10-Q 1 d553476d10q.htm FORM 10-Q Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2013

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM                      TO                     

COMMISSION FILE NUMBER: 001-35388

 

 

PROSPERITY BANCSHARES, INC.®

(Exact name of registrant as specified in its charter)

 

 

 

TEXAS   74-2331986

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

Prosperity Bank Plaza

4295 San Felipe

Houston, Texas 77027

(Address of principal executive offices, including zip code)

(713) 693-9300

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “accelerated filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:

 

Large Accelerated Filer   x    Accelerated Filer   ¨
Non-accelerated Filer   ¨ (Do not check if a smaller reporting company)    Smaller Reporting Company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of August 1, 2013, there were 60,343,210 outstanding shares of the registrant’s Common Stock, par value $1.00 per share.

 

 

 


Table of Contents

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

INDEX TO FORM 10-Q

 

PART I—FINANCIAL INFORMATION

  

Item 1.

  Interim Consolidated Financial Statements   
  Consolidated Balance Sheets as of June 30, 2013 and December 31, 2012 (unaudited)      3   
  Consolidated Statements of Income for the Three and Six Months Ended June 30, 2013 and 2012 (unaudited)      4   
 

Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2013 and 2012 (unaudited)

     5   
 

Consolidated Statements of Changes in Shareholders’ Equity for the Six Months Ended June 30, 2013 and 2012 (unaudited)

     6   
  Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2013 and 2012 (unaudited)      7   
  Notes to Interim Consolidated Financial Statements (unaudited)      8   

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      36   

Item 3.

  Quantitative and Qualitative Disclosures about Market Risk      53   

Item 4.

  Controls and Procedures      53   

PART II—OTHER INFORMATION

  

Item 1.

  Legal Proceedings      53   

Item 1A.

  Risk Factors      53   

Item 2.

  Unregistered Sales of Equity Securities and Use of Proceeds      53   

Item 3.

  Defaults upon Senior Securities      53   

Item 4.

  Mine Safety Disclosures      54   

Item 5.

  Other Information      54   

Item 6.

  Exhibits      54   

Signatures

     55   

 

2


Table of Contents

PART I—FINANCIAL INFORMATION

ITEM 1. INTERIM CONSOLIDATED FINANCIAL STATEMENTS

PROSPERITY BANCSHARES, INC®. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

 

     June 30,     December 31,  
     2013     2012  
     (Dollars in thousands)  
ASSETS     

Cash and due from banks

   $ 250,542      $ 325,952   

Federal funds sold

     606        352   
  

 

 

   

 

 

 

Total cash and cash equivalents

     251,148        326,304   

Available for sale securities, at fair value

     184,349        226,670   

Held to maturity securities, at cost (fair value of $7,820,266 and $7,418,695, respectively)

     7,833,535        7,215,395   
  

 

 

   

 

 

 

Total securities

     8,017,884        7,442,065   

Loans held for sale

     6,186        10,433   

Loans held for investment

     6,166,297        5,169,507   
  

 

 

   

 

 

 

Total loans

     6,172,483        5,179,940   

Less: allowance for credit losses

     (56,176     (52,564
  

 

 

   

 

 

 

Loans, net

     6,116,307        5,127,376   

Accrued interest receivable

     43,650        42,337   

Goodwill

     1,350,834        1,217,162   

Core deposit intangibles, net

     26,688        26,159   

Bank premises and equipment, net

     227,455        205,268   

Other real estate owned

     10,244        7,234   

Bank owned life insurance (BOLI)

     122,199        109,108   

Federal Home Loan Bank of Dallas stock

     44,933        34,461   

Other assets

     59,376        46,099   
  

 

 

   

 

 

 

TOTAL ASSETS

   $ 16,270,718      $ 14,583,573   
  

 

 

   

 

 

 
LIABILITIES AND SHAREHOLDERS’ EQUITY     

LIABILITIES:

    

Deposits:

    

Noninterest-bearing

   $ 3,283,082      $ 3,016,205   

Interest-bearing

     9,225,568        8,625,639   
  

 

 

   

 

 

 

Total deposits

     12,508,650        11,641,844   

Other borrowings

     781,215        256,753   

Securities sold under repurchase agreements

     481,170        454,502   

Junior subordinated debentures

     85,055        85,055   

Accrued interest payable

     2,189        1,904   

Other liabilities

     67,157        54,126   
  

 

 

   

 

 

 

Total liabilities

     13,925,436        12,494,184   

COMMITMENTS AND CONTINGENCIES

     —          —     

SHAREHOLDERS’ EQUITY:

    

Preferred stock, $1 par value; 20,000,000 shares authorized; none issued or outstanding

     —          —     

Common stock, $1 par value; 200,000,000 shares authorized; 60,352,298 and 56,484,234 shares issued at June 30, 2013 and December 31, 2012, respectively; 60,315,210 and 56,447,146 shares outstanding at June 30, 2013 and December 31, 2012, respectively

     60,352        56,484   

Capital surplus

     1,451,064        1,274,290   

Retained earnings

     828,153        750,236   

Accumulated other comprehensive income—net unrealized gain on available for sale securities, net of tax of $3,403 and $4,839, respectively

     6,320        8,986   

Less treasury stock, at cost, 37,088 shares

     (607     (607
  

 

 

   

 

 

 

Total shareholders’ equity

     2,345,282        2,089,389   
  

 

 

   

 

 

 

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

   $ 16,270,718      $ 14,583,573   
  

 

 

   

 

 

 

See notes to interim consolidated financial statements.

 

3


Table of Contents

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)

 

     Three Months Ended June 30,      Six Months Ended June 30,  
     2013      2012      2013      2012  
     (Dollars in thousands, except per share data)  

INTEREST INCOME:

           

Loans, including fees

   $ 89,842       $ 54,793       $ 171,306       $ 108,010   

Securities

     39,384         38,072         75,932         76,393   

Federal funds sold

     76         9         95         87   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total interest income

     129,302         92,874         247,333         184,490   
  

 

 

    

 

 

    

 

 

    

 

 

 

INTEREST EXPENSE:

           

Deposits

     9,170         8,083         17,860         16,874   

Other borrowings

     472         648         834         1,311   

Securities sold under repurchase agreements

     312         59         604         96   

Junior subordinated debentures

     606         418         1,211         697   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total interest expense

     10,560         9,208         20,509         18,978   
  

 

 

    

 

 

    

 

 

    

 

 

 

NET INTEREST INCOME

     118,742         83,666         226,824         165,512   

PROVISION FOR CREDIT LOSSES

     2,550         600         5,350         750   
  

 

 

    

 

 

    

 

 

    

 

 

 

NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES

     116,192         83,066         221,474         164,762   
  

 

 

    

 

 

    

 

 

    

 

 

 

NONINTEREST INCOME:

           

Nonsufficient funds (NSF) fees

     8,346         5,167         16,855         10,556   

Credit card, debit card and ATM card income

     7,007         4,292         13,494         8,128   

Service charges on deposit accounts

     3,304         2,432         6,235         4,873   

Trust income

     896         —           1,913         —     

Mortgage income

     1,567         65         2,558         124   

Other

     4,154         1,700         7,660         3,920   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total noninterest income

     25,274         13,656         48,715         27,601   
  

 

 

    

 

 

    

 

 

    

 

 

 

NONINTEREST EXPENSE:

           

Salaries and employee benefits

     37,517         23,572         70,726         46,824   

Net occupancy and equipment

     4,669         3,492         8,947         7,049   

Debit card, data processing and software amortization

     3,249         1,906         5,819         3,438   

Regulatory assessments and FDIC insurance

     2,579         1,659         4,974         3,207   

Core deposit intangibles amortization

     1,341         1,595         3,096         3,290   

Depreciation

     2,464         2,028         4,842         4,063   

Communications (including telephone, courier and postage)

     2,410         1,802         4,606         3,550   

Other real estate expense

     237         383         460         1,074   

Other

     6,834         4,351         13,597         8,752   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total noninterest expense

     61,300         40,788         117,067         81,247   
  

 

 

    

 

 

    

 

 

    

 

 

 

INCOME BEFORE INCOME TAXES

     80,166         55,934         153,122         111,116   
  

 

 

    

 

 

    

 

 

    

 

 

 

PROVISION FOR INCOME TAXES

     26,322         18,962         49,973         37,657   
  

 

 

    

 

 

    

 

 

    

 

 

 

NET INCOME

   $ 53,844       $ 36,972       $ 103,149       $ 73,459   
  

 

 

    

 

 

    

 

 

    

 

 

 

EARNINGS PER SHARE:

           

Basic

   $ 0.89       $ 0.78       $ 1.76       $ 1.55   
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted

   $ 0.89       $ 0.78       $ 1.76       $ 1.55   
  

 

 

    

 

 

    

 

 

    

 

 

 

See notes to interim consolidated financial statements.

 

4


Table of Contents

PROSPERITY BANCSHARES, INC. ® AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(UNAUDITED)

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2013     2012     2013     2012  
     (Dollars in thousands)  

Net income

   $ 53,844      $ 36,972      $ 103,149      $ 73,459   

Other comprehensive loss, before tax:

        

Securities available for sale:

        

Change in unrealized gain during period

     (2,330     (1,833     (4,101     (3,018
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other comprehensive loss

     (2,330     (1,833     (4,101     (3,018

Deferred tax benefit related to other comprehensive income

     816        642        1,435        1,057   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive loss, net of tax

     (1,514     (1,191     (2,666     (1,961
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

   $ 52,330      $ 35,781      $ 100,483      $ 71,498   
  

 

 

   

 

 

   

 

 

   

 

 

 

See notes to interim consolidated financial statements.

