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PB > SEC Filings for PB > Form 10-Q on 7-Aug-2013All Recent SEC Filings

Show all filings for PROSPERITY BANCSHARES INC | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for PROSPERITY BANCSHARES INC


7-Aug-2013

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Special Cautionary Notice Regarding Forward-Looking Statements

Statements and financial discussion and analysis contained in this quarterly report on Form 10-Q that are not historical facts are forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based on assumptions and involve a number of risks and uncertainties, many of which are beyond the Company's control. Many possible events or factors could affect the future financial results and performance of the Company and could cause such results or performance to differ materially from those expressed in the forward-looking statements. These possible events or factors include, without limitation:

• changes in the strength of the United States economy in general and the strength of the local economies in which the Company conducts operations resulting in, among other things, a deterioration in credit quality or reduced demand for credit, including the result and effect on the Company's loan portfolio and allowance for credit losses;

• changes in interest rates and market prices, which could reduce the Company's net interest margins, asset valuations and expense expectations;

• changes in the levels of loan prepayments and the resulting effects on the value of the Company's loan portfolio;

• changes in local economic and business conditions which adversely affect the Company's customers and their ability to transact profitable business with the company, including the ability of the Company's borrowers to repay their loans according to their terms or a change in the value of the related collateral;

• increased competition for deposits and loans adversely affecting rates and terms;

• the timing, impact and other uncertainties of any future acquisitions, including the Company's ability to identify suitable future acquisition candidates, the success or failure in the integration of their operations, and the ability to enter new markets successfully and capitalize on growth opportunities;

• the possible impairment of goodwill associated with an acquisition and possible adverse short-term effects on the results of operations;

• increased credit risk in the Company's assets and increased operating risk caused by a material change in commercial, consumer and/or real estate loans as a percentage of the total loan portfolio;

• the concentration of the Company's loan portfolio in loans collateralized by real estate;

• the failure of assumptions underlying the establishment of and provisions made to the allowance for credit losses;

• changes in the availability of funds resulting in increased costs or reduced liquidity;

• a deterioration or downgrade in the credit quality and credit agency ratings of the securities in the Company's securities portfolio;


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• increased asset levels and changes in the composition of assets and the resulting impact on the Company's capital levels and regulatory capital ratios;

• the Company's ability to acquire, operate and maintain cost effective and efficient systems without incurring unexpectedly difficult or expensive but necessary technological changes;

• the loss of senior management or operating personnel and the potential inability to hire qualified personnel at reasonable compensation levels;

• government intervention in the U.S. financial system;

• changes in statutes and government regulations or their interpretations applicable to financial holding companies and the Company's present and future banking and other subsidiaries, including changes in tax requirements and tax rates;

• increases in FDIC deposit insurance assessments;

• acts of terrorism, an outbreak of hostilities or other international or domestic calamities, weather or other acts of God and other matters beyond the Company's control; and

• other risks and uncertainties listed from time to time in the Company's reports and documents filed with the Securities and Exchange Commission.

A forward-looking statement may include a statement of the assumptions or bases underlying the forward-looking statement. The Company believes it has chosen these assumptions or bases in good faith and that they are reasonable. However, the Company cautions you that assumptions or bases almost always vary from actual results, and the differences between assumptions or bases and actual results can be material. The Company undertakes no obligation to publicly update or otherwise revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Management's Discussion and Analysis of Financial Condition and Results of Operations analyzes the major elements of the Company's interim consolidated financial statements and accompanying notes. This section should be read in conjunction with the Company's interim consolidated financial statements and accompanying notes included elsewhere in this report and with the consolidated financial statements and accompanying notes and other detailed information appearing in the Company's Annual Report on Form 10-K for the year ended December 31, 2012.

