Earnings Call
Prosperity Bancshares Inc (PB)
Earnings Call Transcript - PB Q1 2020
Operator, Operator
Good day and welcome to Prosperity Bancshares, Inc., First Quarter 2020 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 today's event is being recorded. I would now like to turn the conference over to Charlotte Rasche. Please go ahead.
Charlotte Rasche, Executive Vice President and General Counsel
Thank you. Good morning, ladies and gentlemen, and welcome to Prosperity Bancshares first quarter 2020 earnings conference call. This call is being broadcast live over the Internet at prosperitybankusa.com and will be available for replay at the same location for the next few weeks. I'm Charlotte Rasche, Executive Vice President and General Counsel of Prosperity Bancshares. And on the call 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; May Stanford, 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, Eric. 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, performance or achievements of Prosperity Bancshares to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Additional information concerning factors that could cause actual results to be materially different than those in the forward-looking statements can be found in Prosperity Bancshares' filings with the Securities and Exchange Commission, including Forms 10-Q and 10-K and other reports and statements we have filed with the SEC. All forward-looking statements are expressly qualified in their entirety by these cautionary statements. Now, let me turn the call over to David Zalman.
David Zalman, Senior Chairman and Chief Executive Officer
Thank you, Charlotte. I'd like to welcome and thank everyone listening to our first quarter 2020 conference call. Our merger with LegacyTexas was completed on November 1, 2019. And our management teams continue to find commonalities and strengths that we expect will benefit our company, our shareholders and associates going forward. Our planned operational integration remains on schedule for June of this year. In our efforts to continue to enhance shareholder value, Prosperity repurchased 2,092,000 shares of its common stock at an average weighted price of $52.59 per share during the first quarter of 2020. The net income was $130 million for the three months ended March 31, 2020, compared with $82 million for the same period in 2019. Our earnings per diluted common share were $1.39 for the three months ended March 31, 2020, compared with $1.18 for the same period in 2019, a 17.8% increase. For the first quarter of 2020 on an annualized basis, return on average assets was 1.67%, return on average common equity was 8.86% and return on average tangible common equity was 20.1%. Prosperity's efficiency ratio, excluding net gains on the sale of assets and taxes was 42.9% for the three months ended March 31, 2020. Our loans at March 31, 2020 were $19.1 billion, an increase of $8.7 billion, or 83.7%, compared with the $10.4 billion at March 31, 2019. Linked-quarter loans increased $281 million, or 1.5% or 6% annualized compared with the $18.8 billion at December 31, 2019. Our deposits at March 31, 2020 were $23.8 billion, an increase of $6.6 billion, or 38.5%, compared with the $17.1 billion at March 31, 2019. Our linked-quarter deposits decreased $373 million, or 1.5% from the $24.2 billion at December 31, 2019. A portion of this decrease was due to our planned reduction of higher cost and broker deposits assumed in the LegacyTexas merger. Excluding deposits we assumed in the merger and new deposits we generated at the acquired banking centers since November 1, 2019, deposits at March 31, 2020 grew $1 billion or 6% compared with March 31, 2019 and grew $162 million, 9 basis points or 3.6% annualized compared with December 31, 2019. Our non-performing assets totaled $67 million or 25 basis points of quarterly average interest earning assets at March 31, 2020 compared with $40 million or 21 basis points of quarterly average interest earning assets at March 31, 2019 and $62 million or 25 basis points of quarterly average interest earning assets at December 31, 2019. The increase during the first quarter of 2020 was primarily due to the merger. During the first quarter of 2020, Prosperity increased its allowance for credit losses to $327 million from $87 million in the fourth quarter of 2019 after adopting accounting standard, ASU 2016-13 also known as CECL. The amount of the allowance is based on our CECL methodology. We believe these additional reserves should help to insulate the company during these challenging and unprecedented times. Our allowance for credit losses to total loans, excluding the warehouse purchase program loans now stands at 1.88% compared with 51 basis points at December 31, 2019. With regard to acquisitions, as one would expect conversations with other bankers regarding potential acquisition opportunities have subsided. However, we remain ready to enter into negotiations when it's right for all parties and properly accretive to our existing shareholders. While today's challenges are certainly extraordinary, Prosperity has a deep management team with experience in navigating and adapting in difficult times. We enter this economic downturn from a position of strength, with sound credit quality, robust capital, and liquidity and solid operating fundamentals. We believe that our team will see us through and we remain confident in our long-term future. I would like to thank every associate at Prosperity throughout the past several months, while dealing with various personal challenges related to the pandemic, our retail team operated at full capacity, enabling us to keep our locations open and serve our customers' daily needs. Additionally, our operational staff and lending team were crucial in accepting, processing and submitting thousands of SBA PPP applications and closing loans, working around the clock to assist our customers. Thanks again for your support of our company. Let me turn over our discussion to Asylbek, our Chief Financial Officer to discuss some of the specific financial results we achieved. Asylbek?
