FORM 10-Q UNITED STATES (Mark One) SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001 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, 2001 there were 8,098,935 shares of the registrant's Common Stock, par value $1.00 per share, outstanding. 1
PROSPERITY BANCSHARES, INC.(SM) AND SUBSIDIARIES INDEX TO FORM 10-Q <TABLE> <CAPTION> PART I - FINANCIAL INFORMATION Page ---- <S> <C> Item 1. Interim Financial Statements Consolidated Balance Sheets as of September 30, 2001 (unaudited) and December 31, 2000........................................................... 3 Consolidated Statements of Income for the Three Months and Nine Months Ended September 30, 2001 and 2000 (unaudited)............................... 4 Consolidated Statements of Shareholders' Equity for the Nine Months Ended September 30, 2001 (unaudited) and for the Year Ended December 31, 2000..... 5 Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2001 and 2000 (unaudited)..................................... 6 Notes to Interim Consolidated Financial Statements........................... 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.................................................................. 8 Item 3. Quantitative and Qualitative Disclosures about Market Risk................... 19 PART II - OTHER INFORMATION Item 1. Legal Proceedings............................................................ 20 Item 2. Changes in Securities and Use of Proceeds.................................... 20 Item 3. Defaults upon Senior Securities.............................................. 20 Item 4. Submission of Matters to a Vote of Security Holders.......................... 20 Item 5. Other Information............................................................ 20 Item 6. Exhibits and Reports on Form 8-K............................................. 20 Signatures............................................................................ 20 </TABLE> 2
PART I - FINANCIAL INFORMATION ITEM 1. INTERIM FINANCIAL STATEMENTS PROSPERITY BANCSHARES, INC.(SM) AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (UNAUDITED) <TABLE> <CAPTION> September 30, December 31, 2001 2000 ------------ ------------ (Dollars in thousands, except share data) <S> <C> <C> ASSETS Cash and due from banks.......................................... $ 28,066 $ 35,709 Interest-bearing deposits in financial institutions.............. 392 1,085 Federal funds sold............................................... 12,491 62,369 ---------- ---------- Total cash and cash equivalents................................ 40,949 99,163 Available for sale securities, at fair value (amortized cost of $457,935 (unaudited) and $333,856, respectively).......... 463,631 334,773 Held to maturity securities, at cost (fair value of $267,263 (unaudited) and $250,171, respectively)......................... 261,403 252,178 Loans............................................................ 419,557 411,203 Less allowance for credit losses................................. (5,518) (5,523) ---------- ---------- Loans, net................................................. 414,039 405,680 Accrued interest receivable...................................... 9,519 10,430 Goodwill (net of accumulated amortization of $6,013 (unaudited) and $4,954, respectively)........................... 22,981 24,003 Bank premises and equipment, net................................. 14,884 14,487 Other real estate owned.......................................... -- 545 Other assets..................................................... 4,577 4,881 ---------- ---------- TOTAL ASSETS..................................................... $1,231,983 $1,146,140 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY LIABILITIES: Deposits: Noninterest-bearing.......................................... $ 182,347 $ 187,959 Interest-bearing............................................. 909,314 845,587 ---------- ---------- Total deposits............................................. 1,091,661 1,033,546 Other borrowings................................................ 13,465 13,931 Accrued interest payable........................................ 3,466 3,480 Other liabilities............................................... 7,388 2,850 ---------- ---------- Total liabilities.......................................... 1,115,980 1,053,807 COMPANY-OBLIGATED MANDATORILY REDEEMABLE TRUST PREFERRED SECURITIES OF SUBSIDIARY TRUSTS................................ 27,000 12,000 SHAREHOLDERS' EQUITY: Common stock, $1 par value; 50,000,000 shares authorized; 8,102,511 (unaudited) and 8,075,486, shares issued at September 30, 2001 and December 31, 2000, respectively; 8,098,935 (unaudited) and 8,071,910 shares outstanding at September 30, 2001 and December 31, 2000, respectively....... 8,103 8,075 Capital surplus................................................. 24,933 26,006 Retained earnings............................................... 52,283 45,665 Accumulated other comprehensive income -- net unrealized gain on available for sale securities, net of tax of $1,994 (unaudited) and $312, respectively....... 3,702 605 Less treasury stock, at cost, 3,576 shares at September 30, 2001 (unaudited) and December 31, 2000...................... (18) (18) ---------- ---------- Total shareholders' equity................................. 89,003 80,333 ---------- ---------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY....................... $1,231,983 $1,146,140 ========== ========== </TABLE> See notes to interim consolidated financial statements. 3
