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Edited Transcript of PB earnings conference call or presentation 24-Apr-19 3:30pm GMT

Q1 2019 Prosperity Bancshares Inc Earnings Call

Houston Apr 26, 2019 (Thomson StreetEvents) -- Edited Transcript of Prosperity Bancshares Inc earnings conference call or presentation Wednesday, April 24, 2019 at 3:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Asylbek Osmonov

Prosperity Bancshares, Inc. - Interim CFO

* Charlotte M. Rasche

Prosperity Bancshares, Inc. - Executive VP & General Counsel

* David E. Zalman

Prosperity Bancshares, Inc. - Senior Chairman & CEO

* H. E. Timanus

Prosperity Bancshares, Inc. - Vice Chairman

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Conference Call Participants

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* Brady Matthew Gailey

Keefe, Bruyette, & Woods, Inc., Research Division - MD

* Brett D. Rabatin

Piper Jaffray Companies, Research Division - Senior Research Analyst

* David Patrick Rochester

Deutsche Bank AG, Research Division - Equity Research Analyst

* Ebrahim Huseini Poonawala

BofA Merrill Lynch, Research Division - Director

* Jennifer Haskew Demba

SunTrust Robinson Humphrey, Inc., Research Division - MD

* Jon Glenn Arfstrom

RBC Capital Markets, LLC, Research Division - Analyst

* Matthew Covington Olney

Stephens Inc., Research Division - MD

* Peter J. Winter

Wedbush Securities Inc., Research Division - MD of Equity Research

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Presentation

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Operator [1]

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Good day, and welcome to the Prosperity Bancshares First Quarter 2019 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.

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Charlotte M. Rasche, Prosperity Bancshares, Inc. - Executive VP & General Counsel [2]

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Thank you. Good morning, ladies and gentlemen, and welcome to Prosperity Bancshares First Quarter 2019 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 here with me today is David Zalman, Chairman and Chief Executive Officer; H. E. Tim Timanus Jr., Vice Chairman; Asylbek Osmonov, Interim Chief Financial Officer; Eddie Safady, President; Randy Hester, Chief Lending Officer; Merle Karnes, Chief Credit Officer; Bob Dowdell, Executive Vice President; and David Hollaway, our Former Chief Financial Officer.

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, Cole.

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, 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.

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David E. Zalman, Prosperity Bancshares, Inc. - Senior Chairman & CEO [3]

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Thank you, Charlotte. I'd like to welcome, and thank everyone listening to our first quarter 2019 conference call. For the first quarter of 2019, we showed impressive returns on average tangible common equity of 15.24% annualized and on savings on average assets of 1.46% annualized. Our earnings were $82.402 million in the first quarter 2019 compared to $74.361 million for the same period in 2018, an increase of $8.041 million or 10.8%. It should be noted that earnings in the first quarter of 2018 were impacted by a much higher provision for loan losses, the majority of which was attributable to an acquired bank. Diluted earnings per share were $1.18 for the first quarter of 2019 compared to $1.07 for the same period in 2018, an increase of 10.3%. Loans at March 31, 2019, were $10.414 billion, an increase of $402 million or 4% compared with $10.011 billion at March 31, 2018. Our linked quarter loans increased $43.7 million or 40 basis points, 1.7% annualized from $10.370 billion at December 31, 2018.

During the first quarter of 2019, average -- add this as average loans increased 2.8% annualized. We saw some pause in loan growth during the first quarter impacted by the continued paydowns we experienced and the government shutdown, trade tariff controversy and the seasonal economy. However, we are maintaining our 5% organic loan growth forecast for the year. Our nonperforming assets totaled $40.883 million or 21 basis points of quarterly average interest-earning assets at March 31, 2019, compared with $33.217 million or 17 basis points of quarterly average interest-earning assets at March 31, 2018, and $18.956 million or 10 basis points of quarterly average interest-earning assets at December 31, 2018. The linked quarter change was primarily due to 2 loans. 1 loan is to a well-servicing business and the other loan is for a large home loan, a large home located in one of the higher end neighborhoods in a major city in Texas. The energy loan was classified as a TDR when we restructured it. The customer has banked with us for many years, and we have a strong guarantor who has been servicing the loan when needed and who provided additional collateral in connection with the restructure.

With respect to the home loan, the house is currently on the market and listed for more than the loan amount. With regard to deposits at March 31, 2019, they were $17.198 billion, a decrease of $135 million or 80 basis points compared with $17.333 billion at March 31, 2018. Our linked quarter deposits decreased $58 million or 30 basis points from $17.257 billion at December 31, 2018, primarily due to seasonality. In the fourth quarter of 2018, we saw an increase of $522 million in deposits, which is seasonally normal for us. On an average basis, quarterly deep deposits increased $265 million or 6.2% annualized compared with the quarter ending December 31, 2018.

With regard to acquisitions. As we've indicated in prior quarters, we continue to have active conversations with other banks regarding potential acquisition opportunities. We have experienced more interest from banks considering selling or considering a merger of equals after the announcement of the BB&T and SunTrust merger.