 

5


Table of Contents

PROSPERITY BANCSHARES, INC. ® AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(UNAUDITED)

 

                                Accumulated              
     Common Stock      Capital
Surplus
     Retained
Earnings
    Other
Comprehensive
Income
    Treasury
Stock
    Total
Shareholders’
Equity
 
     Shares      Amount              
     (In thousands, except share and per share data)  

BALANCE AT DECEMBER 31, 2011

     46,947,415       $ 46,947       $ 883,575       $ 623,878      $ 13,472      $ (607   $ 1,567,265   

Net income

              73,459            73,459   

Other comprehensive loss

                (1,961       (1,961

Common stock issued in connection with the exercise of stock options and restricted stock awards

     112,948         113         2,353               2,466   

Common stock issued in connection with the acquisition of Texas Bankers, Inc.

     314,953         315         12,393               12,708   

Common stock issued in connection with the acquisition of The Bank Arlington

     135,347         136         6,063               6,199   

Stock based compensation expense

           2,161               2,161   

Cash dividends declared, $0.39 per share

              (18,480         (18,480
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

BALANCE AT JUNE 30, 2012

     47,510,663       $ 47,511       $ 906,545       $ 678,857      $ 11,511      $ (607   $ 1,643,817   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

BALANCE AT DECEMBER 31, 2012

     56,484,234       $ 56,484       $ 1,274,290       $ 750,236      $ 8,986      $ (607   $ 2,089,389   

Net income

              103,149            103,149   

Other comprehensive loss

                (2,666       (2,666

Common stock issued in connection with the exercise of stock options and restricted stock awards

     78,406         78         1,727               1,805   

Common stock issued in connection with the acquisition of East Texas Financial Services, Inc.

     530,940         531         21,769               22,300   

Common stock issued in connection with the acquisition of Coppermark Bancshares, Inc.

     3,258,718         3,259         151,172               154,431   

Stock based compensation expense

           2,106               2,106   

Cash dividends declared, $0.43 per share

              (25,232         (25,232
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

BALANCE AT JUNE 30, 2013

     60,352,298       $ 60,352       $ 1,451,064       $ 828,153      $ 6,320      $ (607   $ 2,345,282   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

See notes to interim consolidated financial statements.

 

6


Table of Contents

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

     Six Months Ended June 30,  
     2013     2012  
     (Dollars in thousands)  

CASH FLOWS FROM OPERATING ACTIVITIES:

    

Net income

   $ 103,149      $ 73,459   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation and core deposit intangibles amortization

     7,938        7,353   

Provision for credit losses

     5,350        750   

Net amortization of premium on investments

     41,694        21,474   

Loss (gain) on sale or write down of premises, equipment and other real estate

     40        (316

Net accretion of discount on loans

     (26,323     (790

Proceeds from sale of loans held for sale

     98,228        —     

Originations of loans held for sale

     (96,492     —     

Stock based compensation expense

     2,106        2,161   

Decrease (increase) in accrued interest receivable and other assets

     26,407        (32,408

Increase in accrued interest payable and other liabilities

     5,733        13,298   
  

 

 

   

 

 

 

Net cash provided by operating activities

     167,830        84,981   
  

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

    

Proceeds from maturities and principal paydowns of held to maturity securities

     1,380,310        732,832   

Purchase of held to maturity securities

     (2,022,901     (1,545,313

Proceeds from maturities, sales and principal paydowns of available for sale securities

     1,493,689        956,913   

Purchase of available for sale securities

     (1,454,999     (909,999

Net increase in loans held for investment

     (50,106     (144,906

Purchase of bank premises and equipment

     (13,626     (6,546

Proceeds from sale of bank premises, equipment and other real estate

     8,667        7,384   

Net cash and cash equivalents acquired in the purchase of Texas Bankers, Inc.

     —          44,550   

Net cash and cash equivalents acquired in the purchase of The Bank Arlington

     —          12,037   

Net cash and cash equivalents acquired in the purchase of East Texas Financial Services, Inc.

     3,471        —     

Net cash and cash equivalents acquired in the purchase of Coppermark Banchares, Inc.

     288,795        —     
  

 

 

   

 

 

 

Net cash used in investing activities

     (366,700     (853,048
  

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

    

Net (decrease) increase in noninterest-bearing deposits

     (42,054     82,171   

Net (decrease) increase in interest-bearing deposits

     (321,225     148,683   

Net proceeds from other short-term borrowings

     524,583        425,000   

Repayments of other long-term borrowings

     (40,831     (512

Net increase in securities sold under repurchase agreements

     26,668        67,860   

Proceeds from stock option exercises

     1,805        2,466   

Payments of cash dividends

     (25,232     (18,480
  

 

 

   

 

 

 

Net cash provided by financing activities

     123,714        707,188   
  

 

 

   

 

 

 

NET DECREASE IN CASH AND CASH EQUIVALENTS

     (75,156     (60,879

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

     326,304        213,442   
  

 

 

   

 

 

 

CASH AND CASH EQUIVALENTS, END OF PERIOD

   $ 251,148      $ 152,563   
  

 

 

   

 

 

 

NONCASH ACTIVITIES:

    

Stock issued in connection with the Texas Bankers, Inc. acquisition

   $ —        $ 12,708   

Stock issued in connection with the The Bank Arlington acquisition

     —          6,199   

Stock issued in connection with the East Texas Financial Services, Inc. acquisition

     22,300        —     

Stock issued in connection with the Coppermark Bancshares, Inc. acquisition

     154,431        —     

Acquisition of real estate through foreclosure of collateral

     2,733        9,311   

SUPPLEMENTAL INFORMATION:

    

Income taxes paid

   $ 44,615      $ 36,737   

Interest paid

     20,071        19,651   

See notes to interim consolidated financial statements.

 

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Table of Contents

PROSPERITY BANCSHARES, INC. ® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2013

(UNAUDITED)

1. BASIS OF PRESENTATION

The interim consolidated financial statements include the accounts of Prosperity Bancshares, Inc.® (the “Company”) and its wholly-owned subsidiaries, Prosperity Bank® (the “Bank”) and Prosperity Holdings of Delaware, LLC. All intercompany transactions and balances have been eliminated.

The accompanying unaudited interim consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, the statements reflect all adjustments necessary for a fair presentation of the financial position, results of operations and cash flows of the Company on a consolidated basis, and all such adjustments are of a normal recurring nature. These financial statements and the notes thereto should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2012. Operating results for the six-month period ended June 30, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013 or any other period.

2. INCOME PER COMMON SHARE

Outstanding stock options issued by the Company represent the only dilutive effect reflected in diluted weighted average shares. The following table illustrates the computation of basic and diluted earnings per share:

 

     Three Months Ended June 30,      Six Months Ended June 30,  
     2013      2012      2013      2012  
     Amount      Per Share
Amount
     Amount      Per Share
Amount
     Amount      Per Share
Amount
     Amount      Per Share
Amount
 
     (In thousands, except per share data)  

Net income

   $ 53,844          $ 36,972          $ 103,149          $ 73,459      
  

 

 

       

 

 

       

 

 

       

 

 

    

Basic:

                       

Weighted average shares outstanding

     60,250       $ 0.89         47,456       $ 0.78         58,629       $ 1.76         47,347       $ 1.55   
     

 

 

       

 

 

       

 

 

       

 

 

 

Diluted:

                       

Add incremental shares for:

                       

Effect of dilutive securities - options

     144            152            145            161      
  

 

 

       

 

 

       

 

 

       

 

 

    

Total

     60,394       $ 0.89         47,608       $ 0.78         58,774       $ 1.76         47,508       $ 1.55   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

There were no stock options exercisable during the three and six months ended June 30, 2013 or 2012 that would have had an anti-dilutive effect on the above computation.

3. NEW ACCOUNTING STANDARDS

Accounting Standards Updates

ASU 2012-02 “Intangibles—Goodwill and Other (Topic 350) — Testing Indefinite-Lived Intangible Assets for Impairment.” ASU 2012-02 gives entities the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that an indefinite-lived intangible asset is impaired. If, after assessing the totality of events or circumstances, an entity determines it is more likely than not that an indefinite-lived intangible asset is impaired, then the entity must perform the quantitative impairment test. If, under the quantitative impairment test, the carrying amount of the intangible asset exceeds its fair value, an entity should recognize an impairment loss in the amount of that excess permitting an entity to assess qualitative factors when testing indefinite-lived intangible assets for impairment results in guidance that is similar to the goodwill impairment testing guidance in ASU 2011-08. ASU 2012-02 became effective for the Company on January 1, 2013 and did not have a significant impact on the Company’s financial statements.

 

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PROSPERITY BANCSHARES, INC. ® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2013

(UNAUDITED)

 

ASU 2013-02 “Comprehensive Income (Topic 220) — Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.” ASU 2013-02 amends recent guidance related to the reporting of comprehensive income to enhance the reporting of reclassifications out of accumulated other comprehensive income. ASU 2013-02 became effective for the Company on January 1, 2013 and did not have a significant impact on the Company’s financial statements. See Note 10 – Other Comprehensive (Loss) Income for applicable disclosures.

