Many peptide hormones are synthesized as larger precursors which undergo endoproteolytic cleavage at paired basic residues to generate a bioactive molecule. Morphological evidence from several laboratories has implicated either the TGN or immature secretory granules as the site of prohormone cleavage. To identify the site where prohormone cleavage is initiated, we have used retrovirally infected rat anterior pituitary GH3 cells which express high levels of prosomatostatin (proSRIF) (Stoller, T. J., and D. Shields. J. Cell Biol. 1988. 107:2087-2095). By incubating these cells at 20 degrees C, a temperature that prevents exit from the Golgi apparatus, proSRIF accumulated quantitatively in the TGN and no proteolytic processing was evident; processing resumed upon shifting the cells back to 37 degrees C. After the 20 degrees C block, the cells were mechanically permeabilized and pro-SRIF processing determined. Cleavage of proSRIF to the mature hormone was approximately 35-50% efficient, required incubation at 37 degrees C and ATP hydrolysis, but was independent of GTP or cytosol. The in vitro ATP-dependent proSRIF processing was inhibited by inclusion of chloroquine, a weak base, CCCP, a protonophore, or by preincubating the permeabilized cells with low concentrations of N-ethylmaleimide, an inhibitor of vacuolar-type ATP-dependent proton pumps. These data suggest that: (a) proSRIF cleavage is initiated in the TGN, and (b) this reaction requires an acidic pH which is facilitated by a Golgi-associated vacuolar-type ATPase. A characteristic feature of polypeptide hormone-producing cells is their ability to store the mature hormone in dense core secretory granules. To investigate the mechanism of protein sorting to secretory granules, the budding of nascent secretory vesicles from the TGN was determined. No vesicle formation occurred at 20 degrees C; in contrast, at 37 degrees C, the budding of secretory vesicles was approximately 40% efficient and was dependent on ATP, GTP, and cytosolic factors. Vesicle formation was inhibited by GTP gamma S suggesting a role for GTP-binding proteins in this process. Vesicle budding was dependent on cytosolic factors that were tightly membrane associated and could be removed only by treating the permeabilized cells with high salt. After high salt treatment, vesicle formation was dependent on added cytosol or the dialyzed salt extract. The formation of nascent secretory vesicles contrasts with prosomatostatin processing which required only ATP for efficient cleavage. Our results demonstrate that prohormone cleavage which is initiated in the TGN, precedes vesicle formation and that processing can be uncoupled from the generation of nascent secretory vesicles.