Prosperity Bancshares, Inc. — 2016 Q2 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 in Texas and Oklahoma. The filing covers the quarter and six months ended June 30, 2016; financial statements are unaudited. The Bank operated 245 full-service banking locations at quarter-end.
On January 1, 2016, the Company acquired Tradition Bancshares, Inc. and its Houston-area subsidiary, Tradition Bank, for total consideration of approximately $71.5 million, consisting of 679,528 shares of common stock and $39.0 million in cash.
Key financial metrics
| Metric | Three months ended June 30, 2016 | Three months ended June 30, 2015 | Six months ended June 30, 2016 | Six months ended June 30, 2015 |
|---|---|---|---|---|
| Net interest income | $158.5 million | $158.2 million | $324.7 million | $321.1 million |
| Provision for credit losses | $6.0 million | $0.5 million | $20.0 million | $1.8 million |
| Noninterest income | $28.5 million | $30.3 million | $59.3 million | $58.7 million |
| Noninterest expense | $79.2 million | $79.7 million | $159.8 million | $159.2 million |
| Net income | $68.1 million | $71.9 million | $137.0 million | $145.6 million |
| Diluted earnings per share | $0.98 | $1.03 | $1.96 | $2.08 |
| Tax-equivalent net interest margin | 3.37% | 3.39% | 3.43% | 3.48% |
| Efficiency ratio | 42.46% | 42.35% | 41.75% | 42.09% |
At June 30, 2016, total assets were $21.80 billion, total loans were $9.65 billion, securities were $9.27 billion, deposits were $17.22 billion and shareholders’ equity was $3.54 billion. Cash and cash equivalents were $333.7 million. The allowance for credit losses was $83.8 million, or 0.87% of total loans.
Six-month operating cash flow was $226.9 million, compared with $196.5 million in the prior-year period. Investing activities provided $473.8 million, primarily reflecting net securities maturities and paydowns. Financing activities used $931.0 million, driven principally by deposit reductions, repayment activity, stock repurchases and dividends. Cash and cash equivalents declined $230.3 million from year-end 2015.
Other borrowings totaled $606.0 million, including $600.0 million of short-term Federal Home Loan Bank advances. Securities sold under repurchase agreements totaled $320.0 million. The Company reported $4.85 billion of available capacity under its FHLB agreement, with $606.0 million outstanding. The Bank’s capital ratios exceeded the regulatory thresholds for “well capitalized” status; its CET1, total risk-based capital and Tier 1 leverage ratios were 12.92%, 13.63% and 7.61%, respectively.
Material changes versus comparable periods
- Second-quarter net income declined 5.4% year over year, while six-month net income declined 5.9%, primarily because of substantially higher credit-loss provisions.
- Net interest income increased 0.1% in the quarter and 1.1% year to date, but the tax-equivalent net interest margin contracted by two basis points in the quarter and five basis points year to date. Management attributed the pressure principally to lower accretion of acquired-loan discounts.
- Average loans increased 5.8% in the quarter and 5.7% year to date, while reported period-end loans increased 2.2% from December 31, 2015.
- Total deposits decreased 2.6% from year-end 2015, including a 2.3% decline in noninterest-bearing deposits and a 2.7% decline in interest-bearing deposits.
- Net charge-offs increased to $5.9 million in the quarter and $17.6 million year to date, compared with $0.5 million and $1.5 million, respectively, in the prior-year periods. Management cited an energy-loan charge-off in the quarter and one agricultural loan plus three energy loans year to date.
- Nonperforming assets increased to $52.1 million from $43.5 million at December 31, 2015, primarily because of two commercial real estate loans. Nonperforming assets represented 0.54% of loans and other real estate, compared with 0.46% at year-end.
- The Company repurchased $51.1 million of common stock during the six months and declared cash dividends of $41.8 million, or $0.6000 per share.
- Securities declined 2.4% from year-end, while other real estate owned increased to $15.7 million from $3.0 million.
Outlook, commentary, risks and unusual items
The filing does not provide formal earnings or balance-sheet guidance. Management stated that it expects deposits to remain the primary funding source and loans to remain the principal use of funds. Management characterized liquidity as adequate and stated that it does not generally rely on external purchased funds.
Management believed the allowance for credit losses was adequate at June 30, 2016, but cautioned that future losses could be substantial relative to the allowance if economic conditions or borrower performance differ from assumptions. The loan portfolio is concentrated in Texas and Oklahoma and includes significant commercial real estate, residential real estate, commercial and industrial, agriculture and energy exposure. Oil and gas loans totaled $328.4 million, or 3.4% of total loans, with an additional $156.0 million of unfunded oil and gas commitments.
Investment securities had $6.3 million of unrealized losses in the held-to-maturity portfolio and $613 thousand in the available-for-sale portfolio. Management considered the losses temporary, primarily attributable to interest-rate movements, and reported no other-than-temporary impairment losses. The Company had $1.90 billion of goodwill at quarter-end and recorded no goodwill impairment.
Off-balance-sheet commitments included $2.03 billion of commitments to extend credit and $82.6 million of standby letters of credit. Contractual obligations totaled $633.9 million, including $606.9 million of FHLB notes payable and $27.0 million of operating leases.
Principal forward-looking risks identified by management include economic weakness, interest-rate changes, deposit and loan competition, credit deterioration, real estate and commodity-price exposure, liquidity constraints, acquisition integration, goodwill impairment, regulatory changes, cybersecurity and operational failures, model risk, litigation and environmental liability. No material changes to previously disclosed risk factors were reported, and ordinary-course legal proceedings were not expected to have a material adverse effect.
The Company adopted certain accounting updates in 2016 without significant impact. It was evaluating future standards, including the expected-credit-loss model effective January 1, 2020, revenue recognition, leases and stock compensation; management did not anticipate a significant impact from the revenue standards then under review.
Important facts for investors to verify
- Whether elevated provisions and energy- and agriculture-related charge-offs persist, and whether the allowance remains adequate as the portfolio changes.
- Trends in nonperforming assets, other real estate owned and commercial real estate credit quality.
- The sustainability of the 3.43% year-to-date tax-equivalent net interest margin given lower acquired-loan discount accretion and potentially changing interest rates.
- Deposit trends and the Company’s ongoing reliance on FHLB advances and repurchase agreements for liquidity.
- Integration results and final purchase accounting for the Tradition acquisition, including the $34.6 million of related goodwill.
- Execution of the stock repurchase program, capital ratios and the effect of future distributions on the Basel III capital conservation buffer.
- The potential impact of future accounting standards, particularly the expected-credit-loss model, on reserves and reported earnings.