4. SECURITIES

The amortized cost and fair value of investment securities were as follows:

 

     June 30, 2013  
     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair
Value
 
     (Dollars in thousands)  

Available for Sale

          

States and political subdivisions

   $ 33,591       $ 1,172       $ —        $ 34,763   

Collateralized mortgage obligations

     547         10         (1     556   

Mortgage-backed securities

     133,199         8,438         (24     141,613   

Other securities

     7,289         141         (13     7,417   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 174,626       $ 9,761       $ (38   $ 184,349   
  

 

 

    

 

 

    

 

 

   

 

 

 

Held to Maturity

          

U.S. Treasury securities and obligations of U.S. Government agencies

   $ 5,772       $ 51       $ —        $ 5,823   

States and political subdivisions

     362,590         2,089         (1,839     362,840   

Corporate debt securities

     522         8         —          530   

Collateralized mortgage obligations

     75,235         1,530         (60     76,705   

Mortgage-backed securities

     7,376,516         106,996         (124,376     7,359,136   

Qualified School Construction Bonds (QSCB)

     12,900         2,332         —          15,232   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 7,833,535       $ 113,006       $ (126,275   $ 7,820,266   
  

 

 

    

 

 

    

 

 

   

 

 

 
     December 31, 2012  
     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair
Value
 
     (Dollars in thousands)  

Available for Sale

          

States and political subdivisions

   $ 34,743       $ 1,691       $ —        $ 36,434   

Collateralized mortgage obligations

     616         —           (12     604   

Mortgage-backed securities

     168,701         11,742         (27     180,416   

Other securities

     8,786         430         —          9,216   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 212,846       $ 13,863       $ (39   $ 226,670   
  

 

 

    

 

 

    

 

 

   

 

 

 

Held to Maturity

          

U.S. Treasury securities and obligations of U.S. Government agencies

   $ 7,061       $ 160       $ —        $ 7,221   

States and political subdivisions

     391,510         7,074         (354     398,230   

Corporate debt securities

     1,500         28         —          1,528   

Collateralized mortgage obligations

     125,912         2,304         (50     128,166   

Mortgage-backed securities

     6,676,512         196,206         (4,517     6,868,201   

Qualified School Construction Bonds (QSCB)

     12,900         2,449         —          15,349   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 7,215,395       $ 208,221       $ (4,921   $ 7,418,695   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

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PROSPERITY BANCSHARES, INC. ® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2013

(UNAUDITED)

 

Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. The investment securities portfolio is evaluated for OTTI by segregating the portfolio into two general segments and applying the appropriate OTTI model.

In determining OTTI, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the entity has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time

When OTTI occurs, the amount of the other-than-temporary impairment recognized in earnings depends on whether an entity intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss. If an entity intends to sell or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss, the OTTI shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis less any current-period loss, the OTTI shall be separated into the amount representing the credit-related portion of the impairment loss (“credit loss”) and the noncredit portion of the impairment loss (“noncredit portion”). The amount of the total OTTI related to the credit loss is determined based on the difference between the present value of cash flows expected to be collected and the amortized cost basis and such difference is recognized in earnings. The amount of the total OTTI related to the noncredit portion is recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings shall become the new amortized cost basis of the investment.

As of June 30, 2013, the Company does not intend to sell any debt securities and management believes that the Company more likely than not will not be required to sell any debt securities before their anticipated recovery, at which time the Company will receive full value for the securities. Furthermore, as of June 30, 2013, management does not have the intent to sell any of its securities and believes that it is more likely than not that the Company will not have to sell any such securities before a recovery of cost. The unrealized losses are largely due to increases in market interest rates over the yields available at the time the underlying securities were purchased. The fair value is expected to recover as the securities approach their maturity date or repricing date or if market yields for such investments decline. Management does not believe any of the securities are impaired due to reasons of credit quality. Accordingly, as of June 30, 2013, management believes any impairment in the Company’s securities is temporary and no impairment loss has been realized in the Company’s consolidated statements of income.

 

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PROSPERITY BANCSHARES, INC. ® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2013

(UNAUDITED)

 

Securities with unrealized losses segregated by length of time that have been in a continuous loss position at June 30, 2013 and December 31, 2012 were as follows:

 

     June 30, 2013  
   Less than 12 Months     More than 12 Months     Total  
     Estimated
Fair Value
     Unrealized
Losses
    Estimated
Fair Value
     Unrealized
Losses
    Estimated
Fair Value
     Unrealized
Losses
 
     (Dollars in thousands)  

Available for Sale

               

Collateralized mortgage obligations

   $ —         $ —        $ 72       $ (1   $ 72       $ (1

Mortgage-backed securities

     459         —          3,638         (24     4,097         (24

Other securities

     1,724         (13     —           —          1,724         (13
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 2,183       $ (13   $ 3,710       $ (25   $ 5,893       $ (38
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Held to Maturity

               

States and political subdivisions

   $ 168,582       $ (1,716   $ 5,562       $ (123   $ 174,144       $ (1,839

Collateralized mortgage obligations

     1,946         (52     970         (8     2,916         (60

Mortgage-backed securities

     3,246,129         (124,034     11,693         (342     3,257,822         (124,376
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 3,416,657       $ (125,802   $ 18,225       $ (473   $ 3,434,882       $ (126,275
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
     December 31, 2012  
   Less than 12 Months     More than 12 Months     Total  
     Estimated
Fair Value
     Unrealized
Losses
    Estimated
Fair Value
     Unrealized
Losses
    Estimated
Fair Value
     Unrealized
Losses
 
     (Dollars in thousands)  

Available for Sale

               

Collateralized mortgage obligations

   $ —         $ —        $ 603       $ (12   $ 603       $ (12

Mortgage-backed securities

     224         —          3,964         (27     4,188         (27
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 224       $ —        $ 4,567       $ (39   $ 4,791       $ (39
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Held to Maturity

               

States and political subdivisions

   $ 37,322       $ (335   $ 1,140       $ (19   $ 38,462       $ (354

Collateralized mortgage obligations

     2,366         (50     —           —          2,366         (50

Mortgage-backed securities

     1,081,414         (4,516     234         (1     1,081,648         (4,517
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 1,121,102       $ (4,901   $ 1,374       $ (20   $ 1,122,476       $ (4,921
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

At June 30, 2013, there were approximately 353 securities in an unrealized loss position for more than 12 months.

 

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PROSPERITY BANCSHARES, INC. ® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2013

(UNAUDITED)

 

The amortized cost and fair value of investment securities at June 30, 2013, by contractual maturity, are shown below. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations at any time with or without call or prepayment penalties.

 

     Held to Maturity      Available for Sale  
     Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair
Value
 
     (Dollars in thousands)  

Due in one year or less

   $ 29,326       $ 29,403       $ 7,376       $ 7,507   

Due after one year through five years

     125,561         125,618         5,435         5,628   

Due after five years through ten years

     140,710         140,578         23,021         23,805   

Due after ten years

     86,187         88,826         5,048         5,240   
  

 

 

    

 

 

    

 

 

    

 

 

 

Subtotal

     381,784         384,425         40,880         42,180   

Mortgage-backed securities and collateralized mortgage obligations

     7,451,751         7,435,841         133,746         142,169   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 7,833,535       $ 7,820,266       $ 174,626       $ 184,349   
  

 

 

    

 

 

    

 

 

    

 

 

 

The Company had no gain or loss on sale of securities for the three and six months ended June 30, 2013 and 2012. As of June 30, 2013, the Company had eight non-agency CMO’s remaining with a total book value of $2.0 million and total market value of $2.0 million.

At June 30, 2013 and December 31, 2012, the Company did not own securities of any one issuer (other than the U.S. government and its agencies) for which aggregate adjusted cost exceeded 10% of the consolidated shareholders’ equity at such respective dates.

Securities with an amortized cost of $4.08 billion and $4.13 billion and a fair value of $4.08 billion and $4.27 billion at June 30, 2013 and December 31, 2012, respectively, were pledged to collateralize public deposits and for other purposes required or permitted by law.

 

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PROSPERITY BANCSHARES, INC. ® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2013

(UNAUDITED)

 

5. LOANS AND ALLOWANCE FOR CREDIT LOSSES

The loan portfolio consists of various types of loans made principally to borrowers located in Bryan/College Station, Central Texas, Dallas/Fort Worth, East Texas, Houston, South Texas, West Texas and Oklahoma and is classified by major type as follows:

 

     June 30,
2013
     December 31,
2012
 
     (Dollars in thousands)  

Residential mortgage loans held for sale

   $ 6,186       $ 10,433   
  

 

 

    

 

 

 

Commercial and industrial

     999,677         771,114   

Real estate:

     

Construction and land development

     694,585         550,768   

1-4 family residential (including home equity)

     1,654,821         1,432,133   

Commercial real estate (including multi-family residential)

     2,390,820         1,990,642   

Farmland

     230,389         211,156   

Agriculture

     84,556         74,481   

Consumer and other (net of unearned discount)

     111,449         139,213   
  

 

 

    

 

 

 

Total loans held for investment

     6,166,297         5,169,507   
  

 

 

    

 

 

 

Total

   $ 6,172,483       $ 5,179,940   
  

 

 

    

 

 

 

(i) Commercial and Industrial Loans. In nearly all cases, the Company’s commercial loans are made in the Company’s market areas and are underwritten on the basis of the borrower’s ability to service the debt from income. As a general practice, the Company takes as collateral a lien on any available real estate, equipment or other assets owned by the borrower and obtains a personal guaranty of the borrower or principal. Working capital loans are primarily collateralized by short-term assets whereas term loans are primarily collateralized by long-term assets. In general, commercial loans involve more credit risk than residential mortgage loans and commercial mortgage loans and, therefore, usually yield a higher return. The increased risk in commercial loans is due to the type of collateral securing these loans. The increased risk also derives from the expectation that commercial loans generally will be serviced principally from the operations of the business, and those operations may not be successful. Historical trends have shown these types of loans to have higher delinquencies than mortgage loans. As a result of these additional complexities, variables and risks, commercial loans require more thorough underwriting and servicing than other types of loans.

(ii) Commercial Real Estate. The Company makes commercial real estate related loans collateralized by owner-occupied and non-owner-occupied real estate to finance the purchase of real estate. The Company’s commercial real estate related loans are collateralized by first liens on real estate, typically have variable interest rates (or five year or less fixed rates) and amortize over a 15 to 20 year period. Payments on loans secured by such properties are often dependent on the successful operation or management of the properties. Accordingly, repayment of these loans may be subject to adverse conditions in the real estate market or the economy to a greater extent than other types of loans. The Company seeks to minimize these risks in a variety of ways, including giving careful consideration to the property’s operating history, future operating projections, current and projected occupancy, location and physical condition in connection with underwriting these loans. The underwriting analysis also includes credit verification, analysis of global cash flow, appraisals and a review of the financial condition of the borrower. At June 30, 2013, the Company had commercial real estate related loans totaling $2.39 billion which includes commercial real estate loans and multi-family residential loans. At June 30, 2013, approximately 43.8% of the outstanding principal balance of the Company’s commercial real estate related loans was secured by owner-occupied properties.

