PROSPERITY BANCSHARES INC - Quarter Report: 2019 June (Form 10-Q)

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, 2019

☐	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)	(Zip Code)

(281) 269-7199

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class		Trading Symbol(s)		Name of each exchange on which registered
Common stock, par value $1.00 per share		PB		New York Stock Exchange, Inc.

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 every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

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

Large Accelerated Filer	☒	Accelerated Filer	☐

Non-accelerated Filer	☐	Smaller Reporting Company	☐

		Emerging Growth Company	☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

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 July 30, 2019, there were 69,053,368 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.	Financial Statements	3
	Consolidated Balance Sheets as of June 30, 2019 (unaudited) and December 31, 2018	3
	Consolidated Statements of Income for the Three and Six Months Ended June 30, 2019 and 2018 (unaudited)	4
	Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2019 and 2018 (unaudited)	5
	Consolidated Statements of Changes in Shareholders’ Equity for the Three and Six Months Ended June 30, 2019 and 2018 (unaudited)	6
	Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2019 and 2018 (unaudited)	7
	Notes to Consolidated Financial Statements (unaudited)	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	32
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	53
Item 4.	Controls and Procedures	53

PART II—OTHER INFORMATION

Item 1.	Legal Proceedings	55
Item 1A.	Risk Factors	55
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	55
Item 3.	Defaults Upon Senior Securities	55
Item 4.	Mine Safety Disclosures	55
Item 5.	Other Information	55
Item 6.	Exhibits	56
Signatures		57

PART I—FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

PROSPERITY BANCSHARES, INC.^® AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

	June 30,			December 31,
	2019			2018
	(unaudited)
	(Dollars in thousands, except par value)
ASSETS
Cash and due from banks	$	302,069		$	410,575
Federal funds sold		555			552
Total cash and cash equivalents		302,624			411,127
Available for sale securities, at fair value		306,777			84,155
Held to maturity securities, at cost (fair value of $8,656,409 and $9,081,236, respectively)		8,645,163			9,324,811
Total securities		8,951,940			9,408,966
Loans held for sale		20,315			29,367
Loans held for investment		10,567,060			10,340,946
Total loans		10,587,375			10,370,313
Less: allowance for credit losses		(87,006	)		(86,440	)
Loans, net		10,500,369			10,283,873
Accrued interest receivable		57,382			56,532
Goodwill		1,900,845			1,900,845
Core deposit intangibles, net		30,299			32,883
Bank premises and equipment, net		262,479			257,046
Other real estate owned		2,005			1,805
Bank owned life insurance (BOLI)		261,372			260,335
Federal Home Loan Bank of Dallas stock		56,459			55,959
Other assets		49,447			24,031
TOTAL ASSETS	$	22,375,221		$	22,693,402
LIABILITIES AND SHAREHOLDERS’ EQUITY
LIABILITIES:
Deposits:
Noninterest-bearing	$	5,691,236		$	5,666,115
Interest-bearing		11,196,393			11,590,443
Total deposits		16,887,629			17,256,558
Other borrowings		940,874			1,031,126
Securities sold under repurchase agreements		313,825			284,720
Accrued interest payable		5,171			4,201
Other liabilities		99,827			63,973
Total liabilities		18,247,326			18,640,578
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; 69,261,431 shares issued and outstanding at June 30, 2019; 69,846,825 shares issued and outstanding at December 31, 2018		69,261			69,847
Capital surplus		2,012,665			2,045,351
Retained earnings		2,044,696			1,937,316
Accumulated other comprehensive income —net unrealized gain on available for sale securities, net of tax expense of $338 and $82, respectively		1,273			310
Total shareholders’ equity		4,127,895			4,052,824
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	22,375,221		$	22,693,402

See notes to consolidated financial statements.

PROSPERITY BANCSHARES, INC.^® AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)

	Three Months Ended					Six Months Ended
	June 30,					June 30,
	2019		2018			2019			2018
	(Dollars in thousands, except per share data)
INTEREST INCOME:
Loans, including fees	$	133,525	$	128,445		$	263,590		$	244,691
Securities		53,944		55,577			109,592			110,034
Federal funds sold and other earning assets		318		299			720			614
Total interest income		187,787		184,321			373,902			355,339
INTEREST EXPENSE:
Deposits		26,562		16,061			51,690			30,533
Other borrowings		5,556		6,046			10,873			9,019
Securities sold under repurchase agreements		831		411			1,590			761
Total interest expense		32,949		22,518			64,153			40,313
NET INTEREST INCOME		154,838		161,803			309,749			315,026
PROVISION FOR CREDIT LOSSES		800		4,000			1,500			13,000
NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES		154,038		157,803			308,249			302,026
NONINTEREST INCOME:
Nonsufficient funds (NSF) fees		7,973		7,828			15,789			15,655
Credit card, debit card and ATM card income		6,480		6,335			12,451			12,296
Service charges on deposit accounts		4,989		5,150			9,987			10,425
Trust income		2,558		2,251			5,153			4,979
Mortgage income		990		1,109			1,712			1,872
Brokerage income		541		687			1,214			1,312
Gain (loss) on sale of assets		2		(44	)		60			(44	)
Net loss on sale of securities		—		(13	)		—			(13	)
Other		6,425		5,068			11,736			9,827
Total noninterest income		29,958		28,371			58,102			56,309
NONINTEREST EXPENSE:
Salaries and employee benefits		52,941		53,360			104,014			103,759
Net occupancy and equipment		5,492		5,692			10,958			11,301
Credit and debit card, data processing and software amortization		4,904		4,356			9,477			8,804
Regulatory assessments and FDIC insurance		2,325		3,575			4,699			7,150
Core deposit intangibles amortization		1,265		1,501			2,584			3,069
Depreciation		3,111		3,054			6,215			6,087
Communications		2,183		2,606			4,453			5,186
Other real estate expense, net		66		93			(28	)		304
Other		8,534		9,365			17,020			17,996
Total noninterest expense		80,821		83,602			159,392			163,656
INCOME BEFORE INCOME TAXES		103,175		102,572			206,959			194,679
PROVISION FOR INCOME TAXES		20,917		20,975			42,299			38,721
NET INCOME	$	82,258	$	81,597		$	164,660		$	155,958
EARNINGS PER SHARE:
Basic	$	1.18	$	1.17		$	2.36		$	2.23
Diluted	$	1.18	$	1.17		$	2.36		$	2.23

See notes to consolidated financial statements.

PROSPERITY BANCSHARES, INC.^® AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(UNAUDITED)

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2019			2018			2019			2018
	(Dollars in thousands)
Net income	$	82,258		$	81,597		$	164,660		$	155,958
Other comprehensive income, before tax:
Securities available for sale:
Change in unrealized gain during the period		716			380			1,219			580
Total other comprehensive income		716			380			1,219			580
Deferred taxes related to other comprehensive income		(150	)		(80	)		(256	)		(122	)
Other comprehensive income, net of tax		566			300			963			458
Comprehensive income	$	82,824		$	81,897		$	165,623		$	156,416

See notes to consolidated financial statements.

PROSPERITY BANCSHARES, INC.^® AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(UNAUDITED)

													Accumulated
													Other		Total
	Common Stock						Capital			Retained			Comprehensive		Shareholders’
	Shares			Amount			Surplus			Earnings			Income		Equity
	(In thousands, except share and per share data)
Three Months Ended
BALANCE AT MARCH 31, 2019		69,845,925		$	69,846		$	2,048,156		$	1,991,081		$	707	$	4,109,790
Net income											82,258					82,258
Other comprehensive income														566		566
Common stock issued in connection with the issuance of restricted stock awards, net		14,334			14			(14	)							—
Common stock repurchase		(598,828	)		(599	)		(37,822	)							(38,421	)
Stock based compensation expense								2,345								2,345
Cash dividends declared, $0.41 per share											(28,643	)				(28,643	)
BALANCE AT JUNE 30, 2019		69,261,431		$	69,261		$	2,012,665		$	2,044,696		$	1,273	$	4,127,895

Six Months Ended
BALANCE AT DECEMBER 31, 2018		69,846,825		$	69,847		$	2,045,351		$	1,937,316		$	310	$	4,052,824
Net income											164,660					164,660
Other comprehensive income														963		963
Common stock issued in connection with the issuance of restricted stock awards, net		13,434			13			(13	)							—
Common stock repurchase		(598,828	)		(599	)		(37,822	)							(38,421	)
Stock based compensation expense								5,149								5,149
Cash dividends declared, $0.82 per share											(57,280	)				(57,280	)
BALANCE AT JUNE 30, 2019		69,261,431		$	69,261		$	2,012,665		$	2,044,696		$	1,273	$	4,127,895

											Accumulated
											Other			Total
	Common Stock				Capital			Retained			Comprehensive			Shareholders’
	Shares		Amount		Surplus			Earnings			Income			Equity
	(In thousands, except share and per share data)
Three Months Ended
BALANCE AT MARCH 31, 2018		69,819,286	$	69,819	$	2,037,498		$	1,768,783		$	45		$	3,876,145
Net income									81,597						81,597
Other comprehensive income												300			300
Common stock issued in connection with the issuance of restricted stock awards, net		18,900		19		(19	)								—
Stock based compensation expense						2,553									2,553
Cash dividends declared, $0.36 per share									(25,143	)					(25,143	)
BALANCE AT JUNE 30, 2018		69,838,186		69,838		2,040,032			1,825,237			345			3,935,452

Six Months Ended
BALANCE AT DECEMBER 31, 2017		69,490,910	$	69,491	$	2,035,219		$	1,719,557		$	(113	)	$	3,824,154
Net income									155,958						155,958
Other comprehensive income												458			458
Common stock issued in connection with the issuance of restricted stock awards, net		347,276		347		(347	)								—
Stock based compensation expense						5,160									5,160
Cash dividends declared, $0.72 per share									(50,278	)					(50,278	)
BALANCE AT JUNE 30, 2018		69,838,186	$	69,838	$	2,040,032		$	1,825,237		$	345		$	3,935,452

See notes to consolidated financial statements.

PROSPERITY BANCSHARES, INC.^® AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

	Six Months Ended
	June 30,
	2019			2018
	(Dollars in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	164,660		$	155,958
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and core deposit intangibles amortization		8,799			9,156
Provision for credit losses		1,500			13,000
Net amortization of premium on investments		14,196			16,203
Net (gain) loss on sale of other real estate		(231	)		132
Net loss on sale of investment securities		—			13
Net (gain) loss on sale of assets		(60	)		44
Net accretion of discount on loans		(3,020	)		(7,549	)
Net amortization of premium on deposits		—			(106	)
Gain on sale of loans		(1,639	)		(1,761	)
Proceeds from sale of loans held for sale		94,650			100,620
Originations of loans held for sale		(83,959	)		(95,237	)
Stock based compensation expense		5,149			5,160
Increase in accrued interest receivable and other assets		(14,998	)		(32,554	)
Increase (decrease) in accrued interest payable and other liabilities		21,442			(5,206	)
Net cash provided by operating activities		206,489			157,873

CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities and principal paydowns of held to maturity securities		837,003			862,987
Purchase of held to maturity securities		(171,656	)		(940,595	)
Proceeds from maturities and principal paydowns of available for sale securities		7,013,362			8,113,160
Purchase of available for sale securities		(7,234,660	)		(7,999,686	)
Net increase in loans held for investment		(226,664	)		(134,124	)
Purchase of bank premises and equipment		(11,738	)		(6,280	)
Proceeds from sale of bank premises, equipment and other real estate		2,505			2,647
Proceeds from insurance claims		2,633			1,701
Net cash provided by (used in) investing activities		210,785			(100,190	)

CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in noninterest-bearing deposits		25,121			34,267
Net decrease in interest-bearing deposits		(394,050	)		(877,017	)
Net (repayments of) proceeds from other short-term borrowings		(90,000	)		750,000
Repayments of other long-term borrowings		(252	)		(374	)
Net increase (decrease) in securities sold under repurchase agreements		29,105			(31,115	)
Repurchase of common stock		(38,421	)		—
Payments of cash dividends		(57,280	)		(50,278	)
Net cash used in financing activities		(525,777	)		(174,517	)
NET DECREASE IN CASH AND CASH EQUIVALENTS		(108,503	)		(116,834	)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD		411,127			392,313
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	302,624		$	275,479

NONCASH ACTIVITIES:
Acquisition of real estate through foreclosure of collateral	$	1,940		$	153

SUPPLEMENTAL INFORMATION:
Income taxes paid	$	42,850		$	94,610
Interest paid		63,183			39,710

See notes to consolidated financial statements

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2019

(UNAUDITED)

1. BASIS OF PRESENTATION

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

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for 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 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, 2018. Operating results for the six-month period ended June 30, 2019 are not necessarily indicative of the results that may be expected for the year ending December 31, 2019 or any other period.

2. INCOME PER COMMON SHARE

The following table illustrates the computation of basic and diluted earnings per share:

	Three Months Ended June 30,								Six Months Ended June 30,
	2019				2018				2019				2018
	Amount		Per Share Amount		Amount		Per Share Amount		Amount		Per Share Amount		Amount		Per Share Amount
	(Amounts in thousands, except per share data)
Net income	$	82,258			$	81,597			$	164,660			$	155,958
Basic:
Weighted average shares outstanding		69,806	$	1.18		69,839	$	1.17		69,832	$	2.36		69,803	$	2.23
Diluted:
Weighted average shares outstanding		69,806	$	1.18		69,839	$	1.17		69,832	$	2.36		69,803	$	2.23

As of June 30, 2019, all stock options have been exercised and there are no options outstanding. There were no stock options exercisable during the three and six months ended June 30, 2019 or 2018 that would have had an anti-dilutive effect on the above computation.

3. NEW ACCOUNTING STANDARDS

Accounting Standards Updates (“ASU”)

ASU 2016-13, “Financial Instruments – Credit Losses (Topic 326)—Measurement of Credit Losses on Financial Instruments.” ASU 2016-13 requires a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The measurement of current expected credit losses (“CECL”) is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. An entity must use judgment in determining the relevant information and estimation methods that are appropriate in its circumstances. Additionally, available for sale debt securities may realize value either through collection of contractual cash flows or through sale of the security at fair value. Therefore, the amendments limit the amount of the allowance for credit losses to the difference between amortized cost and fair value. ASU 2016-13 will be effective for the Company as of January 1, 2020. The Company’s implementation workgroup is comprised of individuals from various functional areas including credit, risk management, finance and information technology, among others, and meets periodically to discuss the latest developments and monitor implementation progress. The Company is currently working through an implementation plan that includes assessment of processes, portfolio segmentation and model development. The Company is working with a third-party vendor to assist with implementation and model development. CECL compliant models are currently in the development stage, with model testing and documentation being performed concurrently. The Company is assessing CECL disclosure requirements and developing appropriate internal controls around the CECL process. While the Company continues to evaluate the potential impact of ASU 2016‑13 on the Company’s financial statements, the adoption of ASU 2016-13 may result in an increase in the allowance for loan losses as a result of changing from an incurred loss methodology to an expected loss methodology.

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2019

(UNAUDITED)

ASU 2016-02, "Leases (Topic 842)." ASU 2016-02 requires that lessees recognize lease assets and lease liabilities on the balance sheet and disclose key information about leasing arrangements. The requirements for lessors under ASU 2016-02 are largely unchanged from existing guidance, however certain necessary changes have been made to align with specific changes to lessee accounting and key aspects of the revenue recognition guidance (Topic 606).

