Prosperity Bancshares, Inc. (PB) Q1 2026 Earnings Report, Transcript and Summary

Good day, and welcome to the Prosperity Bancshares First Quarter 2026 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Charlotte Rasche, Executive Vice President and General Counsel. Please go ahead, ma'am.

Thank you. Good morning, ladies and gentlemen, and welcome to Prosperity Bancshares First Quarter 2026 Earnings Conference Call. This call is being broadcast live on our website and will be available for replay for the next few weeks. I'm Charlotte Rasche, 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, Senior Vice Chairman; Kevin Hanigan, President and Chief Operating Officer; Randy Hester, Chief Lending Officer; Mays Davenport, Director of Corporate Strategy; and Bob Dowdell, Executive Vice President. Also joining us this morning are Bob Franklin, Chief Executive Officer of Stellar Bancorp; Ray Vitulli, President of Stellar Bancorp; and Paul Egge, Chief Financial Officer of Stellar. 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 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 would like to welcome and thank everyone listening to our first quarter 2026 conference call. The first quarter of 2026 was impactful for the company, and I'm excited to announce that during the quarter, we completed the merger of American Bank Holding Corporation on January 1, 2026, and completed the merger of Southwest Bancshares, Inc. on February 1, 2026, and announced the merger of Stellar Bancorp on January 28, 2026, for which we have now received all necessary regulatory approvals and expect to complete on July 1, 2026. Additionally, we completed a core system conversion in February. We and others believe that Prosperity is doing the right thing. Prosperity has been ranked as one of Forbes America's Best Banks for 2026. And since the list's inception in 2010, was ranked in the top 10 for 14 consecutive years. Prosperity has also been recognized by Newsweek as one of America's Best Regional Banks and was ranked 15th in the S&P Global Market Intelligence top 50 U.S. public bank rankings for 2025. In an effort to continue to enhance shareholder value, Prosperity Bancshares repurchased approximately 837,000 shares of its common stock at an average weighted price of $68.15 a share for a total of $57 million during the 3 months ending March 31, 2026. Our net income was $116 million for 3 months ending March 31, 2026, compared with $130 million for the same period in 2025. The net income per diluted common share was $1.16 for 3 months ending March 31, 2026, compared to $1.37 for the same period in 2025. During the first quarter of 2026, Prosperity incurred merger-related expenses from the mergers with American and Southwest of $42.5 million or $0.34 per diluted common share. Excluding these charges, the net income was $149.9 million and net income per diluted common share was $1.50 for the first quarter of 2026. This represents a 9.5% increase over the $1.37 reported for the same period in 2025. Our loans were $25.2 billion at March 31, 2026, an increase of $3.3 billion or 15.1% compared with $21.9 billion at March 31, 2025. The linked quarter loans increased to $3.4 billion or 16% from $21.8 billion at December 31, 2025. Loans increased primarily due to the mergers with American and Southwest. Excluding the loan increases due to the mergers and excluding the impact of the net charge-off, total loans decreased 1.2% or about 4.8% annually, that did include about $100 million plus in warehouse lending increase. So excluding that, the decrease would have been somewhat more. The deposits were $32.6 billion at March 31, 2026, an increase of $4.6 billion or 16.4% compared with $28 billion at March 31, 2025. Our linked quarter deposits increased $4.1 billion or 14.6% from $28.4 billion at December 31, 2025. Deposits increased primarily due to the mergers. Excluding the deposits acquired from American and Southwest, our core deposits increased about 1.2% and public fund deposits experienced its normal seasonal decrease. Prosperity has strong noninterest-bearing deposits of 32.4% of the total deposits as of March 31, 2026, with a cost of funds of 1.45% and a cost of deposits of 1.32% compared with 1.38% for the same period last year. Our net interest margin on a tax equivalent basis was 3.51% for 3 months ending March 31, 2026, compared with 3.3% for the 3 months ending December 31, 2025. Obviously, the net interest margin was affected by the mergers but it was also impacted by the repricing of assets as we predicted and mentioned during previous calls. Our asset quality, our nonperforming assets totaled $122 million or 33 basis points of quarterly average interest-earning assets as of March 31, 2026, compared with $150 million or 46 basis points of quarterly average interest-earning assets at December 31, 2025. The allowance for credit losses on loans and off-balance sheet credit exposure was $421 million at March 31, 2026, compared with $386 million at March 31, 2025. The allowance for credit losses on loans increased during the first quarter of 2026 due to the mergers of which $47 million was attributable to the American merger and $43 million was attributable to the Southwest merger. Excluding Warehouse Purchase Program loans, the allowance for credit losses on loans to total loans was 1.61% at March 31, 2026, and that's compared with 1.67% at March 31, 2025. Our quarterly net charge-offs were $41 million, the largest amount in our bank's history. This has mitigated somewhat by the total being comprised primarily of two credits both of which were unique in nature and we believe do not represent a trend in the potential future losses. This is evidenced by the lack of any material additions to nonperforming loans in quarter 1, 2026, and only two nonperforming relationships of more than $10 million. Both charged-off credits were generated out of our Dallas office. Both loans were shared national credits. However, both were initially originated and syndicated by us before the loans were moved to much larger banks that were willing to provide modified loan structures that we were not. The larger charge-off of approximately $30 million was to a start-up insurance company. Once that loan was moved and syndicated, Prosperity purchased a percentage of that loan back, although it was a smaller exposure than we previously had. While the borrower had allegedly a strong sponsor that is well known in the industry with the history of backing its investments, it failed to do so this time. The smaller charge-off with a customer who legacy banked for over 15 years and is reflective that in lending money, sometimes things just don't work out. With regard to acquisitions, as previously mentioned, the merger of American Bank Holding Company was completed on January 1, 2026, and the operational integration is scheduled for September 2026, and the merger of Southwest Bancshares was completed on February 1, 2026, and the operational integration is scheduled for November of 2026. We are fortunate to have American and Southwest associates on the Prosperity team. We are excited about our pending merger with Stellar Bancorp and expect to complete the transaction on July 1, 2026. While we continue to have conversations with other bankers regarding potential acquisition opportunities, we remain focused on the completion of the Stellar merger and the integration of all three transactions. Texas and Oklahoma continue to benefit from strong economies and are home to 57 Fortune 500 headquartered companies. Texas also benefits from diversification in various industries, including energy, oil, gas, renewables, technology, manufacturing, trade logistics, major ports health care and finance. Further, it's business-friendly environment, no state income tax, population growth that supports spending and workforce expansion and key role in trade and cross-border commerce positions Texas well for 2026 and the future. While Texas continues to outperform the U.S. on output growth, the labor market has cooled noticeably after years of rapid expansion. The growth in 2026 is expected to be steady, although the state's size, diversity and policy advantages position it well for a rebound. Overall, I would like to thank all of our associates for helping create the success we have had. We have a strong team and a deep bench at Prosperity and will continue to work hard to keep our customers and associates succeed and to increase shareholder value. Thanks again for your support of our company. Let me turn over the discussion to Asylbek Osmonov, our Chief Financial Officer, to discuss some of the specific financial results we achieved. Asylbek?

