================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Form 10-K
(MARK ONE)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- ----------- EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- ----------- EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
------- -------
COMMISSION FILE NUMBER 0-12247
Southside Bancshares, Inc.
(Exact name of registrant as specified in its charter)
TEXAS 75-1848732
(State of incorporation) (I.R.S. Employer Identification No.)
1201 S. BECKHAM AVENUE, TYLER, TEXAS 75701
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (903) 531-7111
Securities registered pursuant to Section 12(b) of the Act:
<Table>
<Caption>
Name of each exchange
Title of each class on which registered
------------------- ---------------------
NONE NONE
</Table>
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES X NO
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K [ ]
As of March 1, 2002, 7,803,539 shares of common stock of Southside
Bancshares, Inc. were outstanding. The aggregate market value of common stock
held by nonaffiliates of the registrant as of January 31, 2002 was $75,395,249.
DOCUMENTS INCORPORATED BY REFERENCE
Registrant's Proxy Statement to be filed for the Annual Meeting of
Shareholders to be held April 18, 2002. (Part III)
================================================================================
PART I
ITEM 1. BUSINESS
GENERAL
Southside Bancshares, Inc. (the "Company"), incorporated in Texas in
1982, is a bank holding company for Southside Bank (the "Bank" or "Southside
Bank"), headquartered in Tyler, Texas. Tyler has a metropolitan area population
of approximately 175,000 and is located approximately 90 miles east of Dallas,
Texas and 90 miles west of Shreveport, Louisiana. The Bank has the largest
deposit base in the Tyler metropolitan area and is the largest bank based on
asset size headquartered in East Texas.
At December 31, 2001, the Company had total assets of $1.3 billion, total
loans of $537.9 million, deposits of $758.0 million, and shareholders' equity of
$68.6 million. The Company had net income of $11.7 million and $9.8 million and
diluted earnings per share of $1.26 and $1.18 for the years ended December 31,
2001 and 2000, respectively. The Company has paid a cash dividend every year
since 1970.
The Bank is a community-focused financial institution that offers a full
range of financial services to individuals, businesses and nonprofit
organizations in the communities it serves. These services include consumer and
commercial loans, deposit accounts, trust services, safe deposit services and
brokerage services.
The Bank's consumer loan services include 1-4 family residential mortgage
loans, home equity, home improvement loans, automobile loans and other
installment loans. Commercial loan services include short-term working capital
loans for inventory and accounts receivable, short and medium-term loans for
equipment or other business capital expansion and commercial real estate loans.
The Bank also offers construction loans primarily for owner-occupied 1-4 family
residential and commercial real estate.
The Bank offers a variety of deposit accounts having a wide range of
interest rates and terms, including savings, money market, interest and
noninterest bearing checking accounts and certificate accounts. The Bank's trust
services include investment, management, administration and advisory services,
primarily for individuals and, to a lesser extent, partnerships and
corporations. At December 31, 2001, the Bank's trust department managed
approximately $333 million of trust assets. Through its 25% owned securities
brokerage affiliate, BSC Securities, L.C., the Bank offers full retail
investment services to its customers. Countywide Loans, Inc. ("Countywide"), the
Company's consumer finance subsidiary, provides basic financial services such as
small loans, check cashing and money orders to individuals, which at December
31, 2001, had $766,000 in loans outstanding.
The Company and the Bank are subject to comprehensive regulation,
examination and supervision by the Board of Governors of the Federal Reserve
System (the "FRB"), the Texas Department of Banking (the "TDB") and the Federal
Depository Insurance Corporation (the "FDIC"), and are subject to numerous laws
and regulations relating to the extension of credit and making of loans to
individuals.
The administrative offices of the Company are located at 1201 S. Beckham
Avenue, Tyler, Texas 75701, and the telephone number is 903-531-7111. The
Company's website can be found at www.southside.com.
MARKET AREA
The Company considers its primary market area to be all of Smith and
Gregg Counties in East Texas, and to a lesser extent, portions of adjoining
counties. During 2001, the Bank opened one branch in Smith County. During the
first quarter of 2002, the Bank opened one branch in Gregg County and one branch
in Smith County. The Bank plans to open two additional branches, both in Smith
County, which should open during the second quarter of 2002. The Company expects
its presence in the Gregg County market area to continue to increase in the
future, however, the city of Tyler in Smith County presently represents the
Company's primary market area.
1
The principal economic activities in the Company's market area include
retail, distribution, manufacturing, medical services, education and oil and gas
industries. Additionally, Tyler's industry base includes conventions and
tourism, as well as retirement relocation. All of these support a growing
regional system of medical service, retail and education centers. Tyler is home
to several nationally recognized health care systems. Tyler hospitals represent
all major specialties and employ over 7,000 individuals.
The Bank serves its markets through fifteen full service branch
locations, eight of which are located in grocery stores. The branches are
located in and around Tyler, Longview, Lindale and Whitehouse. The Company's
television and radio advertising has extended into these market areas for
several years, providing the Bank name recognition throughout Smith and Gregg
counties. Continued advertising combined with strategically placed full service
branches have expanded Southside's name recognition.
The Bank also maintains six motor bank facilities and Countywide
maintains one location. The Bank's customers may also access various banking
services through 25 ATMs owned by the Bank and ATMs owned by others, through
debit cards, and through the Bank's automated telephone, internet and electronic
banking products. These products allow the Bank's customers to apply for loans,
access account information and conduct various transactions from their
telephones and computers.
LENDING ACTIVITIES
The Company's main objective is to seek attractive lending opportunities
in East Texas, primarily in Smith and Gregg Counties. Substantially all of the
Bank's loans are made to borrowers who live in and conduct business in East
Texas, with the exception of selected municipal loans. Total loans as of
December 31, 2001 increased $56.5 million or 11.7% while the average balance was
up $75.9 million or 17.5% when compared to 2000.
Real estate loans as of December 31, 2001 increased $30.1 million or
10.7% from December 31, 2000. Loans to individuals increased $4.6 million or
5.0% from December 31, 2000 and commercial loans decreased $1.2 million or 1.5%.
The increase in real estate loans is due to a stronger real estate market
and a strong commitment by the Company to residential mortgage lending. The
growth of loans made to municipalities in Texas was a result of the Company's
continued strong commitment in this area. Loans to individuals increased due to
greater penetration in the Company's market area. In the portfolio, loans
dependent upon private household income represent a significant concentration.
Due to the number of customers involved who work in all sectors of the local
economy, the Company believes the risk in this portion of the portfolio is
adequately spread throughout the economic community, which assists in mitigating
this concentration.
The aggregate amount of loans that the Bank is permitted to make under
applicable bank regulations to any one borrower, including related entities, is
25% of unimpaired certified capital and surplus. The Bank's legal lending limit
at December 31, 2001 was $12 million. The Bank's largest loan relationship at
December 31, 2001 was approximately $10.5 million.
The average yield on loans for the year ended December 31, 2001 decreased
to 8.17% from 8.45% for the year ended December 31, 2000. This decrease was
reflective of the repricing characteristics of the loans and the decrease in
lending rates during 2001.
2
LOAN PORTFOLIO COMPOSITION AND ASSOCIATED RISK
The following table sets forth loan totals net of unearned discount by
category for the years presented:
<Table>
<Caption>
December 31,
----------------------------------------------------------------------
2001 2000 1999 1998 1997
---------- ---------- ---------- ---------- ----------
Real Estate Loans:
Construction .............. $ 23,631 $ 25,108 $ 18,489 $ 10,509 $ 10,299
1-4 Family Residential .... 147,774 134,672 112,699 93,215 76,243
Other ..................... 139,870 121,381 95,556 68,140 55,802
Commercial Loans ............. 76,470 77,644 66,581 66,795 61,844
Municipals Loans ............. 54,266 31,351 15,141 1,182 128
Loans to Individuals ......... 95,887 91,279 78,980 79,882 91,719
---------- ---------- ---------- ---------- ----------
Total Loans ............... $ 537,898 $ 481,435 $ 387,446 $ 319,723 $ 296,035
========== ========== ========== ========== ==========
</Table>
For purposes of this discussion, the Company's loans are divided into
four categories: Real Estate Loans, Commercial Loans, Municipals Loans and Loans
to Individuals.
REAL ESTATE LOANS
Real estate loans represent the Company's greatest concentration of
loans. However, the amount of risk associated with this group of loans is
mitigated in part due to the type of loans involved. At December 31, 2001, the
majority of the Company's real estate loans were collateralized by properties
located in Smith and Gregg Counties. Of the $311.3 million in real estate loans,
$147.8 million or 47.5% represent loans collateralized by residential dwellings
that are primarily owner occupied. Historically, the amount of losses suffered
on this type of loan has been significantly less than those on other properties.
The Company's loan policy requires appraisal prior to funding any real estate
loans and also outlines the requirements for appraisals on renewals.
Management pursues an aggressive policy of reappraisal on any real estate
loan that becomes troubled and potential exposures are recognized and reserved
for as soon as they are identified. However, the slow pace of absorption for
certain types of properties could adversely affect the volume of nonperforming
real estate loans held by the Company.
Real estate loans are divided into three categories: 1-4 Family
Residential Mortgage Loans, Construction Loans and Commercial Real Estate Loans.
1-4 Family Residential Mortgage Loans
Residential loan originations are generated by the Company's in-house
originations staff, marketing efforts, present customers, walk-in customers and
referrals from real estate agents, mortgage brokers and builders. The Company
focuses its lending efforts primarily on the origination of loans secured by
first mortgages on owner-occupied, 1-4 family residences. Substantially all of
the Company's 1-4 family residential mortgage originations are secured by
properties located in Smith and Gregg Counties. Historically, the Company has
sold a portion of its loan originations to secondary market investors pursuant
to ongoing purchase commitments.
The Company's fixed rate 1-4 family residential mortgage loans generally
have maturities ranging from five to 30 years. These loans are typically fully
amortizing with monthly payments sufficient to repay the total amount of the
loan or amortizing with a balloon feature, typically due in fifteen years or
less.
The Company reviews information concerning the income, financial
condition, employment and credit history when evaluating the creditworthiness of
the applicant.
The Company also makes home equity loans and at December 31, 2001, these
loans totaled $20.8 million.
3
Construction Loans
The Company's construction loans are collateralized by property located
primarily in the Company's market area. The Company's emphasis for construction
loans is directed toward properties that will be owner occupied. Occasionally,
construction loans for projects built on speculation are financed, but these
typically have substantial secondary sources of repayment. The Company's
construction loans to individuals have both adjustable and fixed interest rates
during the construction period. Construction loans to individuals are typically
made in connection with the granting of the permanent loan on the property.
Commercial Real Estate Loans
In determining whether to originate commercial real estate loans, the
Company generally considers such factors as the financial condition of the
borrower and the debt service coverage of the property. Commercial real estate
loans are made at both fixed and adjustable interest rates for terms generally
up to 20 years. Commercial real estate loans primarily include commercial office
buildings, retail, medical and warehouse facilities, hotels and churches. The
majority of these loans, with the exception of those for hotels and churches,
are collateralized by owner occupied properties.
COMMERCIAL LOANS
The Company's commercial loans are diversified to meet most business
needs. Loan types include short-term working capital loans for inventory and
accounts receivable and short- and medium-term loans for equipment or other
business capital expansion. Management does not consider there to be any
material concentration of risk in any one industry type, other than medical, in
this loan category since no industry classification represents over 10% of
loans. The medical community represents a concentration of risk in the Company's
Commercial loan and Commercial Real Estate loan portfolio (see "Market Area").
Risk in the medical community is mitigated because it is spread among multiple
practice types and multiple specialties.
In its commercial business loan underwriting, the Company assesses the
creditworthiness, ability to repay, and the value and liquidity of the
collateral being offered. Terms are generally granted commensurate with the
useful life of the collateral offered.
MUNICIPAL LOANS
The Company formed a special lending department during 1998 that makes
loans to municipalities and school districts throughout the state of Texas. The
majority of the loans to municipalities and school districts have tax or revenue
pledges which additionally support these loans in addition to collateral. Total
loans to municipalities and school districts as of December 31, 2001 increased
$22.9 million while the average balance was up $19.4 million when compared to
2000. At December 31, 2001, the Company had commercial loans to municipalities
and school districts of $53.1 million and real estate loans to municipalities
and school districts of $1.2 million.
LOANS TO INDIVIDUALS
The Bank is a major consumer lender in its trade territory and has been
for many years. The majority of consumer loans outstanding are collateralized by
vehicles, which accounted for approximately $79.3 million at December 31, 2001.
Additionally, the Company makes loans for a full range of other consumer
purposes, which may be secured or unsecured depending on the credit quality and
purpose of the loan.
At this point, the economy in the Bank's trade territory has shown some
signs of slowing but appears stable. Two areas of concern are the nationwide
slowdown, or recession and the personal bankruptcy rate. Management expects
these two events to have some adverse effect on the Company's net charge-offs.
Most of the Company's loans to individuals are collateralized, which management
believes should limit the exposure in this area should current bankruptcy levels
continue.
4
Consumer loan terms vary according to the type and value of collateral,
length of contract and creditworthiness of the borrower. The underwriting
standards employed by the Company for consumer loans include an application, a
determination of the applicant's payment history on other debts, with greatest
weight being given to payment history with the Company, and an assessment of the
borrower's ability to meet existing obligations and payments on the proposed
loan. Although creditworthiness of the applicant is a primary consideration, the
underwriting process also includes a comparison of the value of the collateral,
if any, in relation to the proposed loan amount.
LOAN MATURITIES AND SENSITIVITY TO CHANGES IN INTEREST RATES
The following table represents loan maturities and sensitivity to changes
in interest rates. The amounts of total loans outstanding at December 31, 2001,
which, based on remaining scheduled repayments of principal, are due in (1) one
year or less*, (2) more than one year but less than five years, and (3) more
than five years*, are shown in the following table. The amounts due after one
year are classified according to the sensitivity to changes in interest rates.
<Table>
<Caption>
After One
Due in One but within After Five
Year or Less Five Years Years
------------ ---------- ----------
(in thousands)
Construction Loans......................................... $ 21,351 $ 893 $ 1,387
Real Estate Loans-Other.................................... 130,269 136,872 20,503
Commercial Loans........................................... 67,004 7,813 1,653
Municipal Loans............................................ 8,754 21,874 23,638
All Other Loans............................................ 59,741 31,079 5,067
------------ ---------- ----------
Total Loans.......................................... $ 287,119 $ 198,531 $ 52,248
============ ========== ==========
Loans with Maturities After
One Year for Which: Interest Rates are Fixed or Predetermined $ 249,883
Interest Rates are Floating or Adjustable $ 50,715
</Table>
* The volume of commercial loans due within one year reflects the
Company's general policy of limiting such loans to a short-term
maturity. Loans are shown net of unearned discount. Nonaccrual loans are
reflected in the due after five years column.
LOANS TO AFFILIATED PARTIES
In the normal course of business, the Company's subsidiary, Southside
Bank, makes loans to certain of the Company's, as well as its own, officers,
directors, employees and their related interests. As of December 31, 2001 and
2000, these loans totaled $8.1 million and $8.9 million or 11.8% and 17.2% of
Shareholders' Equity, respectively. Such loans are made in the normal course of
business at normal credit terms, including interest rate and collateral
requirements and do not represent more than normal credit risks contained in the
rest of the loan portfolio for loans of similar types.
5
LOAN LOSS EXPERIENCE AND RESERVE FOR LOAN LOSSES
The loan loss reserve is based on the most current review of the loan
portfolio at that time. Several methods are used to maintain the review in the
most current manner. First, the servicing officer has the primary responsibility
for updating significant changes in a customer's financial position.
Accordingly, each officer prepares status updates on any credit deemed to be
experiencing repayment difficulties which, in the officer's opinion, would place
the collection of principal or interest in doubt. Second, an internal review
officer from the Company is responsible for an ongoing review of the Company's
entire loan portfolio with specific goals set for the volume of loans to be
reviewed on an annual basis. Independent Bank Services, L.C., a partially owned
subsidiary of the Bank, supplements the internal review officer's process by
performing additional loans reviews designed to achieve overall goals of
penetration. Third, Southside Bank is regulated and examined by the FDIC and/or
the Texas Department of Banking on an annual basis.
At each review of a credit, a subjective analysis methodology is used to
grade the respective loan. Categories of grading vary in severity to include
loans which do not appear to have a significant probability of loss at the time
of review to grades which indicate a probability that the entire balance of the
loan will be uncollectible. If full collection of the loan balance appears
unlikely at the time of review, estimates or appraisals of the collateral
securing the debt are used to allocate the necessary reserves. A list of loans,
which are graded as having more than the normal degree of risk associated with
them, is maintained by the internal review officer. This list is updated on a
periodic basis, but no less than quarterly by the servicing officer in order to
properly allocate necessary reserves and keep management informed on the status
of attempts to correct the deficiencies noted in the credit.
Industry experience shows that a portion of the Company's loans will
become delinquent and a portion of the loans will require partial or entire
charge-off. Regardless of the underwriting criteria utilized, losses may be
experienced as a result of various factors beyond the Company's control,
including, among other things, changes in market conditions affecting the value
of properties and problems affecting the credit of the borrower. Management's
determination of the adequacy of allowance for loan losses is based on various
considerations, including an analysis of the risk characteristics of various
classifications of loans, previous loan loss experience, specific loans which
would have loan loss potential, delinquency trends, estimated fair value of the
underlying collateral, current economic conditions, the views of the regulators
(who have the authority to require additional reserves), and geographic and
industry loan concentration.
In addition to maintaining an ongoing review of the loan portfolio, the
internal review officer maintains a history of the loans that have been
charged-off without first being identified as problems. This history is used to
assist in gauging the amount of nonspecifically allocated reserve necessary, in
addition to the portion which is specifically allocated by loan. The internal
review officer also uses the loan portfolio data collected to determine the
allocation of reserve for loan loss appropriate for the risk in each of the
Company's major loan categories.
As of December 31, 2001, the Company's review of the loan portfolio
indicates that a loan loss reserve of $5.9 million is adequate.
6
The following table presents information regarding the average amount of
net loans outstanding, changes in the reserve for loan losses, the ratio of net
loans charged-off to average net loans outstanding, and an allocation of the
reserve for loan loss.
LOAN LOSS EXPERIENCE AND RESERVE FOR LOAN LOSSES
<Table>
<Caption>
Years Ended December 31,
----------------------------------------------------------------
2001 2000 1999 1998 1997
---------- ---------- ---------- ---------- ----------
(dollars in thousands)
Average Net Loans Outstanding .............................. $ 510,468 $ 434,559 $ 341,466 $ 304,255 $ 274,577
========== ========== ========== ========== ==========
Balance of Reserve for Loan Loss at Beginning of Period .... $ 5,033 $ 4,575 $ 3,564 $ 3,370 $ 3,249
---------- ---------- ---------- ---------- ----------
Loan Charge-Offs:
Real Estate-Construction ................................... -- (15) -- -- --
Real Estate-Other .......................................... (35) (14) -- (175) --
Commercial Loans ........................................... (325) (522) (114) (405) (525)
Loans to Individuals ....................................... (1,024) (891) (651) (769) (704)
---------- ---------- ---------- ---------- ----------
Total Loan Charge-Offs ..................................... (1,384) (1,442) (765) (1,349) (1,229)
---------- ---------- ---------- ---------- ----------
Recovery of Loans Previously Charged off:
Real Estate-Construction ................................... -- -- -- -- 10
Real Estate-Other .......................................... 30 34 5 36 14
Commercial Loans ........................................... 288 57 106 90 133
Loans to Individuals ....................................... 292 240 209 202 188
---------- ---------- ---------- ---------- ----------
Total Recovery of Loans Previously Charged-Off ............. 610 331 320 328 345
---------- ---------- ---------- ---------- ----------
Net Loan Charge-Offs ....................................... (774) (1,111) (445) (1,021) (884)
Provision for Loan Loss .................................... 1,667 1,569 1,456 1,215 1,005
---------- ---------- ---------- ---------- ----------
Balance at End of Period ................................... $ 5,926 $ 5,033 $ 4,575 $ 3,564 $ 3,370
========== ========== ========== ========== ==========
Ratio of Net Charge-Offs to Average Net Loans Outstanding .. 0.15% 0.26% 0.13% 0.34% 0.32%
========== ========== ========== ========== ==========
</Table>
Allocation of Reserve for Loan Loss (dollars in thousands):
<Table>
<Caption>
December 31,
--------------------------------------------------------------------------------
2001 2000 1999 1998 1997
-------------- -------------- -------------- --------------- --------------
% of % of % of % of % of
Amount Total Amount Total Amount Total Amount Total Amount Total
------- ------ ------ ------- ------- ------ ------- ------- ------- ------
Real Estate-Construction................ $ 220 3.7% $ 230 4.6% $ 91 2.0% $ 52 1.5% $ 52 1.5%
Real Estate-Other....................... 2,790 47.1% 2,124 42.2% 1,804 39.4% 1,291 36.2% 1,087 32.3%
Commercial Loans........................ 1,399 23.6% 1,561 31.0% 1,558 34.1% 1,182 33.2% 1,181 35.0%
Loans to Individuals.................... 1,420 24.0% 1,097 21.8% 1,077 23.5% 1,017 28.5% 1,040 30.9%
Unallocated............................. 97 1.6% 21 0.4% 45 1.0% 22 0.6% 10 0.3%
------- ------ ------ ------- ------- ------ ------- ------- ------- ------
Balance at End of Period................ $ 5,926 100% $5,033 100% $ 4,575 100% $ 3,564 100% $ 3,370 100%
======= ====== ====== ======= ======= ====== ======= ======= ======= ======
</Table>
See "Consolidated Financial Statements - Note 6.
Loans and Reserve for Possible Loan Losses."
7
NONPERFORMING ASSETS
Nonperforming assets consist of delinquent loans over 90 days past due,
nonaccrual loans, other real estate owned and restructured loans. Nonaccrual
loans are those loans which are more than 90 days delinquent and collection in
full of both the principal and interest is in doubt. Additionally, some loans
that are not delinquent may be placed on nonaccrual status due to doubts about
full collection of principal or interest. When a loan is categorized as
nonaccrual, the accrual of interest is discontinued and the accrued balance is
reversed for financial statement purposes. Other Real Estate Owned (OREO)
represents real estate taken in full or partial satisfaction of debts previously
contracted. The OREO consists of three real estate properties. The Company is
actively marketing the properties and they are not held for investment purposes.
Restructured loans represent loans which have been renegotiated to provide a
reduction or deferral of interest or principal because of deterioration in the
financial position of the borrowers. Categorization of a loan as nonperforming
is not in itself a reliable indicator of potential loan loss. Other factors,
such as the value of collateral securing the loan and the financial condition of
the borrower must be considered in judgments as to potential loan loss.
The following table of nonperforming assets is classified according to
bank regulatory call report guidelines:
<Table>
<Caption>
NONPERFORMING ASSETS
December 31,
------------------------------------------------
2001 2000 1999 1998 1997
-------- -------- -------- -------- --------
(dollars in thousands)
Loans 90 Days Past Due:
Real Estate.................................. $ 404 $ 577 $ 233 $ 412 $ 454
Loans to Individuals......................... 211 43 58 44 232
Commercial................................... 330 599 48 120 56
-------- -------- -------- -------- --------
945 1,219 339 576 742
-------- -------- -------- -------- --------
Loans on Nonaccrual:
Real Estate.................................. 506 336 - 2 108
Loans to Individuals......................... 235 216 281 263 177
Commercial................................... 155 78 422 167 1,059
-------- -------- -------- -------- --------
896 630 703 432 1,344
-------- -------- -------- -------- --------
Restructured Loans:
Real Estate.................................. 130 160 178 197 214
Loans to Individuals......................... 91 151 214 222 189
Commercial................................... 62 78 56 54 32
-------- -------- -------- -------- --------
283 389 448 473 435
-------- -------- -------- -------- --------
Total Nonperforming Loans....................... 2,124 2,238 1,490 1,481 2,521
Other Real Estate Owned......................... 65 43 140 195 364
Repossessed Assets.............................. 213 196 209 326 206
-------- -------- -------- -------- --------
Total Nonperforming Assets...................... $ 2,402 $ 2,477 $ 1,839 $ 2,002 $ 3,091
======== ======== ======== ======== ========
Percentage of Total Assets...................... 0.19% 0.22% 0.18% 0.23% 0.54%
Percentage of Loans and Leases,
Net of Unearned Income....................... 0.45% 0.51% 0.47% 0.63% 1.04%
</Table>
Total nonperforming assets decreased $75,000 or 3.0% between December 31,
2000 and December 31, 2001. Nonperforming assets as a percentage of assets
decreased .03% from the previous year and as a percentage of loans decreased
.06%. Nonperforming assets represent a drain on the earning ability of the
Company. Earnings losses are due both to the loss of interest income and the
costs associated with maintaining the OREO, for taxes, insurance and other
operating expenses. In addition to the nonperforming assets, at December 31,
2001 in the opinion of management, the Company had $397,000 of loans identified
as potential problem loans. A potential problem loan is a loan where information
about possible credit problems of the borrower is known, causing management to
have serious doubts about the ability of the borrower to comply with the present
loan repayment terms and may result in a future classification of the loan in
one of the nonperforming asset categories.
8
The following is a summary of the Company's recorded investment in loans
(primarily nonaccrual loans) for which impairment has been recognized in
accordance with FAS114:
<Table>
<Caption>
Valuation Carrying
Total Allowance Value
------- --------- --------
(in thousands)
Real Estate Loans ................. $ 506 $ 68 $ 438
Commercial Loans .................. 155 11 144
Loans to Individuals .............. 235 35 200
------- --------- --------
Balance at December 31, 2001 ...... $ 896 $ 114 $ 782
======= ========= ========
</Table>
<Table>
<Caption>
Valuation Carrying
Total Allowance Value
------- --------- --------
(in thousands)
Real Estate Loans.................. $ 336 $ 32 $ 304
Commercial Loans................... 78 20 58
Loans to Individuals............... 216 29 187
------- --------- --------
Balance at December 31, 2000....... $ 630 $ 81 $ 549
======= ========= ========
</Table>
For the years ended December 31, 2001 and 2000, the average recorded
investment in impaired loans was approximately $801,000 and $567,000,
respectively. During the years ended December 31, 2001 and 2000, the amount of
interest income reversed on impaired loans placed on nonaccrual and the amount
of interest income subsequently recognized on the cash basis was not material.
The net amount of interest recognized on loans that were nonaccruing or
restructured during the year was $70,000, $122,000 and $125,000 for the years
ended December 31, 2001, 2000 and 1999, respectively. If these loans had been
accruing interest at their original contracted rates, related income would have
been $113,000, $138,000 and $137,000 for the years ended December 31, 2001, 2000
and 1999, respectively.
The following is a summary of the Allowance for Losses on Other Real
Estate Owned for the years presented:
<Table>
<Caption>
Years Ended December 31,
------------------------------------
2001 2000 1999
-------- -------- --------
(in thousands)
Balance at beginning of year ...... $ -- $ 61 $ 658
Acquisition of OREO ........... 8 -- 61
Disposition of OREO ........... (8) (61) (658)
-------- -------- --------
Balance at end of year ............ $ -- $ -- $ 61
======== ======== ========
</Table>
9
SECURITIES ACTIVITY
The securities portfolio of the Company plays a primary role in
management of the interest rate sensitivity of the Company and, therefore, is
managed in the context of the overall balance sheet. The securities portfolio
generates a substantial percentage of the Company's interest income and serves
as a necessary source of liquidity.
The Company accounts for debt and equity securities as follows:
Held to Maturity (HTM). Debt securities that management has the positive
intent and ability to hold until maturity are classified as HTM and are
carried at their remaining unpaid principal balance, net of unamortized
premiums or unaccreted discounts. Premiums are amortized and discounts
are accreted using the level interest yield method over the estimated
remaining term of the underlying security.
Available for Sale (AFS). Debt and equity securities that will be held
for indefinite periods of time, including securities that may be sold in
response to changes in market interest or prepayment rates, needs for
liquidity and changes in the availability of and the yield of alternative
investments are classified as AFS. These assets are carried at market
value. Market value is determined using published quotes as of the close
of business. Unrealized gains and losses are excluded from earnings and
reported net of tax as a separate component of shareholders' equity until
realized.
Management attempts to deploy investable funds into instruments which are
expected to increase the overall return of the portfolio given the current
assessment of economic and financial conditions, while maintaining acceptable
levels of capital, interest rate and liquidity risk.
The following table sets forth the carrying amount of investment
securities, mortgage-backed securities and marketable equity securities at
December 31, 2001 and 2000:
<Table>
<Caption>
December 31,
-----------------------
Available for Sale: 2001 2000
---------- ----------
(in thousands)
U.S. Treasury ............................. $ 11,065 $ 6,015
U.S. Government Agencies................... 21,229 3,502
Mortgage-backed Securities:
Direct Govt. Agency Issues.............. 407,077 254,667
Other Private Issues.................... 47,001 14,619
State and Political Subdivisions........... 126,421 45,150
Other Stocks and Bonds..................... 21,390 22,336
---------- ----------
Total................................ $ 634,183 $ 346,289
========== ==========
</Table>
<Table>
<Caption>
December 31,
-----------------------
Held to Maturity: 2001 2000
---------- ----------
(in thousands)
U.S. Government Agencies................... $ -- $ 39,888
Mortgage-backed Securities:
Direct Govt. Agency Issues.............. -- 67,498
Other Private Issues.................... -- 75,463
State and Political Subdivisions........... -- 54,994
Other Stocks and Bonds..................... -- 9,626
---------- ----------
Total................................ $ -- $ 247,469
========== ==========
</Table>
10
The Company invests in mortgage-backed and related securities, including
mortgage participation certificates, which are insured or guaranteed by U.S.
