Prosperity Bancshares: Loan Declines Are Worrisome (NYSE:PB)

Earnings of Prosperity Bancshares (NYSE:PB) for 2022 will likely be little changed from last year. The bottom line will likely benefit from a rising interest-rate environment thanks to a rate-sensitive loan portfolio. On the other hand, the continued decline in the loan portfolio size will likely drag earnings. Further, the provisioning expense will likely be higher than last year. Overall, I’m expecting Prosperity Bancshares to report earnings of $5.48 per share in 2022, down by just 2% year-over-year. I have barely changed my earnings estimate from the estimate I gave earlier in my last report on Prosperity Bancshares. The year-end target price suggests a small upside from the current market price. Therefore, I’m adopting a hold rating on Prosperity Bancshares.

Asset Mix Deterioration Likely To Continue

Prosperity Bancshares’ loan portfolio declined for the 7th consecutive quarter by the end of March 2022. Meanwhile, the securities portfolio continued to balloon during the quarter. There’s a stark difference between the yields on these two asset subclasses. As mentioned in the 10-Q filing, the average yield on loans was 4.35%, while the average yield on investment securities was just 1.62% during the first quarter of 2022. As a result, the persistent worsening of the asset mix bodes ill for the net interest margin this quarter.

The loan portfolio is likely to decline even further in the second quarter because the management is planning further run-offs in its commercial real estate portfolio. As mentioned in the conference call, the management expects run-offs to range between $150 million to $180 million.

On the other hand, economic factors will likely help the loan portfolio bottom out soon. The purchasing managers’ index is still in the expansionary territory despite the overall slowdown in the economy, as depicted by the decline in GDP in the first quarter of 2022. Apart from the purchasing managers index, the unemployment rate also gives a positive signal for loan growth in the year ahead.

Considering these factors, I’m expecting the loan portfolio to increase by 0.8% by the end of December 2022 from the end of March 2022. This will lead to a full-year decline in the loan portfolio of around 2.3%. Compared to my last report on Prosperity Bancshares, I have revised downwards my end of year estimate for the loan portfolio mostly because of the poor performance in the first quarter that missed my expectations.

Meanwhile, I’m expecting the securities portfolio to increase by around 16% by the end of December 2022 from the end of 2021. The following table shows my balance sheet estimates.

	FY17	FY18	FY19	FY20	FY21	FY22E
Financial Position
Net Loans	9,937	10,284	18,758	19,931	18,330	17,916
Growth of Net Loans	4.2%	3.5%	82.4%	6.3%	(8.0)%	(2.3)%
Other Earning Assets	9,704	9,439	8,571	8,590	12,826	14,912
Deposits	17,821	17,257	24,200	27,360	30,772	31,537
Borrowings and Sub-Debt	829	1,316	1,807	390	449	449
Common equity	3,824	4,053	5,971	6,131	6,427	6,740
Book Value Per Share ($)	55.1	58.1	81.2	65.9	69.7	73.1
Tangible BVPS ($)	27.1	30.4	36.2	30.4	34.0	37.4
Source: SEC Filings, Author’s Estimates (In USD million unless otherwise specified)

Asset Mix Deterioration, Variable Deposit Costs, And Long-Term Bonds To Counter The Benefit Of A Rate-Sensitive Loan Portfolio

The worsening asset mix continued to take a toll on the net interest margin in the first quarter of 2022. The asset mix shift will continue to pressurize the margin in the coming quarters. Moreover, the recent and upcoming interest rate hikes will have a lagged impact on the net interest income because of the large bond portfolio. As mentioned in the conference call, the bond portfolio had an effective duration of 3.6 years.

Moreover, deposits that will reprice soon after a rate hike made up a majority of deposits at the end of March 2022. The quickly repricing deposits, including money market and savings, and interest-bearing demand deposits, made up 57.1% of total deposits at the end of the last quarter, as mentioned in the earnings presentation.

On the other hand, a majority of the loan portfolio will re-price soon after rate hikes, which will help the net interest margin. According to details given in the presentation, floating and variable-rate loans altogether made up 60.8% of total loans at the end of the last quarter.

The management’s interest-rate sensitivity analysis given in the 10-K filing shows that a 200-basis points increase in interest rates could boost the net interest income by 11.0% over twelve months. (Note: as mentioned in the latest 10-Q filing, there have been no material changes in PB’s market risk exposures since the issuance of the 10-K filing.) However, the rate-sensitivity analysis assumes a rate shock. A gradual ramp in interest rates will have a much lower impact than 11.0%.

Considering these factors, I’m expecting the net interest margin to increase by nine basis points in the last nine months of 2022 from 2.88% in the first quarter of 2022.

Revising Downward The Provision Expense Estimate

Prosperity Bancshares continued to book net-zero provisioning in the first quarter of 2022, after reporting nil net provision expense last year. The company surprised me in the previous quarter as I had expected a higher net provision expense.

