Prosperity Bancshares, Inc. (PB) Q1 2020 Earnings Report, Transcript and Summary

Good day and welcome to Prosperity Bancshares, Inc., First Quarter 2020 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 first quarter 2020 earnings conference call. This call is being broadcast live over the Internet at prosperitybankusa.com and will be available for replay at the same location for the next few weeks. I'm Charlotte Rasche, Executive Vice President and General Counsel of Prosperity Bancshares. And on the call with me today is David Zalman, Senior Chairman and Chief Executive Officer; H. E. 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; May Stanford, Director of Corporate Strategy; and Bob Dowdell, Executive Vice President. David Zalman will lead off with a review of the highlights for the recent quarter. He will be followed by Asylbek Osmonov, who will review some of our recent financial statistics; and Tim Timanus, who will discuss our lending activities, including asset quality. Finally, we will open the call for questions. During the call, interested parties may participate live by following the instructions that will be provided by our call moderator, Eric. Before we begin, let me make the usual disclaimers. Certain of the matters discussed in this presentation may constitute forward-looking statements for purposes of the federal securities laws, and as such, may involve known and unknown risks, uncertainties and other factors, which may cause the actual results, performance or achievements of Prosperity Bancshares to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Additional information concerning factors that could cause actual results to be materially different than those in the forward-looking statements can be found in Prosperity Bancshares' filings with the Securities and Exchange Commission, including Forms 10-Q and 10-K and other reports and statements we have filed with the SEC. All forward-looking statements are expressly qualified in their entirety by these cautionary statements. Now, let me turn the call over to David Zalman.

Thank you, Charlotte. I'd like to welcome and thank everyone listening to our first quarter 2020 conference call. Our merger with LegacyTexas was completed on November 1, 2019. And our management teams continue to find commonalities and strengths that we expect will benefit our company, our shareholders and associates going forward. Our planned operational integration, remains on schedule for June of this year. In our efforts to continue to enhance shareholder value, Prosperity repurchased 2,092,000 shares of its common stock at an average weighted price of $52.59 per share during the first quarter of 2020. The net income was 130 million for the three months ended March 31, 2020, compared with 82 million for the same period in 2019. Our earnings per diluted common share were $1.39 for the three months ended March 31, 2020, compared with the $1.18 for the same period in 2019, a 17.8% increase. For the first quarter of 2020 on an annualized basis, return on average assets was 1.67%, return on average common equity was 8.86% and return on average tangible common equity was 20.1%, Prosperity's efficiency ratio, excluding net gains on the sale of assets and taxes was 42.9% for the three months ended March 31, 2020. Our loans at March 31, 2020 were 19.1 billion an increase of 8.7 billion, or 83.7%, compared with the $10.4 billion at March 31, 2019, linked-quarter loans increased 281 million, 1.5% or 6% annualized compared with the 18.8 billion at December 31, 2019. Our deposit at March 31, 2020 were 23.8 billion, an increase of 6.6 billion, or 38.5%, compared with the 17.1 billion at March 31, 2019. Our linked-quarter deposits decreased 373 million, or 1.5% from the $24.2 billion at December 31, 2019. A portion of this decrease was due to our planned reduction of higher cost and broker deposits assumed in the LegacyTexas merger. Excluding deposits, we assume in the merger and new deposits we generated at the acquired banking centers since November 1 2019. Deposits at March 31, 2020 grew $1 billion or 6% compared with March 31, 2019 and grew 162 million, 9 basis points or 3.6% annualized compared with December 31, 2019. Our non-performing assets totaled $67 million or 25 basis points of quarterly average interest earning assets at March 31, 2020 compared with $40 million or 21 basis points of quarterly average interest earning assets at March 31, 2019 and 62 million or 25 basis points of quarterly average interest earning assets at December 31, 2019. The increase during the first quarter of 2020 was primarily due to the merger. During the first quarter of 2020, Prosperity increased its allowance for credit losses to $327 million from $87 million in the fourth quarter of 2019 after adopting accounting standard, ASU 2016-13 also known as CECL. The amount of the allowance is based on our CECL methodology. We believe these additional reserves should help to insulate the company during these challenging and unprecedented times. Our allowance for credit losses to total loans, excluding the warehouse purchase program loans now stands at 1.88% compared with 51 basis points at December 31, 2019. With regard to acquisitions as one would expect conversations with other bankers regarding potential acquisition opportunities has subsided. However, we remain ready to enter into negotiations when it's right for all parties and properly accretive to our existing shareholders. While today's challenges are certainly extraordinary, Prosperity has a deep management team with experience in navigating and adopting in difficult times. We enter this economic downturn from a position of strength, with sound credit quality, robust capital, and liquidity and solid operating fundamentals. We believe that our team will see us through and we remain confident in our long-term future. I would like to thank every associate at Prosperity throughout the past several months, while dealing with various personal challenges related to the pandemic, our retail team operated at full capacity, enabling us to keep our locations open and serve our customers daily needs. Additionally, our operational staff and lending team were crucial and accepting processing and submitting thousands of SBA PPP applications and closing loans working around the clock to assist our customers. Thanks again for your support of our company. Let me turn over our discussion to Asylbek, our Chief Financial Officer to discuss some of the specific financial results we achieved. Asylbek?

