Prosperity Bancshares Inc (PB) 2020 Q3 法說會逐字稿

Good day, and welcome to the Prosperity Bancshares, Inc. Third Quarter 2020 Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded.

I'd now like to turn the conference over to Charlotte Rasche. Please go ahead.

Thank you. Good morning, ladies and gentlemen, and welcome to Prosperity Bancshares Third Quarter 2020 Earnings Conference Call. This call is being broadcast live over the internet at prosperitybankusa.com and will be available for replay at the same location for the next few weeks.

I'm Charlotte Rasche, Executive Vice President and General Counsel of Prosperity Bancshares. And here with me today is David Zalman, Senior Chairman and Chief Executive Officer; H.E Tim Timanus Jr., Chairman; Asylbek Osmonov, Chief Financial Officer; Eddie Safady, Vice Chairman; Kevin Hanigan, President and Chief Operating Officer; Randy Hester, Chief Lending Officer; Merle Karnes, Chief Credit Officer; Mays Davenport, Director of Corporate Strategy; and Bob Dowdell, Executive Vice President. David Zalman will lead off with a review of the highlights for the recent quarter. He will be followed by Asylbek Osmonov, who will review some of our recent financial statistics, and Tim Timanus, who will discuss our lending activities, including asset quality.

Finally, we will open the call for questions. During the call, interested parties may participate live by following the instructions that will be provided by our call moderator, Grant.

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 third quarter 2020 conference call. I'm excited to announce that because of the confidence in our company, our strong capital position and our continued success in increasing earnings as well as showing annualized returns of 19% on average tangible equity and 1.58% on average assets, our Board of Directors voted to increase the fourth quarter dividend to $0.49, a 6.5% increase. The bank continues to do well, and we want to share that success with our shareholders.

As stock prices experienced significant declines late in the third quarter, Prosperity Bank repurchased 98,000 shares of its common stock at a weighted price of $49.99. Our net income was $130.1 million in the third quarter 2020 compared with $81.8 million for the same period in 2019, an increase of $48.3 million or 59%. Our diluted earnings per share was $1.40 for the third quarter 2020 compared to $1.19 for the same period in 2019, an increase of 17.6%.

Net income was $391 million for the 9 months ended September 30, 2020, compared with $246 million for the same period in 2019, an increase of $145 million or 59%. The earnings per diluted common share was $4.20 for the 9 months ended September 30, 2020, compared with $3.55 for the same period in 2019, an increase of 18.3%.

Loans at September 30, 2020, were $20.796 billion, an increase of $10.122 billion or 94.8% compared with $10.673 billion at September 30, 2019. Our linked quarter loans decreased $229 million or 1.1% from $21.25 billion at June 30, 2020.

At September 30, 2020, the company had $1.394 billion of Paycheck Protection Program, also known as PPP, loans. Obviously, the increase year-over-year in total loans is attributable to the Legacy merger.

Our deposits at September 30, 2020, were $26.459 billion, an increase of $9.529 billion or 56% compared with $16.930 billion at September 30, 2019. Our linked quarter deposits increased $306 million or 1.2%, 4.7% annualized, from the $26.153 billion at June 30, 2020. We are starting to see people spending more money and generating more account activity than earlier this year.

Our asset quality remains sound, with nonperforming assets at $69.5 million or 24 basis points of average interest-earning assets. Our total nonperforming assets decreased $8.4 million compared with the second quarter of 2020.

Our net charge-offs were $10.6 million for the 3 months ended September 30, 2020, and were primarily due to $8.6 million and resolved PCD loans. These PCD loans had specific reserves of $15.7 million, of which $8.6 million was allocated to the charge-offs and $7.1 million was moved to the general reserve. In addition, $6.1 million of specific reserves that was released into the general reserve were resolved PCD loans with no charge-off. This represents a total of $13.2 million moved to the general reserve this quarter.

Loans on forbearance decreased from $3.625 billion or 17.2% of total loans as of June 30, 2020, to $231 million or 1.1% of total loans as of October 26, 2020. Our allowance for credit losses as a percent of total loans is higher than any time in my banking career and equates to a coverage ratio of 5.6x our nonperforming loans.

While there have been some merger announcements recently and conversations with other bankers regarding potential acquisition opportunities, M&A activity overall is reduced. We believe that the M&A activity will start to pick up as economic activity continues to increase. We remain to enter into conversations and negotiations when it is right for all parties and is appropriately accretive to our existing shareholders.

We are starting to see green shoots in the economy with consumers and businesses feeling more confident. The unemployment numbers are better than predicted, and we believe third quarter GDP will also be higher than predicted.

Thanks again for your support of our company. Let me turn over our discussion to Asylbek, our Chief Financial Officer, to discuss some of the specific financial results we achieved. Asylbek?

Thank you, Mr. Zalman. Good morning, everyone. Net interest income before provision for credit losses for the 3 months ended September 30, 2020, was $258 million compared to $154 million for the same period in 2019, an increase of $104.1 million or 67.6%. The increase was primarily due to the merger with Legacy and loan discount accretion of $22.5 million in the third quarter of 2020.

