Prosperity Bancshares Inc (PB) 2020 Q2 法說會逐字稿

Good day, everyone, and welcome to the Prosperity Bancshares Second Quarter 2020 Earnings Conference Call. (Operator Instructions) Please note, today's event is being recorded.

At this time, I'd like to turn the conference call over to Charlotte Rasche. Ma'am, please go ahead.

Thank you. Good morning, ladies and gentlemen, and welcome to Prosperity Bancshares Second 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. (Operator Instructions)

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 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, and good morning to everyone. I would like to welcome and thank everyone listening to our second quarter 2020 conference call. We are pleased with our second quarter 2020 results and with completing the operational integration of Legacy on schedule in early June. The team members from Legacy, now Prosperity, have been excellent, and we could not have achieved such a smooth integration without their commitment and efforts. I want to thank all of our team members who worked many hours to make this happen. We remain excited about the combination and look forward to continuing to build the best bank anywhere.

For the second quarter of 2020, we showed impressive returns on average tangible common equity of 19.98% annualized and on average assets of 1.61%. Our earnings were $130.9 million in the second quarter of 2020 compared with $82 million for the same period in 2019, an increase of $48.6 million or 59.1%. Our diluted earnings per share were $1.41 for the second quarter of 2020 compared with $1.18 for the same period in 2019, an increase of 19.5%. The second quarter 2020 earnings per share of $1.41 includes a $0.22 income tax benefit, a $0.06 charge for merger-related expenses and a $0.03 charge for the write-down of fixed assets related to the merger and some CRA funds.

In summary, there was $0.22 in benefit to earnings and $0.09 in deductions mostly related to the merger. Loans at June 30, 2020, were $21.025 billion, an increase of $10.4 billion or 98.6% compared with $10.587 billion at June 30, 2019. Our linked quarter loans increased $1.898 billion or 9.9% from the $19.127 billion at March 31, 2020, of which $1.392 billion were SBA Paycheck Protection Program, sometimes referred to as PPP, loans. Mortgage warehouse loans also increased $843 million in the second quarter of 2020 compared to the first quarter. Our core loans, excluding held for sale and the warehouse purchase program and the PPP loans, decreased $311 million. However, a portion of this decrease resulted from loans that were intentionally removed that were identified in our due diligence of Legacy. We saw strong loan growth in the first part of the second quarter, but that slowed as business shut down or reduced operations in response to various government orders.

Our deposits at June 30, 2020, were $26.153 billion, an increase of $9.265 billion or 54.9% compared with $16.888 billion at June 30, 2019. Our linked quarter deposits increased $2.326 billion or 9.8% from the $23.826 billion at March 31, 2020. Historically, our deposits are lower in the second quarter of the year compared with the first quarter and then begin to increase in the third and fourth quarters for us. But this year, second quarter deposits are higher. A large portion is from the PPP loans as well as reduction in customer spending and customers saving more right now.

With regard to asset quality as always been one of the primary focuses of our bank and always will be, I have always said you will like us in the good times but love us in the bad times. And this is playing out to be true again during this pandemic and oil price downturn. Nonperforming assets totaled $77.9 million or 28 basis points of quarterly average interest-earning assets at June 30, 2020. We continue to provide relief to our loan customers through loan extensions and deferrals when possible.

For the second quarter of 2020, net charge-offs were $13 million. Of these charge-offs, $12.4 million were related to PCD loans with specific reserves of $28.5 million that we acquired in the merger. So further $16.1 million in specific reserves were released to the general reserve in addition to the $10 million provision for loan losses for the second quarter.

M&A activity has subsided during this pandemic, although there are some conversations and probably a few deals working. We believe that the M&A activity will start to pick up as businesses reopen and economic activity increases. Size does seem to matter now, especially with lower net interest margins, the need for increased technology and the potential for additional regulatory burden if there's a change in the administration. An example is the increased volume at our customer call center with many older customers wanting to set up online and mobile banking that have previously not been interested in doing so.

The economy, the Blue Chip consensus forecast estimates that fourth quarter 2020 GDP will end at a negative 5.6% compared with the fourth quarter of 2019. However, they are forecasting a positive 4.8% GDP for the fourth quarter of 2021 compared with the fourth quarter of 2020. They are also forecasting an unemployment rate of 9.4% for the fourth quarter of 2020 compared with unemployment rate of 6.9% for the fourth quarter of 2021.

Based on these estimates, 2021 looks bright. We are positive about our company's future. While our operating environment and economy is changing frequently, we remain focused on addressing whatever comes our way in taking care of our customers and associates. Prosperity continues to focus on building core relationships, maintaining sound asset quality and operating the bank in an efficient manner while investing in ever-changing technology and product distribution channels. We intend to continue to grow the company both organically and through mergers and acquisitions. We want to develop people to be the next generation of leaders, make every customer experience easy and enjoyable and operate in a safe and sound manner.

I want to thank everyone involved in our company for helping to make it the success it has become. 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 June 30, 2020, was $259 million compared to $154.8 million for the same period in 2019, an increase of $104.1 million or 67.2%. The increase was primarily due to the merger with LegacyTexas in November 2019 and loan discount accretion of $24.3 million in the second quarter 2020.

