UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
Form
10-K
(Mark
One)
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X
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ANNUAL REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
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For
the fiscal year ended December 31, 2007
or
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TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
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For
the Transition Period From _____ to _____
Commission
file number 0-12247
Southside
Bancshares, Inc.
(Exact name of
registrant as specified in its charter)
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Texas
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75-1848732
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(State of
incorporation)
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(I.R.S.
Employer Identification No.)
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1201
S. Beckham Avenue, Tyler, Texas
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75701
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(Address of
Principal Executive Offices)
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(Zip
Code)
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Registrant's
telephone number, including area code: (903) 531-7111
Securities
registered pursuant to Section 12(b) of the Act:
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Name of each
exchange
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Title of each
class
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on which
registered
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COMMON
STOCK, $1.25 PAR VALUE
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NASDAQ
Global Select Market
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Securities
registered pursuant to Section 12(g) of the Act:
NONE
Indicate by check mark if the
registrant is a well-known seasoned issuer, as defined in Rule 405 of the
Securities Act.
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YES
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NO
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ü
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Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
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YES
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NO
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ü
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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.
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YES
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ü
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NO
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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 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
[ ] Accelerated
filer [ü] Non-accelerated
filer [ ]
Indicate by check
mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Act).
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YES
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NO
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ü
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The aggregate market value of the
common stock held by non-affiliates of the registrant as of June 29, 2007 was
$240,147,310.
As of February 15,
2008, 13,142,462 shares of common stock of Southside Bancshares, Inc. were
outstanding.
DOCUMENTS
INCORPORATED BY REFERENCE
Certain portions of
the Registrant's Proxy Statement to be filed for the Annual Meeting of
Shareholders to be held April 17, 2008 are incorporated by reference into Part
III of this Annual Report on Form 10-K. Other than those portions of
the proxy statement specifically incorporated by reference pursuant to Items
10-14 of Part III hereof, no other portions of the proxy statement shall be
deemed so incorporated.
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TABLE OF CONTENTS
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Subsidiaries
of the Registrant
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Consent of
Independent Registered Public Accounting Firm
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Certification
Pursuant to Section 302
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Certification
Pursuant to Section 302
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Certification
Pursuant to Section 906
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IMPORTANT INFORMATION ABOUT
THIS REPORT
In this report, the
words “the Company,” “we,” “us,” and “our” refer to the combined entities of
Southside Bancshares, Inc. and its subsidiaries. The words
“Southside” and “Southside Bancshares” refer to Southside Bancshares,
Inc. The words “Southside Bank” and “Fort Worth National Bank” refer
to those entities, respectively, and the words “the Banks” refers to those
entities collectively. The word “SFG” refers to Southside Financial
Group, LLC., of which Southside owns a 50% interest.
FORWARD-LOOKING
INFORMATION
The disclosures set forth in this item are
qualified by the section captioned “Forward-Looking Information” in “Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of
Operations” of this Annual Report on Form 10-K and other cautionary statements
set forth elsewhere in this report.
GENERAL
Southside Bancshares, Inc., incorporated in
Texas in 1982, is a bank holding company for Southside Bank, a Texas state bank
headquartered in Tyler, Texas and Southside Bancshares, Inc. acquired Fort Worth
Bancshares, Inc., the bank holding company for Fort Worth National Bank,
headquartered in Fort Worth, Texas. Tyler has a metropolitan area
population of approximately 195,000 and is located approximately 90 miles east
of Dallas, Texas and 90 miles west of Shreveport, Louisiana. Fort
Worth is the fifth largest city in Texas with a population of approximately
620,000.
At December 31, 2007, our total assets were
$2.20 billion, total loans were $961.2 million, deposits were $1.53 billion, and
shareholders’ equity was $132.3 million. Our net income was $16.7
million and $15.0 million and fully diluted earnings per common share were $1.24
and $1.12 for the years ended December 31, 2007 and 2006,
respectively. We have paid a cash dividend every year since
1970.
We are a community-focused financial
institution that offers a full range of financial services to individuals,
businesses, municipal entities, and non-profit organizations in the communities
we serve. These services include consumer and commercial loans,
deposit accounts, trust services, safe deposit services and brokerage
services.
Our 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. We also
offer construction loans for 1-4 family residential and commercial real
estate. During the third quarter we acquired a 50% ownership interest
and 51% voting interest in SFG, a start-up company that purchases existing high
yield automobile loan portfolios from lenders throughout the United
States.
We offer a variety of deposit
accounts with a wide range of interest rates and terms, including savings, money
market, interest and noninterest bearing checking accounts and certificates of
deposit (“CDs”). Our trust services include investment, management,
administration and advisory services, primarily for individuals and, to a lesser
extent, partnerships and corporations. At December 31, 2007, our
trust department managed approximately $718 million of trust
assets.
1
We and our subsidiaries 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”), the Federal Deposit Insurance Corporation (the “FDIC”) and
the Office of the Comptroller of the Currency (the “OCC”), and are subject to
numerous laws and regulations relating to internal controls, the extension of
credit, making of loans to individuals, deposits, and all other facets of our
operations.
Our administrative offices are located at
1201 S. Beckham Avenue, Tyler, Texas 75701, and our telephone number is
903-531-7111. Our website can be found at www.southside.com. Our
public filings with the Securities and Exchange Commission (the “SEC”) may be
obtained free of charge at either our website or the SEC’s website, www.sec.gov, as soon as reasonably
practicable after filing with the SEC.
RECENT
DEVELOPMENTS
On October 10, 2007, Southside completed the
acquisition of Fort Worth Bancshares, Inc. and its wholly-owned subsidiaries,
Fort Worth Bancorporation, Inc., Fort Worth National Bank and Magnolia Trust
Company I. Southside purchased all of the outstanding capital stock
of Fort Worth Bancshares, Inc. for approximately $37 million. Fort
Worth National Bank operates two banking offices in Fort Worth, one banking
office in Arlington and a loan production office in Austin. At the
time of purchase, Fort Worth National Bank had approximately $124 million in
total assets, $105 million in loans and $103 million in
deposits. Southside retained many of the key employees of Fort Worth
National Bank, and continues to operate Fort Worth National Bank as a separate
depository institution under its existing charter.
On August 8, 2007, Southside acquired a 50%
ownership interest, through a subsidiary of Southside Bank, in Southside
Financial Group, LLC. SFG is engaged in the business of purchasing
high-yield portfolios of automobile loans on a basis from lenders across the
United States. SFG has retained a management team with extensive
experience in the automobile loan industry. Southside Bank’s initial
capital contribution to SFG was $500,000.
MARKET
AREA
We consider our primary market area to be all
of Smith, Gregg, Tarrant, Travis, Cherokee, Anderson, Kaufman, Henderson and
Wood Counties in Texas, and to a lesser extent, portions of adjoining
counties. During 2007, we acquired Fort Worth National Bank, which
operates with two branches in Fort Worth, one branch in Arlington and a loan
production office in Austin. In addition, we opened a full service
grocery store branch in Hawkins in Wood County, as well as our sixth full
service grocery store branch in our largest market area, the city of Tyler, in
Smith County. Our expectation is that our presence in all of the
market areas we serve will continue to grow in the future. In
addition, we continue to explore new markets in which we believe we can expand
successfully.
The principal economic activities in our market
areas include retail, distribution, manufacturing, medical services, education
and oil and gas industries. Additionally, the industry base includes
conventions and tourism, as well as retirement relocation. These
economic activities support a growing regional system of medical service, retail
and education centers. Tyler, Longview, Fort Worth, Austin and
Arlington are home to several nationally recognized health care systems that
represent all major specialties.
We serve our markets through 44 branch
locations, 18 of which are located in grocery stores. The branches
are located in and around Tyler, Longview, Lindale, Gresham, Jacksonville,
Bullard, Chandler, Hawkins, Seven Points, Palestine, Forney, Gun Barrel City,
Athens, Whitehouse, Fort Worth and Arlington. Our television and
radio advertising has extended into most of our East Texas market areas for
several years, providing us name recognition throughout Smith, Gregg and
Cherokee counties along with portions of Anderson and Henderson
counties. We anticipate that continued advertising combined with
strategically placed branches should expand our name recognition in this part of
the state. Fort Worth National Bank is a well recognized name in the
Fort Worth and Arlington markets.
2
We also maintain eight motor bank
facilities. Our customers may also access various banking services
through our 45 automatic teller machines (“ATMs”) and ATMs owned by others,
through debit cards, and through our automated telephone, internet and
electronic banking products. These products allow our customers to
apply for loans from their computers, access account information and conduct
various other transactions from their telephones and computers.
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 our control. During the last ten to fifteen
years the Texas economy has continued to diversify, decreasing the overall
impact of fluctuations in oil and gas prices; however, the oil and gas industry
is still a significant component of the Texas economy. During
2007, we believe our market areas have been realatively resilient and
we have not experinced the effects of the housing led slowdown that
impacted other regions of the United States. We cannot predict
whether current economic conditions will improve, remain the same or
decline.
COMPETITION
The activities we are engaged in 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. During 2007, the number of financial institutions in our
market areas increased, a trend that we expect will
continue. Brokerage and insurance 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 we face. Federal legislation allows credit unions to
use their expanded membership capabilities, combined with tax-free status, to
compete more fiercely for traditional bank business. The tax-free
status granted to credit unions provides them a significant competitive
advantage. Many of the largest banks operating in Texas, including
some of the largest banks in the country, have offices in our market
areas. Many of these institutions have capital resources, broader
geographic markets, and legal lending limits substantially in excess of those
available to us. We face competition from institutions that offer
products and services we do not or cannot currently offer. Some
institutions we compete with offer interest rate levels on loan and deposit
products that we are unwilling to offer due to interest rate risk and overall
profitability concerns. We expect the level of competition to
increase.
EMPLOYEES
At February 15, 2008, we employed approximately
530 full time equivalent persons. None of the employees are
represented by any unions or similar groups, and we have not experienced any
type of strike or labor dispute. We consider the relationship with
our employees to be good.
EXECUTIVE OFFICERS
OF THE REGISTRANT
Our executive officers as of December 31,
2007, were as follows:
B. G. Hartley (Age
78), Chairman of the Board and Chief Executive Officer of Southside Bancshares,
Inc. since 1983. He also serves as Chairman of the Board and Chief
Executive Officer of Southside Bank, having served in these capacities since
Southside Bank's inception in 1960.
Sam Dawson (Age
60), President, Secretary and Director of Southside Bancshares, Inc. since
1998. He also has served as President, Chief Operations Officer and
Director of Southside Bank since 1996. He became an officer of
Southside Bancshares, Inc. in 1982 and of Southside Bank in 1975.
Robbie N. Edmonson
(Age 75), Vice Chairman of the Board of Southside Bancshares, Inc. and Southside
Bank since 1998. He joined Southside Bank as a vice president in
1968.
3
Jeryl Story (Age
56), Executive Vice President of Southside Bancshares, Inc. since 2000, and
Senior Executive Vice President - Loan Administration, Senior Lending Officer
and Director of Southside Bank since 1996. He joined Southside Bank
in 1979 as an officer in Loan Documentation.
Lee R. Gibson (Age
51), Executive Vice President and Chief Financial Officer of Southside
Bancshares, Inc. and of Southside Bank since 2000. He is also a
Director of Southside Bank. He became an officer of Southside
Bancshares, Inc. in 1985 and of Southside Bank in 1984.
All the individuals named above serve in their
capacity as officers of Southside Bancshares, Inc. and Southside Bank and are
appointed annually by the board of directors of each entity.
SUPERVISION AND
REGULATION
General
Banking is a complex, highly regulated
industry. Consequently, our 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. For bank holding
companies, Texas state-chartered banks, and national banks, these authorities
include, but are not limited to, the Federal Reserve, the Federal Deposit
Insurance Corporation (“FDIC”), the Texas Department of Banking (“TDB”), the
Office of the Comptroller of the Currency (“OCC”), United States Department of
Treasury (the “Treasury Department”), the Internal Revenue Service and state
taxing authorities.
The primary goals of the bank regulatory system
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 us
establishes a comprehensive framework for our operations and is intended
primarily for the protection of the FDIC’s Deposit Insurance Fund, our
depositors and the public, rather than our shareholders and
creditors. The following summarizes certain of the more important
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.
Holding Company
Regulation
The Bank
Holding Company Act. As bank holding companies under the Bank
Holding Company Act of 1956 (“BHCA”), as amended, Southside Bancshares, Inc. and
its wholly-owned subsidiary, Southside Delaware Financial Corporation, Fort
Worth Bancshares, Inc. and Fort Worth Bancorporation, Inc. (collectively, the
“Holding Companies”) are registered with and subject to regulation by the
Federal Reserve. The Holding Companies are required to file annual
and other reports with, and furnish information to, the Federal Reserve, which
makes periodic inspections of the Holding Companies.
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 BHCA 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 that are engaged in businesses that are closely related
to banking or that own or control more than five percent of the voting shares of
any company that is not a bank or otherwise engaged in businesses that are
closely related to banking. The Federal Reserve has deemed limited
activities (such as leasing, consumer and commercial finance, certain financial
consulting activities and certain securities brokerage activities) to be closely
related to banking and therefore permissible for a bank holding
company.
