Prosperity Bancshares, Inc. 2018 Q2 Form 10-Q Summary
Business Context and Reporting Period
Prosperity Bancshares, Inc. is a Texas-based financial holding company whose primary subsidiary, Prosperity Bank, provides banking products and services to small and medium-sized businesses and consumers in Texas and Oklahoma. As of June 30, 2018, the Bank operated 242 full-service banking locations. This unaudited Form 10-Q covers the three and six months ended June 30, 2018, with comparisons to the corresponding 2017 periods and to December 31, 2017 for balance-sheet information.
Key Financial Metrics
| Metric | Three months ended June 30, 2018 | Three months ended June 30, 2017 | Change |
|---|
| Net interest income | $161.8 million | $152.2 million | 6.3% increase |
| Provision for credit losses | $4.0 million | $2.8 million | 45.5% increase |
| Noninterest income | $28.4 million | $27.8 million | 2.1% increase |
| Noninterest expense | $83.6 million | $76.4 million | 9.4% increase |
| Net income | $81.6 million | $68.6 million | 19.0% increase |
| Diluted earnings per share | $1.17 | $0.99 | 18.2% increase |
| Tax-equivalent net interest margin | 3.28% | 3.14% | 14 basis-point increase |
| Return on average assets | 1.44% | 1.22% | Increase |
| Return on average common equity | 8.33% | 7.36% | Increase |
| Efficiency ratio | 43.95% | 42.34% | Higher expenses relative to revenue |
| Metric | Six months ended June 30, 2018 | Six months ended June 30, 2017 | Change |
|---|
| Net interest income | $315.0 million | $304.7 million | 3.4% increase |
| Provision for credit losses | $13.0 million | $5.4 million | Increase |
| Noninterest income | $56.3 million | $58.6 million | 3.9% decrease |
| Noninterest expense | $163.7 million | $154.5 million | 5.9% increase |
| Net income | $156.0 million | $137.1 million | 13.7% increase |
| Diluted earnings per share | $2.23 | $1.97 | 13.2% increase |
| Tax-equivalent net interest margin | 3.22% | 3.17% | 5 basis-point increase |
| Return on average assets | 1.38% | 1.22% | Increase |
| Return on average common equity | 8.01% | 7.41% | Increase |
| Efficiency ratio | 44.07% | 42.68% | Higher expenses relative to revenue |
Balance Sheet, Liquidity and Capital
- Total assets were $22.57 billion at June 30, 2018, down 0.1% from December 31, 2017.
- Total loans were $10.15 billion, up 1.3%; loans represented 45.0% of total assets. Commercial real estate, 1-4 family residential, and construction and land loans represented 75.1% of the total loan portfolio.
- Total deposits were $16.98 billion, down 4.7%, primarily due to seasonality. Noninterest-bearing deposits increased 0.6% to $5.66 billion, while interest-bearing deposits decreased 7.2% to $11.32 billion.
- Total shareholders’ equity increased 2.9% to $3.94 billion, supported by $156.0 million of year-to-date net income and partly offset by $50.3 million of dividends. The six-month dividend declared was $0.72 per share.
- Cash and cash equivalents were $275.5 million, down from $392.3 million at year-end 2017. Operating activities provided $157.9 million of cash, investing activities used $100.2 million, and financing activities used $174.5 million.
- Other borrowings increased to $1.25 billion from $505.2 million, including $1.25 billion of FHLB advances. The Company had $5.57 billion of additional funds available under its FHLB agreement.
- Outstanding repurchase agreements were $293.0 million. Total borrowings and repurchase agreements were $1.55 billion.
- The Company had $2.54 billion of commitments to extend credit and $70.7 million of standby letters of credit. These commitments may expire unused.
- The Bank remained above the regulatory thresholds for “well capitalized” status. The Bank’s actual CET1, Tier 1, total capital and leverage ratios were 15.56%, 15.56%, 16.23% and 9.61%, respectively.
Material Changes Versus Prior Comparable Period
- Net income benefited from higher loan and securities yields, loan growth, and a lower effective tax rate following the Tax Cuts and Jobs Act. The effective tax rate declined to 20.4% for the quarter and 19.9% year to date, from 32.0% and 32.6%, respectively.
- Loan interest income increased 11.7% in the quarter and 7.9% year to date, while securities interest income increased 5.0% and 3.7%, respectively.
- Higher deposit and borrowing costs partially offset asset-yield improvements. Average interest-bearing liabilities declined 2.8% in both the quarter and year-to-date periods, but the average rate paid increased.
- Noninterest expense increased faster than noninterest income, primarily because salaries and employee benefits rose to $53.4 million in the quarter and $103.8 million year to date.
- Year-to-date noninterest income declined because the prior-year period included a $3.3 million gain on securities sales; 2018 recorded a $13 thousand loss.
- Provision expense increased to $13.0 million year to date from $5.4 million, and net charge-offs increased to $12.1 million from $7.0 million. The allowance remained broadly stable at $85.0 million, or 0.84% of total loans.
- Nonperforming assets improved to $31.6 million, or 0.31% of loans and other real estate, from $37.5 million, or 0.37%, at year-end 2017.
Outlook, Commentary, Risks and Unusual Items
- Management states that its strategy remains focused on internal growth, efficient operations, cost control and acquisitions or strategic mergers. The filing does not provide quantitative earnings or revenue guidance.
- Management believes liquidity is adequate and does not expect a material change in the Company’s principal sources and uses of funds. However, lower cash balances, reduced interest-bearing deposits and increased FHLB borrowings are important liquidity trends.
- The securities portfolio had approximately $304.7 million of unrealized losses in held-to-maturity securities, primarily mortgage-backed securities. Management attributed the losses mainly to higher market interest rates and concluded that the impairments were temporary and not credit-related.
- Management believes the allowance for credit losses is adequate, but cautions that future adjustments could be required if economic conditions or borrower performance differ from assumptions. The loan portfolio is concentrated in Texas and Oklahoma and is substantially collateralized by real estate.
- Oil and gas loans totaled $352.6 million, or 3.5% of total loans, and unfunded oil and gas commitments totaled $175.2 million. Commodity prices and regional economic conditions could affect credit quality.
- The Company identified interest-rate risk, deposit competition, loan prepayments, liquidity, credit quality, securities valuations, goodwill impairment, acquisitions, cybersecurity, technology, regulatory changes, litigation and operational risks as material potential sources of adverse results.
- ASU 2016-13, which introduces an expected-credit-loss model, becomes effective for the Company on January 1, 2020. The Company was developing its implementation plan and had not determined the eventual financial impact.
- There were no material changes in market-risk disclosures or risk factors from the 2017 Form 10-K. Management concluded that disclosure controls were effective and that no material legal proceedings were expected to adversely affect the financial statements.
Important Facts for Investors to Verify
- Whether loan growth and higher asset yields can offset continued increases in deposit and borrowing costs.
- Whether the elevated year-to-date provision and charge-offs represent a temporary increase or an emerging deterioration in commercial and real-estate credit quality.
- The sustainability of the benefit from the lower federal corporate tax rate and its effect on future earnings.
- Liquidity and funding trends, including the $750.0 million net increase in short-term borrowings and the $842.9 million decline in deposits from year-end.
- The sensitivity of the large mortgage-backed securities portfolio and its unrealized losses to further interest-rate increases or forced sales.
- The potential effect of adopting the expected-credit-loss standard in 2020 and the Company’s progress in developing models, systems and data requirements.
- The extent to which the $2.61 billion of off-balance-sheet credit commitments may require future funding.
- The concentration of lending in Texas and Oklahoma, real estate-related categories, and oil and gas borrowers.