The net interest margin on a tax equivalent basis was 3.69% for the 3 months ended June 30, 2020, compared to 3.16% for the same period in 2019 and 3.81% for the quarter ended March 31, 2020. Excluding purchase accounting adjustments, the core net interest margin for the quarter ended June 30, 2020, was 3.33% compared to 3.14% for the same period in 2019 and 3.36% for the quarter ended March 31, 2020.

Noninterest income was $25.7 million for the 3 months ended June 30, 2020, compared to $30 million for the same period in 2019. The current quarter noninterest income was affected by $3.9 million in write-down of certain assets and general impacts of COVID-19 pandemic. Noninterest expense for the 3 months ended June 30, 2020, was $134.4 million compared to $80.8 million for the same period in 2019. The increase was primarily due to the merger with LegacyTexas and onetime merger-related expenses of $7.5 million due to the core system conversion that occurred in June. In addition to these merger-related expenses, the second quarter result reflected elevated expenses related to increased mortgage activities.

With the core system conversion and operational integration process behind us, we do not anticipate any significant merger-related expenses going forward, and we expect to start realizing the remaining cost savings beginning in the third quarter of 2020. We expect these additional savings to be about $7 million to $9 million per quarter. This, combined with the savings realized in the first and second quarter, will be in line with our previously stated 25% cost savings in noninterest expense.

The efficiency ratio was 46.56% for the 3 months ended June 30, 2020, compared to 43.74% for the same period in 2019 and 42.9% for the 3 months ended March 31, 2020. Excluding merger-related expenses of $7.5 million, the efficiency ratio was 43.97% for the 3 months ended June 30, 2020. The bond portfolio metrics at 6/30/2020 showed a weighted average life of 2.69 years and projected annual cash flows of approximately $2.3 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 June 30, 2020, totaled $77.942 million or 37 basis points of loans and other real estate. The June 30, 2020, nonperforming assets total was made up of $71.595 million in loans, $187,000 in repossessed assets and $6.160 million in other real estate. Of the $77.942 million in nonperforming assets, $12.173 million or 16% are energy credits, $12.073 million of which are service company credits and $100,000 are production company credits. Since June 30, 2020, $15.786 million has been removed from the nonperforming assets list through the sale of collateral. This represents 20% of the nonperforming assets dollars.

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

The average monthly new loan production for the quarter ended June 30, 2020, was $871 million. This includes a total of $1.430 billion in PPP loans booked during the quarter. Loans outstanding at June 30, 2020, were $21.025 billion. The June 30, 2020, loan total is made up of 39% fixed rate loans, 36% floating rate loans and 25% loans resetting at specific intervals. The fixed rate percentage increased somewhat due to the inclusion of the PPP loans.

I'll now turn it over to Charlotte Rasche.

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

(Operator Instructions) And our first question today comes from Dave Rochester from Compass Point.

You guys did a good job hitting the NIM range this quarter ex accretion. So I was just wondering what your thoughts were on that going forward as well as the accretion trend in the back half of the year, if you can. It seems like you guys have a lot of room to move costs -- deposit costs lower, just looking at where you were through rate cycles. So just was curious to get your thoughts there, too.

Yes. I'll probably let Asylbek take it, but I think our accretion was higher than we normally gave guidance for. I think, Asylbek, we're looking, what, at about $11 million to $13 million third quarter?

That's right. So -- yes, for the -- going forward, I think next quarter, we're looking at $11 million to $13 million. It's a little bit elevated because of some of those PCD loans we're working out, which they had discounts on them. And so those have been paying off, bringing additional fair value income this quarter. But if you're looking going forward, we're projecting $11 million to $13 million based on what our model shows right now.

And I think on the second part of the question, Dave, is we have kept our rates a little bit higher than we really had to. I've always said that sometimes in really good times, people pay more than we do. And then when things get a little tougher, we've kept our rates a little higher than everybody else. But we are looking at it right now to reduce our rates a little bit. We should probably do that this week probably sometime.

Yes. So we did reduce the rates -- we reduced rates in the second quarter, but we're looking managing further in the third quarter, reducing it. And if you look at our deposits, I mean our CD is at a higher rate right now, but we're waiting to -- for them to be repriced. I think based what we see, we should have about $2 billion being repriced in the next 12 months.

Right. And I think the biggest -- but we still have a lot of money, like in our premier money market account, that we're still paying 40 basis points, so it's $1 million plus. So we have some room to come down a little bit.

And additional, there is some broker deposit we still have about $100 million to get repriced.

About $100 million.

Yes, next 12 months. So there will be some movements in the deposit cost.

Great. Appreciate that color. And so just given all those opportunities, where do you think the NIM goes from here ex the accretion?

For the next quarter, our model shows that our core margin to be relatively stable, I mean, given the current economic conditions. But however, we do expect to see some additional pressure on NIM because of loan repricing. And if you look at for next quarter, we could see decline in the amount somewhere in mid-single digit, I would say. But I mean there's a lot of moving pieces. It's how the PPP forgiveness is going to work. And we have, as every bank experiences right now, quite a lot of liquidity coming into the bank because of the PPP program we had and the stimulus -- government stimulus.

