Prosperity Bancshares, Inc. — 2Q 2020 Form 10-Q Summary
Business context and reporting period
Prosperity Bancshares, Inc. is a Texas-based financial holding company whose principal subsidiary, Prosperity Bank, provides banking services to businesses and consumers in Texas and Oklahoma. The filing covers the quarter and six months ended June 30, 2020. The Bank operated 275 full-service locations at quarter-end. Results include the LegacyTexas merger from November 1, 2019 and reflect the COVID-19 environment.
Key financial metrics
| Metric | Three months ended June 30, 2020 | Three months ended June 30, 2019 | Six months ended June 30, 2020 | Six months ended June 30, 2019 |
|---|---|---|---|---|
| Total interest income | $286.6 million | $187.8 million | $582.8 million | $373.9 million |
| Net interest income | $259.0 million | $154.8 million | $515.0 million | $309.7 million |
| Provision for credit losses | $10.0 million | $0.8 million | $10.0 million | $1.5 million |
| Noninterest income | $25.7 million | $30.0 million | $60.1 million | $58.1 million |
| Noninterest expense | $134.4 million | $80.8 million | $259.1 million | $159.4 million |
| Net income | $130.9 million | $82.3 million | $261.7 million | $164.7 million |
| Diluted EPS | $1.41 | $1.18 | $2.80 | $2.36 |
| Tax-equivalent net interest margin | 3.69% | 3.16% | 3.75% | 3.18% |
- Second-quarter net income increased 59.1%; six-month net income increased 59.0%. Results benefited from a $20.1 million CARES Act net operating loss carryback tax benefit, partly offset by $7.5 million of merger-related expenses in the quarter.
- Annualized second-quarter return on average common equity was 8.84%, return on average assets was 1.61%, and the efficiency ratio was 46.56%. Six-month figures were 8.85%, 1.64%, and 44.72%, respectively.
- Total assets were $32.97 billion at June 30, 2020, compared with $32.19 billion at December 31, 2019. Total loans were $21.03 billion, up 11.6%, and deposits were $26.15 billion, up 8.1%.
- Warehouse Purchase Program loans increased to $2.56 billion from $1.55 billion at year-end. PPP approvals totaled approximately 11,945 loans and $1.39 billion at June 30, 2020.
- The allowance for credit losses on loans was $324.2 million, or 1.54% of total loans, versus $87.5 million, or 0.46%, at December 31, 2019. The allowance for off-balance-sheet credit exposures was $29.9 million versus $5.6 million.
- Nonperforming assets were $77.9 million, or 0.37% of total loans and other real estate, versus $62.9 million and 0.33% at year-end. Nonaccrual loans were $62.9 million.
- Cash and cash equivalents were $333.4 million, down from $574.1 million at year-end. Six-month operating cash flow was $437.4 million; investing activities used $1.23 billion, while financing activities provided $548.6 million.
- Other borrowings totaled $103.1 million, down from $1.30 billion at December 31, 2019. Repurchase agreements were $365.3 million and subordinated notes were $125.4 million.
- Total shareholders’ equity was $5.95 billion. The Company repurchased 2.1 million shares for $110.1 million during the first six months and declared dividends of $0.92 per share.
- The Bank remained above “well capitalized” regulatory thresholds, with a CET1 ratio of 12.73%, total risk-based capital ratio of 13.23%, and Tier 1 leverage ratio of 9.74% at June 30, 2020.
Material changes versus comparable periods
- Net interest income rose primarily because of the LegacyTexas merger, larger loan balances, and higher acquired-loan discount accretion. Loan discount accretion increased by approximately $23.0 million in the quarter and $49.7 million year to date.
- Net interest margin expanded by 53 basis points in the quarter and 57 basis points year to date, while interest expense declined in the quarter despite substantially higher average interest-bearing liabilities.
- Noninterest expense increased 66.3% in the quarter and 62.6% year to date, primarily from merger-related operating costs, higher salaries and benefits, data processing, occupancy, and other expenses.
- Noninterest income declined 14.3% in the quarter because of a $3.9 million loss on sale or write-down of assets and lower NSF fees. Year-to-date noninterest income increased 3.4%.
- The Company adopted CECL on January 1, 2020. The adoption increased the loan allowance by $240.5 million and the off-balance-sheet allowance by $24.3 million, reducing retained earnings by $92.9 million on a pre-tax basis. The Company elected regulatory capital relief for CECL.
- Common shares outstanding declined to 92.7 million from 94.7 million at year-end due to repurchases. Shareholders’ equity nevertheless declined modestly because of dividends, repurchases, CECL adoption, and accumulated other comprehensive losses.
Guidance, outlook, commentary, risks, and unusual items
- The filing provides no quantitative earnings or revenue guidance. Management states that the impact and duration of COVID-19 cannot be reliably estimated and that six-month results are not necessarily indicative of full-year results.
- COVID-19 may increase borrower financial distress, unemployment, loan delinquencies, collateral losses, operating costs, regulatory scrutiny, and liquidity or capital pressure. The Company provided loan extensions and deferrals and participated in the PPP.
- Key credit concentrations include commercial real estate, 1-4 family residential, and construction, land development, and other land loans, which together represented 71.3% of loans excluding Warehouse Purchase Program loans. Oil and gas loans were $639.4 million, or 3.0% of total loans, and hotel and restaurant loans were $384.8 million and $212.3 million, respectively.
- Management identified interest-rate volatility, economic weakness, oil and gas conditions, deposit and loan competition, merger integration, goodwill impairment, CECL estimation, liquidity, cybersecurity, vendor performance, litigation, and regulatory changes as material risks.
- LegacyTexas-related goodwill was $1.33 billion at June 30, 2020; no goodwill or core deposit intangible impairment was recorded. Merger-related expenses were $8.0 million for the first six months.
- The Company reported no material adverse effect from pending legal proceedings and stated that disclosure controls were effective with no material changes in internal control over financial reporting.
Important facts for investors to verify
- Whether COVID-19-related deferrals, PPP forgiveness timing, unemployment, oil and gas weakness, and commercial real estate stress produce additional delinquencies, charge-offs, or CECL provisions.
- Whether the $324.2 million loan allowance and $29.9 million off-balance-sheet allowance remain adequate under updated economic forecasts.
- The sustainability of elevated net interest margin and acquired-loan discount accretion after merger-related benefits diminish.
- The future effect of the LegacyTexas integration, merger expenses, goodwill valuation, and expected cost synergies.
- Liquidity relative to cash of $333.4 million, $6.18 billion of off-balance-sheet commitments, and the Company’s reliance on deposits and available FHLB capacity.
- The effect of share repurchases and dividends on capital ratios, particularly after the temporary CECL regulatory capital relief expires.