PB - Prosperity Bancshares: Solid Risk Management And Interesting Price

2023-05-16 11:52:17 ET

Summary

• Prosperity Bancshares' deposits are sound and cheap.
• Liquidity and market risk are well covered.
• The P/B signals a strong undervaluation.
• As undervalued as this bank is, I prefer to have exposure through ETFs to regional banks at the moment.

Down -18.50% YTD, Prosperity Bancshares ( PB ) is underperforming the S&P500 but outperforming the major U.S. regional banks. In fact, the IAT ETF has achieved a performance of -36% YTD. But how was this possible? More importantly, will this discrepancy continue in the future?

In this article, based mainly on data obtained from the latest quarterly report , I will answer these questions. In my opinion, Prosperity Bancshares is doing better than its competitors because it is managing various banking risks better.

Deposit soundness and liquidity risk

As you well know, one of the reasons that triggered this succession of bank failures was due to the weakness of deposits. The latter, is the raw material of any bank, as without them banks cannot invest capital over the long term and generate interest income. Borrowing is also a way to raise capital for investment, but it is not as convenient as deposits because it requires higher interest payments. So how is Prosperity Bancshares positioned regarding funding sources?

Total deposits of $27 billion account for almost all of the interest-bearing liabilities, which total about $31 billion. The few billion difference is mainly due to a loan of about $3 billion from the Federal Home Loan Bank, but it is worth clarifying the reason for this move.

In fact, as explained by Chairman Tim Timanus Jr, the bank did not really need it, it simply decided to borrow this amount to better cope with the panic in the days following the SVB bankruptcy. In short, there was no telling how many people would panic and withdraw their savings, so the bank prepared to handle this situation. Currently, the risk seems to have vanished, in fact as early as next quarter this $3 billion will no longer be there on the balance sheet.

So, even considering the future evolution of liabilities, Prosperity Bancshares will probably manage to finance its activities simply with deposits.

37.40% of them, by the way, do not even require an interest rate, while 19.80% cost only 0.26%. Overall, the total cost of deposits is 0.69%, a minuscule figure compared to the current Fed Funds rate.

As of December 31, total deposits were $28.50 billion, so in these 3 months, the bank has lost about $1.50 billion in deposits. Definitely an important amount, but it needs to be put in context in the period in which we are situated.

In addition to low interest rates, Prosperity Bancshares' deposits have an additional strength: 70.10% of them are insured or secured. Deposits without any coverage are the minority, and this is crucial at a time when confidence in the banking system is waning. First Republic basically went bankrupt just because of this, as it was a good bank but with the prevalence of uninsured deposits. In this case, the average account presents $34,336, a rather low figure that also gives an idea about the average customer of this bank.

Now let's assume the worst-case scenario: all uninsured and unsecured deposits must be repaid in a single day due to a sudden bank run. Would Prosperity Bancshares survive?

It would most likely survive, as in just 1 day the bank may have access to $15.53 billion and have $12.16 billion on hand to meet claims. What is more, $4.08 billion would be left over.

Of course, the capital structure would be completely altered as the lost deposits would be replaced by borrowings with a high interest rate that would worsen the net interest margin, but it is likely that the bank could still survive. Of course, this represents an unlikely scenario, but it is just to show how solid the capital structure is. In these times, one cannot take things for granted, especially when it comes to banks.

Market risk and recession

Another problem that plagued some of the failed banks was poor management of market risk. Investing in low-risk securities that generate fixed interest does not circumvent this type of risk, since as interest rates rise, there can be unrealized losses. This is what wiped out Silicon Valley Bank, but can it also happen to Prosperity Bancshares?

Analyzing this slide, we can see that Prosperity Bancshares is well capitalized, even if the unrealized losses were to become realized. In fact, the key ratios set by the Basel Committee are all met, even in the event that the bank is forced to sell off all of its securities.

