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 September 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 October 25, 2007 was 13,110,398 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
	Agreement and Plan of Merger, dated May 17, 2007, as amended, by and among Southside Bancshares, Inc., Southside Merger Sub, Inc. and Fort Worth Bancshares, Inc.
	Certification Pursuant to Section 302
	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)

	September 30,			December 31,
ASSETS	2007			2006
Cash and due from banks	$	47,942		$	52,537
Interest earning deposits		550			550
Federal funds sold		5,650			1,925
Total cash and cash equivalents		54,142			55,012
Investment securities:
Available for sale, at estimated fair value		87,671			98,952
Held to maturity, at cost		1,354			1,351
Mortgage-backed and related securities:
Available for sale, at estimated fair value		665,244			643,164
Held to maturity, at cost		197,798			226,162
Federal Home Loan Bank stock, at cost		17,004			25,614
Other investments, at cost		1,964			882
Loans held for sale		2,231			3,909
Loans:
Loans		795,588			759,147
Less: allowance for loan losses		(7,668	)		(7,193	)
Net Loans		787,920			751,954
Premises and equipment, net		35,031			32,641
Interest receivable		10,011			10,110
Deferred tax asset		7,734			8,678
Other assets		35,925			32,547
TOTAL ASSETS	$	1,904,029		$	1,890,976
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest bearing	$	333,340		$	325,771
Interest bearing		1,020,983			956,704
Total Deposits		1,354,323			1,282,475
Short-term obligations:
Federal funds purchased		–			5,675
FHLB Dallas advances		250,592			322,241
Other obligations		1,569			1,605
Total Short-term obligations		252,161			329,521
Long-term obligations:
FHLB Dallas advances		93,093			129,379
Long-term debt		56,702			20,619
Total Long-term obligations		149,795			149,998
Other liabilities		24,271			18,378
TOTAL LIABILITIES		1,780,550			1,780,372

Off-Balance-Sheet Arrangements, Commitments and Contingencies (Note 11)

Minority interest in Southside Financial Group		383			–

Shareholders' equity:
Common stock: ($1.25 par, 20,000,000 shares authorized,
14,835,255 and 14,075,653 shares issued)		18,544			17,594
Paid-in capital		114,835			100,736
Retained earnings		23,321			29,648
Treasury stock (1,724,857 and 1,718,737 shares at cost)		(22,983	)		(22,850	)
Accumulated other comprehensive loss		(10,621	)		(14,524	)
TOTAL SHAREHOLDERS' EQUITY		123,096			110,604

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY	$	1,904,029		$	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				Nine Months
	Ended September 30,				Ended September 30,
	2007		2006		2007		2006
Interest income
Loans	$	13,134	$	12,089	$	38,381	$	34,045
Investment securities – taxable		552		569		2,004		1,906
Investment securities – tax-exempt		525		541		1,537		1,630
Mortgage-backed and related securities		10,982		11,521		32,079		32,907
Federal Home Loan Bank stock and other investments		245		352		945		1,046
Other interest earning assets		37		29		106		61
Total interest income		25,475		25,101		75,052		71,595
Interest expense
Deposits		10,391		8,126		29,981		21,784
Short-term obligations		3,049		4,649		9,771		12,236
Long-term obligations		1,800		1,964		4,978		6,107
Total interest expense		15,240		14,739		44,730		40,127
Net interest income		10,235		10,362		30,322		31,468
Provision for loan losses		620		226		954		955
Net interest income after provision for loan losses		9,615		10,136		29,368		30,513
Non interest income
Deposit services		4,274		4,036		12,472		11,452
Gain on sale of securities available for sale		126		254		561		478
Gain on sale of loans		424		521		1,493		1,363
Trust income		522		423		1,562		1,230
Bank owned life insurance income		273		260		805		769
Other		784		692		2,310		1,959
Total non interest income		6,403		6,186		19,203		17,251
Non interest expense
Salaries and employee benefits		7,242		6,944		21,644		21,674
Occupancy expense		1,261		1,224		3,619		3,598
Equipment expense		268		239		738		667
Advertising, travel & entertainment		363		366		1,233		1,290
ATM and debit card expense		247		254		743		699
Director fees		126		131		394		443
Supplies		151		152		487		504
Professional fees		413		373		964		1,006
Postage		165		155		468		460
Telephone and communications		193		175		577		529
Other		1,113		1,107		3,367		3,247
Total non interest expense		11,542		11,120		34,234		34,117