The Company’s leases relate primarily to office space and banking centers. The Company identified and reviewed existing leases applicable to ASU 2016-02 and elected certain optional practical expedients: 1) not to reassess whether any expired or existing contracts are or contain leases, 2) not to reassess the lease classification for any expired or existing lease, 3) not to reassess initial direct cost for any existing leases and 4) not to separately identify lease and non-lease components. Additionally, the Company elected the short-term lease exemption for lease terms less than 12 months. The Company adopted ASU 2016-02 on January 1, 2019 using a modified retrospective transition approach without adjusting comparative periods. With the adoption of the new standard, the Company recognized right-of-use assets and lease liabilities of $17.3 million as of January 1, 2019. See Note 9 “Contractual Obligations and Off-Balance Sheet Items — Contractual Obligations — Leases” for additional information.

4. SECURITIES

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

	June 30, 2019
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(Dollars in thousands)
Available for Sale
States and political subdivisions	$	469	$	1	$	—		$	470
Collateralized mortgage obligations		244,256		796		(130	)		244,922
Mortgage-backed securities		60,441		946		(2	)		61,385
Total	$	305,166	$	1,743	$	(132	)	$	306,777
Held to Maturity
U.S. Treasury securities and obligations of U.S. Government agencies	$	22,867	$	43	$	(3	)	$	22,907
States and political subdivisions		215,871		6,088		(144	)		221,815
Collateralized mortgage obligations		462		5		(1	)		466
Mortgage-backed securities		8,405,963		50,480		(45,222	)		8,411,221
Total	$	8,645,163	$	56,616	$	(45,370	)	$	8,656,409

	December 31, 2018
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(Dollars in thousands)
Available for Sale
States and political subdivisions	$	1,159	$	7	$	—		$	1,166
Collateralized mortgage obligations		12,724		69		(37	)		12,756
Mortgage-backed securities		69,880		553		(200	)		70,233
Total	$	83,763	$	629	$	(237	)	$	84,155
Held to Maturity
U.S. Treasury securities and obligations of U.S. Government agencies	$	25,778	$	—	$	(100	)	$	25,678
States and political subdivisions		253,198		3,440		(777	)		255,861
Collateralized mortgage obligations		509		1		(2	)		508
Mortgage-backed securities		9,045,326		5,798		(251,935	)		8,799,189
Total	$	9,324,811	$	9,239	$	(252,814	)	$	9,081,236

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2019

(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 the time of such determination.

When OTTI occurs, the amount of the OTTI 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 will 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 will 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 will become the new amortized cost basis of the investment.

Management has the ability and intent to hold the securities classified as held-to-maturity until they mature, at which time the Company will receive full value for the securities. Furthermore, as of June 30, 2019, management does not have the intent to sell any of the securities classified as available for sale before a recovery of cost. In addition, management believes it is more likely than not that the Company will not be required to sell any of its investment 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, 2019, management believes any impairment in the Company’s securities is temporary, and therefore no impairment loss has been recognized in the Company’s consolidated statement of income.

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

	June 30, 2019
	Less than 12 Months					12 Months or More					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	$	37,871	$	(106	)	$	1,899	$	(24	)	$	39,770	$	(130	)
Mortgage-backed securities		67		(1	)		48		(1	)		115		(2	)
Total	$	37,938	$	(107	)	$	1,947	$	(25	)	$	39,885	$	(132	)
Held to Maturity
U.S. Treasury securities and obligations of U.S. Government agencies	$	—	$	—		$	8,990	$	(3	)	$	8,990	$	(3	)
States and political subdivisions		43,370		(87	)		26,552		(57	)		69,922		(144	)
Collateralized mortgage obligations		79		(1	)		—		—			79		(1	)
Mortgage-backed securities		131,659		(356	)		4,271,546		(44,866	)		4,403,205		(45,222	)
Total	$	175,108	$	(444	)	$	4,307,088	$	(44,926	)	$	4,482,196	$	(45,370	)

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2019

(UNAUDITED)

	December 31, 2018
	Less than 12 Months					12 Months or More					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	$	12	$	—		$	2,096	$	(37	)	$	2,108	$	(37	)
Mortgage-backed securities		50,950		(197	)		2,091		(3	)		53,041		(200	)
Total	$	50,962	$	(197	)	$	4,187	$	(40	)	$	55,149	$	(237	)
Held to Maturity
U.S. Treasury securities and obligations of U.S. Government agencies	$	20,720	$	(76	)	$	4,957	$	(24	)	$	25,677	$	(100	)
States and political subdivisions		89,407		(328	)		58,262		(449	)		147,669		(777	)
Collateralized mortgage obligations		—		—			292		(2	)		292		(2	)
Mortgage-backed securities		1,003,089		(8,401	)		6,873,948		(243,534	)		7,877,037		(251,935	)
Total	$	1,113,216	$	(8,805	)	$	6,937,459	$	(244,009	)	$	8,050,675	$	(252,814	)

At June 30, 2019 and December 31, 2018, there were 287 securities and 731 securities, respectively, in an unrealized loss position for 12 months or more.

The amortized cost and fair value of investment securities at June 30, 2019, 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	$	48,722	$	48,797	$	165	$	165
Due after one year through five years		117,183		118,201		304		305
Due after five years through ten years		68,317		73,134		—		—
Due after ten years		4,516		4,590		—		—
Subtotal		238,738		244,722		469		470
Mortgage-backed securities and collateralized mortgage obligations		8,406,425		8,411,687		304,697		306,307
Total	$	8,645,163	$	8,656,409	$	305,166	$	306,777

The Company recorded no gain or loss on the sale of securities for the three and six months ended June 30, 2019. The Company recorded a $13 thousand loss on the sale of securities for the three and six months ended June 30, 2018. As of June 30, 2019, the Company did not own any non-agency collateralized mortgage obligations.

At June 30, 2019 and December 31, 2018, 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 $5.33 billion and $6.04 billion and a fair value of $5.32 billion and $5.86 billion at June 30, 2019 and December 31, 2018, respectively, were pledged to collateralize public deposits and for other purposes required or permitted by law.

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2019

(UNAUDITED)

5. LOANS AND ALLOWANCE FOR CREDIT LOSSES

The loan portfolio consists of various types of loans and is categorized by major type as follows:

	June 30, 2019		December 31, 2018
	(Dollars in thousands)
Residential mortgage loans held for sale	$	20,315	$	29,367

Commercial and industrial		1,525,628		1,483,571
Real estate:
Construction, land development and other land loans		1,739,308		1,622,289
1-4 family residential (includes home equity)		2,692,963		2,677,542
Commercial real estate (includes multi-family residential)		3,551,668		3,538,557
Farmland		541,469		545,373
Agriculture		195,001		184,128
Consumer and other		321,023		289,486
Total loans held for investment		10,567,060		10,340,946
Total	$	10,587,375	$	10,370,313

Concentrations of Credit. Most of the Company’s lending activity occurs within the states of Texas and Oklahoma. Commercial real estate loans, 1-4 family residential loans and construction, land development and other land loans make up 75.4% of the Company’s total loan portfolio at June 30, 2019. As of June 30, 2019 and December 31, 2018, there were no concentrations of loans related to any single industry in excess of 10% of total loans.

Related Party Loans. As of June 30, 2019 and December 31, 2018, loans outstanding to directors, officers and their affiliates totaled $1.8 million and $1.9 million, respectively. All transactions between the Company and such related parties are conducted 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:

	As of and for the six months ended June 30, 2019			As of and for the year ended December 31, 2018
	(Dollars in thousands)
Beginning balance on January 1	$	1,923		$	2,694
New loans		—			5
Repayments		(168	)		(776	)
Ending balance	$	1,755		$	1,923

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, including requiring appraisals on loans collateralized by real estate. The Company also monitors its delinquency levels for any negative or adverse trends. Nevertheless, the Company’s loan portfolio could 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.

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.

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2019

(UNAUDITED)

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

	June 30, 2019
	Loans Past Due and Still Accruing
	30-89 Days		90 or More Days		Total Past Due Loans		Nonaccrual Loans		Current Loans		Total Loans
	(Dollars in thousands)
Construction, land development and other land loans	$	5,368	$	1,153	$	6,521	$	659	$	1,732,128	$	1,739,308
Agriculture and agriculture real estate (includes farmland)		710		—		710		616		735,144		736,470
1-4 family (includes home equity) ⁽¹⁾		11,107		58		11,165		15,278		2,686,835		2,713,278
Commercial real estate (includes multi-family residential)		14,572		—		14,572		4,135		3,532,961		3,551,668
Commercial and industrial		4,102		383		4,485		16,561		1,504,582		1,525,628
Consumer and other		333		—		333		40		320,650		321,023
Total	$	36,192	$	1,594	$	37,786	$	37,289	$	10,512,300	$	10,587,375

	December 31, 2018
	Loans Past Due and Still Accruing
	30-89 Days		90 or More Days		Total Past Due Loans		Nonaccrual Loans		Current Loans		Total Loans
	(Dollars in thousands)
Construction, land development and other land loans	$	6,363	$	788	$	7,151	$	1,386	$	1,613,752	$	1,622,289
Agriculture and agriculture real estate (includes farmland)		705		—		705		256		728,540		729,501
1-4 family (includes home equity) ⁽¹⁾		10,479		2,995		13,474		4,515		2,688,920		2,706,909
Commercial real estate (includes multi-family residential)		9,063		—		9,063		2,727		3,526,767		3,538,557
Commercial and industrial		6,652		221		6,873		4,215		1,472,483		1,483,571
Consumer and other		1,012		—		1,012		48		288,426		289,486
Total	$	34,274	$	4,004	$	38,278	$	13,147	$	10,318,888	$	10,370,313

(1) Includes $20.3 million and $29.4 million of residential mortgage loans held for sale at June 30, 2019 and December 31, 2018, respectively.

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

	June 30, 2019			December 31, 2018
	(Dollars in thousands)
Nonaccrual loans ⁽¹⁾	$	37,289		$	13,147
Accruing loans 90 or more days past due		1,594			4,004
Total nonperforming loans		38,883			17,151
Repossessed assets		670			—
Other real estate		2,005			1,805
Total nonperforming assets	$	41,558		$	18,956

Nonperforming assets to total loans and other real estate		0.39	%		0.18	%

(1) Includes troubled debt restructurings of $14.3 million and $51 thousand as of June 30, 2019 and December 31, 2018, respectively.

The Company had $41.6 million in nonperforming assets at June 30, 2019 compared with $19.0 million at December 31, 2018. Nonperforming assets were 0.39% of total loans and other real estate at June 30, 2019 compared with 0.18% of total loans and other real estate at December 31, 2018.

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2019

(UNAUDITED)

If interest on nonaccrual loans had been accrued under the original loan terms, approximately $1.2 million and $951 thousand would have been recorded as income for the six months ended June 30, 2019 and 2018, respectively. The Company had $37.3 million in nonaccrual loans at June 30, 2019 compared with $20.4 million at June 30, 2018.

Acquired Loans. Acquired loans were preliminarily recorded at fair value based on a discounted cash flow valuation methodology that considers, among other things, interest rates, projected default rates, loss given default, and recovery rates. During the valuation process, the Company identified Purchased Credit-Impaired (“PCI”) and Non-PCI loans in the acquired loan portfolios. 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. PCI loan identification considers the following factors: payment history and past due status, debt service coverage, loan grading, collateral values and other factors that may indicate deterioration of credit quality since origination. Non-PCI loan identification considers the following factors: account types, remaining terms, annual interest rates or coupons, current market rates, interest types, past delinquencies, timing of principal and interest payments, loan to value ratios, loss exposures and remaining balances. Accretion of purchased discounts on PCI loans will be based on estimated future cash flows, regardless of contractual maturities. Accretion of purchased discounts on Non-PCI loans will be recognized on a level-yield basis based on contractual maturity of individual loans.

PCI Loans. The recorded investment in PCI loans included in the consolidated balance sheet and the related outstanding balance as of the dates indicated are presented in the table below. The outstanding balance represents the total amount owed as of June 30, 2019 and December 31, 2018.

	June 30, 2019			December 31, 2018
	(Dollars in thousands)
PCI loans:
Outstanding balance	$	10,110		$	11,419
Discount		(2,165	)		(2,831	)
Recorded investment	$	7,945		$	8,588

Changes in the accretable yield for acquired PCI loans for the three and six months ended June 30, 2019 and 2018 were as follows:

	Three Months Ended June 30,						Six Months Ended June 30,
	2019			2018			2019			2018
	(Dollars in thousands)
Balance at beginning of period	$	1,234		$	7,685		$	1,534		$	8,121
Reclassifications from nonaccretable		17			55			36			305
Accretion		(347	)		(3,771	)		(666	)		(4,457	)
Balance at June 30,	$	904		$	3,969		$	904		$	3,969

Income recognition on PCI loans is subject to the Company’s ability to reasonably estimate both the timing and amount of future cash flows. PCI loans for which the Company is accruing interest income are not considered non-performing or impaired. The non-accretable difference represents contractual principal and interest the Company does not expect to collect.

Non-PCI Loans. The recorded investment in Non-PCI loans included in the consolidated balance sheet and the related outstanding balance as of the dates indicated are presented in the table below. The outstanding balance represents the total amount owed as of June 30, 2019 and December 31, 2018.

	June 30, 2019			December 31, 2018
	(Dollars in thousands)
Non-PCI loans:
Outstanding balance	$	467,645		$	526,840
Discount		(12,479	)		(14,833	)
Recorded investment	$	455,166		$	512,007

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2019

(UNAUDITED)

Changes in the discount accretion for Non-PCI loans for the three and six months ended June 30, 2019 and 2018 were as follows:

	Three Months Ended June 30,						Six Months Ended June 30,
	2019			2018			2019			2018
	(Dollars in thousands)
Balance at beginning of period	$	13,359		$	18,885		$	14,833		$	20,533
Accretion charge-offs		—			(2	)		—			(10	)
Accretion		(880	)		(1,452	)		(2,354	)		(3,092	)
Balance at June 30,	$	12,479		$	17,431		$	12,479		$	17,431

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.

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2019

(UNAUDITED)

Impaired loans 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 presented in the tables below is reported on a year-to-date basis.

	June 30, 2019
	Recorded Investment		Unpaid Contractual Principal Balance		Related Allowance		Average Recorded Investment
	(Dollars in thousands)
With no related allowance recorded:
Construction, land development and other land loans	$	269	$	270	$	—	$	631
Agriculture and agriculture real estate (includes farmland)		326		326		—		291
1-4 family (includes home equity)		10,035		10,747		—		7,106
Commercial real estate (includes multi-family residential)		3,162		3,341		—		2,945
Commercial and industrial		15,406		17,610		—		9,138
Consumer and other		40		44		—		44
Total		29,238		32,338		—		20,155

With an allowance recorded:
Construction, land development and other land loans		390		390		58		391
Agriculture and agriculture real estate (includes farmland)		290		290		160		145
1-4 family (includes home equity)		5,243		5,272		504		2,754
Commercial real estate (includes multi-family residential)		973		993		283		486
Commercial and industrial		1,155		1,171		329		1,241
Consumer and other		—		—		—		—
Total		8,051		8,116		1,334		5,017

Total:
Construction, land development and other land loans		659		660		58		1,022
Agriculture and agriculture real estate (includes farmland)		616		616		160		436
1-4 family (includes home equity)		15,278		16,019		504		9,860
Commercial real estate (includes multi-family residential)		4,135		4,334		283		3,431
Commercial and industrial		16,561		18,781		329		10,379
Consumer and other		40		44		—		44
	$	37,289	$	40,454	$	1,334	$	25,172

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2019

(UNAUDITED)

	December 31, 2018
	Recorded Investment		Unpaid Contractual Principal Balance		Related Allowance		Average Recorded Investment
	(Dollars in thousands)
With no related allowance recorded:
Construction, land development and other land loans	$	993	$	995	$	—	$	788
Agriculture and agriculture real estate (includes farmland)		256		311		—		194
1-4 family (includes home equity)		4,177		4,903		—		4,048
Commercial real estate (includes multi-family residential)		2,727		2,848		—		2,475
Commercial and industrial		2,870		3,810		—		5,358
Consumer and other		48		76		—		135
Total		11,071		12,943		—		12,998

With an allowance recorded:
Construction, land development and other land loans		391		391		58		195
Agriculture and agriculture real estate (includes farmland)		—		—		—		—
1-4 family (includes home equity)		266		289		56		729
Commercial real estate (includes multi-family residential)		—		—		—		743
Commercial and industrial		1,328		1,332		571		3,740
Consumer and other		—		—		—		—
Total		1,985		2,012		685		5,407

Total:
Construction, land development and other land loans		1,384		1,386		58		983
Agriculture and agriculture real estate (includes farmland)		256		311		—		194
1-4 family (includes home equity)		4,443		5,192		56		4,777
Commercial real estate (includes multi-family residential)		2,727		2,848		—		3,218
Commercial and industrial		4,198		5,142		571		9,098
Consumer and other		48		76		—		135
	$	13,056	$	14,955	$	685	$	18,405

Credit Quality Indicators. As part of the on-going 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:

Grade 1—Credits in this category have risk potential that is virtually nonexistent. These loans may be secured by insured certificates of deposit, insured savings accounts, U.S. Government securities and highly rated municipal bonds.

