FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 934
FOR THE TRANSITION PERIOD FROM____________TO___________
COMMISSION FILE NUMBER: 0-25051
PROSPERITY BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
TEXAS 74-2331986
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
3040 Post Oak Blvd.
Houston, Texas 77056
(Address of principal executive offices, including zip code)
(713) 993-0002
(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 priod 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 [ ]
As of December 23, 1998, there were 5,172,825 shares of the registrant's Common
Stock, par value $1.00 per share, outstanding.
1
<PAGE>
PROSPERITY BANCSHARES, INC. AND SUBSIDIARIES
INDEX TO FORM 10-Q
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of September 30, 1998 (unaudited ) and
December 31,1997
Consolidated Statements of Income for the Three Months and Nine Months
Ended September 30, 1998 and 1997 (unaudited)
Consolidated Statements of Changes in Shareholders' Equity for the
Year Ended December 31, 1997 and for the Nine Months Ended
September 30, 1998 (unaudited)
Consolidated Statements of Cash Flows for the Nine Months Ended
September 30, 1998 and 1997 (unaudited)
Notes to Interim Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Item 3. Quantitative and Qualitative Disclosures about Market Risk
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Changes in Securities and Use of Proceeds
Item 3. Defaults upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
2
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PROSPERITY BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
September 30, December 31,
1998 1997
------------ ------------
(Unaudited)
ASSETS
Cash and due from banks ................ $ 12,406 $ 17,372
Federal funds sold ..................... 1,070 0
--------- ---------
Total cash and cash equivalents 13,476 17,372
Interest-bearing deposits in
financial institutions ............... 99 198
Available-for-sale, at fair value
(amortized cost of $57,976
(unaudited), and $38,650, respectively) 58,485 38,612
Held-to-maturity, at cost (fair
value of $103,168 (unaudited),
and $129,775 respectively) .......... 102,150 129,256
--------- ---------
Total securities ............... 160,635 167,868
Loans .................................. 147,690 120,578
Less allowance for credit losses ....... (1,169) (1,016)
--------- ---------
Loans, net ........................ 146,521 119,562
Bank premises and equipment, net ....... 5,386 5,530
Accrued interest receivable ............ 3,118 2,501
Goodwill, net of accumulated
amortization of $2.9 million
(unaudited) and $2.6 million,
respectively ......................... 5,540 5,644
Other assets ........................... 1,659 1,468
--------- ---------
TOTAL .................................. $ 336,434 $ 320,143
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Deposits:
Noninterest-bearing ............ $ 69,187 $ 61,447
Interest-bearing ............... 236,112 230,070
--------- ---------
Total deposits .............. 305,299 291,517
Note payable ...................... 2,000 0
Other borrowings .................. 0 2,800
Accrued interest payable .......... 749 708
Other liabilities ................. 619 300
--------- ---------
Total liabilities ............ 308,667 295,325
SHAREHOLDERS' EQUITY:
Common stock; $1 par value,
50,000,000 shares authorized;
3,993,884 (unaudited) and
3,993,884 shares issued at
September 30, 1998 and
December 31, respectively;
3,990,308 (unaudited),
3,990,308 shares outstanding at
September 30, 1998 and
December 31, 1997, respectively 3,994 3,994
Capital surplus ................... 4,818 4,818
Retained earnings ................. 18,588 16,049
Accumulated other comprehensive
income-net unrealized
gains and losses on
available-for-sale investment
securities, net of tax of
$198 (unaudited) and $13,
respectively ................... 385 (25)
Less treasury stock, at cost,
3,576 (unaudited), and 3,576
shares, respectively ........... (18) (18)
--------- ---------
Total shareholders' equity ..... 27,767 24,818
--------- ---------
TOTAL .................................. $ 336,434 $ 320,143
========= =========
See accompanying Notes to Interim Consolidated Financial Statements.
3
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PROSPERITY BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
Three Months Nine Months
Ended Ended
September 30, September 30,
----------------- ----------------
1998 1997 1998 1997
------- ------- ------- -------
INTEREST INCOME:
Loans, including fees .... $ 3,127 $ 2,630 $ 8,695 $ 7,582
Investment securities:
Taxable .............. 2,279 2,384 7,155 6,612
Nontaxable ........... 155 139 450 465
Federal funds, sold ...... 78 42 205 157
Deposits in financial
institutions ........... 2 3 7 13
------- ------- ------- -------
Total interest
income ............. 5,641 5,198 16,512 14,829
INTEREST EXPENSE:
Deposits ................. 2,393 2,311 7,040 6,715
Note payable and
federal funds purchased 2 17 69 67
------- ------- ------- -------
Total interest expense 2,395 2,328 7,109 6,782
NET INTEREST INCOME .. 3,246 2,870 9,403 8,047
PROVISION FOR CREDIT LOSSES .. 70 60 215 165
------- ------- ------- -------
NET INTEREST INCOME AFTER
PROVISION FOR CREDIT LOSSES 3,176 2,810 9,188 7,882
NONINTEREST INCOME:
Customer service fees .... 530 527 1,636 1,418
Other .................... 56 62 189 182
------- ------- ------- -------
Total noninterest
income ............ 586 589 1,825 1,600
NONINTEREST EXPENSE:
Salaries and employee
benefits ............... 1,100 1,030 3,214 2,931
Net occupancy expense .... 146 141 396 374
Data processing .......... 202 171 571 462
Goodwill amortization .... 120 115 354 278
Depreciation ........... 126 111 375 316
Other operating expenses . 501 491 1,539 1.364
------- ------- ------- -------
Total noninterest
expenses ........... 2,195 2,059 6,449 5,725
INCOME BEFORE INCOME TAXES ... 1,567 1,340 4,564 3,757
PROVISION FOR INCOME TAXES ... 487 392 1,426 1,148
------- ------- ------- -------
NET INCOME ................... $ 1,080 $ 948 $ 3,138 $ 2,609
======= ======= ======= =======
EARNINGS PER SHARE
Basic ........................ $ 27 $ .26 $ .79 $ .70
======= ======= ======= =======
Diluted ...................... $ .26 $ .25 $ .77 $ .69
======= ======= ======= =======
See accompanying Notes to Interim Consolidated Financial Statements.
