Prosperity Bancshares 10Q 2023 Q3 Quarterly report

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 September 30, 2023

☐ 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 “large accelerated filer”, “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 October 30, 2023, there were 93,714,954 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 September 30, 2023 (unaudited) and December 31, 2022	3
	Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2023 and 2022 (unaudited)	4
	Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2023 and 2022 (unaudited)	5
	Consolidated Statements of Changes in Shareholders’ Equity for the Three and Nine Months Ended September 30, 2023 and 2022 (unaudited)	6
	Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2023 and 2022 (unaudited)	7
	Notes to Consolidated Financial Statements (unaudited)	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	33
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	59
Item 4.	Controls and Procedures	59

PART II—OTHER INFORMATION

Item 1.	Legal Proceedings	60
Item 1A.	Risk Factors	60
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	60
Item 3.	Defaults Upon Senior Securities	60
Item 4.	Mine Safety Disclosures	60
Item 5.	Other Information	60
Item 6.	Exhibits	61
Signatures		62

PART I—FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS


	September 30,			December 31,
	2023			2022
	(unaudited)
	(Dollars in thousands, except par value)
ASSETS
Cash and due from banks	$	512,239		$	423,832
Federal funds sold		234			301
Total cash and cash equivalents		512,473			424,133
Available for sale securities, at fair value		446,165			456,502
Held to maturity securities, at cost (fair value of $10,834,219 and $12,387,125, respectively)		12,746,577			14,019,503
Total securities		13,192,742			14,476,005
Loans held for sale		10,187			554
Loans held for investment		20,510,199			18,098,653
Loans held for investment - Warehouse Purchase Program		912,327			740,620
Total loans		21,432,713			18,839,827
Less: allowance for credit losses on loans		(351,495	)		(281,576	)
Loans, net		21,081,218			18,558,251
Accrued interest receivable		97,006			88,438
Goodwill		3,396,459			3,231,636
Core deposit intangibles, net		67,553			51,348
Bank premises and equipment, net		370,237			339,453
Other real estate owned		9,320			1,963
Bank owned life insurance (BOLI)		379,498			327,439
Federal Home Loan Bank of Dallas stock		69,541			90,025
Other assets		119,637			101,138
TOTAL ASSETS	$	39,295,684		$	37,689,829
LIABILITIES AND SHAREHOLDERS’ EQUITY
LIABILITIES:
Deposits:
Noninterest-bearing	$	10,281,893		$	10,915,448
Interest-bearing		17,030,907			17,618,083
Total deposits		27,312,800			28,533,531
Other borrowings		4,250,000			1,850,000
Securities sold under repurchase agreements		300,714			428,134
Subordinated debentures		—			—
Accrued interest payable		79,561			4,495
Allowance for credit losses on off-balance sheet credit exposures		36,503			29,947
Other liabilities		283,429			144,348
Total liabilities		32,263,007			30,990,455
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; 93,717,454 issued and outstanding at September 30, 2023; 91,313,615 shares issued and outstanding at December 31, 2022		93,718			91,314
Capital surplus		3,700,675			3,541,924
Retained earnings		3,240,214			3,069,609
Accumulated other comprehensive loss —net unrealized loss on available for sale securities, net of tax benefit of $(513) and $(923), respectively		(1,930	)		(3,473	)
Total shareholders’ equity		7,032,677			6,699,374
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	39,295,684		$	37,689,829

See notes to consolidated financial statements.

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)


	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2023			2022			2023			2022
	(Dollars in thousands, except per share data)
INTEREST INCOME:
Loans, including fees	$	308,678		$	210,268		$	842,434		$	596,063
Securities		69,987			68,761			215,225			187,883
Federal funds sold and other earning assets		1,689			525			10,452			2,297
Total interest income		380,354			279,554			1,068,111			786,243
INTEREST EXPENSE:
Deposits		76,069			14,669			187,376			32,064
Other borrowings		62,190			3,719			153,937			4,169
Securities sold under repurchase agreements		2,533			487			7,310			916
Subordinated debentures		38			—			38			—
Total interest expense		140,830			18,875			348,661			37,149
NET INTEREST INCOME		239,524			260,679			719,450			749,094
PROVISION FOR CREDIT LOSSES		—			—			18,540			—
NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES		239,524			260,679			700,910			749,094
NONINTEREST INCOME:
Nonsufficient funds (NSF) fees		8,719			8,887			25,326			25,495
Credit card, debit card and ATM card income		9,285			8,889			27,157			25,948
Service charges on deposit accounts		6,262			6,222			18,266			18,798
Trust income		3,326			3,174			9,909			8,752
Mortgage income		857			340			1,756			1,297
Brokerage income		1,067			940			3,216			2,749
Net (loss) gain on sale or write-down of assets		(45	)		50			2,070			1,847
Other		9,272			6,186			28,997			22,518
Total noninterest income		38,743			34,688			116,697			107,404
NONINTEREST EXPENSE:
Salaries and employee benefits		85,423			79,578			247,944			239,360
Net occupancy and equipment		9,464			8,412			26,424			24,299
Credit and debit card, data processing and software amortization		10,919			9,516			30,829			27,611
Regulatory assessments and FDIC insurance		5,155			2,807			15,225			8,508
Core deposit intangibles amortization		3,576			2,577			9,117			7,778
Depreciation		4,585			4,436			13,676			13,522
Communications		3,686			3,374			10,841			9,499
Net other real estate income		(581	)		(15	)		(1,033	)		(213	)
Merger related expenses		1,104			—			14,855			—
Other		12,326			11,529			36,649			34,578
Total noninterest expense		135,657			122,214			404,527			364,942
INCOME BEFORE INCOME TAXES		142,610			173,153			413,080			491,556
PROVISION FOR INCOME TAXES		30,402			37,333			89,240			104,920
NET INCOME	$	112,208		$	135,820		$	323,840		$	386,636
EARNINGS PER SHARE:
Basic	$	1.20		$	1.49		$	3.50		$	4.22
Diluted	$	1.20		$	1.49		$	3.50		$	4.22

See notes to consolidated financial statements.

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(UNAUDITED)


	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2023			2022			2023			2022
	(Dollars in thousands)
Net income	$	112,208		$	135,820		$	323,840		$	386,636
Other comprehensive income (loss), before tax:
Securities available for sale:
Change in unrealized income (loss) during the period		951			(1,813	)		1,953			(2,587	)
Total other comprehensive income (loss)		951			(1,813	)		1,953			(2,587	)
Deferred tax (expense) benefit related to other comprehensive income (loss)		(200	)		380			(410	)		543
Other comprehensive income (loss), net of tax		751			(1,433	)		1,543			(2,044	)
Comprehensive income	$	112,959		$	134,387		$	325,383		$	384,592

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 (Loss)			Equity
	(In thousands, except share and per share data)
Three Months Ended
BALANCE AT JUNE 30, 2023		93,721,454		$	93,722		$	3,697,524		$	3,179,551		$	(2,681	)	$	6,968,116
Net income											112,208						112,208
Other comprehensive income														751			751
Common stock issued in connection with the issuance (forfeiture) of restricted stock awards, net		(4,000	)		(4	)		4									—
Stock based compensation expense								3,147									3,147
Cash dividends declared, $0.55 per share											(51,545	)					(51,545	)
BALANCE AT SEPTEMBER 30, 2023		93,717,454		$	93,718		$	3,700,675		$	3,240,214		$	(1,930	)	$	7,032,677

Nine Months Ended
BALANCE AT DECEMBER 31, 2022		91,313,615		$	91,314		$	3,541,924		$	3,069,609		$	(3,473	)	$	6,699,374
Net income											323,840						323,840
Other comprehensive income														1,543			1,543
Common stock issued in connection with the issuance of restricted stock awards, net		27,200			27			(27	)								—
Common stock issued in connection with the acquisition of First Bancshares of Texas, Inc.		3,582,675			3,583			220,764									224,347
Common stock repurchase		(1,206,036	)		(1,206	)		(71,042	)								(72,248	)
Stock based compensation expense								9,056									9,056
Cash dividends declared, $1.65 per share											(153,235	)					(153,235	)
BALANCE AT SEPTEMBER 30, 2023		93,717,454		$	93,718		$	3,700,675		$	3,240,214		$	(1,930	)	$	7,032,677


													Accumulated
													Other			Total
	Common Stock						Capital			Retained			Comprehensive			Shareholders’
	Shares			Amount			Surplus			Earnings			Income (Loss)			Equity
	(In thousands, except share and per share data)
Three Months Ended
BALANCE AT JUNE 30, 2022		91,195,646		$	91,196		$	3,535,877		$	2,893,556		$	1,198		$	6,521,827
Net income											135,820						135,820
Other comprehensive loss														(1,433	)		(1,433	)
Common stock issued in connection with the issuance of restricted stock awards, net		14,650			15			(15	)								—
Stock based compensation expense								2,857									2,857
Cash dividends declared, $0.52 per share											(47,429	)					(47,429	)
BALANCE AT SEPTEMBER 30, 2022		91,210,296		$	91,211		$	3,538,719		$	2,981,947		$	(235	)	$	6,611,642

Nine Months Ended
BALANCE AT DECEMBER 31, 2021		92,170,480		$	92,171		$	3,595,023		$	2,738,233		$	1,809		$	6,427,236
Net income											386,636						386,636
Other comprehensive loss														(2,044	)		(2,044	)
Common stock issued in connection with the issuance of restricted stock awards, net		21,700			22			(22	)								—
Common stock repurchase		(981,884	)		(982	)		(64,739	)								(65,721	)
Stock based compensation expense								8,457									8,457
Cash dividends declared, $1.56 per share											(142,922	)					(142,922	)
BALANCE AT SEPTEMBER 30, 2022		91,210,296		$	91,211		$	3,538,719		$	2,981,947		$	(235	)	$	6,611,642

See notes to consolidated financial statements.

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)


	Nine Months Ended
	September 30,
	2023			2022
	(Dollars in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	323,840		$	386,636
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and core deposit intangibles amortization		22,793			21,300
Provision for credit losses		18,540			—
Net amortization of premium on investments		21,412			34,254
Net gain on sale of other real estate and repossessed assets		(780	)		(820	)
Net gain on sale or write down of premises and equipment		(2,070	)		(1,847	)
Net accretion of discount on loans		(5,566	)		(6,488	)
Net amortization of premium on deposits		(450	)		(252	)
Net gain on sale of loans		(1,670	)		(1,193	)
Proceeds from sale of loans held for sale		68,827			50,903
Originations of loans held for sale		(77,242	)		(45,307	)
Stock based compensation expense		9,056			8,457
Decrease (increase) in accrued interest receivable and other assets		47,911			(57,322	)
Increase in accrued interest payable and other liabilities		193,806			118,683
Net cash provided by operating activities		618,407			507,004

CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities and principal paydowns of held to maturity securities		1,308,839			1,710,143
Purchase of held to maturity securities		(3,028	)		(3,756,166	)
Proceeds from maturities and principal paydowns of available for sale securities		11,220,463			15,302,271
Purchase of available for sale securities		(11,026,566	)		(15,280,674	)
Originations of Warehouse Purchase Program loans		(9,877,760	)		(15,919,159	)
Proceeds from pay-offs of Warehouse Purchase Program loans		9,706,053			16,772,094
Net increase in loans held for investment		(818,194	)		(747,296	)
Purchase of bank premises and equipment		(29,517	)		(34,250	)
Proceeds from sale of bank premises, equipment and other real estate		7,170			6,699
Proceeds from insurance claims		11,427			2,603
Net cash used in the purchase of First Bancshares of Texas, Inc.		(24,365	)		—
Net cash provided by (used in) investing activities		474,522			(1,943,735	)

CASH FLOWS FROM FINANCING ACTIVITIES:
Net (decrease) increase in noninterest-bearing deposits		(1,325,801	)		404,109
Net decrease in interest-bearing deposits		(1,472,467	)		(1,875,524	)
Net proceeds from other short-term borrowings		2,199,614			1,165,000
Net (decrease) increase in securities sold under repurchase agreements		(177,294	)		6,205
Redemption of junior subordinated debentures		(3,158	)		—
Repurchase of common stock		(72,248	)		(65,721	)
Payments of cash dividends		(153,235	)		(142,922	)
Net cash used in financing activities		(1,004,589	)		(508,853	)

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		88,340			(1,945,584	)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD		424,133			2,547,980
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	512,473		$	602,396

NONCASH ACTIVITIES:
Acquisition of real estate through foreclosure of collateral	$	10,249		$	2,027

SUPPLEMENTAL INFORMATION:
Income taxes paid	$	93,675		$	95,302
Interest paid		275,113			36,311

See notes to consolidated financial statements

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2023

(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, 2022. Operating results for the nine-month period ended September 30, 2023 are not necessarily indicative of the results that may be expected for the year ending December 31, 2023 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 September 30,								Nine Months Ended September 30,
	2023				2022				2023				2022
	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	$	112,208			$	135,820			$	323,840			$	386,636
Basic:
Weighted average shares outstanding		93,720	$	1.20		91,209	$	1.49		92,628	$	3.50		91,710	$	4.22
Diluted:
Weighted average shares outstanding		93,720	$	1.20		91,209	$	1.49		92,628	$	3.50		91,710	$	4.22

There were no stock options outstanding at September 30, 2023 or exercisable during the three and nine months ended September 30, 2023 or 2022 that would have had an anti-dilutive effect on the above computation.

3. NEW ACCOUNTING STANDARDS

Accounting Standards Updates (“ASU”)

ASU 2022-02, Financial Instruments—Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures. The amendments in ASU 2022-02 eliminated the accounting guidance for troubled debt restructurings and enhanced disclosures for certain loan refinancing and restructurings to borrowers experiencing financial difficulty. This guidance was applied on a prospective basis. Additionally, ASU 2022-02 requires entities to disclose current-period gross charge-offs by year of origination. ASU 2022-02 became effective for the Company on January 1, 2023 and did not have a significant impact on the Company’s financial statements.

ASU 2020-04, Reference Rate Reform: Facilitation of the Effects of Reference Rate Reform on Financial Reporting – ASC Topic 848. ASU 2020-04 became effective for the Company on January 1, 2022 and provides optional expedients and exceptions for applying GAAP to loan and lease agreements, derivative contracts, and other transactions affected by the anticipated transition away from the London Inter-Bank Offered Rate (“LIBOR”) toward new interest rate benchmarks. ASU 2020-04 was effective upon issuance. In addition, the Financial Accounting Standards Board (“FASB”) issued ASU 2022-06 -Reference Rate Reform (Topic 848): Deferral of the Sunset Date of Topic 848, which extends the period of time preparers can utilize the reference rate reform relief guidance provided by ASU 2020-04 from December 31, 2022 to December 31, 2024. ASU 2022-06 was effective upon issuance and did not change the core principles in ASU 2020-04. Prior to the end of 2021, the Company began transitioning away from LIBOR to

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2023

(UNAUDITED)

the Secured Overnight Financing Rate (“SOFR”) or other alternative variable rate indexes for its interest-rate swaps and loans historically using LIBOR as an index. As of September 30, 2023, the Company's interest rate swaps and loan portfolio used SOFR as the index rate. As of December 31, 2022, LIBOR was used as an index rate for approximately 88.2% of the Company’s interest-rate swaps and approximately 1.5% of the Company’s loan portfolio. The adoption of ASU 2020-04 did not have a significant impact on the Company’s financial statements.

4. SECURITIES

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


	September 30, 2023
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(Dollars in thousands)
Available for Sale
Corporate debt securities	$	20,698	$	1,652	$	(865	)	$	21,485
Collateralized mortgage obligations		329,465		1,018		(2,959	)		327,524
Mortgage-backed securities		98,445		22		(1,311	)		97,156
Total	$	448,608	$	2,692	$	(5,135	)	$	446,165
Held to Maturity
U.S. Treasury securities and obligations of U.S. Government agencies	$	7,571	$	—	$	(208	)	$	7,363
States and political subdivisions		113,786		228		(4,723	)		109,291
Corporate debt securities		12,000		—		(4,560	)		7,440
Collateralized mortgage obligations		271,570		—		(29,507	)		242,063
Mortgage-backed securities		12,341,650		64		(1,873,652	)		10,468,062
Total	$	12,746,577	$	292	$	(1,912,650	)	$	10,834,219


	December 31, 2022
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(Dollars in thousands)
Available for Sale
Collateralized mortgage obligations	$	359,251	$	1,190	$	(3,039	)	$	357,402
Mortgage-backed securities		101,647		93		(2,640	)		99,100
Total	$	460,898	$	1,283	$	(5,679	)	$	456,502
Held to Maturity
States and political subdivisions	$	122,361	$	868	$	(3,255	)	$	119,974
Corporate debt securities		12,000		—		(2,520	)		9,480
Collateralized mortgage obligations		271,727		377		(22,922	)		249,182
Mortgage-backed securities		13,613,415		2,575		(1,607,501	)		12,008,489
Total	$	14,019,503	$	3,820	$	(1,636,198	)	$	12,387,125

The investment securities portfolio is measured for expected credit losses by segregating the portfolio into two general segments and applying the appropriate expected credit losses methodology. Investment securities classified as available for sale or held to maturity are evaluated for expected credit losses under FASB ASC 326, “Financial Instruments – Credit Losses.”

