Sterling Bancshares 10-Q 2010 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, 2010

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: 001-34768

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  x    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 1, 2010
[Common Stock, $1.00 par value per share]	101,952,660 shares

STERLING BANCSHARES, INC.

FORM 10-Q

FOR THE QUARTER ENDED SEPTEMBER 30, 2010

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	27
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	47
Item 4.	Controls and Procedures	47
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	48
Item 1A.	Risk Factors	48
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	48
Item 3.	Defaults Upon Senior Securities	48
Item 4.	Reserved	48
Item 5.	Other Information	48
Item 6.	Exhibits	48
SIGNATURES		50

1

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS.

STERLING BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

(In thousands)

	September 30, 2010			December 31, 2009
ASSETS
Cash and cash equivalents	$	366,590		$	246,215
Available-for-sale securities, at fair value		1,169,519			846,216
Held-to-maturity securities, at amortized cost		280,215			222,845
Loans held for sale		7,123			11,778
Loans held for investment		2,862,952			3,233,273
Total loans		2,870,075			3,245,051
Allowance for loan losses		(80,754	)		(74,732	)
Loans, net		2,789,321			3,170,319
Premises and equipment, net		48,507			48,816
Real estate acquired by foreclosure		14,571			16,763
Goodwill		173,210			173,210
Core deposit and other intangibles, net		10,004			11,626
Accrued interest receivable		14,356			16,502
Other assets		173,328			184,536
TOTAL ASSETS	$	5,039,621		$	4,937,048
LIABILITIES AND SHAREHOLDERS’ EQUITY
LIABILITIES:
Deposits:
Noninterest-bearing demand	$	1,248,321		$	1,144,133
Interest-bearing demand		2,014,207			2,004,539
Certificates and other time		840,683			946,279
Total deposits		4,103,211			4,094,951
Other borrowed funds		106,546			97,245
Subordinated debt		78,624			77,338
Junior subordinated debt		82,734			82,734
Accrued interest payable and other liabilities		41,704			44,247
Total liabilities		4,412,819			4,396,515
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS’ EQUITY:
Preferred stock, $1 par value, 1,000,000 shares authorized, no shares issued or outstanding at September 30, 2010 and December 31, 2009		0			0
Common stock, $1 par value, 150,000,000 shares authorized, 103,819,861 and 83,720,767 issued and 101,952,361 and 81,853,266 outstanding at September 30, 2010 and December 31, 2009, respectively		103,820			83,721
Capital surplus		238,536			170,848
Retained earnings		290,429			295,909
Treasury stock, at cost, 1,867,500 shares held at September 30, 2010 and December 31, 2009		(21,399	)		(21,399	)
Accumulated other comprehensive income, net of tax		15,416			11,454
Total shareholders’ equity		626,802			540,533
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	5,039,621		$	4,937,048

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,
	2010		2009			2010			2009
Interest income:
Loans, including fees	$	40,153	$	49,658		$	125,889		$	154,349
Securities:
Taxable		9,841		9,286			28,560			26,659
Non-taxable		1,013		897			2,853			2,687
Deposits in financial institutions		157		64			503			64
Other interest-earning assets		1		29			5			61
Total interest income		51,165		59,934			157,810			183,820
Interest expense:
Demand and savings deposits		3,583		4,403			12,114			11,781
Certificates and other time deposits		2,823		5,504			9,334			19,474
Other borrowed funds		784		346			2,000			1,583
Subordinated debt		747		748			2,139			2,612
Junior subordinated debt		1,071		1,082			3,139			3,441
Total interest expense		9,008		12,083			28,726			38,891
Net interest income		42,157		47,851			129,084			144,929
Provision for credit losses		7,716		56,131			39,988			76,631
Net interest income (loss) after provision for credit losses		34,441		(8,280	)		89,096			68,298
Noninterest income:
Customer service fees		3,728		3,845			10,807			11,709
Net gain on sale of securities		43		4			80			31
Other-than-temporary impairment loss on securities:
Impairment loss on securities		0		0			0			(2,690	)
Noncredit-related loss recognized in other comprehensive income		0		0			0			2,676
Net impairment loss on securities		0		0			0			(14	)
Wealth management fees		1,733		1,862			5,933			5,904
Other		3,986		3,402			7,732			12,774
Total noninterest income		9,490		9,113			24,552			30,404
Noninterest expense:
Salaries and employee benefits		20,722		21,005			61,678			67,434
Occupancy		5,566		5,967			17,065			18,004
Technology		2,267		2,495			7,016			7,475
Professional fees		1,452		1,065			4,829			3,419
Postage, delivery and supplies		661		700			2,088			2,181
Marketing		198		557			738			1,487
Core deposit and other intangibles amortization		537		565			1,623			1,695
Acquisition costs		0		154			0			154
FDIC insurance assessments		2,478		1,741			7,463			6,974
Other		3,899		5,826			15,039			14,871
Total noninterest expense		37,780		40,075			117,539			123,694
Income (loss) before income taxes		6,151		(39,242	)		(3,891	)		(24,992	)
Income tax provision (benefit)		1,696		(14,518	)		(2,694	)		(10,282	)
Net income (loss)	$	4,455	$	(24,724	)	$	(1,197	)	$	(14,710	)
Preferred stock dividends		0		0			0			9,342
Net income (loss) applicable to common shareholders	$	4,455	$	(24,724	)	$	(1,197	)	$	(24,052	)
Earnings (loss) per common share:
Basic	$	0.04	$	(0.30	)	$	(0.01	)	$	(0.31	)
Diluted	$	0.04	$	(0.30	)	$	(0.01	)	$	(0.31	)

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			Total
	Shares			Amount			Shares			Amount									Shares			Amount
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 income:
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 income																													(16,248	)
Preferred stock redemption, accelerated dividend and amortization of preferred stock discount		(125,198	)		(118,012	)											(7,186	)											(125,198	)
Issuance of common stock								8,280			8,280			46,282															54,562
Issuance of common stock under incentive compensation plans and related tax effects								172			172			563															735
Common stock issued for vested restricted stock, net of shares forfeited								49			49			(49	)														0
Stock-based compensation expense														3,279															3,279
Shares held in Rabbi Trust								(7	)		(7	)		(38	)														(45	)
Preferred stock dividends paid																	(2,156	)											(2,156	)
Common stock dividends paid																	(12,556	)											(12,556	)
BALANCE AT SEPTEMBER 30, 2009	$	0		$	0			83,622		$	83,622		$	171,955		$	295,401			(1,868	)	$	(21,399	)	$	15,933		$	545,512
BALANCE AT JANUARY 1, 2010	$	0		$	0			83,721		$	83,721		$	170,848		$	295,909			(1,868	)	$	(21,399	)	$	11,454		$	540,533
Comprehensive income:
Net loss																	(1,197	)											(1,197	)
Net change in unrealized gains and losses on available-for-sale securities, net of taxes of $4,102																										7,618			7,618
Net change in unrealized gains and losses on effective cash flow hedging derivatives, net of taxes of ($1,858)																										(3,451	)		(3,451	)
Less: Reclassification adjustment for gains on available-for-sale securities included in net income, net of taxes of ($111)																										(205	)		(205	)
Total comprehensive income																													2,765
Issuance of common stock, net of issuance costs								20,000			20,000			66,602															86,602
Issuance of common stock under incentive compensation plans and related tax effects								105			105			41															146
Stock-based compensation expense														1,076															1,076
Shares held in Rabbi Trust								(6	)		(6	)		(31	)														(37	)
Common stock dividends paid																	(4,283	)											(4,283	)
BALANCE AT SEPTEMBER 30, 2010	$	0		$	0			103,820		$	103,820		$	238,536		$	290,429			(1,868	)	$	(21,399	)	$	15,416		$	626,802

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,
	2010			2009
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss	$	(1,197	)	$	(14,710	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Amortization and accretion of premiums and discounts on securities, net		4,779			1,355
Net gain on securities		(80	)		(31	)
Other-than-temporary impairment loss on securities		0			14
Net loss (gain) on loans		2,295			(379	)
Provision for credit losses		39,988			76,631
Writedowns, less gains on sale, of real estate acquired by foreclosure		(761	)		1,798
Depreciation and amortization		7,075			7,992
Stock-based compensation expense (net of tax benefit recognized)		1,049			2,402
Excess tax benefits from share-based payment arrangements		(2	)		(37	)
Net (increase) decrease in loans held for sale		(2,988	)		413
Net (gain) loss on sale of bank assets		(377	)		178
Net decrease (increase) in accrued interest receivable and other assets		7,224			(7,323	)
Net decrease in accrued interest payable and other liabilities		(1,281	)		(1,193	)
Net cash provided by operating activities		55,724			67,110
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from the maturities or calls and paydowns of held-to-maturity securities		38,322			18,017
Proceeds from the sale of held-to-maturity securities		1,773			0
Purchases of held-to-maturity securities		(98,117	)		(14,867	)
Proceeds from the maturities or calls and paydowns of available-for-sale securities		251,730			151,910
Proceeds from the sale of available-for-sale securities		10,425			3,585
Purchases of available-for-sale securities		(578,101	)		(346,885	)
Net decrease in loans held for investment		324,788			376,858
Proceeds from sale of real estate acquired by foreclosure		19,016			3,816
Proceeds from sale of premises and equipment		108			49
Purchase of premises and equipment		(5,281	)		(9,202	)
Net cash (used in) provided by investing activities		(35,337	)		183,281
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposit accounts		8,260			188,317
Net increase (decrease) in other borrowed funds		9,801			(309,100	)
Repayment of long-term borrowings		(500	)		0
Proceeds from issuance of common stock under incentive compensation plans		143			699
Proceeds from issuance of common stock, net of expenses		86,602			54,562
Repurchase of common stock for Rabbi Trust		(37	)		(45	)
Excess tax benefits from share-based payment arrangements		2			37
Redemption of preferred stock		0			(125,198	)
Preferred stock dividends paid		0			(2,156	)
Common stock dividends paid		(4,283	)		(12,556	)
Net cash provided by (used in) financing activities		99,988			(205,440	)
NET INCREASE IN CASH AND CASH EQUIVALENTS		120,375			44,951
CASH AND CASH EQUIVALENTS:
Beginning of period		246,215			113,163
End of period	$	366,590		$	158,114
Supplemental information:
Income taxes paid (received)	$	(8,879	)	$	13,500
Interest paid		30,458			41,196
Noncash investing and financing activities-
Acquisition of real estate through foreclosure of collateral		16,063			11,663

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”). 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 2009 Annual Report on Form 10-K.

The Company has evaluated subsequent events through the date the financial statements were issued.

New Accounting Guidance

Fair Value Measurement and Disclosures: In January 2010, the FASB issued Accounting Standards Update (“ASU”) No. 2010-06 (“ASU 2010-06”)Improving Disclosures About Fair Value Measurements which amends ASC 820-10Fair Value Measurement and Disclosures.ASU 2010-06 provides amendments to ASC 820-10 that require new disclosures regarding activity within the Level 1, 2 and 3 fair value measurements. ASU 2010-06 also clarifies existing disclosures regarding the level of disaggregation of assets and liabilities in addition to the disclosures about the valuation techniques and inputs used to measure fair value. ASC 820 affirmed 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 provided additional guidance when the volume and level of activity for the asset or liability significantly decreased and included 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 Company adopted ASU 2010-06 during the first quarter of 2010. The enhanced disclosures related to ASU 2010-06 and ASC 820 are included in Note 17 – Disclosures About Fair Value of Financial Instruments.

Financial Instruments: ASC 825 and ASU 2010-06Financial Instruments require 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 17 – Disclosures About Fair Value of Financial Instruments.

Transfers and Servicing: ASC 860Transfers and Servicing improves 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 became effective for annual reporting periods that began 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. The Company adopted ASC 860 during the first quarter of 2010. The adoption of ASC 860 did not have a significant impact on the Company’s financial condition or results of operations.

Consolidation: ASC 810Consolidation improves 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 is 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. The adoption of ASC 810 did not have a significant impact on the Company’s financial condition or results of operations.

Receivables: In July 2010, the FASB issued ASU 2010-20Receivables (Topic 830) – Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. ASU 2010-20 requires entities to provide disclosures designed to facilitate financial statement users’ evaluation of (i) the nature of credit risk inherent in the entity’s portfolio of financing receivables, (ii) how that risk is analyzed and assessed in arriving at the allowance for credit losses and (iii) the changes and reasons for those changes in the allowance for credit losses. Disclosures must be disaggregated by portfolio segment, the level at which an entity develops and documents a systematic method for determining its allowance for credit losses, and class of financing receivable. The required disclosures include, among other things, a rollforward of the allowance for credit losses as well as information about modified, impaired, nonaccrual and past due loans and credit quality indicators. ASU 2010-20 will be effective for the Company’s financial statements as of December 31, 2010, as it relates to disclosures required as of the end of a reporting period. Disclosures that relate to activity during a reporting period will be required for the Company’s financial statements that include periods beginning on or after January 1, 2011.

