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Edited Transcript of PB earnings conference call or presentation 23-Oct-19 3:30pm GMT

Q3 2019 Prosperity Bancshares Inc Earnings Call

Houston Oct 31, 2019 (Thomson StreetEvents) -- Edited Transcript of Prosperity Bancshares Inc earnings conference call or presentation Wednesday, October 23, 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. - CFO

* Charlotte M. Rasche

Prosperity Bancshares, Inc. - Executive VP & General Counsel

* David E. Zalman

Prosperity Bancshares, Inc. - Chairman of the Board & CEO

* H. E. Timanus

Prosperity Bancshares, Inc. - Vice Chairman

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Conference Call Participants

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* Bradley Jason Milsaps

Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research

* Brady Matthew Gailey

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

* Ebrahim Huseini Poonawala

BofA Merrill Lynch, Research Division - Director

* Jon Glenn Arfstrom

RBC Capital Markets, Research Division - MD

* 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' Third Quarter 2019 Earnings Conference Call. (Operator Instructions) Please note this event is being recorded.

I would like to now 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' Third 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, Chief Financial Officer; Eddie Safady, President; Randy Hester, Chief Lending Officer; Merle Karnes, Chief Credit Officer; 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, Jake.

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 the 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.

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David E. Zalman, Prosperity Bancshares, Inc. - Chairman of the Board & CEO [3]

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Thank you, Charlotte. I would like to welcome and thank everyone listening to our third quarter 2019 conference call. I'm excited to announce that our Board of Directors voted to increase the fourth quarter dividend of 2019 to $0.46 per share, a 12.2% increase from the $0.41 per share in the third quarter of 2019. Our company continues to do well, and we want to share that success with our shareholders. Prosperity Bancshares also repurchased 654,000.6 -- 654,000 shares of its common stock at an average weighted price of $63.59 per share during the third quarter of 2019 and 1.473 million shares of its common stock at an average weighted price of $64.10 per share during the first 3 quarters of 2019.

For the third quarter of 2019, we showed impressive returns on average tangible common equity of 14.77% annualized and on average assets of 1.47% annualized. Our earnings were $81.758 million in the third quarter 2019 compared to $82.523 million for the same period in 2018, a decrease of $765,000. However, in the third quarter of 2018, we had noncore loan discount accretion of $3.457 million compared to only $1.283 million of such income in the third quarter of 2019, a $2.174 million decrease in noncore income.

Our diluted earnings per share were $1.19 for the third quarter of 2019 compared to $1.18 for the same period in 2018, an increase of 80 basis points. Our net income was $246.418 million for the 9 months ended September 30, 2019, compared with $238.481 million for the same period in 2018, an increase of $7.937 million or 3.3%.

Our earnings per diluted common share were $3.55 for the 9 months ended September 30, 2019, compared with $3.42 for the same period in 2018, an increase of 3.8%. It should be noted that during the 9 months ended September 30, 2018, we had $5.329 million more in net income than during the same period in 2019 again due to noncore loan discount accretion income. Our loans at September 30, 2019, were $10.673 billion, an increase of $380 million or 3.7% compared with $10.293 billion at September 30, 2018. Our linked-quarter loans increased $85.970 million or 80 basis points, 3.2% annualized from the $10.587 billion at June 30, 2019.

Our deposits at September 30, 2019, were $16.930 billion, an increase of $196 million or 1.2% compared with the $16.734 billion at September 30, 2018. Our linked quarter deposits increased $42.291 million or 30 basis points from $16.888 billion at June 30, 2019. As mentioned in previous calls, Prosperity generally experiences most of its deposit growth in the fourth and first quarters of the year, and we do not expect that to be different this year.

Completion of our merger with LegacyTexas Financial Group remains on schedule as we've received all required regulatory approvals, and shareholder meetings for each company are scheduled for next week. The management teams from both companies meet on a weekly basis and share many similar viewpoints. Both Legacy's and our goal is 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.

We want to expand our use of technology in our digital products, making it easier for our customers to do business and continue to enhance shareholder value. We believe our customers remain positive about the economy; consumers are still the most positive, while we see commercial customers pausing a bit due to geopolitical concerns. In Texas and Oklahoma, unemployment remains low and demand at business is good. In our opinion, the economy in our market areas remains sustainable.