4
The Bank Holding Company Act restricts the
extension of credit to any bank holding company or non-banking subsidiary by a
subsidiary bank. A bank holding company and its subsidiaries are also
prohibited from engaging in certain tying arrangements in connection with any
extension of credit, lease or sale of property or furnishing of
services. Bank anti-tying regulations are discussed in greater detail
below.
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 Act
(“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 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 brokerage and underwriting,
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
certain of its activities.
Under GLBA, the Federal Reserve serves as the
primary regulator of financial holding companies, with supervisory authority
over the 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. As noted, none of the Holding Companies have elected to
become a financial holding company and to conduct the broader activities
permitted under GLBA. However, there can be no assurance that they
will not make such an election in the future.
In addition, GLBA also imposes additional
restrictions and heightened obligations, including disclosure requirements,
regarding private information collected by financial
institutions. The Holding Companies and their subsidiaries (including
the Banks) are subject to these obligations.
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
approving acquisitions by bank holding companies of banks and companies engaged
in banking-related activities under sections 3 and 4 of the BHCA, the Federal
Reserve considers a number of factors, including expected benefits to the public
such as greater convenience, increased competition, or gains in efficiency, as
weighed against the risks of possible adverse effects, such as undue
concentration of resources, decreased or unfair competition, conflicts of
interest, or unsound banking practices. The Federal Reserve is also empowered to
differentiate between new activities and activities commenced through the
acquisition of a going concern. 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. Texas banking laws also
would not prevent us from making bank acquisitions or establishing banks outside
of the state of Texas. We have no present plans to acquire or
establish banks outside the State of Texas but have not eliminated the
possibility of doing so.
5
Capital
Adequacy. Each of the federal banking agencies, including the
Federal Reserve, the OCC, and the FDIC, has issued substantially similar
risk-based and leverage capital guidelines applicable to banking organizations
they supervise, including bank holding companies and banks. Under the risk-based
capital requirements, the Holding Companies and the Banks are each generally
required to maintain a minimum ratio of total capital to risk-weighted assets
(including certain off-balance sheet activities, such as standby letters of
credit) of 8%. At least half of the total capital must be composed of common
shareholders’ equity excluding unrealized gains or losses on debt securities
available for sale, unrealized gains on equity securities available for sale and
unrealized gains or losses on cash flow hedges, net of deferred income taxes;
plus certain mandatorily redeemable capital securities; less nonqualifying
intangible assets net of applicable deferred income taxes and certain
nonfinancial equity investments. This is called “Tier 1 capital.” The remainder
may consist of qualifying subordinated debt, certain hybrid capital instruments,
qualifying preferred stock and a limited amount of the allowance for credit
losses. This is called “Tier 2 capital.” Tier 1 capital and Tier 2 capital
combined are referred to as total regulatory capital. The Federal
Reserves also expects bank holding companies to maintain a minimum ratio of Tier
1 capital to risk-weighted assets of 4%.
The Federal Reserve requires bank holding
companies that engage in trading activities to adjust their risk-based capital
ratios to take into consideration market risks that may result from movements in
market prices of covered trading positions in trading accounts, or from foreign
exchange or commodity positions, whether or not in trading accounts, including
changes in interest rates, equity prices, foreign exchange rates or commodity
prices. Any capital required to be maintained under these provisions may consist
of a new “Tier 3 capital” consisting of forms of short-term subordinated
debt.
Each of the federal bank regulatory agencies,
including the Federal Reserve, also has established minimum leverage capital
requirements for banking organizations. These requirements provide that banking
organizations that meet certain criteria, including excellent asset quality,
high liquidity, low interest rate exposure and good earnings, and that have
received the highest regulatory rating must maintain a ratio of Tier 1 capital
to total adjusted average assets of at least 3%. Institutions not meeting these
criteria, as well as institutions with supervisory, financial or operational
weaknesses, are expected to maintain a minimum Tier 1 capital to total adjusted
average assets ratio equal to 100 to 200 basis points above that stated minimum.
Holding companies experiencing internal growth or making acquisitions are
expected to maintain strong capital positions substantially above the minimum
supervisory levels without significant reliance on intangible assets. The
Federal Reserve also continues to consider a “tangible Tier 1 capital leverage
ratio” (deducting all intangibles) and other indicators of capital strength in
evaluating proposals for expansion or new activity.
In addition, the Federal Reserve, the OCC and
the FDIC have adopted risk-based capital standards that explicitly identify
concentrations of credit risk and the risk arising from non-traditional
activities, as well as an institution’s ability to manage these risks, as
important factors to be taken into account by each agency in assessing an
institution’s overall capital adequacy. The capital guidelines provide that an
institution’s exposure to a decline in the economic value of its capital due to
changes in interest rates be considered by the agency as a factor in evaluating
a banking organization’s capital adequacy. The agencies also require banks and
bank holding companies to adjust their regulatory capital to take into
consideration the risk associated with certain recourse obligations, direct
credit subsidies, residual interest and other positions in securitized
transactions that expose banking organizations to credit risk.
6
The ratios of Tier 1 capital, total capital to
risk-adjusted assets, and leverage capital of the Company and the Banks as of
December 31, 2007, are shown in the following table.
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Capital
Adequacy Ratios
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||||||||||||||||||||
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Regulatory
Minimums
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Regulatory
Minimums
to be
Well-Capitalized
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Southside
Bancshares, Inc.
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Southside
Bank
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Fort Worth
National Bank
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Risk-based
capital ratios:
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Tier 1
Capital (1)
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4.0 | % | 6.0 | % | 14.92 | % | 15.50 | % | 14.54 | % | ||||||||||
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Total
risk-based capital (2)
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8.0 | 10.0 | 17.02 | 16.41 | 15.51 | |||||||||||||||
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Tier 1
leverage ratio (3)
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4.0 | 5.0 | 7.73 | 7.67 | 13.13 | |||||||||||||||
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(1)
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Common
shareholders’ equity excluding unrealized gains or losses on debt
securities available for sale, unrealized gains on equity securities
available for sale and unrealized gains or losses on cash flow hedges, net
of deferred income taxes; plus certain mandatorily redeemable capital
securities, less nonqualifying intangible assets net of applicable
deferred income taxes, and certain nonfinancial equity investments;
computed as a ratio of risk-weighted assets, as defined in the risk-based
capital guidelines.
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(2)
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The sum of
Tier 1 capital, a qualifying portion of the allowance for credit losses,
qualifying subordinated debt and qualifying unrealized gains on available
for sale equity securities; computed as a ratio of risk-weighted assets,
as defined in the risk-based capital
guidelines.
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(3)
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Tier 1
capital computed as a percentage of fourth quarter average assets less
nonqualifying intangibles and certain nonfinancial equity
investments.
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The federal banking agencies, including the OCC
and the FDIC, are required to take “prompt corrective action” in respect of
depository institutions that do not meet minimum capital requirements. The law
establishes five capital categories for insured depository institutions for this
purpose: “well-capitalized,” “adequately capitalized,” “undercapitalized,”
“significantly undercapitalized” and “critically
undercapitalized.” To be considered “well-capitalized” under these
standards, an institution must maintain a total risk-based capital ratio of 10%
or greater; a Tier 1 risk-based capital ratio of 6% or greater; a leverage
capital ratio of 5% or greater; and must not be subject to any order or written
directive to meet and maintain a specific capital level for any capital
measure. The Banks meet the criteria for “well-capitalized.” Federal
law also requires the bank regulatory agencies to implement systems for “prompt
corrective action” for institutions that fail to meet minimum capital
requirements within the five capital categories, with progressively more severe
restrictions on operations, management and capital distributions according to
the category in which an institution is placed. Failure to meet capital
requirements may also cause an institution to be directed to raise additional
capital. Federal law also mandates that the agencies adopt safety and soundness
standards relating generally to operations and management, asset quality and
executive compensation, and authorizes administrative action against an
institution that fails to meet such standards.
In addition to the “prompt corrective action”
directives, failure to meet capital guidelines may subject a banking
organization to a variety of other enforcement remedies, including additional
substantial restrictions on its operations and activities, termination of
deposit insurance by the FDIC and, under certain conditions, the appointment of
a conservator or receiver.
7
The regulations also establish procedures for
“downgrading” an institution to a lower capital category based on supervisory
factors other than capital. Specifically, a federal banking agency may, after
notice and an opportunity for a hearing, reclassify a well-capitalized
institution as adequately capitalized and may require an adequately capitalized
institution or an undercapitalized institution to comply with supervisory
actions as if it were in the next lower category if the institution is operating
in an unsafe or unsound condition or engaging in an unsafe or unsound
practice. The FDIC may not, however, reclassify a significantly
undercapitalized institution as critically undercapitalized.
Federal Reserve policy requires a bank holding
company to act as a source of financial strength and to take measures to
preserve and protect bank subsidiaries in situations where additional
investments in a troubled bank may not otherwise be warranted. In addition,
where a bank holding company has more than one bank or thrift subsidiary, each
of the bank holding company’s subsidiary depository institutions are responsible
for any losses to the FDIC as a result of an affiliated depository institution’s
failure or anticipated failure. As a result, a bank holding company
may be required to contribute additional capital to its subsidiaries in the form
of capital notes or other instruments which qualify as capital under regulatory
rules. Any such loans from the holding company to its subsidiary
banks likely will be unsecured and subordinated to the bank’s depositors and
perhaps to other creditors of the bank.
Dividends. As
a bank holding company that does not, as an entity, currently engage in separate
business activities of a material nature, the Holding Companies’ ability to pay
cash dividends depends upon the cash dividends received from the
Banks. We must pay essentially all of our operating expenses from
funds we receive from the Banks. Therefore, shareholders may receive
dividends from us only to the extent that funds are available after payment of
our operating expenses. In general, the Federal Reserve discourages
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. We are also subject to certain restrictions on the payment
of dividends as a result of the requirement that we maintain an adequate level
of capital as described above and serve as a source of strength for our
subsidiaries.
Change
in Bank Control Act. Under the Change in Bank Control Act
(“CBCA”), 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 our voting securities or the power to
direct management or policies. 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 our voting
securities.
The Attorney General of the United States may,
within 15 days after approval by the Federal Reserve Board of an acquisition
under section 3 of the BHCA, bring an action challenging such acquisition under
the federal antitrust laws, in which case the effectiveness of such approval is
stayed pending a final ruling by the courts. Failure of the Attorney General to
challenge a section 3 acquisition and the absence of a specific right of action
to challenge section 4 or CBCA acquisitions do not, however, exempt the holding
company from complying with both state and federal antitrust laws after the
acquisition is consummated.
The Federal Reserve has broad authority to
prohibit activities of bank holding companies and their non-bank subsidiaries
which represent unsafe and unsound banking practices or which constitute knowing
or reckless violations of laws or regulations, if those activities caused a
substantial loss to a depository institution. These penalties can be as high as
one million dollars for each day the activity continues.
8
Bank
Regulation
Southside Bank is chartered under the laws of
the State of Texas, is an “insured institution” and is a member of the FDIC’s
Deposit Insurance Fund. It is not a member of the Federal Reserve
System. As such, it 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 Southside Bank. Fort Worth National Bank is a national
bank, and as such is subject to supervision, regulation and examination by the
OCC. The FDIC also has back-up enforcement authority over Fort Worth
National Bank. Ongoing supervision is provided through regular
examinations and other means that allow the regulators to gauge management’s
ability to identify, assess and control risk in all areas of operations in a
safe and sound manner and to ensure compliance with laws and
regulations. As a result, the scope of routine examinations of the
Banks is rather extensive. To facilitate supervision, the Banks are required to
file periodic reports with the regulatory agencies, and much of this information
is made available to the public by the agencies.
Deposit
Insurance. The Banks’ deposits are generally insured up to
$100,000 per depositor and up to $250,000 for certain retirement accounts by the
FDIC’s Deposit Insurance Fund. As insurer, the FDIC imposes deposit
premiums and is authorized to conduct examinations and to require
reporting. 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. For 2007, the minimum
assessment rate is 5 basis points for the institutions the FDIC perceives to
pose the least threat to the Deposit Insurance Fund, and 47 basis points for the
highest risk institutions. Our deposits insurance
assessments may increase or decrease depending upon the risk assessment
classification to which we are assigned by the FDIC. Any increase in
insurance assessments could have an adverse effect on our earnings.
In addition to its role as insurer, the FDIC is
the primary federal regulator of state-chartered banks, including Southside
Bank, that are not members of a Federal Reserve Bank. The FDIC issues
regulations, conducts examinations, requires the filing of reports and generally
supervises and regulates the operations of state-chartered nonmember banks. FDIC
approval is required prior to any merger or consolidation involving state,
nonmember banks, or the establishment or relocation of an office facility
thereof. FDIC supervision and regulation of Southside Bank is intended primarily
for the protection of depositors and the FDIC insurance funds. With
respect to Fort Worth National Bank, OCC approval is required prior to any
merger or consolidation involving national banks, or the establishment or
relocation of an office facility thereof. OCC and FDIC
supervision and regulation of Fort Worth National Bank is intended primarily for
the protection of depositors and the FDIC insurance funds.
