Business Context and Reporting Period
Prosperity Bancshares, Inc. is a Texas-based financial holding company operating through Prosperity Bank. The Bank provides banking products and services to small and medium-sized businesses and consumers through 242 full-service locations in Texas and Oklahoma. This unaudited Form 10-Q covers the three months ended March 31, 2019, with comparisons to the three months ended March 31, 2018 and the balance sheet as of December 31, 2018.
Key Financial Metrics
| Metric | Q1 2019 | Comparable period or prior date |
|---|---|---|
| Net income | $82.4 million | $74.4 million in Q1 2018 |
| Diluted earnings per share | $1.18 | $1.07 in Q1 2018 |
| Total interest income | $186.1 million | $171.0 million in Q1 2018 |
| Net interest income | $154.9 million | $153.2 million in Q1 2018 |
| Tax-equivalent net interest margin | 3.20% | 3.16% in Q1 2018 |
| Provision for credit losses | $0.7 million | $9.0 million in Q1 2018 |
| Noninterest income | $28.1 million | $27.9 million in Q1 2018 |
| Noninterest expense | $78.6 million | $80.1 million in Q1 2018 |
| Efficiency ratio | 42.94% | 44.19% in Q1 2018 |
| Return on average assets | 1.46% | 1.32% in Q1 2018 |
| Return on average common equity | 8.05% | 7.69% in Q1 2018 |
| Total assets | $22.35 billion | $22.69 billion at December 31, 2018 |
| Total loans | $10.41 billion | $10.37 billion at December 31, 2018 |
| Total deposits | $17.20 billion | $17.26 billion at December 31, 2018 |
| Shareholders’ equity | $4.11 billion | $4.05 billion at December 31, 2018 |
| Cash and cash equivalents | $292.1 million | $411.1 million at December 31, 2018 |
Cash Flow, Credit, Debt and Liquidity
- Net cash provided by operating activities was $133.6 million, compared with $77.5 million in Q1 2018.
- Net cash provided by investing activities was $215.1 million, compared with net cash used of $42.5 million in Q1 2018. Investing cash flow reflected securities maturities and paydowns exceeding purchases.
- Net cash used in financing activities was $467.7 million, primarily reflecting repayment of $350.0 million of short-term borrowings, a $30.1 million reduction in repurchase agreements and $28.6 million of dividends.
- Other borrowings totaled $681.0 million, down from $1.03 billion at December 31, 2018. Repurchase agreements totaled $254.6 million, resulting in total borrowings and repurchase agreements of $935.5 million.
- The Company reported $6.31 billion of additional borrowing capacity under its Federal Home Loan Bank of Dallas line. Management stated that liquidity was adequate.
- The allowance for credit losses was $86.1 million, or 0.83% of total loans, compared with $86.4 million, or 0.83%, at December 31, 2018. Net charge-offs were $1.0 million, compared with $9.4 million in Q1 2018.
- Nonperforming assets increased to $40.9 million from $19.0 million at December 31, 2018, and represented 0.39% of total loans and other real estate, compared with 0.18% previously. Nonaccrual loans were $37.5 million.
- Commercial real estate, 1-4 family residential and construction, land development and other land loans comprised 75.7% of the total loan portfolio. Oil and gas loans totaled $380.8 million, or 3.7% of total loans.
- The Bank’s March 31, 2019 regulatory capital ratios exceeded the “well capitalized” thresholds, including a 16.67% CET1 ratio, a 16.67% Tier 1 risk-based ratio, a 17.33% total risk-based ratio and a 10.53% Tier 1 leverage ratio.
Material Changes Versus Prior Comparable Period
- Net income increased 10.8% to $82.4 million, primarily due to higher interest income, lower credit-loss provision expense and lower noninterest expense.
- Interest income on loans increased 11.9% to $130.1 million, reflecting higher loan yields and average loan balances. Average loans increased to $10.39 billion from $9.99 billion.
- Interest expense increased to $31.2 million from $17.8 million as deposit and borrowing rates rose. The average rate on interest-bearing liabilities increased to 0.99% from 0.55%.
- Net interest income increased only 1.1% because higher earning-asset yields and loan growth were substantially offset by higher funding costs. The tax-equivalent net interest margin improved to 3.20% from 3.16%.
- The provision for credit losses declined to $0.7 million from $9.0 million, while net charge-offs declined to $1.0 million from $9.4 million.
- Noninterest expense declined 1.9%, primarily because the FDIC temporary surcharge affecting large banks had ended. Noninterest income was broadly stable, increasing 0.7%.
- Compared with December 31, 2018, total assets declined 1.5%, loans increased 0.4%, deposits declined 0.3%, securities declined 2.9% and shareholders’ equity increased 1.4%.
- Nonperforming assets more than doubled sequentially, primarily because a commercial and industrial loan and a 1-4 family residential loan were placed on nonaccrual status. One $14.8 million commercial and industrial loan was added as a troubled debt restructuring.
Guidance, Outlook, Commentary, Risks and Unusual Items
- The filing does not provide quantitative earnings or financial guidance. Management stated that Q1 results are not necessarily indicative of full-year results.
- Management’s stated strategy emphasizes internal growth, operating efficiency, cost control and potential acquisitions or strategic merger transactions.
- The Company adopted the new lease standard on January 1, 2019 and recognized approximately $17.3 million of right-of-use assets and lease liabilities at adoption. At March 31, 2019, operating lease assets and liabilities were approximately $16 million.
- ASU 2016-13, the current expected credit loss standard, is effective for the Company on January 1, 2020. CECL models were still under development and the potential financial statement impact had not been determined.
- The investment portfolio included approximately $9.14 billion of securities, substantially consisting of mortgage-backed securities. Management reported $115.4 million of unrealized losses on held-to-maturity securities but concluded the losses were temporary and not credit-related; no impairment loss was recognized.
- The Company had $2.57 billion of commitments to extend credit and $65.0 million of standby letters of credit. These commitments may expire unused and do not necessarily represent future cash funding requirements.
- Key risks include changes in interest rates and net interest margin, deposit competition and funding costs, deterioration in Texas and Oklahoma economies, concentrations in real estate lending, oil and gas exposure, credit-loss estimation, liquidity, securities valuations, acquisitions, cybersecurity, technology and regulatory changes.
- Management reported no material changes in market-risk exposures or previously disclosed risk factors. Legal proceedings arising in the ordinary course were not expected to have a material adverse effect.
- No shares were repurchased during the quarter under the authorized program permitting repurchases of up to approximately 3.47 million shares through January 16, 2020.
Important Facts for Investors to Verify
- Whether the increase in nonperforming assets and troubled debt restructurings persists or leads to higher provisions and charge-offs.
- The sustainability of the 3.20% tax-equivalent net interest margin as deposit and borrowing costs rise.
- The potential balance-sheet and capital impact of CECL adoption on January 1, 2020.
- The credit performance and valuation sensitivity of the heavily mortgage-backed securities portfolio, including $115.4 million of unrealized held-to-maturity losses.
- Liquidity coverage relative to declining cash balances, borrowings, deposit trends and $2.64 billion of off-balance-sheet credit and letter-of-credit commitments.
- Future loan growth and concentration risk, particularly in commercial real estate, residential real estate, construction lending and oil and gas.
- Capital ratios, dividend capacity and any future use of the stock repurchase authorization.