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 JUNE 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 August 1, 2002, there were 16,279,370 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> Page ---- <S> <C> <C> PART I - FINANCIAL INFORMATION Item 1. Interim Financial Statements .................................................. 3 Consolidated Balance Sheets as of June 30, 2002 (unaudited) and December 31, 2001 .......................................................... 3 Consolidated Statements of Income for the Three and Six Months Ended June 30, 2002 and 2001 (unaudited) ................................... 4 Consolidated Statements of Shareholders' Equity for the Year Ended December 31, 2001 and for the Six Months Ended June 30, 2002 (unaudited) ................ 5 Consolidated Statements of Cash Flows for the Six Months Ended June 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 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 ............................................................. 21 Item 6. Exhibits and Reports on Form 8-K .............................................. 21 Signatures ............................................................................. 21 </TABLE> 2
PART I - FINANCIAL INFORMATION ITEM 1. INTERIM FINANCIAL STATEMENTS PROSPERITY BANCSHARES, INC.SM AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS <TABLE> <CAPTION> June 30, December 31, 2002 2001 --------- ------------ (unaudited) (Dollars in thousands, except share data) ASSETS <S> <C> <C> Cash and due from banks ...................................................... $ 29,211 $ 41,005 Federal funds sold ........................................................... 13,224 715 ----------- ----------- Total cash and cash equivalents .......................................... 42,435 41,720 Interest-bearing deposits in financial institutions .......................... 198 198 Available for sale securities, at fair value (amortized cost of $228,191 (unaudited) and $481,899, respectively) ..................... 229,842 482,233 Held to maturity securities, at cost (fair value of $566,992 (unaudited) and $274,227, respectively) ................................... 556,017 270,089 Loans ........................................................................ 478,935 424,400 Less allowance for credit losses ............................................. (6,869) (5,985) ----------- ----------- Loans, net ..................................................... 472,066 418,415 Accrued interest receivable .................................................. 9,014 8,466 Goodwill (net of accumulated amortization of $6,354 (unaudited) and $6,354, respectively) ..................................... 25,953 22,641 Core Deposit Intangibles (net of accumulated amortization of $4 and $0) ........................................................... 272 -- Bank premises and equipment, net ............................................. 16,250 15,077 Other real estate owned ...................................................... 157 -- Other assets ................................................................. 8,152 3,486 ----------- ----------- TOTAL ASSETS ................................................................. $ 1,360,356 $ 1,262,325 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY LIABILITIES: Deposits: Noninterest-bearing ................................................... $ 198,022 $ 188,832 Interest-bearing ...................................................... 1,013,911 934,565 ----------- ----------- Total deposits ................................................. 1,211,933 1,123,397 Federal funds purchased ................................................... -- -- Other borrowings .......................................................... 15,477 18,080 Accrued interest payable .................................................. 2,451 2,869 Other liabilities ......................................................... 6,115 2,254 ----------- ----------- Total liabilities .............................................. 1,235,976 1,146,600 COMPANY-OBLIGATED MANDATORILY REDEEMABLE TRUST PREFERRED SECURITIES OF SUBSIDIARY TRUSTS ................................................................... 27,000 27,000 SHAREHOLDERS' EQUITY: Common stock, $1.00 par value; 50,000,000 shares authorized; 16,277,222 (unaudited) and 16,218,022, shares issued at June 30, 2002 and December 31, 2001, respectively; 16,270,070 (unaudited) and 16,210,870 shares outstanding at June 30, 2002 and December 31, 2001, respectively ...... 16,277 16,218 Capital surplus ........................................................... 16,953 16,865 Retained earnings ......................................................... 62,959 55,462 Accumulated other comprehensive income -- net unrealized gain on available for sale securities, net of tax of $661 (unaudited) and $117, respectively ................. 1,228 217 Less treasury stock, at cost, 7,152 shares at June 30, 2002 (unaudited) and December 31, 2001 ............................ (37) (37) ----------- ----------- Total shareholders' equity ..................................... 