FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002
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: 000-25051
PROSPERITY BANCSHARES, INC./SM/
(Exact name of registrant as specified in its charter)
TEXAS 74-2331986
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
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 [ ]
As of November 1, 2002, there were 18,885,872 shares of the registrant's Common
Stock, par value $1.00 per share, outstanding.
PROSPERITY BANCSHARES, INC.(SM) AND SUBSIDIARIES
INDEX TO FORM 10-Q
PART I - FINANCIAL INFORMATION Page
Item 1. Interim Financial Statements .................................... 3
Consolidated Balance Sheets as of September 30, 2002 (unaudited)
and December 31, 2001 .......................................... 3
Consolidated Statements of Income for the Three and Nine Months
Ended September 30, 2002 and 2001 (unaudited) .................. 4
Consolidated Statements of Shareholders' Equity for the Year
Ended December 31 2001 and for the Nine Months Ended
September 30, 2002 (unaudited) ................................. 5
Consolidated Statements of Cash Flows for the Nine Months Ended
September 30, 2002 and 2001 (unaudited) ........................ 6
Notes to Interim Consolidated Financial Statements .............. 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations .......................................... 9
Item 3. Quantitative and Qualitative Disclosures about Market Risk ...... 20
Item 4. Controls and Procedures ......................................... 20
PART II - OTHER INFORMATION
Item 1. Legal Proceedings ............................................... 20
Item 2. Changes in Securities and Use of Proceeds ....................... 21
Item 3. Defaults upon Senior Securities ................................. 21
Item 4. Submission of Matters to a Vote of Security Holders ............. 21
Item 5. Other Information ............................................... 21
Item 6. Exhibits and Reports on Form 8-K ................................ 21
Signatures ............................................................... 22
2
PART I - FINANCIAL INFORMATION
ITEM 1. INTERIM FINANCIAL STATEMENTS
PROSPERITY BANCSHARES, INC.(SM) AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30, December 31,
2002 2001
------------- ------------
(unaudited)
(Dollars in thousands, except share data)
ASSETS
Cash and due from banks ................................. $ 50,242 $ 41,005
Federal funds sold ...................................... 5,501 715
---------- ----------
Total cash and cash equivalents ..................... 55,743 41,720
Interest-bearing deposits in financial institutions ..... 895 198
Available for sale securities, at fair value (amortized
cost of $271,104 (unaudited) and $481,899,
respectively) .......................................... 275,221 482,233
Held to maturity securities, at cost (fair value of
$629,063 (unaudited) and $274,227, respectively) ....... 610,338 270,089
Loans ................................................... 647,715 424,400
Less allowance for credit losses ........................ (8,173) (5,985)
---------- ----------
Loans, net ................................ 639,542 418,415
Accrued interest receivable ............................. 10,260 8,466
Goodwill (net of accumulated amortization of $6,354
(unaudited) and $6,354, respectively) .................. 62,461 22,641
Core Deposit Intangibles (net of accumulated amortization
of $30 and $0) ......................................... 668 --
Bank premises and equipment, net ........................ 23,847 15,077
Other real estate owned ................................. 587 --
Other assets ............................................ 10,547 3,486
---------- ----------
TOTAL ASSETS ............................................ $1,690,109 $1,262,325
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Deposits:
Noninterest-bearing .............................. $ 303,612 $ 188,832
Interest-bearing.................................. 1,163,947 934,565
---------- ----------
Total deposits ............................ 1,467,559 1,123,397
Other borrowings ..................................... 28,309 18,080
Accrued interest payable ............................. 2,385 2,869
Other liabilities..................................... 9,284 2,254
---------- ----------
Total liabilities ......................... 1,507,537 1,146,600
COMPANY-OBLIGATED MANDATORILY REDEEMABLE
TRUST PREFERRED SECURITIES OF SUBSIDIARY TRUSTS ..... 33,000 27,000
SHAREHOLDERS' EQUITY:
Common stock, $1.00 par value; 50,000,000 shares
authorized; 18,893,024 (unaudited) and 16,218,022,
shares issued at September 30, 2002 and
December 31, 2001, respectively; 18,885,872
(unaudited) and 16,210,870 shares outstanding at
September 30, 2002 and December 31, 2001,
respectively ........................................ 18,893 16,218
Capital surplus....................................... 60,273 16,865
Retained earnings..................................... 67,575 55,462
Accumulated other comprehensive income -- net
unrealized gain on available for sale securities,
net of tax of $1,544 (unaudited) and $117,
respectively ........................................ 2,868 217
Less treasury stock, at cost, 7,152 shares at
September 30, 2002 (unaudited) and
December 31, 2001 ................................... (37) (37)
---------- ----------
Total shareholders' equity ................ 149,572 88,725
---------- ----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY .............. $1,690,109 $1,262,325
========== ==========
See notes to interim consolidated financial statements.
3
PROSPERITY BANCSHARES, INC.(SM) AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ------------------------
2002 2001 2002 2001
----------- --------- --------- --------
(Dollars in thousands, except per share data)
INTEREST INCOME:
Loans, including fees ....................... $ 9,828 $ 8,839 $ 25,945 $ 26,578
Securities:
Taxable. ................................... 9,792 9,243 29,685 27,436
Nontaxable ................................. 453 401 1,221 1,190
70% nontaxable preferred dividends ......... 263 344 879 999
Deposits in financial institutions .......... 14 6 14 28
Federal funds sold. ......................... 69 268 161 1,333
--------- --------- --------- --------
Total interest income. .................... 20,419 19,101 57,905 57,564
--------- --------- --------- --------
INTEREST EXPENSE:
Deposits. ................................. 6,245 8,773 18,434 27,624
Note payable and federal funds sold ....... 219 68 669 643
--------- --------- --------- --------
Total interest expense .................. 6,464 8,841 19,103 28,267
--------- --------- --------- --------
NET INTEREST INCOME ..................... 13,955 10,260 38,802 29,297
PROVISION FOR CREDIT LOSSES ................. 120 50 360 50
--------- --------- --------- --------
NET INTEREST INCOME AFTER
PROVISION FOR CREDIT LOSSES .............. 13,835 10,210 38,442 29,247
--------- --------- --------- --------
NONINTEREST INCOME:
Customer service fees ..................... 2,632 1,924 6,491 5,501
Other ..................................... 261 263 889 779
--------- --------- --------- --------
Total noninterest income ................. 2,893 2,187 7,380 6,280
-------- --------- --------- --------
NONINTEREST EXPENSE:
Salaries and employee benefits ............ 3,954 3,247 11,268 9,759
Net occupancy expense ..................... 619 493 1,614 1,483
Data processing ........................... 532 526 1,495 1,551
Core deposit intangible and goodwill
amortization ............................. 26 341 30 1,022
Depreciation expense ...................... 459 385 1,230 1,183
Minority interest trust preferred
securities ............................... 524 475 1,518 1,051
Merger related expenses ................... -- -- -- 2,425
Other ..................................... 2,392 1,601 7,138 4,460
--------- --------- --------- --------
Total noninterest expense ................ 8,506 7,068 24,293 22,934
--------- --------- --------- --------
INCOME BEFORE INCOME TAXES .................. 8,222 5,329 21,529 12,593
PROVISION FOR INCOME TAXES .................. 2,569 1,598 6,590 3,625
--------- --------- --------- --------
NET INCOME .................................. $ 5,653 $ 3,731 $ 14,939 $ 8,968
========= ========= ========= ========
EARNINGS PER SHARE
Basic ....................................... $ 0.33 $ 0.23 $ 0.90 $ 0.56
========= ========= ========= ========
Diluted ..................................... $ 0.32 $ 0.23 $ 0.89 $ 0.55
========= ========= ========= ========
See notes to interim consolidated financial statements.
