UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
☒QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED June 30, 2023
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 August 1, 2023, there were 93,722,454 outstanding shares of the registrant’s Common Stock, par value $1.00 per share.
PROSPERITY BANCSHARES, INC.® AND SUBSIDIARIES
INDEX TO FORM 10-Q
PART I—FINANCIAL INFORMATION
Item 1.
Financial Statements
3
Consolidated Balance Sheets as of June 30, 2023 (unaudited) and December 31, 2022
Consolidated Statements of Income for the Three and Six Months Ended June 30, 2023 and 2022 (unaudited)
4
Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2023 and 2022 (unaudited)
5
Consolidated Statements of Changes in Shareholders’ Equity for the Three and Six Months Ended June 30, 2023 and 2022 (unaudited)
6
Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2023 and 2022 (unaudited)
7
Notes to Consolidated Financial Statements (unaudited)
8
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
33
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
59
Item 4.
Controls and Procedures
PART II—OTHER INFORMATION
Legal Proceedings
60
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
61
Signatures
62
2
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
June 30,
December 31,
2023
2022
(unaudited)
(Dollars in thousands, except par value)
ASSETS
Cash and due from banks
$
396,848
423,832
Federal funds sold
181
301
Total cash and cash equivalents
397,029
424,133
Available for sale securities, at fair value
462,013
456,502
Held to maturity securities, at cost (fair value of $11,647,080 and $12,387,125, respectively)
13,205,306
14,019,503
Total securities
13,667,319
14,476,005
Loans held for sale
10,656
554
Loans held for investment
20,494,407
18,098,653
Loans held for investment - Warehouse Purchase Program
1,148,883
740,620
Total loans
21,653,946
18,839,827
Less: allowance for credit losses on loans
(345,209
)
(281,576
Loans, net
21,308,737
18,558,251
Accrued interest receivable
92,265
88,438
Goodwill
3,383,698
3,231,636
Core deposit intangibles, net
71,128
51,348
Bank premises and equipment, net
365,299
339,453
Other real estate owned
3,107
1,963
Bank owned life insurance (BOLI)
382,011
327,439
Federal Home Loan Bank of Dallas stock
107,229
90,025
Other assets
127,309
101,138
TOTAL ASSETS
39,905,131
37,689,829
LIABILITIES AND SHAREHOLDERS’ EQUITY
LIABILITIES:
Deposits:
Noninterest-bearing
10,364,921
10,915,448
Interest-bearing
17,015,965
17,618,083
Total deposits
27,380,886
28,533,531
Other borrowings
4,800,000
1,850,000
Securities sold under repurchase agreements
434,160
428,134
Subordinated debentures
3,093
—
Accrued interest payable
28,734
4,495
Allowance for credit losses on off-balance sheet credit exposures
36,503
29,947
Other liabilities
253,639
144,348
Total liabilities
32,937,015
30,990,455
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS’ EQUITY:
Preferred stock, $1 par value; 20,000,000 shares authorized; none issued or outstanding
Common stock, $1 par value; 200,000,000 shares authorized; 93,721,454 issued and outstanding at June 30, 2023; 91,313,615 shares issued and outstanding at December 31, 2022
93,722
91,314
Capital surplus
3,697,524
3,541,924
Retained earnings
3,179,551
3,069,609
Accumulated other comprehensive loss —net unrealized loss on available for sale securities, net of tax benefit of $(713) and $(923), respectively
(2,681
(3,473
Total shareholders’ equity
6,968,116
6,699,374
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
See notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
Three Months Ended
Six Months Ended
(Dollars in thousands, except per share data)
INTEREST INCOME:
Loans, including fees
286,638
192,770
533,756
385,795
Securities
72,053
64,111
145,238
119,122
Federal funds sold and other earning assets
1,757
925
8,763
1,772
Total interest income
360,448
257,806
687,757
506,689
INTEREST EXPENSE:
Deposits
63,964
8,641
111,307
17,395
57,351
450
91,747
2,674
244
4,777
429
Total interest expense
123,989
9,335
207,831
18,274
NET INTEREST INCOME
236,459
248,471
479,926
488,415
PROVISION FOR CREDIT LOSSES
18,540
NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES
217,919
461,386
NONINTEREST INCOME:
Nonsufficient funds (NSF) fees
8,512
8,484
16,607
16,608
Credit card, debit card and ATM card income
9,206
8,880
17,872
17,059
Service charges on deposit accounts
6,078
6,365
12,004
12,576
Trust income
3,358
2,875
6,583
5,578
Mortgage income
661
502
899
957
Brokerage income
1,000
917
2,149
1,809
Net gain on sale or write-down of assets
1,994
1,108
2,115
1,797
Other
8,879
8,463
19,725
16,332
Total noninterest income
39,688
37,594
77,954
72,716
NONINTEREST EXPENSE:
Salaries and employee benefits
84,723
80,371
162,521
159,782
Net occupancy and equipment
8,935
8,039
16,960
15,887
Credit and debit card, data processing and software amortization
10,344
9,246
19,910
18,095
Regulatory assessments and FDIC insurance
5,097
2,851
10,070
5,701
Core deposit intangibles amortization
3,167
2,581
5,541
5,201
Depreciation
4,658
4,539
9,091
9,086
Communications
3,693
3,206
7,155
6,125
Net other real estate (income) expense
(497
209
(452
(198
Merger related expenses
12,891
13,751
12,859
11,836
24,323
23,049
Total noninterest expense
145,870
122,878
268,870
242,728
INCOME BEFORE INCOME TAXES
111,737
163,187
270,470
318,403
PROVISION FOR INCOME TAXES
24,799
34,697
58,838
67,587
NET INCOME
86,938
128,490
211,632
250,816
EARNINGS PER SHARE:
Basic
0.94
1.40
2.30
2.73
Diluted
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in thousands)
Net income
Other comprehensive income (loss), before tax:
Securities available for sale:
Change in unrealized income (loss) during the period
1,006
(598
1,002
(773
Total other comprehensive income (loss)
Deferred tax (expense) benefit related to other comprehensive income (loss)
(211
125
(210
162
Other comprehensive income (loss), net of tax
795
(473
792
(611
Comprehensive income
87,733
128,017
212,424
250,205
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 MARCH 31, 2023
90,693,102
90,694
3,507,670
3,144,229
(3,476
6,739,117
Other comprehensive income
Common stock issued in connection with the issuance of restricted stock awards, net
40,450
40
(40
Common stock issued in connection with the acquisition of First Bancshares of Texas, Inc.
3,582,675
3,583
220,764
224,347
Common stock repurchase
(594,773
(595
(33,613
(34,208
Stock based compensation expense
2,743
Cash dividends declared, $0.55 per share
(51,616
BALANCE AT JUNE 30, 2023
93,721,454
BALANCE AT DECEMBER 31, 2022
91,313,615
31,200
31
(31
(1,206,036
(1,206
(71,042
(72,248
5,909
Cash dividends declared, $1.10 per share
(101,690
BALANCE AT MARCH 31, 2022
92,159,730
92,160
3,597,957
2,812,636
1,671
6,504,424
Other comprehensive loss
17,800
18
(18
(981,884
(982
(64,739
(65,721
2,677
Cash dividends declared, $0.52 per share
(47,570
BALANCE AT JUNE 30, 2022
91,195,646
91,196
3,535,877
2,893,556
1,198
6,521,827
BALANCE AT DECEMBER 31, 2021
92,170,480
92,171
3,595,023
2,738,233
6,427,236
7,050
(7
5,600
Cash dividends declared, $1.04 per share
(95,493
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
14,632
14,287
Provision for credit losses
Net amortization of premium on investments
14,515
24,307
Net gain on sale of other real estate and repossessed assets
(46
(607
Net gain on sale or write down of premises and equipment
(2,115
(1,797
Net accretion of discount on loans
(3,291
(5,254
Net amortization of premium on deposits
(240
(184
Net gain on sale of loans
(901
(852
Proceeds from sale of loans held for sale
23,783
33,005
Originations of loans held for sale
(32,984
(28,229
Decrease (increase) in accrued interest receivable and other assets
7,244
(2,200
Increase in accrued interest payable and other liabilities
117,994
26,315
Net cash provided by operating activities
374,672
315,207
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities and principal paydowns of held to maturity securities
857,656
1,173,019
Purchase of held to maturity securities
(3,028
(3,296,089
Proceeds from maturities and principal paydowns of available for sale securities
6,703,648
8,985,597
Purchase of available for sale securities
(6,527,199
(8,981,019
Originations of Warehouse Purchase Program loans
(6,077,557
(11,696,395
Proceeds from pay-offs of Warehouse Purchase Program loans
5,669,294
12,334,471
Net increase in loans held for investment
(793,081
(233,584
Purchase of bank premises and equipment
(18,280
(28,728
Proceeds from sale of bank premises, equipment and other real estate
3,869
6,217
Proceeds from insurance claims
5,831
729
Net cash used in the purchase of First Bancshares of Texas, Inc.
(24,365
Net cash used in investing activities
(203,212
(1,735,782
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (decrease) increase in noninterest-bearing deposits
(1,242,773
282,150
Net decrease in interest-bearing deposits
(1,487,619
(1,188,110
Net proceeds from other short-term borrowings
2,749,614
300,000
Net (decrease) increase in securities sold under repurchase agreements
(43,848
33,686
Repurchase of common stock
Payments of cash dividends
Net cash used in financing activities
(198,564
(733,488
NET DECREASE IN CASH AND CASH EQUIVALENTS
(27,104
(2,154,063
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
2,547,980
CASH AND CASH EQUIVALENTS, END OF PERIOD
393,917
NONCASH ACTIVITIES:
Acquisition of real estate through foreclosure of collateral
1,690
1,657
SUPPLEMENTAL INFORMATION:
Income taxes paid
68,096
59,882
Interest paid
183,592
18,484
See notes to consolidated financial statements
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2023
1. BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Prosperity Bancshares, Inc.® (“Bancshares”) and its wholly-owned subsidiary, Prosperity Bank® (the “Bank,” and together with Bancshares, the “Company”). All intercompany transactions and balances have been eliminated.
The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for financial information and with the rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, the statements reflect all adjustments necessary for a fair presentation of the financial position, results of operations and cash flows of the Company on a consolidated basis; and all such adjustments are of a normal recurring nature. These financial statements and the notes thereto should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2022. Operating results for the six-month period ended June 30, 2023 are not necessarily indicative of the results that may be expected for the year ending December 31, 2023 or any other period.
2. INCOME PER COMMON SHARE
The following table illustrates the computation of basic and diluted earnings per share:
Three Months Ended June 30,
Six Months Ended June 30,
Per Share Amount
(Amounts in thousands, except per share data)
Basic:
Weighted average shares outstanding
92,930
91,772
92,073
91,965
Diluted:
There were no stock options outstanding at June 30, 2023 or exercisable during the three and six months ended June 30, 2023 or 2022 that would have had an anti-dilutive effect on the above computation.
3. NEW ACCOUNTING STANDARDS
Accounting Standards Updates (“ASU”)
ASU 2022-02, Financial Instruments—Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures. The amendments in ASU 2022-02 eliminated the accounting guidance for troubled debt restructurings and enhanced disclosures for certain loan refinancing and restructurings to borrowers experiencing financial difficulty. This guidance was applied on a prospective basis. Additionally, ASU 2022-02 requires entities to disclose current-period gross charge-offs by year of origination. ASU 2022-02 became effective for the Company on January 1, 2023 and did not have a significant impact on the Company’s financial statements.
ASU 2020-04, Reference Rate Reform: Facilitation of the Effects of Reference Rate Reform on Financial Reporting – ASC Topic 848. ASU 2020-04 became effective for the Company on January 1, 2022 and provides optional expedients and exceptions for applying GAAP to loan and lease agreements, derivative contracts, and other transactions affected by the anticipated transition away from LIBOR toward new interest rate benchmarks. ASU 2020-04 was effective upon issuance. In addition, the FASB issued ASU 2022-06 -Reference Rate Reform (Topic 848): Deferral of the Sunset Date of Topic 848, which extends the period of time preparers can utilize the reference rate reform relief guidance provided by ASU 2020-04 from December 31, 2022 to December 31, 2024. ASU 2022-06 was effective upon issuance and did not change the core principles in ASU 2020-04. Prior to the end of 2021, the Company began transitioning away from LIBOR to Secured Overnight Financing Rate (“SOFR”) or other alternative variable rate indexes for its
interest-rate swaps and loans historically using LIBOR as an index. As of June 30, 2023, LIBOR was used as an index rate for approximately 83.7% of the Company’s interest-rate swaps and approximately 0.17% of the Company’s loan portfolio. As of December 31, 2022, LIBOR was used as an index rate for approximately 88.2% of the Company’s interest-rate swaps and approximately 1.5% of the Company’s loan portfolio. The adoption of ASU 2020-04 did not have a significant impact on the Company’s financial statements.
4. SECURITIES
The amortized cost and fair value of investment securities were as follows:
June 30, 2023
Amortized Cost
Gross Unrealized Gains
Gross Unrealized Losses
Fair Value
Available for Sale
Corporate debt securities
20,698
1,599
(446
21,851
Collateralized mortgage obligations
345,155
1,066
(3,406
342,815
Mortgage-backed securities
99,553
76
(2,282
97,347
465,406
2,741
(6,134
Held to Maturity
U.S. Treasury securities and obligations of U.S. Government agencies
7,511
(125
7,386
States and political subdivisions
121,634
938
(3,983
118,589
12,000
(5,160
6,840
281,273
230
(23,370
258,133
12,782,888
967
(1,527,723
11,256,132
2,135
(1,560,361
11,647,080
December 31, 2022
359,251
1,190
(3,039
357,402
101,647
93
(2,640
99,100
460,898
1,283
(5,679
122,361
868
(3,255
119,974
(2,520
9,480
271,727
377
(22,922
249,182
13,613,415
2,575
(1,607,501
12,008,489
3,820
(1,636,198
12,387,125
The investment securities portfolio is measured for expected credit losses by segregating the portfolio into two general segments and applying the appropriate expected credit losses methodology. Investment securities classified as available for sale or held to maturity are evaluated for expected credit losses under 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
9
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 June 30, 2023, management does not have the intent to sell any of the securities classified as available for sale before a recovery of cost. In addition, management believes it is more likely than not that the Company will not be required to sell any of its investment securities before a recovery of cost. The unrealized losses are largely due to changes in market interest rates and spread relationships since the time the underlying securities were purchased. The fair value is expected to recover as the securities approach their maturity date or repricing date, or if market yields for such investments decline. Management does not believe any of the securities are impaired due to reasons of credit quality. Accordingly, as of June 30, 2023, management believes that there is no potential for credit losses on available for sale securities.