4
<PAGE>
PROSPERITY BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
Capital Retained Accumulated Other Treasury Total
Common Stock Surplus Earnings Comprehensive Stock Shareholder's
----------------------- Income-Net Equity
Unrealized (loss)
gain on Available
Shares Amount For Sale Investment
(in thousands) securities
---------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT JANUARY 1, 1997 .. 3,514 $ 3,514 $ 2,298 $ 13,062 $ (21) $ (19) $ 18,834
Net income .................. 3,562 3,562
Net change in
unrealized loss on
available for sale
investment securities ..... (4) (4)
--------
Total comprehensive
income .................... 3,558
Sale of treasury stock ...... 1 1
Issuance of common stock .... 480 480 2,520 3,000
Cash dividends declared,
$0.15 per share ........... (575) (575)
---------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1997 3,994 3,994 4,818 16,049 (25) (18) 24,818
Net income (unaudited) ...... 3,138 3,138
Net change in unrealized gain
on available for sale
investment securities
(unaudited) ............... 410 410
--------
Total comprehensive
income(unaudited) ......... 3,548
Cash dividends
declared, $.15 per share
(unaudited) ............... (599) (599)
BALANCE AT SEPTEMBER 30, 1998
(unaudited) ............... 3,994 $ 3,994 $ 4,818 $ 18,588 $ 385 $ (18) $ 27,767
======== ======== ======== ======== ======== ======== ========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
5
<PAGE>
PROSPERITY BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STTEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
Nine months ended
September 30,
-----------------------
1998 1997
------------ ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income .................................... $ 3,138 $ 2,609
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization ............... 729 594
Provision for credit losses ................. 215 165
Net amortization (accretion) of
premium/discount on investments ........... 128 228
Loss on sale of real estate acquired by
foreclosure ............................... 2 8
Increase in accrued interest receivable and
other assets .............................. (808) (661)
(Decrease) increase in accrued interest and
other liabilities ......................... 121 207
--------- ---------
Total Adjustments ............................. 387 541
--------- ---------
Net cash provided by operating activities $ 3,525 $ 3,150
--------- ---------
Cash flows from investing activities:
Proceeds from maturities and principal
paydowns of held to maturity
in investment securities .................. 42,068 14,375
Purchases of held to maturity investment
securities ................................ (15,205) (42,754)
Proceeds from maturities and principal
paydowns of available for sale
investment securities ..................... 20,457 16,114
Purchases of available for sale investment
securities ................................ (39,592) (3,497)
Net increase in loans ....................... (27,112) (5,474)
Purchase of premises and equipment and ORE .. (232) (508)
Proceeds from sale of bank premises and
equipment and real estate acquired by
foreclosure ............................... 40 144
Net decrease (increase) in interest-bearing
deposits in financial institutions ........ 99 198
Premiums paid for Angleton Branch ........... (1,990)
Net liabilities acquired in purchases of the
Angleton Branch ........................... 28,647
Premiums paid for the West Columbia Branch .. (250)
Net liabilities acquired in the purchase of
the West Columbia Branch .................. 5,798
--------- ---------
Net cash (used in) provided by investing
activities ............................ $ (13,929) $ 5,255
--------- ---------
Cash flows from financing activities:
Net increase in noninterest-bearing deposits $ 5,388 $ 1,531
Net increase (decrease) in interest-bearing
deposits .................................. 2,519 (14,332)
Proceeds from other borrowings .............. 285,860 144,525
Repayment of other borrowings ............... (286,660) (146,927)
Proceeds from the issuance of common stock .. 0 3,000
Sale of treasury stock ...................... 0 1
Payment of cash dividends ................... (599) (575)
--------- ---------
Net cash provided by (used) financing
activities ............................ $ 6,508 $ (12,777)
--------- ---------
6
<PAGE>
NET (DECREASE) INCREASE IN CASH AND CASH
EQUIVALENTS .......................... $ (3,896) $ (4,372)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 17,372 21,744
-------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD ..... $ 13,476 $ 17,372
======== ========
INCOME TAXES PAID ............................ $ 1,334 $ 1,160
======== ========
INTEREST PAID ................................ $ 7,068 $ 6,764
======== ========
NONCASH INVESTING ACTIVITIES:
The Company acquired certain real estate
through foreclosure of collateral on
loans totaling approximately $189,082
during the year ended December 31, 1997.
See accompanying Notes to Interim Consolidated Financial Statements.
7
<PAGE>
PROSPERITY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Prosperity
Bancshares, Inc. (the "Company") and its wholly-owned subsidiaries, First
Prosperity Bank (the "Bank") and Prosperity Holdings, Inc. All significant
inter-company transactions and balances have been eliminated.
The accompanying unaudited 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
Prospectus filed on November 11, 1998. Operating results for the nine month
period ended September 30, 1998, are not necessarily indicative of the results
that may be expected for the year ending December 31, 1998.
INCOME PER COMMON SHARE
The following table illustrates the computation of basic and diluted earnings
per share (in thousands, except per share data):
Three Months Nine Months
Ended Ended
September 30, September 30,
---------------- ----------------
1998 1997 1998 1997
------ ------ ------ ------
Net income available to common
shareholders ......................... $1,080 $ 948 $3,138 $2,609
Weighted average common shares
outstanding .......................... 3,990 3,706 3,990 3,706
Potential dilutive common shares ....... 101 83 101 83
------ ------ ------ ------
Weighted average common shares
and equivalents outstanding .......... 4,091 3,789 4,091 3,789
------ ------ ------ ------
Basic earnings per common share ........ $ .27 $ .26 $ .79 $ .70
====== ====== ====== ======
Diluted earnings per common share ...... $ .26 $ .25 $ .77 $ .69
====== ====== ====== ======
8
<PAGE>
PROSPERITY BANCSHARES, INC AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
SEPTEMBER 30, 1998
(DOLLARS IN THOUSANDS)
(UNAUDITED)
RECENT ACCOUNTING STANDARDS
Effective January 1, 1998, the Company adopted Financial Accounting
Standards No. 130, "Reporting Comprehensive Income", which requires that all
components of comprehensive income and total comprehensive income be reported on
one of the following: the statement of operations, the statement of
shareholders' equity, or a separate statement of comprehensive income.
Comprehensive income is comprised of net income and all changes to shareholders'
equity, except those due to investments by owners (changes in capital surplus)
and distributions to owners (dividends). The Company is reporting comprehensive
income on its statement of changes in shareholders' equity.
SFAS No. 131, "Disclosure about Segments of an Enterprise and Related
Information," requires public companies to report certain information about
their operating segments in their annual financial statements and quarterly
reports issued to shareholders, for years beginning after implementation. It
also requires public companies to report certain information about their
products and services, the geographic areas in which they operate, and their
major customers. This statement is effective for fiscal years beginning after
December 15, 1997. The Company will implement SFAS No 131 for its 1998 Annual
Report on Form 10-K. Implementation of SFAS No. 131 should have no material
effect on the Company's Consolidated Financial Statements.
In June 1998, SFAS No. 133, "Accounting for Derivative Instruments and for
Hedging Activities," was issued. This statement requires companies to recognize
all derivatives as either assets or liabilities in the balance sheet and measure
those instruments at fair value. SFAS No.133 requires that changes in fair value
of a derivative be recognized currently in earnings unless specific hedge
accounting criteria are met. This statement is effective for fiscal years
beginning after June 15, 1999 but early adoption is allowed. The Company does
not currently have any derivative instruments.
RECENT ACQUISITION
GENERAL. The Company's Board of Directors actively pursues an acquisition
strategy designed to increase efficiency, market share and return to
shareholders. As part of this strategy, on October 1, 1998 the Company acquired
Union State Bank ("Union"), a Texas banking association organized in 1907,
pursuant to a statutory merger (the "Union Acquisition"). Union is a single
location community bank whose business includes conventional consumer and
commercial products and services, including interest and noninterest-bearing
depository accounts and commercial, industrial, consumer, agricultural and real
estate lending. At September 30, 1998, Union had total assets of approximately
$79.4 million, total deposits of approximately $66.1 million and total
shareholders' equity of approximately $13.0 million. Union was the only
full-service commercial bank in East Bernard and has a stable customer base.