 

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PROSPERITY BANCSHARES, INC. ® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2013

(UNAUDITED)

 

(iii) 1-4 Family Residential Loans. The Company originates 1-4 family residential mortgage loans and home equity loans collateralized by owner-occupied residential properties located in the Company’s market areas. The Company offers a variety of mortgage loan products which generally are amortized over five to 25 years. Loans collateralized by 1-4 family residential real estate generally have been originated in amounts of no more than 89% of appraised value or have mortgage insurance. The Company requires mortgage title insurance and hazard insurance. The Company has elected to keep all 1-4 family residential loans for its own account rather than selling such loans into the secondary market. By doing so, the Company is able to realize a higher yield on these loans; however, the Company also incurs interest rate risk as well as the risks associated with nonpayments on such loans.

(iv) Construction and Land Development Loans. The Company makes loans to finance the construction of residential and, to a lesser extent, nonresidential properties. Construction loans generally are collateralized by first liens on real estate and have floating interest rates. The Company conducts periodic inspections, either directly or through an agent, prior to approval of periodic draws on these loans. Underwriting guidelines similar to those described above are also used in the Company’s construction lending activities. Construction loans involve additional risks attributable to the fact that loan funds are advanced upon the security of a project under construction, and the project is of uncertain value prior to its completion. Because of uncertainties inherent in estimating construction costs, the market value of the completed project and the effects of governmental regulation on real property, it can be difficult to accurately evaluate the total funds required to complete a project and the related loan to value ratio. As a result of these uncertainties, construction lending often involves the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project rather than the ability of a borrower or guarantor to repay the loan. If the Company is forced to foreclose on a project prior to completion, there is no assurance that the Company will be able to recover all of the unpaid portion of the loan. In addition, the Company may be required to fund additional amounts to complete a project and may have to hold the property for an indeterminate period of time. While the Company has underwriting procedures designed to identify what it believes to be acceptable levels of risks in construction lending, no assurance can be given that these procedures will prevent losses from the risks described above.

(v) Agriculture Loans. The Company provides agriculture loans for short-term crop production, including rice, cotton, milo and corn, farm equipment financing and agriculture real estate financing. The Company evaluates agriculture borrowers primarily based on their historical profitability, level of experience in their particular agriculture industry, overall financial capacity and the availability of secondary collateral to withstand economic and natural variations common to the industry. Because agriculture loans present a higher level of risk associated with events caused by nature, the Company routinely makes on-site visits and inspections in order to identify and monitor such risks.

(vi) Consumer Loans. Consumer loans made by the Company include direct credit automobile loans, recreational vehicle loans, boat loans, home improvement loans, personal loans (collateralized and uncollateralized) and deposit account collateralized loans. The terms of these loans typically range from 12 to 120 months and vary based upon the nature of collateral and size of loan. Generally, consumer loans entail greater risk than do real estate secured loans, particularly in the case of consumer loans that are unsecured or collateralized by rapidly depreciating assets such as automobiles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan balance. The remaining deficiency often does not warrant further substantial collection efforts against the borrower beyond obtaining a deficiency judgment. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws may limit the amount which can be recovered on such loans.

The Company maintains an independent loan review department that reviews and validates the credit risk program on a periodic basis. Results of these reviews are presented to management. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Company’s policies and procedures.

 

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PROSPERITY BANCSHARES, INC. ® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2013

(UNAUDITED)

 

Concentrations of Credit. Most of the Company’s lending activity occurs within the states of Texas and Oklahoma. The majority of the Company’s loan portfolio consists of commercial and industrial, commercial real estate and 1-4 family residential loans. As of June 30, 2013 and December 31, 2012, there were no concentrations of loans related to any single industry in excess of 10% of total loans.

Foreign Loans. The Company has U.S. dollar denominated loans and commitments to borrowers in Mexico. The outstanding balance of these loans and the unfunded amounts available under these commitments were not significant at June 30, 2013 or December 31, 2012.

Related Party Loans. As of June 30, 2013 and December 31, 2012, loans outstanding to directors, officers and their affiliates totaled $6.4 million and $6.7 million, respectively. All transactions entered into between the Company and such related parties are done in the ordinary course of business, made on the same terms and conditions as similar transactions with unaffiliated persons.

An analysis of activity with respect to these related party loans is as follows:

 

     June 30,
2013
    December 31,
2012
 
     (Dollars in thousands)  

Beginning balance on January 1

   $ 6,682      $ 9,809   

New loans and reclassified related loans

     306        967   

Repayments

     (586     (4,094
  

 

 

   

 

 

 

Ending balance

   $ 6,402      $ 6,682   
  

 

 

   

 

 

 

Nonaccrual and Past Due Loans. The Company has several procedures in place to assist it in maintaining the overall quality of its loan portfolio. The Company has established underwriting guidelines to be followed by its officers and the Company also monitors its delinquency levels for any negative or adverse trends. There can be no assurance, however, that the Company’s loan portfolio will not become subject to increasing pressures from deteriorating borrower credit due to general economic conditions.

The Company generally places a loan on nonaccrual status and ceases accruing interest when the payment of principal or interest is delinquent for 90 days, or earlier in some cases, unless the loan is in the process of collection and the underlying collateral fully supports the carrying value of the loan.

The Company requires appraisals on loans collateralized by real estate. With respect to potential problem loans, an evaluation of the borrower’s overall financial condition is made to determine the need, if any, for possible writedowns or appropriate additions to the allowance for credit losses.

 

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PROSPERITY BANCSHARES, INC. ® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2013

(UNAUDITED)

 

An aging analysis of past due loans, segregated by class of loans, is as follows:

 

     June 30, 2013  
     Loans Past Due and Still Accruing      Nonaccrual
Loans
     Current
Loans
     Total
Loans
 
     30-89 Days      90 or More
Days
     Total Past
Due Loans
          
     (Dollars in thousands)         

Construction and land development

   $ 3,946       $ —         $ 3,946       $ 267       $ 690,372       $ 694,585   

Agriculture and agriculture real estate (includes farmland)

     2,123         —           2,123         103         312,719         314,945   

1-4 family (includes home equity) (1)

     9,641         —           9,641         675         1,650,691         1,661,007   

Commercial real estate (includes multi-family residential)

     15,774         217         15,991         2,002         2,372,827         2,390,820   

Commercial and industrial

     16,504         58         16,562         1,132         981,983         999,677   

Consumer and other

     665         50         715         116         110,618         111,449   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 48,653       $ 325       $ 48,978       $ 4,295       $ 6,119,210       $ 6,172,483   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     December 31, 2012  
     Loans Past Due and Still Accruing      Nonaccrual
Loans
     Current
Loans
     Total
Loans
 
     30-89 Days      90 or More
Days
     Total Past
Due Loans
          
   (Dollars in thousands)         

Construction and land development

   $ 3,863       $ —         $ 3,863       $ 1,170       $ 545,735       $ 550,768   

Agriculture and agriculture real estate (includes farmland)

     310         21         331         396         284,910         285,637   

1-4 family (includes home equity) (1)

     2,307         310         2,617         1,598         1,438,351         1,442,566   

Commercial real estate (includes multi-family residential)

     9,163         —           9,163         —           1,981,479         1,990,642   

Commercial and industrial

     4,843         —           4,843         1,469         764,802         771,114   

Consumer and other

     856         —           856         749         137,608         139,213   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 21,342       $ 331       $ 21,673       $ 5,382       $ 5,152,885       $ 5,179,940   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Includes $6.2 million and $10.4 million of residential mortgage loans held for sale at June 30, 2013 and December 31, 2012, respectively.

 

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PROSPERITY BANCSHARES, INC. ® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2013

(UNAUDITED)

 

The following table presents information regarding past due loans and nonperforming assets as of the dates indicated:

 

     June 30,
2013
    December 31,
2012
 
     (Dollars in thousands)  

Nonaccrual loans

   $ 4,295      $ 5,382   

Accruing loans 90 or more days past due

     325        331   
  

 

 

   

 

 

 

Total nonperforming loans

     4,620        5,713   

Repossessed assets

     —          68   

Other real estate

     10,244        7,234   
  

 

 

   

 

 

 

Total nonperforming assets

   $ 14,864      $ 13,015   
  

 

 

   

 

 

 

Nonperforming assets to total loans and other real estate

     0.24     0.25

The Company believes its conservative lending approach has resulted in sound asset quality. The Company had $14.9 million in nonperforming assets at June 30, 2013 compared with $13.0 million at December 31, 2012. If interest on nonaccrual loans had been accrued under the original loan terms, approximately $153 thousand and $176 thousand would have been recorded as income for the six months ended June 30, 2013 and 2012, respectively.

Purchased Credit-Impaired (PCI) Loans. In connection with the acquisition of American State Financial Corporation (ASB) on July 1, 2012, Community National Bank on October 1, 2012, East Texas Financial Services on January 1, 2013 and Coppermark Bancshares, Inc. on April 1, 2013, the Company acquired loans both with and without evidence of credit quality deterioration since origination. The acquired loans were initially recorded at fair value with no carryover of any allowance for loan losses.

Loans acquired with evidence of credit quality deterioration at acquisition for which it was probable that the Company would not be able to collect all contractual amounts due were accounted for as PCI.

The carrying amount of acquired PCI loans included in the consolidated balance sheet and the related outstanding balance at June 30, 2013 and December 31, 2012 were as follows:

 

     June 30,
2013
     December 31,
2012
 
     (Dollars in thousands)  

Acquired PCI loans:

     

Carrying amount

   $ 51,699       $ 22,880   

Outstanding balance

       97,259         46,914   

The outstanding balance represents the total amount owed as of June 30, 2013 and December 31, 2012, including accrued but unpaid interest and any amounts previously charged off. No allowance for loan losses was required on the acquired PCI loans at both June 30, 2013 and December 31, 2012.

