FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004
OR
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER: 000-25051
PROSPERITY BANCSHARES, INC.SM
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
Prosperity Bank Plaza
4295 San Felipe
Houston, Texas 77027
(Address of principal executive offices, including zip code)
(713) 693-9300
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No ¨
As of April 30, 2004, there were 20,954,705 shares of the registrant’s Common Stock, par value $1.00 per share, outstanding.
PROSPERITY BANCSHARES, INC.SM AND SUBSIDIARIES
INDEX TO FORM 10-Q
PART I -FINANCIAL INFORMATION
Item 1.
Interim Financial Statements
Consolidated Balance Sheets as of March 31, 2004 (unaudited) and December 31, 2003 (unaudited)
Consolidated Statements of Income for the Three Months Ended March 31, 2004 and 2003 (unaudited)
Consolidated Statements of Shareholders’ Equity for the Year Ended December 31, 2003 (unaudited) and for the Three Months Ended March 31, 2004 (unaudited)
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2004 and 2003 (unaudited)
Notes to Interim Consolidated Financial Statements (Unaudited)
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
Item 4.
Controls and Procedures
PART II -OTHER INFORMATION
Legal Proceedings
Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
Defaults upon Senior Securities
Submission of Matters to a Vote of Security Holders
Item 5.
Other Information
Item 6.
Exhibits and Reports on Form 8-K
Signatures
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PART I – FINANCIAL INFORMATION
ITEM 1. INTERIM FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
December 31,
2003
(Dollars in thousands,
except share data)
ASSETS
Cash and due from banks
Federal funds sold
Total cash and cash equivalents
Interest-bearing deposits in financial institutions
Available for sale securities, at fair value (amortized cost of $242,744 and $260,533, respectively)
Held to maturity securities, at cost (fair value of $1,201,471 and $1,122,451, respectively)
Loans
Less allowance for credit losses
Loans, net
Accrued interest receivable
Goodwill
Core deposit intangibles, net of accumulated amortization of $1,394 and $1,010, respectively
Bank premises and equipment, net
Other real estate owned
Other assets
TOTAL
LIABILITIES AND SHAREHOLDERS’ EQUITY
LIABILITIES:
Deposits:
Noninterest-bearing
Interest-bearing
Total deposits
Other borrowings
Securities sold under repurchase agreements
Accrued interest payable
Other liabilities
Junior subordinated debentures
Total liabilities
SHAREHOLDERS’ EQUITY:
Common stock, $1 par value; 50,000,000 shares authorized; 20,981,793 and 20,966,706 shares issued at March 31, 2004 and December 31, 2003, respectively; 20,944,705 and 20,929,618 shares outstanding at March 31, 2004 and December 31, 2003, respectively
Capital surplus
Retained earnings
Accumulated other comprehensive income — net unrealized gains on available for sale securities, net of tax of $974 and $1,090, respectively
Less treasury stock, at cost, 37,088 shares at March 31, 2004 and December 31, 2003, respectively
Total shareholders’ equity
See notes to interim consolidated financial statements.
