PROSPERITY BANCSHARES INC, 424B1, 1999-11-12

PROSPERITY BANCSHARES INC
424B1, 1999-11-12
STATE COMMERCIAL BANKS

Previous: SECURITY CAPITAL GLOBAL CAPITAL MANAGEMENT GROUP INC, 13F-HR/A, 1999-11-12

Next: QUAKER PARTNERS LLC, 13F-HR, 1999-11-12

<PAGE> 1

Filed Pursuant to Rule 424(b)(1)
Registration Nos. 333-89481
333-89481-01

1,200,000 TRUST PREFERRED SECURITIES

PROSPERITY CAPITAL TRUST I

9.60% CUMULATIVE TRUST PREFERRED SECURITIES
(LIQUIDATION AMOUNT $10 PER TRUST PREFERRED SECURITY)
FULLY, IRREVOCABLY AND UNCONDITIONALLY GUARANTEED BY

[PROSPERITY BANCSHARES, INC. LOGO]

The trust preferred securities represent undivided beneficial interests in
the assets of Prosperity Capital Trust I. The trust will invest the proceeds of
this offering of trust preferred securities in the 9.60% junior subordinated
debentures of Prosperity Bancshares, Inc.

For each of the trust preferred securities that you own, you are entitled
to receive cumulative cash distributions at an annual rate of 9.60% on March 31,
June 30, September 30 and December 31 of each year, beginning March 31, 2000,
from payments on the debentures. Payment of distributions may be deferred at any
time for up to 20 consecutive quarters. The trust preferred securities are
effectively subordinated to all senior and subordinated indebtedness of
Prosperity Bancshares, Inc. and its subsidiaries. The debentures mature and the
trust preferred securities must be redeemed on November 17, 2029. The trust may
redeem the trust preferred securities, at a redemption price of $10 per trust
preferred security plus accumulated and unpaid distributions, at any time on or
after November 17, 2004, or earlier under certain circumstances.

The trust preferred securities have been approved for listing on the Nasdaq
National Market under the trading symbol "PRSPP."

WE URGE YOU TO CAREFULLY READ THE "RISK FACTORS" SECTION BEGINNING ON PAGE
8, WHERE WE DESCRIBE SPECIFIC RISKS RELATED TO AN INVESTMENT IN THE TRUST
PREFERRED SECURITIES AND RISKS RELATING TO PROSPERITY BANCSHARES, INC., ALONG
WITH THE REMAINDER OF THIS PROSPECTUS, BEFORE YOU MAKE YOUR INVESTMENT DECISION.

THESE SECURITIES ARE NOT SAVINGS ACCOUNTS, DEPOSITS OR OBLIGATIONS OF ANY
BANK AND ARE NOT INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION OR ANY
OTHER GOVERNMENTAL AGENCY.

<TABLE>
<CAPTION>
PER TRUST
PREFERRED
SECURITY TOTAL
--------- -----------
<S> <C> <C>
Public offering price....................................... $10.00 $12,000,000
Underwriting fees to be paid by Prosperity Bancshares,
Inc....................................................... $0.375 $ 450,000
Proceeds to the trust....................................... $10.00 $12,000,000
</TABLE>

The underwriters have entered into a firm commitment underwriting agreement
with Prosperity Bancshares, Inc. and Prosperity Capital Trust I, which means
that all of the trust preferred securities will be purchased by the
underwriters, if any are.

NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE
ADEQUACY OR ACCURACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.

HOWE BARNES INVESTMENTS, INC.
November 12, 1999
<PAGE> 2

[Insert Map of banking center locations]
<PAGE> 3

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Summary................................... 1
Summary Consolidated Financial Data....... 6
Risk Factors.............................. 8
Forward-Looking Information............... 15
Use of Proceeds........................... 16
Accounting Treatment...................... 16
Capitalization............................ 17
Pro Forma Combined Financial Statements... 18
Selected Consolidated Financial Data...... 22
Management's Discussion and Analysis of
Financial Condition and Results of
Operations.............................. 24
Business.................................. 53
Management................................ 58
Interests of Management and Others in
Certain Transactions.................... 62
Beneficial Ownership of Common Stock by
Management and Principal Shareholders... 63
</TABLE>

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Supervision and Regulation................ 64
Description of the Trust.................. 71
Description of the Trust Preferred
Securities.............................. 72
Description of the Debentures............. 83
Book-Entry Issuance....................... 91
Description of the Guarantee.............. 93
Relationship Among the Trust Preferred
Securities, the Debentures and the
Guarantee............................... 95
Federal Income Tax Consequences........... 97
ERISA Considerations...................... 100
Underwriting.............................. 101
Legal Matters............................. 102
Experts................................... 102
Where You Can Find Information............ 103
Index to Financial Statements............. F-1
</TABLE>

You should rely on the information contained in this prospectus. We have
not, and our underwriters have not, authorized any person to provide you with
different information. If anyone provides you with different or inconsistent
information, you should not rely on it. We are not, and our underwriters are
not, making an offer to sell these securities in any jurisdictions where the
offer or sale is not permitted.

You should assume that the information appearing in this prospectus is
accurate as of the date on the front cover of this prospectus only.

i
<PAGE> 4

SUMMARY

The items in the following summary are described in more detail later in
this prospectus. Therefore, you should also read the more detailed information
set forth in this prospectus and in our financial statements. Unless otherwise
indicated, all share and per share information has been adjusted to give effect
to a four-for-one common stock split effective as of September 10, 1998.

PROSPERITY BANCSHARES, INC.

We are a bank holding company headquartered in Houston, Texas. We conduct
business through our subsidiary First Prosperity Bank. As a result of our
October 1, 1999 acquisition of South Texas Bancshares, Inc., we have 15
full-service banking centers located throughout the greater Houston metropolitan
area and nine contiguous counties situated south and southwest of Houston.

On November 12, 1998, we became a publicly traded company when we issued
1,182,517 shares of our common stock in an initial public offering in which we
raised $12.8 million. Our common stock is listed on the Nasdaq National Market
under the symbol "PRSP."

We operate under a community banking philosophy. We seek to develop broad
customer relationships based on service and convenience while maintaining our
conservative approach to lending and strong asset quality. We offer our
customers, primarily consumers and small and medium-sized businesses, a variety
of traditional loan and deposit products, which we tailor to the specific needs
of customers in a given market. As a result of our most recent acquisition, we
can now provide trust services to our customers, and we intend to offer these
services in the future at all of our banking centers.

We began operations in 1983 as a vehicle to acquire the former Allied Bank
in Edna, which was chartered in 1949, and have grown through a combination of
internal growth, the acquisition of existing community banks and branches and
the opening of new banking centers. As a result of these additions and internal
growth, our assets have increased from $79.4 million at the end of 1989 to
$442.8 million at June 30, 1999 and our deposits have increased from $70.3
million to $398.4 million in that same period.

Along with steady asset growth, our financial performance has been
characterized by consistent core earnings and strong asset quality. Our low cost
of funds and stringent cost controls have enabled our net income to grow at a
compounded annual rate of 45.1% since 1989. At the same time, we have maintained
high asset quality as characterized by our 0.07% ratio of nonperforming assets
to total loans and other real estate owned at June 30, 1999.

Our primary market area consists of the communities served by our three
locations in the greater Houston metropolitan area and 12 locations in nine
contiguous counties extending to the south and southwest of Houston. Texas
Highway 59 (scheduled to become Interstate Highway 69), which serves as the
primary "NAFTA Highway" linking the interior United States and Mexico, runs
directly through the center of our market area. The increased traffic along this
NAFTA Highway has enhanced economic activity in our market area and created
opportunities for growth. The diverse nature of the local economies provides us
with a varied customer base and allows us to spread our lending risks throughout
a number of different industries.

Management believes that, as one of the few publicly traded mid-sized
financial institutions that combines responsive community banking with the
variety of products and services of a regional bank holding company, we have a
competitive advantage in our market area and excellent growth opportunities
through acquisitions, new branch locations and additional business development.

Our executive offices are located at 3040 Post Oak Boulevard, Houston,
Texas 77056 and our telephone number is (713) 993-0002.

1
<PAGE> 5

BUSINESS STRATEGY

Our business strategy primarily focuses on the following:

- Continue community banking emphasis

- Expand market share through internal growth and a disciplined acquisition
strategy

- Increase loan volume and diversify loan portfolio

- Enhance cross-selling through the use of incentives and technology

- Continue strict focus on efficiency

- Maintain strong asset quality

RECENT DEVELOPMENTS

On October 1, 1999, we acquired all of the outstanding shares of South
Texas Bancshares. In connection with the acquisition, The Commercial National
Bank of Beeville, a wholly-owned subsidiary of South Texas Bancshares, was
merged into the bank. This acquisition provides us with a presence in South
Texas through the addition of banking centers in the towns of Beeville, Mathis
and Goliad. We believe that this acquisition will not only expand our market
presence and market share in South Texas, but also enable us to achieve certain
cost efficiencies and savings and provide trust services to our customers. At
June 30, 1999, South Texas Bancshares had total assets of $135.8 million, total
deposits of $119.0 million and total loans (net of unearned discount and
allowance for loan losses) of $34.5 million.

Total loans at September 30, 1999 were $197.5 million compared with total
loans of $147.7 million at September 30, 1998, an increase of $49.8 million or
33.7%. Total assets were $444.4 million at September 30, 1999 compared with
$336.4 million at September 30, 1998, an increase of $107.9 million or 32.1%.
The allowance for credit losses at September 30, 1999 was $2.1 million or 1.05%
of total loans compared with $1.2 million or 0.79% of total loans at September
30, 1998. The $900,000 increase was primarily due to a $660,000 allowance for
credit losses acquired in connection with our acquisition of Union State Bank in
East Bernard, Texas in October of 1998 and our monthly provision for credit
losses, made in accordance with our methodology of evaluating estimated losses
in the loan portfolio. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Financial Condition -- Allowance for
Credit Losses." Shareholders' equity increased from $27.8 million at September
30, 1998 to $42.9 million at September 30, 1999, an increase of $15.1 million or
54.4%, primarily due to the $12.8 million raised in our initial public offering.
We had no nonperforming loans at September 30, 1999 or 1998.

Net income for the three months ended September 30, 1999 was $1.6 million
compared with $1.1 million for the three months ended September 30, 1998, an
increase of $505,000 or 46.8%. Diluted earnings per share increased $0.03 or
11.5% to $0.29 for the three months ended September 30, 1999 compared with $0.26
for the three months ended September 30, 1998. Return on average assets for the
three months ended September 30, 1999 was 1.42% compared with 1.28% for the
three months ended September 30, 1998, while return on average equity was 14.79%
for the three months ended September 30, 1999 compared with 15.77% for the same
period in 1998.

Net income for the nine months ended September 30, 1999 was $4.5 million
compared with $3.1 million for the first nine months of 1998, an increase of
$1.4 million or 44.1%. Diluted earnings per share increased $0.07 or 9.1% to
$0.84 for the nine months ended September 30, 1999 compared with $0.77 for the
same period in 1998. The increase in net income for both the three month and
nine month periods ended September 30, 1999 was primarily the result of an
increase in net interest income resulting from growth in loans. Return on
average assets for the nine months ended September 30, 1999 and 1998 was 1.34%
and 1.26%, respectively, while the return on average equity for the same periods
was 14.30% and 15.87%, respectively. The decrease in return on average equity
was expected and is due to the

2
<PAGE> 6

$12.8 million increase in equity in the fourth quarter of 1998 resulting from
the proceeds of our initial public offering.

PROSPERITY CAPITAL TRUST I

The trust, which is the issuer of the trust preferred securities, is a
Delaware business trust. Upon issuance of the trust preferred securities offered
by this prospectus, the purchasers in this offering will own all of the issued
and outstanding trust preferred securities of the trust. In exchange for our
capital contribution to the trust, we will own all of the common securities of
the trust. The trust exists for the sole purposes of:

- issuing the trust preferred securities to the public for cash;

- issuing the common securities to us;

- investing the proceeds from the sale of the trust preferred and common
securities in an equivalent amount of 9.60% junior subordinated
debentures due November 17, 2029 issued by us; and

- engaging in other activities that are incidental to those listed above.

The trust's address is 3040 Post Oak Boulevard, Houston, Texas 77056 and
its telephone number is (713) 993-0002.

THE OFFERING

Trust preferred securities
issuer..................... Prosperity Capital Trust I

Securities that are being
offered.................... The trust is offering 1,200,000 trust preferred
securities, which represent undivided beneficial
interests in the assets of the trust. Those assets
will consist solely of the debentures and interest
paid on the debentures.

The trust will sell the trust preferred securities
to the public for cash. The trust will use that
cash to buy debentures from us.

Offering price............. $10 per trust preferred security.

Payment of distributions... If you purchase the trust preferred securities, you
are entitled to receive cumulative cash
distributions at a 9.60% annual rate. Distributions
will accumulate from the date the trust issues the
trust preferred securities and will be paid
quarterly on March 31, June 30, September 30 and
December 31 of each year beginning March 31, 2000.
The record date for distributions on the trust
preferred securities will be the business day prior
to the distribution date. Please note that the
trust may defer the payment of cash distributions,
as more fully described below.

We have the option to defer
the interest payments...... The trust will rely solely on payments made by us
on the debentures to pay distributions on the trust
preferred securities. So long as no event of
default under the indenture has occurred and is
continuing, we may, at one or more times, defer
interest payments on the debentures for up to 20
consecutive quarters, but not beyond November 17,
2029. If we defer interest payments on the
debentures:

- the trust will also defer distributions on the
trust preferred securities;

3
<PAGE> 7

- distributions you are entitled to will
accumulate; and

- these accumulated distributions will accumulate
additional distributions at an annual rate of
9.60% compounded quarterly.

At the end of any deferral period, we will pay to
the trust all accrued and unpaid amounts on the
debentures. The trust will then pay all accumulated
and unpaid distributions to you.

You will still be taxed if
distributions on the
trust preferred
securities are
deferred................. If a deferral of payment occurs, you will still be
required to recognize the deferred amounts as
income for United States federal income tax
purposes in advance of receiving these amounts for
as long as the debentures remain outstanding, even
if you are a cash basis taxpayer.

Maturity................... The debentures will mature and the trust preferred
securities must be redeemed on November 17, 2029.
We have the option, however, to shorten the
maturity date to a date not earlier than November
17, 2004. We will not shorten the maturity date
unless we have received the prior approval of the
Board of Governors of the Federal Reserve System,
if required.

Redemption of the trust
preferred securities is
possible................. The trust must redeem the trust preferred
securities when the debentures are paid at maturity
or upon any earlier redemption of the debentures.
We may redeem all or part of the debentures on or
after November 17, 2004. In addition, we may
redeem, at any time, all of the debentures if:

- the interest we pay on the debentures is no
longer deductible by us for federal tax purposes
or the trust becomes subject to federal income
tax;

- there is a change in the Investment Company Act
of 1940 that requires the trust to register under
that law; or

- there is a change in the capital adequacy
guidelines of the Federal Reserve that results in
the trust preferred securities not being counted
as Tier 1 capital.

Redemption of the debentures prior to maturity will
be subject to the prior approval of the Federal
Reserve, if required. If the trust preferred
securities are redeemed by the trust, you will
receive the liquidation amount of $10 per trust
preferred security plus any accumulated and unpaid
distributions to the date of redemption.

How the securities will
rank in right of payment... Our obligations under the trust preferred
securities, debentures and guarantee are unsecured
and will rank as follows with regard to right of
payment:

- the trust preferred securities will rank equally
with the common securities of the trust. The
trust will pay distributions on the trust
preferred securities and the common securities
pro rata. However, if we default with respect to
the debentures, then no distributions on

4
<PAGE> 8

the common securities will be paid until all
accumulated and unpaid distributions on the trust
preferred securities have been paid;

- our obligations under the debentures and the
guarantee will rank junior in priority to our
existing and future senior and other subordinated
indebtedness; and

- because we are a holding company, the debentures
and the guarantee will effectively be
subordinated to all existing and future
liabilities of our subsidiaries.

We may distribute the
debentures directly to
you...................... We may, at any time, dissolve the trust and
distribute the debentures to you in exchange for
your trust preferred securities, subject to the
prior approval of the Federal Reserve, if required.
If we distribute the debentures, we will use our
best efforts to list them on a national securities
exchange or comparable automated quotation system.

Our guarantee of payment... We guarantee that the trust will use its assets to
pay the distributions on the trust preferred
securities. However, the guarantee does not apply
when the trust does not have sufficient funds to
make the payments. In this event, your remedy is to
initiate a legal proceeding directly against us for
enforcement of payments under the debentures.

Voting rights of the trust
preferred securities..... Except in limited circumstances, holders of the
trust preferred securities will have no voting
rights.

Nasdaq National Market
symbol................... "PRSPP"

Book-entry................. The trust preferred securities will be represented
by a global security that will be deposited with
and registered in the name of The Depository Trust
Company, New York, New York or its nominee. This
means that you will not receive a certificate for
the trust preferred securities.

Use of proceeds............ We plan to use the net proceeds from the sale of
the trust preferred securities for general
corporate purposes, including investments in and
extensions of credit to the bank, possible new
branch openings and possible acquisitions of
financial institutions or branches of financial
institutions.

RISK FACTORS

Before purchasing the trust preferred securities offered by this
prospectus, you should carefully consider the "Risk Factors" beginning on page
8.

5
<PAGE> 9

SUMMARY CONSOLIDATED FINANCIAL DATA

We are providing the following financial information to aid you in your
financial analysis of us and our ability to pay the principal and interest on
the debentures. This information is only a summary and you should read it in
conjunction with our consolidated financial statements and notes thereto,
"Selected Consolidated Financial Data" and "Management's Discussion and Analysis
of Financial Condition and Results of Operations" included elsewhere in this
prospectus.

<TABLE>
<CAPTION>
AS OF AND FOR THE
SIX MONTHS ENDED
JUNE 30, AS OF AND FOR THE YEARS ENDED DECEMBER 31,
------------------- ----------------------------------------------------
1999 1998 1998 1997 1996 1995 1994
-------- -------- -------- -------- -------- -------- --------
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
Interest income........................... $ 14,553 $ 10,836 $ 23,422 $ 19,970 $ 16,841 $ 14,738 $ 12,644
Interest expense.......................... 6,130 4,716 10,128 9,060 7,923 6,904 5,363
-------- -------- -------- -------- -------- -------- --------
Net interest income..................... 8,423 6,120 13,294 10,910 8,918 7,834 7,281
Provision for credit losses............... 130 145 239 190 230 175 188
-------- -------- -------- -------- -------- -------- --------
Net interest income after provision for
credit losses......................... 8,293 5,975 13,055 10,720 8,688 7,659 7,093
Noninterest income........................ 1,446 1,273 2,492 2,264 1,897 1,489 1,500
Noninterest expense....................... 5,435 4,252 9,058 7,836 6,634 6,046 6,021
-------- -------- -------- -------- -------- -------- --------
Income before taxes..................... 4,304 2,996 6,489 5,148 3,951 3,102 2,572
Provision for income taxes................ 1,367 939 2,029 1,586 1,240 781 609
-------- -------- -------- -------- -------- -------- --------
Net income.............................. $ 2,937 $ 2,057 $ 4,460 $ 3,562 $ 2,711 $ 2,321 $ 1,963
======== ======== ======== ======== ======== ======== ========
COMMON SHARE DATA(1):
Basic earnings per share.................. $ 0.57 $ 0.52 $ 1.08 $ 0.94 $ 0.77 $ 0.66 $ 0.56
Diluted earnings per share................ 0.55 0.50 1.04 0.92 0.76 0.66 0.56
Book value per share...................... 8.13 6.64 8.01 6.22 5.36 4.68 3.81
Tangible book value per share(2).......... 6.33 5.22 6.14 4.81 4.21 3.95 3.02
Cash dividends declared per share......... 0.10 0.10 0.20 0.15 0.10 0.10 0.07
Dividend payout ratio..................... 17.67% 19.40% 23.70% 16.11% 12.95% 15.12% 13.42%
Weighted average shares outstanding
(basic) (in thousands).................. 5,177 3,990 4,116 3,778 3,513 3,514 3,514
Weighted average shares outstanding
(diluted) (in thousands)................ 5,377 4,080 4,309 3,864 3,560 3,523 3,514
Shares outstanding at end of period (in
thousands).............................. 5,195 3,990 5,173 3,990 3,510 3,514 3,514
BALANCE SHEET DATA (AT PERIOD END):
Total assets.............................. $442,774 $335,422 $436,312 $320,143 $293,988 $233,492 $224,022
Securities................................ 221,681 158,685 227,744 167,868 147,564 117,505 121,912
Loans..................................... 188,034 141,080 170,478 120,578 113,382 88,797 76,543
Allowance for credit losses............... 2,013 1,114 1,850 1,016 923 753 588
Total deposits............................ 398,379 307,815 390,659 291,516 270,866 214,534 207,543
Borrowings and notes payable.............. 570 -- 2,437 2,800 3,267 1,517 2,275
Total shareholders' equity................ 42,228 26,478 41,435 24,818 18,833 16,458 13,374
SELECTED FINANCIAL RATIOS AND OTHER DATA:
Performance Ratios and Other Data:
Return on average assets.................. 1.29% 1.25% 1.26% 1.17% 1.05% 1.03% 0.92%
Return on average equity.................. 13.94 15.99 15.97 16.32 15.36 15.56 14.97
Net interest margin(3).................... 4.09 4.14 4.13 4.02 3.91 3.96 3.91
Efficiency ratio(4)....................... 55.07 57.53 57.38 59.48 61.34 64.85 68.56
Number of banking centers................. 12 11 12 11 10 9 9
</TABLE>

(Table continued on next page)

6
<PAGE> 10

- ---------------------

(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) Calculated on a tax-equivalent basis using a 34% federal income tax rate.

(4) Calculated by dividing total noninterest expense, excluding securities
losses, by net interest income plus noninterest income.

(5) At period end, except for net loan charge-offs to average loans, which is
for periods ended at such dates.

(6) Nonperforming loans consist of nonaccrual loans, loans contractually past
due 90 days or more and restructured loans. We had no significant
nonperforming loans at any of the dates indicated.

(7) For purposes of calculating the ratio of earnings to fixed charges, earnings
consist of earnings before income taxes plus interest and one-third of
rental expense. Fixed charges, excluding interest on deposits, consist of
interest on indebtedness and one-third of rental expense (which is deemed
representative of the interest factor). Fixed charges, including interest on
deposits, consist of the foregoing items plus interest on deposits.

(8) At period end, except for average shareholders' equity to average total
assets, which is for periods ended at such dates.

7
<PAGE> 11

RISK FACTORS

An investment in the trust preferred securities involves a number of risks.
You should carefully read and consider the following factors in evaluating us,
our business and the trust, in addition to the other information in this
prospectus, before you purchase the trust preferred securities offered by this
prospectus.

Because the trust will rely on the payments it receives on the debentures
to fund all payments on the trust preferred securities, and because the trust
may distribute the debentures in exchange for the trust preferred securities,
you are making an investment decision that relates to the debentures as well as
the trust preferred securities. You should carefully review the information in
this prospectus about the trust preferred securities, the debentures and the
guarantee.

RISKS RELATED TO AN INVESTMENT IN THESE TRUST PREFERRED SECURITIES

IF WE DO NOT MAKE INTEREST PAYMENTS ON THE DEBENTURES, THE TRUST WILL BE UNABLE
TO PAY DISTRIBUTIONS AND LIQUIDATION AMOUNTS AND THE GUARANTEE WILL NOT APPLY

The trust will depend solely on our payments on the debentures to pay
distributions and the liquidation amount on the trust preferred securities. If
we default on our obligation to pay the principal or interest on the debentures,
the trust will not have sufficient funds to pay distributions or the liquidation
amount on the trust preferred securities. In that case, you will not be able to
rely on the guarantee for payment of these amounts because the guarantee only
applies if the trust has sufficient funds to make distributions on or to pay the
liquidation amount of the trust preferred securities. Instead, you or the
property trustee will have to initiate a direct action against us to enforce the
property trustee's rights under the indenture relating to the debentures. See
"Description of the Guarantee."

IF THE BANK IS UNABLE TO PAY SUFFICIENT DIVIDENDS TO US, THEN WE LIKELY WILL BE
UNABLE TO MAKE PAYMENTS ON THE DEBENTURES, THEREBY LEAVING INSUFFICIENT FUNDS
FOR THE TRUST TO MAKE PAYMENTS TO YOU ON THE TRUST PREFERRED SECURITIES

We are a holding company and substantially all of our assets are held by
our subsidiary bank. Our ability to make payments on the debentures when due
will depend primarily on available cash resources at the holding company and
dividends from the bank. Dividend payments from the bank are subject to
regulatory limitations, generally based on capital levels and current and
retained earnings, imposed by the various regulatory agencies with authority
over the bank. The ability of the bank to pay dividends is also subject to its
profitability, financial condition and capital expenditures and other cash flow
requirements. We cannot assure you that the bank will be able to pay dividends
in the future.

THE DEBENTURES AND THE GUARANTEE RANK LOWER THAN OUR OTHER INDEBTEDNESS, AND OUR
HOLDING COMPANY STRUCTURE EFFECTIVELY SUBORDINATES ANY CLAIMS AGAINST US TO
THOSE OF THE BANK

Our obligations under the debentures and the guarantee are unsecured and
will rank junior in priority of payment to our existing and future senior and
subordinated indebtedness and senior to our capital stock. At June 30, 1999, we
had approximately $570,000 of senior and subordinated indebtedness. However, we
expect from time to time to incur additional indebtedness. The issuance of the
debentures and the trust preferred securities does not limit our ability to
incur additional indebtedness, including indebtedness that ranks senior or equal
in priority of payment to the debentures or the guarantee.

Because we are a holding company, the creditors of the bank will also have
priority over you in any distribution of assets in liquidation, reorganization
or otherwise. Accordingly, the debentures and the guarantee will be effectively
subordinated to all existing and future liabilities of the bank, and you should
look only to our assets for payments on the trust preferred securities and the
debentures. See "Description of the Debentures -- Subordination."

8
<PAGE> 12

WE HAVE THE OPTION TO DEFER INTEREST PAYMENTS ON THE DEBENTURES FOR SUBSTANTIAL
PERIODS, WHICH WOULD CAUSE DISTRIBUTIONS ON THE TRUST PREFERRED SECURITIES TO BE
DEFERRED ALTHOUGH YOU WOULD STILL HAVE TO DECLARE THESE AMOUNTS AS INCOME FOR
TAX PURPOSES

We may, at one or more times, defer interest payments on the debentures for
up to 20 consecutive quarters. If we defer interest payments on the debentures,
the trust will defer distributions on the trust preferred securities during any
deferral period. During a deferral period, you will be required to recognize as
income for federal income tax purposes the amount approximately equal to the
interest that accrues on your proportionate share of the debentures held by the
trust in the tax year in which that interest accrues, even though you will not
receive these amounts until a later date.

You will also not receive the cash related to any accrued and unpaid
interest from the trust if you sell the trust preferred securities before the
end of any deferral period. During a deferral period, accumulated but unpaid
distributions will increase your tax basis in the trust preferred securities. If
you sell the trust preferred securities during a deferral period, your increased
tax basis will decrease the amount of any capital gain or increase the amount of
any capital loss that you may have otherwise realized on the sale. A capital
loss, except in certain limited circumstances, cannot be applied to offset
ordinary income. As a result, deferral of distributions could result in ordinary
income, and a related tax liability for the holder, and a capital loss that may
only be used to offset a capital gain.

We do not currently intend to exercise our right to defer interest payments
on the debentures. However, if we exercise our right in the future, the market
price of the trust preferred securities is likely to fall. The trust preferred
securities may trade at a price that does not fully reflect the value of accrued
but unpaid interest on the debentures. If you sell the trust preferred
securities during an interest deferral period, you may not receive the same
return on investment as someone who continues to hold the trust preferred
securities. Due to our right to defer interest payments, the market price of the
trust preferred securities may be more volatile than the market prices of other
securities without the deferral feature. See "Description of the Trust Preferred
Securities -- Distributions -- Extension Period."

WE MAY REDEEM THE DEBENTURES BEFORE NOVEMBER 17, 2029

Under the following circumstances, and subject to Federal Reserve approval,
if required, we may redeem the debentures before their stated maturity:

- in whole or in part, at any time on or after November 17, 2004; or

- in whole, but not in part, within 90 days after certain occurrences at
any time during the life of the trust. These occurrences include adverse
tax, Investment Company Act or bank regulatory developments.

You should assume that we will exercise our redemption option if we are
able to obtain capital at a lower cost than we must pay on the debentures or if
it is otherwise in our interest to redeem the debentures. If the debentures are
redeemed, the trust must redeem trust preferred securities having an aggregate
liquidation amount equal to the aggregate principal amount of debentures
redeemed, and you may be required to reinvest your principal at a time when you
may not be able to earn a return that is as high as you were earning on the
trust preferred securities. See "Description of the Trust Preferred
Securities -- Redemption or Exchange."

YOU ARE ALSO MAKING AN INVESTMENT DECISION CONCERNING THE DEBENTURES

Subject to the terms of the trust agreement, the trustees may distribute
the debentures to the trust preferred securities holders in exchange for their
trust preferred securities. Because you may receive debentures, you are also, in
effect, making an investment decision with regard to the debentures. You should
carefully review all of the information regarding the debentures contained in
this prospectus.

We cannot predict the market prices for the debentures that may be
distributed. Accordingly, the debentures that you receive upon a distribution,
or the trust preferred securities you hold pending such a
9
<PAGE> 13

distribution, may trade at a discount to the price that you paid to purchase the
trust preferred securities. Although we have agreed to use our best efforts to
list the debentures on a national securities exchange or comparable automated
quotation system if this occurs, there can be no assurance that the debentures
will be approved for listing or that a liquid trading market will exist for the
debentures. This could also have a negative impact on their trading price. See
"Description of the Trust Preferred Securities -- Liquidation Distribution Upon
Termination."

Under current federal income tax law and interpretations, a distribution of
the debentures should not be a taxable event to holders of the trust preferred
securities. If there is a change in law or in legal interpretation, the
distribution could be a taxable event to holders of the trust preferred
securities. See "Federal Income Tax Consequences."

WE HAVE MADE ONLY LIMITED COVENANTS IN THE INDENTURE AND THE TRUST AGREEMENT

The indenture governing the debentures and the trust agreement governing
the trust do not require us to maintain any financial ratios or specified levels
of net worth, revenues, income, cash flow or liquidity, and therefore, do not
protect holders of the debentures or the trust preferred securities in the event
we experience significant adverse changes in our financial condition or results
of operations. In addition, neither the indenture nor the trust agreement limits
our ability or the ability of our subsidiaries to incur additional indebtedness.
Therefore, you should not consider the provisions of these documents as a
significant factor in evaluating whether we will be able to comply with our
obligations under the debenture or the guarantee.

THERE IS NO CURRENT PUBLIC MARKET FOR THE TRUST PREFERRED SECURITIES, AND THEIR
MARKET PRICE MAY BE SUBJECT TO SIGNIFICANT FLUCTUATIONS

There is currently no public market for the trust preferred securities.
Although the trust preferred securities have been approved for listing on the
National Market System of The Nasdaq Stock Market, Inc., there is no guarantee
that an active or liquid trading market will develop or that such listing will
continue. If an active trading market does not develop, the market price and
liquidity of the trust preferred securities will be adversely affected. Even if
an active public market does develop, there is no guarantee that the market
price for the trust preferred securities will equal or exceed the price you pay
for the trust preferred securities.

Future trading prices of the trust preferred securities may be subject to
significant fluctuations in response to prevailing interest rates, our future
financial condition and results of operations, the market for similar securities
and general economic and market conditions. The initial public offering price of
the trust preferred securities has been set at the liquidation amount of the
trust preferred securities and may be greater than the market price following
the offering.

The market price for the trust preferred securities, or the debentures that
you may receive in a distribution, is also likely to decline during any period
in which we defer interest payments on the debentures. If this were the case,
the trust preferred securities or the debentures would not trade at a price that
accurately reflects the value of accrued but unpaid interest on the debentures.

YOU MUST RELY ON THE PROPERTY TRUSTEE TO ENFORCE YOUR RIGHTS IF THERE IS AN
EVENT OF DEFAULT UNDER THE INDENTURE

You may not be able to directly enforce your rights against us if an event
of default under the indenture occurs. If an event of default under the
indenture occurs and is continuing, this event will also be an event of default
under the trust agreement. In that case, you must rely on the enforcement by the
property trustee of its rights as holder of the debentures against us. The
holders of a majority in liquidation amount of the trust preferred securities
will have the right to direct the property trustee to enforce its rights. If the
property trustee does not enforce its rights following an event of default and a
request by the record holders to do so, any record holder may, to the extent
permitted by applicable law, take action directly against us to enforce the
property trustee's rights. If an event of default occurs under the trust
10
<PAGE> 14

agreement that is attributable to our failure to pay interest or principal on
the debentures, or if we default under the guarantee, you may proceed directly
against us. You will not be able to exercise directly any other remedies
available to the holders of the debentures unless the property trustee fails to
do so.

AS A HOLDER OF TRUST PREFERRED SECURITIES YOU HAVE LIMITED VOTING RIGHTS

Holders of trust preferred securities have limited voting rights. Your
voting rights pertain primarily to amendments to the trust agreement. In
general, only we can replace or remove any of the trustees. However, if an event
of default under the trust agreement occurs and is continuing, the holders of at
least a majority in aggregate liquidation amount of the trust preferred
securities may replace the property trustee and the Delaware trustee.

THE TRUST PREFERRED SECURITIES ARE NOT FDIC INSURED

Neither the Federal Deposit Insurance Corporation nor any other
governmental agency has insured the trust preferred securities.

RISKS RELATED TO AN INVESTMENT IN PROSPERITY

WE MAY BE UNABLE TO MANAGE OUR GROWTH DUE TO ACQUISITIONS, WHICH COULD HAVE AN
ADVERSE EFFECT ON OUR BUSINESS

As part of our general strategy, we may acquire financial institutions and
branches of financial institutions that we believe provide a strategic fit with
our business, such as our recent acquisition of South Texas Bancshares. To the
extent that we grow through acquisitions, we cannot assure you that we will be
able to adequately and profitably manage such growth. Our ability to
successfully integrate acquired financial institutions and branches of financial
institutions into our operations depends on our ability to:

- monitor operations;

- control costs;

- maintain positive customer relations;

- maintain regulatory compliance; and

- attract, assimilate and retain qualified personnel.

If we fail to successfully integrate an acquired financial institution's or
branch's operations with our operations, we may experience interruptions in our
business which may have a material adverse impact on our business, financial
condition or results of operations, as well as affect our ability to operate the
bank consistent with safe and sound banking practices. Successful integration of
these operations could be more expensive than anticipated.

Some of the other risks involved with acquisitions in general, including
the acquisition of South Texas Bancshares, include

- changes in results of operations or cash flows;

- unforseen liabilities related to the acquired company or arising from the
acquisition;

- exposure to potential asset quality issues of the acquired company;

- adverse personnel relations;

- diversion of management time and attention;

- loss of customers; and

- deterioration in local economic conditions.

CHANGES IN INTEREST RATES MAY ADVERSELY AFFECT OUR RESULTS OF OPERATIONS

Our earnings are significantly dependent on our net interest income. Net
interest income is the difference between the interest income we earn on loans,
investments and other interest-earning assets and the interest expense we pay on
deposits and other interest-bearing liabilities. Therefore, any change in

11
<PAGE> 15

general market interest rates, such as a change in the monetary policy of the
Federal Reserve or otherwise, can have a significant effect on our net interest
income. Our assets and liabilities may react differently to changes in overall
market rates or conditions because there may be mismatches between the repricing
or maturity characteristics of the assets and liabilities. As a result, an
increase or decrease in market interest rates could have an adverse impact on
our net interest margin and results of operations. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations -- Financial
Condition -- Interest Rate Sensitivity and Liquidity."

LOSS OF OUR EXECUTIVE OFFICERS OR OTHER KEY EMPLOYEES COULD ADVERSELY AFFECT OUR
BUSINESS

Our success is dependent upon the continued service and skills of Tracy T.
Rudolph, our Chairman and President, and David Zalman, the President of the
bank, and other senior officers, such as our banking center presidents. The loss
of services of any of these key personnel could have a negative impact on our
business because of their skills, years of industry experience and the
difficulty of promptly finding qualified replacement personnel. Although we
currently have employment agreements with Messrs. Rudolph and Zalman, there can
be no assurance that they will continue to be employed with us in the future.
See "Management."

WE OPERATE IN A HIGHLY COMPETITIVE MARKET

There is significant competition in Southeast Texas and elsewhere in the
United States for banking customers and our profit depends primarily upon our
ability to compete in our market areas. We experience competition from
commercial banks, savings banks, savings and loans associations, credit unions,
finance companies, mutual funds, investment banking firms and certain other
nonfinancial entities, including retail stores which have their own credit
programs and governmental organizations which may offer more favorable financing
than we can. Many of our competitors have greater financial strength, marketing
capability and name recognition than we do, and operate on a statewide or
nationwide basis. In addition, recent developments in technology and mass
marketing have permitted larger companies to market loans and other products and
services more aggressively to our small business customers. Such advantages may
enable our competitors to realize greater economies of scale and operating
efficiencies than we can. Further, some of our nonbank competitors are not
subject to the same extensive regulations that govern us and the bank.

Federal legislation enacted in August 1998 eased membership limits on
credit unions, which previously were permitted to serve only members that shared
a single, common bond. We expect that this legislation will increase the ability
of credit unions to compete with community banks, such as the bank, for both
deposits and loans. We can provide no assurance that we will be able to compete
effectively against such competition.

OUR BUSINESS IS CONCENTRATED IN SOUTHEAST TEXAS, AND A DOWNTURN IN THE TEXAS
ECONOMY MAY ADVERSELY AFFECT OUR BUSINESS

Substantially all of our business is located in Southeast Texas, and as a
result, our financial condition, results of operations and cash flows are
subject to changes in the economic condition of that area. Since the late 1980s,
the Southeast Texas economy has diversified from the energy industry into
non-energy related industries. As a result, a downturn in the energy industry is
not expected to have the same impact that it did in the 1980s. Nevertheless, a
prolonged period of economic recession or other adverse economic conditions in
Texas or Southeast Texas could result in an increase in nonpayment of loans and
a decrease in collateral value, causing operating losses, impairing liquidity
and eroding capital. Conditions in the Texas and Southeast Texas economies could
deteriorate in the future, and such a deterioration could have a material
adverse effect on our financial condition or results of operations.

12
<PAGE> 16

IF OUR ALLOWANCE FOR CREDIT LOSSES IS NOT ADEQUATE TO COVER ACTUAL LOSSES, OUR
EARNINGS COULD DECREASE

We believe that our allowance for credit losses is maintained at a level
adequate to absorb any inherent losses in our loan portfolio. Management's
estimates used in determining the allowance are based on our historical loan
loss experience, industry diversification of the commercial loan portfolio, the
amount of nonperforming loans and related collateral, volume, growth and
composition of the loan portfolio, current economic conditions that may affect
the borrower's ability to pay and the value of collateral, the evaluation of our
loan portfolio through our internal loan review process and other relevant
factors. These estimates are inherently subjective and their accuracy depends on
the outcome of future events. Ultimate losses may differ from current estimates.
Depending on changes in economic, operating and other conditions, including
changes in interest rates, that are generally beyond our control, our actual
credit losses could increase significantly. As a result, such losses could
exceed our current allowance estimates. We can provide no assurance that our
allowance is sufficient to cover actual credit losses should such losses be
realized.

In addition, federal and state regulators, as an integral part of their
respective supervisory functions, periodically review our allowance for credit
losses. Such regulatory agencies may require us to increase our provision for
credit losses or to recognize further loan charge-offs, based upon judgments
different from those of management. Any increase in our allowance required by
these regulatory agencies could have a negative effective on us. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Financial Condition -- Allowance for Credit Losses."

OUR CURRENT CONCENTRATION IN 1-4 FAMILY RESIDENTIAL LOANS COULD PROVIDE LOWER
YIELDS AND PROFITABILITY, AND DIVERSIFICATION AWAY FROM THIS TYPE OF LOAN MAY
INCREASE OUR CREDIT RISK

At June 30, 1999, 1-4 family residential mortgage loans comprised $86.9
million, or 46.2%, of our loan portfolio. These loans are secured primarily by
properties located in our market area. Because 1-4 family residential mortgage
loans typically have interest rates that are lower than other loans, our
concentration in these loans results in lower yields and profitability for us.
Further, these loans are generally made on the basis of the borrower's ability
to repay and the value of the property securing the loan. A downturn in the
Southeast Texas economy could have an adverse effect on the ability of borrowers
to repay these loans and the value of the property securing such loans.

In addition, one of our business strategies is to diversify our loan
portfolio. This diversification may result in a gradual increase in our
consolidated credit risk, which means that there would be a greater risk that
borrowers will be unable to repay their loans from us. Such defaults which could
result in losses in excess of our allowance for credit losses may have a
material adverse effect on our business, financial condition or results of
operation.

WE HAVE A CONTINUING NEED FOR TECHNOLOGICAL CHANGE

The banking industry is undergoing rapid technological changes with
frequent introductions of new technology-driven products and services. In
addition to better serving customers, the effective use of technology increases
efficiency and enables financial institutions to reduce costs. Our future
success will depend in part upon our ability to address the needs of our
customers by using technology to provide products and services that will satisfy
customer demands for convenience as well as create additional efficiencies in
our operations. Many of our competitors have substantially greater resources to
invest in technological improvements. There can be no assurance that we will be
able to effectively implement new technology-driven products and services or be
successful in marketing such products and services to our customers.

YEAR 2000 ISSUES MAY ADVERSELY AFFECT OUR INFORMATION TECHNOLOGY SYSTEMS

The Year 2000 issue is a computer programming concern that may adversely
affect our information technology systems and software, such as our item and
data processing applications, as well as so-called embedded technology, such as
microprocessors that control various functions, such as our security systems
13
<PAGE> 17

and telecommunication equipment. The phrase "Year 2000 issue" refers to the
concern that certain computer applications will not be able to distinguish dates
in the twentieth and twenty-first centuries. We have developed a plan to
identify and remedy the material Year 2000 issues that directly affect our
systems and products. This plan also includes procedures to evaluate the
preparedness of our key vendors and significant customers in addressing the Year
2000 issue. Nevertheless, our operational and financial systems, or those of our
vendors and customers, could be adversely affected by Year 2000 issues which
could in turn adversely affect our business. In particular, it will be difficult
for us to implement viable contingency plans for any adverse effect of the Year
2000 issue on local or national telecommunications systems or on our local
electric utility. Furthermore, Year 2000 problems may exist in portions of
important computer programs not now suspected, and we could be adversely
affected by issues we have yet to identify. If we fail to adequately address the
Year 2000 issue pertaining to our internal operations or those of our customers
and vendors, that failure could adversely affect our business.

