The addition of Prosperity Common expanded the Fund’s bank basket to six holdings. Houston-based Prosperity Bancshares (PB, Financial) is a bank holding company operating with a traditional community banking mindset, a far cry from the behemoth money center banks that have been exposed as too big to manage, too big to regulate and just plain too conflicted. it appears that management runs a tight ship: the company has been profitable every year since its formation, even during the massive economic downturn in Texas in the late 1980’s and during the 2008/2009 financial crisis. Historically the company has grown by making opportunistic acquisitions of banks and branches around Texas. During 2008, for example, the bank acquired $3.6 billion of deposits and certain assets of Franklin Bank from the Federal Deposit insurance Corporation, as receiver. Management’s wellmanaged, bolt-on acquisition strategy along with superb efficiency and conservative underwriting have produced an enviable track record, with adjusted book value1 compounding at mid-teens rates over the past five, ten and fifteen years. Our analysis suggests that management has an ample runway to continue doing more of the same. prosperity’s operational record, based on asset quality, capital adequacy and profitability recently drew the attention of Forbes Magazine2, which named it as “america’s Best Bank.”
At their present valuation, which approximates 15x 2014 earnings, the shares may not appear obviously undervalued. We note, however, that prosperity’s current earnings power is significantly depressed, we think more temporarily than not, by the presence of a high proportion of low-rate assets, e.g., government securities now on the books. Should interest rates and economic conditions gradually “normalize,” the company’s earning power will undoubtedly grow and the true multiple of earnings will be a much more favorable 12x-13x, per our estimates. Should business conditions remain unchanged in the periods ahead, we believe prosperity Common has limited downside. in spite of the currently depressed earnings, prosperity continues to earn a respectable 8% to 9% return on equity, a reasonable level given the relatively low-risk approach embraced by management.
From Third Avenue Management (Trades, Portfolio)'s second quarter 2014 shareholder letter.