Thank you, Mr. Zalman. Good morning, everyone. Net interest income before provision for credit losses for the 3 months ended March 31, 2026, was $321.2 million, an increase of $55.8 million compared to $265.4 million for the same period in 2025, and increase of $46.2 million compared to $275 million for the quarter ended December 31, 2025. The net interest margin on a tax equivalent basis was 3.51% for the 3 months ended March 31, 2026, an increase of 37 basis points compared to 3.14% for the same period in 2025, and increase of 21 basis points compared to 3.3% for the quarter ended December 31, 2025. Excluding for accounting adjustments, the net interest margin for the 3 months ended March 31, 2026, was 3.44% compared to 3.1% for the same period in 2025 and 3.26% for the quarter ended December 31, 2025. The increase in net interest income and net interest margin during the first quarter 2026 is primarily due to repricing of earning assets and addition of American Bank and Texas Partners banks during this period. The fair value loan income for the first quarter 2026 was $3.7 million compared to $3.1 million for the fourth quarter of 2025. The fair value loan income for the second quarter of 2026 is expected to be in the range of $3 million to $4 million. Noninterest income was $46.5 million for the 3 months ended March 31, 2026, compared to $42.8 million for the quarter ended December 31, 2025, and $41.3 million for the same period in 2025. Noninterest expense was $217.3 million for the 3 months ended March 31, 2026, compared to $138.7 million for the quarter ended December 31, 2025, and $140.3 million for the same period in 2025. The linked quarter increase was primarily due to merger-related expenses of $42.5 million and the addition of American Bank and Texas Partners Bank during this period. For the second quarter of 2026, we expect noninterest expense to be in the range of $176 million to $180 million. This projection does not include additional onetime merger expenses for the quarter. The efficiency ratio was 59.2% for the 3 months ended March 31, 2026, compared to 43.7% for quarter ended December 31, 2025, and 45.7% for the same period in 2025. Excluding merger-related expenses, the efficiency ratio was 47.6% for the 3 months ended March 31, 2026. The bond portfolio metrics at 3/31/2026 have a modified duration of 3.8 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 loan and asset quality.

