better.

You might do better – interestingly down 100 than you are if they stay the same. On the other hand, over 24 months, we still do better interest rates going up or down, 300 basis points..

Yes..

I know it gets kind of complicated..

Yes, it is. I mean, if Fed cuts the rates tomorrow, it will benefit because our overnight borrowing is going to be re-priced lower..

We actually do better it looks like if they do cut. If interest rates went down 100 basis points, we actually do better, a little bit better..

It’s very helpful..

Not much..

It’s very helpful, thank you..

The next question comes from Bill Carcache with Wolfe Research. Please go ahead..

Hi, thank you for taking my questions.

As the debate continues around how long the Fed will keep rates higher for longer, do you think you have a good handle on which of your customers put on swaps a couple, say, two to three years ago when we were still under [indiscernible] and have so far been isolated from the impact of higher rates? Or your customer is not using swaps, just curious how you’re thinking about that sort of interest rate reset risk across your commercial customer base..

Yes, this is Kevin. We don’t have a ton of swaps on the books. In the early days when people were talking about swaps, we offered them a fixed rate just straight out for five years or seven years, and we can question the wisdom of that. Those are our re-pricing opportunities today. So the amount of swaps we have in the book is pretty negligible.

Most of the client base we have is generally, in our opinion, not sophisticated enough for swaps. We tend to do smaller, middle-market clients where you’re educating them on swaps. The ones we have are larger companies, but there is just not a – we don’t have a lot of swaps on the books..

There’s really, I mean, you have some smaller ones, but most of our swaps are in the middle-market lending, really, our larger customers..

Larger middle-market clientele, but it’s – notionally, it’s a couple hundred million dollars..

I think it’s actually lower than that now. Yes, I think it’s....

Oh, you’re right. One of them has recently paid off..

Yes, I think it’s down below $100 million now..

Yes. It’s pretty novel..

Understood. Okay. Understood. That’s really helpful. And then following up on your – the comments that you made around the deposit base, maybe if you could just speak to whether you see any risk that maybe terminal beta expectations could have to drift a little bit higher next year if rates were to hold just at these current levels..

Yes, I think you have to look at what the competition is doing. I think that’s the main driver. I mean, if you stay rate for longer, it might impact it. But what we’ve seen last, I’ll look at last few quarters, we had a – if you just look at cost of our deposit has increased in the first quarter because of the rate environment.

We had significant increase in the second quarter on our cost deposit. But in the third quarter, we actually saw the increase being less than what we had in the second quarter.

So I think that we’re optimistic that the increase in the deposit is going to slow down, then we’ll forego further because I think everyone who won a reprice, they always took opportunity to reprice. Then there is – we believe it’s going to slow down a little bit on the increase on the deposit level of increase going forward..

I completely agree with what Asylbek said. I said, if we use history as a guide, once the Fed pauses, it’s not atypical for betas to continue to rise, but it’s vastly reduced rates. And they may rise for up to six months post pause, again, at nominal levels, but it’s not an immediate freeze when the Fed pauses..

Got it. That’s helpful. And then lastly, we heard on the....

Just one last point I would make..

Yes..

Just one last point. We have a really – unlike a lot of banks of our size, we have a really pretty significant, what I would call smaller town retail deposits that seem to be a lot less sensitive to rates..

Understood. Yes. That makes a lot of sense. Finally, if I could squeeze in one last one. We’ve heard other banks talk about how a positive operating leverage is going to be difficult to achieve next year.

Maybe if you could just help us understand how you’re thinking about positive operating leverage as you look to the new year, given all the moving parts..

What do you mean by positive operating leverage?.

By the ability to grow your revenues faster than your expenses, and effectively manage expenses for the revenue environment, so potentially cut expenses if revenues were to slow or have a little bit more room to invest if revenue growth was stronger just the idea of managing expenses so that revenue growth outpaces expense growth..

I think that’s the beauty of our whole bank. I mean, that’s the whole story where everybody else is there, almost maxed out because their rights have already taken advantage of the higher rates. We’re just going to hit it. We will just be going into our stride of.

Even though we’ll have higher expenses, and we probably manage expenses better than anybody, and we will continue to do that. But the beauty of this whole bank, really, is if the models work and everything goes where everybody else is going to have that challenge, we should be doing much better..

Yes. We’re expecting some positive operating leverage. Our efficiency ratio because of the NIM declines, largely have gone from 42 to 48. As NIM returns and NII improves because of it, our efficiency ratio is going to drop back down to where our normal level is low 40s, where we normally play and….