The Union Acquisition would have been accretive to the Company's earnings
by $0.09 per share on a pro forma basis for the nine months ended September 30,
1998. The Union Acquisition provides the Company a presence in East Bernard, a
community of 1,500 located in northern Wharton County. The acquisition increased
the Company's market share in Wharton County, where the Company's El Campo
Banking Center is located. The acquisition of Union will also help the Company
improve its loan mix by increasing the Company's agriculture loans as of
September 30,1998 from $7.1 million to $17.6 million on a pro forma basis .
Union has a lending philosophy which is similar to that employed by the Company.
The Company's significantly higher lending limit is expected to create lending
opportunities in the market that Union was unable to take advantage of prior to
the acquisition. Similar to its previous acquisitions, the Company believes that
the Union Acquisition will enable the Company to achieve certain economies of
scale and resultant savings from the operation of Union as an additional Banking
Center.
9
<PAGE>
Upon consummation of the Union Acquisition, holders of shares of Union
common stock received $17.6 million in cash as consideration in exchange for
their shares. The source of the Company's funds for the acquisition was a
combination of existing cash ($15.6 million ) and borrowed funds ($2.0 million).
The Union Acquisition was accounted for as a purchase transaction. At the
closing of the Union Acquisition, two executive officers of Union entered into
three year employment agreements with the Company which contain two-year
non-competition clauses.
UNAUDITED PRO FORMA COMBINED CONDENSED FINANCIAL STATEMENTS
The following unaudited pro forma combined condensed financial statements set
forth the consolidated balance sheet at September 30, 1998 and the consolidated
income statements for the nine month period ended September 30, 1998 and for the
year ended December 31, 1997, for the Company and Union and the adjustments
reflecting the acquisition of Union and the pro forma combined information
following such transaction. The Union Acquisition was accounted for as a
purchase and the assets and liabilities were recorded at their estimated fair
market values, with the excess of the respective purchase prices over the net
fair market values recorded as goodwill. The information with respect to the
Company and Union as of September 30, 1998, and the pro forma information is
unaudited. The pro forma balance sheet assumes that the Union Acquisition was
consummated on the balance sheet date. The pro forma income statements assume
that the Union Acquisition was consummated at the beginning of the period
indicated. The pro forma financial statements should be read in conjunction with
the financial statements and notes thereto appearing elsewhere in this
Prospectus. The pro forma combined balance sheet and statements of income are
not necessarily indicative of the combined financial position at consummation of
the Union Acquisition or the results of operation following consummation of the
Union Acquisition.
10
<PAGE>
PRO FORMA COMBINED BALANCE SHEET
September 30, 1998
(Unaudited)
<TABLE>
<CAPTION>
Pro Forma
Adjustments
------------------------
Pro Forma
Company Union Debits Credits Combined
--------- --------- --------- --------- -----------
(Dollars in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Assets
Cash and due from banks ............. $ 12,406 $ 1,717 $ 2,000(b) $ 4,700(b) $ 11,423
Federal funds sold .................. 1,070 14,900 12,900(b) 3,070
--------- --------- --------- --------- ---------
Total cash
and cash equivalents ........ 13,476 16,617 2,000 17,600 14,493
Interest-bearing
deposits in financial
institutions ...................... 99 0 99
Securities
Available-for-sale ................ 58,485 18,836 77,321
Held-to-maturity .................. 102,150 21,809 123,959
--------- --------- ---------
Total securities ............ 160,635 40,645 201,820
Loans
Total loans,
net of unearned
discount ..................... 147,690 21,470 169,160
Allowance for
credit losses ................ (1,169) (656) (1,825)
--------- --------- ---------
Net loans ................... 146,521 20,814 167,335
Goodwill ............................ 5,540 0 4,238(a) 9,778
Premises and equipment .............. 5,386 155 566(a) 6,107
Other real estate owned ............. 0 137 137
Other assets ........................ 4,777 997 5,774
--------- --------- --------- --------- ---------
Total assets ............ $ 336,434 $ 79,365 $ 6,804 $ 17,600 $ 405,003
========= ========= ========= ========= =========
Liabilities and
Shareholders' Equity Liabilities
Deposits ....................... $ 305,299 $ 66,057 $ 371,356
Note payable ................... 2,000 0 $ 2,000(b) 4,000
Other liabilities .............. 1,368 320 192(a) 1,880
--------- --------- --------- ---------
Total liabilities .............. 308,667 66,377 2,192 377,236
Shareholders' equity:
Common stock ................... 3,994 700 $ 700(c) 3,994
Capital surplus ................ 4,818 3,300 3,300(c) 4,818
Retained earnings .............. 18,588 9,002 9,002(c) 18,588
Treasury stock ................. (18) 0 (18)
Net unrealized
gain (loss) on
available for-sale
securities ................... 385 14 14(a) 385
--------- --------- --------- --------- ---------
Total shareholders'
equity ....................... 27,767 12,988 13,002 14 27,767
--------- --------- --------- --------- ---------
Total liabilities
and shareholders'equity $ 336,434 $ 79,365 $ 19,806 $ 19,806 $ 405,003
========= ========= ========= ========= =========
</TABLE>
(a) This adjustment represents the purchase price adjustments to mark Union's
assets and liabilities to fair value upon the consummation of the Union
Acquisition and results in recording of $4.238 million in goodwill.
(b) This adjustment represents the purchase of 100% of the outstanding shares
of stock of Union for $17.6 million consisting of $15.6 million of existing
cash and an additional $2.0 million of cash generated from borrowings under
an existing line of credit.
(c) This adjustment represents the elimination of capital of Union against the
investment in subsidiary of the Company.
