Prosperity Bancshares Inc (PB) 2014 Q3 法說會逐字稿

Good morning and welcome to the Prosperity Bancshares third quarter 2014 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 that this event is being recorded. I would now like to turn the conference over to Ms. Charlotte Rasche. Please go ahead.

Thank you. Good morning ladies and gentlemen and welcome to Prosperity Bancshares third quarter 2014 earnings conference call. This call is being broadcast live over the internet at www.prosperitybankusa.com and will be available for replay at the same location for the next few weeks.

I am Charlotte Rasche, Executive Vice President and General Counsel of Prosperity Bancshares and here with me today is David Zalman, Chairman and Chief Executive Officer, Tim Timanus, Vice Chairman, David Holloway, Chief Financial Officer, Randy Hester, Chief Lending Officer, and Mike Epps, Executive Vice President of Financial Operations and Administration.

David Zalman will lead off with a review of the highlights for the recent quarter. He will be followed by David Holloway who will review some of our recent financial statistics, and Tim Timanus 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 home moderator, Ed. I assume you have all received a copy of the earnings announcement we released earlier this morning. If not, please call Tracy Elkowitz at 281-269-7221 and she will send a copy to you.

Before we begin, let me make the usual disclaimers. Certain of the matters discussed in this presentation may constitute forward-looking statements for the purposes of the Federal Securities Laws and as such, may involve known and unknown risks, uncertainties, and other factors which may cause the actual results, performance, or achievements of Prosperity 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 Bancshare's 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 joining us for our third quarter earnings announcement.

I am very excited to announce such positive results for the third quarter of 2014. I am pleased to announce that Prosperity Bancshares will increase its quarterly dividend to 27.25 cents for the fourth quarter of 2014 which represents an increase of 13.5% from the $0.24 per share currently being paid per quarter.

Prosperity strives to continue to share our success with our shareholders. After listing on the NASDAQ stock market in late 1998, we started paying a dividend of $0.10 per share in the following year. Based on the continued increase in the dividend, it is obvious that Prosperity has the shareholders' interest in mind.

With regard to earnings, we posted earnings of $76.7 million for the three months ended September 30, 2014 and that is compared to $55.2 million for the same period in 2013 which is an increase of $21.2 million or 38.5%.

Our earnings per share for the third quarter of 2014 came in at $1.10 compared to $0.91 for the same period last year, an increase of 20.9%.

The net interest margin on a tax equivalent basis increased to 3.85% for the three months ended September 30, 2014 compared with 3.59% for the same period in 2013 and increased from 3.83% for the three months that ended June 30, 2014.

Excluding purchasing accounting adjustments, the net interest margin on a tax equivalent basis decreased on a linked quarter basis from 3.31% for the quarter ended June 30, 2014 to 3.26% for the quarter ended September 30, 2014.

Our Tier 1 leverage capital ratio stood at 7.4% at September 30, 2014 compared to 6.98% at June 30, 2014. Our strong earnings continue to build capital rapidly.

Loan and deposit growth was impacted by the acquisitions of First Victoria National Bank in November of 2013 and F&M Bank in April of 2014. Excluding loans acquired in these acquisitions and new production at the acquired banking centers since the respective acquisition dates, loans at September 30, 2014 grew $405 million or 6.6% when compared with September 30, 2013 and increased $207 million or 3.2%, 13% annualized on a linked quarter basis. We continue to have record production in loans but still see a lot of paydowns. Tim will discuss this more in detail in his comments.

Strong asset quality continues to be one of the core values of our bank. Non-performing assets total $15,082,000, or 27 basis points of quarterly average earning assets at September 30, 2014 compared with $12.6 million or nine basis points of quarterly average earning assets at September 30, 2013, a $28.5 million or 15 basis points of quarterly average earning assets at June 30, 2014.

While the increase in non-performing assets is significant, it was not unexpected as the loans added to non-performing this quarter were identified during our due diligence of the F&M Bank. While the majority of these loans are non-performing, several are related to renewals that have been delayed due to documentation or procedural issues. As of the date of this call, we expect that approximately $16.5 million of these loans will be paid off, moved or renewed but there are no guarantees that such payoffs and renewals will occur as expected. We believe for the next 12 to 18 months we will have a non-performing asset ratio similar to the one this quarter.

