Prosperity Bancshares, Inc. (NYSE:PB) Q4 2022 Earnings Call Transcript

Prosperity Bancshares, Inc. (NYSE:PB) Q4 2022 Earnings Call Transcript January 25, 2023

Operator: Good morning. Welcome to the Prosperity Bancshares, Inc. Fourth Quarter 2022 Earnings Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Charlotte Rasche. Please go ahead.

Charlotte Rasche: Thank you. Good morning, ladies and gentlemen, and welcome to Prosperity Bancshares fourth quarter 2022 earnings conference call. This call is being broadcast live over the Internet at prosperitybankusa.com and will be available for replay for the next several weeks. I’m Charlotte Rasche, 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 MJ. 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.

David Zalman: Thank you, Charlotte. I’d like to welcome and thank everyone listening to our fourth quarter 2022 conference call. Our annualized return on average assets for the three months ended December 31, 2022, was 1.47% and our annualized return on average tangible common equity came in at 16.2%. Prosperity’s efficiency ratio was 40.8% for the three months ending December 31, 2022. Our net income was $137.9 million for the three months ending December 31, 2022 and that was compared with the $126 million for the same period in 2021, which represented an increase of 8.7%. The net income per diluted common share was $1.51 for the three months ending December 31, 2022 compared with $1.38 for the same period in 2021, which represented an increase of 9.4%.

Our net income was $524 million for the year ended December 31, 2022 compared with $519 million for 2021, an increase of $5 million or 1%. Net income per diluted common share was $5.73 for the year ending December 31, 2022 compared to $5.60 for 2021, an increase of 2.3%. Our loans excluding Warehouse Purchase Program and PPP loans at December 31, 2022, were $18 billion compared with $16 billion — $16.7 billion at December 31, 2021, an increase of $1.4 billion or 8.5%. Our linked-quarter loans excluding Warehouse Purchase Program and PPP loans increased $518 million or 3%, 11.8% annualized from the $17.6 billion at September 30, 2022. Our deposits at December 31, 2022 were $28.5 billion, a decrease of $2.2 billion or 7.3% when you compare to $30.8 billion at December 31, 2021, primarily due to a decrease in public fund deposits.

Linked quarter deposits decreased to $766 million or 2.6% from the $29.3 billion at September 30, 2022. Our period-end and average non-interest bearing deposits saw small increases, but as mentioned earlier, most of the decrease in the total deposits was in the public fund category. Our asset quality, nonperforming assets totaled $27 million or 8 basis points of quarterly average interest-earning assets at December 31, 2022, and that’s compared with $28 million or 9 basis points of quarterly average interest earning assets at December 31, 2021. The allowance for credit losses on loans and off-balance sheet credit exposure was $311 million at December 31, 2022 compared with $316 million last year December 31, 2021 and $312 million at September 30, 2022.

We are excited about our pending merger with First Bancshares of Texas and Lone Star State Bancshares. The combined banks will add approximately $3 billion in assets and increase our market share in the West Texas areas of Lubbock, Midland and Odessa, as well as provide entry into new markets to us in Wichita Falls, Amarillo and the Horseshoe Bay, Marble Falls and Fredericksburg areas in Central Texas. The transactions are pending regulatory and shareholder approvals and are expected to close during the first half of 2023, although delays could occur. During the fourth quarter of 2022, Prosperity continued to see growth in loans, which we expect will continue into 2023. The growth comes from loans, as well as existing loans not paying-off as fast as they did when rates were low and it was opportunistic for borrowers to repay or move the loans.

Consumer spending remains strong, especially in the tourism, restaurant and hospitality sectors. Real estate sales and pricing have been affected by the increase in rates, but we expect that because of inventory levels and the population growth, the impact will be less in Texas and Oklahoma. We believe that the economies in Texas and Oklahoma will outperform other states over the next several years as companies and individuals continue to move to the states because of lower tax rates and a business-friendly political environment. We expect that companies will need more infrastructure and buildings and consumers will need more housing and places to spend their money and both will need banks to finance to grow. While the net interest margin at some banks has improved immediately because of higher rates, we expect Prosperity’s net interest margin to continue to increase over the next several years as our bond portfolio, which yielded 1.96% during the fourth quarter of 2022, reprices to higher yields assuming that rates normalize near the current rate, Overall, we are excited about the growth and future of our company.

I would like to thank our customers, associates, directors and shareholders for helping build such a successful bank. Thanks again for your support of our company. Let me turn over our discussion to Asylbek Osmonov, our Chief Financial Officer to discuss some of the specific financial results we achieved. Asylbek?

Asylbek Osmonov: Thank you, Mr. Zalman. Good morning, everyone. Net interest income before provision for credit losses for the three months ended December 31, 2022 was $256.1 million compared with $244.8 million for the same period in 2021, an increase of $11.4 million or 4.6%. This was due to an increase in loan and security interest income of $28.9 million and $25.7 million, respectively, partially offset by increase in interest expense of $43.6 million. Comparing the quarter ended December 31, 2022 to the same period in 2021, the net interest income increased $11.4 million despite having $7.9 million less in PPP loan fee income and $4.5 million less in fair value loan income. The net interest margin on a tax equivalent basis was 3.05% for the three months ended December 31, 2022 compared to 2.97% for the same period in 2021 and 3.11% for the quarter ended September 30, 2022.

