Business Context and Reporting Period
Prosperity Bancshares, Inc. is a Texas-based financial holding company whose principal subsidiary, Prosperity Bank, provides retail and commercial banking services to consumers and small and medium-sized businesses. The company operated 175 full-service banking locations across Texas and had 1,664 full-time equivalent associates at December 31, 2011.
This Form 10-K covers the fiscal year ended December 31, 2011. The filing also provides unaudited fourth-quarter 2011 information. The consolidated financial statements were audited by Deloitte & Touche LLP, which issued unqualified opinions on the financial statements and internal control over financial reporting.
Key Financial Metrics
| Metric | 2011 | 2010 | Change |
|---|---|---|---|
| Total assets | $9.823 billion | $9.477 billion | +3.7% |
| Total deposits | $8.060 billion | $7.455 billion | +8.1% |
| Total loans | $3.766 billion | $3.485 billion | +8.1% |
| Net interest income | $326.7 million | $318.1 million | +2.7% |
| Provision for credit losses | $5.2 million | $13.6 million | Down $8.4 million |
| Noninterest income | $56.0 million | $53.8 million | +4.1% |
| Noninterest expense | $163.7 million | $166.6 million | -1.7% |
| Net income | $141.7 million | $127.7 million | +11.0% |
| Diluted EPS | $3.01 | $2.73 | +10.3% |
| Return on average assets | 1.47% | 1.38% | +9 basis points |
| Return on average equity | 9.36% | 9.08% | +28 basis points |
| Tax-equivalent net interest margin | 3.98% | 4.04% | Down 6 basis points |
| Efficiency ratio | 42.76% | 44.83% | Improved 207 basis points |
Cash Flow, Liquidity and Capital
- Net cash provided by operating activities was $217.9 million, compared with $177.7 million in 2010.
- Net cash used in investing activities was $365.3 million, primarily reflecting securities purchases and $298.2 million of loan growth.
- Net cash provided by financing activities was $201.5 million, principally due to deposit growth and repayment of $360.0 million of short-term borrowings.
- Cash and cash equivalents increased to $213.4 million from $159.4 million.
- FHLB borrowings and other borrowings declined to $12.8 million from $374.4 million. Including repurchase agreements, total borrowings were $67.7 million at year-end.
- The company had $3.13 billion of additional borrowing capacity under its FHLB collateral agreement, with only $12.8 million outstanding.
- Shareholders’ equity increased to $1.567 billion from $1.452 billion. The company declared cash dividends of $0.72 per share, totaling $33.7 million.
- Company regulatory capital ratios were strong: 15.90% Tier 1 risk-based capital, 17.09% total risk-based capital and 7.89% leverage. Prosperity Bank was classified as well-capitalized, with a 16.81% total risk-based capital ratio and 7.75% leverage ratio.
Asset Quality and Loan Concentration
- Nonperforming assets declined to $12.1 million, or 0.32% of loans and other real estate, from $15.8 million, or 0.45%, in 2010.
- Nonperforming loans were $3.6 million at year-end, with no accruing loans 90 days or more past due.
- Net charge-offs declined to $5.2 million, or 0.14% of average loans, from $13.9 million, or 0.41%.
- The allowance for credit losses was $51.6 million, equal to 1.37% of total loans, compared with 1.48% in 2010.
- Real estate loans represented approximately 85.3% of total loans. Construction and land development loans were $482.1 million, commercial real estate loans were $1.352 billion, and 1-4 family residential loans were $1.007 billion.
Material Changes Versus the Prior Comparable Period
- Profitability improved: net income rose 11.0%, diluted EPS rose 10.3%, ROAA increased 9 basis points and ROAE increased 28 basis points.
- Loan and deposit growth accelerated to 8.1% year over year, driven primarily by internal loan growth and higher core deposits.
- Net interest income increased despite a lower net interest margin because average interest-earning assets grew 4.4% and interest expense declined substantially.
- The average rate paid on interest-bearing liabilities declined from 1.06% to 0.72%, while the average yield on interest-earning assets declined from 4.84% to 4.48%.
- Noninterest expense decreased because of lower FDIC and regulatory assessments, lower other-real-estate expenses and lower core deposit intangible amortization. Salaries and benefits increased due to the full-year effect of 2010 branch acquisitions and higher incentive compensation.
- The company completed no acquisitions during 2011. It redeemed $7.2 million of junior subordinated debentures, including a $383,000 payoff penalty.
- Investment securities increased modestly to $4.659 billion, while securities yields declined to 3.41% from 3.87%. The company recorded a $581,000 loss on the sale of two downgraded non-agency collateralized mortgage obligations but recorded no other-than-temporary impairment.
Guidance, Outlook, Commentary, Risks and Unusual Items
Outlook and Strategic Developments
- Management emphasized continued community banking, organic loan and deposit growth, disciplined acquisitions, cost control, asset-quality management and cross-selling.
- On January 1, 2012, the company completed the acquisition of Texas Bankers, Inc. and issued 314,953 shares of common stock. The acquired institution reported $77.0 million of assets, $27.6 million of loans and $70.4 million of deposits at December 31, 2011.
- The company had pending agreements to acquire East Texas Financial Services, The Bank Arlington and American State Financial Corporation. The largest proposed transaction, American State Financial, involved up to 8.525 million shares and $178.5 million in cash and was expected to close in the third quarter of 2012, subject to shareholder and regulatory approvals.
- The filing does not provide formal earnings or revenue guidance. Management states that future acquisition timing, integration and accretion are uncertain.
Principal Risks and Contingencies
- Heavy exposure to Texas real estate markets, including commercial real estate and construction lending, could increase losses if property values or borrower performance deteriorate.
- Interest-rate changes may reduce net interest income and the net interest margin. The company’s simulation estimated that a 100-basis-point increase could increase 12-month net interest income by 2.1%, while a 100-basis-point decrease could reduce it by 3.7%; actual results may differ.
- Liquidity depends primarily on core deposits, although the company maintains substantial FHLB borrowing capacity. Deposit competition, market disruption or regulatory action could impair funding access.
- Goodwill totaled $924.5 million. Management identified no impairment at year-end, but an unfavorable change in cash flows, profitability or market conditions could result in a future charge.
- Off-balance-sheet exposure included $449.0 million of commitments to extend credit and $14.6 million of standby letters of credit. These commitments may not be fully funded.
- The company had $85.1 million of junior subordinated debentures. Deferring interest could restrict common-stock dividends, and dividend payments are also subject to regulatory limitations.
- Legal proceedings arise in the ordinary course of business; management stated that expected liabilities were not material to the consolidated financial statements.
Most Important Facts for Investors to Verify
- Reconcile the reported 2011 earnings growth with the lower net interest margin and determine how sustainable the benefit from lower funding costs is.
- Review the concentration and performance of commercial real estate, construction and 1-4 family residential loans, including stress-test assumptions for Texas property values.
- Assess whether the $51.6 million allowance for credit losses remains adequate as loans grow and as troubled debt restructurings increase.
- Evaluate the funding and capital impact of the announced acquisitions, particularly the proposed American State Financial transaction requiring significant cash and share issuance.
- Examine the composition, duration and credit exposure of the $4.659 billion securities portfolio, including mortgage-backed securities and downgraded non-agency CMOs.
- Confirm the company’s ability to maintain dividends while servicing $85.1 million of junior subordinated debentures and complying with bank dividend restrictions.