Asylbek Osmonov, Chief Financial Officer
Thank you, Mr. Zalman. Good morning everyone. Net interest income before provision for credit losses for the three months ended March 31, 2020 was $256 million compared to $154.9 million for the same period in 2019, an increase of $101.1 million or 65.3%. The increase was primarily due to the merger with LegacyTexas in November 2019 and $28.5 million in loan discount accretion in the first quarter 2020. The net interest margin on a tax equivalent basis was 3.81% for the three months ended March 31, 2020, compared to 3.2% for the same period in 2019 and 3.66% for the quarter ended December 31, 2019. Excluding purchase accounting adjustments, the core net interest margin for the quarter ended March 31, 2020 was 3.36% compared to 3.16% for the same period in 2019, and 3.26% for the quarter ended December 31, 2019. Non-interest income was $34.4 million for the three months ended March 31, 2020, compared to $28.1 million for the same period in 2019. The increase in non-interest income was primarily due to the merger with LegacyTexas. Note, the debit card income from LegacyTexas is now impacted by the Durbin Amendment. Non-interest expense for the three months ended March 31, 2020, was $124.7 million, compared to $78.6 million for the same period in 2019. The increase was primarily due to the merger with LegacyTexas. For the second quarter 2020, we expect normalized non-interest expense to range around $120 million to $125 million. In addition to this, we expect $3 million to $5 million in one-time merger expenses related to upcoming June conversion. Further, we expect to incur expenses related to the SBA paycheck protection program in the second quarter, which are not included in the normalized non-interest expense guidance. As we discussed in prior quarters, we expect to realize most of our cost savings from the LegacyTexas merger beginning in the third quarter of 2020 after the system integration that is planned for June. To date, we have already realized some cost savings from the merger and eventually expect additional cost savings of approximately $8 million to $9 million per quarter combined this will be in line with announced 25% cost savings. The efficiency ratio was 42.9% for the three months ended March 31, 2020, compared to 42.94% for the same period in 2019 and 58.07% for the three months ended December 31, 2019, which included $46.4 million in merger-related expenses. The bond portfolio metrics at March 31, 2020 showed a weighted average life of 3.08 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 detail on loans and asset quality.
Tim Timanus, Chairman
Thank you, Asylbek. Our non-performing assets at quarter end March 31, 2020 totaled $67,179,000 or 35 basis points of loans and other real estate. At March 31, 2020 non-performing assets totaled made up of $61,449,000 in loans, $278,000 in repossessed assets, and $5,452,000 in other real estate. Of the $67,179,000 in non-performing assets, $13,187,000 or 20% are energy credits, $12,869,000 of which are service company credits and $318,000 are production company credits. Since March 31, 2020, there have been no material deletions from the non-performing assets list. Net charge-offs for the three months ended March 31, 2020 were $801,000. There was no addition to the allowance for credit losses during the quarter ended March 31, 2020. The average monthly new loan production for the quarter ended March 31, 2020, was $476 million. Loans outstanding at March 31, 2020 were $19.127 billion. The March 31, 2020 loan total is made up of 36% fixed rate loans, 36% floating rate loans, and 28% that reset at specific intervals. I'll now turn it over to Charlotte Rasche.
Charlotte Rasche, Executive Vice President and General Counsel
Thank you, Tim. At this time, we are prepared to answer your questions. Eric, can you please assist us with questions?
Operator, Operator
Thank you. We will now begin the question-and-answer session. Our first question today will come from Jennifer Demba of SunTrust. Please proceed with your question.
Jennifer Demba, Analyst
David, can you talk about what you see as your most vulnerable loan bucket over the near-term as we are still kind of in the shutdown and things are reopening slower than we'd like?
David Zalman, Senior Chairman and Chief Executive Officer
Yes, I would say that we haven't yet seen any deterioration in the loan portfolio, possibly because we've extended a number of loans. It's apparent that the most vulnerable area might be the oil and gas portfolio. However, most of it consists of production loans, and around 85% of those are hedged at about $50 to $60 a barrel for this year and partially into next year. There’s a little over $200 million in loans within the service industry, mostly from long-term customers we've had for 20 to 30 years, and we’ve previously navigated through tough times with them in 2016 and 2017 when oil prices dropped to $25 a barrel. Next, another vulnerable area could be hotels and motels until travel resumes. While we haven’t issued many restaurant loans, the PPP funds should significantly benefit these businesses, including hotels and restaurants. The future remains uncertain regarding the economy's recovery, particularly in the third or fourth quarter. Texas seems to be planning a quicker recovery than some other states, with many businesses reopening soon, albeit at reduced capacity. I believe the quicker the reopening, the better it will be. Our underwriting practices have likely been stronger than those of other banks that have taken on less risk, which may help us navigate this situation. While we cannot predict the future, we feel reasonably confident about where we stand. I apologize for the lengthy response; I just wanted to provide some context.
Jennifer Demba, Analyst
Yes. That's okay. Do how much of your loan balances have been deferred overall, and specifically in that hotel and energy bucket?
David Zalman, Senior Chairman and Chief Executive Officer
I don't think that I've broken down. Someone else can respond shortly. As of yesterday, we had 5,643 loans that were extended out of nearly 67,000. This represents about 7%, slightly over 7.7% of our total loans, and the total dollar amount for these extensions was $66,829,000.
