Southwest Bancorp (OKSB) 10-Q 2013 Q1 Quarterly report

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 March 31, 2013

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: 001-34110

SOUTHWEST BANCORP, INC.

(Exact name of registrant as specified in its charter)

Oklahoma	73-1136584
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
608 South Main Street, Stillwater, Oklahoma	74074
(Address of principal executive office)	(Zip Code)

Registrant’s telephone number, including area code: (405) 742-1800

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. 

[ x ] YES[    ] 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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). 

[  x ] YES[    ] NO 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definition 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[ x ] NO 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.  As of May 6, 2013, the issuer has 19,692,430 shares of its Common Stock, par value $1.00, outstanding.

SOUTHWEST BANCORP, INC. 

INDEX TO FORM 10-Q 

PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Unaudited Consolidated Statements of Financial Condition	4
Unaudited Consolidated Statements of Operations	5
Unaudited Consolidated Statements of Comprehensive Income	6
Unaudited Consolidated Statement of Cash Flows	7
Unaudited Consolidated Statements of Sharehoders’ Equity	8
Notes to Unaudited Consolidated Financial Statements	9
ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS	28
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	39
ITEM 4. CONTROLS AND PROCEDURES	40
PART II:  OTHER INFORMATION	41
SIGNATURES	42

1

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

Southwest Bancorp, Inc. (“we”, “our”, “us”, “Southwest”) makes forward-looking statements in this Form 10-Q and documents incorporated by reference into it that are subject to risks and uncertainties.  Forward-looking statements often use words such as “anticipate”, “target”, “outlook”, “forecast”, “will”, “should”, “expect”, “estimate”, “intend”, “plan”, “goal”,
“believe”, or other words with similar meanings.  Forward-looking statements are subject to numerous assumptions, risks, and uncertainties, which change over time, many of which are beyond the control of Southwest.  We intend these statements to be covered by the safe harbor provision for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. 

These forward-looking statements include: 

· Statements of our goals, intentions, and expectations; 

· Estimates of risks and of future costs and benefits; 

· Expectations regarding our future financial performance and the financial performance of our operating segments; 

· Expectations regarding regulatory actions; 

· Expectations regarding our ability to utilize tax loss benefits; 

· Assessments of loan quality, probable loan losses, and the amount and timing of loan payoffs; 

· Estimates of the value of assets held for sale or available for sale; and 

· Statements of our ability to achieve financial and other goals. 

These forward-looking statements are subject to significant uncertainties because they are based upon: the amount and timing of future changes in interest rates, market behavior, and other economic conditions; future laws,  regulations and accounting principles; changes in effective tax rates or the expiration of favorable tax provisions; changes in regulatory standards and examination policies; and a variety of other matters.  These other matters include, among other things, the direct and indirect effects of economic conditions on interest rates, credit quality, loan demand, liquidity, and monetary and supervisory policies of banking regulators.  Because of these uncertainties, the actual future results may be materially different from the results indicated by these forward-looking statements.  In addition, our past growth and performance do not necessarily indicate its future results.  For other factors, risks, and uncertainties that could cause actual results to differ materially from estimates and projections contained in forward-looking statements, please read the “Risk Factors” contained in our reports to the Securities and Exchange Commission. 

The cautionary statements in this Form 10-Q and any documents incorporated by reference herein also identify important factors and possible events that involve risk and uncertainties that could cause our actual results to differ materially from those contained in the forward-looking statements.  These forward-looking statements speak only as of the date on which the statements were made.  We do not intend, and undertake no obligation, to update or revise any forward-looking statements contained in this Form 10-Q, whether as a result of differences in actual results, changes in assumptions, or changes in other factors affecting such statements, except as required by law. 

Management’s discussion and analysis of our consolidated financial condition and results of operations should be read in conjunction with our unaudited consolidated financial statements and the accompanying notes.   

2

SOUTHWEST BANCORP, INC.

Unaudited Consolidated Statements of Financial Condition

	March 31,			December 31,
(Dollars in thousands)	2013			2012
Assets:
Cash and due from banks	$	26,677	$		45,045
Interest-bearing deposits		317,513			243,034
Cash and cash equivalents		344,190			288,079
Securities held to maturity (fair values of $12,539 and $13,659, respectively)		11,777			12,797
Securities available for sale (amortized cost of $348,099 and $358,317, respectively)		353,828			364,315
Loans held for sale		7,297			31,682
Noncovered loans receivable		1,296,317			1,321,346
Less:  Allowance for loan losses		(42,639)			(46,494)
Net noncovered loans receivable		1,253,678			1,274,852
Covered loans receivable (includes loss share: $5,612 and $6,714, respectively)		23,601			25,707
Less:  Allowance for loan losses		(214)			(224)
Net covered loans receivable		23,387			25,483
Net loans receivable		1,277,065			1,300,335
Accrued interest receivable		6,346			6,365
Income tax receivable		1,665			24,525
Premises and equipment, net		21,395			21,691
Noncovered other real estate		9,422			11,315
Covered other real estate		2,243			3,643
Goodwill		1,214			1,214
Other intangible assets, net		4,869			4,864
Other assets		50,383			51,430
Total assets	$	2,091,694	$		2,122,255
Liabilities:
Deposits:
Noninterest-bearing demand	$	416,979	$		424,008
Interest-bearing demand		125,914			112,012
Money market accounts		437,629			423,417
Savings accounts		39,733			37,693
Time deposits of $100,000 or more		317,270			351,273
Other time deposits		340,143			361,175
Total deposits		1,677,668			1,709,578
Accrued interest payable		1,064			1,116
Other liabilities		9,618			13,180
Other borrowings		70,872			70,362
Subordinated debentures		81,963			81,963
Total liabilities		1,841,185			1,876,199
Shareholders' equity:
Common stock - $1 par value; 40,000,000 shares authorized;
19,692,038, 19,529,705, shares issued and outstanding, respectively		19,692			19,530
Paid in capital		101,622			99,705
Retained earnings		127,483			125,093
Accumulated other comprehensive income		1,712			1,728
Total shareholders' equity		250,509			246,056
Total liabilities & shareholders' equity	$	2,091,694	$		2,122,255
The accompanying notes are an integral part of this statement.

3

SOUTHWEST BANCORP, INC.

Unaudited Consolidated Statements of Operations

	For the three months
	ended March 31,
(Dollars in thousands, except earnings per share data)	2013		2012
Interest income:
Interest and fees on loans	$	17,006	$	23,377
Investment securities:
U.S. Government and agency obligations		472		393
Mortgage-backed securities		867		1,319
State and political subdivisions		304		212
Other securities		48		22
Other interest-earning assets		240		184
Total interest income		18,937		25,507
Interest expense:
Interest-bearing demand		45		70
Money market accounts		236		286
Savings accounts		12		13
Time deposits of $100,000 or more		698		1,320
Other time deposits		661		1,207
Other borrowings		220		224
Subordinated debentures		1,459		1,538
Total interest expense		3,331		4,658
Net interest income		15,606		20,849
Provision for loan losses		498		1,716
Net interest income after provision for loan losses		15,108		19,133
Noninterest income:
Service charges and fees		2,660		2,927
Gain on sales of loans, net		814		535
Other noninterst income		63		52
Total noninterest income		3,537		3,514
Noninterest expense:
Salaries and employee benefits		8,136		7,247
Occupancy		2,574		2,545
FDIC and other insurance		491		783
Other real estate, net		353		372
General and administrative		2,834		3,362
Total noninterest expense		14,388		14,309
Income before taxes		4,257		8,338
Taxes on income		1,868		3,127
Net income	$	2,389	$	5,211
Net income available to common shareholders	$	2,389	$	4,119
Basic earnings per common share	$	0.12	$	0.21
Diluted earnings per common share		0.12		0.21
Common dividends declared per share		-		-
The accompanying notes are an integral part of this statement.

4

SOUTHWEST BANCORP, INC.

Unaudited Consolidated Statements of Comprehensive Income 

	For the three months
	ended March 31,
(Dollars in thousands)	2013		2012
Net income	$	2,389	$	5,211
Other comprehensive income:
Unrealized holding gain (loss) on available for sale securities		(269)		114
Change in fair value of derivative used for cash flow hedge		241		225
Other comprehensive income (loss), before tax		(28)		339
Tax benefit (expense) related to items of other comprehensive
income (loss)		12		(154)
Other comprehensive income (loss), net of tax		(16)		185
Comprehensive income	$	2,373	$	5,396
The accompanying notes are an integral part of this statement.

5

SOUTHWEST BANCORP, INC.

Unaudited Consolidated Statement of Cash Flows 

	For the three months
	ended March 31,
(Dollars in thousands)	2013		2012
Operating activities:
Net income	$	2,389	$	5,211
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		498		1,716
Adjustment to other real estate		1,531		147
Deferred tax expense		1,619		3,050
Asset depreciation		611		597
Securities premium amortization, net of discount accretion		1,018		656
Amortization of intangibles		411		296
Stock based compensation expense		313		26
Net gain on sales of available for sale loans		(814)		(535)
Net loss on sales of premises/equipment		4		-
Net gain on sales of other real estate		(1,277)		(100)
Proceeds from sales of held for sale loans		36,968		28,223
Held for sale loans originated for resale		(38,089)		(27,916)
Net changes in assets and liabilities:
Accrued interest receivable		19		(232)
Other assets		626		276
Income tax receivable / payable		22,860		4,073
Excess tax expense from share-based payment arrangements		-		49
Accrued interest payable		(52)		1,327
Other liabilities		(3,437)		373
Net cash provided by operating activities		25,198		17,237
Investing activities:
Proceeds from principal repayments, calls and maturities:
Held to maturity securities		5,000		2,250
Available for sale securities		28,622		15,426
Purchase of other investments		(6)		(3)
Purchases of available for sale securities		(23,402)		(76,726)
Principal repayments, net of loans originated		48,837		118,463
Purchases of premises and equipment		(343)		(575)
Proceeds from sales of premises and equipment		24		91
Proceeds from sales of other real estate		3,410		1,389
Net cash provided by investing activities		62,142		60,315
Financing activities:
Net decrease in deposits		(31,910)		(114,602)
Net increase (decrease) in other borrowings		510		(1,340)
Net proceeds from issuance of common stock		170		14
Excess tax expense from share-based payment arrangements		-		(49)
Preferred stock dividends paid		1		(1)
Net cash used in financing activities		(31,229)		(115,978)
Net increase (decrease) in cash and cash equivalents		56,111		(38,426)
Cash and cash equivalents:
Beginning of period		288,079		229,889
End of period	$	344,190	$	191,463
The accompanying notes are an integral part of this statement.

6

SOUTHWEST BANCORP, INC.

Unaudited Consolidated Statements of Shareholders’ Equity 

										Accumulated
						Additional				Other		Total
	Preferred		Common Stock			Paid in		Retained		Comprehensive		Shareholders'
(Dollars in thousands)	Stock		Shares	Amount		Capital		Earnings		Income		Equity
Balance, December 31, 2011	$	68,455	19,444,213		19,444		98,932		112,647		2,111	$	301,589
Dividends (paid and /or accrued):
Preferred		-	-		-		-		(904)		-		(904)
Warrant amortization		189	-		-		-		(189)		-		-
Net common stock issued under employee
plans and related tax expense		-	1,700		2		(37)		-		-		(35)
Other comprehensive income, net of tax		-	-		-		-		-		185		185
Net income		-	-		-		-		5,211		-		5,211
Balance, March 31, 2012	$	68,644	19,445,913	$	19,446	$	98,895	$	116,765	$	2,296	$	306,046
Balance, December 31, 2012	$	-	19,529,705	$	19,530	$	99,705	$	125,093	$	1,728	$	246,056
Dividends paid		-	-		-		-		1		-		1
Common stock issued		-	161,600		161		1,909		-		-		2,070
Net common stock issued under employee
plans and related tax expense		-	733		1		8		-		-		9
Other comprehensive loss, net of tax		-	-		-		-		-		(16)		(16)
Net income		-	-		-		-		2,389		-		2,389
Balance, March 31, 2013	$	-	19,692,038	$	19,692	$	101,622	$	127,483	$	1,712	$	250,509
The accompanying notes are an integral part of this statement.

7

SOUTHWEST BANCORP, INC.

Notes to Unaudited Consolidated Financial Statements 

NOTE 1: SIGNIFICANT ACCOUNTING AND REPORTING POLICIES

The accompanying unaudited consolidated financial statements were prepared in accordance with instructions for Form 10-Q and, therefore, do not include all information and notes necessary for a complete presentation of financial position, results of operations, shareholders’ equity, cash flows, and comprehensive income in conformity with accounting principles generally accepted in the United States.  However, the unaudited consolidated financial statements include all adjustments which, in the opinion of management, are necessary for a fair presentation.  Those adjustments consist of normal recurring adjustments.  The results of operations for the three months ended March 31, 2013, and the cash flows for the three months ended March 31, 2013, should not be considered indicative of the results to be expected for the full year.  These unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Southwest Bancorp, Inc. Annual Report on Form 10-K for the year ended December 31, 2012. 

