PROSPERITY BANCSHARES INC annual report, FY2022

Business Context and Reporting Period

Prosperity Bancshares, Inc. is a Texas-based financial holding company whose primary subsidiary, Prosperity Bank, provides commercial and retail banking services across Texas and Oklahoma. The Form 10-K covers the fiscal year ended December 31, 2022; fourth-quarter data is included in the unaudited quarterly information. The Bank operated 272 full-service locations and had 3,633 full-time equivalent associates at year-end.

Management’s strategy emphasizes community banking, deposit and loan growth, operating efficiency, disciplined acquisitions and maintaining asset quality. Two acquisitions announced in October 2022 remained pending at year-end.

Financial Performance and Position

Metric	2022	2021	Change
Net income	$524.5 million	$519.3 million	+1.0%
Diluted EPS	$5.73	$5.60	+2.3%
Net interest income	$1.005 billion	$993.3 million	+1.2%
Net interest margin, tax equivalent	3.00%	3.14%	-14 bps
Noninterest income	$145.1 million	$140.0 million	+3.7%
Noninterest expense	$484.2 million	$473.6 million	+2.2%
Return on average assets	1.39%	1.44%	Down 5 bps
Return on average common equity	7.97%	8.21%	Down 24 bps
Efficiency ratio, excluding gains and losses	42.23%	41.83%	Up 40 bps

Interest income increased 4.6% to $1.095 billion, led by a 48.4% increase in securities interest income. Loan interest income declined 4.5%, primarily because of lower PPP fee income and lower loan discount accretion. Interest expense increased 67.1% to $89.6 million as rates on interest-bearing liabilities rose and the Company used additional borrowings.

Fourth-quarter 2022 net income was $137.9 million, or $1.51 diluted EPS, compared with $126.8 million, or $1.38 diluted EPS, in fourth-quarter 2021. Fourth-quarter net interest income was $256.1 million, while interest expense increased to $52.5 million from $8.9 million in the prior-year quarter.

Balance Sheet, Credit Quality and Capital

• Total assets were $37.69 billion, down slightly from $37.83 billion.
• Total loans were $18.84 billion, up 1.2%. Loans were 66.0% of deposits and 50.0% of total assets.
• Loan concentration remained significant: real estate-related loans represented approximately 80.3% of loans excluding Warehouse Purchase Program loans. Commercial real estate loans were $4.99 billion, 1-4 family residential and home equity loans were $6.74 billion, and construction, land development and other land loans were $2.81 billion.
• Nonperforming assets were $27.5 million, or 0.15% of loans and other real estate, compared with $28.1 million and 0.15% in 2021.
• The allowance for credit losses on loans was $281.6 million, or 1.49% of total loans, compared with $286.4 million, or 1.54%, in 2021. No provision for credit losses was recorded in 2022, and net charge-offs declined to $4.8 million from $29.7 million.
• Total deposits declined 7.3% to $28.53 billion, primarily because of lower public fund deposits. Noninterest-bearing deposits increased 1.5% to $10.92 billion and represented 38.3% of year-end deposits.
• Year-end borrowings included $1.85 billion of FHLB advances and $428.1 million of repurchase agreements, compared with no FHLB advances and $448.1 million of repurchase agreements at December 31, 2021.
• Cash and cash equivalents declined to $424.1 million from $2.55 billion, principally due to securities purchases, lower deposits, dividends and share repurchases. The Company had $13.75 billion of additional FHLB borrowing capacity.
• Shareholders’ equity increased 4.2% to $6.70 billion. The Company paid $193.1 million of dividends and repurchased 981,884 shares for $65.7 million during 2022.
• The Company’s CET1, total risk-based capital and leverage ratios were 15.88%, 16.51% and 10.16%, respectively. The Bank’s corresponding ratios were 15.83%, 16.46% and 10.12%; the Bank was classified as well capitalized.