Under the Financial Institutions Reform,
Recovery, and Enforcement Act of 1989 (“FIRREA”), a depository institution
insured by the FDIC can be held liable for any loss incurred by, or reasonably
expected to be incurred by, the FDIC after August 9, 1989 in connection with (i)
the default of a commonly controlled FDIC insured depository institution or (ii)
any assistance provided by the FDIC to a commonly controlled FDIC insured
depository institution in danger of default. FIRREA provides that certain types
of persons affiliated with financial institutions can be fined by the federal
regulatory agency having jurisdiction over a depository institution with federal
deposit insurance (such as the Banks) up to $1 million per day for each
violation of certain regulations related (primarily) to lending to and
transactions with executive officers, directors, and principal shareholders,
including the interests of these individuals. Other violations may result in
civil money penalties of $5,000 to $25,000 per day or in criminal fines and
penalties. In addition, the FDIC has been granted enhanced authority to withdraw
or to suspend deposit insurance in certain cases.
9
Activities
and Investments of Insured State-Chartered and National
Banks. The activities and investments of national banks are
limited to those set forth in the National Bank Act and in statutory
interpretations of the OCC. The FDIC generally limits the activities
and equity investments of state nonmember banks to those that are permissible
for national banks. Under regulations dealing with equity investments, an
insured state bank generally may not directly or indirectly acquire or retain
any equity investment of a type, or in an amount, that is not permissible for a
national bank. However, a state nonmember bank may seek FDIC approval
to engage in activities that are not permissible for a national
bank.
An insured state bank or a national bank is not
prohibited from, among other things, (i) acquiring or retaining a majority
interest in a subsidiary that engages in activities permissible for the parent
bank, (ii) investing as a limited partner in a partnership the sole purpose of
which is direct or indirect investment in the acquisition, rehabilitation or new
construction of a qualified housing project, provided that such limited
partnership investment may not exceed 2% of the bank’s total assets, (iii)
acquiring up to 10% of the voting stock of a company that solely provides or
reinsures directors’, trustees’ and officers’ liability insurance coverage or
bankers’ blanket bond group insurance coverage for insured depository
institutions, and (iv) acquiring or retaining the voting shares of a depository
institution if certain requirements are met.
FDIC regulations implementing the Federal
Deposit Insurance Act (“FDIA”) provide that an insured state-chartered bank may
not, directly, or indirectly through a subsidiary, engage as “principal” in any
activity that is not permissible for a national bank unless the FDIC has
determined that such activities would pose no risk to the insurance fund of
which it is a member and the bank is in compliance with applicable regulatory
capital requirements. Any insured state-chartered bank or savings bank directly
or indirectly engaged in any activity that is not permitted for a national bank
must cease the impermissible activity.
Loans-to-One-Borrower. The
maximum aggregate amount of loans that Southside Bank will be permitted to make
under Texas law to any one borrower, including related entities, is 25% of
Tier 1 capital. The limit for Fort Worth National Bank under the
National Bank Act is 15% of Total capital, plus an additional 10% for loans
secured by readily marketable securities.
Regulation
of Lending Activities. Our loans are subject to numerous
federal and state laws and regulations, including the Truth in Lending Act, the
Federal Consumer Credit Protection Act, the Texas Finance Code, the Texas
Deceptive Trade Practices Act, the Equal Credit Opportunity Act, the Real Estate
Settlement Procedures Act, the Home Mortgage Disclosure Act, the Fair Credit
Reporting Act, and the Flood Disaster Protection Act. Remedies to the
borrower or consumer and penalties to us are provided if we fail to comply with
these laws and regulations. The scope and requirements of these laws
and regulations have expanded significantly in recent years. The Fair
and Accurate Credit Transactions Act of 2003 (“FACTA”) substantially amended the
Fair Credit Reporting Act to impose new duties on institutions such as the Banks
that furnish or receive information from credit reporting
agencies. The new duties relate primarily to situations in which a
consumer could become the victim of an identity theft. The FDIC and
other federal agencies are still in the process of developing regulations
implementing the FACTA provisions.
Brokered
Deposits. The 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.
Anti-Tying
Regulations. Under the Bank Holding Company Act and Federal
Reserve regulations, a bank is prohibited from engaging in certain tying or
reciprocity arrangements with its customers. In general, a bank may
not extend credit, lease, sell property, or furnish any services or fix or vary
the consideration for these products or services on the condition that either:
the customer obtain or provide some additional credit, property, or services
from or to the bank, the bank holding company or subsidiaries thereof, or that
the customer may not obtain some other credit, property, or services from a
competitor, except to the extent reasonable conditions are imposed to assure the
soundness of the credit extended. Certain arrangements
10
are permissible: a
bank may offer combined-balance products and may otherwise offer more favorable
terms if a customer obtains two or more traditional bank products; and certain
foreign transactions are exempt from the general rule. A bank holding
company or any bank affiliate also is subject to anti-tying requirements in
connection with electronic benefit transfer services.
Dividends. All
dividends paid by Southside Bank are paid to the Company, as sole indirect
shareholder of Southside Bank, through Southside Delaware. All
dividends paid by Fort Worth National Bank are paid to the Company, as sole
indirect shareholder of Fort Worth National Bank, through Fort Worth
Bancorporation, Inc. and Fort Worth Bancshares, Inc. Our general
dividend policy is to pay dividends at levels consistent with maintaining
liquidity and preserving applicable capital ratios and servicing
obligations. The dividend policies of the Banks are subject to the
discretion of their respective boards of directors 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 Southside Bank, as a Texas
banking association, to pay dividends is restricted under applicable law and
regulations. We generally may not pay a dividend reducing our 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 us where the payment is deemed to be an unsafe and unsound banking
practice. We are also prohibited from paying dividends that will
reduce our capital below the “well-capitalized” level as defined by the FDIC,
and as a general matter, prefer to maintain a strong capital position which
necessarily limits the amount of dividends we are prepared to declare and
pay.
The ability of Fort Worth National Bank to pay
dividends is subject to similar restrictions. Fort Worth National
Bank may not, without prior OCC approval, pay a dividend that would exceed the
sum of net income in calendar year to date plus retained net earnings of the
immediately previous two years. As a policy matter, the OCC prefers
that national banks pay dividends solely out of net profits then on
hand.
The exact amount of future dividends on the
Banks will be a function of the profitability of the Banks in general (which
cannot be accurately estimated or assured), applicable tax rates in effect from
year to year and the discretion of their respective boards of
directors.
In addition, FDIC regulations generally
prohibits FDIC-insured depository institutions, such the Banks, from making any
capital distribution (including payment of dividends) or paying any management
fee to its holding company if the depository institution would thereafter be
undercapitalized. Undercapitalized depository institutions are subject to
restrictions on borrowing from the Federal Reserve. In addition,
undercapitalized depository institutions are subject to growth limitations and
are required to submit capital restoration plans. A depository institution’s
holding company must guarantee the capital plan, up to an amount equal to the
lesser of 5% of the depository institution’s assets at the time it becomes
undercapitalized or the amount of the capital deficiency when the institution
fails to comply with the plan. The federal banking agencies may not accept a
capital plan without determining, among other things, that the plan is based on
realistic assumptions and is likely to succeed in restoring the depository
institution’s capital. If a depository institution fails to submit an acceptable
plan, it is treated as if it is significantly undercapitalized.
Significantly undercapitalized depository
institutions may be subject to a number of requirements and restrictions,
including orders to sell sufficient voting stock to become adequately
capitalized, requirements to reduce total assets and cessation of receipt of
deposits from correspondent banks. Critically undercapitalized depository
institutions are subject to appointment of a receiver or
conservator.
Various other legislation, including proposals
to revise the bank regulatory system and to limit or expand the investments that
a depository institution may make with insured funds, is from time to time
introduced in Congress. The TDB, the OCC, and the FDIC will examine the Banks
periodically for compliance with various regulatory requirements. Such
examinations, however, are for the protection of the DIF and for depositors and
not for the protection of investors and shareholders.
11
Transactions
with Affiliates. The Holding Companies are legal entities separate and
distinct from the Banks and their other subsidiaries. Various legal limitations
restrict the Banks from lending or otherwise advancing funds to the Holding
Companies or their non-bank subsidiaries. The Holding Companies and
the Banks are subject to Sections 23A and 23B of the Federal Reserve Act and
Federal Reserve Regulation W. 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; (ii) 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 Banks
are 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. Section 23B also prohibits a bank
from purchasing low-quality assets from the bank’s affiliates, and requires that
all of a bank’s extensions of credit to an affiliate be appropriately secured by
acceptable collateral, generally United States government or agency
securities.
Under 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.
Insider Loans. Under
Regulation O of the Federal Reserve, the Bank’s are restricted in the loans that
they may make to their executive officers and directors, the executive officers
and directors of Southside Bancshares, Inc., any owner of 10% or more of its
stock or the stock of Southside Bancshares, Inc., and certain entities
affiliated with any such person.
Standards
for Safety and Soundness. The FDIA requires the
federal banking regulatory agencies to prescribe, by regulation or guideline,
operational and managerial standards for all insured depository institutions
relating to: (i) internal controls, information systems and internal audit
systems; (ii) loan documentation; (iii) credit underwriting; (iv) interest rate
risk exposure; and (v) asset growth. The agencies also must prescribe
standards for asset quality, earnings, and stock valuation, as well as standards
for compensation, fees and benefits. The federal banking agencies
have adopted regulations and Interagency Guidelines Prescribing Standards for
Safety and Soundness (“Guidelines”) to implement these required standards. The
Guidelines set forth the safety and soundness standards that the federal banking
agencies use to identify and address problems at insured depository institutions
before capital becomes impaired. Under the regulations, if the FDIC or the OCC,
as applicable, determines that the Banks fail to meet any standards prescribed
by the Guidelines, the agency may require the Bank in question to submit to the
agency an acceptable plan to achieve compliance with the standard, as required
by the FDIC or the OCC. The final regulations establish deadlines for the
submission and review of such safety and soundness compliance
plans.
Community
Reinvestment Act. Under the Community Reinvestment Act, we
have a continuing and affirmative obligation consistent with safe and sound
banking practices to help meet the needs of our entire community, including low-
and moderate-income neighborhoods. The Community Reinvestment Act
does not establish specific lending requirements or programs for financial
institutions nor does it limit our discretion to develop the types of products
and services that we believe are best suited to our particular
community. Current CRA regulations rate institutions based on their
actual performance in meeting community credit needs. CRA performance is
evaluated by the FDIC and the OCC, the Banks’ primary federal regulators, using
a lending test, an investment test, and a service test. The regulators also will
consider: (i) demographic data about the community; (ii) the institution’s
capacity and constraints; (iii) the
12
institution’s
product offerings and business strategy; and (iv) data on the prior performance
of the institution and similarly-situated lenders. On a periodic
basis, the FDIC or the OCC, as applicable, is charged with preparing a written
evaluation of our record of meeting the credit needs of the entire community and
assigning a rating. Our regulatory agencies will take that record
into account in their evaluation of any application made by us 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
has a Community Reinvestment Act rating of at least satisfactory. We
were last examined for compliance with the Community Reinvestment Act on March
12, 2007 and received a rating of “outstanding.”
Consumer
Regulation. Activities
of the Banks are subject to a variety of statutes and regulations designed to
protect consumers, including the Fair Credit Reporting Act (FCRA), Equal Credit
Opportunity Act (ECOA), and Truth-in-Lending Act (TILA). These laws
and regulations include provisions that:
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·
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limit the
interest and other charges collected or contracted for by the
Banks;
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govern the
Banks’ disclosures of credit terms to consumer
borrowers;
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require the
Banks to provide information to enable the public and public officials to
determine whether they are fulfilling its obligation to help meet the
housing needs of the community it
serves;
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prohibit the
Banks from discriminating on the basis of race, creed or other prohibited
factors when they make decisions to extend
credit;
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require that
the Banks safeguard the personal nonpublic information of their customers,
provide annual notices to consumers regarding the usage and sharing of
such information, and limit disclosure of such information to third
parties except under specific circumstances;
and
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·
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govern the
manner in which the Banks may collect consumer
debts.
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The deposit
operations of the Banks are also subject to laws and regulations
that:
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·
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require the
Banks to adequately disclose the interest rates and other terms of
consumer deposit accounts;
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·
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impose a duty
on the Banks to maintain the confidentiality of consumer financial records
and prescribe procedures for complying with administrative subpoenas of
financial records; and
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govern
automatic deposits to and withdrawals from deposit accounts with the Banks
and the rights and liabilities of customers who use automated teller
machines and other electronic banking
services.
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USA PATRIOT Act/Anti-Money
Laundering. 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
13
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.
Furthermore, financial institutions
must maintain anti-money laundering programs that include established internal
policies, procedures, and controls; a designated compliance officer; an ongoing
employee training program; and testing of the program by an independent audit
function. The Company and the Banks are also prohibited
from entering into specified financial transactions and account relationships
and must meet enhanced standards for due diligence and “knowing your customer”
in their dealings with foreign financial institutions and foreign customers.
Financial institutions must take reasonable steps to conduct enhanced scrutiny
of account relationships to guard against money laundering and to report any
suspicious transactions, and recent laws provide law enforcement authorities
with increased access to financial information maintained by
banks. Anti-money laundering obligations have been substantially
strengthened as a result of the USA Patriot Act, which was renewed in
2006. Bank regulators routinely examine institutions for compliance
with these obligations and are required to consider compliance in connection
with the regulatory review of applications. The regulatory
authorities have been active in imposing “cease and desist” orders and money
penalty sanctions against institutions found to be violating these
obligations.