In addition, bank regulatory agencies, as part of their supervisory
function, are assessing and will continue to assess Year 2000 readiness. The
failure of a financial institution to take appropriate steps to address
deficiencies in its Year 2000 project management process may result in one or
more regulatory enforcement actions which could have a material adverse effect
on such institution. These actions may include the imposition of fines, or
result in the delay or denial of regulatory applications, such as an application
for a merger. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Financial Condition -- Year 2000 Compliance."

WE OPERATE IN A HIGHLY REGULATED ENVIRONMENT

We and the bank operate in a highly regulated environment and are subject
to supervision and examination by various federal and state regulatory agencies.
As a bank holding company, we are subject to regulation and supervision by the
Federal Reserve. The bank, as a Texas banking association, is subject to
regulation and supervision by the Texas Department of Banking and, as a result
of the insurance it has on its deposits, by the FDIC.

Federal and Texas laws and regulations govern numerous matters, including:

- adequate capital and financial condition;

- permissible types, amounts and terms of extensions of credit and
investments;

- permissible nonbanking activities; and

- restrictions on dividend payments.

The federal and state regulators have extensive discretion and power to
prevent or remedy unsafe or unsound practices or violations of law by banks and
bank holding companies. We and the bank undergo periodic examinations by one or
more regulatory agencies. Following such examinations, we may be required, among
other things, to change our asset valuations or the amounts of required loss
allowances or to restrict our operations. Such actions would result from the
regulators' judgments based on information available to them at the time of
their examination. In addition, we are required to serve as a source of
financial strength to the bank, which could result in a decrease of available
funds for dividends to our shareholders and cash flow to securities ranking
senior to our common stock. The bank's operations are also subject to a wide
variety of state and federal consumer protection and similar statutes and
regulations. Such federal and state regulatory restrictions limit the manner in
which we and the bank may conduct business and obtain financing. Those laws and
regulations can and do change significantly from time to time, and any such
change could adversely affect our business. See "Supervision and Regulation."

OUR MANAGEMENT WILL HAVE BROAD DISCRETION TO USE THE OFFERING PROCEEDS FOR
GENERAL CORPORATE PURPOSES WHICH MAY NOT RESULT IN THE MAXIMUM RETURN OR BE IN
YOUR BEST INTERESTS

We will receive approximately $11,415,000 in net proceeds from the sale of
debentures, after deducting estimated underwriting commissions and offering
expenses. Our management will have broad

14
<PAGE> 18

discretion to allocate the net proceeds to uses it believes are appropriate,
which may include uses in the best interests of our common shareholders, such as
dividends on shares of common stock and expansion opportunities. The amount and
timing of any allocation will depend on a number of factors, including our
capital requirements and those of the bank and available expansion
opportunities. Such uses could have a direct effect on our ability to make
payments on the debentures. See "Use of Proceeds."

FORWARD-LOOKING INFORMATION

Statements and financial discussion and analysis contained in this
prospectus that are not historical facts are forward-looking statements made
pursuant to the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995. Forward-looking statements describe our future plans,
strategies and expectations, are based on assumptions and involve a number of
risks and uncertainties, many of which are beyond our control. The important
factors that could cause actual results to differ materially from the
forward-looking statements include, without limitation:

- changes in interest rates and market prices, which could reduce our net
interest margins, asset valuations and expense expectations;

- changes in the levels of loan prepayments and the resulting effects on
the value of our loan portfolio;

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

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

- our ability to identify suitable future acquisition candidates;

- the timing, impact and other uncertainties of our future acquisitions,
including our success or failure in the integration of their operations,
and our ability to enter new markets successfully and capitalize on
growth opportunities;

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

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

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

- increased asset levels and changes in the composition of assets and the
resulting impact on our capital levels and regulatory capital ratios;

- our ability to acquire, operate and maintain cost effective and efficient
systems without incurring unexpectedly difficult or expensive but
necessary technological changes (including changes to address Year 2000
data systems issues);

- our ability to complete our project to assess and resolve any Year 2000
problems on time;

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

- changes in statutes and government regulations or their interpretations
applicable to bank holding companies and our present and future banking
and other subsidiaries, including changes in tax requirements and tax
rates; and

- other factors discussed in the "Risk Factors" section of this prospectus.

15
<PAGE> 19

We undertake no obligation to publicly update or otherwise revise any
forward-looking statements, whether as a result of new information, future
events or otherwise. In light of these risks, uncertainties and assumptions, the
events discussed in any forward-looking statements in this prospectus might not
occur.

USE OF PROCEEDS

The trust will invest all the proceeds from the sale of the trust preferred
securities in the debentures. We will use the net proceeds we receive from the
sale of the debentures, which we estimate to be approximately $11,415,000, for
general corporate purposes, including, among other things, investments in and
extensions of credit to the bank, possible new branch openings and possible
acquisitions of financial institutions or branches of financial institutions.

ACCOUNTING TREATMENT

The trust will be treated, for financial reporting purposes, as our
subsidiary and, accordingly, the accounts of the trust will be included in our
consolidated financial statements. The trust preferred securities will be
presented as a separate line item in our consolidated balance sheet under the
caption "Company Obligated Mandatorily Redeemable Preferred Securities of
Subsidiary Trust Holding Solely Subordinated Debentures," and appropriate
disclosures about the trust preferred securities, the guarantee and the
debentures will be included in the notes to consolidated financial statements.
For financial reporting purposes, we will record distributions payable on the
trust preferred securities as interest expense in our Consolidated Statements of
Income.

Our future reports filed under the Securities Exchange Act of 1934, as
amended, will include a footnote to the consolidated financial statements
stating that:

- the trust is wholly-owned;

- the sole assets of the trust are the debentures and specifying the
debentures' principal amount, interest rate and maturity date; and

- our obligations described in this prospectus, in the aggregate,
constitute a full, irrevocable and unconditional guarantee on a
subordinated basis by us of the obligations of the trust under the trust
preferred securities.

16
<PAGE> 20

CAPITALIZATION

The following table sets forth our indebtedness and capitalization as of
June 30, 1999, on a historical basis and as adjusted to give effect to (i) the
South Texas Bancshares acquisition and (ii) the offering and the application of
the estimated net proceeds. This data should be read in conjunction with the
"Selected Consolidated Financial Data" and the consolidated financial statements
and notes thereto, included elsewhere in this prospectus.

<TABLE>
<CAPTION>
JUNE 30, 1999
------------------------------------------------
AS ADJUSTED
FOR THE
AS ADJUSTED SOUTH TEXAS
FOR THE BANCSHARES
SOUTH TEXAS ACQUISITION
BANCSHARES AND THE
ACTUAL ACQUISITION OFFERING
------- ------------------- ----------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
INDEBTEDNESS:
Short-term borrowings............................... $ -- $ -- $ --
Federal Home Loan Bank advances..................... 570 570 570
Other borrowings.................................... -- -- --
------- ------- -------
Total indebtedness........................ $ 570 $ 570 $ 570
======= ======= =======
Company obligated mandatorily redeemable preferred
securities of subsidiary trust holding solely
subordinated debentures........................... $ -- $ -- $12,000
======= ======= =======
SHAREHOLDERS' EQUITY:
Preferred Stock, $1.00 par value; 20,000,000 shares
authorized; none issued and outstanding........... $ -- $ -- $ --
Common Stock, $1.00 par value; 50,000,000 shares
authorized; 5,195,325 shares issued and
outstanding....................................... 5,199 5,199 5,199
Capital surplus..................................... 16,441 16,441 16,441
Retained earnings................................... 21,870 21,870 21,285
Accumulated other comprehensive income.............. (1,264) (1,264) (1,264)
Treasury stock...................................... (18) (18) (18)
------- ------- -------
Total shareholders' equity................ $42,228 $42,228 $41,643
======= ======= =======
CAPITAL(1):
Dollar basis:
Total risk-based capital....................... $36,140 $37,838
Tier 1 risk-based capital...................... 34,127 31,057
Leverage capital............................... 34,127 31,057
Percentage basis:
Total risk-based capital....................... 19.16% 15.95%
Tier 1 risk-based capital...................... 18.09 13.09
Leverage capital............................... 7.69 5.44
</TABLE>

- ---------------

(1) Federal Reserve guidelines for calculation of Tier 1 capital limit the
aggregate amount of trust preferred securities, including securities similar
to the trust preferred securities, which can be included in Tier 1 capital
to 25% of total Tier 1 capital. As of June 30, 1999, after giving effect to
the South Texas Bancshares Acquisition, which occurred on October 1, 1999,
$7.8 million of the aggregate amount of trust preferred securities would
have qualified as Tier 1 capital, and the remaining amount would have
qualified as Tier 2 capital. Any future increases in other elements of our
Tier 1 capital, including retained earnings, will allow us to include
greater portions of the trust preferred securities in Tier 1 capital.

17
<PAGE> 21

PRO FORMA COMBINED FINANCIAL STATEMENTS

The following pro forma combined balance sheet as of June 30, 1999 and pro
forma combined statements of income for the six months ended June 30, 1999 and
the year ended December 31, 1998 combine our historical consolidated financial
statements with the historical consolidated financial statements of South Texas
Bancshares and are intended to give you a better picture of what the companies
might have looked like as a combined entity. The pro forma balance sheet assumes
that the South Texas Bancshares acquisition was consummated on the balance sheet
date. The pro forma income statements assume that the South Texas Bancshares
acquisition was consummated at the beginning of the period indicated. The
companies may have performed differently if they had been combined.

The unaudited pro forma combined financial statements are presented for
illustrative purposes only. You should not rely on the pro forma information as
being indicative of the consolidated financial position or results of future
operations of the combined entity or of the actual results that would have been
achieved had the acquisition been consummated as of the dates indicated above.

18
<PAGE> 22

PRO FORMA COMBINED BALANCE SHEET
JUNE 30, 1999
(UNAUDITED)

<TABLE>
<CAPTION>
PRO FORMA
ADJUSTMENTS
SOUTH TEXAS ------------------ PRO FORMA
PROSPERITY BANCSHARES(A) DEBITS CREDITS COMBINED
---------- ------------- ------- ------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
ASSETS
Cash and due from banks....................... $ 12,511 $ 9,036 $11,650(b) $ 9,897
Federal funds sold............................ -- 11,700 11,700(b) --
-------- -------- ------- --------
Total cash and cash equivalents...... 12,511 20,736 23,350 9,897
Interest-bearing deposits in financial
institutions................................ -- -- --
Securities:
Available-for-sale securities at fair
value..................................... 138,170 72,477 $ 579(c) 504(c) 210,722
Held-to-maturity at cost.................... 83,511 83,511
-------- -------- ------- ------- --------
Total securities..................... 221,681 72,477 579 504 294,233
Loans:
Total loans, net of unearned discount....... 188,034 35,075 223,109
Allowance for credit losses................. (2,013) (532) (2,545)
-------- -------- --------
Net loans............................ 186,021 34,543 220,564
Goodwill...................................... 9,366 3,378 10,249(c) 3,378(c) 19,615
Premises and equipment........................ 6,054 2,849 1,300(c) 10,203
Other real estate owned....................... 128 -- 128
Other assets.................................. 7,013 1,809 171(c) 197(c) 8,796
-------- -------- ------- ------- --------
Total assets......................... $442,774 $135,792 $12,299 $27,429 $563,436
======== ======== ======= ======= ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits.................................... $398,379 $119,004 $517,383
Other borrowings............................ 570 -- 570
Other liabilities........................... 1,597 1,216 $ 442(c) 3,255
-------- -------- ------- --------
Total liabilities.................... 400,546 120,220 442 521,208
Shareholders' equity:
Common stock................................ 5,199 121 $ 121(d) 5,199
Additional paid-in capital.................. 16,441 3,227 3,227(d) 16,441
Retained earnings........................... 21,870 12,606 12,606(d) 21,870
Accumulated other comprehensive income -- net
unrealized gain (loss) on available-for-sale
securities.................................. (1,264) (382) 382(c) (1,264)
Treasury stock................................ (18) -- (18)
-------- -------- ------- ------- --------
Total shareholders' equity........... 42,228 15,572 15,954 382 42,228
-------- -------- ------- ------- --------
Total liabilities and shareholders'
equity............................. $442,774 $135,792 $15,954 $ 824 $563,436
======== ======== ======= ======= ========
</TABLE>

- ---------------

(a) Certain reclassifications have been made to the financial information of
South Texas Bancshares to conform such information to the classifications
used by Prosperity.

(b) This adjustment represents the purchase of 100% of the outstanding shares
of stock of South Texas Bancshares for $23.4 million.

(c) This adjustment represents the purchase price adjustments to mark South
Texas Bancshares' assets and liabilities to fair value upon consummation of
the acquisition and results in recording $10.2 million in goodwill.

(d) This adjustment represents the elimination of the capital of South Texas
Bancshares against the investment in subsidiary of Prosperity.

19
<PAGE> 23

PRO FORMA COMBINED STATEMENT OF INCOME
SIX MONTHS ENDED JUNE 30, 1999
(UNAUDITED)

<TABLE>
<CAPTION>
PRO FORMA
ADJUSTMENTS
SOUTH TEXAS ------------------ PRO FORMA
PROSPERITY BANCSHARES(A) DEBITS CREDITS COMBINED
---------- ------------- ------ ------- ---------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Interest income:
Interest and fees on loans............. $7,456 $1,724 $ 9,180
Interest on securities................. 6,675 2,220 $ 84(b) 8,979
Interest on federal funds sold......... 422 323 745
------ ------ ---- -------
Total interest income.......... 14,553 4,267 84 18,904
Interest expense:
Interest on deposits................... 6,123 1,848 7,971
Interests on other borrowings.......... 7 -- 7
------ ------ -------
Total interest expense......... 6,130 1,848 7,978
Net interest income...................... 8,423 2,419 84 10,926
Provision for credit losses............ 130 -- 130
------ ------ ---- -------
Net interest income after provision for
credit losses.......................... 8,293 2,419 84 10,796
------ ------ ---- -------
Noninterest income:
Customer service fees.................. 1,241 599 1,840
Other noninterest income............... 205 182 387
------ ------ -------
Total noninterest income....... 1,446 781 2,227
Noninterest expense:
Salaries and employee benefits......... 2,820 1,111 3,931
Net occupancy expense.................. 437 192 $ 22(c) 651
Other noninterest expense.............. 2,178 958 205(d) 75(e) 3,266
------ ------ ----- ---- -------
Total noninterest expense...... 5,435 2,261 227 75 7,848
------ ------ ----- ---- -------
Income before federal income taxes....... 4,304 939 (227) 159 5,175
Provision for federal income taxes..... 1,367 301 29(f) 7(f) 1,690
------ ------ ----- ---- -------
Net income..................... $2,937 $ 638 $(256) $166 $ 3,485
====== ====== ===== ==== =======
Basic earnings per share:
Net income per share................... $ 0.57 $ 2.64 $ 0.67
Average shares outstanding (in
thousands).......................... 5,177 241 5,177
Diluted earnings per share:
Net income per share................... $ 0.55 $ 2.57 $ 0.65
Average shares outstanding (in
thousands).......................... 5,377 248 5,377
</TABLE>

- ---------------

(a) Certain reclassifications have been made to the financial information of
South Texas Bancshares to conform such information to the classifications
used by Prosperity.

(b) This adjustment represents additional accretion on the market value of the
acquired securities portfolio.

(d) This adjustment represents the amortization on $10.2 million in goodwill
over 25 years.

(e) This adjustment represents the elimination of the goodwill expense of the
acquired company.

(f) This adjustment represents the federal income tax effect of the above
adjustments.

20
<PAGE> 24

PRO FORMA COMBINED STATEMENT OF INCOME
YEAR ENDED DECEMBER 31, 1998
(UNAUDITED)

<TABLE>
<CAPTION>
PRO FORMA
ADJUSTMENTS
SOUTH TEXAS ------------------ PRO FORMA
PROSPERITY BANCSHARES(A) DEBITS CREDITS COMBINED
---------- ------------- ------ ------- ---------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Interest income:
Interest and fees on loans............. $12,282 $3,706 $15,988
Interest on securities................. 10,841 4,806 $168(b) 15,815
Interest on federal funds sold......... 299 612 911
------- ------ ---- -------
Total interest income.......... 23,422 9,124 168 32,714
Interest expense:
Interest on deposits................... 9,993 4,108 14,101
Interests on other borrowings.......... 135 -- 135
------- ------ -------
Total interest expense......... 10,128 4,108 14,236
Net interest income...................... 13,294 5,016 168 18,478
Provision for credit losses............ 239 (100) 139
------- ------ ---- -------
Net interest income after provision for
credit losses.......................... 13,055 5,116 168 18,339
------- ------ ---- -------
Noninterest income:
Customer service fees.................. 2,173 1,236 3,409
Other noninterest income............... 319 385 704
------- ------ -------
Total noninterest income....... 2,492 1,621 4,113
Noninterest expense:
Salaries and employee benefits......... 4,541 2,148 6,689
Net occupancy expense.................. 768 395 $ 43(c) 1,206
Other noninterest expense.............. 3,749 2,045 410(d) 150(e) 6,054
------- ------ ----- ---- -------
Total noninterest expense...... 9,058 4,588 453 150 13,949
------- ------ ----- ---- -------
Income before federal income taxes....... 6,489 2,149 (453) 318 8,503
Provision for federal income taxes..... 2,029 704 57(f) 14(f) 2,776
------- ------ ----- ---- -------
Net income..................... $ 4,460 $1,445 $(510) $332 $ 5,727
======= ====== ===== ==== =======
Basic earnings per share:
Net income per share................... $ 1.08 $ 6.01 $ 1.39
Average shares outstanding (in
thousands).......................... 4,116 240 4,116
Diluted earnings per share:
Net income per share................... $ 1.04 $ 5.87 $ 1.33
Average shares outstanding (in
thousands).......................... 4,309 246 4,309
</TABLE>

- ---------------

(a) Certain reclassifications have been made to the financial information of
South Texas Bancshares to conform such information to the classifications
used by Prosperity.

(b) This adjustment represents additional accretion on the market value of the
acquired securities portfolio.

(d) This adjustment represents the amortization on $10.2 million in goodwill
over 25 years.

(e) This adjustment represents the elimination of the goodwill expense of the
acquired company.

(f) This adjustment represents the federal income tax effect of the above
adjustments.

21
<PAGE> 25

SELECTED CONSOLIDATED FINANCIAL DATA

The following selected consolidated financial data for, and as of the end
of, each of the years in the five-year period ended December 31, 1998 are
derived from our consolidated financial statements. The consolidated financial
statements as of December 31, 1998 and 1997 and for each of the years in the
three-year period ended December 31, 1998, and the report thereon of Deloitte &
Touche L.L.P., are included elsewhere in this prospectus. The consolidated
financial data as of and for each of the six months ended June 30, 1999 and 1998
are derived from unaudited consolidated financial statements included elsewhere
in this prospectus, and, in the opinion of management, contain all adjustments
(consisting only of normal recurring adjustments) necessary to present fairly
our financial position and results of operations as of such dates and for such
periods. The results of operations for past periods and for the six months ended
June 30, 1999 are not necessarily indicative of the results of operations that
may be expected for the year ended December 31, 1999, 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,
------------------- ----------------------------------------------------
1999 1998 1998 1997 1996 1995 1994
-------- -------- -------- -------- -------- -------- --------
(UNAUDITED)
(DOLLARS)IN THOUSANDS, EXCEPT PER SHARE
DATA
<S> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Interest income........................... $ 14,553 $ 10,836 $ 23,422 $ 19,970 $ 16,841 $ 14,738 $ 12,644
Interest expense.......................... 6,130 4,716 10,128 9,060 7,923 6,904 5,363
-------- -------- -------- -------- -------- -------- --------
Net interest income..................... 8,423 6,120 13,294 10,910 8,918 7,834 7,281
Provision for credit losses............... 130 145 239 190 230 175 188
-------- -------- -------- -------- -------- -------- --------
Net interest income after provision for
credit losses......................... 8,293 5,975 13,055 10,720 8,688 7,659 7,093
Noninterest income........................ 1,446 1,273 2,492 2,264 1,897 1,489 1,500
Noninterest expense....................... 5,435 4,252 9,058 7,836 6,634 6,046 6,021
-------- -------- -------- -------- -------- -------- --------
Income before taxes..................... 4,304 2,996 6,489 5,148 3,951 3,102 2,572
Provision for income taxes................ 1,367 939 2,029 1,586 1,240 781 609
-------- -------- -------- -------- -------- -------- --------
Net income.............................. $ 2,937 $ 2,057 $ 4,460 $ 3,562 $ 2,711 $ 2,321 $ 1,963
======== ======== ======== ======== ======== ======== ========
COMMON SHARE DATA(1):
Basic earnings per share.................. $ 0.57 $ 0.52 $ 1.08 $ 0.94 $ 0.77 $ 0.66 $ 0.56
Diluted earnings per share................ 0.55 0.50 1.04 0.92 0.76 0.66 0.56
Book value per share...................... 8.13 6.64 8.01 6.22 5.36 4.68 3.81
Tangible book value per share(2).......... 6.33 5.22 6.14 4.81 4.21 3.95 3.02
Cash dividends declared per share......... 0.10 0.10 0.20 0.15 0.10 0.10 0.07
Dividend payout ratio..................... 17.67% 19.40% 23.70% 16.11% 12.95% 15.12% 13.42%
Weighted average shares outstanding
(basic) (in thousands).................. 5,177 3,990 4,116 3,778 3,513 3,514 3,514
Weighted average shares outstanding
(diluted) (in thousands)................ 5,377 4,080 4,309 3,864 3,560 3,523 3,514
Shares outstanding at end of period (in
thousands).............................. 5,195 3,990 5,173 3,990 3,510 3,514 3,514
BALANCE SHEET DATA (AT PERIOD END):
Total assets.............................. $442,774 $335,422 $436,312 $320,143 $293,988 $233,492 $224,022
Securities................................ 221,681 158,685 227,744 167,868 147,564 117,505 121,912
Loans..................................... 188,034 141,080 170,478 120,578 113,382 88,797 76,543
Allowance for credit losses............... 2,013 1,114 1,850 1,016 923 753 588
Total deposits............................ 398,379 307,815 390,659 291,516 270,866 214,534 207,543
Borrowings and notes payable.............. 570 -- 2,437 2,800 3,267 1,517 2,275
Total shareholders' equity................ 42,228 26,478 41,435 24,818 18,833 16,458 13,374
SELECTED FINANCIAL RATIOS AND OTHER DATA:
Performance Ratios and Other Data:
Return on average assets.................. 1.29% 1.25% 1.26% 1.17% 1.05% 1.03% 0.92%
Return on average equity.................. 13.94 15.99 15.97 16.32 15.36 15.56 14.97
Net interest margin(3).................... 4.09 4.14 4.13 4.02 3.91 3.96 3.91
Efficiency ratio(4)....................... 55.07 57.53 57.38 59.48 61.34 64.85 68.56
Number of banking centers................. 12 11 12 11 10 9 9
</TABLE>

(Table continued on next page)

22
<PAGE> 26

- ---------------

(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) Calculated on a tax-equivalent basis using a 34% federal income tax rate.

(4) Calculated by dividing total noninterest expense, excluding securities
losses, by net interest income plus noninterest income.

(5) At period end, except for net loan charge-offs to average loans, which is
for periods ended at such dates.

(6) Nonperforming loans consist of nonaccrual loans, loans contractually past
due 90 days or more and restructured loans. We had no significant
nonperforming loans at any of the dates indicated.

(8) At period end, except for average shareholders' equity to average total
assets, which is for periods ended at such dates.

23
<PAGE> 27

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management's Discussion and Analysis of Financial Condition and Results of
Operations analyzes the major elements of our balance sheets and statements of
income. This section should be read in conjunction with our financial statements
and accompanying notes and other detailed information appearing elsewhere in
this prospectus.

FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998

OVERVIEW

We showed positive earnings growth for the six month period ended June 30,
1999 due to an increase in loan volume and the acquisition of Union State Bank
in East Bernard, Texas in the fourth quarter of 1998, which was accounted for
under the purchase method of accounting. 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. For the six months ended June 30, 1999, our net
income was $2.9 million ($0.55 per common share on a diluted basis) compared
with $2.1 million ($0.50 per common share on a diluted basis) for the same
period in 1998, an increase of $880,000 or 42.8%. We estimate that slightly less
than one-half of this increase was attributable to internal growth. We posted
returns on average common equity of 13.94% and 15.99% and returns on average
assets of 1.29% and 1.25% for the six months ended June 30, 1999 and 1998,
respectively.

Total assets were $442.8 million at June 30, 1999 compared with $436.3
million at December 31, 1998. Total loans increased to $188.0 million at June
30, 1999 from $170.5 million at December 31, 1998, an increase of $17.5 million,
or 10.3%. At June 30, 1999, we had no nonperforming loans and our allowance for
credit losses was $2.0 million. Total deposits were $398.4 million at June 30,
1999 compared with $390.7 million at December 31, 1998, an increase of $7.7
million, or 2.0%. Shareholders' equity increased $793,000, or 1.9%, to $42.2
million at June 30, 1999 compared with $41.4 million at December 31, 1998.

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 our earnings.
Interest rate fluctuations, as well as changes in the amount and type of earning
assets and liabilities, combine to affect net interest income. Our net interest
income is affected by changes in the amount and mix of interest-earning assets
and interest-bearing liabilities, referred to as a "volume change." It is also
affected by changes in yields earned on interest-earning assets and rates paid
on interest-bearing deposits and other borrowed funds, referred to as a "rate
change."

Net interest income increased $2.3 million, or 37.6%, to $8.4 million for
the six months ended June 30, 1999 from $6.1 million for the same period in
1998. This increase was mainly attributable to higher average interest-earning
assets and higher average loans. The net interest margin on a tax-equivalent
basis decreased to 4.09% from 4.14% for the same periods, principally due to a
slightly greater decrease in the yield on interest-earning assets than the
decrease in the rate on interest-bearing liabilities.

24
<PAGE> 28

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>
SIX MONTHS ENDED JUNE 30,
-------------------------------------------------------------------
1999 1998
-------------------------------- --------------------------------
AVERAGE INTEREST AVERAGE AVERAGE INTEREST AVERAGE
OUTSTANDING EARNED/ YIELD/ OUTSTANDING EARNED/ YIELD/
BALANCE PAID RATE(4) BALANCE PAID RATE(4)
----------- -------- ------- ----------- -------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Interest-earning assets:
Loans.............................. $178,861 $ 7,456 8.41% $129,228 $ 5,568 8.69%
Securities(1)...................... 227,710 6,675 5.86 170,005 5,136 6.04
Federal funds sold and other
temporary investments........... 17,421 422 4.82 4,789 132 5.48
-------- ------- -------- -------
Total interest-earning
assets................... 423,992 14,553 6.89% 304,022 10,836 7.16%
------- -------
Less allowance for credit losses... (1,915) (1,047)
-------- --------
Total interest-earning assets,
net of allowance.............. 422,077 302,975
Noninterest-earning assets...... 34,412 27,122
-------- --------
Total assets............... $456,489 $330,097
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing liabilities:
Interest-bearing demand deposits... $ 49,454 $ 372 1.52% $ 41,064 $ 330 1.62%
Savings and money market
accounts........................ 122,230 2,014 3.32 78,704 1,376 3.53
Certificates of deposit............ 158,573 3,737 4.75 115,918 2,942 5.12
Federal funds purchased and other
borrowings...................... 322 7 4.32 2,345 68 5.77
-------- ------- -------- -------
Total interest-bearing
liabilities.............. 330,579 6,130 3.74% 238,031 4,716 4.00%
-------- ------- -------- -------
Noninterest-bearing liabilities:
Noninterest-bearing demand
deposits........................ 81,807 65,057
Other liabilities.................. 1,955 1,426
-------- --------
Total liabilities.......... 414,341 304,514
-------- --------
Shareholders' equity................. 42,148 25,583
-------- --------
Total liabilities and
shareholders' equity..... $456,489 $330,097
======== ========
Net interest rate spread............. 3.15% 3.16%
Net interest income and margin(2).... $ 8,423 4.01% $ 6,120 4.06%
======= =======
Net interest income and margin (tax-
equivalent basis)(3)............... $ 8,597 4.09% $ 6,242 4.14%
======= =======
</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 pretax income and resultant yields on tax-exempt
investments and loans comparable to those on taxable investments and loans,
a tax-equivalent adjustment has been computed using a federal income tax
rate of 34%.

(4) Annualized.

25
<PAGE> 29

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

<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,
1999 VS. 1998
-----------------------------
INCREASE (DECREASE)
DUE TO
-------------------
VOLUME RATE TOTAL
-------- ------- ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Interest-earning assets:
Loans................................................... $2,139 $(251) $1,888
Securities.............................................. 1,743 (204) 1,539
Federal funds sold and other temporary investments...... 348 (58) 290
------ ----- ------
Total increase (decrease) in interest income.... 4,230 (513) 3,717
------ ----- ------
Interest-bearing liabilities:
Interest-bearing demand deposits........................ 67 (25) 42
Savings and money market accounts....................... 761 (123) 638
Certificates of deposit................................. 1,083 (288) 795
Federal funds purchased and other borrowings............ (59) (2) (61)
------ ----- ------
Total increase (decrease) in interest expense... 1,852 (438) 1,414
------ ----- ------
Increase (decrease) in net interest income................ $2,378 $ (75) $2,303
====== ===== ======
</TABLE>

Provision for Credit Losses

Our provision for credit losses is established through charges to income in
the form of the provision in order to bring the total allowance for credit
losses to a level deemed appropriate by our management based on such factors as
our historical loan loss experience, industry diversification of our commercial
loan portfolio, the amount of nonperforming loans and related collateral, the
volume, growth and composition of our loan portfolio, current economic
conditions that may affect the borrower's ability to pay and the value of
collateral, the evaluation of our loan portfolio through our internal loan
review process and other relevant factors.

The provision for credit losses for the six months ended June 30, 1999
decreased $15,000 to $130,000 from $145,000 in the same period in 1998.

Noninterest Income

Noninterest income is an important source of revenue for financial
institutions. Our primary sources of noninterest income are service charges on
deposit accounts and other banking service related fees. Noninterest income
increased $173,000, or 13.6%, to $1.4 million for the six month period ended
June 30, 1999 from $1.3 million for the same period in 1998. The increase in
service charges on deposit accounts was principally due to the Union
acquisition.

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

<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
----------------------
1999 1998
-------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Service charges on deposit accounts......................... $1,241 $1,074
Other noninterest income.................................... 205 199
------ ------
Total noninterest income.......................... $1,446 $1,273
====== ======
</TABLE>

26
<PAGE> 30

Noninterest Expense

Noninterest expense totaled $5.4 million for the six months ended June 30,
1999, an increase of $1.1 million, or 27.8%, from $4.3 million for the same
period in 1998. The increase primarily reflected additional expenses resulting
from the Union acquisition.

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

<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
----------------------
1999 1998
-------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Salaries and employee benefits.............................. $2,820 $2,115
Non-staff expenses:
Net occupancy expense..................................... 437 367
Equipment depreciation.................................... 173 136
Data processing........................................... 417 369
Professional fees......................................... 98 46
Regulatory assessments and FDIC insurance................. 42 35
Ad valorem and franchise taxes............................ 99 101
Goodwill amortization..................................... 323 235
Other..................................................... 1,026 848
------ ------
Total noninterest expense......................... $5,435 $4,252
====== ======
</TABLE>

Salaries and employee benefits for the six month period ended June 30, 1999
totaled $2.8 million, an increase of $705,000, or 33.3%, from $2.1 million for
the six month period ending June 30, 1998. The change was due primarily to an
increase in the number of employees due to the Union acquisition and regular
annual employee salary increases.

Non-staff expenses increased $478,000, or 22.4%, to $2.6 million for the
six month period ended June 30, 1999 from $2.1 million for the same period in
1998. The increase was principally due to the Union acquisition.

Income Taxes

The amount of federal income tax expense is influenced by the amount of
taxable income, the amount of tax-exempt income, the amount of nondeductible
interest expense and the amount of other nondeductible expenses. Income tax
expense increased $428,000, or 45.6%, to $1.4 million for the six months ended
June 30, 1999 from $939,000 for the same period in 1998. The increase was
primarily attributable to higher earnings.

Impact of Inflation

The effects of inflation on the local economy and on our operating results
have been relatively modest for the past several years. Since substantially all
of our 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. We try to control the impact of interest rate fluctuations
by managing the relationship between our interest rate sensitive assets and
liabilities. See "-- Financial Condition -- Interest Rate Sensitivity and
Liquidity."

FINANCIAL CONDITION

Loan Portfolio

Total loans were $188.0 million at June 30, 1999, an increase of $17.5
million, or 10.3%, from $170.5 million at December 31, 1998. Loan growth
occurred primarily in 1-4 family residential and

27
<PAGE> 31

agricultural loans. Period end loans comprised 44.4% of average earning assets
at June 30, 1999 compared with 51.9% at December 31, 1998.

The following table summarizes our loan portfolio by type of loan as of
June 30, 1999 and December 31, 1998:

<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
------------------ ------------------
AMOUNT PERCENT AMOUNT PERCENT
-------- ------- -------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Commercial and industrial...................... $ 18,699 9.9% $ 16,972 10.0%
Real estate:
Construction and land development............ 2,012 1.1 1,727 1.0
1-4 family residential....................... 86,945 46.2 80,062 46.9
Home equity.................................. 9,908 5.3 8,077 4.7
Commercial mortgages......................... 25,238 13.4 22,240 13.1
Farmland..................................... 5,917 3.2 6,148 3.6
Multifamily residential...................... 1,405 0.8 1,090 0.6
Agriculture.................................... 18,578 9.9 14,107 8.3
Consumer....................................... 19,332 10.2 20,055 11.8
-------- ----- -------- -----
Total loans.......................... $188,034 100.0% $170,478 100.0%
======== ===== ======== =====
</TABLE>

Our lending focus is on 1-4 family residential, agricultural, small and
medium-sized business and consumer loans. We offer a variety of commercial
lending products including term loans and lines of credit. We also offer a broad
range of short to medium-term commercial loans, primarily collateralized, 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, we have originated loans for
our own account and have not securitized our loans. The purpose of a particular
loan generally determines its structure. All loans in the 1-4 family residential
category were originated by us.

Loans from $300,000 to $750,000 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.

In nearly all cases, our commercial loans are made in our primary market
area and are underwritten on the basis of the borrower's ability to service such
debt from income. As a general practice, we take as collateral a lien on any
available real estate, equipment or other assets owned by the borrower and
obtain 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.

In addition to commercial loans secured by real estate, we make commercial
mortgage loans to finance the purchase of real property, which generally
consists of real estate with completed structures. Our 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. We seek 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.

28
<PAGE> 32

Additionally, a significant portion of our lending activity has consisted
of the origination of 1-4 family residential mortgage loans collateralized by
owner-occupied properties located in our market areas. We offer a variety of
mortgage loan products which generally are amortized over five to 25 years.
Loans collateralized by 1-4 family residential real estate generally have been
originated in amounts of no more than 89% of appraised value or have mortgage
insurance. We require mortgage title insurance and hazard insurance. We have
elected to keep all 1-4 family residential loans for our own account rather than
selling such loans into the secondary market. By doing so, we are able to
realize a higher yield on these loans; however, we also incur interest rate risk
as well as the risks associated with nonpayments on such loans.

We make 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. We conduct 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 our construction lending activities. Construction loans involve
additional risks attributable to the fact that loan funds are advanced upon the
security of a project under construction, and the project is of uncertain value
prior to its completion. Because of uncertainties inherent in estimating
construction costs, the market value of the completed project and the effects of
governmental regulation on real property, it can be difficult to accurately
evaluate the total funds required to complete a project and the related loan to
value ratio. As a result of these uncertainties, construction lending often
involves the disbursement of substantial funds with repayment dependent, in
part, on the success of the ultimate project rather than the ability of a
borrower or guarantor to repay the loan. If we are forced to foreclose on a
project prior to completion, there is no assurance that we will be able to
recover all of the unpaid portion of the loan. In addition, we may be required
to fund additional amounts to complete a project and may have to hold the
property for an indeterminate period of time. While we have underwriting
procedures designed to identify what we believe 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.

The consumer loans we make 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 the collateral and size of the 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.

We provide agricultural loans for short-term crop production, including
rice, cotton, milo and corn, farm equipment financing and agricultural real
estate financing. We evaluate agricultural borrowers primarily based on 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, we routinely make on-site visits and inspections in order to
monitor and identify such risks.

29
<PAGE> 33

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
June 30, 1999 are summarized in the following table:

<TABLE>
<CAPTION>
JUNE 30, 1999
--------------------------------------------
AFTER ONE
ONE YEAR THROUGH AFTER FIVE
OR LESS FIVE YEARS YEARS TOTAL
-------- ---------- ---------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Commercial and industrial............................. $10,408 $4,691 $3,600 $18,699
Construction and land development..................... 1,693 319 -- 2,012
------- ------ ------ -------
Total........................................ $12,101 $5,010 $3,600 $20,711
======= ====== ====== =======
Loans with a predetermined interest rate.............. $ 5,687 $2,894 $1,495 $10,076
Loans with a floating interest rate................... 6,414 2,116 2,105 10,635
------- ------ ------ -------
Total........................................ $12,101 $5,010 $3,600 $20,711
======= ====== ====== =======
</TABLE>

We have adopted Statement of Financial Accounting Standards ("SFAS") No.
114, Accounting for Creditors for Impairment of a Loan, as amended by SFAS 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 we 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 either the present value of expected future cash flows discounted at
the loan's effective interest rate or the loan's observable market price or 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 effect
on our financial statements.

Nonperforming Assets

We have several procedures in place to assist us in maintaining the overall
quality of our loan portfolio. We have established underwriting guidelines to be
followed by our officers. We also monitor our delinquency levels for any
negative or adverse trends. There can be no assurance, however, that our loan
portfolio will not become subject to increasing pressures from deteriorating
borrower credit due to general economic conditions.

We require appraisals on loans secured by real estate. With respect to
potential problem loans, we make an evaluation of the borrower's overall
financial condition to determine the need, if any, for possible write-downs or
appropriate additions to the allowance for credit losses.

We generally place a loan on nonaccrual status and cease 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. We
generally charge off all loans before attaining nonaccrual status.

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

<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
-------- ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Nonaccrual loans............................................ $ -- $ 5
Restructured loans.......................................... -- --
Other real estate........................................... 128 135
----- -----
Total nonperforming assets........................ $ 128 $ 140
===== =====
Nonperforming assets to total loans and other real estate... 0.07% 0.08%
</TABLE>

30
<PAGE> 34

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 our loan portfolio. Based on an evaluation of the loan
portfolio, management presents a monthly review of the allowance for credit
losses to the bank's Board of Directors, indicating any change in the allowance
since the last review and any recommendations as to adjustments in the
allowance. In making its evaluation, management considers factors such as our
historical loan loss experience, industry diversification of our commercial loan
portfolio, the amount of nonperforming assets and related collateral, the
volume, growth and composition of our loan portfolio, current economic changes
that may affect the borrower's ability to pay and the value of collateral, the
evaluation of our loan portfolio through our internal loan review process and
other relevant factors. Charge-offs occur when loans are deemed to be
uncollectible.

Although we do 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. Some of the risk elements considered include:

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

- for 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;

- 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;

- 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;

- 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

- 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, we consider secondary sources of income and the
financial strength and credit history of the borrower and any guarantors.

We follow a loan review program to evaluate the credit risk in the loan
portfolio. Through the loan review process, we maintain 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.

31
<PAGE> 35

In addition to the internally classified loan list and delinquency list of
loans, we maintain a separate "watch list" which further aids us 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 those of a satisfactory
credit. We review 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 our
historical charge-off experience. We then charge 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, 1999, net recoveries totaled $33,000, or
(0.02)%, of average loans outstanding for the period, compared with net
charge-offs of $47,000, or 0.04%, of average loans for the six months ended June
30, 1998. During the six months ended June 30, 1999, we recorded a provision for
credit losses of $130,000 compared with $145,000 for the same period in 1998. At
June 30, 1999, the allowance totaled $2.0 million, or 1.07% of total loans,
compared with $1.1 million, or 0.79% of total loans, at June 30, 1998.

The following table presents, for the periods indicated, an analysis of the
allowance for credit losses and other related data:

<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
-----------------------
1999 1998
---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Average loans outstanding................................... $178,861 $129,228
======== ========
Gross loans outstanding at end of period.................... $188,034 $141,080
======== ========
Allowance for credit losses at beginning of period.......... $ 1,850 $ 1,016
Balance acquired with Union acquisition..................... -- --
Provision for credit losses................................. 130 145
Charge-offs:
Commercial and industrial................................. -- (1)
Real estate and agriculture............................... (4) (12)
Consumer.................................................. (15) (42)
Recoveries:
Commercial and industrial................................. 5 2
Real estate and agriculture............................... 44 --
Consumer.................................................. 3 6
-------- --------
Net recoveries (charge-offs)................................ 33 (47)
-------- --------
Allowance for credit losses at end of period................ $ 2,013 $ 1,114
======== ========
Ratio of allowance to end of period loans................... 1.07% 0.79%
Ratio of net (recoveries) charge-offs to average loans...... (0.02) 0.04
Ratio of allowance to end of period nonperforming loans..... -- --
</TABLE>

32
<PAGE> 36

The following table describes the allocation of the allowance for credit
losses among various categories of loans and certain other information at June
30, 1999. 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, 1999
-------------------------
PERCENT OF LOANS
AMOUNT TO TOTAL LOANS
------ ----------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Balance of allowance for credit losses applicable to:
Commercial and industrial................................. $ 13 9.9%
Real estate............................................... 18 70.0
Agriculture............................................... 31 9.9
Consumer.................................................. 4 10.2
Unallocated............................................... 1,947 --
------ -----
Total allowance for credit losses................. $2,013 100.0%
====== =====
</TABLE>

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 our recent rate of charge-offs is low, management is aware
that we have been operating in an extremely beneficial economic environment. Our
management, along with a number of economists, has perceived during the past
year an increasing instability in the national and Southeast 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 we have
grown, our aggregate loan portfolio has increased and since we have made a
decision to diversify our loan portfolio into areas other than 1-4 family
residential mortgage loans, the risk profile of our loans has increased. By
virtue of our increased capital levels, we are 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.

