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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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(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, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 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.)
4295 SAN FELIPE 77027
HOUSTON, TEXAS (Zip Code)
(Address of principal executive offices)
Registrant's Telephone Number, Including Area Code: (713) 693-9300
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value
$1.00 per share
---------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No[ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of the Form 10-K or any amendment of this
Form 10-K. [ ]
As of February 13, 2002, the number of outstanding shares of Common Stock
was 8,110,035. 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
$154,769,165.
Documents Incorporated by Reference:
Portions of the Company's Proxy Statement relating to the 2002 Annual
Meeting of Shareholders, which will be filed within 120 days
after December 31, 2001, are incorporated by reference into Part
III, Items 10-13 of this Form 10-K.
PROSPERITY BANCSHARES, INC./sm/
2001 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
PART I
Item 1. Business................................................................................... 1
General................................................................................... 1
Recent Mergers and Acquisitions........................................................... 2
Officers and Associates................................................................... 2
Bank Activities........................................................................... 3
Business Strategies....................................................................... 3
Competition............................................................................... 4
Supervision and Regulation................................................................ 4
Item 2. Properties.................................................................................. 11
Item 3. Legal Proceedings........................................................................... 13
Item 4. Submission of Matters to a Vote of Security Holders......................................... 13
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....................................................................... 21
Item 7A. Quantitative and Qualitative Disclosures about Market Risk.................................. 34
Item 8. Financial Statements and Supplementary Data................................................. 36
Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure........ 36
PART III
Item 10. Directors and Executive Officers of the Registrant.......................................... 36
Item 11. Executive Compensation...................................................................... 36
Item 12. Security Ownership of Certain Beneficial Owners and Management.............................. 36
Item 13. Certain Relationships and Related Transactions.............................................. 36
Part IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K............................. 36
PART I
Special Cautionary Notice Regarding Forward-Looking Statements
Statements and financial discussion and analysis contained in the Annual
Report on Form 10-K that are not historical facts are forward-looking statements
made pursuant to the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995. Forward-looking statements are based on assumptions and
involve a number of risks and uncertainties, many of which are beyond the
Company's control. The Company's actual results may differ materially from what
is expressed in any forward-looking statement. The important factors that could
cause actual results to differ materially from the forward-looking statements
include, without limitation:
. changes in interest rates and market prices, which could reduce the
Company's net interest margins, asset valuations and expense
expectations;
. changes in the levels of loan prepayments and the resulting effects on
the value of the Company's loan portfolio;
. changes in local economic and business conditions which adversely
affect the Company's customers and their ability to transact
profitable business with the company, including the ability of the
Company's borrowers to repay their loans according to their terms or a
change in the value of the related collateral;
. increased competition for deposits and loans adversely affecting rates
and terms;
. the timing, impact and other uncertainties of future acquisitions,
including the Company's ability to identify suitable future
acquisition candidates, the success or failure in the integration of
their operations, and the ability to enter new markets successfully
and capitalize on growth opportunities;
. increased credit risk in the Company's assets and increased operating
risk caused by a material change in commercial, consumer and/or real
estate loans as a percentage of the total loan portfolio;
. the failure of assumptions underlying the establishment of and
provisions made to the allowance for credit losses;
. changes in the availability of funds resulting in increased costs or
reduced liquidity;
. increased asset levels and changes in the composition of assets and
the resulting impact on the Company's capital levels and regulatory
capital ratios;
. the Company's ability to acquire, operate and maintain cost effective
and efficient systems without incurring unexpectedly difficult or
expensive but necessary technological changes;
. the loss of senior management or operating personnel and the potential
inability to hire qualified personnel at reasonable compensation
levels; and
. changes in statutes and government regulations or their
interpretations applicable to bank holding companies and the Company's
present and future banking and other subsidiaries, including changes
in tax requirements and tax rates.
The Company undertakes no obligation to publicly update or otherwise
revise any forward-looking statements, whether as a result of new information,
future events or otherwise, unless the securities laws require the Company to do
so.
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 is a
registered financial holding company that derives substantially all of its
revenues and income from the operation of Prosperity Bank/SM/ (the "Bank"). The
Bank, which changed its name from First Prosperity Bank/SM/ on May 1, 2001, is a
full-service bank that provides a broad line of financial products and services
to small and medium-sized businesses and consumers through 29 full-service
banking locations. The Company's headquarters are located at 4295 San Felipe in
Houston, Texas and its telephone number is (713) 693-9300.
1
The Company's market consists of the communities served by its
eighteen locations in the Greater Houston CMSA and an additional eleven
locations in eight contiguous counties located to the south and southwest of
Houston. The Greater Houston CMSA includes Brazoria, Fort Bend, Galveston,
Harris, Liberty, and Montgomery counties. 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.
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. 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.
Recent Mergers and Acquisitions
In 1999, the Company acquired South Texas Bancshares, Inc. and its
wholly owned subsidiary, The Commercial National Bank of Beeville, 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.
On February 23, 2001, the Company completed a merger with Commercial
Bancshares, Inc., a Texas corporation ("Commercial"), whereby Commercial was
merged with and into the Company (the "Commercial Merger"). In connection with
the Commercial Merger, Heritage Bank, Commercial's wholly owned subsidiary, was
merged with and into the Bank. Similar to its previous acquisitions, this merger
has enabled 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 had 12 full-service banking locations in the Houston
metropolitan area and in three adjacent counties, including Houston-Bellaire,
Cleveland, Cypress, Fairfield, Houston-Downtown, Houston-Medical Center,
Houston-River Oaks, Houston-Tanglewood, Houston-Waugh Drive, Liberty, Magnolia
and Wharton. The transaction was accounted for as a pooling of interests and
therefore the historical financial data of the Company has been restated to
include the accounts and operations of Commercial for all periods prior to the
effective time of the Commercial Merger.
