Prosperity Bancshares, Inc. 2010 Form 10-K Summary
Business context and reporting period
Prosperity Bancshares, Inc. is a Texas financial holding company whose principal subsidiary, Prosperity Bank, provides retail and commercial banking services to consumers and small and medium-sized businesses. The filing covers the fiscal year ended December 31, 2010, with comparative information for 2009 and 2008. At year-end, the Bank operated 175 full-service banking locations across Texas and had 1,708 full-time equivalent associates.
The Company completed acquisitions of three U.S. Bank branches on March 29, 2010 and 19 First Bank branches on April 30, 2010. Four First Bank locations were subsequently consolidated.
Key financial metrics
| Metric | 2010 | 2009 | Change |
|---|---|---|---|
| Total assets | $9.477 billion | $8.850 billion | +7.1% |
| Total deposits | $7.455 billion | $7.259 billion | +2.7% |
| Total loans | $3.485 billion | $3.377 billion | +3.2% |
| Net interest income | $318.1 million | $307.1 million | +3.6% |
| Provision for credit losses | $13.6 million | $28.8 million | -52.8% |
| Noninterest income | $53.8 million | $60.1 million | -10.4% |
| Noninterest expense | $166.6 million | $169.7 million | -1.8% |
| Net income | $127.7 million | $111.9 million | +14.2% |
| Diluted EPS | $2.73 | $2.41 | +13.3% |
| Return on average assets | 1.38% | 1.26% | +12 basis points |
| Return on average equity | 9.08% | 8.57% | +51 basis points |
| Tax-equivalent net interest margin | 4.04% | 4.08% | -4 basis points |
| Efficiency ratio | 44.83% | 46.27% | Improved |
Cash flow from operating activities was $177.7 million, compared with $73.6 million in 2009. Investing activities provided $152.0 million, while financing activities used $365.6 million. Cash and cash equivalents declined to $159.4 million from $195.3 million.
Shareholders’ equity increased 7.5% to $1.452 billion. The allowance for credit losses was $51.6 million, or 1.48% of loans, compared with $51.9 million, or 1.54%, in 2009. Net charge-offs were $13.9 million, broadly unchanged from 2009.
Liquidity was primarily funded by deposits. Noninterest-bearing deposits increased 12.1% to $1.673 billion and represented 22.4% of period-end deposits. Average cost of deposits was 0.82%, and average cost of funds was 0.85%.
Borrowings increased materially, primarily because of $360.0 million in short-term Federal Home Loan Bank advances. Total other borrowings and repurchase agreements were $435.1 million at year-end, compared with $98.7 million in 2009. The Company had $3.28 billion of borrowing capacity under its FHLB collateral agreement, of which $374.4 million was outstanding.
Regulatory capital remained strong. The Company reported a 6.87% leverage ratio, 13.64% Tier 1 risk-based capital ratio and 14.87% total risk-based capital ratio. Prosperity Bank reported a 6.72% leverage ratio, 13.37% Tier 1 ratio and 14.60% total risk-based capital ratio and was classified as well-capitalized.
Material changes versus the prior comparable period
- Net income rose primarily because of higher net interest income, balance-sheet growth and the contribution of the U.S. Bank and First Bank branch acquisitions.
- Average interest-earning assets increased 4.8% to $7.952 billion. Lower funding costs more than offset lower earning-asset yields, although the net interest margin declined slightly.
- Loan growth was modest and was concentrated partly in 1-4 family residential loans, which increased to $824.1 million from $709.1 million. Construction and land development loans declined to $502.3 million from $557.2 million.
- Securities increased 12.1% to $4.617 billion and represented 48.7% of total assets, up from 46.5%. The increase was funded primarily by deposits acquired in the 2010 transactions.
- Nonperforming loans declined to $4.6 million from $8.4 million, while total nonperforming assets declined slightly to $15.8 million from $16.4 million.
- Noninterest income declined because of net losses on sales of other real estate. Noninterest expense declined as FDIC assessment costs and core deposit intangible amortization decreased.
- The Company paid $29.8 million in common dividends, or $0.64 per share, compared with $26.2 million, or $0.57 per share, in 2009.
Guidance, outlook, commentary, risks and unusual items
Management did not provide quantitative earnings guidance. Its stated strategy was to continue community banking, internal loan and deposit growth, disciplined acquisitions, cost control, cross-selling and conservative underwriting. Management indicated that future acquisitions may not be accretive within any particular period.
Management reported no goodwill impairment at December 31, 2010. Goodwill totaled $924.3 million, creating exposure to future impairment if profitability, cash flows or market conditions deteriorate. No other-than-temporary impairment charge was recorded in 2010; the Company had recorded a $14.0 million pre-tax securities impairment charge in 2008.
Material risks include Texas economic and real estate weakness, concentration in commercial real estate and construction lending, interest-rate and liquidity risk, potential increases in credit losses, dependence on deposits and the Bank’s ability to upstream dividends, acquisition and integration risk, technology and cybersecurity risk, regulatory changes, higher FDIC assessments, and possible future capital requirements under Dodd-Frank and Basel III.
At December 31, 2010, real estate loans represented approximately 83.7% of total loans, including 14.4% construction and land development, 27.1% residential real estate and 42.2% commercial real estate. The Company had $492.8 million of commitments to extend credit and $15.2 million of standby letters of credit. These amounts may not represent actual future cash funding requirements.
The Company had $92.3 million of junior subordinated debentures outstanding. Deferral of interest on these instruments could prohibit common-stock dividends during the deferral period. Future contractual payments, including interest, on junior subordinated debentures, FHLB obligations and operating leases totaled $560.3 million.
The Dodd-Frank Act, Basel III proposals and revised FDIC assessment rules were identified as potential sources of future cost, capital, liquidity and profitability impacts. The filing states that legal proceedings arising in the ordinary course were not expected to have a material adverse effect.
Investor verification checklist
- Verify the contribution to 2010 earnings, deposits, loans and goodwill from the U.S. Bank and First Bank branch acquisitions.
- Assess the sustainability of the 2010 margin, including the effect of future interest-rate changes and the Company’s liability-sensitive near-term repricing profile.
- Review commercial real estate and construction-loan concentrations, collateral values, classified loans and allowance adequacy.
- Reconcile the increase in short-term FHLB borrowings with liquidity needs, available collateral and deposit trends.
- Monitor nonperforming assets, net charge-offs, other real estate owned and future credit-loss provisions.
- Evaluate the $924.3 million goodwill balance and the assumptions supporting the absence of impairment.
- Review the effect of FDIC assessment changes, Dodd-Frank implementation, Basel III and potential interest payments on demand deposits.
- Confirm dividend capacity, including regulatory restrictions and the priority of junior subordinated debenture interest over common dividends.