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

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

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

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Thank you, Mr. Zalman. Good morning, everyone. Net interest income before provision for credit losses for the 3 months ended September 30, 2019, was $154 million compared to $157.3 million for the same period in 2018, a decrease of $3.3 million or 2.1%. A lower loan discount accretion in the third quarter 2019 partially contributed to the decrease. The net interest margin on a tax-equivalent basis was 3.16% for the 3 months ended September 30, 2019, compared to 3.15% for the same period in 2018 and 3.16% for the quarter ended June 30, 2019.

Excluding purchase accounting adjustments, the core net interest margin for the quarter ended September 30, 2019, was 3.14% compared to 3.09% for the same period in 2018 and 3.14% for the quarter ended June 30, 2019. Noninterest income was $30.7 million for the 3 months ended September 30, 2019, compared to $30.6 million for the same period in 2018. Noninterest expense for the 3 months ended September 30, 2019, was $80.7 million compared to $81.8 million for the same period in 2018.

The efficiency ratio was 43.7% for the 3 months ended September 30, 2019, compared to 43.5% for the same period in 2018 and 43.74% for the 3 months ended June 30, 2019. The bond portfolio metrics at 9/30/2019 showed a weighted average life of 3.62 years, an effective duration of 3.19, and projected annual cash flows of approximately $1.8 billion.

And with that, let me turn over the presentation to Tim Timanus for some details 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, September 30, 2019, totaled $51.157 million or 48 basis points of loans and other real estate compared to $41.558 million or 39 basis points at June 30, 2019. This is an increase of 23% from June 30, 2019. The September 30, 2019, nonperforming asset total was made up of $50.314 million in loans, $28,000 in repossessed assets and $815,000 in other real estate. Of the $51.157 million in nonperforming assets, approximately $16 million or 31% are energy credits, all of which are service company credits.

Since June 30 -- excuse me, since September 30, 2019, $2.938 million in nonperforming assets are under contract to be sold or have already been removed from the nonperforming asset list. Net charge-offs for the 3 months ended September 30, 2019, were $1.046 million compared to net recoveries of $115,000 for the 3 months ended June 30, 2019.

$1.1 million was added to the allowance for credit losses during the quarter ended September 30, 2019, compared to $800,000 for the quarter ended June 30, 2019. The average monthly new loan production for the quarter ended September 30, 2019, was $289 million compared to $287 million for the quarter ended June 30, 2019. Loans outstanding at September 30, 2019, were $10.673 billion compared to $10.587 billion at June 30, 2019. The September 30, 2019, loan total is made up of 38% fixed-rate loans, 38% floating-rate and 24% variable-rate loans.

I will 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. Jake, 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) The first question comes from Brady Gailey with KBW.

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Brady Matthew Gailey, Keefe, Bruyette, & Woods, Inc., Research Division - MD [2]

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I just want to start with loan growth, and with Legacy about to close, I know in the past when you have done acquisitions, you've kind of looked at a portfolio of the target's loans and decided to run them off. I think I remember either you guys or Kevin talking about that number being about $500 million for Legacy. I was just wondering an update to that number, how much do you expect to move out of Legacy under the Prosperity umbrella? And then how does that impact net loan growth for 2020?

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David E. Zalman, Prosperity Bancshares, Inc. - Chairman of the Board & CEO [3]

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Well, again, the $500 million that Kevin had mentioned and -- like we had mentioned at the same time, is probably a close number to what we are talking about. How that would -- how -- the time frame that it takes to do that, that could take us up to 2 years to probably do that. So I guess if you did some [Bohemian] math and said, you're growing 5% a year on loans, 5x our combined loans -- again, I don't know if you want to count a big portion of theirs are mortgage warehouse -- so we have over $10 billion, so that's -- 5% is $500 million a year, you add their loans to it.

So basically, it would -- it would affect the 5% organic growth, there is no question, I just have to put a pencil to it, and I think you probably can do the same thing, take their $7 million or $8 million and exclude the mortgage warehouse and just take 5% and then subtract out what we're running off, it's a -- it would probably be a pretty easy calculation.

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Brady Matthew Gailey, Keefe, Bruyette, & Woods, Inc., Research Division - MD [4]

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Got it. All right, that's helpful. And then, so buybacks continued in the third quarter. You bought back about 1% of the company and you bought it back a little under $64 a share. The stock now is north of $70 -- well north of $70. So should we expect that buybacks kind of stop with the stock trading at this level?

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David E. Zalman, Prosperity Bancshares, Inc. - Chairman of the Board & CEO [5]

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Right now, I would say the answer to that is yes. I mean, right now, whenever we start buying when we think that the market is really completely out of kilter. We felt like the market was out of kilter at those prices we were buying it at. And so I think we'll be there to support, we still have a lot of capital, we're creating a lot of capital, we have a lot of earnings. You add our earnings, what we have, and you add the earnings that Legacy brings to the table, I mean it's $500 million or so a year. Even after dividends, we have a lot of money. So we'll continue to buy if the stock ever goes disproportionately lower than we think it should be.

