Prosperity Bancshares, Inc. (PB) Earnings Call Transcript

Good day, and welcome to the Prosperity Bancshares Third Quarter 2026 Earnings Conference Call. [Operator Instructions] 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 2026 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. 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, Senior Vice Chairman; Kevin Hanigan, President and Chief Operating Officer; Robert Franklin, Vice Chairman; Randy Hester, Chief Lending Officer; Mays Davenport, Director of Corporate Strategy; Bob Dowdell, Executive Vice President; and Ray Vitulli, Houston area Chairman. 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. -- and as such, may involve known and unknown risks, uncertainties and other factors, which may cause the actual results or performance of Prosperity Bancshares to be materially different from future results or performance expressed or implied by such forward-looking statements. Additional information concerning factors that could cause actual results to be materially different than those in the forward-looking statements can be found in our 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 would like to welcome and thank everyone listening to our third quarter 2026 conference call. I'm pleased to announce that the Board of Directors approved increasing the fourth quarter 2026 dividend to $0.64 per share from $0.60 per share that was paid in the prior 4 quarters, an increase of 6.7%. The increase reflects the continued confidence the Board has in our company and our markets. The compound annual growth rate in dividends declared from 2003 to 2026 was 10.4%. We continue to share our success with our shareholders through the payment of dividends and opportunistic stock repurchases while also continuing to grow our capital. We are proud of this year's growth and would like to highlight the following results. Prosperity's total assets reached $54.1 billion at September 30, 2026, up $15.8 billion or 41% compared with $38 billion at September 30, 2025. Our loans totaled $32 billion at September 30, 2026, an increase of $10 billion or 4% on compared with $22 billion -- excuse me, at September 30, 2025. And our deposits were $41 billion at September 30, 2026, up $13 billion or 48% compared with the $27.8 billion at September 30, 2025. These increases primarily reflect our 3 recent mergers. We are highlighting their magnitude because they demonstrate the expertise of our associates who have extensive experience executing acquisitions and integrating the acquired institutions. Our greater scale strengthens our competitiveness, improves efficiency and enables technology investments that would be difficult for a smaller bank. We completed the operational integration of American Bank in September. All American bank locations are now branded Prosperity Bank, and we welcome the American Bank customers and associates to our family. We remain focused on completing the operational integration of Texas Partners Bank in November and Stellar Bank in March of 2027 and delivering the outcomes we believe are possible. The Texas Partners and Standard Bank teams are already an integral part of our organization and operations. We are excited about our future as a larger bank, including the potential growth in earnings. Excluding the onetime expenses listed in the press release. Net income was $200 million, and earnings per diluted common share was $1.67 for the 3 months ending September 30, 2026. The annualized returns on average assets and average tangible common equity were 1.5% and 15.81% on average tangible common equity for the same period. Excluding the merger-related expenses, the efficiency ratio was 48%. We are proud of these earnings and expect them to improve after all merger-related cost savings are realized. The net interest margin on a tax equivalent basis was 3.73% for the 3 months ending September 30, 2026, up from 3.47% for the 3 months ending in June 30, 2026 and 3.24% for the 3 months ending September 30, 2025. This 49 basis points year-over-year increase reflects the strong net interest margin improvement we expected. Loans totaled $32 billion at September 30, 2026 compared with $22 billion at September 30, 2025. We've seen an increase in our average monthly loan production numbers over the past 2 quarters, this should help bolster our pipelines next year. In the third quarter of 2026, average monthly new loan production increased approximately $180 million compared to the second quarter of 2026 and approximately $320 million compared to the first quarter of 2026. The overall deposits totaled $41 billion at September 30 compared with $27.8 billion at September 30, 2025. Our linked quarter core deposits, excluding Stellar Bank increased 2% annualized during the third quarter of 2026. Our noninterest-bearing deposits of $13.8 billion at September 30, 2026, represented 33.6% of total deposits. The level of noninterest-bearing deposits as a percentage of total deposits continues to remain strong in light of our recent acquisition activity. Looking forward, we believe core deposits will continue to grow in line with our historical run rate of 2% to 4% growth, and we remain conservative with our loan growth projections for '27, projecting flat to slightly increasing loan balances due to the recent acquisitions. We believe that the combination of our growth outlook with our loan pipelines, assets repricing, net interest margin expansion and the realization of our cost savings will drive meaningful earnings per share growth in 2027. Our nonperforming assets totaled $193 million or 41 basis points of quarterly average interest-earning assets at September 30, 2026 compared with $119 million or 36 basis points of quarterly average interest-earning assets at September 30, 2025, and $130 million or 34 basis points of quarterly average interest-earning assets at June 30, 2026. The amount at September 30, 2026 and June 30, 2026, was impacted by nonperforming assets acquired in the mergers. The allowance for credit losses on loans and off-balance sheet credit exposure was $629 million at September 30, 2026. The allowance for credit losses on loans was 3x the amount of nonperforming assets. We are excited about the synergy we have with our new partners, Stellar Bank, Texas Partners Bank and American Bank. Our top priority is the operational integration of the remaining 2 banks, and our combined teams are working very hard to ensure they are successful. We also continue to have conversations with other bankers considering strategic opportunities and are open to transactions that will be beneficial to our company's long-term future and will increase shareholder value. The Texas and Oklahoma economies continue to expand in late 2026 despite labor supply constraints and headwinds from inflation and energy prices. Texas has a growing population of 31.7 million and continues to attract people and businesses with its business-friendly state government and lack of state income tax. Major construction projects across Texas include new data centers, factories producing various products from chips to new drugs and SpaceX and Tesla projects. Both states remain attractive places to live and do business. Thanks again for your support of our company. Let me turn over our discussion to Asylbek Osmonov, our Chief Financial Officer, to discuss the specific financial results we achieved.

