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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2015

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  ☒    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  ☒    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	☒	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  ☒

As of August 3, 2015, there were 70,041,790 outstanding shares of the registrant’s Common Stock, par value $1.00 per share.

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, 2015 and December 31, 2014 (unaudited)	3
	Consolidated Statements of Income for the Three and Six Months Ended June 30, 2015 and 2014 (unaudited)	4
	Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2015 and 2014 (unaudited)	5
	Consolidated Statements of Changes in Shareholders’ Equity for the Six Months Ended June 30, 2015 and 2014 (unaudited)	6
	Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2015 and 2014 (unaudited)	7
	Notes to Interim Consolidated Financial Statements (unaudited)	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	37
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	58
Item 4.	Controls and Procedures	58
PART II—OTHER INFORMATION
Item 1.	Legal Proceedings	59
Item 1A.	Risk Factors	59
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	59
Item 3.	Defaults upon Senior Securities	59
Item 4.	Mine Safety Disclosures	59
Item 5.	Other Information	59
Item 6.	Exhibits	59
Signatures		60

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PART I—FINANCIAL INFORMATION

ITEM 1.     INTERIM CONSOLIDATED FINANCIAL STATEMENTS

PROSPERITY BANCSHARES, INC.^® AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

	June 30,			December 31,
	2015			2014
	(Dollars in thousands, except par value)
ASSETS
Cash and due from banks	$	353,047		$	677,285
Federal funds sold		1,451			569
Total cash and cash equivalents		354,498			677,854
Available for sale securities, at fair value		123,229			145,399
Held to maturity securities, at cost (fair value of $9,592,825 and $8,948,692, respectively)		9,574,850			8,900,377
Total securities		9,698,079			9,045,776
Loans held for sale		10,482			8,602
Loans held for investment		9,103,853			9,235,581
Total loans		9,114,335			9,244,183
Less: allowance for credit losses		(80,972	)		(80,762	)
Loans, net		9,033,363			9,163,421
Accrued interest receivable		51,303			51,941
Goodwill		1,881,955			1,874,191
Core deposit intangibles, net		54,068			58,947
Bank premises and equipment, net		275,347			281,549
Other real estate owned		2,806			3,237
Bank owned life insurance (BOLI)		232,963			230,095
Federal Home Loan Bank of Dallas stock		58,132			15,432
Other assets		43,773			105,290
TOTAL ASSETS	$	21,686,287		$	21,507,733
LIABILITIES AND SHAREHOLDERS’ EQUITY
LIABILITIES:
Deposits:
Noninterest-bearing	$	5,040,628		$	4,936,420
Interest-bearing		11,961,036			12,756,738
Total deposits		17,001,664			17,693,158
Other borrowings		886,741			8,724
Securities sold under repurchase agreements		334,189			315,523
Junior subordinated debentures		-			167,531
Accrued interest payable		2,115			3,190
Other liabilities		104,293			74,781
Total liabilities		18,329,002			18,262,907
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; 70,076,778 and 69,816,653 shares issued at June 30, 2015 and December 31, 2014, respectively; 70,039,690 and 69,779,565 shares outstanding at June 30, 2015 and December 31, 2014, respectively		70,077			69,817
Capital surplus		2,030,732			2,025,235
Retained earnings		1,254,057			1,146,652
Accumulated other comprehensive income—net unrealized gain on available for sale securities, net of tax of $1,629 and $2,008, respectively		3,026			3,729
Less treasury stock, at cost, 37,088 shares		(607	)		(607	)
Total shareholders’ equity		3,357,285			3,244,826
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	21,686,287		$	21,507,733

See notes to interim consolidated financial statements.