On February 22, 2002, the Company entered into a definitive agreement
with American Bancorp of Oklahoma, Inc. to acquire one of its subsidiary banks,
Texas Guaranty Bank, N.A., headquartered in Houston, Texas for $11.8 million in
cash. Following the acquisition, Texas Guaranty Bank will be merged into
Prosperity Bank. The Company will not complete the acquisition unless customary
closing conditions are satisfied or waived, including receipt of the necessary
regulatory approvals and consents from applicable regulatory agencies including
the Federal Reserve Board, the Texas Banking Department and the Federal Deposit
Insurance Corporation. Texas Guaranty Bank operates three banking offices in the
western portion of the greater Houston metropolitan area. As of December 31,
2001, Texas Guaranty Bank had total assets of $82.2 million, total loans of
$59.7 million, total deposits of $62.9 million and shareholders' equity of $9.4
million.
Officers and Associates
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
2
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, Cleveland, East Bernard, Medical Center, Post Oak, River Oaks and
Wharton 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 or Manager with knowledge of the community and lending expertise in
the specific industries found in the community. The Company entrusts its Banking
Center Presidents and Managers with authority and 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 and Managers
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.
As of December 31, 2001, the Company and the Bank had 312 full-time
equivalent associates, 123 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.
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, 2001, the Company maintained
approximately 74,000 separate deposit accounts and 9,500 separate loan accounts
and approximately 16.8% of the Company's total deposits were noninterest-bearing
demand deposits. For the period ended December 31, 2001, the Company's average
cost of funds was 3.32%.
The Company has been an active mortgage lender, with 1-4 family
residential and commercial mortgage loans comprising 59.8% of the Company's
total loans as of December 31, 2001. 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
Royal 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 $4.0 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 Small Business
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, commercial mortgage and
3
commercial loan portfolios. The Company successfully introduced home equity
lending in 1998. The balance of home equity loans was $20.5 million at December
31, 2001 and $16.8 million at December 31, 2000. During the three-year period
from December 31, 1999 to December 31, 2001, the Company grew its commercial and
industrial loans from $42.0 million to $47.0 million, or 11.9% and its
commercial mortgages from $64.7 million to $78.4 million, or 21.2%. In addition,
the Company targets professional service firms such as legal and medical
practices for both loans secured by owner-occupied premises and personal loans
to their principals.
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.
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. Officers and
associates have access to each customer's existing and related account
relationships and are better able to 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.
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.
Competition
The banking business is highly competitive, and the profitability of
the Company depends principally on its 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. 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.
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.
4
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
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The Company is a financial holding company registered under the
Gramm-Leach-Bliley Act and a bank holding company registered under the Bank
Holding Company Act of 1956, as amended ("BHCA"). Accordingly, the Company is
subject to supervision, regulation and examination by the Board of Governors of
the Federal Reserve System ("Federal Reserve Board"). The Gramm-Leach-Bliley
Act, the BHCA and other federal laws subject financial and 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
will generally have priority over most other unsecured claims.
Scope of Permissable Activities. 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. In approving acquisitions or the addition of activities, the Federal
Reserve considers whether the acquisition or the additional activities can
reasonably be expected to produce benefits to the public, such as greater
convenience, increased competition, or gains in efficiency, that outweigh such
possible adverse effects as undue concentration of resources decreased or unfair
competition, conflicts of interest or unsound banking practices.
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.
5
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, 2001, the Company's ratio of Tier 1 capital to total
risk-weighted assets was 18.34% and its ratio of total capital to total
risk-weighted assets was 19.52%. 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, 2001, the Company's leverage ratio was 7.57%.
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.
6
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
acquirer 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.
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.
7
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 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, 2001, the Bank's ratio of Tier 1 capital to total risk-weighted
assets was 15.72% and its ratio of total capital to total risk-weighted assets
was 16.90%. 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, 2001,
the Bank's ratio of Tier 1 capital to average total assets (leverage ratio) was
6.50%. 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
8
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.
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 2001, both the BIF and SAIF rates were .0184% 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.
9
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.
Privacy. In addition to expanding the activities in which banks and
bank holding companies may engage, the Gramm-Leach-Bliley Act also imposed new
requirements on financial institutions with respect to customer privacy. The
Gramm-Leach-Bliley Act generally prohibits disclosure of customer information to
non-affiliated third parties unless the customer has been given the opportunity
to object and has not objected to such disclosure. Financial institutions are
further required to disclose their privacy policies to customers annually.
Financial institutions, however, will be required to comply with state law if it
is more protective of customer privacy than the Gramm-Leach-Bliley Act.
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
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
10
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 29 full-service banking locations.
