Prosperity Bancshares, Inc. — Form 10-Q Summary
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 to small and medium-sized businesses and consumers. As of September 30, 2017, the Bank operated 243 full-service banking locations across Texas and Oklahoma. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2017, with comparisons to the corresponding 2016 periods and December 31, 2016 balance-sheet data.
Financial performance and condition
| Metric | Q3 2017 | Q3 2016 | YTD 2017 | YTD 2016 |
|---|---|---|---|---|
| Net interest income | $156.1 million | $154.1 million | $460.8 million | $478.8 million |
| Provision for credit losses | $6.9 million | $2.0 million | $12.3 million | $22.0 million |
| Noninterest income | $28.8 million | $29.7 million | $87.4 million | $89.0 million |
| Noninterest expense | $77.5 million | $79.5 million | $232.0 million | $239.2 million |
| Net income | $67.9 million | $68.7 million | $205.0 million | $205.7 million |
| Diluted EPS | $0.98 | $0.99 | $2.95 | $2.95 |
| Tax-equivalent net interest margin | 3.22% | 3.29% | 3.18% | 3.38% |
| Efficiency ratio | 41.92% | 43.26% | 42.42% | 42.24% |
At September 30, 2017, total assets were $22.14 billion, loans were $9.91 billion, securities were $9.41 billion, deposits were $16.91 billion and shareholders’ equity was $3.78 billion. Cash and cash equivalents were $303.5 million. Other borrowings totaled $960.4 million and securities sold under repurchase agreements totaled $334.6 million.
For the nine months, operating activities provided $346.4 million of cash, investing activities provided $6.3 million and financing activities used $486.6 million, resulting in a $133.9 million decrease in cash and cash equivalents. The company paid $70.9 million in common dividends. The Bank reported a 14.99% CET1 ratio, 14.99% Tier 1 risk-based capital ratio, 15.69% total risk-based capital ratio and 9.08% Tier 1 leverage ratio, exceeding well-capitalized regulatory thresholds.
Material changes versus comparable periods
- Q3 net income declined 1.1% to $67.9 million, while nine-month net income declined 0.3% to $205.0 million.
- Q3 net interest income increased 1.4%, supported by higher average loans and securities, but the tax-equivalent net interest margin declined 7 basis points to 3.22% as funding costs increased.
- Nine-month net interest income decreased 3.8%, primarily because loan discount accretion declined by $14.3 million and average funding costs increased. The nine-month margin fell 20 basis points to 3.18%.
- Loans increased $289.1 million, or 3.0%, from year-end 2016. Commercial real estate, 1-4 family residential and construction/land-development loans represented 75.2% of the total loan portfolio.
- Deposits decreased $399.8 million, or 2.3%, reflecting a $674.3 million decline in interest-bearing deposits, partially offset by a $274.5 million increase in noninterest-bearing deposits.
- Noninterest expense declined 2.5% in Q3 and 3.0% year to date, primarily due to lower salaries and benefits, core deposit intangible amortization and communications expense.
- The provision for credit losses increased in Q3 to $6.9 million from $2.0 million, while the year-to-date provision decreased to $12.3 million from $22.0 million. Year-to-date net charge-offs declined to $10.8 million from $17.8 million.
- Nonperforming assets declined to $45.8 million from $48.3 million at year-end 2016, and represented 0.46% of loans and other real estate versus 0.50%. The allowance for credit losses was $86.8 million, or 0.88% of total loans.
Outlook, commentary, risks and unusual items
Management stated that Hurricane Harvey had not caused a material financial impact as of September 30, 2017; all but one of the affected banking centers were operational. The filing does not provide specific earnings or revenue guidance.
Management believes liquidity is adequate. The Company had $5.82 billion of total funds available under its Federal Home Loan Bank agreement, of which $960.4 million was outstanding. Outstanding commitments to extend credit were $2.16 billion and standby letters of credit were $62.4 million; these commitments may expire unused.
The securities portfolio included $69.5 million of unrealized losses in held-to-maturity securities, primarily mortgage-backed securities. Management believes the losses are temporary, does not intend to sell the securities before recovery, and reported no other-than-temporary impairment charge.
Key risks include interest-rate and margin pressure, deposit competition and funding availability, economic and commodity-price weakness, concentrations in Texas and Oklahoma and in real-estate-related lending, construction and commercial credit risk, oil-and-gas exposure, changes in the allowance for credit losses, goodwill impairment, regulatory and tax changes, cybersecurity and operational failures, vendor risk, litigation and future acquisition or integration risk. The Company had $1.90 billion of goodwill at September 30, 2017 and recorded no impairment.
The Company adopted ASU 2016-09 in 2017 without significant financial-statement impact. Several accounting standards effective in 2018 through 2020 were not expected to have a significant impact, although the Company was still evaluating the expected-credit-loss standard, ASU 2016-13.
Important facts for investors to verify
- Whether higher deposit and borrowing costs continue to reduce net interest margin and earnings growth.
- The sustainability of 3.0% loan growth given the 75.2% concentration in commercial real estate, residential and construction-related lending.
- Trends in nonperforming loans, troubled debt restructurings and commercial-and-industrial charge-offs, including the $2.5 million of charge-offs related to a restructured loan.
- The adequacy of the $86.8 million allowance for credit losses under changing economic conditions and the future adoption of the expected-credit-loss model.
- The effect of declining deposits, reduced cash balances and $2.23 billion of off-balance-sheet credit and letter-of-credit commitments on liquidity.
- The realization of the securities portfolio’s unrealized losses if interest rates rise or liquidity needs require sales before recovery.
- Potential sensitivity of the $1.90 billion goodwill balance to changes in profitability, cash flows, valuation multiples and market conditions.
- Whether Hurricane Harvey or subsequent regional economic conditions create delayed credit losses despite management’s statement that no material impact had occurred through September 30, 2017.