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PROSPERITY BANCSHARES, INC.^® AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2015		2014		2015		2014
	(Dollars in thousands, except per share data)
INTEREST INCOME:
Loans, including fees	$	119,404	$	138,655	$	244,282	$	245,799
Securities		48,530		47,670		97,092		94,726
Federal funds sold		47		178		212		226
Total interest income		167,981		186,503		341,586		340,751
INTEREST EXPENSE:
Deposits		9,169		10,918		18,746		20,305
Other borrowings		365		189		494		347
Securities sold under repurchase agreements		208		254		411		491
Junior subordinated debentures		-		1,087		791		1,862
Total interest expense		9,742		12,448		20,442		23,005
NET INTEREST INCOME		158,239		174,055		321,144		317,746
PROVISION FOR CREDIT LOSSES		500		6,325		1,750		6,925
NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES		157,739		167,730		319,394		310,821
NONINTEREST INCOME:
Nonsufficient funds (NSF) fees		8,310		9,099		16,228		17,969
Credit card, debit card and ATM card income		6,003		6,030		11,641		11,182
Service charges on deposit accounts		4,189		4,325		8,368		7,934
Trust income		2,047		2,044		4,056		3,844
Mortgage income		1,513		1,208		2,661		1,801
Brokerage income		1,541		1,401		2,950		2,670
Net gain on sale of assets		270		1,301		1,649		4,611
Other		6,424		7,189		11,165		11,250
Total noninterest income		30,297		32,597		58,718		61,261
NONINTEREST EXPENSE:
Salaries and employee benefits		47,819		54,126		97,785		97,534
Net occupancy and equipment		5,812		5,996		11,776		11,335
Credit and debit card, data processing and software amortization		4,045		4,009		7,862		7,193
Regulatory assessments and FDIC insurance		4,253		3,886		8,607		6,612
Core deposit intangibles amortization		2,390		2,630		4,879		4,675
Depreciation		3,420		3,522		6,336		6,723
Communications		2,835		2,919		5,644		5,656
Other real estate expense		129		188		261		584
Other		9,032		10,016		16,047		18,074
Total noninterest expense		79,735		87,292		159,197		158,386
INCOME BEFORE INCOME TAXES		108,301		113,035		218,915		213,696
PROVISION FOR INCOME TAXES		36,369		37,529		73,342		71,053
NET INCOME	$	71,932	$	75,506	$	145,573	$	142,643
EARNINGS PER SHARE:
Basic	$	1.03	$	1.08	$	2.08	$	2.10
Diluted	$	1.03	$	1.08	$	2.08	$	2.10

See notes to interim consolidated financial statements.

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PROSPERITY BANCSHARES, INC.^® AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(UNAUDITED)

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2015			2014			2015			2014
	(Dollars in thousands)
Net income	$	71,932		$	75,506		$	145,573		$	142,643
Other comprehensive loss, before tax:
Securities available for sale:
Change in unrealized gain during period		(640	)		(317	)		(1,082	)		(806	)
Total other comprehensive loss		(640	)		(317	)		(1,082	)		(806	)
Deferred tax benefit related to other comprehensive loss		224			111			379			282
Other comprehensive loss, net of tax		(416	)		(206	)		(703	)		(524	)
Comprehensive income	$	71,516		$	75,300		$	144,870		$	142,119

See notes to interim consolidated financial statements.

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PROSPERITY BANCSHARES, INC.^® AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(UNAUDITED)

											Accumulated
											Other						Total
	Common Stock				Capital			Retained			Comprehensive			Treasury			Shareholders’
	Shares		Amount		Surplus			Earnings			Income			Stock			Equity
	(In thousands, except share and per share data)
BALANCE AT DECEMBER 31, 2013		66,085,179	$	66,085	$	1,798,862		$	917,595		$	4,883		$	(607	)	$	2,786,818
Net income									142,643									142,643
Other comprehensive loss												(524	)					(524	)
Common stock issued in connection with the exercise of stock options and restricted stock awards		398,384		399		2,016												2,415
Common stock issued in connection with the acquisition of F&M Bancorporation Inc.		3,298,022		3,298		214,866												218,164
Stock based compensation expense						3,709												3,709
Cash dividends declared, $0.4800 per share									(32,631	)								(32,631	)
BALANCE AT JUNE 30, 2014		69,781,585	$	69,782	$	2,019,453		$	1,027,607		$	4,359		$	(607	)	$	3,120,594
BALANCE AT DECEMBER 31, 2014		69,816,653	$	69,817	$	2,025,235		$	1,146,652		$	3,729		$	(607	)	$	3,244,826
Net income									145,573									145,573
Other comprehensive loss												(703	)					(703	)
Common stock issued in connection with the issuance of restricted stock awards		260,125		260		(193	)											67
Stock based compensation expense						5,690												5,690
Cash dividends declared, $0.5450 per share									(38,168	)								(38,168	)
BALANCE AT JUNE 30, 2015		70,076,778	$	70,077	$	2,030,732		$	1,254,057		$	3,026		$	(607	)	$	3,357,285

See notes to interim consolidated financial statements.