Prosperity is fortunate to operate in vibrant and growing states. We continue to see employment growth and a tailwind from companies expanding in and moving to Texas and Oklahoma due to a business-friendly political climate and lower tax rates. Approximately 600 jobs are created every day in Texas alone, including Saturday and Sunday. 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 grow the company both organically and through mergers and acquisitions. We want to develop people to be the next generation of leaders, make every customer's experience easy and enjoyable, and operate in a safe and sound manner.

I want to thank everyone involved in our company for helping to make it a success it has become. Thanks again for your support of our company.

Let me turn over our discussion to Asylbek Osmonov, our Interim Chief Financial Officer, to discuss some of the specific financial results we achieved. Asylbek?

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Asylbek Osmonov, Prosperity Bancshares, Inc. - Interim CFO [4]

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Thank you, Mr. Zalman. Net interest income before provision for credit losses for the 3 months ended March 31, 2019, was $154.9 million compared to $153.2 million for the same period in 2018, an increase of $1.7 million or 1.1%. The net interest margin on a tax equivalent basis was 3.20% for the 3 months ended March 31, 2019, compared to 3.16% for the same period in 2018 and 3.15% for the quarter ended December 31, 2018.

Excluding the purchase accounting adjustments, the net interest margin, on a tax equivalent basis for the 3 months ended March 31, 2019, was 3.16% compared to 3.12% for the same period in 2018 and 3.10% for the quarter ended December 31, 2018. Noninterest income was $28.1 million for the 3 months ended March 31, 2019, compared to $27.9 million for the same period in 2018. Noninterest expense for the 3 months ended March 31, 2019, was $78.6 million compared to $80.1 million for the same period in 2018. The efficiency ratio was 42.94% for the 3 months ended March 31, 2019, compared to 44.19% for the same period in 2018 and 43.20% for the 3 months ended December 31, 2018. The bond portfolio metrics at 3/31/2019 showed a weighted average life of 3.79 years, an effective duration of 3.43 and projected annual cash flow of approximately $1.9 billion.

And with that, let me turn over the presentation to Tim Timanus for some detail on loans and asset quality.

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H. E. Timanus, Prosperity Bancshares, Inc. - Vice Chairman [5]

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Thank you, Asylbek. Our nonperforming assets at quarter end March 31, 2019, totaled $40.883 million or 39 basis points of loans and other real estate compared to $18.956 million or 18 basis points at December 31, 2018. This is an increase of $21.927 million from December 31, 2018. As David previously mentioned, this increase is made up of 2 credits: one, an energy-related well service company; and the other, a residential mortgage loan.

The March 31, 2019, nonperforming asset totaled was comprised of $38.138 million in loans, $649,000 in repossessed assets and $2.096 million in other real estate. Of the $40.883 million and nonperforming assets, $17.161 million or 42% are energy credits, all of which are service company credits. Since March 31, 2019, $601,000 in nonperforming assets have been put under contract for sale, but there can be no assurance that these contracts will close.

Net charge-offs for the 3 months ended March 31, 2019 were $1.049 million compared to net charge-offs of $556,000 for the 3 months ended December 31, 2018. $700,000 was added to the allowance for credit losses during the quarter ended March 31, 2019, compared to $1 million for the quarter ended December 31, 2018. The average monthly new loan production for the quarter ended March 31, 2019, was $284 million compared to $248 million for the quarter ended December 31, 2018. Loans outstanding at March 31, 2019, were $10.414 billion compared to $10.370 billion at December 31, 2018. The March 31, 2019, loan total is made up of 38% fixed-rate loans, 38% floating rate and 24% variable rate.

I'll now turn it over to Charlotte Rasche.

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Charlotte M. Rasche, Prosperity Bancshares, Inc. - Executive VP & General Counsel [6]

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question today comes from Jennifer Demba with SunTrust.

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Jennifer Haskew Demba, SunTrust Robinson Humphrey, Inc., Research Division - MD [2]

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David, just wondering if you could give us a little more detail on the new -- 2 new nonperforming loans and their sizes and your expected loss, et cetera.

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David E. Zalman, Prosperity Bancshares, Inc. - Senior Chairman & CEO [3]

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Yes, I'll start off, Tim may want to jump in, but again, the loan that we have is from a customer, a longtime customer that banked with American bank and they love it for a long period of time, it's in the Permian Basin. Old, old company, strong guarantor. It paid down from $30 million to $15 million. We were trying to restructure it for a -- with some -- for a period of time with some interest. And again, the loan ran extremely late, and I don't know, 60 or 90 days. And once it goes over 90 days, even though we got additional collateral with it, it became a TDR with the regulator. So my gut feeling is that the we shouldn't lose any. We've had this borrower for ever and ever, a real strong guarantor. So we shouldn't -- it doesn't look like it, but having said that, you never -- you just don't want to be emphatic that you won't, but our gut feeling is no that we won't lose it. And the home loan is just a very large home loan. Again, I don't want to give it away. Somebody want a home loan, $9 million, it's pretty easy to find out whether it's a -- what city it's in. So -- but it's listed. It's listed for about $13 million, and it's one of the major metropolitan areas and one of the highest, richest parts of town. So we don't think it will have, maybe do you think you'll have seen much of a...

