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, 2021
OR
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER: 001-35388
PROSPERITY BANCSHARES, INC.®
(Exact name of registrant as specified in its charter)
Texas
74-2331986
(State or other jurisdiction
of incorporation or organization)
(I.R.S. Employer
Identification No.)
Prosperity Bank Plaza
4295 San Felipe, Houston, Texas
77027
(Address of principal executive offices)
(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 November 1, 2021, there were 92,164,955 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, 2021 (unaudited) and December 31, 2020
Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2021 and 2020 (unaudited)
4
Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2021 and 2020 (unaudited)
5
Consolidated Statements of Changes in Shareholders’ Equity for the Three and Nine Months Ended September 30, 2021 and 2020 (unaudited)
6
Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2021 and 2020 (unaudited)
7
Notes to Consolidated Financial Statements (unaudited)
8
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
30
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
53
Item 4.
Controls and Procedures
PART II—OTHER INFORMATION
Legal Proceedings
54
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults Upon Senior Securities
Mine Safety Disclosures
Item 5.
Other Information
Item 6.
Exhibits
55
Signatures
56
2
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
September 30,
December 31,
2021
2020
(unaudited)
(Dollars in thousands, except par value)
ASSETS
Cash and due from banks
$
1,055,386
1,342,996
Federal funds sold
237
553
Total cash and cash equivalents
1,055,623
1,343,549
Available for sale securities, at fair value
580,929
651,514
Held to maturity securities, at cost (fair value of $12,186,114 and $8,039,142, respectively)
12,048,439
7,891,306
Total securities
12,629,368
8,542,820
Loans held for sale
10,197
46,777
Loans held for investment
16,949,486
17,357,788
Loans held for investment - Warehouse Purchase Program
1,998,049
2,842,379
Total loans
18,957,732
20,246,944
Less: allowance for credit losses on loans
(287,187
)
(316,068
Loans, net
18,670,545
19,930,876
Accrued interest receivable
71,651
82,068
Goodwill
3,231,636
Core deposit intangibles, net
64,539
73,235
Bank premises and equipment, net
322,799
323,572
Other real estate owned
150
10,593
Bank owned life insurance (BOLI)
326,830
324,356
Federal Home Loan Bank of Dallas stock
8,901
Other assets
130,077
187,669
TOTAL ASSETS
36,512,119
34,059,275
LIABILITIES AND SHAREHOLDERS’ EQUITY
LIABILITIES:
Deposits:
Noninterest-bearing
10,326,489
9,151,233
Interest-bearing
19,125,163
18,209,259
Total deposits
29,451,652
27,360,492
Fed funds purchased and other borrowings
—
Securities sold under repurchase agreements
440,969
389,583
Subordinated notes
Accrued interest payable
1,499
3,462
Allowance for credit losses on off-balance sheet credit exposures
29,947
Other liabilities
242,611
145,122
Total liabilities
30,166,678
27,928,606
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; 92,160,455 shares issued and outstanding at September 30, 2021; 92,570,789 shares issued and outstanding at December 31, 2020
92,161
92,571
Capital surplus
3,591,949
3,634,140
Retained earnings
2,659,370
2,403,189
Accumulated other comprehensive income —net unrealized gain on available for sale securities, net of tax expense of $521 and $205, respectively
1,961
769
Total shareholders’ equity
6,345,441
6,130,669
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
See notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
Three Months Ended
Nine Months Ended
(Dollars in thousands, except per share data)
INTEREST INCOME:
Loans, including fees
213,821
244,255
663,699
734,270
Securities
46,217
38,033
128,602
130,091
Federal funds sold and other earning assets
302
144
993
902
Total interest income
260,340
282,432
793,294
865,263
INTEREST EXPENSE:
Deposits
11,578
22,458
44,228
82,745
Other borrowings
52
3,517
195
309
518
1,403
1,500
4,499
Total interest expense
11,773
24,319
44,746
92,164
NET INTEREST INCOME
248,567
258,113
748,548
773,099
PROVISION FOR CREDIT LOSSES
10,000
20,000
NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES
248,113
753,099
NONINTEREST INCOME:
Nonsufficient funds (NSF) fees
7,962
7,156
21,209
22,244
Credit card, debit card and ATM card income
8,837
8,315
25,786
23,052
Service charges on deposit accounts
6,115
5,920
18,155
17,814
Trust income
2,467
2,502
7,580
7,406
Mortgage income
1,396
2,958
7,617
6,788
Brokerage income
861
628
2,367
1,862
Net gain (loss) on sale or write down of assets
255
(528
(68
(4,858
Other
6,752
7,973
21,563
20,679
Total noninterest income
34,645
34,924
104,209
94,987
NONINTEREST EXPENSE:
Salaries and employee benefits
78,412
75,068
234,060
231,459
Net occupancy and equipment
8,165
8,644
24,044
26,814
Credit and debit card, data processing and software amortization
9,103
8,776
26,054
31,887
Regulatory assessments and FDIC insurance
2,497
2,512
7,837
7,191
Core deposit intangibles amortization
2,878
3,270
8,696
9,926
Depreciation
4,524
4,605
13,577
13,971
Communications
3,013
3,027
8,894
9,546
Net other real estate expense (income)
34
121
(2,250
81
Merger related expenses
8,018
11,189
11,896
33,170
38,135
Total noninterest expense
119,815
117,919
354,082
377,028
INCOME BEFORE INCOME TAXES
163,397
165,118
498,675
471,058
PROVISION FOR INCOME TAXES
34,807
35,054
106,165
79,245
NET INCOME
128,590
130,064
392,510
391,813
EARNINGS PER SHARE:
Basic
1.39
1.40
4.23
4.20
Diluted
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in thousands)
Net income
Other comprehensive income (loss), before tax:
Securities available for sale:
Change in unrealized gains (losses) during the period
1,089
1,325
1,509
(1,204
Total other comprehensive income (loss)
Deferred tax (expense) benefit related to other comprehensive income (loss)
(229
(278
(317
253
Other comprehensive income (loss), net of tax
860
1,047
1,192
(951
Comprehensive income
129,450
131,111
393,702
390,862
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
Accumulated
Total
Common Stock
Capital
Retained
Comprehensive
Shareholders’
Shares
Amount
Surplus
Earnings
Income (Loss)
Equity
(In thousands, except share and per share data)
BALANCE AT JUNE 30, 2021
92,934,789
92,935
3,640,266
2,576,035
1,101
6,310,337
Other comprehensive income
Common stock issued in connection with the issuance of restricted stock awards, net
(7,200
(7
Common stock repurchase
(767,134
(767
(51,322
(52,089
Stock based compensation expense
2,998
Cash dividends declared, $0.49 per share
(45,255
BALANCE AT SEPTEMBER 30, 2021
92,160,455
BALANCE AT DECEMBER 31, 2020
92,570,789
356,800
357
(357
9,488
Cash dividends declared, $1.47 per share
(136,329
BALANCE AT JUNE 30, 2020
92,660,462
92,660
3,632,847
2,224,011
(1,396
5,948,122
(98,028
(98
(4,805
(4,903
3,171
Cash dividends declared, $0.46 per share
(42,624
BALANCE AT SEPTEMBER 30, 2020
92,562,434
92,562
3,631,213
2,311,451
(349
6,034,877
BALANCE AT DECEMBER 31, 2019
94,746,019
94,746
3,734,519
2,140,968
602
5,970,835
Cumulative change in accounting principle upon adoption of ASU 2016-13(1) and other
(92,860
BALANCE AT JANUARY 1, 2020 (AS ADJUSTED FOR CHANGE IN ACCOUNTING STANDARD)
2,048,108
5,877,975
Other comprehensive loss
6,000
(6
(2,189,585
(2,190
(112,774
(114,964
9,474
Cash dividends declared, $1.38 per share
(128,470
(1)
ASU 2016-13 became effective for the Company on January 1, 2020.
CONSOLIDATED STATEMENTS OF CASH FLOWS
CASH FLOWS FROM OPERATING ACTIVITIES:
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and core deposit intangibles amortization
22,273
23,897
Provision for credit losses
Net amortization of premium on investments
42,421
27,318
Net gain on sale of other real estate and repossessed assets
(2,722
(263
Net loss on sale or write down of premises and equipment
68
2,506
Net loss on sale or write down of assets
2,352
Net accretion of discount on loans
(33,912
(75,282
Net amortization of premium on deposits
(1,035
(5,303
Net gain on sale of loans
(7,002
(4,957
Proceeds from sale of loans held for sale
226,262
338,740
Originations of loans held for sale
(185,282
(305,612
Decrease in accrued interest receivable and other assets
68,235
97,047
Increase (decrease) in accrued interest payable and other liabilities
88,401
(24,834
Net cash provided by operating activities
619,705
496,896
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities and principal paydowns of held to maturity securities
2,122,201
1,751,229
Purchase of held to maturity securities
(6,321,814
(466,474
Proceeds from maturities and principal paydowns of available for sale securities
11,372,159
12,027,029
Purchase of available for sale securities
(11,300,006
(12,201,746
Originations of Warehouse Purchase Program loans
(28,057,933
(30,474,590
Proceeds from pay-offs of Warehouse Purchase Program loans
28,902,263
29,296,738
Net decrease (increase) in loans held for investment
409,345
(626,308
Purchase of bank premises and equipment
(14,959
(17,617
Proceeds from sale of bank premises, equipment and other real estate
21,141
4,766
Proceeds from insurance claims
4,809
468
Net cash used in investing activities
(2,862,794
(706,505
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in noninterest-bearing deposits
1,175,256
1,234,434
Net increase in interest-bearing deposits
916,939
1,030,343
Net repayments of other short-term borrowings
(1,300,000
Repayments of other long-term borrowings
(1,160
Net increase in securities sold under repurchase agreements
51,386
2,980
Repurchase of common stock
Payments of cash dividends
Net cash provided by financing activities
1,955,163
723,163
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS
(287,926
513,554
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
574,108
CASH AND CASH EQUIVALENTS, END OF PERIOD
1,087,662
NONCASH ACTIVITIES:
Acquisition of real estate through foreclosure of collateral
6,205
8,229
SUPPLEMENTAL INFORMATION:
Income taxes paid
96,594
132,185
Interest paid
46,709
94,157
See notes to consolidated financial statements
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2021
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, 2020. Operating results for the nine month period ended September 30, 2021 are not necessarily indicative of the results that may be expected for the year ending December 31, 2021 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,
Per Share Amount
(Amounts in thousands, except per share data)
Basic:
Weighted average shares outstanding
92,683
92,656
92,823
93,226
Diluted:
As of September 30, 2021, all stock options have been exercised and there are no options outstanding. There were no stock options exercisable during the three and nine months ended September 30, 2021 or 2020 that would have had an anti-dilutive effect on the above computation.