The Company's headquarters are located at 4295 San Felipe, Houston, Texas. The
Company owns all of the buildings in which its Banking Centers are located other
than the Bellaire, Cypress, Downtown, Fairfield, Medical Center, Needville, Post
Oak, River Oaks, and Waugh Banking Centers. The lease terms of these Banking
Centers expire in October 2007, March 2002, October 2002, December 2002,
December 2004, December 2002, July 2002, December 2004, and February 2011,
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, 2001
-------- ------- -----------------------------
(Dollars in thousands)
Angleton 116 South Velasco $ 31,385
Angleton, TX 77516
Bay City 1600 Seventh St. $ 48,568
Bay City, TX 77404
Beeville (1) 100 South Washington $ 74,764
Beeville, TX 78102
Bellaire 6800 West Loop South Suite 100 $ 26,680
Bellaire, TX 77401
Clear Lake 100 West Medical Center Blvd. $ 57,706
Webster, TX 77598
Cleveland 104 West Crockett $ 76,272
Cleveland, TX 77237
Cuero 106 North Esplanade $ 25,500
Cuero, TX 77954
Cypress (2) 26130 Hempstead Highway $ 33,222
Cypress, TX 77429
Downtown 777 Walker, Suite L140 $ 7,847
Houston, TX 77002
East Bernard 700 Church St. $ 61,921
East Bernard, TX 77435
Edna 102 North Wells $ 46,438
Edna, TX 77962
El Campo 1301 North Mechanic $ 80,750
El Campo, TX 77437
Fairfield 15050 Fairfield Village Square Dr. $ 6,180
Cypress, TX 77429
11
Goliad 145 North Jefferson $ 11,911
Goliad, TX 77963
Hitchcock 8300 Highway 6 $ 13,513
Hitchcock, TX 77563
Liberty 520 Main St. $ 55,523
Liberty, TX 77575
Magnolia 18935 FM 1488 $ 30,763
Magnolia, TX 77355
Mathis 103 North Highway 359 $ 27,983
Mathis, TX 78368
Medical Center 7505 South Main St., Suite 100 $ 18,548
Houston, TX 77030
Needville 8914 North Main St. $ 14,815
Needville, TX 77461
Palacios 600 Henderson $ 25,522
Palacios, TX 77465
Post Oak 3040 Post Oak Blvd. Suite 150 $ 56,423
Houston, TX 77056
River Oaks 4295 San Felipe $104,395
Houston, TX 77027
Sweeny 206 North McKinney $ 12,678
Sweeny, TX 77480
Tanglewood 5707 Woodway $ 5,113
Houston, TX 77057
Victoria 2702 North Navarro $ 31,011
Victoria, TX 77903
West Columbia 510 East Brazos $ 47,398
West Columbia, TX 77486
Waugh 55 Waugh Drive $ 18,635
Houston, TX 77019
Wharton 143 West Burleson $ 71,933
Wharton, TX 77488
- ----------
(1) 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.
(2) The Company currently leases the building in which its Cypress Banking
Center is located, however, it is constructing a new facility located at
25820 Northwest Freeway, Cypress, TX 77429. The Company anticipates that
the Cypress Banking Center will relocate to the new building during March
or April 2002.
12
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 2001.
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 8,105,435
shares outstanding at December 31, 2001. As of December 31, 2001, there were 449
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,
2001:
2001 High Low
- ---- ---- ---
Fourth Quarter ......................... $27.740 $23.860
Third Quarter........................... 27.870 21.500
Second Quarter.......................... 25.220 17.500
First Quarter........................... 22.625 18.750
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
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 $0.39 per share in 2001 and $0.36
per share in 2000, 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. Under federal law, the Bank cannot
pay a dividend if it will cause the Bank to be "undercapitalized." The Bank is
also subject to risk-based capital rules that restrict its ability to pay
dividends. The risk-based capital rules set a specific schedule for achieving
minimum capital levels in relation to risk-weighted assets. Regulatory
authorities can impose stricter limitations on the ability of the Bank to pay
dividends if the they consider the payment to be an unsafe or unsound practice.
The cash dividends paid per share by quarter for the Company's last
two fiscal years were as follows:
2001 2000
---- ----
Fourth quarter............................... $0.10 $0.09
Third quarter................................ 0.10 0.09
Second quarter............................... 0.10 0.09
First quarter................................ 0.09 0.09
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, 2001 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, 2001
and 2000 and for each of the years in the three-year period ended December 31,
2001 and the report thereon of Deloitte & Touche LLP are included elsewhere in
this document. The historical financial data of the Company has been restated to
include the accounts and operations of Commercial Bancshares, Inc. for all
periods prior to February 23, 2001.