In particular, the securities portfolio consists mainly of HTM securities rather than AFS securities. In the case of the former, the unrealized loss is $1.10 billion , for the latter about $4.39 million. With a net income (2022) of $524 million and equity of $6.73 billion, although substantial, the unrealized losses can be amortized.

Moreover, with a Fed likely to have ceased raising interest rates and with a duration of only about 4.5 years, in my view, there is little room for deterioration regarding unrealized losses. So, market risk is not too great a concern for Prosperity Bancshares.

Apparently, even a recession is not a concern, according to the CEO:

When I look at the Texas economy, and I guess I think Texas may be more regional in perspective compared to the rest of the economy. I don't see a hard recession. I don't. That's just me. I think you may see a slowdown. But when you look at people, the customers are still spending money out there. Housing, they're still buying housing. Some of the markets, even in house. Some markets have gone down a little bit in value, but still -- people still needing houses. You have people moving into the state. I mean I think Texas is probably in a pretty good position. I don't see a really hard recession. I don't. I may be wrong. And I don't have anything in the back of my name to say I know what I'm saying, but just my gut feeling, just my gut feeling is.

Even more, according to Kevin Hanigan ((COO)), the current economic environment is an opportunity for Prosperity Bancshares:

I think we will take share without having to change our underwriting standards. Brett, there's enough pencils down, banks that are loaned up, fully loaned up, 90%, 100%, 100-plus percent loan-to-deposit ratio, and they are generally speaking, their pencils down or maybe a deal pays off, they can do a new deal, but if they're not active and I think as Tim said a little earlier, we're seeing opportunities from really good clients that we historically would not have banked because either the structure was too loose or the pricing was too low. Those clients are now coming to us and we're able to get our structure and our pricing on those transactions. So I think this is no different than any other time during stress. We tend to do well. We tend to have liquidity and have the money to a loan. So I think on the loan side, we're in a position to take market share as we want.

The past reduces the uncertainty of the future

To conclude this article, I would like to show a series of slides showing the performance of this bank in recent years. While it is true that past performance is no guarantee for the future, there is no question that a glorious past is never a bad point.

Starting from the total performance, Prosperity Bancshares has performed far better than the market. What surprises me most, however, is the 45-degree angle of the long-term trend. In short, since 1998 this bank has always recovered as best it could after recessions, and every slump was the right time to buy it at a discount. It is not obvious to find banks with such a 25-year trend.

The asset quality of this bank has always been higher than that of its competitors. The Peer Group in this case consists of 113 insured commercial banks with assets between $10 billion and $100 billion. Note the large discrepancy during the great recession.

EPSs have an upward trend over the long term, and Q1 2023 results were better than last year. Again, this is not a foregone conclusion, as some banks have growing earnings but tend to dilute shareholders a lot, consequently generating flat EPS growth. In this case, there was the right mix of new shares issued outstanding and earnings growth.

A similar argument for dividend per share, which has been growing steadily for decades. Currently, the dividend yield is 3.66%, thus also quite high. Of course, there are banks whose dividend yield is higher, but not all of them have the sustainability and consistency of Prosperity Bancshares.

Conclusion

Overall, I rate Prosperity Bancshares as a solid bank with good prospects. It is obvious that in the current environment of strong indecision, the current price may not be the bottom, but then again market timing has never been a good idea. At the current price, the P/B seems to signal a strong undervaluation, and thus the collapse suffered may have been too much.

The average P/B over the past 10 years has been 1.16x, multiplying this figure by the current book value per share of $74.31, the fair value would be $86.19 per share. Following the same calculation, but with tangible book value, the fair value would be $96.85 per share. In short, in both cases, we are well above the current price.

The only reason I do not rate this bank as a buy is simply related to my risk aversion, and right now investing in any regional bank carries a high risk. Of the several I have analyzed so far, Prosperity Bancshares I think is the best investment, but at the moment I prefer to expose myself to this sector only through ETFs.

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