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H. E. Timanus, Prosperity Bancshares, Inc. - Vice Chairman [4]

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Yes, I don't think you'll see a loss. You probably have a marketing term of about anywhere from 6 to 7, 9 months to market it, may be 12 to sell it and move it out?

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David E. Zalman, Prosperity Bancshares, Inc. - Senior Chairman & CEO [5]

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Yes, I think that historically we've been running about $40 million in nonperforming assets. We got as low as $18 million, that's the lowest we've ever been. I've always said that probably a normal NPA for a number for a bank our size would probably always be between $40 million and $60 million. So that's just my guess. But again, you never like to have these go-on-the NPAs. On the other hand, it's not like we're seeing losses on them. We shouldn't see any loss or something like that. So we feel pretty good about it. Tim, do you want to comment?

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H. E. Timanus, Prosperity Bancshares, Inc. - Vice Chairman [6]

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Yes, Jennifer, I can give you a little additional color. Let's start with the well service credit. I'm just going to use round numbers. The balance is about $15 million approximately. And the loan started out at about twice that amount. So it has been paid down quite a bit. It is primarily secured by equipment that as of 2015 had an appraised value of about $32 million. And when we did some restructuring for the customer recently, he pledged additional collateral, that being real estate. It has an appraised value of a little over $9 million. So in terms of appraised values, we appear to be covered on our loan, but I guess that's no guarantee. This well service credit is on interest only right now. It is current. So interest is paid current through the April payment. It will go on an amortization in October of this year, and it's scheduled to amortize over 5 years. As David said, this is a customer that was with American State Bank for many years, and they had a decent history we think. So given the -- what appears to be sufficient collateral based on appraisal, once again, that'll mean that the collateral would sell for the appraised amount. But on paper, there doesn't appear to be an extremely significant loss but there's just no guarantee there. The other loan, that one is the residential loan, in round figures, the balance is about $9 million. It's actually made up of 2 different loans, a first lien and a second lien. The first lien is about $6 million. The second lien is about $3 million. The first lien is basically 1 month past due. It's due for the March payment. The April payment has not come due yet. And the second lien is about 6 months past due. So it's in worse shape than the first lien. And as David mentioned, the house has an appraised value of $14 million. So is there a loss there? I guess, on paper, if you compare it to the appraisal, it doesn't appear to be, but once again, it depends on whether the customer pays and what somebody will really pay for the house. So once again, the balance of the 2 loans is about $9 million and the appraisal on the house is about $14 million. So hopefully, that gives you a little clarity.

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Jennifer Haskew Demba, SunTrust Robinson Humphrey, Inc., Research Division - MD [7]

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Okay. And the residential mortgage, was that also made by an acquired bank?

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David E. Zalman, Prosperity Bancshares, Inc. - Senior Chairman & CEO [8]

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No.

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H. E. Timanus, Prosperity Bancshares, Inc. - Vice Chairman [9]

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No, we made that one.

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Jennifer Haskew Demba, SunTrust Robinson Humphrey, Inc., Research Division - MD [10]

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Okay. And is there any reserve for either loan right at this point?

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David E. Zalman, Prosperity Bancshares, Inc. - Senior Chairman & CEO [11]

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A small amount.

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H. E. Timanus, Prosperity Bancshares, Inc. - Vice Chairman [12]

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Yes, given the excess appraisal amount, the way our model works is the way we process these things. There is not a, what I call, substantial reserve or mark against either one of those loans right now.

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Operator [13]

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And our next question comes from Dave Rochester with Deutsche Bank.

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David Patrick Rochester, Deutsche Bank AG, Research Division - Equity Research Analyst [14]

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The expense trend was a bit better than expected. I think your guidance was for $80 million to $81 million quarterly, sort of a theme with you guys. Was just wondering, how are you thinking about that trend going forward? Do you still expect that to step up as the year progresses? And may be what's the new frame we should use now?

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Asylbek Osmonov, Prosperity Bancshares, Inc. - Interim CFO [15]

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This is Asylbek. I'll take the question. I agree we came in a bit lower this quarter, but as we stated in our prior call, this quarter we expect it to be at the lower end of $80 million to $81 million, and I think we did better than anticipated. But if you're looking forward for next few quarters, we project the noninterest expense to be around $81 million to $82 million. That's what we've been saying in prior quarters.

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David Patrick Rochester, Deutsche Bank AG, Research Division - Equity Research Analyst [16]

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Okay. And then it looked like you let some securities roll off to push borrowings lower. Is that a trend we should expect going forward until purchase rates improve? And then maybe if you could just give us some color as to where securities purchase rates are at this point, that would be great.

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David E. Zalman, Prosperity Bancshares, Inc. - Senior Chairman & CEO [17]

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This is David Zalman. We said, I think in our last call, it doesn't make a lot of sense borrowing a lot of money from the Federal Home Loan Bank and borrowing it at 2.5% and then leveraging into the bond portfolio. So we kind of pulled back on that, and then of course, net interest margin has truly helped this, even though period end deposits were down. The average deposits were up on a 6.2% annualized. So that helped us at the same time, so we had more deposits at the same time. But yes -- I think the answer is -- the short answer is, yes, I mean that's still our strategy going forward. There may be certain times throughout the year, I think our funds get -- deposits are at the lowest probably in midyear. And so generally, you may see a little bit borrowings in midyear pickup at the end, but for the most part, that's probably not a strategy that we want to do as a leverage with the Federal Home Loan Bank anymore.