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Brady Matthew Gailey, Keefe, Bruyette, & Woods, Inc., Research Division - MD [6]

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Okay. And then last question for me is on the margin. It was great to see the margin flat linked-quarter, that's a lot better than most of your peers out there this quarter. But how do you expect the margin to trend towards the back part of the year and into 2020?

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David E. Zalman, Prosperity Bancshares, Inc. - Chairman of the Board & CEO [7]

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Well the reason, probably, our net interest margin did better than our peers, we never went up, our net interest margin never went up like the other guys did, because we had a certain amount of fixed rates on our bond portfolio and our loan portfolio. So as rates came down or are coming down, that helps us at the same time. We have about a 3-year average life, both on the loan portfolio and the bond portfolio.

But going forward, it's a little bit harder question. If you look at our bank without Legacy and you look at our bank with Legacy, we've run both models -- and now again, these are models and we're throwing a lot of information into them, so I can't tell you that they're exactly accurate, especially when you combine Legacy's with ours, because again, we're making a lot of assumptions -- but from what we see, we don't think our combined bank is going to be much different than what our bank would have been uncombined.

We think that if interest rates don't move, we would still see a net interest margin that would increase over 12, 24 and 36 months. If interest rates go down 50 basis points, we see probably a flat margin. If they go down more than 50 basis points, we would see a declining net interest margin. I know that's a lot of information, but that's just kind of what we have right now.

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Operator [8]

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The next question comes from Peter Winter with Wedbush.

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Peter J. Winter, Wedbush Securities Inc., Research Division - MD of Equity Research [9]

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I was just wondering as you guys have had more time to spend with Legacy Bank and getting ready to close the deal, have you noticed or come across any positives or negatives as you've dug deeper, getting ready to combine the 2 banks?

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David E. Zalman, Prosperity Bancshares, Inc. - Chairman of the Board & CEO [10]

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I think that -- I'll start off with the negative side. I don't think that we've found anything negative. I think the loans that we did our due diligence on and the loans that you've been seeing some of their charge-offs this quarter, we completely identified those and there wasn't any surprises in any of that.

We also -- I think our management committee -- we have an Executive Management Committee, and we also meet with their executive manage meeting -- their executive management, which is Kevin and Mays and Tom and Scott and Aaron and Chuck, and we meet with them and our guys, we meet every week. And I would tell you they've been -- it's been a pleasure to work with them. I think that we have to make decisions, but the more we work with them, I think they're more alike -- they're more alike with us and the way we think. But I think it's just -- it's been -- in my opinion, I know everything -- I don't want to be naive, anything can happen, but I think that it's been extremely favorable, and Kevin and I still have a bromance going. We text almost every night.

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Peter J. Winter, Wedbush Securities Inc., Research Division - MD of Equity Research [11]

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Okay. And then you've assumed 25% cost saves, and just given your history, that seems kind of conservative for you guys. You usually beat the expense saves. I guess my question is how quickly do you start to realize the expense saves and get the full amount in the run rate?

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David E. Zalman, Prosperity Bancshares, Inc. - Chairman of the Board & CEO [12]

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Well, this -- again, somebody else can jump in in just a minute, I'm sure, Asylbek or somebody. But this is a little bit different in that even though we're closing the deal in the next few days or so, the operational integration doesn't really completely take effect until June of next year. So you all have done some numbers.

And Asylbek, you may want to jump in.

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Asylbek Osmonov, Prosperity Bancshares, Inc. - CFO [13]

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Yes, I'll give you a little bit of color. Yes, we currently have high-level estimates, but I think once we close the merger, we should have -- able to provide more clear guidance on the timing and the cost. But as we look at it, the elements of the cost saves changes from preliminary, but we still expect to get the 25% cost saves that we announced at the merger. And from the timing perspective, I think we expect to take full advantage of the cost save in 2021. But as you mentioned, probably half of the savings going to come in 2020, because -- since the integration has to take place in 2020.

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David E. Zalman, Prosperity Bancshares, Inc. - Chairman of the Board & CEO [14]

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You'll probably even start consolidating some of the steps even before the complete operational integration with the [computers]...

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

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Absolutely right. There is a few -- I mean, we're working on different projects. I mean we've had a lot of streamlines that we're working through that and some of them will be consolidated before even the -- our mid-year point.

