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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
FORM 10-K
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For The Fiscal Year Ended December 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 0-25051
PROSPERITY BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
TEXAS 74-2331986
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3040 POST OAK BLVD. 77056
HOUSTON, TEXAS (Zip Code)
(Address of principal executive offices)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(713) 993-0002
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value
$1.00 PER SHARE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of the Form 10-K or any amendment of this
Form 10-K. [ ]
As of March 11, 1999, the number of outstanding shares of Common Stock was
5,172,825. As of such date, the aggregate market value of the shares of Common
Stock held by non-affiliates, based on the closing price of the Common Stock on
the Nasdaq National Market System on such date, was approximately $52,596,338.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the Company's Proxy Statement for the 1999 Annual Meeting of
Shareholders (Part III, Items 10-13).
PROSPERITY BANCSHARES, INC.
1998 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PART I
Item 1. Business......................................................... 1
General.......................................................... 1
Business......................................................... 2
Recent Acquisition............................................... 3
Competition...................................................... 3
Associates....................................................... 3
Supervision and Regulation....................................... 3
Item 2. Properties....................................................... 9
Item 3. Legal Proceedings................................................ 10
Item 4. Submission of Matters to a Vote of Security Holders.............. 10
PART II
Item 5. Market for Registrant's Common Equity and Related
Shareholder Matters.............................................. 10
Description of Capital Stock..................................... 11
Item 6. Selected Consolidated Financial Data............................. 12
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations........................................... 15
Overview......................................................... 15
Results of Operations............................................ 15
Financial Condition...............................................19
Year 2000 Compliance..............................................31
Item 7A. Quantitative and Qualitative Disclosures about Market Risk....... 32
Item 8. Financial Statements and Supplementary Data...................... 32
Item 9. Changes In and Disagreements with Accountants on Accounting and
Financial Disclosure............................................ 33
PART III
Item 10. Directors and Executive Officers of the Registrant............... 34
Item 11. Executive Compensation........................................... 34
Item 12. Security Ownership of Certain Beneficial Owners and Management... 34
Item 13. Certain Relationships and Related Transactions................... 34
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.. 34
PART I
ITEM 1. BUSINESS
GENERAL
Prosperity Bancshares, Inc. (the "Company") was formed in 1983 as a
vehicle to acquire the former Allied Bank in Edna, Texas which was chartered in
1949. The Company derives substantially all of its income from its wholly-owned
bank subsidiary, First Prosperity Bank (the "Bank"), which has 12 full-service
banking locations ("Banking Centers") in the greater Houston metropolitan area
and six contiguous counties situated south and southwest of Houston. The
Company's headquarters are located at 3040 Post Oak Boulevard in Houston, Texas
and its telephone number is (713) 993-0002.
The Company has grown through a combination of internal growth, the
acquisition of community banks and the opening of new community banking offices.
Utilizing a low cost of funds and employing stringent cost controls, the Company
has been profitable in every full year of its existence, including the period of
adverse economic conditions in Texas in the late 1980s. From 1988 to 1992, as a
sound and profitable institution, the Company took advantage of this economic
downturn and acquired the deposits and certain assets of failed banks in West
Columbia, El Campo and Cuero, Texas and two failed banks in Houston, which
diversified the Company's franchise and increased its core deposits. The Company
opened a full-service Banking Center in Victoria, Texas in 1993 and the
following year established a Banking Center in Bay City, Texas. The Company
expanded its Bay City presence in 1996 with the acquisition of an additional
branch location from Norwest Bank Texas, and in 1997, the Company acquired the
Angleton, Texas branch of Wells Fargo Bank. In 1998, the Company enhanced its
West Columbia Banking Center with the purchase of a commercial bank branch
located in West Columbia. In addition, the Company acquired Union State Bank
("Union") in East Bernard, Texas, which had loans of $21.5 million and deposits
of $66.1 million as of September 30, 1998 (the "Union Acquisition"). As a result
of the addition of these acquisitions and internal growth, the Company's assets
have increased from $54.2 million at the end of 1987 to $436.3 million as of
December 31, 1998 and its deposits have increased from $46.0 million to $390.7
million in that same period.
The Company's primary market consists of the communities served by its
three locations in the greater Houston metropolitan area and its nine locations
in six contiguous counties (Brazoria, Wharton, Matagorda, Jackson, Victoria and
DeWitt) located to the south and southwest of Houston. Texas Highway 59
(scheduled to become Interstate Highway 69), which serves as one of the primary
trucking routes linking the interior United States and Mexico, runs directly
through the center of the Company's market area. The increased traffic along
this "NAFTA Highway" has enhanced economic activity in the Company's market area
and created opportunities for growth. The diverse nature of the economies in
each local market served by the Company provides the Company with a varied
customer base and allows the Company to spread its lending risk throughout a
number of different industries including farming, ranching, petrochemicals,
manufacturing, tourism, recreation and professional service firms and their
principals. The Company's market areas outside of Houston are dominated by
either small community banks or branches of large regional banks. Management
believes that the Company, as one of the few mid-sized financial institutions
that combines responsive community banking with the sophistication of a regional
bank holding company, has a competitive advantage in its market area and
excellent growth opportunities through acquisitions, new branch locations and
additional business development.
Operating under a community banking philosophy, the Company seeks to
develop broad customer relationships based on service and convenience while
maintaining its conservative approach to lending and strong asset quality. The
Company's directors and officers are important to the Company's success and play
a key role in the Company's business development efforts by actively
participating in a number of civic and public service activities in the
communities served by the Company, such as the Rotary Club, Lion's Club, United
Way and Chamber of Commerce. In addition, the Company's Banking Centers in Bay
City, Clear Lake, Cuero, Edna and Victoria maintain Community Development
Boards, whose function is to solicit new business, develop customer relations
and provide valuable community knowledge to their respective Banking Center
Presidents.
The Company has invested heavily in its officers and associates by
recruiting talented officers in its market areas and providing them with
economic incentive in the form of stock options and bonuses based on
cross-selling performance. The senior management team has substantial experience
in both the Houston markets and the surrounding communities in which the Company
has a presence. Each Banking Center location is administered by a local
President with knowledge of the community and banking skills which complement
the local economy. The Company entrusts its Banking Center Presidents with
authority and flexibility with respect to product pricing and decision making
within general parameters established by the Company. The Company operates each
Banking Center as a separate profit center, maintaining separate data with
respect to each Banking Center's net interest income, efficiency ratio, deposit
growth, loan growth and overall profitability. Banking Center Presidents are
accountable for performance in these areas and compensated accordingly. Each
Banking Center has its own local telephone number, which enables a customer to
be served by a local banker.
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BUSINESS
The Company offers a variety of traditional loan and deposit products to
its customers, which consist primarily of consumers and small and medium-sized
businesses. The Company tailors its products to the specific needs of customers
in a given market. The Company maintains approximately 29,000 separate deposit
accounts and 5,500 separate loan accounts. At December 31, 1998, approximately
21.8% of the Company's total deposits were noninterest-bearing demand deposits
and for the period ended December 31, 1998, the Company's average cost of funds
was 3.11%.
The Company has been an active mortgage lender, with one-to-four family
and commercial mortgage loans comprising 64.8% of the Company's total loans as
of December 31, 1998. The Company also offers loans for automobiles and other
consumer durables, home equity loans, debit cards, personal computer banking and
other cash management services and telebanking. By offering certificates of
deposit, NOW accounts, savings accounts and overdraft protection at competitive
rates, the Company gives its depositors a full range of traditional deposit
products. The Company has successfully introduced Banclub, which for a monthly
fee provides consumers with a package of benefits including unlimited free
checking, personalized checks, credit card protection, free travelers checks,
cashier's checks, money orders and certain travel discounts.
The businesses targeted by the Company are primarily those that require
loans in the $100,000 to $3.0 million range. The Company offers these businesses
a broad array of loan products including term loans, lines of credit and loans
for working capital, business expansion and the purchase of equipment and
machinery, interim construction loans for builders and owner-occupied commercial
real estate loans. For its business customers, the Company has developed a
specialized checking product called Business 10 Checking which provides
discounted fees for checking and normal account analysis.
The Company's main objective is to increase deposits and loans through
additional expansion opportunities while maintaining efficiency and
individualized customer service and maximizing profitability. To achieve this
objective, the Company has employed the following strategic goals:
INCREASE LOAN VOLUME AND DIVERSIFY LOAN PORTFOLIO. The Company seeks to
increase its ratio of loans to deposits from the December 31, 1998 level of
43.6% to approximately 65%. Given the Company's high level of low-cost core
deposits, increased lending activity is expected to significantly enhance the
Company's net income. Historically, the Company has elected to sacrifice some
earnings for the relative security of home mortgage loans. While maintaining its
conservative approach to lending, the Company plans to emphasize both new and
existing loan products. Among new loan products, the Company has successfully
introduced home equity lending, which contributed $8.1 million in new loans
during 1998. The Company has also increased its number of loans to finance the
construction of commercial owner-occupied real estate and loans to commercial
businesses for accounts receivable financing and other purposes. With the Union
Acquisition, the Company's agricultural loans increased from $6.4 million to
$14.1 million during 1998. The Company is also targeting professional service
firms such as legal and medical practices for both loans secured by
owner-occupied premises and personal loans to their principals. As an outgrowth
of its traditional mortgage lending activity, the Company is making more jumbo
mortgage loans, particularly in the Houston area.
MAINTAIN EFFICIENCY RATIO. The Company has always emphasized cost control.
The Company has invested significantly in the infrastructure required to
centralize many of its critical operations, such as data processing and loan
application processing. For its Banking Centers, which the Company operates as
independent profit centers, the Company supplies complete support in the areas
of loan review, internal audit, compliance and training. The Company maintains a
Products Committee which provides support in the areas of product development,
marketing and pricing. Management believes that this centralized infrastructure
can accommodate substantial additional growth while enabling the Company to
minimize operational costs through certain economies of scale. Since 1993, the
Company has acquired three branch locations and established two new offices
while improving its efficiency ratio in each consecutive year.
ENHANCE CROSS-SELLING. The Company recognizes that its customer base
provides significant opportunities to cross-sell various products and has
increased its focus on cross-selling opportunities by training associates to
identify and maximize cross-selling opportunities. The Company uses bonuses to
encourage cross-selling efforts, and fosters friendly competition among the
Banking Centers to achieve better cross-selling results. To assist with
cross-selling efforts the Company has updated its technology to help officers
and associates identify cross-selling opportunities through a readily accessible
Customer Information File which details personal information, existing account
relationships and related account relationships. Using this data, the Company's
officers and associates inform customers of additional products when customers
visit or call the various Banking Centers or use their drive-in facilities. In
addition, the Company includes product information in monthly statements and
other mailouts. The products most frequently targeted for cross-selling include
auto loans, mortgage loans, home equity loans, checking accounts, savings
accounts, certificates of deposit, Individual Retirement Accounts, direct
deposit accounts, personal computer banking and safe deposit boxes.
2
AUGMENT MARKET SHARE. In recent years, the Company has grown in each of
the communities in which it maintains a Banking Center. The Company intends to
continue seeking opportunities, both inside and outside its existing markets, to
expand either by acquiring existing banks or branches of banks or by
establishing new branches. All of the Company's acquisitions have been accretive
to earnings immediately and have supplied the Company with relatively low-cost
deposits which have been used to fund the Company's lending activities. Factors
used by the Company to evaluate expansion opportunities include the similarity
in management and operating philosophies, whether the acquisition will be
accretive to earnings and enhance shareholder value, the ability to achieve
economies of scale to improve the efficiency ratio and the opportunity to
enhance the Company's image and market presence.
RECENT ACQUISITION
The Company's Board of Directors actively pursues an acquisition strategy
designed to increase efficiency, market share and return to shareholders. As
part of this strategy, the Company acquired Union, a Texas banking association
organized in 1907, pursuant to a statutory merger. Union was a single location
community bank whose business includes conventional consumer and commercial
products and services, including interest and noninterest-bearing depository
accounts and commercial, industrial, consumer, agricultural and real estate
lending. As of September 30, 1998, Union had loans of $21.5 million and total
deposits of $66.1 million. Union was the only full-service commercial bank in
East Bernard and has a stable customer base.
The Union acquisition provided the Company with a presence in East
Bernard, a community of 1,500 located in northern Wharton County. The
acquisition increased the Company's market share in Wharton County, where the
Company's El Campo Banking Center is located. Union had a lending philosophy
which is similar to that employed by the Company. The Company's significantly
higher lending limit is expected to create lending opportunities in the market
that Union was unable to take advantage of prior to the acquisition. Similar to
its previous acquisitions, management believes that the Union acquisition will
enable the Company to achieve certain economies of scale and resultant savings
from the operation of Union as an additional Banking Center.
Upon consummation of the Union acquisition, holders of shares of Union
common stock received $17.6 million in cash as consideration in exchange for
their shares. The source of the Company's funds for the acquisition was a
combination of existing cash ($15.6 million) and borrowed funds ($2.0 million).
The Union acquisition was accounted for as a purchase transaction. At the
closing of the Union acquisition, two executive officers of Union entered into
three year employment agreements with the Company which contain two-year
noncompetition clauses.
COMPETITION
The banking business is highly competitive, and the profitability of the
Company depends principally on the Company's ability to compete in its market
areas. The Company competes with other commercial banks, savings banks, savings
and loan associations, credit unions, finance companies, mutual funds, insurance
companies, brokerage and investment banking firms, asset-based 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 the Company. The Company has been able
to compete effectively with other financial institutions by emphasizing customer
service, technology and responsive decision-making on loans; by establishing
long-term customer relationships and building customer loyalty; and by providing
products and services designed to address the specific needs of its customers.
Competition from both financial and nonfinancial institutions is expected to
continue.
ASSOCIATES
As of December 31, 1998, the Company and its wholly-owned subsidiary First
Prosperity Bank (the "Bank") had 138 full-time equivalent associates, 63 of whom
were officers of the Bank. The Company provides medical and hospitalization
insurance to its full-time associates. The Company considers its relations with
associates to be excellent. Neither the Company nor the Bank is a party to any
collective bargaining agreement.
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 Federal Deposit Insurance Corporation ("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.
3
The following description summarizes some of the laws to which the Company
and the Bank are subject. References herein to applicable statutes and
regulations are brief summaries thereof, do not purport to be complete, and are
qualified in their entirety by reference to such statutes and regulations. The
Company believes that it is in compliance in all material respects with these
laws and regulations.
THE COMPANY
The Company is a bank holding company registered under the Bank Holding
Company Act of 1956, as amended ("BHCA"), and it is subject to supervision,
regulation and examination by the Board of Governors of the Federal Reserve
System ("Federal Reserve Board"). The BHCA and other federal laws subject bank
holding companies to particular restrictions on the types of activities in which
they may engage, and to a range of supervisory requirements and activities,
including regulatory enforcement actions for violations of laws and regulations.