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CONSOLIDATED STATEMENTS OF INCOME
INTEREST INCOME:
Loans, including fees
Securities:
Taxable
Nontaxable
70% nontaxable preferred dividends
Deposits in other financial institutions
Total interest income
INTEREST EXPENSE:
Deposits
Note payable and other borrowings
Total interest expense
NET INTEREST INCOME
PROVISION FOR CREDIT LOSSES
NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES
NONINTEREST INCOME:
Customer service fees
Other
Total noninterest income
NONINTEREST EXPENSE:
Salaries and employee benefits
Net occupancy expense
Depreciation expense
Data processing
Communications expense
Core deposit intangibles amortization
Total noninterest expense
INCOME BEFORE INCOME TAXES
PROVISION FOR INCOME TAXES
NET INCOME
EARNINGS PER SHARE
Basic
Diluted
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CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
Capital
Surplus
Retained
Earnings
Accumulated
Comprehensive
Income
Treasury
Stock
Total
Shareholders’
Equity
BALANCE AT DECEMBER 31, 2002
Net income
Net change in unrealized gain on available for sale securities
Total comprehensive income
Exercise of stock options
Refund of escrow shares in connection with the Paradigm acquisition
Common stock issued in connection with the MainBancorp acquisition
Common stock issued in connection with the FSBNT acquisition
Stock option compensation
Junior subordinated debentures issuance costs
Cash dividends declared, $0.25 per share
BALANCE AT DECEMBER 31, 2003
Cash dividends declared, $0.075
BALANCE AT MARCH 31, 2004
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CONSOLIDATED STATEMENTS OF CASH FLOWS
CASH FLOWS FROM OPERATING ACTIVITIES:
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization
Provision for credit losses
Net amortization of discount/premium on investments
Loss on sale of other real estate
Gain on sale of premises and equipment
(Increase) decrease in other assets and accrued interest receivable
Increase in accrued interest payable and other liabilities
Total adjustments
Net cash provided by operating activities
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities and principal paydowns of held to maturity securities
Purchase of held to maturity securities
Proceeds from maturities and principal paydowns of available for sale securities
Purchase of available for sale securities
Net (increase) decrease loans
Purchase of bank premises and equipment
Net decrease in interest-bearing deposits in financial institutions
Net proceeds acquired from sale of bank premises, equipment, and other real estate
Net cash used in investing activities
CASH FLOWS FROM FINANCING ACTIVITIES:
Net decrease in noninterest-bearing deposits
Net increase in interest-bearing deposits
Net (repayments) proceeds from lines of credit
Proceeds from exercise of stock options
Payments of cash dividends
Net cash provided by financing activities
NET DECREASE IN CASH AND CASH EQUIVALENTS
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
CASH AND CASH EQUIVALENTS, END OF PERIOD
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NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2004
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
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® (the “Bank”) and Prosperity Holdings, Inc. All significant inter-company transactions and balances have been eliminated. Prior period data has been restated to reflect the adoption of FIN 46R on January 1, 2004.
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, 2003. Operating results for the three month period ended March 31, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004.
2. INCOME PER COMMON SHARE
The following table illustrates the computation of basic and diluted earnings per share.
Net income available to common shareholders
Weighted average common shares outstanding
Potential dilutive common shares
Weighted average common shares and equivalents outstanding
Basic earnings per common share
Diluted earnings per common share
3. NEW ACCOUNTING STANDARDS
FIN No. 46 “Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulleting No. 51.” FIN 46 establishes accounting guidance for consolidation of variable interest entities (VIE) that function to support the activities of the primary beneficiary. The primary beneficiary of a VIE is the entity that absorbs a majority of the VIE’s expected losses, receives a majority of the VIE’s expected residual returns, or both, as a result of ownership, controlling interest, contractual relationship or other business relationship with a VIE. Prior to the implementation of FIN 46, VIE’s were generally consolidated by an enterprise when the enterprise had a controlling financial interest through ownership of a majority of voting interest in the entity. The provisions of FIN 46 were effective immediately for all arrangements entered into after January 31, 2003, and are otherwise effective at the beginning of the first interim period beginning after December 15, 2003. The Company adopted FIN 46 on July 1, 2003.
In December 2003, the FASB issued FIN 46R, “Consolidation of Variable Interest Entities.” FIN 46R provides guidance on how to identify a variable interest entity and determine when the assets, liabilities, non-controlling interests and results of operations of a variable interest entity need to be included in a company’s consolidated financial statements. A company that holds variable interest in an entity will be required to consolidate the entity if the company’s interest in the
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variable interest entity is such that the company will absorb a majority of the variable interest entity’s expected losses and/or receive a majority of the entity’s expected residual returns, if they occur. As of March 31, 2004, the Company had no investments in variable interest entities requiring consolidation. FIN 46R requires that Prosperity Capital Trust I, Prosperity Capital Trust II, Prosperity Statutory Trust III, Prosperity Statutory Trust IV and Paradigm Capital Trust II be deconsolidated from the consolidated financial statements. The Company adopted FIN 46R on January 1, 2004. After adoption, the trust preferred securities issued by each of the foregoing trusts are no longer shown in the consolidated financial statements. Instead, the junior subordinated debentures issued by the Company to each of these trusts are shown as liabilities in the consolidated balance sheets and interest expense associated with such junior subordinated debentures is shown in the consolidated statements of income.
SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity.” SFAS 150 establishes standards for how an issuer classifies, measures and discloses in its financial statements certain financial instruments with characteristics of both liabilities and equity. SFAS 150 requires that an issuer classify financial instruments that are within its scope as liabilities, in most circumstances. Such financial instruments include (i) financial instruments that are issued in the form of shares that are mandatorily redeemable; (ii) financial instruments that embody an obligation to repurchase the issuer’s equity shares, or are indexed to such an obligation, and that require the issuer to settle the obligation by transferring assets; (iii) financial instruments that embody an obligation that the issuer may settle by issuing a variable number of its equity shares if, at inception, the monetary value of the obligation is predominantly based on a fixed amount, variations in something other than the fair value of the issuer’s equity shares or variations inversely related to changes in the fair value of the issuer’s equity shares; and (iv) certain freestanding financial instruments. The Company adopted SFAS 150 on January 1, 2004.
4. RECENT DEVELOPMENTS
On April 26, 2004, the Company entered into a definitive agreement with Liberty Bancshares, Inc. (“Liberty”), Austin, Texas, pursuant to which Liberty will merge into the Company and its wholly owned subsidiary, Liberty Bank, S.S.B. will merge into the Bank. Under the terms of the agreement, the Company will pay approximately $10.5 million in cash, subject to adjustment, and issue approximately 1.3 million shares of its Common Stock for all of the issued and outstanding capital stock and stock options of Liberty and Liberty Bank, S.S.B. Liberty is privately held and operates six (6) banking offices in Austin, Texas. As of March 31, 2004, Liberty had total assets of $186.7 million, loans of $127.7 million, deposits of $170.0 million and shareholders’ equity of $16.2 million. The transaction is expected to close in the third quarter of 2004. The Company will not complete the acquisition unless customary closing conditions are satisfied or waived, including receipt of the necessary shareholder and regulatory approvals and consents from applicable regulatory agencies including the Federal Reserve Board, the Texas Banking Department and the Federal Deposit Insurance Corporation.
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5. GOODWILL AND CORE DEPOSIT INTANGIBLES
Changes in the carrying amount of the Company’s goodwill and core deposit intangibles (CDI) for three months ended March 31, 2004 were as follows:
Balance as of December 31, 2003
Amortization
Core deposit intangibles-First State Bank of North Texas
Expenses associated with the acquisition of the First State Bank of North Texas
Core deposit intangibles-MainBancorp
Expenses associated with the acquisition of MainBancorp
Balance as of March 31, 2004
The Company initially records the total premium paid on acquisitions as goodwill. After a third party valuation, core deposit intangibles are identified and reclassified from goodwill to core deposit intangibles on the balance sheet. This reclassification had no effect on total assets, liabilities, stockholder’s equity, net income or cash flows.
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Special Cautionary Notice Regarding Forward-Looking Statements
Statements and financial discussion and analysis contained in this quarterly report on Form 10-Q that are not historical facts are forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based on assumptions and involve a number of risks and uncertainties, many of which are beyond the Company’s control. Many possible events or factors could affect the future financial results and performance of the Company and could cause such results or performance to differ materially from those expressed in the forward-looking statements. These possible events or factors include, without limitation:
A forward-looking statement may include a statement of the assumptions or bases underlying the forward-looking statement. The Company believes it has chosen these assumptions or bases in good faith and that they are reasonable. However, the Company cautions you that assumptions or bases almost always vary from actual results, and the differences between assumptions or bases and actual results can be material.
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The Company undertakes no obligation to publicly update or otherwise revise any forward-looking statements, whether as a result of new information, future events or otherwise, unless the securities laws require the Company to do so.
