Prosperity Bancshares Inc Q3 FY2021 Earnings Call

Good day, and welcome to the Prosperity Bancshares Third Quarter 2021 Earnings Conference Call. All participants will be in a listen-only mode. Please note, this event is being recorded. I would now like to turn the conference over to Charlotte Rasche. Please go ahead.

Thank you. Good morning, ladies and gentlemen, and welcome to Prosperity Bancshares third quarter 2021 earnings conference call. This call is being broadcast live over the Internet at prosperitybankusa.com and will be available for replay for the next few weeks. I'm Charlotte Rasche, Executive Vice President and General Counsel of Prosperity Bancshares. And here with me today is David Zalman, Senior Chairman and Chief Executive Officer; H.E. Tim Timanus, Jr., Chairman; Asylbek Osmonov, Chief Financial Officer; Eddie Safady, Vice Chairman; Kevin Hanigan, President and Chief Operating Officer; Randy Hester, Chief Lending Officer; Merle Karnes, Chief Credit Officer; Mays Davenport, Director of Corporate Strategy; and Bob Dowdell, Executive Vice President. David Zalman will lead off with a review of the highlights for the recent quarter. He will be followed by Asylbek Osmonov, who will review some of our recent financial statistics and Tim Timanus, who will discuss our lending activities, including asset quality. Finally, we will open the call for questions. During the call, interested parties may participate live by following the instructions that will be provided by our call moderator, Matt. Before we begin, let me make the usual disclaimers. Certain 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 or performance of Prosperity Bancshares to differ materially from future results or performance expressed or implied by such forward-looking statements. Additional information concerning factors that could cause actual results to be materially different than those in the forward-looking statements can be found in Prosperity Bancshares’ filings with the Securities and Exchange Commission, including Forms 10-Q and 10-K and other reports and statements we have filed with the SEC. All forward-looking statements are expressly qualified in their entirety by these cautionary statements. Now let me turn the call over to David Zalman.

Thank you, Charlotte. I want to extend a warm welcome and express my gratitude to everyone participating in our third quarter 2021 conference call. I'm delighted to share that, reflecting the confidence in our company, our strong capital position, and our ongoing achievements, our Board of Directors has decided to raise the fourth quarter dividend to $0.52, marking a 6.1% increase from the third quarter. Prosperity continues to perform well, and we are eager to share that success with our shareholders. In light of our stock price decline in the third quarter, Prosperity repurchased 767,134 shares of its common stock at an average price of $67.87. Forbes has recognized Prosperity Bank as the second-best bank in America for 2021, and we have consistently ranked in the top 10 of the Forbes list since 2010. For the quarter ending September 30, 2021, Prosperity reported net income of $128.6 million, compared to $130 million for the same period in 2020. The net income per diluted common share was $1.39 for the quarter ending September 30, 2021, compared to $1.40 for the same quarter in 2020. Prosperity continues to demonstrate strong operating metrics, with a return on tangible equity of 16.72% and a return on assets of 1.42% for the third quarter of 2021. Although net interest margins have been compressed due to the low-rate environment, we anticipate improvements if interest rates increase as expected, positioning the bank for enhanced earnings in a higher rate scenario. As of September 30, 2021, our loan portfolio was just under $19 billion, reflecting a decrease of $1.8 billion, or 8.8%, compared to $20.8 billion on September 30, 2020. Excluding warehouse purchase program and PPP loans, our loans increased by $217 million, or 1.3%, which annualizes to 5.3%, from $16.4 billion on June 30, 2021. We've experienced loan growth across the company except in the Dallas/Fort Worth area, where we're actively reducing loans that were categorized as PCD loans at the time of the merger, along with loans in a non-recourse structured commercial real estate category. However, if we exclude those categories, Dallas/Fort Worth continues to show solid growth and secure significant deals in that market. As of September 30, 2021, deposits totaled $29.5 billion, an increase of $3 billion or 11.3% from $26.5 billion on September 30, 2020. Our linked quarter deposits rose by $341 million or 1.2%, annually growing at 4.7% from $29.1 billion on June 30, 2021. The increase in deposits is likely influenced by government benefits and programs initiated during the pandemic, as more individuals save for a security net in light of recent events. Our nonperforming assets were $36.5 million, representing 11 basis points of quarterly average interest-earning assets as of September 30, 2021, a decrease from $69 million or 24 basis points on September 30, 2020, and from $33 million or 11 basis points on June 30, 2021. The year-over-year reduction in nonperforming assets is 47.4%. The allowance for credit losses on loans stood at $297 million, or 1.73% of total loans when excluding warehouse purchase program and PPP loans as of September 30, 2021. The allowance for unfunded commitments remained at $29.9 million as of September 30, 2021. This results in a total reserve of $317 million. Our net charge-offs for the three-month period ending September 30, 2021, were $15.7 million, which included a $4.6 million charge related to resolved PCD loans and $10.8 million from a partial charge-off of one commercial structured real estate loan that was not classified as a PCD loan. For the PCD loans, specific reserves totaled $3.1 million, with $2.2 million allocated to the charge-offs and $944,000 moved to the general reserve. In addition, $14.3 million in specific reserves on resolved PCD loans that had no related charge-offs was released to the general reserve. Overall, in the third quarter of 2021, we resolved $54.9 million in acquired loans, incurred $15.7 million in net charge-offs, and released $15.2 million to the general reserve. We have witnessed an uptick in merger and acquisition transactions recently due to rising technology and staffing costs, added government regulations, and succession planning issues. We expect continued activity in this arena, particularly if current market valuations persist. We remain poised to engage in discussions and negotiations when conditions are favorable for all parties and beneficial to our existing shareholders. The economies in Texas and Oklahoma are thriving as companies relocate from states with higher taxes and stricter regulations, and this migration is projected to create an increase of 493,000 jobs in 2021. This growth, paired with an influx of people moving to the state, necessitates additional housing and infrastructure, driving demand for loans and business opportunities. We are experiencing higher prices for most agricultural products and rising oil prices, which should bolster local economies. While inflation remains above our preferred levels, we anticipate it will moderate next year as the Federal Reserve begins tapering its asset purchases as expected. We also see early signs of increasing inventories and improving supply chains, though stabilization will take some time. Thank you once more for your support of our company. Now, I will turn the conversation over to Asylbek Osmonov, our Chief Financial Officer, to discuss our specific financial results. Asylbek?