Yes. I don't -- we never like to give evasive answers, but there are so many moving parts now. I mean there's $2.3 billion in extra deposits that came in. A lot of people thought $1 billion of that was probably from the PPP loans. But you'd have to think -- or I have to think that if -- so that money we've put out on PPP, they should have used half of that or more. Some saying they didn't spend it because they're waiting to see if -- I don't know what the reason is. But I think there's more -- going to be more liquidity than we anticipate. So you have that. You have the PPP loan that if we do have some room on the deposit side, I would still say to be careful. You'd still see some -- probably mark getting some decline of maybe mid- to single digits probably, just to be careful on everything, I think.

Okay. And then I guess some of that pressure, to your point, is from the just higher liquidity levels?

Higher liquidity levels and repricing of loans.

Loans, yes. But...

And again, when we give you that, we're not showing any increase in loans. If we increased loans, that changes things. And if we buy some securities, which we've been reluctant to do because they've been so low, that changes things. So there's a lot of moving parts on this, this time. There's probably more unknowns this time than ever before for us, I think.

That's right.

Understandable. Appreciate all that. And then just switching to expenses, just based on your comments on the cost savings, are you guys still feeling good about that previous expense guidance or -- I think it was $115 million to $116 million for 4Q. Or are you thinking you may come in a little bit higher than that?

Yes. I think we still believe that we're going to get $7 million to $9 million cost savings next few quarters. But remember, like in my notes, I said that we have elevated mortgage activities, which have some expenses related to that. So with the current environment with the rate being so low, we see a lot of getting new loans or mortgage loans. So that could keep up the volume, which would increase the expenses. But if you look at our current expense for the second quarter, if you take out the onetime expenses and reduce that amount by $7 million to $9 million, that's what we believe going to be on the next quarter.

What do you think about, $118 million plus another $2 million in mortgage?

No, I think it will be 118 -- around $118 million, $119 million including the mortgage.

That includes the $2 million.

That -- including mortgage activity, yes, sir.

Okay.

Okay. And that's for 3Q, the $118 million to $119 million all-in?

Yes. Assuming the mortgage level is going to continue as we see -- we saw in the second quarter.

Yes. Got you. Perfect. And then maybe one last one on credit -- or on capital. You guys obviously have a lot of it. And I was just curious how you're thinking about the buyback here, if you're hearing anything from the regulators on that front and if there's any willingness to reengage there at all.

I think right now, we do have a lot of capital. We're making a lot of money. We like the milk money, no question about it. But I think that regulators at this point in time, if -- I think if we bought back stock, we have no agreement with them. But I would think they would look at negatively if you're buying back stock right now until we see further what the pandemic is doing. So I don't see us buying stock back unless there's some really downturn in the stock, really strong or something like that. But for the immediate future, I think it would be looked at -- it would be frowned upon, as they would say, I think, by the regulators if we bought some stock back right now probably.

Our next call comes from Jennifer Demba from SunTrust.

Question for David. David, what do you see as the most stressed borrowers in your portfolio right now? And what kind of business trends are they seeing right now? And what kind of loss content do you think could potentially arise in the next year or so?

Well, those are all hard questions. Probably, if you would ask me some time ago, we would have said the oil and gas department was the toughest. I think oil and gas, we're used to right now. I think the prices we were at were a lot better. So I don't -- I think we've learned a little about that, although having said that, from what they tell me at some of the meetings I'm at, they still say that oil and gas companies, there's still a large amount of bankruptcies to come from that. I feel pretty good where we're at. I think the most stress that I would see, looking at our portfolios, we have -- again, I'm talking off the top of my head, what, about $300 million in motel loans.

$380 million.

$380 million.

I think the businesses that are most affected by this pandemic are really the hotel, motel loans, which we have about $380 million in that. And then restaurant loans are about a little over $200 million.

But again, we feel pretty good where we're at with most of our customers. I don't want to -- I don't want to be Mr. Happy, but I don't want to be a downer either. I think that we have given some extensions. I think that we've extended or have forbearance on -- again, I'm going to give you some numbers. I'm going to let somebody else jump in on this in a minute, but we extended about 6,700 loans. It's about 9.5% of our loans outstanding. On the other hand, at about 6,700, approximately 4,800 of those already started being repaid. So don't take those for exact numbers. I'll let somebody give you the exact numbers. I'm talking off of the top of my head.

But we really feel pretty good where we're at. Those loans that we charged off this quarter were probably -- the $12.4 million were loans that came over through the Legacy merger. And we fully had reserved on those. In fact, we had $28 million reserved on that. So we were able to put another $16 million into the general reserve plus $10 million that we put. So I feel like we have a real good quarter. Again, I don't want to be a Pollyanna and say things are great, but I feel -- we're probably one of the best banks to be with in these kind of times.

And Kevin, you may want to jump in on some of the oil and gas. What's your feelings on that, too?

Yes. I agree with David. If we look at stress areas, it's -- things that would be on your top of mind, it's probably hotels, although I don't think we have any of them past due at the moment. And I don't think we have any office buildings or retail centers past due either now. Some of those are in deferral periods. And we can talk about that as a separate issue.