Excluding deposits assumed in the First Victoria National Bank and F&M acquisitions and new deposits generated at the acquired banking centers since their respective acquisition dates, deposits at September 30, 2014 grew $550 million or 4.4% compared with September 30, 2013 and decreased $79 million or six basis points on a linked quarter basis. The 4.4% organic deposit growth rate is aligned with our historic growth rates. Historically, our deposits are seasonally low in the third quarter and we experience strong deposit growth in the fourth and first quarters of the year.

The Texas and Oklahoma economies continued to expand during the first nine months of 2014. The employment growth and population growth continues to outpace the majority of the nation. Texas had the highest job creation in the country with approximately 375,000 jobs created in the past year. Over the past year, one of every six new jobs in the country has been located in the state of Texas.

The unemployment rate for Texas is 5.1% and the unemployment rate for Oklahoma is 4.6% while the rate for the rest of the nation was 6.2%.

More specifically, we continue to see strong loan sales. The average apartment vacancy rates are down with rental rates increasing. The office vacancy rates are down with rates also increasing and the general economic outlook for Texas and Oklahoma for the remainder of 2014 is positive.

Thanks again for your support of our Company. Let me turn over our discussion to David Holloway, our Chief Financial Officer.

Thank you, David. Net interest income for provision for credit losses for the three months ended September 30, 2014 was $175.7 million compared with $126.5 million for the three months ended September 30, 2013, an increase of $49.2 million or 38.8%. This increase was primarily due to a 28.8% increase in average interest earning assets.

Non-interest income increased $8.6 million or 39.9% to $30.2 million for the three months ended September 30, 2014 compared to $21.6 million for the same period in 2013. This year over year increase was impacted by the F&M and First Victoria National Bank transactions.

Non-interest expense for the three months ended September 30, 2014 was $85.5 million compared to $61.5 million for the same period in 2013, an increase of $24 million or 39%. Again, the increase was primarily due to the F&M and First Victoria National Bank transactions.

The efficiency ratio was 41.55% for the three months ended September 30, 2014 compared to 41.59% for the same period last year and 42.9% for the three months ended June 30, 2014.

The bond portfolio metrics at 9/30 showed a weighted average life of 4.32 years, an effective duration of 3.89, and projected annual cash flows of approximately $1.5 billion.

And with that, let me turn over the presentation to Tim Timanus for some detail on loans and asset quality. Tim?

Thank you, Dave. Our non-performing assets at quarter end September 30, 2014 totaled $50,082,000 which is 53 basis points of loans and other real estate as compared to $28,521,000 or 31 basis points at the end of the second quarter of this year. This represents an increase of 76% from June 30, 2014. This change primarily results from the addition of approximately $22 million in non-performing assets from F&M Bank and Trust Company.

The June 30, 2014 non-performing asset total consists of $44,557,000 in loans, $21,000 in repossessed assets and $5,504,000 in other real estate. Net chargeoffs for the three months ended September 30, 2014 were $653,000 compared to net chargeoffs of $155,000 for the three months ended June 30, 2014. Five million dollars was added to the allowance for credit losses during the quarter ended September 30, 2014 compared to $6,325,000 for the second quarter of this year.

Our average monthly new loan production for the quarter ended September 30, 2014 was $285 million compared to $241 million for the quarter ended June 30, 2014. This average monthly new loan production for the third quarter of 2014 represented an 18% increase on a linked quarter basis.

Loans outstanding at September 30, 2014 were $9,369,000,000 compared to $9,308,000,000 at June 30, 2014. The September 30, 2014 loan rate structure is made up of 43% fixed rate loans, 35% floating rate loans and 22% variable rate loans.

I will now turn it over to Charlotte who will coordinate your questions.

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

Absolutely. We will now begin the question and answer session. (Operator Instructions)

Our first question comes from Jennifer Demba of SunTrust Robinson Humphrey. Please go ahead.

David, could you just give us some color on, you said you think MPAs are going to stay at this more elevated for you anyway for the next several quarters. Can you give us some color on that and then I have a question on another topic.

We do think with the additional loans that were brought over from the acquisitions that again, it is natural that there are certain loans in the portfolio that may not fit the same risk profile that we have and so I think that we have identified a certain amount of loans in those banks that we acquired and so probably if everything went right, the good news, we would probably be back down at a lower ratio in 12 months, again to be, just so we don't mislead anybody, we think it could take up to 12 to 18 months before the ratio gets back down to something what we're used to, basically.

Can you talk to us about your acquisition pipeline? Do you feel ready now to kind of resume other bank acquisitions now that you have made more investments over the last several quarters?