Privacy
and Data Security. The GLB Act
imposed new requirements on financial institutions with respect to consumer
privacy. The GLB Act generally prohibits disclosure of consumer information to
non-affiliated third parties unless the consumer has been given the opportunity
to object and has not objected to such disclosure. Financial institutions are
further required to disclose their privacy policies to consumers annually.
Financial institutions, however, will be required to comply with state law if it
is more protective of consumer privacy than the GLB Act. The GLB Act
also directed federal regulators, including the FDIC, to prescribe standards for
the security of consumer information. The Banks are subject to such
standards, as well as standards for notifying consumers in the event of a
security breach. Under federal law, the Company must disclose its
privacy policy to consumers, permit consumers to “opt out” of having non-public
customer information disclosed to third parties, and allow customers to opt out
of receiving marketing solicitations based on information about the customer
received from another subsidiary. States may adopt more extensive
privacy protections. The Banks and the Company are similarly required
to have an information security program to safeguard the confidentiality and
security of customer information and to ensure proper disposal. Customers must
be notified when unauthorized disclosure involves sensitive customer information
that may be misused.
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 our business.
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. These limitations apply to both of the Banks.
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.
14
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. The FDIC and the OCC, respectively, are the appropriate
regulatory agencies for Southside Bank and Fort Worth National Bank; the Federal
Reserve is the appropriate regulatory agency for the Holding
Companies.
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 our future
business and earnings, therefore, cannot be predicted accurately.
Annual
Audits. Every bank with total assets in excess of $500
million, such as us, 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 (“GAAP”) and comply with such other
disclosure requirements as prescribed by the FDIC.
All of the above laws and regulations add to
the cost of our operations and thus have a negative impact on
profitability. It should be noted 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 the Holding
Companies. Management cannot predict what other legislation might be
enacted or what other regulations might be adopted and the effects thereof on
us.
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 we 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 we purchase. A
federal statute removes interest ceilings under usury laws for our loans that
are secured by first liens on residential real property. These
restrictions generally apply to both of the Banks.
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.
15
ITEM 1A. RISK
FACTORS
An investment in our common stock is subject to
risks inherent to our business. The material risks and uncertainties that
management believes affect us are described below. Before making an investment
decision, you should carefully consider the risks and uncertainties described
below together with all of the other information included or incorporated by
reference in this report. The risks and uncertainties described below are not
the only ones facing us. Additional risks and uncertainties that
management is not aware of or focused on or that management currently deems
immaterial may also impair our business operations. This report is qualified in
its entirety by these risk factors.
If any of the following risks actually occur,
our financial condition and results of operations could be materially and
adversely affected. If this were to happen, the value of our common
stock could decline significantly, and you could lose all or part of your
investment.
RISKS RELATED TO
OUR BUSINESS
We
are subject to interest rate risk.
Our earnings and cash flows are largely
dependent upon our net interest income. Net interest income is the difference
between interest income earned on interest-earning assets such as loans and
securities and interest expense paid on interest-bearing liabilities such as
deposits and borrowed funds. Interest rates are highly sensitive to many factors
that are beyond our control, including general economic conditions and policies
of various governmental and regulatory agencies and, in particular, the Board of
Governors of the Federal Reserve System. Changes in monetary policy, changes in
interest rates, changes in the yield curve, changes in market risk spreads, and
a prolonged inverted yield curve could influence not only the interest we
receive on loans and securities and the amount of interest we pay on deposits
and borrowings, but such changes could also affect:
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our ability
to originate loans and obtain
deposits;
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net interest
rate spreads and net interest rate
margins;
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our ability
to enter into instruments to hedge against interest rate
risk;
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the fair
value of our financial assets and liabilities;
and
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the average
duration of our loan and mortgage-backed securities
portfolio.
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If the interest rates paid on deposits and
other borrowings increase at a faster rate than the interest rates received on
loans and other investments, our net interest income, and therefore earnings,
could be adversely affected. Earnings could also be adversely
affected if the interest rates received on loans and other investments fall more
quickly than the interest rates paid on deposits and other
borrowings.
Although management believes we have
implemented effective asset and liability management strategies to reduce the
potential effects of changes in interest rates on our results of operations, any
substantial, unexpected, prolonged change in market interest rates could have a
material adverse effect on our financial condition and results of operations.
See the section captioned “Net Interest Income” in “Item 7. Management’s
Discussion and Analysis of Financial Condition and Results of Operations” for
further discussion related to our management of interest rate risk.
16
We
are subject to credit quality risks and our credit policies may not be
sufficient to avoid losses.
We are subject to the risk of losses resulting
from the failure of borrowers, guarantors and related parties to pay interest
and principal amounts on their loans. Although we maintain credit
policies and credit underwriting, monitoring and collection procedures that
management believes are sufficient to manage these risks, these policies and
procedures may not prevent losses, particularly during periods in which the
local, regional or national economy suffers a general decline. If
borrowers fail to repay their loans, our financial condition and results of
operations would be adversely affected.
Our
interest rate risk, liquidity, market value of securities and profitability are
subject to risks associated with the successful implementation of our leverage
strategy.
We implemented a leverage strategy in 1998 for
the purpose of enhancing overall profitability by maximizing the use of our
capital. The effectiveness of our leverage strategy, and therefore
our profitability, may be adversely affected by a number of factors, including
reduced net interest margin and spread, adverse market value changes to the
investment and mortgage-backed and related securities, incorrect modeling
results 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. In addition, we may not be able to obtain wholesale
funding to profitably and properly fund the leverage program. If our
leverage strategy is flawed or poorly implemented, we may incur significant
losses. See the section captioned “Leverage Strategy” in “Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of
Operations.”
We
have a high concentration of loans secured by real estate and a continued
downturn in the real estate market, for any reason, could result in losses and
materially and adversely affect our business, financial condition, results of
operations and future prospects.
A significant portion of our loan portfolio is
dependent on real estate. In addition to the financial strength and
cash flow characteristics of the borrower in each case, often loans are secured
with real estate collateral. At December 31, 2007, approximately
56.8% of our loans have real estate as a primary or secondary component of
collateral. The real estate in each case provides an alternate source
of repayment in the event of default by the borrower and may deteriorate in
value during the time the credit is extended. Beginning in the third
quarter of 2007, there were well-publicized developments in the credit markets,
beginning with a decline in the sub-prime mortgage lending market, which later
extended to the markets for collateralized mortgage obligations, mortgage-backed
securities and the lending markets generally. This decline has
resulted in restrictions in the resale markets for non-conforming loans and has
had an adverse effect on retail mortgage lending operations in many
markets. We believe our markets have been relatively resilient and we
have not
experienced effects associated with these market trends; however, a continued
decline in the credit markets generally could adversely effect our financial
condition and results of operations if we are unable to extend credit or sell
loans in the secondary market. An adverse change in the economy
affecting values of real estate generally or in our primary markets specifically
could significantly impair the value of collateral and our ability to sell the
collateral upon foreclosure. Furthermore, it is likely that, in a
declining real estate market, we would be required to further increase our
allowance for loan losses. If we are required to liquidate the
collateral securing a loan to satisfy the debt during a period of reduced real
estate values or to increase our allowance for loan losses, our profitability
and financial condition could be adversely impacted.
We
have a high concentration of loans directly related to the medical community in
our market area, primarily in Smith and Gregg counties. A negative
change adversely impacting the medical community, for any reason, could result
in losses and materially and adversely affect our business, financial condition,
results of operations and future prospects.
A significant portion of our loan portfolio is
dependent on the medical community. The primary source of repayment
for loans in the medical community is cash flow from continuing
operations. However, changes in the amount the government pays the
medical community through the various government health insurance programs could
adversely impact the medical community, which in turn could result in higher
default rates by borrowers in the medical industry. Increased
regulation of the medical community
17
could also
negatively impact profitability and cash flow in the medical
community. It is likely that, should there be any significant adverse
impact to the medical community, our profitability and financial condition would
also be adversely impacted.
Our allowance for probable loan losses
may be insufficient.
We maintain an allowance for probable loan
losses, which is a reserve established through a provision for probable loan
losses charged to expense. This allowance represents management’s
best estimate of probable losses that have been incurred within the existing
portfolio of loans. The allowance, in the judgment of management, is necessary
to reserve for estimated loan losses and risks inherent in the loan portfolio.
The level of the allowance reflects management’s continuing evaluation of
industry concentrations; specific credit risks; loan loss experience; current
loan portfolio quality; present economic, political and regulatory conditions;
and unidentified losses inherent in the current loan portfolio. The
determination of the appropriate level of the allowance for probable loan losses
inherently involves a high degree of subjectivity and requires us to make
significant estimates and assumptions regarding current credit risks and future
trends, all of which may undergo material changes. Changes in
economic conditions affecting borrowers, new information regarding existing
loans, identification of additional problem loans and other factors, both within
and outside our control, may require an increase in the allowance for probable
loan losses. In addition, bank regulatory agencies periodically
review our allowance for loan losses and may require an increase in the
provision for probable loan losses or the recognition of further loan
charge-offs, based on judgments different than those of
management. In addition, if charge-offs in future periods exceed the
allowance for probable loan losses, we will need additional provisions to
increase the allowance for probable loan losses. Any increases in the
allowance for probable loan losses will result in a decrease in net income and,
possibly, capital, and may have a material adverse effect on our financial
condition and results of operations. See the section captioned “Loan Loss
Experience and Allowance for Loan Losses” in
“Item 7. Management’s Discussion and Analysis of Financial
Condition and Results of Operations” for further discussion related to our
process for determining the appropriate level of the allowance for probable loan
losses.
We
are subject to environmental liability risk associated with lending
activities.
A significant portion of our loan portfolio is
secured by real property. During the ordinary course of business, we
may foreclose on and take title to properties securing certain loans. There is a
risk that hazardous or toxic substances could be found on these
properties. If hazardous or toxic substances are found, we may be
liable for remediation costs, as well as for personal injury and property
damage. Environmental laws may require us to incur substantial expenses and may
materially reduce the affected property’s value or limit our ability to use or
sell the affected property. In addition, future laws or more
stringent interpretations or enforcement policies with respect to existing laws
may increase our exposure to environmental liability. Although we
have policies and procedures to perform an environmental review before
initiating any foreclosure action on nonresidential real property, these reviews
may not be sufficient to detect all potential environmental
hazards. The remediation costs and any other financial liabilities
associated with an environmental hazard could have a material adverse effect on
our financial condition and results of operations.
Our
profitability depends significantly on economic conditions in the State of
Texas.
Our success depends primarily on the general
economic conditions of the State of Texas and the specific local markets in
which we operate. Unlike larger national or other regional banks that
are more geographically diversified, we provide banking and financial
services to customers primarily in the Texas areas of Tyler, Longview, Lindale,
Whitehouse, Chandler, Gresham, Athens, Palestine, Jacksonville, Bullard, Forney,
Seven Points, Gun Barrel City, Fort Worth, Austin and Arlington. The
local economic conditions in these areas have a significant impact on the demand
for our products and services, as well as the ability of our customers to repay
loans, the value of the collateral securing loans and the stability of our
deposit funding sources. A significant decline in general economic
conditions, caused by inflation, recession, acts of terrorism, outbreak of
hostilities or other international or domestic occurrences, unemployment,
changes in securities markets or other factors could impact these local economic
conditions and, in turn, have a material adverse effect on our financial
condition and results of operations.
18
We
operate in a highly competitive industry and market area.
We face substantial competition in all areas of
our operations from a variety of different competitors, many of which are larger
and may have more financial resources. Such competitors primarily
include national, regional, and community banks within the various markets we
operate. Additionally, various out-of-state banks have entered or
have announced plans to enter the market areas in which we currently
operate. We also face competition from many other types of financial
institutions, including, without limitation, savings and loans, credit unions,
finance companies, brokerage firms, insurance companies, factoring companies and
other financial intermediaries. The financial services industry could become
even more competitive as a result of legislative, regulatory and technological
changes, continued consolidation and recent trends in the credit and mortgage
lending markets. Banks, securities firms and insurance companies can
merge under the umbrella of a financial holding company, which can offer
virtually any type of financial service, including banking, securities
underwriting, insurance (both agency and underwriting) and merchant
banking. Also, technology has lowered barriers to entry and made it
possible for non-banks to offer products and services traditionally provided by
banks, such as automatic transfer and automatic payment systems. Many
of our competitors have fewer regulatory constraints and may have lower cost
structures. Additionally, due to their size, many competitors may be
able to achieve economies of scale and, as a result, may offer a broader range
of products and services as well as better pricing for those products and
services than we can.
Our ability to
compete successfully depends on a number of factors, including, among other
things:
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The ability
to develop, maintain and build upon long-term customer relationships based
on top quality service, high ethical standards and safe, sound
assets.
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The ability
to expand our market position.
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The scope,
relevance and pricing of products and services offered to meet customer
needs and demands.
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The rate at
which we introduce new products and services relative to our
competitors.
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Customer
satisfaction with our level of
service.
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Industry and general economic
trends.