We can -- on the oil and gas front, obviously, the stress is less now with prices closer to $40 than it was when we saw single-digit and worst kind of oil and gas numbers. Our portfolio continues to work its way down. If you just look quarter-over-quarter, the portfolio shrunk $80 million over the quarter. Unused commitments shrunk from, I don't know, $390 million to $277 million. And that's largely due to redetermination time. So it was us cutting commitments at redetermination time and putting everybody on MCRs.

$54 million, a little over $54 million of that $80 million decline in oil and gas was from former Legacy clients that had marks on them. And that's where a lot of loss content we reported came from. Just in terms of loss content on that $54 million, it was about 18%, but we had close to 48% reserves up against that. So if you think about the reservable level prior, call it, to mark that was put on this 18 months ago, it was pretty prescient of the Prosperity team to put big marks on that portfolio because we had over $28 million of that $54 million was marked, and we have loss content of about, what -- about $12.5 million.

So overall, I think the portfolio energy-wise is in good shape, a, because of the marks; b, because of the hedging; and c, because we continue to shrink it down, and we were pretty impressive during redetermination time about putting monthly commitment reductions in every deal. So I think we're managing the risk around that portfolio as good as could be expected.

Yes. And I would just say that the -- again, we have almost 1.9% in reserve when you exclude the PPP. I think I'm talking on the top -- from the top of my head and the mortgage warehouse. So we never really ever had that, Tim, reserve before. So I mean I feel really good where we're in. Tim, you wanted to comment, too, didn't you?

I think I can maybe give a little help on the hotel and the restaurant question. Obviously, none of us can firmly predict the future. We can only talk about with certainty where we are today. But it's a lot better than one would probably think it would be. As of June 30 on the nonperforming assets list, we only had 2 hotels. Each one had a balance of about $7 million. So we had a total of about $14 million. One of them is already sold. So $7 million has come off the list, and it's part of that number that I gave, that total number that's come off the list since the end of June. So there's only one remaining hotel in the nonperforming asset list, and it's got a balance of about $7 million. And it's actually current right now. They've resumed payments, and they've kept it current for a while. To be conservative, we left it on the list at the end of the quarter, and we're going to watch it month-by-month going forward. But the good news is it's current right now.

There was only one restaurant on the nonperforming asset list at the end of the quarter, and it had a relatively moderate balance of about $43,000. It happens to be SBA guaranteed, and we've already filed a claim with the SBA to get them to honor their obligation as it relates to that loan. If you look at the total hotel portfolio, about $52 million of that portfolio carries an SBA guarantee. And on the restaurant side, about a little over $10 million of the portfolio carries an SBA guarantee. So right now, things are reasonably stable as it relates to our hotel, motel and restaurant loans. And we just have to see how the future plays out.

I would think -- that's a lot of good color, Tim. And I would say the restaurant loans, we really aren't doing a bunch of mom-and-pop restaurant loans. These are customers that have maybe 30 stores or franchises or something that are usually bigger customers. So did we give you too much color, Jennifer?

Not at all. It was great. I have one more question on credit. And on one of your slides in your deck, it says -- it just calls out medical loans. I'm just curious, are you seeing any stress there or you just decided to strip that out for us?

I'd have to ask Cullen, but I didn't know, I didn't look at it. But no, we're not seeing any stress in the medical side. I think it's just something people have asked us, foreign investors have asked us for to break out. And that's just the reason we broke it out primarily.

Our next question comes from Brad Milsaps from Piper Sandler.

Just curious, trying to figure out the impact of the PPP loans in the quarter. I was curious if you might be able to disclose the average balance and then the level of interest income that you -- including fees and the coupon you recognized in the quarter and then any benefit maybe from FAS 91 deferred loan origination costs that might have been on expenses in the quarter.

Yes. This is Asylbek. I'll give you a little bit of color. So we recognized about $4 million on the fee income during the second quarter, with about $2 million per month. And we deferred all the fees and including fees and deferred some direct expenses over 24 months. As you know, once those loans going to get forgiven and pay off, we can recognize that income at that time. But for time being, it's on the deferral for the 24 months. I think on the average, we -- the average balance, I believe, for the second quarter was about $750 million or so on PPP loan. And if you calculate, including the 1% interest income, we're generating about 2.5% yield on those loans right now.

I think, overall, we -- Brad, we brought in around $50 million in fee income and the -- and probably at about $5 or $6 million in expenses. And so again, we'll amortize that over a 24-month period. But as those get forgiven, we'll probably -- we'll bring it back into income right away. I think the average loan, you may be wrong on that, the $750 million you said -- what's the average loan size about, $350,000?

Well, we booked 12,000 loans in round numbers.

What do you think, Eddie?

The average loan size is below $200,000.

Below $200,000. So our average fee was -- I would say our average fee was probably closer to around 3% probably or not.

[That's right ahead.]

I think that's what you're trying to get is...

Yes. Sorry, I was giving the average balance for the quarter, so total PPP loans.

But he may be right. I was just...

Sorry. I missed that.

Yes. We booked essentially a total of $1.43 billion. And that was spread out over 12,000 loans in round numbers.

Yes. That's right.