3. NEW ACCOUNTING STANDARDS
Accounting Standards Updates (“ASU”)
ASU 2020-04, "Reference Rate Reform: Facilitation of the Effects of Reference Rate Reform on Financial Reporting - Accounting Standards Codification (“ASC”) Topic 848." ASU 2020-04 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 LIBOR toward new interest rate benchmarks. The guidance allows for companies to: (i) account for certain contract modifications as a continuation of the existing contract without additional analysis; (ii) continue hedge accounting when certain critical terms of a hedging relationship change and assess effectiveness in ways that disregard certain potential sources of ineffectiveness; and (iii) make a one-time sale and/or transfer of certain debt securities from held-to-maturity to available-for-sale or trading. This ASU is available for adoption effective March 12, 2020 through December 31, 2022. An entity may elect to apply ASU 2020-04 for contract modifications as of January 1, 2020, or prospectively from a date within an interim period that includes or is subsequent to March 12, 2020, up to the date that the financial statements are available to be issued. Once elected for a Topic or an Industry Subtopic within ASU 2020-04, the amendments must be applied prospectively for all eligible contract modifications for that Topic or Industry Subtopic. The one-time election to sell and/or transfer debt securities classified as held-to-maturity may be made at any time after March 12, 2020. The Company anticipates this ASU will simplify any modifications it executes between the selected start date (yet to be determined) and December 31, 2022 that are directly related to the LIBOR transition by allowing prospective recognition of the continuation of the contract, rather than extinguishment of the old contract resulting in writing off unamortized fees and costs. ASU 2020-04 is not expected to 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, 2021
Amortized Cost
Gross Unrealized Gains
Gross Unrealized Losses
Fair Value
Available for Sale
Collateralized mortgage obligations
547,410
2,073
(35
549,448
Mortgage-backed securities
31,036
638
(193
31,481
578,446
2,711
(228
Held to Maturity
States and political subdivisions
130,032
5,449
135,413
48,394
850
(114
49,130
11,870,013
159,583
(28,025
12,001,571
165,882
(28,207
12,186,114
December 31, 2020
611,353
1,601
(620
612,334
39,187
539
(546
39,180
650,540
2,140
(1,166
166,175
8,341
(32
174,484
96,000
1,669
(219
97,450
7,629,131
144,710
(6,633
7,767,208
154,720
(6,884
8,039,142
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 Financial Accounting Standards Board (“FASB”): ASC 326, “Financial Instruments – Credit Losses.”
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, 2021, 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
9
the securities are impaired due to reasons of credit quality. Accordingly, as of September 30, 2021, 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, 2021, the Company’s municipal securities represent 1.0% 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, 2021, 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:
Less than 12 Months
12 Months or More
Estimated Fair Value
Unrealized Losses
186,963
31,468
218,431
21,149
21,151
186,965
52,617
239,582
1,370
(21
1,469
(47
2,839
9,890
(105
387
(9
10,277
3,379,039
(27,174
149,401
(851
3,528,440
3,390,299
(27,300
151,257
(907
3,541,556
254,318
(608
2,230
(12
256,548
74
26,151
26,225
254,392
28,381
(558
282,773
2,746
26,141
674,795
(6,283
29,900
(350
704,695
703,682
(6,534
733,582
At September 30, 2021 and December 31, 2020, there were 36 securities and 64 securities, respectively, in an unrealized loss position for 12 months or more.
10
The amortized cost and fair value of investment securities at September 30, 2021, by contractual maturity, are shown below. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations at any time with or without call or prepayment penalties.
Due in one year or less
15,407
15,512
Due after one year through five years
70,771
74,287
Due after five years through ten years
26,821
28,414
Due after ten years
17,033
17,200
Subtotal
Mortgage-backed securities and collateralized mortgage obligations
11,918,407
12,050,701
The Company recorded no gain or loss on the sale of securities for the three and nine months ended September 30, 2021 and 2020. As of September 30, 2021, the Company did not own any non-agency collateralized mortgage obligations.
At September 30, 2021 and December 31, 2020, 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 $6.55 billion and $6.11 billion and a fair value of $6.67 billion and $6.23 billion at September 30, 2021 and December 31, 2020, respectively, were pledged to collateralize public deposits and for other purposes required or permitted by law.
5. LOANS AND ALLOWANCE FOR CREDIT LOSSES
The loan portfolio consists of various types of loans and is categorized by major type as follows:
Residential mortgage loans held for sale
Commercial and industrial
2,777,054
3,674,200
Real estate:
Construction, land development and other land loans
2,269,417
1,956,960
1-4 family residential (includes home equity)
5,445,697
4,710,761
Commercial real estate (includes multi-family residential)
5,550,841
6,078,764
Farmland
438,791
410,931
Agriculture
192,706
170,421
Consumer and other
274,980
355,751
Total loans held for investment, excluding Warehouse Purchase Program
Warehouse Purchase Program
Total loans, including Warehouse Purchase Program
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 78.2% and 73.2% of the Company’s total loan portfolio, excluding Warehouse Purchase Program loans, at September 30, 2021 and December 31, 2020, respectively. As of September 30, 2021 and December 31, 2020, excluding Warehouse Purchase Program loans, there were no concentrations of loans related to any single industry in excess of 10% of total loans.
11
Related Party Loans. As of September 30, 2021 and December 31, 2020, loans outstanding to directors, officers and their affiliates totaled $779 thousand and $1.7 million, respectively. All transactions between the Company and such related parties are conducted in the ordinary course of business and made on the same terms and conditions as similar transactions with unaffiliated persons.
An analysis of activity with respect to these related party loans is as follows:
As of and for the
nine months ended
year ended
Beginning balance on January 1
1,732
4,152
New loans
813
Transfers
Repayments
(962
(3,233
Ending balance
779
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.
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:
Loans Past Due and Still Accruing
30-89 Days
90 or More Days
Total Past Due Loans
Nonaccrual Loans
Current Loans
Total Loans
10,182
803
10,985
2,258,432
Warehouse Purchase Program loans
Agriculture and agriculture real estate (includes farmland)
725
373
630,399
631,497
1-4 family (includes home equity) (1)
9,756
23
9,779
10,944
5,435,171
5,455,894
1,871
212
2,083
15,479
5,533,279
8,125
8,159
2,760,770
7,234
80
267,666
37,893
1,038
38,931
35,035
18,883,766
12
14,820
236
15,056
1,262
1,940,642
538
1,344
579,470
581,352
7,527
36
7,563
15,999
4,733,976
4,757,538
17,039
1,409
18,448
10,906
6,049,410
14,383
16,084
3,643,733
380
18
398
1,590
353,763
54,687
1,699
56,386
47,185
20,143,373
Includes $10.2 million and $46.8 million of residential mortgage loans held for sale at September 30, 2021 and December 31, 2020, respectively.
The following table presents information regarding nonperforming assets as of the dates indicated:
Nonaccrual loans (1) (2)
Accruing loans 90 or more days past due
Total nonperforming loans
36,073
48,884
Repossessed assets
326
93
Other real estate
Total nonperforming assets
36,549
59,570
Nonperforming assets to total loans and other real estate
0.19
%
0.29
Nonperforming assets to total loans, excluding Warehouse Purchase Program loans, and other real estate
0.22
0.34
Includes troubled debt restructurings of $6.5 million and $11.3 million as of September 30, 2021 and December 31, 2020, respectively.
(2)
There were no nonperforming or troubled debt restructurings of Warehouse Purchase Program loans or Warehouse Purchase Program lines of credit for the periods presented.
The Company had $36.5 million in nonperforming assets at September 30, 2021 compared with $59.6 million at December 31, 2020. Nonperforming assets were 0.19% of total loans and other real estate at September 30, 2021 and 0.29% of total loans and other real estate at December 31, 2020.
If interest on nonaccrual loans had been accrued under the original loan terms, approximately $2.2 million and $2.3 million would have been recorded as income for the nine months ended September 30, 2021 and 2020, respectively. The Company had $35.0 million in nonaccrual loans at September 30, 2021 compared with $57.4 million at September 30, 2020.
Acquired Loans. Acquired loans were preliminarily recorded at fair value based on a discounted cash flow valuation methodology that considers, among other things, interest rates, projected default rates, loss given default, and recovery rates. During the valuation process, the Company identified purchased credit deteriorated (“PCD”) and Non-PCD loans in the acquired loan portfolios. Loans acquired with evidence of credit quality deterioration at acquisition for which it was probable that the Company would not be able to collect all contractual amounts due were accounted for as 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
13
purchased discounts on PCD loans will be based on future cash flows, taking into account contractual maturities. Accretion of purchased discounts on Non-PCD loans will be recognized on a level-yield basis based on contractual maturity of individual loans.
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, 2021 and December 31, 2020.
PCD loans:
Outstanding balance
89,833
195,631
Discount
(5,569
(14,216
Recorded investment
84,264
181,415
Changes in the accretable yield for acquired PCD loans for the three and nine months ended September 30, 2021 and 2020 were as follows:
Balance at beginning of period
8,695
22,565
14,216
35,654
Adjustments
(449
Accretion charge-offs
(1,508
(1,540
(354
Accretion
(1,618
(5,805
(7,107
(18,091
Balance at September 30,
5,569
16,760
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, 2021, 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, 2021 and December 31, 2020.