RECENT DEVELOPMENTS
On April 26, 2004, the Company entered into a definitive agreement with Liberty Bancshares, Inc. (“Liberty”), Austin, Texas, pursuant to which, Liberty will merge into the Company and its wholly owned subsidiary, Liberty Bank, S.S.B will merge into the Bank. Under the terms of the agreement, the Company will pay approximately $10.5 million in cash, subject to adjustment, and issue approximately 1.3 million shares of its Common Stock for all of the issued and outstanding capital stock and stock options of Liberty and Liberty Bank, S.S.B. Liberty is privately held and operates six (6) banking offices in Austin, Texas. As of March 31, 2004, Liberty had total assets of $186.7 million, loans of $127.7 million, deposits of $170.0 million and shareholders’ equity of $16.2 million. The transaction is expected to close in the third quarter of 2004. The Company will not complete the acquisition unless customary closing conditions are satisfied or waived, including receipt of the necessary shareholder and regulatory approvals and consents from applicable regulatory agencies including the Federal Reserve Board, the Texas Banking Department and the Federal Deposit Insurance Corporation.
OVERVIEW
Prosperity Bancshares, Inc.SM (the “Company”) was formed in 1983 as a vehicle to acquire the former Allied Bank in Edna, Texas which was chartered in 1949 as The First National Bank of Edna. The Company is a registered financial holding company that derives substantially all of its revenues and income from the operation of its bank subsidiary, Prosperity Bank® (“Prosperity Bank®” or the “Bank”). The Bank provides a broad line of financial products and services to small and medium-sized businesses and consumers. The Bank operates fifty-one (51) full-service banking locations; with twenty-nine (29) in the Greater Houston Consolidated Metropolitan Statistical Area (“CMSA”), eleven (11) in eight contiguous counties situated south and southwest of Houston and extending into South Texas and eleven (11) in the Dallas/Fort Worth area. The Greater Houston CMSA includes Brazoria, Chambers, Fort Bend, Galveston, Harris, Liberty, Montgomery and Waller counties. The Company’s headquarters are located at Prosperity Bank Plaza, 4295 San Felipe in Houston, Texas and its telephone number is (713) 693-9300. The Company’s website address is www.prosperitybanktx.com.
The Company generates the majority of its revenues from interest income on loans, service charges on customer accounts and income from investment in securities. The revenues are offset by interest expense paid on deposits and other borrowings and non-interest expenses such as administrative and occupancy expenses. Net interest income is the difference between interest income on earning assets such as loans and securities and interest expense on liabilities such as deposits and borrowings which are used to fund those assets. The level of interest rates and the volume and mix of earning assets and interest-bearing liabilities impact net interest income and margin. The low rate environment has negatively impacted the Company’s net interest margin however the Company has recognized increased net interest income due to the rates paid on interest bearing liabilities decreasing at a greater rate than the decrease in the rate earned on interest earning assets and an increase in the volume of interest-earning assets.
Three principal components of the Company’s growth strategy are internal growth, stringent cost control practices and strategic merger transactions. The Company focuses on continual internal growth. Each Banking Center is operated as a separate profit center, maintaining separate data with respect to its net interest income, efficiency ratio, deposit growth, loan growth and overall profitability. Banking Center Presidents and Managers are accountable for performance in these areas and compensated accordingly. The Company also focuses on maintaining stringent cost control practices and policies. The Company has invested significantly in the infrastructure required to centralize many of its critical operations, such as data processing and loan application processing. Management believes that this centralized infrastructure can accommodate substantial additional growth while enabling the Company to minimize operational costs through certain economies of scale. The Company also intends to continue to seek expansion opportunities. During 2003, eleven (11) banking centers were acquired in the Dallas/Fort Worth area and in April 2004, the Company entered into an agreement to acquire six (6) banking centers in Austin, Texas.