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David E. Zalman, Prosperity Bancshares, Inc. - Chairman of the Board & CEO [16]

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But I think a good number is that 50% of it, I think, is a good way of looking at it.

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Asylbek Osmonov, Prosperity Bancshares, Inc. - CFO [17]

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Yes. I would say 50% in 2020 and full advantage in 2021.

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Operator [18]

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

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Ebrahim Huseini Poonawala, BofA Merrill Lynch, Research Division - Director [19]

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Just had another question around the deal closing. Obviously, it's closing fairly soon. Is there anything from a securities repositioning that you're doing on the asset side around closing that we should be mindful of? And if you can just talk to where your expectations are for the pro forma margin for both banks combined coming into fourth quarter, or I guess 1Q will be the full quarter?

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David E. Zalman, Prosperity Bancshares, Inc. - Chairman of the Board & CEO [20]

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I probably would start with the pro forma. Again, this is just a pro forma and these are putting these 2 models together.

But Asylbek, we're looking, what, at a 3.4% margin?

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Asylbek Osmonov, Prosperity Bancshares, Inc. - CFO [21]

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Yes. Basically, the pro forma -- yes, combining those companies right now, as we don't do much of a balance sheets remixing, we're seeing 3.40% right now.

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David E. Zalman, Prosperity Bancshares, Inc. - Chairman of the Board & CEO [22]

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So you're seeing that -- you'll see -- you've already seen our -- you saw our balance sheet where we were borrowing money from the Federal Home Loan Bank, over $1 billion. We've cut that down dramatically because it didn't make sense anymore to do that. From their -- from Legacy's side, you may see us sell a small portion of their CMO portfolio, not a whole lot, but you'll probably see a little bit of that. And you'll probably see us taking money as our bonds mature, instead of buying securities, and we'll use that money to probably fund their loans.

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Ebrahim Huseini Poonawala, BofA Merrill Lynch, Research Division - Director [23]

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Understood. And the 3.40% gave, just relative to your comments earlier, you do expect that 3.40%-ish margin to stay fairly stable, assuming rates don't go down more than 50 basis points?

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David E. Zalman, Prosperity Bancshares, Inc. - Chairman of the Board & CEO [24]

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The 3.40%, if interest rates don't move at all, we should see a pretty good increase in 12, 24 and 36 months. If interest rates go down 50 basis points, it should be flattish. If it goes down more than 50 basis points, then there will be some decline in the net interest margin.

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Ebrahim Huseini Poonawala, BofA Merrill Lynch, Research Division - Director [25]

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Understood. And just on -- separately, in terms of just loan growth or business outlook, as you look into the fourth quarter, into next year, are things looking better, worse, as you think about the economy? Obviously, Texas still doing very well. But I would appreciate your thoughts just in terms of the feedback you're getting from clients and how you're thinking about next, sort of, 2020?

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David E. Zalman, Prosperity Bancshares, Inc. - Chairman of the Board & CEO [26]

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The consumer is doing extremely well. Manufacturing has slowed a little bit. We've seen businesses that I think are still doing very well, but again, they're pausing, I guess I would say, a little bit, because of the geopolitical, they're looking down the line, they're looking at the election. They're wondering if somebody really does get into office that would really raise taxes and start putting wealth taxes. So I think it just bothers business people to make longer-term decisions when they see something like that.

But overall, when you look at it, our unemployment rates in Oklahoma and Texas are the lowest they've ever been. Still harder to find employees to work, I mean. So it's a very good market, I would say. From a loan side, we continue to see a tremendous amount -- a lot of payoffs, but more so than that, the competition is very, very strong out here. We're seeing banks that are offering rates that we don't feel that we can offer sometimes.

And so I would -- where we put 5% organic growth for this year, I think I would change that to maybe 4% because we're just not going to play -- we're not going to -- I think as Johnny Allison said, we're not going to get the most stupidest award. So we don't want to do that. So we don't -- we want to be there. So I think that we'll be competitive, but, again, we're not going to -- we're just not going to do stupid things either. So with that, I would say that we'll probably be more like about a 4% rate of growth for this year.

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Operator [27]

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The next question comes from Brad Milsaps with Sandler O'Neill.

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Bradley Jason Milsaps, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [28]

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Just to follow up on Ebrahim's kind of balance sheet question. Just kind of curious, you had an update on how you plan to fund or how you plan to approach Legacy's warehouse business?

And then as a part 2 of that, would you anticipate using some of your liquidity to fund it versus where Legacy has relied on wholesale funding to fund that business? I'm just trying to get a sense of kind of what the balance sheet kind of looks like pro forma?