We believe that the allowance for credit losses at June 30, 1999 is
adequate to cover losses inherent in the portfolio as of such date. There can be
no assurance, however, that we will not sustain losses in future periods which
could be substantial in relation to the size of the allowance at June 30, 1999.

Securities

We use our securities portfolio both as a source of income and as a source
of liquidity. At June 30, 1999, investment securities totaled $221.7 million, a
decrease of $6.0 million, or 2.7%, from $227.7 million at December 31, 1998. At
June 30, 1999, securities represented 50.1% of total assets compared with 52.2%
of total assets at December 31, 1998.

33
<PAGE> 37

The following table presents the amortized cost and fair value of
securities classified as available-for-sale at June 30, 1999:

<TABLE>
<CAPTION>
JUNE 30, 1999
------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE
--------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
U.S. Treasury securities and obligations of
U.S. government agencies................... $ 91,468 $ 13 $1,618 $ 89,863
Mortgage-backed securities................. 34,371 41 866 33,546
States and political subdivisions.......... 3,976 128 -- 4,104
Collateralized mortgage obligations........ 10,270 407 20 10,657
-------- ---- ------ --------
Total............................ $140,085 $589 $2,504 $138,170
======== ==== ====== ========
</TABLE>

The following table presents the amortized cost and fair value of
securities classified as held-to-maturity at June 30, 1999:

<TABLE>
<CAPTION>
JUNE 30, 1999
---------------------------------------------
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.................... $42,569 $156 $ 85 $42,640
Mortgage-backed securities.................. 26,149 87 163 26,073
States and political subdivisions........... 14,570 120 49 14,641
Collateralized mortgage obligations......... 223 -- -- 223
------- ---- ---- -------
Total............................. $83,511 $363 $297 $83,577
======= ==== ==== =======
</TABLE>

Mortgage-backed securities are securities that have been developed by
pooling a number of real estate mortgages and which 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, 1999, 56.5% of the mortgage-backed securities we held had
contractual final maturities of more than ten years with a weighted average life
of 4.7 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.

34
<PAGE> 38

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>
JUNE 30, 1999
-------------------------------------------------------------------------------------------
AFTER ONE YEAR AFTER FIVE YEARS
BUT BUT
WITHIN ONE WITHIN FIVE WITHIN TEN AFTER TEN
YEAR YEARS YEARS YEARS TOTAL
--------------- ---------------- ----------------- --------------- ----------------
AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD
------- ----- -------- ----- -------- ------ ------- ----- -------- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Treasury securities
and obligations of U.S.
government agencies........ $11,599 6.00% $ 96,354 6.01% $26,086 6.16% $ -- --% $134,039 6.04%
Mortgage-backed
securities............... 3,724 5.07 16,066 6.21 6,541 6.40 34,188 5.91 60,519 5.99
States and political
subdivisions............. 2,355 6.82 11,902 6.95 4,016 7.37 272 10.62 18,545 7.08
Collateralized mortgage
obligations.............. -- -- -- -- 223 4.66 10,270 6.44 10,493 6.40
------- -------- ------- ------- --------
Total.............. $17,678 5.91% $124,322 6.13% $36,866 6.33% $44,730 6.09% $223,596 6.13%
======= ==== ======== ==== ======= ==== ======= ===== ======== ====
</TABLE>

The tax-exempt states and political subdivisions are not calculated on a
tax-equivalent basis. On a tax-equivalent basis, the yield on states and
political subdivisions would have been 7.46% at June 30, 1999.

We have adopted SFAS No. 115, Accounting for Certain Investments in Debt
and Equity Securities. At the date of purchase, we are 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.

Premises and Equipment

Premises and equipment, net of accumulated depreciation, totaled $6.1
million at June 30, 1999 and December 31, 1998, respectively.

Deposits

We offer a variety of deposit accounts having a wide range of interest
rates and terms. Our deposits consist of demand, savings, money market and time
accounts. We rely primarily on competitive pricing policies and customer service
to attract and retain these deposits. We do not have or accept any brokered
deposits.

Total deposits at June 30, 1999 were $398.4 million compared with $390.7
million at December 31, 1998, an increase of $7.7 million, or 1.97%. At June 30,
1999, noninterest-bearing deposits accounted for approximately 20.3% of total
deposits compared with 21.8% of total deposits at December 31, 1998.
Interest-bearing deposits totaled $317.5 million, or 79.7%, of total deposits at
June 30, 1999 compared with $305.7 million, or 78.3%, of total deposits at
December 31, 1998.

35
<PAGE> 39

The daily average balances and weighted average rates paid on deposits for
the period ended June 30, 1999 are presented below:

<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30, 1999
-----------------
AMOUNT RATE
--------- -----
<S> <C> <C>
Interest-bearing checking................................... $ 49,454 1.52%
Regular savings............................................. 13,790 2.44
Money market savings........................................ 108,440 3.43
Time deposits............................................... 158,573 4.75
-------- ----
Total interest-bearing deposits................... 330,257 3.74
Noninterest-bearing deposits................................ 81,807 --
-------- ----
Total deposits.................................... $412,064 3.00%
======== ====
</TABLE>

The following table sets forth the amount of our certificates of deposit
that were $100,000 or greater by time remaining until maturity at June 30, 1999:

<TABLE>
<CAPTION>
JUNE 30, 1999
----------------------
(DOLLARS IN THOUSANDS)
<S> <C>
Three months or less............................. $17,887
Over three through six months.................... 8,842
Over six through 12 months....................... 12,207
Over 12 months................................... 4,046
-------
Total deposits......................... $42,982
=======
</TABLE>

Other Borrowings

We had $570,000 in Federal Home Loan Bank advances at June 30, 1999,
compared with $2.4 million in such advances at December 31, 1998. The amount of
FHLB advances we have at any given time is based on our daily liquidity position
and will increase or decrease according to our funding needs.

Interest Rate Sensitivity and Liquidity

Our asset liability and funds management policy provides management with
the necessary guidelines for effective funds management, and we have established
a measurement system for monitoring our net interest rate sensitivity position.
We manage our sensitivity position within established guidelines.

Interest rate risk is managed by the Asset Liability Committee ("ALCO"),
which is composed of our senior officers, in accordance with policies approved
by our 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 liabilities; and (ii) an
interest rate shock simulation model. We have traditionally managed our business
to reduce its overall exposure to changes in interest rates.

We manage our exposure to interest rates by structuring our balance sheet
in the ordinary course of business. We do not enter into instruments such as
leveraged derivatives, interest rate swaps, financial

36
<PAGE> 40

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 our interest rate sensitivity analysis at
June 30, 1999:

<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........................................ $ 26,177 $ 15,065 $ 18,782 $163,572 $223,596
Loans............................................. 37,072 16,807 17,235 116,920 188,034
Federal funds sold and other temporary
investments..................................... 45 -- -- -- 45
--------- --------- --------- -------- --------
Total interest-earning assets............... 63,294 31,872 36,017 280,492 411,675
--------- --------- --------- -------- --------
Interest-bearing liabilities:
Demand, money market and savings deposits......... 161,966 -- -- -- 161,966
Certificates of deposit and other time deposits... 16,146 69,391 48,008 22,022 155,567
Federal funds purchased and FHLB advances......... 570 -- -- -- 570
--------- --------- --------- -------- --------
Total interest-bearing liabilities.......... 178,682 69,391 48,088 22,022 318,103
--------- --------- --------- -------- --------
Period GAP.......................................... $(115,388) $ (37,519) $ (11,991) $258,470 $ 93,572
Cumulative GAP...................................... $(115,388) $(152,907) $(164,898) $ 93,572
Period GAP to total assets.......................... (26.06)% (8.47)% (2.71)% 58.37%
Cumulative GAP to total assets...................... (26.06)% (34.53)% (37.24)% 21.13%
</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, we use 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 our June 30, 1999 simulation analysis, we estimate that a 200 basis
point rise in rates over the next 12 month period would have an impact of
approximately (7.36)% on our net interest income for the period, while a 200
basis point decline in rates over the same period would have an impact of
approximately (2.99)% on our net interest income for the period. The change is
relatively small, despite our liability sensitive GAP position. The results are
primarily from the behavior of demand, money market and savings deposits. We
have 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.

37
<PAGE> 41

As a financial institution, our 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 our 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 our operations, we are not subject to foreign
exchange or commodity price risk. We do not own any trading assets.

Our exposure to market risk is reviewed by senior management and our
Investment Committee 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 our 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 on an ongoing basis.
During the past three years, our 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, we do 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.

Asset liquidity is provided by cash and assets which are readily marketable
or which will mature in the near future. As of June 30, 1999, we had cash and
cash equivalents of $12.5 million, down from $18.2 million at December 31, 1998.
The decline was due primarily to an increase in loans.

Capital Resources

Capital management consists of providing equity to support both current and
future operations. We are subject to capital adequacy requirements imposed by
the Federal Reserve and the bank is subject to capital adequacy requirements
imposed by the FDIC and the Texas Banking Department. Both the Federal Reserve
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 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 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
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
38
<PAGE> 42

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 the 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'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.

Shareholders' equity increased to $42.2 million at June 30, 1999 compared
with $41.4 million at December 31, 1998, an increase of $793,000, or 1.9%. The
increase was primarily due to net earnings of $2.9 million, cash dividends paid
of $519,000, and an unrealized loss on available for sale securities of $1.3
million for the six months ended June 30, 1999.

The following table provides a comparison of the leverage and risk-weighted
capital ratios of us and the bank as of June 30, 1999 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 JUNE 30, 1999
----------------- ---------------------- ---------------
<S> <C> <C> <C>
PROSPERITY
Leverage ratio................... 3.00%(1) N/A 7.69%
Tier 1 risk-based capital
ratio......................... 4.00% N/A 18.09%
Risk-based capital ratio......... 8.00% N/A 19.16%
FIRST PROSPERITY BANK
Leverage ratio................... 3.00%(2) 5.00% 5.84%
Tier 1 risk-based capital
ratio......................... 4.00% 6.00% 13.74%
Risk-based capital ratio......... 8.00% 10.00% 14.81%
</TABLE>

- ---------------

(1) The Federal Reserve may require us 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 we or our
suppliers or borrowers do not address these issues, there could be a material
adverse impact on our financial condition or results of operations.

State of Readiness. We formally initiated our Year 2000 project and plan in
November 1997 to insure that our operational and financial systems will not be
adversely affected by Year 2000 related problems. We have 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 us and an assessment of all major IT and
critical non-IT

39
<PAGE> 43

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. Our assessment of critical non-IT systems involved
reviewing such systems to determine whether they were date dependent. Based on
such assessment, we believe that none of our critical non-IT systems are date
dependent. The software for our systems is provided through service bureaus and
software vendors. We have contacted all of our third party vendors and software
providers and are requiring them to demonstrate and represent that the products
provided are or will be Year 2000 compliant and have planned a program of
testing compliance. Our service bureau, which performs substantially all of our
data processing functions, has warranted in writing that its software is Year
2000 compliant and pursuant to applicable regulatory guidelines we have reviewed
the results of user group tests performed by the service provider to verify this
assertion. We believe that we would have recourse against the service provider
for actual damages we incur in the event the service provider breaches this
warranty. In addition, the FDIC has reviewed our compliance with Year 2000
issues.

We have completed the following phases of our Year 2000 plan: (i)
recognizing Year 2000 issues, (ii) assessing the impact of Year 2000 issues on
our critical systems, (iii) upgrading systems as necessary to resolve those Year
2000 issues which have been identified and (iv) developing a business resumption
contingency plan. We have implemented and tested all of our mission critical
systems and continue to monitor customer awareness of Year 2000 issues.

Costs of Compliance. Management does not expect the costs of bringing our
systems into Year 2000 compliance will have a material adverse effect on our
financial condition, results of operations or liquidity. We have budgeted
$10,000 to address Year 2000 issues. As of June 30, 1999, we have incurred
expenses of $6,000 in relation to Year 2000. The largest potential internal risk
to us concerning Year 2000 is the malfunction of our data processing system. In
the event our data processing system does not function properly, we are prepared
to perform functions manually. We believe we are 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 noncompliance by
third parties with which we transact business cannot be accurately gauged. We
identified our largest dollar deposit (aggregate deposits over $500,000) and
loan ($250,000 or more) customers and, based on information available to us,
conducted an evaluation to determine which of those customers are likely to be
affected by Year 2000 issues. We 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 responses indicated that the customers are aware of
Year 2000 issues, are in the process of updating their systems and have informed
us that they believe they will be ready for the Year 2000 date change by the end
of 1999. We will continue to monitor our customers deemed at risk and will
encourage customers to resolve any identified problems. To the extent a problem
is identified, we intend to monitor the customer's progress in resolving such
problem. In the event that Year 2000 noncompliance adversely affects a borrower,
we 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, we plan
to maintain additional cash on hand. We also have access to the FHLB and Federal
Reserve discount windows to address any additional liquidity needs. With respect
to borrowers, our loan documents include a Year 2000 disclosure form and an
addendum to the loan agreement in which the borrower represents and warrants its
Year 2000 compliance to us.

Customer Awareness. We have implemented a series of notifications to our
customers via statement inserts, statement messages and community forums. Future
plans for increasing customer awareness will include advertising and signs
regarding the Year 2000 issue located in the lobby of each banking center.

Contingency Plans. We have finalized our contingency planning with respect
to the Year 2000 date change and believe that if our own systems should fail, we
could convert to a manual entry system for a period of up to six months without
significant losses. We believe that any mission critical systems could be
recovered and operating within seven days. In the event that the Federal Reserve
is unable to handle

40
<PAGE> 44

electronic funds transfers and check clearing, we do not expect the impact to be
material to our financial condition or results of operations as long as we are
able to utilize an alternative electronic funds transfer and clearing source. As
part of our contingency planning, we have reviewed our loan customer base and
the potential impact on capital of Year 2000 noncompliance. Based upon such
review, using what we consider to be a reasonable worst case scenario, we have
assumed that certain of our 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, we believe that it is unlikely that our exposure would
exceed $100,000, although there are no assurances that this amount will not be
substantially higher. We do not believe that this amount is material enough for
us to adjust our current methodology for making provisions to the allowance for
credit losses. In addition, we plan to maintain additional cash on hand to meet
any unusual deposit withdrawal activity.

41
<PAGE> 45

FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996

OVERVIEW

Net income was $4.5 million, $3.6 million and $2.7 million for the years
ended December 31, 1998, 1997 and 1996, respectively, and diluted earnings per
share were $1.04, $0.92 and $0.76 for these same periods. Net income increased
$851,000, or 31.4%, from 1996 to 1997 primarily due to internal growth, the
acquisition of the Angleton, Texas branch of Wells Fargo bank in the second
quarter of 1997 and the acquisition of the Bay City, Texas branch of Norwest
Bank, Texas in 1996. Net income increased $898,000, or 25.2%, from 1997 to 1998
primarily due to internal growth and the Union and Angleton acquisitions. We
estimate that slightly greater than one-half of the increase in net income in
both 1997 and 1998 was due to internal growth. We posted returns on average
assets of 1.26%, 1.17% and 1.05% and returns on average equity of 15.97%, 16.32%
and 15.36% for 1998, 1997 and 1996, respectively. We posted returns on average
assets excluding amortization of goodwill of 1.40%, 1.30%, and 1.15% and returns
on average equity excluding amortization of goodwill of 17.76%, 18.17% and
16.82% for the years ended December 31, 1998, 1997 and 1996, respectively. Our
efficiency ratio was 57.38% in 1998, 59.48% in 1997 and 61.34% in 1996. Our
efficiency ratio excluding amortization of goodwill was 54.21% in 1998, 56.43%
in 1997 and 58.96% in 1996.

Total assets at December 31, 1998, 1997 and 1996 were $436.3 million,
$320.1 million and $294.0 million, respectively. Total deposits at December 31,
1998, 1997 and 1996 were $390.7 million, $291.5 million and $270.9 million,
respectively, with deposit growth from 1996 to 1997 resulting from the Angleton
acquisition and deposit growth from 1997 to 1998 resulting from internal growth
and the Union acquisition. Loans were $170.5 million at December 31, 1998, an
increase of $49.9 million, or 41.4%, from $120.6 million at the end of 1997.
Loans were $113.4 million at year end 1996. Shareholders' equity was $41.4
million, $24.8 million, and $18.8 million at December 31, 1998, 1997 and 1996,
respectively. The increase in shareholders' equity from 1997 to 1998 is
primarily due to our initial public offering of 1,182,517 shares of common stock
in November 1998, in which we raised net proceeds of $12.8 million.

RESULTS OF OPERATIONS

Net Interest Income

1998 versus 1997. Our net interest income for 1998 was $13.3 million,
compared with $10.9 million for 1997, an increase of $2.4 million, or 22.0%. The
improvement in net interest income for 1998 was mainly due to an increase in
total average interest-earning assets and a decrease in funding costs. Average
interest-earning assets increased $50.1 million from $278.8 million to $328.3
million in 1998. Total funding costs decreased eight basis points from 4.04% in
1997 to 3.96% in 1998. For 1998, the net interest margin on a tax-equivalent
basis increased 11 basis points to 4.13% from 4.02% in 1997.

1997 versus 1996. Our net interest income in 1997 was $10.9 million, an
increase of 22.5% over the 1996 level of $8.9 million, due to an increase in the
loan portfolio in 1997. For 1997 as a whole, our funding costs decreased seven
basis points from 4.11% to 4.04%, while asset yields increased eight basis
points from 7.08% to 7.16%.

42
<PAGE> 46

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,
------------------------------------------------------------------------------------------------------
1998 1997 1996
-------------------------------- -------------------------------- --------------------------------
AVERAGE INTEREST AVERAGE AVERAGE INTEREST AVERAGE AVERAGE INTEREST AVERAGE
OUTSTANDING EARNED/ YIELD/ OUTSTANDING EARNED/ YIELD/ OUTSTANDING EARNED/ YIELD/
BALANCE PAID RATE BALANCE PAID RATE BALANCE PAID RATE
----------- -------- ------- ----------- -------- ------- ----------- -------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
ASSETS
Interest-earning assets:
Loans................... $143,196 $12,282 8.58% $117,586 $10,205 8.68% $104,534 $9,136 8.74%
Securities(1)........... 178,416 10,834 6.07 157,677 9,572 6.07 127,607 7,396 5.80
Federal funds sold and
other temporary
investments........... 6,676 306 4.58 3,545 193 5.44 5,743 309 5.38
-------- ------- -------- ------- -------- ------
Total
interest-earning
assets.......... 328,288 23,422 7.13% 278,808 19,970 7.16% 237,884 16,841 7.08%
------- ------- ------
Less allowance for
credit losses......... (1,271) (961) (820)
-------- -------- --------
Total
interest-earning
assets, net of
allowance....... 327,017 277,847 237,064
Noninterest-earning
assets................ 27,834 26,239 20,141
-------- -------- --------
Total assets...... $354,851 $304,086 $257,205
======== ======== ========
LIABILITIES AND
SHAREHOLDERS' EQUITY
Interest-bearing
liabilities:
Interest-bearing demand
deposits.............. $ 41,710 $ 670 1.61% $ 42,898 $ 915 2.13% $ 35,285 $ 741 2.10%
Savings and money market
accounts.............. 83,428 2,838 3.40 64,448 2,158 3.35 49,429 1,620 3.28
Certificates of
deposit............... 128,097 6,485 5.06 113,669 5,785 5.09 105,538 5,359 5.08
Federal funds purchased
and other
borrowings............ 2,267 135 5.96 3,030 202 6.67 2,402 203 8.45
-------- ------- -------- ------- -------- ------
Total
interest-bearing
liabilities..... 255,502 10,128 3.96% 224,045 9,060 4.04% 192,654 7.923 4.11%
-------- ------- -------- ------- -------- ------
Noninterest-bearing
liabilities:
Noninterest-bearing
demand deposits....... 69,810 57,362 46,082
Other liabilities....... 1,606 858 823
-------- -------- --------
Total
liabilities..... 326,918 282,265 239,559
-------- -------- --------
Shareholders' equity...... 27,933 21,821 17,646
-------- -------- --------
Total liabilities
and
shareholders'
equity.......... $354,851 $304,086 $257,205
======== ======== ========
Net interest rate
spread.................. 3.17% 3.12% 2.97%
Net interest income and
margin(2)............... $13,294 4.05% $10,910 3.91% $8,918 3.75%
======= ======= ======
Net interest income and
margin (tax-equivalent
basis)(3)............... $13,571 4.13% $11,222 4.02% $9,290 3.91%
======= ======= ======
</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.

43
<PAGE> 47

The following table presents the dollar amount of changes in interest
income and interest expense for the major components of interest-earning assets
and interest-bearing liabilities and distinguishes between the increase
(decrease) related to 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.

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------------------
1998 VS. 1997 1997 VS. 1996
----------------------- ----------------------
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..................................... $2,223 $(146) $2,077 $1,141 $(72) $1,069
Securities................................ 1,259 3 1,262 1,744 432 2,176
Federal funds sold and other temporary
investments............................ 170 (57) 113 (118) 2 (116)
------ ----- ------ ------ ---- ------
Total increase (decrease) in
interest income................. 3,652 (200) 3,452 2,767 362 3,129
------ ----- ------ ------ ---- ------
Interest-bearing liabilities:
Interest-bearing demand deposits.......... (25) (220) (245) 160 14 174
Savings and money market accounts......... 636 44 680 493 45 538
Certificates of deposit................... 734 (34) 700 413 13 426
Federal funds purchased and other
borrowings............................. (51) (16) (67) 53 (54) (1)
------ ----- ------ ------ ---- ------
Total increase (decrease) in
interest expense................ 1,294 (226) 1,068 1,119 18 1,137
------ ----- ------ ------ ---- ------
Increase in net interest income............. $2,358 $ 26 $2,384 $1,648 $344 $1,992
====== ===== ====== ====== ==== ======
</TABLE>

Provision for Credit Losses

The allowance for credit losses at December 31, 1998 was $1.9 million,
representing 1.09% of outstanding loans. One year earlier, this ratio was 0.84%
of outstanding loans. The provision for credit losses charged against earnings
was $239,000 in 1998 compared with $190,000 in 1997. We made the increased
provision in response to the increase in our loan portfolio, our increased legal
lending limit and the changing risk profile in our loan portfolio. Net loans
charged off in 1998 were $66,000 compared with $97,000 in loan charge-offs in
1997.

During 1997, we made provisions totaling $190,000 to the allowance for
credit losses, a decrease of $40,000 compared with 1996. We recorded a lower
provision in 1997 because we 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 loan charge-offs
for 1996.

Noninterest Income

In 1998, noninterest income totaled $2.5 million, an increase of $228,000,
or 10.1%, versus $2.3 million in 1997. The increase was primarily due to the
Union and Angleton acquisitions and an increase in customer service fees.
Noninterest income for 1997 was $2.3 million, a $367,000 or 19.3% increase from
1996 resulting largely from an increase in income due to insufficient funds
charges and customer service fees.

44
<PAGE> 48

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

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------
1998 1997 1996
------ ------ ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Service charges on deposit accounts........................ $2,173 $2,062 $1,742
Other noninterest income................................... 319 202 155
------ ------ ------
Total noninterest income......................... $2,492 $2,264 $1,897
====== ====== ======
</TABLE>

Noninterest Expense

For the years ended 1998, 1997 and 1996, noninterest expense totaled $9.1
million, $7.8 million and $6.6 million, respectively. Our efficiency ratio
showed a positive trend over this period as it was reduced from 59% in 1996 to
54% in 1998. This reduction reflects our continued success in controlling
operating expenses and integrating the Union, Angleton and Bay City
acquisitions.

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

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------
1998 1997 1996
------ ------ ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Salaries and employee benefits............................. $4,541 $3,968 $3,415
Non-staff expenses:
Net occupancy expense.................................... 768 811 710
Equipment depreciation................................... 290 431 367
Data processing.......................................... 807 642 493
Professional fees........................................ 112 97 114
Regulatory assessments and FDIC insurance................ 73 63 28
Ad valorem and franchise taxes........................... 200 164 140
Goodwill amortization.................................... 500 402 257
Other.................................................... 1,767 1,258 1,110
------ ------ ------
Total noninterest expense........................ $9,058 $7,836 $6,634
====== ====== ======
</TABLE>

For 1998, noninterest expense totaled $9.1 million, an increase of $1.2
million, or 15.6%, over $7.8 million in 1997. Salaries and employee benefits for
1998 totaled $4.5 million, an increase of $573,000, or 14.4%, over $4.0 million
for 1997. Other operating expenses of $1.8 million represented an increase of
$509,000, or 40.5%, compared with $1.3 million in 1997. These increases were
principally due to the Union and Angleton acquisitions. Total noninterest
expenses in 1997 were $7.8 million, an 18.2% increase over the 1996 level of
$6.6 million due principally to the Angleton and Bay City acquisitions. Salaries
and employee benefits in 1997 increased by 16.2% from $3.4 million for the year
ended December 31, 1996 to $4.0 million. The increase was principally due to
additional staff associated with the Union and Angleton acquisitions.

Income Taxes

Income tax expense for the year ended December 31, 1998 was $2.0 million
compared with $1.6 million for the year ended December 31, 1997 and $1.2 million
for the year ended December 31, 1996. The effective tax rate in the years ended
1998, 1997 and 1996 was 31.3%, 30.8% and 31.4%, respectively.

45
<PAGE> 49

FINANCIAL CONDITION

Loan Portfolio

At December 31, 1998, loans were $170.5 million, an increase of $49.9
million or 41.4% from $120.6 million at December 31, 1997. The growth in the
loan portfolio was due to continued strong loan demand, especially in the real
estate area. Our 1-4 family residential loans increased from $53.6 million at
December 31, 1997 to $88.1 million at year end 1998. Agriculture loans also had
a substantial increase from $6.4 million at year end 1997 to $14.1 million at
year end 1998. The growth in agricultural loans was due mainly to the Union
acquisition. At December 31, 1998, total loans were 43.6% of deposits and 39.1%
of total assets. At December 31, 1997, total loans were 41.4% of deposits and
37.7% of total assets.

Loans increased 6.3% during 1997 from $113.4 million at December 31, 1996
to $120.6 million at December 31, 1997. The loan growth during 1997 was
primarily spread between real estate and agriculture loans and was due to
increased demand for loans.

The following table summarizes our loan portfolio by type of loan as of the
dates indicated:

<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
------------------ ------------------ ------------------ ----------------- -----------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
-------- ------- -------- ------- -------- ------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Commercial and
industrial................. $ 16,972 9.9% $ 11,611 9.6% $ 10,633 9.4% $10,445 11.8% $ 9,479 12.4%
Real estate:
Construction and land
development............ 1,727 1.0 6,453 5.3 5,021 4.4 2,507 2.8 2,139 2.8
1-4 family residential... 80,062 47.0 53,625 44.5 49,845 44.0 40,331 45.4 37,247 48.7
Home equity.............. 8,077 4.7 NA NA NA NA NA NA NA NA
Commercial mortgages..... 22,240 13.1 16,277 13.5 14,376 12.7 12,835 14.5 9,520 12.5
Farmland................. 6,148 3.6 5,804 4.8 5,468 4.8 3,989 4.5 3,529 4.6
Multifamily
residential............ 1,090 0.6 937 0.8 1,068 0.9 716 0.8 64 0.0
Agriculture................ 14,107 8.3 6,359 5.3 5,686 5.0 4,666 5.2 4,605 6.0
Consumer................... 20,055 11.8 19,512 16.2 21,285 18.8 13,308 15.0 9.960 13.0
-------- ----- -------- ----- -------- ----- ------- ----- ------- -----
Total loans........ $170,478 100.0% $120,578 100.0% $113,382 100.0% $88,797 100.0% $76,543 100.0%
======== ===== ======== ===== ======== ===== ======= ===== ======= =====
</TABLE>

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, 1998 are summarized in the following table:

<TABLE>
<CAPTION>
DECEMBER 31, 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..................... $10,354 $4,355 $2,263 $16,972
Construction and land development............. 1,707 20 -- 1,727
------- ------ ------ -------
Total............................... $12,061 $4,375 $2,263 $18,699
======= ====== ====== =======
Loans with a predetermined interest rate...... $ 6,248 $2,879 $1,670 $10,797
Loans with a floating interest rate........... 5,813 1,496 593 7,902
------- ------ ------ -------
Total............................... $12,061 $4,375 $2,263 $18,699
======= ====== ====== =======
</TABLE>

Nonperforming Assets

Our conservative lending approach, as well as a healthy local economy, have
resulted in strong asset quality. We had nonperforming assets of $140,000 at
December 31, 1998 and no nonperforming assets as of December 31, 1997 or 1996.

46
<PAGE> 50

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

<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------
1998 1997 1996 1995 1994
----- ----- ----- ----- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Nonaccrual loans....................................... $ 5 $ -- $ -- $ -- $ --
Restructured loans..................................... -- -- -- -- --
Other real estate...................................... 135 -- -- -- 15
----- ----- ----- ----- -----
Total nonperforming assets................... $ 140 $ -- $ -- $ -- $ 15
===== ===== ===== ===== =====
Nonperforming assets to total loans and other real
estate............................................... 0.08% 0.00% 0.00% 0.00% 0.02%
</TABLE>

Allowance for Credit Losses

For the year ended 1998, net charge-offs totaled $66,000 or 0.05% of
average loans outstanding for the period, compared with net charge-offs of
$97,000 or 0.08% of average loans outstanding during 1997. Our net charge-offs
totaled $60,000 or 0.06% of average loans outstanding in 1996. During 1998, we
recorded a provision for credit losses of $239,000 compared with $190,000 for
1997. At December 31, 1998, the allowance totaled $1.9 million, or 1.09% of
total loans. We made a provision for credit losses of $190,000 during 1997
compared with a provision of $230,000 for 1996. At December 31, 1997, the
allowance aggregated $1.0 million, or 0.84% of total loans. At December 31,
1996, the allowance was $923,000, or 0.81% 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,
--------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Average loans outstanding................. $143,196 $117,586 $104,534 $81,631 $69,200
======== ======== ======== ======= =======
Gross loans outstanding at end of
period.................................. $170,478 $120,578 $113,382 $88,797 $76,543
======== ======== ======== ======= =======
Allowance for credit losses at beginning
of period............................... $ 1,016 $ 923 $ 753 $ 588 $ 734
Balance acquired with Union acquisition... 661 -- -- -- --
Provision for credit losses............... 239 190 230 175 188
Charge-offs:
Commercial and industrial............... -- (26) (9) (6) (31)
Real estate and agriculture............. (14) (47) -- (2) (270)
Consumer................................ (67) (57) (64) (24) (129)
Recoveries:
Commercial and industrial............... 5 15 -- -- 17
Real estate and agriculture............. -- 7 -- 3 51
Consumer................................ 10 11 13 19 28
-------- -------- -------- ------- -------
Net (charge-offs) recoveries.............. (66) (97) (60) (10) (334)
Allowance for credit losses at end of
period.................................. $ 1,850 $ 1,016 $ 923 $ 753 $ 588
======== ======== ======== ======= =======
Ratio of allowance to end of period
loans................................... 1.09% 0.84% 0.81% 0.85% 0.77%
Ratio of net charge-offs to average
loans................................... 0.05 0.08 0.06 0.01 0.48
Ratio of allowance to end of period
nonperforming loans..................... -- -- -- -- --
</TABLE>

47
<PAGE> 51

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,
-------------------------------------------
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.......................... $ 18 9.9% $ 41 9.6%
Real estate........................................ 70 70.0 59 68.9
Agriculture........................................ 40 8.3 -- 5.3
Consumer........................................... 1 11.8 51 16.2
Unallocated........................................ 1,721 -- 865 --
------ ----- ------ -----
Total allowance for credit losses.......... $1,850 100.0% $1,016 100.0%
====== ===== ====== =====
</TABLE>

<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------------------------------------
1996 1995 1994
-------------------- -------------------- --------------------
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...... $ 9 9.4% $ 7 11.8% $ 15 12.4%
Real estate.................... 34 66.8 27 68.0 33 68.6
Agriculture.................... -- 5.0 -- 5.2 -- 6.0
Consumer....................... 6 18.8 6 15.0 4 13.0
Unallocated.................... 874 -- 713 -- 536 --
---- ----- ---- ----- ---- -----
Total allowance for
credit losses........ $923 100.0% $753 100.0% $588 100.0%
==== ===== ==== ===== ==== =====
</TABLE>

Securities

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

<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
U.S. Treasury securities and obligations
of U.S. government agencies............. $128,603 $ 83,160 $ 60,830 $ 42,147 $ 33,037
Mortgage-backed securities.............. 66,651 64,168 59,382 41,278 34,956
States and political subdivisions....... 19,048 11,829 13,042 15,753 17,440
Collateralized mortgage obligations..... 12,914 8,749 14,341 18,411 36,676
-------- -------- -------- -------- --------
Total......................... $227,216 $167,906 $147,595 $117,589 $122,109
======== ======== ======== ======== ========
</TABLE>

48
<PAGE> 52

The following table summarizes the contractual maturity of securities and
their weighted average yields (available-for-sale securities are not adjusted
for unrealized gains or losses):

<TABLE>
<CAPTION>
DECEMBER 31, 1998
-------------------------------------------------------------------------------------------
AFTER ONE YEAR AFTER FIVE YEARS
WITHIN BUT WITHIN BUT WITHIN
ONE YEAR FIVE YEARS TEN YEARS AFTER TEN YEARS TOTAL
--------------- ---------------- ----------------- --------------- ----------------
AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD
------- ----- -------- ----- -------- ------ ------- ----- -------- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Treasury securities and
obligations of U.S. government
agencies............................ $18,654 6.07% $ 95,864 6.05% $14,081 6.39% $ -- --% $128,599 6.09%
Mortgage-backed securities.......... 5,515 4.43 23,193 6.16 7,589 6.4 30,361 6.01 66,658 5.98
States and political subdivisions... 1,473 5.04 11,617 4.84 5,684 5.07 272 7.45 19,046 4.96
Collateralized mortgage
obligations....................... 1,606 6.69 890 6.35 -- -- 10,417 6.29 12,913 6.34
------- -------- ------- ------- --------
Total....................... $27,248 5.72% $131,564 5.96% $27,354 6.12% $41,050 6.09% $227,216 5.98%
======= ==== ======== ==== ======= ==== ======= ==== ======== ====
</TABLE>

The following table summarizes the carrying value by classification of
securities as of the dates shown:

<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Available-for-sale...................... $113,828 $ 38,612 $ 49,342 $ 35,452 $ 25,411
Held-to-maturity........................ 113,916 129,256 98,222 82,053 96,501
-------- -------- -------- -------- --------
Total......................... $227,744 $167,868 $147,564 $117,505 $121,912
======== ======== ======== ======== ========
</TABLE>

At December 31, 1998, securities totaled $227.7 million, an increase of
$59.9 million, or 35.7%, from $167.9 million at December 31, 1997, as we
invested deposits from the Union acquisition. At December 31, 1998, securities
represented 56.7% of total deposits and 52.2% of total assets.

Securities increased $20.3 million, or 13.8%, from $147.6 million at
December 31, 1996 to $167.9 million at December 31, 1997, as we invested
deposits from the Angleton and Bay City acquisitions.

49
<PAGE> 53

The following tables present the amortized cost and fair value of
securities classified as available-for-sale at December 31, 1998, 1997 and 1996:

<TABLE>
<CAPTION>
DECEMBER 31, 1998 DECEMBER 31, 1997
---------------------------------------------- ---------------------------------------------
GROSS GROSS GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE COST GAINS LOSSES VALUE
--------- ---------- ---------- -------- --------- ---------- ---------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Treasury securities and
obligations of U.S. government
agencies...................... $ 67,864 $285 $ 58 $ 68,091 $19,988 $ 57 $ -- $20,045
Mortgage-backed securities.... 30,578 98 176 30,500 17,299 61 258 17,102
States and political
subdivisions................ 4,026 239 -- 4,265 1,363 102 -- 1,465
Collateralized mortgage
obligations................. 10,832 166 26 10,972 -- -- -- --
-------- ---- ---- -------- ------- ---- ---- -------
Total................. $113,300 $788 $260 $113,828 $38,650 $220 $258 $38,612
======== ==== ==== ======== ======= ==== ==== =======
</TABLE>

<TABLE>
<CAPTION>
DECEMBER 31, 1996
---------------------------------------------
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.................................... $29,980 $127 $ -- $30,107
Mortgage-backed securities............................. 17,952 43 306 17,689
States and political subdivisions...................... 1,441 105 -- 1,546
Collateralized mortgage obligations.................... -- -- -- --
------- ---- ---- -------
Total........................................ $49,373 $275 $306 $49,342
======= ==== ==== =======
</TABLE>

The following tables present the amortized cost and fair value of
securities classified as held-to-maturity at December 31, 1998, 1997 and 1996:

<TABLE>
<CAPTION>
DECEMBER 31, 1998 DECEMBER 31, 1997
---------------------------------------------- ----------------------------------------------
GROSS GROSS GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE COST GAINS LOSSES VALUE
--------- ---------- ---------- -------- --------- ---------- ---------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Treasury securities and
obligations of U.S. government
agencies...................... $ 60,739 $ 572 $ 2 $ 61,309 $ 63,171 $245 $ 21 $ 63,395
Mortgage-backed securities.... 36,074 265 100 36,239 46,871 372 222 47,021
States and political
subdivisions................ 2,081 -- 3 2,078 8,749 19 15 8,753
Collateralized mortgage
obligations................. 15,022 376 3 15,395 10,465 141 1 10,605
-------- ------ ---- -------- -------- ---- ---- --------
Total................. $113,916 $1,213 $108 $115,021 $129,256 $777 $259 $129,774
======== ====== ==== ======== ======== ==== ==== ========
</TABLE>

<TABLE>
<CAPTION>
DECEMBER 31, 1996
---------------------------------------------
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.................................... $30,849 $121 $121 $30,849
Mortgage-backed securities............................. 41,431 90 704 40,817
States and political subdivisions...................... 14,341 -- 103 14,238
Collateralized mortgage obligations.................... 11,601 173 18 11,756
------- ---- ---- -------
Total........................................ $98,222 $384 $946 $97,660
======= ==== ==== =======
</TABLE>

50
<PAGE> 54

Deposits

Deposits at December 31, 1998 were $390.7 million, an increase of $99.2
million, or 34.0%, from $291.5 million at December 31, 1997. The increase is
attributable to internal growth and the Union acquisition. Noninterest-bearing
deposits of $85.0 million at December 31, 1998 increased $23.6 million, or
38.4%, from $61.4 million at December 31, 1997. Noninterest-bearing deposits as
of December 31, 1997 were $61.4 million compared with $55.2 million at December
31, 1996. Interest-bearing deposits at December 31, 1998 were $305.7 million, up
$75.6 million, or 32.9%, from $230.1 million at December 31, 1997. Total
deposits at December 31, 1996 were $270.9 million.

The daily average balances and weighted average rates paid on deposits for
each of the years ended December 31, 1998, 1997 and 1996 are presented below:

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------------------
1998 1997 1996
--------------- --------------- ---------------
AMOUNT RATE AMOUNT RATE AMOUNT RATE
-------- ---- -------- ---- -------- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Interest-bearing checking................. $ 41,710 1.61% $ 42,898 2.13% $ 35,285 2.10%
Regular savings........................... 10,640 2.45 9,215 2.32 7,674 2.46
Money market savings...................... 72,788 3.54 55,233 3.50 41,755 3.43
Time deposits............................. 128,097 5.06 113,669 5.08 105,538 5.08
-------- ---- -------- ---- -------- ----
Total interest-bearing
deposits...................... 253,235 3.95 221,015 4.00 190,252 4.06
Noninterest-bearing deposits.............. 69,810 -- 57,362 -- 46,082 --
-------- ---- -------- ---- -------- ----
Total deposits.................. $323,045 3.09% $278,377 3.18% $236,334 3.27%
======== ==== ======== ==== ======== ====
</TABLE>

The following table sets forth the amount of our certificates of deposit
that were $100,000 or greater by time remaining until maturity at December 31,
1998:

<TABLE>
<CAPTION>
DECEMBER 31, 1998
----------------------
(DOLLARS IN THOUSANDS)
<S> <C>
Three months or less.............................. $ 5,835
Over three through six months..................... 9,603
Over six through 12 months........................ 21,296
Over 12 months.................................... 6,097
-------
Total deposits.......................... $42,831
=======
</TABLE>

Other Borrowings

Deposits are our primary source of funds for lending and investment
activities. Occasionally, we obtain additional funds from the Federal Home Loan
Bank and correspondent banks. At December 31, 1998, we had borrowings of $2.4
million compared with $2.8 million at December 31, 1997 and zero at December 31,
1996.

At December 31, 1998 and 1997, we had no outstanding borrowings under a
revolving line of credit extended by a commercial bank. At December 31, 1996, we
had $3.3 million outstanding under this line of credit.

51
<PAGE> 55

Interest Rate Sensitivity and Liquidity

The following table sets forth our interest rate sensitivity analysis at
December 31, 1998:

<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................................... $ 24,450 $ 38,838 $ 47,530 $116,398 $227,216
Loans........................................ 31,204 21,744 14,329 103,201 170,478
Other temporary investments.................. 99 -- -- -- 99
--------- --------- --------- -------- --------
Total interest-earning assets......... 55,753 60,582 61,859 219,599 397,793
--------- --------- --------- -------- --------
Interest-bearing liabilities:
Demand, money market and savings deposits.... $ 144,613 $ -- $ -- $ -- $144,613
Certificates of deposit and other time
deposits................................... 17,072 74,756 47,428 21,814 161,070
Federal funds purchased and FHLB advances.... 2,437 -- -- -- 2,437
--------- --------- --------- -------- --------
Total interest-bearing liabilities.... 164,122 74,756 47,428 21,814 308,120
--------- --------- --------- -------- --------
Period GAP................................... $(108,369) $ (14,174) $ 14,431 $197,785 $ 89,673
Cumulative GAP............................... $(108,369) $(122,543) $(108,112) $ 89,673
Period GAP to total assets................... (24.84)% (3.25)% 3.31% 45.33%
Cumulative GAP to total assets............... (24.84)% (28.09)% (24.78)% 20.55%
</TABLE>

See "-- Interest Rate Sensitivity and Liquidity" for the six months ended
June 30, 1999 and 1998 for a discussion of our policies regarding asset and
liability risk management.