PROSPERITY BANCSHARES, INC.(SM) AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) <TABLE> <CAPTION> Three Months Ended Nine Months Ended September 30, September 30, ------------------ ----------------- 2001 2000 2001 2000 ------ ------ ------ ------ (Dollars in thousands, except per share data) <S> <C> <C> <C> <C> INTEREST INCOME: Loans, including fees........ $ 8,839 $ 8,774 $26,578 $24,777 Securities: Taxable..................... 9,243 7,767 27,436 23,409 Nontaxable.................. 401 298 1,190 1,165 70% nontaxable preferred dividends.................. 344 139 999 343 Deposits in financial institutions................ 6 19 28 61 Federal funds sold........... 268 490 1,333 1,331 ------- ------- ------- ------- Total interest income...... 19,101 17,487 57,564 51,086 ------- ------- ------- ------- INTEREST EXPENSE: Deposits................... 8,773 8,518 27,624 23,590 Note payable and federal funds..................... 68 337 643 1,797 ------- ------- ------- ------- Total interest expense.... 8,841 8,855 28,267 25,387 ------- ------- ------- ------- NET INTEREST INCOME...... 10,260 8,632 29,297 25,699 PROVISION FOR CREDIT LOSSES.. 50 75 50 225 ------- ------- ------- ------- NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES 10,210 8,557 29,247 25,474 ------- ------- ------- ------- NONINTEREST INCOME: Customer service fees...... 1,924 1,613 5,501 4,699 Other...................... 263 402 779 1,024 ------- ------- ------- ------- Total noninterest income.. 2,187 2,015 6,280 5,723 ------- ------- ------- ------- NONINTEREST EXPENSE: Salaries and employee benefits.................. 3,247 3,223 9,759 9,594 Net occupancy expense...... 493 582 1,483 1,560 Data processing............ 526 416 1,551 1,284 Goodwill amortization...... 341 272 1,022 819 Depreciation expense....... 385 328 1,183 1,154 Minority interest trust preferred securities...... 475 288 1,051 863 Merger related expenses.... -- -- 2,425 -- Other...................... 1,601 1,554 4,460 4,485 ------- ------- ------- ------- Total noninterest expense. 7,068 6,663 22,934 19,759 ======= ======= ======= ======= INCOME BEFORE INCOME TAXES... 5,329 3,909 12,593 11,438 PROVISION FOR INCOME TAXES... 1,598 1,185 3,625 3,456 ------- ------- ------- ------- NET INCOME................... $ 3,731 $ 2,724 $ 8,968 $ 7,982 ======= ======= ======= ======= EARNINGS PER SHARE Basic........................ $0.46 $0.34 $1.11 $1.00 ======= ======= ======= ======= Diluted...................... $0.45 $0.33 $1.09 $0.97 ======= ======= ======= ======= </TABLE> See notes to interim consolidated financial statements. 4
PROSPERITY BANCSHARES, INC.(SM) AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY <TABLE> <CAPTION> Accumulated Other Comprehensive Income -- Net Unrealized (Loss) Common Stock Gain on Avail- Total --------------------------- Capital Retained able for Sale Treasury Shareholders' Shares Amount Surplus Earnings Securities Stock Equity ----------------- ------- -------- --------- --------------- --------- -------------- (Amounts in thousands, except share data) <S> <C> <C> <C> <C> <C> <C> <C> BALANCE AT JANUARY 1, 2000...... 7,999,298 $7,999 $26,005 $37,719 $(2,681) $ (18) $69,024 Net income..................... 10,701 10,701 Net change in unrealized gain on available for sale securities 3,286 3,286 ------- Total comprehensive income..... 13,987 ------- Sale of common stock........... 76,200 76 259 335 Trust preferred issuance costs. (90) (90) Cash paid to dissenting shareholder in connection with the issuance of common stock in exchange for common stock of Heritage Bank (153) (153) Cash paid in lieu of fractional shares............. (12) (15) (15) Cash dividends declared........ (2,755) (2,755) --------- ------ ------- ------- ------- ----- ------- BALANCE AT DECEMBER 31, 2000.... 8,075,486 8,075 26,006 45,665 605 (18) 80,333 Net income (unaudited).......... 8,968 8,968 Net change in unrealized gain on available for sale securities (unaudited)................. 3,097 3,097 ------- Total comprehensive income (unaudited)................... 12,065 ------- Trust preferred issuance costs (unaudited)................... (476) (476) Cash paid to dissenting shareholder in connection with the issuance of common stock in exchange for common stock of Heritage Bank (unaudited).................. (180) (180) Cash paid to dissenting shareholders in connection with the issuance of common stock in exchange for common stock of Commercial (unaudited).................. (31,775) (32) (635) (667) Sale of common stock (unaudited)................... 58,800 60 218 278 Cash dividends declared (unaudited)................... (2,350) (2,350) --------- ------ ------- ------- ------- ----- ------- BALANCE AT SEPTEMBER 30, 2001 (unaudited).................. 8,102,511 $8,103 $24,933 $52,283 $ 3,702 $ (18) $89,003 ========= ====== ======= ======= ======= ===== ======= </TABLE> See notes to interim consolidated financial statements 5
PROSPERITY BANCSHARES, INC.(SM) AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) <TABLE> <CAPTION> Nine Months Ended September 30, ---------------------- 2001 2000 --------- -------- (Dollars in thousands) <S> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES: Net income.............................................. $ 8,968 $ 7,982 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization......................... 2,205 1,976 Provision for credit losses........................... 50 359 Loss on sale of premises and equipment................ 341 -- Net amortization of premium/discount on investments...................................... 465 4 Decrease (increase) in accrued interest receivable and other assets................................... 1,216 (986) Increase in accrued interest payable and other liabilities............................... 2,940 677 --------- -------- Total adjustments................................... 7,217 2,030 --------- -------- Net cash provided by operating activities........... 16,185 10,012 --------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from maturities and principal paydowns of held to maturity securities............... 155,482 52,403 Purchase of held to maturity securities................. (16,067) (48,887) Proceeds from maturities and principal paydowns of available for sale securities............. 66,883 16,628 Purchase of available for sale securities............... (340,067) (48,010) Net increase in loans................................... (8,354) (24,011) Purchase of bank premises and equipment................. (2,087) (993) Proceeds from sale of bank premises and equipment and other real estate acquired by foreclosure...... 557 31 Proceeds from sale of Federal Home Loan Bank Stock.............................................. -- 5,009 Net liabilities acquired in the purchase of Compass branches................................... -- 77,473 Net decrease in interest-bearing deposits in financial institutions.................... -- (198) --------- -------- Net cash (used in) provided by investing activities.............................. (143,653) 29,445 --------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Net (decrease) increase in noninterest-bearing deposits.............................................. (5,612) 11,608 Net increase (decrease) in interest-bearing deposits.... 