================================================================================
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, 2003
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:
Name of each exchange
Title of each class on which registered
------------------- ---------------------
NONE NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $1.25 PAR VALUE
(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 [ ].
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). YES [X] NO [ ]
The aggregate market value of the common stock held by non-affiliates of the
registrant as of June 30, 2003 was $111,670,019.
As of February 27, 2004, 10,402,485 shares of common stock of Southside
Bancshares, Inc. were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Registrant's Proxy Statement to be filed for the Annual Meeting of Shareholders
to be held April 15, 2004. (Part III)
================================================================================
PART I
ITEM 1. BUSINESS
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 Southside Bancshares, Inc., (the "Company") a bank holding
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," "could," "should," "may," "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, economic or other disruptions caused by military actions
in Iraq, Haiti or other areas, changes in the interest rate environment which
reduce interest margins and may impact prepayments on the mortgage-backed
securities portfolio, changes effecting the leverage strategy, 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.
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 179,000 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, 2003, the Company had total assets of $1.45 billion,
total loans of $589.1 million, deposits of $872.5 million, and shareholders'
equity of $100.4 million. The Company had net income of $13.6 million and $13.3
million and diluted earnings per share of $1.28 for both of the years ended
December 31, 2003 and 2002, 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 loans, 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, commercial real estate loans and
municipal loans. The Bank also offers construction loans primarily for
owner-occupied 1-4 family residential and commercial real estate.
1
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, 2003, the Bank's trust department managed
approximately $389 million of trust assets. Through its 25% owned securities
brokerage affiliate, BSC Securities, LLC, the Bank offers full retail investment
services to its customers. Countywide Loans, Inc. ("Countywide"), the Company's
former consumer finance subsidiary, was closed during the fourth quarter of 2002
due to the Company's inability to penetrate this market in a profitable manner.
The Company and the Bank are subject to comprehensive regulation,
examination and supervision by the Board of Governors of the Federal Reserve
System (the "Federal Reserve"), 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, making of
loans to individuals, deposits, and all facets of operations.
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. The Company's public
filings with the Securities and Exchange Commission may be obtained free of
charge at the Company's website as soon as reasonably practicable.
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 the fourth quarter of 2003, the Bank opened one branch in
Bullard, Texas in Smith County. The Company intends to expand into Jacksonville,
a city located approximately 25 miles south of Tyler in Cherokee County, during
2004. 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.
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 approximately 7,900 individuals.
The Bank serves its markets through nineteen full service branch
locations, twelve of which are located in grocery stores. The branches are
located in and around Tyler, Longview, Lindale, Bullard 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 the Bank's name recognition.
The Bank also maintains six motor bank facilities. The Bank's customers
may also access various banking services through 31 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 from their computers, access account
information and conduct various other transactions from their telephones and
computers.
2
LENDING ACTIVITIES
One of the Company's main objectives 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 municipal loans. Total
loans as of December 31, 2003 increased $18.7 million or 3.3% while the average
balance was up $22.3 million or 4.1% when compared to 2002.
Municipal loans as of December 31, 2003 increased $19.2 million or 25.0%
from December 31, 2002. Commercial loans decreased $1.4 million or 1.7%. Loans
to individuals increased $927,000 or 1.0% from December 31, 2002. Real estate
loans decreased slightly from December 31, 2002 to December 31, 2003.
The growth of loans made to municipalities in Texas was a result of the
Company's continued strong commitment in this area combined with the Company's
ability to close these transactions in a timely manner and greater market
penetration. The decrease in real estate loans was due to the significant volume
of refinancings due to low interest rates and the Company's unwillingness to
match some lower interest rates offered by competing financial institutions due
to concerns about interest rate risk. 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, 2003 was $12 million. The Bank's largest loan relationship at
December 31, 2003 was approximately $10 million.
The average yield on loans for the year ended December 31, 2003 decreased
to 6.50% from 7.17% for the year ended December 31, 2002. This decrease was
reflective of the repricing characteristics of the loans and the decrease in
lending rates due to the overall lower interest rate environment during 2003.
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,
------------------------------------------------------------
2003 2002 2001 2000 1999
-------- -------- -------- -------- --------
(in thousands)
Real Estate Loans:
Construction ................. $ 40,965 $ 34,473 $ 23,631 $ 25,108 $ 18,489
1-4 Family Residential ....... 142,543 144,396 143,926 134,672 112,077
Other ........................ 136,036 140,676 139,870 121,381 95,556
Commercial Loans ................ 81,115 82,530 76,470 77,644 66,581
Municipals Loans ................ 95,743 76,579 54,266 31,351 15,141
Loans to Individuals ............ 92,733 91,806 95,887 91,279 78,980
-------- -------- -------- -------- --------
Total Loans .................. $589,135 $570,460 $534,050 $481,435 $386,824
======== ======== ======== ======== ========
</Table>
For purposes of this discussion, the Company's loans are divided into
four categories: Real Estate Loans, Commercial Loans, Municipal Loans and Loans
to Individuals.
3
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, 2003, the
majority of the Company's real estate loans were collateralized by properties
located in Smith and Gregg Counties. Of the $319.5 million in real estate loans,
$142.5 million or 44.6% 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 an appraisal or evaluation on the property
based on the size and complexity of the transaction prior to funding any real
estate loan and also outlines the requirements for appraisals on renewals.
Management pursues an aggressive policy of reappraisal on any real estate
loan that is in the process of foreclosure and potential exposures are
recognized and reserved for or charged off as soon as they are identified. 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 Other. The Other category
consists of $134.4 million of commercial real estate loans, $1.0 million of
loans secured by multi family properties and $0.6 million of loans secured by
farm land. The Commercial Real Estate portion of Other will be discussed in more
detail below.
1-4 Family Residential Mortgage Loans
Residential loan originations are generated by the Company's loan
officers, in-house originations staff, marketing efforts, present customers,
walk-in customers and referrals from real estate agents, 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 originated a portion of its residential mortgage loans for sale into
the secondary market. These loans are reflected on the balance sheet as loans
held for sale. These secondary market investors typically pay the Company a
service release premium in addition to a predetermined price based on the
interest rate of the loan originated. The Company warehouses these loans until
they are transferred to the secondary market investor, which usually occurs
within 45 days.
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.
Included as part of the 1-4 Family Residential Mortgage Loans, the
Company also makes home equity loans and at December 31, 2003, these loans
totaled $46.3 million.
Construction Loans
The Company's construction loans are collateralized by property located
primarily in the Company's market area. A majority of the Company's construction
loans are directed toward properties that will be owner occupied. Construction
loans for projects built on speculation are financed, but these typically have
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 priced and made with the
intention of granting the permanent loan on the property.
4
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.
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 other industry classification represents over 10% of
loans. Medical loan types include all loan types listed above for commercial
loans. Collateral for these loans varies depending on the type of loan and
financial strength of the borrower. The primary source of repayment for loans in
the medical community is cashflow from continuing operations. 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 has a specific lending department 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
and in some cases, are additionally supported by collateral. Total loans to
municipalities and school districts as of December 31, 2003 increased $19.2
million while the average balance was up $15.0 million when compared to 2002. At
December 31, 2003, the Company had total loans to municipalities and school
districts of $95.7 million.
LOANS TO INDIVIDUALS
One of the Company's goals is to be a major consumer lender in its market
area. The majority of consumer loans outstanding are collateralized by titled
equipment, primarily vehicles, which accounted for approximately $69.6 million
or 75.1% of total loans to individuals at December 31, 2003. The Company's loans
collateralized by titled equipment declined during 2003 due to the zero interest
auto financing and other low interest financing offered by the automobile
industry. Should this type of low financing continue the Company may see
additional decreases in this portfolio. 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 Company's market area appears to show
some signs of modest growth. Two areas of concern are the slow rate of job
growth in the local and national labor markets and the personal bankruptcy rate
in the Company's market area. Management expects these two events could 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.
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 the
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.
5
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, 2003,
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)
Real Estate Loans - Construction ...................... $ 24,647 $ 9,928 $ 6,390
Real Estate Loans - 1-4 Family Residential ............ 50,475 82,506 9,562
Real Estate Loans - Other ............................. 35,135 71,884 29,017
Commercial Loans ...................................... 42,122 25,528 13,465
Municipal Loans ....................................... 11,314 20,146 64,283
Loans to Individuals .................................. 55,910 32,274 4,549
-------- -------- --------
Total Loans ..................................... $219,603 $242,266 $127,266
======== ======== ========
</Table>
<Table>
Loans with Maturities After
One Year for Which: Interest Rates are Fixed or Predetermined $ 276,828
Interest Rates are Floating or Adjustable $ 92,704
</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
totaling $1,547,000 are reflected in the due after five years column.
LOANS TO AFFILIATED PARTIES
In the normal course of business, the Bank makes loans to certain of the
Company's, as well as its own executive officers and directors and their related
interests. As of December 31, 2003 and 2002, these loans totaled $4.3 million
and $3.5 million or 4.2% and 4.4% 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.
LOAN LOSS EXPERIENCE AND ALLOWANCE FOR LOAN LOSSES
The loan loss allowance 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 loan
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 loan review officer's
process by performing additional loan reviews designed to achieve overall goals
of penetration.
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 allowances. A list of loans
or loan relationships of $50,000 or more, which are graded as having more than
the normal degree of risk associated with them, is maintained by the internal
loan review officer. This list is updated on a periodic
6
basis, but no less than quarterly in order to properly allocate necessary
allowances 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 allowances), and geographic and
industry loan concentration.
In addition to maintaining an ongoing review of the loan portfolio, the
internal loan 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 allowance necessary,
in addition to the portion which is specifically allocated by loan. The internal
loan review officer also uses the loan portfolio data collected to determine the
allocation of the allowance for loan loss appropriate for the risk in each of
the Company's major loan categories.
As of December 31, 2003, the Company's review of the loan portfolio
indicates that a loan loss allowance of $6.4 million is adequate to cover
probable losses in the portfolio.
7
The following table presents information regarding the average amount of
net loans outstanding, changes in the allowance for loan losses, the ratio of
net loans charged-off to average net loans outstanding and an allocation of the
allowance for loan losses.
LOAN LOSS EXPERIENCE AND ALLOWANCE FOR LOAN LOSSES
<Table>
<Caption>
Years Ended December 31,
-----------------------------------------------------------------
2003 2002 2001 2000 1999
--------- --------- --------- --------- ---------
(dollars in thousands)
Average Net Loans Outstanding ............................... $ 570,122 $ 547,829 $ 508,560 $ 433,560 $ 340,447
========= ========= ========= ========= =========
Balance of Allowance for Loan Loss at Beginning of Period ... $ 6,195 $ 5,926 $ 5,033 $ 4,575 $ 3,564
--------- --------- --------- --------- ---------
Loan Charge-Offs:
Real Estate-Construction .................................... (17) (215) -- (15) --
Real Estate-1-4 Family Residential .......................... (63) (170) (35) (14) --
Real Estate-Other ........................................... -- -- -- -- --
Commercial Loans ............................................ (693) (610) (325) (522) (114)
Loans to Individuals ........................................ (703) (1,144) (1,024) (891) (651)
--------- --------- --------- --------- ---------
Total Loan Charge-Offs ...................................... (1,476) (2,139) (1,384) (1,442) (765)
--------- --------- --------- --------- ---------
Recovery of Loans Previously Charged-off:
Real Estate-Construction .................................... -- 4 -- -- --
Real Estate-1-4 Family Residential .......................... -- 13 6 1 3
Real Estate-Other ........................................... 3 6 24 33 2
Commercial Loans ............................................ 179 43 288 57 106
Loans to Individuals ........................................ 304 224 292 240 209
--------- --------- --------- --------- ---------
Total Recovery of Loans Previously Charged-Off .............. 486 290 610 331 320
--------- --------- --------- --------- ---------
Net Loan Charge-Offs ........................................ (990) (1,849) (774) (1,111) (445)
Provision for Loan Loss ..................................... 1,209 2,118 1,667 1,569 1,456
--------- --------- --------- --------- ---------
Balance at End of Period .................................... $ 6,414 $ 6,195 $ 5,926 $ 5,033 $ 4,575
========= ========= ========= ========= =========
Ratio of Net Charge-Offs to Average Net Loans Outstanding ... 0.17% 0.34% 0.15% 0.26% 0.13%
========= ========= ========= ========= =========
</Table>
Allocation of Allowance for Loan Loss (dollars in thousands):
<Table>
<Caption>
December 31,
----------------------------------------------------------------------------
2003 2002 2001
---------------------- ---------------------- ----------------------
Percentage Percentage Percentage
of Loans to of Loans to of Loans to
Amount Total Loans Amount Total Loans Amount Total Loans
------ ----------- ------ ----------- ------ -----------
Real Estate
Construction .................... $ 510 7.0% $ 451 6.0% $ 220 4.4%
1-4 Family Residential .......... 906 24.2% 872 25.3% 890 26.9%
Other ........................... 1,798 23.1% 1,642 24.7% 1,900 26.2%
Commercial Loans .................. 1,339 13.8% 1,447 14.5% 1,260 14.3%
Municipal Loans ................... 238 16.2% 193 13.4% 139 10.2%
Loans to Individuals .............. 1,622 15.7% 1,547 16.1% 1,420 18.0%
Unallocated ....................... 1 0.0% 43 0.0% 97 0.0%
------ ------ ------
Ending Balance .................... $6,414 100.0% $6,195 100.0% $5,926 100.0%
====== ====== ======
<Caption>
December 31,
-------------------------------------------------
2000 1999
---------------------- ----------------------
Percentage Percentage
of Loans to of Loans to
Amount Total Loans Amount Total Loans
------ ----------- ------ -----------
Real Estate
Construction .................... $ 230 5.2% $ 91 4.8%
1-4 Family Residential .......... 802 28.0% 840 29.0%
Other ........................... 1,322 25.2% 964 24.7%
Commercial Loans .................. 1,561 16.1% 1,558 17.2%
Municipal Loans ................... -- 6.5% -- 3.9%
Loans to Individuals .............. 1,097 19.0% 1,077 20.4%
Unallocated ....................... 21 0.0% 45 0.0%
------ ------
Ending Balance .................... $5,033 100.0% $4,575 100.0%
====== ======
</Table>
See "Consolidated Financial Statements - Note 7. Loans and Allowance for
Probable Loan Losses."
8
NONPERFORMING ASSETS
Nonperforming assets consist of delinquent loans over 90 days past due,
nonaccrual loans, other real estate owned, repossessed assets 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. 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. Other Real Estate Owned
(OREO) represents real estate taken in full or partial satisfaction of debts
previously contracted. The dollar amount of OREO is based on a current
evaluation of the OREO at the time it is recorded on the Company's books, net of
estimated selling costs. Updated valuations are obtained as needed and any
additional impairments are recognized.
Total nonperforming assets at December 31, 2003 were $2.3 million, down
$1.1 million or 32.6% from $3.4 million at December 31, 2002. Other real estate
owned decreased $329,000 or 62.8% to $195,000 from December 31, 2002 to December
31, 2003. Of the other real estate owned, 7.7% is a residential dwelling and
92.3% is commercial property. The Company is actively marketing all properties
and none are being held for investment purposes. From December 31, 2002 to
December 31, 2003, nonaccrual loans decreased $691,000 or 30.9% to $1.5 million.
Of this total, 9.4% are construction and land development loans, 26.5% are
residential real estate loans, 14.2% are commercial real estate loans, 27.0% are
commercial loans and 22.9% are loans to individuals. Restructured loans
decreased $106,000 or 32.6% to $219,000. Loans 90 days past due or more
decreased $15,000 or 5.2% to $272,000. Repossessed assets increased $37,000 or
336.4% to $48,000.
The following table of nonperforming assets is classified according to
bank regulatory call report guidelines:
<Table>
<Caption>
NONPERFORMING ASSETS
December 31,
------------------------------------------------------
2003 2002 2001 2000 1999
------ ------ ------ ------ ------
(dollars in thousands)
Loans 90 Days Past Due:
Real Estate ................. $ 248 $ 125 $ 404 $ 577 $ 233
Loans to Individuals ........ 20 95 211 43 58
Commercial .................. 4 67 330 599 48
------ ------ ------ ------ ------
272 287 945 1,219 339
------ ------ ------ ------ ------
Loans on Nonaccrual:
Real Estate ................. 775 1,083 506 336 --
Loans to Individuals ........ 354 481 235 216 281
Commercial .................. 418 674 155 78 422
------ ------ ------ ------ ------
1,547 2,238 896 630 703
------ ------ ------ ------ ------
Restructured Loans:
Real Estate ................. 109 115 130 160 178
Loans to Individuals ........ 97 113 91 151 214
Commercial .................. 13 97 62 78 56
------ ------ ------ ------ ------
219 325 283 389 448
------ ------ ------ ------ ------
Total Nonperforming Loans ...... 2,038 2,850 2,124 2,238 1,490
Other Real Estate Owned ........ 195 524 65 43 140
Repossessed Assets ............. 48 11 213 196 209
------ ------ ------ ------ ------
Total Nonperforming Assets ..... $2,281 $3,385 $2,402 $2,477 $1,839
====== ====== ====== ====== ======
Percentage of Total Assets ..... 0.16% 0.25% 0.19% 0.22% 0.18%
Percentage of Loans and Leases,
Net of Unearned Discount ....... 0.39% 0.59% 0.45% 0.51% 0.48%
</Table>
9
Nonperforming assets as a percentage of total assets decreased 0.09%
from the previous year and as a percentage of loans decreased 0.20%.
Nonperforming assets represent a drain on the earning ability of the Company.
Decreases in earnings 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, 2003 in the
opinion of management, the Company had $112,000 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.
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 .................... $ 775 $104 $ 671
Commercial Loans ..................... 418 222 196
Loans to Individuals ................. 354 146 208
------ ---- ------
Balance at December 31, 2003 ......... $1,547 $472 $1,075
====== ==== ======
</Table>
<Table>
<Caption>
Valuation Carrying
Total Allowance Value
------ --------- --------
(in thousands)
Real Estate Loans .................... $1,083 $207 $ 876
Commercial Loans ..................... 674 320 354
Loans to Individuals ................. 481 189 292
------ ---- ------
Balance at December 31, 2002 ......... $2,238 $716 $1,522
====== ==== ======
</Table>
For the years ended December 31, 2003 and 2002, the average recorded
investment in impaired loans was approximately $1,771,000 and $1,562,000,
respectively. During the years ended December 31, 2003 and 2002, 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 $104,000, $160,000 and $70,000 for the years
ended December 31, 2003, 2002 and 2001, respectively. If these loans had been
accruing interest at their original contracted rates, related income would have
been $155,000, $205,000 and $113,000 for the years ended December 31, 2003, 2002
and 2001, 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,
-----------------------------------------
2003 2002 2001
---------- ---------- ----------
(in thousands)
Balance at beginning of year ................... $ -- $ -- $ --
Acquisition of OREO ........................ -- 105 8
Disposition of OREO ........................ -- (105) (8)
---------- ---------- ----------
Balance at end of year ......................... $ -- $ -- $ --
========== ========== ==========
</Table>
10
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 current
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.
Purchase of premiums and discounts are recognized in interest income
using the interest method over the terms of the securities. Declines in
the fair value of HTM and AFS securities below their cost that are deemed
to be other than temporary are reflected in earnings as realized losses.
In estimating other-then-temporary impairment losses, management
considers (1) the length of time and the extent to which the fair value
has been less than cost, (2) the financial condition and near-term
prospects of the issuer, and (3) the intent and ability of the Company to
retain its investment in the issuer for a period of time sufficient to
allow for any anticipated recovery in fair value. Gains and losses on the
sale of securities are recorded on the trade date and are determined
using the specific identification method.
Management attempts to deploy investable funds into instruments which are
expected to provide a reasonable overall return on the portfolio given the
current assessment of economic and financial conditions, while maintaining
acceptable levels of capital, interest rate and liquidity risk.
11
The following table sets forth the carrying amount of investment
securities, mortgage-backed securities and marketable equity securities at
December 31, 2003, 2002 and 2001:
<Table>
<Caption>
December 31,
----------------------------------
Available for Sale: 2003 2002 2001
-------- -------- --------
(in thousands)
U.S. Treasury $ 20,946 $ 26,854 $ 11,065
U.S. Government Agencies 21,015 12,859 21,229
Mortgage-backed Securities:
Direct Govt. and Govt. Sponsored
Entity Issues 572,586 460,638 407,077
Other Private Issues 11,995 28,377 47,001
State and Political Subdivisions 101,807 111,646 126,421
Other Stocks and Bonds 24,778 22,541 21,390
-------- -------- --------
Total $753,127 $662,915 $634,183
======== ======== ========
</Table>
<Table>
<Caption>
December 31,
----------------------------------
Held to Maturity: 2003 2002 2001
-------- -------- --------
(in thousands)
Mortgage-backed Securities:
Direct Govt. Agency Issues $ 6,382 $ -- $ --
-------- -------- --------
Total $ 6,382 $ -- $ --
======== ======== ========
</Table>
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 Freddie Mac,
the Federal National Mortgage Association (the "FNMA") 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.
Mortgage-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, such as, fixed-rate or
adjustable-rate, as well as prepayment risk, are passed on to the certificate
holder. The term of a mortgage-backed pass-through security thus approximates
the term of the underlying mortgages.
12
The Company's mortgage-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 FNMA, Freddie Mac, 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.
The combined investment securities, mortgage-backed securities, and
marketable equity securities portfolio increased to $759.5 million at December
31, 2003, compared to $662.9 million at December 31, 2002, an increase of $96.6
million or 14.6%. Mortgage-backed securities increased $101.9 million or 20.8%
during 2003 when compared to 2002. State and Political Subdivisions decreased
$9.8 million or 8.8% during 2003. U.S. Treasury securities decreased during 2003
compared to 2002 by $5.9 million or 22.0%, U. S. Government agency securities
increased $8.2 million or 63.4%. Other stocks and bonds increased $2.2 million
or 9.9% in 2003 compared to 2002 due to increases of $658,000 in FHLB stock
dividends, $960,000 of trust preferred securities purchased during 2003 and
$619,000 of trust common securities associated with Southside Statutory Trust
III resulting from the adoption of FIN 46 on December 31, 2003. During 2003,
interest rates declined and the yield curve remained steep. The Company used
this low interest rate environment to reposition the securities portfolio in an
attempt to reduce the overall duration and minimize prepayment of premium
mortgage-backed securities. Higher coupon premium mortgage-backed securities
with high selling prices or with a potentially greater prepayment exposure were
replaced with mortgage-backed securities that had characteristics which
potentially might reduce the prepayment exposure. In some cases, higher coupon
premium 30 year mortgage-backed securities with prepayment exposure were
replaced with lower coupon premium 15 year mortgage-backed securities which
lowered the overall duration and potentially reduced the prepayment exposure.
Specific long duration municipal securities were sold and partially replaced
with better call protected or better risk reward profile municipal securities.
The decrease in the municipal securities portfolio was due partially in response
to the growth of the Company's municipal loan portfolio and the amount of tax
free income the Company can support without being subject to alternative minimum
tax long-term.
On January 1, 2001, the Company 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, the Company transferred held to maturity securities into the
available for sale category and the trading category. The Company 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, the
Company 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 the Company to reduce the overall duration of and reposition the
securities portfolio.
13
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 Company 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 Company with valuable balance
sheet opportunities. The higher cost associated with these callable CDs had a
negative impact on the 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%. As a result, the Company's interest expense on this $54.6
million declined after the CDs were called. The Company's current policy allows
for a maximum of $100 million in brokered CDs. The potential higher interest
cost and lack of customer loyalty are risks associated with the use of brokered
CDs. At December 31, 2003, 2002 and 2001, the Company had no brokered CDs and
brokered CDs represented zero percent of deposits.
The market value of the securities portfolio at December 31, 2003 was
$759.5 million, which represented a net unrealized gain on that date of $9.7
million. The net unrealized gain was comprised of $12.4 million in unrealized
gains and $2.8 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.
On January 1, 2004, the Company transferred mortgage-backed securities
totaling $44.4 million from AFS to HTM due to overall balance sheet strategies
and potential changes in market conditions. The Company has a significant amount
of long-term Federal Home Loan Bank fixed rate liabilities and determined it was
appropriate that a portion of the Company's securities portfolio should be
designated HTM. The unrealized loss on the securities transferred from AFS to
HTM was $319,000, net of tax, at the date of transfer based on the fair market
value of the securities on the transfer date. There were no sales from the HTM
portfolio during the years ended December 31, 2003, 2002 or 2001. There were no
securities classified as HTM for the years ended December 31, 2002 and 2001.
14
The maturities classified according to the sensitivity to changes in
interest rates of the December 31, 2003 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 ..................... $ 17,925 1.06% $ 3,021 3.34% $ -- -- $ -- --
U.S. Government Agencies .......... 11,724 1.12% 3,199 2.66% 6,092 4.27% -- --
Mortgage-backed Securities ........ 224,883 4.00% 329,160 3.77% 30,538 3.45% -- --
State and Political Subdivisions... 551 7.39% 3,583 6.83% 9,235 6.30% 88,438 7.00%
Other Stocks and Bonds ............ 22,794 1.50% -- -- -- -- 1,984 6.10%
-------- -------- -------- --------
Total ........................ $277,877 3.49% $338,963 3.79% $ 45,865 4.13% $ 90,422 6.98%
======== ======== ======== ========
</Table>
<Table>
<Caption>
MATURING OR REPRICING
---------------------------------------------------------------------------------------
After 1 But After 5 But
Within 1 Yr. Within 5 Yrs. Within 10 Yrs After 10 Yrs.