4
PROSPERITY BANCSHARES, INC.(SM) AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Accumulated
Other
Comprehensive
Income -- Net
Unrealized Gain
Common Stock (Loss) on Avail- Total
------------------- Capital Retained able for Sale Treasury Shareholders'
Shares Amount Surplus Earnings Securities Stock Equity
-------- -------- ------- -------- -------------- -------- -------------
(Amounts in thousands, except share data)
BALANCE AT JANUARY 1, 2001 ................. 16,150,972 $ 16,151 $ 17,949 $ 45,665 $ 605 $ (37) $ 80,333
Net income ................................. 12,958 12,958
Net change in unrealized gain on
available for sale securities ....... (388) (388)
----------
Total comprehensive income ............ 12,570
----------
Cash paid to dissenting shareholders
in connection with the issuance of
common stock in exchange for common
stock of Commercial Bancshares, Inc.. (63,550) (64) (783) (847)
Trust preferred issuance costs ...... (476) (476)
Sale of common stock .................. 130,600 131 175 306
Cash dividends declared ............... (3,161) (3,161)
---------- -------- -------- -------- --------- --------- ----------
BALANCE AT DECEMBER 31, 2001 ............... 16,218,022 $ 16,218 $ 16,865 $ 55,462 $ 217 $ (37) $ 88,725
Net income (unaudited) ................ 14,939 14,939
Net change in unrealized gain on
available for sale securities
(unaudited) ......................... 2,651 2,651
----------
Total comprehensive income (unaudited). 17,590
----------
Shares issued in connection with the
Paradigm Acquisition ................ 2,580,502 2,580 43,294 45,874
Sale of common stock (unaudited) ...... 94,500 95 117 212
Cash paid in lieu of fractional
shares for the Paradigm Acquisition . (3) (3)
Cash dividends declared (unaudited) . (2,826) (2,826)
---------- -------- -------- --------- --------- --------- ----------
BALANCE AT SEPTEMBER 30, 2002
(unaudited) ........................... 18,893,024 $ 18,893 $ 60,273 $ 67,575 $ 2,868 $ (37) $ 149,572
========== ======== ======== ======== ========= ========= ==========
See notes to interim consolidated financial statements.
5
PROSPERITY BANCSHARES, INC.(SM) AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Nine Months Ended
September 30,
----------------------------
2002 2001
----------- ----------
(Dollars in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income .............................................. $ 14,939 $ 8,968
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation and amortization ......................... 1,260 2,205
Provision for credit losses ........................... 360 50
Loss on sale of premises and equipment ................ 4 341
Gain on sale of other real estate .................... (81) --
Net amortization of premium/discount
on investments ..................................... 2,566 465
(Increase) decrease in accrued interest receivable
and other assets ................................... (2,081) 1,216
(Decrease) increase in accrued interest payable
and other liabilities ............................... (295) 2,940
----------- ----------
Total adjustments ................................... 1,733 7,217
----------- ----------
Net cash provided by operating activities ........... 16,672 16,185
----------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities and principal
paydowns of held to maturity securities ............... 110,013 155,482
Purchase of held to maturity securities ................. (177,942) (16,067)
Proceeds from maturities and principal
paydowns of available for sale securities ............. 69,293 66,883
Purchase of available for sale securities ............... (74,475) (340,067)
Net increase in loans ................................... 3,268 (8,354)
Purchase of bank premises and equipment ................. (1,110) (2,087)
Proceeds from sale of bank premises and equipment
and other real estate acquired by foreclosure ....... 861 557
Premium paid for the purchase of Texas Guaranty
Bank N.A. ........................................... (3,318) --
Net liabilities acquired in the purchase of Texas
Guaranty Bank, N.A. (net of cash of $12,723) ........ 3,815 --
Premium paid for the purchase of The First State
Bank of Needville ................................... (1,686) --
Net liabilities acquired in the purchase of The First
State Bank of Needville (net of cash
of $4,938) .......................................... 2,859 --
Premium paid for the purchase of Paradigm
Bancorporation ...................................... (35,218) --
Net liabilities acquired in the purchase of Paradigm
Bancorporation (net of cash of $14,447) ............. 49,223 --
----------- ----------
Net cash used in investing activities ................. (54,417) (143,653)
----------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in noninterest-bearing
deposits .............................................. 14,143 (5,612)
Net increase in interest-bearing deposits ............... 35,813 63,727
Extensions (repayments) of line of credit ............... 4,429 (466)
Cash paid to dissenting shareholders .................... -- (847)
Proceeds from the issuance of trust preferred
securities ............................................ -- 15,000
Cash paid in lieu of fractional shares for the
Paradigm acquisition .................................. (3) --
Stock issuance costs .................................... -- (476)
Payments of cash dividends .............................. (2,826) (2,350)
Sale of common stock .................................... 212 278
----------- ----------
Net cash provided by
financing activities ............................. 51,768 69,254
----------- ----------
NET INCREASE (DECREASE) OF CASH AND
CASH EQUIVALENTS. ....................................... $ 14,023 $ (58,214)
CASH AND CASH EQUIVALENTS, BEGINNING
OF PERIOD ............................................... 41,720 99,163
----------- ----------
CASH AND CASH EQUIVALENTS, END OF
PERIOD. ................................................. $ 55,743 $ 40,949
=========== ==========
See notes to interim consolidated statements.
6
PROSPERITY BANCSHARES, INC.(SM) AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2002
(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, 2001.
Operating results for the nine month period ended September 30, 2002 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2002.
