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PB > SEC Filings for PB > Form 10-Q on 8-May-2014All Recent SEC Filings

Show all filings for PROSPERITY BANCSHARES INC

Form 10-Q for PROSPERITY BANCSHARES INC


8-May-2014

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;

• 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;


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• 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, 2013.

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 March 31, 2014, the Bank operated 236 full-service banking locations; with 63 in the Houston area, including The Woodlands; 30 in the South Texas area including Corpus Christi and Victoria; 35 in the Dallas/Fort Worth area; 22 in the East Texas area; 30 in the Central Texas area including Austin and San Antonio; 34 in the West Texas area including Lubbock, Midland-Odessa and Abilene; 16 in the Bryan/College Station area and 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 investments 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. The Company has recognized increased net interest income due primarily to an increase in the volume of interest-earning assets.

Three principal components of the Company's growth strategy are internal growth, stringent cost control practices and acquisitions, including strategic merger 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 2013, the Company completed three acquisitions including East Texas Financial Services Inc., Coppermark Bancshares, Inc. and FVNB Corp. On April 1, 2014, the Company announced the completion of the F&M Bancorporation Inc. acquisition.


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Total assets were $18.91 billion at March 31, 2014 compared with $18.64 billion at December 31, 2013, an increase of $271.1 million or 1.5%. Total loans were $7.75 billion at March 31, 2014 compared with $7.78 billion at December 31, 2013, a decrease of $22.8 million or 0.3%. Total deposits were $15.46 billion at March 31, 2014 compared with $15.29 billion at December 31, 2013, an increase of $168.8 million or 1.1%. Total shareholders' equity was $2.84 billion at March 31, 2014 compared with $2.79 billion at December 31, 2013, an increase of $53.9 million or 1.9%.

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, 2013. 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 March 31, 2014. 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, 2013, management does not believe any of its goodwill is impaired as of March 31, 2014 because the fair value of the Company's equity substantially exceeded its carrying value. While the Company believes no impairment existed at March 31, 2014, 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.


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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 in active markets, 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 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 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.

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 9 full-service banking offices: 6 in Oklahoma City, Oklahoma and surrounding areas and 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 FVNB Corp. - On November 1, 2013, the Company completed the acquisition of FVNB Corp. and its wholly owned subsidiary, First Victoria National Bank (collectively, "FVNB") headquartered in Victoria, Texas. FVNB operated 33 banking locations; 4 in Victoria, Texas; 7 in the South Texas area including Corpus Christi; 6 in the Bryan/College Station area; 5 in the Central Texas area including New Braunfels; and 11 in the Houston area including The Woodlands. As of September 30, 2013, FVNB reported, on a consolidated basis, total assets of $2.47 billion, total loans of $1.65 billion and total deposits of $2.20 billion.

SUBSEQUENT EVENTS

Acquisition of F&M Bancorporation Inc. - On April 1, 2014, the Company completed the acquisition of F&M Bancorporation Inc. ("FMBC") and its wholly-owned subsidiary The F&M Bank & Trust Company ("F&M Bank") headquartered in Tulsa, Oklahoma. F&M Bank operated 13 banking offices: 9 in Tulsa, Oklahoma and surrounding areas; 3 in Dallas, Texas and 1 loan production office in Oklahoma City, Oklahoma. As of March 31, 2014, FMBC, on a consolidated basis, reported total assets of $2.41 billion, total loans of $1.74 billion and total deposits of $2.27 billion.

Under the terms of the definitive agreement, Prosperity issued 3,298,022 shares of Prosperity common stock plus $34.2 million in cash for all outstanding shares of FMBC capital stock for total merger consideration of $252.4 million based on the Company's closing stock price of $66.15. The Company recognized initial goodwill of $148.4 million which does not include subsequent fair value adjustments that are still being finalized. Goodwill is calculated as the excess of both the consideration exchanged and liabilities assumed as compared to the fair value of identifiable assets acquired, none of which is expected to be deductible for tax purposes.


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RESULTS OF OPERATIONS

Net income available to common shareholders was $67.1 million ($1.01 per common share on a diluted basis) for the quarter ended March 31, 2014 compared with $49.3 million ($0.86 per common share on a diluted basis) for the quarter ended March 31, 2013, an increase in net income of $17.8 million or 36.2%. The Company posted returns on average common equity of 9.52% and 9.23%, returns on average assets of 1.43% and 1.33% and efficiency ratios of 42.04% and 42.40% for the quarters ended March 31, 2014 and 2013, 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.