----------------- ------------------ ----------------- ------------------
Held to Maturity: Amount Yield Amount Yield Amount Yield Amount Yield
-------- ----- -------- ----- -------- ----- -------- -----
(dollars in thousands)
Mortgage-backed Securities... $ 442 4.57% $ 2,033 4.57% $ 3,907 4.57% $ -- --
-------- -------- -------- --------
Total................... $ 442 4.57% $ 2,033 4.57% $ 3,907 4.57% $ -- --
======== ======== ======== ========
</Table>
DEPOSITS AND BORROWED FUNDS
Deposits provide the Company with its primary source of funds. The
increase of $58.0 million or 7.1% in total deposits during 2003 provided the
Company with funds for the growth in loans. Deposits increased during 2003
primarily due to branch expansion the past few years and increased market
penetration. Time deposits decreased $22.8 million or 6.6% during 2003 compared
to 2002. Noninterest bearing demand deposits increased $36.3 million or 18.8%
during 2003. Interest bearing demand deposits increased $37.0 million or 15.5%
and Saving Deposits increased $7.5 million or 19.9% during 2003. The latter
three categories, which are considered the lowest cost deposits, comprised 63.1%
of total deposits at December 31, 2003 compared to 57.6% at December 31, 2002.
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, 2003, 2002, and 2001:
<Table>
<Caption>
Years Ended December 31,
--------------------------------
2003 2002 2001
-------- -------- --------
(in thousands)
Noninterest Bearing Demand Deposits ......... $229,649 $193,305 $171,802
Interest Bearing Demand Deposits ............ 275,174 238,215 210,742
Savings Deposits ............................ 45,559 38,012 29,628
Time Deposits ............................... 322,147 344,954 345,782
-------- -------- --------
Total Deposits ....................... $872,529 $814,486 $757,954
======== ======== ========
</Table>
15
During the year ended December 31, 2003, total time deposits of $100,000
or more decreased $2.2 million from December 31, 2002. Total time deposits of
$100,000 or more, excluding State of Texas time deposits, decreased $9.2 million
or 8.7% during 2003 compared to 2002, while State of Texas time deposits
increased $7.0 million or 19.7%.
The table below sets forth the maturity distribution of time deposits of
$100,000 or more issued by the Company at December 31, 2003 and 2002:
<Table>
<Caption>
December 31, 2003 December 31, 2002
---------------------------------------- -----------------------------------------
Time Other Time Other
Certificates Time Certificates Time
of Deposit Deposits Total of Deposit Deposits Total
------- ------- -------- -------- ------- --------
(in thousands)
Three months or less ......... $28,456 $21,000 $ 49,456 $ 35,923 $21,000 $ 56,923
Over three to six months ..... 19,051 21,000 40,051 19,991 14,000 33,991
Over six to twelve months .... 20,828 -- 20,828 19,053 459 19,512
Over twelve months ........... 27,582 459 28,041 30,146 -- 30,146
------- ------- -------- -------- ------- --------
Total ................ $95,917 $42,459 $138,376 $105,113 $35,459 $140,572
======= ======= ======== ======== ======= ========
</Table>
Short-term Obligations, consisting primarily of FHLB advances and Federal
Funds Purchased, increased $27.0 million or 15.7% during 2003 when compared to
2002. FHLB advances are collateralized by FHLB stock, nonspecified real estate
loans and securities.
<Table>
<Caption>
Years Ended December 31,
--------------------------------------
2003 2002 2001
-------- -------- --------
(dollars in thousands)
Federal funds purchased
Balance at end of period ...................................... $ 3,525 $ 15,850 $ 25,900
Average amount outstanding during the period (1) .............. 1,300 2,122 3,285
Maximum amount outstanding during the period .................. 24,275 22,875 25,900
Weighted average interest rate during the period (2) .......... 1.4% 2.1% 4.0%
Interest rate at end of period ................................ 1.2% 1.8% 1.9%
Federal Home Loan Bank ("FHLB") Dallas short-term advances
Balance at end of period ...................................... $192,608 $153,422 $114,177
Average amount outstanding during the period (1) .............. 156,854 152,896 165,100
Maximum amount outstanding during the period .................. 210,608 188,477 207,744
Weighted average interest rate during the period (2) .......... 3.9% 3.7% 4.3%
Interest rate at end of period ................................ 3.4% 4.1% 3.3%
Other obligations
Balance at end of period ...................................... $ 2,598 $ 2,500 $ 2,500
Average amount outstanding during the period (1) .............. 1,144 1,707 1,799
Maximum amount outstanding during the period .................. 11,429 2,544 3,301
Weighted average interest rate during the period (2) .......... 0.9% 1.5% 3.6%
Interest rate at end of period ................................ 0.7% 1.0% 1.4%
Short-term junior subordinated debentures (3)
Balance at end of period ...................................... $ -- $ -- $ --
Average amount outstanding during the period (1) .............. 1,753 -- --
Maximum amount outstanding during the period .................. 20,000 -- --
Weighted average interest rate during the period (2) .......... 8.5% -- --
Interest rate at end of period ................................ -- -- --
</Table>
16
(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.
(3) Southside Capital Trust I from September 4, 2003, when redemption was
announced, to October 6, 2003, when redemption was completed.
Long-term Obligations of FHLB advances increased $20.9 million or 9.1%
during 2003 to $252.1 million when compared to $231.1 million in 2002. The
increase was primarily the result of additional funding obtained to fund
security purchases made during 2003.
Long-term junior subordinated convertible debentures decreased $14.2
million during 2003 or 100% when compared to December 31, 2002. During the year
ended December 31, 2003, 1,415,965 convertible trust preferred shares were
converted into the Company's common stock.
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 had a convertible
feature that allowed the owner to convert each security to a share of the
Company's common stock at an adjusted conversion price of $8.64 per common
share. These securities had a distribution rate of 8.75% per annum payable at
the end of each calendar quarter. On December 31, 2003, Southside Capital Trust
II, a subsidiary of Southside Bancshares, Inc., redeemed 6,571 shares of its
8.75% Cumulative Convertible Trust Preferred Securities and all of its 8.75%
Common Securities which totaled $678,000. Prior to the redemption date, December
31, 2003, all other convertible trust preferred shares were converted into the
Company's common stock. This increased the Company's number of shares of common
stock outstanding to 10,358,880 at December 31, 2003.
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
had a distribution rate of 8.50% per annum payable at the end of each calendar
quarter. On October 6, 2003, Southside Capital Trust, a subsidiary of Southside
Bancshares, Inc., redeemed all of its 8.50% Cumulative Trust Preferred
Securities and 8.50% Trust Common Securities which totaled $20,618,560.
Southside Bancshares funded the redemption through the issuance of $20,000,000
of trust preferred securities and $619,000 of trust common securities that
adjust quarterly at a rate equal to the three month LIBOR plus 294 basis points.
The lower interest rate provided interest savings during the fourth quarter and
should provide a better match for the overall interest rate sensitivity position
of the Company.
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 last ten years the East Texas economy has
diversified, decreasing the overall impact of fluctuating oil prices, however,
the East Texas economy is still affected by the oil industry. During 2003 the
economy in the Company's market area has shown some signs of modest growth. The
two areas of concern are the slow rate of job growth in the local and national
labor markets and the personal bankruptcy rate. Management anticipates these two
events could 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.
17
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 vigorously for a share of the financial services
market. The Company expects the number of financial institutions in the
Company's market area to continue to increase. 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. Additionally, the
Company must compete against several institutions located in East Texas and
elsewhere in the Company's market area which have capital resources and legal
loan limits substantially in excess of those available to the Company. The
Company faces competition from institutions that offer products and services the
Company does not or cannot currently offer. Some institutions the Company
competes with offer interest rate levels on loan and deposit products the
Company is unable to profitably offer. The Company expects the competition to
increase.
EMPLOYEES
At February 27, 2004, the Company employed approximately 437 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, 2003, were as follows:
B. G. Hartley (Age 74), 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 Bank, having served in these capacities since the Bank's
inception in 1960.
Sam Dawson (Age 56), President, Secretary and Director of the Company.
President, Chief Operations Officer and Director of the Bank since 1996. He
became an officer of the Company in 1982 and of the Bank during 1975.
Robbie N. Edmonson (Age 71), Vice Chairman of the Board of the Company and the
Bank. He joined the Bank as a vice president in 1968.
Jeryl Story (Age 52), Executive Vice President of the Company. Senior Executive
Vice President - Loan Administration, Senior Lending Officer and Director of the
Bank, since 1996. He joined the Bank in 1979 as an officer in Loan
Documentation.
Lee R. Gibson (Age 47), Executive Vice President and Chief Financial Officer of
the Company and of the Bank. He is also a Director of the Bank. He became an
officer of the Company in 1985 and of the Bank during 1984.
All the individuals named above serve in their capacity as officers of
the Company and/or the Bank and are appointed by the Board of Directors of each
entity.
18
SUPERVISION AND REGULATION
Banking is a complex, highly regulated industry. Consequently, the
Company's growth and earnings performance can be affected not only by decisions
of management and national 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, the Federal Deposit Insurance
Corporation ("FDIC"), the Department of Banking of the State of Texas, United
States Department of Treasury (the "Treasury Department"), the Internal Revenue
Service and state taxing authorities.
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 operations and is intended primarily for the protection of the
FDIC's deposit insurance funds, the Bank's depositors and the public, rather
than the Company's shareholders and creditors. The following summarizes 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.
The Company
Bank Holding Company Act. 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 (i) for the acquisition of more
than five percent of the voting stock in any bank or bank holding company, (ii)
for the acquisition of substantially all the assets of any bank or bank holding
company or (iii) in order to merge or consolidate with another bank holding
company. 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. As discussed below, the Gramm-Leach-Bliley Act, which was
enacted in 1999, established a new type of bank holding company known as a
"financial holding company" that has powers that are not otherwise available to
bank holding companies.
The Bank Holding Company Act restricts the extension of credit to any
bank holding company by its 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 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.
Gramm-Leach-Bliley 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 Act
of 1999 ("GLBA"), which became effective on March 11, 2000, amended the Bank
Holding Company Act and removed certain legal barriers separating the conduct of
various types of
19
financial services businesses. In addition, GLBA substantially revamped the
regulatory scheme within which financial institutions operate.
Under GLBA, bank holding companies meeting certain eligibility
requirements may elect to become a "financial holding company." A financial
holding company may engage in activities that are "financial in nature," as well
as additional activities that the Federal Reserve or Treasury Department
determine are financial in nature or incidental or complimentary to financial
activities. Under GLBA, "financial activities" specifically include insurance,
securities underwriting and dealing, merchant banking, investment advisory and
lending activities.
A bank holding company may become a financial holding company under
GLBA if each of its subsidiary banks is "well capitalized" under the FDIC
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, GLBA 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 GLBA, 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. GLBA also imposes additional restrictions
and heightened disclosure requirements regarding private information collected
by financial institutions. The Company has not elected to become a financial
holding company and to conduct the broader activities permitted under GLBA.
However, there can be no assurance that the Company will not make such an
election in the future.
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 age and deposit concentration limits. In addition,
Texas banking laws permit a bank holding company that 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 has 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 FDIC
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 and the Bank'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.
20
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.
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, 2003,
the Company's total risk-based capital ratio was 18.40%, the Company's Tier 1
risk-based capital ratio was 17.42% and the Company's leverage capital ratio was
8.12%.
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, 2003, 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 receives 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 and
serve as a source of strength for the bank.
Change in Bank Control Act. Under the Change in Bank Control Act,
persons who intend to acquire control of a bank holding company, either directly
or indirectly, must give 60 days prior notice to the Federal Reserve. "Control"
would exist when an acquiring party directly or indirectly has control of at
least 25% of the Company's voting securities or the power to direct the
management or policies of the Company. Under Federal Reserve regulations, a
rebuttable presumption of control would arise with respect to an acquisition
where, after the transaction, the acquiring party has ownership control or the
power to vote at least 10% (but less than 25%) of the Company's voting
securities.
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 TDB and the FDIC. The TDB and the FDIC 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.
21
Regulation of Lending Activities. Loans made by the Bank are subject to
numerous federal and state laws and regulations, including the Truth-In-Lending
Act, Federal Consumer Credit Protection Act, the Texas Finance Code, 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.
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 FDIC 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 FDIC.
The exact amount of future dividends on the stock of the Bank will be a
function of the profitability of the Bank in general, applicable tax rates in
effect from year to year and the discretion of the board of directors of the
Bank. The Bank's ability to pay dividends in the future will directly depend on
the Bank's 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. At December 31, 2003, the Bank was well-capitalized and had a total
risk-based capital ratio of 17.79%, a Tier 1 risk-based capital ratio of 16.81%
and a leverage capital ratio of 7.83%.
The 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, 2003, 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, 2003 were
in excess of the minimum requirements.
Also see discussion of "Capital Resources" under Item 7.
Prompt Corrective Action. Banks are subject to restrictions on their
activities depending on their level of capital. The FDIC'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
22
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 FDIC 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 FDIC. 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 FDIC of a
capital restoration plan for the bank.
If a state nonmember bank is classified as undercapitalized, the FDIC
may take certain actions to correct the capital position of the bank. If a bank
is classified as significantly undercapitalized, the FDIC 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 FDIC 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 FDIC 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 FDIC may, on a
case-by-case basis, permit banks that are adequately capitalized to accept
brokered deposits if the FDIC determines that acceptance of such deposits would
not constitute an unsafe or unsound banking practice with respect to the bank.
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 FDIC 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."
23
Deposit Insurance. The Bank's deposits are insured up to $100,000 per
depositor by the Bank Insurance Fund. As insurer, the FDIC imposes deposit
premiums and is authorized to conduct examinations of and to require reporting
by the Bank. The FDIC 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 FDIC 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 assessment rates, so that banks classified as strongest
were subject in 2003 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 2003 to an assessment on 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 2003. 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.
USA PATRIOT Act. Following the events of September 11, 2001, President
Bush, on October 26, 2001, 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 "USA PATRIOT Act," the law enhances the powers of the
federal government and law enforcement organizations to combat terrorism,
organized crime and money laundering. The USA 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
compliance and due diligence 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.
On April 24, 2002, the Treasury Department issued regulations under the
USA PATRIOT Act. The regulations state that a depository institution will be
deemed in compliance with the Act provided it continues to comply with the
current Bank Secrecy Act regulations.
Transactions with Affiliates. Transactions between the Bank and any of
their affiliates (including the Company) are governed by Sections 23A and 23B of
the Federal Reserve Act. An affiliate of a bank is any company or entity that
controls, is controlled by or is under common control with the bank. A
subsidiary of a bank that is not also a depository institution is not treated as
an affiliate of a bank for purposes of Sections 23A and 23B unless it engages in
activities not permissible for a national bank to engage in directly. Generally,
Sections 23A and 23B (i) limit the extent to which a bank or its subsidiaries
may engage in "covered transactions" with any one affiliate to an amount equal
to 10% of such institution's capital stock and surplus, and limit such
transactions with all affiliates to an amount equal to 20% of such capital stock
and surplus, and (ii) require that all such transactions be on terms that are
consistent with safe and sound banking practices. The term "covered transaction"
includes the making of loans to an affiliate, the purchase of or investment in
securities issued by an affiliate, the purchase of assets from an affiliate, the
issuance of a guarantee for the benefit of an affiliate, and similar
transactions. Most loans by a bank to any of its affiliates must be secured by
collateral in amounts ranging from 100 to 130 percent of the loan amount,
depending on the nature of the collateral. In addition, any covered transaction
by a bank with an affiliate and any sale of assets or provision of services to
an affiliate must be on terms that are substantially the same, or at least as
favorable, to the bank as those prevailing at the time for comparable
transactions with nonaffiliated companies. The Bank is also restricted in the
loans that it may make to its executive officers, and directors, the executive
officers and directors of the Company, any owner of 10% or more of its stock or
the stock of the Company, and certain entities affiliated with any such person.
24
On October 31, 2002, the Federal Reserve issued a new regulation,
Regulation W, effective April 1, 2003, that comprehensively implements sections
23A and 23B of the Federal Reserve Act, which are intended to protect insured
depository institutions from suffering losses arising from transactions with
affiliates. The regulation unifies and updates staff interpretations issued over
the years, incorporates several new interpretative proposals (such as to clarify
when transactions with an unrelated third party will be attributed to an
affiliate) and addresses new issues arising as a result of the expanded scope of
nonbanking activities engaged in by Bank and bank holding companies in recent
years and authorized for financial holding companies under GLBA.
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 FDIC has adopted regulations under the Reigle-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.
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.
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 Company,
therefore, cannot be predicted accurately.
25
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 United States
generally accepted accounting principles and comply with such other disclosure
requirements as prescribed by the FDIC.
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 and the
effects thereof on the Company and the Bank.
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 the Company. A federal statute removes
interest ceilings under usury laws for loans by the Company that are secured by
first liens on residential real property.
ECONOMIC ENVIRONMENT
The monetary policies of regulatory authorities, including the Federal
Reserve, have a significant effect on the operating results of bank holding
companies and their subsidiaries. The Federal Reserve regulates the national
supply of bank credit. Among the means available to the Federal Reserve 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.
26
ITEM 2. PROPERTIES
Southside Bank owns or operates the following properties:
o Southside main branch at 1201 South Beckham Avenue, Tyler,
Texas. The executive offices of Southside Bancshares, Inc. are
located at this location.
o Southside Bank Annex at 1211 South Beckham Avenue, Tyler,
Texas. The Southside Annex is directly adjacent to the main
bank building. Human Resources, the Trust Department and other
support areas are located in this building.
o Operations Annex at 1221 South Beckham Avenue, Tyler, Texas.
Various back office lending, training facilities and other
support areas are located in this building.
o Southside main branch motor bank facility at 1010 East First
Street, Tyler, Texas.
o South Broadway branch at 6201 South Broadway, Tyler, Texas.
o South Broadway branch motor bank facility at 6019 South
Broadway, Tyler, Texas.
o Downtown branch at 113 W. Ferguson Street, Tyler, Texas.
o Gentry Parkway branch and motor bank facility at 2121 West
Gentry Parkway, Tyler, Texas.
o Longview main branch and motor bank facility at 2001 Judson
Road, Longview, Texas.
o Lindale main branch and motor bank facility at 2510 South Main
Street, Lindale Texas.
o Whitehouse main branch and motor bank facility at 901 Highway
110 North, Whitehouse, Texas.
o Thirty-one Automatic Teller Machines (ATM's) located
throughout Smith and Gregg Counties.
Southside bank leases the following locations:
The Company currently operates full service banks in leased space in
twelve grocery stores in the following locations:
o One in Bullard, Texas
o One in Lindale, Texas
o One in Flint, Texas
o One in Whitehouse, Texas
o Three in Longview, Texas
o Five in Tyler, Texas
All of the properties detailed above are suitable and adequate to
provide the banking services intended based on the type of property described.
In addition, the properties for the most part are fully utilized but designed
with productivity in mind and can handle the additional business volume the
Company anticipates it will generate. As additional needs are identified,
individual property enhancements or the need to add properties will be
evaluated.
27
ITEM 3. LEGAL PROCEEDINGS
The 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 the Bank.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the three months ended December 31, 2003, 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.
28
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
MARKET INFORMATION
The Company's common stock trades on the Nasdaq National Market under
the symbol "SBSI." The high/low prices shown below represent the daily weighted
average prices on the Nasdaq National Market for the period from January 1, 2002
to December 31, 2003. During the third quarters of 2003 and 2002, 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, 2003 $ 16.95 - 14.00 $ 18.60 - 15.62 $ 17.22 - 16.02 $ 18.97 - 15.97
December 31, 2002 $ 12.63 - 11.33 $ 14.78 - 12.10 $ 14.63 - 11.87 $ 14.51 - 12.91
</Table>
See "Item 7. Capital Resources" for a discussion of the Company's
common stock repurchase program.
STOCKHOLDERS
There were approximately 1,095 holders of record of the Company's
common stock, the only class of equity securities currently issued and
outstanding, as of February 27, 2004.
DIVIDENDS
Cash dividends declared and paid were $ 0.36, $0.33 and $0.25 per share
for the years ended December 31, 2003, 2002 and 2001 respectively. Stock
dividends of 5% were also declared and paid during each of the years ended
December 31, 2003, 2002 and 2001. 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. For additional discussion relating to
restrictions that limit the Company's ability to pay dividends refer to
"Supervision and Regulation" and "Capital Guidelines" in Item 1. Business and
"Capital Resources" in Item 7. Managements Discussion and Analysis of Financial
Condition and Results of Operations. The cash dividends were paid quarterly each
year as listed below.
Quarterly Cash Dividends Paid
<Table>
<Caption>
Year Ended 1st qtr. 2nd qtr. 3rd qtr. 4th qtr.
- ----------------- -------- -------- -------- --------
December 31, 2003 $ 0.08 $ 0.08 $ 0.10 $ 0.10
December 31, 2002 $ 0.07 $ 0.09 $ 0.07 $ 0.10
December 31, 2001 $ 0.06 $ 0.06 $ 0.06 $ 0.07
</Table>
29
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, 2003.
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,
----------------------------------------------------------------------
2003 2002 2001 2000 1999
------------ ------------ ------------ ------------ ----------
(in thousands, except per share data)
Balance Sheet Data:
Investment Securities ................................. $ 144,876 $ 151,509 $ 158,818 $ 161,285 $ 182,452
============ ============ ============ ============ ==========
Mortgage-backed and Related Securities ................ $ 590,963 $ 489,015 $ 454,078 $ 412,247 $ 347,574
============ ============ ============ ============ ==========
Loans, Net of Allowance for Loan Loss ................. $ 582,721 $ 564,265 $ 528,124 $ 476,402 $ 382,249
============ ============ ============ ============ ==========
Total Assets .......................................... $ 1,454,952 $ 1,349,186 $ 1,276,737 $ 1,151,881 $1,012,565
============ ============ ============ ============ ==========
Deposits .............................................. $ 872,529 $ 814,486 $ 757,954 $ 720,605 $ 587,544
============ ============ ============ ============ ==========
Long-term Obligations ................................. $ 272,694 $ 265,365 $ 297,663 $ 216,595 $ 194,704
============ ============ ============ ============ ==========
Income Statement Data:
Interest & Deposit Service Income ..................... $ 73,958 $ 79,959 $ 87,559 $ 83,463 $ 67,468
============ ============ ============ ============ ==========
Income before cumulative effect of change in
accounting principle .................................. $ 13,564 $ 13,325 $ 12,725 $ 9,825 $ 7,924
============ ============ ============ ============ ==========
Net Income ............................................ $ 13,564 $ 13,325 $ 11,731 $ 9,825 $ 7,924
============ ============ ============ ============ ==========
Per Share Data:
Net Income Per Common Share:
Basic before cumulative effect of change in
accounting principle .............................. $ 1.50 $ 1.53 $ 1.47 $ 1.11 $ 0.89
============ ============ ============ ============ ==========
Basic ............................................... $ 1.50 $ 1.53 $ 1.36 $ 1.11 $ 0.89
============ ============ ============ ============ ==========
Diluted before cumulative effect of change in
accounting principle .............................. $ 1.28 $ 1.28 $ 1.24 $ 1.07 $ 0.86
============ ============ ============ ============ ==========
Diluted ............................................. $ 1.28 $ 1.28 $ 1.15 $ 1.07 $ 0.86
============ ============ ============ ============ ==========
Cash Dividends Paid Per Common Share .................. $ 0.36 $ 0.33 $ 0.25 $ 0.225 $ 0.20
============ ============ ============ ============ ==========
</Table>
30
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, 2003, 2002 and
2001 and financial condition as of December 31, 2003 and 2002. 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.
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 Southside Bancshares, Inc., (the "Company") a bank holding
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," "could," "should," "may," "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, economic or other disruptions caused by military actions
in Iraq, Haiti or other areas, changes in the interest rate environment which
reduce interest margins and may impact prepayments on the mortgage-backed
securities portfolio, changes effecting the leverage strategy, 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.
CRITICAL ACCOUNTING ESTIMATES
The accounting and reporting estimates of the Company conform with
accounting principles generally accepted in the United States and general
practices within the financial services industry. The preparation of financial
statements in conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes. Actual results could differ
from those estimates. The Company considers its critical accounting policies to
include the following:
Allowance for Losses on Loans. The allowance for losses on loans
represents management's best estimate of probable losses inherent in the
existing loan portfolio. The allowance for losses on loans is increased by the
provision for losses on loans charged to expense and reduced by loans
charged-off, net of recoveries. The provision for losses on loans is determined
based on management's assessment of several factors: reviews and evaluations of
specific loans, changes in the nature and volume of the loan portfolio, current
and anticipated economic conditions and the related impact on specific borrowers
and industry groups, historical loan loss experience, the level of classified
and nonperforming loans and the results of regulatory examinations.
31
The loan loss allowance is based on the most current review of the loan
portfolio at that time. The servicing officer has the primary responsibility for
updating significant changes in a customer's financial position. 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. An internal loan 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.
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 allowances. A list of loans
or loan relationships of $50,000 or more, which are graded as having more than
the normal degree of risk associated with them, is maintained by the internal
loan review officer. This list is updated on a periodic basis, but no less than
quarterly in order to properly allocate necessary allowance and keep management
informed on the status of attempts to correct the deficiencies noted in the
credit.
In addition to maintaining an ongoing review of the loan portfolio, the
internal loan 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 allowance necessary,
in addition to the portion which is specifically allocated by loan. The internal
loan review officer also uses the loan portfolio data collected to determine the
allocation of the allowance for loan loss appropriate for the risk in each of
the Company's major loan categories.
Loans are considered impaired if, based on current information and
events, 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. The measurement of impaired loans is generally based on the
present value of expected future cash flows discounted at the historical
effective interest rate stipulated in the loan agreement, except that all
collateral-dependent loans are measured for impairment based on fair value of
the collateral. In measuring the fair value of the collateral, management uses
assumptions (e.g. discount rates) and methodologies (e.g. comparison to the
recent selling price of similar assets) consistent with those that would be
utilized by unrelated third parties.