63,727 35,981 Repayments of line of credit............................ (466) (49,038) Cash paid to dissenting shareholders.................... (847) (156) Cash paid in lieu of fractional shares.................. -- (13) Proceeds from the issuance of trust preferred securities........................................... 15,000 -- Stock issuance costs.................................... (476) (91) Payments of cash dividends.............................. (2,350) (2,033) Sale of common stock.................................... 278 247 --------- -------- Net cash provided by (used in) financing activities............................. 69,254 (3,495) --------- -------- NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS............................................. $ (58,214) $ 35,962 CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD............................................... 99,163 95,031 --------- -------- CASH AND CASH EQUIVALENTS, END OF PERIOD.................................................. $ 40,949 $130,993 ========= ======== </TABLE> See notes to interim consolidated financial statements. 6
PROSPERITY BANCSHARES, INC.(SM) AND SUBSIDIARIES NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2001 (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. These financial statements give retroactive effect to the merger of Commercial Bancshares, Inc., a Texas corporation ("Commercial") with and into the Company which was effective on February 23, 2001 and accounted for as a pooling of interests. 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, 2000 and the Company's Current Report on Form 8-K, as amended, dated February 23, 2001. Operating results for the nine month period ended September 30, 2001 are not necessarily indicative of the results that may be expected for the year ending December 31, 2001. 2. INCOME PER COMMON SHARE The following table illustrates the computation of basic and diluted earnings per share (in thousands, except per share data): <TABLE> <CAPTION> Three Months Ended Nine Months Ended September 30, September 30, ------------------ ----------------- <S> <C> <C> <C> <C> 2001 2000 2001 2000 ------ ------ ------ ------ Net income available to common shareholders......... $3,731 $2,724 $8,968 $7,982 Weighted average common shares outstanding......... 8,097 8,041 8,081 8,022 Potential dilutive common shares................... 166 172 162 198 ------ ------ ------ ------ Weighted average common shares and equivalents outstanding.................................... 8,263 8,213 8,243 8,220 ------ ------ ------ ------ Basic earnings per common share.................... $ 0.46 $ 0.34 $ 1.11 $ 1.00 ====== ====== ====== ====== Diluted earnings per common share.................. $ 0.45 $ 0.33 $ 1.09 $ 0.97 ====== ====== ====== ====== </TABLE> 7
PROSPERITY BANCSHARES, INC.(SM) AND SUBSIDIARIES NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) SEPTEMBER 30, 2001 (UNAUDITED) 3. RECENT ACCOUNTING STANDARDS In July 2001, the Financial Accounting Standards Board has 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 are effective for fiscal years beginning after December 15, 2001, and are effective for interim periods in the initial year of adoption. The Company is currently assessing the financial statement impact of the adoption of SFAS 142. In June 2001, the Financial Accounting Standards Board approved for issuance Statement of Financial Accounting Standards No. 141 (SFAS 141), "Business Combinations". This statement eliminates the pooling method of accounting for business combinations initiated after June 30, 2001. The Company does not believe that the adoption SFAS 141 will have a material effect on its financial statements. SFAS No. 133, "Accounting for Derivative Instruments and for 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. The implementation of this pronouncement on January 1, 2001 did not have a material effect on the Company's financial statements. 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: . changes in interest rates and market prices, which could reduce the Company's net interest margins, asset valuations and expense expectations; . changes in the levels of loan prepayments and the resulting effects on the value of the Company's loan portfolio; . 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. . increased competition for deposits and loans adversely affecting rates and terms; . 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; . 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; . the failure of assumptions underlying the establishment of and provisions made to the allowance for credit losses; . changes in the availability of funds resulting in increased costs or reduced liquidity; 8
. increased asset levels and changes in the composition of assets and the resulting impact on the Company's capital levels and regulatory capital ratios; . the Company's ability to acquire, operate and maintain cost effective and efficient systems without incurring unexpectedly difficult or expensive but necessary technological changes; . the loss of senior management or operating personnel and the potential inability to hire qualified personnel at reasonable compensation levels; and . changes in statutes and government regulations or their interpretations applicable to bank holding companies and the Company's present and future banking and other subsidiaries, including changes in tax requirements and tax rates. 