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David E. Zalman, Prosperity Bancshares, Inc. - Chairman of the Board & CEO [29]

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Yes. I don't know that we'd have the balance sheet exactly the way it is. But the -- fundamentally, we intend to use our money to fund the warehouse receipt -- I mean the mortgage warehouse loans. Again, if I remember looking at their balance sheet this quarter, they were borrowing over $2 billion or so. It -- I think that -- that we'll probably -- we may increase our borrowings a little bit, but for the most part I think that there'll probably be a middle of the road. We'll probably try to fund most of their loans with our core deposits basically.

But having said that, it's not going to work overnight, just that easy, and we'll have to see where we -- their mortgage warehouse loans were higher than they have been traditionally through the average of the year. They usually run about $1 billion -- a little over a $1 billion. I think in this last quarter, again, it was closer to $2 billion. So we need to really see what the average is going to be. But again, I guess going back, fundamentally, we intend to fund -- use our deposits to fund most of their loans. But having said that, you may still see us having to borrow $1 billion or so through this transition period till our stuff runs off.

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Bradley Jason Milsaps, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [30]

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Got it. No, that's helpful. Yes, their margin was down I think 17 basis points, [a lot of that] has to do with the warehouse. And your 3.40% NIM guide, does that obviously include the things you're talking about? Does it also include any accretion income that you would expect to get in '20?

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David E. Zalman, Prosperity Bancshares, Inc. - Chairman of the Board & CEO [31]

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We didn't include any accretion income in the...

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Bradley Jason Milsaps, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [32]

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Okay. Okay. And then just one final...

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David E. Zalman, Prosperity Bancshares, Inc. - Chairman of the Board & CEO [33]

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We don't want to start that again as...

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Bradley Jason Milsaps, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [34]

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I understand. I don't -- we don't want to model it either. Just in terms of CECL, I was just curious if you guys could provide any update. I know there'll be a lot of moving parts with Legacy coming in. They've, historically, maybe provisioned at a higher rate than you guys have. But you have the mark in everything else that goes with CECL. So just kind of curious how to think about sort of that aspect once the deal is closed?

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Asylbek Osmonov, Prosperity Bancshares, Inc. - CFO [35]

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Yes. This is Asylbek. Currently, we're -- both teams are running the parallel on CECL models as a stand-alone basis. But after the merger, we'll work on the consolidated model, like, aligning the, like, qualitative economic factor assumptions. And I think once we go through the process, we'll have better, clearer picture on the consolidated basis. But if it's stand-alone, I mean, our model is showing that we would have about $20 million to $30 million of additional provision related to CECL, which is about 23% to 34%.

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Bradley Jason Milsaps, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [36]

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Got it. That's helpful. And the charge-offs that Legacy had this quarter, obviously, I know you identified those. But does that change your mark at closing or will you still stick with the same -- the mark that you identified initially?

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David E. Zalman, Prosperity Bancshares, Inc. - Chairman of the Board & CEO [37]

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That's a good question. We had $175 million, so let us -- they'll just look at it and see.

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Operator [38]

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

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Matthew Covington Olney, Stephens Inc., Research Division - MD [39]

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From a capital planning standpoint with Legacy, I believe you'll be absorbing some sub-debt and trust-preferred securities. Just remind us of your plans, what you expect to do with this capital and how quickly you could do it.

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David E. Zalman, Prosperity Bancshares, Inc. - Chairman of the Board & CEO [40]

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Asylbek...

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Asylbek Osmonov, Prosperity Bancshares, Inc. - CFO [41]

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Yes. So we're planning to -- once the merger occurs, we're planning to pay off when their maturity comes in. So we're not going to keep it in our balance sheet going forward. But I think one of the maturity comes in in 2020.

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David E. Zalman, Prosperity Bancshares, Inc. - Chairman of the Board & CEO [42]

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We intend to pay off right away.

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Charlotte M. Rasche, Prosperity Bancshares, Inc. - Executive VP & General Counsel [43]

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Yes, in December, December 15.

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Asylbek Osmonov, Prosperity Bancshares, Inc. - CFO [44]

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It's about $15 million.

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Charlotte M. Rasche, Prosperity Bancshares, Inc. - Executive VP & General Counsel [45]

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Yes.

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Matthew Covington Olney, Stephens Inc., Research Division - MD [46]

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Got it. So trust-preferred's paid down almost immediately and the sub-debt comes due, you said in, 2020, is that right?

