Prosperity Bancshares, Inc. — FY2019 Form 10-K Summary
Business context and reporting period
Prosperity Bancshares, Inc. is a Texas-based financial holding company whose principal subsidiary, Prosperity Bank, provides commercial and retail banking services across Texas and Oklahoma. The filing covers the fiscal year ended December 31, 2019. At year-end, the Bank operated 285 full-service banking locations and had 3,901 full-time equivalent associates.
The November 1, 2019 merger with LegacyTexas Financial Group materially expanded the franchise. Prosperity issued 26.2 million shares and paid approximately $318.0 million in cash. LegacyTexas contributed 42 banking centers in North Texas and added commercial middle-market, energy, mortgage warehouse and insurance lending capabilities.
Key financial metrics
| Metric | 2019 | 2018 | Change |
|---|---|---|---|
| Total assets | $32.19 billion | $22.69 billion | +41.9% |
| Total deposits | $24.20 billion | $17.26 billion | +40.2% |
| Total loans | $18.85 billion | $10.37 billion | +81.7% |
| Net interest income | $695.8 million | $629.6 million | +10.5% |
| Provision for credit losses | $4.3 million | $16.4 million | Down $12.1 million |
| Noninterest income | $124.3 million | $116.0 million | +7.1% |
| Noninterest expense | $396.5 million | $326.2 million | +21.6% |
| Net income | $332.6 million | $321.8 million | +3.3% |
| Diluted EPS | $4.52 | $4.61 | Down $0.09 |
| Net interest margin, tax equivalent | 3.32% | 3.18% | +14 basis points |
| Return on average assets | 1.38% | 1.42% | Down 4 basis points |
| Return on average common equity | 7.46% | 8.15% | Down 69 basis points |
| Efficiency ratio | 48.25% | 43.71% | Higher by 454 basis points |
Growth in net interest income reflected higher loan volumes, loan discount accretion from the LegacyTexas merger and higher loan yields. Interest expense increased 40.5% to $137.2 million as funding costs rose; average cost of funds increased to 0.70% from 0.52%.
Merger-related expenses were $46.4 million, contributing to the increase in noninterest expense and the decline in EPS, return ratios and efficiency. The effective tax rate was 20.7%, compared with 20.2% in 2018.
Cash flow, debt and liquidity
- Net cash provided by operating activities was $403.0 million, compared with $320.1 million in 2018.
- Investing activities provided $1.26 billion, primarily reflecting securities maturities and paydowns, net Warehouse Purchase Program activity and related acquisition cash flows.
- Financing activities used $1.50 billion, principally due to reductions in short-term borrowings, dividends of $128.9 million, share repurchases of $94.5 million and the redemption of junior subordinated debentures.
- Cash and cash equivalents increased to $574.1 million from $411.1 million.
- Year-end borrowings included $1.30 billion of FHLB advances and other borrowings, $377.3 million of repurchase agreements and $125.8 million of subordinated notes. The Company had $6.72 billion of additional capacity under its FHLB line.
- At December 31, 2019, the Company had $4.38 billion of commitments to extend credit, $127.9 million of standby letters of credit and $657.2 million of unused Warehouse Purchase Program capacity.
Asset quality, capital and portfolio composition
- Nonperforming assets increased to $62.9 million from $19.0 million, although the ratio remained relatively low at 0.33% of loans and other real estate, versus 0.18% in 2018.
- Nonaccrual loans increased to $55.2 million from $13.1 million. Troubled debt restructurings totaled $13.6 million at year-end, compared with $51 thousand in 2018.
- The allowance for credit losses was $87.5 million, or 0.46% of total loans and 157.1% of nonperforming loans. Net charge-offs declined to $3.3 million from $14.0 million.
- Loans were concentrated in commercial real estate, 1-4 family residential, construction and land development, and commercial and industrial lending. Commercial real estate, 1-4 family residential and construction loans represented approximately 68.6% of total loans excluding certain presentation differences.
- Warehouse Purchase Program loans totaled $1.55 billion, or 8.2% of loans, at year-end; the average balance during 2019 was $251.3 million, creating significant period-end volatility in reported capital and liquidity measures.
- The Company reported CET1, total risk-based capital and leverage ratios of 12.30%, 12.70% and 10.42%, respectively. The Bank reported 12.49%, 12.89% and 10.58%, respectively, and was classified as well capitalized.
Material changes versus the prior comparable period
- The LegacyTexas merger increased total assets by approximately $9.49 billion year over year and added $1.32 billion of goodwill and $60.1 million of core deposit intangibles.
- Common shares outstanding increased from approximately 69.8 million to 94.7 million, primarily because of merger consideration. Shareholders’ equity increased 47.3% to $5.97 billion.
- Loan growth was substantially faster than deposit growth, driven primarily by the merger. Loans-to-deposits increased to 77.9% at year-end.
- Securities declined 8.9% to $8.57 billion and represented 26.6% of assets, compared with 41.5% in 2018.
- Noninterest expense increased disproportionately to revenue because of merger costs and two months of LegacyTexas operating expenses, increasing the efficiency ratio to 48.25%.
- The Company repurchased 1.47 million shares at an average price of $64.10 per share during 2019 and authorized a new program in January 2020 for up to approximately 4.74 million shares.
Guidance, outlook, commentary and risks
Management expects to continue pursuing community banking, internal loan and deposit growth, disciplined acquisitions, cross-selling and centralized operating efficiencies. The filing does not provide formal quantitative earnings or revenue guidance.
The Company adopted the current expected credit loss standard, or CECL, on January 1, 2020. Based on the year-end portfolio and then-current economic expectations, management estimated that the allowance for credit losses and reserve for unfunded commitments would be approximately $340 million to $360 million, with approximately $130 million to $140 million of the increase recorded as an equity adjustment and the remainder reflected through acquired-loan fair value discounts.
- Key risks include interest-rate sensitivity, competition for deposits, credit deterioration, real estate and construction concentrations, oil and gas exposure, and the ability to integrate LegacyTexas.
- Oil and gas production and service loans totaled approximately $698.3 million, or 4.0% of loans excluding Warehouse Purchase Program loans. The Texas and Oklahoma economies remain sensitive to oil and gas prices.
- Goodwill totaled $3.22 billion. Management reported no impairment at year-end, but adverse changes in profitability, cash flows or valuation assumptions could result in future impairment charges.
- The Company is subject to extensive banking, consumer protection, cybersecurity, anti-money-laundering and capital regulation. Litigation arising in the ordinary course was not expected to have a material adverse effect.
- Interest-rate modeling indicated that a 200-basis-point increase could increase 12-month net interest income by 7.3%, while a 100-basis-point decrease could reduce it by 2.8%; actual results may differ materially from the model.
Most important facts for investors to verify
- Whether the LegacyTexas integration produces expected cost savings, revenue benefits and asset-quality outcomes after the first full year of combined operations.
- The actual CECL adoption adjustment and subsequent allowance levels compared with the estimated $340 million to $360 million range.
- Trends in nonperforming assets, troubled debt restructurings, charge-offs and criticized commercial real estate, construction and energy credits.
- Deposit retention, funding costs and loan-to-deposit trends as the enlarged balance sheet matures.
- The sustainability of the 3.32% net interest margin as loan discount accretion declines and interest-rate conditions change.
- Goodwill impairment sensitivity and the final fair-value adjustments related to the LegacyTexas acquisition.
- Future capital ratios after changes in Warehouse Purchase Program balances, dividends and share repurchases.