Excluding purchase accounting adjustments, the net interest margin for the quarter ended December 31, 2022 was 3.04% compared to 2.91% for the same period in 2021 and 3.1% for the quarter ended September 30, 2022. Noninterest income was $37.7 million for the three months ended December 31, 2022 compared to $35.8 million for the same period in 2021 and $34.7 million for the quarter ended September 30, 2022. Noninterest expense for the three months ended December 31, 2022 was $119.2 million compared to $119.5 million for the same period in 2021 and $122.2 million for the quarter ended September 30, 2022. For the first quarter 2023, the new FDIC assessment rate is expected to increase expenses by approximately $2 million. As a result, we expect noninterest expense for the first quarter 2023 to be in the range of $122 million to $124 million.

This excludes any potential impact from one-time merger related costs for our pending acquisition, which are expected to close in the first half of 2023. The efficiency ratio was 40.9% for the three months ended December 31, 2022 compared to 42.8% for the same period in 2021 and 41.4% for the three months ended September 30, 2022. The bond portfolio metrics at December 31, 2022 showed a weighted average life of 5.3 years and projected annual cash flows of approximately $2.2 billion. And with that, let me turn over the presentation to Tim Timanus for some details on loans and asset quality. Timanus?

Tim Timanus: Thank you, Asylbek. Our non-performing assets at quarter end, December 31, 2022 totaled $27,494,000 or 15 basis points of loans and other real estate, compared to $19,878,000 or 11 basis points at September 30, 2022. This represents approximately a 38% increase in non-performing assets. The December 31, 2022 non-performing asset total was comprised of $25,531,000 in loans, $0 in repossessed assets and $1,963,000 in other real estate. Of the $27,494,000 in non-performing assets, only $767,000 are energy credits. Since December 31, 2022, $6,114,000 in non-performing assets have been removed. This represents 22% of the non-performing assets at December 31. Net charge-offs for the three months ended December 31, 2022, were $603 million compared to — excuse me, $603,000, compared to $1,780,000 for the quarter ended September 30, 2022.

No dollars were added to the allowance for credit losses during the quarter ended December 31, 2022, nor were any taken into income from the allowance. The average monthly new loan production for the quarter ended December 31, 2022 was $613 million. Loans outstanding at December 31, 2022 were approximately $18.840 billion, compared to $18.506 billion at September 30, 2022. The December 31, 2022 loan total is made up of 42% fixed rate loans 30% floating rate and 28% variable rate. I will now turn it over to Charlotte Rasche.

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

Q&A Session

Operator: Yes, of course. We will now begin the question-and-answer session. Today’s first question comes from Brady Gailey with KBW. Please go ahead. Brady, your line is open.

Brady Gailey: Sorry. I was muted. Good morning, guys.

David Zalman: Good morning.

Asylbek Osmonov: Good morning.

Brady Gailey: So the margin took a little bit of a step-back in the fourth quarter. I know longer-term as the bond book reprices higher, that’s very beneficial to the margin, but do you think the margin — when do you think the margin can really start to see some material upside from this dynamic of the bond book pricing higher?

Asylbek Osmonov: Hey, Brady, this is Asylbek. I’ll take that and maybe we can add more later. But our story doesn’t change, right? It’s all about our balance sheet mix. If you look at long term, you’re right. I mean, long term looks very positive for us because of a higher interest rate environment we are right now. We have about $14 billion in bond portfolio right now, which is yielding less than 2%. And if you look at our loan portfolio, as Mr. Timanus just mentioned, we have 42% in fixed rate and about 28% in variable, those are going to be repricing over time as well. So that looks very positive on us. And if you look at our bond portfolio, we have about $2.2 billion cash flow coming in every year, and we had very strong loan growth the past few quarters.

And if you could just take that cash flow and put it towards the high-yielding loans, which was 6%, 7% right now yield on loans, that’s going to be very positive in the long term. And one more thing I will add. If you look at our IRR model, if you look at 12 months, 24 months, we see expanding NIM, and that’s very consistent with what we’ve done in the last rate cycle. That’s more color on the long term. But if you look at short term, maybe the first quarter, I would say our NIM going to be a bit flattish because of still repricing of the deposits. And that’s, I think — the wild card is the repricing of the deposits, especially with the environment we are in competition. But we feel very positive about long-term margin, and that — I mean, that should expand in the long term.

David Zalman: Brady, I’m going to jump in for just a minute, if I can. Based on our models that we have, we show pretty significant increases in our net interest margins starting in the six month period, 12-month period, really nice. 24 months is hard to believe something what the model says sometimes. However, that’s predicated on rates where they’re at today, and as rates increase, I think they have plugged in, in this model, a 25 basis points increase in January — I’m sorry, in February and a 25 basis points increase in March. And the model for every 100 basis points increase takes into consideration like on your money market accounts, everyone has a different beta, but we use 65 basis points of that for the increase. So if things went up 100 basis points, we would say 65% in our model.