The accompanying unaudited consolidated financial statements include the accounts of Southwest Bancorp, Inc. (“we”, “our”, “us”, “Southwest”), our wholly owned financial institution subsidiaries, Stillwater National Bank and Trust Company (“Stillwater National”) and Bank of Kansas, SNB Capital Corporation, a lending and loan workout subsidiary, and consolidated subsidiaries of Stillwater National, including SNB Real Estate Holdings, Inc.  All significant intercompany transactions and balances have been eliminated in consolidation.     

In accordance with Accounting Standards Codification (“ASC”) 855, Subsequent Events, we have evaluated subsequent events for potential recognition and disclosure through the date the consolidated financial statements included in this Quarterly Report on Form 10-Q were issued. 

NOTE 2:  INVESTMENT SECURITIES

A summary of the amortized cost and fair values of investment securities at March 31, 2013 and December 31, 2012 follows:

	Amortized		Gross Unrealized				Fair
(Dollars in thousands)	Cost		Gains		Losses		Value
At March 31, 2013
Held to Maturity:
Obligations of state and political subdivisions	$	11,777	$	762	$	-	$	12,539
Total	$	11,777	$	762	$	-	$	12,539
Available for Sale:
Federal agency securities	$	106,165	$	1,181	$	(91)	$	107,255
Obligations of state and political subdivisions		34,641		1,014		(29)		35,626
Residential mortgage-backed securities		196,440		3,389		(353)		199,476
Asset-backed securities		9,560		-		(91)		9,469
Equity securities		1,293		709		-		2,002
Total	$	348,099	$	6,293	$	(564)	$	353,828
At December 31, 2012
Held to Maturity:
Obligations of state and political subdivisions	$	12,797	$	862	$	-	$	13,659
Total	$	12,797	$	862	$	-	$	13,659
Available for Sale:
Federal agency securities	$	114,159	$	1,474	$	(19)	$	115,614
Obligations of state and political subdivisions		34,754		887		(83)		35,558
Residential mortgage-backed securities		200,310		3,668		(303)		203,675
Asset-backed securities		7,794		-		(123)		7,671
Equity securities		1,300		497		-		1,797
Total	$	358,317	$	6,526	$	(528)	$	364,315

8

Residential mortgage-backed securities consist of agency securities underwritten and guaranteed by Government National Mortgage Association, Federal Home Loan Mortgage Corporation, and Federal National Mortgage Association. 

Securities with limited marketability, such as Federal Reserve Bank stock, Federal Home Loan Bank (“FHLB”) stock, and certain other investments, are carried at cost and included in other assets on the unaudited consolidated statement of financial condition.  Total investments carried at cost were $8.5 million at both March 31, 2013 and December 31, 2012.  There are no identified events or changes in circumstances that may have a significant adverse effect on the investments carried at cost.  

A comparison of the amortized cost and approximate fair value of our investment securities by maturity date at March 31, 2013 follows: 

	Available for Sale				Held to Maturity
	Amortized		Fair		Amortized		Fair
(Dollars in thousands)	Cost		Value		Cost		Value
One year or less	$	45,755	$	46,336	$	1,004	$	1,013
More than one year through five years		170,600		173,826		940		962
More than five years through ten years		111,029		112,215		6,407		6,736
More than ten years		20,715		21,451		3,426		3,828
Total	$	348,099	$	353,828	$	11,777	$	12,539

The foregoing analysis assumes that our residential mortgage-backed securities mature during the period in which they are estimated to prepay.  No other prepayment or repricing assumptions have been applied to our investment securities for this analysis. 

Gain or loss on sale of investments is based upon the specific identification method.  There were no sales of securities available for sale as of either March 31, 2013 or March 31, 2012. 

The following table shows securities with gross unrealized losses and their fair values by the length of time that the individual securities had been in a continuous unrealized loss position at March 31, 2013 and December 31, 2012.  Securities whose market values exceed cost are excluded from this table.     

				Continuous Unrealized
		Amortized cost of		Loss Existing for:				Fair value of
	Number of	securities with		Less Than		More Than		securities with
(Dollars in thousands)	Securities	unrealized losses		12 Months		12 Months		unrealized losses
At March 31, 2013
Available for Sale:
Federal agency securities	10	$	22,165	$	(91)	$	-	$	22,074
Obligations of state and political subdivisions	5		6,017		(22)		(7)		5,988
Residential mortgage-backed securities	28		53,583		(341)		(12)		53,230
Asset-backed securities	5		9,560		(91)		-		9,469
Total	48	$	91,325	$	(545)	$	(19)	$	90,761
At December 31, 2012
Available for Sale:
Federal agency securities	5	$	9,887	$	(19)	$	-	$	9,868
Obligations of state and political subdivisions	9		10,457		(83)		-		10,374
Residential mortgage-backed securities	23		46,787		(288)		(15)		46,484
Asset-backed securities	4		7,794		(123)		-		7,671
Total	41	$	74,925	$	(513)	$	(15)	$	74,397

9

We evaluate all securities on an individual basis for other-than-temporary impairment on at least a quarterly basis.  Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability of us to retain our investment in the issuer for a period of time sufficient to allow for an anticipated recovery in fair value. 

Management has the ability and intent to hold the securities classified as held to maturity in the table above until they mature, at which time we expect to receive full value for the securities.  Furthermore, as of March 31, 2013, management does not have the intent to sell any of the securities classified as available for sale in the table above and believes that it is not more likely than not that we will have to sell any such securities before a recovery of cost.  The declines in fair value were attributable to increases in market interest rates over the yields available at the time the underlying securities were purchased or increases in spreads over market interest rates.  Management does not believe any of the securities are impaired due to credit quality.  Accordingly, as of March 31, 2013, management believes the impairment of these investments is not deemed to be other-than-temporary. 

As required by law, available for sale investment securities are pledged to secure public and trust deposits, sweep agreements, and borrowings from the FHLB.  Securities with an amortized cost of $278.9 million and $284.2 million were pledged to meet such requirements at March 31, 2013 and December 31, 2012, respectively.  Any amount over-pledged can be released at any time.

NOTE 3: LOANS AND ALLOWANCE FOR LOAN LOSSES

Southwest extends commercial and consumer credit primarily to customers in the states of Oklahoma, Texas, and Kansas.  Its commercial lending operations are concentrated in Oklahoma City, Tulsa, Dallas, Wichita, and other metropolitan markets in Oklahoma, Texas,  and Kansas.  As a result, the collectability of our loan portfolio can be affected by changes in the economic conditions in those states and markets.  Please see Note 8: Operating Segments for more detail regarding loans by market.  At March 31, 2013 and December 31, 2012, substantially all of our loans were collateralized with real estate, inventory, accounts receivable, and/or other assets or were guaranteed by agencies of the United States government. 

Our loan classifications were as follows: 

	At March 31, 2013				At December 31, 2012
(Dollars in thousands)	Noncovered		Covered		Noncovered		Covered
Real estate mortgage:
Commercial	$	819,873	$	16,970	$	870,975	$	18,298
One-to-four family residential		73,911		4,458		70,954		4,881
Real estate construction:
Commercial		139,462		367		130,753		382
One-to-four family residential		5,015		-		3,656		-
Commercial		232,224		1,715		240,498		2,037
Installment and consumer:
Guaranteed student loans		4,576		-		4,680		-
Other		28,553		91		31,512		109
		1,303,614		23,601		1,353,028		25,707
Less: Allowance for loan losses		(42,639)		(214)		(46,494)		(224)
Total loans, net	$	1,260,975	$	23,387	$	1,306,534	$	25,483

Concentrations of Credit.  At March 31, 2013, $474.8 million, or 36%, of our noncovered loans consisted of loans to individuals and businesses in the healthcare industry.  We do not have any other concentrations of loans to individuals or businesses involved in a single industry totaling 10% or more of total loans. 

Loans Held for Sale.  We had loans which were held for sale of $7.3 million and $31.7 million at March 31, 2013 and December 31, 2012, respectively.  The decline from year-end is due to reclassifying the guaranteed student loans and the United States Department of Agriculture government guaranteed commercial real estate loans back into the loan portfolio and not actively looking to sell these loans.  These loans were reclassified at their respective book value which approximated fair value.  The loans currently classified as held for sale, primarily residential mortgage loans, are carried at the lower of cost or market value.  A substantial portion of the one-to-four family residential loans and loan servicing rights are primarily sold to

10

one buyer.  These mortgage loans are generally sold within a one-month period from loan closing at amounts determined by the investor commitment based upon the pricing of the loan.  These loans are available for sale in the secondary market.  

Loan Servicing.  We earn fees for servicing real estate mortgages and other loans owned by others.  The fees are generally calculated on the outstanding principal balance of the loans serviced and are recorded as noninterest income when earned.  The unpaid principal balance of real estate mortgage loans serviced for others totaled $356.0 million and $301.4 million at March 31, 2013 and 2012, respectively.  Loan servicing rights are capitalized based on estimated fair value at the point of origination.  The servicing rights are amortized over the period of estimated net servicing income.   

Acquired Loans.  On June 19, 2009, Bank of Kansas entered into a purchase and assumption agreement with the Federal Deposit Insurance Corporation (“FDIC”) to acquire substantially all loans as well as certain other related assets of First National Bank of Anthony, Anthony, Kansas (“FNBA”) in an FDIC-assisted transaction.  Bank of Kansas and the FDIC entered into loss sharing agreements that provide Bank of Kansas with significant protection against credit losses from loans and related assets acquired in the transaction.  Under these agreements, the FDIC will reimburse Bank of Kansas for 80% of net losses up to $35.0 million on covered assets, primarily acquired loans and other real estate, and for 95% of any net losses above $35.0 million.  Bank of Kansas services the covered assets.   

Loans covered under the loss sharing agreements with the FDIC, including the amounts of expected reimbursements from the FDIC under these agreements, are reported in loans and are referred to as “covered” loans.  Covered loans were initially recorded at fair value (as determined by the present value of expected future cash flows) with no allowance for loan losses.  Subsequent decreases in expected cash flows are recognized as impairments.  Valuation allowances on these covered loans reflect only losses incurred after the acquisition.   

The expected payments from the FDIC under the loss sharing agreements are recorded as part of the covered loans in the Unaudited Consolidated Statement of Financial Condition.  As of March 31, 2013, Bank of Kansas has identified $22.1 million in cumulative net losses that have been submitted to the FDIC under such loss sharing agreements and no material uncollected amounts were outstanding. 

Changes in the carrying amounts and accretable yields for ASC 310.30 loans were as follows for the three months ended March 31, 2013 and 2012.

	For the three months ended March 31,
	2013					2012
			Carrying				Carrying
	Accretable		amount		Accretable		amount
(Dollars in thousands)	Yield		of loans		Yield		of loans
Balance at beginning of period	$	1,904	$	25,707	$	2,402	$	37,615
Payments received		-		(1,889)		-		(3,291)
Transfers to other real estate / repossessed assets		(33)		(375)		9		(990)
Net charge-offs		(1)		-		(4)		(73)
Net reclassifications to / from nonaccretable amount		-		-		(271)		-
Accretion		(163)		158		(218)		53
Balance at end of period	$	1,707	$	23,601	$	1,918	$	33,314

Nonperforming / Past Due Loans.  We identify past due loans based on contractual terms on a loan by loan basis and generally place loans, except for consumer loans, on nonaccrual when any portion of the principal or interest is ninety  days past due and collateral is insufficient to discharge the debt in full.  Interest accrual may also be discontinued earlier if, in management’s opinion, collection is unlikely.  Generally, consumer installment loans are not placed on nonaccrual but are charged-off when they are four months past due.  Accrued interest is written off when a loan is placed on nonaccrual status.  Subsequent interest income is recorded when cash receipts are received from the borrower and collectability of the principal amount is reasonably assured.   

Under generally accepted accounting principles and instructions to reports of condition and income of federal banking regulators, a nonaccrual loan may be returned to accrual status:  (i) when none of its principal and interest is due and unpaid, repayment is expected, and there has been a sustained period (at least six months) of repayment performance; (ii) when the loan is not brought current, but there is a sustained period of performance and repayment within a reasonable period is

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reasonably assured; or (iii) when the loan otherwise becomes well-secured and in the process of collection.  Purchased nonperforming loans also may be returned to accrual status without becoming fully current.  Loans that have been restructured because of weakened financial positions of the borrowers also may be returned to accrual status if repayment is reasonably assured under the revised terms and there has been a sustained period of repayment performance. 

Management strives to carefully monitor credit quality and to identify loans that may become nonperforming.  At any time, however, there are loans included in the portfolio that will result in losses to us that have not been identified as nonperforming or potential problem loans.  Because the loan portfolio contains a significant number of commercial and commercial real estate loans with relatively large balances, the unexpected deterioration of one or a few such loans may cause a significant increase in nonperforming assets and may lead to a material increase in charge-offs and the provision for loan losses in future periods. 

The following table shows the recorded investment in loans on nonaccrual status. 