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David Patrick Rochester, Deutsche Bank AG, Research Division - Equity Research Analyst [18]

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And then in terms of yields, what are you seeing in the market today, are you high 2s, mid-2s with your bank?

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David E. Zalman, Prosperity Bancshares, Inc. - Senior Chairman & CEO [19]

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No, we're getting, I think -- we did one yesterday, a small one. It was 3.13%, I think, we got yesterday, 3.3%.

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David Patrick Rochester, Deutsche Bank AG, Research Division - Equity Research Analyst [20]

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And then I think last quarter -- go ahead, sorry.

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David E. Zalman, Prosperity Bancshares, Inc. - Senior Chairman & CEO [21]

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That was more of a fixed-rate one, the floating rate. We got probably 3% on it.

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David Patrick Rochester, Deutsche Bank AG, Research Division - Equity Research Analyst [22]

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Okay. Okay. And then last quarter, I think you said new loan yields were sort of in the mid-5s range. Are you still there today? And then I guess bigger picture, given all of this, on the earning asset side, how are you thinking about the NIM trend as we go through the rest of the year?

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David E. Zalman, Prosperity Bancshares, Inc. - Senior Chairman & CEO [23]

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The answer to the first question is, yes. We're still looking at about 5.5%. With regard to the net interest margin, again, we saw some -- there's a number of thing and I'll let Asylbek jump into it, he can get more technical. I always said that we had increased average loans, and we had less Federal Home Loan Bank borrowings and that caused the net interest margin. And he'll go into more detail about it at this time. But for the most part, we've had this model that we've used in the bank since I've been here since 1986 and our model still shows a continual increase in net interest margin over the next 1, 2 and 3 years. And it's modest in the short term, but with a static rise. It's based on a static rise. The rise is not moving one way or another. It continues to go up. And if interest rates go up, it even performs better. So in the long run, our net interest margin should always continue to get better. There may be some glitches, some ups and downs, days, another quarter or something like that, but for the most part, I would say, yes, it should continue to get better. Asylbek?

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Asylbek Osmonov, Prosperity Bancshares, Inc. - Interim CFO [24]

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I agree. This quarter we benefited from our increased loan balances and the pickup in the yield on those loans and our repricing of our security portfolios at higher yield helped a bit. But again, we mentioned before that mix of money is important in funding side. And you saw this quarter that we were able to shrink our FHLB borrowing, and by replacing that, we had an increase on our average deposits. So the mix of money on the funding helped us with the margin. If you -- going forward, if we look at -- if we continue to control our funding costs and give our asset size of the balance sheet some time to reprice on the catch-up, as you mentioned, I think our net interest margin story should be -- continue to be positive, and we might not see the exact same rate hike we saw this quarter but it's going to be still positive.

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Operator [25]

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And our next question comes from Brett Rabatin with Piper Jaffray.

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Brett D. Rabatin, Piper Jaffray Companies, Research Division - Senior Research Analyst [26]

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Wanted to ask about fee income, and I know in the first quarter, deposit service charges are usually a little more seasonal, but the decrease in 1Q this year was a little bigger. And so I was just curious, was there more NSF fees or credit card or debit card? What was the, kind of, impact in 1Q on that? And then just any thoughts on the rebound of that line item in particular?

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David E. Zalman, Prosperity Bancshares, Inc. - Senior Chairman & CEO [27]

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Yes, I mean, Brett, again, our fee income -- I don't remember what it was, $800,000 difference but it's not really material in our company as much, to the bottom line in earnings I would say. For the most part, it is seasonality. But also I think last year, if you're comparing last year or the quarter before, I think sometimes we had some higher trust income, but again, I don't see that really being significant that there was any change in the way we do business or anything like that. I just think it's just one of those things. Asylbek, do you want to...

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Asylbek Osmonov, Prosperity Bancshares, Inc. - Interim CFO [28]

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Yes, I just want to add specific to answer your question. Our NSF fee and the credit card/debit card income decreased this quarter, but if you look at our prior year first quarter, same thing. The trend was so decreased, but we should see some bouncing back on the following quarters. But I agree, going forward, I mean we are in $28 million, $29 million unless there is a one-off thing happened during the quarter, I would say, around $28 million, $29 million.

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David E. Zalman, Prosperity Bancshares, Inc. - Senior Chairman & CEO [29]

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Yes, sometimes you'll have a big trust fee (inaudible) that we did something. But for the most part, I think it's more seasonal like you said.

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Asylbek Osmonov, Prosperity Bancshares, Inc. - Interim CFO [30]

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Exactly right.

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David E. Zalman, Prosperity Bancshares, Inc. - Senior Chairman & CEO [31]

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Tim, you want...