So that’s — I’m just trying to give you some background on it. But — so that’s based on the model. Having said that, the things that always could change if you saw the deposit pressure was there that you had to raise rates faster or more than that in the short term than we thought that could also — that could change the net interest margin as when you do get it. I guess, that’s the point I would make in making it simple, no matter how you look at it, we have a really long way to go in a normalized rate environment with our deal. It just depends on the timing of it, I think. So I think where other banks have gotten most of their net interest margin gain already, ours is yet to come. It’s just a matter of when.

Brady Gailey: So the bond book — the yield on the bond book is 1.96%. When you’re buying new bonds today or like if you look at the bond purchases you did in the fourth quarter, what was the new yield on those?

David Zalman: We don’t have to buy them anymore because our loans have been growing. So we’ve been putting all in the loans. But the fact of the matter is — and we — I think for the short term, I don’t see us really buying bonds as much as really increasing our loan portfolio, really. I think we’ve increased our loan portfolio to $500 million in the last quarter. The first quarter still looks pretty good, too. I know that in some areas of the country they’re talking about a recession. But right now, we still see some strength even in the loan portfolio. So if you ask me my gut feeling with the amount of money that we’re borrowing right now and what we’re doing in loans, I think that most it will go more towards the loans and the reduction in the Federal Home Loan borrowings probably.

Tim Timanus: I think what the 15-year mortgage backs now are about 4.5%. Is that right?

David Zalman: Probably so. Yes.

Tim Timanus: And I think it would be clearly our preference to put those dollars in loans not in securities at that level. So — and we’ve had some success at that here lately. So that’s the plan.

Brady Gailey: And on the loan growth, I think you guys kind of longer-term guide to a mid-single digit level loan growth, but as I look at the last three quarters, annualized, you are growing like north of 10%, so how do you think about loan growth for 2023?

David Zalman: Kevin, do you want to take it?

Kevin Hanigan: Yes. Brady, I think part of this loan growth is driven by slower paydowns across the portfolio, and in particular, that structured real estate portfolio that we had at legacy, which is down under $400 million now, so those payoffs are really slowing down on that side. David mentioned the first month of the year was almost behind us, really strong loan growth for this first month, consistent with what we’ve seen in the last couple of quarters, maybe even a little better than what we’ve seen in the last couple of quarters — quarter-to-date. So if I think about the year, I would say somewhere in the mid-single digits to the very high single digits, with the difference being where single-family mortgage origination pricing comes in.

At the lower end of single-family mortgage origination, it might make more sense for us to package those things and sell them off for the gain, and we’ll make money on the gain versus the loan growth. So if rates are such that, that happens, I would say more towards the mid-single-digit range to the extent we portfolio those, high single-digit loan growth. So that’s the swing factor. Either way, we’re going to make more money. And we’re just cognizant of where the rates are in these things, and we’ll be both strategic and thoughtful on whether we portfolio to loans are selling.

Brady Gailey: Okay, that makes sense. Thanks, Kevin.

Operator: The next question comes from Michael Rose with Raymond James. Please go-ahead.

Michael Rose: Hey. Maybe just sticking with loan growth, Kevin, just on the usual update on the warehouse, it looks like the — not surprisingly, the volumes were a little bit less than what you’d kind of talked about back in October, not surprised just given the MBA’s forecast. But any sort of stab in the near term for warehouse volumes. I would probably expect a little bit more downward pressure and then maybe some stabilization, but I would just love your thoughts. Thanks.

Kevin Hanigan: Yes. And I saw your note this morning, you had me scrambling for our transcript, because I thought I guided right to the number we had. But I’ll call you later on that once I confirm. It has trickled down in January. It always does. Michael, we’re averaging so far for the quarter exactly $590 million. So it’s off from the last quarter average of $729 million, I think, something like that. So I expect this would be kind of the low points for the quarter, and we may rally from here a little bit, but again, depending upon where the 10-year moves, but it seems to be settling in. I’m going to say we’re going to average for the quarter somewhere between $550 million and $600 million.

Michael Rose: Perfect. And then maybe just for David Zalman. Obviously, the two deals announced recently, I know there’s a lot of other banks out there, a lot of dislocations. Just any change and update on kind of your thought process around M&A at this point? And would you potentially look to maybe do additional deals here in the next couple of quarters, even if you’re still integrating the two that you’ve already announced? Thanks.

David Zalman: Well, I think that M&A is part of our plan. I mean, we always for the last 20, 30 years, our plan has been trying to shoot for about an 8% organic growth rate on the loans and about 4% on the deposits and the rest of double-digit always came in with the M&A. So the answer to that would be yes. I think that — if you ask me if it’s as busy as it was last year, I think that there are still deals out there. We’re still getting calls. I think it’s more tempered. Something that is more challenging is the AOCI on most of the banks and books right now. I think that’s a deal that we’ll have to work through on some of these deals. In the past, on larger deals, sometimes you were able to take it and make the mark. And then on some of the smaller deals we marked the mark in the price — so there’s — there will have to be some discussion and adjustment with regard to the AOCI.

But I think there’s always going to be M&A, times change, you wake up one morning, they’re not the same as it was next morning for people. And there’s just a lot of stuff that always goes on. So I think there will always be M&A and we’ll probably be a player in that.