Thank you, Mr. Zalman. Good morning everyone. Net interest income before provision for credit losses for the three months ended March 31, 2020 was 256 million compared to 154.9 million for the same period in 2019, an increase of $101.1 million or 65.3%. The increase was primarily due to the merger with LegacyTexas in November 2019 and 28.5 million in loan discount accretion in the first quarter 2020. The net interest margin on a tax equivalent basis was 3.81% for the three months ended March 31, 2020, compared to 3.2% for the same period in 2019 and 3.66% for the quarter ended December 31, 2019. Excluding purchase accounting adjustments, the core net interest margin for the quarter ended March 31, 2020 was 3.36% compared to 3.16% for the same period in 2019, and 3.26% for the quarter ended December 31, 2019. Non-interest income was 34.4 million for the three months ended March 31, 2020, compared to $28.1 million for the same period in 2019. The increase in non-interest income was primarily due to the merger with LegacyTexas. Note, the debit card income from LegacyTexas is now impacted by the Durbin Amendment. Non-interest expense for the three months ended March 31, 2020, was 124.7 million, compared to 78.6 million for the same period in 2019. The increase was primarily due to the merger with LegacyTexas. For the second quarter 2020, we expect normalized non-interest expense to range around 120 million to 125 million. In addition to this, we expect 3 million to 5 million in one-time merger expenses related to upcoming June conversion. Further, we expect to incur expenses related to SBA paycheck protection program in the second quarter, which are not included in the normalized non-interest expense guidance. As we discussed in prior quarters, we expect to realize most of our cost savings from the LegacyTexas merger beginning in the third quarter of 2020 after the system integration that is planned for June. To date, we have already realized some cost savings from the merger and eventually expect additional cost savings of approximately 8 million to 9 million per quarter combined this will be in line with announced 25% cost savings. The efficiency ratio was 42.9% for the three months ended March 31, 2020, compared to 42.94% for the same period in 2019 and 58.07% for the three months ended December 31, 2019, which included 46.4 million in merger-related expenses. The bond portfolio metrics at March 31, 2020 showed a weighted average life of 3.08 years and projected annual cash flows of approximately 2.2 billion. And with that, let me turn over the presentation to Tim Timanus for some detail on loans and asset quality.

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

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

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question today will come from Jennifer Demba of SunTrust. Please proceed with your question.

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

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

Yes. That's okay. Do how much of your loan balances have been deferred overall, and specifically in that hotel and energy bucket?

I don't think that I haven't broken down. Somebody else can jump in a minute. But what we have -- there wasn't as mentioned in March, but if you looked as of yesterday, we had 5643 loans that we did have an extension on out of 66,000 or almost 67,000. So that would be about 7% -- a little over 7.7% of our loans and the dollar amount that we extended were $66,829,000.

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

Kevin, you want to jump in on the oil and gas at all?

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

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

I think if it were up to me, I'm probably pretty bold. I would probably do it on the other hand, I know the regulators right now, whether or not. No, they haven't said that you can't do something that I think they would like this to make sure that you build your capital. And so I'd say for the most part, I've committed to them that if not in anything formal, but just talking to them unless our stock just went really through the bottom or something. We probably wouldn't be buying stock back right now. So but that's just kind of where we're at.

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

David, I know one of the big aspects of when you bought Legacy was, right sizing their balance sheet, running off some of their loan portfolio, kind of meld the two together, just kind of curious where you are in that process kind of what this environment might do to sort of change the timing of some of that. Or do you kind of have the balance sheet in terms of the left and right side kind of where you'd want it at this point.

I will let Kevin answer it. But I think we're right on schedule. I think when we first said this, we thought there'd be about 400 million in loans or 500 million in loans. And those guys have just done a fantastic team over there. The David Montgomery and Sam Duff, I mean, they're getting -- they're cleaning up the port -- I won't say cleaning up their outsourcing some of the loans that we didn't necessarily want there. As Kevin said earlier, the marks that we had on them, actually this quarter, we actually if we look at our ALL or whatever they want to call it now the CECL calculation we took about, Asylbek how much was that 13 million?

We have 13 million related to that.

