PROSPECTUS
1,716,783 SHARES
[LOGO]
PROSPERITY BANCSHARES, INC.
COMMON STOCK
Of the 1,716,783 shares of Common Stock (the "Common Stock") offered
hereby (the "Offering"), 925,000 shares are being sold by Prosperity
Bancshares, Inc. (the "Company") and 791,783 shares are being sold by certain
shareholders of the Company (the "Selling Shareholders"). Of the shares being
sold by the Selling Shareholders, 486,116 shares are being sold by directors and
executive officers of the Company and accordingly, the proceeds from the sale of
such shares, which constitute a significant portion of the proceeds of the
Offering, will benefit affiliates of Company. The Company will not receive any
proceeds from the sale of shares by the Selling Shareholders. Prior to the
Offering, there has been no established public market for the Common Stock. The
initial public offering price has been determined by negotiations between the
Company and representatives of the Underwriters (the "Representatives"). See
"Underwriting." The shares of Common Stock have been approved for quotation on
The Nasdaq Stock Market's National Market ("Nasdaq/National Market") under the
symbol "PRSP."
THE SHARES OF COMMON STOCK OFFERED HEREBY ARE NOT SAVINGS OR DEPOSIT
ACCOUNTS AND ARE NOT INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE
BANK INSURANCE FUND, THE SAVINGS ASSOCIATION INSURANCE FUND OR ANY OTHER
GOVERNMENTAL AGENCY.
SEE "RISK FACTORS" ON PAGE 9 FOR A DISCUSSION OF CERTAIN FACTORS THAT
SHOULD BE CONSIDERED BY PROSPECTIVE INVESTORS.
------------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------
PROCEEDS PROCEEDS
PRICE TO UNDERWRITING TO TO SELLING
PUBLIC DISCOUNT(1) COMPANY(2) SHAREHOLDERS
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Per Share............................... $12.00 $0.84 $11.16 $11.16
- -----------------------------------------------------------------------------------------------------------------------------
Total(3)................................ $20,601,396 $1,442,098 $10,323,000 $8,836,298
- -----------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) The Company and the Selling Shareholders have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act of 1933, as amended (the "Securities Act"). See
"Underwriting."
(2) Before deducting offering expenses payable by the Company, estimated at
$350,000.
(3) The Company has granted the Underwriters a 30-day option to purchase up to
257,517 additional shares of Common Stock, on the same terms and conditions
as set forth above, solely to cover over-allotments, if any. If such option
is exercised in full, the total Price to Public, Underwriting Discount and
Proceeds to Company will be approximately $23,691,600, $1,658,412, and
$13,196,890, respectively. See "Underwriting."
The shares of Common Stock to be distributed to the public are offered by
the Underwriters, subject to prior sale, when, as and if received and accepted
by the Underwriters, subject to approval of certain legal matters by counsel for
the Underwriters and certain other conditions. The Underwriters reserve the
right to withdraw, cancel or modify such offer and to reject orders in whole or
in part. It is expected that delivery of the certificates for the shares of
Common Stock will be made against payment therefor in Houston, Texas on or about
November 16, 1998.
------------------------------
KEEFE, BRUYETTE & WOODS, INC. HOEFER & ARNETT
INCORPORATED
------------------------------
The date of this Prospectus is November 11, 1998.
<PAGE>
[Map of the State of Texas Depicting the Company's Twelve Banking Center
Locations]
CERTAIN PERSONS PARTICIPATING IN THE OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK
OFFERED HEREBY. SUCH TRANSACTIONS MAY INCLUDE STABILIZING THE MARKET PRICE OF
THE COMMON STOCK, THE PURCHASE OF COMMON STOCK TO COVER SYNDICATE SHORT
POSITIONS AND THE IMPOSITION OF PENALTY BIDS. IN ADDITION, IN CONNECTION WITH
THE OFFERING, THE UNDERWRITERS (AND SELLING GROUP MEMBERS) MAY ENGAGE IN PASSIVE
MARKET MAKING TRANSACTIONS IN THE COMMON STOCK ON THE NASDAQ/NATIONAL MARKET IN
ACCORDANCE WITH RULE 103 OF REGULATION M. FOR A DESCRIPTION OF THESE ACTIVITIES,
SEE "UNDERWRITING."
2
<PAGE>
PROSPECTUS SUMMARY
THE FOLLOWING SUMMARY DOES NOT PURPORT TO BE COMPLETE, AND IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO THE MORE DETAILED INFORMATION AND FINANCIAL
STATEMENTS (INCLUDING THE NOTES THERETO) APPEARING ELSEWHERE IN THIS PROSPECTUS.
UNLESS OTHERWISE INDICATED, ALL SHARE AND PER SHARE INFORMATION HAS BEEN
ADJUSTED TO GIVE EFFECT TO A FOUR FOR ONE COMMON STOCK SPLIT EFFECTED IN THE
FORM OF A STOCK DIVIDEND EFFECTIVE AS OF SEPTEMBER 10, 1998. UNLESS OTHERWISE
INDICATED, ALL INFORMATION IN THIS PROSPECTUS ASSUMES THAT THE UNDERWRITERS'
OVER-ALLOTMENT OPTION IS NOT EXERCISED. REFERENCES TO THE COMPANY IN THIS
PROSPECTUS INCLUDE REFERENCES TO FIRST PROSPERITY BANK WHERE THE CONTEXT
REQUIRES.
THE COMPANY
Prosperity Bancshares, Inc. (the "Company") is a bank holding company
headquartered in Houston, Texas. The Company derives substantially all of its
income from the operation of its wholly-owned bank subsidiary, First Prosperity
Bank (the "Bank"), which has 12 full-service banking locations ("Banking
Centers") in the greater Houston metropolitan area and six contiguous counties
situated south and southwest of Houston. As of June 30, 1998, the Company had
total assets of $335.4 million, gross loans of $141.1 million, total deposits of
$307.8 million and total shareholders' equity of $26.5 million. The Company's
financial performance has been characterized by steady asset growth, consistent
core earnings and strong asset quality. The Company has been profitable in every
full year of its existence.
The Company was formed in 1983 as a vehicle to acquire the former Allied
Bank in Edna, and has grown through a combination of internal growth, the
acquisition of community banks and the opening of new community banking offices.
From 1988 to 1992, as a sound and profitable institution, the Company took
advantage of the economic downturn in Texas and acquired the deposits and
certain assets of failed banks in West Columbia, El Campo and Cuero and two
failed banks in Houston. The Company opened a full-service Banking Center in
Victoria in 1993 and the following year established a Banking Center in Bay
City. The Company expanded its Bay City presence in 1996 with the acquisition of
an additional branch location from Norwest Bank Texas and in 1997 the Company
acquired the Angleton branch of Wells Fargo Bank. In 1998, the Company enhanced
its West Columbia Banking Center with the purchase of a commercial bank branch
located in West Columbia. As a result of the addition of these branches and
internal growth, the Company's assets have increased from $54.2 million at the
end of 1987 to $335.4 million as of June 30, 1998 and its deposits have
increased from $46.0 million to $307.8 million in that same period. In addition,
on October 1, 1998 the Company acquired Union State Bank ("Union") in East
Bernard, which had $76.9 million in assets and $63.7 million in deposits as of
June 30, 1998. The Company paid $17.6 million in cash to the shareholders of
Union in connection with the acquisition, which would have been accretive to the
Company's earnings by $0.08 per share on a pro forma basis for the six months
ended June 30, 1998. See "Recent Acquisition."
The Company's primary market consists of the communities served by its
three locations in the greater Houston metropolitan area and its nine locations
in six contiguous counties (Brazoria, Wharton, Matagorda, Jackson, Victoria and
DeWitt) neighboring Houston. The diverse nature of the economies in each local
market served by the Company provides the Company with a varied customer base
and allows the Company to spread its lending risk throughout a number of
different industries. The Company's market areas outside of Houston are
dominated by either small community banks or branches of large regional banks.
Management believes that the Company, as one of the few mid-sized financial
institutions that combines responsive community banking with the sophistication
of a regional bank holding company, has a competitive advantage in its market
areas and excellent growth opportunities through acquisitions, new branch
locations and additional business development.
Operating under a community banking philosophy, the Company seeks to
develop broad customer relationships based on service and convenience while
maintaining its conservative approach to lending and strong asset quality. The
Company's Board members and executive officers play an important role in the
3
<PAGE>
Company's business development efforts by actively participating in a number of
civic and public service activities in the local communities served by the
Company. The Company has invested heavily in its officers and employees by
recruiting talented bankers in its market areas and rewarding excellent
performance with stock options and other economic incentives. Each of the
Company's Banking Centers is administered by a local President and operated as a
separate profit center, with each Banking Center President being held
accountable for his Banking Center's performance and compensated accordingly.
The Company offers a variety of traditional loan and deposit products to
its customers, which consist primarily of consumers and small and medium-sized
businesses. The Company tailors its products to the specific needs of customers
in a given market. The Company offers consumers home mortgage loans with
adjustable rates, automobile loans, home equity loans, debit cards and cash
management services. For businesses, the Company makes available term loans,
lines of credit and loans for working capital, business expansion and the
purchase of equipment and machinery, interim construction loans for builders and
owner-occupied commercial real estate loans. The Company provides all of its
customers with a full complement of traditional deposit products.
The Company's strategic plan includes the following goals:
o INCREASE LOAN VOLUME AND DIVERSIFY LOAN PORTFOLIO. The Company seeks
to increase its ratio of loans to deposits from the June 30, 1998
level of 45.8% to approximately 65%. Given the Company's high level of
low-cost core deposits, increased lending activity is expected to
significantly enhance the Company's net income. Historically, the
Company has elected to sacrifice some earnings for the relative
security of home mortgage loans. While maintaining its conservative
approach to lending, the Company plans to emphasize loan products such
as home equity loans and loans to finance the construction of
commercial owner-occupied real estate, and target professional service
firms such as legal and medical practices and their principals in an
effort to improve the mix of its loan portfolio.
o MAINTAIN EFFICIENCY RATIO. The Company has always emphasized cost
control. The Company has invested significantly in the infrastructure
required to centralize many of its critical operations, which
management believes can accommodate substantial additional growth and
minimize operational costs through certain economies of scale. Since
1993, the Company has acquired three branch locations and established
two new offices while improving its efficiency ratio in each
consecutive year.
o ENHANCE CROSS-SELLING. The Company trains and incents its employees
to cross-sell various products. To assist in this effort, the Company
has updated its technology to help its officers and employees identify
cross-selling opportunities through a readily accessible Customer
Information File. Using this data, the Company's officers and
directors inform customers of additional products when customers visit
or call the various Banking Centers or use their drive-in facilities.
In addition, the Company includes product information in monthly
statements and other mailouts.
o AUGMENT MARKET SHARE. In recent years, the Company has grown in each
of the communities in which it maintains a Banking Center. The Company
intends to continue seeking opportunities to expand either by
acquiring existing banks or branches of banks or by establishing new
branches. All of the Company's acquisitions have been accretive to
earnings immediately and have supplied the Company with relatively
low-cost deposits which have been used to fund the Company's lending
activities.
4
<PAGE>
THE OFFERING
<TABLE>
<CAPTION>
<S> <C>
Common Stock offered by the
Company.............................. 925,000 shares
Common Stock offered by the Selling
Shareholders....................... 791,783 shares
Common Stock to be outstanding after
the Offering....................... 4,915,308 shares
Use of Proceeds...................... The estimated net proceeds to the Company of the
Offering (approximately $10.0 million) will be used for
general corporate purposes, including support of balance
sheet growth, future acquisitions and to repay certain
indebtedness incurred in the acquisition of Union. See
"Risk Factors -- Management's Discretion as to Use of
Proceeds" and "Use of Proceeds." Of the 791,783
shares being sold by Selling Shareholders, 486,116
shares are being sold by directors and executive
officers of the Company.
Risk Factors......................... See "Risk Factors" and "Dilution" for a discussion
of certain factors that should be considered by each
prospective investor.
Nasdaq/National Market Symbol........ "PRSP"
</TABLE>
5
<PAGE>
SUMMARY CONSOLIDATED FINANCIAL DATA
The following summary consolidated financial data of the Company is derived
from the Selected Consolidated Financial Data appearing elsewhere in this
Prospectus, and should be read in conjunction with the Consolidated Financial
Statements of the Company and the Notes thereto and the information contained in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
<TABLE>
<CAPTION>
AS OF AND FOR THE
SIX MONTHS ENDED
JUNE 30, AS OF AND FOR THE YEARS ENDED DECEMBER 31,
-------------------- -----------------------------------------------------
1998 1997 1997 1996 1995 1994 1993
--------- --------- --------- --------- --------- --------- ---------
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Interest income...................... $ 10,871 $ 9,632 $ 19,970 $ 16,841 $ 14,738 $ 12,644 $ 11,879
Interest expense..................... 4,714 4,453 9,060 7,923 6,904 5,363 4,902
--------- --------- --------- --------- --------- --------- ---------
Net interest income................ 6,157 5,179 10,910 8,918 7,834 7,281 6,977
Provision for credit losses.......... 145 105 190 230 175 188 155
--------- --------- --------- --------- --------- --------- ---------
Net interest income after provision
for credit losses................ 6,012 5,074 10,720 8,688 7,659 7,093 6,822
Noninterest income................... 1,239 1,010 2,264 1,897 1,489 1,500 1,366
Noninterest expense.................. 4,255 3,667 7,836 6,634 6,046 6,021 6,067
--------- --------- --------- --------- --------- --------- ---------
Income before taxes................ 2,996 2,417 5,148 3,951 3,102 2,572 2,121
Provision for income taxes........... 939 756 1,586 1,240 781 609 492
--------- --------- --------- --------- --------- --------- ---------
Net income........................... $ 2,057 $ 1,661 $ 3,562 $ 2,711 $ 2,321 $ 1,963 $ 1,629
========= ========= ========= ========= ========= ========= =========
PER SHARE DATA(1):
Basic earnings per share............. $ 0.52 $ 0.47 $ 0.94 $ 0.77 $ 0.66 $ 0.56 $ 0.47
Diluted earnings per share........... 0.50 0.46 0.92 0.76 0.66 0.56 0.47
Book value........................... 6.64 5.83 6.22 5.36 4.68 3.81 3.66
Tangible book value(2)............... 5.22 4.35 4.81 4.21 3.95 3.02 2.81
Cash dividends....................... 0.10 0.05 0.14 0.10 0.10 0.07 --
Dividend payout ratio................ 19.39% 10.73% 15.27% 12.97% 15.14% 13.42% --%
Weighted average shares outstanding
(basic) (in thousands)............. 3,990 3,564 3,778 3,513 3,514 3,514 3,448
Weighted average shares outstanding
(diluted) (in thousands)........... 4,080 3,648 3,864 3,560 3,523 3,514 3,448
Shares outstanding at end of period
(in thousands)..................... 3,990 3,980 3,990 3,510 3,514 3,514 3,514
BALANCE SHEET DATA:
Total assets......................... $ 335,422 $ 315,079 $ 320,143 $ 293,988 $ 233,492 $ 224,022 $ 214,635
Securities........................... 158,685 157,954 167,868 147,564 117,505 121,912 138,764
Loans................................ 141,080 120,810 120,578 113,382 88,797 76,543 57,495
Allowance for credit losses.......... 1,114 956 1,016 923 753 588 734
Total deposits....................... 307,815 290,252 291,517 270,866 214,534 207,543 198,904
Borrowings and notes payable......... -- 865 2,800 3,267 1,517 2,275 2,275
Total shareholders' equity........... 26,478 23,213 24,818 18,833 16,458 13,374 12,844
AVERAGE BALANCE SHEET DATA:
Total assets......................... $ 330,099 $ 293,896 $ 304,086 $ 257,205 $ 224,701 $ 214,318 $ 202,071
Securities........................... 169,988 150,656 157,677 127,607 119,857 125,585 130,612
Loans................................ 129,228 115,424 117,586 104,534 81,631 69,200 53,422
Allowance for credit losses.......... 1,047 916 961 820 669 686 781
Total deposits....................... 300,938 268,696 278,377 236,334 207,321 197,711 186,673
Total shareholders' equity........... 25,722 20,066 21,821 17,646 14,916 13,109 11,912
PERFORMANCE RATIOS(3):
Return on average assets............. 1.25% 1.13% 1.17% 1.05% 1.03% 0.92% 0.81%
Return on average equity............. 15.99 16.56 16.32 15.36 15.56 14.97 13.68
Net interest margin
(tax-equivalent)(4)................ 4.15 3.95 4.02 3.91 3.96 3.91 3.97
Efficiency ratio(5).................. 57.53 59.25 59.48 61.34 64.85 68.56 72.71
(TABLE CONTINUED ON FOLLOWING PAGE)
6
<PAGE>
<CAPTION>
AS OF AND FOR THE
SIX MONTHS ENDED AS OF AND FOR THE
JUNE 30, YEARS ENDED DECEMBER 31,
-------------------- -----------------------------------------------------
1998 1997 1997 1996 1995 1994 1993
--------- --------- --------- --------- --------- --------- ---------
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
ASSET QUALITY RATIOS(6):
Nonperforming assets to total loans
and other real estate.............. 0.00% 0.12% 0.00% 0.00% 0.00% 0.02% 0.19%
Net loan charge-offs to average
loans.............................. 0.04 0.06 0.08 0.06 0.01 0.48 0.31
Allowance for credit losses to total
loans.............................. 0.79 0.79 0.84 0.81 0.85 0.77 1.28
Allowance for credit losses to
nonperforming loans(7)............. -- -- -- -- -- -- --
CAPITAL RATIOS(6):
Leverage ratio....................... 6.25% 5.73% 6.30% 5.45% 6.05% 5.39% 4.66%
Average shareholders' equity to
average total assets............... 7.79 6.83 7.18 6.86 6.64 6.12 5.89
Tier 1 risk-based capital ratio...... 14.32 14.55 14.94 13.11 14.99 13.75 13.45
Total risk-based capital ratio....... 15.08 15.33 15.73 13.89 15.79 14.37 14.45
</TABLE>
- ------------
(1) Adjusted for a four for one stock split effective September 10, 1998.
(2) Calculated by dividing total assets, less total liabilities and goodwill, by
shares outstanding at end of period.
(3) All interim periods have been annualized.
(4) Calculated using a 34% federal income tax rate.
(5) Calculated by dividing total noninterest expense, excluding securities
losses, by net interest income plus noninterest income.
(6) At period end, except net loan charge-offs to average loans and average
shareholders' equity to average total assets.
(7) Nonperforming loans consist of nonaccrual loans and restructured loans.
7
<PAGE>
RECENT DEVELOPMENTS
OVERVIEW
Net income for the three months ended September 30, 1998 was $1.1 million
compared to $948,000 for the three months ended September 30, 1997, an increase
of 14.0%. Net income for the nine months ended September 30, 1998 was $3.1
million compared to $2.6 million in the first nine months of 1997, an increase
of 20.3%. The increase in both periods was primarily the result of an increase
in net interest income resulting from growth in loans. The Company had no
nonperforming assets as of September 30, 1998 or 1997.
The following table presents for the periods indicated certain summary
consolidated financial data reflecting the Company's results of operations and
financial condition.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
1998 1997 1998 1997
--------- --------- --------- ---------
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE
DATA)
<S> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Net income...................... $ 1,080 $ 948 $ 3,138 $ 2,609
Basic earnings per share... 0.27 0.26 0.79 0.70
Diluted earnings per
share................... 0.26 0.25 0.77 0.69
Weighted average shares
outstanding (basic) (in
thousands).............. 3,990 3,706 3,990 3,706
Weighted average shares
outstanding (diluted)
(in thousands).......... 4,091 3,789 4,091 3,789
PERFORMANCE RATIOS:
Return on average assets........ 1.29% 1.20% 1.26% 1.16%
Return on average equity........ 15.94 16.03 15.97 16.36
Net interest margin
(tax-equivalent) (1).......... 4.22 4.00 4.19 3.97
Efficiency ratio (2)............ 57.23 59.50 57.43 59.07
</TABLE>
SEPTEMBER 30,
------------------------
1998 1997
----------- ----------
(UNAUDITED)
(DOLLARS IN THOUSANDS
EXCEPT PER SHARE DATA)
BALANCE SHEET DATA (3):
Total assets.................... $ 336,434 $ 313,416
Securities...................... 160,635 162,765
Loans........................... 147,690 118,648
Allowance for credit losses..... (1,169) (1,023)
Total deposits.................. 305,299 287,367
Total shareholders' equity...... 27,767 23,878
Book value per share............ 6.96 6.44
Tangible book value per share
(4)............................ 5.57 4.89
ASSET QUALITY RATIOS (3):
Nonperforming assets to total
loans and other real estate.... 0.00% 0.00%
Allowance for credit losses to
nonperforming loans (5)........ -- --
- ------------
(1) Calculated using a 34% federal income tax rate.
(2) Calculated by dividing total noninterest expense, excluding securities
losses, by net interest income plus noninterest income.
(3) At period end.
(4) Calculated by dividing total assets, less total liabilities and goodwill, by
shares outstanding at end of period.
(5) Nonperforming loans consist of nonaccrual loans and restructured loans.
8
<PAGE>
RISK FACTORS
AN INVESTMENT IN THE COMMON STOCK OFFERED HEREBY INVOLVES CERTAIN RISKS. IN
ADDITION TO THE OTHER INFORMATION CONTAINED OR INCORPORATED BY REFERENCE HEREIN,
THE FOLLOWING FACTORS SHOULD BE CONSIDERED CAREFULLY IN EVALUATING THE COMPANY
BEFORE PURCHASING THE COMMON STOCK OFFERED HEREBY. INFORMATION CONTAINED IN THIS
PROSPECTUS CONTAINS "FORWARD-LOOKING STATEMENTS" WHICH CAN BE IDENTIFIED BY
THE USE OF FORWARD-LOOKING TERMINOLOGY SUCH AS "BELIEVES," "ESTIMATES,"
"EXPECTS," "WILL," "WOULD," "SHOULD," "PROJECTED," "CONTEMPLATED" OR
"ANTICIPATES" OR THE NEGATIVE THEREOF OR OTHER VARIATIONS THEREON OR
COMPARABLE TERMINOLOGY. NO ASSURANCE CAN BE GIVEN THAT THE FUTURE RESULTS
COVERED BY THE FORWARD-LOOKING STATEMENTS WILL BE ACHIEVED. THE FOLLOWING
FACTORS COULD CAUSE ACTUAL EXPERIENCE TO VARY MATERIALLY FROM THE FUTURE RESULTS
COVERED IN SUCH FORWARD-LOOKING STATEMENTS. OTHER FACTORS, SUCH AS THE GENERAL
STATE OF THE ECONOMY, COULD ALSO CAUSE ACTUAL EXPERIENCE TO VARY MATERIALLY FROM
THE MATTERS COVERED IN SUCH FORWARD-LOOKING STATEMENTS.
RISKS INVOLVED IN ACQUISITIONS
The Company believes that a portion of its growth will come from
acquisitions of banks and other financial institutions. Such acquisitions,
including the recently completed acquisition of Union (the "Union
Acquisition"), involve risks of changes in results of operations or cash flows,
unforeseen liabilities relating to the acquired institution or arising out of
the acquisition, asset quality problems of the acquired entity and other
conditions not within the control of the Company, such as adverse personnel
relations, loss of customers because of change of identity, deterioration in
local economic conditions and other risks affecting the acquired institution.
See "Recent Acquisition." There can be no assurance that any such acquisitions
will enhance the Company's business, results of operations, cash flows or
financial condition, and such acquisitions may have an adverse effect on the
Company's results of operations, particularly during periods in which the
acquisitions are being integrated into the Company's operations. Operational
areas requiring significant integration include the consolidation of data
processing operations, the combination of employee benefit plans, the creation
of joint account and lending products, the development of unified marketing
plans and other related areas. Successful integration of acquired entities could
require significant expenditures by the Company that could negatively impact the
Company's results of operations. Completion of the acquisition and integration
could divert management's attention from other important issues and impact the
Company's operating results. There can be no assurance that the Company will be
able to identify other suitable acquisition candidates, that acquisitions will
be consummated on acceptable terms or that the Company will be able to
successfully integrate the operations of any acquired entity or business. The
Company's ability to acquire banks and other financial institutions may depend
on its ability to obtain additional debt and equity funding which may not be
available on terms as favorable to the Company as currently available and, if
equity funding is utilized, an acquisition may be dilutive to shareholders.
EXPOSURE TO LOCAL ECONOMIC CONDITIONS
The Company's success is dependent to a significant extent upon general
economic conditions in Texas and to a certain extent, the metropolitan Houston
area. The banking industry in Texas and Houston is affected by general economic
conditions such as inflation, recession, unemployment and other factors beyond
the Company's control. During the mid 1980s, severely depressed oil and gas and
real estate prices materially and adversely affected the Texas and Houston
economies, causing recession and unemployment in the region and resulting in
excess vacancies in the Houston real estate market and elsewhere in the state.
Since 1987, the Texas economy has improved in part due to its expansion into
industries other than those related to energy. As the Texas and Houston
economies have diversified away from the energy industry, however, they have
become more susceptible to adverse effects resulting from recession in the
national economy. Economic recession over a prolonged period or other economic
dislocation in the Texas and Houston area could cause increases in nonperforming
assets, thereby causing operating losses, impairing liquidity and eroding
capital. There can be no assurance that future adverse changes in the Texas or
Houston economies would not have a material adverse effect on the Company's
financial condition, results of operations or cash flows.
9
<PAGE>
INTEREST RATE RISK
The Company's earnings depend to a great extent on "rate differentials,"
which are the differences between interest income that the Company earns on
loans and investments and the interest expense paid on deposits and other
borrowings. These rates are highly sensitive to many factors which are beyond
the Company's control, including general economic conditions and the policies of
various government and regulatory authorities. Increases in the discount rate by
the Board of Governors of the Federal Reserve System ("Federal Reserve Board")
usually lead to rising interest rates, which affect the Company's interest
income, interest expense and investment portfolio. Also, certain governmental
policies affect the cost of funds. From time to time, maturities of assets and
liabilities are not balanced, and a rapid increase or decrease in interest rates
could have an adverse effect on the net interest margin and results of
operations of the Company. The nature, timing and effect of any future changes
in federal monetary and fiscal policies on the Company and its results of
operations are not predictable.
The Company manages its interest rate risk by analyzing the maturity and
repricing relationships between interest-earning assets and interest-bearing
liabilities at specific points in time ("GAP") and by analyzing the effects of
interest rate changes on net interest income over specific periods of time by
projecting the performances of the mix of assets and liabilities in varied
interest rate environments. At June 30, 1998, because the amount of the
Company's interest-bearing liabilities maturing or repricing within the
following twelve months exceeds the amount of interest-earning assets also
maturing or repricing during that same period, the Company is considered to be
liability sensitive, or having a negative GAP. As such, during a period of
rising interest rates, a negative GAP would tend to affect net interest income
adversely. During a period of declining interest rates, a negative GAP would
tend to result in an increase in net interest income. For a discussion of the
Company's interest rate exposure in different interest rate environments, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Financial Condition -- Interest Rate Sensitivity and Liquidity."
COMPETITION
The banking business is highly competitive, and the profitability of the
Company depends principally upon the Company's ability to compete in the market
areas in which its banking operations are located. The Company competes with
other commercial banks, savings banks, savings and loan associations, credit
unions, finance companies, mutual funds, insurance companies, brokerage and
investment banking firms, asset-based non-bank lenders and certain other
nonfinancial entities, including retail stores which may maintain their own
credit programs and certain governmental organizations which may offer more
favorable financing than the Company. Many of such competitors may have greater
financial and other resources than the Company. The Company has been able to
compete effectively with other financial institutions by emphasizing customer
service, technology and responsive decision-making on loans, by establishing
long-term customer relationships and building customer loyalty and by providing
products and services designed to address the specific needs of its customers.
Although the Company has been able to compete effectively in the past, no
assurances may be given that the Company will continue to be able to compete
effectively in the future. Various legislative acts in recent years have led to
increased competition among financial institutions. There can be no assurance
that the United States Congress or the Texas legislature will not enact
legislation that may further increase competitive pressures on the Company.
Competition from both financial and non-financial institutions is expected to
continue. See "The Company -- Competition."
REGULATION AND SUPERVISION
Bank holding companies and banks operate in a highly regulated environment
and are subject to extensive supervision and examination by several federal and
state regulatory agencies. The Company is subject to the Bank Holding Company
Act of 1956, as amended (the "BHCA"), and to regulation and supervision by the
Federal Reserve Board. The Bank, as a Texas state banking association, is
subject to regulation and supervision by the Texas Banking Department and, as a
result of the insurance of its deposits, by the Federal Deposit Insurance
Corporation ("FDIC"). These regulations are intended primarily for the
protection of depositors and customers, rather than for the benefit of
investors. The Company and the
10
<PAGE>
Bank are subject to changes in federal and state laws, as well as changes in
regulations and governmental policies, income tax laws and accounting
principles. The effects of any potential changes cannot be predicted but could
adversely affect the business, operations and cash flows of the Company and the
Bank in the future. See "Supervision and Regulation."
The Federal Reserve Board has adopted a policy that requires a bank holding
company such as the Company to serve as a source of financial strength to its
banking subsidiaries. The Federal Reserve Board has required bank holding
companies to contribute cash to their troubled bank subsidiaries based upon this
"source of strength" policy, which could have the effect of decreasing funds
available for distributions to shareholders. In addition, a bank holding company
in certain circumstances could be required to guarantee the capital plan of an
undercapitalized banking subsidiary. See "Supervision and Regulation."
DIVIDEND HISTORY AND RESTRICTIONS ON ABILITY TO PAY DIVIDENDS
While the Company currently pays cash dividends on the Common Stock, there
is no assurance that the Company will pay dividends on the Common Stock in the
future. It is the policy of the Federal Reserve Board that bank holding
companies should pay cash dividends on common stock only out of income available
over the past year and only if prospective earnings retention is consistent with
the organization's expected future needs and financial condition. The policy
provides that bank holding companies should not maintain a level of cash
dividends that undermines the bank holding company's ability to serve as a
source of strength to its banking subsidiaries.
The Company's principal source of funds to pay dividends on the shares of
Common Stock will be cash dividends that the Company receives from the Bank. The
payment of dividends by the Bank to the Company is subject to certain
restrictions imposed by federal and state banking laws, regulations and
authorities. The federal banking statutes prohibit federally insured banks from
making any capital distributions (including a dividend payment) if, after making
the distribution, the institution would be "undercapitalized" as defined by
statute. In addition, the relevant federal regulatory agencies have authority to
prohibit an insured bank from engaging in an unsafe or unsound practice, as
determined by the agency, in conducting an activity. The payment of dividends
could be deemed to constitute such an unsafe or unsound practice, depending on
the financial condition of the Bank. Regulatory authorities could impose
administratively stricter limitations on the ability of the Bank to pay
dividends to the Company if such limits were deemed appropriate to preserve
certain capital adequacy requirements. As of June 30, 1998, an aggregate of
approximately $6.2 million was available for payment of dividends by the Bank to
the Company under applicable restrictions, without regulatory approval. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Financial Condition -- Capital Resources" and "Supervision and
Regulation -- The Bank."
In addition, in connection with the Union Acquisition, the Company provided
the Federal Reserve Board with a commitment that by January 31, 1999 the Company
would attain on a consolidated basis a leverage ratio of 5.0%, a Tier 1
risk-based capital ratio of 6.0% and a total risk-based capital ratio of 10.0%.
The Company's inability to achieve any of these capital ratios could have an
impact on the Company's ability to pay dividends on its Common Stock.
DEPENDENCE ON KEY PERSONNEL
The Company and the Bank are dependent on certain key personnel including
Tracy T. Rudolph and David Zalman, both of whom are considered to be important
to the success of the Company and the Bank. The unexpected loss of Messrs.
Rudolph or Zalman or other members of senior management could have an adverse
effect on the Company and the Bank. The Company has entered into an employment
agreement with each of Messrs. Rudolph and Zalman. Each agreement is for an
initial term of three years and automatically renews each year thereafter unless
terminated in accordance with its terms. The employment agreements provide that
if the employee is terminated without cause (including constructive termination)
or if a change in control of the Company occurs, the employee shall be entitled
to receive from the Company a lump sum payment equal to three years' base
salary. The employees have the power to terminate the employment agreements upon
30 days prior notice. The employment agreements do not contain
11
<PAGE>
non-compete restrictions. The Company does not maintain key person insurance for
either Mr. Rudolph or Mr. Zalman. See "Management -- Employment Agreements."
ANTI-TAKEOVER EFFECTS OF CERTAIN CHARTER AND BYLAW PROVISIONS
The Company's Articles of Incorporation and Bylaws contain certain
provisions which may delay, discourage or prevent an attempted acquisition or
change of control of the Company. These provisions include: (i) a Board of
Directors classified into three classes of directors with the directors of each
class having staggered, three year terms, (ii) a provision that any special
meeting of shareholders of the Company may be called only by a majority of the
Board of Directors, the Chairman of the Board, the President or the holders of
at least 50% of the shares entitled to vote at the meeting, (iii) a provision
establishing certain advance notice procedures for nomination of candidates for
election as directors and for shareholder proposals to be considered at an
annual or special meeting of shareholders and (iv) a provision that denies
shareholders the right to amend the Bylaws of the Company. The Company's
Articles of Incorporation provide for noncumulative voting for directors and
authorize the Board of Directors of the Company to issue shares of preferred
stock of the Company, $1.00 par value per share, without shareholder approval
and upon such terms as the Board of Directors may determine. The issuance of
preferred stock, while providing desirable flexibility in connection with
possible acquisitions, financings and other corporate purposes, could have the
effect of making it more difficult for a third party to acquire, or of
discouraging a third party from acquiring, a controlling interest in the
Company. In addition, certain provisions of Texas law, including a provision
which restricts certain business combinations between a Texas corporation and
certain affiliated shareholders, may delay, discourage or prevent an attempted
acquisition or change in control of the Company. See "Supervision and
Regulation," "Description of Securities of the Company -- Preferred Stock,"
and "-- Texas Law and Certain Provisions of the Articles of Incorporation and
Bylaws."
MANAGEMENT'S OWNERSHIP INTEREST AND POSSIBLE EFFECTS
After the consummation of the Offering, the executive officers and
directors of the Company and members of the Executive Committee of the Bank will
beneficially own 21.89% of the outstanding shares of Common Stock, and
approximately 20.84% of such shares of Common Stock if the Underwriters' over-
allotment option is fully exercised. Accordingly, these executive officers and
directors will be able to influence, to a significant extent, the outcome of all
matters required to be submitted to the Company's shareholders for approval,
including decisions relating to the election of directors of the Company, the
determination of day-to-day corporate and management policies of the Company and
other significant corporate transactions. See "Management," "Principal and
Selling Shareholders" and "Description of Securities of the Company."
INTERESTS OF COMPANY AFFILIATES IN THE OFFERING
In connection with the Offering, certain persons who are directors or
executive officers of the Company will sell an aggregate of 486,116 shares at
the same per share price as the shares of Common Stock being sold by the
Company. These affiliates will receive, net of the underwriting discount, an
aggregate of $5,425,055 in connection with the sale of their shares. See
"Principal and Selling Shareholders."
DILUTION OF COMMON STOCK
Investors purchasing shares of Common Stock in the Offering will incur
immediate dilution of approximately 55.0% in their investment, in that the
tangible book value of the Company after the Offering will be approximately
$5.40 compared with an initial public offering price of $12.00 per share. See
"Dilution."
NO PRIOR TRADING MARKET
Prior to the Offering, there has been no public market for the shares of
Common Stock. The Common Stock has been approved for quotation on the
Nasdaq/National Market under the symbol "PRSP." One of the requirements for
trading on the Nasdaq National Market is that there be at least three registered
market
12
<PAGE>
makers in the Common Stock before trading can commence. The Representatives have
advised the Company that they intend to make a market in the Common Stock as
long as the volume of trading activity in the Common Stock and certain other
market making conditions justify doing so. Based on discussions with several
additional potential market makers, the Company and the Representatives believe
that a third firm will register as a market maker for the Common Stock.
Nonetheless, there can be no assurance that an active public market will develop
or be sustained after the Offering or that if such a market develops, investors
in the Common Stock will be able to resell their shares at or above the initial
public offering price. Making a market involves maintaining bid and asked
quotations for the Common Stock and being available as principal to effect
transactions in reasonable quantities at those quoted prices, subject to various
securities laws and other regulatory requirements. A public trading market
having the desired characteristics of depth, liquidity and orderliness depends
upon the presence in the marketplace of willing buyers and sellers of the Common
Stock at any given time, which presence is dependent upon the individual
decisions of investors over which neither the Company nor any market maker has
any control.
DETERMINATION OF MARKET PRICE AND POSSIBLE VOLATILITY OF STOCK PRICE
The initial public offering price of the shares of Common Stock has been
determined by negotiations between the Company and the Representatives and does
not necessarily bear any relationship to the Company's book value, past
operating results, financial condition or other established criteria of value
and may not be indicative of the market price of the Common Stock after the
Offering. See "Nature of the Trading Market" and "Underwriting" for
information relating to the method of determining the initial public offering
price. The stock market has from time to time, and particularly in recent
months, experienced significant price and volume volatility. These market
fluctuations may be unrelated to the operating performance of particular
companies whose shares are traded and may adversely affect the market price of
the Common Stock. There can be no assurance that the market price of the Common
Stock will not decline below the initial public offering price.
MANAGEMENT'S DISCRETION AS TO USE OF PROCEEDS
Other than the repayment of $2.0 million of indebtedness incurred in
connection with the Union Acquisition, the Company has no specific plans or
allocations for the remaining net proceeds of the Offering other than for
general corporate purposes, including the support of anticipated balance sheet
growth and future acquisitions. Accordingly, management will have broad
discretion with respect to the expenditure of the net proceeds of the Offering.
See "Use of Proceeds."
SHARES ELIGIBLE FOR FUTURE SALE
The Company will have 4,915,308 shares of Common Stock outstanding after
the Offering. Of these shares, the 1,716,783 shares sold in the Offering (34.93%
of the shares to be issued and outstanding) will be freely tradeable by persons
other than "affiliates" of the Company without restriction or registration
under the Securities Act. The remaining 3,198,525 shares, as well as any shares
purchased by an affiliate in the Offering, constitute "restricted securities"
for purposes of Rule 144 under the Securities Act. "Restricted securities" may
be sold only pursuant to Rule 144 or another exemption from registration under
the Securities Act. In general, under Rule 144 as currently in effect, at any
time following the 90th day after consummation of the Offering, a person who has
beneficially owned "restricted securities" for at least one year, including
persons who may be deemed to be "affiliates" of the Company, would be entitled
to sell in any three month period a number of such shares that does not exceed
the greater of the average weekly trading volume during the four calendar weeks
preceding such sale or one percent of then outstanding shares of Common Stock.
Shares held for at least two years by a person who has not been an "affiliate"
of the Company at any time during the 90 days preceding the sale of such shares
will be freely tradable in accordance with Rule 144(k) under the Securities Act,
without regard to volume and other restrictions of Rule 144. Of the 3,990,308
shares of Common Stock outstanding prior to the Offering, the Company estimates
that 1,075,964 shares will be held by affiliates after the Offering. In
addition, the Company, its executive officers and directors and certain
shareholders (who collectively will own 33.33% of the outstanding shares after
the consummation of the Offering) have agreed with the Representatives not to
13
<PAGE>
offer, sell, contract to sell or otherwise dispose of any of their shares of
Common Stock for a period of 180 days after the date of this Prospectus without
the permission of the Representatives. As of the date of this Prospectus, no
person or entity has any contractual right to require the Company to register
any securities under the Securities Act. No prediction can be made as to the
effect, if any, that future sales of Common Stock or the availability of Common
Stock for future sale will have on the market price of the Common Stock
prevailing from time to time. Sales of a substantial number of such shares in
the future, or the perception that such sales could occur, could adversely
affect the market price of the Common Stock. See "Management" and "Principal
and Selling Shareholders."
REGULATION OF CONTROL
Individuals, alone or acting in concert with others, seeking to acquire 10%
or more of any class of voting securities of the Company must comply with the
Change in Bank Control Act, which requires the prior approval of the Federal
Reserve Board for any such acquisition. Entities seeking to acquire 5% or more
of any class of voting securities of, or otherwise to control, the Company may
be required to obtain the prior approval of the Federal Reserve Board under the
BHCA. Accordingly, prospective investors need to be aware of and to comply with
these requirements, if applicable, in connection with any purchase of shares of
the Common Stock offered hereby.
YEAR 2000 ISSUES
Significant uncertainty exists concerning the potential effects associated
with "Year 2000" issues. The Company formally initiated a project in November
1997 to ensure that its operational and financial systems will not be adversely
affected by Year 2000 software 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 resources that management believes are
necessary to ensure completion. An inventory of all systems and products that
could be affected by the Year 2000 date change has been developed, verified and
categorized as to its importance to the Company. The software for the Company's
systems is primarily provided through service bureaus and software vendors. The
Company is requiring its software providers to demonstrate and represent that
the products provided are or will be Year 2000 compliant and has planned a
program of testing compliance. In the event that 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.
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
condition, results of operations or liquidity. Nonetheless, the Company's
ability to predict the costs associated with Year 2000 compliance is subject to
some uncertainties, and the Company may incur unexpected additional expenditures
in connection with Year 2000 compliance, which expenditures could be material.