The net interest margin on a tax equivalent basis was 3.57% for the 3 months ended September 30, 2020, compared to 3.16% for the same period in 2019 and 3.69% for the quarter ended June 30, 2020. Excluding purchase accounting adjustments, the core net interest margin for the quarter ended September 30, 2020, was 3.25% compared to 3.14% for the same period in 2019 and 3.33% for the quarter ended June 30, 2020. The current interest rate environment, combined with our excess deposit liquidity has continued to impact the net interest margin. This quarter, the excess liquidity negatively impacted the core net interest margin by approximately 4 to 5 basis points.

Noninterest income was $34.9 million for the 3 months ended September 30, 2020, compared to $30.7 million for the same period in 2019 and $25.7 million for the quarter ended June 30, 2020. In the third quarter, we saw improvements in service fees and mortgage income due to the improving economy compared to the second quarter.

Noninterest expense for the 3 months ended September 30, 2020, was $117.9 million compared to $80.7 million for the same period in 2019. The increase was primarily due to the merger with Legacy. On a linked quarter basis, noninterest expense decreased $16.4 million due to the efficiency gain from the core system conversion and operational integration and a decrease in merger-related expenses. For the fourth quarter 2020, we expect noninterest expense of $117 million to $119 million.

The efficiency ratio was 40.2% for the 3 months ended September 30, 2020, compared to 43.7% for the same period in 2019 and 46.6% for the 3 months ended June 30, 2020. The efficiency ratio was impacted by the merger cost savings and higher-than-anticipated loan fair value income during the third quarter. We estimate loan fair value income for the fourth quarter to be around $9 million to $12 million based on the current fair value discount for each loan amortized over its remaining loan life. This does not account for additional discount accretion income that may occur due to early loan pay downs or payoffs, which we -- which cannot be accurately estimated.

The bond portfolio metrics at 9/30/2020 showed a weighted average life of 2.68 years and projected annual cash flows of approximately $2.25 billion.

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

Thank you, Asylbek. Our nonperforming assets at quarter end September 30, 2020, totaled $69.542 million or 33 basis points of loans and other real estate compared to $77.942 million or 37 basis points at June 30, 2020. The represents approximately an 11% decline. The September 30, 2020, nonperforming asset total was made up of $57.874 million in loans, $120,000 in repossessed assets and $11.548 million in other real estate. Of the $69.542 million in nonperforming assets, $11.761 million or 17% are energy credits, all of which are service company credits. Since September 30, 2020, $5.134 million in nonperforming assets have been put under contract for sale. This represents 7.4% of the nonperforming dollars.

Net charge-offs for the 3 months ended September 30, 2020, were $10.570 million compared to $13.001 million for the quarter ended June 30, 2020. $10 million was added to the allowance for credit losses during the quarter ended September 30, 2020.

The average monthly new loan production for the quarter ended September 30, 2020, was $449 million. Loans outstanding at September 30, 2020, were $20.8 billion, which includes $1.394 billion in PPP loans out of the original $1.430 billion booked. The September 30, 2020, loan total is made up of 39% fixed-rate loans, 36% floating-rate loans and 25% that reset at specific intervals.

I'll now turn it over to Charlotte Rasche.

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

(Operator Instructions) Our first question today will come from Jennifer Demba with Truist.

Just wondering about fee income, wondering what you're thinking about the mortgage banking outlook and also the sustainability of the other line items and fee income going forward. Will you see more business activity and consumer activity improvement in those line items?

Jennifer, this is Asylbek. Yes, so I think the net interest income did rebound better this quarter because of the improving economy. And you can see that our NSF fee went up and kind of getting back to the normalized rate we had pre-COVID. So we believe we can -- we'll see continued improvement on that aspect.

On the mortgage income, yes, mortgage has been pretty active lately. So we continue to see the volumes there. And I expect the fee income to continue to be stable or even grow.

So overall, we see a rebound in the fee income. And we're doing different other one-off income that we're generating, like syndication we did in this quarter, which is one-off income. So a few things that are coming in. We see the continued improvement in the fee income in the near future.

Yes. I would just add, Jennifer, that we're seeing our fee income come back because people are -- there's more activity out there, so you're seeing higher NSF fees. I would suggest that those will probably still increase. We had, again, higher mortgage fees where that may, at some point in time, temper back a little bit. Trust, again, we had good trust fees this time. And as Asylbek commented a while ago, the Legacy team created -- or did a $275 million syndication, which created about $1 million. But they continue to do that into a service we didn't have in the past. And so where it may not be as much, and Kevin may want to jump in, we can -- we'll have returning -- we'll have income from that. And also, we charge fees for servicing those at the same time.

David, are you starting to get more incoming calls from potential merger partners interested in having discussions at this point?

I would say no. I mean the -- we've always had kind of a list of who we'd like to eventually be with, and we continue to monitor those and stay in conversation with those. But I would say that we're not seeing -- at this point in time, I would say that it's more muted than in the past, before COVID and the stock price is going down so dramatically. It wouldn't be uncommon to be just busy with those all the time.

I'd say there's activity, but again, I think it will pick up as we get through this COVID deal and the economy comes back. But again, just really focused on the same ones we've been focusing on and, at some point in time, trying to do deals with those.

Our next question will come from Brett Rabatin with Hovde Group.

