Edgar Filing: SOUTHSIDE BANCSHARES INC

body_10q.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

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

For the quarterly period ended June 30, 2007

o 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 or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)

1201 S. Beckham, Tyler, Texas	75701

903-531-7111

(Registrant's telephone number, including area code)

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 o .

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o Accelerated filer x Non-accelerated filer o

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

The number of shares of the issuer's common stock, par value $1.25, outstanding as of July 26, 2007 was 13,081,616 shares.

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

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

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

ITEM 4. CONTROLS AND PROCEDURES

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

ITEM 1A. RISK FACTORS

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

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

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

ITEM 5. OTHER INFORMATION

ITEM 6. EXHIBITS

SIGNATURES

Exhibit Index

Certification Pursuant to Section 302

Certification Pursuant to Section 906

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

(in thousands, except share amounts)

	June 30,			December 31,
ASSETS	2007			2006
Cash and due from banks	$	43,762		$	52,537
Interest earning deposits		544			550
Federal funds sold		11,850			1,925
Total cash and cash equivalents		56,156			55,012
Investment securities:
Available for sale, at estimated fair value		88,566			98,952
Held to maturity, at cost		1,353			1,351
Mortgage-backed and related securities:
Available for sale, at estimated fair value		599,326			643,164
Held to maturity, at cost		207,262			226,162
Federal Home Loan Bank stock, at cost		15,540			25,614
Other investments, at cost		881			882
Loans held for sale		5,042			3,909
Loans:
Loans		768,739			759,147
Less: allowance for loan losses		(7,367	)		(7,193	)
Net Loans		761,372			751,954
Premises and equipment, net		35,268			32,641
Interest receivable		9,921			10,110
Deferred tax asset		10,456			8,678
Other assets		30,633			32,547
TOTAL ASSETS	$	1,821,776		$	1,890,976
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest bearing	$	328,361		$	325,771
Interest bearing		1,007,989			956,704
Total Deposits		1,336,350			1,282,475
Short-term obligations:
Federal funds purchased		–			5,675
FHLB Dallas advances		239,826			322,241
Other obligations		1,511			1,605
Total Short-term obligations		241,337			329,521
Long-term obligations:
FHLB Dallas advances		89,393			129,379
Long-term debt		20,619			20,619
Total Long-term obligations		110,012			149,998
Other liabilities		18,583			18,378
TOTAL LIABILITIES		1,706,282			1,780,372

Off-Balance-Sheet Arrangements, Commitments and Contingencies (Note 9)

Shareholders' equity:
Common stock: ($1.25 par, 20,000,000 shares authorized,
14,805,225 and 14,075,653 shares issued)		18,507			17,594
Paid-in capital		114,462			100,736
Retained earnings		21,392			29,648
Treasury stock (1,724,857 and 1,718,737 shares at cost)		(22,983	)		(22,850	)
Accumulated other comprehensive loss		(15,884	)		(14,524	)
TOTAL SHAREHOLDERS' EQUITY		115,494			110,604

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY	$	1,821,776		$	1,890,976

The accompanying notes are an integral part of these consolidated financial statements.

SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)

(in thousands, except per share data)

	Three Months				Six Months
	Ended June 30,				Ended June 30,
	2007		2006		2007		2006
Interest income
Loans	$	12,733	$	11,328	$	25,247	$	21,956
Investment securities – taxable		616		594		1,452		1,337
Investment securities – tax-exempt		505		490		1,012		1,089
Mortgage-backed and related securities		10,163		11,149		21,097		21,386
Federal Home Loan Bank stock and other investments		330		350		700		694
Other interest earning assets		33		14		69		32
Total interest income		24,380		23,925		49,577		46,494
Interest expense
Deposits		10,025		7,404		19,590		13,658
Short-term obligations		2,776		4,037		6,722		7,587
Long-term obligations		1,518		1,947		3,178		4,143
Total interest expense		14,319		13,388		29,490		25,388
Net interest income		10,061		10,537		20,087		21,106
Provision for loan losses		217		448		334		729
Net interest income after provision for loan losses		9,844		10,089		19,753		20,377
Non interest income
Deposit services		4,270		3,947		8,198		7,416
Gain on sale of securities available for sale		6		101		435		224
Gain on sale of loans		724		469		1,069		842
Trust income		576		403		1,040		807
Bank owned life insurance income		268		265		532		509
Other		818		782		1,526		1,267
Total non interest income		6,662		5,967		12,800		11,065
Non interest expense
Salaries and employee benefits		7,298		7,310		14,402		14,730
Occupancy expense		1,190		1,201		2,358		2,374
Equipment expense		242		225		470		428
Advertising, travel & entertainment		449		472		870		924
ATM and debit card expense		242		275		496		445
Director fees		141		167		268		312
Supplies		188		168		336		352
Professional fees		240		318		551		633
Postage		155		155		303		305
Telephone and communications		193		191		384		354
Other		1,118		1,081		2,254		2,140
Total non interest expense		11,456		11,563		22,692		22,997