In addition, there can be no assurance that the operational and financial
systems of the Company, its suppliers or its customers will not be affected by
Year 2000 software problems. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Financial Condition -- Year
2000 Compliance."
14
<PAGE>
THE COMPANY
GENERAL
The Company was formed in 1983 as a vehicle to acquire the former Allied
Bank in Edna, which was chartered in 1949. The Company's headquarters are
located at 3040 Post Oak Boulevard in Houston, Texas and its telephone number is
(713) 993-0002. As of June 30, 1998, the Company had approximately 155
shareholders of record.
The Company has grown through a combination of internal growth, the
acquisition of community banks and the opening of new community banking offices.
Utilizing a low cost of funds and employing stringent cost controls, the Company
has been profitable in every full year of its existence, including the period of
adverse economic conditions in Texas in the late 1980s. From 1988 to 1992, as a
sound and profitable institution, the Company took advantage of this economic
downturn and acquired the deposits and certain assets of failed banks in West
Columbia, El Campo and Cuero and two failed banks in Houston, which diversified
the Company's franchise and increased its core deposits. The Company opened a
full-service Banking Center in Victoria in 1993 and the following year
established a Banking Center in Bay City. The Company expanded its Bay City
presence in 1996 with the acquisition of an additional branch location from
Norwest Bank Texas and in 1997 the Company acquired the Angleton branch of Wells
Fargo Bank. In 1998, the Company enhanced its West Columbia Banking Center with
the purchase of a commercial bank branch located in West Columbia. As a result
of the addition of these branches and internal growth, the Company's assets have
increased from $54.2 million at the end of 1987 to $335.4 million as of June 30,
1998 and its deposits have increased from $46.0 million to $307.8 million in
that same period. In addition, on October 1, 1998 the Company acquired Union
State Bank ("Union") in East Bernard, which had $76.9 million in assets and
$63.7 million in deposits as of June 30, 1998. The Union Acquisition will
augment the Company's market share in Wharton County and would have been
accretive to the Company's earnings by $0.08 per share on a pro forma basis for
the six months ended June 30, 1998. See "Recent Acquisition."
The Company's primary market consists of the communities served by its
three locations in the greater Houston metropolitan area and its nine locations
in six contiguous counties (Brazoria, Wharton, Matagorda, Jackson, Victoria and
DeWitt) located to the south and southwest of Houston. Texas Highway 59
(scheduled to become Interstate Highway 69), which serves as one of the primary
trucking routes linking the interior United States and Mexico, runs directly
through the center of the Company's market area. The increased traffic along
this "NAFTA Highway" has enhanced economic activity in the Company's market
area and created opportunities for growth. The diverse nature of the economies
in each local market served by the Company provides the Company with a varied
customer base and allows the Company to spread its lending risk throughout a
number of different industries including farming, ranching, petrochemicals,
manufacturing, tourism, recreation and professional service firms and their
principals. The Company's market areas outside of Houston are dominated by
either small community banks or branches of large regional banks. Management
believes that the Company, as one of the few mid-sized financial institutions
that combines responsive community banking with the sophistication of a regional
bank holding company, has a competitive advantage in its market area and
excellent growth opportunities through acquisitions, new branch locations and
additional business development.
Operating under a community banking philosophy, the Company seeks to
develop broad customer relationships based on service and convenience while
maintaining its conservative approach to lending and strong asset quality. The
Company's directors and officers are important to the Company's success and play
a key role in the Company's business development efforts by actively
participating in a number of civic and public service activities in the
communities served by the Company, such as the Rotary Club, Lion's Club, United
Way and Chamber of Commerce. In addition, the Company's Banking Centers in Bay
City, Clear Lake, Cuero, Edna and Victoria maintain Community Development
Boards, whose function is to solicit new business, develop customer relations
and provide valuable community knowledge to their respective Banking Center
Presidents.
15
<PAGE>
The Company has invested heavily in its officers and employees by
recruiting talented officers in its market areas and providing them with
economic incentive in the form of stock options and bonuses based on
cross-selling performance. The senior management team has substantial experience
in both the Houston markets and the surrounding communities in which the Company
has a presence. Each Banking Center location is administered by a local
President with knowledge of the community and banking skills which complement
the local economy. The Company entrusts its Banking Center Presidents with
authority and flexibility with respect to product pricing and decision making
within general parameters established by the Company. The Company operates each
Banking Center as a separate profit center, maintaining separate data with
respect to each Banking Center's net interest income, efficiency ratio, deposit
growth, loan growth and overall profitability. Banking Center Presidents are
accountable for performance in these areas and compensated accordingly. Each
Banking Center has its own local telephone number, which enables a customer to
be served by a local banker.
BUSINESS
The Company offers a variety of traditional loan and deposit products to
its customers, which consist primarily of consumers and small and medium-sized
businesses. The Company tailors its products to the specific needs of customers
in a given market. The Company maintains approximately 25,000 separate deposit
accounts and over 5,000 separate loan accounts. At June 30, 1998, approximately
22.3% of the Company's total deposits were noninterest-bearing demand deposits
and for the period ended June 30, 1998, the Company's average cost of funds was
3.11%.
The Company has been an active mortgage lender, with one-to-four family and
commercial mortgage loans comprising 60.6% of the Company's total loans as of
June 30, 1998. The Company also offers loans for automobiles and other consumer
durables, home equity loans, debit cards, personal computer banking and other
cash management services and telebanking. By offering certificates of deposit,
NOW accounts, savings accounts and overdraft protection at competitive rates,
the Company gives its depositors a full range of traditional deposit products.
The Company has successfully introduced Banclub, which for a monthly fee
provides consumers with a package of benefits including unlimited free checking,
personalized checks, credit card protection, free travelers checks, cashier's
checks and money orders and certain travel discounts.
The businesses targeted by the Company are primarily those that require
loans in the $100,000 to $3.0 million range. The Company offers these businesses
a broad array of loan products including term loans, lines of credit and loans
for working capital, business expansion and the purchase of equipment and
machinery, interim construction loans for builders and owner-occupied commercial
real estate loans. For its business customers, the Company has developed a
specialized checking product called Business 10 Checking which provides
discounted fees for checking and normal account analysis.
STRATEGY
The Company's strategic plan includes the following goals:
INCREASE LOAN VOLUME AND DIVERSIFY LOAN PORTFOLIO. The Company seeks to
increase its ratio of loans to deposits from the June 30, 1998 level of 45.8% to
approximately 65%. Given the Company's high level of low-cost core deposits,
increased lending activity is expected to significantly enhance the Company's
net income. Historically, the Company has elected to sacrifice some earnings for
the relative security of home mortgage loans. While maintaining its conservative
approach to lending, the Company plans to emphasize both new and existing loan
products. Among new loan products, the Company has successfully introduced home
equity lending, which contributed $4.7 million in new loans during the first
half of 1998. The Company has also increased its number of loans to finance the
construction of commercial owner-occupied real estate and loans to commercial
businesses for accounts receivable financing and other purposes. With the Union
Acquisition, the Company's agricultural loans increased from $8.4 million to
$22.2 million on a pro forma basis as of June 30, 1998. The Company is also
targeting professional service firms such as legal and medical practices for
both loans secured by owner-occupied premises and personal loans to their
principals. As an outgrowth of its traditional mortgage lending activity, the
Company is making more jumbo mortgage loans, particularly in the Houston area.
16
<PAGE>
MAINTAIN EFFICIENCY RATIO. The Company has always emphasized cost control.
The Company has invested significantly in the infrastructure required to
centralize many of its critical operations, such as data processing and loan
application processing. For its Banking Centers, which the Company operates as
independent profit centers, the Company supplies complete support in the areas
of loan review, internal audit, compliance and training. The Company maintains a
"products committee" which provides support in the areas of product
development, marketing and pricing. Management believes that this centralized
infrastructure can accommodate substantial additional growth while enabling the
Company to minimize operational costs through certain economies of scale. Since
1993, the Company has acquired three branch locations and established two new
offices while improving its efficiency ratio in each consecutive year.
ENHANCE CROSS-SELLING. The Company recognizes that its customer base
provides significant opportunities to cross-sell various products, and has
increased its focus on cross-selling opportunities by training employees to
identify and maximize cross-selling opportunities. The Company uses bonuses to
encourage cross-selling efforts, and fosters friendly competition among the
Banking Centers to achieve better cross-selling results. To assist with
cross-selling efforts, the Company has updated its technology to help officers
and employees identify cross-selling opportunities through a readily accessible
Customer Information File which details personal information, existing account
relationships and related account relationships. Using this data, the Company's
officers and employees inform customers of additional products when customers
visit or call the various Banking Centers or use their drive-in facilities. In
addition, the Company includes product information in monthly statements and
other mailouts. The products most frequently targeted for cross-selling include
auto loans, mortgage loans, home equity loans, checking accounts, savings
accounts, certificates of deposit, Individual Retirement Accounts, direct
deposit accounts, personal computer banking and safe deposit boxes.
AUGMENT MARKET SHARE. In recent years, the Company has grown in each of
the communities in which it maintains a Banking Center. The Company intends to
continue seeking opportunities, both inside and outside its existing markets, to
expand either by acquiring existing banks or branches of banks or by
establishing new branches. All of the Company's acquisitions have been accretive
to earnings immediately and have supplied the Company with relatively low-cost
deposits which have been used to fund the Company's lending activities. Factors
used by the Company to evaluate expansion opportunities include the similarity
in management and operating philosophies, whether the acquisition will be
accretive to earnings and enhance shareholder value, the ability to achieve
economies of scale to improve the efficiency ratio and the opportunity to
enhance the Company's image and market presence.
17
<PAGE>
FACILITIES
The Company conducts business at 12 full-service Banking Centers. The
following table sets forth specific information on each such location. The
Company's headquarters are located at 3040 Post Oak Boulevard, in Houston,
Texas. The Company owns all of the buildings in which its Banking Centers are
located other than the Post Oak, Meyerland and Victoria Banking Centers.
DEPOSITS AT
LOCATION JUNE 30, 1998
- ------------------------------------- -----------------------
(DOLLARS IN THOUSANDS)
Angleton............................. $30,751
Bay City (7th Street)................ 14,692
Bay City (Avenue F).................. 31,283
Clear Lake........................... 29,410
Cuero................................ 23,493
East Bernard(1)...................... 63,723
Edna................................. 35,540
El Campo............................. 40,795
Houston (Meyerland).................. 19,704
Houston (Post Oak)................... 29,977
Victoria............................. 11,489
West Columbia........................ 40,681
- ------------
(1) Acquired on October 1, 1998 in connection with the Union Acquisition.
COMPETITION
The banking business is highly competitive, and the profitability of the
Company depends principally on the Company's ability to compete in its markets.
The Company competes with other commercial banks, savings banks, savings and
loan associations, credit unions, finance companies, mutual funds, insurance
companies, brokerage and investment banking firms, asset-based non-bank lenders
and certain other nonfinancial entities, including retail stores which may
maintain their own credit programs and certain governmental organizations which
may offer more favorable financing than the Company. The Company has been able
to compete effectively with other financial institutions by emphasizing customer
service, technology and responsive decision-making on loans, by establishing
long-term customer relationships and building customer loyalty, and by providing
products and services designed to address the specific needs of its customers.
See "Risk Factors -- Competition."
EMPLOYEES
As of June 30, 1998, the Company had 118 full-time equivalent employees, 50
of whom were officers of the Bank. The Company provides medical and
hospitalization insurance to its full-time employees. The Company considers its
relations with employees to be excellent. Neither the Company nor the Bank is a
party to any collective bargaining agreement.
LEGAL PROCEEDINGS
The Company and the Bank from time to time are parties to or otherwise
involved in legal proceedings arising in the normal course of business.
Management does not believe that there is any pending or threatened proceeding
against the Company or the Bank which, if determined adversely, would have a
material effect on the business, results of operations or financial condition of
the Company or the Bank.
18
<PAGE>
USE OF PROCEEDS
The net proceeds to be received by the Company from the Offering, after
deducting the underwriting discount and estimated Offering expenses, are
estimated to be approximately $10.0 million, or $12.8 million if the
Underwriters' over-allotment option is fully exercised. The Company intends to
use $2.0 million of such proceeds for repayment of indebtedness (the
"Indebtedness") to Norwest Bank Minnesota, National Association ("Norwest")
incurred in connection with the Union Acquisition. The principal amount of the
Indebtedness is repayable over a seven year period and bears interest at the
federal funds rate plus 2.75%. The Indebtedness is secured by all of the capital
stock of the Bank. Although the Company has no specific plans for the remaining
net proceeds, the Company has elected to make the Offering at this time in order
to have funds available to support anticipated balance sheet growth and to use
in connection with any future acquisition opportunities that the Company decides
to pursue.
Pending the application of the net proceeds, the Company intends to invest
such proceeds in short-term, interest-bearing securities, certificates of
deposit or guaranteed obligations of the United States of America.
DIVIDEND POLICY
Holders of Common Stock are entitled to receive dividends when, as and if
declared by the Company's Board of Directors out of funds legally available
therefor. While the Company has paid dividends on its Common Stock since 1994,
there is no assurance that dividends will be paid in the future.
For a foreseeable period of time, the principal source of cash revenues to
the Company will be dividends paid by the Bank with respect to the Bank's
capital stock. There are certain restrictions on the payment of such dividends
imposed by federal and state banking laws, regulations and authorities. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Financial Condition -- Capital Resources" and "Supervision and
Regulation -- The Bank."
In the future, the declaration and payment of dividends on the Common Stock
will depend upon the earnings and financial condition of the Company, liquidity
and capital requirements, the general economic and regulatory climate, the
Company's ability to service any equity or debt obligations senior to the Common
Stock and other factors deemed relevant by the Company's Board of Directors. See
"Supervision and Regulation" and "Description of Securities of the Company."
As of June 30, 1998, an aggregate of approximately $6.2 million was available
for payment of dividends by the Bank to the Company under applicable
restrictions, without regulatory approval. Regulatory authorities could impose
administratively stricter limitations on the ability of the Bank to pay
dividends to the Company if such limits were deemed appropriate to preserve
certain capital adequacy requirements. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Financial
Condition -- Capital Resources" and "Supervision and Regulation."
In addition, in connection with the Union Acquisition, the Company provided
the Federal Reserve Board with a commitment that by January 31, 1999 the Company
would attain on a consolidated basis a leverage ratio of 5.0%, a Tier 1
risk-based capital ratio of 6.0% and a total risk-based capital ratio of 10.0%.
The Company's inability to achieve any of these capital ratios could have an
impact on the Company's ability to pay dividends on its Common Stock.
19
<PAGE>
DILUTION
As of June 30, 1998, the tangible book value of the Common Stock was $5.22
per share. "Tangible book value per share" represents the amount of total
tangible assets less total liabilities divided by the number of shares of Common
Stock outstanding. After giving effect to the Union Acquisition, including $4.2
million of goodwill and core deposit intangibles and the sale by the Company of
925,000 shares of Common Stock offered hereby (after deducting the underwriting
discount and other estimated offering expenses to be paid by the Company), the
pro forma tangible book value of the Company as of June 30, 1998 would have been
$5.40 per share. This represents an immediate increase in net tangible book
value of $0.18 per share to current shareholders and an immediate dilution of
$6.60 per share to new investors. The following table illustrates this per share
dilution:
Price to public...................... $ 12.00
---------
Tangible book value per share
before Offering................ $ 5.22
Increase per share attributable
to new investors............... $ 0.18
---------
Pro forma tangible book value per
share after Offering............... $ 5.40
---------
Dilution to new investors............ $ 6.60
=========
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, a Texas banking association organized in 1907, pursuant to a statutory
merger. 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 June 30, 1998, Union had
total assets of approximately $76.9 million, total deposits of approximately
$63.7 million (12.9% of which were noninterest-bearing) and total shareholders'
equity of approximately $12.9 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 $0.08 per share on a pro forma basis for the six months ended June 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 June
30, 1998 from $8.4 million to $22.2 million on a pro forma basis. Union had 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.
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.
20
<PAGE>
UNAUDITED PRO FORMA COMBINED CONDENSED FINANCIAL STATEMENTS
The following unaudited pro forma combined condensed financial statements
set forth the consolidated balance sheet at June 30, 1998 and the consolidated
income statements for the six month period ended June 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 June 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 operations following consummation of the
Union Acquisition.
PRO FORMA COMBINED BALANCE SHEET
JUNE 30, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
PRO FORMA
ADJUSTMENTS
-------------------- PRO FORMA
COMPANY UNION DEBITS CREDITS COMBINED
--------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
ASSETS
Cash and due from banks.............. $ 13,054 $ 1,673 $ 2,000(b) $ 4,700(b) $ 12,027
Federal funds sold................... 7,875 5,100 -- 12,900(b) 75
--------- --------- --------- --------- ---------
Total cash and cash
equivalents............... 20,929 6,773 2,000 17,600 12,102
Interest-bearing deposits in
financial institutions............. 99 -- 99
SECURITIES
Available-for-sale............... 44,744 20,069 64,813
Held-to-maturity................. 113,941 24,077 192(a) 138,210
--------- --------- --------- ---------
Total securities............ 158,685 44,146 192 203,023
LOANS
Total loans, net of unearned
discount....................... 141,080 25,227 166,307
Allowance for credit losses...... (1,114) (671) (1,785 )
--------- --------- ---------
Net loans................... 139,966 24,556 164,522
Goodwill............................. 5,659 -- 4,235(a) 9,894
Premises and equipment............... 5,452 165 566(a) 6,183
Other real estate owned.............. -- 139 139
Other assets......................... 4,632 1,162 5,794
--------- --------- --------- --------- ---------
Total assets................ $ 335,422 $ 76,941 $ 6,993 $ 17,600 $401,756
========= ========= ========= ========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits......................... $ 307,815 $ 63,723 $371,538
Funds borrowed/customer
repurchase..................... -- -- $ 2,000(b) 2,000
Other liabilities................ 1,129 354 257(a) 1,740
--------- --------- --------- ---------
Total liabilities........... 308,944 64,077 2,257 375,278
Shareholders' equity:
Common stock..................... 3,994 700 $ 700(c) 3,994
Capital surplus.................. 4,817 3,300 3,300(c) 4,817
Retained earnings................ 17,708 8,929 8,929(c) 17,708
Treasury stock................... (18) -- (18 )
Net unrealized gain (loss) on
available-for-sale
securities..................... (23) (65) 65(a) (23 )
--------- --------- --------- --------- ---------
Total shareholders'
equity.................... 26,478 12,864 12,929 65 26,478
--------- --------- --------- --------- ---------
Total liabilities and
shareholders' equity...... $ 335,422 $ 76,941 $ 12,929 $ 2,322 $401,756
========= ========= ========= ========= =========
</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 $4.235 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 of
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 the capital of Union against
the investment in subsidiary of the Company.
21
<PAGE>
PRO FORMA COMBINED INCOME STATEMENT
SIX-MONTH PERIOD ENDED JUNE 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......... $ 5,568 $ 1,040 $ 6,608
Interest on securities............. 5,176 1,375 6,551
Interest on federal funds sold..... 127 196 323
---------- ------- ----------
Total interest income......... 10,871 2,611 13,482
Interest expense:
Interest on deposits............... 4,646 1,238 5,884
Interest on other borrowings....... 68 -- $ 83(a) 151
---------- ------- ------ ----------
Total interest expense........ 4,714 1,238 83 6,035
Net interest income..................... 6,157 1,373 (83) 7,447
Provision for credit losses........ 145 -- 145
---------- ------- ------ ----------
Net interest income after provision for
credit losses......................... 6,012 1,373 (83) 7,302
Noninterest income:
Service charges.................... 1,136 98 1,234
Other noninterest income........... 103 32 135
---------- ------- ----------
Total noninterest income...... 1,239 130 1,369
Noninterest expense:
Salaries and employee benefits..... 2,115 453 2,568
Net occupancy expense.............. 427 58 10(b) 495
Other noninterest expense.......... 1,713 214 141(c) 2,068
---------- ------- ------ ----------
Total noninterest expense..... 4,255 725 151 5,131
Income before federal income taxes...... 2,996 778 (234) 3,540
Federal income taxes............... 939 248 $ 32(d) 1,155
---------- ------- ------ ------- ----------
Net income.................... $ 2,057 $ 530 $ (234) $ 32 $ 2,385
========== ======= ====== ======= ==========
Basic earnings per share:
Net income per share............... $ .52 $ 7.57 $ .60
Average shares outstanding......... 3,990,308 70,000 3,990,308
========== ======= ==========
Diluted earnings per share:
Net income per share............... $ .50 $ 7.57 $ .58
Average shares outstanding......... 4,080,516 70,000 4,080,516
========== ======= ==========
</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 $4.235 million in goodwill
over 15 years.
(d) This adjustment represents the federal income tax effect of the above
adjustments.
22
<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 -- $ 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.......... 3,057 436 281(c) 3,774
---------- --------- ------- ----------
Total noninterest
expense................. 7,836 1,503 300 9,639
Income before federal income taxes... 5,148 1,588 (464) 6,272
Federal income taxes............... 1,586 422 $ 62(d) 1,946
---------- --------- ------- ------- ----------
Net income................. $ 3,562 $ 1,166 $ (464) $ 62 $ 4,326
========== ========= ======= ======= ==========
Basic earnings per share:
Net income per share............ $ .94 $ 16.66 $ 1.15
Average shares outstanding...... 3,777,880 70,000 3,777,880
========== ========= ==========
Diluted earnings per share:
Net income per share............ $ .92 $ 16.66 $ 1.12
Average shares outstanding...... 3,863,636 70,000 3,863,636
========== ========= ==========
</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 $4.235 million in goodwill
over 15 years.
(d) This adjustment represents the federal income tax effect of the above
adjustments.
23
<PAGE>
CAPITALIZATION
The following table sets forth the consolidated capitalization of the
Company as of June 30, 1998, and as adjusted to give effect to (i) the Union
Acquisition and (ii) the sale by the Company of 925,000 shares of Common Stock
offered hereby, at a per share price of $12.00, net of the underwriting discount
and other estimated offering expenses. See "Use of Proceeds."
<TABLE>
<CAPTION>
JUNE 30, 1998
---------------------------------------------
AS ADJUSTED
AS ADJUSTED FOR THE UNION
FOR THE UNION ACQUISITION AND
ACTUAL ACQUISITION THE OFFERING
------- -------------- ----------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Notes payable........................ $ -- $ 2,000 $ --
Shareholders' Equity:
Preferred Stock, $1 par value,
20,000,000 shares authorized;
none issued and outstanding..... -- -- --
Common Stock, $1 par value;
50,000,000 shares authorized;
3,993,884 shares issued and
3,990,308 shares outstanding;
4,918,884 shares issued and
4,915,308 shares outstanding, as
adjusted........................ 3,994 3,994 4,919
Capital surplus.................... 4,817 4,817 13,865
Retained earnings.................. 17,708 17,708 17,708
Net unrealized gain (loss) on
available-for-sale securities... (23) (23) (23)
Less common stock held in
treasury-at cost................ (18) (18) (18)
------- -------------- ----------------
Total shareholders'
equity..................... 26,478 26,478 36,451
------- -------------- ----------------
Total capitalization....... $26,478 $ 28,478 $ 36,451
======= ============== ================
</TABLE>
NATURE OF THE TRADING MARKET
Prior to the Offering, there has been no public market for the shares of
Common Stock and there can be no assurance that an active public market will
develop or be sustained after the Offering or that if such a market develops,
investors in the Common Stock will be able to resell their shares at or above
the initial public offering price. See "Risk Factors -- No Prior Trading
Market." The initial public offering price of the shares of Common Stock has
been determined by negotiations between the Company and the Representatives and
does not necessarily bear any relationship to the Company's book value, past
operating results, financial condition or other established criteria of value
and may not be indicative of the market price of the Common Stock after the
Offering. Among the factors considered in such negotiations were prevailing
market and general economic conditions, the market capitalizations, trading
histories and stages of development of other traded companies that the Company
and the Representatives believed to be comparable to the Company, the results of
operations of the Company in recent periods, the current financial position of
the Company, estimates of the business potential of the Company and the present
state of the Company's development and the availability for sale in the market
of a significant number of shares of Common Stock. Additionally, consideration
has been given to the general status of the securities market, the market
conditions for new issues of securities and the demand for securities of
comparable companies at the time the Offering was made. See "Underwriting" for
information relating to the method of determining the initial public offering
price. The shares of Common Stock have been approved for quotation on the
Nasdaq/National Market under the symbol "PRSP."
24
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with the Consolidated Financial Statements of the Company and the
Notes thereto, appearing elsewhere in this Prospectus, and the information
contained in "Management's Discussion and Analysis of Financial Condition and
Results of Operations." The selected historical consolidated financial data as
of December 31, 1997 and 1996 and for the three years in the period ended
December 31, 1997 are derived from the Company's Consolidated Financial
Statements which have been audited by Deloitte & Touche LLP. The selected
historical financial data as of December 31, 1995, 1994 and 1993 and for the two
years in the period ended December 31, 1994 are derived from the Consolidated
Financial Statements which have been audited by independent public accountants.
The selected historical consolidated financial data as of and for each of the
six months ended June 30, 1998 and June 30, 1997, have not been audited but, in
the opinion of management, contain all adjustments (consisting of only normal
recurring adjustments) necessary to present fairly the financial position and
results of operations of the Company as of such dates and for such periods. The
results of operations for the six months ended June 30, 1998, are not
necessarily indicative of the results of operations that may be expected for the
year ended December 31, 1998, or for any future periods.
<TABLE>
<CAPTION>
AS OF AND FOR THE
SIX MONTHS ENDED
JUNE 30, AS OF AND FOR THE YEARS ENDED DECEMBER 31,
-------------------- -----------------------------------------------------
1998 1997 1997 1996 1995 1994 1993
--------- --------- --------- --------- --------- --------- ---------
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Interest income......................... $ 10,871 $ 9,632 $ 19,970 $ 16,841 $ 14,738 $ 12,644 $ 11,879
Interest expense........................ 4,714 4,453 9,060 7,923 6,904 5,363 4,902
--------- --------- --------- --------- --------- --------- ---------
Net interest income................. 6,157 5,179 10,910 8,918 7,834 7,281 6,977
Provision for credit losses............. 145 105 190 230 175 188 155
--------- --------- --------- --------- --------- --------- ---------
Net interest income after provision
for credit losses................. 6,012 5,074 10,720 8,688 7,659 7,093 6,822
Noninterest income...................... 1,239 1,010 2,264 1,897 1,489 1,500 1,366
Noninterest expense..................... 4,255 3,667 7,836 6,634 6,046 6,021 6,067
--------- --------- --------- --------- --------- --------- ---------
Income before taxes................. 2,996 2,417 5,148 3,951 3,102 2,572 2,121
Provision for income taxes.............. 939 756 1,586 1,240 781 609 492
--------- --------- --------- --------- --------- --------- ---------
Net income.............................. $ 2,057 $ 1,661 $ 3,562 $ 2,711 $ 2,321 $ 1,963 $ 1,629
========= ========= ========= ========= ========= ========= =========
PER SHARE DATA(1):
Basic earnings per share................ $ 0.52 $ 0.47 $ 0.94 $ 0.77 $ 0.66 $ 0.56 $ 0.47
Diluted earnings per share.............. 0.50 0.46 0.92 0.76 0.66 0.56 0.47
Book value.............................. 6.64 5.83 6.22 5.36 4.68 3.81 3.66
Tangible book value(2).................. 5.22 4.35 4.81 4.21 3.95 3.02 2.81
Cash dividends.......................... 0.10 0.05 0.14 0.10 0.10 0.07 --
Dividend payout ratio................... 19.39% 10.73% 15.27% 12.97% 15.14% 13.42% --%
Weighted average shares outstanding
(basic) (in thousands)................ 3,990 3,564 3,778 3,513 3,514 3,514 3,448
Weighted average shares outstanding
(diluted) (in thousands).............. 4,080 3,648 3,864 3,560 3,523 3,514 3,448
Shares outstanding at end of period (in
thousands)............................ 3,990 3,980 3,990 3,510 3,514 3,514 3,514
BALANCE SHEET DATA:
Total assets............................ $ 335,422 $ 315,079 $ 320,143 $ 293,988 $ 233,492 $ 224,022 $ 214,635
Securities.............................. 158,685 157,954 167,868 147,564 117,505 121,912 138,764
Loans................................... 141,080 120,810 120,578 113,382 88,797 76,543 57,495
Allowance for credit losses............. 1,114 956 1,016 923 753 588 734
Total deposits.......................... 307,815 290,252 291,517 270,866 214,534 207,543 198,904
Borrowings and notes payable............ -- 865 2,800 3,267 1,517 2,275 2,275
Total shareholders' equity.............. 26,478 23,213 24,818 18,833 16,458 13,374 12,844
AVERAGE BALANCE SHEET DATA:
Total assets............................ $ 330,099 $ 293,896 $ 304,086 $ 257,205 $ 224,701 $ 214,318 $ 202,071
Securities.............................. 169,988 150,656 157,677 127,607 119,857 125,585 130,612
Loans................................... 129,228 115,424 117,586 104,534 81,631 69,200 53,422
Allowance for credit losses............. 1,047 916 961 820 669 686 781
Total deposits.......................... 300,938 268,696 278,377 236,334 207,321 197,711 186,673
Total shareholders' equity.............. 25,722 20,066 21,821 17,646 14,916 13,109 11,912
</TABLE>
(TABLE CONTINUED ON FOLLOWING PAGE)
25
<PAGE>
<TABLE>
<CAPTION>
AS OF AND FOR THE
SIX MONTHS ENDED
JUNE 30, AS OF AND FOR THE YEARS ENDED DECEMBER 31,
-------------------- -----------------------------------------------------
1998 1997 1997 1996 1995 1994 1993
--------- --------- --------- --------- --------- --------- ---------
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
PERFORMANCE RATIOS(3):
Return on average assets................ 1.25% 1.13% 1.17% 1.05% 1.03% 0.92% 0.81%
Return on average equity................ 15.99 16.56 16.32 15.36 15.56 14.97 13.68
Net interest margin
(tax-equivalent)(4)................... 4.15 3.95 4.02 3.91 3.96 3.91 3.97
Efficiency ratio(5)..................... 57.53 59.25 59.48 61.34 64.85 68.56 72.71
ASSET QUALITY RATIOS(6):
Nonperforming assets to total loans and
other real estate..................... 0.00% 0.12% 0.00% 0.00% 0.00% 0.02% 0.19%
Net loan charge-offs to average loans... 0.04 0.06 0.08 0.06 0.01 0.48 0.31
Allowance for credit losses to total
loans................................. 0.79 0.79 0.84 0.81 0.85 0.77 1.28
Allowance for credit losses to
nonperforming loans(7)................ -- -- -- -- -- -- --
CAPITAL RATIOS(6):
Leverage ratio.......................... 6.25% 5.73% 6.30% 5.45% 6.05% 5.39% 4.66%
Average shareholders' equity to average
total assets.......................... 7.79 6.83 7.18 6.86 6.64 6.12 5.89
Tier 1 risk-based capital ratio......... 14.32 14.55 14.94 13.11 14.99 13.75 13.45
Total risk-based capital ratio.......... 15.08 15.33 15.73 13.89 15.79 14.37 14.45
</TABLE>
- ------------
(1) Adjusted for a four for one stock split effective September 10, 1998.
(2) Calculated by dividing total assets, less total liabilities and goodwill, by
shares outstanding at end of period.
(3) All interim periods have been annualized.
(4) Calculated using a 34% federal income tax rate.
(5) Calculated by dividing total noninterest expense, excluding securities
losses, by net interest income plus noninterest income.
(6) At period end, except net loan charge-offs to average loans and average
shareholders' equity to average total assets.
(7) Nonperforming loans consist of nonaccrual loans and restructured loans.
26
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management's Discussion and Analysis of Financial Condition and Results of
Operations of the Company analyzes the major elements of the Company's balance
sheets and statements of income. This section should be read in conjunction with
the Company's financial statements and accompanying notes and other detailed
information appearing elsewhere in this Prospectus.
FOR THE SIX MONTHS ENDED JUNE 30, 1998 AND 1997
OVERVIEW
The twelve month period ended June 30, 1998 was marked by strong loan
growth of $20.3 million or 16.8% which is attributable to one-to-four family
residential loans and the Company's entrance into the home equity market. The
Company showed positive earnings growth due to the increase in loan volume and
the acquisition of deposits and certain assets of a branch of Wells Fargo Bank
in Angleton, Texas in the second quarter of 1997 (the "Angleton Acquisition").
Net income for the six months ended June 30, 1998 was $2.1 million, which
was $396,000 or 23.8% more than net income for the six months ended June 30,
1997. Diluted earnings per common share were $0.50 for the six months ended June
30, 1998 and $0.46 for the six months ended June 30, 1997. The increase in net
income reflected higher net interest income and noninterest income. The increase
in net interest income was driven by growth in interest-earning assets,
including strong internal loan growth. Annualized return on average assets and
return on average common equity were 1.25% and 15.99%, respectively, for the six
months ended June 30, 1998 compared with 1.13% and 16.56%, respectively, for the
same period in 1997. Return on average assets and return on average equity
excluding amortization of goodwill were 1.39% and 17.82%, respectively, for the
six months ended June 30, 1998 compared with 1.24% and 18.18%, respectively, for
the same period in 1997. The Company's annualized efficiency ratio, calculated
by dividing total noninterest expense (excluding securities losses) by net
interest income plus noninterest income, was 57.53% for the six months ended
June 30, 1998 and 59.25% for the six months ended June 30, 1997. The Company's
efficiency ratio excluding amortization of goodwill was 54.36% for the six
months ended June 30, 1998 and 56.62% for the six months ended June 30, 1997.
Total assets at June 30, 1998 increased to $335.4 million from $315.1
million at June 30, 1997, an increase of $20.3 million or 6.4%. Deposits rose to
$307.8 million at June 30, 1998 from $290.3 million at June 30, 1997, an
increase of $17.5 million or 6.0%. This increase was attributable to internal
growth and a branch acquisition. Total shareholders' equity was $26.5 million at
June 30, 1998, representing an increase of $3.3 million or 14.2% over total
shareholders' equity of $23.2 million at June 30, 1997.
RESULTS OF OPERATIONS
NET INTEREST INCOME
Net interest income represents the amount by which interest income on
interest-earning assets, including securities and loans, exceeds interest
expense incurred on interest-bearing liabilities, including deposits and other
borrowed funds. Net interest income is the principal source of the Company's
earnings. Interest rate fluctuations, as well as changes in the amount and type
of earning assets and liabilities, combine to affect net interest income.
Net interest income for the six months ended June 30, 1998 was $6.2 million
compared with $5.2 million for the six months ended June 30, 1997, an increase
of $1.0 million or 19.2%. The Company's net interest margin on a tax-equivalent
basis was 4.15% and 3.95% and net interest spread was 3.19% and 3.06% for the
periods ended June 30, 1998 and June 30, 1997, respectively. Net interest income
increased as a result of an increase in interest-earning assets derived
primarily from growth in loans and securities. Loans increased to $141.1 million
for the six months ended June 30, 1998 from $120.8 million for the six months
ended June 30, 1997, an increase of $20.3 million or 16.8%. Home equity loans
accounted for a significant portion of this growth.
27
<PAGE>
The increase in the net interest margin for the first half of 1998 compared
with the first half of 1997 reflects a three basis point increase in the yield
on average interest-earning assets and a 10 basis point decrease in the cost of
interest-bearing liabilities. The yield on average interest-earning assets
increased to 7.15% for the six months ended June 30, 1998 from 7.12% for the six
months ended June 30, 1997, due primarily to higher-yielding loans and
securities. The cost of interest-bearing liabilities decreased to 3.96% for the
six months ended June 30, 1998 from 4.06% for the six months ended June 30,
1997, due mainly to the lower cost of the funds acquired in the Angleton
Acquisition.
The following table presents for the periods indicated the total dollar
amount of average balances, interest income from average interest-earning assets
and the resultant yields, as well as the interest expense on average
interest-bearing liabilities, expressed both in dollars and rates. Except as
indicated in the footnotes, no tax-equivalent adjustments were made and all
average balances are daily average balances. There were no nonaccruing loans at
either June 30, 1998 or June 30, 1997.
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,
----------------------------------------------------------------------
1998 1997
--------------------------------- ---------------------------------
AVERAGE INTEREST AVERAGE AVERAGE INTEREST AVERAGE
OUTSTANDING EARNED/ YIELD/ OUTSTANDING EARNED/ YIELD/
BALANCE PAID RATE BALANCE PAID RATE
----------- ------- ------- ----------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Interest-earning assets:
Loans............................... $ 129,228 $ 5,568 8.62% $ 115,424 $4,953 8.58%
Securities(1)....................... 169,988 5,175 6.09 150,656 4,563 6.06
Federal funds sold and other
temporary investments............. 4,789 127 5.30 4,626 116 5.02
----------- ------- ------- ----------- ------- -------
Total interest-earning
assets....................... 304,005 10,870 7.15% 270,706 9,632 7.12%
------- ------- ------- -------
Less allowance for credit losses.... (1,047) (916)
----------- -----------
Total interest-earning assets,
net of allowance............. 302,958 269,790
Noninterest-earning assets.............. 27,141 24,106
----------- -----------
Total assets................... $ 330,099 $ 293,896
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing liabilities:
Interest-bearing demand deposits.... $ 41,064 $ 330 1.61% $ 43,706 $ 496 2.27%
Savings and money market accounts... 78,704 1,376 3.50 57,182 934 3.27
Certificates of deposit............. 115,919 2,940 5.07 114,698 2,882 5.03
Federal funds purchased and other
borrowings........................ 2,345 68 5.80 3,755 141 7.51
----------- ------- ------- ----------- ------- -------
Total interest-bearing
liabilities.................. 238,032 4,714 3.96% 219,341 4,453 4.06%
----------- ------- ------- ----------- ------- -------
Noninterest-bearing liabilities:
Noninterest-bearing demand
deposits.......................... 65,251 53,109
Other liabilities................... 1,094 1,380
----------- -----------
Total liabilities.............. 304,377 273,830
----------- -----------
Shareholders' equity.................... 25,722 20,066
----------- -----------
Total liabilities and
shareholders' equity......... $ 330,099 $ 293,896
=========== ===========
Net interest rate spread............ 3.19% 3.06%
======= =======
Net interest income and margin(2)... $ 6,156 4.05% $5,179 3.83%
======= ======= ======= =======
Net interest income and margin (tax-
equivalent basis)(3).............. $ 6,308 4.15% $5,347 3.95%
======= ======= ======= =======
</TABLE>
- ------------
(1) Yield is based on amortized cost and does not include any component of
unrealized gains or losses.
(2) The net interest margin is equal to net interest income divided by average
interest-earning assets.
(3) In order to make pre-tax 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 34%.
28
<PAGE>
The following schedule 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 related
to higher 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.
SIX MONTHS ENDED JUNE 30,
-----------------------------
1998 VS. 1997
-----------------------------
INCREASE
(DECREASE) DUE TO
------------------
VOLUME RATE TOTAL
------ --------- ---------
(DOLLARS IN THOUSANDS)
Interest-earning assets:
Loans........................... $ 592 $ 23 $ 615
Securities...................... 586 26 612
Federal funds sold and other
temporary investments......... 4 7 11
------ --------- ---------
Total increase in interest
income.................. 1,182 56 1,238
------ --------- ---------
Interest-bearing liabilities:
Interest-bearing demand
deposits...................... (30) (136) (166)
Savings and money market
accounts...................... 352 90 442
Certificates of deposit......... 31 27 58
Federal funds purchased and
other borrowings.............. (53) (20) (73)
------ --------- ---------
Total increase (decrease)
in interest expense..... 300 (39) 261
------ --------- ---------
Increase in net interest income...... $ 882 $ 95 $ 977
====== ========= =========
PROVISION FOR CREDIT LOSSES
Provisions for credit losses are charged to income to bring the Company's
allowance for credit losses to a level deemed appropriate by management based on
the factors discussed under "-- Financial Condition -- Allowance for Credit
Losses." The provision for credit losses increased to $144,500 for the six
months ended June 30, 1998 from $105,000 for the same time period in 1997, an
increase of $39,500 or 37.6%. The increased provision was made by the Company in
response to the increase in its loan portfolio, its increased legal lending
limit and the changing risk profile in its loan portfolio. The Company had no
nonperforming assets at June 30, 1998.
NONINTEREST INCOME
Noninterest income is an important source of revenue for financial
institutions. Service charges on deposit accounts are the largest component of
noninterest income and a significant source of revenue to the Company.
Noninterest income for the six months ended June 30, 1998 was $1.2 million, an
increase of $229,000 or 22.7% from $1.0 million for the same period in 1997
resulting largely from the increase in the number and volume of accounts
resulting from the Angleton Acquisition.
The following table presents for the periods indicated the major categories
of noninterest income:
SIX MONTHS ENDED
JUNE 30,
--------------------
1998 1997
--------- ---------
(DOLLARS IN
THOUSANDS)
Service charges on deposit
accounts........................... $ 1,074 $ 863
Other noninterest income............. 165 147
--------- ---------
Total noninterest income........ $ 1,239 $ 1,010
========= =========
29
<PAGE>
NONINTEREST EXPENSE
In the six month period ended June 30, 1998, noninterest expense increased
$588,000 or 16.0% to $4.3 million from $3.7 million for the period ended June
30, 1997. The increase reflected additional expenses resulting from the Angleton
Acquisition.