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 $143.7 million for the quarter ended March 31, 2014 compared with $108.1 million for the quarter ended March 31, 2013, an increase of $35.6 million, or 32.9%. The increase in net interest income was primarily due to an increase in average interest-earning assets of $3.27 billion or 25.1% for the three months ended March 31, 2014 compared with the quarter ended March 31, 2013, and a decrease in the average rate paid on interest-bearing liabilities of 6 basis points from 0.42% for the quarter ended March 31, 2013 compared with 0.36% for the quarter ended March 31, 2014. Interest income on loans was $107.1 million for the quarter ended March 31, 2014, an increase of $25.7 million or 31.5% compared with first quarter of 2013 due in part to an increase in average loans outstanding of $2.49 billion. Additionally, during the first quarters of 2014 and 2013, interest income on loans benefitted from purchase accounting loan discount accretion of $13.5 million and $14.3 million, respectively, which partially offset the decrease in interest rates on the loan portfolio. The Company had $119.2 million of total outstanding discounts on purchased loans, of which $85.6 million was accretable at March 31, 2014. Interest income on securities was $47.1 million during the first quarter of 2014, an increase of $10.5 million or 28.8% compared to the first quarter of 2013 due, in part, to an increase in average securities of $711.4 million. Interest income on securities was also impacted by $2.0 million of securities amortization purchase accounting adjustments. Average interest-bearing liabilities increased $2.18 billion for the quarter ended March 31, 2014 compared to the same period in 2013. The net interest margin on a tax equivalent basis increased 20 basis points from 3.42% for the quarter ended March 31, 2013 to 3.62% for the quarter ended March 31, 2014. The impact of the purchase accounting adjustments on the tax equivalent net interest margin was an increase of 29 basis points for the quarter ended March 31, 2014.


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The following table presents, for the periods indicated, the total dollar amount of average balances, interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed in both dollars and rates. 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 March 31,
                                                              2014                                             2013
                                                             Interest                                         Interest
                                             Average          Earned/        Average          Average          Earned/        Average
                                           Outstanding       Interest      Yield/Rate       Outstanding       Interest      Yield/Rate
                                             Balance           Paid            (4)            Balance           Paid            (4)
                                                                              (Dollars in thousands)
Assets
Interest-Earning Assets:
Loans                                      $  7,755,997      $ 107,144            5.60 %    $  5,263,784      $  81,464            6.28 %
Investment securities                         8,466,946         47,056            2.25 %       7,755,567         36,548            1.91 %
Federal funds sold and other earning
assets                                          101,700             48            0.19 %          34,793             19            0.22 %

Total interest-earning assets                16,324,643      $ 154,248            3.83 %      13,054,144      $ 118,031            3.67 %

Allowance for credit losses                     (67,222 )                                        (53,242 )
Noninterest-earning assets                    2,550,893                                        1,849,461

Total assets                               $ 18,808,314                                     $ 14,850,363


Liabilities and Shareholders' Equity
Interest-Bearing Liabilities:
Interest-bearing demand deposits           $  3,554,366      $   2,132            0.24 %    $  2,659,489      $   2,210            0.34 %
Savings and money market deposits             4,992,442          3,155            0.26 %       3,790,416          2,829            0.30 %
Certificates and other time deposits          2,816,701          4,100            0.59 %       2,370,499          3,651            0.62 %
Securities sold under repurchase
agreements                                      347,747            237            0.28 %         448,542            292            0.26 %
Other borrowings                                 51,932            158            1.23 %         358,120            362            0.41 %
Junior subordinated debentures                  124,231            775            2.53 %          85,055            605            2.88 %

Total interest-bearing liabilities           11,887,419         10,557            0.36 %       9,712,121          9,949            0.42 %

Noninterest-Bearing liabilities:
Noninterest-bearing demand deposits           4,018,094                                        2,939,621
Other liabilities                                82,288                                           62,716

Total liabilities                            15,987,801                                       12,714,458
Shareholders' equity                          2,820,513                                        2,135,905

Total liabilities and shareholders'
equity                                     $ 18,808,314                                     $ 14,850,363

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