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Asylbek Osmonov, Prosperity Bancshares, Inc. - CFO [47]

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Yes. I think it's October 2020.

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Charlotte M. Rasche, Prosperity Bancshares, Inc. - Executive VP & General Counsel [48]

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I thought it was -- yes. (inaudible)

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Asylbek Osmonov, Prosperity Bancshares, Inc. - CFO [49]

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Yes. Next year.

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Matthew Covington Olney, Stephens Inc., Research Division - MD [50]

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Okay. Got it. And then going back to the margin discussion and specifically on the core loan yields. Once I back out the accretable income, I believe the core loan yields compressed about 5 bps this quarter. Obviously, you have some variable rate loans to put some pressure on that, but I was a little surprised to see 5 bps of pressure this quarter. Any color you can provide on that?

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David E. Zalman, Prosperity Bancshares, Inc. - Chairman of the Board & CEO [51]

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I -- you know, Matt, I didn't see that. Again, Asylbek, you might have gone into that. I -- when I looked at it -- again, when I compared income to income, I would -- we had probably more accretion last year than this year. So I didn't see the lower income on the loans.

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Asylbek Osmonov, Prosperity Bancshares, Inc. - CFO [52]

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This is Asylbek. On the loans core base, yes, we went down about 4 basis points on the loans. But it's because of their short-term and long-term rate environment we have, so some of those variable and floating loans we have that increased. But if you look at the over -- compared to last year, I mean, we were at core basis at 4.87% on loan yield and we had 5% this year. So compare year-over-year...

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David E. Zalman, Prosperity Bancshares, Inc. - Chairman of the Board & CEO [53]

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I kind of thought it was better, really. Because when you took out the additional accretion we had last year compared to the accretion this year, I thought it was actually better compared to last year.

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Asylbek Osmonov, Prosperity Bancshares, Inc. - CFO [54]

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Yes. We went up 13 basis points in comparison.

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David E. Zalman, Prosperity Bancshares, Inc. - Chairman of the Board & CEO [55]

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Yes. I thought it was positive.

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Asylbek Osmonov, Prosperity Bancshares, Inc. - CFO [56]

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Yes. Even -- in this rate environment it's pretty positive in my mind.

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Matthew Covington Olney, Stephens Inc., Research Division - MD [57]

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Okay. Thank you for that. And then just lastly, the premium amortization expense was about $400,000 higher in the third quarter than in 2Q. Obviously the rate environment is influencing that. As you look towards the fourth quarter, any color you can give us as far as your expectations on the premium amortization expense for 4Q?

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David E. Zalman, Prosperity Bancshares, Inc. - Chairman of the Board & CEO [58]

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You're referring to the securities portfolio basically, I guess?

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Matthew Covington Olney, Stephens Inc., Research Division - MD [59]

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Yes.

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David E. Zalman, Prosperity Bancshares, Inc. - Chairman of the Board & CEO [60]

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My general overall feeling is rates are rising. I think that you should see it decrease to maybe $300,000 from $400,000 probably.

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Asylbek Osmonov, Prosperity Bancshares, Inc. - CFO [61]

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I would echo the same thing, yes. I think it's -- I expect at stand-alone basis, probably less than what we had $8 million. But just...

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David E. Zalman, Prosperity Bancshares, Inc. - Chairman of the Board & CEO [62]

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I mean, it really -- if rates continue to stay where they're at -- it's crazy, we are seeing -- you're seeing the prime rate adjust in the overnight, but there's been some good things, which -- and a big part of this is, if you know our bank and I think you do, a lot of our yield's dependent on the 10-year treasury, and that's been extremely positive over the last few weeks. It's gone from 1.5% to almost 1.8%. And so that makes a big difference when we're buying securities or fixing rates for 5 years, it makes a big difference.

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Asylbek Osmonov, Prosperity Bancshares, Inc. - CFO [63]

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Yes. And I think there is additional seasonality too, because summertime, you know, there is a lot of homes being bought, that I think is going to come down in the fourth quarter. So that's going to help to slow it down as well.

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David E. Zalman, Prosperity Bancshares, Inc. - Chairman of the Board & CEO [64]

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But when that -- when your 10-year went down so much, I mean you saw a lot of refinancing. So if they -- if we can truly have a yield curve and not have this inverted yield curve, you shouldn't see as much of a paydown, I wouldn't think, that -- the refinancing I guess I'll refer to. [I doubt] they're dramatic one way or the other.

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Asylbek Osmonov, Prosperity Bancshares, Inc. - CFO [65]

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Right, right.