Non-PCD loans:
2,585,926
3,869,205
(12,774
(39,587
2,573,152
3,829,618
Changes in the discount accretion for Non-PCD loans for the three and nine months ended September 30, 2021 and 2020 were as follows:
16,535
69,860
39,587
110,130
20
(16
296
(20
(8
(120
(3,761
(16,729
(26,805
(57,191
12,774
53,115
14
Credit Quality Indicators. As part of the on-going monitoring of the credit quality of the Company’s loan portfolio and methodology for calculating the allowance for credit losses, management assigns and tracks loan grades to be used as credit quality indicators. The following is a general description of the loan grades used:
Grade 1—Credits in this category have risk potential that is virtually nonexistent. These loans may be secured by insured certificates of deposit, insured savings accounts, U.S. Government securities and highly rated municipal bonds.
Grade 2—Credits in this category are of the highest quality. These borrowers represent top rated companies and individuals with unquestionable financial standing with excellent global cash flow coverage, net worth, liquidity and collateral coverage.
Grade 3—Credits in this category are not immune from risk but are well protected by the collateral and paying capacity of the borrower. These loans may exhibit a minor unfavorable credit factor, but the overall credit is sufficiently strong to minimize the possibility of loss.
Grade 4—Credits in this category are considered to be of acceptable credit quality with moderately greater risk than Grade 3 and receiving closer monitoring. Loans in this category have sources of repayment that remain sufficient to preclude a larger than normal probability of default and secondary sources are likewise currently of sufficient quantity, quality, and liquidity to protect the Company against loss of principal and interest. These borrowers have specific risk factors, but the overall strength of the credit is acceptable based on other mitigating credit and/or collateral factors and can repay the debt in the normal course of business.
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.
15
The following tables present loans by risk grade, by category of loan and year of origination/renewal at September 30, 2021.
Term Loans
Amortized Cost Basis by Origination Year
2019
2018
2017
Prior
Revolving Loans
Revolving Loans Converted to Term Loans
Construction, Land Development and Other Land Loans
Grade 1
245
Grade 2
148
Grade 3
744,728
653,915
332,320
84,039
104,837
34,627
103,430
4,861
2,062,757
Grade 4
31,050
43,798
67,016
22,165
3,607
5,673
11,215
184,524
Grade 5
8,606
2,196
259
73
11,134
Grade 6
6,117
2,830
559
10,309
Grade 7
Grade 8
Grade 9
PCD Loans
137
163
300
790,746
702,739
399,732
107,007
108,680
41,007
114,645
Agriculture and Agriculture Real Estate (includes Farmland)
2,101
399
16
86
138
8,352
11,092
119
335
1,249
1,958
152,231
99,222
56,952
39,894
26,603
97,818
81,510
554,378
16,141
9,516
2,930
3,981
1,694
11,609
6,317
52,188
1,075
2,377
567
83
613
2,034
6,994
1,230
37
59
655
922
2,903
292
43
374
935
177
252
246
1,610
171,667
113,679
60,715
44,358
28,770
112,482
99,433
393
1-4 Family (includes Home Equity) (1)
115
248
268
89
503
126
5,443
6,677
1,583,659
1,345,180
635,039
431,826
319,370
877,851
105,842
3,055
5,301,822
9,903
10,038
24,691
19,922
21,761
37,732
1,221
125,268
247
308
310
149
481
3,000
4,495
60
4,562
1,870
6,512
350
1,159
1,839
2,586
4,855
10,789
31
185
1,594,057
1,356,279
661,348
458,801
344,324
930,967
107,063
Commercial Real Estate (includes Multi-Family Residential)
14,068
5,490
1,392
6,158
965
28,073
648,945
590,953
708,326
583,116
469,022
1,016,783
93,664
674
4,111,483
95,773
138,201
90,416
118,628
231,747
294,096
971,363
2,786
32,088
19,423
59,490
4,799
148,177
1,520
268,283
1,865
20,025
156
1,225
36,011
44,501
103,783
1,165
12,896
1,394
15,480
19,995
24,133
6,520
517
1,211
52,376
783,444
810,890
826,233
764,141
747,750
1,518,629
99,080
Commercial and Industrial
338,614
56,263
2,012
2,877
550
75
25,704
426,095
490
547
356
796
2,027
8,470
12,754
260,231
204,850
186,056
160,436
56,246
140,386
925,391
2,308
1,935,904
12,170
36,531
39,867
44,875
6,295
17,067
115,939
2,507
275,251
9,010
7,217
10,296
989
15,814
47,874
12,677
2,343
155
154
45
1,561
26,251
43,312
679
297
5,522
537
917
8,260
173
516
10,357
9,144
85
7,329
27,604
633,871
308,221
239,223
229,072
74,120
161,791
1,125,815
4,941
Consumer and Other
15,902
9,400
3,649
1,749
1,527
903
34,650
394
891
577
360
29,436
31,678
43,705
29,590
28,616
16,347
8,555
7,748
43,647
178,213
1,184
5,160
332
69
94
15,384
22,277
5,872
71
101
2,189
61,185
47,230
32,967
18,796
39,589
8,783
66,425
17
356,862
66,177
5,677
4,712
2,215
978
35,576
472,197
15,319
7,196
2,126
1,219
36,851
9,850
8,727
81,288
5,431,548
2,923,710
1,947,309
1,315,658
984,633
2,175,213
1,353,484
11,051
16,142,606
166,221
243,244
224,974
209,903
265,173
366,271
152,578
1,630,871
21,724
44,186
30,855
64,217
6,342
151,843
19,368
338,780
20,659
26,448
408
6,803
36,056
49,146
33,045
172,691
691
647
1,519
8,537
2,656
18,600
2,354
35,004
27,430
7,350
11,126
9,307
1,727
6,033,019
3,339,038
2,220,218
1,622,175
1,343,233
2,773,659
1,612,461
13,929
Includes $10.2 million of residential mortgage loans held for sale at September 30, 2021.
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, 2021 for estimated losses in the Company’s loan portfolio. The amount of the allowance for credit losses is affected by the following: (1) charge-offs of loans that occur when loans are deemed uncollectible and decrease the allowance, (2) recoveries on loans previously charged off that increase the allowance, (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 the borrower’s 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 probable 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 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 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 the borrower’s ability to pay and the value of collateral, the evaluation of the Company’s loan portfolio through its internal loan review process, general economic conditions and other qualitative risk factors both internal and external to the Company and other relevant factors 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 allocated to it. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.
19
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, 2021 and 2020.
1-4 Family (includes Home Equity)
Allowance for credit losses:
Balance June 30, 2021
54,792
8,259
50,615
82,528
98,836
7,854
302,884
2,621
(42
7,982
(12,588
926
Charge-offs
(75
(11,180
(4,252
(1,212
(16,719
Recoveries
63
489
457
1,022
Net charge-offs
(66
(3,763
(755
(15,697
Balance September 30, 2021
57,417
8,280
51,650
79,330
82,485
8,025
287,187
Balance December 31, 2020
44,892
7,824
44,555
87,857
116,795
14,145
316,068
12,411
417
7,202
9,759
(25,434
(4,355
(52
(128
(18,408
(9,950
(2,866
(31,404
114
91
21
122
1,074
2,523
39
(107
(18,286
(8,876
(1,765
(28,881
Balance June 30, 2020
39,862
6,898
33,021
78,207
149,884
16,333
324,205
4,187
554
7,517
3,188
(4,982
(464
(500
(436
(676
(8,444
(1,092
(11,148
22
184
99
256
578
(478
(252
(8,345
(836
(10,570
Balance September 30, 2020
43,571
7,469
40,286
80,719
136,557
15,033
323,635
Balance December 31, 2019
14,654
2,971
15,277
12,332
40,445
1,790
87,469
Impact of adoption ASU 2016-13
14,075
2,797
8,267
48,990
139,624
26,785
240,538
15,302
1,680
17,050
19,992
(22,990
(11,034
(62
(611
(21,733
(3,529
(27,111
40
303
1,021
2,739
(460
(308
(595
(20,522
(2,508
(24,372
The allowance for credit losses on loans as of September 30, 2021 totaled $287.2 million or 1.51% of total loans, including acquired loans with discounts, a decrease of $28.9 million or 9.1% compared to the allowance for credit losses on loans totaling $316.1 million or 1.56% of total loans, including acquired loans with discounts, as of December 31, 2020. Net charge-offs were $15.7 million and $28.9 million for the three and nine months ended September 30, 2021, respectively. Net charge-offs for the third quarter of 2021 included $4.6 million related to resolved PCD loans and $10.8 million related to the partial charge-off of one commercial real estate loan obtained through acquisition. The PCD loans had specific reserves of $3.1 million, of which $2.2 million was allocated to the charge-offs and $944 thousand was moved to the general reserve. Further, an additional $14.3 million of specific reserves on resolved PCD loans without any related charge-offs was released to the general reserve. Net charge-offs for the nine months ended September 30, 2021 included $12.7 million related to PCD loans and $10.8 million related to the partial charge-off of one commercial real estate loan obtained through acquisition. The PCD loans had specific reserves of $12.9 million, of which $9.9 million was allocated to the charge-offs and $3.0 million was moved to the general reserve. Further, an additional $19.9 million of specific reserves on resolved PCD loans without any related charge-offs was released to the general reserve. As of September 30, 2021, the Company had loans totaling $365.8 million pursuant to the Paycheck Protection Program (“PPP”), which are fully guaranteed by the Small Business Administration and do not carry an allowance.
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, 2021 and December 31, 2020, the Company had $29.9 million in allowance for credit losses on off-balance sheet credit exposures. 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, 2021, the Company had $1.80 billion in commitments expected to fund.