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PROSPERITY BANCSHARES, INC.^® AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

	Six Months Ended
	June 30,
	2015			2014
	(Dollars in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	145,573		$	142,643
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and core deposit intangibles amortization		11,215			11,398
Provision for credit losses		1,750			6,925
Net amortization of premium on investments		29,611			25,118
Gain on sale of other real estate		(18	)		(1,344	)
Gain on sale of assets		(1,649	)		(4,611	)
Net accretion of discount on loans		(33,249	)		(38,827	)
Net accretion of discount on deposits		(640	)		-
Gain on sale of loans		(2,565	)		(1,724	)
Proceeds from sale of loans held for sale		107,027			82,292
Originations of loans held for sale		(106,342	)		(86,766	)
Stock based compensation expense		5,690			3,709
Decrease (increase) in accrued interest receivable and other assets		14,699			(6,734	)
Increase in accrued interest payable and other liabilities		25,370			62,376
Net cash provided by operating activities		196,472			194,455
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities and principal paydowns of held to maturity securities		818,864			1,541,089
Purchase of held to maturity securities		(1,522,964	)		(2,146,700	)
Proceeds from maturities and principal paydowns of available for sale securities		1,831,103			1,324,817
Purchase of available for sale securities		(1,810,000	)		(1,300,000	)
Net decrease in loans held for investment		161,954			109,517
Purchase of bank premises and equipment		(5,400	)		(6,709	)
Proceeds from sale of bank premises, equipment and other real estate		6,418			20,874
Net cash and cash equivalents acquired in the purchase of F&M Bancorporation Inc.		—			487,599
Net cash (used in) provided by investing activities		(520,025	)		30,487
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in noninterest-bearing deposits		104,208			161,455
Net decrease in interest-bearing deposits		(795,062	)		(437,594	)
Net proceeds from other short-term borrowings		880,000			190,000
Repayments of other long-term borrowings		(1,983	)		(479	)
Net increase in securities sold under repurchase agreements		18,666			23,985
Redemption of junior subordinated debentures		(167,531	)		-
Proceeds from stock option exercises		67			2,415
Payments of cash dividends		(38,168	)		(32,631	)
Net cash provided by (used in) financing activities		197			(92,849	)
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS		(323,356	)		132,093
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD		677,854			381,390
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	354,498		$	513,483
NONCASH ACTIVITIES:
Stock issued in connection with the F&M Bancorporation Inc. acquisition	$	-		$	218,164
Acquisition of real estate through foreclosure of collateral		1,166			4,401
SUPPLEMENTAL INFORMATION:
Income taxes paid	$	42,580		$	50,843
Interest paid		21,517			24,153

See notes to interim consolidated financial statements.

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PROSPERITY BANCSHARES, INC.^® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2015

(UNAUDITED)

1. BASIS OF PRESENTATION

The interim consolidated financial statements include the accounts of Prosperity Bancshares, Inc.^® (“Bancshares”) and its wholly-owned subsidiary, Prosperity Bank^® (the “Bank”, collectively referred to as the “Company”). All intercompany transactions and balances have been eliminated.

The accompanying unaudited interim consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) 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 U.S. GAAP 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, 2014. Operating results for the six-month period ended June 30, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015 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,
	2015				2014				2015				2014
			Per Share				Per Share				Per Share				Per Share
	Amount		Amount		Amount		Amount		Amount		Amount		Amount		Amount
	(Amounts in thousands, except per share data)
Net income	$	71,932			$	75,506			$	145,573			$	142,643
Basic:
Weighted average shares outstanding		70,037	$	1.03		69,667	$	1.08		70,035	$	2.08		67,936	$	2.10
Diluted:
Add incremental shares for:
Effect of dilutive securities - options		16				61				19				78
Total		70,053	$	1.03		69,728	$	1.08		70,054	$	2.08		68,014	$	2.10

There were no stock options exercisable during the three and six months ended June 30, 2015 or 2014 that would have had an anti-dilutive effect on the above computation.

3. NEW ACCOUNTING STANDARDS

Accounting Standards Updates (“ASU”)

ASU 2015-01, “Income Statement - Extraordinary and Unusual Items (Subtopic 225-20) – Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items.” ASU 2015-01 eliminates from U.S. GAAP the concept of extraordinary items, which, among other things, required an entity to segregate extraordinary items considered to be unusual and infrequent from the results of ordinary operations and show the item separately in the income statement, net of tax, after income from continuing operations. ASU 2015-01 is effective for the Company beginning January 1, 2016, though early adoption is permitted. ASU 2015-01 is not expected to 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, 2015

(UNAUDITED)

ASU 2014-12 “Compensation-Stock Compensation (Topic 718) - Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period.”  ASU 2014-12 requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. The performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. If the performance target becomes probable of being achieved before the end of the requisite service period, the remaining unrecognized compensation cost should be recognized prospectively over the remaining requisite service period. The total amount of compensation cost recognized during and after the requisite service period should reflect the number of awards that are expected to vest and should be adjusted to reflect those awards that ultimately vest. The requisite service period ends when the employee can cease rendering service and still be eligible to vest in the award if the performance target is achieved. ASU 2014-12 is effective for the Company beginning January 1, 2016 and is not expected to have a significant impact on the Company’s financial statements. 