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H. E. Timanus, Prosperity Bancshares, Inc. - Vice Chairman [32]

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One thing as an example of what Asylbek just mentioned are our foreign transactions at our ATMs were down quite a bit in the first quarter compared to the linked quarter. And we've looked at that and tried to understand why that's the case, and candidly, we're not completely sure other than just obviously the usage was not what it had been in the prior quarter, but that's an example of what transpired during this first quarter of this calendar year.

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David E. Zalman, Prosperity Bancshares, Inc. - Senior Chairman & CEO [33]

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We were thinking to use more ATMs during Christmas season. So (inaudible) they ran out of money (inaudible).

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H. E. Timanus, Prosperity Bancshares, Inc. - Vice Chairman [34]

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I think there's truth to that. But to go down, that's just an example. Other things moved also.

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Brett D. Rabatin, Piper Jaffray Companies, Research Division - Senior Research Analyst [35]

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Okay. I appreciate the color there. And then David, I know you've never been a huge fan of share buybacks and using capital. You always have been more for growth or for acquisitions but your TCE is approaching 11% now. Any thoughts on a more aggressive stance on using the capital?

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David E. Zalman, Prosperity Bancshares, Inc. - Senior Chairman & CEO [36]

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I'm still pretty consistent. I'm a good husband. I do what I say. I guess I always said we're going to use the money for -- we're always going to use the money for building a bank organically and -- or else buying another bank and that's still a story today. Same story if the -- if the price just really plummeted then we would jump in. But for the most part, we still want to grow the bank with the capital and that's just something we do. We're doing that. We also increased our dividends about 10% every year, so we're continuing to do that, too. So I think you can see us using the money for increased dividends. You can see it for mergers and acquisitions and organic growth.

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Operator [37]

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And our next question comes from Brady Gailey with KBW.

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Brady Matthew Gailey, Keefe, Bruyette, & Woods, Inc., Research Division - MD [38]

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So maybe following up on the capital and M&A question. David, I heard you say that after BB&T-SunTrust was announced, there's more interest on the selling side and then on the MOE side. I don't think I've heard you talk much about the possibility of doing an MOE. But maybe just give a little more color on -- do you think you're actually closer to announcing another deal? And then is an MOE, I think about you guys with, like, Bank of Oklahoma or Frost, like another longtime Texas franchise. Maybe is an MOE something that you would really consider at this point?

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David E. Zalman, Prosperity Bancshares, Inc. - Senior Chairman & CEO [39]

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I think we're open to anything that enhances shareholder value. And MOEs are very tough. As you mentioned, there is -- before you get anywhere else, you've got to get through the social aspects of it, so they are very tough. We -- again, I think that we're considering -- since the BB&T, as I mentioned, that since the BB&T-SunTrust deal, I've seen an unusual amount of people talking that have never talked in the past. And whether something comes out of that, my gut feeling is that it will. In the past, nobody who got to play God, who didn't get to play God, those were all big deals now. Everybody is looking, I think, at shareholders and shareholder value, and what's good for the company and what's the future of our business. So I think that we're looking at all. We're looking at MOEs. We're looking at outright purchases and mergers, and so I'd leave it open. You just have to kind of stay tuned, hopefully, something will happen, but if it doesn't, it doesn't. But we're going -- we're always going to make the right decision.

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Brady Matthew Gailey, Keefe, Bruyette, & Woods, Inc., Research Division - MD [40]

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And then I mean, if you look at your capital, you're at 10.7% TCE now. So I'm sure if you're doing a deal, you'd like to use as much cash as possible, but I know the math works better when you use your currency, especially with your currency having had a good run, now trading at around 15x earnings. So how do you think about your desire to deploy excess capital and use cash versus the benefit of using your currency in a transaction?

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David E. Zalman, Prosperity Bancshares, Inc. - Senior Chairman & CEO [41]

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Our preference and it almost has to be because if we do a bigger deal, we want at least a double-digit accretion number. So it has to -- whoever we end up or we're going to be with, one way or another, we have to put cash into the deal. We're probably thinking at least 25% cash. I know you guys don't like it because you've got this crazy crossover method analogy that I'll never understand. But the bottom line is that we're probably -- we'll probably always put some cash component into it to make the accretion. We always look buying something and how long does it really take us to get our money back and that's really what we're focused on. And also, we're really focused on the accretion.

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Operator [42]

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And our next question comes from Peter Winter with Wedbush.

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Peter J. Winter, Wedbush Securities Inc., Research Division - MD of Equity Research [43]

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David, if I can just follow-up on the M&A question. Just with regards to the outlook in terms of your tolerance for earnings accretion dilution, what is it on tangible book value in terms of dilution on tangible book? Kind of what's your tolerance for that?

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David E. Zalman, Prosperity Bancshares, Inc. - Senior Chairman & CEO [44]

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Again, I guess in deals that we've looked out in the past, somebody's going to probably jump in to say, "I don't know that we ever really did negative -- that we went negative on tangible." Again, the bottom line what we've always looked on deals is how accretive it is, and how long will it take us to get our money back. And we've always liked to get our money, our full money back. When I say money back, that's the money above what their tangible book value is, whatever the premium we paid for. We'd like to get it back in at least 5 years, and that's kind of our strategy, really. We look at accretion, and how long it takes us to get our money back, basically.