Material Changes Versus the Prior Comparable Period

• Profitability improved modestly, but returns and net interest margin declined as funding costs increased.
• Investment securities increased 12.9% to $14.48 billion and represented 38.4% of total assets, up from 33.9%. The portfolio had $1.64 billion of gross unrealized losses on held-to-maturity securities, primarily reflecting higher market interest rates; management stated that it did not expect material credit losses.
• Deposits decreased $2.24 billion, while FHLB borrowings increased to $1.85 billion, materially changing the funding mix and contributing to the decline in cash balances.
• Loan growth was modest overall, but construction, land development and other land loans increased 22.0%, and 1-4 family residential and home equity loans increased 19.1%. Warehouse Purchase Program loans declined 58.3% to $740.6 million.
• Net charge-offs fell substantially, and nonperforming assets remained low. However, the allowance declined despite a higher-rate and potentially more challenging economic environment.
• Noninterest income increased, while mortgage income fell to $1.4 million from $8.3 million. Merger-related expenses of $272 thousand were recorded in 2022.
• The Company continued transitioning away from LIBOR. Approximately 1.5% of the loan portfolio and certain derivatives and other instruments remained linked to LIBOR at year-end, representing approximately $291.4 million of outstanding loans and other exposures.

Outlook, Commentary, Risks and Unusual Items

The Company did not provide formal earnings or revenue guidance in the filing. Management expects to continue pursuing internal growth and acquisitions while maintaining cost controls and prudent underwriting.

Pending acquisitions of First Bancshares of Texas and Lone Star State Bancshares were expected to close in the first half of 2023, subject to shareholder and regulatory approvals. Consideration consisted of approximately $341.6 million for First Bancshares and $228.7 million for Lone Star, based on the cited October 7, 2022 stock price. The transactions would require cash payments and issuance of approximately 3.58 million and 2.38 million shares, respectively.

• Key earnings sensitivities include deposit pricing, funding costs, interest-rate movements, securities duration and asset-liability repricing behavior. A modeled 200-basis-point rate increase was projected to increase 12-month net interest income by only 2.0%, versus 11.0% under the December 31, 2021 balance sheet.
• Credit risks are concentrated in Texas and Oklahoma real estate, including commercial real estate, construction and residential lending. Risks include declining property values, higher interest rates, recession, inflation, oil and gas volatility and borrower stress.
• The Company had $3.23 billion of goodwill. Management concluded that goodwill was not impaired at December 31, 2022, but adverse changes in cash flows, profitability or valuation could require a future write-down.
• Off-balance-sheet commitments totaled $6.88 billion, including $5.37 billion of commitments to extend credit, $1.44 billion of unused Warehouse Purchase Program capacity and $64.0 million of standby letters of credit. The filing states that these commitments may expire unused.
• Management identified the allowance for credit losses as a significant estimate, relying on historical losses, current conditions, forecasts and qualitative adjustments. The independent auditor identified the general valuation allowance as a critical audit matter.
• Additional risks include liquidity and deposit outflows, reliance on FHLB funding, cybersecurity and vendor disruptions, regulatory changes, climate and severe weather events, litigation, competition and acquisition integration.
• The Company and auditor reported effective internal control over financial reporting, and the auditor issued unqualified opinions on the financial statements and internal controls.

Investor Verification Checklist

• Verify subsequent closing, accounting treatment, funding and integration progress for the First Bancshares and Lone Star acquisitions.
• Monitor deposit trends, uninsured deposits of $12.41 billion at year-end, deposit pricing and continued reliance on FHLB advances.
• Assess the unrealized losses and liquidity implications of the held-to-maturity securities portfolio, including its $12.39 billion fair value versus $14.02 billion amortized cost.
• Review commercial real estate, construction and residential loan performance, criticized assets, delinquencies and changes in the allowance for credit losses.
• Evaluate whether the decline in net interest margin and the modeled reduction in rate sensitivity could pressure future earnings as deposit costs rise.
• Track the remaining LIBOR-linked exposures and the completion of transition to SOFR or other replacement indices.
• Reconcile cash flow, securities purchases, deposit movements and borrowings to assess near-term liquidity resilience.
• Review goodwill impairment sensitivity and the effect of acquisition-related share issuance and cash consideration on per-share results and capital.