The following table presents for the periods indicated the major categories
of noninterest expense:
SIX MONTHS ENDED
JUNE 30,
--------------------
1998 1997
--------- ---------
(DOLLARS IN
THOUSANDS)
Salaries and employee benefits....... $ 2,115 $ 1,901
Non-staff expenses:
Net bank premises expense....... 349 314
Equipment rentals, depreciation
and maintenance............... 201 185
Data processing................. 369 291
Professional fees............... 43 36
Regulatory assessments.......... 35 33
Ad valorem and franchise
taxes......................... 101 81
Goodwill amortization........... 235 163
Other........................... 806 663
--------- ---------
Total noninterest
expense................. $ 4,254 $ 3,667
========= =========
Salaries and employee benefits for the six months ended June 30, 1998 was
$2.1 million, an increase of $214,000 or 11.3% from $1.9 million in the same
period of 1997. The increase was principally due to additional staff associated
with the Angleton Acquisition.
Non-staff expenses increased to $2.1 million for the six month period ended
June 30, 1998 from $1.8 million for the same period in 1997, an increase of
$374,000 or 21.1%. This increase also was largely due to additional expenses
associated with the Angleton Acquisition.
INCOME TAXES
Income tax expense includes the regular federal income tax at the statutory
rate plus the income tax component of the Texas franchise tax. The amount of
federal income tax expense is influenced by the amount of taxable income, the
amount of tax-exempt income, the amount of non-deductible interest expense and
the amount of other non-deductible expenses. Taxable income for the income tax
component of the Texas franchise tax is the federal pre-tax income, plus certain
officers' salaries, less interest income on federal securities. The income tax
component of the Texas franchise tax was zero in the first six months of 1998
and 1997. During the six months ended June 30, 1998, income tax expense was
$939,000 compared with $756,000 for the six months ended June 30, 1997. The
effective tax rate for both the six months ended June 30, 1998 and 1997 was
31.3%.
IMPACT OF INFLATION
The effects of inflation on the local economy and on the Company's
operating results have been relatively modest for the past several years. Since
substantially all of the Company's assets and liabilities are monetary in
nature, such as cash, securities, loans and deposits, their values are less
sensitive to the effects of inflation than to changing interest rates, which do
not necessarily change in accordance with inflation rates. The Company tries to
control the impact of interest rate fluctuations by managing the relationship
between its interest rate sensitive assets and liabilities. See "-- Financial
Condition -- Interest Rate Sensitivity and Liquidity."
30
<PAGE>
FINANCIAL CONDITION
LOAN PORTFOLIO
Loans, net of unearned interest, were $141.1 million at June 30, 1998, an
increase of $20.3 million or 16.8% from $120.8 million at June 30, 1997. The
increase was principally due to loans generated under the Company's new home
equity loan program and one-to-four family residential loans. The State of Texas
passed legislation approving home equity lending effective January 1, 1998. The
Company makes home equity loans in amounts up to 80% of the appraised value. At
June 30, 1998, home equity loans totaled $4.7 million. In addition to offering
competitive mortgage rates, the Company marketed a new 15 year loan product
which resulted in an increase in one-to-four family residential loans during the
period. Construction and land development loans were $9.4 million at June 30,
1998, an increase of $3.1 million or 49.7% from $6.3 million at June 30, 1997.
Growth was primarily due to new home construction in the Houston market.
The following table summarizes as of the dates indicated the loan portfolio
of the Company by type of loan:
<TABLE>
<CAPTION>
JUNE 30,
-----------------------------------------------
1998 1997
--------------------- ---------------------
AMOUNT PERCENT AMOUNT PERCENT
-------- -------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Commercial and industrial............ $ 12,297 8.7% $ 12,870 10.7%
Real estate:
Construction and land
development................... 9,439 6.7 6,307 5.2
1-4 family residential.......... 64,617 45.8 52,780 43.7
Home equity..................... 4,711 3.3 -- --
Commercial mortgages............ 16,201 11.5 14,797 12.2
Farmland........................ 5,502 3.9 5,259 4.4
Multi-family residential........ 1,192 0.8 989 0.8
Agriculture.......................... 8,444 6.0 7,416 6.1
Consumer............................. 18,677 13.3 20,392 16.9
-------- -------- -------- --------
Total loans..................... $141,080 100.0% $120,810 100.0%
======== ======== ======== ========
</TABLE>
The lending focus of the Company is on one-to-four family residential,
agricultural, small and medium-sized business and consumer loans. The Company
offers a variety of commercial lending products including term loans and lines
of credit. A broad range of short to medium-term commercial loans, primarily
collateralized, are made available to businesses for working capital (including
inventory and receivables), business expansion (including acquisitions of real
estate and improvements) and the purchase of equipment and machinery.
Historically, the Company has originated loans for its own account and has not
securitized its loans. The purpose of a particular loan generally determines its
structure. All loans in the one-to-four family residential category were
originated by the Company.
Loans from $200,000 to $500,000 are evaluated and acted upon by an
officers' loan committee, which meets weekly. Loans above that amount must be
approved by the Directors Loan Committee, which meets monthly.
Generally, the Company's commercial loans are made in the Company's primary
market area and are underwritten on the basis of the borrower's ability to
service such 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. Working capital
loans are primarily collateralized by short-term assets whereas term loans are
primarily collateralized by long-term assets. As a result, commercial loans
involve additional complexities, variables and risks and require more thorough
underwriting and servicing than other types of loans.
31
<PAGE>
In addition to commercial loans secured by real estate, the Company makes
commercial mortgage loans to finance the purchase of real property which
generally consists of real estate with completed structures. The Company's
commercial mortgage loans are secured by first liens on real estate, typically
have variable interest rates and amortize over a ten to 15 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, appraisals and a review of the financial condition of the
borrower.
Additionally, a portion of the Company's lending activity has consisted of
the origination of one-to-four family residential mortgage loans collateralized
by owner-occupied 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 one-to-four 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 makes loans to finance the construction of residential and, to
a limited extent, nonresidential properties. Construction loans generally are
secured 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. In keeping with the community-oriented nature of its
customer base, the Company provides construction and permanent financing for
churches located within its market area. 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 indeterminable 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.
Consumer loans made by the Company include direct "A"-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.
Consumer loans entail greater risk than do residential mortgage loans,
particularly in the case of consumer loans that are unsecured or secured 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.
The Company provides agricultural loans for short-term crop production,
farm equipment financing and agricultural real estate financing. The Company
evaluates agricultural borrowers primarily based on
32
<PAGE>
their historical profitability, level of experience in their particular
agricultural industry, overall financial capacity and the availability of
secondary collateral to withstand economic and natural variations common to the
industry. Because agricultural 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 monitor and identify such risks.
The contractual maturity ranges of the commercial and industrial and
construction and land development portfolios and the amount of such loans with
predetermined interest rates and floating interest rates in each maturity range
as of June 30, 1998 are summarized in the following table:
<TABLE>
<CAPTION>
JUNE 30, 1998
---------------------------------------------------
AFTER ONE
ONE YEAR THROUGH AFTER FIVE
OR LESS FIVE YEARS YEARS TOTAL
--------- ----------- ----------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Commercial and industrial............ $ 5,875 $ 5,626 $ 796 $ 12,297
Construction and land development.... 3,528 2,800 3,111 9,439
--------- ----------- ----------- ---------
Total........................... $ 9,403 $ 8,426 $ 3,907 $ 21,736
========= =========== =========== =========
Loans with a predetermined interest
rate............................... $ 3,060 $ 6,264 $ 703 $ 10,027
Loans with a floating interest
rate............................... 6,343 2,162 3,204 11,709
--------- ----------- ----------- ---------
Total........................... $ 9,403 $ 8,426 $ 3,907 $ 21,736
========= =========== =========== =========
</TABLE>
NONPERFORMING ASSETS
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. 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 has historically had strong asset quality. There were no
nonperforming assets (nonaccrual loans, restructured loans and other real
estate) at June 30, 1998 compared with $144,000 at June 30, 1997 which consisted
of a single one-to-four family property which was sold later in the year at a
loss of $8,500. The Company records real estate acquired by foreclosure at the
lesser of the outstanding loan balance or the fair value at the time of
foreclosure, less estimated costs to sell.
The Company requires appraisals on loans secured 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.
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
Company generally charges off all loans before attaining nonaccrual status.
The following table presents information regarding nonperforming assets at
June 30, 1998 and June 30, 1997:
JUNE 30,
--------------------
1998 1997
--------- ---------
(DOLLARS IN
THOUSANDS)
Nonaccrual loans..................... $ -- $ --
Restructured loans................... -- --
Other real estate.................... -- 144
--------- ---------
Total nonperforming assets...... $ -- $ 144
========= =========
Nonperforming assets to total loans
and other real estate.............. 0.00% 0.12%
33
<PAGE>
ALLOWANCE FOR CREDIT LOSSES
The allowance for credit losses is a reserve 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 the diversification by
industry of the Company's commercial loan portfolio, the effect of changes in
the local real estate market on collateral values, the results of recent
regulatory examinations, the effects on the loan portfolio of current economic
indicators and their probable impact on borrowers, the amount of charge-offs for
the period, the amount of nonperforming loans and related collateral security,
the evaluation of its loan portfolio by the loan review function and the annual
examination of the Company's financial statements by its independent auditors.
Charge-offs occur when loans are deemed to be uncollectible.
Although the Company does not determine the total allowance based upon the
amount of loans in a particular type or category, risk elements attributable to
particular loan types or categories are considered in assessing the quality of
individual loans. These risk elements include, but are not limited to, the
following: (i) in the case of single family residential real estate loans, the
borrower's ability to repay the loan, including debt to income ratio and
employment and income stability, the loan to value ratio, and the age, condition
and marketability of collateral; (ii) for non-farm non-residential 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; (iii) 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; (iv) 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 ability
to lease property constructed for lease, the quality and nature of contracts for
presale or preleasing if any, experience and ability of the developer and loan
to value ratio; (v) 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; and (vi) 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.
The Company follows a loan review program to evaluate the credit risk in
the loan portfolio. Through the loan review process, the Company maintains an
internally classified loan list 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. Loans classified as "substandard"
are those loans with clear and defined weaknesses such as a highly-leveraged
position, unfavorable financial ratios, uncertain repayment sources or poor
financial condition, which may jeopardize recoverability of the debt. Loans
classified as "doubtful" are those loans which have characteristics similar to
substandard accounts but with an increased risk that a loss may occur, or at
least a portion of the loan may require a charge-off if liquidated at present.
Loans classified as "loss" are those loans which are in the process of being
charged off.
In addition to the internally classified loan list and delinquency list of
loans, the Company maintains a separate "watch list" which further aids the
Company in monitoring loan portfolios. Watch list loans have one or more
deficiencies that require attention in the short term or pertinent ratios of the
loan account that have weakened to a point where more frequent monitoring is
warranted. These loans do not have all of the characteristics of a classified
loan (substandard or doubtful) but do show weakened elements compared with
34
<PAGE>
those of a satisfactory credit. The Company reviews these loans to assist in
assessing the adequacy of the allowance for credit losses.
In order to determine the adequacy of the allowance for credit losses,
management considers the risk classification or delinquency status of loans and
other factors, such as collateral value, portfolio composition, trends in
economic conditions and the financial strength of borrowers. Management
establishes specific allowances for loans which management believes require
reserves greater than those allocated according to their classification or
delinquent status. An unallocated allowance is also established based on the
Company's historical charge-off experience. The Company then charges to
operations a provision for credit losses to maintain the allowance for credit
losses at an adequate level determined by the foregoing methodology.
For the six months ended June 30, 1998, net charge-offs totaled $47,000 or
0.04% of average loans outstanding for the period, compared with $72,000 in net
charge-offs or 0.06% of average loans outstanding for the six months ended June
30, 1997. The majority of the charge-offs were loans acquired in acquisitions.
During the six months ended June 30, 1998, the Company recorded a provision for
credit losses of $144,500 compared with $105,000 for the six months ended June
30, 1997. At June 30, 1998, the allowance totaled $1.1 million, or 0.79% of
total loans.
The following table presents for the periods indicated an analysis of the
allowance for credit losses and other related data:
SIX MONTHS ENDED JUNE
30,
----------------------
1998 1997
---------- ----------
(DOLLARS IN THOUSANDS)
Average loans outstanding............ $ 129,228 $ 115,424
========== ==========
Gross loans outstanding at end of
period............................. $ 141,080 $ 120,810
========== ==========
Allowance for credit losses at
beginning of period................ $ 1,016 $ 923
Provision for credit losses.......... 145 105
Charge-offs:
Commercial and industrial....... (1) (26)
Real estate and agriculture..... (12) (36)
Consumer........................ (42) (25)
Recoveries:
Commercial and industrial....... 2 13
Real estate and agriculture..... -- --
Consumer........................ 6 2
---------- ----------
Net (charge-offs) recoveries......... (47) (72)
---------- ----------
Allowance for credit losses at end of
period............................. $ 1,114 $ 956
========== ==========
Ratio of allowance to end of period
loans.............................. 0.79% 0.79%
Ratio of net charge-offs to average
loans.............................. 0.04 0.06
Ratio of allowance to end of period
nonperforming loans................ -- --
35
<PAGE>
The following table describes the allocation of the allowance for credit
losses among various categories of loans and certain other information for the
dates indicated. The allocation is made for analytical purposes and is not
necessarily indicative of the categories in which future losses may occur. The
total allowance is available to absorb losses from any segment of loans.
<TABLE>
<CAPTION>
JUNE 30,
----------------------------------------------
1998 1997
--------------------- ---------------------
PERCENT OF PERCENT OF
LOANS TO LOANS TO
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS
------ ----------- ------ -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Balance of allowance for credit
losses applicable to:
Commercial and industrial....... $ 8 8.7% $ -- 10.7%
Real estate..................... 42 72.0 6 66.3
Agriculture..................... -- 6.0 -- 6.1
Consumer........................ 47 13.3 2 16.9
Unallocated..................... 1,017 948
------ ----------- ------ -----------
Total allowance for credit
losses.................. $1,114 100.0% $ 956 100.0%
====== =========== ====== ===========
</TABLE>
The Company believes that the allocation of its allowance for credit losses
is reasonable. Where management is able to identify specific loans or categories
of loans where specific amounts of reserve are required, allocations are
assigned to those categories. Federal and state bank regulators also require
that a bank maintain a reserve that is sufficient to absorb an estimated amount
of unidentified potential losses based on management's perception of economic
conditions, loan portfolio growth, historical charge-off experience and exposure
concentrations. While the Company's recent rate of charge-offs is low,
management is aware that the Company has been operating in an extremely
beneficial economic environment. Management of the Company, along with a number
of economists, has perceived during the past year an increasing instability in
the national and Texas economies and a worldwide economic slowdown that could
contribute to job losses and otherwise adversely affect a broad variety of
business sectors. In addition, as the Company has grown, its aggregate loan
portfolio has increased and as the Company has made a decision to diversify its
loan portfolio into areas other than single family mortgage loans, the risk
profile of the Company's loans has increased. By virtue of its increased capital
levels, the Company is able to make larger loans, thereby increasing the
possibility of one bad loan having a larger adverse impact than before.
Accordingly, management believes that the maintenance of an unallocated reserve
in the current amount is prudent and consistent with regulatory requirements.
The Company believes that the allowance for credit losses at June 30, 1998
is adequate to cover losses inherent in the portfolio as of such date. There can
be no assurance, however, that the Company will not sustain losses in future
periods, which could be substantial in relation to the size of the allowance at
June 30, 1998.
SECURITIES
The Company uses its securities portfolio both as a source of income and as
a source of liquidity. At June 30, 1998, investment securities totaled $158.7
million, an increase of $739,000 from $158.0 million at June 30, 1997. At June
30, 1998, investment securities represented 47.3% of total assets, compared with
50.1% of total assets at June 30, 1997. The yield on the investment portfolio
for the six months ended June 30, 1998 was 6.09% compared with a yield of 6.06%
for the six months ended June 30, 1997.
36
<PAGE>
The following table presents the amortized cost and fair value of
securities classified as available-for-sale at June 30, 1998:
<TABLE>
<CAPTION>
JUNE 30, 1998
------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
U.S. Treasury securities and obligations
of U.S. government agencies........... $27,584 $ 27 $ 20 $27,591
Mortgage-backed securities.............. 15,932 40 158 15,814
States and political subdivisions....... 1,263 76 -- 1,339
--------- ---------- ---------- -------
Total.............................. $44,779 $ 143 $ 178 $44,744
========= ========== ========== =======
</TABLE>
The following table presents the amortized cost and fair value of
securities classified as held-to-maturity at June 30, 1998:
<TABLE>
<CAPTION>
JUNE 30, 1998
-------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
U.S. Treasury securities and obligations
of U.S. government agencies........... $ 59,467 $ 293 $ 22 $ 59,738
Mortgage-backed securities.............. 36,327 66 194 36,199
States and political subdivisions....... 12,515 72 39 12,548
Collateralized mortgage obligations..... 5,632 -- 12 5,620
--------- ---------- ---------- --------
Total.............................. $ 113,941 $ 431 $ 267 $114,105
========= ========== ========== ========
</TABLE>
Mortgage-backed securities are securities which have been developed by
pooling a number of real estate mortgages and are principally issued by federal
agencies such as the Federal National Mortgage Association and the Federal Home
Loan Mortgage Corporation. These securities are deemed to have high credit
ratings, and minimum regular monthly cash flows of principal and interest are
guaranteed by the issuing agencies.
At June 30, 1998, 30.0% of the mortgage-backed securities held by the
Company had contractual final maturities of more than ten years with a weighted
average life of 3.1 years. However, unlike U.S. Treasury and U.S. government
agency securities, which have a lump sum payment at maturity, mortgage-backed
securities provide cash flows from regular principal and interest payments and
principal prepayments throughout the lives of the securities. Mortgage-backed
securities which are purchased at a premium will generally suffer decreasing net
yields as interest rates drop because home owners tend to refinance their
mortgages. Thus, the premium paid must be amortized over a shorter period.
Therefore, these securities purchased at a discount will obtain higher net
yields in a decreasing interest rate environment. As interest rates rise, the
opposite will generally be true. During a period of increasing interest rates,
fixed rate mortgage-backed securities do not tend to experience heavy
prepayments of principal and consequently, the average life of this security
will not be unduly shortened. If interest rates begin to fall, prepayments will
increase.
37
<PAGE>
The following table summarizes the contractual maturity of investment
securities (including federal funds sold) and their weighted average yields.
Available-for-sale securities are not adjusted for unrealized gains or losses.
<TABLE>
<CAPTION>
JUNE 30, 1998
----------------------------------------------------------------------------------------
AFTER FIVE YEARS
AFTER ONE YEAR
BUT BUT
WITHIN ONE YEAR WITHIN FIVE WITHIN TEN YEARS AFTER TEN YEARS
YEARS TOTAL
---------------- ---------------- ---------------- ---------------- --------
AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD TOTAL
------- ----- ------- ----- ------- ----- ------- ----- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
U.S. Treasury securities and obligations
of U.S. government agencies........... $16,483 6.06 % $53,486 6.36 % $17,081 6.26 % $ -- -- % $ 87,050
Mortgage-backed securities.............. 3,515 5.74 15,127 6.15 17,928 6.10 15,689 6.18 52,259
States and political subdivisions....... 2,893 4.40 6,669 5.10 3,844 5.10 372 7.14 13,778
Collateralized mortgage obligations..... -- -- 3,286 6.60 2,347 6.69 -- -- 5,633
Federal funds sold...................... 7,875 5.60 -- -- -- -- -- -- 7,875
------- ----- ------- ----- ------- ----- ------- ----- --------
Total............................... $30,766 5.75 % $78,568 6.22 % $41,200 6.11 % $16,061 6.20 % $166,595
======= ===== ======= ===== ======= ===== ======= ===== ========
</TABLE>
YIELD
-----
U.S. Treasury securities and obligations
of U.S. government agencies........... 6.28 %
Mortgage-backed securities.............. 6.11
States and political subdivisions....... 5.01
Collateralized mortgage obligations..... 6.64
Federal funds sold...................... 5.60
-----
Total............................... 6.10 %
=====
The Company has adopted Statement of Financial Accounting Standards
("SFAS") No. 115, ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT AND EQUITY
SECURITIES ("SFAS 115"). At the date of purchase, the Company is required to
classify debt and equity securities into one of three categories:
held-to-maturity, trading or available-for-sale. At each reporting date, the
appropriateness of the classification is reassessed. Investments in debt
securities are classified as held-to-maturity and measured at amortized cost in
the financial statements only if management has the positive intent and ability
to hold those securities to maturity. Securities that are bought and held
principally for the purpose of selling them in the near term are classified as
trading and measured at fair value in the financial statements with unrealized
gains and losses included in earnings. Investments not classified as either
held-to-maturity or trading are classified as available-for-sale and measured at
fair value in the financial statements with unrealized gains and losses
reported, net of tax, in a separate component of shareholders' equity until
realized.
DEPOSITS
The Company offers a variety of deposit accounts having a wide range of
interest rates and terms. The Company's deposits consist of demand, savings,
money market and time accounts. The Company relies primarily on competitive
pricing policies and customer service to attract and retain these deposits. The
Company does not have any brokered deposits.
The Company's average total deposits for the six months ended June 30, 1998
were $300.9 million or 12.0% over average total deposits during the same period
in 1997. The Company's total deposits at June 30, 1998, were $307.8 million, up
$17.6 million or 6.1% over total deposits at June 30, 1997. The increase in
deposits is attributable to internal growth.
The Company's lending and investing activities are funded principally by
deposits, approximately 61.5% of which are demand and savings deposits. Average
noninterest-bearing deposits at June 30, 1998 increased to $65.3 million
compared with $53.1 million for the first six months of 1997, an increase of
$12.2 million or 23.0% over 1997. Approximately 21.7% of the average deposits
were noninterest-bearing for the six months ended June 30, 1998. As a result,
the Company had a total cost of deposits of 3.11% for such period.
38
<PAGE>
The daily average balances and weighted average rates paid on
interest-bearing deposits for the period ended June 30, 1998 are presented
below:
SIX MONTHS ENDED
JUNE 30, 1998
---------------------
AMOUNT RATE
---------- ---------
(DOLLARS IN
THOUSANDS)
Interest-bearing checking............... $ 41,064 1.61%
Regular savings......................... 9,842 2.46
Money market savings.................... 68,862 3.68
Time deposits........................... 115,919 5.12
---------- ---------
Total interest-bearing deposits.... 235,687 3.98
Noninterest-bearing deposits............ 65,251 --
---------- ---------
Total deposits..................... $ 300,938 3.11%
========== =========
The following table sets forth the amount of the Company's certificates of
deposit that are $100,000 or greater by time remaining until maturity:
JUNE 30, 1998
----------------------
(DOLLARS IN THOUSANDS)
Three months or less................. $ 11,888
Over three through six months........ 5,734
Over six through 12 months........... 11,130
Over 12 months....................... 3,199
----------------------
Total........................... $ 31,951
======================
The Company expects that the majority of the certificates of deposit
maturing within one year will renew. Should this not occur, management believes
that there will be sufficient cash to fund payments.
OTHER BORROWINGS
Deposits are the primary source of funds for the Company's lending and
investment activities. Occasionally, the Company obtains additional funds from
the Federal Home Loan Bank ("FHLB") and correspondent banks. During 1997, the
Company entered into an agreement with Norwest to borrow up to $8.0 million
under a reducing, revolving line of credit (the "Line.") At June 30, 1998, the
Company had no borrowings under the Line compared with $865,000 under a previous
line of credit at June 30, 1997.
INTEREST RATE SENSITIVITY AND LIQUIDITY
The Company's Asset Liability and Funds Management Policy provides
management with the necessary guidelines for effective funds management, and the
Company has established a measurement system for monitoring its net interest
rate sensitivity position. The Company manages its sensitivity position within
established guidelines.
Interest rate risk is managed by the Asset Liability Committee ("ALCO"),
which is composed of senior officers of the Company, in accordance with policies
approved by the Company's Board of Directors. The ALCO formulates strategies
based on appropriate levels of interest rate risk. In determining the
appropriate level of interest rate risk, the ALCO considers the impact on
earnings and capital of the current outlook on interest rates, potential changes
in interest rates, regional economies, liquidity, business strategies and other
factors. The ALCO meets regularly to review, among other things, the sensitivity
of assets and liabilities to interest rate changes, the book and market values
of assets and liabilities, unrealized gains and losses, purchase and sale
activities, commitments to originate loans and the maturities of investments and
borrowings. Additionally, the ALCO reviews liquidity, cash flow flexibility,
maturities of deposits and consumer and commercial deposit activity. Management
uses two methodologies to manage interest rate risk: (i) an analysis of
relationships between interest-earning assets and interest-bearing
39
<PAGE>
liabilities; and (ii) an interest rate shock simulation model. The Company has
traditionally managed its business to reduce its overall exposure to changes in
interest rates.
The Company manages its exposure to interest rates by structuring its
balance sheet in the ordinary course of business. The Company does not enter
into instruments such as leveraged derivatives, interest rate swaps, financial
options, financial future contracts or forward delivery contracts for the
purpose of reducing interest rate risk.
An interest rate sensitive asset or liability is one that, within a defined
time period, either matures or experiences an interest rate change in line with
general market interest rates. The management of interest rate risk is performed
by analyzing the maturity and repricing relationships between interest-earning
assets and interest-bearing liabilities at specific points in time ("GAP") and
by analyzing the effects of interest rate changes on net interest income over
specific periods of time by projecting the performance of the mix of assets and
liabilities in varied interest rate environments. Interest rate sensitivity
reflects the potential effect on net interest income of a movement in interest
rates. A company is considered to be asset sensitive, or having a positive GAP,
when the amount of its interest-earning assets maturing or repricing within a
given period exceeds the amount of its interest-bearing liabilities also
maturing or repricing within that time period. Conversely, a company is
considered to be liability sensitive, or having a negative GAP, when the amount
of its interest-bearing liabilities maturing or repricing within a given period
exceeds the amount of its interest-earning assets also maturing or repricing
within that time period. During a period of rising interest rates, a negative
GAP would tend to affect net interest income adversely, while a positive GAP
would tend to result in an increase in net interest income. During a period of
falling interest rates, a negative GAP would tend to result in an increase in
net interest income, while a positive GAP would tend to affect net interest
income adversely.
The following table sets forth an interest rate sensitivity analysis for
the Company at June 30, 1998:
<TABLE>
<CAPTION>
VOLUMES SUBJECT TO REPRICING WITHIN
------------------------------------------------------------------------
0-30 DAYS 31-180 DAYS 181-365 DAYS AFTER ONE YEAR TOTAL
--------- ----------- ------------ -------------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Interest-earning assets:
Securities............................ $ 15,941 $ 14,900 $ 28,950 $ 98,894 $ 158,685
Loans................................. 24,255 6,709 10,431 99,685 141,080
Federal funds sold and other temporary
investments......................... 7,974 -- -- -- 7,974
--------- ----------- ------------ -------------- ---------
Total interest-earning assets....... 48,170 21,609 39,381 198,579 307,739
--------- ----------- ------------ -------------- ---------
Interest-bearing liabilities:
Demand, money market and savings
deposits............................ 118,726 -- -- -- 118,726
Certificates of deposit and other time
deposits............................ 11,667 51,235 38,179 19,445 120,526
--------- ----------- ------------ -------------- ---------
Total interest-bearing
liabilities....................... 130,393 51,235 38,179 19,445 239,252
--------- ----------- ------------ -------------- ---------
Period GAP.............................. $ (82,223) $ (29,626) $ 1,202 $179,134 $ 68,487
Cumulative GAP.......................... $ (82,223) $(111,849) $ (110,647) $ 68,487
Period GAP to total assets.............. (24.51)% (8.83)% 0.36% 53.41%
Cumulative GAP to total assets.......... (24.51)% (33.35)% (32.99)% 20.42%
</TABLE>
Shortcomings are inherent in any GAP analysis since certain assets and
liabilities may not move proportionally as interest rates change. In addition to
GAP analysis, the Company uses an interest rate risk simulation model and shock
analysis to test the interest rate sensitivity of net interest income and the
balance sheet, respectively. Contractual maturities and repricing opportunities
of loans are incorporated in the model as are prepayment assumptions, maturity
data and call options within the investment portfolio. Assumptions based on past
experience are incorporated into the model for nonmaturity deposit accounts.
Based on the Company's June 30, 1998 simulation analysis, the Company estimates
that a 200 basis point rise or decline in rates over the next 12 month period
would have an impact of less than 6% on its net interest income for the period.
The change is relatively small, despite the Company's liability sensitive GAP
40
<PAGE>
position. The results are primarily from the behavior of demand, money market
and savings deposits. The Company has found that historically interest rates on
these deposits change more slowly in a rising rate environment than in a
declining rate environment. This assumption is incorporated into the simulation
model and is generally not fully reflected in a GAP analysis. The Company
maintains an Investment Committee that reviews the Company's interest rate risk
position, generally on a quarterly basis.
As a financial institution, the Company's primary component of market risk
is interest rate volatility. Fluctuations in interest rates will ultimately
impact both the level of income and expense recorded on most of the Company's
assets and liabilities, and the market value of all interest-earning assets and
interest-bearing liabilities, other than those which have a short term to
maturity. Based upon the nature of the Company's operations, the Company is not
subject to foreign exchange or commodity price risk. The Company does not own
any trading assets.
The Company's exposure to market risk is reviewed on a regular basis.
Interest rate risk is the potential of economic losses due to future interest
rate changes. These economic losses can be reflected as a loss of future net
interest income and/or a loss of current fair market values. The objective is to
measure the effect on net interest income and to adjust the balance sheet to
minimize the inherent risk while at the same time maximizing income. Management
realizes certain risks are inherent, and that the goal is to identify and accept
the risks.
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. During the past three years, the Company's
liquidity needs have primarily been met by growth in core deposits, as
previously discussed. 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, have generally created an adequate
liquidity position.
CAPITAL RESOURCES
Capital management consists of providing equity to support both current and
future operations. The Company is subject to capital adequacy requirements
imposed by the Federal Reserve Board and the Bank is subject to capital adequacy
requirements imposed by the FDIC and the Texas Banking Department. Both the
Federal Reserve Board and the FDIC have adopted risk-based capital requirements
for assessing bank holding company and bank capital adequacy. These standards
define capital and establish minimum capital requirements in relation to assets
and off-balance sheet exposure, adjusted for credit risk. The risk-based capital
standards currently in effect are designed to make regulatory capital
requirements more sensitive to differences in risk profiles among bank holding
companies and banks, to account for off-balance sheet exposure and to minimize
disincentives for holding liquid assets. Assets and off-balance sheet items are
assigned to broad risk categories, each with appropriate relative risk weights.
The resulting capital ratios represent capital as a percentage of total
risk-weighted assets and off-balance sheet items.
The risk-based capital standards issued by the Federal Reserve Board
require all bank holding companies to have "Tier 1 capital" of at least 4.0%
and "total risk-based" capital (Tier 1 and Tier 2) of at least 8.0% of total
risk-adjusted assets. "Tier 1 capital" generally includes common shareholders'
equity and qualifying perpetual preferred stock together with related surpluses
and retained earnings, less deductions for goodwill and various other
intangibles. "Tier 2 capital" may consist of a limited amount of
intermediate-term preferred stock, a limited amount of term subordinated debt,
certain hybrid capital instruments and other debt securities, perpetual
preferred stock not qualifying as Tier 1 capital, and a limited amount of the
general valuation allowance for loan losses. The sum of Tier 1 capital and Tier
2 capital is "total risk-based capital."
The Federal Reserve Board has also adopted guidelines which supplement the
risk-based capital guidelines with a minimum ratio of Tier 1 capital to average
total consolidated assets ("leverage ratio") of 3.0% for institutions with
well diversified risk, including no undue interest rate exposure; excellent
asset
41
<PAGE>
quality; high liquidity; good earnings; and that are generally considered to be
strong banking organizations, rated composite 1 under applicable federal
guidelines, and that are not experiencing or anticipating significant growth.
Other banking organizations are required to maintain a leverage ratio of at
least 4.0% to 5.0%. These rules further provide that banking organizations
experiencing internal growth or making acquisitions will be expected to maintain
capital positions substantially above the minimum supervisory levels and
comparable to peer group averages, without significant reliance on intangible
assets.
Pursuant to Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA"), each federal banking agency revised its risk-based capital
standards to ensure that those standards take adequate account of interest rate
risk, concentration of credit risk and the risks of nontraditional activities,
as well as reflect the actual performance and expected risk of loss on
multifamily mortgages. The Bank is subject to capital adequacy guidelines of the
FDIC that are substantially similar to the Federal Reserve Board's guidelines.
Also pursuant to FDICIA, the FDIC has promulgated regulations setting the levels
at which an insured institution such as the Bank would be considered "well
capitalized," "adequately capitalized," "undercapitalized," "significantly
undercapitalized" and "critically undercapitalized." Under the FDIC's
regulations, the Bank is classified "well capitalized" for purposes of prompt
corrective action. See "Supervision and Regulation -- The Company" and
"-- The Bank."
Shareholders' equity increased from $23.2 million at June 30, 1997 to $26.5
million at June 30, 1998, an increase of $3.3 million or 14.2%. This increase
was primarily the result of net income of $4.0 million, less dividends paid on
Common Stock of approximately $800,000.
The following table provides a comparison of the Company's and the Bank's
leverage and risk-weighted capital ratios as of June 30, 1998 to the minimum and
well capitalized regulatory standards:
<TABLE>
<CAPTION>
TO BE WELL
MINIMUM CAPITALIZED UNDER
REQUIRED FOR CAPITAL PROMPT CORRECTIVE ACTUAL RATIO AT
ADEQUACY PURPOSES ACTION PROVISIONS JUNE 30, 1998
--------------------- ------------------- ----------------
<S> <C> <C> <C>
THE COMPANY
Leverage ratio....................... 3.00%(1) N/A 6.25%
Tier 1 risk-based capital ratio...... 4.00% N/A 14.32%
Risk-based capital ratio............. 8.00% N/A 15.08%
THE BANK
Leverage ratio....................... 3.00%(2) 5.00% 6.21%
Tier 1 risk-based capital ratio...... 4.00% 6.00% 14.22%
Risk-based capital ratio............. 8.00% 10.00% 14.99%
</TABLE>
- ------------
(1) The Federal Reserve Board may require the Company to maintain a leverage
ratio of up to 200 basis points above the required minimum.
(2) The FDIC may require the Bank to maintain a leverage ratio of up to 200
basis points above the required minimum.
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 2000 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
42
<PAGE>
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 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 June 30, 1998,
the Company has not incurred any significant costs in relation to Year 2000. 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 date of the Prospectus, 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.
43
<PAGE>
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 non-compliance. 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 its
current methodology for making provisions to the allowance for credit losses. In
addition, the Company plans to maintain additional cash on hand to meet any
unusual deposit withdrawal activity.
44
<PAGE>
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
OVERVIEW
Net income was $3.6 million, $2.7 million and $2.3 million for the years
ended December 31, 1997, 1996 and 1995, respectively, and diluted earnings per
share were $0.92, $0.76 and $0.66 for these same periods. Earnings growth from
1995 to 1996 and from 1996 to 1997 resulted principally from loan growth and
branch acquisitions. The Company posted returns on average assets of 1.17%,
1.05% and 1.03% and returns on average equity of 16.32%, 15.36% and 15.56% for
the years ended 1997, 1996 and 1995, respectively. The Company posted returns on
average assets excluding amortization of goodwill of 1.30%, 1.15% and 1.13% and
returns on average equity excluding amortization of goodwill of 18.17%, 16.82%
and 16.96% for the years ended December 31, 1997, 1996 and 1995, respectively.
The Company's efficiency ratio was 59.48% in 1997, 61.34% in 1996 and 64.85% in
1995. The Company's efficiency ratio excluding amortization of goodwill was
56.43% in 1997, 58.96% in 1996 and 62.61% in 1995.
Total assets at December 31, 1997, 1996 and 1995 were $320.1 million,
$294.0 million and $233.5 million, respectively. Total deposits at December 31,
1997, 1996 and 1995 were $291.5 million, $270.9 million and $214.5 million,
respectively, with deposit growth in each period resulting largely from the
branch acquisitions in 1996 and 1997. Loans were $120.6 million at December 31,
1997, an increase of $7.2 million or 6.3% from $113.4 million at the end of
1996. Loans were $88.8 million at year end 1995. Shareholders' equity was $24.8
million, $18.8 million and $16.5 million at December 31, 1997, 1996 and 1995,
respectively.
RESULTS OF OPERATIONS
NET INTEREST INCOME
1997 VERSUS 1996. Net interest income for 1997 was $10.9 million, compared
with $8.9 million for 1996, an increase of $2.0 million or 22.5%. The
improvement in net interest income for 1997 was mainly due to an increase in
total interest-earning assets, primarily in the loan portfolio. During 1997, the
yield on interest-earning assets increased eight basis points from 7.08% in 1996
to 7.16% in 1997 primarily due to an increase in the volume of higher-yielding
loans. Total funding costs decreased seven basis points from 4.11% in 1996 to
4.04% in 1997 primarily due to an increase in noninterest-bearing deposits. For
1997, the net interest margin on a tax-equivalent basis increased 11 basis
points to 4.02% from 3.91% in 1996.
1996 VERSUS 1995. Net interest income for the Company in 1996 was $8.9
million, an increase of 14.1% over the 1995 level of $7.8 million, due to an
increase in the loan portfolio in 1996. For 1996 as a whole, the Company's cost
of funds increased eight basis points from 4.03% to 4.11% while asset yields
increased two basis points from 7.06% to 7.08%.
45
<PAGE>
The following table presents for the periods indicated the total dollar
amount of average balances, interest income from average interest-earning assets
and the resultant yields, as well as the interest expense on average
interest-bearing liabilities, expressed both in dollars and rates. Except as
indicated in the footnotes, no tax-equivalent adjustments were made and all
average balances are daily average balances. Nonaccruing loans have been
included in the tables as loans carrying a zero yield.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------------------------------------------------------
1997 1996 1995
---------------------------------- ---------------------------------- -----------
AVERAGE INTEREST AVERAGE AVERAGE INTEREST AVERAGE AVERAGE
OUTSTANDING EARNED/ YIELD/ OUTSTANDING EARNED/ YIELD/ OUTSTANDING
BALANCE PAID RATE BALANCE PAID RATE BALANCE
----------- -------- ------- ----------- -------- ------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
ASSETS
Interest-earning assets:
Loans................................. $ 117,586 $10,205 8.68% $ 104,534 $ 9,136 8.74% $ 81,631
Securities(1)......................... 157,677 9,572 6.07 127,607 7,396 5.80 119,857
Federal funds sold and other temporary
investments.......................... 3,545 193 5.44 5,743 309 5.38 7,285
----------- -------- ------- ----------- -------- ------- -----------
Total interest-earning assets....... 278,808 19,970 7.16% 237,884 16,841 7.08% 208,773
-------- ------- -------- -------
Less allowance for credit losses...... (961) (820) (669)
----------- ----------- -----------
Total interest-earning assets, net
of allowance....................... 277,847 237,064 208,104
Noninterest-earning assets.............. 26,239 20,141 16,597
----------- ----------- -----------
Total assets........................ $ 304,086 $ 257,205 $ 224,701
=========== =========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing liabilities:
Interest-bearing demand deposits...... $ 42,898 $ 915 2.13% $ 35,285 $ 741 2.10% $ 30,309
Savings and money market accounts..... 64,448 2,158 3.35 49,429 1,620 3.28 42,286
Certificates of deposit............... 113,669 5,785 5.09 105,538 5,359 5.08 96,649
Federal funds purchased and other
borrowings........................... 3,030 202 6.67 2,402 203 8.45 1,922
----------- -------- ------- ----------- -------- ------- -----------
Total interest-bearing
liabilities........................ 224,045 9,060 4.04% 192,654 7,923 4.11% 171,166
----------- -------- ------- ----------- -------- ------- -----------
Noninterest-bearing liabilities:
Noninterest-bearing demand deposits... 57,362 46,082 38,077
Other liabilities..................... 858 823 542
----------- ----------- -----------
Total liabilities................... 282,265 239,559 209,785
----------- ----------- -----------
Shareholders' equity.................... 21,821 17,646 14,916
----------- ----------- -----------
Total liabilities and shareholders'
equity............................. $ 304,086 $ 257,205 $ 224,701
=========== =========== ===========
Net interest rate spread................ 3.12% 2.97%
======= =======
Net interest income and margin(2)....... $10,910 3.91% $ 8,918 3.75%
======== ======= ======== =======
Net interest income and margin
(tax-equivalent basis)(3).............. $11,222 4.02% $ 9,290 3.91%
======== ======= ======== =======
</TABLE>
INTEREST AVERAGE
EARNED/ YIELD/
PAID RATE
-------- -------
ASSETS
Interest-earning assets:
Loans................................. $ 7,203 8.82%
Securities(1)......................... 7,107 5.93
Federal funds sold and other temporary
investments.......................... 428 5.88
-------- -------
Total interest-earning assets....... 14,738 7.06%
-------- -------
Less allowance for credit losses......
Total interest-earning assets, net
of allowance.......................
Noninterest-earning assets..............
Total assets........................
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing liabilities:
Interest-bearing demand deposits...... $ 545 1.80%
Savings and money market accounts..... 1,328 3.14
Certificates of deposit............... 4,876 5.05
Federal funds purchased and other
borrowings........................... 155 8.06
-------- -------
Total interest-bearing
liabilities........................ 6,904 4.03%
-------- -------
Noninterest-bearing liabilities:
Noninterest-bearing demand deposits...
