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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
FORM 10-K
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For The Fiscal Year Ended December 31, 1998
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 0-25051
PROSPERITY BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
TEXAS 74-2331986
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3040 POST OAK BLVD. 77056
HOUSTON, TEXAS (Zip Code)
(Address of principal executive offices)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(713) 993-0002
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value
$1.00 PER SHARE
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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of the Form 10-K or any amendment of this
Form 10-K. [ ]
As of March 11, 1999, the number of outstanding shares of Common Stock was
5,172,825. As of such date, the aggregate market value of the shares of Common
Stock held by non-affiliates, based on the closing price of the Common Stock on
the Nasdaq National Market System on such date, was approximately $52,596,338.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the Company's Proxy Statement for the 1999 Annual Meeting of
Shareholders (Part III, Items 10-13).
PROSPERITY BANCSHARES, INC.
1998 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PART I
Item 1. Business......................................................... 1
General.......................................................... 1
Business......................................................... 2
Recent Acquisition............................................... 3
Competition...................................................... 3
Associates....................................................... 3
Supervision and Regulation....................................... 3
Item 2. Properties....................................................... 9
Item 3. Legal Proceedings................................................ 10
Item 4. Submission of Matters to a Vote of Security Holders.............. 10
PART II
Item 5. Market for Registrant's Common Equity and Related
Shareholder Matters.............................................. 10
Description of Capital Stock..................................... 11
Item 6. Selected Consolidated Financial Data............................. 12
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations........................................... 15
Overview......................................................... 15
Results of Operations............................................ 15
Financial Condition...............................................19
Year 2000 Compliance..............................................31
Item 7A. Quantitative and Qualitative Disclosures about Market Risk....... 32
Item 8. Financial Statements and Supplementary Data...................... 32
Item 9. Changes In and Disagreements with Accountants on Accounting and
Financial Disclosure............................................ 33
PART III
Item 10. Directors and Executive Officers of the Registrant............... 34
Item 11. Executive Compensation........................................... 34
Item 12. Security Ownership of Certain Beneficial Owners and Management... 34
Item 13. Certain Relationships and Related Transactions................... 34
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.. 34
PART I
ITEM 1. BUSINESS
GENERAL
Prosperity Bancshares, Inc. (the "Company") was formed in 1983 as a
vehicle to acquire the former Allied Bank in Edna, Texas which was chartered in
1949. The Company derives substantially all of its income from its wholly-owned
bank subsidiary, First Prosperity Bank (the "Bank"), which has 12 full-service
banking locations ("Banking Centers") in the greater Houston metropolitan area
and six contiguous counties situated south and southwest of Houston. The
Company's headquarters are located at 3040 Post Oak Boulevard in Houston, Texas
and its telephone number is (713) 993-0002.
The Company has grown through a combination of internal growth, the
acquisition of community banks and the opening of new community banking offices.
Utilizing a low cost of funds and employing stringent cost controls, the Company
has been profitable in every full year of its existence, including the period of
adverse economic conditions in Texas in the late 1980s. From 1988 to 1992, as a
sound and profitable institution, the Company took advantage of this economic
downturn and acquired the deposits and certain assets of failed banks in West
Columbia, El Campo and Cuero, Texas and two failed banks in Houston, which
diversified the Company's franchise and increased its core deposits. The Company
opened a full-service Banking Center in Victoria, Texas in 1993 and the
following year established a Banking Center in Bay City, Texas. The Company
expanded its Bay City presence in 1996 with the acquisition of an additional
branch location from Norwest Bank Texas, and in 1997, the Company acquired the
Angleton, Texas branch of Wells Fargo Bank. In 1998, the Company enhanced its
West Columbia Banking Center with the purchase of a commercial bank branch
located in West Columbia. In addition, the Company acquired Union State Bank
("Union") in East Bernard, Texas, which had loans of $21.5 million and deposits
of $66.1 million as of September 30, 1998 (the "Union Acquisition"). As a result
of the addition of these acquisitions and internal growth, the Company's assets
have increased from $54.2 million at the end of 1987 to $436.3 million as of
December 31, 1998 and its deposits have increased from $46.0 million to $390.7
million in that same period.
The Company's primary market consists of the communities served by its
three locations in the greater Houston metropolitan area and its nine locations
in six contiguous counties (Brazoria, Wharton, Matagorda, Jackson, Victoria and
DeWitt) located to the south and southwest of Houston. Texas Highway 59
(scheduled to become Interstate Highway 69), which serves as one of the primary
trucking routes linking the interior United States and Mexico, runs directly
through the center of the Company's market area. The increased traffic along
this "NAFTA Highway" has enhanced economic activity in the Company's market area
and created opportunities for growth. The diverse nature of the economies in
each local market served by the Company provides the Company with a varied
customer base and allows the Company to spread its lending risk throughout a
number of different industries including farming, ranching, petrochemicals,
manufacturing, tourism, recreation and professional service firms and their
principals. The Company's market areas outside of Houston are dominated by
either small community banks or branches of large regional banks. Management
believes that the Company, as one of the few mid-sized financial institutions
that combines responsive community banking with the sophistication of a regional
bank holding company, has a competitive advantage in its market area and
excellent growth opportunities through acquisitions, new branch locations and
additional business development.
Operating under a community banking philosophy, the Company seeks to
develop broad customer relationships based on service and convenience while
maintaining its conservative approach to lending and strong asset quality. The
Company's directors and officers are important to the Company's success and play
a key role in the Company's business development efforts by actively
participating in a number of civic and public service activities in the
communities served by the Company, such as the Rotary Club, Lion's Club, United
Way and Chamber of Commerce. In addition, the Company's Banking Centers in Bay
City, Clear Lake, Cuero, Edna and Victoria maintain Community Development
Boards, whose function is to solicit new business, develop customer relations
and provide valuable community knowledge to their respective Banking Center
Presidents.
The Company has invested heavily in its officers and associates by
recruiting talented officers in its market areas and providing them with
economic incentive in the form of stock options and bonuses based on
cross-selling performance. The senior management team has substantial experience
in both the Houston markets and the surrounding communities in which the Company
has a presence. Each Banking Center location is administered by a local
President with knowledge of the community and banking skills which complement
the local economy. The Company entrusts its Banking Center Presidents with
authority and flexibility with respect to product pricing and decision making
within general parameters established by the Company. The Company operates each
Banking Center as a separate profit center, maintaining separate data with
respect to each Banking Center's net interest income, efficiency ratio, deposit
growth, loan growth and overall profitability. Banking Center Presidents are
accountable for performance in these areas and compensated accordingly. Each
Banking Center has its own local telephone number, which enables a customer to
be served by a local banker.
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BUSINESS
The Company offers a variety of traditional loan and deposit products to
its customers, which consist primarily of consumers and small and medium-sized
businesses. The Company tailors its products to the specific needs of customers
in a given market. The Company maintains approximately 29,000 separate deposit
accounts and 5,500 separate loan accounts. At December 31, 1998, approximately
21.8% of the Company's total deposits were noninterest-bearing demand deposits
and for the period ended December 31, 1998, the Company's average cost of funds
was 3.11%.
The Company has been an active mortgage lender, with one-to-four family
and commercial mortgage loans comprising 64.8% of the Company's total loans as
of December 31, 1998. The Company also offers loans for automobiles and other
consumer durables, home equity loans, debit cards, personal computer banking and
other cash management services and telebanking. By offering certificates of
deposit, NOW accounts, savings accounts and overdraft protection at competitive
rates, the Company gives its depositors a full range of traditional deposit
products. The Company has successfully introduced Banclub, which for a monthly
fee provides consumers with a package of benefits including unlimited free
checking, personalized checks, credit card protection, free travelers checks,
cashier's checks, money orders and certain travel discounts.
The businesses targeted by the Company are primarily those that require
loans in the $100,000 to $3.0 million range. The Company offers these businesses
a broad array of loan products including term loans, lines of credit and loans
for working capital, business expansion and the purchase of equipment and
machinery, interim construction loans for builders and owner-occupied commercial
real estate loans. For its business customers, the Company has developed a
specialized checking product called Business 10 Checking which provides
discounted fees for checking and normal account analysis.
The Company's main objective is to increase deposits and loans through
additional expansion opportunities while maintaining efficiency and
individualized customer service and maximizing profitability. To achieve this
objective, the Company has employed the following strategic goals:
INCREASE LOAN VOLUME AND DIVERSIFY LOAN PORTFOLIO. The Company seeks to
increase its ratio of loans to deposits from the December 31, 1998 level of
43.6% to approximately 65%. Given the Company's high level of low-cost core
deposits, increased lending activity is expected to significantly enhance the
Company's net income. Historically, the Company has elected to sacrifice some
earnings for the relative security of home mortgage loans. While maintaining its
conservative approach to lending, the Company plans to emphasize both new and
existing loan products. Among new loan products, the Company has successfully
introduced home equity lending, which contributed $8.1 million in new loans
during 1998. The Company has also increased its number of loans to finance the
construction of commercial owner-occupied real estate and loans to commercial
businesses for accounts receivable financing and other purposes. With the Union
Acquisition, the Company's agricultural loans increased from $6.4 million to
$14.1 million during 1998. The Company is also targeting professional service
firms such as legal and medical practices for both loans secured by
owner-occupied premises and personal loans to their principals. As an outgrowth
of its traditional mortgage lending activity, the Company is making more jumbo
mortgage loans, particularly in the Houston area.
MAINTAIN EFFICIENCY RATIO. The Company has always emphasized cost control.
The Company has invested significantly in the infrastructure required to
centralize many of its critical operations, such as data processing and loan
application processing. For its Banking Centers, which the Company operates as
independent profit centers, the Company supplies complete support in the areas
of loan review, internal audit, compliance and training. The Company maintains a
Products Committee which provides support in the areas of product development,
marketing and pricing. Management believes that this centralized infrastructure
can accommodate substantial additional growth while enabling the Company to
minimize operational costs through certain economies of scale. Since 1993, the
Company has acquired three branch locations and established two new offices
while improving its efficiency ratio in each consecutive year.
