PROSPERITY BANCSHARES INC annual report, FY2021

Prosperity Bancshares, Inc. 2021 Form 10-K Summary

Business context and reporting period

Prosperity Bancshares, Inc. is a Texas-based financial holding company whose principal subsidiary, Prosperity Bank, provides commercial and retail banking services across Texas and Oklahoma. The filing covers the fiscal year ended December 31, 2021; quarterly information includes the fourth quarter ended December 31, 2021. The Bank operated 273 full-service banking locations and had 3,704 full-time equivalent associates at year-end.

The Company operates one reportable banking segment and emphasizes community banking, internal growth, disciplined acquisitions, cost control, loan and deposit growth, and cross-selling. No acquisition was completed in 2021; the 2019 LegacyTexas merger remained an important source of goodwill and acquired-loan accounting effects.

Financial performance and condition

Metric	2021	2020	Change
Net income	$519.3 million	$528.9 million	Down 1.8%
Diluted EPS	$5.60	$5.68	Down 1.4%
Net interest income	$993.3 million	$1.031 billion	Down 3.6%
Noninterest income	$140.0 million	$131.5 million	Up 6.4%
Noninterest expense	$473.6 million	$497.2 million	Down 4.7%
Net interest margin, tax equivalent	3.14%	3.64%	Down 50 basis points
Return on average assets	1.44%	1.62%	Down 18 basis points
Return on average common equity	8.21%	8.85%	Down 64 basis points
Efficiency ratio, excluding asset-sale gains and losses	41.83%	42.58%	Improved

Fourth-quarter 2021 net income was $126.8 million, or $1.38 diluted EPS, compared with $137.1 million, or $1.48 diluted EPS, in the fourth quarter of 2020. Management attributed the full-year earnings decline primarily to lower loan yields and a $52.1 million reduction in loan discount accretion, partly offset by lower funding costs and higher securities income.

Total assets were $37.83 billion, up from $34.06 billion.
Total deposits were $30.77 billion, up $3.41 billion, or 12.5%; noninterest-bearing deposits increased 17.5% to $10.75 billion.
Total loans were $18.62 billion, down $1.63 billion, or 8.1%. Loans were 60.5% of deposits and 49.2% of total assets.
Investment securities increased 50.1% to $12.82 billion and represented 33.9% of total assets, versus 25.1% in 2020.
Average cost of funds declined to 0.18% from 0.43%; average cost of deposits was 0.18%.
Shareholders’ equity was $6.43 billion, up 4.8%. The Company paid $184.3 million of dividends and repurchased $52.1 million of common stock.

Cash flow, debt and liquidity

Net cash provided by operating activities was $694.7 million, compared with $582.3 million in 2020.
Investing activities used $2.72 billion, primarily reflecting purchases of held-to-maturity securities and other securities activity.
Financing activities provided $3.23 billion, principally from deposit growth.
Cash and cash equivalents increased to $2.55 billion from $1.34 billion.
The Company had no FHLB advances, long-term FHLB notes or subordinated notes outstanding at year-end.
Securities sold under repurchase agreements totaled $448.1 million and were collateralized.
The Company had $13.59 billion of available capacity under its FHLB line of credit.
Total uninsured deposits were $14.70 billion, while the Company reported no brokered deposits.
Off-balance-sheet commitments totaled $5.77 billion, including $4.35 billion of commitments to extend credit, $1.31 billion of unused Warehouse Purchase Program capacity and $102.6 million of standby letters of credit.

Asset quality, capital and unusual items

Nonperforming assets declined to $28.1 million, or 0.15% of loans and other real estate, from $59.6 million, or 0.29%, in 2020.
Nonaccrual loans declined to $26.3 million from $47.2 million; nonperforming loans were $27.2 million.
The allowance for credit losses on loans was $286.4 million, or 1.54% of total loans, compared with $316.1 million, or 1.56%, at year-end 2020.
No provision for credit losses was recorded in 2021. Net charge-offs were $29.7 million, including $12.7 million related to resolved purchased credit-deteriorated loans and $10.8 million related to a partial charge-off of one acquired commercial real estate loan.
Goodwill was $3.23 billion. Management concluded that goodwill was not impaired at December 31, 2021, but impairment remains a potential future earnings risk.
Capital ratios remained well above regulatory minimums. Consolidated CET1, total risk-based capital and leverage ratios were 15.10%, 15.45% and 9.62%, respectively. The Bank was classified as well-capitalized, with corresponding ratios of 15.03%, 15.39% and 9.58%.
The Company declared $1.99 per share of dividends in 2021, compared with $1.87 in 2020, and repurchased 767,134 shares at an average price of $67.87.