Held to maturity securities. The Company’s held to maturity investments include mortgage-related bonds issued by either the Government National Mortgage Corporation (“Ginnie Mae”), Federal National Mortgage Association (“Fannie Mae”) or Federal Home Loan Mortgage Corporation (“Freddie Mac”). Ginnie Mae issued securities are explicitly guaranteed by the U.S. government, while Fannie Mae and Freddie Mac issued securities are fully guaranteed by those respective United States government-sponsored agencies and conditionally guaranteed by the full faith and credit of the United States. The Company’s held to maturity securities also include taxable and tax-exempt municipal securities issued primarily by school districts, utility districts and municipalities located in Texas. The Company’s investment in municipal securities is exposed to credit risk. The securities are highly rated by major rating agencies and regularly reviewed by management. A significant portion are guaranteed or insured by either the Texas Permanent School Fund, Assured Guaranty or Build America Mutual. As of June 30, 2023, the Company’s municipal securities represent 0.9% of the securities portfolio. Management has the ability and intent to hold the securities classified as held to maturity until they mature, at which time the Company will receive full value for the securities. Accordingly, as of June 30, 2023, management believes that there is no potential for material credit losses on held to maturity securities.
Securities with unrealized losses, segregated by length of time, that have been in a continuous loss position were as follows:
Less than 12 Months
12 Months or More
Estimated Fair Value
Unrealized Losses
5,154
53,814
(1,108
118,225
(2,298
172,039
93,054
(2,241
1,112
(41
94,166
152,022
(3,795
119,337
(2,339
271,359
58,039
(815
39,709
(3,168
97,748
58,857
(1,863
169,868
(21,507
228,725
479,880
(16,452
10,641,057
(1,511,271
11,120,937
611,002
(24,415
10,850,634
(1,535,946
11,461,636
10
61,559
(3,012
99,179
(27
160,738
95,212
(2,627
291
(13
95,503
156,771
(5,639
99,470
256,241
49,782
(885
16,298
(2,370
66,080
214,538
(22,557
4,358
(365
218,896
5,276,315
(416,053
6,585,470
(1,191,448
11,861,785
5,550,115
(442,015
6,606,126
(1,194,183
12,156,241
At June 30, 2023 and December 31, 2022, there were 850 securities and 174 securities, respectively, in an unrealized loss position for 12 months or more.
The table below summarizes the amortized cost and fair value of investment securities at June 30, 2023, by contractual maturity. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations at any time with or without call or prepayment penalties.
Due in one year or less
15,320
15,181
Due after one year through five years
64,855
64,782
2,550
2,843
Due after five years through ten years
48,892
42,095
18,148
19,008
Due after ten years
12,078
10,757
Subtotal
141,145
132,815
Mortgage-backed securities and collateralized mortgage obligations
13,064,161
11,514,265
444,708
440,162
The Company recorded no gain or loss on the sale of securities for the three and six months ended June 30, 2023 and 2022. As of June 30, 2023, the Company did not own any non-agency collateralized mortgage obligations.
At June 30, 2023 and December 31, 2022, the Company did not own securities of any one issuer (other than the U.S. government and its agencies) for which aggregate adjusted cost exceeded 10% of the consolidated shareholders’ equity at such respective dates.
Securities with an amortized cost of $10.60 billion and $7.87 billion and a fair value of $9.33 billion and $6.90 billion at June 30, 2023 and December 31, 2022, respectively, were pledged to collateralize public deposits and for other purposes required or permitted by law.
11
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
2,746,055
2,594,742
Real estate:
Construction, land development and other land loans
3,215,016
2,805,438
1-4 family residential (includes home equity)
7,747,227
6,740,670
Commercial real estate (includes multi-family residential)
5,676,526
4,986,211
Farmland
584,962
518,095
Agriculture
219,414
169,938
Consumer and other
305,207
283,559
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 81.1% and 80.3% of the Company’s total loan portfolio, excluding Warehouse Purchase Program loans, at June 30, 2023 and December 31, 2022, respectively. As of June 30, 2023 and December 31, 2022, excluding Warehouse Purchase Program loans, there were no concentrations of loans related to any single industry in excess of 10% of total loans.
Related Party Loans. As of June 30, 2023 and December 31, 2022, loans outstanding to directors, officers and their affiliates totaled $535 thousand and $547 thousand, respectively. All transactions between the Company and such related parties are conducted in the ordinary course of business and made on the same terms and conditions as similar transactions with unaffiliated persons.
An analysis of activity with respect to these related party loans is as follows:
As of and for thesix months endedJune 30, 2023
As of and for theyear endedDecember 31, 2022
Beginning balance on January 1
547
6,524
New loans
54
Repayments
(15
(6,031
Ending balance
535
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.
12
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
12,911
1,860
3,200,245
Warehouse Purchase Program loans
Agriculture and agriculture real estate (includes farmland)
6,276
86
6,362
1,199
796,815
804,376
1-4 family (includes home equity) (1)
24,476
19,125
7,714,282
7,757,883
6,006
13,266
5,657,254
8,959
1,658
10,617
22,229
2,713,209
294
44
304,869
58,922
1,744
60,666
57,723
21,535,557
9,976
4,442
14,418
318
2,790,702
1,751
421
685,861
688,033
25,880
25,887
14,762
6,700,575
6,741,224
3,176
1,649
4,981,386
10,575
1,468
12,043
2,453
2,580,246
378
283,170
51,736
5,917
57,653
19,614
18,762,560
13
The following table presents information regarding nonperforming assets as of the dates indicated:
Nonaccrual loans (1) (3)
(2)
Accruing loans 90 or more days past due
Total nonperforming loans
59,467
25,531
Repossessed assets
153
Other real estate
Total nonperforming assets
62,727
27,494
Nonperforming assets to total loans and other real estate
0.29
%
0.15
Nonperforming assets to total loans, excluding Warehouse Purchase Program loans, and other real estate
0.31
Nonaccrual loans to total loans
0.27
0.10
Nonaccrual loans to total loans, excluding Warehouse Purchase Program loans
0.28
0.11
The Company had $62.7 million in nonperforming assets at June 30, 2023 compared with $27.5 million at December 31, 2022. This increase was primarily due to the merger of First Bancshares of Texas, Inc. (“First Bancshares”) into Bancshares and the subsequent merger of its wholly owned subsidiary FirstCapital Bank of Texas, N.A. (“FirstCapital Bank”) into the Bank, (collectively, the “Merger”). Nonperforming assets were 0.29% of total loans and other real estate at June 30, 2023 and 0.15% of total loans and other real estate at December 31, 2022. The Company had $57.7 million in nonaccrual loans at June 30, 2023 compared with $19.6 million at December 31, 2022.
Acquired Loans. Acquired loans were preliminarily recorded at fair value based on a discounted cash flow valuation methodology that considers, among other things, interest rates, projected default rates, loss given default, and recovery rates. Projected default rates, loss given default, and recovery rates for purchased credit deteriorated (“PCD”) loans primarily impact the related allowance, as opposed to the fair value mark. During the valuation process, the Company identified PCD and Non-PCD loans in the acquired loan portfolios. Loans acquired with evidence of credit quality deterioration since origination as of the acquisition date were accounted for as PCD. PCD loan identification considers the following factors: payment history and past due status, debt service coverage, loan grading, collateral values and other factors that may indicate deterioration of credit quality as of the acquisition date when compared to the origination date. Non-PCD loan identification considers the following factors: account types, remaining terms, annual interest rates or coupons, current market rates, interest types, past delinquencies, timing of principal and interest payments, loan to value ratios, loss exposures and remaining balances. Accretion of purchased discounts on PCD and Non-PCD loans will be recognized based on payment structure and the contractual maturity of individual loans.
14
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 June 30, 2023 and December 31, 2022.
PCD loans:
Outstanding balance
661,349
63,383
Discount
(10,110
(3,361
Recorded investment
651,239
60,022
Changes in the accretable yield for acquired PCD loans for the three and six months ended June 30, 2023 and 2022 were as follows:
Balance at beginning of period
3,022
4,317
3,361
4,838
Additions
8,336
Adjustments
(70
Accretion
(1,178
(324
(1,517
(845
Balance at June 30,
10,110
3,993
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 June 30, 2023, represents the amount of discount available to be recognized as income.
Non-PCD Loans. The recorded investment in Non-PCD loans included in the consolidated balance sheet and the related outstanding balance as of the dates indicated are presented in the table below. The outstanding balance represents the total amount owed as of June 30, 2023 and December 31, 2022.
Non-PCD loans:
2,128,501
1,319,507
(23,052
(2,233
2,105,449
1,317,274
Changes in the discount accretion for Non-PCD loans for the three and six months ended June 30, 2023 and 2022 were as follows:
1,701
3,469
2,233
8,143
Addition
22,593
(1,242
265
(1,774
(4,409
23,052
3,734
15
Credit Quality Indicators. As part of the ongoing monitoring of the credit quality of the Company’s loan portfolio and methodology for calculating the allowance for credit losses, management assigns and tracks loan grades to be used as credit quality indicators. The following is a general description of the loan grades used:
Grade 1—Credits in this category have risk potential that is virtually nonexistent. These loans may be secured by insured certificates of deposit, insured savings accounts, U.S. Government securities and highly rated municipal bonds.
Grade 2—Credits in this category are of the highest quality. These borrowers represent top rated companies and individuals with unquestionable financial standing with excellent global cash flow coverage, net worth, liquidity and collateral coverage.
Grade 3—Credits in this category are not immune from risk but are well protected by the collateral and paying capacity of the borrower. These loans may exhibit a minor unfavorable credit factor, but the overall credit is sufficiently strong to minimize the possibility of loss.
Grade 4—Credits in this category are considered to be of acceptable credit quality with moderately greater risk than Grade 3 and receiving closer monitoring. Loans in this category have sources of repayment that remain sufficient to preclude a larger than normal probability of default and secondary sources are likewise currently of sufficient quantity, quality, and liquidity to protect the Company against loss of principal and interest. These borrowers have specific risk factors, but the overall strength of the credit is acceptable based on other mitigating credit and/or collateral factors and can repay the debt in the normal course of business.
Grade 5—Credits in this category constitute an undue and unwarranted credit risk; however, the factors do not rise to a level of substandard. These credits have potential weaknesses and/or declining trends that, if not corrected, could expose the Company to risk at a future date. These loans are monitored on the Company’s internally-generated watch list and evaluated on a quarterly basis.
Grade 6—Credits in this category are considered “substandard” but “non-impaired” loans in accordance with regulatory guidelines. Loans in this category have well-defined weakness that, if not corrected, could make default of principal and interest possible. Loans in this category are still accruing interest and may be dependent upon secondary sources of repayment and/or collateral liquidation.
Grade 7—Credits in this category are deemed “substandard” and “impaired” pursuant to regulatory guidelines. As such, the Company has determined that it is probable that less than 100% of the contractual principal and interest will be collected. These loans are individually evaluated for a specific reserve and will typically have the accrual of interest stopped.
Grade 8—Credits in this category include “doubtful” loans in accordance with regulatory guidance. Such loans are no longer accruing interest and factors indicate a loss is imminent. These loans are also deemed “impaired.” While a specific reserve may be in place while the loan and collateral are being evaluated, these loans are typically charged down to an amount the Company estimates is collectible.
Grade 9—Credits in this category are deemed a “loss” in accordance with regulatory guidelines and have been charged off or charged down. The Company may continue collection efforts and may have partial recovery in the future.
16
The following tables present loans by risk grade, by category of loan and year of origination/renewal at June 30, 2023.
Term Loans
Amortized Cost Basis by Origination Year
2021
2020
2019
Prior
Revolving Loans
Revolving Loans Converted to Term Loans
Construction, Land Development and Other Land Loans
Grade 1
613
Grade 2
675
183
75
933
Grade 3
235,834
1,202,677
618,940
241,563
23,496
178,408
170,350
2,671,268
Grade 4
9,564
91,646
84,853
34,908
6,293
12,364
5,514
245,142
Grade 5
1,119
4,399
18,720
637
998
25,873
Grade 6
5,572
3,012
9,774
Grade 7
1,588
272
Grade 8
Grade 9
PCD Loans
43,047
144,306
35,528
7,173
3,581
7,516
18,402
259,553
289,733
1,439,931
749,292
286,656
52,090
201,778
195,536
Current-period gross write-offs
77
Agriculture and Agriculture Real Estate (includes Farmland)
854
1,372
289
363
595
9,109
12,631
106
1,094
52
1,327
101,112
217,319
89,827
49,421
39,434
108,656
86,124
692,440
8,652
11,841
19,339
4,343
587
9,407
16,788
670
71,627
213
800
441
1,522
3,267
119
478
597
1,014
17
168
207
2,358
1,795
3,851
1,213
3,746
8,118
21,288
111,038
233,765
112,780
57,978
41,732
125,666
120,191
1,226
113
1-4 Family (includes Home Equity) (1)
161
111
349
1,969
1,430
160
256
3,432
110
7,390
833,650
1,904,045
2,147,286
1,091,293
452,578
1,060,720
103,023
1,997
7,594,592
4,917
19,150
25,097
6,081
52,762
3,003
119,494
123
4,443
4,939
9,567
142
1,821
1,978
2,538
3,966
2,521
1,666
8,434
159
1,389
520
439
644
2,237
5,388
840,772
1,928,775
2,177,029
1,100,839
467,990
1,134,345
106,136
50
26
25
101
Commercial Real Estate (includes Multi-Family Residential)
72
6,281
494
2,570
9,345
286,506
913,630
689,196
504,351
323,489
1,210,720
87,435
4,015,486
16,871
106,653
153,488
182,227
105,228
647,105
17,722
1,229,294
366
15,009
59,345
818
75,538
386
12,069
17,644
89,426
119,525
3,653
9,613
11,270
43,268
35,119
8,250
7,885
107,679
529
214,000
314,647
1,069,832
878,555
707,391
472,908
2,126,458
106,576
14,975
Commercial and Industrial
8,184
12,760
9,897
4,340
1,934
6,301
33,881
77,322
676
9,264
327
228
3,954
2,767
17,216
142,559
301,751
188,560
77,413
76,000
166,299
1,056,888
1,632
2,011,102
94,245
21,721
7,764
10,075
10,549
115,265
149,350
409,182
22,546
11,078
1,277
1,052
44,826
425
300
1,463
1,041
8,985
34
13,298
15,602
1,311
171
1,202
3,853
8,619
29,465
13,230
5,188
5,813
1,660
86,905
150,880
254,327
413,534
231,228
100,838
96,369
296,774
1,351,063
1,922
629
20
24
1,242
Consumer and Other
7,023
8,146
4,156
3,019
1,433
6,911
1,777
32,465
94
14,212
422
2,420
5,007
22,155
56,455
47,120
30,581
28,933
13,473
13,799
51,660
242,021
67
39
1,233
1,144
1,348
632
3,924
8,387
19
45
29
130
63,639
69,536
36,015
33,569
16,287
23,762
62,399
2,414
2,516
16,751
22,439
14,342
7,833
3,407
13,807
44,839
123,452
3,414
31,445
593
1,400
13,545
7,936
58,366
2,804,999
4,586,542
3,764,390
1,992,974
928,470
2,738,602
1,555,480
4,335
18,375,792
134,316
251,050
291,774
238,778
132,489
837,535
196,301
883
2,083,126
24,527
16,134
39,052
67,495
10,255
159,076
6,377
16,102
19,249
93,956
145,172
18,140
5,052
3,872
5,511
21,005
4,125
63,302
220,805
86,237
24,912
19,165
122,838
113,980
3,023,039
5,155,373
4,184,899
2,287,271
1,147,376
3,908,783
1,941,901
5,304
15,714
74
163
594
19,024
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 June 30, 2023 for estimated losses in the Company’s loan portfolio. The amount of the allowance for credit losses on loans is affected by the following: (1) charge-offs of loans that occur when loans are deemed uncollectible and decrease the allowance, (2) recoveries on loans previously charged off that increase the allowance, (3) provisions for credit losses charged to earnings that increase the allowance, and (4) provision releases returned to earnings that decrease the allowance. Based on an evaluation of the loan portfolio and consideration of the factors listed below, management presents a quarterly review of the allowance for credit losses to the Bank’s Board of Directors, indicating any change in the allowance since the last review and any recommendations as to adjustments in the allowance. Although management believes it uses the best information available to make determinations with respect to the allowance for credit losses, future adjustments may be necessary if economic conditions or borrower performance differ from the assumptions used in making the initial determinations.