97,380 88,725 ----------- ----------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ................................... $ 1,360,356 $ 1,262,325 =========== =========== </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 Six Months Ended June 30, June 30, --------------------------- ------------------------ 2002 2001 2002 2001 ----------- --------- --------- -------- (Dollars in thousands, except per share data) <S> <C> <C> <C> <C> INTEREST INCOME: Loans, including fees ...................... $ 8,361 $ 8,866 $ 16,117 $ 17,739 Securities: Taxable. .................................. 10,073 9,415 19,887 18,193 Nontaxable ................................ 378 411 768 789 70% nontaxable preferred dividends ........ 264 344 616 655 Deposits in financial institutions ......... 2 7 6 22 Federal funds sold. ........................ 28 100 92 1,065 --------- --------- --------- -------- Total interest income. ................... 19,106 19,143 37,486 38,463 --------- --------- --------- -------- INTEREST EXPENSE: Deposits. ................................ 6,040 9,085 12,189 18,851 Note payable and federal funds sold ...... 243 322 450 575 Other .................................... -- -- -- -- --------- --------- --------- -------- Total interest expense ................. 6,283 9,407 12,639 19,426 --------- --------- --------- -------- NET INTEREST INCOME .................... 12,823 9,736 24,847 19,037 PROVISION FOR CREDIT LOSSES ................ 120 -- 240 -- --------- --------- --------- -------- NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES ............. 12,703 9,736 24,607 19,037 --------- --------- --------- -------- NONINTEREST INCOME: Customer service fees .................... 2,001 1,789 3,859 3,577 Other .................................... 325 269 628 516 --------- --------- --------- -------- Total noninterest income ................ 2,326 2,058 4,487 4,093 -------- --------- --------- -------- NONINTEREST EXPENSE: Salaries and employee benefits ........... 3,405 3,177 7,314 6,512 Net occupancy expense .................... 516 474 995 990 Data processing .......................... 506 520 963 1,025 Core deposit intangible and goodwill amortization ........................... 4 340 4 681 Depreciation expense. .................... 398 383 771 798 Minority interest trust preferred securities ............................. 496 288 994 576 Merger related expenses .................. -- -- -- 2,425 Other .................................... 2,800 1,555 4,746 2,859 --------- --------- --------- -------- Total noninterest expense. .............. 8,125 6,737 15,787 15,866 --------- --------- --------- -------- INCOME BEFORE INCOME TAXES. ................ 6,904 5,057 13,307 7,264 PROVISION FOR INCOME TAXES ................. 2,109 1,487 4,021 2,027 --------- --------- --------- -------- NET INCOME. ................................ $ 4,795 $ 3,570 $ 9,286 $ 5,237 ========= ========= ========= ======== EARNINGS PER SHARE Basic ...................................... $ 0.30 $ 0.22 $ 0.57 $ 0.32 ========= ========= ========= ======== Diluted .................................... $ 0.29 $ 0.22 $ 0.56 $ 0.32 ========= ========= ========= ======== </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 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) <S> <C> <C> <C> <C> <C> <C> <C> <C> 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)................. 9,286 9,285 Net change in unrealized gain on available for sale securities (unaudited).......................... 1,011 1,011 Total comprehensive income (unaudited).. 10,296 ------ Sale of common stock (unaudited)....... 59,200 59 88 147 Cash dividends declared (unaudited).... (1,789) (1,788) ---------- ------- ------- ------- ------ ---- ------- BALANCE AT JUNE 30, 2002 (unaudited)......................... 16,277,222 $16,277 $16,953 $62,959 $1,228 $(37) $97,380 ========== ======= ======= ======= ====== ==== ======= </TABLE> See notes to interim consolidated financial statements. 5
PROSPERITY BANCSHARES, INC.SM AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) <TABLE> <CAPTION> Six Months Ended June 30, ---------------------------- 2002 2001 ---------- ---------- (Dollars in thousands) <S> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES: Net income. ............................................. $ 9,286 $ 5,237 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization ......................... 775 1,480 Provision for credit losses ........................... 240 -- Loss on sale of premises and equipment ................ 6 341 Gain on sale of other real estate .................... (67) -- Net amortization of premium/discount on investments .. 1,601 133 (Increase) decrease in accrued interest receivable and other assets ................................... (3,252) 1,807 Increase in accrued interest payable and other liabilities ............................... 1,747 654 --------- --------- Total adjustments ................................... 1,050 4,415 --------- --------- Net cash provided by operating activities ........... 10,336 9,652 --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from maturities and principal paydowns of held to maturity securities ............... 64,157 131,010 Purchase of held to maturity securities ................. (105,313) -- Proceeds from maturities and principal paydowns of available for sale securities ............. 