OVERVIEW

The Company, a Texas corporation, was formed in 1983 as a vehicle to acquire the former Allied First Bank in Edna, Texas which was chartered in 1949 as The First National Bank of Edna and is now known as Prosperity Bank. The Company is a registered financial holding company that derives substantially all of its revenues and income from the operation of its bank subsidiary, Prosperity Bankฎ ("Prosperity Bankฎ" or the "Bank"). The Bank provides a wide array of financial products and services to small and medium-sized businesses and consumers. As of June 30, 2013, the Bank operated two hundred nineteen (219) full-service banking locations; with fifty-eight (58) in the Houston area; twenty (20) in the South Texas area including Corpus Christi and Victoria; thirty-five (35) in the Dallas/Fort Worth area; twenty-two (22) in East Texas area; thirty-four (34) in the Central Texas area including Austin and San Antonio; thirty-four (34) in the West Texas area including Lubbock, Midland-Odessa and Abilene; ten (10) in the Bryan/College Station area and six (6) in the Central Oklahoma area. The Company's headquarters are located at Prosperity Bank Plaza, 4295 San Felipe in Houston, Texas and its telephone number is (713) 693-9300. The Company's website address is www.prosperitybankusa.com. Information contained on the Company's website is not incorporated by reference into this quarterly report on Form 10-Q and is not part of this or any other report.

The Company generates the majority of its revenues from interest income on loans, service charges on customer accounts and income from investment in securities. The revenues are partially offset by interest expense paid on deposits and other borrowings and noninterest expenses such as administrative and occupancy expenses. Net interest income is the difference between interest income on earning assets such as loans and securities and interest expense on liabilities such as deposits and borrowings which are used to fund those assets. The level of interest rates and the volume and mix of earning assets and interest-bearing liabilities impact net interest income and margin.

Three principal components of the Company's growth strategy are internal growth, stringent cost control practices and acquisitions, including strategic merger transactions and FDIC assisted transactions. The Company focuses on continuous internal growth. Each banking center is operated as a separate profit center, maintaining separate data with respect to its net interest income, efficiency ratio, deposit growth, loan growth and overall profitability. Banking center presidents and managers are accountable for performance in these areas and compensated accordingly. The Company also focuses on maintaining stringent cost control practices and policies. The Company has centralized many of its critical operations, such as data processing and loan processing. Management believes that this centralized infrastructure can accommodate substantial additional growth while enabling the Company to minimize operational costs through certain economies of scale. During 2012, the Company completed four acquisitions including Texas Bankers, Inc., The Bank Arlington, ASB and Community National Bank. In 2013, the Company completed the acquisitions of East Texas Financial Services, Inc. and Coppermark Bancshares, Inc. and has announced the pending acquisition of FVNB Corp.


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Total assets were $16.27 billion at June 30, 2013 compared with $14.58 billion at December 31, 2012, an increase of $1.69 billion or 11.6%. Total loans were $6.17 billion at June 30, 2013 compared with $5.18 billion at December 31, 2012, an increase of $992.5 million or 19.2%. Total deposits were $12.51 billion at June 30, 2013 compared with $11.64 billion December 31, 2012, an increase of $866.8 million or 7.4%. Total shareholders' equity was $2.35 billion at June 30, 2013 compared with $2.09 billion at December 31, 2012, an increase of $255.9 million or 12.2%.

CRITICAL ACCOUNTING POLICIES

The Company's accounting policies are integral to understanding the financial results reported. Accounting policies are described in detail in Note 1 to the consolidated financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2012. The Company believes that of its significant accounting policies, the following may involve a higher degree of judgment and complexity:

Allowance for Credit Losses-The allowance for credit losses is established through charges to earnings in the form of a provision for credit losses. Management has established an allowance for credit losses which it believes is adequate for estimated losses in the Company's loan portfolio. Based on an evaluation of the loan portfolio, management presents a monthly review of the allowance for credit losses to the Bank's Board of Directors, indicating any change in the allowance since the last review and any recommendations as to adjustments in the allowance. In making its evaluation, management considers factors such as historical loan loss experience, industry diversification of the Company's commercial loan portfolio, the amount of nonperforming assets and related collateral, the volume, growth and composition of the Company's loan portfolio, current economic conditions that may affect the borrower's ability to pay and the value of collateral, the evaluation of the Company's loan portfolio through its internal loan review process and other relevant factors. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management's judgment, should be charged off. Charge-offs occur when loans are deemed to be uncollectible.