Wanted to first ask, David, it seems like the payoffs are a challenge for a lot of folks. And obviously, with the $449 million of monthly loan production, the commercial real estate bucket continues to have some atrophy. Do you have -- I guess, one, do you have any visibility into what payoffs might be in the next few quarters, just looking at the rates that you have with those loans? And then just -- I know it's too early to think about a budget for '21 probably, but just thinking about the outlook for growth on the balance sheet, ex PPP eventually shrinking, how are you thinking about managing the balance sheet in the next year from a growth perspective?

Well, our -- again, we had a Management Committee meeting, and we saw different areas of the state do better than other periods of the state. We saw the Houston market, Central Texas market really be up -- shoot up, and then we had -- sometimes East Texas was up. I think the Dallas market was down, South Texas was down, and West Texas was down.

So -- but again, we have probably another layer that probably you have to throw into the equation. If you remember, we have over $400 million in loans that we determined were PCD loans, and so we're still in the process of getting out of those loans. Somebody can jump in, in a minute, to tell me how much, but I think there's probably about $200 million, and Kevin may jump in. So we have that still to go.

And we also saw a decrease in what we call the portfolio of structured commercial real estate loans. They were down about $300 million -- $398 million. So we saw -- and that's an area where that may not be a time that we really wanted to jump into a bunch of commercial structured real estate loans at the same time. But so we -- those really have a quick pay down, and those were decreasing.

So some of our markets really grew and some went the other way, but there's explanations for both. I would say, going forward, we still have some PCD loans that we have to get out of, so that will be some stress on loans coming down. And again, we'll see if we really want to jump back in, or how much we're going to jump back in, or can we get into the structured CRE loans again and get those both moving forward instead of going backwards.

But -- so those are some of the challenges that we have, I think, overall. A lot of it depends on the economy; I think a lot of it, the media; a lot of it, the elections. Yesterday, everybody was happy. This morning, everybody -- the world was coming to an end because of COVID-19. So I think when you ask me for a projection or budget of next year, I would say that in a normalized times, we would be shooting probably more for about a 5% growth rate.

Kevin do you want to add anything to that?

I think that's accurate, David. I think that the PCD loans are down a little bit below the 200 mark. Maybe 175 or 180 was the number I recently saw. But we still have to work through those out of the former Legacy portfolio.

Okay. That's helpful. And then maybe Asylbek back on the margin. It seems like we should be getting close to a floor here, I guess, depending on how you think about core versus stated. Asylbek, any outlook on the margin from your view? And what, if any, can you do to continue to lower the funding cost? It seems like we're getting close to a floor.

I'll talk to about more on the core basis because it's hard to predict with the fair value fluctuating from quarter-to-quarter. But in the core basis, it's -- if we project in the near term, it's kind of hard to predict what NIM would be, and I'll explain why it is. Because there are so many moving parts, right, it's -- as you saw that we -- our core margin was down 8 basis points this quarter, in the third quarter, but like 4 to 5 basis points was due to the liquidity we had in our books. So we continue to see this liquidity in our books. And as you know us, in the fourth quarter, we're going to get additional liquidity from the public funds due to the tax payments, usually it will go up at the end of the year about $400 million or so additional deposits from public funds and others. So that's going to be additional liquidity. But we're mitigating that by -- we're investing in the -- first of all, we try to invest in the loans, but then we're focused on the bond portfolio. We -- right now, we're doing a mix of the variables and the fixed bonds because if rates goes up, we want to kind of have assurance there. That's why we're doing variable securities. .

Then the other part is PPP forgiveness, right? I mean we have $1.4 billion, and we already submitted some applications for forgiveness, and we already received smaller amount, but we -- already that's forgiven. So we don't know how the dynamics on the PPP loan going to go and to see if -- how much of a payoff is going to be there, that would create additional fee income that would impact the margin.

And then deposit costs, yes, we actively manage deposit costs. I know we've done several -- 1 cut in the third quarter, and we're doing additional cuts in the fourth quarter on the deposits, bringing it down.

And the last part would be like sub debt. So we'll be paying off the sub debt, $125 million, in the early December. That's going to be beneficial to the margin.

So there's a lot of moving pieces, and it's kind of hard to give accurate the NIM guidance. But like I'm going to mention that from 8 basis points we declined, 4 to 5 was due to liquidity. So if everything stayed constant, and I'm kind of looking forward to the fourth quarter, I would -- I could see our NIM going down maybe a few basis points on the core basis. I know it was a long answer, but that's...

Brett, the bottom line is, again, we had -- normally, we don't, but we had over $1 billion that we had investing over 9 to 10 basis points. And generally, we don't do something like that, but again, with interest rates being so low, we didn't want to jump into something and just buy the first thing. So hopefully, we're going to get that invested by this quarter. We're pushing to get that investment.

So the other deal that Asylbek is talking about is we have more liquidity coming back, and then you have PPP funds that when those loans get paid back, that could throw a wrench into it.

But if you take all of that stuff aside, I think it's still what we said exactly last quarter that you're going to see 2 to 3 basis points in core change, if you take out these variables with PPP, liquidity and all of that stuff on a normalized basis.

Okay. And just one quick item around the margin. And you mentioned the $2.5 billion of cash flow in the securities portfolio, any idea of how much that's coming off at, and then what you're reinvesting or expecting to reinvest at?