Grade 2—Credits in this category are of the highest quality. These borrowers represent top rated companies and individuals with unquestionable financial standing with excellent global cash flow coverage, net worth, liquidity and collateral coverage.

Grade 3—Credits in this category are not immune from 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.

Grade 4—Credits in this category are considered to be of acceptable credit quality with moderately greater risk than Grade 3 and receiving closer monitoring. Loans in this category have sources of repayment that remain sufficient to preclude a larger than normal probability of default and secondary sources are likewise currently of sufficient quantity, quality, and liquidity to protect the Company against loss of principal and interest. These borrowers have specific risk factors, but the overall strength of the credit is acceptable based on other mitigating credit and/or collateral factors and can repay the debt in the normal course of business.

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2019

(UNAUDITED)

Grade 5—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. These loans are monitored on the Company’s internally-generated watch list and evaluated on a quarterly basis.

Grade 6—Credits in this category are considered “substandard” but “non-impaired” 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. Loans in this category are still accruing interest and may be dependent upon secondary sources of repayment and/or collateral liquidation.

Grade 7—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 contractual principal and interest will be collected. These loans are individually evaluated for a specific reserve and will typically have the accrual of interest stopped.

Grade 8—Credits in this category include “doubtful” loans in accordance with regulatory guidance. Such loans are no longer accruing interest and factors indicate 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 estimates is collectible.

Grade 9—Credits in this category are deemed a “loss” in accordance with regulatory guidelines and have been charged off or charged down. The Company may continue collection efforts and may have partial recovery in the future.

The following table presents loans by risk grade and category of loan at June 30, 2019. Impaired loans include loans in risk grades 7, 8 and 9, as well as any PCI loan that has a specific reserve allocated to it.

	Construction, Land Development and Other Land Loans		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	$	—	$	14,322	$	—	$	—	$	55,562	$	35,091	$	104,975
Grade 2		1,215		3,877		15,430		21,640		12,312		56,519		110,993
Grade 3		1,587,922		647,171		2,600,773		2,892,964		1,102,365		200,582		9,031,777
Grade 4		136,083		64,025		67,445		557,501		265,415		24,325		1,114,794
Grade 5		5,684		5,091		6,486		56,772		61,476		2,827		138,336
Grade 6		7,315		1,029		3,750		15,719		11,814		1,639		41,266
Grade 7		659		326		15,278		4,135		16,543		40		36,981
Grade 8		—		290		—		—		18		—		308
Grade 9		—		—		—		—		—		—		—
PCI Loans		430		339		4,116		2,937		123		—		7,945
Total	$	1,739,308	$	736,470	$	2,713,278	$	3,551,668	$	1,525,628	$	321,023	$	10,587,375

(1) Includes $20.3 million of residential mortgage loans held for sale at June 30, 2019.

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2019

(UNAUDITED)

The following table presents loans by risk grade and category of loan at December 31, 2018. Impaired loans include loans in risk grades 7, 8 and 9, as well as any PCI loan that has a specific reserve allocated to it.

	Construction, Land Development and Other Land Loans		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	$	—	$	15,725	$	—	$	—	$	59,979	$	37,135	$	112,839
Grade 2		1,040		3,974		21,465		22,207		11,003		55,802		115,491
Grade 3		1,509,532		636,674		2,598,600		2,974,474		1,083,328		171,758		8,974,366
Grade 4		99,087		66,650		61,430		481,735		243,743		20,164		972,809
Grade 5		3,673		5,578		12,522		37,942		58,088		2,978		120,781
Grade 6		7,081		282		4,332		16,006		23,081		1,601		52,383
Grade 7		1,384		256		4,395		2,727		4,165		48		12,975
Grade 8		—		—		48		—		33		—		81
Grade 9		—		—		—		—		—		—		—
PCI Loans		492		362		4,117		3,466		151		—		8,588
Total	$	1,622,289	$	729,501	$	2,706,909	$	3,538,557	$	1,483,571	$	289,486	$	10,370,313

(1) Includes $29.4 million of residential mortgage loans held for sale at December 31, 2018.

Allowance for Credit Losses. The allowance for credit losses is 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 as of June 30, 2019 for estimated losses in the Company’s loan portfolio. The amount of the allowance for credit losses is affected by the following: (1) charge-offs of loans that occur when loans are deemed uncollectible and decrease the allowance, (2) recoveries on loans previously charged off that increase the allowance and (3) 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. Although management believes it uses the best information available to make determinations with respect to the allowance for credit losses, future adjustments may be necessary if economic conditions or the borrower’s performance differ from the assumptions used in making the initial determinations.

The Company’s allowance for credit losses consists of two components: (1) a specific valuation allowance based on probable losses on specifically identified loans and (2) 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 total loan portfolio and assigns risk grades to each loan. 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 certain impaired loans, the Company allocates a specific loan loss reserve primarily based on the value of the collateral securing the impaired loan in accordance with ASC Topic 310-10, “Receivables.” The specific reserves are determined on an individual loan basis. Loans for which specific reserves are provided are excluded from the general valuation allowance described below.

In connection with this 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 real estate 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

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2019

(UNAUDITED)

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, land development and other land 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.

In determining the amount of the general valuation allowance, management considers factors such as historical loan loss experience, 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, other qualitative risk factors both internal and external to the Company and other relevant factors in accordance with ASC Topic 450, “Contingencies.” 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 loan that has a specific reserve allocated to it. The Company uses this information to establish the amount of the general valuation allowance. At June 30, 2019, the allowance for credit losses totaled $87.0 million or 0.82% of total loans, including acquired loans with discounts. At December 31, 2018, the allowance for credit losses totaled $86.4 million or 0.83% of total loans, including acquired loans with discounts.

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2019

(UNAUDITED)

The following table details activity in the allowance for credit losses by category of loan for the three and six months ended June 30, 2019 and 2018. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.


	Construction, Land Development and Other Land Loans			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, 2019	$	16,192		$	3,284		$	14,455		$	11,590		$	39,059		$	1,511		$	86,091
Provision for credit losses		(299	)		578			(61	)		575			(710	)		717			800
Charge-offs		(19	)		(54	)		(16	)		—			(125	)		(905	)		(1,119	)
Recoveries		12			8			5			1			953			255			1,234
Net charge-offs		(7	)		(46	)		(11	)		1			828			(650	)		115
Balance June 30, 2019	$	15,886		$	3,816		$	14,383		$	12,166		$	39,177		$	1,578		$	87,006

Six Months Ended
Balance December 31, 2018	$	15,582		$	3,693		$	14,135		$	11,220		$	40,223		$	1,587		$	86,440
Provision for credit losses		311			(1,109	)		256			944			(155	)		1,253			1,500
Charge-offs		(63	)		(64	)		(22	)		—			(2,082	)		(1,797	)		(4,028	)
Recoveries		56			1,296			14			2			1,191			535			3,094
Net charge-offs		(7	)		1,232			(8	)		2			(891	)		(1,262	)		(934	)
Balance June 30, 2019	$	15,886		$	3,816		$	14,383		$	12,166		$	39,177		$	1,578		$	87,006

Allowance for credit losses:
Three Months Ended
Balance March 31, 2018	$	14,622		$	3,304		$	13,072		$	10,853		$	40,340		$	1,409		$	83,600
Provision for credit losses		(173	)		407			395			749			2,161			461			4,000
Charge-offs		—			—			(120	)		(986	)		(1,194	)		(901	)		(3,201	)
Recoveries		1			45			6			—			147			366			565
Net charge-offs		1			45			(114	)		(986	)		(1,047	)		(535	)		(2,636	)
Balance June 30, 2018	$	14,450		$	3,756		$	13,353		$	10,616		$	41,454		$	1,335		$	84,964

Six Months Ended
Balance December 31, 2017	$	14,815		$	3,772		$	14,490		$	10,628		$	38,810		$	1,526		$	84,041
Provision for credit losses		(243	)		(122	)		(766	)		1,476			11,707			948			13,000
Charge-offs		(130	)		—			(386	)		(1,489	)		(9,370	)		(1,911	)		(13,286	)
Recoveries		8			106			15			1			307			772			1,209
Net charge-offs		(122	)		106			(371	)		(1,488	)		(9,063	)		(1,139	)		(12,077	)
Balance June 30, 2018	$	14,450		$	3,756		$	13,353		$	10,616		$	41,454		$	1,335		$	84,964

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2019

(UNAUDITED)

The following table details the amount of the allowance for credit losses allocated to each category of loan as of June 30, 2019, December 31, 2018 and June 30, 2018, on the basis of the impairment methodology used to determine the allowance for credit losses.

	Construction, Land Development and Other Land Loans		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 related to:
June 30, 2019
Individually evaluated for impairment	$	58	$	160	$	504	$	283	$	329	$	—	$	1,334
Collectively evaluated for impairment		15,828		3,656		13,879		11,883		38,848		1,578		85,672
PCI loans		—		—		—		—		—		—		—
Total allowance for credit losses	$	15,886	$	3,816	$	14,383	$	12,166	$	39,177	$	1,578	$	87,006

December 31, 2018
Individually evaluated for impairment	$	58	$	—	$	56	$	—	$	571	$	—	$	685
Collectively evaluated for impairment		15,524		3,693		14,079		11,220		39,652		1,587		85,755
PCI loans		—		—		—		—		—		—		—
Total allowance for credit losses	$	15,582	$	3,693	$	14,135	$	11,220	$	40,223	$	1,587	$	86,440

June 30, 2018
Individually evaluated for impairment	$	—	$	25	$	61	$	—	$	2,741	$	—	$	2,827
Collectively evaluated for impairment		14,450		3,731		13,292		10,616		38,713		1,335		82,137
PCI loans		—		—		—		—		—		—		—
Total allowance for credit losses	$	14,450	$	3,756	$	13,353	$	10,616	$	41,454	$	1,335	$	84,964

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2019

(UNAUDITED)

The following table details the recorded investment in loans by category of loan on the basis of the impairment methodology used to determine the allowance for credit losses as of June 30, 2019, December 31, 2018 and June 30, 2018, excluding $20.3 million, $29.4 million and $27.8 million, respectively, of residential mortgage loans held for sale.


	Construction, Land Development and Other Land Loans		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)
Recorded investment in loans:
June 30, 2019
Individually evaluated for impairment	$	659	$	616	$	15,278	$	4,135	$	16,561	$	40	$	37,289
Collectively evaluated for impairment		1,738,219		735,515		2,673,569		3,544,596		1,508,944		320,983		10,521,826
PCI loans		430		339		4,116		2,937		123		—		7,945
Total loans evaluated for impairment	$	1,739,308	$	736,470	$	2,692,963	$	3,551,668	$	1,525,628	$	321,023	$	10,567,060

December 31, 2018
Individually evaluated for impairment	$	1,384	$	256	$	4,443	$	2,727	$	4,198	$	48	$	13,056
Collectively evaluated for impairment		1,620,413		728,883		2,668,982		3,532,364		1,479,222		289,438		10,319,302
PCI loans		492		362		4,117		3,466		151		—		8,588
Total loans evaluated for impairment	$	1,622,289	$	729,501	$	2,677,542	$	3,538,557	$	1,483,571	$	289,486	$	10,340,946

June 30, 2018
Individually evaluated for impairment	$	508	$	519	$	4,665	$	2,291	$	12,111	$	81	$	20,175
Collectively evaluated for impairment		1,541,567		708,721		2,658,656		3,398,158		1,508,509		271,643		10,087,254
PCI loans		696		377		4,380		5,017		899		—		11,369
Total loans evaluated for impairment	$	1,542,771	$	709,617	$	2,667,701	$	3,405,466	$	1,521,519	$	271,724	$	10,118,798

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2019

(UNAUDITED)

Troubled Debt Restructurings. The restructuring of a loan is considered a “troubled debt restructuring” if both (1) the borrower is experiencing financial difficulties and (2) 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. Under ASC Topic 310-40 “Receivables—Troubled Debt Restructurings by Creditors,” the Company evaluates all loan modifications to identify whether the restructuring constitutes a troubled debt restructuring. As of June 30, 2019 and 2018, the Company had $14.3 million and $208 thousand, respectively, in outstanding troubled debt restructurings. The following table presents information regarding the recorded investment of loans modified as troubled debt restructurings during the six months ended June 30, 2019 and 2018.

	Six Months Ended
	June 30,
	2019						2018
	Number of Loans		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment		Number of Loans		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
	(Dollars in thousands)
Troubled Debt Restructurings
Construction, land development and other land loans		—	$	—	$	—		—	$	—	$	—
Agriculture and agriculture real estate (includes farmland)		—		—		—		—		—		—
1-4 Family (includes home equity)		—		—		—		—		—		—
Commercial real estate (includes multi-family residential)		—		—		—		—		—		—
Commercial and industrial		1		14,783		14,258		2		198		162
Consumer and other		—		—		—		—		—		—
Total		1	$	14,783	$	14,258		2	$	198	$	162

As of June 30, 2019, there have been no defaults on any loans that were modified as troubled debt restructurings during the preceding twelve months. Default is determined at 90 or more days past due. For the six months ended June 30, 2019, the Company added one loan totaling $14.8 million as a new troubled debt restructuring, of which $14.3 million remained outstanding at June 30, 2019. For the six months ended June 30, 2018, the Company added two loans totaling $198 thousand as new troubled debt restructurings, of which $162 thousand remained outstanding at June 30, 2018. The modifications generally related to extending the amortization periods of the loans, which includes loans modified during bankruptcy. The Company did not grant principal reductions on any restructured loans at the time of modification. These modifications did not have a material impact on the Company’s determination of the allowance for credit losses.

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2019

(UNAUDITED)

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 other assets at fair value on a nonrecurring basis such as certain loans including residential mortgage 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. ASC Topic 820 “Fair Value Measurements and Disclosures” 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. The fair value hierarchy is as follows:

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.

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 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.