	At March 31, 2013				At December 31, 2012
(Dollars in thousands)	Noncovered		Covered		Noncovered		Covered
Real estate mortgage:
Commercial	$	13,362	$	2,613	$	18,337	$	3,087
One-to-four family residential		651		50		563		52
Real estate construction:
Commercial		6,409		130		3,355		130
Commercial		11,861		79		12,761		324
Other consumer		73		1		88		2
Total nonaccrual loans	$	32,356	$	2,873	$	35,104	$	3,595

During the first three months of 2013,  an immaterial amount of interest income was received on nonaccruing loans.  If interest on all nonaccrual loans had been accrued for the three months ended March 31, 2013, additional interest income of $0.6 million would have been recorded.

Net cumulative charge-offs against noncovered nonaccrual loans at March 31, 2013 and December 31, 2012 were $11.8 million and $8.3 million, respectively. 

As of March 31, 2013 and December 31, 2012, included in noncovered nonaccrual loans are five and six collateral dependent lending relationships with aggregate principal balances of approximately $27.6 million and $31.2 million, respectively, and related impairment reserves of $4.0 million and $6.8 million, respectively, which were established either based on recent appraisal values obtained for the respective properties or the discounted present value of expected cash flows using the loan’s initial effective interest rate.  At March 31, 2013,  three of the five lending relationships are secured by commercial real estate.

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The following table shows an age analysis of past due loans at March 31, 2013 and December 31, 2012. 

			90 days and								Recorded loans
	30-89 days		greater		Total past				Total		> 90 days and
(Dollars in thousands)	past due		past due		due		Current		loans		accruing
At March 31, 2013
Noncovered:
Real estate mortgage:
Commercial	$	9,015	$	13,362	$	22,377	$	797,496	$	819,873	$	-
One-to-four family residential		792		651		1,443		72,468		73,911		-
Real estate construction:
Commercial		97		6,409		6,506		132,956		139,462		-
One-to-four family residential		-		-		-		5,015		5,015		-
Commercial		879		11,861		12,740		219,484		232,224		-
Other		167		73		240		32,889		33,129		-
Total - noncovered		10,950		32,356		43,306		1,260,308		1,303,614		-
Covered:
Real estate mortgage:
Commercial		527		2,613		3,140		13,830		16,970		-
One-to-four family residential		-		50		50		4,408		4,458		-
Real estate construction:
Commercial		-		130		130		237		367		-
Commercial		-		79		79		1,636		1,715		-
Other		-		1		1		90		91		-
Total - covered		527		2,873		3,400		20,201		23,601		-
Total	$	11,477	$	35,229	$	46,706	$	1,280,509	$	1,327,215	$	-
At December 31, 2012
Noncovered:
Real estate mortgage:
Commercial	$	23,348	$	18,337	$	41,685	$	829,290	$	870,975	$	-
One-to-four family residential		1,479		1,310		2,789		68,165		70,954		747
Real estate construction:
Commercial		3,501		3,355		6,856		123,897		130,753		-
One-to-four family residential		-		-		-		3,656		3,656		-
Commercial		7,358		15,232		22,590		217,908		240,498		2,471
Other		538		160		698		35,494		36,192		72
Total - noncovered		36,224		38,394		74,618		1,278,410		1,353,028		3,290
Covered:
Real estate mortgage:
Commercial real estate		1,090		3,087		4,177		14,121		18,298		-
One-to-four family residential		-		52		52		4,829		4,881		-
Real estate construction:
Commercial		-		130		130		252		382		-
Commercial		-		324		324		1,713		2,037		-
Other		-		2		2		107		109		-
Total - covered		1,090		3,595		4,685		21,022		25,707		-
Total	$	37,314	$	41,989	$	79,303	$	1,299,432	$	1,378,735	$	3,290

Impaired Loans.  A loan is considered to be impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement.  Each loan deemed to be

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impaired (all loans on nonaccrual status and troubled debt restructurings) is evaluated on an individual basis using the discounted present value of expected cash flows using the loan’s initial effective interest rate, the fair value of collateral, or the market value of the loan.  Smaller balance, homogeneous loans, including mortgage, student, and consumer, are collectively evaluated for impairment.     

Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis.  Impaired loans or portions thereof, are charged-off when deemed uncollectible. 

Impaired loans are shown in the following table: 

	With No Specific Allowance				With A Specific Allowance
			Unpaid				Unpaid
	Recorded		Principal		Recorded		Principal		Related
(Dollars in thousands)	Investment		Balance		Investment		Balance		Allowance
At March 31, 2013
Noncovered:
Commercial real estate	$	23,090	$	23,355	$	24,404	$	27,729	$	5,146
One-to-four family residential		651		807		-		-		-
Real estate construction		3,873		7,841		3,365		3,377		249
Commercial		3,402		4,348		10,137		13,541		3,431
Other		5		8		68		90		68
Total noncovered	$	31,021	$	36,359	$	37,974	$	44,737	$	8,894
Covered:
Commercial real estate	$	4,710	$	5,957	$	2,101	$	2,720	$	28
One-to-four family residential		19		24		50		97		4
Real estate construction		130		308		-		-		-
Commercial		79		179		-		-		-
Other		1		2		-		-		-
Total covered	$	4,939	$	6,470	$	2,151	$	2,817	$	32
At December 31, 2012
Noncovered:
Commercial real estate	$	29,425	$	30,340	$	24,630		27,397	$	5,094
One-to-four family residential		563		653		7		7		7
Real estate construction		3,970		7,841		232		256		50
Commercial		3,337		6,975		13,422		13,448		6,492
Other		7		8		81		100		81
Total noncovered	$	37,302	$	45,817	$	38,372		41,208	$	11,724
Covered:
Commercial real estate	$	4,325	$	5,347	$	2,214		3,979	$	22
One-to-four family residential		20		25		52		98		2
Real estate construction		130		308		-		-		-
Commercial		322		1,884		2		3		1
Other		2		4		-		-		-
Total covered	$	4,799	$	7,568	$	2,268	$	4,080	$	25

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The average recorded investment and interest income recognized on impaired loans as of March 31, 2013 and 2012 is shown in the following table:  

	As of and for the three  months ended March 31,
	2013				2012
	Average				Average
	Recorded		Interest		Recorded		Interest
(Dollars in thousands)	Investment		Income		Investment		Income
Noncovered:
Commercial real estate	$	47,880	$	410	$	25,414	$	416
One-to-four family residential		578		-		1,475		-
Real estate construction		5,117		12		12,950		90
Commercial		13,254		34		3,659		19
Other		77		-		118		-
Total noncovered	$	66,906	$	456	$	43,616	$	525
Covered:
Commercial real estate	$	17,803	$	82	$	21,267	$	28
One-to-four family residential		4,724		-		6,681		-
Real estate construction		373		-		5,244		-
Commercial		1,873		-		2,602		-
Other		95		-		224		-
Total covered	$	24,868	$	82	$	36,018	$	28

Troubled Debt Restructurings.  Our loan portfolio also includes certain loans that have been modified in a troubled debt restructuring, where economic concessions have been granted to borrowers who have experienced financial difficulties.  These concessions typically result from loss mitigation activities and can include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance, or other actions.  Troubled debt restructurings are classified as impaired at the time of restructuring and classified as nonperforming, potential problem, or performing restructured, as applicable.  Loans modified in troubled debt restructurings may be returned to performing status after considering the borrowers’ sustained repayment for a reasonable period of at least six months. 

When we modify loans in a troubled debt restructuring, an evaluation of any possible impairment is performed similar to other impaired loans based on the present value of expected future cash flows, discounted at the contractual interest rate of the original loan agreement, or use of the current fair value of the collateral, less selling costs for collateral dependent loans.  If it is determined that the value of the modified loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs, and unamortized premium or discount), an impairment is recognized through an allowance estimate or a charge-off to the allowance.  In periods subsequent to modification, all loans modified in troubled debt restructurings are evaluated, including those that have payment defaults, for possible impairment. 

Troubled debt restructured loans outstanding as of March 31, 2013 and December 31, 2012 are as follows: 

	At March 31, 2013				At December 31, 2012
(Dollars in thousands)	Accruing		Nonaccrual		Accruing		Nonaccrual
Commercial real estate	$	38,330	$	12,691	$	39,170	$	2,953
One-to-four family residential		19		127		27		134
Real estate construction		829		130		847		130
Commercial		1,678		1,200		3,998		351
Consumer		-		68		-		81
Total	$	40,856	$	14,216	$	44,042	$	3,649

At March 31, 2013 and December 31, 2012,  we had no significant commitments to lend additional funds to debtors whose loan terms have been modified in troubled debt restructuring. 

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Loans modified as troubled debt restructurings that occurred during the three months ended March 31, 2013 and  2012 are shown in the following table:     

	For the three months ended March 31,
	2013				2012
	Number of		Recorded		Number of		Recorded
(Dollars in thousands)	Modifications		Investment		Modifications		Investment
Commercial real estate		6	$	10,882		1	$	12,035
One-to-four family residential		-		-		1		99
Real estate construction		-		-		1		973
Commercial		3		576		2		343
Total		9	$	11,458		5	$	13,450

The modifications of loans identified as troubled debt restructurings primarily related to payment extensions and/or reductions in the interest rate.  The financial impact of troubled debt restructurings is not significant.   

The following table presents the recorded investment and the number of loans modified as a troubled debt restructuring which subsequently defaulted during the three months ended March 31, 2013 and 2012.  Default, for this purpose, is deemed to occur when a loan is 90 days or more past due or transferred to nonaccrual and is within twelve months of restructuring.   

	For the three months ended March 31,
	2013				2012
	Number of		Recorded		Number of		Recorded
(Dollars in thousands)	Contracts		Investment		Contracts		Investment
Commercial		1	$	563		2	$	121
Total		1	$	563		2	$	121

Credit Quality Indicators.  To assess the credit quality of loans, we categorize loans into risk categories based on relevant information about the ability of the borrowers to service their debts such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors.  This analysis is performed on a quarterly basis.  We use the following definitions for risk ratings:   

Special mention – Loans classified as special mention have potential weaknesses that deserve management’s close attention.  If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for these loans or of the institution’s credit position at some future date. 

Substandard – Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligors or of the collateral pledged, if any.  Loans so classified have one or more well-defined weaknesses that jeopardize the liquidation of the debt.  They are characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected.  These loans are considered potential problem or nonperforming loans depending on the accrual status of the loans.    

Doubtful – Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristics that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.  These loans are considered nonperforming. 

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Loans not meeting the criteria above that are analyzed as part of the above described process are considered to be pass rated loans.  As of March 31, 2013 and December 31, 2012, based on the most recent analysis performed as of those dates, the risk category of loans by class is as follows: 

	Commercial		1-4 Family		Real Estate
(Dollars in thousands)	Real Estate		Residential		Construction		Commercial		Other		Total
At March 31, 2013
Grade:
Pass	$	665,280	$	74,190	$	90,759	$	208,119	$	33,036	$	1,071,384
Special Mention		91,340		2,307		27,650		5,741		109		127,147
Substandard		78,467		1,760		26,435		13,542		75		120,279
Doubtful		1,756		112		-		6,537		-		8,405
Total	$	836,843	$	78,369	$	144,844	$	233,939	$	33,220	$	1,327,215
At December 31, 2012
Grade:
Pass	$	718,054	$	71,975	$	83,350	$	208,019	$	35,897	$	1,117,295
Special Mention		88,167		1,901		25,964		7,047		181		123,260
Substandard		80,104		1,923		25,477		26,887		223		134,614
Doubtful		2,948		36		-		582		-		3,566
Total	$	889,273	$	75,835	$	134,791	$	242,535	$	36,301	$	1,378,735

Allowance for Loan Losses.  The allowance for loan losses is a reserve established through the provision for loan losses charged to operations.  Loan amounts which are determined to be uncollectible are charged against this allowance, and recoveries, if any, are added to the allowance.  The appropriate amount of the allowance is based on continuous review and evaluation of the loan portfolio and ongoing, quarterly assessments of the probable losses inherent in the loan and lease portfolio.  The amount of the loan loss provision for a period is based solely upon the amount needed to cause the allowance to reach the level deemed appropriate after the effects of net charge-offs for the period. 

Management believes the level of the allowance is appropriate to absorb probable losses inherent in the loan portfolio.  The allowance for loan losses is determined in accordance with regulatory guidelines and generally accepted accounting principles and is comprised of two primary components, specific and general.  There is no one factor, or group of factors, that produces the amount of an appropriate allowance for loan losses, as the methodology for assessing the allowance for loan losses makes use of evaluations of individual impaired loans along with other factors and analysis of loan categories.  This assessment is highly qualitative and relies upon judgments and estimates by management.

The specific allowance is recorded based on the result of an evaluation consistent with ASC 310.10.35, Receivables: Subsequent Measurement, for each impaired loan.  Collateral dependent loans are evaluated for impairment based upon the fair value of the collateral.  The amount and level of the impairment allowance is ultimately determined by management’s estimate of the amount of expected future cash flows or, if the loan is collateral dependent, on the value of collateral, which may vary from period to period depending on changes in the financial condition of the borrower or changes in the estimated value of the collateral.  Charge-offs against the allowance for impaired loans are made when and to the extent loans are deemed uncollectible.  Any portion of a collateral dependent impaired loan in excess of the fair value of the collateral that is determined to be uncollectible is charged off.  