11
<PAGE>
PRO FORMA COMBINED INCOME STATEMENT
NINE- MONTH PERIOD ENDED SEPTEMBER 30, 1998
(Unaudited)
<TABLE>
<CAPTION>
Pro forma
Adjustments
----------------------------
Pro Forma
Company Union Debits Credits Combined
--------- -------- --------- --------- ---------
(Dollars in thousands, except per share data)
<S> <C> <C> <C>
Interest income:
Interest and fees on loans ............. $ 8,695 $ 1,632 $ 10,327
Interest on securities ................. 7,605 1,985 9,590
Interest on federal funds sold ......... 212 304 516
-------- -------- --------
Total interest income ............. 16,512 3,921 20,433
Interest expense:
Interest on deposits ................... 7,040 1,848 8,888
Interest on other borrowings ........... 69 0 $ 123(a) 192
-------- -------- -------- --------
Total interest expense ............ 7,109 1,848 123 9,080
-------- -------- -------- --------
Net interest income ......................... 9,403 2,073 (123) 11,353
Provision for credit losses ............ 215 0 215
-------- -------- --------
Net interest income
after provision for credit losses ...... 9,188 2,073 (123) 11,138
Noninterest income:
Service charges ........................ 1,636 145 1,781
Other noninterest income ............... 189 41 230
-------- -------- --------
Total noninterest income .......... 1,825 186 2,011
Noninterest expense:
Salaries and
employee benefits .................... 3,214 721 3,935
Net occupancy expense .................. 885 53 14(b) 952
Other noninterest expense .............. 2,350 641 127(c) 3,118
-------- -------- -------- --------
Total noninterest expense ......... 6,449 1,415 141 8,005
-------- -------- -------- --------
Income before federal income taxes .......... 4,564 844 (264) 5,144
Federal income taxes ................... 1,426 241 $ 47(d) 1,620
-------- -------- -------- --------
Net income ........................ $ 3,138 $ 603 $ (264) $ 47 $ 3,524
======== ======== ======== ======== ========
Basic earnings per share:
Net income per share ................... $ .79 8.61 $ .88
Average shares outstanding
(in thousands) .................... 3,990 70 3,990
======== ======== ========
Diluted earnings per share:
Net income per share ................... $ .77 8.61 $ .86
Average shares outstanding
(in thousands) ....................... 4,091 70 4,091
======== ======== ========
</TABLE>
(a) This adjustment represents the interest expense on the additional debt.
(b) This adjustment represents additional depreciation expense on the acquired
buildings.
(c) This adjustment represents the amortization of $4.238 million in goodwill
over 25 years.
(d) This adjustment represents the federal income tax effect of the above
adjustments.
12
<PAGE>
PRO FORMA COMBINED INCOME STATEMENT
YEAR ENDED DECEMBER 31, 1997
(Unaudited)
<TABLE>
<CAPTION>
Pro forma
Adjustments
-------------
Pro Forma
Company Union Debits Credits Combined
--------- --------- -------- ---------- -----------
(Dollars in thousands, except per share data)
<S> <C> <C> <C>
Interest income:
Interest and fees on loans ..................... $ 10, 205 $ 2,135 $ 12,340
Interest on securities ......................... 9,572 2,790 12,362
Interest on federal funds sold ................. 193 267 460
--------- -------- --------
Total interest income ..................... 19,970 5,192 25,162
Interest expense:
Interest on deposits ........................... 8,858 2,504 11,362
Interest on other borrowings ................... 202 0 $ 164(a) 366
--------- -------- -------- --------
Total interest expense .................... 9,060 2,504 164 11,728
--------- -------- -------- --------
Net interest income ................................. 10,910 2,688 (164) 13,434
Provision for credit losses .................... 190 (75) 115
--------- -------- --------
Net interest income after provision for credit losses 10,720 2,763 (164) 13,319
Noninterest income:
Service charges ................................ 2,062 218 2,280
Other noninterest income ....................... 202 110 312
--------- -------- --------
Total noninterest income .................. 2,264 328 2,592
Noninterest expense:
Salaries and employee benefits ................. 3,968 945 4,913
Net occupancy expense .......................... 811 122 19(b) 952
Other noninterest expense ...................... 3,057 436 170(c) 3,663
--------- -------- -------- --------
Total noninterest expense ................. 7,836 1,503 189 9,528
--------- -------- -------- --------
Income before federal income taxes .................. 5,148 1,588 (435) 6,383
Federal income taxes ........................... 1,586 422 62(d) 1,946
-------- -------- -------- -------- --------
Net income ................................ $ 3,562 $ 1,166 $ (353) $ 62 $ 4,437
======== ======== ======== ======== ========
Basic earnings per share:
Net income per share ........................... $ .94 $ 16.66 $ 1.17
Average shares outstanding (in thousands) ...... 3,778 70 3,778
======== ======== ========
Diluted earnings per share:
Net income per share ........................... $ .92 $ 16.66 $ 1.15
Average shares outstanding
(in thousands) ............................ 3,864 70 3,864
======== ======== ========
</TABLE>
(a) This adjustment represents the interest expense on the additional debt.
(b) This adjustment represents additional depreciation expense on the acquired
buildings.
(c) This adjustment represents the amortization of $4.238 million in goodwill
over 25 years.
(d) This adjustment represents the federal income tax effect of the above
adjustments.
13
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Prosperity Bancshares, Inc. (the "Company") is a registered bank holding
Company that derives substantially all of its revenues and income from the
operation of First Prosperity Bank (the "Bank"). The Bank is a full service bank
that provides a broad line of financial products and services to small and
medium sized businesses and consumers through 12 full-service banking locations,
three of which are located in the greater Houston metropolitan area. The
following Management's Discussion and Analysis of Financial Condition and
Results of Operations may contain certain forward-looking statements regarding
future financial condition, results of operations, and the Company's business
operations. Such statements involve risks, uncertainties and assumptions,
including, but not limited to, monetary policy and general economic conditions
in Texas and the Houston metropolitan area, the actions of competitors and
customers, the success of the Company in implementing its strategic plan, and
the effects of regulatory restrictions imposed on banks and bank holding
companies generally. Should one or more of these risks or uncertainties
materialize, or should these underlying assumptions prove incorrect, actual
outcomes may vary materially from outcomes expected or anticipated by the
Company.
OVERVIEW
The Company showed positive earnings growth due to the increase in loan
volume and the acquisition of deposits and certain assets of the branch of Wells
Fargo Bank in Angleton, Texas (the "Angleton Acquisition") in the second quarter
of 1997. Net income available to common shareholders was $1.1 million ($0.26 per
common share on a diluted basis) for the quarter ended September 30, 1998
compared with $948,000 ($0.25 per common share on a diluted basis) for the
quarter ended September 30, 1997, an increase of $132,000, or 13.9%. The Company
posted returns on average common equity of 15.94% and 16.03% and returns on
average assets of 1.29% and 1.20% for the quarters ended September 30, 1998 and
1997, respectively. For the nine months ended September 30, 1998, net income
available to common shareholders was $3.1 million ($0.77 per common share on a
diluted basis) compared with $2.6 million ($0.69 per common share on a diluted
basis) for the same period in 1997, an increase of $529,000, or 20.3%.
Total assets were $336.4 million at September 30, 1998 compared with
$320.1 million at December 31, 1997. Total loans increased to $147.7 million at
September 30, 1998 from $120.6 million at December 31, 1997, an increase of
$27.1 million, or 22.5%. Total deposits were $305.3 million at September 30,
1998 compared with $291.5 million at December 31, 1997. Shareholders' equity
increased $2.9 million or 11.9%, to $27.8 million at September 30, 1998 compared
with $24.8 million at December 31, 1997.
RESULTS OF OPERATIONS
Net Interest Income
Net interest income was $3.2 million for the quarter ended September 30,
1998 compared with $2.9 million for the quarter ended September 30, 1997, an
increase of $376,000, or 13.1%. Net interest income increased as a result of an
increase in average interest-earning assets to $310.0 million for the quarter
ended September 30, 1998 from $289.1 million for the quarter ended September 30,
1997, an increase of $20.9 million, or 7.2%. The net interest margin on a tax
equivalent basis, increased to 4.22% from 4.00% for the same periods, primarily
due to loan growth. Net interest income increased $1.4 million, or 16.9% to $9.4
million for the nine months ended September 30, 1998 from $8.0 million for the
same period in 1997. This increase is mainly attributable to higher average
interest-earning assets and higher average loans.
