Sterling Bancshares 10-Q 2009 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2009

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: 0-20750

STERLING BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

Texas	74-2175590
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

10260 Westheimer Houston, Texas	77042
(Address of principal executive offices)	(Zip Code)

713-466-8300

(Registrant’s telephone number, including area code)

[None]

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ¨    Accelerated filer x    Non-accelerated filer ¨    Smaller Reporting Company ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class	Outstanding at November 2, 2009
[Common Stock, $1.00 par value per share]	81,762,121 shares

STERLING BANCSHARES, INC.

FORM 10-Q

FOR THE QUARTER ENDED SEPTEMBER 30, 2009

TABLE OF CONTENTS

PART I.    FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)
	Consolidated Balance Sheets	2
	Consolidated Statements of Income	3
	Consolidated Statements of Shareholders’ Equity	4
	Consolidated Statements of Cash Flows	5
	Notes to Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	29
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	48
Item 4.	Controls and Procedures	48
PART II.  OTHER INFORMATION
Item 1.	Legal Proceedings	49
Item 1A.	Risk Factors	49
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	49
Item 3.	Defaults Upon Senior Securities	49
Item 4.	Submission of Matters to a Vote of Security Holders	49
Item 5.	Other Information	49
Item 6.	Exhibits	50
SIGNATURES		51

1

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS.

STERLING BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

(In thousands, except per share amounts)

	September 30, 2009			December 31, 2008
ASSETS
Cash and cash equivalents	$	158,114		$	113,163
Available-for-sale securities, at fair value		836,521			633,357
Held-to-maturity securities, at amortized cost		162,990			172,039
Loans held for sale		38,187			1,524
Loans held for investment		3,312,520			3,792,290
Total loans		3,350,707			3,793,814
Allowance for loan losses		(70,059	)		(49,177	)
Loans, net		3,280,648			3,744,637
Premises and equipment, net		49,128			46,875
Real estate acquired by foreclosure		11,674			5,625
Goodwill		173,210			173,210
Core deposit and other intangibles, net		12,179			13,874
Accrued interest receivable		16,142			19,428
Other assets		158,912			157,771
TOTAL ASSETS	$	4,859,518		$	5,079,979
LIABILITIES AND SHAREHOLDERS’ EQUITY
LIABILITIES:
Deposits:
Noninterest-bearing demand	$	1,094,346		$	1,123,746
Interest-bearing demand		1,874,746			1,523,969
Certificates and other time		1,038,362			1,171,422
Total deposits		4,007,454			3,819,137
Other borrowed funds		99,486			408,586
Subordinated debt		77,616			78,335
Junior subordinated debt		82,734			82,734
Accrued interest payable and other liabilities		46,716			48,048
Total liabilities		4,314,006			4,436,840
COMMITMENTS AND CONTINGENCIES		—			—
SHAREHOLDERS’ EQUITY:
Preferred stock, $1 par value, 1,000,000 shares authorized, no shares issued or outstanding at September 30, 2009, 125,198 shares issued and outstanding at December 31, 2008		—			118,012
Common stock, $1 par value, 150,000,000 shares authorized, 83,622,435 and 75,127,636 issued and 81,754,935 and 73,260,136 outstanding at September 30, 2009 and December 31, 2008, respectively		83,622			75,128
Capital surplus		171,955			121,918
Retained earnings		295,401			332,009
Treasury stock, at cost, 1,867,500 shares held at September 30, 2009 and December 31, 2008		(21,399	)		(21,399	)
Accumulated other comprehensive income, net of tax		15,933			17,471
Total shareholders’ equity		545,512			643,139
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	4,859,518		$	5,079,979

See Notes to Consolidated Financial Statements.

2

STERLING BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)

(In thousands, except per share amounts)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2009			2008			2009			2008
Interest income:
Loans, including fees	$	49,658		$	59,636		$	154,349		$	182,770
Securities:
Taxable		9,286			7,714			26,659			21,671
Non-taxable		897			909			2,687			2,725
Deposits in financial institutions		64			2			64			10
Other earning assets		29			53			61			162
Total interest income		59,934			68,314			183,820			207,338
Interest expense:
Demand and savings deposits		4,403			4,136			11,781			13,640
Certificates and other time deposits		5,504			8,763			19,474			29,402
Other borrowed funds		346			3,432			1,583			9,193
Subordinated debt		748			1,198			2,612			3,094
Junior subordinated debt		1,082			1,317			3,441			4,301
Total interest expense		12,083			18,846			38,891			59,630
Net interest income		47,851			49,468			144,929			147,708
Provision for credit losses		56,131			10,100			76,631			22,417
Net interest income (loss) after provision for credit losses		(8,280	)		39,368			68,298			125,291
Noninterest income:
Customer service fees		3,845			3,882			11,709			11,906
Net gain (loss) on securities		4			(187	)		31			(187	)
Impairment loss on debt security held-to-maturity:
Impairment loss on debt security held-to-maturity		—			—			(2,690	)		—
Noncredit-related loss on debt security recognized in other comprehensive income		—			—			2,676			—
Net impairment loss on debt security held-to-maturity		—			—			(14	)		—
Wealth management fees		1,862			2,255			5,904			6,956
Other		3,402			3,851			12,774			12,711
Total noninterest income		9,113			9,801			30,404			31,386
Noninterest expense:
Salaries and employee benefits		21,005			21,692			67,434			63,316
Occupancy		5,967			5,367			18,004			15,992
Technology		2,495			2,600			7,475			7,235
Professional fees		1,065			1,257			3,419			3,481
Postage, delivery and supplies		700			871			2,181			2,907
Marketing		557			627			1,487			1,764
Core deposit and other intangibles amortization		565			586			1,695			1,757
Acquisition costs		154			—			154			562
FDIC insurance assessments		1,741			561			6,974			1,762
Other		5,826			5,436			14,871			15,317
Total noninterest expense		40,075			38,997			123,694			114,093
Income (loss) before income taxes		(39,242	)		10,172			(24,992	)		42,584
Income tax provision (benefit)		(14,518	)		3,082			(10,282	)		13,578
Net income (loss)	$	(24,724	)	$	7,090		$	(14,710	)	$	29,006
Preferred stock dividends		—			—			9,342			—
Net income (loss) applicable to common shareholders	$	(24,724	)	$	7,090		$	(24,052	)	$	29,006
Earnings (loss) per common share:
Basic	$	(0.30	)	$	0.10		$	(0.31	)	$	0.40
Diluted	$	(0.30	)	$	0.10		$	(0.31	)	$	0.39

See Notes to Consolidated Financial Statements.

3

STERLING BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(UNAUDITED)

(In thousands)

	Preferred Stock					Common Stock					Capital Surplus			Retained Earnings			Treasury Stock					Accumulated Other Comprehensive Income (Loss)			Total
	Shares		Amount			Shares		Amount									Shares		Amount
BALANCE AT JANUARY 1, 2008	—		$	—		74,926		$	74,926		$	110,367		$	309,903		(1,768	)	$	(20,493	)	$	5,556		$	480,259
Comprehensive income:
Net income															29,006											29,006
Net change in unrealized gains and losses on available-for-sale securities, net of taxes of $125																							232			232
Net change in unrealized gains and losses on effective cash flow hedging derivatives, net of taxes of $1,068																							1,983			1,983
Total comprehensive income																										31,221
Issuance of common stock under incentive compensation plans						129			129			764														893
Common stock issued for vested restricted stock, net of shares forfeited						47			47			(47	)													—
Stock-based compensation expense												2,667														2,667
Shares held in Rabbi Trust						(16	)		(16	)		(140	)													(156	)
Repurchase of common stock																	(100	)		(906	)					(906	)
Cash dividends paid															(12,083	)��										(12,083	)
BALANCE AT SEPTEMBER 30, 2008	—		$	—		75,086		$	75,086		$	113,611		$	326,826		(1,868	)	$	(21,399	)	$	7,771		$	501,895
BALANCE AT JANUARY 1, 2009	125,198		$	118,012		75,128		$	75,128		$	121,918		$	332,009		(1,868	)	$	(21,399	)	$	17,471		$	643,139
Comprehensive loss:
Net loss															(14,710	)										(14,710	)
Net change in unrealized gains and losses on available-for-sale securities, net of taxes of $4,616																							8,572			8,572
Net change in unrealized gains and losses on effective cash flow hedging derivatives, net of taxes of ($4,507)																							(8,371	)		(8,371	)
Noncredit-related impairment loss on held-to-maturity security not expected to be sold, net of taxes of ($936)																							(1,739	)		(1,739	)
Total comprehensive loss																										(16,248	)
Issuance of common stock						8,280			8,280			46,282														54,562
Issuance of common stock under incentive compensation plans						172			172			563														735
Common stock issued for vested restricted stock, net of shares forfeited						49			49			(49	)													—
Stock-based compensation expense												3,279														3,279
Shares held in Rabbi Trust						(7	)		(7	)		(38	)													(45	)
Preferred stock redemption, accelerated dividend and amortization of preferred stock discount	(125,198	)		(118,012	)										(7,186	)										(125,198	)
Preferred stock dividends paid															(2,156	)										(2,156	)
Common stock dividends paid															(12,556	)										(12,556	)
BALANCE AT SEPTEMBER 30, 2009	—		$	—		83,622		$	83,622		$	171,955		$	295,401		(1,868	)	$	(21,399	)	$	15,933		$	545,512

See Notes to Consolidated Financial Statements.

4

STERLING BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(In thousands)

	Nine Months Ended September 30,
	2009			2008
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)	$	(14,710	)	$	29,006
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization and accretion of premiums and discounts on securities, net		1,355			1,239
Net (gain) loss on securities		(31	)		187
Credit-related other-than-temporary impairment on debt security held-to-maturity		14			—
Net gain on loans		(379	)		(127	)
Provision for credit losses		76,631			22,417
Writedowns, less gains on sale, of real estate acquired by foreclosure		1,798			(188	)
Depreciation and amortization		7,992			7,931
Stock-based compensation expense (net of tax benefit recognized)		2,402			1,933
Excess tax benefits from share-based payment arrangements		(37	)		(24	)
Net decrease in loans held for sale		413			9,874
Net loss (gain) on sale of bank assets		178			(125	)
Net increase in accrued interest receivable and other assets		(7,324	)		(20,878	)
Net decrease in accrued interest payable and other liabilities		(1,193	)		(5,505	)
Net cash provided by operating activities		67,110			45,740
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from the maturities or calls and paydowns of held-to-maturity securities		18,017			13,829
Proceeds from the sale of available-for-sale securities		3,585			28,236
Proceeds from the maturities or calls and paydowns of available-for-sale securities		151,910			81,828
Purchases of available-for-sale securities		(346,885	)		(177,996	)
Purchases of held-to-maturity securities		(14,867	)		(8,218	)
Net decrease (increase) in loans held for investment		376,858			(307,877	)
Purchase of bank-owned life insurance		—			(13,875	)
Proceeds from sale of real estate acquired by foreclosure		3,816			2,849
Payment of earnout obligations related to the acquisition of MBM Advisors, Inc.		—			(2,222	)
Cash and cash equivalents acquired with First Horizon National Corp. branch acquisition		—			15,302
Proceeds from sale of loans originated as held for investment		—			11,490
Proceeds from sale of premises and equipment		49			169
Purchase of premises and equipment		(9,202	)		(8,641	)
Net cash provided by (used in) investing activities		183,281			(365,126	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in deposit accounts		188,317			(184,885	)
Net (decrease) increase in other borrowed funds		(309,100	)		420,922
Proceeds from issuance of subordinated debt		—			25,000
Proceeds from issuance of long-term borrowings		—			50,000
Proceeds from issuance of common stock under incentive compensation plans		699			870
Proceeds from issuance of common stock, net of expenses		54,562			—
Repurchase of common stock for Rabbi Trust		(45	)		(156	)
Repurchase of common stock		—			(906	)
Excess tax benefits from share-based payment arrangements		37			24
Redemption of preferred stock		(125,198	)		—
Preferred stock dividends paid		(2,156	)		—
Common stock dividends paid		(12,556	)		(12,083	)
Net cash (used in) provided by financing activities		(205,440	)		298,786
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		44,951			(20,600	)
CASH AND CASH EQUIVALENTS:
Beginning of period		11,663			133,670
End of period	$	158,114		$	113,070
Supplemental information:
Income taxes paid	$	13,500		$	21,125
Interest paid		41,196			63,029
Noncash investing and financing activities –
Acquisition of real estate through foreclosure of collateral		11,663			3,540
Transfer of loans from held for investment to held for sale		36,693			—
Transfer of loans from held for sale to held for investment		—			112,129
Acquisition of MBM Advisors, Inc.
Payable to MBM Advisors, Inc. shareholders		1,119			1,955

See Notes to Consolidated Financial Statements.

5

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

1. ACCOUNTING POLICIES

Basis of Presentation

The consolidated financial statements are unaudited and include the accounts of Sterling Bancshares, Inc. and its subsidiaries (the “Company”) except for those subsidiaries where it has been determined that the Company is not the primary beneficiary. The Company’s accounting and financial reporting policies are in accordance with accounting principles generally accepted in the United States of America for interim financial information and in accordance with the instructions to Form 10-Q. The information furnished in these interim statements reflects all adjustments that are, in the opinion of management, necessary for a fair statement of the results for such periods. Such adjustments are of a normal recurring nature unless otherwise disclosed in this Form 10-Q. The results of operations in the interim statements are not necessarily indicative of the results that may be expected for the full year. The interim financial information should be read in conjunction with the Company’s 2008 Annual Report on Form 10-K.

The Company has evaluated subsequent events through November 9, 2009, the date the financials statements were issued.

New Accounting Guidance

In June 2009, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Codification (“ASC 105”)Generally Accepted Accounting Principles. The Accounting Standards Codification (“ASC”) is the official source of authoritative United States Generally Accepted Accounting Principles (“GAAP”) superseding existing FASB, American Institute of Certified Public Accountants, Emerging Issues Task Force, and related literature. Rules and interpretive releases of the Securities and Exchange Commission (“SEC”) under the authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. All other accounting literature is considered non-authoritative. The switch to the ASC affects the way companies refer to GAAP in financial statements and accounting policies. ASC 105 became effective during the third quarter of 2009 and did not have a significant impact on the Company’s financial statements.

Business Combinations: On January 1, 2009, new authoritative accounting guidance under ASC 805Business Combinations became applicable to the Company’s accounting for business combinations closing on or after January 1, 2009. ASC 805 requires the acquiring entity in a business combination to recognize the assets acquired and liabilities assumed in the transaction; establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; and requires the acquirer to disclose to investors and other users all of the information they need to evaluate and understand the nature and financial effect of the business combination. Assets acquired and liabilities assumed in a business combination that arise from contingencies should be recognized at fair value on the acquisition date if fair value can be determined during the measurement period. If fair value cannot be determined, companies should typically account for the acquired contingencies using existing accounting guidance. ASC 805 will apply to future acquisitions by the Company subsequent to January 1, 2009.

Derivatives and Hedging: ASC 815Derivatives and Hedgingamends prior guidance to amend and expand the disclosure requirements for derivatives and hedging activities to provide greater transparency about (i) how and why an entity uses derivative instruments, (ii) how derivative instruments and related hedge items are accounted for under ASC 815 and its related interpretations, and (iii) how derivative instruments and related hedged items affect an entity’s financial position, results of operations and cash flows. To meet those objectives, the new authoritative accounting guidance requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses on derivative instruments and disclosures about credit-risk-related contingent features in derivative agreements. The new authoritative accounting guidance under ASC 815 became effective for the Company on January 1, 2009 and the required disclosures are reported in Note 10 - Derivative Financial Instruments.

Fair Value Measurement and Disclosures: ASC 820Fair Value Measurement and Disclosures affirms that the fair value measurement objective when a market is not active is the price that would be received by the holder of the financial asset in an orderly transaction (an exit price notion) that is not a forced liquidation or distressed sale at the measurement date. Additionally, in determining fair value for a financial asset, the use of a reporting entity’s own assumptions about future cash flows and appropriately risk-adjusted discount rates is acceptable when relevant observable inputs are not available. Broker (or pricing service) quotes may be an appropriate input when measuring fair value, but they are not necessarily determinative if an active market does not exist for the financial asset. ASC 820 provides additional guidance when the volume and level of activity for the asset or liability have significantly decreased and includes guidance on identifying circumstances that indicate a transaction is not orderly. The Company adopted ASC 820 during the quarter ended June 30, 2009. ASC 820 did not have a significant impact on

6

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

the Company’s financial condition and results of operations. The enhanced disclosures related to ASC 820 are included in Note 16 –Disclosures about Fair Value of Financial Instruments.

Investments – Debt and Equity Securities: ASC 320Investments – Debt and Equity Securitiesamends the other-than-temporary impairment guidance in GAAP for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. ASC 320 requires an entity to recognize the credit component of an other-than-temporary impairment of a debt security in earnings and the noncredit component in other comprehensive income when the entity does not intend to sell the security and it is more likely than not that the entity will not be required to sell the security prior to recovery. ASC 320 became effective for interim and annual reporting periods ending after June 15, 2009. The Company adopted ASC 320 during the quarter ended June 30, 2009. The expanded disclosures and discussion of other-than-temporarily impaired debt securities related to ASC 320 are included in Note 3 – Securities.