Thank you, Asylbek. Nonperforming assets at quarter end March 31, 2026, totaled $122.107 million or 48 basis points of loans and other real estate compared to $150.842 million or 69 basis points at December 31, 2025. Since March 31, 2026, $7.936 million of nonperforming assets have been removed or put under contract for sale. For March 31, 2026, nonperforming asset total was made up of $108.714 million in loans, $136,000 in repossessed assets and $13.257 million in other real estate. Net charge-offs for the 3 months ended March 31, 2026, were $41.309 million compared to net charge-offs of $5.884 million for the quarter ended December 31, 2025. There was no provision to the allowance for credit losses during the quarter ended March 31, 2026. But $91.4 million total was added via the mergers with American Bank and Texas Partners bank. No dollars were taken into income from the allowance during the quarter ended March 31, 2026. The average monthly new loan production for the quarter ended March 31, 2026, was $312 million compared to $314 million for the quarter ended December 31, 2025. Loans outstanding at March 31, 2026, were approximately $25.288 billion, compared to $21.805 billion at December 31, 2025. The March 31, 2026, loan total is made up of 38% fixed-rate loans, 28% floating rate loans and 34% 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, Nick, will assist us with questions.

[Operator Instructions] The first question will come from Catherine Mealor with KBW.

I wanted to first to start out on the NIM guidance. It was great to see the NIM move higher. I know part of this was just the addition of these 2 acquisitions. But interested if you could just help us think about how you're thinking about the margin moving forward next quarter and then once you add in Stellar. And then maybe is there anything within the margin this quarter that felt onetime in nature, either some kind of onetime loan payments or anything like that, that we should be aware of that we should be rolling forward to next quarter?

I'll answer, Catherine. So we are pleased with our margin expansion this quarter. it was, like I mentioned, contributed from our asset repricing during the first quarter and addition of 2 banks to help us with the increase in the margin. But if you look at our rate track model, and it's like based on the static balance sheet, looking for the second quarter, we see that our projected margin for second quarter will be flat and a little slightly higher than the first quarter. And the reason is that there was like -- there was several factors that impact in Q1. We saw continued repricing of earning assets, but we also had -- we recognized about $4 million of loan income from nonaccrual loans, which we don't expect in the second quarter. And also, I think the -- having fewer days than the calendar quarter helped as well -- historically helped our margin. So if those 2 things had an impact on it, but overall, we are very pleased with the expansion.

Do you want to go ahead and give them some kind of guide?

So we continue on the guidance. If you kind of long term, and I'm going to include the Stellar Bank in our model for 2026, I think what the model shows that we'll be exiting combined NIM around 3.70% and -- but for having full year of Prosperity and half year of Stellar, average model shows around 3.60% for 2026.

Okay. Great. And then on the bond, there was a big increase in assume you restructured the portfolios that you acquired. Is this a good run rate for the rent yield on the securities book or anything to be aware of there and how you're thinking about that going forward?

No, I think it's a good run rate. What we've done in the first quarter, we did in addition to bringing the bond book from the acquired banks, we also did buy some securities. That's why you saw almost $1.4 billion including bond portfolio. I think we also continue to buy. So from now on, we -- I see that the yield on bonds should increase a little bit than what we had in the first quarter.

Okay. And where did that $1.4 billion in securities -- what was the rate -- the new rate on that?

So I think it's between -- we were able to get between 4.50% and we were able to get around 4.85%. So it was kind of in between when rate is with the Iran war, the rate fluctuated, so we were able to secure some at 4.85%.

The next question will come from Manan Gosalia with Morgan Stanley.

Can you hear me?

Yes, we can.

All right. Sorry about that. So David, you mentioned the benefits of diversification in Texas. At the same time, you mentioned the labor market is kind of cooling right now. And then maybe if I add on to that, there's clearly a lot more competition, especially from some out-of-state banks. Can you put that together for us in terms of how you're thinking about competition overall, loan spreads, deposit rates, loan growth and just your bigger picture thoughts on the dynamics in the state?

Well, that's a big question. But even though it may be slower growth, there's probably still better growth than anywhere else in the United States. So I still think that Texas is probably the best place to be as far as growth goes. I mean there has -- it's really kind of a -- it's kind of split. Everybody complains about prices going up and when they go to the grocery store or they go buy gas or car that used to cost $60,000 now costs $100,000. And everybody complains about it, but when I talk to people, again, I think probably middle class and upper middle class, it still had to slow people down. People still have a lot of money and they're still spending money. Probably it's affecting lower earning group than maybe the other group. But I think for the long run, Texas has still had tremendous growth. You're still seeing I mean every time California does a thing like they're going to tax people 5% on net worth, make it only makes states like Texas and Florida better. So for the foreseeable future, we still see it very good. Talking about the competition, that is a big deal because you have a lot of banks that want to be in Texas, it's hard for them to get market share, and we're competing against them on loans on a day-to-day basis. And some of the bigger deals that we competed on where we were in the 6% price range, they were down in the 5.9% range. I understand that when we ever go into a new market, that's exactly what we do. We try to underprice something and try to get some market share. So that's what we're looking at from the out-of-state banks coming in. On the deposit side, you still see them throwing sometimes if you're a noncustomer right now like Truist, you are advertising like a 4% rate on a money market rate -- on a money market account, we're closer to the 3%. So they're trying to buy the business. We understand that. At the same time, we have in acquiesce. We lost several big deals where we haven't come down on the price, we haven't come down on the price and we're still trying to maintain our margin, I think that we will continue. And I think that overall, in the long run, we've been through this before. It's not our first rodeo. We'll continue to do good. Our partners, you could saw -- Stellar, they did much better than we did this time. And I think it just shows that things happen over a period of time. They were up over $200 million. where they might have been lagging before. And I think that's the same thing for us. We'll win. We have a number of big deals that we're looking at right now that we -- I think we've agreed to the price. We're just making sure that we want to do the deal. So I do see that. Having said that, we have 3 mergers with banks. And if you look at it historically, I'd like to tell you that you're going to see this mid- to single digit loan growth or double-digit loan growth, and that just doesn't happen. I think that if we can stay flat, that's pretty good this year. I mean, because I think that as you do these deals, you just see some you see some change in that. And just historically, I'd like to say that you're going to be there, we're going to make it. But historically, that's not happening. Kevin, you may have some comments on the deal or...