The general component of the allowance is calculated based on ASC 450, Contingencies.  Loans not evaluated for specific allowance are segmented into loan pools by type of loan.  The commercial real estate and real estate construction pools are further segmented by the market in which the loan collateral is located.  Our primary markets are Oklahoma, Texas, and Kansas, and loans secured by real estate in those states are included in the “in-market” pool, with the remaining defaulting to the “out-of-market” pool.  Estimated allowances are based on historical loss trends with adjustments factored in based on qualitative risk factors both internal and external to us.  The historical loss trend is determined by loan pool and segmentation and is based on the actual loss history experienced by us over the most recent three years.  The qualitative risk factors include, but are not limited to, economic and business conditions, changes in lending staff, lending policies and procedures, quality of loan review, changes in the nature and volume of the portfolios, loss and recovery trends, asset quality trends, and legal and regulatory considerations.  

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Independent appraisals on real estate collateral securing loans are obtained at origination.  New appraisals are obtained periodically and following discovery of factors that may significantly affect the value of the collateral.  Appraisals typically are received within 30 days of request.  Results of appraisals on nonperforming and potential problem loans are reviewed promptly upon receipt and considered in the determination of the allowance for loan losses.  We are not aware of any significant time lapses in the process that have resulted, or would result in, a significant delay in determination of a credit weakness, the identification of a loan as nonperforming, or the measurement of an impairment. 

The following table shows the balance in the allowance for loan losses and the recorded investment in covered and noncovered loans by portfolio classification disaggregated on the basis of impairment evaluation method.   

	Commercial		1-4 Family		Real Estate
(Dollars in thousands)	Real Estate		Residential		Construction		Commercial		Other		Total
At March 31, 2013
Balance at beginning of period	$	27,223	$	861	$	5,271	$	12,604	$	759	$	46,718
Loans charged-off		(458)		(186)		-		(3,926)		(81)		(4,651)
Recoveries		42		19		19		175		33		288
Provision for loan losses		(1,520)		161		669		1,260		(72)		498
Balance at end of period	$	25,287	$	855	$	5,959	$	10,113	$	639	$	42,853
Allowance for loan losses ending balance:
Individually evaluated for impairment	$	5,146	$	-	$	249	$	3,431	$	68	$	8,894
Collectively evaluated for impairment		19,996		786		5,710		6,682		571		33,745
Acquired with deteriorated credit quality		145		69		-		-		-		214
Total ending allowance balance	$	25,287	$	855	$	5,959	$	10,113	$	639	$	42,853
Loans receivable ending balance:
Individually evaluated for impairment	$	47,494	$	651	$	7,238	$	13,539	$	73	$	68,995
Collectively evaluated for impairment		772,379		73,260		137,239		218,685		33,056		1,234,619
Acquired with deteriorated credit quality		16,970		4,458		367		1,715		91		23,601
Total ending loans balance	$	836,843	$	78,369	$	144,844	$	233,939	$	33,220	$	1,327,215

	Commercial		1-4 Family		Real Estate
	Real Estate		Residential		Construction		Commercial		Other		Total
At March 31, 2012
Balance at beginning of period	$	21,749	$	1,016	$	11,177	$	9,827	$	915	$	44,684
Loans charged-off		(25)		(158)		-		(1,483)		(270)		(1,936)
Recoveries		11		35		42		272		259		619
Provision for loan losses		2,052		60		73		(419)		(50)		1,716
Balance at end of period	$	23,787	$	953	$	11,292	$	8,197	$	854	$	45,083
Allowance for loan losses ending balances:
Individually evaluated for impairment	$	4,240	$	40	$	75	$	824	$	108	$	5,287
Collectively evaluated for impairment		19,529		912		11,182		7,367		746		39,736
Acquired with deteriorated credit quality		18		1		35		6		-		60
Total ending allowance balance	$	23,787	$	953	$	11,292	$	8,197	$	854	$	45,083
Loans receivable ending balance:
Individually evaluated for impairment	$	34,856	$	1,473	$	12,624	$	3,312	$	118	$	52,383
Collectively evaluated for impairment		961,630		74,814		213,868		270,012		36,924		1,557,248
Acquired with deteriorated credit quality		22,607		5,766		2,344		2,401		196		33,314
Total ending loans balance	$	1,019,093	$	82,053	$	228,836	$	275,725	$	37,238	$	1,642,945

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NOTE 4:  FAIR VALUE MEASUREMENTS

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.  In estimating fair value, we utilize valuation techniques that are consistent with the market approach, the income approach, and/or the cost approach.  Such valuation techniques are consistently applied.  Inputs to valuation techniques include the assumptions that market participants would use in pricing an asset or liability.

ASC 820, Fair Value Measurements and Disclosure,  establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs.  The fair value hierarchy is as follows: 

Level 1Quoted prices in active markets for identical instruments. 

Level 2Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.   

Level 3Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.   

The estimated fair value amounts have been determined by us using available market information and appropriate valuation methodologies.  However, considerable judgment is required to interpret market data to develop the estimates of fair value.  Accordingly, the estimates presented herein are not necessarily indicative of the amount we could realize in a current market exchange.  The use of different market assumptions and/or estimation methodologies could have a material effect on our estimated fair value amounts.  There were no changes in valuation methods used to estimate fair value during the three months ended March 31, 2013. 

A description of the valuation methodologies used for instruments measured at fair value on a recurring basis is as follows: 

Loans held for sale – Real estate mortgage loans held for sale are carried at the lower of cost or market, which is determined on an individual loan basis based on loan commitments.  Prior year guaranteed student loans held for sale are carried at the lower of cost or market, which is determined on an aggregate basis. 

Available for sale securities – The fair value of U.S. Government and federal agency securities, equity securities, and residential mortgage-backed securities is estimated based on quoted market prices or dealer quotes.  The fair value of other investments such as obligations of state and political subdivisions is estimated based on quoted market prices.  We obtain fair value measurements from an independent pricing service.  The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information, and bond’s terms and conditions, among other things.  We review the prices supplied by our independent pricing service, as well as their underlying pricing methodologies, for reasonableness and to ensure such prices are aligned with traditional pricing matrices. 

The fair value of a single private equity investment is estimated based on our proportionate share of the net asset value, $1.8 million and $1.7 million as of March 31, 2013 and December 31, 2012, respectively.  The investee invests in small and mid-sized U.S. financial institutions and other financial-related companies.  This investment has a quarterly redemption with sixty-five days’ notice. 

Derivative instrument – We utilize an interest rate swap agreement to convert one of our variable-rate subordinated debentures to a fixed rate (cash flow hedge).  The fair value of the interest rate swap agreement is obtained from dealer quotes.   

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The following table summarizes financial assets measured at fair value on a recurring basis as of March 31, 2013 and December 31, 2012. 

			Fair Value Measurement at Reporting Date Using
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
(Dollars in thousands)	Total		(Level 1)		(Level 2)		(Level 3)
At March 31, 2013
Loans held for sale:
One-to-four family residential	$	7,061	$	-	$	7,061	$	-
Government guaranteed commercial real estate		152		-		152		-
Other loans held for sale		84		-		84		-
Available for sale securities:
Federal agency securities		107,255		-		107,255		-
Obligations of state and political subdivisions		35,626		-		35,626		-
Residential mortgage-backed securities		199,476		-		199,476		-
Asset-backed securities		9,469		-		9,469		-
Equity securities		2,002		113		1,889		-
Derivative instrument		(2,954)		-		(2,954)		-
Total	$	358,171	$	113	$	358,058	$	-
At December 31, 2012
Loans held for sale:
Student loans	$	4,680	$	-	$	4,680	$	-
One-to-four family residential		5,112		-		5,112		-
Government guaranteed commercial real estate		21,794		-		21,794		-
Other loans held for sale		96		-		96		-
Available for sale securities:
Federal agency securities		115,614		-		115,614		-
Obligations of state and political subdivisions		35,558		-		35,558		-
Residential mortgage-backed securities		203,675		-		203,675		-
Asset-backed securities		7,671				7,671
Equity securities		1,797		111		1,686		-
Derivative instrument		(3,195)		-		(3,195)		-
Total	$	392,802	$	111	$	392,691	$	-

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).  These assets are recorded at the lower of cost or fair value.  Valuation methodologies for assets measured on a nonrecurring basis are as follows: 

Impaired loans – Certain impaired loans are reported at the fair value of the underlying collateral if repayment is expected solely from collateral.  Collateral values are estimated using Level 2 inputs based on third-party appraisals or Level 3 inputs based on customized discounting criteria.  Certain other impaired loans are remeasured and reported through a specific valuation allowance allocation of the allowance for loan losses based upon the net present value of cash flows.   

Other real estate – Other real estate fair value is based on third-party appraisals for significant properties less the estimated costs to sell the asset.   

Goodwill – Fair value of goodwill is based on the fair value of each of our reporting units to which goodwill is allocated compared with their respective carrying value.  There has been no impairment during 2013 or 2012; therefore, no fair value adjustment was recorded through earnings. 

Core deposit premiums – The fair value of core deposit premiums are based on third-party appraisals. There has been no impairment during 2013 or 2012; therefore, no fair value adjustment was recorded through earnings. 

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Mortgage loan servicing rights – There is no active trading market for loan servicing rights.  The fair value of loan servicing rights is estimated by calculating the present value of net servicing revenue over the anticipated life of each loan.  A cash flow model is used to determine fair value.  Key assumptions and estimates, including projected prepayment speeds and assumed servicing costs, earnings on escrow deposits, ancillary income, and discount rates, used by this model are based on current market sources.  A separate third party model is used to estimate prepayment speeds based on interest rates, housing turnover rates, estimated loan curtailment, anticipated defaults, and other relevant factors.  The prepayment model is updated for changes in market conditions.   

Assets that are measured at fair value on a nonrecurring basis as of March 31, 2013 and December 31, 2012 are summarized below.   

			Fair Value Measurements Using
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs		Total Gains
(Dollars in thousands)	Total		(Level 1)		(Level 2)		(Level 3)		(Losses)
At March 31, 2013
Noncovered impaired loans at fair value :
Commercial real estate	$	29,403	$	-	$	29,403	$	-	$	1,514
One-to-four family residential		78		-		78		-		(60)
Real estate construction		3,366		-		3,366		-		(200)
Commercial		12,070		-		12,070		-		(448)
Other consumer		68		-		68		-		13
Noncovered other real estate		9,422		-		9,422		-		(1,429)
Covered other real estate		2,243		-		2,243		-		(102)
Total	$	56,650	$	-	$	56,650	$	-	$	(712)
At December 31, 2012
Noncovered impaired loans at fair value :
Commercial real estate	$	33,137	$	-	$	33,137	$	-	$	(6,674)
One-to-four family residential		23		-		23		-		(7)
Real estate construction		232		-		232				3,532
Commercial		13,473		-		13,473		-		(6,637)
Other consumer		81		-		81		-		31
Noncovered other real estate		11,315		-		11,315		-		(3,998)
Covered other real estate		3,643		-		3,643		-		(180)
Mortgage loan servicing rights		2,321		-		-		2,321		(465)
Total	$	64,225	$	-	$	61,904	$	2,321	$	(14,398)

Noncovered impaired loans measured at fair value with a carrying amount of $57.8 million were written down to a fair value of $45.0 million, resulting in a life-to-date impairment of $12.8 million, of which $0.8 million was included in the provision for loan losses for the three months ended March 31, 2013.  As of December 31, 2012, noncovered impaired loans measured at fair value with a carrying amount of $61.0 million were written down to the fair value of $46.9 million at December 31, 2012, resulting in a life-to-date impairment charge of $14.1 million, of which $9.8 million was included in the provision for loan losses for the year ended December 31, 2012. 

As of March 31, 2013, noncovered and covered other real estate assets were written down to their fair values, resulting in an impairment charge of approximately $1.4 million and $0.1 million, respectively, which was included in noninterest expense for the three months ended March 31, 2013.  As of December 31, 2012, noncovered and covered other real estate assets were written down to their fair values, resulting in an impairment charge of approximately $4.0 million and $0.2 million, respectively, which was included in noninterest expense for the year ended December 31, 2012.

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For the three months ended March 31, 2013 there was no impairment of mortgage loan servicing rights.  For the year ended December 31, 2012, mortgage loan servicing rights were written down to their fair values, resulting in impairment charges of $0.5 million, which was included in noninterest income for that period.     

ASC 825, Financial Instruments,  requires an entity to provide disclosures about fair value of financial instruments, including those that are not measured and reported at fair value on a recurring or nonrecurring basis.   The methodologies used in estimating the fair value of financial instruments that are measured on a recurring or nonrecurring basis are discussed above.  The methodologies for the other financial instruments are discussed below: 

Cash and cash equivalents – For cash and cash equivalents, the carrying amount is a reasonable estimate of fair value. 

Securities held to maturity – The investment securities held to maturity are carried at cost.  The fair value of the held to maturity securities is estimated based on quoted market prices or dealer quotes. 

Loans – Fair values are estimated for certain homogenous categories of loans adjusted for differences in loan characteristics.  Our loans have been aggregated by categories consisting of commercial, real estate, student, and other consumer.  The fair value of loans is estimated by discounting the cash flows using risks inherent in the loan category and interest rates currently offered for loans with similar terms and credit risks. 