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

	As of June 30, 2019
	Level 1		Level 2		Level 3		Total
	(Dollars in thousands)
Assets:
Available for sale securities:
States and political subdivisions	$	—	$	470	$	—	$	470
Collateralized mortgage obligations		—		244,922		—		244,922
Mortgage-backed securities		—		61,385		—		61,385
Total	$	—	$	306,777	$	—	$	306,777

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2019

(UNAUDITED)

	As of December 31, 2018
	Level 1		Level 2		Level 3		Total
	(Dollars in thousands)
Assets:
Available for sale securities:
States and political subdivisions	$	—	$	1,166	$	—	$	1,166
Collateralized mortgage obligations		—		12,756		—		12,756
Mortgage-backed securities		—		70,233		—		70,233
Total	$	—	$	84,155	$	—	$	84,155

Certain assets and 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). These instruments include other real estate owned, repossessed assets, held to maturity debt securities, loans held for sale and impaired loans, which are included as loans held for investment. For the three and six months ended June 30, 2019, the Company had additions to other real estate owned of $569 thousand and $1.9 million, respectively, of which $569 thousand and $1.7 million, respectively, were outstanding as of June 30, 2019. For the three and six months ended June 30, 2019, the Company had additions to impaired loans of $2.1 million and $30.4 million, respectively, of which $2.1 million and $29.0 million, respectively, were outstanding as of June 30, 2019. The remaining financial assets and liabilities measured at fair value on a non-recurring basis that were recorded in 2019 and remained outstanding at June 30, 2019 were not significant.

The following tables present carrying and fair value information of financial instruments as of the dates indicated:

	As of June 30, 2019
	Carrying		Estimated Fair Value
	Amount		Level 1		Level 2		Level 3		Total
Assets	(Dollars in thousands)
Cash and due from banks	$	302,069	$	302,069	$	—	$	—	$	302,069
Federal funds sold		555		555		—		—		555
Held to maturity securities		8,645,163		—		8,656,409		—		8,656,409
Loans held for sale		20,315		—		20,315		—		20,315
Loans held for investment, net of allowance		10,480,054		—		—		10,378,010		10,378,010
Other real estate owned		2,005		—		2,005		—		2,005

Liabilities
Deposits:
Noninterest-bearing	$	5,691,236	$	—	$	5,691,236	$	—	$	5,691,236
Interest-bearing		11,196,393		—		11,188,468		—		11,188,468
Other borrowings		940,874		—		940,915		—		940,915
Securities sold under repurchase agreements		313,825		—		313,821		—		313,821

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2019

(UNAUDITED)

	As of December 31, 2018
	Carrying		Estimated Fair Value
	Amount		Level 1		Level 2		Level 3		Total
Assets	(Dollars in thousands)
Cash and due from banks	$	410,575	$	410,575	$	—	$	—	$	410,575
Federal funds sold		552		552		—		—		552
Held to maturity securities		9,324,811		—		9,081,236		—		9,081,236
Loans held for sale		29,367		—		29,367		—		29,367
Loans held for investment, net of allowance		10,254,506		—		—		10,144,556		10,144,556
Other real estate owned		1,805		—		1,805		—		1,805

Liabilities
Deposits:
Noninterest-bearing	$	5,666,115	$	—	$	5,666,115	$	—	$	5,666,115
Interest-bearing		11,590,443		—		11,564,521		—		11,564,521
Other borrowings		1,031,126		—		1,031,161		—		1,031,161
Securities sold under repurchase agreements		284,720		—		284,685		—		284,685

The following is a description of the fair value estimates, methods and assumptions that are used by the Company in estimating the fair values of financial instruments.

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 held for sale subjected to nonrecurring fair value adjustments as Level 2.

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. The Company refined the calculation to estimate fair value for loans held for investment to be in accordance with ASU 2016-01. The refined discounted cash flow calculation to determine fair value considers internal and market-based information such as prepayment risk, cost of funds and liquidity.

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 Company classifies the estimated fair value of loans held for investment as Level 3.

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.

The fair value estimates presented herein are based on pertinent information available to management at June 30, 2019. 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.

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2019

(UNAUDITED)

7. GOODWILL AND CORE DEPOSIT INTANGIBLES

Changes in the carrying amount of the Company’s goodwill and core deposit intangibles for the six months ended June 30, 2019 and the year ended December 31, 2018 were as follows:

	Goodwill		Core Deposit Intangibles
	(Dollars in thousands)
Balance as of December 31, 2017	$	1,900,845	$	38,842
Less:
Amortization		—		(5,959	)
Balance as of December 31, 2018		1,900,845		32,883
Less:
Amortization		—		(2,584	)
Balance as of June 30, 2019	$	1,900,845	$	30,299

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 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 core deposit intangibles has occurred. If any such impairment is determined, a write-down is recorded. As of June 30, 2019, there was no impairment recorded on goodwill and core deposit intangibles.

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 (1) twelve months from the date of acquisition or (2) as soon as the Company receives the information it was seeking about facts and circumstances that existed as of the date of acquisition.

Core deposit intangibles are being amortized on a non-pro rata basis over their estimated lives, which the Company believes is between 10 and 15 years. Amortization expense related to intangible assets totaled $1.3 million and $1.5 million for the three months ended June 30, 2019 and 2018, respectively, and $2.6 million and $3.1 million for the six months ended June 30, 2019 and 2018, respectively. The estimated aggregate future amortization expense for core deposit intangibles remaining as of June 30, 2019 is as follows (dollars in thousands):

Remaining 2019	$	2,467
2020		4,483
2021		4,022
2022		3,664
2023		3,350
Thereafter		12,313
Total	$	30,299

8. STOCK–BASED COMPENSATION

At June 30, 2019, the Company had one stock-based employee compensation plan with awards outstanding.

During 2012, Bancshares’ Board of Directors established the Prosperity Bancshares, Inc. 2012 Stock Incentive Plan (the “2012 Plan”), which was approved by Bancshares’ shareholders and authorized 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, 2019, a total of 344,500 shares of common stock have been issued pursuant to vested awards and 390,782 shares of unvested restricted stock have been granted under the 2012 Plan.

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2019

(UNAUDITED)

As of June 30, 2019, the Company had no stock options outstanding. Stock-based compensation expense related to restricted stock was $2.3 million and $2.6 million during the three months ended June 30, 2019 and 2018, respectively, and $5.1 million and $5.2 million during the six months ended June 30, 2019 and 2018, respectively. As of June 30, 2019, there was $14.7 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 1.68 years.

9. CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ITEMS

Contractual Obligations

The Company’s contractual obligations and other commitments to make future payments as of June 30, 2019 (other than deposit obligations and securities sold under repurchase agreements) are summarized below.

Federal Home Loan Bank Borrowings

The Company’s future cash payments associated with its contractual obligations pursuant to its Federal Home Loan Bank (“FHLB”) advances and notes payable as of June 30, 2019 are summarized below. Payments for FHLB notes payable include interest of $75 thousand that will be paid over the future periods. The payments do not include pre-payment options that may be available to the Company.

	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)
Federal Home Loan Bank advances and notes payable	$	940,323	$	448	$	125	$	53	$	940,949

Leases

The Company’s leases relate primarily to operating leases for office space and banking centers. The Company determines if an arrangement is a lease or contains a lease at inception. The Company’s leases have remaining lease terms of 1 to 13 years, which may include the option to extend the lease when it is reasonably certain for the Company to exercise that option. Operating lease right-of-use (ROU) assets and liabilities are recognized at the commencement date based on the present value of lease payments over the lease term. The Company uses its incremental collateralized borrowing rate to determine the present value of lease payments. Short-term leases and leases with variable lease costs are immaterial and the Company does not have any sublease arrangements. As of June 30, 2019, operating lease ROU assets and lease liabilities were approximately $15 million. ROU assets and lease liabilities were classified as other assets and other liabilities, respectively.

As of June 30, 2019, the weighted average remaining lease terms of the Company’s operating leases were 5.2 years. The weighted average discount rate used to determine the lease liabilities as of June 30, 2019 for the Company’s operating leases was 3.43%. Cash paid for the Company’s operating leases for the three and six months ended June 30, 2019 was $1.4 million and $2.8 million, respectively.

The Company’s future undiscounted cash payments associated with its operating leases as of June 30, 2019 are summarized below (dollars in thousands).

Remaining 2019	$	2,412
2020		4,158
2021		3,129
2022		2,639
2023		2,066
2024		1,287
Thereafter		4,057
Total undiscounted lease payments	$	19,748

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2019

(UNAUDITED)

The following table presents a summary of non-cancelable future operating lease commitments as of December 31, 2018 (dollars in thousands):

2019	$	4,897
2020		4,088
2021		3,013
2022		2,319
2023		2,025
Thereafter		3,597
Total non-cancelable lease payments	$	19,939

Off-Balance Sheet Items

In the normal course of business, the Company enters into various transactions that, in accordance with GAAP, 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 expiring by period as of June 30, 2019 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	$	59,278	$	6,892	$	1,540	$	—	$	67,710
Commitments to extend credit		1,079,334		423,900		109,412		1,027,608		2,640,254
Total	$	1,138,612	$	430,792	$	110,952	$	1,027,608	$	2,707,964

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2019

(UNAUDITED)

10. OTHER COMPREHENSIVE INCOME

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

	Three Months Ended June 30,
	2019							2018
	Before Tax Amount		Tax Effect			Net of Tax Amount		Before Tax Amount		Tax Effect			Net of Tax Amount
	(Dollars in thousands)
Other comprehensive income:
Securities available for sale:
Change in unrealized gain during period	$	716	$	(150	)	$	566	$	380	$	(80	)	$	300
Total securities available for sale		716		(150	)		566		380		(80	)		300
Total other comprehensive income	$	716	$	(150	)	$	566	$	380	$	(80	)	$	300

	Six Months Ended June 30,
	2019							2018
	Before Tax Amount		Tax Effect			Net of Tax Amount		Before Tax Amount		Tax Effect			Net of Tax Amount
	(Dollars in thousands)
Other comprehensive income:
Securities available for sale:
Change in unrealized gain during period	$	1,219	$	(256	)	$	963	$	580	$	(122	)	$	458
Total securities available for sale		1,219		(256	)		963		580		(122	)		458
Total other comprehensive income	$	1,219	$	(256	)	$	963	$	580	$	(122	)	$	458

Activity in accumulated other comprehensive income associated with securities available for sale, net of tax, was as follows:

	Securities Available for Sale			Accumulated Other Comprehensive Income
	(Dollars in thousands)
Balance at December 31, 2018	$	310		$	310
Other comprehensive income		963			963
Balance at June 30, 2019	$	1,273		$	1,273

Balance at December 31, 2017	$	(113	)	$	(113	)
Other comprehensive income		458			458
Balance at June 30, 2018	$	345		$	345

11. ACQUISITIONS

On June 17, 2019, Bancshares and LegacyTexas Financial Group, Inc. (“LegacyTexas”) jointly announced the signing of a definitive agreement whereby LegacyTexas, the parent company of LegacyTexas Bank, will merge into Bancshares. LegacyTexas Bank operates 42 locations in 19 North Texas cities in and around the Dallas-Fort Worth area. As of June 30, 2019, LegacyTexas, on a consolidated basis, reported total assets of $9.9 billion, total gross loans of $8.7 billion and total deposits of $7.1 billion.

Under the terms of the merger agreement, stockholders of LegacyTexas will receive 0.5280 shares of Bancshares common stock and $6.28 cash for each LegacyTexas share. Consummation of the merger is subject to certain conditions, including the approval by the shareholders of Bancshares and LegacyTexas and customary regulatory approvals. Based on Bancshares’ closing price of $67.24 on June 14, 2019, the total consideration was valued at approximately $2.1 billion, or approximately $41.78 per share. The merger is expected to close during the fourth quarter of 2019, although delays could occur.

ITEM 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Special Cautionary Notice Regarding Forward-Looking Statements

Statements and financial discussion and analysis contained in this quarterly report on Form 10-Q that are not statements of historical fact constitute forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on assumptions and involve a number of risks and uncertainties, many of which are beyond the Company’s control. Forward-looking statements can be identified by words such as “believes,” “intends,” “expects,” “plans,” “will” and similar references to future periods. Many possible events or factors could affect the future financial results and performance of the Company and could cause such results or performance to differ materially from those expressed in the forward-looking statements. These possible events or factors include, but are not limited to:

•

changes in the strength of the United States economy in general and the strength of the local economies in which the Company conducts operations resulting in, among other things, a deterioration in credit quality or reduced demand for credit, including the result and effect on the Company’s loan portfolio and allowance for credit losses;

•

changes in interest rates and market prices, which could reduce the Company’s net interest margins, asset valuations and expense expectations;

•

changes in the levels of loan prepayments and the resulting effects on the value of the Company’s loan portfolio;

•

changes in local economic and business conditions, including commodity prices, which adversely affect the Company’s customers and their ability to transact profitable business with the Company, including the ability of the Company’s borrowers to repay their loans according to their terms or a change in the value of the related collateral;

•

increased competition for deposits and loans adversely affecting rates and terms;

•

the timing, impact and other uncertainties of any future acquisitions, including the pending acquisition of LegacyTexas and the Company’s ability to identify suitable future acquisition candidates, the success or failure in the integration of their operations, and the ability to enter new markets successfully and capitalize on growth opportunities;

•

the possible impairment of goodwill associated with an acquisition and possible adverse short-term effects on the results of operations;

•

increased credit risk in the Company’s assets and increased operating risk caused by a material change in commercial, consumer and/or real estate loans as a percentage of the total loan portfolio;

•

the concentration of the Company’s loan portfolio in loans collateralized by real estate;

•

the failure of assumptions underlying the establishment of and provisions made to the allowance for credit losses;

•

changes in the availability of funds resulting in increased costs or reduced liquidity;

•

a deterioration or downgrade in the credit quality and credit agency ratings of the securities in the Company’s securities portfolio;

•

increased asset levels and changes in the composition of assets and the resulting impact on the Company’s capital levels and regulatory capital ratios;

•

the Company’s ability to acquire, operate and maintain cost effective and efficient systems without incurring unexpectedly difficult or expensive but necessary technological changes;

•

the loss of senior management or operating personnel and the potential inability to hire qualified personnel at reasonable compensation levels;

•

government intervention in the U.S. financial system;

•

changes in statutes and government regulations or their interpretations applicable to financial holding companies and the Company’s present and future banking and other subsidiaries, including changes in tax requirements and tax rates;

•

the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters;

•

poor performance by external vendors;

•

the cost and effects of a failure, interruption, or breach of security of our systems;

•

the failure of analytical and forecasting models and tools used by the Company to estimate probable credit losses and to measure the fair value of financial instruments;

•

additional risks from new lines of businesses or new products and services;

•

claims or litigation related to intellectual property or fiduciary responsibilities;

•

the failure of the Company’s enterprise risk management framework to identify or address risks adequately;

•

a failure in or breach of operational or security systems of the Company’s infrastructure, or those of its third-party vendors and other service providers, including as a result of cyber attacks;

•

potential risk of environmental liability associated with lending activities;

•

acts of terrorism, an outbreak of hostilities or other international or domestic calamities, weather or other acts of God and other matters beyond the Company’s control; and

•

other risks and uncertainties described in the Company’s Annual Report on Form 10-K or in the Company’s other reports and documents filed with the Securities and Exchange Commission.

A forward-looking statement may include a statement of the assumptions or bases underlying the forward-looking statement. The Company believes it has chosen these assumptions or bases in good faith and that they are reasonable. However, the Company cautions that assumptions or bases almost always vary from actual results, and the differences between assumptions or bases and actual results can be material. Therefore, the Company cautions against placing undue reliance on its forward-looking statements. The forward-looking statements speak only as of the date the statements are made. The Company undertakes no obligation to publicly update or otherwise revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Management’s Discussion and Analysis of Financial Condition and Results of Operations analyzes the major elements of the Company’s balance sheets and statements of income. This section should be read in conjunction with the Company’s consolidated financial statements and accompanying notes included elsewhere in this report and with the consolidated financial statements and accompanying notes and other detailed information appearing in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018.