Income before income tax expense		5,050		4,493		9,861		8,445
Provision for income tax expense		463		950		1,511		1,674
Net Income	$	4,587	$	3,543	$	8,350	$	6,771
Earnings per common share –basic	$	0.35	$	0.28	$	0.64	$	0.53
Earnings per common share –diluted	$	0.34	$	0.27	$	0.62	$	0.51
Dividends declared per common share	$	0.12	$	0.11	$	0.23	$	0.22

The accompanying notes are an integral part of these consolidated financial statements.

SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

(UNAUDITED)

(in thousands, except share amounts)

	Compre-hensive Income			Common Stock		Paid-in Capital		Retained Earnings			Treasury Stock			Accumulated Other Compre- hensive Income (Loss)			Total Share-holders Equity

Balance at December 31, 2005				$	16,633	$	87,962	$	32,054		$	(22,850	)	$	(4,509	)	$	109,290
Net Income	$	6,771							6,771									6,771
Other comprehensive loss, net of tax
Unrealized losses on securities, net of
reclassification adjustment (see Note 3)		(9,167	)												(9,167	)		(9,167	)
Comprehensive loss	$	(2,396	)
Common stock issued (94,803 shares)					119		714											833
Stock compensation expense							14											14
Tax benefit of incentive stock options							41											41
Dividends paid on common stock									(2,626	)								(2,626	)
Stock dividend					728		10,978		(11,706	)								–
Balance at June 30, 2006				$	17,480	$	99,709	$	24,493		$	(22,850	)	$	(13,676	)	$	105,156

Balance at December 31, 2006				$	17,594	$	100,736	$	29,648		$	(22,850	)	$	(14,524	)	$	110,604
Net Income	$	8,350							8,350									8,350
Other comprehensive income, net of tax
Unrealized losses on securities, net of
reclassification adjustment (see Note 3)		(1,533	)												(1,533	)		(1,533	)
Adjustment to net periodic
benefit cost (see Note 3)		173													173			173
Comprehensive Income	$	6,990
Common stock issued (108,634 shares)					137		788											925
Stock compensation expense							14											14
Tax benefit of incentive stock options							21											21
Dividends paid on common stock									(2,927	)								(2,927	)
Purchase of 6,120 shares of common stock												(133	)					(133	)
Stock dividend					776		12,903		(13,679	)								–
Balance at June 30, 2007				$	18,507	$	114,462	$	21,392		$	(22,983	)	$	(15,884	)	$	115,494

The accompanying notes are an integral part of these consolidated financial statements.

SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(in thousands)

	Six Months Ended June 30,
	2007			2006

OPERATING ACTIVITIES:
Net income	$	8,350		$	6,771
Adjustments to reconcile net income to net cash provided by operations:
Depreciation		1,085			1,132
Amortization of premium		2,445			3,066
Accretion of discount and loan fees		(1,314	)		(929	)
Provision for loan losses		334			729
Stock compensation expense		14			14
Decrease (increase) in interest receivable		189			(659	)
Decrease in other assets		1,585			208
Net change in deferred taxes		(1,077	)		(176	)
(Decrease) increase in interest payable		(134	)		338
Decrease in other liabilities		(434	)		(4,378	)
Increase in loans held for sale		(1,133	)		(2,839	)
Gain on sale of available for sale securities		(435	)		(224	)
Gain on sale of assets		–			(1	)
Loss on sale of other real estate owned		1			–
Net cash provided by operating activities		9,476			3,052