 

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PROSPERITY BANCSHARES, INC. ® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2013

(UNAUDITED)

 

Changes in the accretable yield for acquired PCI loans for the three and six month periods ended June 30, 2013 and 2012 were as follows:

 

     Three Month Periods Ended June 30,      Six Month Periods Ended June 30,  
     2013     2012      2013     2012  
     (Dollars in thousands)  

Balance at beginning of period

   $ 7,459      $ —         $ 7,459      $ —     

Additions

     5,792        —           7,528        —     

Reclassifications from nonaccretable

     1,222        —           1,255        —     

Accretion

     (1,462     —           (3,231     —     
  

 

 

   

 

 

    

 

 

   

 

 

 

Balance at June 30

   $ 13,011      $ —         $ 13,011      $ —     
  

 

 

   

 

 

    

 

 

   

 

 

 

Impaired Loans. Loans are considered impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for other loans. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible.

 

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Table of Contents

PROSPERITY BANCSHARES, INC. ® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2013

(UNAUDITED)

 

Impaired loans as of June 30, 2013 are set forth in the following table. No interest income was recognized on impaired loans subsequent to their classification as impaired for the three and six month periods ended June 30, 2013 and 2012. The average recorded investment presented in the table below is reported on a year-to-date basis.

 

     June 30, 2013  
     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
     Average
Recorded
Investment
 
     (Dollars in thousands)  

With no related allowance recorded:

           

Construction and land development

   $ 267       $ 270       $ —         $ 194   

Agriculture and agriculture real estate (includes farmland)

     77         78         —           77   

1-4 family (includes home equity)

     278         324         —           371   

Commercial real estate (includes multi-family residential)

     1,430         1,952         —           914   

Commercial and industrial

     22         1,428         —           55   

Consumer and other

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     2,074         4,052         —           1,611   
  

 

 

    

 

 

    

 

 

    

 

 

 

With an allowance recorded:

           

Construction and land development

     —           —           —           —     

Agriculture and agriculture real estate (includes farmland)

     26         31         23         30   

1-4 family (includes home equity)

     62         79         44         530   

Commercial real estate (includes multi-family residential)

     —           —           —           1,225   

Commercial and industrial

     858         893         819         950   

Consumer and other

     67         83         66         67   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     1,013         1,086         952         2,802   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total:

           

Construction and land development

     267         270         —           194   

Agriculture and agriculture real estate (includes farmland)

     103         109         23         107   

1-4 family (includes home equity)

     340         403         44         901   

Commercial real estate (includes multi-family residential)

     1,430         1,952         —           2,139   

Commercial and industrial

     880         2,321         819         1,005   

Consumer and other

     67         83         66         67   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 3,087       $ 5,138       $ 952       $ 4,413   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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PROSPERITY BANCSHARES, INC. ® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2013

(UNAUDITED)

 

Impaired loans as of December 31, 2012 are set forth in the following tables. No interest income was recognized on impaired loans subsequent to their classification as impaired. The average recorded investment is reported on a year-to-date basis.

 

     December 31, 2012  
     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
     Average
Recorded
Investment
 
     (Dollars in thousands)  

With no related allowance recorded:

           

Construction and land development

   $ 1,144       $ 1,175       $ —         $ 368   

Agriculture and agriculture real estate (includes farmland)

     77         77         —           34   

1-4 family (includes home equity)

     491         522         —           381   

Commercial real estate (includes multi-family residential)

     450         476         —           676   

Commercial and industrial

     87         89         —           75   

Consumer and other

     10         10         —           3   
  

 

 

    

 

 

    

 

 

    

 

 

 
     2,259         2,349         —           1,537   
  

 

 

    

 

 

    

 

 

    

 

 

 

With an allowance recorded:

           

Construction and land development

     —           —           —           451   

Agriculture and agriculture real estate (includes farmland)

     34         41         29         45   

1-4 family (includes home equity)

     999         1,017         273         720   

Commercial real estate (includes multi-family residential)

     2,450         2,451         610         2,725   

Commercial and industrial

     1,043         1,079         1,002         782   

Consumer and other

     66         81         67         21   
  

 

 

    

 

 

    

 

 

    

 

 

 
     4,592         4,669         1,981         4,744   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total:

           

Construction and land development

     1,144         1,175         —           819   

Agriculture and agriculture real estate (includes farmland)

     111         118         29         79   

1-4 family (includes home equity)

     1,490         1,539         273         1,101   

Commercial real estate (includes multi-family residential)

     2,900         2,927         610         3,401   

Commercial and industrial

     1,130         1,168         1,002         857   

Consumer and other

     76         91         67         24   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 6,851       $ 7,018       $ 1,981       $ 6,281   
  

 

 

    

 

 

    

 

 

    

 

 

 

Credit Quality Indicators. As part of the ongoing monitoring of the credit quality of the Company’s loan portfolio and methodology for calculating the allowance for credit losses, management assigns and tracks loan grades to be used as credit quality indicators. The following is a general description of the loan grades used (1-7):

Grade 1 – Credits in this category are of the highest standards of credit quality with virtually no risk of loss. These borrowers would represent top rated companies and individuals with unquestionable financial standing with excellent global cash flow coverage, net worth, liquidity and collateral coverage and/or secured by CD/savings accounts.

Grade 2 – Credits in this category are not immune for risk but are well-protected by the collateral and paying capacity of the borrower. These loans may exhibit a minor unfavorable credit factor, but the overall credit is sufficiently strong to minimize the possibility of loss.

 

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Table of Contents

PROSPERITY BANCSHARES, INC. ® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2013

(UNAUDITED)

 

Grade 3 – Credits in this category constitute an undue and unwarranted credit risk, however the factors do not rise to a level of substandard. These credits have potential weaknesses and/or declining trends that, if not corrected, could expose the Company to risk at a future date. Credits graded 3 are monitored on the Company’s internally generated watch list and evaluated on a quarterly basis.

Grade 4 – Credits in this category are deemed “substandard” loans in accordance with regulatory guidelines. Loans in this category have well-defined weakness that, if not corrected, could make default of principal and interest possible, but it is not yet certain. Loans in this category are still accruing interest and may be dependent upon secondary sources of repayment and/or collateral liquidation.

Grade 5 – Credits in this category are deemed “substandard” and “impaired” pursuant to regulatory guidelines. As such, the Company has determined that it is probable that less than 100% of the principal and interest will be collected. Loans graded 5 are individually evaluated for a specific reserve valuation and will typically have the accrual of interest stopped.

Grade 6 – Credits in this category include “doubtful” loans in accordance with regulatory guidance. Such loans are on nonaccrual and factors have indicated a loss is imminent. These loans are also deemed “impaired.” While a specific reserve may be in place while the loan and collateral is being evaluated these loans are typically charged down to an amount the Company deems collectable.

Grade 7 – Credits in this category are deemed a “loss” in accordance with regulatory guidelines and charged off or charged down. The Company may continue collection efforts and may have partial recovery in the future.

The following table presents risk grades and classified loans by class of loan at June 30, 2013. Classified loans include loans in risk grades 5, 6 and 7.

 

     Construction
and Land

Development
     Agriculture and
Agriculture  Real

Estate (Includes
Farmland)
     1-4 Family
(Includes

Home Equity) (1)
     Commercial
Real Estate
(Includes Multi-

Family Residential)
     Commercial
and  Industrial
     Consumer and
Other
     Total  
     (Dollars in thousands)  

Grade 1

   $ —         $ 4,000       $ 244       $ —         $ 44,984       $ 34,359       $ 83,587   

Grade 2

     668,997         309,985         1,649,194         2,340,613         946,439         77,012         5,992,240   

Grade 3

     5,642         —           4,472         11,593         3,237         11         24,955   

Grade 4

     3,057         431         2,792         9,795         840         —           16,915   

Grade 5

     267         103         329         1,430         880         67         3,076   

Grade 6

     —           —           11         —           —           —           11   

Grade 7

     —           —           —           —           —           —           —     

PCI Loans

     16,622         426         3,965         27,389         3,297         —           51,699   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 694,585       $ 314,945       $ 1,661,007       $ 2,390,820       $ 999,677       $ 111,449       $ 6,172,483   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Includes $6.2 million of residential mortgage loans held for sale at June 30, 2013.

 

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PROSPERITY BANCSHARES, INC. ® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2013

(UNAUDITED)

 

The following table presents risk grades and classified loans by class of loan at December 31, 2012. Classified loans include loans in risk grades 5, 6 and 7.

 

     Construction
and Land
Development
     Agriculture and
Agriculture  Real

Estate (Includes
Farmland)
     1-4 Family
(Includes
Home Equity) (1)
     Commercial
Real Estate
(Includes Multi-
Family Residential)
     Commercial
and Industrial
     Consumer and
Other
     Total  
     (Dollars in thousands)  

Grade 1

   $ 476       $ 4,195       $ 515       $ —         $ 53,965       $ 38,789       $ 97,940   

Grade 2

     537,340         277,333         1,431,095         1,945,319         702,587         100,163         4,993,837   

Grade 3

     7,250         2,024         4,947         11,760         8,926         —           34,907   

Grade 4

     4,256         1,694         4,303         11,711         1,385         176         23,525   

Grade 5

     1,144         111         1,477         2,900         1,130         76         6,838   

Grade 6

     —           —           13         —           —           —           13   

Grade 7

     —           —           —           —           —           —           —     

PCI Loans

     302         280         216         18,952         3,121         9         22,880   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 550,768       $ 285,637       $ 1,442,566       $ 1,990,642       $ 771,114       $ 139,213       $ 5,179,940   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Includes $10.4 million of residential mortgage loans held for sale at December 31, 2012.