Government agencies and government sponsored enterprises, and collateralized
mortgage obligations and real estate mortgage investment conduits.
Mortgage-backed securities (which also are known as mortgage participation
certificates or pass-through certificates) represent a participation interest in
a pool of single-family or multi-family mortgages, the principal and interest
payments on which are passed from the mortgage originators, through
intermediaries (generally U.S. Government agencies, government sponsored
enterprises, and direct whole loans) that pool and repackage the participation
interests in the form of securities, to investors such as the Company. U.S.
Government agencies and government sponsored enterprises, which guarantee the
payment of principal and interest to investors, primarily include the Federal
Home Loan Mortgage Corporation, the Federal National Mortgage Association and
the Government National Mortgage Association. The whole loans the Company
purchases are all AAA rated collateralized mortgage obligations and real estate
mortgage investment conduit tranches rated AAA due to credit support and/or
insurance coverage.
Mortgaged-backed securities typically are issued with stated principal
amounts, and the securities are backed by pools of mortgages that have loans
with interest rates that are within a range and have varying maturities. The
characteristics of the underlying pool of mortgages, i.e., fixed-rate or
adjustable-rate, as well as prepayment risk, are passed on to the certificate
holder. The term of a mortgaged-backed pass-through security thus approximates
the term of the underlying mortgages.
The Company's mortgaged-backed derivative securities include
collateralized mortgage obligations, which include securities issued by entities
which have qualified under the Internal Revenue Code as real estate mortgage
investment conduits. Collateralized mortgage obligations and real estate
mortgage investment conduits (collectively collateralized mortgage obligations)
have been developed in response to investor concerns regarding the uncertainty
of cash flows associated with the prepayment option of the underlying mortgagor
and are typically issued by governmental agencies, government sponsored
enterprises and special purpose entities, such as trusts, corporations or
partnerships, established by financial institutions or other similar
institutions. A collateralized mortgage obligation can be collateralized by
loans or securities which are insured or guaranteed by Federal National Mortgage
Association, Federal Home Loan Mortgage Corporation, the Government National
Mortgage Association, or whole loans which, in the Company's case, are all rated
AAA. In contrast to pass-through mortgage-backed securities, in which cash flow
is received pro rata by all security holders, the cash flow from the mortgages
underlying a collateralized mortgage obligation is segmented and paid in
accordance with a predetermined priority to investors holding various
collateralized mortgage obligation classes. By allocating the principal and
interest cash flows from the underlying collateral among the separate
collateralized mortgage obligation classes, different classes of bonds are
created, each with its own stated maturity, estimated average life, coupon rate
and prepayment characteristics.
Like most fixed-income securities, mortgage-backed and related securities
are subject to interest rate risk. However, unlike most fixed-income securities,
the mortgage loans underlying a mortgage-backed or related security generally
may be prepaid at any time without penalty. The ability to prepay a mortgage
loan generally results in significantly increased price and yield volatility
(with respect to mortgage-backed and related securities) than is the case with
non-callable fixed income securities. Furthermore, mortgage-backed derivative
securities often are more sensitive to changes in interest rates and prepayments
than traditional mortgage-backed securities and are, therefore, even more
volatile.
11
The combined Investment securities, mortgage-backed securities, and
marketable equity securities portfolio increased to $634.2 million on December
31, 2001, compared to $593.8 million on December 31, 2000, an increase of $40.4
million or 6.8%. Mortgage-backed securities increased $41.8 million or 10.1%
during 2001 when compared to 2000. State and Political Subdivisions increased
$26.3 million or 26.2% during 2001. U.S. Treasury securities increased during
2001 compared to 2000 by $5.1 million or 84.0%, U. S. Government Agency
securities decreased $22.2 million or 51.1%. Other stocks and bonds decreased
$10.6 million or 33.1% in 2001 compared to 2000 due to sales of corporate bonds
which more than offset increases of $1.1 million or 5.2% due to FHLB Dallas
stock dividends and purchases in 2001 compared to 2000. During 2001, interest
rates declined and the yield curve steepened as short-term interest rates
decreased significantly more than long-term interest rates. The Company used
this low interest rate environment to reposition the securities portfolio in an
attempt to reduce the overall duration. Several lower coupon, longer duration
mortgage-backed securities were replaced with higher coupon or shorter duration
mortgage-backed securities. Long duration U. S. Government agency securities
were replaced with long duration municipal securities. Specific municipal
securities with final maturities greater than twenty years and larger blocks of
long term municipal security zero coupon bonds were both replaced with thirteen
to twenty year coupon municipal securities.
On January 1, 2001, Southside adopted Financial Accounting Standard No.
133, "Accounting for Derivative Instruments and Hedging Activities," (FAS133).
As allowed by FAS133, at the date of initial application of this statement,
Southside transferred held to maturity securities into the available for sale
category and the trading category. Southside sold the securities transferred
into the trading category during the first quarter of 2001. The effect of
selling the securities in the trading category is shown as a cumulative effect
of a change in accounting principle and reduced net income by $994,000 (net of
taxes) during the first quarter of 2001. During 2001, Southside sold available
for sale securities which resulted in realized gains of $4.1 million or an after
tax gain of $2.7 million. These separate transactions allowed Southside to
reduce the overall duration of and reposition the securities portfolio.
During the second quarter ended June 30, 2000, the Company issued $54.6
million of long-term brokered CDs with one-year call options and additional call
options every six months thereafter, until the CDs mature. The average yield on
these CDs was 8.19% with an average life of 10.8 years. Obtaining this long-term
funding enabled the Bank to take advantage of the higher interest rate
environment, during the first half of 2000 primarily through the purchase of
securities without incurring significant additional interest rate risk. The
options associated with these CDs provided the Bank with valuable balance sheet
opportunities. The higher cost associated with these callable CDs had a negative
impact on net interest spread during the five quarters ended June 30, 2001. In
conjunction with the issuance of these long-term brokered CDs, securities were
purchased with an overall duration and yield approximately that of the brokered
CDs.
During March 2001, the Company notified CD holders that $24.6 million of
brokered CDs were being called April 12, 2001. The Company recorded $195,000 of
additional interest expense associated with the call of the CDs during the first
quarter ended March 31, 2001. Gains on sales of securities were used to offset
this expense. During April 2001, the Company notified CD holders that the
remaining $30.0 million of brokered CDs would be called May 24, 2001. An
additional $357,000 of expense was incurred during the second quarter ending
June 30, 2001, associated with the call of the brokered CDs. These CDs were
replaced with long-term advances from the FHLB at an average rate of
approximately 5.40% and an average life of approximately 4.9 years. As a result,
the Company's interest expense on this $54.6 million declined after the CDs were
called.
12
The market value of the Securities portfolio at December 31, 2001 was
$634.2 million, which represented a net unrealized gain on that date of $9.0
million. The net unrealized gain was comprised of $10.6 million in unrealized
gains and $1.6 million of unrealized losses. Net unrealized gains and losses on
AFS securities, which is a component of Shareholders' Equity on the consolidated
balance sheet, can fluctuate significantly as a result of changes in interest
rates. Because management cannot predict the future direction of interest rates,
the effect on Shareholders' Equity in the future cannot be determined; however,
this risk is monitored closely through the use of shock tests on the AFS
securities portfolio using an array of interest rate assumptions.
During the month ended January 31, 2000, the Company transferred
securities totaling $91.7 million from AFS to HTM due to changes in market
conditions. Of the total transferred, $21.2 million were investment securities
and $70.5 million were mortgage-backed securities. The unrealized loss on the
securities transferred from AFS to HTM was $2.6 million, net of tax, at the date
of transfer. There were no sales from the HTM portfolio during the years ended
December 31, 2001 or 2000. There were no securities classified as HTM for the
year ended December 31, 2001.
The maturities classified according to the sensitivity to changes in
interest rates of the December 31, 2001 securities portfolio and the weighted
yields are presented below. Tax-exempt obligations are shown on a taxable
equivalent basis. Mortgage-backed securities are classified according to
repricing frequency and cash flows from street estimates of principal
prepayments.
<Table>
<Caption>
MATURING OR REPRICING
-------------------------------------------------------------------------------
After 1 But After 5 But
Within 1 Yr. Within 5 Yrs. Within 10 Yrs. After 10 Yrs.
----------------- ----------------- ------------------ ------------------
Available For Sale: Amount Yield Amount Yield Amount Yield Amount Yield
-------- ------- -------- ------- -------- ------- -------- -------
(dollars in thousands)
U.S. Treasury...................... $ 5,954 1.94% $ 5,111 3.52% $ -- -- $ -- --
U.S. Government Agencies........... 14,929 1.82% 6,300 4.46% -- -- -- --
Mortgage-backed Securities......... 161,379 5.73% 243,309 5.78% 45,366 5.77% 4,024 5.73%
State and Political Subdivisions... 581 7.44% 3,461 7.73% 3,834 7.99% 118,545 7.28%
Other Stocks and Bonds............. 21,027 3.00% 103 7.42% -- -- 260 3.34%
-------- -------- -------- --------
Total......................... $203,870 5.06% $258,284 5.73% $ 49,200 5.94% $122,829 7.22%
======== ======== ======== ========
</Table>
13
DEPOSITS AND BORROWED FUNDS
Deposits provide the Company with its primary source of funds. The
increase of $37.3 million or 5.2% in total deposits during 2001 provided the
Company with funds for a portion of the growth in loans. Time deposits decreased
$534,000 or 0.2% during 2001 compared to 2000. This decrease was due to $54.6
million of brokered CDs called during the second quarter ended June 30, 2001.
Time deposits not including brokered CDs increased $54.1 million or 18.5% during
2001 compared to 2000, due in part to State of Texas time deposits increasing
$27.1 million. Noninterest bearing demand deposits increased $4.9 million or
2.9% during 2001. Interest bearing demand deposits increased $27.4 million or
14.9% and Saving Deposits increased $5.6 million or 23.4% during 2001. The
latter three categories, which are considered the lowest cost deposits,
comprised 54.4% of total deposits at December 31, 2001 compared to 51.9% at
December 31, 2000. The increase in total deposits was reflective of overall bank
growth and branch expansion.
The following table sets forth the Company's deposits by category at
December 31, 2001 and 2000:
<Table>
<Caption>
December 31,
-----------------------
2001 2000
---------- ----------
(in thousands)
Noninterest Bearing Demand Deposits......... $ 171,802 $ 166,899
Interest Bearing Demand Deposits............ 210,742 183,383
Savings Deposits............................ 29,628 24,007
Time Deposits............................... 345,782 346,316
---------- ----------
Total Deposits...................... $ 757,954 $ 720,605
========== ==========
</Table>
During the year ended December 31, 2001, total time deposits of $100,000
or more decreased $11.8 million or 7.8% from December 31, 2000. This decrease
was due to $54.6 million of brokered CDs called during the second quarter ended
June 30, 2001. Total time deposits of $100,000 or more not including brokered
CDs actually increased $42.8 million or 44.4% during 2001 compared to 2000 due
in part to State of Texas time deposits increasing $27.1 million.
The table below sets forth the maturity distribution of time deposits of
$100,000 or more issued by the Company at December 31, 2001 and 2000:
<Table>
<Caption>
December 31, 2001 December 31, 2000
--------------------------------- ---------------------------------
Time Other Time Other
Certificates Time Certificates Time
of Deposit Deposits Total of Deposit Deposits Total
------------ -------- --------- ------------ -------- ---------
(in thousands)
Three months or less................ $ 30,450 $ 18,500 $ 48,950 $ 22,671 $ 377 $ 23,048
Over three to six months............ 24,044 21,000 45,044 16,603 12,000 28,603
Over six to twelve months........... 19,265 459 19,724 27,076 459 27,535
Over twelve months.................. 25,669 -- 25,669 71,956 -- 71,956
------------ -------- --------- ------------ -------- ---------
Total....................... $ 99,428 $ 39,959 $ 139,387 $ 138,306 $ 12,836 $ 151,142
============ ======== ========= ============ ======== =========
</Table>
14
Short-term Obligations, consisting primarily of FHLB Dallas advances and
Federal Funds Purchased, decreased $13.7 million or 8.7% during 2001 when
compared to 2000. FHLB Dallas advances are collateralized by FHLB Dallas stock,
nonspecified real estate loans and securities.
<Table>
<Caption>
Years Ended December 31,
----------------------------------
2001 2000 1999
--------- --------- ---------
(dollars in thousands)
Federal Home Loan Bank ("FHLB") Dallas short-term advances
Balance at end of period....................................... $ 114,177 $ 148,940 $ 181,222
Average amount outstanding during the period (1)............... 165,100 156,265 155,719
Maximum amount outstanding during the period................... 207,744 188,899 186,500
Weighted average interest rate during the period (2)........... 4.3% 6.3% 5.3%
Interest rate at end of period................................. 3.3% 6.1% 5.3%
</Table>
(1) The average amount outstanding during the period was computed by
dividing the total daily outstanding principal balances by the number
of days in the period.
(2) The weighted average interest rate during the period was computed by
dividing the actual interest expense by the average balance
outstanding during the period.
Long-term Obligations primarily consisting of FHLB Dallas advances and
junior subordinated debentures increased $81.1 million during 2001 to $297.7
million or a 37.4% increase when compared to $216.6 million in 2000. The
increase was primarily the result of the Company replacing $54.6 million of
long-term callable brokered CDs the Company called during 2001 with long-term
FHLB Dallas advances. The Company also added additional long-term FHLB Dallas
advances as long-term interest rates decreased.
On November 2, 2000, the Company through its wholly-owned subsidiary,
Southside Capital Trust II (the "Trust II Issuer"), sold 1,695,000 cumulative
convertible preferred securities (the "junior subordinated convertible
debentures") at a liquidation amount of $10 per convertible preferred security
for an aggregate amount of $16,950,000. These securities have a convertible
feature that allows the owner to convert each security to a share of the
Company's common stock at a conversion price of $9.52 per common share. These
securities have a distribution rate of 8.75% per annum payable at the end of
each calendar quarter.
On May 18, 1998, the Company through its wholly-owned subsidiary,
Southside Capital Trust (the "Trust Issuer"), sold 2,000,000 preferred
securities (the "junior subordinated debentures") at a liquidation amount of $10
per preferred security for an aggregate amount of $20,000,000. These securities
have a distribution rate of 8.50% per annum payable at the end of each calendar
quarter.
THE BANKING INDUSTRY IN TEXAS
The banking industry is affected by general economic conditions such as
interest rates, inflation, recession, unemployment and other factors beyond the
Company's control. During the mid to late 1980's, declining oil prices had an
indirect effect on the Company's business, and the deteriorating real estate
market caused a significant portion of the increase in the Company's
nonperforming assets during that period. During the early 1990's the East Texas
economy entered into a recovery and growth period that continued throughout the
year 2000. During the last ten years the East Texas economy has diversified,
decreasing the overall impact of declining oil prices, however, the East Texas
economy is still affected by the oil industry. During 2001 the economy in the
Bank's trade territory has shown some signs of slowing but appears stable. The
two areas of concern are the nationwide economic slowdown or recession and the
personal bankruptcy rate. Management expects these trends to have some effect on
the Company's net charge-offs. Management of the Company, however, cannot
predict whether current economic conditions will improve, remain the same or
decline.
15
COMPETITION
The activities engaged in by the Company and its subsidiary, Southside
Bank, are highly competitive. Financial institutions such as savings and loan
associations, credit unions, consumer finance companies, insurance companies,
brokerage companies and other financial institutions with varying degrees of
regulatory restrictions compete more vigorously for a share of the financial
services market. Brokerage companies continue to become more competitive in the
financial services arena and pose an ever increasing challenge to banks.
Legislative changes also greatly affect the level of competition the Company
faces. During 1998 federal legislation allowed credit unions to expand their
membership criteria. This allows credit unions to use their expanded membership
capabilities combined with tax-free status to compete more fiercely for
traditional bank business. Because banks do not enjoy a tax-free status, credit
unions have a competitive advantage. Currently, the Company must compete against
several institutions located in East Texas and elsewhere in the Company's
service area which have capital resources and legal loan limits substantially in
excess of those available to the Company and Southside Bank. The Company expects
the competition to increase.
EMPLOYEES
At December 31, 2001, the Company employed approximately 388 full time
equivalent persons. None of the employees are represented by any unions or
similar groups, and the Company has not experienced any type of strike or labor
dispute. The Company considers the relationship with its employees to be good.
EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company and Southside Bank as of December
31, 2001, were as follows:
B. G. Hartley (Age 72), Chairman of the Board and Chief Executive Officer of the
Company since 1983. He also serves as Chairman of the Board and Chief Executive
Officer of the Company's subsidiary, Southside Bank, having served in these
capacities since the Bank's inception in 1960.
Sam Dawson (Age 54), President, Secretary and Director of the Company.
President, Chief Operations Officer and Director of the Company's subsidiary,
Southside Bank since 1996. He became an officer of the Company in 1982 and of
Southside Bank during 1975.
Robbie N. Edmonson (Age 69), Vice Chairman of the Board of the Company and the
Company's subsidiary, Southside Bank. He joined Southside Bank as a vice
president in 1968.
Jeryl Story (Age 50), Executive Vice President of the Company. Senior Executive
Vice President - Loan Administration, Senior Lending Officer and Director of the
Company's subsidiary, Southside Bank, since 1996. He joined Southside Bank in
1979 as an officer in Loan Documentation.
Lee R. Gibson (Age 45), Executive Vice President and Chief Financial Officer of
the Company and of the Company's subsidiary, Southside Bank. He is also a
Director of Southside Bank. He became an officer of the Company in 1985 and of
Southside Bank during 1984.
All the individuals named above serve in their capacity as officers of
the Company and/or Southside Bank at the pleasure of each entities' Board of
Directors.
16
SUPERVISION AND REGULATION
Banking is a complex, highly regulated industry. Consequently, the
Company's growth and earnings performance can be affected not only by management
decisions and general and local economic conditions, but also by the statutes
administered by, and the regulations and policies of, various governmental
authorities. These authorities include, but are not limited to, the board of
governors of the Federal Reserve System, the Federal Deposit Insurance
Corporation, the Department of Banking of the State of Texas, the Internal
Revenue Service and state taxing authorities. The effect of these statutes,
regulations and policies and any changes to any of them can be significant and
cannot be predicted.
The primary goals of the bank regulatory scheme are to maintain a safe
and sound banking system and to facilitate the conduct of sound monetary policy.
In furtherance of these goals, Congress has created several largely autonomous
regulatory agencies and enacted numerous laws that govern banks, bank holding
companies and the banking industry. The system of supervision and regulation
applicable to the Bank and the Company establishes a comprehensive framework for
the Company's respective operations and is intended primarily for the protection
of the Federal Deposit Insurance Corporation's deposit insurance funds, the
Bank's depositors and the public, rather than the Company's shareholders and
creditors. The following is an attempt to summarize some of the relevant laws,
rules and regulations governing banks and bank holding companies, but does not
purport to be a complete summary of all applicable laws, rules and regulations
governing banks and bank holding companies. The descriptions are qualified in
their entirety by reference to the specific statutes and regulations discussed.
Southside
General. As bank holding companies under the Bank Holding Company Act of
1956, as amended, the Company and Southside Delaware are registered with and
subject to regulation by the Federal Reserve. The Company and Southside Delaware
are both required to file annual and other reports with, and furnish information
to, the Federal Reserve, which makes periodic inspections of the Company and
Southside Delaware.
The Bank Holding Company Act provides that a bank holding company must
obtain the prior approval of the Federal Reserve for the acquisition of more
than five percent of the voting stock or substantially all the assets of any
bank or bank holding company. In addition, the Bank Holding Company Act
restricts the extension of credit to any bank holding company by its subsidiary
bank. The Bank Holding Company Act also provides that, with certain exceptions,
a bank holding company may not engage in any activities other than those of
banking or managing or controlling banks and other authorized subsidiaries or
own or control more than five percent of the voting shares of any company that
is not a bank. The Federal Reserve has deemed limited activities to be closely
related to banking and therefore permissible for a bank holding company.
The Federal Reserve has cease-and-desist powers over bank holding
companies and their nonbanking subsidiaries where their actions would constitute
a serious threat to the safety, soundness or stability of a subsidiary bank.
Federal regulatory agencies also have authority to regulate debt obligations
(other than commercial paper) issued by bank holding companies. This authority
includes the power to impose interest ceilings and reserve requirements on such
debt obligations. A bank holding company and its subsidiaries are also
prohibited from engaging in certain tie-in arrangements in connection with any
extension of credit, lease or sale of property or furnishing of services.
The Modernization Act. Traditionally, the activities of bank holding
companies had been limited to the business of banking and activities closely
related or incidental to banking. The Gramm-Leach-Bliley Financial Services
Modernization Act of 1999, which became effective on March 11, 2000, amended the
Bank Holding Company Act and expanded the types of activities in which a bank
holding company may engage by electing to become a "financial holding company."
A financial holding company may affiliate with securities firms and insurance
companies and engage in other activities that are "financial in nature." In
addition to traditional lending activities, activities that are deemed
"financial in nature" include securities underwriting, dealing in or making a
market in securities, sponsoring mutual funds and investment companies,
insurance underwriting and agency activities, certain merchant banking
activities and activities that the Federal Reserve considers to be closely
related to banking.
17
A bank holding company may become a financial holding company under the
Modernization Act if each of its subsidiary banks is "well capitalized" under
the Federal Deposit Insurance Corporation Improvement Act prompt corrective
action provisions, is "well managed" and has at least a "satisfactory" rating
under the Community Reinvestment Act. In addition, the bank holding company must
file a declaration with the Federal Reserve that the bank holding company elects
to become a financial holding company. A bank holding company that falls out of
compliance with these requirements may be required to cease engaging in some of
its activities.
In a similar manner, the Modernization Act expanded the types of
activities in which a bank may engage. Generally, a bank may engage in
activities that are financial in nature through a "financial subsidiary" if the
bank and each of its depository institution affiliates are "well capitalized",
"well managed" and have at least a "satisfactory" rating under the Community
Reinvestment Act. However, applicable law and regulation provide that the amount
of investment in these activities generally are limited to 45% of the total
assets of the bank, and these investments are not aggregated with the bank for
determining compliance with capital adequacy guidelines. Further, the
transactions between the bank and this type of subsidiary are subject to a
number of limitations.
Under the Modernization Act, the Federal Reserve serves as the primary
"umbrella" regulator of financial holding companies, with supervisory authority
over each parent company and limited authority over its subsidiaries. Expanded
financial activities of financial holding companies generally will be regulated
according to the type of such financial activity: banking activities by banking
regulators, securities activities by securities regulators and insurance
activities by insurance regulators. The Modernization Act also imposes
additional restrictions and heightened disclosure requirements regarding private
information collected by financial institutions. All implementing regulations
under the Modernization Act have not yet become effective in final form, and the
Company cannot predict the full sweep of the new legislation and have not yet
determined whether it will elect to become a financial holding company or if the
Company will conduct any activities through financial subsidiaries.
Interstate Banking. Federal banking law generally provides that a bank
holding company may acquire or establish banks in any state of the United
States, subject to certain aging and deposit concentration limits. In addition,
Texas banking laws permit a bank holding company which owns stock of a bank
located outside the State of Texas to acquire a bank or bank holding company
located in Texas. This type of acquisition may occur only if the Texas bank to
be directly or indirectly controlled by the out-of-state bank holding company
has existed and continuously operated as a bank for a period of at least five
years. In any event, a bank holding company may not own or control banks in
Texas the deposits of which would exceed 20% of the total deposits of all
federally-insured deposits in Texas. The Company has no present plans to acquire
or establish banks outside the State of Texas but have not eliminated the
possibility of doing so.
Capital Adequacy. The Federal Reserve monitors the capital adequacy of
bank holding companies, such as Southside Delaware and the Company, and the
Federal Deposit Insurance Corporation monitors the capital adequacy of the Bank.
The federal bank regulators use a combination of risk-based guidelines and
leverage ratios to evaluate capital adequacy and consider the Company's capital
levels when taking action on various types of applications and when conducting
supervisory activities related to the safety and soundness of the Company and
the Bank.
The Federal Reserve's capital adequacy regulations are based upon a risk
based capital determination, whereby a bank holding company's capital adequacy
is determined in light of the risk, both on- and off-balance sheet, contained in
the company's assets. Different categories of assets are assigned risk
weightings and are counted at a percentage of their book value.
The regulations divide capital between Tier 1 capital (core capital) and
Tier 2 capital. For a bank holding company, Tier 1 capital consists primarily of
common stock, related surplus, noncumulative perpetual preferred stock, minority
interests in consolidated subsidiaries and a limited amount of qualifying
cumulative preferred securities. Goodwill and certain other intangibles are
excluded from Tier 1 capital. Tier 2 capital consists of an amount equal to the
allowance for loan and lease losses up to a maximum of 1.25% of risk weighted
assets, limited other types of preferred stock not included in Tier 1 capital,
hybrid capital instruments and term subordinated debt. Investments in and loans
to unconsolidated banking and finance subsidiaries that constitute capital of
those subsidiaries are excluded from capital. The sum of Tier 1 and Tier 2
capital constitutes qualifying total capital, and the Tier 1 component must
comprise at least 50% of qualifying total capital.
18
Under regulatory capital guidelines, the Company must maintain a minimum
Tier 1 capital ratio of at least 4.0% and a minimum total capital ratio of at
least 8.0%. In addition, banks and bank holding companies are required to
maintain a minimum leverage ratio of Tier 1 capital to average total
consolidated assets (leverage capital ratio) of at least 3.0% for the most
highly-rated, financially sound banks and bank holding companies and a minimum
leverage ratio of at least 4.0% for all other banks. As of December 31, 2001,
the Company's total risk-based capital ratio was 17.08%, the Company's Tier 1
risk-based capital ratio was 13.44% and the Company's leverage capital ratio was
6.50%.
The guidelines also provide that banking organizations experiencing
internal growth or making acquisitions will be expected to maintain strong
capital positions substantially above the minimum supervisory level, without
significant reliance on intangible assets and that the Federal Reserve will
continue to consider a "Tangible Tier 1 Leverage Ratio" in evaluating proposals
for expansion or new activities. The Tangible Tier 1 Leverage Ratio is the ratio
of Tier 1 capital, less intangibles not deducted from Tier 1 capital, to
quarterly average total assets. As of December 31, 2001, the Federal Reserve had
not advised us of any specific minimum Tangible Tier 1 Leverage Ratio applicable
to the Company.
Dividends. As a bank holding company that does not, as an entity,
currently engage in separate business activities of a material nature, the
Company's ability to pay cash dividends depends upon the cash dividends it
receives from the bank through Southside Delaware. The Company's sources of
income are dividends paid by the Bank. The Company must pay all of its operating
expenses from funds the Company received from the Bank. Therefore, shareholders
may receive dividends from the Company only to the extent that funds are
available after payment of the Company's operating expenses. In addition, in
November 1985 the Federal Reserve adopted a policy statement concerning payment
of cash dividends, which generally prohibits bank holding companies from paying
dividends except out of operating earnings, and the prospective rate of earnings
retention appears consistent with the bank holding company's capital needs,
asset quality and overall financial condition. The Company is also subject to
certain restrictions on the payment of dividends as a result of the requirement
that the Company maintain an adequate level of capital as described above.
The Bank
The Bank is subject to various requirements and restrictions under the
laws of the United States and the State of Texas, and to regulation, supervision
and regular examination by the Texas Department of Banking and the Federal
Deposit Insurance Corporation. The Texas Department of Banking and the Federal
Deposit Insurance Corporation have the power to enforce compliance with
applicable banking statutes and regulations. These requirements and restrictions
include requirements to maintain reserves against deposits, restrictions on the
nature and amount of loans that may be made and the interest that may be charged
thereon and restrictions relating to investments and other activities of the
bank.
USA Patriot Act of 2001. On October 26, 2001, President Bush signed into
law the United and Strengthening America by Providing Appropriate Tools Required
to Intercept and Obstruct Terrorism Act of 2001. Also known as the "Patriot
Act," the law enhances the powers of the federal government and law enforcement
organizations to combat terrorism, organized crime and money laundering. The
Patriot Act significantly amends and expands the application of the Bank Secrecy
Act, including enhanced measures regarding customer identity, new suspicious
activity reporting rules and enhanced anti-money laundering programs. Under the
Act, each financial institution is required to establish and maintain anti-money
laundering programs, which include, at a minimum, the development of internal
policies, procedures, and controls; the designation of a compliance officer; an
ongoing employee training program; and an independent audit function to test
programs. In addition, the Act requires the bank regulatory agencies to consider
the record of a bank or bank holding company in combating money laundering
activities in their evaluation of bank and bank holding company merger or
acquisition transactions. Regulations proposed by the U.S. Department of the
Treasury to effectuate certain provisions of the Patriot Act provide that all
transaction or other correspondent accounts held by a U.S. financial institution
on behalf of any foreign bank must be closed within ninety days after the final
regulations are issued, unless the foreign bank has provided the U.S. financial
institution with a means of verification that the institution is not a "shell
bank." Proposed regulations interpreting other provisions of the Patriot Act are
expected to be issued during 2002.