Did we get you what you need, Brad?

Yes. That was great. But just to be clear, Asylbek, that the FAS 91 adjustment wasn't a huge number in the quarter and you still feel comfortable getting down to the kind of expense numbers you talked about earlier, even with that adjustment?

Yes. So -- if those fee, the PPP fee, yes, we deferred it, all the direct expenses were also deferred. But it's part of the interest income, part of it, the way it's how GAAP is done. So it's not going to be impacting our noninterest expense, Brad.

Got it. Okay. And then just as a follow-up, maybe for Kevin. Obviously, a great warehouse quarter. Kind of what's your crystal ball say kind of over the next 90 days in terms of average? And also I noticed the yield was down there, maybe more than some of your peers. Just kind of curious kind of thoughts on that competitive landscape and ability to hold on to pricing.

Yes. This is Kevin, Brad. I'll take that one. Obviously, the quarter was really strong, averaging $1.843 billion, I think, and ending at much higher numbers, almost $2.6 billion. So that ending June month end balance gives us a great running start going into July because those balances carried on for much of the month. Based upon what we're hearing from our clients, we expect the end of this month to be really strong again. And that comes to us by virtue of them asking for overlines or extending facilities at larger levels to get them through this really robust period of time.

What's particularly interesting to me is that the turn days, despite all the volume, the turn days, which typically run for us and the industry at about 17 days, only around at 14 days this quarter. So when you think of that in terms of the amount of activity that have those level of balances with that quick of turn days, it's pretty remarkable. I've been around this business a long time. And typically, we would average in a month, 20 -- 23,000 to 25,000 files. And Q1 was a new record. We did 41,000 files and we did almost 82,000 files in Q2. So the amount of volume going through there is pretty high. And that volume does produce still [off] levels of fee income. We're collecting, I calculated it this morning, about $37 a file that we touch in fee income.

So I think Q3 -- and again, who knows beyond where we sit today. But if rates stay reasonably stable where they are, I think Q3 is going to be even stronger than Q2 was by -- if we average $1.8 million, I wouldn't be surprised, if we average $2 billion or $2.1 billion for the quarter. We'll just see how it plays out from here. But all pretty strong. Finally, on rates, I think rate pressure has kind of subsided, I think, finally. And I would tell you that all of our loans have a lot more floors than them. So every loan that we have, and we have 39 customers, now has a LIBOR floor with LIBOR being 1%. So any moves in LIBOR from where we are now would impact pricing like it has in the past.

And our next question comes from Brady Gailey from KBW.

I wanted to ask about the need or lack thereof of future provisioning. I mean you had a 0 provision last quarter, $10 million this quarter. But David, as you said, your reserves, almost 2%. You guys are known as having one of the cleanest loan books in the industry. So do you think that there will be a need for future provisioning, just given how clean your book is and how strong the reserves are currently?

Well, this time again when I say this is something may go wrong. But even the $10 million provision that we made this time, under CECL or any other type of calculations you have, you have a -- you can go -- you can either be at the high end, the mid-end or the low end. And even to get to $10 million that we had this time, we had to really try to be on the high end of our provisioning. So my gut feeling is, unless something changes, I don't see us provisioning. That's -- I just don't see it right now. I'm sure -- I'm looking at Merle and the credit guys always, they look -- they always like to have everything in the world in there. But the bottom line is again I just -- I see us highly provisioned. I -- when we do these stress tests, I remember when we had the DFAST test, and even under a stress test, the most that you would lose over a 2-year period, I mean, compared to what the stress test say, if they're right, I don't see it.

Now the question is what do regulators, going forward through this pandemic or until we get some guidance, to see what we have? But I think the 1.9% in reserve for loan loss is too high for a bank like ours. Having said that, I think the regulators want to see that. I think your Chief Credit Officer wants to see that. But I think that $354 million that we have in there, I don't think we've lost that since I've been in banking. If you add all the years together, I bet we haven't lost $100 million or $80 million. And that's what some of the banks we bought. So God help us, I hope we don't get there. But in my lifetime, I've never seen us getting close to what we have and what we would use. That's just me. But having said that, I know we have to be careful. We don't know when this will all end and when everything will open back up. But I don't -- I'll throw it out there, I don't see it. I think it's too much. But it is what it is. And we have these calculations and we have to go with the calculations. And it's not just me running a bank, there's the credit people and the regulators and everybody else. But I think it's extremely high, really.

Well, where we are as an individual bank right now is relatively stable. Things are arguably a lot better than a lot of people would assume they would have been. But clearly, there's a lot of instability in the economy out there.

Right.

And our reserve is based on a lot of things. Obviously, a very important part of it is where we are as a bank. But also, there are economic factors that go in there. And a lot of those are not trending well right now for obvious reasons. So it's just very hard to say. I'm inclined to agree with you, David. It's hard to imagine that our portfolio is going to fall apart overnight. But world is what it is and anything can happen.

Kevin, I don't know if you want to add to that at all?

No. I think you've got it covered pretty well.

Brady, I don't know if I answered it. But that's just my overall feelings of that.

Yes. No, that was great. And my second question is the 9.5% of loans that were modified, what is that as of today? And I'm guessing that's come down some. And any idea how much of those initial modifications will need a second modification?

