Without Some Offense, Prosperity Bancshares' Defensive Characteristics Aren't A Big Plus Today

 

When I last wrote about Prosperity Bancshares (PB), my pitch on the stock was largely that it offered some downside protection on a weaker macro recovery and upside tied to M&A activity. Management has remained on the hunt for acquisitions, but hasn’t managed to seal a deal, and meanwhile the economy has come back strong. All of that has contributed to noticeable underperformance at this conservatively-run Texas bank, with the shares underperforming its peers by close to 30% over the past year or so.

It’s quite a bit harder to maintain a positive outlook on Prosperity today, given the bank’s weaker leverage to differentiating loan growth and average (at best) asset sensitivity. The significant surplus capital on the balance sheet is a major “yes, but…”, as the company could announce a meaningful growth-driving M&A transaction at any time and has the option to buy back a meaningful amount of shares. Still, this looks like a middling idea at best without real visibility on growth.

 

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Without Some Offense, Prosperity Bancshares' Defensive Characteristics Aren't A Big Plus Today

Knocked Back By Energy, Green Bancorp Looking To Rebuild The Growth Story Next Year

Energy lending has hamstrung many banks and Green Bancorp's (NASDAQ:GNBC) previously outsized exposure to the energy sector has come back to bite this small Texas lender. Management is moving fairly aggressively to exit its energy lending business and pivot toward lending growth opportunities in Dallas and Austin, but weakness in the Houston metro area remains a concern, as does this company's funding base.

I like Green Bancorp's portfolio banker lending model, and I think the underlying growth in major Texas metro areas like Dallas, Houston, and Austin can support above-average loan growth. That said, there's a lot of competition within Texas, and management needs to prove that it can carve out a durable differentiated lending franchise and expand its base of lower-cost deposits. The current valuation already assumes a lot of improvement (and long-term earnings growth in the range of 20%) and that doesn't leave much room for excitement from me.

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Knocked Back By Energy, Green Bancorp Looking To Rebuild The Growth Story Next Year

Southside Seems Priced Like A Better Bank Than It Appears To Be

Considering the size of the economy and the above-average population growth, it makes sense that both investors and other banks are interested in Texas-based banks. Although worries that weak oil/gas prices would undermine the entire state's economy pressured the shares of many Texas banks earlier this year, many have rebounded strongly and now sit at or near 52-week highs.

Southside Bancshares (NASDAQ:SBSI) is one such bank, and while I'm certainly interested in finding some good investment ideas in the Texas bank sector, I'm not convinced this one qualifies. In its favor, Southside could be an acquisition target for a bank looking to acquire a bigger presence in East Texas, and banks ranging from larger super-regionals like BB&T (NYSE:BBT) and U.S. Bancorp (NYSE:USB) to other Texas-based banks like Hilltop (NYSE:HTH) and Prosperity (NYSE:PB) are looking to build their deposit share in the state. Against that, though, is more leverage than I'd like, a heavily CRE-dependent loan book, and a valuation that already factors in some pretty solid growth expectations.

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Southside Seems Priced Like A Better Bank Than It Appears To Be

Dry Powder, Clean Exposures, And Valuation Make Hilltop Holdings Worth A Look

Like many other Texas banks, Hilltop Holdings (NYSE:HTH) got hit hard earlier this year, only to come back strong and recently challenge its 52-week high. While there is enough diversity to make the notion of a "typical" Texas bank a questionable one, Hilltop at the very least doesn't have the large energy lending exposures that have tripped up some of its comparables.

What Hilltop does have, though, is a strong capital position that can support expanded lending and M&A, not to mention an asset that can be sold (its insurance business) to fund additional moves. Hilltop also has a pretty clean credit profile and a management team that knows how to build (and sell) banking businesses. While the valuation isn't hands-down cheap, there does seem to be enough value and potential here to make it worth a closer look from investors shopping for some bank stock ideas.

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Dry Powder, Clean Exposures, And Valuation Make Hilltop Holdings Worth A Look

Can Prosperity Bancshares Build Value Outside Of M&A?