OVERVIEW

Prosperity Bancshares, Inc., a Texas corporation, was formed in 1983 to acquire the former Allied First Bank in Edna, Texas, which was chartered in 1949 as The First National Bank of Edna and is now known as Prosperity Bank. The Company is a registered financial holding company that derives substantially all of its revenues and income from the operation of its bank subsidiary, Prosperity Bank. The Bank provides a wide array of financial products and services to small and medium-sized businesses and consumers. As of June 30, 2019, the Bank operated 243 full-service banking locations; with 65 in the Houston area, including The Woodlands; 30 in the South Texas area including Corpus Christi and Victoria; 33 in the Dallas/Fort Worth area; 22 in the East Texas area; 29 in the Central Texas area including Austin and San Antonio; 34 in the West Texas area including Lubbock, Midland-Odessa and Abilene; 16 in the Bryan/College Station area; 6 in the Central Oklahoma area; and 8 in the Tulsa, Oklahoma area. The Company’s principal executive office is located at Prosperity Bank Plaza, 4295 San Felipe in Houston, Texas, and its telephone number is (281) 269-7199. The Company’s website address is www.prosperitybankusa.com. Information contained on the Company’s website is not incorporated by reference into this quarterly report on Form 10-Q and is not part of this or any other report.

The Company generates the majority of its revenues from interest income on loans, service charges and fees on customer accounts and income from investment in securities. The revenues are partially offset by interest expense paid on deposits and other borrowings and noninterest expenses such as administrative and occupancy expenses. Net interest income is the difference between interest income on earning assets such as loans and securities and interest expense on liabilities such as deposits and borrowings which are used to fund those assets. Net interest income is the Company’s largest source of revenue. The level of interest rates and the volume and mix of earning assets and interest-bearing liabilities impact net interest income and margin.

Three principal components of the Company’s growth strategy are internal growth, efficient operations and acquisitions, including strategic merger transactions. The Company focuses on continual internal growth. The Company maintains separate data with respect to each banking center’s net interest income, efficiency ratio, deposit growth and loan growth for purposes of measuring its overall profitability. Banking center presidents and managers are accountable for performance in these areas and compensated accordingly. The Company also focuses on maintaining efficiency and stringent cost control practices and policies. The Company has centralized many of its critical operations, such as data processing and loan processing. Management believes that this centralized infrastructure can accommodate substantial additional growth and achieve necessary controls while enabling the Company to minimize operational costs through certain economies of scale. The Company also intends to continue to seek expansion

opportunities. On June 17, 2019, Bancshares and LegacyTexas Financial Group, Inc. (“LegacyTexas”) jointly announced the signing of a definitive agreement whereby LegacyTexas, the parent company of LegacyTexas Bank, will merge into Bancshares.

Total assets were $22.38 billion at June 30, 2019 compared with $22.69 billion at December 31, 2018, a decrease of $318.2 million or 1.4%. Total loans were $10.59 billion at June 30, 2019 compared with $10.37 billion at December 31, 2018, an increase of $217.1 million or 2.1%. Total deposits were $16.89 billion at June 30, 2019 compared with $17.26 billion at December 31, 2018, a decrease of $368.9 million or 2.1%. Total shareholders’ equity was $4.13 billion at June 30, 2019 compared with $4.05 billion at December 31, 2018, an increase of $75.1 million or 1.9%.

CRITICAL ACCOUNTING POLICIES

The Company’s significant accounting policies are integral to understanding the results reported. The Company’s accounting policies are described in detail in Note 1 to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018. The Company believes that of its significant accounting policies, the following may involve a higher degree of judgment and complexity:

Allowance for Credit Losses — The allowance for credit losses is established through charges to earnings in the form of a provision for credit losses. The Company’s allowance for credit losses consists of two elements, (1) specific valuation allowances based on probable losses on impaired loans and (2) 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. The allowance for acquired credit losses is calculated as described under the heading “Accounting for Acquired Loans and the Allowance for Acquired Credit Losses” below. Management has established an allowance for credit losses which it believes is adequate for estimated losses in the Company’s loan portfolio. Based on an evaluation of the portfolio, 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. In making its evaluation, management considers factors such as historical loan loss experience, the amount of nonperforming assets and related collateral, the volume, growth and composition of the portfolio, current economic conditions that may affect the borrower’s ability to pay and the value of collateral, the evaluation of the portfolio through its internal loan review process and other relevant factors. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. Charge-offs occur when loans are deemed to be uncollectible. For further discussion of the methodology used in the determination of the allowance for credit losses, see “Financial Condition – Allowance for Credit Losses” below.

Accounting for Acquired Loans and the Allowance for Acquired Credit Losses — The Company accounts for its acquisitions using the acquisition method of accounting. Accordingly, the assets, including loans, and liabilities of the acquired entity were recorded at their fair values at the acquisition date. No allowance for credit losses related to the acquired loans is recorded on the acquisition date, as the fair value of the acquired loans incorporates assumptions regarding credit risk. These fair value estimates associated with acquired loans, and based on a discounted cash flow model, include estimates related to market interest rates and undiscounted projections of future cash flows that incorporate expectations of prepayments and the amount and timing of principal, interest and other cash flows, as well as any shortfalls thereof.

At period-end after acquisition, the fair-valued acquired loans from each acquisition are reassessed to determine whether an addition to the allowance for credit losses is appropriate due to further credit quality deterioration. For further discussion of the methodology used in the determination of the allowance for credit losses for acquired loans, see “Financial Condition – Allowance for Credit Losses” below.

Fair Values of Financial Instruments—The Company determines the fair market values of financial instruments based on the fair value hierarchy established which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. There are three levels of inputs that may be used to measure fair value. Level 1 inputs include quoted active market prices, where available. If such quoted market prices are not available Level 2 inputs are used. These inputs are based upon internally developed analytical tools that primarily use observable market-based parameters. Level 3 inputs are unobservable inputs which are typically based on an entity’s own assumptions, as there is little, if any, related market activity. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

PENDING ACQUISITIONS

On June 17, 2019, Bancshares and LegacyTexas jointly announced the signing of a definitive agreement whereby LegacyTexas, the parent company of LegacyTexas Bank, will merge into Bancshares. LegacyTexas Bank operates 42 locations in 19 North Texas cities in and around the Dallas-Fort Worth area. As of June 30, 2019, LegacyTexas, on a consolidated basis, reported total assets of $9.9 billion, total gross loans of $8.7 billion and total deposits of $7.1 billion.

RESULTS OF OPERATIONS

Net income available to common shareholders was $82.3 million for the quarter ended June 30, 2019 compared with $81.6 million for the same period in 2018, an increase of $661 thousand or 0.8%. Net income per diluted common share was $1.18 for the quarter ended June 30, 2019 compared with $1.17 for the same period in 2018, an increase of 0.9%. The Company posted annualized returns on average common equity of 7.92% and 8.33%, annualized returns on average assets of 1.46% and 1.44% and efficiency ratios of 43.74% and 43.95% for the quarters ended June 30, 2019 and 2018, respectively. The efficiency ratio is calculated by dividing total non-interest expense by the sum of net interest income and non-interest income. Because the ratio is a measure of revenues and expenses resulting from our lending activities and fee-based banking services, net gains and losses on the sale of assets and securities are not included. Additionally, taxes are not part of this calculation.

For the six months ended June 30, 2019, net income available to common shareholders was $164.7 million compared with $156.0 million for the same period in 2018, an increase of $8.7 million or 5.6%. Net income per diluted common share was $2.36 for the six months ended June 30, 2019 compared with $2.23 for the same period in 2018, an increase of 5.8%. Net income and earnings per diluted common share for the six months ended June 30, 2018 were impacted by significant charge-offs during the first quarter of 2018. The Company posted annualized returns on average common equity of 7.99% and 8.01%, annualized returns on average assets of 1.46% and 1.38% and efficiency ratios of 43.34% and 44.07% for the six months ended June 30, 2019 and 2018, respectively.

Net Interest Income

The Company’s net interest income is affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities, referred to as a “volume change.” It is also affected by changes in yields earned on interest-earning assets and rates paid on interest-bearing deposits and other borrowed funds, referred to as a “rate change.”

For the Three Months Ended June 30, 2019

Net interest income before the provision for credit losses was $154.8 million for the quarter ended June 30, 2019, a decrease of $7.0 million or 4.3%, compared with $161.8 million for the same period in 2018. This change was primarily due to lower loan discount accretion for the second quarter of 2019 and the collection of previously identified troubled assets during the second quarter of 2018.

Interest income on loans was $133.5 million for the quarter ended June 30, 2019, an increase of $5.1 million or 4.0%, compared with $128.4 million for the same period in 2018. This increase was primarily due to higher average loans and higher loan rates, partially offset by a decrease in loan discount accretion for the second quarter of 2019 and the collection of previously identified troubled assets during the second quarter of 2018.

Interest income on securities was $53.9 million for the quarter ended June 30, 2019, a decrease of $1.6 million or 2.9%, compared with $55.6 million for the same period in 2018. This decrease was primarily due to lower average securities, partially offset by higher yields.

Average interest-bearing liabilities were $12.59 billion for the quarter ended June 30, 2019, a decrease of $388.5 million or 3.0%, compared with $12.98 billion for the same period in 2018. The net interest margin on a tax-equivalent basis decreased from 3.28% for the quarter ended June 30, 2018 to 3.16% for the quarter ended June 30, 2019. This change was primarily due to lower loan discount accretion for the second quarter of 2019 and the collection of previously identified troubled assets during the second quarter of 2018.

For the Six Months Ended June 30, 2019

Net interest income before the provision for credit losses was $309.7 million for the six months ended June 30, 2019, a decrease of $5.3 million or 1.7%, compared with $315.0 million for the same period in 2018. This change was primarily due to higher rates on deposits and lower loan discount accretion, partially offset by higher balances and yields on loans. Additionally, net interest income for the six months ended June 30, 2018 was positively impacted by the collection of previously identified troubled assets.

Interest income on loans was $263.6 million for the six months ended June 30, 2019, an increase of $18.9 million or 7.7%, compared with $244.7 million for the same period in 2018. This increase was primarily due to higher average loans and higher loan rates, partially offset by lower loan discount accretion. Additionally, loan interest income for the six months ended June 30, 2018 was positively impacted by the collection of previously identified troubled assets. The Company had $14.6 million of total outstanding discounts on acquired loans, of which $13.4 million was accretable at June 30, 2019.

Interest income on securities was $109.6 million for the six months ended June 30, 2019, a decrease of $442 thousand or 0.4%, compared with $110.0 million for the same period in 2018.

Average interest-bearing liabilities were $12.70 billion for the six months ended June 30, 2019, a decrease of $342.9 million or 2.6%, compared with $13.04 billion for the same period in 2018. The net interest margin on a tax-equivalent basis decreased from 3.22% for the six months ended June 30, 2018 to 3.18% for the six months ended June 30, 2019. This change was primarily due to lower loan discount accretion for the six months ended June 30, 2019 and the collection of previously identified troubled assets during the six months ended June 30, 2018.

The following tables present, for the periods indicated, the total dollar amount of average balances, interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities and the resultant rates. Except as indicated in the footnotes, no tax-equivalent adjustments were made and all average balances are daily average balances. Any nonaccruing loans have been included in the table as loans carrying a zero yield.

	Three Months Ended June 30,
	2019								2018
	Average Outstanding Balance			Interest Earned/Paid		Average Yield/Rate ⁽¹⁾			Average Outstanding Balance			Interest Earned/Paid		Average Yield/Rate ⁽¹⁾
	(Dollars in thousands)
Assets
Interest-Earning Assets:
Loans	$	10,520,425		$	133,525		5.09	%	$	10,044,064		$	128,445		5.13	%
Investment securities		9,185,877			53,944		2.36	%		9,770,963			55,577		2.28	%
Federal funds sold and other earning assets		64,335			318		1.98	%		79,947			299		1.50	%
Total interest-earning assets		19,770,637			187,787		3.81	%		19,894,974			184,321		3.72	%
Allowance for credit losses		(86,158	)							(84,285	)
Noninterest-earning assets		2,842,478								2,809,197
Total assets	$	22,526,957							$	22,619,886

Liabilities and Shareholders' Equity
Interest-Bearing Liabilities:
Interest-bearing demand deposits	$	3,714,968		$	5,813		0.63	%	$	3,971,356		$	4,983		0.50	%
Savings and money market deposits		5,647,494			12,722		0.90	%		5,342,323			6,709		0.50	%
Certificates and other time deposits		2,057,033			8,027		1.57	%		2,094,065			4,369		0.84	%
Other borrowings		883,557			5,556		2.52	%		1,272,032			6,046		1.91	%
Securities sold under repurchase agreements		288,666			831		1.15	%		300,471			411		0.55	%
Total interest-bearing liabilities		12,591,718			32,949		1.05	%		12,980,247			22,518		0.70	%
Noninterest-Bearing Liabilities:
Noninterest-bearing demand deposits		5,674,615								5,646,114
Other liabilities		108,246								75,161
Total liabilities		18,374,579								18,701,522
Shareholders' equity		4,152,378								3,918,364
Total liabilities and shareholders' equity	$	22,526,957							$	22,619,886

Net interest rate spread							2.76	%							3.02	%

Net interest income and margin ^{(2) (3)}				$	154,838		3.14	%				$	161,803		3.26	%

Net interest income and margin (tax equivalent) ⁽⁴⁾				$	155,665		3.16	%				$	162,706		3.28	%

______________

(1) Annualized and based on average balances on an actual 365-day basis for the three months ended June 30, 2019 and 2018.

(2) Yield is based on amortized cost and does not include any component of unrealized gains or losses.

(3) The net interest margin is equal to net interest income divided by average interest-earning assets.

(4) In order to make pretax income and resultant yields on tax-exempt investments and loans comparable to those on taxable investments and loans, a tax-equivalent adjustment has been computed using a federal income tax rate of 21%.

	Six Months Ended June 30,
	2019								2018
	Average Outstanding Balance			Interest Earned/Paid		Average Yield/Rate ⁽¹⁾			Average Outstanding Balance			Interest Earned/Paid		Average Yield/Rate ⁽¹⁾
	(Dollars in thousands)
Assets
Interest-Earning Assets:
Loans	$	10,456,684		$	263,590		5.08	%	$	10,017,340		$	244,691		4.93	%
Investment securities		9,242,605			109,592		2.39	%		9,756,861			110,034		2.27	%
Federal funds sold and other earning assets		68,068			720		2.13	%		80,858			614		1.53	%
Total interest-earning assets		19,767,357		$	373,902		3.81	%		19,855,059		$	355,339		3.61	%
Allowance for credit losses		(86,332	)							(83,140	)
Noninterest-earning assets		2,853,199								2,816,449
Total assets	$	22,534,224							$	22,588,368

Liabilities and Shareholders' Equity
Interest-Bearing Liabilities:
Interest-bearing demand deposits	$	3,930,475		$	12,625		0.65	%	$	4,180,631		$	10,046		0.48	%
Savings and money market deposits		5,560,625			23,906		0.87	%		5,409,991			11,951		0.45	%
Certificates and other time deposits		2,059,877			15,159		1.48	%		2,131,301			8,536		0.81	%
Other borrowings		864,322			10,873		2.54	%		1,003,259			9,019		1.81	%
Securities sold under repurchase agreements		280,692			1,590		1.14	%		313,730			761		0.49	%
Total interest-bearing liabilities		12,695,991			64,153		1.02	%		13,038,912			40,313		0.62	%
Noninterest-Bearing Liabilities:
Noninterest-bearing demand deposits		5,616,541								5,578,592
Other liabilities		97,610								78,270
Total liabilities		18,410,142								18,695,774
Shareholders' equity		4,124,082								3,892,594
Total liabilities and shareholders' equity	$	22,534,224							$	22,588,368

Net interest rate spread							2.79	%							2.99	%

Net interest income and margin ^{(2) (3)}				$	309,749		3.16	%				$	315,026		3.20	%

Net interest income and margin (tax equivalent) ⁽⁴⁾				$	311,439		3.18	%				$	316,870		3.22	%

____________

(1) Annualized and based on average balances on an actual 365-day basis for the six months ended June 30, 2019 and 2018.