Tim Timanus, Chairman
David, I might add. Jennifer, it's really a function of time. If things start to normalize relatively quickly, I suspect we're not going to have that many severe loan problems. If this gets drawn out more and more and more, then obviously that could be a different story. But as David mentioned, Texas is starting to come back online. This weekend, restaurants are allowed to open this weekend at 25% capacity. And then depending on how things go, they're going to go to 50% capacity by mid-May and then once again, based on how things go. They could be at full capacity by the end of May. I said mid-March, I mean in mid-May. So there are a lot of things happening, medical offices are already reopened their client flow is obviously less than what it normally has been. But the important thing is, they're open for business and people can go see doctors now not have to talk to him over the phone. So there are a lot of positive things in play that we're hoping will allow our customers to get back online fairly quickly. But we'll have to just wait see.
David Zalman, Senior Chairman and Chief Executive Officer
Kevin, you want to jump in on the oil and gas at all?
Kevin Hanigan, President and Chief Operating Officer
Yes, Jennifer. As Tim mentioned, a lot of this relates to duration, especially in the oil and gas sector. Low prices can be manageable, but prolonged low prices can be very damaging. Our portfolio currently stands at $719 million, which is 3.8% of the loan portfolio. It's well hedged, as David noted. This year, 88.5% of the proved developed producing reserves are hedged at a weighted average price of $50.93. For next year, 63.2% of the reserves are hedged at $50.24. These hedges are beneficial for us because the industry has become more adept at hedging since 2015. While we may be unique in our reporting, we are not alone in the challenges we face. At $20 oil, nothing operates effectively, so there is potential stress within the portfolio. As we discussed during our January call about our fourth quarter results, we have reserved 12.2% of our energy portfolio. We have maintained a close watch on other companies with energy portfolios, and I don’t think many have such high reserves; a few near that level are just starting to approach 8%. We have a strong reserve against potential losses. We are also making significant efforts to address the former energy credits identified at Legacy, targeting around $200 million to remove from our books. Back in September, our reserve base was $511 million, which has now decreased to $355 million. All resolutions have come in at or below the projected marks, with one resolution hitting exactly on target. We haven't experienced negative marks in any of these resolutions, which shows we're making effective progress. While it's uncertain what the future holds, I believe we have a solid 18 months of hedging in place with strong counterparties, primarily BP and Cargill. Our clients are performing well with these hedge volumes, and we are implementing monthly commitment reductions to capture some cash flows and reduce debt.
Jennifer Demba, Analyst
Thank you. One more question. David, are you inclined to suspend buyback activity right now? Or are you still active?
David Zalman, Senior Chairman and Chief Executive Officer
I think if it were up to me, I'm probably pretty bold. I would probably do it. On the other hand, I know the regulators right now, whether or not. No, they haven't said that you can't do something that I think they would like this to make sure that you build your capital. And so I'd say for the most part, I've committed to them that if not in anything formal, but just talking to them unless our stock just went really through the bottom or something. We probably wouldn't be buying stock back right now. So but that's just kind of where we're at.
Operator, Operator
Thank you. Our next question will come from Brad Milsaps of Piper Sandler. Please proceed with your question.
Brad Milsaps, Analyst
David, I know one of the big aspects of when you bought Legacy was, right sizing their balance sheet, running off some of their loan portfolio, kind of meld the two together, just kind of curious where you are in that process kind of what this environment might do to sort of change the timing of some of that. Or do you kind of have the balance sheet in terms of the left and right side kind of where you'd want it at this point.
David Zalman, Senior Chairman and Chief Executive Officer
I will let Kevin respond to that. However, I believe we are on track. Initially, we anticipated around $400 million to $500 million in loans. The team there has been doing an outstanding job. David Montgomery and Sam Duff have been managing the port effectively; I wouldn’t say they're cleaning up, but they are outsourcing some loans that we preferred not to retain. As Kevin mentioned earlier, the evaluations we made this quarter, if we consider our ALL or whatever they are calling it now in the CECL calculation, we accounted for approximately 13 million.
Asylbek Osmonov, Chief Financial Officer
We have $13 million related to that.
David Zalman, Senior Chairman and Chief Executive Officer
We took $13 million out of a PCD and moved it into the regular allowance. Everything has worked out well so far. While I don't want to say everything is perfect, I believe we are in a good position. I was initially uncertain about staying in the warehouse lending program, but I feel more comfortable with it now. We even managed to pick up a few strong customers who couldn’t secure financing elsewhere and let go of others where we weren’t making as much profit. This has worked out nicely. However, our commercial real estate portfolio hasn’t shown much growth or new loans yet; it's just paying down as expected. I hope this provides some insight, and Kevin, feel free to add anything.
Kevin Hanigan, President and Chief Operating Officer
No, I think David covered a pretty well. If anything, I think we're ahead of schedule, we still have about $50 million on the energy side, we'd like to work our way out of it, at least going back to those original numbers and where we sit today, we'd probably like to work our way out of a lot more than just $50. But, we're ahead of schedule, Brad.
Brad Milsaps, Analyst
Understood. Aside from credit, what are your thoughts on liabilities, specifically regarding the remixing of deposits and how that, along with the current rates, influences your net interest margin? David, you mentioned last quarter that you were aiming for the 335 range, which you achieved this quarter. I'm interested in how the environment affects this and what you can do with Legacy's portfolio of deposits as well.