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Failure to perform in any of these areas could
significantly weaken our competitive position, which could adversely affect our
growth and profitability, which, in turn, could have a material adverse effect
on our financial condition and results of operations.
We
are subject to extensive government regulation and supervision.
Southside Bancshares, Inc., primarily through
Southside Bank, Fort Worth National Bank and certain non-bank subsidiaries, is
subject to extensive federal and state regulation and
supervision. Banking regulations are primarily intended to protect
depositors’ funds, federal deposit insurance funds and the banking system as a
whole, not shareholders. These regulations affect our lending
practices, capital structure, investment practices and dividend policy and
growth, among other things. Congress and federal and state regulatory
agencies continually review banking laws, regulations and policies for possible
changes. Changes to statutes, regulations or regulatory policies, including
changes in interpretation or implementation of statutes, regulations or
policies, could affect us in substantial and unpredictable ways. Such
changes could subject us to additional costs, limit the types of financial
services and products we may offer and/or increase the ability of non-banks to
offer competing financial services and products, among other
things. Failure to comply with laws, regulations or policies could
result in sanctions by regulatory agencies, civil money penalties and/or
reputation damage, which could have a material adverse effect on our business,
financial condition and results of operations. While our
19
policies and
procedures are designed to prevent any such violations, there can be no
assurance that such violations will not occur. See the section
captioned “Supervision and Regulation” in “Item 1. Business” and
“Note 15 –
Shareholders’ Equity” in the notes to consolidated financial statements included
in “Item 8. Financial Statements and Supplementary Data,” which are located
elsewhere in this report.
Our
controls and procedures may fail or be circumvented.
Management regularly reviews and updates our
internal controls, disclosure controls and procedures, and corporate governance
policies and procedures. Any system of controls, however well
designed and operated, is based in part on certain assumptions and can provide
only reasonable, not absolute, assurances that the objectives of the system are
met. Any failure or circumvention of our controls and procedures or
failure to comply with regulations related to controls and procedures could have
a material adverse effect on our business, results of operations and financial
condition.
New
lines of business or new products and services may subject us to additional
risks.
From time to time, we may implement new
delivery systems, such as internet banking, or offer new products and services
within existing lines of business. In August, 2007, through a subsidiary of
Southside Bank, we entered into a joint venture engaged in the purchase and sale
of portfolios of automobile loans nationwide. Although we have
retained a management team with expertise in this industry, we cannot provide
any assurance as to our ability to profitably operate this line of
business. There are substantial risks and uncertainties associated
with these efforts, particularly in instances where the markets are not fully
developed. In developing and marketing new delivery systems and/or
new products and services, we may invest significant time and resources. Initial
timetables for the introduction and development of new lines of business and/or
new products or services may not be achieved and price and profitability targets
may not prove feasible. External factors, such as compliance with regulations,
competitive alternatives, and shifting market preferences, may also impact the
successful implementation of a new line of business or a new product or
service. Furthermore, any new line of business and/or new product or
service could have a significant impact on the effectiveness of our system of
internal controls. Failure to successfully manage these risks in the
development and implementation of new lines of business or new products or
services could have a material adverse effect on our business, results of
operations and financial condition.
We
rely on dividends from our subsidiaries for most of our revenue.
Southside Bancshares, Inc. is a separate and
distinct legal entity from our subsidiaries. We receive substantially
all of our revenue from dividends from our subsidiaries. These
dividends are the principal source of funds to pay dividends on our common stock
and interest and principal on our debt. Various federal and/or state
laws and regulations limit the amount of dividends that Southside Bank, Fort
Worth National Bank, and certain non-bank subsidiaries may pay to Southside
Bancshares, Inc. Also, Southside Bancshares, Inc.’s right to
participate in a distribution of assets upon a subsidiary’s liquidation or
reorganization is subject to the prior claims of the subsidiary’s
creditors. In the event Southside Bank or Fort Worth National Bank is
unable to pay dividends to Southside Bancshares, Inc., Southside Bancshares,
Inc. may not be able to service debt, pay obligations or pay dividends on common
stock. The inability to receive dividends from Southside Bank or Fort
Worth National Bank could have a material adverse effect on Southside
Bancshares, Inc.’s business, financial condition and results of
operations. See the section captioned “Supervision and Regulation” in
“Item 1. Business” and “Note 15 – Shareholders’ Equity” in the notes
to consolidated financial statements included in “Item 8. Financial
Statements and Supplementary Data,” which are located elsewhere in this
report.
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We
may not be able to access capital on favorable terms, including cost of
funds.
The availability and cost of funds may increase
as a result of general economic condition, increased interest rates and
competitive pressures. If we are unable to obtain funds on terms that
are favorable to us, we could be restricted in our ability to extend credit, and
may not be able to obtain sufficient funds to support growth through branching
or acquisition initiatives.
The
holders of our junior subordinated debentures have rights that are senior to
those of our shareholders.
On September 4, 2003, we issued $20.6 million
of floating rate junior subordinated debentures in connection with a $20.0
million trust preferred securities issuance by our subsidiary, Southside
Statutory Trust III. This junior subordinated debenture matures in
September 2033. On August 8 and 10, 2007, we issued $23.2 million and
$12.9 million, respectively, of five year fixed rate converting to floating rate
thereafter, junior subordinated debentures in connection with $22.5 million and
$12.5 million, respectively, trust preferred securities issuances by our
subsidiaries Southside Statutory Trust IV and V, respectively. Trust
IV matures September 2037 and Trust V matures December 2037. As part
of the acquisition of Fort Worth Bancshares, Inc. on October 10, 2007, we
assumed a $3.6 million floating rate junior subordinated debenture issued to
Magnolia Trust Company I in connection with $3.5 million of trust preferred
securities issued in 2005 that matures in 2035.
We conditionally guarantee payments of the
principal and interest on the trust preferred securities. Our junior
subordinated debentures are senior to our shares of common stock. As
a result, we must make payments on the junior subordinated debentures (and the
related trust preferred securities) before any dividends can be paid on our
common stock and, in the event of bankruptcy, dissolution or liquidation, the
holders of the debentures must be satisfied before any distributions can be made
to the holders of common stock. We have the right to defer
distributions on our junior subordinated debentures (and the related trust
preferred securities) for up to five years, during which time no dividends may
be paid to holders of common stock.
Acquisitions
and potential acquisitions may disrupt our business and dilute shareholder
value.
During 2007, we completed the acquisition of
Fort Worth Bancshares, Inc. This was our first
acquisition. Aside from this acquisition, we occasionally investigate
potential merger or acquisition partners that appear to be culturally similar,
have experienced management and possess either significant or attractive market
presence or have potential for improved profitability through financial
management, economies of scale or expanded services. Acquiring other banks,
businesses or branches involves various risks commonly associated with
acquisitions, including, among other things:
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potential
exposure to unknown or contingent liabilities of the target
company;
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exposure to
potential asset quality issues of the target
company;
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difficulty
and expense of integrating the operations and personnel of the target
company;
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potential
disruption to our business;
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potential
diversion of our management’s time and
attention;
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the possible
loss of key employees and customers of the target
company;
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difficulty in
estimating the value of the target company;
and
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potential
changes in banking or tax laws or regulations that may affect the target
company.
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We occasionally evaluate merger and acquisition
opportunities and conduct due diligence activities related to possible
transactions with other financial institutions and financial services companies.
As a result, merger or acquisition discussions and, in some cases, negotiations
may take place and future mergers or acquisitions involving cash, debt or equity
securities may occur at any time. Acquisitions typically involve the
payment of a premium over book and market values, and, therefore, some dilution
of our tangible book value and net income per common share may occur in
connection with any future transaction. Furthermore, failure to realize the
expected revenue increases, cost savings, increases in geographic or product
presence, and/or other projected benefits and synergies from an acquisition
could have a material adverse effect on our financial condition and results of
operations. Failure to integrate Fort Worth National Bank’s
operations, personnel, policies and procedures into Southside’s could have a
material and adverse effect on our financial condition and results of
operations.
We
may not be able to attract and retain skilled people.
Our success depends, in large part, on our
ability to attract and retain key people. Competition for the best
people in most activities we engage in can be intense, and we may not be able to
hire people or to retain them. The unexpected loss of services of one
or more of our key personnel could have a material adverse impact on our
business because of their skills, knowledge of our market, relationships in the
communities we serve, years of industry experience and the difficulty of
promptly finding qualified replacement personnel. Although we have
employment agreements with certain of our executive officers, there is no
guarantee that these officers will remain employed with the
company.
Our information
systems may experience an interruption or breach in security.
We rely heavily on communications and
information systems to conduct our business. Any failure,
interruption or breach in security of these systems could result in failures or
disruptions in our customer relationship management, general ledger, deposit,
loan and other systems. While we have policies and procedures
designed to prevent or limit the effect of the failure, interruption or security
breach of our information systems, there can be no assurance that we can prevent
any such failures, interruptions or security breaches or, if they do occur, that
they will be adequately addressed. The occurrence of any failures,
interruptions or security breaches of our information systems could damage our
reputation, result in a loss of customer business, subject us to additional
regulatory scrutiny, or expose us to civil litigation and possible financial
liability, any of which could have a material adverse effect on our financial
condition and results of operations.
We
continually encounter technological change.
The financial services industry is continually
undergoing rapid technological change with frequent introductions of new
technology-driven products and services. The effective use of technology
increases efficiency and enables financial institutions to better serve
customers and to reduce costs. Our future success depends, in part, upon our
ability to address the needs of our customers by using technology to provide
products and services that will satisfy customer demands, as well as to create
additional efficiencies in our operations. Many of our competitors have
substantially greater resources to invest in technological improvements. We may
not be able to effectively implement new technology-driven products and services
or be successful in marketing these products and services to our customers and
even if we implement such products and services, we may incur substantial costs
in doing so. Failure to successfully keep pace with technological
change affecting the financial services industry could have a material adverse
impact on our business, financial condition and results of
operations.
We
are subject to claims and litigation pertaining to fiduciary
responsibility.
From time to time, customers make claims and
take legal action pertaining to our performance of our fiduciary
responsibilities. Whether customer claims and legal action related to our
performance of our fiduciary responsibilities are founded or unfounded,
defending claims is costly and diverts management’s attention, and if such
claims and legal actions are not resolved in a manner favorable to us, they may
result in significant financial liability and/or adversely affect our market
perception and products and
22
services as well as
impact customer demand for those products and services. Any financial liability
or reputation damage could have a material adverse effect on our business,
financial condition and results of operations.
Severe
weather, natural disasters, acts of war or terrorism and other external events
could significantly impact our business.
Severe weather, natural disasters, acts of war
or terrorism and other adverse external events could have a significant impact
on our ability to conduct business. Such events could affect the stability of
our deposit base, impair the ability of borrowers to repay outstanding loans,
impair the value of collateral securing loans, cause significant property
damage, result in loss of revenue and/or cause us to incur additional expenses.
For example, during 2005, hurricanes Katrina and Rita caused extensive flooding
and destruction along the coastal areas of the Gulf of Mexico. While
the impact of these hurricanes did not significantly affect us, other severe
weather or natural disasters, acts of war or terrorism or other adverse external
events may occur in the future. Although management has established disaster
recovery policies and procedures, there can be no assurance of the effectiveness
of such policies and procedures, and the occurrence of any such event could have
a material adverse effect on our business, financial condition and results of
operations.
RISKS ASSOCIATED
WITH OUR COMMON STOCK
Our
stock price can be volatile.
Stock price volatility may make it more
difficult for you to resell your common stock when you want and at prices you
find attractive. Our stock price can fluctuate significantly in response to a
variety of factors including, among other things:
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actual or
anticipated variations in quarterly results of
operations;
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recommendations
by securities analysts;
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operating and
stock price performance of other companies that investors deem comparable
to us;
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news reports
relating to trends, concerns and other issues in the financial services
industry;
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perceptions
in the marketplace regarding us and/or our
competitors;
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new
technology used, or services offered, by
competitors;
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significant
acquisitions or business combinations, strategic partnerships, joint
ventures or capital commitments by or involving us or our
competitors;
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failure to
integrate acquisitions or realize anticipated benefits from
acquisitions;
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changes in
government regulations; and
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geopolitical
conditions such as acts or threats of terrorism or military
conflicts.
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General market fluctuations, industry factors
and general economic and political conditions and events, such as economic
slowdowns or recessions, interest rate changes or credit loss trends, could also
cause our stock price to decrease regardless of operating results.
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The
trading volume in our common stock is less than that of other larger financial
services companies.
Although our common stock is listed for trading
on the NASDAQ Global Select Market, the trading volume is low, and you are not
assured liquidity with respect to transactions in our common stock. A public
trading market having the desired characteristics of depth, liquidity and
orderliness depends on the presence in the marketplace of willing buyers and
sellers of our common stock at any given time. This presence depends on the
individual decisions of investors and general economic and market conditions
over which we have no control. Given the lower trading volume of our common
stock, significant sales of our common stock, or the expectation of these sales,
could cause our stock price to fall.
An
investment in our common stock is not an insured deposit.
Our common stock is not a bank deposit and,
therefore, is not insured against loss by the FDIC, any other deposit insurance
fund or by any other public or private entity. Investment in our common stock is
inherently risky for the reasons described in this “Risk Factors” section and
elsewhere in this report and is subject to the same market forces that affect
the price of common stock in any company. As a result, if you acquire our common
stock, you may lose some or all of your investment.