No, I agree with you, David. I think not to get too granular, Prosperity ex acquisitions has not had growth in the last couple of quarters. I think as I think about the wise to that, the market has gotten more competitive, particularly on very large construction deals, which we've always played a part in. The market has gotten cheaper in terms of the rates that they're willing to do those deals at and they come off levels of recourse, much lower levels of recourse. And we have not. We have not played in that game. And it's cost us. We've missed out on some deals. I think to augment that or to fight that off a little bit. We're likely to set aside a bucket of, say, $750 million to $1 billion worth of commitments where we'll play in those markets with certain clients, very well-known folks that have been clients for a very long period of time. So I think we'll fight some of that off ourselves ex what happens in the acquisitions. As David said, and this is no surprise to any of you. When we do acquisitions, it is more likely than not that there's some asset runoff from those acquisitions in the ensuing 18 months. It's been the case time and time and time again. And we've got 3 of them. So we'll be fighting those headwinds for the next year to 15 months, 18 months, and I think if we are flat during that period of time, overall, we'll have done pretty well.

And I'd even say some of the out-of-state banks are offering 5.8%, 5.9% and we can get 4.85% on a security with about a 4-year average life. Pretty hard to pay the lender, reserve some money for loan loss and really go that low. But again, at the same time, if a customer is able to bring in, it's just not a dry relationship and that customer is really able to bring over a positive relationship that's a whole different story, and we'll give you credit for that, and we'll probably get as low as that if it's not a dry relationship. But all in all, we still stick with the story that the core deposits are really what makes the bank and that's where we're focused on and we're really focused on increasing net interest income and net income for the shareholder over the next 1 to 2 years. And I have to tell you right now I'm probably more excited than I've ever been in the last 3 years about our future. When I look at the numbers, I mean, we were going -- as you all know, our net interest margin was what it got as low as 2.75% or something like that, 2.90%. Our numbers that we're looking at right now, we're really looking at some really great net interest margin going forward. I think we're looking at probably for the next 2 years, net interest income increasing and so I'm terribly excited for where we're at right now today.

I appreciate all the color. I know that was a fairly broad question, but I appreciate the fusions. So maybe just a follow up there, given the excitement about the forward NIM expansion and forward growth as well. Maybe how are you thinking about additional M&A from here? Does it make sense to integrate the current deals first? Or do you think that there's room to pursue another one if you get something that makes sense for you?

I think the answer that we all need to be doing is these 3 deals are very important. I mean we're going from a $38 billion bank to a $53 billion, $54 billion bank. And so that's -- so our main focus right now is the operational integration of these three deals. And so that's why when we talk about the things we talk about, our whole focus. I mean I don't think you'd ever want to say never on anything. At the same time, our primary focus is bringing these 3 deals together and hitting those consensus numbers that you analysts all have out there, and we feel really good about that.

The next question will come from Dave Rochester with Cantor.

Just as a part of your view on NIM going forward, how are you thinking about the cost of deposits here in a scenario of no rate cuts? Do you think you guys can hold deposit costs here? Can you shift them lower? And then I was just curious where you're seeing new loan yields come in as the remaining fixed rate loans are still rolling off here?

I don't think that -- if interest rates stay where they're at, our net interest margin targets are really good. I mean I think also back talk to you just a minute ago in about a 3.6% average for this year, 3.7% exit. 2027, I think you guys have about 3.8% net interest margin 3.8%. I think if interest rates stay where they're at, we'll hit that or even higher. If interest rates go down 100 basis points, we're probably -- we'll come off of that to some degree. But again, I don't think that we're a lower deposit rates any. And I think our numbers show really higher net interest margins and maybe you do deals. But at the same time, I don't know that I really believe them because as interest rates come down, we never went up as high on a lot of our customers as we -- as they could have gone somewhere else so I don't know that we'll come down as fast or at the same time. So I don't if that gives you any color or not.