So I think right now, if you get a fixed, I think, 1.1, 1.25, I think. On the variable, you might get 50 basis points right now.

Our next question will come from Brady Gailey with KBW.

The mortgage warehouse had another great quarter. I think it was up about 25% linked quarter to $2.3 billion. I mean that's a big number. I know that can be hard to predict, but how do you think about the stability of the warehouse into the seasonally soft 4Q and then as you look out to 2021?

I'm going to let Kevin take that.

Yes. It's -- Brady, it's always a tough one to predict. Anything out more than 6 weeks, it gets pretty tough to predict. Within that 6-week band, we can look at mortgage applications. And we can look out from at the time of application to 6 weeks later, there's a pretty high R square, so that's the time that's going to hit our mortgage warehouse line.

As you said, in the quarter, it was really, really strong. Average balances for the quarter were $2.279 billion versus $1.843 billion last quarter, so up $436 million on average. We ended the quarter particularly strong, highest number ever $2.731 billion. That nice September month end balance carries over into October, so October is turning out to be even a better month. I'd say the average balance so far in the month of October is up a little over $250 million from what it was in Q3. So off to a really good start.

I think that will moderate a little bit going into the fourth quarter. If I just look at -- the Mortgage Bankers Association put out a new forecast about a week ago, and their prediction -- and again, rates could change all of this, their prediction was the fourth quarter in terms of originations would be down about 4%, a little over 4%. It doesn't feel that way so far. The refi boom continues. So I think the fourth quarter is going to be good.

Getting into the first quarter of next year gets a little tougher to predict. But if, again, you look at the MBA forecast, and look, they've never been right, but they've got more data than anybody, and it's hard to be right, so I'm not faulting them, they're predicting for, next year, volume will be down about overall 23%, and that's for 48% down on the refi side of things and about 5% up in purchase volume. And so those rates -- so we'll go whether that forecast is right or long. Most of that decline for next year is skewed to the latter part of the year, so it's in the last 2 quarters. They do expect the first couple of quarters to continue to be strong. So that's probably the best data we have going out beyond 6 weeks is just look at those MBA forecasts.

As you saw, for the quarter, one of the things I was pleased to see was that our weighted average coupon kicked up from 3.10% to 3.18%. It's been a long time since that happened. So that was good to see. Other stats, volume on our books was 51%, purchase; 49, rebuy. So that's about what it was last quarter. Turn days, 15 days to turn the portfolio over. That compares to 14 last quarter, that was like an all-time low, and 17 in a typical quarter.

So all so good -- all good so far for this quarter, and I expect it to be pretty strong.

Kevin, would it be safe to say, even though mortgage lending may be leveling off to some degree and you may see a decrease, we took on a couple of additional customers that may help to keep our balances up more than it would be?

That is safe to say, David. As I look at the pipeline, I think we have 3 or 4 new clients, 1 of them has been through Loan Committee, so -- and we got 3 more scheduled, I think, between now and the end of the year, or probably now in early December. And those things take about 6 weeks to board through all the due diligence and test files and some other things to make sure systems are working before we go full blown with a client. But I do think we'll add a couple of hundred million dollars' worth of new commitments to the books, and that will help our volumes stay a little bit higher than that MBA forecast.

Right. All right, that's helpful. And then you reengaged on buybacks just barely in the third quarter, not a huge amount. But as you think about buybacks going forward, do you think you'll be active here? I mean the stock is at 1.9x of tangible, which is a discount versus where you guys normally trade. So should we expect continued buybacks in size here or no?

Well, probably a little color where we came from. We had a buyback in plan. But as COVID started and you start off with $3.6 billion in forbearance loans, we kind of pulled back and said, hold on, we -- maybe we just need to look at everything. And I think even the regulators would talk to us and say -- they never tell you, you couldn't do it, but at the same time, I think they really wanted us to watch the amount of capital we were spending. So we were cautious at the beginning of the year. And then even in this third quarter, we really wanted to save our bullets to pay back the $125 million in debt that came along with Legacy because that's at 5% or 6%, and that can take us $5 million or $6 million a year right there. So that's what we were focused on.

But when the price dropped so low, we had no choice, we had to jump in. And I would say, probably this -- we feel better where the market is today. I mean we're at 1%. 1.1% of our loans on deferrals are nonperforming or down. I feel kind of good. I'll knock on wood, you never know, but we feel pretty good where we're at from an asset quality issue.

So I would say that if the price drops again, we probably would probably be back in the market to some degree.

Okay. And then finally for me, I just wanted to touch on M&A again. David, what needs to happen for you to get very comfortable being back in the M&A game?

Well, I would say we are very comfortable. We're ready. So it's not us, it's -- I think a lot of it has to do with the other side. The other side, their stock prices are down, what? 25%, 30% or something like that compared to where they were in the high. And even though they could say, well, your stock -- I could say our stock is down, too, but again, for some reason, people like to -- they don't like to sell when the market is the way it is. They like it to be better.

Having said that, I think we -- all banks, we're all going through this deal, ups and down. Nobody really knew where all this pandemic was and all that kind of stuff. I would say that I'm going to -- I'm just going to throw this out there, but I think you'll start seeing more people talking now. I think there's probably 3 or 4 deals, people talking right now out there in the market. And I think by the beginning of the year, you'll start to see some pretty decent deals or significant deals come around again.