Thank you, Mr. Zalman. Good morning, everyone. Net interest income before provision for credit losses for the three months ended September 30, 2021 was $248.6 million, compared to $258.1 million for the same period in 2020, a decrease of $9.5 million or 3.7%. The current quarter net interest income includes $5.4 million in fair value loan income compared to $22.5 million for the same period in 2020, a decrease of $17.2 million. The third quarter of 2021 net interest income, excluding the impacts of PPP loans, warehouse purchase program loans, and fair value loan income, improved compared to the same results in the second quarter 2021. The net interest margin on a tax equivalent basis was 3.10% for the three months ended September 30, 2021, compared to 3.57% for the same period in 2020 and 3.11% for the quarter ended June 30, 2021. Excluding purchase accounting adjustments, the net interest margin for the quarter ended September 30, 2021 was 3.03% compared to 3.25% for the same period in 2020 and 2.96% for the quarter ended June 30, 2021. Noninterest income was $34.6 million for the three months ended September 30, 2021, compared to $34.9 million for the same period in 2020 and $35.6 million for the quarter ended June 30, 2021. Noninterest expense for the three months ended September 30, 2021 was $119.8 million, compared to $117.9 million for the same period in 2020. On a linked quarter basis, noninterest expense increased $4.6 million from $115.2 million for the quarter ended June 30, 2021. The increase was primarily due to a gain on sale of ORE of $1.8 million recorded during the prior quarter and higher current quarter salaries and benefits resulting from higher incentives. For the fourth quarter of 2021, we expect noninterest expense to be in line with the current quarter or in the range of $118 million to $120 million. The efficiency ratio was 42.3% for the three months ended September 30, 2021 compared to 40.2% for the same period in 2020 and 41% for the three months ended June 30, 2021. During the third quarter 2021, we recognized $5.4 million in fair value loan income. This amount includes $3.3 million from anticipated accretion, which is in line with the guidance provided last quarter, and $2.1 million from early payoffs. We estimate fair value loan income from anticipated accretion for the fourth quarter of 2021 to be around $2 million to $3 million. As of September 30, 2021, the remaining discount balance is $18 million. Also, during the third quarter of 2021, we recognized $13.4 million in fee income from PPP loans. As of September 30, 2021, PPP loans had a remaining default fee balance of $15.6 million, with the majority of these deferred fees to be earned in the next two quarters. The bond portfolio metrics at September 30, 2021 showed a weighted average life of 3.5 years and projected annual cash flows of approximately $2.6 billion. And with that, let me turn over the presentation to Tim Timanus for some detail on loans and asset quality. Tim?