19
Transactions with Affiliates. The Bank may not engage in specified
transactions (including, for example, loans) with its affiliates unless the
terms and conditions of those transactions are substantially the same or at
least as favorable to the Bank as those prevailing at the time for comparable
transactions with or involving other nonaffiliated entities. In the absence of
comparable transactions, any transaction between the Bank and its affiliates
must be on terms and under circumstances, including credit standards, that in
good faith would be offered or would apply to nonaffiliated companies. In
addition, transactions referred to as "covered transactions" between the Bank
and its affiliates may not exceed 10% of the Bank's capital and surplus per
affiliate and an aggregate of 20% of its capital and surplus for covered
transactions with all affiliates. Certain transactions with affiliates, such as
loans, also must be secured by collateral of specific types and amounts. The
Bank also is prohibited from purchasing low quality assets from an affiliate.
Every company under common control with the Bank, including the Company and
Southside Delaware, are deemed to be affiliates of the Bank.
Loans to Insiders. Federal law also constrains the types and amounts of
loans that the Bank may make to its executive officers, directors and principal
shareholders. Among other things, these loans must be approved by the Bank's
board of directors in advance, must be on terms and conditions as favorable to
the Bank as those available to an unrelated person and are limited in amount.
Regulation of Lending Activities. Loans made by the Bank are also subject
to numerous federal and state laws and regulations, including the
Truth-In-Lending Act, Federal Consumer Credit Protection Act, the Texas Consumer
Credit Code, the Texas Consumer Protection Code, the Equal Credit Opportunity
Act, the Real Estate Settlement Procedures Act and adjustable rate mortgage
disclosure requirements. Remedies to the borrower or consumer and penalties to
the Bank are provided if the Bank fails to comply with these laws and
regulations. The scope and requirements of these laws and regulations have
expanded significantly in recent years.
Branch Banking. Pursuant to the Texas Finance Code, all banks located in
Texas are authorized to branch statewide. Accordingly, a bank located anywhere
in Texas has the ability, subject to regulatory approval, to establish branch
facilities near any of our facilities and within our market area. If other banks
were to establish branch facilities near our facilities, it is uncertain whether
these branch facilities would have a material adverse effect on the business of
the Bank.
In 1994 Congress adopted the Reigle-Neal Interstate Banking and Branching
Efficiency Act of 1994. That statute provides for nationwide interstate banking
and branching, subject to certain aging and deposit concentration limits that
may be imposed under applicable state laws. Texas law permits interstate
branching in two manners, with certain exceptions. First, a financial
institution with its main office outside of Texas may establish a branch in the
State of Texas by acquiring a financial institution located in Texas that is at
least five years old, so long as the resulting institution and its affiliates
would not hold more than 20% of the total deposits in the state after the
acquisition. In addition, a financial institution with its main office outside
of Texas generally may establish a branch in the State of Texas on a de novo
basis if the financial institution's main office is located in a state that
would permit Texas institutions to establish a branch on a de novo basis in that
state.
The Federal Deposit Insurance Corporation has adopted regulations under
the Riegle-Neal Act to prohibit an out-of-state bank from using the interstate
branching authority primarily for the purpose of deposit production. These
regulations include guidelines to insure that interstate branches operated by an
out-of-state bank in a host state are reasonably helping to meet the credit
needs of the communities served by the out-of-state bank.
Governmental Monetary Policies. The commercial banking business is
affected not only by general economic conditions but also by the monetary
policies of the Federal Reserve. Changes in the discount rate on member bank
borrowings, control of borrowings, open market operations, the imposition of and
changes in reserve requirements against member banks, deposits and assets of
foreign branches, the imposition of and changes in reserve requirements against
certain borrowings by banks and their affiliates and the placing of limits on
interest rates which member banks may pay on time and savings deposits are some
of the instruments of monetary policy available to the Federal Reserve. Those
monetary policies influence to a significant extent the overall growth of all
bank loans, investments and deposits and the interest rates charged on loans or
paid on time and savings deposits. The nature of future monetary policies and
the effect of such policies on the future business and earnings of the Bank,
therefore, cannot be predicted accurately.
20
Dividends. All dividends paid by the Bank are paid to the Company, the
sole indirect shareholder of the Bank, through Southside Delaware. The general
dividend policy of the Bank is to pay dividends at levels consistent with
maintaining liquidity and preserving applicable capital ratios and servicing
obligations. The dividend policy of the Bank is subject to the discretion of the
board of directors of the Bank and will depend upon such factors as future
earnings, financial conditions, cash needs, capital adequacy, compliance with
applicable statutory and regulatory requirements and general business
conditions.
The ability of the Bank, as a Texas banking association, to pay dividends
is restricted under applicable law and regulations. The Bank generally may not
pay a dividend reducing its capital and surplus without the prior approval of
the Texas Banking Commissioner. All dividends must be paid out of net profits
then on hand, after deducting expenses, including losses and provisions for loan
losses. The Federal Deposit Insurance Corporation has the right to prohibit the
payment of dividends by the Bank where the payment is deemed to be an unsafe and
unsound banking practice. The Bank is also subject to certain restrictions on
the payment of dividends as a result of the requirements that it maintain an
adequate level of capital in accordance with guidelines promulgated from time to
time by the Federal Deposit Insurance Corporation.
The exact amount of future dividends on the stock of the Bank will be a
function of the profitability of the Bank in general and applicable tax rates in
effect from year to year. The Bank's ability to pay dividends in the future will
directly depend on the Banks future profitability, which cannot be accurately
estimated or assured.
Capital Adequacy. In 1990, the federal Banking regulators promulgated
capital adequacy regulations to which all national and state banks, such as the
Bank, are subject. These requirements are similar to the Federal Reserve
requirements promulgated with respect to bank holding companies discussed
previously.
Community Reinvestment Act. Under the Community Reinvestment Act, the
Bank has a continuing and affirmative obligation consistent with safe and sound
banking practices to help meet the needs of its entire community, including low-
and moderate-income neighborhoods served by the Bank. The Community Reinvestment
Act does not establish specific lending requirements or programs for financial
institutions nor does it limit the Bank's discretion to develop the types of
products and services that it believes are best suited to its particular
community. On a periodic basis, the Federal Deposit Insurance Corporation is
charged with preparing a written evaluation of the Bank's record of meeting the
credit needs of the entire community and assigning a rating. The bank regulatory
agencies will take that record into account in their evaluation of any
application made by the Bank or the Company for, among other things, approval of
the acquisition or establishment of a branch or other deposit facility, an
office relocation, a merger or the acquisition of shares of capital stock of
another financial institution. An unsatisfactory Community Reinvestment Act
rating may be used as the basis to deny an application. In addition, as
discussed above, a bank holding company may not become a financial holding
company unless each of its subsidiary banks have a Community Reinvestment Act
rating of at least satisfactory. The Bank was last examined for compliance with
the Community Reinvestment Act on October 9, 2001 and received a rating of
"outstanding."
Enforcement Authority. The federal banking laws also contain civil and
criminal penalties available for use by the appropriate regulatory agency
against certain "institution-affiliated parties" primarily including management,
employees and agents of a financial institution, as well as independent
contractors such as attorneys and accountants and others who participate in the
conduct of the financial institution's affairs and who caused or are likely to
cause more than minimum financial loss to or a significant adverse affect on the
institution, who knowingly or recklessly violate a law or regulation, breach a
fiduciary duty or engage in unsafe or unsound practices. These practices can
include the failure of an institution to timely file required reports or the
submission of inaccurate reports. These laws authorize the appropriate banking
agency to issue cease and desist orders that may, among other things, require
affirmative action to correct any harm resulting from a violation or practice,
including restitution, reimbursement, indemnification or guarantees against
loss. A financial institution may also be ordered to restrict its growth,
dispose of certain assets or take other action as determined by the ordering
agency to be appropriate.
21
Annual Audits. Every bank with total assets in excess of $500 million,
such as the Bank, must have an annual independent audit made of the bank's
financial statements by a certified public accountant to verify that the
financial statements of the bank are presented in accordance with generally
accepted accounting principles and comply with such other disclosure
requirements as prescribed by the Federal Deposit Insurance Corporation.
Prompt Corrective Action. Banks are subject to restrictions on their
activities depending on their level of capital. The Federal Deposit Insurance
Corporation's "prompt corrective action" regulations divides banks into five
different categories, depending on their level of capital. Under these
regulations, a bank is deemed to be "well capitalized" if it has a total
risk-based capital ratio of 10% or more, a core capital ratio of six percent or
more and a leverage ratio of five percent or more, and if the bank is not
subject to an order or capital directive to meet and maintain a certain capital
level. Under these regulations, a bank is deemed to be "adequately capitalized"
if it has a total risk-based capital ratio of eight percent or more, a core
capital ratio of four percent or more and a leverage ratio of four percent or
more (unless it receives the highest composite rating at its most recent
examination and is not experiencing or anticipating significant growth, in which
instance it must maintain a leverage ratio of three percent or more). Under
these regulations, a bank is deemed to be "undercapitalized" if it has a total
risk-based capital ratio of less than eight, a core capital ratio of less than
four percent or a leverage ratio of less than four percent. Under these
regulations, a bank is deemed to be "significantly undercapitalized" if it has a
risk-based capital ratio of less than six percent, a core capital ratio of less
than three percent and a leverage ratio of less than three percent. Under such
regulations, a bank is deemed to be "critically undercapitalized" if it has a
leverage ratio of less than or equal to two percent. In addition, the Federal
Deposit Insurance Corporation has the ability to downgrade a bank's
classification (but not to "critically undercapitalized") based on other
considerations even if the bank meets the capital guidelines.
If a state nonmember bank, such as the Bank, is classified as
undercapitalized, the bank is required to submit a capital restoration plan to
the Federal Deposit Insurance Corporation. An undercapitalized bank is
prohibited from increasing its assets, engaging in a new line of business,
acquiring any interest in any company or insured depository institution, or
opening or acquiring a new branch office, except under certain circumstances,
including the acceptance by the Federal Deposit Insurance Corporation of a
capital restoration plan for the bank.
If a state nonmember bank is classified as undercapitalized, the Federal
Deposit Insurance Corporation may take certain actions to correct the capital
position of the bank. If a bank is classified as significantly undercapitalized,
the Federal Deposit Insurance Corporation would be required to take one or more
prompt corrective actions. These actions would include, among other things,
requiring sales of new securities to bolster capital, improvements in
management, limits on interest rates paid, prohibitions on transactions with
affiliates, termination of certain risky activities and restrictions on
compensation paid to executive officers. If a bank is classified as critically
undercapitalized, the bank must be placed into conservatorship or receivership
within 90 days, unless the Federal Deposit Insurance Corporation determines
otherwise.
The capital classification of a bank affects the frequency of
examinations of the bank and impacts the ability of the bank to engage in
certain activities and affects the deposit insurance premiums paid by the bank.
The Federal Deposit Insurance Corporation is required to conduct a full-scope,
on-site examination of every bank at least once every twelve months.
Banks also may be restricted in their ability to accept brokered
deposits, depending on their capital classification. "Well capitalized" banks
are permitted to accept brokered deposits, but all banks that are not well
capitalized are not permitted to accept such deposits. The Federal Deposit
Insurance Corporation may, on a case-by-case basis, permit banks that are
adequately capitalized to accept brokered deposits if the Federal Deposit
Insurance Corporation determines that acceptance of such deposits would not
constitute an unsafe or unsound banking practice with respect to the bank.
Deposit Insurance. The Bank's deposits are insured up to $100,000 per
depositor by the Bank Insurance Fund. As insurer, the Federal Deposit Insurance
Corporation imposes deposit premiums and is authorized to conduct examinations
of and to require reporting by the Bank. The Federal Deposit Insurance
Corporation assesses insurance premiums on a bank's deposits at a variable rate
depending on the probability that the deposit insurance fund will incur a loss
with respect to the bank. The Federal Deposit Insurance Corporation determines
the deposit insurance assessment rates on the basis of the bank's capital
classification and supervisory evaluations. There is currently a 27 basis point
spread between the highest and the lowest
22
assessment rates, so that banks classified as strongest were subject in 2001 to
0% assessment, and banks classified as weakest were subject to an assessment
rate of .27%. In addition to the insurance assessment, each insured bank was
subject in 2001 to an assessment of approximately $1.90 per one hundred dollars
of deposits to service debt issued by the Financing Corporation, a federal
agency established to finance the recapitalization of the former Federal Savings
and Loan Insurance Corporation. Under these assessment criteria, the Bank was
required to pay annual deposit premiums to the Bank Insurance Fund in 2001 in
the amount of $1.90 per hundred dollars of deposits. The Bank's deposits
insurance assessments may increase or decrease depending upon the risk
assessment classification to which the Bank is assigned by the Federal Deposits
Insurance Corporation. Any increase in insurance assessments could have an
adverse effect on the Bank's earnings.
All of the above laws and regulations add to the cost of the Company's
operations and thus have a negative impact on profitability. You should note
that there has been a tremendous expansion experienced in recent years by
financial service providers that are not subject to the same rules and
regulations as are applicable to Southside Delaware and the Company. The
Company's management and the Bank's management cannot predict what other
legislation might be enacted or what other regulations might be adopted or the
effects thereof.
CAPITAL GUIDELINES
Southside Bank is regulated by the TDB and the FDIC. The FDIC requires
minimum levels of Tier 1 capital and risk-based capital for FDIC-insured
institutions. The FDIC requires a minimum leverage ratio of 3% of adjusted total
assets for the highest rated banks. Other banks are required to meet a leverage
standard of 4% or more, determined on a case-by-case basis.
On December 31, 2001, the minimum ratio for qualifying total risk-based
capital was 8% of which 4% must be Tier 1 capital. Southside Bank's actual
capital to total assets and risk-based capital ratios at December 31, 2001 were
in excess of the minimum requirements.
Also see discussion of "Capital Resources" under Item 7.
USURY LAWS
Texas usury laws limit the rate of interest that may be charged by state
banks. Certain Federal laws provide a limited preemption of Texas usury laws.
The maximum rate of interest that Southside Bank may charge on direct business
loans under Texas law varies between 18% per annum and (i) 28% per annum for
business and agricultural loans above $250,000 or (ii) 24% per annum for other
direct loans. Texas floating usury ceilings are tied to the 26-week United
States Treasury Bill Auction rate. Other ceilings apply to open-end credit card
loans and dealer paper purchased by Southside Bank. A Federal statute removes
interest ceilings under usury laws for loans by Southside Bank which are secured
by first liens on residential real property.
ECONOMIC ENVIRONMENT
The monetary policies of regulatory authorities, including the FRB, have
a significant effect on the operating results of bank holding companies and
their subsidiaries. The FRB regulates the national supply of bank credit. Among
the means available to the FRB are open market operations in United States
Government Securities, changes in the discount rate on member bank borrowings,
changes in reserve requirements against member and nonmember bank deposits, and
loans and limitations on interest rates which member banks may pay on time or
demand deposits. These methods are used in varying combinations to influence
overall growth and distribution of bank loans, investments and deposits. Their
use may affect interest rates charged on loans or paid for deposits.
Also see discussion of "Banking Industry in Texas" above.
23
ITEM 2. PROPERTIES
Southside Bank owns or operates the following properties:
o A two story building in Tyler, Texas, at 1201 South Beckham
Avenue and the property adjacent to the main bank building,
known as the Southside Bank Annex. These properties house the
executive offices of Southside Bancshares, Inc.
o Property and a building directly adjacent to the building
housing the Southside Bank Annex. The building is referred to
as the Operations Annex, where various back office lending,
accounts payable operations, other support areas and training
facilities are located.
o Land and building located at 1010 East First Street in Tyler
where motor bank facilities are located.
o Property and a building located at the intersection of South
Broadway Avenue and Grande Boulevard in Tyler. The tract is
occupied by Southside Bank's South Broadway branch, which
currently provides a full line of banking services.
o Property and a building on South Broadway Avenue near the
South Broadway branch where motor bank facilities are located.
o Building located in the downtown square of Tyler which houses
Southside Bank's Downtown branch, providing a full line of
banking services.
o Gentry Parkway branch and motor bank facility at 2121 West
Gentry Parkway in Tyler.
o Longview main branch and motor bank facility at 2001 Judson
Road in Longview, Texas.
o Property on U.S. Highway 69 in Lindale, Texas, where the
Company constructed a branch facility complete with motor bank
facilities.
o Property in Whitehouse, Texas, where the Company constructed a
branch facility complete with motor bank facilities.
o Twenty-five Automatic Teller Machines (ATM) facilities located
throughout Smith and Gregg Counties.
The Company completed the construction of the Lindale branch and motor
bank facility on Highway 69 during the fourth quarter of 2001. Construction of
the branch and motor bank facility in Whitehouse was completed and the branch
opened during February 2002. The Company opened a third full service branch in a
grocery store in Longview in January 2002.
The Company currently operates full service banks in eight grocery
stores in the following locations:
o One in Lindale, Texas
o Three in Longview, Texas
o Four in Tyler, Texas
24
ITEM 3. LEGAL PROCEEDINGS
Southside Bank is party to legal proceedings arising in the normal
conduct of business. Management of the Company believes that such litigation is
not material to the financial position or results of the operations of the
Company or Southside Bank.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the three months ended December 31, 2001, there were no meetings,
annual or special, of the shareholders of the Company. No matters were submitted
to a vote of the shareholders, nor were proxies solicited by management or any
other person.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
MARKET INFORMATION
The Company's common stock began trading on the Nasdaq National Market on
May 14, 1998 under the symbol "SBSI." Prior to that the Company's common stock
was not actively traded on any established public trading market. The high/low
prices shown below represent the closing prices on the Nasdaq National Market
for the period from January 1, 2000 to December 31, 2001. During the third
quarter of 2001, the Company declared and paid a 5% stock dividend. During the
second and fourth quarter of 2000, the Company declared and paid a two for one
stock split and a 5% stock dividend, respectively. During the third quarter of
1999, the Company declared and paid a 5% stock dividend. Stock prices listed
below have been adjusted to give retroactive recognition to stock splits and
stock dividends.
<Table>
<Caption>
Year Ended 1st qtr. 2nd qtr. 3rd qtr. 4th qtr.
- ----------------- ------------- ------------- -------------- ---------------
December 31, 2001 $ 8.93 - 7.74 $ 9.53 - 8.64 $ 12.30 - 9.73 $ 12.78 - 12.05
December 31, 2000 $ 8.56 - 7.59 $ 9.00 - 7.56 $ 7.97 - 6.98 $ 8.01 - 6.65
</Table>
See "Item 7. Capital Resources" for a discussion of the Company's common
stock repurchase program.
STOCKHOLDERS
There were approximately 1,075 holders of record of the Company's common
stock, the only class of equity securities currently issued and outstanding, as
of February 28, 2002.
DIVIDENDS
Cash dividends declared and paid were $0.25 and $0.225 per share for the
years ended December 31, 2001 and 2000, respectively. Cash dividends declared
and paid were $.20 per share for the year ended December 31, 1999. Stock
dividends of 5% were also declared and paid during each of the years ended
December 31, 2001, 2000 and 1999. The Company has paid a cash dividend at least
once every year since 1970. Future dividends will depend on the Company's
earnings, financial condition and other factors which the Board of Directors of
the Company considers to be relevant.
25
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial data regarding the
Company's results of operations and financial position for, and as of the end
of, each of the fiscal years in the five-year period ended December 31, 2001.
This information should be read in conjunction with "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations," as
set forth in this report.
<Table>
<Caption>
As of and For the Years Ended December 31,
----------------------------------------------------------------
2001 2000 1999 1998 1997
----------- ----------- ----------- ----------- -----------
(in thousands, except per share data)
Investment Securities............................ $ 158,818 $ 161,285 $ 182,452 $ 132,794 $ 71,835
=========== =========== =========== =========== ===========
Mortgage-backed and Related Securities........... $ 454,078 $ 412,247 $ 347,574 $ 341,004 $ 141,413
=========== =========== =========== =========== ===========
Loans, Net of Reserve for Loan Loss.............. $ 531,972 $ 476,402 $ 382,871 $ 316,159 $ 292,665
=========== =========== =========== =========== ===========
Total Assets..................................... $ 1,276,737 $ 1,151,881 $ 1,012,565 $ 876,329 $ 571,189
=========== =========== =========== =========== ===========
Deposits......................................... $ 757,954 $ 720,605 $ 587,544 $ 515,034 $ 462,674
=========== =========== =========== =========== ===========
Long-term Obligations............................ $ 297,663 $ 216,595 $ 194,704 $ 176,027 $ 28,547
=========== =========== =========== =========== ===========
Interest & Deposit Service Income................ $ 87,559 $ 83,463 $ 67,468 $ 49,030 $ 39,168
=========== =========== =========== =========== ===========
Net Income....................................... $ 11,731 $ 9,825 $ 7,924 $ 5,351 $ 5,006
=========== =========== =========== =========== ===========
Net Income Per Common Share-Basic................ $ 1.49 $ 1.23 $ 0.98 $ 0.66 $ 0.61
=========== =========== =========== =========== ===========
Net Income Per Common Share-Diluted.............. $ 1.26 $ 1.18 $ 0.95 $ 0.63 $ 0.59
=========== =========== =========== =========== ===========
Cash Dividends Declared Per Common Share......... $ 0.25 $ 0.225 $ 0.20 $ 0.20 $ 0.20
=========== =========== =========== =========== ===========
</Table>
26
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis provides a comparison of the
Company's results of operations for the years ended December 31, 2001, 2000 and
1999 and financial condition as of December 31, 2001 and 2000. This discussion
should be read in conjunction with the financial statements and related notes.
All share data has been adjusted to give retroactive recognition to stock splits
and stock dividends.
CRITICAL ACCOUNTING POLICIES
The Company has established various accounting policies which govern the
application of accounting principles generally accepted in the United States in
the preparation of the Company's financial statements. The significant
accounting policies of the Company are described in the footnotes to the
consolidated financial statements. Certain accounting policies involve
significant judgements and assumptions by management which have a material
impact on the carrying value of certain assets and liabilities; management
considers such accounting policies to be critical accounting policies. The
judgements and assumptions used by management are based on historical experience
and other factors, which are believed to be reasonable under the circumstances.
Because of the nature of the judgements and assumptions made by management,
actual results could differ from these judgements and estimates which could have
a material impact on the carrying values of assets and liabilities and the
results of operations of the Company.
The Company believes the allowance for loan losses is a critical
accounting policy that requires the most significant judgements and estimates
used in preparation of its consolidated financial statements. Refer to Item 1
entitled Loan Loss Experience and Reserve for Loan Loss and Notes to Financial
Statements No. 1, Summary of Significant Accounting and Reporting Policies for a
detailed description of the Company's estimation process and methodology related
to the allowance for loan losses.
FORWARD-LOOKING INFORMATION
Certain statements of other than historical fact that are contained in
this document and in written material, press releases and oral statements issued
by or on behalf of the Company may be considered to be "forward-looking
statements" as that term is defined in the Private Securities Litigation Reform
Act of 1995. These statements may include words such as "expect," "estimate,"
"project," "anticipate," "should," "intend," "probability," "risk," "target,"
"objective" and similar expressions. Forward-looking statements are subject to
significant risks and uncertainties and the Company's actual results may differ
materially from the results discussed in the forward-looking statements. For
example, certain market risk disclosures are dependent on choices about key
model characteristics and assumptions and are subject to various limitations.
See "Item 1 - Business" and "Item 7 - Management's Discussion and Analysis of
Financial Condition and Results of Operations." By their nature, certain of the
market risk disclosures are only estimates and could be materially different
from what actually occurs in the future. As a result, actual income gains and
losses could materially differ from those that have been estimated. Other
factors that could cause actual results to differ materially from
forward-looking statements include, but are not limited to general economic
conditions, either nationally or in the State of Texas, legislation or
regulatory changes which adversely affect the businesses in which the Company is
engaged, changes in the interest rate environment which reduce interest margins,
significant increases in competition in the banking and financial services
industry, changes in consumer spending, borrowing and saving habits,
technological changes, the Company's ability to increase market share and
control expenses, the effect of compliance with legislation or regulatory
changes, the effect of changes in accounting policies and practices and the
costs and effects of unanticipated litigation.
27
FINANCIAL CONDITION
Total assets increased $124.9 million or 10.8% to $1.3 billion at
December 31, 2001 from $1.2 billion at December 31, 2000. The increase was
primarily attributable to a $55.6 million increase in net loans and a $40.4
million increase in the securities portfolio. The securities portfolio totaled
$634.2 million at December 31, 2001 compared to $593.8 million at December 31,
2000. At December 31, 2001, net loans were $532.0 million compared to $476.4
million at December 31, 2000. The increase in loans and securities was funded
primarily by FHLB Dallas advances and deposits.
Nonperforming assets at December 31, 2001 totaled $2.4 million,
representing 0.19% of total assets, compared to $2.5 million or 0.22% of total
assets at December 31, 2000. Nonaccruing loans increased to $896,000 and the
ratio of nonaccruing loans to total loans increased to 0.17% at December 31,
2001 as compared to $630,000 and 0.13% at December 31, 2000. Other real estate
owned increased to $65,000 at December 31, 2001 from $43,000 at December 31,
2000. Loans 90 days past due at December 31, 2001 totaled $945,000 compared to
$1.2 million at December 31, 2000, a decrease of $274,000. Restructured loans at
December 31, 2001 totaled $283,000 compared to $389,000 at December 31, 2000, a
decrease of $106,000.
Deposits increased $37.3 million to $758.0 million at December 31, 2001
from $720.6 million at December 31, 2000. FHLB Dallas advances were $374.9
million at December 31, 2000, a $46.3 million increase from $328.6 million at
December 31, 2000. Short-term FHLB Dallas advances decreased $34.8 million to
$114.2 million at December 31, 2001 from $148.9 million at December 31, 2000.
Long-term FHLB Dallas advances increased $81.1 million to $260.7 million at
December 31, 2001 from $179.6 million at December 31, 2000. Other borrowings at
December 31, 2001 and 2000 totaled $65.4 million and $44.3 million,
respectively, and at December 31, 2001 consisted of $28.4 million short-term
borrowings, $17.0 million of Long-term Junior Subordinated Convertible
Debentures and $20.0 million of Long-term Junior Subordinated Debentures.
On November 2, 2000, the Company through its wholly-owned subsidiary,
Southside Capital Trust II (the "Trust II Issuer"), sold 1,695,000 cumulative
convertible preferred securities (the "junior subordinated convertible
debentures") at a liquidation amount of $10 per convertible preferred security
for an aggregate amount of $16,950,000. These securities have a convertible
feature that allows the owner to convert each security to a share of the
Company's common stock at a conversion price of $9.52 per common share. These
securities have a distribution rate of 8.75% per annum payable at the end of
each calendar quarter.
On May 18, 1998, the Company through its wholly-owned subsidiary,
Southside Capital Trust (the "Trust Issuer"), sold 2,000,000 preferred
securities (the "junior subordinated debentures") at a liquidation amount of $10
per preferred security for an aggregate amount of $20,000,000. These securities
have a distribution rate of 8.50% per annum payable at the end of each calendar
quarter.
Shareholders' equity at December 31, 2001 totaled $68.6 million compared
to $51.7 million at December 31, 2000. The increase primarily reflects the net
income recorded for the year ended December 31, 2001 and an increase in the
accumulated other comprehensive income of $9.2 million, partially offset by the
repurchase of 314,025 shares of the outstanding stock at an average price of
$10.04 per share and the payment of cash dividends.
During 2001 the economy in the Bank's trade territory has shown some
signs of slowing but appears stable. The two areas of concern are the nationwide
economic slowdown or recession and the personal bankruptcy rate. Management
expects these trends to have some effect on the Company's net charge-offs.
Management of the Company, however, cannot predict whether current economic
conditions will improve, remain the same or decline.
28
LEVERAGE STRATEGY
In May 1998 the Company implemented a leverage strategy designed to
enhance its profitability with acceptable levels of credit, interest rate and
liquidity risk. The leverage strategy consists of borrowing long and short-term
funds from the Federal Home Loan Bank and investing the funds primarily in
mortgage-backed securities, and to a lesser extent, long-term municipal
securities. Although mortgage-backed securities often carry lower yields than
traditional mortgage loans and other types of loans the Company makes, these
securities generally increase the overall quality of the Company's assets by
virtue of the securities' underlying insurance or guarantees, are more liquid
than individual loans and may be used to collateralize the Company's borrowings
or other obligations. While the strategy of investing a substantial portion of
the Company's assets in mortgage-backed and municipal securities has resulted in
lower interest rate spreads and margins, the Company believes that the lower
operating expenses and reduced credit and interest rate risk of this strategy
have enhanced its overall profitability.
The Company will attempt to adopt a balance sheet strategy going forward
to gradually reduce the securities portfolio as a percentage of earning assets.
On the liability side, the Company will attempt to gradually reduce Federal Home
Loan Bank borrowings as a percentage of total deposits. The intended net result
is to increase the Company's net interest spread. The leverage strategy is
dynamic and requires ongoing management. As interest rates, funding costs and
security spreads change, the Company's determination of the proper securities to
own and funding to obtain must be re-evaluated. Management has attempted to
design the leverage strategy so that in a rising interest rate environment the
interest income earned on the premium mortgage-backed securities may increase to
help offset the increase in funding costs. As interest rates decrease the
interest income on the premium mortgage-backed securities may decrease due to
increased prepayments on these securities as funding costs decrease. Due to the
unpredictable nature of mortgage-backed securities prepayments and the slope of
the interest rate yield curve, net interest income could fluctuate more than
simulated under ALCO scenarios modeled.