Troubled Debt Restructurings. The restructuring of a loan is considered a “troubled debt restructuring” if both (1) the borrower is experiencing financial difficulties and (2) the creditor has granted a concession. Concessions may include interest rate reductions or below market interest rates, principal forgiveness, restructuring amortization schedules and other actions intended to minimize potential losses. Under ASC Topic 310-40 “Receivables—Troubled Debt Restructurings by Creditors,” the Company evaluates all loan modifications to identify whether the restructuring constitutes a troubled debt restructuring. As of September 30, 2021 and 2020, the Company had $6.5 million and $13.2 million, respectively, in outstanding troubled debt restructurings.
The following table presents information regarding the recorded investment of loans that were modified as troubled debt restructurings during the nine months ended September 30, 2021 and 2020.
Number of Loans
Pre-Modification Outstanding Recorded Investment
Post-Modification Outstanding Recorded Investment
Troubled Debt Restructurings
1-4 Family (includes home equity)
1
As of September 30, 2021, there have been no defaults on any loans that were modified as troubled debt restructurings during the preceding twelve months. Default is determined at 90 or more days past due. The modifications generally relate to extending the amortization periods of the loans, which includes loans modified during bankruptcy.
For the nine months ended September 30, 2021, the Company did not add any loans as new troubled debt restructurings. For the nine months ended September 30, 2020, the Company added one loan totaling $23 thousand as a new troubled debt restructuring, of which $12 thousand remained outstanding at September 30, 2020. The Company did not grant principal reductions on any restructured loans at the time of modification. These modifications did not have a material impact on the Company’s determination of the allowance for credit losses.
Under the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) and the Consolidated Appropriations Act of 2021 (“CAA”), banks may deem that loan modifications do not result in troubled debt restructurings if they are (1) related to the novel strain of coronavirus disease first reported in December 2019 (“COVID-19”); (2) executed on a loan that was not more than 30 days past due as of December 31, 2019; and (3) executed between March 1, 2020, and the earlier of (A) 60 days after the date of termination of the COVID-19 national emergency declaration by the President of the United States or (B) January 1, 2022. Additionally, other short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief are not troubled debt restructurings under ASC Subtopic 310-40 and federal banking agencies’ interagency guidance. These modifications include modifications such as principal and interest payment deferrals, temporary interest only
payment terms, fee waivers, extensions of repayment terms, or delays in payment that are insignificant. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented. The Company's troubled debt restructurings do not include loan modifications related to COVID-19. Beginning in mid-March of 2020, the Company began offering deferral and modification of principal and/or interest payments to selected borrowers on a case-by-case basis. As of September 30, 2021, the Company had approximately $79.5 million in outstanding loans subject to deferral and modification agreements.
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.
The following tables present fair values for assets and liabilities measured at fair value on a recurring basis:
As of September 30, 2021
Level 1
Level 2
Level 3
Assets:
Available for sale securities:
Derivative financial instruments:
Interest rate lock commitments
Forward mortgage-backed securities trades
153
Loan customer counterparty
5,723
Financial institution counterparty
Liabilities:
As of December 31, 2020
Total available for sale securities
11,912
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, 2021, the Company had additions to other real estate owned of $330 thousand and $6.2 million, respectively, of which $150 thousand was outstanding as of September 30, 2021. For the three and nine months ended September 30, 2021, the Company had additions to impaired loans of $11.8 million and $17.5 million, respectively, of which $11.8 million and $14.2 million, respectively, were outstanding as of September 30, 2021. The remaining financial assets and liabilities measured at fair value on a non-recurring basis that were recorded in 2021 and remained outstanding at September 30, 2021 were not significant.
The following tables present carrying and fair value information of financial instruments as of the dates indicated:
Carrying
Assets
Held to maturity securities
Loans held for investment, net of allowance
16,662,299
16,763,069
Liabilities
19,139,735
440,973
17,041,720
17,118,745
18,227,623
389,595
The following is a description of the fair value estimates, methods and assumptions that are used by the Company in estimating the fair values of financial instruments.
Loans held for sale— Loans held for sale are carried at the lower of cost or estimated fair value. Fair value for consumer mortgages held for sale is based on commitments on hand from investors or prevailing market prices. As such, the Company classifies loans held for sale subjected to nonrecurring fair value adjustments as Level 2.
Loans held for investment— The Company does not record loans at fair value on a recurring basis. As such, valuation techniques discussed herein for loans are primarily for estimating fair value disclosures. The Company refined the calculation to estimate fair value for loans held for investment to be in accordance with ASU 2016-01. The refined discounted cash flow calculation to determine fair value considers internal and market-based information such as prepayment risk, cost of funds and liquidity. From time to time, the Company records nonrecurring fair value adjustments to impaired loans to reflect (1) partial write downs that are based on the observable market price or current appraised value of the collateral, or (2) the full charge-off of the loan carrying value. Where appraisals are not available, estimated cash flows are discounted using a rate commensurate with the credit risk associated with those cash flows. Assumptions regarding credit risk, cash flows and discount rates are judgmentally determined using available market information and specific borrower information.
The Company classifies the estimated fair value of loans held for investment as Level 3.
24
Other real estate owned— Other real estate owned is primarily foreclosed properties securing residential loans and commercial real estate. Foreclosed assets are adjusted to fair value less estimated costs to sell upon transfer of the loans to other real estate owned. Subsequently, these assets are carried at the lower of carrying value or fair value less estimated costs to sell. Other real estate carried at fair value based on an observable market price or a current appraised value is classified by the Company as Level 2. When management determines that the fair value of other real estate requires additional adjustments, either as a result of a non-current appraisal or when there is no observable market price, the Company classifies the other real estate as Level 3.
The fair value estimates presented herein are based on pertinent information available to management at September 30, 2021. 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, 2021 and the year ended December 31, 2020 were as follows:
Core Deposit Intangibles
Balance as of December 31, 2019
3,223,671
86,404
Less:
Amortization
(13,169
Add:
Measurement period adjustment of LegacyTexas Merger(1)
7,965
Balance as of December 31, 2020
(8,696
Balance as of September 30, 2021
LegacyTexas Financial Group, Inc. (“LegacyTexas”) merged into Bancshares on November 1, 2019.
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, 2021, there was no impairment recorded on goodwill and core deposit intangibles.
The measurement period for the Company to determine the fair value of acquired identifiable assets and assumed liabilities will be at the end of the earlier of (1) twelve months from the date of acquisition or (2) as soon as the Company receives the information it was seeking about facts and circumstances that existed as of the date of acquisition.
Core deposit intangibles are being amortized on a non-pro rata basis over their estimated lives, which the Company believes is between 10 and 15 years. Amortization expense related to intangible assets totaled $2.9 million and $3.3 million for the three months ended September 30, 2021 and 2020, respectively, and $8.7 million and $9.9 million for the nine months ended September 30, 2021 and 2020, respectively. The estimated aggregate future amortization expense for core deposit intangibles remaining as of September 30, 2021 is as follows (dollars in thousands):
Remaining 2021
2,855
2022
10,336
2023
9,360
2024
8,699
2025
8,173
Thereafter
25,116
25
8. INCOME TAXES
Income tax expense totaled $34.8 million for the three months ended September 30, 2021 compared with $35.1 million for the same period in 2020, a decrease of $247 thousand or 0.7%. Income tax expense totaled $106.2 million for the nine months ended September 30, 2021 compared with $79.2 million for the same period in 2020, an increase of $26.9 million or 34.0%. Net income for the nine months ended September 30, 2020 includes a tax benefit for a net operating loss (“NOL”) of $20.1 million generated as a result of the enactment of the CARES Act and merger related expenses of $8.0 million. The Company’s effective tax rate for the three months ended September 30, 2021 and 2020 was 21.3% and 21.2%, respectively. The Company’s effective tax rate for the nine months ended September 30, 2021 and 2020 was 21.3% and 16.8%, respectively.
The CARES Act. The CARES Act permits a five-year carryback period for NOLs, which allowed the Company to generate an anticipated tax refund and income tax benefit resulting from the tax rate differential between the statutory tax rate of 21% in 2020 and the 35% statutory tax rate in prior years during the carryback period. Due to the NOL generated in 2019 by LegacyTexas, the Company recorded a current benefit for taxes on income for the nine months ended September 30, 2020, that was used to offset taxable income generated between 2014 and 2017 taxed at 35%, resulting in a tax benefit of $20.1 million, which is included in the provision for income taxes in the accompanying condensed consolidated statements of income. This caused a reduction in the effective tax rate during the nine months ended September 30, 2020. As a result of the NOL carryback, there was a reduction in the Company’s deferred tax assets of $30.2 million during the nine months ended September 30, 2020.
9. STOCK–BASED COMPENSATION
At September 30, 2021, the Company had two stock-based employee compensation plans 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 the Company’s 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, 2021, 15,576 shares of common stock had been issued pursuant to vested awards and 382,455 shares of unvested restricted stock have been granted under the 2020 Plan.
During 2012, Bancshares’ Board of Directors established the Prosperity Bancshares, Inc. 2012 Stock Incentive Plan (the “2012 Plan”), which was approved by Bancshares’ shareholders and authorized the issuance of up to 1,250,000 shares of common stock upon the exercise of options granted under the 2012 Plan or pursuant to the grant or exercise, as the case may be, of other awards granted under the 2012 Plan, including restricted stock, stock appreciation rights, phantom stock awards and performance awards. As of September 30, 2021, 728,347 shares of common stock had been issued pursuant to vested awards and 114,778 shares of unvested restricted stock had been granted under the 2012 Plan prior to the adoption of the 2020 Plan by the Company’s shareholders. The Company does not plan to make any further awards pursuant to the 2012 Plan.
As of September 30, 2021, the Company had no stock options outstanding. Stock-based compensation expense related to restricted stock was $3.0 million and $3.2 million during the three months ended September 30, 2021 and 2020, respectively, and $9.5 million and $9.5 million during the nine months ended September 30, 2021 and 2020. As of September 30, 2021, there was $22.4 million of total unrecognized compensation expense related to stock-based compensation arrangements. That cost is expected to be recognized over a weighted average period of 2.24 years.
10. CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ITEMS
The Company’s leases and off-balance sheet items as of September 30, 2021 are summarized below.
