PROSPERITY BANCSHARES INC - 10-K Annual Report

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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, 2000
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.(SM)
(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. [X]

As of February 15, 2001, the number of outstanding shares of Common
Stock was 5,276,525. 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
$88,874,045.

DOCUMENTS INCORPORATED BY REFERENCE:

Portions of the Company's Proxy Statement relating to the 2001 Annual Meeting of
Shareholders, which will be filed within 120 days after December 31, 2000, are
incorporated by reference into Part III, Items 10-13 of this Form 10-K.

PROSPERITY BANCSHARES, INC.(sm)
2000 ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS

PART I
Item 1. Business................................ 2
General................................. 2
Bank Activities......................... 3
Business Strategies..................... 3
Subsequent Event........................ 4
Competition............................. 4
Associates.............................. 5
Supervision and Regulation.............. 5
Item 2. Properties.............................. 11
Item 3. Legal Proceedings....................... 12
Item 4. Submission of Matters to a Vote of
Security Holders........................ 12

PART II
Item 5. Market for Registrant's Common Equity
and Related Shareholder Matters......... 13
Item 6. Selected Consolidated Financial Data.... 14
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of
Operations.............................. 16
Overview................................ 16
Results of Operations................... 16
Financial Condition..................... 20
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.............................. 34

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

SPECIAL CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS

Statements and financial discussion and analysis contained in this Annual
Report on Form 10-K of Prosperity Bancshares, Inc.(sm) (the "Company") that are
not historical facts are forward-looking statements made pursuant to the safe
harbor provisions for the Private Litigation Reform Act of 1995. Forward-
looking statements which describe the Company's future plans, strategies and
expectations, are based on assumptions and involve a number of risks and
uncertainties, many of which are beyond the Company's control. The important
factors that could cause actual results to differ materially from the forward-
looking statements include, without limitation:

. changes in interest rates and market prices, which could reduce the
Company's net interest margins, asset valuations and expense
expectations;

. changes in the levels of loan prepayments and the resulting effects on
the value of the Company's loan portfolio;

. changes in local economic and business conditions which adversely affect
the Company's customers and their ability to transact profitable
business with the Company, including the ability of its borrowers to
repay their loans according to their terms or a change in the value of
the related collateral;

. increased competition for deposits and loans adversely affecting rates
and terms;

. the timing, impact and other uncertainties of the Company's future
acquisitions, including the Company's ability to identify suitable
future acquisition candidates, the success or failure in the integration
of their operations, and the Company's ability to enter new markets
successfully and capitalize on growth opportunities;

. increased credit risk in the Company's assets and increased operating
risk caused by a material change in commercial, consumer and/or real
estate loans as a percentage of the total loan portfolio;

. the failure of assumptions underlying the establishment of and
provisions made to the allowance for credit losses;

. changes in the availability of funds resulting in increased costs or
reduced liquidity;

. increased asset levels and changes in the composition of assets and the
resulting impact on the Company's capital levels and regulatory capital
ratios;

. the Company's ability to acquire, operate and maintain cost effective
and efficient systems without incurring unexpectedly difficult or
expensive, but necessary technological changes;

. the loss of senior management or operating personnel and the potential
inability to hire qualified personnel at reasonable compensations
levels; and

. changes in statutes and government regulations or their interpretations
applicable to bank holding companies and the Company's present and
future banking and other subsidiaries, including changes in tax
requirements and tax rates.

The Company undertakes no obligation to publicly update or otherwise revise
any forward-looking statements, whether as a result of new information, future
events or otherwise.

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ITEM 1. BUSINESS

GENERAL

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/sm/ (the "Bank"), which has 18 full-service banking locations
("Banking Centers") in the greater Houston metropolitan area and twelve
contiguous counties situated south and southwest of Houston and extending into
South Texas. The Company's headquarters are located at 3040 Post Oak Blvd. in
Houston, Texas and its telephone number is (713) 993-0002.

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 has grown through a combination of internal growth, the acquisition of
community banks, branches of banks and the opening of new banking centers.
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 (the "Angleton Acquisition"). In
1998, the Company enhanced its West Columbia Banking Center with the purchase of
a commercial bank branch located in West Columbia and acquired Union State Bank
in East Bernard, Texas, (the "Union Acquisition").

In 1999, the Company acquired South Texas Bancshares, Inc. and its wholly
owned subsidiary, The Commercial National Bank of Beeville ("CNB"), with
locations in Beeville, Mathis and Goliad, Texas (the "South Texas Acquisition").
The Company acquired trust powers in connection with the South Texas
Acquisition. Additionally, effective September 15, 2000, the Company purchased
certain assets and assumed certain liabilities of five branches of Compass Bank
located in El Campo, Hitchcock, Needville, Palacios and Sweeny, Texas (the
"Compass Acquisition"). With the exception of the El Campo location, the former
Compass branches are being operated as full-service Banking Centers. The El
Campo location has been combined with the Company's El Campo Banking Center.

The Company's primary market consists of the communities served by its
three locations in the greater Houston metropolitan area and its 15 locations in
twelve contiguous counties located to the south and southwest of Houston. Texas
Highway 59 (scheduled to become Interstate Highway 69), which serves as the
primary "NAFTA Highway" 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.

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, Pilot
Club, United Way and Chamber of Commerce. In addition, the Company's Banking
Centers in Bay City, Clear Lake, East Bernard, Mathis, Meyerland and Post Oak
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 lending expertise in the specific
industries found in the community. The Company entrusts its Banking Center
Presidents with authority and

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flexibility within general parameters with respect to product pricing and
decision making in order to avoid the bureaucratic structure of larger banks.
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.