Financial Instruments: ASC 825Financial Instruments requires expanded disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. The expanded disclosure requirements for ASC 825 are included in Note 16 – Disclosures about Fair Value of Financial Instruments.

Subsequent Events: ASC 855Subsequent Events addresses events which occur after the balance sheet date but before the issuance of financial statements. Under ASC 855, an entity must record the effects of subsequent events that provide evidence about conditions that existed at the balance sheet date and must disclose but not record the effects of subsequent events which provide evidence about conditions that did not exist at the balance sheet date. The Company adopted ASC 855 for the quarter ended June 30, 2009 and has included the required disclosures in Note 1 – Accounting Policies.

Transfers and Servicing: ASC 860Transfers and Servicingimproves the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets. ASC 860 shall be effective for annual reporting periods that begin after November 15, 2009, for interim periods within the first annual reporting period and for interim and annual reporting periods thereafter, with early adoption prohibited. ASC 860 must be applied to transfers occurring on or after the effective date. Management has not completed its evaluation of ASC 860; however, the Company does not expect it to be material to its financial statements.

Consolidation: ASC 810Consolidationimproves financial reporting by enterprises involved with variable interest entities and any significant changes in risk exposure due to that involvement as well as its affect on the entity’s financial statements. ASC 810 shall be effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within the first annual reporting period, and for interim and annual reporting periods thereafter, with earlier adoption prohibited. Management has not completed its evaluation of ASC 810; however, the Company does not expect it to be material to its financial statements.

2. ACQUISITIONS

During the third quarter of 2009, Sterling Bank (the “Bank”) entered into a definitive purchase and assumption agreement to acquire approximately $500 million in deposits and 19 Texas bank branches from First Bank, a Missouri state-chartered bank. In addition, the Bank will also purchase approximately $230 million of performing business and consumer-related Texas-based loans from First Bank. The transaction is expected to be completed during the fourth quarter of 2009, subject to regulatory approval and other customary closing conditions.

On February 8, 2008, the Company acquired ten branches located in the Dallas and Fort Worth, Texas areas from First Horizon National Corp. (“First Horizon”). This transaction was accounted for using the purchase method of accounting in which the excess of the purchase price over the estimated fair value of the net assets acquired was recorded as goodwill. In addition to these ten bank branches, the Company also agreed to acquire land from First Horizon for possible future Sterling banking centers in Lewisville, Arlington and Fort Worth, Texas. This transaction allowed the Company to achieve a critical presence in Dallas, Texas and an entry into the growing Fort Worth, Texas market. The Company acquired approximately $85.9 million in total assets and assumed deposit accounts of approximately $85.3 million for a premium of $1.7 million. Assets consisted of approximately $54.0 million in loans, $10.9 million in premises and equipment and $15.9 million in cash and other assets. The assets and liabilities were recorded at fair value based on market conditions and risk characteristics at the acquisition date. Excess cost over tangible net assets acquired totaled $5.3 million, of which $231 thousand and $5.1 million have been allocated to core deposits and goodwill, respectively, all of which is expected to be deductible for tax purposes. The results of operations for this acquisition have been included in the Company’s financial results since February 8, 2008.

7

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

3. SECURITIES

The amortized cost and fair value of securities are as follows (in thousands):

	September 30, 2009
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Available-for-Sale
Obligations of the U.S. Treasury and other U.S. government agencies	$	53,880	$	209	$	(84	)	$	54,005
Obligations of states of the U.S. and political subdivisions		1,235		39		—			1,274
Mortgage-backed securities and collateralized mortgage obligations		748,054		20,096		(1,289	)		766,861
Other securities		13,950		485		(54	)		14,381
Total	$	817,119	$	20,829	$	(1,427	)	$	836,521
Held-to-Maturity
Obligations of states of the U.S. and political subdivisions	$	98,914	$	4,719	$	—		$	103,633
Mortgage-backed securities and collateralized mortgage obligations		64,076		313		(11,038	)		53,351
Total	$	162,990	$	5,032	$	(11,038	)	$	156,984
	December 31, 2008
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Available-for-Sale
Obligations of the U.S. Treasury and other U.S. government agencies	$	1,749	$	25	$	—		$	1,774
Obligations of states of the U.S. and political subdivisions		1,331		27		—			1,358
Mortgage-backed securities and collateralized mortgage obligations		608,811		8,487		(1,270	)		616,028
Other securities		15,252		—		(1,055	)		14,197
Total	$	627,143	$	8,539	$	(2,325	)	$	633,357
Held-to-Maturity
Obligations of states of the U.S. and political subdivisions	$	95,910	$	1,930	$	(228	)	$	97,612
Mortgage-backed securities and collateralized mortgage obligations		76,129		86		(9,967	)		66,248
Total	$	172,039	$	2,016	$	(10,195	)	$	163,860

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Expected maturities of securities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. The contractual maturities of securities at September 30, 2009 are shown below (in thousands):

	Available-for-Sale				Held-to-Maturity
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
Due in one year or less	$	25,360	$	25,389	$	10,458	$	10,563
Due after one year through five years		29,755		29,890		52,057		54,537
Due after five years through ten years		—		—		30,441		32,228
Due after ten years		—		—		5,958		6,305
Mortgage-backed securities and collateralized mortgage obligations		748,054		766,861		64,076		53,351
Other securities		13,950		14,381		—		—
Total	$	817,119	$	836,521	$	162,990	$	156,984

The Company does not own securities of any one issuer (other than the U.S. government and its agencies) for which the aggregate adjusted cost exceeds 10% of the consolidated shareholders’ equity at September 30, 2009.

Securities with carrying values totaling $244 million and fair values totaling $254 million were pledged to secure public deposits at September 30, 2009.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Gross Unrealized Losses and Fair Value

The following table shows the gross unrealized losses and fair value of securities by length of time that individual securities in each category had been in a continuous loss position (in thousands). Debt securities on which we have taken only credit-related other-than-temporary impairment (“OTTI”) write-downs are categorized as being “less than 12 months” or “more than 12 months” in a continuous loss position based on the point in time that the fair value declined to below the cost basis and not the period of time since the OTTI write-down.

	September 30, 2009
	Less than 12 Months							More than 12 Months
	Amortized Cost		Gross Unrealized Losses			Fair Value		Amortized Cost		Gross Unrealized Losses			Fair Value
Available-for-Sale
Obligations of the U.S. Treasury and other U.S. government agencies	$	19,950	$	(84	)	$	19,866	$	—	$	—		$	—
Obligations of states of the U.S. and political subdivisions		—		—			—		—		—			—
Mortgage-backed securities and collateralized mortgage obligations		73,444		(579	)		72,865		7,071		(710	)		6,361
Other securities		2,012		—			2,012		11,938		(54	)		11,884
Total	$	95,406	$	(663	)	$	94,743	$	19,009	$	(764	)	$	18,245
Held-to-Maturity
Obligations of states of the U.S. and political subdivisions	$	—	$	—		$	—	$	—	$	—		$	—
Mortgage-backed securities and collateralized mortgage obligations		—		—			—		60,330		(11,038	)		49,292
Total	$	—	$	—		$	—	$	60,330	$	(11,038	)	$	49,292

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

	December 31, 2008
	Less than 12 Months							More than 12 Months
	Amortized Cost		Gross Unrealized Losses			Fair Value		Amortized Cost		Gross Unrealized Losses			Fair Value
Available-for-Sale
Obligations of the U.S. Treasury and other U.S. government agencies	$	—	$	—		$	—	$	—	$	—		$	—
Obligations of states of the U.S. and political subdivisions		—		—			—		—		—			—
Mortgage-backed securities and collateralized mortgage obligations		83,184		(603	)		82,581		33,961		(667	)		33,294
Other securities		3,152		(483	)		2,669		12,100		(572	)		11,528
Total	$	86,336	$	(1,086	)	$	85,250	$	46,061	$	(1,239	)	$	44,822
Held-to-Maturity
Obligations of states of the U.S. and political subdivisions	$	13,392	$	(228	)	$	13,164	$	—	$	—		$	—
Mortgage-backed securities and collateralized mortgage obligations		39,557		(5,506	)		34,051		30,499		(4,461	)		26,038
Total	$	52,949	$	(5,734	)	$	47,215	$	30,499	$	(4,461	)	$	26,038

For all security types discussed below where no OTTI is considered necessary at September 30, 2009, the Company does not intend to sell the securities and it is not more likely than not that the Company will be required to sell the securities before recovery of their amortized cost basis.

Obligations of the U.S. Treasury and other U.S. government agencies: The agency securities consist of discount notes and medium-term notes issued by the Federal Home Loan Bank (“FHLB”), Federal Home Loan Mortgage Corporation (“FHLMC”), and Federal National Mortgage Association (“FNMA”). These securities are fixed rate and may be callable at the option of the issuer. They were purchased at premiums or discounts. They have maturity dates up to seven years and have contractual cash flows guaranteed by agencies of the U.S. Government. The decline in fair value was generally attributable to interest rates and not credit quality. As such, no OTTI is considered necessary for these securities at September 30, 2009.

Obligations of states of the U.S. and political subdivisions: The municipal bonds are largely comprised of General Obligation (GO) bonds issued by school districts or municipalities. These bonds have fixed-rates and maturities of 15 years or less. During 2008, there were credit rating downgrades announced with regard to most of the insurers of the Company’s municipal bonds. These insurers provide a credit enhancement for the vast majority of municipal bond securities owned by the Company. Despite these downgrades, the municipal bonds owned by the Company are all considered to be investment grade due either to the underlying credit rating of the issuer or the current credit rating of the insurer. These securities will continue to be monitored as part of our ongoing impairment analysis, but are expected to perform, even if the nationally recognized statistical ratings organizations (“NRSROs”) further reduce the credit rating of the bond insurers.

Mortgage-backed securities and collateralized mortgage obligations (“CMO”): The agency mortgage-backed securities are comprised largely of fixed and variable rate residential mortgage-backed securities issued by the Government National Mortgage Association (“GNMA”), FNMA, or FHLMC. They have maturity dates of up to 40 years and have contractual cash flows guaranteed by agencies of the U.S. Government. The decline in fair value was generally attributable to changes in interest rates and not credit quality. As such, no OTTI was considered necessary for these securities at September 30, 2009, except as discussed below.

Other securities: These securities include certain interest-only securities, which are tied to underlying government guaranteed loans and are subject to prepayment and interest rate fluctuations. In addition, this category of securities includes a Community

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Reinvestment Act oriented mutual fund. The Company has the ability and intent to hold these investments until a recovery of fair value, which may be maturity. As such, no OTTI is considered necessary for these securities at September 30, 2009.

Other-Than-Temporarily Impaired Debt Securities

Declines in the fair value of individual securities below their amortized cost are assessed to determine whether the impairment is other-than-temporary. The initial indication of OTTI for both debt and equity securities is the duration and length of time the market value has been below cost. Additionally, the Company considers recent events specific to the issuer, including investment downgrades by rating agencies and economic conditions within its industry, and whether it is more likely than not that the Company will be required to sell the security before a recovery in value.

For debt securities, the Company assesses whether OTTI is present when it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the security. When assessing whether the entire amortized cost basis of the security will be recovered, the Company compares the present value of cash flows expected to be collected from the security with the amortized cost basis of the security. If present value of cash flows expected to be collected is less than the amortized cost basis of the security, the entire amortized cost basis of the security will not be recovered (that is, a credit loss exists), and an OTTI is considered to have occurred.

Held-to-Maturity (HTM) Debt Securities

For debt securities where the Company has determined that an OTTI exists and the Company does not intend to sell the security or if it is more likely than not that the Company will not be required to sell the security before recovery of its amortized cost basis, the impairment is separated into the amount that is credit-related and the amount due to all other factors. The credit-related impairment is recognized in earnings, and is the difference between a security’s amortized cost basis and the present value of expected future cash flows discounted at the security’s effective interest rate. For debt securities classified as held-to-maturity, the amount of noncredit-related impairment recognized in other comprehensive income is accreted over the remaining life of the debt security as an increase in the carrying value of the security.

The Company recorded a $14 thousand credit-related OTTI on a held-to-maturity debt security during the second quarter of 2009, based on its cash flow analysis. This security was issued in 2007 and is backed by hybrid adjustable-rate residential mortgage loans. As of September 30, 2009, this security was rated triple-C by Standard and Poor’s (“S&P”) and double-C by Fitch Ratings, Ltd. (“Fitch”) (Moody’s Investor Service (“Moody’s”) does not rate this security). The Company does not intend to sell the security, and it is not more likely than not that the Company will be required to sell the investment before recovery of its remaining amortized cost basis. Therefore, for the nine months ended September 30, 2009 the amount of the credit-related OTTI, $14 thousand, was recognized in earnings and the amount of the noncredit-related impairment of $2.9 million, was recognized in other comprehensive income as of September 30, 2009. The Company did not recognize any credit-related or noncredit-related impairment during the three month period ended September 30, 2009. The management of the Company believes that it will fully collect the carrying value of securities on which it has recorded a noncredit-related impairment in other comprehensive income. The following table sets forth additional information for the OTTI security for the three and nine months ended September 30, 2009 (in thousands):

	September 30, 2009
	Three Months Ended				Nine Months Ended
	Amortized Cost		Estimated Fair Value		Amortized Cost			Estimated Fair Value
Private Label CMO balance at beginning of period	$	7,261	$	4,382	$	7,275		$	7,275
Noncredit-related impairment		—		—		—			(2,893	)
Amortization of noncredit-related impairment		—		203		—			203
Credit-related OTTI		—		—		(14	)		—
Private Label CMO balance at end of period	$	7,261	$	4,585	$	7,261		$	4,585

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

The following table presents a rollforward of the credit-related portion of the HTM OTTI that the Company recognized in earnings (in thousands):

	September 30, 2009
	Three months ended		Nine months ended
Balance of credit-related HTM OTTI at beginning of period	$	14	$	—
Additions for credit-related OTTI not previously recognized		—		14
Balance of credit-related HTM OTTI at end of period	$	14	$	14

In addition to the Private Label CMO referenced above, the Company owned 20 other Private Label CMOs with a total amortized cost basis of $60.4 million as of September 30, 2009. These securities are carried as either held-to-maturity or available-for-sale. The unrealized losses on the Company’s Private Label CMO portfolio as of September 30, 2009 are generally attributable to the widespread deterioration in economic and credit market conditions over the last 24 months. All of the Company’s Private Label CMO securities are backed by residential mortgage loans and were rated in the highest available investment grade category at the time of their purchase. They continue to be rated by one or more of the following NRSROs: Moody’s, S&P and/or Fitch. As of September 30, 2009, 15 of the other 20 Private Label CMOs owned by the Company have been downgraded by one grade or more by at least one of the NRSROs. Of the 15 downgraded securities, 11 were rated “investment grade” (BBB or the Moody’s equivalent rating or higher), as of September 30, 2009.

The Company regularly reviews various credit quality metrics relating to individual Private Label CMOs, such as the ratio of credit enhancement to expected losses along with the ratio of credit enhancement to severely delinquent loans (loans 60 days or more delinquent). For certain securities, the Company develops more detailed loss projections by more specifically evaluating the residential mortgage loans collateralizing the security along with expected default rates and loss severities. Based upon this analysis, a cash flow analysis is conducted of the security to determine if the Company will recover its entire amortized cost basis in the security.

Because the Company currently expects to recover the entire amortized cost basis of these 20 Private Label CMOs and because the Company does not intend to sell the securities and it is not more likely than not that the Company will be required to sell the securities before recovery of their amortized cost basis, the Company does not consider any of its other Private Label CMOs to be other-than-temporarily impaired at September 30, 2009.

Available-for-Sale (AFS) Securities

During the third quarter of 2008, the Company recorded a $722 thousand OTTI loss on securities on certain interest-only strips within the available-for-sale category. These securities are tied to an underling government guaranteed loan and are subject to prepayment and interest rate fluctuations. For available-for-sale securities, there was no OTTI recorded during the three and nine month periods ended September 30, 2009.

Realized Gains and Losses

The following table shows the gross realized gains on the sales of securities (in thousands).