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 17 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 for the three and nine months ended September 30, 2021 was $815 thousand and $2.3 million, respectively, and the Company had no sublease income for the three and nine months ended September 30, 2020. As of September 30, 2021, operating lease ROU assets and lease liabilities were approximately $52.4 million. ROU assets and lease liabilities were classified as other assets and other liabilities, respectively.
26
As of September 30, 2021, the weighted average of remaining lease terms of the Company’s operating leases was 6.5 years. The weighted average discount rate used to determine the lease liabilities as of September 30, 2021 for the Company’s operating leases was 2.19%. Cash paid for the Company’s operating leases for the three months ended September 30, 2021 and 2020 was $2.9 million and $3.3 million, respectively. Cash paid for the Company’s operating leases for the nine months ended September 30, 2021 and 2020 was $9.3 million and $10.5 million, respectively. The Company obtained $1.3 million in ROU assets in exchange for lease liabilities for four operating leases during the nine months ended September 30, 2021.
The Company’s future undiscounted cash payments associated with its operating leases as of September 30, 2021 are summarized below (dollars in thousands).
2,926
11,358
10,549
9,334
8,853
2026
7,910
12,716
Total undiscounted lease payments
63,646
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, 2021 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
Standby letters of credit
97,744
6,279
1,988
106,011
Unused capacity on Warehouse Purchase Program loans
1,161,951
Commitments to extend credit
1,451,772
1,075,704
285,708
1,264,399
4,077,583
2,711,467
1,081,983
287,696
5,345,545
The Company records an allowance for credit losses on off-balance sheet lending-related commitments and guarantees on credit card debt through a charge to provision for credit losses on the Company’s consolidated statement of income. At September 30, 2021 and December 31, 2020, this allowance for credit losses on off-balance sheet lending-related commitments and guarantees on credit card debt, included in “Allowance for credit losses on off-balance sheet credit exposures” on the Company’s consolidated balance sheet, totaled $29.9 million.
27
11. OTHER COMPREHENSIVE INCOME
The tax effects allocated to each component of other comprehensive income were as follows:
Before Tax Amount
Tax Effect
Net of Tax Amount
Other comprehensive income:
Change in unrealized loss during period
Total securities available for sale
Total other comprehensive income
Other comprehensive income (loss):
Activity in accumulated other comprehensive income associated with securities available for sale, net of tax, was as follows:
Securities Available for Sale
Accumulated Other Comprehensive Income (Loss)
Balance at December 31, 2020
Balance at September 30, 2021
Balance at December 31, 2019
Balance at September 30, 2020
12. DERIVATIVE FINANCIAL INSTRUMENTS
The following table provides the outstanding notional balances and fair values of outstanding derivative positions at September 30, 2021 and December 31, 2020.
Outstanding
Notional
Balance
Asset
Derivative
Liability Derivative
13,635
31,750
Commercial loan interest rate swaps and caps:
198,939
224,684
28
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, 2021 and December 31, 2020 are presented in the following table.
Weighted-Average Interest Rate
Received
Paid
2.64
0.80
2.83
0.79
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, 2021 and $11.9 million at December 31, 2020. 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, 2021. 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 $9.3 million at September 30, 2021 and $13.8 million at December 31, 2020.
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, 2021 and 2020 was as follows:
Derivatives not designated as hedging instruments
(298
(305
(82
(2,398
29
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;
the effect, impact, potential duration or other implications of the COVID-19 pandemic, including any actions undertaken by federal, state and local governmental authorities in response to the pandemic;
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;
increased competition for deposits and loans adversely affecting rates and terms;
the timing, impact and other uncertainties of any future acquisitions, including 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 probable credit losses and to measure the fair value of financial instruments;
additional risks from new lines of businesses or new products and services;
claims or litigation related to intellectual property or fiduciary responsibilities;
the failure of the Company’s enterprise risk management framework to identify or address risks adequately;
a failure in or breach of operational or security systems of the Company’s infrastructure, or those of its third-party vendors and other service providers, including as a result of cyber attacks;
potential risk of environmental liability associated with lending activities;
acts of terrorism, an outbreak of hostilities or other international or domestic calamities, civil unrest, insurrections, other political, economic or diplomatic developments, including those caused by public health issues, outbreaks of diseases and pandemics, such as the COVID-19 pandemic, 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, 2020, 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, 2020.
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, 2021, the Bank operated 273 full-service banking locations; with 65 in the Houston area including The Woodlands; 30 in the South Texas area including Corpus Christi and Victoria; 63 in the Dallas/Fort Worth area; 22 in the East Texas area; 29 in the Central Texas area including Austin and San Antonio; 34 in the West Texas area including Lubbock, Midland-Odessa and Abilene; 16 in the Bryan/College Station area; 6 in the Central Oklahoma area; and 8 in the Tulsa, Oklahoma area. The Company’s principal executive office is located at Prosperity Bank Plaza, 4295 San Felipe in Houston, Texas, and its telephone number is (281) 269-7199. The Company’s website address is www.prosperitybankusa.com. Information contained on the Company’s website is not incorporated by reference into this quarterly report on Form 10-Q and is not part of this or any other report.
The Company generates the majority of its revenues from interest income on loans, service charges and fees on customer accounts and income from investment in securities. The revenues are partially offset by interest expense paid on deposits and other borrowings and noninterest expenses such as administrative and occupancy expenses. Net interest income is the difference between interest income on earning assets such as loans and securities and interest expense on liabilities such as deposits and borrowings which are used to fund those assets. Net interest income is the Company’s largest source of revenue. The level of interest rates and the volume and mix of earning assets and interest-bearing liabilities impact net interest income and margin.
Three principal components of the Company’s growth strategy are internal growth, efficient operations and acquisitions, including strategic merger transactions. The Company focuses on continual internal growth. The Company maintains separate data with respect to each banking center’s net interest income, efficiency ratio, deposit growth and loan growth for purposes of measuring its overall profitability. 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.
Total assets were $36.51 billion at September 30, 2021 compared with $34.06 billion at December 31, 2020, an increase of $2.45 billion or 7.2%. Total loans were $18.96 billion at September 30, 2021 compared with $20.25 billion at December 31, 2020, a decrease of $1.29 billion or 6.4%. Total deposits were $29.45 billion at September 30, 2021 compared with $27.36 billion at December 31, 2020, an increase of $2.09 billion or 7.6%. Total shareholders’ equity was $6.35 billion at September 30, 2021 compared with $6.13 billion at December 31, 2020, an increase of $214.8 million or 3.5%.
CRITICAL ACCOUNTING POLICIES
The Company’s significant accounting policies are integral to understanding the results reported. The Company’s accounting policies are described in detail in Note 1 to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020. 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. The fair value of acquired loans incorporates assumptions regarding future credit losses and therefore no allowance for credit losses related to the acquired loans is recorded on the acquisition date.
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 replaces 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 probable losses on impaired loans and 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 the borrower’s ability to pay and the value of collateral, the evaluation of the portfolio through its internal loan review process and other relevant factors. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. Charge-offs occur when loans are deemed to be uncollectible. For further discussion of the methodology used in the determination of the allowance for credit losses on loans, see “Accounting for Acquired Loans and the Allowance for Acquired Credit Losses” and “Financial Condition—Allowance for Credit Losses on Loans” below.
32
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, 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. 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.
Fair Values of Financial Instruments—The Company determines the fair market values of financial instruments based on the fair value hierarchy established, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. There are three levels of inputs that may be used to measure fair value. Level 1 inputs include quoted active market prices, where available. If such quoted market prices are not available, Level 2 inputs are used. These inputs are based upon internally developed analytical tools that primarily use observable, market-based parameters. Level 3 inputs are unobservable inputs which are typically based on an entity’s own assumptions, as there is little, if any, related market activity. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability.
COVID-19 PANDEMIC
The Company continues to monitor the latest developments regarding COVID-19. As of September 30, 2021, the states of Texas and Oklahoma have lifted their respective restrictions on all business and activities. However, as the number of cases attributable to the variants of COVID-19 increase, including the Delta variant, it is possible that some restrictions could be re-introduced. The COVID-19 pandemic has resulted in significant economic uncertainties that have had, and could continue to have, an adverse impact on the Company’s operating income, financial condition and cash flows. The extent to which the COVID-19 pandemic will impact the Company’s operations and financial results during 2021 cannot be reasonably or reliably estimated at this time.
Since the implementation of the Paycheck Protection Program in 2020, the Company has obtained SBA approvals on approximately 18,700 loans totaling $2.036 billion and, as of September 30, 2021, had an outstanding balance of 3,233 loans totaling $365.8 million.
Also, in response to the COVID-19 pandemic, the Company has provided relief to its loan customers through loan extensions and deferrals. The Company’s troubled debt restructurings do not include loan modifications related to COVID-19. Beginning in mid-March of 2020, the Company began offering deferral and modification of principal and/or interest payments to selected borrowers on a case-by-case basis. As of September 30, 2021, the Company had approximately $79.5 million in outstanding loans subject to deferral and modification agreements.
RESULTS OF OPERATIONS
Net income available to common shareholders was $128.6 million for the quarter ended September 30, 2021 compared with $130.1 million for the same period in 2020, a decrease of $1.5 million or 1.1%. Net income per diluted common share was $1.39 for the quarter ended September 30, 2021 compared with $1.40 for the same period in 2020, a decrease of 0.7%. The Company posted annualized returns on average common equity of 8.07% and 8.64%, annualized returns on average assets of 1.42% and 1.58% and efficiency ratios of 42.34% and 40.17% for the quarters ended September 30, 2021 and 2020, respectively. The efficiency ratio is calculated by dividing total noninterest expense 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 of assets are not included. Additionally, taxes are not part of this calculation.
For the nine months ended September 30, 2021, net income available to common shareholders was $392.5 million compared with $391.8 million for the same period in 2020, an increase of $697 thousand or 0.2%. Net income per diluted common share was $4.23 for the nine months ended September 30, 2021 compared with $4.20 for the same period in 2020, an increase of 0.7%. The Company posted annualized returns on average common equity of 8.32% and 8.78%, annualized returns on average assets of 1.47% and 1.62% and efficiency ratios of 41.52% and 43.19% for the nine months ended September 30, 2021 and 2020, respectively.