I'll just add a little bit on the deposit side of it. So we haven't decreased or changed our rates for the past few months now. And based on what we see on the deposit growth we mentioned on our core deposit growth, I think we're holding our own with the current rate. I know it's -- a lot going to depend on the competition. But at the current rate, we believe that we don't need to increase the rates. So they might come down rate overall because we have some higher CDs getting repriced. So we'll see some overall deposit rate or cost of deposits come down a little bit, but not significant, but it will do it because of repricing. But overall, I think as long rate doesn't change, we should be at this level or lower by ourselves. But if you add Stellar, Stellar has a little bit higher. But in the combined one it is still going to be a cost of deposits around 1.40. That's what our model shows. I think on the loan pricing, they want to know on loan pricing, I think if you...

The loan repricing, I mean I think we're kind of good where we're at. I mean I don't see us -- I'm not saying we won't jump to maybe 1 or 2 deals to compete on the 5 or under 6. But for the most part, we're really not going to play that game. And we'd rather buy securities, I think, than just try to play a game just to have a dry relationship to beat somebody out and take a lot of risk.

So new loan yields or where the book is right now? Are they still a little bit higher?

A little bit higher.

Little higher.

Okay. Maybe just one more switching to the loan trends, your thoughts there going forward? I know you mentioned maybe flattish loans this year with all the deals closing, maybe that carries into next year a little bit in terms of like a little bit of a runoff that you normally get. But just looking at Stellar this quarter, which had a solid loan growth quarter. It seemed pretty decently broad-based. I was just thinking about you guys next year and the growth trajectory. I was wondering if you think that with Stellar in the fold, after you have that little bit of runoff, are you thinking that maybe your organic growth profile can improve from where it has been over time?

Yes. Post any, what I would call normal for us, post-acquisition runoff, I do think, particularly with Stellar hitting its stride that we'll return to kind of low to mid-single-digit kind of stuff, but it's going to take a while.

I think even American Bank and Texas Partners are talking, they're excited with where their position is too and has done pretty good.

We just want to be cognizant of the fact that it is typical for us to have some loan declines post acquisitions, and we've done 3 acquisitions, and we want to be realistic about it.

The next question will come from David Chiaverini with Jefferies.

So following up on the deposit side was sort of deposit growth should we expect? Should it kind of trend in line with loans and kind of flattish and the loan-to-deposit ratio stays in the low 70s? How should we think about the deposit side?

I think our deposit side is really not going to be effective. We should have our normal organic growth on the deposit side with the exception of seasonal fluctuations with public funds. And I think we've always done at least 2% to 3% more. Now having said that, one of the banks that joined us has some really larger accounts that really operate under their Treasury -- that are treasury -- their treasury system that they have. They feel comfortable that we -- that they won't lose any of those accounts. On the other hand, it's always possible that there's -- there's a handful of those accounts that are $30 million, $40 million, and that could always affect us to some degree. But for the most part, I mean, all the banks that are joining us were in Texas. We should have growth on the deal. I think that -- I think that we're fine. You'll still continue to be -- still can see core deposit growth with seasonal drops with public funds. As far as the loan-to-deposit ratio is, I think I didn't answer that. We have a policy that we -- it doesn't say we can't go above 85%. But once we start hitting -- we hit 85%, we have to go in front of the Board and discuss that with them. So unlike a lot of the other banks or a number of the other banks that are at 90% and 100%, I don't think you'll see us doing that. I think we feel more comfortable at the 75% and 80% for the most part.

Got it. And then shifting over to the capital side. Can you talk about the Basel III Endgame potential benefit to your capital ratios and then your buyback appetite from here the last couple you've been a little bit more active than you had been historically. How should we think about that going forward?

I think that we're going to make a lot of money or at least it looks like we're going to be making a lot of money at least combined. And so I think that as long as -- whenever we see this, you'll see the price. You saw the buyback when the price of the stock was, I forgot what the average time was $68 or something like that. So I think you'll still see us when the price is an opportunity like it is right now, you'll see us continue to buy back. And again, we have a lot of capital even with the combination of Stellar Bank, and I know we're paying 25% or 30% cash on that, but we still have a lot of capital. And I think going forward, you'll see us continue to buy back if prices stay where they're at, for sure.

Yes. And on the Basel III benefit, we did high-level analysis of impact of the mortgage loans, and it will benefit, but I think it's when we calculate maybe 50 basis points on the capital, that what we saw benefit on the -- once the rule passes on the mortgage loans.

But from a capital standpoint, I mean we're in...

Kind of benefit.

When we look at a pro forma based on our combined earnings of both of these banks even after you take out dividends, you're talking about $500 million or $600 million a year in excess after dividends to do something with. So we have a strong capital going in, and I think we'll have a stronger capital going forward, really and the ability to purchase our own stock back.

