PROSPERITY BANCSHARES INC quarterly report, Q3 FY2020

Prosperity Bancshares, Inc. — 2020 Third-Quarter Form 10-Q

Reporting period: Quarterly and year-to-date periods ended September 30, 2020; filed November 5, 2020. Prosperity Bank operated 275 full-service locations across Texas and Oklahoma. Results include LegacyTexas Financial Group, which merged with the Company on November 1, 2019, limiting direct comparability with 2019.

Financial Overview

MetricQ3 2020Q3 20199M 20209M 2019
Net interest income$258.1 million$154.0 million$773.1 million$463.7 million
Provision for credit losses$10.0 million$1.1 million$20.0 million$2.6 million
Noninterest income$34.9 million$30.7 million$95.0 million$88.8 million
Noninterest expense$117.9 million$80.7 million$377.0 million$240.1 million
Net income$130.1 million$81.8 million$391.8 million$246.4 million
Diluted EPS$1.40$1.19$4.20$3.55
  • Q3 net income increased 59.1%; nine-month net income increased 59.0%. Management attributed the increase primarily to the LegacyTexas merger.
  • Tax-equivalent net interest margin was 3.57% in Q3 and 3.69% for the first nine months, compared with 3.16% and 3.17%, respectively, in the prior-year periods.
  • Annualized Q3 return on average assets was 1.58%, return on average common equity was 8.64%, and the efficiency ratio was 40.17%. Nine-month figures were 1.62%, 8.78%, and 43.19%, respectively.
  • Loan discount accretion contributed approximately $21.3 million to Q3 net interest income and $71.0 million to nine-month net interest income.

Balance Sheet, Liquidity and Capital

Balance-sheet itemSeptember 30, 2020December 31, 2019Change
Total assets$33.20 billion$32.19 billion+3.1%
Total loans$20.80 billion$18.85 billion+10.3%
Total deposits$26.46 billion$24.20 billion+9.3%
Cash and cash equivalents$1.09 billion$574.1 million+$513.6 million
Shareholders’ equity$6.03 billion$5.97 billion+1.1%
  • Loans included $2.73 billion of Warehouse Purchase Program loans and $1.39 billion of PPP loans across 11,948 loans. PPP loans are fully SBA-guaranteed and do not carry an allowance.
  • Other borrowings declined to $2.6 million from $1.30 billion at year-end. Securities sold under repurchase agreements were $380.3 million, and subordinated notes were $125.1 million.
  • The Company had $7.63 billion available under its Federal Home Loan Bank line and no FHLB advances outstanding at September 30, 2020.
  • Nine-month operating cash flow was $496.9 million. Investing activities used $706.5 million, financing activities provided $723.2 million, and cash increased by $513.6 million.
  • The Bank was above “well capitalized” regulatory thresholds, with CET1, Tier 1, total risk-based and Tier 1 leverage ratios of 13.67%, 13.67%, 14.19% and 9.89%, respectively.

Credit Quality and Material Changes

  • The Company adopted CECL on January 1, 2020. The adoption increased the loan allowance by $240.5 million and the off-balance-sheet allowance by $24.4 million, reducing retained earnings by $92.9 million on an after-tax and other-adjustment basis as presented in the filing.
  • The allowance for credit losses on loans was $323.6 million, or 1.56% of total loans, versus $87.5 million, or 0.46%, at December 31, 2019. The off-balance-sheet allowance was $29.9 million versus $5.6 million.
  • Net charge-offs were $10.6 million in Q3 and $24.4 million for nine months, compared with $1.0 million and $2.0 million, respectively, in the prior-year periods. A substantial portion related to resolved purchased credit-deteriorated loans and was covered by specific reserves.
  • Nonperforming assets increased to $69.5 million from $62.9 million, but remained 0.33% of total loans and other real estate. Nonaccrual loans were $57.4 million, and troubled debt restructurings were $13.2 million.
  • The LegacyTexas merger generated approximately $1.33 billion of goodwill and $52.1 million of related core deposit intangibles as of September 30, 2020. Nine-month merger-related expenses were $8.0 million; none were recorded in Q3.
  • The Company repurchased 2.2 million shares for $115.0 million during the first nine months and declared $128.5 million of cash dividends. The quarterly dividend was $0.46 per share.

Outlook, Risks and Unusual Items

  • The filing provides no formal earnings or financial guidance. Management stated that the effect of COVID-19 on operations and 2020 results could not be reliably estimated.
  • COVID-19, elevated unemployment, lower oil and gas prices, borrower payment deferrals, collateral values and economic uncertainty could increase credit losses, reduce demand and pressure liquidity and earnings.
  • Loan concentrations require monitoring: commercial real estate, 1-4 family residential and construction loans represented 71.3% of loans excluding Warehouse Purchase Program loans. Oil and gas loans were $604.7 million, hotels $386.3 million and restaurants $215.1 million at September 30, 2020.
  • Off-balance-sheet commitments totaled $5.10 billion, including $4.18 billion of commitments to extend credit, $803.4 million of unused Warehouse Purchase Program capacity and $112.8 million of standby letters of credit.
  • The Company gave irrevocable notice to redeem its $125.0 million subordinated notes on December 1, 2020, requiring approximately $126.3 million including accrued interest.
  • The nine-month effective tax rate was 16.8%, reduced by a $20.1 million CARES Act NOL carryback benefit. This benefit is not necessarily recurring.
  • Management reported no material changes in market-risk exposures, no material legal proceedings, and effective disclosure controls as of September 30, 2020.

Investor Verification Checklist

  • Assess the sustainability of earnings growth after removing LegacyTexas merger effects, loan discount accretion, PPP-related income and the $20.1 million tax benefit.
  • Review subsequent credit performance, loan deferrals, COVID-19 exposures and whether the $323.6 million CECL allowance remains adequate.
  • Verify trends in commercial real estate, residential, construction, oil and gas, hotel and restaurant portfolios.
  • Confirm completion and funding of the December 1, 2020 subordinated-note redemption and its effect on regulatory capital and liquidity.
  • Monitor PPP forgiveness timing, fee recognition, SBA reimbursement and related regulatory or litigation exposure.
  • Reconcile the reported cash-flow changes with deposit growth, securities activity, Warehouse Purchase Program turnover and debt repayments.