52,227 40,746 Purchase of available for sale securities ............... (31,912) (232,446) Net increase in loans ................................... (9,086) (18,932) Purchase of bank premises and equipment ................. (1,009) (1,028) 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 -- --------- --------- Net cash used in investing activities ................. (29,578) (80,093) --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Net (decrease) in noninterest-bearing deposits. ......... (2,960) (7,864) Net increase in interest-bearing deposits ............... 29,662 24,688 Repayments of line of credit. ........................... (5,103) (308) Cash paid to dissenting shareholders .................... -- (847) Payments of cash dividends. ............................. (1,789) (1,542) Sale of common stock .................................... 147 247 --------- --------- Net cash provided by financing activities .......... 19,957 14,374 --------- --------- NET INCREASE (DECREASE) OF CASH AND CASH EQUIVALENTS. ...... $ 715 $ (56,067) CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ............. 41,720 99,163 --------- --------- CASH AND CASH EQUIVALENTS, END OF PERIOD. .................. $ 42,435 $ 43,096 ========= ========= </TABLE> See notes to interim consolidated financial statements. 6
PROSPERITY BANCSHARES, INC.SM AND SUBSIDIARIES NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS JUNE 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 six month period ended June 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): <TABLE> <CAPTION> Three Months Ended Six Months Ended June 30, June 30, ------------------------ ------------------------ 2002 2001 2002 2001 -------- --------- --------- --------- <S> <C> <C> <C> <C> Net income available to common shareholders .......... $ 4,795 $ 3,570 $ 9,286 $ 5,237 Weighted average common shares outstanding ........ 16,245 16,180 16,236 16,146 Potential dilutive common shares .................. 329 304 331 322 -------- --------- --------- --------- Weighted average common shares and equivalents outstanding .................................. 16,574 16,484 16,567 16,468 -------- --------- --------- --------- Basic earnings per common share ................... $ 0.30 $ 0.22 $ 0.57 $ 0.32 ======== ========= ========= ========= Diluted earnings per common share ................. $ 0.29 $ 0.22 $ 0.56 $ 0.32 ======== ========= ========= ========= </TABLE> 7
PROSPERITY BANCSHARES, INC.(SM) AND SUBSIDIARIES NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) JUNE 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. For the six months ended June 30, 2002, the Company did not record approximately $680,000 in goodwill amortization that would have been recorded prior to adoption of SFAS 142. 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. The adoption this statement is not expected to 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 is 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. 4. RECENT MERGER ACTIVITY On July 15, 2002, the Company announced the signing of a definitive agreement pursuant to which Southwest Bank Holding Company, Dallas, Texas ("Southwest") will merge with and into the Company and Bank of the Southwest, Dallas, Texas will become a subsidiary of the Company. Under the terms of the agreement, the Company will pay approximately $21.0 million in cash. Bank of the Southwest is privately held and operates two (2) banking offices in Dallas, Texas. As of June 30, 2002, Bank of the Southwest had total assets of $129.6 million, loans of $55.3 million, deposits of $114.3 million and shareholders' equity of $14.7 million. The transaction is expected to close before December 31, 2002 and is subject to approval by Bank of the Southwest shareholders, approval by regulators and certain closing conditions. On July 12, 2002, the Company completed the acquisition of The First State Bank, Needville, Texas (the "First State Acquisition") in a cash transaction. The Company's existing Needville Banking Center has relocated into the former First State Bank location effective July 15, 2002. As of June 30, 2002, The First State Bank had total assets of $16.6 million, loans of $5.5 million, deposits of $14.2 million and shareholders' equity of $2.2 million. On May 8, 2002, the Company completed the acquisition of Texas Guaranty Bank, N.A. (the "Texas Guaranty Acquisition") in a cash transaction. Texas Guaranty operated three offices in Houston, Texas, all of which became full service banking centers of the Company. As of the date of closing, Texas Guaranty Bank, N.A. had total assets of $74.0 million, loans of $45.7 million, deposits of $61.8 million and shareholders' equity of $8.6 million. On May 2, 2002, the Company announced that it had entered into a definitive agreement pursuant to which Paradigm Bancorporation, Inc. ("Paradigm") will be merged into the Company and Paradigm's subsidiary bank, 8
Paradigm Bank Texas, will be merged into the Bank. Under terms of the agreement, Prosperity will issue 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 operates a total of eleven (11) banking offices - six (6) in metropolitan Houston and five (5) in the nearby Southeast Texas cities of Dayton, Galveston, Mont Belvieu, and Winnie. As of June 30, 2002, Paradigm had total assets of $250.3 million, total loans of $175.3 million, total deposits of $219.7 million and shareholders' equity of $19.3 million. The transaction is expected to close before September 30, 2002 and is subject to approval by Paradigm shareholders, approval by regulators and certain closing conditions. 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; and o other risks and uncertainties listed from time to time in the Company's reports and documents filed with the Securities and Exchange Commission. 9
