Prosperity Bancshares, Inc. — 1Q 2017 Form 10-Q Summary
Business context and reporting period
Prosperity Bancshares, Inc. is a Texas-based bank holding company whose principal subsidiary, Prosperity Bank, provides banking products and services to businesses and consumers in Texas and Oklahoma. The unaudited filing covers the three months ended March 31, 2017, with comparisons to the three months ended March 31, 2016. The Bank operated 244 full-service locations at quarter-end.
Key financial metrics
| Metric | 1Q 2017 | Comparable / prior period | Change |
|---|---|---|---|
| Net interest income | $152.4 million | $166.3 million | Down 8.3% |
| Noninterest income | $30.8 million | $30.8 million | Essentially unchanged |
| Noninterest expense | $78.1 million | $80.5 million | Down 3.1% |
| Provision for credit losses | $2.7 million | $14.0 million | Down $11.3 million |
| Net income | $68.6 million | $69.0 million | Down 0.6% |
| Diluted EPS | $0.99 | $0.98 | Up $0.01 |
| Tax-equivalent net interest margin | 3.20% | 3.48% | Down 28 basis points |
| Efficiency ratio | 43.01% | 41.08% | Higher, indicating reduced efficiency |
| Return on average assets | 1.23% | 1.24% | Down 1 basis point |
| Return on average common equity | 7.45% | 7.85% | Down 40 basis points |
| Operating cash flow | $144.4 million | $161.0 million | Down $16.6 million |
Interest income was $165.1 million, including $111.7 million from loans and $53.2 million from securities. Interest expense increased to $12.6 million from $10.9 million, primarily because of higher other borrowing costs and balances. The filing does not present a consolidated revenue figure in the income statement; net interest income plus noninterest income totaled approximately $183.3 million.
At March 31, 2017, total assets were $22.48 billion, loans were $9.74 billion, securities were $9.85 billion, deposits were $17.04 billion and shareholders’ equity was $3.69 billion. Cash and cash equivalents were $325.7 million. Other borrowings totaled $1.27 billion, including $1.265 billion of FHLB advances, and repurchase agreements totaled $335.9 million.
The allowance for credit losses was $84.1 million, or 0.86% of total loans, compared with $85.3 million, or 0.89%, at December 31, 2016. Net charge-offs were $3.9 million, or 0.16% of average loans on an annualized basis. Nonperforming assets were $41.2 million, or 0.42% of loans and other real estate, compared with $48.3 million, or 0.50%, at year-end 2016.
The Company’s and Bank’s reported capital ratios exceeded applicable minimums. The Bank’s March 31 ratios included CET1 of 14.32%, Tier 1 risk-based capital of 14.32%, total risk-based capital of 15.01% and Tier 1 leverage of 8.54%; the Bank remained well capitalized.
Material changes versus comparable periods
- Net income declined modestly despite materially lower credit-loss provision expense, because net interest income fell $13.8 million.
- The primary pressure on net interest income was a $9.7 million decrease in loan discount accretion and lower average loan yields. Tax-equivalent net interest margin declined from 3.48% to 3.20%.
- Loans increased $117.2 million, or 1.2%, from December 31, 2016, while deposits declined $271.7 million, or 1.6%. Noninterest-bearing deposits increased $108.3 million, but interest-bearing deposits declined $380.0 million.
- Other borrowings increased $279.9 million from year-end, and cash and cash equivalents declined $111.6 million, primarily reflecting security purchases, loan growth and lower deposits.
- Nonperforming assets improved by $7.1 million, primarily because three loans were charged off and two loans were paid off.
- Noninterest expense declined $2.5 million, primarily from lower salaries and benefits. Noninterest income was effectively flat.
- Common dividends declared increased to $0.34 per share from $0.30 per share in the comparable 2016 quarter. No common stock repurchases were reported in 1Q 2017, compared with $47.2 million in the 2016 period.
Outlook, commentary, risks and unusual items
Management provided no quantitative earnings, margin, loan-growth or expense guidance in the filing. Management stated that first-quarter results are not necessarily indicative of full-year results and described internal growth, operating efficiency and acquisitions as the principal growth strategy. The Company continued to seek expansion opportunities following its 2016 acquisition of Tradition Bancshares.
The securities portfolio had approximately $163.3 million of unrealized losses in held-to-maturity securities at March 31, 2017, largely attributed by management to higher market interest rates. Management stated that it did not intend to sell the securities, expected recovery over time, and recorded no other-than-temporary impairment.
Key risks include interest-rate changes and margin compression, deposit competition and funding availability, credit deterioration, concentrations in Texas and Oklahoma and in real-estate-related lending, oil-and-gas exposure, construction and commercial real-estate risk, potential goodwill impairment, acquisition integration, regulatory changes, cybersecurity and operational failures. Oil-and-gas loans totaled $267.4 million, with $153.1 million of related unfunded commitments.
Off-balance-sheet commitments included $2.08 billion of commitments to extend credit and $77.5 million of standby letters of credit. Contractual obligations totaled $1.29 billion, principally FHLB borrowings and operating leases. Management stated that commitments may expire unused and that the Company had no material exposure to known future cash requirements beyond those disclosed.
The Company adopted ASU 2016-09 on January 1, 2017; management reported no significant financial statement impact, but noted that the change may increase tax-expense volatility. Management was evaluating other pending accounting standards, including the expected-credit-loss standard effective January 1, 2020. No material changes to previously disclosed risk factors were reported, and management concluded that disclosure controls were effective.
Most important facts for investors to verify
- Whether the decline in loan discount accretion and the 28-basis-point margin contraction persist in subsequent quarters.
- The sustainability and composition of deposit balances, particularly the decline in interest-bearing and municipal deposits and the increase in FHLB funding.
- Credit performance in commercial real estate, construction, commercial and industrial, and oil-and-gas portfolios, including the adequacy of the $84.1 million allowance.
- Whether nonperforming assets and troubled debt restructurings remain controlled; TDRs totaled $8.7 million at March 31, 2017.
- The impact of rising rates on the $9.85 billion securities portfolio, including its unrealized losses and significant mortgage-backed-security concentration.
- Future acquisition activity, integration execution and the potential for goodwill impairment, with goodwill of $1.90 billion at quarter-end.
- Actual regulatory capital, liquidity and funding trends in later filings, including the use and maturity of approximately $1.27 billion of FHLB borrowings.