Prosperity Bancshares Inc.'s biggest deal ever could be its most challenging too.
SNB Bancshares Inc., for which the $3.5 billion-asset Houston company has agreed to pay $243 million, has a dominant position in two affluent and rapidly growing suburbs, Katy and Sugar Land.
But the $1.1 billion-asset SNB is also wrestling with a low-yielding securities portfolio, hundreds of million of dollars of expensive borrowings, and serious pressure on its net interest margin.
Barry McCarver, who covers Prosperity for Stephens Inc. in Little Rock, said the cash-and-stock deal holds "a ton of potential profitability if it is executed right." But he was quick to add that SNB, based in Sugar Land, comes with more baggage than other banking companies that Prosperity has acquired.
SNB went public in August 2004, raising $52.2 million. Since then it has taken a $6 million charge to sell off $170 million of securities and slashed its earnings forecast because rates on its deposits have risen faster than its rates on loans.
Its "execution has not been questionable; it has been terrible," Mr. McCarver said. "It is difficult to imagine how it could have gotten caught off guard to that extent."
Investors may also not be sold on the deal, which was announced late Wednesday. Prosperity's stock fell 4.26% on Thursday in heavy trading, closing at $29.68.
Prosperity officials acknowledged SNB's problems but said they would have been more concerned if they had been customer-related. "SNB is in the penalty box, but the problems were somewhat self-inflicted," Dan Rollins, the president of Prosperity Bank, said Thursday. "All of them have been management-related asset/liability issues."
Mr. Rollins added that SNB's strong demographics outweigh its balance-sheet struggles.
"This is an incredible opportunity in the Houston market. That's the real driver behind the whole thing," he said. "Everyone we've talked to said, 'If you want to get something done in Fort Bend County, talk to SNB.' "
The deal would give Prosperity the No. 2 deposit share in Fort Bend, where Sugar Land is located, with 14.4% of the $24 billion market, according to Federal Deposit Insurance Corp. statistics.
According to the Census Bureau, Fort Bend's population increased 25% between 2000 and 2004. Its median household income of $76,300 is 60% higher than the statewide average.
"Looking at the fundamentals of the deal … [Prosperity] builds market share in one of the fastest-growing communities in the country," said Terry J. McEvoy, an analyst with Oppenheimer & Co. Inc. in Portland, Maine, on Thursday. "The franchise value of building a presence in Sugar Land is significant."
Texas has emerged as the nation's most active market for buying banks. Prosperity's deal for SNB is the 25th announced for a Texas bank this year.
It is also Prosperity's second this year. The company has acquired 16 community banks in its home state since 1998.
In September, Prosperity said it would acquire the $72.2 million-asset Grapeland Bancshares of Grapeland, Tex., for $7.3 million. Its biggest deal, until this one for SNB, was for the $761 million-asset FirstCapital Bank in Corpus Christi, which it bought for $135.7 million in March.
The deal for SNB is expected to close in April.
Curtis Carpenter, the managing director of investment banking Alex Sheshunoff & Co. in Austin, said that aside from the markets SNB is in, Prosperity was attracted to its loan portfolio.
Though Prosperity is adept at gathering deposits, it is not known for its ability to generate loans. In SNB, the parent of Southern National Bank of Texas, Prosperity "is getting $600 million of loans and a loan-generating staff in some very attractive markets," Mr. Carpenter said. "That's the real play here."
Prosperity said acquiring SNB would increase its loan-to-deposit ratio from 52.6% to 60%.
Prosperity would pay SNB investors $18.59 a share in cash and stock. The deal price works out to 2.62 times SNB's book value and 27.7 times its projected 2005 earnings.
Mr. McEvoy said Prosperity is paying "a full price" for SNB, but Prosperity said those ratios are in line with those of other recent Texas deals.
Prosperity said it plans to retain SNB's entire management team. President and CEO Harvey Zinn would get a seat on Prosperity's board and would serve as chairman of its Houston region.
Prosperity projects cost savings of 29%, which it said it would achieve by paying off high-rate trust-preferred securities, restructuring its investment portfolio, and retiring $250 million of Federal Home Loan bank advances.
Mr. McCarver said that Prosperity's earnings performance would probably suffer next year as it worked out the problems in SNB's balance sheet. Ultimately, though, Mr. McCarver predicted that Prosperity would make the transaction work and begin reaping benefits in 2007.
"They certainly know how to make acquisitions," he said.