	Three months ended September 30,				Nine months ended September 30,
	2009		2008		2009		2008
Proceeds from sales and calls	$	1,545	$	28,236	$	3,585	$	28,236
Gross realized gains		4		535		31		535
Gross realized losses		—		—		—		—

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

4. LOANS

The loan portfolio is classified by major type as follows (in thousands):

	September 30, 2009				December 31, 2008
	Amount		%		Amount		%
Loans held for sale
Commercial and industrial	$	16,049	0.5	%	$	—	0.0	%
Real estate:
Commercial		21,345	0.6	%		697	0.0	%
Residential mortgage		793	0.0	%		827	0.0	%
Total loans held for sale	$	38,187	1.1	%	$	1,524	0.0	%
Loans held for investment
Domestic:
Commercial and industrial		814,912	24.3	%		1,093,942	28.8	%
Real estate:
Commercial		1,701,535	50.8	%		1,763,712	46.5	%
Construction		394,819	11.8	%		545,303	14.4	%
Residential mortgage		334,973	10.0	%		309,622	8.2	%
Consumer/other		55,048	1.6	%		63,883	1.7	%
Foreign
Commercial and industrial		8,885	0.3	%		13,577	0.4	%
Other loans		2,348	0.1	%		2,251	0.0	%
Total loans held for investment		3,312,520	98.9	%		3,792,290	100.0	%
Total loans	$	3,350,707	100.0	%	$	3,793,814	100.0	%

Loan maturities and rate sensitivity of the loans held for investment, excluding residential mortgage and consumer loans, at September 30, 2009 were as follows (in thousands):

	Due in One Year or Less		Due After One Year Through Five Years		Due After Five Years		Total
Commercial and industrial	$	548,953	$	224,012	$	41,947	$	814,912
Real estate – commercial		254,697		781,753		665,085		1,701,535
Real estate – construction		202,057		111,220		81,542		394,819
Foreign loans		7,014		1,443		2,522		10,979
Total	$	1,012,721	$	1,118,428	$	791,096	$	2,922,245
Loans with a fixed interest rate	$	206,655	$	749,763	$	226,336	$	1,182,754
Loans with a floating interest rate		806,066		368,665		564,760		1,739,491
Total	$	1,012,721	$	1,118,428	$	791,096	$	2,922,245

The loan portfolio consists of various types of loans made principally to borrowers located in the Houston, San Antonio, Dallas and Fort Worth, Texas metropolitan areas.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

As of September 30, 2009, there was no concentration of loans to any one type of industry exceeding 10% of total loans nor were there any loans classified as highly leveraged transactions. The Company’s largest concentration in any single industry is in the energy loan portfolio. At September 30, 2009, the energy loan portfolio totaled $278 million which represents 8.3% of total loans. The petroleum industry is usually divided into three major components: upstream, midstream and downstream. The composition of the collateral of the upstream energy portfolio, at September 30, 2009, consists of 57% gas reserves and 43% oil reserves. The upstream oil sector is a term commonly used to refer to the exploration for and the recovery and production of crude oil and natural gas. The upstream oil sector is also known as the exploration and production sector. These reserve-based loans represent approximately 68% of the energy loan portfolio. The remaining energy loan portfolio consists of well-secured loans to companies that would be classified as midstream energy companies. A midstream energy company is a company that processes and transports crude oil and natural gas. The energy lending group participates in shared national credits which are defined by banking regulators as credits of more than $20 million and with three or more non-affiliated banks as participants. The energy lending group is the only group that consistently participates in shared national credits.

In the ordinary course of business, the Company has granted loans to certain directors, officers and their affiliates. In the opinion of management, all transactions entered into between the Bank and such related parties have been and are in the ordinary course of business and are made on the same terms and conditions as similar transactions with unaffiliated persons.

An analysis of activity with respect to these related-party loans is as follows (in thousands):

	September 30, 2009			December 31, 2008
Beginning balance	$	2,100		$	2,189
New loans		2,816			—
Repayments		(170	)		(89	)
Ending balance	$	4,746		$	2,100

Nonaccrual loans were $95.0 million and $87.5 million at September 30, 2009 and December 31, 2008, respectively. Interest foregone on nonaccrual loans was $2.1 million and $5.0 million for the three and nine months ended September 30, 2009, respectively, and $1.4 million and $2.6 million for the same time periods in 2008, respectively.

A loan is impaired when, based on current information, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for other loans. The Company typically reviews all loans $250 thousand and greater for individual impairment. Additionally, loans restructured in a troubled debt restructuring are considered impaired. Loans are classified as troubled debt restructurings if the Company grants a concession for economic or legal reasons related to the borrower’s deteriorated financial position that the Company would not otherwise have granted. If an individually evaluated loan is considered impaired, a specific valuation allowance is allocated through an increase to the allowance for credit losses, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of the collateral. Impaired loans, or portions thereof, are charged-off when deemed uncollectible.

The recorded investment in individually assessed impaired loans was $74.0 million at December 31, 2008 of which $66.3 million required specific reserves totaling $13.0 million. The recorded investment in individually assessed impaired loans was $125 million at September 30, 2009, of which $51.4 million required specific reserves of $3.4 million. The Company has no further commitments to lend additional funds to these borrowers. Impaired loans at September 30, 2009 included $29.5 million of loans classified as held for sale. In the fourth quarter of 2009, management executed a definitive agreement to sell $16.0 million in net book value loans related to a previously disclosed nonperforming energy loan relationship and a letter of intent to sell $20.9 million in net book value commercial real estate loans out of the Company’s national SBA/commercial real estate portfolio. Management charged-off a portion of these loans against the related allowance for credit losses and reclassified these loans as held for sale at September 30, 2009.

The average recorded investment in impaired loans for the three and nine months ended September 30, 2009 was $123 million and $110 million, respectively, and for the three and nine months ended September 30, 2008 was $62.4 million and $39.9 million, respectively. No interest on impaired loans was received during the three and nine months ended September 30, 2009 and 2008, respectively.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

When management doubts a borrower’s ability to meet payment obligations, which typically occurs when principal or interest payments are more than 90 days past due, the loans are placed on nonaccrual status. Accruing loans 90 days past due or more were $681 thousand and $8.4 million at September 30, 2009 and December 31, 2008, respectively.

5. ALLOWANCE FOR CREDIT LOSSES

An analysis of activity in the allowance for credit losses is as follows (in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2009			2008			2009			2008
Allowance for Credit Losses
Allowance for loan losses at beginning of period	$	53,075		$	41,651		$	49,177		$	34,446
Loans charged-off		37,834			6,249			56,449			12,567
Loan recoveries		(437	)		(447	)		(1,898	)		(1,653	)
Net loans charged-off		37,397			5,802			54,551			10,914
Provision for loan losses		54,381			9,373			75,433			21,690
Allowance for loan losses at end of period		70,059			45,222			70,059			45,222
Allowance for unfunded loan commitments at beginning of period		1,102			927			1,654			927
Provision for losses on unfunded loan commitments		1,750			727			1,198			727
Allowance for unfunded loan commitments at end of period		2,852			1,654			2,852			1,654
Total allowance for credit losses	$	72,911		$	46,876		$	72,911		$	46,876

Net charge-offs were $37.4 million and $54.6 million for the three and nine months ended September 30, 2009, respectively, compared to $5.8 million and $10.9 million for the same periods in 2008, respectively.

6. GOODWILL AND OTHER INTANGIBLES

Goodwill totaled $173 million at September 30, 2009 and December 31, 2008. During the first quarter of 2008, goodwill increased $5.1 million due to the acquisition of First Horizon. This increase was offset by final purchase accounting adjustments related to prior acquisitions.

The Company reviews its goodwill for impairment annually or more frequently if indicators of impairment exist. Goodwill is assigned to reporting units for purposes of impairment testing. Reporting units used for the goodwill impairment testing include our banking operations and MBM Advisors. There was no impairment of goodwill indicated at September 30, 2009.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Other intangible assets totaled $12.2 million at September 30, 2009 including $9.3 million related to core deposits and $2.9 million related to customer relationships. Other intangible assets totaled $13.9 million at December 31, 2008, including $10.7 million related to core deposits and $3.2 million related to customer relationships. The changes in intangibles related to core deposits and customer relationships during 2008 were related to the First Horizon branch acquisition, net of amortization. Core deposit and other intangibles are amortized on an accelerated basis over their estimated useful lives of 10 years. The total amortization expense related to intangible assets was $565 thousand and $1.7 million for the three and nine month periods ended September 30, 2009, respectively, and $586 thousand and $1.8 million for the same time periods in 2008, respectively. The projected amortization for core deposits and other intangibles as of September 30, 2009, is as follows (in thousands):

2009	$	552
2010		2,149
2011		2,011
2012		1,801
2013		1,695
Thereafter		3,971
Total	$	12,179

7. OTHER BORROWED FUNDS

Other borrowed funds are summarized as follows (in thousands):

	September 30, 2009		December 31, 2008
Federal Home Loan Bank advances	$	40,500	$	212,500
Repurchase agreements		57,336		59,936
Federal funds purchased		1,650		36,150
Treasury auction facility		—		100,000
Total	$	99,486	$	408,586

Federal Home Loan Bank Advances– The Company has an available line of credit with the FHLB of Dallas, which allows the Company to borrow on a collateralized basis. At September 30, 2009, the Company had total funds of $1.2 billion available under this agreement of which $40.5 million was outstanding with an average interest rate of 2.95%. At September 30, 2009, the Company had $40.0 million of FHLB advances with a maturity of eight years and $500 thousand of FHLB advances with a remaining maturity of less than one year. These borrowings are collateralized by mortgage loans, certain pledged securities, FHLB stock owned by the Company and any funds on deposit with the FHLB. The Company utilizes these borrowings to meet liquidity needs. Maturing advances are replaced by drawing on available cash, making additional borrowings or through increased customer deposits.

Securities Sold Under Agreements to Repurchase –Securities sold under agreements to repurchase represent the purchase of interests in securities by banking customers and structured repurchase agreements with other financial institutions. Securities sold under agreements to repurchase are stated at the amount of cash received in connection with the transaction. Repurchase agreements with banking customers are settled on the following business day, while structured repurchase agreements with other financial institutions will have varying terms. All securities sold under agreements to repurchase are collateralized by certain pledged securities. The securities underlying the structured repurchase agreements are held in safekeeping by the purchasing financial institution. At September 30, 2009 and December 31, 2008, the Company had securities sold under agreements to repurchase with banking customers of $7.3 million and $9.9 million, respectively. Structured repurchase agreements totaled $50.0 million at September 30, 2009 and December 31, 2008, and consisted of agreements with two separate financial institutions totaling $25.0 million, each that will mature in 2015. These repurchase agreements bear interest at a rate equal to LIBOR less 100 basis points and reset quarterly until the first quarter of 2010 at which time the rate will become fixed at 3.88% and 3.50%, respectively. The rate on these repurchase agreements was zero at September 30, 2009. The rate on these repurchase agreements was 1.22% and 0.87%, respectively, at December 31, 2008. The Company may be required to provide additional collateral based on the fair value of the underlying securities.

Treasury Auction Facility –Treasury Auction Facilities (“TAF”) are term funds auctioned to depository institutions by the Federal Reserve Board. Each TAF auction is for a fixed amount, with the rate determined by the auction process (subject to a

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

minimum bid rate). All advances must be fully collateralized. At September 30, 2009, there were no TAF borrowings outstanding. At December 31, 2008, the Company had $100 million of TAF borrowings outstanding at a rate of 0.42%.

Federal Funds Purchased– The Company has federal funds purchased at correspondent banks. As of September 30, 2009, federal funds outstanding with correspondent banks were $1.7 million and payable upon demand. These funds typically mature within one to ninety days.

8. SUBORDINATED DEBT

During April 2003, the Bank raised approximately $50.0 million through a private offering of subordinated unsecured notes. These subordinated notes bear interest at a fixed rate of 7.375% and mature on April 15, 2013. Interest payments are due semi-annually. The subordinated notes may not be redeemed or called prior to their maturity. Debt issuance costs of approximately $1.0 million are being amortized over the ten-year term of the notes on a straight-line basis. In June 2003, the Bank entered into an interest rate swap agreement with a notional amount of $50.0 million in which the bank swapped the fixed rate to a floating rate (discussed in Note 10).

On June 30, 2008, the Bank entered into a subordinated note in the aggregate principal amount of $25.0 million. The subordinated note bears interest at a rate equal to LIBOR plus 2.50% and is reset quarterly. The unpaid principal balance plus all accrued and unpaid interest on the subordinated debt is due and payable on September 15, 2018. The Bank may prepay the subordinated debt without penalty on any interest payment date on or after September 15, 2013. As of September 30, 2009, the floating rate was 2.80% on the subordinated note compared to 4.50% at December 31, 2008.

9. JUNIOR SUBORDINATED DEBT/COMPANY MANDATORILY REDEEMABLE TRUST PREFERRED SECURITIES

As of September 30, 2009 and December 31, 2008, the Company had the following issues of trust preferred securities outstanding and junior subordinated debt owed to trusts (dollars in thousands):

Description	Issuance Date	Trust Preferred Securities Outstanding		Interest Rate	Junior Subordinated Debt Owed To Trusts		Final Maturity Date
Statutory Trust One	August 30, 2002	$	20,000	3-month LIBOR plus 3.45%	$	20,619	August 30, 2032
Capital Trust III	September 26, 2002		31,250	8.30% Fixed		32,217	September 26, 2032
BOTH Capital Trust I	June 30, 2003		4,000	3-month LIBOR plus 3.10%		4,124	July 7, 2033
Capital Trust IV	March 26, 2007		25,000	3-month LIBOR plus 1.60%		25,774	June 15, 2037
Total		$	80,250		$	82,734

Each of the trusts is a statutory business trust organized for the sole purpose of issuing trust securities and investing the proceeds thereof in junior subordinated debentures of Sterling Bancshares. The preferred trust securities of each trust represent preferred beneficial interests in the assets of the respective trusts and are subject to mandatory redemption upon payments of the junior

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

subordinated debentures held by the trust. The common securities of each trust are wholly-owned by Sterling Bancshares. Each trust’s ability to pay amounts due on the trust preferred securities is solely dependent upon Sterling Bancshares making payments on the related junior subordinated debentures. Sterling Bancshares’ obligations under the junior subordinated debentures and other relevant trust agreements, in aggregate, constitute a full and unconditional guarantee by Sterling Bancshares of each respective trust’s obligations under the trust securities issued by each respective trust.

Each issuance of trust preferred securities outstanding is mandatorily redeemable 30 years after issuance and is callable beginning five years after issuance if certain conditions are met (including the receipt of appropriate regulatory approvals). The trust preferred securities may be prepaid earlier upon the occurrence and continuation of certain events including a change in their tax status or regulatory capital treatment. In each case, the redemption price is equal to 100% of the face amount of the trust preferred securities, plus the accrued and unpaid distributions thereon through the redemption date.

The trust preferred securities issued under Statutory Trust One, BOTH Capital Trust I, and Capital Trust IV bear interest on a floating rate that resets quarterly. As of September 30, 2009, the floating rate on these securities was 3.73%, 3.61% and 1.90%, respectively, compared to 4.91%, 7.92% and 3.60%, respectively, at December 31, 2008.

10. DERIVATIVE FINANCIAL INSTRUMENTS

The Company’s interest rate risk management strategy includes hedging the repricing characteristics of certain assets and liabilities so as to mitigate adverse effects on the Company’s net interest margin and cash flows from changes in interest rates. The Company uses certain derivative instruments to add stability to the Company’s net interest income and to manage the Company’s exposure to interest rate movements.

The Company may designate a derivative as either an accounting hedge of the fair value of a recognized fixed rate asset or an unrecognized firm commitment (“fair value” hedge), or an accounting hedge of a forecasted transaction or of the variability of future cash flows of a floating rate asset or liability (“cash flow” hedge). All derivatives are recorded as other assets or other liabilities on the balance sheet at their respective fair values. To the extent a hedge is considered effective, changes in the fair value of a derivative that is designated and qualifies as a cash flow hedge is recorded in other comprehensive income, net of income taxes. For all hedge relationships, ineffectiveness resulting from differences between the changes in fair value or cash flows of the hedged item and changes in fair value of the derivative are recognized as other income in the results of operations.

The Company estimates the fair value of its interest rate derivatives using a standardized methodology that nets the discounted expected future cash receipts and cash payments (based on observable market inputs). These future net cash flows, however, are susceptible to change due primarily to fluctuations in interest rates. As a result, the estimated values of these derivatives will typically change over time as cash is received and paid and also as market conditions change. As these changes take place, they may have a positive or negative impact on the Company’s estimated valuations.

The table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the Consolidated Balance Sheets (in thousands):

	September 30, 2009						December 31, 2008
			Fair Value						Fair Value
	Notional Amount		Other Assets		Other Liabilities		Notional Amount		Other Assets		Other Liabilities
Derivatives designated as hedging instruments:
Fair value hedge of interest rate risk:
Interest rate swap	$	50,000	$	2,637	$	—	$	50,000	$	3,361	$	—
Cash flow hedge of interest rate risk:
Interest rate floor and collar		—		—		—		363,000		20,967		—
Total derivatives designated as hedging instruments	$	50,000	$	2,637	$	—	$	413,000	$	24,328	$	—

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Fair Value Hedges of Interest Rate Risk

The Company is exposed to changes in the fair value of certain of its fixed-rate obligations due to changes in interest rates. In June 2003, the Bank entered into an interest rate swap agreement with a notional amount of $50.0 million in which the Bank swapped the fixed rate to a floating rate. Under the terms of the swap agreement, the Bank receives a fixed coupon rate of 7.375% and pays a variable interest rate equal to the three-month LIBOR that is reset on a quarterly basis, plus 3.62%. This swap is designated as a fair value hedge of the Company’s $50.0 million subordinated debentures and qualifies for the “short-cut” method of accounting (discussed in Note 8).

For derivatives designated and that qualify as fair value hedges, the gain or loss on the derivative as well as the offsetting loss or gain on the hedged item are recognized in earnings. As the fair value hedge qualifies for the “short-cut” method, the gain or loss on the derivative exactly offsets the loss or gain on the hedged item, resulting in zero net earnings impact. The Company recognized a net reduction to interest expense of $382 thousand and $963 thousand for the three and nine months ended September 30, 2009, respectively, related to the Company’s fair value hedge. For the three and nine months ended September 30, 2008, the Company recognized a net reduction to interest expense of $104 thousand and $102 thousand, respectively.