Michael Rose: Okay. And maybe finally for me, just on the buyback announcement, you haven’t repurchased shares here recently. Is that just more of a kind of a tool in case there’s dislocations? Or would you actually expect to maybe potentially be a little bit opportunistic here? Thanks.

David Zalman: Historically, we’ve used it for dislocation. I think whenever the price gets a little crazy, gets under 70, I think that we’ve been going back into the market. So in the past, and I would say that — I’m not saying that it would be just like that. But in the past, we’ve used it primarily for dislocation.

Michael Rose: All right. Great. Thanks for taking my questions.

Operator: The next question comes from Dave Rochester with Compass Point. Please go ahead.

Dave Rochester: Hey, good morning, guys.

David Zalman: Good morning.

Dave Rochester: I appreciated all the color on the margin earlier. I was just wondering if you could talk about where your incremental loan production yields are, what you’re seeing today. I know the curve has been all over the place. But given where we are today, what are you guys seeing?

Tim Timanus: Basically on the low end, 6.5% on the high end 8% and they’re fluctuating within that range.

Dave Rochester: Got it. So you got a decent amount of upside there from your average yield on the quarter alone over the next few years?

Tim Timanus: We averaged 5% for the quarter, if I remember it correctly. So there is quite a bit of upside available. That’s correct.

Dave Rochester: Yes. Sounds good. And then just a quick one on expenses. I appreciate the 1Q outlook. But I know you guys have your merit increases in 2Q, I think, midway through. So if you have any visibility into how much of a step-up you guys are expecting from that in 2Q and maybe into 3Q, we get the full quarter impact by 3Q, that would be great.

Asylbek Osmonov: Yes. I’ll take this one. And from the merit increase, historically, we increased about 3%, 4%. I think, from the dollar wise, I think it will be consistent with the increase of what we had last year. So it’s going to probably add another $2 million to $3 million additional — yes. So it’s going to be about, I think, calculating about $2 million additional expenses starting in the second quarter.

Dave Rochester: Okay. Great. And maybe one last one on deposits. I was wondering how much in the way of public deposits you guys have left after the decline in 4Q. And then are you guys still thinking about core deposit growth of roughly 2% that you were talking about before? Has that changed at all? And then last one, how are you thinking about deposit betas for the cycle at this point? Thanks.

Tim Timanus: May take some of the

David Zalman: Yes. On the public funds, we ended the year at about $3.3 billion, and that’s about where we are right now. I think it’s safe to say that we have a good relationship with all of our public fund customers with text pool and other rate payers like that above 4% right now. It’s in our best interest, we believe, to let some of that money go at those rates instead of paying that ourselves. That has no indication that we don’t have a good relationship with those public funds. We still have their operating accounts, and we still have their day-to-day dollars with us, and we don’t see that changing. We do have several bids coming up this year, and that’s always a challenge because some banks are — tend to be overly aggressive and some tend to be reasonable. So we just deal with that on a case-by-case basis. But I think we feel good about where we are on public funds right now.

Kevin Hanigan: Yeah. I think as far as the 2% increase. I would — it’s hard for me to say that we would grow 2%, because — just because of the interest rates, some of the rates other banks are paying are pretty high and we haven’t chased the rates, so normally I would just — I would always tell you it’s the lay down that we’re going to be 2% to 4% organically. But I couldn’t tell you that right now and we still want to see where deposits stabilized for our sales, even right now.

David Zalman: Yeah. And probably Asylbek is the best guy to answer on. I think you asked about beta as well through the cycle. I think I know where it is but Asylbek on top of that one.

Asylbek Osmonov: Yes. So if you look at just cycle and I’ll tell the cycle before the December rate increases. So over 3.75 Fed rate increase, our beta for the interest bearing deposit was like 20 basis points. And if you just look at total deposits like 12 basis points over that period, but it’s running less than what we project in our IRR report. But as we know, the betas starts slow and kind of ramps up a little bit — but we’re not even — at the beta wise, we’re not there yet, what we had experienced back in 2015 or 2016 when the rate increased. So we feel very good about that, but I think there’s a competition going on, on the deposits, and I think it’s going to put a little bit of pressure on us.

David Zalman: It’s not only deposits with competitors. I don’t know, it may be 10, 15, 20 years since we been so I can’t give you as much of a scenario where we’ve not had deposit growth. So — but people are going out and you can buy a 4.2% treasury for two years. And there’s just other options and people are looking at some of that stuff. And that’s why it’s hard to really — if historically, we had something to model it on, we could give you a better opinion. We’re just watching it and making changes as we need to on a daily basis. But again, this hasn’t happened so long in banking — and then the last previous years, as you know, we’ve had all the helicopter money that came in at $2 billion and $3 billion a year. So we’re trying to see where all lines out and where it stabilizes.

Dave Rochester: Okay. Great. Thanks, guys. I appreciate the color.

Operator: The next question comes from Peter Winter with D.A. Davidson. Please go ahead.

Peter Winter: Thanks, good afternoon. Credit, obviously, the hallmark for you guys. When I look at that reserve coverage, it’s 10 times the nonperforming loans. So the question is, can you guys still keep a zero provision expense this year even with a mild recession?