Our next question will come from Michael Rose with Raymond James.

We just wanted to make sure this is right, I'm trying to understand. But I think the monthly -- the average monthly loan production was down pretty sharply. Can you just give some color around that, and then what we could expect going forward? I'm trying to reconcile with your comments on core -- potential core expectations for somewhere close to the mid-single digits next year.

Okay. This is Tim, Michael. As I said, it was $449 million average monthly production for the current quarter. If you go back to the first quarter of this calendar year, it was $476 million. And if you go back to the last quarter of '19, that quarter, Legacy was with us 2 months, November and December, it was $496 million. So -- and I left out the quarter ended June of '20 on purpose because we had all those PPP loans that got booked in there that month so -- that quarter, so it skewed that monthly number.

So if you go back to the quarter ended December 31, '19, once again, it was $496 million. Then it went to $476 million. Now it's going to $449 million. And I think all that is directly related to the COVID issues and the oil and gas issues in the state of Texas and Oklahoma.

All that seems to be leveling out at this point in time. No guarantees, obviously. So I don't expect it to deteriorate substantially, if at all, from where we are. And we're hoping that it'll start building back up. We're going to budget some loan growth going forward.

So it just is what it is in terms of the economic environment that we have to operate in. David already addressed the -- some of the pay down issues. Our burn rate has been fairly substantial because of some of the PCD loans that we wanted to exit, et cetera. So I think it's going to be fairly stable going forward. I hope I'm answering your question.

Yes. I think if you take all 3...

Yes. I was trying to get a sense for the drop sequentially.

Yes, I mean, if you take all 3 of those numbers, divide them by 3, you're talking about $25 million average difference a quarter, so that's $100 million a year.

So I don't think -- that shouldn't jump out at anybody. And again, I do think there'll still be more pressure with this COVID 19 probably through the end of the year. So I don't know that you'd see a lot of growth, especially with the loans we're still trying to work out of Legacy. But to me, going through what we've gone through and you're only seeing the $25 million down for the quarter average, I actually think that's pretty good.

Yes. I don't think it's bad given the circumstance. One could easily have predicted a worse situation. We're still seeing decent loan demand come through our Loan Committee. So there's just no reason right now to expect a substantial fall off from where we are.

Got it. Okay. Maybe as a follow-up, can you just remind us where you are on the cost savings from the Legacy deal? I know the systems conversion has now gone and passed. just how much more would you expect to get? And any changes to the target in light of the environment?

Yes. I mean from the cost savings from the acquisition, yes, we realized most of the cost savings. There might be small items we're looking at right now. But I'll have to say that while we maybe have -- we will save a little bit more, but we invest in the technology, which is one of the cost -- one of the highest costs. So from that perspective, we might have savings on one area, but we're going to spend a little bit on another. That's why from my guidance, I gave $117 million to $119 million for the next quarter based on these variable. But overall, yes, we achieved our cost savings from the Legacy merger.

Our next question will come from Brad Milsaps with Piper Sandler.

David, you commented that your reserve is the largest it's really ever been in your career. It seems like most of the charge-offs that you took this quarter were related to the PCD book. Just kind of curious of kind of the drivers behind the provision you took. Maybe kind of what you're doing kind of to review the existing portfolio, and kind of what that means for provisioning as you kind of look out over the next several quarters? Do you think at some point, you're going to start maybe releasing some of that reserve based on what you see? Or kind of how are you thinking about that?

Well, if you go back and look, the charge-offs are really -- the majority of everything is from the PCD loans. And so that money is being put back into the general reserve. Yes, I mean, when you have 5.1x coverage on nonperforming assets, I think that's huge. And somebody who was probably at even -- you have this formula that we have to follow, but there's highs on it, lows and there's a medium. There probably could have been a point we could have taken a position and you could have put it back. But again, with where we're at right now, again, I thought it was still prudent this time to go ahead and put the $10 million in their seal.

But having said that, based on our model, we wouldn't have -- I don't think that -- we have some flexibility in there. I do want to be very careful, but you do have flexibility, whether it be on the high point, low point and moderate point. But I'd say -- I don't know that I'd ever recommend taking money out of the reserve, but what I would say is I don't know that we would have to put money in the reserve going forward for some time, unless something changes dramatically from what we see.

Great. That's helpful. And then just to kind of follow up on liquidity discussion, how are you guys speaking about PPP internally as those loans get forgiven? Are you guys operating under the assumption that a lot of that liquidity will leave the bank? Or are you preparing for getting that money back from the SBA and some of that deposit money sticking around? Just trying to get a sense of sort of how you're thinking about, I won't call it a liquidity problem but just putting all that cash to work, as you kind of think about it internally and trying to size it?

I'll start off if you want. Do you want to give just an overall where we're at on the PPP, Eddie, on the deal? And then I'll go into the liquidity issues, what I think.

Sure. We're still at about $1.4 billion. A little bit under on the balances. We started getting some of the payoffs from the SBA, largely on loans under $50,000. About 400 loans today have been paid off, but it's only represented about $13 million or $14 million so far. We have several thousand more that are in the process of being submitted, and we'll just have to see how long that takes.