The next question will come from Matt Olney with Stephens.

I want to go back to the Stellar Bank discussion. And I think you mentioned the improving loan growth at the bank, but also it looks like the adjusted net income at Stellar Bank was almost $30 million in the first quarter, ex a few nonrecurring items. If I go back to the original assumptions when the deal was announced back in January, it looks like the earnings projections from Stellar for the full year was $113 million. So it seems like you're tracking well above that number, if I just annualize that first quarter. Was there anything else unusual or anything else to consider with that first quarter net income number of almost $30 million? Or is that a clean number that we can carry forward from here?

Matt, thanks for the question. It is a clean number. We actually feel great about the earnings prospects entering into the second quarter, taking the cumulative nature of the growth that we had in the first quarter. So we feel good about the path that we're on and what that implies.

Okay. I appreciate that.

We're paying we paid down on April 1, the last remaining piece of sub debt. So we actually see benefit to margin that will come back -- come out as a byproduct to it.

Okay.

For those of you who don't know, that was Paul, CFO at Stellar.

Great. And then I think you completed the core system conversion at the bank in February. I think there was a mention earlier on the prepared remarks, but I missed it. Just remind us of the time line expectations to complete the remaining conversions for each of the acquired banks?

Yes. First of all, the DNA conversion was a huge deal. I don't want to just keep talking about it, but our bank was more on a back system. And over the weekend, if you had a long weekend by the time we ran everything back through and brought everybody's account back up to date, we may be up by Monday morning, and we may not. And under this new system, we can update everything in about 1.5 hours. So that just tells you how much capacity we have. It was a real big deal to the years to complete. And so I think when you look at our bank and we had 3 major deals. We had a DNA conversion. We've had our plate full. So the team has done just a miraculous job. And so going forward, we're looking at September operational integration for the American Bank. We're looking at a November operational integration for the Texas Partners Bank and for Seller, we're looking at March 8, I think.

The next question will come from Brett Rabatin with Stonex Group.

I wanted to go back to the credits, the 2 credits you guys talked about and you guys obviously have a historical very low net charge-offs, really strong asset quality. So the 2 this quarter were obviously an outlier. But I was hoping maybe for any other color, you mentioned one was an insurance company. Was there a fraud involved? Were these loans from past acquisitions? Was there anything unusual that created the loss exposure relative to what you modified as collateral?

Yes. The big one -- this is Kevin, Brett. The big one was an insurance company. They were in the business of selling Medicare products, so Medicare Plus Medicare Advantage kind of products. And if you want to get to the core of it, their business was doing pretty well for the first 18 to 24 months and not to get too deep into the accounting, but if you call them and you did a Medicare Advantage program through them and your annual premium for the year was, let's just say $240 to make it easy, $20 a month, they would accrue $20 for that first month paid by the government largely. And then the rest of it would be booked as a receivable. So $220 in account receivable. In that business, what you do is you model and project what your account turnover is going to be. So you may wake up 3 months from now and cancel that policy because you think you can get a better deal or you want a different deal. You're unhappy with the deal you've got. So there is some modeling of the turnover of your receivables of people canceling. And what happened here was the cancellation rates were way higher than the model reflected. And that causes obviously two things: a write-down of your receivables by the remaining balance that has not been accrued in the income, and it can cause you to have to restate prior period earnings. And that was the big factor in that overall deal. The deal was backed by a very large, very well-known private equity firm that our bankers have had some experience with in the past, and they have typically backed their deals. In this case, at least to this time, they have not backed the deal. I think we began talking about this deal probably in the third quarter of last year. We talked about it again in the fourth quarter, and we chose to write things down this quarter all the way. So that I would call that a one-off in our case. If we look across the remaining nonaccruals in our book, I think the largest nonaccrual loan we have is $10 million. So there's nothing else out there that looks anything like this. This is truly a one-off. David mentioned the other one has been a long-time client. It was a legacy client in the Buy Here Pay Here car space. High-performing company for 15, 18 years with us that we banked them. And they got a little more aggressive in their business model coming out of COVID, poor timing. And I would differ the first one, which was a one offer and probably should never happen again, a loan we probably should not have made, easy to say today. The second one is the loan we would have made today, and it's just basic business. The guys changed their strategy a bit. The strategy was not successful, and it costs them dearly and it cost us a bit. So I'd say one is a way out there. Nothing else looks like that in the portfolio kind of thing that we're worried about. And the other one, look, it was a bad day.

Well, you'd have to say the original insurance deal, we did have the backing of this big sponsor. We didn't want to release it. They wanted to release and so a huge major, major bank took it and they release the guarantee on it. Our stupidity is enough -- us being stupid, we bought a percentage back. However, a lesser percentage than what we had originally.