Total assets were $2.45 billion at March 31, 2004 compared with $2.40 billion at December 31, 2003. Total loans were $770.2 million at March 31, 2004 compared with $770.1 million at December 31, 2003. Total deposits were $2.12 billion at March 31, 2004 compared with $2.08 billion at December 31, 2003, an increase of $39.1 million, or 1.9%. Shareholders’ equity increased $6.3 million or 2.9%, to $225.9 million at March 31, 2004 compared with $219.6 million at December 31, 2003.
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CRITICAL ACCOUNTING POLICIES
The Company’s accounting policies are integral to understanding the financial results reported. Accounting policies are described in detail in Note 1 to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003. The Company believes that of its significant accounting policies, the following may involve a higher degree of judgment and complexity:
Allowance for Credit Losses - The allowance for credit losses is a reserve established through charges to earnings in the form of a provision for credit losses. Management has established an allowance for credit losses which it believes is adequate for estimated losses in the Company’s loan portfolio. Based on an evaluation of the loan portfolio, management presents a monthly review of the allowance for credit losses to the Bank’s Board of Directors, indicating any change in the allowance since the last review and any recommendations as to adjustments in the allowance. In making its evaluation, management considers factors such as historical loan loss experience, industry diversification of the Company’s commercial loan portfolio, the amount of nonperforming assets and related collateral, the volume, growth and composition of the Company’s loan portfolio, current economic changes that may affect the borrower’s ability to pay and the value of collateral, the evaluation of the Company’s loan portfolio through its internal loan review process and other relevant factors. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. Charge-offs occur when loans are deemed to be uncollectible. The allowance for credit losses includes allowance allocations calculated in accordance with Statement of Financial Accounting Standards (SFAS) No. 114, “Accounting by Creditors for Impairment of a Loan,” as amended by SFAS 118, and allowance allocations determined in accordance with SFAS No. 5, “Accounting for Contingencies.”
RESULTS OF OPERATIONS
Net income available to common shareholders was $8.1 million ($0.38 per common share on a diluted basis) for the quarter ended March 31, 2004 compared with $6.4 million ($0.33 per common share on a diluted basis) for the quarter ended March 31, 2003, an increase of $1.7 million, or 26.2%. The Company posted returns on average common equity of 14.44% and 16.19%, returns on average assets of 1.33% and 1.40% and efficiency ratios of 50.60% and 51.24% for the quarters ended March 31, 2004 and 2003, respectively.
Net Interest Income
Net interest income was $19.3 million for the quarter ended March 31, 2004 compared with $15.5 million for the quarter ended March 31, 2003, an increase of $3.8 million, or 24.5%. Net interest income increased as a result of an increase in average interest-earning assets to $2.19 billion for the quarter ended March 31, 2004 from $1.67 billion for the quarter ended March 31, 2003, an increase of $520.3 million, or 31.2%.
The net interest margin decreased to 3.54% at March 31, 2004 from 3.73% at March 31, 2003. The rate paid on interest-bearing liabilities decreased 37 basis points from 1.97% for the quarter ended March 31, 2003 to 1.60% for the quarter ended March 31, 2004 and the yield on earning assets decreased 50 basis points from 5.32% for the quarter ended March 31, 2003 to 4.82% for the quarter ended March 31, 2004. The volume of interest-bearing liabilities increased $401.5 million and the volume of interest earning assets increased $520.3 million for the same periods. The decrease in the net interest margin is principally due the rate paid on interest earning assets decreasing at a greater rate than the rate paid on interest bearing liabilities.
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 Company adopted FIN 46R on January 1, 2004. FIN 46R requires that Prosperity Capital Trust I, Prosperity Capital Trust II, Prosperity Statutory Trust III, Prosperity Statutory Trust IV and Paradigm Capital Trust II be deconsolidated from the consolidated financial statements. After adoption, the trust preferred securities issued by each of the foregoing trusts are no longer shown in the consolidated financial statements. Instead, the junior subordinated debentures issued by the Company to each of these trusts are shown as liabilities in the consolidated balance sheets and interest expense associated with
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such junior subordinated debentures is shown in the consolidated statements of income. The interest expense associated with the junior subordinated debentures was previously shown as non-interest expense. Prior period data has been restated to reflect the adoption of FIN 46R on January 1, 2004.