A lot of people are waiting to see if that threshold on the paperwork would be reduced for loans under $150,000. So far, that has still only been effective for those of $50,000. And just to give you an idea, about 60% of the number of loans that we have are all under $50,000, but that only represents about 10% of the total dollars.

Yes. So that's kind of an overview. My personal opinion, this is an opinion that I think customers have a lot of money, and I think that a good portion of the liquidity that we have will stay with us. I think it will be there. I think businessmen, for sure, want to keep additional money. If anything, you may see them, if they have some loans, they maybe want to pay down personally. But I don't see liquidity that depositors have going away really. In fact, I think it can only grow.

David, I might comment. I agree with you. If you look at who we made these loans to, the vast majority of the loans went to what I would call our core customer base. They are people that have banked with us for many years, in most cases. So I would be surprised if that money just automatically went somewhere else. I don't see that.

Well, the thing I noticed is that a lot of the money that is in their account, they didn't spend.

That's true in some cases, yes.

I mean they didn't spend it, or else, they used their other funds and were scared that maybe the government wasn't going to really give it back to them. And maybe they were saving just in case to pay if they would like to. But for the most part, a lot of them didn't. They've just -- they're still savers from what I can tell.

Our next question will come from Peter Winter with Wedbush Securities.

I wanted to ask about the core margin beyond the fourth quarter. It just seems that there'll be ongoing pressure on the core margin, just with the reinvestment on the fixed-rate loans and the securities cash flow of over $2 billion. I'm just wondering if you could talk about some of the -- what you're seeing on the core margin beyond the fourth quarter.

Yes. Beyond the fourth quarter, it's very hard to tell. I mean it's -- on PPP loans, I know we're having forgiven us now, but I think the -- most of the PPP, we're expecting more, Eddie, what, first and second quarter of next year.

Yes.

So I mean in the -- with the current economic environment and with the election coming up, it's so hard to give guidance. So I don't think it'll be prudent to give any guidance at this moment.

Yes. I mean, Peter, I think the bottom line is, as you said, I think there could be some downward pressure of 2 to 3 basis points on the core margin.

On the other hand, a lot of things can change that, too. I mean we have been lowering some rates as much as a week ago that's going to help us a little bit. We might have a little bit more down that side. We had $1 billion in liquidity that really wasn't invested at 10 basis points. Hopefully, we would like to build loans, not go backwards in loans.

So all of those dynamics change. We've never been the bank of what's happening now, we've always just tried to hit singles and doubles. And I think for the most part, we don't have things out there that just change dramatically, and I don't think you're going to see us change dramatically. And we're trying to be very transparent. And if I could really give you just a real idea of what I thought the net interest margin would be next year, I would be more than happy to, but there's still a lot of variables, and I just don't think that we can right now. It wouldn't be fair to anybody because I think it could go either way sometimes, probably more so on the downside on the core of maybe 2 to 3 basis points. But -- and just as easy, it could go the other way. I mean you -- if we get all the PPP money back, we can take all that into income, that changes dynamics completely with $40 million.

There's so many dynamics that can change. Economy goes back, you put 5% loans on. So again, I know I'm throwing a lot of stuff out there, but there's a lot of stuff out there right now.

Okay. Because the reason I ask is if I think about expense management for you guys, it's always been a strength of the company. And I'm just wondering with more customers utilizing digital banking, is there any plans to maybe reevaluate the branch network or looking to reduce some of the office square footage with this work from home?

I don't -- Mike, my gut is, we don't have plans to shut locations down unless we do a deal with another bank that has a lot of locations close to us. I will say what is helping us is we needed additional space at our corporate office in Houston. We were considering buying a building or building another building. Again, with the people working from home, it's helped alleviate some of that situation.

So what it may do is cut costs from going up more dramatically in the future, but I don't see us cutting cost at our locations. I think one of the things that I hear more about our customers, they love that they can go almost anywhere in the state of Texas, and we're -- we have a bank there for them, whether they're kids are at school or they start retiring out to the suburbs. And that's probably one of the biggest things they do like about us.

So I'd say that probably as we build new banks, we'll build bank probably with a lesser square footage, and they'll be more digital. But you'll still have banks out there at the same time. Maybe less people in them, but we'll still offer that service. And I think that's what makes us different than a lot of the other people, really.

We saw some of the big guys shut down in places like Victoria, Bank of America and Wells Fargo. And we opened one of the locations where -- why we -- I thought it was crazy because we had so many locations there anyway, and that particular bank grew $30 million or $40 million in a few months.

So for us, it works. I'm not saying for everybody. And as long as we can keep our efficiency ratio and our expenses where they're at, I don't see us closing a bunch of locations. I think that we are -- again, Mays want to talk about it, but we've cut some deals on some -- on the Plano office they were in. it's going to probably save us a couple of million dollars a year, and so -- and some other offices. So...

Yes. Peter, this's Asylbek. But we do look into the expenses, and we try to make sure we cut the expenses. But I want to kind of point that we might have more opportunity to do a little bit of savings. But at the same time, we want to invest in the technology. So we don't want to ignore the technology. And I think it's the future of the bank. So all the savings that we have, we want to invest in technology, and we have been doing that.