BANK ACTIVITIES

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. At December 31, 2000, the Company maintained approximately
49,000 separate deposit accounts and 7,000 separate loan accounts and
approximately 18.5% of the Company's total deposits were noninterest-bearing
demand deposits. For the period ended December 31, 2000, the Company's average
cost of funds was 3.46%.

The Company has been an active mortgage lender, with 1-4 family residential
and commercial mortgage loans comprising 59.4% of the Company's total loans as
of December 31, 2000. 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 the Sunburst account, 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 in its lending efforts 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.

BUSINESS STRATEGIES

The Company's main objective is to increase deposits and loans through
additional expansion opportunities while maintaining efficiency, individualized
customer service and maximizing profitability. To achieve this objective, the
Company has employed the following strategic goals:

Continue Community Banking Emphasis. The Company intends to continue
operating as a community banking organization focused on meeting the specific
needs of consumers and small and medium-sized businesses in its market areas.
The Company will continue to provide a high degree of responsiveness combined
with a wide variety of banking products and services. The Company staffs its
Banking Centers with experienced bankers with lending expertise in the specific
industries found in the community, giving them authority to make certain pricing
and credit decisions, thereby attempting to avoid the bureaucratic structure of
larger banks.

Increase Loan Volume and Diversify Loan Portfolio. Historically, the
Company has elected to sacrifice some earnings for the historically lower credit
losses associated with home mortgage loans. While maintaining its conservative
approach to lending, the Company plans to emphasize both new and existing loan
products, focusing on growing its home equity and commercial loan portfolios.
Among new loan products, the Company successfully introduced home equity lending
in 1998. The balance of home equity loans was $16.8 million at December 31,
2000 and $11.3 million at December 31, 1999. 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. The Company also targets 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.

Continue Strict Focus on Efficiency. The Company plans to maintain its
stringent cost control practices and policies. The Company has invested
significantly in the infrastructure required to centralize many of its critical
operations, such as data processing and loan application processing. 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.

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Enhance Cross-Selling. The Company recognizes that its customer base
provides significant opportunities to cross-sell various products and it seeks
to develop broader customer relationships by identifying cross-selling
opportunities. The Company uses incentives and friendly competition to
encourage cross-selling efforts and increase cross-selling results. To assist
with cross-selling efforts, the Company has updated its technology to help
officers and associates identify cross-selling opportunities. Using data, which
includes existing and related account relationships, 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 mailings.
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.

Expand Market Share Through Internal Growth and a Disciplined Acquisition
Strategy. 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.

Maintain Strong Asset Quality. The Company intends to maintain the strong
asset quality that has been representative of its historical loan portfolio. As
the Company diversifies and increases its lending activities, it may face higher
risks of nonpayment and increased risks in the event of economic downturns. The
Company intends, however, to continue to employ the strict underwriting
guidelines and comprehensive loan review process that have contributed to its
low incidence of nonperforming assets and its minimal charge-offs.

SUBSEQUENT EVENT

The Company actively pursues an acquisition strategy designed to increase
efficiency, market share and return to shareholders. As part of this strategy,
on November 8, 2000, the Company entered into an Agreement and Plan of
Reorganization (the "Agreement") with Commercial Bancshares, Inc., a Texas
corporation ("Commercial"), whereby Commercial will merge with and into the
Company (the "Merger"). Also, pursuant to the Agreement, Commercial's
subsidiary, Heritage Bank, will merge with and into the Bank. The shareholders
of Commercial approved the Merger at a special meeting of shareholders held on
February 14, 2001 and the shareholders of the Company approved the Merger and
the issuance of shares of Company Common Stock at a special meeting of
shareholders held on February 21, 2001. The Company has also received all
required regulatory approvals. It is anticipated that the Merger will be
consummated in late February.

As a result of the Merger, the holders of Commercial common stock will
receive 155 shares of Company Common Stock for each share of Commercial common
stock they own at the effective time ("Effective Time") of the Merger. Based on
this exchange ratio, the Company will issue an aggregate of 2,800,385 shares of
its Common Stock in connection with the Merger. In addition, the options to
purchase shares of Commercial common stock which were outstanding at the
Effective Time will be converted into options to purchase shares of Company
Common Stock. As of February 15, 2001, there were options outstanding to
purchase 90 shares of Commercial common stock at exercise prices ranging from
$225.00 per share to $1,600.00 per share which will be converted into options to
purchase 13,950 shares of Company Common Stock at exercise prices ranging from
$1.45 per share to $10.32 per share. The converted options will be governed by
the original plans under which they were granted.

Similar to its previous acquisitions, management believes that this merger
will enable the Company to achieve certain economies of scale and savings from
the operation of the newly acquired banking offices as additional Banking
Centers. Heritage Bank has 12 full-service banking locations in the Houston
metropolitan area and in three adjacent counties, including Houston-Bellaire,
Cleveland, Cypress, Fairfield, Houston-Downtown, Houston-Medical Center,
Houston-River Oaks/Galleria, Houston-Tanglewood/Memorial, Houston-Waugh Drive,
Liberty, Magnolia and Wharton. Commercial offers conventional consumer and
commercial products and services, including interest and noninterest-bearing
depositor accounts and commercial, consumer and real estate loans. As of
December 31, 2000, Commercial had total assets of approximately $443.0 million,
total loans of approximately $162.5 million, total deposits of approximately
$399.3 million and total shareholders' equity of approximately $27.7 million.

COMPETITION

The banking business is highly competitive, and the profitability of the
Company depends principally on the Company's

4

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 with respect to 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.