6

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

2. SECURITIES

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

	September 30, 2010
	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	$	64,940	$	569	$	0		$	65,509
Obligations of states of the U.S. and political subdivisions		1,140		24		0			1,164
Mortgage-backed securities and collateralized mortgage obligations		1,067,168		24,400		(1,233	)		1,090,335
Other securities		12,555		0		(44	)		12,511
Total	$	1,145,803	$	24,993	$	(1,277	)	$	1,169,519
Held-to-Maturity
Obligations of states of the U.S. and political subdivisions	$	113,028	$	5,439	$	(15	)	$	118,452
Mortgage-backed securities and collateralized mortgage obligations		167,187		3,491		(1,967	)		168,711
Total	$	280,215	$	8,930	$	(1,982	)	$	287,163
	December 31, 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	$	56,417	$	139	$	(69	)	$	56,487
Obligations of states of the U.S. and political subdivisions		1,235		35		0			1,270
Mortgage-backed securities and collateralized mortgage obligations		762,337		14,578		(2,903	)		774,012
Other securities		13,915		660		(128	)		14,447
Total	$	833,904	$	15,412	$	(3,100	)	$	846,216
Held-to-Maturity
Obligations of states of the U.S. and political subdivisions	$	101,091	$	3,479	$	(80	)	$	104,490
Mortgage-backed securities and collateralized mortgage obligations		121,754		281		(4,185	)		117,850
Total	$	222,845	$	3,760	$	(4,265	)	$	222,340

7

STERLING BANCSHARES, INC. AND SUBSIDIARIES

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, 2010, 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	$	55,808	$	56,131	$	14,476	$	14,595
Due after one year through five years		10,272		10,542		46,378		48,829
Due after five years through ten years		0		0		44,908		47,328
Due after ten years		0		0		7,266		7,700
Mortgage-backed securities and collateralized mortgage obligations		1,067,168		1,090,335		167,187		168,711
Other securities		12,555		12,511		0		0
Total	$	1,145,803	$	1,169,519	$	280,215	$	287,163

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, 2010.

Securities with carrying values totaling $255 million and fair values totaling $265 million were pledged to secure public deposits at September 30, 2010.

8

STERLING BANCSHARES, INC. AND SUBSIDIARIES

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, 2010
	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
Mortgage-backed securities and collateralized mortgage obligations	$	130,384	$	(738	)	$	129,646	$	3,846	$	(495	)	$	3,351
Other securities		12,555		(44	)		12,511		0		0			0
Total	$	142,939	$	(782	)	$	142,157	$	3,846	$	(495	)	$	3,351
Held-to-Maturity
Obligations of states of the U.S. and political subdivisions	$	1,053	$	(15	)	$	1,038		0		0			0
Mortgage-backed securities and collateralized mortgage obligations		0		0			0		18,545		(1,967	)		16,578
Total	$	1,053	$	(15	)	$	1,038	$	18,545	$	(1,967	)	$	16,578
	December 31, 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	$	17,492	$	(69	)	$	17,423	$	0	$	0		$	0
Mortgage-backed securities and collateralized mortgage obligations		214,750		(2,201	)		212,549		4,282		(702	)		3,580
Other securities		0		0			0		12,089		(128	)		11,961
Total	$	232,242	$	(2,270	)	$	229,972	$	16,371	$	(830	)	$	15,541
Held-to-Maturity
Obligations of states of the U.S. and political subdivisions	$	4,985	$	(80	)	$	4,905	$	0	$	0		$	0
Mortgage-backed securities and collateralized mortgage obligations		82,385		(960	)		81,425		29,991		(3,225	)		26,766
Total	$	87,370	$	(1,040	)	$	86,330	$	29,991	$	(3,225	)	$	26,766

For all security types discussed below where no OTTI is considered necessary at September 30, 2010, 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 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 and have contractual cash flows guaranteed by agencies of the U.S. Government. The Company has the ability to purchase agency securities with maturity dates up to seven years.

9

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

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 25 years or less. Since late 2008, there have been 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 the Company’s 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 and Government sponsored entities.

As of September 30, 2010, the Company owned 11 private label CMOs with a total amortized cost basis of $22.4 million that had been in an unrealized loss position for more than 12 months. The unrealized losses on the Company’s private label CMO portfolio as of September 30, 2010, were 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 NRSROs. As of September 30, 2010, these private label CMOs have been downgraded by one grade or more by at least one of the NRSROs. All of these downgraded securities, were rated “investment grade” as of September 30, 2010.

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 11 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 private label CMOs to be other-than-temporarily impaired at September 30, 2010.

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 magnitude of loss 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 not 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 during the second quarter of 2009 on one held-to-maturity debt security, based on its cash flow analysis. This security was issued in 2007 and was backed by hybrid adjustable-rate residential

10

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

mortgage loans. At June 30, 2009, the date of OTTI, this security had an amortized cost basis of $7.3 million and a fair value of $4.4 million. At June 30, 2009, this security was an investment grade security. At June 30, 2009, the Company did not have an intent to sell the security, and it was not more likely than not that the Company would be required to sell the investment before recovery of its remaining amortized cost basis. Therefore, at June 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. Subsequent to June 30, 2009, this security was downgraded to no longer being an investment grade security. The continued credit deterioration of this security combined with an increase in the number and amount of below investment grade securities within the Company’s security portfolio contributed to the Company’s decision to sell this security during the fourth quarter of 2009. As a result, the remaining unamortized noncredit-related impairment of $2.5 million that was previously recorded in other comprehensive income was recognized as a realized loss on sale of securities during the fourth quarter of 2009. There was no other-than-temporary impairment recorded on held-to-maturity securities during the three and nine month periods ended September 30, 2010.

Available-for-Sale (AFS) Securities

There was no OTTI recorded during the three and nine month periods ended September 30, 2010 or 2009 on available-for-sale securities.

Realized Gains and Losses on Sales of Securities

HTM Debt Securities

During the second quarter of 2010, the Bank sold one private-label CMO that was classified as held-to-maturity resulting in a realized loss of $236 thousand. The decision to sell this security in the second quarter of 2010 was due to the significant credit downgrading of the security to below investment grade. Given this credit downgrade, the current economic uncertainty along with the increasing levels of delinquencies being reported for all residential mortgage loans, the Company believed there was additional risk associated with holding this security until maturity. This security had a carrying value of $2.0 million at the time of sale.

The following table shows the gross realized losses on the sales of held-to-maturity securities (in thousands).

	Three months ended September 30,				Nine months ended September 30,
	2010		2009		2010		2009
Proceeds from sales	$	0	$	0	$	1,773	$	0
Gross realized gains		0		0		0		0
Gross realized losses		0		0		236		0

Available-for-Sale (AFS) Securities

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

	Three months ended September 30,				Nine months ended September 30,
	2010		2009		2010		2009
Proceeds from sales	$	8,706	$	1,545	$	10,425	$	3,585
Gross realized gains		43		4		316		31
Gross realized losses		0		0		0		0

11

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

3. LOANS

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

	September 30, 2010					December 31, 2009
	Amount		%			Amount		%
Loans held for sale
Real estate:
Commercial	$	2,469		0.1	%	$	10,698		0.3	%
Residential mortgage		4,654		0.1	%		1,080		0.0	%
Total loans held for sale		7,123		0.2	%		11,778		0.3	%
Loans held for investment
Domestic:
Commercial and industrial		588,127		20.5	%		795,789		24.5	%
Real estate:
Commercial		1,589,959		55.4	%		1,667,038		51.6	%
Construction		268,691		9.4	%		360,444		11.1	%
Residential mortgage		362,402		12.6	%		344,807		10.6	%
Consumer/other		44,413		1.5	%		52,124		1.6	%
Foreign loans:
Commercial and industrial		9,078		0.3	%		10,752		0.3	%
Other loans		282		0.1	%		2,319		0.0	%
Total loans held for investment		2,862,952		99.8	%		3,233,273		99.7	%
Total loans	$	2,870,075		100.0	%	$	3,245,051		100.0	%

Loan maturities and rate sensitivity of the loans held for investment, excluding residential mortgage and consumer loans, at September 30, 2010 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	$	372,102	$	194,150	$	21,875	$	588,127
Real estate - commercial		233,826		774,515		581,618		1,589,959
Real estate - construction		107,554		118,807		42,330		268,691
Foreign loans		5,602		1,465		2,134		9,201
Total	$	719,084	$	1,088,937	$	647,957	$	2,455,978
Loans with a fixed interest rate	$	223,373	$	732,465	$	172,761	$	1,128,599
Loans with a floating interest rate		495,711		356,472		475,196		1,327,379
Total	$	719,084	$	1,088,937	$	647,957	$	2,455,978

The loan portfolio consists of various types of loans with approximately 90% outstanding to borrowers located in the Houston, San Antonio, Dallas and Fort Worth, Texas metropolitan areas.

The Company’s largest industry concentration was in the hospitality loan portfolio, which was approximately $293 million, or 10%, of total loans held for investment at September 30, 2010. As of September 30, 2010, there were no other concentrations of loans to any one type of industry exceeding 10% of total loans, nor were there any loans classified as highly leveraged transactions.

12

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

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, 2010			December 31, 2009
Beginning balance	$	2,141		$	2,100
New loans		227			240
Repayments		(139	)		(199	)
Ending balance	$	2,229		$	2,141

A loan is impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. The recorded investment in individually assessed impaired loans was $183 million at September 30, 2010, of which $15.4 million required specific reserves of $3.1 million. The recorded investment in individually assessed impaired loans was $150 million at December 31, 2009, of which $104 million required specific reserves of $11.6 million. The Company has no further significant commitments to lend additional funds to these borrowers. No interest on impaired loans was received during the three and nine month periods ended September 30, 2010 and 2009, respectively.

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. Nonperforming loans of $164 million at September 30, 2010 and $103 million at December 31, 2009, have been categorized by management as nonaccrual loans. Interest foregone on nonaccrual loans was $3.3 million and $8.5 million for the three and nine months ended September 30, 2010, respectively, and $2.1 million and $5.0 million for the same time periods in 2009.

At September 30, 2010, loans restructured as part of troubled debt restructurings totaled approximately $91.1 million of which $73.6 million were considered nonaccrual. Generally, a nonaccrual loan that is restructured remains on nonaccrual for a period of six months to demonstrate that the borrower can meet the restructured terms.

Accruing loans 90 days past due or more were $953 thousand and $41 thousand at September 30, 2010 and December 31, 2009, respectively.

13

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

4. 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,
	2010			2009			2010			2009
Allowance for Credit Losses
Allowance for loan losses at beginning of period	$	80,983		$	53,075		$	74,732		$	49,177
Loans charged-off		8,633			37,834			38,755			56,449
Loan recoveries		(1,186	)		(437	)		(3,937	)		(1,898	)
Net loans charged-off		7,447			37,397			34,818			54,551
Provision for loan losses		7,218			54,381			40,840			75,433
Allowance for loan losses at end of period		80,754			70,059			80,754			70,059
Allowance for unfunded loan commitments at beginning of period		1,502			1,102			2,852			1,654
Provision (credit) for losses on unfunded loan commitments		498			1,750			(852	)		1,198
Allowance for unfunded loan commitments at end of period		2,000			2,852			2,000			2,852
Total allowance for credit losses	$	82,754		$	72,911		$	82,754		$	72,911

5. GOODWILL AND OTHER INTANGIBLES

Goodwill totaled $173 million at September 30, 2010 and December 31, 2009. For the Company’s annual impairment test performed as of September 30, 2010, the Sterling Bank reporting unit did not pass the first step of the impairment test, and therefore, the Company conducted the second step of the impairment testing. The second step required a comparison of the implied fair value of goodwill to the carrying amount of goodwill and was based on information that was as of September 30, 2010. Based on the results of the step two analysis the Company determined there was no impairment of goodwill at September 30, 2010. In light of the overall instability of the economy, the continued volatility in the financial markets, the downward pressure on bank stock prices and expectations of financial performance for the banking industry, including the reporting units, management’s estimates of fair value may be subject to change or adjustment. Estimates of fair value are determined based on a complex model using cash flows and company comparisons. If management’s estimates of future cash flows are inaccurate, the fair value determined could be inaccurate and impairment may not be recognized in a timely manner. If the company’s market capitalization declines or remains below book value, the company may update its valuation analysis to determine whether goodwill is impaired. No assurance can be given that goodwill will not be written down in future periods.

Goodwill and intangible assets that have indefinite useful lives are subject to at least an annual impairment test and more frequently if a triggering event occurs or circumstances change between annual tests that would more likely than not reduce the fair value of our reporting units below their carrying amount. Other intangible assets consist primarily of core deposits and other intangibles. Intangible assets with definite useful lives are amortized on an accelerated basis over the years expected to be benefited, which we believe is approximately 10 years. An intangible asset subject to amortization shall be tested for recoverability whenever events or changes in circumstances, such as a significant or adverse change in the business climate that could affect the value of the intangible asset, indicate that its carrying amount may not be recoverable. An impairment loss is recorded to the extent the carrying amount of the intangible asset exceeds its fair value.

The Company’s annual evaluation is performed as of September 30 of each year. The goodwill impairment test involves a two-step process. Under the first step, goodwill is assigned to reporting units for purposes of impairment testing. Reporting units used for the goodwill impairment testing include our banking subsidiary, Sterling Bank and MBM Advisors, a wholly owned subsidiary of Sterling Bank that provides investment advisory and pension administration/consulting services. The estimation of fair value of each reporting unit is compared with its carrying value including the allocated goodwill. At September 30, 2010, goodwill totaled $173 million of which $165 million, or 95%, was allocated to Sterling Bank. If the estimated fair value of a reporting unit is less than its carrying value including goodwill, the second step is performed to measure the amount of impairment, if any. Goodwill impairment exists when the implied fair value of goodwill derived under step two is less than its carrying value.