The table below presents the effect of the Company’s fair value derivative financial instruments on the Consolidated Statements of Income for the three and nine months ended September 30, 2009 (in thousands):

	Amount of Gain or (Loss) Recognized in Income on Derivative					Amount of Gain or (Loss) Recognized in Income on Hedged Item
	Interest expense					Interest expense
	Three Months Ended		Nine Months Ended			Three Months Ended			Nine Months Ended
Fair value hedge of interest rate risk:
Interest rate swap	$	587	$	(541	)	$	(587	)	$	541

Cash Flow Hedges of Interest Rate Risk

The Company’s objectives in using interest rate derivatives are to add stability to interest income and expense and to manage its exposure to interest rate movements. To accomplish this objective, the Company uses interest rate floors and collars as part of its interest rate risk management strategy. Interest rate floors designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty if interest rates fall below the strike rate on the contract in exchange for an up front premium. Interest rate collars designated as cash flow hedges involve the payments of variable-rate amounts if interest rates rise above the cap strike rate on the contract and receipts of variable-rate amounts if interest rates fall below the floor strike rate on the contract. During 2006, the Company purchased a prime interest rate floor with a notional amount of $113 million and a strike rate of 8.00% and a prime interest rate collar contract with a notional amount of $250 million and an 8.42% interest rate cap and an 8.00% interest rate floor. These contracts were designated as cash flow hedges of the monthly interest receipts from a portion of the Company’s portfolio of prime-based variable rate loans. During the third quarter of 2009, the Company’s interest rate floor matured, and the Company terminated its interest rate collar; accordingly, the Company does not have any derivatives designated as cash flow hedges of interest rate risk as of September 30, 2009.

The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in other comprehensive income and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. During the three and nine months ended September 30, 2009 and 2008, such derivatives were used to hedge the forecasted variable cash inflows associated with existing pools of prime-based loan assets. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings. During the three and nine months ended September 30, 2009, the Company recognized a loss of $24 thousand and gains of $2.1 million, respectively, for hedge ineffectiveness attributable to the aggregate principal amount of the designated loan pools falling below the notional amount.

The amount reported in other comprehensive income related to the gain on the terminated collar will be reclassified to interest income, as interest payments are received on the Company’s variable-rate assets. As of September 30, 2009, the Company estimates that approximately $7.8 million will be reclassified as an increase to interest income during the next twelve months.

20

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

The table below presents the effect of the Company’s cash flow derivative financial instruments on the Consolidated Statements of Income for the three and nine months ended September 30, 2009 (in thousands):

	Amount of Loss Recognized in OCI on Derivative (Effective Portion)						Amount of Gain Reclassified from OCI into Income (Effective Portion)								Amount of Gain or (Loss) Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing)
	Three Months Ended			Nine Months Ended			Three Months Ended				Nine Months Ended				Three Months Ended			Nine Months Ended
							Interest income		Other noninterest income		Interest income		Other noninterest income		Other noninterest income			Other noninterest income
Cash flow hedge of interest rate risk
Interest rate floor and collar	$	(1,016	)	$	(455	)	$	2,044	$	—	$	9,833	$	2,488	$	(24	)	$	2,132

11. STOCK-BASED COMPENSATION

The 2003 Stock Incentive and Compensation Plan (the “2003 Stock Plan”), which has been approved by the shareholders, permits the grant of unrestricted stock units, restricted stock units, phantom stock awards, stock appreciation rights or stock options. On August 31, 2007, the Board of Directors of the Company approved and adopted the Long-Term Incentive Stock Performance Program (the “Program”) pursuant to which the Human Resource Programs Committee of the Board of Directors (the “Committee”) may award equity-based awards to employees who are actively employed by the Company. All awards made under the 2003 Stock Plan vest over a three year period.

Total stock-based compensation expense that was charged against income was $3.3 million and $2.7 million for the nine month periods ended September 30, 2009 and 2008, respectively. The total income tax benefit recognized in the income statement for stock-based compensation arrangements was $876 thousand and $733 thousand for the nine months ended September 30, 2009 and 2008, respectively.

On December 20, 2007, the Company entered into a new employment agreement with its chief executive officer (“CEO”). This agreement replaced the existing agreement, in which the CEO was awarded 187,500 Performance Restricted Share Units (“PRSUs”), to be earned based on specified performance metrics. The total value of this stock grant was based on the current market price on the date of grant. Under the revised agreement, the new performance metrics include earnings per share growth versus the Company’s peer banks and return on assets performance versus the Company’s peer banks. In addition, the vesting period changed from four years to three years. Based on these performance metrics, the CEO will earn a specific number of the eligible share units on December 31, 2009. As of September 30, 2009, there was $175 thousand of total unrecognized compensation expense related to the PRSUs. If the performance measures are not met, no future compensation expense will be recognized, and any previously recognized compensation expense will be reversed.

Stock Purchase Plan –The Company offers the 2004 Employee Stock Purchase Plan (the “Purchase Plan”) to eligible employees. An aggregate of 2.3 million shares of the Company’s common stock may be issued under the Purchase Plan subject to adjustment upon changes in capitalization. During the three and nine months ended September 30, 2009, 19,003 and 62,923 shares, respectively, were subscribed for through payroll deductions under the Purchase Plan compared to 15,914 and 46,506 shares for the same periods in 2008, respectively.

21

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

12. EARNINGS (LOSS) PER COMMON SHARE

Earnings (loss) per common share was computed based on the following (in thousands, except per share amounts):

	Three months ended September 30,					Nine months ended September 30,
	2009			2008		2009			2008
Net income (loss) applicable to common shareholders	$	(24,724	)	$	7,090	$	(24,052	)	$	29,006
Basic:
Weighted average shares outstanding		81,707			73,186		77,659			73,158
Diluted:
Add incremental shares for:
Assumed exercise of outstanding options and nonvested share awards		—			339		—			317
Total		81,707			73,525		77,659			73,475
Earnings (loss) per common share:
Basic	$	(0.30	)	$	0.10	$	(0.31	)	$	0.40
Diluted	$	(0.30	)	$	0.10	$	(0.31	)	$	0.39

The incremental shares for the assumed exercise of the outstanding options and nonvested share awards were determined by application of the treasury stock method. The calculation of diluted loss per common share excludes 1,654,729 and 1,674,852 options and nonvested share awards outstanding for the three and nine months ended September 30, 2009, respectively, and 736,371 and 756,871 options and nonvested share awards outstanding for the three and nine month periods ended September 30, 2008, respectively, which were antidilutive. Options and nonvested share awards have been excluded from the computation of diluted loss per share for the three and nine months ended September 30, 2009, as the effect would have been antidilutive. In addition, the calculation excludes the warrant issued to the U.S. Treasury in December 2008 (the “warrant”) to purchase 2.6 million shares of common stock, which were antidilutive.

13. COMMITMENTS AND CONTINGENCIES

Leases– The Company leases certain office facilities and equipment under operating leases. Rent expense under all noncancelable operating lease obligations, net of income from noncancelable subleases aggregated, was approximately $2.9 million and $8.8 million for the three and nine months ended September 30, 2009, respectively, and $2.5 million and $7.7 million for the three and nine months ended September 30, 2008, respectively. For information regarding these commitments refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2008.

Litigation– The Company has been named as a defendant in various legal actions arising in the normal course of business. In the opinion of management, after reviewing such claims with outside counsel, resolution of these matters will not have a material adverse impact on the consolidated financial statements.

Severance and non-competition agreements– The Company has entered into severance and non-competition agreements with its chief executive officer and certain other executive officers. Under these agreements, upon a termination of employment pursuant to a change in control, each would receive: (i) two years’ base pay; (ii) an annual bonus for two years in an amount equal to the highest annual bonus paid to the respective executive officer during the three years preceding termination or change in control (as defined in the agreement); (iii) continued eligibility for Company perquisites, welfare and life insurance benefit plans, to the extent permitted, and in the event participation is not permitted, payment of the cost of such welfare benefits for a period of two years following termination of employment; (iv) payment of up to $20 thousand in job placement fees; and (v) to the extent permitted by law or the applicable plan, accelerated vesting and termination of all forfeiture provisions under all benefit plans, options, restricted stock grants or other similar awards.

14. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK

The Company is a party to various financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of its customers. These financial instruments include commitments to extend credit and standby and commercial letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated balance sheets. The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual or notional amount of these instruments. The Company uses the same credit policies in making these commitments and conditional obligations as it does for on-balance sheet instruments.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

The following is a summary of the various financial instruments entered into by the Company (in thousands):

	September 30, 2009		December 31, 2008
Commitments to extend credit	$	729,963	$	870,088
Standby and commercial letters of credit		62,877		104,079

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being fully drawn upon, the total commitment amounts disclosed above do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if considered necessary by the Company, upon extension of credit, is based on management’s credit evaluation of the customer.

Standby and commercial letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. In the event of nonperformance by the customers, the Company has rights to the underlying collateral, which can include commercial real estate, physical plant and property, inventory, receivables, cash and marketable securities. The credit risk to the Company in issuing letters of credit is essentially the same as that involved in extending loan facilities to its customers.

15. REGULATORY MATTERS

Capital requirements– The Company is subject to various regulatory capital requirements administered by the state and federal banking agencies. Any institution that fails to meet its minimum capital requirements is subject to actions by regulators that could have a direct material effect on its financial statements. Under the capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines based on the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company’s capital amount and classification under the regulatory framework for prompt corrective action are also subject to qualitative judgments by the regulators.

To meet the capital adequacy requirements, the Company and the Bank must maintain minimum capital amounts and ratios as defined in the regulations. Management believes, as of September 30, 2009 and December 31, 2008, that the Company and the Bank met all capital adequacy requirements to which they are subject.

The most recent notification from the regulatory banking agencies categorized Sterling Bank as “well capitalized” under the regulatory capital framework for prompt corrective action and there have been no events since that notification that management believes have changed the Bank’s category.

On December 12, 2008, as part of the TARP Capital Purchase Program, the Company entered into a Securities Purchase Agreement with the U.S. Treasury, pursuant to which the Company for a purchase price of $125 million in cash (i) sold 125,198 shares of the Company’s Fixed Rate Cumulative Perpetual preferred stock, Series J (“Series J preferred stock”) and (ii) issued a warrant to purchase 2.6 million shares of the Company’s common stock, for a price of $7.18 per share. The Series J preferred stock was nonvoting and qualified as Tier 1 Capital. The preferred stock dividend reduced earnings available to common shareholders and was computed at an annual rate of 5% per year.

During the second quarter of 2009, the Company fully redeemed the $125 million Series J preferred stock that it sold to the U.S. Treasury in December 2008. The Company was approved to pay the funds back without any conditions from regulators. As a result of the redemption, the Company recorded a one-time $7.5 million charge in the form of an accelerated deemed dividend to account for the difference between the amount at which the preferred stock sale had been initially recorded and its redemption price.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Additionally, during the second quarter of 2009, the Company issued 8.3 million shares of its common stock through a public stock offering, which resulted in net proceeds of approximately $54.6 million, after deducting underwriting fees and estimated offering expenses.

The Company’s consolidated and the Bank’s capital ratios are presented in the following table:

	Actual				For Capital Adequacy Purposes				To Be Categorized as Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio		Amount		Ratio		Amount		Ratio
	(In thousands, except percentage amounts)
CONSOLIDATED:
As of September 30, 2009:
Total capital (to risk weighted assets)	$	528,673	13.9	%	$	303,247	8.0	%		N/A	N/A
Tier 1 capital (to risk weighted assets)		424,406	11.2	%		151,623	4.0	%		N/A	N/A
Tier 1 capital (to average assets)		424,406	8.9	%		191,271	4.0	%		N/A	N/A
As of December 31, 2008:
Total capital (to risk weighted assets)	$	632,015	14.9	%	$	338,491	8.0	%		N/A	N/A
Tier 1 capital (to risk weighted assets)		513,518	12.1	%		169,245	4.0	%		N/A	N/A
Tier 1 capital (to average assets)		513,518	10.6	%		194,316	4.0	%		N/A	N/A
STERLING BANK:
As of September 30, 2009:
Total capital (to risk weighted assets)	$	514,052	13.6	%	$	302,982	8.0	%	$	378,728	10.0	%
Tier 1 capital (to risk weighted assets)		409,826	10.8	%		151,491	4.0	%		227,237	6.0	%
Tier 1 capital (to average assets)		409,826	8.6	%		191,139	4.0	%		238,923	5.0	%
As of December 31, 2008:
Total capital (to risk weighted assets)	$	627,695	14.9	%	$	338,224	8.0	%	$	422,780	10.0	%
Tier 1 capital (to risk weighted assets)		509,198	12.0	%		169,112	4.0	%		253,668	6.0	%
Tier 1 capital (to average assets)		509,198	10.5	%		194,180	4.0	%		242,725	5.0	%

Trust preferred securities are included in the Company’s Tier 1 capital for regulatory capital purposes pursuant to guidance from the Federal Reserve.

Dividend restrictions –Dividends paid by the Bank are subject to certain restrictions imposed by regulatory agencies. At September 30, 2009, the aggregate amount of dividends, which legally could be paid without prior approval of various regulatory agencies, totaled approximately $135 million by the Bank.

16. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS

The Company measures fair value based on the assumptions that market participants would use in pricing the asset or liability and establishes a fair value hierarchy. The fair value hierarchy consists of three levels of inputs that may be used to measure fair value as follows:

Level 1 – Inputs that utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. Level 1 assets and liabilities include debt and equity securities that are traded in an active exchange market, as well as certain U.S. Treasury securities that are highly liquid and are actively traded in over-the-counter markets.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Level 2 – Inputs other than those quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These inputs may include quoted prices for similar assets and liabilities in active markets, as well as inputs that are observable for the asset or liability (other than quoted prices), such as interest rates and yield curves that are observable at commonly quoted intervals. Level 2 assets and liabilities include available-for-sale and held-to-maturity securities with quoted prices that are traded less frequently than exchange-traded instruments and derivative contracts whose value is determined using a pricing model with inputs that are observable in the market or can be derived principally from or corroborated by observable market data. Available-for-sale and held-to-maturity securities are valued using observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, prepayment speeds, credit information and the bond’s terms and conditions, among other things. Derivative valuations utilize certain Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by the Company and its counterparties. The significance of the impact of these credit valuation adjustments on the overall valuation of derivative positions are not significant to the overall valuation and result in all derivative valuations being classified in Level 2 of the fair value hierarchy.

Level 3 – Inputs that are unobservable inputs for the asset or liability, which are typically based on an entity’s own assumptions, as there is little, if any, related market activity. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability. This category includes certain interest-only strip securities where independent pricing information was not able to be obtained for a significant portion of the underlying assets and loans held for sale.

We use fair value to measure certain assets and liabilities on a recurring basis when fair value is the primary measure for accounting. This is done primarily for available-for-sale securities and derivatives.

The table below presents the Company’s financial assets measured at fair value on a recurring basis aggregated by the level in the fair value hierarchy within which those measurements fall (in thousands):

	Balance at September 30, 2009		Quoted Prices in Active Markets for Identical Instruments (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Financial assets:
Available-for-sale securities	$	836,521	$	—	$	834,024	$	2,497
Interest rate swap		2,637		—		2,637		—
	Balance at December 31, 2008		Quoted Prices in Active Markets for Identical Instruments (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Financial assets:
Available-for-sale securities	$	633,357	$	—	$	630,841	$	2,516
Cash flow hedges		20,967		—		20,967		—
Interest rate swap		3,361		—		3,361		—

25

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

The table below presents a reconciliation for assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) and summarizes gains and losses due to changes in fair value. Level 3 available-for-sale securities include certain interest-only strips which are valued based on certain observable inputs such as interest rates and credit spreads, as well as unobservable inputs such as estimated net charge-off and prepayment rates.

	Level 3 Instruments Fair Value Measurements Using Significant Unobservable Inputs			Level 3 Instruments Fair Value Measurements Using Significant Unobservable Inputs
	September 30, 2009
	Three Months Ended			Nine Months Ended
	Available-for-Sale Securities			Available-for-Sale Securities
Balance at beginning of period	$	2,394		$	2,516
Total gains or losses for the period included in:
Noninterest income		—			—
Other comprehensive income		294			563
Purchases, issuances, settlements and amortization		(191	)		(582	)
Transfers in and/or out of Level 3		—			—
Balance at end of period	$	2,497		$	2,497
Net unrealized losses included in net income for the period relating to assets held at September 30, 2009	$	—		$	—
	September 30, 2008
	Three Months Ended			Nine Months Ended
	Available-for-Sale Securities			Available-for-Sale Securities
Balance at beginning of period	$	2,822		$	3,586
Total gains or losses for the period included in:
Noninterest income		(722	)		(722	)
Other comprehensive income		1,065			1,039
Purchases, issuances, settlements and amortization		(336	)		(1,074	)
Transfers in and/or out of Level 3		—			—
Balance at end of period	$	2,829		$	2,829
Net unrealized losses included in net income for the period relating to assets held at September 30, 2008	$	(722	)	$	(722	)

Certain financial assets are measured at fair value on a nonrecurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). Fair value is used on a nonrecurring basis to measure certain assets when applying lower of cost or market accounting or when adjusting carrying values. Assets measured on a nonrecurring basis include held-to-maturity debt securities, impaired loans that are collateral dependent, other real estate owned, other repossessed assets and loans held for sale. Assets measured at fair value on a nonrecurring basis are summarized below.