Under the Gramm-Leach-Bliley Act, securities firms and insurance
companies that elect to become financial holding companies may acquire banks and
other financial institutions. The Gramm-Leach-Bliley Act may significantly
change the competitive environment in which the Company and its subsidiaries
conduct business. See "Supervision and Regulation-The Company". The financial
services industry is also likely to become even more competitive as further
technological advances enable more companies to provide financial services.
These technological advances may diminish the importance of depository
institutions and other financial intermediaries in the transfer of funds between
parties.

ASSOCIATES

As of December 31, 2000, the Company and the Bank had 193 full-time
equivalent associates, 82 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.

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. Any claim for breach of such obligation

5

will generally have priority over most other unsecured claims.

Financial Modernization. Under the BHCA, bank holding companies
generally may not acquire a direct or indirect interest in or control of more
than 5% of the voting shares of any company that is not a bank or bank holding
company or from engaging in activities other than those of banking, managing or
controlling banks or furnishing services to or performing services for its
subsidiaries, except that it may engage in, directly or indirectly, certain
activities that the Federal Reserve Board determined to be closely related to
banking or managing and controlling banks as to be a proper incident thereto.

However, the Gramm-Leach-Bliley Act, effective March 11, 2000, eliminated
the barriers to affiliations among banks, securities firms, insurance companies
and other financial service providers and permits bank holding companies to
become financial holding companies and thereby affiliate with securities firms
and insurance companies and engage in other activities that are financial in
nature. The Gramm-Leach-Bliley Act defines "financial in nature" to include
securities underwriting, dealing and market making; sponsoring mutual funds and
investment companies; insurance underwriting and agency; merchant banking
activities; and activities that the Federal Reserve Board has determined to be
closely related to banking. No regulatory approval will be required for a
financial holding company to acquire a company, other than a bank or savings
association, engaged in activities that are financial in nature or incidental to
activities that are financial in nature, as determined by the Federal Reserve
Board.

Under the Gramm-Leach-Bliley Act, a bank holding company may become a
financial holding company by filing a declaration with the Federal Reserve Board
if each of its subsidiary banks is well capitalized under the FDICIA prompt
corrective action provisions, is well managed, and has at least a satisfactory
rating under the Community Reinvestment Act of 1977 ("CRA"). The Company
received approval to become a financial holding company on April 18, 2000.

While the Federal Reserve Board will serve as the "umbrella" regulator
for financial holding companies and has the power to examine banking
organizations engaged in new activities, regulation and supervision of
activities which are financial in nature or determined to be incidental to such
financial activities will be handled along functional lines. Accordingly,
activities of subsidiaries of a financial holding company will be regulated by
the agency or authorities with the most experience regulating that activity as
it is conducted in a financial holding company.

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 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, 2000, the Company's ratio of Tier 1 capital to total
risk-weighted assets was 14.00% and its ratio of total capital to total risk-
weighted assets was 15.06%. 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 are be required to maintain a leverage ratio of 4.0%. As of December
31, 2000, the Company's leverage ratio was 6.14%.

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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 presumption established by the Federal Reserve Board, the
acquisition of 10% or 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.

7

Financial Modernization. Under the Gramm-Leach-Bliley Act, a national
bank may establish a financial subsidiary and engage, subject to limitations on
investment, in activities that are financial in nature, other than insurance
underwriting as principal, insurance company portfolio investment, real estate
development, real estate investment and annuity issuance. To do so, a bank must
be well capitalized, well managed and have a CRA rating of satisfactory or
better. Subsidiary banks of a financial holding company or national banks with
financial subsidiaries must remain well capitalized and well managed in order to
continue to engage in activities that are financial in nature without regulatory
actions or restrictions, which could include divestiture of the financial in
nature subsidiary or subsidiaries. In addition, a financial holding company or
a bank may not acquire a company that is engaged in activities that are
financial in nature unless each of the subsidiary banks of the financial holding
company or the bank has a CRA rating of satisfactory of better.

Although the powers of state chartered banks are not specifically
addressed in the Gramm-Leach-Bliley Act, Texas-chartered banks such as the Bank,
will have the same if not greater powers as national banks through the parity
provision contained in the Texas Constitution.

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 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

8

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, 2000, the Bank's ratio of Tier 1 capital to total risk-weighted
assets was 13.77% and its ratio of total capital to total risk-weighted assets
was 14.83%. 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 4.0% 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 6.0% . As of December 31, 2000,
the Bank's ratio of Tier 1 capital to average total assets (leverage ratio) was
6.04%. 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.

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.

9

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 re-capitalizing 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 was required to equal one-fifth of the SAIF rate through
year-end 1999, or until the insurance funds merged, whichever occurred 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, for the
fourth quarter 2000, both the BIF and SAIF rates were .02120% 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 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.

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, such as the Gramm-Leach-Bliley Act which expanded the
powers of banking institutions and bank holding companies, and proposals to
overhaul the bank regulatory system 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

10

environment of the Company and its banking subsidiaries in substantial and
unpredictable ways. The Company cannot determine the ultimate effect that the
Gramm-Leach-Bliley Act will have, or the effect that any potential legislation,
if enacted, or implemented 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 18 full-service banking locations. The
Company's headquarters are located at 3040 Post Oak Blvd., Houston, Texas. The
Company owns all of the buildings in which its Banking Centers are located other
than the Post Oak, Meyerland, Victoria, Palacios and Needville Banking Centers.
The lease terms of these Banking Centers expire in July 2002, October 2003,
December 2001, December 2003 and June 2001, respectively. The expiration dates
do not include the renewal option periods which may be available. The following
table sets forth specific information on each such location:

Location Address Deposits at December 31, 2000
- --------------------- ----------------------------- -----------------------------
(Dollars in thousands)