Provisions
of our amended and restated articles of incorporation and amended and restated
bylaws, as well as state and federal banking regulations, could delay or prevent
a takeover of us by a third party.
Our amended and restated articles of
incorporation and amended and restated bylaws could delay, defer or prevent a
third party from acquiring us, despite the possible benefit to our shareholders,
or otherwise adversely affect the price of our common stock. These
provisions include, among others, requiring advance notice for raising business
matters or nominating directors at shareholders’ meetings and staggered board
elections.
Any individual, acting alone or with other
individuals, who is seeking to acquire, directly or indirectly, 10.0% or more of
our outstanding common stock must comply with the Change in Bank Control Act,
which requires prior notice to the Federal Reserve for any
acquisition. Additionally, any entity that wants to acquire 5.0% or
more of our outstanding common stock, or otherwise control us, may need to
obtain the prior approval of the Federal Reserve under the Bank Holding Company
Act of 1956, as amended. As a result, prospective investors in our
common stock need to be aware of and comply with those requirements, to the
extent applicable.
RISKS ASSOCIATED
WITH THE BANKING INDUSTRY
The
earnings of financial services companies are significantly affected by general
business and economic conditions.
Our operations and profitability are impacted
by general business and economic conditions in the United States and abroad.
These conditions include short-term and long-term interest rates, inflation,
money supply, political issues, legislative and regulatory changes, fluctuations
in both debt and equity capital markets, broad trends in industry and finance,
and the strength of the U.S. economy and the local economies in which we
operate, all of which are beyond our control. A deterioration in economic
conditions could result in an increase in loan delinquencies and non-performing
assets, decreases in loan collateral values and a decrease in demand for our
products and services, among other things, any of which could have a material
adverse impact on our financial condition and results of
operations.
Financial
services companies depend on the accuracy and completeness of information about
customers and counterparties.
In deciding whether to extend credit or enter
into other transactions, we may rely on information furnished by or on behalf of
customers and counterparties, including financial statements, credit reports and
other financial information. We may also rely on representations of those
customers, counterparties or other third parties, such as independent auditors,
as to the accuracy and completeness of that
24
information.
Reliance on inaccurate or misleading financial statements, credit reports or
other financial information could have a material adverse impact on our
business, financial condition and results of operations.
Consumers
may decide not to use banks to complete their financial
transactions.
Technology and other changes are allowing
parties to complete financial transactions that historically have involved banks
through alternative methods. For example, consumers can now maintain funds that
would have historically been held as bank deposits in brokerage accounts or
mutual funds. Consumers can also complete transactions such as paying bills
and/or transferring funds directly without the assistance of banks. The process
of eliminating banks as intermediaries could result in the loss of fee income,
as well as the loss of customer deposits and the related income generated from
those deposits. The loss of these revenue streams and the lower cost deposits as
a source of funds could have a material adverse effect on our financial
condition and results of operations.
ITEM 1B. UNRESOLVED STAFF
COMMENTS
None
|
ITEM 2. PROPERTIES
|
Southside Bank owns and operates the following
properties:
|
|
·
|
Southside
Bank main branch at 1201 South Beckham Avenue, Tyler,
Texas. The executive offices of Southside Bancshares, Inc. are
located at this location;
|
|
|
·
|
Southside
Bank Annex at 1211 South Beckham Avenue, Tyler, Texas. The
Southside Bank Annex is directly adjacent to the main bank
building. Human Resources, the Trust Department and other
support areas are located in this
building;
|
|
|
·
|
Operations
Annex at 1221 South Beckham Avenue, Tyler, Texas. Various back
office, lending and training facilities and other support areas are
located in this building;
|
|
|
·
|
Southside
main branch motor bank facility at 1010 East First Street, Tyler,
Texas;
|
|
|
·
|
South
Broadway branch at 6201 South Broadway, Tyler,
Texas;
|
|
|
·
|
South
Broadway branch motor bank facility at 6019 South Broadway, Tyler,
Texas;
|
|
|
·
|
Downtown
branch at 113 West Ferguson Street, Tyler,
Texas;
|
|
|
·
|
Gentry
Parkway branch and motor bank facility at 2121 West Gentry Parkway, Tyler,
Texas;
|
|
|
·
|
Longview main
branch and motor bank facility at 2001 Judson Road, Longview,
Texas;
|
|
|
·
|
Lindale main
branch and motor bank facility at 2510 South Main Street, Lindale,
Texas;
|
|
|
·
|
Whitehouse
main branch and motor bank facility at 901 Highway 110 North, Whitehouse,
Texas;
|
|
|
·
|
Jacksonville
main branch and motor bank facility at 1015 South Jackson Street,
Jacksonville, Texas;
|
|
|
·
|
Gun Barrel
City main branch at 901 West Main, Gun Barrel City, Texas;
and
|
|
|
·
|
42 ATM’s
located throughout Smith, Gregg, Cherokee, Anderson and Henderson
Counties.
|
25
Southside Bank
currently operates full service banks in leased space in 18 grocery stores and
two lending centers in leased office space in the following
locations:
|
|
·
|
one in
Bullard, Texas;
|
|
|
·
|
one in
Lindale, Texas;
|
|
|
·
|
one in Flint,
Texas;
|
|
|
·
|
one in
Whitehouse, Texas;
|
|
|
·
|
one in
Chandler, Texas;
|
|
|
·
|
one in Seven
Points, Texas;
|
|
|
·
|
one in
Palestine, Texas;
|
|
|
·
|
one in
Athens, Texas;
|
|
|
·
|
one in
Hawkins, Texas;
|
|
|
·
|
three in
Longview, Texas;
|
|
|
·
|
six in Tyler,
Texas;
|
|
|
·
|
Gresham loan
production office at 16637 FM 2493, Tyler, Texas;
and
|
|
|
·
|
Forney loan
production office at 413 North McGraw, Forney,
Texas.
|
Fort Worth National
Bank owns and operates the following properties:
|
|
·
|
Arlington
branch at 2831 W. Park Row, Arlington,
Texas;
|
|
|
·
|
Fort Worth
branch at 9516 Clifford Street, Fort Worth, Texas;
and
|
|
|
·
|
3 ATM’s
located in Fort Worth and Arlington,
Texas.
|
Fort Worth National
Bank currently operates its main branch and one lending center in leased office
space in the following locations:
|
|
·
|
Main branch
at 701 W. Magnolia, Fort Worth, Texas;
and
|
|
|
·
|
Austin loan
production office at 8200 N. Mopac, Ste. 130, Austin,
Texas.
|
SFG currently
operates its business in leased office space in the following
location:
|
|
·
|
1600 E.
Pioneer Parkway, Ste. 300, Arlington,
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 we anticipate they will generate. As
additional potential needs are identified, individual property enhancements or
the need to add properties will be evaluated.
26
|
ITEM 3. LEGAL
PROCEEDINGS
|
We are party to legal proceedings arising in
the normal conduct of business. Management believes that such
litigation is not material to our financial position or results of
operations.
|
ITEM 4. SUBMISSION OF MATTERS
TO A VOTE OF SECURITY
HOLDERS
|
During the three months ended December 31,
2007, there were no meetings, annual or special, of our
shareholders. No matters were submitted to a vote of the
shareholders, nor were proxies solicited by management or any other
person.
PART II
|
ITEM 5. MARKET FOR
REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS
|
|
AND ISSUER
PURCHASES OF EQUITY
SECURITIES
|
MARKET
INFORMATION
Our common stock trades on the NASDAQ Global
Select Market (formerly the NASDAQ National Market) under the symbol
"SBSI." The high/low prices shown below represent the daily weighted
average prices on the NASDAQ Global Select Market for the period from January 1,
2006 to December 31, 2007. During the second quarter of 2007 and the
first quarter of 2006, we declared and paid a 5% stock
dividend. Stock prices listed below have been adjusted to give
retroactive recognition to stock splits and stock dividends.
|
Year
Ended
|
1st
Quarter
|
2nd
Quarter
|
3rd
Quarter
|
4th
Quarter
|
||||||||||||
|
December 31,
2007
|
$ | 24.64-21.04 | $ | 22.51-21.11 | $ | 23.93-19.24 | $ | 23.74-18.72 | ||||||||
|
December 31,
2006
|
$ | 19.77-18.22 | $ | 21.49-18.12 | $ | 25.55-21.59 | $ | 26.18-23.44 | ||||||||
See "Item 7. Management’s Discussion
and Analysis of Financial Condition and Results of Operations - Capital
Resources" for a discussion of our common stock repurchase program.
SHAREHOLDERS
There were approximately 1,100 holders of
record of our common stock, the only class of equity securities currently issued
and outstanding, as of February 15, 2008.
DIVIDENDS
Cash dividends declared and paid were $0.50 and
$0.47 per share for the years ended December 31, 2007 and 2006,
respectively. Stock dividends of 5% were also declared and paid
during each of the years ended December 31, 2007, 2006 and 2005. We
have paid a cash dividend at least once every year since 1970. Future
dividends will depend on our earnings, financial condition and other factors
that our board of directors considers to be relevant. In addition, we
must make payments on our junior subordinated debentures before any dividends
can be paid on the common stock. For additional discussion relating
to restrictions that limit our ability to pay dividends refer to “Supervision
and Regulation” in “Item 1. Business” and in “Item 7. Management’s Discussion
and Analysis of Financial Condition and Results of Operations –Capital
Resources.” The cash dividends were paid quarterly each year as
listed below.
Quarterly Cash Dividends
Paid
|
Year
Ended
|
1st
Quarter
|
2nd
Quarter
|
3rd
Quarter
|
4th
Quarter
|
||||||||||||
|
December 31,
2007
|
$ | 0.11 | $ | 0.12 | $ | 0.12 | $ | 0.15 | ||||||||
|
December 31,
2006
|
$ | 0.11 | $ | 0.11 | $ | 0.11 | $ | 0.14 | ||||||||
27
STOCK-BASED
COMPENSATION PLANS
Information regarding
stock-based compensation awards outstanding and available for future grants as
of December 31, 2007, is presented in “Item 12. Security Ownership of
Certain Beneficial Owners and Management and Related Stockholder Matters” of
this Annual Report on Form 10-K. Additional information regarding
stock-based compensation plans is presented in “Note 14 — Employee
Benefit Plans" in the notes to consolidated financial statements located
elsewhere in this report.
UNREGISTERED SALES
OF EQUITY SECURITIES, USE OF PROCEEDS AND ISSUER SECURITY
REPURCHASES
During 2007, we did not approve any additional
funding for our stock repurchase plan. No common stock was purchased
during the fourth quarter ended December 31, 2007.
FINANCIAL
PERFORMANCE
The following performance graph does not
constitute soliciting material and should not be deemed filed or incorporated by
reference into any other Company under the Securities Act of 1933 or the
Securities Exchange Act of 1934, except to the extent the filing Company
specifically incorporates the performance graph by reference
therein.
Southside
Bancshares, Inc.
28
|
Period
Ending
|
||||||||||||||||||||||||
|
Index
|
12/31/02
|
12/31/03
|
12/31/04
|
12/31/05
|
12/31/06
|
12/31/07
|
||||||||||||||||||
|
Southside
Bancshares, Inc.
|
100.00 | 133.89 | 177.37 | 168.33 | 229.87 | 196.58 | ||||||||||||||||||
|
Russell
2000
|
100.00 | 147.25 | 174.24 | 182.18 | 215.64 | 212.26 | ||||||||||||||||||
|
Southside
Bancshares Peer Group*
|
100.00 | 137.24 | 160.09 | 168.91 | 187.11 | 156.29 | ||||||||||||||||||
|
*Southside
Bancshares’ Peer Group includes the following Texas banks: Cullen/Frost
Bankers, Inc., First Financial
|
||
|
Bankshares,
Inc., International Bancshares Corporation, MetroCorp Bancshares, Inc.,
Prosperity Bancshares, Inc.,
|
||
|
Sterling
Bancshares, Inc., Texas Capital Bancshares, Inc. and Franklin Bank
Corp.
|
||
|
Source
: SNL Financial LC, Charlottesville, VA
|
|
ITEM 6. SELECTED FINANCIAL
DATA
|
The following table sets forth selected
financial data regarding our 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, 2007. This information should be read in conjunction
with "Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations" and “Item 8. Financial Statements and
Supplementary Data,” as set forth in this report.
|
As of and For
the Years Ended December 31,
|
||||||||||||||||||||
|
2007
|
2006
|
2005
|
2004
|
2003
|
||||||||||||||||
|
(in
thousands, except per share data)
|
||||||||||||||||||||
|
Balance Sheet
Data:
|
||||||||||||||||||||
|
Investment
Securities
|
$ | 110,403 | $ | 100,303 | $ | 121,240 | $ | 133,535 | $ | 144,876 | ||||||||||
|
Mortgage-backed
and Related Securities
|
$ | 917,518 | $ | 869,326 | $ | 821,756 | $ | 720,533 | $ | 590,963 | ||||||||||
|
Loans, Net of
Allowance for Loan Losses
|
$ | 951,477 | $ | 751,954 | $ | 673,274 | $ | 617,077 | $ | 582,721 | ||||||||||
|
Total
Assets
|
$ | 2,196,322 | $ | 1,890,976 | $ | 1,783,462 | $ | 1,619,643 | $ | 1,454,952 | ||||||||||
|
Deposits
|
$ | 1,530,491 | $ | 1,282,475 | $ | 1,110,813 | $ | 940,986 | $ | 872,529 | ||||||||||
|
Long-term
Obligations
|
$ | 146,558 | $ | 149,998 | $ | 229,032 | $ | 351,287 | $ | 272,694 | ||||||||||
|
Income
Statement Data:
|
||||||||||||||||||||
|
Interest
& Deposit Service Income
|
$ | 123,021 | $ | 112,434 | $ | 94,275 | $ | 80,793 | $ | 73,958 | ||||||||||
|
Net
Income
|
$ | 16,684 | $ | 15,002 | $ | 14,592 | $ | 16,099 | $ | 13,564 | ||||||||||
|
Per Share
Data:
|
||||||||||||||||||||
|
Net Income
Per Common Share:
|
||||||||||||||||||||
|
Basic
|
$ | 1.28 | $ | 1.16 | $ | 1.15 | $ | 1.27 | $ | 1.24 | ||||||||||
|
Diluted
|
$ | 1.24 | $ | 1.12 | $ | 1.10 | $ | 1.20 | $ | 1.05 | ||||||||||
|
Cash
Dividends Paid Per Common Share
|
$ | 0.50 | $ | 0.47 | $ | 0.46 | $ | 0.42 | $ | 0.36 | ||||||||||
29
|
ITEM 7. MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND
|
|
RESULTS
OF
OPERATIONS
|
The following discussion and analysis provides
a comparison of our results of operations for the years ended December 31, 2007,
2006, and 2005 and financial condition as of December 31, 2007 and
2006. This discussion should be read in conjunction with the
financial statements and related notes included elsewhere in this
report. All share data has been adjusted to give retroactive
recognition to stock splits and stock dividends.
