Prosperity Bancshares Inc Q2 FY2025 Earnings Call

Good morning, and welcome to the Prosperity Bancshares Second Quarter 2025 Earnings Conference Call. 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 Second Quarter 2025 Earnings Conference Call. This call is being broadcast live on our website and will be available for replay for the next few weeks. I'm Charlotte Rasche, Executive Vice President and General Counsel of Prosperity Bancshares. Here with me today is David Zalman, Senior Chairman and Chief Executive Officer; H.E. Tim Timanus Junior, Chairman; Asylbek Osmonov, Chief Financial Officer; Eddie Safady, Vice Chairman; Kevin Hanigan, President and Chief Operating Officer; Randy Hester, Chief Lending 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. Before we begin, let me make the usual disclaimers. Certain of the matters discussed in this presentation may constitute forward-looking statements for the purposes of the federal securities laws. As such, they 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 those expressed or implied by such forward-looking statements. Additional information concerning factors that could cause actual results to be materially different can be found in our filings with the Securities and Exchange Commission, including Forms 10-Q and 10-K and other reports and statements we have filed. All forward-looking statements are expressly qualified in their entirety by these cautionary statements. Now let me turn the call over to David Zalman.

Thank you, Charlotte. I would like to welcome and thank everyone listening to our second quarter 2025 conference call. I'm proud to announce that we entered into a definitive agreement with American Bank Holding Company in Corpus Christi to merge. We have followed American Bank closely for more than 2 decades and have tremendous respect for the bank and for the people that have contributed to its success. Our banks have a complementary footprint, and we are familiar with and remain committed to the communities that American Bank serves, including both financial products and community support. This combination will strengthen our presence and operations in South Texas and surrounding areas and enhance our presence in Central Texas, including in San Antonio, a highly desirable, high-growth area. With regard to earnings, our net income was $135 million for the 3 months ending June 30, 2025, compared with $111 million for the same period in 2024, an increase of $23 million or 21%. The net income per diluted common share was $1.42 for the 3 months ending June 30, 2025, compared with $1.17 for the same period in 2024, an increase of 21%. Net income for the 3 months ending June 30, 2024, included the impact of a merger-related credit loss provision and merger-related expenses from the Lone Star transaction, the FDIC special assessment, a net gain on the Visa Stock Exchange and the Sullivan investment securities. Excluding these one-time items for the 3 months ending in June 30, 2024, the net income was $116 million and earnings per share was $1.22. When comparing these results with the quarter ended June 30, 2025, net income increased $18 million to $135 million or 16%, and our earnings per share increased $0.20 or 16.4%. Our annualized return on average assets and average tangible common equity for the quarter ending June 30, 2025, compared with the same period in 2024 was a 1.41% return on average assets compared with 1.17% and a 13.44% return on average tangible common equity compared to 12.34%. The net interest margin on a tax equivalent basis was 3.18% for the 3 months ending June 30, 2025, compared with 2.94% for the same period in 2024 and with 3.14% for the 3 months ending March 30, 2025. As mentioned on prior calls, these are the results we expected and we anticipate these tailwinds should continue to be positive for the near future. Loans were $22.1 billion at June 30, 2025, a decrease of $123 million compared with $22.3 billion at June 30, 2024. Our linked quarter loans increased $219 million or 4% annualized from $21.9 billion at March 31, 2025. Overall, the bank grew loans by $220 million in the second quarter of 2025 or 4% on an annualized basis, with most of the growth attributable to the seasonal strength of the mortgage warehouse business. However, we remain positive on our ability to grow loans in the second half of the year. We saw consistently higher monthly new production numbers in the second quarter, and core commercial loans, excluding mortgage warehouse loans, were up $73 million or 2.4% annualized. We have been focused on using our liquidity to fund commercial loan growth, and we are starting to see progress. Deposits were $27.4 billion at June 30, 2025, a decrease of $459 million or 1.6% compared with $27.9 billion at June 30, 2024. The linked quarter deposits decreased $553 million or 2% from $28 billion at March 31, 2025, primarily due to decreases in public fund deposits, higher-cost deposits acquired in the recent acquisitions and business deposits and our disciplined deposit pricing. Prosperity generally experiences seasonality with its public fund deposits as public funds customers use the tax dollars that they receive in December and January throughout the year, resulting in lower deposit balances in the second and third quarters. Our bankers' focus is on building core deposits. Our noninterest-bearing deposits represented 34.3% of our total deposits at June 30, 2025. With regard to asset quality, our nonperforming assets totaled $110 million or 33 basis points of quarterly average interest-earning assets at June 30, 2025, compared with $89 million or 25 basis points of quarterly average interest-earning assets at June 30, 2024, and $81 million or 24 basis points of quarterly average interest-earning assets at March 31, 2025, with a significant portion of the balance for each period attributable to the acquired loans. At June 30, 2025, the allowance for credit losses on loans was $346 million, and the allowance for credit losses on loans and off-balance sheet credit exposure was $383 million. The allowance for credit losses on loans was 3.47 times the amount of nonperforming assets. We are very excited about our pending merger with American Bank Holding Company and American Banking Corpus Christi. We also continue to have conversations with other bankers considering strategic opportunities. We believe that higher technology and staffing costs, funding costs, loan competition, succession planning concerns, and increased regulatory burden all point to continued consolidation. We remain ready to move forward in the event a transaction materializes that will be beneficial to our company's long-term future and increased shareholder value. Texas was rated as the second best state for business in 2025 by CNBC. However, we believe we should have been number one; that's just a little humor, guys, but Texas continues to shine as more people and companies move to the state because of the business-friendly political structure and no state income tax. Prosperity continues to focus on building core customer relationships, maintaining sound asset quality, and operating the bank in an efficient manner while investing in ever-changing technology and product distribution channels. We intend to continue to grow the company both organically and through mergers and acquisitions. I want to thank everyone involved in our company for helping to make it the success it has become. Thanks again for your support of our company. Let me turn over our discussion to Asylbek Osmonov, our Chief Financial Officer, to discuss some of the specific financial results we achieved.

