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 businesses and consumers in Texas and Oklahoma. The filing covers the three and nine months ended September 30, 2019. The Bank operated 243 full-service banking locations at period-end. Financial statements are unaudited and presented in accordance with U.S. GAAP.
On November 1, 2019, after the reporting date, the Company completed its merger with LegacyTexas Financial Group, Inc. LegacyTexas reported September 30, 2019 assets of approximately $10.5 billion, gross loans of $9.1 billion and deposits of $6.5 billion. Consideration consisted of 0.5280 Prosperity shares and $6.28 in cash per LegacyTexas share, subject to limited exceptions.
Key financial metrics
| Metric | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Net interest income | $154.0 million | $157.3 million | $463.7 million | $472.3 million |
| Provision for credit losses | $1.1 million | $2.4 million | $2.6 million | $15.4 million |
| Noninterest income | $30.7 million | $30.6 million | $88.8 million | $86.9 million |
| Noninterest expense | $80.7 million | $81.8 million | $240.1 million | $245.4 million |
| Net income | $81.8 million | $82.5 million | $246.4 million | $238.5 million |
| Diluted EPS | $1.19 | $1.18 | $3.55 | $3.42 |
| Net interest margin, tax-equivalent | 3.16% | 3.15% | 3.17% | 3.20% |
| Efficiency ratio | 43.70% | 43.50% | 43.46% | 43.88% |
| Return on average assets | 1.47% | 1.46% | 1.47% | 1.41% |
| Return on average common equity | 7.89% | 8.30% | 7.95% | 8.11% |
At September 30, 2019, total assets were $22.09 billion, total loans were $10.67 billion, total deposits were $16.93 billion, shareholders’ equity was $4.13 billion and cash and cash equivalents were $420.9 million. The allowance for credit losses was $87.1 million, or 0.82% of total loans.
Loans were concentrated in real estate-related categories: commercial real estate, 1-4 family residential, and construction, land development and other land loans represented 76.1% of total loans. Oil and gas loans totaled $339.5 million, or 3.2% of total loans.
Cash flow, debt and liquidity
- Net cash provided by operating activities was $349.2 million for the first nine months of 2019, compared with $226.2 million in the prior-year period.
- Investing activities provided $570.6 million, primarily reflecting net proceeds from securities activity, compared with $130.0 million of cash used in investing activities in 2018.
- Financing activities used $910.1 million, including a $430.0 million repayment of short-term borrowings, $94.5 million of share repurchases and $85.3 million of dividends.
- Cash and cash equivalents increased $9.8 million from December 31, 2018.
- Other borrowings totaled $600.8 million, consisting primarily of FHLB advances, compared with $1.03 billion at December 31, 2018. Repurchase agreements totaled $311.4 million.
- The Company reported $6.72 billion of available FHLB borrowing capacity and stated that its liquidity position was adequate.
- Off-balance-sheet commitments included $2.68 billion of commitments to extend credit and $70.0 million of standby letters of credit. These commitments may expire unused.
Material changes versus comparable periods
- Third-quarter net income declined 0.9%, while diluted EPS increased 0.8% because of the lower share count following repurchases.
- Nine-month net income increased 3.3% and diluted EPS increased 3.8%, benefiting in part from substantially lower credit-loss provisions and lower noninterest expense.
- Third-quarter net interest income decreased 2.1%. Higher loan balances and loan yields were more than offset by higher deposit funding costs and lower securities balances.
- The tax-equivalent net interest margin increased slightly in the quarter but declined for the nine-month period, primarily because of lower loan discount accretion and the absence of prior-year collections from previously identified troubled assets.
- Total loans increased 2.9% from December 31, 2018, while total deposits decreased 1.9%. Noninterest-bearing deposits increased 2.1%, but interest-bearing deposits declined 3.8%.
- Nonperforming assets increased materially to $51.2 million from $19.0 million at December 31, 2018. Nonperforming assets as a percentage of loans and other real estate increased to 0.48% from 0.18%. Nonaccrual loans increased to $50.0 million from $13.1 million.
- The allowance increased only modestly to $87.1 million from $86.4 million, while the allowance-to-nonperforming-loans ratio declined to 173.0% from 504.0%.
- Securities declined 9.7% to $8.50 billion. Held-to-maturity securities had $36.5 million of unrealized losses, primarily related to mortgage-backed securities. Management considered the declines temporary and recorded no impairment loss.
- The Company repurchased 1.473 million shares for $94.5 million during the first nine months and declared dividends of $1.23 per share.
Guidance, outlook, commentary and risks
- The Company provided no formal earnings or revenue guidance. It cautioned that nine-month results are not necessarily indicative of full-year results.
- CECL adoption is scheduled for January 1, 2020. Management expected the allowance-to-loans ratio to increase from 0.82% to between 1.00% and 1.10%, excluding the anticipated impact of the LegacyTexas merger. A third-party model validation was completed during the quarter, with parallel processes planned for the fourth quarter.
- Management identified interest-rate volatility, deposit and loan competition, funding availability, credit deterioration, real estate concentrations, oil and gas exposure, changing economic conditions and potential changes in collateral values as significant risks.
- The LegacyTexas merger creates integration, execution, cost-savings, synergy and goodwill-impairment risks. The filing states that additional acquisition accounting disclosures were omitted because of the proximity of the merger to the filing date.
- Management believes the allowance for credit losses is adequate, but acknowledges that future adjustments could be substantial if economic conditions or borrower performance differ from assumptions.
- Legal proceedings arise in the ordinary course of business; management believes any resulting liability will not materially affect the financial statements.
- Management reported effective disclosure controls and procedures and no material changes in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Reconcile the post-November 1, 2019 financial impact, purchase accounting, fair-value marks, goodwill and integration costs from the LegacyTexas merger.
- Assess CECL adoption effects against the stated 1.00%–1.10% allowance ratio estimate and determine whether merger-related balances materially change that estimate.
- Monitor the sharp increase in nonaccrual loans, nonperforming assets and troubled debt restructurings, especially within commercial real estate and commercial and industrial loans.
- Evaluate the effect of deposit repricing and funding costs on net interest margin, particularly after the merger.
- Review the Company’s exposure to Texas and Oklahoma real estate, oil and gas borrowers, construction lending and unfunded credit commitments.
- Confirm the sustainability of dividends and share repurchases after merger consideration, integration requirements and potential regulatory capital needs.
- Verify regulatory capital ratios after the merger and after adoption of CECL; at September 30, 2019, the Bank exceeded the thresholds for “well capitalized” status.