CAUTIONARY NOTICE
REGARDING 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. 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, 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;
|
30
|
·
|
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 SEC. 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 reported in the financial
statements and accompanying notes. Actual results could differ from
those estimates. We consider our critical accounting policies to
include the following:
Allowance for Losses on
Loans. The allowance for losses on loans represents our 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 our assessment of several factors: reviews and
evaluations of specific loans, changes in the nature and volume of the loan
portfolio, and current 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.
The loan loss allowance is based on the most
current review of the loan portfolio. 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. Our internal loan review department is responsible for an
ongoing review of our loan portfolio with specific goals set for the loans to be
reviewed on an annual basis.
At each review, a subjective analysis
methodology is used to grade the respective loan. Categories of
grading vary in severity from loans that do not appear to have a significant
probability of loss at the time of review to loans that 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. The internal loan review department maintains a
list of all loans or loan relationships that are graded as having more than the
normal degree of risk associated with them. In addition, a list of
loans or loan relationships of $50,000 or more is updated on a periodic basis in
order to properly allocate necessary allowance and keep management informed on
the status of attempts to correct the deficiencies noted with respect to the
loan.
31
Loans are considered impaired if, based on
current information and events, it is probable that we 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 the fair value of the collateral. In measuring
the fair value of the collateral, we use assumptions such as discount rates, and
methodologies, such as comparison to the recent selling price of similar assets,
consistent with those that would be utilized by unrelated third parties
performing a valuation.
Changes in the financial condition of
individual borrowers, economic conditions, historical loss experience and the
conditions of the various markets in which collateral may be sold all may affect
the required level of the allowance for losses on loans and the associated
provision for loan losses.
As of December 31, 2007, our review of the loan
portfolio indicated that a loan loss allowance of $9.8 million was adequate to
cover probable losses in the portfolio.
Refer to “Loan Loss Experience and Allowance
for Loan Losses” and “Note 1 – Summary of Significant Accounting and Reporting
Policies” to our consolidated financial statements for a detailed description of
our 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 our assets and
liabilities. GAAP requires 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.
Fair values for most investment and
mortgage-backed 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 value of
fixed rate 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. Fair values for fixed rate CDs are
estimated using a discounted cash flow calculation that applies interest rates
currently being offered for deposits of similar remaining maturities. The fair
value of Federal Home Loan Bank (“FHLB”) advances is estimated by discounting
the future cash flows using rates at which advances would be made to borrowers
with similar credit ratings and for the same remaining
maturities. The fair values of other real estate owned (“OREO”) are
typically determined based on appraisals by third parties, less estimated costs
to sell and recorded at the lower of cost or fair value. The fair
value of the fixed rate long-term debt is estimated by discounting future cash
flows using rates at which fixed rate long-term debt would be made to borrowers
with similar credit ratings and for remaining maturities.
Impairment of Investment Securities
and Mortgage-backed Securities. Investment and mortgage-backed
securities classified as available for sale (“AFS”) are carried at fair value
and the impact of changes in fair value are recorded on our consolidated balance
sheet as an unrealized gain or loss in “Accumulated other comprehensive income
(loss),” a separate component of shareholders’ equity. Securities
classified as AFS or held to maturity (“HTM”) are subject to our review to
identify when a decline in value is other-than-temporary. Factors
considered in determining whether a decline in value is other-than-temporary
include: whether the decline is substantial; the duration of the decline; the
reasons for the decline in value; whether the decline is related to a credit
event or to a change in interest rate; our ability and intent to hold the
investment for a period of time that will allow for a recovery of value; and the
financial condition and near-term prospects of the issuer. When it is
determined that a decline in value is other-than-temporary, the carrying value
of the security is reduced to its estimated fair value, with a corresponding
charge to earnings.
32
Defined Benefit Pension Plan.
The plan obligations and related assets of the defined benefit pension plan (the
“Plan”) are presented in “Note 14 – Employee Benefits” to our 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, we utilized
a cash flow matching analysis to determine a range of appropriate discount rates
for our defined benefit pension and restoration plans. In developing
the cash flow matching analysis, we constructed a portfolio of high quality
non-callable bonds (rated AA- or better) to match as close as possible the
timing of future benefit payments of the plans at December 31,
2007. Based on this cash flow matching analysis, we were able to
determine an appropriate discount rate.
Salary increase assumptions are based upon
historical experience and our anticipated future actions. The
expected long-term rate of return assumption reflects the average return
expected based on the investment strategies and asset allocation on the assets
invested to provide for the Plan’s liabilities. We considered broad
equity and bond indices, long-term return projections, and actual long-term
historical Plan performance when evaluating the expected long-term rate of
return assumption. At December 31, 2007, the weighted-average
actuarial assumptions of the Plan were: a discount rate of 6.25%; a long-term
rate of return on plan assets of 7.50%; and assumed salary increases of
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, 2007, our
net income increased $1.7 million, or 11.2%, to $16.7 million, from $15.0
million for the same period in 2006. The increase in net income was
primarily attributable to the increase in net interest income and noninterest
income partially offset by an increase in the provision for loan losses and
noninterest expense. This increase in noninterest income was offset
by noninterest expense due primarily to increases in salaries and employee
benefits due to the acquisition of Fort Worth National Bank during the fourth
quarter of 2007 and an interest in SFG in the third quarter of
2007. Earnings per fully diluted share increased $0.12, or 10.7% to
$1.24, for the year ended December 31, 2007, from $1.12 for the same period in
2006.
During the year ended December 31, 2006, our
net income increased $410,000, or 2.8%, to $15.0 million, from $14.6 million for
the same period in 2005. The increase in net income was primarily
attributable to the increase in noninterest income and decrease in the provision
for loan losses. This increase in noninterest income was offset by
noninterest expense due primarily to increases in salaries and employee benefits
due to normal payroll increases and staff increases due to branch expansion and
the new regional lending initiative. Earnings per fully diluted share
were $1.12 and $1.10, respectively, for the years ended December 31, 2006 and
2005.
FINANCIAL CONDITION
Our total assets
increased $305.3 million, or 16.1%, to $2.20 billion at December 31, 2007 from
$1.89 billion at December 31, 2006. The increase was partially
attributable to our acquisition of Fort Worth Bancshares, Inc. during October
2007. Fort Worth Bancshares, Inc.’s total consolidated assets as of
December 31, 2007 were $158.8 million. The acquisition of Fort Worth
Bancshares, Inc. and our interest in SFG contributed to our increase in loans of
$202.1 million, or 26.6%, as compared to December 31, 2006. Fort
Worth National Bank loans acquired represented $105.6 million of the increase
in loans. SFG loans represented approximately $56 million of the
increase in loans. At December 31, 2007, loans were
$961.2
33
million
compared to $759.1 million at December 31, 2006. Our securities
portfolio also contributed to the increase by $53.7 million, or 5.4%, to $1.0
billion as compared to $996.1 million at December 31, 2006. Our
organic increase in loans and securities was funded by increases in
deposits.
Our nonperforming assets at December 31, 2007
increased to $3.9 million, and represented 0.18% of total assets, compared to
$2.1 million, or 0.11%, of total assets at December 31,
2006. Nonaccruing loans increased to $2.9 million and the ratio of
nonaccruing loans to total loans increased to 0.30% at December 31, 2007 as
compared to $1.3 million and 0.18% at December 31, 2006. Not
including the $2.0 million increase in nonperforming assets attributable to the
SFG automobile loans, nonperforming assets for Southside would have decreased by
$148,000. Approximately $265,000 of the nonaccrual loans at December
31, 2007, is one loan that has an average SBA guarantee of 75%. OREO
decreased to $153,000 at December 31, 2007 from $351,000 at December 31,
2006. Loans 90 days past due at December 31, 2007 increased to
$400,000 compared to $128,000 at December 31, 2006. Repossessed
assets increased to $255,000 at December 31, 2007 from $78,000 at December 31,
2006. Restructured loans at December 31, 2007 increased slightly to
$225,000 compared to $220,000 at December 31, 2006.
Our deposits increased $248.0 million to $1.53
billion at December 31, 2007 from $1.28 billion at December 31,
2006. Fort Worth National Bank deposits acquired in the fourth
quarter of 2007 represent $109.1 million of the increase. The
remaining $138.9 million increase was primarily due to branch expansion and
increased market penetration. Due to the increase in deposits during
2007, FHLB advances decreased $11.6 million to $440.0 million at December 31,
2007, from $451.6 million at December 31, 2006. Short-term FHLB
advances increased $31.6 million to $353.8 million at December 31, 2007 from
$322.2 million at December 31, 2006. Long-term FHLB advances
decreased $43.1 million to $86.2 million at December 31, 2007 from $129.4
million at December 31, 2006. Other borrowings at December 31, 2007
and 2006 totaled $69.8 million and $27.9 million, respectively, and at December
31, 2007 consisted of $9.5 million of short-term borrowings and $60.3 million of
long-term debt.
The increase in long-term debt resulted from
approximately $36.1 million of subordinated debentures issued to finance the
acquisition of Fort Worth Bancshares, Inc. and approximately $3.6 million in
subordinated debentures previously issued by Fort Worth Bancshares, Inc. and
assumed in connection with the acquisition.
Assets under management in our trust department
exceeded $700 million for the first time during 2007 and were approximately $718
million at December 31, 2007.
Shareholders' equity at December 31, 2007
totaled $132.3 million compared to $110.6 million at December 31,
2006. The increase primarily reflects the net income of $16.7 million
recorded for the year ended December 31, 2007, and the common stock issued of
$1.6 million as a result of our incentive stock option and dividend reinvestment
plans, a decrease in the accumulated other comprehensive loss of $9.8 million,
all of which were partially offset by the payment of cash dividends to our
shareholders of $6.5 million. The decrease in accumulated other
comprehensive loss is composed of an increase of $1.1 million, net of tax,
related to the change in the unfunded status of our defined benefit plan and an
$8.7 million, net of tax, unrealized gain on securities, net of reclassification
adjustment. See “Note 4 – Comprehensive Income (Loss)” to our
consolidated financial statements.
During 2007 the economy in our market area
appeared to reflect only slight effects of the housing led economic slowdown
impacting other regions of the United States. We 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 interest
rate risk indicators, credit risk, operations risk, liquidity risk, capital
risk, regulatory risk, competition risk, yield curve risk, and economic
risk.
34
LEVERAGE STRATEGY
We utilize wholesale funding and securities to
enhance our profitability and balance sheet composition by determining
acceptable levels of credit, interest rate and liquidity risk consistent with
prudent capital management. The leverage strategy consists of
borrowing a combination of long and short-term funds from the FHLB and issuing
brokered CDs. These funds are invested primarily in agency mortgage-backed
securities, and to a lesser extent, long-term municipal
securities. Although agency mortgage-backed securities often carry
lower yields than traditional mortgage loans and other types of loans we make,
these securities generally increase the overall quality of our assets because of
underlying insurance or guarantees, are more liquid than individual loans and
may be used to collateralize our borrowings or other
obligations. While the strategy of investing a substantial portion of
our assets in agency mortgage-backed and municipal securities has resulted in
lower interest rate spreads and margins, we believe that the lower operating
expenses and reduced credit risk combined with the managed interest rate risk of
this strategy have enhanced our overall profitability over the last several
years. At this time, we utilize the leverage strategy with the goal
of enhancing overall profitability by maximizing the use of our
capital.