(2) Yield is based on amortized cost and does not include any component of unrealized gains or losses.

(3) The net interest margin is equal to net interest income divided by average interest-earning assets.

The following table presents information regarding the dollar amount of changes in interest income and interest expense for the periods indicated for each major component of interest-earning assets and interest-bearing liabilities and distinguishes between the changes attributable to changes in volume and changes in interest rates. For purposes of this table, changes attributable to both rate and volume which cannot be segregated have been allocated to rate.

	Three Months Ended June 30,									Six Months Ended June 30,
	2019 vs. 2018									2019 vs. 2018
	Increase									Increase
	(Decrease)									(Decrease)
	Due to Change in									Due to Change in
	Volume			Rate			Total			Volume			Rate			Total
	(Dollars in thousands)
Interest-Earning Assets:
Loans ⁽¹⁾	$	6,092		$	(1,012	)	$	5,080		$	10,732		$	8,167		$	18,899
Investment securities ⁽¹⁾		(3,328	)		1,695			(1,633	)		(5,800	)		5,358			(442	)
Federal funds sold and other earning assets		(58	)		77			19			(97	)		203			106
Total increase in interest income		2,706			760			3,466			4,835			13,728			18,563

Interest-Bearing Liabilities:
Interest-bearing demand deposits		(322	)		1,152			830			(601	)		3,180			2,579
Savings and money market deposits		383			5,630			6,013			333			11,622			11,955
Certificates and other time deposits ⁽¹⁾		(77	)		3,735			3,658			(286	)		6,909			6,623
Other borrowings		(1,847	)		1,357			(490	)		(1,249	)		3,103			1,854
Securities sold under repurchase agreements		(16	)		436			420			(80	)		909			829
Total (decrease) increase in interest expense		(1,879	)		12,310			10,431			(1,883	)		25,723			23,840
Increase (decrease) in net interest income	$	4,585		$	(11,550	)	$	(6,965	)	$	6,718		$	(11,995	)	$	(5,277	)

______________

(1) Includes impact of purchase accounting adjustments.

Provision for Credit Losses

Management actively monitors the Company’s asset quality and provides specific loss provisions when necessary. Provisions for credit losses are charged to income to bring the total allowance for credit losses to a level deemed appropriate by management of the Company based on such factors as historical credit loss experience, the amount of nonperforming loans and related collateral, the volume growth and composition of the loan portfolio, current economic conditions that may affect the borrower’s ability to pay and the value of collateral, the evaluation of the loan portfolio through the internal loan review process and other relevant factors.

Loans are charged off against the allowance for credit losses when appropriate. Although management believes it uses the best information available to make determinations with respect to the provision for credit losses, future adjustments may be necessary if economic conditions differ from the assumptions used in making the initial determinations.

The Company recorded an $800 thousand provision for credit losses for the quarter ended June 30, 2019 and a $4.0 million provision for credit losses for the quarter ended June 30, 2018. Net recoveries were $115 thousand for the quarter ended June 30, 2019 compared with net charge-offs of $2.6 million for the quarter ended June 30, 2018. The Company made a $1.5 million provision for credit losses for the six months ended June 30, 2019 and a $13.0 million provision for credit losses for the six months ended June 30, 2018. Net charge-offs were $934 thousand for the six months ended June 30, 2019 compared with $12.1 million for the six months ended June 30, 2018. See "Financial Condition – Allowance for Credit Losses" below for more information.

Noninterest Income

The Company’s primary sources of recurring noninterest income are nonsufficient funds (“NSF”) fees, credit, debit and ATM card income and service charges on deposit accounts. Additionally, the Company generates recurring noninterest income from its trust, mortgage and brokerage lines of business. Noninterest income does not include loan origination fees which are recognized over the life of the related loan as an adjustment to yield using the interest method. Noninterest income totaled $30.0 million for the three months ended June 30, 2019 compared with $28.4 million for the same period in 2018, an increase of $1.6 million or 5.6%. Noninterest income totaled $58.1 million for the six months ended June 30, 2019 compared with $56.3 million for the same period in 2018, an increase of $1.8 million or 3.2%. The change during both periods was primarily due to an increase in other noninterest income.

The following table presents, for the periods indicated, the major categories of noninterest income:

	Three Months Ended June 30,					Six Months Ended June 30,
	2019		2018			2019		2018
	(Dollars in thousands)
Nonsufficient funds (NSF) fees	$	7,973	$	7,828		$	15,789	$	15,655
Credit card, debit card and ATM card income		6,480		6,335			12,451		12,296
Service charges on deposit accounts		4,989		5,150			9,987		10,425
Trust income		2,558		2,251			5,153		4,979
Mortgage income		990		1,109			1,712		1,872
Brokerage income		541		687			1,214		1,312
Bank owned life insurance income		1,321		1,317			2,610		2,628
Net gain (loss) on sale of assets		2		(44	)		60		(44	)
Net loss on sale of securities		—		(13	)		—		(13	)
Other		5,104		3,751			9,126		7,199
Total noninterest income	$	29,958	$	28,371		$	58,102	$	56,309

Noninterest Expense

Noninterest expense totaled $80.8 million for the quarter ended June 30, 2019 compared with $83.6 million for the quarter ended June 30, 2018, a decrease of $2.8 million or 3.3%. Noninterest expense totaled $159.4 million for the six months ended June 30, 2019 compared with $163.7 million for the six months ended June 30, 2018, a decrease of $4.3 million or 2.6%. The change during both periods was primarily due to decreases in regulatory assessments and FDIC insurance and in other noninterest expense.

The following table presents, for the periods indicated, the major categories of noninterest expense:

	Three Months Ended June 30,				Six Months Ended June 30,
	2019		2018		2019			2018
	(Dollars in thousands)
Salaries and employee benefits ⁽¹⁾	$	52,941	$	53,360	$	104,014		$	103,759
Non-staff expenses:
Net occupancy and equipment		5,492		5,692		10,958			11,301
Credit and debit card, data processing and software amortization		4,904		4,356		9,477			8,804
Regulatory assessments and FDIC insurance		2,325		3,575		4,699			7,150
Core deposit intangibles amortization		1,265		1,501		2,584			3,069
Depreciation		3,111		3,054		6,215			6,087
Communications ⁽²⁾		2,183		2,606		4,453			5,186
Other real estate expense, net ⁽³⁾		66		93		(28	)		304
Other		8,534		9,365		17,020			17,996
Total noninterest expense	$	80,821	$	83,602	$	159,392		$	163,656

(1) Includes stock-based compensation expense of $2.3 million and $2.6 million for the three months ended June 30, 2019 and 2018, respectively, and $5.1 million and $5.2 million for the six months ended June 30, 2019 and 2018, respectively.

(2) Communications expense includes telephone, data circuits, postage and courier expenses.

(3) Other real estate expense is net of rental income and gains and losses on sales of real estate.

Income Taxes

Income tax expense totaled $20.9 million for the three months ended June 30, 2019 compared with $21.0 million for the same period in 2018, a decrease of $58 thousand or 0.3%. Income tax expense totaled $42.3 million for the six months ended June 30, 2019 compared with $38.7 million for the same period in 2018, an increase of $3.6 million or 9.2%. This increase was due to higher pre-tax net earnings for the six months ended June 30, 2019. The Company’s effective tax rate for the three months ended June 30, 2019 and 2018 was 20.3% and 20.4%, respectively. The Company’s effective tax rate for the six months ended June 30, 2019 and 2018 was 20.4% and 19.9%, respectively.

FINANCIAL CONDITION

Loan Portfolio

The Company separates its loan portfolio into two general categories of loans: (1) “legacy loans,” which are loans originated by Prosperity Bank and made pursuant to the Company’s loan policy and procedures in effect at the time the loan was made, and (2) “acquired loans,” which are loans acquired in a business combination and preliminarily recorded at fair value at acquisition date. Those acquired loans that are renewed or substantially modified after the date of the business combination, thereby subjecting them to the Company’s allowance for credit losses methodology, are referred to as “acquired legacy loans.” If a renewal or substantial modification of an acquired loan is underwritten by the Company with a new credit analysis, the loan may no longer be categorized as an acquired loan. For example, acquired loans to one borrower may be combined into a new loan with a new loan number and categorized as a legacy loan. Acquired loans with a fair value discount or premium at the date of the business combination that remained at the reporting date are referred to as “fair-valued acquired loans.” All fair-valued acquired loans are further categorized into “PCI loans” (purchased credit-impaired loans) and “Non-PCI loans.” Acquired loans with evidence of credit quality deterioration at acquisition for which it is probable that the Company would not be able to collect all contractual amounts due are PCI loans.

The following tables summarize the Company’s legacy and acquired loan portfolios broken out into legacy loans, acquired legacy loans, Non-PCI loans and PCI loans, as of the dates indicated.

	June 30, 2019
			Acquired Loans
	Legacy Loans		Acquired Legacy Loans		Non-PCI Loans		PCI Loans		Total Loans
	(Dollars in thousands)
Residential mortgage loans held for sale	$	20,315	$	—	$	—	$	—	$	20,315
Commercial and industrial		1,348,545		149,089		27,871		123		1,525,628
Real estate:
Construction, land development and other land loans		1,711,630		15,096		12,152		430		1,739,308
1-4 family residential (includes home equity)		2,491,571		65,291		131,985		4,116		2,692,963
Commercial real estate (includes multi-family residential)		3,083,000		235,088		230,643		2,937		3,551,668
Farmland		484,784		12,071		44,275		339		541,469
Agriculture		157,163		37,786		52		—		195,001
Consumer and other		293,610		19,225		8,188		—		321,023
Total loans held for investment		9,570,303		533,646		455,166		7,945		10,567,060
Total	$	9,590,618	$	533,646	$	455,166	$	7,945	$	10,587,375

	December 31, 2018
			Acquired Loans
	Legacy Loans		Acquired Legacy Loans		Non-PCI Loans		PCI Loans		Total Loans
	(Dollars in thousands)
Residential mortgage loans held for sale	$	29,367	$	—	$	—	$	—	$	29,367
Commercial and industrial		1,281,069		170,221		32,130		151		1,483,571
Real estate:
Construction, land development and other land loans		1,595,052		11,101		15,644		492		1,622,289
1-4 family residential (includes home equity)		2,446,160		73,809		153,456		4,117		2,677,542
Commercial real estate (includes multi-family residential)		3,003,176		276,849		255,066		3,466		3,538,557
Farmland		485,101		13,431		46,479		362		545,373
Agriculture		139,849		44,208		71		—		184,128
Consumer and other		257,484		22,841		9,161		—		289,486
Total loans held for investment		9,207,891		612,460		512,007		8,588		10,340,946
Total	$	9,237,258	$	612,460	$	512,007	$	8,588	$	10,370,313

At June 30, 2019, total loans were $10.59 billion, an increase of $217.1 million or 2.1%, compared with $10.37 billion at December 31, 2018. Loans at June 30, 2019 included $20.3 million of loans held for sale compared with $29.4 million at December 31, 2018. At June 30, 2019, loans represented 47.3% of total assets compared with 45.7% of total assets at December 31, 2018.

The loan portfolio consists of various types of loans categorized by major type as follows:

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

Included in commercial and industrial loans are (1) commitments to oil and gas producers secured by proven, developed and producing reserves and (2) commitments to service, equipment and midstream companies secured mainly by accounts receivable, inventory and equipment. Mineral reserve values supporting commitments to producers are normally re-determined semi-annually using reserve studies prepared by a third-party or the Company’s oil and gas engineer. Accounts receivable and inventory borrowing bases for service companies are typically re-determined monthly. Funding requests by both producers and service companies are monitored relative to the most recently determined borrowing base. As of June 30, 2019, oil and gas loans totaled $367.0 million or 3.5% of total loans, compared with total oil and gas loans of $372.5 million or 3.6% of total loans as of December 31, 2018. In addition, as of June 30, 2019, the Company had total unfunded commitments to oil and gas companies of $220.4 million compared with total unfunded commitments to oil and gas companies of $238.5 million as of December 31, 2018. Total unfunded commitments to producers include letters of credit issued in lieu of oil well plugging bonds.

(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.

(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 and nonowner-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 mortgage department also offers a variety of mortgage loan products which are generally amortized over 30 years, including FHA and VA loans. The Company sells these longer-term loans into the secondary market.

(iv) Construction, Land Development and Other Land Loans. The Company makes loans to finance the construction of residential and 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, the Company may not 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. Although the Company has underwriting procedures designed to identify what it believes to be acceptable levels of risks in construction lending, these procedures may not prevent losses from the risks described above.

(v) Agriculture Loans. The Company provides agriculture loans for short-term beef and 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.

Nonperforming Assets

Nonperforming assets include loans on nonaccrual status, accruing loans 90 days or more past due, repossessed assets and real estate which has been acquired through foreclosure and is awaiting disposition. Nonperforming assets do not include PCI loans unless the timing and amount of projected cash flows can no longer be reasonably estimated. PCI loans become subject to the Company's allowance for credit losses methodology when a deterioration in projected cash flows is identified.

Nonperforming assets increased $22.6 million, or 119.2%, to $41.6 million at June 30, 2019 compared with $19.0 million at December 31, 2018, of which $3.3 million and $4.7 million, respectively, were attributable to acquired loans. The increase in nonperforming assets was primarily due to a commercial and industrial loan and a 1-4 family residential loan being placed on nonaccrual during the six months ended June 30, 2019.

The following tables present information regarding nonperforming assets differentiated among legacy loans, acquired legacy loans, Non-PCI loans and PCI loans, as of the dates indicated:

	June 30, 2019
				Acquired Loans
	Legacy Loans			Acquired Legacy Loans			Non-PCI Loans			PCI Loans		Total
	(Dollars in thousands)
Nonaccrual loans ⁽¹⁾	$	34,092		$	1,138		$	2,059		$	—	$	37,289
Accruing loans 90 or more days past due		1,594			—			—			—		1,594
Total nonperforming loans		35,686			1,138			2,059			—		38,883
Repossessed assets		650			—			20			—		670
Other real estate		1,970			—			35			—		2,005
Total nonperforming assets	$	38,306		$	1,138		$	2,114		$	—	$	41,558

Nonperforming assets to total loans and other real estate by category		0.40	%		0.21	%		0.46	%	—			0.39	%

	December 31, 2018
				Acquired Loans
	Legacy Loans			Acquired Legacy Loans			Non-PCI Loans			PCI Loans			Total
	(Dollars in thousands)
Nonaccrual loans ⁽¹⁾	$	9,177		$	1,737		$	2,214		$	19		$	13,147
Accruing loans 90 or more days past due		3,783			221			—			—			4,004
Total nonperforming loans		12,960			1,958			2,214			19			17,151
Repossessed assets		—			—			—			—			—
Other real estate		1,315			455			35			—			1,805
Total nonperforming assets	$	14,275		$	2,413		$	2,249		$	19		$	18,956

Nonperforming assets to total loans and other real estate by category		0.15	%		0.39	%		0.44	%		0.22	%		0.18	%

(1) Includes troubled debt restructurings of $14.3 million and $51 thousand as of June 30, 2019 and December 31, 2018, respectively.