2. INCOME PER COMMON SHARE
The following table illustrates the computation of basic and diluted
earnings per share (in thousands, except per share data):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ --------------------------
2002 2001 2002 2001
-------- --------- --------- ---------
Net income available to common shareholders $ 5,653 $ 3,731 $ 14,939 $ 8,968
Weighted average common shares outstanding 17,097 16,194 16,526 16,162
Potential dilutive common shares 324 332 326 324
-------- --------- --------- ---------
Weighted average common shares and equivalents
outstanding 17,421 16,526 16,852 16,486
-------- --------- --------- ---------
Basic earnings per common share $ 0.33 $ 0.23 $ 0.90 $ 0.56
======== ========= ========= =========
Diluted earnings per common share $ 0.32 $ 0.23 $ 0.89 $ 0.55
======== ========= ========= =========
7
PROSPERITY BANCSHARES, INC.(SM) AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
SEPTEMBER 30, 2002
(DOLLARS IN THOUSANDS)
(UNAUDITED)
3. RECENT ACCOUNTING STANDARDS
In July 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 142 (SFAS 142), Goodwill and Other Intangible
Assets, which addresses the accounting for goodwill and other intangible assets.
SFAS 142 specifies that, among other things, intangible assets with an
indefinite useful life and goodwill will no longer be amortized. The standard
requires goodwill to be periodically tested for impairment and written down to
fair value if considered impaired. The provisions of SFAS 142 were effective for
fiscal years beginning after December 15, 2001.
In July 2001, FASB issued SFAS 143, Accounting for Asset Retirement
Obligations. The statement requires entities to record the fair value of a
liability for an asset retirement obligation in the period in which it is
incurred. When the liability is initially recorded, the entity capitalizes a
cost by increasing the carrying amount of the related long-lived asset. Over
time, the liability is accreted to its present value each period, and the
capitalized cost is depreciated over the useful life of the related asset. Upon
settlement of the liability, an entity either settles the obligation for its
recorded amount or incurs a gain or loss upon settlement. The standard is
effective for fiscal years beginning after September 15, 2002, with earlier
application encouraged. Management does not believe the adoption of this
statement will have a material impact on the Company's financial position or
results of operations.
In August 2001, the FASB issued SFAS 144, Accounting for Impairment or
Disposal of Long-lived Assets. SFAS 144 addresses financial accounting and
reporting for the impairment of long-lived assets and for long-lived assets to
be disposed of. It supersedes, with exceptions, SFAS 121, Accounting for the
Impairment of Long-lived Assets and Long-lived Assets to be Disposed Of, and was
effective for fiscal years beginning after December 15, 2001. Management
believes the adoption of this statement did not have a material impact on the
Company's financial position or results of operations.
In October 2002, the FASB issued SFAS 147, Acquisitions of Certain
Financial Institutions ("SFAS 147"). SFAS 147 provides guidance on the
accounting for the acquisition of a financial institution, except transactions
between two or more mutual enterprises. The Company's management does not
believe that the implementation of this standard will have a material impact on
the Company's financial position or results of operations.
4. RECENT MERGER ACTIVITY
On November 1, 2002, the Company completed the acquisition of First
National Bank of Bay City, Bay City, Texas ("FNB"), through the merger of FNB
with and into Prosperity Bank. Under the terms of the Agreement and Plan of
Reorganization dated as of August 15, 2002, as amended, the Company paid
approximately $5.1 million in cash for all of the issued and outstanding common
stock of FNB. FNB was privately held and operated one (1) location in Bay City,
Texas, which was closed and consolidated with Prosperity Bank's Bay City banking
center. As of September 30, 2002, FNB had total assets of $27.1 million, total
loans of $8.3 million, total deposits of $23.2 million and shareholders' equity
of $3.6 million.
On October 1, 2002, the Company completed the acquisition of Southwest Bank
Holding Company, Dallas, Texas ("Southwest"). Southwest's wholly owned
subsidiary, Bank of the Southwest, Dallas, Texas, became a subsidiary of the
Company. Under the terms of the Agreement and Plan of Merger dated as of July
14, 2002, the Company paid approximately $19.6 million in cash. Bank of the
Southwest was privately held and operated two (2) banking offices in Dallas,
Texas. As of September 30, 2002, Southwest had total assets of $121.9 million,
total loans of $58.7 million, total deposits of $108.9 million and shareholders'
equity of $12.6 million.
On September 1, 2002, the Company completed the acquisition of Paradigm
Bancorporation, Inc. ("Paradigm") in a stock transaction. Under terms of the
Agreement and Plan of Reorganization dated as of May 2, 2002, Prosperity issued
approximately 2.58 million shares of its common stock for all outstanding shares
of Paradigm (giving effect to the two for one stock split). Paradigm operated a
total of eleven (11) banking offices - six (6) in the greater metropolitan
Houston area and five (5) in the nearby Southeast Texas cities of Dayton,
Galveston, Mont Belvieu, and Winnie. As of September 1, 2002, Paradigm
Bancorporation had total assets of $248.7 million, total loans of $175.7
million, total deposits of $218.3 million and shareholders' equity of $17.0
million.
8
On July 12, 2002, the Company completed the acquisition of The First State
Bank, Needville, Texas ("First State") for approximately $3.7 million in cash.
Prosperity Bank's existing Needville Banking Center has relocated into the
former First State Bank location effective July 15, 2002. As of July 12, 2002,
The First State Bank had total assets of $16.3 million, loans of $5.5 million,
deposits of $14.1 million and shareholders' equity of $2.1 million.
On May 8, 2002, the Company completed the acquisition of Texas Guaranty
Bank, N.A. ("Texas Guaranty") for approximately $11.8 million in cash. Texas
Guaranty Bank operated three offices in Houston, Texas, all of which became full
service banking centers of Prosperity Bank. As of May 8, 2002, Texas Guaranty
Bank had total assets of $74.0 million, loans of $45.7 million, deposits of
$61.8 million and shareholders' equity of $8.6 million.
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 the 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. The
important factors that could cause actual results to differ materially from the
forward-looking statements include, without limitation:
o changes in interest rates and market prices, which could reduce the
Company's net interest margins, asset valuations and expense expectations;
o changes in the levels of loan prepayments and the resulting effects on the
value of the Company's loan portfolio;
o changes in local economic and business conditions which adversely affect
the Company's customers and their ability to transact profitable business
with the company, including the ability of the Company's borrowers to repay
their loans according to their terms or a change in the value of the
related collateral;
o increased competition for deposits and loans adversely affecting rates and
terms;
o the timing, impact and other uncertainties of future acquisitions,
including the Company's ability to identify suitable future acquisition
candidates, the success or failure in the integration of their operations,
and the ability to enter new markets successfully and capitalize on growth
opportunities;
o increased credit risk in the Company's assets and increased operating risk
caused by a material change in commercial, consumer and/or real estate
loans as a percentage of the total loan portfolio;
o the failure of assumptions underlying the establishment of and provisions
made to the allowance for credit losses;
o changes in the availability of funds resulting in increased costs or
reduced liquidity;
o increased asset levels and changes in the composition of assets and the
resulting impact on the Company's capital levels and regulatory capital
ratios;
o the Company's ability to acquire, operate and maintain cost effective and
efficient systems without incurring unexpectedly difficult or expensive but
necessary technological changes;
o the loss of senior management or operating personnel and the potential
inability to hire qualified personnel at reasonable compensation levels;
o changes in statutes and government regulations or their interpretations
applicable to financial holding companies and the Company's present and
future banking and other subsidiaries, including changes in tax
requirements and tax rates;
o acts of terrorism, an outbreak of hostilities or other international or
domestic calamities, weather or other acts of God and other matters beyond
the Company's control; and
9
o other risks and uncertainties listed from time to time in the Company's
reports and documents filed with the Securities and Exchange Commission.