Impaired loans are reported at the fair value of the underlying collateral if repayment is expected solely from the collateral. Collateral values are estimated using Level 2 inputs based on observable market data or Level 3 inputs based on customized discounting criteria. During the nine months ended September 30, 2009, individually assessed impaired loans over $250 thousand were remeasured and reported at fair value through a specific valuation allowance allocation of the allowance for possible loan

26

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

losses based upon the fair value of the underlying collateral. Individually assessed impaired loans with a carrying value of $135 million were reduced by a specific valuation allowance or charged-down to their fair value of $101 million during the nine months ended September 30, 2009.

The Company recorded additions to other real estate owned and other repossessed assets of $9.6 million and $33 thousand, respectively, which were outstanding at September 30, 2009. The fair value of a foreclosed asset, upon initial recognition is estimated using Level 2 inputs within the fair value hierarchy based on observable market data and Level 3 inputs based on customized discounting criteria. In connection with the measurement and initial recognition of the foregoing foreclosed assets, the Company recognized charge-offs through the allowance for loan losses. Foreclosed assets totaling $5.4 million were remeasured at fair value subsequent to initial recognition. In connection with the remeasurement, the Company recorded a loss on other real estate owned of $1.4 million and on other repossessed assets of $37 thousand for the nine months ended September 30, 2009.

The Company recorded a $14 thousand credit-related OTTI on a held-to-maturity debt security with an amortized cost basis of $7.3 million, during the second quarter of 2009, based on its cash flow analysis using Level 2 inputs within the fair value hierarchy. The Company does not intend to sell the security and it is not more likely than not that the Company will be required to sell the investment before recovery of its remaining amortized cost basis. Therefore, the amount of the credit-related OTTI, $14 thousand, was recognized in earnings, and the amount of the noncredit-related impairment of $2.7 million, was recognized in other comprehensive income at September 30, 2009.

As of September 30, 2009, the Company had a balance of $38.2 million in loans held for sale. Loans held for sale are considered a Level 3 input within the fair value hierarchy based on current investor market pricing from investors in these types of loans.

During the second quarter of 2009, the Company fully redeemed the $125 million Series J preferred stock that it sold to the U.S. Treasury in December 2008. In 2008, the Company sold 125,198 preferred shares and issued a warrant to purchase 2.6 million shares of the Company’s common stock. The proceeds from the TARP Capital Purchase Program were allocated between the preferred stock and the warrant based on relative fair values. The Series J preferred stock was determined using Level 3 inputs based on similar types of securities. The fair value of the Series J preferred stock was determined based on assumptions regarding the discount rate (market rate) on the preferred stock which was estimated to be approximately 11% at the date of issuance. The discount on the Series J preferred stock was accreted to par value using a constant effective yield of 6.4% over a five-year term, which is the expected life of the preferred stock. The fair value of the warrant was determined based on Level 2 inputs using the Black-Scholes-Merton option pricing model which incorporated assumptions at the date of issuance including the Company’s common stock price of $5.68, a dividend yield of 3.87%, stock price volatility of 45% and risk-free interest rate of 2.77%.

The Company did not record any liabilities at fair value for which measurement of the fair value was made on a nonrecurring basis at September 30, 2009.

The following is a summary of the carrying values and estimated fair values of certain financial instruments (in thousands):

	September 30, 2009				December 31, 2008
	Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
Financial assets:
Held-to-maturity securities	$	162,990	$	156,984	$	172,039	$	163,860
Loans held for sale		38,187		38,202		1,524		1,524
Loans held for investment, net of allowance		3,242,461		3,277,875		3,743,113		3,835,965
Financial liabilities:
Time deposits		1,038,362		1,040,342		1,171,422		1,175,389
Other borrowed funds		99,486		98,458		408,586		399,879
Subordinated debt		77,616		69,732		78,335		63,462
Junior subordinated debt		82,734		55,690		82,734		115,597

The summary above excludes financial assets and liabilities for which carrying value approximates fair value. For financial assets, these include cash and short-term investments. In addition, the fair values of loan commitments and letters of credit are excluded from the summary above as these items are not significant. The Company’s lending commitments have variable interest rates and are funded at current market rates on the date they are drawn upon; therefore, the fair value of these commitments would approximate their carrying value, if drawn upon. For financial liabilities, these include demand, savings, and money market deposits. The estimated fair value of demand, savings, and money market deposits is the amount payable on demand at the reporting date because the accounts have no stated maturity and the customer has the ability to withdraw funds immediately. Also excluded from the summary are financial instruments recorded at fair value on a recurring basis, as previously described.

Held-to-Maturity Securities– These securities are classified within Level 2 of the fair value hierarchy. Securities are valued based on quoted prices in an active market when available. If quoted market prices are not available for the specific security, then

27

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows. In certain cases where there is limited activity or less transparency around inputs to the valuation, securities can be classified within Level 3 of the valuation hierarchy. These securities would be valued based on certain observable inputs such as interest rates and credit spreads, as well as unobservable inputs such as estimated net charge-off and prepayment rates.

Loans Held for Sale– Fair value equals quoted market prices, if available. If a quoted market price is not available, the fair value is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same original maturities or the fair value of the collateral if the loan is collateral dependent. When assumptions are made using significant unobservable inputs, such loans are classified within Level 3 of the fair value hierarchy.

Loans Held for Investment– The fair value of loans is estimated by discounting the future cash flows on ‘pass’ grade loans using the LIBOR yield curve adjusted by a factor which reflects the credit and interest rate risk inherent in the loan. These future cash flows are then reduced by the estimated ‘life-of-the-loan’ aggregate credit losses in the loan portfolio. These adjustments for lifetime future credit losses are highly judgmental because the Company does not have a validated model to estimate lifetime losses on large portions of its loan portfolio. Impaired loans are not included in this credit adjustment as they are already considered to be held at fair value. Loans, other than those held for sale, are not normally purchased and sold by the Company, and there are no active trading markets for most of this portfolio.

Time Deposits– The fair value of time deposits is estimated by discounting future cash flows using the LIBOR yield curve plus a spread to represent current rates at which similar deposits would be priced.

Subordinated Debt– The fair value of subordinated debt is estimated by discounting future cash flows using the LIBOR yield curve plus a spread to represent current rates at which similar subordinated debt would be priced.

Junior Subordinated Debt– The fair value of junior subordinated debt is estimated by discounting future cash flows using the LIBOR yield curve plus a spread to represent current rates at which similar junior subordinated debt would be priced.

Other Borrowed Funds– Fair value is generally estimated based on the discounted cash flow method using the LIBOR yield curve plus credit spread, adjusted for an estimate of the Company’s credit quality. Contractual cash flows are discounted using rates currently offered for new borrowings with similar remaining maturities and, as such, these discount rates include our current spread levels.

These fair value disclosures represent the Company’s estimates based on relevant market information and information about the financial instruments. Fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of the various instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in the above methodologies and assumptions could significantly affect the estimates.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

FORWARD-LOOKING STATEMENTS

This report, other periodic reports filed by us under the Exchange Act, and other written or oral statements made by or on behalf of the Company contain certain statements relating to future events and our future results which constitute forward-looking statements under the Private Securities Litigation Reform Act of 1995. These “forward-looking statements” are typically identified by words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates,” or words of similar meaning, or future or conditional verbs such as “should,” “could,” or “may.”

Forward-looking statements reflect our expectation or predictions of future conditions, events or results based on information currently available and involve risks and uncertainties that may cause actual results to differ materially from those in such statements. These risks and uncertainties include, but are not limited to, the risks identified in Item 1A of this report and the following:

• general business and economic conditions in the markets we serve may be less favorable than anticipated which could decrease the demand for loan, deposit and other financial services and increase loan delinquencies and defaults;

• changes in market rates and prices may adversely impact the value of securities, loans, deposits and other financial instruments and the interest rate sensitivity of our balance sheet;

• our liquidity requirements could be adversely affected by changes in our assets and liabilities;

• our investment securities portfolio is subject to credit risk, market risk, and illiquidity;

• the effect of legislative or regulatory developments including changes in laws concerning taxes, banking, securities, insurance and other aspects of the financial securities industry;

• competitive factors among financial services organizations, including product and pricing pressures and our ability to attract, develop and retain qualified banking professionals;

• the effect of changes in accounting policies and practices, as may be adopted by the FASB, the SEC, the Public Company Accounting Oversight Board and other regulatory agencies;

• the effect of fiscal and governmental policies of the U.S. federal government;

• due to our participation in various programs sponsored by the U.S. Government, we are subject to certain restrictions on our business and these programs are subject to change beyond our control;

• federal and state governments could pass legislation responsive to current credit conditions; and

• we could experience higher credit losses because of federal or state legislation or regulatory action that reduces the amount the Bank’s borrowers are otherwise contractually required to pay under existing loan contracts. Also, we could experience higher credit losses because of federal or state legislation or regulatory action that limits the Bank’s ability to foreclose on property or other collateral or makes foreclosure less economically feasible. New legislation and regulatory changes could also result in the loss of revenue or require us to change our business practices such as by limiting the fees we may charge.

Forward-looking statements speak only as of the date of this report. We do not undertake to update forward-looking statements to reflect circumstances or events that occur after the date of this report or to reflect the occurrence of unanticipated events except as required by federal securities laws.

For additional discussion of such risks, uncertainties and assumptions, see our Annual Report on Form 10-K for the year ended December 31, 2008, filed with the Securities and Exchange Commission.

OVERVIEW

For more than 35 years, Sterling Bancshares, Inc. and Sterling Bank have served the banking needs of small to medium-sized businesses. We provide a broad array of financial services to Texas businesses and consumers through 60 banking centers in the greater metropolitan areas of Houston, San Antonio, Dallas and Fort Worth, Texas.

At September 30, 2009, we had consolidated total assets of $4.9 billion, total loans of $3.4 billion, total deposits of $4.0 billion and shareholder’s equity of $546 million.

We reported a net loss of $24.7 million, or $0.30 per diluted share for the quarter ended September 30, 2009, compared to net income of $7.1 million or $0.10 per diluted share earned for the third quarter of 2008. Net loss applicable to common shareholders for the nine months ended September 30, 2009 was $24.1 million, or $0.31 per diluted common share, compared with net income applicable to common shareholders of $29.0 million, or $0.39 per diluted common share earned for the same period in 2008.

Our third quarter results were reflective of the current economic environment which led to an increased provision for credit losses and elevated charge-offs. During the third quarter, we charged-off specific nonperforming loan amounts against the related reserves. In addition, the elevated charge-offs and our views about economic uncertainties have led to an increased provision for credit losses.

CRITICAL ACCOUNTING POLICIES

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make a number of judgments, estimates and assumptions that affect the reported amount of assets, liabilities, income and expenses in our Consolidated Financial Statements and accompanying notes. We believe that the judgments, estimates and assumptions used in the preparation of our Consolidated Financial Statements are appropriate given the factual circumstances as of September 30, 2009.

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Various elements of our accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. We have identified five accounting policies that, due to the judgments, estimates and assumptions inherent in those policies, and the sensitivity of our Consolidated Financial Statements to those judgments, estimates and assumptions, are critical to an understanding of our Consolidated Financial Statements. These policies relate to the methodology that determines our valuation of financial instruments, allowance for credit losses, accounting for goodwill and other intangibles, accounting for derivatives and the assumptions used in determining stock-based compensation.

These policies and the judgments, estimates and assumptions are described in greater detail in our 2008 Annual Report on Form 10-K in the “Critical Accounting Policies” section of Management’s Discussion and Analysis and in Note 1 to the Consolidated Financial Statements – “Organization and Summary of Significant Accounting and Reporting Policies.”

NEW ACCOUNTING GUIDANCE

In June 2009, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Codification (“ASC 105”) Generally Accepted Accounting Principles. The Accounting Standards Codification (“ASC”) is the official source of authoritative United States Generally Accepted Accounting Principles (“GAAP”) superseding existing FASB, American Institute of Certified Public Accountants, Emerging Issues Task Force, and related literature. Rules and interpretive releases of the Securities and Exchange Commission (“SEC”) under the authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. All other accounting literature is considered non-authoritative. The switch to the ASC affects the way companies refer to GAAP in financial statements and accounting policies. ASC 105 became effective during the third quarter of 2009 and did not have a significant impact on the Company’s financial statements.

Business Combinations: On January 1, 2009, new authoritative accounting guidance under ASC 805Business Combinations became applicable to the Company’s accounting for business combinations closing on or after January 1, 2009. ASC 805 requires the acquiring entity in a business combination to recognize the assets acquired and liabilities assumed in the transaction; establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; and requires the acquirer to disclose to investors and other users all of the information they need to evaluate and understand the nature and financial effect of the business combination. Assets acquired and liabilities assumed in a business combination that arise from contingencies should be recognized at fair value on the acquisition date if fair value can be determined during the measurement period. If fair value cannot be determined, companies should typically account for the acquired contingencies using existing accounting guidance. ASC 805 will apply to future acquisitions by the Company subsequent to January 1, 2009.

Derivatives and Hedging: ASC 815Derivatives and Hedgingamends prior guidance to amend and expand the disclosure requirements for derivatives and hedging activities to provide greater transparency about (i) how and why an entity uses derivative instruments, (ii) how derivative instruments and related hedge items are accounted for under ASC 815 and its related interpretations, and (iii) how derivative instruments and related hedged items affect an entity’s financial position, results of operations and cash flows. To meet those objectives, the new authoritative accounting guidance requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses on derivative instruments and disclosures about credit-risk-related contingent features in derivative agreements. The new authoritative accounting guidance under ASC 815 became effective for the Company on January 1, 2009 and the required disclosures are reported in Note 10 - Derivative Financial Instruments.

Fair Value Measurement and Disclosures: ASC 820Fair Value Measurement and Disclosures affirms that the fair value measurement objective when a market is not active is the price that would be received by the holder of the financial asset in an orderly transaction (an exit price notion) that is not a forced liquidation or distressed sale at the measurement date. Additionally, in determining fair value for a financial asset, the use of a reporting entity’s own assumptions about future cash flows and appropriately risk-adjusted discount rates is acceptable when relevant observable inputs are not available. Broker (or pricing service) quotes may be an appropriate input when measuring fair value, but they are not necessarily determinative if an active market does not exist for the financial asset. ASC 820 provides additional guidance when the volume and level of activity for the asset or liability have significantly decreased and includes guidance on identifying circumstances that indicate a transaction is not orderly. The Company adopted ASC 820 during the quarter ended June 30, 2009. ASC 820 did not have a significant impact on the Company’s financial condition and results of operations. The enhanced disclosures related to ASC 820 are included in Note 16 –Disclosures about Fair Value of Financial Instruments.

Investments – Debt and Equity Securities: ASC 320Investments – Debt and Equity Securities amends the other-than-temporary impairment guidance in GAAP for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. ASC 320 requires an

30

entity to recognize the credit component of an other-than-temporary impairment of a debt security in earnings and the noncredit component in other comprehensive income when the entity does not intend to sell the security and it is more likely than not that the entity will not be required to sell the security prior to recovery. ASC 320 became effective for interim and annual reporting periods ending after June 15, 2009. The Company adopted ASC 320 during the quarter ended June 30, 2009. The expanded disclosures and discussion of other-than-temporarily impaired debt securities related to ASC 320 are included in Note 3 – Securities.

Financial Instruments: ASC 825Financial Instruments requires expanded disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. The expanded disclosure requirements for ASC 825 are included in Note 16 – Disclosures about Fair Value of Financial Instruments.

Subsequent Events: ASC 855Subsequent Events addresses events which occur after the balance sheet date but before the issuance of financial statements. Under ASC 855, an entity must record the effects of subsequent events that provide evidence about conditions that existed at the balance sheet date and must disclose but not record the effects of subsequent events which provide evidence about conditions that did not exist at the balance sheet date. The Company adopted ASC 855 for the quarter ended June 30, 2009 and has included the required disclosures in Note 1 – Accounting Policies.

Transfers and Servicing: ASC 860Transfers and Servicingimproves the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets. ASC 860 shall be effective for annual reporting periods that begin after November 15, 2009, for interim periods within the first annual reporting period and for interim and annual reporting periods thereafter, with early adoption prohibited. ASC 860 must be applied to transfers occurring on or after the effective date. Management has not completed its evaluation of ASC 860; however, the Company does not expect it to be material to its financial statements.

Consolidation: ASC 810Consolidationimproves financial reporting by enterprises involved with variable interest entities and any significant changes in risk exposure due to that involvement as well as its affect on the entity’s financial statements. ASC 810 shall be effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within the first annual reporting period, and for interim and annual reporting periods thereafter, with earlier adoption prohibited. Management has not completed its evaluation of ASC 810; however, the Company does not expect it to be material to its financial statements.