Other liabilities.....................
Total liabilities...................
Shareholders' equity....................
Total liabilities and shareholders'
equity.............................
Net interest rate spread................ 3.03%
=======
Net interest income and margin(2)....... $ 7,834 3.75%
======== =======
Net interest income and margin
(tax-equivalent basis)(3).............. $ 8,272 3.96%
======== =======
- ------------
(1) Yield is based on amortized cost and does not include any component of
unrealized gains or losses.
(2) The net interest margin is equal to net interest income divided by average
interest-earning assets.
(3) In order to make pre-tax 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 34%.
46
<PAGE>
The following schedule 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 related
to higher outstanding balances and the volatility of interest rates. For
purposes of this table, changes attributable to both rate and volume which can
not be segregated have been allocated to rate.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------------------------
1997 VS. 1996 1996 VS. 1995
------------------------- --------------------------
INCREASE INCREASE
(DECREASE) (DECREASE)
DUE TO DUE TO
--------------- ----------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
------ ----- ------ ------ ------ ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans................................. $1,141 $ (72) $1,069 $2,020 $ (87) $1,933
Securities............................ 1,744 432 2,176 460 (171) 289
Federal funds sold and other temporary
investments........................ (118) 2 (116) (91) (28) (119)
------ ----- ------ ------ ------ ------
Total increase (decrease) in
interest income.................. 2,767 362 3,129 2,389 (286) 2,103
------ ----- ------ ------ ------ ------
Interest-bearing liabilities:
Interest-bearing demand deposits...... 160 14 174 90 106 196
Savings and money market accounts..... 493 45 538 224 68 292
Certificates of deposit............... 413 13 426 449 34 483
Federal funds purchased and other
borrowings......................... 53 (54) (1) 38 10 48
------ ----- ------ ------ ------ ------
Total increase in interest
expense.......................... 1,119 18 1,137 801 218 1,019
------ ----- ------ ------ ------ ------
Increase (decrease) in net interest
income................................ $1,648 $ 344 $1,992 $1,588 $ (504) $1,084
====== ===== ====== ====== ====== ======
</TABLE>
PROVISION FOR CREDIT LOSSES
The allowance for credit losses at December 31, 1997 was $1.0 million,
representing 0.84% of outstanding loans. One year earlier, this ratio was 0.81%
of outstanding loans. The provision for credit losses charged against earnings
was $190,000 in 1997 compared with $230,000 in 1996. The Company recorded a
lower provision in 1997 because it had specific reserves in the amount of
$45,000 which were no longer necessary due to the repayment of the related
loans. Net loans charged off in 1997 were $97,000 compared with $60,000 in 1996.
During 1996, the Company made provisions totaling $230,000 to the allowance
for credit losses, an increase of $55,000 compared with 1995. Net loans charged
off in 1996 were $60,000, compared with $10,000 in loan charge-offs for 1995.
NONINTEREST INCOME
For 1997, noninterest income totaled $2.3 million, an increase of $367,000
or 19.3% versus $1.9 million in 1996. The increase was primarily due to the
branch acquisitions in Bay City and Angleton and an increase in customer service
fees. Noninterest income for 1996 was $1.9 million, a $408,000 or 27.4% increase
from 1995 resulting largely from an increase in income from insufficient funds
charges and customer service fees.
The following table presents for the periods indicated the major categories
of noninterest income:
YEARS ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
(DOLLARS IN THOUSANDS)
Service charges on deposit accounts..... $ 1,948 $ 1,633 $ 1,280
Other noninterest income................ 316 264 209
--------- --------- ---------
Total noninterest income........... $ 2,264 $ 1,897 $ 1,489
========= ========= =========
47
<PAGE>
NONINTEREST EXPENSE
For the years ended 1997, 1996 and 1995, noninterest expense totaled $7.8
million, $6.6 million and $6.0 million, respectively. The Company's efficiency
ratio showed a positive trend over this period, reflecting the Company's
continued success in controlling operating expenses and integrating its branch
acquisitions.
The following table presents for the periods indicated the major categories
of noninterest expense:
YEARS ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
(DOLLARS IN THOUSANDS)
Salaries and employee benefits.......... $ 3,968 $ 3,415 $ 3,041
Non-staff expenses
Net bank premises expense.......... 683 604 522
Equipment rentals, depreciation and
maintenance...................... 375 294 282
Data processing.................... 642 493 387
Professional fees.................. 97 114 103
Regulatory assessments and FDIC
insurance........................ 63 28 253
Ad valorem and franchise taxes..... 164 140 115
Goodwill amortization.............. 402 257 209
Other.............................. 1,442 1,289 1,134
--------- --------- ---------
Total noninterest expense..... $ 7,836 $ 6,634 $ 6,046
========= ========= =========
For 1997, noninterest expense totaled $7.8 million, an increase of $1.2
million or 18.2% over $6.6 million in 1996. Salaries and employee benefits for
1997 totaled $4.0 million, an increase of $553,000 or 16.2% over $3.4 million
for 1996. Other operating expenses of $1.4 million represented an increase of
$153,000 or 11.9% compared with $1.3 million in 1996. These increases were
principally due to the Bay City and Angleton branch acquisitions. Total
noninterest expenses in 1996 were $6.6 million, a 9.7% increase over the prior
year's level of $6.0 million. Salaries and employee benefits in 1996 increased
by 12.3% from $3.0 million to $3.4 million.
INCOME TAXES
Income tax expense includes the regular federal income tax at the statutory
rate plus the income tax component of the Texas franchise tax. The income tax
component of the Texas franchise tax was zero in 1997, 1996 and 1995. In 1997
income tax expense was $1.6 million compared with $1.2 million in 1996. The 1995
amount was $781,000. The effective tax rates in 1997, 1996 and 1995,
respectively, were 30.8%, 31.4% and 25.2%.
FINANCIAL CONDITION
LOAN PORTFOLIO
At December 31, 1997, loans were $120.6 million, an increase of $7.2
million or 6.3% over loans at December 31, 1996 of $113.4 million. The growth in
the loan portfolio was due to continued strong loan demand, especially in the
real estate area. At December 31, 1997, total loans were 41.4% of deposits and
37.7% of total assets. At December 31, 1996, total loans were 41.9% of deposits
and 38.6% of total assets.
Loans increased 27.7% during 1996 from $88.8 million at December 31, 1995
to $113.4 million at December 31, 1996. The loan growth during 1996 was spread
between real estate and consumer loans. One-to-four family residential loans
increased from $40.3 million at December 31, 1995 to $49.8 million at year end
1996. Consumer loans also had a substantial increase from $13.3 million at year
end 1995 to $21.3 million at year end 1996.
48
<PAGE>
The following table summarizes as of the dates indicated the loan portfolio
of the Company by type of loan:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------------------------------------------------------------
1997 1996 1995 1994
-------------------- -------------------- -------------------- --------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
--------- -------- --------- -------- --------- -------- --------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Commercial and industrial............ $ 11,611 9.6% $ 10,633 9.4% $ 10,445 11.8% $ 9,479 12.4%
Real estate:
Construction and land
development....................... 6,453 5.3 5,021 4.4 2,507 2.8 2,139 2.8
1-4 family residential.............. 53,625 44.5 49,845 44.0 40,331 45.4 37,247 48.7
Commercial mortgages................ 16,277 13.5 14,376 12.7 12,835 14.5 9,520 12.5
Farmland............................ 5,804 4.8 5,468 4.8 3,989 4.5 3,529 4.6
Multi-family residential............ 937 0.8 1,068 0.9 716 0.8 64 0.0
Agriculture.......................... 6,359 5.3 5,686 5.0 4,666 5.2 4,605 6.0
Consumer............................. 19,512 16.2 21,285 18.8 13,308 15.0 9,960 13.0
--------- --- --------- --- --------- --- --------- ---
Total loans......................... $ 120,578 100.0% $ 113,382 100.0% $ 88,797 100.0% $ 76,543 100.0%
========= === ========= === ========= === ========= ===
</TABLE>
1993
--------------------
AMOUNT PERCENT
--------- --------
Commercial and industrial............ $ 4,466 7.8%
Real estate:
Construction and land
development....................... 2,495 4.4
1-4 family residential.............. 26,815 46.7
Commercial mortgages................ 7,152 12.5
Farmland............................ 3,149 5.5
Multi-family residential............ 132 0.0
Agriculture.......................... 3,060 5.3
Consumer............................. 10,226 17.8
--------- ---
Total loans......................... $ 57,495 100.0%
========= ===
The contractual maturity ranges of the commercial and industrial and
construction and land development portfolios and the amount of such loans with
predetermined interest rates and floating rates in each maturity range as of
December 31, 1997 are summarized in the following table:
<TABLE>
<CAPTION>
DECEMBER 31, 1997
----------------------------------------------------
AFTER ONE
ONE YEAR THROUGH AFTER FIVE
OR LESS FIVE YEARS YEARS TOTAL
--------- ------------ ----------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Commercial and industrial............ $ 4,337 $6,815 $ 459 $ 11,611
Construction and land development.... 1,750 1,747 2,956 6,453
--------- ------------ ----------- ---------
Total...................... $ 6,087 $8,562 $ 3,415 $ 18,064
========= ============ =========== =========
Loans with a predetermined interest
rate............................... $ 2,944 $4,805 $ 447 $ 8,196
Loans with a floating interest
rate............................... 3,143 3,757 2,968 9,868
--------- ------------ ----------- ---------
Total...................... $ 6,087 $8,562 $ 3,415 $ 18,064
========= ============ =========== =========
</TABLE>
The Company has adopted Statement of Accounting Standards No. 114,
ACCOUNTING FOR CREDITORS FOR IMPAIRMENT OF A LOAN ("SFAS 114"), as amended by
Statement of Accounting Standards No. 118, ACCOUNTING BY CREDITORS FOR
IMPAIRMENT OF A LOAN-INCOME RECOGNITION AND DISCLOSURES. Under SFAS No. 114, as
amended, a loan is considered impaired based on current information and events,
if it is probable that the Company will be unable to collect the scheduled
payments of principal or interest when due according to the contractual terms of
the loan agreement. The fair value of impaired loans is based on the present
value of expected future cash flows discounted at the loan's effective interest
rate or the loan's observable market price or based on the fair value of the
collateral if the loan is collateral-dependent. The implementation of SFAS Nos.
114 and 118 did not have a material adverse affect on the Company's financial
statements.
NONPERFORMING ASSETS
The Company's conservative lending approach, as well as a healthy local
economy, has resulted in strong asset quality. The Company had no nonperforming
assets as of December 31, 1997, 1996 or 1995.
49
<PAGE>
The following table presents information regarding nonperforming assets at
the dates indicated:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------------------------
1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Nonaccrual loans..................... $ -- $ -- $ -- $ -- $ --
Restructured loans................... -- -- -- -- --
Other real estate.................... -- -- -- 15 112
--------- --------- --------- --------- ---------
Total nonperforming assets...... $ -- $ -- $ -- $ 15 $ 112
========= ========= ========= ========= =========
Nonperforming assets to total loans
and other real estate.............. 0.00% 0.00% 0.00% 0.02% 0.19%
</TABLE>
ALLOWANCE FOR CREDIT LOSSES
For the year ended 1997, net charge-offs totaled $97,000 or 0.08% of
average loans outstanding for the period, compared with $60,000 or 0.06% in net
charge-offs during 1996. The Company's net charge-offs totaled $10,000 or 0.01%
of average loans outstanding in 1995. During 1997, the Company recorded a
provision for credit losses of $190,000 compared with $230,000 for 1996. At
December 31, 1997, the allowance totaled $1.0 million, or 0.84% of total loans.
The Company made a provision for credit losses of $230,000 during 1996 compared
with a provision of $175,000 for 1995. At December 31, 1996, the allowance
aggregated $923,000, or 0.81% of total loans. At December 31, 1995, the
allowance was $753,000, or 0.85% of total loans.
The following table presents for the periods indicated an analysis of the
allowance for credit losses and other related data:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------------------------
1997 1996 1995 1994 1993
---------- ---------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Average loans outstanding............ $ 117,586 $ 104,534 $ 81,631 $ 69,200 $ 53,422
========== ========== ========= ========= =========
Gross loans outstanding at end of
period............................. $ 120,578 $ 113,382 $ 88,797 $ 76,543 $ 57,495
========== ========== ========= ========= =========
Allowance for credit losses at
beginning of period................ $ 923 $ 753 $ 588 $ 734 $ 745
Provision for credit losses.......... 190 230 175 188 155
Charge-offs:
Commercial and industrial.......... (26) (9) (6) (31) (119)
Real estate and agriculture........ (47) -- (2) (270) (120)
Consumer........................... (57) (64) (24) (129) (195)
Recoveries:
Commercial and industrial.......... 15 -- -- 17 31
Real estate and agriculture........ 7 -- 3 51 152
Consumer........................... 11 13 19 28 85
---------- ---------- --------- --------- ---------
Net (charge-offs) recoveries......... (97) (60) (10) (334) (166)
---------- ---------- --------- --------- ---------
Allowance for credit losses at end of
period............................. $ 1,016 $ 923 $ 753 $ 588 $ 734
========== ========== ========= ========= =========
Ratio of allowance to end of period
loans.............................. 0.84% 0.81% 0.85% 0.77% 1.28%
Ratio of net charge-offs to average
loans.............................. 0.08 0.06 0.01 0.48 0.31
Ratio of allowance to end of period
nonperforming loans................ -- -- -- -- --
</TABLE>
50
<PAGE>
The following tables describe the allocation of the allowance for credit
losses among various categories of loans and certain other information for the
dates indicated. The allocation is made for analytical purposes and is not
necessarily indicative of the categories in which future losses may occur. The
total allowance is available to absorb losses from any segment of loans.
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------
1997 1996
--------------------- ---------------------
PERCENT OF PERCENT OF
LOANS TO LOANS TO
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS
------ ----------- ------ -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Balance of allowance for credit losses
applicable to:
Commercial and industrial.......... $ 41 9.6% $ 9 9.4%
Real estate........................ 59 68.9 34 66.8
Agriculture........................ -- 5.3 -- 5.0
Consumer........................... 51 16.2 6 18.8
Unallocated........................ 865 874
------ ----------- ------ -----------
Total allowance for credit
losses..................... $1,016 100.0% $ 923 100.0%
====== =========== ====== ===========
<CAPTION>
DECEMBER 31,
-----------------------------------------------------------------------
1995 1994 1993
--------------------- --------------------- ---------------------
PERCENT OF PERCENT OF PERCENT OF
LOANS TO LOANS TO LOANS TO
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS
------ ----------- ------ ----------- ------ -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Balance of allowance for credit losses
applicable to:
Commercial and industrial.......... $ 7 11.8% $ 15 12.4% $ 3 7.8%
Real estate........................ 27 68.0 33 68.6 194 69.1
Agriculture........................ -- 5.2 -- 6.0 -- 5.3
Consumer........................... 6 15.0 4 13.0 9 17.8
Unallocated........................ 713 536 528
------ ----------- ------ ----------- ------ -----------
Total allowance for credit
losses..................... $ 753 100.0% $ 588 100.0% $ 734 100.0%
====== =========== ====== =========== ====== ===========
</TABLE>
SECURITIES
The following table summarizes the amortized cost of investment securities
as of the dates shown (available-for-sale securities are not adjusted for
unrealized gains or losses):
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------------------
1997 1996 1995 1994 1993
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
U.S. Treasury securities and obligations
of U.S. government agencies........... $ 83,160 $ 60,830 $ 42,147 $ 33,037 $ 31,892
Mortgage-backed securities.............. 64,168 59,382 41,278 34,956 47,282
States and political subdivisions....... 11,829 13,042 15,753 17,440 19,175
Collateralized mortgage obligations..... 8,749 14,341 18,411 36,676 40,415
---------- ---------- ---------- ---------- ----------
Total.............................. $ 167,906 $ 147,595 $ 117,589 $ 122,109 $ 138,764
========== ========== ========== ========== ==========
</TABLE>
51
<PAGE>
The following table summarizes the contractual maturity of investment
securities and their weighted average yields. Available-for-sale securities are
not adjusted for unrealized gains or losses.
<TABLE>
<CAPTION>
DECEMBER 31, 1997
-----------------------------------------------------------------------------------------
AFTER ONE YEAR AFTER FIVE YEARS
BUT BUT
WITHIN ONE YEAR WITHIN FIVE YEARS WITHIN TEN YEARS AFTER TEN YEARS
TOTAL
----------------- ----------------- ----------------- ----------------- ---------
AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD TOTAL
--------- ----- --------- ----- --------- ----- --------- ----- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
U.S. Treasury securities and obligations
of U.S. government agencies............ $ 28,392 5.97 % $ 54,768 6.27 % $ -- -- % $ -- -- % $ 83,160
Mortgage-backed securities.............. 2,223 4.85 26,679 6.43 18,249 6.11 17,017 6.24 64,168
States and political subdivisions....... 3,903 4.61 5,107 5.24 2,447 5.80 372 7.24 11,829
Collateralized mortgage obligations..... -- -- 4,258 6.45 4,491 6.13 -- -- 8,749
--------- ----- --------- ----- --------- ----- --------- ----- ---------
Total................................ $ 34,518 5.74 % $ 90,812 6.27 % $ 25,187 6.23 % $ 17,389 6.26 % $ 167,906
========= ===== ========= ===== ========= ===== ========= ===== =========
</TABLE>
YIELD
-----
U.S. Treasury securities and obligations
of U.S. government agencies............ 6.24 %
Mortgage-backed securities.............. 6.23
States and political subdivisions....... 5.21
Collateralized mortgage obligations..... 6.18
-----
Total................................ 6.16 %
=====
The following table summarizes the carrying value by classification of
securities as of the dates shown:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------------------
1997 1996 1995 1994 1993
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Available-for-sale...................... $ 38,612 $ 49,342 $ 35,452 $ 25,411 $ --
Held-to-maturity........................ 129,256 98,222 82,053 96,501 138,764
---------- ---------- ---------- ---------- ----------
Total.............................. $ 167,868 $ 147,564 $ 117,505 $ 121,912 $ 138,764
========== ========== ========== ========== ==========
</TABLE>
At December 31, 1997, investment securities of $167.9 million increased
$20.3 million from $147.6 million at December 31, 1996, as the Company invested
excess deposits from the Angleton Acquisition. At December 31, 1997, investment
securities represented 57.6% of total deposits and 52.4% of total assets.
Approximately $66.4 million or 40.0% of the Company's investment securities
reprice within one year.
Investment securities increased from $117.5 million at December 31, 1995 to
$147.6 million at December 31, 1996, largely due to the Bay City branch
acquisition.
The following tables present the amortized cost and fair value of
securities classified as available-for-sale at December 31, 1997, 1996 and 1995:
<TABLE>
<CAPTION>
DECEMBER 31, 1997 DECEMBER 31, 1996
------------------------------------------------ -------------------------------------
GROSS GROSS GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR AMORTIZED UNREALIZED UNREALIZED
COST GAINS LOSSES VALUE COST GAINS LOSSES
--------- ---------- ---------- ------- --------- ---------- ----------
(DOLLARS IN THOUSANDS)
U.S. Treasury securities and obligations
<S> <C> <C> <C> <C> <C> <C> <C>
of U.S. government agencies........... $19,988 $ 56 $ -- $20,044 $29,980 $127 $ --
Mortgage-backed securities.............. 17,299 62 258 17,103 17,952 43 306
States and political subdivisions....... 1,363 102 -- 1,465 1,441 105 --
--------- ---------- ---------- ------- --------- ---------- ----------
Total............................... $38,650 $220 $258 $38,612 $49,373 $275 $306
========= ========== ========== ======= ========= ========== ==========
</TABLE>
FAIR
VALUE
-------
U.S. Treasury securities and obligations
of U.S. government agencies........... $30,107
Mortgage-backed securities.............. 17,689
States and political subdivisions....... 1,546
-------
Total............................... $49,342
=======
<TABLE>
<CAPTION>
DECEMBER 31, 1995
------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
U.S. Treasury securities and obligations
of U.S. government agencies........... $20,247 $ 69 $ -- $20,316
Mortgage-backed securities.............. 13,860 -- 294 13,566
States and political subdivisions....... 1,429 141 -- 1,570
--------- ---------- ---------- -------
Total.............................. $35,536 $ 210 $ 294 $35,452
========= ========== ========== =======
</TABLE>
52
<PAGE>
The following tables present the amortized cost and fair value of
securities classified as held-to-maturity at December 31, 1997, 1996 and 1995:
<TABLE>
<CAPTION>
DECEMBER 31, 1997 DECEMBER 31, 1996
------------------------------------------------- -------------------------------------
GROSS GROSS GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR AMORTIZED UNREALIZED UNREALIZED
COST GAINS LOSSES VALUE COST GAINS LOSSES
--------- ---------- ---------- -------- --------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
U.S. Treasury securities and obligations
of U.S. government agencies........... $ 63,171 $244 $ 20 $ 63,395 $30,849 $121 $121
Mortgage-backed securities.............. 46,871 369 219 47,021 41,431 90 704
States and political
subdivisions.......................... 10,465 141 -- 10,606 11,601 173 18
Collateralized mortgage
obligations........................... 8,749 19 15 8,753 14,341 -- 103
--------- ---------- ---------- -------- --------- ---------- ----------
Total............................... $129,256 $773 $254 $129,775 $98,222 $384 $946
========= ========== ========== ======== ========= ========== ==========
</TABLE>
FAIR
VALUE
-------
U.S. Treasury securities and obligations
of U.S. government agencies........... $30,849
Mortgage-backed securities.............. 40,817
States and political
subdivisions.......................... 11,756
Collateralized mortgage
obligations........................... 14,238
-------
Total............................... $97,660
=======
<TABLE>
<CAPTION>
DECEMBER 31, 1995
------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
U.S. Treasury securities and obligations
of U.S. government agencies........... $21,900 $ 21 $ 169 $21,752
Mortgage-backed securities.............. 27,417 6 420 27,003
States and political subdivisions....... 14,324 248 40 14,532
Collateralized mortgage obligations..... 18,412 1 238 18,175
--------- ---------- ---------- -------
Total.............................. $82,053 $ 276 $ 867 $81,462
========= ========== ========== =======
</TABLE>
DEPOSITS
Deposits at December 31, 1997 were $291.5 million, an increase of $20.6
million, or 7.6% from $270.9 million at December 31, 1996. The increase was
mainly due to the Angleton Acquisition in the second quarter of 1997.
Noninterest-bearing deposits of $61.4 million at December 31, 1997 increased
$6.2 million, or 11.2% from $55.2 million at December 31, 1996.
Noninterest-bearing deposits as of December 31, 1996 were $55.2 million compared
with $42.9 million at December 31, 1995. Interest-bearing deposits were $215.7
million, up $44.0 million or 25.6% from $171.7 million at December 31, 1995. The
Company does not accept brokered deposits. Total deposits at December 31, 1995
were $214.6 million.
The daily average balances and weighted average rates paid on deposits for
each of the years ended December 31, 1997, 1996 and 1995 are presented below:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------------------------------
1997 1996 1995
---------------- ---------------- ----------------
AMOUNT RATE AMOUNT RATE AMOUNT RATE
-------- ---- -------- ---- -------- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Interest-bearing checking............... $ 42,898 2.13% $ 35,285 2.10% $ 30,309 1.80%
Regular savings......................... 9,215 2.32 7,674 2.46 6,772 2.47
Money market savings.................... 55,233 3.50 41,755 3.43 35,514 3.27
Time deposits........................... 113,669 5.08 105,538 5.08 96,649 5.05
-------- ---- -------- ---- -------- ----
Total interest-bearing deposits.... 221,015 4.00 190,252 4.06 169,244 3.99
Noninterest-bearing deposits............ 57,362 -- 46,082 -- 38,077 --
-------- ---- -------- ---- -------- ----
Total deposits..................... $278,377 3.18% $236,334 3.27% $207,321 3.26%
======== ==== ======== ==== ======== ====
</TABLE>
53
<PAGE>
The following table sets forth the amount of the Company's certificates of
deposit that are $100,000 or greater by time remaining until maturity:
DECEMBER 31, 1997
----------------------
(DOLLARS IN THOUSANDS)
Three months or less.................... $ 1,567
Over three through six months........... 3,370
Over six through 12 months.............. 11,992
Over 12 months.......................... 6,226
----------------------
Total.............................. $ 23,155
======================
OTHER BORROWINGS
Deposits are the primary source of funds for the Company's lending and
investment activities. Occasionally, the Company obtains additional funds from
the FHLB and correspondent banks. At December 31, 1997, the Company had
borrowings of $2.8 million compared to zero at both December 31, 1996 and 1995.
At December 31, 1997, the Company had no outstanding borrowings under the
Line extended by a commercial bank. During 1997, the Company paid off the
outstanding balance under a similar agreement (the "Old Line") with another
commercial bank. At December 31, 1996 and 1995, borrowings under the Old Line
totaled $3.3 million and $1.5 million, respectively.
INTEREST RATE SENSITIVITY AND LIQUIDITY
The following table sets forth an interest rate sensitivity analysis for
the Company at December 31, 1997:
<TABLE>
<CAPTION>
VOLUMES SUBJECT TO REPRICING WITHIN
-----------------------------------------------------------
0-30 31-180 181-365 AFTER
DAYS DAYS DAYS ONE YEAR TOTAL
---------- ---------- ---------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Interest-earning assets:
Securities.......................... $ 9,644 $ 36,432 $ 20,379 $ 101,413 $ 167,868
Loans............................... 16,621 18,020 12,279 73,658 120,578
Other temporary investments......... 198 -- -- -- 198
---------- ---------- ---------- --------- ---------
Total interest-earning
assets....................... 26,463 54,452 32,658 175,071 288,644
---------- ---------- ---------- --------- ---------
Interest-bearing liabilities:
Demand, money market and savings
deposits.......................... 119,770 -- -- -- 119,770
Certificates of deposit and other
time deposits..................... 18,495 46,730 30,773 14,302 110,300
Federal funds purchased and FHLB
advances.......................... 2,800 -- -- -- 2,800
---------- ---------- ---------- --------- ---------
Total interest-bearing
liabilities.................. 141,065 46,730 30,773 14,302 232,870
---------- ---------- ---------- --------- ---------
Period GAP..................... $ (114,602) $ 7,722 $ 1,885 $ 160,769 $ 55,774
Cumulative GAP................. $ (114,602) $ (106,880) $ (104,995) $ 55,774
Period GAP to total assets..... (35.80)% 2.41% 0.59% 50.22%
Cumulative GAP to total
assets....................... (35.80)% (33.39)% (32.80)% 17.42%
</TABLE>
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Interest Rate Sensitivity and Liquidity" for the six months ended
June 30, 1998 and June 30, 1997 for a discussion of the Company's policies
regarding asset and liability risk management.
CAPITAL RESOURCES
Shareholders' equity increased to $24.8 million at December 31, 1997 from
$18.8 million at December 31, 1996, an increase of $6.0 million or 31.9%. This
increase was primarily the result of net income of $3.6 million plus a Common
Stock issuance of $3.0 million, less dividends paid on Common Stock of $574,000.
During 1996, shareholders' equity increased by $2.3 million or 13.9% from $16.5
million at December 31, 1995.
54
<PAGE>
The following table provides a comparison of the Company's and the Bank's
leverage and risk-weighted capital ratios as of December 31, 1997 to the minimum
and well capitalized regulatory standards:
<TABLE>
<CAPTION>
TO BE WELL CAPITALIZED
MINIMUM REQUIRED UNDER PROMPT
FOR CAPITAL CORRECTIVE ACTION ACTUAL RATIO AT
ADEQUACY PURPOSES PROVISIONS DECEMBER 31, 1997
----------------- ----------------------- ------------------
THE COMPANY
<S> <C> <C> <C>
Leverage ratio....................... 3.00%(1) N/A 6.30%
Tier 1 risk-based capital ratio...... 4.00% N/A 14.94%
Risk-based capital ratio............. 8.00% N/A 15.73%
THE BANK
Leverage ratio....................... 3.00%(2) 5.00% 6.13%
Tier 1 risk-based capital ratio...... 4.00% 6.00% 14.80%
Risk-based capital ratio............. 8.00% 10.00% 15.59%
</TABLE>
- ------------
(1) The Federal Reserve Board may require the Company to maintain a leverage
ratio of up to 200 basis points above the required minimum.
(2) The FDIC may require the Bank to maintain a leverage ratio of up to 200
basis points above the required minimum.
55
<PAGE>
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
The following is a list of all of the directors and executive officers of
the Company and members of the Executive Committee of the Bank, their respective
positions with the Company and the Bank and their ages.
NAME POSITION AGE
- ------------------------------------------------------------------- ---
Harry Bayne................... Director of the Company 58
Robert L. Benter.............. President of the Bank's Post Oak 46
Banking Center;
Member of the Executive Committee
of the Bank
Donald A. Bolton, Jr.......... President of the Bank's Victoria 49
Banking Center;
Member of the Executive Committee
of the Bank
James A. Bouligny............. Director of the Company 62
J.T. Herin.................... Director of the Company 82
Randy D. Hester............... President of the Bank's West Columbia 40
Banking Center; Member of the
Executive Committee of the Bank
David Hollaway................ Treasurer and Chief Financial Officer 42
of the Company and Senior Vice
President and Chief Financial
Officer of the Bank
Tracy T. Rudolph.............. Chairman of the Board and President 59
of the Company and Chairman of
the Board of the Bank
Charles M. Slavik............. Director of the Company 82
Harrison Stafford............. Director of the Company 86
Robert Steelhammer............ Director of the Company 57
David Zalman.................. Director and Vice President/Secretary 42
of the Company; Director and
President of the Bank
HARRY BAYNE. Mr. Bayne has been a director of the Company since 1989. He
is President and Chief Executive Officer of Varitec Industries, Inc. in Houston.
Since 1967, Mr. Bayne has served as President of Bayne TV & Appliance Co., a
subsidiary of Varitec Industries, Inc. Mr. Bayne is active in the Houston and
Bay Area Chambers of Commerce.
ROBERT L. BENTER. Mr. Benter, President of the Bank's Post Oak Banking
Center in Houston, joined the Bank in 1992 as an Executive Vice President and
senior lending officer. From 1988 to 1992, he served as an Executive Vice
President of Compass Bank-Houston. From 1978 to 1988, Mr. Benter was employed by
First Republic Bank-San Felipe and attained the position of Banking Center
President. Mr. Benter began his banking career in 1974 at Community Bank in
Austin.
DONALD A. BOLTON, JR. Mr. Bolton has been President of the Bank's Victoria
Banking Center since 1993 and currently oversees all of the Bank's lending
activity outside of Houston. Prior to joining the Bank, Mr. Bolton was employed
by First Victoria National Bank for 20 years, progressing from Senior Vice
President to Chief Lending Officer.
JAMES A. BOULIGNY. Mr. Bouligny has been a director of the Company since
1991. Mr. Bouligny is a name partner in the El Campo law firm of Duckett,
Bouligny & Collins, LLP. Mr. Bouligny received a Bachelor of Business
Administration degree and a Juris Doctor degree from the University of Texas.
Mr. Bouligny's civic activities include a 24 year tenure as a member of the
Board of Directors of Wharton County Junior College. He is currently a member of
the MG and Lillie Johnson Foundation.
J.T. HERIN. Mr. Herin has been a director of the Company since 1989. His
affiliation with the Bank started in 1953 with his election to the Board of
Directors. He is the owner of the J-Bar Ranch in Ganado.
RANDY D. HESTER. Mr. Hester is President of the Bank's West Columbia
Banking Center. He joined the Bank in 1991 as Manager of the Loan Function and
Operations of the Cuero Banking Center. Prior to
56
<PAGE>
joining the Bank, Mr. Hester was President of Texas Premier Bank in Victoria and
held various lending and management positions at its affiliate, Bank of
Kerrville. Mr. Hester began his banking career in 1978 at First City-Windsor
Park Bank in San Antonio.
DAVID HOLLAWAY. Mr. Hollaway has been Senior Vice President and Chief
Financial Officer of the Bank since 1992 and Treasurer of the Company since
1993. He became Chief Financial Officer of the Company in 1998. From 1990 to
1992, Mr. Hollaway worked for the Resolution Trust Corporation in its Gulf Coast
Consolidated Office in Houston. From 1988 to 1990, he worked as the Cost
Accounting Manager of San Jacinto Savings Association in Bellaire, Texas. From
1981 to 1988, Mr. Hollaway was Vice President-Auditor of South Main Bank in
Houston. Mr. Hollaway is a Certified Public Accountant.
TRACY T. RUDOLPH. Mr. Rudolph founded the Company in 1983 and has served
as Chairman of the Board since its inception. From 1980 to 1986, Mr. Rudolph was
Chairman and Chief Executive Officer of South Main Bank in Houston. Prior to
that, he worked at Town & Country Bank in Houston from 1972 to 1980, where he
became Chairman and Chief Executive Officer prior to the bank's acquisition by
Allied Bancshares, Inc. Mr. Rudolph has over 35 years of commercial banking
experience.
CHARLES M. SLAVIK. Mr. Slavik has been a director of the Company since
1993 and was a founding director of the Bank in 1949. Mr. Slavik is currently
Chairman of the Board of both Slavik's, Inc. and Slavik's Funeral Home. Mr.
Slavik attended St. Edward's University and Landig College of Mortuary Science.
He was commissioned as a Second Lieutenant in World War II and was released from
active duty as a Captain in 1946. Mr. Slavik has served as a member of the Edna
Rotary Club, Veterans of Foreign Wars, the Edna Hospital Board and the Chamber
of Commerce. From 1959 to 1963, Mr. Slavik served as Mayor of Edna.
HARRISON STAFFORD. Mr. Stafford has been a director of the Company since
1987 and was involved in the founding of the Bank in 1949. Mr. Stafford engages
in farming, ranching and investments. Mr. Stafford graduated from the University
of Texas, where he was a three year All-Conference football player. Mr. Stafford
has been inducted into the National Collegiate Football Hall of Fame, the
University of Texas Hall of Fame and the Texas High School Hall of Fame. Mr.
Stafford has participated actively in the Edna Rotary Club and the University of
Texas Ex's Association, and has served as president of the Edna Independent
School District Board and as a member of the Lavaca Navidad River Authority.
ROBERT STEELHAMMER. Mr. Steelhammer has been a director of the Company
since its inception. Mr. Steelhammer is a name partner with the law firm of
Steelhammer & Miller, P.C. in Houston. He received a Bachelor of Science degree
from the University of Texas and a Juris Doctor degree from South Texas College
of Law. He is a member of the State Bar of Texas, a registered professional
engineer for the State of Texas and a member of the American Institute of
Chemical Engineers.
DAVID ZALMAN. Mr. Zalman joined the Bank as President in 1986 and became a
director and Vice President/Secretary of the Company in 1987. From 1978 to 1986,
Mr. Zalman was employed by Commercial Bancshares, Inc. in El Campo, beginning as
cashier and rising to become Chief Executive Officer. Mr. Zalman received a
Bachelor of Business Administration degree in Finance and Marketing from the
University of Texas in 1978. He has served as a member of the El Campo City
Council, the Edna Rotary Club and the El Campo Lion's Club and as president of
the West Wharton County United Way.
Directors are elected for three year terms, classified into Classes I, II
and III. Messrs. Herin, Slavik and Stafford are Class I directors with terms of
office expiring on the date of the Company's annual meeting of shareholders in
1999; Messrs. Bayne, Bouligny and Steelhammer are Class II directors with terms
of office expiring on the date of the Company's annual meeting of shareholders
in 2000; and Messrs. Rudolph and Zalman are Class III directors with terms of
office expiring on the date of the Company's annual meeting of shareholders in
2001. Each officer of the Company is elected by the Board of Directors of the
Company and holds office until his successor is duly elected and qualified or
until his or her earlier death, resignation or removal.
The Board of Directors has established Audit and Compensation Committees.
The Audit Committee reviews the general scope of the audit conducted by the
Company's independent auditors and matters
57
<PAGE>
relating to the Company's internal control systems. In performing its function,
the Audit Committee meets separately with representatives of the Company's
independent auditors and with representatives of senior management. The Audit
Committee is composed of Messrs. Bayne, Bouligny and Steelhammer, all of whom
are outside directors.
The Compensation Committee is responsible for making recommendations to the
Board of Directors with respect to the compensation of the Company's executive
officers and is responsible for the establishment of policies dealing with
various compensation and employee benefit matters. The Compensation Committee
also administers the Company's stock option plans and makes recommendations to
the Board of Directors as to option grants to Company employees under such
plans. The Compensation Committee is comprised of Messrs. Bayne, Bouligny,
Herin, Slavik, Stafford and Steelhammer, all of whom are outside directors.
EMPLOYMENT AGREEMENTS
Tracy T. Rudolph and David Zalman have entered into employment agreements
with the Company. Each agreement is for an initial term of three years and
automatically renews each year thereafter unless terminated in accordance with
its terms. The employment agreements provide that if the employee is terminated
without cause (including constructive termination) or if a change in control of
the Company occurs, the employee shall be entitled to receive from the Company a
lump sum payment equal to three years' base salary. The employment agreements do
not contain non-compete restrictions. The employees have the power to terminate
the employment agreements upon 30 days prior notice.
DIRECTOR COMPENSATION
Directors of the Company receive a $1,250 fee for each Board meeting
attended and no fees for each committee meeting attended. Directors of the Bank
receive a $350 fee for each Board meeting attended and $300 for each committee
meeting attended.
EXECUTIVE COMPENSATION AND OTHER INFORMATION
The following table provides certain summary information concerning
compensation paid or accrued by the Company to or on behalf of the Company's
Chairman of the Board and President and each of the other two most highly
compensated executive officers of the Company whose compensation exceeds
$100,000 (determined as of the end of the last fiscal year) for the fiscal years
ended December 31, 1997:
SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION
<TABLE>
<CAPTION>
NAME AND OTHER ANNUAL ALL OTHER
PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION COMPENSATION
- ---------------------------------------- --------- ---------- --------- ------------ ---------------
<S> <C> <C> <C> <C> <C>
Tracy T. Rudolph........................ 1997 $ 225,000 $ -- $ -- $ 7,348(1)
Chairman of the Board and President of
the Company and Chairman of the Board
the Bank
David Zalman............................ 1997 185,000 -- -- 7,630(2)
Vice President/Secretary of the
Company and President of the Bank
Robert L. Benter........................ 1997 92,500 12,000 -- 1,020(3)
President of the Post Oak Banking
Center; Member of the Executive
Committee of the Bank
</TABLE>
- ------------
(1) Consists of contributions by the Company to the 401(k) Plan of $4,750 and
premiums paid by the Company on a life insurance policy for the benefit of
Mr. Rudolph.
(2) Consists of contributions by the Company to the 401(k) Plan of $4,750 and
premiums paid by the Company on two life insurance policies for the benefit
of Mr. Zalman.
(3) Consists of contributions by the Company to the 401(k) Plan.
58
<PAGE>
STOCK OPTION PLANS
The Company has outstanding options to purchase 320,000 shares of Common
Stock issued pursuant to a stock option plan approved by the shareholders in
1995 (the "1995 Plan") for executive officers and directors. Under the 1995
Plan, the options vest ratably over a ten year period beginning on the date of
the grant; however, no options may be exercised until the optionee has completed
five years of employment with the Company after the date of the grant. The
options were granted at an average exercise price of $4.75. Compensation expense
was not recognized for the options because the options had an exercise price
approximating the fair value of the Common Stock at the time of the grant. No
options granted under the 1995 Plan will be exercisable until May 31, 2000.
Options to purchase an additional 20,000 shares are available for issuance under
the 1995 Plan.
The Company's Board of Directors and shareholders approved a new stock
incentive plan in 1998 (the "1998 Plan") which authorizes the issuance of up
to 460,000 shares of Common Stock under both "non-qualified" and "incentive"
stock options to employees and "non-qualified" stock options to directors who
are not employees. Generally, under the 1998 Plan it is intended that the
options will vest 60% at the end of the third year following the date of grant
and an additional 20% at the end of each of the two following years; however, an
individual option may vest as much as 20% at the end of the first or second year
following the date of grant if necessary to maximize the "incentive" tax
treatment to the optionee for the particular option being granted. Options under
the 1998 Plan generally must be exercised within ten years following the date of
grant or no later than three months after optionee's termination with the
Company, if earlier. The 1998 Plan also provides for the granting of restricted
stock awards, stock appreciation rights, phantom stock awards and performance
awards on substantially similar terms. No options or other awards have been
granted under the 1998 Plan. The 1998 Plan provides that in the event of a
change in control of the Company, all options granted immediately vest and
become exercisable. In addition, the 1998 Plan permits the Compensation
Committee, which administers the 1998 Plan, discretion in the event of a change
in control to modify in certain respects the terms of awards under the 1998
Plan, including (i) providing for the payment of cash in lieu of such award,
(ii) limiting the time during which an option may be exercised, (iii) making
adjustments to options to reflect the change in control and (iv) providing that
options shall be exercisable for another form of consideration in lieu of the
Common Stock pursuant to the terms of the transaction resulting in a change in
control.