Goodwill and Intangible Assets-Goodwill and intangible assets that have indefinite useful lives are subject to an impairment test at least annually, or more often, if events or circumstances indicate that it is more likely than not that the fair value of Prosperity Bank, the Company's only reporting unit with assigned goodwill, is below the carrying value of its equity. The Company has the option to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining the need to perform step one of the annual test for goodwill impairment. An entity has an unconditional option to bypass the qualitative assessment described in the preceding paragraph for any reporting unit in any period and proceed directly to performing the first step of the goodwill impairment test. An entity may resume performing the qualitative assessment in any subsequent period.

If the Company bypasses the qualitative assessment, a two-step goodwill impairment test is performed. The two-step process begins with an estimation of the fair value of the Company's reporting unit compared with its carrying value. If the carrying amount exceeds the fair value of the reporting unit, a second test is completed comparing the implied fair value of the reporting unit's goodwill to its carrying value to measure the amount of impairment.

Estimating the fair value of the Company's reporting unit is a subjective process involving the use of estimates and judgments, particularly related to future cash flows of the reporting unit, discount rates (including market risk premiums) and market multiples. Material assumptions used in the valuation models include the comparable public company price multiples used in the terminal value, future cash flows and the market risk premium component of the discount rate. The estimated fair values of the reporting unit is determined using a blend of two commonly used valuation techniques: the market approach and the income approach. The Company gives consideration to both valuation techniques, as either technique can be an indicator of value. For the market approach, valuations of the reporting unit were based on an analysis of relevant price multiples in market trades in companies with similar characteristics. For the income approach, estimated future cash flows (derived from internal forecasts and economic expectations) and terminal value (value at the end of the cash flow period, based on price multiples) were discounted. The discount rate was based on the imputed cost of equity capital.

The Company had no intangible assets with indefinite useful lives at June 30, 2013. Other identifiable intangible assets that are subject to amortization are amortized on an accelerated basis over the years expected to be benefited, which the Company believes is between eight and fifteen years. These amortizable intangible assets are reviewed for impairment if circumstances indicate their value may not be recoverable based on a comparison of fair value to carrying value. Based on the Company's annual goodwill impairment test as of September 30, 2012, management does not believe any of its goodwill is impaired as of June 30, 2013 because the fair value of the Company's equity substantially exceeded its carrying value. While the Company believes no impairment existed at June 30,


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2013, under accounting standards applicable at that date, different conditions or assumptions, or changes in cash flows or profitability, if significantly negative or unfavorable, could have a material adverse effect on the outcome of the Company's impairment evaluation and financial condition or future results of operations.

Stock-Based Compensation-The Company accounts for stock-based employee compensation plans using the fair value-based method of accounting. The Company's results of operations reflect compensation expense for all employee stock-based compensation, including the unvested portion of stock options granted prior to 2003. The fair value of stock options granted is estimated at the date of grant using the Black-Scholes option-pricing model. This model requires the input of subjective assumptions including stock price volatility and employee turnover that are utilized to measure compensation expense.

Other-Than-Temporarily Impaired Securities-When the fair value of a security is below its amortized cost, and depending on the length of time the condition exists and the extent the fair market value is below amortized cost, additional analysis is performed to determine whether an impairment exists. Available for sale and held to maturity securities are analyzed quarterly for possible other-than-temporary impairment. The analysis considers (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, (iii) whether the market decline was affected by macroeconomic conditions, and (iv) whether the entity has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. Often, the information available to conduct these assessments is limited and rapidly changing, making estimates of fair value subject to judgment. If actual information or conditions are different than estimated, the extent of the impairment of the security may be different than previously estimated, which could have a material effect on the Company's results of operations and financial condition.