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2023

(UNAUDITED)

impairment loss (“noncredit portion”). The amount of the total expected credit losses 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 expected credit losses related to the noncredit portion is recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the expected credit losses recognized in earnings will become the new amortized cost basis of the investment.

As of September 30, 2023, 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 changes in market interest rates and spread relationships since 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 September 30, 2023, management believes that there is no potential for credit losses on available for sale securities.

Held to maturity securities. The Company’s held to maturity investments include mortgage-related bonds issued by either the Government National Mortgage Corporation (“Ginnie Mae”), Federal National Mortgage Association (“Fannie Mae”) or Federal Home Loan Mortgage Corporation (“Freddie Mac”). Ginnie Mae issued securities are explicitly guaranteed by the U.S. government, while Fannie Mae and Freddie Mac issued securities are fully guaranteed by those respective United States government-sponsored agencies and conditionally guaranteed by the full faith and credit of the United States. The Company’s held to maturity securities also include taxable and tax-exempt municipal securities issued primarily by school districts, utility districts and municipalities located in Texas. The Company’s investment in municipal securities is exposed to credit risk. The securities are highly rated by major rating agencies and regularly reviewed by management. A significant portion are guaranteed or insured by either the Texas Permanent School Fund, Assured Guaranty or Build America Mutual. As of September 30, 2023, the Company’s municipal securities represent 0.9% of the securities portfolio. 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. Accordingly, as of September 30, 2023, management believes that there is no potential for material credit losses on held to maturity securities.

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


	September 30, 2023
	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
Corporate debt securities	$	7,173	$	(865	)	$	—	$	—		$	7,173	$	(865	)
Collateralized mortgage obligations		44,012		(373	)		116,982		(2,586	)		160,994		(2,959	)
Mortgage-backed securities		2,698		(55	)		92,530		(1,256	)		95,228		(1,311	)
Total	$	53,883	$	(1,293	)	$	209,512	$	(3,842	)	$	263,395	$	(5,135	)
Held to Maturity
U.S. Treasury securities and obligations of U.S. Government agencies	$	7,363	$	(208	)	$	—	$	—		$	7,363	$	(208	)
States and political subdivisions		50,902		(997	)		39,698		(3,726	)		90,600		(4,723	)
Corporate debt securities		—		—			7,440		(4,560	)		7,440		(4,560	)
Collateralized mortgage obligations		51,009		(1,187	)		191,012		(28,320	)		242,021		(29,507	)
Mortgage-backed securities		227,436		(7,382	)		10,235,113		(1,866,270	)		10,462,549		(1,873,652	)
Total	$	336,710	$	(9,774	)	$	10,473,263	$	(1,902,876	)	$	10,809,973	$	(1,912,650	)

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2023

(UNAUDITED)


	December 31, 2022
	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	$	61,559	$	(3,012	)	$	99,179	$	(27	)	$	160,738	$	(3,039	)
Mortgage-backed securities		95,212		(2,627	)		291		(13	)		95,503		(2,640	)
Total	$	156,771	$	(5,639	)	$	99,470	$	(40	)	$	256,241	$	(5,679	)
Held to Maturity
States and political subdivisions	$	49,782	$	(885	)	$	16,298	$	(2,370	)	$	66,080	$	(3,255	)
Corporate debt securities		9,480		(2,520	)		—		—			9,480		(2,520	)
Collateralized mortgage obligations		214,538		(22,557	)		4,358		(365	)		218,896		(22,922	)
Mortgage-backed securities		5,276,315		(416,053	)		6,585,470		(1,191,448	)		11,861,785		(1,607,501	)
Total	$	5,550,115	$	(442,015	)	$	6,606,126	$	(1,194,183	)	$	12,156,241	$	(1,636,198	)

At September 30, 2023 and December 31, 2022, there were 947 securities and 174 securities, respectively, in an unrealized loss position for 12 months or more.

The table below summarizes the amortized cost and fair value of investment securities at September 30, 2023, by contractual maturity. 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	$	25,590	$	25,761	$	—	$	—
Due after one year through five years		49,927		48,679		2,550		2,865
Due after five years through ten years		45,822		39,137		18,148		18,620
Due after ten years		12,018		10,517		—		—
Subtotal		133,357		124,094		20,698		21,485
Mortgage-backed securities and collateralized mortgage obligations		12,613,220		10,710,125		427,910		424,680
Total	$	12,746,577	$	10,834,219	$	448,608	$	446,165

The Company recorded no gain or loss on the sale of securities for the three and nine months ended September 30, 2023 and 2022. As of September 30, 2023, the Company did not own any non-agency collateralized mortgage obligations.

At September 30, 2023 and December 31, 2022, 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 $10.33 billion and $7.87 billion and a fair value of $8.75 billion and $6.90 billion at September 30, 2023 and December 31, 2022, 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

SEPTEMBER 30, 2023

(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:


	September 30, 2023		December 31, 2022
	(Dollars in thousands)
Residential mortgage loans held for sale	$	10,187	$	554

Commercial and industrial		2,603,028		2,594,742
Real estate:
Construction, land development and other land loans		3,200,479		2,805,438
1-4 family residential (includes home equity)		7,991,904		6,740,670
Commercial real estate (includes multi-family residential)		5,606,837		4,986,211
Farmland		595,182		518,095
Agriculture		206,751		169,938
Consumer and other		306,018		283,559
Total loans held for investment, excluding Warehouse Purchase Program		20,510,199		18,098,653
Warehouse Purchase Program		912,327		740,620
Total loans, including Warehouse Purchase Program	$	21,432,713	$	18,839,827

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 81.9% and 80.3% of the Company’s total loan portfolio, excluding Warehouse Purchase Program loans, at September 30, 2023 and December 31, 2022, respectively. As of September 30, 2023 and December 31, 2022, excluding Warehouse Purchase Program loans, there were no concentrations of loans related to any single industry in excess of 10% of total loans.

Related Party Loans. As of September 30, 2023 and December 31, 2022, loans outstanding to directors, officers and their affiliates totaled $295 thousand and $547 thousand, 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 nine months ended September 30, 2023			As of and for the year ended December 31, 2022
	(Dollars in thousands)
Beginning balance on January 1	$	547		$	6,524
New loans		57			54
Repayments		(309	)		(6,031	)
Ending balance	$	295		$	547

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. A loan may be returned to accrual status when all the principal and interest amounts contractually due are brought current and future principal and interest amounts contractually due are reasonably assured, which is typically evidenced by a sustained period (at least six months) of repayment performance by the borrower.

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2023

(UNAUDITED)

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 write-downs or appropriate additions to the allowance for credit losses.

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


	September 30, 2023
	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	$	9,238	$	—	$	9,238	$	7,746	$	3,183,495	$	3,200,479
Warehouse Purchase Program loans		—		—		—		—		912,327		912,327
Agriculture and agriculture real estate (includes farmland)		3,755		—		3,755		1,511		796,667		801,933
1-4 family (includes home equity) (1)		34,229		—		34,229		23,439		7,944,423		8,002,091
Commercial real estate (includes multi-family residential)		5,974		—		5,974		5,228		5,595,635		5,606,837
Commercial and industrial		51,314		397		51,711		21,787		2,529,530		2,603,028
Consumer and other		493		—		493		18		305,507		306,018
Total	$	105,003	$	397	$	105,400	$	59,729	$	21,267,584	$	21,432,713


	December 31, 2022
	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	$	9,976	$	4,442	$	14,418	$	318	$	2,790,702	$	2,805,438
Warehouse Purchase Program loans		—		—		—		—		740,620		740,620
Agriculture and agriculture real estate (includes farmland)		1,751		—		1,751		421		685,861		688,033
1-4 family (includes home equity) (1)		25,880		7		25,887		14,762		6,700,575		6,741,224
Commercial real estate (includes multi-family residential)		3,176		—		3,176		1,649		4,981,386		4,986,211
Commercial and industrial		10,575		1,468		12,043		2,453		2,580,246		2,594,742
Consumer and other		378		—		378		11		283,170		283,559
Total	$	51,736	$	5,917	$	57,653	$	19,614	$	18,762,560	$	18,839,827

(1)

Includes $10.2 million and $554 thousand of residential mortgage loans held for sale at September 30, 2023 and December 31, 2022, respectively.

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2023

(UNAUDITED)

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


	September 30, 2023			December 31, 2022
	(Dollars in thousands)
Nonaccrual loans (1) (3)	$	59,729		$	19,614		(2)
Accruing loans 90 or more days past due		397			5,917
Total nonperforming loans		60,126			25,531
Repossessed assets		35			—
Other real estate		9,320			1,963
Total nonperforming assets	$	69,481		$	27,494

Nonperforming assets to total loans and other real estate		0.32	%		0.15	%
Nonperforming assets to total loans, excluding Warehouse Purchase Program loans, and other real estate		0.34	%		0.15	%
Nonaccrual loans to total loans		0.28	%		0.10	%
Nonaccrual loans to total loans, excluding Warehouse Purchase Program loans		0.29	%		0.11	%

(1)

ASU 2022-02 became effective for the Company on January 1, 2023.

(2)

Includes troubled debt restructurings of $4.6 million as of December 31, 2022.

(3)

There were no nonperforming Warehouse Purchase Program loans or Warehouse Purchase Program lines of credit for the periods presented.

The Company had $69.5 million in nonperforming assets at September 30, 2023 compared with $27.5 million at December 31, 2022. This increase was primarily due to the merger of First Bancshares of Texas, Inc. (“First Bancshares”) into Bancshares and the subsequent merger of its wholly owned subsidiary FirstCapital Bank of Texas, N.A. (“FirstCapital Bank”) into the Bank (collectively, the “Merger”). Nonperforming assets were 0.32% of total loans and other real estate at September 30, 2023 and 0.15% of total loans and other real estate at December 31, 2022. The Company had $59.7 million in nonaccrual loans at September 30, 2023 compared with $19.6 million at December 31, 2022.

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. Projected default rates, loss given default, and recovery rates for purchased credit deteriorated (“PCD”) loans primarily impact the related allowance, as opposed to the fair value mark. During the valuation process, the Company identified PCD and Non-PCD loans in the acquired loan portfolios. Loans acquired with evidence of credit quality deterioration since origination as of the acquisition date were accounted for as PCD. PCD 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 as of the acquisition date when compared to the origination date. Non-PCD 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 PCD and Non-PCD loans will be recognized based on payment structure and the contractual maturity of individual loans.

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2023

(UNAUDITED)

PCD Loans. The recorded investment in PCD 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 September 30, 2023 and December 31, 2022.


	September 30, 2023			December 31, 2022
	(Dollars in thousands)
PCD loans:
Outstanding balance	$	620,324		$	63,383
Discount		(9,343	)		(3,361	)
Recorded investment	$	610,981		$	60,022

Changes in the accretable yield for acquired PCD loans for the three and nine months ended September 30, 2023 and 2022 were as follows:


	Three Months Ended September 30,						Nine Months Ended September 30,
	2023			2022			2023			2022
	(Dollars in thousands)
Balance at beginning of period	$	10,110		$	3,993		$	3,361		$	4,838
Additions		—			—			8,336			—
Adjustments		—			—			(70	)		—
Accretion		(767	)		(322	)		(2,284	)		(1,167	)
Balance at September 30,	$	9,343		$	3,671		$	9,343		$	3,671

Income recognition on PCD loans is subject to the timing and amount of future cash flows. PCD loans for which the Company is accruing interest income are not considered nonperforming or impaired. The PCD discount reflected above as of September 30, 2023, represents the amount of discount available to be recognized as income.

Non-PCD Loans. The recorded investment in Non-PCD 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 September 30, 2023 and December 31, 2022.


	September 30, 2023			December 31, 2022
	(Dollars in thousands)
Non-PCD loans:
Outstanding balance	$	1,959,822		$	1,319,507
Discount		(21,543	)		(2,233	)
Recorded investment	$	1,938,279		$	1,317,274

Changes in the discount accretion for Non-PCD loans for the three and nine months ended September 30, 2023 and 2022 were as follows:


	Three Months Ended September 30,						Nine Months Ended September 30,
	2023			2022			2023			2022
	(Dollars in thousands)
Balance at beginning of period	$	23,052		$	3,734		$	2,233		$	8,143
Addition		—			—			22,593			—
Accretion charge-offs		(1	)		14			(1	)		14
Accretion		(1,508	)		(912	)		(3,282	)		(5,321	)
Balance at September 30,	$	21,543		$	2,836		$	21,543		$	2,836

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2023

(UNAUDITED)

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

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.

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 are 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.

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2023

(UNAUDITED)

The following tables present loans by risk grade, by category of loan and year of origination/renewal at September 30, 2023.


	Term Loans
	Amortized Cost Basis by Origination Year
	2023		2022		2021		2020		2019		Prior		Revolving Loans		Revolving Loans Converted to Term Loans		Total
	(Dollars in thousands)

Construction, Land Development and Other Land Loans
Grade 1	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Grade 2		1,136		178		—		—		—		70		—		—		1,384
Grade 3		413,440		1,103,554		495,407		210,484		21,398		171,312		201,230		7,015		2,623,840
Grade 4		40,692		98,550		94,091		35,723		2,396		11,667		5,467		—		288,586
Grade 5		—		—		4,399		—		18,678		629		915		—		24,621
Grade 6		—		—		6,217		191		230		1,185		—		—		7,823
Grade 7		—		928		1,647		3,318		—		1,587		266		—		7,746
Grade 8		—		—		—		—		—		—		—		—		—
Grade 9		—		—		—		—		—		—		—		—		—
PCD Loans		47,107		129,665		30,405		7,458		3,553		6,267		22,024		—		246,479
Total	$	502,375	$	1,332,875	$	632,166	$	257,174	$	46,255	$	192,717	$	229,902	$	7,015	$	3,200,479

Current-period gross write-offs	$	—	$	77	$	—	$	—	$	—	$	—	$	—	$	—	$	77

Agriculture and Agriculture Real Estate (includes Farmland)
Grade 1	$	1,002	$	1,318	$	323	$	393	$	19	$	391	$	8,770	$	—	$	12,216
Grade 2		—		75		104		—		—		1,073		52		—		1,304
Grade 3		128,543		193,029		87,352		47,367		37,641		101,562		82,906		95		678,495
Grade 4		9,971		16,900		19,557		5,395		451		7,955		22,387		1,008		83,624
Grade 5		70		794		286		—		441		1,466		—		—		3,057
Grade 6		—		—		116		—		—		478		—		—		594
Grade 7		—		—		1,334		—		15		162		—		—		1,511
Grade 8		—		—		—		—		—		—		—		—		—
Grade 9		—		—		—		—		—		—		—		—		—
PCD Loans		216		2,333		1,769		3,793		1,214		3,604		2,914		5,289		21,132
Total	$	139,802	$	214,449	$	110,841	$	56,948	$	39,781	$	116,691	$	117,029	$	6,392	$	801,933

Current-period gross write-offs	$	—	$	—	$	—	$	113	$	—	$	—	$	—	$	—	$	113

1-4 Family (includes Home Equity) (1)
Grade 1	$	76	$	158	$	—	$	110	$	—	$	—	$	—	$	—	$	344
Grade 2		738		1,403		158		249		32		3,162		119		—		5,861
Grade 3		1,066,962		2,011,417		2,165,072		1,065,471		436,951		991,862		93,437		1,463		7,832,635
Grade 4		11,650		20,065		24,273		5,945		13,627		51,076		3,191		—		129,827
Grade 5		—		58		—		122		—		2,496		—		—		2,676
Grade 6		—		—		224		15		244		1,582		—		—		2,065
Grade 7		244		3,984		5,244		3,528		1,904		8,459		76		—		23,439
Grade 8		—		—		—		—		—		—		—		—		—
Grade 9		—		—		—		—		—		—		—		—		—
PCD Loans		175		1,523		515		439		640		1,952		—		—		5,244
Total	$	1,079,845	$	2,038,608	$	2,195,486	$	1,075,879	$	453,398	$	1,060,589	$	96,823	$	1,463	$	8,002,091