ASU 2014-11 “Transfers and Servicing (Topic 860) - Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosure.”  ASU 2014-11 changes the accounting for repurchase-to-maturity transactions to secured borrowing accounting. It also requires separate accounting for a transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counterparty, which will result in secured borrowing accounting and disclosure for the repurchase agreement. ASU 2014-11 became effective for the Company on January 1, 2015 and did not have a significant impact on the Company’s financial statements. 

ASU 2014-09 “Revenue from Contract with Customers (Topic 606).”  ASU 2014-09  supersedes the revenue recognition requirements in Revenue Recognition (Topic 605), and most industry-specific guidance throughout the Industry Topics of the Codification.  Additionally, ASU 2014-09  supersedes some cost guidance included in Revenue Recognition—Construction-Type and Production-Type Contracts (Subtopic 605-35).  In addition, the existing requirements for the recognition of a gain or loss on the transfer of nonfinancial assets that are not in a contract with a customer are amended to be consistent with the guidance on recognition and measurement.   The core principle of ASU 2014-09 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.  ASU 2014-09 is effective for the Company beginning January 1, 2018, with retrospective application to each prior reporting period presented. The Company is currently evaluating the requirements of ASU 2014-09, but it is not expected to have a significant impact on the Company’s financial statements. 

ASU 2014-04 “Receivables—Troubled Debt Restructurings by Creditors (Subtopic 310-40) — Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure.” ASU 2014-04 intends to reduce diversity by clarifying when an in substance repossession or foreclosure occurs, that is, when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan receivable should be derecognized and the real estate property recognized. ASU 2014-04 became effective for the Company on January 1, 2015 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, 2015

(UNAUDITED)

4. SECURITIES

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

	June 30, 2015
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
	(Dollars in thousands)
Available for Sale
States and political subdivisions	$	9,207	$	65	$	-		$	9,272
Collateralized mortgage obligations		29,824		103		(10	)		29,917
Mortgage-backed securities		66,955		4,380		(12	)		71,323
Other securities		12,588		160		(31	)		12,717
Total	$	118,574	$	4,708	$	(53	)	$	123,229
Held to Maturity
U.S. Treasury securities and obligations of U.S. Government agencies	$	51,936	$	971	$	(1	)	$	52,906
States and political subdivisions		388,356		5,335		(1,319	)		392,372
Collateralized mortgage obligations		7,899		62		(3	)		7,958
Mortgage-backed securities		9,126,659		92,646		(79,716	)		9,139,589
Total	$	9,574,850	$	99,014	$	(81,039	)	$	9,592,825

	December 31, 2014
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
	(Dollars in thousands)
Available for Sale
States and political subdivisions	$	14,402	$	183	$	-		$	14,585
Collateralized mortgage obligations		33,519		91		(37	)		33,573
Mortgage-backed securities		79,153		5,344		(14	)		84,483
Other securities		12,588		201		(31	)		12,758
Total	$	139,662	$	5,819	$	(82	)	$	145,399
Held to Maturity
U.S. Treasury securities and obligations of U.S. Government agencies	$	52,353	$	360	$	(74	)	$	52,639
States and political subdivisions		404,356		6,147		(1,422	)		409,081
Collateralized mortgage obligations		19,585		215		(8	)		19,792
Mortgage-backed securities		8,424,083		96,650		(53,553	)		8,467,180
Total	$	8,900,377	$	103,372	$	(55,057	)	$	8,948,692

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PROSPERITY BANCSHARES, INC.^® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2015

(UNAUDITED)

Management evaluates securities for other-than-temporary impairment (“OTTI”) 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 analysis. Investment securities classified as available for sale or held to maturity are evaluated for OTTI under Financial Accounting Standards Board (“FASB”): Accounting Standards Codification (“ASC”) Topic 320, “Investments-Debt and Equity Securities.”