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 8, 2002, the Company announced a two-for-one stock split effected in the form of a 100 percent stock dividend to shareholders of record on May 20, 2002 and was effective on May 31, 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 Prosperity BankSM. The Bank, which changed its name from First Prosperity BankSM 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 32 full-service banking locations in the greater Houston metropolitan area and fourteen contiguous counties situated south and southwest of Houston and extending into South Texas. Total assets were $1.36 billion at June 30, 2002 compared with $1.26 billion at December 31, 2001. Total loans increased to $478.9 million at June 30, 2002 from $424.4 million at December 31, 2001, an increase of $54.5 million, or 12.9%. Loans from the Texas Guaranty Acquisition totaled $45.7 million. Total deposits were $1.21 billion at June 30, 2002 compared with $1.12 billion at December 31, 2001, a increase of $88.5 million, or 7.9%. Shareholders' equity increased $8.7 million or 9.8%, to $97.4 million at June 30, 2002 compared with $88.7 million at December 31, 2001. RESULTS OF OPERATIONS AS REPORTED Net income available to common shareholders was $4.8 million ($0.29 per common share on a diluted basis) for the quarter ended June 30, 2002 compared with $3.6 million ($0.22 per common share on a diluted basis) for the quarter ended June 30, 2001, an increase of $1.2 million, or 34.3%. The Company posted returns on average common equity of 20.16% and 17.30%, returns on average assets of 1.43% and 1.22% and efficiency ratios of 52.06% and 56.05% for the quarters ended June 30, 2002 and 2001, respectively. For the six months ended June 30, 2002, net income available to common shareholders was $9.3 million ($0.56 per common share on a diluted basis) compared with $5.2 million ($0.32 per common share on a diluted basis) for the same period in 2001, an increase of $4.1 million or 77.3%. The Company posted returns on average common equity of 19.77% and 12.72%, returns on average assets of 1.42% and 0.90% and efficiency ratios of 52.20% and 67.79% for the six months ended June 30, 2002 and 2001, respectively. The increase in earnings per share, ROAA, ROAE and the efficiency ratio for the six months ended June 30, 2002 compared with the same period in 2001 was primarily due to $2.4 million in pre-tax merger-related expenses and other charges incurred in connection with the merger of Commercial Bancshares, Inc. ("the Commercial Merger") into the Company on February 23, 2001 which was accounted for as a pooling of interests. Results of Operations Excluding Merger-Related Expenses Net income for the six months ended June 30, 2002 was $9.3 million ($0.56 per common share on a diluted basis) compared with net income of $6.8 million ($0.42 per common share on a diluted basis) for the six months ended June 30, 2001, an increase of $2.5 million or 36.3%. The net income for the six months ended June 30, 2001 of $6.8 million does not include the pre-tax merger-related expenses of $2.4 million incurred in connection with the Commercial Merger. Excluding the merger-related expenses in 2001, the Company would have posted returns on average common equity of 19.77% and 16.54%, returns on average assets of 1.42% and 1.17% and efficiency ratios of 52.20% and 57.04% for the six months ended June 30, 2002 and 2001, respectively. 10
Net Interest Income Net interest income was $12.8 million for the quarter ended June 30, 2002 compared with $9.7 million for the quarter ended June 30, 2001, an increase of $3.1 million, or 31.7%. Net interest income increased as a result of an increase in average interest-earning assets to $1.26 billion for the quarter ended June 30, 2002 from $1.09 billion for the quarter ended June 30, 2001, an increase of $168.5 million, or 15.4%. The net interest margin on a tax-equivalent basis increased to 4.21% from 3.74% for the same periods principally due to a 182 basis point decrease in the rate paid on interest-bearing liabilities from 4.28% for the quarter ended June 30, 2001 to 2.46% for the quarter ended June 30, 2002, partially offset by a 94 basis point decrease in the yield on earning assets from 6.99% for the quarter ended June 30, 2001 to 6.05% for the quarter ended June 30, 2002. Net interest income increased $5.8 million, or 30.5%, to $24.8 million for the six months ended June 30, 2002 from $19.0 million for the same period in 2001. This increase is mainly attributable to higher average interest-earning assets. The net interest margin on a tax-equivalent basis increased to 4.17% from 3.67% for the same periods principally due to a 191 basis point decrease in the rate paid on interest-bearing liabilities from 4.44% for the six months ended June 30, 2001 to 2.53% for the six months ended June 30, 2002, partially offset by a 103 basis point decrease in the yield on earning assets from 7.10% for the six months ended June 30, 2001 to 6.07% for the six months ended June 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 June 30, 2002 and 2001 and for the six months ended June 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. <TABLE> <CAPTION> Three Months Ended June 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) <S> <C> <C> <C> <C> <C> <C> Assets Interest-earning assets: Loans. ............................ $ 456,520 $ 8,361 7.33% $ 425,747 8,866 8.33% Securities(1). .................... 799,286 10,719 5.36 661,122 10,170 6.15 Federal funds sold and other temporary investments ............ 7,575 26 1.37 8,010 107 5.34 --------- -------- --------- ------- Total interest-earning assets.... 1,263,381 19,106 6.05% 1,094,879 19,143 6.99% -------- ------- Less allowance for credit losses... (6,498) (5,598) --------- --------- Total interest-earning assets, net of allowance. .............. 1,256,883 1,089,281 Noninterest-earning assets ..... 85,386 76,671 -------- --------- Total assets .................... $1,342,269 $1,165,952 ========= ========== Liabilities and shareholders' equity Interest-bearing liabilities: Interest-bearing demand deposits $ 238,509 $ 792 1.33% $ 190,484 $ 1,196 2.51% Savings and money market accounts.. 286,168 1,249 1.75 241,164 2,057 3.41 Certificates of deposit. .......... 476,364 3,999 3.36 424,493 5,832 5.50 Federal funds purchased and other borrowings. ...................... 20,676 243 4.70 23,476 322 5.49 --------- -------- --------- ------- Total interest-bearing liabilities .................... 1,021,717 6,283 2.46% 879,617 9,407 4.28% --------- -------- --------- ------- Noninterest-bearing liabilities: Noninterest-bearing demand deposits 190,008 184,431 Company-obligated mandatorily redeemable trust preferred securities of subsidiary trusts ......................... 27,000 12,000 Other liabilities. ................ 8,408 7,366 ------- ------- Total liabilities. .............. 1,247,133 1,083,414 --------- --------- Shareholders' equity ................ 95,136 82,538 --------- --------- Total liabilities and shareholders' equity .......... $1,342,269 $1,165,952 ========== ========== Net interest rate spread ............ 3.59% 2.71% Net interest income and margin(2).... $ 12,823 4.06% $ 9,736 3.56% ========= ======== Net interest income and margin (tax-equivalent basis)(3) .......... $ 13,287 4.21% $ 10,244 3.74% ========= ======== </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%. (4) Annualized. 12
<TABLE> <CAPTION> Six Months Ended June 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) <S> <C> <C> <C> <C> <C> <C> Assets Interest-earning assets: Loans. ........................... $ 436,918 $16,117 7.38% $ 416,609 $17,739 8.52% Securities(1). ................... 787,022 21,277 5.41 627,824 19,637 6.26 Federal funds sold and other temporary investments ........... 11,908 92 1.55 39,175 1,087 5.55 ---------- ------- ---------- ------- Total interest-earning assets. .. 1,235,848 37,486 6.07% 1,038,608 38,463 7.10% ------- ------- Less allowance for credit losses . (6,272) (5,563) ---------- ---------- Total interest-earning assets, net of allowance. ............. 1,229,576 1,078,045 Noninterest-earning assets .... 82,312 82,545 ---------- ---------- Total assets ................... $1,311,888 $1,160,590 ========== ========== Liabilities and shareholders' equity Interest-bearing liabilities: Interest-bearing demand deposits . $ 238,836 $ 1,585 1.33% $ 193,994 $ 2,685 2.77% Savings and money market accounts. 282,005 2,498 1.77 244,755 4,426 3.62 Certificates of deposit. ......... 459,352 8,106 3.53 417,143 11,740 5.63 Federal funds purchased and other borrowings. ..................... 17,323 450 5.20 20,091 575 5.72 ---------- ------- ---------- ------- Total interest-bearing liabilities ................... 997,516 12,639 2.53% 875,983 19,426 4.44% ---------- ------- ---------- ------- Noninterest-bearing liabilities: Noninterest-bearing demand deposits ....................... 185,701 181,916 Company-obligated mandatorily redeemable trust preferred securities of subsidiary trusts ....................... 27,000 12,000 Other liabilities. ............... 7,719 8,324 ---------- ---------- Total liabilities. ............. 1,217,936 1,078,223 ---------- ---------- Shareholders' equity ............... 93,952 82,367 ---------- ---------- Total liabilities and shareholders' equity. ......... $1,311,888 $1,160,590 ========== ========== Net interest rate spread ........... 3.53% 2.66% Net interest income and margin(2). . $24,847 4.02% $ 19,037 3.51% ======= ======== Net interest income and margin (tax-equivalent basis)(3) ......... $25,791 4.17% $ 19,905 3.67% ======= ======== </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%. (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. <TABLE> <CAPTION> Three Months Ended June 30, ----------------------------------- 2002 vs. 2001 ----------------------------------- Increase (Decrease) Due to ---------------------- Volume Rate Total --------- --------- --------- (Dollars in thousands) <S> <C> <C> <C> Interest-earning assets: Loans..................................... $ 641 $(1,146) $ (505) Securities................................ 2,125 (1,576) 549 Federal funds sold and other temporary investments............................. (6) (75) (81) ------ ------- ------- Total increase (decrease) in interest income................................ 2,760 (2,797) (37) ------ ------- ------- Interest-bearing liabilities: Interest-bearing demand deposits.......... 302 (706) (404) Savings and money market accounts......... 384 (1,192) (808) Certificates of deposit................... 