Prosperity Bancshares Inc (PB) 2016 Q4 法說會逐字稿

Good morning and welcome to the Prosperity Bancshares fourth-quarter 2016 earnings conference call.

(Operator Instructions)

Please note this 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 fourth-quarter 2016 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'm Charlotte Rasche, Executive Vice President and General Counsel of Prosperity Bancshares. And here with me today is David Zalman, Chairman and Chief Executive Officer; H.E. Tim Timanus, Jr., Vice Chairman; David Hollaway, Chief Financial Officer; Eddie Safady, President; Randy Hester, Chief Lending Officer; Mike Epps, EVP for Financial Operations and Administration; and Merle Karnes, Chief Credit Officer.

David Zalman will lead off with a review of the highlights for the recent quarter. He will be followed by David Hollaway, 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, Amy.

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 Bancshares filings with the Securities and Exchange Commission including forms 10-Q and 10K 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 for listening to our fourth-quarter 2016 conference call. For the fourth quarter, we had impressive annualized returns on average tangible common equity of 16.3% and on average assets of 1.26%.

Our earnings were $68.7 million for the fourth quarter of 2016 compared with $70.4 million for the same period in 2015. The net income, excluding purchase accounting adjustments, was $64.1 million for the three months ending December 31, 2016, compared with $66.1 million for the three months ended December 31, 2015.

Our diluted earnings per share were $0.99 for the fourth quarter of 2016, compared to $1.01 for the same period in 2015. Loans at December 31, 2016 were $9.6 billion, an increase of $183.4 million or 1.9% compared with $9.4 billion at December 31, 2015.

Our linked quarter loans increased $73.7 million, 80 basis points, or 3.1% annualized from $9.5 billion at September 30, 2016. At December 31, 2016, oil and gas loans totaled $284.5 million or 3% of total loans, compared with oil and gas loans of $399 million or 4.2% of total loans at December 31, 2015.

The $114.5 million decrease represents a 28.7% decrease in oil and gas loans when compared to their level at December 31, 2015. On a linked quarter basis, oil and gas loans decreased $24.4 million from $308.9 million or 3.2% of total loans at September 30, 2016.

Our nonperforming assets at December 31, 2016, were $48.3 million or 25 basis points of quarterly average earnings assets, compared with $60.1 million or 32 basis points of quarterly average earning assets at September 30, 2016. This represents a 19.7% decrease in nonperforming assets when comparing this quarter to last quarter. Tim will discuss this in more detail later in the call.

Our nonperforming asset ratios were the lowest in the industry and a sign of solid asset quality. Deposits at December 31, 2016 or $17.3 billion, a decrease of $373 million or 2.1% when compared with $17.6 billion at December 31, 2015.

This decrease was primarily due to one public fund deposit that we did not accept in 2016 that had accepted in prior years. Historically this fund would make a large deposit at year-end and withdrawal it shortly after year end. The decrease in deposit was also due to the bank reducing broker deposits that we assumed in recent acquisitions.

Our linked quarter deposits increased $385 million, 2.3% or 9.1% annualized from the $16.9 billion at September 30, 2016. We typically experience a large increase in deposits in the fourth quarter. For 2016, we have not seen the organic growth in deposits that we historically have experienced and it was primarily due to a number of our customers using their cash to operate given lower oil and agricultural prices.

With regard to acquisitions, as we've indicated in prior quarters, we continue to have active conversations with other bankers regarding potential acquisition opportunities. We remain ready to enter into a deal when it is right for all parties and is appropriately accretive to our existing shareholders.

A little on the economy. We are excited going into the 2017 year. The Texas and Oklahoma economies are improving with rising oil and gas prices. Further expected increases of interest rates will help our net interest margin over the longer-term. We see optimism in our customer base, with business is now willing to expand purchasing.

With a better economy and the absence of the loan contraction we had the last several years, we believe that we will have more normalized organic growth in loans and deposits for 2017. Again, we are very excited for the coming year.