Income before income tax expense		4,476		5,202		14,337		13,647
Provision for income tax expense		976		1,150		2,487		2,824
Net Income	$	3,500	$	4,052	$	11,850	$	10,823
Earnings per common share –basic	$	0.27	$	0.31	$	0.91	$	0.84
Earnings per common share –diluted	$	0.26	$	0.30	$	0.88	$	0.81
Dividends declared per common share	$	0.12	$	0.11	$	0.35	$	0.33

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	$	10,823							10,823									10,823
Other comprehensive loss, net of tax
Unrealized losses on securities, net of
reclassification adjustment (see Note 4)		(941	)												(941	)		(941	)
Comprehensive income	$	9,882
Common stock issued (139,723 shares)					175		1,098											1,273
Stock compensation expense							20											20
Tax benefit of incentive stock options							161											161
Dividends paid on common stock									(3,977	)								(3,977	)
Stock dividend					728		10,978		(11,706	)								–
Balance at September 30, 2006				$	17,536	$	100,219	$	27,194		$	(22,850	)	$	(5,450	)	$	116,649

Balance at December 31, 2006				$	17,594	$	100,736	$	29,648		$	(22,850	)	$	(14,524	)	$	110,604
Net Income	$	11,850							11,850									11,850
Other comprehensive income, net of tax
Unrealized gains on securities, net of
reclassification adjustment (see Note 4)		3,643													3,643			3,643
Adjustment to net periodic
benefit cost (see Note 4)		260													260			260
Comprehensive income	$	15,753
Common stock issued (138,664 shares)					174		1,089											1,263
Stock compensation expense							20											20
Tax benefit of incentive stock options							87											87
Dividends paid on common stock									(4,498	)								(4,498	)
Purchase of 6,120 shares of common stock												(133	)					(133	)
Stock dividend					776		12,903		(13,679	)								–
Balance at September 30, 2007				$	18,544	$	114,835	$	23,321		$	(22,983	)	$	(10,621	)	$	123,096

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)

	Nine Months Ended September 30,
	2007			2006
				(Restated)
OPERATING ACTIVITIES:
Net income	$	11,850		$	10,823
Adjustments to reconcile net income to net cash provided by operations:
Depreciation		1,640			1,708
Amortization of premium		3,658			4,479
Accretion of discount and loan fees		(1,829	)		(1,477	)
Provision for loan losses		954			955
Stock compensation expense		20			20
Decrease (increase) in interest receivable		99			(165	)
Decrease (increase) in other assets		1,312			(1,945	)
Net change in deferred taxes		(1,067	)		(347	)
Increase in interest payable		166			739
Increase in other liabilities		728			3,155
Decrease in loans held for sale		1,678			2,237
Gain on sale of available for sale securities		(561	)		(478	)
Gain on sale of assets		–			(1	)
Loss on sale of other real estate owned		1			10
Earnings allocated to minority interest		(117	)		–
Net cash provided by operating activities		18,532			19,713

INVESTING ACTIVITIES:
Proceeds from sales of investment securities available for sale		10,007			46,744
Proceeds from sales of mortgage-backed securities available for sale		68,897			47,333
Proceeds from maturities of investment securities available for sale		75,514			14,888
Proceeds from maturities of mortgage-backed securities available for sale		78,530			80,104
Proceeds from maturities of mortgage-backed securities held to maturity		29,847			25,970
Proceeds from redemption of Federal Home Loan Bank stock		10,729			3,413
Purchases of investment securities available for sale		(73,129	)		(27,369	)
Purchases of investment securities held to maturity		–			(1,348	)
Purchases of mortgage-backed securities available for sale		(164,826	)		(189,656	)
Purchases of mortgage-backed securities held to maturity		(2,180	)		(41,282	)
Purchases of Federal Home Loan Bank stock and other investments		(3,201	)		(995	)
Net increase in loans		(37,457	)		(63,245	)
Purchases of premises and equipment		(4,030	)		(1,185	)
Proceeds from sales of premises and equipment		–			1
Proceeds from sales of other real estate owned		334			469
Proceeds from sales of repossessed assets		238			302
Net cash used in investing activities		(10,727	)		(105,856	)

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)

	Nine Months Ended
	September 30,
	2007			2006
FINANCING ACTIVITIES:				(Restated)
Net increase (decrease) in demand and savings accounts		39,841			(14,409	)
Net increase in certificates of deposit		31,792			114,373
Net (decrease) increase in federal funds purchased		(5,675	)		2,550
Proceeds from FHLB Advances		4,624,601			5,588,804
Repayment of FHLB Advances		(4,732,536	)		(5,605,108	)
Proceeds from issuance of long-term debt		36,083			–
Net capital contributions from minority interest investment in consolidated entities		500			–
Tax benefit of incentive stock options		87			161
Purchases of common stock		(133	)		–
Proceeds from the issuance of common stock		1,263			1,273
Dividends paid		(4,498	)		(3,977	)
Net cash (used in) provided by financing activities		(8,675	)		83,667