712 (2,545) (1,833) Federal funds purchased and other borrowings.............................. (38) (41) (79) ------- ------- ------- Total increase (decrease) in interest expense............................... 1,360 (4,484) (3,124) ------- ------- ------- Increase in net interest income............. $ 1,400 $ 1,687 $ 3,087 ======= ======= ======= </TABLE> <TABLE> <CAPTION> Six Months Ended June 30, ----------------------------------- 2002 vs. 2001 ----------------------------------- Increase (Decrease) Due to ---------------------- Volume Rate Total --------- --------- --------- (Dollars in thousands) <S> <C> <C> <C> Interest-earning assets: Loans........................................ $ 865 $ (2,487) $ (1,622) Securities................................... 4,979 (3,339) 1,640 Federal funds sold and other temporary investments................................ (757) (238) (995) --------- --------- --------- Total increase (decrease) in interest income.................................. 5,087 (6,064) (977) --------- --------- --------- Interest-bearing liabilities: Interest-bearing demand deposits............. 621 (1,721) (1,100) Savings and money market accounts............ 674 (2,602) (1,928) Certificates of deposit...................... 1,188 (4,822) (3,634) Federal funds purchased and other borrowings. (79) (46) (125) --------- --------- --------- Total increase (decrease) in interest expense................................. 2,404 (9,191) (6,787) --------- --------- --------- Increase in net interest income................ $ 2,683 $ 3,127 $ 5,810 ========= ========= ========= </TABLE> 14
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, 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. There was a $120,000 provision for credit losses for the quarter ended June 30, 2002 compared with no provision for the corresponding period in 2001. There was a $240,000 provision for credit losses for the six months ended June 30, 2002, compared with no provision for the same period in 2001. 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 Six Months Ended June 30, June 30, --------------------- ---------------------- 2002 2001 2002 2001 -------- ------- --------- --------- (Dollars in thousands) <S> <C> <C> <C> <C> Service charges on deposit accounts. ........ $ 2,001 $ 1,789 $ 3,859 $ 3,577 Other noninterest income .................... 325 269 628 516 ------- ------- ------- -------- Total noninterest income. ................ $ 2,326 $ 2,058 $ 4,487 $ 4,093 ======= ======= ======= ======== </TABLE> Noninterest income totaled $2.3 million for the three months ended June 30, 2002 compared with $2.1 million for the same period in 2001, an increase of $268,000, or 13.0%. Noninterest income increased $394,000, or 9.6%, to $4.5 million for the six months ended June 30, 2002 from $4.1 million for the same period in 2001. Noninterest Expense Noninterest expense totaled $8.1 million for the quarter ended June 30, 2002 compared with $6.7 million for the quarter ended June 30, 2001, an increase of $1.4 million, or 20.6%. This increase is principally due to increases in salaries and employee benefits, increases in minority interest expense related to trust preferred securities issued by the Company's subsidiary trusts and acquisition expenses. Noninterest expense totaled $15.8 million for the six months ended June 30, 2002, a decrease of $79,000, or 0.50%, from $15.9 million for the same period in 2001. The decrease was primarily due to the $2.4 million in merger-related expenses and other charges incurred in connection with the merger of Commercial with the Company in February 2001. 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 six months ended June 30, 2002 would have increased $2.3 million or 17.5% compared with the same period in 2001. This increase is principally due to increases in salaries and employee benefits, increases in minority interest expense related to the trust preferred securities and acquisition expenses, 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: <TABLE> <CAPTION> Three Months Ended Six Months Ended June 30, June 30, -------------------- ------------------- 2002 2001 2002 2001 --------- --------- -------- -------- (Dollars in thousands) <S> <C> <C> <C> <C> Salaries and employee benefits ........................... $ 3,405 $ 3,178 $ 7,314 $ 6,513 Non-staff expenses: Net occupancy expense ................................ 516 474 995 990 Depreciation ......................................... 398 383 771 798 Data processing ...................................... 506 520 963 1,025 Regulatory assessments and FDIC insurance ............ 81 71 154 122 Ad valorem and franchise taxes. ...................... 127 119 248 245 Core deposit intangibles and goodwill amortization ... 4 340 4 681 Minority interest expense trust preferred securities ......................................... 496 288 994 576 Merger-related expenses .............................. -- -- -- 2,425 Other ................................................ 2,592 1,364 4,344 2,491 --------- --------- -------- ------- Total non-staff expenses ................................. 