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SELECTED FINANCIAL DATA

	Three Months Ended September 30,						Nine Months Ended September 30,						Year Ended December 31,
	2009			2008			2009			2008			2008
	(Dollars and shares in thousands, except per share amounts)
INCOME STATEMENT DATA:
Net interest income	$	47,851		$	49,468		$	144,929		$	147,708		$	198,084
Provision for credit losses		56,131			10,100			76,631			22,417			29,917
Noninterest income		9,113			9,801			30,404			31,386			41,027
Noninterest expense		40,075			38,997			123,694			114,093			153,210
Income (loss) before income taxes		(39,242	)		10,172			(24,992	)		42,584			55,984
Net income (loss)		(24,724	)		7,090			(14,710	)		29,006			38,619
Net income (loss) applicable to common shareholders		(24,724	)		7,090			(24,052	)		29,006			38,221
BALANCE SHEET DATA (at period-end):
Total assets	$	4,859,518		$	4,947,229		$	4,859,518		$	4,947,229		$	5,079,979
Total loans		3,350,707			3,745,094			3,350,707			3,745,094			3,793,814
Allowance for loan losses		70,059			45,222			70,059			45,222			49,177
Total securities		999,511			717,979			999,511			717,979			805,396
Total deposits		4,007,454			3,574,120			4,007,454			3,574,120			3,819,137
Other borrowed funds		99,486			668,069			99,486			668,069			408,586
Subordinated debt		77,616			74,266			77,616			74,266			78,335
Junior subordinated debt		82,734			82,734			82,734			82,734			82,734
Common equity		545,512			501,895			545,512			501,895			525,127
Preferred equity		—			—			—			—			118,012
COMMON SHARE DATA:
Earnings (loss) per common share (1):
Basic shares	$	(0.30	)	$	0.10		$	(0.31	)	$	0.40		$	0.52
Diluted shares	$	(0.30	)	$	0.10		$	(0.31	)	$	0.39		$	0.52
Shares used in computing earnings per common share:
Basic shares		81,707			73,186			77,659			73,158			73,177
Diluted shares		81,707			73,525			77,659			73,475			73,488
End of period common shares outstanding		81,755			73,219			81,755			73,219			73,260
Book value per common share at period-end	$	6.67		$	6.85		$	6.67		$	6.85		$	7.17
Cash dividends paid per common share	$	0.055		$	0.055		$	0.165		$	0.165		$	0.220
Common stock dividend payout ratio		(18.19	)%		56.83	%		(85.45	)%		41.65	%		41.72	%
SELECTED PERFORMANCE RATIOS AND OTHER DATA:
Return on average common equity (2)		(16.98	)%		5.61	%		(5.77	)%		7.75	%		7.60	%
Return on average assets (2)		(1.97	)%		0.57	%		(0.39	)%		0.81	%		0.80	%
Tax equivalent net interest margin (3)		4.20	%		4.44	%		4.26	%		4.59	%		4.55	%
Efficiency ratio (4)		69.56	%		64.08	%		68.73	%		62.57	%		63.04	%
Full-time equivalent employees		1,013			1,119			1,013			1,119			1,116
Number of banking centers		60			59			60			59			59
LIQUIDITY AND CAPITAL RATIOS:
Average loans to average deposits		85.86	%		101.77	%		91.82	%		100.19	%		101.31	%
Period-end shareholders’ equity to total assets		11.23	%		10.14	%		11.23	%		10.14	%		12.66	%
Average shareholders’ equity to average assets		11.60	%		10.20	%		12.18	%		10.44	%		10.50	%
Period-end tangible capital to total tangible assets		7.70	%		6.60	%		7.70	%		6.60	%		9.32	%
Tier 1 capital to risk-weighted assets		11.20	%		9.18	%		11.20	%		9.18	%		12.14	%
Total capital to risk-weighted assets		13.95	%		11.82	%		13.95	%		11.82	%		14.94	%
Tier 1 leverage ratio (Tier 1 capital to average assets)		8.88	%		8.15	%		8.88	%		8.15	%		10.57	%
ASSET QUALITY RATIOS:
Period-end allowance for credit losses to period-end loans		2.18	%		1.25	%		2.18	%		1.25	%		1.34	%
Period-end allowance for loan losses to period-end loans		2.09	%		1.21	%		2.09	%		1.21	%		1.30	%
Period-end allowance for loan losses to nonperforming loans		73.76	%		64.11	%		73.76	%		64.11	%		56.21	%
Nonperforming loans to period-end loans		2.83	%		1.88	%		2.83	%		1.88	%		2.31	%
Nonperforming assets to period-end assets		2.20	%		1.52	%		2.20	%		1.52	%		1.84	%
Net charge-offs to average loans (2)		4.27	%		0.62	%		2.01	%		0.40	%		0.40	%

(1) The calculation of diluted earnings per common share excludes 1,654,729 and 1,674,852 options and nonvested share awards outstanding for the three and nine months ended September 30, 2009, respectively, 837,381 options and nonvested share awards outstanding for the year ended December 31, 2008, and 736,371 and 756,871 options and nonvested share awards outstanding for the three and nine month periods ended September 30, 2008, respectively, which were antidilutive. Options and nonvested share awards have been excluded from the computation of diluted loss per share for the three and nine months ended September 30, 2009, as the effect would have been antidilutive. In addition, the calculation excludes the warrant to purchase 2.6 million shares of common stock outstanding for the three and nine months ended September 30, 2009, which were antidilutive.

(2) Interim periods annualized.

(3) Taxable-equivalent basis assuming a 35% tax rate.

(4) The efficiency ratio is calculated by dividing noninterest expense less acquisition costs, hurricane related costs and a one-time severance charge by tax equivalent basis net interest income plus noninterest income less net gain (loss) on investment securities.

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RESULTS OF OPERATIONS

Net Income (Loss) Applicable to Common Shareholders –Net loss was $24.7 million, or $0.30 per diluted share, for the third quarter ended September 30, 2009, compared to net income of $7.1 million, or $0.10 per diluted common share, earned for the third quarter of 2008. Net loss applicable to common shareholders for the nine months ended September 30, 2009 was $24.1 million, or $0.31 per diluted common share, compared to net income of $29.0 million, or $0.39 per diluted common share earned for the same period in 2008.

Net Interest Income – Net interest income represents the amount by which interest income on interest-earning assets, including loans and securities, exceeds interest paid on interest-bearing liabilities, including deposits and borrowings. Net interest income is our principal source of earnings. Interest rate fluctuations, as well as changes in the amount and type of earning assets and liabilities, combine to effect net interest income.

The Federal Reserve Board significantly influences market interest rates, including rates offered for loans and deposits by many financial institutions. Generally, when the Federal Open Market Committee (“FOMC”) of the Federal Reserve Board changes the target overnight interest rate charged by banks, the market responds with a similar change in the prime lending rate. Our loan portfolio is impacted significantly by changes in short-term interest rates. During 2008, the FOMC significantly reduced overnight interest rates by 225 basis points to 2.00% at June 30, 2008 and an additional 175 basis points to 0.25% at December 31, 2008. Rates have remained at this historically low level throughout 2009. This decline in interest rates negatively impacted our net interest income and margin during 2008 and 2009.

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Certain average balances, together with the total dollar amounts of interest income and expense and the average tax equivalent interest yield/rates are included below (in thousands):

	Three Months Ended September 30,
	(Dollars in thousands)
	2009							2008
	Average Balance			Interest		Average Yield/Rate		Average Balance			Interest		Average Yield/Rate
Interest-Earning Assets:
Loans held for sale (1)	$	1,607		$	23	5.68	%	$	110,721		$	1,756	6.31	%
Loans held for investment (1):
Taxable		3,467,555			49,586	5.67	%		3,598,381			57,815	6.39	%
Non-taxable (2)		5,080			72	5.60	%		4,472			95	8.46	%
Securities:
Taxable		844,651			9,286	4.36	%		642,152			7,714	4.78	%
Non-taxable (2)		97,858			1,307	5.30	%		97,607			1,284	5.23	%
Deposits in financial institutions		106,392			64	0.24	%		326			2	1.88	%
Other interest-earning assets		38,419			29	0.30	%		11,122			53	1.90	%
Total interest-earning assets		4,561,562			60,367	5.25	%		4,464,781			68,719	6.12	%
Noninterest-earning assets:
Cash and due from banks		46,106							98,532
Premises and equipment, net		50,123							40,926
Other assets		371,967							369,692
Allowance for loan losses		(51,856	)						(40,148	)
Total noninterest-earning assets		416,340							469,002
Total Assets	$	4,977,902						$	4,933,783
Interest-Bearing Liabilities:
Deposits:
Demand and savings	$	1,837,612		$	4,403	0.95	%	$	1,410,719		$	4,136	1.17	%
Certificates and other time		1,084,513			5,504	2.01	%		1,145,196			8,763	3.04	%
Other borrowed funds		145,625			346	0.94	%		581,212			3,432	2.35	%
Subordinated debt		77,232			748	3.84	%		74,098			1,198	6.43	%
Junior subordinated debt		82,734			1,082	5.19	%		82,734			1,317	6.33	%
Total interest-bearing liabilities		3,227,716			12,083	1.49	%		3,293,959			18,846	2.28	%
Noninterest-bearing sources:
Demand deposits		1,124,076							1,093,053
Other liabilities		48,480							43,608
Total noninterest-bearing liabilities		1,172,556							1,136,661
Shareholders’ equity		577,630							503,163
Total Liabilities and Shareholders’ Equity	$	4,977,902						$	4,933,783
Tax Equivalent Net Interest Income and Margin (2) (3)					48,284	4.20	%					49,873	4.44	%
Tax Equivalent Adjustment:
Loans					23							30
Securities					410							375
Total tax equivalent adjustment					433							405
Net Interest Income				$	47,851						$	49,468

(1) For the purpose of calculating loan yields, average loan balances include nonaccrual loans with no related interest income.

(2) Taxable-equivalent adjustments are the result of increasing income from nontaxable loans and securities by an amount equal to the taxes that would be paid if the income were fully taxable based on a 35% federal tax rate, thus making tax-exempt yields comparable to taxable asset yields.

(3) The net interest margin is equal to net interest income divided by average total interest-earning assets.

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	Nine Months Ended September 30,
	(Dollars in thousands)
	2009							2008
	Average Balance			Interest		Average Yield/Rate		Average Balance			Interest		Average Yield/Rate
Interest-Earning Assets:
Loans held for sale (1)	$	2,064		$	89	5.75	%	$	94,677		$	4,681	6.60	%
Loans held for investment (1):
Taxable		3,624,478			154,098	5.68	%		3,514,320			177,950	6.76	%
Non-taxable (2)		5,141			237	6.16	%		3,260			202	8.27	%
Securities:
Taxable		772,386			26,659	4.61	%		610,877			21,671	4.74	%
Non-taxable (2)		97,069			3,902	5.37	%		97,278			3,820	5.25	%
Deposits in financial institutions		60,885			64	0.14	%		590			10	2.26	%
Other interest-earning assets		29,336			61	0.28	%		10,168			162	2.13	%
Total interest-earning assets		4,591,359			185,110	5.39	%		4,331,170			208,496	6.43	%
Noninterest-earning assets:
Cash and due from banks		55,201							98,219
Premises and equipment, net		49,912							39,441
Other assets		369,081							359,630
Allowance for loan losses		(52,177	)						(36,386	)
Total noninterest-earning assets		422,017							460,904
Total Assets	$	5,013,376						$	4,792,074
Interest-Bearing Liabilities:
Deposits:
Demand and savings	$	1,693,613		$	11,781	0.93	%	$	1,419,654		$	13,640	1.28	%
Certificates and other time		1,137,866			19,474	2.29	%		1,109,199			29,402	3.54	%
Other borrowed funds		241,653			1,583	0.88	%		500,268			9,193	2.45	%
Subordinated debt		77,582			2,612	4.50	%		57,687			3,094	7.16	%
Junior subordinated debt		82,734			3,441	5.56	%		82,734			4,301	6.94	%
Total interest-bearing liabilities		3,233,448			38,891	1.61	%		3,169,542			59,630	2.51	%
Noninterest-bearing sources:
Demand deposits		1,123,858							1,076,695
Other liabilities		45,252							45,748
Total noninterest-bearing liabilities		1,169,110							1,122,443
Shareholders’ equity		610,818							500,089
Total Liabilities and Shareholders’ Equity	$	5,013,376						$	4,792,074
Tax Equivalent Net Interest Income and Margin (2) (3)					146,219	4.26	%					148,866	4.59	%
Tax Equivalent Adjustment:
Loans					75							63
Securities					1,215							1,095
Total tax equivalent adjustment					1,290							1,158
Net Interest Income				$	144,929						$	147,708

(1) For the purpose of calculating loan yields, average loan balances include nonaccrual loans with no related interest income.

(2) Taxable-equivalent adjustments are the result of increasing income from nontaxable loans and securities by an amount equal to the taxes that would be paid if the income were fully taxable based on a 35% federal tax rate, thus making tax-exempt yields comparable to taxable asset yields.

(3) The net interest margin is equal to net interest income divided by average total interest-earning assets.

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Tax equivalent net interest income decreased $1.6 million or 3.2% to $48.3 million and $2.6 million or 1.8% to $146 million for the three and nine month periods ended September 30, 2009, respectively, compared to the same time periods in 2008. Our tax equivalent net interest margin was 4.20% and 4.26% for the three and nine month periods ended September 30, 2009, respectively, compared to 4.44% and 4.59% for the three and nine month periods ended September 30, 2008, respectively. This decline in net interest margin was due, in part, to the significant decline in short-term interest rates and an increase in nonperforming assets. The negative impact of the decline in short-term interest rates was partially mitigated by the work we have done in recent years to position our balance sheet to be more neutral to movements in short-term interest rates including the interest rate hedge that was established in 2006. Additionally, changes in the mix of interest-earning assets and liabilities influence our net interest income and margin.

Tax equivalent interest income on loans decreased $10.0 million and $28.4 million for the three and nine month periods ended September 30, 2009, respectively, compared to the same periods in 2008. This decrease was due primarily to a decline in yield earned of 72 basis points and 107 basis points for the three and nine months ended September 30, 2009, respectively, compared to the same periods in 2008 resulting from a decline in interest rates during 2008 and an increase in nonperforming loans during both 2008 and 2009. For the purpose of calculating loan yields, average loan balances include nonaccrual loans with no related interest income. Interest forgone on nonaccrual loans was $2.1 million and $5.0 million for the three and nine month periods ended September 30, 2009, respectively, compared to $1.4 million and $2.6 million for the same periods in 2008. This increase in nonaccrual loans resulted in a reduction in net interest margin of six basis points and seven basis points for the three and nine month periods ended September 30, 2009, respectively. The decrease in yield was partially offset by additional interest income from the interest rate hedge that we purchased in 2006 which provided additional interest income of $327 thousand or three basis points and $4.0 million or 12 basis points for the three and nine month periods ended September 30, 2009, respectively, compared to the same periods in 2008. The hedge converted a portion of our loan portfolio from variable rate loans to fixed rate loans.

Tax equivalent interest income on securities increased $1.6 million and $5.1 million for the three and nine month periods ended September 30, 2009, respectively, compared to the same periods in 2008 due to an increase in the average securities and yield earned. Average securities increased $203 million or 27.4% and $161 million or 22.8% for the three and nine month periods ended September 30, 2009, respectively, compared to the same periods in 2008. We increased the securities portfolio as a percentage of interest-earning assets beginning in 2009. On average, the securities portfolio represented approximately 21% and 19% for the three and nine months ended September 30, 2009, respectively, compared to 17% and 16% for the same periods in 2008.

Net interest income and margin were also impacted by an increase in the use of lower yielding interest-earning deposits. Average interest-earning deposits in financial institutions increased $106 million and $60.8 million for the three and nine month periods ended September 30, 2009, respectively. The average yield on these deposits was 0.24% ad 0.14% for the three and nine months ended September 30, 2009, respectively.

Total interest expense decreased $6.8 million and $20.7 million for the three and nine month periods ended September 30, 2009, respectively, over the comparable periods in 2008 due primarily to a decline in interest rates and the utilization of lower cost noninterest and interest-bearing demand and savings deposits. The decline in interest rates was partially offset by an increase in average interest-bearing liabilities for the nine month period ended September 30, 2009, of $63.9 million or 2.0% compared to the same period in 2008. This decrease in interest expense was primarily due to a decrease in interest expense on deposits of $3.0 million and $11.8 million for the three and nine month periods ended September 30, 2009, respectively, compared to the same periods in 2008 resulting from a decrease in the average rate paid on all interest-bearing deposits of 66 basis points and 79 basis points for the three and nine month periods ended September 30, 2009, respectively, compared to the same periods in 2008.

Average other borrowed funds for the three and nine month periods ended September 30, 2009, decreased $436 million and $259 million, respectively, compared to the same periods in 2008. These borrowings provided additional funding at a rate of 0.94% and 0.88% for the three and nine month periods ended September 30, 2009, respectively, for a decrease in funding costs of 141 basis points and 157 basis points for the three and nine month periods ended September 30, 2009, respectively, compared to the same periods in 2008. The decreased borrowings and interest rates contributed to a decrease in interest expense on other borrowings of $3.1 million and $7.6 million for the three and nine month periods ended September 30, 2009, respectively, compared to the same periods in 2008.