Capital Resources

Shareholders' equity increased to $41.4 million at December 31, 1998 from
$24.8 million at December 31, 1997, an increase of $16.6 million or 67.0%. This
increase was primarily the result of net income of $4.5 million plus $12.8
million in net proceeds from our initial public offering, offset by dividends
paid on the common stock of $1.1 million. During 1997, shareholders' equity
increased by $6.0 million, or 31.9%, from $18.8 million at December 31, 1996.
This increase was due to net income of $3.6 million plus $3.0 million in
proceeds from the issuance of 480,000 shares of our common stock, offset by
dividends paid on the common stock of $575,000.

The following table provides a comparison of the leverage and risk-weighted
capital ratios of us and the bank as of December 31, 1998 to the minimum and
well capitalized regulatory standards:

<TABLE>
<CAPTION>
TO BE WELL
MINIMUM CAPITALIZED
REQUIRED UNDER PROMPT
FOR CAPITAL CORRECTIVE ACTION ACTUAL RATIO AT
PURPOSES PROVISIONS DECEMBER 31, 1998
----------------- ---------------------- -----------------
<S> <C> <C> <C>
PROSPERITY
Leverage ratio................. 3.00%(1) N/A 7.58%
Tier 1 risk-based capital
ratio....................... 4.00% N/A 18.02%
Risk-based capital ratio....... 8.00% N/A 19.08%
FIRST PROSPERITY BANK
Leverage ratio................. 3.00%(2) 5.00% 5.00%
Tier 1 risk-based capital
ratio....................... 4.00% 6.00% 11.87%
Risk-based capital ratio....... 8.00% 10.00% 12.93%
</TABLE>

- ---------------

(1) The Federal Reserve may require us 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.

52
<PAGE> 56

BUSINESS

GENERAL

We were formed in 1983 as a vehicle to acquire the former Allied Bank in
Edna, Texas which was chartered in 1949. We derive substantially all of our
income from our wholly-owned bank subsidiary, First Prosperity Bank. As a result
of our recent acquisition of South Texas Bancshares, we have 15 full-service
banking centers in the greater Houston metropolitan area and nine contiguous
counties situated to the south and southwest of Houston and extending into South
Texas.

Operating under a community banking philosophy, we seek to develop broad
customer relationships based on service and convenience while maintaining our
conservative approach to lending and strong asset quality. We have grown through
a combination of internal growth, the acquisition of community banks and
branches and the opening of new banking centers. Utilizing a low cost of funds
and employing stringent cost controls, we have been profitable in every full
year of our existence, including the period of adverse economic conditions in
Texas in the late 1980s. Since 1989, our net income has grown at a compounded
annual rate of 45.1%.

From 1988 to 1992, as a sound and profitable institution, we took advantage
of the economic downturn and acquired the deposits and certain assets of failed
banks in West Columbia, El Campo and Cuero, Texas and two failed banks in
Houston, which diversified our franchise and increased our core deposits. We
opened a full-service banking center in Victoria, Texas in 1993 and the
following year established a banking center in Bay City, Texas. We expanded our
Bay City presence in 1996 with the acquisition of an additional branch location
from Norwest Bank Texas, and in 1997, we acquired the Angleton, Texas branch of
Wells Fargo Bank. In 1998, we enhanced our West Columbia banking center with the
purchase of a commercial bank branch located in West Columbia and acquired Union
State Bank in East Bernard, Texas. As a result of the addition of these
acquisitions and internal growth, our assets have increased from $79.4 million
at the end of 1989 to $442.8 million as of June 30, 1999 and our deposits have
increased from $70.3 million to $398.4 million in that same period. In addition,
on October 1, 1999, we acquired South Texas Bancshares, with locations in
Beeville, Mathis and Goliad, Texas. At June 30, 1999, South Texas Bancshares had
total assets of $135.8 million, total deposits of $119.0 million and total loans
(net of unearned discount and allowance for loan losses) of $34.5 million. Along
with steady asset growth, our financial performance has been characterized by
consistent core earnings and strong asset quality.

Our primary market consists of the communities served by our three
locations in the greater Houston metropolitan area and our 12 locations in nine
contiguous counties (Brazoria, Wharton, Matagorda, Jackson, Victoria, DeWitt,
Goliad, Bee and San Patricio) located to the south and southwest of Houston and
extending into South Texas. Texas Highway 59 (scheduled to become Interstate
Highway 69), which serves as the primary "NAFTA Highway" linking the interior
United States and Mexico, runs directly through the center of our market area.
The increased traffic along this NAFTA Highway has enhanced economic activity in
our market area and created opportunities for growth. The diverse nature of the
economies in each local market we serve provides us with a varied customer base
and allows us to spread our lending risk throughout a number of different
industries including farming, ranching, petrochemicals, manufacturing, tourism,
recreation and professional service firms and their principals. Our primary
competition in our market areas outside of Houston is small community banks or
branches of large regional banks. Management believes that as one of the few
publicly traded mid-sized financial institutions that combines responsive
community banking with the variety of products and services of a regional bank
holding company, we have a competitive advantage in our market area and
excellent growth opportunities through acquisitions, new branch locations and
additional business development.

Our directors and officers are important to our success in developing broad
customer relationships and play a key role in our business development efforts
by actively participating in a number of civic and public service activities in
the communities we serve, such as the Rotary Club, Lion's Club, United Way and
Chamber of Commerce. In addition, our banking centers in Bay City, Clear Lake,
Cuero, Edna,

53
<PAGE> 57

Meyerland, Post Oak and Victoria maintain community development boards. The
functions of these boards are to solicit new business, develop customer
relations and provide valuable community knowledge to their respective banking
center Presidents.

We have invested heavily in our officers and associates by recruiting
talented officers in our market areas and providing them with economic
incentives in the form of stock options and bonuses based on cross-selling
performance. The senior management team has substantial experience in both our
Houston and surrounding market areas. Each banking center location is
administered by a local president with knowledge of the community and lending
expertise in the specific industries found in the community. We entrust our
banking center presidents with authority and flexibility within general
parameters with respect to product pricing and decision making in order to avoid
the bureaucratic structure of larger banks. We operate 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.

BANK ACTIVITIES

We offer a variety of traditional loan and deposit products to our
customers, which consist primarily of consumers and small and medium-sized
businesses. We tailor our products to the specific needs of customers in a given
market. At October 1, 1999, we maintained approximately 48,000 separate deposit
accounts and 7,000 separate loan accounts.

We have been an active mortgage lender, with 1-4 family residential and
commercial mortgage loans comprising 59.6% of our total loans as of June 30,
1999. We also offer 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, we give our
depositors a full range of traditional deposit products. We have 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, money orders and certain
travel discounts.

The businesses we target are primarily those that require aggregate loans
in the $100,000 to $3.0 million range. We offer 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 our business customers, we have developed a specialized checking product
called Business 10 Checking which provides discounted fees for checking and
normal account analysis.

BUSINESS STRATEGIES

Our main objective is to take advantage of expansion opportunities while
maintaining efficiency and individualized customer service and maximizing
profitability. To achieve this objective, we have emphasized the following
strategies:

Continue Community Banking Emphasis. We intend to continue operating as a
community banking organization focused on meeting the specific needs of
consumers and small and medium-sized businesses in our market areas. We will
continue to provide a high degree of responsiveness combined with a wide variety
of banking products and services. We staff our banking centers with experienced
bankers with lending expertise in the specific industries found in the
community, giving them authority to make certain pricing and credit decisions,
thereby attempting to avoid the bureaucratic structure of large banks.

Expand Market Share Through Internal Growth and a Disciplined Acquisition
Strategy. We intend to continue seeking opportunities, both inside and outside
our existing markets, to expand either by establishing new branches or by
acquiring existing banks or branches of banks. All of our acquisitions have

54
<PAGE> 58

been accretive to earnings immediately and have supplied us with relatively
low-cost deposits which have been used to fund our lending activities. Factors
we use to evaluate expansion opportunities include 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 our efficiency ratio and the opportunity to enhance our image and market
presence.

Increase Loan Volume and Diversify Loan Portfolio. Historically, we have
elected to trade off some earnings for the historically lower credit losses
associated with home mortgage loans. While maintaining our conservative approach
to lending, we plan to emphasize both new and existing loan products, focusing
on growing our home equity and commercial loan portfolios. Among new loan
products, we have successfully introduced home equity lending. At June 30, 1999,
we had a balance of $9.9 million in such loans. We have also increased our
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. We are 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 our traditional mortgage
lending activity, we are making more jumbo mortgage loans, particularly in the
Houston area.

Enhance Cross-Selling Through the Use of Incentives and Technology. We
recognize that our customer base provides significant opportunities to
cross-sell various products, and therefore we seek to develop broader customer
relationships by identifying cross-selling opportunities. We use training,
incentives and friendly competition to encourage cross-selling efforts and
increase cross-selling results. To assist with cross-selling efforts, we have
updated our technology to help officers and associates identify cross-selling
opportunities. Using data which includes existing and related account
relationships, our officers and associates inform customers of additional
products when customers visit or call the various banking centers or use their
drive-in facilities. In addition, we include 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.

Continue Strict Focus on Efficiency. We plan to maintain our stringent cost
control practices and policies. We have invested significantly in the
infrastructure required to centralize many of our critical operations, such as
data processing and loan application processing. For our banking centers, which
we operate as independent profit centers, we supply complete support in the
areas of loan review, internal audit, compliance and training. We maintain 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 us to minimize
operational costs through certain economies of scale.

Maintain Strong Asset Quality. We intend to maintain the strong asset
quality that has been representative of our historical loan portfolio. As we
diversify and increase our lending activities, we may face higher risks of
nonpayment and increased risks in the event of economic downturns. We intend,
however, to continue to employ the strict underwriting guidelines and
comprehensive loan review process that have contributed to our low incidence of
nonperforming assets and our minimal charge-offs.

RECENT ACQUISITION

We actively pursue an acquisition strategy designed to increase efficiency,
market share and return to shareholders. As part of this strategy, on October 1,
1999 we acquired South Texas Bancshares and its subsidiary, The Commercial
National Bank of Beeville, pursuant to a statutory merger for aggregate cash
consideration of $23,350,000. We will operate the newly acquired banking
locations in Beeville, Mathis and Goliad, Texas as banking centers, continuing
to conduct business which includes conventional consumer and commercial products
and services, including interest and noninterest-bearing depository accounts and
commercial, industrial, consumer, agricultural and real estate lending. As of
June 30, 1999, South Texas

55
<PAGE> 59

Bancshares had total assets of $135.8 million, total deposits of $119.0 million
and total loans (net of unearned discount and allowance for loan losses) of
$34.5 million.

The South Texas Bancshares acquisition has provided us with a presence in
the South Texas towns of Beeville, Mathis and Goliad. We believe South Texas
Bancshares had a lending philosophy which is similar to our own philosophy. Our
significantly higher lending limit is expected to create lending opportunities
in the market that South Texas Bancshares was unable to take advantage of prior
to the acquisition. Furthermore, the acquisition provided us with the ability to
offer trust services to our customers. Similar to our previous acquisitions, the
South Texas Bancshares acquisition is expected to be accretive to earnings
immediately and result in economies of scale and savings for us from the
operation of the newly acquired offices as additional banking centers.

COMPETITION

The banking business is highly competitive, and our profitability depends
principally on our ability to compete successfully in our market areas. We
compete 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 nonbank 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 we do. We have been able to compete
effectively with other financial institutions by emphasizing customer service,
technology and responsive decision-making by establishing long-term customer
relationships and building customer loyalty as well as by providing products and
services designed to address the specific needs of our customers. We expect
competition from both financial and nonfinancial institutions to continue.

ASSOCIATES

As of June 30, 1999, we and the bank had 136 full-time equivalent
associates, 65 of whom were officers of the bank. We provide medical and
hospitalization insurance to our full-time associates. We consider our relations
with our associates to be excellent. Neither we nor the bank is a party to any
collective bargaining agreement.

PROPERTIES

We conduct business at 15 full-service banking center locations. Our
corporate headquarters are located at 3040 Post Oak Boulevard, Houston, Texas.
We own all of the buildings in which our banking centers are located other than
the Post Oak, Meyerland and Victoria banking centers. The lease terms of the
Post Oak, Meyerland and Victoria banking centers expire in July 2002, October
2003 and December 2001, respectively. The expiration dates do not include the
renewal option periods which may be available. The following table sets forth
specific information on each of our banking centers:

<TABLE>
<CAPTION>
DEPOSITS AT
LOCATION ADDRESS JUNE 30, 1999
- -------- ------- ----------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Angleton............................ 116 South Velasco $30,868
Angleton, Texas 77516
Bay City-North...................... 1600 Seventh St 16,209
Bay City, Texas 77404
Bay City-South...................... 3700 Avenue F 29,627
Bay City, Texas 77404
Beeville(1)......................... 100 South Washington 78,578
Beeville, Texas 78107
1901 North St. Mary's Street
Beeville, Texas 78107
</TABLE>

56
<PAGE> 60

<TABLE>
<CAPTION>
DEPOSITS AT
LOCATION ADDRESS JUNE 30, 1999
- -------- ------- ----------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Clear Lake.......................... 100 West Medical Center Blvd $27,948
Webster, Texas 77598
Cuero............................... 106 North Esplanade 23,776
Cuero, Texas 77954
East Bernard........................ 700 Church St 63,331
East Bernard, Texas 77435
Edna................................ 102 North Wells 33,869
Edna, Texas 77962
El Campo............................ 1301 North Mechanic 44,261
El Campo, Texas 77437
Goliad.............................. 145 North Jefferson 12,953
Goliad, Texas 77963
Mathis.............................. 103 North Highway 359 27,471
Mathis, Texas 78368
Meyerland........................... 8801 West Loop South 20,902
Houston, Texas 77252
3040 Post Oak Blvd. Suite
Post Oak............................ 150 54,887
Houston, Texas 77056
Victoria............................ 2702 North Navarro 14,196
Victoria, TX 77903
West Columbia....................... 510 East Brazos 38,505
West Columbia, TX 77486
</TABLE>

- ---------------

(1) The Beeville banking center consists of the main office located at 100 South
Washington and a drive-thru facility located approximately one-half mile
from the main office.

LEGAL PROCEEDINGS

We and the bank are from time to time 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 us or the
bank which, if determined adversely, would have a material effect on our
business, financial condition or results of operations or those of the bank.

57
<PAGE> 61

MANAGEMENT

EXECUTIVE OFFICERS AND DIRECTORS

The following table sets forth certain information with respect to our
executive officers and directors and the executive officers of the bank:

<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
Harry Bayne................................ 59 Class II Director of Prosperity
James A. Bouligny.......................... 63 Class II Director of Prosperity
J. T. Herin................................ 83 Class I Director of Prosperity
David Hollaway............................. 43 Treasurer and Chief Financial Officer of
Prosperity; Senior Vice President and
Chief Financial Officer of First
Prosperity Bank
Tracy T. Rudolph........................... 60 Chairman of the Board, Class III Director
and President of Prosperity; Chairman of
the Board of First Prosperity Bank
Charles M. Slavik.......................... 83 Class I Director of Prosperity
Harrison Stafford.......................... 87 Class I Director of Prosperity
Robert Steelhammer......................... 58 Class II Director of Prosperity
David Zalman............................... 43 Class III Director and Vice
President/Secretary of Prosperity; Director
and President of First Prosperity Bank
</TABLE>

There are no family relationships among any of our executive officers and
directors.

Harry Bayne. Mr. Bayne has been a director of Prosperity since 1989. He has
been the President and Chief Executive Officer of Varitec Industries, Inc. in
Houston for more than the past five years. 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.

Jim Bouligny. Mr. Bouligny has been a director of Prosperity since 1991.
Mr. Bouligny has been a name partner in the El Campo law firm of Duckett,
Bouligny & Collins, LLP for more than the past five years. 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 Prosperity since 1989. His
affiliation with the bank started in 1953 with his election to the Board of
Directors. He has been the owner of the J-Bar Ranch in Ganado for more than the
past five years.

David Hollaway. Mr. Hollaway has been Senior Vice President and Chief
Financial Officer of the bank since 1992 and Treasurer of Prosperity since 1993.
He became Chief Financial Officer of Prosperity 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 Prosperity 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 President and Chief Executive Officer prior to that 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 Prosperity since 1993
and was a founding director of the bank in 1949. Mr. Slavik has been the
Chairman of the Board of both Slavik's, Inc. and

58
<PAGE> 62

Slavik's Funeral Home for more than the past five years. 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 Prosperity since
1987 and was involved in the founding of the bank in 1949. Mr. Stafford has
engaged in farming, ranching and investments for more than the past five years.
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 Prosperity since
its inception. Mr. Steelhammer has been a name partner with Steelhammer &
Miller, P.C. in Houston for more than the past five years. 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 Prosperity in 1987. From 1978 to 1986,
Mr. Zalman was employed by Commercial State Bank 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 to 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 our annual meeting of shareholders in 2002;
Messrs. Bayne, Bouligny and Steelhammer are Class II directors with terms of
office expiring on the date of our annual meeting of shareholders in 2000; and
Messrs. Rudolph and Zalman are Class III directors with terms of office expiring
on the date of our annual meeting of shareholders in 2001. Each of our officers
is elected by the Board of Directors and holds office until his successor is
duly elected and qualified or until his earlier death, resignation or removal.

OPERATION OF OUR BOARD OF DIRECTORS

Our Board of Directors established Audit and Compensation Committees in
July 1998. The purpose of the Audit Committee is to review the general scope of
the audit conducted by our independent auditors and matters relating to our
internal control systems. In performing its function, the Audit Committee will
review reports from our independent auditors and meet separately with
representatives of senior management. The Audit Committee is comprised of
Messrs. Bayne, Bouligny and Steelhammer, each of whom is an outside director.
Prior to the formation of the Audit Committee, all matters relating to our
external audit and internal control systems were reviewed by the Board of
Directors of the bank.

The Compensation Committee is responsible for making recommendations to the
Board of Directors with respect to the compensation of our executive officers
and is responsible for the establishment of policies dealing with various
compensation and employee benefit matters. The Compensation Committee also
administers our stock option plans and makes recommendations to the Board of
Directors as to option grants to our employees and employees of the bank under
such plans. The Compensation Committee is comprised of Messrs. Bayne, Bouligny,
Herin, Slavik, Stafford and Steelhammer, each of whom is an outside director.
The members of the recently formed Compensation Committee were the same
directors who handled all compensation, stock options and employee benefit
matters prior to the formation of the Compensation Committee.
59
<PAGE> 63

EMPLOYMENT AGREEMENTS

Tracy T. Rudolph and David Zalman entered into employment agreements with
us in January 1998. 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 we undergo a change in
control, the employee shall be entitled to receive from us 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.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

Prior to the formation of the Compensation Committee in 1998, matters
related to compensation and employee benefit matters of our executive officers
and stock options for our employees and employees of the bank were considered
and determined by our Board of Directors. However, because such compensation
matters directly affected Messrs. Rudolph and Zalman, who serve as directors and
executive officers, Messrs. Rudolph and Zalman did not participate in such
discussions or decisions. No member of the Compensation Committee is or was an
officer or employee of our company or the bank.

DIRECTOR COMPENSATION

Our directors receive a $1,250 fee for each meeting of our Board of
Directors attended and no fees for each committee meeting attended. Directors of
the bank receive a $350 fee for each meeting of the bank's Board of Directors
attended and a $300 fee for each committee meeting attended.

EXECUTIVE COMPENSATION

The following table provides certain summary information concerning
compensation we paid or accrued to or on behalf of our Chairman of the Board and
Chief Executive Officer and our other most highly compensated executive officer
(determined as of the end of the last fiscal year) for each of the two fiscal
years ended December 31, 1998:

<TABLE>
<CAPTION>
ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION
- --------------------------- ---- -------- ------ ------------
<S> <C> <C> <C> <C>
Tracy T. Rudolph...................................... 1998 $238,542 $ -- $7,129(1)
Chairman of the Board and President of Prosperity; 1997 225,000 -- 6,324
Chairman of the Board of First Prosperity Bank
David Zalman.......................................... 1998 206,667 -- 7,593(2)
Vice President/Secretary of Prosperity; President of
First 1997 185,000 -- 6,606
Prosperity Bank
</TABLE>

- ---------------

(1) Consists of contributions by us to the 401(k) Plan of $4,531 in 1998 and
$3,726 in 1997 and premiums paid by us on a life insurance policy for the
benefit of Mr. Rudolph.

(2) Consists of contributions by us to the 401(k) Plan of $4,533 in 1998 and
$3,726 in 1997 and premiums paid by us on two life insurance policies for
the benefit of Mr. Zalman.

STOCK OPTION PLANS

We have outstanding options to purchase 297,500 shares of common stock
issued pursuant to a stock option plan approved by our shareholders in 1995 (the
"1995 Plan") for our executive officers and directors. 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. Under the 1995 Plan, the
options vest ratably over a ten year period beginning on the date of the grant,
however, pursuant to the Incentive Stock Option Agreement ("Agreement") signed
by each optionee, no options may be exercised until the optionee has completed

60
<PAGE> 64

five years of employment with us after the date of the grant. Notwithstanding
the Agreement, the 1995 Plan provides that the Board of Directors may in its
sole discretion accelerate the time at which any option may be exercised. In
early 1999, the Compensation Committee of the Board of Directors accelerated the
time at which the options held by two of our executive officers, Tracy T.
Rudolph and David Zalman, could be exercised. As a result, 22,900 options are
currently exercisable and an additional 45,400 options will be exercisable
beginning January 1, 2000. Options to purchase an additional 20,000 shares are
available for issuance under the 1995 Plan.

Our Board of Directors and shareholders approved a second stock option 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 10 years following the date of grant or no later than three
months after the optionee's termination of employment with us, 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 we undergo a change in
control, 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 SFAS No.
123, Accounting for Stock-Based Compensation. 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. Although it does not require the fair value based method to be adopted, a
company must comply with the disclosure requirements set forth in the statement.
We have continued to apply accounting in Accounting Principles Board Opinion No.
25, Accounting for Stock Issued to Employees, and related interpretations, and,
accordingly, provide the pro forma disclosures of net income and earnings per
share.

BENEFIT PLAN

We have established a contributory profit sharing plan pursuant to Section
401(k) of the Internal Revenue Code covering substantially all employees. At
least three months of service is required for an employee to be eligible for
employer-matching contributions. Participants may contribute up to 15% of their
annual compensation to the 401(k) plan, not to exceed the maximum amount
allowable under Internal Revenue Service regulations. Each year we determine, in
our discretion, the amount of matching contributions. Total plan expenses
charged to our operations were approximately $112,000, $87,000 and $72,000 in
1998, 1997 and 1996, respectively.

61
<PAGE> 65

INTERESTS OF MANAGEMENT AND OTHERS IN CERTAIN TRANSACTIONS

Many of our directors, executive officers and principal shareholders (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 our customers. During 1998 and the six months ended June 30,
1999, we made loans in the ordinary course of business to many of our directors,
executive officers and principal shareholders 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 us and did not involve more than the normal risk of
collectibility or present other unfavorable features. Loans to our directors,
executive officers and principal shareholders are subject to limitations
contained in the Federal Reserve Act, the principal effect of which is to
require that extensions of credit by us to executive officers, directors and
principal shareholders satisfy the foregoing standards. On June 30, 1999, all of
such loans aggregated $4.1 million, which was approximately 11.95% of our Tier 1
capital at such date.

We expect to have such transactions or transactions on a similar basis with
our directors, executive officers and principal shareholders and their
associates in the future.

62
<PAGE> 66

BENEFICIAL OWNERSHIP OF COMMON STOCK BY
MANAGEMENT AND PRINCIPAL SHAREHOLDERS

The following table sets forth certain information regarding the beneficial
ownership of our common stock as of September 30, 1999, by (i) our directors and
executive officers, (ii) each shareholder whom we know to own beneficially 5% or
more of the common stock and (iii) all of our directors and executive officers
as a group. Unless otherwise indicated, based on information furnished by such
shareholders, management believes that each person has sole voting and
dispositive power over their shares and the address of each shareholder is the
same as our address.

<TABLE>
<CAPTION>
SHARES PERCENTAGE
BENEFICIALLY BENEFICIALLY
NAME OWNED(1) OWNED(1)
- ---- ------------ ------------
<S> <C> <C>
Harry Bayne................................................. 94,709 1.82%
James A. Bouligny........................................... 158,006 3.04%
J. T. Herin................................................. 33,733 *
David Hollaway.............................................. 2,440(2) *
Tracy T. Rudolph............................................ 187,400(3) 3.59%
Charles M. Slavik........................................... 34,990(4) *
Harrison Stafford........................................... 90,300(5) 1.74%
Robert Steelhammer.......................................... 126,410(6) 2.43%
David Zalman................................................ 412,434(7) 7.87%
Directors and executive officers as a group (9 persons)..... 1,140,422 21.67%
</TABLE>

- ---------------

* Indicates ownership which does not exceed 1.0%.

(1) The percentage beneficially owned was calculated based on 5,195,325 shares
of common stock issued and outstanding. This percentage assumes the exercise
by the shareholder or group named in each row of all options for the
purchase of common stock held by such shareholder or group and exercisable
within 60 days.

(2) Includes 440 shares held of record by our 401(k) plan as custodian for Mr.
Hollaway's spouse.

(3) Includes 2,000 shares held of record by the Tracy T. Rudolph 2000 Trust, of
which Mr. Rudolph is the trustee, 4,640 shares held of record by our 401(k)
plan as custodian for Mr. Rudolph and 22,900 shares which may be acquired
within 60 days pursuant to options granted under the 1995 Plan.

(4) Consists of 34,990 shares held of record by the Charles and Emma Slavik
Investment Partnership, of which Mr. Slavik is general partner.

(5) Consists of 90,300 shares held of record by the Harrison Stafford Investment
Partnership, of which Mr. Stafford is general partner.

(6) Includes 410 shares held of record by a 401(k) plan for the benefit of Mr.
Steelhammer.

(7) Includes 6,400 shares held of record by Mr. Zalman as custodian for his
minor children and 45,400 shares which may be acquired within 60 days
pursuant to options granted under the 1995 Plan.

63
<PAGE> 67

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 we 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. We believe that we
are in compliance in all material respects with these laws and regulations.

PROSPERITY

We are a bank holding company registered under the Bank Holding Company Act
of 1956, as amended ("BHCA"), and therefore subject to supervision, regulation
and examination by the Federal Reserve. 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 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 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 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, 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 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 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,

64
<PAGE> 68

decreased or unfair competition, conflicts of interest, or unsound banking
practices). The Federal Reserve is also empowered to differentiate between
activities commenced de novo and activities commenced through acquisition of a
going concern.

Securities Activities. The Federal Reserve 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's
Regulation Y, for example, generally requires a holding company to give the
Federal Reserve 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 its consolidated net worth. The Federal Reserve 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 could take the position that paying a
dividend would constitute an unsafe or unsound banking practice.

The Federal Reserve 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 $1.0 million 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 nonbanking services offered by a holding company or its
affiliates.

Capital Adequacy Requirements. The Federal Reserve 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, 1999, our ratio of Tier 1 capital to total risk-weighted
assets was 18.09% and our ratio of total capital to total risk-weighted assets
was 19.16%.

In addition to the risk-based capital guidelines, the Federal Reserve 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 are required to maintain a leverage ratio of at least 4.0%. As of June
30, 1999, our leverage ratio was 7.69%.

The federal banking agencies' risk-based and leverage ratios are minimum
supervisory ratios generally applicable to banking organizations that meet
certain specified criteria. 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 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.

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
65
<PAGE> 69

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
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 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 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 has been notified and has not objected to the transaction. Under
a rebuttable presumption established by the Federal Reserve, 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 us, would,
under the circumstances set forth in the presumption, constitute acquisition of
control of us.

In addition, any entity is required to obtain the approval of the Federal
Reserve under the BHCA before acquiring 25% (5% in the case of an acquiror that
is a bank holding company) or more of our outstanding common stock, or otherwise
obtaining control or a "controlling influence" over us.

FIRST PROSPERITY BANK

The bank is a Texas-chartered banking association, the deposits of which
are insured by the Bank Insurance Fund ("BIF") of the FDIC. 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 subject the bank to special restrictions,
requirements, potential enforcement actions and periodic examination by the FDIC
and the Texas Banking Department. Because the Federal Reserve regulates us, as
the bank holding company parent of the bank, the Federal Reserve 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, 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.

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

66
<PAGE> 70

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 affiliates, including us and any of our
nonbanking subsidiaries, 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
our securities or obligations or the securities or obligations of any of our
nonbanking 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 Federal Reserve 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 our
operating funds and for the foreseeable future it is anticipated that dividends
paid by the bank to us will continue to be our 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 we are a legal entity separate and distinct from our subsidiaries,
our 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 us)
or any shareholder or creditor thereof.

Examinations. The FDIC periodically examines and evaluates insured banks.
Based on 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 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

67
<PAGE> 71

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 us. As of June 30,
1999, the bank's ratio of Tier 1 capital to total risk-weighted assets was
13.74% and its ratio of total capital to total risk-weighted assets was 14.81%.

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 6.0%. As of June 30, 1999, the
bank's ratio of Tier 1 capital to average total assets (leverage ratio) was
5.84%.

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. The bank is classified as "well capitalized" for
purposes of the FDIC's prompt corrective action regulations.

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 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
68
<PAGE> 72

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 current range of
BIF assessments is between 0% and 0.27% of deposits.

The FDIC established a process for raising or lowering all rates for
insured institutions semi-annually if conditions warrant a change. Under this
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 Savings Association
Insurance Fund ("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, for the second quarter of
1999, the BIF rate was .01176% of deposits and the SAIF rate was .0588% of
deposits and for the third quarter of 1999, the BIF rate was .01160% of deposits
and the SAIF rate was .0580% 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 us or our 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. The Texas
Banking Department also has broad enforcement powers over the bank, including
the power to impose orders, remove officers and directors, impose fines and
appoint supervisors and conservators.

Brokered Deposit Restrictions. Institutions that are only "adequately
capitalized" (as defined for purposes of the prompt corrective action rules
described above) 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
69
<PAGE> 73

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.

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 its ongoing customer
relations.

INSTABILITY AND 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 environment in which we and our banking subsidiaries operate in
substantial and unpredictable ways. We cannot determine the ultimate effect that
potential legislation, if enacted, or implementing regulations with respect
thereto, would have upon our financial condition or results of operations or
that of our 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 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, have a significant effect on the operating results of bank
holding companies and their subsidiaries. Among the means available to the
Federal Reserve 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 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 us and our subsidiaries cannot be
predicted.

70
<PAGE> 74

DESCRIPTION OF THE TRUST

The trust is a statutory business trust formed pursuant to the Delaware
Business Trust Act under a trust agreement executed by us, as sponsor for the
trust, and the trustees, and a certificate of trust filed with the Delaware
Secretary of State. The trust agreement will be amended and restated in its
entirety in the form filed as an exhibit to the registration statement of which
the prospectus is a part, as of the date the trust preferred securities are
initially issued. The trust agreement will be qualified under the Trust
Indenture Act of 1939.

Upon issuance of the trust preferred securities, the holders will own all
of the issued and outstanding trust preferred securities. We will acquire common
securities in an amount equal to at least 3% of the total capital of the trust
and will own, directly or indirectly, all of the issued and outstanding common
securities (together with the trust preferred securities, the "trust
securities"). The trust exists for the purposes of:

- issuing the trust preferred securities to the public for cash;

- issuing its common securities to us in exchange for our capitalization of
the trust;

- investing the proceeds from the sale of the trust securities in an
equivalent amount of debentures; and

- engaging in other activities that are incidental to those listed above.

The rights of the holders of the trust securities are as set forth in the
trust agreement, the Delaware Business Trust Act and the Trust Indenture Act.
The trust agreement does not permit the trust to borrow money or make any
investment other than in the debentures. Other than with respect to the trust
securities, we have agreed to pay for all debts and obligations and all costs
and expenses of the trust and the offering of the trust preferred securities,
including the fees and expenses of the trustees and any income taxes, duties and
other governmental charges, and all costs and expenses related to these charges,
to which the trust may become subject, except for United States withholding
taxes that are properly withheld.

Pursuant to the trust agreement, the number of trustees of the trust will
initially be five. Three of the trustees will be persons who are our employees
or officers or who are affiliated with us (the "administrative trustees"). The
fourth trustee will be an institution that maintains its principal place of
business in the State of Delaware (the "Delaware trustee"). Initially, First
Union Trust Company, National Association, a national banking association
("First Union"), will act as Delaware trustee. The fifth trustee will be a
financial institution that is unaffiliated with us and will serve as
institutional trustee under the trust agreement and as indenture trustee for the
purposes of compliance with the provisions of the Trust Indenture Act (the
"property trustee"). Initially, First Union will also be the property trustee.
For the purpose of compliance with the provisions of the Trust Indenture Act,
First Union will also act as guarantee trustee and indenture trustee under the
guarantee agreement and the indenture. We, as holder of all of the common
securities, will have the right to appoint, remove or replace any trustee unless
an event of default under the indenture shall have occurred and be continuing,
in which case only the holders of the trust preferred securities may remove the
indenture trustee or the property trustee. The trust has a term of approximately
31 years but may terminate earlier as provided in the trust agreement.

The property trustee will hold the debentures for the benefit of the
holders of the trust securities and will have the power to exercise all rights,
powers and privileges under the indenture as the holder of the debentures. In
addition, the property trustee will maintain exclusive control of a segregated
noninterest-bearing "property account" to hold all payments made in respect of
the debentures for the benefit of the holders of the trust securities. The
property trustee will make payments of distributions and payments on
liquidation, redemption and otherwise to the holders of the trust securities out
of funds from the property account. The guarantee trustee will hold the
guarantee for the benefit of the holders of the trust preferred securities.

71
<PAGE> 75

DESCRIPTION OF THE TRUST PREFERRED SECURITIES

The trust preferred securities will be issued pursuant to the trust
agreement, which will be qualified as an indenture under the Trust Indenture
Act. First Union will act as property trustee for the trust preferred securities
under the trust agreement for purposes of complying with the provisions of the
Trust Indenture Act. The terms of the trust preferred securities will include
those stated in the trust agreement and those made part of the trust agreement
by the Trust Indenture Act. The following is a summary of the material terms and
provisions of the trust preferred securities and the trust agreement. A form of
the trust agreement has been filed as an exhibit to the registration statement
of which this prospectus forms a part.

GENERAL

The trust agreement authorizes the administrative trustees, on behalf of
the trust, to issue the trust securities, which are comprised of the trust
preferred securities to be sold to the public and the common securities. We will
own all of the common securities issued by the trust. The trust preferred
securities will represent preferred undivided beneficial interests in the assets
of the trust, and the holders of the trust preferred securities will be entitled
to a preference upon an event of default with respect to distributions and
amounts payable on redemption or liquidation over the common securities. The
trust is not permitted to issue any securities other than the trust securities
or incur any other indebtedness.

The trust preferred securities will rank equally, and payments on the trust
preferred securities will be made proportionally, with the common securities,
except as described under "-- Subordination of Common Securities" below.

The property trustee will hold legal title to the debentures in trust for
the benefit of the holders of the trust securities. We guarantee the payment of
distributions out of money held by the trust, and payments upon redemption of
the trust preferred securities or liquidation of the trust, to the extent
described under "Description of the Guarantee." The guarantee agreement does not
cover the payment of any distribution or the liquidation amount when the trust
does not have sufficient funds available to make these payments.

DISTRIBUTIONS

Source of Distributions. The funds of the trust available for distribution
to holders of the trust preferred securities will be limited to payments made
under the debentures, which the trust will purchase with the proceeds from the
sale of the trust securities. Distributions will be paid through the property
trustee, who will hold the amounts received from our interest payments on the
debentures in the property account for the benefit of the holders of the trust
preferred securities. If we do not make interest payments on the debentures, the
property trustee will not have funds available to pay distributions on the trust
preferred securities.

Payment of Distributions. Distributions on the trust preferred securities
will be payable at the annual rate of 9.60% of the $10 stated liquidation
amount, payable quarterly on March 31, June 30, September 30 and December 31 of
each year, to the holders of the trust preferred securities on the relevant
record dates. The record date will be the business day immediately preceding the
relevant distribution date. The first distribution date for the trust preferred
securities will be March 31, 2000.

Distributions will accumulate from the date of issuance, and the amount
payable for any period will be computed on the basis of a 360-day year of twelve
30-day months. If the distribution date is not a business day, then payment of
the distributions will be made on the next day that is a business day, without
any additional interest or other payment in respect of the delay. However, if
the next business day is in the next calendar year, payment of the distribution
will be made on the immediately preceding business day. "Business day" means any
day other than a Saturday, a Sunday, a day on which banking institutions in The
City of New York or Wilmington, Delaware are authorized or required by law or
executive order to remain closed or a day on which the corporate trust office of
the property trustee or the indenture trustee is closed for business.

72
<PAGE> 76

Extension Period. As long as no event of default under the indenture has
occurred and is continuing, we have the right to defer the payment of interest
on the debentures at any time for a period not exceeding 20 consecutive
quarters. However, no extension period may extend beyond November 17, 2029 or
end on a date other than an interest payment date, which dates are the same as
the distribution dates. If we defer the payment of interest, quarterly
distributions on the trust preferred securities will also be deferred during any
such extension period. Any deferred distributions under the trust preferred
securities will accumulate additional amounts at the annual rate of 9.60%,
compounded quarterly from the relevant distribution date. The term
"distributions" as used in this prospectus includes those accumulated amounts.

During an extension period, we may not:

- declare or pay any dividends or distributions on, or redeem, purchase,
acquire or make a liquidation payment with respect to, any of our capital
stock (other than the reclassification of any class of our capital stock
into another class of capital stock) or allow any of our subsidiaries to
do the same with respect to their capital stock (other than the payment
of dividends or distributions to us);

- make any payment of principal, interest or premium on or repay,
repurchase or redeem any debt securities that rank equally with or junior
in interest to the debentures or allow any of our subsidiaries to do the
same;

- make any guarantee payments with respect to any other guarantee by us of
any other debt securities of any of our subsidiaries if the guarantee
ranks equally with or junior to the debentures other than payments under
the guarantee; or

- redeem, purchase or acquire less than all of the debentures or any of the
trust preferred securities.

After the termination of any extension period and the payment of all amounts
then due, we may elect to begin a new extension period, subject to the above
requirements.

We have no current intention of exercising our right to defer distributions
on the trust preferred securities by extending the interest payment period on
the debentures.

REDEMPTION OR EXCHANGE

General. Subject to the prior approval of the Federal Reserve, if required,
we may redeem the debentures prior to maturity:

- in whole at any time, or in part from time to time, on or after November
17, 2004;

- in whole, but not in part, at any time within 90 days following the
occurrence of a Tax Event, an Investment Company Event or a Capital
Treatment Event as defined below; or

- at any time, to the extent of any trust preferred securities we
repurchase.

Mandatory Redemption. Upon our repayment or redemption, in whole or in
part, of any debentures, whether on November 17, 2029 or earlier, the property
trustee will apply the proceeds to redeem a like amount of the trust securities,
upon not less than 30 days nor more than 60 days notice, at the redemption
price. The redemption price will equal 100% of the aggregate liquidation amount
of the trust securities plus accumulated but unpaid distributions and Additional
Interest (as defined below) to the date of redemption. If less than all of the
debentures are to be repaid or redeemed on a date of redemption, then the
proceeds from such repayment or redemption will be allocated to redemption of
the trust preferred securities and the common securities proportionally.

"Additional Interest" means the additional amounts as may be necessary to
be paid by us in order that the amount of distributions then due and payable by
the trust on the outstanding trust securities will not be reduced as a result of
any additional taxes, duties and other governmental charges to which the trust
has become subject.

73
<PAGE> 77

Distribution of Debentures. Upon prior approval of the Federal Reserve, if
required, we will have the right at any time to dissolve, wind-up or terminate
the trust and, after satisfaction of the liabilities of creditors of the trust
as provided by applicable law, including, without limitation, amounts due and
owing the trustees of the trust, cause the debentures to be distributed directly
to the holders of trust securities in liquidation of the trust. See
"-- Liquidation Distribution Upon Termination."

After the liquidation date fixed for any distribution of debentures in
exchange for trust preferred securities:

- those trust preferred securities will no longer be deemed to be
outstanding; and

- any certificates representing trust preferred securities will be deemed
to represent debentures with a principal amount equal to the liquidation
amount of those trust preferred securities, and bearing accrued and
unpaid interest in an amount equal to the accumulated and unpaid
distributions on the trust preferred securities until the certificates
are presented to the administrative trustees or their agent for transfer
or reissuance.

There can be no assurance as to the market prices for the trust preferred
securities or the debentures that may be distributed if a dissolution and
liquidation of the trust were to occur. The trust preferred securities that an
investor may purchase, or the debentures that an investor may receive on
dissolution and liquidation of the trust, may trade at a discount to the price
that the investor paid to purchase the trust preferred securities.

Redemption upon a Tax Event, Investment Company Event or Capital Treatment
Event. If a Tax Event, an Investment Company Event or a Capital Treatment Event
(each as defined below) occurs, we have the right to redeem the debentures in
whole and thereby cause a mandatory redemption of the trust securities in whole
at the redemption price. If one of these events occurs and we do not elect to
redeem the debentures, or we elect to dissolve the trust and cause the
debentures to be distributed to holders of the trust securities, then the trust
preferred securities will remain outstanding and Additional Interest may be
payable on the debentures. See "Description of Debentures -- Redemption or
Exchange."

"Tax Event" means the receipt by the trust and us of an opinion of counsel
experienced in such matters stating that there is more than an insubstantial
risk that:

- interest payable by us on the debentures is not, or within 90 days of the
date of the opinion will not be, deductible by us, in whole or in part,
for federal income tax purposes;

- the trust is, or will be within 90 days after the date of the opinion,
subject to federal income tax with respect to income received or accrued
on the debentures; or

- the trust is, or will be within 90 days after the date of opinion,
subject to more than an immaterial amount of other taxes, duties,
assessments or other governmental charges, as a result of any amendment
to any tax laws or regulations.

"Investment Company Event" means the receipt by the trust and us of an
opinion of counsel experienced in such matters to the effect that the trust is
or will be considered an "investment company" that is required to be registered
under the Investment Company Act, as a result of the occurrence of a change in
law or regulation or a change in interpretation or application of law or
regulation.