ENHANCE CROSS-SELLING. The Company recognizes that its customer base
provides significant opportunities to cross-sell various products and has
increased its focus on cross-selling opportunities by training associates to
identify and maximize cross-selling opportunities. The Company uses bonuses to
encourage cross-selling efforts, and fosters friendly competition among the
Banking Centers to achieve better cross-selling results. To assist with
cross-selling efforts the Company has updated its technology to help officers
and associates identify cross-selling opportunities through a readily accessible
Customer Information File which details personal information, existing account
relationships and related account relationships. Using this data, the Company's
officers and associates inform customers of additional products when customers
visit or call the various Banking Centers or use their drive-in facilities. In
addition, the Company includes product information in monthly statements and
other mailouts. The products most frequently targeted for cross-selling include
auto loans, mortgage loans, home equity loans, checking accounts, savings
accounts, certificates of deposit, Individual Retirement Accounts, direct
deposit accounts, personal computer banking and safe deposit boxes.
2
AUGMENT MARKET SHARE. In recent years, the Company has grown in each of
the communities in which it maintains a Banking Center. The Company intends to
continue seeking opportunities, both inside and outside its existing markets, to
expand either by acquiring existing banks or branches of banks or by
establishing new branches. All of the Company's acquisitions have been accretive
to earnings immediately and have supplied the Company with relatively low-cost
deposits which have been used to fund the Company's lending activities. Factors
used by the Company to evaluate expansion opportunities include the similarity
in management and operating philosophies, whether the acquisition will be
accretive to earnings and enhance shareholder value, the ability to achieve
economies of scale to improve the efficiency ratio and the opportunity to
enhance the Company's image and market presence.
RECENT ACQUISITION
The Company's Board of Directors actively pursues an acquisition strategy
designed to increase efficiency, market share and return to shareholders. As
part of this strategy, the Company acquired Union, a Texas banking association
organized in 1907, pursuant to a statutory merger. Union was a single location
community bank whose business includes conventional consumer and commercial
products and services, including interest and noninterest-bearing depository
accounts and commercial, industrial, consumer, agricultural and real estate
lending. As of September 30, 1998, Union had loans of $21.5 million and total
deposits of $66.1 million. Union was the only full-service commercial bank in
East Bernard and has a stable customer base.
The Union acquisition provided the Company with a presence in East
Bernard, a community of 1,500 located in northern Wharton County. The
acquisition increased the Company's market share in Wharton County, where the
Company's El Campo Banking Center is located. Union had a lending philosophy
which is similar to that employed by the Company. The Company's significantly
higher lending limit is expected to create lending opportunities in the market
that Union was unable to take advantage of prior to the acquisition. Similar to
its previous acquisitions, management believes that the Union acquisition will
enable the Company to achieve certain economies of scale and resultant savings
from the operation of Union as an additional Banking Center.
Upon consummation of the Union acquisition, holders of shares of Union
common stock received $17.6 million in cash as consideration in exchange for
their shares. The source of the Company's funds for the acquisition was a
combination of existing cash ($15.6 million) and borrowed funds ($2.0 million).
The Union acquisition was accounted for as a purchase transaction. At the
closing of the Union acquisition, two executive officers of Union entered into
three year employment agreements with the Company which contain two-year
noncompetition clauses.
COMPETITION
The banking business is highly competitive, and the profitability of the
Company depends principally on the Company's ability to compete in its market
areas. The Company competes with other commercial banks, savings banks, savings
and loan associations, credit unions, finance companies, mutual funds, insurance
companies, brokerage and investment banking firms, asset-based nonbank lenders
and certain other nonfinancial entities, including retail stores which may
maintain their own credit programs and certain governmental organizations which
may offer more favorable financing than the Company. The Company has been able
to compete effectively with other financial institutions by emphasizing customer
service, technology and responsive decision-making on loans; by establishing
long-term customer relationships and building customer loyalty; and by providing
products and services designed to address the specific needs of its customers.
Competition from both financial and nonfinancial institutions is expected to
continue.
ASSOCIATES
As of December 31, 1998, the Company and its wholly-owned subsidiary First
Prosperity Bank (the "Bank") had 138 full-time equivalent associates, 63 of whom
were officers of the Bank. The Company provides medical and hospitalization
insurance to its full-time associates. The Company considers its relations with
associates to be excellent. Neither the Company nor the Bank is a party to any
collective bargaining agreement.
SUPERVISION AND REGULATION
The supervision and regulation of bank holding companies and their
subsidiaries is intended primarily for the protection of depositors, the deposit
insurance funds of the Federal Deposit Insurance Corporation ("FDIC") and the
banking system as a whole, and not for the protection of the bank holding
company shareholders or creditors. The banking agencies have broad enforcement
power over bank holding companies and banks including the power to impose
substantial fines and other penalties for violations of laws and regulations.
3
The following description summarizes some of the laws to which the Company
and the Bank are subject. References herein to applicable statutes and
regulations are brief summaries thereof, do not purport to be complete, and are
qualified in their entirety by reference to such statutes and regulations. The
Company believes that it is in compliance in all material respects with these
laws and regulations.
THE COMPANY
The Company is a bank holding company registered under the Bank Holding
Company Act of 1956, as amended ("BHCA"), and it is subject to supervision,
regulation and examination by the Board of Governors of the Federal Reserve
System ("Federal Reserve Board"). The BHCA and other federal laws subject bank
holding companies to particular restrictions on the types of activities in which
they may engage, and to a range of supervisory requirements and activities,
including regulatory enforcement actions for violations of laws and regulations.
REGULATORY RESTRICTIONS ON DIVIDENDS; SOURCE OF STRENGTH. It is the policy
of the Federal Reserve Board that bank holding companies should pay cash
dividends on common stock only out of income available over the past year and
only if prospective earnings retention is consistent with the organization's
expected future needs and financial condition. The policy provides that bank
holding companies should not maintain a level of cash dividends that undermines
the bank holding company's ability to serve as a source of strength to its
banking subsidiaries.
Under Federal Reserve Board policy, a bank holding company is expected to
act as a source of financial strength to each of its banking subsidiaries and
commit resources to their support. Such support may be required at times when,
absent this Federal Reserve Board policy, a holding company may not be inclined
to provide it. As discussed below, a bank holding company in certain
circumstances could be required to guarantee the capital plan of an
undercapitalized banking subsidiary.
In the event of a bank holding company's bankruptcy under Chapter 11 of
the U.S. Bankruptcy Code, the trustee will be deemed to have assumed and is
required to cure immediately any deficit under any commitment by the debtor
holding company to any of the federal banking agencies to maintain the capital
of an insured depository institution, and any claim for breach of such
obligation will generally have priority over most other unsecured claims.
ACTIVITIES "CLOSELY RELATED" TO BANKING. The BHCA prohibits a bank holding
company, with certain limited exceptions, from acquiring direct or indirect
ownership or control of any voting shares of any company which is not a bank or
from engaging in any activities other than those of banking, managing or
controlling banks and certain other subsidiaries, or furnishing services to or
performing services for its subsidiaries. One principal exception to these
prohibitions allows the acquisition of interests in companies whose activities
are found by the Federal Reserve Board, by order or regulation, to be so closely
related to banking or managing or controlling banks, as to be a proper incident
thereto. Some of the activities that have been determined by regulation to be
closely related to banking are making or servicing loans, performing certain
data processing services, acting as an investment or financial advisor to
certain investment trusts and investment companies, and providing securities
brokerage services. Other activities approved by the Federal Reserve Board
include consumer financial counseling, tax planning and tax preparation, futures
and options advisory services, check guaranty services, collection agency and
credit bureau services, and personal property appraisals. In approving
acquisitions by bank holding companies of companies engaged in banking-related
activities, the Federal Reserve Board considers a number of factors, and weighs
the expected benefits to the public (such as greater convenience and increased
competition or gains in efficiency) against the risks of possible adverse
effects (such as undue concentration of resources, decreased or unfair
competition, conflicts of interest, or unsound banking practices). The Federal
Reserve Board is also empowered to differentiate between activities commenced de
novo and activities commenced through acquisition of a going concern.
SECURITIES ACTIVITIES. The Federal Reserve Board has approved applications
by bank holding companies to engage, through nonbank subsidiaries, in certain
securities-related activities (underwriting of municipal revenue bonds,
commercial paper, consumer receivable-related securities and one-to-four family
mortgage-backed securities), provided that the affiliates would not be
"principally engaged" in such activities for purposes of Section 20 of the
Glass-Steagall Act. In limited situations, holding companies may be able to use
such subsidiaries to underwrite and deal in corporate debt and equity
securities.
SAFE AND SOUND BANKING PRACTICES. Bank holding companies are not permitted
to engage in unsafe and unsound banking practices. The Federal Reserve Board's
Regulation Y, for example, generally requires a holding company to give the
Federal Reserve Board prior notice of any redemption or repurchase of its own
equity securities, if the consideration to be paid, together with the
consideration paid for any repurchases or redemptions in the preceding year, is
equal to 10% or more of the company's consolidated net worth. The Federal
Reserve Board may oppose the transaction if it believes that the transaction
would constitute an unsafe or
4
unsound practice or would violate any law or regulation. Depending upon the
circumstances, the Federal Reserve Board could take the position that paying a
dividend would constitute an unsafe or unsound banking practice.
The Federal Reserve Board has broad authority to prohibit activities of
bank holding companies and their nonbanking subsidiaries which represent unsafe
and unsound banking practices or which constitute violations of laws or
regulations, and can assess civil money penalties for certain activities
conducted on a knowing and reckless basis, if those activities caused a
substantial loss to a depository institution. The penalties can be as high as
$1.0 million for each day the activity continues.
ANTI-TYING RESTRICTIONS. Bank holding companies and their affiliates are
prohibited from tying the provision of certain services, such as extensions of
credit, to other services offered by a holding company or its affiliates.
