Business Context and Reporting Period
Prosperity Bancshares, Inc. is a Texas financial holding company whose principal subsidiary, Prosperity Bank, provides retail and commercial banking services to consumers and small and medium-sized businesses in Texas and Oklahoma. This Form 10-K covers the fiscal year ended December 31, 2013, with comparisons primarily to 2012.
At year-end, Prosperity Bank operated 238 full-service banking locations and had 2,995 full-time-equivalent associates. The Company completed three acquisitions during 2013: East Texas Financial Services, Coppermark Bancshares and FVNB Corp., adding approximately 30 banking centers after consolidation.
Key Financial Metrics
| Metric | 2013 | 2012 | Change |
|---|---|---|---|
| Net interest income | $498.8 million | $380.7 million | 31.0% increase |
| Provision for credit losses | $17.2 million | $6.1 million | Increase |
| Noninterest income | $95.4 million | $75.5 million | 26.3% increase |
| Noninterest expense | $247.2 million | $198.5 million | 24.6% increase |
| Net income | $221.4 million | $167.9 million | 31.9% increase |
| Diluted earnings per share | $3.65 | $3.23 | 13.0% increase |
| Return on average assets | 1.36% | 1.35% | Improved |
| Return on average equity | 9.31% | 9.10% | Improved |
| Tax-equivalent net interest margin | 3.58% | 3.53% | 5 basis-point increase |
| Efficiency ratio | 41.60% | 43.48% | Improved |
| Total assets | $18.64 billion | $14.58 billion | 27.8% increase |
| Total loans | $7.78 billion | $5.18 billion | 50.1% increase |
| Total deposits | $15.29 billion | $11.64 billion | 31.3% increase |
| Shareholders’ equity | $2.79 billion | $2.09 billion | 33.4% increase |
Cash Flow, Liquidity and Debt
- Net cash provided by operating activities was $307.7 million, compared with $209.8 million in 2012.
- Investing activities generated net cash of $8.9 million, largely because cash acquired in the 2013 acquisitions offset securities purchases and loan growth.
- Financing activities used $261.4 million, including repayments of short-term borrowings, reductions in repurchase agreements and $54.0 million of common-stock dividends.
- Cash and cash equivalents increased to $381.4 million from $326.3 million.
- The Company had $15.29 billion of deposits, $10.7 million of other borrowings and $364.4 million of securities sold under repurchase agreements at year-end.
- The Company reported $4.67 billion of availability under its Federal Home Loan Bank line, with only $10.7 million outstanding at year-end.
- Junior subordinated debentures increased to $124.2 million from $85.1 million, primarily because debt was assumed in the FVNB acquisition.
- Off-balance-sheet commitments totaled $1.56 billion, including $1.52 billion of commitments to extend credit and $47.1 million of standby letters of credit. These commitments may expire unused.
Asset Quality and Capital
- Nonperforming assets increased to $22.5 million from $13.0 million, while nonperforming assets as a percentage of loans and other real estate increased to 0.29% from 0.25%.
- Nonperforming loans were $15.2 million, compared with $5.7 million in 2012.
- The allowance for credit losses increased to $67.3 million, but declined to 0.87% of total loans from 1.01%, primarily because acquired loans were recorded at fair value and included purchase discounts.
- Net charge-offs declined to $2.5 million from $5.1 million, or 0.04% of average loans versus 0.11%.
- Real-estate-related loans represented approximately 78.1% of total loans, including commercial real estate, residential real estate, construction and land loans.
- The Company’s Tier 1 risk-based capital ratio was 13.27%, total risk-based capital ratio was 14.02% and leverage ratio was 7.42%.
- Prosperity Bank’s corresponding ratios were 12.95%, 13.70% and 7.24%; the Bank was classified as well capitalized.
Material Changes Versus the Prior Comparable Period
- Growth was driven principally by the three 2013 acquisitions. Excluding acquired loans and subsequent production at acquired banking centers, loans held for investment grew approximately 5.6%.
- Average interest-earning assets increased 29.6%, while the average rate paid on interest-bearing liabilities declined from 0.48% to 0.39%. The higher asset base and lower funding costs drove the increase in net interest income.