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Peter J. Winter, Wedbush Securities Inc., Research Division - MD of Equity Research [45]

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Okay.

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David E. Zalman, Prosperity Bancshares, Inc. - Senior Chairman & CEO [46]

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Dilution, I know it's a big deal now on The Street now, this dilution and crossover methods of accounting, but again, we've done 42 transactions, and the way we do them have been extremely successful. And I know there's some on this crossover method, they don't like to see dilution. I know they want the crossover method not to be back more than 3 years, but the crossover method that's being used now and the method I say getting our money back, it's a different way of accounting it I realize. So maybe they will come back about the same, I don't know.

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Peter J. Winter, Wedbush Securities Inc., Research Division - MD of Equity Research [47]

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Okay. And then just a follow-up question. You reiterated the guidance for loan growth at 5%, and if I look at average loan growth, it moderated this quarter, and the end of period isn't that much higher than the average. So I was just wondering, what's some of the drivers to get to that 5% loan growth this year.

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David E. Zalman, Prosperity Bancshares, Inc. - Senior Chairman & CEO [48]

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Well, again, if you looked at period end, we were down at 1.7 -- I think it's 1.7% annualized. If you looked at average loans throughout the quarter, we were up to about 2.8%. On the last few days of the period, we had $120-something million loan payoff and another big loan pay off. So again, not what -- 3% is not where we want to be at. We want to be at 5%, but I -- for me, the fundamentals still look very good. In our economy, we still have people moving here. We have a lot of request. I think again somebody can jump in a minute, but I think when I heard last time, we had about $1.3 billion in loans that are booked but not funded yet. So maybe bigger than we've ever had before, especially in Dallas and Houston and Austin. So if that's an indication -- now having said that, we turn -- our portfolio turns over a lot. So $1.3 billion sounds like a lot, but again, we get a lot of payoffs, because a lot of our loans are on payoffs. But from what I can tell right now, some of our guys are excited, they are busier than we ever -- than they have seen in a long time, but again, it's got to happen. It's got to come. You've got to really make it happen. So from what everybody's telling me, fundamentals are good, people are still doing deals and that's how we're coming up with it. I don't think 5% is unrealistic at all, really.

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H. E. Timanus, Prosperity Bancshares, Inc. - Vice Chairman [49]

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Pipeline is full.

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David E. Zalman, Prosperity Bancshares, Inc. - Senior Chairman & CEO [50]

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The pipeline is full, yes. Tim, did you want to say anything?

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H. E. Timanus, Prosperity Bancshares, Inc. - Vice Chairman [51]

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Well, I think what you've just described is accurate. Our primary business that we like to do, that pipeline still seems to be fine. If there's been any slowdown in the market overall, my perception has been in the very large real estate projects, primarily those that get funding through nonrecourse financing and candidly really very little equity on the part of the borrower and the project. Those are loans that we've never felt were appropriate for our bank anyway. So the fact that some of those may have fallen off in terms of the overall market volume really doesn't affect us. So I think everything still looks reasonably decent. I mean Texas and Oklahoma are doing fine as far as we can tell. So I don't see any substantial weakness there at all.

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David E. Zalman, Prosperity Bancshares, Inc. - Senior Chairman & CEO [52]

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In fact, I would say, if things weren't as strong as they were, you wouldn't see all the payoffs that we're getting because all these projects that we're doing are really getting financed in the secondary market, and they wouldn't be doing that unless the economy was good.

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H. E. Timanus, Prosperity Bancshares, Inc. - Vice Chairman [53]

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Well, that's exactly right. I mean it's a mixed blessing. It's not good that we're losing their earning asset, but it's justification of our decision when somebody wants to buy the project or refinance it. So you're right. I mean those are solid projects, and that's just the way the market works sometimes.

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Operator [54]

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And our next question comes from Ebrahim Poonawala with Bank of America Merrill Lynch.

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Ebrahim Huseini Poonawala, BofA Merrill Lynch, Research Division - Director [55]

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Just had a question on -- sorry, if you already addressed this around deposit costs. So I heard your comments around expectation for the margin to trend higher from here, but, one, I guess do you expect deposit growth to keep pace with loan growth? And secondarily, what are you seeing in terms of pricing competition? Are you seeing things ease up? Or do you still expect pressure on deposit pricing, based on what competitors are doing?

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David E. Zalman, Prosperity Bancshares, Inc. - Senior Chairman & CEO [56]

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You want to start off, Asylbek?

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Asylbek Osmonov, Prosperity Bancshares, Inc. - Interim CFO [57]

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I can give little bit of highlight on that. Regarding the deposits, we did normalize our deposit rate that went by last quarter and some of that increased cost carried over to this quarter. But this quarter, we had not increased any of those deposits significantly. So from the deposit costing, I think it should moderate a little bit. I don't think it's going to be as significant increase we saw this quarter. But I think we have to just look at long term when you look into margin. Like, we mentioned earlier 12 months, 24 months. Once our balance sheet -- the asset side of the balance sheet reprices and catch up, that time we -- that's why we see our margin increasing. But we don't look at it like in next quarter, we look at it on the long term.