"Capital Treatment Event" means the receipt by the trust and us of an
opinion of counsel experienced in such matters to the effect that there is more
than an insubstantial risk of impairment of our ability to treat the trust
preferred securities as Tier 1 capital for purposes of the current capital
adequacy guidelines of the Federal Reserve, as a result of any amendment to any
laws or any regulations.

For all of the events described above, we or the trust must request and
receive an opinion of counsel with regard to the event within a reasonable
period of time after we became aware of the possible occurrence of an event of
this kind.

74
<PAGE> 78

REDEMPTION PROCEDURES

Trust preferred securities may be redeemed at the redemption price with the
applicable proceeds from our contemporaneous redemption of the debentures.
Redemptions of the trust preferred securities will be made and the redemption
price will be payable on each date of redemption only to the extent that the
trust has funds available for the payment of the redemption price. See
"-- Subordination of Common Securities."

Notice of any redemption will be mailed at least 30 days but not more than
60 days before the date of redemption to each holder of trust securities to be
redeemed at its registered address. Unless we default in payment of the
redemption price on the debentures, interest will cease to accrue on the
debentures called for redemption on and after the date of redemption.

If the trust gives notice of redemption of its trust securities, then the
property trustee, to the extent funds are available, will irrevocably deposit
with the depositary for the trust securities funds sufficient to pay the
aggregate redemption price and will give the depositary for the trust securities
irrevocable instructions and authority to pay the redemption price to the
holders upon surrender of their certificates evidencing the trust securities.
See "Book-Entry Issuance." If the trust preferred securities are no longer in
book-entry form, the property trustee, to the extent funds are available, will
deposit with the designated paying agent for such trust preferred securities
funds sufficient to pay the aggregate redemption price and will give the paying
agent irrevocable instructions and authority to pay the redemption price to the
holders upon surrender of their certificates evidencing the trust preferred
securities. Notwithstanding the foregoing, distributions payable on or prior to
the date of redemption for any trust securities called for redemption will be
payable to the holders of the trust securities on the relevant record dates for
the related distribution dates.

If notice of redemption has been given and we have deposited funds as
required, then on the date of the deposit all rights of the holders of the trust
securities called for redemption will cease, except the right to receive the
redemption price, but without interest on such redemption price after the date
of redemption. The trust securities will also cease to be outstanding on the
date of the deposit. If any date fixed for redemption of trust securities is not
a business day, then payment of the redemption price payable on that date will
be made on the next day that is a business day without any additional interest
or other payment in respect of the delay. However, if the next business day is
in the next succeeding calendar year, payment of the interest will be made on
the immediately preceding business day.

If payment of the redemption price in respect of trust securities called
for redemption is improperly withheld or refused and not paid by the trust, or
by us pursuant to the guarantee, distributions on the trust securities will
continue to accumulate at the applicable rate from the date of redemption
originally established by the trust for the trust securities to the date the
redemption price is actually paid. In this case, the actual payment date will be
considered the date fixed for redemption for purposes of calculating the
redemption price. See "Description of the Guarantee."

Payment of the redemption price on the trust preferred securities and any
distribution of debentures to holders of trust preferred securities will be made
to the applicable recordholders as they appear on the register for the trust
preferred securities on the relevant record date. The record date will be the
business day immediately preceding the date of redemption or liquidation date,
as applicable.

If less than all of the trust securities are to be redeemed, then the
aggregate liquidation amount of the trust securities to be redeemed will be
allocated proportionately between the common securities and the trust preferred
securities based upon the relative liquidation amounts. The particular trust
preferred securities to be redeemed will be selected by the property trustee
from the outstanding trust preferred securities not previously called for
redemption by a method the property trustee deems fair and appropriate. This
method may provide for the redemption of portions equal to $10 or an integral
multiple of $10 of the liquidation amount of the trust preferred securities. The
property trustee will promptly notify the registrar for the trust preferred
securities in writing of the trust preferred securities selected for redemption
and, in the case of any trust preferred securities selected for partial
redemption, the liquidation

75
<PAGE> 79

amount to be redeemed. For all purposes of the trust agreement, unless the
context otherwise requires, all provisions relating to the redemption of trust
preferred securities will relate to the portion of the aggregate liquidation
amount of trust preferred securities which has been or is to be redeemed.

Subject to applicable law, and if we are not exercising our right to defer
interest payments on the debentures, we may, at any time, purchase outstanding
trust preferred securities.

SUBORDINATION OF COMMON SECURITIES

Payment of distributions on, and the redemption price of, the trust
preferred securities and common securities will be made based on the liquidation
amount of these securities. However, if an event of default under the indenture
has occurred and is continuing, no distributions on or redemption of the common
securities may be made. Further, no payments may be made on the common
securities unless payment in full in cash of all accumulated and unpaid
distributions (including Additional Interest, if any is required) on all of the
outstanding trust preferred securities for all distribution periods terminating
on or before that time, or in the case of payment of the redemption price,
payment of the full amount of the redemption price on all of the outstanding
trust preferred securities then called for redemption, has been made or
provided. All funds available to the property trustee will first be applied to
the payment in full in cash of all distributions (including Additional Interest,
if any is required) on, or the redemption price of, the trust preferred
securities then due and payable.

In the case of the occurrence and continuance of any event of default under
the trust agreement resulting from an event of default under the indenture, we,
as holder of the common securities, will be deemed to have waived any right to
act with respect to that event of default under the trust agreement until the
effect of the event of default has been cured, waived or otherwise eliminated.
Until the event of default under the trust agreement has been so cured, waived
or otherwise eliminated, the property trustee will act solely on behalf of the
holders of the trust preferred securities and not on our behalf, and only the
holders of the trust preferred securities will have the right to direct the
property trustee to act on their behalf.

LIQUIDATION DISTRIBUTION UPON TERMINATION

We will have the right at any time to dissolve, wind-up or terminate the
trust and cause the debentures to be distributed to the holders of the trust
preferred securities. This right is subject, however, to our receiving approval
of the Federal Reserve, if required.

In addition, the trust will automatically terminate upon expiration of its
term and will terminate earlier on the first to occur of:

- our bankruptcy, dissolution or liquidation;

- the distribution of a like amount of the debentures to the holders of the
trust securities, if we have given written direction to the property
trustee to terminate the trust;

- redemption of all of the trust preferred securities as described under
"-- Redemption or Exchange -- Mandatory Redemption;" or

- the entry of an order for the dissolution of the trust by a court of
competent jurisdiction.

With the exception of a redemption as described under "-- Redemption or
Exchange -- Mandatory Redemption," if an early termination occurs, the trust
will be liquidated by the administrative trustees as expeditiously as they
determine to be possible. After satisfaction of liabilities to creditors of the
trust as provided by applicable law, the trustees will distribute to the holders
of trust securities debentures:

- in an aggregate stated principal amount equal to the aggregate stated
liquidation amount of the trust securities;

- with an interest rate identical to the distribution rate on the trust
securities; and

- with accrued and unpaid interest equal to accumulated and unpaid
distributions on the trust securities.

76
<PAGE> 80

However, if the property trustee determines that the distribution is not
practical, then the holders will be entitled to receive a proportionate amount
of the liquidation distribution. The liquidation distribution will be the amount
equal to the aggregate of the liquidation amount plus accumulated and unpaid
distributions to the date of payment. If the liquidation distribution can be
paid only in part because the trust has insufficient assets available to pay in
full the aggregate liquidation distribution, then the amounts payable directly
by the trust on the trust securities will be paid to us, as the holder of the
common securities, and the holders of the trust preferred securities on a
proportional basis based on liquidation amounts. However, if an event of default
under the indenture has occurred and is continuing, the trust preferred
securities will have a priority over the common securities. See
"-- Subordination of Common Securities."

Under current United States federal income tax law and interpretations and
assuming that the trust is treated as a grantor trust, as is expected, a
distribution of the debentures should not be a taxable event to holders of the
trust preferred securities. Should there be a change in law, a change in legal
interpretation, a Tax Event or another circumstance, however, the distribution
could be a taxable event to holders of the trust preferred securities. See
"Federal Income Tax Consequences -- Receipt of Debentures or Cash Upon
Liquidation of the Trust." If we do not elect to redeem the debentures prior to
maturity or to liquidate the trust and distribute the debentures to holders of
the trust preferred securities, the trust preferred securities will remain
outstanding until the repayment of the debentures.

If we elect to dissolve the trust and thus cause the debentures to be
distributed to holders of the trust preferred securities in liquidation of the
trust, we will continue to have the right to shorten the maturity of the
debentures. See "Description of the Debentures -- General."

LIQUIDATION VALUE

The amount of the liquidation distribution payable on the trust preferred
securities in the event of any liquidation of the trust is $10 per trust
preferred security plus accumulated and unpaid distributions to the date of
payment, which may be in the form of a distribution of debentures having a
liquidation value and accrued interest of an equal amount. See "-- Liquidation
Distribution Upon Termination."

EVENTS OF DEFAULT; NOTICE

Any one of the following events constitutes an event of default under the
trust agreement with respect to the trust preferred securities:

- the occurrence of an event of default under the indenture (see
"Description of the Debentures -- Debenture Events of Default");

- a default by the trust in the payment of any distribution when it becomes
due and payable, and continuation of the default for a period of 30 days;

- a default by the trust in the payment of any redemption price of any of
the trust securities when it becomes due and payable;

- a default in the performance, or breach, in any material respect, of any
covenant or warranty of the trustees in the trust agreement, other than
those defaults covered in the previous two points, and continuation of
the default or breach for a period of 60 days after there has been given,
by registered or certified mail, to the trustee(s) by the holders of at
least 25% in aggregate liquidation amount of the outstanding trust
preferred securities, a written notice specifying the default or breach
and requiring it to be remedied and stating that the notice is a "Notice
of Default" under the trust agreement; or

- the occurrence of events of bankruptcy or insolvency with respect to the
property trustee and our failure to appoint a successor property trustee
within 60 days.

77
<PAGE> 81

Within five business days after the occurrence of any event of default
actually known to the property trustee, the property trustee will transmit
notice of the event of default to the holders of the trust preferred securities,
the administrative trustees and to us, unless the event of default has been
cured or waived. We and the administrative trustees are required to file
annually with the property trustee a certificate as to whether or not we are
each in compliance with all the conditions and covenants applicable to us and
the administrative trustee, respectively, under the trust agreement.

If an event of default under the indenture has occurred and is continuing,
the trust preferred securities will have preference over the common securities
upon termination of the trust. See "-- Subordination of Common Securities" and
"-- Liquidation Distribution Upon Termination." The existence of an event of
default under the trust agreement does not entitle the holders of trust
preferred securities to accelerate the maturity thereof, unless the event of
default is caused by the occurrence of an event of default under the indenture
and both the indenture trustee and holders of at least 25% in principal amount
of the debentures fail to accelerate the maturity thereof.

REMOVAL OF THE TRUSTEES

Unless an event of default under the indenture has occurred and is
continuing, any trustee may be removed at any time by us. If an event of default
under the indenture has occurred and is continuing, only the holders of a
majority in liquidation amount of the outstanding trust preferred securities may
remove the property trustee or the Delaware trustee. The holders of the trust
preferred securities have no right to vote to appoint, remove or replace the
administrative trustees. These rights are vested exclusively with us as the
holder of the common securities. No resignation or removal of a trustee and no
appointment of a successor trustee will be effective until the successor trustee
accepts the appointment in accordance with the trust agreement.

CO-TRUSTEES AND SEPARATE PROPERTY TRUSTEE

Unless an event of default under the indenture has occurred and is
continuing, for the purpose of meeting the legal requirements of the Trust
Indenture Act or of any jurisdiction in which any part of the trust property may
at the time be located, we will have the power to appoint at any time or times,
and upon written request of the property trustee will appoint, one or more
persons or entity either (i) to act as a co-trustee, jointly with the property
trustee, of all or any part of the trust property, or (ii) to act as separate
trustee of any trust property. In either case these trustees will have the
powers that may be provided in the instrument of appointment, and will have
vested in them any property, title, right or power deemed necessary or
desirable, subject to the provisions of the trust agreement. In case an event of
default under the indenture has occurred and is continuing, the property trustee
alone will have power to make the appointment.

MERGER OR CONSOLIDATION OF TRUSTEES

Generally, any person or successor to any of the trustees may be a
successor trustee to any of the trustees, including a successor resulting from a
merger or consolidation. However, any successor trustee must meet all of the
qualifications and eligibility standards to act as a trustee.

MERGERS, CONSOLIDATIONS, AMALGAMATIONS OR REPLACEMENTS OF THE TRUST

The trust may not merge with or into, consolidate, amalgamate, or be
replaced by, or convey, transfer or lease its properties and assets
substantially as an entirety to any corporation or other person, except as
described below. The trust may, at our request, with the consent of the
administrative trustees and without the consent of the holders of the trust
preferred securities, the property trustee or the Delaware trustee, undertake a
transaction listed above if the following conditions are met:

- the successor entity either (a) expressly assumes all of the obligations
of the trust with respect to the trust preferred securities, or (b)
substitutes for the trust preferred securities other securities having
substantially the same terms as the trust preferred securities (referred
to as "successor
78
<PAGE> 82

securities") so long as the successor securities rank the same in
priority as the trust preferred securities with respect to distributions
and payments upon liquidation, redemption and otherwise;

- we expressly appoint a trustee of the successor entity possessing
substantially the same powers and duties as the property trustee in its
capacity as the holder of the debentures;

- the successor securities are listed or will be listed upon notification
of issuance, on any national securities exchange or other organization on
which the trust preferred securities are then listed, if any;

- the merger, consolidation, amalgamation, replacement, conveyance,
transfer or lease does not adversely affect the rights, preferences and
privileges of the holders of the trust preferred securities (including
any successor securities) in any material respect;

- the successor entity has a purpose substantially identical to that of the
trust;

- prior to the merger, consolidation, amalgamation, replacement,
conveyance, transfer or lease, we have received an opinion from
independent counsel to the effect that (a) any transaction of this kind
does not adversely affect the rights, preferences and privileges of the
holders of the trust preferred securities (including any successor
securities) in any material respect, and (b) following the transaction,
neither the trust nor the successor entity will be required to register
as an "investment company" under the Investment Company Act; and

- we own all of the common securities of the successor entity and guarantee
the obligations of the successor entity under the successor securities at
least to the extent provided by the guarantee.

Notwithstanding the foregoing, the trust may not, except with the consent of
holders of 100% in liquidation amount of the trust preferred securities, enter
into any transaction of this kind or permit any other person to consolidate,
amalgamate, merge with or into, or replace the trust if the transaction would
cause the trust or the successor entity to be classified as other than a grantor
trust for United States federal income tax purposes.

VOTING RIGHTS; AMENDMENT OF TRUST AGREEMENT

Except as provided below and under "Description of the
Guarantee -- Amendments and Assignment" and as otherwise required by the Trust
Indenture Act and the trust agreement, the holders of the trust preferred
securities will have no voting rights.

The trust agreement may be amended from time to time by us and the
trustees, without the consent of the holders of the trust preferred securities,
in the following circumstances:

- with respect to acceptance of appointment by a successor trustee;

- to cure any ambiguity, correct or supplement any provisions in the trust
agreement that may be inconsistent with any other provision, or to make
any other provisions with respect to matters or questions arising under
the trust agreement, as long as the amendment is not inconsistent with
the other provisions of the trust agreement and does have a material
adverse effect on the interests of any holder of trust securities; or

- to modify, eliminate or add to any provisions of the trust agreement if
necessary to ensure that the trust will be classified for federal income
tax purposes as a grantor trust at all times that any trust securities
are outstanding or to ensure that the trust will not be required to
register as an "investment company" under the Investment Company Act.

With the consent of the holders of a majority of the aggregate liquidation
amount of the outstanding trust securities, we and the trustees may amend the
trust agreement if the trustees receive an opinion of counsel to the effect that
the amendment or the exercise of any power granted to the trustees in accordance
with the amendment will not affect the trust's status as a grantor trust for
federal income tax

79
<PAGE> 83

purposes or the trust's exemption from status as an "investment company" under
the Investment Company Act. However, without the consent of each holder of trust
securities, the trust agreement may not be amended to (i) change the amount or
timing of any distribution on the trust securities or otherwise adversely affect
the amount of any distribution required to be made in respect of the trust
securities as of a specified date, or (ii) restrict the right of a holder of
trust securities to institute suit for the enforcement of the payment on or
after that date.

As long as the property trustee holds any debentures, the trustees will
not:

- direct the time, method and place of conducting any proceeding for any
remedy available to the indenture trustee, or executing any trust or
power conferred on the property trustee with respect to the debentures;

- waive any past default that is waivable under the indenture;

- exercise any right to rescind or annul a declaration that the principal
of all the debentures will be due and payable; or

- consent to any amendment, modification or termination of the indenture or
the debentures, where the consent is required, without obtaining the
prior approval of the holders of a majority in aggregate liquidation
amount of all outstanding trust securities. However, where a consent
under the indenture requires the consent of each holder of the affected
debentures, no consent will be given by the property trustee without the
prior consent of each holder of the trust securities.

The trustees may not revoke any action previously authorized or approved by a
vote of the holders of the trust securities except by subsequent vote of the
holders of the trust securities. The property trustee will notify each holder of
trust securities of any notice of default with respect to the debentures. In
addition to obtaining the foregoing approvals of the holders of the trust
securities, prior to taking any of the foregoing actions the trustees must
obtain an opinion of counsel experienced in these matters to the effect that the
trust will not be classified as an association taxable as a corporation for
federal income tax purposes on account of the action.

Any required approval of holders of trust securities may be given at a
meeting of holders of the trust securities convened for the purpose or pursuant
to written consent. The property trustee will cause a notice of any meeting at
which holders of the trust securities are entitled to vote, or of any matter
upon which action by written consent of the holders is to be taken, to be given
to each holder of record of trust securities.

No vote or consent of the holders of trust preferred securities will be
required for the trust to redeem and cancel its trust preferred securities in
accordance with the trust agreement.

Notwithstanding the fact that holders of trust preferred securities are
entitled to vote or consent under any of the circumstances described above, any
of the trust preferred securities that are owned by us, the trustees or any
affiliate of us or any trustee, will, for purposes of the vote or consent, be
treated as if they were not outstanding.

GLOBAL TRUST PREFERRED SECURITIES

The trust preferred securities will be represented by one or more global
trust preferred securities registered in the name of The Depository Trust
Company, New York, New York ("DTC") or its nominee. A global trust preferred
security is a security representing interests of more than one beneficial
holder. Beneficial interests in the global trust preferred securities will be
shown on, and transfers will be effected only through, records maintained by
participants. Participants are brokers, dealers, or others with accounts with
DTC. Except as described below, trust preferred securities in definitive form
will not be issued in exchange for the global trust preferred securities. See
"Book-Entry Issuance."

80
<PAGE> 84

No global trust preferred security may be exchanged for trust preferred
securities registered in the names of persons other than DTC or its nominee
unless:

- DTC notifies the indenture trustee that it is unwilling or unable to
continue as a depositary for the global trust preferred security and we
are unable to locate a qualified successor depositary;

- we execute and deliver to the indenture trustee a written order stating
that we elect to terminate the book-entry system through DTC; or

- there shall have occurred and be continuing an event of default under the
indenture.

Any global trust preferred security that is exchangeable pursuant to the
preceding sentence shall be exchangeable for definitive certificates registered
in the names as DTC shall direct. It is expected that the instructions will be
based upon directions received by DTC with respect to ownership of beneficial
interests in the global trust preferred security. If trust preferred securities
are issued in definitive form, the trust preferred securities will be in
denominations of $10 and integral multiples of $10 and may be transferred or
exchanged at the offices described below.

Unless and until it is exchanged in whole or in part for the individual
trust preferred securities represented thereby, a global trust preferred
security may not be transferred except as a whole by DTC to a nominee of DTC, by
a nominee of DTC to DTC or another nominee of DTC or by DTC or any nominee to a
successor depositary or any nominee of the successor.

Payments on global trust preferred securities will be made to DTC, as the
depositary for the global trust preferred securities. If the trust preferred
securities are issued in definitive form, distributions will be payable, the
transfer of the trust preferred securities will be registrable, and trust
preferred securities will be exchangeable, for trust preferred securities of
other denominations of a like aggregate liquidation amount, at the corporate
office of the property trustee, or at the offices of any paying agent or
transfer agent appointed by the administrative trustees. However, payment of any
distribution may be made at the option of the administrative trustees by check
mailed to the address of record of the persons entitled to the distribution or
by wire transfer. In addition, if the trust preferred securities are issued in
definitive form, the record dates for payment of distributions will be the 15th
day of the month in which the relevant distribution date occurs. For a
description of the terms of DTC arrangements relating to payments, transfers,
voting rights, redemptions and other notices and other matters, see "Book-Entry
Issuance."

Upon the issuance of one or more global trust preferred securities, and the
deposit of the global trust preferred security with or on behalf of DTC or its
nominee, DTC or its nominee will credit, on its book-entry registration and
transfer system, the respective aggregate liquidation amounts of the individual
trust preferred securities represented by the global trust preferred security to
the accounts of persons that have accounts with DTC. These accounts shall be
designated by the dealers, underwriters or agents with respect to the trust
preferred securities. Ownership of beneficial interests in a global trust
preferred security will be limited to persons or entities with an account with
DTC or who may hold interest through any person or entity with an account that
may hold interests through participants. With respect to interests of any person
or entity with an account with DTC, ownership of beneficial interests in a
global trust preferred security will be shown on, and the transfer of that
ownership will be effected only through, records maintained by the applicable
depositary or its nominee. With respect to persons or entities who hold interest
in a global trust preferred security through a participant, the interest and any
transfer of the interest will be shown on the participant's records. The laws of
some states require that certain purchasers of securities take physical delivery
of these securities in definitive form. These laws may impair the ability to
transfer beneficial interests in a global trust preferred security.

So long as DTC or another depositary, or its nominee, is the registered
owner of the global trust preferred security, the depositary or the nominee, as
the case may be, will be considered the sole owner or holder of the trust
preferred securities represented by the global trust preferred security for all
purposes under the trust agreement. Except as described in this prospectus,
owners of beneficial interests in a global trust preferred security will not be
entitled to have any of the individual trust preferred securities

81
<PAGE> 85

represented by the global trust preferred security registered in their names,
will not receive or be entitled to receive physical delivery of any the trust
preferred securities in definitive form and will not be considered the owners or
holders of the trust preferred securities under the trust agreement.

None of us, the property trustee, any paying agent or the securities
registrar for the trust preferred securities will have any responsibility or
liability for any aspect of the records relating to or payments made on account
of beneficial ownership interests of the global trust preferred security
representing the trust preferred securities or for maintaining, supervising or
reviewing any records relating to the beneficial ownership interests.

We expect that DTC or its nominee, upon receipt of any payment of the
liquidation amount or distributions in respect of a global trust preferred
security, immediately will credit participants' accounts with payments in
amounts proportionate to their respective beneficial interest in the aggregate
liquidation amount of the global trust preferred security as shown on the
records of DTC or its nominee. We also expect that payments by participants to
owners of beneficial interests in the global trust preferred security held
through the participants will be governed by standing instructions and customary
practices, as is now the case with securities held for the accounts of customers
in bearer form or registered in "street name." The payments will be the
responsibility of the participants. See "Book-Entry Issuance."

PAYMENT AND PAYING AGENCY

Payments in respect of the trust preferred securities shall be made to DTC,
which shall credit the relevant accounts of participants on the applicable
distribution dates, or, if any of the trust preferred securities are not held by
DTC, the payments shall be made by check mailed to the address of the holder as
listed on the register of holders of the trust preferred securities. The paying
agent for the trust preferred securities will initially be the property trustee
and any co-paying agent chosen by the property trustee and acceptable to us and
the administrative trustees. The paying agent for the trust preferred securities
may resign as paying agent upon 30 days written notice to the administrative
trustees, the property trustee and us. If the property trustee no longer is the
paying agent for the trust preferred securities, the administrative trustees
will appoint a successor to act as paying agent. The successor must be a bank or
trust company acceptable to us and the property trustee.

REGISTRAR AND TRANSFER AGENT

The property trustee will act as the registrar and the transfer agent for
the trust preferred securities. Registration of transfers of trust preferred
securities will be effected without charge by or on behalf of the trust, but
upon payment of any tax or other governmental charges that may be imposed in
connection with any transfer or exchange. The trust and its registrar and
transfer agent will not be required to register or cause to be registered the
transfer of trust preferred securities after they have been called for
redemption.

INFORMATION CONCERNING THE PROPERTY TRUSTEE

The property trustee, until the occurrence and continuance of an event of
default under the trust agreement, undertakes to perform only the duties set
forth in the trust agreement. After an event of default under the trust
agreement, the property trustee must exercise the same degree of care and skill
as a prudent person exercises or uses in the conduct of its own affairs. Subject
to this provision, the property trustee is under no obligation to exercise any
of the powers vested in it by the trust agreement at the request of any holder
of trust preferred securities unless it is offered reasonable indemnity against
the costs, expenses and liabilities that might be incurred. If no event of
default under the trust agreement has occurred and is continuing and the
property trustee is required to decide between alternative causes of action,
construe ambiguous provisions in the trust agreement or is unsure of the
application of any provision of the trust agreement, and the matter is not one
on which holders of trust preferred securities are entitled to vote upon, then
the property trustee will take the action directed in writing by us. If the
property trustee is not so directed, then it will take the action it deems
advisable and in the best interests

82
<PAGE> 86

of the holders of the trust securities and will have no liability except for its
own bad faith, negligence or willful misconduct.

MISCELLANEOUS

The administrative trustees are authorized and directed to conduct the
affairs of and to operate the trust in such a way that:

- the trust will not be deemed to be an "investment company" required to be
registered under the Investment Company Act;

- the trust will not be classified as an association taxable as a
corporation for federal income tax purposes; and

- the debentures will be treated as our indebtedness for federal income tax
purposes.

In this regard, we and the administrative trustees are authorized to take any
action not inconsistent with applicable law, the certificate of trust or the
trust agreement, that we and the administrative trustees determine to be
necessary or desirable for these purposes.

Holders of the trust preferred securities have no preemptive or similar
rights. The trust agreement and the trust preferred securities will be governed
by Delaware law.

DESCRIPTION OF THE DEBENTURES

Concurrently with the issuance of the trust preferred securities, the trust
will invest the proceeds from the sale of the trust securities in the debentures
issued by us. The debentures will be issued as unsecured debt under the
indenture between us and First Union, as trustee (the "indenture trustee"). The
indenture will be qualified under the Trust Indenture Act.

The following discussion is subject to, and is qualified in its entirety by
reference to, the indenture and to the Trust Indenture Act. We urge prospective
investors to read the form of the indenture, which is filed as an exhibit to the
registration statement of which this prospectus forms a part.

GENERAL

The debentures will be limited in aggregate principal amount to
$12,380,000, this amount being the sum of the aggregate stated liquidation
amounts of the trust securities. The debentures will bear interest at the annual
rate of 9.60% of the principal amount. The interest will be payable quarterly on
March 31, June 30, September 30 and December 31 of each year, beginning March
31, 2000, to the person in whose name each debenture is registered at the close
of business on the business day immediately preceding the day interest is due.
It is anticipated that, until the liquidation, if any, of the trust, the
debentures will be held in the name of the property trustee in trust for the
benefit of the holders of the trust securities.

The amount of interest payable for any period will be computed on the basis
of a 360-day year of twelve 30-day months. If any date on which interest is
payable on the debentures is not a business day, then payment of interest will
be made on the next day that is a business day without any additional interest
or other payment in respect of the delay. However, if the next business day is
in the next calendar year, payment of the interest will be made on the
immediately preceding business day. Accrued interest that is not paid on the
applicable interest payment date will bear additional interest on the amount due
at the annual rate of 9.60%, compounded quarterly. The term "interest," includes
quarterly interest payments, interest on quarterly interest payments not paid on
the applicable interest payment date and additional interest, as applicable.

The debentures will mature on November 17, 2029, the stated maturity date.
We may shorten this date once at any time to any date not earlier than November
17, 2004, subject to the prior approval of the Federal Reserve, if required.

83
<PAGE> 87

We will give notice to the indenture trustee and the holders of the
debentures no more than 180 days and no less than 90 days prior to the
effectiveness of any change in the stated maturity date. We will not have the
right to redeem the debentures from the trust until after November 17, 2004,
except if a Tax Event, an Investment Company Event or a Capital Treatment Event
has occurred, or to the extent we have repurchased trust preferred securities.

The debentures will be unsecured and will rank junior to all of our senior
and subordinate indebtedness. Because we are a holding company, our right to
participate in any distribution of assets of any of our subsidiaries, upon any
subsidiary's liquidation or reorganization or otherwise, and thus the ability of
holders of the debentures to benefit indirectly from any distribution by a
subsidiary, is subject to the prior claim of creditors of the subsidiary, except
to the extent that we may be recognized as a creditor of the subsidiary. The
debentures will, therefore, be effectively subordinated to all existing and
future liabilities of our subsidiaries, and holders of debentures should look
only to our assets for payment. The indenture does not limit our ability to
incur or issue secured or unsecured senior and junior debt. See
"-- Subordination."

The indenture does not contain provisions that afford holders of the
debentures protection in the event of a highly leveraged transaction or other
similar transaction involving us, nor does it require us to maintain or achieve
any financial performance levels or to obtain or maintain any credit rating on
the debentures.

OPTION TO EXTEND INTEREST PAYMENT PERIOD

As long as no event of default under the indenture has occurred and is
continuing, we have the right under the indenture to defer the payment of
interest on the debentures at any time for a period not exceeding 20 consecutive
quarters. However, no extension period may extend beyond the stated maturity of
the debentures or end on a date other than a date interest is normally due. At
the end of an extension period, we must pay all interest then accrued and
unpaid, together with interest thereon at the annual rate of 9.60% compounded
quarterly. During an extension period, interest will continue to accrue and
holders of debentures, or the holders of trust preferred securities if they are
then outstanding, will be required to accrue and recognize as income for federal
income tax purposes the accrued but unpaid interest amounts in the year in which
such amounts accrued. See "Federal Income Tax Consequences -- Interest Payment
Period and Original Issue Discount."

During an extension period, we may not:

- redeem, purchase or acquire less than all of the debentures or any of the
trust preferred securities.

Prior to the termination of any extension period, so long as no event of
default under the indenture is continuing, we may further defer the payment of
interest subject to the above stated requirements. Upon the termination of any
extension period and the payment of all amounts then due, we may elect to begin
a new extension period at any time. We have no present intention of exercising
our right to defer payments of interest on the debentures.

84
<PAGE> 88

We must give the property trustee, the administrative trustees and the
indenture trustee notice of our election of an extension period at least two
business days prior to the earlier of (i) the next date on which distributions
on the trust securities would have been payable except for the election to begin
an extension period, or (ii) the date we are required to give notice of the
record date, or the date the distributions are payable, to the Nasdaq National
Market, or other applicable self-regulatory organization, or to holders of the
trust preferred securities, but in any event at least one business day prior to
the record date.

Subject to the foregoing, there is no limitation on the number of times
that we may elect to begin an extension period.

ADDITIONAL SUMS TO BE PAID AS A RESULT OF ADDITIONAL TAXES

If the trust is required to pay any additional taxes, duties or other
governmental charges as a result of the occurrence of a Tax Event, we will pay
as additional amounts on the debentures any amounts which may be required so
that the net amounts received and retained by the trust after paying any
additional taxes, duties or other governmental charges will not be less than the
amounts the trust would have received had the additional taxes, duties or other
governmental charges not been imposed.

REDEMPTION OR EXCHANGE

Subject to prior approval of the Federal Reserve, if required, we may
redeem the debentures prior to maturity:

- in whole at any time, or in part from time to time, on or after November
17, 2004;

- in whole, but not in part, at any time within 90 days following the
occurrence of a Tax Event, an Investment Company Event or a Capital
Treatment Event; or

- at any time, to the extent of any trust preferred securities we
repurchase.

In each case we will pay a redemption price equal to the accrued and unpaid
interest on the debentures so redeemed to the date fixed for redemption, plus
100% of the principal amount of the debentures.

Notice of any redemption will be mailed at least 30 days but not more than
60 days before the redemption date to each holder of debentures to be redeemed
at its registered address. Redemption of less than all outstanding debentures
shall be effected proportionately, by lot or in any other manner deemed to be
fair by the indenture trustee. Unless we default in payment of the redemption
price for the debentures, on and after the redemption date interest shall cease
to accrue on the debentures or portions thereof called for redemption.

The debentures will not be subject to any sinking fund.

DISTRIBUTION UPON LIQUIDATION

As described under "Description of the Trust Preferred
Securities -- Liquidation Distribution Upon Termination," under certain
circumstances and with the Federal Reserve's approval, the debentures may be
distributed to the holders of the trust preferred securities in liquidation of
the trust after satisfaction of liabilities to creditors of the trust. If this
occurs, we will use our best efforts to list the debentures on the Nasdaq
National Market or other stock exchange or national quotation service, on which
the trust preferred securities are then listed, if any. There can be no
assurance as to the market price of any debentures that may be distributed to
the holders of trust preferred securities.

RESTRICTIONS ON PAYMENTS

We are restricted from making certain payments (as described below) if at
that time:

- an event of default is continuing under the indenture;

- we are in default with respect to our obligations under the guarantee; or

- we have given notice of our election to extend an interest payment period
with respect to the debentures and the notice has not been rescinded or
the extension period is continuing.

85
<PAGE> 89

If any of the above events have occurred, we will not:

- declare or pay any dividends or distributions on, or redeem, purchase,
acquire, or make a liquidation payment with respect to, any of our
capital stock (other than the reclassification of any class of our
capital stock into another class of capital stock) or allow any of our
subsidiaries to do the same with respect to their capital stock (other
than the payment of dividends or distributions to us);

- make any payment of principal, interest or premium on, or repay or
repurchase or redeem any of our debt securities that rank equally with or
junior to the debentures or allow any of our subsidiaries to do the same;

- make any guarantee payments with respect to any guarantee by us of the
debt securities of any of our subsidiaries if the guarantee ranks equally
with or junior to the debentures other than payments under the guarantee;
or

- redeem, purchase or acquire less than all of the debentures or any of the
trust preferred securities.

SUBORDINATION

Under the indenture, the debentures are subordinated and junior in right of
payment to all of our senior and subordinated debt. Upon any payment or
distribution of assets to our creditors upon any liquidation, dissolution,
winding up, reorganization, assignment for the benefit of creditors, marshaling
of assets or any bankruptcy, insolvency, debt restructuring or similar
proceedings in connection with any insolvency or bankruptcy proceedings of
Prosperity, the holders of senior and subordinated debt will first be entitled
to receive payment in full of principal (and premium, if any) and interest
before the holders of debentures will be entitled to receive or retain any
payment in respect of the debentures.

In the event of the acceleration of the maturity of any debentures, the
holders of all or our senior and subordinated debt outstanding at the time of
the acceleration will also be entitled to first receive payment in full of all
amounts due, including any amounts due upon acceleration, before the holders of
the debentures will be entitled to receive or retain any payment in respect of
the principal of or interest on the debentures.

No payments of principal or interest in respect of the debentures may be
made if there has occurred and is continuing a default in any payment with
respect to any of our senior or subordinated debt or an event of default with
respect to any of our senior or subordinated debt resulting in the acceleration
of the maturity of the debentures, or if any judicial proceeding is pending with
respect to any default.

The term "debt" means, with respect to any entity, whether recourse is to
all or a portion of the assets of an entity and whether or not contingent:

- every obligation of the entity for money borrowed;

- every obligation of the entity evidenced by bonds, debentures, notes or
other similar instruments, including obligations incurred in connection
with the acquisition of property, assets or businesses;

- every reimbursement obligation of the entity with respect to letters of
credit, bankers' acceptances or similar facilities issued for the account
of the entity;

- every obligation of the entity issued or assumed as the deferred purchase
price of property or services, excluding trade accounts payable or
accrued liabilities arising in the ordinary course of business;

- every capital lease obligation of the entity; and

- every obligation of the type referred to in the first five points of
another person and all dividends of another person the payment of which,
in either case, the entity has guaranteed or is responsible or liable,
directly or indirectly, as obligor or otherwise.

86
<PAGE> 90

The term "senior debt" means, with respect to us, the principal of and
premium and interest, including interest accruing on or after the filing of any
petition in bankruptcy or for reorganization relating to us whether or not a
claim for post-petition interest is allowed in the proceeding, on debt, whether
incurred on or prior to the date of the indenture or incurred after the date.
Senior debt also includes all indebtedness, whether incurred on or prior to the
date of the indenture or thereafter incurred, for claims in respect of
derivative products such as interest and foreign exchange rate contracts,
commodity contracts and similar arrangements. However, senior debt will not be
deemed to include:

- any debt where it is provided in the instrument creating the debt that
the obligations are not superior in right of payment to the debentures or
to other debt which is equal with, or subordinated to, the debentures;

- any of our debt that when incurred and without respect to any election
under the federal bankruptcy laws was without recourse to us;

- any debt of ours to any of our subsidiaries;

- any debt to any of our employees;

- any debt that by its terms is subordinated to trade accounts payable or
accrued liabilities arising in the ordinary course of business to the
extent that payments made to the holders of the debt by the holders of
the debentures as a result of the subordination provisions of the
indenture would be greater than they otherwise would have been as a
result of any obligation of the holders to pay amounts over to the
obligees on the trade accounts payable or accrued liabilities arising in
the ordinary course of business as a result of subordination provisions
to which the debt is subject; and

- debt which constitutes subordinated debt.

The term "subordinated debt" means, with respect to us, the principal of,
premium and interest, including interest accruing on or after the filing of any
petition in bankruptcy or for reorganization relating to us whether or not the
claim for post-petition interest is allowed in the proceeding, on debt.
Subordinated debt includes debt incurred on or prior to the date of the
indenture or thereafter incurred, which is by its terms expressly provided to be
junior and subordinate to other debt of ours, other than the debentures.
However, subordinated debt will not be deemed to include:

- any of our debt which when incurred and without respect to any election
under the federal bankruptcy laws, was without recourse to us;

- any debt of ours to any of our subsidiaries;

- any debt to any of our employees;

- any debt which by its terms is subordinated to trade accounts payable or
accrued liabilities arising in the ordinary course of business to the
extent that payments made to the holders of the debt by the holders of
the debentures as a result of the subordination provisions of the
indenture would be greater than they otherwise would have been as a
result of any obligation of the holders to pay amounts over to the
obligees on the trade accounts payable or accrued liabilities arising in
the ordinary course of business as a result of subordination provisions
to which the debt is subject;

- debt which constitutes senior debt; and

- any debt of ours under debt securities (and guarantees in respect of
these debt securities) initially issued to any trust, or a trustee of a
trust, partnership or other entity affiliated with us that is, directly
or indirectly, a financing vehicle of ours in connection with the
issuance by that entity of preferred securities or other securities which
are intended to qualify for "Tier 1" capital treatment.

We expect from time to time to incur additional indebtedness, and there is
no limitation on the amount we may incur. At June 30, 1999, we had consolidated
senior debt and subordinated debt of approximately $570,000.
87
<PAGE> 91

PAYMENT AND PAYING AGENTS

Generally, payment of principal of and any interest on the debentures will
be made at the office of the indenture trustee in Wilmington, Delaware. However,
we have the option to make payment of any interest by (i) check mailed to the
address of the person entitled to payment at the address listed in the register
of holders of the debentures, or (ii) transfer to an account maintained by the
person entitled thereto as specified in the register of holders of the
debentures, provided that proper transfer instructions have been received by the
regular record date. Payment of any interest on debentures will be made to the
person in whose name the debenture is registered at the close of business on the
regular record date for the interest payment, except in the case of defaulted
interest. We may at any time designate additional paying agents for the
debentures or rescind the designation of any paying agent for the debentures.
However, we will at all times be required to maintain a paying agent in
Wilmington, Delaware, and each place of payment for the debentures.

Any moneys deposited with the indenture trustee or any paying agent for the
debentures, or then held by us in trust, for the payment of the principal of or
interest on the debentures and remaining unclaimed for two years after the
principal or interest has become due and payable, will be repaid to us on May 31
of each year. If we hold any of this money in trust, then it will be discharged
from the trust to us and the holder of the debenture will thereafter look, as a
general unsecured creditor, only to us for payment.

REGISTRAR AND TRANSFER AGENT

The indenture trustee will act as the registrar and the transfer agent for
the debentures. Debentures may be presented for registration of transfer, with
the form of transfer endorsed thereon, or a satisfactory written instrument of
transfer, duly executed, at the office of the registrar. Provided that we
maintain a transfer agent in Wilmington, Delaware, we may rescind the
designation of any transfer agent or approve a change in the location through
which any transfer agent acts. We may at any time designate additional transfer
agents with respect to the debentures.

In the event of any redemption, neither we nor the indenture trustee will
be required to (i) issue, register the transfer of or exchange debentures during
a period beginning at the opening of business 15 days before the day of
selection for redemption of debentures and ending at the close of business on
the day of mailing of the relevant notice of redemption, or (ii) transfer or
exchange any debentures so selected for redemption, except, in the case of any
debentures being redeemed in part, any portion not to be redeemed.

MODIFICATION OF INDENTURE

We and the indenture trustee may, from time to time without the consent of
the holders of the debentures, amend, waive or supplement the indenture for
purposes which do not materially adversely affect the rights of the holders of
the debentures. Other changes may be made by us and the indenture trustee with
the consent of the holders of a majority in principal amount of the outstanding
debentures. However, without the consent of the holder of each outstanding
debenture affected by the proposed modification, no modification may:

- extend the fixed maturity of the debentures;

- reduce the principal amount or the rate or extend the time of payment of
interest; or

- reduce the percentage of principal amount of debentures required to amend
the indenture.

As long as any of the trust preferred securities remain outstanding, no
modification may be made that requires the consent of the holders of the
debentures, no termination of the indenture may occur, and no waiver of any
event of default under the indenture may be effective, without the prior consent
of the holders of a majority of the aggregate liquidation amount of the trust
preferred securities.

88
<PAGE> 92

DEBENTURE EVENTS OF DEFAULT

The indenture provides that any one or more of the following described
events with respect to the debentures that has occurred and is continuing
constitutes an event of default under the indenture:

- failure for 30 days to pay any interest on the debentures when due,
subject to deferral of any due date in the case of an extension period;

- failure to pay any principal on the debentures when due whether at
maturity, upon redemption by declaration or otherwise;

- failure to observe or perform in any material respect other covenants
contained in the indenture for 90 days after written notice to us from
the indenture trustee or the holders of at least 25% in aggregate
outstanding principal amount of the debentures; or

- our bankruptcy, insolvency or reorganization or dissolution of the trust.