Thank you, Mr. Zalman. Good morning, everyone. The third quarter represents the first full quarter that includes Stellar Bank, and our results reflect both the increased scale of combined company and ongoing integration activity for all 3 merged banks. Net interest income before provision for credit losses for 3 months ended September 30, 2026, was $443 million, an increase of $169.5 million compared to $273.4 million for the same period in 2025 and increase of $112.4 million compared to $330.6 million for the quarter ended June 30, 2026. The net interest margin on a tax equivalent basis was 3.73% for the 3 months ended September 30, 2026, an increase of 49 basis points compared to 3.24% for the same period in 2025, an increase of 26 basis points compared to 3.47% for the quarter ended June 30, 2026. The linked quarter increase was primarily due to additional Stellar Bank and higher investment yields. Excluding purchase accounting adjustments, the net interest margin for the 3 months ended September 30, 2026, was 3.59% compared to 3.19% for the same period in 2025 and 3.41% for the quarter ended June 30, 2026. Fair value loan income for the third quarter of 2026 was $11.6 million compared to $4 million for the second quarter of 2026. Fair value loan income for the fourth quarter of 2026 is expected to be in the range of $7 million to $10 million. Noninterest income was $52.7 million for the 3 months ended September 30, 2026, compared to $60.7 million for the quarter ended June 30, 2026 and $41.2 million for the same period in 2025. The second quarter of 2026 included a net gain of $8.2 million, resulting from the conversion of Visa stock partially offset by the loss on the sale of investment securities. The noninterest income for the third quarter of 2026 was reduced by $2.6 million net loss due to write-down of assets. Noninterest expense was $308.6 million for the 3 months ended September 30, 2026 compared to $176.2 million for the quarter ended June 30, 2026 and $138.6 million for the same period in 2025. The third quarter of 2026 included $69.7 million of merger-related expenses. Excluding these merger-related expenses, noninterest expense was $238.9 million. This amount includes the operating expenses of Stellar Bank. During the third quarter, we continued to realize cost savings from the acquired banks with additional savings expected as we complete the remaining 2 system conversions. For the fourth quarter of 2026, we expect noninterest expense to be in the range of $235 million to $238 million, excluding remaining onetime merger-related expenses. The efficiency ratio was 62.1% for the 3 months ended September 30, 2026, compared to 46% for the quarter ended June 30, 2026 and 44.1% for the same period in 2025. Excluding merger-related expenses, the efficiency ratio was 48% for the third quarter of 2026. The provision for income taxes for the third quarter of 2026 included approximately $5 million related to out-of-state tax settlement. This onetime tax expense reduced diluted earnings per share by approximately $0.04 and resulted in higher-than-normal effective tax rate of 24.4%. The bond portfolio metrics at September 30, 2026 and have a modified duration of 3.9 and projected annual cash flows of approximately $2.2 billion. And with that, let me turn the presentation over to Tim Timanus for some additional loans and asset quality.

