Prosperity Bancshares, Inc. — 2023 First-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 across Texas and Oklahoma. The unaudited report covers the three months ended March 31, 2023, with comparisons to the three months ended March 31, 2022 and balance-sheet comparisons to December 31, 2022. The Bank operated 272 full-service locations at quarter-end.
Financial performance and position
| Metric | Q1 2023 | Comparable period or prior year-end | Change |
|---|---|---|---|
| Net income | $124.7 million | $122.3 million in Q1 2022 | Up 1.9% |
| Diluted EPS | $1.37 | $1.33 in Q1 2022 | Up 3.0% |
| Net interest income | $243.5 million | $239.9 million in Q1 2022 | Up 1.5% |
| Tax-equivalent net interest margin | 2.93% | 2.88% in Q1 2022 | Up 5 basis points |
| Noninterest income | $38.3 million | $35.1 million in Q1 2022 | Up 8.9% |
| Noninterest expense | $123.0 million | $119.9 million in Q1 2022 | Up 2.6% |
| Efficiency ratio | 43.68% | 43.68% in Q1 2022 | Unchanged |
| Return on average assets | 1.31% | 1.29% in Q1 2022 | Improved |
| Total assets | $37.83 billion | $37.69 billion at December 31, 2022 | Up 0.4% |
| Total loans | $19.33 billion | $18.84 billion at December 31, 2022 | Up 2.6% |
| Total deposits | $27.00 billion | $28.53 billion at December 31, 2022 | Down 5.4% |
| Shareholders’ equity | $6.74 billion | $6.70 billion at December 31, 2022 | Up 0.6% |
| Cash and cash equivalents | $405.6 million | $424.1 million at December 31, 2022 | Down $18.6 million |
Interest income increased to $327.3 million from $248.9 million, primarily reflecting higher loan and securities balances and rates. Interest expense increased sharply to $83.8 million from $8.9 million because of higher deposit rates and $3.37 billion of Federal Home Loan Bank borrowings outstanding at quarter-end. The net interest margin nevertheless expanded modestly.
Operating cash flow was $179.8 million, compared with $235.7 million in Q1 2022. Investing activities used $102.1 million, while financing activities used $96.2 million, primarily because of deposit declines, dividends and share repurchases, partly offset by $1.52 billion of short-term borrowings. The Company paid $50.1 million in dividends and repurchased 611,263 shares for $38.0 million.
The allowance for credit losses on loans was $282.2 million, or 1.46% of total loans, compared with $281.6 million, or 1.49%, at December 31, 2022. The Company recorded no provision for credit losses in either comparative quarter and reported $615,000 of net recoveries in Q1 2023.
Nonperforming assets were $24.5 million, or 0.13% of total loans and other real estate, compared with $27.5 million, or 0.15%, at year-end. Nonaccrual loans increased to $22.5 million from $19.6 million, while accruing loans 90 days or more past due declined to zero from $5.9 million.
Material changes versus prior comparable periods
- Net income and diluted EPS increased modestly despite substantially higher funding costs.
- Loan interest income rose 28.0% and securities interest income rose 33.0%; average loan yields and securities yields also increased.
- Average interest-bearing liability costs increased to 1.63% from 0.17%, with average other borrowings of $2.89 billion versus none in Q1 2022.
- Deposits declined both sequentially and year over year. Average deposits fell 9.8% year over year to $27.89 billion, increasing reliance on borrowings.
- Total loans increased $494.5 million during the quarter, including a $58.5 million increase in Warehouse Purchase Program loans.
- Noninterest expense increased due primarily to higher FDIC insurance and regulatory assessments and $860,000 of merger-related expenses; salaries and benefits declined.
- The Company adopted ASU 2022-02 prospectively on January 1, 2023. The filing states that adoption did not materially affect the financial statements and eliminated the former troubled-debt-restructuring accounting model for new modifications.
Guidance, outlook, commentary, risks and unusual items
The filing does not provide formal earnings, margin, loan-growth or deposit-growth guidance. Management states that quarterly results are not necessarily indicative of full-year results.
Liquidity is supported by deposits, cash, amortizing securities and loan portfolios, and access to the Federal Home Loan Bank of Dallas. The Company reported $11.29 billion of available FHLB borrowing capacity and $3.37 billion of outstanding FHLB advances at March 31, 2023, bearing a weighted-average rate of 5.01%.
Off-balance-sheet exposures included $4.97 billion of commitments to extend credit, $1.32 billion of unused Warehouse Purchase Program capacity and $60.3 million of standby letters of credit. The associated off-balance-sheet credit-loss allowance was $29.9 million.
Key risks include deposit competition and funding costs, interest-rate volatility, unrealized losses in the securities portfolio, concentration in residential and commercial real estate, economic and commodity conditions affecting Texas and Oklahoma borrowers, credit-loss estimate uncertainty, liquidity availability, acquisitions and integration, goodwill impairment, cybersecurity, technology and regulatory changes. Held-to-maturity securities had $1.39 billion of gross unrealized losses at March 31, 2023; management stated that it intends and expects to be able to hold the securities and does not consider the losses credit-related.
LIBOR remained an index for approximately 88.1% of interest-rate swaps and 0.39% of the loan portfolio at quarter-end. The Company continued transitioning affected instruments to SOFR or other alternative indexes.
The Company completed the acquisition of First Bancshares of Texas on May 1, 2023, after the reporting date, issuing 3,583,370 shares and paying approximately $91.5 million in cash. The pending Lone Star State Bancshares transaction was expected to close in the second quarter of 2023 and involved 2,376,182 shares plus approximately $64.1 million in cash, subject to conditions and regulatory approvals.
Management reported effective disclosure controls and no material changes in internal control over financial reporting. The Company stated that ordinary-course legal proceedings are not expected to have a material adverse effect.
Important facts for investors to verify
- Whether deposit outflows continue and whether higher-cost FHLB and other borrowings materially pressure future net interest margins.
- The sustainability of loan growth, particularly in commercial real estate, construction and 1-4 family residential lending.
- Trends in nonaccrual loans, criticized loans, charge-offs, recoveries and the adequacy of the $282.2 million loan-loss allowance.
- The size and duration of unrealized losses in the $13.60 billion held-to-maturity securities portfolio and the Company’s ability to hold those securities to recovery or maturity.
- The financial and capital effects of the First Bancshares acquisition and the expected Lone Star transaction, including purchase accounting, integration costs and potential goodwill changes.
- Actual deposit pricing, liquidity capacity and borrowing levels following the March 2023 regional-bank stress period.
- Progress in transitioning the remaining LIBOR-linked derivatives and loans.
- Regulatory capital strength: the Bank reported a 15.53% CET1 ratio, 15.53% Tier 1 risk-based ratio, 16.35% total risk-based ratio and 10.03% Tier 1 leverage ratio, all above well-capitalized thresholds.