I can give a little more certainty to that. Obviously, we can't give 100% certainty. As has been previously mentioned, we extended some payments on -- it was -- to be precise, it was 6,727 loans. And the total aggregate outstanding balance of those loans together was $3.626 billion. And that's extending at least 1 month. Most of them were 2 or 3 months. There have been a few, not many, that has gone as far as 4 months being extended. But really, the vast majority of those were 2- or 3-month extensions. Out of that [6,727], 4,864 of those loans have already resumed making normal payments.

And the aggregate total balance of those 4,864 that have resumed payments and are still paying, that balance is $2.283 billion. So how long those that have resumed payments continue to do so? Obviously, we can't say with certainty. But those customers are implying to us that they have reasonable stability in their business right now. We still continue to extend the pain here or there for a few customers but not near as many as we did in April and May. So everything seems to have stabilized a bit. But obviously, there's just no guarantees.

Yes. I mean I think 4,800 loans resuming payments out of 6,727 loans that we extend is pretty good. I think that shows some -- it shows you that our customers that we have are really good customers, I believe.

Our next question comes from Ken Zerbe from Morgan Stanley.

Were the PCD loans you guys took charge-offs on this quarter, were they sold in the quarter? I'm just trying to figure out like how you also were able to release the $16 million of other reserves on those back into the general portfolio or general reserves?

The loans were moved out of the bank, we were paid off.

Got it. Okay. And you took a charge on those as they -- got it, okay. And then just -- I just want to make sure I got the math right on this. I understand, David, you certainly think the reserves were very high and you struggled to get to $10 million of provision. If you moved the $16 million of specific reserves into general reserves, is it a fair way of looking at it that your provision expense this quarter, based on what your CECL model says, your CECL model says you should have booked a $26 million provision, but you had $16 million coming from the specific and then $10 million is coming from regular provisions?

You're hitting the nail on the head, I think. We actually put $26 million into the general reserve this month basically.

But you have a wide range in there. And we were at the upper end of that range. If he's asking, would we have been required to put $26 million in there if we hadn't got that?

No. I mean that's right. I see what you're saying. Yes. No, we took the upper range of what we could be in. And so basically. But the next -- but the bottom line is, technically, we increased the general reserve by $26 million this quarter, basically. Because the difference between the $28 million we had in reserve and what we collected, we actually -- there was $16 million more in specific reserves that in the old days, that $16 million, before you had this new accounting, that $16 million would have come to the income statement. Now it doesn't. It used to be called [SOP 03-3] or something like that. In today's world, it doesn't come through the income statement. It goes directly. Well, I guess, if we wouldn't have added to the other reserves, it might have. But we put it to the reserve, the general reserves.

But it doesn't automatically go into income the way it used to.

No. I guess if -- I'm trying to put it from a technical standpoint, I'm learning something myself, I guess. If we would just said, Asylbek, that we couldn't put that $16 million into the general reserve, I guess, that might have been pulled back into the income statement.

Yes. Technically, in all the old ways, you would take that $16 million as SOP 03-3 fair value income. And technically, if the model, we've decided not to go with the upper end, you could technically take it at a provision income. Because once it releases, you could take a provision income. But based on the model and our discussion, we believe that just leaving it as general reserve was more appropriate.

It wouldn't be prudent in today's world to bring something back into income, I don't think, with the pandemic and not knowing where everything is going to eventually settle out at, I don't think.

Yes. But in a perfect world, you technically should have taken...

Yes. In a perfect world, we weren't in a pandemic and all that, we probably wouldn't have even put the $10 million in and we might have been taking the $16 million back into...

As a provision income.

Okay. And then just last question. Just in terms of fee income, are you seeing any rebound in deposit service charges? And also just more broadly, like how do you see fee income trending over the next quarter or 2?

Go ahead. You can jump in on, Asylbek. I have seen this last month, our -- finally, our service charges picked up over $1 million this last month, these general overall service charges. What -- you were going to say...

No. That's exactly. Because those fee income we saw down in the April and May month and we saw some bounce-back in June. So if we continue that way, I believe the fee income will go up. So you were right on, Mr. Zalman.

Yes. I think as the economy opens up, I mean, really the service charge income -- and people really just weren't spending money, I mean, they're sending money and they're not doing things. But I think we did see this last month. I saw the service charge income did do pretty good, just $1 million.

But just one wildcard I would just throw out there, we just have to conscious there's a second stimulus package they're talking about passing it. So they're going to give the stimulus money to people. They will have excess liquidity there, too, that could impact. But it's just a wildcard.

Yes. I think you could see another round of big deposits come in, probably increase this quarter. With the stimulus package and all that, you probably could.

You also have to take into consideration that during the worst of it for us, which were the months of April and May. We specifically waived a number of service charges for customers to help them out.

That's a good point, Mr. Timanus.

And we're not seeing the necessity right now to do as much of that.

I forgot. That's a good point. Some of that decrease was because we waived certain charges.

We purposely waved the service charges for a number of customers to help them out. And the necessity for that, of course, could come back. But right now, we're not seeing it. So I think that by itself is going to create some addition compared to where we were during this last quarter.