REGULATORY RESTRICTIONS ON DIVIDENDS; SOURCE OF STRENGTH. It is the policy
of the Federal Reserve Board that bank holding companies should pay cash
dividends on common stock only out of income available over the past year and
only if prospective earnings retention is consistent with the organization's
expected future needs and financial condition. The policy provides that bank
holding companies should not maintain a level of cash dividends that undermines
the bank holding company's ability to serve as a source of strength to its
banking subsidiaries.
Under Federal Reserve Board policy, a bank holding company is expected to
act as a source of financial strength to each of its banking subsidiaries and
commit resources to their support. Such support may be required at times when,
absent this Federal Reserve Board policy, a holding company may not be inclined
to provide it. As discussed below, a bank holding company in certain
circumstances could be required to guarantee the capital plan of an
undercapitalized banking subsidiary.
In the event of a bank holding company's bankruptcy under Chapter 11 of
the U.S. Bankruptcy Code, the trustee will be deemed to have assumed and is
required to cure immediately any deficit under any commitment by the debtor
holding company to any of the federal banking agencies to maintain the capital
of an insured depository institution, and any claim for breach of such
obligation will generally have priority over most other unsecured claims.
ACTIVITIES "CLOSELY RELATED" TO BANKING. The BHCA prohibits a bank holding
company, with certain limited exceptions, from acquiring direct or indirect
ownership or control of any voting shares of any company which is not a bank or
from engaging in any activities other than those of banking, managing or
controlling banks and certain other subsidiaries, or furnishing services to or
performing services for its subsidiaries. One principal exception to these
prohibitions allows the acquisition of interests in companies whose activities
are found by the Federal Reserve Board, by order or regulation, to be so closely
related to banking or managing or controlling banks, as to be a proper incident
thereto. Some of the activities that have been determined by regulation to be
closely related to banking are making or servicing loans, performing certain
data processing services, acting as an investment or financial advisor to
certain investment trusts and investment companies, and providing securities
brokerage services. Other activities approved by the Federal Reserve Board
include consumer financial counseling, tax planning and tax preparation, futures
and options advisory services, check guaranty services, collection agency and
credit bureau services, and personal property appraisals. In approving
acquisitions by bank holding companies of companies engaged in banking-related
activities, the Federal Reserve Board considers a number of factors, and weighs
the expected benefits to the public (such as greater convenience and increased
competition or gains in efficiency) against the risks of possible adverse
effects (such as undue concentration of resources, decreased or unfair
competition, conflicts of interest, or unsound banking practices). The Federal
Reserve Board is also empowered to differentiate between activities commenced de
novo and activities commenced through acquisition of a going concern.
SECURITIES ACTIVITIES. The Federal Reserve Board has approved applications
by bank holding companies to engage, through nonbank subsidiaries, in certain
securities-related activities (underwriting of municipal revenue bonds,
commercial paper, consumer receivable-related securities and one-to-four family
mortgage-backed securities), provided that the affiliates would not be
"principally engaged" in such activities for purposes of Section 20 of the
Glass-Steagall Act. In limited situations, holding companies may be able to use
such subsidiaries to underwrite and deal in corporate debt and equity
securities.
SAFE AND SOUND BANKING PRACTICES. Bank holding companies are not permitted
to engage in unsafe and unsound banking practices. The Federal Reserve Board's
Regulation Y, for example, generally requires a holding company to give the
Federal Reserve Board prior notice of any redemption or repurchase of its own
equity securities, if the consideration to be paid, together with the
consideration paid for any repurchases or redemptions in the preceding year, is
equal to 10% or more of the company's consolidated net worth. The Federal
Reserve Board may oppose the transaction if it believes that the transaction
would constitute an unsafe or
4
unsound practice or would violate any law or regulation. Depending upon the
circumstances, the Federal Reserve Board could take the position that paying a
dividend would constitute an unsafe or unsound banking practice.
The Federal Reserve Board has broad authority to prohibit activities of
bank holding companies and their nonbanking subsidiaries which represent unsafe
and unsound banking practices or which constitute violations of laws or
regulations, and can assess civil money penalties for certain activities
conducted on a knowing and reckless basis, if those activities caused a
substantial loss to a depository institution. The penalties can be as high as
$1.0 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 services offered by a holding company or its affiliates.
CAPITAL ADEQUACY REQUIREMENTS. The Federal Reserve Board has adopted a
system using risk-based capital guidelines to evaluate the capital adequacy of
bank holding companies. Under the guidelines, specific categories of assets are
assigned different risk weights, based generally on the perceived credit risk of
the asset. These risk weights are multiplied by corresponding asset balances to
determine a "risk-weighted" asset base. The guidelines require a minimum total
risk-based capital ratio of 8.0% (of which at least 4.0% is required to consist
of Tier 1 capital elements). Total capital is the sum of Tier 1 and Tier 2
capital. As of December 31, 1998, the Company's ratio of Tier 1 capital to total
risk-weighted assets was 18.02% and its ratio of total capital to total
risk-weighted assets was 19.08%. SEE "MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - FINANCIAL CONDITION - CAPITAL
RESOURCES."
In addition to the risk-based capital guidelines, the Federal Reserve
Board uses a leverage ratio as an additional tool to evaluate the capital
adequacy of bank holding companies. The leverage ratio is a company's Tier 1
capital divided by its average total consolidated assets. Certain highly rated
bank holding companies may maintain a minimum leverage ratio of 3.0%, but other
bank holding companies may be required to maintain a leverage ratio of up to 200
basis points above the regulatory minimum. As of December 31, 1998, the
Company's leverage ratio was 7.58%.
The federal banking agencies' risk-based and leverage ratios are minimum
supervisory ratios generally applicable to banking organizations that meet
certain specified criteria, assuming that they have the highest regulatory
rating. Banking organizations not meeting these criteria are expected to operate
with capital positions well above the minimum ratios. The federal bank
regulatory agencies may set capital requirements for a particular banking
organization that are higher than the minimum ratios when circumstances warrant.
Federal Reserve Board guidelines also provide that banking organizations
experiencing internal growth or making acquisitions will be expected to maintain
strong capital positions substantially above the minimum supervisory levels,
without significant reliance on intangible assets.
IMPOSITION OF LIABILITY FOR UNDERCAPITALIZED SUBSIDIARIES. Bank regulators
are required to take "prompt corrective action" to resolve problems associated
with insured depository institutions whose capital declines below certain
levels. In the event an institution becomes "undercapitalized," it must submit a
capital restoration plan. The capital restoration plan will not be accepted by
the regulators unless each company having control of the undercapitalized
institution guarantees the subsidiary's compliance with the capital restoration
plan up to a certain specified amount. Any such guarantee from a depository
institution's holding company is entitled to a priority of payment in
bankruptcy.
The aggregate liability of the holding company of an undercapitalized bank
is limited to the lesser of 5% of the institution's assets at the time it became
undercapitalized or the amount necessary to cause the institution to be
"adequately capitalized." The bank regulators have greater power in situations
where an institution becomes "significantly" or "critically" undercapitalized or
fails to submit a capital restoration plan. For example, a bank holding company
controlling such an institution can be required to obtain prior Federal Reserve
Board approval of proposed dividends, or might be required to consent to a
consolidation or to divest the troubled institution or other affiliates.
ACQUISITIONS BY BANK HOLDING COMPANIES. The BHCA requires every bank
holding company to obtain the prior approval of the Federal Reserve Board before
it may acquire all or substantially all of the assets of any bank, or ownership
or control of any voting shares of any bank, if after such acquisition it would
own or control, directly or indirectly, more than 5% of the voting shares of
such bank. In approving bank acquisitions by bank holding companies, the Federal
Reserve Board is required to consider the financial and managerial resources and
future prospects of the bank holding company and the banks concerned, the
convenience and needs of the communities to be served, and various competitive
factors.
CONTROL ACQUISITIONS. The Change in Bank Control Act prohibits a person or
group of persons from acquiring "control" of a bank holding company unless the
Federal Reserve Board has been notified and has not objected to the transaction.
Under a rebuttable
5
presumption established by the Federal Reserve Board, the acquisition of 10% of
more of a class of voting stock of a bank holding company with a class of
securities registered under Section 12 of the Exchange Act, such as the Company,
would, under the circumstances set forth in the presumption, constitute
acquisition of control of the Company.
In addition, any entity is required to obtain the approval of the Federal
Reserve Board under the BHCA before acquiring 25% (5% in the case of an acquiror
that is a bank holding company) or more of the outstanding Common Stock of the
Company, or otherwise obtaining control or a "controlling influence" over the
Company.
THE BANK
The Bank is a Texas-chartered banking association, the deposits of which
are insured by the Bank Insurance Fund ("BIF"). The Bank is not a member of the
Federal Reserve System; therefore, the Bank is subject to supervision and
regulation by the FDIC and the Texas Banking Department. Such supervision and
regulation 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 Board regulates the bank holding company
parent of the Bank, the Federal Reserve Board also has supervisory authority
which directly affects the Bank.
EQUIVALENCE TO NATIONAL BANK POWERS. The Texas Constitution, as amended in
1986, provides that a Texas-chartered bank has the same rights and privileges
that are or may be granted to national banks domiciled in Texas. To the extent
that the Texas laws and regulations may have allowed state-chartered banks to
engage in a broader range of activities than national banks, the Federal Deposit
Insurance Corporation Improvement Act of 1991 ("FDICIA") has operated to limit
this authority. FDICIA provides that no state bank or subsidiary thereof may
engage as principal in any activity not permitted for national banks, unless the
institution complies with applicable capital requirements and the FDIC
determines that the activity poses no significant risk to the insurance fund. In
general, statutory restrictions on the activities of banks are aimed at
protecting the safety and soundness of depository institutions.
BRANCHING. Texas law provides that a Texas-chartered bank can establish a
branch anywhere in Texas provided that the branch is approved in advance by the
Texas Banking Department. The branch must also be approved by the FDIC, which
considers a number of factors, including financial history, capital adequacy,
earnings prospects, character of management, needs of the community and
consistency with corporate powers.
RESTRICTIONS ON TRANSACTIONS WITH AFFILIATES AND INSIDERS. Transactions
between the Bank and its nonbanking subsidiaries, including the Company, are
subject to Section 23A of the Federal Reserve Act. In general, Section 23A
imposes limits on the amount of such transactions, and also requires certain
levels of collateral for loans to affiliated parties. It also limits the amount
of advances to third parties which are collateralized by the securities or
obligations of the Company or its subsidiaries.
Affiliate transactions are also subject to Section 23B of the Federal
Reserve Act which generally requires that certain transactions between the Bank
and its affiliates be on terms substantially the same, or at least as favorable
to the Bank, as those prevailing at the time for comparable transactions with or
involving other nonaffiliated persons.
The restrictions on loans to directors, executive officers, principal
shareholders and their related interests (collectively referred to herein as
"insiders") contained in the Federal Reserve Act and Regulation O apply to all
insured institutions and their subsidiaries and holding companies. These
restrictions include limits on loans to one borrower and conditions that must be
met before such a loan can be made. There is also an aggregate limitation on all
loans to insiders and their related interests. These loans cannot exceed the
institution's total unimpaired capital and surplus, and the FDIC may determine
that a lesser amount is appropriate. Insiders are subject to enforcement actions
for knowingly accepting loans in violation of applicable restrictions.
RESTRICTIONS ON DISTRIBUTION OF SUBSIDIARY BANK DIVIDENDS AND ASSETS.
Dividends paid by the Bank have provided a substantial part of the Company's
operating funds and for the foreseeable future it is anticipated that dividends
paid by the Bank to the Company will continue to be the Company's principal
source of operating funds. Capital adequacy requirements serve to limit the
amount of dividends that may be paid by the Bank. Under federal law, the Bank
cannot pay a dividend if, after paying the dividend, the Bank will be
"undercapitalized." The FDIC may declare a dividend payment to be unsafe and
unsound even though the Bank would continue to meet its capital requirements
after the dividend.
Because the Company is a legal entity separate and distinct from its
subsidiaries, its right to participate in the distribution of assets of any
subsidiary upon the subsidiary's liquidation or reorganization will be subject
to the prior claims of the subsidiary's creditors. In the event of a liquidation
or other resolution of an insured depository institution, the claims of
depositors and other
6
general or subordinated creditors are entitled to a priority of payment over the
claims of holders of any obligation of the institution to its shareholders,
including any depository institution holding company (such as the Company) or
any shareholder or creditor thereof.
EXAMINATIONS. The FDIC periodically examines and evaluates insured banks.
Based 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 committees of such institutions must
include members with experience in banking or financial management, must have
access to outside counsel, and must not include representatives of large
customers.
CAPITAL ADEQUACY REQUIREMENTS. The FDIC has adopted regulations
establishing minimum requirements for the capital adequacy of insured
institutions. The FDIC may establish higher minimum requirements if, for
example, a bank has previously received special attention or has a high
susceptibility to interest rate risk.
The FDIC's risk-based capital guidelines generally require state banks to
have a minimum ratio of Tier 1 capital to total risk-weighted assets of 4.0% and
a ratio of total capital to total risk-weighted assets of 8.0%. The capital
categories have the same definitions for the Bank as for the Company. As of
December 31, 1998, the Bank's ratio of Tier 1 capital to total risk-weighted
assets was 11.87% and its ratio of total capital to total risk-weighted assets
was 12.93%. SEE "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULT OF OPERATION OF THE COMPANY - FINANCIAL CONDITION CAPITAL RESOURCES."
The FDIC's leverage guidelines require state banks to maintain Tier 1
capital of no less than 5.0% of average total assets, except in the case of
certain highly rated banks for which the requirement is 3.0% of average total
assets. The Texas Banking Department has issued a policy which generally
requires state chartered banks to maintain a leverage ratio (defined in
accordance with federal capital guidelines) of 6% . As of December 31, 1998, the
Bank's ratio of Tier 1 capital to average total assets (leverage ratio) was
4.99%. SEE "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULT OF OPERATION OF THE COMPANY - FINANCIAL CONDITION - CAPITAL RESOURCES."