INVESTING ACTIVITIES:
Proceeds from sales of investment securities available for sale		4,953			39,197
Proceeds from sales of mortgage-backed securities available for sale		51,430			30,651
Proceeds from maturities of investment securities available for sale		57,891			14,175
Proceeds from maturities of mortgage-backed securities available for sale		50,874			53,060
Proceeds from maturities of mortgage-backed securities held to maturity		20,596			16,683
Proceeds from redemption of Federal Home Loan Bank stock		10,729			2,019
Purchases of investment securities available for sale		(51,789	)		(23,027	)
Purchases of investment securities held to maturity		–			(1,348	)
Purchases of mortgage-backed securities available for sale		(60,474	)		(157,067	)
Purchases of mortgage-backed securities held to maturity		(2,180	)		(33,749	)
Purchases of Federal Home Loan Bank stock and other investments		(654	)		(657	)
Net increase in loans		(10,048	)		(45,119	)
Purchases of premises and equipment		(3,712	)		(933	)
Proceeds from sales of premises and equipment		–			1
Proceeds from sales of other real estate owned		334			45
Proceeds from sales of repossessed assets		191			185
Net cash provided by (used in) investing activities		68,141			(105,884	)

The accompanying notes are an integral part of these consolidated financial statements.

SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

(UNAUDITED)

(in thousands)

	Six Months Ended
	June 30,
	2007			2006
FINANCING ACTIVITIES:
Net increase in demand and savings accounts		21,773			5,388
Net increase in certificates of deposit		31,944			78,801
Net (decrease) increase in federal funds purchased		(5,675	)		10,600
Proceeds from FHLB Advances		2,786,999			3,608,804
Repayment of FHLB Advances		(2,909,400	)		(3,603,261	)
Tax benefit of incentive stock options		21			41
Purchases of common stock		(133	)		–
Proceeds from the issuance of common stock		925			833
Dividends paid		(2,927	)		(2,626	)
Net cash (used in) provided by financing activities		(76,473	)		98,580

Net increase (decrease) in cash and cash equivalents		1,144			(4,252	)
Cash and cash equivalents at beginning of period		55,012			51,829
Cash and cash equivalents at end of period	$	56,156		$	47,577

SUPPLEMENTAL DISCLOSURES FOR CASH FLOW INFORMATION:
Interest paid	$	29,624		$	25,050
Income taxes paid		2,000			1,150

SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Acquisition of other repossessed assets and real estate through foreclosure	$	197		$	957
Payment of 5% stock dividend		13,679			11,706
Adjustment to pension liability		(262	)		–
Unsettled trades to purchase securities		941			–

The accompanying notes are an integral part of these consolidated financial statements

SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS

1. Basis of Presentation

The term “Company” is used throughout this report to refer to Southside Bancshares, Inc. and its subsidiaries. The term “Bank” is used to refer to Southside Bank wherever a distinction between Southside Bancshares, Inc. and Southside Bank aids in the understanding of this report.

The consolidated balance sheet as of June 30, 2007, and the related consolidated statements of income, shareholders' equity and cash flows and notes to the financial statements for the three and six month periods ended June 30, 2007 and 2006 are unaudited; in the opinion of management, all adjustments necessary for a fair presentation of such financial statements have been included. Such adjustments consisted only of normal recurring items. All significant intercompany accounts and transactions are eliminated in consolidation. The preparation of these consolidated financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) 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.

Interim results are not necessarily indicative of results for a full year. These financial statements should be read in conjunction with the financial statements and notes thereto in our Annual Report on Form 10-K for the year ended December 31, 2006. All share data has been adjusted to give retroactive recognition to stock splits and stock dividends. For a description of our significant accounting and reporting policies, refer to Note 1 of the Notes to Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2006.