And our next question comes from Peter Winter from Wedbush.

I wanted to ask about the loan trends, the core loan trends. I was just curious, how much is left in terms of the runoff of legacy? And then secondarily, what's the loan demand like in the core portfolio ex the mortgage warehouse?

Okay. Let me -- I'm trying to read my notes here that they wrote for me. But I think we started off with about $400 million in loans. I think we started with around $400 million in loans from Legacy that we decided that we thought that we would try to outsource out of the banks. I think so far, we've moved out in the first quarter and the second quarter about $131 million of those loans, so still about $283 million left there. So we'll have to get through that. But as far as loans go, again we had tremendous growth in the PPP, we had tremendous growth in the mortgage warehouse. We actually saw a decrease. I think if you looked at our core loans this quarter, I think I said -- I'm talking from the top of my head again, so forgive me if I'm wrong. But I'm thinking around $311 million, $312 million less in core loans. And out of those core loans, I would say that about $65 million of that was really made up of these loans that we talked about earlier that we got out of them. We had some recoveries on them. So that was about $65 million. And I would say probably just some of the other loans from Legacy, the merger and the CRE product. We're not putting on as many of those particular loans naturally in this type of economy, good commercial real estate on the retail side. It's not something we would jump into.

So having said that, if you look just at core loans, I think we're down about -- if you take out the $65 million, I think that was about 1.6%. And of course, you'd have to annualize that. But 1.6% for the quarter, we were down. I -- really, when I look at everybody else, that was considered pretty good. I think going forward, to give a number of loan growth going forward, I think it's hard. Like I said before, the shutdowns, we were having great growth both in the first quarter and the first part of the second quarter. As the shutdowns came, we saw things contract. So with us having to get out of still a couple hundred million in loans, $280 million in loans at Legacy and looking at the pandemic where it's at, I would have to forecast that probably the best you could have core for us would probably be anywhere from a 0% to 3% growth rate this time, I think. That's just me talking. Somebody else may want to jump in. Kevin, do you want to jump in on that and see?

No. David, I agree across the board. We're still seeing deals in loan committee every Thursday. Some new things are getting approved. But I think you can all understand. It's a really tough time to underwrite a loan. I mean the retail center comes in and what do you do? How many of these people are paying? How many of these people are going to be able to continue to pay? How many are being deferred? Same on a commercial office building, what's the future of commercial office buildings? I don't think we've -- it would have to be a pretty spectacular amount of equity and a really strong guarantor to do a retail deal or a commercial office building deal. That's an already constructed office building, forget new construction for the most part, unless it's again a really, really unusual situation.

It's just, on one hand, I'd say it's a really tough time for underwriting. On the other hand, I could tell you it's really easy. There's a lot of things you're just not going to touch during this period of time. So while loans shrunk, I guess, the $312 million number and a good portion of that was running off some stuff that -- out of the Legacy portfolio we didn't want to keep, it's going to be tough in this environment. And I'm not worried about not producing loan growth right now. I'd like to see a little more clarity as to what underwriting looks like across the board. I think we all would before we feel better about producing a whole lot of loan growth.

I think that's right. And I think also you could say loans that we're looking at now, I mean, if you're coming to us for a multifamily project or an office building, where we might have been willing to get 40% down, 35% or 40% down in the past and go with somebody lease it, we're probably going to ask for some guarantor support and other [global] support more than just a project itself. So I think your underwriting, we're toughening up right now. We'll lose it as things turn around. But right now, we're able to get a little bit better comfort if we're doing stuff, we're able to get a little bit better collateral support and guarantor support, I think.

The only sector really that doesn't appear to slow down a bit is homebuilding. Most of our homebuilders are still selling their houses and building their houses. We haven't seen a big drop in demand from our homebuilders. But everything else has slowed a bit. Not a screeching halt, but has slowed a bit. And we had already slowed our approach to apartments and office buildings before the virus, anybody ever knew anything about it.

I think that's right. There should be an opportunity for us, so will other banks, if anything. I don't think -- whereas I think that we can be more optimistic on something and maybe we can get better terms. We may be able to do it where some of the other banks can't, at least we have in the past.

In the past, that's exactly been the case. When things have gotten bad, especially really bad, and other banks have been crippled and found themselves in a position of really being unable to loan. We've been able to get some customers in that are good customers because they can't find financing the way they have wanted it in the past. And our conservative terms become more acceptable to them. So it has worked that way almost every time.

Did we answer, Peter?

Yes. Above and beyond. That's very helpful. Can I just a follow-up question on earning asset yields. Can you talk about how much is cash flowing in the securities portfolio and what you're reinvesting that rate at? And then secondarily, the yield is still fairly high on the loans held for investment. I'm just wondering what the new loans or reinvestments are going on, on the loan portfolio as well.