Tim Timanus, Chairman
This is Tim. I can give you a little insight on that. I've been working with May's and others on the Legacy side to reduce some of our interest expense. And I think we're having a good success. We're trying to do it in what I would call a considerate fashion because we don't want to run off customers that have the capability of being core customers and staying with us over time. So we're taking a, I guess you could call it somewhat of a relaxed approach, but yet focused and determined on lowering these rates and I think we're having good success. May can maybe add to it, but I'm not aware that we have lost any customers that we feel like are on the core customer side, some that are more on the hot money side, just inevitably will end up going somewhere else. So we're very focused on it. We have been. We continue to be. All the interest costs are going down. Obviously, the high price ones go down just like the low price ones, although there is a differential there. So I think we're having good success. I feel good about it.
Asylbek Osmonov, Chief Financial Officer
This is Asylbek. I would like to add that related to the broker CDs that we have. We have about at least $250 million at 2.5% that we are planning to reprice hopefully soon. So there's that one and also we have $125 million in subordinated debt that we can pay off and I think end of the year in December. So that definitely going to help us with the repricing of high cost deposits.
David Zalman, Senior Chairman and Chief Executive Officer
In terms of deposits, even though they may have decreased from the Legacy side, this month we likely saw a positive increase of around $1 billion over the last month or two. Some of this may be attributed to the PPP, but typically, during challenging times, we observe that more individuals tend to deposit their money with us. Historically, our peak deposits occur in the fourth and first quarters. In April, we experienced a $1 billion increase. Looking back, we noticed similar patterns in 2008; when times get tougher, more people choose to place their funds with us, correct Asylbek?
Asylbek Osmonov, Chief Financial Officer
The flight to safety, you can see that.
David Zalman, Senior Chairman and Chief Executive Officer
And as far as the net interest margin, I think that Asylbek will probably tell you this, I asked him he feels comfortable in projecting anywhere from 3.45 to 3.55 net interest margin going forward. Total if you want the net interest margin without the accretion, what do you have three, but.
Asylbek Osmonov, Chief Financial Officer
Yes. It is likely to be in the low to mid 3.30s, excluding accretion. The range of 3.45 to 3.55 is based on the anticipated $13 million to $15 million in fair value income we expect for the second quarter. Regarding the margin, our balance sheet is well-structured for the current environment. About 31% of our total interest-earning assets are fixed-rate bonds, and around 35% of our loans are also fixed-rate. This structure helps us maintain our margin, which I believe will remain stable. However, the SBA PPP program's timing for forgiveness and funding could slightly affect our margin in the second quarter, potentially leading to some dilution. But in terms of EPS or our bottom line, it should prove very beneficial for us.
David Zalman, Senior Chairman and Chief Executive Officer
So it probably wouldn't be dilutive if you could take the whole premium that you're getting the 3% or 5% that you're getting in that wouldn't be dilutive if you have to take that from what you're telling me over a two year period.
Asylbek Osmonov, Chief Financial Officer
Yes. Exactly.
David Zalman, Senior Chairman and Chief Executive Officer
And a lot of money that will be coming in from that PPP program. I think when it's all set and done, we'll have $1.50 billion to $2 billion in PPP loans, depending if we get them all approved or not.
Asylbek Osmonov, Chief Financial Officer
That's going to definitely impact our bottom-line and EPS in an accretive way.
Operator, Operator
Our next question will come from David Rochester of Compass Point. Please proceed with your question.
David Rochester, Analyst
On the energy book, you guys gave a lot of great detail on that. You look pretty well protected at this point. But I was just wondering how far along you were in the spring redeterminations and what you're seeing from the standpoint of line reduction and what you're baking in for oil prices in your new DACs?
Tim Timanus, Chairman
We're well into the redetermination. It's an ongoing process. The customers are fully aware that process is underway and appropriate and called for. We haven't had really any resistance to the process. Obviously, some people don't like the fallout of the numbers, but they are what they are. We haven't had any what I'd call declared defaults so far in the process. We seem to be working well with virtually all the customers. We understand where they are. They understand where we are. I think it's like everything else that relates to our loan portfolio. It's really a matter of how long does it stay weak. Right now, I'm not overly concerned about it. If prices are bad a year from now and two years from now, we're probably going to be more concerned about it. So I feel good about where we are in the redeterminations. People have the option of pledging additional collateral, the option of paying us down. Sometimes we need to give certain customers a little more time and we're willing to be considerate of that and look at it. So it's a viable process. It's not a process that has broken down in any way at this point in time.
Kevin Hanigan, President and Chief Operating Officer
This is Kevin. I would just add to that. We're about halfway through at this stage of the game. General sense in terms of what's happening is commitment reductions of anywhere from 40% to 50% across the board and heavy usage almost I think every client, we've instituted MCRs on.
Jennifer Demba, Analyst
Yes. Okay. And then in terms of the oil price you guys are using in your DACs now?
Kevin Hanigan, President and Chief Operating Officer
Somewhere between $25 and $30.