I would like to thank our home team once again for a job well done. Thanks again for your support of our Company. Let me turn over our discussion for David Hollaway, our Chief Financial Officer to discuss some of the specific financial results we achieved. David?

Thank you, David. Net interest income before provision for credit losses for the three months ended December 31, 2016 was $153.8 million compared to $153.3 million for the three months ended December 31, 2015. For the full year of 2016, net interest income was $632.6 million compared to $630.5 million for 2015.

The net interest margin on a tax equivalent basis was 3.26% for the quarter ended December 31, 2016, compared to 3.24% for the same period in 2015, and 3.29% for the quarter ended September 30, 2016. Excluding purchase accounting adjustments, the net interest margin on tax equivalent basis for the quarter ended December 31, 2016 was 3.12%, compared to 3.11% for the same period in 2015, and 3.14% for the quarter ended September 30, 2016.

Concerning the bond portfolio, net amortization was $11.5 million for the fourth quarter 2016, compared to $11.3 million in the third quarter of 2016. This increase was due to a larger bond portfolio, which was $9 billion at the beginning of the quarter and increased to $9.7 billion by the end of the quarter.

Noninterest income was $29.5 million for the three months ended December 31, 2016, compared to $30.3 million for the same period in 2015 and for the full year 2016, noninterest income was $118.4 million, compared to $120.8 million for the full year 2015. Noninterest expense for the three months ended December 31, 2016 was $79.1 million, compared to $77.9 million for the same period in 2015 and for the full year of 2016, noninterest expense was a $318.4 million compared to $313.5 million for 2015, an increase of 1.5% and this increase was primarily due to the Tradition acquisition that closed at the beginning of the 2016 year.

The efficiency ratio was 43.3% for the three months ended December 31, 2016, compared to 42.6% for the same period last year, and 43.3% for the three months ended September 30, 2016. For the full year of 2016, the efficiency ratio was 42.5%, compared to 41.9% in 2015. The bond portfolio metrics at 12/31 showed a weighted average life of 4.1 years effective duration of 3.7 and projected annual cash flows of approximately $1.6 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. I will highlight some of the information that David Zalman has given us.

Our nonperforming assets at the end of the year, December 31, 2016, totaled $48.302 million which is 50 basis points of loans and other real estate, compared to $60.166 million or 63 basis points at the end of the third quarter of 2016; this represents a 20% decrease from September 30, 2016. The December 31, 2016 nonperforming asset total was made up of $32.598 million in loans, $241,000 in repossessed assets, and $15.463 million in other real estate.

Of the $32.598 million in loans, $20.705 million or 64% in energy credits. This is broken down between $13.717 million in exploration and production credits, and $6.988 million in service company credits. Since December 31, 2016, two ORE properties totaling $126,000 have gone under contract for sale but there can be no assurance that these contracts will close.

Net charge-offs for the three months ended December 31, 2016 were $2.259 million, compared to net charge-offs of $241,000 for the three months ended September 30, 2016. Net charge-offs for year ended December 31, 2016 were $20.58 million compared to $6.938 million for the year ended December 31, 2015.

$2 million was added to the allowance for credit losses during the quarter ended December 31, 2016. This same amount, $2 million, was added for the third quarter of 2016.

$24 million was added during the year 2016, compared to $7.560 million for 2015. The average monthly new loan production for the fourth quarter ended December 31, 2016 was $286 million, compared to $221 million for the third quarter ended September 30, 2016; this is a 29% increase.

Loans outstanding at December 31, 2016 were $9.622 billion, compared to $9.548 billion at September 30, 2016 and $9.439 billion at December 31, 2015. The December 31, 2016 loan total is made up of 41% fixed rate loans, 35% floating rate, and 24% variable rate.

Charlotte, I will now turn it over to you.

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

We will now begin the question-and-answer session.

(Operator Instructions)

The first question is from Steve Moss of FBR.

Good morning. Morning. On loan growth you sound pretty upbeat about the outlook here, I was wondering what you're seeing in the loan pipeline and what are you thinking about loan growth for the overall year.