13 million that was really related to that we took it out of a PCD, was it PCD and put it into the regular allowance. So everything so far has worked out really good. I mean, knock on wood, I don't want to just say everything's perfect in the world, but I think that we're really -- I think we are where we want to be I was a little bit leery on the -- where we going to stay in the warehouse lending program? I think we've gotten more comfortable with it and we were even able to -- there are some customers that we probably picked up a couple of customers because they were so strong that they couldn't get financing somewhere else and probably outsource a couple that we weren't making as much money on. And so that's worked out real well with this. I think the other portfolio was that commercial real estate portfolio, we really haven't seen a lot of growth in that portfolio yet, or a lot of loans. So again, it's just paying down like it is. I hope that gives you some color. And Kevin, you may want to jump in.

No, I think David covered a pretty well. If anything, I think we're ahead of schedule, we still have about, 50 million on the energy side, we'd like to work our way out of it, at least going back to those original numbers and where we sit today, we'd probably like to work our way out of a lot more than just 50. But, we're ahead of schedule Brad.

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

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

This is Asylbek. I would like to add that related to the broker CDs that we have. We have about at least 250 million at 2.5% that we are planning to reprice hopefully soon. So there's that one and also we have 125 in subordinated debt that we can payoff and I think end of the year in December. So that definitely going to help us with the repricing of high cost deposits.

In really deposits, I know even though they might have been down from the Legacy side, we have this month I guess with, we probably just -- probably in the last month or two positive increase probably $1 billion. And again, some of that's probably because of the PPP, but usually in times like this. And normally our peak deposits come in the fourth quarter and first quarter. And now it's not a time and this month we saw like in April. $1 billion increase. And so when we went back and looked, this happened in 2008 when times get a little tougher, we tend more people put more of their money with this us is that right Asylbek?

The flight to safety, you can see that.

And as far as the net interest margin, I think that Asylbek will probably tell you this, I asked him he feels comfortable in projecting anywhere from 3.45 to 3.55 net interest margin going forward. On total if you want the net interest margin without the accretion, what do you have three, but

Yes. Probably low to mid 3.30s that would be without accretion. And when we provided range 3.45 to 3.55, we've based on the about 13 million to 15 million fair value income that we expect in the second quarter. And related to the margin, I can speak a little bit. The way our balance sheet is structured, I think is very better insulated in this time environment, because we have -- if you look at our total interest earning assets 31% is in the bond portfolio with fixed rate. And also, we have about 35% of loans and fixed rates. So that definitely helped us to maintain, I would say our margin definitely is going to stay flat. But I think the wildcard in this environment is our SBA PPP program that depending on the timing of forgiveness, timing of the funding, it could impact the margin in the second quarter. I mean, it's going to be diluted a little bit to the margin. But if you look at from the EPS or bottom line, it will be very accretive to us.

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

Yes. Exactly.

And a lot of money that will be coming in from that PPP program. I think when it's all set and done, we'll have $1.50 billion to $2 billion in PPP loans, depending if we get them all approved or not.

That's going to definitely impact our bottom-line and EPS in a accretive way.

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

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

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

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

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

Somewhere between $25 and $30.

Closer to $20.

Yes. Thanks, Kevin, Merle is here. Merle said that we're probably using in the $20s. Merle, is that right?

Well, we're starting out in the low $20s. We're probably averaging into the mid-20s.

Yes. We have a stressed case that we're running and it takes it down to high teens, low $20s.

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

I think it's the same as what you just said. I think. And so again, I think it's exactly what you said. I think that we'll probably do better in these kind of times than maybe some of our peers because we're in a better position probably.

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

Really, we haven't probably last month, we might have bought because we got around -- we bought up a couple of 100 million dollars because we got around that 2.4%. Right now, really, with rates where they're at, we're just paying it down and taking the money and putting it back instead of borrowing from the Federal Home Loan Bank using that as a substitute and putting it back into the loan side.

They are on the warehouse.

Warehouse receipt deal. Yes, not warehouse receipt, we are warehouse mortgage.

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

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

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

I wanted to follow up on the SBA's PPP program. What's the average fee that you're seeing currently?

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

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

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

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

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

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

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

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

And what right now, we're not faced with obvious defaults that could change.

No, that could change.

That could get worse. And if it does, then our model will address it appropriately.

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

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

That is a fair way today. But, that what we call interest mark is going to bleed off over time. So over the next 18 to 24-plus months, that piece of what you call reserves is going to deplete. Still being 12%, everything over 12% is depletable.

We went back to look and with oil went to $25 a barrel. We first, I asked then to go back and tell me how much money have we ever lost over a two year period. And so I think in two years, and this may be in the slide show that we did. I think it was in 2016 and 2017 and over a two year period, we lost about $35 million and $25 million of that or $24 million of that was oil and gas and the majority of that was from a bank that we bought in Oklahoma there, so most of those losses came from that. So but again, we were smaller at that side. So that if we go through something like that, again, I can't say that's what our total losses, it could be who knows, it could be $80 million, it could be $90 million, who knows, but again, that just gives you some flavor where it was when oil went to $25 last time what we charge-off over a two year period.