Asylbek Osmonov: Yes, I can maybe give a little bit of color from then we run the model in — as we explained before, we have a base scenario, and we also bake in the recessionary scenarios. So what — based on the two scenarios combined that the allowance levels we have right now is considered appropriate. And I think going forward, we just have to run the models and see where the economy at that time and to see where the allowance will be, but

David Zalman: Yes. I mean, the first time we used in the model, we had a COVID variant in there, so we were high using that. And then we went to oil with I think at some point, we use that now and right now, the — there’s some talk of a recession in this year. So that allows us to keep more money in the reserve using those variables like that.

Tim Timanus: Yes. I think it’s highly dependent on how high rates get and that remains to be seen. And if for some reason, population growth should slow down or even go the other direction in Texas and Oklahoma, that would have an impact on it. We don’t foresee that, but things happen in life that you don’t foresee. So I think the answer to your question is, certainly, at this point in time, we wouldn’t anticipate right away an increase in the reserve. But as the year plays out, we just have to watch some of those things that I just mentioned.

Kevin Hanigan: Yes. Last thing I’d add and I think Tim covered it in his prepared remarks was that we did move up, NPA has moved up to $27 million from $19 million or $20 million. Most of that was just some loans that didn’t get renewed at year-end that have subsequently been renewed. So that number is back down to where it had been. So in terms of stress, we haven’t seen any yet. That doesn’t mean we can walk out of this meeting and get a phone call that somebody stumbled, but we’re watching it, and we feel good about where we sit.

Tim Timanus: That’s correct. A wildcard is always the price of oil and gas. And right now, it’s good, it’s stable. But it never stays the same. If we’ve learned anything, we’ve learned that. So next year, we still think it would probably be stable, but we’ll just have to see where it goes.

Peter Winter: Okay. And then just second question, just I realize regulators operate kind of in a black box. But when you first announced the two acquisitions, the thought was you’re going to close it in the first quarter, now you’re saying in the first half of the year. When does that impact the synergies from the deal, the accretion to the deal maybe pushes out a little bit? And two, are the regulators saying anything that causing change a little bit in terms of the timing of closing the deals?

David Zalman: I’m blaming that statement on our general counsel — from closing the first quarter to the first half just to be cautious on the deal with everything happening, I mean, I think we’re still trying to shoot for a first quarter closing. But she felt that we should put first half just because of the way things are in the regulatory environment right now.

Tim Timanus: I think it’s important to emphasize, we don’t have any answer yet from the regulators. So until we do, we can’t schedule a closing.

Peter Winter: Got it. Okay. Thank you.

Operator: The next question comes from Manan Gosalia with Morgan Stanley. Please go ahead.

Manan Gosalia: Hey, good afternoon.

Asylbek Osmonov: Good afternoon.

David Zalman: Good afternoon.

Manan Gosalia: I had a question on NIM and just given the positive dynamics that you have on the security side, how should we think about the potential downside in NIM if the Fed begins cutting rates in the back half of this year? Should that actually be maybe a little bit of a benefit in the near term if deposit competition alleviate and your securities keep repricing higher?

Asylbek Osmonov: I think overall, big picture, I mean, even Fed would decrease rate, and we don’t know, we’re just speculating if they would and how much. We still are in the bond portfolio, we’re sitting less than 2%. So even they decrease. I mean, there’s still a lot of upside for us and also on the loan. So even if there is a foreseeable future, you see the decrease, I think we still have upside. And definitely, you’re right, I think from the cost perspective on deposit costs definitely helped the decreased rate environment.

David Zalman: I think it probably helps on mergers and acquisitions too, it will change the valuation of the loss in the portfolio and the AOCI probably. But for the most part, the yields that we have in the bond portfolio today really reflect a time and period that we’ve not seen before in banking where interest rates were at zero. So in any type of normalization of rates we stand to benefit on a repricing too.

Manan Gosalia: Got it. And then maybe to round out the discussion on the funding side, can you help us with how we should think about FHLB and CDs as a source of funding. So to the extent that deposit pressure accelerates from here, how much room do you have to bring your loan-to-deposit ratios up versus the 66% or so that it’s at right now?

David Zalman: So first of all, we have the capability to borrow $15 billion if we want overnight just because of our pledging that we have with the Federal Home Loan Bank. But for the most part, and you can jump in, Asylbek, if you want, but we have a certain amount of bonds that just rolls off every year, which is about $2 billion, close to $2 billion. So instead of buying securities like we have in the past, we would take that money and either put them into the loans that we discuss the growth in loans and also the reduction in the debt. Also, the banks that are joining us will probably take a certain portion of their liquidity instead of reinvesting it and probably pay down the Federal Home Loan Bank too. So it will probably be a combination of money that we get from paydowns in our own portfolio and also the banks that join us, really necessarily have a big portfolio, but the other one, I would have to look and see, but we’re looking at doing that and probably using that money just to pay down the Federal Home Loan Bank probably.

Manan Gosalia: Got it. So it feels like you wouldn’t be leaning into CDs at all?

David Zalman: I think that people are going to move money in CDs over time as — if rates stay higher like they are. But again, we’ve not been the type of bank that goes and advertisers in the paper for CDs or high CD rates or really any high rates. That may change. We don’t see that right now. But historically, that’s just not something — we’ve never chased the money before because we’ve had so much liquidity. And we still have tremendous amount of liquidity when you look at our ability to borrow and the core deposits that we have.