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.
STOCK SPLIT
On May 31, 2002, the Company effected a two-for-one stock split in the form
of a 100 percent stock dividend to shareholders of record on May 20, 2002. The
Company's Common Stock outstanding increased to approximately 16.2 million
shares after the split. All per share and share information has been restated to
reflect this split.
OVERVIEW
The Company is a registered financial holding company that derives
substantially all of its revenues and income from the operation of its two bank
subsidiaries, Prosperity Bank/SM/ and Bank of the Southwest. Bank of the
Southwest was acquired on October 1, 2002 and therefore no financial information
regarding Bank of the Southwest is included in the financial statements of the
Company at September 30, 2002. Both banks provide a broad line of financial
products and services to small and medium-sized businesses and consumers. Bank
of the Southwest operates two (2) full service banking locations in Dallas,
Texas and Prosperity Bank/SM/ operates forty (40) full-service banking locations
in the greater Houston metropolitan area and fifteen contiguous counties
situated south and southwest of Houston and extending into South Texas.
Total assets were $1.69 billion at September 30, 2002 compared with $1.26
billion at December 31, 2001. Total loans increased to $647.7 million at
September 30, 2002 from $424.4 million at December 31, 2001, an increase of
$223.3 million, or 52.6%. Loans acquired in the Texas Guaranty acquisition
totaled $45.7 million and loans acquired in the Paradigm acquisition totaled
$175.7 million. Total deposits were $1.47 billion at September 30, 2002 compared
with $1.12 billion at December 31, 2001, a increase of $344.2 million, or 30.6%.
Shareholders' equity increased $60.9 million or 68.9%, to $149.6 million at
September 30, 2002 compared with $88.7 million at December 31, 2001.
RESULTS OF OPERATIONS AS REPORTED
Net income available to common shareholders was $5.7 million ($0.32 per
common share on a diluted basis) for the quarter ended September 30, 2002
compared with $3.7 million ($0.23 per common share on a diluted basis) for the
quarter ended September 30, 2001, an increase of $1.9 million, or 51.5%. The
Company posted returns on average common equity of 19.43% and 17.34%, returns on
average assets of 1.54% and 1.25% and efficiency ratios of 48.90% and 55.07% for
the quarters ended September 30, 2002 and 2001, respectively.
For the nine months ended September 30, 2002, net income available to
common shareholders was $14.9 million ($0.89 per common share on a diluted
basis) compared with $9.0 million ($0.55 per common share on a diluted basis)
for the same period in 2001, an increase of $6.0 million or 66.9%. The Company
posted returns on average common equity of 19.64% and 14.30%, returns on average
assets of 1.46% and 1.02% and efficiency ratios of 50.99% and 63.38% for the
nine months ended September 30, 2002 and 2001, respectively. The increase in
earnings per share, ROAA, ROAE and the efficiency ratio for the nine months
ended September 30, 2002 compared with the same period in 2001 was primarily due
to the combined effect of earning asset growth and the $2.4 million in pre-tax
merger-related expenses and other charges incurred in February 2001 in
connection with the merger of Commercial Bancshares, Inc. (the "Commercial
Merger") into the Company, which was accounted for as a pooling of interests.
Results of Operations Excluding Merger-Related Expenses
Excluding the pre-tax merger-related expenses of $2.4 million incurred in
2001 in connection with the Commercial Merger, net income for the nine months
ended September 30, 2002 was $14.9 million ($0.89 per common share on a diluted
basis) compared with net income of $10.5 million ($0.64 per common share on a
diluted basis) for the nine months ended September 30, 2001, an increase of $4.4
million or 41.2%. Excluding the merger-related expenses in 2001, the Company
would have posted returns on average common equity of 19.64% and 16.82%, returns
on average assets of 1.46% and 1.20% and efficiency ratios of 50.99% and 56.36%
for the nine months ended September 30, 2002 and 2001, respectively.
10
Net Interest Income
Net interest income was $14.0 million for the quarter ended September 30,
2002 compared with $10.3 million for the quarter ended September 30, 2001, an
increase of $3.7 million, or 36.0%. Net interest income increased primarily as a
result of an increase in average interest-earning assets to $1.36 billion for
the quarter ended September 30, 2002 from $1.12 billion for the quarter ended
September 30, 2001, an increase of $240.1 million, or 21.4%. Additionally, net
interest income increased due to a change in the net interest margin from 3.66%
for the three months ended September 30, 2001 to 4.10% for the three months
ended September 30, 2002.
The expansion of the net interest margin was principally due to a 154 basis
point decrease in the rate paid on interest-bearing liabilities from 3.94% for
the quarter ended September 30, 2001 to 2.40% for the quarter ended September
30, 2002, partially offset by a 81 basis point decrease in the yield on earning
assets from 6.81% for the quarter ended September 30, 2001 to 6.00% for the
quarter ended September 30, 2002.
Net interest income increased $9.5 million, or 32.4%, to $38.8 million for
the nine months ended September 30, 2002 from $29.3 million for the same period
in 2001. This increase is mainly attributable to an increase in average
interest-earning assets to $1.28 billion for the nine months ended September 30,
2002 from $1.10 billion for the nine months ended September 30, 2001, an
increase of $181.6 million, or 16.6%. Additionally, net interest income
increased due to a change in the net interest margin from 3.56% for the nine
months ended September 30, 2001 to 4.05% for the nine months ended September 30,
2002.
The expansion of the net interest margin was primarily due to a 178 basis
point decrease in the rate paid on interest-bearing liabilities from 4.27% for
the nine months ended September 30, 2001 to 2.49% for the nine months ended
September 30, 2002, partially offset by a 96 basis point decrease in the yield
on earning assets from 7.00% for the nine months ended September 30, 2001 to
6.04% for the nine months ended September 30, 2002.
11
The following tables set forth, for each category of interest-earning
assets and interest-bearing liabilities, the average amounts outstanding, the
interest earned or paid on such amounts, and the average rate earned or paid for
the quarter ended September 30, 2002 and 2001 and for the nine months ended
September 30, 2002 and 2001, respectively. The tables also set forth 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.