Accrued interest receivable – The carrying amount is a reasonable estimate of fair value for accrued interest receivable. 

Investment included in other assets – The estimated fair value of investments included in other assets, which primarily consists of investments carried at cost, approximates their carrying values. 

Deposits – The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the statement of financial condition date.  The fair value of fixed maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities. 

Other liabilities and accrued interest payable – The estimated fair value of other liabilities, which primarily includes trade accounts payable and accrued interest payable, approximates their carrying values. 

Other borrowings – Included in other borrowings are FHLB advances, securities sold under agreements to repurchase, and treasury tax and loan demand notes.  The fair value for fixed rate FHLB advances is based upon discounted cash flow analysis using interest rates currently being offered for similar instruments.  The fair values of other borrowings are the amounts payable at the statement of financial condition date, as the carrying amount is a reasonable estimate of fair value due to the short-term maturity rates.   

Subordinated debentures – Two of our subordinated debentures have floating rates that reset quarterly and our third subordinated debenture has a fixed rate.  The fair value of our fixed rate subordinated debenture is based on market price.  The fair value of the floating rate subordinated debentures approximates carrying value at March 31, 2013. 

The carrying values and estimated fair values of our financial instruments segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value, were as follows: 

	At March 31, 2013				At December 31, 2012
	Carrying		Fair		Carrying		Fair
(Dollars in thousands)	Values		Values		Values		Values
Financial assets:
Level 2 inputs:
Cash and cash equivalents	$	344,190	$	344,190	$	288,079	$	288,079
Securities held to maturity		11,777		12,539		12,797		13,659
Accrued interest receivable		6,346		6,346		6,365		6,365
Investments included in other assets		8,537		8,537		8,531		8,531
Level 3 inputs:
Total loans, net of allowance		1,284,362		1,252,642		1,332,017		1,301,942
Financial liabilities:
Level 2 inputs:
Deposits		1,677,668		1,629,148		1,709,578		1,666,653
Accrued interest payable		1,064		1,064		1,116		1,116
Other liabilities		6,664		6,664		9,985		9,985
Other borrowings		70,872		74,378		70,362		74,057
Subordinated debentures		81,963		83,136		81,963		82,998

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NOTE 5:  DERIVATIVE INSTRUMENTS

We have an interest rate swap agreement with a total notional amount of $25.0 million.  The interest rate swap contract was designated as a hedging instrument in cash flow hedges with the objective of protecting the overall cash flow from our quarterly interest payments on the SBI Capital Trust II preferred securities throughout the seven year period beginning February 11, 2011 and ending April 7, 2018 from the risk of variability of those payments resulting from changes in the three-month London Interbank Offered Rate (“LIBOR”).  Under the swap, we pay a fixed interest rate of 6.15% and receive a variable interest rate of three-month LIBOR plus a margin of 2.85% on a total notional amount of $25.0 million, with quarterly settlements.  The rate received by us as of March 31, 2013 was 3.15%. 

The estimated fair value of the interest rate derivative contract outstanding as of March 31, 2013 and December 31, 2012 resulted in a pre-tax loss of $3.0 million and $3.2 million, respectively, and was included in other liabilities in the unaudited consolidated statement of financial condition.  We obtained the counterparty valuation to validate its interest rate derivative contract as of March 31, 2013 and December 31, 2012.   

The effective portion of our gain or loss due to changes in the fair value of the derivative hedging instrument, a $0.1 million loss and a $0.2 million loss for the three months ended March 31, 2013 and March 31, 2012, respectively, is included in other comprehensive income, net of tax, while the ineffective portion (indicated by the excess of the cumulative change in the fair value of the derivative over that which is necessary to offset the cumulative change in expected future cash flows on the hedge transaction) is included in other noninterest income or other noninterest expense.  No ineffectiveness related to the interest rate derivative was recognized during either reporting period.   

Net cash flows as a result of the interest rate swap agreement were $0.2 million for both the three months ended March 31, 2013 and March 31, 2012, and were included in interest expense on subordinated debentures.   

Derivative contracts involve the risk of dealing with institutional derivative counterparties and their ability to meet contractual terms.  Institutional counterparties must have an investment grade credit rating and be approved by our asset/liability management committee.  Our credit exposure on interest rate swaps is limited to the net favorable value and interest payments of all swaps by each counterparty.  Credit exposure may be reduced by the amount of collateral pledged by the counterparty.  There are no credit-risk-related contingent features associated with our derivative contract. 

The fair value of cash and securities posted as collateral by us related to the derivative contract was $4.1 million and $4.2 million at March 31, 2013 and December 31, 2012, respectively.

NOTE 6: TAXES ON INCOME 

Net deferred tax assets totaled $30.6 million at March 31, 2013 and $32.2 million at December 31, 2012.  Net deferred tax assets are included in other assets and no valuation allowance is recorded. 

We are in a cumulative pretax loss position for the trailing three-year period ended March 31, 2013.  Under current accounting guidance, this represents significant negative evidence in the determination of the need for a valuation allowance.  Included in the three-year pretax loss position is $101.0 million related to the nonrecurring sale of nonperforming assets and potential problem loans that occurred in the fourth quarter of 2011.   

We conducted an interim analysis to assess the need for a valuation allowance at March 31, 2013.  As part of this analysis management considered negative evidence associated with our trailing cumulative loss position against positive evidence associated with the taxable income generated in the first three months of 2013,  a  long history of taxable income, and projected pre-tax income in future years.  While realization of the deferred tax benefit is not assured, it is management’s judgment, after review of all available evidence and based on the weight of such evidence, that a valuation allowance is not required as realization of these benefits meets the “more likely than not” standard under generally accepted accounting principles.   

ASC 704, Income Taxes,  defines the threshold for recognizing the benefits of tax return positions in the financial statements as “more-likely-than-not” to be sustained by the appropriate taxing authority.  During the first quarter of 2013, new information was obtained related to tax credits taken on prior tax returns that may not be sustained upon examination.  After analyzing all available information, Southwest recorded a liability against the previously recorded tax benefit.  The total gross balance of this unrecognized tax benefit at March 31, 2013, was $0.3 million, all of which would favorably affect the effective tax rate in future periods if recognized.  Additionally, Southwest recognizes interest accrued related to unrecognized

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tax benefits and penalties as operating expenses. For the three months ended March 31, 2013, less than $0.1 million has been accrued in interest and penalties.

We or one of our subsidiaries file income tax returns in the U.S. federal jurisdiction and various state jurisdictions.  We are no longer subject to U.S. federal or state tax examinations for years before 2009. 

NOTE 7: EARNINGS PER SHARE

Earnings per common share is computed using the two-class method prescribed by ASC 260, Earnings Per Share.  Using the two-class method, basic earnings per common share is computed based upon net income available to common shareholders divided by the weighted average number of common shares outstanding during each period, which excludes outstanding unvested restricted stock.  Diluted earnings per share is computed using the weighted average number of common shares determined for the basic earnings per common share computation plus the dilutive effect of stock options using the treasury stock method.  Stock options and warrants with exercise prices greater than the average market price of common shares were not included in the computation of earnings per diluted share as they would have been antidilutive.  On March 31, 2013, there were no antidilutive stock options, and as of March 31, 2012 there were 19,500 antidilutive stock options to purchase common shares, respectively.  An antidilutive warrant to purchase 703,753 shares of common stock was also outstanding on March 31, 2013 and 2012. 

The following table shows the computation of basic and diluted earnings per common share: 

	For the three months
	ended March 31,
(Dollars in thousands, except earnings per share data)	2013		2012
Numerator:
Net income	$	2,389	$	5,211
Preferred dividend		-		(903)
Warrant amortization		-		(189)
Net income available to common shareholders	$	2,389	$	4,119
Earnings allocated to participating securities		(17)		-
Numerator for basic earnings per common share	$	2,372	$	4,119
Effect of reallocating undistributed earnings
of participating securities		17		-
Numerator for diluted earnings per common share	$	2,389	$	4,119
Denominator:
Denominator for basic earnings per common share -
Weighted average common shares outstanding		19,451,490		19,444,698
Effect of dilutive securities:
Stock options		-		-
Warrant		-		-
Denominator for diluted earnings per common share		19,451,490		19,444,698
Earnings per common share:
Basic	$	0.12	$	0.21
Diluted	$	0.12	$	0.21

NOTE 8:  OPERATING SEGMENTS  

Southwest operates five principal segments:  Oklahoma Banking, Texas Banking, Kansas Banking, Secondary Market, and Other Operations.  The Oklahoma Banking segment, the Texas Banking segment, and the Kansas Banking segment provide deposit and lending services.  The Secondary Market segment consists of residential mortgage lending services to customers.  Other Operations includes Southwest’s funds management unit, SNB Wealth Management, and corporate investments.    

The primary purpose of the funds management unit is to manage Southwest’s overall internal liquidity needs and interest rate risk.  Each segment borrows funds from or provides funds to the funds management unit as needed to support its operations. 

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The value of funds provided to and the cost of funds borrowed from the funds management unit by each segment are internally priced at rates that approximate market rates for funds with similar duration.  The yield used in the funds transfer pricing curve is a blend of rates based on the volume usage of retail and brokered certificates of deposit and FHLB advances. 

Effective January 1, 2013, and as a result of new management, Southwest began to identify reportable segments by geographic location of relationship manager.  Operating results are adjusted for allocated service and management costs.  In addition to this realignment, management decided to eliminate a capital credit allocation between the reportable segments.  Prior year information has been realigned and reallocated for consistency with current identified reportable segments.   

The accounting policies of each reportable segment are the same as those of Southwest.  Expenses for consolidated back-office operations are allocated to operating segments based on estimated uses of those services.  General overhead expenses such as executive administration, accounting, and audit are allocated based on the direct expense and/or deposit and loan volumes of the operating segment.  Income tax expense for the operating segments is calculated at statutory rates.  The Other Operations segment records the tax expense or benefit necessary to reconcile to the consolidated financial statements.

Capital is assigned to each of the segments using a risk-based capital pricing methodology that assigns capital ratios by asset, deposit, or revenue category based on credit risk, interest rate risk, market risk, operational risk, and liquidity risk.   

The following table summarizes financial results by operating segment: 

For the three  months ended March 31, 2013
	Oklahoma		Texas		Kansas		Secondary		Other		Total
(Dollars in thousands)	Banking		Banking		Banking		Market		Operations*		Company
Net interest income	$	8,259	$	5,015	$	2,486	$	136	$	(290)	$	15,606
Provision for loan losses		870		(294)		(77)		(1)		-		498
Noninterest income		1,767		387		465		714		204		3,537
Noninterest expenses		7,371		2,607		2,895		562		953		14,388
Income (loss) before taxes		1,785		3,089		133		289		(1,039)		4,257
Taxes on income		783		1,355		59		127		(456)		1,868
Net income (loss)	$	1,002	$	1,734	$	74	$	162	$	(583)	$	2,389
* Includes externally generated loss of $0.2 million, primarily from investing services, and an internally generated revenue of $0.1 million from the funds management unit
Fixed asset expenditures	$	12	$	-	$	-	$	-	$	$ 331	$	343
Total loans at period end		628,748		495,815		195,355		7,297		-		1,327,215
Total assets at period end		644,066		492,657		200,781		9,924		744,266		2,091,694
Total deposits at period end		1,210,995		186,378		266,345		3,569		10,381		1,677,668

For the three  months ended March 31, 2012
	Oklahoma		Texas		Kansas		Secondary		Other		Total
(Dollars in thousands)	Banking		Banking		Banking		Market		Operations*		Company
Net interest income	$	10,323	$	6,958	$	2,519	$	386	$	663	$	20,849
Provision for loan losses		2,428		480		(1,192)		-		-		1,716
Noninterest income		1,760		457		541		550		206		3,514
Noninterest expenses		7,050		2,956		2,794		481		1,028		14,309
Income (loss) before taxes		2,605		3,979		1,458		455		(159)		8,338
Taxes on income		977		1,492		547		171		(60)		3,127
Net income (loss)	$	1,628	$	2,487	$	911	$	284	$	(99)	$	5,211
* Includes externally generated revenue of $0.4 million, primarily from investing services, and an internally generated revenue of $0.5 million from the funds management unit
Fixed asset expenditures	$	139	$	63	$	7	$	-	$	366	$	575
Total loans at period end		810,217		616,455		177,508		38,765		-		1,642,945
Total assets at period end		841,512		613,989		184,428		41,112		587,223		2,268,264
Total deposits at period end		1,367,160		151,856		267,630		3,274		16,860		1,806,780

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NOTE 9:  NEW AUTHORITATIVE ACCOUNTING GUIDANCE

In December 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2011-11, Balance Sheet (Topic 201) – Disclosures about Offsetting Assets and Liabilities.  ASU 2011-11 amends Topic 210, “Balance Sheet,” to require an entity to disclose both gross and net information about financial instruments, such as sales and repurchase agreements and reverse sale and repurchase agreements and securities borrowing/lending arrangements, and derivative instruments that are eligible for offset in the statement of financial position and/or subject to a master netting arrangement or similar agreement. In January 2013, FASB issued Accounting Standards Update No. 2013-01 Balance Sheet (Topic 210) – Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities (“ASU 2013-01”) which clarifies that ordinary trade receivables are not within the scope of ASU 2011-11.    ASU 2011-11, as amended by ASU 2013-01, became effective for the us on January 1, 2013 and did not have a significant impact on the financial statements. 