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. ISSUANCE OF PREFERRED SECURITIES OF PROSPERITY STATUTORY TRUST II In July 2001, the Company formed Prosperity Statutory Trust II ("Trust II") and on July 31, 2001, Trust II issued 15,000 Floating Rate Capital Securities (the "Capital Securities") with an aggregate liquidation value of $15,000,000 to a third party. Concurrent with the issuance of the Capital Securities, Trust II issued trust common securities to the Company in the aggregate liquidation value of $464,000. The proceeds of the issuance of the Capital Securities and trust common securities were invested in the Company's Floating Rate Junior Subordinated Deferrable Interest Debentures (the "Junior Subordinated Debentures"). The Junior Subordinated Debentures will mature on July 31, 2031, which date may be shortened to a date not earlier than July 31, 2006, if certain conditions are met (including the Company having received prior approval of the Federal Reserve and any other required regulatory approvals). These Junior Subordinated Debentures, which are the only assets of Trust II, are subordinate and junior in right of payment to all present and future senior indebtedness (as defined in the Indenture dated July 31, 2001) of the Company. The Junior Subordinated Debentures will accrue interest at a floating rate equal to 3-month LIBOR plus 3.58%, not to exceed 12.50%, payable quarterly. The annual interest rate on the Debentures for the period from July 31, 2001 through October 30, 2001 is equal to 7.29%. The quarterly distributions on the Capital Securities will be paid at the same rate that interest is paid on the Junior Subordinated Debentures. The Company has fully and unconditionally guaranteed the Trust II's obligations under the Capital Securities. Trust II must redeem the Capital Securities when the Junior Subordinated Debentures are paid at maturity or upon any earlier prepayment of the Junior Subordinated Debentures. The Junior Subordinated Debentures may be prepaid if certain events occur, including a change in the tax status or regulatory capital treatment of the Capital Securities or a change in existing laws that requires Trust II to register as an investment company. For financial reporting purposes, Trust II is treated as a subsidiary of the Company and consolidated in the corporate financial statements. The Capital Securities are treated as Tier 1 capital by the Federal Reserve. The treatment of the Capital Securities as Tier 1 capital, in addition to the ability to deduct the expense of the Junior Subordinated Debentures for federal income tax purposes, provided the Company with a cost-effective method of raising capital. The Company received net proceeds of $15.0 million, which will be used for the general corporate purposes of the Company and the Bank, including supporting continued expansion activities in the Houston metropolitan area and surrounding counties through the establishment and/or acquisition of additional Banking Centers and possible acquisitions. OVERVIEW The Company is a registered financial holding company that derives substantially all of its revenues and income from the operation of Prosperity Bank(SM) (the "Bank"). The Bank, which changed its name from First Prosperity Bank(SM) on May 1, 2001, is a full-service bank that provides a broad line of financial products and services to small and medium-sized businesses and consumers through 29 full-service banking locations in the greater Houston metropolitan area and thirteen contiguous counties situated south and southwest of Houston and extending into South Texas. 9
On February 23, 2001, the Company and Commercial completed a merger whereby Commercial was merged with and into the Company (the "Merger"). In connection with the Merger, Heritage Bank, Commercial's wholly owned subsidiary, was merged with and into the Bank. Heritage Bank had 12 full-service banking locations in the Houston metropolitan area and in three adjacent counties, including Houston- Bellaire, Cleveland, Cypress, Fairfield, Houston-Downtown, Houston-Medical Center, Houston-River Oaks, Houston-Tanglewood/Memorial, Houston-Waugh Drive, Liberty, Magnolia and Wharton. In connection with the Merger, the Company incurred approximately $2.4 million in pretax merger-related expenses and other charges (the "Special Charge"). The transaction was accounted for as a pooling interests and therefore the historical financial data of the Company has been restated to include the accounts and operations of Commercial for all periods prior to the effective time of the Merger. Total assets were $1.23 billion at September 30, 2001 compared with $1.15 billion at December 31, 2000. Total loans increased to $419.6 million at September 30, 2001 from $411.2 million at December 31, 2000, an increase of $8.4 million, or 2.0%. Total deposits were $1.09 billion at September 30, 2001 compared with $1.03 billion at December 31, 2000, a increase of $58.1 million, or 5.6%. Shareholders' equity increased $8.7 million or 10.8%, to $89.0 million at September 30, 2001 compared with $80.3 million at December 31, 2000. Results of Operations Excluding Merger-Related Expenses If the Company had not incurred the Special Charge of $2.4 million in connection with the Merger, net income for the nine months ended September 30, 2001 would have been $10.5 million ($1.28 per common share on a diluted basis) compared with $8.0 million ($0.97 per common share on a diluted basis) for the nine months ended September 30, 2000, an increase in net income of $2.6 million, or 32.1%. The Company would have posted a return on average common equity of 16.82%, a return on average assets of 1.20% and an efficiency ratio of 56.36% for the nine months ended September 30, 2001. Results of Operations as Reported Net income available to common shareholders was $3.7 million ($0.45 per common share on a diluted basis) for the quarter ended September 30, 2001 compared with $2.7 million ($0.33 per common share on a diluted basis) for the quarter ended September 30, 2000, an increase in net income of $1.0 million, or 37.0%. The Company posted returns on average common equity of 17.34% and 14.82%, returns on average assets of 1.25% and 1.07% and efficiency ratios of 55.07% and 61.54% for the quarters ended September 30, 2001 and 2000, respectively. Net income available to common shareholders for the nine months ended September 30, 2001 was $9.0 million ($1.09 per common share on a diluted basis) compared with $8.0 million ($0.97 per common share on a diluted basis) for the same period in 2000, an increase in net income of $986,000 or 12.4%. The Company posted returns on average common equity of 14.30% and 14.98%, returns on average assets of 1.02% and 1.04% and efficiency ratios of 63.38% and 61.83% for the nine months ended September 30, 2001 and 2000, respectively. RESULTS OF OPERATIONS Net Interest Income Net interest income was $10.3 million for the quarter ended September 30, 2001 compared with $8.6 million for the quarter ended September 30, 2000, an increase of $1.6 million, or 