Changes in the financial condition of individual borrowers, in economic
conditions, in historical loss experience and in the conditions of the various
markets in which collateral may be sold may all affect the required level of the
allowance for losses on loans and the associated provision for loan losses.
As of December 31, 2003, the Company's review of the loan portfolio
indicates that a loan loss allowance of $6.4 million is adequate to cover
probable losses in the portfolio.
Refer to Item 1 entitled Loan Loss Experience and Allowance 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.
Estimation of Fair Value. The estimation of fair value is significant
to a number of the Company's assets, including available for sale investment
securities and other real estate owned. These are all recorded at either fair
value or at the lower of cost or fair value. Furthermore, accounting principles
generally accepted in the United Sates require disclosure of the fair value of
financial instruments as a part of the notes to the consolidated financial
statements. Fair values are volatile and may be influenced by a number of
factors, including market interest rates, prepayment speeds, discount rates and
the shape of yield curves.
32
Fair values for most available for sale investment securities are based
on quoted market prices, where available. If quoted market prices are not
available, fair values are based on the quoted prices of similar instruments.
The fair values of other real estate owned are typically determined based on
appraisals by third parties, less estimated costs to sell.
Defined Benefit Retirement Plan. The plan obligations and related
assets of the defined benefit retirement plan are presented in Note 13 of the
Notes to Consolidated Financial Statements. Plan assets, which consist primarily
of marketable equity and debt instruments, are valued using market quotations.
Plan obligations and the annual pension expense are determined by independent
actuaries and through the use of a number of assumptions. Key assumptions in
measuring the plan obligations include the discount rate, the rate of salary
increases and the estimated future return on plan assets. In determining the
discount rate, the Company utilizes the yield on high-quality, fixed-income
investments currently available with maturities corresponding to the anticipated
timing of the benefit payments. Salary increase assumptions are based upon
historical experience and anticipated future management actions. Asset returns
are based upon the anticipated average rate of earnings expected on the invested
funds of the plan. At December 31, 2003, the weighted-average actuarial
assumption of the Company's plan were: discount rate 6.5%; long-term rate of
return on plan assets 9.0%; and assumed salary increases 4.50%. Material changes
in pension benefit costs may occur in the future due to changes in these
assumptions. Future annual amounts could be impacted by changes in the number of
plan participants, changes in the level of benefits provided, changes in the
discount rates, changes in the expected long-term rate of return, changes in the
level of contributions to the plan and other factors.
OVERVIEW
OPERATING RESULTS
During the year ended December 31, 2003, the Company's net income
increased $239,000 or 1.8% to $13.6 million, from $13.3 million for the same
period in 2002. The increase in net income was primarily attributable to an
increase in noninterest income and a decrease in provision for loan losses.
Noninterest income increased primarily due to the increases in deposit services
income, mortgage servicing release fees income, gains on sales of securities
available for sale and other noninterest income. These increases were partially
offset by an increase in noninterest expense, a decrease in net interest income
and an increase in income taxes. The majority of the increase in noninterest
expense was a result of bank growth and the costs associated with the opening of
six new branches during 2002 and 2003 and amortization expense related to
expensing the unamortized origination cost associated with the redemption of
Southside Capital Trust I. Earnings per fully diluted share were $1.28 for each
of the years ended December 31, 2003 and 2002.
FINANCIAL CONDITION
Total assets increased $105.8 million or 7.8% to $1.45 billion at
December 31, 2003 from $1.35 billion at December 31, 2002. The increase was
primarily attributable to a $96.6 million increase in the securities portfolio
and to a lesser extent a $18.5 million increase in net loans. The securities
portfolio totaled $759.5 million at December 31, 2003 compared to $662.9 million
at December 31, 2002. At December 31, 2003, net loans were $582.7 million
compared to $564.3 million at December 31, 2002. The increase in securities and
loans was funded by increases in deposits and FHLB advances.
Nonperforming assets at December 31, 2003 decreased to $2.3 million, and
represented 0.16% of total assets, compared to $3.4 million or 0.25% of total
assets at December 31, 2002. Nonaccruing loans decreased to $1.5 million and the
ratio of nonaccruing loans to total loans decreased to 0.26% at December 31,
2003 as compared to $2.2 million and 0.39% at December 31, 2002. Other real
estate owned decreased to $195,000 at December 31, 2003 from $524,000 at
December 31, 2002. Loans 90 days past due at December 31, 2003 decreased to
$272,000 compared to $287,000 at December 31, 2002. Restructured loans at
December 31, 2003 decreased to $219,000 compared to $325,000 at December 31,
2002. Overall, asset quality improved during 2003.
33
Deposits increased $58.0 million to $872.5 million at December 31, 2003
from $814.5 million at December 31, 2002. FHLB advances were $444.7 million at
December 31, 2003, a $60.1 million increase from $384.6 million at December 31,
2002. Short-term FHLB advances increased $39.2 million to $192.6 million at
December 31, 2003 from $153.4 million at December 31, 2002. Long-term FHLB
advances increased $20.9 million to $252.1 million at December 31, 2003 from
$231.1 million at December 31, 2002. Other borrowings at December 31, 2003 and
2002 totaled $26.7 million and $52.6 million, respectively, and at December 31,
2003 consisted of $6.1 million of Short-term borrowings and $20.6 million of
Long-term debt.
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 had a convertible
feature that allowed the owner to convert each security to a share of the
Company's common stock at an adjusted conversion price of $8.64 per common
share. These securities had a distribution rate of 8.75% per annum payable at
the end of each calendar quarter. On December 31, 2003, Southside Capital Trust
II, a subsidiary of Southside Bancshares, Inc., redeemed 6,571 shares of its
8.75% Cumulative Convertible Trust Preferred Securities and all of its 8.75%
Common Securities which totaled $678,000. Prior to the redemption date, December
31, 2003, all other convertible trust preferred shares were converted into the
Company's common stock. This increased the Company's number of shares of common
stock outstanding to 10,358,880 at December 31, 2003.
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
had a distribution rate of 8.50% per annum payable at the end of each calendar
quarter. On October 6, 2003, Southside Capital Trust, a subsidiary of Southside
Bancshares, Inc., redeemed all of its 8.50% Cumulative Trust Preferred
Securities and 8.50% Trust Common Securities which totaled $20,618,560.
Southside Bancshares funded the redemption through the issuance of $20,000,000
of trust preferred securities and $619,000 of trust common securities that
adjust quarterly at a rate equal to the three month LIBOR plus 294 basis points.
The lower interest rate provided interest savings during the fourth quarter and
should provide a better match for the overall interest rate sensitivity position
of the Company.
Shareholders' equity at December 31, 2003 totaled $100.4 million compared
to $80.3 million at December 31, 2002. The increase primarily reflects the net
income recorded for the year ended December 31, 2003, and the increase in the
common stock issued of $14.5 million as a result of conversions from the
Company's junior subordinated convertible debentures into the Company's common
stock and the Company's incentive stock option and dividend reinvestment plans.
These increases were partially offset by the repurchase of 221,800 shares of the
outstanding stock at an average price of $17.27 per share, the payment of cash
dividends and a decrease in the accumulated other comprehensive income of $1.2
million.
During 2003 the economy in the Company's market area appeared to show
some signs of modest growth. The two areas of concern are the slow rate of job
growth in the local and national labor markets and the personal bankruptcy rate.
Management anticipates these two events could 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.
Key financial indicators management follows include but are not limited
to, numerous interest rate sensitivity and risk, credit risk, operations risk,
liquidity risk, capital risk, regulatory risk, competition risk, and economic
risk.
34
LEVERAGE STRATEGY
In May 1998 the Company implemented a leverage strategy designed with the
potential to enhance its profitability by maximizing the use of the Company's
capital with acceptable levels of credit, interest rate and liquidity risk. The
leverage strategy consists of borrowing a combination of long and short-term
funds from the Federal Home Loan Bank of Dallas (the "FHLB") and investing the
funds primarily in premium mortgage-backed securities, and to a lesser extent,
long-term municipal securities. Although premium 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. In addition, in low
interest rate environments the amortization expense for premium mortgage-backed
securities is associated with substantially higher prepayments experienced and
reduces the overall yields of the premium mortgage-backed securities portfolio.
While the strategy of investing a substantial portion of the Company's assets in
premium 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 risk combined with the managed interest rate risk of this
strategy have enhanced its overall profitability over the last several years. At
this time, the Company maintains the leverage strategy for the purpose of
enhancing overall profitability by maximizing the use of the Company's capital.
Risks associated with the asset structure the Company maintains are a lower net
interest rate spread and margin when compared to its peers and increased
interest rate risk. The Company's asset structure, spread and margin increases
the need to monitor the Company's interest rate risk. An additional risk is the
change in market value of the AFS securities portfolio as a result of changes in
interest rates. Significant increases in interest rates could impact the
Company's equity capital significantly.
The Company will attempt to adopt a balance sheet strategy going
forward to gradually reduce the securities portfolio as a percentage of earning
assets assuming adequate quality loan growth is available in the Company's
market area. If adequate quality loan growth is not available to achieve the
Company's goal of enhancing profitability by maximizing the use of the Company's
capital, as described above, then additional securities will be purchased.
During 2003, sufficient quality loan growth was not available at a market price
the Company was willing to accept. As a result, the securities portfolio as a
percentage of total assets increased to 52.2% at December 31, 2003 from 49.1% at
December 31, 2002. On the liability side, the Company will continue to utilize a
combination of advances and deposits to achieve its strategy of minimizing cost
while achieving overall interest rate risk objectives as well as Asset Liability
Committee (ALCO) objectives. During the 2003 low interest rate environment,
long-term deposits necessary to balance ALCO objectives, as a result of
long-term assets added to the balance sheet, have not been available in the
Company's market area at a market price the Company was willing to accept. As a
result, FHLB borrowings as a percentage of deposits increased to 51.0% at
December 31, 2003 from 47.2% at December 31, 2002. The intended net result of
the overall balance sheet strategy 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, the length of interest rate cycles, and
the slope of the interest rate yield curve, net interest income could fluctuate
more than simulated under the ALCO scenarios modeled.
35
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, prepayment rates of mortgage-backed securities and
loans, repricings of loan relationships, 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,
2003 COMPARED TO DECEMBER 31, 2002
NET INTEREST INCOME
Net interest income is one of the principal sources 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.
Net interest income for the year ended December 31, 2003 was $31.3
million, a decrease of $1.5 million or 4.6% compared to the same period in 2002.
The overall decrease in net interest income was due to the fact that decreases
in interest income from loans and securities were more than decreases in
interest expense from deposits and other borrowings which decreased the net
yield on average interest earning assets. Average interest earning assets
increased $69.6 million or 5.8%, and the net yield on average interest earning
assets decreased from 3.11% at December 31, 2002 to 2.80% at December 31, 2003.
Net interest income decreased during the first nine months ended September 30,
2003 as a result of decreases in the Company's net interest margin and spread to
2.74% and 2.26%, respectively, when compared to the same period in 2002, which
was due in large part to significantly lower mortgage interest rates and the
lower overall interest rate environment primarily during the second quarter
ended June 30, 2003. This led to substantially increased residential mortgage
refinancing nationwide and in the Company's market area combined with increased
repricing of all of the Company's other loan types primarily during the second
quarter ended June 30, 2003 and the third quarter ended September 30, 2003.
Net interest income increased during the fourth quarter as a result of
increases in the Company's net interest margin and spread during the fourth
quarter ended December 31, 2003 to 2.96% and 2.55%, respectively when compared
to 2.87% and 2.36%, respectively for the same period in 2002, which was due to
several factors. The higher overall interest rate environment during the fourth
quarter ended December 31, 2003 led to decreased residential mortgage
refinancing nationwide and in the Company's market area combined with decreased
repricing of all of the Company's other loan types during the fourth quarter
ended December 31, 2003. A return to long-term interest rate levels experienced
in May and June of 2003 could impact the Company's net interest margin in the
future due to increased prepayments and repricings. Other factors that impacted
Southside's net interest margin and spread included $31.9 million of fixed rate
FHLB advances at an average rate of 3.86% that repriced during the fourth
quarter of 2003, and the reduction in interest expense on Southside Bancshares
trust preferred securities during the fourth quarter ended December 31, 2003. An
increase in average earning assets during the fourth quarter ended December 31,
2003 was also a contributing factor for the increase in net interest income.
36
During the year ended December 31, 2003, average loans, funded by the
growth in average deposits, increased $22.3 million or 4.1%, compared to the
same period in 2002. The average yield on loans decreased from 7.17% at December
31, 2002 to 6.50% at December 31, 2003, reflective of an overall average
decrease in interest rates. As interest rates declined, especially short-term
interest rates, loan customers increasingly requested floating rate loans, which
lowered the overall yield on loans. In addition, the Company has experienced a
large number of loan customers requesting loan repricings due to lower interest
rates offered to them by competing financial institutions. If interest rates
remain low or move lower the Company anticipates it will be required to meet
lower interest rate offers from competing financial institutions in order to
retain quality loan relationships, which could impact the overall loan yield.
The decrease in interest income on loans of $2.7 million or 7.1% was the result
of the decrease in interest rates partially offset by the increase in average
loans.
Average investment and mortgage-backed securities increased $39.9 million
or 6.5% for the year ended December 31, 2003 when compared to the same period in
2002. This increase was primarily funded by an increase in the Company's average
deposits. The overall yield on average investment and mortgage-backed securities
decreased to 4.13% during the year ended December 31, 2003 from 5.39% during the
same period in 2002, due in large part to increased prepayment speeds on
mortgage-backed securities which led to increased amortization expense and
increased cash to reinvest in a lower interest rate environment. Interest income
on investment and mortgage-backed securities decreased $5.4 million in 2003 or
17.9% compared to 2002 due to the decrease in the average yield on securities
during 2003, which more than offset the increase in the average balance.
Interest income from marketable equity securities, federal funds and
other interest earning assets decreased $98,000 or 13.9% for the year ended
December 31, 2003 when compared to 2002 as a result of lower interest rates in
2003.
During the year ended December 31, 2003 securities increased more than
loans. As a result, the mix of the Company's interest earning assets reflected a
decrease in total loans as a percentage of total average interest earning assets
compared to the prior year end as loans averaged 45.7% compared to 46.4% during
2002, a direct result of slower loan growth and a larger increase in securities.
Securities averaged 53.7% of the total and other interest earning asset
categories averaged 0.6% for December 31, 2003. During 2002 the comparable mix
was 53.4% in securities and 0.2% in the other interest earning asset categories.
Total interest expense decreased $6.7 million or 18.5% to $29.7 million
during the year ended December 31, 2003 as compared to $36.4 million during the
same period in 2002. The decrease was attributable to a decrease in interest
rates partially offset by an increase in average interest bearing liabilities of
$32.9 million or 3.2%. Average interest bearing deposits increased $32.6 million
or 5.5% while the average rate paid decreased from 2.73% at December 31, 2002 to
1.82% at December 31, 2003. Average time deposits decreased $23.3 million or
6.6% and the average rate paid decreased 83 basis points. Average interest
bearing demand deposits increased $47.0 million or 23.0% while the average rate
paid decreased 64 basis points. Average savings deposits increased $8.8 million
or 25.4% while the average rate paid decreased 81 basis points. Average
noninterest bearing demand deposits increased $23.6 million or 12.8% during
2003. The latter three categories, which are considered the lowest cost
deposits, comprised 60.2% of total average deposits during the year ended
December 31, 2003 compared to 54.4% during 2002 and 51.7% during 2001. The
increase in average total deposits is reflective of overall bank growth and
branch expansion.
The Company's current policy allows for a maximum of $100 million in
brokered CDs. The potential higher interest cost and lack of customer loyalty
are risks associated with the use of brokered CDs. At December 31, 2003, 2002
and December 31, 2001, the Company had no brokered CDs and brokered CDs
represented zero percent of deposits.
37
The following table sets forth the Company's deposit averages by
category for the years ended December 31, 2003, 2002 and 2001:
COMPOSITION OF DEPOSITS
<Table>
<Caption>
Years Ended December 31,
-----------------------------------------------------------------------------------
2003 2002 2001
------------------------ ------------------------ -------------------------
(dollars in thousands)
AVG. AVG. AVG. AVG. AVG. AVG.
BALANCE YIELD BALANCE YIELD BALANCE YIELD
-------- -------- -------- -------- -------- --------
Noninterest Bearing Demand Deposits ..... $207,253 N/A $183,683 N/A $166,828 N/A
Interest Bearing Demand Deposits ........ 251,348 0.75% 204,344 1.39% 179,438 2.54%
Savings Deposits ........................ 43,687 0.67% 34,848 1.48% 26,380 2.35%
Time Deposits ........................... 331,713 2.79% 354,966 3.62% 348,190 5.66%
-------- -------- --------
Total Deposits ..................... $834,001 1.37% $777,841 2.08% $720,836 3.45%
======== ======== ========
</Table>
Average short-term interest bearing liabilities, consisting primarily of
FHLB advances and federal funds purchased, were $159.3 million, an increase of
$2.6 million or 1.6% for the year ended December 31, 2003 when compared to the
same period in 2002. Interest expense associated with short-term interest
bearing liabilities increased $436,000 or 7.6% and the average rate paid
increased 21 basis points for the year ended December 31, 2003 when compared to
the same period in 2002 due primarily to higher interest bearing FHLB advances
rolling into short-term from long-term. Average long-term interest bearing
liabilities consisting of FHLB advances decreased $330,000 or 0.1% during the
year ended December 31, 2003 to $232.4 million as compared to $232.7 million at
December 31, 2002. Interest expense associated with long-term FHLB advances
decreased $1.8 million or 15.6% and the average rate paid decreased 76 basis
points for the year ended December 31, 2003 when compared to the same period in
2002. The long-term advances were obtained from the FHLB primarily to fund
long-term securities and loans. FHLB advances are collateralized by FHLB stock,
securities and nonspecific real estate loans.
Average short-term junior subordinated debentures increased $1.8 million
or 100% during the year ended December 31, 2003 when compared to same period in
2002. The increase is due to the fact that on September 4, 2003, the Company
announced it would redeem on October 6, 2003 the $20.0 million of long-term
junior subordinated debentures the Company originally issued during 1998. This
reflects the reclassification of the long-term junior subordinated debentures to
short-term until they were redeemed.
Average long-term junior subordinated convertible debentures were $11.7
million for the year ended December 31, 2003 compared to $15.3 million for the
same period in 2002. On December 31, 2003, Southside Capital Trust II, a
subsidiary of Southside Bancshares, Inc., redeemed 6,571 shares of its 8.75%
Cumulative Convertible Trust Preferred Securities and all of its 8.75% Common
Securities which totaled $678,000. Prior to the redemption date, December 31,
2003, all other convertible trust preferred shares were converted into the
Company's common stock. This increased the Company's number of shares of common
stock outstanding to 10,358,880 at December 31, 2003. Interest expense
associated with the long-term convertible debt decreased $500,000 or 37.5% and
the average rate paid decreased 157 basis points for the year ended December 31,
2003, when compared to the same period in 2002.
Average long-term junior subordinated debentures remained the same at $20
million from December 31, 2002 to December 31, 2003. Interest expense decreased
$281,000 or 16.5% and the average rate paid decreased 140 basis points for the
year ended December 31, 2003 when compared to the same period in 2002. On
October 6, 2003, Southside Capital Trust I, a subsidiary of Southside
Bancshares, Inc., redeemed all of its 8.50% Cumulative Trust Preferred
Securities and 8.50% Trust Common Securities which totaled $20,618,560.
Southside Bancshares funded the redemption through the issuance of $20,000,000
of trust preferred securities and $619,000 of trust common securities that
adjust quarterly at a rate equal to the three month LIBOR plus 294 basis points.
The lower interest rate provided interest savings during the fourth quarter and
should provide a better match for the overall interest rate sensitivity position
of Southside Bancshares.
38
RESULTS OF OPERATIONS
The following table presents average balance sheet amounts and average
yields for the years ended December 31, 2003, 2002 and 2001. The information
should be reviewed in conjunction with the financial statements for the same
years then ended. 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, 2003 December 31, 2002
---------------------------------- ---------------------------------
AVG. AVG. AVG. AVG.
BALANCE INTEREST YIELD BALANCE INTEREST YIELD
----------- -------- ----- ----------- -------- -----
ASSETS
INTEREST EARNING ASSETS:
Loans(1) (2) ......................... $ 570,122 $37,035 6.50% $ 547,829 $39,278 7.17%
Loans Held For Sale .................. 5,694 309 5.43% 4,502 317 7.04%
Securities:
Inv. Sec. (Taxable)(4) ............... 31,040 622 2.00% 27,363 923 3.37%
Inv. Sec. (Tax-Exempt)(3)(4) ......... 86,935 6,220 7.15% 115,918 8,494 7.33%
Mortgage-backed Sec.(4) .............. 535,506 20,149 3.76% 470,272 23,647 5.03%
Marketable Equity Sec ................ 22,734 519 2.28% 22,106 654 2.96%
Interest Earning Deposits ............ 622 10 1.61% 675 22 3.26%
Federal Funds Sold ................... 7,303 79 1.08% 1,736 30 1.73%
----------- ------- ----------- -------
Total Interest Earning Assets ........ 1,259,956 64,943 5.15% 1,190,401 73,365 6.16%
NONINTEREST EARNING ASSETS:
Cash and Due From Banks .............. 36,862 35,649
Bank Premises and Equipment .......... 30,038 29,947
Other Assets ......................... 42,112 40,607
Less: Allowance for Loan Loss ...... (6,534) (6,118)
----------- -----------
Total Assets ......................... $ 1,362,434 $ 1,290,486
=========== ===========
<Caption>
AVERAGE BALANCES AND YIELDS
(dollars in thousands)
Years Ended
----------------------------------
December 31, 2001
----------------------------------
AVG. AVG.
BALANCE INTEREST YIELD
----------- -------- -----
ASSETS
INTEREST EARNING ASSETS:
Loans(1) (2) ......................... $ 508,560 $41,542 8.17%
Loans Held For Sale .................. 1,908 151 7.91%
Securities:
Inv. Sec. (Taxable)(4) ............... 37,585 2,062 5.49%
Inv. Sec. (Tax-Exempt)(3)(4) ......... 96,283 7,193 7.47%
Mortgage-backed Sec.(4) .............. 475,443 29,507 6.21%
Marketable Equity Sec ................ 20,746 854 4.12%
Interest Earning Deposits ............ 977 58 5.94%
Federal Funds Sold ................... 2,145 93 4.34%
----------- -------
Total Interest Earning Assets ........ 1,143,647 81,460 7.12%
NONINTEREST EARNING ASSETS:
Cash and Due From Banks .............. 32,849
Bank Premises and Equipment .......... 25,552
Other Assets ......................... 24,320
Less: Allowance for Loan Loss ...... (5,572)
-----------
Total Assets ......................... $ 1,220,796
===========
</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 $1,941,
$1,494 and $991 for the years ended December 31, 2003, 2002 and 2001,
respectively.
(3) Interest income includes taxable-equivalent adjustments of $2,002,
$2,630 and $2,287 for the years ended December 31, 2003, 2002 and 2001,
respectively.
(4) For the purpose of calculating the average yield, the average balance
of securities is presented at historical cost.
Note: As of December 31, 2003, 2002 and 2001, loans totaling $1,547, $2,238
and $896, 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.
39
<Table>
<Caption>
AVERAGE BALANCES AND YIELDS
(dollars in thousands)
Years Ended
--------------------------------------------------------------------------
December 31, 2003 December 31, 2002
-------------------------------- ---------------------------------
AVG. AVG. AVG. AVG.
BALANCE INTEREST YIELD BALANCE INTEREST YIELD
---------- -------- ----- ---------- -------- -----
LIABILITIES AND SHAREHOLDERS' EQUITY
INTEREST BEARING LIABILITIES:
Savings Deposits ......................... $ 43,687 291 .67% $ 34,848 517 1.48%
Time Deposits ............................ 331,713 9,257 2.79% 354,966 12,840 3.62%
Interest Bearing
Demand Deposits ...................... 251,348 1,889 .75% 204,344 2,840 1.39%
Short-term Interest
Bearing Liabilities .................. 159,298 6,165 3.87% 156,725 5,729 3.66%
Short-term Junior Subordinated
Debentures (5) .......................... 1,753 154 8.78% -- -- --
Long-term Interest Bearing
Liabilities-FHLB Dallas .............. 232,371 9,643 4.15% 232,701 11,424 4.91%
Long-term Junior Subordinated
Convertible Debentures (6) .............. 11,673 834 7.14% 15,314 1,334 8.71%
Long-term Junior Subordinated
Debentures (7) .......................... 20,000 1,419 7.10% 20,000 1,700 8.50%
---------- ------- ---------- -------
Total Interest Bearing Liabilities ....... 1,051,843 29,652 2.82% 1,018,898 36,384 3.57%
NONINTEREST BEARING LIABILITIES:
Demand Deposits .......................... 207,253 183,683
Other Liabilities ........................ 18,487 12,545
---------- ----------
Total Liabilities ........................ 1,277,583 1,215,126
SHAREHOLDERS' EQUITY ..................... 84,851 75,360
---------- ----------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY .................... $1,362,434 $1,290,486
========== ==========
NET INTEREST INCOME ...................... $35,291 $36,981
======= =======
NET YIELD ON AVERAGE
EARNING ASSETS .......................... 2.80% 3.11%
==== ====
NET INTEREST SPREAD ...................... 2.33% 2.59%
==== ====
<Caption>
AVERAGE BALANCES AND YIELDS
(dollars in thousands)
Years Ended
-----------------------------------
December 31, 2001
-----------------------------------
AVG. AVG.