RESULTS OF OPERATIONS
The Company's results of operations are dependent primarily on net
interest income, which is the difference between the income earned on its loan,
securities and investment portfolios and its cost of funds, consisting of the
interest paid on deposits and borrowings. Results of operations are also
affected by the Company's noninterest income, provision for loan losses and
noninterest expenses. General economic and competitive conditions, particularly
changes in interest rates, government policies and actions of regulatory
authorities, also significantly affect the Company's results of operations.
Future changes in applicable law, regulations or government policies may also
have a material impact on the Company.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDING DECEMBER 31, 2001 COMPARED
TO DECEMBER 31, 2000
OVERVIEW
During the year ended December 31, 2001, the Company's net income
increased $1.9 million or 19.4% to $11.7 million, from $9.8 million for the same
period in 2000. The increase in net income was primarily attributable to an
increase in noninterest income and net interest income due to the increase in
earning assets. Noninterest income increased primarily due to the gain on
securities available for sale and increases in deposit services income. These
increases were partially offset by an increase in noninterest expense, provision
for loan losses and the cumulative effect of change in accounting principle due
to the implementation of FAS 133 in 2001. The majority of the increase in
noninterest expense was a result of bank growth and the costs associated with
the opening of several new branches. Earnings per share of $1.26 represented an
increase of $0.08 or 6.8% over the year ended December 31, 2000.
NET INTEREST INCOME
Net interest income is the principal source of a financial institution's
earnings stream and represents the difference or spread between interest and fee
income generated from interest earning assets and the interest expense paid on
deposits and borrowed funds. Fluctuations in interest rates as well as volume
and mix changes in interest earning assets and interest bearing liabilities
materially impact net interest income.
29
Net interest income for the year ended December 31, 2001 was $30.6
million, an increase of $1.3 million or 4.6% compared to the same period in
2000. Average interest earning assets increased $145.0 million or 14.5%, while
the net yield on average earning assets decreased from 3.22% at December 31,
2000 to 2.96% at December 31, 2001. As interest rates decreased during 2001, the
Company's premium mortgage-backed securities decreased in yield as prepayment
speeds increased. This decrease in yield, along with the decrease in the yield
on average loans, combined to decrease the net yield on average earning assets.
During the year ended December 31, 2001, average loans, funded by the
growth in average deposits, increased $75.9 million or 17.5%, compared to the
same period in 2000. The average yield on loans decreased from 8.45% at December
31, 2000 to 8.17% at December 31, 2001, reflective of an overall decrease in
interest rates. The increase in interest income on loans of $4.5 million or
12.3% was the result of the increase in average loans.
Average investment and mortgage-backed securities increased $68.3 million
or 12.6% for the year ended December 31, 2001 when compared to the same period
in 2000. This increase was primarily a result of increasing the Company's
leverage strategy to offset interest expense associated with the convertible
preferred securities issued in November 2000. The overall yield on average
securities decreased to 6.36% during the year ended December 31, 2001 from 7.35%
during the same period in 2000, due in part to increased prepayment speeds on
mortgage-backed securities which led to increased amortization expense. The
repositioning of the securities portfolio in an attempt to lower duration also
decreased the overall yield on the securities portfolio. Interest income on
investment and mortgage-backed securities decreased $910,000 in 2001 or 2.4%
compared to 2000 due to the decrease in the average yield of securities during
2001, which more than offset the increase in the average balance.
Interest income from marketable equity securities, federal funds and
other interest earning assets decreased $789,000 or 44.0% for the year ended
December 31, 2001 when compared to 2000 as a result of lower rates in 2001 and a
special dividend of $304,000 in 2000 on the Company's FHLB Dallas stock which
more than offset the average balance increase of 3.1%.
During the year ended December 31, 2001, the mix of the Company's
interest earning assets reflected an increase in loans compared to the prior
year end as loans averaged 44.6% of total average interest earning assets
compared to 43.5% during 2000, a direct result of significant loan growth.
Securities averaged 55.1% of the total and other interest earning asset
categories averaged 0.3% for December 31, 2001. During 2000 the comparable mix
was 56.1% in securities and 0.4% in the other interest earning asset categories.
Total interest expense increased $1.4 million or 3.1% to $47.6 million
during the year ended December 31, 2001 as compared to $46.1 million during the
same period in 2000. The increase was attributable to an increase in average
interest bearing liabilities of $110.5 million or 12.8%. Average interest
bearing deposits increased $58.3 million or 11.8% while the average rate paid
decreased from 4.81% at December 31, 2000 to 4.49% at December 31, 2001. Average
time deposits increased $40.5 million or 13.2% while the average rate paid
decreased 29 basis points. Average interest bearing demand deposits increased
$13.6 million or 8.2% and average savings deposits increased $4.2 million or
18.8%. Average noninterest bearing demand deposits increased during 2001 $20.9
million or 14.4%. The latter three categories, which are considered the lowest
cost deposits, comprised 51.7% of total average deposits during the year ended
December 31, 2001 compared to 52.0% during 2000 and 56.6% during 1999. The
increase in average total deposits is reflective of overall bank growth and
branch expansion.
During the second quarter ended June 30, 2000, the Company issued $54.6
million of long-term brokered CDs with one-year call options and additional call
options every six months thereafter, until the CDs mature. The average yield on
these CDs was 8.19% with an average life of 10.8 years. Obtaining this long-term
funding enabled the Bank to take advantage of the higher interest rate
environment, primarily through the purchase of securities without incurring
significant additional interest rate risk. The higher cost associated with these
callable CDs had a negative impact on net interest spread during the five
quarters ended June 30, 2001. The options associated with these CDs provided the
bank with valuable balance sheet opportunities. In conjunction with the issuance
of these long-term brokered CDs, securities were purchased with an overall
duration and yield approximately that of the brokered CDs.
30
During March 2001, the Company notified CD holders that $24.6 million of
brokered CDs were being called April 12, 2001. The Company recorded $195,000 of
additional interest expense associated with the call of the CDs during the first
quarter ended March 31, 2001. Gains on sales of securities were used to offset
this expense. During April 2001, the Company notified CD holders that the
remaining $30.0 million of brokered CDs would be called May 24, 2001. An
additional $357,000 of expense was incurred during the second quarter ending
June 30, 2001, associated with the call of the brokered CDs. These CDs were
replaced with long-term advances from the FHLB at an average rate of
approximately 5.40% and an average life of approximately 4.9 years. As a result,
the Company's interest expense on this $54.6 million declined after the CDs were
called.
During the second quarter ended June 30, 2000, the bank introduced a new
Platinum Money Market Deposit Account. This account pays a higher rate on larger
deposit balances than the bank's other money market account. As deposits shift
to the new money market account, the higher interest cost associated with this
change will have a negative impact on net interest margin. The bank hopes to
attract new deposits due to the competitive rate of this account. While the
interest rate on this account is higher than the Company's previous money market
account, the interest rate is comparable to short-term borrowings from the FHLB.
The following table sets forth the Company's deposit averages by category
for the years ended December 31, 2001, 2000 and 1999:
<Table>
<Caption>
COMPOSITION OF DEPOSITS
Years Ended December 31,
------------------------------------------------------
2001 2000 1999
---------------- ---------------- ----------------
(dollars in thousands)
AVG. AVG. AVG. AVG. AVG. AVG.
BALANCE YIELD BALANCE YIELD BALANCE YIELD
--------- ----- --------- ----- --------- -----
Noninterest Bearing Demand Deposits.............. $ 166,828 N/A $ 145,883 N/A $ 137,499 N/A
Interest Bearing Demand Deposits................. 179,438 2.54% 165,790 2.99% 147,878 2.83%
Savings Deposits................................. 26,380 2.35% 22,207 2.57% 19,272 2.56%
Time Deposits.................................... 348,190 5.66% 307,663 5.95% 233,354 5.08%
--------- --------- ---------
Total Deposits.............................. $ 720,836 3.45% $ 641,543 3.72% $ 538,003 3.08%
========= ========= =========
</Table>
Average short-term interest bearing liabilities, consisting primarily of
FHLB Dallas advances and federal funds purchased, were $170.2 million, an
increase of $9.0 million or 5.6% for the year ended December 31, 2001 when
compared to the same period in 2000. Average long-term interest bearing
liabilities consisting of FHLB Dallas advances increased $28.7 million or 15.3%
during the year ended December 31, 2001 as compared to $187.0 million at
December 31, 2000. The long-term advances were obtained from the FHLB Dallas
primarily to replace long-term brokered CDs called during the second quarter
ended June 30, 2001. FHLB Dallas advances are collateralized by FHLB Dallas
stock, securities and nonspecific real estate loans.
Average long-term junior subordinated convertible debentures were $17.0
million for the year ended December 31, 2001 compared to $2.4 million for the
same period in 2000. The increase is a result of the sale of 1,695,000
Convertible Preferred Securities on November 2, 2000 at a liquidation amount of
$10 per Convertible Preferred Security for an aggregate amount of $16,950,000.
These securities have a distribution rate of 8.75% per annum payable at the end
of each calendar quarter.
Average long term junior subordinated debentures remained the same at $20
million from December 31, 2000 to December 31, 2001.
Average long-term and short-term interest bearing liabilities other than
deposits increased $52.2 million or 14.1%, a direct result of replacing the
long-term brokered CDs called during the second quarter ended June 30, 2001 with
long-term FHLB Dallas advances. This increase contributed to the higher interest
expense in 2001, as well as providing the primary source of funding for the
increase in average investment, mortgage-backed and marketable equity
securities.
31
RESULTS OF OPERATIONS
The following table presents average balance sheet amounts and average
yields for the years ended December 31, 2001, 2000 and 1999. The information
should be reviewed in conjunction with the other financial statements. Two major
components affecting the Company's earnings are the interest earning assets and
interest bearing liabilities. A summary of average interest earning assets and
interest bearing liabilities is set forth below, together with the average yield
on the interest earning assets and the average cost of the interest bearing
liabilities.
<Table>
<Caption>
AVERAGE BALANCES AND YIELDS
(dollars in thousands)
Years Ended
------------------------------------------------------------------------------------------------
December 31, 2001 December 31, 2000 December 31, 1999
------------------------------ ------------------------------ ------------------------------
AVG. AVG. AVG. AVG. AVG. AVG.
ASSETS BALANCE INTEREST YIELD BALANCE INTEREST YIELD BALANCE INTEREST YIELD
- ------ ----------- -------- ----- ----------- -------- ----- ----------- -------- -----
INTEREST EARNING ASSETS:
Loans(1)(2) ..................... $ 510,468 $ 41,693 8.17% $ 434,559 $ 36,733 8.45% $ 341,466 $ 28,290 8.28%
Securities:
Inv. Sec. (Taxable)(4) .......... 37,585 2,062 5.49% 77,971 5,446 6.98% 73,806 4,391 5.95%
Inv. Sec. (Tax-Exempt)(3)(4) .... 96,283 7,193 7.47% 88,462 7,147 8.08% 91,084 6,756 7.42%
Mortgage-backed Sec.(4) ......... 475,443 29,507 6.21% 374,531 27,155 7.25% 358,258 22,080 6.16%
Marketable Equity Sec ........... 20,746 854 4.12% 19,351 1,553 8.03% 17,180 911 5.30%
Interest Earning Deposits ....... 977 58 5.94% 964 65 6.74% 2,936 175 5.96%
Federal Funds Sold .............. 2,145 93 4.34% 2,838 176 6.20% 4,914 247 5.03%
----------- -------- ----------- -------- ----------- --------
Total Interest Earning Assets ... 1,143,647 81,460 7.12% 998,676 78,275 7.84% 889,644 62,850 7.06%
-------- -------- --------
NONINTEREST EARNING ASSETS:
Cash and Due From Banks ......... 32,849 31,621 29,548
Bank Premises and Equipment ..... 25,552 21,952 19,891
Other Assets .................... 24,320 17,815 11,961
Less: Reserve for Loan Loss .. (5,572) (4,944) (4,040)
----------- ----------- -----------
Total Assets .................... $ 1,220,796 $ 1,065,120 $ 947,004
=========== =========== ===========
LIABILITIES AND SHAREHOLDERS'
EQUITY:
INTEREST BEARING LIABILITIES:
Savings Deposits ............... $ 26,380 621 2.35% $ 22,207 570 2.57% $ 19,272 493 2.56%
Time Deposits .................. 348,190 19,714 5.66% 307,663 18,307 5.95% 233,354 11,866 5.08%
Interest Bearing
Demand Deposits ............. 179,438 4,557 2.54% 165,790 4,958 2.99% 147,878 4,186 2.83%
Short-term Interest
Bearing Liabilities ......... 170,184 7,302 4.29% 161,162 10,177 6.31% 162,287 8,535 5.26%
Long-term Interest Bearing
Liabilities-FHLB Dallas ..... 215,674 12,186 5.65% 187,011 10,211 5.46% 175,028 9,236 5.28%
Long-term Junior Subordinated
Convertible Debentures ...... 16,950 1,483 8.75% 2,447 214 8.75% -- --
Long-term Junior
Subordinated Debentures ..... 20,000 1,700 8.50% 20,000 1,700 8.50% 20,000 1,700 8.50%
----------- -------- ----------- -------- ----------- --------
Total Interest Bearing
Liabilities ................. 976,816 47,563 4.87% 866,280 46,137 5.33% 757,819 36,016 4.75%
-------- -------- --------
NONINTEREST BEARING LIABILITIES:
Demand Deposits ................. 166,828 145,883 137,499
Other Liabilities ............... 14,400 10,480 9,956
----------- ----------- -----------
Total Liabilities ............... 1,158,044 1,022,643 905,274
SHAREHOLDERS' EQUITY ............ 62,752 42,477 41,730
----------- ----------- -----------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY ........... $ 1,220,796 $ 1,065,120 $ 947,004
=========== =========== ===========
NET INTEREST INCOME ............. $ 33,897 $ 32,138 $ 26,834
======== ======== ========
NET YIELD ON AVERAGE
EARNING ASSETS ................... 2.96% 3.22% 3.02%
===== ===== =====
</Table>
(1) Loans are shown net of unearned discount. Interest on loans includes
fees on loans which are not material in amount.
(2) Interest income includes taxable-equivalent adjustments of $991, $494
and $92 as of December 31, 2001, 2000 and 1999, respectively.
(3) Interest income includes taxable-equivalent adjustments of $2,287,
$2,363 and $2,070 as of December 31, 2001, 2000 and 1999, respectively.
(4) For the purpose of calculating the average yield, the average balance of
securities is presented at historical cost.
Note: For the years ended December 31, 2001, 2000 and 1999, loans totaling
$896, $630 and $703, respectively, were on nonaccrual status. The policy
is to reverse previously accrued but unpaid interest on nonaccrual
loans; thereafter, interest income is recorded to the extent received
when appropriate.
32
ANALYSIS OF CHANGES IN INTEREST INCOME AND INTEREST EXPENSE
The following tables set forth the dollar amount of increase (decrease)
in interest income and interest expense resulting from changes in the volume of
interest earning assets and interest bearing liabilities and from changes in
yields (in thousands):
<Table>
<Caption>
Years Ended December 31,
2001 Compared to 2000
----------------------------------------
Average Average Increase
Volume Yield (Decrease)
------------ ----------- -----------
INTEREST INCOME:
Loans (1)........................................................... $ 6,235 $ (1,275) $ 4,960
Investment Securities (Taxable)..................................... (2,393) (991) (3,384)
Investment Securities (Tax-Exempt) (1).............................. 606 (560) 46
Mortgage-backed Securities.......................................... 6,630 (4,278) 2,352
Marketable Equity Securities........................................ 105 (804) (699)
Federal Funds Sold.................................................. (37) (46) (83)
Interest Earning Deposits........................................... 1 (8) (7)
------------ ----------- -----------
Total Interest Income............................................ 11,147 (7,962) 3,185
------------ ----------- -----------
INTEREST EXPENSE:
Savings Deposits.................................................... 101 (50) 51
Time Deposits....................................................... 2,326 (919) 1,407
Interest Bearing Demand Deposits.................................... 386 (787) (401)
Federal Funds Purchased and Other
Interest Bearing Liabilities..................................... 543 (3,418) (2,875)
FHLB Dallas Advances................................................ 1,609 366 1,975
Long-term Junior Subordinated Convertible Debentures................ 1,269 -- 1,269
------------ ----------- -----------
Total Interest Expense........................................... 6,234 (4,808) 1,426
------------ ----------- -----------
Net Interest Earnings............................................... $ 4,913 $ (3,154) $ 1,759
============ =========== ===========
</Table>
<Table>
<Caption>
Years Ended December 31,
2000 Compared to 1999
----------------------------------------
Average Average Increase
Volume Yield (Decrease)
------------ ----------- -----------
INTEREST INCOME:
Loans (1)........................................................... $ 7,858 $ 585 $ 8,443
Investment Securities (Taxable)..................................... 258 797 1,055
Investment Securities (Tax-Exempt) (1).............................. (199) 590 391
Mortgage-backed Securities.......................................... 1,039 4,036 5,075
Marketable Equity Securities........................................ 127 515 642
Federal Funds Sold.................................................. (120) 49 (71)
Interest Earning Deposits........................................... (130) 20 (110)
------------ ----------- -----------
Total Interest Income............................................ 8,833 6,592 15,425
------------ ----------- -----------
INTEREST EXPENSE:
Savings Deposits.................................................... 75 2 77
Time Deposits....................................................... 4,198 2,243 6,441
Interest Bearing Demand Deposits.................................... 527 245 772
Federal Funds Purchased and Other
Interest Bearing Liabilities..................................... (60) 1,702 1,642
FHLB Dallas Advances................................................ 647 328 975
Long-term Junior Subordinated Convertible Debentures................ 214 -- 214
------------ ----------- -----------
Total Interest Expense........................................... 5,601 4,520 10,121
------------ ----------- -----------
Net Interest Earnings............................................... $ 3,232 $ 2,072 $ 5,304
============ =========== ===========
</Table>
(1) Interest yields on loans and securities which are nontaxable for
Federal Income Tax purposes are presented on a taxable equivalent
basis.
NOTE: Volume/Yield variances (change in volume times change in yield) have
been allocated to amounts attributable to changes in volumes and to changes
in yields in proportion to the amounts directly attributable to those
changes.
33
PROVISION FOR LOAN LOSSES
The provision for loan losses for the period ended December 31, 2001 was
$1.7 million compared to $1.6 million for December 31, 2000. For the year ended
December 31, 2001, the Company's subsidiary, Southside Bank, had net charge-offs
of loans of $774,000, a decrease of 30.3% compared to December 31, 2000. For the
year ended December 31, 2000, net charge-offs on loans were $1.1 million.
The decrease in net charge-offs for 2001 is reflective of the decrease in
charge-offs and the increase in recoveries. Net charge-offs for commercial loans
decreased $428,000 from December 31, 2000 more than offsetting the increase in
net charge-offs for loans to individuals of $81,000 from December 31, 2000.
As of December 31, 2001, the Company's review of the loan portfolio
indicates that a loan loss reserve of $5.9 million is adequate.
NONINTEREST INCOME
Noninterest income consists of revenues generated from a broad range of
financial services and activities including fee based services. The following
schedule lists the accounts from which noninterest income was derived, gives
totals for these accounts for the year ended December 31, 2001 and the
comparable year ended December 31, 2000 and indicates the percentage changes:
<Table>
<Caption>
Years Ended
December 31,
--------------------------- Percent
2001 2000 Change
------------ ------------ --------
(dollars in thousands)
Deposit services.................................................. $ 9,377 $ 8,045 16.6%
Gains (losses) on sales of securities available for sale.......... 4,073 (535) 861.3%
Trust income...................................................... 961 726 32.4%
Other............................................................. 2,305 1,991 15.8%
------------ ------------
Total noninterest income.......................................... $ 16,716 $ 10,227 63.4%
============ ============
</Table>
Total noninterest income for the year ended December 31, 2001 increased
63.4% or $6.5 million compared to 2000. Securities gains increased $4.6 million
or 861.3% from 2000. Of the $4.1 million in net securities gains from the AFS
portfolio in 2001, there were $2.1 million in realized losses and $6.2 million
in realized gains. The Company sold securities out of its AFS portfolio to
accomplish Asset Liability Committee and investment portfolio objectives aimed
at repositioning and reducing the overall duration of the securities portfolio
and maximizing the total return of the securities portfolio. Sales of AFS
securities were the result of changes in economic conditions and a change in the
desired mix of the securities portfolio. During 2001, interest rates declined
and the yield curve steepened as short-term interest rates decreased
significantly more than long-term interest rates. The Company used this
interest-rate environment to reposition the securities portfolio in an attempt
to lower the overall duration. Several lower coupon, longer duration
mortgage-backed securities were replaced with higher coupon or shorter duration
mortgage-backed securities. Long duration U. S. Government agency securities
were replaced with long duration municipal securities. Specific municipal
securities with maturities greater than twenty years and larger blocks of
long-term municipal security zero coupon bonds were replaced with thirteen to
twenty year coupon municipal securities.
The increase in deposit services income of $1.3 million or 16.6% was a
result of the overdraft privilege program, increased numbers of deposit accounts
and increased deposit activity. Trust income increased $235,000 or 32.4% due to
growth in the Trust department. Other noninterest income increased $314,000 or
15.8% primarily as a result of increases in bank owned life insurance income and
an increase in mortgage servicing release fees income. During the fourth quarter
ended December 31, 2001, the Company purchased Bank Owned Life Insurance in the
amount of $15 million on all of its eligible Bank and Company officers at the
level of Vice President and above. The increase in cash surrender value is shown
as a component of noninterest income.
34
NONINTEREST EXPENSE
The following schedule lists the accounts which comprise noninterest
expense, gives totals for these accounts for the year ended December 31, 2001
and the comparable year ended December 31, 2000 and indicates the percentage
changes:
<Table>
<Caption>
Years Ended
December 31,
---------------------------- Percent
2001 2000 Change
------------ ------------ --------
(dollars in thousands)
Salaries and employee benefits.................................... $ 17,696 $ 15,165 16.7%
Net occupancy expense............................................. 3,358 2,947 13.9%
Equipment expense................................................. 734 659 11.4%
Advertising, travel and entertainment............................. 1,650 1,623 1.7%
Supplies.......................................................... 615 563 9.2%
Professional fees................................................. 617 545 13.2%
Other............................................................. 4,749 3,952 20.2%
------------ ------------
Total noninterest expense......................................... $ 29,419 $ 25,454 15.6%
============ ============
</Table>
Noninterest expense for the year ended December 31, 2001 increased $4.0
million or 15.6% when compared to the year ended December 31, 2000. Salaries and
employee benefits increased $2.5 million or 16.7% due to several factors. Direct
salary expense and payroll taxes increased $1.4 million or 10.9% as a result of
branch expansion, overall bank growth and pay increases. Retirement expense
increased $850,000 or 148.6% for the year ended December 31, 2001 due to
increased numbers of participants, actuarial assumptions and a lower return on
plan assets. Health and life insurance expense increased $282,000 or 15.8% for
the year ended December 31, 2001 due to increased health claims expense and
reinsurance costs.
Net occupancy expense increased $411,000 or 13.9% for the year ended
December 31, 2001 compared to the same period in 2000, largely due to higher
real estate taxes, depreciation expense and branch expansion.
Equipment expense increased $75,000 or 11.4% for the year ended December
31, 2001 when compared to 2000 due to additional locations. Supplies expense
increased $52,000 or 9.2% as a result of bank growth and branch expansion.
Professional fees increased $72,000 or 13.2% due to additional internal audit,
loan review and data processing related fees.
Other expense increased $797,000 or 20.2% during the year ended December
31, 2001 compared to 2000. The increase was due primarily to increases in dues
to directors, ATM fees, bank analysis fees, trust expense, and costs associated
with the Bank's website and online banking. Also, costs associated with the
Company's junior subordinated debentures increased.
INCOME TAXES
Income tax expense was $3.5 million for the year ended December 31, 2001
and represented an $864,000 or 32.5% increase from the year ended December 31,
2000. The effective tax rate as a percentage of pre-tax income was 21.7% in
2001, 21.3% in 2000 and 20.2% in 1999. The increase in the effective tax rate
and income tax expense for 2001 was primarily a result of higher taxable income.
35
DECEMBER 31, 2000 COMPARED TO DECEMBER 31, 1999
OVERVIEW
During the year ended December 31, 2000, the Company's net income
increased $1.9 million or 24.0% to $9.8 million, from $7.9 million for the same
period in 1999. The increase in net income was primarily attributable to an
increase in interest income due to a more favorable net interest spread and the
growth in earning assets. Noninterest income, not including gains or losses on
sales of securities, also grew due to deposit services income. These increases
were partially offset by an increase in noninterest expense and losses on sales
of securities. Earnings per share of $1.18 represented an increase of $0.23 or
24.2% over the year ended December 31, 1999.
NET INTEREST INCOME
Net interest income increased $4.6 million or 18.7% for the year ended
December 31, 2000 compared to the same period in 1999.
Interest income for the year ended December 31, 2000 increased $14.7
million or 24.3% to $75.4 million compared to the same period in 1999. The
increased interest income in 2000 was attributable to the increase in average
interest earning assets during the year.
Average interest earning assets, totaling $998.7 million at December 31,
2000, increased $109.0 million or 12.3% over December 31, 1999 primarily as a
result of increases in average loans and, to a lesser extent, average investment
and mortgage-backed securities. During the year ended December 31, 2000 the mix
of the Company's interest earning assets reflected an increase in loans compared
to the prior year end as loans averaged 43.5% of total average interest earning
assets compared to 38.4% during 1999, a direct result of significant loan
growth. Securities averaged 56.1% of the total and other interest earning asset
categories averaged 0.4% for December 31, 2000. During 1999 the comparable mix
was 60.7% in securities and 0.9% in the other interest earning asset categories.
The overall yield on investment, mortgage-backed and marketable equity
securities increased 105 basis points to 7.37% during 2000 compared to the same
period in 1999, due in part to decreased prepayment speeds on premium
mortgage-backed securities which led to decreased amortization expense, combined
with a restructuring of a portion of the securities portfolio into higher
yielding securities due to higher overall interest rates.
The average yield on average interest earning assets increased 78 basis
points during the year ended December 31, 2000 as compared to 1999 primarily as
a result of the increase in the average yield on loans and the increase in the
overall mix of earning assets with higher yielding securities. The average yield
on loans for the year ended December 31, 2000 increased to 8.45% from 8.28% for
the year ended December 31, 1999. This increase was reflective of an overall
increase in interest rates.
Interest income on loans increased $8.0 million or 28.5% compared to 1999
due to the increase in average loans and average yield on loans during 2000.
Interest income on securities increased $6.9 million in 2000 or 21.4%
compared to 1999 primarily due to the increase in the average securities and the
increase in the average yield on securities during 2000.
The increase in interest expense for the year ended December 31, 2000 of
$10.1 million or 28.1% was attributable to an increase in average interest
bearing liabilities of $108.5 million or 14.3% and an increase in the average
yield on interest bearing liabilities from 4.75% at December 31, 1999 to 5.33%
at December 31, 2000. Average interest bearing deposits increased $95.2 million
or 23.8% while the average rate paid increased from 4.13% at December 31, 1999
to 4.81% at December 31, 2000. Average time deposits increased $74.3 million or
31.8% while the average rate paid increased 87 basis points along with an
increase in average interest bearing demand deposits of $17.9 million or 12.1%
and an increase in average savings deposits of $2.9 million or 15.2%. Average
noninterest bearing demand deposits increased $8.4 million or 6.1% during 2000.
The latter three categories, which are considered the lowest cost deposits,
36
comprised 52.0% of total average deposits during the year ended December 31,
2000 compared to 56.6% during 1999 and 54.2% during 1998. The increase in
average total deposits is reflective of overall bank growth, brokered CD
issuance, branch expansion, and except for the brokered CDs issued, was the
primary source of funding the increase in average loans.
Average long-term junior subordinated convertible debentures were $2.4
million for the year ended December 31, 2000 compared to zero for the same
period in 1999. The increase is a result of the sale of 1,695,000 Convertible
Preferred Securities on November 2, 2000 at a liquidation amount of $10 per
Convertible Preferred Security for an aggregate amount of $16,950,000. These
securities have a distribution rate of 8.75% per annum payable at the end of
each calendar quarter. This increase in Average Long-term Junior Subordinated
Convertible Debentures contributed to the higher average rate paid in 2000 when
compared to 1999.
Average long term junior subordinated debentures remained the same at $20
million from December 31, 1999 to December 31, 2000.
Average long-term and short-term interest bearing liabilities other than
deposits increased $13.3 million or 3.7%, a direct result of the Company's
leverage strategy and ALCO objectives. This increase contributed to the higher
interest expense in 2000, as well as providing the primary source of funding for
the increase in average investment, mortgage-backed and marketable equity
securities.
PROVISION FOR LOAN LOSSES
The provision for loan losses at December 31, 2000 and 1999 was $1.6
million and $1.5 million, respectively. For the year ended December 31, 2000,
the Company's subsidiary, Southside Bank, had net charge-offs of loans of $1.1
million, an increase of 149.7% compared to December 31, 1999. For the year ended
December 31, 1999, net charge-offs on loans were $445,000.