The following table sets forth, for each category of interest-earning assets and interest-bearing liabilities, the average amounts outstanding, the interest earned or paid on such amounts, and the average rate earned or paid for the quarters ended March 31, 2004 and 2003. The table also sets forth the average rate paid on total interest-bearing liabilities, and the net interest margin on average total interest-earning assets for the same periods. Except as indicated in the footnotes, no tax-equivalent adjustments were made and all average balances are daily average balances. Any nonaccruing loans have been included in the table as loans carrying a zero yield.
Assets
Interest-earning assets:
Securities(1)
Federal funds sold and other temporary investments
Total interest-earning assets
Total interest-earning assets, net of allowance
Noninterest-earning assets
Total assets
Liabilities and shareholders’ equity
Interest-bearing liabilities:
Interest-bearing demand deposits
Savings and money market accounts
Certificates of deposit
Federal funds purchased and other borrowings
Total interest-bearing liabilities
Noninterest-bearing liabilities:
Noninterest-bearing demand deposits
Shareholders’ equity
Total liabilities and shareholders’ equity
Net interest rate spread
Net interest income and margin (2)
Net interest income and margin (tax-equivalent basis) (3)
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The following table presents the dollar amount of changes in interest income and interest expense for the major components of interest-earning assets and interest-bearing liabilities and distinguishes between the increase (decrease) related to outstanding balances and the volatility of interest rates. For purposes of this table, changes attributable to both rate and volume which cannot be segregated have been allocated to rate.
Increase
(Decrease)
Due to
Securities
Total increase (decrease) in interest income
Total increase (decrease) in interest expense
Increase (decrease) in net interest income
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.
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 provision for credit losses, future adjustments may be necessary if economic conditions differ from the assumptions used in making the initial determinations.
The Company made a $120,000 provision for credit losses for the quarter ended March 31, 2004 and for the quarter ended March 31, 2003. For the quarter ended March 31, 2004, net charge-offs were $5,000 compared with net charge-offs of $383,000 for the quarter ended March 31, 2003.
Noninterest Income
The Company’s primary sources of noninterest income are service charges on deposit accounts and other banking service related fees. Non-interest income does not include loan origination fees which are recognized over the life of the related loan as an adjustment to yield using the interest method. Banking related service fees include check cashing fees, official check fees, safe deposit box rent and currency handling fees. Noninterest income totaled $5.3 million for the three months ended March 31, 2004 compared with $3.8 million for the same period in 2003, an increase of $1.4 million, or 37.3%. The increase was primarily due to an increase in insufficient funds charges and customer service charges which resulted from an increase in the number of accounts due to the Abrams, Dallas Bancshares, MainBancorp and FSBNT acquisitions in 2003. At March 31, 2004, the four acquisitions added approximately 33,500 deposit accounts and over 5,000 debit cards.
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The following table presents for the periods indicated the major categories of noninterest income:
Service charges on deposit accounts
Banking related service fees
Trust and investment income
Gain on sale of assets
Other noninterest income
Noninterest Expense
Noninterest expense totaled $12.5 million for the quarter ended March 31, 2004 compared with $9.9 million for the quarter ended March 31, 2003, an increase of $2.5 million, or 25.5%. This increase is principally due to increases in salaries and employee benefits, core deposit intangibles amortization and other expenses. The increase in other expenses is principally due to advertising expense. The following table presents, for the periods indicated, the major categories of noninterest expense:
Non-staff expenses:
Net occupancy and equipment expense
Depreciation
Professional fees
Regulatory assessments and FDIC insurance
Ad valorem and franchise taxes
Total non-staff expenses
Salaries and employee benefit expenses were $6.7 million for the quarter ended March 31, 2004 compared with $5.4 million for the quarter ended March 31, 2003, an increase of $1.3 million, or 24.0%. The change was principally due to additional staff associated with the Abrams, Dallas Bancshares, MainBancorp and FSBNT acquisitions in 2003. The number of full-time equivalent (FTE) associates employed by the Company increased from 496 at March 31, 2003 to 612 at March 31, 2004.