2. Earnings Per Share

Earnings per share on a basic and diluted basis has been adjusted to give retroactive recognition to stock splits and stock dividends and is calculated as follows (in thousands, except per share amounts):

	Three Months				Six Months
	Ended June 30,				Ended June 30,

	2007		2006		2007		2006
Basic Earnings and Shares:
Net Income	$	4,587	$	3,543	$	8,350	$	6,771

Weighted-average basic shares outstanding		13,035		12,853		13,008		12,830


Basic Earnings Per Share:
Net Income	$	0.35	$	0.28	$	0.64	$	0.53


Diluted Earnings and Shares:
Net Income	$	4,587	$	3,543	$	8,350	$	6,771


Weighted-average basic shares outstanding		13,035		12,853		13,008		12,830
Add: Stock options		401		484		421		496
Weighted-average diluted shares outstanding		13,436		13,337		13,429		13,326

Diluted Earnings Per Share:
Net Income	$	0.34	$	0.27	$	0.62	$	0.51

For the three and six month periods ended June 30, 2007 and 2006, there were no antidilutive options.

3. Comprehensive Income (Loss)

The components of other comprehensive income (loss) are as follows (in thousands):

	Six Months Ended June 30, 2007
	Before-Tax			Tax (Expense)			Net-of-Tax
	Amount			Benefit			Amount
Unrealized losses on securities:
Unrealized holding losses arising during period	$	(1,888	)	$	642		$	(1,246	)
Less: reclassification adjustment for gains
included in net income		435			(148	)		287
Net unrealized losses on securities		(2,323	)		790			(1,533	)
Adjustment to net periodic benefit cost		262			(89	)		173
Other comprehensive loss	$	(2,061	)	$	701		$	(1,360	)

	Three Months Ended June 30, 2007
	Before-Tax			Tax (Expense)			Net-of-Tax
	Amount			Benefit			Amount
Unrealized losses on securities:
Unrealized holding losses arising during period	$	(5,556	)	$	1,889		$	(3,667	)
Less: reclassification adjustment for gains
included in net income		6			(2	)		4
Net unrealized losses on securities		(5,562	)		1,891			(3,671	)
Adjustment to net periodic benefit cost		104			(35	)		69
Other comprehensive loss	$	(5,458	)	$	1,856		$	(3,602	)

	Six Months Ended June 30, 2006
	Before-Tax			Tax (Expense)			Net-of-Tax
	Amount			Benefit			Amount
Unrealized losses on securities:
Unrealized holding losses arising during period	$	(13,665	)	$	4,646		$	(9,019	)
Less: reclassification adjustment for gains
included in net income		224			(76	)		148
Net unrealized losses on securities		(13,889	)		4,722			(9,167	)

Other comprehensive loss	$	(13,889	)	$	4,722		$	(9,167	)

	Three Months Ended June 30, 2006
	Before-Tax			Tax (Expense)			Net-of-Tax
	Amount			Benefit			Amount
Unrealized losses on securities:
Unrealized holding losses arising during period	$	(5,982	)	$	2,034		$	(3,948	)
Less: reclassification adjustment for gains
included in net income		101			(34	)		67
Net unrealized losses on securities		(6,083	)		2,068			(4,015	)

Other comprehensive loss	$	(6,083	)	$	2,068		$	(4,015	)

4. Securities

The amortized cost and estimated market value of investment and mortgage-backed securities as of June 30, 2007 and December 31, 2006, are reflected in the tables below (in thousands):


	June 30, 2007
AVAILABLE FOR SALE:	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Market Value
Investment Securities:
U.S. Treasury	$	18,157	$	–	$	1,051	$	17,106
Government Sponsored Enterprise Debentures		8,999		–		2		8,997
State and Political Subdivisions		54,361		1,077		480		54,958
Other Stocks and Bonds		7,591		9		95		7,505
Mortgage-backed Securities:
U.S. Government Agencies		73,596		274		1,669		72,201
Government Sponsored Enterprises		527,797		896		8,196		520,497
Other Private Issues		6,711		39		122		6,628
Total	$	697,212	$	2,295	$	11,615	$	687,892

HELD TO MATURITY:
Investment Securities:
Other Stocks and Bonds	$	1,353	$	14	$	–	$	1,367
Mortgage-backed Securities:
U.S. Government Agencies		28,228		–		621		27,607
Government Sponsored Enterprises		179,034		44		3,485		175,593
Total	$	208,615	$	58	$	4,106	$	204,567