I will take that. I will start off. Hey, Steve. This is David Zalman,

We are more upbeat this year. For the last couple of years -- first off all we just look at in our markets, we had good places in our markets. We had places like Boston that is on fire, Dallas on fire, at the same time we had oil and gas industries impacting the use in markets impacting South Texas, the Permian Basin, and also Oklahoma.

Having said that, we also are having -- we are also after some of the larger acquisitions we had. We had some loans that we were really try to work out of and trying to reduce that, so we are a lot more optimistic right now. As Tim mentioned earlier, just in this last month, I think, what was it a 29% increase?

That is correct on a linked quarter basis.

We are seeing a lot more people talking about loans. We are seeing our customers asked about loans and we've recently had a management committee meeting, and I don't want to go into detail on every area that we have, but we have a number of areas where we have regional Chairmans and Presidents, and all of them have quite a few loans that are in the pipeline.

If we can close those, we are very optimistic. We think that we will get back to -- historically if you take out the last two years with this oil and gas deal that we've had in the economy in Texas, historically we used to run about 8% organically loan growth. I don't know that I want to commit to the 8% this year, but maybe 5% to 6%, we do feel comfortable in saying we should hit.

Okay, and given the recent moves in interest rates, just wondering what your expectations are around for an interest margin in the first quarter.

I think that (inaudible) and Dave probably will jump in on this. Our interest margin, as I've explained before, is probably not as drastic as some of the other banks that have a lot higher loan to deposit ratio, that have floating rate loans. We have $9 billion in securities and $9 billion something in loans and as interest rates go up they will certainly help us. I always tell people it is trying to turn the Queen Mary around in the parking lot out here.

We won't see the full part of that or the full benefit of that for probably a couple of years, but having said that, 200 basis points increase or 300 basis points increase over the next couple of years as the Fed has predicted, it increases our income dramatically. It is a real plus.

Okay, and also with regard to M&A, you mentioned that you continue to have discussions. Are you seeing a change in attitudes about selling given the election results and recent run-up in stock prices?

You know, I would say most of those deals that we have been working on were prior to the election results, and again, we worked on a number of deals this year whether or not we didn't go further with them because of whether it was a pricing issue, whether it was a cultural issue or a number of other things, for some reason we didn't, they weren't met. I have to say that I really haven't talked to a number of people as far as actually making a deal since the November election.

I think most people are a lot more upbeat, especially from the regulatory side. I think you have feelings from both groups. You have feelings that say wow, look at the prices and now is the time to sell. You have others that say wow, I think times are going to get better, let me hold on-site. I think it is mixed still right now.

All right. Thank you very much.

The next question is from Scott Valentin at Compass Point.

Good morning, thanks for taking my question. Just with regard to, you mentioned securities portfolio grew quite a bit during the quarter and given the outlook for higher rates, is there going to be any change in the way you approach securities management?

Historically we have such a roll off in our bond portfolios. Dave mentioned earlier I'm thinking around $1.5 billion or $1.6 billion a year. That usually we would always just buy in advance of the roll off and we can leverage the bank loan, but when interest rates got so much lower like in the product that we buy and was going at 1.8, we really backed off of the deal.

Now the interest rates have gone back up, we probably are going to keep the leverage on the bank. Because, we're not trying to call rates, we're just trying to buy in advance of the bonds that are rolling off. That will probably help us going forward for 2017.

Yes. There is so much cash flow coming off the bond portfolio, so getting ahead is good, and obviously if the loan growth can be there in this coming year that could soak up some of the cash flow coming back to us and actually going to loans if all goes well.

And do you happen to have the duration of the portfolio?

Yes, the duration on the portfolio is approximately 3.7.

Is that up substantially from or is it up from 3Q? I don't have that number.

From 3Q, no. We have been right around that 3.8, 3.7 (inaudible). 3.8, 3.7 is where we have been running so not too much change.