Angleton 116 South Velasco $28,637
Angleton, TX 77516

Bay City (1) 1600 Seventh St. $46,166
Bay City, TX 77404

Beeville (2) 100 South Washington $88,051
Beeville, TX 78102

Clear Lake 100 West Medical Center Blvd. $39,780
Webster, TX 77598

Cuero 106 North Esplanade $23,394
Cuero, TX 77954

East Bernard 700 Church St. $62,136
East Bernard, TX 77435

Edna 102 North Wells $38,611
Edna, TX 77962

11

El Campo 1301 North Mechanic $74,008
El Campo, TX 77437

Goliad 145 North Jefferson $11,634
Goliad, TX 77963

Hitchcock 8300 Highway 6 $18,066
Hitchcock, TX 77563

Mathis 103 North Highway 359 $27,452
Mathis, TX 78368

Meyerland 8801 West Loop South $25,514
Houston, TX 77252

Needville 8914 North Main Street $15,155
Needville, TX 77461

Palacios 315 Henderson $25,782
Palacios, TX 77465

Post Oak 3040 Post Oak Blvd. Suite 150 $39,333
Houston, TX 77056

Sweeny 206 North McKinney $14,671
Sweeny, TX 77480

Victoria 2702 North Navarro $15,458
Victoria, TX 77903

West Columbia 510 East Brazos $40,414
West Columbia, TX 77486

- ------------------
(1) The Bay City Banking Center consists of the main office located at 1600
Seventh Street and a drive-thru facility located approximately one mile
from the main office.

(2) The Beeville Banking Center consists of the main office located at 100
South Washington and a drive-thru facility located approximately one-
half mile from the main office.

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 2000.

12

PART II.

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS

The Company's Common Stock began trading on November 12, 1998 and is listed
on the Nasdaq National Market System ("Nasdaq NMS") under the symbol "PRSP".
Prior to that date, the Common Stock was privately held and not listed on any
public exchange or actively traded. The Company had a total of 5,271,525 shares
outstanding at December 31, 2000. As of February 15, 2001, there were 204
shareholders of record. The number of beneficial owners is unknown to the
Company at this time.

The following table presents the high and low sales prices for the Common
Stock reported on the Nasdaq NMS during the two years ended December 31, 2000:

2000 High Low
---- ----- ---

Fourth Quarter... $20.000 $17.125
Third Quarter.... 18.875 16.125
Second Quarter... 16.875 13.938
First Quarter.... 16.689 12.875

1999
----
Fourth Quarter... 17.875 14.000
Third Quarter.... 16.875 13.875
Second Quarter... 15.000 12.313
First Quarter.... 13.250 12.063

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 $0.36 per share in 2000 and
aggregating $0.20 per share in 1999, 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 by quarter for the Company's last two fiscal
years were as follows:

2000 1999
----- -----

Fourth quarter.... $0.09 $0.05

Third quarter..... 0.09 0.05

Second quarter.... 0.09 0.05

First quarter..... 0.09 0.05

13

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

The following selected consolidated financial data for, and as of the end
of, each of the years in the five-year period ended December 31, 2000 are
derived from and should be read in conjunction with the Company's consolidated
financial statements and the notes thereto and the information contained in
"Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations." The consolidated financial statements as of December
31, 2000, 1999 and 1998 and for each of the years in the three-year period ended
December 31, 2000 and the report thereon of Deloitte & Touche LLP are included
elsewhere in this document.

As of and for the Years Ended December 31,
----------------------------------------------------------
2000 1999 1998 1997 1996
-------- ------- -------- -------- --------
(Dollars in thousands, except per share data)

INCOME STATEMENT DATA:
Interest income.............. $ 41,606 $ 31,412 $ 23,422 $ 19,970 $ 16,841
Interest expense............. 19,394 13,033 10,128 9,060 7,923
-------- ------- -------- -------- --------
Net interest income......... 22,212 18,379 13,294 10,910 8,918
Provision for credit losses.. 275 280 239 190 230
-------- ------- -------- -------- --------
Net interest income after
provision for credit
losses..................... 21,937 18,099 13,055 10,720 8,688
Noninterest income........... 5,352 3,521 2,492 2,264 1,897
Noninterest expense.......... 16,093 12,138 9,058 7,836 6,634
-------- ------- -------- -------- --------
Income before taxes......... 11,196 9,482 6,489 5,148 3,951
Provision for income taxes... 3,169 3,008 2,029 1,586 1,240
-------- ------- -------- -------- --------
Net income................... $ 8,027 $ 6,474 $ 4,460 $ 3,562 $ 2,711
======== =========== ======== ======== ========

PER SHARE DATA(1):
Basic earnings per share..... $ 1.53 $ 1.25 $ 1.08 $ 0.94 $ 0.77
Diluted earnings per share... 1.48 1.20 1.04 0.92 0.76
Book value per share......... 9.98 8.33 8.01 6.22 5.36
Cash dividends declared...... 0.36 0.20 0.20 0.15 0.10
Dividend payout ratio........ 23.52% 16.02% 23.70% 16.11% 12.95%
Weighted average shares
outstanding (basic)
(in thousands).............. 5,232 5,186 4,116 3,778 3,513
Weighted average shares
outstanding (diluted)
(in thousands).............. 5,418 5,392 4,309 3,864 3,560
Shares outstanding at end of
period (in thousands)....... 5,272 5,195 5,173 3,990 3,510

BALANCE SHEET DATA (AT
PERIOD END):
Total assets................. $703,073 $ 608,673 $436,312 $320,143 $293,988
Securities................... 379,652 312,671 227,744 167,868 147,564
Loans........................ 248,665 223,505 170,478 120,578 113,382
Allowance for credit losses.. 3,099 2,753 1,850 1,016 923
Total deposits............... 634,262 534,756 390,659 291,516 270,866
Borrowings and notes payable. -- 15,700 2,437 2,800 3,267
Total shareholders' equity... 52,619 43,266 41,435 24,818 18,833