18.9%. Net interest income increased primarily due to an increase in the amount of interest earning assets and a decrease in the average rate paid on interest-bearing liabilities. As a result, the net interest margin on a tax-equivalent basis increased to 3.84% from 3.79% for the same periods. Average interest-earning assets increased to $1.12 billion for the quarter ended September 30, 2001 compared with $944.0 million for the quarter ended September 30, 2000, an increase of $178.0 million, or 18.9%. The average rate on interest bearing liabilities decreased 78 basis points to 3.94% for the three months ended September 30, 2001 compared with 4.72% for the same period in 2000. The Company's average rate on interest-bearing liabilities decreased due to the cuts in the discount rate by the Federal Reserve during 2001. Net interest income increased $3.6 million, or 14.0%, to $29.3 million for the nine months ended September 30, 2001 compared with $25.7 million for the same period in 2000. This increase is mainly attributable to higher average interest-earning assets resulting from purchases of investment securities and increased loan originations. Average interest-earning assets increased to $1.10 billion for the nine months ended September 30, 2001 compared with $939.3 million for the nine months ended September 30, 2000, an increase of $157.1 million, or 16.7%. The net interest margin on a tax-equivalent basis decreased to 3.74% compared with 3.78% for the same periods. This decrease is attributable 10
to a 25 basis point decrease in the yield on total average interest-earning assets for the nine months ended September 30, 2001 partially offset by a 21 basis point decrease in rate paid on total average interest-bearing liabilities for the same period. 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." 11
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. Any nonaccruing loans have been included in the table as loans carrying a zero yield. <TABLE> <CAPTION> Three Months Ended September 30, ------------------------------------------------------------------------- 2001 2000 ------------------------------------ ---------------------------------- Average Interest Average Average Interest Average Outstanding Earned/ Yield/ Outstanding Earned/ Yield/ Balance Paid Rate (4) Balance Paid Rate (4) ----------- ---------- ------- ----------- -------- -------- (Dollars in thousands) <S> <C> <C> <C> <C> <C> <C> ASSETS Interest-earning assets: Loans.......................................... $ 427,984 $ 8,839 8.26% $389,445 $8,774 9.01% Securities(1).................................. 663,089 9,988 6.03 523,148 8,204 6.27 Federal funds sold and other temporary investments................................... 30,919 274 3.54 31,415 509 6.48 ---------- ---------- ---------- -------- Total interest-earning assets................ 1,121,992 19,101 6.81% 944,008 17,487 7.41 ---------- -------- Less allowance for credit losses............... (5,579) (5,235) ---------- ---------- Total interest-earning assets, net of allowance................................ 1,116,413 938,773 Noninterest-earning assets.................. 78,484 78,363 ---------- ---------- Total assets................................. $1,194,897 $1,017,136 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY Interest-bearing liabilities: Interest-bearing demand deposits............... $ 194,277 $ 1,062 2.19% $ 179,019 $1,602 3.58% Savings and money market accounts.............. 252,015 3,161 5.02 212,051 2,153 4.06 Certificates of deposit........................ 438,772 4,550 4.15 334,472 4,763 5.70 Federal funds purchased and other borrowings.................................... 13,563 68 2.01 25,201 337 5.35 ---------- ---------- ---------- -------- Total interest-bearing liabilities........... 898,627 8,841 3.94% 750,743 8,855 4.72% ---------- ---------- ---------- -------- Noninterest-bearing liabilities: Noninterest-bearing demand deposits............ 177,296 176,196 Company-obligated mandatorily redeemable trust preferred securities of subsidiary trusts........................ 24,500 12,000 Other liabilities.............................. 8,413 4,680 ---------- ---------- Total liabilities............................ 1,108,836 943,619 ---------- ---------- Shareholders' equity............................. 86,061 73,517 ---------- ---------- Total liabilities and shareholders' equity... $1,194,897 $1,017,136 ========== ========== Net interest rate spread......................... 2.87% 2.69% Net interest income and margin(2)................ $10,260 3.66% $8,632 3.66% ========== ======== Net interest income and margin (tax-equivalent basis)(3)....................... $10,763 3.84% $8,955 3.79% ========== ======== </TABLE> - ----------------- (1) Yield is based on amortized cost and does not include any component of unrealized gains or losses. (2) The net interest margin is equal to net interest income divided by average interest-earning assets. (3) In order to make pretax income and resultant yields on tax-exempt investments and loans comparable to those on taxable investments and loans, a tax-equivalent adjustment has been computed using a federal income tax rate of 35% and 34% for the quarters ended September 30, 2001 and September 30, 2000, respectively. (4) Annualized. 12
<TABLE> <CAPTION> Nine Months Ended September 30, ------------------------------------------------------------------------- 2001 2000 ------------------------------------ ---------------------------------- Average Interest Average Average Interest Average Outstanding Earned/ Yield/ Outstanding Earned/ Yield/ Balance Paid Rate (4) Balance Paid Rate (4) ----------- ---------- ------- ----------- -------- -------- (Dollars in thousands) <S> <C> <C> <C> <C> <C> <C> ASSETS Interest-earning assets: Loans........................................... $ 420,401 $ 26,578 8.43% $ 378,506 $24,777 8.73% Securities(1)................................... 639,579 29,625 6.18 532,014 24,917 6.24 Federal funds sold and other temporary investments.................................... 36,423 1,361 4.98 28,801 1,392 6.44 ---------- -------- ---------- ------- Total interest-earning assets.................. 1,096,403 57,564 7.00% 939,321 51,086 7.25% -------- ------- Less allowance for credit losses................ (5,568) (5,167) ---------- ---------- Total interest-earning assets, net of allowance................................. 1,090,835 934,154 Noninterest-earning assets................... 81,190 85,213 ---------- ---------- Total assets.................................. $1,172,025 $1,019,367 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY Interest-bearing liabilities: Interest-bearing demand deposits................ $ 194,088 $ 3,747 2.57% $ 182,872 $ 4,669 3.40% Savings and money market accounts............... 247,175 7,587 4.09 214,278 6,160 3.83 Certificates of deposit......................... 424,352 16,290 5.12 320,511 12,761 5.31 Federal funds purchased and other borrowings..................................... 17,915 643 4.79 38,496 1,797 6.22 ---------- -------- ---------- ------- Total interest-bearing liabilities............ 883,530 28,267 4.27% 756,157 25,387 4.48% ---------- -------- ---------- ------- Noninterest-bearing liabilities: Noninterest-bearing demand deposits............. 180,376 173,115 Company-obligated mandatorily redeemable trust preferred securities of subsidiary trusts........................ 16,167 12,000 Other liabilities............................... 8,354 7,056 ---------- ---------- Total liabilities............................. 1,088,427 948,328 ---------- ---------- Shareholders' equity.............................. 83,598 71,039 ---------- ---------- Total liabilities and shareholders' equity.... $1,172,025 $1,019,367 ========== ========== Net interest rate spread.......................... 2.73% 2.77% Net interest income and margin(2)................. $ 29,297 3.56% $25,699 3.65% ======== ======= Net interest income and margin (tax-equivalent basis)(3)........................ $ 30,779 3.74% $26,625 3.78% ======== ======== </TABLE> - ------------------ (1) Yield is based on amortized cost and does not include any component of unrealized gains or losses. (2) The net interest margin is equal to net interest income divided by average interest-earning assets. (3) In order to make pretax income and resultant yields on tax-exempt investments and loans comparable to those on taxable investments and loans, a tax-equivalent adjustment has been computed using a federal income tax rate of 35% and 34% for the nine months ended September 30, 2001 and September 30, 2000, respectively. (4) Annualized. 13
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. <TABLE> <CAPTION> Three Months Ended September 30, -------------------------------- 2001 vs. 2000 -------------------------------- Increase (Decrease) Due to ------------------- Volume Rate Total ------- -------- -------- (Dollars in thousands) <S> <C> <C> <C> Interest-earning assets: Loans........................................... $ 868 $ (803) $ 65 Securities...................................... 2,195 (411) 1,784 Federal funds sold and other temporary investments.................................... (8) (227) (235) ------ ------- ------- Total increase (decrease) in interest income... 3,055 (1,441) 1,614 ------ ------- ------- Interest-bearing liabilities: Interest-bearing demand deposits................ 137 (677) (540) Savings and money market accounts............... 406 602 1,008 Certificates of deposit......................... 1,485 (1,698) (213) Federal funds purchased and other borrowings.... (156) (113) (269) ------ ------- ------- Total increase (decrease) in interest expense.. 1,872 (1,886) (14) ------ ------- ------- Increase in net interest income.................. $1,183 $ 445 $ 1,628 ====== ======= ======= Nine Months Ended September 30, ------------------------------- 2001 vs. 2000 ------------------------------- Increase (Decrease) Due to ------------------- Volume Rate Total ------- -------- -------- (Dollars in thousands) Interest-earning assets: Loans........................................... $2,742 $ (941) $ 1,801 Securities...................................... 5,038 (330) 4,708 Federal funds sold and other temporary investments.................................... 368 (399) (31) ------ ------- ------- Total increase (decrease) in interest income... 8,148 (1,670) 6,478 ------ ------- ------- Interest-bearing liabilities: Interest-bearing demand deposits................ 286 (1,208) (922) Savings and money market accounts............... 946 481 1,427 Certificates of deposit......................... 4,134 (605) 3,529 Federal funds purchased and other borrowings.... (961) (193) (1,154) ------ ------- ------- Total increase in interest expense............. 4,405 (1,525) 2,880 ------ ------- ------- Increase (decrease) in net interest income....... $3,743 $ (145) $ 3,598 ====== ======= ======= </TABLE> Provision for Credit Losses Management actively monitors the Company's asset quality and provides specific loss provisions when necessary. Loans are charged-off against the provision for credit losses when appropriate. Although management believes it uses the best information available to make determinations with respect to the provision 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, 2001, the allowance for credit losses amounted to $5.5 million, or 1.32% of total loans compared with $5.5 million, or 1.34% of total loans at December 31, 2000. 14
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 Company made a $50,000 provision for credit losses for the three months ended September 30, 2001, a decrease from the provision of $75,000 for the same period in 2000. This was the only provision made for the nine months ended September 30, 2001, a decrease from the provision of $225,000 for the corresponding period in 2000. 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: <TABLE> <CAPTION> Three Months Ended Nine Months Ended September 30, September 30, ------------------ ----------------- 2001 2000 2001 2000 ------ ------ ------ ------ (Dollars in thousands) <S> <C> <C> <C> <C> Service charges on deposit accounts.... $1,924 $1,613 $5,501 $4,699 Other noninterest income............... 263 402 779 1,024 ------ ------ ------ ------ Total noninterest income.............. $2,187 $2,015 $6,280 $5,723 ====== ====== ====== ====== </TABLE> Noninterest income totaled $2.2 million for the three months ended September 30, 2001 compared with $2.0 million for the same period in 2000, an increase of $172,000, or 8.5%. Noninterest income increased $557,000, or 9.7%, to $6.3 million for the nine months ended September 30, 2001 from $5.7 million for the same period in 2000. Noninterest Expense Noninterest expense totaled $7.1 million for the quarter ended September 30, 2001 compared with $6.7 million for the quarter ended September 30, 2000, an increase of $405,000, or 6.1%. Noninterest expense totaled $22.9 million for the nine months ended September 30, 2001, an increase of $3.2 million, or 16.1%, from $19.8 million for the same period in 2000. The increase was principally due to the one-time merger related charges associated with the Merger with Commercial and an increase in minority interest trust preferred securities expense related to the issuance of additional trust preferred securities in July 2001. See "Issuance of Preferred Securities of Prosperity Statutory Trust II" for a more detailed description of the issuance. 15