Thank you, Asylbek. Our nonperforming assets at quarter end September 30, 2021 totaled $36,549,000 or 19 basis points of loans and other real estate compared to $33,664,000 or 17 basis points at June 30, 2021. This represents approximately a 9% increase in nonperforming assets, which comes from one loan. The September 30, 2021 nonperforming asset total was made up of $36,073,000 in loans, $326,000 in repossessed assets, and $150,000 in other real estate. Of the $36,549,000 in nonperforming assets, $5,459,000 or 15% are energy credits, all of which are service company credits. The $5,459,000 as of September 30, 2021 is a 35% decline from $8,378,000 as of June 30, 2021. Since September 30, 2021, $7,990,000 in nonperforming assets have been put under contracts for sale, but there is no assurance that these contracts will close. Net charge-offs for the three months ended September 30, 2021 were $15,697,000 compared to $4,326,000 for the quarter ended June 30, 2021. The $15,697,000 includes approximately $11 million charged off on one commercial credit secured by an office building. No dollars were added to the allowance for credit losses during the quarter ended September 30, 2021 nor were any taken into income from the allowance. The average monthly loan production for the quarter ended September 30, 2021 was $596 million. Loans outstanding at September 30, 2021 were approximately $18.958 billion, which includes approximately $366 million in PPP loans. The September 30, 2021 loan total is composed of 38% fixed rate loans, 37% floating rate, and 25% variable rate. I will now turn it over to Charlotte Rasche.

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

Our first question will come from Jennifer Demba with Truist. Please go ahead.

Thank you. Good morning.

Good morning.

Good morning.

I'm wondering if you could give us some color on the $11 million charge-off during the quarter.

Sure, Jennifer, this is Kevin. Let me handle that. It was out of our structured CRE portfolio. Project in Houston which survived the five-year energy downturn and was weakened a bit out of the energy downturn and coming out of COVID, combined with a loss of a tenant, got us worried about the credit that’s still current to this day. Although there were some lateness in the last couple of months. We elected to have it reappraised and charge down. I won't go into the exact numbers on it because we're in the process of a final resolution of that credit, and I don't want to disrupt that process in any way, shape, or form. I will tell you that if you back up and look back at merger time, out of that structured CRE portfolio, at the time of the merger, we had a little over $500 million of structured CRE in Houston. And about $91 million of that was in the energy corridor. And you'll remember, Jennifer, back then, from since you guys covered us, we were reporting on how that portfolio was doing throughout the energy crisis, particularly in the energy corridor. That portfolio has shrunk in the last two years from that $510 million to $177 million today. And what we have left in the energy corridor is a total of $17 million down from $91 million. So despite the massive, if you will, derisking of that portfolio in Houston, we had this one asset between the energy crisis and COVID, just didn't make it.

And look, they’re current today, we have a cooperative borrower. We just took what we think is a prudent action of marking it down by a new appraisal and to a level we feel like we can deal with it.

I think another real positive also is, even though it was a loan that we didn't set aside for a PPD loan, we have a great guy named David Montgomery, who recovered about an extra $15 million in money that we did have set aside for PCD loans that we never had to use and we took back into the general reserve. So under CECL accounting, you don't get to see it. But if we were still accounting last year, probably for last year you have a $15 million recovery too. So I think that's the positive thing about.

Yes, overall the PCD loans and the related marks resulted in a little over $15 million, specifically $15.2 million, that was returned to the general account, and this was the main issue reflected in our accounts, which you can consider against that. I don't see this as a significant trend; it’s just one asset that we encountered some challenges with.

In previous transactions, there were instances where we might overlook something and later recover those items we didn't account for. The current situation reflects what we've presented under the CECL format. Moving forward, rather than reserving for individual loans, we should consider a reserve for a specific category of loans. Historically, this approach has yielded better results, and I believe we will continue to see positive outcomes.

I think we might emphasize also just for clarity, that the main reason we took the step that we did on this one credit is that two major tenants have given notice that they're not going to renew their leases. I believe those two tenants are current right now, but they're going to be moving out soon. And the owner of the building has not been able to find a replacement for those two tenants. When they do move out, it appears that the building will not have an NOI sufficient enough to make our payments. So that's why we chose to do what we did. And once again, at the time that we joined forces with legacy, this building was doing well in terms of its NOI. So there wasn't a reason to put a mark on it at that time.