Okay. Great. And on non interest expense items, seller and comp jumped quite a bit linked quarter, wondering how we should think about earnest expense going forward.

That is just a bigger picture on the expense because I think a lot of people are curious about that. I just want to say, let's look at it overall and as we grow in these next few quarters, we want to run in that $79.5 million to $80.5 million range.

Okay. Thanks.

The next question is from Jon Afstrom at RBC.

Good morning, everyone. Tim or David, maybe a question for you on the average monthly new loan production. Is that a number you expect to go higher in 2017? It sounds like you are pretty optimistic but just curious on that.

Well, obviously, we hope so. Let me answer that way to begin with. There is reason to think that it may very well go higher.

Our people are out there every day working very hard. We're seeing quite a few loans coming in to us. That's obviously a positive.

On the negative side, competition is still very, very strong, and there are a lot of lenders that are willing to do things on a nonrecourse basis, and we always have been somewhat hesitant about that. We've always been sensitive about fixing rates out too terribly long. Other lenders do not seem to be quite that sensitive.

There are always headwinds from competition, but the economies that we work in seem to have more good news coming available than bad news so, yes, I think we are reasonably optimistic.

I think, John, it is really hard to put in words since the November election, the momentum that we've seen in all of our customers right now, and maybe it is a real positive. It looks like where people were always worried about the regulatory environment of letting people working people work maybe half time and maybe cutting down and certainly not expanding, a lot of that has changed.

I think that if our administration is saying things like this and they can carry out through what some of the things they are saying, I think it looks extremely positive.

Okay. You said loan committee meetings are busier, maybe more optimistic than they were three or four months ago?

I hear loan committees our longer. There are getting back to stay later at night, and also the loans that are in the hopper that are yet to be funded, maybe bigger than I have seen in the long, long time.

Okay.

We really hit the doldrums in the second and third quarters of last year on loan production and you can attribute that to I guess whatever you want. I personally believe it was just uncertainty in our economies and in Texas and Oklahoma, but that has definitely picked up and we don't see any reason why that pickup won't continue.

To acquisition runoff has slowed down tremendously.

You probably didn't hear that, but Randy also said that the acquisition run off that you normally have on some of our larger acquisitions has slowed down a lot and probably -- I think that contraction that we get from American bond with the momentum that we have should stand for a very positive year, we think.

And that goes to the growth guidance, that's maybe the West Texas and Oklahoma pieces where you feel you are essentially done with the run off?

I think West Texas, the South Texas, and I think Oklahoma also.

Okay. Good. That helps. Thank you very much.

The next question is from Ebrahim Poonawala at Bank of America Merrill Lynch.

Good morning. I have a quick question one and I'm sorry if I missed it in your opening remarks on deposit growth. I think you gave good color around maybe a 5% to 6% loan growth here.

What are your thoughts around deposit growth rebounding into 2017 and how do you think about that visually, maybe some customers drawing down on their existing cash balances as they make investments versus getting in new deposit growth?

Can you repeat (multiple speakers).

The question is, just to rephrase, you are asking what are we looking for? What do we think about deposit growth in this upcoming year? Is that the question?

Right.

I will take a first. I think we are projecting around 4% deposit growth this year and certainly with all those points that you brought up, I think you mentioned if the economy starts booming, a lot of these people sitting on a cash position they begin to invest that. I think that the size of the bank, we have historically grown around that 4% through all various economies and interest rate cycles, so I think it is a goal we want to continue to try to strive for. David, do you agree with this?

I agree with all of that and I will go back over the last two years. We looked at customers that averaged, especially in the oil and gas industry, maybe $5 million or $6 million in their checking accounts. Today they may have $200,000 or $300,000 and they are asking for an operating line of credit.

Having said that, this year it looks like there really starting to make some money, especially in the service industry. It looks like they are getting their pricing back. I think you will see that, and also the agricultural prices. Agricultural prices have been really down. So a lot of these customers that had a lot of money that they either made from agriculture or got from oil and gas royalties or something like that, they depleted that.