The Company’s allowance for credit losses on loans consists of two components: (1) a specific valuation allowance based on expected losses on specifically identified loans and (2) a general valuation allowance based on historical lifetime loan loss experience, current economic conditions, reasonable and supportable forecasted economic conditions and other qualitative risk factors both internal and external to the Company.
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:
In addition, for each category, the Company considers secondary sources of income and the financial strength and credit history of the borrower and any guarantors.
In determining the amount of the general valuation allowance, management considers factors such as historical lifetime loan loss experience, concentration risk of specific loan types, the volume, growth and composition of the Company’s loan portfolio, current economic conditions and reasonable and supportable forecasted economic conditions that may affect borrower ability to pay and the value of collateral, the evaluation of the Company’s loan portfolio through its internal loan review process, other qualitative risk factors both internal and external to the Company and other relevant factors in accordance with ASC Topic 326, “Financial Instruments – Credit Losses.” Historical lifetime loan loss experience is determined by utilizing an open-pool (“cumulative loss rate”) methodology. Adjustments to the historical lifetime loan loss experience are made for differences in current loan pool risk characteristics such as portfolio concentrations, delinquency, non-accrual, and watch list levels, as well as changes in current and forecasted economic conditions such as unemployment rates, property and collateral values, and other indices relating to economic activity. The utilization of reasonable and supportable forecasts includes an immediate reversion to lifetime historical loss rates. Based on a review of these factors for each loan type, the Company applies an estimated percentage to the outstanding balance of each loan type, excluding any loan that has a specific reserve. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.
The following table details activity in the allowance for credit losses on loans by category of loan for the three and six months ended June 30, 2023 and 2022.
1-4 Family (includes Home Equity)
Allowance for credit losses on loans:
Balance March 31, 2023
80,561
8,061
62,538
67,972
57,296
5,763
282,191
Initial allowance on loans purchased with credit deterioration
15,237
2,914
1,590
21,002
26,332
67,099
Provision for credit losses on loans
(3,890
201
3,524
12,748
(1,498
11,984
Charge-offs
(77
(113
(36
(14,975
(341
(1,291
(16,833
Recoveries
27
191
245
768
Net (charge-offs) recoveries
(50
78
70
(14,957
(160
(1,046
(16,065
Balance June 30, 2023
91,858
11,254
67,722
86,765
81,970
5,640
345,209
Balance December 31, 2022
78,853
7,699
60,795
66,272
62,319
5,638
281,576
(2,195
557
5,127
14,447
(7,993
2,041
(101
(2,516
(19,024
197
311
2,554
453
3,574
Net charge-offs
(37
84
210
(14,956
1,312
(2,063
(15,450
Balance March 31, 2022
61,007
7,903
59,368
74,103
76,303
6,479
285,163
2,717
426
696
(3,697
(806
664
(192
(1,268
(1,460
32
(395
389
216
(1,052
(1,204
Balance June 30, 2022
63,729
8,338
60,096
70,011
75,694
6,091
283,959
Balance December 31, 2021
58,897
7,759
56,710
75,005
80,412
7,597
286,380
5,257
467
3,441
(4,965
(4,901
701
(435
(155
(100
(39
(663
(2,675
(4,067
267
846
468
1,646
(425
112
(55
(29
(2,207
(2,421
The allowance for credit losses on loans as of June 30, 2023 totaled $345.2 million or 1.59% of total loans, including acquired loans with discounts, an increase of $63.6 million or 22.6% compared to the allowance for credit losses on loans totaling $281.6 million or 1.49% of total loans, including acquired loans with discounts, as of December 31, 2022. The provision for credit losses was $18.5 million for the three and six months ended June 30, 2023 compared to no provision for credit losses for the three and six months ended June 30, 2022. As a result of the loans acquired in the Merger that was completed on May 1, 2023, the second quarter of 2023 included a $12.0 million provision for credit losses on loans and a $6.5 million provision for credit losses on off-balance sheet credit exposures.
21
Net charge-offs were $16.1 million and $15.5 million for the three and six months ended June 30, 2023, respectively, compared to net charge-offs of $1.2 million and $2.4 million for the three and six months ended June 30, 2022, respectively. Net charge-offs for the three and six months ended June 30, 2023 both included $15.0 million related to one commercial real estate loan obtained in a previous merger. Additionally, $3.5 million and $3.7 million of specific reserves on resolved PCD loans without any related charge-offs was released to the general reserve for the three and six months ended June 30, 2023, respectively.
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 June 30, 2023 and December 31, 2022, the Company had $36.5 million and $29.9 million in allowance for credit losses on off-balance sheet credit exposures, respectively; with the increase primarily due to the Merger. The allowance for credit losses on off-balance sheet credit exposures is a separate line item on the Company’s consolidated balance sheet. As of June 30, 2023, the Company had $2.57 billion in commitments expected to fund.
The following table represents a rollforward of the allowance for credit losses on off-balance sheet credit exposures for the periods shown.
Three Months Ended June 30
Six Months Ended June 30
Provision for credit losses on off-balance sheet credit exposures
6,556
Balance at end of period
Loan Modifications Made to Borrowers Experiencing Financial Difficulty. On January 1, 2023, the Company adopted ASU 2022-02, “Financial Instruments—Credit Losses (Topic 326): Troubled Debt Restructurings. and Vintage Disclosures”, which eliminated the accounting guidance for troubled debt restructurings and enhanced disclosures for certain loan refinancing and restructurings to borrowers experiencing financial difficulty. This guidance was applied on a prospective basis. As of the adoption date, all restructurings, including restructurings for borrowers experiencing financial difficulty, are evaluated to determine whether they result in a new loan or a continuation of an existing loan. Upon adoption of this guidance, the Company only establishes a specific reserve for modifications to borrowers experiencing financial difficulty when the loan is identified as impaired. The effect of most modifications of loans made to borrowers who are experiencing financial difficulty is already included in the allowance for credit losses because of the measurement methodologies used to estimate the allowance. The Company adjusts the terms of loans for certain borrowers when it believes such changes will help its customers manage their loan obligations and increase the collectability of the loans.
Modifications to borrowers experiencing financial difficulty may include but are not limited to changes in committed loan amount, interest rate, amortization, note maturity, borrower, guarantor, collateral, forbearance, forgiveness of principal or interest, and other actions intended to minimize economic loss and to avoid foreclosure or repossession of collateral. The approval of modifications of loans for borrowers experiencing financial difficulty are handled on a case-by-case basis.
22
The following table displays the amortized cost of loans that were both experiencing financial difficulty and modified during the three and six months ended June 30, 2023, presented by category of loan and type of modification.
Payment Delay
Term Extension
Interest Rate Reduction
Percentage of Total Loans Held for Investment
Three Months Ended June 30, 2023
304
0.00
1,175
0.01
1,294
2,773
0.02
Six Months Ended June 30, 2023
5,408
0.03
7,006
0.04
The following tables describe the financial effect of the modifications made to loans whose borrowers are experiencing financial difficulty:
Loan Type
Short-term principal deferral
Short-term extension
Reduced contractual interest rate
The Company did not have any loans made to borrowers experiencing financial difficulty that were modified during the three and six months ended June 30, 2023 that subsequently defaulted and were modified in the twelve months prior to that default. Payment default is defined as movement to nonperforming status, foreclosure or charge-off, whichever occurs first.
Prior to the adoption of ASU 2022-02, the restructuring of a loan was considered a “troubled debt restructuring” if both (1) the borrower was experiencing financial difficulties and (2) the creditor had granted a concession. Concessions may have included interest rate reductions or below market interest rates, principal forgiveness, restructuring amortization schedules and other actions intended to minimize potential losses. Loans that were restructured in a troubled debt restructuring loan prior to the adoption of ASU 2022-02 will continue to be accounted for under the historical troubled debt restructuring accounting until the loan is paid off, liquidated or subsequently modified. As of June 30, 2022, the Company had $933 thousand in outstanding troubled debt restructurings. For the six months ended June 30, 2022, the Company did not add any loans as new troubled debt restructurings. There were no charge-offs related to restructured loans for the six months ended June 30, 2022.
23
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:
The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for such asset or liability. In estimating fair value, the Company utilizes valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. Such valuation techniques are consistently applied. Inputs to valuation techniques include the assumptions that market participants would use in pricing an asset or liability.
The fair value disclosures below represent the Company’s estimates based on relevant market information and information about the financial instruments. Fair value estimates are based on judgments regarding current economic conditions, risk characteristics of the various instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in the above methodologies and assumptions could significantly affect the estimates.
The following tables present fair values for assets and liabilities measured at fair value on a recurring basis:
As of June 30, 2023
Level 1
Level 2
Level 3
Assets:
Available for sale securities:
Derivative financial instruments:
Interest rate lock commitments
203
Forward mortgage-backed securities trades
122
Loan customer counterparty
Financial institution counterparty
5,318
Liabilities:
1
As of December 31, 2022
Total available for sale securities
5,522
Certain assets and liabilities are measured at fair value on a nonrecurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). These instruments include other real estate owned, repossessed assets, held to maturity debt securities, loans held for sale and impaired loans, which are included as loans held for investment. For the three and six months ended June 30, 2023, the Company had additions to other real estate owned of $1.1 million and $1.6 million, respectively, of which $1.1 million were outstanding as of June 30, 2023. For the three and six months ended June 30, 2023, the Company had additions to impaired loans of $17.1 million and $22.5 million, respectively, of which $17.1 million and $20.8 million, respectively, were outstanding as of June 30, 2023. The remaining financial assets and liabilities measured at fair value on a non-recurring basis that were recorded in 2023 and remained outstanding at June 30, 2023 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
20,149,198
19,488,281
Liabilities
16,963,645
4,712,812
434,102
Subordianted debentures
3,088
17,817,077
17,550,309
17,563,711
428,061
The following is a description of the fair value estimates, methods and assumptions that are used by the Company in estimating the fair values of financial instruments.
Loans held for sale— Loans held for sale are carried at the lower of cost or estimated fair value. Fair value for consumer mortgages held for sale is based on commitments on hand from investors or prevailing market prices. As such, the Company classifies loans held for sale subjected to nonrecurring fair value adjustments as Level 2.
Loans held for investment— The Company does not record loans at fair value on a recurring basis. As such, valuation techniques discussed herein for loans are primarily for estimating fair value disclosures. The Company refined the calculation to estimate fair value for loans held for investment to be in accordance with ASU 2016-01. The refined discounted cash flow calculation
to determine fair value considers internal and market-based information such as prepayment risk, cost of funds and liquidity. From time to time, the Company records nonrecurring fair value adjustments to impaired loans to reflect (1) partial write-downs that are based on the observable market price or current appraised value of the collateral, or (2) the full charge-off of the loan carrying value. Where appraisals are not available, estimated cash flows are discounted using a rate commensurate with the credit risk associated with those cash flows. Assumptions regarding credit risk, cash flows and discount rates are judgmentally determined using available market information and specific borrower information.
The Company classifies the estimated fair value of loans held for investment as Level 3.
Other real estate owned— Other real estate owned is primarily foreclosed properties securing residential loans and commercial real estate. Foreclosed assets are adjusted to fair value less estimated costs to sell upon transfer of the loans to other real estate owned. Subsequently, these assets are carried at the lower of carrying value or fair value less estimated costs to sell. Other real estate carried at fair value based on an observable market price or a current appraised value is classified by the Company as Level 2. When management determines that the fair value of other real estate requires additional adjustments, either as a result of a non-current appraisal or when there is no observable market price, the Company classifies the other real estate as Level 3.
The fair value estimates presented herein are based on pertinent information available to management at June 30, 2023. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since those dates and, therefore, current estimates of fair value may differ significantly from the amounts presented herein.
7. GOODWILL AND CORE DEPOSIT INTANGIBLES
Changes in the carrying amount of the Company’s goodwill and core deposit intangibles for the six months ended June 30, 2023 and the year ended December 31, 2022 were as follows:
Core Deposit Intangibles
Balance as of December 31, 2021
61,684
Less:
Amortization
(10,336
Balance as of December 31, 2022
(5,541
Add:
First Bancshares Merger
152,062
25,321
Balance as of June 30, 2023
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 June 30, 2023, there was no impairment recorded on goodwill and core deposit intangibles.
The measurement period for the Company to determine the fair value of acquired identifiable assets and assumed liabilities will be at the end of the earlier of (1) twelve months from the date of acquisition or (2) as soon as the Company receives the information it was seeking about facts and circumstances that existed as of the date of acquisition.