CORRECTIVE MEASURES FOR CAPITAL DEFICIENCIES. The federal banking
regulators are required to take "prompt corrective action" with respect to
capital-deficient institutions. Agency regulations define, for each capital
category, the levels at which institutions are "well capitalized," "adequately
capitalized," "under capitalized," "significantly under capitalized" and
"critically under capitalized." A "well capitalized" bank has a total risk-based
capital ratio of 10.0% or higher; a Tier 1 risk-based capital ratio of 6.0% or
higher; a leverage ratio of 5.0% or higher; and is not subject to any written
agreement, order or directive requiring it to maintain a specific capital level
for any capital measure. An "adequately capitalized" bank has a total risk-based
capital ratio of 8.0% or higher; a Tier 1 risk-based capital ratio of 4.0% or
higher; a leverage ratio of 4.0% or higher (3.0% or higher if the bank was rated
a composite 1 in its most recent examination report and is not experiencing
significant growth); and does not meet the criteria for a well capitalized bank.
A bank is "under capitalized" if it fails to meet any one of the ratios required
to be adequately capitalized. 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.
7
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 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, the current BIF rate is .0126%
of deposits and the SAIF rate is .0630% of deposits.
ENFORCEMENT POWERS. The FDIC and the other federal banking agencies have
broad enforcement powers, including the power to terminate deposit insurance,
impose substantial fines and other civil and criminal penalties and appoint a
conservator or receiver. Failure to comply with applicable laws, regulations and
supervisory agreements could subject the Company or its banking subsidiaries, as
well as officers, directors and other institution-affiliated parties of these
organizations, to administrative sanctions and potentially substantial civil
money penalties. The appropriate federal banking agency may appoint the FDIC as
conservator or receiver for a banking institution (or the FDIC may appoint
itself, under certain circumstances) if any one or more of a number of
circumstances exist, including, without limitation, the fact that the banking
institution is undercapitalized and has no reasonable prospect of becoming
adequately capitalized; fails to become adequately capitalized when required to
do so; fails to submit a timely and acceptable capital restoration plan; or
materially fails to implement an accepted capital restoration plan. 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. Adequately capitalized institutions cannot
accept, renew or roll over brokered deposits except with a waiver from the FDIC,
and are subject to restrictions on the interest rates that can be paid on such
deposits. Undercapitalized institutions may not accept, renew, or roll over
brokered deposits.
CROSS-GUARANTEE PROVISIONS. The Financial Institutions Reform, Recovery
and Enforcement Act of 1989 ("FIRREA") contains a "cross-guarantee" provision
which generally makes commonly controlled insured depository institutions liable
to the FDIC for any losses incurred in connection with the failure of a commonly
controlled depository institution.
COMMUNITY REINVESTMENT ACT. The Community Reinvestment Act of 1977 ("CRA")
and the regulations issued thereunder are intended to encourage banks to help
meet the credit needs of their service area, including low and moderate income
neighborhoods, consistent with the safe and sound operations of the banks. These
regulations also provide for regulatory assessment of a bank's record in meeting
the needs of its service area when considering applications to establish
branches, merger applications and applications to acquire the assets and assume
the liabilities of another bank. FIRREA requires federal banking agencies to
make public a rating of a bank's performance under the CRA. In the case of a
bank holding company, the CRA performance record of the banks involved in the
transaction are reviewed in connection with the filing of an application to
acquire ownership or control of shares or assets of a bank or to merge with any
other bank holding company. An unsatisfactory record can substantially delay or
block the transaction.
8
CONSUMER LAWS AND REGULATIONS. In addition to the laws and regulations
discussed herein, the Bank is also subject to certain consumer laws and
regulations that are designed to protect consumers in transactions with banks.
While the list set forth herein is not exhaustive, these laws and regulations
include the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds
Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity
Act, and the Fair Housing Act, among others. These laws and regulations mandate
certain disclosure requirements and regulate the manner in which financial
institutions must deal with customers when taking deposits or making loans to
such customers. The Bank must comply with the applicable provisions of these
consumer protection laws and regulations as part of their ongoing customer
relations.
INSTABILITY 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 operating environment of the Company and its banking
subsidiaries in substantial and unpredictable ways. The Company cannot determine
the ultimate effect that potential legislation, if enacted, or implementing
regulations with respect thereto, would have upon the financial condition or
results of operations of the Company or its subsidiaries.
EXPANDING ENFORCEMENT AUTHORITY
One of the major additional burdens imposed on the banking industry by
FDICIA is the increased ability of banking regulators to monitor the activities
of banks and their holding companies. In addition, the Federal Reserve Board and
FDIC are possessed of extensive authority to police unsafe or unsound practices
and violations of applicable laws and regulations by depository institutions and
their holding companies. For example, the FDIC may terminate the deposit
insurance of any institution which it determines has engaged in an unsafe or
unsound practice. The agencies can also assess civil money penalties, issue
cease and desist or removal orders, seek injunctions, and publicly disclose such
actions. FDICIA, FIRREA and other laws have expanded the agencies' authority in
recent years, and the agencies have not yet fully tested the limits of their
powers.
EFFECT ON ECONOMIC ENVIRONMENT
The policies of regulatory authorities, including the monetary policy of
the Federal Reserve Board, have a significant effect on the operating results of
bank holding companies and their subsidiaries. Among the means available to the
Federal Reserve Board to affect the money supply are open market operations in
U.S. government securities, changes in the discount rate on member bank
borrowings, and changes in reserve requirements against member bank deposits.
These means are used in varying combinations to influence overall growth and
distribution of bank loans, investments and deposits, and their use may affect
interest rates charged on loans or paid for deposits.
Federal Reserve Board monetary policies have materially affected the
operating results of commercial banks in the past and are expected to continue
to do so in the future. The nature of future monetary policies and the effect of
such policies on the business and earnings of the Company and its subsidiaries
cannot be predicted.
ITEM 2. PROPERTIES
The Company conducts business at 12 full-service banking locations. The
following table sets forth specific information on each such location. The
Company's headquarters are located at 3040 Post Oak Blvd. located in Houston,
Texas. The Company owns all of the buildings in which its Banking Centers are
located other than the Post Oak, Meyerland and Victoria Banking Centers.
LOCATION ADDRESS DEPOSITS AT DECEMBER 31, 1998
- -------- ------- -----------------------------
(Dollars in thousands)
Angleton 116 South Velasco $28,403
Angleton, TX 77516
Bay City-North 1600 Seventh St $14,194
Bay City, TX 77404
Bay City-South 3700 Avenue F $29,914
Bay City, TX 77404
9
Clear Lake 100 West Medical Center Blvd $32,509
Webster, TX 77598
Cuero 106 North Esplanade $25,144
Cuero, TX 77954
East Bernard 700 Church St $70,656
East Bernard, TX 77435
Edna 102 North Wells $35,969
Edna, TX 77962
El Campo 1301 N Mechanic $45,126
El Campo, TX 77437
Meyerland 8801 West Loop South $21,670
Houston, TX 77252
Post Oak 3040 Post Oak Blvd. Suite 150 $28,086
Houston, TX 77056
Victoria 2702 North Navarro $14,400
Victoria, TX 77903
West Columbia 510 East Brazos $41,167
West Columbia, TX 77486
ITEM 3. LEGAL PROCEEDINGS
Neither the Company nor the Bank is currently a party to any material
legal proceeding.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of 1998.
PART II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
In November 1998, the Company's registration statement ("Registration
Statement") previously filed with the Securities and Exchange Commission ("SEC")
was declared effective pursuant to which 1,974,300 shares of the Company's
common stock ("Common Stock") were sold to the public. Prior to this offering,
the Company's Common Stock was privately held and not listed on any public
exchange or actively traded. The Common Stock began trading on November 12, 1998
and is listed on the Nasdaq National Market System ("Nasdaq NMS") under the
symbol "PRSP". The Company had a total of 5,172,825 shares outstanding at
December 31, 1998. As of March 11, 1999, there were 234 shareholders of record.
The number of beneficial owners is unknown to the Company at this time.
Prior to trading on the Nasdaq NMS, there was no established trading
market for the Common Stock, however, since the Common Stock began trading on
the Nasdaq NMS, the high and low Common Stock prices by quarter were as follows:
1998 HIGH LOW
---- ------- ------
Fourth Quarter (since November $12.625 $12.00
12, 1998)
10
Holders of Common Stock are entitled to receive dividends when, as and if
declared by the Company's Board of Directors out of funds legally available
therefor. While the Company has declared dividends on its Common Stock since
1994, and paid quarterly dividends aggregating $0.20 per share in 1998, there is
no assurance that the Company will continue to pay dividends in the future.
The principal source of cash revenues to the Company is dividends paid by
the Bank with respect to the Bank's capital stock. There are certain
restrictions on the payment of such dividends imposed by federal and state
banking laws, regulations and authorities. See "MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" AND "BUSINESS -
SUPERVISION AND REGULATION - THE BANK".
The cash dividends paid per share (adjusted for a four for one stock split
effective September 10, 1998) by quarter were as follows:
1998 1997
------ ------
Fourth quarter............... $ 0.05 $0.05
Third quarter................ 0.05 0.05
Second quarter............... 0.05 0.05
First quarter................ 0.05 0.025
DESCRIPTION OF CAPITAL STOCK
The authorized capital stock of the Company consists of (i) 50,000,000
shares of Common Stock, $1.00 par value per share, of which 5,172,825 shares
were issued and outstanding as of December 31, 1998 and (ii) 20,000,000 shares
of preferred stock, $1.00 par value per share ("Preferred Stock"), none of which
were issued or outstanding as of December 31, 1998.
The following discussion of the terms and provisions of the Company's
capital stock is qualified in its entirety by reference to the Company's
Articles of Incorporation and Bylaws, copies of which have been filed as
exhibits to this Annual Report on Form 10-K:
COMMON STOCK: The holders of the Common Stock are entitled to one vote for
each share of Common Stock owned, except as expressly provided by law, and all
voting power is in the Common Stock. Holders of Common Stock may not cumulate
their votes for the election of directors. Holders of Common Stock do not have
preemptive rights to acquire any additional, unissued or treasury shares of the
Company, or securities of the Company convertible into or carrying a right to
subscribe for or acquire shares of the Company.
Holders of Common Stock will be entitled to receive dividends out of funds
legally available therefor, if and when properly declared by the Board of
Directors. However, the Board of Directors may not declare or pay cash dividends
on Common Stock, and no Common Stock may be purchased by the Company, unless
full dividends have been declared and paid on any outstanding Preferred Stock
for the current dividend period and, with respect to any outstanding cumulative
Preferred Stock, all past dividend periods. As of December 31, 1998, there was
no Preferred Stock issued or outstanding.
Upon the liquidation of the Company, the holders of Common Stock are
entitled to share pro rata in any distribution of the assets of the Company,
after the holders of shares of Preferred Stock have received the liquidation
preference of their shares plus any cumulated but unpaid dividends (whether or
not earned or declared), if any, and after all other indebtedness of the Company
has been retired.
11
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with the Consolidated Financial Statements of the Company and the
Notes thereto, appearing elsewhere in this Annual Report on Form 10-K, and the
information contained in "Management's Discussion and Analysis of Financial
Condition and Results of Operations." The Consolidated Balance Sheets as of
December 31, 1998 and 1997 and the Consolidated Statements of Income for each of
the years in the three-year period ended December 31, 1998 and the report
thereon of Deloitte & Touche LLP are included elsewhere in this document.
AS OF AND FOR THE YEARS ENDED DECEMBER 31,
----------------------------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(Dollars in thousands, except per share data)
INCOME STATEMENT DATA:
Interest income .......................... $ 23,422 $ 19,970 $ 16,841 $ 14,738 $ 12,644
Interest expense ......................... 10,128 9,060 7,923 6,904 5,363
-------- -------- -------- -------- --------
Net interest income .................... 13,294 10,910 8,918 7,834 7,281
Provision for credit losses .............. 239 190 230 175 188
-------- -------- -------- -------- --------
Net interest income after provision
for credit losses ..................... 13,055 10,720 8,688 7,659 7,093
Noninterest income ....................... 2,492 2,264 1,897 1,489 1,500
Noninterest expense ...................... 9,058 7,836 6,634 6,046 6,021
-------- -------- -------- -------- --------
Income before taxes .................... 6,489 5,148 3,951 3,102 2,572
Provision for income taxes ............... 2,029 1,586 1,240 781 609
-------- -------- -------- -------- --------
Net income ............................... $ 4,460 $ 3,562 $ 2,711 $ 2,321 $ 1,963
======== ======== ======== ======== ========
PER SHARE DATA(1):
Basic earnings per share ................. $ 1.08 $ 0.94 $ 0.77 $ 0.66 $ 0.56
Diluted earnings per share ............... 1.04 0.92 0.76 0.66 0.56
Book value ............................... 8.01 6.22 5.36 4.68 3.81
Tangible book value(2) ................... 6.14 4.81 4.21 3.95 3.02
Cash dividends declared .................. 0.20 0.15 0.10 0.10 0.07
Dividend payout ratio .................... 19.23% 15.96% 12.97% 15.14% 13.42%
Weighted average shares outstanding
(basic) (in thousands) ................. 4,116 3,778 3,513 3,514 3,514
Weighted average shares outstanding
(diluted) (in thousands) ............... 4,309 3,864 3,560 3,523 3,514
Shares outstanding at end of period
(in thousands) ......................... 5,173 3,990 3,510 3,514 3,514
BALANCE SHEET DATA:
Total assets ............................. $436,312 $320,143 $293,988 $233,492 $224,022
Securities ............................... 227,744 167,868 147,564 117,505 121,912
Loans .................................... 170,478 120,578 113,382 88,797 76,543
Allowance for credit losses .............. 1,850 1,016 923 753 588
Total deposits ........................... 390,659 291,516 270,866 214,534 207,543
Borrowings and notes payable ............. 2,437 2,800 3,267 1,517 2,275
Total shareholders' equity ............... 41,435 24,818 18,833 16,458 13,374
AVERAGE BALANCE SHEET DATA:
Total assets ............................. $354,851 $304,086 $257,205 $224,701 $214,318
Securities ............................... 178,416 157,677 127,607 119,857 125,585
Loans .................................... 143,196 117,586 104,534 81,631 69,200
Allowance for credit losses .............. 1,271 961 820 669 686
Total deposits ........................... 323,045 278,377 236,334 207,321 197,711
Total shareholders' equity ............... 27,933 21,821 17,646 14,916 13,109
(TABLE CONTINUED ON NEXT PAGE)
12
AS OF AND FOR THE YEARS ENDED DECEMBER 31,
--------------------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(Dollars in thousands, except per share data)
PERFORMANCE RATIOS:
Return on average assets ................................ 1.26% 1.17% 1.05% 1.03% 0.92%
Return on average equity ................................ 15.97 16.32 15.36 15.56 14.97
Net interest margin
(tax-equivalent)(3) ................................... 4.13 4.02 3.91 3.96 3.91
Efficiency ratio(4) ..................................... 57.38 59.48 61.34 64.85 68.56
ASSET QUALITY RATIOS(5):
Nonperforming assets to total loans and
other real estate ..................................... 0.08% 0.00% 0.00% 0.00% 0.02%
Net loan charge-offs to average loans ................... 0.05 0.08 0.06 0.01 0.48
Allowance for credit losses to total
loans ................................................. 1.09 0.84 0.81 0.85 0.77
Allowance for credit losses to
nonperforming loans(6) ................................ -- -- -- -- --
CAPITAL RATIOS(5):
Leverage ratio (quarterly average)....................... 7.58% 6.30% 5.45% 6.05% 5.39%
Average shareholders' equity to average
total assets .......................................... 7.87 7.18 6.86 6.64 6.12
Tier 1 risk-based capital ratio ......................... 18.02 14.94 13.11 14.99 13.75
Total risk-based capital ratio .......................... 19.08 15.73 13.89 15.79 14.37
- ----------
(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 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 net loan charge-offs to average loans and average
shareholders' equity to average total assets.