In October 2012, FASB issued Accounting Standards Update No. 2012-06, Business Combinations (Topic 805) – Subsequent Accounting for an Indemnification Asset Recognized at the Acquisition Date as a Result of a Government-Assisted Acquisition of a financial Institution (“ASU 2012-06”). ASU 2012-06 requires that when a reporting entity initially recognizes an indemnification asset (in accordance with Subtopic 805-20, Business Combinations—Identifiable Assets and Liabilities, and Any Noncontrolling Interest) as a result of a government-assisted acquisition of a financial institution and subsequently a change in the cash flows expected to be collected on the indemnification asset occurs, the reporting entity would be required to account for the change in the measurement of the indemnification asset on the same basis as the change in the assets subject to indemnification. Any amortization of changes in value of the indemnification asset would be limited to the contractual term of the indemnification agreement (that is, the lesser of the term of the indemnification agreement and the remaining term of the indemnified assets). The amendments resulting from ASU 2012-06 would be applied prospectively to any new indemnification assets acquired and to changes in expected cash flows of existing indemnification assets occurring on or after the date of adoption. The guidance is effective for us beginning January 1, 2013 and did not have a significant impact on Southwest’s financial statements.

In February 2013, FASB issued Accounting Standard Update No. 2013-02, Comprehensive Income (Topic 220) – Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income (“ASU 2013-02”). ASU 2013-02 requires an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under U.S. generally accepted accounting principles (GAAP) to be reclassified in its entirety to net income. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures required under U.S. GAAP that provide additional detail about those amounts. ASU 2013-02 is effective for us beginning January 1, 2013 and did not have a significant impact on the financial statements.

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SOUTHWEST BANCORP, INC. 

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

CRITICAL ACCOUNTING POLICIES, JUDGMENTS AND ESTIMATES

The accounting and reporting policies followed by Southwest Bancorp, Inc. (“we”, “our”, ���us”, “Southwest”) conform, in all material respects, to U.S. generally accepted accounting principles (“GAAP”) and to general practices within the financial services industry.  The preparation of the financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes.  While we base our estimates on historical experience, current information, and other factors deemed to be relevant, actual results could differ from those estimates. 

We consider accounting estimates to be critical to reported financial results if (i) the accounting estimate requires management to make assumptions about matters that are highly uncertain and (ii) different estimates that management reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, could have a material impact on our financial statements.  Accounting policies related to the allowance for loan losses and goodwill and other intangible assets are considered to be critical, as these policies involve considerable subjective judgment and estimation by management. 

There have been no significant changes in our application of critical accounting policies since December 31, 2012. 

GENERAL

We are a bank holding company for Stillwater National Bank and Trust Company (“Stillwater National”) and Bank of Kansas. Through our subsidiaries, we offer commercial and consumer lending, deposit and investment services, specialized cash management, and other financial services from offices in Oklahoma, Texas, and Kansas, and on the Internet, through SNB DirectBanker®.  We were organized in 1981 as the holding company for Stillwater National, which was chartered in 1894.  At March 31, 2013, we had total assets of $2.1 billion, deposits of $1.7 billion, and shareholders’ equity of $250.5 million. 

Our area of expertise focuses on the special financial needs of healthcare and health professionals, businesses and their managers and owners, and commercial and commercial real estate borrowers.  We established a strategic focus on healthcare lending in 1974.  We provide credit and other services, such as deposits, cash management, and document imaging for physicians and other healthcare practitioners to start or develop their practices and finance the development and purchase of medical offices, clinics, surgical care centers, hospitals, and similar facilities.  As of March 31, 2013, approximately $474.8 million, or 36%, of our noncovered loans were loans to individuals and businesses in the healthcare industry.  We conduct regular market reviews of our current and potential healthcare lending and the appropriate concentrations within healthcare based upon economic and regulatory conditions. 

We also focus on commercial real estate mortgage and construction credits.  Additionally, subprime residential lending has never been a part of our business strategy, and our exposure to subprime mortgage loans and subprime lenders is minimal.  One-to-four family mortgages account for 6% of total noncovered loans.  As of March 31, 2013 approximately $1.0 billion, or 74%, of our noncovered loans were commercial real estate mortgage and construction loans, including $328.4 million of loans to individuals and businesses in the healthcare industry.   

Our common stock is traded on the NASDAQ Global Select Market under the symbol OKSB.  Our public trust preferred securities are traded on the NASDAQ Global Select Market under the symbol OKSBP.  We focus on converting our strategic vision into long-term shareholder value.  Our vision includes a commercial banking model and a community banking model focused on more traditional banking operations in our three-state market.   

At March 31, 2013, the Oklahoma Banking segment accounted for $628.7 million in loans, the Texas Banking segment accounted for $495.8 million in loans, the Kansas Banking segment accounted for $195.4 million in loans, and the Secondary Market segment accounted for $7.3 million in loans.  Please see “Financial Condition:  Loans” below for additional information.     

For additional information on our operating segments, please see “Note 8: Operating Segments” in the Notes to Unaudited Consolidated Financial Statements. 

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FINANCIAL CONDITION

Investment Securities

The following table shows the composition of the investment portfolio at the dates indicated: 

	March 31,		December 31,
(Dollars in thousands)	2013		2012		$ Change		% Change
Federal agency securities	$	107,255	$	115,614	$	(8,359)	(7.23)	%
Obligations of state and political subdivisions		47,403		48,355		(952)	(1.97)
Residential mortgage-backed securities		199,476		203,675		(4,199)	(2.06)
Asset-backed securities		9,469		7,671		1,798	23.44
Equity securities		2,002		1,797		205	11.41
Total	$	365,605	$	377,112	$	(11,507)	(3.05)	%

Loans

Total loans, including loans held for sale, were $1.3 billion at March 31, 2013.  The following table shows the composition of the loan portfolio at the dates indicated: 

	March 31, 2013				December 31, 2012				Total		Total
(Dollars in thousands)	Noncovered		Covered		Noncovered		Covered		$ Change		% Change
Real estate mortgage
Commercial	$	819,873	$	16,970	$	870,975	$	18,298	$	(52,430)	(5.90)	%
One-to-four family residential		73,911		4,458		70,954		4,881		2,534	3.34
Real estate construction
Commercial		139,462		367		130,753		382		8,694	6.63
One-to-four family residential		5,015		-		3,656		-		1,359	37.17
Commercial		232,224		1,715		240,498		2,037		(8,596)	(3.54)
Installment and consumer
Guaranteed student loans		4,576		-		4,680		-		(104)	(2.22)
Other		28,553		91		31,512		109		(2,977)	(9.41)
Total loans	$	1,303,614	$	23,601	$	1,353,028	$	25,707	$	(51,520)	(3.74)	%

The composition of loans held for sale and a  reconciliation to total loans is shown in the following table: 

	March 31,		December 31,
(Dollars in thousands)	2013		2012		$ Change		% Change
Loans held for sale:
Student loans	$	-	$	4,680	$	(4,680)	(100.00)	%
One-to-four family residential		7,061		5,112		1,949	38.13
Government guaranteed commercial real estate		152		21,794		(21,642)	(99.30)
Other loans held for sale		84		96		(12)	(12.50)
Total loans held for sale		7,297		31,682		(24,385)	(76.97)
Noncovered portfolio loans		1,296,317		1,321,346		(25,029)	(1.89)
Covered portfolio loans		23,601		25,707		(2,106)	(8.19)
Total  loans	$	1,327,215	$	1,378,735	$	(51,520)	(3.74)	%

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Allowance for Loan Losses

Management determines the appropriate level of the allowance for loan losses using an established methodology.  (See “Note 3:  Loans and Allowance for Loan Losses” in the Notes to Unaudited Consolidated Financial Statements.)  Management believes the amount of the allowance is appropriate, based on our analysis.      

The allowance for loan losses on noncovered loans is comprised of two components.  Loans deemed to be impaired (all loans on nonaccrual status and troubled debt restructurings) are evaluated on an individual basis using the discounted present value of expected cash flows, the fair value of collateral, or the market value of the loan, and a specific allowance is recorded based upon the result.  Collateral dependent loans are evaluated for impairment based upon the fair value of the collateral.  Any portion of a collateral dependent impaired loan in excess of the fair value of the collateral that is determined to be uncollectible is charged off. 

The allowance on the unimpaired noncovered loans is determined by use of historical loss ratios adjusted for qualitative internal and external risk factors, segmented into loan pools by type of loan and market area. 

The composition of the allowance for loan losses is shown in the following table: 

	As of March 31, 2013						As of December 31, 2012
(Dollars in thousands)	Loan Balance		Allowance		Allowance %		Loan Balance		Allowance		Allowance %
Noncovered
Nonaccrual	$	32,356	$	4,872	15.1	%	$	35,103	$	7,740	22.0	%
Performing TDR		36,638		4,022	11.0			40,570		3,983	9.8
All other		1,227,323		33,745	2.7			1,245,673		34,771	2.8
Total noncovered	$	1,296,317	$	42,639	3.3	%	$	1,321,346	$	46,494	3.5	%
Covered
Total covered	$	23,601	$	214	0.9	%	$	25,707	$	224	0.9	%
Total	$	1,319,918	$	42,853	3.2	%	$	1,347,053	$	46,718	3.5	%

The decrease in the allowance for nonaccrual loans was the result of a current period charge-offs related to nonperforming loans.  The decrease in the allowance relating to the other noncovered loans resulted from the decrease in the loan portfolio as well as the impairment of the loan portfolio and in consideration of trends and qualitative factors, including portfolio loss trends as well as management’s assessment of economic risk, asset quality trends, levels of potential problem loans, and loan concentrations in commercial real estate mortgage and construction loans. 

The amount of the loan loss provision for a period is based solely upon the amount needed to cause the allowance to reach the level deemed appropriate, after the effects of net charge-offs for the period.  Net charge-offs for the first three months of 2013 were $4.4 million, primarily related to one loan, which is an increase of $3.0 million, or 231%, from the $1.3 million recorded for the first three months of 2012.  The provision for loan losses for the first three months of 2013 was $0.5, representing a decrease of $1.2 million, or 71%, from the $1.7 million recorded for the first three months of 2012. 

Nonperforming Loans 

At March 31, 2013, the allowance for loan losses was 131.78% of noncovered nonperforming loans, compared to 121.10% of noncovered nonperforming loans, at December 31, 2012 (see “Provision for Loan Losses” on page 41).  Noncovered nonaccrual loans, which comprise the majority of noncovered nonperforming loans, were $32.4 million as of March 31, 2013,  a decrease of $2.7 million, or 8%, from December 31, 2012.  We have taken cumulative net charge-offs related to these noncovered nonaccrual loans of $11.8 million as of March 31, 2013.  Noncovered nonaccrual loans at March 31, 2013 were comprised of 33 relationships and were primarily concentrated in commercial real estate (41%), commercial and industrial (37%), and real estate construction (20%) loans.  All noncovered nonaccrual loans are considered impaired and are carried at their estimated collectible amounts.  These noncovered loans are believed to have sufficient collateral and are in the process of being collected.  Covered nonperforming loans at March 31, 2013 of $2.9 million are subject to protection under the loss share agreements with the FDIC. 

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	March 31, 2013						December 31, 2012
(Dollars in thousands)	Noncovered			Covered			Noncovered			Covered
Nonaccrual loans:
Commercial real estate	$	13,362		$	2,613		$	18,337		$	3,087
One-to-four family residential		651			50			563			52
Real estate construction		6,409			130			3,355			130
Commercial		11,861			79			12,761			324
Other consumer		73			1			88			2
Total nonaccrual loans		32,356			2,873			35,104			3,595
Past due 90 days or more:
One-to-four family residential		-			-			747			-
Commercial		-			-			2,471			-
Other consumer		-			-			72			-
Total past due 90 days or more		-			-			3,290			-
Total nonperforming loans		32,356			2,873			38,394			3,595
Other real estate		9,422			2,243			11,315			3,643
Total nonperforming assets	$	41,778		$	5,116		$	49,709		$	7,238
Nonperforming assets to portfolio loans receivable and
other real estate		3.20	%		19.80	%		3.73	%		24.66	%
Nonperforming loans to portfolio loans receivable		2.50			12.17			2.91			13.98
Allowance for loan losses to nonperforming loans		131.78			7.45			121.10			6.23
Government-guaranteed portion of nonperforming loans	$	-		$	2,117		$	76		$	2,456

At March 31, 2013,  five credit relationships represented 85% of noncovered nonperforming loans and 66% of noncovered nonperforming assets.  These were all collateral dependent and commercial or commercial real estate lending relationships and had an aggregate principal balance of $27.6 million and related impairment reserves of $4.0 million.  Aggregate charge-offs for these five relationships were $10.1 million as of March 31, 2013. 