AVERAGE BALANCE SHEET DATA:
Total assets................. $621,105 $ 485,757 $354,851 $304,086 $257,205
Securities................... 330,323 241,543 178,416 157,677 127,607
Loans........................ 232,836 193,687 143,196 117,586 104,534
Allowance for credit losses.. 2,924 2,146 1,271 961 820
Total deposits............... 553,486 438,623 323,045 278,377 236,334
Total shareholders' equity... 46,096 42,745 27,933 21,821 17,646

PERFORMANCE RATIOS:
Return on average assets..... 1.29% 1.33% 1.26% 1.17% 1.05%
Return on average equity..... 17.41 15.15 15.97 16.32 15.36
Net interest margin
(tax-equivalent) (2)........ 4.09 4.18 4.13 4.02 3.91
Efficiency ratio(3).......... 56.57 55.13 57.38 59.48 61.34

(Table continued on next page)

14

As of and for the Years Ended December 31,
----------------------------------------------------------
2000 1999 1998 1997 1996
-------- ------- -------- -------- --------
(Dollars in thousands, except per share data)

Asset Quality Ratios(4):
Nonperforming assets to
total loans and
other real estate........... 0.00% 0.00% 0.00% 0.00% 0.00%
Net loan (recoveries)
charge-offs
to average loans........... (0.01) (0.03) 0.05 0.08 0.06
Allowance for credit losses
to total loans.............. 1.25 1.23 1.09 0.84 0.81
Allowance for credit losses
to nonperforming loans(5)... -- -- -- -- --

CAPITAL RATIOS(4):
Leverage ratio............... 6.14% 6.28% 7.58% 6.30% 5.45%
Average shareholders' equity
to average total assets..... 7.42 8.80 7.87 7.18 6.86
Tier 1 risk-based capital
ratio....................... 14.00 14.35 18.02 14.94 13.11
Total risk-based capital
ratio....................... 15.06 16.71 19.08 15.73 13.89

- ------------------
(1) Adjusted for a four-for-one stock split effective September 10, 1998.

(2) Calculated on a tax-equivalent basis using a 34% federal income tax rate.

(3) Calculated by dividing total noninterest expense, excluding securities
losses and credit loss provisions, by net interest income plus noninterest
income. The interest expense related to debentures issued by the Company in
connection with the issuance by a subsidiary trust of trust preferred
securities is treated as interest expense for this calculation.
Additionally, taxes are not part of this calculation.

(4) At period end, except for net loan charge-offs to average loans and average
shareholders' equity to average total assets, which is for periods ended at
such dates.

(5) Nonperforming loans consist of nonaccrual loans, loans contractually past
due 90 days or more and restructured loans. The Company had no significant
nonperforming loans at any of the dates indicated.

15

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, 2000, 1999 AND 1998

OVERVIEW

Net income was $8.0 million, $6.5 million and $4.5 million for the years
ended December 31, 2000, 1999 and 1998, respectively, and diluted earnings per
share were $1.48, $1.20 and $1.04, respectively for these same periods. Earnings
growth from both 1998 to 1999 and 1999 to 2000 resulted principally from an
increase in loan volume and acquisitions, including the South Texas Acquisition
and the Union Acquisition. The Company posted returns on average assets of
1.29%, 1.33% and 1.26% and returns on average equity of 17.41%, 15.15% and
15.97% for the years ended December 31, 2000, 1999 and 1998, respectively. The
Company posted returns on average assets excluding amortization of goodwill and
related tax expense of 1.45%, 1.46% and 1.37% and returns on average equity
excluding amortization of goodwill and related tax expense of 19.57%, 16.57% and
17.38% for the years ended December 31, 2000, 1999 and 1998, respectively. The
Company's efficiency ratio was 56.57% in 2000, 55.13% in 1999 and 57.38% in
1998. The Company's efficiency ratio excluding amortization of goodwill was
52.32% in 2000, 51.85% in 1999 and 54.21% in 1998.

Total assets at December 31, 2000, 1999 and 1998 were $703.1 million,
$608.7 million and $463.3 million, respectively. Total deposits at December 31,
2000, 1999 and 1998 were $634.3 million, $534.8 million, and $390.7 million,
respectively, with deposit growth in each period resulting from acquisitions and
internal growth. Total loans were $248.7 at December 31, 2000, an increase of
$25.2 million or 11.3% from $223.5 million at the end of 1999. Total loans were
$170.5 million at year-end 1998. At December 31, 2000, the Company had no
nonperforming loans and its allowance for credit losses was $3.1 million.
Shareholders' equity was $52.6 million, $43.3 million and $41.4 million at
December 31, 2000, 1999 and 1998, 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. The
Company's net interest income is affected by changes in the amount and mix of
interest-earning assets and interest-bearing liabilities, referred to as a
"volume change." It is also affected by changes in yields earned on interest-
earning assets and rates paid on interest-bearing deposits and other borrowed
funds, referred to as a "rate change."

2000 versus 1999. Net interest income for 2000 was $22.2 million compared
with $18.4 million for 1999, an increase of $3.8 million or 20.7%. The
improvement in net interest income for 2000 was mainly due to an increase in
total average interest-earning assets. Average interest-earning assets
increased $123.7 million from $449.7 million in 1999 to $573.4 million in 2000.
Total cost of interest-bearing liabilities increased 61 basis points from 3.72%
in 1999 to 4.33% in 2000. For 2000, the net interest margin on a tax-equivalent
basis decreased nine basis points to 4.09% from 4.18% in 1999.