CAPITAL ADEQUACY REQUIREMENTS. The Federal Reserve Board has adopted a
system using risk-based capital guidelines to evaluate the capital adequacy of
bank holding companies. Under the guidelines, specific categories of assets are
assigned different risk weights, based generally on the perceived credit risk of
the asset. These risk weights are multiplied by corresponding asset balances to
determine a "risk-weighted" asset base. The guidelines require a minimum total
risk-based capital ratio of 8.0% (of which at least 4.0% is required to consist
of Tier 1 capital elements). Total capital is the sum of Tier 1 and Tier 2
capital. As of December 31, 1998, the Company's ratio of Tier 1 capital to total
risk-weighted assets was 18.02% and its ratio of total capital to total
risk-weighted assets was 19.08%. SEE "MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - FINANCIAL CONDITION - CAPITAL
RESOURCES."
In addition to the risk-based capital guidelines, the Federal Reserve
Board uses a leverage ratio as an additional tool to evaluate the capital
adequacy of bank holding companies. The leverage ratio is a company's Tier 1
capital divided by its average total consolidated assets. Certain highly rated
bank holding companies may maintain a minimum leverage ratio of 3.0%, but other
bank holding companies may be required to maintain a leverage ratio of up to 200
basis points above the regulatory minimum. As of December 31, 1998, the
Company's leverage ratio was 7.58%.
The federal banking agencies' risk-based and leverage ratios are minimum
supervisory ratios generally applicable to banking organizations that meet
certain specified criteria, assuming that they have the highest regulatory
rating. Banking organizations not meeting these criteria are expected to operate
with capital positions well above the minimum ratios. The federal bank
regulatory agencies may set capital requirements for a particular banking
organization that are higher than the minimum ratios when circumstances warrant.
Federal Reserve Board guidelines also provide that banking organizations
experiencing internal growth or making acquisitions will be expected to maintain
strong capital positions substantially above the minimum supervisory levels,
without significant reliance on intangible assets.
IMPOSITION OF LIABILITY FOR UNDERCAPITALIZED SUBSIDIARIES. Bank regulators
are required to take "prompt corrective action" to resolve problems associated
with insured depository institutions whose capital declines below certain
levels. In the event an institution becomes "undercapitalized," it must submit a
capital restoration plan. The capital restoration plan will not be accepted by
the regulators unless each company having control of the undercapitalized
institution guarantees the subsidiary's compliance with the capital restoration
plan up to a certain specified amount. Any such guarantee from a depository
institution's holding company is entitled to a priority of payment in
bankruptcy.
The aggregate liability of the holding company of an undercapitalized bank
is limited to the lesser of 5% of the institution's assets at the time it became
undercapitalized or the amount necessary to cause the institution to be
"adequately capitalized." The bank regulators have greater power in situations
where an institution becomes "significantly" or "critically" undercapitalized or
fails to submit a capital restoration plan. For example, a bank holding company
controlling such an institution can be required to obtain prior Federal Reserve
Board approval of proposed dividends, or might be required to consent to a
consolidation or to divest the troubled institution or other affiliates.
ACQUISITIONS BY BANK HOLDING COMPANIES. The BHCA requires every bank
holding company to obtain the prior approval of the Federal Reserve Board before
it may acquire all or substantially all of the assets of any bank, or ownership
or control of any voting shares of any bank, if after such acquisition it would
own or control, directly or indirectly, more than 5% of the voting shares of
such bank. In approving bank acquisitions by bank holding companies, the Federal
Reserve Board is required to consider the financial and managerial resources and
future prospects of the bank holding company and the banks concerned, the
convenience and needs of the communities to be served, and various competitive
factors.
CONTROL ACQUISITIONS. The Change in Bank Control Act prohibits a person or
group of persons from acquiring "control" of a bank holding company unless the
Federal Reserve Board has been notified and has not objected to the transaction.
Under a rebuttable
5
presumption established by the Federal Reserve Board, the acquisition of 10% of
more of a class of voting stock of a bank holding company with a class of
securities registered under Section 12 of the Exchange Act, such as the Company,
would, under the circumstances set forth in the presumption, constitute
acquisition of control of the Company.
In addition, any entity is required to obtain the approval of the Federal
Reserve Board under the BHCA before acquiring 25% (5% in the case of an acquiror
that is a bank holding company) or more of the outstanding Common Stock of the
Company, or otherwise obtaining control or a "controlling influence" over the
Company.
THE BANK
The Bank is a Texas-chartered banking association, the deposits of which
are insured by the Bank Insurance Fund ("BIF"). The Bank is not a member of the
Federal Reserve System; therefore, the Bank is subject to supervision and
regulation by the FDIC and the Texas Banking Department. Such supervision and
regulation subject the Bank to special restrictions, requirements, potential
enforcement actions and periodic examination by the FDIC and the Texas Banking
Department. Because the Federal Reserve Board regulates the bank holding company
parent of the Bank, the Federal Reserve Board also has supervisory authority
which directly affects the Bank.
EQUIVALENCE TO NATIONAL BANK POWERS. The Texas Constitution, as amended in
1986, provides that a Texas-chartered bank has the same rights and privileges
that are or may be granted to national banks domiciled in Texas. To the extent
that the Texas laws and regulations may have allowed state-chartered banks to
engage in a broader range of activities than national banks, the Federal Deposit
Insurance Corporation Improvement Act of 1991 ("FDICIA") has operated to limit
this authority. FDICIA provides that no state bank or subsidiary thereof may
engage as principal in any activity not permitted for national banks, unless the
institution complies with applicable capital requirements and the FDIC
determines that the activity poses no significant risk to the insurance fund. In
general, statutory restrictions on the activities of banks are aimed at
protecting the safety and soundness of depository institutions.
BRANCHING. Texas law provides that a Texas-chartered bank can establish a
branch anywhere in Texas provided that the branch is approved in advance by the
Texas Banking Department. The branch must also be approved by the FDIC, which
considers a number of factors, including financial history, capital adequacy,
earnings prospects, character of management, needs of the community and
consistency with corporate powers.
RESTRICTIONS ON TRANSACTIONS WITH AFFILIATES AND INSIDERS. Transactions
between the Bank and its nonbanking subsidiaries, including the Company, are
subject to Section 23A of the Federal Reserve Act. In general, Section 23A
imposes limits on the amount of such transactions, and also requires certain
levels of collateral for loans to affiliated parties. It also limits the amount
of advances to third parties which are collateralized by the securities or
obligations of the Company or its subsidiaries.
Affiliate transactions are also subject to Section 23B of the Federal
Reserve Act which generally requires that certain transactions between the Bank
and its affiliates be on terms substantially the same, or at least as favorable
to the Bank, as those prevailing at the time for comparable transactions with or
involving other nonaffiliated persons.
The restrictions on loans to directors, executive officers, principal
shareholders and their related interests (collectively referred to herein as
"insiders") contained in the Federal Reserve Act and Regulation O apply to all
insured institutions and their subsidiaries and holding companies. These
restrictions include limits on loans to one borrower and conditions that must be
met before such a loan can be made. There is also an aggregate limitation on all
loans to insiders and their related interests. These loans cannot exceed the
institution's total unimpaired capital and surplus, and the FDIC may determine
that a lesser amount is appropriate. Insiders are subject to enforcement actions
for knowingly accepting loans in violation of applicable restrictions.
RESTRICTIONS ON DISTRIBUTION OF SUBSIDIARY BANK DIVIDENDS AND ASSETS.
Dividends paid by the Bank have provided a substantial part of the Company's
operating funds and for the foreseeable future it is anticipated that dividends
paid by the Bank to the Company will continue to be the Company's principal
source of operating funds. Capital adequacy requirements serve to limit the
amount of dividends that may be paid by the Bank. Under federal law, the Bank
cannot pay a dividend if, after paying the dividend, the Bank will be
"undercapitalized." The FDIC may declare a dividend payment to be unsafe and
unsound even though the Bank would continue to meet its capital requirements
after the dividend.
Because the Company is a legal entity separate and distinct from its
subsidiaries, its right to participate in the distribution of assets of any
subsidiary upon the subsidiary's liquidation or reorganization will be subject
to the prior claims of the subsidiary's creditors. In the event of a liquidation
or other resolution of an insured depository institution, the claims of
depositors and other
6
general or subordinated creditors are entitled to a priority of payment over the
claims of holders of any obligation of the institution to its shareholders,
including any depository institution holding company (such as the Company) or
any shareholder or creditor thereof.
EXAMINATIONS. The FDIC periodically examines and evaluates insured banks.
Based on such an evaluation, the FDIC may revalue the assets of the institution
and require that it establish specific reserves to compensate for the difference
between the FDIC-determined value and the book value of such assets. The Texas
Banking Department also conducts examinations of state banks but may accept the
results of a federal examination in lieu of conducting an independent
examination.
AUDIT REPORTS. Insured institutions with total assets of $500 million or
more must submit annual audit reports prepared by independent auditors to
federal and state regulators. In some instances, the audit report of the
institution's holding company can be used to satisfy this requirement. Auditors
must receive examination reports, supervisory agreements and reports of
enforcement actions. In addition, financial statements prepared in accordance
with generally accepted accounting principles, management's certifications
concerning responsibility for the financial statements, internal controls and
compliance with legal requirements designated by the FDIC, and an attestation by
the auditor regarding the statements of management relating to the internal
controls must be submitted. For institutions with total assets of more than $3
billion, independent auditors may be required to review quarterly financial
statements. FDICIA requires that independent audit committees be formed,
consisting of outside directors only. The committees of such institutions must
include members with experience in banking or financial management, must have
access to outside counsel, and must not include representatives of large
customers.
CAPITAL ADEQUACY REQUIREMENTS. The FDIC has adopted regulations
establishing minimum requirements for the capital adequacy of insured
institutions. The FDIC may establish higher minimum requirements if, for
example, a bank has previously received special attention or has a high
susceptibility to interest rate risk.
The FDIC's risk-based capital guidelines generally require state banks to
have a minimum ratio of Tier 1 capital to total risk-weighted assets of 4.0% and
a ratio of total capital to total risk-weighted assets of 8.0%. The capital
categories have the same definitions for the Bank as for the Company. As of
December 31, 1998, the Bank's ratio of Tier 1 capital to total risk-weighted
assets was 11.87% and its ratio of total capital to total risk-weighted assets
was 12.93%. SEE "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULT OF OPERATION OF THE COMPANY - FINANCIAL CONDITION CAPITAL RESOURCES."
