PROSPERITY BANCSHARES INC annual report, FY2014

Prosperity Bancshares, Inc. 2014 Form 10-K Summary

Business context and reporting period

Prosperity Bancshares, Inc. is a Texas financial holding company whose principal operating subsidiary, Prosperity Bank, provides commercial and consumer banking services in Texas and Oklahoma. The filing covers the fiscal year ended December 31, 2014; quarterly information includes the fourth quarter ended December 31, 2014. The Bank operated 245 full-service locations and had 3,096 full-time-equivalent associates at year-end.

The Company completed the acquisition of F&M Bancorporation Inc. on April 1, 2014, expanding its Oklahoma and Dallas markets. Consideration consisted of 3,298,022 shares and $34.2 million in cash, for total stated merger consideration of $252.4 million.

Financial performance and condition

Metric	2014	2013	Change
Net interest income	$671.2 million	$498.8 million	+34.5%
Provision for credit losses	$18.3 million	$17.2 million	+6.0%
Noninterest income	$122.9 million	$95.4 million	+28.8%
Noninterest expense	$330.0 million	$247.2 million	+33.5%
Net income	$297.4 million	$221.4 million	+34.4%
Diluted earnings per share	$4.32	$3.65	+18.4%
Return on average assets	1.44%	1.36%	+8 basis points
Return on average common equity	9.66%	9.31%	+35 basis points
Tax-equivalent net interest margin	3.80%	3.58%	+22 basis points
Efficiency ratio	41.81%	41.60%	+21 basis points

Fourth-quarter 2014 net income was $78.2 million, or $1.12 diluted earnings per share, compared with $63.0 million, or $0.98 diluted earnings per share, in the fourth quarter of 2013.

Average earning assets increased 25.9%, primarily from the F&M acquisition and the full-year impact of the 2013 FVNB acquisition. Interest income benefited from $95.9 million of purchase-accounting loan discount accretion. The average cost of funds declined to 0.25% from 0.29%, while average noninterest-bearing deposits increased 40.1% to $4.69 billion.

Total assets were $21.51 billion, up 15.4% from $18.64 billion.
Total loans were $9.24 billion, up 18.9%; commercial and industrial loans grew 41.1% to $1.81 billion.
Commercial real estate loans were $3.03 billion, or 32.8% of total loans.
Total deposits were $17.69 billion, up 15.7%; noninterest-bearing deposits were $4.94 billion, or approximately 28.0% of deposits.
Investment securities were $9.05 billion, or 42.1% of total assets.
Shareholders’ equity was $3.24 billion, up 16.4%.
Cash and cash equivalents were $677.9 million, compared with $381.4 million at year-end 2013.

Cash flow, debt, liquidity and capital

Net cash provided by operating activities was $348.3 million, compared with $307.7 million in 2013.
Net cash used in investing activities was $72.2 million, primarily reflecting securities activity and acquisition-related cash flows.
Net cash provided by financing activities was $20.4 million, including $68.4 million of cash dividends paid.
Year-end borrowings included $8.7 million of FHLB long-term notes and $315.5 million of securities sold under repurchase agreements.
The Company had $5.91 billion available under its FHLB line of credit, with $8.7 million outstanding at year-end.
Junior subordinated debentures totaled $167.5 million at year-end, with $41.2 million subsequently redeemed or scheduled for redemption in January 2015 and the remaining debentures scheduled for redemption during the first quarter of 2015.
Company regulatory capital ratios were 13.80% Tier 1 risk-based capital, 14.56% total risk-based capital and 7.69% leverage. Bank ratios were 13.46%, 14.22% and 7.50%, respectively. The Bank was classified as well-capitalized.
The Company reported $2.00 billion of commitments to extend credit and $112.5 million of standby letters of credit. These commitments may expire unused and do not necessarily represent future cash funding requirements.

Material changes versus the prior comparable period

F&M added approximately $2.27 billion of deposits and $1.60 billion of loans at acquisition; the transaction also added $198.2 million of goodwill and $27.1 million of core deposit intangibles at year-end, subject to final fair-value adjustments.
Loan growth substantially exceeded organic growth because of the F&M acquisition, while deposits excluding F&M increased 2.2% during the year.
Nonperforming loans increased to $33.6 million from $15.2 million, and nonperforming assets increased to $36.9 million from $22.5 million. The nonperforming-assets ratio rose to 0.40% from 0.29%.
The allowance for credit losses increased 20.0% to $80.8 million, remaining 0.87% of total loans. The increase was principally attributable to growth and reclassification of acquired legacy loans; $15.6 million of the provision related to acquired loans.
Net charge-offs increased to $4.8 million from $2.5 million, but remained low at 0.05% of average loans.
Goodwill increased to $1.87 billion from $1.67 billion. Management reported no goodwill impairment.
Merger-related expenses were $3.1 million in 2014, including approximately $2.5 million related to F&M.
Cash dividends declared increased to $0.9925 per share from $0.8850, while the dividend payout ratio declined to 22.99% from 24.41%.

Guidance, outlook, commentary, risks and unusual items

Management did not provide quantified earnings or revenue guidance. Its stated strategy is to pursue internal loan and deposit growth, disciplined acquisitions, community banking, cost control, cross-selling and maintenance of conservative underwriting and asset quality.

Management expects acquisitions, new banking centers and internal growth to remain important growth avenues, but cautions that future acquisitions may not be accretive within any particular period.
Basel III capital rules became effective January 1, 2015. Management estimated that the Company and Bank would have exceeded initial minimum requirements as of December 31, 2014. Trust preferred securities began to phase out of Tier 1 capital, supporting the Company’s decision to redeem the related debentures.
Key risks include Texas and Oklahoma economic conditions, including potential effects from declining oil prices; interest-rate changes; real estate and commercial-loan concentrations; acquisition integration; liquidity; regulatory and consumer-compliance requirements; cybersecurity and third-party vendor disruptions; and potential goodwill impairment.
The securities portfolio was concentrated in mortgage-backed securities. Management reported $55.1 million of unrealized losses in held-to-maturity securities but concluded that the declines were temporary and recorded no other-than-temporary impairment charges.
The Company enhanced its allowance methodology during the fourth quarter of 2014 by more precisely aligning qualitative environmental factors with portfolio segments.
Legal proceedings arise in the ordinary course of business; management believes any ultimate liability will not materially affect the financial statements.
Deloitte & Touche LLP issued unqualified opinions on the consolidated financial statements and internal control over financial reporting.

Important facts for investors to verify

Reconcile reported earnings growth with acquisition contribution, including purchase-accounting loan discount accretion of $95.9 million.
Monitor the increase in nonperforming loans and assets, particularly acquired legacy and PCI loans.
Evaluate whether the $80.8 million allowance remains adequate as commercial, real estate and acquired loan balances expand.
Confirm the timing, funding source and capital effects of the planned redemption of the remaining junior subordinated debentures.
Assess the sensitivity of net interest income to interest-rate changes; the filing’s model estimated declines of 2.7% under a 200-basis-point increase and 3.5% under a 100-basis-point decrease.
Review the sustainability of the $1.87 billion goodwill balance and the assumptions used in impairment testing.
Consider the liquidity impact of $2.11 billion in off-balance-sheet credit commitments and standby letters of credit.