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H. E. Timanus, Prosperity Bancshares, Inc. - Vice Chairman [58]

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Yes, if I can summarize, Ebrahim, the deposit cost seems to have normalized. I think for a long period of time deposit cost was real low. And then we saw in the last quarter, in the first part of this quarter, people really taking money out of their checking accounts. It really wasn't earning hardly anything, trying to go more in the money market accounts and even purchase CDs and stuff like that. But having said that, we think that we have seen it more normalized now and so you have bigger impact. But again, it's just a buildup we think. Net interest margin, going forward, as you mentioned, we do think that since repricing our assets, a $9 billion bond portfolio from $2.43 billion to say you're getting $3 billion or a little over $3 billion. You can do the math on that over the next 1, 2 and 3 years. So that really increases margin, that without any increase in interest rates. And I think your third question was, what about grow loans. Our loans, we're expecting at least 5%. We hope we do better. I think on deposit growth, we're shooting for about 2% to 4%. So you can do the math on that, too, organic growth.

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Ebrahim Huseini Poonawala, BofA Merrill Lynch, Research Division - Director [59]

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Understood. That's very helpful. And just if I can add one more further to the M&A question. It would seem that given the strength in your stock and your currency and what you mentioned in terms of a lot more conversation, your ability to do a deal probably is the strongest it has been in 4 to 5 years. Is it still that seller expectations around pricing remain high? Or are there other factors where you would still rather do something in footprint versus out of footprint that's a hurdle to dealmaking?

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David E. Zalman, Prosperity Bancshares, Inc. - Senior Chairman & CEO [60]

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I'll answer it in 2 ways. I'd say the MOE, most people talking about an MOE realize you can't pay a big premium if you're doing an MOE. So you've seen banks that have paid a big premium for one over the other and both stocks get killed. So I think in doing an MOE, a number of people I think they really understand it and some they may not understand that. I've talked to 2 different companies, 2 different ways. One understands it, one doesn't understand it as well. Hopefully, over time, they do understand it better. And then in all outright purchase, I would say probably a quarter ago, the price expectations were a little too high. I would say, this quarter that they have mitigated a little bit, too. So I think it's working in our favor both ways.

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Operator [61]

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(Operator Instructions) And our next question comes from Matt Olney with Stephens.

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Matthew Covington Olney, Stephens Inc., Research Division - MD [62]

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I want to get back to the balance sheet strategy, and you mentioned you're taking down your borrowings. Do we see the full impact of this in 1Q? Or are we going to see the remaining impact of this during 2Q? And then as a follow-up, is there additional opportunity to take down borrowings from these current levels, assuming the yield curve remains where it's at?

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David E. Zalman, Prosperity Bancshares, Inc. - Senior Chairman & CEO [63]

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I'll start off with it now and throw it to Asylbek, but I think for the most part, we were borrowing as much as what Asylbek had last year, $1.5 billion or something. I think in the last -- I think at the last conference call, we said we were going to stick around $800 million to $1 billion. We've been able to do that. I think it's still our goal to keep it under $1 billion. There may be times in the summer when we may have to borrow back up a little bit, but for the most part, our hope is to reduce that and try to fund it with core deposits, basically our core deposit growth, basically, and maybe even reducing securities. Whatever we don't put in loans, we can always reduce securities to help on that end. But the long and short of it is, I don't think that we benefit having a big leverage position. Asylbek, you want to join in on?

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Asylbek Osmonov, Prosperity Bancshares, Inc. - Interim CFO [64]

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Yes, I completely agree with that statement. I think overall our borrowings were at a level of about $850 million or so this quarter, and it's probably going to tick up a little bit as we mentioned because with the midyear, but if we were able to continue to keep our borrowings, I think we should still positively impact going forward, but it all depends on our (inaudible).

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David E. Zalman, Prosperity Bancshares, Inc. - Senior Chairman & CEO [65]

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I think a lot of it's on deposits. See the deposits that came in for such a long time, we were flushed with deposits. Nobody was really working their money because they weren't any place to get any better. I think as interest rates went up, we saw -- we had a number, a lot of public funds. Those public funds did go. They were really rate-sensitive, and we understand that, some portion of it. So their model went somewhere else. This -- we shouldn't see the drawdown is much this year as we saw last year, I think just because of those public fund deals. So there may be some, but I just can't give you an exact number. But the philosophy is the same. The philosophy is to try to maintain the Federal Home Loan Bank at least at $1 billion or under.

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Asylbek Osmonov, Prosperity Bancshares, Inc. - Interim CFO [66]

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Exactly, like we iterated. We want to keep our borrowings lower and increase our deposits, that would help us going forward.

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Matthew Covington Olney, Stephens Inc., Research Division - MD [67]

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Okay. That's helpful. And then on the securities book, I think the premium amortization expense was around $6.5 million in the first quarter. And given where the yield curve is today, would you expect the migrations from that $6.5 million per quarter level?