Thank you, Asylbek. Our nonperforming assets at quarter end September 30, 2026, totaled $193,872 or 60 basis points of loans and other real estate compared to $130,576 or 52 basis points at June 30, 2026. Since September 30, 2026, $4,289 million of nonperforming assets have been removed or put under contract for sale. The September 30, 2026, nonperforming asset total was comprised of $171,031 in loans, $57,000 in repossessed assets and $22,784 and other real estate. Net charge-offs for the 3 months ended September 30, 2026, were $4,437 million compared to net charge-offs of $2,183,000 for the quarter ended June 30, 2026. There was no provision to the allowance for credit losses during the quarter ended September 30, 2026. No dollars were taken into income from the allowance during the quarter ended September 30, 2026. The average monthly new loan production for the quarter ended September 30, 2026 was $635 million compared to $454 million for the quarter ended June 30, 2026. Loans outstanding at September 30, 2026, were approximately $32.06 billion, compared to $25.028 billion at June 30, 2026. The September 30, 2026 loan total is made up of 38% fixed-rate loans, 30% floating rate loans and 32% 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, Megan will assist us with questions.

[Operator Instructions] The first question comes from Dave Rochester with Cantor.

Wanted to start on the margin outlook for the quarter. I appreciate the accretion on the loans of $7 million to $10 million. Maybe just to wrap up on the accretion side. I think you had some on the securities book as well. I imagine some of that might continue. And then the CDs might be more short-lived, but I was just curious if there are any expectations for that as well, so that accretion number might be a little bit bigger in 4Q.

Yes. For the fourth quarter, I mean, we're excited to see the continued repricing of bond portfolio. As I mentioned, we still have $2.2 billion of annualized cash flow from bond portfolio, we have a $2.92, average rate on the bond, and we've been recently buying like $5.50 to $5.75. So that's going to continue to reprice on the bond portfolio side. On the loan side, we have a 38% on the fixed loans. They're going to continue to reprice -- if you look at our average rate on loans without fair value, it's $5.93, so we are putting higher loans on our production. So that's going to benefit from that. But one thing I want to note that we did increase our deposit rates in the end of the third quarter. due to the Fed increase rate. So it has not fully baked in, in our third quarter, but we'll see that baked in, in the fourth quarter. So I think if you're looking on margin, I think it's going to be flat to slightly up because it takes a little time for assets to reprice. But in long term, our model shows we're going to continue to expand on the margin significantly as the bond portfolio and the loan kind of reprice. And if you look for 12 and 24 was looking really good. And the assumption we provided that exit rate on the fourth quarter margin being $3.70, $.3.75 as is. So we're comfortable that. And the guidance we provided for next year is also stands as a or average for the quarter, like $3.80 to $3.85 right now. So we are seeing expansion of the margin.

Yes. I think it's for some help on accretion. So the accretion on the loans, like I said, $7 million to $10 million -- on the CD accretion, we had, what, $2.5 million. I think it's going to reduce a little bit to $1.3 million for the fourth quarter and kind of burns off first and second quarter of next year.

Okay. So accretion comes down in 4Q, but the underlying margin is expanding. And so that's what kind of keeps it flat to maybe up a little bit just on a reported basis.

That's correct. That's right.

Okay. That's great. It's good to hear that you guys are still thinking positively about the margin. You have a lot of opportunities there to expand that it sounds like. Maybe just switching to expenses real quick. That result was solid. The guide certainly shows you've got some more cost savings coming. Where is -- where do you think that expense range that $2.35 to $2.38 goes as you head into next year? I know you'll get a lot more of the cost savings from Stellar on the integration, so maybe those flow through more fully into 2Q, and that's normally when you've got your merit coming through on a full quarter basis. So I was just curious how you think that trends to the extent that you've got projections through the year?

Yes, that's a good question. We did see some cost savings already baking in. It's not just from American but some of cost savings from Stellar and Texas Partners -- so we're going to continue to see that. I think based on our estimates, we have additional $65 million to $70 million pretax of cost savings coming in if you compare to our third quarter expenses. If you look at our expectation when we all settled in more like starting second quarter and third quarter, when we have like quarterly clean expense run rate, I would say, we're looking at about $220 million to $225 million per quarter. That's a pretax number. So that's going to be our run rate on everything is settled.

All right. Great. Maybe just one last one on credit. Through the deal accounting and whatnot, that allowance ratio went up pretty decently this quarter. It seems like you're pretty well positioned to have a 0 provision for '27 you don't have a crystal ball, but is that kind of what it feels like at this point?

I think so. I mean, really at $193 million in total nonperforming assets and having over $600 million in provision or allowance, I think we cover pretty good.

When we said '27, I wasn't sure if you meant next year, 27% 27 years worth 27 years worth SP59206847 Let's take the next year for now.

The next question comes from Brett Rabatin with StoneX Group.

I wanted to -- just to go back, I know last quarter, you mentioned that you were going to probably have to increase deposit rates a little bit and then you just alluded to it. I was just curious, your money market rate average was up 9 basis points linked quarter, but it's -- your core funding is really low cost, great core deposit funding base. As how much you increased the rate? And then how much should we be thinking about the cost of funds from here and how you guys are thinking about the margin with potential rate hikes?