Manan Gosalia: Great. I appreciate it. Thank you.

Operator: The next question comes from Matt Olney with Stephens. Please go ahead.

Matt Olney: Hey, thanks. Good morning, everybody.

David Zalman: Hey, Matt.

Asylbek Osmonov: Good morning.

Tim Timanus: Good morning.

Matt Olney: I want to drill down on deposit pricing. And I think last quarter you mentioned that early in 4Q, you increased some of the posted rates across the network. And obviously, we saw that in the 4Q results and some of the deposit pricing pressure. Asylbek, you mentioned incremental deposit pricing pressure in 1Q. Any notable changes in the deposit posted rates over the last few weeks or months?

Asylbek Osmonov: Yes. We — end of December, we increased our deposits a little bit again. But overall, if you look at the third — fourth quarter, our beta was overall — on the interest-bearing deposits for the fourth quarter was like 30 basis points. So right now, we sit there, we might increase a little bit rates on deposits, but we don’t have a specific on how much of an increase it will be.

David Zalman: If you remember our last meeting, Matt, our last time, I said that probably we saw interest rates going up, and really our money market rate was hardly at anything, what, 50 basis points at that. And I mentioned that be prepared that our net interest margin would probably go down five basis points or six basis points, which it did, because we did take our money market account all the way up to 2.25%. And we also offered — and one of the CD products, if you went for 22 months at 3.5% on that. So those are the two things that move. I would say, if we go up some more, it would be — we see a quarter of a point increase in February and a quarter of a point in March, our model has it that we’re going to go up 65 basis points of that.

So what’s 60 times — 6% of 50. So that’s another 30 basis points or something like that. So you could see us still raise in our modeling that could go up to now. If we saw something that really changed and there was so much competition in the money just going out of the bank or something, we might have to make a different, we may have to go up more or something like that. But again, I don’t think any of that changes our modeling. We’ve never been a quarter-to-quarter player. We’ve been a long-term player. Our net interest margin over time, no matter how you cut it, it’s still real positive. And the reason we raised rates last time is because we had core customers, and we want to be more fair with them and give more to them. And even if that happened again, we would do that.

But again, it’s still not going to change the longer-term outlook of the net interest margin.

Kevin Hanigan: Yes, Matt, this is Kevin. I’d just add with the cash flows coming off the bond book and our loan-to-deposit ratio sub 70%, we’ve got a little room to let that loan-to-deposit ratio drift up and protect margin at least in the short run. Brian?

Matt Olney: Yes, okay.

David Zalman: I think it even improve your margin, just if you can keep up your loans, too, just I’m not even saying 10%, you pick up 2% or 3% on a couple of billion dollars’ worth of loans, you really improve your margin dramatically.

Matt Olney: And sticking with the deposits, I was encouraged that you’re — on the average basis, your noninterest-bearing deposits were pretty flat in 4Q from 3Q. Most of your competitors are seeing some pretty big pressure there. Any color on your depositors and maybe how they’re unique versus some of your other public bank peers in Texas?

David Zalman: I just — we see some of our depositors. I think there was a lot of money that came into the banks with the helicopter money and people who had investments everywhere else. Nobody was paying anything. So you see some depositors some — I think it’s really some of your bigger depositor like I watched I was in a trust committee meeting day before yesterday, and I saw where this customer could add $15 million with us in the bank, but he moved it over to our trust department because our trust department was hiring another higher rate from a Goldman Sachs or something like that. So we are seeing some of that at the same time.

Kevin Hanigan: Greater percentage of retail deposits, more granularity drives some of that for us compared to some of our Texas peers anyhow, but maybe more commercial deposits. It’s these small towns where we have really big market shares and granular portfolios where we’re getting pressure or people that ask us to come off of our rate sheets tends to be from professionally managed money, bigger company that’s got $50 million, $60 million, $70 million in the bank that’s got a CFO that’s keeping track of things and

David Zalman: And we can count those on our hands.

Kevin Hanigan: Right. There’s only a handful of those, and they’re willing to work with us. It’s kind of, we don’t have to go all the way to the market. That’s usually a conversation between either Eddie and David, Tim and myself. But hey, let’s take these guys to 2.50 or 2.75 if our rates is 2.25. And thus far anyhow that kept most of the money with us.

Tim Timanus: Yes. I think what you’ve just said, Kevin, is 100% correct. I would say when I said previously that we have a good relationship with our public fund customers, I think that’s the same with all of our deposit customers. And they don’t tend — if they feel like they need a higher rate, they don’t tend just to take money out of the bank and put it somewhere. They tend to contact us first, and we talk about it. And while we do have to go up sometimes, we typically don’t have to go for and above, at least that’s been the case so far. So I think there is upward pressure on deposit rates, but I don’t see it getting out of hand. I think it’s relatively stable. And I think we have the kind of relationship with our customers where it can be managed.

Kevin Hanigan: Yes, I said this on the last call, too, in this rate environment, from a guy who ran a 95%, 98% loan-to-deposit ratio bank ex the warehouse. So with the warehouse, it was running 110%. I’m glad to be sitting in this room.