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
14
<PAGE>
borrowed funds, referred to as a "rate change." 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 quarters ended September 30, 1998
and 1997. 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.
15
<PAGE>
<TABLE>
<CAPTION>
Three Months Ended September 30,
1998 1997
------------------------------------------- ---------------------------------------
Average Interest Average Average Interest Average
Outstanding Paid/ Yield Outstanding Paid/ Yield
Balance Earned Rate Balance Earned Rate
------------------------------------------- ---------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
ASSETS:
Interest-earning assets:
Loans ............................ $ 145,604 $ 3,127 8.52% $ 119,797 2,630 8.71%
Securities ....................... 157,674 2,434 6.12 165,260 2,523 6.06
Federal funds sold and other
temporary investments .......... 6,764 80 4.69 4,062 45 4.40
--------- --------- --------- --------- --------- ---------
Total interest earning
assets ...................... 310,042 5,641 7.22% 289,119 5,198 7.13%
Less allowance for credit losses ..... (1,135) (976)
--------- ---------
Total interest-earning
assets, net of allowance ........... 308,907 288,143
Non-interest earning assets ......... 25,787 27,057
--------- ---------
Total assets .............. $ 334,694 $ 315,200
========= =========
LIABILITIES AND SHAREHOLDERS'
EQUITY
Interest-bearing liabilities:
Interest-bearing demand deposits ..... $ 36,362 $ 140 1.54% $ 42,829 $ 234 2.15%
Savings and money
market accounts ................ 81,442 718 3.49 70,023 586 3.32
Certificates of deposit ........... 119,959 1,535 5.08 114,696 1,439 4.98
Federal funds purchased and
other borrowings ............... 125 2 6.35 1,999 69 13.7
--------- --------- --------- --------- --------- ---------
Total interest-bearing
liabilities ................ 237,888 2,395 3.99% 229,547 2,328 4.02%
--------- --------- --------- --------- --------- ---------
Noninterest-bearing liabilities:
Noninterest-bearing
demand deposits .................. 67,993 60,471
Other liabilities .................. 1,651 1,637
--------- ---------
Total liabilities ........ 307,532 291,655
Shareholders' equity ................. 27,162 23,545
--------- ---------
Total liabilities and
shareholders' equity ..... $ 334,694 $ 315,200
========= =========
Net interest rate spread ............. 3.23% 3.11%
========= =========
Net interest income and margin ....... $ 3,246 4.15% $ 2,870 3.94%
========= ========= ========= =========
Net interest income and
margin tax equivalent basis ........ $ 3,300 4.22% $ 2,929 4.00%
========= ========= ========= =========
</TABLE>
16
<PAGE>
<TABLE>
<CAPTION>
Nine Months Ended September 30,
----------------------------------------------------------------------------------------
1998 1997
----------------------------------------- -------------------------------------------
Average Interest Average Average Interest Average
Outstanding Paid/ Yield Outstanding Paid/ Yield
Balance Earned Rate Balance Earned Rate
----------- --------- --------- ----------- --------- ----------
<S> <C> <C> <C> <C> <C> <C>
ASSETS:
Interest-earning assets:
Loans .............................. $ 134,741 $ 8,695 8.60% $ 116,901 $ 7,582 8.65%
Securities ......................... 165,837 7,605 6.11 155,583 7,077 6.06
Federal funds sold and other
temporary investments ............ 6,101 212 4.63 4,902 170 4.62
--------- --------- --------- --------- --------- ---------
Total interest
earning assets ................ 306,679 16,512 7.18% 277,386 14,829 7.13%
Less allowance for credit
losses ............................... (1,077) (936)
--------- ---------
Total interest-earning
assets, net of allowance ............. 305,602 276,450
Non-interest earning assets ........... 26,041 26,233
--------- ---------
Total Assets .................... $ 331,643 $ 302,683
========= =========
LIABILITIES AND
SHAREHOLDERS' EQUITY
Interest-bearing liabilities:
Interest-bearing demand deposits ....... $ 39,477 $ 471 1.59 $ 43,416 $ 840 2.58
Savings and money
market accounts .................. 79,625 2,094 3.51 61,502 1,519 3.29
Certificates of deposit ............ 117,281 4,475 5.09 114,713 4,356 5.06
Fed funds purchased and
other borrowings ................. 1,596 69 5.76 1,526 67 5.85
--------- --------- --------- --------- --------- ---------
Other Borrowings
Total interest-bearing
liabilities .................. 237,979 7,109 3.99% 221,157 6,782 4.09%
--------- --------- --------- --------- --------- ---------
Noninterest-bearing liabilities:
Noninterest-bearing demand
deposits .......................... 66,111 55,878
Other liabilities ................ 1,124 3,435
--------- ---------
Total liabilities ............... 305,214 280,470
Shareholders' equity ................... 26,429 22,213
--------- ---------
Total liabilities
and shareholders' equity ...... $ 331,643 $ 302,683
========= =========
Net interest rate spread ............... 3.20% 3.04%
========= =========
Net interest income and margin ......... $ 9,403 4.09% $ 8,047 3.87%
========= ========= ========= =========
Net interest income and
margin tax equivalent basis .......... $ 9,591 4.19% $ 8,246 3.97%
========= ========= ========= =========
</TABLE>
17
<PAGE>
The following table presents 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 outstanding balances and the volatility of interest rates. For
purposes of this table changes attributable to both rate and volume, which
cannot be segregated, have been allocated to rate.
Three months ended September 30
1998 vs. 1997
Increase (decrease) due to
--------------------------------
Volume Rate Total
-------- ------ -------
(Dollars in thousands)
Interest-earning assets:
Loans ............................. $ 562 $ (65) $ 497
Securities ........................ (115) 26 (89)
Federal funds sold and other
temporary investments ........... 30 5 35
----- ----- -----
Total increase in interest income 477 (34) 443
----- ----- -----
Interest-bearing liabilities:
Interest-bearing demand
deposits ........................ (35) (58) (93)
Savings and money market
accounts ........................ 95 36 131
Certificates of deposit ........... 66 30 96
Federal funds purchased and
other borrowings ................ (64) (3) (67)
----- ----- -----
Total increase (decrease)
in interest expense ........... 62 5 67
----- ----- -----
Increase in net interest income ........ $ 415 $ (39) $ 376
===== ===== =====
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 loan 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 September 30, 1998, the allowance for credit losses
amounted to $1.2 million, or 0.79% of total loans.
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 experience, the volume and type of policies,
general economic conditions and other factors related to the collectibility of
loans in the Company's portfolio.
The provision for credit losses for the quarter ended September 30, 1998 was
$70,000 compared with $60,000 for the quarter ended September 30, 1997. The
increase resulted from continued growth in loans. The provision for credit
losses for the nine months ended September 30, 1998 increased $50,000 to
$215,000 from $165,000 in the corresponding period last year. For the nine
months ended September 30, 1998, net charge-offs were $62,000, or 0.05% of
average loans.