Yes. I think we -- I mean, it wasn't 1 rate for everything. We kind of looked at it different buckets of the deposits and the different rate increases. But I'll tell you this for -- if you're looking for fourth quarter specifically, we calculated what would be average cost of deposit would be. It's going to go up by like 6 or 7 basis points from the Q3. So we're shooting maybe cost average will be 146, 145%, 146% on the cost of deposits. But if you look at cost of fund total I think kind of goes up from 150 to 157 to 58, so 8 basis points with our deposit increase that we did end of the quarter -- on the third quarter.

And our primary focus, Brett, again, we really don't it's not that we don't focus on them. It's just that they're not as rate driven as you're checking accounts and all that -- our main focus really on the increase was really on the money market accounts and really focused on balances that were $1 million or more. We actually raised our money market rates about 0.25 point from 2.75% to 3%. And again, we're still offering the special rates. We have a couple of special CD rates where are they running.

So like 7 months cities like 3.75%.

So we're offering a couple of special promotional deals like that. But that's really where we're focused on, and that's where the rates increase. And I would say, going forward, if interest rates increase, again, that's probably the focus where we'll be in at those 2 products primarily. The majority of the rest of the bank is just core funding and -- and I think the rate-driven stuff is probably more in that. And even that is not rate driven like a lot of other banks, really.

Okay. That's helpful. And then the other question I wanted to ask was just around loans. And with the monthly production up to $635 million, it sounds like the outlook is still for maybe modest growth from here. Does the production give you guys any confidence that growth might improve from here? And then just any color on the payoffs from the legacy prosperity or the deals that you've had, how much that might have impacted 3Q?

Yes, Brent, David's nodding at me. This is Kevin. So I'll take that one. And bear with me as I walk you through a couple of things, and what may seemingly get off topic and end up back on topic, if you will. So the monthly production, we have looked back as if all the acquisitions were done last year. So we looked at the production by bank, American Partners Stellar ourselves, going back to January, and those numbers have picked up from Q1 to Q2 to Q3. And it went up about $180 million in total between Q1 and Q2, a little over $200 million. So it's not only going up, but it's increasing its path upward. It's worth noting the major driver of that upward trajectory is in prosperity, the legacy Prosperity portfolio. Stellar dipped down a little bit in Q2 and Q3. We believe that to be largely related to the acquisition and getting to know each other and lenders getting to know each other. And what we have seen there is a rebound in their pipeline. So I think as that pipeline improves, we picked back up to where Stellar was and see further improvement. That's all the tailwinds for loan growth. The headwind is our history and what happens when we make acquisitions, I think you all know it. but I'll say it, it is not unusual. In fact, it's more typical that loans at those institutions tend to shrink for 6 months to a year after an acquisition. So that to me, that ties in, where David said, he thinks loans for next year are probably flat and maybe up a little bit. It's the headwind of integrating Stellar, and it's the tailwind of this production improving. So I would say for the good side, of next year. And before I get into what I think '28 is going to be, and I know it's way too early to be talking about '28 by well briefly. I think the good side for 2027 from our perspective, is now the Street is seeing a new run rate with Stellar on board, and that run rate is pretty strong. Depending upon what you add back, it was $1.67 to $1.69. So I think from an earnings perspective, we've got this nice new run rate, nice new margin. We have the continued margin expansion from repricing and we got another $70 million worth of pretax cost saves. So I think that delivers in spite of what is likely to be a flat kind of loan growth year, that's going to deliver double digits. In fact, low to mid-teen double-digit EPS growth for 2027, even with flat. If I take that and say we'd go through the Stellar transition through 2027, and we rebound off of this new production that we're currently seeing and look into 2028. And let's face a lot of things going to happen between now and then. So this gets pitcher. But that leads us to believe in 2028, we can get to low mid -- I'm going to say, 3% to 5% loan growth kind of numbers in 2028, post dealing with all the potential runoff from the acquisition. So what that means is another year of double-digit EPS growth. So I think we're really set up for two consecutive years of really nice EPS growth maybe a little disappointing to you that we can't take out more growth next year, but we're being realistic and just trying to offset this nice production increase with our history and knowing what happens. So long-winded, but I think we're really in a great position from an EPS growth standpoint for the next 2 years.

That's great, Kevin. I appreciate the nature of there. That helps explain quite a bit.

The next question comes from Janet Lee with TD Cowen.

Three -- back to your net interest margin, 3.80% to 3.85% for '27. That's great. Strong core NIM expansion. Just given the value of the curve moving up significantly more since we last spoke, why not it could be higher? I feel like this rate environment is actually pretty good for you, for your NIM?