As of and for the Years Ended December 31,
------------------------------------------------------------------
2001 2000 1999 1998 1997
---------- ---------- ----------- ---------- ----------
(Dollars in thousands, except per share data)
Income Statement Data:
Interest income............................. $ 76,520 $ 70,079 $ 56,458 $ 46,026 $ 39,197
Interest expense............................ 35,785 35,564 26,189 21,923 18,434
---------- ---------- ----------- ---------- ----------
Net interest income...................... 40,735 34,515 30,269 24,103 20,763
Provision for credit losses................. 700 275 420 264 720
---------- ---------- ----------- ---------- ----------
Net interest income after provision
for credit losses...................... 40,035 34,240 29,849 23,839 20,043
Noninterest income.......................... 8,590 7,760 6,151 4,808 4,758
Noninterest expense......................... 30,295/1/ 26,767 21,822 17,989 16,037
---------- ---------- ----------- ---------- ----------
Income before taxes...................... 18,330/1/ 15,233 14,178 10,658 8,764
Provision for income taxes.................. 5,372/1/ 4,532 4,747 3,577 2,811
---------- ---------- ----------- ---------- ----------
Net income.................................. $ 12,958/1/ $ 10,701 $ 9,431 $ 7,081 $ 5,953
========== ========== =========== ========== ==========
Per Share Data(2):
Basic earnings per share.................... $ 1.60/3/ $ 1.33 $ 1.18 $ 1.02 $ 0.90
Diluted earnings per share.................. 1.57/3/ 1.30 1.15 1.00 0.89
Book value per share........................ 10.95 9.95 8.63 7.75 6.46
Cash dividends declared..................... 0.39 0.36 0.20 0.20 0.15
Dividend payout ratio....................... 24.39% 25.75% 19.10% 33.82% 35.24%
Weighted average shares outstanding (basic)
(in thousands)........................... 8,086 8,032 7,986 6,916 6,578
Weighted average shares outstanding (diluted)
(in thousands)........................... 8,249 8,227 8,204 7,115 6,670
Shares outstanding at end of period
(in thousands)........................... 8,105 8,072 7,995 7,973 6,790
Balance Sheet Data (at period end):
Total assets................................ $1,262,325 $1,146,140 $ 1,027,631 $ 800,158 $ 653,462
Securities.................................. 752,322 586,952 514,983 455,202 360,496
Loans....................................... 424,400 411,203 366,803 276,106 209,013
Allowance for credit losses................. 5,985 5,523 5,031 3,682 2,567
Total deposits.............................. 1,123,397 1,033,546 878,589 714,365 593,086
Borrowings and notes payable................ 18,080 13,931 53,119 17,508 10,823
Total shareholders' equity.................. 88,725 80,333 69,025 61,781 43,868
Company-obligated mandatorily redeemable
preferred securities of subsidiary
trusts (4)............................... 27,000 12,000 12,000 -- --
Average Balance Sheet Data:
Total assets................................ $1,191,190 $1,045,882 $ 875,781 $ 700,410 $ 596,625
Securities.................................. 666,241 550,431 465,788 392,026 329,484
Loans....................................... 419,553 383,054 319,178 238,855 197,423
Allowance for credit losses................. 5,586 5,245 4,272 2,994 1,984
Total deposits.............................. 1,061,195 920,526 767,879 628,557 540,488
Total shareholders' equity.................. 85,319 72,952 64,911 47,574 45,098
Company-obligated mandatorily redeemable
preferred securities of subsidiary
trusts (4)............................... 18,875 12,000 1,500 -- --
(Table continued on next page)
14
As of and for the Years Ended December 31,
------------------------------------------------------------------
2001 2000 1999 1998 1997
---------- ---------- ----------- ---------- ----------
(Dollars in thousands, except per share data)
Performance Ratios:
Return on average assets.................. 1.09%/5/ 1.02% 1.08% 1.01% 1.00%
Return on average equity.................. 15.19/5/ 14.67 14.53 14.88 13.20
Net interest margin (tax-equivalent) (6).. 3.86 3.69 3.77 3.75 3.87
Efficiency ratio(7)....................... 60.14/5/ 62.29 59.29 61.72 62.31
Asset Quality Ratios(8):
Nonperforming assets to total loans and
other real estate...................... 0.00% 0.32% 0.34% 0.14% 0.93%
Net loan charge-offs (recoveries)
to average loans....................... 0.06 (0.04) (0.11) (0.08) 0.06
Allowance for credit losses to total
loans.................................. 1.41 1.34 1.37 1.33 1.23
Allowance for credit losses to
nonperforming loans(9)................. n/m/10/ 700.89 657.65 941.69 132.39
Capital Ratios(8):
Leverage ratio............................ 7.57% 6.17% 6.17% 6.59% 6.00%
Average shareholders' equity to average
total assets........................... 7.16 6.98 7.41 6.79 7.56
Tier 1 risk-based capital ratio........... 18.34 13.80 13.89 15.06 14.15
Total risk-based capital ratio............ 19.52 14.93 15.74 16.14 15.12
- ----------
(1) Certain income statement data for the year ended December 31, 2001 includes
the merger-related expenses of $2.4 million. If these merger-related
expenses were excluded, the income statement data would have been as
follows:
Noninterest expense................................... $ 27,870
-----------
Income before income taxes............................ 20,755
Provision for income taxes............................ 6,221
-----------
Net income............................................ $ 14,534
(2) Adjusted for a four-for-one stock split effective September 10, 1998.
(3) Earnings per share amounts for the year ended December 31, 2001 include the
merger-related expenses of $2.4 million. If these merger-related expenses
were excluded, basic earnings per share would have been $1.80 and diluted
earnings per share would have been $1.76.
(4) Consists of $12.0 million of trust preferred securities of Prosperity
Capital Trust I due November 12, 2029 and $15.0 million of trust preferred
securities of Prosperity Statutory Trust II due July 31, 2031.
(5) Selected performance ratios for the year ended December 31, 2001 include
the merger-related expenses of $2.4 million. If these merger-related
expenses were excluded, the performance ratios would have been as follows:
Return on average assets............................... 1.22%
Return on average equity............................... 17.04
Efficiency ratio....................................... 55.06
(6) Calculated on a tax-equivalent basis using a 35% federal income tax rate
for the year ended December 31, 2001 and a 34% federal income tax rate for
the years ended December 31, 1997 through December 31, 2000.
(7) 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 subsidiary trusts of trust preferred
securities is treated as interest expense for this calculation.
Additionally, taxes are not part of this calculation.
(8) 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.
(9) Nonperforming loans consist of nonaccrual loans, loans contractually past
due 90 days or more and restructured loans.
(10) Amount not meaningful. Nonperforming assets totaled $1,000 at December 31,
2001.