Okay. That's very detailed color. I appreciate that. And then, David, I wanted to ask, when I look at your map, I mean you're pretty dense in Texas. Is strategy from here, you're obviously very focused on integrating these 3 acquisitions. But would the strategy from here be more density? Or would you look to new markets? Are there markets -- are there other smaller markets in Texas that might have great deposits, other community banks? Just any thoughts on how you see the environment from that perspective.

As we mentioned before, first of all, I'd say we don't want to grow just to grow. But having said that, scale has just become very, very important. I look at our income statement, and I see just buying equipment, technologies, like $2 million a month, sometimes, that doesn't count what the technology we spend, $75 million, $80 million, $90 million a year on that. So scale is important, but we don't want to say we grow to grow. We still, as we mentioned earlier, I think that we really think that a real bank -- the real value in it is the core deposits, where if you don't want to grow loans that you can still buy bonds and still have a good 1.5% plus return. I think that we've all talked about it. We like where we're at right now. But we also -- we still -- again, our primary objective is still to put these 3 deals together. But our real -- our deal is to really be in -- we grew up in the times when you had Texas Commerce and our First City and an Allied and all that. And it's still our plan and goal to continue to make one of the Texas biggest banks, not just because it's big, but they can offer services from a technology standpoint to the biggest customers to the smallest customers. And we'll continue to do that, but we're going to do it at a pace -- we're not going to do it at a pace until we really can put these deals together and really show you that everything that we can make the $6 or something since this year, when we make the $7 or something since next year. We want to show everybody that we can do that. And that like in the past, when we promised that we'd bring in that margins up. We want to do what we say that we're going to do. But but the future is still building that larger bank that we want to be for everybody.

The next question will come from Janet Lee with TD Cowen.

I appreciate the near-term guidance you provided on expenses for the second quarter, just given a lot of moving pieces with some cost saves at Stellar in the third quarter. Is there some sort of fuller expense guide you could give for the year or where the efficiency ratio could trend? Is it -- is this mid-40s level a good place to be? Or how should we think about the trajectory?

Janet, I don't know if I can give a specific guidance long term because we're still trying to integrate two banks and then Stellar coming in the second half of the year. But what we said earlier on at least two banks that we merged, cost savings that we announced, that we are working toward it and we're going to achieve those cost savings. I mean, we're already getting some of the cost saves now, but most of them come when the integration of the system, what we mentioned in September, November, then when we're going to see that. Also, with the Stellar addition, we're going to probably see most of the cost savings next year. And with Stellar 35% cost save, we feel very comfortable about the cost saves on that side of it. So if you combine all together, I think the goal for us to get back to the -- with all the cost savings and get back to the mid 40s that will we ran historically, 44%, 45%, 46%. So that's the goal, and I think it is achievable.

Got it. That's fair. And you said the loan accretion income expected to stay around this $3 million to $4 million range on the loan side in the second quarter. Could you remind us where this could go with the Stellar the third quarter? Or could you maybe provide a projection around the full PAA as opposed to just loan accretion?

Yes. On the -- for second quarter, yes, it's a saying $3 million to $4 million. With the addition of Stellar, I mean, it can a lot of change, right, it depends on the market rate environment when we do merge with Stellar July. So it's kind of hard to say. But I'll tell you when we did our projection when we put together in January, we said that we're probably going to expect about at least on 2027, about $10 million to $12 million of interest -- fair value income from Stellar, that's a pretax number. That's what we estimated. But again, a lot of can change depending on the rate environment in July.

That was for loan and securities.

For loans, yes, and security is going to reprice. I think Stellar was about, what, 3.5% margin. So they're going to reprice a little bit and maybe 100 basis points or so.

Got it. And the 3.70% NIM that was the target for the...

Yes, that was -- yes, that's going to be our exit, meaning the end of the year combined Prosperity Bank and Stellar together.

With 3.6% average for the year.

For the year because we can just going to have Stellar for half a year.

The next question will come from Jared Shaw of Barclays.

I guess just on the $30 million charge-off that you had highlighted, was there a specific reserve associated with that prior to the charge-off?

Yes. For that specific, we had a reserve half of it last year because I think when we kind of start seeing that and we reserved rest of it and charge off this one. That's why we didn't see any of the P&L impacts this quarter because we provisioned half last quarter and we charged off the remaining half this quarter.

Okay. Okay. And then on the Stellar deal last quarter, a couple of times, you mentioned that just given their underwriting and pricing, you didn't expect to see any runoff from that portfolio. But today, it sounds like maybe there could be some run off. What should we assume is potentially at risk from the stellar portfolio of running off? And I guess what changed to change your view on that?

Kevin can jump in a minute, but again, I think we're just trying to prepare everybody that you have Stellar, you have Texas Partners Bank and American that just historically that we have lost loans through these deals. And again, we don't want to give somebody a deal that says, okay, we thought it was great that they increased $200-and-something million. But again, we don't want to come here and tell you we're going to have a 5% or 6% loan growth when historically, we've seen things that I guess we're just being cautious really.