Thank you, Mr. Zalman. Good morning, everyone. Net interest income before provision for credit losses for the 3 months ended June 30, 2025, was $267.7 million, an increase of $8.9 million compared to $258.8 million for the same period in 2024, an increase of $2.3 million compared to $265.4 million for the quarter ended March 31, 2025. Fair value loan income for the second quarter of 2025 was $3.1 million, compared to $3.3 million for the first quarter of 2025. The fair value loan income for the third quarter of 2025 is expected to be in the range of $2 million to $3 million. The net interest margin on a tax equivalent basis was 3.18% for the 3 months ended June 30, 2025, an increase of 24 basis points compared to 2.94% for the same period in 2024, and an increase of 4 basis points compared to 3.14% for the quarter ended March 31, 2025. Excluding purchase accounting adjustments, the net interest margin for the 3 months ended June 30, 2025, was 3.14% compared to 2.86% for the same period in 2024 and 3.1% for the quarter ended March 31, 2025. Noninterest income was $43 million for the 3 months ended June 30, 2025, compared to $41.3 million for the quarter ended March 31, 2025, and $46 million for the same period in 2024. The prior year noninterest income included $10.7 million in net gain on sale of securities. Noninterest expense for the 3 months ended June 30, 2025, was $138.6 million, compared to $140.3 million for the quarter ended March 31, 2025, and $152.8 million for the same period in 2024. The prior year noninterest expense included $4.4 million in merger-related expenses and $3.6 million in FDIC special assessments. For the third quarter of 2025, we expect noninterest expense to be in the range of $141 million to $144 million. The efficiency ratio was 44.8% for the 3 months ended June 30, 2025, compared to 45.7% for the quarter ended March 31, 2025 and 51.8% for the same period in 2024. The bond portfolio metrics at June 30, 2025, have a modified duration of 3.8 and projected annual cash flows of approximately $1.9 billion. And with that, let me turn the presentation to Tim Timanus for some details on loan and asset quality.