I would say that we are breathing better. We kind of committed, if you'll remember at the beginning of last year that after such the number of acquisitions that we did and the bank went from $10 billion to $20 billion that we really wanted to put a year under our belt and make sure that our backroom operations were in good order, that our IT was good and all the things that the DSI and all of the things that regulators want us to do at the same time and I have to say that I feel really good where we are at right now and I think that if the right opportunity were to come around then we would probably pursue it.

What does the pipeline look like right now versus maybe six months, a year ago?

Just yesterday probably I had two different investment banks calling me but they are smaller banks. These are banks that are probably $500 million, $600 million in size. We'll just have to make a decision. If I think in the last week or so I probably had four banks thrown at us but again, I think we really have to make a decision. What really impacts us? What really moves the needle? Does it make sense? Is it in our backyard or not in our backyard? Those are just all the considerations that we have to make and do we want to take time out for a bank that size or do we want to wait for something that is a little bit bigger? Those are just ? they are just opportunistic questions that we had and we haven't made a decision and truthfully, up until the last month or so, we really weren't considering buying anything at that point. We did stick with the schedule that we told everybody and I think only now are we back looking and considering different deals right now.

Our next question comes from Jefferson Harralson of KBW. Please go ahead.

Hey Jefferson, are you there?

Hello Jefferson Harralson from KBW. Your line is open to ask your question.

Our next question comes from Brett Rabatin of Sterne, Agee. Please go ahead.

Wanted to first I guess ask about capital ratios. I know last quarter there was some consternation about you taking capital ratios down a little bit. They are up a little higher this quarter so I guess David, was hoping maybe for some color on how you feel about the capital ratio and where it is today, that kind of take. Any kind of common or I assume, debt as well, capital raise, were off the table?

As mentioned earlier in my comments, we went from six-point-something to 7.4% Tier 1 leverage ratio which is, you can see how rapidly our capital is building and so we are really pleased with that.

At the same time, I think we would always be opportunistic. If the right deal came along or we felt it was the right time or something, I don't want to mislead anybody. I think we will always be opportunistic with regard to that. Again, we are very pleased with where our capital is and how fast it is growing. I think that Dave probably could give more color but I think that probably our capital growth at 1% a year, capital to asset ratio, so we do have good earnings.

Okay then I guess the other thing I was hoping just to get from you guys is the payoffs, how much that affected, aside from the past acquisitions, how much payoffs affected the organic portfolio and then you may have given it but I missed it, the monthly loan production. I joined a little late so I may have missed that number.

This is Tim. The average monthly new loan production for this most recent quarter was $285 million per month and our burn rate is a bit of a rough calculation but for that quarter it was about $265 million so our production did exceed the burn rate. That is the good news. I guess the bad news is the burn rate is still relatively high. Some of the elements of that burn rate are obviously the loans that we are not particularly comfortable with and are okay seeing leave the Company.

We have always for the last several quarters had a fairly substantial burn rate and that is still the case but those are the rough numbers, $285 million production and $265 burn rate.

Our next question comes from Carl Dorf of Dorf Asset Management. Please go ahead.

Can you discuss the energy situation a little bit, its impact on you, basically what is your direct exposure to energy loans, your indirect exposure and what price if any would you be concerned about it having an impact on your portfolio?

Carl, I didn't know you were still alive. I hadn't heard from you in a long time.

I'm still alive, still holding the original stock that I bought, still living and kicking and doing well, thank you. You guys are too.

Carl was one of our first year holders when we ever went public in '98, Anyway, Carl, where we are at today, I'll give you some color on our loans.

Oil and gas producers that are secured by oil and gas right now is $340 million and then loans to oil and gas people that are in the service industry which are secured and unsecured is about $207 million. We can even break it down to loans that, loans to oil and gas producers that are secure, unsecured and secured with other types of collateral is about $97 million. If you added the whole group up together, that is loans to oil and gas producers of $340 million, loans to oil and gas producers that are other collateral types not oil and gas is $97 million and then you add loans to the oil and gas servicers which are about $200 million. It is about $644 million.

I would say that as oil prices have gone down, we stay in close contact especially with our guys in the Permian Basin. From everything that they are telling us and what we're talking, I wouldn't say they're going ? for the most part, they are watching everything but again, I don't know that anybody is startled or changed a whole lot of data or said anything that made me pause but for the most part, they feel that ? that is actually out at the Permian Basin area ? that historically, they have watched these things in the past and prices have come down and it may take three to six months and then prices go back up.