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 consolidated financial statements and accompanying notes and other
detailed information appearing elsewhere in this Annual Report on Form 10-K. The
Commercial Merger was accounted for as a pooling of interests and therefore the
historical financial data of the Company has been restated to include the
accounts and operations of Commercial for all periods prior to the effective
time of the merger.
For the Years Ended December 31, 2001, 2000 and 1999
Overview
Net income was $13.0 million, $10.7 million and $9.4 million for the
years ended December 31, 2001, 2000 and 1999, respectively, and diluted earnings
per share were $1.57, $1.30 and $1.15, respectively for these same periods.
Earnings growth during both 2000 and 2001 resulted principally from an increase
in loan volume and acquisitions, including the Compass and the South Texas
Acquisitions. The Company posted returns on average assets of 1.09%, 1.02% and
1.08% and returns on average equity of 15.19%, 14.67% and 14.53% for the years
ended December 31, 2001, 2000 and 1999, respectively. The Company posted returns
on average assets excluding amortization of goodwill and related tax expense of
1.18%, 1.12% and 1.15% and returns on average equity excluding amortization of
goodwill and related tax expense of 16.55%, 16.08% and 15.52% for the years
ended December 31, 2001, 2000 and 1999, respectively. The Company's efficiency
ratio was 60.14% in 2001, 62.29% in 2000 and 59.29% in 1999. The Company's
efficiency ratio excluding amortization of goodwill was 57.29% in 2001, 59.47%
in 2000 and 57.20% in 1999.
Total assets at December 31, 2001, 2000 and 1999 were $1.262 billion,
$1.146 billion and $1.028 billion, respectively. Total deposits at December 31,
2001, 2000 and 1999 were $1.123 billion, $1.034 billion, and $878.6 million,
respectively, with deposit growth in each period resulting from acquisitions and
internal growth. Total loans were $424.4 million at December 31, 2001, an
increase of $13.2 million or 3.2% from $411.2 million at the end of 2000. Total
loans were $366.8 million at year-end 1999. At December 31, 2001, the Company
had $1,000 in nonperforming loans and its allowance for credit losses was $6.0
million. Shareholders' equity was $88.7 million, $80.3 million and $69.0 million
at December 31, 2001, 2000 and 1999, respectively.
On February 23, 2001, the Company completed its merger with Commercial
Bancshares, Inc. As a result of the Commercial Merger, the Company issued an
aggregate of 2,768,610 shares of its Common Stock to the holders of Commercial
common stock. In addition, in lieu of issuing shares of Company Common Stock,
cash in the amount of $569,625 was paid to a dissenting shareholder in March
2001 and cash in the amount of $97,650 was paid to a dissenting shareholder in
May 2001. The options to purchase shares of Commercial common stock which were
outstanding at the effective time of the Commercial Merger were converted into
options to purchase 13,330 shares of Company Common Stock. In connection with
the Commercial Merger, the Company incurred approximately $2.4 million in pretax
merger-related expenses and other charges (the "Special Charge"). The
transaction was accounted for as a pooling of interests and therefore the
historical financial data of the Company has been restated to include the
accounts and operations of Commercial for all periods prior to the effective
time of the Commercial Merger.
Results of Operations Excluding Merger-Related Expenses
If the Company had not incurred the Special Charge of $2.4 million in
connection with the Commercial Merger, net income for the year ended December
31, 2001 would have been $14.5 million ($1.76 per common share on a diluted
basis) compared with $10.7 million ($1.30 per common share on a diluted basis)
for the year ended December 31, 2000, an increase in net income of $3.8 million,
or 35.8%. The Company would have posted a return on average common equity of
17.04%, a return on average assets of 1.22% and an efficiency ratio of 55.06%
for the year ended December 31, 2001. The Company would have posted a return on
average assets excluding amortization of goodwill and related tax expense of
1.32% and a return on average equity excluding amortization of goodwill and
related tax expense of 18.39% for the year ended December 31, 2001. The
Company's efficiency ratio excluding amortization of goodwill would have been
52.21% for the year ended December 31, 2001.
Results of Operations
Net Interest Income
The Company's operating results depend primarily on its net interest
income, which is the difference between interest income on interest-earning
assets, including securities and loans, and interest expense incurred on
interest-bearing liabilities, including deposits and other borrowed funds.
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
16
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."
2001 versus 2000. Net interest income for the year ended December 31,
2001 was $40.7 million compared with $34.5 million for the year ended December
31, 2000, an increase of $6.2 million or 18.0%. The improvement in net interest
income for 2001 was principally due to an increase in total average
interest-earning assets and a decrease in the rate paid on interest-bearing
liabilities that exceeded the decrease in the yield on interest-earning assets
by 22 basis points. Average interest-earning assets increased $144.9 million
from $971.4 million at December 31 2000 to $1.116 billion at December 31, 2001.
Total cost of interest-bearing liabilities decreased 58 basis points from 4.57%
at December 31, 2000 to 3.99% at December 31, 2001. Total yield on
interest-earning assets decreased 36 basis points from 7.21% at December 31,
2000 to 6.85% at December 31, 2001. The net interest margin on a tax-equivalent
basis increased 17 basis points to 3.86% at December 31, 2001 from 3.69% at
December 31, 2000.
