Prosperity Bancshares, Inc. — 2019 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 businesses and consumers in Texas and Oklahoma. The unaudited report covers the three and six months ended June 30, 2019, with comparisons to the comparable 2018 periods. Prosperity Bank operated 243 full-service banking locations at quarter-end.
Key Financial Metrics
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net income | $82.3 million | $81.6 million | $164.7 million | $156.0 million |
| Diluted EPS | $1.18 | $1.17 | $2.36 | $2.23 |
| Net interest income | $154.8 million | $161.8 million | $309.7 million | $315.0 million |
| Provision for credit losses | $0.8 million | $4.0 million | $1.5 million | $13.0 million |
| Noninterest income | $30.0 million | $28.4 million | $58.1 million | $56.3 million |
| Noninterest expense | $80.8 million | $83.6 million | $159.4 million | $163.7 million |
| Net interest margin, tax-equivalent | 3.16% | 3.28% | 3.18% | 3.22% |
| Efficiency ratio | 43.74% | 43.95% | 43.34% | 44.07% |
Quarterly annualized return on average assets was 1.46%, return on average common equity was 7.92%, and the effective tax rate was 20.3%. Six-month figures were 1.46%, 7.99%, and 20.4%, respectively.
- Total assets were $22.38 billion at June 30, 2019, down 1.4% from December 31, 2018.
- Total loans were $10.59 billion, up 2.1% from year-end; loans represented 47.3% of total assets.
- Total deposits were $16.89 billion, down 2.1%; noninterest-bearing deposits increased 0.4%, while interest-bearing deposits declined 3.4%.
- Total shareholders’ equity was $4.13 billion, up 1.9% from year-end.
- The allowance for credit losses was $87.0 million, or 0.82% of total loans, compared with $86.4 million, or 0.83%, at December 31, 2018.
- Cash and cash equivalents were $302.6 million, compared with $411.1 million at year-end.
- Other borrowings were $940.9 million, primarily Federal Home Loan Bank advances, and repurchase agreements were $313.8 million.
- Six-month operating cash flow was $206.5 million. Investing activities provided $210.8 million, while financing activities used $525.8 million, producing a $108.5 million decrease in cash and cash equivalents.
Material Changes Versus Comparable Period
- Second-quarter net income increased 0.8%, while six-month net income increased 5.6%; six-month 2018 results included substantially higher credit provisions and charge-offs.
- Net interest income declined 4.3% in the quarter and 1.7% year to date. Management attributed the decline primarily to lower loan discount accretion, higher deposit costs, and the prior-year benefit from collecting previously identified troubled assets.
- Loan interest income increased 4.0% in the quarter and 7.7% year to date because of higher average loan balances and loan rates, partly offset by lower discount accretion.
- Interest expense rose materially as deposit pricing increased. Average interest-bearing liability cost increased to 1.05% in the quarter from 0.70% and to 1.02% year to date from 0.62%.
- Noninterest income increased 5.6% in the quarter and 3.2% year to date, primarily because of higher other noninterest income.
- Noninterest expense decreased 3.3% in the quarter and 2.6% year to date, primarily due to lower regulatory assessments and FDIC insurance expense.
- Nonperforming assets rose to $41.6 million, or 0.39% of loans and other real estate, from $19.0 million, or 0.18%, at December 31, 2018. The increase was primarily related to commercial and industrial and 1-4 family residential loans placed on nonaccrual status.
- The company repurchased 818,641 shares during the second quarter at an average price of $64.52 per share, including 219,813 shares settled in July.
Guidance, Outlook, Commentary, Risks and Unusual Items
- The filing does not provide formal earnings or balance-sheet guidance. Management cautions that six-month results are not necessarily indicative of full-year results.
- On June 17, 2019, Prosperity announced a definitive agreement to acquire LegacyTexas Financial Group. LegacyTexas reported approximately $9.9 billion of assets, $8.7 billion of gross loans, and $7.1 billion of deposits at June 30, 2019. Consideration was approximately $2.1 billion, consisting of 0.5280 Prosperity shares and $6.28 cash per LegacyTexas share. Closing was expected in the fourth quarter of 2019, subject to shareholder and regulatory approvals, with possible delays.
- Management reported that the Bank remained well capitalized. At June 30, 2019, the Bank’s CET1, Tier 1, total capital, and Tier 1 leverage ratios were 16.49%, 16.49%, 17.15%, and 10.60%, respectively.
- Liquidity was supported by deposits, cash, securities maturities, loan repayments, and access to a $6.55 billion FHLB line, of which $940 million was outstanding. The company had $2.64 billion of commitments to extend credit and $67.7 million of standby letters of credit; these commitments may expire unused.
- ASU 2016-13, the current expected credit loss standard, becomes effective January 1, 2020. Management was developing models, testing processes, and internal controls, but had not quantified the adoption impact. Adoption may increase the allowance for credit losses.
- The loan portfolio is concentrated in Texas and Oklahoma and is heavily exposed to real estate: commercial real estate, 1-4 family residential, and construction and land loans represented 75.4% of total loans. Oil and gas loans were $367.0 million, or 3.5% of total loans, with $220.4 million of unfunded commitments.
- The securities portfolio included $45.4 million of unrealized losses in held-to-maturity securities, primarily mortgage-backed securities. Management considered the losses temporary and reported no credit-related impairment.
- Principal risks include interest-rate and margin pressure, deposit competition, credit deterioration, real estate and oil-and-gas exposure, liquidity changes, acquisition execution and integration, goodwill impairment, cybersecurity and vendor risks, regulatory changes, and model risk.
- The company reported no material changes in market-risk disclosures or risk factors from its 2018 Form 10-K. Management stated that disclosure controls were effective and that there were no material legal proceedings or material changes in internal control over financial reporting.
Important Facts for Investors to Verify
- Whether the increase in nonperforming assets, including $14.3 million of troubled debt restructurings, remains contained and whether additional provisions or charge-offs develop.
- The expected balance-sheet, capital, dilution, cash consideration, cost savings, credit marks, and integration risks associated with the LegacyTexas transaction.
- The impact of deposit repricing and interest-rate changes on net interest margin, which declined to 3.16% in the quarter.
- The quantified effect of CECL adoption beginning January 1, 2020 and the adequacy of the $87.0 million allowance under changing economic conditions.
- The sustainability of liquidity and capital levels after share repurchases, dividends, loan growth, and the proposed acquisition.
- The composition and valuation sensitivity of the $8.95 billion securities portfolio, particularly its mortgage-backed securities and unrealized losses.