In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 123, ACCOUNTING FOR STOCK-BASED
COMPENSATION ("SFAS 123"). This statement established fair value based
accounting and reporting standards for all transactions in which a company
acquires goods or services by issuing its equity investments, which includes
stock-based compensation plans. Under SFAS 123, compensation cost is measured at
the grant date based on the value of the award and is recognized over the
service period, which is usually the vesting period. Fair value of stock options
is determined using an option-pricing model. This statement encourages companies
to adopt as prescribed the fair value based method of accounting to recognize
compensation expense for employee stock compensation plans. However, it does not
require the fair value based method to be adopted but a company must comply with
the disclosure requirements set forth in the statement. The Company has
continued to apply Accounting Principles Board Opinion No. 25, ACCOUNTING FOR
STOCK ISSUED TO EMPLOYEES, ("APB 25") and related Interpretations, and,
accordingly, will provide the pro forma disclosures of net income and earnings
per share.
OPTIONS GRANTED DURING 1997
The Company did not grant any options to its executive officers during
1997.
BENEFIT PLAN
The Company has established a contributory profit sharing plan (the
"Plan") pursuant to Internal Revenue Code Section 401(k) covering
substantially all employees. At least one year of service is required to be
eligible for employer-matching contributions. Participants may contribute up to
15% of their compensation to the Plan. Each year the Company determines, at its
discretion, the amount of matching
59
<PAGE>
contributions. Total Plan expense charged to the Company's operations for 1997
and 1996 was approximately $87,000 and $72,000, respectively. The Company has
expensed $48,000 for 1998 contributions during the period ended June 30, 1998.
INTERESTS OF MANAGEMENT AND OTHERS IN CERTAIN TRANSACTIONS
Many of the directors, executive officers and principal shareholders of the
Company (I.E., those who own 10% or more of the Common Stock) and their
associates, which include corporations, partnerships and other organizations in
which they are officers or partners or in which they and their immediate
families have at least a 5% interest, are customers of the Company. During 1997,
the Company made loans in the ordinary course of business to many of the
directors, executive officers and principal shareholders of the Company and
their associates, all of which were on substantially the same terms, including
interest rates and collateral, as those prevailing at the time for comparable
transactions with persons unaffiliated with the Company and did not involve more
than the normal risk of collectibility or present other unfavorable features.
Loans to directors, executive officers and principal shareholders of the Company
are subject to limitations contained in the Federal Reserve Act, the principal
effect of which is to require that extensions of credit by the Company to
executive officers, directors and principal shareholders satisfy the foregoing
standards. On June 30, 1998, all of such loans aggregated $3.0 million, which
was approximately 14.4% of the Company's Tier 1 capital at such date.
The Company expects to have such transactions or transactions on a similar
basis with its directors, executive officers and principal shareholders and
their associates in the future.
60
<PAGE>
PRINCIPAL AND SELLING SHAREHOLDERS
The following table sets forth certain information regarding the beneficial
ownership of the Company's Common Stock as of June 30, 1998, by (i) each
director and executive officer of the Company and members of the Executive
Committee of the Bank, (ii) each person who is known by the Company to own
beneficially 5% or more of the Common Stock, (iii) all directors and executive
officers as a group and (iv) the Selling Shareholders, who will sell 791,783
shares of Common Stock in the Offering. Unless otherwise indicated, each person
has sole voting and dispositive power over the shares indicated as owned by such
person and the address of each shareholder is the same as the address of the
Company. Messrs. Bayne, Bouligny, Herin, Rudolph, Stafford, Steelhammer and
Zalman have each been a director of the Company for more than three years. See
"Management -- Directors and Executive Officers of the Company."
<TABLE>
<CAPTION>
SHARES BENEFICIALLY SHARES BENEFICIALLY
OWNED OWNED
PRIOR TO THE OFFERING AFTER THE OFFERING(1)
----------------------- NUMBER OF SHARES ------------------------
BENEFICIAL OWNER NUMBER PERCENT TO BE SOLD NUMBER PERCENT
- ---------------------------------------- --------- ------- ---------------- --------- -------
PRINCIPAL AND OTHER SHAREHOLDERS
- ----------------------------------------
<S> <C> <C> <C> <C> <C>
Dr. Perry Mueller....................... 200,000(2) 5.01% 64,000 136,000 2.77%
Estate of Louis Tittizer................ 280,472(3) 7.03 -0- 280,472 5.71
LLPA General Partnership................ 228,160(4) 5.72 166,667 61,493 1.25
Joe Zalman, Jr.......................... 159,508(5) 4.00 75,000 84,508 1.72
DIRECTORS AND EXECUTIVE OFFICERS
- ----------------------------------------
Harry Bayne............................. 168,324 4.22 73,615 94,709 1.93
Robert L. Benter........................ 2,920(6) * -0- 2,920 *
Donald A. Bolton, Jr.................... 12,000(7) * -0- 12,000 *
James A. Bouligny....................... 201,756 5.06 43,750 158,006 3.21
J.T. Herin.............................. 100,400 2.52 66,667 33,733 *
Randy D. Hester......................... 14,272(8) * -0- 14,272
David Hollaway.......................... 2,000 * -0- 2,000
Tracy T. Rudolph........................ 320,000(9) 8.02 180,000 140,000 2.85
Charles M. Slavik....................... 43,740(10) 1.10 8,750 34,990 *
Harrison Stafford....................... 132,800(11) 3.33 42,500 90,300 1.84
Robert Steelhammer...................... 176,000 4.41 50,000 126,000 2.56
David Zalman............................ 387,868(12) 9.72 20,834 367,034 7.47
Directors and Executive Officers as a
Group................................. 1,562,080 39.15% 486,116 1,075,964 21.89%
</TABLE>
- ------------
* Denotes ownership of less than 1.0%
(1) Assumes (i) the issuance of 925,000 shares in the Offering and (ii) the
sale of 791,783 shares by the Selling Shareholders.
(2) Includes 107,144 shares held of record by First National Bank of Lake
Jackson as custodian for Dr. Mueller's self-directed IRA and 26,188 shares
held of record by First Prosperity Bank as custodian for Dr. Mueller's
self-directed IRA. Dr. Mueller's address is 203 That Way, Lake Jackson,
Texas 77566.
(3) The address of Mr. Tittizer's Estate is P. O. Box 519, Edna, Texas 77976.
(4) LLPA General Partnership's address is 1177 West Loop South, Suite 1450,
Houston, Texas 77027.
(5) Includes 69,776 shares held of record by Zalman Farms, of which Mr. Joe
Zalman is a general partner and 53,800 shares held of record by Mr. Joe
Zalman's self-directed IRA.
(6) Includes 920 shares held of record by the Company's 401(k) Plan as
custodian for Mr. Benter.
(7) Includes 8,000 shares held of record by Bolton Brothers Separate Property
Investment Partnership, of which Mr. Bolton is a general partner and 4,000
shares held of record by the Company's 401(k) Plan as custodian for Mr.
Bolton.
(8) Includes 8,000 shares held of record by the Company's 401(k) Plan as
custodian for Mr. Hester and 4,000 shares held of record by the Company's
401(k) Plan as custodian for Janet L. Hester, the wife of Mr. Hester.
(9) Includes 4,640 shares held of record by the Company's 401(k) Plan as
custodian for Mr. Rudolph.
(10) Includes 38,740 shares held of record by the Charles and Emma Slavik
Investment Partnership, of which Mr. Slavik is general partner.
(11) Includes 132,800 shares held of record by the Harrison Stafford Investment
Partnership, of which Mr. Stafford is general partner.
(12) Includes 3,200 shares held of record by Mr. Zalman as custodian for Britain
Zalman, the minor son of Mr. Zalman, and 3,200 shares held of record by Mr.
Zalman as custodian for Cullen Zalman, the minor son of Mr. Zalman.
61
<PAGE>
SUPERVISION AND REGULATION
The supervision and regulation of bank holding companies and their
subsidiaries is intended primarily for the protection of depositors, the deposit
insurance funds of the FDIC and the banking system as a whole, and not for the
protection of the bank holding company shareholders or creditors. The banking
agencies have broad enforcement power over bank holding companies and banks
including the power to impose substantial fines and other penalties for
violations of laws and regulations.
The following description summarizes some of the laws to which the Company
and the Bank are subject. References herein to applicable statutes and
regulations are brief summaries thereof, do not purport to be complete, and are
qualified in their entirety by reference to such statutes and regulations. The
Company believes that as of the date of this Prospectus it is in compliance in
all material respects with these laws and regulations.
THE COMPANY
The Company is a bank holding company registered under the BHCA, and it is
subject to supervision, regulation and examination by the Federal Reserve Board.
The BHCA and other federal laws subject bank holding companies to particular
restrictions on the types of activities in which they may engage, and to a range
of supervisory requirements and activities, including regulatory enforcement
actions for violations of laws and regulations.
REGULATORY RESTRICTIONS ON DIVIDENDS; SOURCE OF STRENGTH. It is the policy
of the Federal Reserve Board that bank holding companies should pay cash
dividends on common stock only out of income available over the past year and
only if prospective earnings retention is consistent with the organization's
expected future needs and financial condition. The policy provides that bank
holding companies should not maintain a level of cash dividends that undermines
the bank holding company's ability to serve as a source of strength to its
banking subsidiaries.
Under Federal Reserve Board policy, a bank holding company is expected to
act as a source of financial strength to each of its banking subsidiaries and
commit resources to their support. Such support may be required at times when,
absent this Federal Reserve Board policy, a holding company may not be inclined
to provide it. As discussed below, a bank holding company in certain
circumstances could be required to guarantee the capital plan of an
undercapitalized banking subsidiary.
In the event of a bank holding company's bankruptcy under Chapter 11 of the
U.S. Bankruptcy Code, the trustee will be deemed to have assumed and is required
to cure immediately any deficit under any commitment by the debtor holding
company to any of the federal banking agencies to maintain the capital of an
insured depository institution, and any claim for breach of such obligation will
generally have priority over most other unsecured claims.
ACTIVITIES "CLOSELY RELATED" TO BANKING. The BHCA prohibits a bank
holding company, with certain limited exceptions, from acquiring direct or
indirect ownership or control of any voting shares of any company which is not a
bank or from engaging in any activities other than those of banking, managing or
controlling banks and certain other subsidiaries, or furnishing services to or
performing services for its subsidiaries. One principal exception to these
prohibitions allows the acquisition of interests in companies whose activities
are found by the Federal Reserve Board, by order or regulation, to be so closely
related to banking or managing or controlling banks, as to be a proper incident
thereto. Some of the activities that have been determined by regulation to be
closely related to banking are making or servicing loans, performing certain
data processing services, acting as an investment or financial advisor to
certain investment trusts and investment companies, and providing securities
brokerage services. Other activities approved by the Federal Reserve Board
include consumer financial counseling, tax planning and tax preparation, futures
and options advisory services, check guaranty services, collection agency and
credit bureau services, and personal property appraisals. In approving
acquisitions by bank holding companies of companies engaged in banking-related
activities, the Federal Reserve Board considers a number of factors, and weighs
the expected benefits to the public (such as greater convenience and increased
competition or gains in efficiency) against the risks of possible adverse
effects (such as undue concentration of resources,
62
<PAGE>
decreased or unfair competition, conflicts of interest, or unsound banking
practices). The Federal Reserve Board is also empowered to differentiate between
activities commenced de novo and activities commenced through acquisition of a
going concern.
SECURITIES ACTIVITIES. The Federal Reserve Board has approved applications
by bank holding companies to engage, through nonbank subsidiaries, in certain
securities-related activities (underwriting of municipal revenue bonds,
commercial paper, consumer receivable-related securities and one-to-four family
mortgage-backed securities), provided that the affiliates would not be
"principally engaged" in such activities for purposes of Section 20 of the
Glass-Steagall Act. In limited situations, holding companies may be able to use
such subsidiaries to underwrite and deal in corporate debt and equity
securities.
SAFE AND SOUND BANKING PRACTICES. Bank holding companies are not permitted
to engage in unsafe and unsound banking practices. The Federal Reserve Board's
Regulation Y, for example, generally requires a holding company to give the
Federal Reserve Board prior notice of any redemption or repurchase of its own
equity securities, if the consideration to be paid, together with the
consideration paid for any repurchases or redemptions in the preceding year, is
equal to 10% or more of the company's consolidated net worth. The Federal
Reserve Board may oppose the transaction if it believes that the transaction
would constitute an unsafe or unsound practice or would violate any law or
regulation. Depending upon the circumstances, the Federal Reserve Board could
take the position that paying a dividend would constitute an unsafe or unsound
banking practice.
The Federal Reserve Board has broad authority to prohibit activities of
bank holding companies and their nonbanking subsidiaries which represent unsafe
and unsound banking practices or which constitute violations of laws or
regulations, and can assess civil money penalties for certain activities
conducted on a knowing and reckless basis, if those activities caused a
substantial loss to a depository institution. The penalties can be as high as
$1,000,000 for each day the activity continues.
ANTI-TYING RESTRICTIONS. Bank holding companies and their affiliates are
prohibited from tying the provision of certain services, such as extensions of
credit, to other services offered by a holding company or its affiliates.
CAPITAL ADEQUACY REQUIREMENTS. The Federal Reserve Board has adopted a
system using risk-based capital guidelines to evaluate the capital adequacy of
bank holding companies. Under the guidelines, specific categories of assets are
assigned different risk weights, based generally on the perceived credit risk of
the asset. These risk weights are multiplied by corresponding asset balances to
determine a "risk-weighted" asset base. The guidelines require a minimum total
risk-based capital ratio of 8.0% (of which at least 4.0% is required to consist
of Tier 1 capital elements). Total capital is the sum of Tier 1 and Tier 2
capital. As of June 30, 1998, the Company's ratio of Tier 1 capital to total
risk-weighted assets was 14.32% and its ratio of total capital to total
risk-weighted assets was 15.08%. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Financial Condition -- Capital
Resources."
In addition to the risk-based capital guidelines, the Federal Reserve Board
uses a leverage ratio as an additional tool to evaluate the capital adequacy of
bank holding companies. The leverage ratio is a company's Tier 1 capital divided
by its average total consolidated assets. Certain highly-rated bank holding
companies may maintain a minimum leverage ratio of 3.0%, but other bank holding
companies may be required to maintain a leverage ratio of up to 200 basis points
above the regulatory minimum. As of June 30, 1998, the Company's leverage ratio
was 6.25%.
The federal banking agencies' risk-based and leverage ratios are minimum
supervisory ratios generally applicable to banking organizations that meet
certain specified criteria, assuming that they have the highest regulatory
rating. Banking organizations not meeting these criteria are expected to operate
with capital positions well above the minimum ratios. The federal bank
regulatory agencies may set capital requirements for a particular banking
organization that are higher than the minimum ratios when circumstances warrant.
Federal Reserve Board guidelines also provide that banking organizations
experiencing internal growth or making acquisitions will be expected to maintain
strong capital positions substantially above the minimum supervisory levels,
without significant reliance on intangible assets.
63
<PAGE>
IMPOSITION OF LIABILITY FOR UNDERCAPITALIZED SUBSIDIARIES. Bank regulators
are required to take "prompt corrective action" to resolve problems associated
with insured depository institutions whose capital declines below certain
levels. In the event an institution becomes "undercapitalized," it must submit
a capital restoration plan. The capital restoration plan will not be accepted by
the regulators unless each company having control of the undercapitalized
institution guarantees the subsidiary's compliance with the capital restoration
plan up to a certain specified amount. Any such guarantee from a depository
institution's holding company is entitled to a priority of payment in
bankruptcy.
The aggregate liability of the holding company of an undercapitalized bank
is limited to the lesser of 5% of the institution's assets at the time it became
undercapitalized or the amount necessary to cause the institution to be
"adequately capitalized." The bank regulators have greater power in situations
where an institution becomes "significantly" or "critically"
undercapitalized or fails to submit a capital restoration plan. For example, a
bank holding company controlling such an institution can be required to obtain
prior Federal Reserve Board approval of proposed dividends, or might be required
to consent to a consolidation or to divest the troubled institution or other
affiliates.
ACQUISITIONS BY BANK HOLDING COMPANIES. The BHCA requires every bank
holding company to obtain the prior approval of the Federal Reserve Board before
it may acquire all or substantially all of the assets of any bank, or ownership
or control of any voting shares of any bank, if after such acquisition it would
own or control, directly or indirectly, more than 5% of the voting shares of
such bank. In approving bank acquisitions by bank holding companies, the Federal
Reserve Board is required to consider the financial and managerial resources and
future prospects of the bank holding company and the banks concerned, the
convenience and needs of the communities to be served, and various competitive
factors.
CONTROL ACQUISITIONS. The Change in Bank Control Act prohibits a person or
group of persons from acquiring "control" of a bank holding company unless the
Federal Reserve Board has been notified and has not objected to the transaction.
Under a rebuttable presumption established by the Federal Reserve Board, the
acquisition of 10% of more of a class of voting stock of a bank holding company
with a class of securities registered under Section 12 of the Exchange Act, such
as the Company, would, under the circumstances set forth in the presumption,
constitute acquisition of control of the Company.
In addition, any entity is required to obtain the approval of the Federal
Reserve Board under the BHCA before acquiring 25% (5% in the case of an acquiror
that is a bank holding company) or more of the outstanding Common Stock of the
Company, or otherwise obtaining control or a "controlling influence" over the
Company.
THE BANK
The Bank is a Texas-chartered banking association, the deposits of which
are insured by the Bank Insurance Fund ("BIF"). The Bank is not a member of
the Federal Reserve System; therefore, the Bank is subject to supervision and
regulation by the FDIC and the Texas Banking Department. Such supervision and
regulation subjects the Bank to special restrictions, requirements, potential
enforcement actions and periodic examination by the FDIC and the Texas Banking
Department. Because the Federal Reserve Board regulates the bank holding company
parent of the Bank, the Federal Reserve Board also has supervisory authority
which directly affects the Bank.
EQUIVALENCE TO NATIONAL BANK POWERS. The Texas Constitution, as amended in
1986, provides that a Texas-chartered bank has the same rights and privileges
that are or may be granted to national banks domiciled in Texas. To the extent
that the Texas laws and regulations may have allowed state-chartered banks to
engage in a broader range of activities than national banks, the Federal Deposit
Insurance Corporation Improvement Act of 1991 ("FDICIA") has operated to limit
this authority. FDICIA provides that no state bank or subsidiary thereof may
engage as principal in any activity not permitted for national banks, unless the
institution complies with applicable capital requirements and the FDIC
determines that the activity poses no significant risk to the insurance fund. In
general, statutory restrictions on the activities of banks are aimed at
protecting the safety and soundness of depository institutions.
64
<PAGE>
BRANCHING. Texas law provides that a Texas-chartered bank can establish a
branch anywhere in Texas provided that the branch is approved in advance by the
Texas Banking Department. The branch must also be approved by the FDIC, which
considers a number of factors, including financial history, capital adequacy,
earnings prospects, character of management, needs of the community and
consistency with corporate powers.
RESTRICTIONS ON TRANSACTIONS WITH AFFILIATES AND INSIDERS. Transactions
between the Bank and its nonbanking subsidiaries, including the Company, are
subject to Section 23A of the Federal Reserve Act. In general, Section 23A
imposes limits on the amount of such transactions, and also requires certain
levels of collateral for loans to affiliated parties. It also limits the amount
of advances to third parties which are collateralized by the securities or
obligations of the Company or its subsidiaries.
Affiliate transactions are also subject to Section 23B of the Federal
Reserve Act which generally requires that certain transactions between the Bank
and its affiliates be on terms substantially the same, or at least as favorable
to the Bank, as those prevailing at the time for comparable transactions with or
involving other nonaffiliated persons.
The restrictions on loans to directors, executive officers, principal
shareholders and their related interests (collectively referred to herein as
"insiders") contained in the Federal Reserve Act and Regulation O apply to all
insured institutions and their subsidiaries and holding companies. These
restrictions include limits on loans to one borrower and conditions that must be
met before such a loan can be made. There is also an aggregate limitation on all
loans to insiders and their related interests. These loans cannot exceed the
institution's total unimpaired capital and surplus, and the FDIC may determine
that a lesser amount is appropriate. Insiders are subject to enforcement actions
for knowingly accepting loans in violation of applicable restrictions.
RESTRICTIONS ON DISTRIBUTION OF SUBSIDIARY BANK DIVIDENDS AND
ASSETS. Dividends paid by the Bank have provided a substantial part of the
Company's operating funds and for the foreseeable future it is anticipated that
dividends paid by the Bank to the Company will continue to be the Company's
principal source of operating funds. Capital adequacy requirements serve to
limit the amount of dividends that may be paid by the Bank. Under federal law,
the Bank cannot pay a dividend if, after paying the dividend, the Bank will be
"undercapitalized." The FDIC may declare a dividend payment to be unsafe and
unsound even though the Bank would continue to meet its capital requirements
after the dividend.
Because the Company is a legal entity separate and distinct from its
subsidiaries, its right to participate in the distribution of assets of any
subsidiary upon the subsidiary's liquidation or reorganization will be subject
to the prior claims of the subsidiary's creditors. In the event of a liquidation
or other resolution of an insured depository institution, the claims of
depositors and other general or subordinated creditors are entitled to a
priority of payment over the claims of holders of any obligation of the
institution to its shareholders, including any depository institution holding
company (such as the Company) or any shareholder or creditor thereof.
EXAMINATIONS. The FDIC periodically examines and evaluates insured banks.
Based upon such an evaluation, the FDIC may revalue the assets of the
institution and require that it establish specific reserves to compensate for
the difference between the FDIC-determined value and the book value of such
assets. The Texas Banking Department also conducts examinations of state banks
but may accept the results of a federal examination in lieu of conducting an
independent examination.
AUDIT REPORTS. Insured institutions with total assets of $500 million or
more must submit annual audit reports prepared by independent auditors to
federal and state regulators. In some instances, the audit report of the
institution's holding company can be used to satisfy this requirement. Auditors
must receive examination reports, supervisory agreements and reports of
enforcement actions. In addition, financial statements prepared in accordance
with generally accepted accounting principles, management's certifications
concerning responsibility for the financial statements, internal controls and
compliance with legal requirements designated by the FDIC, and an attestation by
the auditor regarding the statements of management relating to the internal
controls must be submitted. For institutions with total assets of more
65
<PAGE>
than $3 billion, independent auditors may be required to review quarterly
financial statements. FDICIA requires that independent audit committees be
formed, consisting of outside directors only. The committees of such
institutions must include members with experience in banking or financial
management, must have access to outside counsel, and must not include
representatives of large customers.
CAPITAL ADEQUACY REQUIREMENTS. The FDIC has adopted regulations
establishing minimum requirements for the capital adequacy of insured
institutions. The FDIC may establish higher minimum requirements if, for
example, a bank has previously received special attention or has a high
susceptibility to interest rate risk.
The FDIC's risk-based capital guidelines generally require state banks to
have a minimum ratio of Tier 1 capital to total risk-weighted assets of 4.0% and
a ratio of total capital to total risk-weighted assets of 8.0%. The capital
categories have the same definitions for the Bank as for the Company. As of June
30, 1998, the Bank's ratio of Tier 1 capital to total risk-weighted assets was
14.22% and its ratio of total capital to total risk-weighted assets was 14.99%.
See "Management's Discussion and Analysis of Financial Condition and Result of
Operation of the Company -- Financial Condition -- Capital Resources."
The FDIC's leverage guidelines require state banks to maintain Tier 1
capital of no less than 5.0% of average total assets, except in the case of
certain highly rated banks for which the requirement is 3.0% of average total
assets. The Texas Banking Department has issued a policy which generally
requires state chartered banks to maintain a leverage ratio (defined in
accordance with federal capital guidelines) of 6%. As of June 30, 1998, the
Bank's ratio of Tier 1 capital to average total assets (leverage ratio) was
6.21%. See "Management's Discussion and Analysis of Financial Condition and
Result of Operation of the Company -- Financial Condition -- Capital
Resources."
CORRECTIVE MEASURES FOR CAPITAL DEFICIENCIES. The federal banking
regulators are required to take "prompt corrective action" with respect to
capital-deficient institutions. Agency regulations define, for each capital
category, the levels at which institutions are "well capitalized,"
"adequately capitalized," "under capitalized," "significantly under
capitalized" and "critically under capitalized." A "well capitalized" bank
has a total risk-based capital ratio of 10.0% or higher; a Tier 1 risk-based
capital ratio of 6.0% or higher; a leverage ratio of 5.0% or higher; and is not
subject to any written agreement, order or directive requiring it to maintain a
specific capital level for any capital measure. An "adequately capitalized"
bank has a total risk-based capital ratio of 8.0% or higher; a Tier 1 risk-based
capital ratio of 4.0% or higher; a leverage ratio of 4.0% or higher (3.0% or
higher if the bank was rated a composite 1 in its most recent examination report
and is not experiencing significant growth); and does not meet the criteria for
a well capitalized bank. A bank is "under capitalized" if it fails to meet any
one of the ratios required to be adequately capitalized.
In addition to requiring undercapitalized institutions to submit a capital
restoration plan, agency regulations contain broad restrictions on certain
activities of undercapitalized institutions including asset growth,
acquisitions, branch establishment and expansion into new lines of business.
With certain exceptions, an insured depository institution is prohibited from
making capital distributions, including dividends, and is prohibited from paying
management fees to control persons if the institution would be undercapitalized
after any such distribution or payment.
As an institution's capital decreases, the FDIC's enforcement powers become
more severe. A significantly undercapitalized institution is subject to mandated
capital raising activities, restrictions on interest rates paid and transactions
with affiliates, removal of management and other restrictions. The FDIC has only
very limited discretion in dealing with a critically undercapitalized
institution and is virtually required to appoint a receiver or conservator.
Banks with risk-based capital and leverage ratios below the required
minimums may also be subject to certain administrative actions, including the
termination of deposit insurance upon notice and hearing, or a temporary
suspension of insurance without a hearing in the event the institution has no
tangible capital.
DEPOSIT INSURANCE ASSESSMENTS. The Bank must pay assessments to the FDIC
for federal deposit insurance protection. The FDIC has adopted a risk-based
assessment system as required by FDICIA. Under
66
<PAGE>
this system, FDIC-insured depository institutions pay insurance premiums at
rates based on their risk classification. Institutions assigned to higher risk
classifications (that is, institutions that pose a greater risk of loss to their
respective deposit insurance funds) pay assessments at higher rates than
institutions that pose a lower risk. An institution's risk classification is
assigned based on its capital levels and the level of supervisory concern the
institution poses to the regulators. In addition, the FDIC can impose special
assessments in certain instances.
The FDIC established a process for raising or lowering all rates for
insured institutions semi-annually if conditions warrant a change. Under this
new system, the FDIC has the flexibility to adjust the assessment rate schedule
twice a year without seeking prior public comment, but only within a range of
five cents per $100 above or below the premium schedule adopted. Changes in the
rate schedule outside the five cent range above or below the current schedule
can be made by the FDIC only after a full rulemaking with opportunity for public
comment.
On September 30, 1996, President Clinton signed into law an act that
contained a comprehensive approach to recapitalizing the SAIF and to assure the
payment of the Financing Corporation's ("FICO") bond obligations. Under this
new act, banks insured under the BIF are required to pay a portion of the
interest due on bonds that were issued by FICO to help shore up the ailing
Federal Savings and Loan Insurance Corporation in 1987. The BIF rate must equal
one-fifth of the SAIF rate through year-end 1999, or until the insurance funds
are merged, whichever occurs first. Thereafter BIF and SAIF payers will be
assessed pro rata for the FICO bond obligations. With regard to the assessment
for the FICO obligation, the current BIF rate is .0126% of deposits and the SAIF
rate is .0630% of deposits.
ENFORCEMENT POWERS. The FDIC and the other federal banking agencies have
broad enforcement powers, including the power to terminate deposit insurance,
impose substantial fines and other civil and criminal penalties and appoint a
conservator or receiver. Failure to comply with applicable laws, regulations and
supervisory agreements could subject the Company or its banking subsidiaries, as
well as officers, directors and other institution-affiliated parties of these
organizations, to administrative sanctions and potentially substantial civil
money penalties. The appropriate federal banking agency may appoint the FDIC as
conservator or receiver for a banking institution (or the FDIC may appoint
itself, under certain circumstances) if any one or more of a number of
circumstances exist, including, without limitation, the fact that the banking
institution is undercapitalized and has no reasonable prospect of becoming
adequately capitalized; fails to become adequately capitalized when required to
do so; fails to submit a timely and acceptable capital restoration plan; or
materially fails to implement an accepted capital restoration plan.
BROKERED DEPOSIT RESTRICTIONS. Adequately capitalized institutions cannot
accept, renew or roll over brokered deposits except with a waiver from the FDIC,
and are subject to restrictions on the interest rates that can be paid on such
deposits. Undercapitalized institutions may not accept, renew, or roll over
brokered deposits.
CROSS-GUARANTEE PROVISIONS. The Financial Institutions Reform, Recovery
and Enforcement Act of 1989 ("FIRREA") contains a "cross-guarantee"
provision which generally makes commonly controlled insured depository
institutions liable to the FDIC for any losses incurred in connection with the
failure of a commonly controlled depository institution.
COMMUNITY REINVESTMENT ACT. The Community Reinvestment Act of 1977
("CRA") and the regulations issued thereunder are intended to encourage banks
to help meet the credit needs of their service area, including low and moderate
income neighborhoods, consistent with the safe and sound operations of the
banks. These regulations also provide for regulatory assessment of a bank's
record in meeting the needs of its service area when considering applications to
establish branches, merger applications and applications to acquire the assets
and assume the liabilities of another bank. FIRREA requires federal banking
agencies to make public a rating of a bank's performance under the CRA. In the
case of a bank holding company, the CRA performance record of the banks involved
in the transaction are reviewed in connection with the filing of an application
to acquire ownership or control of shares or assets of a bank or to merge with
any other bank holding company. An unsatisfactory record can substantially delay
or block the transaction.
67
<PAGE>
CONSUMER LAWS AND REGULATIONS. In addition to the laws and regulations
discussed herein, the Bank is also subject to certain consumer laws and
regulations that are designed to protect consumers in transactions with banks.
While the list set forth herein is not exhaustive, these laws and regulations
include the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds
Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity
Act, and the Fair Housing Act, among others. These laws and regulations mandate
certain disclosure requirements and regulate the manner in which financial
institutions must deal with customers when taking deposits or making loans to
such customers. The Bank must comply with the applicable provisions of these
consumer protection laws and regulations as part of their ongoing customer
relations.
INSTABILITY OF REGULATORY STRUCTURE
Various legislation, including proposals to overhaul the bank regulatory
system, expand the powers of banking institutions and bank holding companies and
limit the investments that a depository institution may make with insured funds,
is from time to time introduced in Congress. Such legislation may change banking
statutes and the operating environment of the Company and its banking
subsidiaries in substantial and unpredictable ways. The Company cannot determine
the ultimate effect that potential legislation, if enacted, or implementing
regulations with respect thereto, would have upon the financial condition or
results of operations of the Company or its subsidiaries.
EXPANDING ENFORCEMENT AUTHORITY
One of the major additional burdens imposed on the banking industry by
FDICIA is the increased ability of banking regulators to monitor the activities
of banks and their holding companies. In addition, the Federal Reserve Board and
FDIC are possessed of extensive authority to police unsafe or unsound practices
and violations of applicable laws and regulations by depository institutions and
their holding companies. For example, the FDIC may terminate the deposit
insurance of any institution which it determines has engaged in an unsafe or
unsound practice. The agencies can also assess civil money penalties, issue
cease and desist or removal orders, seek injunctions, and publicly disclose such
actions. FDICIA, FIRREA and other laws have expanded the agencies' authority in
recent years, and the agencies have not yet fully tested the limits of their
powers.
EFFECT ON ECONOMIC ENVIRONMENT
The policies of regulatory authorities, including the monetary policy of
the Federal Reserve Board, have a significant effect on the operating results of
bank holding companies and their subsidiaries. Among the means available to the
Federal Reserve Board to affect the money supply are open market operations in
U.S. Government securities, changes in the discount rate on member bank
borrowings, and changes in reserve requirements against member bank deposits.
These means are used in varying combinations to influence overall growth and
distribution of bank loans, investments and deposits, and their use may affect
interest rates charged on loans or paid for deposits.
Federal Reserve Board monetary policies have materially affected the
operating results of commercial banks in the past and are expected to continue
to do so in the future. The nature of future monetary policies and the effect of
such policies on the business and earnings of the Company and its subsidiaries
cannot be predicted.
68
<PAGE>
DESCRIPTION OF SECURITIES OF THE COMPANY
AUTHORIZED CAPITAL STOCK
The authorized capital stock of the Company consists of (i) 20,000,000
shares of preferred stock, $1.00 per share par value ("Preferred Stock"),
issuable in series, none of which are issued and outstanding and (ii) 50,000,000
shares of Common Stock, $1.00 per share par value, of which 3,993,884 shares
were issued and 3,990,308 shares were outstanding as of June 30, 1998. The terms
of any new series of preferred stock may be fixed by the Board of Directors of
the Company within certain limits set by the Company's Articles of
Incorporation.
The following discussion of the terms and provisions of the Company's
capital stock is qualified in its entirety by reference to the Company's
Articles of Incorporation and Bylaws, copies of which have been filed as
exhibits to the Registration Statement of which this Prospectus is a part.
PREFERRED STOCK
The Company is authorized to issue 20,000,000 shares of Preferred Stock.
The Preferred Stock (or other securities convertible in whole or in part into
Preferred Stock) is available for issuance from time to time for various
purposes as determined by the Company's Board of Directors, including, without
limitation, making future acquisitions, raising additional equity capital and
financing. Subject to certain limits set by the Company's Articles of
Incorporation, the Preferred Stock (or such convertible securities) may be
issued on such terms and conditions, and at such times and in such situations,
as the Board of Directors in its sole discretion determines to be appropriate,
without any further approval or action by the shareholders (unless otherwise
required by laws, rules, regulations or agreements applicable to the Company).
Moreover, except as otherwise limited by the Articles of Incorporation or
applicable laws, rules or regulations, the Board of Directors has the sole
authority to determine the relative rights and preferences of the Preferred
Stock and any series thereof without shareholder approval. The Company's
Articles of Incorporation require all shares of Preferred Stock to be identical,
except as to the following characteristics, which may vary between different
series of Preferred Stock:
(i) dividend rate, preference of dividend with respect to any other
class or series of stock, and cumulativity, non-cumulativity or partial
cumulativity of dividends;
(ii) redemption price and terms, including, to the extent permitted
by law, the manner in which shares are to be chosen for redemption if less
than all the shares of a series are to be redeemed;
(iii) sinking fund provisions for the redemption or purchase of
shares;
(iv) the amount payable upon shares in the event of voluntary or
involuntary liquidation;
(v) the terms and conditions on which shares may be converted, if the
shares of any series are issued with the privilege of conversion;
(vi) voting rights; and
(vii) such other powers, preferences and rights as the Board of
Directors shall determine.
The Board of Directors does not intend to seek shareholder approval prior
to any issuance of Preferred Stock or any series thereof, unless otherwise
required by law. Under the Texas Business Corporation Act ("TBCA"),
shareholder approval prior to the issuance of shares of Common Stock or
Preferred Stock is required in connection with certain mergers. Frequently,
opportunities arise that require prompt action, such as the possible acquisition
of a property or business or the private sale of securities, and it is the
belief of the Board of Directors that the delay necessary for shareholder
approval of a specific issuance could be to the detriment of the Company and its
shareholders. The Board of Directors does not intend to issue any shares of
Common Stock or Preferred Stock except on terms which the Board of Directors
deems to be in the best interests of the Company and its then existing
shareholders.
69
<PAGE>
Although the Preferred Stock could be deemed to have an anti-takeover
effect, the Board of Directors is not aware of any takeover efforts. If a
hostile takeover situation should arise, shares of Preferred Stock could be
issued to purchasers sympathetic with the Company's management or others in such
a way as to render more difficult or to discourage a merger, tender offer, proxy
contest, the assumption of control by a holder of a large block of the Company's
securities or the removal of incumbent management.
The effects of the issuance of the Preferred Stock on the holders of Common
Stock could include, among other things, (i) reduction of the amount otherwise
available for payments of dividends on Common Stock if dividends are payable on
the series of Preferred Stock; (ii) restrictions on dividends on Common Stock if
dividends on the series of Preferred Stock are in arrears; (iii) dilution of the
voting power of Common Stock if the series of Preferred Stock has voting rights,
including a possible "veto" power if the series of Preferred Stock has class
voting rights; (iv) dilution of the equity interest of holders of Common Stock
if the series of Preferred Stock is convertible, and is converted, into Common
Stock; and (v) restrictions on the rights of holders of Common Stock to share in
the Company's assets upon liquidation until satisfaction of any liquidation
preference granted to the holders of the series of Preferred Stock. Holders of
Common Stock have no preemptive rights to purchase or otherwise acquire any
Preferred Stock or securities convertible into Preferred Stock that may be
issued.
COMMON STOCK
The holders of the Common Stock are entitled to one vote for each share of
Common Stock owned. Except as expressly provided by law and except for any
voting rights which may be conferred by the Board of Directors on any shares of
Preferred Stock issued, all voting power is in the Common Stock. Holders of
Common Stock may not cumulate their votes for the election of directors. Holders
of Common Stock do not have preemptive rights to acquire any additional,
unissued or treasury shares of the Company, or securities of the Company
convertible into or carrying a right to subscribe for or acquire shares of the
Company.
Holders of Common Stock will be entitled to receive dividends out of funds
legally available therefor, if and when properly declared by the Board of
Directors. See "Risk Factors -- Dividend History and Restrictions on Ability to
Pay Dividends" and "Supervision and Regulation."
On the liquidation of the Company, the holders of Common Stock are entitled
to share pro rata in any distribution of the assets of the Company, after the
holders of shares of Preferred Stock have received the liquidation preference of
their shares plus any cumulated but unpaid dividends (whether or not earned or
declared), if any, and after all other indebtedness of the Company has been
retired.
TEXAS LAW AND CERTAIN PROVISIONS OF THE ARTICLES OF INCORPORATION AND BYLAWS
Certain provisions of Texas law, the Company's Articles of Incorporation
and the Company's Bylaws could make more difficult the acquisition of the
Company by means of a tender offer, a proxy contest or otherwise and the removal
of incumbent officers and directors. These provisions are intended to discourage
certain types of coercive takeover practices and inadequate takeover bids and to
encourage persons seeking to acquire control of the Company to negotiate first
with the Company.
The Company is subject to the provisions of the Texas Business Combination
Law (Articles 13.01 through 13.08 of the TBCA), which provides that a Texas
corporation such as the Company may not engage in certain business combinations,
including mergers, consolidations and asset sales, with a person, or an
affiliate or associate of such person, who is an "Affiliated Shareholder"
(generally defined as the holder of 20% or more of the corporation's voting
shares) for a period of three years from the date such person became an
Affiliated Shareholder unless: (i) the business combination or purchase or
acquisition of shares made by the Affiliated Shareholder was approved by the
board of directors of the corporation before the Affiliated Shareholder became
an Affiliated Shareholder or (ii) the business combination was approved by the
affirmative vote of the holders of at least two-thirds of the outstanding voting
shares of the corporation not beneficially owned by the Affiliated Shareholder,
at a meeting of shareholders called for that purpose (and not by written
consent), not less than six months after the Affiliated Shareholder became an
Affiliated Shareholder. The Texas Business Combination Law is not applicable to:
(i) the business combination of a
70
<PAGE>
corporation: (a) where the corporation's original charter or bylaws contain a
provision expressly electing not to be governed by the Texas Business
Combination Law, (b) that adopted an amendment to its charter or bylaws before
December 31, 1997, expressly electing not to be governed by the Texas Business
Combination Law, or (c) that adopts an amendment to its charter or bylaws after
December 31, 1997, by the affirmative vote of the holders, other than Affiliated
Shareholders, of at least two-thirds of the outstanding voting shares of the
corporation, expressly electing not to be governed by the Texas Business
Combination Law; (ii) a business combination of a corporation with an Affiliated
Shareholder that became an Affiliated Shareholder inadvertently, if the
Affiliated Shareholder: (a) as soon as practicable divests itself of enough
shares to no longer be an Affiliated Shareholder and (b) would not at any time
within the three year period preceding the announcement of the business
combination have been an Affiliated Shareholder but for the inadvertent
acquisition; (iii) a business combination with an Affiliated Shareholder that
was the beneficial owner of 20% or more of the outstanding voting shares of the
corporation on December 31, 1996, and continuously until the announcement date
of the business combination; (iv) a business combination with an Affiliated
Shareholder who became an Affiliated Shareholder through a transfer of shares of
the corporation by will or intestate succession and continuously was such an
Affiliated Shareholder until the announcement date of the business combination;
and (v) a business combination of a corporation with a wholly owned subsidiary
if the subsidiary is not an affiliate or associate of the Affiliated Shareholder
other than by reason of the Affiliated Shareholder's beneficial ownership of the
voting shares of the corporation. Neither the Articles of Incorporation nor the
Bylaws of the Company contain any provision expressly providing that the Company
will not be subject to the Texas Business Combination Law. The Texas Business
Combination Law may have the effect of inhibiting a non-negotiated merger or
other business combination involving the Company, even if such event would be
beneficial to the Company's shareholders.
The following discussion is a summary of certain material provisions of the
Company's Articles of Incorporation and the Company's Bylaws, copies of which
are filed as exhibits to the Registration Statement of which this Prospectus is
a part.