And what the benefit with -- merger with Legacy was very beneficial. What I see is that they had a great technology and we have a great technology, and when you're consolidating these 2 banks, you kind of look at and evaluate each of this IT system, and you pick the best one. It might cost a little bit more, but you look at -- from the -- our customer perspective and we choose the best system. So we've been investing quite a lot in the technology lately, so that might be offsetting some of the cost saves that could come up. So in the net, I think we're just going to stay where we are. And -- but...

But net-net, something that I've looked at, I think sometimes you see that, okay, you can have a reduction in staff or you can have a smaller deal and you save money there, but then when I look at what we spend on technology, it takes that and some.

Exactly. That's....

So I don't know, you may save on some. But with this technology, I mean, I saw this month, just it was unreal how much money we spend a month on technology. It's just a lot.

Let me emphasize a couple of things that have just been said. David mentioned the fact that we picked up some additional customers because some of our competitors closed down their locations. That's primarily been, as David mentioned, Wells Fargo and Bank of America. And granted, it's been in some of our smaller communities, but in essence, those banks have vacated those communities. And it has benefited us quite a bit, very significantly so in those communities themselves. And while there's a clear direction towards technology and banking, which we understand, we embrace and we intend to continue with and even improve what we offer in that regard, we still have many, many customers that come to the banks, come through the motor banks, come to the lobbies. We don't see any indication at all that our customers don't want to use the brick-and-mortar. So I would suspect we're going to hold our place.

Well, you can see the deposits. The new deposits we grew this quarter, I mean, when I walked through the lobby of the bank that I sit in, I see 2 or 3 people whose accounts with other banks are closed. Once you to get an appointment, I think they like the service.

I have customers mention to me all the time how much they appreciate our network of banking facilities that they can actually go to if they have a need to do so. I think it gives us a real edge. It's important.

Well, I think, I don't have the edge that they can go there, but then I'd have to say our call centers have really been great, too, with the technology. So we offer both really.

Right.

Our next question will come from Bill Carcache with Wolfe Research.

David, I wanted to follow-up on your earlier M&A comments. Some investors have started to wonder whether it may be getting increase -- incrementally more difficult for you guys to continue to grow via acquisition in Texas after the Legacy Texas deal. Can you speak to that and more broadly discuss how close we are to the point where you're satisfied with your positioning in Texas? And could we see you start to consider growing more aggressively in other markets outside of Texas?

I think that we've always said that our first and foremost would be to continue to build our Texas, Oklahoma, franchise because that's where we're at. I think that's still our first focus. And just go to the FDIC website and pull all the banks that are over $1 billion in Texas, and you'll see there's a hell of a lot of them. So I think there's a hell of a lot of opportunity there.

But having said that, I don't know that we'll ever -- I don't know that we will say no to something that makes sense. I don't know that we want to be somewhere -- do something with somebody that has $10 billion but they're in 5 different states or something like that. But if there's something in another site that has -- and they have good control, and they control the market share, I think that we would look at that. At the same time, it would be probably our second pick, not our first pick. But we're not opposed to looking at that. I think that we're ready.

Kevin and the Legacy team have been so good that I would have never thought that we would even be in a position to do this at this point, and we are because of them. They've been just great members and really helped us build this deal. And so I think it allows us to look at things in a different perspective. They've added a different perspective. They've done things that we didn't do in the past that we were probably scared to do more in the warehouse financing stuff that they did and some of the other commercial middle market lending that we're getting more comfortable with. And so I think that its broadened our horizons at the same time, too. I think that maybe they got some from us on the underwriting side that's helped them.

So I think we're all learning together. And I think that because of our deal and our deals that we put together, it provides us the ability to look at more opportunities than we might have if we were just by ourselves like a year ago.

I don't know if that gives you any color or not.

Yes. Yes, no, that's very helpful. Separately, your efficiency ratio, ex merger charges, is at the lowest levels we've seen. And your comments on expenses were very helpful, but can you give some color on how much of the efficiency improvement you think is a function of scale benefits? And how do you -- I guess, how do you all think about the trajectory of operating efficiency in light of the technology investments that you've discussed?

Yes. I mean the efficiency was, what? 40.2% this quarter, and it was aided by the cost savings we had and also this fair value income that we generated. So it's -- I think going -- looking forward, I mean, we ran about, what? 42%, 43% as pre-Legacy. So I think if it normalized, I would say, probably we're going to be running around that rate, maybe a little bit less. So we did gain efficiency from that perspective. But at the same time, investment in technology is pushing up the expenses. But I mean -- overall, I mean, if you look at it, we are best-in-class in efficiency ratio.

I think we always say that we can't get any better, somehow we do. But again, I'd say if you go any deeper, you're cutting red meat. If you're not cutting fat, you're cutting red meat probably.

Understood. And lastly, we have a good idea of what to expect from a tax policy perspective if Trump is reelected. But under a blue wave scenario, that leads to corporate tax rates to rise to 28%. Can you discuss what that would translate into for you guys?