	December 31, 2006
AVAILABLE FOR SALE:	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Market Value
Investment Securities:
U.S. Treasury	$	27,104	$	–	$	721	$	26,383
Government Sponsored Enterprise Debentures		9,923		–		–		9,923
State and Political Subdivisions		54,037		1,488		390		55,135
Other Stocks and Bonds		7,611		12		112		7,511
Mortgage-backed Securities:
U.S. Government Agencies		72,183		425		1,209		71,399
Government Sponsored Enterprises		570,777		1,250		7,377		564,650
Other Private Issues		7,190		20		95		7,115
Total	$	748,825	$	3,195	$	9,904	$	742,116

HELD TO MATURITY:
Investment Securities:
Other Stocks and Bonds	$	1,351	$	7	$	16	$	1,342
Mortgage-backed Securities:
U.S. Government Agencies		30,788		–		407		30,381
Government Sponsored Enterprises		195,374		97		3,104		192,367
Total	$	227,513	$	104	$	3,527	$	224,090

The Bank concluded that, based on the creditworthiness of the issuer, the unrealized loss on each security in the above table represents a temporary impairment and does not require adjustment to the carrying amount of any of the individual securities. Additionally, the Bank has the ability and the intent to hold such securities through recovery of the unrealized losses.

Investment and mortgage-backed securities with book values of $322.9 million at June 30, 2007 and $454.6 million at December 31, 2006 were pledged to collateralize FHLB advances, public funds, trust deposits, repurchase agreements and for other purposes, as required or permitted by law.

5. Loans and Allowance for Probable Loan Losses

The following table sets forth loan totals by category for the periods presented (in thousands):

	At		At
	June 30,		December 31,
	2007		2006

Real Estate Loans:
Construction	$	46,876	$	39,588
1-4 Family Residential		223,996		227,354
Other		177,918		181,047
Commercial Loans		125,609		118,962
Municipal Loans		110,416		106,155
Loans to Individuals		83,924		86,041
Total Loans	$	768,739	$	759,147

The summaries of the Allowance for Loan Losses are as follows (in thousands):

	Three Months Ended June 30,						Six Months Ended June 30,
	Three Months Ended June 30,						Six Months Ended June 30,

	2007			2006			2007			2006

Balance at beginning of period	$	7,261		$	7,193		$	7,193		$	7,090
Provision for loan losses		217			448			334			729
Loans charged off		(616	)		(744	)		(1,209	)		(1,447	)
Recoveries of loans charged off		505			449			1,049			974
Balance at end of period	$	7,367		$	7,346		$	7,367		$	7,346

6. Employee Benefit Plans

The components of net periodic benefit cost are as follows (in thousands):

	Six Months Ended June 30,
	Defined Benefit
	Pension Plan						Restoration Plan
	2007			2006			2007			2006
Service cost	$	665		$	669		$	31		$	34
Interest cost		1,156			1,095			84			92
Expected return on assets		(1,264	)		(1,162	)		–			–
Transition obligation recognition		–			–			1			1
Net loss recognition		241			392			42			90
Prior service credit amortization		(21	)		(21	)		(1	)		(1	)
Net periodic benefit cost	$	777		$	973		$	157		$	216

	Three Months Ended June 30,
	Defined Benefit
	Pension Plan						Restoration Plan
	2007			2006			2007		2006
Service cost	$	356		$	347		$	16	$	16
Interest cost		566			548			39		43
Expected return on assets		(631	)		(581	)		–		–
Transition obligation recognition		–			–			–		–
Net loss recognition		105			203			10		40
Prior service credit amortization		(11	)		(21	)		–		(1	)
Net periodic benefit cost	$	385		$	496		$	65	$	98

Employer Contributions

We previously disclosed in our financial statements for the year ended December 31, 2006, that we expected to contribute $3.0 million to our defined benefit pension plan and $88,000 to our post retirement benefit plan in 2007. As of June 30, 2007, we had contributed $3.0 million to the defined benefit pension plan, and $40,000 of contributions had been made to the post retirement benefit plan.

7. Incentive Stock Options

In April 1993, we adopted the Southside Bancshares, Inc. 1993 Incentive Stock Option Plan ("the ISO Plan"), a stock-based incentive compensation plan. The ISO Plan expired March 31, 2003. Prior to January 1, 2006, we applied APB Opinion 25 and related Interpretations in accounting for the ISO Plan and disclosed the pro forma information required by SFAS 123 and SFAS 148. There was no compensation expense recognized for the stock options prior to January 1, 2006.