Current-period gross write-offs	$	—	$	20	$	50	$	26	$	—	$	25	$	—	$	—	$	121

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2023

(UNAUDITED)


	Term Loans
	Amortized Cost Basis by Origination Year
	2023		2022		2021		2020		2019		Prior		Revolving Loans		Revolving Loans Converted to Term Loans		Total
	(Dollars in thousands)

Commercial Real Estate (includes Multi-Family Residential)
Grade 1	$	—	$	—	$	—	$	—	$	—	$	—	$	48	$	—	$	48
Grade 2		—		1,439		—		483		—		2,467		—		—		4,389
Grade 3		377,792		940,534		685,352		487,881		318,912		1,084,441		85,263		240		3,980,415
Grade 4		32,814		150,750		175,683		179,686		104,998		546,811		14,942		1,127		1,206,811
Grade 5		—		—		—		—		14,988		45,636		1,555		—		62,179
Grade 6		—		934		1,548		11,946		15,938		89,267		—		—		119,633
Grade 7		—		827		365		—		3,473		563		—		—		5,228
Grade 8		—		—		—		—		—		—		—		—		—
Grade 9		—		—		—		—		—		—		—		—		—
PCD Loans		17,500		47,252		45,997		40,404		8,078		68,523		380		—		228,134
Total	$	428,106	$	1,141,736	$	908,945	$	720,400	$	466,387	$	1,837,708	$	102,188	$	1,367	$	5,606,837

Current-period gross write-offs	$	—	$	14,975	$	—	$	—	$	—	$	584	$	—	$	—	$	15,559

Commercial and Industrial
Grade 1	$	13,792	$	11,407	$	9,334	$	3,841	$	1,267	$	5,054	$	33,533	$	43	$	78,271
Grade 2		708		8,029		253		217		—		3,842		2,438		—		15,487
Grade 3		200,642		281,096		177,474		68,507		43,171		152,826		994,460		684		1,918,860
Grade 4		68,384		20,313		15,982		11,176		22,026		88,864		184,842		478		412,065
Grade 5		3,182		22,373		2,263		1,060		408		470		1,255		6,475		37,486
Grade 6		42		489		275		1,398		1,080		1,111		4,671		111		9,177
Grade 7		4,712		15,360		186		—		77		693		759		—		21,787
Grade 8		—		—		—		—		—		—		—		—		—
Grade 9		—		—		—		—		—		—		—		—		—
PCD Loans		6,410		23,067		11,847		4,755		5,658		1,156		56,805		197		109,895
Total	$	297,872	$	382,134	$	217,614	$	90,954	$	73,687	$	254,016	$	1,278,763	$	7,988	$	2,603,028

Current-period gross write-offs	$	10	$	622	$	145	$	45	$	—	$	506	$	1,875	$	—	$	3,203

Consumer and Other
Grade 1	$	11,930	$	7,329	$	3,463	$	2,396	$	1,314	$	4,686	$	1,873	$	—	$	32,991
Grade 2		12,584		14,202		—		—		—		2,009		7		—		28,802
Grade 3		61,873		43,988		28,130		28,237		11,606		11,571		49,034		92		234,531
Grade 4		1,926		290		1,191		1,068		1,301		572		3,231		—		9,579
Grade 5		—		—		—		—		—		—		—		—		—
Grade 6		—		—		—		—		—		—		—		—		—
Grade 7		—		—		—		15		3		—		—		—		18
Grade 8		—		—		—		—		—		—		—		—		—
Grade 9		—		—		—		—		—		—		—		—		—
PCD Loans		—		—		41		10		23		—		23		—		97
Total	$	88,313	$	65,809	$	32,825	$	31,726	$	14,247	$	18,838	$	54,168	$	92	$	306,018

Current-period gross write-offs	$	3,866	$	71	$	4	$	27	$	5	$	20	$	62	$	11	$	4,066

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2023

(UNAUDITED)


	Term Loans
	Amortized Cost Basis by Origination Year
	2023		2022		2021		2020		2019		Prior		Revolving Loans		Revolving Loans Converted to Term Loans		Total
	(Dollars in thousands)

Warehouse Purchase Program
Grade 1	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Grade 2		—		—		—		—		—		—		—		—		—
Grade 3		912,327		—		—		—		—		—		—		—		912,327
Grade 4		—		—		—		—		—		—		—		—		—
Grade 5		—		—		—		—		—		—		—		—		—
Grade 6		—		—		—		—		—		—		—		—		—
Grade 7		—		—		—		—		—		—		—		—		—
Grade 8		—		—		—		—		—		—		—		—		—
Grade 9		—		—		—		—		—		—		—		—		—
PCD Loans		—		—		—		—		—		—		—		—		—
Total	$	912,327	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	912,327

Current-period gross write-offs	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—

Total
Grade 1	$	26,800	$	20,212	$	13,120	$	6,740	$	2,600	$	10,131	$	44,224	$	43	$	123,870
Grade 2		15,166		25,326		515		949		32		12,623		2,616		—		57,227
Grade 3		3,161,579		4,573,618		3,638,787		1,907,947		869,679		2,513,574		1,506,330		9,589		18,181,103
Grade 4		165,437		306,868		330,777		238,993		144,799		706,945		234,060		2,613		2,130,492
Grade 5		3,252		23,225		6,948		1,182		34,515		50,697		3,725		6,475		130,019
Grade 6		42		1,423		8,380		13,550		17,492		93,623		4,671		111		139,292
Grade 7		4,956		21,099		8,776		6,861		5,472		11,464		1,101		—		59,729
Grade 8		—		—		—		—		—		—		—		—		—
Grade 9		—		—		—		—		—		—		—		—		—
PCD Loans		71,408		203,840		90,574		56,859		19,166		81,502		82,146		5,486		610,981
Total	$	3,448,640	$	5,175,611	$	4,097,877	$	2,233,081	$	1,093,755	$	3,480,559	$	1,878,873	$	24,317	$	21,432,713

Current-period gross write-offs	$	3,876	$	15,765	$	199	$	211	$	5	$	1,135	$	1,937	$	11	$	23,139

(1)

Includes $10.2 million of residential mortgage loans held for sale at September 30, 2023.

Allowance for Credit Losses on Loans. The allowance for credit losses is adjusted 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 September 30, 2023 for estimated losses in the Company’s loan portfolio. The amount of the allowance for credit losses on loans 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, (3) provisions for credit losses charged to earnings that increase the allowance, and (4) provision releases returned to earnings that decrease 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 borrower performance differ from the assumptions used in making the initial determinations.

The Company’s allowance for credit losses on loans consists of two components: (1) a specific valuation allowance based on expected losses on specifically identified loans and (2) a general valuation allowance based on historical lifetime loan loss experience, current economic conditions, reasonable and supportable forecasted economic conditions and other qualitative risk factors both internal and external to the Company.

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2023

(UNAUDITED)

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 326-20, “Financial Instruments – Credit Losses.” 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 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 the Warehouse Purchase Program, the capitalization and liquidity of the mortgage banking client, the operating experience, the client’s satisfactory underwriting of purchased loans and the consistent timeliness by the client of loan resale to investors;

•

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 lifetime loan loss experience, concentration risk of specific loan types, the volume, growth and composition of the Company’s loan portfolio, current economic conditions and reasonable and supportable forecasted economic conditions that may affect borrower ability to pay and the value of collateral, the evaluation of the Company’s loan portfolio through its internal loan review process, other qualitative risk factors both internal and external to the Company and other relevant factors in accordance with ASC Topic 326, “Financial Instruments – Credit Losses.” Historical lifetime loan loss experience is determined by utilizing an open-pool (“cumulative loss rate”) methodology. Adjustments to the historical lifetime loan loss experience are made for differences in current loan pool risk characteristics such as portfolio concentrations, delinquency, non-accrual, and watch list levels, as well as changes in current and forecasted economic conditions such as unemployment rates, property and collateral values, and other indices relating to economic activity. The utilization of reasonable and supportable forecasts includes an immediate reversion to lifetime historical loss rates. 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. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2023

(UNAUDITED)

The following table details activity in the allowance for credit losses on loans by category of loan for the three and nine months ended September 30, 2023 and 2022.


	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 on loans:
Three Months Ended
Balance June 30, 2023	$	91,858		$	11,254		$	67,722		$	86,765		$	81,970		$	5,640		$	345,209
Initial allowance on loans purchased with credit deterioration		1,641			—			—			4,290			3,763			—			9,694
Provision for credit losses on loans		1,437			149			3,932			(4,554	)		(2,455	)		1,491			—
Charge-offs		—			—			(20	)		(584	)		(1,961	)		(1,550	)		(4,115	)
Recoveries		5			—			98			14			367			223			707
Net (charge-offs) recoveries		5			—			78			(570	)		(1,594	)		(1,327	)		(3,408	)
Balance September 30, 2023	$	94,941		$	11,403		$	71,732		$	85,931		$	81,684		$	5,804		$	351,495

Nine Months Ended
Balance December 31, 2022	$	78,853		$	7,699		$	60,795		$	66,272		$	62,319		$	5,638		$	281,576
Initial allowance on loans purchased with credit deterioration		16,878			2,914			1,590			25,292			30,095			24			76,793
Provision for credit losses		(758	)		706			9,059			9,893			(10,448	)		3,532			11,984
Charge-offs		(77	)		(113	)		(121	)		(15,559	)		(3,203	)		(4,066	)		(23,139	)
Recoveries		45			197			409			33			2,921			676			4,281
Net (charge-offs) recoveries		(32	)		84			288			(15,526	)		(282	)		(3,390	)		(18,858	)
Balance September 30, 2023	$	94,941		$	11,403		$	71,732		$	85,931		$	81,684		$	5,804		$	351,495

Allowance for credit losses on loans:
Three Months Ended
Balance June 30, 2022	$	63,729		$	8,338		$	60,096		$	70,011		$	75,694		$	6,091		$	283,959
Provision for credit losses		2,454			(377	)		(1,213	)		(2,098	)		(37	)		1,271			—
Charge-offs		—			(119	)		(59	)		(757	)		(253	)		(1,386	)		(2,574	)
Recoveries		4			—			261			—			268			261			794
Net (charge-offs) recoveries		4			(119	)		202			(757	)		15			(1,125	)		(1,780	)
Balance September 30, 2022	$	66,187		$	7,842		$	59,085		$	67,156		$	75,672		$	6,237		$	282,179

Nine Months Ended
Balance December 31, 2021	$	58,897		$	7,759		$	56,710		$	75,005		$	80,412		$	7,597		$	286,380
Provision for credit losses		7,711			90			2,228			(7,063	)		(4,938	)		1,972			—
Charge-offs		(435	)		(274	)		(159	)		(796	)		(917	)		(4,061	)		(6,642	)
Recoveries		14			267			306			10			1,115			729			2,441
Net (charge-offs) recoveries		(421	)		(7	)		147			(786	)		198			(3,332	)		(4,201	)
Balance September 30, 2022	$	66,187		$	7,842		$	59,085		$	67,156		$	75,672		$	6,237		$	282,179

The allowance for credit losses on loans as of September 30, 2023 totaled $351.5 million or 1.64% of total loans, including acquired loans with discounts, an increase of $69.9 million or 24.8% compared to the allowance for credit losses on loans totaling $281.6 million or 1.49% of total loans, including acquired loans with discounts, as of December 31, 2022. There was no provision for credit losses for the three months ended September 30, 2023 and a provision for credit losses of $18.5 million for the nine months ended September 30, 2023 compared to no provision for credit losses for the three and nine months ended September 30, 2022. As a result of the loans acquired in the Merger that was completed on May 1, 2023, the second quarter of 2023 included a $12.0 million provision for credit losses on loans and a $6.5 million provision for credit losses on off-balance sheet credit exposures.

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2023

(UNAUDITED)

Net charge-offs were $3.4 million for the three months ended September 30, 2023 compared to net charge-offs of $1.8 million for the three months ended September 30, 2022. Net charge-offs for the three months ended September 30, 2023 included $298 thousand related to resolved PCD loans. Additionally, reserves on PCD loans increased by $9.7 million due to revised Day One accounting for PCD loans at the time of the Merger. Further, $12.5 million of reserves on resolved PCD loans was released to the general reserve.

Net charge-offs were $18.9 million for the nine months ended September 30, 2023 compared with $4.2 million for the nine months ended September 30, 2022. Net charge-offs for the nine months ended September 30, 2023 included $15.0 million related to one commercial real estate loan obtained in a previous merger. Additionally, reserves on PCD loans increased by $76.8 million due to the Merger and $16.2 million of reserves on resolved PCD loans was released to the general reserve.

Allowance for Credit Losses on Off-Balance Sheet Credit Exposures. The allowance for credit losses on off-balance sheet credit exposures estimates expected credit losses over the contractual period in which there is exposure to credit risk via a contractual obligation to extend credit, except when an obligation is unconditionally cancellable by the Company. The allowance is adjusted by provisions for credit losses charged to earnings that increase the allowance, or by provision releases returned to earnings that decrease the allowance. The estimate includes consideration of the likelihood that funding will occur and an estimate of expected credit losses on the commitments expected to fund. The estimate of commitments expected to fund is affected by historical analysis of utilization rates. The expected credit loss rates applied to the commitments expected to fund are affected by the general valuation allowance utilized for outstanding balances with the same underlying assumptions and drivers. As of September 30, 2023 and December 31, 2022, the Company had $36.5 million and $29.9 million in allowance for credit losses on off-balance sheet credit exposures, respectively; with the increase due to the Merger. The allowance for credit losses on off-balance sheet credit exposures is a separate line item on the Company’s consolidated balance sheet. As of September 30, 2023, the Company had $2.48 billion in commitments expected to fund.

The following table represents a rollforward of the allowance for credit losses on off-balance sheet credit exposures for the periods shown.


	Three Months Ended September 30				Nine Months Ended September 30
	2023		2022		2023		2022
	(Dollars in thousands)
Balance at beginning of period	$	36,503	$	29,947	$	29,947	$	29,947
Provision for credit losses on off-balance sheet credit exposures		—		—		6,556		—
Balance at end of period	$	36,503	$	29,947	$	36,503	$	29,947

Loan Modifications Made to Borrowers Experiencing Financial Difficulty. On January 1, 2023, the Company adopted ASU 2022-02, “Financial Instruments—Credit Losses (Topic 326): Troubled Debt Restructurings. and Vintage Disclosures”, which eliminated the accounting guidance for troubled debt restructurings and enhanced disclosures for certain loan refinancing and restructurings to borrowers experiencing financial difficulty. This guidance was applied on a prospective basis. As of the adoption date, all restructurings, including restructurings for borrowers experiencing financial difficulty, are evaluated to determine whether they result in a new loan or a continuation of an existing loan. Upon adoption of this guidance, the Company only establishes a specific reserve for modifications to borrowers experiencing financial difficulty when the loan is identified as impaired. The effect of most modifications of loans made to borrowers who are experiencing financial difficulty is already included in the allowance for credit losses because of the measurement methodologies used to estimate the allowance. The Company adjusts the terms of loans for certain borrowers when it believes such changes will help its customers manage their loan obligations and increase the collectability of the loans.

Modifications to borrowers experiencing financial difficulty may include but are not limited to changes in committed loan amount, interest rate, amortization, note maturity, borrower, guarantor, collateral, forbearance, forgiveness of principal or interest, and other actions intended to minimize economic loss and to avoid foreclosure or repossession of collateral. The approval of modifications of loans for borrowers experiencing financial difficulty are handled on a case-by-case basis.

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2023

(UNAUDITED)

The following table displays the amortized cost of loans that were both experiencing financial difficulty and modified during the three and nine months ended September 30, 2023, presented by category of loan and type of modification.