18
<PAGE>
Set forth below is an analysis of the allowance for credit losses for the nine
months ended September 30, 1998:
Nine months ended
September 30, 1998
------------------
(Dollars in thousands)
Average loans outstanding .................. $ 134,741
=========
Gross loans outstanding at end of period ... $ 147,690
=========
Allowance for credit losses at
beginning of period ...................... $ 1,016
Provision for credit losses ................ 215
Charge-offs:
Commercial and industrial .......... (1)
Real estate and agriculture ........ (12)
Consumer ........................... (61)
Recoveries:
Commercial and industrial .......... 3
Real estate and agriculture ........ 0
Consumer ........................... 9
---------
Net loan (charge-offs) recoveries ......... (62)
---------
Allowance for credit losses at end of period 1,169
=========
Ratio of allowance to end of period
loans .................................... 0.79%
Ratio of net charge-offs to average
loans .................................... 0.05%
Ratio of allowance to end of period
nonperforming loans ...................... --
19
<PAGE>
Noninterest Income
The Company's primary sources of noninterest income are service charges on
deposit accounts and other banking service related fees. The following table
presents, for the periods indicated, the major categories of noninterest income:
Three Months Ended Nine Months Ended
------------------ -----------------
September 30, September 30,
------------------ -----------------
1998 1997 1998 1997
------- ------ ------ ------
(Dollars in thousands)
Service charges on deposit accounts $ 530 $ 527 $1,636 $1,418
Fees income ....................... 36 38 111 114
Other noninterest income .......... 20 24 78 68
------ ------ ------ ------
Total noninterest income $ 586 $ 589 $1,825 $1,600
====== ====== ====== ======
Noninterest income totaled $1.8 million for the nine months ended September 30,
1998 compared with $1.6 million for the same period in 1997, and increase of
$225,000, or 14.1%. The increase in service charges on deposit accounts was due
to the Angleton Acquisition.
Noninterest Expense
Noninterest expense totaled $2.2 million for the quarter ended September 30,
1998 compared with $2.1 million for the quarter ended September 30, 1997, an
increase of $136,000, or 6.6%. The increase was due to the Angleton Acquisition.
The following table presents, for the periods indicated, the major categories of
noninterest expense:
Three Months Ended Nine Months Ended
------------------ -----------------
September 30, September 30,
------------------ -----------------
1998 1997 1998 1997
------ ------ ------ ------
(Dollars in thousands)
Salaries and employee benefits .......... $1,100 $1,030 $3,214 $2,931
Non -staff expenses:
Net occupancy expense ........... 146 141 396 374
Depreciation .................... 126 111 375 316
Data processing ................. 202 171 571 462
Professional fees ............... 36 22 82 57
Regulatory assessments
and FDIC insurance ............ 18 15 53 45
Ad valorem and franchise taxes .. 54 39 145 123
Goodwill amortization ........... 120 115 354 278
Other ........................... 393 415 1,259 1,139
------ ------ ------ ------
Total non-staff
expenses .............. 1,095 1,041 3,235 2,794
------ ------ ------ ------
Total noninterest
expense ............... $2,195 $2,059 $6,449 $5,725
====== ====== ====== ======
Much of the increase in noninterest expense for the nine month period
ended September 30, 1998 compared with the same period in 1997 was due to
additional expenses associated with the Angleton Acquisition.
20
<PAGE>
Salaries and employee benefit expenses were $1.1 million for the quarter
ended September 30, 1998 and $3.2 million for the nine months ended September
30, 1998, an increase of $70,000, or 6.8%, and $283,000, or 9.7%, compared with
the same periods in 1997. The changes were due primarily to an increase in the
number of employees due to the Angleton Acquisition and annual employee salary
increases.
Non-staff expenses increased $66,000, or 6.4%, to $1.1 million for the
quarter ended September 30, 1998 compared to the same period in 1997. For the
nine months ended September 30, 1998, non-staff expenses increased $441,000, or
15.8%.
Income Taxes
Income tax expense increased $95,000 to $487,000 for the quarter ended September
30, 1998 from $392,000 for the same period in 1997. The increase was primarily
attributable to higher pretax net earnings.
FINANCIAL CONDITION
Loan Portfolio
Total loans were $147.7 million at September 30, 1998, an increase of $27.1
million, or 22.5% from $120.6 million at December 31, 1997. Loan growth occurred
primarily in 1-4 family residential and home equity loans. Loans comprised 43.9%
of average earning assets at September 30, 1998 compared with 42.1% at December
31, 1997.
The following table summarizes the loan portfolio of the Company by type
of loan as of September 30, 1998 and December 31, 1997:
September 30, 1998 September 30, 1997
-------------------- --------------------
Amount Percent Amount Percent
--------- --------- -------- --------
(Dollars in thousands)
Commercial and industrial ...... $ 12,744 8.6% $ 11,611 9.6%
Real estate:
Construction and
land development ......... 2,118 1.4 6,453 5.4
1-4 family residential ..... 73,732 49.9 53,625 44.5
Home equity ................ 6,844 4.6 -- --
Commercial mortgages ....... 20,778 14.1 16,277 13.5
Farmland ................... 5,364 3.6 5,804 4.8
Multi family residential ... 1,159 .8 937 .8
Agriculture ................ 7,127 4.8 6,359 5.3
Consumer ................... 17,824 12.2 19,512 16.1
-------- -------- -------- --------
Total loans ............ $147,690 100.0% $120,578 100.0%
======== ======== ======== ========
NONPERFORMING ASSETS
The company had no nonperforming assets for the for the period ended
September 30, 1998 and had $47,000 in nonperforming assets for the period ended
December 31, 1997. The Company generally places a loan on nonaccrual status and
ceases accruing interest when the payment of principal or interest is
21
<PAGE>
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 Company generally charges off all loans before attaining
nonaccrual status.
September 30, December 31,
------------- -------------
1998 1997
(Dollars in thousands)
Non-accrual loans ........................... $ 0 $ 0
Accruing loans 90 or more days past due ..... 0 47
--- ---
Total non-performing loans .................. 0 47
Other real estate ........................... 0 0
--- ---
Total non-performing assets ........ $ 0 $47
=== ===
SECURITIES
Securities totaled $160.6 million at September 30, 1998 compared with
$167.9 million at December 31, 1997, a decline of $7.2 million, or 4.3%. The
decline occurred as maturing securities were used to fund loans. At September
30, 1998, securities represented 47.7% of total assets compared with 52.4% of
total assets at December 31, 1997.
PREMISES AND EQUIPMENT
Premises and equipment, net of accumulated depreciation, totaled $5.4
million at September 30, 1998, a decline of $144,000, or 2.6%, from $5.5 million
at December 31, 1997. The decline was due primarily to depreciation of existing
premises and equipment.