Non-staff expenses increased $1.2 million, or 27.2%, to $5.8 million for the quarter ended March 31, 2004 compared to $4.5 million during the same period in 2003. The increase was principally due to additional expenses associated with the Abrams, Dallas Bancshares, MainBancorp and FSBNT acquisitions, increases in core deposit intangibles amortization related to the 2003 acquisitions and increases in advertising expenses which are included in other expenses.
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Income Taxes
Income tax expense increased $1.0 million to $4.0 million for the quarter ended March 31, 2004 from $2.9 million for the same period in 2003. The increase was primarily attributable to higher pretax net earnings for the quarter ended March 31, 2004 when compared to the same period in 2003.
FINANCIAL CONDITION
Loan Portfolio
Total loans were $770.2 million at March 31, 2004, an increase of $170,000, or 0.02% from $770.1 million at December 31, 2003. Period end loans comprised 30.0% of average earning assets at March 31, 2004 compared with 42.1% at December 31, 2003.
The following table summarizes the loan portfolio of the Company by type of loan as of March 31, 2004 and December 31, 2003:
March 31,
2004
Commercial and industrial
Real estate:
Construction and land development
1-4 family residential
Home equity
Commercial mortgages
Farmland
Multifamily residential
Agriculture
Consumer
Total loans
Nonperforming Assets
The Company had $610,000 in nonperforming assets at March 31, 2004 and $967,000 in nonperforming assets at December 31, 2003.
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.
Nonaccrual loans
Restructured loans
Accruing loans 90 or more days past due
Total nonperforming loans
Repossessed assets
Other real estate
Total nonperforming assets
Non-performing assets to total loans and other real estate
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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 March 31, 2004, the allowance for credit losses amounted to $10.5 million, or 1.36% of total loans compared with $10.4 million, or 1.34% of total loans at December 31, 2003.
Set forth below is an analysis of the allowance for credit losses for the three months ended March 31, 2004 and the year ended December 31, 2003:
Three Months Ended
March 31, 2004
Year Ended
December 31, 2003
Average loans outstanding
Gross loans outstanding at end of period
Allowance for credit losses at beginning of period
Balance acquired with the Abrams, Dallas Bancshares, MainBancorp and FSBNT acquisitions
Charge-offs:
Real estate and agriculture
Recoveries:
Net charge-offs
Allowance for credit losses at end of period
Ratio of allowance to end of period loans
Ratio of charge-offs to average loans
Ratio of nonperforming loans to end of period loans
Securities totaled $1.43 billion at March 31, 2004 compared with $1.38 million at December 31 2008, an increase of $49.8 million, or 3.6%. The increase was principally due to increased growth in deposits and a decrease in total loans. At March 31, 2004, securities represented 58.2% of total assets compared with 57.4% of total assets at December 31, 2003.
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The following table summarizes the amortized cost of securities as of the dates shown (available-for-sale securities are not adjusted for unrealized gains or losses):
U.S. Treasury securities and obligations of U.S. government agencies
70% non-taxable preferred stock
States and political subdivisions
Corporate debt securities
Equity securities
Collateralized mortgage obligations
Mortgage-backed securities
Premises and Equipment
Premises and equipment, net of accumulated depreciation, totaled $33.7 million and $34.3 million at March 31, 2004 and December 31, 2003, respectively.
Total deposits were $2.12 billion at March 31, 2004 compared with $2.08 billion at December 31, 2003, an increase of $39.1 million or 1.9%. At March 31, 2004, non-interest bearing deposits accounted for approximately 20.9% of total deposits compared with 22.4% of total deposits at December 31, 2003. Interest-bearing demand deposits totaled $1.68 billion, or 79.1%, of total deposits at March 31, 2004 compared with $1.62 billion, or 77.6%, of total deposits at December 31, 2003.