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Operator [66]

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

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Jon Glenn Arfstrom, RBC Capital Markets, Research Division - MD [67]

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Maybe one for you, Tim. Credit looks fine, but give us an update on health in ag and energy. And then maybe just, even though it's not a huge number, touch on the increase in NPLs?

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H. E. Timanus, Prosperity Bancshares, Inc. - Vice Chairman [68]

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Well, let me do the last part of the question first. The nonperforming list is really made up primarily of -- the bulk of it -- in 4 credits. They total about $33 million to $34 million. One of them is a home mortgage credit that we've got about $9 million in, and the appraisals that we have are in the $12 million to $13 million range. So on paper, there isn't a loss there. We shall see.

Another one is a well service company, and there's about $13 million to $14 million outstanding there. It's actually current. They're making the payments timely. On paper, once again, in terms of appraisals, there's enough equipment to pay it off and they also pledged additional real estate that has an appraised value of about $9 million. So on paper, we don't think there's any loss there.

And then the other 2 credits are commercial real estate credits, one about $7 million. It's actually current. We think there's value there. We think if we had to foreclose, we probably wouldn't lose anything or wouldn't lose much. But once again, it's current and it's actually performing at this moment. And then the second one is about $3 million. And we're going to be paid off, we think, by the end of this week. So when you take the $33 million, $34 million that's in these 4 credits out, it makes our nonperforming look pretty good.

Agriculture, it's not the best, but it's not a dramatic problem either. You hear a lot of publicity about the tariffs and all that and the government is covering a lot of these farmers with payments from the government in that regard. So while I don't think agriculture is booming and doing as well as it could, I don't see any big problems there.

And then what was the third part of the question?

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Jon Glenn Arfstrom, RBC Capital Markets, Research Division - MD [69]

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Energy, primarily energy service, yes.

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H. E. Timanus, Prosperity Bancshares, Inc. - Vice Chairman [70]

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Energy, in our opinion, is kind of in the doldrums. It's not getting significantly better, it's not getting significantly worse. Most of the people that we talk to think that the oil price is going to fluctuate between $45 and $55 over the course of the next year. The majority of the people that we do business with now can handle that. Obviously, if those predictions are incorrect and it goes way down, then it's a problem for everybody.

The service sector seems to be struggling more than the production side right now, I think, because of what I just said. I think the forecasts are flat in terms of pricing of the commodity. So there's not a whole lot of extra dollars being spent on service work. We've said over time that most of the customers that we have are customers that have been in business for a long time and have weathered the storms. They started the last downturn with strong balance sheets. Those balance sheets were hurt quite a bit in 2015, '16 and into '17, but they're still alive and are bouncing back a little bit. And so I don't see a whole lot of change right now.

Now the credits that Legacy is bringing to the table are more on the production side. I know that they have focused on removing some of those out of the bank, so we'll see how that goes. So I guess I have, personally, a little less confidence in where some of theirs are going to be. But having said that, we've looked at the credits. We think they're going to be okay and they're dealing with them, so we don't think there's any major issue there.

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Jon Glenn Arfstrom, RBC Capital Markets, Research Division - MD [71]

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Okay. That's all helpful. And then, David, maybe one for you. I think we all understand the efficiency from the merger and the expected runoff and we've seen you do that many times. But as you look through this a little bit more and talk with the Legacy management team, any areas where you are a bit more optimistic in terms of opportunities for new business, whether it's a product line or just larger lending limits?

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David E. Zalman, Prosperity Bancshares, Inc. - Chairman of the Board & CEO [72]

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I think it's a combination of that, Jon. I'm really excited about it. I mean, you really have -- mortgage warehouse, I would admit that we don't have the experience that they have in it, so we're there to learn in that. They have the commercial real estate portfolio that is a little bit different than ours.

But again, I think that this gives us an opportunity to really dominate 2 of the largest markets in [state] of Texas. You're going to -- I mean, we dominate Dallas, we dominate Houston, and I think just the size that we have and what we can offer, the different products that we can offer, we're really beefing up right now on our new cash management system. And so you combine that with the lenders that we have out there in both markets will become very prevalent.

And I think it's just -- I think it's a great opportunity. These guys really are -- have been great to work with. As Tim said, they do have some issues maybe on the oil and gas side, we've identified that. I think it's something we can work with. We've been through many of these things and I just think it's going to be a great opportunity, and if we can move through it quick, get a -- and we'll go onto our next deal.