(6) Nonperforming loans consist of nonaccrual loans, loans contractually past
due 90 days or more and restructured loans.
13
SPECIAL CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS
Certain of the matters discussed in this document and in the documents
incorporated into this document by reference, including matters discussed under
the caption "Management's Discussion and Analysis of Financial Condition and
Results of Operations," may constitute forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995, and as such may
involve known and unknown risks, uncertainties and other factors which may cause
the actual results, performance or achievements of the Company to be materially
different from future results, performance or achievements expressed or implied
by such forward-looking statements. The words "expects," "estimates,"
"anticipates," "contemplated," "intends," "plans," " believes," "seek," "will,"
"would," "should," "projected" and similar expressions are intended to identify
such forward-looking statements
The Company's actual results or experience may differ materially from the
results anticipated in such forward-looking statements due to a variety of
factors, including, but not limited to: (1) the effects of future acquisitions,
if any; (2) the effects of future economic conditions on the Company and its
customers; (3) governmental monetary and fiscal policies, as well as legislative
and regulatory changes; (4) the risks of changes in interest rates on the level
and composition of deposits, loan demand and the values of loan collateral,
securities and interest rate protection agreements, as well as interest rate
risks; (5) the effects of competition from other commercial banks, thrifts,
mortgage banking firms, insurance companies, money market and other mutual funds
and other financial institutions operating in the Company's market areas and
elsewhere, including competitors offering banking products and services by mail,
telephone, computer and the Internet; (6) the failure of assumptions underlying
the establishment of reserves for loan losses and estimations of values of
collateral and various financial assets and liabilities and technological
changes, including "Year 2000" data systems compliance issues, are more
difficult or expensive than anticipated; and (7) other uncertainties set forth
in the Company's other public reports and filings and public statements. All
written or oral forward-looking statements attributable to the Company are
expressly qualified in their entirety by these cautionary statements.
14
ITEM 7. 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 the Company's balance sheets and
statements of income. This section should be read in conjunction with the
Company's financial statements and accompanying notes and other detailed
information appearing elsewhere in this Annual Report on Form 10-K.
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. Earnings growth from
1996 to 1997 and from 1997 to 1998 resulted principally from loan growth and
branch acquisitions, including the Union Acquisition. The Company 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 the years ended 1998, 1997 and 1996, respectively.
The Company 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. The Company's efficiency ratio was 57.38% in 1998,
59.48% in 1997, and 61.34% in 1996. The Company's 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 in each period resulting from branch
acquisitions and internal growth in 1996, 1997 and 1998. Loans were $170.5 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.
RESULTS OF OPERATIONS
NET INTEREST INCOME
Net interest income represents the amount by which interest income on
interest-earning assets, including securities and loans, exceeds interest
expense incurred on interest-bearing liabilities, including deposits and other
borrowed funds. Net interest income is the principal source of the Company's
earnings. Interest rate fluctuations, as well as changes in the amount and type
of earning assets and liabilities, combine to affect net interest income.
1998 VERSUS 1997. 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. Net interest income for the Company 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, the Company's cost
of funds decreased seven basis points from 4.11% to 4.04% while asset yields
increased eight basis points from 7.08% to 7.16%.
15
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.
YEARS ENDED DECEMBER 31,
-------------------------------------------------------------------------
1998 1997
---------------------------------- -------------------------------------
AVERAGE INTEREST AVERAGE AVERAGE INTEREST AVERAGE
OUTSTANDING EARNED/ YIELD/ OUTSTANDING EARNED/ YIELD/
BALANCE PAID RATE BALANCE PAID RATE
----------- --------- ------- ----------- --------- -------
(Dollars in thousands)
ASSETS
Interest-earning assets:
Loans .................................. $ 143,196 $ 12,282 8.58% $ 117,586 $ 10,205 8.68%
Securities(1) .......................... 178,416 10,834 6.07 157,677 9,572 6.07
Federal funds sold and other temporary
investments ............................ 6,676 306 4.58 3,545 193 5.44
----------- --------- ----------- ---------
Total interest-earning assets ......... 328,288 23,422 7.13% 278,808 19,970 7.16%
--------- ------- --------- -------
Less allowance for credit losses ....... (1,271) (961)
----------- -----------
Total interest-earning assets, net
of allowance ......................... 327,017 277,847
Noninterest-earning assets ............... 27,834 26,239
----------- -----------
Total assets .......................... $ 354,851 $ 304,086
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing liabilities:
Interest-bearing demand deposits ....... $ 41,710 $ 670 1.61% $ 42,898 $ 915 2.13%
Savings and money market accounts ...... 83,428 2,838 3.40 64,448 2,158 3.35
Certificates of deposit ................ 128,097 6,485 5.06 113,669 5,785 5.09
Federal funds purchased and other
borrowings ............................. 2,267 135 5.96 3,030 202 6.67
----------- --------- ----------- ---------
Total interest-bearing
liabilities .......................... 255,502 10,128 3.96% 224,045 9,060 4.04%
----------- --------- ------- ----------- --------- -------
Noninterest-bearing liabilities:
Noninterest-bearing demand deposits .... 69,810 57,362
Other liabilities ...................... 1,606 858
----------- ----------
Total liabilities ..................... 326,918 282,265
----------- ----------
Shareholders' equity ..................... 27,933 21,821
----------- ----------
Total liabilities and shareholders'
equity ............................... $ 354,851 $ 304,086
=========== ===========
Net interest rate spread ................. 3.17% 3.12%
======= =======
Net interest income and margin(2) ....... $ 13,294 4.05% $ 10,910 3.91%
========= ======= ========= =======
Net interest income and margin
(tax-equivalent basis)(3) ............... $ 13,571 4.13% $ 11,222 4.02%
========= ======= ========= =======
YEARS ENDED DECEMBER 31,
-------------------------------------
1996
-------------------------------------
AVERAGE INTEREST AVERAGE
OUTSTANDING EARNED/ YIELD/
BALANCE PAID RATE
----------- --------- -------
(Dollars in thousands)
ASSETS
Interest-earning assets:
Loans .................................. $ 104,534 $ 9,136 8.74%
Securities(1) .......................... 127,607 7,396 5.80
Federal funds sold and other temporary
investments ............................ 5,743 309 5.38
----------- ---------
Total interest-earning assets ......... 237,884 16,841 7.08%
--------- -------
Less allowance for credit losses ....... (820)
-----------
Total interest-earning assets, net
of allowance ......................... 237,064
Noninterest-earning assets ............... 20,141
-----------
Total assets .......................... $ 257,205
===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing liabilities:
Interest-bearing demand deposits ....... $ 35,285 $ 741 2.10%
Savings and money market accounts ...... 49,429 1,620 3.28
Certificates of deposit ................ 105,538 5,359 5.08
Federal funds purchased and other
borrowings ............................. 2,402 203 8.45%
----------- ---------
Total interest-bearing
liabilities .......................... 192,654 7.923 4.11%
----------- --------- -------
Noninterest-bearing liabilities:
Noninterest-bearing demand deposits .... 46,082
Other liabilities ...................... 823
-----------
Total liabilities ..................... 239,559
-----------
Shareholders' equity ..................... 17,646
-----------
Total liabilities and shareholders'
equity ............................... $ 257,205
===========
Net interest rate spread ................. 2.97%
=======
Net interest income and margin(2) ....... $ 8,918 3.75%
========= =======
Net interest income and margin
(tax-equivalent basis)(3) ............... $ 9,290 3.91%
========= =======
(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%.
16
The following schedule presents the dollar amount of changes in interest
income and interest expense for the major components of interest-earning assets
and interest-bearing liabilities and distinguishes between the increase related
to higher outstanding balances and the volatility of interest rates. For
purposes of this table, changes attributable to both rate and volume which can
not be segregated have been allocated to rate.
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)
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 in interest expense .......................... 1,294 (226) 1,068 1,119 18 1,137
------- ------- ------- ------- ------- -------
Increase (decrease) in net interest income ....................... $ 2,358 $ 26 $ 2,384 $ 1,648 $ 344 $ 1,992
======= ======= ======= ======= ======= =======
PROVISION FOR CREDIT LOSSES
Provisions for credit losses are charged to income to bring the Company's
allowance for credit losses to a level deemed appropriate by management based on
the factors discussed under "-Financial Condition - Allowance for Credit
Losses". The 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. The increased provision was
made by the Company in response to the increase in its loan portfolio, its
increased legal lending limit and the changing risk profile in its loan
portfolio. Net loans charged off in 1998 were $66,000 compared with $97,000 in
1997.
During 1997, the Company made provisions totaling $190,000 to the
allowance for credit losses, a decrease of $40,000 compared with 1996. The
Company recorded a lower provision in 1997 because it had specific reserves in
the amount of $45,000 which were no longer necessary due to the repayment of the
related loans. Net loans charged off in 1997 were $97,000, compared with $60,000
in loan charge-offs for 1996.
NONINTEREST INCOME
Noninterest income is an important source of revenue for financial
institutions. Service charges on deposit accounts are the largest component of
noninterest income and a significant source of revenue to the Company. 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 branch 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 from insufficient funds charges and customer service fees.
17
The following table presents for the periods indicated the major
categories of noninterest income:
YEARS ENDED DECEMBER 31,
------------------------------
1998 1997 1996
------ ------ ------
(Dollars in thousands)
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
====== ====== ======
NONINTEREST EXPENSE
For the years ended 1998, 1997 and 1996, noninterest expense totaled $9.1
million, $7.8 million and $6.6 million, respectively. The Company's efficiency
ratio showed a positive trend over this period, reflecting the Company's
continued success in controlling operating expenses and integrating its branch
acquisitions.
The following table presents for the periods indicated the major
categories of noninterest expense:
YEARS ENDED DECEMBER 31,
------------------------
1998 1997 1996
------ ------ ------
(Dollars in thousands)
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
====== ====== ======
In 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
$325,000 or 22.5% compared with $1.4 million in 1997. These increases were
principally due to branch 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 branch acquisitions. Salaries and employee benefits in 1997
increased by 16.2% from $3.4 million to $4.0 million. The increase was
principally due to additional staff associated with the Union and Angleton
acquisitions.
INCOME TAXES
Income tax expense includes the regular federal income tax at the
statutory rate plus the income tax component of the Texas franchise tax. The
amount of federal income tax expense is influenced by the amount of taxable
income, the amount of tax-exempt income, the amount of nondeductible interest
expense and the amount of other nondeductible expenses. Taxable income for the
income tax component of the Texas franchise tax is the federal pretax income,
plus certain officers' salaries, less interest income on federal securities. The
income tax component of the Texas franchise tax was zero in the years of 1998
and 1997. In 1998, income tax expense was $2.0 million compared with $1.6
million for 1997. The effective tax rate in the years ended 1998 and 1997 was
31.3% and 30.8%, respectively.
18
IMPACT OF INFLATION
The effects of inflation on the local economy and on the Company's
operating results have been relatively modest for the past several years. Since
substantially all of the Company's assets and liabilities are monetary in
nature, such as cash, securities, loans and deposits, their values are less
sensitive to the effects of inflation than to changing interest rates, which do
not necessarily change in accordance with inflation rates. The Company tries to
control the impact of interest rate fluctuations by managing the relationship
between its interest rate sensitive assets and liabilities. See "Financial
Condition - Interest Rate Sensitivity and Liquidity."
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. One-to-four 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 spread
between real estate and agriculture loans.
The following table summarizes as of the dates indicated the loan
portfolio of the Company by type of loan:
DECEMBER 31,
--------------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
----------------- ----------------- ----------------- ----------------- ------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
-------- ------- -------- ------- -------- ------- -------- ------- -------- -------
(Dollars in thousands)
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 ....... 88,139 51.7 53,625 44.5 49,845 44.0 40,331 45.4 37,247 48.7
Commercial mortgages ......... 22,240 13.1 16,277 13.5 14,376 12.7 12,335 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%
======== ===== ======== ===== ======== ===== ======== ===== ======== ======
The lending focus of the Company is on one-to-four family residential,
agricultural, small and medium-sized business and consumer loans. The Company
offers a variety of commercial lending products including term loans and lines
of credit. A broad range of short to medium-term commercial loans, primarily
collateralized, are made available to businesses for working capital (including
inventory and receivables), business expansion (including acquisitions of real
estate and improvements) and the purchase of equipment and machinery.
Historically, the Company has originated loans for its own account and has not
securitized its loans. The purpose of a particular loan generally determines its
structure. All loans in the one-to-four family residential category were
originated by the Company.
Loans from $200,000 to $500,000 are evaluated and acted upon by an
officers' loan committee, which meets weekly. Loans above that amount must be
approved by the Directors Loan Committee, which meets monthly.
Generally, the Company's commercial loans are made in the Company's
primary market area and are underwritten on the basis of the borrower's ability
to service such debt from income. As a general practice, the Company takes as
collateral a lien on any available real estate, equipment or other assets owned
by the borrower and obtains a personal guaranty of the borrower. Working capital
loans are primarily collateralized by short-term assets whereas term loans are
primarily collateralized by long-term assets. As a result, commercial loans
involve additional complexities, variables and risks and require more thorough
underwriting and servicing than other types of loans.
19
In addition to commercial loans secured by real estate, the Company makes
commercial mortgage loans to finance the purchase of real property which
generally consists of real estate with completed structures. The Company's
commercial mortgage loans are secured by first liens on real estate, typically
have variable interest rates and amortize over a ten to 15 year period. Payments
on loans secured by such properties are often dependent on the successful
operation or management of the properties. Accordingly, repayment of these loans
may be subject to adverse conditions in the real estate market or the economy to
a greater extent than other types of loans. The Company seeks to minimize these
risks in a variety of ways, including giving careful consideration to the
property's operating history, future operating projections, current and
projected occupancy, location and physical condition in connection with
underwriting these loans. The underwriting analysis also includes credit
verification, appraisals and a review of the financial condition of the
borrower.