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, 2015, 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, 2015, 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, 2015

(UNAUDITED)

Securities with unrealized losses, segregated by length of time, that have been in a continuous loss position were as follows:

	June 30, 2015
	Less than 12 Months					More than 12 Months					Total
	Estimated		Unrealized			Estimated		Unrealized			Estimated		Unrealized
	Fair Value		Losses			Fair Value		Losses			Fair Value		Losses
	(Dollars in thousands)
Available for Sale
Collateralized mortgage obligations	$	-	$	-		$	5,298	$	(10	)	$	5,298	$	(10	)
Mortgage-backed securities		155		-			2,692		(12	)		2,847		(12	)
Other securities		1,706		(31	)		-		-			1,706		(31	)
Total	$	1,861	$	(31	)	$	7,990	$	(22	)	$	9,851	$	(53	)
Held to Maturity
U.S. Treasury securities and obligations of U.S. Government agencies	$	500	$	(1	)	$	-	$	-		$	500	$	(1	)
States and political subdivisions		45,734		(245	)		53,902		(1,074	)		99,636		(1,319	)
Collateralized mortgage obligations		-		-			296		(3	)		296		(3	)
Mortgage-backed securities		2,728,331		(32,930	)		1,786,337		(46,786	)		4,514,668		(79,716	)
Total	$	2,774,565	$	(33,176	)	$	1,840,535	$	(47,863	)	$	4,615,100	$	(81,039	)

	December 31, 2014
	Less than 12 Months					More than 12 Months					Total
	Estimated		Unrealized			Estimated		Unrealized			Estimated		Unrealized
	Fair Value		Losses			Fair Value		Losses			Fair Value		Losses
	(Dollars in thousands)
Available for Sale
Collateralized mortgage obligations	$	6,675	$	(36	)	$	45	$	(1	)	$	6,720	$	(37	)
Mortgage-backed securities		358		-			2,837		(14	)		3,195		(14	)
Other securities		1,706		(31	)		-		-			1,706		(31	)
Total	$	8,739	$	(67	)	$	2,882	$	(15	)	$	11,621	$	(82	)
Held to Maturity
U.S. Treasury securities and obligations of U.S. Government agencies	$	17,098	$	(74	)	$	-	$	-		$	17,098	$	(74	)
States and political subdivisions		45,680		(425	)		44,760		(997	)		90,440		(1,422	)
Collateralized mortgage obligations		670		(5	)		322		(3	)		992		(8	)
Mortgage-backed securities		1,149,380		(2,600	)		2,349,143		(50,953	)		3,498,523		(53,553	)
Total	$	1,212,828	$	(3,104	)	$	2,394,225	$	(51,953	)	$	3,607,053	$	(55,057	)

At June 30, 2015 and December 31, 2014, there were 487 securities and 501 securities, respectively, 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, 2015

(UNAUDITED)

The amortized cost and fair value of investment securities at June 30, 2015, 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		Fair		Amortized		Fair
	Cost		Value		Cost		Value
	(Dollars in thousands)
Due in one year or less	$	35,523	$	35,597	$	12,688	$	12,818
Due after one year through five years		185,036		186,467		4,618		4,644
Due after five years through ten years		162,059		165,223		3,859		3,894
Due after ten years		57,674		57,991		630		633
Subtotal		440,292		445,278		21,795		21,989
Mortgage-backed securities and collateralized mortgage obligations		9,134,558		9,147,547		96,779		101,240
Total	$	9,574,850	$	9,592,825	$	118,574	$	123,229

The Company recorded no gain or loss on sale of securities for the three and six months ended June 30, 2015 and 2014. As of June 30, 2015, the Company did not own any non-agency collateralized mortgage obligations.

At June 30, 2015 and December 31, 2014, 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 $4.88 billion and $5.08 billion and a fair value of $4.89 billion and $5.10 billion at June 30, 2015 and December 31, 2014, respectively, were pledged to collateralize public deposits and for other purposes required or permitted by law.

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NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2015

(UNAUDITED)

5. LOANS AND ALLOWANCE FOR CREDIT LOSSES

The loan portfolio consists of various types of loans made principally to borrowers located within the states of Texas and Oklahoma and is categorized by major type as follows:

	June 30,		December 31,
	2015		2014
	(Dollars in thousands)
Residential mortgage loans held for sale	$	10,482	$	8,602
Commercial and industrial		1,654,517		1,806,267
Real estate:
Construction, land development and other land loans		1,068,056		1,026,475
1-4 family residential (including home equity)		2,552,170		2,513,579
Commercial real estate (including multi-family residential)		2,958,239		3,030,340
Farmland		399,654		361,943
Agriculture		201,091		189,703
Consumer and other		270,126		307,274
Total loans held for investment		9,103,853		9,235,581
Total	$	9,114,335	$	9,244,183

(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 as well as 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 thorough underwriting and more active servicing than other types of loans.

