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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended March 31, 2003

OR

For the transition period from                                  to                                  

Commission File Number: 000-25051

PROSPERITY BANCSHARES, INC.^SM

(Exact name of registrant as specified in its charter)

4295 San Felipe

Houston, Texas 77027

(Address of principal executive offices, including zip code)

(713) 693-9300

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter 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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).  Yes  x    No  ¨

As of May 8, 2003, there were 18,944,027 shares of the registrant’s Common Stock, par value $1.00 per share, outstanding.

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PROSPERITY BANCSHARES, INC.^SM AND SUBSIDIARIES

INDEX TO FORM 10-Q

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PART I – FINANCIAL INFORMATION

ITEM 1. INTERIM FINANCIAL STATEMENTS

PROSPERITY BANCSHARES, INC.^SM AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

See notes to interim consolidated financial statements.

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PROSPERITY BANCSHARES, INC.^SM AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)

See notes to interim consolidated financial statements.

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PROSPERITY BANCSHARES, INC.^SM AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

See notes to interim consolidated financial statements.

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PROSPERITY BANCSHARES, INC.^SM AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

See notes to interim consolidated financial statements.

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PROSPERITY BANCSHARES, INC.^SM AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2003

(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

(UNAUDITED)

1. BASIS OF PRESENTATION

The interim consolidated financial statements include the accounts of Prosperity Bancshares, Inc.^SM (the “Company”) and its wholly-owned subsidiaries, Prosperity Bank ^SM (the “Bank”) and Prosperity Holdings, Inc. On May 31, 2002, Prosperity completed a two-for-one stock split effected in the form of a 100 percent stock dividend. All prior period per share and share data have been restated to reflect this split. All significant inter-company transactions and balances have been eliminated.

The accompanying unaudited interim consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, the statements reflect all adjustments necessary for a fair presentation of the financial position, results of operations and cash flows of the Company on a consolidated basis, and all such adjustments are of a normal recurring nature. These financial statements and the notes thereto should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2002. Operating results for the three month period ended March 31, 2003 are not necessarily indicative of the results that may be expected for the year ending December 31, 2003.

2. INCOME PER COMMON SHARE

The following table illustrates the computation of basic and diluted earnings per share.

3. RECENT DEVELOPMENTS

On May 6, 2003, the Company completed the acquisition of Abrams Centre Bancshares, Dallas, Texas (“Abrams”). Abrams wholly owned subsidiary, Abrams Centre National Bank, became a subsidiary of the Company. Under the terms of the Agreement and Plan of Merger, the Company paid approximately $16.3 million in cash. Abrams operated two (2) banking offices in Dallas, Texas. As of March 31, 2003, Abrams Centre National Bank had total assets of $96.5 million, loans of $31.7 million, deposits of $70.8 million and shareholders’ equity of $14.0 million.

On March 4, 2003, the Company entered into a definitive agreement with Dallas Bancshares Corporation, Dallas, Texas. Pursuant to the agreement, Dallas Bancshares will merge into the Company and its wholly owned subsidiary, BankDallas will merge into the Bank. Under the terms of the agreement, the Company will pay approximately $7.0 million in cash. Dallas Bancshares is privately held and operates one (1) banking office in Dallas, Texas. As of March 31, 2003, BankDallas had total assets of $42.0 million, loans of $28.3 million, deposits of $37.6 million and shareholders’ equity of $4.3 million. The transaction is expected to close in the second quarter of 2003. The Company will not complete the acquisition

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PROSPERITY BANCSHARES, INC. ^SM AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS—(CONTINUED)

MARCH 31, 2003

(DOLLARS IN THOUSANDS)

(UNAUDITED)

unless customary closing conditions are satisfied or waived, including receipt of the necessary shareholder and regulatory approvals and consents from applicable regulatory agencies including the Federal Reserve Board, the Texas Banking Department and the Federal Deposit Insurance Corporation.

4. STOCK INCENTIVE PROGRAM

The Company has two stock-based employee compensation plans. Prior to 2003, the Company accounted for those plans under the recognition and measurement provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based employee compensation cost was reflected in previously reported results, as all options granted under those plans had an exercise prices equal to the market value of the underlying common stock on the date of grant. In December 2002, the FASB issued Statement No. 148 (SFAS 148). Accounting for Stock-Based Compensation – Transition and Disclosure, an amendment to FASB Statement 123. SFAS 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS 148 is effective for financial statements for fiscal years ending after December 15, 2002. Effective January 1, 2003, the Company adopted the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, as provided by SFAS No. 148 for stock-based employee compensation.

If compensation expense had been recorded based on the fair value at the grant date for awards consistent with SFAS No. 123 for the quarter ended March 31, 2002, the Company’s net income and earnings per share would have been as follows:

5. GOODWILL AMORTIZATION

In June 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards SFAS No. 142, Goodwill and Other Intangible Assets (SFAS No. 142). SFAS No. 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually in accordance with the provisions of SFAS No. 142. SFAS No. 142 also requires that intangible assets with estimable useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS No. 121 and subsequently, SFAS No. 144 after its adoption.

The Company adopted the provisions of SFAS No. 142 as of January 1, 2002. Goodwill and intangible assets determined to have an indefinite useful life acquired in a purchase business combination completed after June 30, 2001 are no longer amortized.