To determine the fair value of the reporting units under step one of the impairment test, both an income approach and market approach were utilized. The income approach was based on projected cash flows derived from assumptions of balance sheet and income statement activity. Value was then derived by present valuing the projected cash flows using an appropriate risk-adjusted discount rate based on a market participant’s cost of equity. Value under the market approach was based on applying various market capitalization pricing multiples, such as price to tangible book, price to earnings, etc., observed from comparable companies to the reporting unit. The results of the income and market approach were weighted to arrive at the final estimation of fair value for the reporting unit. As the ability to identify truly comparable companies lessened given the fluctuations in market capitalization across the banking industry, the Company believed that a heavier weighting on the income approach was more appropriate.

The aggregate fair values of the reporting units as determined under step one of the impairment test were compared to market capitalization as an assessment of the reasonableness of the estimated fair values of the reporting units. For each of the impairment tests performed, the comparison between the aggregate fair values and market capitalization indicated an implied premium which was within the range of control premiums observed in the marketplace.

14

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

To determine the implied fair value of goodwill, the fair value of Sterling Bank (as determined in step one) was allocated to all assets and liabilities of the reporting unit including any recognized or unrecognized intangible assets in a manner similar to a purchase price allocation. Key valuations included the fair value of the loan portfolio and debt, and the assessment of core deposit and trade name intangible assets. The valuation of the loan portfolio, net of allowance for credit losses resulted in an overall discount of approximately three percent which we believe was supported by transactions occurring in the marketplace and was consistent with the “exit price” principle of fair value. The implied fair value of Sterling Bank’s goodwill exceeded its carrying value by an estimated 20% as of September 30, 2010; therefore, the Company determined there was no impairment of goodwill as of that date.

Other intangible assets totaled $10.0 million at September 30, 2010 including $7.5 million related to core deposits and $2.5 million related to customer relationships. Other intangible assets totaled $11.6 million at December 31, 2009, including $8.8 million related to core deposits and $2.8 million related to customer relationships. 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 $537 thousand and $1.6 million for the three and nine month periods ended September 30, 2010, respectively, and $565 thousand and $1.7 million for the same time periods in 2009, respectively.

The projected amortization for core deposits and other intangibles as of September 30, 2010 was as follows (in thousands):

2010	$	527
2011		2,011
2012		1,801
2013		1,695
2014		1,584
Thereafter		2,386
Total	$	10,004

6. OTHER BORROWED FUNDS

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

	September 30, 2010		December 31, 2009
Federal Home Loan Bank advances	$	40,000	$	40,500
Repurchase agreements		64,679		55,695
Federal funds purchased and other short-term borrowings		1,867		1,050
Total	$	106,546	$	97,245

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, 2010, the Company had total funds of $1.8 billion available under this agreement of which $40.0 million was outstanding with an average interest rate of 2.94%. At September 30, 2010, the Company had $40.0 million of FHLB advances with a maturity of seven years. 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

15

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

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 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, 2010 and December 31, 2009, the Company had securities sold under agreements to repurchase with banking customers of $14.7 million and $5.7 million, respectively. Structured repurchase agreements totaled $50.0 million at September 30, 2010 and December 31, 2009, 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 fixed rate of 3.88% and 3.50%, respectively. The rate on these repurchase agreements was zero at December 31, 2009. The Company may be required to provide additional collateral based on the fair value of the underlying pledged securities.

7. SUBORDINATED DEBT

The Bank has $75.0 million of subordinated debt outstanding as of September 30, 2010. Of that $75.0 million, $50.0 million is in subordinated unsecured notes that 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 9).

The remaining subordinated debt outstanding at the Bank is 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 note is due and payable on September 15, 2018. The Bank may prepay the subordinated note without penalty on any interest payment date on or after September 15, 2013. As of September 30, 2010, the floating rate was 2.79% on the subordinated note compared to 2.75% at December 31, 2009.

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

As of September 30, 2010 and December 31, 2009, 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 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.

16

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

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, 2010, the floating rate on these securities was 3.74%, 3.63% and 1.89%, respectively, compared to 3.70%, 3.38% and 1.85%, respectively, at December 31, 2009.

9. 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). The Company may also designate 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 noninterest income.

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 Company’s only derivative contract outstanding at both September 30, 2010 and December 31, 2009, was an interest rate swap agreement that was designated as a fair value hedge. The table below presents the fair value of the Company’s interest rate swap agreement as well as its classification on the Consolidated Balance Sheets (in thousands):

September 30, 2010						December 31, 2009
		Fair Value						Fair Value
Notional Amount		Other Assets		Other Liabilities		Notional Amount		Other Assets		Other Liabilities
$	50,000	$	3,639	$	0	$	50,000	$	2,357	$	0

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. This swap is designated as a fair value hedge of the Company’s $50.0 million in subordinated debentures and qualifies for the “short-cut” method of accounting. 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%.

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 interest rate swap agreement 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.

17

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

The table below presents the effect of the Company’s interest rate swap agreement on the Consolidated Statements of Income (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 Three Months Ended September 30,				Interest expense Nine Months Ended September 30,					Interest expense Three Months Ended September 30,						Interest expense Nine Months Ended September 30,
2010		2009		2010		2009			2010			2009			2010			2009
$	375	$	587	$	1,282	$	(541	)	$	(375	)	$	(587	)	$	(1,282	)	$	541

The Company recognized a net reduction to interest expense of $396 thousand and $1.3 million for the three and nine months ended September 30, 2010, respectively, related to the Company’s interest rate swap agreement. For the three and nine months ended September 30, 2009, the Company recognized a net reduction to interest expense of $382 thousand and $963 thousand, respectively

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 used 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, 2010 and December 31, 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, 2010 and 2009, 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 gains of $24 thousand and $2.1 million, respectively, for hedge ineffectiveness attributable to the aggregate principal amount of the designated loan pools falling below the notional amount. No hedge ineffectiveness was recognized during the three and nine month periods ended September 30, 2010.

At September 30, 2010, there was no remaining gain reported in other comprehensive income related to the terminated collar.

The table below presents the effect of the Company’s interest rate floor and collar on the Consolidated Statements of Income (in thousands):

	Three Months Ended September 30,					Nine Months  Ended September 30,
	2010		2009			2010		2009
Amount of gain recognized in OCI (effective portion)	$	0	$	(1,016	)	$	0	$	(455	)
Amount of gain reclassified from OCI into income (effective portion):
Interest income		717		2,044			5,309		9,833
Other noninterest income		0		0			0		2,488
Amount of gain recognized into other noninterest income
(Ineffective portion and amount excluded from effectiveness testing)		0		(24	)		0		2,132

18

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

10. INCOME TAXES

Net deferred tax assets totaled $29.9 million at September 30, 2010 and $26.3 million at December 31, 2009. No valuation allowance was recorded against deferred tax assets at September 30, 2010, as management believes that it is more likely than not that all of the deferred tax assets will be realized because they were supported by recoverable taxes paid in prior years. The provision for income taxes during interim reporting periods historically has been calculated by applying an estimate of the annual effective tax rate for the full fiscal year to “ordinary” income or loss (pre-tax income or loss excluding significant unusual or infrequently occurring items) for the reporting period. For the reporting period ended September 30, 2010, the Company has computed the provision for income taxes based on the actual effective tax rate for the year-to-date by applying the discrete method. The Company has determined that small changes in estimated “ordinary” income, combined with the impact of permanent non-taxable items result in significant changes in the estimated annual effective tax rate. As such, the historical method would not provide a reliable estimate for the reporting period ended September 30, 2010. The actual effective rate for the reporting period ended September 30, 2010 is impacted by the level of permanent differences, including tax-advantaged investment and loan income, resulting in an effective rate above statutory rates for the interim reporting periods.

The Company files income tax returns in the U.S. federal jurisdiction. The Company is no longer subject to U.S. federal income tax examinations by tax authorities for years before 2006.

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.

Included in the Program are certain grants of performance-based share awards whose vesting is contingent on the Company obtaining certain performance metrics. These performance metrics include an earnings per share growth versus the Company’s peer banks and a return on assets performance versus the Company’s peer banks. The Company records the performance-based share awards assuming performance metrics will be obtained. Periodically, the Company assesses its metrics as compared to its peers and estimates a certain percentage of the awards will be earned. During 2009 the Company revised its estimates for performance-based share awards granted in 2007 to reflect a 50% performance obtainment. During 2010 the Company revised its estimates for performance-based share awards granted in 2008 to reflect that no vesting would occur due to the Company’s performance measures not being achieved. As a result, during the three and nine month periods ended September 30, 2010, the Company reversed approximately $400 thousand and $1.4 million, respectively, of stock-based compensation expense related to performance-based share awards granted in 2008. The Company estimates that performance metrics will be obtained for performance-based shares granted in 2009 and 2010, however, if performance measures are not met, the expense for these awards not earned will be reversed.

Total stock-based compensation expense that was charged against income was $463 thousand and $1.1 million for the three and nine month periods ended September 30, 2010, respectively, and $1.2 million and $3.3 million, respectively, for the same time periods in 2009. The total income tax benefit recognized in the income statement for stock-based compensation arrangements was $30 thousand and $25 thousand, respectively, for the three and nine month periods ended September 30, 2010 and $320 thousand and $876 thousand, respectively, for the three and nine month periods ended September 30, 2009.

On December 20, 2007, the Company entered into an 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 the stock grant was based on the current market price on the date of grant. The Company recorded the performance-based share awards assuming 100% of the performance metrics would be obtained. During 2009, the Company revised its estimate and determined that the CEO had earned 50% of the PRSUs awarded in 2007. This plan expired on December 31, 2009.

On July 9, 2010, the Company entered into a new employment agreement with its CEO, in which the CEO was awarded 187,500 PRSUs. The PRSUs will be earned based on specified performance metrics which include an earnings per share growth versus the Company’s peer banks and a return on assets performance versus the Company’s peer banks. The PRSUs have a three year vesting period and will vest on June 30, 2013, based on the Company’s performance as compared to its peers over the three year period beginning July 1, 2010, and ending on June 30, 2013.

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, 2010, 15,008 and 50,747 shares, respectively, were subscribed for through payroll deductions under the Purchase Plan compared to 19,003 and 62,923 shares for the same periods in 2009, respectively.

12. SHAREHOLDERS’ EQUITY

Common stock –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.

19

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

During the first quarter of 2010, the Company issued 20.0 million shares of its common stock through a public stock offering, which resulted in net proceeds of approximately $86.6 million, after deducting underwriting fees and estimated offering expenses.

Preferred stock – 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 and (ii) issued a ten-year warrant (the “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 was sold to the U.S. Treasury in December of 2008. The Company was approved to pay the funds back without any condition from regulators. As a result of the redemption, the Company recorded a one-time $7.5 million charge to retained earnings 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. The Warrant to purchase 2.6 million shares of the Company’s common stock remained outstanding with the U.S. Treasury until they were auctioned by the U.S. Treasury in June 2010. The Warrant is listed on Nasdaq under the symbol “SBIBW.”

Treasury stock – On April 25, 2005, the Company’s Board of Directors authorized the repurchase of up to 2.5 million shares of common stock, not to exceed 500 thousand shares in any calendar year. On January 29, 2007, the Company’s Board of Directors authorized an increase in the number of shares to be repurchased to adjust for the three-for-two stock split approved by the Board of Directors on October 30, 2006. On July 30, 2007, the Company’s Board of Directors amended its existing common stock repurchase program (the “Repurchase Program”). The amendment increased by 750 thousand shares the total number of shares that may be repurchased by the Company under the Repurchase Program in the fiscal year 2007. The aggregate number of shares originally approved by the Board of Directors for repurchase under the Repurchase Program remains unchanged at 3.8 million 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. There were no shares repurchased during the three and nine month periods ended September 30, 2010 and 2009.

13. 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,
	2010		2009			2010			2009
Net income (loss) applicable to common shareholders	$	4,455	$	(24,724	)	$	(1,197	)	$	(24,052	)
Basic:
Weighted average shares outstanding		101,934		81,707			97,487			77,659
Diluted:
Add incremental shares for:
Assumed exercise of outstanding options and nonvested share awards		278		0			0			0
Total		102,212		81,707			97,487			77,659
Earnings (loss) per common share:
Basic	$	0.04	$	(0.30	)	$	(0.01	)	$	(0.31	)
Diluted	$	0.04	$	(0.30	)	$	(0.01	)	$	(0.31	)

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 earnings per common share excludes 1,812,905 shares because they were antidilutive for the three months ended September 30, 2010. Options and novested share awards have been excluded from the computation of diluted loss per share for the nine month period ended September 30, 2010, and the three and nine month periods ended September 30, 2009, as the effect would have been antidilutive. In addition, the calculation excludes the Warrant issued in December 2008 to purchase 2.6 million shares of common stock, which was antidilutive.

20

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

14. 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 $2.3 million and $7.9 million for the three and nine months ended September 30, 2010, respectively, and $2.9 million and $8.8 million for the three and nine months ended September 30, 2009, respectively. For information regarding these commitments refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.