The increase in net charge-offs for 2000 is reflective of the overall
growth in the Company's loan portfolio and the low level of net charge-offs for
1999. Net charge-offs for commercial loans and loans to individuals both
increased. As of December 31, 2000, the Company's review of the loan portfolio
indicated that a loan loss reserve of $5.0 million was adequate.
NONINTEREST INCOME
The following table sets forth the accounts from which noninterest income
was derived, gives totals for these accounts for the year ended December 31,
2000 and the comparable year ended December 31, 1999 and indicates the
percentage changes:
<Table>
<Caption>
Years Ended
December 31,
--------------------------- Percent
2000 1999 Change
------------ ------------ --------
(dollars in thousands)
Deposit services.............................................. $ 8,045 $ 6,780 18.7%
(Losses) gain on sales of securities available for sale....... (535) 149 (459.1%)
Trust income.................................................. 726 631 15.1%
Other......................................................... 1,991 1,672 19.1%
------------ ------------
Total Noninterest Income................................. $ 10,227 $ 9,232 10.8%
============ ============
</Table>
Total noninterest income for the year ended December 31, 2000 increased
10.8% or $1.0 million compared to 1999. Securities losses increased $684,000 or
459.1% from 1999. Of the $535,000 in net securities losses from the AFS
portfolio in 2000, there were $1.5 million in realized losses and $1.0 million
in realized gains. The Company sold securities out of its AFS portfolio to
accomplish Asset Liability Committee and investment portfolio objectives aimed
at maximizing the total return of the securities portfolio. Sales of AFS
securities were the result of changes in economic conditions and a change in the
mix of the securities portfolio. As rates increased during 2000, lower yielding
securities were sold and replaced with higher
37
yielding securities. The increase in deposit services income of $1.3 million or
18.7% was a result of the introduction of an overdraft privilege program in June
1997 and a free checking account program introduced during the first quarter of
1999, which increased overdraft fees, increased numbers of deposit accounts and
increased deposit activity. Trust income increased $95,000 or 15.1% due to
growth in the Trust department. Other noninterest income increased $319,000 or
19.1% primarily as a result of increases in credit card income, official check
fee income and other fee income.
NONINTEREST EXPENSE
The following schedule lists the accounts which comprise noninterest
expense, gives totals for these accounts for the year ended December 31, 2000
and the comparable year ended December 31, 1999 and indicates the percentage
changes:
<Table>
<Caption>
Years Ended
December 31,
---------------------------- Percent
2000 1999 Change
------------ ------------ --------
(dollars in thousands)
Salaries and employee benefits.................................... $ 15,165 $ 13,427 12.9%
Net occupancy expense............................................. 2,947 2,655 11.0%
Equipment expense................................................. 659 537 22.7%
Advertising, travel and entertainment............................. 1,623 1,322 22.8%
Supplies.......................................................... 563 494 14.0%
Professional fees................................................. 545 591 (7.8%)
Other............................................................. 3,952 3,498 13.0%
------------- ------------
Total noninterest expense......................................... $ 25,454 $ 22,524 13.0%
============= ============
</Table>
Noninterest expense for the year ended December 31, 2000 increased $2.9
million or 13.0% when compared to the year ended December 31, 1999. Salaries and
employee benefits increased $1.7 million or 12.9% due to several factors. Direct
salary expense and payroll taxes increased $1.5 million or 13.2% as a result of
overall bank growth and pay increases. Retirement expense decreased $189,000 or
25.3% for the year ended December 31, 2000 due to actuarial assumptions and a
higher return on plan assets. Deferred compensation expense decreased $198,000
or 93.9% due to changes in deferred compensation plans expensed during 1999.
Health and life insurance expense increased $634,000 or 55.5% for the year ended
December 31, 2000 due to increased health claims expense.
Net occupancy expense increased $292,000 or 11.0% for the year ended
December 31, 2000 compared to the same period in 1999, largely due to higher
real estate taxes and depreciation expense.
Equipment expense increased $122,000 or 22.7% for the year ended December
31, 2000 when compared to 1999 due to additional locations.
Advertising, travel and entertainment expense increased $301,000 or 22.8%
for the year ended December 31, 2000 compared to the same period in 1999 due to
an increased advertising budget and additional expenses associated with
additional locations and growth in assets.
Other expense increased $454,000 or 13.0% during the year ended December
31, 2000 compared to 1999. The increase was due primarily to ATM fees and
telephone expense due to added locations. In addition, bank exam and bank
analysis fees increased due to bank asset and transaction growth. Also, costs
associated with the Company's junior subordinated debentures increased.
INCOME TAXES
Income tax expense was $2.7 million for the year ended December 31, 2000
and represented a $660,000 or 33.0% increase from the year ended December 31,
1999. The effective tax rate as a percentage of pre-tax income was 21.3% in
2000, 20.2% in 1999 and 18.6% in 1998. The increase in the effective tax rate
and income tax expense for 2000 was primarily a result of higher taxable income.
38
MANAGEMENT OF LIQUIDITY
Liquidity management involves the ability to convert assets to cash with
a minimum of loss. The Company must be capable of meeting its obligations to its
customers at any time. This means addressing (1) the immediate cash withdrawal
requirements of depositors and other funds providers; (2) the funding
requirements of all lines and letters of credit; and (3) the short-term credit
needs of customers. Liquidity is provided by short-term investments that can be
readily liquidated with a minimum risk of loss.
Cash, Interest Earning Deposits, Federal Funds Sold and short-term
investments with maturities or repricing characteristics of one year or less
continue to be a substantial percentage of total assets. At December 31, 2001,
these investments were 20.1% of Total Assets, as compared with 15.5% for
December 31, 2000, and 13.0% for December 31, 1999. Liquidity is further
provided through the matching, by time period, of rate sensitive interest
earning assets with rate sensitive interest bearing liabilities. The Company has
three lines of credit for the purchase of federal funds. Two $15.0 million and
one $10.0 million unsecured lines of credit have been established with Bank of
America, Frost Bank and Texas Independent Bank, respectively.
The Asset/Liability Management Committee of the bank closely monitors
various liquidity ratios, interest rate spreads and margins, interest rate shock
reports and market value of portfolio equity with rates shocked plus and minus
200 basis points to ensure the Company a satisfactory liquidity position. Market
value of portfolio equity is defined as the net present value of an
institution's existing assets, liabilities and off-balance sheet instruments.
Market value of portfolio equity analysis is the general measure used by
regulatory authorities for assessing an institution's interest rate risk. The
extent to which assets will gain or lose value in relation to the gains or
losses of liabilities and/or interest rate contracts determines the appreciation
or depreciation in equity on a market-value basis. Such market value analysis is
intended to evaluate the impact of immediate and sustained parallel
interest-rate shifts of the current yield curve upon the market value of the
current balance sheet. In addition, the bank utilizes a simulation model to
determine the impact of net interest income under several different interest
rate scenarios. By utilizing this technology, the bank attempts to determine
changes that need to be made to the asset and liability mixes to minimize the
change in net interest income under these various interest rate scenarios.
39
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In the banking industry, a major risk exposure is changing interest
rates. The primary objective of monitoring the Company's interest rate
sensitivity, or risk, is to provide management the tools necessary to manage the
balance sheet to minimize adverse changes in net interest income as a result of
changes in the direction and level of interest rates. Federal Reserve Board
monetary control efforts, the effects of deregulation and legislative changes
have been significant factors affecting the task of managing interest rate
sensitivity positions in recent years.
The interest rate risk inherent in assets and liabilities may be
determined by analyzing the extent to which such assets and liabilities are
"interest rate sensitive" and by measuring an institution's interest rate
sensitivity "gap." An asset or liability is said to be interest rate sensitive
within a defined time period if it matures or reprices within that period. The
difference or mismatch between the amount of interest earning assets maturing or
repricing within a defined period and the amount of interest bearing liabilities
maturing or repricing within the same period is defined as the interest rate
sensitivity gap. An institution is considered to have a negative gap if the
amount of interest bearing liabilities maturing or repricing within a specified
time period exceeds the amount of interest earning assets maturing or repricing
within the same period. If more interest earning assets than interest bearing
liabilities mature or reprice within a specified period, then the institution is
considered to have a positive gap. Accordingly, in a rising interest rate
environment in an institution with a negative gap, the cost of its rate
sensitive liabilities would theoretically rise at a faster pace than the yield
on its rate sensitive assets, thereby diminishing future net interest income. In
a falling interest rate environment, a negative gap would indicate that the cost
of rate sensitive liabilities would decline at a faster pace than the yield on
rate sensitive assets and improve net interest income. For an institution with a
positive gap, the reverse would be expected. The table on page 43 shows interest
sensitivity gaps for four different intervals as of December 31, 2001.
In an attempt to manage its exposure to changes in interest rates,
management closely monitors the Company's exposure to interest rate risk.
Management maintains an asset/liability committee which meets regularly and
reviews the Company's interest rate risk position and makes recommendations for
adjusting this position. In addition, the Board reviews on a monthly basis the
Company's asset/liability position. The Company primarily uses two methods for
measuring and analyzing interest rate risk: Net income simulation analysis and
market value of portfolio equity modeling. Through these simulations the Company
attempts to estimate the impact on net interest income of a 200 basis point
parallel shift in the yield curve. Policy guidelines limit the estimated change
in net interest income to 10 percent of forecasted net income over the
succeeding 12 months and 200 basis point parallel rate shock. Policy guidelines
limit the change in market value of equity in a 200 basis point parallel rate
shock to 20 percent of the base case. The results of the valuation analysis as
of December 31, 2001, were within policy guidelines. This type of stimulation
analysis requires numerous assumptions including but not limited to changes in
balance sheet mix, prepayment assumptions and changes in spreads. Assumptions
are based on management's best estimates but may not accurately reflect actual
results under certain changes in interest rates.
40
The following table provides information about the Company's financial
instruments that are sensitive to changes in interest rates. Except for the
effects of prepayments and scheduled principal amortization, the table presents
principal cash flows and related weighted average interest rates by the
contractual term to maturity. Nonaccrual loans are not included in the Loan
totals. All instruments are classified as other than trading.
EXPECTED MATURITY DATE
(dollars in thousands)
<Table>
<Caption>
Years Ending December 31,
------------------------------------------------------------------------------------------------------------
Fair
2002 2003 2004 2005 2006 Thereafter Total Value
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
Fixed Rate Loans ...... $ 200,560 $ 93,718 $ 54,264 $ 33,117 $ 17,432 $ 51,352 $ 450,443 $ 465,546
8.06% 7.91% 7.67% 7.45% 7.28% 6.26% 7.70%
Adjustable Rate
Loans ................ 35,844 2,675 5,960 8,766 9,471 23,843 86,559 86,559
5.25% 5.44% 5.42% 5.35% 5.14% 5.72% 5.40%
Mortgage-backed
Securities ............ 157,184 103,217 67,538 44,011 28,543 53,585 454,078 454,078
5.78% 5.78% 5.78% 5.77% 5.77% 5.61% 5.76%
Investments and Other
Interest Earning
Assets ................ 43,233 11,852 387 1,693 1,043 122,639 180,847 180,847
2.49% 4.17% 7.70% 8.05% 7.22% 7.29% 5.95%
Total Interest
Earning Assets ........ $ 436,821 $ 211,462 $ 128,149 $ 87,587 $ 56,489 $ 251,419 $ 1,171,927 $ 1,187,030
6.46% 6.63% 6.57% 6.41% 6.16% 6.57% 6.51%
Savings Deposits ...... $ 2,963 $ 1,481 $ 1,481 $ 1,481 $ 1,481 $ 20,741 $ 29,628 $ 28,118
1.65% 1.65% 1.65% 1.65% 1.65% 1.65% 1.65%
NOW Deposits .......... 38,402 4,166 4,166 4,166 4,166 58,328 113,394 106,587
1.61% 1.00% 1.00% 1.00% 1.00% 1.00% 1.21%
Money Market
Deposits .............. 20,607 6,869 6,869 6,869 6,869 20,606 68,689 67,891
1.80% 1.77% 1.77% 1.77% 1.77% 1.77% 1.78%
Platinum Money
Market ................ 20,061 2,149 2,149 2,149 2,151 -- 28,659 28,966
1.96% 1.95% 1.95% 1.95% 1.95% -- 1.96%
Certificates of
Deposit ............... 255,205 48,256 19,985 10,786 11,200 350 345,782 352,691
3.86% 5.09% 4.87% 6.53% 5.16% 6.50% 4.22%
FHLB Dallas Advances .. 114,758 110,867 57,233 18,920 29,616 43,496 374,890 379,589
3.32% 4.88% 4.69% 5.55% 5.37% 6.15% 4.59%
Other Borrowings ...... 28,400 -- -- -- -- 36,950 65,350 65,350
1.86% -- -- -- -- 8.61% 5.68%
Total Interest
Bearing Liabilities ... $ 480,396 $ 173,788 $ 91,883 $ 44,371 $ 55,483 $ 180,471 $ 1,026,392 $ 1,029,192
3.25% 4.66% 4.23% 4.47% 4.32% 3.97% 3.81%
</Table>
41
Residential fixed rate loans are assumed to have annual prepayment
rates between 9% and 25% of the portfolio. Commercial and multi-family real
estate loans are assumed to prepay at an annualized rate between 10% and 39%.
Consumer loans are assumed to prepay at an annualized rate between 10% and 35%.
Fixed and adjustable rate mortgage-backed securities, including Collateralized
Mortgage Obligations ("CMOs") and Real Estate Mortgage Investment Conduits
("REMICs"), have annual payment assumptions ranging from 10% to 37%. At December
31, 2001, the contractual maturity of substantially all of the Company's
mortgage-backed or related securities was in excess of ten years. The actual
maturity of a mortgage-backed or related security is less than its stated
maturity due to regular principal payments and prepayments of the underlying
mortgages. Prepayments that are faster than anticipated may shorten the life of
the security and affect its yield to maturity. The yield to maturity is based
upon the interest income and the amortization of any premium or discount related
to the security. In accordance with generally accepted accounting principles,
premiums and discounts are amortized over the estimated lives of the loans,
which decrease and increase interest income, respectively. The prepayment
assumptions used to determine the amortization period for premiums and discounts
can significantly affect the yield of the mortgage-backed or related security,
and these assumptions are reviewed periodically to reflect actual prepayments.
Although prepayments of underlying mortgages depend on many factors, including
the type of mortgages, the coupon rate, the age of mortgages, the geographical
location of the underlying real estate collateralizing the mortgages and general
levels of market interest rates, the difference between the interest rates on
the underlying mortgages and the prevailing mortgage interest rates generally is
the most significant determinant of the rate of prepayments. During periods of
falling mortgage interest rates, if the coupon rate of the underlying mortgages
exceeds the prevailing market interest rates offered for mortgage loans,
refinancing may increase and accelerate the prepayment of the underlying
mortgages and the related security. At December 31, 2001, of the $454.1 million
of mortgage-backed and related securities held by the Company, an aggregate of
$449.9 million were secured by fixed-rate mortgage loans and an aggregate of
$4.2 million were secured by adjustable-rate mortgage loans.
The Company assumes 70% of savings accounts and transaction accounts at
December 31, 2001, are core deposits and are, therefore, expected to roll-off
after five years. The Company assumes 30% of Money Market accounts at December
31, 2001 are core deposits and are, therefore, expected to roll-off after five
years. The Company does not consider any of its Platinum Money Markets accounts
as core deposits. No roll-off rate is applied to certificates of deposit. Fixed
maturity deposits reprice at maturity.
In evaluating the Company's exposure to interest rate risk, certain
limitations inherent in the method of analysis presented in the foregoing table
must be considered. For example, although certain assets and liabilities may
have similar maturities or periods to repricing, they may react in different
degrees to changes in market interest rates. Also, the interest rates on certain
types of assets and liabilities may fluctuate in advance of changes in market
interest rates, while interest rates on other types may lag behind changes in
market rates. Additionally, certain assets, such as adjustable rate mortgages,
have features which restrict changes in interest rates, prepayment and early
withdrawal levels may deviate significantly from those assumed in calculating
the table. Finally, the ability of many borrowers to service their debt may
decrease in the event of an interest rate increase. The Company considers all of
these factors in monitoring its exposure to interest rate risk.
42
The following table sets forth certain information as of December 31,
2001 with respect to rate sensitive assets and liabilities and interest
sensitivity gap (dollars in thousands):
<Table>
<Caption>
1-3 Mos. 4-12 Mos. 1-5 Yrs. Over 5 Yrs. Total
------------ ------------ ------------ ------------ ------------
Rate Sensitive Assets (RSA)
Loans(1) ............................. $ 158,421 $ 128,698 $ 198,531 $ 51,352 $ 537,002
Securities ........................... 82,145 121,725 258,284 172,029 634,183
Other Interest Earning Assets ........ 742 -- -- -- 742
------------ ------------ ------------ ------------ ------------
Total Rate Sensitive Assets .......... $ 241,308 $ 250,423 $ 456,815 $ 223,381 $ 1,171,927
============ ============ ============ ============ ============
Rate Sensitive Liabilities (RSL)
Interest Bearing Deposits ............ $ 141,248 $ 195,990 $ 148,889 $ 100,025 $ 586,152
Other Interest Bearing Liabilities ... 100,505 42,653 216,636 80,446 440,240
------------ ------------ ------------ ------------ ------------
Total Rate Sensitive Liabilities ..... $ 241,753 $ 238,643 $ 365,525 $ 180,471 $ 1,026,392
============ ============ ============ ============ ============
Gap (2) .............................. (445) 11,780 91,290 42,910 145,535
Cumulative Gap ....................... (445) 11,335 102,625 145,535
Cumulative Ratio of RSA to RSL ....... 1.00 1.02 1.12 1.14 1.14
Gap/Total Earning Assets ............. (0.0%) 1.0% 7.8% 3.7% 12.4%
</Table>
================================================================================
(1) Amount is equal to total loans net of unearned discount less nonaccrual
loans at December 31, 2001.
(2) Gap equals Total RSA minus Total RSL.
The Asset Liability Management Committee of Southside Bank closely
monitors the desired gap along with various liquidity ratios to ensure a
satisfactory liquidity position for the Company. Management continually
evaluates the condition of the economy, the pattern of market interest rates and
other economic data to determine the types of investments that should be made
and at what maturities. Using this analysis, management from time to time
assumes calculated interest sensitivity gap positions to maximize net interest
income based upon anticipated movements in the general level of interest rates.
Regulatory authorities also monitor the Bank's gap position along with other
liquidity ratios. In addition, the Bank utilizes a simulation model to determine
the impact of net interest income under several different interest rate
scenarios. By utilizing this technology, the Bank can determine changes that
need to be made to the asset and liability mixes to minimize the change in net
interest income under these various interest rate scenarios.
43
CAPITAL RESOURCES
Total Shareholders' Equity at December 31, 2001 of $68.6 million
increased 32.7% or $16.9 million from December 31, 2000 and represented 5.4% of
total assets at December 31, 2001 compared to 4.5% at December 31, 2000. The
increase in the percent of Shareholders' Equity to Total Assets is a result of
the increase in the unrealized gains in the securities portfolio and the
increase in net income.
Net income for 2001 of $11.7 million was the major contributor to the
increase in Shareholders' Equity at December 31, 2001 along with the net
increase in unrealized gains of $9.2 million on AFS securities and the issuance
of $895,000 in common stock (143,856 shares) through the Company's dividend
reinvestment plan and incentive stock option plan. Decreases to Shareholders'
Equity consisted of $1.9 million in dividends paid and the purchase of $3.2
million in treasury stock (314,025 shares). The Company purchased treasury stock
pursuant to a common stock repurchase plan instituted in late 1994. Under the
repurchase plan, the Board of Directors establishes, on a quarterly basis, total
dollar limitations and price per share for stock to be repurchased. The Board
reviews this plan in conjunction with the capital needs of the Company and
Southside Bank and may, at its discretion, modify or discontinue the plan.
During the third quarter of 2001, the Company issued a 5% stock dividend, which
had no net effect on Shareholders' Equity. The Company's dividend policy
requires that any cash dividend payments made by the Company not exceed
consolidated earnings for that year. Shareholders should not anticipate a
continuation of the cash dividend simply because of the implementation of a
dividend reinvestment program. The payment of dividends will depend upon future
earnings, the financial condition of the Company, and other related factors.
The Bank is subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the Bank's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the Bank
must meet specific capital guidelines that involve quantitative measures of the
Bank's assets, liabilities, and certain off-balance-sheet items as calculated
under regulatory accounting practices. The Bank's capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital
adequacy require the Bank to maintain minimum amounts and ratios (set forth in
the table below) of Total and Tier 1 capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average
assets (as defined). Management believes, as of December 31, 2001, that the Bank
meets all capital adequacy requirements to which it is subject.
44
To be categorized as well capitalized, the Bank must maintain minimum
Total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in
the following table:
<Table>
<Caption>
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
-------------------------- -------------------------- --------------------------
Amount Ratio Amount Ratio Amount Ratio
------------ ------------ ------------ ------------ ------------ ------------
(dollars in thousands)
As of December 31, 2001:
Total Capital (to Risk Weighted Assets)
Consolidated ............................. $ 102,996 17.08% $ 48,245 8.00% N/A N/A
============ ============ ============ ============ ============ ============
Bank Only ................................ $ 96,676 16.03% $ 48,243 8.00% $ 60,304 10.00%
============ ============ ============ ============ ============ ============
Tier 1 Capital (to Risk Weighted Assets)
Consolidated ............................. $ 81,058 13.44% $ 24,122 4.00% N/A N/A
============ ============ ============ ============ ============ ============
Bank Only ................................ $ 90,862 15.07% $ 24,122 4.00% $ 36,182 6.00%
============ ============ ============ ============ ============ ============
Tier 1 Capital (to Average Assets) (1)
Consolidated ............................. $ 81,058 6.50% $ 49,858 4.00% N/A N/A
============ ============ ============ ============ ============ ============
Bank Only ................................ $ 90,862 7.29% $ 49,857 4.00% $ 62,321 5.00%
============ ============ ============ ============ ============ ============
As of December 31, 2000:
Total Capital (to Risk Weighted Assets)
Consolidated ............................. $ 94,817 16.63% $ 45,605 8.00% N/A N/A
============ ============ ============ ============ ============ ============
Bank Only ................................ $ 87,495 15.30% $ 45,741 8.00% $ 57,176 10.00%
============ ============ ============ ============ ============ ============
Tier 1 Capital (to Risk Weighted Assets)
Consolidated ............................. $ 71,169 12.48% $ 22,802 4.00% N/A N/A
============ ============ ============ ============ ============ ============
Bank Only ................................ $ 82,758 14.47% $ 22,870 4.00% $ 34,306 6.00%
============ ============ ============ ============ ============ ============
Tier 1 Capital (to Average Assets) (1)
Consolidated ............................. $ 71,169 6.31% $ 45,148 4.00% N/A N/A
============ ============ ============ ============ ============ ============
Bank Only ................................ $ 82,758 7.33% $ 45,176 4.00% $ 56,470 5.00%
============ ============ ============ ============ ============ ============
</Table>
(1) Refers to quarterly average assets as calculated by bank regulatory
agencies.
The table below summarizes key equity ratios for the Company for the
years ended December 31, 2001, 2000 and 1999.
<Table>
<Caption>
Years Ended December 31,
--------------------------------------
2001 2000 1999
---------- ---------- ----------
Percentage of Net Income to:
Average Total Assets ............................... .96% .92% .84%
Average Shareholders' Equity ....................... 18.69% 23.13% 18.99%
Percentage of Dividends Declared Per Common
Share to Net Income Per Common Share-Basic ......... 16.78% 18.29% 20.41%
Percentage of Dividends Declared Per Common
Share to Net Income Per Common Share-Diluted ....... 19.84% 19.07% 21.05%
Percentage of Average Shareholders'
Equity to Average Total Assets ..................... 5.14% 3.99% 4.41%
</Table>
45
ACCOUNTING CHANGES
On June 15, 1998, the Financial Accounting Standards Board (FASB)
issued Financial Accounting Standard No. 133, "Accounting for Derivative
Instruments and Hedging Activities" (FAS133). FAS133 and its amendments are
effective for all fiscal quarters of all fiscal years beginning after June 15,
2000. FAS133 requires that all derivative instruments be recorded on the balance
sheet at their fair value. Changes in the fair value of derivatives are recorded
each period in current earnings or other comprehensive income, depending on
whether a derivative is designated as part of a hedge transaction and, if it is,
the type of hedge transaction.
In June 2000, the Financial Accounting Standards Board issued Financial
Accounting Standard No. 138, "Accounting for Derivative Instruments and Hedging
Activities, an Amendment of Financial Accounting Standard No. 133," which
addresses a limited number of issues causing implementation difficulties for
numerous entities that apply Financial Accounting Standard No. 133, as amended.
Financial Accounting Standard No. 138 amends the accounting and reporting
standards of Financial Accounting Standard No. 133, as amended, for certain
derivative instruments, certain hedging activities and for decisions made by the
Financial Accounting Standards Board relating to the Derivatives Implementation
Group process.
On January 1, 2001, Southside adopted Financial Accounting Standard No.
133, "Accounting for Derivative Instruments and Hedging Activities," (FAS133).
As allowed by FAS133, at the date of initial application of this statement,
Southside transferred held to maturity securities into the available for sale
category and the trading category. Southside sold the securities transferred
into the trading category during the first quarter of 2001. The effect of
selling the securities in the trading category is shown as a cumulative effect
of a change in accounting principle and reduced net income by $994,000 (net of
taxes) during the first quarter of 2001. During 2001, Southside sold available
for sale securities which resulted in realized gains of $4.1 million or an after
tax gain of $2.7 million. These separate transactions allowed Southside to
reduce the overall duration of and reposition the securities portfolio.
In June 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 141 "Business Combinations" (FAS 141) and
Statement of Financial Accounting Standard No. 142 "Goodwill and Other
Intangible Assets" (FAS 142). FAS 141 requires all business combinations
initiated after June 30, 2001 to be accounted for using the purchase method.
Under FAS 142, goodwill and intangible assets with indefinite lives are no
longer amortized but are reviewed annually (or more frequently if impairment
indicators arise) for impairment. Separable intangible assets that are not
deemed to have indefinite lives will continue to be amortized over their useful
lives (but with no maximum life). The amortization provisions of FAS 142 apply
to goodwill and intangible assets acquired after June 30, 2001. With respect to
goodwill and intangible assets acquired prior to July 1, 2001, the Company is
required to adopt FAS 142 effective January 1, 2002. The adoption of this new
accounting pronouncement is not expected to have a material impact on the
Company's consolidated financial position or results of operations.
EFFECTS OF INFLATION
The consolidated financial statements of the Company, and their related
notes, have been prepared in accordance with generally accepted accounting
principles, that require the measurement of financial position and operating
results in terms of historical dollars, without considering the change in the
relative purchasing power of money over time and due to inflation. The impact of
inflation is reflected in the increased cost of the Company's operations. Unlike
many industrial companies, nearly all of the assets and liabilities of the
Company are monetary. As a result, interest rates have a greater impact on the
Company's performance than do the effects of general levels of inflation.
Interest rates do not necessarily move in the same direction or to the same
extent as the price of goods and services.
46
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item is set forth in Part IV.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Certain of the information required under this item appears
beginning on page 2 of the Company's definitive proxy statement
for the Annual Meeting of Shareholders to be held April 18, 2002,
and is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required under this item appears beginning on
page 8 of the Company's definitive proxy statement for the Annual
Meeting of Shareholders to be held April 18, 2002, and is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required under this item beginning on page 2
of the Company's definitive proxy statement for the Annual Meeting
of Shareholders to be held April 18, 2002, and is incorporated
herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required under this item beginning on page 11
of the Company's definitive proxy statement for the Annual Meeting
of Shareholders to be held April 18, 2002, and is incorporated
herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)
1. Financial Statements
The following consolidated financial statements of Southside
Bancshares, Inc. and its subsidiaries are filed as part of this
report.
Consolidated Balance Sheets as of December 31, 2001 and 2000.
Consolidated Statements of Income for the years ended
December 31, 2001, 2000 and 1999.
Consolidated Statements of Shareholders' Equity for the years
ended December 31, 2001, 2000 and 1999.
Consolidated Statements of Cash Flow for the years ended
December 31, 2001, 2000 and 1999.
Notes to Consolidated Financial Statements.
47
2. Financial Statement Schedules
All schedules are omitted because they are not
applicable or not required, or because the required
information is included in the consolidated financial
statements or notes thereto.
3. Exhibits
<Table>
<Caption>
Exhibit
No.
-----------
3 (a)(i) - Articles of Incorporation as amended and in effect on December 31,
1992, of SoBank, Inc. (now named Southside Bancshares, Inc.)(filed
as Exhibit 3 to the Registrant's Form 10-K for the year ended
December 31, 1992, and incorporated herein by reference).
3 (a)(ii) - Articles of Amendment effective May 9, 1994 to Articles of
Incorporation of SoBank, Inc. (now named Southside Bancshares,
Inc.) (filed as Exhibit 3(a)(ii) to the Registrant's Form 10-K for
the year ended December 31, 1994, and incorporated herein by
reference).
3 (b) - Bylaws as amended and in effect on March 23, 1995 of Southside
Bancshares, Inc. (filed as Exhibit 3(b) to the Registrant's Form
10-K for the year ended December 31, 1994, and incorporated herein
by reference).