Yes. I'd say it's cautious. I do think they underwrite much like we do. It does take -- and again, I went through this on the other side in 2019 with a large lending staff. It takes 6 to 9 months to get integrated into the system and how the underwriting is done at prosperity at the forms in the process. it takes a while, and then lenders get used to it and things stabilize.

I think it's even more than that, Kevin. I think even I look at what we did in our production this first quarter. And it was definitely impacted by doing a DNA conversion, people trying to get their loans to the loan committee doing working with 3 different banks to put it all together. So I think there's -- when you're doing this, I mean, we increased our assets, you can do the math between $38 million and $54 billion. That's a lot of increases, so to try to massage and put all this together, things are not going to be just exactly the way they were. And if you -- and I would say this that if you think they're going to be exact complex, you're going to have this exponential growth I think it would be a mistake. I think right now, we really need to focus on putting all this together, making sure everybody fits in good and take our time in doing it right.

Just to clarify 1 thing in my mind, I call provision, but that's 1 I meant like specific results, we put specific reserve on that loan provision expense.

The next question will come from Jon Arfstrom with RBC Capital Markets.

I might have missed this, but Kevin, can you touch on the warehouse lending business and your outlook there?

Yes, warehouse as you know, Jon, averaged $1.207 billion, I think, for the quarter, but we closed out at $1.430 billion something, maybe $1.432 billion or $1.433 billion. So it ended up the quarter really strong. It's backed off a bit from there. I think yesterday, it closed at about $1.240 billion, $1.238 billion, something like that. I think it will be higher on average in the second quarter than it was in the first. So I'll call it $1.3 billion to $1.25 billion.

Because even our own mortgage company, we're finally seeing where they're making money, and most of our mortgage companies are doing pretty better. Yes, so it probably ought to be a little better.

Okay. Good. And then maybe also, Kevin, you talked about construction and being a little more cautious there due to competition, but there was still decent growth for the quarter. Was that acquisition-driven? Or is there activity that you guys are putting on the balance sheet now?

No. Construction has been weak. What I was saying is we're losing out on a lot of construction deals because of the competition in the market is willing to do it with less recourse and way cheaper spreads to SOFR and that we are looking at establishing a bucket for a handful of clients that would be our A+ rated clients where we might be willing to do things at a little cheaper rate and a little less recourse.

Yes. I mean, the bottom line is we lost some really larger deals, $100 million-plus deals because, again, we just weren't willing to go down to the pricing and the terms and conditions that those guys are willing to do and we could buy on, not have the risk to still make the money.

Okay. David, one for you. That's maybe an odd question with your Stellar team in the room, but you got beat up last quarter on the pricing and during the quarter on the price paid. Just curious how you're thinking about it a quarter later. It sounds like you still believe the accretion is there and the 2027 EPS numbers are there. But and maybe Stellar is doing better than planned. But how are you feeling about this quarter later? Just it's a big deal, obviously.

I couldn't be happier. I think it's a great deal. I mean I think there's a huge difference between 1 bank and another bank. And I think I'm not just saying is because these guys are in here. If we were ever to sell our bank, I wouldn't sell for anything less on a multiple that these guys that we pay for. So I think it's top-notch. I think you are going to -- I thank all the analysts -- in the end of 2027 when we make the money, we're going to make, I think everybody going to say, I know it the whole time. But right now, I got to prove it. But you guys are all going to say, well, we knew it the whole time, and that's when the stock is going to go to $95 or $100. But which I'm telling you it's going to happen, and I feel better than I have in 3 years about all these different deals.

Yes, Jon, this is Kevin. Look, we did get a little dinged up, right? We -- the market thought we paid a little too much, and they thought -- they thought we were using estimates that were greater than the market had for 2026. But I think we did it based upon a deep dive of due diligence and knowing these people really, really well in the course of putting the acquisition together and feeling comfortable with their internal numbers. And it's really rare for us to put out numbers that are above the consensus when we're doing a public deal. It's rare for anybody to do. We did it. And I think they've proven up with a clean quarter that's really good this quarter. And my guess is when we look back at all of this, the estimates that we used for Stellar for 2026 are going to be better than the one -- they're going to -- we're going to end up doing better than even the ones we.

Well, I would even go a step further that and Bob can jump in if he wants, but I know this goes from American and probably for Bob, both, if they wouldn't have got the price they wouldn't have done the deal. I mean they know what they're worth. Bob, you may jump in and say that, but I wouldn't. I mean, I wouldn't do a deal if we knew we were worth more.

Absolutely, David. I'm kind of thinking now we didn't pay it enough.

I knew that was...

This concludes our question-and-answer session. I would like to turn the conference back over to Charlotte Rasche for any 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 attending today's presentation. You may now disconnect.