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 small and medium-sized businesses and consumers. The unaudited filing covers the three and six months ended June 30, 2017, compared with the corresponding 2016 periods. The Bank operated 243 full-service locations across Texas and Oklahoma.
Financial Highlights
| Metric | Q2 2017 | Q2 2016 | Change |
|---|---|---|---|
| Net interest income | $152.2 million | $158.5 million | Down 3.9% |
| Provision for credit losses | $2.8 million | $6.0 million | Down 54.2% |
| Noninterest income | $27.8 million | $28.5 million | Down 2.4% |
| Noninterest expense | $76.4 million | $79.2 million | Down 3.5% |
| Income before taxes | $100.8 million | $101.7 million | Down 0.9% |
| Net income | $68.6 million | $68.1 million | Up 0.7% |
| Diluted EPS | $0.99 | $0.98 | Up $0.01 |
| Tax-equivalent net interest margin | 3.14% | 3.37% | Down 23 basis points |
| Efficiency ratio | 42.34% | 42.46% | Improved 12 basis points |
| Metric | Six Months 2017 | Six Months 2016 | Change |
|---|---|---|---|
| Net interest income | $304.7 million | $324.7 million | Down 6.2% |
| Provision for credit losses | $5.4 million | $20.0 million | Down 72.9% |
| Noninterest income | $58.6 million | $59.3 million | Down 1.1% |
| Noninterest expense | $154.5 million | $159.8 million | Down 3.3% |
| Net income | $137.1 million | $137.0 million | Up 0.1% |
| Diluted EPS | $1.97 | $1.96 | Up $0.01 |
| Tax-equivalent net interest margin | 3.17% | 3.43% | Down 26 basis points |
| Efficiency ratio | 42.68% | 41.75% | Worsened 93 basis points |
Annualized return on average common equity was 7.36% in the second quarter and 7.41% for the first six months, compared with 7.70% and 7.77%, respectively, in the prior-year periods. Annualized return on average assets was 1.22% for both 2017 periods, compared with 1.24% in 2016.
Balance Sheet, Liquidity and Capital
- Total assets were $22.30 billion at June 30, 2017, down 0.2% from December 31, 2016.
- Total loans were $9.86 billion, up 2.5% from year-end 2016; loans represented 44.2% of total assets.
- Total deposits were $17.07 billion, down 1.4%. Noninterest-bearing deposits increased 4.0% to $5.40 billion, while interest-bearing deposits declined 3.7% to $11.67 billion.
- Total securities were $9.58 billion, down 1.5% from year-end and equal to 43.0% of total assets. The portfolio was heavily concentrated in mortgage-backed securities.
- Cash and cash equivalents were $322.7 million, down from $437.4 million at December 31, 2016. Management stated that liquidity remained adequate.
- Other borrowings totaled $1.04 billion and repurchase agreements totaled $346.3 million. The Company had $5.72 billion of available FHLB funding, with $1.04 billion outstanding.
- Shareholders’ equity increased 2.6% to $3.74 billion, principally from first-half net income of $137.1 million, partly offset by $47.2 million of cash dividends.
- The Bank remained well capitalized. Its June 30, 2017 CET1, Tier 1, total risk-based and Tier 1 leverage ratios were 14.67%, 14.67%, 15.36% and 8.74%, respectively.
Material Changes Versus Prior Comparable Period
- Net interest income declined primarily because loan discount accretion decreased by $4.8 million in the quarter and $14.6 million year to date. Higher funding costs also reduced the margin.
- Average securities increased, supporting higher securities interest income, but this was insufficient to offset lower loan interest income.
- Interest expense increased by $4.8 million in the quarter and $6.5 million year to date, largely due to higher costs and balances of other borrowings and higher deposit rates.
- Credit costs improved materially. The first-half provision declined to $5.4 million from $20.0 million, and net charge-offs declined to $7.0 million from $17.6 million.
- Noninterest expense declined due primarily to lower salaries and benefits and lower core deposit intangible amortization.
- Noninterest income included a $3.3 million gain on securities sales and a $3.8 million loss on asset sales in the second quarter. Management stated that the asset sale loss primarily related to an aircraft acquired in a prior acquisition.
- Loans grew despite lower deposits, while cash declined and FHLB borrowings increased by approximately $45 million from year-end.
Asset Quality, Risks and Unusual Items
- Nonperforming assets were $47.6 million, or 0.48% of loans and other real estate, compared with $48.3 million and 0.50% at December 31, 2016.
- Nonaccrual loans were $30.5 million, and accruing loans 90 days or more past due were $1.6 million.
- The allowance for credit losses was $83.8 million, or 0.85% of total loans, compared with $85.3 million, or 0.89%, at year-end. Coverage of nonperforming loans was 260.8%.
- Three commercial and industrial loans were modified as troubled debt restructurings during the first six months, with $8.1 million outstanding at June 30, 2017. No defaults occurred on restructurings completed during the preceding twelve months.
- Commercial real estate, 1-4 family residential and construction or land-development loans represented 74.8% of the total loan portfolio, creating meaningful real-estate concentration risk.
- Oil and gas loans totaled $287.8 million, or 2.9% of total loans, with an additional $175.0 million of unfunded oil and gas commitments.
- The securities portfolio had $77.5 million of unrealized losses in held-to-maturity securities, largely mortgage-backed securities. Management considered the losses temporary and did not record an impairment charge.
- Goodwill totaled $1.90 billion. No goodwill or core deposit intangible impairment was recorded, but impairment testing depends on assumptions about cash flows, discount rates and market valuations.
- Off-balance-sheet commitments included $2.15 billion of commitments to extend credit and $72.7 million of standby letters of credit. These amounts may not represent actual future funding requirements.
- Contractual obligations totaled $1.06 billion, including $1.04 billion of FHLB notes payable and $22.3 million of operating lease obligations.
Guidance and Management Commentary
The filing does not provide specific earnings, revenue, margin or loan-growth guidance. Management described its strategy as a combination of internal growth, efficient operations, cost control and selective acquisitions. Management stated that liquidity was adequate, the allowance for credit losses was adequate as of June 30, 2017, and the securities portfolio was not impaired for credit reasons. The Company continued evaluating new accounting standards, including credit-loss, revenue-recognition and lease guidance; management did not expect most standards to have a significant impact, although the potential impact of the new credit-loss standard remained under evaluation.
Key forward-looking risks include economic and local-market deterioration, interest-rate changes, deposit and loan competition, real-estate and oil-and-gas exposure, credit-loss estimation, liquidity availability, securities valuation, goodwill impairment, regulatory changes, acquisitions and integration, cybersecurity, operational disruptions and dependence on key personnel.
Investor Verification Checklist
- Verify whether the decline in net interest margin persists as loan discount accretion declines and funding costs rise.
- Monitor deposit trends, particularly the decline in interest-bearing deposits and reliance on FHLB borrowings.
- Assess the quality and concentration of commercial real estate, construction, residential and oil-and-gas loans.
- Track nonperforming assets, troubled debt restructurings, charge-offs and the adequacy of the $83.8 million allowance.
- Review the duration, unrealized losses and interest-rate sensitivity of the mortgage-backed securities portfolio.
- Evaluate the sustainability of earnings excluding the $3.3 million securities gain and the unusual asset-sale loss.
- Confirm future effects of ASU 2016-13 and other pending accounting standards on capital, earnings and credit-loss reserves.
- Review regulatory capital ratios and the capacity to continue dividends while maintaining the capital conservation buffer.