33
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, 2021
Net interest income before the provision for credit losses was $248.6 million for the quarter ended September 30, 2021, a decrease of $9.5 million or 3.7%, compared with $258.1 million for the same period in 2020. The change was primarily due to a decrease in the average balance and average rate on loans and a decrease in loan discount accretion of $17.2 million, partially offset by an increase in the average investment securities balance and a decrease in the average rate on interest-bearing liabilities.
Interest income on loans was $213.8 million for the quarter ended September 30, 2021, a decrease of $30.4 million or 12.5%, compared with $244.3 million for the same period in 2020. The change was primarily due to a decrease in the average balance and average rate on loans and a decrease in loan discount accretion of $17.2 million.
Interest income on securities was $46.2 million for the quarter ended September 30, 2021, an increase of $8.2 million or 21.5%, compared with $38.0 million for the same period in 2020, primarily due to an increase in the average investment securities balance.
Average interest-bearing liabilities were $19.38 billion for the quarter ended September 30, 2021, an increase of $1.60 billion or 9.0%, compared with $17.78 billion for the same period in 2020, primarily due to an increase in interest-bearing demand deposits and savings and money market deposits partially offset by decreases in other borrowings and subordinated notes.
The net interest margin on a tax-equivalent basis was 3.10% for the quarter ended September 30, 2021, a decrease of 47 basis points or 13.2% compared to 3.57% for the same period in 2020. The change was primarily due to a decrease in the average rate on loans and a decrease in loan discount accretion of $17.2 million, partially offset by an increase in the average investment securities balance and a decrease in the average rate on interest-bearing liabilities.
For the Nine Months Ended September 30, 2021
Net interest income before the provision for credit losses was $748.5 million for the nine months ended September 30, 2021, a decrease of $24.6 million or 3.2%, compared with $773.1 million for the same period in 2020. The change was primarily due to a decrease in the average rate on interest-earning assets and a decrease in loan discount accretion of $41.4 million, partially offset by a decrease in the average rate on interest-bearing liabilities.
Interest income on loans was $663.7 million for the nine months ended September 30, 2021, a decrease of $70.6 million or 9.6%, compared with $734.3 million for the same period in 2020. The change was primarily due to a decrease in the average rate on loans and a decrease in loan discount accretion of $41.4 million. The Company had $18.3 million of total outstanding accretable discounts on purchased loans as of September 30, 2021.
Interest income on securities was $128.6 million for the nine months ended September 30, 2021, a decrease of $1.5 million or 1.1%, compared with $130.1 million for the same period in 2020. This change was primarily due to lower average yields, partially offset by an increase in average securities balances.
Average interest-bearing liabilities were $19.28 billion for the nine months ended September 30, 2021, an increase of $1.57 billion or 8.8%, compared with $17.71 billion for the same period in 2020, primarily due to an increase in interest-bearing demand deposits and savings and money market deposits partially offset by decreases in other borrowings and subordinated notes.
The net interest margin on a tax-equivalent basis was 3.20% for the nine months ended September 30, 2021, a decrease of 49 basis points or 13.3%, compared to 3.69% for the nine months ended September 30, 2020. The change was primarily due to a decrease in the average rate on loans, a decrease in loan discount accretion of $41.4 million, lower rates on investment securities and higher cash balances due to excess liquidity, partially offset by a decrease in the average rate on interest-bearing liabilities.
The following table presents, for the periods indicated, the total dollar amount of average balances, interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities and the resultant rates. Except as indicated in the footnotes, no tax-equivalent adjustments were made and all average balances are daily average balances. Any nonaccruing loans have been included in the table as loans carrying a zero yield.
Average Outstanding Balance
Interest Earned/Paid
Average Yield/Rate (1)
Interest-Earning Assets:
11,714
3.08
50,606
420
3.30
17,102,998
199,019
4.62
18,267,559
225,596
4.91
1,836,252
14,711
3.18
2,279,461
18,239
18,950,964
4.48
20,597,626
4.72
Investment securities
12,184,964
1.50
7,603,762
1.99
734,787
0.16
618,228
0.09
Total interest-earning assets
31,870,715
3.24
28,819,616
3.90
Allowance for credit losses on loans
(301,011
(321,424
Noninterest-earning assets
4,728,965
4,482,646
Total assets
36,298,669
32,980,838
Liabilities and Shareholders' Equity
Interest-Bearing Liabilities:
Interest-bearing demand deposits
6,089,678
3,614
0.24
5,221,722
5,028
0.38
Savings and money market deposits
9,944,664
4,522
0.18
8,937,751
7,833
0.35
Certificates and other time deposits
2,897,123
3,442
0.47
3,103,290
9,597
1.23
Federal funds purchased and other borrowings
13,898
1.49
448,338
0.17
378,888
0.32
125,256
4.76
Total interest-bearing liabilities
19,379,803
17,780,805
0.54
Noninterest-Bearing Liabilities:
Noninterest-bearing demand deposits
10,286,062
8,980,814
229,502
167,532
29,925,314
26,959,098
Shareholders' equity
6,373,355
6,021,740
Total liabilities and shareholders' equity
Net interest rate spread
3.00
3.36
Net interest income and margin (2) (3)
3.09
3.56
Net interest income and margin (tax equivalent) (4)
249,118
3.10
258,771
3.57
Annualized and based on average balances on an actual 365-day or 366-day basis for the three months ended September 30, 2021 and 2020.
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%.
35
19,507
439
3.01
60,256
1,575
3.49
17,228,462
613,813
17,890,010
690,175
5.15
2,061,432
49,447
3.21
1,749,568
42,520
3.25
19,309,401
4.60
19,699,834
4.98
10,849,373
1.58
8,029,097
2.16
1,151,647
0.12
339,229
0.36
31,310,421
3.39
28,068,160
4.12
(307,500
(325,036
4,644,874
4,540,440
35,647,795
32,283,564
6,160,988
15,028
0.33
5,054,320
16,745
0.44
9,747,706
15,765
8,481,852
30,700
0.48
2,969,151
13,435
0.60
3,243,564
35,300
1.45
439,018
1.07
403,254
370,225
0.51
125,475
4.79
19,281,099
0.31
17,714,454
0.69
9,855,599
8,354,410
24,321
194,347
239,747
29,360,992
26,332,932
6,286,803
5,950,632
3.43
3.20
3.68
750,320
775,170
3.69
Annualized and based on average balances on an actual 365-day or 366-day basis for the nine months ended September 30, 2021 and 2020.
(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%.
The following table presents information regarding the dollar amount of changes in interest income and interest expense for the periods indicated for each major component of interest-earning assets and interest-bearing liabilities and distinguishes between the changes attributable to changes in volume and changes in interest rates. For purposes of this table, changes attributable to both rate and volume which cannot be segregated have been allocated to rate.
2021 vs. 2020
Increase
(Decrease)
Due to Change in
Volume
Rate
(323
(329
(1,064
(72
(1,136
Loans held for investment (1)
(14,412
(12,165
(26,577
(25,482
(50,880
(76,362
(3,552
(3,528
7,581
(654
6,927
Investment securities (1)
22,979
(14,795
8,184
45,563
(47,052
(1,489
132
158
2,188
(2,097
Total increase (decrease) in interest income
4,718
(26,810
(22,092
28,786
(100,755
(71,969
831
(2,245
(1,414
3,642
(5,359
(1,717
888
(4,199
(3,311
4,545
(19,480
(14,935
Certificates and other time deposits (1)
(639
(5,516
(6,155
(2,976
(18,889
(21,865
(3,517
(170
(1,011
(885
(1,503
(1,500
(4,499
Total decrease in interest expense
(419
(12,127
(12,546
(2,679
(44,739
(47,418
Increase (decrease) in net interest income
5,137
(14,683
(9,546
31,465
(56,016
(24,551
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 the borrower’s ability to pay and the value of collateral, the evaluation of the loan portfolio through the internal loan review process and other relevant factors.
Loans are charged off against the allowance for credit losses when appropriate. Although management believes it uses the best information available to make determinations with respect to the provision for credit losses, future adjustments may be necessary if economic conditions differ from the assumptions used in making the initial determinations.
The Company had no provision for credit losses for the quarter ended September 30, 2021 and a $10.0 million provision for credit losses for the quarter ended September 30, 2020. The Company had no provision for credit losses for the nine months ended September 30, 2021 and a $20.0 million provision for credit losses for the nine months ended September 30, 2020.
Net charge-offs were $15.7 million for the quarter ended September 30, 2021 compared with net charge-offs of $10.6 million for the quarter ended September 30, 2020. Net charge-offs for the third quarter of 2021 included $4.6 million related to resolved PCD loans and $10.8 million related to the partial charge-off of one commercial real estate loan obtained through acquisition. The PCD loans had specific reserves of $3.1 million, of which $2.2 million was allocated to the charge-offs and $944 thousand was moved to the general reserve. Further, an additional $14.3 million of specific reserves on resolved PCD loans without any related charge-offs was released to the general reserve.
Net charge-offs were $28.9 million for the nine months ended September 30, 2021 compared with $24.4 million for the nine months ended September 30, 2020. Net charge-offs for the nine months ended September 30, 2021 included $12.7 million related to resolved PCD loans and $10.8 million related to the partial charge-off of one commercial real estate loan obtained through acquisition. The PCD loans had specific reserves of $12.9 million, of which $9.9 million was allocated to the charge-offs and $3.0 million was
moved to the general reserve. Further, an additional $19.9 million of specific reserves on resolved PCD loans without any related charge-offs was released to the general reserve.