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 previously entered into severance and non-competition agreements with its CEO and certain other executive officers. Under agreements with executive officers, upon a termination of employment under the circumstances described in the agreements, 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 agreements); (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.

On July 9, 2010, the Company entered into a new employment agreement with its CEO deemed effective as of July 1, 2010. If, prior to the expiration of the employment term and prior to a change of control, the Company terminates the CEO’s employment without cause, or the CEO voluntarily resigns for good reason, the Company shall be obligated to pay the CEO a lump sum cash payment in an amount equal to the aggregate base salary that he would have earned during the remainder of the employment term, and shall be obligated to continue the provision of benefits under the terms of the new employment agreement through the employment term. The CEO would also be entitled to receive a pro rata portion of 187,500 PRSUs. If, following a change of control, the Company terminates the CEO’s employment for any reason other than death or disability, or the CEO voluntarily resigns for good reason, the Company shall be obligated to pay the CEO a lump sum cash payment equal to three times his base salary and cash bonus as calculated pursuant to the Employment Agreement, and shall be obligated to continue benefits through the remainder of the employment term or three years after the change of control.

15. 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.

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

	September 30, 2010		December 31, 2009
Commitments to extend credit	$	665,454	$	704,107
Standby and commercial letters of credit		53,848		55,312

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 customer, the Company has rights to the underlying collateral,

21

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

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.

16. 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, Sterling Bancshares and the Bank must maintain minimum capital amounts and ratios as defined in the regulations. Management believes, as of September 30, 2010 and December 31, 2009, that Sterling Bancshares 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.

In the current economic environment, the Company regularly assesses its ability to maintain and build its regulatory capital levels. In making this assessment, the Company takes into account a variety of factors, including its views as to the duration of the recession and the consequent impact on its markets and the real estate markets in particular, the Company’s provisioning for and charge-offs of nonperforming assets, the liquidity needs of its organization, the capital levels of its peer institutions, and its ability to access the capital markets.

The Company also takes into account its discussions and agreements with the Federal Deposit Insurance Corporation (“FDIC”) and its other regulators. As part of an informal agreement that Sterling Bank entered into on January 26, 2010, with the FDIC and the Texas Department of Banking, the Company submitted to such regulatory agencies a capital management plan that reflects Sterling Bank’s plans to maintain for the next three years minimum regulatory capital levels that are in excess of the minimum requirements to remain well-capitalized but below its regulatory capital levels at September 30, 2010. If the Company is unable to maintain the regulatory capital levels that it proposes in its capital management plan or if it fails to adequately resolve any other matters that any of its regulators may require the Company to address in the future, the Company could become subject to more stringent supervisory actions. At September 30, 2010, the Company believes it is in compliance regarding the informal agreement with the regulatory agencies and the capital plan that was submitted and accepted by those agencies.

22

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

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, 2010:
Total capital (to risk weighted assets)	$	597,088		17.9	%	$	267,119		8.0	%		N/A		N/A
Tier 1 capital (to risk weighted assets)		508,394		15.2	%		133,560		4.0	%		N/A		N/A
Tier 1 capital (to average assets)		508,394		10.5	%		193,060		4.0	%		N/A		N/A
As of December 31, 2009:
Total capital (to risk weighted assets)	$	526,919		14.4	%	$	292,569		8.0	%		N/A		N/A
Tier 1 capital (to risk weighted assets)		424,409		11.6	%		146,284		4.0	%		N/A		N/A
Tier 1 capital (to average assets)		424,409		8.9	%		191,045		4.0	%		N/A		N/A
STERLING BANK:
As of September 30, 2010:
Total capital (to risk weighted assets)	$	553,177		16.6	%	$	266,897		8.0	%	$	333,621		10.0	%
Tier 1 capital (to risk weighted assets)		464,518		13.9	%		133,448		4.0	%		200,173		6.0	%
Tier 1 capital (to average assets)		464,518		9.6	%		192,929		4.0	%		241,161		5.0	%
As of December 31, 2009:
Total capital (to risk weighted assets)	$	513,792		14.1	%	$	292,309		8.0	%	$	365,386		10.0	%
Tier 1 capital (to risk weighted assets)		411,322		11.3	%		146,154		4.0	%		219,232		6.0	%
Tier 1 capital (to average assets)		411,322		8.6	%		190,915		4.0	%		238,644		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. The capital management plan that the Company submitted to its regulators, reflects a variety of operational factors including the Company’s plans for dividend payments from the Bank to Sterling Bancshares and from Sterling Bancshares to its shareholders.

17. 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.

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

23

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

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.

The Company uses 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, 2010		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	$	1,169,519	$	0	$	1,169,519	$	0
Interest rate swap		3,639		0		3,639		0
	Balance at December 31, 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	$	846,216	$	0	$	843,731	$	2,485
Interest rate swap		2,357		0		2,357		0

24

STERLING BANCSHARES, INC. AND SUBSIDIARIES

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 included 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.

	Three Months Ended September 30,
	2010			2009
Balance at beginning of period	$	0		$	2,394
Total gains or losses for the period included in:
Noninterest income		0			0
Other comprehensive income		0			294
Purchases, issuances, settlements and amortization		0			(191	)
Transfers in and/or out of Level 3		0			0
Balance at end of period	$	0		$	2,497
Net unrealized losses included in net income for the period relating to assets held at the end of period	$	0		$	0
	Nine Months Ended September 30,
	2010			2009
Balance at beginning of period	$	2,485		$	2,516
Total gains or losses for the period included in:
Noninterest income		213			0
Other comprehensive income		0			563
Purchases, issuances, settlements and amortization		(2,698	)		(582	)
Transfers in and/or out of Level 3		0			0
Balance at end of period	$	0		$	2,497
Net unrealized losses included in net income for the period relating to assets held at the end of period	$	0		$	0

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, 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 three and nine month periods ended September 30, 2010, individually assessed impaired loans over $100 thousand were remeasured and reported at fair value through a specific valuation allowance allocation of the allowance for loan losses or through a charge-off based upon the fair value of the underlying collateral. Individually assessed impaired loans with an outstanding book value at September 30, 2010 of $60.0 million were reduced by a specific valuation allowance or charged-down to their fair value of $41.8 million during the nine months ended September 30, 2010.

The Company recorded additions to other real estate owned and other repossessed assets of $12.2 million and $8 thousand, respectively, which were outstanding at September 30, 2010. 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 were remeasured at fair value

25

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

subsequent to their initial recognition. In connection with the remeasurement, the Company recorded write-downs of other real estate owned of $392 thousand and $1.7 million, respectively, for the three and nine month periods ended September 30, 2010. During the three and nine month periods ended September 30, 2010, the Company sold other real estate owned with a book value of $8.5 million and $16.6 million, respectively resulting in net gains of $1.4 million and $2.4 million, for the same time periods.

As of September 30, 2010, the Company had a balance of $7.1 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. Loans are classified as held for sale when management has positively determined that the loans will be sold in the foreseeable future and the Company has the ability to do so. The classification may be made upon origination or subsequent to the origination or purchase. Once a decision has been made to sell loans not previously classified as held for sale, such loans are transferred into the held for sale classification and carried at the lower of cost or fair value. During the nine month periods ended September 30, 2010, the Company recorded a lower of cost or market adjustment of $3.0 million on certain nonperforming commercial real estate loans. There were no lower of cost or market adjustments recorded during the three month period ended September 30, 2010

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, 2010.

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

	September 30, 2010				December 31, 2009
	Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
Financial assets:
Held-to-maturity securities	$	280,215	$	287,163	$	222,845	$	222,340
Loans held for sale		7,123		7,123		11,778		11,778
Loans held for investment, net of allowance		2,782,198		2,682,537		3,158,541		2,998,569
Financial liabilities:
Time deposits		840,683		841,088		946,279		946,897
Other borrowed funds		106,546		113,529		97,245		95,368
Subordinated debt		78,624		73,515		77,338		72,889
Junior subordinated debt		82,734		65,664		82,734		54,414

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 primarily 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 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. The estimate of lifetime credit losses was increased during 2009 because of more recent loss experience and the expectation of a prolonged cycle of economic weakness. The Company has applied a liquidity

26

STERLING BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

spread to the discount rate due to a deterioration in the market for loan sales. 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.

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 the Company’s current spread levels.

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.

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.

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

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q, other periodic reports filed by us under the Exchange Act, and other written or oral statements made by or on behalf of us 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 liquidity risk;

• 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;

27

• 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;

• the enactment and implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act;

• federal and state governments could pass additional 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, 2009, filed with the Securities and Exchange Commission.

RECENT LEGISLATION IMPACTING THE FINANCIAL SERVICES INDUSTRY

We operate in a highly regulated environment. Recent and future changes in the laws and regulations that govern our operations, corporate governance, and executive compensation, changes in the accounting principles that are applicable to us, and our potential failure to comply with the foregoing, may adversely affect us.

We are subject to extensive regulation, supervision, and legislation that governs almost all aspects of our operations. See “Management’s Discussion and Analysis — Supervision and Regulation” included in our Annual Report on Form 10-K for the year ended December 31, 2009. The laws and regulations applicable to the banking industry could change at any time and are primarily intended for the protection of customers, depositors and the deposit insurance funds. Intended to protect customers, depositors and deposit insurance funds, these laws and regulations, among other matters, prescribe minimum capital requirements, impose limitations on the business activities in which we can engage, limit the dividends or distributions that our banking institutions can pay to our holding company, restrict the ability of institutions to guarantee our parent company’s debt, impose certain specific accounting requirements on us that may be more restrictive and may result in greater or earlier charges to earnings or deductions in our capital than generally accepted accounting principles. Compliance with laws and regulations can be difficult and costly, and changes to laws and regulations often impose additional compliance costs, higher fees and insurance premiums and additional oversight by us or third party personnel. Further, our failure to comply with these laws and regulations, even if the failure follows a good faith effort or a difference in interpretation, could subject us to restrictions on our business activities, fines and other penalties, any of which could adversely affect our results of operations, capital base and the price of our securities.

28

The President of the United States signed the “Dodd-Frank Wall Street Reform and Consumer Protection Act”, or the Dodd-Frank Act, into law on July 21, 2010. This legislation makes extensive changes to the laws regulating financial services firms as well as to corporate governance matters affecting public companies. It requires significant rule-making and, in addition, mandates numerous studies, which could result in additional legislative or regulatory action. We are in the process of evaluating this new legislation.

Among other things, the legislation authorizes various assessments and fees, including increases in Federal Deposit Insurance Corporation premiums (and changes in how such premiums will be assessed), requires the establishment of minimum leverage and risk-based capital requirements for insured depository institutions, and requires the SEC to complete studies and develop rules or approve stock exchange rules regarding various investor protection issues, including shareholder access to the proxy process, and various matters pertaining to executive compensation and compensation committee oversight.

The legislation also establishes a new independent Consumer Financial Protection Bureau which will have broad rulemaking, supervisory and enforcement authority over consumer products, including mortgages, home-equity loans and credit cards. Further, states will be permitted to adopt stricter consumer protection laws and state attorney generals can enforce those laws as well as consumer protection rules issued by the Consumer Financial Protection Bureau.

The changes resulting from the Dodd-Frank Act and its associated rulemaking could impact the profitability of our business activities, require changes to certain of our business practices, impose upon us more stringent capital, liquidity and leverage ratio requirements or otherwise adversely affect our business. These changes may also require us to invest significant management attention and resources to evaluate and make necessary changes. We are continuing to evaluate the effects of the Dodd-Frank Act on the Company. We do not believe it will have a material impact on our financial position and results of operations.

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 56 banking centers in the greater metropolitan areas of Houston, San Antonio, Dallas and Fort Worth, Texas.

At September 30, 2010, we had consolidated total assets of $5.0 billion, total loans of $2.9 billion, total deposits of $4.1 billion and shareholder’s equity of $627 million.

We reported net income of $4.5 million, or $0.04 per diluted common share for the quarter ended September 30, 2010, compared to a net loss of $24.7 million, or $0.30 per diluted share for the third quarter of 2009. Net loss applicable to common shareholders for the nine months ended September 30, 2010, was $1.2 million, or $0.01 per diluted common share, compared with a net loss applicable to common shareholders of $24.1 million, or $0.31 per diluted common share for the same period in 2009.

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, 2010.

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 2009 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.”

29

NEW ACCOUNTING GUIDANCE

Fair Value Measurement and Disclosures: In January 2010, the FASB issued Accounting Standards Update (“ASU”) No. 2010-06 (“ASU 2010-06”)Improving Disclosures About Fair Value Measurements which amends ASC 820-10Fair Value Measurement and Disclosures.ASU 2010-06 provides amendments to ASC 820-10 that require new disclosures regarding activity within the Level 1, 2 and 3 fair value measurements. ASU 2010-06 also clarifies existing disclosures regarding the level of disaggregation of assets and liabilities in addition to the disclosures about the valuation techniques and inputs used to measure fair value. ASC 820 affirmed 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 provided 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. We adopted ASC 820 during the quarter ended June 30, 2009. ASC 820 did not have a significant impact on our financial condition and results of operations. We adopted ASU 2010-06 during the first quarter of 2010. The enhanced disclosures related to ASU 2010-06 and ASC 820 are included in Note 17 – Disclosures About Fair Value of Financial Instruments.