Probably..

That’s really just a function of this kind of late-stage asset re-pricing that we have..

Once the Queen Mary turns, we’ll be doing better..

Understood. That is super helpful. Thank you so much. Appreciate it..

The next question comes from Brody Preston with UBS. Please go ahead..

Hey, good morning, everyone..

Good morning..

Good morning..

I just wanted to clarify something on the expense guidance. I think you said 2% to 3% for next year, excluding the special assessment.

Is that inclusive of Lone Star or would Lone Star be additive to that expense guide?.

That was a core number I was giving. Lone Star will be added on top of it..

Got it. Thank you for that. And I know it’s challenging, but if you had to kind of hazard a guess for our modeling purposes, when do you think we should layer Lone Star in from a closing timing perspective..

I’d say it’s hard to say. We’re hoping sooner rather than later. Our latest extension with them is through March 31..

Right..

So I think both companies are focused on getting it done before then..

Got it. Thank you for that. And then I did just want to clarify on the timing of the cash flow from the securities book.

Is that pretty even as well, so about $500 million a quarter moving forward?.

Yes, that’s even..

Got it. And just given that you have seasonal muni strength through the fourth quarter and the first quarter, typically, I think it was said earlier you could pay down more deposits. Is there any thought to maybe just keeping a little bit of that left over in cash just for the eventual third quarter kind of runoff a little bit next year.

So you don’t have to take up borrowings next year in case you do get that 3Q runoff of muni?.

Yes. I think we’ll – definitely the cash coming in from the public funds will probably keep it, but we don’t know how long they’re going to keep it, probably not long-term. So from that standpoint, we’re not going to be investing. But, yes, I think we’ll keep it ballpark same.

I don’t think we’re going to increase significant or decrease significant our cash..

We don’t – I mean, the bottom line is we don’t want to be borrowing $4 billion..

Yes, that’s exactly, that’s….

Our bank historically, we never – I guess if you go back, we – it’s not uncommon to see as $1 billion or $2 billion, but we don’t like being $4 billion and $5 billion..

Got it. Understood. I appreciate that. And so at what point, I guess from the securities roll off perspective, would you think about maybe reinvesting some of those cash flows? Is it kind of once borrowings gets back down close to zero? I’m just trying to think about when the yield on that portfolio could start to pick up again..

Right now I see all the payments being going to reduce our debt. So I don’t see, ask me in a couple of quarters maybe. I think with the money is probably spoken for a while here, I think instead of reinvesting..

Yes, I think we’re going to continue just paying down the borrowing at this moment..

And loan demand is going to be a factor in that..

That’s true. Yes, that’s true. I mean, the loan demand, even though we’ve tried to moderate it, we’ve tried to cut it down, we may decide if things the pricing does get good and we’re finally getting terms and conditions that we like, we may want to increase that. So that’s a good point, Tim..

Got it. Okay.

And sorry to stay kind of in the weeds here, but any thought given to when you do decide to start reinvesting, maybe putting some of those securities on as AFS just to give you more flexibility in the future than the HTM book gives you?.

No..

Got it. Thank you. And I did also just want to ask, I noticed that there was some strength from First Capital on the deposit side when I was looking at the press release.

Anything specific that drove that?.

I think right at quarter end they had a customer that sold his business and was pretty good size chunk of money. Most of that money has subsequently moved off the balance sheet..

Got it. And then this is my last one. I just wanted to try the buyback question a little bit differently, David. I just pulled up the price to tangible book chart on SNL and hit max just to get a long-term view. And this is at least per SNL’s history, the cheapest your stock has ever been on price to tangible book value.

And so if you do get the clarity that you’re looking for in terms of whether or not HTM is going to be included in capital and as you noted, it doesn’t feel like the winds are blowing that way right now. How aggressive would you be on the buyback? I think you’ve got 3.4 million shares left in the existing authorization that expires in January.

I assume you’d re-up that, but you just got a lot of capital. The stock is very cheap.

And so once we get that clarity, would you look to be more aggressive than even perhaps you’ve typically been in the past?.

I mentioned earlier, I think this is the best price and that we’ve ever had that anybody could buy in right now into our stock. So I think we would be interested in purchasing more. On the other hand, a lot of it depends on possible mergers and acquisitions at the same time too. So we have to keep both of those into consideration I think.

Do we really think, is it better to buy our stock back or can we make more money by buying or acquiring another bank? And so I know that’s hard. It’s not giving you what you need. But those are really truthfully.