We are starting to see that rebuild, so that is a real positive sign.

That is extremely helpful. And just going back to in terms of the net interest margin, I think David, you mentioned about longer term, what you expect the net interest margin can do. Looking out into 2017, from your own -- given your expectations around loan growth, getting on some high yielding assets on the balance sheet and deposit growth, do you anticipate your reported margins to be relatively flat in this mid-teen, 20's?

Yes, let's be a little clear on that, because when we say this I want to say it without the loan share value income in there like the core margin and yes, we would agree with that core margin should be pretty stable over the next few quarters. What you have seen in the last couple of quarters.

Of course none of that takes into consideration what is proposed in tax rates (multiple speakers), or tax per regulatory less Durbin Amendment, a number of those things can change this whole thing dramatically. And I know that you can't count on them, but anybody can do that math. If you see our tax rate go from 35% to say 20%, you are talking probably $50 million there or $60 million. On the Durbin Amendment alone, if we get some relief there that could be $15 million to $20 million for us.

Combining those kinds of things with the regulatory relief and net interest margin, everything that we are telling you right now could change dramatically.

That's fair, and, David, you mentioned the discount depletion. I had in my notes about that being about $5 million to $7 million per quarter as we look out into 2017. Is that still true and what was it in the fourth quarter?

Fourth quarter it was around $7 million and really going forward would like to say $5 million to $6 million instead of $5 million to $7 million.

Understood, that's helpful. And one last question if I could ask Dave Zalman in terms of M&A, I heard your comments earlier, any thoughts around going outside your footprint if a larger deal comes through or if that makes strategic sense or do you want to be limited to the footprint as you think about M&A in the near-term?

No. As we mentioned earlier I think Texas and Oklahoma, because we are here, would always be our first choice, but throughout the year we've talked with banks in surrounding states that are close to us and we are not -- at our size we are not opposed going -- I should never say never -- I don't know that we will ever go to California or New York, but I never say never.

We are not opposed to looking at states around us. We're just not opposed to that.

Banks of a certain size or --

They asked a question or lobbed one to me, basically what size we're looking at. There are 50 banks in Texas that are over $1 billion in size, probably over 50, but we'd like to see $1 billion plus, $2 billion maybe is probably the nicest size. On the other hand if there is a bank that's in one of our markets and it is $500 million or $600 million and it is something that is one of our major markets, we will look at that too at the same time.

Historically thought, the banks we have looked at have been banks that have been around for a long, long time, and have a good core deposit base and really not based on just higher rate CD money and more core loans. That is the kind of deal we're looking at. Maybe not something that has just really been started and really has a lot of time money.

Understood. Thanks for taking the questions.

The next question is from Gary Tenner at D.A. Davidson.

Thanks. Good morning. I was hoping for some additional detail on these curry investments in the quarter in terms of what the yield was on the new purchases.

I think most of the new purchases that we're looking at is probably around 225 to 240 probably.

That is correct.

Okay, and the premium amortization this quarter as you noted up a little bit sequentially, but on a larger portfolio, if rates stay where they are, where do you think that run rate goes to?

That is the million dollar question, because just to put a finer point on that, just as an example, the CPR piece begin to slow down which you would think they will based on where rates are going. I don't think I can give you a number but I can give you some color to get you to a number.

We've talk about 11.5 this quarter compared to 11.3 but just because of an increase in rates here since the election, this might put some points that we were at $4 million in October in amortization and we dropped down to $3.7 million in December. You can see within the quarter, we can see some positive trends going on.

If you just assume $3.7 million for the month you can see that is going to be a big improvement to us and if these speeds really begin to slow down we should see some more positive tick ups. I think it is good here and we're just a little too early in it. We have not seen it yet, but I think we will see some positives coming in regards to net amortization. Is that too long of an answer for it on that?

That is perfect. I appreciate the color. Thanks.

Next question is from Peter Winter at Wedbush Securities.

