Prosperity Bancshares, Inc. — 2020 Third-Quarter Form 10-Q
Reporting period: Quarterly and year-to-date periods ended September 30, 2020; filed November 5, 2020. Prosperity Bank operated 275 full-service locations across Texas and Oklahoma. Results include LegacyTexas Financial Group, which merged with the Company on November 1, 2019, limiting direct comparability with 2019.
Financial Overview
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|
| Net interest income | $258.1 million | $154.0 million | $773.1 million | $463.7 million |
| Provision for credit losses | $10.0 million | $1.1 million | $20.0 million | $2.6 million |
| Noninterest income | $34.9 million | $30.7 million | $95.0 million | $88.8 million |
| Noninterest expense | $117.9 million | $80.7 million | $377.0 million | $240.1 million |
| Net income | $130.1 million | $81.8 million | $391.8 million | $246.4 million |
| Diluted EPS | $1.40 | $1.19 | $4.20 | $3.55 |
- Q3 net income increased 59.1%; nine-month net income increased 59.0%. Management attributed the increase primarily to the LegacyTexas merger.
- Tax-equivalent net interest margin was 3.57% in Q3 and 3.69% for the first nine months, compared with 3.16% and 3.17%, respectively, in the prior-year periods.
- Annualized Q3 return on average assets was 1.58%, return on average common equity was 8.64%, and the efficiency ratio was 40.17%. Nine-month figures were 1.62%, 8.78%, and 43.19%, respectively.
- Loan discount accretion contributed approximately $21.3 million to Q3 net interest income and $71.0 million to nine-month net interest income.
Balance Sheet, Liquidity and Capital
| Balance-sheet item | September 30, 2020 | December 31, 2019 | Change |
|---|
| Total assets | $33.20 billion | $32.19 billion | +3.1% |
| Total loans | $20.80 billion | $18.85 billion | +10.3% |
| Total deposits | $26.46 billion | $24.20 billion | +9.3% |
| Cash and cash equivalents | $1.09 billion | $574.1 million | +$513.6 million |
| Shareholders’ equity | $6.03 billion | $5.97 billion | +1.1% |
- Loans included $2.73 billion of Warehouse Purchase Program loans and $1.39 billion of PPP loans across 11,948 loans. PPP loans are fully SBA-guaranteed and do not carry an allowance.
- Other borrowings declined to $2.6 million from $1.30 billion at year-end. Securities sold under repurchase agreements were $380.3 million, and subordinated notes were $125.1 million.
- The Company had $7.63 billion available under its Federal Home Loan Bank line and no FHLB advances outstanding at September 30, 2020.
- Nine-month operating cash flow was $496.9 million. Investing activities used $706.5 million, financing activities provided $723.2 million, and cash increased by $513.6 million.
- The Bank was above “well capitalized” regulatory thresholds, with CET1, Tier 1, total risk-based and Tier 1 leverage ratios of 13.67%, 13.67%, 14.19% and 9.89%, respectively.
Credit Quality and Material Changes
- The Company adopted CECL on January 1, 2020. The adoption increased the loan allowance by $240.5 million and the off-balance-sheet allowance by $24.4 million, reducing retained earnings by $92.9 million on an after-tax and other-adjustment basis as presented in the filing.
- The allowance for credit losses on loans was $323.6 million, or 1.56% of total loans, versus $87.5 million, or 0.46%, at December 31, 2019. The off-balance-sheet allowance was $29.9 million versus $5.6 million.
- Net charge-offs were $10.6 million in Q3 and $24.4 million for nine months, compared with $1.0 million and $2.0 million, respectively, in the prior-year periods. A substantial portion related to resolved purchased credit-deteriorated loans and was covered by specific reserves.
- Nonperforming assets increased to $69.5 million from $62.9 million, but remained 0.33% of total loans and other real estate. Nonaccrual loans were $57.4 million, and troubled debt restructurings were $13.2 million.
- The LegacyTexas merger generated approximately $1.33 billion of goodwill and $52.1 million of related core deposit intangibles as of September 30, 2020. Nine-month merger-related expenses were $8.0 million; none were recorded in Q3.
- The Company repurchased 2.2 million shares for $115.0 million during the first nine months and declared $128.5 million of cash dividends. The quarterly dividend was $0.46 per share.
Outlook, Risks and Unusual Items
- The filing provides no formal earnings or financial guidance. Management stated that the effect of COVID-19 on operations and 2020 results could not be reliably estimated.
- COVID-19, elevated unemployment, lower oil and gas prices, borrower payment deferrals, collateral values and economic uncertainty could increase credit losses, reduce demand and pressure liquidity and earnings.
- Loan concentrations require monitoring: commercial real estate, 1-4 family residential and construction loans represented 71.3% of loans excluding Warehouse Purchase Program loans. Oil and gas loans were $604.7 million, hotels $386.3 million and restaurants $215.1 million at September 30, 2020.
- Off-balance-sheet commitments totaled $5.10 billion, including $4.18 billion of commitments to extend credit, $803.4 million of unused Warehouse Purchase Program capacity and $112.8 million of standby letters of credit.
- The Company gave irrevocable notice to redeem its $125.0 million subordinated notes on December 1, 2020, requiring approximately $126.3 million including accrued interest.
- The nine-month effective tax rate was 16.8%, reduced by a $20.1 million CARES Act NOL carryback benefit. This benefit is not necessarily recurring.
- Management reported no material changes in market-risk exposures, no material legal proceedings, and effective disclosure controls as of September 30, 2020.
Investor Verification Checklist
- Assess the sustainability of earnings growth after removing LegacyTexas merger effects, loan discount accretion, PPP-related income and the $20.1 million tax benefit.
- Review subsequent credit performance, loan deferrals, COVID-19 exposures and whether the $323.6 million CECL allowance remains adequate.
- Verify trends in commercial real estate, residential, construction, oil and gas, hotel and restaurant portfolios.
- Confirm completion and funding of the December 1, 2020 subordinated-note redemption and its effect on regulatory capital and liquidity.
- Monitor PPP forgiveness timing, fee recognition, SBA reimbursement and related regulatory or litigation exposure.
- Reconcile the reported cash-flow changes with deposit growth, securities activity, Warehouse Purchase Program turnover and debt repayments.