2000 versus 1999. Net interest income for the year ended December 31,
2000 was $34.5 million compared with $30.3 million for the year ended December
31, 1999, an increase of $4.2 million or 14.0%. The improvement in net interest
income for 2000 was mainly due to an increase in total average interest-earning
assets and an increase in the yield on earning-assets, partially offset by an
increase in the cost of interest-bearing liabilities. Average interest-earning
assets increased $156.2 million from $815.2 million at December 31, 1999 to
$971.4 million at December 31, 2000. Total cost of interest-bearing liabilities
increased 59 basis points from 3.98% at December 31, 1999 to 4.57% at December
31, 2000. Total yield on interest-earning assets increased 28 basis points from
6.93% at December 31, 1999 to 7.21% at December 31, 2000. At December 31, 2000,
the net interest margin on a tax-equivalent basis decreased eight basis points
to 3.69% from 3.77% at December 31, 1999.
17
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,
-------------------------------------------------------------------------
2001 2000
------------------------------------- ---------------------------------
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 .................................... $ 419,553 $ 34,731 8.28% $ 383,054 $ 33,599 8.77%
Securities(1) ............................ 666,241 40,353 6.06 550,431 33,978 6.17
Federal funds sold and other temporary
investments ............................. 30,478 1,436 4.71 37,929 2,502 6.60
----------- ----------- ---------- --------
Total interest-earning assets .......... 1,116,272 76,520 6.85% 971,414 70,079 7.21%
----------- --------
Less allowance for credit losses ......... (5,586) (5,245)
----------- ----------
Total interest-earning assets, net
of allowance .......................... 1,110,686 966,169
Noninterest-earning assets .............. 80,504 79,713
----------- ----------
Total assets ........................... $ 1,191,190 $1,045,882
=========== ==========
Liabilities and shareholders' equity
Interest-bearing liabilities:
Interest-bearing demand deposits ......... $ 199,077 $ 4,529 2.27% $ 185,486 $ 6,346 3.42%
Savings and money market accounts ........ 252,576 7,978 3.16 220,266 8,628 3.92
Certificates of deposit .................. 428,314 22,273 5.20 339,580 18,577 5.47
Federal funds purchased and other
borrowings .............................. 17,219 1,005 5.84 32,333 2,013 6.23
----------- ----------- ---------- --------
Total interest-bearing
liabilities ........................... 897,186 35,785 3.99% 777,665 35,564 4.57%
----------- ----------- ---------- --------
Noninterest-bearing liabilities:
Noninterest-bearing demand deposits ...... 181,228 175,194
Company obligated mandatorily redeemable
trust preferred securities of subsidiary
trusts ................................. 18,875 12,000
Other liabilities ........................ 8,582 8,071
----------- ----------
Total liabilities ...................... 1,105,871 972,930
----------- ----------
Shareholders' equity ....................... 85,319 72,952
----------- ----------
Total liabilities and shareholders'
equity ................................ $ 1,191,190 $1,045,882
=========== ==========
Net interest rate spread .................. 2.86% 2.64%
Net interest income and margin(2) .......... $ 40,735 3.65% $ 34,515 3.55%
=========== ========
Net interest income and margin
(tax-equivalent basis)(3) ................. $ 43,057 3.86% $ 35,890 3.69%
=========== ========
Years Ended December 31,
--------------------------------
1999
--------------------------------
Average Interest Average
Outstanding Earned/ Yield/
Balance Paid Rate
----------- -------- -------
(Dollars in thousands)
Assets
Interest-earning assets:
Loans .................................... $319,178 $26,710 8.37%
Securities(1) ............................ 465,788 28,170 6.05
Federal funds sold and other temporary
investments ............................. 30,214 1,578 5.22
-------- -------
Total interest-earning assets .......... 815,180 56,458 6.93%
-------
Less allowance for credit losses ......... (4,272)
--------
Total interest-earning assets, net
of allowance .......................... 810,908
Noninterest-earning assets .............. 64,873
--------
Total assets ........................... $875,781
========
Liabilities and shareholders' equity
Interest-bearing liabilities:
Interest-bearing demand deposits ......... $170,338 $ 5,255 3.09%
Savings and money market accounts ........ 190,515 6,486 3.40
Certificates of deposit .................. 260,682 12,346 4.74
Federal funds purchased and other
borrowings .............................. 36,107 2,102 5.82
-------- -------
Total interest-bearing
liabilities ........................... 657,642 26,189 3.98%
-------- -------
Noninterest-bearing liabilities:
Noninterest-bearing demand deposits ...... 146,344
Company obligated mandatorily redeemable
trust preferred securities of subsidiary
trusts ................................. 3,813
Other liabilities ........................ 3,071
--------
Total liabilities ...................... 810,870
--------
Shareholders' equity ....................... 64,911
--------
Total liabilities and shareholders'
equity ................................ $875,781
========
Net interest rate spread................... 2.95%
Net interest income and margin(2) .......... $30,269 3.71%
=======
Net interest income and margin
(tax-equivalent basis)(3) ................. $30,763 3.77%
=======
- ----------
(1) Yield is based on amortized cost and does not include any component of
unrealized gains or losses.
(2) The net interest margin is equal to net interest income divided by average
interest-earning assets.
(3) In order to make pretax income and resultant yields on tax-exempt
investments and loans comparable to those on taxable investments and loans,
a tax-equivalent adjustment has been computed using a federal income tax
rate of 35% for the year ended December 31, 2001 and 34% for the periods
ended December 31, 2000 and December 31, 1999 and other applicable
effective tax rates.