Noninterest Income –Noninterest income consisted of the following (in thousands):

	For the Three Months Ended September 30,					For the Nine Months Ended September 30,
	2009		2008			2009		2008
Customer service fees	$	3,845	$	3,882		$	11,709	$	11,906
Net gain (loss) on securities		4		(187	)		17		(187	)
Wealth management fees		1,862		2,255			5,904		6,956
Bank-owned life insurance		884		964			2,651		2,726
Debit card income		588		614			1,759		1,882
Other		1,930		2,273			8,364		8,103
Total	$	9,113	$	9,801		$	30,404	$	31,386

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Total noninterest income for the three and nine month periods ended September 30, 2009, decreased $688 thousand and $982 thousand, respectively, compared to the same periods in 2008. Details of the changes in the various components of noninterest income are discussed below:

Customer service fees for the nine months ended September 30, 2009, decreased $197 thousand compared to the same period in 2008. This decrease was primarily due to lower transaction activity.

Wealth management fees decreased $393 thousand and $1.1 million for the three and nine months ended September 30, 2009, respectively, compared to the same periods in 2008. The decrease in wealth management fees was due primarily to a decline in investment management fees which are assessed based on the market value of managed assets. Our total assets under management have decreased over the prior year due to recent market conditions. Our wealth management group provides customized solutions for high net worth customers by integrating financial services with traditional banking products and services such as private banking, money management, full-service brokerage, financial planning, personal and institutional trust and retirement services, as well as insurance and risk management services.

Other noninterest income decreased $343 thousand for the three month period ended September 30, 2009, compared to the same period in 2008 due primarily to a decrease in lending fees of approximately $700 thousand. Other noninterest income increased $261 thousand for the nine months ended September 30, 2009, compared to the same period in 2008. This increase was due primarily to $2.1 million in gains recorded as a result of the cash flow hedge ineffectiveness for the nine months ended September 30, 2009. This increase was partially offset by a decrease in lending fees of approximately $1.5 million for the nine months ended September 30, 2009, compared to the same period in 2008.

Noninterest Expense –Noninterest expense consisted of the following (in thousands):

	For the Three Months Ended September 30,				For the Nine Months Ended September 30,
	2009		2008		2009		2008
Salaries and employee benefits	$	21,005	$	21,692	$	67,434	$	63,316
Occupancy		5,967		5,367		18,004		15,992
Technology		2,495		2,600		7,475		7,235
Professional fees		1,065		1,257		3,419		3,481
Postage, delivery and supplies		700		871		2,181		2,907
Marketing		557		627		1,487		1,764
Core deposit and other intangibles amortization		565		586		1,695		1,757
Acquisition costs		154		—		154		562
FDIC insurance assessments		1,741		561		6,974		1,762
Net gains and carrying costs of other real estate and foreclosed property		1,743		193		1,798		188
Other		4,083		5,243		13,073		15,129
Total	$	40,075	$	38,997	$	123,694	$	114,093

Total noninterest expense for the three and nine month periods ended September 30, 2009, increased $1.1 million and $9.6 million, respectively, compared to the same periods in 2008. Details of the changes in the various components of noninterest expense are discussed below:

Salaries and employee benefits for the three month period ended September 30, 2009, decreased $687 thousand compared to the same period in 2008. This decrease is a result of our company-wide expense reduction initiative. Salaries and employee benefits increased $4.1 million for the nine month period ended September 30, 2009, compared to the same period in 2008. This increase was primarily due to a one-time severance charge of $2.1 million recorded during the second quarter of 2009 as part of our ongoing company-wide expense reduction initiative. The remaining increase was due primarily to a decrease in cost deferrals related to lending activities and increases in employee benefits, including stock-based compensation, deferred compensation and additional employer matches due to changes in our 401(k) Plan.

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Occupancy expense for the three and nine month periods ended September 30, 2009, increased $600 thousand and $2.0 million, respectively, compared to the same periods in 2008. This increase was due primarily to the consolidation of our central and corporate offices into one central location in Houston. We expect to complete this move over the next year as the timing of the move is aligned with the renewals and expirations of our existing leases. In addition, during 2009 we opened two new banking centers in Houston.

During the third quarter of 2009, we recorded $154 thousand of acquisition-related expenses incurred in connection with the First Bank branch acquisition that is expected to close during the fourth quarter of 2009, subject to regulatory approval and other customary closing conditions. We entered into a definitive purchase and assumption agreement to acquire approximately $500 million in deposits and 19 Texas bank branches from First Bank. Of the 19 branches to be acquired, 11 are in the Houston metropolitan area and eight are located in the Dallas metropolitan area. In addition, we will also purchase approximately $230 million of performing business and consumer-related Texas-based loans from First Bank.

During the first quarter of 2008, we recorded $562 thousand in acquisition-related expenses incurred in connection with the First Horizon branch acquisition. Acquisition expenses include retention bonuses and data processing costs related to the conversion of computer systems.

We have chosen to participate in the FDIC’s Temporary Liquidity Guarantee Program which allows funds in noninterest-bearing transaction deposit accounts to be fully FDIC-insured. FDIC insurance premiums increased $1.2 million and $5.2 million for the three and nine month periods ended September 30, 2009, respectively, compared to the same periods in 2008, primarily due to increased FDIC assessment rates and higher average deposits. In addition, we recorded a special FDIC assessment of $2.3 million during the second quarter of 2009 as the FDIC levied a special assessment to all insured depository institutions totaling five basis points of each institution’s total assets less Tier 1 capital. The special assessment was part of the FDIC’s efforts to rebuild the Deposit Insurance Fund. In September 2009, the FDIC proposed a rule that will require all insured depository institutions, with limited exceptions, to prepay their estimated quarterly assessments in December 2009 for the fourth quarter of 2009 and for all of 2010, 2011 and 2012.

Other noninterest expense decreased $1.2 million and $2.1 million for the three and nine month periods ended September 30, 2009, respectively, compared to the same periods in 2008. These decreases can be attributed to our ongoing company-wide expense reduction plan as we have identified additional ways to reduce expenses in areas within the bank, which include consolidating certain banking centers, cutting vendor costs, and eliminating unnecessary service agreements. These actions are all part of building and maintaining a long-term sustainable cost discipline throughout the entire organization.

Income Taxes – We recorded a tax benefit of $14.5 million and $10.3 million from federal and state income taxes during the three and nine month periods ended September 30, 2009, respectively, and we provided $3.1 million and $13.6 million for federal and state income taxes for the same periods in 2008, respectively. The effective tax rate was approximately 37% for three month period ended September 30, 2009 as compared to 30% for the same period in 2008. The effective tax rate was 41% for the nine month period ended September 30, 2009 as compared to 32% for the same period in 2008. We expect the effective tax rate to revert back to the 30% range for the remainder of 2009. Our effective tax rate is impacted by tax-exempt income from loans, securities and bank-owned life insurance.

FINANCIAL CONDITION

Loans Held for Sale –Loans held for sale were $38.2 million and $1.5 million at September 30, 2009 and December 31, 2008, respectively. During the fourth quarter of 2009, management executed a definitive agreement to sell $16.0 million in net book value loans related to a previously disclosed nonperforming energy loan relationship and a letter of intent to sell $20.9 million in net book value commercial real estate loans out of our national SBA/commercial real estate portfolio for total net proceeds of $36.9 million. These sales are expected to close during the fourth quarter of 2009. Management charged-off a portion of these loans against the related allowance for credit losses and reclassified these loans as held for sale at September 30, 2009. Loans held for sale included $29.5 million of loans classified as nonperforming.

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Loans Held for Investment –The following table summarizes our loan portfolio by type, excluding loans held for sale (dollars in thousands):

	September 30, 2009				December 31, 2008
	Amount		%		Amount		%
Commercial and industrial	$	814,912	24.6	%	$	1,093,942	28.8	%
Real estate:
Commercial		1,701,535	51.4	%		1,763,712	46.5	%
Construction		394,819	11.9	%		545,303	14.4	%
Residential mortgage (including multi-family residential)		334,973	10.1	%		309,622	8.2	%
Consumer/other		55,048	1.7	%		63,883	1.7	%
Foreign loans		11,233	0.3	%		15,828	0.4	%
Total loans held for investment	$	3,312,520	100.0	%	$	3,792,290	100.0	%

At September 30, 2009, loans held for investment were $3.3 billion, a decrease of $480 million or 12.7% over loans held for investment at December 31, 2008. The decline in loan growth during 2009 was due in part to principal reductions in energy loans and a slowing demand resulting from customer decisions to defer new projects, reduce inventory positions, and pay down lines of credit. Additionally, during 2009 management recorded charge-offs of approximately $36.7 million to record impaired collateral dependent loans at their underlying collateral or sales value. During the third quarter of 2009, management reclassified $36.9 million of loans to held for sale due to management’s intention to sell these loans in the fourth quarter of 2009.

Our primary lending focus is commercial loans and owner-occupied real estate loans to businesses with annual revenues of $100 million or less. Typically, our customers have financing requirements between $50 thousand and $5 million. At September 30, 2009, commercial real estate loans and commercial and industrial loans were 51.4% and 24.6%, respectively, of loans held for investment.

We make commercial loans primarily to small and medium-sized businesses and to professionals. Our commercial loan products include revolving lines of credit, letters of credit, working capital loans, loans to finance accounts receivable and inventory and equipment finance leases. Commercial loans typically have floating rates of interest and are for varying terms (generally not exceeding three years). In most instances, these loans are personally guaranteed by the business owner and are secured by accounts receivable, inventory and/or other business assets. In addition to the commercial loans secured solely by non-real estate business assets, we make commercial loans that are secured by owner-occupied real estate, as well as other business assets.

Commercial mortgage loans are often secured by first liens on real estate, typically have floating interest rates, and are most often amortized over a 15-year period with balloon payments due at the end of three years. In underwriting commercial mortgage loans, we give consideration to the property’s operating history, future operating projections, current and projected occupancy, location and physical condition. The underwriting analysis also includes credit checks, appraisals and a review of the financial condition of the borrower.

Our Capital Markets group originates, co-originates or purchases first-lien, commercial real estate mortgage loans referred by other financial institutions nationwide. This loan portfolio consists of approximately $365 million in commercial real estate loans with collateral outside of Texas. The average-sized loan within this portfolio is $1.0 million with the largest loan being approximately $4.0 million. Over half of these loans are secured by owner-occupied facilities. These loans generally have low loan-to-value ratios (below 60%) and many have a U.S. Small Business Administration second lien behind our first lien. The loans without SBA second liens

39

were underwritten with similar collateral and equity requirements. We utilize real estate appraisers familiar with the geographic region in which the property is located in all potential loans. These appraisals are reviewed by a third-party appraisal review vendor for accuracy and compliance with our underwriting standards and banking regulations.

The following table summarizes our commercial, construction and multifamily residential real estate loan portfolios, excluding foreign loans, by the type of property securing the credit (dollars in thousands). Multifamily residential real estate is included in the residential mortgage real estate loan category.

	September 30, 2009
	Amount		%
Property type:
Office and office warehouse	$	433,187	20.3	%
Retail		360,380	16.9	%
Acquisition and land development		228,223	10.7	%
Hospitality		295,894	13.8	%
1 – 4 family		112,756	5.3	%
Industrial warehouse		82,099	3.8	%
Multfamily residential		48,368	2.3	%
Other		576,106	26.9	%
	$	2,137,013	100.0	%

The Bank makes automobile, boat, home improvement and other loans to consumers. These loans are primarily made to customers who have other business relationships with us.

As of September 30, 2009, there was no concentration of loans to any one type of industry exceeding 10% of total loans nor were there any loans classified as highly leveraged transactions. The Company’s largest concentration in any single industry is in the energy loan portfolio. At September 30, 2009, the energy loan portfolio totaled $278 million which represents 8.3% of total loans. The petroleum industry is usually divided into three major components: upstream, midstream and downstream. The composition of the collateral of the upstream energy portfolio, at September 30, 2009, consists of 57% gas reserves and 43% oil reserves. The upstream oil sector is a term commonly used to refer to the exploration for and the recovery and production of crude oil and natural gas. The upstream oil sector is also known as the exploration and production sector. These reserve-based loans represent approximately 68% of the energy loan portfolio. The remaining energy loan portfolio consists of well-secured loans to companies that would be classified as midstream energy companies. A midstream energy company is a company that processes and transports crude oil and natural gas. The energy lending group participates in shared national credits which are defined by banking regulators as credits of more than $20 million and with three or more non-affiliated banks as participants. The energy lending group is the only group that consistently participates in shared national credits.

At September 30, 2009, loans held for investment were 82.7% of deposits and 68.2% of total assets. Loans held for investment were 99.3% of deposits and 74.7% of total assets at December 31, 2008.

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Securities – Our securities portfolio at September 30, 2009, totaled $1 billion as compared to $805 million at December 31, 2008, an increase of $195 million or 24.1%.

Net unrealized gains on the available-for-sale securities were $19.4 million at September 30, 2009, as compared to $6.2 million at December 31, 2008.

We review investment securities on an ongoing basis for the presence of OTTI with formal reviews performed quarterly. Net OTTI losses on individual investment securities are recognized as a realized loss through earnings when it is more likely than not that we will not collect all of the contractual cash flows or we are unable to hold the securities to recovery.

For debt securities that are considered other-than-temporarily impaired and that we do not intend to sell and will not be required to sell prior to recovery of our amortized cost basis, we separate OTTI into the amount that is credit-related and the amount that is due to all other factors. The credit loss component is recognized in earnings and is the difference between a security’s amortized cost basis and the present value of expected future cash flows discounted at the security’s effective interest rate. The amount due to all other factors is recognized in other comprehensive income.

During the second quarter of 2009, we recorded a $2.9 million OTTI on one held-to-maturity debt security which included $14 thousand of credit-related OTTI and $2.9 million recorded directly to other comprehensive income for the noncredit-related impairment amount.

Deposits –The following table summarizes our deposit portfolio by type (dollars in thousands):

	September 30, 2009				December 31, 2008
	Amount		%		Amount		%
Noninterest-bearing demand	$	1,094,346	27.3	%	$	1,123,746	29.4	%
Interest-bearing demand		1,874,746	46.9	%		1,523,969	39.9	%
Certificates and other time deposits:
Jumbo		594,590	14.8	%		660,427	17.3	%
Regular		273,721	6.8	%		317,719	8.3	%
Brokered		170,051	4.2	%		193,276	5.1	%
Total deposits	$	4,007,454	100.0	%	$	3,819,137	100.0	%

Total deposits as of September 30, 2009, increased $188 million to $4.0 billion, up 4.9% compared to $3.8 billion at December 31, 2008. This increase was due to internal deposit growth. The percentage of interest-bearing and noninterest-bearing demand deposits to total deposits as of September 30, 2009 was 46.9% and 27.3%, respectively, and our loan to deposit ratio was 84.0%.

Other Borrowed Funds – As of September 30, 2009, we had $99.5 million in other borrowings compared to $409 million at December 31, 2008, a decrease of $309 million. This decline in borrowings was the result of an increase in total deposits. Our primary source of other borrowings is the Federal Home Loan Bank (“FHLB”). These borrowings are collateralized by mortgage loans, certain pledged securities, FHLB stock and any funds on deposit with the FHLB. FHLB advances are available to us under a security and pledge agreement. At September 30, 2009, we had total funds of $1.2 billion available under this agreement of which $40.5 million was outstanding with an average interest rate of 2.95%. At September 30, 2009, we had $40.0 million of

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FHLB advances that mature in eight years and $500 thousand of FHLB advances with a remaining maturity of less than one year. We utilize these borrowings to meet liquidity needs. Maturing advances are replaced by drawing on available cash, making additional borrowings or through increased customer deposits.

Securities sold under agreements to repurchase represent the purchase of interests in securities by banking customers and structured repurchase agreements with other financial institutions. At September 30, 2009 and December 31, 2008, we had securities sold under agreements to repurchase with banking customers of $7.3 million and $9.9 million, respectively. Structured repurchase agreements totaled $50.0 million at September 30, 2009 and December 31, 2008 and consisted of agreements with two separate financial institutions totaling $25.0 million, each that will mature in 2015. These repurchase agreements bear interest at a rate equal to LIBOR less 100 basis points and reset quarterly until the first quarter of 2010 at which time the rate will become fixed at 3.88% and 3.50%, respectively. The rate on these repurchase agreements was zero at September 30, 2009. The rate on these repurchase agreements was 1.22% and 0.87%, respectively, at December 31, 2008.

Treasury Auction Facilities (“TAF”) are term funds auctioned to depository institutions by the Federal Reserve Board. Each TAF auction is for a fixed amount, with the rate determined by the auction process (subject to a minimum bid rate). All advances must be fully collateralized. At September 30, 2009, there were no TAF borrowings outstanding. At December 31, 2008, we had $100 million of TAF borrowings outstanding at a rate 0.42%.

We have federal funds purchased at correspondent banks that typically mature within one to ninety days. As of September 30, 2009, federal funds outstanding with correspondent banks were $1.7 million and payable upon demand.

ASSET QUALITY

Risk Elements – Our nonperforming and past due loans are substantially collateralized by assets, with any excess of loan balances over collateral values specifically allocated in the allowance for loan losses. On an ongoing basis, we receive updated appraisals on loans secured by real estate, particularly those categorized as nonperforming loans and potential problem loans. In those instances where updated appraisals reflect reduced collateral values, an evaluation of the borrower’s overall financial condition is made to determine the need, if any, for possible write-downs or appropriate additions to the allowance for loan losses.