Matt Olney: Okay. I appreciate all the color, guys. And then just one more on loan growth. It looks like the drivers of that 4Q loan growth was from construction and single family. Kevin, you addressed a single-family portfolio kind of driven by yields as far as kind of the factor in 2023. What about construction? Is that going to be the primary driver of the loan growth in 2023?

Kevin Hanigan: I think we’re going to see it in construction, which is funding up projects that we’ve approved. We’ve got a big, very large unfunded and funding up construction book of really good customers, underwritten for rates being materially higher than they are now, and we feel pretty good about that portfolio. And I think we’re going to continue to see some success this year on the C&I side.

David Zalman: Yes, some of our markets really have some unfunded loan commitments that are really strong right now. Our Houston market had probably over $700 million and Central Texas had — how much, Eddie did you

Eddie Safady : About $300 million or $400 million.

David Zalman: $300 million or $400 million. So if those hold up our book, it looks pretty good. But again, anything can change. We just don’t want to tell you something that’s going to be this glorious because if you do go into a resection or something like that, that can all change. Overall, I think the guidance that Kevin gave a while ago is a really good guidance to stick with really.

Matt Olney: Okay. Thanks, guys.

Operator: The next question comes from Jon Arfstrom with RBC Capital Markets. Please go ahead.

Jon Arfstrom: Hi. Good morning everyone.

David Zalman: Hi, Jon.

Jon Arfstrom: I’m probably not going to ask about deposit pricing, but I guess how — just stepping back, how optimistic are you on the longer-term margin? You talked about putting on loans at 6% to 8%. And certainly, securities yields are higher, and you’re saying that you’re not overly worried about deposit pricing. I mean what could this margin look like in 12 or 24 months with that kind of increase in earning asset yield?

David Zalman: I’d give you what the model said in front of me, but somebody may shoot me if I did. I think I would take away from it. It’s not a question whether the net interest margin has a lot of a big increase in it. It’s just when it happens. I mean, if we stick with not having to increase rates a whole lot more than where we’re at right now, you start seeing pretty good increases in six months, 12 months and 24 months is huge. On the other hand, if we’re something — for some reason — if for some reason, if you — if the competition come back or we just saw tons of deposits going somewhere else that we had to change overnight, that would change the duration when this net interest margin would increase. But overall, it looks extremely positive. It’s just a matter of managing it really.

Kevin Hanigan: Yes. Timing-wise, I think the sooner the Fed goes into pause mode, the sooner this happened.

David Zalman: You got an inversion factor here, right now, too. To me, that’s a really big deal. I mean — I mean when you’re 10 years span 3.5 and your two year treasuries span 4.2. There’s an inversion factor at the same time. So I don’t want to be evasive on what you’re asking, Jon, just it’s really — we’re trying to manage through it ourselves. But again, I’ve always used the term parking the Queen Mary out in the parking lot, we parked it quite a few times. So we’re probably in that process right now navigating parking the Queen Mary right now.

Jon Arfstrom: It ties into my next question, but I agree, I think a pause would be great for you guys and just if they held it there. This kind of goes back to the, I guess, the Queen Mary and parking lot. I’m thinking of Sugar Land. But when you’re — you talked about the marks on M&A targets. What are you seeing there? Is this like SMB type issues? Is it that bad yet? Or do you expect it to be like that, where you’re going to have bigger opportunities longer term? How big of an issue is that? And what are you seeing from some of these potential sellers? What’s the message?

David Zalman: I think the real challenge on AOCI is if you’re talking about a real large merger partner. The smaller ones you can deal with and really in some of the smaller ones, that we’ve done, we mark-to-market, what it is. So the seller actually takes the hit on the loss. I think it’s really the bigger ones that we’re really looking at. And it’s just one of those sayings I’d say.

Tim Timanus: It’s hard to do the deal as it’s picking up and they have that issue.

David Zalman: And it’s hard to pay what they wanted in the past, I would say it like this and not — and if you have to mark-to-market on a bigger deal, it just hurts your — it hurts your capital, your tangible capital ratio, and it’s not something that we’re willing to go down on that much. There’s going to be some give and take on the seller and the buyer, I think, in the future if it’s a bigger deal.

Kevin Hanigan: Yes. The earn back part isn’t — it’s very capable, right? Yes. But the goodwill sticks forever. And those are — these bigger deals, it runs into a big goodwill number that you don’t get rid of.

David Zalman: I mean from an earnings standpoint, when you look at one of these deals when you model it out, the earnings are just if you mark everything to market are just phenomenal. I mean because the bond portfolio may be like us instead of waiting two and three years to get all that money back, you’re marking it to market right there. And so the earnings for the first two or three years just look phenomenal on a deal like that. But the problem is really on the tangible capital issue, I think.

Jon Arfstrom: Okay. All right. Thanks for the time. I appreciate it.

Operator: The next question comes from Bill Carcache with Wolfe Research. Please go ahead.

Bill Carcache: Thanks. Good morning, everyone.

David Rochester: Good Morning.

Bill Carcache: I wanted to follow up on your comments around why your noninterest-bearing deposit mix has held up materially better than many other banks. I appreciate all the color that you gave. I wanted to ask if you could also discuss how much of a role earnings credit adjustments play in your relationship with some of your commercial customers? And has that been entering into the discussions more?