The holders of a majority of the aggregate outstanding principal amount of
the debentures have the right to direct the time, method and place of conducting
any proceeding for any remedy available to the indenture trustee. The indenture
trustee, or the holders of at least 25% in aggregate outstanding principal
amount of the debentures, may declare the principal due and payable immediately
upon an event of default under the indenture. The holders of a majority of the
outstanding principal amount of the debentures may annul the declaration and
waive the default if the default has been cured and a sum sufficient to pay all
matured installments of interest and principal due otherwise than by
acceleration, has been deposited with the indenture trustee. The holders may not
annul the declaration and waive a default if the default is the non-payment of
the principal of the debentures which has become due solely by the acceleration.
Should the holders of the debentures fail to annul the declaration and waive the
default, the holders of at least 25% in aggregate liquidation amount of the
trust preferred securities will have this right.

If an event of default under the indenture has occurred and is continuing,
the property trustee will have the right to declare the principal of and the
interest on the debentures, and any other amounts payable under the indenture,
to be forthwith due and payable and to enforce its other rights as a creditor
with respect to the debentures.

We are required to file annually with the indenture trustee a certificate
as to whether or not we are in compliance with all of the conditions and
covenants applicable to us under the indenture.

ENFORCEMENT OF CERTAIN RIGHTS BY HOLDERS OF THE TRUST PREFERRED SECURITIES

If an event of default under the indenture has occurred and is continuing
and the event is attributable to our failure to pay interest on or principal of
the debentures on the payment date on which the payment is due and payable, then
a holder of trust preferred securities may initiate a direct action against us.
In connection with a direct action, we will have a right to counter the amount
of the direct action to the extent of any payment made by us to the holder of
trust preferred securities with respect to the direct action. We may not amend
the indenture to remove the foregoing right to bring a direct action without the
prior written consent of all of the holders of the trust preferred securities.
If the right to bring a direct action is removed, the trust may become subject
to the reporting obligations under the Securities Exchange Act of 1934.

The holders of the trust preferred securities will not be able to exercise
directly any remedies, other than those set forth in the preceding paragraph,
available to the holders of the debentures unless there has been an event of
default under the trust agreement. See "Description of the Trust Preferred
Securities -- Events of Default; Notice."

CONSOLIDATION, MERGER, SALE OF ASSETS AND OTHER TRANSACTIONS

We may not consolidate with or merge into any other entity or convey or
transfer our properties and assets substantially as an entirety to any entity,
and no entity may be consolidated with or merged into us
89
<PAGE> 93

or sell, convey, transfer or otherwise dispose of its properties and assets
substantially as an entirety to us, unless:

- if we consolidate with or merge into another person or convey or transfer
our properties and assets substantially as an entirety to any person, the
successor person is organized under the laws of the United States or any
State or the District of Columbia, and the successor person expressly
assumes by supplemental indenture our obligations on the debentures, or
substitutes securities having substantially similar terms;

- immediately after giving effect, no event of default under the indenture,
and no event which, after notice or lapse of time, or both, would become
an event of default under the indenture, has occurred and is continuing;
and

- other conditions as prescribed in the indenture are met.

SATISFACTION AND DISCHARGE

The indenture will cease to be of further effect and we will be deemed to
have satisfied and discharged the indenture when all debentures not previously
delivered to the indenture trustee for cancellation:

- have become due and payable, or

- will become due and payable at their stated maturity within one year or
are to be called for redemption within one year, and we deposit or cause
to be deposited with the indenture trustee funds, in trust, for the
purpose and in an amount sufficient to pay and discharge the entire
indebtedness on the debentures not previously delivered to the indenture
trustee for cancellation, for the principal and interest due to the date
of the deposit or to the stated maturity or redemption date, as the case
may be.

We may still be required to provide officers' certificates, opinions of
counsel and pay fees and expenses due after these events occur.

GOVERNING LAW

The indenture and the debentures will be governed by and construed in
accordance with the laws of the State of Texas.

INFORMATION CONCERNING THE INDENTURE TRUSTEE

The indenture trustee is subject to all the duties and responsibilities
specified with respect to an indenture trustee under the Trust Indenture Act.
Subject to these provisions, the indenture trustee is under no obligation to
exercise any of the powers vested in it by the indenture at the request of any
holder of debentures, unless offered reasonable indemnity by the holder against
the costs, expenses and liabilities which might be incurred. The indenture
trustee is not required to expend or risk its own funds or otherwise incur
personal financial liability in the performance of its duties if the indenture
trustee reasonably believes that repayment or adequate indemnity is not
reasonably assured to it.

MISCELLANEOUS

We have agreed, pursuant to the indenture, for so long as trust preferred
securities remain outstanding:

- to maintain directly or indirectly 100% ownership of the common
securities of the trust except that certain successors that are permitted
pursuant to the indenture may succeed to our ownership of the common
securities;

90
<PAGE> 94

- not to voluntarily terminate, wind up or liquidate the trust without
prior approval of the Federal Reserve, if required;

- to use our reasonable efforts to cause the trust (a) to remain a business
trust (and to avoid involuntary termination, winding up or liquidation),
except in connection with a distribution of debentures, the redemption of
all of the trust securities of the trust or mergers, consolidations or
amalgamations, each as permitted by the trust agreement; and (b) to
otherwise continue not to be treated as an association taxable as a
corporation or partnership for federal income tax purposes; and

- to use our reasonable efforts to cause each holder of trust securities to
be treated as owning an individual beneficial interest in the debentures.

BOOK-ENTRY ISSUANCE

GENERAL

DTC will act as securities depositary for the trust preferred securities
and may act as securities depositary for all of the debentures in the event of
the distribution of the debentures to the holders of trust preferred securities.
Except as described, the trust preferred securities will be issued only as
registered securities in the name of Cede & Co. (DTC's nominee). One or more
global trust preferred securities will be issued for the trust preferred
securities and will be deposited with DTC.

DTC is a limited purpose trust company organized under New York banking
law, a "banking organization" within the meaning of the New York banking law, a
member of the Federal Reserve System, a "clearing corporation" within the
meaning of the New York Uniform Commercial Code, and a "clearing agency"
registered pursuant to Section 17A of the Securities Exchange Act of 1934. DTC
holds securities that its participants deposit with DTC. DTC also facilitates
the settlement among participants of securities transactions, such as transfers
and pledges, in deposited securities through electronic computerized book-entry
changes in participants' accounts, thereby eliminating the need for physical
movement of securities certificates. Direct participants include securities
brokers and dealers, banks, trust companies, clearing corporations and certain
other organizations. DTC is owned by a number of its direct participants and by
the New York Stock Exchange, Inc., the American Stock Exchange, Inc. and the
National Association of Securities Dealers, Inc. Access to the DTC system is
also available to indirect participants, such as securities brokers and dealers,
banks and trust companies that clear through or maintain custodial relationships
with direct participants, either directly or indirectly. The rules applicable to
DTC and its participants are on file with the SEC.

Purchases of trust preferred securities within the DTC system must be made
by or through direct participants, which will receive a credit for the trust
preferred securities on DTC's records. The ownership interest of each actual
purchaser of each trust preferred security ("beneficial owner") is in turn to be
recorded on the direct and indirect participant's records. Beneficial owners
will not receive written confirmation from DTC of their purchases, but
beneficial owners are expected to receive written confirmations providing
details of the transactions, as well as periodic statements of their holdings,
from the direct or indirect participants through which the beneficial owners
purchased trust preferred securities. Transfers of ownership interests in the
trust preferred securities are to be accomplished by entries made on the books
of participants acting on behalf of beneficial owners. Beneficial owners will
not receive certificates representing their ownership interest in trust
preferred securities, except if use of the book-entry system for the trust
preferred securities is discontinued.

DTC will have no knowledge of the actual beneficial owners of the trust
preferred securities; DTC's records reflect only the identity of the direct
participants to whose accounts the trust preferred securities are credited,
which may or may not be the beneficial owners. The participants will remain
responsible for keeping account of their holdings on behalf of their customers.

91
<PAGE> 95

The information in this section concerning DTC and DTC's book-entry system
has been obtained from sources that we believe to be accurate, but we and the
trust assume no responsibility for the accuracy thereof. Neither we nor the
trust have any responsibility for the performance by DTC or its participants of
their respective obligations as described in this prospectus or under the rules
and procedures governing their respective operations.

NOTICES AND VOTING

Conveyance of notices and other communications by DTC to direct
participants, by direct participants to indirect participants, and by direct and
indirect participants to beneficial owners will be governed by arrangements
among them, subject to any statutory or regulatory requirements as may be in
effect from time to time.

Redemption notices will be sent to Cede & Co. as the registered holder of
the trust preferred securities. If less than all of the trust preferred
securities are being redeemed, the amount to be redeemed will be determined in
accordance with the trust agreement.

Although voting with respect to the trust preferred securities is limited
to the holders of record of the trust preferred securities, in those instances
in which a vote is required, neither DTC nor Cede & Co. will itself consent or
vote with respect to trust preferred securities. Under its usual procedures, DTC
would mail an omnibus proxy to the property trustee as soon as possible after
the record date. The omnibus proxy assigns Cede & Co.'s consenting or voting
rights to those direct participants to whose accounts the trust preferred
securities are credited on the record date.

DISTRIBUTION FUNDS

The property trustee will make distribution payments on the trust preferred
securities to DTC. DTC's practice is to credit direct participants' accounts on
the relevant payment date in accordance with their respective holdings shown on
DTC's records unless DTC has reason to believe that it will not receive payments
on the payment date. Payments by participants to beneficial owners will be
governed by standing instructions and customary practices and will be the
responsibility of the participant and not of DTC, the property trustee, the
trust or us, subject to any statutory or regulatory requirements as may be in
effect from time to time. Payment of distributions to DTC is the responsibility
of the property trustee, disbursement of the payments to direct participants is
the responsibility of DTC, and disbursements of the payments to the beneficial
owners is the responsibility of direct and indirect participants.

SUCCESSOR DEPOSITORIES AND TERMINATION OF BOOK-ENTRY SYSTEM

DTC may discontinue providing its services with respect to any of the trust
preferred securities at any time by giving reasonable notice to the property
trustee and us. If no successor securities depositary is obtained, definitive
trust preferred securities representing the trust preferred securities are
required to be printed and delivered. We also have the option to discontinue use
of the system of book-entry transfers through DTC (or a successor depositary).
After an event of default under the indenture, the holders of a majority in
liquidation amount of trust preferred securities may determine to discontinue
the system of book-entry transfers through DTC. In these events, definitive
certificates for the trust preferred securities will be printed and delivered.

92
<PAGE> 96

DESCRIPTION OF THE GUARANTEE

The trust preferred securities guarantee agreement will be executed and
delivered by us concurrently with the issuance of the trust preferred securities
for the benefit of the holders of the trust preferred securities. The guarantee
agreement will be qualified as an indenture under the Trust Indenture Act. First
Union, the guarantee trustee, will act as trustee for purposes of complying with
the provisions of the Trust Indenture Act, and will also hold the guarantee for
the benefit of the holders of the trust preferred securities. Prospective
investors are urged to read the form of the guarantee agreement, which has been
filed as an exhibit to the registration statement of which this prospectus forms
a part.

GENERAL

We agree to pay in full on a subordinated basis, to the extent described in
the guarantee agreement, the guarantee payments (as defined below) to the
holders of the trust preferred securities, as and when due, regardless of any
defense or counterclaim that the trust may have or assert other than the defense
of payment.

The following payments with respect to the trust preferred securities are
called the "guarantee payments" and, to the extent not paid or made by the trust
and to the extent that the trust has funds available for those distributions,
will be subject to the guarantee:

- any accumulated and unpaid distributions required to be paid on the trust
preferred securities;

- with respect to any trust preferred securities called for redemption, the
redemption price; and

- upon a voluntary or involuntary dissolution, winding up or liquidation of
the trust (other than in connection with the distribution of debentures
to the holders of trust preferred securities or a redemption of all of
the trust preferred securities), the lesser of:

(a) the amount of the liquidation distribution; or

(b) the amount of assets of the trust remaining available for distribution
to holders of trust preferred securities in liquidation of the trust.

We may satisfy our obligations to make a guarantee payment by making a direct
payment of the required amounts to the holders of the trust preferred securities
or by causing the trust to pay the amounts to the holders.

The guarantee agreement is a guarantee, on a subordinated basis, of the
guarantee payments, but the guarantee only applies to the extent the trust has
funds available for those distributions. If we do not make interest payments on
the debentures purchased by the trust, the trust will not have funds available
to make the distributions and will not pay distributions on the trust preferred
securities.

STATUS OF THE GUARANTEE

The guarantee constitutes our unsecured obligation that ranks junior in
right of payment to all of our senior and subordinated debt in the same manner
as the debentures. We expect to incur additional indebtedness in the future,
although we have no specific plans in this regard presently, and neither the
indenture nor the trust agreement limits the amounts of the obligations that we
may incur.

The guarantee constitutes a guarantee of payment and not of collection. If
we fail to make guarantee payments when required, holders of trust preferred
securities may institute a legal proceeding directly against us to enforce their
rights under the guarantee without first instituting a legal proceeding against
any other person or entity.

The guarantee will not be discharged except by payment of the guarantee
payments in full to the extent not paid by the trust or upon distribution of the
debentures to the holders of the trust preferred securities. Because we are a
holding company, our right to participate in any distribution of assets of any
subsidiary upon the subsidiary's liquidation or reorganization or otherwise is
subject to the prior claims of
93
<PAGE> 97

creditors of that subsidiary, except to the extent we may be recognized as a
creditor of that subsidiary. Our obligations under the guarantee, therefore,
will be effectively subordinated to all existing and future liabilities of our
subsidiaries, and claimants should look only to our assets for payments under
the guarantee.

AMENDMENTS AND ASSIGNMENT

Except with respect to any changes that do not materially adversely affect
the rights of holders of the trust preferred securities, in which case no vote
will be required, the guarantee may be amended only with the prior approval of
the holders of a majority of the aggregate liquidation amount of the outstanding
trust preferred securities. See "Description of the Trust Preferred
Securities -- Voting Rights; Amendment of Trust Agreement."

EVENTS OF DEFAULT; REMEDIES

An event of default under the guarantee agreement will occur upon our
failure to make any required guarantee payments or to perform any other
obligations under the guarantee. The holders of a majority in aggregate
liquidation amount of the trust preferred securities have the right to direct
the time, method and place of conducting any proceeding for any remedy available
to the guarantee trustee in respect of the guarantee and may direct the exercise
of any power conferred upon the guarantee trustee under the guarantee agreement.

Any holder of trust preferred securities may initiate and prosecute a legal
proceeding directly against us to enforce its rights under the guarantee without
first instituting a legal proceeding against the trust, the guarantee trustee or
any other person or entity.

We are required to provide to the guarantee trustee annually a certificate
as to whether or not we are in compliance with all of the conditions and
covenants applicable to us under the guarantee agreement.

TERMINATION OF THE GUARANTEE

The guarantee will terminate and be of no further force and effect upon:

- full payment of the redemption price of the trust preferred securities;

- full payment of the amounts payable upon liquidation of the trust; or

- distribution of the debentures to the holders of the trust preferred
securities.

If at any time any holder of the trust preferred securities must restore
payment of any sums paid under the trust preferred securities or the guarantee,
the guarantee will continue to be effective or will be reinstated with respect
to such amounts.

INFORMATION CONCERNING THE GUARANTEE TRUSTEE

The guarantee trustee, other than during the occurrence and continuance of
our default in performance of the guarantee, undertakes to perform only those
duties as are specifically set forth in the guarantee. When an event of default
has occurred and is continuing, the guarantee trustee must exercise the same
degree of care and skill as a prudent person would exercise or use in the
conduct of his or her own affairs. Subject to those provisions, the guarantee
trustee is under no obligation to exercise any of the powers vested in it by the
guarantee at the request of any holder of any trust preferred securities unless
it is offered reasonable indemnity against the costs, expenses and liabilities
that might be incurred thereby.

EXPENSE AGREEMENT

We will, pursuant to the Agreement as to Expenses and Liabilities entered
into by us and the trust under the trust agreement, irrevocably and
unconditionally guarantee to each person or entity to whom the trust becomes
indebted or liable, the full payment of any costs, expenses or liabilities of
the trust, other
94
<PAGE> 98

than obligations of the trust to pay to the holders of the trust preferred
securities or other similar interests in the trust of the amounts due to the
holders pursuant to the terms of the trust preferred securities or other similar
interests, as the case may be. Third party creditors of the trust may proceed
directly against us under the expense agreement, regardless of whether they had
notice of the expense agreement.

GOVERNING LAW

The guarantee will be governed by the laws of the State of Texas.

RELATIONSHIP AMONG THE TRUST PREFERRED SECURITIES, THE
DEBENTURES AND THE GUARANTEE

FULL AND UNCONDITIONAL GUARANTEE

We irrevocably guarantee, as and to the extent described in this
prospectus, payments of distributions and other amounts due on the trust
preferred securities, to the extent the trust has funds available for the
payment of these amounts. We and the trust believe that, taken together, our
obligations under the debentures, the indenture, the trust agreement, the
expense agreement and the guarantee agreement provide, in the aggregate, a full,
irrevocable and unconditional guarantee, on a subordinated basis, of payment of
distributions and other amounts due on the trust preferred securities. No single
document standing alone or operating in conjunction with fewer than all of the
other documents constitutes a guarantee. It is only the combined operation of
these documents that has the effect of providing a full, irrevocable and
unconditional guarantee of the obligations of the trust under the trust
preferred securities.

If and to the extent that we do not make payments on the debentures, the
trust will not pay distributions or other amounts due on the trust preferred
securities. The guarantee does not cover payment of distributions when the trust
does not have sufficient funds to pay the distributions. In this event, the
remedy of a holder of trust preferred securities is to institute a legal
proceeding directly against us for enforcement of payment of the distributions
to the holder. Our obligations under the guarantee are subordinate and junior in
right of payment to all of our other indebtedness.

SUFFICIENCY OF PAYMENTS

As long as payments of interest and other payments are made when due on the
debentures, these payments will be sufficient to cover distributions and other
payments due on the trust preferred securities, primarily because:

- the aggregate principal amount of the debentures will be equal to the sum
of the aggregate stated liquidation amount of the trust securities;

- the interest rate and interest and other payment dates on the debentures
will match the distribution rate and distribution and other payment dates
for the trust preferred securities;

- we will pay for any and all costs, expenses and liabilities of the trust,
except the obligations of the trust to pay to holders of the trust
preferred securities the amounts due to the holders pursuant to the terms
of the trust preferred securities; and

- the trust will not engage in any activity that is not consistent with the
limited purposes of the trust.

ENFORCEMENT RIGHTS OF HOLDERS OF TRUST PREFERRED SECURITIES

A holder of any trust preferred security may institute a legal proceeding
directly against us to enforce its rights under the guarantee without first
instituting a legal proceeding against the guarantee trustee, the trust or any
other person. A default or event of default under any of our senior or
subordinated debt would not constitute a default or event of default under the
trust agreement. In the event, however, of payment defaults under, or
acceleration of, our senior or subordinated debt, the subordination provisions
of the indenture provide that no payments may be made in respect of the
debentures until the obligations have
95
<PAGE> 99

been paid in full or any payment default has been cured or waived. Failure to
make required payments on the debentures would constitute an event of default
under the trust agreement.

LIMITED PURPOSE OF THE TRUST

The trust preferred securities evidence preferred undivided beneficial
interests in the assets of the trust. The trust exists for the exclusive
purposes of issuing the trust securities, investing the proceeds thereof in
debentures and engaging in only those other activities necessary, advisable or
incidental thereto. A principal difference between the rights of a holder of a
trust preferred security and the rights of a holder of a debenture is that a
holder of a debenture is entitled to receive from us the principal amount of and
interest accrued on debentures held, while a holder of trust preferred
securities is entitled to receive distributions from the trust (or from us under
the guarantee) if and to the extent the trust has funds available for the
payment of the distributions.

RIGHTS UPON TERMINATION

Upon any voluntary or involuntary termination, winding-up or liquidation of
the trust involving the liquidation of the debentures, the holders of the trust
preferred securities will be entitled to receive, out of assets held by the
trust, the liquidation distribution in cash. See "Description of the Trust
Preferred Securities -- Liquidation Distribution Upon Termination."

Upon our voluntary or involuntary liquidation or bankruptcy, the property
trustee, as holder of the debentures, would be a subordinated creditor of ours.
Therefore, the property trustee would be subordinated in right of payment to all
of our senior and subordinated debt, but is entitled to receive payment in full
of principal and interest before any of our stockholders receive payments or
distributions. Since we are the guarantor under the guarantee and have agreed to
pay for all costs, expenses and liabilities of the trust other than the
obligations of the trust to pay to holders of the trust preferred securities the
amounts due to the holders pursuant to the terms of the trust preferred
securities, the positions of a holder of the trust preferred securities and a
holder of the debentures relative to our other creditors and to our shareholders
in the event of liquidation or bankruptcy are expected to be substantially the
same.

96
<PAGE> 100

FEDERAL INCOME TAX CONSEQUENCES

GENERAL

The following summary of the material federal income tax considerations
that may be relevant to the purchasers of trust preferred securities represents
the opinion of Bracewell & Patterson, L.L.P., counsel to us and the trust
insofar as it relates to matters of law and legal conclusions. The conclusions
expressed herein are based upon current provisions of the Internal Revenue Code
of 1986, regulations thereunder and current administrative rulings and court
decisions, all of which are subject to change at any time, with possible
retroactive effect. Subsequent changes may cause tax consequences to vary
substantially from the consequences described below. Furthermore, the
authorities on which the following summary is based are subject to various
interpretations, and it is therefore possible that the federal income tax
treatment of the purchase, ownership and disposition of trust preferred
securities may differ from the treatment described below. In rendering its
opinion, Bracewell & Patterson, L.L.P. has not sought a ruling from the Internal
Revenue Service as to any tax consequences, and its opinion is not binding on
the Internal Revenue Service.

No attempt has been made in the following discussion to comment on all
federal income tax matters affecting purchasers of trust preferred securities.
Moreover, the discussion generally focuses on holders of trust preferred
securities who are individual citizens or residents of the United States and who
acquire trust preferred securities on their original issue at their offering
price and hold trust preferred securities as capital assets. The discussion has
only limited application to dealers in securities, corporations, estates, trusts
or nonresident aliens and does not address all the tax consequences that may be
relevant to holders who may be subject to special tax treatment, such as, for
example, banks, thrifts, real estate investment trusts, regulated investment
companies, insurance companies, dealers in securities or currencies, tax-exempt
investors or persons that will hold the trust preferred securities as a position
in a "straddle," as part of a "synthetic security" or "hedge," as part of a
"conversion transaction" or other integrated investment, or as other than a
capital asset. The following summary also does not address the tax consequences
to persons that have a functional currency other than the U.S. dollar or the tax
consequences to shareholders, partners or beneficiaries of a holder of trust
preferred securities. Further, it does not include any description of any
alternative minimum tax consequences or the tax laws of any state or local
government or of any foreign government that may be applicable to the trust
preferred securities. Accordingly, each prospective investor should consult, and
should rely exclusively on, the investor's own tax advisors in analyzing the
federal, state, local and foreign tax consequences of the purchase, ownership or
disposition of trust preferred securities.

CLASSIFICATION OF THE DEBENTURES

In accordance with the opinion of Bracewell & Patterson, L.L.P., we intend
to take the position that the debentures will be classified for federal income
tax purposes as our indebtedness under current law, and, by acceptance of a
trust preferred security, each holder covenants to treat the debentures as
indebtedness and the trust preferred securities as evidence of an indirect
beneficial ownership interest in the debentures. No assurance can be given,
however, that this position will not be challenged by the Internal Revenue
Service or, if challenged, that it will not be successful. The remainder of this
discussion assumes that the debentures will be classified for federal income tax
purposes as our indebtedness.

CLASSIFICATION OF THE TRUST

With respect to the trust preferred securities, Bracewell & Patterson,
L.L.P. has rendered its opinion generally to the effect that, assuming full
compliance with the terms of the trust agreement and indenture, the trust will
be classified for federal income tax purposes as a grantor trust and not as an
association taxable as a corporation. Accordingly, for federal income tax
purposes, each holder of trust preferred securities generally will be treated as
owning an undivided beneficial interest in the debentures, and each holder will
be required to include in its gross income any interest with respect to the
debentures at the time such interest is accrued or is received, in accordance
with the holder's method of accounting. If the
97
<PAGE> 101

debentures were determined to be subject to the original issue discount ("OID")
rules, each holder would instead be required to include in its gross income any
OID accrued with respect to its allocable share of the debentures whether or not
cash were actually distributed to the holder.

INTEREST PAYMENT PERIOD AND ORIGINAL ISSUE DISCOUNT

United States persons (including cash basis taxpayers) that hold debt
instruments issued with OID must generally include such OID in income as it
accrues on a constant yield method even if there is not a corresponding receipt
of cash attributable to such income. Debt instruments such as the debentures
will generally be treated as issued with OID if the stated interest on the
instrument does not constitute "qualified stated interest." Qualified stated
interest is generally any one of a series of stated interest payments on an
instrument that are unconditionally payable at least annually at a single fixed
rate. In determining whether stated interest on an instrument is unconditionally
payable and thus constitutes qualified stated interest, remote contingencies as
to the timely payment of stated interest are ignored. In the case of the
debentures, we have concluded that the likelihood of exercising our option to
defer payments of interest is remote.

If the option to defer any payment of interest was determined not to be
"remote" or if we actually exercise our option to defer the payment of interest,
the debentures would be treated as issued with OID at the time of issuance or at
the time of such exercise, as the case may be, and all stated interest would
thereafter be treated as OID as long as the debentures remained outstanding. In
such event, all of a United States person's taxable interest income in respect
of the debentures would constitute OID that would have to be included in income
on a constant yield method before the receipt of the cash attributable to such
income, regardless of such person's method of tax accounting, and actual
distributions of stated interest would not be reported as taxable income.
Consequently, a holder of trust preferred securities would be required to
include such OID in gross income even though we would not make any actual cash
payments during an extension period.

Because income on the trust preferred securities will constitute interest,
corporate holders of trust preferred securities will not be entitled to a
dividends-received deduction with respect to any income recognized with respect
to the trust preferred securities.

MARKET DISCOUNT AND ACQUISITION PREMIUM

Holders of trust preferred securities other than holders who purchased the
trust preferred securities upon original issuance may be considered to have
acquired their undivided interests in the debentures with "market discount" or
"acquisition premium" as these phrases are defined for federal income tax
purposes. Such holders are advised to consult their tax advisors as to the
income tax consequences of the acquisition, ownership and disposition of the
trust preferred securities.

RECEIPT OF DEBENTURES OR CASH UPON LIQUIDATION OF THE TRUST

Under the circumstances described under "Description of the Trust Preferred
Securities -- Redemption or Exchange" and "-- Liquidation Distribution Upon
Termination," the debentures may be distributed to holders of trust preferred
securities upon a liquidation of the trust. Under current federal income tax
law, such a distribution would be treated as a nontaxable event to the holder
and would result in the holder having an aggregate tax basis in the debentures
received in the liquidation equal to the holder's aggregate tax basis in the
trust preferred securities immediately before the distribution. A holder's
holding period in debentures received in liquidation of the trust would include
the period for which the holder held the trust preferred securities.

If, however, a Tax Event occurs which results in the trust being treated as
an association taxable as a corporation, the distribution would likely
constitute a taxable event to holders of the trust preferred securities. Under
certain circumstances described herein, the debentures may be redeemed for cash
and the proceeds of the redemption distributed to holders in redemption of their
trust preferred securities. Under current law, such a redemption should, to the
extent that it constitutes a complete redemption,
98
<PAGE> 102

constitute a taxable disposition of the redeemed trust preferred securities, and
a holder for federal income tax purposes, should recognize gain or loss as if
the holder sold the trust preferred securities for cash.

DISPOSITION OF TRUST PREFERRED SECURITIES

A holder that sells trust preferred securities will recognize gain or loss
equal to the difference between the amount realized on the sale of the trust
preferred securities and the holder's adjusted tax basis in the trust preferred
securities. A holder's adjusted tax basis in the trust preferred securities
generally will be its initial purchase price increased by OID previously
includible in the holder's gross income to the date of disposition and decreased
by payments received on the trust preferred securities to the date of
disposition. A gain or loss of this kind will generally be a capital gain or
loss and will be a long-term capital gain or loss if the trust preferred
securities have been held for more than one year at the time of sale.

The trust preferred securities may trade at a price that does not
accurately reflect the value of accrued but unpaid interest with respect to the
underlying debentures. A holder that disposes of its trust preferred securities
between record dates for payments of distributions thereon will be required to
include accrued but unpaid interest on the debentures through the date of
disposition in income as ordinary income, and to add the amount to its adjusted
tax basis in its proportionate share of the underlying debentures deemed
disposed of. To the extent the selling price is less than the holder's adjusted
tax basis a holder will recognize a capital loss. The adjusted basis would
include, in the form of OID, all accrued but unpaid interest. Subject to certain
limited exceptions, capital losses cannot be applied to offset ordinary income
for federal income tax purposes.

EFFECT OF POSSIBLE CHANGES IN TAX LAWS

Congress and the Clinton Administration have considered certain proposed
tax law changes in the past that would, among other things, generally deny
corporate issuers a deduction for interest in respect of certain debt
obligations if the debt obligations have a maximum term in excess of 15 years
and are not shown as indebtedness on the issuer's applicable consolidated
balance sheet. Other proposed tax law changes would have denied interest
deductions if the term was in excess of 20 years. Although these proposed tax
law changes have not been enacted into law, there can be no assurance that tax
law changes will not be reintroduced into future legislation which, if enacted
after the date hereof, may adversely affect the federal income tax deductibility
of interest payable on the debentures. Accordingly, there can be no assurance
that a Tax Event will not occur. A Tax Event would permit us, upon approval of
the Federal Reserve if then required, to cause a redemption of the trust
preferred securities before, as well as after, November 17, 2004. See
"Description of the Debentures -- Redemption or Exchange" and "Description of
the Trust Preferred Securities -- Redemption or Exchange -- Redemption upon a
Tax Event, Investment Company Event or Capital Treatment Event."

BACKUP WITHHOLDING AND INFORMATION REPORTING

The amount of qualified stated interest, or, if applicable, OID, accrued on
the trust preferred securities held of record by individual citizens or
residents of the United States, or certain trusts, estates and partnerships,
will be reported to the Internal Revenue Service on Forms 1099-INT, or, where
applicable, forms 1099-OID, which forms should be mailed to the holders by
January 31 following each calendar year. Payments made on, and proceeds from the
sale of, the trust preferred securities may be subject to a "backup" withholding
tax (currently at 31%) unless the holder complies with certain identification
and other requirements. Any amounts withheld under the backup withholding rules
will be allowed as a credit against the holder's federal income tax liability,
provided the required information is provided to the Internal Revenue Service.

THE FEDERAL INCOME TAX DISCUSSION SET FORTH ABOVE IS INCLUDED FOR GENERAL
INFORMATION ONLY AND MAY NOT BE APPLICABLE DEPENDING UPON THE PARTICULAR
SITUATION OF A HOLDER OF TRUST PREFERRED SECURITIES. HOLDERS OF TRUST PREFERRED
SECURITIES SHOULD CONSULT THEIR TAX ADVISORS WITH RESPECT TO THE TAX
CONSEQUENCES TO THEM OF THE PURCHASE, OWNERSHIP AND DISPOSITION OF THE TRUST
PREFERRED SECURITIES,

99
<PAGE> 103

INCLUDING THE TAX CONSEQUENCES UNDER STATE, LOCAL, FOREIGN AND OTHER TAX LAWS
AND THE POSSIBLE EFFECTS OF CHANGES IN FEDERAL OR OTHER TAX LAWS.

ERISA CONSIDERATIONS

Employee benefit plans that are subject to the Employee Retirement Income
Security Act of 1974, or Section 4975 of the Internal Revenue Code, generally
may purchase trust preferred securities, subject to the investing fiduciary's
determination that the investment in trust preferred securities satisfies
ERISA's fiduciary standards and other requirements applicable to investments by
the plan.

In any case, we and/or any of our affiliates may be considered a "party in
interest" (within the meaning of ERISA) or a "disqualified person" (within the
meaning of Section 4975 of the Internal Revenue Code) with respect to certain
plans. These plans generally include plans maintained or sponsored by, or
contributed to by, any such persons with respect to which we or any of our
affiliates are a fiduciary or plans for which we or any of our affiliates
provide services. The acquisition and ownership of trust preferred securities by
a plan (or by an individual retirement arrangement or other plans described in
Section 4975(e)(1) of the Internal Revenue Code) with respect to which we or any
of our affiliates are considered a party in interest or a disqualified person
may constitute or result in a prohibited transaction under ERISA or Section 4975
of the Internal Revenue Code, unless the trust preferred securities are acquired
pursuant to and in accordance with an applicable exemption.

As a result, plans with respect to which we or any of our affiliates or any
of its affiliates is a party in interest or a disqualified person should not
acquire trust preferred securities unless the trust preferred securities are
acquired pursuant to and in accordance with an applicable exemption. Any other
plans or other entities whose assets include plan assets subject to ERISA or
Section 4975 of the Internal Revenue Code proposing to acquire trust preferred
securities should consult with their own counsel.

100
<PAGE> 104

UNDERWRITING

Subject to the terms and conditions of the underwriting agreement among us,
the trust and the underwriters listed on the table below for whom Howe Barnes
Investments, Inc. is acting as representative, the underwriters have severally
agreed to purchase from the trust an aggregate of 1,200,000 trust preferred
securities in the amounts set forth below opposite their respective names.

<TABLE>
<CAPTION>
NUMBER OF TRUST
UNDERWRITERS PREFERRED SECURITIES
- ------------ --------------------
<S> <C>
Howe Barnes Investments, Inc. ....................... 660,000
First Union Securities, Inc. ........................ 100,000
Morgan Keegan & Company, Inc. ....................... 100,000
Stifel, Nicolaus & Company, Incorporated............. 100,000
Fahnstock & Co., Inc. ............................... 30,000
Ryan, Beck & Co., Inc. .............................. 30,000
Sandler O'Neill & Partners, L.P. .................... 30,000
Tucker Anthony Cleary Gull, Inc. .................... 30,000
George K. Baum & Company............................. 20,000
First Southwest Company.............................. 20,000
Hoefer & Arnett Incorporated......................... 20,000
Mesirow Financial ................................... 20,000
Pacific Crest Securities............................. 20,000
Samco Capital Markets................................ 20,000
---------
Total...................................... 1,200,000
=========
</TABLE>

The underwriting agreement requires the underwriters to accept and pay for
all of the trust preferred securities, if any are taken. In addition, the
underwriting agreement sets forth customary conditions that must be satisfied on
the part of us and the trust before the underwriters are obligated to purchase
the trust preferred securities. These conditions include the accuracy of
specific representations and warranties and the receipt of opinions of counsel
and reports from accountants as to our status and the status of the trust and
the trust preferred securities.

The table below shows the price and proceeds on a per security and
aggregate basis:

<TABLE>
<CAPTION>
PER TRUST
PREFERRED SECURITY TOTAL
------------------ -----------
<S> <C> <C>
Public offering price.................................... $ 10.00 $12,000,000
Underwriting fees to be paid by Prosperity Bancshares,
Inc. .................................................. $ 0.375 $ 450,000
Proceeds to the trust.................................... $ 10.00 $12,000,000
</TABLE>

The proceeds we will receive as shown in the table above do not reflect
estimated expenses of $135,000 payable by us.

All of the proceeds to the trust will be used to purchase the debentures
from us. We have agreed to pay the underwriters 3.75% of the public offering
price per trust preferred security for an aggregate of $450,000, for arranging
the sale of the trust preferred securities and the subsequent investment in the
debentures.

The underwriters propose to offer the trust preferred securities in part
directly to the public at the initial public offering price set forth above, and
in part to securities dealers at this price less a concession not in excess of
$0.20 per trust preferred security. The underwriters may allow, and the dealers
may reallow, a concession not in excess of $0.15 per trust preferred security to
brokers and dealers. After the trust preferred securities are released for sale
to the public, the offering price and other selling terms may from time to time
be varied by the underwriters.

101
<PAGE> 105

We and the trust have agreed to indemnify the several underwriters against
several liabilities, including liabilities under the Securities Act of 1933.
Generally, the indemnification provisions in the underwriting agreement provide
for full indemnification of the underwriters in actions related to the
disclosure in this prospectus unless such disclosure was provided by the
underwriters specifically for use in this prospectus.

In connection with the offering, the underwriters may purchase and sell the
trust preferred securities in the open market. These transactions may include
stabilizing transactions and purchases to cover syndicate short positions
created in connection with the offering. Stabilizing transactions consist of
bids or purchases for the purpose of preventing or retarding a decline in the
market price of the trust preferred securities; and syndicate short positions
involve the sale by the underwriters of a greater number of securities than they
are required to purchase from us in the offering. The underwriters also may
impose a penalty bid, whereby selling concessions allowed to syndicate members
or other broker-dealers in respect of the securities sold in the offering for
their own account may be reclaimed by the syndicate if the trust preferred
securities are repurchased by the syndicate in stabilizing or covering
transactions. These activities may stabilize, maintain or otherwise affect the
market price of the trust preferred securities, which may be higher than the
price that might otherwise prevail in the open market. These activities, if
commenced, may be discontinued at any time. These transactions may be effected
in the over-the-counter market or otherwise.

The underwriters have advised the trust that they do not intend to confirm
any sales of trust preferred securities to any discretionary accounts. In
connection with the offer and sale of the trust preferred securities, the
underwriters will comply with Rule 2810 under the NASD Conduct Rules.

LEGAL MATTERS

Certain legal matters, including matters relating to federal income tax
considerations, for us and the trust will be passed upon by Bracewell &
Patterson, L.L.P., Houston, Texas, counsel to us and the trust. Certain legal
matters will be passed upon for the underwriters by Barack Ferrazzano Kirschbaum
Perlman & Nagelberg, Chicago, Illinois. Bracewell & Patterson, L.L.P. and Barack
Ferrazzano Kirschbaum Perlman & Nagelberg may rely on the opinion of Richards,
Layton & Finger, P.A., Wilmington, Delaware, as to matters of Delaware law.

EXPERTS

The consolidated financial statements of Prosperity as of December 31, 1998
and 1997 and for each of the three years in the period ended December 31, 1998,
included in this prospectus, have been audited by Deloitte & Touche LLP,
independent auditors, as stated in their report appearing herein, and are
included in reliance upon such report given upon their authority as experts in
accounting and auditing.

The consolidated financial statements of South Texas as of December 31,
1998 and 1997 and for each of the two years in the period ended December 31,
1998, included in this prospectus, have been audited by Padgett, Stratemann &
Co., L.L.P., independent auditors, as stated in their report appearing herein,
and are included in reliance upon such report given upon their authority as
experts in accounting and auditing.

102
<PAGE> 106

WHERE YOU CAN FIND INFORMATION

This prospectus is a part of a Registration Statement on Form S-1 filed by
us and the trust with the Securities and Exchange Commission under the
Securities Act, with respect to the trust preferred securities, the debentures
and the guarantee. This prospectus does not contain all the information set
forth in the registration statement, certain parts of which are omitted in
accordance with the rules and regulations of the SEC. For further information
with respect to us and the securities offered by this prospectus, reference is
made to the registration statement, including the exhibits to the registration
statement. Statements contained in this prospectus concerning the provisions of
such documents are necessarily summaries of such documents and each such
statement is qualified in its entirety by reference to the copy of the
applicable document filed with the SEC.

We file periodic reports, proxy statements and other information with the
SEC. Our filings are available to the public over the Internet at the SEC's web
site. The address of that site is http://www.sec.gov. You may also inspect and
copy these materials at the public reference facilities of the SEC at 450 Fifth
Street, N.W., Room 1024, Washington, D.C. 20549, as well as at 500 West Madison
Street, Suite 1400, Chicago, Illinois 60661 and 75 Park Place, Room 1400, New
York, New York 10007. Copies of such material can be obtained at prescribed
rates from the Public Reference Section of the SEC at 450 Fifth Street, N.W.,
Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further
information.

The trust is not currently subject to the information reporting
requirements of the Securities Exchange Act of 1934 and although the trust will
become subject to such requirements upon the effectiveness of the Registration
Statement, it is not expected that the trust will be required to file separate
reports under the Securities Exchange Act of 1934.

We have not included separate financial statements of the trust in this
prospectus. We do not consider that separate financial statements would be
material to holders of trust preferred securities because we will own all of the
trust's voting securities, the trust has no independent operations and we
guarantee the payments on the trust preferred securities to the extent described
in this prospectus.

103
<PAGE> 107

TABLE OF CONTENTS TO FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PROSPERITY BANCSHARES, INC.

Independent Auditors' Report.............................. F-2

Consolidated Balance Sheets as of June 30, 1999
(Unaudited) and December 31, 1998
and 1997............................................... F-3

Consolidated Statements of Income for the Six Months Ended
June 30, 1999 (Unaudited) and June 30, 1998 (Unaudited)
and for the Years Ended December 31, 1998, 1997 and
1996................................................... F-4

Consolidated Statements of Shareholders' Equity for the
Years Ended December 31, 1998, 1997 and 1996 and for
the Six Months Ended June 30, 1999 (Unaudited)......... F-5

Consolidated Statements of Cash Flows for the Six Months
Ended June 30, 1999 (Unaudited) and June 30, 1998
(Unaudited) and for the Years Ended December 31, 1998,
1997
and 1996............................................... F-6

Notes to Consolidated Financial Statements................ F-8

SOUTH TEXAS BANCSHARES, INC.

Independent Auditors' Report.............................. F-28

Consolidated Balance Sheets as of June 30, 1999 and 1998
(Unaudited)............................................ F-29

Consolidated Balance Sheets as of December 31, 1998 and
1997................................................... F-30

Consolidated Statements of Income for the Six Months Ended
June 30, 1999 and 1998 (Unaudited)..................... F-31

Consolidated Statements of Income for the Years Ended
December 31, 1998 and 1997............................. F-32

Consolidated Statements of Changes in Stockholders' Equity
for the Six Months Ended June 30, 1999 and 1998
(Unaudited)............................................ F-33

Consolidated Statements of Changes in Stockholders' Equity
for the Years Ended December 30, 1998 and 1997......... F-34

Consolidated Statements of Cash Flows for the Six Months
Ended June 30, 1999 and 1998 (Unaudited)............... F-35

Consolidated Statements of Cash Flows for the Years Ended
December 31, 1998 and 1997............................. F-36

Notes to Consolidated Financial Statements................ F-37
</TABLE>

F-1
<PAGE> 108

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, 1998 and 1997, and the related consolidated statements of income,
shareholders' equity and cash flows for each of the three years in the period
ended December 31, 1998. 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, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998 in conformity with generally accepted accounting principles.