Yes, David, that's right. That went from about mid-June of 2016 through the first quarter of 2018. So it was half of year 2016 and all of 2017 and the first portion of 2018. So that's exactly correct.

But as far as reserves, and again, you never can say you have too many, but in my lifetime as a banker, I never have never been at 1.88%. This is a whole new dimension for me. So I hope we don't need it, but that's more than I've never been in a bank where capital ratios we used to operate when we first started off and we had 5%. We thought we were in great shape. But now we have capital ratios of 10%, you've got allowance for loan losses of almost 2%. I mean, I don't know, I know we're in the situation right now, but I don't know that really the banking industry has ever gone into a downturn of where we're at right now as strong as most banks are right now also.

Our next question will come from Ebrahim Poonawala of Bank of America. Please proceed with your question.

Most of my questions have been answered. Just one, I guess for Kevin, to the extent you can -- how do you see the mortgage warehouse business playing out both in terms of just the demand over the next few months or over the next couple of quarters? And what you're seeing on the pricing side in terms of lending spreads?

Yes. Lending spreads have been pretty stable after years of being beaten down on margin there. I think you saw in the Q, our weighted average coupon for the quarter was 3.62 on the warehouse. And notably, it was a pretty big quarter in terms of refi. Purchased refi volume was 51% purchased 49% refi. So a lot of refi volume in the quarter. I actually think that warehouse volumes this year are going to peak in mid-May. So we're not too far away from what I think will be peak volumes. It will be somewhere between May 15 and May 2020 by my math. And for us, that peak could be somewhere between $2 billion and $2.3 billion and we've said we'd like to kind of keep this at $2 billion. We got a lot of bulge facilities out there to get folks grew volume. Just keep in mind, volume that comes on to our balance sheet is usually an application that was taken by one of our customers six weeks ago. So what I do expect post, call it, May 20, is that purchase volume is going to drop pretty dramatically and we're going to see a much lower balance from May 20 to June. And when that purchase volume returns, I don't know. And once it starts returning, realize we got another six weeks of lag before that application gets back on the line. So it may be a couple of months of lower volumes in the June-July period, which is normally when we're at the peak. So this year is going to be a little bit different, in my opinion. And just based upon all the facts we're looking at. So my crystal ball isn't all that good past July and they will all depend then on whether the purchase volume goes back if people put their houses back on the market, if there's traffic, but that there just isn't much foot traffic today. That also extends over into the purchase market. I think homebuilders are going to have a tough quarter in Q2. They all had pretty good quarters in Q1, record kind of quarters through February and then some bust outs started to occur on contracts in March. There will be pockets of the United States and homebuilding in Q2 where you will see some homebuilders. We're not talking about the national guys, for the most part that will actually have negative sales volume in Q2, but there'll be more bust outs than they have in new contracts. So this will be temporary, but both for homebuilders and I think for the warehouse, it's going to be a different Q2 than we've ever seen before.

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

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

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

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

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

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

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

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

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

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

He might have dropped off.

Or mute maybe.

Probably mute.

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

I'd move to the next one, he is probably off.

All right. Our next question will come from Kevin Zerbe of Morgan Stanley. Please proceed with your question.

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

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

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

Just we're talking about expenses. Yes, not the net income, yes, expenses. So I would say between $114 million to $116 million will be a run rate after all the savings we realized from the conversion.

Our next question will come from Jon Arfstrom of RBC Capital Markets. Please proceed with your question.

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

I'll start off. Midland/Odessa is kind of a crazy mark to begin with when oil and gas prices are at the there's really no -- there's not enough housing. There's not enough people, restaurants, maybe work one shift instead of 2. So I see a lot of that becoming more normalized. That's in the Midland/Odessa area. I think that the Lubbock area is more really based in the West Texas area is really based more on a college town with Texas Tech University. We didn't really see big increases or decreases in the market over there. I think it's probably a lot, not only in oil and gas, but it's probably agricultural related to some degree. And again, based on a college town, you have retail and Merle, you've lived there, and you may have some comments on what you see in the West Texas and how you feel about it?

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

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

I think we've got one.

We might have one, yes.

I think it's an older hotel. I think it's breakeven to around 30% occupancy.

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

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

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

We don't have any drilling rigs financed.

Well, we might have one too.

We still have that one maybe?

Well, it's a...

It's produces...

Pulling units and stuff.

Yes. I don't know about drilling.

It doesn't work.

Drilling rigs.

We still have those work over rigs to...

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

Also we don't have any pipe.

We don't have any pipe.

We don't have any pipe.

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

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

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

I think it goes back to my old saying you'll like us in the good times. But you'll love us in the bad times.

I've never heard you say that before. Just kidding. All right. Thanks a lot. Appreciate it.

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

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

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