Both of those go hand in hand of how much stock we can buyback and how much we – I really don’t think that we’re going to be impacted by the HTM number. I don’t think, I mean the Fed themselves have $1 trillion, $200 million loss on their balance sheet. So it’d be hard to spank somebody else when we got such a – when the Fed’s got such a big loss.

But – and they know that time will work that out. So I don’t think that’s going to be an issue. So I think once we do find out really where regulatory is going to be, we would be more interested in buying our stock, especially at these prices.

But again, we still – we’re constantly in talks with other banks at the same time too, and that would impact that..

It’d be a fair statement to say that when we look at buying another bank, particularly any bank of size, we look at tangible book value earned back on that transaction versus a buyback..

Right..

And we do realize there’s not much integration risk on doing a buyback, so it’s a safer bet. So you’d be willing to suffer more dilution on your own deal than you would on buying another bank..

And what’s different this time, I think in M&A than it’s ever been before. When you’re looking at acquiring or merging with a bank, banks have losses in their portfolio.

So instead of being net capital positive, just what somebody recommended at the beginning of the call, why don’t you take some of your capital and redo your bond portfolio, we’re not willing to do that.

But in a merger – in acquisition, you got to market to market, so you’re going to mark their capital down, which would bring the overall capital down, although we will get that money back really quickly. So those are just the considerations..

Yes, I would just think that just given the experience with Lone Star for a relatively simple deal, and it’s been extended due to factors that are outside of your control and may not be warranted, it just seems like the buyback, which is something that I know your shareholders would like, would be the safest and easiest route.

So you’re not kind of tied up with a merger but I appreciate….

If there’s nothing else, we’ll buyback our stock. Let me say that..

Got it. Thanks, guys..

The next question comes from Matt Olney with Stephens. Please go ahead..

Hey, thanks, guys. Just following-up on the time deposits. Asylbek, do you have any color on those time deposits being rolled over here in the near-term just the dollar amounts and the prices the yields come off that..

Yes. I mean we introduced our seven-month special CD program seven months ago. So we see those rolling over and we see a good level of renewal on that one. And I mean but from the growth, we don’t see as much of an increase in the growth what we saw in the first two months of it from dollar wise Matt, I think I need to get back with you.

I don’t have specifics on the….

How much is in that we sold in that product?.

$1.5 billion..

I think its $1.5 billion..

$1.5 billion..

$1.5 billion, $1.7 billion, something like that, yes..

Yes..

And we don’t have hardly any CDs that go beyond two years..

Well, our total CDs are what right now? I doubt that they’re under 10% of our….

Its about 12%, higher than 10%. But that only grows or we see that is in that seven-month special program, and they’re just renewing it..

But over time, if rates stay higher, I think you will see the percentage of CDs to other deposits continue to grow. I remember before rates went to zero, it wasn’t uncommon for a bank like us to have 20% or 30% of their money in certificates of deposits. So, over time, I think you could see that change for sure..

Yes, Matt, I did confirm it’s $1.5 billion on the seven-month specialty, right..

Okay. Thanks for that. And then on the $4 billion borrowing position. Any color on the duration here? I assume most if not all these are eligible to be paid down in the near-term..

Yes, essentially, we have a $3 billion from the Fed that we can pay off anytime and rest of them with FHLB overnight pretty much. So all $4 billion can be paid off in a day if we need to..

Okay. Perfect. And then on those cash flows, you mentioned Asylbek the $2.1 billion that you expect over the next 12 months.

Any color or commentary you can give us as far as the yields on those maturities?.

2%..

Yes, exactly. It’s exactly pretty much the same with our portfolio shows around 2%..

Okay. Got it. Okay. That’s all from me. Thanks, guys..

The next question comes from Jon Arfstrom with RBC Capital Markets. Please go ahead..

Thanks. I hope I’m last. Hope I’m the last one..

We had heard from you for a while. We thought you quite loving us..

There are no. There’s love, David, 20-year love.

Just – yes, real quick, the $10 billion – little over $10 billion in noninterest-bearing deposits, do you feel like is that a floor? Is it over in terms of the noninterest-bearing outflows?.

Anybody would like to say yes, that it is, but we really don’t know that. I think that if interest rates stay high, when I see money moving normally, you would think it’s because our money market rate, we’re paying about 3% that’s if you have over, what $1 million in it or something, or $100,000….

For the 50% $500,000….