Nonperforming assets were 0.39% of total loans and other real estate at June 30, 2019 compared with 0.18% of total loans and other real estate at December 31, 2018. The allowance for credit losses as a percentage of total nonperforming loans was 223.8% at June 30, 2019 and 504.0% at December 31, 2018.

Allowance for Credit Losses

The allowance for credit losses is established through charges to earnings in the form of a provision for credit losses. The amount of the allowance for credit losses is affected by the following: (1) charge-offs of loans that occur when loans are deemed uncollectible and decrease the allowance, (2) recoveries on loans previously charged off that increase the allowance and (3) 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. Although management believes it uses the best information available to make determinations with respect to the allowance for credit losses, future adjustments may be necessary if economic conditions or the borrower’s performance differ from the assumptions used in making the initial determinations.

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 total loan portfolio and assigns risk grades to each loan. 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 certain impaired loans, the Company allocates a specific loan loss reserve primarily based on the value of the collateral securing the impaired loan. The specific reserves are determined on an individual loan basis. Loans for which specific reserves are provided 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, 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 loan that has a specific reserve allocated to it. The Company uses this information to establish the amount of the general valuation allowance.

A change in the allowance for credit losses can be attributable to several factors, most notably (1) specific reserves identified for impaired loans, (2) historical credit loss information, (3) changes in environmental factors and (4) growth in the balance of legacy loans and the re-categorization of fair-valued acquired loans to acquired legacy loans, which subjects such loans to the allowance methodology.

Changes in the Company’s asset quality are reflected in the allowance in several ways. Specific reserves that are calculated on a loan-by-loan basis and the qualitative assessment of all other loans reflect current changes in the credit quality of the loan portfolio. Historical credit losses, on the other hand, are based on a three-year look back period, which are then applied to estimate current credit losses inherent in the loan portfolio. A deterioration in the credit quality of the loan portfolio in the current period would increase the historical credit loss factor to be applied in future periods, just as an improvement in credit quality would decrease the historical credit loss factor.

The allowance for credit losses is further determined by the size of the loan portfolio subject to the allowance methodology and environmental factors that include Company-specific risk indicators and general economic conditions, both of which are constantly changing. The Company evaluates the economic and portfolio-specific factors on a quarterly basis to determine a qualitative component of the general valuation allowance. The factors include economic metrics, business conditions, delinquency trends, credit concentrations, nature and volume of the portfolio and other adjustments for items not covered by specific reserves and historical loss experience. Management’s assessment of qualitative factors is a statistically based approach to determine the inherent probable loss associated with such factors. Based on the Company’s actual historical loan loss experience relative to economic and loan portfolio-specific factors at the time the losses occurred, management is able to identify the probable level of incurred losses as of the date of measurement. The correlation of historical loss experience with current economic conditions provides an estimate of inherent and probable losses that has not been previously factored into the general valuation allowance by the determination of specific reserves and recent historical losses. Additionally, the Company considers qualitative factors not easily quantified and the possibility of model imprecision.

Utilizing the aggregation of specific reserves, historical loss experience and a qualitative component, management is able to determine the valuation allowance to reflect the full inherent probable loss.

In determining the allowance for credit losses, management also considers the type of loan (legacy or acquired) and the credit quality of the loan. The Company distinguishes between legacy loans and acquired legacy loans, which are accounted for under the contractual yield method, and fair-valued acquired loans consisting of Non-PCI loans and PCI loans, which are accounted for as purchased loans.

Loans acquired in business combinations are initially recorded at fair value, which includes an estimate of inherent credit losses expected to be realized over the remaining lives of the loans, and therefore no corresponding allowance for credit losses is recorded for these loans at acquisition. When a fair-valued acquired loan is renewed at its maturity date, the loan is re-categorized as an acquired legacy loan. When a fair-valued acquired loan is modified after acquisition, the loan is independently evaluated subsequent to the modification decision to determine whether the modification was substantial, and therefore, requires that the loan be re-categorized as an acquired legacy loan. This determination is based on a discounted cash-flow analysis. Generally, when a change in discounted cash-flow of greater than 10% is identified, the fair-valued acquired loan becomes categorized as an acquired legacy loan. If and when a fair-valued acquired loan becomes an acquired legacy loan, the acquired legacy loan is evaluated at the time of renewal or modification in accordance with the Company’s allowance for credit losses methodology described above.

Non-PCI loans that were not deemed impaired subsequent to the acquisition date are considered non-impaired and are evaluated as part of the general valuation allowance. Non-PCI loans that have not become impaired subsequent to acquisition are segregated into a pool for each acquisition for allowance calculation purposes. For each pool, the Company estimates a hypothetical allowance for credit losses also referred to as an “indicated reserve” that is calculated in accordance with GAAP requirements. The Company uses the acquired bank’s past loss history adjusted for qualitative factors to establish the indicated reserve. The indicated reserve for each pool of Non-PCI loans is compared with the remaining discount for the respective pool to test for credit quality deterioration and the possible need for a loan loss provision. To the extent the remaining discount of the pool is greater than the indicated reserve, no additional allowance is necessary. If the remaining discount of the pool is less than the indicated reserve, the difference results in an increase to the allowance recorded through a provision for credit losses.

Non-PCI loans that have deteriorated to an impaired status subsequent to acquisition are evaluated for a specific reserve on a quarterly basis which, when identified, is added to the allowance for credit losses. The Company reviews impaired Non-PCI loans on a loan-by-loan basis and determines the specific reserve based on the difference between the recorded investment in the loan and one of three factors: expected future cash flows, observable market price or fair value of the collateral. Because essentially all of the Company’s impaired Non-PCI loans have been collateral-dependent, the amount of the specific reserve historically has been determined by comparing the fair value of the collateral securing the Non-PCI loan with the recorded investment in such loan. In the future, the Company will continue to analyze impaired Non-PCI loans on a loan-by-loan basis and may use an alternative measurement method to determine the specific reserve, as appropriate and in accordance with applicable accounting standards.

PCI loans are individually monitored on a quarterly basis to assess for deterioration subsequent to acquisition and are only subject to the Company’s allowance methodology when a deterioration in projected cash flows is identified. If a deterioration in projected cash flows is identified, an additional provision for credit losses is made. PCI loans were recorded at their acquisition date fair values, which were based on expected cash flows and included estimates of expected future credit losses. The Company’s estimates of loan fair values at the acquisition date may be adjusted for a period of up to one year as the Company continues to evaluate its estimate of expected future cash flows at the acquisition date. If the Company determines that losses arose after the acquisition date, the additional losses will be reflected as a provision for credit losses. An allowance for credit losses is not calculated for PCI loans that have not experienced deterioration subsequent to the acquisition date. See “Critical Accounting Policies” above for more information.

As described in the section captioned “Critical Accounting Policies” above, the Company’s determination of the allowance for credit losses involves a high degree of judgment and complexity. The Company’s analysis of qualitative, or environmental, factors on pools of loans with common risk characteristics, in combination with the quantitative historical loss information and specific reserves, provides the Company with an estimate of inherent losses. The allowance must reflect changes in the balance of loans subject to the allowance methodology, as well as the estimated imminent losses associated with those loans.

The following tables present, as of and for the periods indicated, information regarding the allowance for credit losses differentiated between legacy loans and acquired loans. Reported net charge-offs may include those from Non-PCI loans and PCI loans, but only if the total charge-off required is greater than the remaining discount.

	As of and for the Six Months Ended June 30, 2019
	Legacy			Acquired
	Loans			Loans			Total
	(Dollars in thousands)
Average loans outstanding	$	9,388,230		$	1,068,454		$	10,456,684
Gross loans outstanding at end of period	$	9,590,618		$	996,757		$	10,587,375
Allowance for credit losses at beginning of period	$	78,956		$	7,484		$	86,440
Provision for credit losses		3,206			(1,706	)		1,500
Charge-offs:
Commercial and industrial		(2,077	)		(5	)		(2,082	)
Real estate and agriculture		(130	)		(19	)		(149	)
Consumer and other		(1,776	)		(21	)		(1,797	)
Recoveries:
Commercial and industrial		755			436			1,191
Real estate and agriculture		1,357			11			1,368
Consumer and other		521			14			535
Net charge-offs		(1,350	)		416			(934	)
Allowance for credit losses at end of period	$	80,812		$	6,194		$	87,006
Ratio of allowance to end of period loans		0.84	%		0.62	%		0.82	%
Ratio of net charge-offs (recoveries) to average loans (annualized)		0.03	%		(0.08	%)		0.02	%
Ratio of allowance to end of period nonperforming loans		226.5	%		193.7	%		223.8	%

	As of and for the Six Months Ended June 30, 2018
	Legacy			Acquired
	Loans			Loans			Total
	(Dollars in thousands)
Average loans outstanding	$	8,655,398		$	1,361,942		$	10,017,340
Gross loans outstanding at end of period	$	8,874,629		$	1,271,936		$	10,146,565
Allowance for credit losses at beginning of period	$	73,407		$	10,634		$	84,041
Provision for credit losses		13,571			(571	)		13,000
Charge-offs:
Commercial and industrial		(8,148	)		(1,222	)		(9,370	)
Real estate and agriculture		(1,630	)		(375	)		(2,005	)
Consumer and other		(1,882	)		(29	)		(1,911	)
Recoveries:
Commercial and industrial		74			233			307
Real estate and agriculture		123			7			130
Consumer and other		767			5			772
Net charge-offs		(10,696	)		(1,381	)		(12,077	)
Allowance for credit losses at end of period	$	76,282		$	8,682		$	84,964
Ratio of allowance to end of period loans		0.86	%		0.68	%		0.84	%
Ratio of net charge-offs to average loans (annualized)		0.25	%		0.20	%		0.24	%
Ratio of allowance to end of period nonperforming loans		601.7	%		101.0	%		399.5	%

The Company had gross charge-offs on legacy loans of $4.0 million during the six months ended June 30, 2019. Partially offsetting these charge-offs were recoveries on legacy loans of $2.6 million. Gross charge-offs on acquired loans were $45 thousand during the six months ended June 30, 2019. Offsetting these charge-offs were recoveries on acquired loans of $461 thousand. Total charge-offs for the six months ended June 30, 2019 were $4.0 million, partially offset by total recoveries of $3.1 million.

The following tables show the allocation of the allowance for credit losses among various categories of loans disaggregated between legacy loans, acquired legacy loans, Non-PCI loans and PCI loans at the dates indicated. The allocation is made for analytical purposes and is not necessarily indicative of the categories in which future losses may occur. The total allowance is available to absorb losses from any loan category, regardless of whether allocated to a legacy loan or an acquired loan.

	June 30, 2019
			Acquired Loans
	Legacy Loans		Acquired Legacy Loans		Non-PCI Loans		PCI Loans		Total Allowance		Percent of Loans to Total Loans
	(Dollars in thousands)
Balance of allowance for credit losses applicable to:
Commercial and industrial	$	34,975	$	4,202	$	—	$	—	$	39,177		14.4	%
Real estate		41,154		1,278		3		—		42,435		75.6	%
Agriculture and agriculture real estate		3,125		691		—		—		3,816		7.0	%
Consumer and other		1,558		20		—		—		1,578		3.0	%
Total allowance for credit losses	$	80,812	$	6,191	$	3	$	—	$	87,006		100.0	%

	December 31, 2018
			Acquired Loans
	Legacy Loans		Acquired Legacy Loans		Non-PCI Loans		PCI Loans		Total Allowance		Percent of Loans to Total Loans
	(Dollars in thousands)
Balance of allowance for credit losses applicable to:
Commercial and industrial	$	35,088	$	5,135	$	—	$	—	$	40,223		14.3	%
Real estate		39,475		1,453		9		—		40,937		75.9	%
Agriculture and agriculture real estate		2,828		865		—		—		3,693		7.0	%
Consumer and other		1,565		22		—		—		1,587		2.8	%
Total allowance for credit losses	$	78,956	$	7,475	$	9	$	—	$	86,440		100.0	%

At June 30, 2019, the allowance for credit losses totaled $87.0 million compared with $86.4 million at December 31, 2018, an increase of $566 thousand or 0.7%. The allowance for credit losses totaled 0.82% of total loans at June 30, 2019 and 0.83% of total loans at December 31, 2018.

At June 30, 2019, $80.8 million of the allowance for credit losses was attributable to legacy loans, an increase of $1.9 million or 2.4% compared with $79.0 million of the allowance at December 31, 2018. This change was primarily attributable to increases in the legacy loan balance and specific reserves identified for loans with deteriorated credit quality. At June 30, 2019, $6.2 million of the allowance for credit losses was attributable to acquired legacy loans compared with $7.5 million of the allowance at December 31, 2018, a decrease of $1.3 million or 17.2%. This change was primarily attributable to decreases in acquired legacy loan balances and specific reserves identified for loans with deteriorated credit quality, partially offset by higher historical loss rates. At June 30, 2019, $3 thousand of the allowance for credit losses was attributable to Non-PCI loans compared with $9 thousand of the allowance at December 31, 2018, a decrease of $6 thousand or 66.7%. At June 30, 2019 and December 31, 2018, there was no allowance for credit losses attributable to PCI loans.

At June 30, 2019, the Company had $14.6 million of total outstanding discounts on Non-PCI and PCI loans, of which $13.4 million was accretable.

The Company believes that the allowance for credit losses at June 30, 2019 is adequate to cover estimated losses in the loan portfolio as of such date. Nevertheless, the Company could sustain losses in future periods which could be substantial in relation to the size of the allowance at June 30, 2019.

Securities

The carrying cost of securities totaled $8.95 billion at June 30, 2019 compared with $9.41 billion at December 31, 2018, a decrease of $457.0 million or 4.9%. At June 30, 2019, securities represented 40.0% of total assets compared with 41.5% of total assets at December 31, 2018.

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

	June 30, 2019
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(Dollars in thousands)
Available for Sale
States and political subdivisions	$	469	$	1	$	—		$	470
Collateralized mortgage obligations		244,256		796		(130	)		244,922
Mortgage-backed securities		60,441		946		(2	)		61,385
Total	$	305,166	$	1,743	$	(132	)	$	306,777
Held to Maturity
U.S. Treasury securities and obligations of U.S. Government agencies	$	22,867	$	43	$	(3	)	$	22,907
States and political subdivisions		215,871		6,088		(144	)		221,815
Collateralized mortgage obligations		462		5		(1	)		466
Mortgage-backed securities		8,405,963		50,480		(45,222	)		8,411,221
Total	$	8,645,163	$	56,616	$	(45,370	)	$	8,656,409

	December 31, 2018
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(Dollars in thousands)
Available for Sale
States and political subdivisions	$	1,159	$	7	$	—		$	1,166
Collateralized mortgage obligations		12,724		69		(37	)		12,756
Mortgage-backed securities		69,880		553		(200	)		70,233
Total	$	83,763	$	629	$	(237	)	$	84,155
Held to Maturity
U.S. Treasury securities and obligations of U.S. Government agencies	$	25,778	$	—	$	(100	)	$	25,678
States and political subdivisions		253,198		3,440		(777	)		255,861
Collateralized mortgage obligations		509		1		(2	)		508
Mortgage-backed securities		9,045,326		5,798		(251,935	)		8,799,189
Total	$	9,324,811	$	9,239	$	(252,814	)	$	9,081,236

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. 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.

Management has the ability and intent to hold the securities classified as held-to-maturity until they mature, at which time the Company will receive full value for the securities. Furthermore, as of June 30, 2019, management does not have the intent to sell any of the securities classified as available for sale before a recovery of cost. In addition, management believes it is more likely than not that the Company will not be required to sell any of its investment 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, 2019, management believes any impairment in the Company’s securities is temporary, and therefore no impairment loss has been realized in the Company’s consolidated statements of income.