	Payment Delay		Term Extension		Interest Rate Reduction		Total		Percentage of Total Loans Held for Investment
	(Dollars in thousands)
Three Months Ended September 30, 2023
Commercial and industrial	$	—	$	5,639	$	—	$	5,639		0.03	%
Construction, land development and other land loans		—		—		—		—		0.00	%
Commercial real estate (includes multi-family residential)		—		—		6,922		6,922		0.03	%
Agriculture		—		419		—		419		0.00	%
Total	$	—	$	6,058	$	6,922	$	12,980		0.05	%

Nine Months Ended September 30, 2023
Commercial and industrial	$	—	$	5,639	$	292	$	5,931		0.03	%
Construction, land development and other land loans		—		6,054		—		6,054		0.03	%
Commercial real estate (includes multi-family residential)		1,294		—		6,922		8,216		0.04	%
Agriculture		—		419		—		419		0.00	%
Total	$	1,294	$	12,112	$	7,214	$	20,620		0.10	%

The following tables describe the modifications made to loans whose borrowers are experiencing financial difficulty:


Payment Delay
Loan Type	Three Months Ended September 30, 2023	Nine Months Ended September 30, 2023
Commercial real estate (includes multi-family residential)	̶̶̶	Short-term principal deferral

Term Extension
Loan Type	Three Months Ended September 30, 2023	Nine Months Ended September 30, 2023
Commercial and industrial	Short-term extension	Short-term extension
Construction, land development and other land loans	̶̶̶	Short-term extension
Agriculture	Short-term extension	Short-term extension

Interest Rate Reduction
Loan Type	Three Months Ended September 30, 2023	Nine Months Ended September 30, 2023
Commercial and industrial	̶̶̶	Reduced contractual interest rate
Commercial real estate (includes multi-family residential)	Reduced contractual interest rate	Reduced contractual interest rate

The Company did not have any loans made to borrowers experiencing financial difficulty that were modified during the three and nine months ended September 30, 2023 that subsequently defaulted and were modified in the twelve months prior to that default. Payment default is defined as movement to nonperforming status, foreclosure or charge-off, whichever occurs first.

Prior to the adoption of ASU 2022-02, the restructuring of a loan was considered a “troubled debt restructuring” if both (1) the borrower was experiencing financial difficulties and (2) the creditor had granted a concession. Concessions may have included interest rate reductions or below market interest rates, principal forgiveness, restructuring amortization schedules and other actions intended to minimize potential losses. Loans that were restructured in a troubled debt restructuring loan prior to the adoption of ASU 2022-02 will continue to be accounted for under the historical troubled debt restructuring accounting until the loan is paid off, liquidated or subsequently modified. As of September 30, 2022, the Company had $806 thousand in outstanding troubled debt restructurings. For

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2023

(UNAUDITED)

the nine months ended September 30, 2022, the Company did not add any loans as new troubled debt restructurings. There were no charge-offs related to restructured loans for the nine months ended September 30, 2022.

6. FAIR VALUE

The Company uses fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. Fair values represent the estimated price that would be received from selling an asset or paid to transfer a liability, otherwise known as an “exit price.” Securities available for sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis. 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.

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2023

(UNAUDITED)

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


	As of September 30, 2023
	Level 1		Level 2		Level 3		Total
	(Dollars in thousands)
Assets:
Available for sale securities:
Corporate debt securities	$	—	$	21,485	$	—	$	21,485
Collateralized mortgage obligations		—		327,524		—		327,524
Mortgage-backed securities		—		97,156		—		97,156
Total	$	—	$	446,165	$	—	$	446,165

Derivative financial instruments:
Interest rate lock commitments	$	—	$	302	$	—	$	302
Forward mortgage-backed securities trades		—		240		—		240
Loan customer counterparty		—		—		—		—
Financial institution counterparty		—		5,660		—		5,660
Liabilities:
Derivative financial instruments:
Interest rate lock commitments	$	—	$	35	$	—	$	35
Forward mortgage-backed securities trades		—		3		—		3
Loan customer counterparty		—		5,699		—		5,699
Financial institution counterparty		—		—		—		—


	As of December 31, 2022
	Level 1		Level 2		Level 3		Total
	(Dollars in thousands)
Assets:
Available for sale securities:
Collateralized mortgage obligations	$	—	$	357,402	$	—	$	357,402
Mortgage-backed securities		—		99,100		—		99,100
Total available for sale securities	$	—	$	456,502	$	—	$	456,502

Derivative financial instruments:
Interest rate lock commitments	$	—	$	94	$	—	$	94
Forward mortgage-backed securities trades		—		31		—		31
Loan customer counterparty		—		—		—		—
Financial institution counterparty		—		5,522		—		5,522
Liabilities:
Derivative financial instruments:
Interest rate lock commitments	$	—	$	6	$	—	$	6
Forward mortgage-backed securities trades		—		—		—		—
Loan customer counterparty		—		5,522		—		5,522
Financial institution counterparty		—		—		—		—

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 nine months ended September 30, 2023, the Company had additions to other real estate owned of $8.6 million and $10.2 million, respectively, of which $8.2 million and $8.4 million, respectively, were outstanding as of September 30, 2023. For the three and nine months ended September 30, 2023, the Company had additions to impaired loans of $13.7 million and $36.3 million, respectively, of which $13.7 million and $20.3 million, respectively, were outstanding as of September 30, 2023. The remaining financial assets and liabilities measured at fair value on a non-recurring basis that were recorded in 2023 and remained outstanding at September 30, 2023 were not significant.

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2023

(UNAUDITED)

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


	As of September 30, 2023
	Carrying		Estimated Fair Value
	Amount		Level 1		Level 2		Level 3		Total
	(Dollars in thousands)
Assets
Cash and due from banks	$	512,239	$	512,239	$	—	$	—	$	512,239
Federal funds sold		234		234		—		—		234
Held to maturity securities		12,746,577		—		10,834,219		—		10,834,219
Loans held for sale		10,187		—		10,187		—		10,187
Loans held for investment, net of allowance		20,158,704		—		—		19,017,863		19,017,863
Loans held for investment - Warehouse Purchase Program		912,327		—		912,327		—		912,327
Other real estate owned		9,320		—		9,320		—		9,320
Liabilities
Deposits:
Noninterest-bearing	$	10,281,893	$	—	$	10,281,893	$	—	$	10,281,893
Interest-bearing		17,030,907		—		16,984,181		—		16,984,181
Other borrowings		4,250,000		—		4,179,418		—		4,179,418
Securities sold under repurchase agreements		300,714		—		300,662		—		300,662


	As of December 31, 2022
	Carrying		Estimated Fair Value
	Amount		Level 1		Level 2		Level 3		Total
	(Dollars in thousands)
Assets
Cash and due from banks	$	423,832	$	423,832	$	—	$	—	$	423,832
Federal funds sold		301		301		—		—		301
Held to maturity securities		14,019,503		—		12,387,125		—		12,387,125
Loans held for sale		554		—		554		—		554
Loans held for investment, net of allowance		17,817,077		—		—		17,550,309		17,550,309
Loans held for investment - Warehouse Purchase Program		740,620		—		740,620		—		740,620
Other real estate owned		1,963		—		1,963		—		1,963
Liabilities
Deposits:
Noninterest-bearing	$	10,915,448	$	—	$	10,915,448	$	—	$	10,915,448
Interest-bearing		17,618,083		—		17,563,711		—		17,563,711
Other borrowings		1,850,000		—		1,850,000		—		1,850,000
Securities sold under repurchase agreements		428,134		—		428,061		—		428,061

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

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2023

(UNAUDITED)

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 loans. 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 September 30, 2023. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since those dates and, therefore, current estimates of fair value may differ significantly from the amounts presented herein.

7. GOODWILL AND CORE DEPOSIT INTANGIBLES

Changes in the carrying amount of the Company’s goodwill and core deposit intangibles for the nine months ended September 30, 2023 and the year ended December 31, 2022 were as follows:


	Goodwill		Core Deposit Intangibles
	(Dollars in thousands)
Balance as of December 31, 2021	$	3,231,636	$	61,684
Less:
Amortization		—		(10,336	)
Balance as of December 31, 2022		3,231,636		51,348
Less:
Amortization		—		(9,117	)
Add:
First Bancshares Merger		164,823		25,322
Balance as of September 30, 2023	$	3,396,459	$	67,553

Goodwill is recorded as of 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 or core deposit intangibles has occurred. If any such impairment is determined, a write-down is recorded. As of September 30, 2023, 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.

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2023

(UNAUDITED)

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 $3.6 million and $2.6 million for the three months ended September 30, 2023 and 2022, respectively, and $9.1 million and $7.8 million for the nine months ended September 30, 2023 and 2022, respectively. The estimated aggregate future amortization expense for core deposit intangibles remaining as of September 30, 2023 is as follows (dollars in thousands):


Remaining 2023	$	3,559
2024		12,813
2025		11,410
2026		10,376
2027		9,288
Thereafter		20,107
Total	$	67,553

8. STOCK–BASED COMPENSATION

At September 30, 2023, Bancshares had one active stock-based incentive compensation plan with awards outstanding.

On March 3, 2020, Bancshares’ Board of Directors established the Prosperity Bancshares, Inc. 2020 Stock Incentive Plan (the “2020 Plan”), which was approved by Bancshares' shareholders on April 21, 2020. The 2020 Plan authorizes the issuance of up to 2,500,000 shares of common stock upon the exercise of options or pursuant to the grant or exercise, as the case may be, of other awards granted under the 2020 Plan, including incentive stock options, nonqualified stock options, stock appreciation rights, shares of restricted stock and restricted stock units. As of September 30, 2023, 65,932 shares of restricted common stock have vested and 505,593 shares of unvested restricted stock have been issued under the 2020 Plan.

As of September 30, 2023, the Company had no stock options outstanding. Stock-based compensation expense related to restricted stock was $3.1 million and $2.9 million during the three months ended September 30, 2023 and 2022, respectively, and $9.1 million and $8.5 million during the nine months ended September 30, 2023 and 2022, respectively. As of September 30, 2023, there was $9.9 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 1.99 years.

9. CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ITEMS

Contractual Obligations

The Company’s contractual obligations and other commitments to make future payments (other than deposit obligations and securities sold under repurchase agreements) as of September 30, 2023 are summarized below. The Company’s future cash payments associated with its contractual obligations pursuant to the Federal Reserve's Bank Term Funding Program (“BTFP”) and Federal Home Loan Bank (“FHLB”) advances as of September 30, 2023 are summarized below. The future interest payments were calculated using the current rate in effect at September 30, 2023. Payments under the BTFP include interest of $102.8 million that will be due over the future periods. These payments do not include prepayment 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)
Bank Term Funding Program	$	3,102,848		—		—		—	$	3,102,848
Federal Home Loan Bank advances		1,250,000		—		—		—		1,250,000
	$	4,352,848	$	—	$	—	$	—	$	4,352,848

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2023

(UNAUDITED)

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 15 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 has one sublease arrangement. Sublease income was $816 thousand and $807 thousand for the three months ended September 30, 2023 and 2022, and $2.3 million and $2.4 million for the nine months ended September 30, 2023 and 2022, respectively. As of September 30, 2023, operating lease ROU assets and lease liabilities were approximately $38.6 million. ROU assets and lease liabilities were classified as other assets and other liabilities, respectively.

As of September 30, 2023, the weighted average of remaining lease terms of the Company’s operating leases was 4.2 years. The weighted average discount rate used to determine the lease liabilities as of September 30, 2023 for the Company’s operating leases was 2.0%. Cash paid for the Company’s operating leases was $3.1 million and $2.7 million for the three months ended September 30, 2023 and 2022, respectively, and was $9.0 million and $8.1 million for the nine months ended September 30, 2023 and 2022, respectively. During the nine months ended September 30, 2023, the Company obtained $3.2 million in ROU assets in exchange for lease liabilities for seven operating leases, four of which, reflecting $2.7 million in ROU assets, were related to the Merger.

The Company’s future undiscounted cash payments associated with its operating leases as of September 30, 2023 are summarized below (dollars in thousands).


Remaining 2023	$	2,696
2024		10,301
2025		9,737
2026		8,592
2027		5,569
2028		2,588
Thereafter		5,283
Total undiscounted lease payments	$	44,766

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, unused capacity on Warehouse Purchase Program loans and commitments to extend credit expiring by period as of September 30, 2023 are summarized below. Since commitments associated with letters of credit, unused capacity of Warehouse Purchase Program loans and commitments to extend credit may expire unused, the amounts shown may 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	$	72,215	$	7,456	$	1,100	$	26	$	80,797
Unused capacity on Warehouse Purchase Program loans		1,170,673		—		—		—		1,170,673
Commitments to extend credit		1,728,337		1,080,668		306,129		1,898,917		5,014,051
Total	$	2,971,225	$	1,088,124	$	307,229	$	1,898,943	$	6,265,521

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2023

(UNAUDITED)

The Company records an allowance for credit losses on off-balance sheet credit exposure that is adjusted through a charge to provision for credit losses on the Company’s consolidated statement of income. At September 30, 2023 and December 31, 2022, this allowance, reported as a separate line item on the Company’s consolidated balance sheet, totaled $36.5 million and $29.9 million, respectively. The increase in the allowance was primarily due to the Merger.

10. OTHER COMPREHENSIVE INCOME

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


	Three Months Ended September 30,
	2023							2022
	Before Tax Amount		Tax Effect			Net of Tax Amount		Before Tax Amount			Tax Effect		Net of Tax Amount
	(Dollars in thousands)
Other comprehensive income (loss):
Securities available for sale:
Change in unrealized gain (loss) during period	$	951	$	(200	)	$	751	$	(1,813	)	$	380	$	(1,433	)
Total securities available for sale		951		(200	)		751		(1,813	)		380		(1,433	)
Total other comprehensive income (loss)	$	951	$	(200	)	$	751	$	(1,813	)	$	380	$	(1,433	)


	Nine Months Ended September 30,
	2023							2022
	Before Tax Amount		Tax Effect			Net of Tax Amount		Before Tax Amount			Tax Effect		Net of Tax Amount
	(Dollars in thousands)
Other comprehensive income (loss):
Securities available for sale:
Change in unrealized gain (loss) during period	$	1,953	$	(410	)	$	1,543	$	(2,587	)	$	543	$	(2,044	)
Total securities available for sale		1,953		(410	)		1,543		(2,587	)		543		(2,044	)
Total other comprehensive income (loss)	$	1,953	$	(410	)	$	1,543	$	(2,587	)	$	543	$	(2,044	)

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


	Securities Available for Sale			Accumulated Other Comprehensive Income (Loss)
	(Dollars in thousands)
Balance at December 31, 2022	$	(3,473	)	$	(3,473	)
Other comprehensive income		1,543			1,543
Balance at September 30, 2023	$	(1,930	)	$	(1,930	)

Balance at December 31, 2021	$	1,809		$	1,809
Other comprehensive loss		(2,044	)		(2,044	)
Balance at September 30, 2022	$	(235	)	$	(235	)

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2023

(UNAUDITED)

11. DERIVATIVE FINANCIAL INSTRUMENTS

The following table provides the outstanding notional balances and fair values of outstanding derivative positions at September 30, 2023 and December 31, 2022.


	September 30, 2023						December 31, 2022
	Outstanding Notional Balance		Asset Derivative Fair Value		Liability Derivative Fair Value		Outstanding Notional Balance		Asset Derivative Fair Value		Liability Derivative Fair Value
	(Dollars in thousands)
Interest rate lock commitments	$	19,296	$	302	$	35	$	4,599	$	94	$	6
Forward mortgage-backed securities trades		28,250		240		3		5,250		31		—
Commercial loan interest rate swaps and caps:
Loan customer counterparty		67,535		—		5,699		93,214		—		5,522
Financial institution counterparty		67,535		5,660		—		93,214		5,522		—

These financial instruments are not designated as hedging instruments and are used for asset and liability management and commercial customers’ financing needs. All derivatives are carried at fair value in either other assets or other liabilities.

Interest rate lock commitments (“IRLCs”) — In the normal course of business, the Company enters into interest rate lock commitments with consumers to originate mortgage loans at a specified interest rate. These commitments, which contain fixed expiration dates, offer the borrower an interest rate guarantee provided the loan meets underwriting guidelines and closes within the timeframe established by the Company.

Forward mortgage-backed securities trades — The Company manages the changes in fair value associated with changes in interest rates related to IRLCs by using forward sold commitments known as forward mortgage-backed securities trades. These instruments are typically entered into at the time the interest rate lock commitment is made.

Interest rate swaps and caps — These derivative positions relate to transactions in which the Company enters into an interest rate swap or cap with a customer, while at the same time entering into an offsetting interest rate swap or cap with another financial institution. An interest rate swap transaction allows the Company’s customer to effectively convert a variable rate loan to a fixed rate. In connection with each swap, the Company agrees to pay interest to the customer on a notional amount at a variable interest rate and receive interest from the customer on a similar notional amount at a fixed interest rate. At the same time, the Company agrees to pay another financial institution the same fixed interest rate on the same notional amount and receive the same variable interest rate on the same notional amount. In connection with each interest rate cap, the Company sells a cap to the customer and agrees to pay interest if the underlying index exceeds the strike price defined in the cap agreement. Simultaneously the Company purchases a cap with matching terms from another financial institution that agrees to pay the Company if the underlying index exceeds the strike price.