4,720 3,559 8,473 9,353 Total noninterest expense. ............................... $ 8,125 $ 6,737 $ 15,787 $ 15,866 ========= ========= ======== ======== </TABLE> Salaries and employee benefit expenses were $3.4 million for the quarter ended June 30, 2002 compared with $3.2 million for the quarter ended June 30, 2001, an increase of $227,000, or 7.1%. For the six months ended June 30, 2002, salaries and employee benefits increased $801,000 or 12.3% compared with the same period in 2001. Both increases were principally due to annual employee salary increases. The increase for the six months ended June 30, 2002 was also attributable to additional accumulations for 2002 anticipated incentive compensation. Non-staff expenses increased $1.2 million, or 32.7%, to $4.7 million for the quarter ended June 30, 2002 compared with the same period in 2001. The increase was principally due to acquisition expenses for the three months ended June 30, 2002 and a decrease in goodwill amortization due to a recent accounting change. For the six month period ended June 30, 2002, non-staff expenses decreased $880,000, or 9.4%, to $8.5 million from $9.4 million for the same period in 2001. The decrease was principally due to the $2.4 million one-time merger- related charges incurred in 2001 and a decrease in goodwill amortization due to a recent accounting change partially offset by acquisition expenses incurred during the six months ended June 30, 2002. 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. For the six months ended June 30, 2002, the Company did not record approximately $680,000 in goodwill amortization that would have been recorded prior to the adoption of SFAS 142. 16
Income Taxes Income tax expense increased $622,000, or 41.8%, to $2.1 million for the three months ended June 30, 2002 from $1.5 million for the same period in 2001. For the six month period ended June 30, 2002, income tax expense increased $1.9 million, or 98.4%, to $4.0 million from $2.0 million for the same period in 2001. The increase was primarily attributable to higher pretax net earnings which resulted from an increase in the net interest margin and lower net interest expense for the six months ended June 30, 2002 when compared to the same period in 2001. In addition, the Company incurred $2.4 million in merger-related expenses during the six months ended June 30, 2001 which had a tax benefit of approximately $849,000. FINANCIAL CONDITION Loan Portfolio Total loans were $478.9 million at June 30, 2002, an increase of $54.5 million, or 12.8% from $424.4 million at December 31, 2001. Loans from the Texas Guaranty Acquisition totaled $45.7 million. Loan growth occurred primarily in construction and land development loans and commercial mortgage loans. Period end loans comprised 38.8% of average earning assets at June 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 June 30, 2002 and December 31, 2001: <TABLE> <CAPTION> June 30, December 31, 2002 2001 ------------------ ------------------- Amount Percent Amount Percent --------- ------- -------- ------- (Dollars in thousands) <S> <C> <C> <C> <C> Commercial and industrial ............... $ 54,752 11.4% $ 46,986 11.1% Real estate: Construction and land development. .... 31,134 6.5 20,963 4.9 1-4 family residential ................ 181,140 37.8 175,253 41.3 Home equity ........................... 22,315 4.7 20,541 4.8 Commercial mortgages .................. 106,550 22.2 78,446 18.5 Farmland .............................. 12,254 2.6 10,686 2.5 Multifamily residential ............... 12,001 2.5 9,694 2.3 Agriculture ............................. 22,316 4.7 15,757 3.7 Other ................................... 963 0.2 953 0.2 Consumer................................. 35,510 7.4 45,121 10.7 -------- ----- -------- ---- Total loans......................... $478,935 100.0% $ 424,400 100.0% ======== ===== ========= ===== </TABLE> Nonperforming Assets The Company had $444,000 in nonperforming assets at June 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. The following table presents information regarding nonperforming assets as of the dates indicated: <TABLE> <CAPTION> June 30, December 31, 2002 2001 ----------- --------- (Dollars in thousands) <S> <C> <C> Nonaccrual loans. .................................. $ 287 $ 1 Accruing loans 90 or more days past due. ........... -- -- ------ ------- Total nonperforming loans ....................... 287 -- Other real estate .................................. 157 -- ------ ------- Total nonperforming assets ...................... $ 444 $ 1 ====== ======= </TABLE> 17
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 June 30, 2002, the allowance for credit losses amounted to $6.9 million, or 1.43% 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: <TABLE> <CAPTION> Six Months Ended Year Ended June 30, 2002 December 31, 2001 ----------------- ----------------- (Dollars in thousands) <S> <C> <C> Average loans outstanding ........................... $ 456,520 $ 419,553 ========== ========== Gross loans outstanding at end of period. ........... $ 478,935 $ 424,400 ========== ========== Allowance for credit losses at beginning of period ............................... $ 5,985 $ 5,523 Balance acquired with the Texas Guaranty Bank Acquisition ....................................... 545 -- Provision for credit losses ......................... 240 700 Charge-offs: Commercial and industrial ......................... (6) (180) Real estate and agriculture ....................... (34) (175) Consumer........................................... (27) (74) Recoveries: Commercial and industrial ......................... 14 15 Real estate and agriculture ....................... 113 121 Consumer........................................... 