- Average noninterest-bearing deposits increased by $902.7 million to $3.35 billion, contributing to a decline in total cost of funds from 0.37% to 0.29%.
- Noninterest income benefited from acquired trust, mortgage, credit-card and related operations. Debit-card income was negatively affected by the Durbin Amendment’s interchange-fee limits applicable to institutions with assets above $10 billion.
- Noninterest expense increased with the larger branch and employee base. Full-time-equivalent associates increased from 2,266 to 2,995.
- Pre-tax merger-related expenses were $3.2 million in 2013 versus $7.0 million in 2012.
- Goodwill increased to $1.67 billion from $1.22 billion, and core deposit intangibles increased to $42.0 million from $26.2 million, primarily from the 2013 acquisitions. No goodwill impairment was recorded.
- Common shares outstanding increased substantially because the Company issued shares as acquisition consideration; year-end shares outstanding increased to 66.0 million from 56.4 million.
- Cash dividends declared increased to $0.89 per share from $0.80 per share.
Outlook, Commentary, Risks and Unusual Items
Management’s strategy emphasizes community banking, internal loan and deposit growth, disciplined acquisitions, stringent expense control, sound asset quality and cross-selling. Management expects acquisitions and internal growth to remain important sources of expansion but does not guarantee that future acquisitions will be accretive within any particular period.
The Company had entered into an agreement to acquire F&M Bancorporation Inc., headquartered in Tulsa, Oklahoma. The proposed consideration was approximately 3.3 million Prosperity shares plus $47.0 million in cash, subject to adjustments, shareholder approval and regulatory approvals. Closing was expected in the second quarter of 2014.
- Key risks include the concentration of lending in Texas and Oklahoma and the high proportion of real-estate-related loans, particularly commercial real estate and construction lending.
- Rapid acquisition-led growth creates integration, personnel, systems, operational, funding and regulatory-capital risks.
- Interest-rate changes may affect net interest income, securities valuations, deposit costs and loan demand. The filing’s model estimated a 2.6% decline in 12-month net interest income under an immediate 200-basis-point increase and a 3.8% decline under a 100-basis-point decrease.
- Management’s allowance estimate is judgmental and may be insufficient if credit losses, delinquencies, collateral declines or economic deterioration exceed assumptions.
- Goodwill of $1.67 billion is subject to future impairment testing; an impairment charge could materially reduce earnings.
- Regulatory changes include Basel III capital requirements beginning January 1, 2015 and the phase-out of trust preferred securities from Tier 1 capital. The Company expected to make the election allowing continued exclusion of certain accumulated other comprehensive income effects from regulatory capital.
- The Company is subject to CFPB oversight because the Bank’s assets exceeded $10 billion, as well as stress-testing, consumer-protection, deposit-insurance and other banking requirements.
- Management reported no material unresolved legal proceedings, no material future capital-expenditure commitments and no other material known cash requirements. Ordinary-course litigation was not expected to have a material adverse effect.
- Deloitte & Touche issued unqualified opinions on the consolidated financial statements and internal control over financial reporting.
Facts Investors Should Verify
- Reconcile reported earnings growth with acquisition-related contributions, purchase-accounting loan discount accretion of $62.7 million and the increase in diluted shares.
- Assess whether the 2013 increase in nonperforming loans and nonperforming assets represents a broader deterioration in acquired or organically originated credit portfolios.
- Review the sustainability of the 3.58% net interest margin, including sensitivity to deposit repricing, interest rates and the run-off of acquired-loan accretion.
- Evaluate commercial real estate, construction and other real-estate concentrations against local Texas and Oklahoma economic conditions and collateral values.
- Review the valuation and impairment sensitivity of $1.67 billion of goodwill and $42.0 million of core deposit intangibles.
- Confirm the final terms, regulatory approvals, closing status and integration effects of the pending F&M Bancorporation acquisition.
- Assess the effect of Basel III implementation and the exclusion of trust preferred securities from Tier 1 capital beginning in 2015 and 2016.
- Verify liquidity under stress, including deposit behavior, available FHLB capacity, repurchase-agreement collateral and the $1.56 billion of unfunded commitments.