** 10 (a)(i) - Deferred Compensation Plan for B. G. Hartley effective February
13, 1984, as amended June 28, 1990, December 15, 1994, November
20, 1995, December 21, 1999 and June 29, 2001 (filed as Exhibit
10(a)(i) to the Registrant's Form 10-Q for the quarter ended June
30, 2001, and incorporated herein by reference).
** 10 (a)(ii) - Deferred Compensation Plan for Robbie N. Edmonson effective
February 13, 1984, as amended June 28, 1990 and March 16, 1995
(filed as Exhibit 10(a)(ii) to the Registrant's Form 10-K for the
year ended December 31, 1995, and incorporated herein by
reference).
** 10 (b) - Officers Long-term Disability Income Plan effective June 25, 1990
(filed as Exhibit 10(b) to the Registrant's Form 10-K for the year
ended June 30, 1990, and incorporated herein by reference).
** 10 (c) - Retirement Plan Restoration Plan for the subsidiaries of SoBank,
Inc. (now named Southside Bancshares, Inc.)(filed as Exhibit 10(c)
to the Registrant's Form 10-K for the year ended December 31,
1992, and incorporated herein by reference).
** 10 (d) - Incentive Stock Option Plan effective April 1, 1993 of SoBank,
Inc. (now named Southside Bancshares, Inc.) (filed as Exhibit
10(d) to the Registrant's Form 10-K for the year ended December
31, 1994, and incorporated herein by reference).
** 10 (e) - Form of Deferred Compensation Agreements dated June 30, 1994 with
each of Titus Jones and Andy Wall as amended November 13, 1995.
(filed as Exhibit 10(e) to the Registrant's Form 10-K for the year
ended December 31, 1995, and incorporated herein by reference).
</Table>
48
<Table>
** 10 (f) - Form of Deferred Compensation Agreements dated June 30, 1994 with
each of Sam Dawson, Lee Gibson and Jeryl Story as amended October
15, 1997 and Form of Deferred Compensation Agreement dated October
15, 1997 with Lonny Uzzell (filed as Exhibit 10(f) to the
Registrant's Form 10-K for the year ended December 31, 1997, and
incorporated herein by reference).
** 10 (g) - Post Retirement Agreement for B. G. Hartley effective June 20,
2001 (filed as Exhibit 10(g) to the Registrant's Form 10-Q for the
quarter ended June 30, 2001, and incorporated herein by reference).
* 21 - Subsidiaries of the Registrant.
* 23 - Consent of Independent Accountants.
----------
* Filed herewith.
** Compensation plan, benefit plan or employment contract or
arrangement.
(b) Reports on Form 8-K
None.
</Table>
49
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
SOUTHSIDE BANCSHARES, INC.
BY: /s/ B. G. HARTLEY
-------------------------------------------------
B. G. Hartley, Chairman of the Board
and Director (Principal Executive Officer)
/s/ LEE R. GIBSON
-------------------------------------------------
Lee R. Gibson, CPA, Executive Vice President
and Chief Financial Officer (Principal
DATED: March 7, 2002 Financial and Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the date indicated.
<Table>
<Caption>
Signature Title Date
--------- ----- ----
/s/ B. G. HARTLEY Chairman of the Board March 7, 2002
------------------------------------- and Director
(B. G. Hartley)
/s/ ROBBIE N. EDMONSON Vice Chairman of the Board March 7, 2002
------------------------------------- and Director
(Robbie N. Edmonson)
/s/ SAM DAWSON President and Secretary March 7, 2002
------------------------------------- and Director
(Sam Dawson)
/s/ FRED E. BOSWORTH Director March 7, 2002
-------------------------------------
(Fred E. Bosworth)
/s/ HERBERT C. BUIE Director March 7, 2002
-------------------------------------
(Herbert C. Buie)
/s/ ROLLINS CALDWELL Director March 7, 2002
-------------------------------------
(Rollins Caldwell)
/s/ MICHAEL D. GOLLOB Director March 7, 2002
-------------------------------------
(Michael D. Gollob)
/s/ W. D. (JOE) NORTON Director March 7, 2002
-------------------------------------
(W. D. (Joe) Norton)
/s/ PAUL W. POWELL Director March 7, 2002
-------------------------------------
(Paul W. Powell)
/s/ WILLIAM SHEEHY Director March 7, 2002
-------------------------------------
(William Sheehy)
</Table>
50
Report of Independent Accountants
To the Shareholders and Board of Directors of
Southside Bancshares, Inc.:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income, shareholders' equity and cash flows present
fairly, in all material respects, the financial position of Southside
Bancshares, Inc. and its subsidiaries at December 31, 2001 and December 31,
2000, and the results of its operations and its cash flows for the years then
ended in conformity with accounting principles generally accepted in the United
States of America. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with auditing standards generally accepted in the
United States of America, which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
As discussed in Note 5 to the financial statements on January 1, 2001, the
Company changed its method of accounting for debt and equity securities.
/s/ PRICEWATERHOUSECOOPERS LLP
PricewaterhouseCoopers LLP
Dallas, Texas
March 4, 2002
51
SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
<Table>
<Caption>
December 31, December 31,
2001 2000
--------------- ---------------
ASSETS
Cash and due from banks .............................................. $ 52,681 $ 38,800
Investment securities:
Available for sale ................................................ 158,818 56,777
Held to maturity, at cost (market value $0 and $107,650) .......... -- 104,508
--------------- ---------------
Total Investment securities ..................................... 158,818 161,285
Mortgage-backed and related securities:
Available for sale ................................................ 454,078 269,286
Held to maturity, at cost (market value $0 and $145,826) .......... -- 142,961
--------------- ---------------
Total Mortgage-backed securities and related securities ......... 454,078 412,247
Marketable equity securities:
Available for sale ................................................ 21,287 20,226
Loans:
Loans, net of unearned discount .................................. 537,898 481,435
Less: reserve for loan losses .................................... (5,926) (5,033)
--------------- ---------------
Net Loans ....................................................... 531,972 476,402
Premises and equipment, net .......................................... 27,748 25,475
Interest receivable .................................................. 8,622 9,117
Deferred tax asset ................................................... -- 2,922
Other assets ......................................................... 21,531 5,407
--------------- ---------------
TOTAL ASSETS .................................................... $ 1,276,737 $ 1,151,881
=============== ===============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest bearing ............................................... $ 171,802 $ 166,899
Interest bearing .................................................. 586,152 553,706
--------------- ---------------
Total Deposits .................................................. 757,954 720,605
Short-term obligations:
Federal funds purchased ........................................... 25,900 5,025
FHLB Dallas advances .............................................. 114,177 148,940
Other obligations ................................................. 2,500 2,278
--------------- ---------------
Total Short-term obligations .................................... 142,577 156,243
Long-term obligations:
FHLB Dallas advances .............................................. 260,713 179,645
Junior subordinated convertible debentures ........................ 16,950 16,950
Junior subordinated debentures .................................... 20,000 20,000
--------------- ---------------
Total Long-term obligations ..................................... 297,663 216,595
Deferred tax liability ............................................... 1,634 --
Other liabilities .................................................... 8,324 6,743
--------------- ---------------
TOTAL LIABILITIES ............................................... 1,208,152 1,100,186
--------------- ---------------
Commitments and Contingencies (Note 14 and 15)
Shareholders' equity:
Common stock: ($1.25 par, 20,000,000 shares authorized,
8,733,297 and 8,215,135 shares issued) .................... 10,917 10,269
Paid-in capital ................................................... 35,195 30,226
Retained earnings ................................................. 25,133 19,891
Treasury stock (920,577 and 606,552 shares at cost) ............... (8,511) (5,357)
Accumulated other comprehensive gain (loss) ....................... 5,851 (3,334)
--------------- ---------------
TOTAL SHAREHOLDERS' EQUITY ..................................... 68,585 51,695
--------------- ---------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ..................... $ 1,276,737 $ 1,151,881
=============== ===============
</Table>
The accompanying notes are an integral part of these consolidated
financial statements.
52
SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share data)
<Table>
<Caption>
Years Ended December 31,
-------------------------------------------------
2001 2000 1999
------------- ------------- -------------
Interest income
Loans .................................................................. $ 40,702 $ 36,239 $ 28,198
Investment securities .................................................. 6,968 10,230 9,077
Mortgage-backed and related securities ................................. 29,507 27,155 22,080
Marketable equity securities ........................................... 854 1,553 911
Other interest earning assets .......................................... 151 241 422
------------- ------------- -------------
Total interest income ............................................ 78,182 75,418 60,688
------------- ------------- -------------
Interest expense
Deposits ............................................................... 24,892 23,835 16,545
Short-term obligations ................................................. 7,302 10,177 8,535
Long-term obligations .................................................. 15,369 12,125 10,936
------------- ------------- -------------
Total interest expense ........................................... 47,563 46,137 36,016
------------- ------------- -------------
Net interest income ....................................................... 30,619 29,281 24,672
Provision for loan losses ................................................. 1,667 1,569 1,456
------------- ------------- -------------
Net interest income after provision for loan losses ....................... 28,952 27,712 23,216
------------- ------------- -------------
Noninterest income
Deposit services ....................................................... 9,377 8,045 6,780
Gain (loss) on sales of securities available for sale .................. 4,073 (535) 149
Trust income ........................................................... 961 726 631
Other .................................................................. 2,305 1,991 1,672
------------- ------------- -------------
Total noninterest income ......................................... 16,716 10,227 9,232
------------- ------------- -------------
Noninterest expense
Salaries and employee benefits ......................................... 17,696 15,165 13,427
Net occupancy expense .................................................. 3,358 2,947 2,655
Equipment expense ...................................................... 734 659 537
Advertising, travel & entertainment .................................... 1,650 1,623 1,322
Supplies ............................................................... 615 563 494
Professional fees ...................................................... 617 545 591
Other .................................................................. 4,749 3,952 3,498
------------- ------------- -------------
Total noninterest expense ........................................ 29,419 25,454 22,524
------------- ------------- -------------
Income before federal tax expense ......................................... 16,249 12,485 9,924
------------- ------------- -------------
Provision (benefit) for federal tax expense
Current ................................................................ 3,728 2,572 2,033
Deferred ............................................................... (204) 88 (33)
------------- ------------- -------------
Total income taxes ............................................... 3,524 2,660 2,000
------------- ------------- -------------
Income before cumulative effect of change in accounting
principle ......................................................... 12,725 9,825 7,924
Cumulative effect of change in accounting principle,
net of tax ....................................................... (994) -- --
------------- ------------- -------------
Net Income ................................................................ $ 11,731 $ 9,825 $ 7,924
============= ============= =============
Earnings Per Common Share:
Basic:
Income before cumulative effect of change in accounting principle .... $ 1.62 $ 1.23 $ 0.98
Cumulative effect of change in accounting principle, net of tax ...... (0.13) -- --
------------- ------------- -------------
Net income ........................................................... $ 1.49 $ 1.23 $ 0.98
============= ============= =============
Diluted:
Income before cumulative effect of change in accounting principle .... $ 1.36 $ 1.18 $ 0.95
Cumulative effect of change in accounting principle, net of tax ...... (0.10) -- --
------------- ------------- -------------
Net income ........................................................... $ 1.26 $ 1.18 $ 0.95
============= ============= =============
</Table>
The accompanying notes are an integral part of these consolidated
financial statements.
53
SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(in thousands, except share amounts)
<Table>
<Caption>
Accumulated
Other
Compre- Compre- Total
hensive hensive Share-
Income Common Paid in Retained Treasury Income holders'
(Loss) Stock Capital Earnings Stock (Loss) Equity
--------- -------- --------- --------- ---------- ---------- ----------
Balance at December 31, 2000................ $ $ 10,269 $ 30,226 $ 19,891 $ (5,357) $ (3,334) $ 51,695
Net Income.................................. 11,731 11,731 11,731
Other comprehensive income, net of tax
Unrealized gains on securities, net of
reclassification adjustment (see
Note 3).................................. 9,241 9,241 9,241
Minimum pension liability adjustment........ (56) (56) (56)
---------
Comprehensive income........................ $ 20,916
=========
Common stock issued (143,856 shares)........ 180 715 895
Tax benefit of incentive stock options...... 123 123
Dividends paid on common stock.............. (1,890) (1,890)
Purchase of 314,025 shares of
treasury stock........................... (3,154) (3,154)
Stock dividend.............................. 468 4,131 (4,599) --
--------- --------- --------- ---------- ---------- ---------
Balance at December 31, 2001................ $ 10,917 $ 35,195 $ 25,133 $ (8,511) $ 5,851 $ 68,585
========= ========= ========= ========= ========= =========
Balance at December 31, 1999................ $ $ 9,748 $ 27,472 $ 14,583 $ (4,544) $ (9,587) $ 37,672
Net Income.................................. 9,825 9,825 9,825
Other comprehensive income, net of tax
Unrealized gains on securities, net of
reclassification adjustment (see
Note 3).................................. 6,277 6,277 6,277
Minimum pension liability adjustment........ (24) (24) (24)
---------
Comprehensive income........................ $ 16,078
=========
Common stock issued (53,964 shares)......... 67 343 410
Tax benefit of incentive stock options...... 6 6
Dividends paid on common stock.............. (1,658) (1,658)
Purchase of 94,050 shares of
treasury stock........................... (813) (813)
Stock dividend.............................. 454 2,405 (2,859) --
--------- --------- --------- ---------- ---------- ---------
Balance at December 31, 2000................ $ 10,269 $ 30,226 $ 19,891 $ (5,357) $ (3,334) $ 51,695
========= =========- ========== ========= ========= =========
</Table>
(continued)
54
SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (continued)
(in thousands, except share amounts)
<Table>
<Caption>
Accumulated
Other
Compre- Compre- Total
hensive hensive Share-
Income Common Paid in Retained Treasury Income holders'
(Loss) Stock Capital Earnings Stock (Loss) Equity
--------- -------- --------- --------- ---------- ----------- ---------
Balance at December 31, 1998................ $ $ 9,214 $ 24,198 $ 11,391 $ (3,158) $ 4,768 $ 46,413
Net Income.................................. 7,924 7,924 7,924
Other comprehensive loss, net of tax
Unrealized losses on securities, net of
reclassification adjustment (see
Note 3).................................. (14,352) (14,352) (14,352)
Minimum pension liability adjustment........ (3) (3) (3)
---------
Comprehensive loss.......................... $ (6,431)
=========
Common stock issued (77,012 shares)......... 96 360 456
Tax benefit of incentive stock options...... 29 29
Dividends paid on common stock.............. (1,409) (1,409)
Purchase of 148,150 shares of
treasury stock........................... (1,386) (1,386)
Stock dividend.............................. 438 2,885 (3,323)
--------- --------- --------- ---------- ---------- ----------
Balance at December 31, 1999................ $ 9,748 $ 27,472 $ 14,583 $ (4,544) $ (9,587) $ 37,672
========= =========- ========== ========= ========= =========
</Table>
The accompanying notes are an integral part of these consolidated
financial statements.
55
SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
(in thousands)
<Table>
<Caption>
Years Ended December 31,
-----------------------------------------
2001 2000 1999
----------- ----------- -----------
OPERATING ACTIVITIES:
Net income .................................................................... $ 11,731 $ 9,825 $ 7,924
Adjustments to reconcile net cash provided by operations:
Depreciation ................................................................ 1,966 1,699 1,474
Amortization of premium ..................................................... 7,595 1,610 4,657
Accretion of discount and loan fees ......................................... (1,301) (2,043) (1,774)
Provision for loan losses ................................................... 1,667 1,569 1,456
Tax benefit of incentive stock options ...................................... 123 6 29
Decrease (increase) in interest receivable .................................. 495 (1,554) (1,498)
(Increase) decrease in other assets ......................................... (16,085) (636) 331
(Increase) decrease in deferred tax asset ................................... (176) 100 (33)
(Decrease) increase in interest payable ..................................... (461) 517 702
Increase (decrease) in other payables ....................................... 2,179 (2,880) (4,862)
(Gain) loss on sale of securities available for sale ........................ (4,073) 535 (149)
Gain on sale of assets ...................................................... (45) -- (86)
Gain on sale of other real estate owned ..................................... (6) (17) (129)
Cumulative effect of change in accounting principle ......................... 994 -- --
Proceeds from sales of trading securities ................................... 99,595 -- --
----------- ----------- -----------
Net cash provided by operating activities ............................... 104,198 8,731 8,042
INVESTING ACTIVITIES:
Proceeds from sale of investment securities available for sale .............. 100,810 87,280 81,700
Proceeds from sale of mortgage-backed securities available for sale ......... 170,521 209,087 111,969
Proceeds from maturities of investment securities available for sale ........ 67,939 6,939 26,093
Proceeds from maturities of mortgage-backed securities available for sale ... 164,532 38,449 89,702
Proceeds from maturities of investment securities held to maturity .......... -- 8,430 3,347
Proceeds from maturities of mortgage-backed securities held to maturity ..... -- 4,991 2,357
Purchases of investment securities available for sale ....................... (207,194) (73,508) (149,299)
Purchases of mortgage-backed securities available for sale .................. (424,780) (308,826) (222,610)
Purchases of investment securities held to maturity ......................... -- (3,829) (21,708)
Purchases of mortgage-backed securities held to maturity .................... -- (3,110) (2,258)
Purchases of marketable equity securities available for sale ................ (1,061) (1,683) (4,372)
Net increase in loans ....................................................... (59,040) (96,366) (69,299)
Purchases of premises and equipment ......................................... (4,256) (5,868) (4,200)
Proceeds from sale of premises and equipment ................................ 62 -- 672
Proceeds from sale of repossessed assets .................................... 1,381 1,003 1,290
Proceeds from sale of other real estate owned ............................... 389 390 356
----------- ----------- -----------
Net cash used in investing activities ................................... (190,697) (136,621) (156,260)
</Table>
(continued)
56
SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW (continued)
(in thousands)
<Table>
<Caption>
Years Ended December 31,
-----------------------------------------
2001 2000 1999
----------- ----------- -----------
FINANCING ACTIVITIES:
Net increase in demand and savings accounts ............................. $ 37,882 $ 43,873 $ 47,765
Net (decrease) increase in certificates of deposit ...................... (533) 89,188 24,745
Proceeds from FHLB Dallas advances ...................................... 4,975,117 1,071,180 258,100
Repayment of FHLB Dallas advances ....................................... (4,928,812) (1,098,521) (176,201)
Issuance of junior subordinated convertible debentures .................. -- 16,950 --
Net increase (decrease) in federal funds purchased ...................... 20,875 4,950 (4,093)
Proceeds from the issuance of common stock .............................. 895 410 456
Purchase of treasury stock .............................................. (3,154) (813) (1,386)
Dividends paid .......................................................... (1,890) (1,658) (1,409)
----------- ----------- -----------
Net cash provided by financing activities ......................... 100,380 125,559 147,977
----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents .................... 13,881 (2,331) (241)
Cash and cash equivalents at beginning of year .......................... 38,800 41,131 41,372
----------- ----------- -----------
Cash and cash equivalents at end of year ................................ $ 52,681 $ 38,800 $ 41,131
=========== =========== ===========
SUPPLEMENTAL DISCLOSURE FOR CASH FLOW INFORMATION:
Interest paid ........................................................... $ 48,024 $ 45,620 $ 35,315
Income taxes paid ....................................................... $ 3,025 $ 2,725 $ 1,725
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Acquisition of other repossessed assets and real estate
through foreclosure ................................................. $ 1,803 $ 1,266 $ 1,131
Transfer of held to maturity securities to trading securities ........... 99,792 -- --
</Table>
The accompanying notes are an integral part of these consolidated
financial statements.
57
NOTES TO FINANCIAL STATEMENTS Southside Bancshares, Inc. and Subsidiaries
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING AND REPORTING POLICIES
The significant accounting and reporting policies of Southside
Bancshares, Inc. (the "Company"), and its wholly owned subsidiaries,
Southside Delaware Financial Corporation, Southside Bank (the "Bank")
and the nonbank subsidiary, are summarized below.
Organization and Basis of Presentation. The consolidated financial
statements include the accounts of the Company, Southside Delaware
Financial Corporation, Southside Bank and the nonbank subsidiary, which
did not conduct any business in 2001. Southside Bank offers a full
range of financial services to commercial, industrial, financial and
individual customers. All significant intercompany accounts and
transactions are eliminated in consolidation. The preparation of these
consolidated financial statements in conformity with generally accepted
accounting principles requires the use of management's estimates. These
estimates are subjective in nature and involve matters of judgment.
Actual amounts could differ from these estimates.
Cash Equivalents. Cash equivalents, for purposes of reporting cash
flow, include cash and amounts due from banks.
Loans. All loans are stated at principal outstanding net of unearned
income. Interest income on installment loans is recognized primarily
using the level yield method. Interest income on other loans is
credited to income based primarily on the principal outstanding at
contract rates of interest. Loans receivable that management has the
intent and ability to hold for the foreseeable future or until maturity
or pay-off are reported at their outstanding principal adjusted for any
charge-offs, the reserve for loan losses, and any deferred fees or
costs on originated loans and unamortized premiums or discounts on
purchased loans. A loan is considered impaired, based on current
information and events, if it is probable that the Company will be
unable to collect the scheduled payments of principal or interest when
due according to the contractual terms of the loan agreement.
Substantially all of the Company's impaired loans are
collateral-dependent, and as such, are measured for impairment based on
the fair value of the collateral.
Loan Fees. The Company treats loan fees, net of direct costs, as an
adjustment to the yield of the related loan over its term.
Reserve for Loan Losses. A reserve for loan losses is provided through
charges to income in the form of a provision for loan losses. Loans
which management believes are uncollectible are charged against this
account with subsequent recoveries, if any, credited to the account.
The amount of the reserve for loan losses is determined by management's
evaluation of the quality and inherent risks in the loan portfolio,
economic conditions and other factors which warrant current
recognition.
Nonaccrual Loans. A loan is placed on nonaccrual when principal or
interest is contractually past due 90 days or more unless, in the
determination of management, the principal and interest on the loan are
well collateralized and in the process of collection. In addition, a
loan is placed on nonaccrual when, in the opinion of management, the
future collectibility of interest and principal is in serious doubt.
When classified as nonaccrual, accrued interest receivable on the loan
is reversed and the future accrual of interest is suspended. Payments
of contractual interest are recognized as income only to the extent
that full recovery of the principal balance of the loan is reasonably
certain.
Other Real Estate Owned. Other Real Estate Owned includes real estate
acquired in full or partial settlement of loan obligations. Other Real
Estate Owned is carried at the lower of (1) the recorded amount of the
loan for which the foreclosed property previously served as collateral
or (2) the fair market value of the property. Prior to foreclosure, the
recorded amount of the loan is written down, if necessary, to the
appraised fair market value of the real estate to be acquired, less
selling costs, by charging the reserve for loan losses. Any subsequent
reduction in fair market value is charged to results of operations
through the Reserve for Losses on Other Real Estate Owned account.
Costs of maintaining and operating foreclosed properties are expensed
as incurred. Expenditures to complete or improve foreclosed properties
are capitalized only if expected to be recovered; otherwise, they are
expensed.
58
Securities. The Company uses the specific identification method to
determine the basis for computing realized gain or loss. The Company
accounts for debt and equity securities as follows:
Held to Maturity (HTM). Debt securities that management has
the positive intent and ability to hold until maturity are
classified as HTM and are carried at their remaining unpaid
principal balance, net of unamortized premiums or unaccreted
discounts. Premiums are amortized and discounts are accreted
using the level interest yield method over the estimated
remaining term of the underlying security.
Available for Sale (AFS). Debt and equity securities that will
be held for indefinite periods of time, including securities
that may be sold in response to changes in market interest or
prepayment rates, needs for liquidity and changes in the
availability of and the yield of alternative investments are
classified as AFS. These assets are carried at market value.
Market value is determined using published quotes as of the
close of business. Unrealized gains and losses are excluded
from earnings and reported net of tax in Accumulated Other
Comprehensive Income until realized.
Premises and Equipment. Bank premises and equipment are stated at cost,
net of accumulated depreciation. Depreciation is computed on a straight
line basis over the estimated useful lives of the related assets.
Useful lives are estimated to be twenty to forty years for premises and
three to ten years for equipment. Maintenance and repairs are charged
to income as incurred while major improvements and replacements are
capitalized.
Income Taxes. The Company files a consolidated Federal income tax
return. Deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities
and their respective tax bases. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in
the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities
of changes in tax rates is recognized in income in the period the
change occurs.
Stock Options. The Company applies the provisions of Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" and related interpretations, in accounting for its
stock-based compensation plans. Under Opinion 25, compensations cost is
measured as the excess, if any of the quoted market price of the
Company's stock at the date of the grant above the amount an employee
must pay to acquire the stock. The Financial Accounting Standards Board
(FASB) published Statement of Financial Accounting Standard No. 123,
"Accounting for Stock-Based Compensation" (FAS123) on January 1, 1996
which encourages, but does not require, companies to recognize
compensation expense for grants of stock, stock options and other
equity instruments to employees based on new fair value accounting
rules. Companies that choose not to adopt the new rules will continue
to apply existing rules, but will be required to disclose pro forma net
income and earnings per share under the new method. The Company elected
to provide the pro forma disclosures for 1999, 2000 and 2001.
Accounting Changes. On June 15, 1998, the Financial Accounting
Standards Board (FASB) issued Financial Accounting Standard No. 133,
"Accounting for Derivative Instruments and Hedging Activities"
(FAS133). FAS133 and its amendments are effective for all fiscal
quarters of all fiscal years beginning after June 15, 2000. FAS133
requires that all derivative instruments be recorded on the balance
sheet at their fair value. Changes in the fair value of derivatives are
recorded each period in current earnings or other comprehensive income,
depending on whether a derivative is designated as part of a hedge
transaction and, if it is, the type of hedge transaction.
In June 2000, the Financial Accounting Standards Board issued Financial
Accounting Standard No. 138, "Accounting for Derivative Instruments and
Hedging Activities, an Amendment of Financial Accounting Standards
Board Statement No. 133," which addresses a limited number of issues
causing implementation difficulties for numerous entities that apply
Financial Accounting Standard No. 133, as amended. Financial Accounting
Standard No. 138 amends the accounting and reporting standards of
Financial Accounting Standard No. 133, as amended, for certain
derivative instruments, certain hedging activities and for decisions
made by the Financial Accounting Standards Board relating to the
Derivatives Implementation Group process.
59
On January 1, 2001, Southside adopted Financial Accounting Standard No.
133, "Accounting for Derivative Instruments and Hedging Activities,"
(FAS133). As allowed by FAS133, at the date of initial application of
this statement, Southside transferred held to maturity securities into
the available for sale category and the trading category. Southside
sold the securities transferred into the trading category during the
first quarter of 2001. The effect of selling the securities in the
trading category is shown as a cumulative effect of a change in
accounting principle and reduced net income by $994,000 (net of taxes)
during the first quarter of 2001. During 2001, Southside sold available
for sale securities which resulted in realized gains of $4.1 million or
an after tax gain of $2.7 million. These separate transactions allowed
Southside to reduce the overall duration of and reposition the
securities portfolio.
In June 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 141 "Business Combinations" (FAS
141) and Statement of Financial Accounting Standard No. 142 "Goodwill
and Other Intangible Assets" (FAS 142). FAS 141 requires all business
combinations initiated after June 30, 2001 to be accounted for using
the purchase method. Under FAS 142, goodwill and intangible assets with
indefinite lives are no longer amortized but are reviewed annually (or
more frequently if impairment indicators arise) for impairment.
Separable intangible assets that are not deemed to have indefinite
lives will continue to be amortized over their useful lives (but with
no maximum life). The amortization provisions of FAS 142 apply to
goodwill and intangible assets acquired after June 30, 2001. With
respect to goodwill and intangible assets acquired prior to July 1,
2001, the Company is required to adopt FAS 142 effective January 1,
2002. The adoption of this new accounting pronouncement is not expected
to have a material impact on the Company's consolidated financial
position or results of operations.
General. Certain prior period amounts have been reclassified to conform
to current year presentation and had no impact on net income or equity.