Asylbek Osmonov, Chief Financial Officer
Closer to $20.
David Zalman, Senior Chairman and Chief Executive Officer
Yes. Thanks, Kevin, Merle is here. Merle said that we're probably using in the low $20s. We're probably averaging into the mid-20s.
David Rochester, Analyst
That's great color. I appreciate that, guys. And then I guess in terms of your loan growth outlook, just if we get some thoughts there. I know in the past, you guys had typically put together some decent loan growth when the environment is tougher because all the other banks tend to tighten their underwriting standards and you guys are already operating with tight standards. So, was just wondering what your thoughts were on that as you're seeing that unfold today?
David Zalman, Senior Chairman and Chief Executive Officer
I think it's the same as what you just said. I think. And so again, I think it's exactly what you said. I think that we'll probably do better in these kind of times than maybe some of our peers because we're in a better position probably.
Brad Milsaps, Analyst
Yes. Okay. And then just switching to the margin, which is curious where you're seeing securities reinvestment rates these days. And if you guys were buying to replace any of the runoff you were talking about? I know you talked about some decent cash flow coming off that or if you're just planning on working borrowings down a little bit?
David Zalman, Senior Chairman and Chief Executive Officer
We might have made some purchases last month, around 100 million dollars, due to the 2.4% rate. Currently, with the interest rates as they are, we are focusing on paying down our debt and reinvesting the money instead of borrowing from the Federal Home Loan Bank and using that as a substitute for our loan portfolio.
Asylbek Osmonov, Chief Financial Officer
They are on the warehouse.
David Rochester, Analyst
Got you. And then maybe just one last one on M&A. Appreciated the thoughts you just gave earlier. I was just curious if you'd still be interested in FDIC-assisted deals if those were to pop up over the next year or so, depending on how bad things get. And if you'd go for only end market deals or if you'd go outside the market for those types of situations?
David Zalman, Senior Chairman and Chief Executive Officer
If you look back even when like that some of our better deals we've gotten even like the Franklin deal when it has been at times like this. And yes, we did jump in, and that's generally when we can get things at a pretty reasonable price. And so we would be interested in naturally. We would be more interested in an end market deal. Having said that, from a shareholder standpoint, depending on how sexy it was and we can make some money, we consider that too.
Operator, Operator
Our next question will come from Brady Gailey of KBW. Please proceed with your question.
Brady Gailey, Analyst
I wanted to follow up on the SBA's PPP program. What's the average fee that you're seeing currently?
Eddie Safady, Vice Chairman
This is Eddie. In the first tranche, we approved about $630 million across 2,700 loans. The average fee on those loans was approximately 3.2%, or around 3% generally. We are currently in the early stages of the second phase, and as of this morning, we have approximately 3,000 approvals totaling around $500 million, with many more to process. We haven’t fully analyzed the fees yet, but I can tell you that the average loan size has decreased in this tranche; it started at about $190,000 and now averages closer to $150,000.
David Zalman, Senior Chairman and Chief Executive Officer
Probably we had to make an assumption, you'd probably be more what about a 3% fee.
Brady Gailey, Analyst
So I mean if you guys end up doing $1.7 billion of PPP loans at a 3% fee, I mean that's $50 million of pre-tax earnings that could potentially flow through the margin over the next couple of quarters as most of these loans are forgiven. Is that the right way to think about that?
Eddie Safady, Vice Chairman
It is. I mean, there are some expenses that need to come out of that a little bit. But these loans are 24-month amortizations, but the forgiveness period will start eight weeks after they can start financing, eight weeks after their first funding. And the rate at which they will be retiring that debt is yet to be seen. We can conceivably see the lion's share of that coming up in the next 12 months.
David Zalman, Senior Chairman and Chief Executive Officer
Having said that, though, too, I think this is money that we really weren't counting on. And if our model would led us our methodology, I would like to see if we could put some of that money, again, increasing our allowance for loan losses, if possible. So I wouldn't want you to count it just as extra found money. That's just cautioning you on that. If we can and the model will allow us, I don't know that you can ever have too much money in reserves.
Brady Gailey, Analyst
And then on that topic, it's odd to see a zero provision this quarter, but totally understandable given the credit quality of Prosperity and where your reserves are already at, did you think that you could see a zero provision going forward from here as well?
David Zalman, Senior Chairman and Chief Executive Officer
I would like to allocate the additional funds we have coming in towards something, although Merle may think I'm referring to a specific methodology. This methodology includes an aspect related to the economic environment that allows for some flexibility. I want to invest more of this surplus money, especially since we have other incoming resources that exceed our typical budget. If there's a provision, it would involve this extra money and the methodology would need to permit it.
Tim Timanus, Chairman
And what right now, we're not faced with obvious defaults that could change.
David Zalman, Senior Chairman and Chief Executive Officer
No, that could change.
Tim Timanus, Chairman
That could get worse. And if it does, then our model will address it appropriately.
David Zalman, Senior Chairman and Chief Executive Officer
But again, it would be nice to just say here's another $40 million or $50 million you have an income that you didn't count on. But it would be nice if we could put some of that away in my thoughts. Yes. That makes sense. And then looking lastly for me, looking at the energy reserve of around 12%, I think that is excluding another $21 million of fair value mark. So once you bake that into it, it's more like a 15% energy reserve. Is that the right way to think about it?
