PROSPERITY BANCSHARES INC quarterly report, Q2 FY2011

Prosperity Bancshares, Inc. — Form 10-Q Summary

Business Context and Reporting Period

Prosperity Bancshares, Inc. is a Texas financial holding company whose principal subsidiary, Prosperity Bank, provides banking products and services to small and medium-sized businesses and consumers primarily in Texas. The filing covers the unaudited quarter and six months ended June 30, 2011, with comparisons to the corresponding 2010 periods and to December 31, 2010 for balance-sheet items.

Key Financial Metrics

Metric	Three months ended June 30, 2011	Three months ended June 30, 2010	Six months ended June 30, 2011	Six months ended June 30, 2010
Net interest income	$83.6 million	$80.6 million	$164.0 million	$158.4 million
Provision for credit losses	$1.4 million	$3.3 million	$3.1 million	$7.7 million
Noninterest income	$13.5 million	$13.3 million	$27.4 million	$26.3 million
Noninterest expense	$42.5 million	$43.0 million	$84.2 million	$82.8 million
Net income	$35.1 million	$31.7 million	$69.0 million	$62.7 million
Diluted EPS	$0.75	$0.68	$1.47	$1.34

Second-quarter net income increased 10.5%; first-half net income increased 9.9%.
Tax-equivalent net interest margin was 4.06% in the second quarter versus 4.00% in the prior-year quarter, but 4.04% for the first half versus 4.09% in the prior-year period.
Second-quarter return on average assets was 1.45%, return on average common equity was 9.36%, and the efficiency ratio was 43.58%. First-half figures were 1.43%, 9.29%, and 43.94%, respectively.
At June 30, 2011, total assets were $9.66 billion, loans were $3.67 billion, deposits were $7.67 billion, and shareholders’ equity was $1.51 billion.
Cash and cash equivalents were $146.3 million, compared with $159.4 million at December 31, 2010.
The allowance for credit losses was $51.9 million, or 1.42% of total loans, compared with 1.48% at year-end 2010. First-half net charge-offs were $2.8 million, or 0.15% of average loans on an annualized basis.
Total other borrowings were $248.8 million, securities sold under repurchase agreements were $91.3 million, and junior subordinated debentures were $85.1 million at June 30, 2011.
Consolidated capital ratios were 15.93% total risk-based capital, 14.72% Tier 1 risk-based capital, and 7.24% Tier 1 leverage. The Bank exceeded regulatory “well capitalized” thresholds.

Material Changes Versus Prior Comparable Period

Net interest income rose primarily because average interest-earning assets increased and deposit pricing declined. The average rate paid on interest-bearing liabilities fell to 0.76% from 1.17% in the second quarter.
Interest income declined despite higher loan balances because securities yields and overall earning-asset yields decreased. Average earning-asset yield fell to 4.59% from 4.89%.
The provision for credit losses declined 57% in the quarter and 60% for the first six months, while net charge-offs also decreased.
Loans increased $180.2 million, or 5.2%, from year-end 2010. Growth was concentrated in 1-4 family residential, commercial mortgage, farmland, and commercial and industrial loans; construction and land-development loans declined.
Deposits increased $212.8 million, or 2.9%, and noninterest-bearing deposits rose to 23.3% of total deposits from 22.4% at year-end.
Other borrowings decreased $125.6 million from year-end, while repurchase agreements increased $30.6 million.
Noninterest expense declined 1.2% in the quarter but increased 1.7% for the first six months. Salaries and employee benefits increased 7.0% in the quarter and 8.4% year to date, primarily due to higher incentive compensation.
Nonperforming assets declined to $12.7 million from $15.8 million at year-end, and the ratio to loans and other real estate improved to 0.35% from 0.45%.

Cash Flow, Liquidity, Outlook, and Risks

For the first six months, operating activities provided $110.7 million, investing activities used $222.2 million, and financing activities provided $98.5 million, resulting in a $13.1 million decrease in cash and cash equivalents.
Investing uses included $1.38 billion of securities purchases and $189.8 million of loan growth, partially offset by $1.34 billion of securities maturities, sales, and principal repayments.
Management states that deposits remain the primary funding source and loans the primary use of funds. The Company generally does not rely heavily on purchased funds and reported $3.20 billion of total capacity under its FHLB collateral agreement, of which $248.8 million was outstanding.
Off-balance-sheet commitments totaled $460.5 million, including $444.8 million of commitments to extend credit and $15.8 million of standby letters of credit. These commitments may expire unused and do not necessarily represent future cash funding requirements.
Contractual obligations totaled $408.2 million, including future payments on junior subordinated debentures, FHLB borrowings, and operating leases.
Management provided no quantitative earnings guidance. It described a strategy focused on internal growth, cost control, and strategic acquisitions, while cautioning that results are subject to economic conditions, interest rates, credit quality, deposit and loan competition, liquidity, regulation, acquisition execution, goodwill impairment, and securities valuations.
The Company sold two non-agency collateralized mortgage obligations after their downgrade below investment grade, recording a $581,000 securities loss. Management stated that it did not believe its remaining securities were impaired for credit-quality reasons.
The Company redeemed $7.2 million of junior subordinated debentures in March 2011 and incurred a $383,000 payoff penalty recorded as interest expense.
No material changes to previously disclosed risk factors were reported. Management concluded that disclosure controls were effective and that no material adverse legal proceedings were pending.

Important Facts for Investors to Verify

Confirm the sustainability of loan and deposit growth and the effect of continued low interest rates on earning-asset yields and net interest margin.
Monitor commercial real estate, construction, residential, and commercial lending concentrations and changes in classified or nonperforming loans.
Assess whether the allowance for credit losses remains adequate as the loan portfolio expands and economic conditions change.
Review the securities portfolio for further downgrades, market-value changes, prepayment risk, and other-than-temporary impairment exposure.
Evaluate liquidity against the $460.5 million of off-balance-sheet commitments and scheduled contractual obligations.
Review the carrying value and impairment sensitivity of approximately $924.5 million of goodwill and $24.8 million of core deposit intangibles.
Verify the filing’s detailed balance-sheet, cash-flow, capital-ratio, and regulatory disclosures, including any typographical inconsistencies in dates or descriptive text.