Three Months Ended September 30,
-----------------------------------------------------------------
2002 2001
----------------------------- ----------------------------------
Average Interest Average Average Interest Average
Outstanding Earned/ Yield/ Outstanding Earned/ Yield/
Balance Paid Rate (4) Balance Paid Rate (4)
----------- ------- --------- --------- ------ ---------
(Dollars in thousands)
Assets
Interest-earning assets:
Loans ............................. $ 537,466 $ 9,828 7.31% $ 427,984 $ 8,839 8.26%
Securities(1) ..................... 808,187 10,508 5.20 663,089 9,988 6.03
Federal funds sold and other
temporary investments ............ 16,459 83 2.02 30,919 274 3.54
---------- ------- ---------- --------
Total interest-earning assets ... 1,362,112 20,419 6.00% 1,121,992 19,101 6.81%
------- --------
Less allowance for credit losses .. (7,307) (5,579)
---------- ----------
Total interest-earning assets,
net of allowance ............... 1,354,805 1,116,413
Noninterest-earning assets ..... 111,184 78,484
---------- ----------
Total assets .................... $1,465,989 $1,194,897
========== ==========
Liabilities and shareholders' equity
Interest-bearing liabilities:
Interest-bearing demand deposits .. $ 238,636 $ 775 1.30% $ 194,277 $ 1,062 2.19%
Savings and money market accounts . 311,421 1,338 1.72 252,015 3,161 5.02
Certificates of deposit ........... 513,025 4,132 3.22 438,772 4,550 4.15
Federal funds purchased and other
borrowings. ...................... 15,668 219 5.59 13,563 68 2.01
--------- -------- ---------- --------
Total interest-bearing
liabilities .................... 1,078,750 6,464 2.40% 898,627 8,841 3.94%
--------- -------- ---------- --------
Noninterest-bearing liabilities:
Noninterest-bearing demand
deposits.......................... 232,450 177,296
Company-obligated mandatorily
redeemable trust preferred
securities of subsidiary
trusts ......................... 28,000 24,500
Other liabilities. ................ 10,409 8,413
---------- ----------
Total liabilities. .............. 1,349,609 1,108,836
--------- -----------
Shareholders' equity ................ 116,380 86,061
--------- ----------
Total liabilities and
shareholders' equity ........... $1,465,989 $1,194,897
========== ==========
Net interest rate spread ............ 3.60% 2.87%
Net interest income and margin(2) ... $ 13,955 4.10% $ 10,260 3.66%
========= ========
Net interest income and margin
(tax-equivalent basis)(3) .......... $ 14,399 4.23% $ 10,763 3.84%
========= ========
- -------------------
(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 35%.
(4) Annualized.
12
Nine Months Ended September 30,
-----------------------------------------------------------------
2002 2001
----------------------------- ----------------------------------
Average Interest Average Average Interest Average
Outstanding Earned/ Yield/ Outstanding Earned/ Yield/
Balance Paid Rate (4) Balance Paid Rate (4)
----------- ------- --------- --------- ------ ---------
(Dollars in thousands)
Assets
Interest-earning assets:
Loans ............................. $ 470,374 $25,945 7.35% $ 420,401 $26,578 8.43%
Securities(1) ..................... 794,155 31,785 5.34 639,579 29,625 6.18
Federal funds sold and other
temporary investments ............ 13,442 175 1.74 36,423 1,361 4.98
---------- -------- ---------- -------
Total interest-earning assets .... 1,277,971 57,905 6.04% 1,096,403 57,564 7.00%
--------- -------
Less allowance for credit losses .. (6,621) (5,568)
----------- ----------
Total interest-earning assets,
net of allowance ............... 1,271,350 1,090,835
Noninterest-earning assets ..... 91,440 81,190
---------- ----------
Total assets .................... $1,362,790 $1,172,025
========== ==========
Liabilities and shareholders' equity
Interest-bearing liabilities:
Interest-bearing demand deposits .. $ 238,729 $ 2,360 1.32% $ 194,088 $ 3,747 2.57%
Savings and money market accounts . 291,776 3,836 1.75 247,175 7,587 4.09
Certificates of deposit. .......... 477,285 12,238 3.42 424,352 16,290 5.12
Federal funds purchased and other
borrowings. ...................... 16,764 669 5.32 17,915 643 4.79
---------- -------- ---------- -------
Total interest-bearing
liabilities .................... 1,024,554 19,103 2.49% 883,530 28,267 4.27%
---------- --------- ---------- -------
Noninterest-bearing liabilities:
Noninterest-bearing demand
deposits ......................... 200,784 180,376
Company-obligated mandatorily
redeemable trust preferred
securities of subsidiary
trusts ........................ 27,333 16,167
Other liabilities. ................ 8,691 8,354
---------- ----------
Total liabilities. .............. 1,261,362 1,088,427
---------- ----------
Shareholders' equity ................ 101,428 83,598
---------- ----------
Total liabilities and
shareholders' equity .......... $1,362,790 $1,172,025
========== ==========
Net interest rate spread ............ 3.56% 2.73%
Net interest income and margin(2) ... $ 38,802 4.05% $ 29,297 3.56%
========= ========
Net interest income and margin
(tax-equivalent basis)(3) .......... $ 40,189 4.19% $ 30,779 3.74%
========= ========
- --------------------
(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 35%.
(4) Annualized.
13
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."
The following tables present the dollar amount of changes in interest
income and interest expense for the major components of interest-earning assets
and interest-bearing liabilities and distinguish between the increase (decrease)
related to outstanding balances and the volatility of interest rates for the
periods indicated. For purposes of these tables, changes attributable to both
rate and volume which cannot be segregated have been allocated to rate.