Noninterest Income
The Company’s primary sources of recurring noninterest income are nonsufficient funds (“NSF”) fees, credit, debit and ATM card income, and service charges on deposit accounts. Additionally, the Company generates recurring noninterest income from its 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 $34.6 million for the three months ended September 30, 2021 compared with $34.9 million for the same period in 2020, a decrease of $279 thousand or 0.8%. Noninterest income totaled $104.2 million for the nine months ended September 30, 2021 compared with $95.0 million for the same period in 2020, an increase of $9.2 million or 9.7%. This increase was primarily due to lower net loss on write-downs of assets, an increase in credit card, debit card and ATM card income and an increase in other noninterest income.
The following table presents, for the periods indicated, the major categories of noninterest income:
Bank owned life insurance income
1,449
3,911
4,502
5,427
6,524
17,652
16,177
38
Noninterest Expense
Noninterest expense totaled $119.8 million for the quarter ended September 30, 2021 compared with $117.9 million for the quarter ended September 30, 2020, an increase of $1.9 million or 1.6%, primarily due to an increase in salaries and benefits. Noninterest expense totaled $354.1 million for the nine months ended September 30, 2021 compared with $377.0 million for the nine months ended September 30, 2020, a decrease of $22.9 million or 6.1%. The change was primarily due to decreases in merger related expenses, data processing, net occupancy and equipment and other noninterest expense as a result of efficiencies gained following the LegacyTexas Bank system conversion during the second quarter of 2020 and net gains on sale of other real estate of $2.7 million, partially offset by an increase in salaries and benefits.
The following table presents, for the periods indicated, the major categories of noninterest expense:
Salaries and employee benefits (1)
Non-staff expenses:
Communications (2)
Net other real estate expense (income) (3)
Merger related expenses (4)
Includes stock-based compensation expense of $3.0 million and $3.2 million for the three months ended September 30, 2021 and 2020, respectively, and $9.5 million for the nine months ended September 30, 2021 and 2020.
Communications expense includes telephone, data circuits, postage and courier expenses.
Net other real estate (income) expense is comprised of rental expense, rental income and gains and losses on sales of real estate.
LegacyTexas merged into Bancshares on November 1, 2019.
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 $34.8 million for the three months ended September 30, 2021 compared with $35.1 million for the same period in 2020, a decrease of $247 thousand or 0.7%. Income tax expense totaled $106.2 million for the nine months ended September 30, 2021 compared with $79.2 million for the same period in 2020, an increase of $26.9 million or 34.0%. Net income for the nine months ended September 30, 2020 includes a tax benefit for a NOL of $20.1 million generated as a result of the enactment of the CARES Act and merger related expenses of $8.0 million. The Company’s effective tax rate for the three months ended September 30, 2021 and 2020 was 21.3% and 21.2%, respectively. The Company’s effective tax rate for the nine months ended September 30, 2021 and 2020 was 21.3% and 16.8%, 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 preliminarily 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.
Acquired Loans
Originated Loans
Re-
Underwritten Acquired Loans
Non-PCD Loans
1,689,678
698,772
361,000
Warehouse purchase program
2,134,982
121,027
13,108
4,216,061
300,919
928,532
3,803,551
464,540
1,230,374
406,172
9,723
21,286
164,437
28,130
139
234,967
19,111
18,713
Total loans held for investment
14,647,897
1,642,222
18,947,535
14,658,094
Re-Underwritten Acquired Loans
2,082,366
890,278
625,102
76,454
1,752,925
125,820
77,674
541
3,143,532
358,745
1,206,891
1,593
3,548,257
576,444
1,861,743
92,320
372,627
10,576
25,994
1,734
126,533
43,476
412
290,300
24,876
31,802
8,773
14,158,919
2,030,215
20,200,167
14,205,696
At September 30, 2021, total loans were $18.96 billion, a decrease of $1.29 billion or 6.4%, compared with $20.25 billion at December 31, 2020. Loans at September 30, 2021 included $10.2 million of loans held for sale and $2.00 billion of Warehouse Purchase Program loans compared with $46.8 million of loans held for sale and $2.84 billion of Warehouse Purchase Program loans at December 31, 2020. At September 30, 2021, loans represented 51.9% of total assets compared with 59.4% of total assets at December 31, 2020.
The loan portfolio consists of various types of loans categorized by major type as follows:
(i) Commercial and Industrial Loans. In nearly all cases, the Company’s commercial loans are made in the Company’s market areas and are underwritten on the basis of the borrower’s ability to service the debt from income. 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. As of September 30, 2021, oil and gas loans totaled $569.3 million (net of discount and excluding PPP loans totaling $55.8 million) or 3.0% of total loans, compared with total oil and gas loans of $512.7 million (net of discount and excluding PPP loans totaling $88.7 million) or 2.5% of total loans as of December 31, 2020. In addition, as of September 30, 2021, the Company had total unfunded commitments to oil and gas companies of $363.3 million compared with total unfunded commitments to oil and gas companies of $243.2 million as of December 31, 2020. Total unfunded commitments to producers include letters of credit issued in lieu of oil well plugging bonds.
(ii) Commercial Real Estate. The Company makes commercial real estate loans collateralized by owner-occupied and nonowner-occupied real estate to finance the purchase of real estate. The Company’s commercial real estate loans are collateralized by first liens on real estate, typically have variable interest rates (or five year or less fixed rates) and amortize over a 15- to 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. As of September 30, 2021, loans to hotels totaled $407.1 million (excluding PPP loans totaling $5.7 million) or 2.1% of total loans, compared to $393.8 million (excluding PPP loans totaling $6.5 million) or 1.9% of total loans at December 31, 2020. As of September 30, 2021, loans to restaurants totaled $198.2 million (excluding PPP loans totaling $49.7 million) or 1.0% of total loans, compared to $214.7 million (excluding PPP loans totaling $83.6 million) or 1.1% of total loans at December 31, 2020.
(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 floating interest rates. The Company conducts periodic inspections, either directly or through an agent, prior to approval of periodic draws on
41
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 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. PCD loans are reported as nonperforming assets when a deterioration in projected cash flows is identified.
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
42
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 decreased $23.0 million, or 38.6%, to $36.5 million at September 30, 2021 compared with $59.6 million at December 31, 2020, of which $14.1 million and $18.7 million, respectively, were attributable to acquired loans. The decrease in nonperforming assets was primarily due to a $12.2 million decrease in nonaccrual loans in the commercial and industrial and 1-4 family residential portfolios as well as a $10.4 million decrease in other real estate resulting from the sale of two 1-4 family residential properties.
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:
Nonaccrual loans (1)(2)
21,983
665
12,219
168
1,015
22,006
22,466
12,235
Nonperforming assets to total loans and other real estate by category
0.15
0.10
0.20
Nonperforming assets to total loans, excluding Warehouse Purchase Program loans, and other real estate by category
32,650
2,953
10,867
715
396
1,303
33,046
7,711
2,882
40,850
15,052
0.39
Nonperforming assets were 0.19% of total loans and other real estate at September 30, 2021 and 0.29% of total loans and other real estate at December 31, 2020. The allowance for credit losses as a percentage of total nonperforming loans was 796.1% at September 30, 2021 and 646.6% at December 31, 2020.
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, 2021 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 the borrower’s performance differ from the assumptions used in making the initial determinations.
The Company’s allowance for credit losses consists of two components: (1) a specific valuation allowance based on 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 the borrower’s ability to pay and the value of collateral, the evaluation of the Company’s loan portfolio through its internal loan review process, general economic conditions, other qualitative risk factors both internal and external to the Company and other relevant factors. 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 allocated to it. The Company uses this information to establish the amount of the general valuation allowance.
A change in the allowance for credit losses can be attributable to several factors, most notably (1) specific reserves identified for impaired loans, (2) historical 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,
44
management is able to identify the probable 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 become impaired subsequent to acquisition are assessed for the specific 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 individually monitored on a quarterly basis to assess for changes in expected cash flows subsequent to acquisition. If a deterioration in cash flows is identified, an additional provision for credit losses is made. PCD loans were recorded at their acquisition date fair values, which were based on expected cash flows and included estimates of expected future credit losses. The Company’s estimates of loan fair values at the acquisition date may be adjusted for a period of up to one year as the Company continues to evaluate its estimate of expected future cash flows at the acquisition date. If the Company determines that losses arose after the acquisition date, the additional losses will be reflected as a provision for credit losses. See “Critical Accounting Policies” above for more information.
As described in the section captioned “Critical Accounting Policies” above, the Company’s determination of the allowance for credit losses involves a high degree of judgment and complexity. The Company’s analysis of qualitative, or environmental, factors on pools of loans with common risk characteristics, in combination with the quantitative historical 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 allowance for credit losses on loans as of September 30, 2021 totaled $287.2 million or 1.51% of total loans, including acquired loans with discounts, a decrease of $28.9 million or 9.1% compared to the allowance for credit losses on loans totaling $316.1 million or 1.56% of total loans, including acquired loans with discounts, as of December 31, 2020. For further discussion on the provision for credit losses, see “Results of Operations—Provision for Credit Losses” above.
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, 2021
Average loans outstanding
13,913,479
5,395,922
Gross loans outstanding at end of period
4,299,638
Allowance for credit losses at beginning of period
150,630
165,438
30,571
(30,571
Charge-offs:
(3,471
(6,479
Real estate and agriculture
(820
(17,768
(18,588
(2,576
(290
Recoveries:
746
328
334
348
913
188
Net charge-offs(1)
(4,874
(24,007
Allowance for credit losses at end of period
176,327
110,860
Ratio of allowance to end of period loans
1.20
2.58
1.51
Ratio of allowance to end of period loans, excluding Warehouse Purchase Program
1.69
Ratio of net charge-offs to average loans (annualized)
0.05
0.59
Ratio of allowance to end of period nonperforming loans
801.3
788.1
796.1
As of and for the Nine Months Ended September 30, 2020
12,655,534
7,044,300
14,053,312
6,742,329
20,795,641
77,013
10,456
Cumulative effect from adoption of ASU 2016-13 (2)
28,107
212,431
32,519
(12,519
(20,597
(167
(1,682
(1,849
(3,043
(486
295
916
447
507
986
Net charge-offs (1)
(2,618
(21,754
135,021
188,614
Ratio of allowance to end of period loans (2)
0.96
2.80
1.56
Ratio of allowance to end of period loans, excluding Warehouse Purchase Program (2)
1.19
1.79
0.03
0.41
295.5
1548.4
559.2
There was no net charge-off activity on Warehouse Purchase Program loans during the periods presented.