Additionally, a portion of the Company's lending activity has consisted of
the origination of one-to-four family residential mortgage loans collateralized
by owner-occupied properties located in the Company's market areas. The Company
offers a variety of mortgage loan products which generally are amortized over
five to 25 years. Loans collateralized by one-to-four family residential real
estate generally have been originated in amounts of no more than 89% of
appraised value or have mortgage insurance. The Company requires mortgage title
insurance and hazard insurance.
The Company makes loans to finance the construction of residential and, to
a limited extent, nonresidential properties. Construction loans generally are
secured by first liens on real estate and have floating interest rates. The
Company conducts periodic inspections, either directly or through an agent,
prior to approval of periodic draws on these loans. Underwriting guidelines
similar to those described above are also used in the Company's construction
lending activities. In keeping with the community-oriented nature of its
customer base, the Company provides construction and permanent financing for
churches located within its market area. Construction loans involve additional
risks attributable to the fact that loan funds are advanced upon the security of
a project under construction, and the project is of uncertain value prior to its
completion. Because of uncertainties inherent in estimating construction costs,
the market value of the completed project and the effects of governmental
regulation on real property, it can be difficult to accurately evaluate the
total funds required to complete a project and the related loan to value ratio.
As a result of these uncertainties, construction lending often involves the
disbursement of substantial funds with repayment dependent, in part, on the
success of the ultimate project rather than the ability of a borrower or
guarantor to repay the loan. If the Company is forced to foreclose on a project
prior to completion, there is no assurance that the Company will be able to
recover all of the unpaid portion of the loan. In addition, the Company may be
required to fund additional amounts to complete a project and may have to hold
the property for an indeterminable period of time. While the Company has
underwriting procedures designed to identify what it believes to be acceptable
levels of risks in construction lending, no assurance can be given that these
procedures will prevent losses from the risks described above.
Consumer loans made by the Company include direct "A"-credit automobile
loans, recreational vehicle loans, boat loans, home improvement loans, home
equity loans, personal loans (collateralized and uncollateralized) and deposit
account collateralized loans. The terms of these loans typically range from 12
to 120 months and vary based upon the nature of collateral and size of loan.
Consumer loans entail greater risk than do residential mortgage loans,
particularly in the case of consumer loans that are unsecured or secured by
rapidly depreciating assets such as automobiles. In such cases, any repossessed
collateral for a defaulted consumer loan may not provide an adequate source of
repayment for the outstanding loan balance. The remaining deficiency often does
not warrant further substantial collection efforts against the borrower beyond
obtaining a deficiency judgment. In addition, consumer loan collections are
dependent on the borrower's continuing financial stability, and thus are more
likely to be adversely affected by job loss, divorce, illness or personal
bankruptcy. Furthermore, the application of various federal and state laws may
limit the amount which can be recovered on such loans.
The Company provides agricultural loans for short-term crop production,
farm equipment financing and agricultural real estate financing. The Company
evaluates agricultural borrowers primarily based on their historical
profitability, level of experience in their particular agricultural industry,
overall financial capacity and the availability of secondary collateral to
withstand economic and natural variations common to the industry. Because
agricultural loans present a higher level of risk associated with events caused
by nature, the Company routinely makes on-site visits and inspections in order
to monitor and identify such risks.
20
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:
DECEMBER 31, 1998
-------------------------------------
AFTER ONE AFTER
ONE YEAR THROUGH FIVE
OR LESS FIVE YEARS YEARS TOTAL
------- ---------- ------- -------
(Dollars in thousands)
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
======= ======= ======= =======
The Company has 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 the Company will be unable to collect the scheduled payments of principal
or interest when due according to the contractual terms of the loan agreement.
The fair value of impaired loans is based on 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 affect on the Company's financial statements.
NONPERFORMING ASSETS
The Company has several procedures in place to assist it in maintaining
the overall quality of its loan portfolio. The Company has established
underwriting guidelines to be followed by its officers. The Company also
monitors its delinquency levels for any negative or adverse trends. There can be
no assurance, however, that the Company's loan portfolio will not become subject
to increasing pressures from deteriorating borrower credit due to general
economic conditions.
The Company requires appraisals on loans secured by real estate. With
respect to potential problem loans, an evaluation of the borrower's overall
financial condition is made to determine the need, if any, for possible
write-downs or appropriate additions to the allowance for credit losses.
The Company generally places a loan on nonaccrual status and ceases
accruing interest when the payment of principal or interest is delinquent for 90
days, or earlier in some cases, unless the loan is in the process of collection
and the underlying collateral fully supports the carrying value of the loan. The
Company generally charges off all loans before attaining nonaccrual status.
The Company's conservative lending approach, as well as a healthy local
economy, has resulted in strong asset quality. The Company had nonperforming
assets of $140,000 on December 31, 1998 and no nonperforming assets as of
December 31, 1997 or 1996.
21
The following table presents information regarding nonperforming assets at
the dates indicated:
DECEMBER 31,
---------------------------------------------
1998 1997 1996 1995 1994
------ ------ ------ ------ -----
(Dollars in thousands)
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%
ALLOWANCE FOR CREDIT LOSSES
The allowance for credit losses is a reserve established through charges
to earnings in the form of a provision for credit losses. Management has
established an allowance for credit losses which it believes is adequate for
estimated losses in the Company's loan portfolio. Based on an evaluation of the
loan portfolio, management presents a monthly review of the allowance for credit
losses to the Bank's Board of Directors, indicating any change in the allowance
since the last review and any recommendations as to adjustments in the
allowance. In making its evaluation, management considers the diversification by
industry of the Company's commercial loan portfolio, the effect of changes in
the local real estate market on collateral values, the results of recent
regulatory examinations, the effects on the loan portfolio of current economic
indicators and their probable impact on borrowers, the amount of charge-offs for
the period, the amount of nonperforming loans and related collateral security,
the evaluation of its loan portfolio by the loan review function and the annual
examination of the Company's financial statements by its independent auditors.
Charge-offs occur when loans are deemed to be uncollectible.
Although the Company does not determine the total allowance based upon the
amount of loans in a particular type or category, risk elements attributable to
particular loan types or categories are considered in assessing the quality of
individual loans. These risk elements include, but are not limited to, the
following: (i) in the case of single family residential real estate loans, the
borrower's ability to repay the loan, including debt to income ratio and
employment and income stability, the loan to value ratio, and the age, condition
and marketability of collateral; (ii) for non-farm non-residential loans and
multifamily residential loans, the debt service coverage ratio (income from the
property in excess of operating expenses compared to loan payment requirements),
operating results of the owner in the case of owner-occupied properties, the
loan to value ratio, the age and condition of the collateral and the volatility
of income, property value and future operating results typical of properties of
that type; (iii) for agricultural real estate loans, the experience and
financial capability of the borrower, projected debt service coverage of the
operations of the borrower and loan to value ratio; (iv) for construction and
land development loans, the perceived feasibility of the project including the
ability to sell developed lots or improvements constructed for resale or ability
to lease property constructed for lease, the quality and nature of contracts for
presale or preleasing, if any, experience and ability of the developer and loan
to value ratio; (v) for commercial and industrial loans, the operating results
of the commercial, industrial or professional enterprise, the borrower's
business, professional and financial ability and expertise, the specific risks
and volatility of income and operating results typical for businesses in that
category and the value, nature and marketability of collateral; and (vi) for
non-real estate agricultural loans, the operating results, experience and
financial capability of the borrower, historical and expected market conditions
and the value, nature and marketability of collateral. In addition, for each
category, the Company considers secondary sources of income and the financial
strength and credit history of the borrower and any guarantors.
The Company follows a loan review program to evaluate the credit risk in
the loan portfolio. Through the loan review process, the Company maintains an
internally classified loan list which, along with the delinquency list of loans,
helps management assess the overall quality of the loan portfolio and the
adequacy of the allowance for credit losses. Loans classified as "substandard"
are those loans with clear and defined weaknesses such as a highly-leveraged
position, unfavorable financial ratios, uncertain repayment sources or poor
financial condition, which may jeopardize recoverability of the debt. Loans
classified as "doubtful" are those loans which have characteristics similar to
substandard accounts but with an increased risk that a loss may occur, or at
least a portion of the loan may require a charge-off if liquidated at present.
Loans classified as "loss" are those loans which are in the process of being
charged off.
In addition to the internally classified loan list and delinquency list of
loans, the Company maintains a separate "watch list" which further aids the
Company in monitoring loan portfolios. Watch list loans have one or more
deficiencies that require attention in
22
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. The Company
reviews these loans to assist in assessing the adequacy of the allowance for
credit losses.
In order to determine the adequacy of the allowance for credit losses,
management considers the risk classification or delinquency status of loans and
other factors, such as collateral value, portfolio composition, trends in
economic conditions and the financial strength of borrowers. Management
establishes specific allowances for loans which management believes require
reserves greater than those allocated according to their classification or
delinquent status. An unallocated allowance is also established based on the
Company's historical charge-off experience. The Company then charges to
operations a provision for credit losses to maintain the allowance for credit
losses at an adequate level determined by the foregoing methodology.
For the year ended 1998, net charge-offs totaled $66,000 or 0.05% of
average loans outstanding for the period, compared with $97,000 or 0.08% in net
charge-offs during 1997. The Company's net charge-offs totaled $60,000 or 0.06%
of average loans outstanding in 1996. During 1998, the Company 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.
The Company 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:
YEARS ENDED DECEMBER 31,
-----------------------------------------------------------------
1998 1997 1996 1995 1994
--------- --------- --------- --------- ---------
(Dollars in thousands)
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 88
Charge-offs:
Commercial and industrial ................. (0) (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 ............... 0 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 ....................... -- -- -- -- --
23
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.
DECEMBER 31,
------------------------------------------
1998 1997
------------------- ---------------------
PERCENT OF PERCENT OF
LOANS TO LOANS TO
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS
------ ----------- ------ -----------
(Dollars in thousands)
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%
====== ===== ====== =====
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)
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%
==== ===== ==== ===== ==== =====
The Company believes that the allocation of its allowance for credit
losses is reasonable. Where management is able to identify specific loans or
categories of loans where specific amounts of reserve are required, allocations
are assigned to those categories. Federal and state bank regulators also require
that a bank maintain a reserve that is sufficient to absorb an estimated amount
of unidentified potential losses based on management's perception of economic
conditions, loan portfolio growth, historical charge-off experience and exposure
concentrations. While the Company's recent rate of charge-offs is low,
management is aware that the Company has been operating in an extremely
beneficial economic environment. Management of the Company, along with a number
of economists, has perceived during the past year an increasing instability in
the national and Texas economies and a worldwide economic slowdown that could
contribute to job losses and otherwise adversely affect a broad variety of
business sectors. In addition, as the Company has grown, its aggregate loan
portfolio has increased and since the Company has made a decision to diversify
its loan portfolio into areas other than single family mortgage loans, the risk
profile of the Company's loans has increased. By virtue of its increased capital
levels, the Company is able to make larger loans, thereby increasing the
possibility of one bad loan having a larger adverse impact than before.
Accordingly, management believes that the maintenance of an unallocated reserve
in the current amount is prudent and consistent with regulatory requirements.
24
The Company believes that the allowance for credit losses at December 31,
1998 is adequate to cover losses inherent in the portfolio as of such date.
There can be no assurance, however, that the Company will not sustain losses in
future periods, which could be substantial in relation to the size of the
allowance at December 31, 1998.
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):
DECEMBER 31,
------------------------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(Dollars in thousands)
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
======== ======== ======== ======== ========
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):
DECEMBER 31, 1998
---------------------------------------------------------------------------------------------
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 TOTAL YIELD
-------- ----- -------- ----- -------- ----- -------- ----- -------- ----
(Dollars in thousands)
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%
======== ==== ======== ==== ======== ==== ======== ==== ======== ====
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 be 7.52%.
The following table summarizes the carrying value by classification of
securities as of the dates shown:
DECEMBER 31,
----------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(Dollars in thousands)
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
======== ======== ======== ======== ========
At December 31, 1998, securities totaled $227.7 million, an increase of
$59.9 million from $167.9 million at December 31, 1997, since the Company
invested excess deposits from the Union acquisition. At December 31, 1998,
securities represented 56.7% of total deposits and 52.2% of total assets.
Securities increased from $147.6 million at December 31, 1996 to $167.9
million at December 31, 1997 since the Company invested excess deposits from
branch acquisitions.
25
The following tables present the amortized cost and fair value of
securities classified as available-for-sale at December 31, 1998 and 1997:
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)
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
Collateralized mortgage obligations ..... 10,832 166 26 10,972 -- -- -- --
States and political subdivisions ....... 4,026 239 -- 4,265 1,363 102 -- 1,465
--------- ---------- ---------- -------- --------- ---------- ---------- --------
Total ................................ $ 113,300 $ 788 $ 260 $113,828 $ 38,650 $ 220 $ 258 $ 38,612
========= ========== ========== ======== ========= ========== ========== ========
The following tables present the amortized cost and fair value of securities
classified as held-to-maturity at December 31, 1998 and 1997:
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)
VALUE
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 ....... 15,022 376 3 15,395 10,465 141 1 10,605
Collateralized mortgage obligations ..... 2,081 -- 3 2,078 8,749 19 15 8,753
--------- ---------- ---------- -------- --------- ---------- ---------- --------
Total ................................ $ 113,916 $ 1,213 $ 108 $115,021 $ 129,256 $ 777 259 $129,774
========= ========== ========== ======== ========= ========== ========== ========
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 December 31, 1998, 45.5% of the mortgage-backed securities held by the
Company had contractual final maturities of more than ten years with a weighted
average life of 4.6 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.
The Company has adopted SFAS No. 115, ACCOUNTING FOR CERTAIN INVESTMENTS
IN DEBT AND EQUITY SECURITIES. At the date of purchase, the Company is required
to classify debt and equity securities into one of three categories:
held-to-maturity, trading or available-for-sale. At each reporting date, the
appropriateness of the classification is reassessed. Investments in debt
securities are classified as held-to-maturity and measured at amortized cost in
the financial statements only if management has the positive intent and ability
to hold those securities to maturity. Securities that are bought and held
principally for the purpose of selling them in the near term are classified as
trading and measured at fair value in the financial statements with unrealized
gains and losses included in earnings. Investments not classified as either
held-to-maturity or trading are classified as available-for-sale and measured at
fair value in the financial statements with unrealized gains and losses
reported, net of tax, in a separate component of shareholders' equity until
realized.