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Jon Glenn Arfstrom, RBC Capital Markets, Research Division - MD [73]

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Okay. And then just one last one. You talked earlier about expanded use of technology. Any area -- specific area you'd call out where you feel like you have to catch up the quickest, where you might be at a disadvantage?

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David E. Zalman, Prosperity Bancshares, Inc. - Chairman of the Board & CEO [74]

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I don't know that we have to catch up. But for me, it -- I just think that if you're going to be in business, and I talked about this earlier before this meeting ever started, I just think almost everything has to be digital. It -- not only -- in the past, things were digital just on your checking account and you could look at your little -- your phone and all that. I think, going forward, your checking account has to be digital, your mortgage application has to be digital, your -- I think even small commercial loans are going to have to be more digital.

I think everything that we offer -- people are important on that, I mean I think it's a combination, but I think you're going to have to have the digital platform for everything. And I think that's what we're moving, to open up a new account, and doing just about anything, our goal is to really be digital in any product that we offer. That's my goal. And that doesn't happen overnight, but that's really my goal, really.

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Operator [75]

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The next question comes from [Ryan Orion].

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Unidentified Analyst [76]

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Is that me, [Brian Foran]? Okay, [Ryan Orion], with no firm. I am unattached. Maybe just going back to what the pro forma financials are going to look like. If you kind of put the 2 balance sheets together and just think about normalized mortgage warehouse, some of the funding efficiencies, I mean is kind of the earning assets land around $28 billion, and then they'll do whatever from there based on growth, or is it a little lower or higher than that? Can you help us think about just a point estimate or a range for where earning assets might be in, call it, 6 months once most of the dust has settled on the repositioning?

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David E. Zalman, Prosperity Bancshares, Inc. - Chairman of the Board & CEO [77]

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Again, that's a just -- Asylbek will give you better color on it. My gut feeling, it's around $30 billion.

Do you have it, Asylbek?

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Asylbek Osmonov, Prosperity Bancshares, Inc. - CFO [78]

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Yes. I think it's going to be around between $28 billion to $30 billion...

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David E. Zalman, Prosperity Bancshares, Inc. - Chairman of the Board & CEO [79]

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Assets -- total assets?

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Asylbek Osmonov, Prosperity Bancshares, Inc. - CFO [80]

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No, these are earning assets.

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David E. Zalman, Prosperity Bancshares, Inc. - Chairman of the Board & CEO [81]

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Earnings assets.

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Asylbek Osmonov, Prosperity Bancshares, Inc. - CFO [82]

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Yes. Total assets if we spend as of 9/30, it's about $32 billion to $33 billion.

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David E. Zalman, Prosperity Bancshares, Inc. - Chairman of the Board & CEO [83]

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Right.

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Unidentified Analyst [84]

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And then maybe just more broadly on the deal. I mean you certainly referenced, David, you and Kevin have hit it off. At the time, there was a lot of concern and narrative that maybe the cultures didn't mesh and maybe some of the LegacyTexas lenders' higher-than-expected attrition could be a key risk for the deal. I know it hasn't even closed yet, so it's early.

But just any -- how are you feeling on that next level down? I don't know if you've had a chance to talk with those lenders or Kevin, but as you look at that next level down, do you feel better, worse or about the same on LegacyTexas commercial lending -- lender attrition?

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David E. Zalman, Prosperity Bancshares, Inc. - Chairman of the Board & CEO [85]

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I feel good where we're at. They've gotten over, was it 50 or 60?

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Asylbek Osmonov, Prosperity Bancshares, Inc. - CFO [86]

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62.

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David E. Zalman, Prosperity Bancshares, Inc. - Chairman of the Board & CEO [87]

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62 signed contracts. Most of their people all signed contracts to stay with us. So that means they're not endured to life with us, but they're giving us a chance. And every deal that has been successful in our history -- we've done 42 of them -- and only 2 of them, I wouldn't say I regret, they've been tough. And every deal that's been extremely successful is successful because of the management that stays with us. So the success of this deal truly will be -- it will be because of Kevin, Mays, the team -- Aaron, Chuck, the team that stayed, Tom, and it would those guys, if they're staying and they're going to be a part of it, this deal is going to work fine.

I'm looking at the table, around the table right now, and I see Tim brought his company over and the majority of all of his people stayed. I look at Eddie, he brought his people over, majority of his people stayed. So the success of any of this thing -- of everything is to really make it -- everybody has to work together and management has to be part of it. If management is not part of it then it's a tougher deal.

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Operator [88]

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This concludes our question-and-answer session. I would like to now 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 [89]

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Thank you, Jake. 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.

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Operator [90]

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