Allowance for Credit Losses. The allowance for credit losses is a valuation established through charges to earnings in the form of a provision for credit losses. Management has established an allowance for credit losses which it believes is adequate for estimated losses in the Company’s loan portfolio. The amount of the allowance for credit losses is affected by the following: (i) charge-offs of loans that occur when loans are deemed uncollectible and decrease the allowance, (ii) recoveries on loans previously charged off that increase the allowance and (iii) provisions for credit losses charged to earnings that increase the allowance. Based on an evaluation of the loan portfolio and consideration of the factors listed below, management presents a quarterly review of the allowance for credit losses to the Bank’s Board of Directors, indicating any change in the allowance since the last review and any recommendations as to adjustments in the allowance.

The Company’s allowance for credit losses consists of two components: a specific valuation allowance based on probable losses on specifically identified loans and a general valuation allowance based on historical loan loss experience, general economic conditions and other qualitative risk factors both internal and external to the Company.

In setting the specific valuation allowance, the Company follows a loan review program to evaluate the credit risk in the loan portfolio. Through this loan review process, the Company maintains an internal list of impaired loans which, along with the delinquency list of loans, helps management assess the overall quality of the loan portfolio and the adequacy of the allowance for credit losses. All loans that have been identified as impaired are reviewed on a quarterly basis in order to determine whether a specific reserve is required. For each impaired loan, the Company allocates a specific loan loss reserve primarily based on the value of the collateral securing the impaired loan requiring a reserve. The specific reserves are determined on an individual loan basis. Impaired loans are excluded from the general valuation allowance described below.

In determining the amount of the general valuation allowance, management considers factors such as historical loan loss experience, industry diversification of the Company’s commercial loan portfolio, concentration risk of specific loan types, the volume, growth and composition of the Company’s loan portfolio, current economic conditions that may affect the borrower’s ability to pay and the value of collateral, the evaluation of the Company’s loan portfolio through its internal loan review process, general economic conditions and other qualitative risk factors both internal and external to the Company and other relevant factors.

Based on a review of these factors for each loan type, the Company applies an estimated percentage to the outstanding balance of each loan type, excluding any impaired loan. The Company uses this information to establish the amount of the general valuation allowance.

 

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Table of Contents

PROSPERITY BANCSHARES, INC. ® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2013

(UNAUDITED)

 

In connection with its review of the loan portfolio, the Company considers risk elements attributable to particular loan types or categories in assessing the quality of individual loans. Some of the risk elements include:

 

   

for 1-4 family residential mortgage loans, the borrower’s ability to repay the loan, including a consideration of the debt to income ratio and employment and income stability, the loan to value ratio, and the age, condition and marketability of collateral;

 

   

for commercial mortgage loans and multifamily residential loans, the debt service coverage ratio (income from the property in excess of operating expenses compared to loan payment requirements), operating results of the owner in the case of owner-occupied properties, the loan to value ratio, the age and condition of the collateral and the volatility of income, property value and future operating results typical of properties of that type;

 

   

for construction and land development loans, the perceived feasibility of the project including the ability to sell developed lots or improvements constructed for resale or the ability to lease property constructed for lease, the quality and nature of contracts for presale or prelease, if any, experience and ability of the developer and loan to value ratio;

 

   

for commercial and industrial loans, the operating results of the commercial, industrial or professional enterprise, the borrower’s business, professional and financial ability and expertise, the specific risks and volatility of income and operating results typical for businesses in that category and the value, nature and marketability of collateral;

 

   

for agriculture real estate loans, the experience and financial capability of the borrower, projected debt service coverage of the operations of the borrower and loan to value ratio; and

 

   

for non-real estate agriculture loans, the operating results, experience and financial capability of the borrower, historical and expected market conditions and the value, nature and marketability of collateral.

In addition, for each category, the Company considers secondary sources of income and the financial strength and credit history of the borrower and any guarantors.

At June 30, 2013, the allowance for credit losses totaled $56.2 million or 0.91% of total loans. At December 31, 2012, the allowance aggregated $52.6 million or 1.01% of total loans.

 

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Table of Contents

PROSPERITY BANCSHARES, INC. ® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2013

(UNAUDITED)

 

The following table details the recorded investment in loans and activity in the allowance for credit losses by portfolio segment for the three and six months ended June 30, 2013. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

 

     Construction
and Land
Development
    Agriculture
and
Agriculture
Real Estate
(includes
Farmland)
    1-4 Family
(includes
Home
Equity)
    Commercial
Real Estate
(includes
Multi-Family
residential)
    Commercial
and
Industrial
    Consumer
and Other
    Total  
     (Dollars in thousands)  

Allowance for credit losses:

              

Three Months Ended

              

Balance March 31, 2013

   $ 12,235      $ 887      $ 14,112      $ 21,869      $ 5,400      $ 546      $ 55,049   

Provision for credit losses

     (120     108        (642     1,763        1,041        400        2,550   

Charge-offs

     (257     (13     (51     (826     (258     (587     (1,992

Recoveries

     133        —          16        25        110        285        569   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net charge-offs

     (124     (13     (35     (801     (148     (302     (1,423
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance June 30, 2013

   $ 11,991      $ 982      $ 13,435      $ 22,831      $ 6,293      $ 644      $ 56,176   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Six Months Ended

              

Balance January 1, 2013

   $ 11,909      $ 764      $ 13,942      $ 19,607      $ 5,777      $ 565      $ 52,564   

Provision for credit losses

     150        223        (370     3,969        723        655        5,350   

Charge-offs

     (257     (13     (162     (895     (413     (1,192     (2,932

Recoveries

     189        8        25        150        206        616        1,194   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net charge-offs

     (68     (5     (137     (745     (207     (576     (1,738
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance June 30, 2013

   $ 11,991      $ 982      $ 13,435      $ 22,831      $ 6,293      $ 644      $ 56,176   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowance for credit losses related to:

              

June 30, 2013

              

Individually evaluated for impairment

   $ —        $ 23      $ 44      $ —        $ 819      $ 66      $ 952   

Collectively evaluated for impairment

     11,991        959        13,391        22,831        5,474        578        55,224   

PCI loans

     —          —          —          —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total allowance for credit losses

   $ 11,991      $ 982      $ 13,435      $ 22,831      $ 6,293      $ 644      $ 56,176   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Recorded investment in loans:

              

June 30, 2013

              

Individually evaluated for impairment

   $ 267      $ 103      $ 340      $ 1,430      $ 880      $ 67      $ 3,087   

Collectively evaluated for impairment

     677,696        314,416        1,656,702        2,362,001        995,500        111,382        6,117,697   

PCI loans

     16,622        426        3,965        27,389        3,297        —          51,699   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans evaluated for impairment

   $ 694,585      $ 314,945      $ 1,661,007      $ 2,390,820      $ 999,677      $ 111,449      $ 6,172,483   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

24


Table of Contents

PROSPERITY BANCSHARES, INC. ® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2013

(UNAUDITED)

 

The following table details the recorded investment in loans and activity in the allowance for credit losses by portfolio segment for the three and six months ended June 30, 2012. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

 

     Construction
and Land
Development
    Agriculture
and
Agriculture
Real Estate
(includes
Farmland)
     1-4 Family
(Includes
Home
Equity)
    Commercial
Real Estate
(Commercial
Mortgage and
Multi-Family)
    Commercial
and
Industrial
    Consumer
and Other
    Total  

Allowance for credit losses:

     (Dollars in thousands)   

Three Months Ended

               

Balance March 31, 2012

   $ 11,340      $ 620       $ 12,523      $ 21,910      $ 4,012      $ 1,237      $ 51,642   

Provision for credit losses

     (96     119         894        (209     406        (514     600   

Charge-offs

     (1,183     —           (99     (346     (243     (235     (2,106

Recoveries

     4        3         8        51        63        117        246   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net charge-offs

     (1,179     3         (91     (295     (180     (118     (1,860
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance June 30, 2012

   $ 10,065      $ 742       $ 13,326      $ 21,406      $ 4,238      $ 605      $ 50,382   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Six Months Ended

               

Balance January 1, 2012

   $ 12,094      $ 511       $ 12,645      $ 21,460      $ 3,826      $ 1,058      $ 51,594   

Provision for credit losses

     (828     228         822        259        577        (308     750   

Charge-offs

     (1,209     —           (151     (369     (321     (438     (2,488

Recoveries

     8        3         10        56        156        293        526   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net charge-offs

     (1,201     3         (141     (313     (165     (145     (1,962
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance June 30, 2012

   $ 10,065      $ 742       $ 13,326      $ 21,406      $ 4,238      $ 605      $ 50,382   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowance for credit losses related to:

               

June 30, 2012

               

Individually evaluated for impairment

   $ 17      $ 35       $ 220      $ 1,026      $ 354      $ 5      $ 1,657   

Collectively evaluated for impairment

     10,048        707         13,106        20,380        3,884        600        48,725   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total allowance for credit losses

   $ 10,065      $ 742       $ 13,326      $ 21,406      $ 4,238      $ 605      $ 50,382   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Recorded investment in loans:

               

June 30, 2012

               

Individually evaluated for impairment

   $ 327      $ 44       $ 630      $ 3,121      $ 503      $ 6      $ 4,631   

Collectively evaluated for impairment

     466,557        192,418         1,238,453        1,481,666        459,170        107,437        3,945,701   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans evaluated for impairment

   $ 466,884      $ 192,462       $ 1,239,083      $ 1,484,787      $ 459,673      $ 107,443      $ 3,950,332   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

25


Table of Contents

PROSPERITY BANCSHARES, INC. ® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2013

(UNAUDITED)

 

Troubled Debt Restructurings. The restructuring of a loan is considered a “troubled debt restructuring” if both (i) the borrower is experiencing financial difficulties and (ii) the creditor has granted a concession. Concessions may include interest rate reductions or below market interest rates, principal forgiveness, restructuring amortization schedules and other actions intended to minimize potential losses.