The filing contains an apparent inconsistency regarding the allowance for credit losses: the consolidated balance sheet and MD&A report $286.4 million at December 31, 2021, while the critical audit matter discussion refers to an allowance of approximately $316 million. Investors should reconcile this difference to the audited financial statements and Note 5.

Material changes versus comparable periods

Profitability weakened modestly as lower loan yields and reduced purchase-accounting discount accretion outweighed the benefit of lower interest expense.
Net interest margin declined 50 basis points, although the average cost of interest-bearing liabilities fell from 0.63% to 0.28%.
Deposit growth substantially exceeded loan growth, leading to a significant increase in investment securities and cash.
Loan mix shifted toward residential and construction lending as commercial and industrial and commercial real estate balances declined.
Asset quality improved materially, with nonperforming assets declining by more than half year over year.
Noninterest expense declined following the completion of the LegacyTexas system conversion and the absence of merger-related expenses in 2021.
Income tax expense increased to $140.4 million from $116.1 million, partly because 2020 included a $20.1 million CARES Act net operating loss carryback benefit.

Outlook, management commentary and risks

Management provided no quantitative earnings or revenue guidance. It intends to continue pursuing internal growth, deposit and loan expansion, efficiency initiatives, community banking, and disciplined acquisition opportunities. Future acquisitions may not be accretive within any particular period.

COVID-19 restrictions in Texas and Oklahoma had been lifted at year-end, but the Company continued to identify uncertainty from new variants, economic volatility and borrower stress. PPP approvals totaled approximately 18,700 loans and $2.04 billion; outstanding PPP balances were $169.9 million across 1,512 loans.
Approximately $29.5 million of loans remained subject to COVID-related deferral or modification agreements.
Approximately $2.1 billion of loans and certain other financial instruments remained directly or indirectly dependent on LIBOR. The Company discontinued originating LIBOR-based loans after December 31, 2021 and is transitioning to SOFR, BSBY or other replacement rates.
Interest-rate risk is material. A modeled 200-basis-point increase in rates was estimated to increase 12-month net interest income by 11.0%, while a 100-basis-point decline was estimated to reduce it by 5.4%; actual results may differ materially.
Approximately 73.4% of loans were in real estate-related categories, creating sensitivity to property values, construction activity, occupancy and regional economic conditions.
Texas and Oklahoma concentration, oil and gas exposure, commercial real estate, construction lending and the Warehouse Purchase Program could increase credit or earnings volatility.
Cybersecurity, third-party service providers, regulatory compliance, consumer protection, climate-related developments, litigation and changes in banking regulation remain material risks.
The Company had $3.23 billion of goodwill and significant mortgage-backed securities exposure. Rising rates could pressure securities valuations, prepayments, funding costs and net interest income.

The Company and Bank reported no material unresolved legal proceedings. Management and Deloitte & Touche LLP concluded that internal control over financial reporting was effective, and Deloitte issued unqualified audit opinions.

Investor verification checklist

Reconcile the $286.4 million allowance for credit losses in the financial statements with the approximately $316 million amount cited in the critical audit matter.
Assess the sustainability of earnings excluding purchase-accounting discount accretion, PPP-related effects and the 2020 tax benefit.
Monitor the effect of rising interest rates on the 33.9% securities-to-assets ratio, net interest margin and unrealized securities losses.
Review concentrations and underwriting performance in commercial real estate, construction, residential real estate, energy lending and mortgage warehouse balances.
Track deposit retention, uninsured deposits, liquidity capacity and the potential funding needs of $5.77 billion of off-balance-sheet commitments.
Evaluate the LIBOR transition for the approximately $2.1 billion of affected loans and other instruments, including fallback language and customer renegotiations.
Confirm the timing and regulatory-capital effects of CECL transition adjustments beginning in 2022.
Review future acquisition activity, goodwill impairment sensitivity and the effect of continued share repurchases and dividends on capital and liquidity.