I guess the comfort level that I have is I've went out and met with a lot of these people and they are not the same people that were really in the 80s. Well, they are the same people but I don't think they are going to make the same mistakes and they keep telling me that this is not the same situation as in the 80s when [Leister Dunphy] really controlled the pricing. I would say overall, they still feel comfortable and feeling the idea, they are telling me that even at the $70 price, they still make pretty good money.

I think when you listen to guys like [Teba] and Pickens and guys like that on CNBC, they think that once it falls below $70, that that may impact things that will slow down drilling. That is the color that I have, Carl.

(Operator Instructions) Our next question comes from Matt Olney of Stephens Inc. Please go ahead.

I wanted to ask more about that securities portfolio being relatively flattish and I am curious how you expect to manage that securities book relative to your overall capital levels and what is your current bias as to the size of that securities book in 2015?

Matt, try to give it to us again what you are asking for, maybe one question at a time.

Sure, so the securities book was relatively flattish in the quarter and I am trying to get a better idea as to your expectation of the size of the securities book over the next few quarters and the second part of that I guess was how you think about the size of the securities book relative to how you think about your capital levels and then the capital build that you want to see?

Let's start with one I think. The first question on the investment portfolio being flattish, I think it is more flattish because basically we are seeing loans grow and we are not buying as many securities. Perhaps that is a good thing. In fact, we would like to see our loan to deposit ratio grow. It has always been hard when you give the exact relation because we still have a number of loans that we think that are going to be outsourced at the banks that we acquired, maybe another couple hundred million, $250 million, but our thought is that we really would like to see the loan portfolio decrease and that money go into the loans.

The second question I think you're asking, how did that relate to capital? I don't know that we have ever thought about it in respect to how it relates to capital.

Most of it is in HTM, right? So it you kind of come at it from that perspective, if rates, as they're going up, you're going to have an unrealized loss in that but again, it's an HTM so in theory, that really shouldn't impact us from a capital perspective unless you are looking at overall [EVE] as a concept.

Okay, I see where you are coming from on that. Over 90%, probably 90%, 95% of our deal is in HTM and we have always done like that because of our capital ratios that we have had. Again, we're not, I would say we are not fond of call rates in any one form or fashion. I think that we are biding all markets and we are trying to stay with a very short duration and very short average life and where other banks, again, if interest rates go up and they really do have loan portfolios that really and truly are floating, they will probably perform better than us.

It will take us about 18 months for our portfolio to turn around and really take advantage of the increase in rates. I think everybody does want to see an increase in rates. They may not want to see the valuation because as we all know, those are going to ? we will have a negative valuation on some of those, a lot of our bond portfolio but again, a lot of it is HTM and we are trying to stay short duration and a short average life.

That's helpful, guys, thank you. And then I believe Tim, you mentioned that the burn rate was elevated in third quarter. I know it is a tricky question but how much longer do you expect that burn rate to remain relatively elevated?

I think that goes back to David's answer on the non-performing assets. We expect the level to be likely where it is today for the next handful of quarters and if we continue to see loans that don't fit our model, so to speak, and make efforts to move those out, I anticipate that the burn rate hopefully is not going to exceed the new loan production but I think we are going to continue to see a fairly substantial burn rate until we move through some of these credits that don't fit us very well.

I think the bulk of the refinancing has occurred. We have been going through that for three years or so now and I think most of that is beyond us, not all of it obviously, but a lot of that is beyond us.

Another issue is the fact that the economy is so good in our marketplaces that people have profits in their assets. We are continuing to see people sell assets and take those profits so I think that is going to continue. Obviously, it is tied to the economy in our area.

I don't see a lot of change in the burn rate as a percentage of new loan production.

At the beginning of the year we said when we had these big acquisitions that there is a certain amount of loans that we thought we would lose over a period of time, 12 to 18 months, and what we did say is our organic portfolio grows 8% to 10% a year so if you start at the beginning at the year with $6 billion, before the acquisitions of the other loans we said at 8%, that is about $480 million and our goal for this year, and I think that we are right on track, is we said that basically we think our organic growth rate would offset any losses that we had in dealing with the banks that we acquire and I think we have actually done a little bit better. We have actually grown loans overall in addition to the loans that we are trying to outsource.

I think the total would be I think at least another 12 months, probably.

Okay and then lastly, can you give some commentary as far as the capital and the trust preferred status and what the impact would be of losing the Tier 1 status from some of those trust preferred securities into 2015 and then kind of how you expect to replace that capital?