The FDIC's leverage guidelines require state banks to maintain Tier 1
capital of no less than 5.0% of average total assets, except in the case of
certain highly rated banks for which the requirement is 3.0% of average total
assets. The Texas Banking Department has issued a policy which generally
requires state chartered banks to maintain a leverage ratio (defined in
accordance with federal capital guidelines) of 6% . As of December 31, 1998, the
Bank's ratio of Tier 1 capital to average total assets (leverage ratio) was
4.99%. SEE "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULT OF OPERATION OF THE COMPANY - FINANCIAL CONDITION - CAPITAL RESOURCES."
CORRECTIVE MEASURES FOR CAPITAL DEFICIENCIES. The federal banking
regulators are required to take "prompt corrective action" with respect to
capital-deficient institutions. Agency regulations define, for each capital
category, the levels at which institutions are "well capitalized," "adequately
capitalized," "under capitalized," "significantly under capitalized" and
"critically under capitalized." A "well capitalized" bank has a total risk-based
capital ratio of 10.0% or higher; a Tier 1 risk-based capital ratio of 6.0% or
higher; a leverage ratio of 5.0% or higher; and is not subject to any written
agreement, order or directive requiring it to maintain a specific capital level
for any capital measure. An "adequately capitalized" bank has a total risk-based
capital ratio of 8.0% or higher; a Tier 1 risk-based capital ratio of 4.0% or
higher; a leverage ratio of 4.0% or higher (3.0% or higher if the bank was rated
a composite 1 in its most recent examination report and is not experiencing
significant growth); and does not meet the criteria for a well capitalized bank.
A bank is "under capitalized" if it fails to meet any one of the ratios required
to be adequately capitalized. The Bank is classified as "well capitalized" for
purposes of the FDIC's prompt corrective action regulations.
In addition to requiring undercapitalized institutions to submit a capital
restoration plan, agency regulations contain broad restrictions on certain
activities of undercapitalized institutions including asset growth,
acquisitions, branch establishment and expansion into new lines of business.
With certain exceptions, an insured depository institution is prohibited from
making capital distributions, including dividends, and is prohibited from paying
management fees to control persons if the institution would be undercapitalized
after any such distribution or payment.
As an institution's capital decreases, the FDIC's enforcement powers
become more severe. A significantly undercapitalized institution is subject to
mandated capital raising activities, restrictions on interest rates paid and
transactions with affiliates, removal of management and other restrictions. The
FDIC has only very limited discretion in dealing with a critically
undercapitalized institution and is virtually required to appoint a receiver or
conservator.
7
Banks with risk-based capital and leverage ratios below the required
minimums may also be subject to certain administrative actions, including the
termination of deposit insurance upon notice and hearing, or a temporary
suspension of insurance without a hearing in the event the institution has no
tangible capital.
DEPOSIT INSURANCE ASSESSMENTS. The Bank must pay assessments to the FDIC
for federal deposit insurance protection. The FDIC has adopted a risk-based
assessment system as required by FDICIA. Under this system, FDIC-insured
depository institutions pay insurance premiums at rates based on their risk
classification. Institutions assigned to higher risk classifications (that is,
institutions that pose a greater risk of loss to their respective deposit
insurance funds) pay assessments at higher rates than institutions that pose a
lower risk. An institution's risk classification is assigned based on its
capital levels and the level of supervisory concern the institution poses to the
regulators. In addition, the FDIC can impose special assessments in certain
instances. The current range of BIF assessments is between 0% and 0.27% of
deposits.
The FDIC established a process for raising or lowering all rates for
insured institutions semi-annually if conditions warrant a change. Under this
system, the FDIC has the flexibility to adjust the assessment rate schedule
twice a year without seeking prior public comment, but only within a range of
five cents per $100 above or below the premium schedule adopted. Changes in the
rate schedule outside the five cent range above or below the current schedule
can be made by the FDIC only after a full rulemaking with opportunity for public
comment.
On September 30, 1996, President Clinton signed into law an act that
contained a comprehensive approach to recapitalizing the Savings Association
Insurance Fund ("SAIF") and to assure the payment of the Financing Corporation's
("FICO") bond obligations. Under this new act, banks insured under the BIF are
required to pay a portion of the interest due on bonds that were issued by FICO
to help shore up the ailing Federal Savings and Loan Insurance Corporation in
1987. The BIF rate must equal one-fifth of the SAIF rate through year-end 1999,
or until the insurance funds are merged, whichever occurs first. Thereafter BIF
and SAIF payers will be assessed pro rata for the FICO bond obligations. With
regard to the assessment for the FICO obligation, the current BIF rate is .0126%
of deposits and the SAIF rate is .0630% of deposits.
ENFORCEMENT POWERS. The FDIC and the other federal banking agencies have
broad enforcement powers, including the power to terminate deposit insurance,
impose substantial fines and other civil and criminal penalties and appoint a
conservator or receiver. Failure to comply with applicable laws, regulations and
supervisory agreements could subject the Company or its banking subsidiaries, as
well as officers, directors and other institution-affiliated parties of these
organizations, to administrative sanctions and potentially substantial civil
money penalties. The appropriate federal banking agency may appoint the FDIC as
conservator or receiver for a banking institution (or the FDIC may appoint
itself, under certain circumstances) if any one or more of a number of
circumstances exist, including, without limitation, the fact that the banking
institution is undercapitalized and has no reasonable prospect of becoming
adequately capitalized; fails to become adequately capitalized when required to
do so; fails to submit a timely and acceptable capital restoration plan; or
materially fails to implement an accepted capital restoration plan. The Texas
Banking Department also has broad enforcement powers over the Bank, including
the power to impose orders, remove officers and directors, impose fines and
appoint supervisors and conservators.
BROKERED DEPOSIT RESTRICTIONS. Adequately capitalized institutions cannot
accept, renew or roll over brokered deposits except with a waiver from the FDIC,
and are subject to restrictions on the interest rates that can be paid on such
deposits. Undercapitalized institutions may not accept, renew, or roll over
brokered deposits.
CROSS-GUARANTEE PROVISIONS. The Financial Institutions Reform, Recovery
and Enforcement Act of 1989 ("FIRREA") contains a "cross-guarantee" provision
which generally makes commonly controlled insured depository institutions liable
to the FDIC for any losses incurred in connection with the failure of a commonly
controlled depository institution.
COMMUNITY REINVESTMENT ACT. The Community Reinvestment Act of 1977 ("CRA")
and the regulations issued thereunder are intended to encourage banks to help
meet the credit needs of their service area, including low and moderate income
neighborhoods, consistent with the safe and sound operations of the banks. These
regulations also provide for regulatory assessment of a bank's record in meeting
the needs of its service area when considering applications to establish
branches, merger applications and applications to acquire the assets and assume
the liabilities of another bank. FIRREA requires federal banking agencies to
make public a rating of a bank's performance under the CRA. In the case of a
bank holding company, the CRA performance record of the banks involved in the
transaction are reviewed in connection with the filing of an application to
acquire ownership or control of shares or assets of a bank or to merge with any
other bank holding company. An unsatisfactory record can substantially delay or
block the transaction.
8
CONSUMER LAWS AND REGULATIONS. In addition to the laws and regulations
discussed herein, the Bank is also subject to certain consumer laws and
regulations that are designed to protect consumers in transactions with banks.
While the list set forth herein is not exhaustive, these laws and regulations
include the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds
Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity
Act, and the Fair Housing Act, among others. These laws and regulations mandate
certain disclosure requirements and regulate the manner in which financial
institutions must deal with customers when taking deposits or making loans to
such customers. The Bank must comply with the applicable provisions of these
consumer protection laws and regulations as part of their ongoing customer
relations.
INSTABILITY AND REGULATORY STRUCTURE
Various legislation, including proposals to overhaul the bank regulatory
system, expand the powers of banking institutions and bank holding companies and
limit the investments that a depository institution may make with insured funds,
is from time to time introduced in Congress. Such legislation may change banking
statutes and the operating environment of the Company and its banking
subsidiaries in substantial and unpredictable ways. The Company cannot determine
the ultimate effect that potential legislation, if enacted, or implementing
regulations with respect thereto, would have upon the financial condition or
results of operations of the Company or its subsidiaries.
EXPANDING ENFORCEMENT AUTHORITY
One of the major additional burdens imposed on the banking industry by
FDICIA is the increased ability of banking regulators to monitor the activities
of banks and their holding companies. In addition, the Federal Reserve Board and
FDIC are possessed of extensive authority to police unsafe or unsound practices
and violations of applicable laws and regulations by depository institutions and
their holding companies. For example, the FDIC may terminate the deposit
insurance of any institution which it determines has engaged in an unsafe or
unsound practice. The agencies can also assess civil money penalties, issue
cease and desist or removal orders, seek injunctions, and publicly disclose such
actions. FDICIA, FIRREA and other laws have expanded the agencies' authority in
recent years, and the agencies have not yet fully tested the limits of their
powers.
EFFECT ON ECONOMIC ENVIRONMENT
The policies of regulatory authorities, including the monetary policy of
the Federal Reserve Board, have a significant effect on the operating results of
bank holding companies and their subsidiaries. Among the means available to the
Federal Reserve Board to affect the money supply are open market operations in
U.S. government securities, changes in the discount rate on member bank
borrowings, and changes in reserve requirements against member bank deposits.
These means are used in varying combinations to influence overall growth and
distribution of bank loans, investments and deposits, and their use may affect
interest rates charged on loans or paid for deposits.
Federal Reserve Board monetary policies have materially affected the
operating results of commercial banks in the past and are expected to continue
to do so in the future. The nature of future monetary policies and the effect of
such policies on the business and earnings of the Company and its subsidiaries
cannot be predicted.
ITEM 2. PROPERTIES
The Company conducts business at 12 full-service banking locations. The
following table sets forth specific information on each such location. The
Company's headquarters are located at 3040 Post Oak Blvd. located in Houston,
Texas. The Company owns all of the buildings in which its Banking Centers are
located other than the Post Oak, Meyerland and Victoria Banking Centers.