Core deposit intangibles are being amortized on a non-pro rata basis over their estimated lives, which the Company believes is between 10 and 15 years. Amortization expense related to intangible assets totaled $3.2 million and $2.6 million for the three months ended June 30, 2023 and 2022, respectively, and $5.5 million and $5.2 million for the six months ended June 30, 2023 and 2022, respectively. The estimated aggregate future amortization expense for core deposit intangibles remaining as of June 30, 2023 is as follows (dollars in thousands):
Remaining 2023
7,135
2024
12,813
2025
11,409
2026
10,376
2027
9,288
Thereafter
20,107
8. STOCK–BASED COMPENSATION
At June 30, 2023, Bancshares had one active stock-based incentive compensation plan with awards outstanding.
On March 3, 2020, Bancshares’ Board of Directors established the Prosperity Bancshares, Inc. 2020 Stock Incentive Plan (the “2020 Plan”), which was approved by Bancshares' shareholders on April 21, 2020. The 2020 Plan authorizes the issuance of up to 2,500,000 shares of common stock upon the exercise of options or pursuant to the grant or exercise, as the case may be, of other awards granted under the 2020 Plan, including incentive stock options, nonqualified stock options, stock appreciation rights, shares of restricted stock and restricted stock units. As of June 30, 2023, 65,432 shares of common stock had been issued pursuant to vested restricted stock awards and 510,093 shares of unvested restricted stock have been granted under the 2020 Plan.
As of June 30, 2023, the Company had no stock options outstanding. Stock-based compensation expense related to restricted stock was $2.7 million during the three months ended June 30, 2023 and 2022 and $5.9 million and $5.6 million during the six months ended June 30, 2023 and 2022, respectively. As of June 30, 2023, there was $13.3 million of total unrecognized compensation expense related to stock-based compensation arrangements. That cost is expected to be recognized over a weighted average period of 1.76 years.
9. CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ITEMS
Contractual Obligations
The Company’s contractual obligations and other commitments to make future payments (other than deposit obligations and securities sold under repurchase agreements) as of June 30, 2023 are summarized below. The Company’s future cash payments associated with its contractual obligations pursuant to its subordinated debentures, the Federal Reserve's Bank Term Funding Program (“BTFP”) and Federal Home Loan Bank (“FHLB”) advances as of June 30, 2023 are summarized below. The future interest payments were calculated using the current rate in effect at June 30, 2023. Payments for the subordinated debentures include interest of $2.6 million that will be due over the future periods. In July 2023, the Company gave irrevocable notice of its intent to redeem the Subordinated Debentures on September 18, 2023. Payments under the BTFP include interest of $141.6 million that will be due over the future periods. These payments do not include prepayment options that may be available to the Company.
1 year or less
More than 1 year but less than 3 years
3 years or more but less than 5 years
5 years or more
487
4,512
5,730
Bank Term Funding Program
3,141,614
Federal Home Loan Bank advances
1,800,000
4,941,858
4,947,344
28
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 was $688 thousand and $800 thousand for the three months ended June 30, 2023 and 2022, and $1.5 million and $1.6 million for the six months ended June 30, 2023 and 2022, respectively. As of June 30, 2023, operating lease ROU assets and lease liabilities were approximately $40.7 million. ROU assets and lease liabilities were classified as other assets and other liabilities, respectively.
As of June 30, 2023, the weighted average of remaining lease terms of the Company’s operating leases was 5.2 years. The weighted average discount rate used to determine the lease liabilities as of June 30, 2023 for the Company’s operating leases was 2.7%. Cash paid for the Company’s operating leases was $3.1 million and $2.7 million, for the three months ended June 30, 2023 and 2022, respectively, and was $5.9 million and $5.5 million for the six months ended June 30, 2023 and 2022, respectively. During the six months ended June 30, 2023 , the Company obtained $3.0 million in ROU assets in exchange for lease liabilities for six operating leases, four of which, reflecting $2.7 million in ROU assets, were related to the Merger.
The Company’s future undiscounted cash payments associated with its operating leases as of June 30, 2023 are summarized below (dollars in thousands).
5,469
10,229
9,663
8,536
5,568
2028
2,588
5,283
Total undiscounted lease payments
47,336
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 June 30, 2023 are summarized below. Since commitments associated with letters of credit, unused capacity of Warehouse Purchase Program loans and commitments to extend credit may expire unused, the amounts shown may not necessarily reflect the actual future cash funding requirements.
Standby letters of credit
70,552
8,001
2,578
81,157
Unused capacity on Warehouse Purchase Program loans
959,117
Commitments to extend credit
1,865,681
1,007,818
320,147
1,948,768
5,142,414
2,895,350
1,015,819
322,725
1,948,794
6,182,688
The Company records an allowance for credit losses on off-balance sheet credit exposure that is adjusted through a charge to provision for credit losses on the Company’s consolidated statement of income. At June 30, 2023 and December 31, 2022, this allowance, reported as a separate line item on the Company’s consolidated balance sheet, totaled $36.5 million and $29.9 million, respectively. The increase in the allowance was primarily due to the Merger.
10. OTHER COMPREHENSIVE INCOME
The tax effects allocated to each component of other comprehensive income (loss) were as follows:
Before Tax Amount
Tax Effect
Net of Tax Amount
Other comprehensive income (loss):
Change in unrealized gain (loss) during period
Total securities available for sale
Activity in accumulated other comprehensive income (loss) associated with securities available for sale, net of tax, was as follows:
Securities Availablefor Sale
Accumulated Other Comprehensive Income (Loss)
Balance at December 31, 2022
Balance at June 30, 2023
Balance at December 31, 2021
Balance at June 30, 2022
30
11. DERIVATIVE FINANCIAL INSTRUMENTS
The following table provides the outstanding notional balances and fair values of outstanding derivative positions at June 30, 2023 and December 31, 2022.
OutstandingNotionalBalance
AssetDerivativeFair Value
Liability DerivativeFair Value
16,447
4,599
27,250
5,250
Commercial loan interest rate swaps and caps:
67,657
93,214
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 June 30, 2023 and December 31, 2022 are presented in the following table.
Weighted-Average Interest Rate
Received
Paid
3.08
6.59
3.05
5.18
The Company’s credit exposure on interest rate swaps is limited to the net favorable value of all swaps by each counterparty, which was approximately $5.3 million at June 30, 2023 and $5.5 million at December 31, 2022. This credit exposure is partly mitigated as transactions with customers are secured by the collateral, if any, securing the underlying transaction being hedged. The Company’s credit exposure, net of collateral pledged, relating to interest rate swaps with upstream financial institution counter-parties was $358 thousand at June 30, 2023. A credit support annex is in place and allows the Company to call collateral from upstream financial institution counter-parties. Collateral levels are monitored and adjusted on a regular basis for changes in interest rate swap values. The Company’s cash collateral pledged for interest rate swaps was zero at June 30, 2023 and December 31, 2022.
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 six months ended June 30, 2023 and 2022 was as follows:
Derivatives not designated as hedging instruments
173
114
(5
208
158
479
12. ACQUISITIONS
Merger of First Bancshares of Texas, Inc. — Effective May 1, 2023, the Company completed the Merger of First Bancshares into Bancshares and the subsequent merger of its wholly owned subsidiary FirstCapital Bank into the Bank. FirstCapital Bank operated 16 full-service banking offices in six different markets in West, North and Central Texas areas, including its main office in Midland, and banking offices in Midland, Lubbock, Amarillo, Wichita Falls, Burkburnett, Byers, Henrietta, Dallas, Horseshoe Bay, Marble Falls and Fredericksburg, Texas. As of March 31, 2023, First Bancshares, on a consolidated basis, reported total assets of $2.14 billion, total loans of $1.65 billion and total deposits of $1.71 billion. The acquisition was not considered significant to the Company’s financial statements and therefore pro forma financial data and related disclosures are not included.
Pursuant to the terms of the definitive agreement, Bancshares issued 3,583,370 shares of its common stock with a closing price of $62.62 per share plus approximately $91.5 million in cash for all outstanding shares of First Bancshares. As of June 30, 2023, the Company recognized goodwill of $152.1 million which does not include all the subsequent fair value adjustments that have not yet been finalized. Goodwill represents the excess of the total purchase price paid over the fair value of the assets acquired, net of the fair value of liabilities assumed. Additionally, as of June 30, 2023, total core deposit intangibles related to First Bancshares were $25.3 million. During the second quarter of 2023, the Company completed the operational conversion of FirstCapital Bank.
Pending Merger of Lone Star State Bancshares, Inc. — On October 11, 2022, Bancshares and Lone Star State Bancshares, Inc. (“Lone Star”) jointly announced the signing of a definitive merger agreement whereby Lone Star, the parent company of Lone Star State Bank of West Texas (“Lone Star Bank”), will merge with and into Bancshares. Lone Star Bank operates five banking offices in the West Texas area, including its main office in Lubbock, and one banking center in each of Brownfield, Midland, Odessa and Big Spring, Texas. As of June 30, 2023, Lone Star, on a consolidated basis, reported total assets of $1.28 billion, total loans of $1.07 billion and total deposits of $1.12 billion.
Under the terms of the merger agreement, Bancshares will issue 2,376,182 shares of its common stock plus $64.1 million in cash for all outstanding shares of Lone Star capital stock, subject to certain conditions and potential adjustments. Based on the closing price of Bancshares’ common stock of $69.27 on October 7, 2022, the total consideration was valued at approximately $228.7 million. The transaction is subject to customary closing conditions, including the receipt of regulatory approvals. The shareholders of Lone Star approved the transaction on March 28, 2023. The transaction is expected to close during the third quarter of 2023, although delays could occur.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Special Cautionary Notice Regarding Forward-Looking Statements
Statements and financial discussion and analysis contained in this quarterly report on Form 10-Q that are not statements of historical fact constitute forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on assumptions and involve a number of risks and uncertainties, many of which are beyond the Company’s control. Forward-looking statements can be identified by words such as “believes,” “intends,” “expects,” “plans,” “will” and similar references to future periods. Many possible events or factors could affect the future financial results and performance of the Company and could cause such results or performance to differ materially from those expressed in the forward-looking statements. These possible events or factors include, but are not limited to:
A forward-looking statement may include a statement of the assumptions or bases underlying the forward-looking statement. The Company believes it has chosen these assumptions or bases in good faith and that they are reasonable. However, the Company cautions that assumptions or bases almost always vary from actual results, and the differences between assumptions or bases and actual results can be material. Therefore, the Company cautions against placing undue reliance on its forward-looking statements. The forward-looking statements speak only as of the date the statements are made. The Company undertakes no obligation to publicly update or otherwise revise any forward-looking statements, whether as a result of new information, future events or otherwise.
Management’s Discussion and Analysis of Financial Condition and Results of Operations analyzes the major elements of the Company’s balance sheets and statements of income. This section should be read in conjunction with the Company’s consolidated financial statements and accompanying notes included in Part I, Item 1 of this report and with the consolidated financial statements and accompanying notes and other detailed information appearing in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022.
OVERVIEW
Prosperity Bancshares, Inc., a Texas corporation (“Bancshares”), is a registered financial holding company that derives substantially all of its revenues and income from the operation of its bank subsidiary, Prosperity Bank (the “Bank,” and together with Bancshares, the “Company”). The Bank provides a wide array of financial products and services to businesses and consumers throughout Texas and Oklahoma. As of June 30, 2023, the Bank operated 286 full-service banking locations: 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; 32 in the Central Texas area including Austin and San Antonio; 44 in the West Texas area including Lubbock, Midland-Odessa, Abilene; Amarillo and Wichita Falls; 16 in the Bryan/College Station area, 6 in the Central Oklahoma area; 8 in the Tulsa, Oklahoma area. The Company’s principal executive office is located at Prosperity Bank Plaza, 4295 San Felipe in Houston, Texas, and its telephone number is (281) 269-7199. The Company’s website address is www.prosperitybankusa.com. Information contained on the Company’s website is not incorporated by reference into this quarterly report on Form 10-Q and is not part of this or any other report.
The Company generates the majority of its revenues from interest income on loans, service charges and fees on customer accounts and income from investment in securities. The revenues are partially offset by interest expense paid on deposits and other borrowings and noninterest expenses such as administrative and occupancy expenses. Net interest income is the difference between interest income on earning assets such as loans and securities and interest expense on liabilities such as deposits and borrowings which are used to fund those assets. Net interest income is the Company’s largest source of revenue. The level of interest rates and the volume and mix of earning assets and interest-bearing liabilities impact net interest income and margin.
Three principal components of the Company’s growth strategy are internal growth, efficient operations and acquisitions, including strategic merger transactions. The Company focuses on continual internal growth. The Company maintains separate data with respect to each banking center’s net interest income, efficiency ratio, deposit growth and loan growth for purposes of measuring its overall profitability. The Company also focuses on maintaining efficiency and stringent cost control practices and policies. The
Company has centralized many of its critical operations, such as data processing and loan processing. Management believes that this centralized infrastructure can accommodate substantial additional growth and achieve necessary controls while enabling the Company to minimize operational costs through certain economies of scale. The Company also intends to continue to seek expansion opportunities. On May 1, 2023, the Company acquired First Bancshares of Texas, Inc. (“First Bancshares”) headquartered in Midland, Texas, as described under “—Recent Acquisition” below. On October 11, 2022, Bancshares announced the signing of a definitive merger agreement with Lone Star State Bancshares, Inc. (“Lone Star”) headquartered in Lubbock, Texas, as described under “—Pending Acquisition” below.
Total assets were $39.91 billion at June 30, 2023 compared with $37.69 billion at December 31, 2022, an increase of $2.22 billion or 5.9%. Total loans were $21.65 billion at June 30, 2023 compared with $18.84 billion at December 31, 2022, an increase of $2.81 billion or 14.9%. Total deposits were $27.38 billion at June 30, 2023 compared with $28.53 billion at December 31, 2022, a decrease of $1.15 billion or 4.0%. Total shareholders’ equity was $6.97 billion at June 30, 2023 compared with $6.70 billion at December 31, 2022, an increase of $268.7 million or 4.0%.
RECENT ACQUISITION
Merger of First Bancshares of Texas, Inc. — Effective May 1, 2023, the Company completed the merger of First Bancshares into Bancshares and the subsequent merger of its wholly owned subsidiary, FirstCapital Bank of Texas, N.A. (“FirstCapital Bank”), into the Bank (collectively, the “Merger”). FirstCapital Bank operated 16 full-service banking offices in six different markets in West, North and Central Texas areas, including its main office in Midland, and banking offices in Midland, Lubbock, Amarillo, Wichita Falls, Burkburnett, Byers, Henrietta, Dallas, Horseshoe Bay, Marble Falls and Fredericksburg, Texas. As of March 31, 2023, First Bancshares, on a consolidated basis, reported total assets of $2.14 billion, total loans of $1.65 billion and total deposits of $1.71 billion.