Fair Values of Financial Instruments-The Company determines the fair market values of financial instruments based on the fair value hierarchy established which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. There are three levels of inputs that may be used to measure fair value. Level 1 inputs include quoted market prices, where available. If such quoted market prices are not available Level 2 inputs are used. These inputs are based upon internally developed models that primarily use observable market-based parameters. Level 3 inputs are unobservable inputs which are typically based on an entity's own assumptions, as there is little, if any, related market activity. The Company's assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

RECENT ACQUISITIONS

Acquisition of Coppermark Bancshares, Inc.-On April 1, 2013, the Company completed the acquisition of Coppermark Bancshares, Inc. and its wholly-owned subsidiary, Coppermark Bank (collectively "Coppermark") headquartered in Oklahoma City, Oklahoma. Coppermark operated nine (9) full-service banking offices: six (6) in Oklahoma City, Oklahoma and surrounding areas and three
(3) in the Dallas, Texas area. As of March 31, 2013, Coppermark reported, on a consolidated basis, total assets of $1.25 billion, total loans of $847.6 million and total deposits of $1.11 billion.

Acquisition of East Texas Financial Services, Inc.- On January 1, 2013, the Company completed the acquisition of East Texas Financial Services, Inc. (OTC BB: FFBT) and its wholly-owned subsidiary, First Federal Bank Texas. East Texas Financial Services operated four (4) banking offices in the Tyler MSA, including three locations in Tyler, Texas and one location in Gilmer, Texas. As of December 31, 2012, East Texas Financial Services reported, on a consolidated basis, total assets of $165.0 million, total loans of $129.3 million and total deposits of $112.3 million.

SUBSEQUENT EVENTS

Pending Acquisition of FVNB Corp. - On July 1, 2013, the Company announced the signing of a definitive merger agreement to acquire FVNB Corp. and its wholly-owned subsidiary First Victoria National Bank (collectively, "FVNB") headquartered in Victoria, Texas. FVNB operates thirty-four (34) banking locations. As of June 30, 2013, FVNB Corp., on a consolidated basis, reported total assets of $2.4 billion, total loans of $1.6 billion and total deposits of $2.2 billion. Under the terms of the definitive agreement, the Company will issue approximately 5,570,818 shares of Company common stock plus $91.25 million in cash for all outstanding shares of FVNB Corp. capital stock, subject to certain conditions and potential adjustments. The transaction is subject to customary closing conditions, including the receipt of customary regulatory approvals and approval by FVNB's shareholders.

RESULTS OF OPERATIONS

Net income available to common shareholders was $53.8 million ($0.89 per common share on a diluted basis) for the quarter ended June 30, 2013 compared with $37.0 million ($0.78 per common share on a diluted basis) for the quarter ended June 30, 2012, an increase in net income of $16.9 million or 45.6%. The Company posted returns on average common equity of 9.27% and 9.06%,


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returns on average assets of 1.33% and 1.35% and efficiency ratios of 42.51% and 41.94% for the quarters ended June 30, 2013 and 2012, respectively. The efficiency ratio is calculated by dividing total non-interest expense, excluding credit loss provisions, by net interest income plus non-interest income, excluding net gains and losses on the sale of securities and assets. Additionally, taxes are not part of this calculation.

For the six months ended June 30, 2013, net income available to common shareholders was $103.1 million ($1.76 per common share on a diluted basis) compared with $73.5 million ($1.55 per common share on a diluted basis) for the same period in 2012, an increase in net income of $29.7 million or 40.4%. The Company posted returns on average common equity of 9.25% and 9.10%, returns on average assets of 1.33% and 1.37% and efficiency ratios of 42.46% and 42.09% for the six months ended June 30, 2013 and 2012, respectively.

Net Interest Income

The Company's net interest income is affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities, referred to as a "volume change." It is also affected by changes in yields earned on interest-earning assets and rates paid on interest-bearing deposits and other borrowed funds, referred to as a "rate change."

Net interest income before the provision for credit losses was $118.7 million for the quarter ended June 30, 2013 compared with $83.7 million for the quarter ended June 30, 2012, an increase of $35.1 million, or 41.9%. This increase includes $12.0 million related to purchase accounting accretion during the three months ended June 30, 2013. During the three months ended June 30, 2012, $756 thousand of purchase accounting accretion was recorded. The average rate paid on interest-bearing liabilities decreased 12 basis points from 0.52% for the quarter ended June 30, 2012 compared with 0.40% for the quarter ended June 30, 2013, while the average yield on interest-earning assets decreased 23 basis points from 3.90% for the quarter ended June 30, 2012 compared with 3.67% for the quarter ended June 30, 2013. The average volume of interest-bearing liabilities increased $3.32 billion and the average volume of interest-earning assets increased $4.54 billion for the same period as a result of the acquisitions over the past year. The net interest margin on a tax equivalent basis decreased 12 basis points from 3.55% for the quarter ended June 30, 2012 compared with 3.43% for the quarter ended June 30, 2013. The impact on net interest margin of the purchase accounting accretion was an increase of 34 basis points.