Net decrease in cash and cash equivalents		(870	)		(2,476	)
Cash and cash equivalents at beginning of period		55,012			51,829
Cash and cash equivalents at end of period	$	54,142		$	49,353

SUPPLEMENTAL DISCLOSURES FOR CASH FLOW INFORMATION:
Interest paid	$	44,564		$	39,388
Income taxes paid		3,200			2,350

SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Acquisition of other repossessed assets and real estate through foreclosure	$	381		$	1,164
Payment of 5% stock dividend		13,679			11,706
Adjustment to pension liability		(394	)		–
Unsettled trades to purchase securities		(5,357	)		(7,795	)
Unsettled trades to sell securities		4,882			4,174

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 September 30, 2007, and the related consolidated statements of income, shareholders' equity and cash flows and notes to the financial statements for the three and nine month periods ended September 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, which will be amended to reflect an adjustment for non-cash activity related to unsettled trades. Please see additional discussion in Note 2.

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, which will be amended to reflect an adjustment to non-cash activity related to unsettled trades.

2. Restatement of the Statement of Cash Flows for the Nine Months Ended September 30, 2006

On November 13, 2007, the Company filed a Form 8-K reporting that management concluded that certain cash flows from operating, investing and financing activities were incorrect in several of the Company’s historical Consolidated Statement of Cash Flows. Management intends to amend its Form 10-K for the year ended December 31, 2006, to restate the Consolidated Statement of Cash Flows for the years ended December 31, 2006, 2005 and 2004. In addition, the Company intends to amend its Form 10-Qs for the first and second quarters of 2007 to restate the Consolidated Statements of Cash Flows for the periods ended March 31 and June 30, 2006 contained therein.

The restatements for the periods described above were caused by the lack of a non-cash adjustment that should have been reflected in the Company's Consolidated Statement of Cash Flows in accordance with Statement of Financial Accounting Standard No. 95, Statement of Cash Flows. Securities and brokered deposit trades generally settle in cash several days after the contractual trade date, although generally accepted accounting principles require us to recognize trades as of the trade date. In the accounting periods being restated, the Company failed to recognize those trades that were between the trade date and settlement date, and therefore had not yet been consummated in the exchange of cash. These unsettled trades historically had been reflected in the Company's Consolidated Statement of Cash Flows as actual cash flows from operating activities, with corresponding activity in cash flows from investing activities for the unsettled securities trades, and a corresponding activity in cash flows from financing activities for the unsettled brokered deposit trades. These unsettled trades should have instead been reflected as non-cash adjustments and reported in the Supplemental Disclosures on Non-cash Investing and Financing Activities.

For all periods restated there was no change in the Company’s Total Cash and Cash Equivalents, Net Increase in Cash and Cash Equivalents, Consolidated Statements of Income, Consolidated Balance Sheets or Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Income. Accordingly, the Company’s historical revenues, net income, earnings per share, total assets and regulatory capital remain unchanged.

For the nine-month period ended September 30, 2006, there was no adjustment required to be made to cash flows from financing activities as originally reported. The table below reflects the changes made to the Statement of Cash Flows for the nine-month period ended September 30, 2006 to appropriately reflect the impact of unsettled securities transactions that occurred during the nine months then ended:

	For the nine months ended September 30, 2006
	(in thousands)
	As Originally						As
	Reported			Adjustment			Restated

Decrease (increase) in other assets	$	(6,119	)	$	4,174		$	(1,945	)
Increase in other liabilities		3,417			(262	)		3,155
Net cash provided by operating activities		15,801			3,912			19,713

Proceeds from sales of investment securities available for sale		47,634			(890	)		46,744
Proceeds from sales of mortgage-backed securities available for sale		50,617			(3,284	)		47,333
Purchases of mortgage-backed securities available for sale		(197,451	)		7,795			(189,656	)
Purchases of mortgage-backed securities held to maturity		(33,749	)		(7,533	)		(41,282	)

Net cash used in investing activities		(101,944	)		(3,912	)		(105,856	)

Supplemental disclosures of noncash investing and financing activities:
Unsettled trades to purchase securities		–			(7,795	)		(7,795	)
Unsettled trades to sell securities		–			4,174			4,174