1999 versus 1998. Net interest income for 1999 was $18.4 million compared
with $13.3 million for 1998, an increase of $5.1 million or 38.3%. The
improvement in net interest income for 1999 was mainly due to an increase in
total average interest-earning assets and a decrease in funding costs. Average
interest-earning assets increased $121.4 million from $328.3 million to $449.7
million in 1999. Total cost of interest-bearing liabilities decreased 24 basis
points from 3.96% in 1998 to 3.72% in 1999. For 1999, the net interest margin
on a tax-equivalent basis increased five basis points to 4.18% from 4.13% in
1998.

16

The following table presents for the periods indicated the total dollar
amount of average balances, interest income from average interest-earning assets
and the resultant yields, as well as the interest expense on average interest-
bearing liabilities, expressed both in dollars and rates. Except as indicated in
the footnotes, no tax-equivalent adjustments were made and all average balances
are daily average balances. Any nonaccruing loans have been included in the
table as loans carrying a zero yield.

Years Ended December 31,
----------------------------------------------------------------------
2000 1999
--------------------------------- ----------------------------------
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...................... $232,836 $20,537 8.82% $193,687 $16,386 8.46%
Securities(1).............. 330,323 20,400 6.18 241,543 14,292 5.92
Federal funds sold and
other temporary
investments............... 10,193 669 6.56 14,491 734 5.00
-------- ------- -------- -------
Total interest-earning
assets................. 573,352 41,606 7.26% 449,721 31,412 6.98%
------- -------
Less allowance for credit
losses.................... (2,924) (2,146)
-------- --------
Total interest-earning
assets, net
of allowance........... 570,428 447,575
Noninterest-earning assets 50,677 38,182
-------- --------
Total assets............ $621,105 $485,757
======== ========

LIABILITIES AND
SHAREHOLDERS' EQUITY
Interest-bearing liabilities:
Interest-bearing demand
deposits.................. $ 70,676 $ 1,207 1.71% $ 54,396 $ 862 1.58%
Savings and money market
accounts.................. 146,082 5,575 3.82 125,015 4,103 3.28
Certificates of deposit.... 223,894 12,142 5.42 169,417 8,006 4.73
Federal funds purchased
and other borrowings...... 7,141 470 6.58 1,169 62 5.23
-------- ------- -------- -------
Total interest-bearing
liabilities............ 447,793 19,394 4.33% 349,997 13,033 3.72%
-------- ------- -------- -------
Noninterest-bearing
liabilities:
Noninterest-bearing demand
deposits.................. 112,834 89,795
Company obligated
mandatorily redeemable
trust preferred
securities of subsidiary
trust.................... 12,000 1,500
Other liabilities.......... 2,382 1,720
-------- --------
Total liabilities....... 575,009 443,012
-------- --------
Shareholders' equity......... 46,096 42,745
-------- --------
Total liabilities and
shareholders'
equity................. $621,105 $485,757
======== ========
Net interest rate spread..... 2.93% 3.26%
Net interest income and
margin(2)................... $22,212 3.87% $18,379 4.09%
======= =======
Net interest income and
margin......................
(tax-equivalent basis)(3)... $23,470 4.09% $18,781 4.18%
======= =======

Years Ended December 31,
---------------------------------
1998
---------------------------------
Average Interest Average
Outstanding Earned/ Yield/
Balance Paid Rate
----------- -------- -------
(Dollars in thousands)

ASSETS
Interest-earning assets:
Loans...................... $143,196 $ 12,282 8.58%
Securities(1).............. 178,416 10,834 6.07
Federal funds sold and
other temporary
investments............... 6,676 306 4.58
-------- --------
Total interest-earning
assets................. 328,288 23,422 7.13%
-------- --------
Less allowance for credit
losses.................... (1,271)
--------
Total interest-earning
assets, net
of allowance........... 327,017
Noninterest-earning assets 27,834
--------
Total assets............ $354,851
========

LIABILITIES AND
SHAREHOLDERS' EQUITY
Interest-bearing liabilities:
Interest-bearing demand
deposits.................. $ 41,710 $ 670 1.61%
Savings and money market
accounts.................. 83,428 2,838 3.40
Certificates of deposit.... 128,097 6,485 5.06
Federal funds purchased
and other borrowings...... 2,267 135 5.96
-------- --------
Total interest-bearing
liabilities............ 255,502 10,128 3.96%
-------- --------
Noninterest-bearing
liabilities:
Noninterest-bearing demand
deposits.................. 69,810
Company obligated
mandatorily redeemable
trust preferred
securities of subsidiary
trust.................... --
Other liabilities.......... 1,606
--------
Total liabilities....... 326,918
--------
Shareholders' equity......... 27,933
--------
Total liabilities and
shareholders'
equity................. $354,851
========
Net interest rate spread..... 3.17%
Net interest income and
margin(2)................... $ 13,294 4.05%
========
Net interest income and
margin......................
(tax-equivalent basis)(3)... $ 13,571 4.13%
========

- -----------------
(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% and other applicable effective tax rates.

17

The following table presents the dollar amount of changes in interest
income and interest expense for the major components of interest-earning
assets and interest-bearing liabilities and distinguishes between the
increase (decrease) related to higher outstanding balances and the volatility
of interest rates. For purposes of this table, changes attributable to both
rate and volume which cannot be segregated have been allocated to rate.