The following table presents, for the periods indicated, the major categories of noninterest expense: <TABLE> <CAPTION> Three Months Ended Nine Months Ended September 30, September 30, ------------------ ------------------- 2001 2000 2001 2000 ------ ------ ------- ------- (Dollars in thousands) <S> <C> <C> <C> <C> Salaries and employee benefits............... $3,247 $3,223 $ 9,759 $ 9,594 Non-staff expenses: Net occupancy expense....................... 493 582 1,483 1,560 Depreciation................................ 385 328 1,183 1,154 Data processing............................. 526 416 1,551 1,284 Regulatory assessments and FDIC insurance... 55 58 177 159 Ad valorem and franchise taxes.............. 118 132 363 379 Goodwill amortization....................... 341 272 1,022 819 Minority interest expense trust preferred securities................................. 475 288 1,051 863 Merger related expenses..................... -- -- 2,425 -- Other....................................... 1,428 1,364 3,920 3,947 ------ ------ ------- ------- Total non-staff expenses..................... 3,822 3,440 13,175 10,165 Total noninterest expense.................... $7,068 $6,663 $22,934 $19,759 ====== ====== ======= ======= </TABLE> Non-staff expenses increased $382,000, or 11.1%, to $3.8 million for the quarter ended September 30, 2001 compared with the same period in 2000. For the nine month period ended September 30, 2001, non-staff expenses, including $2.4 million in merger related expenses, increased $3.0 million, or 29.6%, to $13.2 million from $10.2 million for the same period in 2000. Excluding the merger related expenses, non-staff expenses increased $585,000 or 5.8%, compared with the nine months ended September 30, 2000. Income Taxes Income tax expense increased $413,000, or 34.9%, to $1.6 million for the three months ended September 30, 2001 from $1.2 million for the same period in 2000. For the nine month period ended September 30, 2001, income tax expense increased $169,000, or 4.9%, to $3.6 million from $3.5 million for the same period in 2000. FINANCIAL CONDITION Loan Portfolio Total loans were $419.6 million at September 30, 2001, an increase of $8.4 million, or 2.0% from $411.2 million at December 31, 2000. Loan growth occurred primarily in construction and land development loans and multi-family residential loans. Period end loans comprised 37.4% of average earning assets at September 30, 2001 compared with 38.8% at December 31, 2000. 16
The following table summarizes the loan portfolio of the Company by type of loan as of September 30, 2001 and December 31, 2000: September 30, December 31, 2001 2000 ---------------- ----------------- Amount Percent Amount Percent ------ ------- ------ ------- (Dollars in thousands) Commercial and industrial.... $ 44,312 11.0% $ 46,529 11.3% Real estate: Construction and land development............... 24,383 6.2 20,128 4.9 1-4 family residential...... 178,148 41.0 175,525 42.7 Home equity................. 19,707 4.4 16,762 4.1 Commercial mortgages........ 78,643 18.6 75,896 18.5 Farmland.................... 10,113 2.5 12,218 3.0 Multifamily residential..... 6,275 1.4 2,961 0.7 Agriculture.................. 15,526 4.6 13,251 3.2 Other........................ 3,291 0.8 2,557 0.6 Consumer..................... 39,159 9.5 45,376 11.0 -------- ----- -------- ----- Total loans................ $419,557 100.0% $411,203 100.0% ======== ===== ======== ===== Nonperforming Assets The Company had $539,000 in nonperforming assets at September 30, 2001 compared with $1.3 million in nonperforming assets at December 31, 2000, a decrease of $796,000 or 59.6%. The decrease was principally due to the sale of other real estate and a decrease in accruing loans 90 or more days past due. Of the $539,000 in nonperforming loans, $411,000 is attributed to one nonaccrual loan. The Company generally places a loan on nonaccrual status and ceases accruing interest when the payment of principal or interest is delinquent for 90 days, or earlier in some cases, unless the loan is in the process of collection and the underlying collateral fully supports the carrying value of the loan. The Company generally charges off all loans before attaining nonaccrual status. The following table presents information regarding nonperforming assets as of the dates indicated: September 30, December 31, 2001 2000 ------------- ------------ (Dollars in thousands) Nonaccrual loans........................... $ 489 $ 10 Accruing loans 90 or more days past due.... 50 780 ----- ------ Total nonperforming loans................. 539 790 Other real estate.......................... -- 545 ----- ------ Total nonperforming assets................ $ 539 $1,335 ===== ====== 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, 2001, the allowance for credit losses amounted to $5.5 million, or 1.32% of total loans compared with $5.5 million, or 1.34% of total loans at December 31, 2000. 17