Financial Instruments: ASC 825 and ASU 2010-06 Financial 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 17 – Disclosures About Fair Value of Financial Instruments.

Transfers and Servicing: ASC 860Transfers and Servicing improves 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 is 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. The adoption of ASC 860 did not have a significant impact on our financial condition or results of operations.

Consolidation: ASC 810Consolidation improves 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 is 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. The adoption of ASC 810 did not have a significant impact on our financial condition or results of operations.

Receivables: In July 2010, the FASB issued ASU 2010-20Receivables (Topic 830) – Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. ASU 2010–20 requires entities to provide disclosures designed to facilitate financial statement users’ evaluation of (i) the nature of credit risk inherent in the entity’s portfolio of financing receivables, (ii) how that risk is analyzed and assessed in arriving at the allowance for credit losses and (iii) the changes and reasons for those changes in the allowance for credit losses. Disclosures must be disaggregated by portfolio segment, the level at which an entity develops and documents a systematic method for determining its allowance for credit losses, and class of financing receivable. The required disclosures include, among other things, a rollforward of the allowance for credit losses as well as information about modified, impaired, nonaccrual and past due loans and credit quality indicators. ASU 2010–20 will be effective for the Company’s financial statements as of December 31, 2010, as it relates to disclosures required as of the end of a reporting period. Disclosures that relate to activity during a reporting period will be required for the Company’s financial statements that include periods beginning on or after January 1, 2011.

30

SELECTED FINANCIAL DATA

	Three Months Ended September 30,						Nine Months Ended September 30,						Year Ended December 31,
	2010			2009			2010			2009			2009
	(Dollars and shares in thousands, except per share amounts)
INCOME STATEMENT DATA:
Net interest income	$	42,157		$	47,851		$	129,084		$	144,929		$	191,709
Provision for credit losses		7,716			56,131			39,988			76,631			87,631
Noninterest income		9,490			9,113			24,552			30,404			35,895
Noninterest expense		37,780			40,075			117,539			123,694			163,184
Income (loss) before income taxes		6,151			(39,242	)		(3,891	)		(24,992	)		(23,211	)
Net income (loss)		4,455			(24,724	)		(1,197	)		(14,710	)		(12,974	)
Net income (loss) applicable to common shareholders		4,455			(24,724	)		(1,197	)		(24,052	)		(22,316	)
BALANCE SHEET DATA (at period-end):
Total assets	$	5,039,621		$	4,859,518		$	5,039,621		$	4,859,518		$	4,937,048
Total loans		2,870,075			3,350,707			2,870,075			3,350,707			3,245,051
Allowance for loan losses		80,754			70,059			80,754			70,059			74,732
Total securities		1,449,734			999,511			1,449,734			999,511			1,069,061
Total deposits		4,103,211			4,007,454			4,103,211			4,007,454			4,094,951
Other borrowed funds		106,546			99,486			106,546			99,486			97,245
Subordinated debt		78,624			77,616			78,624			77,616			77,338
Junior subordinated debt		82,734			82,734			82,734			82,734			82,734
Shareholders’ equity		626,802			545,512			626,802			545,512			540,533
COMMON SHARE DATA:
Earnings (loss) per common share (1):
Basic shares	$	0.04		$	(0.30	)	$	(0.01	)	$	(0.31	)	$	(0.28	)
Diluted shares	$	0.04		$	(0.30	)	$	(0.01	)	$	(0.31	)	$	(0.28	)
Shares used in computing earnings (loss) per common share:
Basic shares		101,934			81,707			97,487			77,659			78,696
Diluted shares		102,212			81,707			97,487			77,659			78,696
End of period common shares outstanding		101,952			81,755			101,952			81,755			81,853
Book value per common share at period-end	$	6.15		$	6.67		$	6.15		$	6.67		$	6.60
Cash dividends paid per common share	$	0.015		$	0.055		$	0.045		$	0.165		$	0.180
Common stock dividend payout ratio		34.35	%		(18.19	)%		(358.14	)%		(85.45	)%		(106.36	)%
SELECTED PERFORMANCE RATIOS AND OTHER DATA:
Return on average common equity (2)		2.80	%		(16.98	)%		(0.26	)%		(5.77	)%		(4.01	)%
Return on average assets (2)		0.35	%		(1.97	)%		(0.03	)%		(0.39	)%		(0.26	)%
Tax equivalent net interest margin (3)		3.68	%		4.20	%		3.81	%		4.26	%		4.22	%
Efficiency ratio (4)		72.53	%		69.56	%		75.86	%		68.73	%		69.17	%
Full-time equivalent employees		986			1,013			986			1,013			1,012
Number of banking centers		56			60			56			60			58
LIQUIDITY AND CAPITAL RATIOS:
Average loans to average deposits		71.63	%		85.86	%		74.51	%		91.82	%		88.33	%
Period-end shareholders’ equity to total assets		12.44	%		11.23	%		12.44	%		11.23	%		10.95	%
Average shareholders’ equity to average assets		12.53	%		11.60	%		12.15	%		12.18	%		11.92	%
Period-end tangible capital to total tangible assets		9.13	%		7.70	%		9.13	%		7.70	%		7.48	%
Tier 1 capital to risk-weighted assets		15.23	%		11.20	%		15.23	%		11.20	%		11.61	%
Total capital to risk-weighted assets		17.88	%		13.95	%		17.88	%		13.95	%		14.41	%
Tier 1 leverage ratio (Tier 1 capital to average assets)		10.53	%		8.88	%		10.53	%		8.88	%		8.89	%
ASSET QUALITY RATIOS:
Period-end allowance for credit losses to period-end loans		2.88	%		2.18	%		2.88	%		2.18	%		2.39	%
Period-end allowance for loan losses to period-end loans		2.81	%		2.09	%		2.81	%		2.09	%		2.30	%
Period-end allowance for loan losses to nonperforming loans		49.31	%		73.76	%		49.31	%		73.76	%		72.86	%
Nonperforming loans to period-end loans		5.71	%		2.83	%		5.71	%		2.83	%		3.16	%
Nonperforming assets to period-end assets		3.54	%		2.20	%		3.54	%		2.20	%		2.42	%
Net charge-offs to average loans (2)		1.01	%		4.27	%		1.52	%		2.01	%		1.72	%

(1) The calculation of diluted earnings per common share excludes 1,812,905 shares for the three months ended September 30, 2010, as the effect would have been antidilutive. Options and novested share awards have been excluded from the computation of diluted loss per share for the nine month period ended September 30, 2010, the three and nine month periods ended September 30, 2009 and for the year ended 2009, as the effect would have been antidilutive.

(2) Interim periods annualized.

(3) Taxable-equivalent basis assuming a 35% tax rate. The Company presents net interest income on a tax-equivalent basis. Accordingly, net interest income from tax-exempt securities and loans is presented in the net interest income results on a basis comparable to taxable securities and loans. This non-GAAP financial measure allows management to assess the comparability of net interest income arising from both taxable and tax-exempt sources.

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

31

RESULTS OF OPERATIONS

Net Income (Loss) Applicable to Common Shareholders –Net income was $4.5 million, or $0.04 per diluted common share, for the third quarter ended September 30, 2010, compared to a net loss of $24.7 million, or $0.30 per diluted common share, for the third quarter of 2009

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 to 0.25% at December 31, 2008. Rates remained at this historically low level throughout 2009 and 2010 and have negatively impacted our net interest income and margin during these periods.

32

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)
	2010								2009
	Average Balance			Interest		Average Yield/Rate			Average Balance			Interest		Average Yield/Rate
Interest-Earning Assets:
Loans held for sale (1)	$	5,390		$	28		2.06	%	$	1,607		$	23		5.68	%
Loans held for investment (1):
Taxable		2,930,124			40,122		5.43	%		3,467,555			49,586		5.67	%
Non-taxable (2)		295			4		5.52	%		5,080			72		5.60	%
Securities:
Taxable		1,286,050			9,841		3.04	%		844,651			9,286		4.36	%
Non-taxable (2)		112,188			1,497		5.30	%		97,858			1,307		5.30	%
Deposits in financial institutions		260,167			157		0.24	%		106,392			64		0.24	%
Other interest-earning assets		566			1		0.84	%		38,419			29		0.30	%
Total interest-earning assets		4,594,780			51,650		4.46	%		4,561,562			60,367		5.25	%
Noninterest-earning assets:
Cash and due from banks		65,765								46,106
Premises and equipment, net		48,359								50,123
Other assets		405,569								371,967
Allowance for loan losses		(81,171	)							(51,856	)
Total noninterest-earning assets		438,522								416,340
Total Assets	$	5,033,302							$	4,977,902
Interest-Bearing Liabilities:
Deposits:
Demand and savings	$	2,003,914		$	3,583		0.71	%	$	1,837,612		$	4,403		0.95	%
Certificates and other time		870,041			2,823		1.29	%		1,084,513			5,504		2.01	%
Other borrowed funds		103,902			784		2.99	%		145,625			346		0.94	%
Subordinated debt		78,472			747		3.78	%		77,232			748		3.84	%
Junior subordinated debt		82,734			1,071		5.14	%		82,734			1,082		5.19	%
Total interest-bearing liabilities		3,139,063			9,008		1.14	%		3,227,716			12,083		1.49	%
Noninterest-bearing sources:
Demand deposits		1,224,403								1,124,076
Other liabilities		39,078								48,480
Total noninterest-bearing liabilities		1,263,481								1,172,556
Shareholders’ equity		630,758								577,630
Total Liabilities and Shareholders’ Equity	$	5,033,302							$	4,977,902
Tax Equivalent Net Interest Income and Margin (2) (3)					42,642		3.68	%					48,284		4.20	%
Non-GAAP to GAAP Reconciliation:
Tax Equivalent Adjustment:
Loans					1								23
Securities					484								410
Total tax equivalent adjustment					485								433
Net Interest Income				$	42,157							$	47,851

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

(2) Taxable-equivalent basis assuming a 35% tax rate. Net interest income is presented on a tax-equivalent basis. Accordingly, net interest income from tax-exempt securities and loans is presented in the net interest income results on a basis comparable to taxable securities and loans. This non-GAAP financial measure allows management to assess the comparability of net interest income arising from both taxable and tax-exempt sources.

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

33

	Nine Months Ended September 30,
	(Dollars in thousands)
	2010								2009
	Average Balance			Interest		Average Yield/Rate			Average Balance			Interest		Average Yield/Rate
Interest-Earning Assets:
Loans held for sale (1)	$	10,109		$	129		1.70	%	$	2,064		$	89		5.75	%
Loans held for investment (1):
Taxable		3,046,899			125,677		5.51	%		3,624,478			154,098		5.68	%
Non-taxable (2)		3,113			122		5.26	%		5,141			237		6.16	%
Securities:
Taxable		1,138,539			28,560		3.35	%		772,386			26,659		4.61	%
Non-taxable (2)		104,647			4,206		5.37	%		97,069			3,902		5.37	%
Deposits in financial institutions		272,475			503		0.25	%		60,885			64		0.14	%
Other interest-earning assets		1,268			5		1.01	%		29,336			61		0.28	%
Total interest-earning assets		4,577,050			159,202		4.65	%		4,591,359			185,110		5.39	%
Noninterest-earning assets:
Cash and due from banks		65,409								55,201
Premises and equipment, net		48,205								49,912
Other assets		407,562								369,081
Allowance for loan losses		(78,794	)							(52,177	)
Total noninterest-earning assets		442,382								422,017
Total Assets	$	5,019,432							$	5,013,376
Interest-Bearing Liabilities:
Deposits:
Demand and savings	$	2,008,236		$	12,114		0.81	%	$	1,693,613		$	11,781		0.93	%
Certificates and other time		909,618			9,334		1.37	%		1,137,866			19,474		2.29	%
Other borrowed funds		101,602			2,000		2.63	%		241,653			1,583		0.88	%
Subordinated debt		78,012			2,139		3.67	%		77,582			2,612		4.50	%
Junior subordinated debt		82,734			3,139		5.07	%		82,734			3,441		5.56	%
Total interest-bearing liabilities		3,180,202			28,726		1.21	%		3,233,448			38,891		1.61	%
Noninterest-bearing sources:
Demand deposits		1,189,144								1,123,858
Other liabilities		40,078								45,252
Total noninterest-bearing liabilities		1,229,222								1,169,110
Shareholders’ equity		610,008								610,818
Total Liabilities and Shareholders’ Equity	$	5,019,432							$	5,013,376
Tax Equivalent Net Interest Income and Margin (2) (3)					130,476		3.81	%					146,219		4.26	%
Non-GAAP to GAAP Reconciliation:
Tax Equivalent Adjustment:
Loans					39								75
Securities					1,353								1,215
Total tax equivalent adjustment					1,392								1,290
Net Interest Income				$	129,084							$	144,929

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

(2) Taxable-equivalent basis assuming a 35% tax rate. Net interest income is presented on a tax-equivalent basis. Accordingly, net interest income from tax-exempt securities and loans is presented in the net interest income results on a basis comparable to taxable securities and loans. This non-GAAP financial measure allows management to assess the comparability of net interest income arising from both taxable and tax-exempt sources.