The commercial loan customer counterparty weighted average received and paid interest rates for interest rate swaps outstanding at September 30, 2023 and December 31, 2022 are presented in the following table.


	Weighted-Average Interest Rate
	September 30, 2023						December 31, 2022
	Received			Paid			Received			Paid
Loan customer counterparty		3.07	%		6.79	%		3.05	%		5.18	%

The Company’s credit exposure on interest rate swaps is limited to the net favorable value of all swaps by each counterparty, which was approximately $5.7 million at September 30, 2023 and $5.5 million at December 31, 2022. This credit exposure is partly mitigated as transactions with customers are secured by the collateral, if any, securing the underlying transaction being hedged. The Company’s credit exposure, net of collateral pledged, relating to interest rate swaps with upstream financial institution counter-parties was zero at September 30, 2023. A credit support annex is in place and allows the Company to call collateral from upstream financial institution counter-parties. Collateral levels are monitored and adjusted on a regular basis for changes in interest rate swap values. The Company’s cash collateral pledged for interest rate swaps was zero at September 30, 2023 and December 31, 2022.

PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2023

(UNAUDITED)

The initial and subsequent changes in the fair value of IRLCs and the forward sales of mortgage-backed securities are recorded in net gain on sale of mortgage loans. These gains and losses were not attributable to instrument-specific credit risk. For interest rate swaps and caps, because the Company acts as an intermediary for its customer, changes in the fair value of the underlying derivative contracts substantially offset each other and do not have a material impact on its results of operations. Income (loss) for the three and nine months ended September 30, 2023 and 2022 was as follows:


	Three Months Ended September 30,						Nine Months Ended September 30,
Derivatives not designated as hedging instruments	2023			2022			2023		2022
	(Dollars in thousands)
Interest rate lock commitments	$	(11	)	$	(264	)	$	103	$	(269	)
Forward mortgage-backed securities trades		510			343			668		822

12. ACQUISITIONS

Merger of First Bancshares of Texas, Inc. — Effective May 1, 2023, the Company completed the Merger of First Bancshares into Bancshares and the subsequent merger of its wholly owned subsidiary FirstCapital Bank into the Bank. FirstCapital Bank operated 16 full-service banking offices in six different markets in West, North and Central Texas areas, including its main office in Midland, and banking offices in Midland, Lubbock, Amarillo, Wichita Falls, Burkburnett, Byers, Henrietta, Dallas, Horseshoe Bay, Marble Falls and Fredericksburg, Texas. As of March 31, 2023, First Bancshares, on a consolidated basis, reported total assets of $2.14 billion, total loans of $1.65 billion and total deposits of $1.71 billion. The acquisition was not considered significant to the Company’s financial statements and therefore pro forma financial data and related disclosures are not included.

Pursuant to the terms of the definitive agreement, Bancshares issued 3,583,370 shares of its common stock with a closing price of $62.62 per share plus approximately $91.5 million in cash for all outstanding shares of First Bancshares. As of September 30, 2023, the Company recognized goodwill of $164.8 million, which does not include all the subsequent fair value adjustments that have not yet been finalized. Goodwill represents the excess of the total purchase price paid over the fair value of the assets acquired, net of the fair value of liabilities assumed. During the second quarter of 2023, the Company completed the operational conversion of FirstCapital Bank.

Pending Merger of Lone Star State Bancshares, Inc. — On October 11, 2022, Bancshares and Lone Star State Bancshares, Inc. (“Lone Star”) jointly announced the signing of a definitive merger agreement whereby Lone Star, the parent company of Lone Star State Bank of West Texas (“Lone Star Bank”), will merge with and into Bancshares. Lone Star Bank operates five banking offices in the West Texas area, including its main office in Lubbock, and one banking center in each of Brownfield, Midland, Odessa and Big Spring, Texas. As of September 30, 2023, Lone Star, on a consolidated basis, reported total assets of $1.27 billion, total loans of $1.10 billion and total deposits of $1.11 billion.

Under the terms of the merger agreement, Bancshares will issue 2,376,182 shares of its common stock plus $64.1 million in cash for all outstanding shares of Lone Star capital stock, subject to certain conditions and potential adjustments. Based on the closing price of Bancshares’ common stock of $69.27 on October 7, 2022, the total consideration was valued at approximately $228.7 million. The transaction is subject to customary closing conditions, including the receipt of regulatory approvals. The shareholders of Lone Star approved the transaction on March 28, 2023.

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;

•

volatility 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 fluctuations in the price of oil, natural gas and other commodities, 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;

•

the potential impacts of climate change;

•

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

•

the timing, impact and other uncertainties of any future acquisitions, including the pending acquisition of Lone Star, 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 residential and commercial real estate;

•

the failure of assumptions underlying the establishment of and provisions made to the allowance for credit losses, including such assumptions related to potential, pending or recent acquisitions;

•

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 the Company’s systems;

•

the failure of analytical and forecasting models and tools used by the Company to estimate expected 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, civil unrest, insurrections, other political, economic or diplomatic developments, including those caused by public health issues, outbreaks of diseases and pandemics, 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 for the year ended December 31, 2022, 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 in Part I, Item 1 of 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, 2022.

OVERVIEW

Prosperity Bancshares, Inc., a Texas corporation (“Bancshares”), 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,” and together with Bancshares, the “Company”). The Bank provides a wide array of financial products and services to businesses and consumers throughout Texas and Oklahoma. As of September 30, 2023, the Bank operated 285 full-service banking locations: 65 in the Houston area, including The Woodlands; 30 in the South Texas area including Corpus Christi and Victoria; 62 in the Dallas/Fort Worth area; 22 in the East Texas area; 32 in the Central Texas area including Austin and San Antonio; 44 in the West Texas area including Lubbock, Midland-Odessa, Abilene; Amarillo and Wichita Falls; 16 in the Bryan/College Station area, 6 in the Central Oklahoma area; 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. 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 May 1, 2023, the Company acquired First Bancshares of Texas, Inc. (“First Bancshares”) headquartered in Midland, Texas, as described under “—Recent Acquisition” below. On October 11, 2022, Bancshares announced the signing of a definitive merger agreement with Lone Star State Bancshares, Inc. (“Lone Star”) headquartered in Lubbock, Texas, as described under “—Pending Acquisition” below.

Total assets were $39.30 billion at September 30, 2023 compared with $37.69 billion at December 31, 2022, an increase of $1.61 billion or 4.3%. Total loans were $21.43 billion at September 30, 2023 compared with $18.84 billion at December 31, 2022, an increase of $2.59 billion or 13.8%. Total deposits were $27.31 billion at September 30, 2023 compared with $28.53 billion at December 31, 2022, a decrease of $1.22 billion or 4.3%. Total shareholders’ equity was $7.03 billion at September 30, 2023 compared with $6.70 billion at December 31, 2022, an increase of $333.3 million or 5.0%.

RECENT ACQUISITION

Merger of First Bancshares of Texas, Inc. — Effective May 1, 2023, the Company completed the merger of First Bancshares into Bancshares and the subsequent merger of its wholly owned subsidiary, FirstCapital Bank of Texas, N.A. (“FirstCapital Bank”), into the Bank (collectively, the “Merger”). FirstCapital Bank operated 16 full-service banking offices in six different markets in West, North and Central Texas areas, including its main office in Midland, and banking offices in Midland, Lubbock, Amarillo, Wichita Falls, Burkburnett, Byers, Henrietta, Dallas, Horseshoe Bay, Marble Falls and Fredericksburg, Texas. As of March 31, 2023, First Bancshares, on a consolidated basis, reported total assets of $2.14 billion, total loans of $1.65 billion and total deposits of $1.71 billion.

Pursuant to the terms of the definitive agreement, Bancshares issued 3,583,370 shares of its common stock with a closing price of $62.62 per share plus approximately $91.5 million in cash for all outstanding shares of First Bancshares. As of September 30, 2023, the Company recognized goodwill of $164.8 million which does not include all the subsequent fair value adjustments that have not yet been finalized. During the second quarter of 2023, the Company completed the operational conversion of FirstCapital Bank.

PENDING ACQUISITION

Pending Merger of Lone Star State Bancshares, Inc. — On October 11, 2022, Bancshares and Lone Star jointly announced the signing of a definitive merger agreement whereby Lone Star, the parent company of Lone Star State Bank of West Texas (“Lone Star Bank”), will merge with and into the Company. Lone Star Bank operates 5 banking offices in the West Texas area, including its main office in Lubbock, and one banking center in each of Brownfield, Midland, Odessa and Big Spring, Texas. As of September 30, 2023, Lone Star, on a consolidated basis, reported total assets of $1.27 billion, total loans of $1.10 billion and total deposits of $1.11 billion.

Under the terms of the merger agreement, Bancshares will issue 2,376,182 shares of its common stock plus $64.1 million in cash for all outstanding shares of Lone Star capital stock, subject to certain conditions and potential adjustments. Based on the closing price of Bancshares' common stock of $69.27 on October 7, 2022, the total consideration was valued at approximately $228.7 million. The transaction is subject to customary closing conditions, including the receipt of regulatory approvals. The shareholders of Lone Star approved the transaction on March 28, 2023.

CRITICAL ACCOUNTING ESTIMATES

The preparation of financial statements in conformity with GAAP requires the Company to establish accounting policies and make estimates that affect amounts reported in the consolidated financial statements. An accounting estimate requires assumptions and judgments about uncertain matters that could have a material effect on the consolidated financial statements. Estimates are made using facts and circumstances known at a point in time. Changes in those facts and circumstances could produce results substantially different from those estimates. 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, 2022. The Company believes that of its significant accounting policies, the following may involve a higher degree of judgment and complexity:

Business Combinations—Generally, acquisitions are accounted for under the acquisition method of accounting in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 805, Business Combinations. A business combination occurs when the Company acquires net assets that constitute a business and obtains control over that business. Business combinations are effected through the transfer of consideration consisting of cash and/or common stock and are accounted for using the acquisition method. Accordingly, the assets and liabilities of the acquired business are recorded at their respective fair values at the acquisition date. Determining the fair value of assets and liabilities, especially the loan portfolio, is a process involving significant judgment regarding methods and assumptions used to calculate estimated fair values. Fair values are subject to refinement for up to one year after the closing date of the acquisition as information relative to closing date fair values becomes available. The results of operations of an acquired entity are included in the Company’s consolidated results from acquisition date, and prior periods are not restated.

Allowance for Credit Losses— The allowance for credit losses is accounted for in accordance with FASB ASC 326, Measurement of Credit Losses on Financial Instruments which replaced the incurred loss methodology with an expected loss methodology that is referred to as the current expected credit loss (“CECL”) methodology. CECL 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 allowance for credit losses is an allowance available for losses on loans and held-to-maturity securities. The allowance for credit losses is adjusted through charges to earnings in the form of a provision for credit losses. All losses are charged to the allowance when the loss actually occurs or when a determination is made that such a loss is likely and can be reasonably estimated. Recoveries are credited to the allowance at the time of recovery.

The Company’s allowance for credit losses consists of two elements: (1) specific valuation allowances based on expected losses on impaired loans and certain purchased credit-deteriorated loans (“PCD”) loans; and (2) a general valuation allowance based on historical lifetime loan loss experience, current economic conditions, reasonable and supportable forecasted economic conditions and other qualitative risk factors both internal and external to the Company. 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 lifetime loan loss experience, the amount of nonperforming assets and related collateral, the volume, growth and composition of the portfolio, current economic conditions and reasonable and supportable forecasted economic conditions that may affect borrower 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. Pursuant to the Company's adoption of ASU 2022-02 effective January 1, 2023, the Company prospectively discontinued troubled debt restructurings accounting and no longer measures the economic concession for loan modifications occurring on or after the adoption date. In addition, modifications to loans previously designated as troubled debt restructurings that occur on or after January 1, 2023, are accounted for under the newly adopted ASU and result in the elimination of any prior economic concession recorded in the allowance related to such loans. For further discussion of the methodology used in the determination of the allowance for credit losses on loans, see “Accounting for Acquired Loans and the Allowance for Acquired Credit Losses” below and “Financial Condition—Allowance for Credit Losses on Loans” 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 are recorded at their fair values at the acquisition date. The fair value estimates associated with acquired loans, 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. 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 on Loans” below. For further discussion of the Company’s acquisition and loan accounting, see Note 5 to the consolidated financial statements.

RESULTS OF OPERATIONS

Net income available to common shareholders was $112.2 million for the quarter ended September 30, 2023 compared with $135.8 million for the same period in 2022. The change was primarily due to an increase in interest expense and noninterest expense, partially offset by increases in loan interest income and noninterest income. Net income per diluted common share was $1.20 for the quarter ended September 30, 2023 compared with $1.49 for the same period in 2022. The Company posted annualized returns on average common equity of 6.39% and 8.24%, annualized returns on average assets of 1.13% and 1.45% and efficiency ratios of 48.74% and 41.38% for the quarters ended September 30, 2023 and 2022, respectively. The efficiency ratio is calculated by dividing total noninterest expense (excluding net gains and losses on the sale or write down of assets and securities) by the sum of net interest

income and noninterest income. Because the ratio is a measure of revenues and expenses resulting from the Company’s lending activities and fee-based banking services, net gains and losses on the sale or write-down of assets and securities are not included. Additionally, taxes are not part of this calculation.

Net income available to common shareholders was $323.8 million for the nine months ended September 30, 2023 compared with $386.6 million for the same period in 2022. The change was primarily due to lower net interest income, merger related provision for credit losses of $18.5 million and merger related expenses of $14.9 million. Net income per diluted common share was $3.50 for the nine months ended September 30, 2023 compared with $4.22 for the same period in 2022, and was also impacted by merger related provision and expenses. The Company posted annualized returns on average common equity of 6.25% and 7.88%, annualized returns on average assets of 1.11% and 1.37% and efficiency ratios of 48.50% and 42.70% for the nine months ended September 30, 2023 and 2022, 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 September 30, 2023

Net interest income before the provision for credit losses was $239.5 million for the quarter ended September 30, 2023, a decrease of $21.2 million or 8.1%, compared with $260.7 million for the same period in 2022. The change was primarily due to an increase in average balance and average rate on other borrowings and an increase in the average rates on interest-bearing deposits, partially offset by an increase in the average balances and average rates on loans.

Interest income on loans was $308.7 million for the quarter ended September 30, 2023, an increase of $98.4 million or 46.8%, compared with $210.3 million for the same period in 2022. The increase was due to an increase in both the average balances and average rates on loans.

Interest income on securities was $70.0 million for the quarter ended September 30, 2023, an increase of $1.2 million or 1.8%, compared with $68.8 million for the same period in 2022, primarily due to an increase in the average rates on investment securities.

Average interest-bearing liabilities were $21.98 billion for the quarter ended September 30, 2023, an increase of $2.42 billion or 12.3%, compared with $19.57 billion for the same period in 2022, primarily due to an increase in other borrowings partially offset by a decrease in interest-bearing deposits. The average rate on interest-bearing liabilities was 2.54% for the quarter ended September 30, 2023, an increase of 216 basis points, compared with 0.38% for the same period in 2022.

The net interest margin on a tax-equivalent basis was 2.72% for the quarter ended September 30, 2023, a decrease of 39 basis points compared with 3.11% for the same period in 2022. The change was primarily due to an increase in the average balance and average rate on other borrowings and an increase in the average rates on interest-bearing deposits, partially offset by an increase in the average balance and average rate on loans held for investment.

For the Nine Months Ended September 30, 2023

Net interest income before the provision for credit losses was $719.5 million for the nine months ended September 30, 2023, a decrease of $29.6 million or 4.0%, compared with $749.1 million for the same period in 2022. The change was primarily due to an increase in the average balance and average rate on other borrowings and an increase in average rates on interest-bearing deposits, partially offset by an increase in the average balance and average rate on loans held for investment.

Interest income on loans was $842.4 million for the nine months ended September 30, 2023, an increase of $246.4 million or 41.3%, compared with $596.1 million for the same period in 2022. The change was due to an increase in both the average balance and average rate on loans held for investment.

Interest income on securities was $215.2 million for the nine months ended September 30, 2023, an increase of $27.3 million or 14.6%, compared with $187.9 million for the same period in 2022, primarily due to an increase in the average rates on investment securities, partially offset by a decrease in the average balances on investment securities.

Average interest-bearing liabilities were $21.55 billion for the nine months ended September 30, 2023, an increase of $1.41 billion or 7.0%, compared with $20.14 billion for the same period in 2022, primarily due to an increase in other borrowings partially offset by a decrease in interest-bearing deposits. The average rate on interest-bearing liabilities was 2.16% for the nine months ended September 30, 2023, an increase of 191 basis points, compared with 0.25% for the same period in 2022.