On the other hand, there are others who will lease it again since this is a nice building. It changes from having a negative perception. This isn't a rundown building; it's a really nice property. I believe there will be no issue finding more tenants, and it’s just a matter of time. But considering what we needed to do, we took the necessary steps.

Correct.

Thank you.

Our next question will come from Brady Gailey with KBW. Please go ahead.

Thanks. Good morning, guys.

Good morning.

Good morning.

It was encouraging to see Prosperity resume its share buybacks. The stock price is currently a bit higher compared to the average price at which you repurchased shares in the third quarter. I understand that you can be sensitive to price changes. However, your capital is increasing, and it has been a while since you've announced any M&A deals. Additionally, it was nice to see the dividend increase. Can you share your thoughts on future buybacks and potential further dividend increases? Given the excess capital that Prosperity currently has, have you become less sensitive to the buyback price?

We have become less sensitive to price in our recent buybacks; the last time we bought shares, it was around $40, and now we're purchasing at $67. The bottom line is that we're making profit, and we did raise the dividend. I believe we will be opportunistic moving forward. Personally, I feel our stock remains a solid investment today. Overall, I think we are less sensitive to the price, although I wouldn't say we would pay just anything for it. Still, we believe it’s a good buy.

Yes, all right. Then maybe one for Kevin just on the mortgage warehouse. Earlier in the year and last year it was such a robust level. And now it's coming down to that kind of $1.8 billion level. Is that are we at a normalized level? Or do you think that longer-term we should think about the warehouse continuing to slip a little bit?

Yes, I would say we are normalizing, keeping in mind the seasonality factor as well. For the quarter, the average was around $1.836 billion. October has been quite favorable, averaging just over that at approximately $1.855 billion. However, because of seasonality and assuming rates remain close to where they are with a slight increase, I believe we will finish the year likely around $1.005 billion, maybe as much as $1.550 billion. The average for the quarter will probably be between $1.007 billion and $1.750 billion.

All right, that's helpful. Then last one on the …

That's 100 million lower than where we are today compared to Q3.

Yes. Okay. And then the last one for me, a credible yield took a significant step down. I heard your comments about how you only have $18 million left in that area. So it seems like it's time to refill that. You've been relatively quiet on the M&A front, and we noticed the recent deal in Texas that I thought might have made sense for Prosperity. David, could you provide an update on the M&A conversations, how they're progressing, do you think you're getting closer, or anything else? What's the latest on your M&A strategy?

I believe there are more mergers and acquisitions ahead. There's no doubt about it, especially with the increasing regulatory requirements and the CFPB's focus, particularly on larger banks needing to report various dynamics that make home loans feel more like commodities. The costs of retaining talent are rising too. Considering these added regulatory burdens, I anticipate more activity in this area. We were involved in the happy deal, which primarily involved a couple of us and Johnny, and we might have offered slightly more per share. However, they chose Johnny because they wanted to maintain their brand. That would have been challenging for us due to competition with other banks, as you couldn't have a Prosperity Bank in one part of town and a Happy State Bank in another. We had a good opportunity to evaluate the bank, and we are actively examining other potential deals. We have also been working on some unexpected opportunities in the short term, as well as ongoing discussions we've had for two, three, or four years. It's not a matter of if these transactions will occur but rather when they will take place.

Okay, got it. Good luck. Thanks.

Our next question will come from Dave Rochester with Compass Point. Please go ahead.

Hey, good morning, guys.

Good morning.

Just want to start in the loan trends. I was wondering how the pipeline looked at quarter end, what the trend was there versus the prior quarter? And then I saw the runoff in CRE shrank a little bit this quarter. I was just wondering if you're better able to offset that structured CRE runoff now with new business or the amount of runoff you're expecting and shrunk a little bit. And then where do you think that stabilizes?

Go ahead, Tim.

I believe the deal flow is stable. It isn’t significantly increasing, nor is it decreasing. Therefore, I think we can maintain our position and even see some growth. For instance, there was a recent major announcement in Houston where a leading apartment developer sold its entire portfolio of over 20 properties for billions of dollars. To my knowledge, this is the first instance of such significant outside investment in Houston in the past two to three years. The buyer clearly sees potential in the Houston apartment market. This indicates that things may be improving, so I don't see any reason for concern regarding the deal flow. Kevin, you may want to add your thoughts on this.