BALANCE INTEREST YIELD
---------- -------- -----
LIABILITIES AND SHAREHOLDERS' EQUITY
INTEREST BEARING LIABILITIES:
Savings Deposits ......................... $ 26,380 621 2.35%
Time Deposits ............................ 348,190 19,714 5.66%
Interest Bearing
Demand Deposits ...................... 179,438 4,557 2.54%
Short-term Interest
Bearing Liabilities .................. 170,184 7,302 4.29%
Short-term Junior Subordinated
Debentures (5) .......................... -- -- --
Long-term Interest Bearing
Liabilities-FHLB Dallas .............. 215,674 12,186 5.65%
Long-term Junior Subordinated
Convertible Debentures (6) .............. 16,950 1,483 8.75%
Long-term Junior Subordinated
Debentures (7) .......................... 20,000 1,700 8.50%
---------- -------
Total Interest Bearing Liabilities ....... 976,816 47,563 4.87%
NONINTEREST BEARING LIABILITIES:
Demand Deposits .......................... 166,828
Other Liabilities ........................ 14,400
----------
Total Liabilities ........................ 1,158,044
SHAREHOLDERS' EQUITY ..................... 62,752
----------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY .................... $1,220,796
==========
NET INTEREST INCOME ...................... $33,897
=======
NET YIELD ON AVERAGE
EARNING ASSETS .......................... 2.96%
====
NET INTEREST SPREAD ...................... 2.25%
====
</Table>
(5) Southside Capital Trust I from September 4, 2003, when redemption was
announced, to October 6, 2003, when redemption was completed.
(6) Southside Capital Trust II
(7) Southside Capital Trust I through September 3, 2003, the day before its
redemption was announced and Southside Statutory Trust III issued
September 4, 2003.
40
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,
2003 Compared to 2002
-------------------------------------------
Average Average Increase
Volume Yield (Decrease)
-------- -------- ----------
INTEREST INCOME:
Loans (1) .................................................... $ 1,553 $ (3,796) $ (2,243)
Loans Held For Sale .......................................... 74 (82) (8)
Investment Securities (Taxable) .............................. 112 (413) (301)
Investment Securities (Tax-Exempt) (1) ....................... (2,078) (196) (2,274)
Mortgage-backed Securities ................................... 2,987 (6,485) (3,498)
Marketable Equity Securities ................................. 18 (153) (135)
Federal Funds Sold ........................................... 64 (15) 49
Interest Earning Deposits .................................... (2) (10) (12)
-------- -------- --------
Total Interest Income ..................................... 2,728 (11,150) (8,422)
-------- -------- --------
INTEREST EXPENSE:
Savings Deposits ............................................. 108 (334) (226)
Time Deposits ................................................ (798) (2,785) (3,583)
Interest Bearing Demand Deposits ............................. 553 (1,504) (951)
Short-term Interest Bearing Liabilities ...................... 95 341 436
Short-term Junior Subordinated Debentures .................... 154 -- 154
Long-term FHLB Dallas Advances ............................... (16) (1,765) (1,781)
Long-term Junior Subordinated Convertible Debentures ......... (285) (215) (500)
Long-term Junior Subordinated Debentures ..................... -- (281) (281)
-------- -------- --------
Total Interest Expense .................................... (189) (6,543) (6,732)
-------- -------- --------
Net Interest Income .......................................... $ 2,917 $ (4,607) $ (1,690)
======== ======== ========
</Table>
<Table>
<Caption>
Years Ended December 31,
2002 Compared to 2001
-------------------------------------------
Average Average Increase
Volume Yield (Decrease)
-------- -------- ----------
INTEREST INCOME:
Loans (1) .................................................... $ 3,056 $ (5,320) $ (2,264)
Loans Held For Sale .......................................... 184 (18) 166
Investment Securities (Taxable) .............................. (471) (668) (1,139)
Investment Securities (Tax-Exempt) (1) ....................... 1,441 (140) 1,301
Mortgage-backed Securities ................................... (318) (5,542) (5,860)
Marketable Equity Securities ................................. 53 (253) (200)
Federal Funds Sold ........................................... (15) (48) (63)
Interest Earning Deposits .................................... (15) (21) (36)
-------- -------- --------
Total Interest Income ..................................... 3,915 (12,010) (8,095)
-------- -------- --------
INTEREST EXPENSE:
Savings Deposits ............................................. 165 (269) (104)
Time Deposits ................................................ 377 (7,251) (6,874)
Interest Bearing Demand Deposits ............................. 565 (2,282) (1,717)
Short-term Interest Bearing Liabilities ...................... (548) (1,025) (1,573)
Long-term FHLB Dallas Advances ............................... 915 (1,677) (762)
Long-term Junior Subordinated Convertible Debentures ......... (143) (6) (149)
-------- -------- --------
Total Interest Expense .................................... 1,331 (12,510) (11,179)
-------- -------- --------
Net Interest Income .......................................... $ 2,584 $ 500 $ 3,084
======== ======== ========
</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.
41
PROVISION FOR LOAN LOSSES
The provision for loan losses for the year ended December 31, 2003 was
$1.2 million compared to $2.1 million for December 31, 2002. For the year ended
December 31, 2003, the Company had net charge-offs of loans of $990,000, a
decrease of 46.5% compared to December 31, 2002. For the year ended December 31,
2002, net charge-offs on loans were $1.8 million.
The decrease in net charge-offs for 2003 is reflective of the decrease in
total charge-offs and the increase in total recoveries. Total charge-offs for
commercial loans increased $83,000 from December 31, 2002. Total charge-offs for
loans to individuals decreased $441,000 from December 31, 2002 reflective of the
general decreases in losses for the year. Total charge-offs for 1-4 family
residential loans and construction loans decreased $107,000 and $198,000,
respectively from December 31, 2002 primarily due to charge-offs associated with
one builder and one of his clients in 2002. Total recoveries increased $196,000
from December 31, 2002.
As of December 31, 2003, the Company's review of the loan portfolio
indicates that a loan loss allowance of $6.4 million is adequate to cover
probable losses in the portfolio.
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, 2003 and the
comparable year ended December 31, 2002 and indicates the percentage changes:
<Table>
<Caption>
Years Ended
December 31,
---------------------- Percent
2003 2002 Change
------- ------- -------
(dollars in thousands)
Deposit services ...................................... $12,958 $10,718 20.9%
Gains on sales of securities available for sale ....... 5,033 3,853 30.6%
Gain on sale of loans ................................. 2,667 2,044 30.5%
Trust income .......................................... 1,063 1,031 3.1%
Bank owned life insurance income ...................... 986 966 2.1%
Other ................................................. 1,406 979 43.6%
------- -------
Total noninterest income .............................. $24,113 $19,591 23.1%
======= =======
</Table>
Total noninterest income for the year ended December 31, 2003 increased
23.1% or $4.5 million compared to 2002. Securities gains increased $1.2 million
or 30.6% from 2002. Of the $5.0 million in net securities gains from the AFS
portfolio in 2003, there were $0.6 million in realized losses and $5.6 million
in realized gains. The Company sold securities out of its AFS portfolio to
accomplish ALCO and investment portfolio objectives aimed at repositioning the
securities portfolio in an effort to maximize the total return of the securities
portfolio, reduce alternative minimum tax and attempt to reduce prepayments on
mortgage-backed securities due to the lower interest rates experienced during
2003. Sales of AFS securities were the result of changes in economic conditions
and a change in the desired mix of the securities portfolio. During 2003,
interest rates declined and the yield curve remained steep. The Company used
this interest-rate environment to reposition the securities portfolio. Higher
coupon premium mortgage-backed securities with high selling prices or with a
potentially greater prepayment exposure were replaced with mortgage-backed
securities that had characteristics which potentially might reduce the
prepayment exposure. Specific low selling yield and long duration municipal
securities were sold and partially replaced for the most part with better call
protected municipal securities.
42
The increase in deposit services income of $2.2 million or 20.9% was a
result of increases in overdraft income, increased numbers of deposit accounts,
increased deposit activity and an increase in the pricing of deposit service
charges during the third quarter ended September 30, 2003. Gain on sale of loans
increased $623,000 or 30.5% due to the significant increase in mortgage loan
refinancings the Company handled during 2003 as a result of the lower interest
rate environment. Other noninterest income increased $427,000 or 43.6% primarily
as a result of increases in other fee income, income from check sales and income
from subsidiaries. The income from subsidiaries increased due to the closing of
the Company's former consumer finance subsidiary that had incurred losses in
2002.
NONINTEREST EXPENSE
The following schedule lists the accounts which comprise noninterest
expense, gives totals for these accounts for the year ended December 31, 2003
and the comparable year ended December 31, 2002 and indicates the percentage
changes:
<Table>
<Caption>
Years Ended
December 31,
---------------------- Percent
2003 2002 Change
------- ------- -------
(dollars in thousands)
Salaries and employee benefits ........... $23,182 $21,553 7.6%
Net occupancy expense .................... 3,954 3,903 1.3%
Equipment expense ........................ 712 684 4.1%
Advertising, travel and entertainment .... 1,775 1,721 3.1%
ATM and bank analysis fees ............... 954 859 11.1%
Amortization ............................. 990 68 1355.9%
Supplies ................................. 638 706 (9.6%)
Professional fees ........................ 685 666 2.9%
Postage .................................. 566 537 5.4%
Other .................................... 4,650 4,125 12.7%
------- ------- -------
Total noninterest expense ................ $38,106 $34,822 9.4%
======= ======= =======
</Table>
Noninterest expense for the year ended December 31, 2003 increased $3.3
million or 9.4% when compared to the year ended December 31, 2002. Salaries and
employee benefits increased $1.6 million or 7.6% due to several factors. Direct
salary expense and payroll taxes increased $1.0 million or 6.0% as a result of
branch expansion, overall bank growth and pay increases. Retirement expense
increased significantly by $564,000 or 31.1% for the year ended December 31,
2003 due to a change in the actuarial present value assumption which decreased
from 6.75% for the year ended December 31, 2002 to 6.50% for the year ended
December 31, 2003, a lower return on plan assets during 2002 than projected and
an increase in the number of participants. Retirement expense for 2005 could
increase significantly due to a possible low return on plan assets, the
continued low discount rate or a possible decrease in this rate, increased
funding required and the increasing numbers of participants. The Company is
currently using a 9.0% assumed long-term rate of return. Due to the decline in
major stock market indexes for three straight years combined with low interest
rates the Company's rate of return on plan assets did not achieve a 9.0% return
for the years ended December 31, 2002, 2001 and 2000. During 2003, the Company
achieved a return above the 9.0% assumed long-term rate of return. The Company
will continue to evaluate the assumed long-term rate of return of 9.0% to
determine if it should be changed in the future. If this assumption were
decreased the cost and funding required for the retirement plan could increase.
Health and life insurance expense increased slightly by $17,000 or 0.7% for the
year ended December 31, 2003 due to increased health claims expense and
reinsurance costs. Health insurance costs are rising nationwide and these costs
may increase in 2004.
43
Net occupancy expense increased $51,000 or 1.3% for the year ended
December 31, 2003 compared to the same period in 2002, largely due to branch
expansion, higher real estate taxes and depreciation expense.
ATM and Bank analysis fees increased $95,000 or 11.1% for the year ended
December 31, 2003 compared to the same period in 2002 due primarily to overall
deposit and activity growth and a decrease in the earnings credit rate due to
lower interest rates.
Amortization expense increased $922,000 or 1,355.9% due to the redemption
of Southside Capital Trust I cumulative trust preferred securities. The
unamortized origination cost associated with the redemption was expensed during
the third quarter of 2003.
Other expense increased $525,000 or 12.7% during the year ended December
31, 2003 compared to 2002. The increase was due primarily to the retirement of
assets in a grocery store branch, liability insurance, personnel placement fees,
other losses and bank examination fees. The retirement of assets in the grocery
branch was a result of relocating the branch within the store prior to fully
depreciating the original lease improvements.
INCOME TAXES
Income tax expense was $2.6 million for the year ended December 31, 2003
and represented a $399,000 or 18.3% increase from the year ended December 31,
2002. The effective tax rate as a percentage of pre-tax income was 16.0% in
2003, 14.1% in 2002 and 21.7% in 2001. The increase in the effective tax rate
and income tax expense for 2003 was due to the increase in taxable income for
the year ended December 31, 2003 when compared to December 31, 2002. The
increase in taxable income was partially a result of a decrease in tax free
income during 2003. The Company decreased its municipal securities portfolio
during 2003 and has further decreased it during the first quarter of 2004 to
reduce the overall level of tax free income from the securities portfolio and to
allow the Company the opportunity to grow its municipal loan portfolio. During
2002 and 2003 the Company was in an alternative minimum tax position due to
unusually high retirement expenses, the one time $1.0 million amortization
expense during 2003 and the level of tax free income. The Company will not have
the amortization expense in 2004 and has the ability to and is addressing the
appropriate level of tax free income so as to not be in an alternative minimum
tax position. Because management believes, based on this information, this is
reversible in the future no valuation allowance is deemed necessary at this
time.
DECEMBER 31, 2002 COMPARED TO DECEMBER 31, 2001
OVERVIEW
During the year ended December 31, 2002, the Company's net income
increased $1.6 million or 13.6% to $13.3 million, from $11.7 million for the
same period in 2001. 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 increases in
deposit services income, bank owned life insurance income, mortgage servicing
release fees income, and trust income. These increases were partially offset by
an increase in noninterest expense and provision for loan losses. The majority
of the increase in noninterest expense was a result of bank growth and the costs
associated with the opening of five new branches. Earnings per share of $1.28
represented an increase of $0.13 or 11.3% over the year ended December 31, 2001.
44
NET INTEREST INCOME
Net interest income for the year ended December 31, 2002 was $32.9
million, an increase of $2.2 million or 7.3% compared to the same period in
2001. The overall increase in net interest income was due to the fact that
decreases in interest income from loans and securities were more than offset by
decreases in interest expense from deposits and other borrowings which increased
the net yield on average interest earning assets. Average interest earning
assets increased $46.8 million or 4.1%, and the net yield on average interest
earning assets increased from 2.96% at December 31, 2001 to 3.11% at December
31, 2002. During the fourth quarter ended December 31, 2002 the Company's net
interest margin was 2.87% and the net interest spread was 2.36% which reflected
a decrease when compared to the same quarter in 2001. The net interest margin
and net interest spread for the quarter ended December 31, 2001 was 3.19% and
2.62%, respectively. The decrease in the net interest margin and spread during
the fourth quarter of 2002 was due in part to lower mortgage interest rates and
the lower overall interest rate environment which led to substantially increased
residential mortgage refinancings nationwide and in the Company's market area
combined with substantially increased repricings of all of the Company's other
loan types.
As interest rates decreased during 2002, the Company's yield on premium
mortgage-backed securities decreased 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, 2002, average loans, funded by the
growth in average deposits, increased $39.3 million or 7.7%, compared to the
same period in 2001. The average yield on loans decreased from 8.17% at December
31, 2001 to 7.17% at December 31, 2002, reflective of an overall decrease in
interest rates. As interest rates declined, especially short-term interest
rates, loan customers increasingly requested floating rate loans, which lowered
the overall yield on loans. In addition, the Company experienced a large number
of loan customers that requested loan repricings due to lower interest rates
offered to them by competing financial institutions. The decrease in interest
income on loans of $2.6 million or 6.4% was the result of the decrease in
interest rates partially offset by the increase in average loans.
Average investment and mortgage-backed securities increased $4.2 million
or 0.7% for the year ended December 31, 2002 when compared to the same period in
2001. This increase was primarily a result of a slight increase in the Company's
leverage strategy. The overall yield on average investment and mortgage-backed
securities decreased to 5.39% during the year ended December 31, 2002 from 6.36%
during the same period in 2001, due in part to increased prepayment speeds on
mortgage-backed securities which led to increased amortization expense and
increased cash to reinvest in a lower interest rate environment. During 2002 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 $6.0 million in 2002 or
16.6% compared to 2001 due to the decrease in the average yield of securities
during 2002, which more than offset the increase in the average balance.
Interest income from marketable equity securities, federal funds and
other interest earning assets decreased $299,000 or 29.8% for the year ended
December 31, 2002 when compared to 2001 as a result of lower interest rates in
2002.
During the year ended December 31, 2002, the mix of the Company's
interest earning assets reflected an increase in total loans compared to the
prior year end as loans averaged 46.4% of total average interest earning assets
compared to 44.6% during 2001, a direct result of loan growth. Securities
averaged 53.4% of the total and other interest earning asset categories averaged
0.2% for December 31, 2002. During 2001 the comparable mix was 55.1% in
securities and 0.3% in the other interest earning asset categories.
45
Total interest expense decreased $11.2 million or 23.5% to $36.4 million
during the year ended December 31, 2002 as compared to $47.6 million during the
same period in 2001. The decrease was attributable to a decrease in interest
rates partially offset by an increase in average interest bearing liabilities of
$42.1 million or 4.3%. Average interest bearing deposits increased $40.2 million
or 7.2% while the average rate paid decreased from 4.49% at December 31, 2001 to
2.73% at December 31, 2002. Average time deposits increased $6.8 million or 1.9%
while the average rate paid decreased 204 basis points. Average interest bearing
demand deposits increased $24.9 million or 13.9% while the average rate paid
decreased 115 basis points. Average savings deposits increased $8.5 million or
32.1% while the average rate paid decreased 87 basis points. Average noninterest
bearing demand deposits increased $16.9 million or 10.1% during 2002. The latter
three categories, which are considered the lowest cost deposits, comprised 54.4%
of total average deposits during the year ended December 31, 2002 compared to
51.7% during 2001 and 52.0% during 2000. The increase in average total deposits
was 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 Company 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 that approximated the brokered CDs.
46
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%. As a result, the Company's interest expense on this $54.6
million declined after the CDs were called. The Company's current policy allows
for a maximum of $100 million in brokered CDs. The potential higher interest
cost and lack of customer loyalty are risks associated with the use of brokered
CDs. At December 31, 2002 and December 31, 2001, the Company had no brokered CDs
and brokered CDs represented zero percent of deposits.
Average short-term interest bearing liabilities, consisting primarily of
FHLB advances and federal funds purchased, were $156.7 million, a decrease of
$13.5 million or 7.9% for the year ended December 31, 2002 when compared to the
same period in 2001. Interest expense associated with short-term interest
bearing liabilities decreased $1.6 million or 21.5% and the average rate paid
decreased 63 basis points for the year ended December 31, 2002 when compared to
the same period in 2001. Average long-term interest bearing liabilities
consisting of FHLB advances increased $17.0 million or 7.9% during the year
ended December 31, 2002 to $232.7 million as compared to $215.7 million at
December 31, 2001. Interest expense associated with long-term FHLB advances
decreased $762,000 or 6.25% and the average rate paid decreased 74 basis points
for the year ended December 31, 2002 when compared to the same period in 2001.
The long-term advances were obtained from the FHLB primarily to fund long-term
securities and to a lesser extent long-term loans. FHLB advances are
collateralized by FHLB stock, securities and nonspecific real estate loans.
Average junior subordinated convertible debentures were $15.3 million for
the year ended December 31, 2002 compared to $16.95 million for the same period
in 2001. During the year ended December 31, 2002, 272,464 convertible trust
preferred shares were converted into the Company's common stock. The total
convertible trust preferred shares converted to date represented 16.1% of the
initial convertible trust preferred issue. Interest expense associated with the
convertible debt decreased $149,000 or 10.0% and the average rate paid decreased
4 basis points for the year ended December 31, 2002, when compared to the same
period in 2001.
Average junior subordinated debentures remained the same at $20 million
from December 31, 2001 to December 31, 2002. Interest expense and the average
rate paid were the same for the years ended December 31, 2002 and 2001.
PROVISION FOR LOAN LOSSES
The provision for loan losses for the year ended December 31, 2002 was
$2.1 million compared to $1.7 million for December 31, 2001. For the year ended
December 31, 2002, the Company's subsidiary, Southside Bank, had net charge-offs
of loans of $1.8 million, an increase of 138.9% compared to December 31, 2001.
For the year ended December 31, 2001, net charge-offs on loans were $774,000.
The increase in net charge-offs for 2002 is reflective of the increase in
total charge-offs and the decrease in total recoveries. Total charge-offs for
commercial loans increased $285,000 from December 31, 2001 due to the increase
in small business loans charged off resulting from the slower economy in the
Company's market area. Total charge-offs for loans to individuals increased
$120,000 from December 31, 2001 reflective of increased consumer bankruptcies.
Total charge-offs for real estate loans and construction loans increased
$135,000 and $215,000, respectively from December 31, 2001 primarily due to
charge-offs associated with one builder and one of his clients. Total recoveries
decreased $320,000 from December 31, 2001 primarily as a result of two
recoveries on old charge-offs the Company received during 2001 that totaled
$230,000.
As of December 31, 2002, the Company's review of the loan portfolio
indicated that a loan loss allowance of $6.2 million was adequate to cover
probable losses in the portfolio.
47
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, 2002 and the
comparable year ended December 31, 2001 and indicates the percentage changes:
<Table>
<Caption>
Years Ended
December 31,
---------------------- Percent
2002 2001 Change
------- ------- -------
(dollars in thousands)
Deposit services ...................................... $10,718 $ 9,377 14.3%
Gains on sales of securities available for sale ....... 3,853 4,073 (5.4%)
Gain on sale of loans ................................. 2,044 1,057 93.4%
Trust income .......................................... 1,031 961 7.3%
Bank owned life insurance income ...................... 966 109 786.2%
Other ................................................. 979 1,099 (10.9%)
------- -------
Total noninterest income .............................. $19,591 $16,676 17.5%
======= =======
</Table>
Total noninterest income for the year ended December 31, 2002 increased
17.5% or $2.9 million compared to 2001. Securities gains decreased $220,000 or
5.4% from 2001. Of the $3.9 million in net securities gains from the AFS
portfolio in 2002, there were $340,000 in realized losses and $4.2 million in
realized gains. The Company sold securities out of its AFS portfolio to
accomplish ALCO and investment portfolio objectives aimed at repositioning and
reducing the overall duration of the securities portfolio in an effort to
maximize 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 2002, interest rates declined and the
yield curve remained steep. The Company used this interest-rate environment to
reposition the securities portfolio in an attempt to lower the overall duration
and minimize prepayment of the premium mortgage-backed securities. Higher coupon
premium mortgage-backed securities with high selling prices or with a
potentially greater prepayment exposure were replaced with mortgage-backed
securities that had characteristics which potentially might reduce the
prepayment exposure. In some cases, higher coupon premium 30 year
mortgage-backed securities with prepayment exposure were replaced with lower
coupon premium 15 year mortgage-backed securities which lowered the overall
duration and potentially reduced the prepayment exposure. Specific lower coupon
or long duration municipal securities were sold and partially replaced with
higher coupon municipal securities.
The increase in deposit services income of $1.3 million or 14.3% was a
result of increases in overdraft income, increased numbers of deposit accounts
and increased deposit activity. Bank owned life insurance income increased
$857,000 or 786.2%. 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 net increase in cash surrender value is shown as a component of
noninterest income. Gain on sale of loans increased $987,000 or 93.4% due to the
significant increase in mortgage loan refinancings the Company handled during
2002 as a result of the lower interest rate environment. Trust income increased
$70,000 or 7.3% due to growth in the Trust department. Other noninterest income
decreased $120,000 or 10.9% primarily as a result of decreases in Travelers
Express income combined with an increase in the loss associated with BSC
Securities and Countywide.
48
NONINTEREST EXPENSE
The following schedule lists the accounts which comprise noninterest
expense, gives totals for these accounts for the year ended December 31, 2002
and the comparable year ended December 31, 2001 and indicates the percentage
changes:
<Table>
<Caption>
Years Ended
December 31,
---------------------- Percent
2002 2001 Change
------- ------- -------
(dollars in thousands)
Salaries and employee benefits ............ $21,553 $17,626 22.3%
Net occupancy expense ..................... 3,903 3,358 16.2%
Equipment expense ......................... 684 734 (6.8)%
Advertising, travel and entertainment ..... 1,721 1,650 4.3%
ATM and bank analysis fees ................ 859 812 5.8%
Amortization .............................. 68 81 (16.0)%
Supplies .................................. 706 615 14.8%
Professional fees ......................... 666 617 7.9%
Postage ................................... 537 454 18.3%
Other ..................................... 4,125 3,432 20.2%
------- -------
Total noninterest expense ................. $34,822 $29,379 18.5%
======= =======
</Table>
Noninterest expense for the year ended December 31, 2002 increased $5.4
million or 18.5% when compared to the year ended December 31, 2001. Salaries and
employee benefits increased $3.9 million or 22.3% due to several factors. Direct
salary expense and payroll taxes increased $3.1 million or 22.1% as a result of
branch expansion, overall bank growth and pay increases. Retirement expense
increased significantly by $389,000 or 27.3% for the year ended December 31,
2002 due to a change in the actuarial present value assumption which decreased
from 7.25% for the year ended December 31, 2001 to 6.75% for the year ended
December 31, 2002, a lower return on plan assets than projected and an increase
in the number of participants. Health and life insurance expense increased
significantly by $394,000 or 19.8% for the year ended December 31, 2002 due to
increased health claims expense and reinsurance costs.
Net occupancy expense increased $545,000 or 16.2% for the year ended
December 31, 2002 compared to the same period in 2001, largely due to branch
expansion, higher real estate taxes and depreciation expense.
ATM and Bank analysis fees increased $47,000 or 5.8% for the year ended
December 31, 2002 compared to the same period in 2001 due primarily to overall
deposit growth.
Supplies expense increased $91,000 or 14.8% as a result of bank growth
and branch expansion. Professional fees increased $49,000 or 7.9% due to
additional internal audit, loan review and data processing related fees. Postage
expense increased $83,000 or 18.3% for the year ended December 31, 2002 compared
to the same period in 2001 due primarily to increases in postage rates.
Other expense increased $693,000 or 20.2% during the year ended December
31, 2002 compared to 2001. The increase was due primarily to increases in dues
to directors, liability insurance, auto expense, other losses, losses on other
real estate owned, legal fees and bank examination fees.