The anticipated low loan growth in the year ahead will likely require provisioning for expected loan losses. However, the net provision expense will most probably remain below normal as the current allowances appear excessive relative to the portfolio’s credit risk. Nonaccrual loans made up 0.12% of total loans at the end of March 2022, while allowances made up a relatively larger 1.58% of total loans, as mentioned in the 10-Q filing.

Overall, I’m expecting Prosperity Bancshares to report a provision expense, net of reversals, of $3 million in 2022, representing 0.02% of total loans. In comparison, the net provision expense averaged 0.09% of total loans in the last five years. In my last report on Prosperity Bancshares, I estimated a net provision expense of $8 million for 2022. I have slashed my net provision expense estimate for 2022 due to the surprise in the first quarter and my updated loan growth estimate.

Expecting Earnings To Remain Flattish This Year

The anticipated margin expansion, loan portfolio decline, and net provision expense growth will likely lead to flattish earnings this year. Overall, I’m expecting Prosperity Bancshares to report earnings of $5.48 per share in 2022, down by just 2% year-over-year. The following table shows my income statement estimates.

	FY17	FY18	FY19	FY20	FY21	FY22E
Income Statement
Net interest income	617	630	696	1,031	993	994
Provision for loan losses	14	16	4	20	–	3
Non-interest income	117	116	124	132	140	142
Non-interest expense	313	326	397	497	474	487
Net income – Common Sh.	272	322	333	529	519	505
EPS – Diluted ($)	3.92	4.61	4.52	5.68	5.60	5.48
Source: SEC Filings, Author’s Estimates (In USD million unless otherwise specified)

In my last report on Prosperity Bancshares, I estimated earnings of $5.46 per share for 2022. My updated earnings estimate is barely changed because the cut in the loan estimate cancels out the slashing of the provisioning estimate.

Actual earnings may differ materially from estimates because of the risks and uncertainties related to inflation, and consequently the timing and magnitude of interest rate hikes.

Adopting A Hold Rating Due To A Small Upside

Prosperity Bancshares has maintained a long tradition of increasing its dividend per share in the last quarter of every year. If the company increases its quarterly dividend by $0.03 per share to $0.55 per share in 4Q 2022, then it’ll have a payout ratio of 38.5%, which is close to the five-year average of 34.7%. Therefore, I believe Prosperity Bancshares will easily maintain its dividend trend this year. The dividend estimate for 2022 implies a dividend yield of 3.0%.

I’m using the historical price-to-tangible book (“P/TB”) and price-to-earnings (“P/E”) multiples to value Prosperity Bancshares. The stock has traded at an average P/TB ratio of 2.17 in the past, as shown below.

	FY18	FY19	FY20	FY21	Average
T. Book Value per Share ($)	30.4	31.1	30.4	34.0
Average Market Price ($)	71.5	69.6	59.7	72.7
Historical P/TB	2.35x	2.24x	1.96x	2.14x	2.17x
Source: Company Financials, Yahoo Finance, Author’s Estimates

Multiplying the average P/TB multiple with the forecast tangible book value per share of $37.4 gives a target price of $81.4 for the end of 2022. This price target implies a 16.5% upside from the May 19 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.

P/TB Multiple	1.97x	2.07x	2.17x	2.27x	2.37x
TBVPS – Dec 2022 ($)	37.4	37.4	37.4	37.4	37.4
Target Price ($)	73.9	77.6	81.4	85.1	88.9
Market Price ($)	69.8	69.8	69.8	69.8	69.8
Upside/(Downside)	5.8%	11.2%	16.5%	21.9%	27.3%
Source: Author’s Estimates

The stock has traded at an average P/E ratio of around 13.6x in the past, as shown below.

	FY18	FY19	FY20	FY21	Average
Earnings per Share ($)	4.61	4.52	5.68	5.60
Average Market Price ($)	71.5	69.6	59.7	72.7
Historical P/E	15.5x	15.4x	10.5x	13.0x	13.6x
Source: Company Financials, Yahoo Finance, Author’s Estimates

Multiplying the average P/E multiple with the forecast earnings per share of $5.48 gives a target price of $74.5 for the end of 2022. This price target implies a 6.6% upside from the May 19 closing price. The following table shows the sensitivity of the target price to the P/E ratio.

P/E Multiple	11.6x	12.6x	13.6x	14.6x	15.6x
EPS 2022 ($)	5.48	5.48	5.48	5.48	5.48
Target Price ($)	63.5	69.0	74.5	79.9	85.4
Market Price ($)	69.8	69.8	69.8	69.8	69.8
Upside/(Downside)	(9.1)%	(1.2)%	6.6%	14.5%	22.3%
Source: Author’s Estimates

Equally weighting the target prices from the two valuation methods gives a combined target price of $77.9, which implies an 11.6% upside from the current market price. This upside isn’t high enough for me; therefore, I’m adopting a hold rating on Prosperity Bancshares. I wouldn’t consider investing in the stock unless its market price dipped by more than 5% from the current level.