The net interest margin on a tax-equivalent basis was 2.79% for the nine months ended September 30, 2023, a decrease of 20 basis points, compared with 2.99% for the nine months ended September 30, 2022. The change was primarily due to an increase in the average balance and average rate on other borrowings and an increase in the average rates on interest-bearing deposits, partially offset by an increase in the average balances and average rates on loans held for investment and an increase in average rates on investment securities.

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 tables as loans carrying a zero yield.


	Three Months Ended September 30,
	2023								2022
	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 held for sale	$	9,832		$	162		6.54	%	$	4,136		$	57		5.47	%
Loans held for investment		20,496,075			290,566		5.62	%		17,275,866			199,417		4.58	%
Loans held for investment - Warehouse Purchase Program		972,936			17,950		7.32	%		938,589			10,794		4.56	%
Total loans		21,478,843			308,678		5.70	%		18,218,591			210,268		4.58	%
Investment securities		13,512,137			69,987		2.05	%		14,962,847			68,761		1.82	%
Federal funds sold and other earning assets		125,690			1,689		5.33	%		87,859			525		2.37	%
Total interest-earning assets		35,116,670			380,354		4.30	%		33,269,297			279,554		3.33	%
Allowance for credit losses on loans		(343,967	)							(283,244	)
Noninterest-earning assets		4,829,336								4,480,512
Total assets	$	39,602,039							$	37,466,565

Liabilities and Shareholders' Equity
Interest-Bearing Liabilities:
Interest-bearing demand deposits	$	4,768,485		$	5,182		0.43	%	$	6,155,511		$	2,345		0.15	%
Savings and money market deposits		8,977,824			44,446		1.96	%		10,172,986			9,479		0.37	%
Certificates and other time deposits		3,172,178			26,441		3.31	%		2,185,529			2,845		0.52	%
Other borrowings		4,671,449			62,190		5.28	%		577,828			3,719		2.55	%
Securities sold under repurchase agreements		389,149			2,533		2.58	%		473,584			487		0.41	%
Subordinated debentures		2,578			38		5.85	%		—			—		—
Total interest-bearing liabilities		21,981,663			140,830		2.54	%		19,565,438			18,875		0.38	%
Noninterest-Bearing Liabilities:
Noninterest-bearing demand deposits		10,269,162								11,048,856
Allowance for credit losses on off-balance sheet credit exposures		36,504								29,947
Other liabilities		290,217								231,812
Total liabilities		32,577,546								30,876,053
Shareholders' equity		7,024,493								6,590,512
Total liabilities and shareholders' equity	$	39,602,039							$	37,466,565

Net interest rate spread							1.76	%							2.95	%
Net interest income and margin (2) (3)				$	239,524		2.71	%				$	260,679		3.11	%
Net interest income and margin (tax equivalent) (4)				$	240,524		2.72	%				$	261,137		3.11	%

(1)

Annualized and based on average balances on an actual 365-day basis for the three months ended September 30, 2023 and 2022.

(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% and other applicable effective tax rates.


	Nine Months Ended September 30,
	2023								2022
	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 held for sale	$	5,389		$	267		6.62	%	$	3,980		$	137		4.60	%
Loans held for investment		19,546,826			797,861		5.46	%		16,931,422			564,736		4.46	%
Loans held for investment - Warehouse Purchase Program		831,143			44,306		7.13	%		1,153,762			31,190		3.61	%
Total loans		20,383,358			842,434		5.53	%		18,089,164			596,063		4.41	%
Investment securities		13,937,483			215,225		2.06	%		14,579,521			187,883		1.72	%
Federal funds sold and other earning assets		290,275			10,452		4.81	%		913,923			2,297		0.34	%
Total interest-earning assets		34,611,116			1,068,111		4.13	%		33,582,608			786,243		3.13	%
Allowance for credit losses on loans		(303,518	)							(284,486	)
Noninterest-earning assets		4,722,064								4,462,318
Total assets	$	39,029,662							$	37,760,440

Liabilities and Shareholders' Equity
Interest-Bearing Liabilities:
Interest-bearing demand deposits	$	5,260,463		$	12,765		0.32	%	$	6,453,810		$	6,951		0.14	%
Savings and money market deposits		9,235,646			122,992		1.78	%		10,579,351			17,978		0.23	%
Certificates and other time deposits		2,627,402			51,619		2.63	%		2,409,251			7,135		0.40	%
Other borrowings		4,001,994			153,937		5.14	%		232,253			4,169		2.40	%
Securities sold under repurchase agreements		419,304			7,310		2.33	%		462,994			916		0.26	%
Subordinated debentures		1,375			38		3.69	%		—			—		—
Total interest-bearing liabilities		21,546,184			348,661		2.16	%		20,137,659			37,149		0.25	%
Noninterest-Bearing Liabilities:
Noninterest-bearing demand deposits		10,310,878								10,848,605
Allowance for credit losses on off-balance sheet credit exposures		32,181								29,947
Other liabilities		232,903								198,196
Total liabilities		32,122,146								31,214,407
Shareholders' equity		6,907,516								6,546,033
Total liabilities and shareholders' equity	$	39,029,662							$	37,760,440

Net interest rate spread							1.97	%							2.88	%
Net interest income and margin (2) (3)				$	719,450		2.78	%				$	749,094		2.98	%
Net interest income and margin (tax equivalent) (4)				$	722,316		2.79	%				$	750,469		2.99	%

(1)

Annualized and based on average balances on an actual 365-day basis for the nine months ended September 30, 2023 and 2022.

(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)

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 in interest income and interest expense related to purchase accounting adjustments and changes attributable to both rate and volume which cannot be segregated have been allocated to rate.


	Three Months Ended September 30,									Nine Months Ended September 30,
	2023 vs. 2022									2023 vs. 2022
	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 held for sale	$	78		$	27		$	105		$	49		$	81		$	130
Loans held for investment (1)		37,171			53,978			91,149			87,235			145,890			233,125
Loans held for investment - Warehouse Purchase Program		395			6,761			7,156			(8,721	)		21,837			13,116
Investment securities (1)		(6,667	)		7,893			1,226			(8,274	)		35,616			27,342
Federal funds sold and other earning assets		226			938			1,164			(1,567	)		9,722			8,155
Total increase in interest income		31,203			69,597			100,800			68,722			213,146			281,868

Interest-Bearing Liabilities:
Interest-bearing demand deposits		(528	)		3,365			2,837			(1,286	)		7,100			5,814
Savings and money market deposits		(1,114	)		36,081			34,967			(2,283	)		107,297			105,014
Certificates and other time deposits (1)		1,284			22,312			23,596			646			43,838			44,484
Other borrowings		26,347			32,124			58,471			67,668			82,100			149,768
Securities sold under repurchase agreements		(88	)		2,134			2,046			(86	)		6,480			6,394
Subordinated debentures		38			—			38			38			—			38
Total increase in interest expense		25,939			96,016			121,955			64,697			246,815			311,512
Increase (decrease) in net interest income	$	5,264		$	(26,419	)	$	(21,155	)	$	4,025		$	(33,669	)	$	(29,644	)

(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 on loans and off-balance sheet credit exposures to a level deemed appropriate by management of the Company based on such factors as historical lifetime credit loss experience, the amount of nonperforming loans and related collateral, the volume growth and composition of the loan portfolio, current economic conditions and reasonable and supportable forecasted economic conditions that may affect borrower 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.

There was no provision for credit losses for the three months ended September 30, 2023 and a provision for credit losses of $18.5 million for the nine months ended September 30, 2023 compared to no provision for credit losses for the three and nine months ended September 30, 2022. As a result of the loans acquired in the Merger, the nine months ended September 30, 2023 included a $12.0 million provision for credit losses on loans and a $6.5 million provision for credit losses on off-balance sheet credit exposures.

Net charge-offs were $3.4 million for the quarter ended September 30, 2023 compared with net charge-offs of $1.8 million for the quarter ended September 30, 2022. Net charge-offs for the three months ended September 30, 2023 included $298 thousand related to resolved PCD loans. Additionally, reserves on PCD loans increased by $9.7 million due to revised Day One accounting for PCD loans at the time of the Merger. Further, $12.5 million of reserves on resolved PCD loans was released to the general reserve.

Noninterest Income

The Company’s primary sources of recurring noninterest income are credit, debit and ATM card income, nonsufficient funds fees and service charges on deposit accounts. Additionally, the Company generates recurring noninterest income from its various additional products and services, including trust services, mortgage lending, brokerage and independent sales organization sponsorship operations. 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 $38.7 million for the three months ended September 30, 2023 compared with $34.7 million for the same period in 2022, an increase of $4.1 million or 11.7%, primarily due to increases in other noninterest income, bank owned life insurance income, mortgage income and debit card fee income. Noninterest income totaled $116.7 million for the nine months ended September 30, 2023 compared with $107.4 million for the same period in 2022, an increase of $9.3 million or 8.7%, primarily due to increases in credit card, debit card and ATM card income, trust income, other noninterest income and the Merger.

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


	Three Months Ended September 30,					Nine Months Ended September 30,
	2023			2022		2023		2022
	(Dollars in thousands)
Nonsufficient funds fees	$	8,719		$	8,887	$	25,326	$	25,495
Credit card, debit card and ATM card income		9,285			8,889		27,157		25,948
Service charges on deposit accounts		6,262			6,222		18,266		18,798
Trust income		3,326			3,174		9,909		8,752
Mortgage income		857			340		1,756		1,297
Brokerage income		1,067			940		3,216		2,749
Bank owned life insurance income		1,864			1,214		4,771		3,790
Net (loss) gain on sale or write-down of assets		(45	)		50		2,070		1,847
Other		7,408			4,972		24,226		18,728
Total noninterest income	$	38,743		$	34,688	$	116,697	$	107,404

Noninterest Expense

Noninterest expense totaled $135.7 million for the quarter ended September 30, 2023 compared with $122.2 million for the quarter ended September 30, 2022, an increase of $13.4 million or 11.0%, primarily due to the Merger. Noninterest expense totaled $404.5 million for the nine months ended September 30, 2023 compared with $364.9 million for the nine months ended September 30, 2022, an increase of $39.6 million or 10.8%, primarily due to the Merger.

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


	Three Months Ended September 30,						Nine Months Ended September 30,
	2023			2022			2023			2022
	(Dollars in thousands)
Salaries and employee benefits (1)	$	85,423		$	79,578		$	247,944		$	239,360
Non-staff expenses:
Net occupancy and equipment		9,464			8,412			26,424			24,299
Credit and debit card, data processing and software amortization		10,919			9,516			30,829			27,611
Regulatory assessments and FDIC insurance		5,155			2,807			15,225			8,508
Core deposit intangibles amortization		3,576			2,577			9,117			7,778
Depreciation		4,585			4,436			13,676			13,522
Communications (2)		3,686			3,374			10,841			9,499
Net other real estate income (3)		(581	)		(15	)		(1,033	)		(213	)
Merger related expenses		1,104			—			14,855			—
Other		12,326			11,529			36,649			34,578
Total noninterest expense	$	135,657		$	122,214		$	404,527		$	364,942

(1)

Includes stock-based compensation expense of $3.1 million and $2.9 million for the three months ended September 30, 2023 and 2022, respectively, and $9.1 million and $8.5 million for the nine months ended September 30, 2023 and 2022, respectively.

(2)

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

(3)

Net other real estate income is comprised of rental expense, rental income and gains and losses on sales of real estate.

Income Taxes

The amount of federal and state income tax expense is influenced by the amount of pre-tax income, the amount of tax-exempt income and the amount of other nondeductible expenses. Income tax expense totaled $30.4 million for the three months ended September 30, 2023 compared with $37.3 million for the same period in 2022, a decrease of $6.9 million or 18.6%. Income tax expense totaled $89.2 million for the nine months ended September 30, 2023 compared with $104.9 million for the same period in 2022, a decrease of $15.7 million or 14.9%. The Company’s effective tax rate for the three months ended September 30, 2023 and 2022 was 21.3% and 21.6%, respectively. The Company’s effective tax rate for the nine months ended September 30, 2023 and 2022 was 21.6% and 21.3%, respectively.

FINANCIAL CONDITION

Loan Portfolio

The Company separates its loan portfolio into two general categories of loans: (1) “originated 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 recorded at fair value at acquisition date. Those acquired loans that are renewed or substantially modified after the date of the business combination are referred to as “re-underwritten acquired 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 an originated 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 purchased credit-deteriorated loans (“PCD loans”) and “Non-PCD loans.” Acquired loans with evidence of credit quality deterioration as of the acquisition date when compared to the origination date are classified as PCD loans.

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


	September 30, 2023
			Acquired Loans
	Originated Loans		Re-Underwritten Acquired Loans		Non-PCD Loans		PCD Loans		Total Loans
	(Dollars in thousands)
Residential mortgage loans held for sale	$	10,187	$	—	$	—	$	—	$	10,187

Commercial and industrial		1,628,627		621,265		243,241		109,895		2,603,028
Warehouse purchase program		912,327		—		—		—		912,327
Real estate:
Construction, land development and other land loans		2,824,902		123,484		5,614		246,479		3,200,479
1-4 family residential (includes home equity)		7,006,106		221,223		759,331		5,244		7,991,904
Commercial real estate (includes multi-family residential)		4,156,222		341,812		880,669		228,134		5,606,837
Farmland		551,811		9,000		22,465		11,906		595,182
Agriculture		153,580		33,499		10,446		9,226		206,751
Consumer and other		273,246		16,162		16,513		97		306,018
Total loans held for investment		17,506,821		1,366,445		1,938,279		610,981		21,422,526
Total	$	17,517,008	$	1,366,445	$	1,938,279	$	610,981	$	21,432,713


	December 31, 2022
			Acquired Loans
	Originated Loans		Re-Underwritten Acquired Loans		Non-PCD Loans		PCD Loans		Total Loans
	(Dollars in thousands)
Residential mortgage loans held for sale	$	554	$	—	$	—	$	—	$	554

Commercial and industrial		1,711,433		730,969		137,272		15,068		2,594,742
Warehouse purchase program		740,620		—		—		—		740,620
Real estate:
Construction, land development and other land loans		2,672,903		126,607		5,759		169		2,805,438
1-4 family residential (includes home equity)		5,918,995		232,975		588,700		—		6,740,670
Commercial real estate (includes multi-family residential)		3,967,943		410,834		562,834		44,600		4,986,211
Farmland		498,512		5,740		13,658		185		518,095
Agriculture		140,838		29,041		59		—		169,938
Consumer and other		245,131		29,436		8,992		—		283,559
Total loans held for investment		15,896,375		1,565,602		1,317,274		60,022		18,839,273
Total	$	15,896,929	$	1,565,602	$	1,317,274	$	60,022	$	18,839,827

At September 30, 2023, total loans were $21.43 billion, an increase of $2.59 billion or 13.8%, compared with $18.84 billion at December 31, 2022. Loans at September 30, 2023 included $10.2 million of loans held for sale and $912.3 million of Warehouse Purchase Program loans compared with $554 thousand of loans held for sale and $740.6 million of Warehouse Purchase Program loans at December 31, 2022. At September 30, 2023, loans represented 54.5% of total assets compared with 50.0% of total assets at December 31, 2022.

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 based on the borrower’s ability to service the debt from income. Working capital loans are primarily collateralized by short-term assets whereas term loans are primarily collateralized by long-term assets. As a general practice, term loans are secured by any available real estate, equipment or other assets owned by the borrower. Both working capital and term loans are typically supported by a personal guaranty of a principal. 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 largely 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.

(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 25-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 and guarantor. Loans to hotels and restaurants are included in commercial real estate loans.

(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 30 years. Loans collateralized by 1-4 family residential real estate generally have been originated in amounts of no more than 89% of appraised value. The Company requires mortgage title insurance, as well as hazard, wind and/or flood insurance as appropriate. The Company prefers to retain residential mortgage 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 non-payments 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, which are sold to secondary market investors.

(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 variable 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, with heightened analysis of construction and/or development costs. 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) Warehouse Purchase Program. The Warehouse Purchase Program allows unaffiliated mortgage originators (“Clients”) to close 1-4 family real estate loans in their own name and manage their cash flow needs until the loans are sold to investors. The Company's Clients are strategically targeted for their experienced management teams and analyzed for the expected profitability of each Client’s business model over the long term. The Clients are located across the U.S. and originate mortgage loans primarily through traditional retail and/or wholesale business models using underwriting standards as required by United States government-sponsored enterprise agencies, “Agencies” such as Fannie Mae, private investors to which the mortgage loans are ultimately sold and/or mortgage insurers.