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

34

Tax equivalent net interest income decreased $5.6 million or 11.7% to $42.6 million and $15.7 million or 10.8% to $130 million for the three and nine month periods ended September 30, 2010, respectively, compared to the same time periods in 2009. Our tax equivalent net interest margin was 3.68% and 3.81% for the three and nine month periods ended September 30, 2010, respectively, compared to 4.20% and 4.26% for the three and nine month periods ended September 30, 2009, respectively. This decline in net interest income and margin was due to a decline in average loans as a percentage of interest-earning assets, an increase in nonperforming assets, lower interest income from interest rate hedges, and increased liquidity, partially offset by deposit growth. Changes in the mix of interest-earning assets and liabilities influence our net interest income and margin. During the first nine months of 2009, we had a larger percentage of interest-earning assets invested in higher-yielding loans as compared to 2010. Average loans as a percentage of average interest-earning assets decreased from 79% in the first nine months of 2009 to 67% during 2010, while average securities increased from 19% of average interest-earning assets during the first nine months of 2009 to 27% during 2010. We increased securities as a percentage of interest-earning assets to further diversify our interest-earning asset portfolio and further utilize excess liquidity. We made this decision in part to support our interest income stream in light of the economic conditions having a negative impact on interest earnings from our loan portfolio.

Tax equivalent interest income on loans decreased $9.5 million and $28.5 million for the three and nine month periods ended September 30, 2010, respectively, compared to the same periods in 2009. The decrease in interest income on loans was due primarily to a decline in average loans. On average, loans decreased $538 million or 15.5% and $572 million or 15.7%, respectively, for the three and nine month periods ended September 30, 2010, compared to the same time periods in 2009. Net interest margin was also negatively impacted by an increase in nonperforming loans. For the purpose of calculating loan yields, average loan balances include nonaccrual loans with no related interest income. Nonaccrual loans increased $68.8 million to $164 million at September 30, 2010, compared to $95 million at September 30, 2009. Interest forgone on nonaccrual loans was $3.3 million and $8.5 million for the three and nine month periods ended September 30, 2010, respectively, compared to $2.1 million and $5.0 million for the same periods in 2009. This increase in nonaccrual loans resulted in a reduction in net interest margin of 10 basis points for both the three and nine month periods ended September 30, 2010, compared to the same periods in 2009. Additionally, during the three and nine month periods ended September 30, 2010, interest income from the interest rate hedges that we purchased in 2006 decreased $2.3 million and $5.5 million, respectively. During the third quarter of 2009, our interest rate floor matured. As of August 1, 2010, the remaining gain associated with our interest rate collar was fully amortized into interest income. At September 30, 2010, we did not have any outstanding interest rate hedges associated with our loan portfolio.

Tax equivalent interest income on securities increased $745 thousand and $2.2 million for the three and nine month periods ended September 30, 2010, respectively, compared to the same periods in 2009. The increase in interest income on securities is due to an increase in average securities. On average, securities increased $456 million or 48.4% and $374 million or 43.0% for the three and nine month periods ended September 30, 2010, respectively, compared to the same periods in 2009. We increased the securities portfolio as a percentage of interest-earning assets beginning in 2009. On average, the securities portfolio represented approximately 27% of average interest-earning assets for the nine month period ended September 30, 2010, compared to 19% for the same period in 2009. The increase in interest income earned from higher securities was offset by a decrease in yield earned. Average yield earned was 3.21% and 3.52%, respectively, for the three and nine month periods ended September 30, 2010, compared to 4.46% and 4.70% for the same time periods in 2009. This decrease in yield was due to lower market interest rates.

Net interest income and margin were also impacted by an increase in the use of lower yielding interest-earning cash during the first nine months of 2010. Average interest-earning cash deposits in other financial institutions was $260 million and $272 million, respectively, for the three and nine month periods ended September 30, 2010, compared to $106 million and $60.9 million, respectively, for the same time periods in 2009. The average yield on these deposits was 0.24% and 0.25% for the three and nine month periods ended September 30, 2010, respectively, compared to 0.24% and 0.14%, respectively, for the same time periods in 2009.

Total interest expense decreased $3.1 million and $10.2 million, respectively, for the three and nine month periods ended September 30, 2010, over the comparable periods in 2009, due primarily to a decline in rates paid and the utilization of lower cost interest-bearing demand and savings deposits. Beginning in 2009, we allowed some of our higher cost certificate and other time deposits to mature and be replaced with lower cost interest-bearing demand deposits. On average, certificate and other time deposits decreased of $214 million and $228 million, respectively, for the three and nine month periods ended September 30, 2010, compared to the same time periods in 2009. The average rate paid on certificate and other time deposits was 1.29% and 1.37%, respectively, for the three and nine month periods ended September 30, 2010, compared to 2.01% and 2.29%, respectively, for the same time periods in 2009. The decrease in average balance combined with lower rates resulted in a decrease in interest expense on certificate and other time deposits of $2.7 million and $10.1 million, respectively, for the three and nine month periods ended September 30, 2010, compared to the same time period in 2009. The decline in average certificate and other time deposits was offset by an increase in average interest-bearing demand deposits of $166 million and $315 million, respectively, for the three and nine months periods ended September 30, 2010, compared to the same time period in 2009. The rate paid on interest-bearing demand deposits was 0.71% and 0.81% for three and nine month periods ended September 30, 2010, compared to 0.95% and 0.93%, respectively, for the same time periods in 2009.

Average other borrowed funds for the three and nine month periods ended September 30, 2010, decreased $41.7 million and $140 million, respectively, compared to the same periods in 2009. The average rate paid on other borrowed funds was 2.99% and 2.63% for the three and nine month periods ended September 30, 2010, respectively, compared to 0.94% and 0.88%, respectively, for the same time periods in 2009. The increase in rate paid on the borrowings was due in part to $50 million of our structured repurchase agreements becoming fixed at an average rate of 3.69% during the first quarter of 2010. These borrowings had a zero percent rate as of December 31, 2009.

35

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

	For the Three Months Ended September 30,				For the Nine Months Ended September 30,
	2010		2009		2010			2009
Customer service fees	$	3,728	$	3,845	$	10,807		$	11,709
Other-than-temporary impairment loss on securities		0		4		0			17
Net gain on sale of securities		43		0		80			0
Wealth management fees		1,733		1,862		5,933			5,904
Net gain (loss) on loans		297		80		(2,295	)		400
Bank-owned life insurance		911		884		2,696			2,651
Debit card income		633		588		1,886			1,759
Other		2,145		1,850		5,445			7,964
Total	$	9,490	$	9,113	$	24,552		$	30,404

Total noninterest income for the three month period ended September 30, 2010, increased $377 thousand, compared to the same period in 2009 and decreased $5.9 million for the nine month period ended September 30, 2010, compared to the same time period in 2009. Details of the changes in the various components of noninterest income are discussed below:

We recorded a $14 thousand credit-related other-than-temporary impairment (“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 was backed by hybrid adjustable-rate residential mortgage loans. As of the date of OTTI, this security was an investment grade security. As of the date of OTTI, we did not intend to sell the security, and it was not more likely than not that we would be required to sell the investment before recovery of its remaining amortized cost basis. Therefore, for the nine month period ended September 30, 2009, the amount of the credit-related OTTI of $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. There was no OTTI recorded during the three and nine month periods ended September 30, 2010.

Net gain on sale of securities during the three and nine month periods ended September 30, 2010, was due to a realized gain of $253 thousand on the sale of our SBA interest-only strip portfolio during the second quarter of 2010. This gain was offset by the sale of one private-label CMO that was classified as held-to-maturity, resulting in a realized loss of $236 thousand during the second quarter of 2010. The decision to sell this security in the second quarter of 2010 was due to the credit downgrading of this security to below investment grade in May 2010. Given this credit downgrading, the current economic uncertainty along with the increasing levels of delinquencies being reported for all residential mortgage loans, we believed there was additional risk associated with holding this security until maturity. This security had a carrying value of $2.0 million at the time of sale.

Wealth management fees decreased $129 thousand for the three month period ended September 30, 2010, compared to the same period in 2009 and increased $29 thousand for the nine month period ended September 30, 2010, compared to the same periods in 2009. The decrease in wealth management fees for the three month period ended September 30, 2010, was due to a decrease in brokerage fees. 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 investment advisory and pension administration/consulting services.

Net losses on loans for the nine month period ended September 30, 2010, of $2.3 million was due to lower of cost or market adjustments of $3.0 million on certain nonperforming commercial real estate loans held for sale. These losses were offset by approximately $246 thousand and $568 thousand of gains from the sale of residential mortgage loans originated by us during the three and nine month periods ended September 30, 2010, respectively.

Other noninterest income increased $295 thousand for the three month period ended September 30, 2010, and decreased $2.5 million for the nine months ended September 30, 2010, respectively, compared to the same periods in 2009. The decrease for the nine month period ended September 30, 2010, compared to 2009 was due primarily to $2.1 million in gains recorded as a result of the cash flow hedge ineffectiveness recorded in 2009.

36

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

	For the Three Months Ended September 30,					For the Nine Months Ended September 30,
	2010			2009		2010		2009
Salaries and employee benefits	$	20,722		$	21,005	$	61,678	$	67,434
Occupancy		5,566			5,967		17,065		18,004
Technology		2,267			2,495		7,016		7,475
Professional fees		1,452			1,065		4,829		3,419
Postage, delivery and supplies		661			700		2,088		2,181
Marketing		198			557		738		1,487
Core deposit and other intangibles amortization		537			565		1,623		1,695
Acquisition costs		0			154		0		154
FDIC insurance assessments		2,478			1,741		7,463		6,974
Net (gains) losses and carrying costs of other real estate and foreclosed property		(414	)		1,743		872		1,798
Other		4,313			4,083		14,167		13,073
Total	$	37,780		$	40,075	$	117,539	$	123,694

Total noninterest expense for the three and nine month periods ended September 30, 2010, decreased $2.3 million and $6.2 million, respectively, compared to the same periods in 2009. Details of the changes in the various components of noninterest expense are discussed below:

Salaries and employee benefits for the three and nine month periods ended September 30, 2010, decreased $283 thousand and $5.8 million, respectively, compared to the same periods in 2009. During the third quarter of 2010, we recorded severance charges of approximately $1.0 million, as part of our ongoing company-wide expense reduction initiative. During the second quarter of 2009, we recorded a one-time severance charge of $2.1 million. As a result of these expense reduction initiatives, salary expense decreased $467 thousand and $2.3 million for the three and nine month periods ended September 30, 2010, respectively, compared to the same time periods in 2009. Additionally, during the three and nine month periods ended September 30, 2010, we reversed approximately $400 thousand and $1.4 million, respectively of stock-based compensation expense related to certain performance-based stock awards that are not expected to be fully earned at this time because our performance has fallen below the threshold performance metrics specified in the respective stock awards.

Professional fees for the three and nine month periods ended September 30, 2010, increased $387 thousand and $1.4 million, respectively, compared to the same periods in 2009. This increase was due to legal fees resulting from activities related to nonperforming assets and increased consulting fees associated with a review of our personnel, policies and procedures.

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 $737 thousand and $489 thousand for the three and nine month periods ended September 30, 2010, respectively, compared to the same time periods in 2009. During the second quarter of 2009, we recorded a special FDIC assessment of $2.3 million which was levied to all insured depository institutions and totaled five basis points of each institution’s total assets less Tier 1 capital. The decrease in FDIC premiums resulting from the special assessment in June 2009, was offset by increased costs in 2010 due to higher FDIC assessment rates and average deposits.

Gains net of losses and carrying costs of other real estate and foreclosed properties were $414 thousand for the three month period ended September 30, 2010. Net losses and carrying costs on other real estate owned and foreclosed property were $872 thousand for the nine month period ended September 30, 2010, and $1.7 million and $1.8 million for the three and nine month periods ended September 30, 2009. Losses on other real estate owned foreclosed property during 2009 and 2010 were due primarily to increased real estate foreclosures due to weaker economic conditions that have resulted in declines in property values.

Other noninterest expense increased $230 thousand and $1.1 million for the three and nine month periods ended September 30, 2010, respectively, compared to the same periods in 2009. The increase in other noninterest expense was due in part to an increase in appraisal fees resulting from increases in nonperforming loans.

Income Taxes – We provided $1.7 million, for an effective rate of 27.6%, for federal and state income taxes during the three month period ended September 30, 2010. We recorded a tax benefit of $2.7 million for the nine month period ended September 30, 2010, and a tax benefit of $14.5 million and $10.3 million during the three and nine month periods ended September 30, 2009, respectively. The effective tax benefit rate was 69.2% for the nine month period ended September 30, 2010, and 37.0% and 41.1%

37

for the three and nine month periods ended September 30, 2009, respectively. The effective tax rates differed from the U.S. statutory rate of 35% during the comparable periods primarily due to the effect of tax-exempt income from loans, securities and life insurance policies. Our provision for income taxes during interim reporting periods historically has been calculated by applying an estimate of the annual effective tax rate for the full fiscal year to “ordinary” income or loss (pre-tax income or loss excluding significant unusual or infrequently occurring items) for the reporting period. For the reporting period ended September 30, 2010, we have computed our provision for income taxes based on the actual effective tax rate for the year-to-date by applying the discrete method. We have determined that small changes in estimated “ordinary” income, combined with the impact of permanent non-taxable items result in significant changes in the estimated annual effective tax rate. As such, the historical method would not provide a reliable estimate for the reporting period ended September 30, 2010. The actual effective rate is impacted by the level of permanent differences, including tax-advantaged investment and loan income, resulting in an effective rate above statutory rates for the interim reporting periods.