26
DEPOSITS
The Company offers a variety of deposit accounts having a wide range of
interest rates and terms. The Company's deposits consist of demand, savings,
money market and time accounts. The Company relies primarily on competitive
pricing policies and customer service to attract and retain these deposits. The
Company does not have or accept any brokered 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 the Union acquisition in the fourth quarter of 1998 and internal
growth. 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:
YEARS ENDED DECEMBER 31,
-----------------------------------------------------
1998 1997 1996
--------------- --------------- ---------------
AMOUNT RATE AMOUNT RATE AMOUNT RATE
-------- ---- -------- ---- -------- ----
(Dollars in thousands)
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%
======== ==== ======== ==== ======== ====
The following table sets forth the amount of the Company's certificates of
deposit that are $100,000 or greater by time remaining until maturity:
DECEMBER 31, 1998
--------------------
(Dollars in thousands)
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 ....................................... $ 42,831
====================
OTHER BORROWINGS
Deposits are the primary source of funds for the Company's lending and
investment activities. Occasionally, the Company obtains additional funds from
the Federal Home Loan Bank ("FHLB") and correspondent banks. At December 31,
1998, the Company had borrowings of $2.4 million compared to $2.8 million at
December 31, 1997 and zero at December 31, 1996.
At December 31, 1998 and 1997, the Company had no outstanding borrowings
under a revolving line of credit extended by a commercial bank.
INTEREST RATE SENSITIVITY AND LIQUIDITY
The Company's Asset Liability and Funds Management Policy provides
management with the necessary guidelines for effective funds management, and the
Company has established a measurement system for monitoring its net interest
rate sensitivity position. The Company manages its sensitivity position within
established guidelines.
27
Interest rate risk is managed by the Asset Liability Committee ("ALCO"),
which is composed of senior officers of the Company, in accordance with policies
approved by the Company's Board of Directors. The ALCO formulates strategies
based on appropriate levels of interest rate risk. In determining the
appropriate level of interest rate risk, the ALCO considers the impact on
earnings and capital of the current outlook on interest rates, potential changes
in interest rates, regional economies, liquidity, business strategies and other
factors. The ALCO meets regularly to review, among other things, the sensitivity
of assets and liabilities to interest rate changes, the book and market values
of assets and liabilities, unrealized gains and losses, purchase and sale
activities, commitments to originate loans and the maturities of investments and
borrowings. Additionally, the ALCO reviews liquidity, cash flow flexibility,
maturities of deposits and consumer and commercial deposit activity. Management
uses two methodologies to manage interest rate risk: (i) an analysis of
relationships between interest-earning assets and interest-bearing liabilities;
and (ii) an interest rate shock simulation model. The Company has traditionally
managed its business to reduce its overall exposure to changes in interest
rates.
The Company manages its exposure to interest rates by structuring its
balance sheet in the ordinary course of business. The Company does not enter
into instruments such as leveraged derivatives, interest rate swaps, financial
options, financial future contracts or forward delivery contracts for the
purpose of reducing interest rate risk.
An interest rate sensitive asset or liability is one that, within a
defined time period, either matures or experiences an interest rate change in
line with general market interest rates. The management of interest rate risk is
performed by analyzing the maturity and repricing relationships between
interest-earning assets and interest-bearing liabilities at specific points in
time ("GAP") and by analyzing the effects of interest rate changes on net
interest income over specific periods of time by projecting the performance of
the mix of assets and liabilities in varied interest rate environments. Interest
rate sensitivity reflects the potential effect on net interest income of a
movement in interest rates. A company is considered to be asset sensitive, or
having a positive GAP, when the amount of its interest-earning assets maturing
or repricing within a given period exceeds the amount of its interest-bearing
liabilities also maturing or repricing within that time period. Conversely, a
company is considered to be liability sensitive, or having a negative GAP, when
the amount of its interest-bearing liabilities maturing or repricing within a
given period exceeds the amount of its interest-earning assets also maturing or
repricing within that time period. During a period of rising interest rates, a
negative GAP would tend to affect net interest income adversely, while a
positive GAP would tend to result in an increase in net interest income. During
a period of falling interest rates, a negative GAP would tend to result in an
increase in net interest income, while a positive GAP would tend to affect net
interest income adversely.
28
The following tables set forth an interest rate sensitivity analysis for
the Company at December 31, 1998:
AT DECEMBER 31, 1998
VOLUMES SUBJECT TO REPRICING WITHIN
------------------------------------------------------------------------
0-30 31-180 181-365 AFTER
DAYS DAYS DAYS ONE YEAR TOTAL
--------- --------- --------- --------- ---------
(Dollars in thousands)
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 ................................ 17,112 74,756 47,428 21,814 161,110
Federal funds purchased and FHLB
advances ..................................... 2,435 -- -- -- 2,435
--------- --------- --------- --------- ---------
Total interest-bearing liabilities ....... 164,160 74,756 47,428 21,814 308,158
--------- --------- --------- --------- ---------
Period GAP ............................... $(108,407) $ (14,174) $ 14,431 $ 197,785 $ 89,635
Cumulative GAP ........................... $(108,407) $(122,581) $(108,150) $ 89,635 --
Period GAP to total assets ............... (24.85)% (3.25)% 3.31% 45.33% --
Cumulative GAP to total assets ........... (24.85)% (28.09)% (24.79)% 20.54% --
Shortcomings are inherent in any GAP analysis since certain assets and
liabilities may not move proportionally as interest rates change. In addition to
GAP analysis, the Company uses an interest rate risk simulation model and shock
analysis to test the interest rate sensitivity of net interest income and the
balance sheet, respectively. Contractual maturities and repricing opportunities
of loans are incorporated in the model as are prepayment assumptions, maturity
data and call options within the investment portfolio. Assumptions based on past
experience are incorporated into the model for nonmaturity deposit accounts.
Based on the Company's December 31, 1998 simulation analysis, the Company
estimates that a 200 basis point rise or decline in rates over the next 12 month
period would have an impact of less than 5% on its net interest income for the
period. The change is relatively small, despite the Company's liability
sensitive GAP position. The results are primarily from the behavior of demand,
money market and savings deposits. The Company has found that historically
interest rates on these deposits change more slowly in a rising rate environment
than in a declining rate environment. This assumption is incorporated into the
simulation model and is generally not fully reflected in a GAP analysis. The
Company maintains an Investment Committee that reviews the Company's interest
rate risk position, generally on a quarterly basis.
As a financial institution, the Company's primary component of market risk
is interest rate volatility. Fluctuations in interest rates will ultimately
impact both the level of income and expense recorded on most of the Company's
assets and liabilities, and the market value of all interest-earning assets and
interest-bearing liabilities, other than those which have a short term to
maturity. Based upon the nature of the Company's operations, the Company is not
subject to foreign exchange or commodity price risk. The Company does not own
any trading assets.
The Company's exposure to market risk is reviewed on a regular basis.
Interest rate risk is the potential of economic losses due to future interest
rate changes. These economic losses can be reflected as a loss of future net
interest income and/or a loss of current fair market values. The objective is to
measure the effect on net interest income and to adjust the balance sheet to
minimize the inherent risk while at the same time maximizing income. Management
realizes certain risks are inherent, and that the goal is to identify and accept
the risks.
Liquidity involves the Company's ability to raise funds to support asset
growth or reduce assets to meet deposit withdrawals and other payment
obligations, to maintain reserve requirements and otherwise to operate the
Company on an ongoing basis. During the past three years, the Company's
liquidity needs have primarily been met by growth in core deposits, as
previously discussed. Although access to purchased funds from correspondent
banks is available and has been utilized on occasion to take advantage of
investment opportunities, the Company does not generally rely on these external
funding sources. The cash and federal funds sold position, supplemented by
amortizing investment and loan portfolios, have generally created an adequate
liquidity position.
29
CAPITAL RESOURCES
Capital management consists of providing equity to support both current
and future operations. The Company is subject to capital adequacy requirements
imposed by the Federal Reserve Board and the Bank is subject to capital adequacy
requirements imposed by the FDIC and the Texas Banking Department. Both the
Federal Reserve Board and the FDIC have adopted risk-based capital requirements
for assessing bank holding company and bank capital adequacy. These standards
define capital and establish minimum capital requirements in relation to assets
and off-balance sheet exposure, adjusted for credit risk. The risk-based capital
standards currently in effect are designed to make regulatory capital
requirements more sensitive to differences in risk profiles among bank holding
companies and banks, to account for off-balance sheet exposure and to minimize
disincentives for holding liquid assets. Assets and off-balance sheet items are
assigned to broad risk categories, each with appropriate relative risk weights.
The resulting capital ratios represent capital as a percentage of total
risk-weighted assets and off-balance sheet items.
The risk-based capital standards issued by the Federal Reserve Board
require all bank holding companies to have "Tier 1 capital" of at least 4.0% and
"total risk-based" capital (Tier 1 and Tier 2) of at least 8.0% of total
risk-adjusted assets. "Tier 1 capital" generally includes common shareholders'
equity and qualifying perpetual preferred stock together with related surpluses
and retained earnings, less deductions for goodwill and various other
intangibles. "Tier 2 capital" may consist of a limited amount of
intermediate-term preferred stock, a limited amount of term subordinated debt,
certain hybrid capital instruments and other debt securities, perpetual
preferred stock not qualifying as Tier 1 capital, and a limited amount of the
general valuation allowance for loan losses. The sum of Tier 1 capital and Tier
2 capital is "total risk-based capital."
The Federal Reserve Board has also adopted guidelines which supplement the
risk-based capital guidelines with a minimum ratio of Tier 1 capital to average
total consolidated assets ("leverage ratio") of 3.0% for institutions with well
diversified risk, including no undue interest rate exposure; excellent asset
quality; high liquidity; good earnings; and that are generally considered to be
strong banking organizations, rated composite 1 under applicable federal
guidelines, and that are not experiencing or anticipating significant growth.
Other banking organizations are required to maintain a leverage ratio of at
least 4.0% to 5.0%. These rules further provide that banking organizations
experiencing internal growth or making acquisitions will be expected to maintain
capital positions substantially above the minimum supervisory levels and
comparable to peer group averages, without significant reliance on intangible
assets.
Pursuant to FDICIA, each federal banking agency revised its risk-based
capital standards to ensure that those standards take adequate account of
interest rate risk, concentration of credit risk and the risks of nontraditional
activities, as well as reflect the actual performance and expected risk of loss
on multifamily mortgages. The Bank is subject to capital adequacy guidelines of
the FDIC that are substantially similar to the Federal Reserve Board's
guidelines. Also pursuant to FDICIA, the FDIC has promulgated regulations
setting the levels at which an insured institution such as the Bank would be
considered "well capitalized," "adequately capitalized," "undercapitalized,"
"significantly undercapitalized" and "critically undercapitalized." Under the
FDIC's regulations, the Bank is classified "well capitalized" for purposes of
prompt corrective action. SEE "BUSINESS - SUPERVISION AND REGULATION - THE
COMPANY" AND " - THE BANK."
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%. This
increase was primarily the result of net income of $4.5 million plus proceeds of
the Company`s initial public offering of $12.8 million, offset by dividends paid
on the Common Stock of $1.1 million and expenses of the public offering of
$356,000. During 1997, shareholders' equity increased by $6.0 million or 31.9%
from $18.8 million at December 31, 1996.
30
The following table provides a comparison of the Company's and the Bank's
leverage and risk-weighted capital ratios as of December 31, 1998 to the minimum
and well capitalized regulatory standards:
TO BE WELL CAPITALIZED
MINIMUM REQUIRED UNDER PROMPT
FOR CAPITAL CORRECTIVE ACTION ACTUAL RATIO AT
ADEQUACY PURPOSES PROVISIONS DECEMBER 31, 1998
----------------- ---------------------- -----------------
THE COMPANY
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%
THE BANK
Leverage ratio ....................................... 3.00%(2) 5.00% 4.99%
Tier 1 risk-based capital ratio ...................... 4.00% 6.00% 11.87%
Risk-based capital ratio ............................. 8.00% 10.00% 12.93%
(1) The Federal Reserve Board may require the Company to maintain a leverage
ratio of up to 200 basis points above the required minimum.
(2) The FDIC may require the Bank to maintain a leverage ratio of up to 200
basis points above the required minimum.
YEAR 2000 COMPLIANCE
GENERAL. The Year 2000 risk involves computer programs and computer
software that are not able to perform without interruption into the Year 2000.
If computer systems do not correctly recognize the date change from December 31,
1999 to January 1, 2000, computer applications that rely on the date field could
fail or create erroneous results. Such erroneous results could affect interest,
payment or due dates or cause the temporary inability to process transactions,
send invoices or engage in similar normal business activities. If these issues
are not addressed by the Company, its suppliers and its borrowers, there could
be a materially adverse impact on the Company's financial condition or results
of operations.
STATE OF READINESS. The Company formally initiated its Year 2000 project
and plan in November 1997 to insure that its operational and financial systems
will not be adversely affected by Year 2000 problems. The Company has formed a
Year 2000 project team and the Board of Directors and management are supporting
all compliance efforts and allocating the necessary resources to ensure
completion. An inventory of all systems and products (including both information
technology ("IT") and non-informational technology ("non-IT") systems) that
could be affected by the Year 2000 date change has been developed, verified and
categorized as to its importance to the Company and an assessment of all major
IT and critical non-IT systems has been completed. This assessment involved
inputting test data which simulates the Year 2000 date change into such IT
systems and reviewing the system output for accuracy. The Company's assessment
of critical non-IT systems involved reviewing such systems to determine whether
they were date dependent. Based on such assessment, the Company believes that
none of its critical non-IT systems are date dependent. The software for the
Company's systems is provided through service bureaus and software vendors. The
Company has contacted all of its third party vendors and software providers and
is requiring them to demonstrate and represent that the products provided are or
will be Year 2000 compliant and has planned a program of testing compliance. The
Company's service bureau, which performs substantially all of the Company's data
processing functions, has warranted in writing that its software is Year 2000
compliant and pursuant to applicable regulatory guidelines the Company is has
reviewed the results of user group tests performed by the service provider to
verify this assertion. The Company believes it would have recourse against the
service provider for actual damages incurred by the Company in the event the
service provider breaches this warranty. In addition, the Company's compliance
with Year 2000 issues has been reviewed by the FDIC in 1998.
Except as discussed above, the Company has completed the following phases
of its Year 2000 plan: (i) recognizing Year 2000 issues, (ii) assessing the
impact of Year 2000 issues on the Company's critical systems and (iii) upgrading
systems as necessary to resolve those Year 2000 issues which have been
identified. The Company is in the final stages of testing and implementing those
systems that have been upgraded.
COSTS OF COMPLIANCE. Management does not expect the costs of bringing the
Company's systems into Year 2000 compliance will have a materially adverse
effect on the Company's financial conditions, results of operations or
liquidity. The Company has budgeted $10,000 to address Year 2000 issues. As of
December 31, 1998, the Company has not incurred any significant costs in
relation to Year 2000. The largest potential risk to the Company concerning Year
2000 is the malfunction of its data processing system. In the event its data
processing system does not function properly, the Company is prepared to perform
functions manually.