Three Months Ended September 30,
---------------------------------
2002 vs. 2001
---------------------------------
Increase
(Decrease)
Due to
----------------------
Volume Rate Total
--------- --------- ---------
(Dollars in thousands)
Interest-earning assets:
Loans ...................................... $ 2,261 $ (1,272) $ 989
Securities ................................. 2,186 (1,666) 520
Federal funds sold and other temporary
investments .............................. (128) (63) (191)
--------- --------- ---------
Total increase (decrease) in interest
income ................................. 4,319 (3,001) 1,318
--------- --------- ---------
Interest-bearing liabilities:
Interest-bearing demand deposits ........... 242 (529) (287)
Savings and money market accounts. ......... 745 (2,568) (1,823)
Certificates of deposit. ................... 770 (1,188) (418)
Federal funds purchased and other
borrowings ............................... 11 140 151
--------- --------- ---------
Total increase (decrease) in interest
expense ................................. 1,768 (4,145) (2,377)
--------- --------- ---------
Increase in net interest income .............. $ 2,551 $ 1,144 $ 3,695
========= ========== =========
Nine Months Ended September 30,
-------------------------------------
2002 vs. 2001
-------------------------------------
Increase
(Decrease)
Due to
----------------------
Volume Rate Total
--------- --------- ---------
(Dollars in thousands)
Interest-earning assets:
Loans ...................................... $ 3,159 $ (3,792) $ (633)
Securities ................................. 7,160 (5,000) 2,160
Federal funds sold and other temporary
investments .............................. (859) (327) (1,186)
--------- --------- ---------
Total increase (decrease) in interest
income ................................ 9,460 (9,119) 341
--------- --------- ---------
Interest-bearing liabilities:
Interest-bearing demand deposits ........... 862 (2,249) (1,387)
Savings and money market accounts .......... 1,369 (5,120) (3,751)
Certificates of deposit. ................... 2,032 (6,084) (4,052)
Federal funds purchased and other
borrowings ............................... (41) 67 26
---------- --------- ---------
Total increase (decrease) in interest
expense ................................ 4,222 (13,386) (9,164)
--------- --------- ---------
Increase in net interest income .............. $ 5,238 $ 4,267 $ 9,505
========= ========= =========
Provision for Credit Losses
Management actively monitors the Company's asset quality and provides
specific loss provisions when necessary. Provisions for credit losses are
charged to income to bring the total allowance for credit losses to a level
deemed appropriate by management of the Company based on such factors as
historical credit loss experience, industry diversification of the commercial
loan portfolio, the amount of nonperforming loans and related collateral,
14
the volume growth and composition of the loan portfolio, current economic
conditions that may affect the borrower's ability to pay and the value of
collateral, the evaluation of the loan portfolio through the internal loan
review function and other relevant factors.
Provisions for credit losses are charged to income to bring the total
allowance for credit losses to a level deemed appropriate by management of the
Company based on such factors as historical loan loss experience, industry
diversification of the commercial loan portfolio, the amount of nonperforming
loans and related collateral, the volume growth and composition of the loan
portfolio, current economic conditions that may affect the borrower's ability to
pay and the value of collateral, the evaluation of the loan portfolio through
the internal loan review function and other relevant factors.
The provision for credit losses for the quarter ended September 30, 2002
was $120,000 compared with a $50,000 provision for the corresponding period in
2001. The provision for credit losses for the nine months ended September 30,
2002 was $360,000 compared with a $50,000 provision for the same period in 2001.
The $310,000 increase in the provision for credit losses was primarily due to a
52.6% increase in the Company's loan portfolio from $424.4 million at December
31, 2001 to $647.7 million at September 30, 2002.
Noninterest Income
The Company's primary sources of noninterest income are service charges on
deposit accounts and other banking service related fees. The following table
presents, for the periods indicated, the major categories of noninterest income:
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------------------------------
2002 2001 2002 2001
-------- ------- --------- ---------
(Dollars in thousands)
Service charges on deposit accounts .. $ 2,632 $ 1,924 $ 6,491 $ 5,501
Other noninterest income ............. 261 263 889 779
------- ------- ------- --------
Total noninterest income .......... $ 2,893 $ 2,187 $ 7,380 $ 6,280
======= ======= ======= ========
Noninterest income totaled $2.9 million for the three months ended
September 30, 2002 compared with $2.2 million for the same period in 2001, an
increase of $706,000, or 32.3%. Noninterest income increased $1.1 million, or
17.5%, to $7.4 million for the nine months ended September 30, 2002 from $6.3
million for the same period in 2001. The increase is primarily attributable to
the Texas Guaranty and Paradigm acquisitions.
Noninterest Expense
Noninterest expense totaled $8.5 million for the quarter ended September
30, 2002 compared with $7.1 million for the quarter ended September 30, 2001, an
increase of $1.4 million, or 20.4%. This change is principally due to increases
in salaries and employee benefits, building and equipment costs and general
operating expenses related to the Paradigm, First State and Texas Guaranty
acquisitions.
Noninterest expense totaled $24.3 million for the nine months ended
September 30, 2002, an increase of $1.4 million, or 5.9%, from $22.9 million for
the same period in 2001. In February 2001, the Company incurred $2.4 million in
merger-related expenses and other charges in connection with the merger of
Commercial. The $2.4 million in merger-related charges include closing costs,
legal fees, accounting fees, broker fees, employee related costs, and contract
terminations. Had the Company not incurred the $2.4 million in merger-related
expenses in 2001, noninterest expense for the nine months ended September 30,
2002 would have increased $3.8 million or 18.5% compared with the same period in
2001. This change is principally due to increases in salaries and employee
benefits, building and equipment costs and general operating expenses associated
with the Paradigm, First State and Texas Guaranty acquisitions. The change in
non-interest expense was also impacted by an increase in minority interest
expense related to the trust preferred securities due to the issuance of $15.0
million in trust preferred securities in July 2001 which was partially offset by
a decrease in goodwill amortization expense due to a recent accounting change.
15
The following table presents, for the periods indicated, the major
categories of noninterest expense:
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- ------------------
2002 2001 2002 2001
--------- --------- -------- --------
(Dollars in thousands)
Salaries and employee benefits ................ $ 3,954 $ 3,247 $ 11,268 $ 9,759
Non-staff expenses:
Net occupancy expense ..................... 619 493 1,614 1,483
Depreciation .............................. 459 385 1,230 1,183
Data processing ........................... 532 526 1,495 1,551
Communications expense (telephone, data
circuits and courier) ................... 462 380 1,274 1,040
Professional fees ......................... 125 101 384 212
Regulatory assessments and FDIC insurance.. 77 55 231 177
Ad valorem and franchise taxes............. 148 118 396 363
Core deposit intangibles and goodwill
amortization ............................ 26 341 30 1,022
Minority interest expense trust preferred
securities .............................. 524 475 1,518 1,051
Merger-related expenses ................... -- -- -- 2,425
Other ..................................... 1,580 947 4,853 2,668
--------- --------- -------- -------
Total non-staff expenses ...................... 4,552 3,822 13,025 13,175
Total noninterest expense ..................... $ 8,506 $ 7,068 $ 24,293 $ 22,934
========= ========= ======== ========
Salaries and employee benefit expenses were $4.0 million for the quarter
ended September 30, 2002 compared with $3.3 million for the quarter ended
September 30, 2001, an increase of $707,000, or 21.8%. For the nine months ended
September 30, 2002, salaries and employee benefits increased $1.5 million or
15.5% compared with the same period in 2001. Both increases were principally due
to annual employee salary increases and additional staff associated with the
Texas Guaranty, First State and Paradigm acquisitions.