60
2. Earnings Per Share
Earnings per share on a basic and diluted basis as required by Statement of
Financial Accounting Standard No. 128, "Earnings Per Share" (FAS128), has been
adjusted to give retroactive recognition to stock splits and stock dividends and
is calculated as follows (in thousands, except per share amounts):
<Table>
<Caption>
Years Ended December 31,
----------------------------------------
2001 2000 1999
----------- ----------- -----------
Basic Earnings and Shares:
Income before cumulative effect of
accounting change ........................................ $ 12,725 $ 9,825 $ 7,924
Cumulative effect of change in accounting
principle, net of tax .................................... (994) -- --
----------- ----------- -----------
Net income ................................................. $ 11,731 $ 9,825 $ 7,924
=========== =========== ===========
Weighted-average basic shares outstanding .................. 7,848 7,993 8,059
=========== =========== ===========
Basic Earnings Per Share:
Income before cumulative effect of
accounting change ........................................ $ 1.62 $ 1.23 $ 0.98
Cumulative effect of change in accounting
principle, net of tax .................................... (0.13) -- --
----------- ----------- -----------
Net income ................................................. $ 1.49 $ 1.23 $ 0.98
=========== =========== ===========
Diluted Earnings and Shares:
Income before cumulative effect
of accounting change ..................................... $ 12,725 $ 9,825 $ 7,924
Add: Applicable dividend on convertible debentures ........ 979 142 --
----------- ----------- -----------
Adjusted net income ........................................ 13,704 9,967 7,924
Cumulative effect of change in accounting
principle, net of tax .................................... (994) -- --
----------- ----------- -----------
Net income ................................................. $ 12,710 $ 9,967 $ 7,924
=========== =========== ===========
Weighted-average basic shares outstanding .................. 7,848 7,993 8,059
Add: Stock options ........................................ 428 207 259
Convertible debentures ............................... 1,780 253 --
----------- ----------- -----------
Weighted-average diluted shares outstanding ................ 10,056 8,453 8,318
=========== =========== ===========
Diluted Earnings Per Share:
Income before cumulative effect of
accounting change ....................................... $ 1.36 $ 1.18 $ 0.95
Cumulative effect of change in accounting
principle, net of tax .................................... (0.10) -- --
----------- ----------- -----------
Net income ................................................. $ 1.26 $ 1.18 $ 0.95
=========== =========== ===========
</Table>
61
3. COMPREHENSIVE INCOME
The components of accumulated comprehensive income (loss) as required by
Statement of Financial Accounting Standard No. 130, "Reporting Comprehensive
Income" are as follows (in thousands):
<Table>
<Caption>
Year Ended December 31, 2001
-----------------------------------------------
Before-Tax Tax (Expense) Net-of-Tax
Amount Benefit Amount
------------- ------------- -------------
Unrealized gains on securities:
Unrealized holding gains arising during period ..... $ 18,075 $ (6,146) $ 11,929
Less: reclassification adjustment for gains
realized in net income ......................... 4,073 (1,385) 2,688
------------- ------------- -------------
Net unrealized gains .............................. 14,002 (4,761) 9,241
Minimum pension liability adjustment .................. (85) 29 (56)
------------- ------------- -------------
Other comprehensive income ............................ $ 13,917 $ (4,732) $ 9,185
============= ============= =============
</Table>
<Table>
<Caption>
Year Ended December 31, 2000
-----------------------------------------------
Before-Tax Tax (Expense) Net-of-Tax
Amount Benefit Amount
------------- ------------- -------------
Unrealized gains on securities:
Unrealized holding gains arising during period ..... $ 8,976 $ (3,052) $ 5,924
Less: reclassification adjustment for losses
realized in net income ......................... (535) 182 (353)
------------- ------------- -------------
Net unrealized gains .............................. 9,511 (3,234) 6,277
Minimum pension liability adjustment .................. (36) 12 (24)
------------- ------------- -------------
Other comprehensive income ............................ $ 9,475 $ (3,222) $ 6,253
============= ============= =============
</Table>
<Table>
<Caption>
Year Ended December 31, 1999
-----------------------------------------------
Before-Tax Tax (Expense) Net-of-Tax
Amount Benefit Amount
------------- ------------- -------------
Unrealized losses on securities:
Unrealized holding losses arising during period .... $ (21,597) $ 7,343 $ (14,254)
Less: reclassification adjustment for gains
realized in net income ......................... 149 (51) 98
------------- ------------- -------------
Net unrealized losses ............................. (21,746) 7,394 (14,352)
Minimum pension liability adjustment .................. (5) 2 (3)
------------- ------------- -------------
Other comprehensive loss .............................. $ (21,751) $ 7,396 $ (14,355)
============= ============= =============
</Table>
4. CASH AND DUE FROM BANKS
The Company is required to maintain cash reserve balances with the Federal
Reserve Bank. The reserve balances were $250,000 and $4.5 million as of December
31, 2001 and 2000, respectively.
62
5. INVESTMENT, MORTGAGE-BACKED AND MARKETABLE EQUITY SECURITIES
The amortized cost and estimated market value of investment, mortgage-backed and
marketable equity securities as of December 31, 2001 and 2000 are reflected in
the tables below (in thousands). There were no securities classified in the HTM
category at December 31, 2001.
<Table>
<Caption>
AVAILABLE FOR SALE
---------------------------------------------------------------------
Gross Gross Estimated
December 31, Amortized Unrealized Unrealized Market
2001 Cost Gains Losses Value
--------------- --------------- --------------- ---------------
U.S. Treasury .......................... $ 11,000 $ 67 $ 2 $ 11,065
U.S. Government Agencies ............... 21,101 135 7 21,229
Mortgage-backed Securities:
Direct Govt. Agency Issues ........... 401,207 7,098 1,228 407,077
Other Private Issues ................. 46,194 877 70 47,001
State and Political Subdivisions ....... 124,249 2,415 243 126,421
Other Stocks and Bonds ................. 21,387 3 -- 21,390
--------------- --------------- --------------- ---------------
Total ................................ $ 625,138 $ 10,595 $ 1,550 $ 634,183
=============== =============== =============== ===============
</Table>
<Table>
<Caption>
AVAILABLE FOR SALE
---------------------------------------------------------------------
Gross Gross Estimated
December 31, Amortized Unrealized Unrealized Market
2000 Cost Gains Losses Value
--------------- --------------- --------------- ---------------
U.S. Treasury .......................... $ 6,001 $ 15 $ 1 $ 6,015
U.S. Government Agencies ............... 3,502 -- -- 3,502
Mortgage-backed Securities:
Direct Govt. Agency Issues ........... 250,190 4,598 121 254,667
Other Private Issues ................. 14,170 532 83 14,619
State and Political Subdivisions ....... 43,609 1,741 200 45,150
Other Stocks and Bonds ................. 22,327 9 -- 22,336
--------------- --------------- --------------- ---------------
Total ................................ $ 339,799 $ 6,895 $ 405 $ 346,289
=============== =============== =============== ===============
</Table>
<Table>
<Caption>
HELD TO MATURITY
---------------------------------------------------------------------
Gross Gross Estimated
December 31, Amortized Unrealized Unrealized Market
2000 Cost Gains Losses Value
--------------- --------------- --------------- ---------------
U.S. Government Agencies ............... $ 39,888 $ 871 $ 212 $ 40,547
Mortgage-backed Securities:
Direct Govt. Agency Issues ........... 67,498 2,069 136 69,431
Other Private Issues ................. 75,463 1,182 250 76,395
State and Political Subdivisions ....... 54,994 2,353 1 57,346
Other Stocks and Bonds ................. 9,626 131 -- 9,757
--------------- --------------- --------------- ---------------
Total ................................ $ 247,469 $ 6,606 $ 599 $ 253,476
=============== =============== =============== ===============
</Table>
63
Interest income recognized on securities for the years presented:
<Table>
<Caption>
Years Ended December 31,
---------------------------------------------------
2001 2000 1999
--------------- --------------- ---------------
(in thousands)
U.S. Treasury .......................... $ 347 $ 403 $ 707
U.S. Government Agencies ............... 1,262 4,197 3,322
Mortgage-backed Securities ............. 29,507 27,155 22,080
State and Political Subdivisions ....... 5,114 4,913 4,698
Other Stocks and Bonds ................. 1,099 2,270 1,261
--------------- --------------- ---------------
Total interest income on securities .... $ 37,329 $ 38,938 $ 32,068
=============== =============== ===============
</Table>
During the month ended January 31, 2000, the Company transferred securities
totaling $91.7 million from AFS to HTM due to changes in market conditions. Of
the total transferred, $21.2 million were investment securities and $70.5
million were mortgage-backed securities. The unrealized loss on the securities
transferred from AFS to HTM was $2.6 million, net of tax, at the date of
transfer. There were no sales from the HTM portfolio during the years ended
December 31, 2001 or 2000. There were no securities classified as HTM for the
year ended December 31, 2001.
On January 1, 2001, Southside adopted Financial Accounting Standard No. 133,
"Accounting for Derivative Instruments and Hedging Activities," (FAS133). As
allowed by FAS133, at the date of initial application of this statement,
Southside transferred held to maturity securities into the available for sale
category and the trading category. Southside sold the securities transferred
into the trading category during the first quarter of 2001. The effect of
selling the securities in the trading category is shown as a cumulative effect
of a change in accounting principle and reduced net income by $994,000 (net of
taxes) during the first quarter of 2001. During 2001, Southside sold available
for sale securities which resulted in realized gains of $4.1 million or an after
tax gain of $2.7 million. These separate transactions allowed Southside to
reduce the overall duration of and reposition the securities portfolio.
Of the $4.1 million in net securities gains from the AFS portfolio in 2001,
there were $2.1 million in realized losses and $6.2 million in realized gains.
Of the $535,000 in net securities losses on sales from the AFS portfolio in
2000, there were $1.5 million in realized losses and $1.0 million in realized
gains. Of the $149,000 in net securities gains on sales from the AFS portfolio
in 1999, there were $856,000 in realized gains and $707,000 in realized losses.
The scheduled maturities of AFS and HTM securities as of December 31, 2001 are
presented below. Mortgage-backed securities are presented in total by category.
<Table>
<Caption>
Amortized Aggregate
Cost Fair Value
--------------- ---------------
(in thousands)
Available for sale securities:
Due in one year or less ....................... $ 42,499 $ 42,491
Due after one year through five years ......... 14,696 14,975
Due after five years through ten years ........ 3,699 3,834
Due after ten years ........................... 116,843 118,805
--------------- ---------------
177,737 180,105
Mortgage-backed securities ....................... 447,401 454,078
--------------- ---------------
Total ...................................... $ 625,138 $ 634,183
=============== ===============
</Table>
Investment securities with book values of $376.2 million and $344.0 million were
pledged as of December 31, 2001 and 2000, respectively, to collateralize FHLB
Dallas advances, public and trust deposits or for other purposes as required by
law.
64
6. LOANS AND RESERVE FOR POSSIBLE LOAN LOSSES
Loans in the accompanying consolidated balance sheets are classified as follows:
<Table>
<Caption>
December 31, December 31,
2001 2000
--------------- ---------------
Real Estate Loans: (in thousands)
Construction ................................. $ 23,631 $ 25,108
1-4 family residential ....................... 147,774 134,672
Other ........................................ 139,870 121,381
Commercial loans ................................. 76,476 77,670
Municipal Loans .................................. 54,266 31,351
Loans to individuals ............................. 96,233 92,607
--------------- ---------------
Total loans ...................................... 538,250 482,789
Less: Unearned income ....................... 352 1,354
Reserve for loan losses ............... 5,926 5,033
--------------- ---------------
Net loans ........................................ $ 531,972 $ 476,402
=============== ===============
</Table>
The following is a summary of the Reserve for Loan Losses for the years ended
December 31, 2001, 2000 and 1999:
<Table>
<Caption>
Years Ended December 31,
-----------------------------------------------------
2001 2000 1999
--------------- --------------- ---------------
(in thousands)
Balance at beginning of year ..................... $ 5,033 $ 4,575 $ 3,564
Provision for loan losses ................. 1,667 1,569 1,456
Loans charged off ......................... (1,384) (1,442) (765)
Recoveries of loans charged off ........... 610 331 320
--------------- --------------- ---------------
Balance at end of year ........................... $ 5,926 $ 5,033 $ 4,575
=============== =============== ===============
</Table>
Nonaccrual loans at December 31, 2001 and 2000 were $896,000 and $630,000,
respectively. Loans with terms modified in troubled debt restructuring at
December 31, 2001 and 2000 were $283,000 and $389,000, respectively.
For the years ended December 31, 2001 and 2000, the average recorded investment
in impaired loans was approximately $801,000 and $567,000, respectively. During
the years ended December 31, 2001 and 2000, the amount of interest income
reversed on impaired loans placed on nonaccrual and the amount of interest
income subsequently recognized on the cash basis was not material.
The amount of interest recognized on nonaccrual or restructured loans was
$70,000, $122,000 and $125,000 for the years ended December 31, 2001, 2000 and
1999, respectively. If these loans had been accruing interest at their original
contracted rates, related income would have been $113,000, $138,000 and $137,000
for the years ended December 31, 2001, 2000 and 1999, respectively.
65
The following is a summary of the Company's recorded investment in loans
(primarily nonaccrual loans) for which impairment has been recognized in
accordance with FAS114:
<Table>
<Caption>
Valuation Carrying
Total Allowance Value
---------- ---------- ----------
(in thousands)
Real Estate ................................. $ 506 $ 68 $ 438
Commercial Loans ............................ 155 11 144
Loans to Individuals ........................ 235 35 200
---------- ---------- ----------
Balance at December 31, 2001 ................ $ 896 $ 114 $ 782
========== ========== ==========
</Table>
<Table>
<Caption>
Valuation Carrying
Total Allowance Value
---------- ---------- ----------
(in thousands)
Real Estate ................................. $ 336 $ 32 $ 304
Commercial Loans ............................ 78 20 58
Loans to Individuals ........................ 216 29 187
---------- ---------- ----------
Balance at December 31, 2000 ................ $ 630 $ 81 $ 549
========== ========== ==========
</Table>
7. BANK PREMISES AND EQUIPMENT
<Table>
<Caption>
December 31, December 31,
2001 2000
--------------- ---------------
(in thousands)
Bank premises ............................................ $ 29,409 $ 27,002
Furniture and equipment .................................. 15,216 13,473
--------------- ---------------
44,625 40,475
Less accumulated depreciation ............................ 16,877 15,000
--------------- ---------------
Total ........................................... $ 27,748 $ 25,475
=============== ===============
</Table>
Depreciation expense was $1,966,000, $1,699,000 and $1,474,000 for the years
ended December 31, 2001, 2000 and 1999, respectively. Rent expense was $468,000,
$447,000 and $424,000 for the years ended December 31, 2001, 2000 and 1999,
respectively.
Future minimum rental commitments under noncancelable leases are (in thousands):
<Table>
2002 $ 350
2003 317
2004 209
2005 187
2006 147
----------------
$ 1,210
================
</Table>
66
8. OTHER REAL ESTATE OWNED
The following is a summary of the Allowance for Losses on Other Real Estate
Owned (OREO) for the periods presented:
<Table>
<Caption>
Years Ended December 31,
-----------------------------------------------------
2001 2000 1999
--------------- --------------- ---------------
(in thousands)
Balance at beginning of year ................ $ -- $ 61 $ 658
Acquisition of OREO ..................... 8 -- 61
Disposition of OREO ..................... (8) (61) (658)
--------------- --------------- ---------------
Balance at end of year ...................... $ -- $ -- $ 61
=============== =============== ===============
</Table>
For the year ended December 31, 2001, provision and other expense from ORE
properties exceeded income by $16,000. For the years ended December 31, 2000 and
1999, income from OREO properties exceeded the provision and other expenses by
$2,000 and $58,000, respectively.
9. INTEREST BEARING DEPOSITS
<Table>
<Caption>
December 31, December 31,
2001 2000
--------------- ---------------
(in thousands)
Savings deposits ................................. $ 29,628 $ 24,007
Money market demand deposits ..................... 68,689 60,355
Platinum money market deposits ................... 28,659 15,455
NOW demand deposits .............................. 113,394 107,573
Certificates and other time deposits
of $100,000 or more ............................ 139,387 151,142
Certificates and other time
deposits under $100,000 ........................ 206,395 195,174
--------------- ---------------
Total ................................... $ 586,152 $ 553,706
=============== ===============
</Table>
For the years ended December 31, 2001, 2000 and 1999, interest expense on time
deposits of $100,000 or more was $8.2 million, $7.9 million and $3.4 million,
respectively.
At December 31, 2001, the scheduled maturities of certificates and other time
deposits are as follows (in thousands):
<Table>
2002 $ 255,205
2003 48,256
2004 19,985
2005 10,786
2006 and thereafter 11,550
-------------------
$ 345,782
===================
</Table>
The aggregate amount of demand deposits that has been reclassified as loans were
$1.9 million and $1.0 million for December 31, 2001 and 2000, respectively.
67
10. SHORT-TERM BORROWINGS
Information related to short-term borrowings is provided in the table below.
<Table>
<Caption>
Years Ended December 31,
2001 2000 1999
--------------- --------------- ---------------
(in thousands)
Federal funds purchased
Balance at end of period ..................................... $ 25,900 $ 5,025 $ 75
Average amount outstanding during the period (1) ............. 3,285 2,687 4,660
Maximum amount outstanding during the period ................. 25,900 15,325 24,068
Weighted average interest rate during the period (2) ......... 4.0% 6.6% 5.1%
Interest rate at end of period ............................... 1.9% 6.5% 4.3%
Federal Home Loan Bank ("FHLB") Dallas advances
Balance at end of period ..................................... $ 114,177 $ 148,940 $ 181,222
Average amount outstanding during the period (1) ............. 165,100 156,265 155,719
Maximum amount outstanding during the period ................. 207,744 188,899 186,500
Weighted average interest rate during the period (2) ......... 4.3% 6.3% 5.3%
Interest rate at end of period ............................... 3.3% 6.1% 5.3%
Treasury tax and loan funds
Balance at end of period ..................................... $ 2,500 $ 2,278 $ 4,744
Average amount outstanding during the period (1) ............. 1,799 2,210 1,908
Maximum amount outstanding during the period ................. 3,301 4,604 4,747
Weighted average interest rate during the period (2) ......... 3.6% 5.8% 4.0%
Interest rate at end of period ............................... 1.4% 5.8% 4.7%
</Table>
(1) The average amount outstanding during the period was computed by
dividing the total daily outstanding principal balances by the number
of days in the period.
(2) The weighted average interest rate during the period was computed by
dividing the actual interest expense by the average balance outstanding
during the period.
The Company has three lines of credit for the purchase of federal funds. Two
$15.0 million and one $10.0 million unsecured lines of credit have been
established with Bank of America, Frost Bank and Texas Independent Bank,
respectively.
68
11. LONG TERM OBLIGATIONS
<Table>
<Caption>
Years Ended December 31,
-------------------------------------
2001 2000 1999
-------- --------- --------
(in thousands)
FHLB Dallas advances
Balance at end of period............................................ $260,713 $179,645 $174,704
Average amount outstanding during the period (1).................... 215,674 187,011 175,028
Maximum amount outstanding during the period........................ 260,713 210,460 174,870
Weighted average interest rate during the period (2)................ 5.7% 5.5% 5.3%
Interest rate at end of period...................................... 5.2% 5.7% 5.4%
</Table>
(1) The average amount outstanding during the period was computed by
dividing the total daily outstanding principal balances by the number
of days in the period.
(2) The weighted average interest rate during the period was computed by
dividing the actual interest expense by the average balance
outstanding during the period.
Maturities of fixed rate FHLB Dallas Long-term advances based on scheduled
repayments at December 31, 2001 are (in thousands):
<Table>
<Caption>
Under Due Due Over 2001
1 Year 1-5 Years 6-10 Years 10 Years Total
------------ ------------- ------------ ------------ ------------
Total long-term obligations........ $ 581 $ 216,637 $ 42,738 $ 757 $ 260,713
============= ============== ============= ============= =============
</Table>
FHLB Dallas advances are collateralized by FHLB Dallas stock, nonspecified real
estate loans and mortgage-backed securities.
In April 1998, the Company formed a wholly-owned non-banking subsidiary
Southside Capital Trust (the "Trust Issuer"). The Trust Issuer was created under
the Business Trust Act of Delaware for the sole purpose of issuing and selling
Preferred Securities and Common Securities and using proceeds from the sale of
the Preferred Securities and Common Securities to acquire Junior Subordinated
Debentures (the "Debentures") issued by the Company. Accordingly, the Debentures
are the sole assets of the Trust Issuer and payments under the Debentures are
the sole revenue of the Trust Issuer. All of the Common Securities are owned by
the Company.
On November 2, 2000, the Company through its wholly-owned subsidiary, Southside
Capital Trust II (the "Trust II Issuer"), sold 1,695,000 cumulative convertible
preferred securities (the "junior subordinated convertible debentures") at a
liquidation amount of $10 per convertible preferred security for an aggregate
amount of $16,950,000. These securities have a convertible feature that allows
the owner to convert each security to a share of the Company's common stock at a
conversion price of $9.52 per common share. These securities have a distribution
rate of 8.75% per annum payable at the end of each calendar quarter.
On May 18, 1998, the Company through its wholly-owned subsidiary, Southside
Capital Trust (the "Trust Issuer"), sold 2,000,000 preferred securities (the
"junior subordinated debentures") at a liquidation amount of $10 per preferred
security for an aggregate amount of $20,000,000. These securities have a
distribution rate of 8.50% per annum payable at the end of each calendar
quarter.
69
The Company's obligations under the Debentures and related documents, taken
together, constitute a full and unconditional guarantee by the Company of the
Trust Issuer's obligations under the Preferred Securities. Although the
Debentures are treated as debt of the Company, they currently qualify for Tier 1
capital treatment subject to a limitation that the securities included as Tier 1
capital not exceed 25% of total Tier 1 capital. The Securities are callable by
the Company on or about June 30, 2003, or earlier in the event the deduction of
related interest for federal income taxes is prohibited, treatment as Tier 1
capital is no longer permitted or certain other contingencies arise. The
Preferred Securities must be redeemed upon maturity of the Debentures in year
2028.
12. EMPLOYEE BENEFITS
Southside Bank has a deferred compensation agreement with eight of its executive
officers, which generally provides for payment of an aggregate amount of $3.9
million over a maximum period of fifteen years after retirement or death.
Deferred compensation expense was $369,000, $13,000 and $211,000 for the years
ended December 31, 2001, 2000 and 1999, respectively.
The Company provides accident and health insurance for substantially all
employees through an insurance program funded by the Company. Health insurance
benefits are offered to retired employees who pay a premium based on cost as
determined by a third party administrator. Substantially all of the Company's
employees may become eligible for those benefits if they reach normal retirement
age after fifteen years of employment with the Company. The cost of health care
benefits was $1,897,000, $1,451,000 and $1,122,000 for the years ended December
31, 2001, 2000 and 1999, respectively. There were ten retirees and six retirees
participating in the health insurance plan as of December 31, 2001 and 2000,
respectively.
The Company has an Employee Stock Ownership Plan which covers substantially all
employees. Contributions to the plan are at the sole discretion of the Board of
Directors. There were no contributions to the plan for the year ended December
31, 2001. Contributions to the plan for the years ended December 31, 2000 and
1999 were $100,000. At December 31, 2001 and 2000, 215,573 and 207,123 shares of
common stock were owned by the Employee Stock Ownership Plan, respectively. The
number of shares have been adjusted as a result of stock splits and stock
dividends. These shares are treated as externally held shares for dividend and
earnings per share calculations.
The Company has an Officers Long-term Disability Income Plan, (the "Disability
Plan"), which covers officers of the Company and Southside Bank in the event
they become disabled as defined under its terms. Individuals are automatically
covered under the plan if they (a) have been elected as an officer, (b) have
been an employee of the Company and Southside Bank for three years and (c)
receive earnings of $50,000 or more on an annual basis. The Disability Plan
provides, among other things, that should a covered individual become totally
disabled he would receive 66-2/3%, not to exceed $10,000 per month, of their
current salary. The benefits paid out of this plan are limited by the benefits
paid to the individual under the terms of other Company sponsored benefit plans.
The Company and Southside Bank have a defined benefit pension plan pursuant to
which participants are entitled to benefits based on final average monthly
compensation and years of credited service determined in accordance with plan
provisions. All employees of the Company and Southside Bank who have worked
1,000 hours or more in their first twelve months of employment or during any
plan year thereafter are eligible to participate. Employees are vested upon the
earlier of five years credited service or the employee attaining 60 years of
age. Benefits are payable monthly commencing on the later of age 65 or the
participant's date of retirement. Eligible participants may retire at reduced
benefit levels after reaching age 55. The Company contributes amounts to the
pension fund sufficient to satisfy funding requirements of the Employee
Retirement Income Security Act. Plan assets included 145,844 shares of Southside
Bancshares, Inc. stock purchased at fair market value at December 31, 2001 and
2000. The number of shares have been adjusted as a result of stock splits and
stock dividends.
70
<Table>
<Caption>
December 31, December 31,
Change in Projected Benefit Obligation 2001 2000
------------ ------------
(in thousands)
Benefit obligation at end of prior year ............... $ 15,111 $ 13,548
Service cost .......................................... 877 679
Interest cost ......................................... 1,270 1,030
Actuarial loss ........................................ 2,859 488
Benefits paid ......................................... (674) (634)
Expenses paid ......................................... (44) --
------------ ------------
Benefit obligation at end of year ................. $ 19,399 $ 15,111
============ ============
</Table>
<Table>
<Caption>
December 31, December 31,
Change in Plan Assets 2001 2000
------------ ------------
(in thousands)
Fair value of plan assets at end of prior year ........ $ 13,845 $ 14,117
Actual return ......................................... 524 (123)
Employer contribution ................................. 1,150 485
Benefits paid ......................................... (674) (634)
Expenses paid ......................................... (44) --
------------ ------------
Fair value of plan assets at end of year .......... $ 14,801 $ 13,845
============ ============
</Table>
<Table>
<Caption>
December 31, December 31,
Reconciliation of Funded Status 2001 2000
------------ ------------
(in thousands)
Funded status ......................................... $ (4,598) $ (1,266)
Unrecognized net loss ................................. 4,211 729
Unrecognized net transition asset ..................... (92) (139)
------------ ------------
Accrued benefit cost .............................. $ (479) $ (676)
============ ============
</Table>
The weighted average discount rate and rate of increase in future compensation
levels used in determining actuarial present value of the projected benefit
obligation was 7.25% and 4.50% and 7.50% and 4.50% at December 31, 2001 and
2000, respectively. The assumed long-term rate of return on plan assets was 9.0%
at December 31, 2001 and 2000.
Net periodic pension cost for the years ended December 31, 2001, 2000 and 1999
included the following components:
<Table>
<Caption>
Years Ended December 31,
-----------------------------
2001 2000 1999
------- ------- -------
(in thousands)
Service cost .......................................... $ 877 $ 679 $ 714
Interest cost ......................................... 1,270 1,030 957
Expected return on assets ............................. (1,217) (1,245) (1,068)
Transition asset recognition .......................... (46) (46) (46)
Net loss recognition .................................. 70 -- 9
------- ------- -------
Net periodic benefit cost ............................. $ 954 $ 418 $ 566
======= ======= =======
</Table>
71
The Company has a nonfunded supplemental retirement plan (restoration plan) for
its employees whose benefits under the principal retirement plan are reduced
because of compensation deferral elections or limitations under federal tax
laws.
<Table>
<Caption>
December 31, December 31,
Change in Projected Benefit Obligation 2001 2000
----------- ------------
(in thousands)
Benefit obligation at end of prior year ............... $ 468 $ 635
Service cost .......................................... 16 3
Interest cost ......................................... 54 35
Actuarial loss (gain) ................................. 306 (149)
Benefits paid ......................................... (56) (56)
----- -----
Benefit obligation at end of year .................. $ 788 $ 468
===== =====
</Table>
<Table>
<Caption>
December 31, December 31,
Change in Plan Assets 2001 2000
----------- ------------
(in thousands)
Fair value of plan assets at end of prior year ........ $ -- $ --
Employer contribution ................................. 56 56
Benefits paid ......................................... (56) (56)
---- ----
Fair value of plan assets at end of year ........... $ -- $ --
==== ====
</Table>
<Table>
<Caption>
December 31, December 31,
Reconciliation of Funded Status 2001 2000
----------- ------------
(in thousands)
Funded status ......................................... $(788) $(468)
Unrecognized net loss ................................. 387 106
Unrecognized net transition obligation ................ 16 19
----- -----
Accrued benefit cost .................................. (385) (343)
Additional minimum liability .......................... (195) (112)
----- -----
Accrued benefit liability ............................. (580) (455)
Intangible asset ...................................... 16 19
Accumulated other comprehensive income ................ 179 93
----- -----
Net amount recognized ................................. $(385) $(343)
===== =====
</Table>
The weighted average discount rate and rate of increase in future compensation
levels used in determining actuarial present value of the projected benefit
obligation was 7.25% and 4.50% and 7.50% and 4.50% at December 31, 2001 and
2000, respectively. The assumed long-term rate of return on plan assets was 9.0%
at December 31, 2001 and 2000.
Net periodic postretirement benefit cost for the years ended December 31, 2001,
2000 and 1999 includes the following components:
<Table>
<Caption>
Years Ended December 31,
-----------------------------
2001 2000 1999
------- ------- -------
(in thousands)
Service cost ............................................ $16 $ 3 $13
Interest cost ........................................... 54 35 46
Transition obligation recognition ....................... 3 3 3
Net loss recognition .................................... 26 4 21
--- --- ---
Net periodic benefit cost ............................... $99 $45 $83
=== === ===
</Table>
72
Incentive Stock Options
In April 1993, the Company adopted the Southside Bancshares, Inc. 1993 Incentive
Stock Option Plan ("the Plan"), a stock-based incentive compensation plan. The
Company applies APB Opinion 25 and related Interpretations in accounting for the
Plan and discloses the pro forma information required by FAS123.
Under the Plan, the Company is authorized to issue shares of Common Stock
pursuant to "Awards" granted in the form of incentive stock options (intended to
qualify under Section 422 of the Internal Revenue Code of 1986, as amended).
Awards may be granted to selected employees and directors of the Company or any
subsidiary. At December 31, 2001 and 2000, there were 18,486 options available
for grant. At December 31, 1999, there were 309,105 options available for grant.
The Plan provides that the exercise price of any stock option may not be less
than the fair market value of the Common Stock on the date of grant. There were
no incentive stock options granted in 2001. The Company granted incentive stock
options in 1999 and 2000. These stock options have contractual terms of 10
years. All options vest on a graded schedule, 20% per year for 5 years,
beginning on the first anniversary date of the grant date. In accordance with
APB 25, the Company has not recognized any compensation cost for these stock
options.