I would agree with Tim that our pipeline is strong. We experienced about 3.5% growth in Q2 and 5.3% in Q4. In response to your question, Dave, some of that growth was supported by slightly lower commercial real estate (CRE) payoffs this quarter, totaling approximately $100 million. As I mentioned in the last quarterly call, my expectation was $200 million in payoffs for both Q3 and Q4. The 5.3% growth stemmed from a combination of improved production and results related to the CRE payoffs. However, I've adjusted my Q4 payoff expectation to $130 million. We are nearing the end of reductions in that portfolio, which is positively impacting loan growth. Additionally, we are observing an increase in revolver funding in our commercial and industrial (C&I) book, with usage at a higher level than it has been in years as businesses recover and hold more receivables while overstocking inventory due to future supply concerns. In the first three weeks of October, our C&I balances have increased by $55 million, marking a strong start for the quarter. Increased usage of revolvers among C&I companies is a positive indicator for both our firm and the broader U.S. economy. It suggests that conditions are improving, and I believe we can achieve mid-single-digit growth in both Q4 and the first quarter of next year. We are feeling more optimistic about our growth prospects.

And I think the other thing is if we didn’t have the structured real estate running off, our growth rate would probably be around 7%.

Almost 8%.

I think we're doing pretty well with our growth in the 8% range. For those who have been with us for a long time, you've seen how we’ve merged with different companies and that introduces certain risks. Despite this, our growth was solid, even considering the factors that reduced it to 8%. I believe we did fairly well overall. Looking across the entire state, we experienced growth in nearly every area, including Oklahoma. Overall, we feel optimistic about our current position.

Yes, the growth was in Central Texas and Houston, but it was a little bit of everywhere. You're right.

But again, if you looked in Dallas, and you added back the structured real estate, you are seeing good growth there.

That's correct. That's right.

We had growth. Go ahead Dave.

I was just going to mention that there was some good growth in energy; I'm curious about your outlook on that as there are some promising opportunities, and we should expect to see more of it.

We have a significant client in the Midland-Odessa area who has been with us for around 30 years. He has about as much in his checking account as he does in borrowed funds from us. Recently, he purchased a large stake in Exxon when they were selling part of their ownership, and it appears he has nearly doubled his investment. That was a significant transaction.

Well, that was – look, that was just shy of $100 million, Dave, and net of that we grew 60. So the portfolio outside of that single transaction actually shrunk $40 million. We've always said, we're not turning our back on that industry. We're just trying to be selective and prudent in what we do. And I think that's going to continue to be the case.

We are focusing on growing our relationships with long-standing customers who have been with us for 30 years and continue to support us. This is very important. Our primary focus is on these longstanding clients, especially during challenging times.

Yes. Okay. Well, that 130, that you mentioned in terms of expected runoff in the structured book, is that pretty much it, is that wrap it up?

I think in terms of materially, there's always going to be something dropping out, but it'll be not the big numbers that we've had. That thing shrunk almost a $1 billion in 2 years.

Yes, you don't.

It's going to be close to the end. And I believe, based on my experience in Dallas for the last 22 years, that Dallas might contribute to the loan growth story moving forward.

Yes. Good. Maybe we can just get one last one in on the positive growth. I know, that's generally really strong in the fourth quarter, it's your strongest quarter of the year. And you normally have more deposit growth and loan growth in that particular quarter not to make any comment on loan growth for 4Q, but normally the positive growth is pretty robust, we are just wondering, given where the curve is today, it's a little bit better than it was the last quarter. What are your thoughts on growing the securities, but that was like you grew that a decent amount in 3Q. So just curious where purchase yields were for the quarter, where they are today? If any notable change there, what your thoughts are on that growth going forward?

Yes, you're completely correct. Even during the third quarter, we sometimes experience negative deposit growth in normal circumstances. However, there's currently a significant amount of money available. We're seeing about 11% growth year-over-year and 4% for the quarter, but we expect deposit levels to really increase in the fourth quarter. In previous times when the spread or yield curve was favorable, we would occasionally borrow up to $2 billion from the Federal Home Loan Bank to take advantage of our cash flow. However, given the lower levels of REITs, we stopped borrowing that $2 billion. Now, we typically maintain over $1 billion instead of purchasing from them. We're not aggressively buying back right now; we're making purchases as our funds come in, but we're not making substantial moves. Our goal is to continue increasing loans to allocate more funds into that area.