3. 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				Nine Months
	Ended September 30,				Ended September 30,

	2007		2006		2007		2006
Basic Earnings and Shares:
Net Income	$	3,500	$	4,052	$	11,850	$	10,823

Weighted-average basic shares outstanding		13,091		12,896		13,036		12,852


Basic Earnings Per Share:
Net Income	$	0.27	$	0.31	$	0.91	$	0.84


Diluted Earnings and Shares:
Net Income	$	3,500	$	4,052	$	11,850	$	10,823


Weighted-average basic shares outstanding		13,091		12,896		13,036		12,852
Add: Stock options		363		498		401		499
Weighted-average diluted shares outstanding		13,454		13,394		13,437		13,351

Diluted Earnings Per Share:
Net Income	$	0.26	$	0.30	$	0.88	$	0.81

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

4. Comprehensive Income (Loss)

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

	Nine Months Ended September 30, 2007
	Before-Tax		Tax (Expense)			Net-of-Tax
	Amount		Benefit			Amount
Unrealized gains on securities:
Unrealized holding gains arising during period	$	6,081	$	(2,068	)	$	4,013
Less: reclassification adjustment for gains
included in net income		561		(191	)		370
Net unrealized gains on securities		5,520		(1,877	)		3,643
Adjustment to net periodic benefit cost		394		(134	)		260
Other comprehensive income	$	5,914	$	(2,011	)	$	3,903

	Three Months Ended September 30, 2007
	Before-Tax		Tax (Expense)			Net-of-Tax
	Amount		Benefit			Amount
Unrealized gains on securities:
Unrealized holding gains arising during period	$	7,969	$	(2,710	)	$	5,259
Less: reclassification adjustment for gains
included in net income		126		(43	)		83
Net unrealized gains on securities		7,843		(2,667	)		5,176
Adjustment to net periodic benefit cost		132		(45	)		87
Other comprehensive income	$	7,975	$	(2,712	)	$	5,263

	Nine Months Ended September 30, 2006
	Before-Tax			Tax (Expense)			Net-of-Tax
	Amount			Benefit			Amount
Unrealized losses on securities:
Unrealized holding losses arising during period	$	(948	)	$	322		$	(626	)
Less: reclassification adjustment for gains
included in net income		478			(163	)		315
Net unrealized losses on securities		(1,426	)		485			(941	)

Other comprehensive loss	$	(1,426	)	$	485		$	(941	)

	Three Months Ended September 30, 2006
	Before-Tax		Tax (Expense)			Net-of-Tax
	Amount		Benefit			Amount
Unrealized gains on securities:
Unrealized holding gains arising during period	$	12,717	$	(4,324	)	$	8,393
Less: reclassification adjustment for gains
included in net income		254		(87	)		167
Net unrealized gains on securities		12,463		(4,237	)		8,226

Other comprehensive income	$	12,463	$	(4,237	)	$	8,226

5. Securities

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


	September 30, 2007
AVAILABLE FOR SALE:	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Market Value
Investment Securities:
U.S. Treasury	$	15,194	$	1	$	351	$	14,844
Government Sponsored Enterprise Debentures		5,178		7		–		5,185
State and Political Subdivisions		58,985		1,463		354		60,094
Other Stocks and Bonds		7,586		24		62		7,548
Mortgage-backed Securities:
U.S. Government Agencies		85,214		641		952		84,903
Government Sponsored Enterprises		577,334		2,441		4,396		575,379
Other Private Issues		5,042		–		80		4,962
Total	$	754,533	$	4,577	$	6,195	$	752,915

HELD TO MATURITY:
Investment Securities:
Other Stocks and Bonds	$	1,354	$	23	$	–	$	1,377
Mortgage-backed Securities:
U.S. Government Agencies		27,071		–		314		26,757
Government Sponsored Enterprises		170,727		158		2,054		168,831
Total	$	199,152	$	181	$	2,368	$	196,965


	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 $338.3 million at September 30, 2007 and $454.6 million at December 31, 2006 were pledged to collateralize Federal Home Loan Bank (“FHLB”) advances, public funds, trust deposits, repurchase agreements and for other purposes, as required or permitted by law.