Thank you, Asylbek. Nonperforming assets at quarter end June 30, 2025, totaled $110,487,000 or 50 basis points of loans and other real estate, compared to $81,419,000 or 37 basis points at March 31, 2025. This is an increase of $29,068,000 on a linked-quarter basis. Since June 30, 2025, $1,138,000 of nonperforming assets have been put under contract for sale. At June 30, 2025, the nonperforming asset total was made up of $102,607,000 in loans, $6,000 in repossessed assets, and $7,874,000 in other real estate. Net charge-offs for the 3 months ended June 30, 2025, were $3,017,000 compared to net charge-offs of $2,704,000 for the quarter ended March 31, 2025. This is an increase of $313,000 on a linked-quarter basis. There was no addition to the allowance for credit losses during the quarter ended June 30, 2025. No dollars were taken into income from the allowance during the quarter ended June 30, 2025. The average monthly new loan production for the quarter ended June 30, 2025, was $353 million, compared to $317 million for the quarter ended March 31, 2025. This is a $36 million increase on a linked-quarter basis. Loans outstanding at June 30, 2025, were approximately $22.197 billion, compared to $21.978 billion at March 31, 2025. The June 30, 2025 loan total is made up of 36% fixed-rate loans, 34% floating-rate loans, and 30% variable-rate loans. I will now turn it over to Charlotte Rasche.

Thank you, Tim. At this time, we are prepared to answer your questions, our call operator will assist us with questions.

Our first question comes from Michael Rose with Raymond James.

Just wanted to get some color. It looks like there was some purchase loan decline this quarter. But can we just get an update on any sort of revised expectations for loan growth ex warehouse? It seems like the industry is starting to pick up a little bit here. I assume you had some paydowns as well that were kind of impacting this quarter's growth. I did sense some optimism at the front of the call. So just trying to get an update there. And then if Kevin is there, would love the update on the warehouse. Just it looks like it did a little bit better on average than what you talked about last quarter?

Yes. Thanks, Michael. I'll try to tackle both and see if anybody wants to add on. In terms of loan growth, the quarter has started off a little better than the prior quarters. We do have some loan growth, not a ton, call it, $40 million worth so far for the quarter. The pipeline looks pretty good. So I think single-digit growth for the rest of the year is probably achievable. Just as a side, we’ve also had some okay core deposit growth, I think, almost maybe $90 million so far for the quarter. So both of those seem to have stabilized a bit. Loan demand is okay. If there's been another point of weakness, it's been usage on corporate or middle market kind of revolvers, usage is down quite a bit from where it had been with people taking excess cash and paying down debt rather than growing their balance sheets, and we’ll see whether that shifts around or not. I think a lot of that was tariff related. On the warehouse, just by way of background, we averaged for the last quarter $1.179 billion. We thought it would be about $1.150 billion. So we're just slightly ahead of where we were thinking. So far for this quarter, Michael, through last night, we have averaged $1.307 billion to be exact. And last night, we closed out a little lower than normal at $1.226 billion. That's not unusual for this time of the month. We get a lot of Ginnie Mae settlements in the 20th, 21st, 22nd of every month. On balance, I think we will probably average a little better this quarter than last, at $1.250 billion. Typically, our third quarter is our best quarter in normal times, and these are more kind of normal times. So I do expect it to be a little bit better, close to $100 million better on average than Q2.

I think the thing that we liked about it, too, rightly or wrongly we really saw commercial, our commercial loans pick up and mortgage loans went down. But again, we have so many mortgage loans that we've seen that there were $73 million more in commercial loans increase. I think that was good. We do seem to see a lot of, I don't know, I wouldn't call it production, but there's a lot of stuff going through loan committee now. So things look pretty good, I think.

Michael, this is Tim. Yes, with regard to what David just said. And I do see coming up the next handful of months, basically the same way that Kevin does. So I think he's spot on.

Very helpful. And then maybe one for Asylbek. Just on the margin, not as much momentum there, I think, as we would have thought. You have the range that you talked about 3.25% to 3.30%. I noticed that interest-bearing deposit costs were flat. So maybe just walk us through some of the puts and takes as we think about the next couple of quarters, bond portfolio pricing pick up, further ability to lower deposit costs, CDs maturing, etc. And just how we should think about the trend relative to what you talked about earlier this year?