49
INCOME TAXES
Income tax expense was $2.2 million for the year ended December 31,
2002 and represented a $1.3 million or 38.1% decrease from the year ended
December 31, 2001. The effective tax rate as a percentage of pre-tax income was
14.1% in 2002, 21.7% in 2001 and 21.3% in 2000. The decrease in the effective
tax rate and income tax expense for 2002 was due to the increase in tax free
income for the year ended December 31, 2002 when compared to December 31, 2001.
CAPITAL RESOURCES
Total shareholders' equity at December 31, 2003 of $100.4 million
increased 25.0% or $20.1 million from December 31, 2002 and represented 6.9% of
total assets at December 31, 2003 compared to 6.0% at December 31, 2002.
Net income for 2003 of $13.6 million was the major contributor to the
increase in shareholders' equity at December 31, 2003 along with the issuance of
$14.5 million in common stock (1,792,629 shares) through conversions of
Southside Capital Trust II's preferred securities into the Company's common
stock and the Company's incentive stock option and dividend reinvestment plans.
Decreases to shareholders' equity consisted of a decrease of $1.2 million in
accumulated other comprehensive income, $3.2 million in dividends paid and the
purchase of $3.8 million in common stock (221,800 shares). The Company purchased
common 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. 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 2003, 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 including the discretion of the Board of Directors.
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, 2003, that the Bank
meets all capital adequacy requirements to which it is subject.
50
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
-------- ----- -------- ----- -------- -----
As of December 31, 2003: (dollars in thousands)
Total Capital (to Risk Weighted Assets)
Consolidated ............................. $120,072 18.40% $ 52,213 8.00% N/A N/A
======== ===== ======== ==== ======== =====
Bank Only ................................ $116,083 17.79% $ 52,212 8.00% $ 65,266 10.00%
======== ===== ======== ==== ======== =====
Tier 1 Capital (to Risk Weighted Assets)
Consolidated ............................. $113,678 17.42% $ 26,106 4.00% N/A N/A
======== ===== ======== ==== ======== =====
Bank Only ................................ $109,689 16.81% $ 26,106 4.00% $ 39,159 6.00%
======== ===== ======== ==== ======== =====
Tier 1 Capital (to Average Assets) (1)
Consolidated ............................. $113,678 8.12% $ 56,028 4.00% N/A N/A
======== ===== ======== ==== ======== =====
Bank Only ................................ $109,689 7.83% $ 56,003 4.00% $ 70,004 5.00%
======== ===== ======== ==== ======== =====
As of December 31, 2002:
Total Capital (to Risk Weighted Assets)
Consolidated (2) ......................... $109,207 17.42% $ 50,146 8.00% N/A N/A
======== ===== ======== ==== ======== =====
Bank Only (2) ............................ $103,624 16.53% $ 50,145 8.00% $ 62,681 10.00%
======== ===== ======== ==== ======== =====
Tier 1 Capital (to Risk Weighted Assets)
Consolidated (2) ......................... $ 92,472 14.75% $ 25,073 4.00% N/A N/A
======== ===== ======== ==== ======== =====
Bank Only (2) ............................ $ 97,500 15.55% $ 25,072 4.00% $ 37,609 6.00%
======== ===== ======== ==== ======== =====
Tier 1 Capital (to Average Assets) (1)
Consolidated (2) ......................... $ 92,472 7.09% $ 52,143 4.00% N/A N/A
======== ===== ======== ==== ======== =====
Bank Only (2) ............................ $ 97,500 7.48% $ 52,140 4.00% $ 65,175 5.00%
======== ===== ======== ==== ======== =====
</Table>
(1) Refers to quarterly average assets as calculated by bank
regulatory agencies.
(2) Restated
The table below summarizes key equity ratios for the Company for the
years ended December 31, 2003, 2002 and 2001.
<Table>
<Caption>
Years Ended December 31,
-------------------------------------
2003 2002 2001
------- ------- -------
Percentage of Net Income to:
Average Total Assets ............................... 1.00% 1.03% .96%
Average Shareholders' Equity ....................... 15.99% 17.68% 18.69%
Percentage of Dividends Declared Per Common
Share to Net Income Per Common Share-Basic ......... 24.00% 21.57% 18.38%
Percentage of Dividends Declared Per Common
Share to Net Income Per Common Share-Diluted ....... 28.13% 25.78% 21.74%
Percentage of Average Shareholders'
Equity to Average Total Assets ..................... 6.23% 5.84% 5.14%
</Table>
51
ACCOUNTING PRONOUNCEMENTS
In November 2002, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others (FIN 45),
which covers guarantees such as standby letters of credit, performance
guarantees, and direct or indirect guarantees of the indebtedness of others, but
not guarantees of funding. FIN 45 requires a guarantor to recognize, at the
inception of a guarantee, a liability in an amount equal to the fair value of
the obligation undertaken in issuing the guarantee, and requires disclosure
about maximum potential payments that might be required, as well as the
collateral or other recourse obtainable. The recognition and measurement
provisions of FIN 45 were effective on a prospective basis after December 31,
2002. The adoption of FIN 45 did not have a material impact on the Company's
consolidated financial statements.
In January 2003, the FASB issued Interpretation No. 46 Consolidation of
Variable Interest Entities (FIN 46), which establishes guidance for determining
when an entity should consolidate another entity that meets the definition of a
variable interest entity. FIN 46 requires a variable interest entity to be
consolidated by a company if that company will absorb a majority of the expected
losses, will receive a majority of the expected residual returns, or both.
Transferors to qualified special-purpose entities ("QSPEs") and certain other
interests in a QSPE are not subject to the requirements of FIN 46. On December
17, 2003, the FASB revised FIN 46 (FIN 46R) and deferred the effective date of
FIN 46 to no later than the end of the first reporting period that ends after
March 15, 2004, however, for special-purpose entities the Company would be
required to apply FIN 46 as of December 31, 2003.
The Company adopted FIN 46 in connection with its consolidated financial
statements for the year ended December 31, 2003. FIN 46 required the Company to
de-consolidate its investments in Southside Statutory Trust III in its financial
statements. Effective December 31, 2003, the Company deconsolidated the
wholly-owned issuing trust entity resulting in a recharacterization of the
underlying consolidated debt obligation from the previous trust preferred
securities obligation to the junior subordinated debenture obligation that exist
between the Company and the issuing trust entity. As a result of adopting FIN 46
on December 31, 2003, the Company did not restate its prior period consolidated
financial statements. In July 2003, the Board of Governors of the Federal
Reserve issued a supervisory letter instructing bank holding companies to
continue to include the trust preferred securities in their Tier 1 capital for
regulatory capital purposes until notice is given to the contrary. The Federal
Reserve intends to review the regulatory implications of any accounting
treatment changes and, if necessary or warranted, provide further appropriate
guidance. There can be no assurance that the Federal Reserve will continue to
permit institutions to include trust preferred securities in Tier 1 capital for
regulatory capital purposes. If, as of December 31, 2003, the Company was not
permitted to include a portion of the $20.0 million in trust preferred
securities issued by Southside Statutory Trust III in its Tier 1 capital, the
Company would still exceed the regulatory required minimums for capital adequacy
purposes. If the trust preferred securities were no longer permitted to be
included in Tier 1 capital, the Company would also be permitted to redeem the
capital securities.
In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133
on Derivative Instruments and Hedging Activities. This statement amends SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities" and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
No. 133. This Statement is effective for contracts entered into or modified
after June 30, 2003, except in certain circumstances, and for hedging
relationships designated after June 30, 2003. The adoption of FAS 149 did not
have a material impact on the Company's consolidated financial statements.
In May 2003, FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. This statement
provides new rules on the accounting for certain financial instruments that,
under previous guidance, issuers could account for as equity. Such financial
instruments include mandatorily redeemable shares, instruments that require the
issuer to buy back some of its shares in exchange for cash or other assets, or
obligations that can be settled with shares, the monetary value of which is
fixed. Most of the guidance in SFAS No. 150 is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the
52
beginning of the first interim period beginning after June 30, 2003. The
adoption of FAS 150 did not have a material impact on the Company's consolidated
financial statements.
In December 2003, the FASB issued SFAS No. 132 (revised 2003), Employers'
Disclosures about Pensions and Postretirement Benefits. This statement requires
additional disclosures about the assets, obligations and cash flows of defined
benefit pension and postretirement plans, as well as the expense recorded for
such plans. As of December 31, 2003, the Company has disclosed the required
elements related to its defined benefit pension plan in Note 13 to these
consolidated financial statements.
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.
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, 2003,
these investments were 22.4% of total assets, as compared with 25.0% for
December 31, 2002, and 20.1% for December 31, 2001. 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 one of the general measures 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 on 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 mix to minimize the change in
net interest income under these various interest rate scenarios.
The Bank uses FHLB as a significant source of liquidity. FHLB advances
are collateralized by FHLB stock, nonspecified real estate loans and securities.
If this source of funding were not available the costs associated with obtaining
funding to replace FHLB advances maturing could be more expensive or could be
unavailable. In the event alternative funding was not available, sales of
securities would be necessary to provide liquidity which could impact net
income.
53
The Bank issues letters of credit and has unfunded loan commitments and
lines of credit. If all of these were to fund at one time the Company would need
to draw on some of it's sources of liquidity which would include FHLB advances,
federal funds purchase lines, brokered CD's, or the sale of securities.
54
CONTRACTUAL CASH OBLIGATIONS
The following summarizes the Company's contractual cash obligations and
commercial commitments at December 31, 2003, and the effect such obligations are
expected to have on liquidity and cash flow in future periods.
<Table>
<Caption>
PAYMENTS DUE BY PERIOD
------------------------------------------------------------------
LESS THAN 2-3 4-5 AFTER 5
CONTRACTUAL OBLIGATIONS 1 YEAR YEARS YEARS YEARS TOTAL
-------- -------- ------- ------- --------
(Dollars in thousands)
Long-term debt, including current maturities (1) ...... $ -- $ -- $ -- $20,619 $ 20,619
FHLB Dallas advances (2) .............................. 142,734 183,479 55,519 62,951 444,683
Operating leases (3) .................................. 596 1,077 367 -- 2,040
Deferred Compensation Agreements (4) .................. 611 341 348 2,615 3,915
Time Deposits ......................................... 236,963 58,689 26,295 200 322,147
Securities Purchased not paid for ..................... 1,723 -- -- -- 1,723
TOTAL CONTRACTUAL CASH OBLIGATIONS .................... $382,627 $243,586 $82,529 $86,385 $795,127
</Table>
(1) The Company had long-term floating rate debt that was indexed to 3 month
LIBOR. The total balance of debt was $20.6 million at December 31, 2003 with a
scheduled maturity date of 2033.
(2) The Company had FHLB advances with maturity dates ranging from 2004 through
2015, with a total balance of $444,683 at December 31, 2003.
(3) The Company had various operating leases for its copy machines that total
$261,000 and expire on or before the end of 2007. In addition, the Company has
operating leases totaling $1.8 million on its retail branch locations which have
future commitments of up to five years and additional options, the Company
controls, beyond the commitment period.
(4) The Bank has deferred compensation agreements with seven officers of the
Company and the Bank totaling $3.9 million. Payments from the plan are to
commence at the time of retirement. As of December 31, 2003, no payments had
been made from the plan. Of the seven officers included in the plan, two were
eligible for retirement at December 31, 2003 and one is eligible for retirement
in April 2005. All other officers are eligible at various times after five
years. The totals reflected under five years assume the two eligible officers
could retire at any time and the officer eligible in 2005 will retire at the
scheduled retirement date.
The table on page 57 shows the expected maturities for interest earning assets
and interest bearing liabilities as of December 31, 2003.
55
ITEM 7 A. 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 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 59 shows interest
sensitivity gaps for four different intervals as of December 31, 2003.
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, 2003, were within policy guidelines. Due to the level of
interest at December 31, 2003, many of the interest rates cannot move down 200
basis points. As part of the overall assumptions, certain assets and liabilities
have been given reasonable floors. In the present interest rate environment,
management is primarily focusing on the shock down 100 basis points and the
shock up 100 and 200 basis points. This type of stimulation analysis requires
numerous assumptions including but not limited to changes in balance sheet mix,
prepayment rates on mortgage-related assets and fixed rate loans, cash flows and
repricings of all financial instruments, changes in volumes and pricing, future
shapes of the yield curve, relationship of market interest rates to each other
(basis risk), credit spread and deposit sensitivity. Assumptions are based on
management's best estimates but may not accurately reflect actual results under
certain changes in interest rates.
56
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. Callable FHLB Advances are presented based on
contractual maturity. Loans held for sale totaling $3,319,000 are classified in
the one year category. Adjustable rate student loans totaling $5.3 million are
classified in the one year category. Nonaccrual loans totaling $1,547,000 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
2004 2005 2006 2007 2008 Thereafter Total Value
-------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Fixed Rate Loans ....... $181,966 $ 88,334 $ 54,312 $ 34,666 $ 15,404 $ 82,565 $ 457,247 $ 477,361
6.63% 6.76% 6.59% 6.44% 6.34% 5.62% 6.44%
Adjustable Rate Loans... 40,956 11,206 10,548 19,041 8,755 43,154 133,660 133,660
4.42% 4.42% 4.69% 4.50% 4.30% 4.51% 4.47%
Mortgage-backed
Securities ............. 225,325 143,650 91,529 59,336 36,678 34,445 590,963 590,946
4.00% 3.88% 3.78% 3.66% 3.55% 3.58% 3.85%
Investments and Other
Interest Earning Assets. 53,580 1,021 991 3,802 3,989 105,749 169,132 169,132
1.32% 8.34% 5.36% 3.40% 4.06% 6.76% 4.90%
Total Interest
Earning Assets.......... $501,827 $ 244,211 $ 157,380 $ 116,845 $ 64,826 $ 265,913 $1,351,002 $1,371,099
4.70% 4.97% 4.82% 4.61% 4.35% 5.63% 4.92%
Savings Deposits........ $ 4,556 $ 2,278 $ 2,278 $ 2,278 $ 2,278 $ 31,891 $ 45,559 $ 42,158
0.40% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40%
NOW Deposits............ 37,165 5,369 5,369 5,369 5,369 75,165 133,806 124,361
0.75% 0.11% 0.11% 0.11% 0.11% 0.11% 0.29%
Money Market Deposits... 23,182 7,727 7,727 7,727 7,727 23,184 77,274 76,232
1.26% 1.26% 1.26% 1.26% 1.26% 1.26% 1.26%
Platinum Money Market... 44,866 4,807 4,807 4,807 4,807 -- 64,094 64,766
0.93% 0.93% 0.93% 0.93% 0.93% -- 0.93%
Certificates of Deposit. 236,963 36,695 21,994 18,710 7,585 200 322,147 327,795
1.87% 3.71% 4.44% 4.65% 3.34% 6.50% 2.45%
FHLB Dallas Advances.... 142,734 96,843 86,636 20,543 34,976 62,951 444,683 449,980
2.74% 2.98% 3.28% 4.10% 4.86% 5.32% 3.49%
Other Borrowings....... 6,123 -- -- -- -- 20,619 26,742 26,742
1.00% -- -- -- -- 4.10% 3.39%
Total Interest
Bearing Liabilities.... $495,589 $ 153,719 $ 128,811 $ 59,434 $ 62,742 $ 214,010 $1,114,305 $1,112,034
1.90% 2.87% 3.09% 3.15% 3.36% 2.20% 2.38%
</Table>
57
Residential fixed rate loans are assumed to have annual prepayment rates
between 7% and 35% of the portfolio. Commercial and multi-family real estate
loans are assumed to prepay at an annualized rate between 8% and 40%. Consumer
loans are assumed to prepay at an annualized rate between 8% and 30%. Commercial
loans are assumed to prepay at an annual rate between 8% and 45%. Municipal
loans are assumed to prepay at an annual rate between 6% and 15%. 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 6% to 50%. At December 31, 2003,
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, 2003, of the $591 million of
mortgage-backed and related securities held by the Company, all were secured by
fixed-rate mortgage loans.
The Company assumes 70% of savings accounts and transaction accounts at
December 31, 2003, are core deposits and are, therefore, expected to roll-off
after five years. The Company assumes 30% of money market accounts at December
31, 2003 are core deposits and are, therefore, expected to roll-off after five
years. The Company does not consider any of its Platinum Money Market 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.
58
The following table sets forth certain information as of December 31,
2003 with respect to rate sensitive assets and liabilities and interest
sensitivity gap (dollars in thousands):
<Table>
<Caption>
Rate Sensitive Assets (RSA) 1-3 Mos. 4-12 Mos. 1-5 Yrs. Over 5 Yrs. Total
-------- --------- -------- ----------- ----------
Loans(1) ............................... $196,479 $119,147 $192,716 $ 82,565 $ 590,907
Securities ............................. 101,184 177,135 340,996 140,194 759,509
Other Interest Earning Assets .......... 586 -- -- -- 586
-------- -------- -------- -------- ----------
Total Rate Sensitive Assets ............ $298,249 $296,282 $533,712 $222,759 $1,351,002
======== ======== ======== ======== ==========
Rate Sensitive Liabilities (RSL)
Interest Bearing Deposits .............. $140,925 $205,807 $165,708 $130,440 $ 642,880
Other Interest Bearing Liabilities ..... 67,229 81,628 238,998 83,570 471,425
-------- -------- -------- -------- ----------
Total Rate Sensitive Liabilities ....... $208,154 $287,435 $404,706 $214,010 $1,114,305
======== ======== ======== ======== ==========
Gap (2) ................................ 90,095 8,847 129,006 8,749 236,697
Cumulative Gap ......................... 90,095 98,942 227,948 236,697
Cumulative Ratio of RSA to RSL ......... 1.43 1.20 1.25 1.21 1.21
Gap/Total Earning Assets ............... 6.7% 0.7% 9.5% 0.6% 17.5%
</Table>
------------------------------------------------------------------------
(1) Amount is equal to total loans net of unearned discount less nonaccrual
loans at December 31, 2003.
(2) Gap equals Total RSA minus Total RSL.
The Asset Liability Management Committee of the 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.
59
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.
ITEM 9 A. CONTROLS AND PROCEDURES
The Company's Chief Executive Officer and its Chief Financial
Officer undertook an evaluation of the company's disclosure controls
and procedures (as defined in Exchange Act Rules 13a-15(e) and
15d-15(e) as of the end of the period covered by this report and
concluded that the Company's controls and procedures are effective in
ensuring that all material information required to be filed in this
annual report has been made known to them in a timely fashion. There
have been no significant changes in internal controls, or in factors
that could significantly affect internal controls, subsequent to the
date the Chief Executive Officer and Chief Financial Officer completed
their evaluation.
60
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required under this item 10 appears beginning
on page 2 of the Company's definitive Proxy Statement for the Annual
Meeting of Shareholders to be held April 15, 2004 that will be filed
within 120 days following the fiscal year end December 31, 2003 (the
"Proxy Statement") is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required under this item 11 appears beginning
on page 8 of the Proxy Statement is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required under this item 12 beginning on page
2 of the Proxy Statement is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required under this item 13 beginning on page
13 of the Proxy Statement is incorporated herein by reference.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required under this item 14 beginning on page
6 of the Proxy Statement is incorporated herein by reference.
61
PART IV
ITEM 15. 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, 2003 and 2002.
Consolidated Statements of Income for the years ended December
31, 2003, 2002 and 2001.
Consolidated Statements of Shareholders' Equity for the years
ended December 31, 2003, 2002 and 2001.
Consolidated Statements of Cash Flow for the years ended
December 31, 2003, 2002 and 2001.
Notes to Consolidated Financial Statements.
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
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).
4.1 - Form of Indenture with respect to Southside
Bancshares, Inc.'s 8.50% Junior Subordinated
Debentures (filed as exhibit 4.1 to the
Registrant's Form S-2 filed with the
Securities and Exchange Commission on May
13, 1998, and incorporated herein by
reference).
4.2 - Form of 8.50% Junior Subordinated Debenture
(included as an exhibit to the Form of
Indenture filed as Exhibit 4.1 to the
Registrant's Form S-2 filed with the
Securities and Exchange Commission on May
13, 1998, and incorporated herein by
reference).
4.3 - Certificate of Trust of Southside Capital
Trust I (included as an exhibit to the Form
of Amended and Restated Trust Agreement
filed as Exhibit 4.5 to the Registrant's
Form S-2 filed with the Securities and
Exchange Commission on May 13, 1998, and
incorporated herein by reference).
62
4.4 - Form of Trust Agreement of Southside Capital
Trust I (included as an exhibit to the Form
of Amended and Restated Trust Agreement
filed as Exhibit 4.5 to the Registrant's
Form S-2 filed with the Securities and
Exchange Commission on May 13, 1998, and
incorporated herein by reference).
4.5 - Form of Amended and Restated Trust Agreement
of Southside Capital Trust I (filed as
Exhibit 4.5 to the Registrant's Form S-2
filed with the Securities and Exchange
Commission on May 13, 1998, and incorporated
herein by reference).
4.6 - Form of Certificate for 8.50% Trust
Preferred Security of Southside Capital
Trust I (included as an exhibit to the Form
of Amended and Restated Trust Agreement
filed as Exhibit 4.5 to the Registrant's
Form S-2 filed with the Securities and
Exchange Commission on May 13, 1998, and
incorporated herein by reference).
4.7 - Form of Guarantee Agreement for Southside
Capital Trust I (filed as exhibit 4.7 to the
Registrant's Form S-2 filed with the
Securities and Exchange Commission on May
13, 1998, and incorporated herein by
reference).
4.8 - Form of Indenture with respect to Southside
Bancshares, Inc.'s 8.75% Convertible
Subordinated Debentures (filed as Exhibit
4.9 to the Registrant's Form S-2 filed with
the Securities and Exchange Commission on
October 13, 2000, and incorporated herein by
reference).
4.9 - Form of 8.75% Convertible Subordinated
Debenture (included as an exhibit to the
Form of Indenture filed as Exhibit 4.9 to
the Registrant's Form S-2 filed with the
Securities and Exchange Commission on
October 13, 2000, and incorporated herein by
reference).
4.10 - Certificate of Trust of Southside Capital
Trust II (included as an exhibit to the Form
of Amended and Restated Trust Agreement
filed as Exhibit 4.13 to the Registrant's
Form S-2 filed with the Securities and
Exchange Commission on October 13, 2000, and
incorporated herein by reference).
4.11 - Form of Trust Agreement of Southside Capital
Trust II (included as an exhibit to the Form
of Amended and Restated Trust Agreement
filed as Exhibit 4.13 to the Registrant's
Form S-2 filed with the Securities and
Exchange Commission on October 13, 2000, and
incorporated herein by reference).
4.12 - Form of Amended and Restated Trust Agreement
of Southside Capital Trust II (filed as
exhibit 4.13 to the Registrant's Form S-2
filed with the Securities and Exchange
Commission on October 13, 2000, and
incorporated herein by reference).
4.13 - Form of Certificate for 8.75% Trust
Preferred Security of Southside Capital
Trust II (included as an exhibit to the Form
of Amended and Restated Trust Agreement
filed as Exhibit 4.13 to the Registrant's
Form S-2 filed with the Securities and
Exchange Commission on October 13, 2000, and
incorporated herein by reference).
4.14 - Form of Guarantee Agreement for Southside
Capital Trust II (filed as exhibit 4.15 to
the Registrant's Form S-2 filed with the
Securities and Exchange Commission on
October 13, 2000, and incorporated herein by
reference).
63
4.15 - Management agrees to furnish to the
Securities and Exchange Commission, upon
request, a copy of any other agreements or
instruments of Southside Bancshares, Inc.
and its subsidiaries defining the rights of
holders of any long-term debt whose
authorization does not exceed 10% of total
assets.
** 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 Agreement
dated June 30, 1994 with 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).
** 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) - Postretirement 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).
64
* 21 - Subsidiaries of the Registrant.
* 23 - Consent of Independent Accountants.
* 31.1 - Certification Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
* 31.2 - Certification Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
* 32.1 - Certification Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
* 32.2 - Certification Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
- ------------------
* Filed herewith.
** Compensation plan, benefit plan or employment contract or
arrangement.
(b) Reports on Form 8-K
A current report on Form 8-K was filed with the Securities and Exchange
Commission on October 23, 2003 with respect to a press release issued
by the Company, on October 23, 2003 announcing its earnings for the
third quarter of 2003.
A current report on Form 8-K was filed with the Securities and Exchange
Commission on October 31, 2003 with respect to a press release issued
by the Company, on October 30, 2003 announcing the redemption of the
Southside Capital Trust II trust securities.
65
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 Chief Executive Officer
(Principal Executive Officer)
/s/ LEE R. GIBSON
-------------------------------------------
Lee R. Gibson, CPA, Executive Vice
President and Chief Financial Officer
(Principal Financial and Accounting
Officer)
DATED: March 9, 2004
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 9, 2004
- ------------------------------------- and Director
(B. G. Hartley)
/s/ ROBBIE N. EDMONSON Vice Chairman of the Board March 9, 2004
- ------------------------------------- and Director
(Robbie N. Edmonson)
/s/ SAM DAWSON President and Secretary March 9, 2004
- ------------------------------------- and Director
(Sam Dawson)
/s/ FRED E. BOSWORTH Director March 9, 2004
- -------------------------------------
(Fred E. Bosworth)
/s/ HERBERT C. BUIE Director March 9, 2004
- -------------------------------------
(Herbert C. Buie)
/s/ ALTON CADE Director March 9, 2004
- -------------------------------------
(Alton Cade)
/s/ ROLLINS CALDWELL Director March 9, 2004
- -------------------------------------
(Rollins Caldwell)
/s/ Director
- -------------------------------------
(Michael D. Gollob)
/s/ JOE NORTON Director March 9, 2004
- -------------------------------------
(Joe Norton)
/s/ PAUL W. POWELL Director March 9, 2004
- -------------------------------------
(Paul W. Powell)
/s/ WILLIAM SHEEHY Director March 9, 2004
- -------------------------------------
(William Sheehy)
</Table>
66
Report of Independent Auditors
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, 2003 and 2002, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2003, 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 6 to the financial statements on January 1, 2001, the
Company adopted Financial Accounting Standard No. 133 "Accounting for Derivative
Instruments and Hedging Activities".