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Nonperforming assets consisted of the following (in thousands):

	September 30, 2009			December 31, 2008
Nonperforming Assets
Nonaccrual loans:
Loans held for sale	$	29,472		$	—
Loans held for investment		65,515			87,491
Total nonaccrual loans		94,987			87,491
Real estate acquired by foreclosure		11,674			5,625
Other repossessed assets		33			154
Total nonperforming assets	$	106,694		$	93,270
Accruing loans 30 to 89 days past due	$	23,364		$	30,492
Nonperforming loans to period-end loans		2.83	%		2.31	%
Nonperforming assets to period-end assets		2.20	%		1.84	%

Nonperforming assets were $107 million at September 30, 2009, a $13.4 million increase from December 31, 2008. Nonaccrual loans at September 30, 2009 include $29.5 million of loans that have been classified as held for sale. Nonaccrual loans held for sale includes a $16.0 million energy lending relationship and $13.5 million of commercial real estate loans. These loan have sales agreements and are expected to close in the fourth quarter of 2009. Upon transfer to the held for sale category, these loans were charged down to their estimated sales price. Nonaccrual loans held for investment were $65.5 million at September 30, 2009. The largest of these loans is a $9.0 million multi-use land development loan that is not performing as agreed; however, we are in a favorable position due to the underlying collateral.

Included in the nonperforming loans held for sale balance are nonperforming loans related to an energy customer that is currently in Chapter 11 bankruptcy. Total exposure to this customer as of September 30, 2009 and December 31, 2008, was $16.0 million and $29.2 million, respectively, as we recorded charge-offs of $9.6 million and $2.0 million on this relationship during the second and third quarters of 2009, respectively. While completing our analysis of the allowance for credit losses for the quarter ended June 30, 2008, we were notified that this borrower was in the process of filing for Chapter 11 bankruptcy protection. This borrower was part of a shared national credit totaling approximately $2.4 billion. Our participation was approximately $20.0 million at June 30, 2008. Due to the announced bankruptcy and the significance of this credit relationship

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to us, we immediately placed the loan on nonaccrual and disclosed it as part of our nonperforming loans as of June 30, 2008. At June 30, 2008, we recorded a provision for credit losses of $3.7 million. As legally required, we funded additional proceeds of $9.2 million (net of an $800 thousand purchase discount) related to this borrower in July of 2008, increasing our overall exposure to $29.2 million in the third quarter of 2008. We recorded an additional provision for credit losses of $600 thousand in the third quarter of 2008 due to this increased exposure. The estimated provision for both the second and third quarters of 2008 were based on management’s review of information indicating that the customer had significant, valuable energy and fixed assets.

During the first quarter of 2009, the borrower announced its intentions to liquidate its various business units through direct sales and auctions and submitted an analysis of the expected sales proceeds of the various business units. After analyzing the information as submitted through the bankruptcy proceedings and the new direction of the bankruptcy, management determined an additional $5.3 million provision was prudent bringing the total amount reserved on this relationship to $9.6 million, approximately 36% of the amount of debt outstanding at March 31, 2009.

During the second quarter of 2009, the borrower filed its plan of reorganization with the Bankruptcy court which included firm estimates of each creditor’s losses as well as the remaining assets of the company. As such, we recorded a charge-off of $9.6 million, the entire allowance for credit losses related to this loan. During the fourth quarter of 2009, we entered into an agreement to sell this loan. As such, we reclassified this relationship to loans held for sale at September 30, 2009 and recorded an additional provision for credit losses and related charge-off of $2.0 million to record the loan at its agreed upon sales price of $16.0 million. This sale is expected to close in the fourth quarter of 2009.

Accruing loans past due 90 days or more at September 30, 2009, totaled $681 thousand, down $7.8 million compared to $8.4 million at December 31, 2008.

Allowance for Credit Losses –The allowance for credit losses and the related provision for credit losses are determined based on the historical credit loss experience, changes in the loan portfolio, including size, mix and risk of the individual loans, and current economic conditions. We monitor economic conditions in our local market areas and the probable impact on borrowers, on past-due amounts, on related collateral values, on the number and size of the nonperforming loans and on the resulting amount of charge-offs for the period.

The provision for credit losses for the three and nine months ended September 30, 2009, was $56.1 million and $76.6 million, respectively, as compared to $10.1 million and $22.4 million for the same periods in 2008, respectively. During 2009, we have taken steps to significantly reduce our total nonperforming loans and increase our allowance for loan losses thereby better positioning our balance sheet for future growth and profitability. These actions include the write-down of certain collateral-based impaired loans to their underlying collateral and the execution of a definitive agreement to sell $16.0 million in net book value loans related to a previously disclosed nonperforming energy loan relationship and a letter of intent to sell $20.9 million in net book value commercial real estate loans out of our national SBA/commercial real estate portfolio. As a result of the actions, we recorded additional charge-offs of $29.4 million for the third quarter of 2009. Additionally, as a result of the proposed loan sales, management determined that it was appropriate to provide $13.6 million in additional provision in order to record these loans at their underlying and agreed upon sales price. We charged-off a portion of these loans against the related allowance for credit losses and reclassified these loans as held for sale at September 30, 2009.

During the third quarter of 2009, we assessed certain estimates we used in determining the adequacy of our allowance for loan losses. We concluded that in light of the two proposed loan sale transactions discussed above, the deterioration in the real estate market, and the continuing uncertainty in the economy, it was appropriate to revise certain accounting estimates used in determining the adequacy of the allowance for loan losses to better reflect current conditions. The application of these accounting estimates resulted in the Company recording an additional $15 million in provision for credit losses in the third quarter of 2009.

Net charge-offs were $37.4 million or 4.27% (annualized) and $54.6 million or 2.01% (annualized) of average total loans for the three and nine months ended September 30, 2009, respectively, compared to $5.8 million or 0.62% (annualized) and $10.9 million or 0.40% (annualized) of average total loans for the same periods in 2008, respectively. The increase in charge-offs during the quarter ended September 30, 2009, was due to $27.4 million of charge-offs related to collateral-based nonperforming loans and

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commercial real estate loans transferred to held for sale. Additionally, we recorded a charge-off of $9.6 million during the second quarter of 2009 related to an energy customer that is currently in Chapter 11 bankruptcy which had previously been provided for in our allowance for loan losses. This relationship was transferred to loans held for sale at September 30, 2009, as the company entered into a definitive agreement to sell this loan in the fourth quarter of 2009. As a result, we recorded an additional charge-off of $2.0 million during the third quarter of 2009.

The allowance for loan losses at September 30, 2009, was $70.1 million and represented 2.09% of total loans. The allowance for loan losses at September 30, 2009, was 73.76% of nonperforming loans, up from 56.21% at December 31, 2008. The allowance for unfunded lending commitments was $2.9 million as of September 30, 2009 compared to $1.7 million as of December 31, 2008.

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The following table presents an analysis of the allowance for credit losses and other related data (dollars in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2009			2008			2009			2008
Allowance for loan losses at beginning of period	$	53,075		$	41,651		$	49,177		$	34,446
Charge-offs:
Commercial, financial, and industrial		3,895			3,713			19,378			7,644
Real estate, mortgage and construction		33,621			1,879			35,962			3,612
Consumer		318			657			1,109			1,311
Total charge-offs		37,834			6,249			56,449			12,567
Recoveries
Commercial, financial, and industrial		251			277			1,177			1,106
Real estate, mortgage and construction		23			28			301			112
Consumer		163			142			420			435
Total recoveries		437			447			1,898			1,653
Net charge-offs		37,397			5,802			54,551			10,914
Provision for loan losses		54,381			9,373			75,433			21,690
Allowance for loan losses at end of period		70,059			45,222			70,059			45,222
Allowance for unfunded loan commitments at beginning of period		1,102			927			1,654			927
Provision for losses on unfunded loan commitments		1,750			727			1,198			727
Allowance for unfunded loan commitments at end of period		2,852			1,654			2,852			1,654
Total allowance for credit losses	$	72,911		$	46,876		$	72,911		$	46,876
Period-end allowance for credit losses to period-end loans		2.18	%		1.25	%		2.18	%		1.25	%
Period-end allowance for loan losses to period-end loans		2.09	%		1.21	%		2.09	%		1.21	%
Period-end allowance for loan losses to nonperforming loans		73.76	%		64.11	%		73.76	%		64.11	%
Net charge-offs to average loans (annualized)		4.27	%		0.62	%		2.01	%		0.40	%

INTEREST RATE SENSITIVITY

We manage interest rate risk by positioning the balance sheet to maximize net interest income while maintaining an acceptable level of risk, remaining mindful of the relationship between profitability, liquidity and interest rate risk. The overall interest rate risk position and strategies for the management of interest rate risk are reviewed by senior management, the Asset/Liability Management Committee and our Board of Directors on an ongoing basis.

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We measure interest rate risk using a variety of methodologies including, but not limited to, dynamic simulation analysis and static balance sheet rate shocks. Dynamic simulation analysis is the primary tool used to measure interest rate risk and allows us to model the effects of non-parallel movements in multiple yield curves, changes in borrower and depositor behaviors, changes in loan and deposit pricing, and changes in loan and deposit portfolio compositions and growth rates over a 24-month horizon.

We utilize static balance sheet rate shocks to estimate the potential impact on net interest income of changes in interest rates under various rate scenarios. This analysis estimates a percentage of change in these metrics from the stable rate base scenario versus alternative scenarios of rising and falling market interest rates by instantaneously shocking a static balance sheet. The following table summarizes the simulated change over a 12-month horizon as of September 30, 2009 and December 31, 2008:

Changes in Interest Rates (Basis Points)	Increase (Decrease) in Net Interest Income
September 30, 2009
+200	9.69	%
+100	4.61	%
Base	0.00	%
-100	-7.46	%
December 31, 2008
+200	4.13	%
+100	2.86	%
Base	0.00	%
-100	-4.92	%

Each rate scenario reflects unique prepayment and repricing assumptions. Because of uncertainties related to customer behaviors, loan and deposit pricing levels, competitor behaviors, and socio-economic factors that could effect the shape of the yield curve, this analysis is not intended to and does not provide a precise forecast of the effect actual changes in market rates will have on us. The interest rate sensitivity analysis includes assumptions that (i) the composition of our interest sensitive assets and liabilities existing at period-end will remain constant over the measurement period; and (ii) changes in market rates are parallel and instantaneous across the yield curve regardless of duration or repricing characteristics of specific assets or liabilities. Further, this analysis does not contemplate any actions that we might undertake in response to changes in market factors. Accordingly, this analysis is not intended to and does not provide a precise forecast of the effect actual changes in market rates may have on us.

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CAPITAL AND LIQUIDITY

Capital – At September 30, 2009, shareholders’ equity totaled $546 million or 11.2% of total assets, as compared to $643 million or 12.7% of total assets at December 31, 2008. Our risk-based capital ratios together with the minimum capital amounts and ratios at September 30, 2009 were as follows (dollars in thousands):

	Actual				For Minimum Capital Adequacy Purposes
	Amount		Ratio		Amount		Ratio
Total capital (to risk weighted assets)	$	528,673	13.9	%	$	303,247	8.0	%
Tier 1 capital (to risk weighted assets)		424,406	11.2	%		151,623	4.0	%
Tier 1 capital (to average assets)		424,406	8.9	%		191,271	4.0	%

During 2008, we received $125 million in capital from the U.S. Treasury as the result of our participation in the U.S. Treasury’s Capital Purchase Program. During 2009, we fully redeemed the $125 million preferred stock that we sold to the U.S. Treasury in December of 2008. See Note 15 to our Consolidated Financial Statements for further discussion of regulatory capital requirements.

Additionally, during 2009, we issued 8.3 million shares of our common stock through a public stock offering, which resulted in net proceeds of approximately $54.6 million, after deducting underwriting fees and estimated offering expenses.

Liquidity –The objectives of our liquidity management is to maintain our ability to meet day-to-day deposit withdrawals and other payment obligations, to raise funds to support asset growth, to maintain reserve requirements and otherwise operate on an ongoing basis. We strive to manage a liquidity position sufficient to meet operating requirements while maintaining an appropriate balance between assets and liabilities to meet the expectations of our shareholders. In recent years, our liquidity needs have primarily been met by growth in deposits including brokered certificates of deposit. In addition to deposits, we have access to funds from correspondent banks and from the Federal Home Loan Bank, supplemented by amortizing securities and loan portfolios. For more information regarding liquidity, please refer to our 2008 Annual Report on Form 10-K.

Sterling Bancshares must provide for its own liquidity and fund its own obligations. The primary source of Sterling Bancshares’ revenues is from dividends declared by the Bank. There are statutory and regulatory provisions that could limit the ability of the Bank to pay dividends to Sterling Bancshares. At September 30, 2009, the aggregate amount of dividends, which legally could be paid without prior approval of various regulatory agencies, totaled $135 million. It is not anticipated that such restrictions will have an impact on our ability to meet our ongoing cash obligations.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

There have been no material changes in market risk we face since December 31, 2008. For information regarding the market risk of our financial instruments, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Interest Rate Sensitivity.” Our principal market risk exposure is to interest rates.

ITEM 4. CONTROLS AND PROCEDURES.

Evaluation of Disclosure Controls and Procedures –We maintain disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 as amended (the “Exchange Act”), that are designed to provide reasonable assurance that information required to be disclosed by us in the reports that we file, furnish or submit to the Securities and Exchange Commission under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the Commission’s rules and forms, and that information is accumulated and communicated to our management, including our principal executive and financial officers, as appropriate, to allow timely decisions regarding required

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disclosure. We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our “disclosure controls and procedures” as of the end of the period covered by this report. Based on that evaluation, such officers have concluded that the design and operation of these disclosure controls and procedures were effective.

We enhanced review and evaluation control procedures to restrict modification of terms for loans, specifically extension of maturity dates. We review these control procedures on an ongoing basis and management anticipates that such control procedures will operate effectively for the remainder of 2009. Additional control procedures will be implemented as determined necessary.

There were no other changes in our internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) of the Exchange Act) during the most recent fiscal quarter that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS.

None.

ITEM 1A. RISK FACTORS.

Information regarding risk factors appears in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Forward-Looking Statements,” in Part I – Item 2 of this Form 10-Q and in Part I – Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2008. There have been no material changes from the risk factors previously disclosed in our Annual Report on Form 10-K.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

On July 30, 2007, the Company’s Board of Directors amended its existing common stock repurchase program (the “Program”) originally adopted by the Board on April 26, 2005. The aggregate number of shares originally approved by the Board for repurchase under the Program remains unchanged at 3,750,000 shares. The Company may repurchase shares of common stock from time to time in the open market or through privately negotiated transactions from available cash or other borrowings. No shares were repurchased by the Company during the three months ended September 30, 2009.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

None.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

None.

ITEM 5. OTHER INFORMATION.

On August 5, 2009, our Board of Directors unanimously approved an amendment to Section 5.2 of the Company’s Amended and Restated Bylaws, which increased the ownership percentage required to call a special meeting of the shareholders from 10% to 25%. The amendment is effective August 5, 2009.

This summary is qualified in its entirety by reference to the First Amendment to the Amended and Restated Bylaws of Sterling Bancshares, Inc. filed as Exhibit 3.1 to this Quarterly Report on Form 10-Q and incorporated by reference herein.

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ITEM 6. EXHIBITS.

*3.1	First Amendment to the Amended and Restated Bylaws of Sterling Bancshares, Inc.
10.1	Purchase and Assumption Agreement, dated August 7, 2009, by and between Sterling Bank and First Bank [Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on August 10, 2009 (File No. 0-20750).]
11	Statement Regarding Computation of Earnings Per Share (included as Note 12) to Consolidated Financial Statements on page 22 of this Quarterly Report on Form 10-Q.
*31.1	Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 of J. Downey Bridgwater, Chairman, President and Chief Executive Officer.
*31.2	Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 of Zach L. Wasson, Executive Vice President and Chief Financial Officer.
**32.1	Section 1350 Certification of the Chief Executive Officer.
**32.2	Section 1350 Certification of the Chief Financial Officer.

* As filed herewith.

** As furnished herewith.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused the report to be signed on its behalf by the undersigned thereunto duly authorized.

	STERLING BANCSHARES, INC.
Date: November 9, 2009	By:	/s/ J. Downey Bridgwater
		J. Downey Bridgwater   Chairman, President and   Chief Executive Officer   (Principal Executive Officer)

Date: November 9, 2009	By:	/s/ Zach L. Wasson
		Zach L. Wasson   Executive Vice President   and Chief Financial Officer   (Principal Financial and Accounting Officer)

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EXHIBIT INDEX

Exhibit	Description
*3.1	First Amendment to the Amended and Restated Bylaws of Sterling Bancshares, Inc.
10.1	Purchase and Assumption Agreement, dated August 7, 2009, by and between Sterling Bank and First Bank [Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on August 10, 2009 (File No. 0-20750).]
11	Statement Regarding Computation of Earnings Per Share (included as Note 12) to Consolidated Financial Statements on page 22 of this Quarterly Report on Form 10-Q.
*31.1	Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 of J. Downey Bridgwater, Chairman, President and Chief Executive Officer.
*31.2	Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 of Zach L. Wasson, Executive Vice President and Chief Financial Officer.
**32.1	Section 1350 Certification of the Chief Executive Officer.
**32.2	Section 1350 Certification of the Chief Financial Officer.

* As filed herewith.

** As furnished herewith.

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