Yes. We are -- if you look at our balance sheet, we're neutral to modestly asset sensitive. So if you look at our model, yes, increased rate environment does help benefits us. But when we run the model, we kept it flat rate. there's expectation rate or Fed going to increase run rates. But for our model, we kept it flat. So I mean there might be a possibility to do better, but us being conservative, we're just going to stick to our guidance to -- that we provided.

Yes, I think, Janet, our models, again, maybe trying to underpromise and overperform. But our models look really good for '28 and '29 quite ranging. So I mean we're -- we really -- as Kevin mentioned earlier, we really are looking at some double-digit earnings increases over the next couple of years.

Right. Makes sense. And just to make sure I'm interpreting correctly, your core deposits growing 2% to 4% and loans being flat to slightly increasing in '27. Is that excluding the runoffs? Or is that inclusive?

No, that's -- we refer core deposits. That's all deposits, excluding public loans and government agencies and stuff like that. We have a lot of what we have in public funds right now close $2 billion or $3 billion. credit -- and those are real seasonal in nature. Like right now, they're probably lower than they are all year right now next quarter. You can see our public funds increase $500 million to $800 million probably. I mean, it's very possible in the out of state in the bank through and start running out at the end of the first quarter and second quarter again. So when I refer to the core deposits, it's our checking accounts or money market accounts and stuff like that, just our core. And again, we don't have any wholesale deposits. We don't have any broker deposits or anything like that.

Right. And on the loan side, on the flat to slightly that's inclusive of the potential any one offs?

We do because I think because, again, Gosh, I hope I'm not overly optimistic. I think Stellar bank and our bank are very, very similar in nature, and I don't see an in loan committee, and I don't see a whole lot of difference in what they would have done and what we will do. So I just -- I really think that Stellar Bank and us are very much like, and I don't see a lot of change. Again, as Kevin mentioned, no matter what we do and how hard we try sometimes, we do go backwards and acquisitions. But I think with Stellar and American Bank too and Texas partner, all of us are very similar in the way we lend money and so I don't see a whole lot of changes in what we do. So I'm hoping for the best, Janet.

All right. If I can squeeze in 1 more. Maybe I missed it. Could you talk about your appetite around buybacks from here?

Well, it's $60-something, it's got a huge appetite -- and we have the money to do it with. I mean we're projecting earnings of how much next year also that when we had projected earnings was the analysts have us total earnings. I mean it's a $50 million to $880 million, something like that. So it's even really high. So you take the $0.64 a quarter dividend, and that's what about $300 million...

$10 million or so.

So we have -- we have a lot of gun powder to do something with.

The next question comes from Michael Rose with Raymond James.

Just following up on loan growth. I asked this a lot, but Kevin, if you can give some updates on kind of mortgage lending in the warehouse, just given the higher for longer backdrop. Obviously, you saw -- you were fairly close, I think, to your average guide for the quarter, but just given where mortgage rates are now, if you can just discuss kind of the near-term outlook in next year?

Yes. Thanks, Michael. Yes, for the quarter, we averaged [ $1.229 billion ] I think, and our estimate going into the quarter on the highest it was $1.225 billion. So we were spot on that one. Since quarter end, it's been a downward trend. At the end of the quarter, we were at $1.132 billion. Last night, we ended up at $1.110 billion, and we're basically at $1.1 billion average for quarter-to-date, and I expect that to go down further. A, because the rates [indiscernible] because of the typical seasonal decline in warehouse in Q4. So Michael, I'm thinking on the low side, $850 million to maybe on the high side, $900 million average for the quarter.

All right. That's helpful. I appreciate it, Kevin. And then maybe, David, just you talked about kind of ongoing conversations with bankers for M&A opportunities, but clearly, you're integrating a bunch of deals right now. Any do you expect that we could see a little bit of a pause here? Or if you just find the right opportunity, you guys are just open for business and you're going to make the decision based on what's out there at this point?

I think we're always in the market, but let's face it. I mean our focus is truly the combination of Stellar Bank and Texas Partners. That's our primary focus. For us to really jump into something, it has to make a whole lot of sense and maybe increase our Texas franchise or something like that, that would be significant. But that's really our main focus right now is to really put these banks together really for the most part.

Yes. I'd say in the near-term buybacks way more likely than acquisition.

Yes, the stock price that it's added we weren't trading less than 10x earnings, we'd probably make more money buying our stock back than really buying somebody else really.

Makes sense. I appreciate all the color.

The next question comes from David Chiaverini Jefferies.