As discussed in Note 2, the Company has restated its financial statements as of
December 31, 2002 and for the year then ended.
PricewaterhouseCoopers LLP
Dallas, Texas
March 4, 2004
67
SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
<Table>
<Caption>
December 31, December 31,
2003 2002
----------- -----------
(Restated)
ASSETS
Cash and due from banks ......................................... $ 47,223 $ 49,607
Investment securities:
Available for sale .......................................... 144,876 151,509
Mortgage-backed and related securities:
Available for sale .......................................... 584,581 489,015
Held to maturity ............................................ 6,382 --
Marketable equity securities:
Available for sale .......................................... 23,670 22,391
Loans held for sale ............................................. 3,319 11,781
Loans:
Loans, net of unearned discount ............................ 589,135 570,460
Less: allowance for loan losses ............................ (6,414) (6,195)
----------- -----------
Net Loans .................................................. 582,721 564,265
Premises and equipment, net ..................................... 30,629 30,100
Interest receivable ............................................. 8,433 8,930
Other assets .................................................... 23,118 21,588
----------- -----------
TOTAL ASSETS ............................................... $ 1,454,952 $ 1,349,186
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest bearing .......................................... $ 229,649 $ 193,305
Interest bearing ............................................. 642,880 621,181
----------- -----------
Total Deposits ............................................. 872,529 814,486
Short-term obligations:
Federal funds purchased ...................................... 3,525 15,850
FHLB Dallas advances ......................................... 192,608 153,422
Other obligations ............................................ 2,598 2,500
----------- -----------
Total Short-term obligations ............................... 198,731 171,772
Long-term obligations:
FHLB Dallas advances ......................................... 252,075 231,140
Junior subordinated convertible debentures ................... -- 14,225
Junior subordinated debentures ............................... -- 20,000
Long-term debt ............................................... 20,619 --
----------- -----------
Total Long-term obligations ................................ 272,694 265,365
Deferred tax liability .......................................... 1,551 2,680
Other liabilities ............................................... 9,061 14,561
----------- -----------
TOTAL LIABILITIES .......................................... 1,354,566 1,268,864
----------- -----------
Commitments and Contingencies (Note 17)
Shareholders' equity:
Common stock: ($1.25 par, 20,000,000 shares authorized,
11,779,467 and 9,557,598 shares issued) ...................... 14,724 11,947
Paid-in capital .............................................. 63,144 44,050
Retained earnings ............................................ 32,979 29,805
Treasury stock (1,420,587 and 1,198,787 shares at cost) ...... (16,544) (12,714)
Accumulated other comprehensive income ....................... 6,083 7,234
----------- -----------
TOTAL SHAREHOLDERS' EQUITY ................................ 100,386 80,322
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ................ $ 1,454,952 $ 1,349,186
=========== ===========
</Table>
The accompanying notes are an integral part of these consolidated financial
statements.
68
SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share data)
<Table>
<Caption>
Years Ended December 31,
----------------------------------
2003 2002 2001
------- -------- --------
Interest income
Loans .................................................................. $35,403 $ 38,101 $ 40,702
Investment securities .................................................. 4,840 6,787 6,968
Mortgage-backed and related securities ................................. 20,149 23,647 29,507
Marketable equity securities ........................................... 519 654 854
Other interest earning assets .......................................... 89 52 151
------- -------- --------
Total interest income ............................................ 61,000 69,241 78,182
------- -------- --------
Interest expense
Deposits ............................................................... 11,437 16,197 24,892
Short-term obligations ................................................. 6,319 5,729 7,302
Long-term obligations .................................................. 11,896 14,458 15,369
------- -------- --------
Total interest expense ........................................... 29,652 36,384 47,563
------- -------- --------
Net interest income ....................................................... 31,348 32,857 30,619
Provision for loan losses ................................................. 1,209 2,118 1,667
------- -------- --------
Net interest income after provision for loan losses ....................... 30,139 30,739 28,952
------- -------- --------
Noninterest income
Deposit services ....................................................... 12,958 10,718 9,377
Gain (loss) on sales of securities available for sale .................. 5,033 3,853 4,073
Gain on sale of loans .................................................. 2,667 2,044 1,057
Trust income ........................................................... 1,063 1,031 961
Bank owned life insurance income ....................................... 986 966 109
Other .................................................................. 1,406 979 1,099
------- -------- --------
Total noninterest income ......................................... 24,113 19,591 16,676
------- -------- --------
Noninterest expense
Salaries and employee benefits ......................................... 23,182 21,553 17,626
Net occupancy expense .................................................. 3,954 3,903 3,358
Equipment expense ...................................................... 712 684 734
Advertising, travel & entertainment .................................... 1,775 1,721 1,650
ATM and bank analysis fees ............................................. 954 859 812
Amortization ........................................................... 990 68 81
Supplies ............................................................... 638 706 615
Professional fees ...................................................... 685 666 617
Postage ................................................................ 566 537 454
Other .................................................................. 4,650 4,125 3,432
------- -------- --------
Total noninterest expense ........................................ 38,106 34,822 29,379
------- -------- --------
Income before federal tax expense ......................................... 16,146 15,508 16,249
------- -------- --------
Provision (benefit) for federal tax expense
Current ................................................................ 2,208 2,854 3,728
Deferred ............................................................... 374 (671) (204)
------- -------- --------
Total income taxes ............................................... 2,582 2,183 3,524
------- -------- --------
Income before cumulative effect of change in accounting principle ......... 13,564 13,325 12,725
Cumulative effect of change in accounting principle, net of tax ........... -- -- (994)
------- -------- --------
Net Income ................................................................ $13,564 $ 13,325 $ 11,731
======= ======== ========
Earnings Per Common Share:
Basic:
Income before cumulative effect of change in accounting principle .... $ 1.50 $ 1.53 $ 1.47
Cumulative effect of change in accounting principle, net of tax ...... -- -- (0.11)
------- -------- --------
Net income ........................................................... $ 1.50 $ 1.53 $ 1.36
======= ======== ========
Diluted:
Income before cumulative effect of change in accounting principle .... $ 1.28 $ 1.28 $ 1.24
Cumulative effect of change in accounting principle, net of tax ...... -- -- (0.09)
------- -------- --------
Net income ........................................................... $ 1.28 $ 1.28 $ 1.15
======= ======== ========
</Table>
The accompanying notes are an integral part of these consolidated financial
statements.
69
SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(in thousands, except share amounts)
<Table>
<Caption>
Compre-
hensive Common Paid in Retained Treasury
Income Stock Capital Earnings Stock
-------- -------- -------- -------- --------
Balance at December 31, 2002 ..................... $ $ 11,947 $ 44,050 $ 29,805 $(12,714)
Net Income ....................................... 13,564 13,564
Other comprehensive income, net of tax
Unrealized losses on securities, net of
reclassification adjustment (see Note 4) ..... (2,917)
Minimum pension liability adjustment ............. 1,766
--------
Comprehensive income ............................. $ 12,413
========
Common stock issued (1,792,629 shares) ........... 2,240 12,214
Tax benefit of incentive stock options ........... 223
Dividends paid on common stock ................... (3,196)
Purchase of 221,800 shares of
common stock .................................. (3,830)
Stock dividend ................................... 537 6,657 (7,194)
-------- -------- -------- --------
Balance at December 31, 2003 ..................... $ 14,724 $ 63,144 $ 32,979 $(16,544)
======== ======== ======== ========
Balance at December 31, 2001 ..................... $ $ 10,917 $ 35,195 $ 25,133 $ (8,511)
Net Income ....................................... 13,325 13,325
Other comprehensive income, net of tax
Unrealized gains on securities, net of
reclassification adjustment (see Note 4) ..... 3,333
Minimum pension liability adjustment (1) ......... (1,950)
--------
Comprehensive income ............................. $ 14,708
========
Common stock issued (428,822 shares) ............. 536 3,159
Tax benefit of incentive stock options ........... 183
Dividends paid on common stock ................... (2,646)
Purchase of 278,210 shares of
common stock .................................. (4,203)
Stock dividend ................................... 494 5,513 (6,007)
-------- -------- -------- --------
Balance at December 31, 2002 ..................... $ 11,947 $ 44,050 $ 29,805 $(12,714)
======== ======== ======== ========
<Caption>
Accumulated
Other
Compre- Total
hensive Share-
Income holders'
(Loss) Equity
----------- --------
Balance at December 31, 2002 ..................... $ 7,234 $ 80,322
Net Income ....................................... 13,564
Other comprehensive income, net of tax
Unrealized losses on securities, net of
reclassification adjustment (see Note 4) ..... (2,917) (2,917)
Minimum pension liability adjustment ............. 1,766 1,766
Comprehensive income .............................
Common stock issued (1,792,629 shares) ........... 14,454
Tax benefit of incentive stock options ........... 223
Dividends paid on common stock ................... (3,196)
Purchase of 221,800 shares of
common stock .................................. (3,830)
Stock dividend ................................... --
-------- --------
Balance at December 31, 2003 ..................... $ 6,083 $100,386
======== ========
Balance at December 31, 2001 ..................... $ 5,851 $ 68,585
Net Income ....................................... 13,325
Other comprehensive income, net of tax
Unrealized gains on securities, net of
reclassification adjustment (see Note 4) ..... 3,333 3,333
Minimum pension liability adjustment (1) ......... (1,950) (1,950)
Comprehensive income .............................
Common stock issued (428,822 shares) ............. 3,695
Tax benefit of incentive stock options ........... 183
Dividends paid on common stock ................... (2,646)
Purchase of 278,210 shares of
common stock .................................. (4,203)
Stock dividend ................................... --
-------- --------
Balance at December 31, 2002 ..................... $ 7,234 $ 80,322
======== ========
</Table>
(1) Restated
(continued)
70
SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (continued)
(in thousands, except share amounts)
<Table>
<Caption>
Compre-
hensive Common Paid in Retained Treasury
Income Stock Capital Earnings Stock
-------- -------- -------- -------- --------
Balance at December 31, 2000 ..................... $ $ 10,269 $ 30,226 $ 19,891 $ (5,357)
Net Income ....................................... 11,731 11,731
Other comprehensive income, net of tax
Unrealized gains on securities, net of
reclassification adjustment (see Note 4) ..... 9,241
Minimum pension liability adjustment ............. (56)
--------
Comprehensive income ............................. $ 20,916
========
Common stock issued (143,856 shares) ............. 180 715
Tax benefit of incentive stock options ........... 123
Dividends paid on common stock ................... (1,890)
Purchase of 314,025 shares of
common stock .................................. (3,154)
Stock dividend ................................... 468 4,131 (4,599)
-------- -------- -------- --------
Balance at December 31, 2001 ..................... $ 10,917 $ 35,195 $ 25,133 $ (8,511)
======== ======== ======== ========
<Caption>
Accumulated
Other
Compre- Total
hensive Share-
Income holders'
(Loss) Equity
----------- --------
Balance at December 31, 2000 ..................... $ (3,334) $51,695
Net Income ....................................... 11,731
Other comprehensive income, net of tax
Unrealized gains on securities, net of
reclassification adjustment (see Note 4) ..... 9,241 9,241
Minimum pension liability adjustment ............. (56) (56)
Comprehensive income .............................
Common stock issued (143,856 shares) ............. 895
Tax benefit of incentive stock options ........... 123
Dividends paid on common stock ................... (1,890)
Purchase of 314,025 shares of
common stock .................................. (3,154)
Stock dividend ................................... --
-------- -------
Balance at December 31, 2001 ..................... $ 5,851 $68,585
======== =======
</Table>
The accompanying notes are an integral part of these consolidated financial
statements.
71
SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
(in thousands)
<Table>
<Caption>
Years Ended December 31,
-----------------------------------------
2003 2002 2001
--------- --------- ---------
OPERATING ACTIVITIES:
Net income ....................................................................... $ 13,564 $ 13,325 $ 11,731
Adjustments to reconcile net cash provided by operations:
Depreciation ................................................................... 2,355 2,321 1,966
Amortization of premium ........................................................ 13,666 10,400 7,595
Accretion of discount and loan fees ............................................ (254) (359) (1,301)
Provision for loan losses ...................................................... 1,209 2,118 1,667
Decrease (increase) in interest receivable ..................................... 497 (308) 495
(Increase) decrease in other assets ............................................ (1,823) 202 (16,085)
(Increase) decrease in deferred tax asset ...................................... (537) 280 (176)
Decrease in interest payable ................................................... (526) (406) (461)
(Decrease) increase in other liabilities ....................................... (2,199) 3,742 2,179
Decrease (increase) in loans held for sale ..................................... 8,462 (7,933) (3,848)
Tax benefit of incentive stock options ......................................... 223 183 123
Gain on sale of securities available for sale .................................. (5,033) (3,853) (4,073)
Loss on retirement of premises and equipment ................................... 159 -- --
Gain on sale of premises and equipment ......................................... (7) (12) (45)
Impairment of other real estate owned .......................................... 70 -- --
(Gain) loss on sale of other real estate owned ................................. (14) 67 (6)
Cumulative effect of change in accounting principle ............................ -- -- 994
Proceeds from sales of trading securities ...................................... -- -- 99,595
--------- --------- ---------
Net cash provided by operating activities .................................. 29,812 19,767 100,350
INVESTING ACTIVITIES:
Proceeds from sale of investment securities available for sale ................. 90,212 108,416 100,810
Proceeds from sale of mortgage-backed securities available for sale ............ 144,787 116,125 170,521
Proceeds from maturities of investment securities available for sale ........... 75,742 15,874 67,939
Proceeds from maturities of mortgage-backed securities available for sale ...... 252,818 210,972 164,532
Purchases of investment securities available for sale .......................... (157,839) (111,281) (207,194)
Purchases of mortgage-backed securities available for sale ..................... (507,452) (368,872) (424,780)
Purchases of mortgage-backed securities held to maturity ....................... (6,382) -- --
Purchases of marketable equity securities available for sale ................... (1,279) (1,106) (1,061)
Net increase in loans .......................................................... (20,704) (40,619) (55,192)
Purchases of premises and equipment ............................................ (3,082) (4,680) (4,256)
Proceeds from sale of premises and equipment ................................... 46 19 62
Proceeds from sale of repossessed assets ....................................... 885 504 1,381
Proceeds from sale of other real estate owned .................................. 391 1,532 389
--------- --------- ---------
Net cash used in investing activities ...................................... (131,857) (73,116) (186,849)
</Table>
(continued)
72
SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW (continued)
(in thousands)
<Table>
<Caption>
Years Ended December 31,
------------------------------------------------
2003 2002 2001
----------- ------------ -----------
FINANCING ACTIVITIES:
Net increase in demand and savings accounts ............................... $ 80,850 $ 57,361 $ 37,882
Net decrease in certificates of deposit ................................... (22,807) (829) (533)
Proceeds from FHLB Dallas advances ........................................ 2,851,988 10,342,329 4,975,117
Repayment of FHLB Dallas advances ......................................... (2,791,867) (10,332,657) (4,928,812)
Proceeds from issuance of long-term debt .................................. 20,619 -- --
Repayment of junior subordinated debentures ............................... (20,000) -- --
Net decrease in junior subordinated convertible debentures ................ (14,225) (2,725) --
Net (decrease) increase in federal funds purchased ........................ (12,325) (10,050) 20,875
Proceeds from the issuance of common stock ................................ 14,454 3,695 895
Purchase of common stock .................................................. (3,830) (4,203) (3,154)
Dividends paid ............................................................ (3,196) (2,646) (1,890)
----------- ------------ -----------
Net cash provided by financing activities ........................... 99,661 50,275 100,380
----------- ------------ -----------
Net (decrease) increase in cash and cash equivalents ...................... (2,384) (3,074) 13,881
Cash and cash equivalents at beginning of year ............................ 49,607 52,681 38,800
----------- ------------ -----------
Cash and cash equivalents at end of year .................................. $ 47,223 $ 49,607 $ 52,681
=========== ============ ===========
SUPPLEMENTAL DISCLOSURE FOR CASH FLOW INFORMATION:
Interest paid ............................................................. $ 30,178 $ 36,789 $ 48,024
Income taxes paid ......................................................... $ 2,050 $ 2,150 $ 3,025
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Acquisition of other repossessed assets and real estate
through foreclosure ................................................... $ 1,040 $ 2,360 $ 1,803
Transfer of held to maturity securities to trading securities ............. $ -- $ -- $ 99,792
Minimum pension plan liability adjustment (1) ............................. $ (2,796) $ 2,796 $ --
</Table>
The accompanying notes are an integral part of these consolidated financial
statements.
(1) Restated for 2002.
73
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,
the Bank and the nonbank subsidiary, which did not conduct any business in 2003.
The 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 discount.
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 allowance 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.
Loans Held For Sale. Loans originated and intended for sale in the secondary
market are carried at the lower of aggregate cost or fair value, as determined
by aggregate outstanding commitments from investors or current investor yield
requirements. Net unrealized losses are recognized through a valuation allowance
by charges to income.
Gains or losses on sales of mortgage loans are recognized based on the
difference between the selling price and the carrying value of the related
mortgage loans sold.
Loan Fees. The Company treats loan fees, net of direct costs, as an adjustment
to the yield of the related loan over its term.
Allowance for Loan Losses. An allowance 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
allowance 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
74
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 net of estimated selling costs. 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 allowance for loan losses. Any subsequent reduction in fair market value is
charged to results of operations through the Allowance 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.
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.
Purchase premiums and discounts are recognized in interest income using the
interest method over the terms of the securities. Declines in the fair value of
held to maturity and available for sale securities below their cost that are
deemed to be other than temporary are reflected in earnings as realized losses.
In estimating other than temporary impairment losses, management considers (1)
the length of time and the extent to which the fair value has been less than
cost, (2) the financial condition and near-term prospects of the issuer, and (3)
the intent and ability of the Company to retain its investment in the issuer for
a period of time sufficient to allow for any anticipated recovery in fair value.
Gains and losses on the sale of securities are recorded on the trade date and
are determined using the specific identification method.
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.
75
Use of Estimates. In preparing consolidated financial statements in conformity
with generally accepted accounting principles, management is required to make
estimates and assumptions that affect the reported amounts of assets and
liabilities as of the date of the balance sheet and reported amounts of revenues
and expenses during the reporting period. Actual results could differ from those
estimates. Material estimates that are particularly susceptible to significant
change in the near term relate to the determination of the allowance for loan
losses and the valuation of deferred tax assets.
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, compensation 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 2001, 2002 and 2003.
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 2003, 2002, and 2001 would approximate the
pro forma amounts below (in thousands, except per share amounts, net of taxes):
<Table>
<Caption>
Years Ended December 31,
------------------------------------------------------------------------------------------
As Pro As Pro As Pro
Reported Forma Reported Forma Reported Forma
2003 2003 2002 2002 2001 2001
---------- ---------- ---------- ---------- ---------- ----------
FAS123 Charge ....... $ -- $ 160 $ -- $ 176 $ -- $ 220
Net Income .......... $ 13,564 $ 13,404 $ 13,325 $ 13,149 $ 11,731 $ 11,511
Net Income per Common
Share-Basic ...... $ 1.50 $ 1.48 $ 1.53 $ 1.51 $ 1.36 $ 1.33
Net Income per Common
Share-Diluted .... $ 1.28 $ 1.27 $ 1.28 $ 1.26 $ 1.15 $ 1.13
</Table>
The effects of applying FAS123 in this pro forma disclosure are not indicative
of future amounts.
General. Certain prior period amounts have been reclassified to conform to
current year presentation and had no impact on net income or equity.
Accounting Pronouncements. In November 2002, the Financial Accounting Standards
Board (FASB) issued Interpretation No. 45, Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others (FIN 45), which covers guarantees such as standby letters of credit,
performance guarantees, and direct or indirect guarantees of the indebtedness of
others, but not guarantees of funding. FIN 45 requires a guarantor to recognize,
at the inception of a guarantee, a liability in an amount equal to the fair
value of the obligation undertaken in issuing the guarantee, and requires
disclosure about maximum potential payments that might be required, as well as
the collateral or other recourse obtainable. The recognition and measurement
provisions of FIN 45 were effective on a prospective basis after December 31,
2002. The adoption of FIN 45 did not have a material impact on the Company's
consolidated financial statements.
76
In January 2003, the FASB issued Interpretation No. 46 Consolidation of Variable
Interest Entities (FIN 46), which establishes guidance for determining when an
entity should consolidate another entity that meets the definition of a variable
interest entity. FIN 46 requires a variable interest entity to be consolidated
by a company if that company will absorb a majority of the expected losses, will
receive a majority of the expected residual returns, or both. Transferors to
qualified special-purpose entities ("QSPEs") and certain other interests in a
QSPE are not subject to the requirements of FIN 46. On December 17, 2003, the
FASB revised FIN 46 (FIN 46R) and deferred the effective date of FIN 46 to no
later than the end of the first reporting period that ends after March 15, 2004,
however, for special-purpose entities the Company would be required to apply FIN
46 as of December 31, 2003.
The Company adopted FIN 46 in connection with its consolidated financial
statements for the year ended December 31, 2003. FIN 46 required the Company to
de-consolidate its investments in Southside Statutory Trust III in its financial
statements. Effective December 31, 2003, the Company deconsolidated the
wholly-owned issuing trust entity resulting in a recharacterization of the
underlying consolidated debt obligation from the previous trust preferred
securities obligation to the junior subordinated debenture obligation that exist
between the Company and the issuing trust entity. As a result of adopting FIN 46
on December 31, 2003, the Company did not restate its prior period consolidated
financial statements. In July 2003, the Board of Governors of the Federal
Reserve issued a supervisory letter instructing bank holding companies to
continue to include the trust preferred securities in their Tier 1 capital for
regulatory capital purposes until notice is given to the contrary. The Federal
Reserve intends to review the regulatory implications of any accounting
treatment changes and, if necessary or warranted, provide further appropriate
guidance. There can be no assurance that the Federal Reserve will continue to
permit institutions to include trust preferred securities in Tier 1 capital for
regulatory capital purposes. If, as of December 31, 2003, the Company was not
permitted to include a portion of the $20.0 million in trust preferred
securities issued by Southside Statutory Trust III in its Tier 1 capital, the
Company would still exceed the regulatory required minimums for capital adequacy
purposes. If the trust preferred securities were no longer permitted to be
included in Tier 1 capital, the Company would also be permitted to redeem the
capital securities.
In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities. This statement amends SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities" and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
No. 133. This Statement is effective for contracts entered into or modified
after June 30, 2003, except in certain circumstances, and for hedging
relationships designated after June 30, 2003. The adoption of FAS 149 did not
have a material impact on the Company's consolidated financial statements.
In May 2003, FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. This statement
provides new rules on the accounting for certain financial instruments that,
under previous guidance, issuers could account for as equity. Such financial
instruments include mandatorily redeemable shares, instruments that require the
issuer to buy back some of its shares in exchange for cash or other assets, or
obligations that can be settled with shares, the monetary value of which is
fixed. Most of the guidance in SFAS No. 150 is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June 30,
2003. The adoption of FAS 150 did not have a material impact on the Company's
consolidated financial statements.
In December 2003, the FASB issued SFAS No. 132 (revised 2003), Employers'
Disclosures about Pensions and Postretirement Benefits. This statement requires
additional disclosures about the assets, obligations and cash flows of defined
benefit pension and postretirement plans, as well as the expense recorded for
such plans. As of December 31, 2003, the Company has disclosed the required
elements related to its defined benefit pension plan in Note 13 to these
consolidated financial statements.
77
2. FINANCIAL STATEMENT RESTATEMENT FOR 2002
Certain financial statement components for the year ended December 31, 2002 have
been restated. It is important to note, the restatement entries described below
completely reversed in the financial statements for the year ended December 31,
2003. It is also important to note, net income and earnings per share did not
change for any of the years presented.
During the preparation of the Form 10-K for December 31, 2003, the Company
discovered, while reviewing retirement plan workpapers, that a minimum pension
plan liability adjustment that should have been reflected on the balance sheet
as of December 31, 2002 was inadvertently overlooked. The oversight occurred due
in part to the fact that the Company, historically, had not had a minimum
pension plan liability adjustment in its defined benefit plan. The entries
required for 2002 completely reversed during 2003 as the minimum pension plan
liability adjustment reversed to zero as of December 31, 2003.
The net effect of the entries required, increased other liabilities, decreased
deferred tax liability and decreased shareholders equity due to the minimum
pension liability adjustment entry to accumulated other comprehensive income.