A summary of the status of our nonvested shares as of June 30, 2007 is as follows:

	Six Months Ended June 30, 2007
	Number of Options			Weighted Average Grant-Date Fair Value
Nonvested at beginning of the period		12,257		$	4.91
Vested		(6,127	)	$	4.91
Cancelled		(383	)	$	4.91
Nonvested at end of period		5,747		$	4.91

For the three and six months ended June 30, 2007 and 2006, we recorded approximately $7,000 and $14,000, respectively, of stock-based compensation expense. As of June 30, 2007 and 2006, there was $20,000 and $47,000, respectively, of total unrecognized compensation cost related to the ISO Plan for nonvested options granted in March 2003. The cost is expected to be recognized over a weighted-average period of 9 months.

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%; expected life of 6 years; and expected volatility of 28.90%.

Under the ISO Plan, we were 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). Before the ISO Plan expired, awards were granted to selected employees and directors. No stock options have been available for grant under the ISO Plan since its expiration in March 2003. Currently, we do not offer share-based payment programs to our employees.

The ISO Plan provided that the exercise price of any stock option not be less than the fair market value of the common stock on the date of grant. The outstanding 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.

A summary of the status of our stock options as of June 30, 2007 and the changes during the six months ended on those dates is presented below:

	Number of Options			Weighted Average Exercise Prices		Weighted Average Remaining Contract Life (Years)		Aggregate Intrinsic Value (in thousands)
Outstanding at December 31, 2006		604,281		$	5.76
Exercised		(90,601	)	$	5.43
Cancelled		(383	)	$	12.61
Outstanding at June 30, 2007		513,297		$	5.82		2.60	$	8,278
Exercisable at June 30, 2007		507,550		$	5.74		2.56	$	8,226

The total intrinsic value (i.e., the amount by which the fair value of the underlying common stock exceeds the exercise price of a stock option on exercise date) of stock options exercised during the six months ended June 30, 2007 and 2006 were $1.5 million and $1.1 million, respectively.

Cash received from stock option exercises for the six months ended June 30, 2007 and 2006 was $360,000 and $396,000, respectively. The tax benefit realized for the deductions related to the stock option exercises were $21,000 and $41,000 for the six months ended June 30, 2007 and 2006, respectively.

8. Accounting Pronouncements

Statements of Financial Accounting Standards

SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115.” SFAS 159, issued by the Financial Accounting Standards Board (“FASB”) in February 2007, allows entities to irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and financial liabilities that are not otherwise required to be measured at fair value, with changes in fair value recognized in earnings as they occur. SFAS 159 also requires entities to report those financial assets and financial liabilities measured at fair value in a manner that separates those reported fair values from the carrying amounts of similar assets and liabilities measured using another measurement attribute on the face of the statement of financial position. Lastly, SFAS 159 establishes presentation and disclosure requirements designed to improve comparability between entities that elect different measurement attributes for similar assets and liabilities. SFAS 159 is effective for fiscal years beginning after November 15, 2007, with early adoption permitted if an entity also early adopts the provisions of SFAS 157. We intend to adopt SFAS 159 on January 1, 2008. We have not yet determined if, or to what extent, we will elect to use the fair value option to value our financial assets and liabilities or the impact that the implementation of SFAS 159 will have on our consolidated financial statements.

SFAS No. 157, “Fair Value Measurements.” SFAS 157 defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. SFAS 157 is effective for us on January 1, 2008 and is not expected to have a material impact on our consolidated financial statements.

SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments — an amendment of FASB Statements No. 133 and 140.” SFAS 155 amends SFAS 133, “Accounting for Derivative Instruments and Hedging Activities” and SFAS 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” SFAS 155 permits, but does not require, fair value accounting for hybrid financial instruments that contain an embedded derivative that would otherwise require bifurcation in accordance with SFAS 133. SFAS 155 also eliminated the temporary exemption for interests in securitized financial assets provided for by SFAS 133, Derivatives Implementation Group (“DIG”) Issue D1, “Application of Statement 133 to Beneficial Interests in Securitized Financial Assets.” However, in January 2007, the FASB issued interpretive guidance in SFAS 133, DIG Issue B40, “Application of Paragraph 13(b) to Securitized Interests in Prepayable Financial Assets.” In DIG Issue B40, the FASB concluded that a securitized interest in prepayable financial assets was not subject to the bifurcation requirements of SFAS 155 provided that the interest met both the following criteria: (1) the right to accelerate the settlement of the securitized interest cannot be controlled by the investor; and (2) the securitized interest itself does not contain an embedded derivative for which bifurcation would be required other than an embedded derivative that results solely from the embedded call options in the underlying financial assets. The guidance in DIG Issue B40 is effective upon the adoption of SFAS 155. SFAS 155 was effective for all financial instruments acquired or issued after December 31, 2006 as well as to those hybrid financial instruments that had been previously bifurcated under SFAS 133. The adoption of SFAS 155 did not have a material impact on our consolidated financial statements.

Emerging Issues Task Force Consensuses

In September 2006, the Emerging Issues Task Force (“EITF”) reached a final consensus on Issue 06-4, “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements.” EITF 06-4 requires that for a split-dollar life insurance arrangement, an employer should recognize a liability for future benefits in accordance with SFAS 106, “Employers' Accounting for Postretirement Benefits Other Than Pensions.” Under the guidance, the purchase of an endorsement type policy does not constitute a settlement since the policy does not qualify as nonparticipating because the policyholders are subject to the favorable and unfavorable experience of the insurance company. EITF 06-4 is effective for fiscal years beginning after December 15, 2007. We are currently assessing the impact of the adoption of EITF 06-4 on our consolidated financial statements.

In September 2006, the EITF reached a final consensus on Issue 06-5, “Accounting for Purchases of Life Insurance.” EITF 06-5 provides guidance on FASB Technical Bulletin No. 85-4, “Accounting for Purchases of Life Insurance.” Under the guidance, the policyholder should consider any additional amounts included in the contractual terms of the policy in determining the amount that could be realized under the insurance contract. In addition, the policyholder should also determine the amount that could be realized under the life insurance contract assuming the surrender of an individual-life by individual-life policy. EITF 06-5 was effective for fiscal years beginning after December 15, 2006. The adoption of EITF 06-5 did not have a material impact on our consolidated financial statements.

Financial Accounting Standards Board Staff Positions and Interpretations

FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement 109.” FASB Interpretation No. 48 (“FIN 48”) prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Benefits from tax positions should be recognized in the financial statements only when it is more likely than not that the tax position will be sustained upon examination by the appropriate taxing authority that would have full knowledge of all relevant information. A tax position that meets the more-likely-than-not recognition threshold is measured at the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not recognition threshold should be derecognized in the first subsequent financial reporting period in which that threshold is no longer met. Interpretation 48 also provides guidance on the accounting for and disclosure of unrecognized tax benefits, interest and penalties.

We adopted the provisions of FIN 48 on January 1, 2007. As of the date of adoption, we had no unrecognized tax benefits and thus had accrued no interest or penalties on such benefits. At adoption, we did not anticipate a significant increase in unrecognized tax benefits during the subsequent 12 months. As of January 1, 2007, our 2003 through 2006 tax years were open to examination by the Internal Revenue Service and state taxing jurisdictions. There were no material changes in these items during the current quarter. While we typically do not incur significant interest or penalties on income tax liabilities, it is our policy to classify such amounts as interest expense and miscellaneous expense, respectively. We did not change our policy on classification of interest and penalties upon adoption of FIN 48.

9. Off-Balance-Sheet Arrangements, Commitments and Contingencies

Financial Instruments with Off-Balance-Sheet-Risk. In the normal course of business, we are a party to certain financial instruments, with off-balance-sheet risk, to meet the financing needs of our 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 we have 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.

We had outstanding unused commitments to extend credit of $118.0 million and $99.5 million at June 30, 2007 and 2006, 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 June 30, 2007 and 2006 were $9.3 million and $7.9 million, respectively, and are reflected in the due after one year category. We had outstanding standby letters of credit of $3.9 million and $3.6 million at June 30, 2007 and 2006, respectively.