$500,000, okay, so you would think that maybe that’s where the money would be leaving from to go to buying these treasuries now. But when I really look at it, we have another not only the $10 billion that we have in noninterest-bearing, we have another how much in interest bearing checking is paying 2015 or 25 basis points a huge amount of money.

But those are the two categories that I actually see go. People are – they are just starting to work their money more. So I guess the answer to the question is in and by itself, I think you probably will see, we will see money come out of those accounts buying either higher rate CDs or going to buy treasuries at the same time.

Hopefully, our bank historically Jon has grown the bank 2% to 4% a year organically in deposits. And of course, you hadn’t seen that at all. So I’m hoping this is just a gut feel, is that we will start maybe at some point we’ll turn around and start building that bank again to offset what’s really going out.

But people – the bottom line, people are working their money. This is an interesting because I asked Asylbek to look into it. Our bank historically, before you had all the helicopter money drop, we would grow the bank 2% to 4% organically every year on deposit side. And then of course, you had 10% and 20% gains with helicopter money.

But Asylbek went back and took all the money that we’ve lost and taken out the money that came from the acquisition of First Capital. And believe it or not today, if you would have never had the helicopter money, we’re kind of about in the same place. We’re still grown about 2% to 4%..

Yes..

So whether it looks like a lot of the money has left the bank, if you wouldn’t had it to begin with all the helicopter money, we’re probably right where we would have been to begin with. I know that’s getting kind of esoteric, but we really wanted to look at that.

So I think what – so I think the future is we’ll still get back to that other category too. You will see banks in the future start going deposits again organically, I think at some point in time..

Okay. Just two more random ones. FTEs were up 140 employees. And I normally wouldn’t ask about it, but that’s more than normal.

Is that acquisition word or what’s driving that?.

Yes. I think because acquisition had an impact on it, because FDA kind of on average, so that’s had three months of people from the FCB acquisition that’s impacting..

I think you have that, but you also have the regulators are pushing harder for data governance. They’re pushing harder in BSA. They’re pushing harder in compliance. I think you’re seeing all of that..

Yes..

Now some of that can probably be offset by the mortgage department. The mortgage I think we’re letting people go or reassess them in the mortgage department, so we might be able to offset that. But part of that is just regulatory burden too. As you get bigger and bigger, the regulatory burden, nobody would believe it. It’s crazy..

Yes, that’s what I was getting at. That’s what I was wondering. I remember you saying once, David, you had, after the financial crisis, 20 new employees working for the government, but they were on your payroll instead of the government, something like that..

Yes, but it was just 20 now..

Now probably over 200 now..

Okay. And just one more, and this can be quick, but on credit, it sounds like you’re not seeing anything.

But I’m curious, do you guys expect a credit cycle for the industry? When you look around and you look at your peers and you look at some of the loan proposals that you’re making to take loans from other banks, do you guys expect the credit cycle?.

To me, I mean, I’ll be the first to answer. These other guys can answer too. But I think the credit cycle is probably going to be more regional in nature. I think that if you’re in San Francisco or New York, you have populations that are moving out.

I think those are going to probably be impacted, especially from the office space and more so than I think what we’re seeing in Texas and Oklahoma, A properties don’t seem to be affected at all. In fact, if anything, more people are moving to the A properties. It’s really the B and C properties that are impacted.

And the bigger charge-off that we had last quarter or so really came from a three deal office deal that we had that really never was passed due. And maybe we jumped the gun and just sold it too quick. But we always like to get rid of our problems right away. But so I think you do see that seasonally popping up.

I do think that from the First Capital Bank that we acquired, we do see some problems. They’re not really commercial real estate office problems. They’re more in what nursing home, Randy? A couple of nursing homes and stuff..

Yes, some acute care and some spotty retail..

So we see that. And so I think a lot of it has to do with the underwriting and the risk that the banks took too. But it also comes from where you’re located. I think your circumstances around you add a lot to it.

So I think the banks that had good underwriting or even the banks that had good underwriting are located in growth states are going to be fine. The banks that have good underwriting in states where they’re seeing outflow, they probably will be fine too.

But the banks that historically have had bad underwriting, they’re going to be bad in both of those scenarios regional. And I think it’s just going to always go back. I think it’s going to go back to your underwriting really that’s just me..

All right. Thanks for the time. I appreciate it..

This concludes our question-and-answer session. I would now like to hand the call back to Charlotte Rasche for closing remarks..

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

The conference has now concluded. Thank you for your participation. You may now disconnect your lines..