A summary of the adjustments made and their effect on the financial statements
is presented below:
<Table>
<Caption>
As of and for the year then
ended December 31, 2002
----------------------------
(dollars in thousands)
As Originally
Stated Restated
------------- ----------
Deferred tax liability ...................... $ 3,631 $ 2,680
Other liabilities ........................... $ 11,765 $ 14,561
Total Liabilities ........................... $1,267,019 $1,268,864
Accumulated other comprehensive income ...... $ 9,079 $ 7,234
Total Shareholders Equity ................... $ 82,167 $ 80,322
Comprehensive Income ........................ $ 16,553 $ 14,708
</Table>
78
3. 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,
----------------------------------
2003 2002 2001
------- ------- --------
Basic Earnings and Shares:
Income before cumulative effect of accounting change .... $13,564 $13,325 $ 12,725
Cumulative effect of change in accounting principle,
net of tax ............................................. -- -- (994)
------- ------- --------
Net income .............................................. $13,564 $13,325 $ 11,731
======= ======= ========
Weighted-average basic shares outstanding ............... 9,034 8,700 8,653
======= ======= ========
Basic Earnings Per Share:
Income before cumulative effect of accounting change .... $ 1.50 $ 1.53 $ 1.47
Cumulative effect of change in accounting principle,
net of tax ............................................. -- -- (0.11)
------- ------- --------
Net income .............................................. $ 1.50 $ 1.53 $ 1.36
======= ======= ========
Diluted Earnings and Shares:
Income before cumulative effect of accounting change .... $13,564 $13,325 $ 12,725
Add: Applicable dividend on convertible debentures ..... 551 880 979
------- ------- --------
Adjusted net income ..................................... 14,115 14,205 13,704
Cumulative effect of change in accounting principle,
net of tax ............................................. -- -- (994)
------- ------- --------
Net income .............................................. $14,115 $14,205 $ 12,710
======= ======= ========
Weighted-average basic shares outstanding ............... 9,034 8,700 8,653
Add: Stock options ..................................... 639 631 471
Convertible debentures ......................... 1,349 1,772 1,962
------- ------- --------
Weighted-average diluted shares outstanding ............. 11,022 11,103 11,086
======= ======= ========
Diluted Earnings Per Share:
Income before cumulative effect of accounting change .... $ 1.28 $ 1.28 $ 1.24
Cumulative effect of change in accounting principle,
net of tax ............................................. -- -- (0.09)
------- ------- --------
Net income .............................................. $ 1.28 $ 1.28 $ 1.15
======= ======= ========
</Table>
For the years ended December 31, 2003, 2002 and 2001, there were no antidilutive
shares.
79
4. 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, 2003
--------------------------------------------------
Before-Tax Tax (Expense) Net-of-Tax
Amount Benefit Amount
------------ ------------ ------------
Unrealized losses on securities:
Unrealized holding gains arising during period .... $ 613 $ (208) $ 405
Less: reclassification adjustment for gains
realized in net income ........................ 5,033 (1,711) 3,322
------------ ------------ ------------
Net unrealized losses ............................ (4,420) 1,503 (2,917)
Minimum pension liability adjustment ................. 2,677 (911) 1,766
------------ ------------ ------------
Other comprehensive loss ............................. $ (1,743) $ 592 $ (1,151)
============ ============ ============
</Table>
<Table>
<Caption>
Year Ended December 31, 2002
--------------------------------------------------
Before-Tax Tax (Expense) Net-of-Tax
Amount Benefit Amount
------------ ------------ ------------
Unrealized gains on securities:
Unrealized holding gains arising during period .... $ 8,903 $ (3,027) $ 5,876
Less: reclassification adjustment for gains
realized in net income ........................ 3,853 (1,310) 2,543
------------ ------------ ------------
Net unrealized gains ............................. 5,050 (1,717) 3,333
Minimum pension liability adjustment (1) ............. (2,955) 1,005 (1,950)
------------ ------------ ------------
Other comprehensive income ........................... $ 2,095 $ (712) $ 1,383
============ ============ ============
</Table>
(1) Restated
<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>
The components of accumulated other comprehensive income as of December 31, 2003
and 2002 are reflected in the table below (in thousands).
<Table>
<Caption>
Years Ended December 31,
------------------------
2003 2002
------- -------
Unrealized gains on AFS securities ..... $ 6,385 $ 9,302
Minimum pension liability .............. (302) (2,068)
------- -------
Total .................................. $ 6,083 $ 7,234
======= =======
</Table>
80
5. 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 as of December 31, 2003 and
2002.
6. 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, 2003 and 2002 are reflected in
the tables below (in thousands). There were no securities classified in the HTM
category at December 31, 2002.
<Table>
<Caption>
AVAILABLE FOR SALE
-------------------------------------------------------------
Gross Gross Estimated
December 31, Amortized Unrealized Unrealized Market
2003 Cost Gains Losses Value
------------ ---------- ---------- ---------- ----------
U.S. Treasury ............................. $ 20,905 $ 41 $ -- $ 20,946
U.S. Government Agencies .................. 20,958 68 11 21,015
Mortgage-backed Securities:
Direct Govt. and Govt. Sponsored
Entity Issues ........................... 567,103 7,608 2,125 572,586
Other Private Issues .................... 11,265 730 -- 11,995
State and Political Subdivisions .......... 98,455 3,960 608 101,807
Other Stocks and Bonds .................... 24,768 22 12 24,778
---------- ---------- ---------- ----------
Total ................................... $ 743,454 $ 12,429 $ 2,756 $ 753,127
========== ========== ========== ==========
</Table>
<Table>
<Caption>
HELD TO MATURITY
-------------------------------------------------------------
Gross Gross Estimated
December 31, Amortized Unrealized Unrealized Market
2003 Cost Gains Losses Value
------------ ---------- ---------- ---------- ----------
Mortgage-backed Securities:
Direct Govt. and Govt. Sponsored
Entity Issues ........................... $ 6,382 $ -- $ 17 $ 6,365
---------- ---------- ---------- ----------
Total ................................... $ 6,382 $ -- $ 17 $ 6,365
========== ========== ========== ==========
</Table>
<Table>
<Caption>
AVAILABLE FOR SALE
-------------------------------------------------------------
Gross Gross Estimated
December 31, Amortized Unrealized Unrealized Market
2002 Cost Gains Losses Value
------------ ---------- ---------- ---------- ----------
U.S. Treasury ............................. $ 26,805 $ 51 $ 2 $ 26,854
U.S. Government Agencies .................. 12,802 57 -- 12,859
Mortgage-backed Securities:
Direct Govt. and Govt. Sponsored
Entity Issues ........................... 453,905 7,397 664 460,638
Other Private Issues .................... 27,498 910 31 28,377
State and Political Subdivisions .......... 105,266 6,380 -- 111,646
Other Stocks and Bonds .................... 22,544 -- 3 22,541
---------- ---------- ---------- ----------
Total ................................... $ 648,820 $ 14,795 $ 700 $ 662,915
========== ========== ========== ==========
</Table>
81
The following table represents the unrealized loss on securities for the year
ended December 31, 2003.
(in thousands)
<Table>
<Caption>
LESS THAN 12 MONTHS 12 MONTHS OR MORE TOTAL
--------------------------- --------------------------- ---------------------------
DESCRIPTION OF Fair Unrealized Fair Unrealized Fair Unrealized
SECURITIES Value Loss Value Loss Value Loss
---------- ---------- ---------- ---------- ---------- ----------
U.S. Government
Agencies ................ $ 8,689 $ 11 $ -- $ -- $ 8,689 $ 11
Mortgage-Backed
Securities .............. 213,724 2,058 10,461 84 224,185 2,142
State & Political
Subdivisions ............ 25,581 608 -- -- 25,581 608
Other Stocks and ........ 733 12 -- -- 733 12
Bonds
TOTAL TEMPORARILY
IMPAIRED SECURITIES ..... $ 248,727 $ 2,689 $ 10,461 $ 84 $ 259,188 $ 2,773
</Table>
The securities listed above all have fixed maturities. The temporary impairment
at December 31, 2003 was related to changes in interest rates. As interest rates
change, the temporary impairment will also change. As the securities move closer
to maturity or payments on mortgage-backed securities are received, the
temporary impairment will change. The duration of all but a small portion of the
temporary impairments is less than twelve months and the unrealized loss
outstanding greater than twelve months represents only 0.8% of the total fair
value of those securities that had a temporary impairment at December 31, 2003.
Interest income recognized on securities for the years presented:
<Table>
<Caption>
Years Ended December 31,
-----------------------------------
2003 2002 2001
------- ------- -------
(in thousands)
U.S. Treasury ............................. $ 296 $ 294 $ 347
U.S. Government Agencies .................. 150 499 1,262
Mortgage-backed Securities ................ 20,149 23,647 29,507
State and Political Subdivisions .......... 4,341 5,984 5,114
Other Stocks and Bonds .................... 572 664 1,099
------- ------- -------
Total interest income on securities ....... $25,508 $31,088 $37,329
======= ======= =======
</Table>
On January 1, 2004, the Company transferred mortgage-backed securities totaling
$44.4 million from AFS to HTM due to overall balance sheet strategies and
potential changes in market conditions. The Company has a significant amount of
long-term Federal Home Loan Bank fixed rate liabilities and determined it was
appropriate that a portion of the Company's securities portfolio should be
designated HTM. The unrealized loss on the securities transferred from AFS to
HTM was $319,000, net of tax, at the date of transfer based on the fair market
value of the securities on the transfer date. There were no sales from the HTM
portfolio during the years ended December 31, 2003, 2002 or 2001. There were no
securities classified as HTM for the years ended December 31, 2002 and 2001.
82
On January 1, 2001, the Company 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. The Company 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 $5.0 million in net securities gains from the AFS portfolio in 2003,
there were $5.6 million in realized gains and $600,000 in realized losses. Of
the $3.9 million in net securities gains from the AFS portfolio in 2002, there
were $4.2 million in realized gains and $340,000 in realized losses. Of the $4.1
million in net securities gains on sales from the AFS portfolio in 2001, there
were $6.2 million in realized gains and $2.1 million in realized losses.
The scheduled maturities of AFS and HTM securities as of December 31, 2003, are
presented below. Mortgage-backed securities are presented in total by category.
As of December 31, 2003, the only securities classified as HTM were in the
mortgage-backed securities category.
<Table>
<Caption>
Amortized Aggregate
Cost Fair Value
---------- ----------
(in thousands)
Available for sale securities:
Investment and Marketable Equity Securities
Due in one year or less ....................... $ 52,989 $ 52,994
Due after one year through five years ......... 9,728 9,803
Due after five years through ten years ........ 15,072 15,327
Due after ten years ........................... 87,297 90,422
---------- ----------
165,086 168,546
Mortgage-backed securities ....................... 578,368 584,581
---------- ----------
Total ...................................... $ 743,454 $ 753,127
========== ==========
</Table>
<Table>
<Caption>
Amortized Aggregate
Cost Fair Value
---------- ----------
(in thousands)
Held to maturity securities:
Mortgage-backed securities ....................... $ 6,382 $ 6,365
---------- ----------
Total ...................................... $ 6,382 $ 6,365
========== ==========
</Table>
Investment securities with book values of $503.2 million and $401.5 million were
pledged as of December 31, 2003 and 2002, respectively, to collateralize FHLB
advances, public and trust deposits or for other purposes as required by law.
83
7. LOANS AND ALLOWANCE FOR PROBABLE LOAN LOSSES
Loans in the accompanying consolidated balance sheets are classified as follows:
<Table>
<Caption>
December 31, December 31,
2003 2002
-------- --------
Real Estate Loans: (in thousands)
Construction ............................ $ 40,965 $ 34,473
1-4 family residential .................. 142,543 144,396
Other ................................... 136,036 140,676
Commercial loans ............................ 81,115 82,531
Municipal loans ............................. 95,743 76,579
Loans to individuals ........................ 92,738 91,871
-------- --------
Total loans ................................. 589,140 570,526
Less: Unearned discount ................ 5 66
Allowance for loan losses ........ 6,414 6,195
-------- --------
Net loans ................................... $582,721 $564,265
======== ========
</Table>
The following is a summary of the Allowance for Loan Losses for the years ended
December 31, 2003, 2002 and 2001:
<Table>
<Caption>
Years Ended December 31,
-------------------------------------
2003 2002 2001
------- ------- -------
(in thousands)
Balance at beginning of year ................ $ 6,195 $ 5,926 $ 5,033
Provision for loan losses ............ 1,209 2,118 1,667
Loans charged off .................... (1,476) (2,139) (1,384)
Recoveries of loans charged off ...... 486 290 610
------- ------- -------
Balance at end of year ...................... $ 6,414 $ 6,195 $ 5,926
======= ======= =======
</Table>
Nonaccrual loans at December 31, 2003 and 2002 were $1.5 million and $2.2
million, respectively. Loans with terms modified in troubled debt restructuring
at December 31, 2003 and 2002 were $219,000 and $325,000, respectively.
For the years ended December 31, 2003 and 2002, the average recorded investment
in impaired loans was approximately $1,771,000 and $1,562,000, respectively.
During the years ended December 31, 2003 and 2002, 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
$104,000, $160,000 and $70,000 for the years ended December 31, 2003, 2002 and
2001, respectively. If these loans had been accruing interest at their original
contracted rates, related income would have been $155,000, $205,000 and $113,000
for the years ended December 31, 2003, 2002 and 2001, respectively.
84
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 .................. $ 775 $ 104 $ 671
Commercial Loans ................... 418 222 196
Loans to Individuals ............... 354 146 208
---------- ---------- ----------
Balance at December 31, 2003 ....... $ 1,547 $ 472 $ 1,075
========== ========== ==========
</Table>
<Table>
<Caption>
Valuation Carrying
Total Allowance Value
---------- ---------- ----------
(in thousands)
Real Estate Loans .................. $ 1,083 $ 207 $ 876
Commercial Loans ................... 674 320 354
Loans to Individuals ............... 481 189 292
---------- ---------- ----------
Balance at December 31, 2002 ....... $ 2,238 $ 716 $ 1,522
========== ========== ==========
</Table>
8. BANK PREMISES AND EQUIPMENT
<Table>
<Caption>
December 31, December 31,
2003 2002
---------- ----------
(in thousands)
Bank premises ...................... $ 34,884 $ 32,659
Furniture and equipment ............ 13,327 16,508
---------- ----------
48,211 49,167
Less accumulated depreciation ...... 17,582 19,067
---------- ----------
Total ..................... $ 30,629 $ 30,100
========== ==========
</Table>
Depreciation expense was $2.4 million, $2.3 million and $2.0 million for the
years ended December 31, 2003, 2002 and 2001, respectively. Rent expense was
$473,000, $532,000 and $468,000 for the years ended December 31, 2003, 2002 and
2001, respectively.
Future minimum rental commitments under noncancelable leases are (in thousands):
<Table>
2004 $ 596
2005 580
2006 497
2007 258
2008 109
----------
$ 2,040
==========
</Table>
85
9. 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,
---------------------------------------
2003 2002 2001
-------- -------- --------
(in thousands)
Balance at beginning of year ....... $ -- $ -- $ --
Acquisition of OREO ............ -- 105 8
Disposition of OREO ............ -- (105) (8)
-------- -------- --------
Balance at end of year ............. $ -- $ -- $ --
======== ======== ========
</Table>
For the years ended December 31, 2003 and 2002, the total of other real estate
owned was $195,000 and $524,000, respectively. Other real estate owned is
reflected in other assets in the Company's consolidated balance sheets.
For the year ended December 31, 2003 and 2002, provision and other expense from
OREO properties exceeded income by $94,000 and $126,000, respectively. For the
year ended December 31, 2001, income from OREO properties exceeded the provision
and other expenses by $21,000.
10. INTEREST BEARING DEPOSITS
<Table>
<Caption>
December 31, December 31,
2003 2002
------------ ------------
(in thousands)
Savings deposits ............................ $ 45,559 $ 38,012
Money market demand deposits ................ 77,274 68,749
Platinum money market deposits .............. 64,094 44,147
NOW demand deposits ......................... 133,806 125,319
Certificates and other time deposits
of $100,000 or more ....................... 138,376 140,572
Certificates and other time
deposits under $100,000 ................... 183,771 204,382
-------- --------
Total .............................. $642,880 $621,181
======== ========
</Table>
For the years ended December 31, 2003, 2002 and 2001, interest expense on time
deposits of $100,000 or more was $3.2 million, $4.5 million and $8.2 million,
respectively.
At December 31, 2003, the scheduled maturities of certificates and other time
deposits are as follows (in thousands):
<Table>
2004 $ 236,963
2005 36,695
2006 21,994
2007 18,710
2008 and thereafter 7,785
--------------
$ 322,147
==============
</Table>
The aggregate amount of demand deposit overdrafts that have been reclassified as
loans were $1.4 million and $1.3 million for December 31, 2003 and 2002,
respectively.
86
11. SHORT-TERM BORROWINGS
Information related to short-term borrowings is provided in the table below.
<Table>
<Caption>
Years Ended December 31,
------------------------
2003 2002
-------- --------
(in thousands)
Federal funds purchased
Balance at end of period ..................................... $ 3,525 $ 15,850
Average amount outstanding during the period (1) ............. 1,300 2,122
Maximum amount outstanding during the period ................. 24,275 22,875
Weighted average interest rate during the period (2) ......... 1.4% 2.1%
Interest rate at end of period ............................... 1.2% 1.8%
Federal Home Loan Bank ("FHLB") Dallas advances
Balance at end of period ..................................... $192,608 $153,422
Average amount outstanding during the period (1) ............. 156,854 152,896
Maximum amount outstanding during the period ................. 210,608 188,477
Weighted average interest rate during the period (2) ......... 3.9% 3.7%
Interest rate at end of period ............................... 3.4% 4.1%
Other obligations
Balance at end of period ..................................... $ 2,598 $ 2,500
Average amount outstanding during the period (1) ............. 1,144 1,707
Maximum amount outstanding during the period ................. 11,429 2,544
Weighted average interest rate during the period (2) ......... 0.9% 1.5%
Interest rate at end of period ............................... 0.7% 1.0%
Short-term junior subordinated convertible debentures (3)
Balance at end of period ..................................... $ -- $ --
Average amount outstanding during the period (1) ............. 1,753 --
Maximum amount outstanding during the period ................. 20,000 --
Weighted average interest rate during the period (2) ......... 8.5% --
Interest rate at end of period ............................... -- --
</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.
(3) Southside Capital Trust I from September 4, 2003, when redemption was
announced, to October 6, 2003, when redemption was completed.
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.
87
12. LONG TERM OBLIGATIONS
<Table>
<Caption>
Years Ended December 31,
----------------------------
2003 2002
---------- ----------
(in thousands)
FHLB Dallas advances
Balance at end of period ..................................... $ 252,075 $ 231,140
Weighted average interest rate during the period (2) ......... 4.2% 4.9%
Interest rate at end of period ............................... 3.6% 4.5%
Junior subordinated convertible debentures
Balance at end of period ..................................... $ -- $ 14,225
Weighted average interest rate during the period (2) ......... 7.1% 8.7%
Interest rate at end of period ............................... -- 8.8%
Junior subordinated debentures
Balance at end of period ..................................... $ -- $ 20,000
Weighted average interest rate during the period (2) ......... 7.2% 8.5%
Interest rate at end of period ............................... -- 8.5%
Long-term debt
Balance at end of period ..................................... $ 20,619 $ --
Weighted average interest rate during the period (2) ......... 4.1% --
Interest rate at end of period ............................... 4.1% --
</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 long-term obligations based on scheduled repayments at
December 31, 2003 are (in thousands):
<Table>
<Caption>
Under Due Due Over
1 Year 1-5 Years 6-10 Years 10 Years Total
---------- ---------- ---------- ---------- ----------
FHLB Dallas advances .............. $ 409 $ 218,699 $ 32,261 $ 706 $ 252,075
Long-term debt .................... -- -- -- 20,619 20,619
---------- ---------- ---------- ---------- ----------
Total long-term obligations .... $ 409 $ 218,699 $ 32,261 $ 21,325 $ 272,694
========== ========== ========== ========== ==========
</Table>
FHLB advances are collateralized by FHLB stock, nonspecified real estate loans
and mortgage-backed securities.
The long-term debt reflected in the table above has a stated maturity date of
September 4, 2033 with an option to prepay the debt beginning September 4, 2008.
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 had a convertible feature that allowed
the owner to convert each security to a share of the Company's common stock at
an adjusted conversion price of $8.64 per common share. These securities had a
distribution rate of 8.75% per annum payable at the end of each calendar
quarter. On December 31, 2003, Southside Capital Trust II, a subsidiary of
Southside Bancshares, Inc.,
88
redeemed 6,571 shares of its 8.75% Cumulative Convertible Trust Preferred
Securities and all of its 8.75% Common Securities which totaled $678,000. Prior
to the redemption date, December 31, 2003, all other convertible trust preferred
shares were converted into the Company's common stock. This increased the
Company's number of shares of common stock outstanding to 10,358,880 at December
31, 2003.
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 had a
distribution rate of 8.50% per annum payable at the end of each calendar
quarter. On October 6, 2003, Southside Capital Trust, a subsidiary of Southside
Bancshares, Inc., redeemed all of its 8.50% Cumulative Trust Preferred
Securities and 8.50% Trust Common Securities which totaled $20,618,560.
Southside Bancshares funded the redemption through the issuance of $20,000,000
of trust preferred securities and $619,000 of trust common securities that
adjust quarterly at a rate equal to the three month LIBOR plus 294 basis points.
The lower interest rate provided interest savings during the fourth quarter and
should provide a better match for the overall interest rate sensitivity position
of the Company.
13. EMPLOYEE BENEFITS
Southside Bank has a deferred compensation agreement with seven 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 $117,000, $236,000 and $369,000 for the years
ended December 31, 2003, 2002 and 2001, respectively. For the years ended
December 31, 2003 and 2002, the deferred compensation plan liability totaled
$2.1 million and $1.9 million, 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 $2,278,000, $2,266,000 and $1,897,000 for the years ended December
31, 2003, 2002 and 2001, respectively. There were twelve retirees and eight
retirees participating in the health insurance plan as of December 31, 2003 and
2002, 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, 2003. Contributions to the plan for the years ended December 31, 2002 and
2001 were $100,000 and $0, respectively. At December 31, 2003 and 2002, 231,463
and 236,870 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 has purchased an insurance policy that is expected to cover any
costs associated with this plan, and as such no liability is recorded.
89
The Company and the 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 the 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 160,794 shares of Company stock purchased at fair market
value at December 31, 2003 and 2002. The number of shares have been adjusted as
a result of stock splits and stock dividends. The Company uses a measurement
date of December 31, for its plans. During 2003 the Company's underfunded status
improved $2.2 million to an underfunded status of $6.0 million at December 31,
2003.
<Table>
<Caption>
December 31, December 31,
Change in Projected Benefit Obligation 2003 2002
----------- -----------
(in thousands)
Benefit obligation at end of prior year .......... $ 23,478 $ 19,399
Service cost ..................................... 1,394 1,075
Interest cost .................................... 1,607 1,427
Amendments ....................................... -- 13
Actuarial loss ................................... 1,779 2,406
Benefits paid .................................... (862) (750)
Expenses paid .................................... (49) (92)
---------- ----------
Benefit obligation at end of year ............. $ 27,347 $ 23,478
========== ==========
</Table>
<Table>
<Caption>
December 31, December 31,
Change in Plan Assets 2003 2002
---------- ----------
(in thousands)
Fair value of plan assets at end of prior year ... $ 15,278 $ 14,801
Actual return .................................... 2,575 (681)
Employer contribution ............................ 4,400 2,000
Benefits paid .................................... (862) (750)
Expenses paid .................................... (49) (92)
---------- ----------
Fair value of plan assets at end of year ...... $ 21,342 $ 15,278
========== ==========
</Table>
<Table>
<Caption>
December 31, December 31,
Reconciliation of Funded Status ............... 2003 2002
---------- ----------
(in thousands)
Funded status ..................................... $ (6,004) $ (8,200)
Unrecognized net loss ............................. 8,560 8,423
Unrecognized prior service costs .................. 11 12
Unrecognized net transition asset ................. -- (46)
---------- ----------
Prepaid benefit cost .............................. 2,567 189
Additional minimum liability ...................... -- (2,808)
---------- ----------
Prepaid benefit cost/(accrued benefit liability) .. 2,567 (2,619)
Intangible asset .................................. -- 12
Accumulated other comprehensive income
adjustment ...................................... -- 2,796
---------- ----------
Net amount recognized ............................. $ 2,567 $ 189
========== ==========
Accumulated benefit obligation .................... $ 20,533 $ 17,897
========== ==========
</Table>
90
At December 31, 2003 and 2002, the assumptions used to determine the benefit
obligation are as follows:
<Table>
<Caption>
December 31, December 31,
2003 2002
------- -------
Discount rate ..................... 6.50% 6.75%
Compensation increase rate ........ 4.50% 4.50%
</Table>
Net periodic pension cost for the years ended December 31, 2003, 2002 and 2001
included the following components:
<Table>
<Caption>
Years Ended December 31,
-------------------------------------
2003 2002 2001
------- ------- -------
(in thousands)
Service cost ....................... $ 1,394 $ 1,075 $ 877
Interest cost ...................... 1,607 1,427 1,270
Expected return on assets .......... (1,341) (1,298) (1,217)
Transition asset recognition ....... (46) (46) (46)
Net loss recognition ............... 407 173 70
Prior service cost amortization .... 1 1 --
------- ------- -------
Net periodic benefit cost .......... $ 2,022 $ 1,332 $ 954
======= ======= =======
</Table>
For the years ended December 31, 2003, 2002, and 2001, the assumptions used to
determine net periodic pension cost are as follows:
<Table>
<Caption>
Years Ended December 31,
-----------------------------------
2003 2002 2001
---- ---- ----
Discount rate ......................................... 6.75% 7.25% 7.50%
Expected long-term rate of return on plan assets ...... 9.00% 9.00% 9.00%
Compensation increase rate ............................ 4.50% 4.50% 4.50%
</Table>
The expected long-term rate of return assumption reflects the average return
expected on the assets invested to provide for the Plan's liabilities. The
Company considered broad equity and bond indicies long-term return projections,
as well as actual long-term historical Plan performance when evaluating the
expected long-term rate of return assumption.
<Table>
<Caption>
Percentage of Plan Assets
Asset Category at December 31,
-------------------------
2003 2002
------ ------
Equity securities ....... 60.5% 52.1%
Debt securities ......... 13.6% 14.3%
Other ................... 25.9% 33.6%
</Table>
The Company's attempts to invest Plan assets to employ investment strategies
that achieve a weighted average target asset allocation of 60% to 70% in equity
securities, 30% to 40% in fixed income and approximately 5% to 10% in cash.
During the 2002 and 2003 the amount invested in cash at year end exceeds the
average target asset allocation of 5% to 10%. It is anticipated the level of
cash will more closely match the targeted levels in future years.