Michael, let me just start off. I have kind of the model in front of me and just to kind of give you some color. Our net interest margin continues and Mike, it continues to grow. I think we're showing with no change in interest rates at 3.35% net interest margin in 6 months. If interest rates go down 100 basis points in that 6 months, it's at 3.3%. On a 12-month time frame with no change in interest rates, we get to 3.48% and with 100 basis points down in 12 months, we’re at 3.40%. In 24 months, and I won't go past that, we're at 3.76% with no change in our net interest margin and 3.61% with 100 basis points down. So our model still shows great expansion in the net interest margin over a period of time. Sorry to jump in on you.

No, that's correct. To provide some insight into why we're achieving these numbers, our cost of deposit model indicates that it will remain stable, with little decrease in deposit costs. We observe two key factors influencing repricing. Firstly, regarding our bond portfolio, we have approximately $1.9 billion generating cash flow each year, with an average rate around 2.15%. This will reprice considerably, depending on whether we allocate it to loans, which would result in an increase of over 300 basis points, or to securities, which would yield more than 2.5%. On the loan front, we expect around $5 billion in cash flow, with about 60%, or $3 billion, coming from fixed variable rates that are likely to reprice at higher rates than our current loans. These factors indicate that we can continue to enhance our net interest margin and overall net interest income. Consequently, we anticipate maintaining a net interest margin between 3.25% and 3.3% for the year.

The next question is from Catherine Mealor with KBW.

I just want to follow up on the margin. It was just the size of the balance sheet as we think about the cash and average earning assets kind of coming down. How should we be thinking about the size of the bond book and the size of cash in the next couple of quarters?

I'll start by noting that our balance sheet size has decreased by 1.6% in deposits compared to last year. As mentioned earlier, this quarter typically sees a reduction in deposits, but we believe they have stabilized now. The third quarter might still reflect our current situation, but we expect to see an increase in the fourth quarter. Much of this will depend on interest rates. If we were not as disciplined as we have been, we could easily grow our balance sheet since we do not have any broker deposits. By offering interest rates around 4.5% to 5%, we could expand our balance sheet significantly. However, we've chosen to manage our net interest margin carefully. In summary, I believe we have stabilized and anticipate modest growth moving forward.

Yes. I agree. That's exactly right. I'll just say on the model, fundamentally, nothing changed from us. It just was the deposit drop off we saw in the second quarter impacted NII as we saw it. But fundamentally, our model is still showing continued expansion in the margin and net interest income.

We also cut the product off that. This is a product that was designed just for minority lending, low-income lending that again, there's not much money down, and you even get some walking-around money when you go, and this was to help with fair lending. And again, it's kind of a catch-22, if you don't produce a certain amount of this kind of production, then if you really want to expand and grow, you're out of the game also. So it's just part of the deal. But again, I think that we’ve got all under control. The good news is that as we repossess this stuff, we've gotten out of it pretty quick with very little loss.

Yes. To add to that, while we can never predict the future, we currently don't see anything concerning in our commercial loan system at this time. There is a possibility, perhaps even a likelihood, that we may see a slight increase in the single-family mortgage portfolio from the current $51 million. Fortunately, that asset class tends to have a very low loss given default. Overall, as we evaluate our situation today, we went through our reserve analysis at the end of the quarter and determined that we did not need to increase reserves, and I don't anticipate any changes to that outlook.

We also cut the product off that. This is a product that was designed just for minority lending, low-income lending that, again, that there's not much money down and you even get some walking-around money when you go, and this was to help with fair lending. And again, it's kind of a catch-22, if you don't produce a certain amount of this kind of production, then if you really want to expand and grow, you're out of the game also. So it’s just part of the deal. But again, I think that we've got all under control. And the good news is that as we repossess this stuff, we've gotten out of it pretty quick with very little loss.

That's right. And we did discontinue that type of loan actually over a year ago.

The next question is from Stephen Scouten with Piper Sandler.

Just going back to American Bank. David, you mentioned the four additional branches in San Antonio. Since that is the third largest metropolitan statistical area in Texas, do you plan to further expand your presence in San Antonio beyond this acquisition? Are you considering new hires or could additional mergers and acquisitions in that market be a possibility?

I guess I should just say stay tuned, I guess.

