PROSPERITY BANCSHARES INC quarterly report, Q2 FY2015

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. As of June 30, 2015, the Bank operated 245 full-service banking locations. The filing covers the unaudited quarter and six months ended June 30, 2015, compared primarily with the comparable 2014 periods and December 31, 2014 balance-sheet data.

Key financial metrics

Metric	Three months ended June 30, 2015	Three months ended June 30, 2014	Six months ended June 30, 2015	Six months ended June 30, 2014
Net interest income	$158.2 million	$174.1 million	$321.1 million	$317.7 million
Provision for credit losses	$0.5 million	$6.3 million	$1.8 million	$6.9 million
Noninterest income	$30.3 million	$32.6 million	$58.7 million	$61.3 million
Noninterest expense	$79.7 million	$87.3 million	$159.2 million	$158.4 million
Net income	$71.9 million	$75.5 million	$145.6 million	$142.6 million
Diluted earnings per share	$1.03	$1.08	$2.08	$2.10

Second-quarter return on average common equity was 8.61%, return on average assets was 1.33%, and the efficiency ratio was 42.35%.
Six-month return on average common equity was 8.80%, return on average assets was 1.35%, and the efficiency ratio was 42.09%.
Tax-equivalent net interest margin was 3.39% for the quarter and 3.48% for the six months, compared with 3.83% and 3.73%, respectively, in the 2014 periods.
Total assets were $21.69 billion at June 30, 2015, compared with $21.51 billion at December 31, 2014. Total loans were $9.11 billion, securities were $9.70 billion, and total deposits were $17.00 billion.
Shareholders’ equity was $3.36 billion, up from $3.24 billion at year-end 2014. Cash and cash equivalents were $354.5 million, down from $677.9 million.
The allowance for credit losses was $81.0 million, or 0.89% of total loans, compared with $80.8 million, or 0.87%, at December 31, 2014. Six-month net charge-offs were $1.5 million, or 0.03% of average loans on an annualized basis.
Nonperforming assets were $35.1 million, or 0.39% of loans and other real estate, compared with $36.9 million, or 0.40%, at year-end 2014.
Cash flow from operating activities was $196.5 million for the six months. Investing activities used $520.0 million, principally reflecting net securities purchases. Financing activities provided $0.2 million.
Total other borrowings were $886.7 million, including $880.0 million of short-term FHLB advances, compared with $8.7 million at December 31, 2014. Repurchase agreements were $334.2 million. The company had no junior subordinated debentures after redeeming $167.5 million during the first quarter.
The company reported $5.72 billion of additional availability under its FHLB agreement. Outstanding commitments to extend credit were $1.86 billion, and standby letters of credit totaled $101.8 million.
At June 30, 2015, the Bank’s Common Equity Tier 1, Tier 1 risk-based, total risk-based, and Tier 1 leverage ratios were 12.81%, 12.81%, 13.53%, and 7.29%, respectively; the Bank remained categorized as well capitalized.

Material changes versus comparable periods

Second-quarter net income declined 4.7% year over year, while six-month net income increased 2.1%. Second-quarter diluted EPS fell from $1.08 to $1.03; six-month diluted EPS declined from $2.10 to $2.08.
Second-quarter net interest income decreased 9.1%, primarily because purchase-accounting loan discount accretion declined by $11.8 million. The six-month result increased 1.1% because higher average earning assets and lower funding costs more than offset lower yields and lower purchase-accounting accretion.
Average second-quarter loans decreased 3.5% year over year, while average securities increased 10.8%. For the six-month period, average loans increased 6.3% and average securities increased 10.0%.
Noninterest income declined 7.1% in the quarter and 4.2% for the six months, mainly because of lower NSF fees and lower gains on asset sales. Noninterest expense declined 8.7% in the quarter but increased 0.5% for the six months.
Compared with year-end 2014, loans declined 1.4% and deposits declined 3.9%; noninterest-bearing deposits increased 2.1%, while interest-bearing deposits declined 6.2%. Securities increased 7.2%.
Acquired-loan balances continued to decline through repayments, accretion, and loan migration. PCI loans had a recorded investment of $46.3 million versus $57.1 million at year-end 2014, while Non-PCI loans declined to $1.66 billion from $2.10 billion.

Outlook, commentary, risks, contingencies, and unusual items

No quantitative earnings or operating guidance is provided. Management states that six-month results are not necessarily indicative of full-year results and continues to emphasize internal growth, cost control, centralized operations, and acquisitions.

On August 6, 2015, after quarter-end, the company announced a proposed acquisition of Tradition Bancshares, Inc. and Tradition Bank. Consideration is expected to include approximately 679,679 Prosperity shares and $39.0 million in cash, subject to adjustments, regulatory approvals, shareholder approval, and other closing conditions. Tradition reported June 30, 2015 assets of $522.1 million, loans of $242.4 million, and deposits of $463.8 million.
Management believes unrealized securities losses are temporary and primarily reflect higher market interest rates rather than credit deterioration. Held-to-maturity securities had gross unrealized losses of $81.0 million at June 30, 2015; no other-than-temporary impairment was recognized.
Key risks include interest-rate and net-interest-margin pressure, deposit and loan competition, liquidity and funding availability, real-estate and commercial-loan concentrations, credit deterioration, allowance estimation risk, securities valuation risk, acquisition integration and goodwill impairment, regulatory changes, operational and cybersecurity failures, vendor risk, litigation, and adverse economic or weather conditions.
Management believes the allowance for credit losses is adequate, but states that future adjustments could be material if economic conditions or borrower performance differ from assumptions. The company’s loan portfolio is concentrated principally in Texas and Oklahoma and includes substantial commercial real estate, residential real estate, and commercial and industrial loans.
The company reported no material changes to previously disclosed risk factors, no material adverse legal proceedings, and effective disclosure controls as of June 30, 2015.

Important facts for investors to verify

Whether the lower second-quarter margin and reduced purchase-accounting accretion represent a continuing drag on earnings.
The sustainability and cost of the increased use of short-term FHLB advances following the decline in deposits and cash balances.
Trends in commercial real estate, commercial and industrial, and acquired-loan credit quality, including nonperforming assets and required allowance levels.
The closing conditions, purchase accounting, funding, capital impact, and integration risks associated with the pending Tradition acquisition.
The sensitivity of the large securities portfolio to interest-rate changes, prepayments, unrealized losses, and potential other-than-temporary impairment.
The company’s ability to maintain well-capitalized Bank ratios while pursuing asset growth, dividends, and acquisitions.