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Prosperity Bancshares: EPS Volatility, Core NIM Pressure Makes M&A A Necessity

 December 28, 2012 09:38 AM

(By Mani) Investors of Prosperity Bancshares, Inc. (NYSE: PB) are concerned over both the near-term risk to earnings in the low-for longer interest rate environment given its balance sheet and the potential for earnings volatility connected to accretable yield.

Prosperity's earnings through the second quarter of 2012 were not impacted by purchase accounting accretion, unlike many other acquisitive banks. Other similar-sized banks that have made acquisitions such as IberiaBank Corp. (NASDAQ:IBKC) and FirstMerit Corp. (NASDAQ:FMER) witnessed quarter-over-quarter volatility in recent EPS connected to the acquired assets, which in turn has had a negative impact on their market valuation.

[Related -Falling Securities Portfolio Yields To Pressure NIM]

The primary reason behind this difference is that Prosperity has done limited FDIC-assisted deals and that the other companies it has acquired had higher-quality loans and thus a smaller loan mark. Both the American State deal earlier in the year, and the Coppermark transactions just announced were essentially Prosperity buying smaller versions of themselves in terms of low credit costs and low loan/deposit levels.

This changed in the third quarter when it recorded purchase accounting accretion of $11 million, or 10.5 percent of the quarterly net interest income.

"One year ago we may have just overlooked this component of the quarter; however, investor sentiment towards PAA has become more negative," Oppenheimer analyst Terry McEvoy said in a client note.

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While purchase accounting accretion adds to revenue and EPS during the early quarters after an acquisition closes, it will naturally begin to decline.

"We feel 4Q12 net interest income could miss consensus estimates as falling assets yields and lower PAA exert downward pressure on the net interest margin," the analyst noted.

Looking ahead for Prosperity, there inevitably will be some changes in accretable yield in any given quarter, especially following the expected closing of Coppermark Banc deal in the first quarter. Such volatility may pressure the stock's valuation.

The inherent decline in accretable yield could be offset by stronger loan growth and higher interest rates – but both of them are not expected over the near-to-mid term.

"As such, pursuing additional acquisitions may be a necessity for Prosperity to keep growing earnings. This clearly poses a risk to the company as competition for deals intensifies in '13 and if it is forced to look outside of Texas," McEvoy said.

Prosperity recently announced a deal to acquire Coppermark Bancshares for $194 million in cash and stock. The transaction includes $1.3 billion in assets, $1.2 billion in deposits and $874 million in loans and is Prosperity's fifth deal in the past year.

The acquisition also marks the company's first move outside of Texas which may signal  scarcity of attractive Texas-based acquisition targets.

"Should Prosperity continue to diversify outside of the state, the company could experience multiple compression as it loses some of its "Texas" premium," McEvoy noted.

However, the bank has witnessed modest relative multiple compression in 2012 but still has a valuable currency to pursue additional deals in or around Texas.

"Following the move up in price since mid-November we recommend shareholders take profits in Prosperity Banc," McEvoy added. 



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