Okay. Fair enough. And then maybe on pricing around the deal. I mean the 3-year earn-back feels like maybe towards the longer end of what we've seen from you guys. Would you say that that was kind of pushing the limits of what you would want to do from an earn-back perspective on a deal?

That 3-year, Kevin, help me, does that 3-year include the way it was priced? It looked like it was priced higher than some of the other deals at 2.2x. But again, when we looked at the bank, and you added back the AOCI, the price was like 1.8x, which for a bank like that, we thought was a very, very good deal. So that 3-year was that based on the...

It does include that.

But again, I think for a bank that's a quality bank like this, that 3 years is not unreasonable at all, and I would do it again tomorrow if we get another bank like that. It's really a sweet bank.

Great. And then just as you think about future targets, I mean, I know the last 3 deals have been maybe towards the smaller and more digestible end of the spectrum. Do you think about maybe a more meaningfully sized deal? And additionally, would you look at anything outside of Texas and Oklahoma today? Or do you want to continue to deepen that footprint in the strength of those markets?

I would say to stay tuned. There's a lot happening at the moment, and it’s challenging to provide specifics. As I’ve mentioned before, we have always had a strong preference for Texas, where our presence is widespread. If you drive for 30 minutes, you're likely to see one of our banks. Although we are not heavily focused on the valley area, El Paso might be the first point we consider. Our primary focus remains in Texas, but we would also look into opportunities in Oklahoma if they arise. If a deal presents a genuine market share that we can strategically benefit from, we would certainly be interested. No, this is just our existing balance sheet. So that should help, no question.

The next question is from Ebrahim Poonawala with Bank of America.

This is Eric on for EB. Just had one on the fee income line. It has been running above, I think previously, you've talked about $36 million to $38 million as kind of the run rate that you view, but it's been above that for several quarters now. Is the run rate in your mind higher now? Like how should we think about that kind of moving forward?

Yes, Eric, I agree. I think that I would probably update our run rate to $38 million to $40 million now because what we've seen very strong, our service fees and debit card fees overall have increased because of the volume. So yes, we see an increase in overall noninterest income. I would say I would update the range to $38 million to $40 million.

Okay. That's helpful. And then maybe one more on M&A, David, based on everything you've said, I have a guess of what you'll say, but does the American deal limit the ability to complete any other deals until that closes? Or are you still very active?

No, we're still very active.

The next question is from Jon Arfstrom with RBC Capital Markets.

Just a follow-up on that. I know you guys had a tough time with the last deal getting to close on time. Any evidence of less regulatory pressures, David? I mean I don't think you're going to get into that situation again. But any evidence of that?

I hope so. You saw the Cadence deal close in just a few months. We understand that the banking industry wanted to remove that from their books before something else occurred. However, everyone we've spoken to indicates that historically, we used to finalize a bank deal in three months. I'm optimistic that we can return to that timeframe of three to four months. Last year, we began with the DOJ in a town of 10,000 people where we were viewed as a major bank, and there were significant distances involved. I won't get into all the specifics, but then there was another deal following that. From what everyone tells me, there's a stronger emphasis on substance right now, and unless there are changes in the administration, which I don't foresee, it appears to be a more straightforward path moving ahead.

Okay. You mentioned this earlier, but do you feel you have enough branch density in some of your larger markets? I'm also interested in the faster-growing outer suburbs of the big cities in Texas. Do you feel you have sufficient density there, or is that something you're targeting?

Well, that's what we're building right now. I do think if you look at Houston, Dallas, Austin, probably the only place that we don't have enough stores or locations is the San Antonio market, which we would like to expand there. Anytime we can move into a market and be number one in market share in the second tier like Corpus Christi, that's the stuff we love. We've done that in Victoria, Corpus, Midland, Odessa, Lubbock area, Bryan-College Station. Whenever we can do that, that's really a sweet spot for us.

Okay. And then Kevin, just one for you, a follow-up from very early. You talked about revolvers being down a bit, and you thought it was maybe just from some of the uncertainty last quarter. But anything else in your mind driving that change? And do you expect that to stabilize?

I do. We spent the better part of a couple of days digging into it here, last week and this week and talking to clients. I think it's not only going to stabilize, but it's probably going to go the other way.

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. 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.

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