Deloitte & Touche LLP

February 18, 1999
Houston, Texas

F-2
<PAGE> 109

PROSPERITY BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
June 30, December 31,
----------- -------------------
1999 1998 1997
----------- -------- --------
(Dollars in thousands)
(Unaudited)
<S> <C> <C> <C>
ASSETS
Cash and due from banks (Note 3)............................ $ 12,511 $ 18,243 $ 17,372
Interest-bearing deposits in financial institutions......... -- 99 198
Available for sale securities, at fair value (amortized cost
of $140,085 (unaudited), $113,300 and $38,650
respectively) (Note 4).................................. 138,170 113,828 38,612
Held to maturity securities, at cost (fair value of $83,577
(unaudited), $115,021 and $129,774 respectively) (Note
4)...................................................... 83,511 113,916 129,256
Loans (Notes 5 and 6)....................................... 188,034 170,478 120,578
Less allowance for credit losses (Note 7)................... (2,013) (1,850) (1,016)
-------- -------- --------
Loans, net......................................... 186,021 168,628 119,562
Accrued interest receivable................................. 4,316 3,990 2,501
Goodwill, net of accumulated amortization of $3,400
(unaudited), $3,077 and $2,577, respectively............ 9,366 9,690 5,644
Bank premises and equipment, net (Note 8)................... 6,054 6,105 5,530
Other assets................................................ 2,825 1,813 1,468
-------- -------- --------
TOTAL....................................................... $442,774 $436,312 $320,143
======== ======== ========

LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Deposits (Note 9):
Noninterest-bearing................................ $ 80,846 $ 84,976 $ 61,447
Interest-bearing................................... 317,533 305,683 230,069
-------- -------- --------
Total deposits................................. 398,379 390,659 291,516
Other borrowings (Note 10).............................. 570 2,437 2,800
Accrued interest payable................................ 978 1,081 709
Other liabilities....................................... 619 700 300
-------- -------- --------
Total liabilities.............................. 400,546 394,877 295,325
COMMITMENTS AND CONTINGENCIES
(Note 12 and 16)
SHAREHOLDERS' EQUITY (Notes 14, 17, and 18):
Common stock, $1 par value; 50,000,000 shares
authorized; 5,198,901 (unaudited), 5,176,401 and
3,993,884, shares issued at June 30, 1999, December
31, 1998 and 1997, respectively; 5,195,325
(unaudited), 5,172,825 and 3,990,308 shares
outstanding at June 30, 1999, December 31, 1998 and
1997, respectively................................. 5,199 5,176 3,993
Capital surplus......................................... 16,441 16,477 4,818
Retained earnings....................................... 21,870 19,452 16,049
Accumulated other comprehensive income -- net unrealized
gains (losses) on available for sale securities,
net of tax benefit of $651, (unaudited) and tax of
$179 and $13, respectively......................... (1,264) 348 (24)
Less treasury stock, at cost, 3,576 (unaudited), 3,576
and 3,576 shares, respectively..................... (18) (18) (18)
-------- -------- --------
Total shareholders' equity..................... 42,228 41,435 24,818
-------- -------- --------
TOTAL....................................................... $442,774 $436,312 $320,143
======== ======== ========
</TABLE>

See notes to consolidated financial statements.

F-3
<PAGE> 110

PROSPERITY BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME

<TABLE>
<CAPTION>
For the Six Months For the Years Ended
Ended June 30, December 31,
------------------ -----------------------------
1999 1998 1998 1997 1996
------- ------- ------- ------- -------
(Unaudited)
(Dollars in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
INTEREST INCOME:
Loans, including fees..................... $ 7,456 $ 5,568 $12,282 $10,206 $ 9,136
Securities:
Taxable.............................. 6,211 4,841 10,152 8,950 6,648
Nontaxable........................... 464 295 682 605 723
Federal funds sold........................ 422 127 299 193 310
Deposits in financial institutions........ -- 5 7 16 24
------- ------- ------- ------- -------
Total interest income........... 14,553 10,836 23,422 19,970 16,841
------- ------- ------- ------- -------
INTEREST EXPENSE:
Deposits.................................. 6,123 4,647 9,993 8,858 7,720
Note payable and federal funds
purchased.............................. -- -- 24 132 203
Other..................................... 7 69 111 70 --
------- ------- ------- ------- -------
Total interest expense.......... 6,130 4,716 10,128 9,060 7,923
------- ------- ------- ------- -------
NET INTEREST INCOME........................... 8,423 6,120 13,294 10,910 8,918
PROVISION FOR CREDIT LOSSES (Note 7).......... 130 145 239 190 230
------- ------- ------- ------- -------
NET INTEREST INCOME AFTER PROVISION
FOR CREDIT LOSSES......................... 8,293 5,975 13,055 10,720 8,688
------- ------- ------- ------- -------
NONINTEREST INCOME:
Customer service fees..................... 1,241 1,074 2,173 2,062 1,742
Other..................................... 205 199 319 202 155
------- ------- ------- ------- -------
Total noninterest income........ 1,446 1,273 2,492 2,264 1,897
------- ------- ------- ------- -------
NONINTEREST EXPENSE:
Salaries and employee benefits (Note
15).................................... 2,820 2,115 4,541 3,968 3,415
Net occupancy expense..................... 437 367 768 811 710
Data processing........................... 417 369 807 642 493
Goodwill amortization..................... 323 235 500 402 257
Depreciation expense...................... 175 136 290 431 367
Other..................................... 1,265 1,030 2,152 1,582 1,392
------- ------- ------- ------- -------
Total noninterest expense....... 5,435 4,252 9,058 7,836 6,634
------- ------- ------- ------- -------
INCOME BEFORE INCOME TAXES.................... 4,304 2,996 6,489 5,148 3,951
PROVISION FOR INCOME TAXES (Note 13).......... 1,367 939 2,029 1,586 1,240
------- ------- ------- ------- -------
NET INCOME.................................... $ 2,937 $ 2,057 $ 4,460 $ 3,562 $ 2,711
======= ======= ======= ======= =======
EARNINGS PER SHARE (Note 1):
Basic..................................... $ 0.57 $ 0.52 $ 1.08 $ 0.94 $ 0.77
======= ======= ======= ======= =======
Diluted................................... $ 0.55 $ 0.50 $ 1.04 $ 0.92 $ 0.76
======= ======= ======= ======= =======
</TABLE>

See notes to consolidated financial statements.

F-4
<PAGE> 111

PROSPERITY BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

<TABLE>
<CAPTION>
Accumulated
Other
Comprehensive
Income -- Net
Unrealized Loss
Common Stock on Available Total
------------------ Capital Retained for Sale Treasury Shareholders'
Shares Amount Surplus Earnings Securities Stock Equity
--------- ------ ------- -------- --------------- -------- -------------
(Amounts in thousands, except share data)
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT JANUARY 1, 1996............. 3,513,884 $3,513 $ 2,298 $10,701 $ (55) $ 16,457
Net income..................... 2,711 2,711
Net change in unrealized loss
on available for sale
securities................. 35 35
--------
Total comprehensive income..... 2,745
--------
Purchase of treasury stock..... $(19) (19)
Cash dividends declared, $0.10
per share.................. (351) (351)
--------- ------ ------- ------- ------- ---- --------
BALANCE AT DECEMBER 31, 1996........... 3,513,884 3,513 2,298 13,061 (20) (19) 18,833
Net income..................... 3,562 3,562
Net change in unrealized loss
on available for sale
securities................. (4) (4)
--------
Total comprehensive income..... 3,558
--------
Sale of treasury stock......... 1 1
Issuance of common stock....... 480,000 480 2,520 3,000
Cash dividends declared, $0.15
per share.................. (574) (574)
--------- ------ ------- ------- ------- ---- --------
BALANCE AT DECEMBER 31, 1997........... 3,993,884 3,993 4,818 16,049 (24) (18) 24,818
Net income..................... 4,460 4,460
Net change in unrealized loss
on available for sale
securities................. 372 372
--------
Total comprehensive income..... 4,832
--------
Sale of common stock........... 1,182,517 1,183 11,659 12,841
Cash dividends declared, $0.20
per share.................. (1,057) (1,057)
--------- ------ ------- ------- ------- ---- --------
BALANCE AT DECEMBER 31, 1998........... 5,176,401 5,176 16,477 19,452 348 (18) 41,435
Net income (unaudited)......... 2,937 2,937
Net change in unrealized gain
(loss) on available for
sale securities
(unaudited)................ (1,612) (1,612)
--------
Total comprehensive income
(unaudited)................ 1,325
--------
Sale of common stock
(unaudited)................ 22,500 23 76 99
Stock issuance cost
(unaudited)................ (112) (112)
Cash dividends declared, $0.10
per share (unaudited)...... (519) (519)
--------- ------ ------- ------- ------- ---- --------
BALANCE AT JUNE 30, 1999 (UNAUDITED)... 5,198,901 $5,199 $16,441 $21,870 $(1,264) $(18) $ 42,228
========= ====== ======= ======= ======= ==== ========
</TABLE>

See notes to consolidated financial statements.

F-5
<PAGE> 112

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,
------------------------ ------------------------------
1999 1998 1998 1997 1996
--------- --------- -------- -------- --------
(Unaudited)
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income....................................... $ 2,937 $ 2,057 $ 4,460 $ 3,562 $ 2,711
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization............... 628 488 1,023 833 624
Provision for credit losses................. 130 145 239 190 230
Net amortization of premium/discount on
investments............................. 153 79 236 340 285
Loss on sale of real estate acquired by
foreclosure............................. -- 2 2 2 --
Increase in accrued interest receivable..... (326) (502) (624) (297) (126)
(Increase) in other assets.................. (361) (162) (180) (396) (222)
(Decrease) increase in accrued interest
payable and other liabilities........... (7) 93 217 (80) (138)
-------- -------- -------- -------- --------
Total adjustments....................... 217 143 913 592 653
-------- -------- -------- -------- --------
Net cash provided by operating
activities......................... 3,154 2,200 5,373 4,154 3,364
-------- -------- -------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities and principal paydowns
of held to maturity securities.............. 30,653 26,924 54,725 35,405 23,334
Purchase of held to maturity securities.......... (282) (11,814) (15,983) (66,766) (39,744)
Proceeds from sales of available for sale
securities..................................
Proceeds from maturities and principal paydowns
of available for sale securities............ 9,548 17,584 24,109 14,206 12,061
Purchase of available for sale securities........ (36,352) (23,586) (81,729) (3,497) (25,942)
Net increase in loans............................ (17,523) (20,486) (28,433) (7,482) (14,189)
Net proceeds from sale of real estate acquired by
foreclosure................................. (253) (176) 38 187 --
Purchase of bank premises and equipment.......... (343) (743) (364)
Proceeds from sale of bank premises and
equipment................................... -- 40 -- -- 4
Net decrease (increase) in interest-bearing
deposits in financial institutions.......... 99 99 99 198 (198)
Premium paid for Angleton branch................. -- -- -- (1,990) --
Net liabilities acquired in purchase of Angleton
branch (net of acquired cash of $565)....... -- -- -- 28,647 --
Premium paid for Bay City branch................. -- -- -- -- (1,750)
Net liabilities acquired in purchase of Bay City
branch (net of acquired cash of $492)....... -- -- -- -- 27,542
Premium paid for West Columbia branch............ -- (250) (250) -- --
Net liabilities acquired in purchase of West
Columbia branch (net of acquired cash of
$84)........................................ -- 5,799 5,799 -- --
Premium paid for East Bernard branch............. -- -- (4,297) -- --
Net liabilities acquired in purchase of East
Bernard branch (net of acquired cash of
$16,602).................................... -- -- 3,134 -- --
-------- -------- -------- -------- --------
Net cash (used in) investing activities..... (14,308) (5,866) (43,131) (1,835) (19,246)
-------- -------- -------- -------- --------
</TABLE>

(Table continued on following page)
F-6
<PAGE> 113

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,
------------------------ ---------------------------
1999 1998 1998 1997 1996
--------- --------- ------- ------- -------
(Unaudited)
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (decrease) increase in
noninterest-bearing deposits.... $(4,130) $ 6,892 $13,881 $ 1,210 $ 5,212
Net increase (decrease) in
interest-bearing deposits....... 11,850 3,530 13,328 (9,861) 12,455
Proceeds from line of credit......... -- -- 2,000 3,266
Repayments of line of credit......... (1,865) -- (2,000) (3,266) (1,517)
Proceeds from other borrowings,
net............................. -- -- -- -- --
Repayments of other borrowings,
net............................. -- (2,800) (365) 2,800 --
Proceeds from the issuance of common
stock........................... 99 -- 12,842 3,000 --
Stock issuance costs................. (112) -- -- -- --
Purchase of treasury stock........... -- -- -- -- (19)
Sale of treasury stock............... -- -- -- 1
Payments of cash dividends........... (519) (399) (1,057) (575) (351)
------- ------- ------- ------- -------
Net cash (used in) provided
by financing
activities............ 5,323 7,223 38,629 (6,691) 19,046
------- ------- ------- ------- -------
NET (DECREASE) INCREASE IN CASH AND CASH
EQUIVALENTS.......................... $(5,831) $ 3,557 $ 871 $(4,372) $ 3,164
CASH AND CASH EQUIVALENTS, BEGINNING OF
PERIOD............................... 18,342 17,372 17,372 21,744 18,580
------- ------- ------- ------- -------
CASH AND CASH EQUIVALENTS, END OF
PERIOD............................... $12,511 $20,929 $18,243 $17,372 $21,744
======= ======= ======= ======= =======
INCOME TAXES PAID......................... $ 1,399 $ 946 $ 1,882 $ 1,681 $ 1,111
======= ======= ======= ======= =======
INTEREST PAID............................. $ 6,232 $ 4,699 $ 9,755 $ 9,039 $ 7,849
======= ======= ======= ======= =======
NONCASH INVESTING ACTIVITIES:
The Company acquired certain real estate
through foreclosure of collateral on
loans totaling approximately $140,
$189, and $0 during the years ended
December 31, 1998, 1997, and 1996,
respectively.
</TABLE>

See notes to consolidated financial statements.

F-7
<PAGE> 114

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 twelve branch banking offices in South Central Texas, with
three locations in Houston and nine locations south, southeast and southwest of
Houston in Angleton, Bay City, Cuero, East Bernard, 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:

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 these estimates.

SECURITIES -- 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 securities 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.

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
F-8
<PAGE> 115
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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 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

F-9
<PAGE> 116
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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 30 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.

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 (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 and
1996 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 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.

F-10
<PAGE> 117
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following table illustrates the computation of basic and diluted
earnings per share after effect of stock split (Note 17):

<TABLE>
<CAPTION>
June 30, December 31,
--------------------------------- ---------------------------------------------------
1999 1998 1998 1997 1996
--------------- --------------- --------------- --------------- ---------------
Per Per Per Per Per
Share Share Share Share Share
Amount Amount Amount Amount Amount Amount Amount Amount Amount Amount
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
(Dollars in thousands, except per share data)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net income.................. $2,937 $2,057 $4,460 $3,562 $2,711
Basic --
Weighted average shares
outstanding......... 5,177... $0.57 3,990 $0.52 4,116 $1.08 3,778 $0.94 3,513 $0.77
===== ===== ===== ===== =====
Diluted:
Weighted average shares
outstanding......... 5,177 3,990 4,116 3,778 3,513
Effect of dilutive
securities -- options... 200 90 193 86 47
------ ------ ------ ------ ------
Total................... $5,377 $0.55 $4,080 $0.50 $4,309 $1.04 $3,864 $0.92 $3,560 $0.76
====== ===== ====== ===== ====== ===== ====== ===== ====== =====
</TABLE>

RECENTLY ISSUED ACCOUNTING STANDARDS -- Statement of Financial Accounting
Standards ("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
shareholders' equity, or (3) a separate statement of comprehensive income.
Comprehensive income is comprised of net income and all changes to shareholders'
equity, except those due to investments by owners (changes in 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 shareholders' equity.

Other comprehensive income consists of unrealized gains and losses on
available for sale securities. For the year ended December 31, 1998, the change
in net unrealized loss on available for sale securities is reported in the
consolidated statement of shareholders' equity.

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. The Company has adopted
SFAS No. 131 effective January 1, 1998. Adoption had no material effect on the
consolidated financial statements.

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, 2000.
Management believes the implementation of this pronouncement will not have a
material effect on the Company's financial statements.

INTERIM FINANCIAL DATA -- The interim financial data and related notes for
the six month periods ended June 30, 1998 and 1999 included herein are
unaudited; however, in the opinion of management such interim financial data
includes all adjustments (consisting only of normal recurring adjustments)
necessary for a fair representation of the results of the interim periods. The
operating results for interim periods may not be indicative of the results
expected for the full year.

F-11
<PAGE> 118
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

2. ACQUISITIONS

Effective October 1, 1998, the Company purchased $21.5 million in loans,
$66.1 million in deposits, and $292,000 in real property and fixed assets from
Union State Bank in East Bernard, Texas.

In connection with the purchase, the Company paid a cash premium of
approximately $4.3 million. This premium was recorded as goodwill and will be
amortized on a straight-line basis over 25 years. The acquisition was partially
financed with proceeds from the 1997 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 bank were recorded at
their fair values at the acquisition date.

The following summarized proforma information assumes the Union State Bank
acquisition had occurred on January 1, 1997:

<TABLE>
<CAPTION>
Year Ended
December 31,
-----------------------
1998 1997
---------- ----------
(Dollars in thousands,
except per share data)
<S> <C> <C>
Net interest income........................... $15,204 $13,434
Net earnings.................................. 5,169 4,326
Earnings per share (diluted).................. 1.20 1.12
</TABLE>

On February 27, 1998, the Company purchased for cash certain assets and
liabilities and all deposits and related accrued interest payable of Community
State Bank in West Columbia. The Company acquired $103,000 in loans, and $5.9
million in deposits. The Company paid a cash premium of $250,000 which is being
amortized over fifteen years using the straight-line method. The acquisition was
accounted for using the purchase method of accounting.

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 is being
amortized on a straight-line basis over 15 years. The acquisition was partially
financed with proceeds from the 1997 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.

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.

In connection with the purchase, the Company paid a cash premium of
$1,750,000. This premium was recorded as goodwill and is being 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.

F-12
<PAGE> 119
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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 $5,399,000 and $5,849,000 at and
December 31, 1998 and 1997.

4. SECURITIES

The amortized cost and fair value of debt securities are as follows:

<TABLE>
<CAPTION>
June 30, 1999
---------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair Carrying
Cost Gains Losses Value Value
--------- ---------- ---------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
AVAILABLE FOR SALE
U.S. Treasury securities and
obligations of U.S.
government agencies......... $ 91,468 $ 13 $1,618 $ 89,863 $ 89,863
States and political
subdivisions................... 3,976 128 -- 4,104 4,104
Collateralized mortgage
obligations.................... 10,270 407 20 10,657 10,657
Mortgage-backed securities....... 34,371 41 866 33,546 33,546
-------- ---- ------ -------- --------

Total............................ $140,085 $589 $2,504 $138,170 $138,170
======== ==== ====== ======== ========

HELD TO MATURITY
U.S. Treasury securities and
obligations of U.S.
government agencies......... $ 42,569 $156 $ 85 $ 42,640 $ 42,569
States and political
subdivisions................... 14,570 120 49 14,641 14,570
Collateralized mortgage
obligations.................... 223 -- -- 223 223
Mortgage-backed securities....... 26,149 87 163 26,073 26,149
-------- ---- ------ -------- --------

Total............................ $ 83,511 $363 $ 297 $ 83,577 $ 83,511
======== ==== ====== ======== ========
</TABLE>

F-13
<PAGE> 120
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

<TABLE>
<CAPTION>
December 31, 1998
---------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair Carrying
Cost Gains Losses Value Value
--------- ---------- ---------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
AVAILABLE FOR SALE
U.S. Treasury securities and
obligations of U.S.
government agencies......... $ 67,864 $ 285 $ 58 $ 68,091 $ 68,091
States and political
subdivisions................... 4,026 239 -- 4,265 4,265
Collateralized mortgage
obligations.................... 10,832 166 26 10,972 10,972
Mortgage-backed securities....... 30,578 98 176 30,500 30,500
-------- ------ ---- -------- --------
Total............................ $113,300 $ 788 $260 $113,828 $113,828
======== ====== ==== ======== ========
HELD TO MATURITY
U.S. Treasury securities and
obligations of U.S.
government agencies......... $ 60,739 $ 572 $ 2 $ 61,309 $ 60,739
States and political
subdivisions................... 15,022 376 3 15,395 15,022
Collateralized mortgage
obligations.................... 2,081 -- 3 2,078 2,081
Mortgage-backed securities....... 36,074 265 100 36,239 36,074
-------- ------ ---- -------- --------
Total............................ $113,916 $1,213 $108 $115,021 $113,916
======== ====== ==== ======== ========
</TABLE>

<TABLE>
<CAPTION>
December 31, 1997
---------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair Carrying
Cost Gains Losses Value Value
--------- ---------- ---------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
AVAILABLE FOR SALE
U.S. Treasury securities and
obligations of U.S.
government agencies......... $ 19,988 $ 57 $ -- $ 20,045 $ 20,045
States and political
subdivisions................... 1,363 102 -- 1,465 1,465
Mortgage-backed securities....... 17,299 61 258 17,102 17,102
-------- ---- ---- -------- --------
Total............................ $ 38,650 $220 $258 $ 38,612 $ 38,612
======== ==== ==== ======== ========
HELD TO MATURITY
U.S. Treasury securities and
obligations of U.S.
government agencies......... $ 63,171 $245 $ 21 $ 63,395 $ 63,171
States and political
subdivisions................... 10,465 141 1 10,605 10,465
Collateralized mortgage
obligations.................... 8,749 19 15 8,753 8,749
Mortgage-backed securities....... 46,871 372 222 47,021 46,871
-------- ---- ---- -------- --------
Total............................ $129,256 $777 $259 $129,774 $129,256
======== ==== ==== ======== ========
</TABLE>

F-14
<PAGE> 121
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The amortized cost and fair value of debt securities at December 31, 1998,
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
--------- -------- --------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Due in one year or less.................... $ 16,118 $ 16,230 $ 4,009 $ 4,026
Due after one year through five years...... 56,945 57,684 50,536 50,756
Due after five years through ten years..... 2,695 2,792 17,070 17,274
Due after ten years........................ -- -- 272 296
-------- -------- -------- --------
Subtotal................................... 75,758 76,706 71,887 72,412
Mortgage-backed securities and
collateralized mortgage obligations... 38,158 38,315 41,413 41,476
-------- -------- -------- --------
Total...................................... $113,916 $115,021 $113,300 $113,828
======== ======== ======== ========
</TABLE>

There were no sales of held to maturity or available for sale investments
in debt securities during 1998, 1997 and 1996.

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 December 31, 1998 and December 31,
1997. Securities with amortized costs of approximately $68,245,999 and
$61,303,319 and a fair value of approximately $68,698,655 and $61,146,428 at
December 31, 1998 and 1997, 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>
June 30, December 31,
----------- --------------------
1999 1998 1997
----------- -------- --------
(Unaudited)
(Dollars in thousands)
<S> <C> <C> <C>
Commercial and industrial......................... $ 18,699 $ 16,972 $ 11,611
Real estate:
Construction and land development............ 2,012 1,727 6,453
1-4 family residential....................... 96,853 88,139 53,625
Commercial mortgages......................... 25,238 22,240 16,277
Farmland..................................... 5,917 6,148 5,804
Multi-family residential..................... 1,405 1,090 937
Agriculture....................................... 18,578 14,107 6,359
Consumer.......................................... 19,753 20,711 20,498
-------- -------- --------
Total............................................. 188,455 171,134 121,564
Less unearned discount............................ 379 656 986
-------- -------- --------
Total............................................. $188,034 $170,478 $120,578
======== ======== ========
</TABLE>

F-15
<PAGE> 122
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following table summarizes as of the dates indicated the loan portfolio
of the Company by type of loan:

<TABLE>
<CAPTION>
December 31, 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......................... $10,354 $4,355 $2,263 $16,972
Construction and land development................. 1,707 20 1,727
------- ------ ------ -------
Total.............................. $12,061 $4,375 $2,263 $18,699
======= ====== ====== =======
Loans with a predetermined interest rate.......... $ 6,248 $2,879 $1,670 $10,797
Loans with a floating interest rate............... 5,813 1,496 593 7,902
------- ------ ------ -------
Total.............................. $12,061 $4,375 $2,263 $18,699
======= ====== ====== =======
</TABLE>

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.

As of December 31, 1998 and 1997, loans outstanding to directors, officers
and their affiliates were approximately $2,231,000 and $2,432,000, 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,
-----------------------
1998 1997
--------- ---------
(Dollars in thousands)
<S> <C> <C>
Beginning balance........................................... $ 2,432 $ 3,210
New loans and reclassified related loans.................... 2,046 1,045
Repayments.................................................. (2,247) (1,823)
------- -------
Ending balance.............................................. $ 2,231 $ 2,432
======= =======
</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, 1999 (unaudited). The Company had $5,000 in nonaccrual loans
and no 90 days or more past due, or restructured loans at December 31, 1998.

F-16
<PAGE> 123
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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,
---------------- ------------------------
1999 1998 1998 1997 1996
------ ------ ------ ------ ----
(Unaudited)
) (Dollars in thousands
<S> <C> <C> <C> <C> <C>
Balance at beginning of year.................... $1,850 $1,016 $1,016 $ 923 $753
Balance acquired with acquisition.......... -- -- 661 -- --
Addition -- provision charged to
operations............................ 130 145 239 190 230
Net charge-offs:
Loans charged off................ (19) (55) (81) (130) (73)
Loan recoveries.................. 52 8 15 33 13
------ ------ ------ ------ ----
Total net charge-offs........................... 33 (47) (66) (97) (60)
------ ------ ------ ------ ----
Balance at end of period........................ $2,013 $1,114 $1,850 $1,016 $923
====== ====== ====== ====== ====
</TABLE>

8. PREMISES AND EQUIPMENT

Premises and equipment are summarized as follows:

<TABLE>
<CAPTION>
Year Ended
December 31,
----------------------
1998 1997
-------- --------
(Dollars in thousands)
<S> <C> <C>
Land............................................. $1,131 $ 935
Buildings........................................ 5,599 4,766
Furniture, fixtures and equipment................ 2,551 2,164
Construction in progress......................... 32 388
------ ------
Total............................................ 9,313 8,253
Less accumulated depreciation.................... 3,208 2,723
------ ------
Premises and equipment, net...................... $6,105 $5,530
====== ======
</TABLE>

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, 1999 and December 31, 1998 and 1997 were as follows:

<TABLE>
<CAPTION>
December 31,
June 30, -----------------
1999 1998 1997
----------- ------- -------
(Unaudited)
)(Dollars in thousands
<S> <C> <C> <C>
Three months or less.......................... $17,887 $ 5,835 $ 1,567
Greater than three through six months......... 8,842 9,603 3,370
Greater than six through twelve months........ 12,207 21,296 11,992
Thereafter.................................... 4,046 6,097 6,226
------- ------- -------
Total......................................... $42,982 $42,831 $23,155
======= ======= =======
</TABLE>

F-17
<PAGE> 124
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Interest expense for certificates of deposit in excess of $100,000 was
approximately $593,000, $1,492,000 and $1,264,000 and $1,291,000 for the six
months ended June 30, 1999 (unaudited) and the years ended December 31, 1998,
1997, and 1996, 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 December 31, 1998 and
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.

OTHER BORROWINGS -- At December 31, 1998, Federal Home Loan Bank ("FHLB")
advances totaled $2,435,000 with a floating interest rate of 5.55%. There were
advances at December 31, 1997 of $2,800,000.

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 these
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, -----------------
1999 1998 1997
----------- ------- -------
(Unaudited)
)(Dollars in thousands
<S> <C> <C> <C>
Financial instruments whose contract amounts represent
credit risk:
Commitments to extend credit................ $18,325 $19,698 $11,856
Standby letters of credit................... 360 233 315
</TABLE>

F-18
<PAGE> 125
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

At December 31, 1998, approximately $12.9 million of commitments to extend
credit have fixed rates ranging from 6.65% to 11.75%. 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.

13. INCOME TAXES

The components of the provision for federal income taxes are as follows:

<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------
1998 1997 1996
------ ------ ------
(Dollars in thousands)
<S> <C> <C> <C>
Current.................................................. $2,106 $1,634 $1,340
Deferred................................................. (77) (48) (100)
------ ------ ------
Total.................................................... $2,029 $1,586 $1,240
====== ====== ======
</TABLE>

The provision for federal income taxes differs from the amount computed by
applying the federal income tax statutory rate on income as follows:

<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------
1998 1997 1996
------ ------ ------
(Dollars in thousands)
<S> <C> <C> <C>
Taxes calculated at statutory rate....................... $2,206 $1,750 $1,343
Increase (decrease) resulting from:
Tax-exempt interest............................ (275) (251) (258)
Amortization of goodwill....................... 54 57 57
Other, net..................................... 44 30 98
------ ------ ------
Total.................................................... $2,029 $1,586 $1,240
====== ====== ======
</TABLE>

F-19
<PAGE> 126
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Deferred tax assets and liabilities are as follows:

<TABLE>
<CAPTION>
December 31,
----------------------
1998 1997
---------- ---------
(Dollars in thousands)
<S> <C> <C>
Deferred tax assets --
Allowance for credit losses............................ $ 284,000 $225,000
Other.................................................. 4,000 --
--------- --------
Total deferred tax assets................................... 288,000 225,000
--------- --------
Deferred tax liabilities:
Accretion on investments............................... $ 206,000 $189,000
Bank premises and equipment............................ 192,000 24,000
Unrealized loss on available for sale investment
securities........................................ 179,000.. 13,000
Other.................................................. -- 7,000
--------- --------
Total deferred tax liabilities.............................. 577,000 233,000
--------- --------
Net deferred tax liabilities................................ $(289,000) $ (8,000)
========= ========
</TABLE>

14. STOCK INCENTIVE PROGRAM

During 1995 the Company's Board of Directors approved a stock option plan
(the "Plan") for executive officers and key associates to purchase common stock
of Bancshares. On May 31, 1995, the Company granted 260,000 options, after stock
split, (see Note 17) which vest over a ten-year period beginning on the date of
grant. Ten percent of the options vest each year, however no options may 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 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,
---------------------------------------------------------------
1998 1997 1996
------------------- ------------------- -------------------
(Amounts in thousands)
Weighted- Weighted- Weighted-
Number Average Number Average Number Average
of Exercise of Exercise of Exercise
Options Price Options Price Options Price
------- --------- ------- --------- ------- ---------
<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 -- -- -- --
------- ----- ------- ----- ------- -----
Options outstanding, end of
period......................... 320,000 $4.71 260,000 $4.40 260,000 $4.40
======= ===== ======= ===== ======= =====
</TABLE>

There were no options granted, exercised, forfeited, or expired during 1997
and 1996. At December 31, 1998, 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
(after stock split). 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.

On the grant date, the weighted-average 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

F-20
<PAGE> 127
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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 $4,449,936, $3,555,480, and $2,704,040 for the years ended
December 31, 1998, 1997, and 1996, respectively. Diluted earnings per share
would have be $1.03, $0.92 and $0.80 for the years ended December 31, 1998, 1997
and 1996, 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 $112,000, $87,000, and $72,000
for the years ended December 31, 1998, 1997 and 1996, respectively.

16. COMMITMENTS

Leases -- A summary of noncancelable future operating lease commitments as of
December 31, 1998 follows:

<TABLE>
<S> <C>
1999............................................ $ 206,518
2000............................................ 221,839
2001............................................ 221,839
2002............................................ 222,739
2003............................................ 223,639
----------
Total........................................... $1,096,574
==========
</TABLE>

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 $193,000 for the year ended 1998, $191,000 for the year ended
December 31, 1997 and $180,000 for the year ended December 31, 1996.

Litigation -- The Company has been named as a defendant in various legal
actions arising in the normal course of business. In the opinion of management,
after reviewing such claims with outside counsel, resolution of such matters
will not have a materially adverse impact on the consolidated financial
statements. Various lawsuits are pending against the Company.

17. SHAREHOLDERS' EQUITY

During 1998, the Company had an Initial Public Offering selling 1,182,517
shares. Net proceeds of $12,840,890 were used to fund general corporate
purposes, including support of balance sheet growth, future acquisitions and to
repay certain indebtedness incurred in the acquisition of Union State Bank.

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.

During 1997, the Company sold 480,000 shares of common stock at $6.25 per
share, after stock split, which approximated the book value of the Company at
the time of the sale. Proceeds to the Company totaling

F-21
<PAGE> 128
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

$3,000,000 were used to fund the acquisition of a branch (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 $8,750,000
and $7,400,000 available for payment of dividends by Bancshares and by the Bank
to Bancshares, respectively, at December 31, 1998 under these restrictions.
Dividends paid by Bancshares during the years ended December 31, 1998 and 1997
were $1,056,517 and $574,536, respectively. Dividends paid by the Bank to
Bancshares during the years ended December 31, 1998 and 1997 were $995,000 and
$2,922,150, 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 judgements 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 December 31, 1998 and 1997, that the Company and the
Bank met all capital adequacy requirements to which they are subject.

At December 31, 1998, 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-22
<PAGE> 129
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 December 31, 1998 and 1997:

<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> <C> <C>
CONSOLIDATED:
AS OF DECEMBER 31, 1998:
Total Capital
(to Risk Weighted
Assets)................... $33,248 19.08% $13,937 8.0% N/A N/A
Tier I Capital
(to Risk Weighted
Assets)................... $31,398 18.02% $ 6,969 4.0% N/A N/A
Tier I Capital
(to Average Assets)....... $31,398 7.58% $12,422 3.0% N/A N/A
AS OF DECEMBER 31, 1997:
Total Capital
(to Risk Weighted
Assets)................... $20,234 15.73% $10,293 8.0% N/A N/A
Tier I Capital
(to Risk Weighted
Assets)................... $19,218 14.94% $ 5,146 4.0% N/A N/A
Tier I Capital
(to Average Assets)....... $19,218 6.30% $ 9,151 3.0% N/A N/A
</TABLE>

<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> <C> <C>
BANK ONLY:
AS OF DECEMBER 31, 1998:
Total Capital
(to Risk Weighted
Assets).................. $22,516 12.93% $13,934 8.0% $17,417 10.0%
Tier I Capital
(to Risk Weighted
Assets).................. $20,666 11.87% $ 6,967 4.0% $10,450 6.0%
Tier I Capital
(to Average Assets)...... $20,666 5.00% $12,419 3.0% $20,698 5.0%
AS OF DECEMBER 31, 1997:
Total Capital
(to Risk Weighted
Assets).................. $20,056 15.59% $10,292 8.0% $12,865 10.0%
Tier I Capital
(to Risk Weighted
Assets).................. $19,040 14.80% $ 5,146 4.0% $ 7,719 6.0%
Tier I Capital
(to Average Assets)...... $19,040 6.13% $ 9,320 3.0% $15,533 5.0%
</TABLE>

19. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS

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

F-23
<PAGE> 130
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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,
-----------------------------------------
1998 1997
------------------- -------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Financial assets:
Cash and cash equivalents................. $ 18,243 $ 18,243 $ 17,372 $ 17,372
Interest-bearing deposits in financial
institutions......................... 99 99 198 198
Held to maturity securities............... 113,916 115,021 129,256 129,774
Available for sale securities............. 113,828 113,828 38,612 38,612
Loans..................................... 170,478 186,874 120,578 129,601
Less allowance for loan losses............ (1,850) (1,850) (1,016) (1,016)
-------- -------- -------- --------
Total.......................................... $414,714 $432,215 $305,000 $314,541
======== ======== ======== ========
Financial liabilities:
Deposits.................................. $390,659 $391,590 $291,516 $291,779
Other borrowing........................... 2,437 2,437 2,800 2,800
-------- -------- -------- --------
Total.......................................... $393,096 $394,027 $294,316 $294,579
======== ======== ======== ========
</TABLE>

The differences in fair value and carrying value of commitments to extend
credit and standby letters of credit were not material at December 31, 1998 and
1997.

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

F-24
<PAGE> 131
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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. PARENT COMPANY ONLY FINANCIAL STATEMENTS

PROSPERITY BANCSHARES, INC.
(PARENT COMPANY ONLY)
BALANCE SHEETS

<TABLE>
<CAPTION>
December 31,
-----------------------
1998 1997
---------- ----------
(Dollars in thousands)
<S> <C> <C>
ASSETS
Cash.............................................. $10,688 $ 153
Investment in subsidiaries........................ 25,323 19,066
Goodwill, net..................................... 5,380 5,593
Other assets...................................... 49 11
------- -------
TOTAL............................................. $41,440 $24,823
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Note payable
Accrued interest payable and other
liabilities................................ $ 5 $ 5
------- -------
Total liabilities.................. 5 5
------- -------
SHAREHOLDERS' EQUITY:
Common stock................................. 5,176 3,993
Capital surplus.............................. 16,477 4,818
Retained earnings............................ 19,452 16,049
Unrealized losses on available for sale
securities, net of tax.................. 348 (24)
Less treasury stock, at cost (3,576 shares at
December 31, 1998 and 1997,
respectively)........................... (18) (18)
------- -------
Total shareholders' equity......... 41,435 24,818
------- -------
TOTAL............................................. $41,440 $24,823
======= =======
</TABLE>

F-25
<PAGE> 132
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

PROSPERITY BANCSHARES, INC.
(PARENT COMPANY ONLY)
STATEMENTS OF INCOME

<TABLE>
<CAPTION>
For the Years Ended December 31,
----------------------------------
1998 1997 1996
-------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C>
OPERATING INCOME:
Dividends from subsidiaries....................... $ 995 $2,922 $ 661
OPERATING EXPENSE:
Interest expense.................................. 24 120 203
Amortization of goodwill.......................... 463 392 248
Other expenses.................................... 69 66 49
------ ------ ------

Total operating expense................. 556 578 500
------ ------ ------

INCOME BEFORE INCOME TAX BENEFIT AND EQUITY IN
UNDISTRIBUTED EARNINGS OF SUBSIDIARIES............ 439 2,344 161
FEDERAL INCOME TAX BENEFIT............................. 136 137 86
------ ------ ------

INCOME BEFORE EQUITY IN UNDISTRIBUTED
EARNINGS OF SUBSIDIARIES.......................... 575 2,481 247
EQUITY IN UNDISTRIBUTED EARNINGS OF SUBSIDIARIES....... 3,885 1,081 2,464
------ ------ ------

NET INCOME............................................. $4,460 $3,562 $2,711
====== ====== ======
</TABLE>

F-26
<PAGE> 133
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 Years Ended December 31,
---------------------------------
1998 1997 1996
--------- --------- ---------
(Dollars in thousands)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income......................................... $ 4,460 $ 3,562 $ 2,711
Adjustments to reconcile net income to net cash
provided by operating activities:
Equity in undistributed earnings of
subsidiaries................................ (3,885) (1,081) (2,464)
Amortization of goodwill...................... 463 392 248
Increase in other assets...................... (38) (6) (2)
Increase (decrease) in other liabilities...... 4 (33)
------- ------- -------
Total adjustments........................ (3,460) (691) (2,251)
------- ------- -------
Net cash flows provided by operating
activities............................. 1,000 2,871 460
------- ------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Premiums paid for branch acquisitions.............. (250) (1,990) (1,750)
Capital contribution to subsidiary................. (2,000)
------- ------- -------
Net cash flows used in investing
activities............................. (2,250) (1,990) (1,750)
------- ------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of line of credit........................ (2,000) (3,267) (1,517)
Proceeds from line of credit....................... 2,000 3,266
Issuance of common stock........................... 12,842 3,000
Payments of cash dividends......................... (1,057) (574) (351)
Sale (purchase) of treasury stock.................. 1 (19)
------- ------- -------
Net cash flows (used in) provided by
financing activities................... 11,785 (840) 1,379
------- ------- -------
NET INCREASE IN CASH AND CASH EQUIVALENTS............... 10,535 41 89
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD.......... 153 112 23
------- ------- -------
CASH AND CASH EQUIVALENTS, END OF PERIOD................ $10,688 $ 153 $ 112
======= ======= =======
</TABLE>

21. SUBSEQUENT EVENT (UNAUDITED)

On October 1, 1999, the Company acquired South Texas Bancshares, Inc.

F-27
<PAGE> 134

INDEPENDENT AUDITORS' REPORT

The Board of Directors and Stockholders
South Texas Bancshares, Inc. and Subsidiary
Beeville, Texas

We have audited the accompanying consolidated balance sheets of South Texas
Bancshares, Inc. and Subsidiary as of December 31, 1998 and 1997, and the
related consolidated statements of income, changes in stockholders' equity, and
cash flows for the years then ended. 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 audits 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 consolidated financial statements referred to above present
fairly, in all material respects, the financial position of South Texas
Bancshares, Inc. and Subsidiary as of December 31, 1998 and 1997, and the
results of their operations and their cash flows for the years then ended, in
conformity with generally accepted accounting principles.

Padgett, Stratemann & Co., L.L.P.