Although not subject to any legally binding commitment, when the Company makes a purchase decision, it acquires a 100% participation interest in the mortgage loans originated by its Clients. Individual mortgage loans are warehoused in the Company’s portfolio only for a short duration, averaging less than 30 days. When instructed by a Client that a warehoused loan has been sold to an investor, the Company delivers the note to the investor that pays the Company, which in turn remits the net sales proceeds to the Client.

(vi) Agriculture Loans. The Company provides agriculture loans for short-term livestock 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 industry segment, 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.

(vii) 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) 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, personal bankruptcy or death. 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 PCD loans unless the loan has deteriorated since the acquisition date.

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. A loan may be returned to accrual status when all the principal and interest amounts contractually due are brought current and future principal and interest amounts contractually due are reasonably assured, which is typically evidenced by a sustained period (at least six months) of repayment performance by the borrower.

Nonperforming assets increased $42.0 million to $69.5 million at September 30, 2023 compared with $27.5 million at December 31, 2022, of which $32.9 million and $9.1 million, respectively, were attributable to acquired loans.

The following tables present information regarding nonperforming assets differentiated among originated loans, re-underwritten acquired loans, Non-PCD loans and PCD loans, as of the dates indicated:


	September 30, 2023
				Acquired Loans
	Originated Loans			Re-Underwritten Acquired Loans			Non-PCD Loans			PCD Loans			Total
	(Dollars in thousands)
Nonaccrual loans (1)(3)	$	26,871		$	2,738		$	8,683		$	21,437		$	59,729
Accruing loans 90 or more days past due		397			—			—			—			397
Total nonperforming loans		27,268			2,738			8,683			21,437			60,126
Repossessed assets		35			—			—			—			35
Other real estate		9,320			—			—			—			9,320
Total nonperforming assets	$	36,623		$	2,738		$	8,683		$	21,437		$	69,481

Nonperforming assets to total loans and other real estate		0.21	%		0.20	%		0.45	%		3.51	%		0.32	%
Nonperforming assets to total loans, excluding Warehouse Purchase Program loans, and other real estate		0.22	%		0.20	%		0.45	%		3.51	%		0.34	%
Nonaccrual loans to total loans		0.15	%		0.20	%		0.45	%		3.51	%		0.28	%
Nonaccrual loans to total loans, excluding Warehouse Purchase Program loans		0.16	%		0.20	%		0.45	%		3.51	%		0.29	%


	December 31, 2022
				Acquired Loans
	Originated Loans			Re-Underwritten Acquired Loans			Non-PCD Loans			PCD Loans			Total
	(Dollars in thousands)
Nonaccrual loans (2)(3)	$	10,544		$	2,138		$	6,764		$	168		$	19,614
Accruing loans 90 or more days past due		5,917			—			—			—			5,917
Total nonperforming loans		16,461			2,138			6,764			168			25,531
Repossessed assets		—			—			—			—			—
Other real estate		1,963			—			-			—			1,963
Total nonperforming assets	$	18,424		$	2,138		$	6,764		$	168		$	27,494

Nonperforming assets to total loans and other real estate		0.12	%		0.14	%		0.51	%		0.28	%		0.15	%
Nonperforming assets to total loans, excluding Warehouse Purchase Program loans, and other real estate		0.12	%		0.14	%		0.51	%		0.28	%		0.15	%
Nonaccrual loans to total loans		0.07	%		0.14	%		0.51	%		0.28	%		0.10	%
Nonaccrual loans to total loans, excluding Warehouse Purchase Program loans		0.07	%		0.14	%		0.51	%		0.28	%		0.11	%

(1)

ASU 2022-02 became effective for the Company on January 1, 2023.

(2)

Includes troubled debt restructurings of $4.6 million as of December 31, 2022.

(3)

There were no nonperforming Warehouse Purchase Program loans or Warehouse Purchase Program lines of credit for the periods presented.

Nonperforming assets were 0.32% of total loans and other real estate at September 30, 2023 and 0.15% of total loans and other real estate at December 31, 2022. The allowance for credit losses on loans as a percentage of total nonperforming loans was 584.6% at September 30, 2023 and 1,102.9% at December 31, 2022.

Allowance for Credit Losses on Loans

The allowance for credit losses is adjusted through charges to earnings in the form of a provision for credit losses. Management has established an allowance for credit losses on loans which it believes is adequate as of September 30, 2023 for estimated losses in the Company’s loan portfolio. The amount of the allowance for credit losses on loans 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, (3) provisions for credit losses charged to earnings that increase the allowance, and (4) provision releases returned to earnings that decrease 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 borrower performance differ from the assumptions used in making the initial determinations.

The Company’s allowance for credit losses on loans consists of two components: (1) a specific valuation allowance based on expected lifetime losses on specifically identified loans and (2) a general valuation allowance based on historical lifetime loan loss experience, current economic conditions, reasonable and supportable forecasted 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 lifetime loan loss experience, concentration risk of specific loan types, the volume, growth and composition of the Company’s loan portfolio, current economic conditions and reasonable and supportable forecasted economic conditions that may affect borrower ability to pay and the value of collateral, the evaluation of the Company’s loan portfolio through its internal loan review process, other qualitative risk factors both internal and external to the Company and other relevant factors. Historical lifetime loan loss experience is determined by utilizing an open-pool (“cumulative loss rate”) methodology. Adjustments to the historical lifetime loan loss experience are made for differences in current loan pool risk characteristics such as portfolio concentrations, delinquency, non-accrual, and watch list levels, as well as changes in current and forecasted economic conditions such as unemployment rates, property and collateral values, and other indices relating to economic activity. The utilization of reasonable and supportable forecasts includes an immediate reversion to lifetime historical loss rates. 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. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

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 lifetime credit loss information, (3) changes in current and forecasted environmental factors and (4) growth in the balance of loans.

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 lifetime credit losses, on the other hand, are based on an open-pool (“cumulative loss rate”) methodology, which is then applied to estimate lifetime credit losses in the loan portfolio. A deterioration in the credit quality of the loan portfolio in the current period would increase the historical lifetime loss rate to be applied in future periods, just as an improvement in credit quality would decrease the historical lifetime loss rate.

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 current economic metrics, reasonable and supportable forecasted 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 lifetime loss experience. Management’s assessment of qualitative factors is a statistically based approach to determine the loss rate adjustment associated with such factors. Based on the Company’s actual historical lifetime loan loss experience relative to economic and loan portfolio-specific factors at the time the losses occurred, management is able to identify the expected level of lifetime losses as of the date of measurement. The correlation of historical loss experience with current and forecasted economic conditions provides an estimate of lifetime losses that has not been previously factored into the general valuation allowance by the determination of specific reserves and lifetime 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 lifetime loss.

The Company accounts for its acquisitions using the acquisition method of accounting. Accordingly, the assets, including loans, and liabilities of the acquired entity are recorded at their fair values at the acquisition date. 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.

Non-PCD 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-PCD 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-PCD 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-PCD 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-PCD loan with the recorded investment in such loan. In the future, the Company will continue to analyze impaired Non-PCD 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.

PCD loans are monitored individually or on a pooled basis quarterly to assess for changes in expected cash flows subsequent to acquisition. If a deterioration in cash flows is identified, an increase to the PCD reserves for that individual loan or pool of loans is made. PCD loans were recorded at their acquisition date fair values, which were based on expected cash flows and considers 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. See “Critical Accounting Estimates” above for more information.

As described in the section captioned “Critical Accounting Estimates” 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 lifetime loss information and specific reserves, provides the Company with an estimate of lifetime losses. The allowance must reflect changes in the balance of loans subject to the allowance methodology, as well as the estimated lifetime losses associated with those loans.

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


	As of and for the Nine Months Ended September 30, 2023
	Originated Loans			Acquired Loans			Total
	(Dollars in thousands)
Average loans outstanding	$	16,955,872		$	3,427,486		$	20,383,358
Gross loans outstanding at end of period	$	17,517,008		$	3,915,705		$	21,432,713
Allowance for credit losses on loans at beginning of period	$	209,467		$	72,109		$	281,576
Initial allowance on loans purchased with credit deterioration		—			76,793			76,793
Provision for credit losses		28,847			(16,863	)		11,984
Charge-offs:
Commercial and industrial		(2,478	)		(725	)		(3,203	)
Real estate and agriculture		(15,870	)		—			(15,870	)
Consumer and other		(4,012	)		(54	)		(4,066	)
Recoveries:
Commercial and industrial		1,636			1,285			2,921
Real estate and agriculture		389			295			684
Consumer and other		650			26			676
Net (charge-offs) recoveries(1)		(19,685	)		827			(18,858	)
Allowance for credit losses on loans at end of period	$	218,629		$	132,866		$	351,495
Ratio of allowance to end of period loans		1.25	%		3.39	%		1.64	%
Ratio of allowance to end of period loans, excluding Warehouse Purchase Program		1.32	%		3.39	%		1.71	%
Ratio of net charge-offs (recoveries) to average loans (annualized)		0.15	%		(0.03	%)		0.12	%
Ratio of allowance to end of period nonperforming loans		801.8	%		404.4	%		584.6	%
Ratio of allowance to end of period nonaccrual loans		813.6	%		404.4	%		588.5	%


	As of and for the Nine Months Ended September 30, 2022
	Originated Loans			Acquired Loans			Total
	(Dollars in thousands)
Average loans outstanding	$	14,173,656		$	3,915,508		$	18,089,164
Gross loans outstanding at end of period	$	15,398,640		$	3,107,648		$	18,506,288
Allowance for credit losses on loans at beginning of period	$	186,736		$	99,644		$	286,380
Provision for credit losses		15,228			(15,228	)		—
Charge-offs:
Commercial and industrial		(863	)		(54	)		(917	)
Real estate and agriculture		(904	)		(760	)		(1,664	)
Consumer and other		(3,896	)		(165	)		(4,061	)
Recoveries:
Commercial and industrial		961			154			1,115
Real estate and agriculture		576			21			597
Consumer and other		675			54			729
Net (charge-offs) recoveries(1)		(3,451	)		(750	)		(4,201	)
Allowance for credit losses on loans at end of period	$	198,513		$	83,666		$	282,179
Ratio of allowance to end of period loans		1.29	%		2.69	%		1.52	%
Ratio of allowance to end of period loans, excluding Warehouse Purchase Program		1.37	%		2.69	%		1.60	%
Ratio of net charge-offs (recoveries) to average loans (annualized)		0.03	%		0.03	%		0.03	%
Ratio of allowance to end of period nonperforming loans		2,176.2	%		931.2	%		1,558.4	%
Ratio of allowance to end of period nonaccrual loans		2,221.0	%		951.7	%		1,591.6	%

(1)

There was no net charge-off activity on Warehouse Purchase Program loans during the periods presented.

The Company had gross charge-offs on originated loans of $22.4 million during the nine months ended September 30, 2023. Partially offsetting these charge-offs were recoveries on originated loans of $2.7 million. Gross charge-offs on acquired loans were $779 thousand during the nine months ended September 30, 2023. Offsetting these charge-offs were recoveries on acquired loans of $1.6 million. Total charge-offs for the nine months ended September 30, 2023 were $23.1 million, partially offset by total recoveries

of $4.3 million. Net charge-offs for the nine months ended September 30, 2023 included $15.0 million related to one commercial real estate loan.

The following table shows the allocation of the net charge-offs among various categories of loans as of the dates indicated.


	Nine Months Ended September 30
	2023						2022
	Amount			Ratio of Net Charge-offs (Recoveries) to Average Loans (Annualized)			Amount			Ratio of Net Charge-offs (Recoveries) to Average Loans (Annualized)
	(Dollars in thousands)
Balance of net (charge-offs) recoveries applicable to:
Commercial and industrial	$	(282	)		0.00	%	$	198			0.00	%
Real estate:
Construction, land development and other land loans		(32	)		0.00	%		(421	)		0.00	%
1-4 family residential (including home equity)		288			0.00	%		147			0.00	%
Commercial real estate (including multi-family residential)		(15,526	)		0.10	%		(786	)		0.01	%
Agriculture (includes farmland)		84			0.00	%		(7	)		0.00	%
Consumer and other		(3,390	)		0.02	%		(3,332	)		0.02	%
Total net (charge-offs) recoveries	$	(18,858	)		0.12	%	$	(4,201	)		0.03	%

The following tables show the allocation of the allowance for credit losses on loans among various categories of loans disaggregated between originated loans, re-underwritten acquired loans, Non-PCD loans and PCD 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 an originated loan or an acquired loan.


	September 30, 2023
			Acquired Loans
	Originated Loans		Re-Underwritten Acquired Loans		Non-PCD Loans		PCD Loans		Total Allowance		Percent of Loans to Total Loans(1)
	(Dollars in thousands)
Balance of allowance for credit losses on loans applicable to:
Commercial and industrial	$	30,283	$	21,324	$	6,707	$	23,370	$	81,684		12.7	%
Real estate		176,145		8,938		16,285		51,236		252,604		81.9	%
Agriculture and agriculture real estate		7,137		791		369		3,106		11,403		3.9	%
Consumer and other		5,064		465		255		20		5,804		1.5	%
Total allowance for credit losses on loans	$	218,629	$	31,518	$	23,616	$	77,732	$	351,495		100.0	%


	December 31, 2022
			Acquired Loans
	Originated Loans		Re-Underwritten Acquired Loans		Non-PCD Loans		PCD Loans		Total Allowance		Percent of Loans to Total Loans(1)
	(Dollars in thousands)
Balance of allowance for credit losses on loans applicable to:
Commercial and industrial	$	30,837	$	25,736	$	5,091	$	655	$	62,319		14.3	%
Real estate		167,270		10,225		11,978		16,447		205,920		80.3	%
Agriculture and agriculture real estate		6,845		731		111		12		7,699		3.8	%
Consumer and other		4,515		917		206		—		5,638		1.6	%
Total allowance for credit losses on loans	$	209,467	$	37,609	$	17,386	$	17,114	$	281,576		100.0	%

(1)

Loans outstanding as of a percentage of total loans, excluding Warehouse Purchase Program loans.

The allowance for credit losses on loans totaled $351.5 million at September 30, 2023 compared to $281.6 million at December 31, 2022, an increase of $69.9 million or 24.8%, primarily due to the Merger. The allowance for credit losses on loans totaled 1.64% of total loans at September 30, 2023 and 1.49% of total loans at December 31, 2022.

At September 30, 2023, $218.6 million of the allowance for credit losses on loans was attributable to originated loans, an increase of $9.2 million or 4.4% compared with $209.5 million of the allowance at December 31, 2022. At September 30, 2023, $31.5 million of the allowance for credit losses on loans was attributable to re-underwritten acquired loans compared with $37.6 million of the allowance at December 31, 2022, a decrease of $6.1 million or 16.2%. At September 30, 2023, $23.6 million of the allowance for credit losses on loans was attributable to Non-PCD loans compared with $17.4 million of the allowance at December 31, 2022, an increase of $6.2 million or 35.8%. At September 30, 2023, $77.7 million of the allowance for credit losses on loans was attributable to PCD loans compared with $17.1 million of the allowance at December 31, 2022, an increase of $60.6 million or 354.2%.

At September 30, 2023, the Company had $30.9 million of total outstanding accretable discounts on Non-PCD loans and PCD loans. The Company believes that the allowance for credit losses on loans at September 30, 2023 is adequate to absorb expected lifetime losses that may be realized from 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 September 30, 2023.

Allowance for Credit Losses on Off-Balance Sheet Credit Exposures

The allowance for credit losses on off-balance sheet credit exposures estimates expected credit losses over the contractual period in which there is exposure to credit risk via a contractual obligation to extend credit, except when an obligation is unconditionally cancelable by the Company. The allowance is adjusted by provisions for credit losses charged to earnings that increase the allowance, or by provision releases returned to earnings that decrease the allowance. The estimate includes consideration of the likelihood that funding will occur and an estimate of expected credit losses on the commitments expected to fund. The estimate of commitments expected to fund is affected by historical analysis of utilization rates. The expected credit loss rates applied to the commitments expected to fund are affected by the general valuation allowance utilized for outstanding balances with the same underlying assumptions and drivers. As of September 30, 2023 and December 31, 2022, the Company had $36.5 million and $29.9 million, respectively, in allowance for credit losses on off-balance sheet credit exposures, with the increase due to the Merger. The allowance for credit losses on off-balance sheet credit exposures is a separate line item on the Company’s consolidated balance sheet.

The following table represents a rollforward of the allowance for credit losses on off-balance sheet credit exposures for the periods shown.