Good morning. I wanted to follow up on M&A; what the M&A environment is like. I'm wondering is it getting more competitive with all the banks seeing increase stock prices, because there were a couple of acquisitions in your markets which went to other banks. I'm trying to get a sense of the competitive landscape is like.

Well, Peter, this is David. When I look back to 2016, we looked at a number of deals. I don't want to give you exactly the number that we looked at, but we looked at deals that were located in the state of. We looked at deals that were located outside the state of Texas. And some of the deals that we looked at, we probably have first chance on some of the deals you are talking about.

We might not have been able to get there because of the price. We wanted something to be accretive and it didn't. We probably didn't do some deals because of pricing. We probably didn't do some deals because of difference in culture in lending maybe or maybe just the culture of the bank. We still looked at a number of deals and I think that we will continue to look at a number of deals but you are right.

There have been deals in our backyard that we didn't do and it is either a pricing issue or it was something else in the culture or the lending side of it.

But is it getting more competitive with everybody's stock price moving up? Making it harder?

Well again, -- really if you are dealing with another bank that is publicly traded, you are just trading Chinese marbles really. Their stock price is high, our stock price is high so that's not as big a deal. I think where the benefit really comes when you are dealing with a bank that maybe is not publicly traded.

That is when you have a lot more leverage probably. I think there are just both sides of it. I think I mentioned it earlier.

I think there are some people that as prices have gone up and after the election everybody has gotten positive with, especially from a regulatory -- the regulatory standpoint was the thing that really probably helped us the most. People were just frustrated and tired with the regulatory environment. So that will be a real key with some of these people going forward and the other side of it is people were saying look at these prices today, let's not miss out on that.

I cannot just give you an exact answer. I think it is mixed and I think that you will see good activity again this year.

Okay, and just one follow-up question on the core margin, David Hollaway said it was going to be relatively flat, but I'm wondering why it wouldn't move up with an improved outlook on loan growth and with the higher rates less premium amortization expense?

I agree. I can clarify. Absolutely, when the rates begin to move up -- again if rates move up, that is what Dave was saying earlier, our margin just does not jump up just because rates move up.

We have to get all that cash flow reinvested so we'll definitely see that positive. We absolutely agree, if the net loan growth sticks, then we do have a positive bias to that margin but if you are just saying statically, you are looking at what you could have today and projecting forward, that is what I was saying.

And I think what you are trying to say too is the same thing I said, David, we're not like a number of other banks where maybe a lot more is on a floating base and it changes right away and it just takes us a while. Cash flow, cash flow just takes us a while before we can reinvest it on one hand. The gentleman that asked about the amortization a while ago, it is nice, but maybe it slows down and you do not have as much amortization exposed in the bond portfolio. The other side of that coin is you are not getting the money back to reinvest fast enough.

Again, longer-term, interest rates going up over the longer term, really is an extreme positive. In the short run, just like when interest rates went down so dramatically and we had $300 million or $400 million gain in the bond portfolio, nobody gave us any credit for that. I think as interest rates go up, 200 basis point or 300 basis points you are going an unrealized loss and I am sure there will be some criticism. In the long run, with the short duration of 3.7 years and the improved earnings that we get from it, it is all positive.

Thanks.

(Operator Instructions)

Our next question is from Matt Olney at Stephens Inc.

Hey, good morning. This is Matt Olney. Most of my questions have been answer, but maybe a couple more on the energy books. Were there any charge-offs during the quarter on energy loans?

Yes. Most of the net charge-offs during the quarter, Matt, was one energy credit. Almost all of it was.

Okay. And what does that reserve stand at now? Do you have the mark against these energy loans as well from the acquired book?

Yes. Just a minute. The reserve is about 2%, a little over 2%, and the mark, the total mark on the book is a little over 1%. If you look at the energy loans that are not marked, it is about 2.2% and those that are marked it is a little over 1%.

Great. That does it for me. Thanks.

This concludes our question-and-answer session. I would like to turn the conference back over to Miss Rasche for closing remarks.

Thank you, Amy. 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. Thank you.

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