Business Context and Reporting Period
Prosperity Bancshares, Inc. is a Texas-based financial holding company whose primary subsidiary, Prosperity Bank, provides retail and commercial banking services to consumers and small and medium-sized businesses. The bank operated 242 full-service locations across Texas and Oklahoma and had 3,017 full-time equivalent associates at December 31, 2017.
This Form 10-K covers the fiscal year ended December 31, 2017. The filing also provides unaudited quarterly information; fourth-quarter 2017 net income was $67.1 million, or $0.97 diluted earnings per share.
Key Financial Metrics
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Total assets | $22.59 billion | $22.33 billion | +1.1% |
| Total loans | $10.02 billion | $9.62 billion | +4.1% |
| Total deposits | $17.82 billion | $17.31 billion | +3.0% |
| Net interest income | $616.9 million | $632.6 million | -2.5% |
| Provision for credit losses | $14.3 million | $24.0 million | -40.3% |
| Noninterest income | $116.6 million | $118.4 million | -1.5% |
| Noninterest expense | $313.1 million | $318.4 million | -1.7% |
| Net income | $272.2 million | $274.5 million | -0.8% |
| Diluted EPS | $3.92 | $3.94 | -0.5% |
| Net interest margin, tax equivalent | 3.19% | 3.35% | -16 basis points |
| Return on average assets | 1.22% | 1.25% | -3 basis points |
| Return on average common equity | 7.26% | 7.69% | -43 basis points |
| Efficiency ratio | 42.76% | 42.50% | +26 basis points |
Cash flow from operating activities was $390.7 million, compared with $334.4 million in 2016. Investing activities used $372.6 million, primarily reflecting a $387.5 million increase in loans held for investment. Financing activities used $63.2 million, including $95.9 million of dividends and $485.0 million of net repayments of short-term borrowings. Cash and cash equivalents ended the year at $392.3 million.
Shareholders’ equity increased 5.0% to $3.82 billion. Year-end borrowings included $505.2 million of other borrowings and $324.2 million of securities sold under repurchase agreements. The company reported $5.77 billion of available capacity under its Federal Home Loan Bank line, with $505.2 million outstanding.
Asset quality improved: nonperforming assets declined to $37.5 million from $48.3 million, or 0.37% of loans and other real estate versus 0.50%. Net charge-offs declined to $15.6 million from $20.1 million, and the allowance for credit losses was $84.0 million, or 0.84% of loans.
Regulatory capital remained strong. The company reported CET1, total risk-based and leverage ratios of 15.08%, 15.74% and 9.31%, respectively. Prosperity Bank reported corresponding ratios of 14.98%, 15.65% and 9.25% and remained classified as well-capitalized.
Material Changes Versus the Prior Comparable Period
- Net income decreased modestly despite loan and deposit growth, primarily because interest expense increased and loan discount accretion declined.
- Interest expense increased $17.3 million, while the average rate on interest-bearing liabilities rose from 0.33% to 0.46% and the total cost of funds rose from 0.24% to 0.33%.
- Average loans increased 2.0% and average securities increased 3.0%, but the tax-equivalent net interest margin fell to 3.19%.
- Loan growth was concentrated in construction, land development and other land loans, which increased 19.4% and represented 15.1% of total loans. Commercial real estate represented 33.1% of loans.
- Noninterest expense declined, helped by lower salaries and benefits and lower core deposit intangible amortization, although other real estate expense increased to $3.3 million from $0.5 million.
- Noninterest income included a $3.3 million gain on sale of securities and a $1.9 million net loss on sale of assets.
- The Tax Cuts and Jobs Act produced a one-time, non-cash income tax expense of $1.4 million from remeasurement of deferred tax assets and liabilities.
- The company paid $1.38 per share in dividends during 2017, compared with $1.24 per share in 2016.
Guidance, Outlook, Commentary, Risks and Unusual Items
Management emphasized continued community banking, internal loan and deposit growth, disciplined acquisitions, cross-selling, efficiency and prudent asset-quality management. The filing does not provide numerical earnings, revenue or margin guidance.
Management stated that Hurricane Harvey had not produced a material financial impact through December 31, 2017. The company also reported no goodwill impairment, no other-than-temporary impairment charges on securities, and no material adverse effect from pending litigation.
Principal risks include interest-rate and net-interest-margin pressure, credit losses, real estate and construction concentration, exposure to Texas and Oklahoma economic conditions and oil-price volatility, deposit competition, liquidity, acquisition execution, goodwill impairment, cybersecurity and vendor disruption, regulatory changes, consumer compliance, and the future implementation of the expected-credit-loss accounting standard in 2020.
At year-end, off-balance-sheet commitments included $2.38 billion of commitments to extend credit and $72.4 million of standby letters of credit. Management stated that many commitments may expire unused and that no material future cash requirements associated with known uncertainties or capital expenditures were identified.
Important Facts for Investors to Verify
- Confirm the sustainability of loan growth, particularly in construction, land development and commercial real estate portfolios.
- Monitor deposit pricing, funding mix, FHLB borrowings and the effect of rising interest rates on net interest margin.
- Review credit migration, criticized loans, charge-offs and allowance adequacy as the portfolio expands.
- Assess the valuation sensitivity of the $1.90 billion goodwill balance and the potential impact of future acquisitions.
- Evaluate the effect of the 2020 expected-credit-loss standard on reserves, retained earnings and regulatory capital.
- Review liquidity capacity and the potential funding requirements associated with $2.45 billion of total off-balance-sheet credit commitments.
- Consider the company’s substantial exposure to Texas and Oklahoma real estate, energy-related borrowers and local economic conditions.
- Verify the basis for management’s interest-rate sensitivity model, which estimated a 7.6% decline in 12-month net interest income under an immediate 100-basis-point rate decrease.