Non-staff expenses increased $730,000, or 19.1%, to $4.6 million for the
quarter ended September 30, 2002 compared with the same period in 2001. The
increase was principally due to acquisition expenses for the three months ended
September 30, 2002, partially offset by a decrease in goodwill amortization due
to a recent accounting change. For the nine month period ended September 30,
2002, non-staff expenses decreased $150,000, or 1.2%, to $13.0 million from
$13.2 million for the same period in 2001. Non-staff expenses for the nine
months ended September 30, 2001 included $2.4 million in pre-tax merger expenses
related to the Commercial Merger. Had the Company not incurred the $2.4 million
in pre-tax merger expenses in 2001, non-staff expenses would have increased $2.3
million, or 21.2%, to $13.0 million for the nine months ended September 30,
2002. The increase was primarily due to the Paradigm, First State and Texas
Guaranty acquisitions.
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.
16
Income Taxes
Income tax expense increased $971,000, or 60.8%, to $2.6 million for the
three months ended September 30, 2002 from $1.6 million for the same period in
2001. For the nine month period ended September 30, 2002, income tax expense
increased $3.0 million, or 81.8%, to $6.6 million from $3.6 million for the same
period in 2001. The increase was primarily attributable to higher pretax net
earnings which resulted from an increase in net interest income for the nine
months ended September 30, 2002 when compared to the same period in 2001. In
addition, the Company incurred $2.4 million in merger-related expenses during
the nine months ended September 30, 2001 which had a tax benefit of
approximately $849,000.
FINANCIAL CONDITION
Loan Portfolio
Total loans were $647.7 million at September 30, 2002, an increase of
$223.3 million, or 52.6% from $424.4 million at December 31, 2001. Loans
acquired in the Texas Guaranty Acquisition totaled $45.7 million and loans
acquired in the Paradigm acquisition totaled $175.7 million. Loan growth
occurred primarily in construction and land development loans and commercial
mortgage loans. Period end loans comprised 50.7% of average earning assets at
September 30, 2002 compared with 38.0% at December 31, 2001.
The following table summarizes the loan portfolio of the Company by type of
loan as of September 30, 2002 and December 31, 2001:
September 30, December 31,
2002 2001
------------------ ------------------
Amount Percent Amount Percent
--------- ------- -------- -------
(Dollars in thousands)
Commercial and industrial..$ 86,678 13.4% $ 46,986 11.1%
Real estate:
Construction and land
development......... 52,163 8.1 20,963 4.9
1-4 family residential... 197,876 30.5 175,253 41.3
Home equity.............. 24,246 3.7 20,541 4.8
Commercial mortgages..... 168,686 26.0 78,446 18.5
Farmland................. 13,120 2.0 10,686 2.5
Multifamily residential.. 12,941 2.0 9,694 2.3
Agriculture................ 28,934 4.5 15,757 3.7
Other...................... 1,098 0.2 953 0.2
Consumer................... 61,973 9.6 45,121 10.7
-------- ----- -------- ----
Total loans........... $647,715 100.0% $ 424,400 100.0%
======== ===== ========= =====
Nonperforming Assets
The Company had $789,000 in nonperforming assets at September 30, 2002 and
$1,000 in nonperforming assets at December 31, 2001. 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. However, in connection with its
recent acquisitions, the Company acquired $34,000 in nonaccrual loans.
17
The following table presents information regarding nonperforming assets as
of the dates indicated:
September 30, December 31,
2002 2001
----------- ---------
(Dollars in thousands)
Nonaccrual loans. $ 34 $ 1
Accruing loans 90 or more days past due... 168 --
------ -------
Total nonperforming loans.............. 202 --
Other real estate......................... 587 --
------ -------
Total nonperforming assets............. $ 789 $ 1
====== =======
Allowance for Credit Losses
Management actively monitors the Company's asset quality and provides
specific loss allowances when necessary. Loans are charged-off against the
allowance for credit losses when appropriate. Although management believes it
uses the best information available to make determinations with respect to the
allowance for credit losses, future adjustments may be necessary if economic
conditions differ from the assumptions used in making the initial
determinations. As of September 30, 2002, the allowance for credit losses
amounted to $8.2 million, or 1.26% of total loans compared with $6.0 million, or
1.41% of total loans at December 31, 2001.
Set forth below is an analysis of the allowance for credit losses for
the periods indicated:
Nine Months Ended Year Ended
September 30, 2002 December 31, 2001
---------------------- -------------------
(Dollars in thousands)
Average loans outstanding........................ $ 470,374 $ 419,553
========== ==========
Gross loans outstanding at end of period......... $ 647,715 $ 424,400
========== ==========
Allowance for credit losses at
beginning of period............................ $ 5,985 $ 5,523
Balances acquired with the Texas Guaranty,
First State and Paradigm acquisitions.......... 1,858 --
Provision for credit losses...................... 360 700
Charge-offs:
Commercial and industrial...................... (38) (180)
Real estate and agriculture.................... (93) (175)
Consumer....................................... (113) (74)
Recoveries:
Commercial and industrial...................... 34 15
Real estate and agriculture.................... 118 121
Consumer....................................... 62 55
------- ----------
Net (charge-offs)................................ (29) (238)
------- ----------
Allowance for credit losses at end of period..... $ 8,173 $ 5,985
======= ==========
Ratio of allowance to end of period
loans.......................................... 1.26% 1.41%
Ratio of net charge-offs to average
loans.......................................... 0.01% 0.06%
Ratio of nonperforming loans to end of
period loans................................... 0.03% n/m(1)
(1) Amount not meaningful. Nonperforming loans totaled $1,000 at December 31,
2001.
18
Securities
Securities totaled $885.6 million at September 30, 2002 compared with
$752.3 million at December 31, 2001, an increase of $133.2 million, or 17.7%. At
September 30, 2002, securities represented 52.4% of total assets compared with
59.6% of total assets at December 31, 2001. The growth in securities was
primarily due to the Paradigm, First State and Texas Guaranty acquisitions.
Premises and Equipment
Premises and equipment, net of accumulated depreciation, totaled $23.8
million at September 30, 2002 and $15.1 million at December 31, 2001. The $8.8
million increase was primarily due to the Paradigm, First State and Texas
Guaranty acquisitions.
Deposits
Total deposits were $1.47 billion at September 30, 2002 compared with $1.12
billion at December 31, 2001, an increase of $344.2 million or 30.6%. Total
deposits acquired in the Paradigm acquisition were $218.3 million, total
deposits acquired in the First State acquisition were $14.1 million and total
deposits acquired in the Texas Guaranty acquisition were $61.8 million. At
September 30, 2002, noninterest-bearing deposits accounted for 20.7% of total
deposits compared with 16.8% of total deposits at December 31, 2001.
Interest-bearing deposits totaled $1.16 billion, or 79.3%, of total deposits at
September 30, 2002 compared with $934.6 million, or 83.2%, of total deposits at
December 31, 2001.
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 September 30,
2002, the Company had $28.3 million in FHLB borrowings, of which $15.3 million
consisted of FHLB notes payable and $13.0 million consisted of FHLB advances.