I'm going to start from the top of my head. And again, I'm not reading from anything. But again, we haven't been buying any securities, most of -- we've let all of our borrowings run out and we've taken that money and really just fund the mortgage warehouse deal now. We're having some liquidity right now. We still haven't bought anything, probably got $400 million, $500 million. We'll probably go in and buy some securities and it will probably be a mixture of some floating rate stuff with some 15-year mortgage-backed securities. It will be somewhere in between. But as Kevin mentioned earlier, we hope that some of the liquidity is going to be taken up by the mortgage warehouse financing towards the end of the quarter or in the next few months. But we'll probably still have to buy some. But again, we just -- we've been letting it run off. And I think, gosh, I'm talking from the top of my head, but we have probably, what, over $1 billion a year, $1 billion that rolls off.

Yes. Our annual cash flow right now is projected about $2.3 billion.

It's going up.

Yes. It's going up significantly because all the refinances and the new mortgage. But yes, for the second quarter, we didn't buy any of those securities. We use all the money toward the warehouse and paying down the borrowings. But now we'll be looking into the...

I think we'll be forced to buy some securities this quarter, probably. Again, I don't know if that will be $300 million or $500 million. But we'll probably be forced to do something like that.

And on the yield question, on the average, I'd say, most of the new loans we're booking now are about 4%. And that's about where we are.

I think the fixed rate will probably get in a little bit better than...

Yes. I'm just saying across the board.

Yes. Across the board.

Across the board. That's pretty close to what it would be.

And our next question comes from Michael Rose from Raymond James.

The 2 loans that were -- the PCD loans, were they -- I'm sorry if I missed it. Were they energy loans?

It was more than 2 loans. But yes, they were energy loans.

Yes, Michael, I think it was 4 loans totaling of $54 million, roughly.

That's correct.

Okay. So what was the haircut on what you guys sold that?

I'm sorry. It was the 18% discount off the principal balance, whereas we had about 48% or 49% specific reserves up against it.

Okay. Kevin, what's the go-forward outlook for the energy business for you guys. I know it was obviously a bigger piece at Legacy. But given that things have changed. I mean is it still a business that Prosperity had real interest in being in, in any sort of size or capacity?

Yes. I mean I should take that to David. But I would say our position is cautious. We're in Texas. So I think our intention is to remain in the business to be -- to stick to our knitting in terms of underwriting. And now that we've gone through a redetermination period under the Prosperity loan policy, all of the Legacy loans are now more conforming with the Prosperity loan policy in terms of advanced rates and how we do engineering and things like that. The portfolio will probably continue to shrink, Michael, before it gets any bigger. Because we're being particularly cautious right now. I think we'll remain that way. But I don't see us as a Texas bank exiting the business. But we've got it a little over 3%, between 3% and 4% of our total loan assets. And that's probably not a bad place to be, maybe a shade lower than that in the near term.

Okay. And maybe just one for...

I'll ask David to weigh in on that.

Yes. I agree with everything you're saying. I think when Kevin and I first thought to put these deals together, I think Kevin said he didn't care we ever in the oil and gas business again.

I did.

And I said, "Well, we are in Texas and we will be in the oil and gas business." I think it will just be different. There'll be a difference in underwriting. And again, I think probably not as many deals with shared credits and private equity and stuff like that, it would be the oil and gas fields will be primarily more to core customers that can show in the underwriting whatever they buy that, that particular deal could pay itself back in 4 or 5 years. And that's the way we would structure it basically.

Okay. That's helpful. And maybe one final one for you, David. We're 90 days past the last earnings call. We're past the conversion for the Legacy deal. What have you learned at this point? And has your views on potential M&A partners changed, just given what you've learned maybe in the past 90 days?

Yes. I'm back in love again with M&A after our bromance with Kevin. After the -- last -- he may not be in bromance with me. I don't know, his back is hurting right now today, but...

I still love you, David.

Okay. Good. No, this has been great. I lost some of the love of M&A after one of the deals that we did. It just -- everything that was said was just kind of the opposite. But this has been really good. And not only Kevin and his team, when I talk with the team, I really couldn't tell, would we really be interested in, in this mortgage warehouse? And it's really turned out -- it's really felt a great need with interest rates going as low as they have, I mean, having the option of doing this. And I feel better with it because I feel good with their team. Their team, the mortgage warehouse team, really knows what they're doing. And I have a lot of confidence in them. So I really feel good with that piece of the business. And really almost everybody that I've worked with at Legacy, all the people are very professional, very astute. I think they're -- I couldn't be more pleased, let me just say that.

And going forward, any updated views on M&A for you guys?

Yes. I mean I think I mentioned that M&A probably right now, where we've had a lot of calling in the past when things are good, everybody's call -- not everybody, but usually we have 2 or 3 deals working at any given time. That's probably not the case right now. But having said that, generally, what happens in times like this is generally we get a deal that we would never been counted on. It's a deal that somebody is in -- that has some issues and they have to get out of it. And I wouldn't be surprised if we get -- a lot of it depends on this pandemic and how long it lasts. But I wouldn't be surprised if something like that comes to us. And we've had deals, even some really good deals, come to us right now. But again, the price that they want right now would be -- and where they're located wouldn't be what we want to do exactly right now.

And ladies and gentlemen, at this time, we'll end today's question-and-answer session. I'd like to turn the conference call back over for any closing remarks.

Thank you, Jamie. 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.

Ladies and gentlemen, with that, we'll conclude today's conference call. We do thank you for joining. You may now disconnect your lines.