Noncovered performing loans considered potential problem loans, loans which are not included in the past due or nonaccrual categories but for which known information about possible credit problems causes management to be uncertain as to the ability of the borrowers to comply with the present loan repayment terms, amounted to approximately $89.6 million at March 31, 2013, compared to $94.4 million at December 31, 2012.  Substantially all of these loans were performing in accordance with their present terms at March 31, 2013.  Additionally, as of March 31, 2013 and December 31, 2012, there were  $4.0 million and $3.2 million, respectively, of covered potential problem loans, which are subject to protection under the loss share agreements with the FDIC.  Loans may be monitored by management and reported as potential problem loans for an extended period of time during which management continues to be uncertain as to the ability of certain borrowers to comply with the present loan repayment terms.   

At March 31, 2013, the reserve for unfunded loan commitments was $3.0 million, a $0.1 million, or 4%, increase from the amount at December 31, 2012.  Management believes the amount of the reserve is appropriate and is included in other liabilities on the unaudited consolidated statement of financial condition.  The increase related to loss ratios in categories where commitments are centered.       

Deposits and Other Borrowings

Our deposits were $1.7 billion at both March 31, 2013 and December 31, 2012.  The following table shows the composition of deposits at the dates indicated: 

	March 31,		December 31,
(Dollars in thousands)	2013		2012		$ Change		% Change
Noninterest-bearing demand	$	416,979	$	424,008	$	(7,029)	(1.66)	%
Interest-bearing demand		125,914		112,012		13,902	12.41
Money market accounts		437,629		423,417		14,212	3.36
Savings accounts		39,733		37,693		2,040	5.41
Time deposits of $100,000 or more		317,270		351,273		(34,003)	(9.68)
Other time deposits		340,143		361,175		(21,032)	(5.82)
Total deposits	$	1,677,668	$	1,709,578	$	(31,910)	(1.87)	%

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Stillwater National has substantial unused borrowing availability in the form of unsecured brokered certificate of deposits from Bank of America Merrill Lynch, Citigroup Global Markets, Inc., Wells Fargo Bank, NA, UBS Securities, LLC, RBC Capital Markets Corp., and Morgan Stanley & Co., Inc. in connection with its retail certificate of deposit program.    There were no retail certificates of deposit as of March 31, 2013 or December 31, 2012. 

Some of our interest-bearing deposits were obtained through brokered transactions and we participate in the Certificate of Deposit Account Registry Service (“CDARS”).  There were no brokered certificates of deposit as of March 31, 2013or December 31, 2012.    CDARS deposits totaled $5.8 million at March 31, 2013 and $9.9 million as of December 31, 2012.

Other borrowings, which includes short-term federal funds purchased, FHLB borrowings, and repurchase agreements, increased $0.5 million, or 1%, to $70.9 million during the first three months of 2013.  The increase primarily reflects the timing of repurchase agreements for the period.   

Shareholders’ Equity

Shareholders’ equity increased  $4.5 million, or 2%, primarily due to income of $2.4 million, for the first three months of 2013, and common stock issuances of $2.1 million.  Net unrealized holding gains on available for sale investment securities and derivative instruments (net of tax) remained flat at $1.7 million at March 31, 2013. 

At March 31, 2013, Southwest, Stillwater National, and Bank of Kansas continued to exceed all applicable regulatory capital requirements.  See “Capital Requirements” on page 38. 

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RESULTS OF OPERATIONS 

FOR THE THREE MONTH PERIODS ENDED MARCH 31, 2013 and 2012 

Net income available to common shareholders for the first quarter of 2013 of $2.4 million represented a decrease of $1.7 million from the $4.1 million net income recorded for the first quarter of 2012.  Diluted earnings per share were $0.12 for the first quarter of 2013, compared to $0.21 for the first quarter of 2012.  The decrease in quarterly net income available to common shareholders was the result of a $5.2 million, or 25%, decrease in net interest income offset in part by a $1.3 million, or 40%, decrease in income tax expense, a $1.2 million, or 71%, decrease in the provision for loan losses, and the $1.1 million decrease primarily in dividends on preferred stock due to the repurchase during 2012.   

Provisions for loan losses are booked in the amounts necessary to maintain the allowance for loan losses at an appropriate level at period end after net charge-offs for the period.  (See “Note 3:  Loans and Allowance for Loan Losses” in the Notes to Unaudited Consolidated Financial Statements and “Provision for Loan Losses” on page 36.)  

On an operating segment basis, the decrease in net income was the net result of a  $0.8 million decrease from the Kansas Banking segment, a  $0.8 million decrease in net income from the Texas Banking segment, a $0.6 million decrease from the Oklahoma Banking segment, and a $0.1 million decrease from the Secondary Market segment.

Net Interest Income 

	For the three months
	ended March 31,
(Dollars in thousands)	2013		2012		$ Change		% Change
Interest income:
Loans	$	17,006	$	23,377	$	(6,371)	(27.25)	%
Investment securities:
U.S. government and agency obligations		472		393		79	20.10
Mortgage-backed securities		867		1,319		(452)	(34.27)
State and political subdivisions		304		212		92	43.40
Other securities		48		22		26	118.64
Other interest-earning assets		240		184		56	30.38
Total interest income		18,937		25,507		(6,570)	(25.76)
Interest expense:
Interest-bearing demand deposits		45		70		(25)	(35.71)
Money market accounts		236		286		(50)	(17.48)
Savings accounts		12		13		(1)	(7.69)
Time deposits of $100,000 or more		698		1,320		(622)	(47.12)
Other time deposits		661		1,207		(546)	(45.24)
Other borrowings		220		224		(4)	(1.79)
Subordinated debentures		1,459		1,538		(79)	(5.14)
Total interest expense		3,331		4,658		(1,327)	(28.49)
Net interest income	$	15,606	$	20,849	$	(5,243)	(25.15)	%

Net interest income is the difference between the interest income we earn on our loans, investments, and other interest-earning assets and the interest paid on interest-bearing liabilities, such as deposits and borrowings.  Net interest income is affected by changes in market interest rates because rates on different types of assets and liabilities may react differently and at different times to changes in market interest rates.  When interest-earning assets mature or reprice more quickly than interest-bearing liabilities, falling interest rates could reduce net interest income.  Similarly, when interest-bearing liabilities mature or reprice more quickly than interest-earning assets in a period, an increase of market rates of interest could reduce net interest income.  

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AVERAGE BALANCES, YIELDS AND RATES 

The following table shows average interest-earning assets and interest-bearing liabilities and the average yields and rates on them for the periods indicated.

	For the three months ended March 31,
	2013						2012
	Average				Average		Average				Average
(Dollars in thousands)	Balance		Interest		Yield/Rate		Balance		Interest		Yield/Rate
Assets
Noncovered loans (1) (2)	$	1,330,578	$	16,514	5.03	%	$	1,664,615	$	22,723	5.49	%
Covered loans (1)		24,895		492	8.01			36,050		654	7.30
Investment securities (2)		380,525		1,691	1.80			314,925		1,946	2.49
Other interest-earning assets		268,396		240	0.36			181,637		184	0.41
Total interest-earning assets		2,004,394		18,937	3.83			2,197,227		25,507	4.67
Other assets		87,592						158,921
Total assets	$	2,091,986					$	2,356,148
Liabilities and shareholders' equity
Interest-bearing demand deposits	$	133,600	$	45	0.14	%	$	120,605	$	70	0.23	%
Money market accounts		419,635		236	0.23			393,820		286	0.29
Savings accounts		38,721		12	0.13			34,587		13	0.15
Time deposits		683,159		1,359	0.81			931,792		2,527	1.09
Total interest-bearing deposits		1,275,115		1,652	0.53			1,480,804		2,896	0.79
Other borrowings		69,728		220	1.28			54,848		224	1.64
Subordinated debentures		81,963		1,459	7.12			81,963		1,538	7.51
Total interest-bearing liabilities		1,426,806		3,331	0.95			1,617,615		4,658	1.16
Noninterest-bearing demand deposits		403,547						378,959
Other liabilities		12,285						48,688
Shareholders' equity		249,348						310,886
Total liabilities and shareholders' equity	$	2,091,986					$	2,356,148
Net interest income and interest rate spread			$	15,606	2.88	%			$	20,849	3.51	%
Net interest margin (3)					3.16	%					3.82	%
Ratio of average interest-earning assets
to average interest-bearing liabilities		140.48%						135.83%
(1) Average balances include nonaccrual loans.  Fees included in interest income on loans receivable are not considered material.
(2) Interest on tax-exempt loans and securities is not shown on a tax-equivalent basis because it is not considered material.
(3) Net interest margin = annualized net interest income / average interest-earning assets

Compared to the first quarter of 2012, the first quarter 2013 yields on our interest-earning assets decreased 84 basis points, while the rates paid on our interest-bearing liabilities decreased 21 basis points, resulting in a decrease in the interest rate spread to 2.88%.  During the same periods, annualized net interest margin was 3.16% and 3.82%, respectively, and the ratio of average interest-earning assets to average interest-bearing liabilities increased to 140.48% from 135.83%.  Included in both the first quarter of 2013 and the first quarter of 2012 were immaterial adjustments of the discount accretion on loans and the loss share receivable, offset in part by immaterial interest reversal on nonaccrual loans.     

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RATE VOLUME TABLE 

The following table analyzes changes in interest income and interest expense of Southwest for the periods indicated.  For each category of interest-earning asset and interest-bearing liability, information is provided on changes attributable to:  (i) changes in volume (changes in volume multiplied by the prior period’s rate); and (ii) changes in rates (changes in rate multiplied by the prior period’s volume).  Changes in rate-volume (changes in rate multiplied by the changes in volume) are allocated between changes in rate and changes in volume in proportion to the relative contribution of each. 

The decrease in net interest income is primarily the result of the reduction in loan volume. 

	For the three months ended March 31,
	2013 vs. 2012
	Increase		Due to Change
	Or		In Average:
(Dollars in thousands)	(Decrease)		Volume		Rate
Interest earned on:
Noncovered loans receivable (1)	$	(6,209)	$	(4,275)	$	(1,934)
Covered loans receivable		(162)		(216)		54
Investment securities (1)		(255)		357		(612)
Other interest-earning assets		56		80		(24)
Total interest income		(6,570)		(4,054)		(2,516)
Interest paid on:
Interest-bearing demand		(25)		7		(32)
Money market accounts		(50)		18		(68)
Savings accounts		(1)		1		(2)
Time deposits		(1,168)		(588)		(580)
Other borrowings		(4)		53		(57)
Subordinated debentures		(79)		-		(79)
Total interest expense		(1,327)		(509)		(818)
Net interest income	$	(5,243)	$	(3,545)	$	(1,698)
(1) Interest on tax-exempt loans and securities is not shown on a tax-equivalent basis because it is not considered material.

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Provisions for Loan Losses  

The provision for loan losses is the amount of expense that is required to maintain the allowance for losses at an appropriate level based upon the inherent risks in the loan portfolio after the effects of net charge-offs for the period.  (See “Note 3:  Loans and Allowance for Loan Losses” in the Notes to Unaudited Consolidated Financial Statements and “Loans” on page 29.) 

Noninterest Income

	For the three months
	ended March 31,
(Dollars in thousands)	2013		2012		$ Change		% Change
Noninterest income:
Other service charges	$	2,340	$	2,421	$	(81)	(3.35)	%
Other fees		320		506		(186)	(36.76)
Other noninterest income		63		52		11	21.15
Gain on sales of loans:
One-to-four family residential		794		535		259	48.41
All other loan sales		20		-		20	-
Total noninterest income	$	3,537	$	3,514	$	23	0.65	%

Other fees income decreased as a result of the increased amortization of mortgage servicing rights during the first quarter of 2013. 

Gain on sales of loans is a reflection of the activity in the mortgage lending areas discussed elsewhere in this report. 

Noninterest Expense

	For the three months
	ended March 31,
(Dollars in thousands)	2013		2012		$ Change		% Change
Noninterest expense:
Salaries and employee benefits	$	8,136	$	7,247	$	889	12.27	%
Occupancy		2,574		2,545		29	1.14
FDIC and other insurance		491		783		(292)	(37.29)
Other real estate (net)		353		372		(19)	(5.11)
Unfunded loan commitment reserve		116		95		21	22.11
Other general and administrative		2,718		3,267		(549)	(16.80)
Total noninterest expense	$	14,388	$	14,309	$	79	0.55	%

The number of full-time equivalent employees decreased from  422 at the beginning of the quarter to 412 as of March 31, 2013.  The increase from prior year is primarily the result of increased employee benefit expense and increased accrued bonus expense.

Our financial institution subsidiaries pay deposit insurance premiums to the FDIC based on assessment rates.  The decrease from prior year is primarily the result of the decrease in assets, which is the basis for the premium calculation, and a decrease in the assessment rates.   

The first quarter of 2013 other real estate net expenses included $1.4 million in property write-downs offset by gains on sales of other properties.  Subsequent to the end of the first quarter, we were successful in the sale of an other real estate property.  The commercial real estate property was included in first quarter other real estate in our Texas market at a value of $7.2 million and this sale will generate a pre-tax gain on sale of $1.7 million, which will be reflected in second quarter other real estate net expenses.

The unfunded loan commitment reserve expense increased as a result of the application of our methodology to calculate the reserve.   