Tim Timanus, Chairman
That is a fair way today. But, that what we call interest mark is going to bleed off over time. So over the next 18 to 24-plus months, that piece of what you call reserves is going to deplete. Still being 12%, everything over 12% is depletable.
David Zalman, Senior Chairman and Chief Executive Officer
We went back to look and with oil went to $25 a barrel. We first, I asked them to go back and tell me how much money have we ever lost over a two year period. And so I think in two years, and this may be in the slideshow that we did. I think it was in 2016 and 2017 and over a two year period, we lost about $35 million and $25 million of that or $24 million of that was oil and gas and the majority of that was from a bank that we bought in Oklahoma there, so most of those losses came from that. So but again, we were smaller at that side. So that if we go through something like that, again, I can't say that's what our total losses, it could be who knows, it could be $80 million, it could be $90 million, who knows, but again, that just gives you some flavor where it was when oil went to $25 last time what we charge-off over a two year period.
Tim Timanus, Chairman
Yes, David, that's right. That went from about mid-June of 2016 through the first quarter of 2018. So it was half of year 2016 and all of 2017 and the first portion of 2018. So that's exactly correct.
David Zalman, Senior Chairman and Chief Executive Officer
But as far as reserves, and again, you never can say you have too many, but in my lifetime as a banker, I never have never been at 1.88%. This is a whole new dimension for me. So I hope we don't need it, but that's more than I've never been in a bank where capital ratios we used to operate when we first started off and we had 5%. We thought we were in great shape. But now we have capital ratios of 10%, you've got allowance for loan losses of almost 2%. I mean, I don't know, I know we're in the situation right now, but I don't know that really the banking industry has ever gone into a downturn of where we're at right now as strong as most banks are right now also.
Operator, Operator
Our next question will come from Ebrahim Poonawala of Bank of America. Please proceed with your question.
Ebrahim Poonawala, Analyst
Most of my questions have been answered. I just have one more for Kevin regarding how you see the mortgage warehouse business developing in terms of demand over the next few months or the next couple of quarters. Additionally, what are you observing on the pricing side concerning lending spreads?
Kevin Hanigan, President and Chief Operating Officer
Yes. Lending spreads have been pretty stable after years of being beaten down on margin there. I think you saw in the Q, our weighted average coupon for the quarter was 3.62 on the warehouse. And notably, it was a pretty big quarter in terms of refi. Purchased refi volume was 51% purchased 49% refi. So a lot of refi volume in the quarter. I actually think that warehouse volumes this year are going to peak in mid-May. So we're not too far away from what I think will be peak volumes. It will be somewhere between May 15 and May 2020 by my math. And for us, that peak could be somewhere between $2 billion and $2.3 billion and we've said we'd like to kind of keep this at $2 billion. We got a lot of bulge facilities out there to get folks grew volume. Just keep in mind, volume that comes onto our balance sheet is usually an application that was taken by one of our customers six weeks ago. So what I do expect post, call it, May 20, is that purchase volume is going to drop pretty dramatically and we're going to see a much lower balance from May 20 to June. And when that purchase volume returns, I don't know. And once it starts returning, realize we got another six weeks of lag before that application gets back on the line. So it may be a couple of months of lower volumes in the June-July period, which is normally when we're at the peak. So this year is going to be a little bit different, in my opinion. And just based upon all the facts we're looking at. So my crystal ball isn't all that good past July and they will all depend then on whether the purchase volume goes back if people put their houses back on the market, if there's traffic, but that there just isn't much foot traffic today. That also extends over into the purchase market. I think homebuilders are going to have a tough quarter in Q2. They all had pretty good quarters in Q1, record kind of quarters through February and then some bust outs started to occur on contracts in March. There will be pockets of the United States and homebuilding in Q2 where you will see some homebuilders. We're not talking about the national guys, for the most part that will actually have negative sales volume in Q2, but there'll be more bust outs than they have in new contracts. So this will be temporary, but both for homebuilders and I think for the warehouse, it's going to be a different Q2 than we've ever seen before.
Ebrahim Poonawala, Analyst
That is actually very helpful. Thank you. And do you just staying on that, do you see any risk or concern that any of these independent mortgage companies could run into trouble because of what's going on with the market and deferments, et cetera, that they are stuck with, borrowers who might be deferring right at the onset after taking the loan?
Kevin Hanigan, President and Chief Operating Officer
Yes, we haven't seen any significant issues yet. Looking at our portfolio, which is what I can comment on, the volume of deferments over the 17 days we've held it has been under 1%. Recently, we've noted that some government-sponsored enterprises are willing to purchase these loans even with deferments, which should help stabilize the market. If mortgage warehouse companies were to encounter challenges, it would likely have happened when they faced some mortgage servicing rights write-downs, especially for those with substantial MSRs. There were also some companies that had to settle hedging positions during March, which involved significant amounts of money. Our clients managed to navigate that period well, not without some difficulties, but without any serious liquidity issues. We closely monitored our portfolio during that time. In fact, we stopped accepting jumbos without defined takeout options by the second week of March due to a slowdown in the jumbo market. We took the necessary precautions and continue to monitor MSRs and hedge volumes.