The maturity dates on the FHLB notes payable range from the years 2004 to 2018
and have interest rates ranging from 5.95% to 6.48%. At December 31, 2001, the
Company had $18.1 million in FHLB borrowings of which $13.3 million consisted of
FHLB notes payable and $4.8 million consisted of FHLB advances. Any FHLB
advances are secured by a blanket lien on the Bank's first mortgage loans
against one-to-four family residential properties.
At September 30, 2002 and December 31, 2001, the Company had no outstanding
borrowings under a revolving line of credit extended by a commercial bank.
Trust Preferred Securities
At September 30, 2002, the Company's subsidiary trusts had outstanding
$33.0 million in trust preferred securities compared with $27.0 million at
December 31, 2001. The increase is due to the assumption of $6.0 million in
trust preferred securities in connection with the Paradigm acquisition.
Liquidity
Effective management of balance sheet liquidity is necessary to fund growth
in earning assets and to pay liability maturities, depository customers'
withdrawal requirements and shareholders' dividends. The Company has numerous
sources of liquidity including a significant portfolio of shorter-term assets,
marketable investment securities (excluding those presently classified as
"held-to-maturity"), increases in customers' deposits, and access to borrowing
arrangements. Available borrowing arrangements maintained by the Company include
federal funds lines with other commercial banks and an advancement arrangement
with the FHLB.
Asset liquidity is provided by cash and assets which are readily marketable
or which will mature in the near future. As of September 30, 2002, the Company
had cash and cash equivalents of $55.7 million, an increase from $41.7 million
at December 31, 2001.
19
Capital Resources
Total shareholders' equity was $149.6 million at September 30, 2002
compared with $88.7 million at December 31, 2001, an increase of $60.8 million,
or 68.6%. The increase was primarily due to net earnings of $14.9 million,
common stock issued in the Paradigm acquisition of $46.5 million and a net
change in unrealized gain on available for sale securities of $2.7 million,
partially offset by cash dividends paid of $2.8 million.
Both the Board of Governors of the Federal Reserve System, with respect to
the Company, and the Federal Deposit Insurance Corporation ("FDIC"), with
respect to the Bank, have established certain minimum risk-based capital
standards that apply to bank holding companies and federally insured banks. As
of September 30, 2002, the Company's Tier 1 capital, total risk-based capital
and leverage capital ratios were 15.44%, 16.52% and 8.31%, respectively. As of
September 30, 2002, the Bank's risk-based capital ratios were above the levels
required for the Bank to be designated as "well capitalized" by the FDIC, with
Tier-1 capital, total risk-based capital and leverage capital ratios of 12.74%,
13.83% and 6.85%, respectively.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company manages market risk, which for the Company is primarily
interest rate risk, through its Asset Liability Committee which is composed of
senior officers of the Company, in accordance with policies approved by the
Company's Board of Directors.
The Company uses simulation analysis to examine the potential effects of
market changes on net interest income and market value. It considers
macroeconomic variables, Company strategy, liquidity and other factors as it
quantifies market risk. Based on the Company's September 30, 2002 simulation
analysis, the Company estimates that its current net interest income structure
would change by approximately (4.72)% over the next twelve months assuming an
immediate 100 basis point decline in rates and change by approximately 1.66%
over the next twelve months assuming an immediate 100 basis point increase in
rates. See Form 10-K, Item 7 "Management's Discussion and Analysis and Results
of Operations-Interest Rate Sensitivity and Liquidity" which was filed on March
8, 2002 for further discussion.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures. Within 90 days prior to
the date of this report, the Company carried out an evaluation, under the
supervision and with the participation of management, including it's Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of it's disclosure controls and procedures. Based on this
evaluation, the Company's Chief Executive Officer and Chief Financial Officer
concluded that the Company's disclosure controls and procedures (as defined in
Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934 (the
"Exchange Act")) are effective to ensure that information required to be
disclosed by the Company in reports that it files or submits under the Exchange
Act is recorded, processed, summarized and reported to the Company's management
within the time periods specified in the Securities and Exchange Commission's
rules and forms.
Changes in internal controls. Subsequent to the date of the most recent
evaluation, there were no significant changes in the Company's internal controls
or in other factors that could significantly affect the Company's disclosure
controls and procedures, and there were no corrective actions with regard to
significant deficiencies and material weaknesses based on such evaluation.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Not Applicable
20
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
a. Not applicable
b. Not applicable
c. Not applicable
d. Not applicable
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable
ITEM 5. OTHER INFORMATION
Not applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits:
Exhibit
Number Description
------- -----------
99.1 Certification of Chief Executive Officer pursuant
to 18 U.S.C., Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Certification of Chief Financial Officer pursuant
to 18 U.S.C., Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
b. Reports on Form 8-K:
(i) The Company filed a Current Report on Form 8-K under Item 5 of
Form 8-K on July 12, 2002 to announce the completion of the
acquisition of The First State Bank in Needville, Texas.
(ii) The Company filed a Current Report on Form 8-K under Item 5 of
Form 8-K on July 15, 2002 to announce the signing of a definitive
agreement with Southwest Bank Holding Company, Dallas, Texas,
providing for the merger of Southwest Bank Holding Company into
the Company.
(iii) The Company filed a Current Report on Form 8-K under Item 5 of
Form 8-K on July 15, 2002 to announce the release of the
Company's earnings for the second quarter 2002.
21
(iv) The Company filed a Current Report on Form 8-K under Item 5 of
Form 8-K on August 16, 2002 to announce the signing of a
definitive agreement with First National Bank of Bay City, Bay
City, Texas, pursuant to which First National Bank will be merged
into Prosperity Bank.
(v) The Company filed a Current Report on Form 8-K under Item 5 of
Form 8-K on September 3, 2002 to announce the completion of the
merger of Paradigm Bancorporation, Inc. into the Company.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PROSPERITY BANCSHARES, INC.(SM)
(Registrant)
Date: 11/14/02 /s/ David Zalman
------------- --------------------------------
David Zalman
Chief Executive Officer/President
Date: 11/14/02 /s/ David Hollaway
------------ --------------------------------
David Hollaway
Chief Financial Officer
22
CERTIFICATIONS
I, David Zalman, President and Chief Executive Officer of the registrant,
certify that:
1. I have reviewed this quarterly report on Form 10-Q of Prosperity
Bancshares, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary in order
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal controls;
and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect the internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 14, 2002
/s/ David Zalman
--------------------------------
David Zalman
President and Chief Executive Officer
23
I, David Hollaway, Chief Financial Officer of the registrant, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Prosperity
Bancshares, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary in order
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal controls;
and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect the internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 14, 2002
/s/ David Hollaway
------------------------------
David Hollaway
Chief Financial Officer
24
EXHIBIT INDEX
Exhibit
Number Description
- ------- -----------
99.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.,
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
99.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.,
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.