FINANCIAL CONDITION

Loans Held for Sale– Loans held for sale were $7.1 million and $11.8 million at September 30, 2010 and December 31, 2009, respectively. Loans held for sale at September 30, 2010, consisted of $2.5 million of commercial real estate and $4.7 million of residential mortgage loans. Loans held for sale at December 31, 2009, consisted of $10.7 million of commercial real estate and $1.0 million of residential mortgage loans. Loans are classified as held for sale when management has positively determined that the loans will be sold in the foreseeable future and we have the ability to do so. The classification may be made upon origination or subsequent to the origination or purchase. Once a decision has been made to sell loans not previously classified as held for sale, such loans are transferred into the held for sale classification and carried at the lower of cost or fair value.

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

	September 30, 2010					December 31, 2009
	Amount		%			Amount		%
Commercial and industrial	$	588,127		20.5	%	$	795,789		24.6	%
Real estate:
Commercial		1,589,959		55.5	%		1,667,038		51.6	%
Construction		268,691		9.4	%		360,444		11.1	%
Residential		362,402		12.7	%		344,807		10.7	%
Consumer/other		44,413		1.6	%		52,124		1.6	%
Foreign loans		9,360		0.3	%		13,071		0.4	%
Total loans held for investment	$	2,862,952		100.0	%	$	3,233,273		100.0	%

At September 30, 2010, loans held for investment were $2.9 billion, a decrease of $370 million or 11.5% over loans held for investment at December 31, 2009. The decline in loans during 2010 was due, in part, to principal reductions in commercial and industrial loans including our energy lending portfolio, and declines in construction and development and commercial real estate loans. Our energy lending portfolio decreased $136 million or 52.0% to $126 million at September 30, 2010, compared to $262 million at December 31, 2009. The remaining decrease in commercial and industrial loans was the result of customers reducing their inventory positions and paying down on lines-of-credit. Commercial real estate and construction and development loans decreased $77.1 million and $91.8 million, respectively, for September 30, 2010, compared to December 31, 2009. These decreases were due to our decision to reduce our exposure to these loan categories, and slowing demand resulting from customer decisions to defer new projects.

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, 2010, commercial real estate loans and commercial and industrial loans were 55.5% and 20.5%, 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. 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 and are most often amortized over a 15-year period with balloon payments due at the end of three to five 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.

We also make loans to finance the construction of residential and nonresidential properties, such as retail shopping centers and commercial office buildings. Generally, construction loans are secured by first liens on real estate. We conduct periodic inspections, either directly or through an architect or other agent, prior to approval of periodic draws on these loans. Underwriting guidelines similar to those described above are also used our construction lending activities. Construction and development loans were $269 million at September 30, 2010, a decrease of $91.8 million since December 31, 2009. This decrease was due to lower customer demand and our efforts to reduce our exposure to those types of loans in the current environment.

38

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 at September 30, 2010 (dollars in thousands). Multifamily residential real estate is included in the residential mortgage real estate loan category.

	Amount		%
Property type:
Office and office warehouse	$	384,095		20.1	%
Retail		354,718		18.5	%
Hospitality		293,347		15.3	%
Acquisition and land development		191,872		10.0	%
1-4 family		46,635		2.4	%
Industrial warehouse		83,902		4.4	%
Multifamily residential		64,319		3.4	%
Other		496,374		25.9	%
Total	$	1,915,262		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.

At September 30, 2010, our hospitality portfolio totaled $293 million which represented approximately 10% of total loans held for investment compared to $303 million or 9.3% of total loans held for investment at December 31, 2009. The hospitality industry is a several billion dollar industry that primarily depends on the availability of leisure time and disposable income as well as business activity. The majority of the portfolio consists of mid-priced hotels and motels, most of which are nationally flagged properties in major metropolitan statistical areas. There are no resort-type or luxury properties included within this portfolio. In underwriting these property types, appraisals provide valuation for lending purposes of land and buildings only. There were no new loans added to the portfolio during 2009 or 2010. We saw deterioration in this portfolio during 2009 and continuing into 2010 as $39.3 million of loans at September 30, 2010, were nonperforming, up from $20.2 million at December 31, 2009. Over the last 18 months the industry has experienced significant declines in occupancy rates, average daily room rates, and revenue per available room. As a result of this deterioration, we charged-off approximately $1.0 million and $12.6 million against the allowance for credit losses associated with this loan portfolio during the three and nine months ended September 30, 2010, respectively. Approximately $70 million of our hospitality loans at September 30, 2010, are located outside of Texas and were originated through our Capital Markets and SBA groups which are discussed in further detail below.

Our Capital Markets and SBA group originated, co-originated or purchased first-lien, commercial real estate mortgage loans referred by other financial institutions nationwide. At September 30, 2010, this loan portfolio consists of $315.7 million in commercial real estate with collateral outside of Texas, of which $95.9 million is in California. 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 approximately 50% of these loans have a U.S. Small Business Administration second lien behind our first lien. The loans without SBA second liens 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 to evaluate all loans. These appraisals are reviewed by a third-party appraisal review vendor for accuracy and compliance with our underwriting standards and banking regulations. We have not originated these types of loans since early 2008 as market conditions began to change. We saw deterioration in this portfolio during 2009 and continuing into 2010 as $51.8 million of loans at September 30, 2010, and $33.1 million of loans at December 31, 2009, were nonperforming. At September 30, 2010 and December 31, 2009, $1.7 million and $9.9 million, respectively, of these nonperforming loans were classified as held for sale. As a result of this deterioration, we charged-off approximately $2.2 million and $12.7 million against the allowance for credit losses associated with this loan portfolio during the three and nine months ended September 30, 2010, respectively. This portfolio also includes $4.9 million and $16.0 million in loans that were 30 to 89 days past due as of September 30, 2010 and December 31, 2009, respectively.

39

The following table summarizes our out-of-state Capital Markets and SBA commercial real estate loan portfolio by the type of property securing the credit. Property type concentrations are stated as a percentage of year-end total Capital Markets and SBA commercial real estate loans as of September 30, 2010 (dollars in thousands):

	Amount		%
Property type:
Office and office warehouse	$	71,211		22.6	%
Retail		63,999		20.3	%
Hospitality		70,410		22.3	%
Industrial warehouse		23,494		7.4	%
Multifamily residential		5,352		1.7	%
Other		81,218		25.7	%
Total	$	315,684		100.0	%

At September 30, 2010, loans held for investment were 69.8% of deposits and 56.8% of total assets. Loans held for investment were 79.0% of deposits and 65.5% of total assets at December 31, 2009.

Securities -Our securities portfolio at September 30, 2010, totaled $1.4 billion as compared to $1.1 billion at December 31, 2009, an increase of $381 million or 35.6%. During 2009 and 2010 we increased the securities as a percentage of interest-earning assets to further diversify our interest-earning asset portfolio and further utilize excess liquidity. We made this decision in part to support our interest income stream in light of the economic conditions having a negative impact on our interest earnings from our loan portfolio. These securities represented 28.8% and 21.7% of total assets as of September 30, 2010 and December 31, 2009, respectively.

Net unrealized gains on the available-for-sale securities were $23.7 million at September 30, 2010, as compared to $12.3 million at December 31, 2009.

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.

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

	September 30, 2010					December 31, 2009
	Amount		%			Amount		%
Noninterest-bearing demand deposits	$	1,248,321		30.4	%	$	1,144,133		27.9	%
Interest-bearing demand and savings deposits		2,014,207		49.2	%		2,004,539		49.0	%
Time deposits		736,468		17.9	%		802,270		19.6	%
Brokered certificates of deposit		104,215		2.5	%		144,009		3.5	%
Total deposits	$	4,103,211		100.0	%	$	4,094,951		100.0	%

Total deposits as of September 30, 2010, increased $8.3 million to $4.1 billion, compared to $4.1 billion at December 31, 2009. This increase was primarily concentrated in our noninterest-bearing demand deposits which increased $104 million or 9.1% as of September 30, 2010, as compared to December 31, 2009. The growth in noninterest-bearing demand deposits was offset by a decline in time deposits and brokered certificates of deposit which decreased $65.8 million or 8.2% and $39.8 million or 27.6%, respectively, as of September 30, 2010, compared to December 31, 2009, due to our decision to let some of our higher cost deposits mature and be replaced with lower cost interest-bearing demand deposits. Approximately 69.5% of deposits at September 30, 2010, were interest-bearing. The percentage of interest-bearing demand and noninterest-bearing demand deposits to total deposits as of September 30, 2010, was 49.0% and 30.4%, respectively, and our loan to deposit ratio at September 30, 2010, was 69.9%.

40

Other Borrowed Funds – As of September 30, 2010, we had $107 million in other borrowings compared to $97.2 million at December 31, 2009, an increase of $9.3 million. 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, 2010, we had total funds of $1.8 billion available under this agreement of which $40.0 million was outstanding with an average interest rate of 2.94%. At September 30, 2010, we had $40.0 million of FHLB advances that mature in seven years. 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, 2010 and December 31, 2009, we had securities sold under agreements to repurchase with banking customers of $14.7 million and $5.7 million, respectively. Structured repurchase agreements totaled $50.0 million at September 30, 2010 and December 31, 2009, 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 fixed rate of 3.88% and 3.50%, respectively, at September 30, 2010. The rate on these repurchase agreements was zero at December 31, 2009.

ASSET QUALITY

Risk Elements –We have several systems and procedures in place to assist in managing the overall quality of the loan portfolio. In addition to established underwriting guidelines and approval processes, we monitor delinquency levels for any negative or adverse trends. We also perform reviews of the loan portfolios on a regular basis to identify troubled loans and to assess their overall probability of collection.

Ongoing portfolio reviews are conducted by our internal loan review department under an established loan review program. Loans are reviewed based on current risks within the loan portfolio with a targeted loan review penetration of at least 50% annually of the total outstanding balance of commercial and real estate loan portfolios. Additionally, on a annual basis we review all loans with of $1 million or greater

Through the loan review process, we maintain an internally classified loan list, which, along with the delinquency list of loans, helps us assess the overall quality of the loan portfolios and the adequacy of the allowance for credit losses. Loans on this list are classified as substandard, doubtful or loss based on probability of repayment, collateral valuation and related collectability.

Our classified loan list is also used to identify loans that are considered nonperforming. Nonperforming loans are loans which have been categorized by management as nonaccrual because collection of interest is doubtful. 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 within a short time following receipt of the appraisal to determine the need, if any, for possible write-downs or appropriate additions to the allowance for loan losses.

Potential problem loans are substandard loans that are not considered nonperforming but where information known by management indicates that the borrower may be unable to comply with the present terms.

In cases where a borrower experiences financial difficulty but is current on their payments and we make certain concessionary modifications to contractual terms, the loan is classified as a restructured-accruing loan. Most restructured-accruing loans are the result of providing certain borrowers a temporary reduction in their payments for a three to six month period. These reductions are generally in the form of a partial or interest only payment. We typically do not extend payment maturities, reduce interest rates or forgive principal or interest.

If management determines that it is in the best interest of the Company and the borrower, it will restructure a loan that has already been classified as nonaccrual. Nonaccrual loans that are restructured remain on nonaccrual for a period of at least six months to demonstrate that the borrower can meet the restructured terms. However, performance prior to the restructuring, or significant events that coincide with the restructuring, are included in assessing whether the borrower can meet the new terms and may result in the loan being returned to accrual at the time of restructuring or after a shorter performance period. If the borrower’s ability to meet the revised payment schedule is uncertain, the loan remains classified as a nonaccrual loan.

41

Nonperforming assets consisted of the following (in thousands):

	September 30, 2010			December 31, 2009
Nonperforming loans:
Loans held for sale:
Real estate - Commercial	$	1,665		$	9,896
Loans held for sale		1,665			9,896
Loans held for investment:
Commercial and industrial		6,870			5,832
Real estate:
Commercial		113,793			62,363
Construction		20,031			12,398
Residential		21,215			11,778
Consumer/other		187			297
Loans held for investment		162,096			92,668
Total nonperforming loans		163,761			102,564
Foreclosed assets:
Real estate acquired by foreclosure		14,571			16,763
Other repossessed assets		50			38
Total foreclosed assets		14,621			16,801
Total nonperforming assets	$	178,382		$	119,365
Restructured - accruing	$	17,495		$	69,857
Potential problem loans	$	169,646		$	187,513
Accruing loans past due 90 days or more	$	953		$	41
Nonperforming loans to period-end loans		5.71	%		3.16	%
Nonperforming assets to period-end assets		3.54	%		2.42	%

Nonperforming assets were $178 million at September 30, 2010, a $59.0 million increase from December 31, 2009. Nonaccrual loans at September 30, 2010 and December 31, 2009, include $1.7 million and $9.9 million, respectively, of commercial real estate loans that have been classified as held for sale. The primary increase in nonperforming loans was related to nonowner-occupied commercial real estate loans.