CLASSIFIED BOARD OF DIRECTORS. Under the Company's Bylaws, the Board of
Directors is classified into three classes, with the directors being elected for
staggered, three-year terms. The classification of the Company's Board of
Directors will have the effect of making it more difficult to change the
composition of the Board of Directors, because at least two annual meetings of
the shareholders would be required to change the control of the Board of
Directors rather than one. In addition, the Bylaws provide that directors may be
removed by the shareholders only for cause and that vacancies on the Board of
Directors may be filled by the remaining directors.
ADVANCE NOTICE OF SHAREHOLDER PROPOSALS AND NOMINATIONS. The Company's
Bylaws establish an advance notice procedure for shareholders to make
nominations of candidates for election as directors or bring other business
before any meeting of shareholders of the Company (the "Shareholder Notice
Procedure"). The Shareholder Notice Procedure provides that only persons who
are nominated by, or at the direction of, the Board, or by a shareholder who has
given timely written notice to the Secretary of the Company prior to the meeting
at which directors are to be elected, will be eligible for election as directors
of the Company and that, at a shareholders' meeting, only such business may be
conducted as has been brought before the meeting by, or at the direction of, the
Board of Directors or by a shareholder who has given timely written notice to
the Secretary of the Company of such shareholder's intention to bring such
business before such meeting.
Under the Shareholder Notice Procedure, for notice of shareholder
nominations or other business to be made at a shareholders' meeting to be
timely, such notice must be received by the Company not less than 60 days prior
to the meeting.
A shareholder's notice to the Company proposing to nominate a person for
election as a director or proposing other business must contain certain
information specified in the Bylaws, including the identity and address of the
nominating shareholder, a representation that the shareholder is a record holder
of stock of the Company entitled to vote at the meeting and information
regarding each proposed nominee or each
71
<PAGE>
proposed matter of business that would be required under the federal securities
laws to be included in a proxy statement soliciting proxies for the proposed
nominee or the proposed matter of business.
The Shareholder Notice Procedure may have the effect of precluding a
contest for the election of directors or the consideration of shareholder
proposals if the proper procedures are not followed, and of discouraging or
deterring a third party from conducting a solicitation of proxies to elect its
own slate of directors or to approve its own proposal, without regard to whether
consideration of such nominees or proposals might be harmful or beneficial to
the Company and its shareholders.
SPECIAL MEETINGS OF SHAREHOLDERS. The Articles of Incorporation provide
that special meetings of shareholders can be called by a majority of the Board
of Directors, the Chairman of the Board, the President or the holders of at
least 50% of the outstanding shares of stock entitled to vote at the meeting.
REDUCED SHAREHOLDER VOTE REQUIRED FOR CERTAIN ACTIONS. The Company's
Articles of Incorporation provide that, notwithstanding any provision of the
TBCA that would require approval of more than a majority of the shares entitled
to vote on such matter and present or represented by proxy at the meeting, the
vote or approval of a majority of the shares of the Company's stock entitled to
vote on such matter will be sufficient to approve such matter. This provision
reduces the required shareholder approval level for certain actions such as a
merger, a consolidation, a share exchange, certain sales of substantially all of
the Company's assets, a dissolution or an amendment to the Company's Articles of
Incorporation, each of which would otherwise require two-thirds shareholder
approval under Texas law.
NO ACTION BY WRITTEN CONSENT WITHOUT UNANIMOUS WRITTEN CONSENT. Under the
TBCA, no action required or permitted to be taken at an annual or special
meeting of shareholders may be taken by written consent in lieu of a meeting of
shareholders without the unanimous written consent of all shareholders unless
the articles of incorporation specifically allow action by less than unanimous
consent. The Company's Articles of Incorporation do not contain such a
provision.
AMENDMENT OF BYLAWS. The Company's Bylaws provide that the Bylaws may be
amended only by the Board of Directors. Shareholders do not have the power to
amend the Company Bylaws.
72
<PAGE>
UNDERWRITING
Subject to the terms and conditions of the Purchase Agreement among the
Company, the Selling Shareholders and the Representatives on behalf of the
Underwriters, the Underwriters have agreed severally to purchase from the
Company and the Selling Shareholders the following respective number of shares
of Common Stock at the initial public offering price less the underwriting
discounts and commissions set forth on the cover page of this Prospectus.
NAME NO. OF SHARES
- ------------------------------------- --------------
Keefe, Bruyette & Woods, Inc......... 1,115,909
Hoefer & Arnett, Incorporated........ 600,874
--------------
Total........................... 1,716,783
==============
The Purchase Agreement provides that the obligations of the Underwriters
are subject to certain conditions precedent and that the Underwriters will
purchase all such shares of the Common Stock if any of such shares are
purchased. The Underwriters are obligated to take and pay for all of the shares
of Common Stock offered hereby (other than those covered by the over-allotment
option described below) if any are taken.
The Company has been advised by the Representatives that the Underwriters
propose to offer to such shares of Common Stock to the public at the public
offering price set forth on the cover page of this Prospectus and to certain
dealers at such price less a concession not in excess of $0.50 per share. The
Underwriters may allow, and such dealers may re-allow, a concession not in
excess of $0.10 per share to certain other dealers. After the initial public
offering, the offering price and other selling terms may be changed by the
Underwriters.
Pursuant to the Purchase Agreement, the Company has granted to the
Underwriters an option, exercisable not later than 30 days after the date of
this Prospectus, to purchase up to 257,517 additional shares of Common Stock at
the public offering price, less the underwriting discounts and commissions set
forth on the cover page of this Prospectus, solely to cover over-allotments. To
the extent that the Underwriters exercise such option, the Underwriters will
become obligated, subject to certain conditions, to purchase approximately the
same percentage of such additional shares as the number set forth next to such
Underwriter's name in the preceding table bears to the total number of shares in
such table, and the Company will be obligated, pursuant to the option, to sell
such shares to the Underwriters.
The Company, each of its directors and executive officers, each of the
Selling Shareholders and certain other shareholders of the Company have agreed
not to sell or otherwise dispose of any shares of Common Stock for a period of
180 days after the date of this Prospectus without the prior written consent of
the Representatives. See "Risk Factors -- Shares Eligible for Future Sale."
The Company and the Selling Shareholders have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act.
Until the distribution of the Common Stock is completed, rules of the
Commission (as defined herein) may limit the ability of the Underwriters and
certain selling group members to bid for and purchase the Common Stock. As an
exception to these rules, the Underwriters are permitted to engage in certain
transactions that stabilize the price of the Common Stock. Such transactions
consist of bids or purchases for the purpose of pegging, fixing or maintaining
the price of the Common Stock.
If the Underwriters create a short position in the Common Stock in
connection with the Offering, i.e., if they sell a greater aggregate number of
shares of Common Stock than is set forth on the cover page of this Prospectus,
the Underwriters may reduce the short position by purchasing shares of Common
Stock in the open market. The Underwriters may also elect to reduce any short
position by exercising all or part of the over-allotment option described above.
The Underwriters may also impose a penalty bid on certain selling group
members. This means that if the Underwriters purchase Common Stock in the open
market to reduce the selling group members' short
73
<PAGE>
position or to stabilize the price of the Common Stock, they may reclaim the
amount of the selling concession from the selling group members who sold those
shares of Common Stock as part of the Offering.
In general, purchases of a security for the purpose of stabilization or to
reduce a short position could cause the price of the security to be higher than
it might be in the absence of such purchases. The imposition of a penalty bid
might also have an effect on the price of a security to the extent that it were
to discourage resales of the security.
Neither the Company nor the Representatives make any representation or
prediction as to the direction or magnitude of any effect that the transactions
described above may have on the price of the Common Stock. In addition, neither
the Company nor the Representatives make any representation that the
Underwriters will engage in such transactions or that such transactions, once
commenced, will not be discontinued without notice.
The Underwriters and dealers may engage in passive market making
transactions in the shares of Common Stock in accordance with Rule 103 of
Regulation M promulgated by the Commission. In general, a passive market maker
may not bid for, or purchase, shares of Common Stock at a price that exceeds the
highest independent bid. In addition, the net daily purchases made by any
passive market maker generally may not exceed 30% of its average daily trading
volume in the Common Stock during a specified two month prior period, or 200
shares, whichever is greater. A passive market maker must identify passive
market making bids as such on the Nasdaq electronic inter-dealer reporting
system. Passive market making may stabilize or maintain the market price of the
Common Stock above independent market levels. Underwriters and dealers are not
required to engage in passive market making and may end passive market making
activities at any time.
Prior to the Offering, there has been no public market for the Common
Stock. Consequently, the initial public offering price for the Common Stock has
been determined by negotiations between the Company and the Representatives.
Among the factors considered in such negotiations were prevailing market and
general economic conditions, the market capitalizations, trading histories and
stages of development of other traded companies that the Company and the
Representatives believed to be comparable to the Company, the results of
operations of the Company in recent periods, the current financial position of
the Company, estimates of the business potential of the Company and the present
state of the Company's development and the availability for sale in the market
of a significant number of shares of Common Stock. Additionally, consideration
has been given to the general status of the securities market, the market
conditions for new issues of securities and the demand for securities of
comparable companies at the time the Offering was made.
The Common Stock has been approved for quotation on the Nasdaq/National
Market.
LEGAL MATTERS
The validity of the shares of Common Stock to be issued by the Company will
be passed upon by Bracewell & Patterson, L.L.P., Houston, Texas. Certain legal
matters with respect to the Common Stock offered hereby will be passed upon for
the Underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New
York.
EXPERTS
The consolidated balance sheets of the Company as of December 31, 1997 and
1996 and the related consolidated statements of income, shareholders' equity,
and cash flows for each of the three years in the period ended December 31,
1997, included in this Prospectus have been audited by Deloitte & Touche LLP,
independent auditors, as stated in their reports appearing herein, and are
included in reliance upon the reports of such firm, given upon their authority
as experts in accounting and auditing.
The statements of condition of Union as of December 31, 1997 and 1996 and
the related statements of income, changes in shareholders' equity and cash flows
for each of the two years in the period ended
74
<PAGE>
December 31, 1997 included in this Prospectus have been audited by Harper &
Pearson Company, independent auditors, as stated in their reports appearing
herein, and are included in reliance upon the reports of such firm, given upon
their authority as experts in accounting and auditing.
AVAILABLE INFORMATION
The Company has not previously been subject to the reporting requirements
of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). The
Company has filed with the Securities and Exchange Commission (the
"Commission") a Registration Statement on Form S-1 (the "Registration
Statement") under the Securities Act, with respect to the offer and sale of
Common Stock pursuant to this Prospectus. This Prospectus, filed as a part of
the Registration Statement, does not contain all of the information set forth in
the Registration Statement or the exhibits and schedules thereto in accordance
with the rules and regulations of the Commission and reference is hereby made to
such omitted information. Statements made in this Prospectus concerning the
contents of any contract, agreement or other document filed as an exhibit to the
Registration Statement are summaries of the terms of such contracts, agreements
or documents and are not necessarily complete. Reference is made to each such
exhibit for a more complete description of the matters involved and such
statements shall be deemed qualified in their entirety by such reference. The
Registration Statement and the exhibits and schedules thereto filed with the
Commission may be inspected, without charge, and copies may be obtained at
prescribed rates, at the public reference facility maintained by the Commission
at Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549 and at the
regional offices of the Commission located at 7 World Trade Center, 13th Floor,
New York, New York 10048 and CitiCorp Center, 500 West Madison Street, Suite
1400, Chicago, Illinois 60621-2511. For further information pertaining to the
Common Stock offered by this Prospectus and the Company, reference is made to
the Registration Statement. The Registration Statement and other information
filed by the Company with the Commission are also available at the Commission's
World Wide Web site on the Internet at http://www.sec.gov.
As a result of the Offering, the Company and its shareholders will become
subject to the proxy solicitation rules, annual and periodic reporting
requirements, restrictions of stock purchases and sales by affiliates and
certain other requirements of the Exchange Act. The Company intends to furnish
its shareholders with annual reports containing audited financial statements
certified by independent auditors and quarterly reports containing unaudited
financial statements for the first three quarters of each fiscal year.
75
<PAGE>
TABLE OF CONTENTS TO FINANCIAL STATEMENTS
PAGE
----
PROSPERITY BANCSHARES, INC.
Independent Auditors' Report....... F-2
Consolidated Balance Sheet as of
June 30, 1998 (Unaudited) and
December 31, 1997 and 1996....... F-3
Consolidated Statement of Income
for the Six Months Ended June 30,
1998 (Unaudited) and June 30, 1997
(Unaudited) and for the Years
Ended December 31, 1997, 1996
and 1995......................... F-4
Consolidated Statement of Changes
in Shareholders' Equity for the
Years Ended December 31, 1997,
1996 and 1995 and for the Six
Months Ended
June 30, 1998 (Unaudited)........ F-5
Consolidated Statement of Cash
Flows for the Six Months Ended
June 30, 1998 (Unaudited) and June
30, 1997 (Unaudited) and for the
Years Ended
December 31, 1997, 1996 and
1995.............................. F-6
Notes to Consolidated Financial
Statements........................ F-8
UNION STATE BANK
Independent Auditor's Report....... F-27
Statements of Condition as of June
30, 1997 and 1996 (Unaudited)..... F-28
Statements of Condition as of
December 31, 1997 and 1996........ F-29
Statements of Income for the Six
Months Ended June 30, 1998 and
1997 (Unaudited).................. F-30
Statements of Income for the Years
Ended December 31, 1997 and
1996.............................. F-31
Statements of Changes in
Shareholders' Equity for the Six
Months Ended June 30, 1998 and
1997 (Unaudited).................. F-32
Statements of Changes in
Shareholders' Equity for the Years
Ended December 31, 1997 and
1996.............................. F-33
Statements of Cash Flows for the
Six Months Ended June 30, 1998 and
1997 (Unaudited).................. F-34
Statements of Cash Flows for the
Years Ended December 31, 1997 and
1996.............................. F-35
Notes to Financial Statements for
the Years Ended December 31, 1997
and 1996.......................... F-36
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Shareholders and Board of Directors of
Prosperity Bancshares, Inc. and Subsidiaries:
We have audited the accompanying consolidated balance sheets of Prosperity
Bancshares, Inc. and subsidiaries (collectively, the "Company") as of December
31, 1997 and 1996, and the related consolidated statements of income,
shareholders' equity and cash flows for each of the three years in the period
ended December 31, 1997. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion such consolidated financial statements present fairly, in
all material respects, the financial position of Prosperity Bancshares, Inc. and
subsidiaries as of December 31, 1997 and 1996, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997 in conformity with generally accepted accounting principles.
Deloitte & Touche LLP
January 23, 1998 (except
for Note 23 as to which the
date is September 10, 1998)
Houston, Texas
F-2
<PAGE>
PROSPERITY BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
JUNE 30, --------------------------------
1998 1997 1996
--------------- --------------- ---------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Cash and due from banks (Note 3)........ $ 13,054,238 $ 17,372,158 $ 15,954,319
Federal funds sold...................... 7,875,000 5,790,000
--------------- --------------- ---------------
Total cash and cash
equivalents................ 20,929,238 17,372,158 21,744,319
Interest-bearing deposits in financial
institutions.......................... 99,000 198,000 396,000
Available for sale securities, at fair
value (amortized cost of $44,779,100
(unaudited), $38,650,389 and
$49,372,925, respectively) (Note 4)... 44,744,151 38,612,395 49,341,523
Held to maturity securities, at cost
(fair value of $114,105,268
(unaudited), $129,774,737 and
$97,659,201, respectively) (Note 4)... 113,941,104 129,256,453 98,222,352
Loans (Notes 5 and 6)................... 141,079,572 120,577,987 113,382,477
Less allowance for credit losses (Note
7).................................... (1,113,713) (1,015,576) (922,833)
--------------- --------------- ---------------
Loans, net.................... 139,965,859 119,562,411 112,459,644
Accrued interest receivable............. 3,003,004 2,500,976 2,204,402
Goodwill, net of accumulated
amortization of $2,811,310
(unaudited), $2,576,686 and
$2,175,167, respectively.............. 5,658,789 5,643,413 4,054,818
Bank premises and equipment, net (Note
8).................................... 5,451,855 5,529,664 4,500,146
Other assets............................ 1,629,212 1,467,612 1,065,249
--------------- --------------- ---------------
TOTAL................................... $ 335,422,212 $ 320,143,082 $ 293,988,453
=============== =============== ===============
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Deposits (Note 9):
Noninterest-bearing................ $ 68,563,414 $ 61,447,143 $ 55,180,183
Interest-bearing................... 239,251,963 230,069,769 215,686,187
--------------- --------------- ---------------
Total deposits................ 307,815,377 291,516,912 270,866,370
Note payable (Note 10)................ 3,266,666
Other borrowings (Note 10)............ 2,800,000
Accrued interest payable.............. 724,784 708,494 688,139
Other liabilities..................... 404,232 300,079 333,966
--------------- --------------- ---------------
Total liabilities............. 308,944,393 295,325,485 275,155,141
COMMITMENTS AND CONTINGENCIES
(Notes 12 and 16)
SHAREHOLDERS' EQUITY (Notes 14, 17, 18
and 22):
Common stock, $1 par value; 50,000,000
shares authorized; 3,993,884
(unaudited), 3,993,884 and
3,513,884 shares issued at June 30,
1998, December 31, 1997 and 1996,
respectively; 3,990,308
(unaudited), 3,990,308 and
3,510,148 shares outstanding at
June 30, 1998, December 31, 1997
and 1996, respectively............. 3,993,884 3,993,884 3,513,884
Capital surplus....................... 4,817,782 4,817,782 2,297,602
Retained earnings..................... 17,707,546 16,049,334 13,061,698
Accumulated other comprehensive
income -- net unrealized losses on
available for sale investment
securities, net of tax of $11,883
(unaudited), $12,919 and $10,677,
respectively....................... (23,066) (25,076) (20,725)
Less treasury stock, at cost 3,576
(unaudited), 3,576 and 3,736
shares, respectively............... (18,327) (18,327) (19,147)
--------------- --------------- ---------------
Total shareholders' equity.... 26,477,819 24,817,597 18,833,312
--------------- --------------- ---------------
TOTAL................................... $ 335,422,212 $ 320,143,082 $ 293,988,453
=============== =============== ===============
</TABLE>
See notes to consolidated financial statements.
F-3
<PAGE>
PROSPERITY BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
FOR THE SIX MONTHS ENDED FOR THE YEARS ENDED
JUNE 30, DECEMBER 31,
-------------------------- ------------------------------------------
1998 1997 1997 1996 1995
------------ ------------ -------------- ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
INTEREST INCOME:
Loans, including fees.............. $ 5,568,210 $ 4,953,742 $ 10,205,405 $ 9,136,451 $ 7,203,450
Investment securities:
Taxable......................... 4,876,213 4,228,118 8,950,157 6,647,877 6,241,258
Nontaxable...................... 295,080 325,640 604,968 723,285 850,410
Federal funds sold................. 126,531 115,523 193,300 309,396 428,161
Deposits in financial
institutions.................... 4,635 9,161 15,842 23,990 14,682
------------ ------------ -------------- ------------ ------------
Total interest income......... 10,870,669 9,632,184 19,969,672 16,840,999 14,737,961
------------ ------------ -------------- ------------ ------------
INTEREST EXPENSE:
Deposits........................... 4,646,711 4,312,058 8,858,172 7,719,880 6,749,468
Note payable and federal funds
purchased....................... 66,638 49,398 132,106 203,204 154,776
Other.............................. 1,414 91,809 69,566
------------ ------------ -------------- ------------ ------------
Total interest expense........ 4,714,763 4,453,265 9,059,844 7,923,084 6,904,244
------------ ------------ -------------- ------------ ------------
NET INTEREST INCOME.................. 6,155,906 5,178,919 10,909,828 8,917,915 7,833,717
PROVISION FOR CREDIT LOSSES (Note
7)................................. 144,500 104,970 189,970 230,000 175,000
------------ ------------ -------------- ------------ ------------
NET INTEREST INCOME AFTER PROVISION
FOR CREDIT LOSSES.................. 6,011,406 5,073,949 10,719,858 8,687,915 7,658,717
------------ ------------ -------------- ------------ ------------
NONINTEREST INCOME:
Customer service fees.............. 1,135,887 918,678 2,061,799 1,742,200 1,391,196
Investment securities losses....... (28,424)
Other.............................. 103,485 91,013 202,239 155,298 126,193
------------ ------------ -------------- ------------ ------------
Total noninterest income...... 1,239,372 1,009,691 2,264,038 1,897,498 1,488,965
------------ ------------ -------------- ------------ ------------
NONINTEREST EXPENSE:
Salaries and employee benefits
(Note 15)....................... 2,114,627 1,900,744 3,967,508 3,414,553 3,040,540
Net occupancy expense.............. 426,514 377,394 810,717 710,400 608,26
Data processing.................... 369,246 290,532 641,813 493,257 387,499
Federal Deposit Insurance
Corporation assessment.......... 234,454
Goodwill amortization.............. 234,623 162,730 401,520 257,406 208,794
Depreciation expense............... 253,457 198,086 431,169 366,598 323,859
Other.............................. 856,235 737,533 1,582,807 1,392,024 1,241,855
------------ ------------ -------------- ------------ ------------
Total noninterest expense..... 4,254,702 3,667,019 7,835,534 6,634,238 6,045,526
------------ ------------ -------------- ------------ ------------
INCOME BEFORE INCOME TAXES........... 2,996,076 2,416,621 5,148,362 3,951,175 3,102,156
PROVISION FOR INCOME TAXES (Note
13)................................ 938,832 755,795 1,586,190 1,240,443 780,729
------------ ------------ -------------- ------------ ------------
NET INCOME........................... $ 2,057,244 $ 1,660,826 $ 3,562,172 $ 2,710,732 $ 2,321,427
============ ============ ============== ============ ============
EARNINGS PER SHARE
(Note 1):
Basic.............................. $ 0.52 $ 0.47 $ 0.94 $ 0.77 $ 0.66
============ ============ ============== ============ ============
Diluted............................ $ 0.50 $ 0.46 $ 0.92 $ 0.76 $ 0.66
============ ============ ============== ============ ============
</TABLE>
See notes to consolidated financial statements.
F-4
<PAGE>
PROSPERITY BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
ACCUMULATED OTHER
COMPREHENSIVE
INCOME --
NET UNREALIZED
LOSS ON
COMMON STOCK AVAILABLE FOR
--------------------- CAPITAL RETAINED SALE INVESTMENT
SHARES AMOUNT SURPLUS EARNINGS SECURITIES
-------- --------- --------- ---------- ------------------
<S> <C> <C> <C> <C> <C>
BALANCE AT JANUARY 1, 1995........... 3,513,884 $3,513,884 $2,297,602 $8,732,315 $ (648,417)
Net income....................... 2,321,427
Accretion of unrealized loss.....
Unrealized loss on held to
maturity investment securities
transferred to available for
sale investments securities in
accordance with the FASB
one-time reassessment (Note
3)............................. (502,175)
Net change in unrealized loss on
available for sale investment
securities..................... 1,095,062
Total comprehensive income.......
Cash dividends declared, $0.10
per share...................... (351,388)
-------- --------- --------- ---------- ------------------
BALANCE AT DECEMBER 31, 1995......... 3,513,884 3,513,884 2,297,602 10,702,354 (55,530)
Net income....................... 2,710,732
Net change in unrealized loss on
available for sale investment
securities..................... 34,805
Total comprehensive income.......
Purchase of treasury stock.......
Cash dividends declared, $0.10
per share...................... (351,388)
-------- --------- --------- ---------- ------------------
BALANCE AT DECEMBER 31, 1996......... 3,513,884 3,513,884 2,297,602 13,061,698 (20,725)
Net income....................... 3,562,172
Net change in unrealized loss on
available for sale.............
Net change in unrealized loss on
available for sale investment
securities..................... (4,351)
Total comprehensive income.......
Sale of treasury stock........... 180
Issuance of common stock......... 480,000 480,000 2,520,000
Cash dividends declared, $0.15
per share...................... (574,536)
-------- --------- --------- ---------- ------------------
BALANCE AT DECEMBER 31, 1997......... 3,993,884 3,993,884 4,817,782 16,049,334 (25,076)
Net income (unaudited)........... 2,057,244
Net change in unrealized loss on
available for sale investment
securities (unaudited)......... 2,010
Total comprehensive income
(unaudited)....................
Cash dividends declared, $0.10
per share (unaudited).......... (399,032)
-------- --------- --------- ---------- ------------------
BALANCE AT JUNE 30, 1998
(UNAUDITED)........................ 3,993,884 $3,993,884 $4,817,782 $17,707,546 $ (23,066)
======== ========= ========= ========== ==================
<CAPTION>
NET UNREALIZED
LOSS ON HELD TO
MATURITY INVESTMENT
SECURITIES TOTAL
TRANSFERRED FROM TREASURY SHAREHOLDERS'
AVAILABLE FOR SALE STOCK EQUITY
-------------------- -------- -------------
<S> <C> <C>
BALANCE AT JANUARY 1, 1995........... $ (512,407) $13,373,977
Net income....................... 2,321,427
Accretion of unrealized loss..... 19,232 19,232
Unrealized loss on held to
maturity investment securities
transferred to available for
sale investments securities in
accordance with the FASB
one-time reassessment (Note
3)............................. 502,175
Net change in unrealized loss on
available for sale investment
securities..................... 1,095,062
-------------
Total comprehensive income....... 3,435,721
Cash dividends declared, $0.10
per share...................... (351,388)
-------------------- -------- -------------
BALANCE AT DECEMBER 31, 1995......... 16,458,310
Net income....................... 2,710,732
Net change in unrealized loss on
available for sale investment
securities..................... 34,805
-------------
Total comprehensive income....... 2,745,537
Purchase of treasury stock....... $(19,147) (19,147)
Cash dividends declared, $0.10
per share...................... (351,388)
-------------------- -------- -------------
BALANCE AT DECEMBER 31, 1996......... (19,147 ) 18,833,312
Net income....................... 3,562,172
Net change in unrealized loss on
available for sale.............
Net change in unrealized loss on
available for sale investment
securities..................... (4,351)
-------------
Total comprehensive income....... 3,557,821
Sale of treasury stock........... 820 1,000
Issuance of common stock......... 3,000,000
Cash dividends declared, $0.15
per share...................... (574,536)
-------------------- -------- -------------
BALANCE AT DECEMBER 31, 1997......... (18,327 ) 24,817,597
Net income (unaudited)........... 2,057,244
Net change in unrealized loss on
available for sale investment
securities (unaudited)......... 2,010
-------------
Total comprehensive income
(unaudited).................... 2,059,244
Cash dividends declared, $0.10
per share (unaudited).......... (399,032)
-------------------- -------- -------------
BALANCE AT JUNE 30, 1998
(UNAUDITED)........................ $ $(18,327) $26,477,819
==================== ======== =============
</TABLE>
See notes to consolidated financial statements.
F-5
<PAGE>
PROSPERITY BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE SIX MONTHS ENDED FOR THE YEARS ENDED
JUNE 30, DECEMBER 31,
---------------------------- -------------------------------------------
1998 1997 1997 1996 1995
------------- ------------- ------------- ------------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income......................... $ 2,057,244 $ 1,660,826 $ 3,562,172 $ 2,710,732 $ 2,321,427
Adjustments to reconcile net income
to net cash provided by operating
activities:
Depreciation and amortization.... 488,080 380,816 832,689 624,004 532,652
Provision for credit losses...... 144,500 104,970 189,970 230,000 175,000
Gain on disposal of bank premises
and equipment.................. (362) (2,032)
Net amortization (accretion) of
premium/discount on
investments.................... 78,717 135,264 340,156 284,992 (135,615)
Loss on sale of investment
securities..................... 28,424
Loss on sale of real estate
acquired by foreclosure........ 1,888 2,383 2,332
Increase in accrued interest
receivable..................... (502,028) (319,486) (296,574) (124,910) (441,971)
(Increase) decrease in other
assets......................... (161,600) (284,499) (396,589) (222,481) 662,993
(Decrease) increase in accrued
interest payable and other
liabilities.................... 92,968 164,843 (80,190) (137,708) 369,338
------------- ------------- ------------- ------------- -------------
Total adjustments.............. 142,525 161,908 591,845 653,535 1,191,121
------------- ------------- ------------- ------------- -------------
Net cash provided by operating
activities.................. 2,199,769 1,822,734 4,154,017 3,364,267 3,512,548
------------- ------------- ------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities and
principal paydowns of held to
maturity in investment
securities....................... 26,923,917 9,582,598 35,405,320 23,334,343 9,999,261
Purchase of held to maturity
investment securities............ (11,813,919) (26,965,495) (66,765,304) (39,744,846) (10,693,295)
Proceeds from sales of available
for sale investment securities... 21,892,501
Proceeds from maturities and
principal paydowns of available
for sale investment securities... 17,584,015 8,789,159 14,205,712 12,061,185 9,324,042
Purchase of available for sale
investment securities............ (23,586,091) (1,995,313) (3,497,451) (25,941,913) (25,894,641)
Net increase in loans.............. (20,485,851) (7,643,171) (7,481,819) (14,189,016) (12,357,605)
Net proceeds from sale of real
estate acquired by foreclosure... 186,699 106,882
Purchase of bank premises and
equipment........................ (175,647) (100,025) (742,949) (363,769) (741,934)
Proceeds from sale of bank premises
and equipment.................... 40,000 3,642 2,430
Net decrease (increase) in
interest-bearing deposits in
financial institutions........... 99,000 198,000 198,000 (198,000)
Premium paid for Angleton branch... (1,990,114) (1,990,114)
Net liabilities acquired in
purchase of Angleton branch (net
of acquired cash of $565,247).... 28,646,876 28,646,876
Premium paid for Bay City branch... (1,750,000)
Net liabilities acquired in
purchase of Bay City branch (net
of acquired cash of $492,210).... 27,541,971
Premium paid for West Columbia
branch........................... (250,000)
------------- ------------- ------------- ------------- -------------
Net liabilities acquired in
purchase of West Columbia branch
(net of acquired cash of
$5,548,318)...................... 5,798,318
Net cash (used in) provided by
investing activities........ (5,866,258) 8,522,516 (1,835,030) (19,246,403) (8,362,359)
------------- ------------- ------------- ------------- -------------
</TABLE>
(TABLE CONTINUED ON FOLLOWING PAGE)
F-6
<PAGE>
<TABLE>
<CAPTION>
FOR THE SIX MONTHS ENDED FOR THE YEARS ENDED
JUNE 30, DECEMBER 31,
---------------------------- -------------------------------------------
1998 1997 1997 1996 1995
------------- ------------- ------------- ------------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in noninterest-bearing
deposits......................... $ 6,892,880 $ (2,000,318) $ 1,209,964 $ 5,211,914 $ 1,785,696
Net (decrease) increase in
interest-bearing deposits........ 3,529,721 (8,403,089) (9,860,910) 12,455,035 5,205,012
Proceeds from line of credit....... 3,266,666
Repayments of note payable......... (2,402,017) (3,266,666) (1,156,666) (758,334)
Proceeds from other borrowings..... 283,860,000 144,525,000 296,585,000
Repayments of other borrowings..... (286,660,000) (144,525,000) (293,785,000)
Proceeds from the issuance of
common stock..................... 2,938,175 3,000,000
Purchase of treasury stock......... (19,147)
Sale of treasury stock............. 1,000
Payments of cash dividends......... (399,032) (175,505) (574,536) (351,388) (351,388)
------------- ------------- ------------- ------------- -------------
Net cash (used) provided by
financing activities........ 7,223,569 (10,042,754) (6,691,148) 19,046,414 5,880,986
------------- ------------- ------------- ------------- -------------
NET (DECREASE) INCREASE IN CASH AND
CASH EQUIVALENTS................... $ 3,557,080 $ 302,496 $ (4,372,161) $ 3,164,278 $ 1,031,175
CASH AND CASH EQUIVALENTS, BEGINNING
OF PERIOD.......................... 17,372,158 21,744,319 21,744,319 18,580,041 17,548,866
------------- ------------- ------------- ------------- -------------
CASH AND CASH EQUIVALENTS, END OF
PERIOD............................. $ 20,929,238 $ 22,046,815 $ 17,372,158 $ 21,744,319 $ 18,580,041
============= ============= ============= ============= =============
INCOME TAXES PAID.................... $ 834,011 $ 725,000 $ 1,681,354 $ 1,111,805 $ 742,787
============= ============= ============= ============= =============
INTEREST PAID........................ $ 4,698,473 $ 4,335,396 $ 9,039,489 $ 7,849,375 $ 6,757,099
============= ============= ============= ============= =============
NONCASH INVESTING ACTIVITIES:
The Company acquired certain real
estate through foreclosure of
collateral on loans totaling
approximately $189,082, $0, and
$94,000 during the year ended
December 31, 1997, 1996, and 1995,
respectively.
The Company transferred securities
classified as held to maturity with
a cost basis of $14,970,881 and a
carrying value of $14,210,010 to
available for sale during November
1995 in connection with the one
time reassessment permitted by the
FASB.
The Company transferred securities
classified as held to maturity with
a cost basis of $51,999,852 to
available for sale on January 1,
1995 in connection with the
adoption of SFAS No. 115.
</TABLE>
See notes to consolidated financial statements.
F-7
<PAGE>
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING AND REPORTING
POLICIES
NATURE OF OPERATIONS -- Prosperity Bancshares, Inc. ("Bancshares") and
its subsidiaries, Prosperity Holdings, Inc. ("Holdings") and First Prosperity
Bank (the "Bank") (collectively referred to as the "Company") provide retail
and commercial banking services.
The Bank operates eleven branch banking offices in South Central Texas,
with three locations in Houston and eight locations south, southeast and
southwest of Houston in Angleton, Bay City, Cuero, Edna, El Campo, West Columbia
and Victoria.
PRINCIPLES OF CONSOLIDATION -- The consolidated financial statements
include the accounts of Bancshares and its wholly owned subsidiaries. All
significant intercompany transactions have been eliminated in consolidation. The
accounting and reporting policies of the Company conform to generally accepted
accounting principles ("GAAP") and the prevailing practices within the banking
industry. A summary of significant accounting and reporting policies is as
follows:
INTERIM FINANCIAL INFORMATION -- Financial information as of June 30, 1998
and for the six months ended June 30, 1998 and 1997 is unaudited. Such
information includes all adjustments (consisting of only normal recurring
adjustments), that are necessary in the opinion of management, for a fair
statement of the financial information in the interim periods. The results from
operations for the periods ended June 30, 1998 is not necessarily indicative of
the results for the full fiscal year.
USE OF ESTIMATES -- The preparation of financial statements in conformity
with GAAP requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. Actual results could
differ from those estimates.
SECURITIES -- Investment securities held to maturity are carried at cost,
adjusted for the amortization of premiums and the accretion of discounts.
Management has the positive intent and the Company has the ability to hold these
assets as long-term investments until their estimated maturities. Under certain
circumstances (including the deterioration of the issuer's creditworthiness or a
change in tax law or statutory or regulatory requirements), securities may be
sold or transferred to another portfolio.
Securities available for sale are carried at fair value. Unrealized gains
and losses are excluded from earnings and reported, net of tax, as a separate
component of shareholders' equity until realized. Securities within the
available for sale portfolio may be used as part of the Company's
asset/liability strategy and may be sold in response to changes in interest
risk, prepayment risk or other similar economic factors.
Declines in the fair value of individual held-to-maturity and
available-for-sale securities below their cost that are other than temporary
would result in write-downs of the individual securities to their fair value.
The related write-downs would be included in earnings as realized losses.
Premiums and discounts are amortized and accreted to operations using the
level-yield method of accounting, adjusted for prepayments as applicable. The
specific identification method of accounting is used to compute gains or losses
on the sales of these assets. Interest earned on these assets is included in
interest income.
LOANS -- Loans are stated at the principal amount outstanding, net of
unearned discount and fees. Unearned discount relates principally to consumer
installment loans. The related interest income for multipayment loans is
recognized principally by the "sum of the digits" method which records
interest in proportion to the declining outstanding balances of the loans; for
single payment loans, such income is recognized using the straight-line method.
F-8
<PAGE>
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Effective January 1, 1995, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 114, "Accounting by Creditors for
Impairment of a Loan," as amended by SFAS No. 118, "Accounting by Creditors
for Impairment of a Loan -- Income Recognition and Disclosure." SFAS No. 114
applies to all impaired loans, with the exception of groups of smaller-balance
homogeneous loans that are collectively evaluated for impairment. A loan is
defined as impaired by SFAS No. 114 if, based on current information and events,
it is probable that a creditor will be unable to collect all amounts due, both
interest and principal, according to the contractual terms of the loan
agreement. Specifically, SFAS No. 114 requires that the allowance for credit
losses related to impaired loans be determined based on the difference of
carrying value of loans and the present value of expected cash flows discounted
at the loan's effective interest rate or, as a practical expedient, the loan's
observable market price or the fair value of the collateral if the loan is
collateral dependent. Prior to the adoption of SFAS No. 114, the Company's
methodology for determining the adequacy of the allowance for credit losses did
not incorporate the concept of the time value of money and the expected future
interest cash flow.
As permitted by SFAS No. 118, interest revenue received on impaired loans
continues to be either applied against principal or realized as interest
revenue, according to management's judgment as to the collectibility of
principal. Adoption of these pronouncements, SFAS Nos. 114 and 118, had no
impact on the Company's consolidated financial statements including the level of
the allowance for credit losses.
OTHER REAL ESTATE -- Real estate properties acquired through, or in lieu
of, loan foreclosure are to be sold and are initially recorded at the lesser of
the outstanding loan balance or the fair value at the date of foreclosure
establishing a new cost basis. After foreclosure, valuations are periodically
performed by management and the real estate is carried at the lower of carrying
amount or fair value less cost to sell. Revenue and expenses from operations and
changes in the valuation allowance are included in the net gain/loss and
carrying costs of other real estate.
NONREFUNDABLE FEES AND COSTS ASSOCIATED WITH LENDING ACTIVITIES -- Loan
origination fees are recognized over the life of the related loan as an
adjustment to yield using the interest method.
Generally, loan commitment fees are deferred, except for certain
retrospectively determined fees, and recognized as an adjustment of yield by the
interest method over the related loan life or, if the commitment expires
unexercised, recognized in income upon expiration of the commitment.
NONPERFORMING LOANS AND PAST DUE LOANS -- Included in the nonperforming
loan category are loans which have been categorized by management as nonaccrual
because collection of interest is doubtful and loans which have been
restructured to provide a reduction in the interest rate or a deferral of
interest or principal payments. When the payment of principal or interest on a
loan is delinquent for 90 days, or earlier in some cases, the loan is placed on
nonaccrual status unless the loan is in the process of collection and the
underlying collateral fully supports the carrying value of the loan. If the
decision is made to continue accruing interest on the loan, periodic reviews are
made to confirm the accruing status of the loan. When a loan is placed on
nonaccrual status, interest accrued during the current year prior to the
judgment of uncollectibility is charged to operations. Interest accrued during
prior periods is charged to allowance for credit losses. Generally, any payments
received on nonaccrual loans are applied first to outstanding loan amounts and
next to the recovery of charged-off loan amounts. Any excess is treated as
recovery of lost interest.
Restructured loans are those loans on which concessions in terms have been
granted because of a borrower's financial difficulty. Interest is generally
accrued on such loans in accordance with the new terms.
ALLOWANCE FOR CREDIT LOSSES -- The allowance for credit losses is a
valuation allowance available for losses incurred on loans. All losses are
charged to the allowance when the loss actually occurs or when a
F-9
<PAGE>
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
determination is made that such a loss is probable. Recoveries are credited to
the allowance at the time of recovery.
Throughout the year, management estimates the probable level of losses to
determine whether the allowance for credit losses is adequate to absorb losses
in the existing portfolio. Based on these estimates, an amount is charged to the
provision for credit losses and credited to the allowance for credit losses in
order to adjust the allowance to a level determined to be adequate to absorb
losses.
Management's judgment as to the level of losses on existing loans involves
the consideration of current and anticipated economic conditions and their
potential effects on specific borrowers; an evaluation of the existing
relationships among loans, probable credit losses and the present level of the
allowance; results of examinations of the loan portfolio by regulatory agencies;
and management's internal review of the loan portfolio. In determining the
collectibility of certain loans, management also considers the fair value of any
underlying collateral. The amounts ultimately realized may differ from the
carrying value of these assets because of economic, operating or other
conditions beyond the Company's control.
Estimates of credit losses involve an exercise of judgment. While it is
possible that in the short term the Company may sustain losses which are
substantial in relation to the allowance for credit losses, it is the judgment
of management that the allowance for credit losses reflected in the consolidated
balance sheets is adequate to absorb probable losses that exist in the current
loan portfolio.
PREMISES AND EQUIPMENT -- Premises and equipment are carried at cost less
accumulated depreciation. Depreciation expense is computed principally using the
straight-line method over the estimated useful lives of the assets which range
from three to thirty years.
AMORTIZATION OF GOODWILL -- Goodwill is amortized using the straight-line
method over a period of 15 to 25 years. Goodwill is periodically assessed for
impairment.
INCOME TAXES -- Bancshares files a consolidated federal income tax return.
The Bank computes federal income taxes as if it filed a separate return and
remits to, or is reimbursed by, Bancshares based on the portion of taxes
currently due or refundable. Deferred tax assets and liabilities are recognized
for the estimated tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases.
Realization of net deferred tax assets is dependent on generating
sufficient future taxable income. Although realization is not assured,
management believes it is more likely than not that all of the net deferred tax
assets will be realized. The amount of the net deferred tax asset considered
realizable, however, could be reduced in the short term if estimates of future
taxable income are reduced.