The following table summarizes the daily average balances and weighted average rates paid on deposits for the dates presented below:
Interest-bearing checking
Regular savings
Money market savings
Time deposits
Total interest-bearing deposits
Noninterest-bearing deposits
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 March 31, 2004, the Company had $11.7 million in FHLB borrowings and at December 31, 2003 the Company had $11.9 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%. FHLB notes payable are secured by a blanket lien on the Bank’s first mortgage loans against one-to-four family residential properties.
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At March 31, 2004 the Company had $18.8 million in securities sold under repurchase agreements compared with $19.0 million at December 31, 2003.
Junior Subordinated Debentures
At March 31, 2004 and December 31, 2003, the Company had outstanding $59.8 million in junior subordinated debentures issued to the Company’s subsidiary trusts.
Liquidity
Liquidity involves the Company’s ability to raise funds to support asset growth or reduce assets to meet deposit withdrawals and other payment obligations, to maintain reserve requirements and otherwise to operate the Company on an ongoing basis. The Company’s liquidity needs have primarily been met by growth in core deposits and the issuance of junior subordinated debentures. Although access to purchased funds from correspondent banks is available and has been utilized on occasion to take advantage of investment opportunities, the Company does not generally rely on these external funding sources. The cash and federal funds sold position, supplemented by amortizing investment and loan portfolios, have generally created an adequate liquidity position.
Asset liquidity is provided by cash and assets which are readily marketable or which will mature in the near future. As of March 31, 2004 and December 31, 2003, the Company had cash and cash equivalents of $83.7 million.
Contractual Obligations
The following tables summarize the Company’s contractual obligations and other commitments to make future payments as of March 31, 2004 (other than deposit obligations). The Company’s future cash payments associated with its contractual obligations pursuant to its junior subordinated debentures, FHLB notes payable and operating leases as of March 31, 2004 are summarized below. Payments for borrowings do not include interest. Payments related to leases are based on actual payments specified in underlying contracts.
Remaining
Fiscal 2004
Fiscal
2005-2006
2007-2008
Federal Home Loan Bank notes payable
Operating leases
Off-Balance Sheet Items
The Company’s commitments associated with outstanding standby letters of credit and commitments to extend credit as of March 31, 2004 are summarized below. Since commitments associated with letters of credit and commitments to extend credit may expire unused, the amounts shown do not necessarily reflect the actual future cash funding requirements:
Standby letters of credit
Commitments to extend credit
In the normal course of business, the Company enters into various transactions, which, in accordance with accounting principles generally accepted in the United States, are not included in its consolidated balance sheets. The Company enters into these transactions to meet the financing needs of its customers. These transactions include commitments to extend credit and standby letters of credit, which involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amounts recognized in the consolidated balance sheets.
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Capital Resources
Total shareholders’ equity was $225.9 million at March 31, 2004 compared with $219.6 million at December 31, 2003, an increase of $6.3 million, or 2.9%. The increase was due primarily to net earnings of $8.1 million partially offset by dividends paid of $1.6 million for the three months ended March 31, 2004.
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 March 31, 2004, the Company’s Tier 1 risk-based capital, total risk-based capital and leverage capital ratios were 16.68%, 17.78% and 6.87%, respectively. As of March 31, 2004, 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 risk-based capital, total risk-based capital and leverage capital ratios of 15.40%, 16.51% and 6.34%, 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. The Company considers macroeconomic variables, Company strategy, liquidity and other factors as it quantifies market risk. See the Company’s Annual Report on Form 10-K, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Interest Rate Sensitivity and Liquidity” which was filed on March 12, 2004 for further discussion.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures. As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of its management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of its disclosure controls and procedures. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported to the Company’s management within the time periods specified in the Securities and Exchange Commission’s rules and forms.
Changes in internal controls over financial reporting. There were no changes in the Company’s internal controls over financial reporting that occurred during the Company’s most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
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PART II – OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Not Applicable
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES
a. Not applicable
b. Not applicable
c. Not applicable
d. Not applicable
e. Not applicable
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
ITEM 5. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
The following exhibits are filed with this Quarterly Report on Form 10-Q;
Description of Exhibit
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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.
Date: 05/07/04
/s/ David Zalman
/s/ David Hollaway
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