February 25, 1999
San Antonio, Texas

F-28
<PAGE> 135

SOUTH TEXAS BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
June 30,
-----------------------------
1999 1998
------------ ------------
(Unaudited)
<S> <C> <C>
ASSETS
Cash and due from banks..................................... $ 9,036,471 $ 6,617,125
Federal funds sold.......................................... 11,700,000 9,675,000
------------ ------------
Total cash and cash equivalents................... 20,736,471 16,292,125
Securities:
Available for sale securities, at fair value.............. 72,477,456 14,523,107
Held to maturity securities, at cost...................... -- 63,603,378
------------ ------------
Total securities.................................. 72,477,456 78,126,485
Loans:
Total loans, net of unearned discount..................... 35,075,322 36,922,145
Allowance for loan losses................................. (532,179) (526,907)
------------ ------------
Net loans......................................... 34,543,143 36,395,238
Accrued interest receivable................................. 1,321,972 1,387,924
Excess of cost over fair value of net assets acquired....... 3,378,074 3,528,722
Bank premises and equipment, net............................ 2,848,556 3,287,977
Prepaid expenses and other assets........................... 486,686 423,631
------------ ------------
Total assets...................................... $135,792,358 $139,442,102
============ ============

LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits.................................................. $119,004,273 $123,189,302
Accrued interest payable.................................. 502,240 524,561
Other liabilities......................................... 713,522 748,596
------------ ------------
Total liabilities................................. 120,220,035 124,462,459
Stockholders' Equity:
Preferred stock, $1 par value; 1,000,000 shares
authorized; no shares issued........................... -- --
Common stock, $.50 par value; 1,000,000 shares authorized;
241,423 (unaudited) and 240,473 (unaudited) shares
issued and outstanding at June 30, 1999 and 1998,
respectively........................................... 120,712 120,236
Surplus................................................... 3,227,576 3,197,051
Retained earnings......................................... 12,605,983 11,682,873
Accumulated other comprehensive income (loss)............. (381,948) (20,517)
------------ ------------
Total stockholders' equity........................ 15,572,323 14,979,643
------------ ------------
Total liabilities and stockholders' equity........ $135,792,358 $139,442,102
============ ============
</TABLE>

Notes to consolidated financial statements form an integral part of these
statements.

F-29
<PAGE> 136

SOUTH TEXAS BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
December 31,
---------------------------
1998 1997
------------ ------------
<S> <C> <C>
ASSETS
Cash and due from banks..................................... $ 8,637,989 $ 7,076,546
Federal funds sold.......................................... 12,100,000 8,050,000
------------ ------------
Total cash and cash equivalents................... 20,737,989 15,126,546
Securities available for sale............................... 22,509,958 9,845,086
Securities to be held to maturity........................... 54,517,043 73,407,209
Loans -- net of allowance for loan losses................... 37,397,936 35,477,295
Bank premises and equipment................................. 3,049,022 3,484,972
Accrued interest receivable................................. 1,273,301 1,355,898
Excess of cost over fair value of net assets acquired....... 3,453,398 3,604,046
Prepaid expenses and other assets........................... 94,377 267,848
Other real estate owned..................................... 84,761 --
------------ ------------
$143,117,785 $142,568,900
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Demand deposits........................................ $ 23,816,596 $ 20,025,359
Savings and NOW deposits............................... 48,138,492 50,943,290
Other time deposits.................................... 54,679,042 55,699,428
------------ ------------
Total deposits.................................... 126,634,130 126,668,077
Accrued interest payable............................... 525,206 557,383
Other liabilities...................................... 632,877 588,119
------------ ------------
Total liabilities................................. 127,792,213 127,813,579
------------ ------------
Stockholders' Equity
Preferred stock -- $1 par value; 1,000,000 shares
authorized; no shares issued...................... -- --
Common stock -- $.50 par value; 1,000,000 shares
authorized; 241,423 shares issued and outstanding
(239,968 shares outstanding in 1997).............. 120,712 119,984
Surplus................................................ 3,227,576 3,182,514
Retained earnings...................................... 11,968,100 11,486,915
Accumulated other comprehensive income (loss).......... 9,184 (34,092)
------------ ------------
Total stockholders' equity................... 15,325,572 14,755,321
------------ ------------
$143,117,785 $142,568,900
============ ============
</TABLE>

Notes to consolidated financial statements form an integral part of these
statements.

F-30
<PAGE> 137

SOUTH TEXAS BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME

<TABLE>
<CAPTION>
For the Six Months Ended
June 30,
-------------------------
1999 1998
---------- ----------
(Unaudited)
<S> <C> <C>
Interest income:
Loans, including fees..................................... $1,723,901 $1,844,960
Investment securities..................................... 2,220,052 2,479,007
Federal funds sold........................................ 322,792 286,674
---------- ----------
Total interest income............................. 4,266,745 4,610,641
Interest expense............................................ 1,848,025 2,120,482
---------- ----------
Net interest income......................................... 2,418,720 2,490,159
Provision for loan losses................................... -- --
---------- ----------
Net interest income after provision for loan losses......... 2,418,720 2,490,159
---------- ----------
Other income:
Service charges and fees.................................. 598,654 601,882
Other..................................................... 182,109 192,916
---------- ----------
Total other income................................ 780,763 794,798
---------- ----------
Other expense:
Employee compensation and benefits........................ 1,110,688 1,087,108
Occupancy expense......................................... 191,696 190,708
Other..................................................... 958,391 998,737
---------- ----------
Total other expense............................... 2,260,775 2,276,553
---------- ----------
Income before federal income taxes........................ 938,708 1,008,404
Federal income tax expense................................ 300,825 331,663
---------- ----------
Net income................................................ $ 637,883 $ 676,741
========== ==========
Basic earnings per share:
Net income per share...................................... $ 2.64 $ 2.82
Average shares outstanding................................ 241,423 240,163
========== ==========
Diluted earnings per share:
Net income per share...................................... $ 2.57 $ 2.75
Average shares outstanding................................ 247,939 245,812
========== ==========
</TABLE>

Notes to consolidated financial statements form an integral part of these
statements.

F-31
<PAGE> 138

SOUTH TEXAS BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME

<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1998 1997
---------- ----------
<S> <C> <C>
Interest Income:
Loans, including fees.................................. $3,705,785 $3,296,775
Investment securities.................................. 4,813,294 4,686,774
Federal funds sold..................................... 611,669 732,927
---------- ----------
Total interest income........................ 9,130,748 8,716,476
Interest Expense............................................ 4,108,071 4,078,835
---------- ----------
Net interest income.......................... 5,022,677 4,637,641
Recovery of provision for loan losses....................... 100,000 80,000
---------- ----------
Net interest income after recovery of
provision for loan losses.............. 5,122,677 4,717,641
---------- ----------
Other Income:
Service charges and fees............................... 1,236,117 1,222,510
Settlement of lawsuit.................................. -- 29,999
Other.................................................. 377,948 290,798
---------- ----------
1,614,065 1,543,307
---------- ----------
Other Expenses:
Employee compensation and benefits..................... 2,148,274 2,060,340
Occupancy and equipment expenses....................... 1,058,943 1,012,417
Other.................................................. 1,380,336 1,408,922
---------- ----------
4,587,553 4,481,679
---------- ----------
Income Before Federal Income Tax............................ 2,149,189 1,779,269
Federal Income Tax Expense.................................. 704,374 596,438
---------- ----------
Net Income.................................................. $1,444,815 $1,182,831
========== ==========
Earnings Per Share of Common Stock.......................... $ 6.01 $ 4.96
========== ==========
Average Common Shares Outstanding........................... 240,361 238,689
========== ==========
</TABLE>

Notes to consolidated financial statements form an integral part of these
statements.

F-32
<PAGE> 139

SOUTH TEXAS BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
SIX MONTHS ENDED JUNE 30, 1998
(UNAUDITED)

<TABLE>
<CAPTION>
Accumulated
Other
Comprehensive
Income -- Net
Unrealized Loss
on Available Total
Common Retained for Sale Stockholders'
Stock Surplus Earnings Securities Equity
-------- ---------- ----------- --------------- -------------
<S> <C> <C> <C> <C> <C>
Balance at December 31,
1997.......................... $119,984 $3,182,514 $11,486,915 $ (34,092) $14,755,321
Comprehensive income:
Net income............... -- -- 676,741 -- 676,741
Net change in unrealized
loss on available for
sale securities........ -- -- -- 13,575 13,575
-------- ---------- ----------- ----------- -----------
Total comprehensive
income............ -- -- 676,741 13,575 690,316
Issuance of common stock.... 252 14,537 -- -- 14,789
Cash dividends paid......... -- -- (480,783) -- (480,783)
-------- ---------- ----------- ----------- -----------
Balance at June 30, 1998...... $120,236 $3,197,051 $11,682,873 $ (20,517) $14,979,643
======== ========== =========== =========== ===========
</TABLE>

SOUTH TEXAS BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
SIX MONTHS ENDED JUNE 30, 1999
(UNAUDITED)

<TABLE>
<CAPTION>
Accumulated
Other
Comprehensive
Income -- Net
Unrealized Loss
on Available Total
Common Retained for Sale Stockholders'
Stock Surplus Earnings Securities Equity
-------- ---------- ----------- --------------- -------------
<S> <C> <C> <C> <C> <C>
Balance at December 31,
1998.......................... $120,712 $3,227,576 $11,968,100 $ 9,184 $15,325,572
Comprehensive income:
Net income............... -- -- 637,883 -- 637,883
Net change in unrealized
gain on available for
sale securities........ -- -- -- (391,132) (391,132)
-------- ---------- ----------- ----------- -----------
Total comprehensive
income............ -- -- 637,883 (391,132) 246,751
-------- ---------- ----------- ----------- -----------
Balance at June 30, 1999...... $120,712 $3,227,576 $12,605,983 $ (381,948) $15,572,323
======== ========== =========== =========== ===========
</TABLE>

Notes to consolidated financial statements form an integral part of these
statements.

F-33
<PAGE> 140

SOUTH TEXAS BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

YEARS ENDED DECEMBER 31, 1998 AND 1997

<TABLE>
<CAPTION>
Accumulated
Other
Common Retained Comprehensive
Stock Surplus Earnings Income (Loss) Total
-------- ---------- ----------- ------------- -----------
<S> <C> <C> <C> <C> <C>
BALANCE AT JANUARY 1, 1997.............. $119,249 $3,140,589 $11,022,158 $(51,841) $14,230,155
Comprehensive income:
Net income -- year ended
December 31, 1997.......... -- -- 1,182,831 -- 1,182,831
Change in net unrealized gain
(loss) on securities
available for sale, net of
reclassification
adjustment................. -- -- -- 17,749 17,749
-------- ---------- ----------- -------- -----------
Total comprehensive income..... -- -- 1,182,831 17,749 1,200,580
Cash dividends paid -- $3 per
share.......................... -- -- (718,074) -- (718,074)
Issuance of 1,470 shares of common
stock through exercise of stock
options........................ 735 41,925 -- -- 42,660
-------- ---------- ----------- -------- -----------
BALANCE AT DECEMBER 31, 1997............ 119,984 3,182,514 11,486,915 (34,092) 14,755,321
Comprehensive income:
Net income -- year ended
December 31, 1998.......... -- -- 1,444,815 -- 1,444,815
Change in net unrealized gain
(loss) on securities
available for sale, net of
reclassification
adjustment................. -- -- -- 43,276 43,276
-------- ---------- ----------- -------- -----------
Total comprehensive income..... -- -- 1,444,815 43,276 1,488,091
Cash dividends paid -- $4 per
share.......................... -- -- (963,630) -- (963,630)
Issuance of 1,455 shares of common
stock through exercise of stock
options........................ 728 45,062 -- -- 45,790
-------- ---------- ----------- -------- -----------
BALANCE AT DECEMBER 31, 1998............ $120,712 $3,227,576 $11,968,100 $ 9,184 $15,325,572
======== ========== =========== ======== ===========
</TABLE>

Notes to consolidated financial statements form an integral part of these
statements.

F-34
<PAGE> 141

SOUTH TEXAS BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
For the Six Months Ended
June 30,
----------------------------
1999 1998
------------ ------------
(Unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................ $ 637,883 $ 676,741
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation, amortization and accretion............... 393,389 312,450
(Gain) on sale of real estate acquired by
foreclosure.......................................... (103,465) --
(Increase) in assets:
Accrued interest receivable.......................... (48,671) (32,026)
Prepaid expenses and other assets.................... (71,198) (38,427)
(Decrease) increase in liabilities:
Accrued interest payable............................. (22,966) (32,822)
Other liabilities.................................... 80,645 160,477
------------ ------------
Net cash provided by operating activities......... 865,617 1,046,393
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities and principal paydowns of held to
maturity investment securities......................... -- 22,795,795
Purchases of held to maturity investment securities....... -- (13,099,030)
Proceeds from maturities and principal paydowns of
available for sale investment securities............... 23,894,277 1,821,858
Purchase of available for sale investment securities...... (20,119,505) (6,476,198)
Net decrease (increase) in loans.......................... 2,854,793 (917,943)
Purchases of bank premises and equipment.................. (71,843) (60,527)
Proceeds from sale of bank premises and equipment and ORE
acquired by foreclosure................................ 205,000 --
------------ ------------
Net cash provided by investing activities......... 6,762,722 4,063,955
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (decrease) in deposits................................ (7,629,857) (3,478,775)
Proceeds from the issuance of common stock................ -- 14,790
Dividends paid to stockholders............................ -- (480,784)
------------ ------------
Net cash used by financing activities............. (7,629,857) (3,944,769)
------------ ------------
Net (decrease) increase in cash and cash equivalents........ (1,518) 1,165,579
Cash and cash equivalents, beginning of period.............. 20,737,989 15,126,546
------------ ------------
Cash and cash equivalents, end of period.................... $ 20,736,471 $ 16,292,125
============ ============
</TABLE>

Notes to consolidated financial statements form an integral part of these
statements.

F-35
<PAGE> 142

SOUTH TEXAS BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS

INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

<TABLE>
<CAPTION>
Years Ended December 31,
---------------------------
1998 1997
------------ ------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income............................................. $ 1,444,815 $ 1,182,831
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation, amortization, and accretion......... 704,877 306,036
Gain on sale of other real estate owned........... -- (3,951)
Recovery of provision for loan losses............. (100,000) (80,000)
(Increase) decrease in assets:
Accrued interest receivable.................. 82,597 (463,309)
Prepaid expenses and other assets............ 173,471 (10,697)
Increase (decrease) in liabilities:
Accrued interest payable..................... (32,177) 255,149
Other liabilities............................ 22,464 13,059
------------ ------------
Net cash provided by operating activities.... 2,296,047 1,199,118
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from maturities of investment securities...... 49,658,745 33,359,946
Purchases of investment securities..................... (43,364,869) (22,711,851)
Net increase in loans.................................. (1,820,641) (5,136,694)
Additions to bank premises and equipment............... (206,052) (399,537)
Net payment for acquisition of branches................ -- (2,285,574)
Proceeds from the sale of other real estate owned...... -- 79,162
------------ ------------
Net cash provided by investing activities.... 4,267,183 2,905,452
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net decrease in deposits............................... $ (33,947) $ (4,391,634)
Dividends paid to stockholders......................... (963,630) (718,074)
Proceeds from issuance of common stock................. 45,790 42,660
------------ ------------
Net cash used in financing activities........ (951,787) (5,067,048)
------------ ------------
Net increase (decrease) in cash and cash
equivalents............................. 5,611,443 (962,478)
Cash and Cash Equivalents At Beginning of Year.............. 15,126,546 16,089,024
------------ ------------
Cash and Cash Equivalents At End of Year.................... $ 20,737,989 $ 15,126,546
============ ============
SCHEDULES OF OTHER CASH FLOW INFORMATION
Interest paid.......................................... $ 4,140,248 $ 3,823,686
============ ============
Federal income taxes paid.............................. $ 621,502 $ 477,534
============ ============
Branch building transferred to other real estate
owned............................................. $ 84,761 $ --
============ ============
</TABLE>

Notes to consolidated financial statements form an integral part of these
statements.

F-36
<PAGE> 143

SOUTH TEXAS BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accounting and reporting policies of South Texas Bancshares, Inc. (the
Holding Company) and its wholly-owned subsidiary, CNB Delaware Company (the
Delaware Company) conform to generally accepted accounting principles and to
general practices within the banking industry. The preparation of the 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. Following is a summary of the Delaware Company's wholly-owned
subsidiary, Commercial National Bank of Beeville's (the Bank's) more significant
accounting and reporting policies:

PRINCIPALS OF CONSOLIDATION -- The consolidated financial statements
include the accounts of South Texas Bancshares, Inc. (the Holding Company) and
the accounts of its wholly-owned subsidiary, CNB Delaware Company (the Delaware
Company) and the accounts of the Delaware Company's wholly-owned subsidiary,
Commercial National Bank of Beeville (the Bank). All significant intercompany
accounts and transactions have been eliminated in consolidation.

OTHER COMPREHENSIVE INCOME -- Effective January 1, 1998, the Company
adopted Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income," which was issued in June 1997. Statement No. 130
establishes new rules for the reporting and display of comprehensive income and
its components, but has no effect on the Company's net income or total
stockholders' equity. Statement No. 130 requires unrealized gains and losses on
the Company's available for sale securities, which prior to adoption were
reported separately in stockholders' equity, to be included in comprehensive
income. Prior year consolidated financial statements have been reclassified to
conform to the requirements of Statement No. 130.

EXCESS OF COST OVER FAIR VALUE OF NET ASSETS ACQUIRED (GOODWILL) -- The
excess of the cash consideration paid over the fair value of the tangible net
assets or deposits acquired in purchase transactions is recorded as goodwill and
is being amortized into other noninterest expense over a period from 25 to 40
years.

INVESTMENTS IN SECURITIES -- Pursuant to SFAS No. 115, the Bank's
investments in securities are classified in three categories and accounted for
as follows:

- Trading Securities. Government bonds held principally for resale in the
near term are classified as trading securities and recorded at their fair
values. Unrealized gains and losses on trading securities are included in
other income. During the years ended December 31, 1998 and 1997, the Bank
had no securities classified as trading securities.

- Securities to be Held to Maturity. Bonds, notes, and debentures for which
the Bank has the positive intent and ability to hold to maturity are
reported at cost adjusted for amortization of premiums and accretion of
discounts, which are recognized in interest income using the interest
method over the period to maturity.

- Securities Available for Sale. Securities available for sale consist of
bonds, notes, and debentures not classified as trading securities nor as
securities to be held to 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.

Unrealized holding gains and losses on securities available for sale are
reported as a net amount in a separate component of other comprehensive income.

Gains and losses on the sale of securities available for sale are
determined using the specific-identification method and are included in
earnings.
F-37
<PAGE> 144
SOUTH TEXAS BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Premiums and discounts are recognized in interest income using the interest
method over the period to maturity.

The transfer of a security between categories of investments is accounted
for at fair value. For a debt security transferred into the available-for-sale
category from the held-to-maturity category, the unrealized holding gain or loss
at the date of the transfer is recognized in a separate component of other
comprehensive income.

LOANS -- Loans that management has the intent and ability to hold for the
foreseeable future or until maturity or payoff are reported at their outstanding
principal adjusted for any charge-offs, the allowance for loan losses, any
deferred fees or costs on originated loans, and unamortized premiums or
discounts on purchased loans.

Loan origination fees are recognized as income and loan origination costs
are expensed as incurred, as management has determined that capitalization of
these items would be immaterial to the consolidated financial statements.

Interest on loans is accrued and credited to income based on the principal
amount outstanding. The accrual of interest on impaired loans is discontinued
when, in the opinion of management, there is an indication that the borrower may
be unable to meet payments as they become due. Upon such discontinuance, all
unpaid accrued interest is reversed. Interest income is subsequently recognized
only to the extent cash payments are received.

The allowance for loan losses is increased by charges to income and
decreased by charge-offs (net of recoveries). Management's periodic evaluation
of the adequacy of the allowance is based on the Bank's past loan loss
experience, known and inherent risks in the portfolio, adverse situations that
may affect the borrowers' ability to repay, the estimated value of any
underlying collateral, and current economic conditions.

BANK PREMISES AND EQUIPMENT -- Bank premises and equipment are stated at
cost, net of accumulated depreciation. Depreciation is recognized on
straight-line and accelerated methods over the estimated useful lives of the
assets. The estimated useful lives range from 3 to 40 years.

PENSION COSTS -- Pension costs are charged to salaries and employee
benefits expense and are funded as accrued.

OTHER REAL ESTATE OWNED -- Real estate acquired by foreclosure is carried
at the lower of the recorded investment in the property or its fair value. Prior
to foreclosure, the value of the underlying loan is written down to the fair
value of the real estate to be acquired by a charge to the allowance for loan
losses, if necessary. Any subsequent write-downs are charged against operating
expenses. Operating expenses of such properties, net of related income, and
gains and losses on their disposition are included in other income and expenses.

INCOME TAXES -- The Company files a consolidated federal income tax return.
Federal income taxes are recorded by the subsidiary on a separate-company basis.

Provisions for income taxes are based on taxes payable or refundable for
the current year (after exclusion of nontaxable income such as interest on state
and municipal securities) and deferred taxes on temporary differences between
the amount of taxable income and pretax financial income and between the tax
bases of assets and liabilities and their reported amounts in the consolidated
financial statements. Deferred tax assets and liabilities are included in the
consolidated financial statements at currently enacted income tax rates
applicable to the period in which the deferred tax assets and liabilities are
expected to be realized or settled as prescribed in SFAS No. 109, "Accounting
for Income Taxes." As changes in tax laws or rates are enacted, deferred tax
assets and liabilities are adjusted through the provisions for income taxes.

F-38
<PAGE> 145
SOUTH TEXAS BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

CASH AND CASH EQUIVALENTS -- For the purposes of presentation in the
consolidated statements of cash flows, cash and cash equivalents are defined as
those amounts included in the consolidated balance sheet captions "cash and due
from banks" and "federal funds sold."

EARNINGS PER SHARE OF COMMON STOCK -- Earnings per share of common stock is
computed by dividing earnings by the weighted average number of shares of common
stock outstanding during the period.

OFF-BALANCE SHEET FINANCIAL INSTRUMENTS -- In the ordinary course of
business, the Bank has entered into off-balance sheet financial instruments
consisting of commitments to extend credit and standby letters of credit. Such
financial instruments are recorded in the consolidated financial statements when
they are funded or related fees are incurred or received.

FAIR VALUE OF FINANCIAL INSTRUMENTS -- SFAS No. 107, "Disclosures About
Fair Value of Financial Instruments," requires disclosure of fair value
information about financial instruments, whether or not recognized in the
consolidated balance sheet, for which it is practicable to estimate that value.
In cases where quoted market prices are not available, fair values are based on
estimates using present value or other valuation techniques. Those techniques
are significantly affected by the assumptions used, including the discount rate
and estimates of future cash flows. In that regard, the derived fair value
estimates cannot be substantiated by comparison to independent markets and, in
many cases, could not be realized in immediate settlement of the instrument.
SFAS No. 107 excludes certain financial instruments from its disclosure
requirements. Accordingly, the aggregate fair value amounts presented do not
represent the underlying value of the Bank.

The following methods and assumptions were used by the Bank in estimating
the fair value of its financial instruments:

CARRYING AMOUNTS APPROXIMATE FAIR VALUES for the following instruments:

<TABLE>
<S> <C>
Cash and due from banks
Federal funds sold
Securities available for sale
Variable rate loans and fixed rate loans that reprice
frequently
Accrued interest receivable
Demand deposits
Savings and NOW deposits
Certificates of deposit that reprice frequently
Accrued interest payable
</TABLE>

QUOTED MARKET PRICES, where available, or if not available, based on quoted
market prices of comparable instruments for securities to be held to maturity.

DISCOUNTED CASH FLOWS using interest rates currently being offered on
instruments with similar terms and with similar credit quality:

<TABLE>
<S> <C>
Fixed rate loans with terms exceeding one year
Fixed rate certificates of deposit with terms exceeding one
year
</TABLE>

QUOTED FEES CURRENTLY BEING CHARGED for similar instruments:

<TABLE>
<S> <C>
Off-balance sheet instruments:
Letters of credit
Lending commitments
</TABLE>

F-39
<PAGE> 146
SOUTH TEXAS BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

representation of the results of the interim periods. The operating results for
interim periods may not be indicative of the results expected for the full year.

2. INVESTMENT SECURITIES

Investment securities have been classified in the consolidated balance
sheets according to management's intent. The amortized cost of investment
securities and their approximate fair values at December 31 were as follows:

<TABLE>
<CAPTION>
December 31, 1998
---------------------------------------------------
Gross Gross Approximate
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
SECURITIES AVAILABLE FOR SALE
U.S. Treasury securities.............. $ 500,342 $ 2,940 $ -- $ 503,282
U.S. Government agency securities..... 15,500,307 61,505 10,360 15,551,452
Mortgage-backed securities............ 6,495,393 20,539 60,708 6,455,224
----------- -------- ------- -----------
$22,496,042 $ 84,984 $71,068 $22,509,958
=========== ======== ======= ===========
SECURITIES TO BE HELD TO MATURITY
U.S. Treasury securities.............. $14,978,158 $233,095 $ -- $15,211,253
U.S. Government agency securities..... 18,739,871 88,362 5,532 18,822,701
Mortgage-backed securities............ 17,093,632 108,994 1,737 17,200,889
State and municipal securities........ 3,581,032 152,481 -- 3,733,513
Federal Reserve Bank stock............ 124,350 -- -- 124,350
----------- -------- ------- -----------
$54,517,043 $582,932 $ 7,269 $55,092,706
=========== ======== ======= ===========
</TABLE>

<TABLE>
<CAPTION>
December 31, 1997
---------------------------------------------------
Gross Gross Approximate
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
SECURITIES AVAILABLE FOR SALE
U.S. Treasury securities.............. $ 1,995,416 $ 8,438 $ -- $ 2,003,854
U.S. Government agency securities..... 3,981,546 -- 1,972 3,979,574
Mortgage-backed securities............ 3,919,778 9,222 67,342 3,861,658
----------- -------- ------- -----------
$ 9,896,740 $ 17,660 $69,314 $ 9,845,086
=========== ======== ======= ===========
SECURITIES TO BE HELD TO MATURITY
U.S. Treasury securities.............. $22,984,222 $221,143 $ 292 $23,205,073
U.S. Government agency securities..... 33,715,374 149,159 25,657 33,838,876
Mortgage-backed securities............ 12,908,657 74,075 29,095 12,953,637
State and municipal securities........ 3,674,606 107,513 206 3,781,913
Federal Reserve Bank stock............ 124,350 -- -- 124,350
----------- -------- ------- -----------
$73,407,209 $551,890 $55,250 $73,903,849
=========== ======== ======= ===========
</TABLE>

Investment securities carried at approximately $22,300,000 and $20,100,000
at December 31, 1998 and 1997, respectively, were pledged to secure public fund
deposits and for other purposes as required by law.

F-40
<PAGE> 147
SOUTH TEXAS BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The scheduled maturities of securities to be held to maturity and
securities available for sale at December 31, 1998 were as follows:

<TABLE>
<CAPTION>
Securities to be Securities
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.............. $13,018,730 $13,086,626 $ 2,497,079 $ 2,513,482
Due from one year to five years...... 21,227,563 21,513,976 13,503,570 13,541,252
Due from five to ten years........... 2,690,408 2,782,423 -- --
Due in more than ten years........... 362,360 384,442 -- --
----------- ----------- ----------- -----------
37,299,061 37,767,467 16,000,649 16,054,734
Mortgage-backed securities........... 17,093,632 17,200,889 6,495,393 6,455,224
Federal Reserve Bank stock........... 124,350 124,350 -- --
----------- ----------- ----------- -----------
$54,517,043 $55,092,706 $22,496,042 $22,509,958
=========== =========== =========== ===========
</TABLE>

There were no sales of securities during December 31, 1998 or 1997.

On January 1, 1999, the Company adopted the provisions of FASB Statement
No. 133, Accounting for Derivative Financial Instruments and Hedging Activities.
The adoption of this accounting standard did not have an effect on the capital
or earnings of the Company. In connection with the adoption, the Company
reclassified $54,369,000 of investment securities with an unrealized gain net of
tax of $380,000 from the held to maturity account to the available for sale
account. This reclassification was made in accordance with the provisions of the
accounting standard allowing this transfer and does not call into question the
Company's intent or ability to hold future debt investment securities to their
maturity.

3. LOANS AND ALLOWANCE FOR LOAN LOSSES

The components of loans in the consolidated balance sheets were as follows:

<TABLE>
<CAPTION>
December 31,
-------------------------
1998 1997
----------- -----------
<S> <C> <C>
Commercial................................................. $13,800,752 $ 9,863,156
Real estate:
Residential........................................... 6,093,334 5,821,415
Nonresidential........................................ 11,409,187 13,143,371
Agricultural............................................... 2,329,467 2,524,002
Installment................................................ 4,206,873 4,473,007
Other...................................................... 146,822 190,026
----------- -----------
37,986,435 36,014,977
Allowance for loan losses.................................. 588,499 537,682
----------- -----------
$37,397,936 $35,477,295
=========== ===========
</TABLE>

F-41
<PAGE> 148
SOUTH TEXAS BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Changes in the allowance for loan losses were as follows:

<TABLE>
<CAPTION>
Years Ended
December 31,
--------------------
1998 1997
--------- --------
<S> <C> <C>
Balance at beginning of year................................ $ 537,682 $523,951
Recovery of provision for loan losses....................... (100,000) (80,000)
Loans charged off........................................... (41,804) (31,182)
Recoveries of loans charged off............................. 192,621 124,913
--------- --------
Balance at end of year...................................... $ 588,499 $537,682
========= ========
</TABLE>

Impairment of loans having an aggregate recorded investment of $74,816 at
December 31, 1998 and $150,845 at December 31, 1997 has been recognized in
conformity with the FASB Statement No. 114, as amended by FASB Statement No.
118. The average recorded investment in impaired loans during 1998 and 1997 was
$112,831 and $125,465, respectively. The total allowance for loan losses related
to those loans was $19,000 and $25,000 at December 31, 1998 and 1997. There was
$1,829 in interest recognized for cash payments on impaired loans during the
year ended December 31, 1998 ($1,952 in 1997).

The Bank is not committed to lend additional funds to borrowers whose loans
have been classified as impaired.

4. BANK PREMISES AND EQUIPMENT

Components of bank premises and equipment included in the consolidated
balance sheets were as follows:

<TABLE>
<CAPTION>
December 31,
------------------------
1998 1997
---------- ----------
<S> <C> <C>
Land........................................................ $ 558,376 $ 558,376
Buildings................................................... 3,226,368 3,330,027
Equipment and furniture..................................... 2,820,350 2,810,430
---------- ----------
6,605,094 6,698,833
Less accumulated depreciation............................... 3,556,072 3,213,861
---------- ----------
$3,049,022 $3,484,972
========== ==========
</TABLE>

5. DEPOSITS

The aggregate amount of short-term jumbo certificates of deposit (CDs),
each with a minimum denomination of $100,000, was approximately $11,850,000 at
December 31, 1998 ($11,118,000 at December 31, 1997).

At December 31, 1998, the scheduled maturities of CDs are as follows:

<TABLE>
<S> <C>
Year ending December 31,
1999...................................................... $40,567,173
2000...................................................... 11,220,921
2001...................................................... 2,621,135
2002...................................................... 269,813
-----------
$54,679,042
===========
</TABLE>

F-42
<PAGE> 149
SOUTH TEXAS BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

6. FEDERAL INCOME TAX

The provision for federal income tax consisted of the following:

<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1998 1997
---------- ----------
<S> <C> <C>
Currently paid or payable................................... $638,387 $489,095
Deferred.................................................... 65,987 107,343
-------- --------
$704,374 $596,438
======== ========
</TABLE>

The provision for federal income tax is less than that computed by applying
the federal statutory rate of 34% as indicated in the following analysis:

<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1998 1997
---------- ----------
<S> <C> <C>
Tax based on statutory rate................................. $730,724 $604,951
Effect of tax-exempt income................................. (58,915) (34,470)
Interest and other nondeductible expenses................... 8,327 6,786
Other -- net................................................ 24,238 19,171
-------- --------
$704,374 $596,438
======== ========
</TABLE>

The components of the deferred income tax liability included in other
liabilities were as follows:

<TABLE>
<CAPTION>
December 31,
----------------------
1998 1997
--------- ---------
<S> <C> <C>
Deferred tax assets related to:
Nonaccrual loan interest............................... $ 14,987 $ 14,401
Net unrealized depreciation on securities available for
sale.............................................. -- 17,563
--------- ---------
Total deferred tax assets................................... 14,987 31,964
--------- ---------
Deferred tax liabilities related to:
Goodwill............................................... (41,841) (18,782)
Depreciation........................................... (277,949) (249,418)
Allowance for loan losses.............................. (199,929) (192,003)
Net unrealized appreciation on securities available for
sale.............................................. (4,731) --
Other.................................................. (45,874) (38,817)
--------- ---------
Total deferred tax liabilities.............................. (570,324) (499,020)
--------- ---------
Net deferred tax liability.................................. $(555,337) $(467,056)
========= =========
</TABLE>

7. COMMITMENTS AND CONTINGENT LIABILITIES

The consolidated financial statements do not reflect various commitments
and contingent liabilities which arise in the normal course of business and
which involve elements of credit risk, interest rate risk, and liquidity risk.
These commitments and contingent liabilities are described in note
16 -- Financial Instruments.

The Bank is party to litigation and claims arising in the normal course of
business. Management, after consultation with legal counsel, believes that the
liabilities, if any, arising from such litigation and claims will not be
material to the Company's financial position.

F-43
<PAGE> 150
SOUTH TEXAS BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

8. EMPLOYEE BENEFIT PLAN

The Company has a 401(k) plan covering substantially all full-time
employees who have been employed at least one year. The annual contribution to
the 401(k) plan is discretionary and is determined by the Board of Directors.
The Board of Directors approved contributions to the 401(k) plan of $95,000 in
1998 and $97,000 in 1997.

9. BRANCH ACQUISITIONS

On March 14, 1997, the Company entered into a contract with Pacific
Southwest Bank to purchase branches in Beeville and Goliad. The premium paid for
the purchase was 5% of the average branch deposit base (the average of the
respective branch deposits as measured on the initial contract date and the
closing date). The total premium of approximately $2,541,000 has been recorded
as goodwill and is included in the consolidated financial statements with excess
of cost over fair value of net assets acquired. Branch deposits approximated $47
million on the closing date.

10. RELATED PARTY TRANSACTIONS

The Bank has entered into transactions with its directors, significant
shareholders, and their affiliates (related parties). Such transactions were
made in the ordinary course of business on substantially the same terms and
conditions, including interest rates and collateral, as those prevailing at the
same time for comparable transactions with other customers, and did not, in the
opinion of management, involve more than normal credit risk or present other
unfavorable features. The aggregate amount of loans to such related parties at
December 31, 1998 was $1,938,685. During 1998, new loans to such related parties
amounted to $1,095,293 and repayments amounted to $1,982,433.

11. CONCENTRATIONS OF CREDIT

Substantially all of the Bank's loans, commitments, and standby letters of
credit have been granted to customers in Bee, Goliad, and San Patricio Counties
and surrounding areas. Substantially all of these customers are depositors of
the Bank. Investments in state and municipal securities also involve
governmental entities within the Bank's market area and throughout Texas. The
concentrations of credit by type of loan are set forth in note 3. The
distribution of commitments to extend credit approximates the distribution of
loans outstanding. Standby letters of credit were granted primarily to
commercial borrowers.

12. STOCK OPTION PLANS

The Company has adopted stock option plans allowing for the purchase of
common stock of the Holding Company by eligible executive officers at set
prices. At the time options are granted, the exercise price is set to be an
amount equal to the fair market value of the stock. Executive officers then have
a fixed period to exercise granted options extending over the next 10 years. The
following table summarizes the activity in the stock option plans:

<TABLE>
<CAPTION>
Years Ended
December 31,
------------------
1998 1997
------- -------
(Number of Shares)
<S> <C> <C>
Options outstanding at beginning of year.................... 12,230 12,250
Options granted............................................. 2,450 1,950
Options exercised........................................... (1,455) (1,470)
Options cancelled or forfeited.............................. -- (500)
------ ------
Options outstanding at end of year.......................... 13,225 12,230
====== ======
</TABLE>

F-44
<PAGE> 151
SOUTH TEXAS BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

At December 31, 1998, outstanding options to purchase 13,225 shares of
stock of the Holding Company were exercisable at prices ranging from $28 to $35
per share. At December 31, 1998, a total of 7,800 additional shares of stock
have been reserved for future grants.

Effective January 1, 1996, the Company adopted the disclosure provisions of
SFAS No. 123, "Accounting for Stock-Based Compensation." However, the Company
will continue to account for stock-based compensation using APB Opinion No. 25
for both stock option plans and, accordingly, no compensation cost will be
recognized for stock options in the consolidated financial statements. If
compensation cost would have been recorded based on the fair value method at the
date of grant for stock options under SFAS No. 123, management believes the
effect on the Company's net income and net income per share would not have been
material.

13. TRUST ASSETS

Trust assets and other properties, except cash deposits, held by the Bank
in agency or other fiduciary capacities for its customers are not assets of the
Company and, accordingly, are not included in the accompanying consolidated
financial statements. The unaudited market value of trust assets was
approximately $56,787,000 and $42,611,000 at December 31, 1998 and 1997,
respectively.

14. DIVIDEND RESTRICTIONS

The Bank, as a National Bank, is subject to the dividend restrictions set
forth by the Comptroller of the Currency. Under such restrictions, the Bank may
not, without the prior approval of the Comptroller of the Currency, declare
dividends in excess of the sum of the current year's earnings (as defined) plus
the retained earnings (as defined) from the prior two years. The dividends, as
of December 31, 1998, that the Bank could declare without the approval of the
Comptroller of the Currency, amounted to approximately $373,000.

15. REGULATORY MATTERS

The Bank is subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum capital requirements
can initiate certain mandatory -- and possibly additional
discretionary -- actions by regulators that, if undertaken, could have a direct
material effect on the Bank's consolidated financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective action,
the Bank must meet specific capital guidelines that involve 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 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 (set forth in the table
below) of total and Tier I capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier I capital (as defined) to average
assets (as defined). Management believes, as of December 31, 1998, that the Bank
meets all capital adequacy requirements to which it is subject.

As of December 31, 1998, the most recent notification from the Office of
the Comptroller of the Currency 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 are no conditions or
events since that notification that management believes have changed the
institution's category.

F-45
<PAGE> 152
SOUTH TEXAS BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The Bank's actual capital amounts and ratios are presented in the following
table:

<TABLE>
<CAPTION>
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
------------------- ------------------------ ------------------------
Amount Ratio Amount Ratio Amount Ratio
----------- ----- ---------- ----- ---------- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
AS OF DECEMBER 31, 1998:
Total Capital (to Risk-Weighted
Assets)...................... $12,095,742 21.3% M $4,535,152 M 8.0% M $5,668,940 M 10.0%
Tier I Capital (to Risk-Weighted
Assets)...................... $11,507,243 20.3% M $2,267,576 M 4.0% M $3,401,364 M 6.0%
Tier I Capital (to Average
Assets)...................... $11,507,243 8.2% M $5,609,566 M 4.0% M $7,011,957 M 5.0%
AS OF DECEMBER 31, 1997:
Total Capital (to Risk-Weighted
Assets)...................... $13,340,890 24.7% M $4,325,840 M 8.0% M $5,407,300 M 10.0%
Tier I Capital (to Risk-Weighted
Assets)...................... $10,885,610 20.1% M $2,162,920 M 4.0% M $3,244,380 M 6.0%
Tier I Capital (to Average
Assets)...................... $10,885,610 8.2% M $5,345,209 M 4.0% M $6,681,512 M 5.0%
</TABLE>
"M" represents "greater than or equal to".

16. FINANCIAL INSTRUMENTS

The Bank is party to 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 amount recognized in the
consolidated financial statements. The contract or notional amounts of those
instruments reflect the extent of the Bank's involvement in particular classes
of financial instruments.

The Bank's exposure to credit losses 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 notional amount of
those instruments. The Bank uses the same credit policies in making commitments
and conditional obligations as it does for on-balance sheet instruments.

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 drawn upon, the total commitment amounts do not necessarily
represent future cash requirements.

The Bank evaluates each customer's creditworthiness on a case-by-case
basis. The amount of collateral obtained, if it is deemed necessary by the Bank
upon extension of credit, is based on management's credit evaluation of the
counterparty. Collateral held varies but may include accounts receivable;
inventory; property, plant, and equipment; and income-producing commercial
properties.

Standby letters of credit are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party. Those guarantees are
primarily issued to support public and private borrowing arrangements. The
credit risk involved in issuing letters of credit is essentially the same as
that involved in extending loan facilities to customers.

F-46
<PAGE> 153
SOUTH TEXAS BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The estimated fair values of the Bank's financial instruments were as
follows:

<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997
------------------------- -------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Financial Assets
Cash and due from banks............ $ 8,637,989 $ 8,637,989 $ 7,076,546 $ 7,076,546
Federal funds sold................. 12,100,000 12,100,000 8,050,000 8,050,000
Securities available for sale...... 22,509,958 22,509,958 9,845,086 9,845,086
Securities to be held to
maturity...................... 54,517,043 55,092,706 73,407,209 73,903,849
Loans -- net....................... 37,397,936 37,254,687 35,477,295 35,391,011
Accrued interest receivable........ 1,273,301 1,273,301 1,355,898 1,355,898
Financial Liabilities
Demand deposits.................... 23,816,596 23,816,596 20,025,359 20,025,359
Savings and NOW deposits........... 48,138,492 48,138,492 50,943,290 50,943,290
Other time deposits................ 54,679,042 54,853,333 55,699,428 55,769,131
Accrued interest payable........... 525,206 525,206 557,383 557,383
</TABLE>

The fair value of off-balance sheet financial instruments is not
significant.

A summary of the notional amounts of the Bank's financial instruments with
off-balance sheet risk at December 31, 1998 is as follows:

<TABLE>
<CAPTION>
Notional
Amount
----------
<S> <C>
Commitments to extend credit................................ $7,791,549
Standby letters of credit................................... 31,000
</TABLE>

F-47
<PAGE> 154

- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

1,200,000 TRUST PREFERRED SECURITIES

PROSPERITY CAPITAL TRUST I

9.60% CUMULATIVE TRUST PREFERRED SECURITIES
(LIQUIDATION AMOUNT $10 PER TRUST PREFERRED SECURITY)
FULLY, IRREVOCABLY AND UNCONDITIONALLY GUARANTEED BY

[PROSPERITY BANCSHARES, INC. LOGO]

---------------------

HOWE BARNES INVESTMENTS, INC.

---------------------

November 12, 1999
---------------------

UNTIL DECEMBER 7, 1999 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL
DEALERS THAT EFFECT TRANSACTIONS IN THE REGISTERED SECURITIES, WHETHER OR NOT
PARTICIPATING IN THIS OFFERING, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS
DELIVERY REQUIREMENT IS IN ADDITION TO THE DEALERS' OBLIGATION TO DELIVER A
PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD
ALLOTMENTS OR SUBSCRIPTIONS.

- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------