STOCK-BASED COMPENSATION -- The Company accounts for its employee stock
options using the intrinsic value-based method and makes pro forma disclosures
of net income and earnings per share using the fair value-based method (see Note
14).
STATEMENTS OF CASH FLOWS -- For purposes of reporting cash flows, cash and
cash equivalents include cash and due from banks as well as federal funds sold
that mature in three days or less.
RECLASSIFICATIONS -- Certain reclassifications have been made to 1997, 1996
and 1995 balances to conform to the current year presentation. All
reclassifications have been applied consistently for the periods presented.
EARNINGS PER SHARE -- SFAS No. 128, "Earnings per share," requires
presentation of basic and diluted earnings per share. Basic earnings per share
has been computed by dividing net income available to common shareholders by the
weighted average number of common shares outstanding for the reporting period.
Diluted earnings per share reflects the potential dilution that could occur if
securities or other contracts to issue common stock were exercised or converted
into common stock. Net income per common
F-10
<PAGE>
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
share for all periods presented has been calculated in accordance with SFAS 128.
Outstanding stock options issued by the Company represent the only dilutive
effect reflected in diluted weighted average shares.
The following table illustrates the computation of basic and diluted
earnings per share after effect of stock split (Note 22):
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
------------------------------------- -------------------------------------------------
1998 1997 1997 1996 1995
----------------- ----------------- ----------------- ----------------- ---------
PER PER PER PER
SHARE SHARE SHARE SHARE
AMOUNT AMOUNT AMOUNT AMOUNT AMOUNT AMOUNT AMOUNT AMOUNT AMOUNT
--------- ------ --------- ------ --------- ------ --------- ------ ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net income........................... $2,057,244 $1,660,826 $3,562,172 $2,710,732 $2,321,427
Basic --
Weighted average shares
outstanding.................... 3,990,308 $0.52 3,564,216 $0.47 3,770,880 $0.94 3,513,260 $0.77 3,513,884
====== ====== ====== ======
Diluted:
Weighted average shares
outstanding.................... 3,990,308 3,564,216 3,777,880 3,513,260 3,513,884
Effect of dilutive securities --
options........................ 90,208 84,248 85,756 46,472 9,156
--------- --------- --------- --------- ---------
Total............................ $4,080,516 $0.50 $3,648,464 $0.46 $3,863,636 $0.92 $3,559,732 $0.76 $3,523,040
========= ====== ========= ====== ========= ====== ========= ====== =========
</TABLE>
PER
SHARE
AMOUNT
------
Net income...........................
Basic --
Weighted average shares
outstanding.................... $0.66
======
Diluted:
Weighted average shares
outstanding....................
Effect of dilutive securities --
options........................
Total............................ $0.66
======
RECENTLY ISSUED ACCOUNTING STANDARDS -- Statement of Financial Accounting
Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and
Hedging Activities" establishes accounting and reporting standards for
derivative instruments and requires that an entity recognize all derivatives as
either assets or liabilities in the balance sheet and measure those instruments
at fair value. This statement is effective for periods beginning after June 15,
1999. Management believes the implementation of this pronouncement will not have
a material effect on the Company's financial statements.
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information" establishes new standards for public companies to report
information about their operating segments, products and services, geographic
areas and major customers. The statement is effective for financial statements
issued for periods beginning after December 15, 1997. Management has not yet
determined what its reporting segments will be under SFAS No. 131.
2. ACQUISITION OF BRANCHES
ANGLETON BRANCH -- During March 1997, the Company entered into a purchase
and assumption agreement with another bank to purchase certain assets and to
assume certain deposit accounts and related accrued interest payable of a branch
located in Angleton, Texas. Effective June 20, 1997, the Company purchased
approximately $723,000 in real property and fixed assets and assumed deposits,
including unpaid accrued interest, totaling approximately $29,370,000.
In connection with the purchase, the Company paid a cash premium of
approximately $1,990,000. This premium was recorded as goodwill and will be
amortized on a straight-line basis over 15 years. The acquisition was partially
financed with proceeds from the common stock issuance (see Note 17).
The acquisition was accounted for using the purchase method of accounting.
Accordingly, the assets and liabilities of the acquired branch were recorded at
their fair values at the acquisition date.
BAY CITY BRANCH -- During March 1996, the Company entered into a purchase
and assumption agreement with another bank to purchase certain assets and to
assume certain deposit accounts and related accrued interest payable of a branch
located in Bay City, Texas. Effective June 21, 1996, the Company purchased
approximately $10,600,000 in loans and $680,000 in real property and fixed
assets and assumed deposits, including unpaid accrued interest, totaling
approximately $38,824,000.
F-11
<PAGE>
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In connection with the purchase, the Company paid a cash premium of
$1,750,000. This premium was recorded as goodwill and will be amortized on a
straight-line basis over 15 years. The acquisition was financed with proceeds
from a note payable to an unaffiliated bank (see Note 10).
The acquisition was accounted for using the purchase method of accounting.
Accordingly, the assets and liabilities of the acquired branch were recorded at
their fair values at the acquisition date.
3. CASH AND DUE FROM BANKS
The Bank is required by the Federal Reserve Bank to maintain average
reserve balances. "Cash and due from banks" in the consolidated balance sheets
includes amounts so restricted of approximately $2,980,000, $5,849,000 and
$5,300,000 at June 30, 1998 (unaudited) and December 31, 1997 and 1996,
respectively.
4. INVESTMENT SECURITIES
The amortized cost and fair value of investments in debt securities are as
follows:
<TABLE>
<CAPTION>
JUNE 30, 1998 (UNAUDITED)
-----------------------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR CARRYING
COST GAINS LOSSES VALUE VALUE
--------------- ---------- ---------- --------------- ---------------
<S> <C> <C> <C> <C> <C>
AVAILABLE FOR SALE
U.S. Treasury securities and
obligations of U.S. government
agencies........................... $ 27,583,488 $ 27,053 $ 19,700 $ 27,590,823 $ 27,590,823
States and political subdivisions.... 1,263,712 75,612 1,339,324 1,339,324
Mortgage-backed securities........... 15,931,900 40,558 158,454 15,815,004 15,814,004
--------------- ---------- ---------- --------------- ---------------
Total................................ $ 44,779,100 $ 143,205 $ 178,154 $ 44,744,151 $ 44,744,151
=============== ========== ========== =============== ===============
HELD TO MATURITY
U.S. Treasury securities and
obligations of U.S. government
agencies........................... $ 59,467,478 $ 292,615 $ 21,904 $ 59,738,189 $ 59,467,478
States and political subdivisions.... 12,514,684 72,228 39,260 12,547,652 12,514,684
Collateralized mortgage
obligations........................ 5,632,377 12,079 5,620,298 5,632,377
Mortgage-backed securities........... 36,326,565 66,440 193,876 36,199,129 36,326,565
--------------- ---------- ---------- --------------- ---------------
Total................................ $ 113,941,104 $ 431,283 $ 267,119 $ 114,105,268 $ 113,941,104
=============== ========== ========== =============== ===============
</TABLE>
F-12
<PAGE>
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
DECEMBER 31, 1997
-----------------------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR CARRYING
COST GAINS LOSSES VALUE VALUE
--------------- ---------- ---------- --------------- ---------------
<S> <C> <C> <C> <C>
AVAILABLE FOR SALE
U.S. Treasury securities and
obligations of U.S. government
agencies........................... $ 19,988,186 $ 56,500 $ 20,044,686 $ 20,044,686
States and political subdivisions.... 1,363,584 101,972 1,465,556 1,465,556
Mortgage-backed securities........... 17,298,619 61,928 $ 258,394 17,102,153 17,102,153
--------------- ---------- ---------- --------------- ---------------
Total................................ $ 38,650,389 $ 220,400 $ 258,394 $ 38,612,395 $ 38,612,395
=============== ========== ========== =============== ===============
HELD TO MATURITY
U.S. Treasury securities and
obligations of U.S. government
agencies........................... $ 63,171,223 $ 244,781 $ 20,836 $ 63,395,168 $ 63,171,223
States and political subdivisions.... 10,464,979 141,304 754 10,605,529 10,464,979
Collateralized mortgage
obligations........................ 8,748,951 18,729 14,852 8,752,828 8,748,951
Mortgage-backed securities........... 46,871,300 372,485 222,573 47,021,212 46,871,300
--------------- ---------- ---------- --------------- ---------------
Total................................ $ 129,256,453 $ 777,299 $ 259,015 $ 129,774,737 $ 129,256,453
=============== ========== ========== =============== ===============
<CAPTION>
DECEMBER 31, 1996
---------------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR CARRYING
COST GAINS LOSSES VALUE VALUE
----------- ---------- ---------- ----------- -----------
AVAILABLE FOR SALE
U.S. Treasury securities and
obligations of U.S. government
agencies........................... $29,979,702 $ 127,534 $30,107,236 $30,107,236
States and political subdivisions.... 1,441,325 105,576 $ 345 1,546,556 1,546,556
Mortgage-backed securities........... 17,951,898 42,808 306,975 17,687,731 17,687,731
----------- ---------- ---------- ----------- -----------
Total................................ $49,372,925 $ 275,918 $ 307,320 $49,341,523 $49,341,523
=========== ========== ========== =========== ===========
HELD TO MATURITY
U.S. Treasury securities and
obligations of U.S. government
agencies........................... $30,849,828 $ 120,934 $ 121,381 $30,849,381 $30,849,828
States and political subdivisions.... 11,601,438 172,603 17,934 11,756,107 11,601,438
Collateral mortgage obligations...... 14,340,845 397 103,724 14,237,518 14,340,845
Mortgage-backed securities........... 41,430,241 90,859 704,905 40,816,195 41,430,241
----------- ---------- ---------- ----------- -----------
Total................................ $98,222,352 $ 384,793 $ 947,944 $97,659,201 $98,222,352
=========== ========== ========== =========== ===========
</TABLE>
F-13
<PAGE>
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The amortized cost and fair value of debt securities at December 31, 1997,
by contractual maturity, are shown below. Expected maturities will differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
<TABLE>
<CAPTION>
HELD TO MATURITY AVAILABLE FOR SALE
---------------------------- --------------------------
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
------------ ------------ ----------- -----------
<S> <C> <C> <C> <C>
Due in one year or less.............. $ 14,205,605 $ 14,222,315 $18,090,971 $18,138,915
Due after one year through five
years.............................. 55,875,860 58,187,772 1,997,215 2,005,924
Due after five years through ten
years.............................. 3,554,737 1,590,610 891,197 957,512
Due after ten years.................. 372,387 407,891
------------ ------------ ----------- -----------
Subtotal............................. 73,636,202 74,000,697 21,351,770 21,510,242
Mortgage-backed securities and
collateralized mortgage
obligations........................ 55,620,251 55,774,040 17,298,619 17,102,153
------------ ------------ ----------- -----------
Total................................ $129,256,453 $129,774,737 $38,650,389 $38,612,395
============ ============ =========== ===========
</TABLE>
There were no sales of held to maturity or available for sale investments
in debt securities during 1998 (unaudited), 1997 and 1996. In 1995, there were
no sales of held to maturity investments in debt securities. During 1995,
proceeds from sales of available for sale investments in debt securities were
$21,892,501. Gross gains of $140,330 and gross losses of $168,754 for 1995, were
realized on those sales.
The Company does not own securities of any one issuer (other than the U.S.
government and its agencies) for which aggregate adjusted cost exceeds 10% of
the consolidated shareholders' equity at June 30, 1998 (unaudited) and December
31, 1997. Securities with amortized costs of approximately $58,104,387,
$61,303,319 and $66,267,494 and a fair value of approximately $58,032,496,
$61,146,428 and $65,456,055 at June 30, 1998 (unaudited) and December 31, 1997
and 1996, respectively, were pledged to secure public deposits and for other
purposes required or permitted by law.
5. LOANS
The loan portfolio consists of various types of loans made principally to
borrowers located in Southeast Texas and is classified by major type as follows
(rounded):
<TABLE>
<CAPTION>
DECEMBER 31,
JUNE 30, --------------------------------
1998 1997 1996
------------ --------------- ---------------
(UNAUDITED)
<S> <C> <C> <C>
Commercial and industrial............ $ 12,297,000 $ 11,611,000 $ 10,633,000
Real estate:
Construction and land
development..................... 9,439,000 6,453,000 5,021,000
I-4 family residential............. 69,328,000 53,625,000 49,845,000
Commercial mortgages............... 16,201,000 16,277,000 14,376,000
Farmland........................... 5,502,000 5,804,000 5,468,000
Multi-family residential........... 1,192,000 937,000 1,068,000
Agriculture.......................... 8,444,000 6,359,000 5,686,000
Consumer............................. 19,502,000 20,498,000 22,561,000
------------ --------------- ---------------
Total................................ 141,905,000 121,564,000 114,658,000
Less unearned discount............... 825,000 986,000 1,276,000
------------ --------------- ---------------
Total................................ $141,080,000 $ 120,578,000 $ 113,382,000
============ =============== ===============
</TABLE>
F-14
<PAGE>
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
As discussed in Note 1, the Bank adopted SFAS No. 114 and 118 effective
January 1, 1995. Adoption of these statements had no impact on the Company's
financial statements including the level of the allowance for credit losses.
Instead, it resulted only in a reallocation of the existing allowance for credit
losses.
At June 30, 1998 (unaudited) and December 31, 1997 and 1996, there was no
recorded investment in impaired loans under SFAS No. 114, "Accounting by
Creditors for Impairment of a Loan." At December 31, 1995, the recorded
investment in impaired loans under SFAS No. 114 was approximately $23,000 and
required an allowance for credit losses of approximately $5,000. The average
recorded investment in impaired loans for the year ended December 31, 1995 was
approximately $19,000. The Company recognized interest revenue on these impaired
loans of approximately $3,000 in 1995.
As of June 30, 1998 (unaudited) and December 31, 1997 and 1996, loans
outstanding to directors, officers and their affiliates were approximately
$3,036,000, $2,432,000 and $3,210,000, respectively. In the opinion of
management, all transactions entered into between the Company and such related
parties have been, and are, 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:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
SIX MONTHS ENDED ------------------------------
JUNE 30, 1998 1997 1996
---------------- -------------- --------------
(UNAUDITED)
<S> <C> <C> <C>
Beginning balance.................... $2,432,000 $ 3,210,000 $ 3,046,000
New loans and reclassified related
loans.............................. 1,476,000 1,045,000 1,262,000
Repayments........................... (872,000) (1,823,000) (1,098,000)
---------------- -------------- --------------
Ending balance....................... $3,036,000 $ 2,432,000 $ 3,210,000
================ ============== ==============
</TABLE>
6. NONPERFORMING LOANS AND PAST DUE LOANS
The Company had no nonaccrual, 90 days or more past due, or restructured
loans at June 30, 1998 (unaudited), December 31, 1997 or 1996.
7. ALLOWANCE FOR CREDIT LOSSES
An analysis of activity in the allowance for credit losses is as follows:
<TABLE>
<CAPTION>
SIX MONTHS ENDED YEAR ENDED
JUNE 30, DECEMBER 31,
------------------------ ------------------------------------
1998 1997 1997 1996 1995
------------ ---------- ------------ ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Balance at beginning of year......... $ 1,015,576 $ 922,833 $ 922,833 $ 752,972 $ 588,321
Addition -- provision charged to
operations.................... 144,500 104,970 189,970 230,000 175,000
Net charge-offs:
Loans charged off.......... (54,777) (87,226) (130,086) (73,360) (32,206)
Loan recoveries............ 8,414 15,567 32,859 13,221 21,857
------------ ---------- ------------ ---------- ----------
Total net charge-offs................ (46,363) (71,659) (97,227) (60,139) (10,349)
------------ ---------- ------------ ---------- ----------
Balance at end of period............. $ 1,113,713 $ 956,144 $ 1,015,576 $ 922,833 $ 752,972
============ ========== ============ ========== ==========
</TABLE>
F-15
<PAGE>
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
8. PREMISES AND EQUIPMENT
Premises and equipment are summarized as follows:
YEAR ENDED
DECEMBER 31,
JUNE 30, --------------------------
1998 1997 1996
----------- ------------ ------------
(UNAUDITED)
Land................................. $ 934,559 $ 934,559 $ 624,858
Buildings............................ 5,180,418 4,766,007 4,322,046
Furniture, fixtures and equipment.... 2,258,240 2,164,222 1,868,563
Construction in progress............. 16,439 388,269 12,719
----------- ------------ ------------
Total................................ 8,389,656 8,253,057 6,828,186
Less accumulated depreciation........ 2,937,801 2,723,393 2,328,040
----------- ------------ ------------
Premises and equipment, net.......... $ 5,451,855 $ 5,529,664 $ 4,500,146
=========== ============ ============
9. DEPOSITS
Included in interest-bearing deposits are certificates of deposit in
amounts of $100,000 or more. These certificates and their remaining maturities
at June 30, 1998 and December 31, 1997 and 1996 were as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
JUNE 30, ------------------------------
1998 1997 1996
------------ -------------- --------------
(UNAUDITED)
<S> <C> <C> <C>
Three months or less................. $ 11,888,000 $ 1,567,000 $ 12,570,000
Greater than three through six
months............................. 5,734,000 3,370,000 8,320,000
Greater than six through twelve
months............................. 11,130,000 11,992,000 5,669,000
Thereafter........................... 3,199,000 6,226,000 3,504,000
------------ -------------- --------------
Total................................ $ 31,951,000 $ 23,155,000 $ 30,063,000
============ ============== ==============
</TABLE>
Interest expense for certificates of deposit in excess of $100,000 was
approximately $593,000, $1,264,000, $1,291,000, and $1,247,000 for the periods
ended June 30, 1998 (unaudited), December 31, 1997, 1996, and 1995,
respectively.
The Company has no brokered deposits and there are no major concentrations
of deposits.
10. NOTE PAYABLE AND OTHER BORROWINGS
NOTE PAYABLE -- During December 1997, Bancshares entered into an agreement
with a bank to borrow up to $8,000,000 under a reducing, revolving line of
credit (the "Line"). The purpose of the Line is to provide funding for
potential acquisitions in the future. The maximum amount available under the
Line is reduced by $1,142,857 each year beginning December 1998 with all amounts
due and payable on December 31, 2004. The Line bears interest, payable
quarterly, at the Federal Funds Rate plus 2.75%. The Line is collateralized by
100% of the issued and outstanding common shares of Holdings and the Bank. At
June 30, 1998 (unaudited) and December 31, 1997, Bancshares had no outstanding
borrowings under the Line. During 1997, Bancshares paid off the outstanding
balance under a similar agreement (the "Old Line") with a bank. At December
31, 1996, borrowings under the Old Line totaled $3,266,666.
OTHER BORROWINGS -- At December 31, 1997, Federal Home Loan Bank ("FHLB")
advances totaled $2,800,000 with a floating interest rate of 6.9%. There were no
advances at June 30, 1998 (unaudited) or
F-16
<PAGE>
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
December 31, 1996. The FHLB line of credit agreement matures May 14, 1999. The
advances under the FHLB line of credit are secured by a blanket pledge of the
Bank's one-to-four family mortgages.
11. INTEREST RATE RISK
The Company is principally engaged in providing real estate, consumer and
commercial loans, with interest rates that are both fixed and variable. These
loans are primarily funded through short-term demand deposits and longer-term
certificates of deposit with variable and fixed rates. The fixed real estate
loans are more sensitive to interest rate risk because of their fixed rates and
longer maturities.
12. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
In the normal course of business, the Company is a party to various
financial instruments with off-balance-sheet risk to meet the financing needs of
its customers and to reduce its own exposure to fluctuations in interest rates.
These financial instruments include commitments to extend credit and standby
letters of credit. These instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amounts recognized in the
consolidated balance sheets. The contract or notional amounts of these
instruments reflect the extent of the Company's involvement in particular
classes of financial instruments.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit and
standby letters of credit is represented by the contractual amount of those
instruments. The Company uses the same credit policies in making these
commitments and conditional obligations as it does for on-balance-sheet
instruments.
The following is a summary of the various financial instruments entered
into by the Company:
<TABLE>
<CAPTION>
DECEMBER 31,
JUNE 30, ------------------------------
1998 1997 1996
------------ -------------- --------------
(UNAUDITED)
<S> <C> <C> <C>
Financial instruments whose contract
amounts represent credit risk:
Commitments to extend credit.... $ 10,348,000 $ 11,856,158 $ 11,660,000
Standby letters of credit....... 279,000 315,200 45,000
</TABLE>
At June 30, 1998 (unaudited), approximately $3,900,000 of commitments to
extend credit have fixed rates ranging from 6.60% to 11.50%. Commitments to
extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract. Commitments generally
have fixed expiration dates or other termination clauses and may require payment
of a fee. Since many of the commitments are expected to expire without being
fully drawn upon, the total commitment amounts disclosed above do not
necessarily represent future cash requirements.
Standby letters of credit are conditional commitments issued by the Company
to guarantee the performance of a customer to a third party. The credit risk
involved in issuing letters of credit is essentially the same as that involved
in extending loan facilities to customers.
The Company evaluates customer creditworthiness on a case-by-case basis.
The amount of collateral obtained, if considered necessary by the Company upon
extension of credit, is based on management's credit evaluation of the customer.
F-17
<PAGE>
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
13. INCOME TAXES
The components of the provision for federal income taxes are as follows:
YEAR ENDED DECEMBER 31,
--------------------------------------
1997 1996 1995
------------ ------------ ----------
Current.............................. $ 1,634,000 $ 1,340,000 $ 686,000
Deferred............................. (48,000) (100,000) 95,000
------------ ------------ ----------
Total................................ $ 1,586,000 $ 1,240,000 $ 781,000
============ ============ ==========
The provision for federal income taxes differs from the amount computed by
applying the federal income tax statutory rate on income as follows:
YEAR ENDED DECEMBER 31,
----------------------------------------
1997 1996 1995
------------ ------------ ------------
Taxes calculated at statutory rate... $ 1,750,000 $ 1,343,000 $ 1,055,000
Increase (decrease) resulting from:
Tax-exempt interest............. (251,000) (258,000) (295,000)
Amortization of goodwill........ 57,000 57,000 50,000
Other, net...................... 30,000 98,000 (29,000)
------------ ------------ ------------
Total................................ $ 1,586,000 $ 1,240,000 $ 781,000
============ ============ ============
Deferred tax assets and liabilities are as follows:
DECEMBER 31,
----------------------
1997 1996
---------- ----------
Deferred tax assets --
Allowance for credit losses..... $ 225,000 $ 194,000
---------- ----------
Total deferred tax assets............ 225,000 194,000
---------- ----------
Deferred tax liabilities:
Accretion on investments........ $ 189,000 $ 162,000
Bank premises and equipment..... 24,000 71,000
Unrealized loss on available for
sale investment securities.... 13,000 11,000
Other........................... 7,000 4,000
---------- ----------
Total deferred tax liabilities....... 233,000 248,000
---------- ----------
Net deferred tax liabilities......... $ (8,000) $ (54,000)
========== ==========
14. STOCK INCENTIVE PROGRAM
During 1995 the Company's Board of Directors approved a stock option plan
(the "Plan") for executive officers and key employees to purchase common stock
of Bancshares. On May 31, 1995, the Company granted 260,000 options, after stock
split, (see Note 22) which vest over a ten-year period beginning on the date of
grant. Fifty percent of the options vest after the five year period and ten
percent vest in each year thereafter. The options may not be exercised until the
optionee has completed five years of employment after the date of grant. The
options were granted at an average exercise price of $4.40 (after stock split).
Compensation expense was not recognized for the stock options because the
options had an
F-18
<PAGE>
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
exercise price approximating the fair value of Bancshares' common stock at the
date of grant. The maximum number of options available for grant under the Plan
is 340,000 (after stock split).
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------
JUNE 30, 1998 1997 1996 1995
---------------------- ---------------------- ---------------------- ---------
WEIGHTED- WEIGHTED- WEIGHTED-
NUMBER AVERAGE NUMBER AVERAGE NUMBER AVERAGE NUMBER
OF EXERCISE OF EXERCISE OF EXERCISE OF
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE OPTIONS
--------- ---------- --------- ---------- --------- ---------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Options outstanding, beginning of
period............................. 260,000 $ 4.40 260,000 $ 4.40 260,000 $ 4.40
Options granted...................... 60,000 6.25 260,000
--------- ---------- --------- ---------- --------- ---------- ---------
Options outstanding, end of period... 320,000 $ 4.75 260,000 $ 4.40 260,000 $ 4.40 260,000
========= ========== ========= ========== ========= ========== =========
</TABLE>
WEIGHTED-
AVERAGE
EXERCISE
PRICE
----------
Options outstanding, beginning of
period.............................
Options granted...................... $ 4.40
----------
Options outstanding, end of period... $ 4.40
==========
There were no options granted, exercised, forfeited, or expired during 1997
and 1996. At June 30, 1998 (unaudited) and December 31, 1997 and 1996, there
were no options that were exercisable under the Plan. On February 10, 1998, the
Company granted 60,000 options under the Plan. The options were granted at an
exercise price of $6.25. Compensation expense was not recorded for the stock
options because the exercise price approximated the fair value of common stock
at the date of grant.
The weighted-average grant date fair value of the stock options granted in
1995 was $.39. The weighted-average remaining contractual life of options
outstanding at December 31, 1997 was 7.42 years. The fair value of each stock
option was estimated using an option-pricing model with the following
assumptions used: risk-free interest rate of 6.49%; dividend yield of 4.54%; and
an expected life of 6.5 years.
If compensation expense had been recorded based on the fair value at the
grant date for awards consistent with SFAS No. 123, the Company's net income
would have been $2,052,660, $3,555,480, $2,704,040 and $2,317,522 and earnings
per share would have been $.53, $.94, $.77 and $.66 for the six months ended
June 30, 1998 (unaudited) and the years ended December 31, 1997, 1996 and 1995,
respectively.
15. PROFIT SHARING PLAN
The Company has adopted a profit sharing plan pursuant to Section 401(k) of
the Internal Revenue Code whereby participants may contribute up to 15% of their
compensation. Matching contributions are made at the discretion of the Company.
Such matching contributions were approximately $48,000, $38,000, $87,000,
$72,000 and $56,000 for the six months ended June 30, 1998 (unaudited) and 1997
(unaudited) and the years ended December 31, 1997, 1996, and 1995, respectively.
16. COMMITMENTS AND CONTINGENCIES
LEASES -- A summary of noncancelable future operating lease commitments as
of December 31, 1997 follows:
1998................................. $ 189,606
1999................................. 102,214
2000................................. 50,821
2001................................. 50,821
2002................................. 50,821
----------
Total................................ $ 444,283
==========
F-19
<PAGE>
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
It is expected that in the normal course of business, expiring leases will
be renewed or replaced by leases on other property or equipment.
Rent expense under all noncancelable operating lease obligations aggregated
approximately $191,000 for the year ended December 31, 1997 and $180,000 for the
years ended December 31, 1996 and 1995.
LITIGATION -- Various lawsuits are pending against the Company. Management,
after reviewing these lawsuits with outside counsel, considers that the
aggregate liabilities, if any, will not be material to the consolidated
financial statements.
17. SHAREHOLDERS' EQUITY
During 1997, the Company sold 480,000 shares of common stock at $6.25 per
share, after stock split, (see Note 22), which approximated the book value of
the Company at the time of the sale. Proceeds to the Company totaling $3,000,000
were used to fund the acquisition of a branch (see Note 2) and to repay
borrowings under a line of credit arrangement with a bank (Note 10).
Dividends paid by Bancshares and the Bank are subject to restrictions by
certain regulatory agencies. There was an aggregate of approximately $7,300,000
and $4,835,000 available for payment of dividends by Bancshares and by the Bank
to Bancshares, respectively, at December 31, 1997 under these restrictions.
Dividends paid by Bancshares during the years ended December 31, 1997 and 1996
were $574,536 and $351,388, respectively. Dividends paid by the Bank to
Bancshares during the years ended December 31, 1997 and 1996 were $2,922,150 and
$661,000, respectively.
18. REGULATORY MATTERS
The Company and the Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. Any institution that
fails to meet its minimum capital requirements is subject to actions by
regulators that could have a direct material effect on the Company's and the
Bank's financial statements. Under the capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines based on the Bank's assets, liabilities and certain off-
balance-sheet items as calculated under regulatory accounting practices. The
Company's and the Bank's capital amounts and the Bank's classification under the
regulatory framework for prompt corrective action are also subject to
qualitative judgments by the regulators about the components, risk weightings
and other factors.
To meet the capital adequacy requirements, the Company and the Bank must
maintain minimum capital amounts and ratios as defined in the regulations.
Management believes, as of June 30, 1998 and December 31, 1997, that the Company
and the Bank met all capital adequacy requirements to which they are subject.
At December 31, 1997, the most recent notification from the State of Texas
Department of Banking categorized the Bank as well capitalized under the
regulatory framework for prompt corrective action. To be categorized as well
capitalized the Bank must maintain minimum total risk-based, Tier I risk-based
and Tier I leverage ratios as set forth in the table. There have been no
conditions or events since that notification which management believes have
changed the Bank's category.
F-20
<PAGE>
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following is a summary of the Company's and the Bank's capital ratios
at June 30, 1998 (unaudited), December 31, 1997 and 1996:
<TABLE>
<CAPTION>
TO BE WELL
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
---------------------- ---------------------- --------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
-------------- ----- -------------- ----- ----------- -----
<S> <C> <C> <C> <C>
CONSOLIDATED:
AS OF JUNE 30, 1998 (UNAUDITED):
Total Capital (to Risk Weighted
Assets)........................ $ 21,974,135 15.08% $ 11,656,560 8.0% N/A N/A
Tier I Capital (to Risk Weighted
Assets)........................ 20,860,423 14.32% 5,828,280 4.0% N/A N/A
Tier I Capital (to Average
Assets)........................ 20,860,423 6.25% 10,017,360 3.0% N/A N/A
AS OF DECEMBER 31, 1997:
Total Capital (to Risk Weighted
Assets)........................ $ 20,233,587 15.73% $ 10,292,800 8.0% N/A N/A
Tier I Capital (to Risk Weighted
Assets)........................ 19,217,587 14.94% 5,146,400 4.0% N/A N/A
Tier I Capital (to Average
Assets)........................ 19,217,587 6.30% 9,150,600 3.0% N/A N/A
AS OF DECEMBER 31, 1996:
Total Capital (to Risk Weighted
Assets)........................ $ 15,756,054 13.89% $ 9,076,240 8.0% N/A N/A
Tier I Capital (to Risk Weighted
Assets)........................ 14,878,054 13.11% 4,538,120 4.0% N/A N/A
Tier I Capital (to Average
Assets)........................ 14,878,054 5.45% 8,186,910 3.0% N/A N/A
<CAPTION>
TO BE WELL
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
--------------------- ---------------------- --------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------------ ------ -------------- ----- ----------- -----
BANK ONLY:
AS OF JUNE 30, 1998 (UNAUDITED):
Total Capital (to Risk Weighted
Assets)........................ $ 21,837,916 14.99% $ 11,656,080 8.0% $14,570,100 10.0%
Tier I Capital (to Risk Weighted
Assets)........................ 20,724,204 14.22% 5,828,040 4.0% 8,742,060 6.0%
Tier I Capital (to Average
Assets)........................ 20,724,204 6.21% 10,016,160 3.0% 16,693,600 5.0%
AS OF DECEMBER 31, 1997:
Total Capital (to Risk Weighted
Assets)........................ $ 20,056,438 15.59% $ 10,291,920 8.0% $12,864,900 10.0%
Tier I Capital (to Risk Weighted
Assets)........................ 19,040,438 14.80% 5,145,960 4.0% 7,718,940 6.0%
Tier I Capital (to Average
Assets)........................ 19,040,438 6.13% 9,319,920 3.0% 15,533,200 5.0%
AS OF DECEMBER 31, 1996:
Total Capital (to Risk Weighted
Assets)........................ $ 18,827,802 16.60% $ 9,075,840 8.0% $11,344,800 10.0%
Tier I Capital (to Risk Weighted
Assets)........................ 17,949,802 15.82% 4,537,920 4.0% 6,806,880 6.0%
Tier I Capital (to Average
Assets)........................ 17,949,802 6.48% 8,306,760 3.0% 13,844,600 5.0%
</TABLE>
F-21
<PAGE>
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
19. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INFORMATION
Disclosures of the estimated fair value amounts of financial instruments
have been determined by the Company using available market information and
appropriate valuation methodologies. However, considerable judgment is
necessarily required in interpreting market data to develop the estimates of
fair value. Accordingly, the estimates presented herein are not necessarily
indicative of the amounts the Company could realize in a current market
exchange. The use of different market assumptions and/or estimation
methodologies could have a material effect on the estimated fair value amounts.
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.
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.
LOAN RECEIVABLES -- For 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.
DEPOSIT LIABILITIES -- 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.
LONG-TERM DEBT AND 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.
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.
The estimated fair values of the Company's financial instruments are as
follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------
1997 1996
---------------------- ----------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Financial assets:
Cash and cash equivalents....... $ 17,372 $ 17,372 $ 21,744 $ 21,744
Interest-bearing deposits in
financial institutions........ 198 198 396 396
Held to maturity securities..... 129,256 129,775 98,222 97,659
Available for sale securities... 38,612 38,612 49,342 49,342
Loans........................... 120,578 129,601 113,382 117,976
Less allowance for loan
losses........................ (1,016) (1,016) (923) (923)
---------- ---------- ---------- ----------
Total................................ $ 305,000 $ 314,542 $ 282,163 $ 286,194
========== ========== ========== ==========
Financial liabilities:
Deposits........................ $ 291,517 $ 291,779 $ 270,866 $ 271,274
Note payable.................... 3,267 3,267
Other borrowing................. 2,800 2,800
---------- ---------- ---------- ----------
Total................................ $ 294,317 $ 294,579 $ 274,133 $ 274,541
========== ========== ========== ==========
</TABLE>
F-22
<PAGE>
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The differences in fair value and carrying value of commitments to extend
credit and standby letters of credit were not material at December 31, 1997 and
1996.
The fair value estimates presented herein are based on pertinent
information available to management as of the dates indicated. 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.
20. COMPREHENSIVE INCOME
SFAS No. 130, "Reporting Comprehensive Income" requires that all
components of comprehensive income and total comprehensive income be reported on
one of the following: (1) the statement of income, (2) the statement of
stockholders' equity, or (3) a separate statement of comprehensive income.
Comprehensive income is comprised of net income and all changes to stockholders'
equity, except those due to investments by owners (changes in paid-in capital)
and distributions to owners (dividends). The Company adopted this statement
effective January 1, 1998 and has elected to report comprehensive income in the
consolidated statements of stockholders' equity.
Other comprehensive income consists of unrealized gains and losses on
available for sale securities. For the six months ended June 30, 1998, the
change in net unrealized loss on available for sale securities is reported in
the consolidated statement of stockholders' equity.
21. PARENT COMPANY ONLY FINANCIAL STATEMENTS
PROSPERITY BANCSHARES, INC.
(PARENT COMPANY ONLY)
BALANCE SHEETS
<TABLE>
<CAPTION>
JUNE 30, 1998 1997 1996
------------- -------------- --------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Cash................................. $ 111,410 $ 153,610 $ 111,848
Investment in subsidiaries........... 20,747,224 19,065,984 17,988,765
Goodwill, net........................ 5,612,701 5,592,791 3,995,130
Other assets......................... 12,163 11,008 5,455
------------- -------------- --------------
TOTAL................................ $ 26,483,498 $ 24,823,393 $ 22,101,198
============= ============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Note payable.................... $ 3,266,666
Accrued interest payable and
other liabilities............. $ 5,679 $ 5,796 1,220
------------- -------------- --------------
Total liabilities.......... 5,679 5,796 3,267,886
------------- -------------- --------------
SHAREHOLDERS' EQUITY:
Common Stock.................... 3,993,884 3,993,884 3,513,884
Capital surplus................. 4,817,782 4,817,782 2,797,607
Retained earnings............... 17,707,546 16,049,334 13,061,698
Unrealized losses on available
for sale investment
securities, net of tax........ (23,066) (25,076) (20,725)
Less treasury stock, at cost
3,576 (unaudited), 3,576 and
3,736 shares at June 30, 1998,
December 31, 1997 and 1996,
respectively)................. (18,327) (18,327) (19,147)
------------- -------------- --------------
Total shareholders'
equity.................. 26,477,819 24,817,597 18,833,312
------------- -------------- --------------
TOTAL................................ $ 26,483,498 $ 24,823,393 $ 22,101,198
============= ============== ==============
</TABLE>
F-23
<PAGE>
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
PROSPERITY BANCSHARES, INC.
(PARENT COMPANY ONLY)
STATEMENTS OF INCOME
<TABLE>
<CAPTION>
FOR THE SIX MONTHS
ENDED JUNE 30, FOR THE YEARS ENDED DECEMBER 31,
-------------------------- ----------------------------------------
1998 1997 1997 1996 1995
------------ ------------ ------------ ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING INCOME --
Dividends from subsidiaries..... $ 595,000 $ 2,039,000 $ 2,922,150 $ 661,000 $ 1,352,777
OPERATING EXPENSE:
Interest expense................ 1,414 91,809 119,682 202,649 153,152
Amortization of goodwill........ 230,090 158,197 392,453 248,339 199,728
Other expenses.................. 56,947 28,688 66,416 48,987 31,135
------------ ------------ ------------ ------------ ------------
Total operating expense.... 288,451 278,694 578,551 499,975 384,015
------------ ------------ ------------ ------------ ------------
INCOME BEFORE INCOME TAX BENEFIT AND
EQUITY IN UNDISTRIBUTED EARNINGS OF
SUBSIDIARIES....................... 306,549 1,760,306 2,343,599 161,025 968,762
FEDERAL INCOME TAX BENEFIT........... 71,465 41,323 137,003 85,555 62,658
------------ ------------ ------------ ------------ ------------
INCOME BEFORE EQUITY IN UNDISTRIBUTED
EARNINGS OF SUBSIDIARIES........... 378,014 1,801,629 2,480,602 246,580 1,031,420
EQUITY IN UNDISTRIBUTED EARNINGS OF
SUBSIDIARIES 1,679,230 (140,803) 1,081,570 2,464,152 1,290,007
------------ ------------ ------------ ------------ ------------
NET INCOME........................... $ 2,057,244 $ 1,660,826 $ 3,562,172 $ 2,710,732 $ 2,321,427
============ ============ ============ ============ ============
</TABLE>
F-24
<PAGE>
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
PROSPERITY BANCSHARES, INC.
(PARENT COMPANY ONLY)
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE SIX MONTHS ENDED
JUNE 20, FOR THE YEARS ENDED DECEMBER 31,
-------------------------- ----------------------------------------
1998 1997 1997 1996 1995
------------ ------------ ------------ ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income......................... $ 2,057,244 $ 1,660,826 $ 3,562,172 $ 2,710,732 $ 2,321,427
Adjustments to reconcile net income
to net cash provided by operating
activities:
Equity in undistributed earnings
of subsidiaries................ (1,679,230) 140,803 (1,081,570) (2,464,152) (1,290,007)
Decrease in due to subsidiary.... (157,777)
Amortization of goodwill......... 230,090 158,197 392,453 248,339 199,728
(Increase) decrease in other
assets......................... (1,155) 8,442 (5,553) (1,570) 1,601
Increase (decrease) in other
liabilities.................... (117) 36,694 4,576 (33,577) 34,791
------------ ------------ ------------ ------------ ------------
Total adjustments........... (1,450,412) 344,136 (690,094) (2,250,960) (1,211,664)
------------ ------------ ------------ ------------ ------------
Net cash flows provided by
operating activities...... 606,832 2,004,962 2,872,078 459,772 1,109,763
------------ ------------ ------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Premium paid for branch
acquisition...................... (250,000) (1,990,114) (1,990,114) (1,750,000)
------------ ------------ ------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of notes payable......... (2,402,017) (3,266,666) (1,516,666) (758,334)
Proceeds from line of credit....... 3,266,666
Issuance of common stock........... 2,938,175 3,000,000
Payments of cash dividends......... (399,032) (175,505) (574,536) (351,388) (351,388)
Sale (purchase) of treasury
stock............................ 1,000 (19,147)
------------ ------------ ------------ ------------ ------------
Net cash flows (used in)
provided by financing
activities................ (399,032) 360,653 (840,202) 1,379,465 (1,109,722)
------------ ------------ ------------ ------------ ------------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS................... (42,200) 375,501 41,762 89,237 41
CASH AND CASH EQUIVALENTS, BEGINNING
OF PERIOD.......................... 153,610 111,848 111,848 22,611 22,570
------------ ------------ ------------ ------------ ------------
CASH AND CASH EQUIVALENTS, END OF
PERIOD............................. $ 111,410 $ 487,349 $ 153,610 $ 111,848 $ 22,611
============ ============ ============ ============ ============
</TABLE>
F-25
<PAGE>
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
22. PENDING ACQUISITION
During November 1997, the Company entered into a purchase and assumption
agreement with another bank to purchase certain assets and to assume certain
deposit accounts and related accrued interest payable of a branch located in
West Columbia, Texas. This transaction, which has met regulatory approval, is
expected to be completed on or about February 27, 1998. At that time, the
Company expects to purchase loans totaling approximately $120,000 and assume
deposit liabilities of approximately $7,500,000. The Company expects to pay a
cash premium totaling approximately $250,000 for the transaction.