LOCATION ADDRESS DEPOSITS AT DECEMBER 31, 1998
- -------- ------- -----------------------------
(Dollars in thousands)
Angleton 116 South Velasco $28,403
Angleton, TX 77516
Bay City-North 1600 Seventh St $14,194
Bay City, TX 77404
Bay City-South 3700 Avenue F $29,914
Bay City, TX 77404
9
Clear Lake 100 West Medical Center Blvd $32,509
Webster, TX 77598
Cuero 106 North Esplanade $25,144
Cuero, TX 77954
East Bernard 700 Church St $70,656
East Bernard, TX 77435
Edna 102 North Wells $35,969
Edna, TX 77962
El Campo 1301 N Mechanic $45,126
El Campo, TX 77437
Meyerland 8801 West Loop South $21,670
Houston, TX 77252
Post Oak 3040 Post Oak Blvd. Suite 150 $28,086
Houston, TX 77056
Victoria 2702 North Navarro $14,400
Victoria, TX 77903
West Columbia 510 East Brazos $41,167
West Columbia, TX 77486
ITEM 3. LEGAL PROCEEDINGS
Neither the Company nor the Bank is currently a party to any material
legal proceeding.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of 1998.
PART II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
In November 1998, the Company's registration statement ("Registration
Statement") previously filed with the Securities and Exchange Commission ("SEC")
was declared effective pursuant to which 1,974,300 shares of the Company's
common stock ("Common Stock") were sold to the public. Prior to this offering,
the Company's Common Stock was privately held and not listed on any public
exchange or actively traded. The Common Stock began trading on November 12, 1998
and is listed on the Nasdaq National Market System ("Nasdaq NMS") under the
symbol "PRSP". The Company had a total of 5,172,825 shares outstanding at
December 31, 1998. As of March 11, 1999, there were 234 shareholders of record.
The number of beneficial owners is unknown to the Company at this time.
Prior to trading on the Nasdaq NMS, there was no established trading
market for the Common Stock, however, since the Common Stock began trading on
the Nasdaq NMS, the high and low Common Stock prices by quarter were as follows:
1998 HIGH LOW
---- ------- ------
Fourth Quarter (since November $12.625 $12.00
12, 1998)
10
Holders of Common Stock are entitled to receive dividends when, as and if
declared by the Company's Board of Directors out of funds legally available
therefor. While the Company has declared dividends on its Common Stock since
1994, and paid quarterly dividends aggregating $0.20 per share in 1998, there is
no assurance that the Company will continue to pay dividends in the future.
The principal source of cash revenues to the Company is dividends paid by
the Bank with respect to the Bank's capital stock. There are certain
restrictions on the payment of such dividends imposed by federal and state
banking laws, regulations and authorities. See "MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" AND "BUSINESS -
SUPERVISION AND REGULATION - THE BANK".
The cash dividends paid per share (adjusted for a four for one stock split
effective September 10, 1998) by quarter were as follows:
1998 1997
------ ------
Fourth quarter............... $ 0.05 $0.05
Third quarter................ 0.05 0.05
Second quarter............... 0.05 0.05
First quarter................ 0.05 0.025
DESCRIPTION OF CAPITAL STOCK
The authorized capital stock of the Company consists of (i) 50,000,000
shares of Common Stock, $1.00 par value per share, of which 5,172,825 shares
were issued and outstanding as of December 31, 1998 and (ii) 20,000,000 shares
of preferred stock, $1.00 par value per share ("Preferred Stock"), none of which
were issued or outstanding as of December 31, 1998.
The following discussion of the terms and provisions of the Company's
capital stock is qualified in its entirety by reference to the Company's
Articles of Incorporation and Bylaws, copies of which have been filed as
exhibits to this Annual Report on Form 10-K:
COMMON STOCK: The holders of the Common Stock are entitled to one vote for
each share of Common Stock owned, except as expressly provided by law, and all
voting power is in the Common Stock. Holders of Common Stock may not cumulate
their votes for the election of directors. Holders of Common Stock do not have
preemptive rights to acquire any additional, unissued or treasury shares of the
Company, or securities of the Company convertible into or carrying a right to
subscribe for or acquire shares of the Company.
Holders of Common Stock will be entitled to receive dividends out of funds
legally available therefor, if and when properly declared by the Board of
Directors. However, the Board of Directors may not declare or pay cash dividends
on Common Stock, and no Common Stock may be purchased by the Company, unless
full dividends have been declared and paid on any outstanding Preferred Stock
for the current dividend period and, with respect to any outstanding cumulative
Preferred Stock, all past dividend periods. As of December 31, 1998, there was
no Preferred Stock issued or outstanding.
Upon the liquidation of the Company, the holders of Common Stock are
entitled to share pro rata in any distribution of the assets of the Company,
after the holders of shares of Preferred Stock have received the liquidation
preference of their shares plus any cumulated but unpaid dividends (whether or
not earned or declared), if any, and after all other indebtedness of the Company
has been retired.
11
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with the Consolidated Financial Statements of the Company and the
Notes thereto, appearing elsewhere in this Annual Report on Form 10-K, and the
information contained in "Management's Discussion and Analysis of Financial
Condition and Results of Operations." The Consolidated Balance Sheets as of
December 31, 1998 and 1997 and the Consolidated Statements of Income for each of
the years in the three-year period ended December 31, 1998 and the report
thereon of Deloitte & Touche LLP are included elsewhere in this document.
AS OF AND FOR THE YEARS ENDED DECEMBER 31,
----------------------------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(Dollars in thousands, except per share data)
INCOME STATEMENT DATA:
Interest income .......................... $ 23,422 $ 19,970 $ 16,841 $ 14,738 $ 12,644
Interest expense ......................... 10,128 9,060 7,923 6,904 5,363
-------- -------- -------- -------- --------
Net interest income .................... 13,294 10,910 8,918 7,834 7,281
Provision for credit losses .............. 239 190 230 175 188
-------- -------- -------- -------- --------
Net interest income after provision
for credit losses ..................... 13,055 10,720 8,688 7,659 7,093
Noninterest income ....................... 2,492 2,264 1,897 1,489 1,500
Noninterest expense ...................... 9,058 7,836 6,634 6,046 6,021
-------- -------- -------- -------- --------
Income before taxes .................... 6,489 5,148 3,951 3,102 2,572
Provision for income taxes ............... 2,029 1,586 1,240 781 609
-------- -------- -------- -------- --------
Net income ............................... $ 4,460 $ 3,562 $ 2,711 $ 2,321 $ 1,963
======== ======== ======== ======== ========
PER SHARE DATA(1):
Basic earnings per share ................. $ 1.08 $ 0.94 $ 0.77 $ 0.66 $ 0.56
Diluted earnings per share ............... 1.04 0.92 0.76 0.66 0.56
Book value ............................... 8.01 6.22 5.36 4.68 3.81
Tangible book value(2) ................... 6.14 4.81 4.21 3.95 3.02
Cash dividends declared .................. 0.20 0.15 0.10 0.10 0.07
Dividend payout ratio .................... 19.23% 15.96% 12.97% 15.14% 13.42%
Weighted average shares outstanding
(basic) (in thousands) ................. 4,116 3,778 3,513 3,514 3,514
Weighted average shares outstanding
(diluted) (in thousands) ............... 4,309 3,864 3,560 3,523 3,514
Shares outstanding at end of period
(in thousands) ......................... 5,173 3,990 3,510 3,514 3,514
BALANCE SHEET DATA:
Total assets ............................. $436,312 $320,143 $293,988 $233,492 $224,022
Securities ............................... 227,744 167,868 147,564 117,505 121,912
Loans .................................... 170,478 120,578 113,382 88,797 76,543
Allowance for credit losses .............. 1,850 1,016 923 753 588
Total deposits ........................... 390,659 291,516 270,866 214,534 207,543
Borrowings and notes payable ............. 2,437 2,800 3,267 1,517 2,275
Total shareholders' equity ............... 41,435 24,818 18,833 16,458 13,374
AVERAGE BALANCE SHEET DATA:
Total assets ............................. $354,851 $304,086 $257,205 $224,701 $214,318
Securities ............................... 178,416 157,677 127,607 119,857 125,585
Loans .................................... 143,196 117,586 104,534 81,631 69,200
Allowance for credit losses .............. 1,271 961 820 669 686
Total deposits ........................... 323,045 278,377 236,334 207,321 197,711
Total shareholders' equity ............... 27,933 21,821 17,646 14,916 13,109
(TABLE CONTINUED ON NEXT PAGE)
12
AS OF AND FOR THE YEARS ENDED DECEMBER 31,
--------------------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(Dollars in thousands, except per share data)
PERFORMANCE RATIOS:
Return on average assets ................................ 1.26% 1.17% 1.05% 1.03% 0.92%
Return on average equity ................................ 15.97 16.32 15.36 15.56 14.97
Net interest margin
(tax-equivalent)(3) ................................... 4.13 4.02 3.91 3.96 3.91
Efficiency ratio(4) ..................................... 57.38 59.48 61.34 64.85 68.56
ASSET QUALITY RATIOS(5):
Nonperforming assets to total loans and
other real estate ..................................... 0.08% 0.00% 0.00% 0.00% 0.02%
Net loan charge-offs to average loans ................... 0.05 0.08 0.06 0.01 0.48
Allowance for credit losses to total
loans ................................................. 1.09 0.84 0.81 0.85 0.77
Allowance for credit losses to
nonperforming loans(6) ................................ -- -- -- -- --
CAPITAL RATIOS(5):
Leverage ratio (quarterly average)....................... 7.58% 6.30% 5.45% 6.05% 5.39%
Average shareholders' equity to average
total assets .......................................... 7.87 7.18 6.86 6.64 6.12
Tier 1 risk-based capital ratio ......................... 18.02 14.94 13.11 14.99 13.75
Total risk-based capital ratio .......................... 19.08 15.73 13.89 15.79 14.37
- ----------
(1) Adjusted for a four-for-one stock split effective September 10, 1998.
(2) Calculated by dividing total assets, less total liabilities and goodwill,
by shares outstanding at end of period.