Pursuant to the terms of the definitive agreement, Bancshares issued 3,583,370 shares of its common stock with a closing price of $62.62 per share plus approximately $91.5 million in cash for all outstanding shares of First Bancshares. As of June 30, 2023, the Company recognized goodwill of $152.1 million which does not include all the subsequent fair value adjustments that have not yet been finalized. Additionally, as of June 30, 2023, total core deposit intangibles related to First Bancshares were $25.3 million. During the second quarter of 2023, the Company completed the operational conversion of FirstCapital Bank.
PENDING ACQUISITION
Pending Merger of Lone Star State Bancshares, Inc. — On October 11, 2022, Bancshares and Lone Star jointly announced the signing of a definitive merger agreement whereby Lone Star, the parent company of Lone Star State Bank of West Texas (“Lone Star Bank”), will merge with and into the Company. Lone Star Bank operates 5 banking offices in the West Texas area, including its main office in Lubbock, and one banking center in each of Brownfield, Midland, Odessa and Big Spring, Texas. As of June 30, 2023, Lone Star, on a consolidated basis, reported total assets of $1.28 billion, total loans of $1.07 billion and total deposits of $1.12 billion.
Under the terms of the merger agreement, Bancshares will issue 2,376,182 shares of its common stock plus $64.1 million in cash for all outstanding shares of Lone Star capital stock, subject to certain conditions and potential adjustments. Based on the closing price of Bancshares' common stock of $69.27 on October 7, 2022, the total consideration was valued at approximately $228.7 million. The transaction is subject to customary closing conditions, including the receipt of regulatory approvals. The shareholders of Lone Star approved the transaction on March 28, 2023. The transaction is expected to close during the third quarter of 2023, although delays could occur.
CRITICAL ACCOUNTING ESTIMATES
The preparation of financial statements in conformity with GAAP requires the Company to establish accounting policies and make estimates that affect amounts reported in the consolidated financial statements. An accounting estimate requires assumptions and judgments about uncertain matters that could have a material effect on the consolidated financial statements. Estimates are made using facts and circumstances known at a point in time. Changes in those facts and circumstances could produce results substantially different from those estimates. The Company’s accounting policies are described in detail in Note 1 to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022. The Company believes that of its significant accounting policies, the following may involve a higher degree of judgment and complexity:
35
Business Combinations—Generally, acquisitions are accounted for under the acquisition method of accounting in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 805, Business Combinations. A business combination occurs when the Company acquires net assets that constitute a business and obtains control over that business. Business combinations are effected through the transfer of consideration consisting of cash and/or common stock and are accounted for using the acquisition method. Accordingly, the assets and liabilities of the acquired business are recorded at their respective fair values at the acquisition date. Determining the fair value of assets and liabilities, especially the loan portfolio, is a process involving significant judgment regarding methods and assumptions used to calculate estimated fair values. Fair values are subject to refinement for up to one year after the closing date of the acquisition as information relative to closing date fair values becomes available. The results of operations of an acquired entity are included in the Company’s consolidated results from acquisition date, and prior periods are not restated.
Allowance for Credit Losses— The allowance for credit losses is accounted for in accordance with FASB ASC 326, Measurement of Credit Losses on Financial Instruments which replaced the incurred loss methodology with an expected loss methodology that is referred to as the current expected credit loss (“CECL”) methodology. CECL requires a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The allowance for credit losses is an allowance available for losses on loans and held-to-maturity securities. The allowance for credit losses is adjusted through charges to earnings in the form of a provision for credit losses. All losses are charged to the allowance when the loss actually occurs or when a determination is made that such a loss is likely and can be reasonably estimated. Recoveries are credited to the allowance at the time of recovery.
The Company’s allowance for credit losses consists of two elements: (1) specific valuation allowances based on expected losses on impaired loans and certain purchased credit-deteriorated loans (“PCD”) loans; and (2) a general valuation allowance based on historical lifetime loan loss experience, current economic conditions, reasonable and supportable forecasted economic conditions and other qualitative risk factors both internal and external to the Company. Management has established an allowance for credit losses which it believes is adequate for estimated losses in the Company’s loan portfolio. Based on an evaluation of the portfolio, management presents a quarterly review of the allowance for credit losses to the Bank’s Board of Directors, indicating any change in the allowance since the last review and any recommendations as to adjustments in the allowance. In making its evaluation, management considers factors such as historical lifetime loan loss experience, the amount of nonperforming assets and related collateral, the volume, growth and composition of the portfolio, current economic conditions and reasonable and supportable forecasted economic conditions that may affect borrower ability to pay and the value of collateral, the evaluation of the portfolio through its internal loan review process and other relevant factors. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. Charge-offs occur when loans are deemed to be uncollectible. Pursuant to the Company's adoption of ASU 2022-02 effective January 1, 2023, the Company prospectively discontinued troubled debt restructurings accounting and no longer measures the economic concession for loan modifications occurring on or after the adoption date. In addition, modifications to loans previously designated as troubled debt restructurings that occur on or after January 1, 2023, are accounted for under the newly adopted ASU and result in the elimination of any prior economic concession recorded in the allowance related to such loans. For further discussion of the methodology used in the determination of the allowance for credit losses on loans, see “Accounting for Acquired Loans and the Allowance for Acquired Credit Losses” below and “Financial Condition—Allowance for Credit Losses on Loans” below.
Accounting for Acquired Loans and the Allowance for Acquired Credit Losses — The Company accounts for its acquisitions using the acquisition method of accounting. Accordingly, the assets, including loans, and liabilities of the acquired entity are recorded at their fair values at the acquisition date. The fair value estimates associated with acquired loans, 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.
RESULTS OF OPERATIONS
Net income available to common shareholders was $86.9 million for the quarter ended June 30, 2023 compared with $128.5 million for the same period in 2022, and was impacted by merger related provision for credit losses of $18.5 million and merger related expenses of $12.9 million. Net income per diluted common share was $0.94 for the quarter ended June 30, 2023 compared with $1.40 for the same period in 2022, and was also impacted by merger related provision and expenses. The Company posted annualized returns on average common equity of 5.01% and 7.84%, annualized returns on average assets of 0.89% and 1.36% and efficiency ratios of 53.21% and 43.12% for the quarters ended June 30, 2023 and 2022, respectively. The efficiency ratio is calculated by dividing total noninterest expense (excluding net gains and losses on the sale or write down of assets and securities) by the sum of
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net interest income and noninterest income. Because the ratio is a measure of revenues and expenses resulting from the Company’s lending activities and fee-based banking services, net gains and losses on the sale or write-down of assets and securities are not included. Additionally, taxes are not part of this calculation.
Net income available to common shareholders was $211.6 million for the six months ended June 30, 2023 compared with $250.8 million for the same period in 2022, and was impacted by merger related provision for credit losses of $18.5 million and merger related expenses of $13.8 million. Net income per diluted common share was $2.30 for the six months ended June 30, 2023 compared with $2.73 for the same period in 2022, and was also impacted by merger related provision and expenses. The Company posted annualized returns on average common equity of 6.18% and 7.69%, annualized returns on average assets of 1.09% and 1.32% and efficiency ratios of 48.38% and 43.40% for the six months ended June 30, 2023 and 2022, respectively.
Net Interest Income
The Company’s net interest income is affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities, referred to as a “volume change.” It is also affected by changes in yields earned on interest-earning assets and rates paid on interest-bearing deposits and other borrowed funds, referred to as a “rate change.”
For the Three Months Ended June 30, 2023
Net interest income before the provision for credit losses was $236.5 million for the quarter ended June 30, 2023, a decrease of $12.0 million or 4.8%, compared with $248.5 million for the same period in 2022. The change was primarily due to an increase in average balances and rates on borrowings and an increase in the average rates on interest-bearing deposits, partially offset by an increase in the average balances and average rates on loans held for investment and an increase in average rates on investment securities.
Interest income on loans was $286.6 million for the quarter ended June 30, 2023, an increase of $93.9 million or 48.7%, compared with $192.8 million for the same period in 2022. The change was primarily due to an increase in the average balances and average rates on loans held for investment.
Interest income on securities was $72.1 million for the quarter ended June 30, 2023, an increase of $7.9 million or 12.4%, compared with $64.1 million for the same period in 2022, primarily due to an increase in the average rates on investment securities, partially offset by a decrease in the average balances on investment securities.
Average interest-bearing liabilities were $21.83 billion for the quarter ended June 30, 2023, an increase of $1.70 billion or 8.5%, compared with $20.13 billion for the same period in 2022, primarily due to an increase in other borrowings partially offset by a decrease in interest-bearing deposits. The average rate on interest-bearing liabilities was 2.28% for the quarter ended June 30, 2023, an increase of 209 basis points, compared with 0.19% for the same period in 2022.
The net interest margin on a tax-equivalent basis was 2.73% for the quarter ended June 30, 2023, a decrease of 24 basis points compared with 2.97% for the same period in 2022. The change was primarily due to an increase in average balances and average rates on borrowings and an increase in the average rates on interest-bearing deposits, partially offset by an increase in the average balances and average rates on loans held for investment and an increase in average rates on investment securities.
For the Six Months Ended June 30, 2023
Net interest income before the provision for credit losses was $479.9 million for the six months ended June 30, 2023, a decrease of $8.5 million or 1.7%, compared with $488.4 million for the same period in 2022. The change was primarily due to an increase in the average balances and average rates on other borrowings and an increase in average rates on interest-bearing deposits, partially offset by increases in the average balances and average rates on loans held for investment and increases in average rates on investment securities.
Interest income on loans was $533.8 million for the six months ended June 30, 2023, an increase of $148.0 million or 38.4%, compared with $385.8 million for the same period in 2022. The change was primarily due to an increase in the average balances and average rates on loans held for investment.
Interest income on securities was $145.2 million for the six months ended June 30, 2023, an increase of $26.1 million or 21.9%, compared with $119.1 million for the same period in 2022, primarily due to an increase in the average rates on investment securities, partially offset by a decrease in the average balances on investment securities.
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Average interest-bearing liabilities were $21.32 billion for the six months ended June 30, 2023, an increase of $896.3 million or 4.4%, compared with $20.43 billion for the same period in 2022, primarily due to an increase in other borrowings partially offset by a decrease in interest-bearing deposits. The average rate on interest-bearing liabilities was 1.97% for the quarter ended June 30, 2023, an increase of 179 basis points, compared with 0.18% for the same period in 2022.
The net interest margin on a tax-equivalent basis was 2.83% for the six months ended June 30, 2023, a decrease of 9 basis points, compared with 2.92% for the six months ended June 30, 2022. The changes were primarily due to an increase in the average balances and average rates on interest-bearing liabilities, partially offset by an increase in average balances and average rates on loans and an increase in average rates on investment securities.
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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:
3,910
6.87
3,199
5.02
19,802,751
270,688
5.48
16,799,609
182,286
4.35
898,768
15,883
7.09
1,257,521
10,444
3.33
20,705,429
5.55
18,060,329
4.28
Investment securities
13,976,818
2.07
14,989,666
1.72
150,300
4.69
540,907
0.69
Total interest-earning assets
34,832,547
4.15
33,590,902
Allowance for credit losses on loans
(283,594
(284,550
Noninterest-earning assets
4,738,673
4,448,060
Total assets
39,287,626
37,754,412
Liabilities and Shareholders' Equity
Interest-Bearing Liabilities:
Interest-bearing demand deposits
5,147,453
3,791
0.30
6,437,614
2,154
0.13
Savings and money market deposits
9,156,047
43,025
1.88
10,702,273
4,473
0.17
Certificates and other time deposits
2,652,064
17,148
2.59
2,409,663
2,014
0.34
4,427,914
5.20
112,582
1.60
441,303
2.43
463,108
0.21
1,547
Total interest-bearing liabilities
21,826,328
2.28
20,125,240
0.19
Noninterest-Bearing Liabilities:
Noninterest-bearing demand deposits
10,274,819
10,855,802
30,022
220,775
186,344
32,351,944
31,197,333
Shareholders' equity
6,935,682
6,557,079
Total liabilities and shareholders' equity
Net interest rate spread
1.87
2.89
Net interest income and margin (2) (3)
2.72
2.97
Net interest income and margin (tax equivalent) (4)
237,313
248,916
3,131
105
6.76
3,901
80
4.14
19,064,334
507,294
5.37
16,756,345
365,319
4.40
759,071
26,357
7.00
1,263,132
20,396
3.26
19,826,536
5.43
18,023,378
4.32
14,153,681
14,384,681
1.67
373,931
4.73
1,333,800
34,354,148
4.04
33,741,859
3.03
(282,959
(285,118
4,667,547
4,453,117
38,738,736
37,909,858
5,510,530
7,583
6,605,431
4,606
0.14
9,366,694
78,546
1.69
10,785,902
8,499
0.16
2,350,498
25,178
2.16
2,522,966
4,290
3,661,719
5.05
56,602
434,632
2.22
457,612
774
21,324,847
1.97
20,428,513
0.18
10,332,082
10,746,819
29,985
203,769
181,157
31,890,683
31,386,436
6,848,053
6,523,422
2.85
2.82
2.92
481,613
2.83
489,332
The following table presents information regarding the dollar amount of changes in interest income and interest expense for the periods indicated for each major component of interest-earning assets and interest-bearing liabilities and distinguishes between the changes attributable to changes in volume and changes in interest rates. For purposes of this table, changes in interest income and interest expense related to purchase accounting adjustments and changes attributable to both rate and volume which cannot be segregated have been allocated to rate.
2023 vs. 2022
Increase
(Decrease)
Due to Change in
Volume
Rate
(16
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Loans held for investment (1)
32,586
55,816
88,402
50,318
91,657
141,975
(2,980
8,419
5,439
(8,139
14,100
5,961
Investment securities (1)
(4,332
12,274
7,942
(1,913
28,029
26,116
(668
1,500
832
(1,275
8,266
6,991
Total increase in interest income
24,615
78,027
102,642
38,975
142,093
181,068
(432
2,069
1,637
(764
3,741
2,977
(646
39,198
38,552
(1,118
71,165
70,047
Certificates and other time deposits (1)
14,931
15,134
(293
21,181
20,888
17,249
39,652
56,901
28,662
62,635
91,297
(12
2,442
2,430
(22
4,370
4,348
Total increase in interest expense
16,362
98,292
114,654
26,465
163,092
189,557
(Decrease) increase in net interest income
8,253
(20,265
(12,012
12,510
(20,999
(8,489
Provision for Credit Losses
Management actively monitors the Company’s asset quality and provides specific loss provisions when necessary. Provisions for credit losses are charged to income to bring the total allowance for credit losses on loans and off-balance sheet credit exposures to a level deemed appropriate by management of the Company based on such factors as historical lifetime credit loss experience, the amount of nonperforming loans and related collateral, the volume growth and composition of the loan portfolio, current economic conditions and reasonable and supportable forecasted economic conditions that may affect borrower ability to pay and the value of collateral, the evaluation of the loan portfolio through the internal loan review process and other relevant factors.