I thought Texas-based Prosperity Bancshares (NYSE:PB) looked like an interesting value back in late January of 2015, and the shares are up more than 10% since then but it has not been a smooth ride. Like other Texas banks, including Cullen/Frost (NYSE:CFR), Texas Capital (NASDAQ:TCBI), International Bancshares (NASDAQ:IBOC), and Green Bancorp (NASDAQ:GNBC), Prosperity shares had a rough time from late 2015 into early 2016 on worries that the steep decline in energy prices would undermine the bank's credit quality and loan growth in Texas and Oklahoma.

There are signs of weakness that shouldn't be ignored, including rising unemployment and shaky commercial real estate numbers in Houston, but Prosperity continues to have a strong credit quality profile, a good efficiency ratio, and a very disciplined overall approach. On the other hand, loan growth is weak and I have more doubts now about Prosperity's ability to grow outside of M&A. I believe that Prosperity can post mid-to-high single-digit earnings growth from here (equating to a low double-digit ROE down the road), but that no longer supports a compelling buy thesis.

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Can Prosperity Bancshares Build Value Outside Of M&A?

Seeking Alpha: Energy's Fall Creates An Opportunity At Prosperity Bancshares

Wall Street may not be a zero-sum game at all times, but I think it happens often enough to say that bad news in one spot is usually good news somewhere else. I'm not remotely happy that oil's freefall has created a crater in the energy portion of my portfolio, but that drop has taken down the shares of many Texas banks, including Prosperity Bancshares (NYSE:PB).

While an ongoing energy rout would eventually damage Prosperity's loan growth and credit quality, direct energy lending is less than 10% of the loan book and Prosperity has exceptionally clean credit metrics. I would expect Prosperity to return to its M&A ways at some point this year and although not a screaming bargain by conventional metrics, the value in these shares is getting interesting.

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Energy's Fall Creates An Opportunity At Prosperity Bancshares

Seeking Alpha: Bank Of The Ozarks Continues To Execute

Even allowing for the fact that growth becomes more difficult as a company get bigger, if Bank of the Ozarks (NASDAQ:OZRK) continues to execute like this it is not going to be a small bank for long. This Arkansas-bank remains heavily weighted to real estate-based commercial lending, but continues to use disciplined underwriting to control risk while leveraging a very low-cost deposit base. The shares don't look cheap by most of the bank valuation metrics I like, but quality growth doesn't come cheap and I still see opportunities for outperformance and value-building acquisitions.

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Bank Of The Ozarks Continues To Execute

Investopedia: Bank Of The Ozarks Continues To Build Value

I've long praised Little Rock-based Bank of the Ozarks (Nasdaq:OZRK) as one of the best-run banks that most investors probably don't know about. This bank has long used a mix of opportunistic M&A and focused lending expertise to grow what has become an increasing valuable Southern/Southeastern banking franchise. While today's price is not exactly a bargain, there are worse fates in investing than to hold somewhat expensive positions in very promising companies.

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http://www.investopedia.com/stock-analysis/041213/bank-ozarks-continues-build-value-ozrk-bxs-rf-pb.aspx

Seeking Alpha: High Quality And Ample Dry Powder Make Prosperity Bancshares One To Watch

While Texas-based Prosperity Bancshares (PB) has gone along with the year-to-date mid-cap bank stock rally, the overall performance over the past year hasn't been all that special. A lot of that has to do with the valuation; investors have generally been happy to assign robust multiples to this bank due to its uncommon growth and quality, but those same multiples seem to have left these shares a relative also-ran in performance.

And so it is today - while Prosperity is a very well-run bank and has substantial long-term growth potential (not to mention ample dry powder on the balance sheet), the valuation today is not what I'd call "can't miss." With mid-cap banks in general looking a little pricey, Prosperity isn't a bad relative call today, but more nimble investors may want to focus their time and attention today on small-cap banks while waiting for a pullback in names like Prosperity.

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High Quality And Ample Dry Powder Make Prosperity Bancshares One To Watch

Investopedia: Bank Of America Is A Mess Unlike Any Other

Maybe the best thing that can be said about the U.S. banking industry is that it's in better shape than its European cousin. That's faint praise indeed, and Bank Of America (NYSE:BAC) continues to stand out as an especially challenged major U.S. bank. While there is undeniable value in this large banking franchise, it seems like every quarter pushes out the timeline for realizing that value. 

Q3 Earnings are Whatever You Want Them to Be  
Bank earnings are never the easiest to analyze or interpret in good times, and bad times only make it worse. Investors have to countermand all manner of special charges and benefits, and B of A had more than a dozen of them this time around. Making matters worse, no two analysts or investors are going to see exactly eye-to-eye on what constitutes the "real" earnings power.

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http://stocks.investopedia.com/stock-analysis/2011/Bank-Of-America-Is-A-Mess-Unlike-Any-Other-BAC-WFC-USB-C-GS-BRK.A-FCNCA1022.aspx

Investopedia: PNC Acquires Another Fixer-Up Bank Chain

For a well-run bank, PNC (NYSE:PNC) is not shy about taking on other banks' troubles in the name of market expansion. Having expanded into the Midwest and Florida with the acquisition of National City in 2008, PNC is moving into the Southeast region of the U.S. with the acquisition of Royal Bank of Canada's (NYSE:RY) U.S. banking operations. While a curious deal in some respects, it could represent a toe-hold for a firm quickly become a super-regional player. 

Terms of the Deal  
PNC will be paying $3.45 billion to Royal Bank of Canada for its U.S. operations, a regional bank with $25 billion in assets and 424 branches in Alabama, Florida, Georgia, North Carolina, South Carolina and Virginia. PNC will have the option of paying up to $1 billion of the deal price in its own stock, a move that would prospectively represent about 3% of the bank's stock. To raise the cash for the deal, PNC will likely need to issue instruments like debt and trust preferred securities (a form of preferred stock).

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http://stocks.investopedia.com/stock-analysis/2011/PNC-Acquires-Another-Fixer-Up-Bank-Chain-PNC-RY-TD-BMO-RF-SNV-CFR0621.aspx

Investopedia: More, Better, Faster Please

If a part-time investor can read all of Citigroup's (NYSE:C) earnings and not get a headache, that is an impressive accomplishment. After all, just consider the impact of credit value adjustments (CVA) in this period - Citi incorporated a $1.1 billion loss into its earnings because its debt actually became more valuable. So, things are getting better at Citi, and that causes them to recognize a loss. That is just part of the fun-filled, anything-but-logical world of bank accounting, but investors who can maintain the patience and inner peace to look through all of this might still find an interesting recovery/rebound prospect in this stock.

The Quarter That Was
Okay, here is a quick run-down of the major salient points of Citigroup's fiscal fourth quarter earnings. Revenue (excluding that CVA) was down about 6%. Weakness in investment banking (fixed income revenue was down almost one-third sequentially) certainly hurt, but a 3% net interest income was pretty feeble in its own right, as was the decline in net interest margin to below 3% (2.97%). Consumer banking was "stable" overall as pretty good overseas performance covered up for a 5% decline in North America.

Credit was better, as the NPA ratio improved 44 basis points (to 3.25%) and the NCO ratio declined as well, as non-performing loans dropped 13% sequentially. Feeling better about credit, Citi released about $2.3 billion from its loan loss reserves (that is, the company's charge-offs exceeded the provisions it took for bad debt), with a little more than half of that coming from the consumer business. On the other hand, the company is having to build its litigation reserves - a common issue these days for large banks like Citi, Wells Fargo (NYSE:WFC), Bank of America (NYSE:BAC) and others facing legal disputes with mortgage borrowers, mortgage insurers (like Assured Guaranty (NYSE:AGO), and mortgage buyers like Fannie and Freddie.

More Trouble Still to Come?
Speaking of Freddie and Fannie, Citi may not really be out of the woods here just yet. The company spent about a quarter-billion dollars this quarter buying back mortgages, but a Bloomberg report suggests that Citi has still been selling an unacceptably high percentage of bad loans to Freddie. Still, it would seem likely that the worst of the mortgage repurchase issue is over for Citi, at least as it pertains to the GSEs Fannie and Freddie. After all, if Bank of America got a pennies-on-the-dollar deal, why would Citi not expect the same? 


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