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PROSPERITY BANCSHARES, INC. ^SM AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS—(CONTINUED)

MARCH 31, 2003

(DOLLARS IN THOUSANDS)

(UNAUDITED)

Changes in the carrying amount of the Company’s goodwill for three months ended March 31, 2003 were as follows:

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Special Cautionary Notice Regarding Forward-Looking Statements

Statements and financial discussion and analysis contained in this quarterly report on Form 10-Q that are not historical facts are forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based on assumptions and involve a number of risks and uncertainties, many of which are beyond the Company’s control. Many possible events or factors could affect the future financial results and performance of the Company and could cause such results or performance to differ materially from those expressed in the forward-looking statements. These possible events or factors include, without limitation:

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A forward-looking statement may include a statement of the assumptions or bases underlying the forward-looking statement. The Company believes it has chosen these assumptions or bases in good faith and that they are reasonable. However, the Company cautions you that assumptions or bases almost always vary from actual results, and the differences between assumptions or bases and actual results can be material.

The Company undertakes no obligation to publicly update or otherwise revise any forward-looking statements, whether as a result of new information, future events or otherwise, unless the securities laws require the Company to do so.

RECENT DEVELOPMENTS

On May 6, 2003, the Company completed the acquisition of Abrams Centre Bancshares, Dallas, Texas (“Abrams”). Abrams wholly owned subsidiary, Abrams Centre National Bank, became a subsidiary of the Company. Under the terms of the Agreement and Plan of Merger, the Company paid approximately $16.3 million in cash. Abrams operated two (2) banking offices in Dallas, Texas. As of March 31, 2003, Abrams Centre National Bank had total assets of $96.5 million, loans of $31.7 million, deposits of $70.8 million and shareholders’ equity of $14.0 million.

On March 4, 2003, the Company entered into a definitive agreement with Dallas Bancshares Corporation, Dallas, Texas. Pursuant to the agreement, Dallas Bancshares will merge into the Company and its wholly owned subsidiary, BankDallas will merge into the Bank. Under the terms of the agreement, the Company will pay approximately $7.0 million in cash. Dallas Bancshares is privately held and operates one (1) banking office in Dallas, Texas. As of March 31, 2003, BankDallas had total assets of $42.0 million, loans of $28.3 million, deposits of $37.6 million and shareholders’ equity of $4.3 million. The transaction is expected to close in the second quarter of 2003. The Company will not complete the acquisition unless customary closing conditions are satisfied or waived, including receipt of the necessary shareholder and regulatory approvals and consents from applicable regulatory agencies including the Federal Reserve Board, the Texas Banking Department and the Federal Deposit Insurance Corporation.

OVERVIEW

Prosperity Bancshares, Inc.^SM (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 is a registered financial holding company that derives substantially all of its revenues and income from the operation of its bank subsidiary, Prosperity Bank^SM (“Prosperity Bank” or the “Bank”). The Bank provides a broad line of financial products and services to small and medium-sized businesses and consumers. The Bank operates forty (40) full-service banking locations in the Greater Houston CMSA and fifteen contiguous counties situated south and southwest of Houston and extending into South Texas and two (2) full service banking locations in Dallas, Texas. The Greater Houston CMSA includes Brazoria, Chambers, Fort Bend, Galveston, Harris, Liberty, and Montgomery counties.

Total assets were $1.88 billion at March 31, 2003 compared with $1.82 billion at December 31, 2002. Total loans decreased to $656.6 million at March 31, 2003 from $679.6 million at December 31, 2002, a decrease of $23.0 million, or

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3.4%. Total deposits were $1.63 billion at March 31, 2003 compared with $1.59 billion at December 31, 2002, an increase of $47.7 million, or 3.0%. Shareholders’ equity increased $5.5 million or 3.6%, to $160.3 million at March 31, 2003 compared with $154.7 million at December 31, 2002.

RESULTS OF OPERATIONS AS REPORTED

Net income available to common shareholders was $6.4 million ($0.33 per common share on a diluted basis) for the quarter ended March 31, 2003 compared with $4.5 million ($0.27 per common share on a diluted basis) for the quarter ended March 31, 2002, an increase of $1.9 million, or 42.3%. The Company posted returns on average common equity of 16.19% and 19.36%, returns on average assets of 1.40% and 1.40% and efficiency ratios of 51.24% and 52.34% for the quarters ended March 31, 2003 and 2002, respectively.

Net Interest Income

Net interest income was $16.1 million for the quarter ended March 31, 2003 compared with $12.0 million for the quarter ended March 31, 2002, an increase of $4.1 million, or 34.2%. Net interest income increased as a result of an increase in average interest-earning assets to $1.67 billion for the quarter ended March 31, 2003 from $1.20 billion for the quarter ended March 31, 2002, an increase of $460.6 million, or 38.1%. The net interest margin on a tax equivalent basis decreased to 4.00% from 4.15% for the same periods, principally due to a 77 basis point decrease in the rate paid on interest-bearing liabilities from 2.61% for the quarter ended March 31, 2002 to 1.84% for the quarter ended March 31, 2003 and a $349.0 million increase in total interest-bearing liabilities for the same periods, partially offset by a 77 basis point decrease in the yield on earning assets from 6.09% for the quarter ended March 31, 2002 to 5.32% for the quarter ended March 31, 2003 and a $460.6 million increase in total interest-earning assets for the same periods.

The Company’s net interest income is affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities, referred to as a “volume change.” It is also affected by changes in yields earned on interest-earning assets and rates paid on interest-bearing deposits and other borrowed funds, referred to as a “rate change.”

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The following table sets forth, for each category of interest-earning assets and interest-bearing liabilities, the average amounts outstanding, the interest earned or paid on such amounts, and the average rate earned or paid for the quarters ended March 31, 2003 and 2002. The table also sets forth the average rate paid on total interest-bearing liabilities, and the net interest margin on average total interest-earning assets for the same periods. Except as indicated in the footnotes, no tax-equivalent adjustments were made and all average balances are daily average balances. Any nonaccruing loans have been included in the table as loans carrying a zero yield.