31
The Company believes it is in compliance with regulatory guidelines regarding
Year 2000 compliance, including the timetable for achieving compliance.
RISKS RELATED TO THIRD PARTIES. The impact of Year 2000 non-compliance by
third parties with which the Company transacts business cannot be accurately
gauged. The Company identified its largest dollar deposit (aggregate deposits
over $500,000) and loan ($250,000 or more) customers and, based on information
available to the Company, conducted a preliminary evaluation to determine which
of those customers are likely to be affected by Year 2000 issues. The Company
then surveyed those customers deemed at risk to determine their readiness with
respect to Year 2000 issues, including their awareness of Year 2000 issues,
plans to address such issues and progress with respect to such plans. The survey
included approximately 71% of all depositors with average balances of $500,000
or greater, which is approximately 10% of its total dollar deposit base, and
approximately 53% of its borrowers of $250,000 or more, which is approximately
13% of its total dollar loan base. As of the date hereof, all but two customers
have responded to the survey. The responses show that the customers are aware of
Year 2000 issues and are in the process of updating their systems and have
informed the Company that they believe they will be ready for the Year 2000 date
change by the end of 1999. The Company will continue to review such responses
and will encourage customers to resolve any identified problems. To the extent a
problem is identified, the Company intends to monitor the customer's progress in
resolving such problem. In the event that Year 2000 noncompliance adversely
affects a borrower, the Company may be required to charge-off the loan to that
borrower. For a discussion of possible effects of such charge-offs, see "-
Contingency Plans" below. In the event that Year 2000 noncompliance causes a
depositor to withdraw funds, the Company plans to maintain additional cash on
hand. The Company relies on the Federal Reserve for electronic fund transfers
and check clearing and understands that the Federal Reserve expects its systems
to be Year 2000 compliant by the end of 1998. With respect to its borrowers, the
Company includes in its loan documents a Year 2000 disclosure form and an
addendum to the loan agreement in which the borrower represents and warrants its
Year 2000 compliance to the Company.
CONTINGENCY PLANS. The Company has finalized its contingency planning with
respect to the Year 2000 date change and believes that if its own systems should
fail, the Company could convert to a manual entry system for a period of up to
six months without significant losses. The Company believes that any mission
critical systems could be recovered and operating within seven days. In the
event that the Federal Reserve is unable to handle electronic funds transfers
and check clearing, the Company does not expect the impact to be material to its
financial condition or results of operations as long as the Company is able to
utilize an alternative electronic funds transfer and clearing source. As part of
its contingency planning, the Company has reviewed its loan customer base and
the potential impact on capital of Year 2000 non-compliance. Based on such
review, using what it considers to be a reasonable worst case scenario, the
Company has assumed that certain of its commercial borrowers whose businesses
are most likely to be affected by Year 2000 noncompliance would be unable to
repay their loans, resulting in charge-offs of loan amounts in excess of
collateral values. If such were the case, the Company believes that it is
unlikely that its exposure would exceed $300,000, although there are no
assurances that this amount will not be substantially higher. The Company does
not believe that this amount is material enough for the Company to adjust its
current methodology for making provisions to the allowance for credit losses. In
addition, the Company plans to maintain additional cash on hand to meet any
unusual deposit withdrawal activity.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For information regarding the market risk of the Company's financial
instruments, see "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATION - FINANCIAL CONDITION - INTEREST RATE SENSITIVITY AND
LIQUIDITY". The Company's principal market risk exposure is to changes in
interest rates.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements, the reports thereon, the notes thereto and
supplementary data commence at page F-1 of this Annual Report on Form 10-K.
32
The following table presents certain unaudited quarterly financial
information concerning the Company's results of operations for each of the two
years ended December 31, 1998. The information should be read in conjunction
with the historical Consolidated Financial Statements of the Company and the
Notes thereto appearing elsewhere in the Annual Report on Form 10-K.
CONSOLIDATED QUARTERLY FINANCIAL DATA OF THE COMPANY
QUARTER ENDED 1998
-----------------------------------------------------
(unaudited)
DECEMBER 31 SEPTEMBER 30 JUNE 30 MARCH 31
----------- ------------ --------- --------
(Dollars in thousands, except per share data)
Interest income .......................................................... $ 6,910 $ 5,641 $ 5,597 $ 5,274
Interest expense ......................................................... 3,019 2,395 2,412 2,302
----------- ------------ --------- --------
Net interest income ................................................. 3,891 3,246 3,185 2,972
Provision for credit losses .............................................. 24 70 75 70
----------- ------------ --------- --------
Net interest income after provision ................................. 3,867 3,176 3,110 2,902
Noninterest income ....................................................... 667 586 622 617
Noninterest expense ...................................................... 2,609 2,195 2,148 2,106
----------- ------------ --------- --------
Income before income taxes .......................................... 1,925 1,567 1,584 1,413
Provision for income taxes ............................................... 603 487 499 440
----------- ------------ --------- --------
Net income ............................................................... $ 1,322 $ 1,080 $ 1,085 $ 973
=========== ============ ========= ========
Earnings per share:
Basic ............................................................... $ 0.29 $ 0.27 $ 0.27 $ 0.24
=========== ============ ========= ========
Diluted ............................................................. 0.28 0.26 0.27 0.24
=========== ============ ========= ========
QUARTER ENDED 1998
-----------------------------------------------------
(unaudited)
DECEMBER 31 SEPTEMBER 30 JUNE 30 MARCH 31
----------- ------------ --------- --------
(Dollars in thousands, except per share data)
Interest income .......................................................... $ 5,141 $ 5,198 $ 4,912 $ 4,719
Interest expense ......................................................... 2,279 2,328 2,262 2,191
----------- ------------ --------- --------
Net interest income ................................................. 2,862 2,870 2,650 2,528
Provision for credit losses .............................................. 25 60 30 75
----------- ------------ --------- --------
Net interest income after provision ................................. 2,837 2,810 2,620 2,453
Noninterest income ....................................................... 662 589 499 514
Noninterest expense ...................................................... 2,108 2,059 1,877 1,792
----------- ------------ --------- --------
Income before income taxes .......................................... 1,391 1,340 1,242 1,175
Provision for income taxes ............................................... 438 392 390 366
----------- ------------ --------- --------
Net income .......................................................... $ 953 $ 948 $ 852 $ 809
=========== ============ ========= ========
Earnings per share:
Basic ............................................................... $ 0.24 $ 0.24 $ 0.23 $ 0.23
=========== ============ ========= ========
Diluted ............................................................. 0.23 0.23 0.23 0.23
=========== ============ ========= ========
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There have been no disagreements with accountants on any matter of
accounting principles or practices or financial statement disclosures during the
two year period ended December 31, 1998.
33
PART III.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information under the captions "Election of Directors," "Continuing
Directors and Executive Officers" and "Section 16(a) Beneficial Ownership
Reporting Compliance" in the Company's Proxy Statement dated April 1, 1999,
relating to the 1999 Annual Meeting of Shareholders (the "1999 Proxy Statement")
is incorporated herein by reference in response to this item.
ITEM 11. EXECUTIVE COMPENSATION
The information under the caption "Executive Compensation and Other
Matters" in the 1999 Proxy Statement is incorporated herein by reference in
response to this item.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information under the caption "Beneficial Ownership of Common Stock by
Management of the Company and Principal Shareholders" in the 1999 Proxy
Statement is incorporated herein by reference in response to this item.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information under the caption "Interests of Management and Others in
Certain Transactions" in the 1999 Proxy Statement is incorporated herein by
reference in response to this item.
PART IV.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
Reference is made to the Financial Statements, the reports thereon, the
Notes thereto and supplementary data commencing at page F-1 of this Annual
Report on Form 10-K. Set forth below is a list of such Financial Statements:
Independent Auditors' Report
Consolidated Balance Sheets as of December 31, 1998 and 1997
Consolidated Statements of Income for the Years Ended December 31, 1998,
1997, and 1996
Consolidated Statements of Changes in Shareholders' Equity for the Years
Ended December 31, 1998, 1997 and 1996
Consolidated Statements of Cash Flows for the Years Ended December 31,
1998, 1997 and 1996
Notes to Consolidated Financial Statements
FINANCIAL STATEMENT SCHEDULES
All supplemental schedules are omitted as inapplicable or because the
required information is included in the Consolidated Financial Statements or
Notes thereto.
EXHIBITS
Each exhibit marked with an asterisk is filed with this Annual Report on
Form 10-K.
EXHIBIT
NUMBER DESCRIPTION
------- -----------
3.1 - Amended and Restated Articles of Incorporation of the Company
(incorporated herein by reference to Exhibit 3.1 to the Company's
Registration Statement on Form S-1 (Registration No. 333-63267) (the
"Registration Statement").
34
3.2 - Amended and Restated Bylaws of the Company (incorporated herein by
reference to Exhibit 3.2 to the Registration Statement).
4 - Specimen form of certificate evidencing the Common Stock
(incorporated herein by reference to Exhibit 4 to the Registration
Statement).
10.1 - Prosperity Bancshares, Inc. 1995 Stock Option Plan (incorporated
herein by reference to Exhibit 10.1 to the Registration Statement).
10.2 - Prosperity Bancshares, Inc. 1998 Stock Incentive Plan (incorporated
herein by reference to Exhibit 10.2 to the Registration Statement).
10.3 - Employment Agreements (incorporated herein by reference to Exhibit
10.3 to the Registration Statement).
10.4 - Agreement and Plan of Reorganization dated June 5, 1998 between the
Company, First Prosperity Bank and Union State Bank (incorporated
herein by reference to Exhibit 10.4 to the Registration Statement).
10.5 - Loan Agreement dated December 27, 1997 between the Company and
Norwest Bank Minnesota, National Association (incorporated herein by
reference to Exhibit 10.5 to the Registration Statement).
21 - Subsidiaries of Prosperity Bancshares, Inc. (incorporated herein by
reference to Exhibit 21 to the Registration Statement).
27* - Financial Data Schedule.
REPORTS ON FORM 8-K
The Company did not file any Current Reports on Form 8-K during the fourth
quarter of 1998.
35
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934, PROSPERITY BANCSHARES, INC., HAS DULY CAUSED THIS REPORT TO BE
SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN THE CITY
OF HOUSTON AND STATE OF TEXAS ON MARCH 11, 1999.
PROSPERITY BANCSHARES, INC.
BY: /S/TRACY T. RUDOLPH
TRACY T. RUDOLPH
CHAIRMAN OF THE BOARD
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED,
THIS REPORT HAS BEEN SIGNED BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT
IN THE INDICATED CAPACITIES ON MARCH 11, 1999.
SIGNATURE POSITIONS
/s/TRACY T. RUDOLPH Chairman of the Board (principal
Tracy T. Rudolph executive officer)
/s/DAVID HOLLAWAY Chief Financial Officer (principal
David Hollaway financial officer and principal
accounting officer)
/s/HARRY BAYNE Director
Harry Bayne
/s/JAMES A. BOULIGNY Director
James A. Bouligny
/s/J.T. HERIN Director
J.T. Herin
/s/CHARLES M. SLAVIK Director
Charles M. Slavik
/s/HARRISON STAFFORD Director
Harrison Stafford
/s/ROBERT STEELHAMMER Director
Robert Steelhammer
/s/DAVID ZALMAN Director
David Zalman
36
TABLE OF CONTENTS TO FINANCIAL STATEMENTS
PAGE
Prosperity Bancshares, Inc.
Independent Auditors' Report.................... F-2
Consolidated Balance Sheets as of
December 31, 1998 and 1997 ............... F-3
Consolidated Statements of Income
for the Years Ended December 31, 1998
1997 and 1996............................. F-4
Consolidated Statements of Changes
in Shareholders' Equity for the
Years Ended December 31, 1998,
1997 and 1996............................. F-5
Consolidated Statements of Cash
Flows for the Years Ended
December 31, 1998, 1997
and 1996.................................. F-6
Notes to Consolidated Financial
Statements................................ F-8
F-1
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
/s/ DELOITTE & TOUCHE LLP
February 18, 1999
Houston, Texas
F-2
PROSPERITY BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
--------------------------------
1998 1997
--------- ---------
(Dollars in thousands)
ASSETS
Cash and due from banks (Note 3) ..................................................... $ 18,243 $ 17,372
Interest-bearing deposits in financial institutions .................................. 99 198
Available for sale securities, at fair value
(amortized cost of $113,300 and $38,650,
respectively) (Note 4) ......................................................... 113,828 38,612
Held to maturity securities, at cost
(fair value of $115,021 and $129,774,
respectively) (Note 4) ........................................................... 113,916 129,256
Loans (Notes 5 and 6) ................................................................ 170,478 120,578
Less allowance for credit losses (Note 7) ............................................ (1,850) (1,016)
--------- ---------
Loans, net ........................................................... 168,628 119,562
Accrued interest receivable .......................................................... 3,990 2,501
Goodwill, net of accumulated
amortization of $3,077 and
$2,577, respectively ............................................................. 9,690 5,644
Bank premises and equipment, net (Note 8) ............................................ 6,105 5,530
Other assets ......................................................................... 1,813 1,468
--------- ---------
TOTAL ................................................................................ $ 436,312 $ 320,143
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Deposits (Note 9):
Noninterest-bearing .......................................................... $ 84,976 $ 61,447
Interest-bearing ............................................................. 305,683 230,069
--------- ---------
Total deposits ....................................................... 390,659 291,516
Other borrowings (Note 10) ....................................................... 2,437 2,800
Accrued interest payable ......................................................... 1,081 709
Other liabilities ................................................................ 700 300
--------- ---------
Total liabilities .................................................... 394,877 295,325
COMMITMENTS AND CONTINGENCIES
(Notes 12 and 16)
SHAREHOLDERS' EQUITY (Notes 14, 17, and 18):
Common stock, $1 par value; 50,000,000 shares
authorized; 5,176,401 and 3,993,884,
shares issued at December 31, 1998 and
1997, respectively; 5,172,825 and
3,990,308 shares outstanding at
December 31, 1998 and 1997, respectively ..................................... 5,176 3,993
Capital surplus .................................................................. 16,477 4,818
Retained earnings ................................................................ 19,452 16,049
Accumulated other comprehensive income net
unrealized gains (losses) on available for sale
securities, net of tax of $179 and
$13, respectively ............................................................ 348 (24)
Less treasury stock, at cost, 3,576 and
3,576 shares, respectively ................................................... (18) (18)
--------- ---------
Total shareholders' equity ........................................... 41,435 24,818
--------- ---------
TOTAL ................................................................................ $ 436,312 $ 320,143
========= =========
See notes to consolidated financial statements.