(3) Calculated using a 34% federal income tax rate.
(4) Calculated by dividing total noninterest expense, excluding securities
losses, by net interest income plus noninterest income.
(5) At period end, except net loan charge-offs to average loans and average
shareholders' equity to average total assets.
(6) Nonperforming loans consist of nonaccrual loans, loans contractually past
due 90 days or more and restructured loans.
13
SPECIAL CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS
Certain of the matters discussed in this document and in the documents
incorporated into this document by reference, including matters discussed under
the caption "Management's Discussion and Analysis of Financial Condition and
Results of Operations," may constitute forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995, and as such may
involve known and unknown risks, uncertainties and other factors which may cause
the actual results, performance or achievements of the Company to be materially
different from future results, performance or achievements expressed or implied
by such forward-looking statements. The words "expects," "estimates,"
"anticipates," "contemplated," "intends," "plans," " believes," "seek," "will,"
"would," "should," "projected" and similar expressions are intended to identify
such forward-looking statements
The Company's actual results or experience may differ materially from the
results anticipated in such forward-looking statements due to a variety of
factors, including, but not limited to: (1) the effects of future acquisitions,
if any; (2) the effects of future economic conditions on the Company and its
customers; (3) governmental monetary and fiscal policies, as well as legislative
and regulatory changes; (4) the risks of changes in interest rates on the level
and composition of deposits, loan demand and the values of loan collateral,
securities and interest rate protection agreements, as well as interest rate
risks; (5) the effects of competition from other commercial banks, thrifts,
mortgage banking firms, insurance companies, money market and other mutual funds
and other financial institutions operating in the Company's market areas and
elsewhere, including competitors offering banking products and services by mail,
telephone, computer and the Internet; (6) the failure of assumptions underlying
the establishment of reserves for loan losses and estimations of values of
collateral and various financial assets and liabilities and technological
changes, including "Year 2000" data systems compliance issues, are more
difficult or expensive than anticipated; and (7) other uncertainties set forth
in the Company's other public reports and filings and public statements. All
written or oral forward-looking statements attributable to the Company are
expressly qualified in their entirety by these cautionary statements.
14
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Management's Discussion and Analysis of Financial Condition and Results of
Operations analyzes the major elements of the Company's balance sheets and
statements of income. This section should be read in conjunction with the
Company's financial statements and accompanying notes and other detailed
information appearing elsewhere in this Annual Report on Form 10-K.
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
OVERVIEW
Net income was $4.5 million, $3.6 million and $2.7 million for the years
ended December 31, 1998, 1997 and 1996, respectively, and diluted earnings per
share were $1.04, $0.92, and $0.76 for these same periods. Earnings growth from
1996 to 1997 and from 1997 to 1998 resulted principally from loan growth and
branch acquisitions, including the Union Acquisition. The Company posted returns
on average assets of 1.26%, 1.17% and 1.05% and returns on average equity of
15.97%, 16.32% and 15.36% for the years ended 1998, 1997 and 1996, respectively.
The Company posted returns on average assets excluding amortization of goodwill
of 1.40%, 1.30%, and 1.15% and returns on average equity excluding amortization
of goodwill of 17.76%, 18.17%, and 16.82% for the years ended December 31, 1998,
1997 and 1996, respectively. The Company's efficiency ratio was 57.38% in 1998,
59.48% in 1997, and 61.34% in 1996. The Company's efficiency ratio excluding
amortization of goodwill was 54.21% in 1998, 56.43% in 1997, and 58.96% in 1996.
Total assets at December 31, 1998, 1997 and 1996 were $436.3 million,
$320.1 million and $294.0 million, respectively. Total deposits at December 31,
1998, 1997 and 1996 were $390.7 million, $291.5 million, and $270.9 million,
respectively, with deposit growth in each period resulting from branch
acquisitions and internal growth in 1996, 1997 and 1998. Loans were $170.5 at
December 31, 1998, an increase of $49.9 million or 41.4% from $120.6 million at
the end of 1997. Loans were $113.4 million at year end 1996. Shareholders'
equity was $41.4 million, $24.8 million, and $18.8 million at December 31, 1998,
1997 and 1996, respectively.
RESULTS OF OPERATIONS
NET INTEREST INCOME
Net interest income represents the amount by which interest income on
interest-earning assets, including securities and loans, exceeds interest
expense incurred on interest-bearing liabilities, including deposits and other
borrowed funds. Net interest income is the principal source of the Company's
earnings. Interest rate fluctuations, as well as changes in the amount and type
of earning assets and liabilities, combine to affect net interest income.
1998 VERSUS 1997. Net interest income for 1998 was $13.3 million, compared
with $10.9 million for 1997, an increase of $2.4 million or 22.0%. The
improvement in net interest income for 1998 was mainly due to an increase in
total average interest-earning assets and a decrease in funding costs. Average
interest-earning assets increased $50.1 million from $278.8 million to $328.3
million in 1998. Total funding costs decreased eight basis points from 4.04% in
1997 to 3.96% in 1998. For 1998, the net interest margin on a tax-equivalent
basis increased 11 basis points to 4.13% from 4.02% in 1997.
1997 VERSUS 1996. Net interest income for the Company in 1997 was $10.9
million, an increase of 22.5% over the 1996 level of $8.9 million, due to an
increase in the loan portfolio in 1997. For 1997 as a whole, the Company's cost
of funds decreased seven basis points from 4.11% to 4.04% while asset yields
increased eight basis points from 7.08% to 7.16%.
15
The following table presents for the periods indicated the total dollar
amount of average balances, interest income from average interest-earning assets
and the resultant yields, as well as the interest expense on average
interest-bearing liabilities, expressed both in dollars and rates. Except as
indicated in the footnotes, no tax-equivalent adjustments were made and all
average balances are daily average balances. Nonaccruing loans have been
included in the tables as loans carrying a zero yield.
YEARS ENDED DECEMBER 31,
-------------------------------------------------------------------------
1998 1997
---------------------------------- -------------------------------------
AVERAGE INTEREST AVERAGE AVERAGE INTEREST AVERAGE
OUTSTANDING EARNED/ YIELD/ OUTSTANDING EARNED/ YIELD/
BALANCE PAID RATE BALANCE PAID RATE
----------- --------- ------- ----------- --------- -------
(Dollars in thousands)
ASSETS
Interest-earning assets:
Loans .................................. $ 143,196 $ 12,282 8.58% $ 117,586 $ 10,205 8.68%
Securities(1) .......................... 178,416 10,834 6.07 157,677 9,572 6.07
Federal funds sold and other temporary
investments ............................ 6,676 306 4.58 3,545 193 5.44
----------- --------- ----------- ---------
Total interest-earning assets ......... 328,288 23,422 7.13% 278,808 19,970 7.16%
--------- ------- --------- -------
Less allowance for credit losses ....... (1,271) (961)
----------- -----------
Total interest-earning assets, net
of allowance ......................... 327,017 277,847
Noninterest-earning assets ............... 27,834 26,239
----------- -----------
Total assets .......................... $ 354,851 $ 304,086
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing liabilities:
Interest-bearing demand deposits ....... $ 41,710 $ 670 1.61% $ 42,898 $ 915 2.13%
Savings and money market accounts ...... 83,428 2,838 3.40 64,448 2,158 3.35
Certificates of deposit ................ 128,097 6,485 5.06 113,669 5,785 5.09
Federal funds purchased and other
borrowings ............................. 2,267 135 5.96 3,030 202 6.67
----------- --------- ----------- ---------
Total interest-bearing
liabilities .......................... 255,502 10,128 3.96% 224,045 9,060 4.04%
----------- --------- ------- ----------- --------- -------
Noninterest-bearing liabilities:
Noninterest-bearing demand deposits .... 69,810 57,362
Other liabilities ...................... 1,606 858
----------- ----------
Total liabilities ..................... 326,918 282,265
----------- ----------
Shareholders' equity ..................... 27,933 21,821
----------- ----------
Total liabilities and shareholders'
equity ............................... $ 354,851 $ 304,086
=========== ===========
Net interest rate spread ................. 3.17% 3.12%
======= =======
Net interest income and margin(2) ....... $ 13,294 4.05% $ 10,910 3.91%
========= ======= ========= =======
Net interest income and margin
(tax-equivalent basis)(3) ............... $ 13,571 4.13% $ 11,222 4.02%
========= ======= ========= =======
YEARS ENDED DECEMBER 31,
-------------------------------------
1996
-------------------------------------
AVERAGE INTEREST AVERAGE
OUTSTANDING EARNED/ YIELD/
BALANCE PAID RATE
----------- --------- -------
(Dollars in thousands)
ASSETS
Interest-earning assets:
Loans .................................. $ 104,534 $ 9,136 8.74%
Securities(1) .......................... 127,607 7,396 5.80
Federal funds sold and other temporary
investments ............................ 5,743 309 5.38
----------- ---------
Total interest-earning assets ......... 237,884 16,841 7.08%
--------- -------
Less allowance for credit losses ....... (820)
-----------
Total interest-earning assets, net
of allowance ......................... 237,064
Noninterest-earning assets ............... 20,141
-----------
Total assets .......................... $ 257,205
===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing liabilities:
Interest-bearing demand deposits ....... $ 35,285 $ 741 2.10%
Savings and money market accounts ...... 49,429 1,620 3.28
Certificates of deposit ................ 105,538 5,359 5.08
Federal funds purchased and other
borrowings ............................. 2,402 203 8.45%
----------- ---------
Total interest-bearing
liabilities .......................... 192,654 7.923 4.11%
----------- --------- -------
Noninterest-bearing liabilities:
Noninterest-bearing demand deposits .... 46,082
Other liabilities ...................... 823
-----------
Total liabilities ..................... 239,559
-----------
Shareholders' equity ..................... 17,646
-----------
Total liabilities and shareholders'
equity ............................... $ 257,205
===========
Net interest rate spread ................. 2.97%
=======
Net interest income and margin(2) ....... $ 8,918 3.75%
========= =======
Net interest income and margin
(tax-equivalent basis)(3) ............... $ 9,290 3.91%
========= =======
(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 34%.