A summary of the status of the Company's stock options as of December 31, 2001,
2000 and 1999 and the changes during the year ended on those dates is presented
below:
<Table>
<Caption>
2001 2000 1999
----------------------- ---------------------- -----------------------
WEIGHTED WEIGHTED WEIGHTED
# SHARES OF AVERAGE # SHARES OF AVERAGE # SHARES OF AVERAGE
UNDERLYING EXERCISE UNDERLYING EXERCISE UNDERLYING EXERCISE
OPTIONS PRICES OPTIONS PRICES OPTIONS PRICES
---------- ------- ---------- ------- ---------- -------
Outstanding at beginning
of the year 1,215,201 $6.34 934,560 $6.10 828,459 $5.62
Granted -- -- 294,005 $7.04 165,562 $7.62
Exercised (109,895) $4.37 (9,978) $4.21 (49,450) $2.81
Forfeited -- -- (3,386) $7.46 (10,011) $7.60
Expired -- -- -- -- -- --
Outstanding at end of year 1,105,306 $6.54 1,215,201 $6.34 934,560 $6.10
Exercisable at end of year 671,385 $6.05 584,886 $5.42 425,765 $4.97
Weighted-average FV of
options granted during the
year N/A $ 1.83 $ 2.13
</Table>
The fair value of each stock option granted is estimated on the date of grant
using the Black-Scholes method of option pricing with the following
weighted-average assumptions for grants in 2000 and 1999, respectively: dividend
yield of 2.95% and 2.30%; risk-free interest rates of 5.95% and 6.05%; the
expected lives of 6 years; the expected volatility is 23.21% and 22.25%.
73
The following table summarizes information about stock options outstanding at
December 31, 2001:
<Table>
<Caption>
Options Outstanding Options Exercisable
--------------------------------------------- -------------------------------
NUMBER WEIGHTED AVG. NUMBER
RANGE OF OUTSTANDING REMAINING WEIGHTED AVG. EXERCISABLE WEIGHTED AVG.
EXERCISE PRICES AT 12/31/01 CONTR. LIFE EXERCISE PRICE AT 12/31/01 EXERCISE PRICE
$ 2.58 to $ 5.60 335,989 3.5 $4.74 335,989 $4.74
$ 6.95 to $ 7.89 769,317 7.4 $7.32 335,396 $7.36
- ---------------- --------- --- ----- --------- -----
$ 2.58 to $ 7.89 1,105,306 6.2 $6.54 671,385 $6.05
========= =========
</Table>
Pro Forma Net Income and Net Income Per Common Share
Had the compensation cost for the Company's stock-based compensation plans been
determined consistent with the requirements of FAS123, the Company's net income
and net income per common share for 2001, 2000, and 1999 would approximate the
pro forma amounts below (in thousands, except per share amounts, net of taxes):
<Table>
<Caption>
As Pro As Pro As Pro
Reported Forma Reported Forma Reported Forma
12/31/01 12/31/01 12/31/00 12/31/00 12/31/99 12/31/99
-------- -------- -------- -------- -------- --------
FAS123 Charge ................. $ -- $ 333 $ -- $ 330 $ -- $ 316
Net Income .................... $11,731 $11,398 $ 9,825 $ 9,495 $ 7,924 $ 7,608
Net Income per Common
Share-Basic ................ $ 1.49 $ 1.45 $ 1.23 $ 1.19 $ 0.98 $ 0.94
Net Income per Common
Share-Diluted .............. $ 1.26 $ 1.23 $ 1.18 $ 1.14 $ 0.95 $ 0.91
</Table>
The effects of applying FAS123 in this pro forma disclosure are not indicative
of future amounts.
13. SHAREHOLDERS' EQUITY
Cash dividends declared and paid were $0.25 and $0.225 per share for the years
ended December 31, 2001 and 2000, respectively. Cash dividends declared and paid
were $0.20 per share for the year ended December 31, 1999. Future dividends will
depend on the Company's earnings, financial condition and other factors which
the Board of Directors of the Company considers to be relevant. The Company's
dividend policy requires that any dividend payments made by the Company not
exceed consolidated earnings for that year.
The Bank is subject to various regulatory capital requirements administered by
the federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory and possibly additional discretionary actions by
regulators that, if undertaken, could have a direct material effect on the
Bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's assets,
liabilities, and certain off-balance-sheet items as calculated under regulatory
accounting practices. The Bank's capital amounts and classification are also
subject to qualitative judgments by the regulators regarding components, risk
weightings, and other factors.
74
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the table
below) of Total and Tier 1 capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average
assets (as defined). Management believes, as of December 31, 2001, that the Bank
meets all capital adequacy requirements to which it is subject.
As of December 31, 2001, the most recent notification from the Federal Deposit
Insurance Corporation categorized the Bank as well capitalized under the
regulatory framework for prompt corrective action. To be categorized as well
capitalized the Bank must maintain minimum Total risk-based, Tier 1 risk-based,
and Tier 1 leverage ratios as set forth in the table. There are no conditions or
events since that notification that management believes have changed the
institution's category.
<Table>
<Caption>
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
--------------------- -------------------- ---------------------
Amount Ratio Amount Ratio Amount Ratio
---------- ------- ---------- ------- ---------- --------
(in thousands)
As of December 31, 2001:
Total Capital (to Risk Weighted Assets)
Consolidated........................... $ 102,996 17.08% $ 48,245 8.00% N/A N/A
========== ======= ========== ======= ========== ========
Bank Only.............................. $ 96,676 16.03% $ 48,243 8.00% $ 60,304 10.00%
========== ======= ========== ======= ========== ========
Tier 1 Capital (to Risk Weighted Assets)
Consolidated........................... $ 81,058 13.44% $ 24,122 4.00% N/A N/A
========== ======= ========== ======= ========== ========
Bank Only.............................. $ 90,862 15.07% $ 24,122 4.00% $ 36,182 6.00%
========== ======= ========== ======= ========== ========
Tier 1 Capital (to Average Assets)(1)
Consolidated........................... $ 81,058 6.50% $ 49,858 4.00% N/A N/A
========== ======= ========== ======= ========== ========
Bank Only.............................. $ 90,862 7.29% $ 49,857 4.00% $ 62,321 5.00%
========== ======= ========== ======= ========== ========
As of December 31, 2000:
Total Capital (to Risk Weighted Assets)
Consolidated........................... $ 94,817 16.63% $ 45,605 8.00% N/A N/A
========== ======= ========== ======= ========== ========
Bank Only.............................. $ 87,495 15.30% $ 45,741 8.00% $ 57,176 10.00%
========== ======= ========== ======= ========== ========
Tier 1 Capital (to Risk Weighted Assets)
Consolidated........................... $ 71,169 12.48% $ 22,802 4.00% N/A N/A
========== ======= ========== ======= ========== ========
Bank Only.............................. $ 82,758 14.47% $ 22,870 4.00% $ 34,306 6.00%
========== ======= ========== ======= ========== ========
Tier 1 Capital (to Average Assets)(1)
Consolidated........................... $ 71,169 6.31% $ 45,148 4.00% N/A N/A
========== ======= ========== ======= ========== ========
Bank Only.............................. $ 82,758 7.33% $ 45,176 4.00% $ 56,470 5.00%
========== ======= ========== ======= ========== ========
</Table>
(1) Refers to quarterly average assets as calculated by bank regulatory
agencies.
Payment of dividends by the Bank is limited under regulation. The amount that
can be paid in any calendar year without prior approval of the Bank's regulatory
agencies cannot exceed the lesser of net profits (as defined) for that year plus
the net profits for the preceding two calendar years, or retained earnings.
75
The table below summarizes key equity ratios for the Company for the years ended
December 31, 2001, 2000 and 1999.
<Table>
<Caption>
Years Ended December 31,
-----------------------------
2001 2000 1999
------- ------- -------
Percentage of Net Income to:
Average Total Assets ................................. .96% .92% .84%
Average Shareholders' Equity ......................... 18.69% 23.13% 18.99%
Percentage of Dividends Declared Per Common
Share to Net Income Per Common Share-Basic ........... 16.78% 18.29% 20.41%
Percentage of Dividends Declared Per Common
Share to Net Income Per Common Share-Diluted ......... 19.84% 19.07% 21.05%
Percentage of Average Shareholders'
Equity to Average Total Assets ....................... 5.14% 3.99% 4.41%
</Table>
14. DIVIDEND REINVESTMENT AND COMMON STOCK REPURCHASE PLAN
The Company has a Dividend Reinvestment Plan funded by stock authorized, but not
yet issued. Proceeds from the sale of the common stock will be used for general
corporate purposes and could be directed to the Company's subsidiaries. For the
year ended December 31, 2001, 37,894 shares were sold under this plan at an
average price of $10.96 per share, reflective of other trades at the time of
each sale. For the year ended December 31, 2000, 44,732 shares were sold under
this plan at an average price of $8.24 per share, reflective of other trades at
the time of each sale.
The Company instituted a Common Stock Repurchase Plan in late 1994. Under the
repurchase plan, the Board of Directors establishes, on a quarterly basis, total
dollar limitations and price per share for stock to be repurchased. The Board
reviews this plan in conjunction with the capital needs of the Company and
Southside Bank and may, at its discretion, modify or discontinue the plan.
During 2001, 314,025 shares of treasury stock were purchased under this plan at
a cost of $3.2 million. During 2000, 94,050 shares of treasury stock were
purchased under this plan at a cost of $813,000.
15. INCOME TAXES
The provisions for federal income taxes included in the accompanying statements
of income consist of the following (in thousands):
<Table>
<Caption>
Years Ended December 31,
-----------------------------
2001 2000 1999
------- ------- -------
Current tax provision ................................. $ 3,728 $ 2,572 $ 2,033
Deferred tax expense (benefit) ........................ (204) 88 (33)
------- ------- -------
Provision for tax expense charged to operations ....... $ 3,524 $ 2,660 $ 2,000
======= ======= =======
</Table>
76
The components of the net deferred tax asset (liability) as of December 31, 2001
and 2000 are summarized below (in thousands):
<Table>
<Caption>
Assets Liabilities
-------- -----------
Allowance for losses on OREO ............................ $ 67 $
Reserve for loan losses ................................. 2,015
Retirement and other benefit plans ...................... 928
Unrealized gains on securities available for sale ....... (3,075)
Loan origination costs .................................. (88)
Premises and equipment .................................. (321)
FHLB Dallas stock dividends ............................. (1,326)
Other ................................................... 166
------- -------
Gross deferred tax assets (liabilities) .............. 3,176 (4,810)
------- -------
Net deferred tax liability at December 31, 2001 ... $(1,634)
=======
</Table>
<Table>
<Caption>
Assets Liabilities
-------- -----------
Allowance for Losses on OREO ........................... $ 101 $
Reserve for Loan Losses ................................ 1,711
Retirement and Other Benefit Plans ..................... 831
Unrealized losses on securities available for sale ..... 1,685
Loan Origination Costs ................................. (88)
Premises and Equipment ................................. (292)
FHLB Dallas Stock Dividends ............................ (1,128)
Other .................................................. 102
------- -------
Gross deferred tax assets (liabilities) ............. 4,430 (1,508)
------- -------
Net deferred tax asset at December 31, 2000 ...... $ 2,922
=======
</Table>
A reconciliation of tax at statutory rates and total tax expense is as follows
(dollars in thousands):
<Table>
<Caption>
Years Ended December 31,
---------------------------------------------------------
2001 2000 1999
------------------ ------------------ ------------------
Percent Percent Percent
of of of
Pre-Tax Pre-Tax Pre-Tax
Amount Income Amount Income Amount Income
------ ------- ------ ------- ------ -------
Calculated Tax Expense ....................... $ 5,525 34.0% $ 4,245 34.0% $ 3,374 34.0%
Increase (Decrease) in Taxes from:
Tax Exempt Interest .......................... (2,417) (14.9%) (2,001) (16.0%) (1,661) (16.7%)
Other Net .................................... 416 2.6% 416 3.3% 287 2.9%
------- ----- ------- ----- ------- -----
Provision for Tax Expense Charged to
Operations ................................ $ 3,524 21.7% $ 2,660 21.3% $ 2,000 20.2%
======= ===== ======= ===== ======= =====
</Table>
77
16. COMMITMENTS AND CONTINGENCIES
In the normal course of business the Company buys and sells securities. At
December 31, 2001, the Company had commitments to purchase $800,000 in
securities. There were no commitments to purchase securities at December 31,
2000 and 1999.
The Company, or its subsidiaries, is involved with various litigation which
resulted in the normal course of business. Management of the Company, after
consulting with its legal counsel, believes that any liability resulting from
litigation will not have a material effect on the financial position and results
of operations and the liquidity of the Company or its subsidiaries.
17. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
In the normal course of business the Company is a party to certain financial
instruments, with off-balance-sheet risk, to meet the financing needs of its
customers. These off-balance-sheet instruments include commitments to extend
credit and standby letters of credit. These instruments involve, to varying
degrees, elements of credit and interest rate risk in excess of the amount
reflected in the financial statements. The contract or notional amounts of these
instruments reflect the extent of involvement and exposure to credit loss the
Company has in these particular classes of financial instruments.
Commitments to extend credit are agreements to lend to a customer provided that
the terms established in the contract are met. Commitments generally have fixed
expiration dates and may require payment of fees. Since some commitments are
expected to expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements. Standby letters of credit are
conditional commitments issued to guarantee the performance of a customer to a
third party. These guarantees are primarily issued to support public and private
borrowing arrangements. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loan commitments to
customers.
The Company had outstanding unused commitments to extend credit of $46.9 million
and $54.2 million at December 31, 2001 and 2000, respectively. The Company had
outstanding standby letters of credit of $775,000 and $406,000 at December 31,
2001 and 2000, respectively.
The Company applies the same credit policies in making commitments and standby
letters of credit as it does for on-balance-sheet instruments. The Company
evaluates each customer's credit worthiness on a case-by-case basis. The amount
of collateral obtained, if deemed necessary, upon extension of credit is based
on management's credit evaluation of the borrower. Collateral held varies but
may include real estate, accounts receivable, inventory, property, plant, and
equipment.
18. SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK
The economy of the Company's market area, East Texas, is directly tied to the
oil and gas industry. Oil prices have had an indirect effect on the Company's
business. Although the Company has a diversified loan portfolio, a significant
portion of its loans are collateralized by real estate. Repayment of these loans
is in part dependent upon the economic conditions in the market area. Part of
the risk associated with real estate loans has been mitigated since 47.5% of
this group represents loans collateralized by residential dwellings that are
primarily owner occupied. Losses on this type of loan have historically been
less than those on speculative properties. Many of the remaining real estate
loans are collateralized primarily with owner occupied commercial real estate.
The mortgage-backed securities held by the Company consist solely of Government
agency pass-through securities which are either directly or indirectly backed by
the full faith and credit of the United States Government.
78
19. RELATED PARTY TRANSACTIONS
Loan activity of executive officers, directors, and their affiliates for the
years ended December 31, 2001 and 2000 were (in thousands):
<Table>
<Caption>
2001 2000
------- -------
Beginning Balance of Loans ............................ $ 5,240 $ 5,765
Additional Loans .................................... 2,101 2,114
Payments ............................................ (3,525) (2,639)
------- -------
Ending Balance of Loans ............................... $ 3,816 $ 5,240
======= =======
</Table>
Other indebtedness of officers and employees as of December 31, 2001 and 2000
was $4.3 million and $3.7 million, respectively.
The Company incurred legal costs of $145,000, $134,000 and $150,000 during the
years ended December 31, 2001, 2000 and 1999, respectively, from a law firm of
which an outside director of the Company is a partner. The Company paid
approximately $88,000, $69,000 and $54,000 in insurance premiums during the
years ended December 31, 2001, 2000 and 1999, respectively, to companies of
which two outside directors are officers.
20. DISCLOSURES ABOUT THE FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standard No. 107, "Disclosures about Fair
Value of Financial Instruments" (FAS107), requires disclosure of fair value
information about financial instruments, whether or not recognized in the
balance sheet, for which it is practicable to estimate that value. In cases
where quoted market prices are not available, fair values are based on estimates
using present value or other estimation techniques. Those techniques are
significantly affected by the assumptions used, including the discount rate and
estimates of future cash flows. Such techniques and assumptions, as they apply
to individual categories of the Company's financial instruments, are as follows:
Cash and due from banks: The carrying amounts for cash and due from
banks is a reasonable estimate of those assets' fair value.
Investment, mortgage-backed and marketable equity securities: Fair
values for these securities are based on quoted market prices, where
available. If quoted market prices are not available, fair values are
based on quoted market prices for similar securities.
Loans receivable: For adjustable rate loans that reprice frequently and
with no significant change in credit risk, the carrying amounts are a
reasonable estimate of those assets' fair value. The fair value of
other types of loans is estimated by discounting the future cash flows
using the current rates at which similar loans would be made to
borrowers with similar credit ratings and for the same remaining
maturities. Nonperforming loans are estimated using discounted cash
flow analyses or underlying value of the collateral where applicable.
Deposit liabilities: The fair value of demand deposits, savings
accounts, and certain money market deposits is the amount on demand at
the reporting date, that is, the carrying value. Fair values for fixed
rate certificates of deposits are estimated using a discounted cash
flow calculation that applies interest rates currently being offered
for deposits of similar remaining maturities.
79
Federal funds purchased: Federal funds purchased generally have an
original term to maturity of one day and thus are considered short-term
borrowings. Consequently, their carrying value is a reasonable estimate
of fair value.
Commitments to extend credit: The carrying amounts of commitments to
extend credit and standby letters of credit are a reasonable estimate
of those assets' fair value.
FHLB Dallas advances: The fair value of these advances is estimated by
discounting the future cash flows using rates at which advances would
be made to borrowers with similar credit ratings and for the same
remaining maturities.
The following table presents the Company's assets, liabilities, and unrecognized
financial instruments at both their respective carrying amounts and fair value:
<Table>
<Caption>
At December 31, 2001 At December 31, 2000
---------------------- ---------------------
Carrying Carrying
Amount Fair Value Amount Fair Value
---------- ----------- --------- ----------
(in thousands)
Financial assets:
Cash and due from banks ...................... $ 52,681 $ 52,681 $ 38,800 $ 38,800
Investment securities:
Available for sale ......................... 158,818 158,818 56,777 56,777
Held to maturity ........................... -- -- 104,508 107,650
Mortgage-backed and related securities:
Available for sale ......................... 454,078 454,078 269,286 269,286
Held to maturity ........................... -- -- 142,961 145,826
Marketable equity securities:
Available for sale ......................... 21,287 21,287 20,226 20,226
Loans, net ...................................... 531,972 547,075 476,402 479,783
Financial liabilities:
Retail deposits .............................. $757,954 $726,491 $720,605 $693,873
Federal funds purchased ...................... 25,900 25,900 5,025 5,025
FHLB Dallas advances ......................... 374,890 379,589 328,585 328,063
Junior subordinated debentures ............... 20,000 20,000 20,000 20,000
Junior subordinated convertible
debentures ............................... 16,950 16,950 16,950 16,950
Off-balance sheet liabilities:
Commitments to extend credit ................. 39,285 39,285 47,393 47,393
Standby letters of credit .................... 775 775 406 406
Credit card arrangements ..................... 7,655 7,655 6,801 6,801
</Table>
As discussed earlier, the fair value estimate of financial instruments for which
quoted market prices are unavailable is dependent upon the assumptions used.
Consequently, those estimates cannot be substantiated by comparison to
independent markets and, in many cases, could not be realized in immediate
settlement of the instruments. Accordingly, the aggregate fair value amounts
presented in the above fair value table do not necessarily represent the
underlying value of the Company.
80
21. QUARTERLY FINANCIAL INFORMATION OF REGISTRANT
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
<Table>
<Caption>
2001
-----------------------------------------
Fourth Third Second First
Quarter Quarter Quarter Quarter
-------- -------- -------- --------
Interest income ....................................... $ 18,669 $ 19,027 $ 20,076 $ 20,410
Net interest income ................................... 8,378 7,344 7,581 7,316
Income before provision for income taxes .............. 4,908 3,418 3,257 4,666
Provision for income taxes ............................ 1,034 629 679 1,182
Income before cumulative effect of
accounting change ................................... 3,874 2,789 2,578 3,484
Cumulative effect of change in
accounting principle ................................ -- -- -- (994)
Net income ............................................ 3,874 2,789 2,578 2,490
Earnings per share
Basic:
Income before cumulative effect of
accounting change ............................. $ 0.49 $ 0.36 $ 0.33 $ 0.44
Cumulative effect of change in
accounting principle .......................... -- -- -- (0.13)
-------- -------- -------- --------
Net income ...................................... $ 0.49 $ 0.36 $ 0.33 $ 0.31
======== ======== ======== ========
Diluted:
Income before cumulative effect of
accounting change ............................. $ 0.40 $ 0.30 $ 0.29 $ 0.37
Cumulative effect of change in
accounting principle .......................... -- -- -- (0.10)
-------- -------- -------- --------
Net income ...................................... $ 0.40 $ 0.30 $ 0.29 $ 0.27
======== ======== ======== ========
</Table>
<Table>
<Caption>
2000
-----------------------------------------
Fourth Third Second First
Quarter Quarter Quarter Quarter
-------- -------- -------- --------
Interest income ....................................... $20,190 $19,182 $18,513 $17,533
Net interest income ................................... 7,232 7,095 7,551 7,403
Income before provision for income taxes .............. 3,180 2,954 3,183 3,168
Provision for income taxes ............................ 628 592 714 726
Net income ............................................ 2,552 2,362 2,469 2,442
Earnings per share
Basic ............................................. $ 0.32 $ 0.30 $ 0.31 $ 0.30
Diluted ........................................... 0.29 0.29 0.30 0.30
</Table>
81
22. PARENT COMPANY FINANCIAL INFORMATION
Condensed financial information for Southside Bancshares, Inc. (parent company
only) was as follows:
CONDENSED BALANCE SHEETS
<Table>
<Caption>
December 31, December 31,
2001 2000
----------- ------------
(in thousands)
ASSETS
Cash and due from banks .............................. $ 6,288 $ 7,031
Investment in bank subsidiary at equity in
underlying net assets ............................. 96,933 79,476
Investment in nonbank subsidiary at equity in
underlying net assets ............................. 15 15
Other assets ......................................... 2,352 2,270
--------- ---------
TOTAL ASSETS ................................. $ 105,588 $ 88,792
========= =========
LIABILITIES
Junior subordinated debentures ....................... $ 20,000 $ 20,000
Junior subordinated convertible debentures ........... 16,950 16,950
Other liabilities .................................... 53 147
--------- ---------
TOTAL LIABILITIES ............................ 37,003 37,097
--------- ---------
SHAREHOLDERS' EQUITY
Common stock ($1.25 par, 20,000,000 shares
authorized:
8,733,297 and 8,215,135 and shares issued) ..... 10,917 10,269
Paid-in capital ...................................... 35,195 30,226
Retained earnings .................................... 25,133 19,891
Treasury stock (920,577 and 606,552 shares) .......... (8,511) (5,357)
Accumulated other comprehensive income (loss) ........ 5,851 (3,334)
--------- ---------
TOTAL SHAREHOLDERS' EQUITY ................... 68,585 51,695
--------- ---------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ... $ 105,588 $ 88,792
========= =========
</Table>
82
CONDENSED STATEMENTS OF INCOME
<Table>
<Caption>
December 31, December 31, December 31,
2001 2000 1999
----------- ------------ ------------
(in thousands)
INCOME
Dividends from subsidiary ....................................... $ 6,000 $ -- $ --
-------- -------- --------
TOTAL INCOME ............................................... 6,000 -- --
-------- -------- --------
EXPENSE
Interest expense ................................................ 3,183 1,914 1,700
Salaries and employee benefits .................................. 1 100 100
Other ........................................................... 481 382 348
-------- -------- --------
TOTAL EXPENSE .............................................. 3,665 2,396 2,148
-------- -------- --------
Income (loss) before federal income tax expense ................. 2,335 (2,396) (2,148)
Benefit for federal income tax expense .......................... 1,246 815 730
-------- -------- --------
Income (loss) before equity in undistributed
earnings of subsidiaries ..................................... 3,581 (1,581) (1,418)
Equity in undistributed earnings of subsidiaries ................ 8,150 11,406 9,342
-------- -------- --------
NET INCOME ................................................. $ 11,731 $ 9,825 $ 7,924
======== ======== ========
</Table>
CONDENSED STATEMENTS OF CASH FLOW
<Table>
<Caption>
December 31, December 31, December 31,
2001 2000 1999
----------- ------------ ------------
(in thousands)
OPERATING ACTIVITIES:
Net Income .................................................... $ 11,731 $ 9,825 $ 7,924
Adjustments to reconcile net income
to cash provided by operations:
Equity in undistributed earnings of subsidiaries ............ (8,150) (11,406) (9,342)
(Increase) decrease in other assets ......................... (82) (1,030) 45
(Decrease) increase in other liabilities .................... (93) 105 31
-------- -------- --------
Net cash provided by (used in) operating activities .... 3,406 (2,506) (1,342)
INVESTING ACTIVITIES:
Investments in subsidiaries ................................... -- (8,000) --
-------- -------- --------
Net cash used in investing activities .................. -- (8,000) --
FINANCING ACTIVITIES:
Purchase of treasury stock .................................... (3,154) (813) (1,386)
Proceeds from issuance of common stock ........................ 895 410 456
Dividends paid ................................................ (1,890) (1,658) (1,409)
Proceeds from the issuance of junior subordinated
convertible debentures .................................... -- 16,950 --
-------- -------- --------
Net cash (used in) provided by financing activities .... (4,149) 14,889 (2,339)
Net (decrease) increase in cash and cash equivalents .......... (743) 4,383 (3,681)
Cash and cash equivalents at beginning of year ................ 7,031 2,648 6,329
-------- -------- --------
Cash and cash equivalents at end of year ...................... $ 6,288 $ 7,031 $ 2,648
======== ======== ========
</Table>
83
INDEX TO EXHIBITS
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION
-------- -----------
3 (a)(i) - Articles of Incorporation as amended and in effect on
December 31, 1992, of SoBank, Inc. (now named Southside
Bancshares, Inc.)(filed as Exhibit 3 to the Registrant's
Form 10-K for the year ended December 31, 1992, and
incorporated herein by reference).
3 (a)(ii) - Articles of Amendment effective May 9, 1994 to Articles
of Incorporation of SoBank, Inc. (now named Southside
Bancshares, Inc.) (filed as Exhibit 3(a)(ii) to the
Registrant's Form 10-K for the year ended December 31,
1994, and incorporated herein by reference).
3 (b) - Bylaws as amended and in effect on March 23, 1995 of
Southside Bancshares, Inc. (filed as Exhibit 3(b) to the
Registrant's Form 10-K for the year ended December 31,
1994, and incorporated herein by reference).
** 10 (a)(i) - Deferred Compensation Plan for B. G. Hartley effective
February 13, 1984, as amended June 28, 1990, December 15,
1994, November 20, 1995, December 21, 1999 and June 29,
2001 (filed as Exhibit 10(a)(i) to the Registrant's Form
10-Q for the quarter ended June 30, 2001, and
incorporated herein by reference).
** 10 (a)(ii) - Deferred Compensation Plan for Robbie N. Edmonson
effective February 13, 1984, as amended June 28, 1990 and
March 16, 1995 (filed as Exhibit 10(a)(ii) to the
Registrant's Form 10-K for the year ended December 31,
1995, and incorporated herein by reference).
** 10 (b) - Officers Long-term Disability Income Plan effective June
25, 1990 (filed as Exhibit 10(b) to the Registrant's Form
10-K for the year ended June 30, 1990, and incorporated
herein by reference).
** 10 (c) - Retirement Plan Restoration Plan for the subsidiaries of
SoBank, Inc. (now named Southside Bancshares, Inc.)(filed
as Exhibit 10(c) to the Registrant's Form 10-K for the
year ended December 31, 1992, and incorporated herein by
reference).
** 10 (d) - Incentive Stock Option Plan effective April 1, 1993 of
SoBank, Inc. (now named Southside Bancshares, Inc.)
(filed as Exhibit 10(d) to the Registrant's Form 10-K for
the year ended December 31, 1994, and incorporated herein
by reference).
** 10 (e) - Form of Deferred Compensation Agreements dated June 30,
1994 with each of Titus Jones and Andy Wall as amended
November 13, 1995. (filed as Exhibit 10(e) to the
Registrant's Form 10-K for the year ended December 31,
1995, and incorporated herein by reference).
</Table>
<Table>
** 10 (f) - Form of Deferred Compensation Agreements dated June 30,
1994 with each of Sam Dawson, Lee Gibson and Jeryl Story
as amended October 15, 1997 and Form of Deferred
Compensation Agreement dated October 15, 1997 with Lonny
Uzzell (filed as Exhibit 10(f) to the Registrant's Form
10-K for the year ended December 31, 1997, and
incorporated herein by reference).
** 10 (g) - Post Retirement Agreement for B. G. Hartley effective
June 20, 2001 (filed as Exhibit 10(g) to the Registrant's
Form 10-Q for the quarter ended June 30, 2001, and
incorporated herein by reference).
* 21 - Subsidiaries of the Registrant.
* 23 - Consent of Independent Accountants.
</Table>
- ----------
* Filed herewith.
** Compensation plan, benefit plan or employment contract or
arrangement.