During 2009 and 2010 we granted certain borrowers minor concessions in the form of temporary payment reductions. We believe these payment reductions are a practical and customary business practice and can help a quality borrower get through a challenging time or difficult temporary situation. These concessions better protect the bank’s interests by improving the borrower’s ability to repay its loan in full. Due to the prolonged economic downturn, we have determined that it is appropriate to report all modifications that result in even the slightest accommodation as a restructured loan. At September 30, 2010, restructured-accruing loans were $17.5 million compared to $69.9 million at December 31, 2009. Restructured-accruing loans at December 31, 2009, included $33.1 million of loans that were originated as part of our Capital Markets and SBA group. Restructured-accruing loans at September 30, 2010, consisted of loans that were modified during the nine month period ended September 30, 2010.

42

Potential problem loans were $170 million at September 30, 2010, down from $188 million at December 31, 2009. The decrease in potential problem loans during the nine month period ended September 30, 2010, was due to the increase in nonperforming loans. Approximately $140 million of loans were moved to nonperforming status during the first nine months of 2010. Our credit administration, loan review, and special assets groups, as well as all of our lending personnel, continue to actively identify and remove problem credits from our portfolio. Potential problem loans at December 31, 2009, included $51.9 million of loans that we have classified as restructured-accruing.

Accruing loans past due 90 days or more at September 30, 2010, totaled $953 thousand compared to $41 thousand at December 31, 2009.

Allowance for Credit Losses –The allowance for credit losses is a valuation allowance consisting of the allowance for loan losses and the allowance for unfunded lending commitments. It is established through charges to earnings in the form of a provision for credit losses and is reduced by net charge-offs.

Based on an evaluation of the loan portfolio, management presents a quarterly review of the allowance for credit losses to the Bank’s Board of Directors, indicating any changes in the allowance since the last review and any recommendations as to adjustments in the allowance. In making our evaluation, we consider the industry diversification of the commercial loan portfolio and the effect of changes in the local real estate market on collateral values. We also consider the results of recent regulatory examinations, our history of credit experience and our ongoing internal credit reviews.

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. Our allowance for credit losses consists of two components including a specific reserve on individual loans that are considered impaired and a component based upon probable but unidentified losses inherent in the loan portfolio.

The portion of the allowance for credit losses related to probable but unidentified losses inherent in the loan portfolio is based on a calculated historical loss ratio, migration analysis and certain qualitative risk factors. We calculate the historical loss ratio and migration analysis for pools of similar loans with similar characteristics based on the proportion of actual charge-offs experienced to the average loans in the pool. These loan pools are divided by loan type including commercial and industrial, commercial real estate, consumer and 1-4 family residential mortgage loans. The historical loss ratios and migration analysis are updated quarterly based on actual charge-off experience. This historical loss ratio and migration analysis are then applied to the outstanding period-end loan pools.

In addition to the calculated historical loss ratio, general valuation allowances are based on general economic conditions and other qualitative risk factors. The qualitative factors include, among other things: (i) changes in lending policies and procedures; (ii) changes in national and local economic and business conditions and developments; (iii) changes in the nature and volume of the loan/lease portfolio; (iv) changes in the experience, ability and depth of lending management and staff; (v) changes in the trend or the volume and severity of past due and classified loans/leases; (vi) trends in the volume of nonaccrual loans, troubled debt restructurings, delinquencies and other loan/lease modifications; (vii) changes in the quality of the Bank’s loan review system and the degree of oversight by the Bank’s board of directors; (viii) the existence and effect of any concentrations of credit, and changes in the level of such concentrations; and (ix) the effect of external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the Bank’s current loan/lease portfolio.

43

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,
	2010			2009			2010			2009
Allowance for loan losses at beginning of period	$	80,983		$	53,075		$	74,732		$	49,177
Charge-offs:
Commercial, financial, and industrial		1,034			3,895			4,689			19,378
Real estate, mortgage and construction		7,314			33,621			33,314			35,962
Consumer		285			318			752			1,109
Total charge-offs		8,633			37,834			38,755			56,449
Recoveries
Commercial, financial, and industrial		481			251			1,397			1,177
Real estate, mortgage and construction		633			23			2,299			301
Consumer		72			163			241			420
Total recoveries		1,186			437			3,937			1,898
Net charge-offs		7,447			37,397			34,818			54,551
Provision for loan losses		7,218			54,381			40,840			75,433
Allowance for loan losses at end of period		80,754			70,059			80,754			70,059
Allowance for unfunded loan commitments at beginning of period		1,502			1,102			2,852			1,654
Provision for losses on unfunded loan commitments		498			1,750			(852	)		1,198
Allowance for unfunded loan commitments at end of period		2,000			2,852			2,000			2,852
Total allowance for credit losses	$	82,754		$	72,911		$	82,754		$	72,911
Period-end allowance for credit losses to period-end loans		2.88	%		2.18	%		2.88	%		2.18	%
Period-end allowance for loan losses to period-end loans		2.81	%		2.09	%		2.81	%		2.09	%
Period-end allowance for loan losses to nonperforming loans		49.31	%		73.76	%		49.31	%		73.76	%
Net charge-offs to average loans (annualized)		1.01	%		4.27	%		1.52	%		2.01	%

The allowance for loan losses at September 30, 2010, was $81.0 million and represented 2.81% of total loans. The allowance for loan losses at September 30, 2010, was 49.31% of nonperforming loans, down from 72.86% at December 31, 2009. The allowance for unfunded lending commitments was $2.0 million as of September 30, 2010, compared to $2.9 million as of December 31, 2009.

Net charge-offs were $7.4 million or 1.01% (annualized) and $34.8 million or 1.52% of average total loans for the three and nine months ended September 30, 2010, respectively, compared to $37.4 million or 4.27% (annualized) and $54.6 million or 2.01% of average total loans for the same periods in 2009, respectively. Charge-offs during the three and nine month period ended September 30, 2010, were primarily related to continued declines in commercial real estate value that collateralize our nonperforming commercial real estate portfolio. We experienced more significant declines in these values during the first quarter of 2010, resulting in net charge-offs of $21.0 million. During the second and third quarters of 2010 we began to see stabilization in collateral valuations resulting in lower net charge-offs of $6.3 million and $7.4 million, respectively. Approximately $12.6 million of charge-offs during the nine month period ended September 30, 2010, were related to hospitality loans which have experienced reductions in real estate values as the industry has gone through significant declines in occupancy rates, average daily room rates, and revenue per available room.

Charge-offs decreased $30.0 million and $19.7 million, respectively, for the three and nine month periods ended September 30, 2010, compared to the same time periods in 2009. Approximately $27 million of charge-offs recorded during the third quarter of 2009 were due to the write-down of collateral-based nonperforming loans and certain nonperforming commercial real estate loans that were transferred to held for sale. The recording of these charge-offs in the third quarter of 2009 was due to the period of time these loans had been in a nonperforming status and management’s determination that repayment of the loan was reliant on the underlying collateral. Additionally, during the three and nine month periods ended September 30, 2009, we recorded charge-offs of $2.0 million and $11.6 million, respectively, related to SemGroup, an energy customer that was in Chapter 11 bankruptcy. We recorded $9.6 million of charge-offs related to this customer during the second quarter of 2009 due to the borrower filing 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. 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 closed in the fourth quarter of 2009.

44

The provision for loan losses for the three and nine month periods ended September 30, 2010 was $7.2 million and $40.8 million, respectively, as compared to $54.4 million and $75.4 million for the same periods in 2009, respectively. The decrease in the provision for loan losses of $47.2 million and $34.6 million for the three and nine month periods ended September 30, 2010, compared to the same time period in 2009 was due to significant declines in commercial real estate values during 2009, the SemGroup relationship discussed below and the previously discussed actions that we took during the third quarter of 2009 to reduce total nonperforming loans. Additionally, during the third quarter of 2009, we assessed certain estimates we use 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.

During the first and third quarters of 2009, we recorded additional provision for credit losses associated with the SemGroup relationship of $5.3 million and $2.0 million, respectively to bring the total allowance for credit losses associated with SemGroup to $11.6 million. The provision recorded during the second quarter of 2009, was due to the borrower filing 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. The additional provision of $2.0 million recorded during the third quarter of 2009 was to record the loan at its’ agreed upon sales price. During the third quarter of 2009, it was our intent to sell approximately $20 million in net book value commercial real estate loans out of our national SBA/commercial real estate portfolio. As a result of this anticipated sale, management determined that it was appropriate to provide $13.6 million in additional provision due to the estimated valuations of these loans. 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.

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.

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, 2010 and December 31, 2009:

Changes in Interest Rates (Basis Points)	Increase (Decrease) in Net Interest Income
September 30, 2010
+300		13.84	%
+200		11.20	%
+100		6.99	%
Base		0.00	%
-100		(8.45	)%
December 31, 2009
+300		8.73	%
+200		6.75	%
+100		3.76	%
Base		0.00	%
-100		(6.36	)%

45

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.

CAPITAL AND LIQUIDITY

Capital - At September 30, 2010, shareholders’ equity totaled $627 million or 12.4% of total assets, as compared to $541 million or 11.0% of total assets at December 31, 2009. Our risk-based capital ratios together with the minimum capital amounts and ratios at September 30, 2010 were as follows (dollars in thousands):

	Actual					For Minimum Capital Adequacy Purposes
	Amount		Ratio			Amount		Ratio
Total capital (to risk weighted assets)	$	597,088		17.9	%	$	267,119		8.0	%
Tier 1 capital (to risk weighted assets)		508,394		15.2	%		133,560		4.0	%
Tier 1 capital (to average assets)		508,394		10.5	%		193,060		4.0	%

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.

During the first quarter of 2010, we issued 20.0 million shares of our common stock through a public stock offering, which resulted in net proceeds of approximately $86.6 million, after deducting underwriting fees and estimated offering expenses.

In the current economic environment, we regularly assess our ability to maintain and build our regulatory capital levels. In making this assessment, we take into account a variety of factors, including our views as to the duration of the recession and the consequent impact on its markets and the real estate markets in particular, our provisioning for and charge-off of nonperforming assets, the liquidity needs of our organization, the capital levels of our peer institutions, and our ability to access the capital markets.

We also take into account our discussions and agreements with the Federal Deposit Insurance Corporation (“FDIC”) and our other regulators. As part of an informal agreement that Sterling Bank entered into on January 26, 2010, with the FDIC and the Texas Department of Banking, we submitted to such regulatory agencies a capital management plan that reflects Sterling Bank’s plans to maintain for the next three years minimum regulatory capital levels that are in excess of the minimum requirements to remain well-capitalized but below our regulatory capital levels at September 30, 2010. If we are unable to maintain the regulatory capital levels that we propose in our capital management plan or if we fail to adequately resolve any other matters that any of our regulators may

46

require us to address in the future, we could become subject to more stringent supervisory actions. At September 30, 2010, we believe we are in compliance regarding the informal agreement with the regulatory agencies and the capital plan that was submitted and accepted by those agencies.

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. 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 2009 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. The capital management plan that we submitted to our regulators reflects a variety of operational factors including our plans for dividend payments from Sterling Bank to Sterling Bancshares and from Sterling Bancshares to our shareholders.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

There have been no material changes in market risk we face since December 31, 2009. 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 SEC under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the SEC’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 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.

47

There were no 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, 2009. 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.

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

None.

ITEM 4. RESERVED

Removed and reserved.

ITEM 5. OTHER INFORMATION.

None.

ITEM 6. EXHIBITS.

11	Statement Regarding Computation of Earnings Per Share (included as Note 13) to Consolidated Financial Statements on page 21 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.

48

**32.1	Section 1350 Certification of the Chief Executive Officer.
**32.2	Section 1350 Certification of the Chief Financial Officer.
***101.INS	XBRL Instance Document
***101.SCH	XBRL Taxonomy Extension Schema Document
***101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document
***101.DEF	XBRL Taxonomy Extension Definitions Linkbase Document
***101.LAB	XBRL Taxonomy Extension Label Linkbase Document
***101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document

* As filed herewith.

** As furnished herewith.

*** In accordance with Rule 406T of Regulation S-T, the XBRL related information in Exhibits 101 to this Quarterly Report on Form 10-Q shall not be deemed to be “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section, and shall not be part of any registration statement or other document filed under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, except as shall be expressly set forth by specific reference in such filing.

49

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 5, 2010	By:	/S/    J. DOWNEY BRIDGWATER
		J. Downey Bridgwater
		Chairman, President and Chief Executive Officer (Principal Executive Officer)
Date: November 5, 2010	By:	/S/    ZACH L. WASSON
		Zach L. Wasson
		Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)

50

EXHIBIT INDEX

Exhibit	Description
11	Statement Regarding Computation of Earnings Per Share (included as Note 13) to Consolidated Financial Statements on page 21 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.
***101.INS	XBRL Instance Document
***101.SCH	XBRL Taxonomy Extension Schema Document
***101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document
***101.DEF	XBRL Taxonomy Extension Definitions Linkbase Document
***101.LAB	XBRL Taxonomy Extension Label Linkbase Document
***101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document

* As filed herewith.

** As furnished herewith.

*** In accordance with Rule 406T of Regulation S-T, the XBRL related information in Exhibits 101 to this Quarterly Report on Form 10-Q shall not be deemed to be “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section, and shall not be part of any registration statement or other document filed under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, except as shall be expressly set forth by specific reference in such filing.

51