Deposits

Total deposits were $16.89 billion at June 30, 2019 compared with $17.26 billion at December 31, 2018, a decrease of $368.9 million or 2.1%. At June 30, 2019, noninterest-bearing deposits totaled $5.69 billion, an increase of $25.1 million or 0.4% compared with $5.67 billion at December 31, 2018. Interest-bearing deposits totaled $11.20 billion at June 30, 2019 compared with $11.59 billion at December 31, 2018, a decrease of $394.0 million or 3.4%.

Average deposits for the six months ended June 30, 2019 were $17.17 billion, a decrease of $133.0 million or 0.8%, compared with $17.30 billion for the six months ended June 30, 2018. This change was primarily due to a decrease in municipal account balances. The ratio of average interest-bearing deposits to total average deposits was 67.3% during the first six months of 2019 compared with 67.8% during the first six months of 2018.

The following table summarizes the daily average balances and weighted average rates paid on deposits for the periods indicated below:

	Six Months Ended June 30,
	2019					2018
	Average Balance		Average Rate ⁽¹⁾			Average Balance		Average Rate ⁽¹⁾
	(Dollars in thousands)
Interest-bearing demand deposits	$	3,930,475		0.65	%	$	4,180,631		0.48	%
Regular savings		2,253,843		0.45	%		2,299,185		0.33	%
Money market savings		3,306,782		1.15	%		3,110,806		0.53	%
Certificates, IRAs and other time deposits		2,059,877		1.48	%		2,131,301		0.81	%
Total interest-bearing deposits		11,550,977		0.90	%		11,721,923		0.53	%
Noninterest-bearing demand deposits		5,616,541					5,578,592
Total deposits	$	17,167,518		0.61	%	$	17,300,515		0.36	%

(1) Annualized and based on average balances on an actual 365-day basis for the six months ended June 30, 2019 and 2018.

Other Borrowings

The following table presents the Company’s borrowings as of the dates indicated:

	June 30, 2019		December 31, 2018
	(Dollars in thousands)
FHLB advances	$	940,000	$	1,030,000
FHLB long-term notes payable		874		1,126
Total other borrowings		940,874		1,031,126
Securities sold under repurchase agreements		313,825		284,720
Total	$	1,254,699	$	1,315,846

FHLB advances and long-term notes payable— The Company has an available line of credit with the FHLB of Dallas, which allows the Company to borrow on a collateralized basis. The Company’s FHLB advances are typically considered short-term borrowings and are used to manage liquidity as needed. Maturing advances are replaced by drawing on available cash, making additional borrowings or through increased customer deposits. At June 30, 2019, the Company had total funds of $6.55 billion available under this line. FHLB advances of $940 million were outstanding at June 30, 2019, at a weighted average rate of 2.37%. Long-term notes payable were $874 thousand at June 30, 2019, with a weighted average rate of 4.81%. The maturity dates on the FHLB notes payable range from the years 2020 to 2027 and have interest rates ranging from 4.54% to 5.23%.

Securities sold under repurchase agreements— At June 30, 2019, the Company had $313.8 million in securities sold under repurchase agreements with banking customers compared with $284.7 million at December 31, 2018, an increase of $29.1 million or 10.2%. Repurchase agreements are generally settled on the following business day; however, approximately $7.4 million of the repurchase agreements outstanding at June 30, 2019 have maturity dates ranging from 6 to 24 months. All securities sold under repurchase agreements are collateralized by certain pledged securities.

Liquidity

Liquidity involves the Company’s ability to raise funds to support asset growth or reduce assets to meet deposit withdrawals and other payment obligations, to maintain reserve requirements and otherwise to operate the Company on an ongoing basis. The Company’s largest source of funds is deposits and its largest use of funds is loans. The Company does not expect a change in the source or use of its funds in the future. Although access to purchased funds from correspondent banks is available and has been utilized on occasion to take advantage of investment opportunities, the Company does not generally rely on this external funding source. The cash and federal funds sold position, supplemented by amortizing investment and loan portfolios, has generally created an adequate liquidity position.

As of June 30, 2019, the Company had outstanding $2.64 billion in commitments to extend credit and $67.7 million in commitments associated with outstanding standby letters of credit. Since commitments associated with letters of credit and commitments to extend credit may expire unused, the total outstanding may not necessarily reflect the actual future cash funding requirements.

The Company has no exposure to future cash requirements associated with known uncertainties or capital expenditures of a material nature.

Asset liquidity is provided by cash and assets which are readily marketable or which will mature in the near future. As of June 30, 2019, the Company had cash and cash equivalents of $302.6 million compared with $411.1 million at December 31, 2018, a decrease of $108.5 million or 26.4%. The decrease was primarily due to the net decrease in interest-bearing deposits of $394.1 million and the net increase in loans held for investment of $226.7 million, partially offset by the net proceeds on investment securities of $444.0 million.

Share Repurchases

In January 2018, the Bancshares Board of Directors authorized a stock repurchase program under which Bancshares may repurchase up to 5%, or approximately 3.47 million shares, of its outstanding common stock over a two-year period expiring on January 16, 2020, at the discretion of management. Repurchases under this program may be made from time to time in open market transactions, and pursuant to any trading plan that may be adopted in accordance with Rule 10b5-1 of the Securities Exchange Act of 1934, as amended (“Exchange Act”). In June 2019, the Bancshares Board of Directors authorized Bancshares to repurchase shares of its outstanding common stock outside the safe harbor provided by Rule 10b-18 of the Exchange Act prior to the time that a joint proxy statement/prospectus is sent to the shareholders of LegacyTexas and Bancshares seeking their vote on the approval of the merger of LegacyTexas into Bancshares, and after completion of such votes. The timing and actual number of shares repurchased will depend on a variety of factors including price, corporate and regulatory requirements, market conditions, and other corporate liquidity requirements and priorities. Shares of stock repurchased are held as authorized but unissued shares. Bancshares is not obligated to purchase any particular number of shares, and may suspend, modify or terminate the program at any time and for any reason, without prior notice. During the second quarter of 2019, Bancshares repurchased 818.6 thousand shares of its common stock at an average weighted price of $64.52 per share (including 219.8 thousand shares purchased for which the settlement occurred in July 2019.)

Contractual Obligations

Federal Home Loan Bank Borrowings

The Company’s future cash payments associated with its contractual obligations pursuant to its FHLB borrowings as of June 30, 2019 are summarized below. Payments for FHLB borrowings include interest of $75 thousand that will be paid over the future periods. The payments do not include pre-payment options that may be available to the Company.

	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)
Federal Home Loan Bank advances and notes payable	$	940,323	$	448	$	125	$	53	$	940,949

Leases

The Company’s future undiscounted cash payments associated with its operating leases as of June 30, 2019 are summarized below (dollars in thousands).

Remaining 2019	$	2,412
2020		4,158
2021		3,129
2022		2,639
2023		2,066
2024		1,287
Thereafter		4,057
Total undiscounted lease payments	$	19,748

The following table presents a summary of non-cancelable future operating lease commitments as of December 31, 2018 (dollars in thousands):

2019	$	4,897
2020		4,088
2021		3,013
2022		2,319
2023		2,025
Thereafter		3,597
Total non-cancelable lease payments	$	19,939

Off-Balance Sheet Items

	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	$	59,278	$	6,892	$	1,540	$	—	$	67,710
Commitments to extend credit		1,079,334		423,900		109,412		1,027,608		2,640,254
Total	$	1,138,612	$	430,792	$	110,952	$	1,027,608	$	2,707,964

Capital Resources

Total shareholders’ equity was $4.13 billion at June 30, 2019 compared with $4.05 billion at December 31, 2018, an increase of $75.1 million or 1.9%. The increase was primarily the result of net income of $164.7 million, partially offset by dividend payments of $57.3 million for the six months ended June 30, 2019

The Basel III Capital Rules adopted by the federal regulatory authorities in 2013 substantially revised the risk-based capital requirements applicable to the Company and the Bank. The Basel III Capital Rules became effective for the Company on January 1, 2015, subject to a phase-in period for certain provisions. The Basel III Capital Rules require a capital conservation buffer with respect to each of the Common Equity Tier 1, Tier 1 risk-based and total risk-based capital ratios, which provides for capital levels that exceed the minimum risk-based capital adequacy requirements. The capital conservation buffer of 2.5% was fully phased-in on January 1, 2019. A financial institution with a conservation buffer of less than the required amount will be subject to limitations on capital distributions, including dividend payments and stock repurchases, and certain discretionary bonus payments to executive officers.

Financial institutions are categorized by the FDIC based on minimum Common Equity Tier 1, Tier 1 risk-based, total risk-based and Tier 1 leverage ratios. As of June 30, 2019, the Bank’s capital ratios were above the levels required for the Bank to be designated as “well capitalized.”

The following table provides a comparison of the Company’s and the Bank’s risk-weighted and leverage capital ratios to the minimum and well-capitalized regulatory standards as of June 30, 2019:

	Minimum Required For Capital Adequacy Purposes				Minimum Required Plus Capital Conservation Buffer			To Be Categorized As Well Capitalized Under Prompt Corrective Action Provisions			Actual Ratio as of June 30, 2019
The Company
CET1 capital (to risk weighted assets)		4.50	%			7.00	%	N/A				16.59	%
Tier 1 capital (to risk weighted assets)		6.00	%			8.50	%	N/A				16.59	%
Total capital (to risk weighted assets)		8.00	%			10.50	%	N/A				17.25	%
Tier 1 capital (to average assets)		4.00	%	⁽¹⁾		4.00	%	N/A				10.67	%

The Bank
CET1 capital (to risk weighted assets)		4.50	%			7.00	%		6.50	%		16.49	%
Tier 1 capital (to risk weighted assets)		6.00	%			8.50	%		8.00	%		16.49	%
Total capital (to risk weighted assets)		8.00	%			10.50	%		10.00	%		17.15	%
Tier 1 capital (to average assets)		4.00	%	⁽²⁾		4.00	%		5.00	%		10.60	%

(1) The Federal Reserve Board may require the Company to maintain a leverage ratio above the required minimum.

(2) The FDIC may require the Bank to maintain a leverage ratio above the required minimum.

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company manages market risk, which for the Company is primarily interest rate risk, through its Asset Liability Committee consisting of senior officers of the Company, in accordance with policies approved by the Company’s Board of Directors.

The Company uses simulation analysis to examine the potential effects of market changes on net interest income and market value. The Company considers macroeconomic variables, Company strategy, liquidity and other factors as it quantifies market risk. See Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Interest Rate Sensitivity and Liquidity” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018, filed on February 27, 2019 (the “2018 Form 10-K”), for further discussion. There have been no material changes in the Company’s market risk exposures that would affect the quantitative and qualitative disclosures from those disclosed in the 2018 Form 10-K and presented as of December 31, 2018.

ITEM 4.

CONTROLS AND PROCEDURES

Evaluation of disclosure controls and procedures. As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of its management, including its Chief Executive Officer and Interim Chief Financial Officer, of the effectiveness of the design and operation of its disclosure controls and procedures. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management was

required to apply judgment in evaluating its controls and procedures. Based on this evaluation, the Company’s Chief Executive Officer and Interim Chief Financial Officer concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) were effective as of the end of the period covered by this report.

Changes in internal control over financial reporting. There were no changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended June 30, 2019 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II—OTHER INFORMATION

ITEM 1.

LEGAL PROCEEDINGS

The Company and the Bank are defendants, from time to time, in legal actions arising from transactions conducted in the ordinary course of business. After consultations with legal counsel, the Company and the Bank believe that the ultimate liability, if any, arising from such actions will not have a material adverse effect on their financial statements.

ITEM 1A.

RISK FACTORS

There have been no material changes in the Company’s risk factors from those disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018.

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

a. None.

b. None.

c. The following table details the Company’s repurchases of shares of its common stock during the three months ended June 30, 2019:

Period	Total Number of Shares Purchased		Weighted Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Program		Maximum Number of Shares That May Yet Be Purchased Under the Plan at the End of the Period ⁽²⁾
April 1 - April 30, 2019		—	$	—		—		3,474,496
May 1 - May 31, 2019		—		—		—		3,474,496
June 1 - June 30, 2019 ⁽¹⁾		818,641		64.52		818,641		2,655,855
Total		818,641	$	64.52		818,641

(1)	Includes 219,813 shares purchased for which the settlement occurred in July 2019.

(2)

On January 19, 2018, the Company announced a stock repurchase program that authorized the repurchase of up to 5%, or approximately 3.47 million shares, of the Company’s outstanding common stock over a two-year period expiring on January 16, 2020, at the discretion of management. Under the stock repurchase program, the Company could repurchase shares from time to time at prevailing market prices, through open-market purchases or privately negotiated transactions, depending upon market conditions. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Financial Condition—Share Repurchases” for additional information.

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4.

MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5.

OTHER INFORMATION

None.

ITEM 6.

EXHIBITS

Exhibit Number			Description of Exhibit

2.1			Agreement and Plan of Reorganization, dated as of June 16, 2019, by and between Prosperity Bancshares, Inc. and LegacyTexas Financial Group, Inc. (incorporated herein by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed on June 17, 2019)

3.1			Amended and Restated Articles of Incorporation of Prosperity Bancshares, Inc. (incorporated herein by reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-1 (Registration No. 333-63267) (the “Registration Statement”))

3.2			Articles of Amendment to Amended and Restated Articles of Incorporation of Prosperity Bancshares, Inc. (incorporated herein by reference to Exhibit 3.2 to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2006)

3.3			Amended and Restated Bylaws of Prosperity Bancshares, Inc. (incorporated herein by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on June 20, 2019)

4.1			Form of certificate representing shares of the Company’s common stock (incorporated herein by reference to Exhibit 4 to the Registration Statement)

10.1			Executive Employment Agreement, dated as of June 16, 2019, by and among Prosperity Bank, LegacyTexas Bank and Kevin J. Hanigan (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on June 20, 2019)

10.2			Executive Employment Agreement, dated as of June 16, 2019, by and among Prosperity Bank, LegacyTexas Bank and J. Mays Davenport (incorporated herein by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on June 20, 2019)

10.3			Form of Director Support Agreement by and among Prosperity Bancshares, Inc., LegacyTexas Financial Group, Inc., LegacyTexas Bank and each of the non-employee directors of LegacyTexas Financial Group, Inc. and LegacyTexas Bank (incorporated herein by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed on June 20, 2019)

31.1*			Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended

31.2*			Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended

32.1**			Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2**			Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

101.INS			XBRL Instance Document – The instance document does not appear in the interactive data file because its XBRL tags are embedded within the Inline XBRL document

101.SCH*			Inline XBRL Taxonomy Extension Schema Document

101.CAL*			Inline XBRL Taxonomy Extension Calculation Linkbase Document

101.LAB*			Inline XBRL Taxonomy Extension Label Linkbase Document

101.PRE*			Inline XBRL Taxonomy Extension Presentation Linkbase Document

101.DEF*			Inline XBRL Taxonomy Extension Definition Linkbase Document

104			The cover page from the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2019 (formatted as Inline XBRL and contained in Exhibits 101)

*	Filed with this Quarterly Report on Form 10-Q.

**	Furnished with this Quarterly Report on Form 10-Q.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		PROSPERITY BANCSHARES, INC. ^® (Registrant)

Date: 08/02/19		/S/ DAVID ZALMAN
		David Zalman
		Chairman and Chief Executive Officer

Date: 08/02/19		/S/ ASYLBEK OSMONOV
		Asylbek Osmonov
		Chief Financial Officer