The Company expects to contribute $4.0 million to its defined benefit plan and
$64,000 to its postretirement benefit plan in 2004.
91
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 2003 2002
---------- ----------
(in thousands)
Benefit obligation at end of prior year ......................... $ 1,068 $ 788
Service cost .................................................... 45 24
Interest cost ................................................... 96 68
Amendments ...................................................... -- (13)
Actuarial loss .................................................. 442 257
Benefits paid ................................................... (64) (56)
---------- ----------
Benefit obligation at end of year ............................ $ 1,587 $ 1,068
========== ==========
</Table>
<Table>
<Caption>
December 31, December 31,
Change in Plan Assets 2003 2002
---------- ----------
(in thousands)
Fair value of plan assets at end of prior year .................. $ -- $ --
Employer contribution ........................................... 64 56
Benefits paid ................................................... (64) (56)
---------- ----------
Fair value of plan assets at end of year ..................... $ -- $ --
========== ==========
</Table>
<Table>
<Caption>
December 31, December 31,
Reconciliation of Funded Status 2003 2002
---------- ----------
(in thousands)
Funded status ................................................... $ (1,587) $ (1,068)
Unrecognized net loss ........................................... 942 594
Unrecognized prior service costs ................................ (10) (11)
Unrecognized net transition obligation .......................... 11 13
---------- ----------
Accrued benefit cost ............................................ (644) (472)
Additional minimum liability .................................... (457) (340)
---------- ----------
Accrued benefit liability ....................................... (1,101) (812)
Intangible asset ................................................ -- 2
Accumulated other comprehensive income adjustment ............... 457 338
---------- ----------
Net amount recognized ........................................... $ (644) $ (472)
========== ==========
Accumulated benefit obligation .................................. $ 1,101 $ 812
========== ==========
</Table>
At December 31, 2003 and 2002, the assumptions used to determine the benefit
obligation are as follows:
<Table>
<Caption>
December 31, December 31,
2003 2002
------- -------
Discount rate ...................... 6.50% 6.75%
Compensation increase rate ......... 4.50% 4.50%
</Table>
92
Net periodic postretirement benefit cost for the years ended December 31, 2003,
2002 and 2001 includes the following components:
<Table>
<Caption>
Years Ended December 31,
----------------------------------------------
2003 2002 2001
---------- ---------- ----------
(in thousands)
Service cost ................................ $ 45 $ 24 $ 16
Interest cost ............................... 96 68 54
Transition obligation recognition ........... 3 3 3
Net loss recognition ........................ 93 49 26
Prior service cost amortization ............. (1) (1) --
---------- ---------- ----------
Net periodic benefit cost ................... $ 236 $ 143 $ 99
========== ========== ==========
</Table>
For the years ended December 31, 2003, 2002 and 2001, the assumptions used to
determine net periodic postretirement benefit cost are as follows:
<Table>
<Caption>
Years Ended December 31,
----------------------------------
2003 2002 2001
---- ---- ----
Discount rate....................................................... 6.75% 7.25% 7.50%
Compensation increase rate.......................................... 4.50% 4.50% 4.50%
</Table>
401(k) Plan
The Company has a 401(k) defined contribution plan covering substantially all
employees of the Company, who have completed one year of service and are age
twenty-one or older. A participant may elect to defer a percentage of their
compensation subject to certain limits based on federal tax laws. For the years
ended December 31, 2003, 2002 and 2001, expense attributable to the Plan
amounted to $52,000, $53,000 and $31,000, respectively.
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 and FAS148.
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. There were no options available for grant at December 31, 2003. At
December 31, 2002 and 2001, there were 24,618 and 20,809 options available for
grant, respectively.
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
28,875 options granted in 2003. There were no incentive stock options granted in
2002 or 2001. 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.
93
A summary of the status of the Company's stock options as of December 31, 2003,
2002 and 2001 and the changes during the year ended on those dates is presented
below:
<Table>
<Caption>
2003 2002 2001
------------------------- -------------------------- -------------------------
# SHARES OF WEIGHTED # SHARES OF WEIGHTED # SHARES OF WEIGHTED
UNDERLYING AVERAGE UNDERLYING AVERAGE UNDERLYING AVERAGE
OPTIONS EXERCISE OPTIONS EXERCISE OPTIONS EXERCISE
PRICES PRICES PRICES
----------- -------- ----------- -------- ----------- --------
Outstanding at beginning
of the year ...................... 1,102,304 $ 5.98 1,218,153 $5.93 1,339,932 $5.75
Granted .......................... 28,875 $15.33 -- -- -- --
Exercised ........................ (135,480) $ 4.77 (112,040) $5.35 (121,170) $3.96
Forfeited ........................ (10,590) $ 6.51 (3,809) $6.37 (609) $6.38
Expired .......................... -- -- -- -- -- --
Outstanding at end of year ....... 985,109 $ 6.42 1,102,304 $5.98 1,218,153 $5.93
Exercisable at end of year ....... 797,361 $ 6.08 802,262 $5.75 740,130 $5.48
Weighted-average FV of
options granted during the
year ............................. 4.91 N/A N/A
</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 2003: dividend yield of 1.93%
risk-free interest rate of 4.93%; the expected life of 6 years; the expected
volatility is 28.90%.
The following table summarizes information about stock options outstanding at
December 31, 2003:
<Table>
<Caption>
Options Outstanding Options Exercisable
------------------------------------------------ ----------------------------
WEIGHTED AVG.
REMAINING
RANGE OF NUMBER CONTRACT LIFE WEIGHTED AVG. NUMBER WEIGHTED AVG.
EXERCISE PRICES OUTSTANDING (YEARS) EXERCISE PRICE EXERCISABLE EXERCISE PRICE
--------------- ----------- ------------- -------------- ----------- --------------
$ 3.88 to $ 6.38 638,909 4.3 $ 5.72 516,938 $ 5.56
$ 6.91 to $ 15.33 346,200 5.5 $ 7.72 280,423 $ 7.04
----------------- ------- --- ------- ------- -------
$ 3.88 to $ 15.33 985,109 4.7 $ 6.42 797,361 $ 6.08
======= =======
</Table>
94
14. SHAREHOLDERS' EQUITY
Cash dividends declared and paid were $0.36, $0.33 and $.25 per share for the
years ended December 31, 2003, 2002 and 2001, respectively. 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.
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, 2003, that the Bank
meets all capital adequacy requirements to which it is subject.
95
As of December 31, 2003, the most recent notification from the FDIC 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
-------- ----- ------- ------ -------- -----
As of December 31, 2003: (dollars in thousands)
Total Capital (to Risk Weighted Assets)
Consolidated ....................................... $120,072 18.40% $52,213 8.00% N/A N/A
======== ===== ======= ==== ======== =====
Bank Only .......................................... $116,083 17.79% $52,212 8.00% $ 65,266 10.00%
======== ===== ======= ==== ======== =====
Tier 1 Capital (to Risk Weighted Assets)
Consolidated ....................................... $113,678 17.42% $26,106 4.00% N/A N/A
======== ===== ======= ==== ======== =====
Bank Only .......................................... $109,689 16.81% $26,106 4.00% $ 39,159 6.00%
======== ===== ======= ==== ======== =====
Tier 1 Capital (to Average Assets) (1)
Consolidated ....................................... $113,678 8.12% $56,028 4.00% N/A N/A
======== ===== ======= ==== ======== =====
Bank Only .......................................... $109,689 7.83% $56,003 4.00% $ 70,004 5.00%
======== ===== ======= ==== ======== =====
As of December 31, 2002:
Total Capital (to Risk Weighted Assets)
Consolidated (2) ................................... $109,207 17.42% $50,146 8.00% N/A N/A
======== ===== ======= ==== ======== =====
Bank Only (2) ...................................... $103,624 16.53% $50,145 8.00% $ 62,681 10.00%
======== ===== ======= ==== ======== =====
Tier 1 Capital (to Risk Weighted Assets)
Consolidated (2) ................................... $ 92,472 14.75% $25,073 4.00% N/A N/A
======== ===== ======= ==== ======== =====
Bank Only (2) ...................................... $ 97,500 15.55% $25,072 4.00% $ 37,609 6.00%
======== ===== ======= ==== ======== =====
Tier 1 Capital (to Average Assets) (1)
Consolidated (2) ................................... $ 92,472 7.09% $52,143 4.00% N/A N/A
======== ===== ======= ==== ======== =====
Bank Only (2) ...................................... $ 97,500 7.48% $52,140 4.00% $ 65,175 5.00%
======== ===== ======= ==== ======== =====
</Table>
(1) Refers to quarterly average assets as calculated by bank
regulatory agencies.
(2) Restated
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.
96
15. 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, 2003, 36,690 shares were sold under this plan at an
average price of $17.27 per share, reflective of other trades at the time of
each sale. For the year ended December 31, 2002, 37,374 shares were sold under
this plan at an average price of $14.98 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 2003, 221,800 shares of common stock were purchased under this plan at a
cost of $3.8 million. During 2002, 278,210 shares of common stock were purchased
under this plan at a cost of $4.2 million.
16. 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,
---------------------------------
2003 2002 2001
------ ------- -------
Current tax provision ........................................... $2,208 $ 2,854 $ 3,728
Deferred tax expense (benefit) .................................. 374 (671) (204)
------ ------- -------
Provision for tax expense charged to operations ................. $2,582 $ 2,183 $ 3,524
====== ======= =======
</Table>
97
The components of the net deferred tax liability as of December 31, 2003 and
2002 are summarized below (in thousands):
<Table>
<Caption>
Assets Liabilities
---------- ----------
Allowance for losses on OREO .................................... $ 72 $
Allowance for loan losses ....................................... 2,181
Retirement and other benefit plans .............................. 121
Unrealized gains on securities available for sale ............... (3,289)
Premises and equipment .......................................... (536)
FHLB Dallas stock dividends ..................................... (1,716)
Alternative minimum tax credit .................................. 1,353
Minimum pension liability ....................................... 155
Other ........................................................... 108
---------- ----------
Gross deferred tax assets (liabilities) ...................... 3,990 (5,541)
---------- ----------
Net deferred tax liability at December 31, 2003 ........... $ (1,551)
==========
</Table>
<Table>
<Caption>
Assets Liabilities
---------- ----------
Allowance for losses on OREO .................................... $ 67 $
Allowance for loan losses ....................................... 2,106
Retirement and other benefit plans .............................. 810
Unrealized gains on securities available for sale ............... (4,792)
Premises and equipment .......................................... (450)
FHLB Dallas stock dividends ..................................... (1,544)
Minimum pension liability (1) ................................... 1,066
Other ........................................................... 57
---------- ----------
Gross deferred tax assets (liabilities) ...................... 4,106 (6,786)
---------- ----------
Net deferred tax liability at December 31, 2002 ........... $ (2,680)
==========
</Table>
(1) Restated
A reconciliation of tax at statutory rates and total tax expense is as follows
(dollars in thousands):
<Table>
<Caption>
Years Ended December 31,
----------------------------------------------------------------------------
2003 2002 2001
-------------------- -------------------- --------------------
Percent Percent Percent
of of of
Pre-Tax Pre-Tax Pre-Tax
Amount Income Amount Income Amount Income
------- ------ ------- ------ ------- ------
Calculated Tax Expense ...................... $ 5,490 34.0% $ 5,273 34.0% $ 5,525 34.0%
Increase (Decrease) in Taxes from:
Tax Exempt Interest ......................... (2,876) (17.8%) (3,135) (20.2%) (2,417) (14.9%)
Other Net ................................... (32) (0.2%) 45 0.3% 416 2.6%
------- ------ ------- ------ ------- ------
Provision for Tax Expense Charged to
Operations ............................... $ 2,582 16.0% $ 2,183 14.1% $ 3,524 21.7%
======= ====== ======= ====== ======= ======
</Table>
98
17. COMMITMENTS AND CONTINGENCIES
In the normal course of business the Company buys and sells securities. At
December 31, 2003 and 2002, the Company had recorded in its balance sheet
commitments to purchase $1.7 million and $5.3 million in securities,
respectively.
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.
18. 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 $57.3 million
and $55.4 million at December 31, 2003 and 2002, respectively. Each commitment
has a maturity date and the commitment expires on that date with the exception
of credit card and ready reserve commitments which have no stated maturity date.
Unused commitments for credit card and ready reserve at December 31, 2003 and
2002 were $8.8 million and $8.3 million, respectively and are reflected in the
due after one year category. The Company had outstanding standby letters of
credit of $.9 million and $1.1 million at December 31, 2003 and 2002,
respectively. The scheduled maturities of unused commitments are presented below
as of December 31, 2003 and 2002.
<Table>
<Caption>
December 31,
--------------------
2003 2002
------- -------
(in thousands)
Unused commitments:
Due in one year or less ............. $23,473 $33,016
Due after one year .................. 33,812 22,401
------- -------
Total ............................ $57,285 $55,417
======= =======
</Table>
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 cash or cash equivalents, negotiable instruments, real estate,
accounts receivable, inventory, property, plant, and equipment.
99
19. 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 44.6% 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 almost exclusively of
government agency pass-through securities which are either directly or
indirectly backed by the full faith and credit of the United States Government
or guaranteed by Government Sponsored Entities FNMA or Freddie Mac.
20. RELATED PARTY TRANSACTIONS
Loan activity of executive officers of the registrant and directors of the
registrant and Southside Bank and their affiliates for the years ended December
31, 2003 and 2002 were (in thousands):
<Table>
<Caption>
2003 2002
------- -------
Beginning Balance of Loans ........ $ 3,496 $ 3,797
Additional Loans ................ 2,341 1,613
Payments ........................ (1,575) (1,914)
------- -------
Ending Balance of Loans ........... $ 4,262 $ 3,496
======= =======
</Table>
The Company incurred legal costs of $232,000, $202,000 and $145,000 during the
years ended December 31, 2003, 2002 and 2001, respectively, from a law firm of
which a director of the Company is a partner. The Company paid approximately
$125,000, $117,000 and $88,000 in insurance premiums during the years ended
December 31, 2003, 2002 and 2001, respectively, to a company of which a director
has a related interest.
100
21. 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.
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 amounts of commitments to extend
credit are a reasonable estimate of those assets' fair value.
FHLB 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.
Junior subordinated debentures and junior subordinated convertible
debentures: Fair values for these securities are based on quoted market
prices.
Long-term debt: The carrying amount for long-term debt is a reasonable
estimate of the debts' fair value due to the fact the debt floats based
on LIBOR and resets quarterly.
101
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, 2003 At December 31, 2002
----------------------- -----------------------
Carrying Carrying
Amount Fair Value Amount Fair Value
-------- ---------- -------- ----------
(in thousands)
Financial assets:
Cash and due from banks ...................... $ 47,223 $ 47,223 $ 49,607 $ 49,607
Investment securities:
Available for sale ......................... 144,876 144,876 151,509 151,509
Mortgage-backed and related securities:
Available for sale ......................... 584,581 584,581 489,015 489,015
Held to maturity ........................... 6,382 6,365 -- --
Marketable equity securities:
Available for sale ......................... 23,670 23,670 22,391 22,391
Loans, net of allowance ......................... 582,721 602,835 564,265 588,781
Loans held for sale ............................. 3,319 3,319 11,781 11,781
Financial liabilities:
Retail deposits .............................. $872,529 $832,539 $814,486 $797,024
Federal funds purchased ...................... 3,525 3,525 15,850 15,850
FHLB Dallas advances ......................... 444,683 449,980 384,562 397,194
Junior subordinated convertible
debentures .................................. -- -- 14,225 24,098
Junior subordinated debentures ............... -- -- 20,000 20,700
Long-term debt ............................... 20,619 20,619 -- --
Off-balance sheet liabilities:
Commitments to extend credit ................. -- 49,402 -- 47,928
Credit card arrangements ..................... -- 7,883 -- 7,489
</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.
102
22. QUARTERLY FINANCIAL INFORMATION OF REGISTRANT
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(in thousands, except per share data)
<Table>
<Caption>
2003
----------------------------------------------------------
Fourth Third Second First
Quarter Quarter Quarter Quarter
---------- ---------- ---------- ----------
Interest income ....................................... $ 15,281 $ 14,608 $ 15,437 $ 15,674
Net interest income ................................... 8,726 7,289 7,874 7,459
Income before provision for income taxes .............. 4,972 3,103 4,017 4,054
Provision for income taxes ............................ 942 353 590 697
Net income ............................................ 4,030 2,750 3,427 3,357
Earnings per share
Basic: ............................................ $ 0.43 $ 0.30 $ 0.39 $ 0.38
Diluted: .......................................... $ 0.37 $ 0.26 $ 0.33 $ 0.32
</Table>
<Table>
<Caption>
2002
----------------------------------------------------------
Fourth Third Second First
Quarter Quarter Quarter Quarter
---------- ---------- ---------- ----------
Interest income ....................................... $ 16,500 $ 17,723 $ 17,509 $ 17,509
Net interest income ................................... 7,746 8,633 8,441 8,037
Income before provision for income taxes .............. 3,442 5,092 3,910 3,064
Provision for income taxes ............................ 388 948 549 298
Net income ............................................ 3,054 4,144 3,361 2,766
Earnings per share
Basic: ............................................ $ 0.35 $ 0.48 $ 0.38 $ 0.32
Diluted: .......................................... $ 0.30 $ 0.39 $ 0.32 $ 0.27
</Table>
103
23. PARENT COMPANY FINANCIAL INFORMATION
Condensed financial information for Southside Bancshares, Inc. (parent company
only) was as follows: (in thousands)
CONDENSED BALANCE SHEETS
<Table>
<Caption>
December 31, December 31,
ASSETS 2003 2002
------------- -------------
(Restated)
Cash and due from banks ......................................... $ 3,228 $ 5,282
Investment in bank subsidiary at equity in
underlying net assets ........................................ 116,270 107,002
Investment in nonbank subsidiary at equity in
underlying net assets ........................................ 634 15
Other assets .................................................... 908 2,270
------------- -------------
TOTAL ASSETS ............................................ $ 121,040 $ 114,569
============= =============
LIABILITIES
Junior subordinated convertible debentures ...................... $ -- $ 14,225
Junior subordinated debentures .................................. -- 20,000
Long-term debt .................................................. 20,619 --
Other liabilities ............................................... 35 22
------------- -------------
TOTAL LIABILITIES ....................................... 20,654 34,247
------------- -------------
SHAREHOLDERS' EQUITY
Common stock ($1.25 par, 20,000,000 shares authorized:
11,779,467 and 9,557,598 shares issued) ......................... 14,724 11,947
Paid-in capital ................................................. 63,144 44,050
Retained earnings ............................................... 32,979 29,805
Treasury stock (1,420,587 and 1,198,787 shares at cost) ......... (16,544) (12,714)
Accumulated other comprehensive income .......................... 6,083 7,234
------------- -------------
TOTAL SHAREHOLDERS' EQUITY .............................. 100,386 80,322
------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY .............. $ 121,040 $ 114,569
============= =============
</Table>
104
CONDENSED STATEMENTS OF INCOME
<Table>
<Caption>
Years Ended December 31,
--------------------------------------
2003 2002 2001
-------- -------- --------
INCOME (in thousands)
Dividends from subsidiary ............................................ $ 6,000 $ 7,250 $ 6,000
-------- -------- --------
TOTAL INCOME .................................................... 6,000 7,250 6,000
-------- -------- --------
EXPENSE
Interest expense ..................................................... 2,407 3,034 3,183
Salaries and employee benefits ....................................... -- 100 1
Amortization ......................................................... 990 68 81
Other ................................................................ 591 477 400
-------- -------- --------
TOTAL EXPENSE ................................................... 3,988 3,679 3,665
-------- -------- --------
Income before federal income tax expense ............................. 2,012 3,571 2,335
Benefit for federal income tax expense ............................... 1,356 1,251 1,246
-------- -------- --------
Income before equity in undistributed earnings of subsidiaries ....... 3,368 4,822 3,581
Equity in undistributed earnings of subsidiaries ..................... 10,196 8,503 8,150
-------- -------- --------
NET INCOME ...................................................... $ 13,564 $ 13,325 $ 11,731
======== ======== ========
</Table>
CONDENSED STATEMENTS OF CASH FLOW
<Table>
<Caption>
Years Ended December 31,
--------------------------------------
2003 2002 2001
-------- -------- --------
(in thousands)
OPERATING ACTIVITIES:
Net Income ......................................................... $ 13,564 $ 13,325 $ 11,731
Adjustments to reconcile net income
to cash provided by operations:
Equity in undistributed earnings of subsidiaries ................. (10,196) (8,503) (8,150)
Decrease (increase) in other assets .............................. 1,362 82 (82)
Increase (decrease) in other liabilities ......................... 13 (31) (93)
-------- -------- --------
Net cash provided by operating activities ................... 4,743 4,873 3,406
INVESTING ACTIVITIES:
Investments in subsidiaries ........................................ (619) -- --
-------- -------- --------
Net cash used in investing activities ....................... (619) -- --
FINANCING ACTIVITIES:
Purchase of common stock ........................................... (3,830) (4,203) (3,154)
Proceeds from issuance of common stock ............................. 14,454 3,695 895
Dividends paid ..................................................... (3,196) (2,646) (1,890)
Proceeds from issuance of long-term debt ........................... 20,619 -- --
Repayment of junior subordinated debentures ........................ (20,000) -- --
Net decrease in junior subordinated convertible debentures ......... (14,225) (2,725) --
-------- -------- --------
Net cash used in financing activities ............................ (6,178) (5,879) (4,149)
Net decrease in cash and cash equivalents .......................... (2,054) (1,006) (743)
Cash and cash equivalents at beginning of year ..................... 5,282 6,288 7,031
-------- -------- --------
Cash and cash equivalents at end of year ........................... $ 3,228 $ 5,282 $ 6,288
======== ======== ========
</Table>
105
INDEX TO 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).
4.1 - Form of Indenture with respect to Southside Bancshares, Inc.'s 8.50% Junior
Subordinated Debentures (filed as exhibit 4.1 to the Registrant's Form S-2
filed with the Securities and Exchange Commission on May 13, 1998, and
incorporated herein by reference).
4.2 - Form of 8.50% Junior Subordinated Debenture (included as an exhibit to the
Form of Indenture filed as Exhibit 4.1 to the Registrant's Form S-2 filed
with the Securities and Exchange Commission on May 13, 1998, and
incorporated herein by reference).
4.3 - Certificate of Trust of Southside Capital Trust I (included as an exhibit to
the Form of Amended and Restated Trust Agreement filed as Exhibit 4.5 to the
Registrant's Form S-2 filed with the Securities and Exchange Commission on
May 13, 1998, and incorporated herein by reference).
4.4 - Form of Trust Agreement of Southside Capital Trust I (included as an exhibit
to the Form of Amended and Restated Trust Agreement filed as Exhibit 4.5 to
the Registrant's Form S-2 filed with the Securities and Exchange Commission
on May 13, 1998, and incorporated herein by reference).
4.5 - Form of Amended and Restated Trust Agreement of Southside Capital Trust I
(filed as Exhibit 4.5 to the Registrant's Form S-2 filed with the Securities
and Exchange Commission on May 13, 1998, and incorporated herein by
reference).
4.6 - Form of Certificate for 8.50% Trust Preferred Security of Southside Capital
Trust I (included as an exhibit to the Form of Amended and Restated Trust
Agreement filed as Exhibit 4.5 to the Registrant's Form S-2 filed with the
Securities and Exchange Commission on May 13, 1998, and incorporated herein
by reference).
4.7 - Form of Guarantee Agreement for Southside Capital Trust I (filed as exhibit
4.7 to the Registrant's Form S-2 filed with the Securities and Exchange
Commission on May 13, 1998, and incorporated herein by reference).
4.8 - Form of Indenture with respect to Southside Bancshares, Inc.'s 8.75%
Convertible Subordinated Debentures (filed as Exhibit 4.9 to the
Registrant's Form S-2 filed with the Securities and Exchange
</Table>
<Table>
Commission on October 13, 2000, and incorporated herein
by reference).
4.9- Form of 8.75% Convertible Subordinated Debenture (included as an exhibit to the
Form of Indenture filed as Exhibit 4.9 to the Registrant's Form S-2 filed with the
Securities and Exchange Commission on October 13, 2000, and incorporated herein
by reference).
4.10 - Certificate of Trust of Southside Capital Trust II (included as an exhibit to
the Form of Amended and Restated Trust Agreement filed as Exhibit 4.13 to
the Registrant's Form S-2 filed with the Securities and Exchange Commission
on October 13, 2000, and incorporated herein by reference).
4.11 - Form of Trust Agreement of Southside Capital Trust II (included as an exhibit
to the Form of Amended and Restated Trust Agreement filed as Exhibit 4.13 to
the Registrant's Form S-2 filed with the Securities and Exchange Commission
on October 13, 2000, and incorporated herein by reference).
4.12 - Form of Amended and Restated Trust Agreement of Southside Capital Trust II
(filed as exhibit 4.13 to the Registrant's Form S-2 filed with the
Securities and Exchange Commission on October 13, 2000, and incorporated
herein by reference).
4.13 - Form of Certificate for 8.75% Trust Preferred Security of Southside Capital
Trust II (included as an exhibit to the Form of Amended and Restated Trust
Agreement filed as Exhibit 4.13 to the Registrant's Form S-2 filed with the
Securities and Exchange Commission on October 13, 2000, and incorporated
herein by reference).
4.14 - Form of Guarantee Agreement for Southside Capital Trust II (filed as exhibit 4.15 to
the Registrant's Form S-2 filed with the Securities and Exchange Commission on
October 13, 2000, 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
</Table>
<Table>
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 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).
** 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) - Postretirement 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.
* 31.1 - Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002
* 31.2 - Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002
* 32.1 - Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
* 32.2 - Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
</Table>
- ------------------
* Filed herewith.
** Compensation plan, benefit plan or employment contract or arrangement.