Years Ended December 31,
-------------------------------------------------------------------
2000 vs. 1999 1999 vs. 1998
--------------------------- ---------------------------
Increase Increase
(Decrease) (Decrease)
Due to Due to
----------------- ----------------
Volume Rate Total Volume Rate Total
------- ------- -------- ------- ------- -------
(Dollars in thousands)

Interest-earning assets:
Loans............................................. $3,312 $ 839 $ 4,151 $4,331 $(227) $4,104
Securities........................................ 5,253 855 6,108 3,833 (375) 3,458
Federal funds sold and other temporary
investments..................................... (218) 153 (65) 353 75 428
------ ------ ------- ------ ----- ------
Total increase (decrease) in interest income.... 8,347 1,847 10,194 8,517 (527) 7,990
------ ------ ------- ------ ----- ------
Interest-bearing liabilities:
Interest-bearing demand deposits.................. 258 87 345 204 (12) 192
Savings and money market accounts................. 691 781 1,472 1,415 (150) 1,265
Certificates of deposit........................... 2,574 1,562 4,136 2,092 (571) 1,521
Federal funds purchased and other borrowings...... 317 91 408 (64) (9) (73)
------ ------ ------- ------ ----- ------
Total increase (decrease) in interest expense... 3,840 2,521 6,361 3,647 (742) 2,905
------ ------ ------- ------ ----- ------
Increase in net interest income.................... $4,507 $ (674) $ 3,833 $4,870 $ 215 $5,085
====== ====== ======= ====== ===== ======

Provision for Credit Losses

The Company's provision for credit losses is established through charges to
income in the form of the provision in order 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, 2000 was $3.1 million,
representing 1.25% of outstanding loans. The provision for credit losses for
the year ended December 31, 2000 was $275,000 compared with $280,000 for the
year ended December 31, 1999. The provision for credit losses for the year ended
December 31, 1999 was $280,000 compared with $239,000 in 1998. Net loan
recoveries were $25,000 in 2000 compared with $57,000 in 1999 and net loan
charge-offs of $66,000 in 1998.

Noninterest Income

Noninterest income is an important source of revenue for financial
institutions. The Company's primary sources of noninterest income are service
charges on deposit accounts and other banking service related fees. Loan
origination fees are recognized over the life of the related loan as an
adjustment to yield using the interest method. In 2000, noninterest income
totaled $5.4 million, an increase of $1.9 million or 54.3% versus $3.5 million
in 1999. The increase was primarily due to the South Texas Acquisition and an
increase in insufficient funds charges. Noninterest income for 1999 was $3.5
million, a $1.0 million or 40.0% increase from $2.5 million in 1998, resulting
largely from an increase in income due to the Union Acquisition and an increase
in customer service fees.

18

The following table presents for the periods indicated the major categories
of noninterest income:

Years Ended December 31,
------------------------
2000 1999 1998
------ ------ ------
(Dollars in thousands)

Service charges on deposit accounts.... $4,468 $3,010 $2,173
Other noninterest income............... 884 511 319
------ ------ ------
Total noninterest income.............. $5,352 $3,521 $2,492
====== ====== ======

Noninterest Expense

For the years ended 2000, 1999 and 1998, noninterest expense totaled $16.1
million, $12.1 million and $9.1 million, respectively. The Company's efficiency
ratio showed a positive trend over this period as it was reduced from 57.38% in
1998 to 56.57% in 2000. This reduction reflects the Company's continued success
in controlling operating expenses and the cost savings achieved following the
integration of the Compass, South Texas and Union Acquisitions.

The following table presents for the periods indicated the major categories
of noninterest expense:

Years Ended December 31,
--------------------------
2000 1999 1998
------- ------- ------
(Dollars in thousands)

Salaries and employee benefits................. $ 7,206 $ 6,198 $4,541
Non-staff expenses:
Net occupancy expense......................... 810 666 535
Depreciation expense.......................... 936 689 523
Data processing............................... 1,134 880 807
Professional fees............................. 324 245 112
Regulatory assessments and FDIC insurance..... 172 109 73
Ad valorem and franchise taxes................ 318 213 200
Goodwill amortization......................... 1,124 715 500
Minority expense-trust preferred securities... 1,151 142 --
Other......................................... 2,918 2,281 1,767
------- ------- ------
Total noninterest expense.................... $16,093 $12,138 $9,058
======= ======= ======

For the year ended December 31, 2000, noninterest expense totaled $16.1
million, an increase of $4.0 million or 33.1% over $12.1 million in 1999.
Salaries and employee benefits for 2000 totaled $7.2 million, an increase of
$1.0 million or 16.1% over $6.2 million for 1999. Other operating expenses of
$2.9 million represented an increase of $637,000 or 27.7% compared with $2.3
million in 1999. These increases were principally due to the Compass and South
Texas Acquisitions. Total noninterest expenses in 1999 were $12.1 million, a
33.0% increase over the 1998 level of $9.1 million primarily due to the South
Texas and Union Acquisitions. Salaries and employee benefits in 1999 increased
by 37.8% from $4.5 million to $6.2 million. The increase was principally due to
additional staff associated with the South Texas and Union Acquisitions.

Income Taxes

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. For the year
ended December 31, 2000, income tax expense was $3.2 million compared with $3.0
million for the year ended December 31, 1999 and $2.0 million for the year ended
December 31, 1998. The effective tax rate in the years ended December 31, 2000,
1999, and 1998 was 28.3%, 31.7% and 31.3%, respectively.

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

19

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, 2000, total loans were $248.7 million, an increase of $25.2
million or 11.3% from $223.5 million at December 31, 1999. The growth in the
loan portfolio was due to continued strong loan demand and the South Texas
Acquisition. At December 31, 2000, total loans were 39.2% of deposits and 35.4%
of total assets. At December 31, 1999, total loans were 41.8% of deposits and
36.7% of total assets.

Loans increased 31.1% during 1999 from $170.5 million at December 31, 1998
to $223.5 million at December 31, 1999. The loan growth during 1999 was due to
strong loan demand, especially in the real estate and agriculture areas.