Loans are charged off against the allowance for credit losses when appropriate. Although management believes it uses the best information available to make determinations with respect to the provision for credit losses, future adjustments may be necessary if economic conditions differ from the assumptions used in making the initial determinations.
The provision for credit losses was $18.5 million for the three and six months ended June 30, 2023 compared to no provision for credit losses for the three and six months ended June 30, 2022. As a result of the loans acquired in the Merger, the second quarter of 2023 included a $12.0 million provision for credit losses on loans and a $6.5 million provision for credit losses on off-balance sheet credit exposures.
Net charge-offs were $16.1 million for the quarter ended June 30, 2023 compared with net charge-offs of $1.2 million for the quarter ended June 30, 2022. Net charge-offs for the three months ended June 30, 2023 included $15.0 million related to one commercial real estate loan obtained in a previous merger. Additionally, $3.5 million of specific reserves on resolved PCD loans without any related charge-offs was released to the general reserve.
Net charge-offs were $15.5 million for the six months ended June 30, 2023 compared with $2.4 million for the six months ended June 30, 2022. Net charge-offs for the six months ended June 30, 2023 included $15.0 million related to one commercial real estate loan obtained in a previous merger. Additionally, $3.7 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 credit, debit and ATM card income, nonsufficient funds fees and service charges on deposit accounts. Additionally, the Company generates recurring noninterest income from its various additional products and services, including trust services, mortgage lending, brokerage and independent sales organization sponsorship operations. Noninterest income does not include loan origination fees, which are recognized over the life of the related loan as an adjustment to yield using the interest method.
Noninterest income totaled $39.7 million for the three months ended June 30, 2023 compared with $37.6 million for the same period in 2022, an increase of $2.1 million or 5.6%. Noninterest income totaled $78.0 million for the six months ended June 30, 2023 compared with $72.7 million for the same period in 2022, an increase of $5.2 million or 7.2%, primarily due to increases in trust income, credit card, debit card and ATM income and other noninterest income.
The following table presents, for the periods indicated, the major categories of noninterest income:
Nonsufficient funds fees
Bank owned life insurance income
1,553
1,293
2,907
2,576
7,326
7,170
16,818
13,756
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Noninterest Expense
Noninterest expense totaled $145.9 million for the quarter ended June 30, 2023 compared with $122.9 million for the quarter ended June 30, 2022, an increase of $23.0 million or 18.7%, primarily due to $12.9 million of merger related expenses, an increase in salaries and benefits and an increase in additional expenses related to two months of FirstCapital Bank operations. Noninterest expense totaled $268.9 million for the six months ended June 30, 2023 compared with $242.7 million for the six months ended June 30, 2022, an increase of $26.1 million or 10.8%, primarily due to $13.8 million of merger related expenses, an increase in Federal Deposit Insurance Corporation assessments of $4.4 million and an increase in additional expenses related to two months of FirstCapital Bank operations.
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 (income) expense (3)
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 $24.8 million for the three months ended June 30, 2023 compared with $34.7 million for the same period in 2022, a decrease of $9.9 million or 28.5%. Income tax expense totaled $58.8 million for the six months ended June 30, 2023 compared with $67.6 million for the same period in 2022, a decrease of $8.7 million or 12.9%. The Company’s effective tax rate for the three months ended June 30, 2023 and 2022 was 22.2% and 21.3%, respectively. The Company’s effective tax rate for the six months ended June 30, 2023 and 2022 was 21.8% and 21.2%, respectively.
FINANCIAL CONDITION
Loan Portfolio
The Company separates its loan portfolio into two general categories of loans: (1) “originated loans,” which are loans originated by Prosperity Bank and made pursuant to the Company’s loan policy and procedures in effect at the time the loan was made, and (2) “acquired loans,” which are loans acquired in a business combination and recorded at fair value at acquisition date. Those acquired loans that are renewed or substantially modified after the date of the business combination are referred to as “re-underwritten acquired loans.” If a renewal or substantial modification of an acquired loan is underwritten by the Company with a new credit analysis, the loan may no longer be categorized as an acquired loan. For example, acquired loans to one borrower may be combined into a new loan with a new loan number and categorized as an originated loan. Acquired loans with a fair value discount or premium at the date of the business combination that remained at the reporting date are referred to as “fair-valued acquired loans.” All fair-valued acquired loans are further categorized into purchased credit-deteriorated loans (“PCD loans”) and “Non-PCD loans.” Acquired loans with evidence of credit quality deterioration as of the acquisition date when compared to the origination date are classified as PCD loans.
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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
1,688,051
618,978
288,146
Warehouse purchase program
2,829,751
119,650
6,062
6,714,307
225,886
801,646
4,171,470
338,059
952,997
540,531
8,978
23,390
12,063
168,641
28,120
13,428
9,225
263,146
22,151
19,780
Total loans held for investment
17,524,780
1,361,822
21,643,290
17,535,436
1,711,433
730,969
137,272
15,068
2,672,903
126,607
5,759
169
5,918,995
232,975
588,700
3,967,943
410,834
562,834
44,600
498,512
5,740
13,658
185
140,838
29,041
245,131
29,436
8,992
15,896,375
1,565,602
18,839,273
15,896,929
At June 30, 2023, total loans were $21.65 billion, an increase of $2.81 billion or 14.9%, compared with $18.84 billion at December 31, 2022. Loans at June 30, 2023 included $10.7 million of loans held for sale and $1.15 billion of Warehouse Purchase Program loans compared with $554 thousand of loans held for sale and $740.6 million of Warehouse Purchase Program loans at December 31, 2022. At June 30, 2023, loans represented 54.3% of total assets compared with 50.0% of total assets at December 31, 2022.
The loan portfolio consists of various types of loans categorized by major type as follows:
(i) Commercial and Industrial Loans. In nearly all cases, the Company’s commercial loans are made in the Company’s market areas and are underwritten based on the borrower’s ability to service the debt from income. Working capital loans are primarily collateralized by short-term assets whereas term loans are primarily collateralized by long-term assets. As a general practice, term loans are secured by any available real estate, equipment or other assets owned by the borrower. Both working capital and term loans are typically supported by a personal guaranty of a principal. In general, commercial loans involve more credit risk than residential mortgage loans and commercial mortgage loans and, therefore, usually yield a higher return. The increased risk in commercial loans is due to the type of collateral securing these loans as well as the expectation that commercial loans generally will be serviced principally from the operations of the business, and those operations may not be successful. Historical trends have shown these types of loans to have higher delinquencies than mortgage loans. As a result of these additional complexities, variables and risks, commercial loans require more thorough underwriting and servicing than other types of loans.
Included in commercial and industrial loans are (1) commitments to oil and gas producers largely secured by proven, developed and producing reserves and (2) commitments to service, equipment and midstream companies secured mainly by accounts receivable, inventory and equipment. Mineral reserve values supporting commitments to producers are normally re-determined semi-annually using reserve studies prepared by a third-party or the Company’s oil and gas engineer. Accounts receivable and inventory borrowing bases for service companies are typically re-determined monthly. Funding requests by both producers and service companies are monitored relative to the most recently determined borrowing base.
(ii) Commercial Real Estate. The Company makes commercial real estate loans collateralized by owner-occupied and nonowner-occupied real estate to finance the purchase of real estate. The Company’s commercial real estate loans are collateralized by first liens on real estate, typically have variable interest rates (or five year or less fixed rates) and amortize over a 15- to 25-year period. Payments on loans secured by nonowner-occupied properties are often dependent on the successful operation or management of the properties. Accordingly, repayment of these loans may be subject to adverse conditions in the real estate market or the economy to a greater extent than other types of loans. The Company seeks to minimize these risks in a variety of ways, including giving careful consideration to the property’s operating history, future operating projections, current and projected occupancy, location and physical condition, in connection with underwriting these loans. The underwriting analysis also includes credit verification, analysis of global cash flow, appraisals and a review of the financial condition of the borrower and guarantor. Loans to hotels and restaurants are included in commercial real estate loans.
(iii) 1-4 Family Residential Loans. The Company’s lending activities also include the origination of 1-4 family residential mortgage loans (including home equity loans) collateralized by owner-occupied and nonowner-occupied residential properties located in the Company’s market areas. The Company offers a variety of mortgage loan portfolio products which generally are amortized over five to 30 years. Loans collateralized by 1-4 family residential real estate generally have been originated in amounts of no more than 89% of appraised value. The Company requires mortgage title insurance, as well as hazard, wind and/or flood insurance as appropriate. The Company prefers to retain residential mortgage loans for its own account rather than selling them into the secondary market. By doing so, the Company incurs interest rate risk as well as the risks associated with non-payments on such loans. The Company’s mortgage department also offers a variety of mortgage loan products which are generally amortized over 30 years, including FHA and VA loans, which are sold to secondary market investors.
(iv) Construction, Land Development and Other Land Loans. The Company makes loans to finance the construction of residential and nonresidential properties. Construction loans generally are collateralized by first liens on real estate and have variable interest rates. The Company conducts periodic inspections, either directly or through an agent, prior to approval of periodic draws on these loans. Underwriting guidelines similar to those described above are also used in the Company’s construction lending activities, with heightened analysis of construction and/or development costs. Construction loans involve additional risks attributable to the fact that loan funds are advanced upon the security of a project under construction, and the project is of uncertain value prior to its completion. Because of uncertainties inherent in estimating construction costs, the market value of the completed project and the effects of governmental regulation on real property, it can be difficult to accurately evaluate the total funds required to complete a project and the related loan to value ratio. As a result of these uncertainties, construction lending often involves the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project rather than the ability of a borrower or guarantor to repay the loan. If the Company is forced to foreclose on a project prior to completion, the Company may not be able to recover all of the unpaid portion of the loan. In addition, the Company may be required to fund additional amounts to complete a project and may have to hold the property for an indeterminate period of time. Although the Company has underwriting procedures designed to identify what it believes to be acceptable levels of risks in construction lending, these procedures may not prevent losses from the risks described above.
(v) Warehouse Purchase Program. The Warehouse Purchase Program allows unaffiliated mortgage originators (“Clients”) to close 1-4 family real estate loans in their own name and manage their cash flow needs until the loans are sold to investors. The Company's Clients are strategically targeted for their experienced management teams and analyzed for the expected profitability of each Client’s business model over the long term. The Clients are located across the U.S. and originate mortgage loans primarily through traditional retail and/or wholesale business models using underwriting standards as required by United States government-sponsored enterprise agencies, “Agencies” such as Fannie Mae, private investors to which the mortgage loans are ultimately sold and/or mortgage insurers.
Although not subject to any legally binding commitment, when the Company makes a purchase decision, it acquires a 100% participation interest in the mortgage loans originated by its Clients. Individual mortgage loans are warehoused in the Company’s portfolio only for a short duration, averaging less than 30 days. When instructed by a Client that a warehoused loan has been sold to an investor, the Company delivers the note to the investor that pays the Company, which in turn remits the net sales proceeds to the Client.
(vi) Agriculture Loans. The Company provides agriculture loans for short-term livestock and crop production, including rice, cotton, milo and corn, farm equipment financing and agriculture real estate financing. The Company evaluates agriculture borrowers primarily based on their historical profitability, level of experience in their particular industry segment, overall financial capacity and the availability of secondary collateral to withstand economic and natural variations common to the industry. Because agriculture loans present a higher level of risk associated with events caused by nature, the Company routinely makes on-site visits and inspections in order to identify and monitor such risks.
(vii) Consumer Loans. Consumer loans made by the Company include direct “A”-credit automobile loans, recreational vehicle loans, boat loans, home improvement loans, personal loans (collateralized and uncollateralized) and deposit account collateralized loans. The terms of these loans typically range from 12 to 180 months and vary based upon the nature of collateral and size of loan. Generally, consumer loans entail greater risk than do real estate secured loans, particularly in the case of consumer loans that are unsecured or collateralized by rapidly depreciating assets such as automobiles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan balance. The remaining deficiency often does not warrant further substantial collection efforts against the borrower beyond obtaining a deficiency judgment. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness, personal bankruptcy or death. Furthermore, the application of various federal and state laws may limit the amount which can be recovered on such loans.
The Company maintains an independent loan review department that reviews and validates the credit risk program on a periodic basis. Results of these reviews are presented to management. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Company’s policies and procedures.
Nonperforming Assets
Nonperforming assets include loans on nonaccrual status, accruing loans 90 days or more past due, repossessed assets and real estate which has been acquired through foreclosure and is awaiting disposition. Nonperforming assets do not include PCD loans unless the loan has deteriorated since the acquisition date.
The Company generally places a loan on nonaccrual status and ceases accruing interest when the payment of principal or interest is delinquent for 90 days, or earlier in some cases, unless the loan is in the process of collection and the underlying collateral fully supports the carrying value of the loan. A loan may be returned to accrual status when all the principal and interest amounts contractually due are brought current and future principal and interest amounts contractually due are reasonably assured, which is typically evidenced by a sustained period (at least six months) of repayment performance by the borrower.
Nonperforming assets increased $35.2 million to $62.7 million at June 30, 2023 compared with $27.5 million at December 31, 2022, of which $30.9 million and $9.1 million, respectively, were attributable to acquired loans. Acquired loans increased primarily due to the Merger.
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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)(3)
27,347
1,774
7,040
21,562
1,717
29,064
21,589
117
2,744
31,844
7,520
0.36
3.32
0.33
3.31
Nonaccrual loans (2)(3)
10,544
2,138
6,764
16,461
-
18,424
0.12
0.51
0.07
Nonperforming assets were 0.29% of total loans and other real estate at June 30, 2023 and 0.15% of total loans and other real estate at December 31, 2022. The allowance for credit losses on loans as a percentage of total nonperforming loans was 580.5% at June 30, 2023 and 1,102.9% at December 31, 2022.
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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 June 30, 2023 for estimated losses in the Company’s loan portfolio. The amount of the allowance for credit losses on loans is affected by the following: (1) charge-offs of loans that occur when loans are deemed uncollectible and decrease the allowance, (2) recoveries on loans previously charged off that increase the allowance, (3) provisions for credit losses charged to earnings that increase the allowance, and (4) provision releases returned to earnings that decrease the allowance. Based on an evaluation of the loan portfolio and consideration of the factors listed below, management presents a quarterly review of the allowance for credit losses to the Bank’s Board of Directors, indicating any change in the allowance since the last review and any recommendations as to adjustments in the allowance. Although management believes it uses the best information available to make determinations with respect to the allowance for credit losses, future adjustments may be necessary if economic conditions or borrower performance differ from the assumptions used in making the initial determinations.
The Company’s allowance for credit losses on loans consists of two components: (1) a specific valuation allowance based on expected lifetime losses on specifically identified loans and (2) a general valuation allowance based on historical lifetime loan loss experience, current economic conditions, reasonable and supportable forecasted economic conditions and other qualitative risk factors both internal and external to the Company.
In setting the specific valuation allowance, the Company follows a loan review program to evaluate the credit risk in the total loan portfolio and assigns risk grades to each loan. Through this loan review process, the Company maintains an internal list of impaired loans which, along with the delinquency list of loans, helps management assess the overall quality of the loan portfolio and the adequacy of the allowance for credit losses. All loans that have been identified as impaired are reviewed on a quarterly basis in order to determine whether a specific reserve is required. For certain impaired loans, the Company allocates a specific loan loss reserve primarily based on the value of the collateral securing the impaired loan. The specific reserves are determined on an individual loan basis. Loans for which specific reserves are provided are excluded from the general valuation allowance described below.
In determining the amount of the general valuation allowance, management considers factors such as historical lifetime loan loss experience, concentration risk of specific loan types, the volume, growth and composition of the Company’s loan portfolio, current economic conditions and reasonable and supportable forecasted economic conditions that may affect borrower ability to pay and the value of collateral, the evaluation of the Company’s loan portfolio through its internal loan review process, other qualitative risk factors both internal and external to the Company and other relevant factors. Historical lifetime loan loss experience is determined by utilizing an open-pool (“cumulative loss rate”) methodology. Adjustments to the historical lifetime loan loss experience are made for differences in current loan pool risk characteristics such as portfolio concentrations, delinquency, non-accrual, and watch list levels, as well as changes in current and forecasted economic conditions such as unemployment rates, property and collateral values, and other indices relating to economic activity. The utilization of reasonable and supportable forecasts includes an immediate reversion to lifetime historical loss rates. Based on a review of these factors for each loan type, the Company applies an estimated percentage to the outstanding balance of each loan type, excluding any loan that has a specific reserve. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.
A change in the allowance for credit losses can be attributable to several factors, most notably (1) specific reserves identified for impaired loans, (2) historical lifetime credit loss information, (3) changes in current and forecasted environmental factors and (4) growth in the balance of loans.
Changes in the Company’s asset quality are reflected in the allowance in several ways. Specific reserves that are calculated on a loan-by-loan basis and the qualitative assessment of all other loans reflect current changes in the credit quality of the loan portfolio. Historical lifetime credit losses, on the other hand, are based on an open-pool (“cumulative loss rate”) methodology, which is then applied to estimate lifetime credit losses in the loan portfolio. A deterioration in the credit quality of the loan portfolio in the current period would increase the historical lifetime loss rate to be applied in future periods, just as an improvement in credit quality would decrease the historical lifetime loss rate.
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The allowance for credit losses is further determined by the size of the loan portfolio subject to the allowance methodology and environmental factors that include Company-specific risk indicators and general economic conditions, both of which are constantly changing. The Company evaluates the economic and portfolio-specific factors on a quarterly basis to determine a qualitative component of the general valuation allowance. The factors include current economic metrics, reasonable and supportable forecasted economic metrics, business conditions, delinquency trends, credit concentrations, nature and volume of the portfolio and other adjustments for items not covered by specific reserves and historical lifetime loss experience. Management’s assessment of qualitative factors is a statistically based approach to determine the loss rate adjustment associated with such factors. Based on the Company’s actual historical lifetime loan loss experience relative to economic and loan portfolio-specific factors at the time the losses occurred, management is able to identify the expected level of lifetime losses as of the date of measurement. The correlation of historical loss experience with current and forecasted economic conditions provides an estimate of lifetime losses that has not been previously factored into the general valuation allowance by the determination of specific reserves and lifetime historical losses. Additionally, the Company considers qualitative factors not easily quantified and the possibility of model imprecision.
Utilizing the aggregation of specific reserves, historical loss experience and a qualitative component, management is able to determine the valuation allowance to reflect the full lifetime loss.
The Company accounts for its acquisitions using the acquisition method of accounting. Accordingly, the assets, including loans, and liabilities of the acquired entity are recorded at their fair values at the acquisition date. These fair value estimates associated with acquired loans, and based on a discounted cash flow model, include estimates related to market interest rates and undiscounted projections of future cash flows that incorporate expectations of prepayments and the amount and timing of principal, interest and other cash flows, as well as any shortfalls thereof.
Non-PCD loans that were not deemed impaired subsequent to the acquisition date are considered non-impaired and are evaluated as part of the general valuation allowance.
Non-PCD loans that have deteriorated to an impaired status subsequent to acquisition are evaluated for a specific reserve on a quarterly basis which, when identified, is added to the allowance for credit losses. The Company reviews impaired Non-PCD loans on a loan-by-loan basis and determines the specific reserve based on the difference between the recorded investment in the loan and one of three factors: expected future cash flows, observable market price or fair value of the collateral. Because essentially all of the Company’s impaired Non-PCD loans have been collateral-dependent, the amount of the specific reserve historically has been determined by comparing the fair value of the collateral securing the Non-PCD loan with the recorded investment in such loan. In the future, the Company will continue to analyze impaired Non-PCD loans on a loan-by-loan basis and may use an alternative measurement method to determine the specific reserve, as appropriate and in accordance with applicable accounting standards.
PCD loans are monitored individually or on a pooled basis quarterly to assess for changes in expected cash flows subsequent to acquisition. If a deterioration in cash flows is identified, an increase to the PCD reserves for that individual loan or pool of loans is made. PCD loans were recorded at their acquisition date fair values, which were based on expected cash flows and considers estimates of expected future credit losses. The Company’s estimates of loan fair values at the acquisition date may be adjusted for a period of up to one year as the Company continues to evaluate its estimate of expected future cash flows at the acquisition date. If the Company determines that losses arose after the acquisition date, the additional losses will be reflected as a provision for credit losses. See “Critical Accounting Estimates” above for more information.
As described in the section captioned “Critical Accounting Estimates” above, the Company’s determination of the allowance for credit losses involves a high degree of judgment and complexity. The Company’s analysis of qualitative, or environmental, factors on pools of loans with common risk characteristics, in combination with the quantitative historical lifetime loss information and specific reserves, provides the Company with an estimate of lifetime losses. The allowance must reflect changes in the balance of loans subject to the allowance methodology, as well as the estimated lifetime losses associated with those loans.
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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 Six Months Ended June 30, 2023
Average loans outstanding
16,561,790
3,264,746
Gross loans outstanding at end of period
4,118,510
Allowance for credit losses on loans at beginning of period
209,467
72,109
28,005
(16,021
Charge-offs:
(518
(724
Real estate and agriculture
(15,266
(2,465
(51
Recoveries:
1,330
1,224
273
567
Net (charge-offs) recoveries(1)
(16,207
757
Allowance for credit losses on loans at end of period
221,265
123,944
Ratio of allowance to end of period loans
1.26
3.01
1.59
Ratio of allowance to end of period loans, excluding Warehouse Purchase Program
1.35
1.68
Ratio of net charge-offs (recoveries) to average loans (annualized)
0.20
(0.05
%)
Ratio of allowance to end of period nonperforming loans
761.3
407.7
580.5
Ratio of allowance to end of period nonaccrual loans
809.1
408.0
598.0
As of and for the Six Months Ended June 30, 2022
13,838,584
4,184,794
14,913,054
3,295,790
18,208,844
186,736
99,644
10,359
(10,359
(609
(54
(686
(43
(729
(2,526
(149
707
139
317
332
(2,372
(49
194,723
89,236
1.31
2.71
1.56
1.41
1.66
1,695.2
975.8
1,376.3
1,697.1
1,377.2
The Company had gross charge-offs on originated loans of $18.2 million during the six months ended June 30, 2023. Partially offsetting these charge-offs were recoveries on originated loans of $2.0 million. Gross charge-offs on acquired loans were $775 thousand during the six months ended June 30, 2023. Offsetting these charge-offs were recoveries on acquired loans of $1.5 million.
Total charge-offs for the six months ended June 30, 2023 were $19.0 million, partially offset by total recoveries of $3.6 million. Net charge-offs for the six months ended June 30, 2023 included $15.0 million related to one commercial real estate loan.
The following table shows the allocation of the net charge-offs among various categories of loans as of the dates indicated.
Ratio of Net Charge-offs (Recoveries) to Average Loans (Annualized)
Ratio ofNet Charge-offs (Recoveries) to Average Loans (Annualized)
Balance of net (charge-offs) recoveries applicable to:
(0.01
1-4 family residential (including home equity)
Commercial real estate (including multi-family residential)
Agriculture (includes farmland)
Total net (charge-offs) recoveries
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.
TotalAllowance
Percent of Loans to Total Loans(1)
Balance of allowance for credit losses on loans applicable to:
33,741
19,479
3,903
24,847
13.4
Real estate
175,104
8,364
10,370
52,507
246,345
81.2
Agriculture and agriculture real estate
7,524
537
3,117
3.9
4,896
573
145
1.5
Total allowance for credit losses on loans
28,953
14,494
80,497
100.0
30,837
25,736
5,091
655
14.3
167,270
10,225
11,978
205,920
80.3
6,845
731
3.8
4,515
206
1.6
37,609
17,386
17,114
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The allowance for credit losses on loans totaled $345.2 million at June 30, 2023 compared to $281.6 million at December 31, 2022, an increase of $63.6 million or 22.6%, primarily due to the Merger. The allowance for credit losses on loans totaled 1.59% of total loans at June 30, 2023 and 1.49% of total loans at December 31, 2022.
At June 30, 2023, $221.3 million of the allowance for credit losses on loans was attributable to originated loans, an increase of $11.8 million or 5.6% compared with $209.5 million of the allowance at December 31, 2022. At June 30, 2023, $29.0 million of the allowance for credit losses on loans was attributable to re-underwritten acquired loans compared with $37.6 million of the allowance at December 31, 2022, a decrease of $8.7 million or 23.0%. At June 30, 2023, $14.5 million of the allowance for credit losses on loans was attributable to Non-PCD loans compared with $17.4 million of the allowance at December 31, 2022, a decrease of $2.9 million or 16.6%. At June 30, 2023, $80.5 million of the allowance for credit losses on loans was attributable to PCD loans compared with $17.1 million of the allowance at December 31, 2022, an increase of $63.4 million or 370.4%.
At June 30, 2023, the Company had $33.2 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 June 30, 2023 is adequate to absorb expected lifetime losses that may be realized from the loan portfolio as of such date. Nevertheless, the Company could sustain losses in future periods which could be substantial in relation to the size of the allowance at June 30, 2023.
Allowance for Credit Losses on Off-Balance Sheet Credit Exposures
The allowance for credit losses on off-balance sheet credit exposures estimates expected credit losses over the contractual period in which there is exposure to credit risk via a contractual obligation to extend credit, except when an obligation is unconditionally 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 June 30, 2023 and December 31, 2022, the Company had $36.5 million and $29.9 million in allowance for credit losses on off-balance sheet credit exposures, respectively; with the increase primarily due to the Merger. The allowance for credit losses on off-balance sheet credit exposures is a separate line item on the Company’s consolidated balance sheet.
The carrying cost of securities totaled $13.67 billion at June 30, 2023 compared with $14.48 billion at December 31, 2022, a decrease of $808.7 million or 5.6%. At June 30, 2023, securities represented 34.2% of total assets compared with 38.4% of total assets at December 31, 2022.
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 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.
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As of June 30, 2023, management does not have the intent to sell any of the securities classified as available for sale before a recovery of cost. In addition, management believes it is more likely than not that the Company will not be required to sell any of its investment securities before a recovery of cost. The unrealized losses are largely due to changes in market interest rates and spread relationships since the time the underlying securities were purchased. The fair value is expected to recover as the securities approach their maturity date or repricing date or if market yields for such investments decline. Management does not believe any of the securities are impaired due to reasons of credit quality. Accordingly, as of June 30, 2023, management believes that there is no potential for credit losses on available for sale securities.
Held to maturity securities. The Company’s held to maturity investments include mortgage-related bonds issued by either the Government National Mortgage Corporation (“Ginnie Mae”), Federal National Mortgage Association (“Fannie Mae”) or Federal Home Loan Mortgage Corporation (“Freddie Mac”). Ginnie Mae issued securities are explicitly guaranteed by the U.S. government, while Fannie Mae and Freddie Mac issued securities are fully guaranteed by those respective United States government-sponsored agencies, and conditionally guaranteed by the full faith and credit of the United States. The Company’s held to maturity securities also include taxable and tax-exempt municipal securities issued primarily by school districts, utility districts and municipalities located in Texas. The Company’s investment in municipal securities is exposed to credit risk. The securities are highly rated by major rating agencies and regularly reviewed by management. A significant portion are guaranteed or insured by either the Texas Permanent School Fund, Assured Guaranty or Build America Mutual. As of June 30, 2023, the Company’s municipal securities represent 0.9% of the securities portfolio. Management has the ability and intent to hold the securities classified as held to maturity until they mature, at which time the Company will receive full value for the securities. Accordingly, as of June 30, 2023, management believes that there is no potential for material credit losses on held to maturity securities.
Total deposits were $27.38 billion at June 30, 2023 compared with $28.53 billion at December 31, 2022, a decrease of $1.15 billion or 4.0%. At June 30, 2023, noninterest-bearing deposits totaled $10.36 billion, a decrease of $550.5 million or 5.0% compared with $10.92 billion at December 31, 2022. Interest-bearing deposits totaled $17.02 billion at June 30, 2023 compared with $17.62 billion at December 31, 2022, a decrease of $602.1 million or 3.4%. The changes were primarily due to a decrease in business deposits and public fund deposits, partially offset by an increase in deposits acquired in the Merger.
Average deposits for the six months ended June 30, 2023 were $27.56 billion, a decrease of $3.10 billion or 10.1%, compared with $30.66 billion for the six months ended June 30, 2022. The ratio of average interest-bearing deposits to total average deposits was 62.5% and 64.9% during the first six months of 2023 and 2022, respectively.
The following table summarizes the daily average balances and weighted average rates paid on deposits for the periods indicated below:
Average Balance
Average Rate (1)
Regular savings
3,318,291
0.70
3,513,593
Money market savings
6,048,403
2.23
7,272,309
Certificates, IRAs and other time deposits
Total interest-bearing deposits
17,227,722
1.30
19,914,299
27,559,804
0.81
30,661,118
Other Borrowings
The following table presents the Company’s borrowings as of the dates indicated:
3,000,000
FHLB advances
Total other borrowings
Subordinated debentures - Floating rate notes maturing on March 2034
5,237,253
2,278,134
Bank Term Funding Program— During the second quarter of 2023, the Bank participated in the Federal Reserve's Bank Term Funding Program (“BTFP”). At June 30, 2023, the Bank had secured borrowing capacity of $3.33 billion collateralized by the par value of pledged securities totaling $3.33 billion. At June 30, 2023, the balance outstanding was $3.00 billion consisting of three term advances maturing in May 2024 and June 2024, at a weighted average interest rate of 5.13%. Under the BTFP program, eligible depository institutions can obtain loans of up to one year in length by pledging U.S. Treasuries, agency debt and mortgage-backed securities, and other qualifying assets as collateral. These assets will be valued at par. Eligible depository institutions can request advances under the BTFP until at least March 11, 2024.
FHLB advances and long-term notes payable— The Company has an available line of credit with the Federal Home Loan Bank of Dallas (“FHLB”), which allows the Company to borrow on a collateralized basis. The Company’s FHLB advances are typically considered short-term borrowings and are used to manage liquidity as needed. Maturing advances are replaced by drawing on available cash, making additional borrowings or through increased customer deposits. At June 30, 2023, the Company had total funds of $9.02 billion available under this line. FHLB advances of $1.80 billion were outstanding at June 30, 2023, at a weighted average interest rate of 5.31%. At June 30, 2023, the Company had no FHLB long-term notes payable balance.
Securities sold under repurchase agreements— At June 30, 2023, the Company had $434.2 million in securities sold under repurchase agreements with banking customers compared with $428.1 million at December 31, 2022, an increase of $6.0 million or 1.4%. Repurchase agreements are generally settled on the following business day; however, approximately $4.2 million of the repurchase agreements outstanding at June 30, 2023 have maturity dates ranging from 12 to 24 months. All securities sold under repurchase agreements are collateralized by certain pledged securities.
Subordinated debentures— On May 1, 2023, in connection with the acquisition of First Bancshares, the Company assumed the obligation related to a $3.09 million Floating Rate Junior Subordinated Deferrable Interest Debentures and trust preferred securities (the "Subordinated Debentures") that mature in March 2034 (the “Maturity Date”). The Subordinated Debentures, which qualify as Tier 1 capital for regulatory purposes, have an annual interest rate of 3-Month LIBOR plus 2.85%. Also, the interest rate cannot exceed the maximum rate permitted by New York law. The Subordinated Debentures are subordinated in right of payment to all of the Company’s senior indebtedness and effectively subordinated to all existing and future debt and all other liabilities of the Company’s subsidiaries. Dividends on the trust preferred securities are cumulative and the Company may defer the payments for up to five years. In July 2023, the Company gave irrevocable notice of its intent to redeem the Subordinated Debentures on September 18, 2023.
LIBOR Transition
As of June 30, 2023, LIBOR was used as an index rate for approximately 83.7% of the Company’s interest-rate swaps and approximately 0.17% of the Company’s loan portfolio. As of December 31, 2022, LIBOR was used as an index rate for approximately 88.2% of the Company’s interest-rate swaps and approximately 1.5% of the Company’s loan portfolio. On September 30, 2021, the Company began transitioning away from LIBOR to Secured Overnight Financing Rate (“SOFR”) or other alternative variable rate indexes for its interest-rate swaps and loans historically using LIBOR as an index.
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
55
not generally rely on this external funding source. The cash and federal funds sold position, supplemented by amortizing investment and loan portfolios, has generally created an adequate liquidity position.
As of June 30, 2023, the Company had outstanding $5.14 billion in commitments to extend credit, $81.2 million in commitments associated with outstanding standby letters of credit and $959.1 million 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 June 30, 2023, the Company had cash and cash equivalents of $397.0 million compared with $424.1 million at December 31, 2022, a decrease of $27.1 million or 6.4%. The decrease was primarily due to a decrease in deposits of $2.73 billion, cash used related to loans of $1.20 billion, payment of cash dividends of $101.7 million, repurchase of common stock of $72.2 million, a decrease in securities sold under repurchase agreements of $43.8 million and net cash used in the purchase of First Bancshares of $24.4 million, partially offset by proceeds from short-term borrowings of $2.75 billion, net purchases of investment securities of $1.03 billion and net cash provided by operating activities of $374.7 million.
Share Repurchases
On January 17, 2023, the Company announced a stock repurchase program under which up to 5%, or approximately 4.6 million shares, of Bancshares outstanding common stock may be acquired over a one-year period expiring on January 17, 2024, at the discretion of management. Under the stock repurchase program, Bancshares may repurchase shares from time to time at prevailing market prices, through open-market purchases or privately negotiated transactions, depending upon market conditions. Repurchases under this program may also be made in transactions outside the safe harbor during a pending merger, acquisition or similar transaction. The timing and actual number of shares repurchased will depend on a variety of factors including price, corporate and regulatory requirements, market conditions, and other corporate liquidity requirements and priorities. Shares of stock repurchased are held as authorized but unissued shares. Bancshares is not obligated to purchase any particular number of shares, and Bancshares may suspend, modify or terminate the program at any time and for any reason without prior notice. Bancshares repurchased approximately 595 thousand shares of its common stock at an average weighted price of $57.49 per share during the three months ended June 30, 2023 and approximately 1.21 million shares of its common stock at an average weighted price of $59.88 per share during the six months ended June 30, 2023.
The Company’s contractual obligations and other commitments to make future payments (other than deposit obligations and securities sold under repurchase agreements) as of June 30, 2023 are summarized below.
Borrowings
The Company’s future cash payments associated with its Subordinated Debentures, the Federal Reserve's BTFP and FHLB advances as of June 30, 2023 are summarized below. The future interest payments were calculated using the current rate in effect at June 30, 2023. Payments for the Subordinated Debentures include interest of $2.6 million that will be due over the future periods. In July 2023, the Company gave irrevocable notice of its intent to redeem the Subordinated Debentures on September 18, 2023. Payments under the BTFP include interest of $141.6 million that will be due over the future periods. These payments do not include prepayment options that may be available to the Company.
56
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 was $688 thousand and $800 thousand for the three months ended June 30, 2023 and 2022 and was $1.5 million and $1.6 million for the six months ended June 30, 2023 and 2022, respectively. As of June 30, 2023, operating lease ROU assets and lease liabilities were approximately $40.7 million. ROU assets and lease liabilities were classified as other assets and other liabilities, respectively.
As of June 30, 2023, the weighted average of remaining lease terms of the Company’s operating leases was 5.2 years. The weighted average discount rate used to determine the lease liabilities as of June 30, 2023 for the Company’s operating leases was 2.7%. Cash paid for the Company’s operating leases was $3.1 million and $2.7 million for the three months ended June 30, 2023 and 2022, respectively, and was $5.9 million and $5.5 million for the six months ended June 30, 2023 and 2022, respectively. During the six months ended June 30, 2023, the Company obtained $3.0 million in ROU assets in exchange for lease liabilities for six operating leases, four of which, reflecting $2.7 million in ROU assets, were related to the Merger.
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 June 30, 2023 are summarized below. Since commitments associated with letters of credit, unused capacity of Warehouse Purchase Program loans and commitments to extend credit may expire unused, the amounts shown may not necessarily reflect the actual future cash funding requirements.
Allowance for Credit Losses on Off-balance Sheet Credit Exposures. The Company records an allowance for credit losses on off-balance sheet credit exposure that is adjusted through a charge to provision for credit losses on the Company’s consolidated statement of income. At June 30, 2023 and December 31, 2022, this allowance, reported as a separate line item on the Company’s consolidated balance sheet, totaled $36.5 million and $29.9 million, respectively. The increase in the allowance was primarily due to the Merger.
57
Capital Resources
Total shareholders’ equity was $6.97 billion at June 30, 2023 compared with $6.70 billion at December 31, 2022, an increase of $268.7 million or 4.0%. The increase was primarily the result of the common stock issuance in connection with the Merger of $224.3 million and net income of $211.6 million, partially offset by dividend payments of $101.7 million and common stock repurchases of $72.2 million.
The Basel III Capital Rules adopted by the federal regulatory authorities in 2013 substantially revised the risk-based capital requirements applicable to the Company and the Bank. The Basel III Capital Rules became effective for the Company on January 1, 2015, subject to a phase-in period for certain provisions. The Basel III Capital Rules require a capital conservation buffer with respect to each of the Common Equity Tier 1, Tier 1 risk-based and total risk-based capital ratios, which provides for capital levels that exceed the minimum risk-based capital adequacy requirements. The capital conservation buffer of 2.5% was fully phased-in on January 1, 2019. A financial institution with a conservation buffer of less than the required amount will be subject to limitations on capital distributions, including dividend payments and stock repurchases, and certain discretionary bonus payments to executive officers.
In response to the COVID-19 pandemic, in March 2020 the joint federal bank regulatory agencies issued an interim final rule that allowed banking organizations that implemented CECL in 2020 to mitigate the effects of the CECL accounting standard in their regulatory capital for two years. This two-year delay is in addition to the three-year transition period that the agencies had already made available. The Company adopted the option provided by the interim final rule, which delayed the effects of CECL on its regulatory capital through 2021, after which the effects will be phased in over a three-year period from January 1, 2022 through December 31, 2024. Under the interim final rule, the amount of adjustments to regulatory capital deferred until the phase-in period include both the initial impact of the Company’s adoption of CECL on January 1, 2020 and 25% of subsequent changes in the Company’s allowance for credit losses during each quarter of the two-year period ending December 31, 2021. The cumulative amount of the transition adjustments is being phased in over the three-year transition period that began on January 1, 2022, with 75% recognized in 2022, 50% recognized in 2023, and 25% recognized in 2024.
Financial institutions are categorized by the FDIC based on minimum Common Equity Tier 1, Tier 1 risk-based, total risk-based and Tier 1 leverage ratios. As of June 30, 2023, the Bank’s capital ratios were above the levels required for the Bank to be designated as “well capitalized.”
The following table provides a comparison of the Company’s and the Bank’s risk-weighted and leverage capital ratios to the minimum and well-capitalized regulatory standards as of June 30, 2023:
Minimum Required For Capital Adequacy Purposes
Minimum Required Plus Capital Conservation Buffer
To Be Categorized As Well Capitalized Under Prompt Corrective Action Provisions
Actual Ratio as of June 30, 2023
The Company
CET1 capital (to risk-weighted assets)
4.50
N/A
14.49
Tier 1 capital (to risk-weighted assets)
6.00
8.50
Total capital (to risk-weighted assets)
8.00
10.50
15.52
Tier 1 capital (to average assets)
4.00
(1)
9.96
The Bank
6.50
14.45
10.00
15.48
5.00
9.94
58
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company manages market risk, which for the Company is primarily interest rate risk, through its Asset Liability Committee consisting of senior officers of the Company, in accordance with policies approved by the Company’s Board of Directors.
The Company uses simulation analysis to examine the potential effects of market changes on net interest income and market value. The Company considers macroeconomic variables, Company strategy, liquidity and other factors as it quantifies market risk. See Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Interest Rate Sensitivity and Liquidity” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022, filed on February 24, 2023 (the “2022 Form 10-K”), for further discussion. There have been no material changes in the Company’s market risk exposures that would affect the quantitative and qualitative disclosures from those disclosed in the 2022 Form 10-K and presented as of December 31, 2022.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures. As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of its management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of its disclosure controls and procedures. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management was required to apply judgment in evaluating its controls and procedures. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) were effective as of the end of the period covered by this report.
Changes in internal control over financial reporting. There were no changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended June 30, 2023 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
ITEM 1. LEGAL PROCEEDINGS
Bancshares and the Bank are defendants, from time to time, in legal actions arising from transactions conducted in the ordinary course of business. After consultations with legal counsel, Bancshares and the Bank believe that the ultimate liability, if any, arising from such actions will not have a material adverse effect on their financial statements.
ITEM 1A. RISK FACTORS
There have been no material changes in the Company’s risk factors from those disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
a. None.
b. None.
c. The following table details the Company’s repurchases of shares of its common stock during the three months ended June 30, 2023:
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)
April 1 - April 30, 2023
3,954,268
May 1 - May 31, 2023
201,951
57.59
3,752,317
June 1 - June 30, 2023
392,822
57.43
3,359,495
594,773
57.49
(1) On January 17, 2023, Bancshares announced a stock repurchase program under which up to 5%, or approximately 4.6 million shares, of its outstanding common stock may be acquired over a one-year period expiring on January 17, 2024, at the discretion of management. Under the stock repurchase program, Bancshares could repurchase shares from time to time at prevailing market prices, through open-market purchases or privately negotiated transactions, depending upon market conditions. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Financial Condition—Share Repurchases” for additional information.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
ITEM 5. OTHER INFORMATION
c. During the three months ended June 30, 2023, no director or officer of the Company adopted or terminated a “Rule 10b5-1 trading arrangement” or “non-Rule 10b5-1 trading arrangement,” as each term is defined in Item 408(a) of Regulation S-K.
ITEM 6. EXHIBITS
Exhibit
Number
Description of Exhibit
3.1
Amended and Restated Articles of Incorporation of Prosperity Bancshares, Inc. (incorporated herein by reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-1 (Registration No. 333-63267) (the “Registration Statement”))
3.2
Articles of Amendment to Amended and Restated Articles of Incorporation of Prosperity Bancshares, Inc. (incorporated herein by reference to Exhibit 3.2 to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2006 (File No. 001-35388))
3.3
Amended and Restated Bylaws of Prosperity Bancshares, Inc. (incorporated herein by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on June 20, 2019 (File No. 001-35388))
4.1
Form of certificate representing shares of the Company’s common stock (incorporated herein by reference to Exhibit 4 to the Registration Statement)
31.1*
Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended
31.2*
Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended
32.1**
Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2**
Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS*
Inline XBRL Instance Document – The instance document does not appear in the interactive data file because its XBRL tags are embedded within the Inline XBRL document
101.SCH*
Inline XBRL Taxonomy Extension Schema Document
101.CAL*
Inline XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB*
Inline XBRL Taxonomy Extension Label Linkbase Document
101.PRE*
Inline XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF*
Inline XBRL Taxonomy Extension Definition Linkbase Document
104
The cover page from the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2023 (formatted as Inline XBRL and contained in Exhibits 101)
* Filed with this Quarterly Report on Form 10-Q.
** Furnished with this Quarterly Report on Form 10-Q.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
PROSPERITY BANCSHARES, INC. ®
(Registrant)
Date: 8/7/2023
/S/ DAVID ZALMAN
David Zalman
Senior Chairman and Chief Executive Officer
/S/ ASYLBEK OSMONOV
Asylbek Osmonov
Chief Financial Officer