DEPOSITS
Total deposits were $305.3 million at September 30, 1998 compared with
$291.5 million at December 31, 1997, an increase of $13.8 million. At September
30, 1998, non-interest bearing deposits accounted for approximately 22.7% of
total deposits. Interest-bearing demand deposits totaled $236.1 million, or
77.3%, of total deposits at September 30, 1998 compared with $230.1 million, or
78.9%, of total deposits at December 31, 1997.
BORROWINGS
The Company had notes payable as of September 30, 1998 of $2.0 million and
had Federal Home Loan Bank advances of $2.8 million for the same period in 1997.
LIQUIDITY
Effective management of balance sheet liquidity is necessary to fund
growth in earning assets and to pay liability maturities, depository customers'
withdrawal requirements and shareholders' dividends. Thc Company has numerous
sources of liquidity including a significant portfolio of shorter-term assets,
marketable investment securities (excluding those presently classified as
"held-to-maturity"), increases in customers' deposits, and access to borrowing
arrangements. Available borrowing arrangements maintained by the Company include
federal funds lines with other commercial banks and an advancement arrangement
with the Federal Home Loan Bank ("FHLB").
Asset liquidity is provided by cash and assets which are readily
marketable or which will mature in the near future. As of September 30, 1998,
the Company had cash and cash equivalents of $13.5
22
<PAGE>
million, down from $17.4 million at December 31, 1997. The decline was due
primarily to an increase in loans.
CAPITAL RESOURCES
Total shareholders' equity was $27.8 million at September 30, 1998
compared with $24.8 million at December 31, 1997, an increase of $3.0 million,
or 11.9%. The increase was due primarily to net earnings of $3.1 million (less
dividends of $575,000) for the nine months ended September 30, 1998.
Both the Board of Governors of the Federal Reserve System, with respect to
the Company, and the Federal Deposit Insurance Corporation, with respect to the
Bank, have established certain minimum risk-based capital standards that apply
to bank holding companies and federally insured banks. The Company's risk-based
capital ratios remain above the levels designated as "well capitalized" on
September 30, 1998, with Tier 1 capital, total risk-based capital and leverage
capital ratios of 15.4%, 16.3% and 6.6%, respectively. The bank's risk-based
capital ratios remain above the levels designated as "well capitalized" on
September 30, 1998, with Tier-1 capital, total risk-based capital and leverage
capital ratios of 15.4%, 16.2% and 6.5%, respectively.
YEAR 2000 COMPLIANCE
GENERAL. The Year 2000 risk involves computer programs and computer
software that are not able to perform without interruption into the Year 2000.
If computer systems do not correctly recognize the date change from December 31,
1999 to January 1, 2000, computer applications that rely on the date field could
fail or create erroneous results. Such erroneous results could affect interest,
payment or due dates or cause the temporary inability to process transactions,
send invoices or engage in similar normal business activities. If these issues
are not addressed by the Company, its suppliers and its borrowers, there could
be a material adverse impact on the Company's financial condition or results of
operations.
STATE OF READINESS. The Company formally initiated its Year 2000 project
and plan in November 1997 to insure that its operational and financial systems
will not be adversely affected by year problems. The Company has formed a Year
2000 project team and the Board of Directors and management are supporting all
compliance efforts and allocating the necessary resources to ensure completion.
An inventory of all systems and products (including both information technology
("IT") and non-informational technology ("non-IT") systems) that could be
affected by the Year 2000 date change has been developed, verified and
categorized as to its importance to the Company and an assessment of all major
IT and critical non-IT systems has been completed. This assessment involved
inputting test data which simulates the Year 2000 date change into such IT
systems and reviewing the system output for accuracy. The Company's assessment
of critical non-IT systems involved reviewing such systems to determine whether
they were date dependent. Based on such assessment, the Company believes that
none of its critical non-IT systems are date dependent. The software for the
Company's systems is provided through service bureaus and software vendors. The
Company has contacted all of its third party vendors and software providers and
is requiring them to demonstrate and represent that the products provided are or
will be Year 2000 compliant and has planned a program of testing compliance. The
Company's service bureau, which performs substantially all of the Company's data
processing functions, has warranted in writing that its software is Year 2000
compliant and pursuant to applicable regulatory guidelines the Company is
currently reviewing the results of user group tests performed by the service
provider to verify this assertion. The Company believes it would have recourse
against the service provider for actual damages incurred by the Company in the
event the service provider breaches this warranty. In addition, the Company's
compliance with Year 2000 issues has been reviewed by the FDIC in 1998.
Except as discussed above, the Company has completed the following phases
of its Year 2000 plan: (I) recognizing Year 2000 issues, (ii) assessing the
impact of Year 2000 issues on the Company's critical systems and (iii) upgrading
systems as necessary to resolve those Year 2000 issues which have
23
<PAGE>
been identified. The Company is in the final stages of testing and implementing
those systems that have been upgraded.
COSTS OF COMPLIANCE. Management does not expect the costs of bringing the
Company's systems into Year 2000 compliance will have a material adverse effect
on the Company's financial conditions, results of operations or liquidity. The
Company has budgeted $10,000 to address Year 2000 issues. As of September 30,
1998, the Company has incurred about $1,000 in costs to address these issues.
The largest potential risk to the Company concerning Year 2000 is the
malfunction of its data processing system. In the event its data processing
system does not function properly, the Company is prepared to perform functions
manually. The Company believes it is in compliance with regulatory guidelines
regarding Year 2000 compliance, including the timetable for achieving
compliance.
RISKS RELATED TO THIRD PARTIES. The impact of Year 2000 non-compliance by
third parties with which the Company transacts business cannot be accurately
gauged. The Company identified its largest dollar deposit (aggregate deposits
over $500,000) and loan ($250,000 or more ) customers and, based on information
available to the Company, conducted a preliminary evaluation to determine which
of those customers are likely to be affected by Year 2000 issues. The Company
then surveyed those customers deemed at risk to determine their readiness with
respect to Year 2000 issues, including their awareness of Year 2000 issues,
plans to address such issues and progress with respect to such plans. The survey
included approximately 71% of all depositors with average balances of $500,000
or greater, which is approximately 10 % of its total dollar deposit base , and
approximately 53% of its borrowers of $250,000 or more, which is approximately
13% of its total dollar loan base. The responses to these surveys are due by
December 31, 1998. As of the September 30, 1998, approximately 23.6% of such
customers have responded to the survey and all of those customers are aware of
Year 2000 issues, are in the process of updating their systems and have informed
the Company that they believe they will be ready for the Year 2000 date change
by the end of 1999. The Company will continue to review such responses as they
are returned and will encourage customers to resolve any identified problems. To
the extent a problem is identified, the Company intends to monitor the
customer's progress in resolving such problem. In the event that Year 2000
noncompliance adversely affects a borrower, the Company may be required to
charge-off the loan to that borrower. For a discussion of possible effects of
such charge-offs, see "--Contingency Plans" below. In the event that Year 2000
noncompliance causes a depositor to withdraw funds, the Company plans to
maintain additional cash on hand. The Company relies on the Federal Reserve for
electronic fund transfers and check clearing and understands that the Federal
Reserve expects its systems to be Year 2000 compliant by the end of 1998. With
respect to its borrowers, the Company includes in its loan documents a Year 2000
disclosure form and an addendum to the loan agreement in which the borrower
represents and warrants its Year 2000 compliance to the Company.