Our ability to acquire and retain deposits remains strong. There is no issue with customers wanting to deposit money with us. However, if interest rates increase significantly, this may change, as some high-rate payers who had to exit the market might return. We've experienced similar situations in the past and can manage them effectively. Overall, I believe our deposits are solid and will likely remain so for some time.

All of our deposits are primarily core deposits. We don't actively seek out many CDs, and most of our growth comes from our core customers.

That's correct.

Yes, and where are you seeing those securities yields today?

I think they're closer to probably at 1.5 is what we're shooting for.

That's what we see.

Okay. That's where the book yield is right now. So not really diluted at this point?

No.

That's great. All right. Thanks, guys.

Thanks.

Our next question will come from Peter Winter with Wedbush. Please go ahead.

Good morning. I wanted to ask on the lending environment, I know it's always competitive, but can you talk about what's happening in the portfolio in terms of new loan yields versus loans maturing?

Yes, it is very competitive, particularly regarding pricing. The yields we are booking currently range from a low of 2.75 to a high of 4.5. We aim to achieve a yield starting with a 3 as much as possible. However, for stronger credits, this is becoming increasingly challenging. Overall, that reflects the spread we are experiencing.

Well, I think generally we know what our loan average is this month, around 430. You mentioned something about that.

Yes, I think around 4% I think.

That's the average for the third quarter, just under 4%?

Yes, that’s right.

Okay. And then, if I could ask, if I think about Prosperity, one of the strengths is that ability to manage expenses. But going through earnings, we've been hearing a lot of discussion about inflation pressures as we move into next year. And I was just wondering, could you talk about some of those inflation pressures that you're seeing? And maybe how you're thinking about expense growth next year?

Yes, we are experiencing pressure because we interact heavily with our vendors, and we're feeling significant pressure not only from them but also from the HR side as many are trying to recruit our employees. However, we are implementing a lot of technology to replace some of the manual work we do, focusing on automation in various areas. We have numerous projects underway that should help reduce expenses and counteract the inflationary pressures we are facing. On the positive side, we have long-term contracts in place for major expenses, so that aspect is manageable. We're examining all facets of our expenses, including branches and automation processes that I mentioned earlier. We hope that as we put these processes into action, they will help mitigate some of the rising costs due to inflation. Looking at the next two quarters, I believe the projection of 118 million to 120 million should remain steady at least through the second quarter, and by then, the initiatives we are working on are expected to yield positive results.

Yes, there's no question inflation is there, Peter, and we're watching it. We're watching it very strongly. And we're going to try everything we can to even that may cause us money from the technology side to automate more. And I would say, there are also positions in the company and jobs where we've had. Let me say this, that the things that maybe branches are something that we didn't look at in the past that were not profitable, or certain areas of the bank that weren't profitable, we're going to fix that because you just have to in these kinds of times, and that's where we hope to do it.

The last thing I would add is, I think about this in a broader context, sometimes looking at our customer base and they've got rising wages, just like we all do, but they have also another component of their struggles here, which is their rising input costs, whether that steel or the products they're getting, and every company is dealing with that, except for banks. When you think about our input costs, it's our wages and cost of money. The cost of money is still going down for us. If you look at the cost of our deposits, it's still trending down. And I think it will trend down again in the fourth quarter. So we're just dealing with the wage pressure part of it, and not having to deal with the other input costs. So I think financial services is relatively less affected by input costs than just about any other industry in America.

Having contracts in place is really securing things for us.

For long-term contracts, yes.

That's great. And then if I could just sneak in one more. Just the core margin had a really nice increase and I'm assuming a lot of that was driven by the repricing of the public funds and I'm just wondering how much is left and maybe if you could just talk about what the core margin looks like for next quarter?

It's difficult to provide an exact prediction for next quarter, but I can share some variables that may help you. Our PPP fee income was $13.4 million this quarter, an increase from the second quarter, contributing to a rise in net interest income. We also experienced solid core loan growth of 5.3% on an annualized basis in the third quarter. Looking ahead, we expect to see continued improvement in net interest income. You should factor in my earlier guidance regarding fair value income and PPP fees. We currently have $15.6 million in deferred fees remaining, and we anticipate it will take about two quarters to recognize most of that. These are the key factors to consider as we think about our trajectory for net interest income.