David Zalman: I’ll start it off. The earnings credit were again, we’ve been raising that. I think we raised it 10 basis points this morning. But again, we continue to raise that. I think the granularity is really the reason for the noninterest-bearing accounts. We don’t have — we don’t have like 10% or 20% of our customers that control almost everything in the bank. It’s — we have so many businesses and small businesses around the state just because of — we’re in metro areas, we’re in small communities. And I think it’s just extremely granular. And there’s not one person — there’s not one person owns the bank, I guess, you could say. It just made up of a bunch of immigrants, I guess, from everywhere — so all of that makes it more granular, I think.

Kevin Hanigan: Yes. And on the ECR, while we get rate requests for off-sheet rate requests, Frequently, the ECR doesn’t come up all that frequent, and it’s that professionally managed larger corporation that’s got a bunch of money with us, which we can count on a couple of hands where those CFOs are thumping on us for ECR. But we haven’t had to move nearly as much as you would think.

Bill Carcache: Okay. It’s really helpful.

David Zalman: I just haven’t seen how much pressure at all on the ECR.

Kevin Hanigan: I can take the one client that has been pretty adamant about us keeping pace. And that’s the only phone call I’ve received in last couple of months.

Tim Timanus: That one was friendly pressure.

Kevin Hanigan: It was friendly pressure. It’s like, hey, did you mean pathway on this thing and we’ll just call it a day and I think specifically in that case, Tim and I had a conversation came up with a number and went back to the CFO and he said, “I’ll take it. We’re good. Talk soon.”

Tim Timanus: It was a very reasonable conversation.

Bill Carcache: Yes. That makes a lot of sense. That’s super helpful color. Thank you. Separately, I wanted to circle back on the commentary about the expected improvement in NIM over the next several years as the bond portfolio reprices. I wanted to ask if there’s any way you consider putting on swaps to potentially lock in some of the benefit of the higher rate environment to the extent that we do start to think about the scenario where the Fed ends up cutting before you have the opportunity to fully see that repricing benefit show up. Curious what your thoughts are around potentially putting on swaps or otherwise using

David Zalman: Historically, and again, things change all the time. Historically, when we would look at doing swaps by the time you pay the premium to do the swap and everything, your profit was all gone. And in our business, primarily — our business is primarily monitoring risk and taking risk and that’s — we’ve made more money taking risk over periods of time and understanding what the risks are than paying it to somebody else. I guess that may change at some point in time. But again, from what we’ve looked at, we’ve been able to bite and beat the insurance guy a couple of times.

Kevin Hanigan: I’ve had a couple of theoretical questions, thought processes and discussions around that. Nothing that’s caused us to pull the trigger on anything.

Tim Timanus: Yes. I mean if you look historically, and things don’t always repeat themselves. But historically, we’ve been able to manage all types of environments without really going to derivatives in an all-in way.

David Zalman: I think we’ve been able to do that, though, Tim, because of the makeup of the bank and the depositors, there’s so many. I think if you had so much of your money in high-yielding money markets or CDs. And if our customer base wasn’t so granular and so mixed, I don’t think we can do it, but because we’re so mixed we’re able to do that, I think. A lot of the banks aren’t.

Kevin Hanigan: Our loan-to-deposit ratio gives us room. We’re not under the pressure some are.

Bill Carcache: That’s really helpful. If I may squeeze in one last one. In an environment where rates do stay higher for longer as the Fed proceeds with QE. I’d love to hear David from you and the rest of the team, how you’re thinking about the risk that the mix of noninterest-bearing deposits may not just go back to sort of the 2019 pre-COVID levels, but could potentially overshoot back towards even pre-GFC levels. And of course, back then, everyone’s noninterest-bearing mix was much lower.

David Zalman: I don’t know that ours was a whole lot lower. What are we a 30-something percent right now, what do we have?

Asylbek Osmonov: Yes, I think it’s 38%

Tim Timanus: 38%

David Zalman: 38% probably before that, we were probably averaging about 30%, 35% or something like that. So I don’t see a tremendous amount of change. And again, I just think it’s a real granular deal so I really don’t see that happening.

Tim Timanus: It could lessen, but I don’t see it falling dramatically.

David Zalman: I think it will change, though. I think that I think you’re going to see depositors take money out of sometimes out of checking accounts or even interest-bearing checking accounts and smaller accounts are going to start when these rates stay where they’re at, they’re going to go into CDs and stuff like that. So I do think you’ll see a mix where you had less than 10% of your money in CDs. I don’t think we’ll get back to where it was at one point. At one point, we had, what, 20% or 30% of our money on CDs. I don’t see that — I don’t think it would be unreasonable to say that you could have 20% of your money in CDs again one day if rates stay up where they’re at like this.

Tim Timanus: Well, we’re at 7% now, and that’s low.

David Zalman: We’re not paying anything that’s the problem.

Kevin Hanigan: That’s the opportunity.

Bill Carcache: That’s fantastic. Thank you again for taking all my question. I really appreciate it. It’s very helpful.

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

Charlotte Rasche: Thank you. Thank you, ladies and gentlemen, for taking the time to participate in our call today. We appreciate your support of our company, and we will continue to work on building shareholder value.

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