During the six months ended June 30, 2013, a $249 thousand loan was restructured. Default is determined at 90 or more days past due. The restructured loans from prior periods are performing and accruing loans.

6. FAIR VALUE

The Company uses fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. Fair values represent the estimated price that would be received from selling an asset or paid to transfer a liability, otherwise known as an “exit price.” Securities available for sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis such as certain loans including loans held-for-sale, goodwill and other intangible assets and other real estate owned. These nonrecurring fair value adjustments typically involve application of lower-of-cost-or-market accounting or write downs of individual assets.

Fair Value Hierarchy

The Company groups financial assets and financial liabilities measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

 

   

Level 1—Quoted prices in active markets for identical assets or liabilities.

 

   

Level 2—Other significant observable inputs (including quoted prices in active markets for similar assets or liabilities) or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

   

Level 3—Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair values requires significant management judgment or estimation.

The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for such asset or liability. In estimating fair value, the Company utilizes valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. Such valuation techniques are consistently applied. Inputs to valuation techniques include the assumptions that market participants would use in pricing an asset or liability.

The fair value disclosures below represent the Company’s estimates based on relevant market information and information about the financial instruments. Fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of the various instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in the above methodologies and assumptions could significantly affect the estimates.

 

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PROSPERITY BANCSHARES, INC. ® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2013

(UNAUDITED)

 

The following tables present fair values for assets measured at fair value on a recurring basis:

 

     As of June 30, 2013  
     Level 1      Level 2      Level 3      Total  
     (Dollars in thousands)  

Available for sale securities:

           

States and political subdivisions

   $ —         $ 34,763       $ —         $ 34,763   

Collateralized mortgage obligations

     —           556         —           556   

Mortgage-backed securities

     —           141,613         —           141,613   

Other securities

     7,417         —           —           7,417   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 7,417       $ 176,932       $ —         $ 184,349   
  

 

 

    

 

 

    

 

 

    

 

 

 
     As of December 31, 2012  
     Level 1      Level 2      Level 3      Total  
     (Dollars in thousands)  

Available for sale securities:

        

States and political subdivisions

   $ —         $ 36,434       $ —         $ 36,434   

Collateralized mortgage obligations

     —           604         —           604   

Mortgage-backed securities

     —           180,416         —           180,416   

Other securities

     7,688         1,528         —           9,216   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 7,688       $ 218,982      $ —         $ 226,670   
  

 

 

    

 

 

    

 

 

    

 

 

 

Certain financial assets and financial liabilities are measured at fair value on a nonrecurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). Financial assets measured at fair value on a non-recurring basis during the reported periods include certain impaired loans reported at the fair value of the underlying collateral if repayment is expected solely from the collateral. Collateral values are estimated using Level 2 inputs based on observable market data, typically in the case of real estate collateral. For the six months ended June 30, 2013, the Company had additions to impaired loans of $5.4 million, of which $1.5 million were outstanding at June 30, 2013.

Financial assets measured at fair value on a non-recurring basis during the reported periods also include other real estate owned and repossessed assets. For the three and six months ended June 30, 2013, the Company had additions to other real estate owned of $1.1 million and $2.7 million, of which $432 thousand and $1.4 million were outstanding at June 30, 2013, respectively. The remaining financial assets and financial liabilities measured at fair value on a non-recurring basis that were recorded in 2013 and remained outstanding at June 30, 2013 were not significant. During the reported periods, all fair value measurements for other real estate owned and repossessed assets utilized Level 2 inputs based on observable market data. There were no transfers between Level 1 and Level 2 assets during the six months ended June 30, 2013.

The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for such asset or liability. In estimating fair value, the Company utilizes valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. Such valuation techniques are consistently applied. Inputs to valuation techniques include the assumptions that market participants would use in pricing an asset or liability. FASB ASC Topic 820 establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs.

These fair value disclosures represent the Company’s estimates based on relevant market information and information about the financial instruments. Fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of the various instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in the above methodologies and assumptions could significantly affect the estimates.

 

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PROSPERITY BANCSHARES, INC. ® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2013

(UNAUDITED)

 

The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:

Cash and due from banks—For these short-term instruments, the carrying amount is a reasonable estimate of fair value. The Company classifies the estimated fair value of these instruments as Level 1.

Federal funds sold—For these short-term instruments, the carrying amount is a reasonable estimate of fair value. The Company classifies the estimated fair value of these instruments as Level 1.

Securities — Fair value measurements based upon quoted prices are considered Level 1 inputs. Level 1 securities consist of U.S. Treasury securities and certain equity securities which are included in the available for sale portfolio. For all other available for sale and held to maturity securities, if quoted prices are not available, fair values are measured using Level 2 inputs. For these securities, the Company generally obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things. The Company reviews the prices supplied by the independent pricing service, as well as their underlying pricing methodologies, for reasonableness.

Securities available for sale are recorded at fair value on a recurring basis.

Loans held for investment — The Company does not record loans at fair value on a recurring basis. As such, valuation techniques discussed herein for loans are primarily for estimating fair value disclosures. However, from time to time, the Company records nonrecurring fair value adjustments to impaired loans to reflect (1) partial write downs that are based on the observable market price or current appraised value of the collateral, or (2) the full charge-off of the loan carrying value. Where appraisals are not available, estimated cash flows are discounted using a rate commensurate with the credit risk associated with those cash flows. Assumptions regarding credit risk, cash flows and discount rates are judgmentally determined using available market information and specific borrower information.

The estimated fair value approximates carrying value for variable-rate loans that reprice frequently and with no significant change in credit risk. The fair value of fixed-rate loans and variable-rate loans which reprice on an infrequent basis is estimated by discounting future cash flows using the current interest rates at which similar loans with similar terms would be made to borrowers of similar credit quality. An overall valuation adjustment is made for specific credit risks as well as general portfolio credit risk. The Company classifies the estimated fair value of loans held for investment as Level 3.

Loans held for sale— Loans held for sale are carried at the lower of cost or estimated fair value. Fair value for consumer mortgages held for sale is based on commitments on hand from investors or prevailing market prices. As such, the Company classifies loans subjected to nonrecurring fair value adjustments as Level 1.

Federal Home Loan Bank of Dallas Stock— The fair value of FHLB stock is estimated to be equal to its carrying amount as reported in the accompanying Consolidated Balance Sheets, given it is not a publicly traded equity security, it has an adjustable dividend rate, and all transactions in the stock are executed at the stated par value. FHLB stock is considered a Level 1 fair value.

Other real estate owned— Other real estate owned is primarily foreclosed properties securing residential loans and commercial real estate. Foreclosed assets are adjusted to fair value less estimated costs to sell upon transfer of the loans to other real estate owned. Subsequently, these assets are carried at the lower of carrying value or fair value less estimated costs to sell. Other real estate carried at fair value based on an observable market price or a current appraised value is classified by the Company as Level 2. When management determines that the fair value of other real estate requires additional adjustments, either as a result of a non-current appraisal or when there is no observable market price, the Company classifies the other real estate as Level 3.

Deposits—The fair value of demand deposits, savings accounts and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities. Deposits fair value measurements utilize Level 2 inputs.

Junior subordinated debentures—The fair value of the junior subordinated debentures was calculated using the quoted market prices, if available. If quoted market prices are not available, fair value is estimated using quoted market prices for similar subordinated debentures. Junior subordinated debentures fair value measurements utilize Level 2 inputs.

 

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Table of Contents

PROSPERITY BANCSHARES, INC. ® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2013

(UNAUDITED)

 

Other borrowings—Rates currently available to the Company for debt with similar terms and remaining maturities are used to estimate the fair value of other borrowings using a discounted cash flows methodology and are measured utilizing Level 2 inputs.

Securities sold under repurchase agreements—The fair value of securities sold under repurchase agreements is the amount payable on demand at the reporting date and are measured utilizing Level 2 inputs.

Off-balance sheet financial instruments—The fair value of commitments to extend credit and standby letters of credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreement and the present creditworthiness of the counterparties. The Company has reviewed the unfunded portion of commitments to extend credit as well as standby and other letters of credit, and has determined that the fair value of such financial instruments is not material. The Company classifies the estimated fair value of credit-related financial instruments as Level 3.

The following table summarizes the carrying values and estimated fair values of certain financial instruments not recorded at fair value on a regular basis:

 

     As of June 30, 2013  
     Carrying
Amount
     Estimated Fair Value  
        Level 1      Level 2      Level 3      Total  
     (Dollars in thousands)  

Assets

  

Cash and due from banks

   $ 250,542       $ 250,542       $ —         $ —         $ 250,542   

Federal funds sold

     606         606         —           —           606   

Held to maturity securities

     7,833,535         —           7,820,266         —           7,820,266   

Loans held for sale

     6,186         6,186         —           —           6,186   

Loans held for investment, net of allowance

     6,110,121         —           —           6,145,277         6,145,277   

Federal Home Loan Bank of Dallas stock

     44,933         44,933         —           —           44,933   

Liabilities

              

Deposits:

              

Noninterest-bearing

   $ 3,283,082       $ —         $ 3,283,527       $ —         $ 3,283,527   

Interest-bearing

     9,225,568         —           9,241,538         —           9,241,538   

Other borrowings

     781,215         —           782,863         —           782,863   

Securities sold under repurchase agreements

     481,170         —           481,314         —           481,314   

Junior subordinated debentures

     85,055         —           81,656         —           81,656   
     As of December 31, 2012  
     Carrying
Amount
     Estimated Fair Value  
        Level 1      Level 2      Level 3      Total  
     (Dollars in thousands)  

Assets

  

Cash and due from banks

   $ 325,952       $ 325,952       $ —         $ —         $ 325,952   

Federal funds sold

     352         352         —           —           352   

Held to maturity securities

     7,215,395         —           7,418,695         —           7,418,695   

Loans held for sale

     10,433         10,433         —           —           10,433   

Loans held for investment, net of allowance

     5,116,943         —           —           5,186,779         5,186,779   

Federal Home Loan Bank of Dallas stock

     34,461         34,461         —           —           34,461   

Liabilities

              

Deposits:

              

Noninterest-bearing

   $ 3,016,205       $ —         $ 3,016,205       $ —         $ 3,016,205   

Interest-bearing

     8,625,639         —           8,640,625         —           8,640,625   

Other borrowings

     256,753         —           258,819         —           258,819   

Securities sold under repurchase agreements

     454,502         —           454,596         —           454,596   

Junior subordinated debentures

     85,055         —           72,705         —           72,705   

 

29


Table of Contents

PROSPERITY BANCSHARES, INC. ® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2013

(UNAUDITED)

 

The Company’s off-balance sheet commitments including letters of credit, which totaled $1.20 billion at June 30, 2013, are funded at current market rates at the date they are drawn upon. It is management’s opinion that the fair value of these commitments would approximate their carrying value, if drawn upon.