F-3
PROSPERITY BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------------------------
1998 1997 1996
------- ------- -------
(Dollars in thousands, except per share data)
INTEREST INCOME:
Loans, including fees ......................................... $12,282 $10,206 $ 9,136
Securities:
Taxable ................................................... 10,152 8,950 6,648
Nontaxable ................................................ 682 605 723
Federal funds sold ............................................ 299 193 310
Deposits in financial institutions ........................... 7 16 24
------- ------- -------
Total interest income .................................. 23,422 19,970 16,841
------- ------- -------
INTEREST EXPENSE:
Deposits ...................................................... 9,993 8,858 7,720
Note payable and federal funds
purchased ................................................. 24 132 203
Other ......................................................... 111 70
------- ------- -------
Total interest expense ........................................ 10,128 9,060 7,923
------- ------- -------
NET INTEREST INCOME .............................................. 13,294 10,910 8,918
PROVISION FOR CREDIT LOSSES (Note 7) ............................. 239 190 230
------- ------- -------
NET INTEREST INCOME AFTER PROVISION
FOR CREDIT LOSSES ............................................. 13,055 10,720 8,688
------- ------- -------
NONINTEREST INCOME:
Customer service fees ......................................... 2,173 2,062 1,742
Other ......................................................... 319 202 155
------- ------- -------
Total noninterest income ............................... 2,492 2,264 1,897
------- ------- -------
NONINTEREST EXPENSE:
Salaries and employee benefits
(Note 15) ................................................. 4,541 3,968 3,415
Net occupancy expense ......................................... 768 811 710
Data processing ............................................... 807 642 493
Goodwill amortization ......................................... 500 402 257
Depreciation expense .......................................... 290 431 367
Other ......................................................... 2,152 1,582 1,392
------- ------- -------
Total noninterest expense .............................. 9,058 7,836 6,634
------- ------- -------
INCOME BEFORE INCOME TAXES ....................................... 6,489 5,148 3,951
PROVISION FOR INCOME TAXES (Note 13) ............................. 2,029 1,586 1,240
------- ------- -------
NET INCOME ....................................................... $ 4,460 $ 3,562 $ 2,711
======= ======= =======
EARNINGS PER SHARE
(Note 1):
Basic ......................................................... $ 1.08 $ 0.94 $ 0.77
======= ======= =======
Diluted ....................................................... $ 1.04 $ 0.92 $ 0.76
======= ======= =======
See notes to consolidated financial statements.
F-4
PROSPERITY BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
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)
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
========= ====== ======= ======== =============== ======== =============
See notes to consolidated financial statements.
F-5
PROSPERITY BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
------------------------------------------------
1998 1997 1996
-------- -------- --------
(Dollars in thousands)
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:
Depreciation and amortization .................................... 1,023 833 624
Provision for credit losses ...................................... 239 190 230
Net amortization (accretion) of
premium/discount on investments ............................... 236 340 285
Loss on sale of real estate
acquired by foreclosure ........................................ 2 2
Increase in accrued interest receivable .......................... (624) (297) (126)
Increase in other assets ......................................... (180) (396) (222)
(Decrease) increase in accrued
interest payable and other liabilities ........................ 217 (80) (138)
-------- -------- --------
Total adjustments .............................................. 913 592 653
-------- -------- --------
Net cash provided by operating activities ...................... 5,373 4,154 3,364
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities and
principal paydowns of held to
maturity securities .............................................. 54,725 35,405 23,334
Purchase of held to maturity securities ............................. (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 .............................................. 24,109 14,206 12,061
Purchase of available for sale securities ........................... (81,729) (3,497) (25,942)
Net increase in loans ............................................... (28,433) (7,482) (14,189)
Net proceeds from sale of real
estate acquired by foreclosure ................................... 38 187
Purchase of bank premises and equipment ............................. (343) (743) (364)
Proceeds from sale of bank premises
and equipment .................................................... 4
Net decrease (increase) in
interest-bearing deposits in
financial institutions ........................................... 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)
Net liabilities acquired in purchase of
West Columbia branch (net
of acquired cash of $84) ......................................... 5,799
Premium paid for purchase of East Bernard .............................. (4,297)
Net liabilities acquired in purchase of
East Bernard (net of acquired
cash of $16,602) ................................................. 3,134
-------- -------- --------
Net cash (used in) investing activities ........................ (43,131) (1,835) (19,246)
-------- -------- --------
See notes to consolidated financial statements.
(TABLE CONTINUED ON FOLLOWING PAGE)
F-6
PROSPERITY BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
------------------------------------------------------
1998 1997 1996
--------- --------- --------
(Dollars in thousands)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in noninterest-bearing
deposits ................................................. $ 13,881 $ 1,210 $ 5,212
Net (decrease) increase in
interest-bearing deposits ................................ 13,328 (9,861) 12,455
Proceeds from line of credit ................................ 2,000 3,266
Repayments of line of credit ................................ (2,000) (3,266) (1,517)
Proceeds from other borrowings .............................. (330,070) 296,585
Repayments of other borrowings .............................. 329,705 (293,785)
Proceeds from the issuance of
common stock ............................................. 12,842 3,000
Purchase of treasury stock .................................. (19)
Sale of treasury stock ...................................... 1
Payments of cash dividends .................................. (1,057) (575) (351)
--------- --------- --------
Net cash (used in) provided by
financing activities ............................... 38,629 (6,691) 19,046
--------- --------- --------
NET (DECREASE) INCREASE IN CASH AND
CASH EQUIVALENTS ............................................ $ 871 $ (4,372) $ 3,164
CASH AND CASH EQUIVALENTS, BEGINNING
OF PERIOD ................................................... 17,372 21,744 18,580
--------- --------- --------
CASH AND CASH EQUIVALENTS, END OF
PERIOD ...................................................... $ 18,243 $ 17,372 $ 21,744
========= ========= ========
INCOME TAXES PAID .............................................. $ 1,882 $ 1,681 $ 1,111
========= ========= ========
INTEREST PAID .................................................. $ 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.
See notes to consolidated financial statements.
F-7
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 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.
F-8
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
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 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.
F-9
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
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 (see Note
14).
STATEMENTS OF CASH FLOWS -- For purposes of reporting cash flows, cash and
cash equivalents include cash and due from banks as well as federal funds sold
that mature in three days or less.
RECLASSIFICATIONS -- Certain reclassifications have been made to 1997 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.
The following table illustrates the computation of basic and diluted
earnings per share after effect of stock split (Note 17):
DECEMBER 31,
-------------------------------------------------------------
1998 1997 1996
----------------- ----------------- -----------------
PER PER PER
SHARE SHARE SHARE
AMOUNT AMOUNT AMOUNT AMOUNT AMOUNT AMOUNT
------ ------ ------ ------ ------ ------
(Dollars in thousands, except per share data)
Net income ....................................................... $4,460 $3,562 $2,711
Basic:
Weighted average shares
outstanding ............................................... 4,116 $ 1.08 3,778 $ 0.94 3,513 $ 0.77
====== ====== ======
Diluted:
Weighted average shares
outstanding ............................................... 4,116 3,778 3,513
Effect of dilutive securities --
options ................................................... 193 86 47
------ ------ ------
Total ....................................................... 4,309 $ 1.04 3,864 $ 0.92 3,560 $ 0.76
====== ====== ====== ====== ====== ======
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
stockholders' equity, or (3) a separate statement of comprehensive income.
Comprehensive income is comprised of net income and all changes to stockholders'
equity, except those due to investments by owners (changes in paid-in capital)
and distributions to owners (dividends). The Company adopted this statement
effective January 1, 1998 and has elected to report comprehensive income in the
consolidated statements of stockholders' equity.
F-10
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
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 stockholders' 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, 1999.
Management believes the implementation of this pronouncement will not have a
material effect on the Company's financial statements.
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 (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:
YEAR ENDED DECEMBER 31,
-----------------------
1998 1997
------- -------
(Dollars in thousands, except per share data)
Net interest income .................. $15,204 $13,434
Net earnings ......................... 5,169 4,326
Earnings per share (diluted) ......... 1.20 1.12
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 (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.
F-11
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
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.
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.
F-12
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
4. SECURITIES
The amortized cost and fair value of debt securities are as follows:
DECEMBER 31, 1998
-------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR CARRYING
COST GAINS LOSSES VALUE VALUE
--------- ---------- ---------- -------- --------
(Dollars in thousands)
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
========= ========== ========== ======== ========
DECEMBER 31, 1997
-------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR CARRYING
COST GAINS LOSSES VALUE VALUE
--------- ---------- ---------- -------- --------
(Dollars in thousands)
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
========= ========== ========== ======== ========
F-13
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.
HELD TO MATURITY AVAILABLE FOR SALE
------------------------ ------------------------
(Dollars in thousands)
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
--------- -------- --------- --------
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
========= ======== ========= ========
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):
DECEMBER 31,
-------------------------
(Dollars in thousands)
1998 1997
-------- --------
Commercial and industrial .................... $ 16,972 $ 11,611
Real estate:
Construction and land
development ............................. 1,727 6,453
1-4 family residential ..................... 88,139 53,625
Commercial mortgages ....................... 22,240 16,277
Farmland ................................... 6,148 5,804
Multi-family residential ................... 1,090 937
Agriculture .................................. 14,107 6,359
Consumer ..................................... 20,711 20,498
-------- --------
Total ........................................ 171,134 121,564
Less unearned discount ....................... 656 986
-------- --------
Total ........................................ $170,478 $120,578
======== ========
F-14
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:
DECEMBER 31, 1998
--------------------------------------------
AFTER ONE
ONE YEAR THROUGH AFTER FIVE
OR LESS FIVE YEARS YEARS TOTAL
-------- ---------- ---------- -------
(Dollars in thousands)
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 $18,649
======== ========== ========== =======
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:
YEAR ENDED
DECEMBER 31,
----------------------
(Dollars in thousands)
1998 1997
------- -------
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
======= =======
6. NONPERFORMING LOANS AND PAST DUE LOANS
The Company had $5,000 in nonaccrual loans and no 90 days or more past
due, or restructured loans at December 31, 1998, The Company had no nonaccrual,
90 days or more past due, or restructured loans at December 31, 1997.
F-15
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:
YEAR ENDED
DECEMBER 31,
-----------------------------
(Dollars in thousands)
1998 1997 1996
------- ------- -----
Balance at beginning of year ................. $ 1,016 $ 923 $ 753
Balance acquired with acquisition ....... 661
Addition -- provision charged to
operations ............................. 239 190 230
Net charge-offs:
Loans charged off ................... (81) (130) (73)
Loan recoveries ..................... 15 33 13
------- ------- -----
Total net charge-offs ........................ (66) (97) (60)
------- ------- -----
Balance at end of period ..................... $ 1,850 $ 1,016 $ 923
======= ======= =====
8. PREMISES AND EQUIPMENT
Premises and equipment are summarized as follows:
YEAR ENDED
DECEMBER 31,
---------------------
(Dollars in thousands)
1998 1997
------ ------
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
====== ======
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 December 31, 1998 and 1997 were as follows:
DECEMBER 31,
--------------------
(Dollars in thousands)
1998
----------
Three months or less .................... $ 5,835
Four through six months ................. 9,603
Seven through twelve months ............. 21,296
Thereafter .............................. 6,097
----------
Total ................................... $ 42,831
==========
F-16
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Interest expense for certificates of deposit in excess of $100,000 was
approximately $1,492,000 $1,264,000, and $1,291,000, for the terms 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:
DECEMBER 31,
----------------------
1998 1997
------- -------
(Dollars in thousands)
Financial instruments whose contract
amounts represent credit risk:
Commitments to extend credit ................ $19,698 $11,856
Standby letters of credit ................... 233 315
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
F-17
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
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:
YEAR ENDED DECEMBER 31,
-----------------------------------------
(Dollars in thousands)
1998 1997 1996
------- ------- -------
Current ..................... $ 2,106 $ 1,634 $ 1,340
Deferred .................... (77) (48) (100)
------- ------- -------
Total ....................... $ 2,029 $ 1,586 $ 1,240
======= ======= =======
The provision for federal income taxes differs from the amount computed by
applying the federal income tax statutory rate on income as follows:
YEAR ENDED DECEMBER 31,
---------------------------------
(Dollars in thousands)
1998 1997 1996
------- ------- -------
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
======= ======= =======
F-18
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Deferred tax assets and liabilities are as follows:
DECEMBER 31,
-------------------------
1998 1997
--------- ---------
(Dollars in thousands)
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)
========= =========
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 not be
exercised until the optionee has completed five years of employment after the
date of grant. The options were granted at an average exercise price of $4.40
(after stock split). Compensation expense was not recognized for the stock
options because the options had an 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).
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
------- --------- ------- --------- ------- ---------
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
======= ========= ======= ========= ======= =========
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 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.
F-19
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
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:
1999................................... $ 206,518
2000................................... 221,839
2001................................... 221,839
2002................................... 222,739
2003................................... 223,639
----------
Total.................................. $1,096,574
==========
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 $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.
F-20
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
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-21
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:
TO BE WELL
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
-------------------- -------------------- --------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
-------- -------- -------- -------- -------- --------
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
TO BE WELL
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
-------------------- -------------------- --------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
-------- -------- -------- -------- -------- --------
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 4.99% $ 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%
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 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.
F-22
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
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):
DECEMBER 31,
------------------------------------------------
(Dollars in thousands)
1998 1997
---------------------- ----------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
--------- --------- --------- ---------
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
Note payable
Other borrowing .............. 2,437 2,437 2,800 2,800
--------- --------- --------- ---------
Total ............................. $ 393,096 $ 394,027 $ 294,316 $ 294,579
========= ========= ========= =========
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
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.
F-23
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
20. PARENT COMPANY ONLY FINANCIAL STATEMENTS
PROSPERITY BANCSHARES, INC.
(PARENT COMPANY ONLY)
BALANCE SHEETS
DECEMBER 31,
--------------------
1998 1997
-------- --------
(Dollars in thousands)
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
======== ========
F-24
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
PROSPERITY BANCSHARES, INC.
(PARENT COMPANY ONLY)
STATEMENTS OF INCOME
FOR THE YEARS
ENDED DECEMBER 31,
----------------------------
1998 1997 1996
------ ------ ------
(Dollars in thousands)
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
====== ====== ======
F-25
PROSPERITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
PROSPERITY BANCSHARES, INC.
(PARENT COMPANY ONLY)
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
-------- ------- -------
(Dollars in thousands)
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
======== ======= =======
F-26
EXHIBIT INDEX
Exhibit Description
Number
27 Financial Data Schedule
F-27