The following table summarizes the Company's loan portfolio by type of loan
as of the dates indicated:

December 31,
----------------------------------------------------------------------------------------------
2000 1999 1998 1997 1996
----------------- ----------------- ----------------- ----------------- ------------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
-------- ------- -------- ------- -------- ------- -------- ------- -------- --------
(Dollars in thousands)

Commercial and industrial.... $ 28,272 11.4% $ 28,279 12.7% $ 16,972 9.9% $ 11,611 9.6% $ 10,633 9.4%
Real estate:
Construction and land
development................ 4,470 1.8 4,015 1.8 1,727 1.0 6,453 5.3 5,021 4.4
1-4 family residential...... 102,359 41.1 97,359 43.5 80,062 47.0 53,625 44.5 49,845 44.0
Home equity................. 16,762 6.7 11,343 5.1 8,077 4.7 NA NA NA NA
Commercial mortgages........ 45,404 18.3 38,752 17.3 22,240 13.1 16,277 13.5 14,376 12.7
Farmland.................... 11,112 4.5 7,404 3.3 6,148 3.6 5,804 4.8 5,468 4.8
Multifamily residential..... 1,083 0.4 1,837 0.8 1,090 0.6 937 0.8 1,068 0.9
Agriculture.................. 12,318 5.0 12,735 5.7 14,107 8.3 6,359 5.3 5,686 5.0
Consumer..................... 26,885 10.8 21,781 9.8 20,055 11.8 19,512 16.2 21,285 18.8
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total loans............... $248,665 100.0% $223,505 100.0% $170,478 100.0% $120,578 100.0% $113,382 100.0%
======== ===== ======== ===== ======== ===== ======== ===== ======== =====

The lending focus of the Company is on 1-4 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. The Company also offers a broad range of short to medium-term
commercial loans, primarily collateralized, 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 1-4 family residential category were
originated by the Company.

Loans from $300,000 to $750,000 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.

In nearly all cases, 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.

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

20

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 significant portion of the Company's lending activity has
consisted of the origination of 1-4 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 1-4 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 has elected to keep
all 1-4 family residential loans for its own account rather than selling such
loans into the secondary market. By doing so, the Company is able to realize a
higher yield on these loans; however, the Company also incurs interest rate risk
as well as the risks associated with nonpayments on such loans.

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. 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
indeterminate 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,
including rice, cotton, milo and corn, 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.

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, 2000 are summarized in the following table:

December 31, 2000
--------------------------------------------
After One
One Year Through After Five
or Less Five Years Years Total
-------- ---------- ---------- -------
(Dollars in thousands)

Commercial and industrial................... $13,726 $12,500 $2,046 $28,272
Construction and land development........... 4,271 199 -- 4,470
------- ------- ------ -------
Total................................ $17,997 $12,699 $2,046 $32,742
======= ======= ====== =======
Loans with a predetermined interest rate.... $ 8,064 $ 9,124 $ 693 $17,881
Loans with a floating interest rate......... 9,933 3,575 1,353 14,861
------- ------- ------ -------
Total................................ $17,997 $12,699 $2,046 $32,742
======= ======= ====== =======

21

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 such 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 no nonperforming
assets as of December 31, 2000 and 1999, and $5,000 nonperforming assets as of
December 31, 1998.

The following table presents information regarding nonperforming assets at
the dates indicated:

December 31,
-----------------------------------------------------
2000 1999 1998 1997 1996
-------- -------- -------- ------- --------
(Dollars in thousands)

Nonaccrual loans...................... $ -- $ -- $ 5 $ -- $ --
Restructured loans.................... -- -- -- -- --
Other real estate..................... -- -- -- -- --
----- ----- ----- ----- -----
Total nonperforming assets.......... $ -- $ -- $ 5 $ -- $ --
====== ===== ===== ===== =====
Nonperforming assets to total loans
and other real estate................ 0.00% 0.00% 0.00% 0.00% 0.00%

Allowance for Credit Losses

The allowance for credit losses is a reserve established through charges to
earnings in the form of a provision for credit losses. Management has
established an allowance for credit losses which it believes is adequate for
estimated losses in the Company's loan portfolio. Based on an evaluation of the
loan portfolio, management presents a monthly review of the allowance for credit
losses to the Bank's Board of Directors, indicating any change in the allowance
since the last review and any recommendations as to adjustments in the
allowance. In making its evaluation, management considers factors such as
historical loan loss experience, industry diversification of the Company's
commercial loan portfolio, the amount of nonperforming assets and related
collateral, the volume, growth and composition of the Company's loan portfolio,
current economic changes that may affect the borrower's ability to pay and the
value of collateral, the evaluation of the Company's loan portfolio through its
internal loan review process and other relevant factors. Charge-offs occur when
loans are deemed to be uncollectible.

The Company considers risk elements attributable to particular loan types
or categories in assessing the quality of individual loans. Some of the risk
elements include: (i) in the case of 1-4 family residential mortgage loans, the
borrower's ability to repay the loan, including a consideration of the 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

22

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, unfavorable financial ratios, uncertain repayment sources or poor
financial condition, which may jeopardize recoverability of the debt. Loans
classified as "doubtful" are those loans which have characteristics similar to
substandard accounts but with an increased risk that a loss may occur, or at
least a portion of the loan may require a charge-off if liquidated at present.
Loans classified as "loss'' are those loans which are in the process of being
charged off.

In addition to the internally classified loan list and delinquency list of
loans, the Company maintains a separate "watch list" which further aids the
Company in monitoring loan portfolios. Watch list loans have one or more
deficiencies that require attention in the short term or pertinent rati