16
The following schedule 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 related
to higher outstanding balances and the volatility of interest rates. For
purposes of this table, changes attributable to both rate and volume which can
not be segregated have been allocated to rate.
YEARS ENDED DECEMBER 31,
--------------------------------------------------------------
1998 VS. 1997 1997 VS. 1996
----------------------------- -----------------------------
INCREASE INCREASE
(DECREASE) (DECREASE)
DUE TO DUE TO
------------------ ------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
------- ------- ------- ------- ------- -------
(Dollars in thousands)
Interest-earning assets:
Loans .......................................................... $ 2,223 $ (146) $ 2,077 $ 1,141 $ (72) $ 1,069
Securities ..................................................... 1,259 3 1,262 1,744 432 2,176
Federal funds sold and other temporary
investments ................................................. 170 (57) 113 (118) 2 (116)
------- ------- ------- ------- ------- -------
Total increase (decrease) in interest income ................ 3,652 (200) 3,452 2,767 362 3,129
------- ------- ------- ------- ------- -------
Interest-bearing liabilities:
Interest-bearing demand deposits ............................... (25) (220) (245) 160 14 174
Savings and money market accounts .............................. 636 44 680 493 45 538
Certificates of deposit ........................................ 734 (34) 700 413 13 426
Federal funds purchased and other borrowings ................... (51) (16) (67) 53 (54) (1)
------- ------- ------- ------- ------- -------
Total increase in interest expense .......................... 1,294 (226) 1,068 1,119 18 1,137
------- ------- ------- ------- ------- -------
Increase (decrease) in net interest income ....................... $ 2,358 $ 26 $ 2,384 $ 1,648 $ 344 $ 1,992
======= ======= ======= ======= ======= =======
PROVISION FOR CREDIT LOSSES
Provisions for credit losses are charged to income to bring the Company's
allowance for credit losses to a level deemed appropriate by management based on
the factors discussed under "-Financial Condition - Allowance for Credit
Losses". The allowance for credit losses at December 31, 1998 was $1.9 million,
representing 1.09% of outstanding loans. One year earlier, this ratio was 0.84%
of outstanding loans. The provision for credit losses charged against earnings
was $239,000 in 1998 compared with $190,000 in 1997. The increased provision was
made by the Company in response to the increase in its loan portfolio, its
increased legal lending limit and the changing risk profile in its loan
portfolio. Net loans charged off in 1998 were $66,000 compared with $97,000 in
1997.
During 1997, the Company made provisions totaling $190,000 to the
allowance for credit losses, a decrease of $40,000 compared with 1996. The
Company recorded a lower provision in 1997 because it had specific reserves in
the amount of $45,000 which were no longer necessary due to the repayment of the
related loans. Net loans charged off in 1997 were $97,000, compared with $60,000
in loan charge-offs for 1996.
NONINTEREST INCOME
Noninterest income is an important source of revenue for financial
institutions. Service charges on deposit accounts are the largest component of
noninterest income and a significant source of revenue to the Company. In 1998,
noninterest income totaled $2.5 million, an increase of $228,000 or 10.1% versus
$2.3 million in 1997. The increase was primarily due to the branch acquisitions
and an increase in customer service fees. Noninterest income for 1997 was $2.3
million, a $367,000 or 19.3% increase from 1996 resulting largely from an
increase in income from insufficient funds charges and customer service fees.
17
The following table presents for the periods indicated the major
categories of noninterest income:
YEARS ENDED DECEMBER 31,
------------------------------
1998 1997 1996
------ ------ ------
(Dollars in thousands)
Service charges on deposit accounts ........ $2,173 $2,062 $1,742
Other noninterest income ................... 319 202 155
------ ------ ------
Total noninterest income ............. $2,492 $2,264 $1,897
====== ====== ======
NONINTEREST EXPENSE
For the years ended 1998, 1997 and 1996, noninterest expense totaled $9.1
million, $7.8 million and $6.6 million, respectively. The Company's efficiency
ratio showed a positive trend over this period, reflecting the Company's
continued success in controlling operating expenses and integrating its branch
acquisitions.
The following table presents for the periods indicated the major
categories of noninterest expense:
YEARS ENDED DECEMBER 31,
------------------------
1998 1997 1996
------ ------ ------
(Dollars in thousands)
Salaries and employee benefits ..................... $4,541 $3,968 $3,415
Non-staff expenses:
Net occupancy expense ........................ 768 811 710
Equipment depreciation ....................... 290 431 367
Data processing .............................. 807 642 493
Professional fees ............................ 112 97 114
Regulatory assessments and FDIC insurance .... 73 63 28
Ad valorem and franchise taxes ............... 200 164 140
Goodwill amortization ........................ 500 402 257
Other ........................................ 1,767 1,258 1,110
------ ------ ------
Total noninterest expense ............... $9,058 $7,836 $6,634
====== ====== ======
In 1998, noninterest expense totaled $9.1 million, an increase of $1.2
million or 15.6% over $7.8 million in 1997. Salaries and employee benefits for
1998 totaled $4.5 million, an increase of $573,000 or 14.4% over $4.0 million
for 1997. Other operating expenses of $1.8 million represented an increase of
$325,000 or 22.5% compared with $1.4 million in 1997. These increases were
principally due to branch acquisitions. Total noninterest expenses in 1997 were
$7.8 million, an 18.2% increase over the 1996 level of $6.6 million due
principally to branch acquisitions. Salaries and employee benefits in 1997
increased by 16.2% from $3.4 million to $4.0 million. The increase was
principally due to additional staff associated with the Union and Angleton
acquisitions.
INCOME TAXES
Income tax expense includes the regular federal income tax at the
statutory rate plus the income tax component of the Texas franchise tax. The
amount of federal income tax expense is influenced by the amount of taxable
income, the amount of tax-exempt income, the amount of nondeductible interest
expense and the amount of other nondeductible expenses. Taxable income for the
income tax component of the Texas franchise tax is the federal pretax income,
plus certain officers' salaries, less interest income on federal securities. The
income tax component of the Texas franchise tax was zero in the years of 1998
and 1997. In 1998, income tax expense was $2.0 million compared with $1.6
million for 1997. The effective tax rate in the years ended 1998 and 1997 was
31.3% and 30.8%, respectively.
18
IMPACT OF INFLATION
The effects of inflation on the local economy and on the Company's
operating results have been relatively modest for the past several years. Since
substantially all of the Company's assets and liabilities are monetary in
nature, such as cash, securities, loans and deposits, their values are less
sensitive to the effects of inflation than to changing interest rates, which do
not necessarily change in accordance with inflation rates. The Company tries to
control the impact of interest rate fluctuations by managing the relationship
between its interest rate sensitive assets and liabilities. See "Financial
Condition - Interest Rate Sensitivity and Liquidity."
FINANCIAL CONDITION
LOAN PORTFOLIO
At December 31, 1998, loans were $170.5 million, an increase of $49.9
million or 41.4% from $120.6 million at December 31, 1997. The growth in the
loan portfolio was due to continued strong loan demand, especially in the real
estate area. One-to-four family residential loans increased from $53.6 million
at December 31, 1997 to $88.1 million at year end 1998. Agriculture loans also
had a substantial increase from $6.4 million at year end 1997 to $14.1 million
at year end 1998. The growth in agricultural loans was due mainly to the Union
Acquisition. At December 31, 1998, total loans were 43.6% of deposits and 39.1%
of total assets. At December 31, 1997, total loans were 41.4% of deposits and
37.7% of total assets.
Loans increased 6.3% during 1997 from $113.4 million at December 31, 1996
to $120.6 million at December 31, 1997. The loan growth during 1997 was spread
between real estate and agriculture loans.
The following table summarizes as of the dates indicated the loan
portfolio of the Company by type of loan:
DECEMBER 31,
--------------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
----------------- ----------------- ----------------- ----------------- ------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
-------- ------- -------- ------- -------- ------- -------- ------- -------- -------
(Dollars in thousands)
Commercial and industrial ..... $ 16,972 9.9% $ 11,611 9.6% $ 10,633 9.4% $ 10,445 11.8% $ 9,479 12.4%
Real estate:
Construction and land
development ................. 1,727 1.0 6,453 5.3 5,021 4.4 2,507 2.8 2,139 2.8
1-4 family residential ....... 88,139 51.7 53,625 44.5 49,845 44.0 40,331 45.4 37,247 48.7
Commercial mortgages ......... 22,240 13.1 16,277 13.5 14,376 12.7 12,335 14.5 9,520 12.5
Farmland ..................... 6,148 3.6 5,804 4.8 5,468 4.8 3,989 4.5 3,529 4.6
Multifamily residential ...... 1,090 0.6 937 0.8 1,068 0.9 716 0.8 64 0.0
Agriculture ................... 14,107 8.3 6,359 5.3 5,686 5.0 4,666 5.2 4,605 6.0
Consumer ...................... 20,055 11.8 19,512 16.2 21,285 18.8 13,308 15.0 9.960 13.0
-------- ----- -------- ----- -------- ----- -------- ----- -------- ------
Total loans .................. $170,478 100.0% $120,578 100.0% $113,382 100.0% $ 88,797 100.0% $ 76,543 100.0%
======== ===== ======== ===== ======== ===== ======== ===== ======== ======
The lending focus of the Company is on one-to-four family residential,
agricultural, small and medium-sized business and consumer loans. The Company
offers a variety of commercial lending products including term loans and lines
of credit. A broad range of short to medium-term commercial loans, primarily
collateralized, are made available to businesses for working capital (including
inventory and receivables), business expansion (including acquisitions of real
estate and improvements) and the purchase of equipment and machinery.
Historically, the Company has originated loans for its own account and has not
securitized its loans. The purpose of a particular loan generally determines its
structure. All loans in the one-to-four family residential category were
originated by the Company.
Loans from $200,000 to $500,000 are evaluated and acted upon by an
officers' loan committee, which meets weekly. Loans above that amount must be
approved by the Directors Loan Committee, which meets monthly.
