Prosperity Bancshares, Inc. — 2018 Third-Quarter Form 10-Q
Business Context and Reporting Period
Prosperity Bancshares, Inc. is a Texas-based financial holding company whose principal subsidiary, Prosperity Bank, provides banking products and services to small and medium-sized businesses and consumers in Texas and Oklahoma. As of September 30, 2018, the Bank operated 242 full-service locations. This unaudited Form 10-Q covers the three and nine months ended September 30, 2018, compared with the corresponding 2017 periods.
Key Financial Metrics
| Metric | Three Months 2018 | Three Months 2017 | Nine Months 2018 | Nine Months 2017 |
|---|---|---|---|---|
| Net interest income | $157.3 million | $156.1 million | $472.3 million | $460.8 million |
| Provision for credit losses | $2.4 million | $6.9 million | $15.4 million | $12.3 million |
| Noninterest income | $30.6 million | $28.8 million | $86.9 million | $87.4 million |
| Noninterest expense | $81.8 million | $77.5 million | $245.4 million | $232.0 million |
| Net income | $82.5 million | $67.9 million | $238.5 million | $205.0 million |
| Diluted EPS | $1.18 | $0.98 | $3.42 | $2.95 |
- Third-quarter net income increased 21.5%; nine-month net income increased 16.3%.
- Annualized return on average assets was 1.46% for the quarter and 1.41% for the nine-month period. Return on average common equity was 8.30% and 8.11%, respectively.
- The efficiency ratio was 43.50% for the quarter and 43.88% for the nine-month period, compared with 41.92% and 42.42% in the prior-year periods.
- Tax-equivalent net interest margin was 3.15% for the quarter and 3.20% for the nine-month period, compared with 3.22% and 3.18%, respectively.
Balance Sheet, Liquidity and Capital
- Total assets were $22.61 billion at September 30, 2018, essentially unchanged from $22.59 billion at December 31, 2017.
- Total loans were $10.29 billion, up 2.7% from year-end 2017. Commercial real estate, 1-4 family residential, and construction and land loans represented 75.3% of total loans.
- Total deposits were $16.73 billion, down 6.1% from year-end. Noninterest-bearing deposits increased 1.4%, while interest-bearing deposits declined 9.5%; management attributed the decline primarily to seasonality.
- Other borrowings increased to $1.50 billion from $505.2 million, principally reflecting a $1.0 billion increase in short-term FHLB advances. The Company had $5.48 billion of total funds available under its FHLB agreement, with $1.50 billion outstanding.
- Cash and cash equivalents were $294.5 million, down from $392.3 million at year-end. Nine-month operating cash flow was $226.2 million, investing activities used $130.0 million, and financing activities used $194.1 million.
- Shareholders’ equity was $4.00 billion, up 4.5%, primarily from net income, partly offset by $75.4 million of dividends.
- The Bank remained well capitalized. Its September 30, 2018 CET1, Tier 1, total capital and Tier 1 leverage ratios were 15.85%, 15.85%, 16.51% and 9.88%, respectively.
Material Changes Versus Prior Comparable Period
- Net interest income increased modestly as higher loan and securities yields and loan growth were substantially offset by higher funding costs and lower loan discount accretion.
- Third-quarter net interest margin declined because of a $4.4 million reduction in loan discount accretion; the nine-month margin improved modestly because of higher asset yields.
- Provision expense decreased substantially in the third quarter, while the nine-month provision increased because of higher legacy-loan provisions.
- Noninterest expense increased 5.5% for the quarter and 5.8% year to date, primarily due to higher salaries and employee benefits.
- The effective tax rate declined to 20.5% for the quarter and 20.1% year to date from 32.5% in both 2017 periods, primarily due to the Tax Cuts and Jobs Act.
- Nonperforming assets declined to $16.8 million, or 0.16% of loans and other real estate, from $37.5 million, or 0.37%, at December 31, 2017. The decline was primarily attributable to the sale of $9.3 million of other real estate and lower commercial and industrial nonaccrual loans.
- The allowance for credit losses was $86.0 million, or 0.84% of total loans, compared with $84.0 million, or 0.84%, at year-end. Nine-month net charge-offs increased to $13.4 million from $10.8 million.
Outlook, Risks, Contingencies and Unusual Items
- Management stated that it intends to continue pursuing internal growth, operating efficiency and acquisitions or strategic merger opportunities. The filing provides no formal earnings or revenue guidance.
- Management believes securities portfolio unrealized losses are temporary and primarily reflect higher market interest rates, not credit deterioration. Held-to-maturity securities had $335.953 million of unrealized losses at September 30, 2018.
- Management believes the allowance for credit losses is adequate, but acknowledges that future adjustments could be substantial if economic conditions or borrower performance differ from assumptions.
- Loan concentrations and risks include Texas and Oklahoma markets, real-estate-backed lending, construction and land development, commercial real estate, agriculture and oil-and-gas lending. Oil-and-gas loans totaled $365.1 million, with $230.1 million of unfunded commitments.
- Off-balance-sheet commitments totaled $2.59 billion, including $2.53 billion of commitments to extend credit and $62.8 million of standby letters of credit; actual funding may be lower because commitments can expire unused.
- The Company had $1.90 billion of goodwill and reported no goodwill impairment. Changes in cash flows, profitability or valuation assumptions could nevertheless result in future impairment.
- ASU 2016-13, the current expected credit loss standard, is effective for the Company on January 1, 2020. The Company was developing its implementation plan and had not determined the potential financial statement impact.
- The Company reported no material changes in market-risk exposures or risk factors from the 2017 Form 10-K. Routine legal proceedings are not expected to have a material adverse effect.
Important Facts for Investors to Verify
- Whether deposit declines attributed to seasonality reverse and how reliance on FHLB advances affects funding costs and liquidity.
- Whether net interest margin remains pressured by deposit repricing, higher borrowing costs and declining purchase-accounting accretion.
- Credit performance in the real-estate-heavy loan portfolio, including construction, commercial real estate and oil-and-gas exposures.
- Future provision requirements, net charge-offs and the adequacy of the $86.0 million allowance as the loan portfolio grows.
- The eventual balance-sheet and earnings impact of adopting the current expected credit loss standard in 2020.
- Whether the $2.53 billion of unfunded credit commitments translate into material cash funding needs.
- The effect of interest-rate changes on the securities portfolio, including the significant unrealized losses in held-to-maturity mortgage-backed securities.