I will answer that last part first. It is correct to observe on the trust preferred for us it is not going to count as Tier 1 capital starting January 1. We only get, in 2015 it will only count up to 25% and then in 2016, it counts zero so with that in mind, we probably will redeem the trust preferred because it just doesn't help us from a Tier 1 capital perspective. So the second part --

I got the same, what is our total trust preferred, [$167 million]. We are making about $300 million a year less the dividend which is, how much is our dividend now? It is going to be about a dollar (cross talk) you are talking about $70 million less of ? it should still leave us with retained equity, barring any acquisitions or anything like that but about $225 million so you can obviously see that the earnings that we have will, even if we regain the trust preferred, would offset any loss of that plus still increase about, what, $160 million, $40 million, $50 million, $60 million, $65 million still increase additional capital in that year's time.

Even with the redemption you are still looking at an 8% number by the time we get to end of next year.

Our next question comes from Jon Arfstrom of RBC Capital Markets. Please go ahead.

Just a question, Dave Holloway, on expenses. It looks like FTEs came down quite a bit and I am just, and expense control was great. I am just wondering if you feel like there is some more room there or is this kind of the natural balance in terms of where you are at from an expense point of view?

I think, Zalman and (inaudible) because last quarter he wasn't clear on this so maybe I can answer it a little bit better.

I think it was clear. They just couldn't understand.

I think it is a good observation. As we came through this last quarter you do see significant headcount reduction. That is just the natural evolution when we acquire these other institutions and there is just this resetting of headcount and where we place everybody so you saw a huge decrease which really helps us from an expense reduction perspective and so when you look forward, I think we are there. We have Mike Epps is in the room with me. He will correct me if I say this incorrectly but I think from the acquisition perspective, we have done what we needed to do. That's what I think you see in the third quarter. What you don't see and what has helped us is it helped offset some of this regulatory expense that we have had to add, whether it be DFAS or some of the validation expenses around it or BSA or whatever. It helps set some of that out so when we look forward, I think the number you see is a good number. It may vary a little bit but I think it is a good number what you see today in this quarter.

Okay and then on the non-interest income, it was kind of a noisy quarter last quarter. Would you call this a pretty clean quarter from a non-interest income point of view or are there any call-outs in there?

No, I absolutely agree with that. I think this is a pretty, actually a good quarter without any noise in it.

The question on credit, so I understand it, it sounds like you have maybe about one-third of the non-performers that you paid off or moved or renewed but yet you are saying it will be flat. Is this something where you are actually, you are seeing deterioration, you're expecting the categories to fill back up or is this something where you see some things in the acquired portfolio you don't like and you are being proactive in trying to work them out early? Just help me understand that.

None of this is unexpected. In fact, if you went back and looked at our due diligence, it is almost (inaudible), you would almost think we had some ESP or something but we didn't. We identified all that. We knew that when we did the due diligence on the company. We think that this ratio would hold that because we have identified a certain amount of loans that we know that we do want in or out of the bank and so when you are doing that and you are asking customers to do that, there is going to be a little bit of tension sometimes. Normally, when a loan is made on interest only for three or four years and you want the customer to start paying and they don't feel like they need to start paying principal payment, you just go through a little bit of a transition and those are some of the things we're going through, that we can try to get their loans the way we want them or if we can't, well then they're just going to beat us but I don't think that there is anything unexpected. We counted on this to begin with, quite frankly.

Our next question comes from Bryce Rowe of Robert W. Baird. Please go ahead.

Just a follow up on the question about the trust preferred and I might have missed this but can you talk about the anticipated timing of the redemption for the trust preferreds?

I think first of all, David or Charlotte can jump in, we still have to notify the regulators that we want to do this or intend to do this and of course, they have to signoff what we're doing at the same time so I think if everything happens which we think it will ? you never know ? but if all that happens, what do you think, Charlotte, is our timeframe, or Dave?

By the end of the first quarter 2015.

(Operator Instructions) I do show that one more person has come into our question queue. The question that we have is going to come from Chris Stulpin of Merion Capital. Please go ahead.

Just on the last question, you mentioned you have to notify regulators when you attempt to exit your trust preferred position and I believe the timing was for 1Q '15. Is that timing for notifying regulators or is that the timing for actually exiting the trust preferred?

That was the timing for redeeming the trust preferred.

Okay for redemption, okay ? perfect, thank you very much.

(Operator Instructions) And once again, this does conclude our question and answer session. I would now like to turn the conference back over to Ms. Charlotte Rasche for any closing remarks.

Thank you, Ed. Thank you ladies and gentlemen. We appreciate you 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. Thank you.

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