18
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,
--------------------------------------------------------
2001 vs. 2000 2000 vs. 1999
-------------------------- ---------------------------
Increase Increase
(Decrease) (Decrease)
Due to Due to
---------------- -----------------
Volume Rate Total Volume Rate Total
------ ------- ------- ------- ------- -------
(Dollars in thousands)
Interest-earning assets:
Loans .............................................. $3,201 $(2,069) $ 1,132 $ 5,345 $ 1,544 $ 6,889
Securities ......................................... 7,149 (774) 6,375 5,119 689 5,808
Federal funds sold and other temporary
investments .................................... (492) (574) (1,066) 403 521 924
------ ------- ------- ------- ------- -------
Total increase (decrease) in interest income.... 9,858 (3,417) 6,441 10,867 2,754 13,621
------ ------- ------- ------- ------- -------
Interest-bearing liabilities:
Interest-bearing demand deposits ................... 465 (2,282) (1,817) 467 624 1,091
Savings and money market accounts .................. 1,266 (1,916) (650) 1,013 1,129 2,142
Certificates of deposit ............................ 4,854 (1,158) 3,696 3,737 2,494 6,231
Federal funds purchased and other borrowings ....... (941) (67) (1,008) (220) 131 (89)
------ ------- ------- ------- ------- -------
Total increase (decrease) in interest expense... 5,644 (5,423) 221 4,997 4,378 9,375
------ ------- ------- ------- ------- -------
Increase (decrease) in net interest income ............ $4,214 $ 2,006 $ 6,220 $ 5,870 $(1,624) $ 4,246
====== ======= ======= ======= ======= =======
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, 2001 was $6.0 million,
representing 1.41% of outstanding loans. The provision for credit losses for the
year ended December 31, 2001 was $700,000 compared with $275,000 for the year
ended December 31, 2000. The increase of $425,000 was primarily due to $238,000
in net loan charge-offs during 2001 compared with $171,000 in net loan
recoveries during 2000. The provision for credit losses for the year ended
December 31, 2000 was $275,000 compared with $420,000 in 1999. Net loan
recoveries were $363,000 in 1999.
Noninterest Income
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 2001, noninterest income
totaled $8.6 million, an increase of $830,000 or 10.7% compared with $7.8
million in 2000. The increase was primarily due to an increase in insufficient
funds charges. Noninterest income for 2000 was $7.8 million, a $1.6 million or
26.2% increase from $6.2 million in 1999, resulting largely from an increase in
income due to the South Texas Acquisition and an increase in customer service
fees. The following table presents for the periods indicated the major
categories of noninterest income:
Years Ended December 31,
------------------------------
2001 2000 1999
------ ------ ------
(Dollars in thousands)
Service charges on deposit accounts ........ $7,530 $6,576 $4,925
Other noninterest income ................... 1,060 1,184 1,226
------ ------ ------
Total noninterest income ................ $8,590 $7,760 $6,151
====== ====== ======
19
Noninterest Expense
For the years ended December 31, 2001, 2000 and 1999, noninterest
expense totaled $30.3 million, $26.8 million and $21.8 million, respectively.
The Company's efficiency ratio improved in 2001 as it was reduced from 62.29% at
December 31, 2000 to 60.14% at December 31, 2001. Excluding merger-related
expenses of $2.4 million, the Company's efficiency ratio would have been 55.06%
at December 31, 2001. This reduction reflects the Company's continued success in
controlling operating expenses and the cost savings achieved following the
integration of the Commercial Merger in the first quarter of 2001, the Compass
Acquisition in the fourth quarter of 2000 and the South Texas Acquisition in the
fourth quarter of 1999. The Company's efficiency ratio was 59.29% at December
31, 1999.
The following table presents for the periods indicated the major
categories of noninterest expense:
Years Ended December 31,
---------------------------
2001 2000 1999
------- ------- -------
(Dollars in thousands)
Salaries and employee benefits ...................... $12,955 $12,931 $11,149
Non-staff expenses:
Net occupancy expense ....................... 1,971 1,761 1,350
Depreciation expense ........................ 1,570 1,553 1,241
Data processing ............................. 2,126 1,956 1,651
Regulatory assessments and FDIC insurance ... 249 284 189
Ad valorem and franchise taxes .............. 434 473 368
Goodwill amortization ....................... 1,363 1,160 751
Minority expense-trust preferred securities.. 1,580 1,151 561
Merger-related expenses ..................... 2,425 -- --
Other ....................................... 5,622 5,498 4,562
------- ------- -------
Total noninterest expense ........... $30,295 $26,767 $21,822
======= ======= =======
For the year ended December 31, 2001, noninterest expense totaled
$30.3 million, an increase of $3.5 million or 13.2% over $26.8 million for the
same period in 2000. The increase in noninterest expense included $2.4 million
in merger related expenses. Excluding merger related expenses, noninterest
expense increased $1.1 million or 4.1%. Minority expense-trust preferred
securities increased $429,000 from $1.2 million at December 31, 2000 to $1.6
million at December 31, 2001. Other operating expenses of $5.6 million
represented an increase of $124,000 or 2.3% compared with $5.5 million in 2000.
These increases were principally due to the Compass Acquisition. Total
noninterest expenses in 2000 were $26.8 million, a 22.7% increase over the 1999
level of $21.8 million primarily due to the South Texas and Compass
Acquisitions. Salaries and employee benefits in 2000 increased by 16.0% from
$11.1 million to $12.9 million. The increase was principally due to additional
staff associated with the Compass and South Texas 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, 2001, income tax expense was $5.4 million compared with $4.5
million for the year ended December 31, 2000 and $4.7 million for the year ended
December 31, 1999. The effective tax rate in the years ended December 31, 2001,
2000 and 1999 was 29.3%, 29.8% and 33.5%, respectively.