Ebrahim Poonawala, Analyst
That's helpful. Thank you. And just one question, David, as a follow-up on M&A. Given what you talked about in terms of, at least for now, being a little bit of a capital build mode until things settle down. Does it suggest that for the near-term and I guess, near-term is whatever the next three to six months, it's highly unlikely that you enter a deal or you entertain any M&A transactions until you get the integration piece complete and until we get to some form of the other side of the lockdowns?
David Zalman, Senior Chairman and Chief Executive Officer
I believe I understood your question, although it was a bit unclear. I think you're inquiring about our views on mergers and acquisitions or our future plans. Our primary focus is on the operational integration happening in June. That said, if a genuine opportunity arises, we would definitely consider it, as this is the type of moment we prepare for. We are always ready, but these situations put us in a strong position to act when necessary. If something comes up, I have great confidence in the Legacy team, including Kevin, Mays, and the entire group, who have been exceptional partners for us. The business we have maintained has met our expectations, and I feel secure with our current teams. Thus, if an opportunity presents itself, we would move forward.
Operator, Operator
Our next question will come from Michael Rose of Raymond James. Please proceed with your question.
Michael Rose, Analyst
Hey guys. Just two quick ones. First, I understand the comments around the buyback. If I look back to kind of the great financial crisis, you guys still continue to increase your dividend and I guess that strong ROA pre-tax earnings trends, any reason to think that you'd slow on annual dividend increases from here?
David Zalman, Senior Chairman and Chief Executive Officer
I hope not. My kids need milk money. So I hope they get what they need. It's the only thing from what we see right now, I don't see that being an issue. But again, I can't tell you that something would jump up in the third or fourth quarter and it's an automatic either, but it's certainly I hope that's not the case. If you ask me which way we're leaning, it would be more for dividend increases, especially with the increase in earnings that we are projecting.
Michael Rose, Analyst
Got it. I appreciate the comment, very similar to what Johnny Allison said, but in a different way. One other question, just as it relates to the timing of cost savings, have any of them been pushed back, the systems conversion is still on track to go as planned and anything we should think about there? Thanks.
Asylbek Osmonov, Chief Financial Officer
No, I think it's a place it's already in process. So we're waiting for our June conversion. After the June conversion, we should have start seeing the savings. Our June because so close to the quarter end, our conversion, it might be little bit delayed on the realizing the cost, but as we said, that we already realized about $2 million to $3 million cost savings this quarter, and we are planning to do another $8 million to $9 million in future quarters. So it gets us to 25% cost savings. But we're hoping to do more than that, but definitely, we'll achieve our 25% cost saves that we announced.
Operator, Operator
Our next question will come from Gary Tenner of D.A. Davidson. Please proceed with your question.
David Zalman, Senior Chairman and Chief Executive Officer
He might have dropped off.
Tim Timanus, Chairman
Or mute maybe.
David Zalman, Senior Chairman and Chief Executive Officer
I'd move to the next one, he is probably off.
Operator, Operator
All right. Our next question will come from Kevin Zerbe of Morgan Stanley. Please proceed with your question.
Ken Zerbe, Analyst
Hey. It's Ken Zerbe. Just a really quick follow-up on the expense comment that you just made. The $2 million to $3 million and then $8 million to $9 million of additional that you're going to get, is the $2 million to $3 million already included in the $120 million to $125 million, such that kind of like the normal run rate after everything is said and done, should be close to like about $114 million. Just want to make sure I got my numbers right. Thanks.
Asylbek Osmonov, Chief Financial Officer
Yes. So clarification. So yes, the $2 million to $3 million cost savings already baked in the $120 million to $125 million range I provided. So if you take another $8 million to $9 million, I think run rate assuming everything stays same as we're thinking right now, is going to be around $114 million to $116 million.
David Zalman, Senior Chairman and Chief Executive Officer
You had the tax effect, the $8 million or $9 million, right?
Asylbek Osmonov, Chief Financial Officer
Just we're talking about expenses. Yes, not the net income, yes, expenses. So I would say between $114 million to $116 million will be a run rate after all the savings we realized from the conversion.
Operator, Operator
Our next question will come from Jon Arfstrom of RBC Capital Markets. Please proceed with your question.
Jon Arfstrom, Analyst
A quick question. Most of the stuff has been handled, but can you touch a little bit on West Texas and the kind of activity you're seeing there, non-energy related, I guess, in terms of your thoughts on stresses in real estate portfolio or housing. I know you have some exposure in the Permian, probably Eagle Ford as well,. just give us an idea what you're seeing there?
David Zalman, Senior Chairman and Chief Executive Officer
I'll start off. Midland/Odessa is quite an unpredictable market right now, especially with the current oil and gas prices. There is a shortage of housing and not enough people, which means restaurants might only operate one shift instead of two. I expect a lot of this situation to stabilize over time in the Midland/Odessa area. The Lubbock area, which is predominantly a college town thanks to Texas Tech University, hasn't experienced significant fluctuations in the market. Its economy seems to be influenced not only by oil and gas but also to some extent by agriculture. Given its status as a college town, it supports retail as well. Merle, since you've lived there, you might have some insights regarding the West Texas market and your perspective on it.