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David E. Zalman, Prosperity Bancshares, Inc. - Senior Chairman & CEO [68]

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Again, I'll just jump in. I think that rates did tend to go down on mortgages. What we've seen really kind of an uptick -- and I understand why the premium amortization might have increased, interest rates go down, people refinancing. But recently, we have seen interest rates on mortgages go up. So I don't see that. I don't see premium amortization increasing. It might even -- again, I wish I would add in our ALM meeting before I did this, but I probably even say that may be decreasing. Asylbek, what's your opinion...

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Asylbek Osmonov, Prosperity Bancshares, Inc. - Interim CFO [69]

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I would say it's going to stay the same or maybe a little tick up, but I don't think it's going to drop less than $6.6 million, I'm thinking, because special with the interest rate dropping during this quarter compared to what we had in the fourth quarter.

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David E. Zalman, Prosperity Bancshares, Inc. - Senior Chairman & CEO [70]

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So the interest rates, really, that should be -- the amortization should be affected by accelerated paydowns. And I don't see -- if interest rates are going up on mortgages, not ever so much but slightly, you still wouldn't think that you would see a bigger payoff in mortgages. So maybe just let's leave it where it's at...

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Asylbek Osmonov, Prosperity Bancshares, Inc. - Interim CFO [71]

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And see it next quarter. Yes, I agree.

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Matthew Covington Olney, Stephens Inc., Research Division - MD [72]

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Okay. That's helpful. And then just lastly on M&A. Obviously, the footprint is now in Texas and Oklahoma. I think you've discussed the preference for staying in these markets. But it seems like a lot of these MOE possibilities could also be out of the footprint. So just remind me kind of what the tolerance is at this point for moving out of the footprint.

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David E. Zalman, Prosperity Bancshares, Inc. - Senior Chairman & CEO [73]

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I think you're right. I've always said that our first place would be in the markets that we're in and that would be Texas and Oklahoma. Having said that, if that doesn't work, we would go out of state. Preferably on states that are contiguous to us or if we have to jump a state to the other one, but that's primarily our focus. I don't necessarily see us in -- I've always said I don't necessarily see us in California. And I should never say never, but they got a poster wanted sign on the boundary when I come in because I can't get in there, maybe. In New York, I don't really see us in New York as much, but I think where the states that are contiguous to us, the Midwest, we're open to those kind of deals, basically.

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Operator [74]

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And our next question comes from Jon Arfstrom with RBC Capital Markets.

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Jon Glenn Arfstrom, RBC Capital Markets, LLC, Research Division - Analyst [75]

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David, they don't -- they won't let you take or lit cigar into California. So if you put it out, I think they will let you in.

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David E. Zalman, Prosperity Bancshares, Inc. - Senior Chairman & CEO [76]

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I don't know. Just having one in the car, they could say they could smell it. I don't know. They cannot let me in.

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Jon Glenn Arfstrom, RBC Capital Markets, LLC, Research Division - Analyst [77]

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All right. Maybe a question for you, Tim or David, just on the loan production again. Your monthly loan production is up sequentially, but it's down from last year. And I guess I've never asked the question in terms of how you calculate that. Is that a net or a gross? And I guess what I'm getting to, are you saying that payoffs are higher today than they were a year ago? And that kind of the gross monthly production is just as high? Or is this may be something that's a little bit different than a year ago, if that makes sense?

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H. E. Timanus, Prosperity Bancshares, Inc. - Vice Chairman [78]

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It does. It is a gross number. As I've said earlier, the average production for this quarter was $284 million. For the fourth quarter of '18, it was $248 million. But for the entire year of '18, it was $288 million. So our production for this quarter in '19 was a little bit less than the average for the entire year of '18, but you have to go back and look at what made up that number for '18. Our average in the first quarter of '18 was $329 million, by far the best it's ever been in the history of the company. And rightly or wrongly, we just haven't been able to sustain that production since the first quarter of '18. On the payoffs, as an example, once again, looking at the first quarter of this year, on the incoming side, it's $284 million. On the payoff side, it's approximately $269 million. Now these aren't hard numbers and you have to realize that because out of the $284 million, there are construction loans in there that haven't started to fund up yet, the borrower's equity is being used to start the projects, their lines of credits that necessarily haven't funded up. So there are lot of working parts to this. But if you just look at production and once again gross of $284 million, the burn rate was $269 million. So it never all sticks, and it's moving all the time. So I hope I'm answering your question.

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Jon Glenn Arfstrom, RBC Capital Markets, LLC, Research Division - Analyst [79]

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Yes -- no -- you are. And then just in terms of some of the payoff, paydown activity. Any different than it was a year ago, would you say?

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H. E. Timanus, Prosperity Bancshares, Inc. - Vice Chairman [80]

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Well, the average for all of 2018 was $259 million. So at $269 million for the first quarter, it's above that average, obviously. And it's way above what it was in December, it was $222 million for the quarter ended December of '18. So yes, it spiked up this quarter.

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Operator [81]

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And this will conclude our question-and-answer session. I'd like to turn the conference back over to Charlotte Rasche for any closing remarks.

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Charlotte M. Rasche, Prosperity Bancshares, Inc. - Executive VP & General Counsel [82]

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Thank you, Cole. Thank you, ladies and gentlemen, for taking 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.

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Operator [83]

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