And you mentioned public funds, I can give you a little color on that, that might be helpful. At the end of the June 21 quarter, our average interest expense on public funds was 71 basis points. At the end of September, this most recent quarter, it had decreased to 33 basis points. And between now and mid-year 2023 we have several hundred million in public funds that are going to reprice. And at this point in time, the public funds that are repricing are typically being done in the 10 to 20 basis points range. So we're going to see, I believe, continued decreases in public fund costs.

Yes. I believe that in the fourth quarter, our interest expense will likely be lower than it was in the third quarter due to the repricing of public funds.

Peter, that super core is trademark, if you're going to use it.

I'll send over a fee. Thank you. That's all I had. Thanks very much.

Our next question will come from Jon Arfstrom with RBC Capital Markets. Please go ahead.

Thanks. Good morning, everyone.

Good morning, Jon.

Good morning.

Just a couple of follow ups. Do you feel like Texas loan growth is accelerating at this point? It's obviously much stronger than many other areas of the country, but do you think it can continue to accelerate into 2022?

I believe it is. This is Kevin. Speaking from my personal perspective and based on my daily market experience, I think it's gaining momentum. We're entering an intriguing phase when the supply chain stabilizes and returns to a more normal state. Due to pent-up demand, I anticipate a brief period of rapid growth as consumers acquire products they've been waiting for. This will likely lead to a positive situation temporarily, followed by a slight dip as we clear the backlog of demand, if that makes sense.

Yes.

So I think the industry is going to see better growth than we've seen, followed by really good growth when we pull through the supply chain issues, and then it moderates from there.

And I agree with that. And I think one thing to add to it that we need to focus on is what really happens in the energy side of the Texas economy and Oklahoma's to for that matter. If these increased prices really are sustainable, that's going to start having a trickle effect throughout the entire economy. I think it's a little too soon to make a call on that. But obviously, things have changed dramatically in just a few months in terms of the price of oil and natural gas, all of which helps Texas and Oklahoma. Well, I think Texas is going to be better than most all other states just …

In migration.

Yes, with the ongoing migration, many people are moving into the area, and there's a need to develop housing and infrastructure. Given the current administration's stance against fossil fuels, I anticipate this trend will only increase. I recently spoke with a service company owner who mentioned that business is thriving. The service sector is really picking up, and I don't expect to see a surge of new entrants into the market like we did in the past. Instead, the existing older companies will likely dominate, leading to higher prices due to limited supply and growing demand. Additionally, with inflation, Texas agriculture is seeing a rise in commodity prices, including cotton, which has not been this high in a decade, as well as corn and milo. So, we have rising commodity prices, increasing oil and gas values, and more people moving in. I feel that the conditions are very favorable.

Okay, David, I asked you about this a couple of quarters ago. How do you view higher rates in your business model? On one hand, you're expanding the securities portfolio, and I assume you need to be somewhat cautious and protect yourself. On the other hand, two-thirds of your loan portfolios are linked to higher rates. How do you navigate the balance between these two factors?

So I want to make sure I understand the question; your question is what exactly I don't know that I got it.

I would like to know how you view the extension risk on the portfolio as you invest at lower rates. On the other hand, it seems you are anticipating higher rates, which would positively impact your company's earnings trajectory.

It may sound a bit unusual, but we're not actively trying to predict interest rates. If we examine our loan portfolio, we see a turnover of about three years, and similarly, our bond portfolio also refreshes roughly every three to four years. Regarding structured real estate, we're estimating that our new loan growth will range between eight to twelve percent. So, we aren't attempting to time the market with rates. In fact, higher rates could significantly benefit us, as our models indicate. For instance, a 100 basis point increase looks favorable, but a 200 basis point rise presents even greater potential for growth. We intend to keep our current buying strategy, and as new funds come in, we'll continue to invest while positioning ourselves accordingly. Occasionally, we may buy more during spikes, and I expect that trend will persist. However, we aren't looking to time the rates. Additionally, it's important to note that our portfolio costs surged this quarter. If that trend slows down, it would be a significant advantage for us.

Yes, I mean, this quarter, we'll have $15.1 million amortization and its reading. It seems like it should slow down. I don't know it's going to be that significant, but even slows down to $14 million, that's an extra million dollars there that …

I remember when it was $8 million.

It was last year.

Yes, of course, you have a bigger portfolio. But still, that the go from $8 million to $15 million - $8 million or $15 million, it's a lot.

Okay. All right. Thanks for the help. I appreciate it.

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

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

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