The fair value estimates presented herein are based on pertinent information available to management at June 30, 2013. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since those dates and, therefore, current estimates of fair value may differ significantly from the amounts presented herein.

7. GOODWILL AND CORE DEPOSIT INTANGIBLES

Changes in the carrying amount of the Company’s goodwill and core deposit intangibles (“CDI”) for six months ended June 30, 2013 and the year ended December 31, 2012 were as follows:

 

           Core Deposit  
   Goodwill     Intangibles  
     (Dollars in thousands)  

Balance as of December 31, 2011

   $ 924,537      $ 20,996   

Less:

    

Amortization

     —          (7,229

Add:

    

Acquisition of Texas Bankers, Inc.

     6,077        —     

Acquisition of The Bank Arlington

     2,102        —     

Acquisition of ASB

     274,119        12,392   

Acquisition of Community National Bank

     10,327        —     
  

 

 

   

 

 

 

Balance as of December 31, 2012

     1,217,162        26,159   

Less:

    

Amortization

     —          (3,096

Add:

    

Measurement period adjustment of The Bank Arlington

     (130     —     

Measurement period adjustment of ASB

     (3,094     2,110   

Measurement period adjustment of Community National Bank

     2,006        —     

Acquisition of East Texas Financial Services, Inc.

     16,944        —     

Acquisition of Coppermark Bancshares, Inc.

     117,946        1,515   
  

 

 

   

 

 

 

Balance as of June 30, 2013

   $ 1,350,834      $ 26,688   
  

 

 

   

 

 

 

Goodwill is recorded on the acquisition date of each entity. The Company may record subsequent adjustments to goodwill for amounts undeterminable at acquisition date, such as deferred taxes and real estate valuations, and therefore the goodwill amounts reflected in the table above may change accordingly. The Company initially records the total premium paid on acquisitions as goodwill. After finalizing the valuation, core deposit intangibles are identified and reclassified from goodwill to core deposit intangibles on the balance sheet. This reclassification has no effect on total assets, liabilities, shareholders’ equity, net income or cash flows. Management performs an evaluation annually, and more frequently if a triggering event occurs, of whether any impairment of the goodwill and other intangibles has occurred. If any such impairment is determined, a write-down is recorded. As of June 30, 2013, there were no impairments recorded on goodwill.

The measurement period for the Company to determine the fair value of acquired identifiable assets and assumed liabilities will be at the end of the earlier of (i) twelve months from the date of acquisition or (ii) as soon as the Company receives the information it was seeking about facts and circumstances that existed as of the date of acquisition. As such, certain acquisitions completed during 2012 and 2013 may be subject to adjustment.

 

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PROSPERITY BANCSHARES, INC. ® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2013

(UNAUDITED)

 

Core deposit intangibles are amortized on an accelerated basis over their estimated lives, which the Company believes is between 8 and 15 years. Amortization expense related to intangible assets totaled $1.3 million and $1.6 million for the three months ended June 30, 2013 and 2012, respectively, and $3.1 million and $3.3 million for the six months ended June 30, 2013 and 2012, respectively. The estimated aggregate future amortization expense for intangible assets remaining as of June 30, 2013 was as follows (dollars in thousands):

 

Remaining 2013

   $ 2,938   

2014

     4,841   

2015

     4,201   

2016

     3,761   

2017

     2,076   

Thereafter

     8,871   
  

 

 

 

Total

   $ 26,688   
  

 

 

 

8. STOCK BASED COMPENSATION

At June 30, 2013, the Company had four stock-based employee compensation plans and one stock option plan assumed in connection with an acquisition under which no additional options will be granted. Two of the four plans adopted by the Company have expired and therefore no additional awards may be issued under those plans.

During 2004, the Company’s Board of Directors adopted the Prosperity Bancshares, Inc. 2004 Stock Incentive Plan (the “2004 Plan”) which authorizes the issuance of up to 1,250,000 shares of common stock pursuant to the exercise or grant, as the case may be, of awards under such plan and the shareholders approved the 2004 Plan in 2005. The Company has granted shares with forfeiture restrictions (“restricted stock”) to certain directors, officers and associates under the 2004 Plan. The awardee is not entitled to the shares until they vest, which is generally over a one to five year period, but the awardee is entitled to receive dividends on and vote the shares prior to vesting. The shares granted do not have a cost to the awardee and the only requirement of vesting is continued service to the Company. Compensation cost related to restricted stock is calculated based on the fair value of the shares at the date of grant. If the awardee leaves the Company before the shares vest, the unvested shares are forfeited.

On February 22, 2012, the Company’s Board of Directors adopted the Prosperity Bancshares, Inc. 2012 Stock Incentive Plan (the “2012 Plan”), subject to approval by the Company’s shareholders. The Company’s shareholders approved the 2012 Plan at the annual meeting of shareholders on April 17, 2012. The 2012 Plan authorizes the issuance of up to 1,250,000 shares of common stock upon the exercise of options granted under the 2012 Plan or pursuant to the grant or exercise, as the case may be, of other awards granted under the 2012 Plan, including restricted stock, stock appreciation rights, phantom stock awards and performance awards. As of June 30, 2013, no options or other awards have been granted under the 2012 Plan.

The Company received $1.1 million and $1.8 million in cash from the exercise of stock options during the three-month periods ended June 30, 2013 and 2012, respectively, and $1.8 million and $2.5 million during the six-month periods ended June 30, 2013 and 2012, respectively. There was no tax benefit realized from option exercises of the share-based payment arrangements during the three and six month periods ended June 30, 2013 and 2012.

As of June 30, 2013, there was $6.7 million of total unrecognized compensation expense related to stock-based compensation arrangements. That cost is expected to be recognized over a weighted average period of 2.1 years.

 

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PROSPERITY BANCSHARES, INC. ® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2013

(UNAUDITED)

 

9. CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ITEMS

Contractual Obligations

The following table summarizes the Company’s contractual obligations and other commitments to make future payments as of June 30, 2013 (other than deposit obligations). The payments do not include pre-payment options that may be available to the Company. The Company’s future cash payments associated with its contractual obligations pursuant to its junior subordinated debentures, FHLB borrowings and operating leases as of June 30, 2013 are summarized below. Payments for junior subordinated debentures include interest of $47.3 million that will be paid over the future periods. The future interest payments were calculated using the current rate in effect at June 30, 2013. The current principal balance of the junior subordinated debentures at June 30, 2013 was $85.1 million. Payments for FHLB borrowings include interest of $2.5 million that will be paid over the future periods. Payments related to leases are based on actual payments specified in underlying contracts.

 

     1 year or less      More than 1
year but less
than 3 years
     3 years or
more but less
than 5 years
     5 years or
more
     Total  
     (Dollars in thousands)  

Junior subordinated debentures

   $ 1,169       $ 4,676       $ 4,675       $ 121,870       $ 132,390   

Federal Home Loan Bank notes payable and other borrowings

     770,683         3,836         2,312         6,899         783,730   

Operating leases

     2,650         7,785         3,264         380         14,079   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 774,502       $ 16,297       $ 10,251       $ 129,149       $ 930,199   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Off-Balance Sheet Items

In the normal course of business, the Company enters into various transactions, which, in accordance with accounting principles generally accepted in the United States, are not included in its consolidated balance sheets. The Company enters into these transactions to meet the financing needs of its customers. These transactions include commitments to extend credit and standby letters of credit, which involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amounts recognized in the consolidated balance sheets.

The Company’s commitments associated with outstanding standby letters of credit and commitments to extend credit as of June 30, 2013 are summarized below. Since commitments associated with letters of credit and commitments to extend credit may expire unused, the amounts shown do not necessarily reflect the actual future cash funding requirements.

 

     1 year or less      More than 1
year but less
than 3 years
     3 years or
more but less
than 5 years
     5 years or
more
     Total  
     (Dollars in thousands)  

Standby letters of credit

   $ 37,788       $ 2,612       $ 30       $ —         $ 40,430   

Commitments to extend credit

     299,677         495,644         76,598         286,697         1,158,616   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 337,465       $ 498,256       $ 76,628       $ 286,697       $ 1,199,046   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

32


Table of Contents

PROSPERITY BANCSHARES, INC. ® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2013

(UNAUDITED)

 

10. OTHER COMPREHENSIVE (LOSS) INCOME

The tax effects allocated to each component of other comprehensive (loss) income were as follows:

 

     Three Months Ended June 30,  
     2013     2012  
     Before Tax
Amount
    Tax
Benefit
     Net of Tax
Amount
    Before Tax
Amount
    Tax
Benefit
     Net of Tax
Amount
 
     (Dollars in thousands)  

Other comprehensive loss:

              

Securities available for sale:

              

Change in unrealized gain during period

   $ (2,330   $ 816       $ (1,514   $ (1,833   $ 642       $ (1,191
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total securities available for sale

     (2,330     816         (1,514     (1,833     642         (1,191
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total other comprehensive loss

   $ (2,330   $ 816       $ (1,514   $ (1,833   $ 642       $ (1,191