6. Loans and Allowance for Probable Loan Losses

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

	At		At
	September 30,		December 31,
	2007		2006

Real Estate Loans:
Construction	$	56,714	$	39,588
1-4 Family Residential		225,381		227,354
Other		178,847		181,047
Commercial Loans		125,809		118,962
Municipal Loans		110,084		106,155
Loans to Individuals		98,753		86,041
Total Loans	$	795,588	$	759,147

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

	Three Months Ended September 30,						Nine Months Ended September 30,
	Three Months Ended September 30,						Nine Months Ended September 30,

	2007			2006			2007			2006

Balance at beginning of period	$	7,367		$	7,346		$	7,193		$	7,090
Provision for loan losses		620			226			954			955
Loans charged off		(797	)		(727	)		(2,006	)		(2,174	)
Recoveries of loans charged off		478			509			1,527			1,483
Balance at end of period	$	7,668		$	7,354		$	7,668		$	7,354

7.	Long-term Obligations

Long-term obligations are summarized as follows (in thousands):

	September 30,		December 31,
	2007		2006

Federal Home Loan Bank Dallas Advances (1)
Varying maturities to 2017	$	93,093	$	129,379

Long-term Debt (2)
Southside Statutory Trust III Due 2033 (3)		20,619		20,619
Southside Statutory Trust IV Due 2037 (4)		23,196		–
Southside Statutory Trust V Due 2037 (5)		12,887		–
Total Long-term Debt		56,702		20,619

Total Long-term Obligations	$	149,795	$	149,998

(1) At September 30, 2007, the weighted average cost of these advances was 4.65%.

(2)

This long-term debt consists of trust preferred securities that qualify under the risk-based capital guidelines as Tier 1 capital, subject to certain limitations.

(3)

This debt carries an adjustable rate of 8.171% through December 30, 2007 and adjusts quarterly at a rate equal to three-month LIBOR plus 294 basis points.

(4)

This debt carries a fixed rate of 6.518% through October 30, 2012 and thereafter, adjusts quarterly at a rate equal to three-month LIBOR plus 130 basis points.

(5)

This debt carries a fixed rate of 7.48% through December 15, 2012 and thereafter, adjusts quarterly at a rate equal to three-month LIBOR plus 225 basis points.

8. Employee Benefit Plans

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

	Nine Months Ended September 30,
	Defined Benefit
	Pension Plan						Restoration Plan
	2007			2006			2007			2006
Service cost	$	998		$	1,004		$	46		$	51
Interest cost		1,734			1,642			126			138
Expected return on assets		(1,897)			(1,743	)		–			–
Transition obligation recognition		–			–			2			2
Net loss recognition		362			588			64			135
Prior service credit amortization		(31	)		(31	)		(2	)		(2	)
Net periodic benefit cost	$	1,166		$	1,460		$	236		$	324

	Three Months Ended September 30,
	Defined Benefit
	Pension Plan						Restoration Plan
	2007			2006			2007			2006
Service cost	$	333		$	335		$	15		$	17
Interest cost		578			547			42			46
Expected return on assets		(633	)		(581	)		–			–
Transition obligation recognition		–			–			1			1
Net loss recognition		121			196			22			45
Prior service credit amortization		(10	)		(10	)		(1	)		(1	)
Net periodic benefit cost	$	389		$	487		$	79		$	108

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 September 30, 2007, we had contributed $3.0 million to the defined benefit pension plan, and $60,000 of contributions had been made to the post retirement benefit plan.

9. 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 Statement of Financial Accounting Standards (“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 September 30, 2007 is as follows:

	Nine Months Ended September 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 nine months ended September 30, 2007 and 2006, we recorded approximately $6,000 and $20,000, respectively, of stock-based compensation expense. As of September 30, 2007 and 2006, there was $13,000 and $40,000, 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 six 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 six 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 five years, beginning on the first anniversary date of the grant date.

A summary of the status of our stock options as of September 30, 2007 and the changes during the nine months ended 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		(110,523	)	$	5.52		–	$	–
Cancelled		(383	)	$	12.61		–	$	–
Outstanding at September 30, 2007		493,375		$	5.81		2.36	$	8,107
Exercisable at September 30, 2007		487,628		$	5.73		2.33	$	8,052

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 nine months ended September 30, 2007 and 2006 were both $1.8 million, respectively.

Cash received from stock option exercises for the nine months ended September 30, 2007 and 2006 was $478,000 and $621,000, respectively. The tax benefit realized for the deductions related to the stock option exercises were $87,000 and $161,000 for the nine months ended September 30, 2007 and 2006, respectively.

10. 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 and September 30, 2007, 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.

11. 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 $115.2 million and $103.7 million at September 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 September 30, 2007 and 2006 were $8.8 million and $8.2 million, respectively, and are reflected in the due after one year category. We had outstanding standby letters of credit of $4.0 million and $3.3 million at September 30, 2007 and 2006, respectively.

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

	September 30,
	2007	2006
Unused commitments: