Prosperity Bancshares (PB) 10-Q 2011 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2011

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: 000-25051

PROSPERITY BANCSHARES, INC.^®

(Exact name of registrant as specified in its charter)

TEXAS	74-2331986
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

Prosperity Bank Plaza

4295 San Felipe

Houston, Texas 77027

(Address of principal executive offices, including zip code)

(281) 269-7199

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

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

Large Accelerated Filer	x	Accelerated Filer	¨
Non-accelerated Filer	¨  (Do not check if a smaller reporting company)	Smaller Reporting Company	¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of August 1, 2011, there were 46,890,944 outstanding shares of the registrant’s Common Stock, par value $1.00 per share.

PROSPERITY BANCSHARES, INC.^® AND SUBSIDIARIES

INDEX TO FORM 10-Q

		Page
PART I—FINANCIAL INFORMATION
Item 1.	Interim Consolidated Financial Statements		3
	Condensed Consolidated Balance Sheets as of June 30, 2011 (unaudited) and December 31, 2010 (unaudited)		3
	Condensed Consolidated Statements of Income for the Three and Six Months Ended June 30, 2011 and 2010 (unaudited)		4
	Condensed Consolidated Statements of Changes in Shareholders’ Equity for the Year Ended December 31, 2010 (unaudited) and for the Six Months Ended June 30, 2011 (unaudited)		5
	Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2011 and 2010 (unaudited)		6
	Notes to Interim Condensed Consolidated Financial Statements (unaudited)		8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		27
Item 3.	Quantitative and Qualitative Disclosures about Market Risk		43
Item 4.	Controls and Procedures		43
PART II—OTHER INFORMATION
Item 1.	Legal Proceedings		43
Item 1A.	Risk Factors		43
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		43
Item 3.	Defaults upon Senior Securities		43
Item 4.	Removed and Reserved		44
Item 5.	Other Information		44
Item 6.	Exhibits		44
Signatures			45

2

PART I—FINANCIAL INFORMATION

ITEM 1. INTERIM CONSOLIDATED FINANCIAL STATEMENTS

PROSPERITY BANCSHARES, INC.^®AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

	June 30, 2011			December 31, 2010
	(Dollars in thousands, except share data)
ASSETS
Cash and due from banks	$	145,910		$	158,975
Federal funds sold		350			393
Total cash and cash equivalents		146,260			159,368
Available for sale securities, at fair value (amortized cost of $355,187 and $406,546, respectively)		378,834			428,553
Held to maturity securities, at cost (fair value of $4,409,272 and $4,310,807, respectively)		4,262,830			4,188,563
Loans held for investment		3,665,248			3,485,023
Less allowance for credit losses		(51,932	)		(51,584	)
Loans, net		3,613,316			3,433,439
Accrued interest receivable		29,731			29,935
Goodwill		924,537			924,258
Core deposit intangibles, net of accumulated amortization of $54,355 and $50,378, respectively		24,799			28,776
Bank premises and equipment, net		160,119			159,053
Other real estate owned		8,841			11,053
Bank Owned Life Insurance (BOLI)		49,352			48,697
Federal Home Loan Bank of Dallas stock		24,764			24,982
Other assets		33,764			39,895
TOTAL ASSETS	$	9,657,147		$	9,476,572
LIABILITIES AND SHAREHOLDERS’ EQUITY
LIABILITIES:
Deposits:
Noninterest-bearing	$	1,788,756		$	1,673,190
Interest-bearing		5,878,936			5,781,730
Total deposits		7,667,692			7,454,920
Other borrowings		248,839			374,433
Securities sold under repurchase agreements		91,288			60,659
Accrued interest payable		3,197			4,014
Other liabilities		49,428			37,942
Junior subordinated debentures		85,055			92,265
Total liabilities		8,145,499			8,024,233
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; 46,925,532 and 46,721,114 shares issued at June 30, 2011 and December 31, 2010, respectively; 46,888,444 and 46,684,026 shares outstanding at June 30, 2011 and December 31, 2010, respectively		46,926			46,721
Capital surplus		881,509			876,050
Retained earnings		568,449			515,871
Accumulated other comprehensive income—unrealized gain on available for sale securities, net of tax of $8,277 and $7,702, respectively		15,371			14,304
Treasury stock, at cost, 37,088 shares		(607	)		(607	)
Total shareholders’ equity		1,511,648			1,452,339
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	9,657,147		$	9,476,572

See notes to interim condensed consolidated financial statements.

3

PROSPERITY BANCSHARES, INC.^® AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)

	Three Months Ended June 30,				Six Months Ended June 30,
	2011		2010		2011		2010
	(In thousands, except per share data)
INTEREST INCOME:
Loans, including fees	$	53,703	$	52,681	$	105,903	$	104,134
Securities		41,919		46,603		83,123		91,617
Federal funds sold and other earning assets		30		74		35		103
Total interest income		95,652		99,358		189,061		195,854
INTEREST EXPENSE:
Deposits		11,064		17,573		22,576		35,058
Junior subordinated debentures		598		799		1,745		1,590
Securities sold under repurchase agreements		110		175		179		323
Note payable and federal funds sold		250		211		518		511
Total interest expense		12,022		18,758		25,018		37,482
NET INTEREST INCOME		83,630		80,600		164,043		158,372
PROVISION FOR CREDIT LOSSES		1,400		3,275		3,100		7,685
NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES		82,230		77,325		160,943		150,687
NONINTEREST INCOME:
Customer service fees		12,546		12,680		24,588		24,269
Other		984		616		2,809		2,005
Total noninterest income		13,530		13,296		27,397		26,274
NONINTEREST EXPENSE:
Salaries and employee benefits		23,994		22,431		47,198		43,543
Net occupancy expense		3,547		3,708		7,195		7,142
Depreciation expense		2,037		2,147		4,058		4,153
Data processing		1,780		1,742		3,452		3,157
Core deposit intangible amortization		1,943		2,280		3,977		4,570
Other		9,213		10,741		18,329		20,209
Total noninterest expense		42,514		43,049		84,209		82,774
INCOME BEFORE INCOME TAXES		53,246		47,572		104,131		94,187
PROVISION FOR INCOME TAXES		18,154		15,826		35,161		31,443
NET INCOME	$	35,092	$	31,746	$	68,970	$	62,744
EARNINGS PER SHARE
Basic	$	0.75	$	0.68	$	1.47	$	1.35
Diluted	$	0.75	$	0.68	$	1.47	$	1.34

See notes to interim condensed consolidated financial statements.

4

PROSPERITY BANCSHARES, INC.^® AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(UNAUDITED)

	Common Stock				Capital Surplus		Retained Earnings			Accumulated Other Comprehensive Income			Treasury Stock			Total Shareholders’ Equity
	Shares		Amount
	(Amounts in thousands, except share and per share data)
BALANCE AT JANUARY 1, 2010		46,577,968		46,578		870,460		418,008			16,806			(607	)		1,351,245
Comprehensive Income:
Net income								127,708									127,708
Net change in unrealized gain on available for sale securities (net of tax benefit of $1,347)											(2,502	)					(2,502	)
Total comprehensive income																	125,206
Common stock issued in connection with the exercise of stock options and restricted stock awards		143,146		143		2,553											2,696
Stock based compensation expense						3,037											3,037
Cash dividends declared, $0.64 per share								(29,845	)								(29,845	)
BALANCE AT DECEMBER 31, 2010		46,721,114		46,721		876,050		515,871			14,304			(607	)		1,452,339
Comprehensive income:
Net income								68,970									68,970
Net change in unrealized gain on available for sale securities (net of tax of $575)											1,067						1,067
Total comprehensive income																	70,037
Common stock issued in connection with the exercise of stock options and restricted stock awards		204,418		205		3,816											4,021
Stock based compensation expense						1,643											1,643
Cash dividends declared, $0.35 per share								(16,392	)								(16,392	)
BALANCE AT JUNE 30, 2011		46,925,532	$	46,926	$	881,509	$	568,449		$	15,371		$	(607	)	$	1,511,648

See notes to interim condensed consolidated financial statements.

5

PROSPERITY BANCSHARES, INC.^® AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

	Six Months Ended June 30,
	2011			2010
	(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	68,970		$	62,744
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		8,035			8,723
Stock based compensation expense		1,643			1,483
Net amortization of premium on loans and deposits		(21	)		(473	)
Provision for credit losses		3,100			7,685
Net amortization of discount on investments		12,862			6,715
Net loss on sale of other real estate		526			1,983
Net gain on sale of premises and equipment		(360	)		(399	)
Net decrease in accrued interest receivable and other assets		5,898			2,667
Net increase (decrease) in accrued interest payable and other liabilities		9,997			(273	)
Net cash provided by operating activities		110,650			90,855
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities and principal paydowns of securities held to maturity		590,984			523,461
Purchase of securities held to maturity		(678,500	)		(1,319,657	)
Proceeds from maturities, sales and principal paydowns of securities available for sale		751,747			1,092,095
Purchase of securities available for sale		(700,000	)		(999,998	)
Net (increase) decrease in loans held for investment		(189,803	)		52,686
Purchase of bank premises and equipment		(5,528	)		(11,510	)
Net proceeds from sale of bank premises, equipment and other real estate		8,869			21,152
Cash and cash equivalents acquired in the purchase of U.S. Bank branches		—			344,722
Premium paid for U.S. Bank branches		—			(13,136	)
Cash and cash equivalents acquired in the purchase of First Bank branches		—			379,771
Premium paid for First Bank branches		—			(26,876	)
Net cash (used in) provided by investing activities		(222,231	)		42,710

6

PROSPERITY BANCSHARES, INC.^® AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

	Six Months Ended June 30,
	2011			2010
	(In thousands)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in noninterest-bearing deposits		115,566			(44,397	)
Net increase (decrease) in interest-bearing deposits		97,452			(267,969	)
Net repayments of long-term debt		(593	)		(11,205	)
Redemption of junior subordinated debentures		(7,210	)		—
Net (repayments of) proceeds from short-term debt		(125,000	)		140,000
Net increase in securities sold under repurchase agreements		30,629			16,657
Proceeds from exercise of stock options		4,021			1,693
Payments of cash dividends		(16,392	)		(14,443	)
Net cash provided by (used in) financing activities		98,473			(179,664	)
NET DECREASE IN CASH AND CASH EQUIVALENTS	$	(13,108	)	$	(46,099	)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD		159,368			195,317
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	146,260		$	149,218
SUPPLEMENTAL DISCLOSURES:
Cash paid for interest	$	25,835		$	38,295
Cash paid for income taxes		34,458			34,550
Noncash investing and financing activities – acquisition of real estate through foreclosure of collateral		7,948			19,878

See notes to interim condensed consolidated financial statements.

7

PROSPERITY BANCSHARES, INC.^® AND SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2011

(UNAUDITED)

1. BASIS OF PRESENTATION

The interim condensed consolidated financial statements include the accounts of Prosperity Bancshares, Inc.^® (the “Company”) and its wholly-owned subsidiaries, Prosperity Bank^® (the “Bank”) and Prosperity Holdings of Delaware, LLC. All significant inter-company transactions and balances have been eliminated.

The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles 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, 2010. Operating results for the six-month period ended June 30, 2011 are not necessarily indicative of the results that may be expected for the year ending December 31, 2011 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,
	2011		2010		2011		2010
	(In thousands, except per share amounts)
Net income available to common shareholders	$	35,092	$	31,746	$	68,970	$	62,744
Weighted average common shares outstanding		46,864		46,610		46,799		46,581
Potential dilutive common shares		193		244		202		276
Weighted average common shares and equivalents outstanding		47,057		46,854		47,001		46,857
Basic earnings per common share	$	0.75	$	0.68	$	1.47	$	1.35
Diluted earnings per common share	$	0.75	$	0.68	$	1.47	$	1.34

The incremental shares for the assumed exercise of the outstanding options were determined by application of the treasury stock method. There were no stock options outstanding during the quarter ended June 30, 2011 or 2010 that would have had an anti-dilutive effect on the above computation.

3. NEW ACCOUNTING STANDARDS

Accounting Standards Updates

ASU No. 2010-06,“Fair Value Measurements and Disclosures (Topic 820)—Improving Disclosures About Fair Value Measurements.”ASU 2010-06 requires expanded disclosures related to fair value measurements including (i) the amounts of significant transfers of assets or liabilities between Levels 1 and 2 of the fair value hierarchy and the reasons for the transfers, (ii) the reasons for transfers of assets or liabilities in or out of Level 3 of the fair value hierarchy, with significant transfers disclosed separately, (iii) the policy for determining when transfers between levels of the fair value hierarchy are recognized and (iv) for recurring fair value measurements of assets and liabilities in Level 3 of the fair value hierarchy, a gross presentation of information about purchases, sales, issuances and settlements. ASU 2010-06 further clarifies that (i) fair value measurement disclosures should be provided for each class of assets and liabilities (rather than major category), which would generally be a subset of assets or liabilities within a line item in the statement of financial position and (ii) company’s should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements for each class of assets and liabilities included in Levels 2 and 3 of the fair value hierarchy. The disclosures related to the gross presentation of purchases, sales, issuances and settlements of

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PROSPERITY BANCSHARES, INC.^® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2011

(UNAUDITED)

assets and liabilities included in Level 3 of the fair value hierarchy were required for the Company beginning January 1, 2011. The remaining disclosure requirements and clarifications made by ASU 2010-06 became effective for the Company on January 1, 2010.

ASU No. 2010-20,“Receivables (Topic 310)—Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” ASU 2010-20 requires entities to provide disclosures designed to facilitate financial statement users’ evaluation of (i) the nature of credit risk inherent in the entity’s portfolio of financing receivables, (ii) how that risk is analyzed and assessed in arriving at the allowance for credit losses and (iii) the changes and reasons for those changes in the allowance for credit losses. Disclosures must be disaggregated by portfolio segment, the level at which an entity develops and documents a systematic method for determining its allowance for credit losses, and class of financing receivable, which is generally a disaggregation of portfolio segment. The required disclosures include, among other things, a rollforward of the allowance for credit losses as well as information about modified, impaired, non-accrual and past due loans and credit quality indicators. ASU 2010-20 became effective for the Company’s financial statements as of December 31, 2010, as it relates to disclosures required as of the end of a reporting period. Disclosures that relate to activity during a reporting period was required for the Company’s financial statements that include periods beginning on or after January 1, 2011.

ASU No. 2010-28,“Intangibles—Goodwill and Other (Topic 350)—When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts.” ASU 2010-28 modifies Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist such as if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. ASU 2010-28 became effective for the Company on January 1, 2011 and did not have a significant impact on the Company’s financial statements.

ASU No. 2010-29,“Business Combinations (Topic 805)—Disclosure of Supplementary Pro Forma Information for Business Combinations.” ASU 2010-29 provides clarification regarding the acquisition date that should be used for reporting the pro forma financial information disclosures required by Topic 805 when comparative financial statements are presented. ASU 2010-29 also requires entities to provide a description of the nature and amount of material, nonrecurring pro forma adjustments that are directly attributable to the business combination. ASU 2010-29 is effective for the Company prospectively for business combinations occurring after December 31, 2010.

ASU No. 2011-01,“Deferral of the Effective Date of Disclosures About Troubled Debt Restructurings in Update No. 2010-20”. ASU 2011-01 temporarily deferred the effective date for disclosures related to troubled debt restructurings to coincide with the effective date of a proposed accounting standards update related to troubled debt restructurings, which is effective for periods ending after June 15, 2011.

ASU No. 2011-02,“A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring”. ASU 2011-02 provides additional guidance or clarification to help determine whether a creditor has granted a concession and whether a debtor is experiencing financial difficulties for purposes of determining whether a restructuring constitutes a troubled debt restructuring. ASU 2011-02 will be effective for the Company on July 1, 2011, and applies retrospectively to restructurings occurring on or after January 1, 2011. The adoption of ASU 2011-02 is not expected to have a significant impact on the Company’s financial statements.

9

PROSPERITY BANCSHARES, INC.^® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2011

(UNAUDITED)

4. LOANS AND ALLOWANCE FOR CREDIT LOSSES

The loan portfolio consists of various types of loans made principally to borrowers located in South Texas, Houston, Central Texas, Bryan/College Station, East Texas and Dallas/Fort Worth and is classified by major type as follows:

	June 30, 2011		December 31, 2010
	(Dollars in thousands)
Commercial and industrial	$	423,743	$	409,426
Real estate:
Construction and land development		483,581		502,327
1-4 family residential		941,250		824,057
Home equity		131,213		118,781
Commercial mortgage		1,329,784		1,288,023
Agriculture real estate		115,515		98,871
Multi-family residential		81,717		82,626
Agriculture		45,265		41,881
Consumer (net of unearned discount)		81,132		87,977
Other		32,048		31,054
Total	$	3,665,248	$	3,485,023

(i) Commercial and Industrial Loans. In nearly all cases, the Company’s commercial loans are made in the Company’s market areas and are underwritten on the basis of the borrower’s ability to service the debt from income. As a general practice, the Company takes as collateral a lien on any available real estate, equipment or other assets owned by the borrower and obtains a personal guaranty of the borrower or principal. Working capital loans are primarily collateralized by short-term assets whereas term loans are primarily collateralized by long-term assets. In general, commercial loans involve more credit risk than residential mortgage loans and commercial mortgage loans and, therefore, usually yield a higher return. The increased risk in commercial loans is due to the type of collateral securing these loans. The increased risk also derives from 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.

(ii) Commercial Mortgages. The Company makes commercial mortgage loans collateralized by owner-occupied and non-owner-occupied real estate to finance the purchase of real estate. The Company’s commercial mortgage loans are collateralized by first liens on real estate, typically have variable interest rates (or five year or less fixed rates) and amortize over a 15 to 20 year period. Payments on loans secured by such properties are often dependent on the successful operation or management of the properties. Accordingly, repayment of these loans may be subject to adverse conditions in the real estate market or the economy to a greater extent than other types of loans. The Company seeks to minimize these risks in a variety of ways, including giving careful consideration to the property’s operating history, future operating projections, current and projected occupancy, location and physical condition in connection with underwriting these loans. The underwriting analysis also includes credit verification, analysis of global cash flow, appraisals and a review of the financial condition of the borrower. At June 30, 2011, approximately 36.5% of the outstanding principal balance of the Company’s commercial real estate loans was secured by owner-occupied properties. At June 30, 2011, the Company had commercial real estate loans totaling $1.90 billion which include the categories of construction and land development loans, commercial mortgage loans and multi-family residential loans.

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PROSPERITY BANCSHARES, INC.^® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2011

(UNAUDITED)

(iii) 1-4 Family Residential Loans. The Company originates 1-4 family residential mortgage loans collateralized by owner-occupied residential properties located in the Company’s market areas. The Company offers a variety of mortgage loan products which generally are amortized over five to 25 years. Loans collateralized by 1-4 family residential real estate generally have been originated in amounts of no more than 89% of appraised value or have mortgage insurance. The Company requires mortgage title insurance and hazard insurance. The Company has elected to keep all 1-4 family residential loans for its own account rather than selling such loans into the secondary market. By doing so, the Company is able to realize a higher yield on these loans; however, the Company also incurs interest rate risk as well as the risks associated with nonpayments on such loans.

(iv) Construction and Land Development Loans. The Company makes loans to finance the construction of residential and, to a lesser extent, nonresidential properties. Construction loans generally are collateralized by first liens on real estate and have floating interest rates. The Company conducts periodic inspections, either directly or through an agent, prior to approval of periodic draws on these loans. Underwriting guidelines similar to those described above are also used in the Company’s construction lending activities. Construction loans involve additional risks attributable to the fact that loan funds are advanced upon the security of a project under construction, and the project is of uncertain value prior to its completion. Because of uncertainties inherent in estimating construction costs, the market value of the completed project and the effects of governmental regulation on real property, it can be difficult to accurately evaluate the total funds required to complete a project and the related loan to value ratio. As a result of these uncertainties, construction lending often involves the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project rather than the ability of a borrower or guarantor to repay the loan. If the Company is forced to foreclose on a project prior to completion, there is no assurance that the Company will be able to recover all of the unpaid portion of the loan. In addition, the Company may be required to fund additional amounts to complete a project and may have to hold the property for an indeterminate period of time. While the Company has underwriting procedures designed to identify what it believes to be acceptable levels of risks in construction lending, no assurance can be given that these procedures will prevent losses from the risks described above.

(v) Agriculture Loans. The Company provides agriculture loans for short-term crop production, including rice, cotton, milo and corn, farm equipment financing and agriculture real estate financing. The Company evaluates agriculture borrowers primarily based on their historical profitability, level of experience in their particular agriculture industry, overall financial capacity and the availability of secondary collateral to withstand economic and natural variations common to the industry. Because agriculture loans present a higher level of risk associated with events caused by nature, the Company routinely makes on-site visits and inspections in order to identify and monitor such risks.

(vi) Consumer Loans. Consumer loans made by the Company include direct credit automobile loans, recreational vehicle loans, boat loans, home improvement loans, home equity loans, personal loans (collateralized and uncollateralized) and deposit account collateralized loans. The terms of these loans typically range from 12 to 120 months and vary based upon the nature of collateral and size of loan. Generally, consumer loans entail greater risk than do real estate secured loans, particularly in the case of consumer loans that are unsecured or collateralized by rapidly depreciating assets such as automobiles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan balance. The remaining deficiency often does not warrant further substantial collection efforts against the borrower beyond obtaining a deficiency judgment. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws may limit the amount which can be recovered on such loans.

11

PROSPERITY BANCSHARES, INC.^® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2011

(UNAUDITED)

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.

Concentrations of Credit. Most of the Company’s lending activity occurs within the State of Texas, including the four largest metropolitan areas of Austin, Dallas/Ft. Worth, Houston and San Antonio. The majority of the Company’s loan portfolio consists of commercial real estate loans and commercial and industrial loans. As of June 30, 2011 and December 31, 2010, there were no concentrations of loans related to any single industry in excess of 10% of total loans.

Foreign Loans. The Company has U.S. dollar denominated loans and commitments to borrowers in Mexico. The outstanding balance of these loans and the unfunded amounts available under these commitments were not significant at June 30, 2011 or December 31, 2010.

Related Party Loans.As of June 30, 2011 and December 31, 2010, loans outstanding to directors, officers and their affiliates totaled $9.6 million and $12.8 million, respectively. All transactions entered into between the Company and such related parties are done in the ordinary course of business, made on the same terms and conditions as similar transactions with unaffiliated persons.

An analysis of activity with respect to these related-party loans is as follows:

	June 30, 2011			December 31, 2010
	(Dollars in thousands)
Beginning balance	$	12,783		$	15,540
New loans and reclassified related loans		3,181			910
Repayments		(6,347	)		(3,667	)
Ending balance	$	9,617		$	12,783

Nonaccrual and Past Due Loans. The Company has several procedures in place to assist it in maintaining the overall quality of its loan portfolio. The Company has established underwriting guidelines to be followed by its officers and the Company also monitors its delinquency levels for any negative or adverse trends. There can be no assurance, however, that the Company’s loan portfolio will not become subject to increasing pressures from deteriorating borrower credit due to general economic conditions.

The Company generally places a loan on nonaccrual status and ceases accruing interest when the payment of principal or interest is delinquent for 90 days, or earlier in some cases, unless the loan is in the process of collection and the underlying collateral fully supports the carrying value of the loan.

12

PROSPERITY BANCSHARES, INC.^® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2011

(UNAUDITED)

The Company requires appraisals on loans collateralized by real estate. With respect to potential problem loans, an evaluation of the borrower’s overall financial condition is made to determine the need, if any, for possible writedowns or appropriate additions to the allowance for credit losses.

As of the dates indicated, nonaccrual loans, segregated by class of loans, were as follows:

	June 30, 2011		December 31, 2010
	(Dollars in thousands)
Construction and land development	$	137	$	1,417
Agriculture and agriculture real estate		16		11
1-4 family (includes home equity)		835		1,559
Commercial real estate (commercial mortgage and multi-family residential)		1,681		235
Commercial and industrial		842		1,179
Consumer and other		7		38
Total	$	3,518	$	4,439

An age analysis of past due loans, segregated by class of loans, as of June 30, 2011 was as follows:

	As of June 30, 2011
	Loans 30-89  Days Past Due		Loans 90 or  More Days Past Due		Total Past Due  Loans		Current Loans		Accruing Loans 90  or More Days Past Due
	(Dollars in thousands)
Construction and land development	$	2,556	$	136	$	2,692	$	480,889	$	34
Agriculture and agriculture real estate		345		44		389		160,391		60
1-4 family (includes home equity)		2,050		676		2,726		1,069,737		—
Commercial real estate (commercial mortgage and multi- family residential)		6,374		1,514		7,888		1,403,613		195
Commercial and industrial		1,889		725		2,614		421,129		—
Consumer and other		415		17		432		112,748		17
Total	$	13,629	$	3,112	$	16,741	$	3,648,507	$	306

13

PROSPERITY BANCSHARES, INC.^® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2011

(UNAUDITED)

The following table presents information regarding past due loans and nonperforming assets at the dates indicated:

	June 30, 2011			December 31, 2010
	(Dollars in thousands)
Nonaccrual loans	$	3,518		$	4,439
Accruing loans 90 or more days past due		306			189
Total nonperforming loans		3,824			4,628
Repossessed assets		15			161
Other real estate		8,841			11,053
Total nonperforming assets	$	12,680		$	15,842
Nonperforming assets to total loans and other real estate		0.35	%		0.45	%

The Company’s conservative lending approach has resulted in strong asset quality. The Company had $12.7 million in nonperforming assets at June 30, 2011 compared with $15.8 million at December 31, 2010. If interest on nonaccrual loans had been accrued under the original loan terms, approximately $97,000 would have been recorded as income for the six months ended June 30, 2011.

Impaired Loans. Loans are considered impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for other loans. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible.

14

PROSPERITY BANCSHARES, INC.^® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2011

(UNAUDITED)

Impaired loans as of June 30, 2011 are set forth in the following table. No interest income was recognized on impaired loans subsequent to their classification as impaired.

	June 30, 2011
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment  Quarter to Date		Average Recorded Investment  Year to Date
	(Dollars in thousands)
With no related allowance recorded:
Construction and land development	$	37	$	37	$	—	$	19	$	54
Agriculture and agriculture real estate		6		7		—		6		4
1-4 family (includes home equity)		138		162		—		200		210
Commercial real estate (commercial mortgage and multi-family residential)		1,447		1,467		—		987		731
Commercial and industrial		272		1,273		—		299		317
Consumer and other		—		—		—		4		2
With an allowance recorded:
Construction and land development		89		89		21		109		515
Agriculture and agriculture real estate		10		11		10		11		11
1-4 family (includes home equity)		483		493		207		304		625
Commercial real estate (commercial mortgage and multi-family residential)		350		358		208		305		203
Commercial and industrial		547		739		389		520		589
Consumer and other		7		19		7		11		17
Total:
Construction and land development		126		126		21		128		569
Agriculture and agriculture real estate		16		18		10		17		15
1-4 family (includes home equity)		621		655		207		504		835
Commercial real estate (commercial mortgage and multi-family residential)		1,797		1,825		208		1,292		934
Commercial and industrial		819		2,012		389		819		906
Consumer and other		7		19		7		15		19

Credit Quality Indicators.As part of the ongoing monitoring of the credit quality of the corporations 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 (1-7):

Grade 1 – Credits in this category are of the highest standards of credit quality with virtually no risk of loss. These borrowers would represent top rated companies and individuals with unquestionable financial standing with excellent global cash flow coverage, net worth, liquidity and collateral coverage and/or secured by CD/savings accounts.

Grade 2 – Credits in this category are not immune for 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.

15

PROSPERITY BANCSHARES, INC.^® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2011

(UNAUDITED)

Grade 3 – Credits graded 3 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 bank to risk at a future date. Credits graded 3 are monitored on the banks internally generated watch list and evaluated on a quarterly basis.

Grade 4 – Credits in this category are deemed “substandard” 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, but it is not yet certain. Loans in this category are still accruing interest and may be dependent upon secondary sources of repayment and/or collateral liquidation.

Grade 5– Credits in this category are deemed “substandard” and “impaired” pursuant to regulatory guidelines. As such, the Bank has determined that it is probable that less than 100% of the principal and interest will be collected. Loans graded 5 are individually evaluated for a specific reserve valuation and will typically have the accrual of interest stopped.

Grade 6– Credits in this category include “doubtful” loans in accordance with regulatory guidance. Such loans are on nonaccrual and factors have indicated a loss is imminent. These loans are also deemed “impaired.” While a specific reserve may be in place while the loan and collateral is being evaluated these loans are typically charged down to an amount the bank deems can be collected.

Grade 7 – Credits in this category are deemed a “loss” in accordance with regulatory guidelines and charged off or charged down. The bank may continue collection efforts and may have partial recovery in the future.

The following table presents risk grades and classified loans by class of loan at June 30, 2011. Classified loans include loans in Risk Grades 5, 6 and 7.

	Construction and Land Development		Agriculture and Agriculture Real Estate		1-4 Family (Includes Home Equity)		Commercial Real Estate (Commercial Mortgage and Multi-Family)		Commercial and  Industrial		Consumer and Other		Total
	(Dollars in thousands)
Grade 1	$	—	$	3,705	$	—	$	—	$	49,132	$	31,314	$	84,151
Grade 2		465,749		156,888		1,057,828		1,374,714		372,139		81,853		3,509,171
Grade 3		4,986		119		9,506		11,517		710		—		26,838
Grade 4		12,719		52		4,508		23,473		943		6		41,701
Grade 5		127		16		607		1,797		377		7		2,931
Grade 6		—		—		14		—		442		—		456
Grade 7		—		—		—		—		—		—		—
Total	$	483,581	$	160,780	$	1,072,463	$	1,411,501	$	423,743	$	113,180	$	3,665,248

16

PROSPERITY BANCSHARES, INC.^® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2011

(UNAUDITED)

The following table presents risk grades and classified loans by class of loan at December 31, 2010. Classified loans include loans in Risk Grades 5, 6 and 7.

	Construction and Land Development		Agriculture and Agriculture Real Estate		1-4 Family (Includes Home Equity)		Commercial Real Estate (Commercial Mortgage and Multi-Family)		Commercial and  Industrial		Consumer and Other		Total
	(Dollars in thousands)
Grade 1	$	—	$	4,057	$	—	$	—	$	41,455	$	35,188	$	80,700
Grade 2		479,443		136,607		930,110		1,335,222		364,150		83,797		3,329,330
Grade 3		4,492		—		6,571		13,165		858		1		25,087
Grade 4		16,937		77		4,663		22,041		1,883		15		45,614
Grade 5		1,455		11		1,425		221		286		30		3,429
Grade 6		—		—		69		—		794		—		863
Grade 7		—		—		—		—		—		—		—
Total	$	502,327	$	140,752	$	942,838	$	1,370,649	$	409,426	$	119,031	$	3,485,023

Allowance for Credit Losses.The allowance for credit losses is a valuation established through charges to earnings in the form of a provision for credit losses. Management has established an allowance for credit losses which it believes is adequate for estimated losses in the Company’s loan portfolio. The amount of the allowance for credit losses is affected by the following: (i) charge-offs of loans that occur when loans are deemed uncollectible and decrease the allowance, (ii) recoveries on loans previously charged off that increase the allowance and (iii) provisions for credit losses charged to earnings that increase the allowance. Based on an evaluation of the loan portfolio and consideration of the factors listed below, management presents a quarterly review of the allowance for credit losses to the Bank’s Board of Directors, indicating any change in the allowance since the last review and any recommendations as to adjustments in the allowance.

The Company’s allowance for credit losses consists of two components: a specific valuation allowance based on probable losses on specifically identified loans and a general valuation allowance based on historical loan loss experience, general economic conditions and other qualitative risk factors both internal and external to the Company.

In setting the specific valuation allowance, the Company follows a loan review program to evaluate the credit risk in the loan portfolio. 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 each impaired loan, the Company allocates a specific loan loss reserve primarily based on the value of the collateral securing the impaired loan in accordance with ASC Topic 310,Receivables. The specific reserves are determined on an individual loan basis. Loans for which specific reserves are provided are excluded from the general valuation allowance described below.

In determining the amount of the general valuation allowance, management considers factors such as historical loan loss experience, industry diversification of the Company’s commercial loan portfolio, concentration risk of specific loan types, the volume, growth and composition of the Company’s loan portfolio, current economic conditions that may affect the borrower’s ability to pay and the value of collateral, the evaluation of the Company’s loan portfolio through its internal loan review process, general economic conditions and other qualitative risk factors both internal and external to the Company and other relevant factors in accordance with ASC Topic 450. Based on a review of these factors for each loan type, the Company applies an estimated percentage to the outstanding balance of each loan type, excluding any loan that has a specific reserve allocated to it. The Company uses this information to establish the amount of the general valuation allowance.

17

PROSPERITY BANCSHARES, INC.^® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2011

(UNAUDITED)

In connection with its review of the loan portfolio, the Company considers risk elements attributable to particular loan types or categories in assessing the quality of individual loans. Some of the risk elements include:

• for 1-4 family residential mortgage loans, the borrower’s ability to repay the loan, including a consideration of the debt to income ratio and employment and income stability, the loan to value ratio, and the age, condition and marketability of collateral;

• for commercial mortgage loans and multifamily residential loans, the debt service coverage ratio (income from the property in excess of operating expenses compared to loan payment requirements), operating results of the owner in the case of owner-occupied properties, the loan to value ratio, the age and condition of the collateral and the volatility of income, property value and future operating results typical of properties of that type;

• for construction and land development loans, the perceived feasibility of the project including the ability to sell developed lots or improvements constructed for resale or the ability to lease property constructed for lease, the quality and nature of contracts for presale or prelease, if any, experience and ability of the developer and loan to value ratio;

• for commercial and industrial loans, the operating results of the commercial, industrial or professional enterprise, the borrower’s business, professional and financial ability and expertise, the specific risks and volatility of income and operating results typical for businesses in that category and the value, nature and marketability of collateral;

• for agricultural real estate loans, the experience and financial capability of the borrower, projected debt service coverage of the operations of the borrower and loan to value ratio; and

• for non-real estate agricultural loans, the operating results, experience and financial capability of the borrower, historical and expected market conditions and the value, nature and marketability of collateral.

In addition, for each category, the Company considers secondary sources of income and the financial strength and credit history of the borrower and any guarantors.

At June 30, 2011, the allowance for credit losses totaled $51.9 million or 1.42% of total loans. At December 31, 2010, the allowance aggregated $51.6 million or 1.48% of total loans.

18

PROSPERITY BANCSHARES, INC.^® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2011

(UNAUDITED)

The following table details the recorded investment in loans and activity in the allowance for credit losses by portfolio segment for the six months ended June 30, 2011. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

	Construction and Land Development			Agriculture and Agriculture Real Estate		1-4 Family (Including Home Equity)			Commercial Real Estate (Commercial Mortgage and Multi-Family)			Commercial and Industrial			Consumer and Other			Total
	(Dollars in thousands)
Allowance for credit losses:
Beginning balance	$	15,304		$	271	$	9,724		$	21,239		$	3,891		$	1,155		$	51,584
Provision for credit losses		(788	)		67		997			2,047			445			332			3,100
Charge-offs		(1,281	)		—		(386	)		(501	)		(805	)		(607	)		(3,580	)
Recoveries		129			1		3			4			319			372			828
Net charge-offs		(1,152	)		1		(383	)		(497	)		(486	)		(235	)		(2,752	)
Ending balance		13,364			339		10,338			22,789			3,850			1,252			51,932
Ending balance: individually evaluated for impairment		21			10		207			208			389			7			842
Ending balance: collectively evaluated for impairment	$	13,343		$	329	$	10,131		$	22,581		$	3,461		$	1,245		$	51,090
Loans:
Ending balance: individually evaluated for impairment		17,832			187		14,635			36,789			2,472			12			71,927
Ending balance: collectively evaluated for impairment		465,749			160,593		1,057,828			1,374,712			421,271			113,168			3,593,321
Ending balance	$	483,581		$	160,780	$	1,072,463		$	1,411,501		$	423,743		$	113,180		$	3,665,248

19

PROSPERITY BANCSHARES, INC.^® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2011

(UNAUDITED)

5. FAIR VALUE

Effective January 1, 2008, the Company adopted FASB ASC Topic 820,Fair Value Measurement and Disclosures. ASC Topic 820, which defines fair value, addresses aspects of the expanding application of fair value accounting and establishes a consistent framework for measuring fair value. Fair value represents the estimated price that would be received from selling an asset or paid to transfer a liability, otherwise known as an “exit price”.

Fair Value Hierarchy

ASC Topic 820 specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. In accordance with ASC Topic 820, these inputs are summarized in the three broad levels listed below:

• Level 1—Quoted prices in active markets for identical assets or liabilities. Level 1 assets include U.S. Treasury securities that are highly liquid and are actively traded in over-the-counter markets.

• Level 2—Other significant observable inputs (including quoted prices in active markets for similar assets or liabilities) or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. The Company’s Level 2 assets include U.S. government and agency mortgage-backed debt securities, corporate securities, municipal bonds and CRA funds.

• Level 3—Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair values requires significant management judgment or estimation.

In determining the appropriate levels, the Company performs a detailed analysis of the assets and liabilities that are subject to ASC Topic 820.

The following table summarizes financial assets and financial liabilities measured at fair value on a recurring basis as of June 30, 2011, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value. There were no movements between levels for the six months ended June 30, 2011.

	Level 1		Level 2		Level 3		Total
	(Dollars in thousands)
Available for sale securities (at fair value):
States and political subdivisions (including QZAB)	$	—	$	49,105	$	—	$	49,105
Corporate debt securities and other		—		9,170		—		9,170
Collateralized mortgage obligations		—		853		—		853
Mortgage-backed securities		—		319,706		—		319,706
TOTAL	$	—	$	378,834	$	—	$	378,834

Certain assets and liabilities are measured at fair value on a non-recurring 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 and impaired loans per ASC Topic 310,Receivables. For the six months ended June 30, 2011, the Company had additions to impaired loans of $2.0 million and additions to other real estate owned of $7.9 million, of which $1.6 million and $2.5 million were outstanding June 30, 2011, respectively. During the reported periods, all fair value measurements for other real estate owned and impaired loans utilized Level 2 inputs with impaired loans reported at the fair value of the underlying collateral when repayment is expected solely from the collateral. The remaining financial assets and financial liabilities measured at fair value on a non-recurring basis that were recorded in 2011 and remained outstanding at June 30, 2011 were not significant.

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. FASB ASC Topic 820 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.

20

PROSPERITY BANCSHARES, INC.^® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2011

(UNAUDITED)

These fair value disclosures represent the Company’s estimates based on relevant market information and information about the financial instruments. Fair value estimates are based on judgments regarding future expected loss experience, 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 methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:

Cash and Cash Equivalents—For these short-term instruments, the carrying amount is a reasonable estimate of fair value.

Federal Funds Sold—The carrying amount is a reasonable estimate of fair value.

Securities —For securities held as investments, fair value equals quoted market price, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.

Loans Held for Investment—For fixed rate loans and certain homogeneous categories of loans (such as some residential mortgages and other consumer loans), fair value is estimated by discounting the future cash flows using the risk-free Treasury rate for the applicable maturity, adjusted for servicing and credit risk. The carrying value of variable rate loans approximates fair value because the loans reprice frequently to current market rates.

Deposits —The fair value of demand deposits, savings accounts and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities.

Junior Subordinated Debentures—The fair value of the junior subordinated debentures was calculated using the quoted market prices, if available. If quoted market prices are not available, fair value is estimated using quoted market prices for similar subordinated debentures.

Other Borrowings—Rates currently available to the Company for debt with similar terms and remaining maturities are used to estimate the fair value of existing debt using a discounted cash flows methodology.

Securities Sold Under Repurchase Agreements—The fair value of securities sold under repurchase agreements is the amount payable on demand at the reporting date.

Off-Balance Sheet Financial Instruments—The fair value of commitments to extend credit and standby letters of credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreement and the present creditworthiness of the counterparties.

21

PROSPERITY BANCSHARES, INC.^® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2011

(UNAUDITED)

FASB ASC Topic 825,Financial Instruments, requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis. The carrying amount and estimated fair values of the Company’s financial instruments are as follows:

	June 30,				December 31,
	2011				2010
	Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
	(Dollars in thousands)
Financial assets:
Cash and due from banks	$	145,910	$	145,910	$	158,975	$	158,975
Federal funds sold		350		350		393		393
Held to maturity securities		4,262,830		4,409,272		4,188,563		4,310,807
Available for sale securities		378,834		378,834		428,553		428,553
Loans held for investment, net of allowance for credit losses		3,613,316		3,593,297		3,433,439		3,421,488
Total	$	8,401,240	$	8,527,663	$	8,209,923	$	8,320,216
Financial liabilities:
Deposits	$	7,667,692	$	7,677,856	$	7,454,920	$	7,467,523
Junior subordinated debentures		85,055		80,210		92,265		92,284
Other borrowings		248,839		250,554		374,433		375,882
Securities sold under repurchase agreements		91,288		91,288		60,659		60,659
Total	$	8,092,874	$	8,099,908	$	7,982,277	$	7,996,348

The Company’s off-balance sheet commitments, which total $460.5 million at June 30, 2011, are funded at current market rates at the date they are drawn upon. It is management’s opinion that the fair value of these commitments would approximate their carrying value, if drawn upon.

The fair value estimates presented herein are based on pertinent information available to management at June 30, 2011. 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.

6. GOODWILL AND CORE DEPOSIT INTANGIBLES

Changes in the carrying amount of the Company’s goodwill and core deposit intangibles (CDI) for the six months ended June 30, 2011 were as follows:

	Goodwill		Core Deposit Intangibles
	(Dollars in thousands)
Balance as of December 31, 2010	$	924,258	$	28,776
Amortization		—		(3,977	)
Acquisition of First Bank branches		279		—
Balance as of June 30, 2011	$	924,537	$	24,799

22

PROSPERITY BANCSHARES, INC.^® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2011

(UNAUDITED)

Purchase accounting adjustments to prior year acquisitions were made to adjust deferred tax asset and liability balances. Goodwill is recorded on the acquisition date of each entity. The Company may record subsequent adjustments to goodwill for amounts undeterminable at acquisition date, such as deferred taxes and real estate valuations, and therefore the goodwill amounts reflected in the table above 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 or liabilities. Management performs an evaluation annually, and more frequently if a triggering event occurs, of whether any impairment of the goodwill and other intangibles has occurred. If any such impairment is determined, a write down is recorded. As of June 30, 2011, there were no impairments recorded on goodwill or other intangibles.

Core deposit intangibles are amortized on an accelerated basis over their estimated lives, which the Company believes is between 8 and 10 years. Gross core deposit intangibles outstanding were $79.2 million at June 30, 2011 and December 31, 2010, respectively. Net core deposit intangibles outstanding were $24.8 million and $28.8 million at the same dates, respectively. Amortization expense related to intangible assets totaled $1.9 million and $2.3 million for the three months ended June 30, 2011 and 2010, respectively, and $4.0 million and $4.6 million for the six months ended June 30, 2011 and 2010, respectively. The estimated aggregate future amortization expense for intangible assets remaining as of June 30, 2011 is as follows (dollars in thousands):

Remaining 2011	$	3,803
2012		6,347
2013		4,465
2014		3,314
2015		2,804
Thereafter		4,066
Total	$	24,799

7. STOCK BASED COMPENSATION

At June 30, 2011, the Company had three stock-based employee compensation plans and one stock option plan assumed in connection with acquisitions under which no additional options will be granted. Two of the three plans adopted by the Company have expired and therefore no additional awards may be issued under those plans. The Company accounts for stock-based employee compensation plans using the fair value-based method of accounting in accordance with ASC Topic 718.ASC Topic 718 was effective for companies in 2006; however, the Company has been recognizing compensation expense since January 1, 2003. The Company recognized $1.6 million and $1.5 million in stock-based compensation expense for the six months ended June 30, 2011 and 2010, respectively, and $936,000 and $692,000 in stock-based compensation expense for the three months ended June 30, 2011 and 2010, respectively. There was approximately $548,000 and $469,000 of income tax benefit recorded for the stock-based compensation expense for the six months ended June 30, 2011 and 2010, respectively, and $314,000 and $217,000 of income tax benefit recorded for the stock-based compensation expense for the three months ended June 30, 2011 and 2010, respectively.

23

PROSPERITY BANCSHARES, INC.^® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2011

(UNAUDITED)

The Company has granted shares of common stock (“restricted stock”) to certain directors and associates under the Company’s 2004 Stock Incentive Plan. The awardee is not entitled to the shares until they vest, which is generally over a 1 to 5 year period, but the awardee is entitled to receive dividends on and vote the shares prior to vesting. The shares granted do not have a cost to the awardee and the only requirement of vesting is continued service to the Company. Compensation cost related to restricted stock is calculated based on the market price of the shares at the date of grant. If the awardee leaves the Company before the shares vest, the unvested shares are forfeited. As of June 30, 2011, there were 385,650 shares of restricted stock outstanding with a weighted average grant date fair value of $37.30.

Stock options are issued at the current market price on the date of the grant, subject to a pre-determined vesting period with a contractual term of 10 years. Options assumed in connection with acquisitions have contractual terms as established in the original option grant agreements entered into prior to acquisition. The fair value of stock options granted is estimated at the date of grant using the Black-Scholes option-pricing model. Stock-based compensation expense is recognized ratably over the requisite service period for all awards.

The fair value of options was estimated using an option-pricing model with the following weighted average assumptions:

	June 30,
	2011			2010
Expected life (years)		5.29			5.14
Risk free interest rate		3.66	%		3.88	%
Volatility		20.99	%		21.21	%
Dividend yield		1.25	%		1.26	%

A summary of changes in outstanding vested and unvested options during the six months ended June 30, 2011 is set forth below:

	Number of Options			Weighted Average Exercise Price		Weighted Average Remaining Contractual Term		Aggregate Intrinsic Value
	(In thousands)					(In years)		(In thousands)
Options outstanding, beginning of period		696		$	27.24
Options granted		—			—
Options forfeited		—			—
Options exercised		(166	)		24.28
Options outstanding, end of period		530		$	28.17		4.38	$	8,296
Options vested or expected to vest		514		$	27.94		4.34	$	8,166
Options exercisable, end of period		240		$	26.57		3.44	$	4,144

No options were granted during the six months ended June 30, 2011 or June 30, 2010. The total intrinsic value of the options exercised during the six month periods ended June 30, 2011 and 2010 was $3.2 million and $986,000, respectively. The total fair value of shares vested during the six month periods ended June 30, 2011 and 2010 was $144,000 and $124,000, respectively.

24

PROSPERITY BANCSHARES, INC.^® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2011

(UNAUDITED)

A summary of changes in non-vested options is set forth below:

	Six Months Ended June 30,
	2011					2010
	Number of Options			Weighted Average Grant  Date Fair Value		Number of Options			Weighted Average Grant  Date Fair Value
	(In thousands)					(In thousands)
Non-vested options outstanding, beginning of period		313		$	6.89		376		$	6.78
Options granted		—			—		—			—
Non-vested options forfeited		—			—		(15	)		6.94
Options vested		(23	)		6.30		(21	)		5.78
Non-vested options outstanding, end of period		290		$	6.93		340		$	6.84

The Company received $4.0 million and $1.7 million in cash from the exercise of stock options during the six month periods ended June 30, 2011 and 2010, respectively. There was no tax benefit realized from option exercises of the stock-based compensation arrangements during the six month periods ended June 30, 2011 and 2010.

As of June 30, 2011, there was $8.4 million of total unrecognized compensation expense related to non-vested stock-based compensation arrangements. That cost is expected to be recognized over a weighted average period of 2.8 years.

8. CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ITEMS

Contractual Obligations

The following table summarizes the Company’s contractual obligations and other commitments to make future payments as of June 30, 2010 (other than deposit obligations). The payments do not include pre-payment options that may be available to the Company. The Company’s future cash payments associated with its contractual obligations pursuant to its junior subordinated debentures, FHLB borrowings and operating leases as of June 30, 2011 are summarized below. Payments for junior subordinated debentures include interest of $51.7 million that will be paid over the future periods. The future interest payments were calculated using the current rate in effect at June 30, 2011. With respect to floating interest rates, the payments were determined based on the 3-month LIBOR in effect at June 30, 2011. The current principal balance of the junior subordinated debentures at June 30, 2011 was $85.1 million. Payments for FHLB borrowings include interest of $3.8 million that will be paid over the future periods. Payments related to leases are based on actual payments specified in underlying contracts.

	Payments due in:
	Remaining Fiscal  2011		Fiscal 2012-2013		Fiscal 2014-2015		Thereafter		Total
	(Dollars in thousands)
Junior subordinated debentures	$	1,162	$	4,645	$	4,645	$	126,258	$	136,710
Federal Home Loan Bank borrowings		236,263		3,356		3,836		9,211		252,666
Operating leases		2,719		9,435		5,254		1,426		18,834
Total	$	240,144	$	17,436	$	13,735	$	136,895	$	408,210

25

PROSPERITY BANCSHARES, INC.^® AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2011

(UNAUDITED)

Off-Balance Sheet Items

In the normal course of business, the Company enters into various transactions, which, in accordance with accounting principles generally accepted in the United States, are not included in its consolidated balance sheets. The Company enters into these transactions to meet the financing needs of its customers. These transactions include commitments to extend credit and standby letters of credit, which involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amounts recognized in the consolidated balance sheets.

The Company’s commitments associated with outstanding standby letters of credit and commitments to extend credit as of June 30, 2011 are summarized below. Since commitments associated with letters of credit and commitments to extend credit may expire unused, the amounts shown do not necessarily reflect the actual future cash funding requirements:

	Remaining Fiscal  2011		Fiscal 2012-2013		Fiscal 2014-2015		Thereafter		Total
	(Dollars in thousands)
Standby letters of credit	$	8,524	$	4,055	$	3,121	$	54	$	15,754
Commitments to extend credit		131,970		170,148		3,782		138,866		444,766
Total	$	140,494	$	174,203	$	6,903	$	138,920	$	460,520

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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 historical facts are forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based on assumptions and involve a number of risks and uncertainties, many of which are beyond the Company’s control. 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, without limitation:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

• government intervention in the U.S. financial system;

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

• increases in FDIC deposit insurance assessments;

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

• other risks and uncertainties listed from time to time in the Company’s reports and documents filed with the Securities and Exchange Commission.

A forward-looking statement may include a statement of the assumptions or bases underlying the forward-looking statement. The Company believes it has chosen these assumptions or bases in good faith and that they are reasonable. However, the Company cautions you that assumptions or bases almost always vary from actual results, and the differences between assumptions or bases and actual results can be material. 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.

27

Management’s Discussion and Analysis of Financial Condition and Results of Operations analyzes the major elements of the Company’s interim consolidated financial statements and accompanying notes. This section should be read in conjunction with the Company’s interim consolidated financial statements and accompanying notes included elsewhere in this report and with the consolidated financial statements and accompanying notes and other detailed information appearing in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.

OVERVIEW

The Company, a Texas corporation, was formed in 1983 as a vehicle to acquire the former Allied First Bank in Edna, Texas which was chartered in 1949 as The First National Bank of Edna and is now known as Prosperity Bank. The Company is a registered financial holding company that derives substantially all of its revenues and income from the operation of its bank subsidiary, Prosperity Bank^® (“Prosperity Bank^®” or the “Bank”). The Bank provides a wide array of financial products and services to small and medium-sized businesses and consumers. As of June 30, 2010, the Bank operated one hundred seventy-five (175) full-service banking locations; with sixty (60) in the Houston area, twenty (20) in the South Texas area including Corpus Christi and Victoria, thirty-three (33) in the Central Texas, ten (10) in the Bryan/College Station area, twenty-one (21) in East Texas and thirty-one (31) in the Dallas/Fort Worth, Texas area. The Company’s headquarters are located at Prosperity Bank Plaza, 4295 San Felipe in Houston, Texas and its telephone number is (281) 269-7199. The Company’s website address iswww.prosperitybanktx.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 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. 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, stringent cost control practices and strategic merger transactions. The Company focuses on continuous internal growth. Each banking center is operated as a separate profit center, maintaining separate data with respect to its net interest income, efficiency ratio, deposit growth, loan growth and overall profitability. Banking center presidents and managers are accountable for performance in these areas and compensated accordingly. The Company also focuses on maintaining stringent cost control practices and policies. The Company has invested significantly in the infrastructure required to centralize many of its critical operations, such as data processing and loan processing. Management believes that this centralized infrastructure can accommodate substantial additional growth while enabling the Company to minimize operational costs through certain economies of scale. The Company also intends to continue to seek expansion opportunities. On March 26, 2010, the Company purchased three (3) retail branches of U.S. Bank. The three banking centers acquired by the Company were the Texas locations U.S. Bank acquired from the FDIC on October 30, 2009 when U.S. Bank acquired the nine (9) subsidiary banks of FBOP Corporation. On April 30, 2010, the Company purchased nineteen (19) Texas retail branches of First Bank, and subsequently consolidated four of these branches into nearby existing Company banking centers.

Total assets were $9.66 billion at June 30, 2011 compared with $9.48 billion at December 31, 2010, an increase of $180.6 million or 1.9%. Total loans were $3.67 billion at June 30, 2011 compared with $3.49 billion at December 31, 2010, an increase of $180.2 million or 5.2%. Total deposits were $7.67 billion at June 30, 2011 compared with $7.45 billion December 31, 2010, an increase of $212.8 million or 2.9%. Total shareholders’ equity was $1.51 billion at June 30, 2011 compared with $1.45 billion at December 31, 2010, an increase of $59.3 million or 4.1%.

CRITICAL ACCOUNTING POLICIES

The Company’s accounting policies are integral to understanding the financial results reported. 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, 2010. The Company believes that of its significant accounting policies, the following may involve a higher degree of judgment and complexity:

Allowance for Credit Losses—The allowance for credit losses is established through charges to earnings in the form of a provision for credit losses. 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 loan portfolio, management presents a monthly review of the allowance for credit losses to the Bank’s Board of Directors, indicating any change in the allowance since the last review and any recommendations as to adjustments in the allowance. In making its evaluation, management considers factors such as historical loan loss experience, industry diversification of the Company’s commercial loan portfolio, the amount of nonperforming assets and related collateral, the volume, growth and composition of the Company’s loan portfolio, current economic conditions that may affect the borrower’s ability to pay and the value of collateral, the evaluation of the Company’s loan portfolio through its internal loan review process and other relevant factors. Portions of the

28

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. The allowance for credit losses includes allowance allocations calculated in accordance with FASB ASC Topic 310, “Receivables,” and allowance allocations determined in accordance with FASB ASC Topic 450, “Contingencies.”

Goodwill and Intangible Assets—Goodwill and intangible assets that have indefinite useful lives are subject to an impairment test at least annually, or more often, if events or circumstances indicate that it is more likely than not that the fair value of Prosperity Bank, the Company’s only reporting unit with assigned goodwill, is below the carrying value of its equity. Goodwill is tested for impairment using a two-step process that begins with an estimation of the fair value of the Company’s reporting unit compared with its carrying value. If the carrying amount exceeds the fair value of the reporting unit, a second test is completed comparing the implied fair value of the reporting unit’s goodwill to its carrying value to measure the amount of impairment. The Company estimated the fair value of its reporting unit through several valuation techniques that consider, among other things, the historical and current financial position and results of operations of the Company, general economic and market conditions and exit prices for recent market transactions. The Company had no intangible assets with indefinite useful lives at June 30, 2011. Other identifiable intangible assets that are subject to amortization are amortized on an accelerated basis over the years expected to be benefited, which the Company believes is between eight and ten years. These amortizable intangible assets are reviewed for impairment if circumstances indicate their value may not be recoverable based on a comparison of fair value to carrying value. Based on the Company’s annual goodwill impairment test as of September 30, 2010, management does not believe any of its goodwill is impaired as of June 30, 2011 because the fair value of the Company’s equity exceeded its carrying value. While the Company believes no impairment existed at June 30, 2011 under accounting standards applicable at that date, different conditions or assumptions, or changes in cash flows or profitability, if significantly negative or unfavorable, could have a material adverse effect on the outcome of the Company’s impairment evaluation and financial condition or future results of operations.

Stock-Based Compensation—The Company accounts for stock-based employee compensation plans using the fair value-based method of accounting in accordance with FASB ASC Topic 718, Stock Compensation.ASC 718 was effective for companies in 2006; however, the Company had been recognizing compensation expense since January 1, 2003. The Company’s results of operations reflect compensation expense for all employee stock-based compensation, including the unvested portion of stock options granted prior to 2003. ASC 718 requires that management make assumptions including stock price volatility and employee turnover that are utilized to measure compensation expense. The fair value of stock options granted is estimated at the date of grant using the Black-Scholes option-pricing model. This model requires the input of subjective assumptions.

Other-Than-Temporarily Impaired Securities—The Company’s available for sale securities portfolio is reported at fair value. When the fair value of a security is below its amortized cost, and depending on the length of time the condition exists and the extent the fair market value is below amortized cost, additional analysis is performed to determine whether an impairment exists. Available for sale and held to maturity securities are analyzed quarterly for possible other-than-temporary impairment. The analysis considers (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, (iii) whether the market decline was affected by macroeconomic conditions, and (iv) whether the entity has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. Often, the information available to conduct these assessments is limited and rapidly changing, making estimates of fair value subject to judgment. If actual information or conditions are different than estimated, the extent of the impairment of the security may be different than previously estimated, which could have a material effect on the Company’s results of operations and financial condition.

RESULTS OF OPERATIONS

Net income available to common shareholders was $35.1 million ($0.75 per common share on a diluted basis) for the quarter ended June 30, 2011 compared with $31.7 million ($0.68 per common share on a diluted basis) for the quarter ended June 30, 2010, an increase in net income of $3.3 million or 10.5%. The Company posted returns on average common equity of 9.36% and 9.12%, returns on average assets of 1.45% and 1.34% and efficiency ratios of 43.58% and 46.04% for the quarters ended June 30, 2011 and 2010, respectively. The efficiency ratio is calculated by dividing total noninterest expense (excluding credit loss provisions) by net interest income plus noninterest income (excluding net gains and losses on the sale of securities and assets). Additionally, taxes are not part of this calculation.

For the six months ended June 30, 2011, net income available to common shareholders was $69.0 million ($1.47 per common share on a diluted basis) compared with $62.7 million ($1.34 per common share on a diluted basis) for the same period in 2010, an increase in net income of $6.2 million or 9.9%. The Company posted returns on average common equity of 9.29% and 9.09%, returns on average assets of 1.43% and 1.37% and efficiency ratios of 43.94% and 44.93% for the six months ended June 30, 2011 and 2010, respectively.

29

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.”

Net interest income before the provision for credit losses was $83.6 million for the quarter ended June 30, 2011 compared with $80.6 million for the quarter ended June 30, 2010, an increase of $3.0 million, or 3.8%. Net interest income increased as a result of an increase in average interest-earning assets to $8.35 billion for the quarter ended June 30, 2011 compared with $8.16 billion for the quarter ended June 30, 2010, an increase of $196.3 million, or 2.4%. The increase is net interest income was also partially due to decreased interest expense resulting from lower deposit pricing.

The net interest margin on a tax equivalent basis increased to 4.06% for the quarter ended June 30, 2011 compared with 4.00% for the quarter ended June 30, 2010. The average rate paid on interest-bearing liabilities decreased 41 basis points from 1.17% for the quarter ended June 30, 2010 to 0.76% for the quarter ended June 30, 2011. The average yield on earning assets decreased 30 basis points from 4.89% for the quarter ended June 30, 2010 to 4.59% for the quarter ended June 30, 2011. The volume of interest-bearing liabilities decreased $95.6 million and the volume of interest-earning assets increased $196.3 million for the same periods.

Net interest income before the provision for credit losses increased $5.7 million, or 3.6%, to $164.0 million for the six months ended June 30, 2011 compared with $158.4 million for the same period in 2010. This increase was mainly attributable to higher average interest-earning assets. The net interest margin on a tax equivalent basis decreased to 4.04% compared with 4.09% for the same periods.

30

The following tables set forth, for each category of interest-earning assets and interest-bearing liabilities, the average amounts outstanding, the interest earned or paid on such amounts, and the average rate earned or paid for the three and the six month periods ended June 30, 2011 and 2010. The tables also set forth the average rate paid on total interest-bearing liabilities, and the net interest margin on average total interest-earning assets for the same periods. Except as indicated in the footnotes, no tax-equivalent adjustments were made and all average balances are daily average balances. Any nonaccruing loans have been included in the table as loans carrying a zero yield.

	Three Months Ended June 30,
	2011								2010
	Average Outstanding Balance			Interest Earned/ Paid		Average Yield/ Rate (2)			Average Outstanding Balance			Interest Earned/ Paid		Average Yield/ Rate (2)
	(Dollars in thousands)
Assets
Interest-earning assets:
Loans	$	3,631,256		$	53,703		5.93	%	$	3,404,127		$	52,681		6.21	%
Securities (1)		4,707,217			41,919		3.56			4,642,246			46,603		4.02
Federal funds sold and other temporary investments		13,218			30		0.91			109,027			74		0.27
Total interest-earning assets		8,351,691			95,652		4.59	%		8,155,400			99,358		4.89	%
Less allowance for credit losses		(51,861	)							(52,726	)
Total interest-earning assets, net of allowance		8,299,830								8,102,674
Noninterest-earning assets		1,378,738								1,387,543
Total assets	$	9,678,568							$	9,490,217
Liabilities and shareholders’ equity
Interest-bearing liabilities:
Interest-bearing demand deposits	$	1,403,331		$	2,061		0.59	%	$	1,381,215		$	2,517		0.73	%
Savings and money market accounts		2,403,330			3,348		0.56			2,248,950			4,292		0.77
Certificates of deposit		2,175,165			5,655		1.04			2,599,197			10,764		1.66
Junior subordinated debentures		85,055			598		2.82			92,265			799		3.47
Federal funds purchased and other borrowings		218,310			250		0.46			44,477			211		1.90
Securities sold under repurchase agreements		68,413			110		0.64			83,092			175		0.84
Total interest-bearing liabilities		6,353,604			12,022		0.76	%		6,449,196			18,758		1.17	%
Noninterest-bearing liabilities:
Noninterest-bearing demand deposits		1,770,664								1,583,010
Other liabilities		54,915								65,518
Total liabilities		8,179,183								8,097,724
Shareholders’ equity		1,499,385								1,392,493
Total liabilities and shareholders’ equity	$	9,678,568							$	9,490,217
Net interest rate spread							3.83	%							3.72	%
Net interest income and margin (3)				$	83,630		4.02	%				$	80,600		3.96	%
Net interest income and margin (tax-equivalent basis) (4)				$	84,603		4.06	%				$	81,332		4.00	%

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

(2) Annualized.

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

(4) In order to make pretax income and resultant yields on tax-exempt investments and loans comparable to those on taxable investments and loans, a tax-equivalent adjustment has been computed using a federal income tax rate of 35%.

31

	Six Months Ended June 30,
	2011								2010
	Average Outstanding Balance			Interest Earned/ Paid		Average Yield/ Rate (2)			Average Outstanding Balance			Interest Earned/ Paid		Average Yield/ Rate (2)
	(Dollars in thousands)
Assets
Interest-earning assets:
Loans	$	3,574,207		$	105,903		5.98	%	$	3,373,654		$	104,134		6.22	%
Securities (1)		4,692,639			83,123		3.54			4,411,177			91,617		4.15
Federal funds sold and other temporary investments		13,200			35		0.53			84,916			103		0.24
Total interest-earning assets		8,280,046			189,061		4.60	%		7,869,747			195,854		5.02	%
Less allowance for credit losses		(51,780	)							(52,240	)
Total interest-earning assets, net of allowance		8,228,266								7,817,507
Noninterest-earning assets		1,387,885								1,369,399
Total assets	$	9,616,151							$	9,186,906
Liabilities and shareholders’ equity
Interest-bearing liabilities:
Interest-bearing demand deposits	$	1,446,008		$	4,299		0.60	%	$	1,382,751		$	5,255		0.77	%
Savings and money market accounts		2,381,326			6,684		0.57			2,143,678			8,312		0.78
Certificates of deposit		2,176,359			11,593		1.07			2,493,091			21,491		1.74
Junior subordinated debentures		88,059			1,745		4.00			92,265			1,590		3.48
Federal funds purchased and other borrowings		205,201			518		0.51			38,312			511		2.69
Securities sold under repurchase agreements		60,058			179		0.60			77,204			323		0.84
Total interest-bearing liabilities		6,357,011			25,018		0.79	%		6,227,301			37,482		1.21	%
Noninterest-bearing liabilities:
Noninterest-bearing demand deposits		1,721,967								1,514,877
Other liabilities		52,956								64,726
Total liabilities		8,131,934								7,806,904
Shareholders’ equity		1,484,217								1,380,002
Total liabilities and shareholders’ equity	$	9,616,151							$	9,186,906
Net interest rate spread							3.81	%							3.81	%
Net interest income and margin (3)				$	164,043		4.00	%				$	158,372		4.06	%
Net interest income and margin (tax-equivalent basis) (4)				$	165,905		4.04	%				$	159,797		4.09	%

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

(2) Annualized.

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

(4) In order to make pretax income and resultant yields on tax-exempt investments and loans comparable to those on taxable investments and loans, a tax-equivalent adjustment has been computed using a federal income tax rate of 35%.

32

The following tables present the dollar amount of changes in interest income and interest expense for the major components of interest-earning assets and interest-bearing liabilities and distinguishes between the increase (decrease) related to changes in outstanding balances and the volatility of interest rates. For purposes of these tables, changes attributable to both rate and volume that cannot be segregated have been allocated to rate.

	Three Months Ended June 30,
	2011 vs. 2010
	Increase (Decrease) Due to
	Volume			Rate			Total
	(In thousands)
Interest-earning assets:
Loans	$	3,515		$	(2,493	)	$	1,022
Securities		652			(5,336	)		(4,684	)
Federal funds sold and other temporary investments		(65	)		21			(44	)
Total increase (decrease) in interest income		4,102			(7,808	)		(3,706	)
Interest-bearing liabilities:
Interest-bearing demand deposits		40			(496	)		(456	)
Savings and money market accounts		295			(1,239	)		(944	)
Certificates of deposit		(1,756	)		(3,353	)		(5,109	)
Junior subordinated debentures		(62	)		(139	)		(201	)
Federal funds purchased and other borrowings		825			(786	)		39
Securities sold under repurchase agreements		(31	)		(34	)		(65	)
Total decrease in interest expense		(689	)		(6,047	)		(6,736	)
Increase (decrease) in net interest income	$	4,791		$	(1,761	)	$	3,030
	Six Months Ended June 30,
	2011 vs. 2010
	Increase (Decrease) Due to
	Volume			Rate			Total
	(In thousands)
Interest-earning assets:
Loans	$	6,190		$	(4,421	)	$	1,769
Securities		5,846			(14,340	)		(8,494	)
Federal funds sold and other temporary investments		(87	)		19			(68	)
Total increase (decrease) in interest income		11,949			(18,742	)		(6,793	)
Interest-bearing liabilities:
Interest-bearing demand deposits		240			(1,196	)		(956	)
Savings and money market accounts		921			(2,549	)		(1,628	)
Certificates of deposit		(2,730	)		(7,168	)		(9,898	)
Junior subordinated debentures		(72	)		227			155
Federal funds purchased and other borrowings		2,226			(2,219	)		7
Securities sold under repurchase agreements		(72	)		(72	)		(144	)
Total increase (decrease) in interest expense		513			(12,977	)		(12,464	)
Increase (decrease) in net interest income	$	11,436		$	(5,765	)	$	5,671

Provision for Credit Losses

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

33

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

The Company made a $1.4 million provision for credit losses for the quarter ended June 30, 2011 and a $3.3 million provision for the quarter ended June 30, 2010. Net charge-offs were $1.2 million for the quarter ended June 30, 2011 compared with net charge-offs of $2.4 million for the quarter ended June 30, 2010. The Company made a $3.1 million provision for credit losses for the six months ended June 30, 2011 and a $7.7 million provision for the six months ended June 30, 2010. Net charge-offs were $2.8 million for the six months ended June 30, 2011 compared with $6.8 million for the six months ended June 30, 2010.

Noninterest Income

The Company’s primary sources of recurring noninterest income are non-sufficient funds fees (NSF fees), debit and ATM card income and service charges on deposit accounts. 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 $13.5 million for the three months ended June 30, 2011 compared with $13.3 million for the same period in 2010, an increase of $234,000 or 1.8%. Noninterest income totaled $27.4 million for the six months ended June 30, 2011 compared with $26.3 million for the same period in 2010, an increase of $1.1 million or 4.3%. Both increases were primarily due to the increases in debit card and ATM card income and decreases in net loss on sale of ORE, partially offset by decreases in NSF fees and increases in loss on sale of securities.

The net loss on sale of ORE was $366,000 for the three months ended June 30, 2011 compared with a net loss of $1.7 million for the three months ended June 30, 2010. The net loss on sale of ORE was $526,000 for the six months ended June 30, 2011 compared with a net loss of $2.0 million for the same period in 2010.

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

	Three Months Ended June  30,						Six Months Ended June  30,
	2011			2010			2011			2010
	(In thousands)
Non-sufficient Funds	$	6,226		$	6,917		$	12,333		$	13,402
Debit card and ATM card income		3,809			3,201			7,261			5,928
Service charges on deposit accounts		2,511			2,562			4,994			4,939
Banking related service fees		523			546			1,024			1,015
Investment income		175			136			328			350
Bank owned life insurance income (BOLI)		346			598			681			925
Net gain on sale of assets		195			399			360			399
Net loss on sale of ORE		(366	)		(1,689	)		(526	)		(1,983	)
Net loss on sale of securities		(581	)		—			(581	)		—
Other noninterest income		692			626			1,523			1,299
Total noninterest income	$	13,530		$	13,296		$	27,397		$	26,274

34

Noninterest Expense

Noninterest expense totaled $42.5 million for the quarter ended June 30, 2011 compared with $43.0 million for the quarter ended June 30, 2010, a decrease of $535,000 million or 1.2%. Noninterest expense totaled $84.2 million for the six months ended June 30, 2011 compared with $82.8 million for the six months ended June 30, 2010, an increase of $1.4 million or 1.7%. The following table presents, for the periods indicated, the major categories of noninterest expense:

	Three Months Ended June  30,				Six Months Ended June  30,
	2011		2010		2011		2010
	(In thousands)
Salaries and employee benefits (1)	$	23,994	$	22,431	$	47,198	$	43,543
Non-staff expenses:
Net occupancy		3,547		3,708		7,195		7,142
Depreciation		2,037		2,147		4,058		4,153
Data processing		1,780		1,742		3,452		3,157
Communications		1,747		2,016		3,439		4,035
Printing and supplies		458		486		902		964
Professional fees		670		905		1,242		1,621
Regulatory assessments and FDIC insurance		2,894		2,801		5,895		5,410
Ad valorem and franchise taxes		1,005		982		2,011		1,918
Core deposit intangibles amortization		1,943		2,280		3,977		4,570
Other real estate		294		851		586		1,417
Other		2,145		2,700		4,254		4,844
Total non-staff expenses		18,520		20,618		37,011		39,231
Total noninterest expense	$	42,514	$	43,049	$	84,209	$	82,774

(1) Includes stock based compensation expense of $936,000 and $692,000 for the three months ended June 30, 2011 and 2010, respectively, and $1.6 million and $1.5 million for the six months ended June 30, 2011 and 2010, respectively.

Salaries and employee benefit expenses were $24.0 million for the quarter ended June 30, 2011 compared with $22.4 million for the quarter ended June 30, 2010, an increase of $1.6 million, or 7.0%. The increase was principally due to an increase in annual employee incentive pay. For the six months ended June 30, 2011, salaries and employee benefit expenses were $47.2 million, an increase of $3.7 million or 8.4% compared with $43.5 million for the six months ended June 30, 2010. The number of full-time equivalent (FTE) associates employed by the Company was 1,675 at June 30, 2011 and 1,753 at June 30, 2010.

Other expense decreased $555,000 or 20.6% from $2.7 million for the three months ended June 30, 2010 to $2.1 million for the three months ended June 30, 2011. Other expense decreased $590,000 or 12.2% from $4.8 million for the six months ended June 30, 2010 to $4.3 million for the six months ended June 30, 2011. Overall general expenses were down due to continued efficiencies implemented by the Company.

Income Taxes

Income tax expense increased $2.3 million or 14.7% to $18.2 million for the quarter ended June 30, 2011 compared with $15.8 million for the same period in 2010. For the six months ended June 30, 2011, income tax expense totaled $35.2 million, an increase of $3.7 million or 11.9% compared with $31.4 million for the same period in 2010. The increase was primarily attributable to higher pretax net earnings for the three and six months ended June 30, 2011 compared with the same respective periods in 2010. The effective tax rate for the three months ended June 30, 2011 and 2010 was 34.1% and 33.3%, respectively. The effective tax rate for the six months ended June 30, 2011 and 2010 was 33.8% and 33.4%, respectively.

35

FINANCIAL CONDITION

Loan Portfolio

Total loans were $3.67 billion at June 30, 2011, an increase of $180.2 million or 5.2% compared with $3.49 billion at December 31, 2010.

The following table summarizes the loan portfolio of the Company by type of loan as of June 30, 2011 and December 31, 2010:

	June 30, 2011					December 31, 2010
	Amount		Percent			Amount		Percent
	(In thousands)
Commercial and industrial	$	423,743		11.6	%	$	409,426		11.7	%
Real estate:
Construction and land development		483,581		13.2			502,327		14.4
1-4 family residential		941,250		25.7			824,057		23.7
Home equity		131,213		3.6			118,781		3.4
Commercial mortgages		1,329,784		36.3			1,288,023		37.0
Farmland		115,515		3.2			98,871		2.8
Multifamily residential		81,717		2.2			82,626		2.4
Agriculture		45,265		1.2			41,881		1.2
Consumer (net of unearned discount)		81,132		2.2			87,977		2.5
Other		32,048		0.8			31,054		0.9
Total loans	$	3,665,248		100.0	%	$	3,485,023		100.0	%

Nonperforming Assets

The Company had $12.7 million in nonperforming assets at June 30, 2011 and $15.8 million in nonperforming assets at December 31, 2010, a decrease of $3.2 million or 19.9%. The ratio of nonperforming assets to loans and other real estate was 0.35% at June 30, 2011 compared with 0.45% at December 31, 2010.

The Company generally places a loan on nonaccrual status and ceases accruing interest when the payment of principal or interest is delinquent for 90 days, or earlier in some cases, unless the loan is in the process of collection and the underlying collateral fully supports the carrying value of the loan.

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

	June 30, 2011			December 31, 2010
	(Dollars in thousands)
Nonaccrual loans	$	3,518		$	4,439
Accruing loans 90 or more days past due		306			189
Total nonperforming loans		3,824			4,628
Repossessed assets		15			161
Other real estate		8,841			11,053
Total nonperforming assets	$	12,680		$	15,842
Nonperforming assets to total loans and other real estate		0.35	%		0.45	%
Nonperforming assets to average earning assets		0.15	%		0.20	%

36

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

	June 30, 2011		December 31, 2010
	(Dollars in thousands)
Commercial	$	875	$	1,317
Construction		4,692		8,469
1-4 family (including home equity)		2,875		3,933
Commercial real estate (including multi-family)		4,151		2,022
Agriculture and agriculture real estate		51		11
Consumer		36		90
Total nonperforming assets	$	12,680	$	15,842

Allowance for Credit Losses

Management actively monitors the Company’s asset quality and provides specific loss allowances when necessary. 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 allowance for credit losses, future adjustments may be necessary if economic conditions differ from the assumptions used in making the initial determinations. As of June 30, 2011, the allowance for credit losses amounted to $51.9 million or 1.42% of total loans compared with $51.6 million or 1.48% of total loans at December 31, 2010.

Set forth below is an analysis of the allowance for credit losses for the six months ended June 30, 2011 and the year ended December 31, 2010:

	Six Months Ended June  30, 2011			Year Ended December 31,  2010
	(Dollars in thousands)
Average loans outstanding	$	3,574,207		$	3,394,502
Gross loans outstanding at end of period	$	3,665,248		$	3,485,023
Allowance for credit losses at beginning of period	$	51,584		$	51,863
Provision for credit losses		3,100			13,585
Charge-offs:
Commercial and industrial		(805	)		(2,863	)
Real estate and agriculture		(2,167	)		(10,549	)
Consumer		(608	)		(2,071	)
Recoveries:
Commercial and industrial		319			346
Real estate and agriculture		136			444
Consumer		373			829
Net charge-offs		(2,752	)		(13,864	)
Allowance for credit losses at end of period	$	51,932		$	51,584
Ratio of allowance to end of period loans		1.42	%		1.48	%
Ratio of net charge-offs to average loans (annualized)		0.15	%		0.41	%
Ratio of allowance to end of period nonperforming loans		1,358.1	%		1,114.6	%

37

Securities

The carrying cost of securities totaled $4.64 billion at June 30, 2011 compared with $4.62 billion at December 31, 2010, an increase of $24.5 million or 0.5%. At June 30, 2011, securities represented 48.1% of total assets compared with 48.7% of total assets at December 31, 2010.

The Company recorded a loss on sale of securities of $581,000 for the three and six months ended June 30, 2011 compared with no loss on sale of securities for the three or six months ended June 30, 2010. The Company sold two non-agency CMOs with a total book value of $3.2 million due to a downgrade of the CMOs to less than investment grade in the second quarter of 2011. Following this sale, at June 30, 2011, the Company has nine investment grade non-agency CMOs remaining with a book value of $4.0 million.

The following table summarizes the amortized cost of securities as of the dates shown (available for sale securities are not adjusted for unrealized gains or losses):

	June 30, 2011		December 31, 2010
	(In thousands)
U.S. Treasury securities and obligations of U.S. government agencies	$	9,922	$	10,996
States and political subdivisions		74,139		76,031
Corporate debt securities		2,987		2,984
Collateralized mortgage obligations		369,901		444,827
Mortgage-backed securities		4,132,880		4,032,083
Qualified Zone Academy Bond (QZAB) and Qualified School Constructions Bonds (QSCB)		20,900		20,900
Equity securities		7,288		7,288
Total amortized cost	$	4,618,017	$	4,595,109
Total fair value	$	4,788,106	$	4,739,360

Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. The investment securities portfolio is evaluated for OTTI by segregating the portfolio into two general segments and applying the appropriate OTTI model. Investment securities classified as available for sale or held to maturity are generally evaluated for OTTI under FASB ASC Topic 320,Investments—Debt and Equity Securities. Certain purchased beneficial interests, including non-agency mortgage-backed securities, asset-backed securities, and collateralized debt obligations, that had credit ratings at the time of purchase of below AA are evaluated using the model outlined in ASC Topic 325,Investments-Other. The Company currently does not own any securities that are accounted for under ASC Topic 325.

In determining OTTI under ASC Topic 320, management considers many factors, including: (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, (iii) whether the market decline was affected by macroeconomic conditions, and (iv) whether the entity has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The assessment of whether an OTTI decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time. If applicable, the second segment of the portfolio uses the OTTI guidance provided by ASC Topic 325 that is specific to purchased beneficial interests that, on the purchase date, were rated below AA. Under the ASC Topic 325 model, the Company compares the present value of the remaining cash flows as estimated at the preceding evaluation date to the current expected remaining cash flows. An OTTI is deemed to have occurred if there has been an adverse change in the remaining expected future cash flows.

When OTTI occurs under either model, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current period credit loss. If an entity intends to sell or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current period credit loss, the OTTI shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis less any current period loss, the OTTI shall be separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings. The amount of the total OTTI related to other factors shall be recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings shall become the new amortized cost basis of the investment.

38

Management does not intend to sell any debt securities or more likely than not will not be required to sell any debt securities before their anticipated recovery, at which time the Company will receive full value for the securities. Furthermore, management has the intent to hold the securities classified as available for sale that were in a loss position as of June 30, 2011 for a period of time sufficient for an entire recovery of the cost basis of the securities. The unrealized losses are largely due to increases in market interest rates over the yields available at the time the underlying securities were purchased. The fair value is expected to recover as the securities approach their maturity date or repricing date or if market yields for such investments decline. Management does not believe any of the securities are impaired due to reasons of credit quality. Accordingly, as of June 30, 2011, management believes any impairment in the Company’s securities are temporary and no impairment loss has been realized in the Company’s consolidated income statement.

The following tables present the amortized cost and fair value of securities classified as available for sale at June 30, 2011:

	June 30, 2011
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(In thousands)
States and political subdivisions	$	46,588	$	2,539	$	(22	)	$	49,105
Corporate debt securities and other		8,776		394		—			9,170
Collateralized mortgage obligations		875		—		(22	)		853
Mortgage-backed securities		298,948		20,828		(70	)		319,706
Total	$	355,187	$	23,761	$	(114	)	$	378,834

The following tables present the amortized cost and fair value of securities classified as held to maturity at June 30, 2011:

	June 30, 2011
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(In thousands)
U.S. Treasury securities and obligations of U.S. government agencies	$	9,921	$	650	$	—		$	10,571
States and political subdivisions		48,451		2,121		(391	)		50,181
Corporate debt securities		1,500		159		—			1,659
Collateralized mortgage obligations		369,027		8,275		(352	)		376,950
Mortgage-backed securities		3,833,931		140,460		(4,480	)		3,969,911
Total	$	4,262,830	$	151,665	$	(5,223	)	$	4,409,272

Premises and Equipment

Premises and equipment, net of accumulated depreciation, totaled $160.1 million and $159.1 million at June 30, 2011 and December 31, 2010, respectively, an increase of $1.1 million or 0.7%.

Deposits

Total deposits were $7.67 billion at June 30, 2011 compared with $7.45 billion at December 31, 2010, an increase of $212.8 million or 2.9%. At June 30, 2011, noninterest-bearing deposits accounted for approximately 23.3% of total deposits compared with 22.4% of total deposits at December 31, 2010. Interest-bearing demand deposits totaled $5.88 billion or 76.7% of total deposits at June 30, 2011 compared with $5.78 billion or 77.6% of total deposits at December 31, 2010.

39

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

	Six Months Ended June 30, 2011					Year Ended December 31, 2010
	Average Balance		Average Rate			Average Balance		Average Rate
	(Dollars in thousands)
Interest-bearing demand	$	1,446,008		0.60	%	$	1,336,400		0.67	%
Regular savings		449,111		0.40			377,456		0.46
Money market savings		1,932,215		0.61			1,812,239		0.74
Time deposits		2,176,359		1.07			2,438,968		1.53
Total interest-bearing deposits		6,003,693		0.76			5,965,063		1.03
Noninterest-bearing deposits		1,728,508		—			1,567,676		—
Total deposits	$	7,732,201		0.59	%	$	7,532,739		0.82	%

Other Borrowings

The Company utilizes borrowings to supplement deposits to fund its lending and investment activities. Borrowings consist of funds from the Federal Home Loan Bank (“FHLB”) and correspondent banks. FHLB advances are considered short-term, overnight borrowings. At June 30, 2011, the Company had $235.0 million in FHLB advances and $13.8 million in FHLB long-term notes payable compared with $360.0 million in FHLB advances and $14.4 million in FHLB long-term notes payable at December 31, 2010. FHLB advances are available to the Company under a security and pledge agreement. At June 30, 2011, the Company had total funds of $3.20 billion available under this agreement of which $248.8 million was outstanding. The weighted average interest rate paid on the FHLB notes payable at June 30, 2011 end was 5.2%. The maturity dates on the FHLB notes payable range from the years 2011 to 2028 and have interest rates ranging from 4.08% to 6.10%. The highest outstanding balance of FHLB advances during the six months ended June 30, 2011 was $474.0 million compared with $465.0 million for the year ended December 31, 2010. The average rate paid on FHLB advances for the six months ended June 30, 2011 was 0.16%.

At June 30, 2011, the Company had $91.3 million in securities sold under repurchase agreements compared with $60.7 million at December 31, 2010, an increase of $30.6 million or 50.5%.

The following table presents the Company’s borrowings at June 30, 2011and December 31, 2010:

	June 30, 2011		December 31, 2010
	(In thousands)
FHLB advances	$	235,000	$	360,000
FHLB long-term notes payable		13,839		14,433
Total other borrowings		248,839		374,433
Securities sold under repurchase agreements		91,288		60,659
Total	$	340,127	$	435,092

Junior Subordinated Debentures

At June 30, 2011 and December 31, 2010, the Company had outstanding $85.1 million and $92.3 million in junior subordinated debentures issued to the Company’s unconsolidated subsidiary trusts, respectively. On March 7, 2011, the Company redeemed $7.2 million in junior subordinated debentures held by TXUI Statutory Trust I that bore a fixed interest rate of 10.60%. A penalty of $383,000 was incurred in connection with the payoff and recorded as interest expense.

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A summary of pertinent information related to the Company’s seven issues of junior subordinated debentures outstanding at June 30, 2011 is set forth in the table below:

Description	Issuance Date	Trust Preferred Securities Outstanding		Interest Rate(1)	Junior Subordinated Debt Owed to Trusts		Maturity Date(2)
Prosperity Statutory Trust II	July 31, 2001	$	15,000,000	3 month LIBOR + 3.58%, not to exceed 12.50%	$	15,464,000		July 31, 2031
Prosperity Statutory Trust III	Aug. 15, 2003		12,500,000	3 month LIBOR + 3.00%(3)		12,887,000		Sept. 17, 2033
Prosperity Statutory Trust IV	Dec. 30, 2003		12,500,000	3 month LIBOR + 2.85%(4)		12,887,000		Dec. 30, 2033
SNB Capital Trust IV(5)	Sept. 25, 2003		10,000,000	3 month LIBOR + 3.00%		10,310,000		Sept. 25, 2033
TXUI Statutory Trust II(6)	Dec. 19, 2003		5,000,000	3 month LIBOR + 2.85%(7)		5,155,000		Dec. 19, 2033
TXUI Statutory Trust III(6)	Nov. 30, 2005		15,500,000	3 month LIBOR + 1.39%		15,980,000		Dec. 15, 2035
TXUI Statutory Trust IV(6)	Mar. 31, 2006		12,000,000	3 month LIBOR + 1.39%		12,372,000		June 30, 2036

(1) The 3-month LIBOR in effect as of June 30, 2011 was 0.25%.

(2) All debentures are callable five years from issuance date.

(3) The debentures bore a fixed interest rate of 6.50% until September 17, 2008, when the rate began to float on a quarterly basis based on the 3-month LIBOR plus 3.00%.

(4) The debentures bore a fixed interest rate of 6.50% until December 30, 2008, when the rate began to float on a quarterly basis based on the 3-month LIBOR plus 2.85%.

(5) Assumed in connection with the SNB acquisition on April 1, 2006.

(6) Assumed in connection with the TXUI acquisition on January 31, 2007.

(7) The debentures bore a fixed interest rate of 6.45% until January 23, 2009, when the rate began to float on a quarterly basis based on the 3-month LIBOR plus 2.85%.

Liquidity

Liquidity involves the Company’s ability to raise funds to support asset growth or reduce assets to meet deposit withdrawals and other payment obligations, to maintain reserve requirements and otherwise to operate the Company on an ongoing basis. The Company’s largest source of funds is deposits and its largest use of funds is loans. The Company does not expect a change in the source or use of its funds in the future. Although access to purchased funds from correspondent banks is available and has been utilized on occasion to take advantage of investment opportunities, the Company does not generally rely on these external funding sources. 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, 2011, the Company had outstanding $444.8 million in commitments to extend credit and $15.8 million in commitments associated with outstanding standby letters of credit. Since commitments associated with letters of credit and commitments to extend credit may expire unused, the total outstanding may not necessarily reflect the actual future cash funding requirements.

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

Asset liquidity is provided by cash and assets which are readily marketable or which will mature in the near future. As of June 30, 2011, the Company had cash and cash equivalents of $146.3 million compared with $159.4 million at December 31, 2010, a decrease of $13.1 million. The decrease was primarily due to purchases of securities of $1.38 billion, an increase in loans of $189.8 million, net repayments of short-term debt of $125.0 million and purchases of premises and equipment of $5.5 million, partially offset by an increase in deposits of $213.0 million, proceeds from the maturities and repayments of securities of $1.34 billion, net earnings of $69.0 million, proceeds from the sale of bank premises, equipment and ORE of $8.9 million, an increase in securities sold under repurchase agreements of $30.6 million and net amortization of discount on investments of $12.9 million.

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Contractual Obligations

The following table summarizes the Company’s contractual obligations and other commitments to make future payments as of June 30, 2010 (other than deposit obligations). The payments do not include pre-payment options that may be available to the Company. The Company’s future cash payments associated with its contractual obligations pursuant to its junior subordinated debentures, FHLB borrowings and operating leases as of June 30, 2011 are summarized below. Payments for junior subordinated debentures include interest of $51.7 million that will be paid over the future periods. The future interest payments were calculated using the current rate in effect at June 30, 2011. With respect to floating interest rates, the payments were determined based on the 3-month LIBOR in effect at June 30, 2011. The current principal balance of the junior subordinated debentures at June 30, 2011 was $85.1 million. Payments for FHLB borrowings include interest of $3.8 million that will be paid over the future periods. Payments related to leases are based on actual payments specified in underlying contracts.

	Payments due in:
	Remaining Fiscal  2011		Fiscal 2012-2013		Fiscal 2014-2015		Thereafter		Total
	(Dollars in thousands)
Junior subordinated debentures	$	1,162	$	4,645	$	4,645	$	126,258	$	136,710
Federal Home Loan Bank borrowings		236,263		3,356		3,836		9,211		252,666
Operating leases		2,719		9,435		5,254		1,426		18,834
Total	$	240,144	$	17,436	$	13,735	$	136,895	$	408,210

Off-Balance Sheet Items

In the normal course of business, the Company enters into various transactions, which, in accordance with accounting principles generally accepted in the United States, are not included in its consolidated balance sheets. The Company enters into these transactions to meet the financing needs of its customers. These transactions include commitments to extend credit and standby letters of credit, which involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amounts recognized in the consolidated balance sheets.

The Company’s commitments associated with outstanding standby letters of credit and commitments to extend credit as of June 30, 2011 are summarized below. Since commitments associated with letters of credit and commitments to extend credit may expire unused, the amounts shown do not necessarily reflect the actual future cash funding requirements:

	Remaining Fiscal  2011		Fiscal 2012-2013		Fiscal 2014-2015		Thereafter		Total
	(In thousands)
Standby letters of credit	$	8,524	$	4,055	$	3,121	$	54	$	15,754
Commitments to extend credit		131,970		170,148		3,782		138,866		444,766
Total	$	140,494	$	174,203	$	6,903	$	138,920	$	460,520

Capital Resources

Total shareholders’ equity was $1.51 billion at June 30, 2011 compared with $1.45 billion at December 31, 2010, an increase of $59.3 million or 4.1%. The increase was due primarily to net earnings of $69.0 million and common stock issued in connection with the exercise of stock options and restricted stock awards of $4.0 million, partially offset by dividends paid of $16.4 million for the six months ended June 30, 2011.

Both the Board of Governors of the Federal Reserve System with respect to the Company, and the Federal Deposit Insurance Corporation (“FDIC”) with respect to the Bank, have established certain minimum risk-based capital standards that apply to bank holding companies and federally insured banks. The following table sets forth the Company’s total risk-based capital, Tier 1 risk-based capital and Tier 1 to average assets (leverage) ratios as of June 30, 2011:

Consolidated Capital Ratios
Total capital (to risk weighted assets)	15.93	%
Tier 1 capital (to risk weighted assets)	14.72	%
Tier 1 capital (to average assets)	7.24	%

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As of June 30, 2011, the Bank’s risk-based capital ratios were above the levels required for the Bank to be designated as “well capitalized” by the FDIC. To be designated as “well capitalized”, the minimum ratio requirements for the Bank’s total risk-based capital, Tier 1 risk-based capital, and Tier 1 to average assets (leverage) capital ratios must be 10.0%, 6.0% and 5.0%, respectively. The following table sets forth the Bank’s total risk-based capital, Tier 1 risk-based capital and Tier 1 to average assets (leverage) ratios as of June 30, 2011:

Capital Ratios (Bank Only)
Total capital (to risk weighted assets)	15.64	%
Tier 1 capital (to risk weighted assets)	14.43	%
Tier 1 capital (to average assets)	7.09	%

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 which is composed 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 the Company’s Annual Report on Form 10-K for the year ended December 31, 2010, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Interest Rate Sensitivity and Liquidity” which was filed on March 1, 2011 for further discussion.

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, 2011 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II—OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The Company and the Bank are defendants, from time to time, in legal actions arising from transactions conducted in the ordinary course of business. The Company and Bank believe, after consultations with legal counsel, 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, 2010.

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

a. Not applicable

b. Not applicable

c. Not applicable

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable

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ITEM 4. [REMOVED AND RESERVED]

ITEM 5. OTHER INFORMATION

Not applicable

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)
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 October 19, 2007)
4.1	Form of certificate representing shares of the Company’s common stock (incorporated 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*	Interactive Financial Data

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

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

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SIGNATURES

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

	PROSPERITY BANCSHARES, INC.®         (Registrant)
Date: 08/09/11	/S/    DAVID ZALMAN
	David Zalman
	Chairman and Chief Executive Officer
Date: 08/09/11	/S/    DAVID HOLLAWAY
	David Hollaway
	Chief Financial Officer

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