Net interest income before the provision for credit losses increased $61.3 million, or 37.0%, to $226.8 million for the six months ended June 30, 2013 compared with $165.5 million for the same period in 2012. This increase includes $26.3 million related to purchase accounting accretion during the six months ended June 30, 2013. During the six months ended June 30, 2012, $701 thousand of purchase accounting accretion was recorded. The increase in net interest income was primarily attributable to higher average interest-earning assets as a result of the acquisitions over the past year. The average volume of interest-earning assets increased $4.23 billion for the six months ended June 30, 2013 compared with the same period in 2012. The net interest margin on a tax equivalent basis decreased to 3.43% for the six months ended June 30, 2013 compared with 3.60% for the same period in 2012. The impact on the net interest margin of the purchase accounting accretion was an increase of 40 basis points.


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The following tables set forth, for each category of interest-earning assets and interest-bearing liabilities, the average amounts outstanding, the interest earned or paid on such amounts, and the average rate earned or paid for the three and the six month periods ended June 30, 2013 and 2012. The tables also set forth the average rate paid on total interest-bearing liabilities, and the net interest margin on average total interest-earning assets for the same periods. Except as indicated in the footnotes, no tax-equivalent adjustments were made and all average balances are daily average balances. Any nonaccruing loans have been included in the table as loans carrying a zero yield.

                                                                       Three Months Ended June 30,
                                                          2013                                             2012
                                                         Interest                                         Interest
                                                          Earned/        Average                           Earned/        Average
                                         Average         Interest      Yield/Rate         Average         Interest      Yield/Rate
                                         Balance           Paid            (4)            Balance           Paid            (4)
                                                                          (Dollars in thousands)
Assets
Interest-Earning Assets:
Loans                                  $  6,114,598      $  89,842            5.89 %    $  3,914,352      $  54,793            5.63 %
Investment securities                     7,964,157         39,384            1.98 %       5,635,810         38,072            2.70 %
Federal funds sold and other earning
assets                                       35,113             76            0.87 %          20,916              9            0.17 %

Total interest-earning assets            14,113,868        129,302            3.67 %       9,571,078         92,874            3.90 %

Allowance for credit losses                 (57,754 )                                        (50,746 )
Noninterest-earning assets                2,114,816                                        1,398,857

Total assets                           $ 16,170,930                                     $ 10,919,189

Liabilities and Shareholders' Equity
Interest-Bearing Liabilities:
Interest-bearing demand deposits       $  2,580,750          2,100            0.33 %    $  1,706,176          2,089            0.49 %
Savings and money market deposits         4,261,466          3,172            0.30 %       2,779,524          2,444            0.35 %
Certificates and other time deposits      2,543,895          3,898            0.61 %       1,880,096          3,550            0.76 %
Securities sold under repurchase
agreements                                  471,430            312            0.27 %          98,968             59            0.24 %
Federal funds purchased and other
borrowings                                  541,034            472            0.35 %         610,499            418            0.28 %
Junior subordinated debentures               85,055            606            2.86 %          85,055            648            3.06 %

Total interest-bearing liabilities       10,483,630         10,560            0.40 %       7,160,318          9,208            0.52 %

Noninterest-Bearing liabilities:
Noninterest-bearing demand deposits       3,295,211                                        2,069,965
Other liabilities                            69,741                                           56,742

Total liabilities                        13,848,582                                        9,287,025
Shareholders' equity                      2,322,348                                        1,632,164

Total liabilities and shareholders'
equity                                 $ 16,170,930                                     $ 10,919,189

Net interest rate spread                                                      3.27 %                                           3.39 %
. . .
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