46
The Company had gross charge-offs on originated loans of $6.9 million during the nine months ended September 30, 2021. Partially offsetting these charge-offs were recoveries on originated loans of $2.0 million. Gross charge-offs on acquired loans were $24.5 million during the nine months ended September 30, 2021. Partially offsetting these charge-offs were recoveries on acquired loans of $530 thousand. Total charge-offs for the nine months ended September 30, 2021 were $31.4 million, partially offset by total recoveries of $2.5 million.
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.
Allowance
Percent of Loans to Total Loans(1)
Balance of allowance for credit losses applicable to:
29,137
27,199
18,695
7,454
16.4
Real estate
135,211
11,414
24,648
17,124
188,397
78.3
Agriculture and agriculture real estate
7,063
863
182
172
3.7
4,916
473
1.6
Total allowance for credit losses
39,923
43,998
26,939
100.0
31,537
29,358
31,798
24,102
21.1
106,154
11,363
30,194
29,593
177,304
73.4
6,233
1,189
230
3.4
6,706
828
5,896
2.1
42,625
63,050
59,763
Loans outstanding as of a percentage of total loans, excluding Warehouse Purchase Program loans.
The allowance for credit losses totaled $287.2 million at September 30, 2021 and $316.1 million at December 31, 2020. The allowance for credit losses totaled 1.51% of total loans at September 30, 2021 and 1.56% of total loans at December 31, 2020.
At September 30, 2021, $176.3 million of the allowance for credit losses was attributable to originated loans, an increase of $25.7 million or 17.1% compared with $150.6 million of the allowance at December 31, 2020. At September 30, 2021, $39.9 million of the allowance for credit losses was attributable to re-underwritten acquired loans compared with $42.6 million of the allowance at December 31, 2020, a decrease of $2.7 million or 6.3%. At September 30, 2021, $44.0 million of the allowance for credit losses was attributable to Non-PCD loans compared with $63.1 million of the allowance at December 31, 2020, a decrease of $19.1 million or 30.2%. At September 30, 2021, $26.9 million of the allowance for credit losses was attributable to PCD loans compared with $59.8 million of the allowance at December 31, 2020, a decrease of $32.8 million or 54.9%.
At September 30, 2021, the Company had $18.3 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, 2021 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, 2021.
47
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 looking at 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, 2021 and December 31, 2020, the Company had $29.9 million in allowance for credit losses on off-balance sheet credit exposures. The allowance for credit losses on off-balance sheet credit exposures is a separate line item on the Company’s consolidated balance sheet.
The carrying cost of securities totaled $12.63 billion at September 30, 2021 compared with $8.54 billion at December 31, 2020, an increase of $4.09 billion or 47.8%. At September 30, 2021, securities represented 34.6% of total assets compared with 25.1% of total assets at December 31, 2020.
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.”
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
48
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, 2021, 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, 2021, management believes that there is no potential for credit losses on available for sale securities.
Total deposits were $29.45 billion at September 30, 2021 compared with $27.36 billion at December 31, 2020, an increase of $2.09 billion or 7.6%. At September 30, 2021, noninterest-bearing deposits totaled $10.33 billion, an increase of $1.18 billion or 12.8% compared with $9.15 billion at December 31, 2020. Interest-bearing deposits totaled $19.13 billion at September 30, 2021 compared with $18.21 billion at December 31, 2020, an increase of $915.9 million or 5.0%.
Average deposits for the nine months ended September 30, 2021 were $28.73 billion, an increase of $3.60 billion or 14.3%, compared with $25.13 billion for the nine months ended September 30, 2020. The ratio of average interest-bearing deposits to total average deposits was 65.7% and 66.8% during the first nine months of 2021 and 2020, respectively.
The following table summarizes the daily average balances and weighted average rates paid on deposits for the periods indicated below:
Average Balance
Average Rate (1)
Regular savings
3,100,257
0.11
2,791,252
Money market savings
6,647,449
0.27
5,690,600
0.61
Certificates, IRAs and other time deposits
Total interest-bearing deposits
18,877,845
16,779,736
0.66
28,733,444
0.21
25,134,146
49
Other Borrowings
The following table presents the Company’s borrowings as of the dates indicated:
FHLB advances and long-term notes payable— The Company has an available line of credit with the FHLB of Dallas, which allows the Company to borrow on a collateralized basis. The Company’s FHLB advances are typically considered short-term borrowings and are used to manage liquidity as needed. Maturing advances are replaced by drawing on available cash, making additional borrowings or through increased customer deposits. At September 30, 2021, the Company had total funds of $13.91 billion available under this line. At September 30, 2021 and December 31, 2020, the Company had no FHLB advances or long-term notes payable balances.
Securities sold under repurchase agreements— At September 30, 2021, the Company had $441.0 million in securities sold under repurchase agreements with banking customers compared with $389.6 million at December 31, 2020, an increase of $51.4 million or 13.2%. Repurchase agreements are generally settled on the following business day; however, approximately $5.4 million of the repurchase agreements outstanding at September 30, 2021 have maturity dates ranging from 6 to 24 months. All securities sold under repurchase agreements are collateralized by certain pledged securities.
Liquidity
Liquidity involves the Company’s ability to raise funds to support asset growth 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, 2021, the Company had outstanding $4.08 billion in commitments to extend credit, $106.0 million in commitments associated with outstanding standby letters of credit and $1.16 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, 2021, the Company had cash and cash equivalents of $1.06 billion compared with $1.34 billion at December 31, 2020, a decrease of $287.9 million or 21.4%. The decrease was primarily due to the purchases of securities, payment of cash dividends of $136.3 million and the repurchase of common stock of $52.1 million, partially offset by the increase in deposits and net cash provided by operating activities of $619.7 million.
Share Repurchases
On January 26, 2021, Bancshares announced a stock repurchase program under which Bancshares could repurchase up to 5%, or approximately 4.65 million shares, of Bancshares’ outstanding common stock over a one-year period expiring on January 26, 2022, 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. Bancshares repurchased 767,134 shares of its common stock at an average weighted price of $67.87 during the three and nine months ended September 30, 2021.
50
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 17 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 for the three and nine months ended September 30, 2021 was $815 thousand and $2.3 million, respectively, and the Company had no sublease income for the three and nine months ended September 30, 2020. As of September 30, 2021, operating lease ROU assets and lease liabilities were approximately $52.4 million. ROU assets and lease liabilities were classified as other assets and other liabilities, respectively.
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, 2021 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.
Allowance for Credit Losses on Off-balance Sheet Credit Exposures. The Company records an allowance for credit losses on off-balance sheet lending-related commitments and guarantees on credit card debt through a charge to provision for credit losses on the Company’s consolidated statement of income. At September 30, 2021 and December 31, 2020, this allowance for credit losses on off-balance sheet lending-related commitments and guarantees on credit card debt, included in “Allowance for credit losses on off-balance sheet credit exposures” on the Company’s consolidated balance sheet, totaled $29.9 million.
51
Capital Resources
Total shareholders’ equity was $6.35 billion at September 30, 2021 compared with $6.13 billion at December 31, 2020, an increase of $214.8 million or 3.5%. The increase was primarily the result of net income of $392.5 million partially offset by dividend payments of $136.3 million and repurchase of common stock of $52.1 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 allows banking organizations that implement 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 at 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.
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, 2021, 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, 2021:
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, 2021
The Company
CET1 capital (to risk weighted assets)
4.50
7.00
N/A
14.84
Tier 1 capital (to risk weighted assets)
6.00
8.50
Total capital (to risk weighted assets)
8.00
10.50
15.20
Tier 1 capital (to average assets)
4.00
9.55
The Bank
6.50
14.78
10.00
15.14
5.00
9.52
The Federal Reserve Board may require the Company to maintain a leverage ratio above the required minimum.
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, 2020, filed on February 26, 2021 (the “2020 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 2020 Form 10-K and presented as of December 31, 2020.
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, 2021 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
ITEM 1.
LEGAL PROCEEDINGS
The Company and the Bank are defendants, from time to time, in legal actions arising from transactions conducted in the ordinary course of business. After consultations with legal counsel, the Company and the Bank believe that the ultimate liability, if any, arising from such actions will not have a material adverse effect on their financial statements.
ITEM 1A.
RISK FACTORS
There have been no material changes in the Company’s risk factors from those disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020.
ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
a. None.
b. None.
c. The following table details the Company’s repurchases of shares of its common stock during the three months ended September 30, 2021:
Period
Total Number of Shares Purchased
Weighted Average Price Paid per Share
Total Number of Shares Purchased as Part of Publicly Announced Plans or Program
Maximum Number of Shares That May Yet Be Purchased Under the Plan at the End of the Period (1)
July 1 - July 31, 2021
4,646,789
August 1 - August 31, 2021
217,236
68.67
4,429,553
September 1 - September 30, 2021
549,898
67.55
3,879,655
767,134
67.87
On January 26, 2021, the Company announced a stock repurchase program under which up to 5%, or approximately 4.65 million shares, of its outstanding common stock may be acquired over a one-year period expiring on January 26, 2022, at the discretion of management. Under the 2021 stock repurchase program, the Company may repurchase shares from time to time at prevailing market prices, through open-market purchases or privately negotiated transactions, depending upon market conditions. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Financial Condition—Share Repurchases” for additional information.
DEFAULTS UPON SENIOR SECURITIES
None.
MINE SAFETY DISCLOSURES
Not applicable.
ITEM 5.
OTHER INFORMATION
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, 2021 (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: 11/04/2021
/S/ DAVID ZALMAN
David Zalman
Senior Chairman and Chief Executive Officer
/S/ ASYLBEK OSMONOV
Asylbek Osmonov
Chief Financial Officer