CONTINGENCY PLANS. The Company has finalized its contingency planning with
respect to the Year 2000 date change and believes that if its own systems should
fail, the company could convert to a manual entry system for a period of up to
six months without significant losses. The company believes that any mission
critical systems could be recovered and operating within seven days. In the
event that the Federal Reserve is unable to handle-electronic funds transfers
and check clearing, the Company does not expect the impact to be material to its
financial condition or results of operations as long as the Company is able to
utilize an alternative electronic funds transfer and clearing source. As part of
its contingency planning, the Company has reviewed its loan customer base and
the potential impact on capital of Year 2000 noncompliance. Based upon such
review, using what it considers to be a reasonable worst case scenario, the
Company has assumed that certain of its commercial borrowers whose businesses
are most likely to be affected by Year 2000 noncompliance would be unable to
repay their loans, resulting in charge-offs of loan amounts in excess of
collateral values. If such were the case, the Company believes that it is
unlikely that its exposure would exceed $300,000, although there are no
assurances that this amount will not be substantially higher. The Company does
not believe that this amount is material enough for the Company to adjust it
current methodology for making provisions to the allowance for credit losses. In
addition, the Company plans to maintain additional cash on hand to met any
unusual deposit withdrawal activity.
24
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company manages market risk, 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. It considers
macroeconomic variables, Company strategy, liquidity and other factors as it
quantifies market risk. There have been no material changes of this nature since
the Prospectus filing on November 11, 1998.
25
<PAGE>
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDING
Not Applicable
ITEM 2. CHANGES IN SECURITIES
a. Not applicable
b. Not applicable
c. Not applicable
d. See Rider 24A
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
See Rider 24B
ITEM 5. OTHER INFORMATION
Not applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. The following exhibit is filed with this report: Exhibit 27.
Financial Data Schedule
b. No reports on Form 8-K were filed by the Company during the three
months ended September 30, 1998.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Company has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PROSPERITY BANCSHARES, INC.
/s/ DAVID ZALMAN
David Zalman
Vice President/Secretary
/s/ DAVID HOLLAWAY
David Hollaway
Chief Financial Officer
26
<PAGE>
Rider 24A
Use of Proceeds
The effective date of the Registration Statement for which use of proceeds
information is being disclosed herein was November 10, 1998 and the SEC file
number assigned to the Registration Statement was 333-63267. The offering (the
"Offering") to which the Registration Statement related commenced on November
12, 1998 and has been terminated following the sale of all securities
registered. The managing underwriter for the offering was Keefe, Bruyette and
Woods, Inc. The class of securities registered by the Registration Statement was
the Company's Common Stock, par value $1.00 per share.
For the account of the Company, the number of shares of Common Stock
registered and sold was 1,182,517 and the aggregate offering price of such
shares was $14,190,204. For the account of the selling shareholders, the number
of shares of Common Stock registered and sold was 791,783 and the aggregate
offering price of such shares was $9,501,396.
In connection with the Offering, the Company incurred expenses of $993,314
for underwriter's discounts and other expenses of $356,392 resulting in total
expenses of $1,349,706. No Offering expenses were paid to an affiliate of the
Company.
The net proceeds of the Offering to the Company were $13,196,890, of which
the Company used $2,000,000 for repayment of indebtedness to Norwest Bank
Minnesota, National Bank Minnesota, National Association and $11,196,890 for
working capital.
27
<PAGE>
Rider 24B
On September 9, 1998, the Company held a special meeting of shareholders to
consider and act upon the following items:
1. to consider and act upon a proposal to amend the Company's Articles of
Incorporation to increase the number of authorized shares of common
stock to 50 million shares and to increase the number of authorized
shares of preferred stock to 20 million shares, issuable in series by
the Board of Directors;
2. to consider and act upon a proposal to amend the Bylaws of the Company
to provide for the classification of the Board of Directors into three
classes of directors with staggered terms of office;
3. to elect eight directors, with three directors to serve until the 2001
annual meeting of shareholders, three directors to serve until the
2000 annual meeting of shareholders and two directors to serve until
the 1999 annual meeting of shareholders;
4. to consider and act upon a proposal to amend the Bylaws of the Company
to permit the Bylaws of the Company to be amended only by the Board of
Directors;
5. to consider and act upon a proposal to amend the Company's Articles of
Incorporation to provide for indemnification to the fullest extent
allowed by law;
6. to consider and act upon a proposal to amend the Company's Articles of
Incorporation to reclassify and amend Article Four, Section 4.3.1
which prohibits preemptive rights as Article Thirteen;
7. to consider and act upon a proposal to reclassify Article Four,
Section 4.3.3 which prohibits cumulative voting as Article Fourteen;
8. to consider and act upon a proposal to amend the Company's Articles of
Incorporation to reduce from two-thirds to a majority the number of
shares of common stock required to approve extraordinary corporate
transactions;
9. to consider and act upon a proposal to amend the Company's Articles of
Incorporation to limit, consistent with Texas law, the liability of
the Company's directors for monetary damages in certain instances;
10. to consider and act upon a proposal to amend the Company's Articles of
Incorporation to increa from 10% to 50% the percentage of the
outstanding shares of the Company entitled to vote that is required to
call a special meeting of Company's shareholders; and
11. to consider and act upon a proposal to approve the Company's 1998
Stock Incentive Plan.
28
<PAGE>
With respect to the election of directors, the voting was as follows:
BROKER
NOMINEE FOR WITHHELD NON-VOTE
------- ------- -------- --------
843,391 15,275
J. T. Herin 843,391 15,275
Charles Slavik 843,391 15,275
Harrison Stafford 843,391 15,275
Harry Bayne 843,391 15,275
Jim Bouligny 843,391 15,275
Robert Steelhammer 843,391 15,275
Tracy T. Rudolph 843,391 15,275
David Zalman 843,391 15,275
With respect to each of the other items of business listed above, the voting was
as follows:
Broker
For Against Abstain Non-Vote
Amendment of Articles to
increase authorized stock 843,391 15,275
Amendment of Bylaws to
classify the Board of
Directors 843,391 15,275
Amendment of Bylaws to
permit the amendment of
the Bylaws only by the
Board of Directors 843,391 15,275
Amendment of Articles to
provide for
idemnification to the
fullest extent allowed by
law 843,391 15,275
Reclassify and amend
Article Four, Section
4.3.1 of the Articles 837,591 15,275 5,800
Reclassify Article Four,
Section 4.3.3 of the
Articles 837,591 21,075
Amendment of Articles to
reduce the vote required
to approve extraordinary
corporate transactions 843,391 15,275
Amendment of Articles to
limit the liability of
Directors for monetary
damages in certain
instances 842,991 15,675
Amendment of Articles to
increase the percentage
of shares required to
call a special meeting of
shareholders 843,391 15,275
Approval of the Company's
1998 Stock Incentive Plan 842,991 15,675
There was no other business to come before the meeting.
29
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