39 55 ------- --------- Net recoveries (charge-offs). ....................... 99 (238) Allowance for credit losses at end of period. ....... $ 6,869 $ 5,985 ======= ========= Ratio of allowance to end of period loans ........... 1.43% 1.41% Ratio of net (recoveries) charge-offs to average loans ............................................. (0.02)% 0.06% Ratio of nonperforming loans to end of period loans ...................................... 0.06% n/m(1) </TABLE> - ----------------- (1) Amount not meaningful. Nonperforming loans totaled $1,000 at December 31, 2001. Securities Securities totaled $785.9 million at June 30, 2002 compared with $752.3 million at December 31, 2001, an increase of $33.5 million, or 4.5%. At June 30, 2002, securities represented 57.8% of total assets compared with 59.6% of total assets at December 31, 2001. Premises and Equipment Premises and equipment, net of accumulated depreciation, totaled $16.3 million at June 30, 2002 and $15.1 million at December 31, 2001. 18
Deposits Total deposits were $1.21 billion at June 30, 2002 compared with $1.12 billion at December 31, 2001, an increase of $88.5 million. At June 30, 2002, noninterest-bearing deposits accounted for 16.3% of total deposits compared with 16.8% of total deposits at December 31, 2001. Interest-bearing deposits totaled $1.01 billion, or 83.7%, of total deposits at June 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 June 30, 2002, the Company had $15.5 million in FHLB borrowings, all of which consisted of FHLB notes payable. 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 June 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 June 30, 2002 and December 31, 2001, the Company's subsidiary trusts had outstanding $27.0 million in trust preferred securities. 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 June 30, 2002, the Company had cash and cash equivalents of $42.4 million, an increase from $41.7 million at December 31, 2001. Capital Resources Total shareholders' equity was $97.4 million at June 30, 2002 compared with $88.7 million at December 31, 2001, an increase of $8.7 million, or 9.8%. The increase was primarily due to net earnings of $9.3 million and a net change in unrealized gain on available for sale securities of $1.0 million, offset by cash dividends paid of $1.8 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 June 30, 2002, the Company's Tier 1 capital, total risk-based capital and leverage capital ratios were 17.03%, 18.24% and 7.37%, respectively. As of June 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 14.95%, 16.16% and 6.47%, respectively. 19
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 the Company's Annual Report on Form 10-K filing on March 8, 2002. See Form 10-K, Item 7 "Management's Discussion and Analysis and Results of Operations-Interest Rate Sensitivity and Liquidity". 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 On April 16, 2002, the Company held its Annual Meeting of Shareholders to consider and act upon the items listed below. All share information has been restated to give effect to the two-for-one stock split effective May 31, 2002. 1. A. Virgil Pace, Jr., Perry Mueller, Jr., Charles M. Slavik and Harrison Stafford II were elected as a Class II directors to serve on the Board of Directors of the Company until the Company's 2005 Annual Meeting of Shareholders and until their successors are duly elected and qualified. A total of 11,010,796 shares were voted in favor of the election of A. Virgil Pace, Jr. and 341,086 shares were withheld from voting. A total of 11,064,796 shares were voted in favor of the election of Perry Mueller and 287,086 shares were withheld from voting. A total of 10,858,572 shares were voted in favor of the election of Charles M. Slavik and 493,310 shares were withheld from voting. A total of 11,072,916 shares were voted in favor of the election of Harrison Stafford II and 278,966 shares were withheld from voting. The following Class I and Class III directors continued in office after the Annual Meeting: Harry L. Bayne, James A. Bouligny, Charles A. Davis, Ned S. Holmes, Tracy T. Rudolph, Robert Steelhammer, H.E. Timanus, Jr. and David Zalman. 2. The shareholders ratified the appointment of Deloitte & Touche LLP as the independent auditors of the books and accounts of the Company for the year ending December 31, 2002. A total of 11,099,166 shares were voted in favor of the appointment, 250,336 shares were voted against the appointment and 2,380 shares abstained from voting. 20
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. (i) The Company filed a Current Report on Form 8-K under Item 5 of Form 8-K on May 2, 2002 to report the signing of a definitive agreement with Paradigm Bancorporation, Inc. pursuant to which Paradigm will be merged into the Company. (ii) The Company filed a Current Report on Form 8-K under Item 5 of Form 8-K on May 8, 2002 to announce a two-for-one stock split to be effected in the form of a 100% stock dividend. (iii) The Company filed a Current Report on Form 8-K under Item 5 of Form 8-K on May 9, 2002 to report the completion of the acquisition of Texas Guaranty Bank, N.A. 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: 08/14/02 /s/ David Zalman ---------------------------------- David Zalman Chief Executive Officer/President Date: 08/14/02 /s/ David Hollaway ---------------------------------- David Hollaway Chief Financial Officer 21