Prosperity Bancshares, Inc.

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

Prosperity Bancshares, Inc. is a regional financial holding company operating primarily in Texas and Oklahoma, providing commercial and retail banking services with a focus on relationship banking and community involvement, and has recently had 2 mergers in 2022 and 2023.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview:

Prosperity Bancshares (PB) operates as a regional bank primarily within Texas and Oklahoma, with recent acquisitions expanding its footprint. Its core business is traditional commercial and retail banking, offering services such as checking and savings accounts, loans, treasury management, trust and wealth management, and other financial services. A key aspect of their strategy is a relationship-focused, community banking model, which emphasizes strong ties with local markets and businesses. They are also actively involved in acquiring other regional banks.

  • Revenue Distribution:
    • Net interest income, a key source of revenue for banks, is generated from loans and other interest-bearing assets.
  • Noninterest income is also present, consisting of fees from service charges, credit and debit card services, trust activities, and other areas. * Historically, they had a large revenue from mortgage loans, however, with higher interest rates this source of revenue has dropped.
  • Industry Trends:
    • The banking industry is facing headwinds from rising interest rates (which increase funding costs), regulatory changes, inflation, and the effects of the pandemic on loan repayment.
    • Technology is playing a larger role, which affects branch use and the need to innovate quickly.
  • Consolidation in the banking industry has become prevalent, as banks seek to gain scale and efficiencies.
  • Margins:
    • Operating margins as a percentage of assets for the most recent quarters are 40.1-41.1, which is good, but there could be a possible downturn in future periods.
  • Net interest margin is around 3.1% at the latest reports.
  • Competitive Landscape:
    • The market for banking is fiercely competitive, consisting of other regional banks, national banks, credit unions, and non-bank lenders, all vying for the same customers.
    • Regional banks must differentiate themselves through unique service offerings or niche markets in their approach to credit. They face increased competition in the digital realm by online and fintech competitors.
  • What makes PB different?:
    • Their long experience in Texas and Oklahoma, and focus on relationship-driven banking, and community support.
    • The company is actively involved in M&A.

Financials Analysis:

Prosperity Bancshares’ financials demonstrate a mix of strengths and weaknesses.

  • Income Statement Analysis
    • Recent interest income have been higher on both lending and investments, however, costs have also risen.
    • Net income has been slightly higher due to increased yield in investments and loans.
    • Noninterest income has stayed at approximately the same level for 2 years, though, given that there has been a huge decline in mortgages and fees, it’s surprising. Management seems to be focusing on cross selling to the existing customer base.
  • Balance Sheet Analysis
    • Loans comprise a large portion of the company’s assets.
    • The level of securities has been changing lately in an effort to increase the yield for the bank.
    • They have high levels of deposits, which are a liability.
  • Cash Flow Analysis: * Cash flow from operations is strong.
  • Free cash flow is a lot more volatile. They have reduced the investments in assets, so their net cash flow is good.
    • Financing cash flow is unstable. They take loans from the FED and then distribute them.

Moat Analysis:

Prosperity Bancshares has a narrow moat (3/5) based on switching costs and cost advantages stemming from its long-term presence and localized brand loyalty. Here’s why:

  1. Switching Costs (Partial):
    • Customers tend to stick with their local bank due to existing relationships, convenience of branches, ease of use with the website and apps, and the hassle of changing accounts.
    • These are not as high as tech companies or others with more entrenched relationships.
    • A bank like Citi, for example, where customers tend to use it as their main method of payment and credit is able to build higher switching costs.
  2. Cost Advantages (Localized): * The strong understanding of local markets and customers (as evidenced by their 40+ acquisitions in this region) means that some banks might not be able to compete in such an effective way. * Their knowledge of the market, the location of their loans, and the ability to evaluate their borrowers effectively might provide it with a slight edge.
    • Limitations:
      • The banking sector is known to be very competitive. They are subject to regulatory risk, interest rate risk, and credit risk.
    • This means, that companies that do not have a strong advantage from tech, brand, or scale are unable to get a large edge in this space.

Risks to the Moat and Business Resilience:

  1. Interest Rate Risk: A primary risk for PB, like all banks, lies in interest rate fluctuations that might pressure earnings. The company has the majority of its interest rate liability with deposits from customers, and the asset side is loans. A mismatch in the duration of both will result in higher risk. They manage the risk well, however, with a relatively small gap between liability and asset durations.
  2. Credit Risk: A recession could hurt the value of their loans, and they have more exposure to real estate than they do to other industries, which is concerning because of the high interest rates impacting the affordability of homes. If this increases, defaults will rise.
    • Credit risk as a percentage of loans is around 1% - 1.3%. In the last 10 years, it has ranged from 0.5% to 2.5%, so while at these levels now, it is possible for them to experience higher defaults than they currently do.
  3. Competition Risk: They are continuously acquiring and consolidating with other banks. Although they may have experience in M&A, it is still a high risk. They may overpay, over estimate synergies, and may be hard to integrate. The more they get, the harder it will be to manage.
  4. Regulatory Risk: Banks are subject to stringent regulations, that change frequently, thereby making management difficult.
  5. Technological Disruption: Newer digital and fintech companies could erode their customer base.

Understandability Rating: 2/5

  • Traditional Regional Banking: The business model is straightforward, especially for individuals familiar with how banks operate.
  • Financial Statement Complexity: Analyzing banks’ financial statements, however, can be hard and time-consuming. This is mainly because of the many factors that affect the valuation of a bank. They are also extremely sensitive to macroeconomic fluctuations that might be hard to foresee accurately, such as interest rates and local economies.
  • Complex M&A strategy: Although acquisitions are common in the industry, knowing why a bank would acquire a different entity and figuring out their strategic benefits, requires an in-depth understanding of each individual bank.
  • Overall: For an experienced investor, PB’s business is not very hard to understand, because of their simple banking practices, however, there is a lot of complex components involved.

Balance Sheet Health: 4/5

  • Capital and leverage ratios are acceptable by regulatory metrics.
  • They have a diverse and large enough deposit base that allows it to acquire new entities using its existing base.
  • They have ample liquidity and funding options.
  • Good coverage ratios.
  • Their profitability is great for the industry and has been for decades, proving that management understands how to manage assets well.

Recent Concerns:

Prosperity Bancshares has recently faced concerns related to its loan portfolio, in view of the current rise in interest rates. The impact of these increases in real estate has created worry on the repayment of residential loans by borrowers. Furthermore, given that they recently had two large acquisitions, their integration poses a short-term risk if they are not done properly, since it makes the bank’s assets and liabilities more complex.

Management’s perspective: Management has indicated they are aware of interest rate and market fluctuation risks and has taken several steps to minimize them by balancing both their loan and deposit durations, by being very disciplined in their pricing, and their underwriting standards. They are also confident in their ability to find and acquire companies that are right for their strategy to generate long-term growth for their shareholders.

This in-depth analysis should allow you to gain a broader view of the company and its long term prospects.