Set forth below is an analysis of the allowance for credit losses for the periods indicated: <TABLE> <CAPTION> As of and For the Nine As of and For the Months Ended September 30, Year Ended December 31, 2001 2000 -------------------------- ----------------------- (Dollars in thousands) <S> <C> <C> Average loans outstanding.......................... $420,401 $383,054 ======== ======== Gross loans outstanding at end of period........... $419,557 $411,203 ======== ======== Allowance for credit losses at beginning of period............................... $ 5,523 $ 5,031 Balance acquired with the Compass Acquisition...... -- 47 Provision for credit losses........................ 50 275 Charge-offs: Commercial and industrial......................... (163) (117) Real estate and agriculture....................... (--) (38) Consumer.......................................... (56) (63) Recoveries: Commercial and industrial......................... 14 43 Real estate and agriculture....................... 116 263 Consumer.......................................... 34 82 -------- -------- Net (charge-offs) recoveries....................... (55) 170 -------- -------- Allowance for credit losses at end of period....... $ 5,518 $ 5,523 ======== ======== Ratio of allowance to end of period loans.......... 1.32% 1.34% Ratio of net charge-offs (recoveries) to average loans............................................. 0.01% (0.04)% Ratio of nonperforming loans to end of period loans...................................... 0.12% 0.19% </TABLE> Securities Securities totaled $725.0 million at September 30, 2001 compared with $587.0 million at December 31, 2000, an increase of $138.1 million or 23.5%. The increase is primarily attributable to an increase in deposits as the Company used the excess liquidity to purchase securities. At September 30, 2001, securities represented 58.9% of total assets compared with 51.2% of total assets at December 31, 2000. Premises and Equipment Premises and equipment, net of accumulated depreciation, totaled $14.9 million at September 30, 2001 and $14.5 million at December 31, 2000. Deposits Total deposits were $1.09 billion at September 30, 2001 compared with $1.03 billion at December 31, 2000, an increase of $58.1 million. At September 30, 2001, noninterest-bearing deposits accounted for 16.7% of total deposits compared with 18.2% of total deposits at December 31, 2000. Interest-bearing deposits totaled $909.3 million, or 83.3%, of total deposits at September 30, 2001 compared with $845.6 million, or 81.8%, of total deposits at December 31, 2000. Other Borrowings The Company had no notes payable and $13.5 million in Federal Home Loan Bank ("FHLB") advances at September 30, 2001, compared with no notes payable and $13.9 million in FHLB advances at December 31, 2000. The FHLB advances are secured by a blanket lien on the Bank's first mortgage loans against one-to-four family residential properties. The maturity dates range from the years 2004 to 2018 and have interest rates ranging from 18
5.95% to 6.48%. In addition, the Company had no federal funds purchased on September 30, 2001 or December 31, 2000. Trust Preferred Securities In July 2001, the Company formed Trust II and on July 31, 2001, Trust II issued 15,000 Floating Rate Capital Securities with an aggregate liquidation value of $15.0 million to a third party. The proceeds of the issuance were invested in the Company's Floating Rate Junior Subordinated Debentures which mature on July 31, 2031, which date may be shortened to a date not earlier than July 31, 2006, if certain conditions are met. For a more detailed description of the issuance, see "Issuance of Preferred Securities of Prosperity Statutory Trust II." As a result of the issuance by Trust II, the Company's subsidiary trusts had outstanding $27.0 million in trust preferred securities at September 30, 2001 compared with the $12.0 million of trust preferred securities issued by Prosperity Capital Trust I ("Trust I") outstanding at December 30, 2000. The Company's 9.60% junior subordinated debentures issued to Trust I mature on November 17, 2029, which date may be shortened to a date not earlier than November 17, 2004, if certain conditions are met. 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, 2001, the Company had cash and cash equivalents of $41.0 million, down from $99.2 million at December 31, 2000. The decline was due primarily to a decrease in federal funds sold of $49.9 million. Capital Resources Total shareholders' equity was $89.0 million at September 30, 2001 compared with $80.3 million at December 31, 2000, an increase of $8.7 million, or 10.8%. The increase was primarily due to net earnings of $9.0 million and a net change in unrealized gain on available for sale securities of $3.1 million, offset by cash dividends paid of $2.4 million, cash paid to dissenting shareholders in connection with the issuance of common stock in exchange for common stock of Commercial of $668,000 and trust preferred issuance costs of $476,000. 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, 2001, the Company's Tier 1 capital, total risk-based capital and leverage capital ratios were 17.53%, 18.61% and 7.62%, respectively. As of September 30, 2001, 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 14.73%, 15.82% and 6.40%, 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. There have been no material changes of this nature since December 31, 2000. See the Company's Annual Report on Form 10-K, Item 7 "Management's Discussion and Analysis and Results of Operations-Interest Rate Sensitivity and Liquidity". 19
PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Not Applicable 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 No. Description ----------- ----------- 4.1 Indenture dated as of July 31, 2001 by and between Prosperity Bancshares, Inc., as Issuer, and State Street Bank and Trust Company of Connecticut, National Association, with respect to the Floating Rate Junior Subordinated Deferrable Interest Debentures of Prosperity Bancshares, Inc. 4.2 Amended and Restated Declaration of Trust of Prosperity Statutory Trust II dated as of July 31, 2001. 4.3 Guarantee Agreement dated as of July 31, 2001 by and between Prosperity Bancshares, Inc. and State Street Bank and Trust Company of Connecticut, National Association. b. i. On August 1, 2001 the Company filed a Form 8-K under Item 9 to disclose statements made by representatives of the Company to analysts regarding the Company's offer to purchase FVNB Corp. ii. On September 20, 2001 the Company filed a Form 8-K under Item 5 announcing the Company's approval of a stock repurchase plan. 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: 11/12/01 /s/ David Zalman -------- --------------------------------- David Zalman Chief Executive Officer/President Date: 11/12/01 /s/ David Hollaway -------- --------------------------------- David Hollaway Chief Financial Officer 20