Generally, the Company's commercial loans are made in the Company's
primary market area and are underwritten on the basis of the borrower's ability
to service such debt from income. As a general practice, the Company takes as
collateral a lien on any available real estate, equipment or other assets owned
by the borrower and obtains a personal guaranty of the borrower. Working capital
loans are primarily collateralized by short-term assets whereas term loans are
primarily collateralized by long-term assets. As a result, commercial loans
involve additional complexities, variables and risks and require more thorough
underwriting and servicing than other types of loans.
19
In addition to commercial loans secured by real estate, the Company makes
commercial mortgage loans to finance the purchase of real property which
generally consists of real estate with completed structures. The Company's
commercial mortgage loans are secured by first liens on real estate, typically
have variable interest rates and amortize over a ten to 15 year period. Payments
on loans secured by such properties are often dependent on the successful
operation or management of the properties. Accordingly, repayment of these loans
may be subject to adverse conditions in the real estate market or the economy to
a greater extent than other types of loans. The Company seeks to minimize these
risks in a variety of ways, including giving careful consideration to the
property's operating history, future operating projections, current and
projected occupancy, location and physical condition in connection with
underwriting these loans. The underwriting analysis also includes credit
verification, appraisals and a review of the financial condition of the
borrower.
Additionally, a portion of the Company's lending activity has consisted of
the origination of one-to-four family residential mortgage loans collateralized
by owner-occupied properties located in the Company's market areas. The Company
offers a variety of mortgage loan products which generally are amortized over
five to 25 years. Loans collateralized by one-to-four family residential real
estate generally have been originated in amounts of no more than 89% of
appraised value or have mortgage insurance. The Company requires mortgage title
insurance and hazard insurance.
The Company makes loans to finance the construction of residential and, to
a limited extent, nonresidential properties. Construction loans generally are
secured by first liens on real estate and have floating interest rates. The
Company conducts periodic inspections, either directly or through an agent,
prior to approval of periodic draws on these loans. Underwriting guidelines
similar to those described above are also used in the Company's construction
lending activities. In keeping with the community-oriented nature of its
customer base, the Company provides construction and permanent financing for
churches located within its market area. Construction loans involve additional
risks attributable to the fact that loan funds are advanced upon the security of
a project under construction, and the project is of uncertain value prior to its
completion. Because of uncertainties inherent in estimating construction costs,
the market value of the completed project and the effects of governmental
regulation on real property, it can be difficult to accurately evaluate the
total funds required to complete a project and the related loan to value ratio.
As a result of these uncertainties, construction lending often involves the
disbursement of substantial funds with repayment dependent, in part, on the
success of the ultimate project rather than the ability of a borrower or
guarantor to repay the loan. If the Company is forced to foreclose on a project
prior to completion, there is no assurance that the Company will be able to
recover all of the unpaid portion of the loan. In addition, the Company may be
required to fund additional amounts to complete a project and may have to hold
the property for an indeterminable period of time. While the Company has
underwriting procedures designed to identify what it believes to be acceptable
levels of risks in construction lending, no assurance can be given that these
procedures will prevent losses from the risks described above.
Consumer loans made by the Company include direct "A"-credit automobile
loans, recreational vehicle loans, boat loans, home improvement loans, home
equity loans, personal loans (collateralized and uncollateralized) and deposit
account collateralized loans. The terms of these loans typically range from 12
to 120 months and vary based upon the nature of collateral and size of loan.
Consumer loans entail greater risk than do residential mortgage loans,
particularly in the case of consumer loans that are unsecured or secured by
rapidly depreciating assets such as automobiles. In such cases, any repossessed
collateral for a defaulted consumer loan may not provide an adequate source of
repayment for the outstanding loan balance. The remaining deficiency often does
not warrant further substantial collection efforts against the borrower beyond
obtaining a deficiency judgment. In addition, consumer loan collections are
dependent on the borrower's continuing financial stability, and thus are more
likely to be adversely affected by job loss, divorce, illness or personal
bankruptcy. Furthermore, the application of various federal and state laws may
limit the amount which can be recovered on such loans.
The Company provides agricultural loans for short-term crop production,
farm equipment financing and agricultural real estate financing. The Company
evaluates agricultural borrowers primarily based on their historical
profitability, level of experience in their particular agricultural industry,
overall financial capacity and the availability of secondary collateral to
withstand economic and natural variations common to the industry. Because
agricultural loans present a higher level of risk associated with events caused
by nature, the Company routinely makes on-site visits and inspections in order
to monitor and identify such risks.
20
The contractual maturity ranges of the commercial and industrial and
construction and land development portfolios and the amount of such loans with
predetermined interest rates and floating rates in each maturity range as of
December 31, 1998 are summarized in the following table:
DECEMBER 31, 1998
-------------------------------------
AFTER ONE AFTER
ONE YEAR THROUGH FIVE
OR LESS FIVE YEARS YEARS TOTAL
------- ---------- ------- -------
(Dollars in thousands)
Commercial and industrial ............... $10,354 $ 4,355 $ 2,263 $16,972
Construction and land development ....... 1,707 20 -- 1,727
------- ------- ------- -------
Total ......................... $12,061 $ 4,375 $ 2,263 $18,699
======= ======= ======= =======
Loans with a predetermined interest rate $ 6,248 $ 2,879 $ 1,670 $10,797
Loans with a floating interest rate ..... 5,813 1,496 593 7,902
------- ------- ------- -------
Total ......................... $12,061 $ 4,375 $ 2,263 $18,699
======= ======= ======= =======
The Company has adopted Statement of Financial Accounting Standards
("SFAS") No. 114, ACCOUNTING FOR CREDITORS FOR IMPAIRMENT OF A LOAN, as amended
by SFAS No. 118, ACCOUNTING BY CREDITORS FOR IMPAIRMENT OF A LOAN-INCOME
RECOGNITION AND DISCLOSURES. Under SFAS No. 114, as amended, a loan is
considered impaired based on current information and events, if it is probable
that the Company will be unable to collect the scheduled payments of principal
or interest when due according to the contractual terms of the loan agreement.
The fair value of impaired loans is based on either the present value of
expected future cash flows discounted at the loan's effective interest rate or
the loan's observable market price or the fair value of the collateral if the
loan is collateral-dependent. The implementation of SFAS Nos. 114 and 118 did
not have a material adverse affect on the Company's financial statements.
NONPERFORMING ASSETS
The Company has several procedures in place to assist it in maintaining
the overall quality of its loan portfolio. The Company has established
underwriting guidelines to be followed by its officers. The Company also
monitors its delinquency levels for any negative or adverse trends. There can be
no assurance, however, that the Company's loan portfolio will not become subject
to increasing pressures from deteriorating borrower credit due to general
economic conditions.
The Company requires appraisals on loans secured by real estate. With
respect to potential problem loans, an evaluation of the borrower's overall
financial condition is made to determine the need, if any, for possible
write-downs or appropriate additions to the allowance for credit losses.
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 Company's conservative lending approach, as well as a healthy local
economy, has resulted in strong asset quality. The Company had nonperforming
assets of $140,000 on December 31, 1998 and no nonperforming assets as of
December 31, 1997 or 1996.
21
The following table presents information regarding nonperforming assets at
the dates indicated:
DECEMBER 31,
---------------------------------------------
1998 1997 1996 1995 1994
------ ------ ------ ------ -----
(Dollars in thousands)
Nonaccrual loans.................. $ 5 $ -- $ -- $ -- $ --
Restructured loans................ -- -- -- -- --
Other real estate................. 135 -- -- -- 15
----- ------ ------ ------ ------
Total nonperforming assets... $ 140 $ -- $ -- $ -- $ 15
===== ====== ====== ===== =====
Nonperforming assets to total loans
and other real estate........... 0.08% 0.00% 0.00% 0.00% 0.02%
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 the diversification by
industry of the Company's commercial loan portfolio, the effect of changes in
the local real estate market on collateral values, the results of recent
regulatory examinations, the effects on the loan portfolio of current economic
indicators and their probable impact on borrowers, the amount of charge-offs for
the period, the amount of nonperforming loans and related collateral security,
the evaluation of its loan portfolio by the loan review function and the annual
examination of the Company's financial statements by its independent auditors.
Charge-offs occur when loans are deemed to be uncollectible.
Although the Company does not determine the total allowance based upon the
amount of loans in a particular type or category, risk elements attributable to
particular loan types or categories are considered in assessing the quality of
individual loans. These risk elements include, but are not limited to, the
following: (i) in the case of single family residential real estate loans, the
borrower's ability to repay the loan, including debt to income ratio and
employment and income stability, the loan to value ratio, and the age, condition
and marketability of collateral; (ii) for non-farm non-residential loans and
multifamily residential loans, the debt service coverage ratio (income from the
property in excess of operating expenses compared to loan payment requirements),
operating results of the owner in the case of owner-occupied properties, the
loan to value ratio, the age and condition of the collateral and the volatility
of income, property value and future operating results typical of properties of
that type; (iii) for agricultural real estate loans, the experience and
financial capability of the borrower, projected debt service coverage of the
operations of the borrower and loan to value ratio; (iv) for construction and
land development loans, the perceived feasibility of the project including the
ability to sell developed lots or improvements constructed for resale or ability
to lease property constructed for lease, the quality and nature of contracts for
presale or preleasing, if any, experience and ability of the developer and loan
to value ratio; (v) for commercial and industrial loans, the operating results
of the commercial, industrial or professional enterprise, the borrower's
business, professional and financial ability and expertise, the specific risks
and volatility of income and operating results typical for businesses in that
category and the value, nature and marketability of collateral; and (vi) for
non-real estate agricultural loans, the operating results, experience and
financial capability of the borrower, historical and expected market conditions
and the value, nature and marketability of collateral. In addition, for each
category, the Company considers secondary sources of income and the financial
strength and credit history of the borrower and any guarantors.
The Company follows a loan review program to evaluate the credit risk in
the loan portfolio. Through the loan review process, the Company maintains an
internally classified loan list which, along with the delinquency list of loans,
helps management assess the overall quality of the loan portfolio and the
adequacy of the allowance for credit losses. Loans classified as "substandard"
are those loans with clear and defined weaknesses such as a highly-leveraged
position, un