(ii) Commercial Real Estate. The Company makes commercial real estate loans collateralized by owner-occupied and nonowner-occupied real estate to finance the purchase of real estate. The Company’s commercial real estate 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 nonowner-occupied 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, 2015, approximately 47.5% of the outstanding principal balance of the Company’s commercial real estate loans were secured by owner-occupied properties.

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NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2015

(UNAUDITED)

(iii) 1-4 Family Residential Loans. The Company’s lending activities also include the origination of 1-4 family residential mortgage loans (including home equity loans) collateralized by owner-occupied residential properties located in the Company’s market areas. The Company offers a variety of mortgage loan portfolio 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 retains these portfolio loans for its own account rather than selling them into the secondary market. By doing so, the Company incurs interest rate risk as well as the risks associated with nonpayments on such loans. The Company’s Home Loan Center offers a variety of mortgage loan products which are generally amortized over 30 years, including FHA and VA loans. The Company sells the loans originated by the Home Loan Center into the secondary market.

(iv) Construction, Land Development and Other Land 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 “A”-credit automobile loans, recreational vehicle loans, boat loans, home improvement loans, personal loans (collateralized and uncollateralized), credit cards and deposit account collateralized loans. The terms of these loans typically range from 12 to 180 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, 2015

(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 real estate, 1-4 family residential loans, and commercial and industrial loans. As of June 30, 2015 and December 31, 2014, 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 was not significant at June 30, 2015 or December 31, 2014.

Related Party Loans. As of June 30, 2015 and December 31, 2014, loans outstanding to directors, officers and their affiliates totaled $4.0 million and $4.9 million, respectively. All transactions entered into between the Company and such related parties are done in the ordinary course of business and 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,			December 31,
	2015			2014
	(Dollars in thousands)
Beginning balance on January 1	$	4,940		$	6,187
New loans		174			4,913
Repayments and reclassified related loans		(1,161	)		(6,160	)
Ending balance	$	3,953		$	4,940

Nonperforming Assets and 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, 2015 

(UNAUDITED)

An aging analysis of past due loans, segregated by category of loan, is presented below:

	June 30, 2015
	Loans Past Due and Still Accruing
			90 or More		Total Past		Nonaccrual		Current		Total
	30-89 Days		Days		Due Loans		Loans		Loans		Loans
	(Dollars in thousands)
Construction, land development and other land loans	$	2,896	$	153	$	3,049	$	421	$	1,064,586	$	1,068,056
Agriculture and agriculture real estate (includes farmland)		728		-		728		605		599,412		600,745
1-4 family (includes home equity) (1)		2,456		-		2,456		2,987		2,557,209		2,562,652
Commercial real estate (includes multi-family residential)		5,640		-		5,640		7,536		2,945,063		2,958,239
Commercial and industrial		16,615		-		16,615		20,164		1,617,738		1,654,517
Consumer and other		302		-		302		274		269,550		270,126
Total	$	28,637	$	153	$	28,790	$	31,987	$	9,053,558	$	9,114,335

	December 31, 2014
	Loans Past Due and Still Accruing
			90 or More		Total Past		Nonaccrual		Current		Total
	30-89 Days		Days		Due Loans		Loans		Loans		Loans
	(Dollars in thousands)
Construction, land development and other land loans	$	7,667	$	-	$	7,667	$	526	$	1,018,282	$	1,026,475
Agriculture and agriculture real estate (includes farmland)		2,995		377		3,372		96		548,178		551,646
1-4 family (includes home equity) (1)		2,261		82		2,343		3,570		2,516,268		2,522,181
Commercial real estate (includes multi-family residential)		12,679		65		12,744		6,340		3,011,256		3,030,340
Commercial and industrial		18,305		869		19,174		20,537		1,766,556		1,806,267
Consumer and other		612		800		1,412		353		305,509		307,274
Total	$	44,519	$	2,193	$	46,712	$	31,422	$	9,166,049	$	9,244,183

(1) Includes $10.5 million and $8.6 million of residential mortgage loans held for sale at June 30, 2015 and December 31, 2014, respectively.

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PROSPERITY BANCSHARES, INC.^® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2015

(UNAUDITED)

The following table presents information regarding nonperforming assets as of the dates indicated:

June 30, December 31,