I can take that. So if -- under Biden, assuming he wins, the tax rate is 28%. So we kind of ran pro forma analysis on taxes to see how much our tax -- effective tax rate would be. I mean if you look at currently, at 21%, our effective tax rate is around 21%. So when we ran the pro forma, our effective tax rate will be around 28%. And the reason is because, I mean, we don't have significant tax-exempt income that would be making differential. But since -- it could be changed because now since the tax increases, we might be investing in tax-exempt assets that would help us. But right now, at the pro forma at 9/30, we're staying at 28% or so.

I think it's hard to call. I mean it's easy to just take a pencil and make up the difference between 21% and 28%, you just multiply another 7% to what your taxes are.

On the other hand, usually for every action, there's a reaction. And what I've seen is if that happens, you never know, there may be a difference in the yield curve, where we're at right now, where we like the -- more of the yield curve, it's more flatter right now. But again, any kind of pickup in the yield curve, if anything, your 10 years instead of being 80 basis points, it's 150, it's huge when you multiply that by $30 billion in assets.

So it's really hard to call. I mean, fundamentally, it's very basic, you can just take the difference. But usually, for every action, there's a reaction. And historically, we've operated under Republican administrations, and we've operated under Democratic administrations, and it's always been -- we've always been successful at it in both.

Our next question comes from Gary Tenner with D.A. Davidson.

Just wanted to ask a quick follow-up in terms of kind of the balance sheet expectations on the investment portfolio with the $1 billion of cash. I think the comment was that you're focusing on putting that to work. If it goes into the investment portfolio, is that kind of ratable over the fourth quarter? Or would you want to get that invested sooner than later?

I think we're trying to push it sooner than later, yes. Again, when you start buying -- we buy in blocks of $100 million to $200 million. And so a lot of the stuff we have to buy, it's just -- it's not out that we may have to deal directly with Fannie Mae or Freddie Mac. And there's just so much production they have a month, too, at the same time. Buying sometimes in the secondary market, it's hard to get blocks and stuff like that, or at least at the coupons we want and so. So it's not an overnight deal. It's not like you can go take and invest $1 billion, but we're already working on it. And I'm hoping that within -- over the next month or so, we'll have invested.

Yes. And also, we're monitoring our deposit, I mean, how sticky the deposits are. So that's going to be a big role in -- to see how much will be invested in the securities. But I agree, we're actively trying to invest those liquidity as much as possible to variable and fixed-rate securities.

Okay. And then the quarterly cash flow coming off the service portfolio right now?

Right now, annualized cash flow is about $2.2 billion on those securities over the next 12 months.

Our next question will come from Jennifer Demba with Truist.

Two questions for you, David. With so many industry headwinds for Prosperity and the bank, the yield curve, lower loan accretion, tough mortgage comparisons, maybe a higher tax rate, can earnings per share be up for Prosperity next year? Are there any levers that you have that could make that happen? And then I have another question.

I don't know that they'll be exactly where they're at this year because it's been a great year. But I would say we'll probably do better than what the analysts have us at.

So the wildcard, Jennifer, here is a fair value income on loans because it's going to be decreasing next year. So that's going to be a significant amount of income that we generated this year that we might not have next year.

Now having said that, Asylbek, if you take $30 million or $40 million into income from PPP, you could beat this year.

That's a good point.

You don't know, but I mean, if everything were static and we were amortizing, the money we're getting from the PPP, leave that out, I do think they'll get it next year, and I think that will change the dynamics, and it could be more than you did this year. But leaving that aside, I still think we'll do better than what the analysts have us at, just in my own calculation.

And my second question is when I talk to investors sometimes about owning your stock, one concern that comes out is that Prosperity is going to do a less-than-desirable transaction. And I'm just wondering if you could speak to your long-term discipline in the face of earnings headwinds that you haven't done unattractive deals, that you've waited, you've been patient and waited for the right deals, no matter how long they have taken to come around. So can you just talk to that maybe?

Yes. People can say whatever they want, but history tells you the real story. If you just go back and look at us, we've never done a deal just to do deals. It had to make sense where the people had to be with us, that we could -- it helped our franchise. It -- there was something that added to us that would help us get -- I don't think we ever did a deal that wasn't accretive. You can see how much the Legacy has really added to our bottom line. I can't imagine if they weren't with us right now, you wouldn't see a 17.6% accretion year-over-year this time. And so I think they were a big part of that, I think every deal we've ever done.

And I would say, out of the 40-something deals we've done, all but maybe the exception of 2, we've been a little bit -- that hadn't turned out our way maybe from the social side, but from the earnings side, it's always turned out our way.

And I don't -- when you own as much stock as I do, or we all do in this room, I'm not here just to build a company to -- just to be bigger. I mean as my age and it stays on and people keep running it, I want to make sure that it's the right thing and we make more money and that's safe and sound. I don't ever want to do a deal -- with the amount of stock I have and my family has in this thing, I never want to do a deal just to say we're going to do a deal to be bigger.

Jennifer, this is Kevin. I want to tell you, the guy who sat across on the other side of the table from David and team for 2 years trying to get them to do an unattractive deal in terms of the price, and there was never a waiver into their discipline about what they expected and modeled for accretion. They didn't want anybody -- any investment banker's model was no good. They had their own model -- modeling accretion, and there was not an iota of budge, and I tried for 2 years. So -- and I consider myself a pretty good salesman, and I got nowhere.

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

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

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