For the third quarter of 2014, it can be argued that no company turned in a better performance than Prosperity Bancshares (PB 1.86%). By nearly every measure, the company absolutely crushed it.
Investors take note
The key to investing in bank stocks, which are known for flying high in good times and crashing hard when the economy dips, is buying the best-run banks -- even if that means paying a bit of a premium. These top banks are run efficiently with a watchful eye toward risk management. They avoid losses in recessions and grow prudently when the economy is strong.
Prosperity is one of these top-tier banks.
Image source: Company website
For the third quarter, the company reported a 21% year-over-year increase in earnings per share, to $1.10. That beat the consensus estimate of $1.07 per share. Revenue was up 38% to $217 million, beating the consensus by about $15 million.
The dramatic increases in both profit and revenue was primarily driven by a series of acquisitions. This M&A activity increased the bank's earning assets and deposit base, enabling Prosperity to absorb a nearly 40% increase in noninterest expenses and still increase profitability.
The bank's efficiency ratio, which was already much better than peer averages, improved even further in the quarter to 41.55%. The efficiency ratio measures the ratio of a bank's noninterest expenses to its net revenue. A lower percentage is better, indicating increased profitability.
Thanks to this exceptional performance, the bank also increased its dividend by nearly 14% for the coming fourth-quarter payout.
The market's reaction
The market reacted to the release by sending the stock about 10% higher since its monthly low on Oct. 15. Year to date, though, the stock is down about 6.6%.
This lackluster performance through 2014 isn't without cause. The bank's acquisition strategy has increased its level of nonperforming assets on the balance sheet, drawing concerns even in light of the increasing profit and revenue. Nonperforming assets are loans that are severely past due, plus homes in foreclosure.
Again, the key to long-term success when investing in banks is to find those that don't suffer massive loan losses when the economy hits a speed bump. That means keeping nonperforming loans to a minimum throughout the business cycle.
According to Prosperity's third-quarter filing with the FDIC, nonperforming loans increased 91% from the preceding quarter and 758% from the third quarter of 2013.
Cause for concern, or no big deal?
While those increases in problem loans are absolutely troubling on a percentage basis, the actual dollar figures should put your fears to rest. The bank has over $21 billion in total assets, but just $44.6 million in problem loans and $50.1 million in total problem assets.
That problem asset level was 0.24% of the bank's total assets, which is roughly one-third the level seen on average across the industry. Furthermore, the bank has already reserved over $77 million to cover any potential losses stemming from these problem assets. That means that even if these loans do deteriorate further, the bank shouldn't see any noticeable impact on the income statement or in its capital levels.
The bottom line is that Prosperity Bancshares is a top-tier U.S. regional bank with fantastic earnings, a rock-solid balance sheet, and the kind of credit and risk culture that outperforms in good or bad economies.