23. SUBSEQUENT EVENTS
On September 10, 1998, the Company effected a four for one common stock
split in the form of a common stock dividend (the "Stock Split"). All share
and per share information for common stock has been restated to reflect the
Stock Split. In September 1998, the Company increased the number of authorized
shares of common stock from 1,000,000 to 50,000,000 and authorized 20,000,000
shares of preferred stock with a par value of $1.
In June 1998, the Company entered into a merger agreement with a bank
located in East Bernard, Texas. This transaction, which has met regulatory
approval, is expected to be completed on or about October 1, 1998.
On February 10, 1998, the Company granted 60,000 options under the 1995
stock option plan. The options were granted at an exercise price of $6.25.
Compensation expense was not recorded for the stock options because the exercise
price approximated the fair value of common stock at the date of the grant.
In 1998, the Company approved a new stock option plan which authorizes the
issuance of up to 460,000 shares of common stock.
******
F-26
<PAGE>
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors
Union State Bank
East Bernard, Texas
We have audited the accompanying statements of condition of Union State
Bank as of December 31, 1997 and 1996, and the related statements of income,
changes in shareholders' equity and cash flows for the years then ended. These
financial statements are the responsibility of the Bank's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Union State Bank at December
31, 1997 and 1996, and the results of its operations and its cash flows for the
years then ended in conformity with generally accepted accounting principles.
Harper & Pearson Company
Houston, Texas
January 23, 1998
F-27
<PAGE>
UNION STATE BANK
STATEMENTS OF CONDITION
JUNE 30, 1998 AND 1997
(UNAUDITED)
1998 1997
-------------- --------------
ASSETS
Cash and due from banks.............. $ 1,672,840 $ 1,681,819
Federal funds sold................... 5,100,000 3,100,000
-------------- --------------
Total cash and cash equivalents...... 6,772,840 4,781,819
Securities available for sale........ 20,069,030 15,847,429
Securities to be held to maturity at
cost, fair value of $24,269,037 and
$31,147,700 at June 30, 1998 and
1997, respectively................. 24,076,943 31,153,834
Loans................................ 25,227,167 23,626,280
Less allowance for possible loan
losses........................ 670,702 718,656
-------------- --------------
Loans, net...................... 24,556,465 22,907,624
Bank premises and equipment, net..... 165,029 209,013
Accrued interest receivable.......... 1,083,643 1,082,035
Deferred federal income taxes........ 33,255 110,225
Other assets, net.................... 183,385 211,428
-------------- --------------
$ 76,940,590 $ 76,303,407
============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits:
Noninterest-bearing............. $ 8,203,315 $ 7,715,830
Interest-bearing................ 55,519,663 56,442,834
-------------- --------------
Total Deposits.................. 63,722,978 64,158,664
Accrued interest payable........ 293,691 264,928
Other liabilities............... 59,680 79,347
-------------- --------------
Total Liabilities............... 64,076,349 64,502,939
-------------- --------------
Commitments
Shareholders' Equity
Common stock, $10 par value,
70,000 shares authorized,
issued and outstanding........ 700,000 700,000
Capital surplus................. 3,300,000 3,300,000
Retained earnings............... 8,928,797 7,998,818
Net unrealized losses on
securities available for sale,
net........................... (64,556) (198,350)
-------------- --------------
Total Shareholders' Equity...... 12,864,241 11,800,468
-------------- --------------
$ 76,940,590 $ 76,303,407
============== ==============
See accompanying notes.
F-28
<PAGE>
UNION STATE BANK
STATEMENTS OF CONDITION
DECEMBER 31, 1997 AND 1996
1997 1996
-------------- --------------
ASSETS
Cash and due from banks................. $ 2,513,928 $ 2,502,038
Federal funds sold...................... 6,300,000 6,000,000
-------------- --------------
Total cash and cash equivalents.... 8,813,928 8,502,038
Securities available for sale........... 19,195,963 18,373,655
Securities to be held to maturity at
cost, fair value of $29,789,918 and
$31,225,616 at December 31, 1997 and
1996, respectively.................... 29,620,984 31,181,829
Loans................................... 20,438,344 19,473,356
Less allowance for possible loan
losses........................... 649,669 702,274
-------------- --------------
Loans, net......................... 19,788,675 18,771,082
Bank premises and equipment, net........ 186,731 209,606
Accrued interest receivable............. 795,002 779,924
Deferred federal income taxes........... 82,206 108,162
Other assets, net....................... 215,349 435,554
-------------- --------------
$ 78,698,838 $ 78,361,850
============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits:
Noninterest-bearing................ $ 8,550,127 $ 9,020,075
Interest-bearing................... 57,593,728 57,624,409
-------------- --------------
Total Deposits..................... 66,143,855 66,644,484
Accrued interest payable........... 276,145 256,372
Other liabilities.................. 23,842 2,632
-------------- --------------
Total Liabilities.................. 66,443,842 66,903,488
-------------- --------------
Commitments
Shareholders' Equity
Common stock, $10 par value, 70,000
shares authorized, issued and
outstanding...................... 700,000 700,000
Capital surplus.................... 3,300,000 3,300,000
Retained earnings.................. 8,398,957 7,652,705
Net unrealized losses on securities
available for sale, net.......... (143,961) (194,343)
-------------- --------------
Total Shareholders' Equity......... 12,254,996 11,458,362
-------------- --------------
$ 78,698,838 $ 78,361,850
============== ==============
See accompanying notes.
F-29
<PAGE>
UNION STATE BANK
STATEMENTS OF INCOME
SIX MONTHS ENDED JUNE 30, 1998 AND 1997
(UNAUDITED)
1998 1997
------------ ------------
INTEREST INCOME
Interest and fees on loans...... $ 1,040,303 $ 980,080
Securities available for sale... 599,768 514,952
Securities to be held to
maturity....................... 775,749 967,480
Federal funds sold.............. 195,565 77,371
------------ ------------
Total Interest Income........... 2,611,385 2,539,883
------------ ------------
INTEREST EXPENSE
Deposits........................ 1,238,241 1,229,806
------------ ------------
Total Interest Expense.......... 1,238,241 1,229,806
------------ ------------
NET INTEREST INCOME.................. 1,373,144 1,310,077
PROVISION FOR POSSIBLE CREDIT LOSSES -- --
------------ ------------
NET INTEREST INCOME AFTER PROVISION
FOR
POSSIBLE CREDIT LOSSES............. 1,373,144 1,310,077
------------ ------------
OTHER INCOME
Customer service charges........ 97,678 98,899
Other service charges and
fees........................... 23,453 25,186
Other........................... 9,156 59,473
------------ ------------
Total Other Income.............. 130,287 183,558
------------ ------------
OTHER EXPENSE
Salaries and employee
benefits....................... 453,222 438,171
Net occupancy and equipment
expense........................ 58,271 59,137
Data processing................. 52,417 49,227
Professional services fees...... 37,505 38,427
Taxes other than income taxes... 55,499 55,335
Other........................... 68,443 71,225
------------ ------------
Total Other Expense............. 725,357 711,522
------------ ------------
EARNINGS BEFORE INCOME TAXES......... 778,074 782,113
INCOME TAXES......................... 248,234 226,000
------------ ------------
NET EARNINGS......................... $ 529,840 $ 556,113
============ ============
See accompanying notes.
F-30
<PAGE>
UNION STATE BANK
STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1997 AND 1996
1997 1996
------------ ------------
INTEREST INCOME
Interest and fees on loans...... $ 2,135,057 $ 2,180,517
Securities available for sale... 964,771 965,685
Securities to be held to
maturity....................... 1,825,390 1,908,964
Federal funds sold.............. 266,891 149,549
------------ ------------
Total Interest Income........... 5,192,109 5,204,715
------------ ------------
INTEREST EXPENSE
Deposits........................ 2,504,186 2,505,963
------------ ------------
Total Interest Expense.......... 2,504,186 2,505,963
------------ ------------
NET INTEREST INCOME.................. 2,687,923 2,698,752
REDUCTION OF ALLOWANCE FOR POSSIBLE
CREDIT LOSSES...................... 75,000 55,000
------------ ------------
NET INTEREST INCOME AFTER REDUCTION
OF ALLOWANCE FOR POSSIBLE CREDIT
LOSSES............................. 2,762,923 2,753,752
------------ ------------
OTHER INCOME
Customer service charges........ 218,173 172,749
Other service charges and
fees............................ 37,561 46,815
Other........................... 72,984 59,908
------------ ------------
Total Other Income.............. 328,718 279,472
------------ ------------
OTHER EXPENSE
Salaries and employee
benefits....................... 945,129 931,227
Net occupancy and equipment
expense........................ 121,879 139,302
Data processing................. 101,001 115,103
Professional services fees...... 64,227 65,518
Taxes other than income taxes... 105,828 106,967
Other real estate losses and
expenses....................... 5,247 100,381
Other........................... 160,078 159,520
------------ ------------
Total Other Expense............. 1,503,389 1,618,018
------------ ------------
EARNINGS BEFORE INCOME TAXES......... 1,588,252 1,415,206
INCOME TAXES......................... 422,000 406,674
------------ ------------
NET EARNINGS......................... $ 1,166,252 $ 1,008,532
============ ============
See accompanying notes.
F-31
<PAGE>
UNION STATE BANK
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
SIX MONTHS ENDED JUNE 30, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
ACCUMULATED
OTHER
COMPREHENSIVE
INCOME-NET
UNREALIZED
LOSSES
SECURITIES
COMMON CAPITAL RETAINED AVAILABLE
STOCK SURPLUS EARNINGS FOR SALE TOTAL
---------- ------------ ------------ -------------- --------------
<S> <C> <C> <C> <C> <C>
Balance -- December 31, 1997......... $ 700,000 $ 3,300,000 $ 8,398,957 $ (143,961) $ 12,254,996
Net Earnings......................... -- -- 529,840 -- 529,840
Net Change in Unrealized Losses On
Securities Available for Sale...... -- -- -- 79,405 79,405
--------------
Total Comprehensive Income........... -- -- -- -- 609,245
Dividends............................ -- -- -- -- --
---------- ------------ ------------ -------------- --------------
Balance -- June 30, 1998............. $ 700,000 $ 3,300,000 $ 8,928,797 $ (64,556) $ 12,864,241
========== ============ ============ ============== ==============
</TABLE>
UNION STATE BANK
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
SIX MONTHS ENDED JUNE 30, 1997
(UNAUDITED)
<TABLE>
<CAPTION>
ACCUMULATED
OTHER
COMPREHENSIVE
INCOME-NET
UNREALIZED
LOSSES
SECURITIES
COMMON CAPITAL RETAINED AVAILABLE
STOCK SURPLUS EARNINGS FOR SALE TOTAL
---------- ------------ ------------ -------------- --------------
<S> <C> <C> <C> <C> <C>
Balance -- December 31, 1996......... $ 700,000 $ 3,300,000 $ 7,652,705 $ (194,343) $ 11,458,362
Net Earnings......................... -- -- 556,113 -- 556,113
Net Change in Unrealized Losses On
Securities Available for Sale...... -- -- -- (4,007) (4,007)
--------------
Total Comprehensive Income........... -- -- -- -- 552,106
Dividends............................ -- -- (210,000) -- (210,000)
---------- ------------ ------------ -------------- --------------
Balance -- June 30, 1997............. $ 700,000 $ 3,300,000 $ 7,998,818 $ (198,350) $ 11,800,468
========== ============ ============ ============== ==============
</TABLE>
See accompanying notes.
F-32
<PAGE>
UNION STATE BANK
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1997 AND 1996
<TABLE>
<CAPTION>
ACCUMULATED
OTHER
COMPREHENSIVE
INCOME-NET
UNREALIZED
LOSSES
SECURITIES
COMMON CAPITAL RETAINED AVAILABLE
STOCK SURPLUS EARNINGS FOR SALE TOTAL
---------- ------------ ------------ -------------- --------------
<S> <C> <C> <C> <C> <C>
Balance -- December 31, 1995......... $ 700,000 $ 3,300,000 $ 7,064,173 $ (124,976) $ 10,939,197
Net Earnings......................... -- -- 1,008,532 -- 1,008,532
Net Change in Unrealized Losses On
Securities Available for Sale...... -- -- -- (69,367) (69,367)
--------------
Total Comprehensive Income........... 939,165
Dividends............................ (420,000) (420,000)
---------- ------------ ------------ -------------- --------------
Balance -- December 31, 1996......... 700,000 3,300,000 7,652,705 (194,343) 11,458,362
Net Earnings......................... -- -- 1,166,252 -- 1,166,252
Net Change in Unrealized Losses On
Securities Available for Sale...... -- -- -- 50,382 50,382
--------------
Total Comprehensive Income........... 1,216,634
Dividends............................ (420,000) (420,000)
---------- ------------ ------------ -------------- --------------
Balance -- December 31, 1997......... $ 700,000 $ 3,300,000 $ 8,398,957 $ (143,961) $ 12,254,996
========== ============ ============ ============== ==============
</TABLE>
See accompanying notes.
F-33
<PAGE>
UNION STATE BANK
STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 1998 AND 1997
(UNAUDITED)
1998 1997
-------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings.................... $ 529,840 $ 556,113
-------------- --------------
Adjustments to reconcile net
earnings to net cash provided
by operating activities:
Provision for depreciation and
amortization............... 21,702 21,067
Deferred federal income
taxes...................... 48,951 (2,063)
Change in operating assets and
liabilities:
Accrued interest receivable... (288,641) (302,111)
Other assets.................. 31,964 224,126
Accrued interest payable...... 17,546 8,556
Other liabilities............. 35,838 76,715
-------------- --------------
Total adjustments............... (132,640) 26,290
-------------- --------------
Net cash provided by operating
activities.................... 397,200 582,403
-------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of securities
available for sale............ (4,115,000) --
Purchases of securities to be
held to maturity.............. -- (3,131,678)
Proceeds from paydowns and
maturities of securities...... 8,865,379 5,681,892
Loans originated/proceeds
received, net................. (4,767,790) (4,136,542)
Capital expenditures, net....... -- (20,474)
-------------- --------------
Net cash used by investing
activities.................... (17,411) (1,606,802)
-------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in deposits.......... (2,420,877) (2,485,820)
Dividends paid.................. -- (210,000)
-------------- --------------
Net cash used by financing
activities.................... (2,420,877) (2,695,820)
-------------- --------------
NET DECREASE IN CASH AND CASH
EQUIVALENTS........................ (2,041,088) (3,720,219)
CASH AND CASH EQUIVALENTS AT
BEGINNING OF YEAR.................. 8,813,928 8,502,038
-------------- --------------
CASH AND CASH EQUIVALENTS AT END OF
YEAR............................... $ 6,772,840 $ 4,781,819
============== ==============
See accompanying notes.
F-34
<PAGE>
UNION STATE BANK
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1997 AND 1996
1997 1996
-------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings.................... $ 1,166,252 $ 1,008,532
-------------- --------------
Adjustments to reconcile net
earnings to net cash provided
by operating activities:
Reduction of allowance for
possible credit losses..... (75,000) (55,000)
Provision for depreciation and
amortization............... 43,349 56,889
Deferred federal income
taxes...................... -- 67,025
Change in operating assets and
liabilities:
Accrued interest receivable... (15,078) 112,773
Other assets.................. 220,205 394,445
Accrued interest payable...... 19,773 (29,250)
Other liabilities............. 21,210 (32,143)
-------------- --------------
Total adjustments............... 214,459 514,739
-------------- --------------
Net cash provided by operating
activities.................... 1,380,711 1,523,271
-------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of securities
available for sale............ (5,997,276) (5,024,297)
Purchases of securities to be
held to maturity.............. (5,329,972) (4,383,004)
Proceeds from maturities of
securities.................... 12,142,123 12,342,209
Loans originated/proceeds
received, net................. (942,593) 1,381,848
Capital expenditures, net....... (20,474) (68,107)
-------------- --------------
Net cash (used) provided by
investing activities.......... (148,192) 4,248,649
-------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in deposits.......... (500,629) (256,505)
Dividends paid.................. (420,000) (420,000)
-------------- --------------
Net cash used by financing
activities.................... (920,629) (676,505)
-------------- --------------
NET INCREASE IN CASH AND CASH
EQUIVALENTS........................ 311,890 5,095,415
CASH AND CASH EQUIVALENTS AT
BEGINNING OF YEAR.................. 8,502,038 3,406,623
-------------- --------------
CASH AND CASH EQUIVALENTS AT END OF
YEAR............................... $ 8,813,928 $ 8,502,038
============== ==============
See accompanying notes.
F-35
<PAGE>
UNION STATE BANK
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND 1996
NOTE A SUMMARY OF SIGNIFICANT ACCOUNTING AND REPORTING POLICIES
The accounting and reporting policies of Union State Bank are in accordance
with generally accepted accounting principles and the prevailing practices
within the banking industry. A summary of significant accounting policies is as
follows:
ESTIMATES -- The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change
relate to the determination of the allowance for possible credit losses on
loans, the valuation of real estate acquired in connection with foreclosures or
in satisfaction of loans and in the determination of investment security
estimated market values. In connection with the determination of the allowances
for possible losses on loans and foreclosed real estate, management obtains
independent appraisals for significant properties. The estimated market value of
investment securities is determined by a third party investment company.
While management uses available information to recognize losses on loans
and foreclosed real estate, further reductions in the carrying amounts of loans
and foreclosed assets may be necessary based on changes in local economic
conditions. In addition, regulatory agencies, as an integral part of their
examination process, periodically review the estimated losses on loans and
foreclosed real estate. Such agencies may require the Bank to recognize
additional losses based on their judgments about information available to them
at the time of their examination. Because of these factors, it is reasonably
possible that the estimated losses on loans and foreclosed real estates may
change materially in the near term. However, the amount of the change that is
reasonably possible cannot be estimated.
INTERIM FINANCIAL INFORMATION -- Financial information as of and for the
six months ended June 30, 1998 and 1997 is unaudited. Such information includes
all adjustments (consisting of only normal recurring adjustments), that are
necessary in the opinion of management, for a fair statement of the financial
information in the interim periods. The results from operations for the periods
ended June 30, 1998 is not necessarily indicative of the results for the full
fiscal year.
TRADING SECURITIES -- Securities that are held for short-term resale are
classified as trading account securities and recorded at their fair values.
Realized and unrealized gains and losses on trading account securities are
included in other income. At December 31, 1997 and 1996, the Bank did not
classify any of its securities as trading securities.
SECURITIES HELD TO MATURITY -- Government, Federal agency, and corporate
debt securities that management has the positive intent and ability to hold to
maturity are reported at cost, adjusted for amortization of premiums and the
accretion of discounts that are recognized in interest income using methods
approximating the interest method over the period to maturity. Mortgage backed
securities represent participating interests in pools of long-term first
mortgage loans originated and serviced by issuers of the securities. Mortgage
backed securities are carried at unpaid principal balances, adjusted for
unamortized premiums and unearned discounts. Premiums and discounts are
amortized using methods approximating the interest method over the remaining
period to contractual maturity, adjusted for anticipated prepayments.
SECURITIES AVAILABLE FOR SALE -- Available for sale securities consist of
investment securities not classified as trading securities nor as held to
maturity securities and are measured and presented at fair market value.
Unrealized holding gains and losses, net of tax, on available for sale
securities are reported as
F-36
<PAGE>
UNION STATE BANK
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
a net amount in a separate component of shareholders' equity until realized.
Gains and losses on the sale of available for sale securities are determined
using the specific identification method. The amortization of premiums and the
accretion of discounts are recognized in interest income using methods
approximating the interest method over the period of maturity.
Declines in the fair value of individual held to maturity and available for
sale securities below their cost that are other than temporary result in
write-downs of the individual securities to their fair value. The related
write-downs are included in earnings as realized losses.
CONCENTRATIONS OF CREDIT -- Substantially all of the Bank's loans,
commitments and letters of credit have been granted to customers in the Bank's
market area. Generally, such customers are depositors of the Bank. The
concentrations of credit by type of loan are set forth in Note C. It is the
Bank's policy to not extend credit to any single borrower or group of related
borrowers in excess of the Bank's legal lending limit.
INTEREST RATE RISK -- The Bank is principally engaged in providing
short-term commercial loans with interest rates that fluctuate with various
market indices and intermediate-term, fixed rate real estate loans. These loans
are primarily funded through short-term demand deposits and longer-term
certificates of deposit with fixed rates.
LOANS -- Loans are stated at the principal amount outstanding, net of
unearned discount. Unearned discount relates principally to consumer installment
loans. The related interest income for multi-payment loans is recognized as
interest in proportion to the declining outstanding balances of the loans; for
single payment loans such income is recognized under the straight-line method.
Both methods approximate the interest method.
NON-PERFORMING LOANS AND PAST DUE LOANS -- Included in the non-performing
loan category are loans which have been categorized by management as nonaccrual
because collection of interest is doubtful and loans which have been
restructured to provide a reduction in the interest rate or a deferral of
interest or principal payments.
When the payment of principal or interest on a loan is delinquent for 90
days, or earlier in some cases, the loan is placed on nonaccrual status, unless
the loan is in the process of collection and the underlying collateral fully
supports the carrying value of the loan. If the decision is made to continue
accruing interest on the loan, periodic reviews are made to confirm the accruing
status of the loan.
When a loan is placed on nonaccrual status or identified as impaired,
interest accrued and uncollected during the current year prior to the judgment
of uncollectibility, is charged to operations. Interest accrued during prior
periods is charged to allowance for possible credit losses. Generally, any
payments received on nonaccrual loans are applied first to outstanding loan
amounts and next to the recovery of charged-off loan amounts. Any excess is
treated as recovery of lost interest.
Renegotiated loans are those loans on which concessions in terms have been
granted because of a borrower's financial difficulty. Interest is generally
accrued on such loans in accordance with the new terms.
ALLOWANCE FOR POSSIBLE CREDIT LOSSES -- The allowance for possible credit
losses is a valuation allowance available for losses incurred on loans and other
commitments to extend credit. All losses are charged to the allowance for
possible credit losses when the loss actually occurs or when a determination is
made that a loss is likely to occur. Recoveries are credited to the allowance at
the time of recovery.
Throughout the year, management estimates the likely level of losses to
determine whether the allowance for possible credit losses is adequate to absorb
anticipated losses in the existing portfolio. Based on these estimates, an
amount is charged to the provision for possible credit losses and credited to
the
F-37
<PAGE>
UNION STATE BANK
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
allowance for possible credit losses in order to adjust the allowance to a level
determined to be adequate to absorb losses.
Management's judgment as to the level of losses on existing loans involves
the consideration of current and anticipated economic conditions and their
potential effects on specific borrowers; an evaluation of the existing
relationships among loans, potential loan losses, and the present level of the
allowance; results of examinations of the loan portfolio by regulatory agencies;
results of examinations of the loan portfolio by an external consultant; and
management's internal review of the loan portfolio. In determining the
collectibility of certain loans, management also considers the fair value of any
underlying collateral. The amounts ultimately realized may differ from the
carrying value of these assets because of economic, operating or other
conditions beyond the Bank's control.
It should be understood that estimates of credit losses involve judgment.
While it is possible that in particular periods the Bank may sustain losses
which are substantial relative to the allowance for credit losses, it is the
judgment of management that the allowances for credit losses reflected in the
statements of condition are adequate to absorb losses which may exist in the
current loan portfolio.
BANK PREMISES AND EQUIPMENT -- Bank Premises and equipment are carried at
cost less accumulated depreciation and amortization. Depreciation expense is
computed principally on a tax method which approximates the straight-line method
over the estimated useful lives of the assets.
REAL ESTATE ACQUIRED BY FORECLOSURE -- Real estate acquired by foreclosure
is recorded at the fair value of the property less any selling costs, as
applicable, at the time of foreclosure. Subsequent to foreclosure, real estate
is carried at the lower of its new cost basis or fair value, less estimated
costs to sell. Any adjustments to reflect declines in value below the recorded
amounts are recognized and are charged to income in the period such
determination is assessed. Required developmental costs associated with
foreclosed property under construction are capitalized and considered in
determining the fair value of the property.
Operating expenses of such properties, net of related income, and gains and
losses on their disposition are included in other non-interest expense.
INCOME TAXES -- Under SFAS No. 109, the Bank uses the balance sheet
approach for recording deferred taxes. The balance sheet approach accounts for
deferred income taxes by applying statutory tax rates in effect at the balance
sheet date to differences between the book basis and the tax basis of assets and
liabilities. The resulting deferred tax assets and liabilities are adjusted to
reflect changes in tax law or rates.
STATEMENTS OF CASH FLOWS -- For purposes of reporting cash flows, cash and
cash equivalents include cash and due from banks and federal funds sold.
Generally, federal funds are sold for one-day periods.
F-38
<PAGE>
UNION STATE BANK
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NOTE B INVESTMENT SECURITIES
Investment securities have been classified according to management's
intent. The amortized cost and estimated market values of investments in debt
securities at December 31, 1997 and 1996 are summarized as follows:
<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
-------------- ---------- ---------- --------------
<S> <C> <C> <C> <C>
1997
Securities Available For Sale:
U.S. Gov't & Agency Securities..... $ 9,323,464 $ 9,409 $ (12,512) $ 9,320,361
Collateralized Mortgage
Obligations...................... 3,161,837 -- (150,038) 3,011,799
Mortgage-backed Securities......... 6,928,785 32,864 (97,846) 6,863,803
-------------- ---------- ---------- --------------
$ 19,414,086 $ 42,273 $ (260,396) $ 19,195,963
============== ========== ========== ==============
Securities to be Held to Maturity:
U.S. Gov't & Agency Securities..... $ 13,795,511 $ 47,936 $ (28,149) $ 13,815,298
Municipal -- Nontaxable............ 7,017,330 139,447 (1,069) 7,155,708
Municipal -- Taxable............... 300,000 -- (1,627) 298,373
Mortgage-backed Securities......... 8,508,143 68,157 (55,761) 8,520,539
-------------- ---------- ---------- --------------
$ 29,620,984 $ 255,540 $ (86,606) $ 29,789,918
============== ========== ========== ==============
1996
Securities Available For Sale:
U.S. Gov't Agency Securities....... $ 6,822,059 $ 14,780 $ (12,250) $ 6,824,589
Collateralized Mortgage
Obligations...................... 3,596,195 -- (189,508) 3,406,687
Mortgage-backed Securities......... 8,249,861 27,747 (135,229) 8,142,379
-------------- ---------- ---------- --------------
$ 18,668,115 $ 42,527 $ (336,987) $ 18,373,655
============== ========== ========== ==============
Securities to be Held to Maturity:
U.S. Gov't & Agency Securities..... $ 16,147,535 $ 74,505 $ (70,749) $ 16,151,291
Municipal -- Nontaxable............ 7,201,160 101,610 (26,054) 7,276,716
Mortgage-backed Securities......... 7,833,134 80,173 (115,698) 7,797,609
-------------- ---------- ---------- --------------
$ 31,181,829 $ 256,288 $ (212,501) $ 31,225,616
============== ========== ========== ==============
</TABLE>
F-39
<PAGE>
UNION STATE BANK
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The amortized cost and estimated market value of debt securities at
December 31, 1997, by contractual maturities, are shown below. Expected
maturities will differ from contractual maturities because borrowers may have
the right to call or prepay obligations with or without call or prepayment
penalties.
<TABLE>
<CAPTION>
SECURITIES HELD TO SECURITIES AVAILABLE FOR
MATURITY SALE
-------------------------- --------------------------
AMORTIZED MARKET AMORTIZED MARKET
COST VALUE COST VALUE
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Due in 1 year or less................ $ 6,551,243 $ 6,540,982 $ 4,980,875 $ 4,975,879
Due from 1 year to 5 years........... 10,405,983 10,507,451 4,343,589 4,344,482
Due from 5 years to 10 years......... 4,155,615 4,220,946 -- --
Due after 10 years................... -- -- -- --
Collateralized Mortgage
Obligations........................ -- -- 3,161,837 3,011,799
Mortgage-Backed Securities........... 8,508,143 8,520,539 6,928,785 6,863,803
----------- ----------- ----------- -----------
$29,620,984 $29,789,918 $19,414,086 $19,195,963
=========== =========== =========== ===========
</TABLE>
Investment securities with a carrying amount of $5,459,692 and $8,576,876
at December 31, 1997 and 1996, respectively, were pledged to secure public
deposits and other borrowings.
There were no significant realized gains or losses in 1997 or 1996.
NOTE C LOANS
The loan portfolio consists of various types of loans made principally to
borrowers located in Wharton and Ft. Bend Counties, Texas, and are classified by
major type as follows:
1997 1996
-------------- --------------
Commercial........................... $ 2,335,648 $ 3,408,195
Real Estate.......................... 6,005,292 5,398,113
Consumer............................. 2,229,856 2,355,088
Farming.............................. 9,849,895 8,296,194
Other................................ 17,653 15,786
-------------- --------------
20,438,344 19,473,376
Less unearned discount............... -- (20)
-------------- --------------
$ 20,438,344 $ 19,473,356
============== ==============
Loan maturities of the loan portfolio at December 31, 1997 are as follows:
<TABLE>
<CAPTION>
WITHIN 1 YEAR 1 - 5 YEARS AFTER 5 YEARS TOTAL
------------- ----------- ------------- --------------
<S> <C> <C> <C> <C>
Loans at fixed interest rates........... $ 3,267,161 $ 5,396,306 $ 2,167,650 $ 10,831,117
Loans at variable interest rates........ 9,607,227 -- -- 9,607,227
------------- ----------- ------------- --------------
$ 12,874,388 $ 5,396,306 $ 2,167,650 $ 20,438,344
============= =========== ============= ==============
</TABLE>
F-40
<PAGE>
UNION STATE BANK
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
In the ordinary course of business, the Bank has and expects to continue to
have transactions, including borrowings, with its officers, directors, principal
stockholders, and their affiliates. In the opinion of management, such
transactions were on substantially the same terms, including interest rates and
collateral, as those prevailing at the time of comparable transactions with
other persons and did not involve more than a normal risk of collectibility or
present any other unfavorable features to the Bank. Loans to such borrowers are
summarized as follows:
1997 1996
------------ -------------
Balance, January 1...................... $ 551,554 $ 872,768
New loans during the year............... 482,225 991,170
Repayments during the year.............. (144,441) (1,312,384)
Other reductions........................ (203,818) --
------------ -------------
Balance, December 31.................... $ 685,520 $ 551,554
============ =============
NOTE D NONPERFORMING LOANS AND PAST DUE LOANS
The following table presents information relating to non-performing loans
and past due loans:
1997 1996
--------- ---------
Nonaccrual loans........................ $ 17,902 $ 36,507
========= =========
90 days or more past due loans.......... $ 3,556 $ 12,630
========= =========
With respect to the above nonperforming loans, the following table presents
interest income that would have been earned under the original terms of the
loans.
1997 1996
--------- ---------
Foregone income......................... $ 6,534 $ 7,567
========= =========
NOTE E ALLOWANCE FOR POSSIBLE CREDIT LOSSES
An analysis of activity in the allowance for possible credit losses is as
follows:
1997 1996
---------- ----------
Balance at beginning of year............ $ 702,274 $ 737,099
Reduction of allowance for possible
credit losses......................... (75,000) (55,000)
Loan recoveries......................... 24,455 20,175
Loans charged off....................... (2,060) --
---------- ----------
Balance at end of year.................. $ 649,669 $ 702,274
========== ==========
Impaired loans as defined by FASB Statement No. 114, "Accounting by
Creditors for Impairment of a Loan" are not significant at December 31, 1997
and 1996.
F-41
<PAGE>
UNION STATE BANK
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NOTE F BANK PREMISES AND EQUIPMENT
Bank premises and equipment are summarized below:
1997 1996
------------ ------------
Land.................................... $ 10,675 $ 10,675
Buildings............................... 566,071 566,071
Furniture, fixtures and equipment....... 415,073 407,250
------------ ------------
991,819 983,996
Less accumulated depreciation........... (805,088) (774,390)
------------ ------------
$ 186,731 $ 209,606
============ ============
NOTE G ACCRUED INTEREST RECEIVABLE
Accrued interest receivable at December 31, 1997 and 1996 consists of the
following:
1997 1996
---------- ----------
Loans................................... $ 312,922 $ 256,210
Mortgage-backed securities.............. 95,867 103,772
Investments and other................... 386,213 419,942
---------- ----------
$ 795,002 $ 779,924
========== ==========
NOTE H OTHER ASSETS
Other assets are summarized below:
1997 1996
------------ ------------
Other real estate.................... $ -- $ 84,530
Contracts for deed................... 35,525 57,478
Notes receivable..................... 105,929 220,881
Purchased interest and other......... 73,895 72,665
------------ ------------
$ 215,349 $ 435,554
============ ============
An analysis of activity in real estate acquired by foreclosure for the year
ended December 31, 1997 and 1996 is as follows:
1997 1996
------------ ------------
Balance, beginning of year........... $ 84,530 525,313
Real estate foreclosures............. 45,735 25,276
Real estate sales and payments....... (130,265) (375,004)
------------ ------------
Balance, end of year................. -- 175,585
Allowance for loss on real estate.... -- (91,055)
------------ ------------
Real estate acquired by foreclosure,
net................................ $ -- $ 84,530
============ ============
F-42
<PAGE>
UNION STATE BANK
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NOTE I DEPOSITS
Included in interest-bearing deposits are certificates of deposit in
amounts of $100,000 or more. These certificates and their remaining maturities
at December 31, 1997 and 1996 are as follows:
1997 1996
------------ ------------
Three months or less................. $ 3,233,424 $ 3,830,295
Four through twelve months........... 5,604,437 4,663,921
Thereafter........................... 955,409 915,750
------------ ------------
$ 9,793,270 $ 9,409,966
============ ============
Interest expense for certificates of deposit in excess of $100,000 amounted
to approximately $476,281 and $477,270 for the years ended December 31, 1997 and
1996, respectively. The bank has no brokered deposits and there are no major
concentrations of deposits.
NOTE J FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Bank is party to various financial instruments with off-balance sheet
risk in the normal course of business to meet the financing needs of its
customers. These financial instruments include commitments to extend credit and
standby letters of credit. Those instruments involve, to varying degrees,
elements of credit and interest rate risk in excess of the amounts recognized in
the statements of condition. The contract or notional amounts of those
instruments reflect the extent of the involvement the Bank has in particular
classes of financial instruments. The Bank's exposure to credit loss in the
event of nonperformance by the other party to the financial instrument for
commitments to extend credit and standby letters of credit is represented by the
contractual amount of those instruments. The Bank uses the same credit policies
in making these commitments and conditional obligations as it does for
on-balance-sheet instruments.
The following is a summary of the various financial instruments whose
contract amounts represent credit risk:
1997 1996
------------ ------------
Commitments to extend credit............ $ 7,792,741 $ 6,416,767
Standby letters of credit............... $ 16,800 $ 67,700
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since many of the commitments are expected to
expire without being fully drawn upon, the total commitment amounts disclosed
above do not necessarily represent future cash requirements.
The Bank evaluates each customer's credit worthiness on a case-by-case
basis. The amount of collateral obtained, if considered necessary by the Bank
upon extension of credit, is based on management's credit evaluation of the
customer.
Standby letters of credit are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party. The credit risk
involved in issuing letters of credit is essentially the same as that involved
in extending loan facilities to its customers.
NOTE K EMPLOYEE BENEFITS
The Bank has a defined contribution savings plan in effect for
substantially all full-time employees. An employee must contribute at least four
percent of base pay to participate, which is then matched by the Bank. The Board
of Directors may also make discretionary contributions each year. Benefit
expenses amounted to $27,413 and $28,519 in 1997 and 1996, respectively.
F-43
<PAGE>
UNION STATE BANK
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NOTE L INCOME TAXES
Income tax expense consists of the following:
1997 1996
---------- ----------
Current................................. $ 422,000 $ 339,649
Deferred................................ -- 67,025
---------- ----------
$ 422,000 $ 406,674
========== ==========
The provision for federal income taxes differs from the amount computed by
applying the federal income tax statutory rate on earnings as follows:
1997 1996
------------ ----------
Taxes calculated at statutory rate...... $ 540,006 $ 481,170
Increase (decrease) resulting from:
Nontaxable interest income......... (103,249) (94,785)
Other, net......................... (14,757) 20,289
------------ ----------
$ 422,000 $ 406,674
============ ==========
Deferred income taxes result primarily from temporary differences relating
to the loan loss reserve and the recognition of unrealized investment losses on
securities available for sale.
NOTE M STATEMENTS OF CASH FLOWS
Interest payments of $2,484,413 and $2,531,832 were made during 1997 and
1996, respectively. Federal income tax payments of $406,708 and $358,769 were
made during 1997 and 1996, respectively.
NOTE N REGULATORY MATTERS
The Bank is subject to various regulatory capital requirements. Failure to
meet the minimum regulatory capital requirements can initiate certain mandatory,
and possible additional discretionary actions by regulators, that if undertaken,
could have a direct material affect on the Bank's financial statements. Under
the regulatory capital adequacy guidelines and the regulatory framework for
prompt corrective action, the Bank must meet specific capital guidelines
involving quantitative measures of the Bank's assets, liabilities, and certain
off-balance sheet items as calculated under regulatory accounting practices. The
Bank's capital amounts and classification under the prompt corrective action
guidelines are also subject to qualitative judgments by the regulators about
components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios of total risk-based
capital and Tier I capital to risk-weighted assets (as defined in the
regulations), and Tier I capital to adjusted total assets (as defined).
Management believes, as of December 31, 1997 and 1996, that the Bank meets all
the capital adequacy requirements to which it is subject.
F-44
<PAGE>
UNION STATE BANK
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
As of December 31, 1997, the Bank was categorized as well capitalized under
the regulatory framework for prompt corrective action. To remain categorized as
well capitalized, the Bank will have to maintain minimum total risk-based, Tier
I risk-based, and Tier I leverage ratios as disclosed in the table below. There
are no conditions or events since the most recent notification that management
believes have changed the Bank's prompt corrective action category.
<TABLE>
<CAPTION>
TO BE WELL
CAPITALIZED
UNDER PROMPT
FOR CAPITAL CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
-------------------- ------------------- -------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------------ ----- ----------- ----- ----------- -----
<S> <C> <C> <C> <C> <C> <C>
1997
Total Risk Based Capital
(to Risk Weighted Assets)............. $ 12,771,000 43.3 % $ 2,361,680 8.0% $ 2,952,100 10.0%
Tier I Capital
(to Risk Weighted Assets)............. $ 12,399,000 42.0 % $ 1,180,840 4.0% $ 1,771,260 6.0%
Tier I Capital
(to Adjusted Total Assets)............ $ 12,399,000 15.6 % $ 3,182,560 4.0% $ 3,978,200 5.0%
1996
Total Risk Based Capital
(to Risk Weighted Assets)............. $ 12,009,000 42.5 % $ 2,262,560 8.0% 2,828,200 10.0%
Tier I Capital
(to Risk Weighted Assets)............. $ 11,652,000 41.2 % $ 1,131,280 4.0% $ 1,696,920 6.0%
Tier I Capital
(to Adjusted Total Assets)............ $ 11,652,000 15.1 % $ 3,091,520 4.0% $ 3,864,400 5.0%
</TABLE>
F-45
<PAGE>
NO DEALER, SALESPERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS IN
CONNECTION WITH THE OFFER CONTAINED HEREIN, AND, IF GIVEN OR MADE, SUCH
INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE COMPANY OR THE UNDERWRITER. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER
TO SELL OR A SOLICITATION OF AN OFFER TO BUY THE SHARES OF COMMON STOCK OFFERED
HEREBY BY ANYONE IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION IS NOT
AUTHORIZED, OR IN WHICH THE PERSON MAKING SUCH OFFER OR SOLICITATION IS NOT
QUALIFIED TO DO SO, OR TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH
SOLICITATION OR OFFER. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE
HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE AN IMPLICATION THAT THERE HAS
BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR THAT THE
INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO ITS DATE.
------------------------------
TABLE OF CONTENTS
PAGE
----
Prospectus Summary................... 3
Summary Consolidated Financial
Data............................... 6
Recent Developments.................. 8
Risk Factors......................... 9
The Company.......................... 15
Use of Proceeds...................... 19
Dividend Policy...................... 19
Dilution............................. 20
Recent Acquisition................... 20
Unaudited Pro Forma Combined
Condensed Financial Statements..... 21
Capitalization....................... 24
Nature of the Trading Market......... 24
Selected Consolidated Financial
Data............................... 25
Management's Discussion and Analysis
of Financial Condition and Results
of Operations...................... 27
Management........................... 56
Principal and Selling Shareholders... 61
Supervision and Regulation........... 62
Description of Securities of the
Company............................ 69
Underwriting......................... 73
Legal Matters........................ 74
Experts.............................. 74
Available Information................ 75
Table of Contents to Financial
Statements......................... F-1
------------------------------
UNTIL DECEMBER 6, 1998, (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL
DEALERS EFFECTING TRANSACTIONS IN THE REGISTERED SECURITIES WHETHER OR NOT
PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS.
THIS DELIVERY REQUIREMENT IS IN ADDITION TO THE OBLIGATIONS OF DEALERS TO
DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR
UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
1,716,783 SHARES
[LOGO]
PROSPERITY BANCSHARES, INC.
COMMON STOCK
------------------------------
PROSPECTUS
------------------------------
KEEFE, BRUYETTE & WOODS, INC.
HOEFER & ARNETT
INCORPORATED
NOVEMBER 11, 1998