The scheduled maturities of unused commitments as of June 30, 2007 and 2006 were as follows (in thousands):

	June 30,
	2007		2006
Unused commitments:
Due in one year or less	$	87,271	$	57,812
Due after one year		30,691		41,697
Total	$	117,962	$	99,509

We apply the same credit policies in making commitments and standby letters of credit as we do for on-balance-sheet instruments. We evaluate 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 and property, plant, and equipment.

Lease Commitments. We lease certain branch facilities and office equipment under operating leases. It is expected that certain leases will be renewed or equipment replaced with new leased equipment as these leases expire.

Securities. In the normal course of business we buy and sell securities. There were $941,000 of unsettled trades to purchase and no unsettled trades to sell securities at June 30, 2007. At December 31, 2006, there were no unsettled trades to purchase or sell securities.

Litigation. We are subject to litigation in the normal course of business. Management, after consulting with our legal counsel, believes that any liability resulting from litigation will not have a material effect on our financial position and results of operations or our liquidity.

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

The following is a discussion of the consolidated financial condition, changes in financial condition, and results of our operations, and should be read and reviewed in conjunction with the financial statements, and the notes thereto, in this presentation and in our Annual Report on Form 10-K for the year ended December 31, 2006.

We reported an increase in net income for the three months and six months ended June 30, 2007 compared to the same periods in 2006. Net income for the three and six months ended June 30, 2007 was $4.6 million and $8.4 million, respectively, compared to $3.5 million and $6.8 million, respectively, for the same periods in 2006.

All share data has been adjusted to give retroactive recognition to stock splits and stock dividends.

Forward Looking Statements

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., a bank holding company, may be considered to be “forward-looking statements” within the meaning of and subject to the protections of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not guarantees of future performance, nor should they be relied upon as representing management’s views as of any subsequent date. These statements may include words such as "expect," "estimate," "project," "anticipate," “appear,” "believe," "could," "should," "may," "intend," "probability," "risk," "target," "objective," “plans,” “potential,” and similar expressions. Forward-looking statements are statements with respect to our beliefs, plans, expectations, objectives, goals, anticipations, assumptions, estimates, intentions and future performance, and are subject to significant known and unknown risks and uncertainties, which could cause our actual results to differ materially from the results discussed in the forward-looking statements. For example, discussions of the effect of our expansion, trends in asset quality and earnings from growth, and certain market risk disclosures are based upon information presently available to management and are dependent on choices about key model characteristics and assumptions and are subject to various limitations. 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, the following:

general economic conditions, either globally, nationally, in the State of Texas, or in the specific markets

in which we operate;

legislation, regulatory changes or changes in monetary or fiscal policy that adversely affect the businesses in which we are engaged;

adverse changes in the status or financial condition of the Government Sponsored Enterprises (the “GSEs”) impacting the GSEs’ guarantees or ability to pay or issue debt;

economic or other disruptions caused by acts of terrorism in the United States, Europe or other areas;

changes in the interest rate yield curve such as flat, inverted or steep yield curves, or changes in the interest rate environment that impact interest margins and may impact prepayments on the mortgage-backed securities portfolio;

unexpected outcomes of existing or new litigation involving us;

changes impacting the leverage strategy;

significant increases in competition in the banking and financial services industry;

changes in consumer spending, borrowing and saving habits;

technological changes;

our ability to increase market share and control expenses;

the effect of changes in federal or state tax laws;

the effect of compliance with legislation or regulatory changes;

the effect of changes in accounting policies and practices;

the costs and effects of unanticipated litigation;

risks of mergers and acquisitions including the related time and cost of implementing transactions and the potential failure to achieve expected gains, revenue growth or expense savings; and

failure of assumptions underlying allowance for loan losses and other estimates.

Additional information concerning us and our business, including additional factors that could materially affect our financial results, is included in our filings with the Securities and Exchange Commission. All written or oral forward-looking statements made by us or attributable to us are expressly qualified by this cautionary notice. We disclaim any obligation to update any factors or to announce publicly the result of revisions to any of the forward-looking statements included herein to reflect future events or developments.

Critical Accounting Estimates

Our accounting and reporting estimates 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 GAAP requires management to make estimates and assumptions that affect the amounts rep