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The decrease in other general and administrative is primarily the result of lower consulting fees and legal fees.    

Taxes on Income

Southwest’s income tax expense was $1.9 million for the first three months of 2013 compared $3.1 million for the first three months of 2012,  a decrease of $1.3 million, or 40%.  The decrease in the income tax expense is the result of decreased income.  The effective tax rate for the first three months of 2013 was 43.88% due to a $0.3 million reserve for tax credits.     

LIQUIDITY

Liquidity is measured by a financial institution’s ability to raise funds through deposits, borrowed funds, capital, or the sale of highly marketable assets such as available for sale investments.  Additional sources of liquidity, including cash flow from the repayment of loans and the sale of participations in outstanding loans, are also considered in determining whether liquidity is satisfactory.  Liquidity is also achieved through growth of deposits, reductions in liquid assets, and accessibility to capital and money markets.  These funds are used to meet deposit withdrawals, maintain reserve requirements, fund loans, and operate the organization. 

Southwest, Stillwater National, and Bank of Kansas have available various forms of short-term borrowings for cash management and liquidity purposes.  These forms of borrowings include federal funds purchased, securities sold under agreements to repurchase, and borrowings from the Federal Reserve Bank (“FRB”) and the Federal Home Loan Bank of Topeka (“FHLB”). 

Stillwater National also carries interest-bearing demand notes issued by the U.S. Treasury in connection with the Treasury Tax and Loan note program.  There was no outstanding balance of those notes at March 31, 2013.  Stillwater National has approved federal funds purchase lines totaling $80.0 million with four banks.  There was no outstanding balance on these lines at March 31, 2013.  Stillwater National is qualified to borrow funds from the FRB through their Borrower-In-Custody (“BIC”) program.  Collateral under this program consists of pledged selected commercial and industrial loans.  Currently the collateral allows Stillwater National to borrow up to $28.2 million.  As of March 31, 2013, no borrowings were made through the BIC program.  In addition, Stillwater National has available a $224.2 million line of credit and Bank of Kansas has a $44.0 million line of credit from the FHLB.  Borrowings under the FHLB lines are secured by investment securities and loans.  At March 31, 2013, the Stillwater National FHLB line of credit had an outstanding balance of $20.0 million, and the Bank of Kansas line of credit had an outstanding balance of $5.0 million.   

(See also “Deposits and Other Borrowings” on page 33 for funds available on brokered certificate of deposit lines of credit and “Note 8: Operating Segments” in the Notes to Unaudited Consolidated Financial Statements for a discussion of Southwest’s funds management unit.) 

Stillwater National sells securities under agreements to repurchase with Stillwater National retaining custody of the collateral.  Collateral consists of U.S. government agency obligations, which are designated as pledged with Stillwater National’s safekeeping agent.  These transactions are for one to four day periods.  Outstanding balances under this program were $45.9 million and $45.4 million as of March 31, 2013 and December 31, 2012, respectively. 

At March 31, 2013, $278.9 million of the total carrying value of investment securities of $348.1 million were pledged as collateral to secure public and trust deposits, sweep agreements, and borrowings from the FHLB.  Any amount over pledged can be released at any time. 

During the first three months of 2013,  no category of short-term borrowings had an average balance that exceeded 30% of ending shareholders’ equity. 

During the first three months of 2013, cash and cash equivalents increased by $56.1 million, or 19%, to $344.2 million.  This increase was the net results of cash provided from investing activities of $62.1 million (primarily from net repayments of loans offset by purchases of available for sale securities) and cash provided by operating activities of $25.2 million, offset in part by cash used in financing activities of $31.2 million (primarily from decreases in deposits).  

During the first three months of 2012, cash and cash equivalents decreased by $38.4 million, or 17%, to $191.5 million.  This decrease was the net result of cash used in financing activities of $116.0 million (primarily from decreases in deposits) offset in part by cash provided from investing of $60.3 million (primarily net repayments of loans and proceeds from repayments, calls and maturities of securities) and cash provided by operating activities of $17.2 million. 

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CAPITAL REQUIREMENTS

Bank holding companies are required to maintain capital ratios set by the FRB in its Risk-Based Capital Guidelines.  At March 31, 2013,  we exceeded all applicable capital requirements, having a total risk-based capital ratio of 23.54%, a Tier I risk-based capital ratio of 22.25%, and a Tier 1 leverage ratio of 15.59%.  As of March 31, 2013, Stillwater National and Bank of Kansas met the criteria for classification as “well-capitalized” institutions under the prompt corrective action rules of the Federal Deposit Insurance Act.  Designation as a well-capitalized institution under these regulations does not constitute a recommendation or endorsement of Southwest, Stillwater National, or Bank of Kansas by bank regulators.     

EFFECTS OF INFLATION

The unaudited consolidated financial statements and related unaudited consolidated financial data presented herein have been prepared in accordance with accounting principles generally accepted in the United States of America and practices within the banking industry which require the measurement of financial position and operating results in terms of historical dollars without considering fluctuations in the relative purchasing power of money over time due to inflation.  Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature.  As a result, interest rates have a more significant impact on a financial institution’s performance than do the effects of general levels of inflation. 

*   *   *   *   *   *   *

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 

Our income is largely dependent on our net interest income.  We seek to maximize our net interest margin within an acceptable level of interest rate risk.  Interest rate risk can be defined as the amount of forecasted net interest income that may be gained or lost due to favorable or unfavorable movements in interest rates.  Interest rate risk, or sensitivity, arises when the maturity or repricing characteristics of assets differ significantly from the maturity or repricing characteristics of liabilities.  Net interest income is also affected by changes in the portion of interest-earning assets that are funded by interest-bearing liabilities rather than by other sources of funds such as noninterest-bearing deposits and shareholders’ equity. 

We attempt to manage interest rate risk while enhancing net interest margin by adjusting our asset/liability position.  At times, depending on the level of general interest rates, the relationship between long-term and other interest rates, market conditions, and competitive factors, we may increase our interest rate risk position in order to increase its net interest margin.  We monitor interest rate risk and adjust the composition of our rate-sensitive assets and liabilities in order to limit our exposure to changes in interest rates on net interest income over time.  Our asset/liability committee reviews our interest rate risk position and profitability and recommends adjustments.  Our asset/liability committee also reviews the securities portfolio, formulates investment strategies, and oversees the timing and implementation of transactions.  Notwithstanding our interest rate risk management activities, the actual magnitude, direction, and relationship of future interest rates are uncertain and can have adverse effects on net income and liquidity.

A principal objective of our asset/liability management effort is to balance the various factors that generate interest rate risk, thereby maintaining our interest rate sensitivity within acceptable risk levels.  To measure our interest rate sensitivity position, we utilize a simulation model that facilitates the forecasting of net interest income over the next twelve month period under a variety of interest rate and growth scenarios. 

The earnings simulation model uses numerous assumptions regarding the effect of changes in interest rates on the timing and extent of repricing characteristics, future cash flows, and customer behavior.  These assumptions are inherently uncertain and, as a result, the model cannot precisely estimate net income.  Actual results differ from simulated results due to the timing, magnitude, and frequency of interest rate changes and changes in market conditions, cash flows, and management strategies, among other factors.

The balance sheet is subject to quarterly testing for six alternative interest rate shock possibilities to indicate the inherent interest rate risk.  Average interest rates are shocked by +/- 100, 200, and 300 basis points (“bp”), although we may elect not to use particular scenarios that we determine are impractical in a current rate environment.  It is management’s goal to structure the balance sheet so that net interest earnings at risk over a twelve-month period and the economic value of equity at risk do not exceed policy guidelines at various interest rate shock levels. 

Measures of net interest income at risk produced by simulation analysis are indicators of an institution’s short-term performance in alternative rate environments.  These measures are typically based upon a relatively brief period, usually one year.  They do not necessarily indicate the long-term prospects or economic value of the institution.

Estimated Changes in Net Interest Income

Changes in Interest Rates:	+  300 bp	+200 bp	+100 bp
March 31, 2013	(2.38)%	0.49%	0.63%
December 31, 2012	0.55%	(2.10)%	(3.64)%

The current overnight rate as established by the Federal Open Market Committee is in the 0% to 0.25% range.  We believe that all down rate scenarios are impractical since they would result in an overnight rate of less than 0%.  As a result, the down 100 bp, down 200 bp and down 300 bp scenarios have been excluded.  Net interest income at risk experienced an improvement in two of the three rising interest rate scenarios when compared to the December 31, 2012 risk position.  Our greatest exposure to changes in interest rate is in the +300 bp scenario with a decline in net interest income of (2.38%) on March 31, 2013, an 2.93% reduction from the December 31, 2012 level of 0.55%. The subsidiary banks are in compliance with all policy limits established for net interest income at risk.  

The measures of equity value at risk indicate the ongoing economic value of Southwest by considering the effects of changes in interest rates on our cash flows, and discounting the cash flows to estimate the present value of assets and liabilities.  The difference between these discounted values of the assets and liabilities is the economic value of equity, which, in theory, approximates the fair value of net assets. 

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Estimated Changes in Economic Value of Equity (EVE)

Changes in Interest Rates:	+300 bp	+200 bp	+100 bp
March 31, 2013	(3.44)%	(2.79)%	(2.00)%
December 31, 2012	(8.12)%	(6.00)%	(3.64)%

As of March 31, 2013 the economic value of equity measure improved in each of the three rising interest rate scenarios when compared to the December 31, 2012 percentages.  Our largest economic value of equity exposure is the +300 bp scenario. The +300 bp scenario was (3.44%) on March 31, 2013, a 4.68% reduction over the December 31, 2012 value of (8.12%). The subsidiary banks are in compliance with all policy limits established for the economic value of equity. 

*   *   *   *   *   *   *

ITEM 4. CONTROLS AND PROCEDURES 

Disclosure Controls and Procedures 

As required by SEC rules, Southwest’s management evaluated the effectiveness of Southwest’s disclosure controls and procedures as of March 31, 2013.  Southwest’s Chief Executive Officer and Chief Financial Officer participated in the evaluation.  Based on this evaluation, Southwest’s Chief Executive Officer and Chief Financial Officer concluded that Southwest’s disclosure controls and procedures were effective as of March 31, 2013. 

Changes in Internal Control over Financial Reporting 

As disclosed in Part II, Item 9A of our Annual Report on Form 10-K for the year ended December 31,2012, management identified a deficiency in the valuation analysis related to the goodwill of our Kansas market segment (reporting unit) that was determined to be a material weakness related to our review and verification controls with respect to the hypothetical purchase price allocation portion of our annual goodwill impairment analysis.  Subsequent to December 31, 2012, we have enhanced our review and verification controls related to goodwill and other intangible assets.

During the first quarter of 2013, we have continued the process of developing and implementing new processes and procedures to remediate the material weakness that existed in our internal control over financial reporting as of December 31, 2012, and continue the improvement of our overall system of internal controls over financial reporting.  Specifically, we expanded and improved our review of the valuation and impairment processes related to goodwill and other intangible assets.  No impairments were identified during the current quarter.    Our new CFO (who joined Southwest during the fourth quarter of 2012) along with other key members of management, were active participants in these processes.  We believe the steps taken have improved the effectiveness of our internal control over financial reporting.

As of March 31, 2013, management believes it has put in place controls that are sufficient to address the material weaknesses mentioned above, and believes that such material weakness has been remediated.  Our Audit Committee has directed management to monitor and test the controls implemented and develop additional controls should any of the new controls require additional enhancement. 

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PART II:  OTHER INFORMATION 

Item 1:  Legal proceedings

Southwest and its subsidiaries are regularly subject to various claims and legal actions arising in the normal course of business.  Management currently does not expect that ultimate disposition of any of these matters will have a material adverse effect on Southwest’s financial statements.  Southwest is not currently aware of any additional or material changes to pending or threatened litigation against Southwest or its subsidiaries that involves Southwest or any of its subsidiaries or that involves any of the property of Southwest or its subsidiaries that could have a material adverse effect on Southwest’s financial statements. 

Item 1A:  Risk Factors 

There were no material changes in risk factors during the first three months of 2013 from those disclosed in our Form 10-K  for the year ended December 31, 2012.  

Item 2:  Unregistered sales of equity securities and use of proceeds

None

Item 3:  Defaults upon senior securities

None 

Item 4:  Mine Safety Disclosures 

Not Applicable 

Item 5:  Other information

None  

Item 6:  Exhibits

Exhibit 31(a), (b)   Rule 13a-14(a)/15d-14(a) Certifications 

Exhibit 32(a), (b)   18 U.S.C. Section 1350 Certifications 

Exhibit 101   Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Consolidated Statements of Financial Condition, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Shareholders’ Equity, (v) the Consolidated Statements of Cash Flows, and (v) the Notes to the Consolidated Financial Statements

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SIGNATURES 

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

SOUTHWEST BANCORP, INC. 

(Registrant) 

By:  /s/ Mark W. Funke	May 6, 2013
Mark W. Funke President and Chief Executive Officer  (Principal Executive Officer)	Date
By:  /s/ Joe T. Shockley, Jr.	May 6, 2013
Joe T. Shockley, Jr. Executive Vice President, Chief   Financial Officer   (Principal Financial Officer)	Date

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