Goodwill Amortization
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 141, Business
Combinations, (SFAS No. 141) and SFAS No. 142, Goodwill and Other Intangible
Assets (SFAS No. 142). SFAS No. 141 requires that the purchase method of
accounting be used for all business combinations. SFAS No. 141 specifies
criteria that intangible assets acquired in a business combination must meet to
be recognized and reported separately from goodwill. SFAS No. 142 requires that
goodwill and intangible assets with indefinite useful lives no longer be
amortized, but instead be tested for impairment at least annually in accordance
with the provisions of SFAS No. 142. SFAS No. 142 also requires that intangible
assets with estimable useful lives be amortized over their respective estimated
useful lives to their estimated residual values, and reviewed
20
for impairment in accordance with SFAS No. 121 and subsequently, SFAS No. 144
after its adoption.
The Company adopted the provisions of SFAS No. 141 as of July 1, 2001,
and SFAS No. 142 was effective January 1, 2002. Goodwill and intangible assets
determined to have an indefinite useful life acquired in a purchase business
combination completed after June 30, 2001, but before SFAS No. 142 is adopted in
full, are not amortized.
As of the date of adoption of SFAS No. 142, the Company expects to
have unamortized goodwill in the amount of $22.6 million and no unamortized
identifiable intangible assets, all of which will be subject to the transition
provisions of SFAS No. 142. Amortization expense related to goodwill was $1.4
million and $1.2 million for years ended December 31, 2001 and 2000,
respectively. Because of the extensive effort needed to comply with adopting
SFAS No. 142, it is not practicable to reasonably estimate the impact of
adopting the Statement on the Company's financial statements at the date of this
report, including whether the Company will be required to recognize any
transitional impairment losses as the cumulative effect of a change in
accounting principle.
Impact of Inflation
The effects of inflation on the local economy and on the Company's
operating results have been relatively modest for the past several years. Since
substantially all of the Company's assets and liabilities are monetary in
nature, such as cash, securities, loans and deposits, their values are less
sensitive to the effects of inflation than to changing interest rates, which do
not necessarily change in accordance with inflation rates. The Company tries to
control the impact of interest rate fluctuations by managing the relationship
between its interest rate sensitive assets and liabilities. See "Financial
Condition - Interest Rate Sensitivity and Market Risk."
Financial Condition
Loan Portfolio
At December 31, 2001, total loans were $424.4 million, an increase of
$13.2 million or 3.2% from $411.2 million at December 31, 2000. At December 31,
2001, total loans were 37.8% of deposits and 33.6% of total assets. At December
31, 2000, total loans were 39.8% of deposits and 35.9% of total assets.
Loans increased 12.1% during 2000 from $366.8 million at December 31,
1999 to $411.2 million at December 31, 2000. The loan growth during 2000 was due
to strong loan demand and the South Texas Acquisition.
The following table summarizes the Company's loan portfolio by type of
loan as of the dates indicated:
December 31,
------------------------------------------------------------
2001 2000 1999
------------------ ------------------ ------------------
Amount Percent Amount Percent Amount Percent
-------- ------- -------- ------- -------- -------
(Dollars in thousands)
Commercial and industrial .... $ 46,986 11.1% $ 46,529 11.3% $ 42,003 11.5%
Real estate:
Construction and land
development ............... 20,963 4.9 20,128 4.9 21,333 5.8
1-4 family residential ...... 175,253 41.3 175,525 42.7 165,238 45.1
Home equity ................. 20,541 4.8 16,762 4.1 11,343 3.1
Commercial mortgages ........ 78,446 18.5 75,896 18.5 64,738 17.7
Farmland .................... 10,686 2.5 12,218 3.0 8,552 2.3
Multifamily residential ..... 9,694 2.3 2,961 0.7 3,071 0.8
Agriculture .................. 15,757 3.7 13,251 3.2 13,592 3.7
Other ........................ 953 0.2 2,563 0.6 2,671 0.7
Consumer ..................... 45,121 10.7 45,370 11.0 34,262 9.3
-------- ----- -------- ----- -------- -----
Total loans ........... $424,400 100.0% $411,203 100.0% $366,803 100.0%
======== ===== ======== ===== ======== =====
December 31,
---------------------------------------
1998 1997
------------------ ------------------
Amount Percent Amount Percent
-------- ------- -------- -------
(Dollars in thousands)
Commercial and industrial .... $ 33,242 12.0% $ 28,221 13.4%
Real estate:
Construction and land
development ............... 12,477 4.5 15,113 7.2
1-4 family residential ...... 123,581 44.8 80,717 38.6
Home equity ................. 8,077 2.9 NA NA
Commercial mortgages ........ 41,436 15.0 36,515 17.5
Farmland .................... 6,455 2.3 6,206 3.0
Multifamily residential ..... 2,074 0.8 1,834 0.9
Agriculture .................. 15,138 5.5 7,262 3.5
Other ........................ 2,511 0.9 350 0.2
Consumer ..................... 31,115 11.3 32,795 15.7
-------- ----- -------- -----
Total loans ........... $276,106 100.0% $209,013 100.0%
======== ===== ======== =====
The lending focus of the Company is on 1-4 family residential loans
and small and medium-sized business 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.
21
Loans from $750,000 to $2.0 million 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.
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 secur