	Three Months Ended September 30				Nine Months Ended September 30
	2023		2022		2023		2022
	(Dollars in thousands)
Balance at beginning of period	$	36,503	$	29,947	$	29,947	$	29,947
Provision for credit losses on off-balance sheet credit exposures		—		—		6,556		—
Balance at end of period	$	36,503	$	29,947	$	36,503	$	29,947

Securities

The carrying cost of securities totaled $13.19 billion at September 30, 2023 compared with $14.48 billion at December 31, 2022, a decrease of $1.28 billion or 8.9%. At September 30, 2023, securities represented 33.6% of total assets compared with 38.4% of total assets at December 31, 2022.

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


	September 30, 2023
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(Dollars in thousands)
Available for Sale
Corporate debt securities	$	20,698	$	1,652	$	(865	)	$	21,485
Collateralized mortgage obligations		329,465		1,018		(2,959	)		327,524
Mortgage-backed securities		98,445		22		(1,311	)		97,156
Total	$	448,608	$	2,692	$	(5,135	)	$	446,165
Held to Maturity
U.S. Treasury securities and obligations of U.S. Government agencies	$	7,571	$	—	$	(208	)	$	7,363
States and political subdivisions		113,786		228		(4,723	)		109,291
Corporate debt securities		12,000		—		(4,560	)		7,440
Collateralized mortgage obligations		271,570		—		(29,507	)		242,063
Mortgage-backed securities		12,341,650		64		(1,873,652	)		10,468,062
Total	$	12,746,577	$	292	$	(1,912,650	)	$	10,834,219


	December 31, 2022
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(Dollars in thousands)
Available for Sale
Collateralized mortgage obligations	$	359,251	$	1,190	$	(3,039	)	$	357,402
Mortgage-backed securities		101,647		93		(2,640	)		99,100
Total	$	460,898	$	1,283	$	(5,679	)	$	456,502
Held to Maturity
States and political subdivisions	$	122,361	$	868	$	(3,255	)	$	119,974
Corporate debt securities		12,000		—		(2,520	)		9,480
Collateralized mortgage obligations		271,727		377		(22,922	)		249,182
Mortgage-backed securities		13,613,415		2,575		(1,607,501	)		12,008,489
Total	$	14,019,503	$	3,820	$	(1,636,198	)	$	12,387,125

Available for sale securities. For available for sale securities in an unrealized loss position, the amount of the expected credit losses 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 expected credit losses 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 expected credit losses 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 expected credit losses 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 expected credit losses related to the noncredit portion is recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the expected credit losses recognized in earnings will become the new amortized cost basis of the investment.

As of September 30, 2023, 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 changes in market interest rates and spread relationships since 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 September 30, 2023, management believes that there is no potential for credit losses on available for sale securities.

Held to maturity securities. The Company’s held to maturity investments include mortgage-related bonds issued by either the Government National Mortgage Corporation (“Ginnie Mae”), Federal National Mortgage Association (“Fannie Mae”) or Federal Home Loan Mortgage Corporation (“Freddie Mac”). Ginnie Mae issued securities are explicitly guaranteed by the U.S. government, while Fannie Mae and Freddie Mac issued securities are fully guaranteed by those respective United States government-sponsored agencies, and conditionally guaranteed by the full faith and credit of the United States. The Company’s held to maturity securities also include taxable and tax-exempt municipal securities issued primarily by school districts, utility districts and municipalities located in Texas. The Company’s investment in municipal securities is exposed to credit risk. The securities are highly rated by major rating agencies and regularly reviewed by management. A significant portion are guaranteed or insured by either the Texas Permanent School Fund, Assured Guaranty or Build America Mutual. As of September 30, 2023 the Company’s municipal securities represent 0.9% of the securities portfolio. 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. Accordingly, as of September 30, 2023, management believes that there is no potential for material credit losses on held to maturity securities.

Deposits

Total deposits were $27.31 billion at September 30, 2023 compared with $28.53 billion at December 31, 2022, a decrease of $1.22 billion or 4.3%. At September 30, 2023, noninterest-bearing deposits totaled $10.28 billion, a decrease of $633.6 million or 5.8% compared with $10.92 billion at December 31, 2022. Interest-bearing deposits totaled $17.03 billion at September 30, 2023 compared with $17.62 billion at December 31, 2022, a decrease of $587.2 million or 3.3%. The changes were primarily due to a decrease in business deposits and public fund deposits, partially offset by an increase in Merger acquired deposits.

Average deposits for the nine months ended September 30, 2023 were $27.43 billion, a decrease of $2.86 billion or 9.4%, compared with $30.29 billion for the nine months ended September 30, 2022. The ratio of average interest-bearing deposits to total average deposits was 62.4% and 64.2% during the first nine months of 2023 and 2022, respectively.

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


	Nine Months Ended September 30,
	2023					2022
	Average Balance		Average Rate (1)			Average Balance		Average Rate (1)
	(Dollars in thousands)
Interest-bearing demand deposits	$	5,260,463		0.32	%	$	6,453,810		0.14	%
Regular savings		3,241,991		0.70	%		3,541,681		0.14	%
Money market savings		5,993,655		2.36	%		7,037,670		0.27	%
Certificates, IRAs and other time deposits		2,627,402		2.63	%		2,409,251		0.40	%
Total interest-bearing deposits		17,123,511		1.46	%		19,442,412		0.22	%
Noninterest-bearing demand deposits		10,310,878					10,848,605
Total deposits	$	27,434,389		0.91	%	$	30,291,017		0.14	%

(1)

Annualized and based on average balances on an actual 365-day basis for the nine months ended September 30, 2023 and 2022.

Other Borrowings

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


	September 30, 2023		December 31, 2022
	(Dollars in thousands)
Bank Term Funding Program	$	3,000,000	$	—
FHLB advances		1,250,000		1,850,000
Total other borrowings		4,250,000		1,850,000
Securities sold under repurchase agreements		300,714		428,134
Total	$	4,550,714	$	2,278,134

Bank Term Funding Program— During the second quarter of 2023, the Bank participated in the Federal Reserve's Bank Term Funding Program (“BTFP”). At September 30, 2023, the Bank had secured borrowing capacity of $3.08 billion collateralized by the par value of pledged securities totaling $3.08 billion. At September 30, 2023, the balance outstanding was $3.00 billion consisting of three term advances maturing in May 2024 and June 2024, at a weighted average interest rate of 5.13%. Under the BTFP program, eligible depository institutions can obtain loans of up to one year in length by pledging U.S. Treasuries, agency debt and mortgage-backed securities, and other qualifying assets as collateral. These assets will be valued at par. Eligible depository institutions can request advances under the BTFP until at least March 11, 2024.

FHLB advances and long-term notes payable— The Company has an available line of credit with the Federal Home Loan Bank of Dallas (“FHLB”), 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 September 30, 2023, the Company had total borrowing capacity of $10.7 billion under this line. FHLB advances of $1.25 billion were outstanding at September 30, 2023, at a weighted average interest rate of 5.51%. At September 30, 2023, the Company had no FHLB long-term notes payable.

Securities sold under repurchase agreements— At September 30, 2023, the Company had $300.7 million in securities sold under repurchase agreements with banking customers compared with $428.1 million at December 31, 2022, a decrease of $127.4 million or 29.8%. Repurchase agreements are generally settled on the following business day; however, approximately $3.0 million of the repurchase agreements outstanding at September 30, 2023 have maturity dates ranging from 12 to 24 months. All securities sold under repurchase agreements are collateralized by certain pledged securities.

Subordinated debentures— On May 1, 2023, in connection with the acquisition of First Bancshares, the Company assumed the obligation related to $3.09 million of Floating Rate Junior Subordinated Deferrable Interest Debentures and trust preferred securities (the "Subordinated Debentures"), which the Company redeemed on September 18, 2023. Accordingly, as of September 30, 2023, the Company had no Subordinated Debentures outstanding.

LIBOR Transition

On September 30, 2021, the Company began transitioning away from London Inter-Bank Offered Rate (“LIBOR”) to the Secured Overnight Financing Rate (“SOFR”) or other alternative variable rate indexes for its interest-rate swaps and loans historically using LIBOR as an index. As of December 31, 2022, LIBOR was used as an index rate for approximately 88.2% of the Company’s interest-rate swaps and approximately 1.5% of the Company’s loan portfolio. As of September 30, 2023, the Company's interest rate swaps and loan portfolio used SOFR as the index rate.

Liquidity

Liquidity involves the Company’s ability to raise funds to support asset growth and acquisitions 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 and manage unexpected events. 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 September 30, 2023, the Company had outstanding $5.01 billion in commitments to extend credit, $80.8 million in commitments associated with outstanding standby letters of credit and $1.17 billion in commitments associated with unused capacity on Warehouse Purchase Program loans. Since commitments associated with letters of credit, unused capacity on Warehouse Purchase

Program loans 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 September 30, 2023, the Company had cash and cash equivalents of $512.5 million compared with $424.1 million at December 31, 2022, an increase of $88.3 million or 20.8%. The increase was primarily due to net proceeds from short-term borrowings of $2.20 billion, net proceeds from maturities and principal paydowns of investment securities of $1.50 billion and net cash provided by operating activities of $618.4 million, partially offset by a decrease in deposits of $2.80 billion, a net increase in loans of $989.9 million, payment of cash dividends of $153.2 million, repurchase of common stock of $72.2 million, a decrease in securities sold under repurchase agreements of $177.3 million and net cash used in the purchase of First Bancshares of $24.4 million.

Share Repurchases

On January 17, 2023, the Company announced a stock repurchase program under which up to 5%, or approximately 4.6 million shares, of Bancshares outstanding common stock may be acquired over a one-year period expiring on January 17, 2024, at the discretion of management. Under the stock repurchase program, Bancshares may repurchase shares from time to time at prevailing market prices, through open-market purchases or privately negotiated transactions, depending upon market conditions. Repurchases under this program may also be made in transactions outside the safe harbor during a pending merger, acquisition or similar transaction. 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 Bancshares may suspend, modify or terminate the program at any time and for any reason without prior notice. Under its 2023 stock repurchase program, Bancshares repurchased zero shares of its common stock during the three months ended September 30, 2023 and approximately 1.21 million shares of its common stock at an average weighted price of $59.88 per share during the nine months ended September 30, 2023.

Contractual Obligations

Borrowings

The Company’s future cash payments associated with the Federal Reserve's BTFP and FHLB advances as of September 30, 2023 are summarized below. The future interest payments were calculated using the current rate in effect at September 30, 2023. Payments under the BTFP include interest of $102.8 million that will be due over the future periods. These payments do not include prepayment 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)
Bank Term Funding Program	$	3,102,848		—		—		—	$	3,102,848
Federal Home Loan Bank advances		1,250,000		—		—		—		1,250,000
	$	4,352,848	$	—	$	—	$	—	$	4,352,848

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 15 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 has one sublease arrangement. Sublease income was $816 thousand and $807 thousand for the three months ended September 30, 2023 and 2022 and $2.3 million and $2.4 million for the nine months ended September 30, 2023 and 2022, respectively. As of September 30, 2023, operating lease ROU assets and lease liabilities were approximately $38.6 million. ROU assets and lease liabilities were classified as other assets and other liabilities, respectively.

As of September 30, 2023, the weighted average of remaining lease terms of the Company’s operating leases was 4.2 years. The weighted average discount rate used to determine the lease liabilities as of September 30, 2023 for the Company’s operating leases was 2.0%. Cash paid for the Company’s operating leases was $3.1 million and $2.7 million for the three months ended September 30, 2023 and 2022, respectively, and $9.0 million and $8.1 million for the nine months ended September 30, 2023 and 2022, respectively. During the nine months ended September 30, 2023, the Company obtained $3.2 million in ROU assets in exchange for lease liabilities for seven operating leases, four of which, reflecting $2.7 million in ROU assets, were related to the Merger.

The Company’s future undiscounted cash payments associated with its operating leases as of September 30, 2023 are summarized below (dollars in thousands).


Remaining 2023	$	2,696
2024		10,301
2025		9,737
2026		8,592
2027		5,569
2028		2,588
Thereafter		5,283
Total undiscounted lease payments	$	44,766

Off-Balance Sheet Items

The Company’s commitments associated with outstanding standby letters of credit, unused capacity of Warehouse Purchase Program loans and commitments to extend credit expiring by period as of September 30, 2023 are summarized below. Since commitments associated with letters of credit, unused capacity of Warehouse Purchase Program loans and commitments to extend credit may expire unused, the amounts shown may 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	$	72,215	$	7,456	$	1,100	$	26	$	80,797
Unused capacity on Warehouse Purchase Program loans		1,170,673		—		—		—		1,170,673
Commitments to extend credit		1,728,337		1,080,668		306,129		1,898,917		5,014,051
Total	$	2,971,225	$	1,088,124	$	307,229	$	1,898,943	$	6,265,521

Allowance for Credit Losses on Off-balance Sheet Credit Exposures. The Company records an allowance for credit losses on off-balance sheet credit exposure that is adjusted through a charge to provision for credit losses on the Company’s consolidated statement of income. At September 30, 2023 and December 31, 2022, this allowance, reported as a separate line item on the Company’s consolidated balance sheet, totaled $36.5 million and $29.9 million, respectively. The increase in the allowance was due to the Merger.

Capital Resources

Total shareholders’ equity was $7.03 billion at September 30, 2023 compared with $6.70 billion at December 31, 2022, an increase of $333.3 million or 5.0%. The increase was primarily the result of the common stock issuance in connection with the Merger of $224.3 million and net income of $323.8 million, partially offset by dividend payments of $153.2 million and common stock repurchases of $72.2 million.

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.

In response to the COVID-19 pandemic, in March 2020 the joint federal bank regulatory agencies issued an interim final rule that allowed banking organizations that implemented CECL in 2020 to mitigate the effects of the CECL accounting standard in their regulatory capital for two years. This two-year delay is in addition to the three-year transition period that the agencies had already made available. The Company adopted the option provided by the interim final rule, which delayed the effects of CECL on its regulatory capital through 2021, after which the effects will be phased in over a three-year period from January 1, 2022 through December 31, 2024. Under the interim final rule, the amount of adjustments to regulatory capital deferred until the phase-in period include both the initial impact of the Company’s adoption of CECL on January 1, 2020 and 25% of subsequent changes in the Company’s allowance for credit losses during each quarter of the two-year period ending December 31, 2021. The cumulative amount of the transition adjustments is being phased in over the three-year transition period that began on January 1, 2022, with 75% recognized in 2022, 50% recognized in 2023, and 25% recognized in 2024.

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 September 30, 2023, 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 September 30, 2023:


	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 September 30, 2023
The Company
CET1 capital (to risk-weighted assets)		4.50	%			7.00	%	N/A				14.98	%
Tier 1 capital (to risk-weighted assets)		6.00	%			8.50	%	N/A				14.98	%
Total capital (to risk-weighted assets)		8.00	%			10.50	%	N/A				16.05	%
Tier 1 capital (to average assets) (leverage)		4.00	%	(1)		4.00	%	N/A				10.03	%

The Bank
CET1 capital (to risk-weighted assets)		4.50	%			7.00	%		6.50	%		14.92	%
Tier 1 capital (to risk-weighted assets)		6.00	%			8.50	%		8.00	%		14.92	%
Total capital (to risk-weighted assets)		8.00	%			10.50	%		10.00	%		16.00	%
Tier 1 capital (to average assets) (leverage)		4.00	%	(2)		4.00	%		5.00	%		9.99	%

(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, 2022, filed on February 24, 2023 (the “2022 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 2022 Form 10-K and presented as of December 31, 2022.

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 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 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 September 30, 2023 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

Bancshares 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, Bancshares 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, 2022.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

a. None.

b. None.

c. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Financial Condition—Share Repurchases” in Item 2 of Part I of this report for information regarding Bancshares’ stock repurchase program. No repurchases of Bancshares’ common stock were made during the third quarter of 2023.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION

c. During the three months ended September 30, 2023, no director or officer of the Company adopted or terminated a “Rule 10b5-1 trading arrangement” or “non-Rule 10b5-1 trading arrangement,” as each term is defined in Item 408(a) of Regulation S-K.

ITEM 6. EXHIBITS


Exhibit Number		Description of Exhibit

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 (File No. 001-35388))

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 (File No. 001-35388))

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

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*		Inline 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 September 30, 2023 (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: 11/3/2023		/S/ DAVID ZALMAN
		David Zalman
		Senior Chairman and Chief Executive Officer

Date: 11/3/2023		/S/ ASYLBEK OSMONOV
		Asylbek Osmonov
		Chief Financial Officer

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Prosperity Bancshares (PB) 10-Q2023 Q3 Quarterly report

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