Merle Karnes, Chief Credit Officer
Lubbock's economy is pretty stable, both upturn and downturn. There's not much upside Lubbock, but there's not much downside. It's pretty much a 2% to 3% annual growth rate. Midland/Odessa, I think that David's right. The thing has been so stretched. There's some absorption that will take just to get back to normal. There'll be some job loss but they can redeploy some of those people. I think net-net there's going to be a lot of stress. You're going to see some stress in the hotels because a lot of those hotels have been; number one, fully occupied. They're not going to be fully occupied, whether it's by COVID or by oil and gas work. So there'll be some stress there, but we don't have much hotels exposure, hardly any.
David Zalman, Senior Chairman and Chief Executive Officer
And we didn't do any over there, did we?
Merle Karnes, Chief Credit Officer
I think we've got one.
Tim Timanus, Chairman
We might have one, yes.
David Zalman, Senior Chairman and Chief Executive Officer
That's good. Yes. On the other hand, I would say that the price of oil and gas will largely depend on the economy recovering. Earlier, we discussed E&P loans being hedged, with at least 85% or around 80% hedged from what we had from Legacy. We also had some from the West Texas area, and most of the borrowers there were not required to hedge because one borrower received an $80 million or $90 million loan and paid it down to $20 million or $30 million while having $120 million on deposit in the bank. Another borrower has a loan but also has $60 million in the bank and with trust companies. What you're going to see is a decline in production. The borrowers who are hedged will likely continue to produce because it makes financial sense for them, but others we've spoken to are significantly reducing production and will not operate at current levels until the market improves. Once the economy recovers, you'll see an uptick in oil and gas prices as well.
Tim Timanus, Chairman
I think it's important to note that to use the old Texas saying, this isn't the first rodeo out there. These people are used to boom and bust. That's the way it's always been. And I think we've been personally, I think we've been rational and conservative in our loan approvals. And most of our customers that are out there have been through these ups and downs before. As you just said, we don't have many hotels. We don't have many restaurants. Real estate values clearly are not solid right now. But our customers have been through these hard times before. And right now, they're holding in there. So I am as comfortable as I can be.
David Zalman, Senior Chairman and Chief Executive Officer
And fortunately we didn't finance any drilling companies. That's always good.
Tim Timanus, Chairman
We don't have any drilling rigs financed.
David Zalman, Senior Chairman and Chief Executive Officer
Well, we might have one too.
Tim Timanus, Chairman
We still have those work over rigs to?
David Zalman, Senior Chairman and Chief Executive Officer
Yes, we have some service company. But once again, these are people that have been in business for quite some time.
Kevin Hanigan, President and Chief Operating Officer
Also we don't have any pipe.
David Zalman, Senior Chairman and Chief Executive Officer
We don't have any pipe.
Tim Timanus, Chairman
We don't have any pipe.
David Zalman, Senior Chairman and Chief Executive Officer
Again, we don't want to make it sound like we're not free from any sin. And we don't know really what the future, but we do feel comfortable where we're at and we'll be able to get through all of this, we think so.
Jon Arfstrom, Analyst
That's fair. Tim, maybe to you, periodically ask about the average monthly production numbers. But I'm assuming if you take out PPP late March and kind of April to-date is pretty weak. Just curious what if that's true and kind of the activity you're seeing? And then what is the kind of corporate Prosperity message to the lenders, is it keep your customers close or is it going to take some market share? Just curious what you're telling your lenders to work on?
Tim Timanus, Chairman
Well, I think new loan applications probably have dwindled a little bit, but in actuality, not all that much. Our loan committee meetings are still reasonably robust. So there hasn't been a marked slowdown in new requests, but there has been some, once again. We try to stay when it comes to lending, always in the middle of the fairway. Good times or bad times, we try to adhere to discipline and principles. We try to lend into cash flow and good collateral and borrowers that have experience and are honest. And that's always been our message to our lenders, and it really hasn't changed. As was mentioned earlier in this call, if things really start to deteriorate and get bad, we suspect some lenders are going to freeze up and quit lending or certainly slow down considerably their lending activities. And historically, that's always been an opportunity for us to pick up good customers that we haven't had before. So that's always a possibility. We're not hoping that happens, but it could. So there's no different message to our people. Our approach is the same yesterday, today and tomorrow, just be conservative and try to bring in good customers and it's really not any different right now.
David Zalman, Senior Chairman and Chief Executive Officer
I think it goes back to my old saying you'll like us in the good times. But you'll love us in the bad times.
Jon Arfstrom, Analyst
I've never heard you say that before. Just kidding. All right. Thanks a lot. Appreciate it.
Operator, Operator
Thank you. This will conclude our question-and-answer session. I would now like to turn the conference back over to Charlotte Rasche for any closing remarks.
Charlotte Rasche, Executive Vice President and General Counsel
Thank you, Eric. 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.
Operator, Operator
The conference is now concluded. Thank you very much for attending today's presentation. You may now disconnect.