Risks associated with the asset structure we
maintain include a lower net interest rate spread and margin when compared to
our peers, changes in the slope of the yield curve, which can reduce our net
interest rate spread and margin, increased interest rate risk, the length of
interest rate cycles, and the unpredictable nature of mortgage-backed securities
prepayments. See “Item 1A. Risk Factors – Risks Related to
Our Business.” During the first half of 2007, the interest rate yield
curve was relatively flat to only slightly positively sloped. During
the second half of 2007, the Federal Reserve decreased the overnight fed funds
rate by 100 basis points while at the same time short-term U. S. Treasury
interest rates decreased more than long-term U. S. Treasury interest
rates. These changes during 2007 resulted in a positively sloped U.
S. Treasury yield curve at December 31, 2007. Our asset structure,
net interest spread and net interest margin require an increase in the need to
monitor our 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, especially long-term
interest rates, could adversely impact the market value of the AFS securities
portfolio, which could also significantly impact our equity
capital. 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 scenarios modeled by our Asset/Liability Committee (“ALCO”)
and described under “Item 7A. Quantitative and Qualitative
Disclosures about Market Risk” in this report.
The management of the securities portfolio as a
percentage of earning assets is guided by changes in our overall loan and
deposit levels combined with changes in our wholesale funding
levels. If adequate quality loan growth is not available to achieve
our goal of enhancing profitability by maximizing the use of capital, as
described above, then we could purchase additional securities, if appropriate,
which could cause securities as a percentage of earning assets to
increase. Should we determine that increasing the securities
portfolio or replacing the current securities maturities and principal payments
is not an efficient use of capital, we could decrease the level of securities
through proceeds from maturities, principal payments on mortgage-backed
securities or sales. During the year ended December 31, 2007, credit
and volatility spreads increased which, combined with the steeper yield curve,
led to buying opportunities in agency mortgage-backed securities and to a lesser
extent municipal securities. While loan growth during the year was
adequate, a majority of this growth did not occur until the last half of the
year. At December 31, 2007, the securities portfolio as a percentage
of total assets decreased to 47.8% from 52.7% at December 31, 2006 primarily as
a result of the Fort Worth National Bank acquisition. The current
interest rate yield curve and spreads remain investment friendly and changes to
the securities portfolio as a percentage of earning assets will be guided by
changes in our loan and deposit levels during the first quarter of 2008 as well
as the availability of attractive investment opportunities. During
the year ended December 31, 2007, we increased our investment and
mortgage-backed securities approximately $45.7 million as investment and
mortgage-backed securities excluding the net unrealized gain on AFS securities
increased from $976.3 million at December 31, 2006 to $1.0 billion at December
31, 2007. Our leverage strategy is dynamic and requires ongoing
management and will be reevaluated as market conditions warrant. As
interest rates, yield curves, mortgage-backed securities prepayments, funding
costs, security spreads and loan and deposit portfolios change, our
determination of the proper
35
types and
maturities of securities to own, proper amount of securities to own and funding
needs and funding sources will continue to be reevaluated.
With respect to liabilities, we will continue
to utilize a combination of FHLB advances and deposits to achieve our strategy
of minimizing cost while achieving overall interest rate risk objectives as well
as the liability management objectives of the ALCO. The FHLB funding
and the brokered CDs represent wholesale funding sources we currently
utilize. Our FHLB borrowings at December 31, 2007 decreased 2.6%, or
$11.6 million, to $440.0 million from $451.6 million at December 31, 2006
primarily as a result of an increase in deposits. At December 31,
2007, our callable brokered CDs totaled $123.4 million. During the
year ended December 31, 2007, we did not issue any brokered CDs; however, our
brokered CDs increased $9.5 million through the acquisition of Fort Worth
National Bank. The callable brokered CDs have maturities from
approximately one to four years and have calls that we control, all of which are
currently six months or less. The $9.5 million of brokered CDs
related to Fort Worth National Bank are not callable and have maturities of
approximately one year. As we integrate our funds management
processes the banks will likely issue similar structures of brokered CDs when
needed. We utilized long-term brokered CDs because the brokered CDs
better matched overall ALCO objectives by protecting Southside Bank with fixed
rates should interest rates increase, while providing Southside Bank options to
call the funding should interest rates decrease. Our wholesale
funding policy currently allows maximum brokered CDs of $150 million; however,
this amount could be increased to match changes in ALCO
objectives. The potential higher interest expense and lack of
customer loyalty are risks associated with the use of brokered
CDs. Due to the significant decrease in interest rates, including
brokered CD rates during the first quarter of 2008, we called approximately
$91.3 million of our brokered CDs. Based on current pricing, we
anticipate replacing this long-term funding with long-term FHLB
borrowings. For the year ended December 31, 2007, the large increase
in non-brokered deposits, partially associated with the Fort Worth National Bank
acquisition, and the decrease in FHLB borrowings resulted in a decrease in our
total wholesale funding as a percentage of deposits, not including brokered CDs,
from 49.6% at December 31, 2006, to 41.0% at December 31, 2007.
RESULTS OF
OPERATIONS
Our results of operations are dependent
primarily on net interest income, which is the difference between the interest
income earned on assets (loans and investments) and interest expense due on our
funding sources (deposits and borrowings) during a particular
period. Results of operations are also affected by our noninterest
income, provision for loan losses, noninterest expenses and income tax
expense. General economic and competitive conditions, particularly
changes in interest rates, changes in interest rate yield curves, prepayment
rates of mortgage-backed securities and loans, repricing of loan relationships,
government policies and actions of regulatory authorities, also significantly
affect our results of operations. Future changes in applicable law,
regulations or government policies may also have a material impact on
us.
COMPARISON OF OPERATING
RESULTS FOR THE YEARS ENDED DECEMBER 31, 2007 COMPARED TO DECEMBER 31,
2006
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 or interest rate yield curves,
as well as repricing characteristics and volume and changes in the mix of
interest earning assets and interest bearing liabilities, materially impact net
interest income.
Net interest income for the year ended December
31, 2007 was $43.9 million, an increase of $2.2 million, or 5.3%, compared to
the same period in 2006. The overall increase in net interest income
was primarily the result of increases in interest income from loans and a
decrease in interest expense on short-term and long-term obligations that was
partially offset by an increase in interest expense on deposits and a decrease
in interest income from mortgage-backed and related securities and FHLB stock
and other investments. During the year ended December 31, 2007, total
interest income increased $8.8
36
million, or 9.1%,
from $97.0 million to $105.7 million. The increase in total interest
income was the result of an increase in average interest earning assets of $40.2
million, or 2.3%, from $1.75 billion to $1.79 billion, and the increase in
average yield on average interest earning assets from 5.74% for the year ended
December 31, 2006 to 6.10% for the year ended December 31,
2007. Total interest expense increased $6.6 million, or 11.9%, to
$61.9 million during the year ended December 31, 2007 as compared to $55.3
million during the same period in 2006. The increase was attributable
to an increase in the average yield on interest bearing liabilities for the year
ended December 31, 2007, to 4.30% from 3.89% for the same period in 2006 and an
increase in average interest bearing liabilities of $20.5 million, or 1.4%, from
$1.42 billion to $1.44 billion.
Net interest income increased during 2007 as a
result of increases in our average interest earning assets during 2007 when
compared to 2006, and the increase in our net interest margin during the year
ended December 31, 2007 to 2.64%, when compared to 2.57% for the same period in
2006. The net interest spread decreased to 1.80% as compared to 1.85%
for the same period in 2006. The increase in our net interest margin
reflects the volume changes combined with the rate changes. The
decrease in our net interest spread reflects an increase in the average
short-term borrowing and long-term FHLB advances rates that exceeded the
increase in the yields on the average earning assets. Future changes
in the interest rates or yield curve could influence our net interest margin and
net interest spread during future quarters. Future changes in
interest rates could also impact prepayment speeds on our mortgage-backed
securities, which could influence our net interest margin and net interest
spread during future quarters.
During the year ended December 31, 2007,
average loans increased $87.7 million, or 12.1% from $722.3 million to $809.9
million, compared to the same period in 2006. The average yield on
loans increased from 6.70% at December 31, 2006 to 7.16% at December 31,
2007. The increase in the yield on loans was due to the increase in
credit spreads, the repricing characteristics of Southside Bank’s loan
portfolio, the higher yielding automobile portfolios purchased during the second
half of 2007 and the higher yielding Fort Worth National Bank loan portfolio
acquired October 10, 2007. Due to the competitive loan pricing
environment, we anticipate that we may be required to offer lower interest rate
loans that compete with those offered by other financial institutions in order
to retain quality loan relationships. Offering lower interest rate
loans could impact the overall loan yield and, therefore
profitability. The increase in interest income on loans of $9.5
million, or 20.4%, resulted from the increase in average loans and the average
yield on loans.
Average investment and mortgage-backed
securities decreased $40.6 million, or 4.1%, from $989.1 million to $948.5
million, for the year ended December 31, 2007 when compared to the same period
in 2006. This decrease was attributable to the deleveraging strategy
in place from June 2006 to June 2007. Southside began to releverage
the balance sheet during the second half of 2007.
The overall yield on average investment and
mortgage-backed securities increased to 5.21% during the year ended December 31,
2007 from 5.06% during the same period in 2006. Interest income on
investment and mortgage-backed securities decreased $579,000 in 2007, or 1.2%,
compared to 2006 due to the decrease in the average balances while partially
offset by the increase in overall yield. The increase in the average
yield primarily reflects higher credit and swap spreads and decreased prepayment
rates on mortgage-backed securities, which led to decreased amortization
expense, combined with the reinvestment of proceeds from lower-yielding matured
securities into higher yielding securities due to the overall higher credit and
swap spreads. An overall housing slowdown nationwide during 2007 when
compared to 2006 contributed to a decrease in residential mortgage refinancing
nationwide and in our market area. A return to a lower long-term
interest rate level similar to that experienced during 2003 could impact our net
interest margin in the future due to increased prepayments and
repricings.
37
Average FHLB stock and other investments
decreased $7.8 million, or 27.9%, to $20.2 million, for the year ended December
31, 2007, when compared to $28.0 million for 2006, primarily due to the average
decrease in FHLB advances during 2007 when compared to 2006. Interest
income from our FHLB stock and other investments decreased $216,000, or 15.3%,
during 2007, when compared to 2006, due to the decrease in average balance which
was offset by the increase in average yield from 5.04% for the year ended
December 31, 2006 compared to 5.91% for the same period in
2007. Average federal funds sold and other interest earning assets
increased $1.9 million, or 101.2%, to $3.7 million, for the year ended December
31, 2007, when compared to $1.8 million for 2006. Interest income
from federal funds sold and other interest earning assets increased $93,000, or
101.1%, for the year ended December 31, 2007, when compared to 2006, as a result
of the increase in the average balance while the average yield remained at 5.00%
for both 2006 and 2007.
During the year ended December 31, 2007,
average loans increased while average securities decreased. As a
result, the mix of our average interest earning assets reflected an increase in
average total loans as a percentage of total average interest earning assets
compared to the prior year as loans averaged 45.6% during 2007 compared to 41.6%
during 2006, a direct result of loan growth, including the acquisition of Fort
Worth National Bank and the investment in SFG. Average securities
were 54.2% of average total interest earning assets and other interest earning
asset categories averaged 0.2% for December 31, 2007. During 2006,
the comparable mix was 58.3% in securities and 0.1% in the other interest
earning asset categories.
Total interest expense increased $6.6 million,
or 11.9%, to $61.9 million during the year ended December 31, 2007 as compared
to $55.3 million during the same period in 2006. The increase was
primarily attributable to increased funding costs associated with an increase in
average interest bearing liabilities, including an increase in deposits and FHLB
advances of $20.5 million, or 1.4%, and an increase in the average yield on
interest bearing liabilities from 3.89% for 2006 to 4.30% for the year ended
December 31, 2007.
Average interest bearing deposits increased
$163.7 million, or 18.9%, from $867.3 million to $1.03 billion, and the average
rate paid increased from 3.54% for the year ended December 31, 2006 compared to
4.02% for the year ended December 31, 2007. Average time deposits
increased $97.4 million, or 20.9%, from $467.2 million to $564.6 million, and
the average rate paid increased 51 basis points. Of the average
increase in time deposits, $42.1 million was attributable to the issuance of
callable brokered CDs during 2006. Average interest bearing demand
deposits increased $64.9 million, or 18.6%, and the average rate paid increased
44 basis points. Average savings deposits increased $1.3 million, or
2.6%, and the average rate paid increased three basis
points. Interest expense for interest bearing deposits for the year
ended December 31, 2007, increased $10.8 million, or 35.1%, when compared to the
same period in 2006 due to the increase in the average balance and
yield. Average noninterest bearing demand deposits increased $14.5
million, or 4.6%, during 2007. The latter three categories, which are
considered the lowest cost deposits, comprised 58.5% of total average deposits
during the year ended December 31, 2007 compared to 60.5% during
2006. The increase in our average total deposits is the result of
overall bank growth and branch expansion and the acquisition of Fort Worth
National Bank.
During the year ended December 31, 2007, we did
not issue brokered CDs; however, our brokered CDs increased $9.5 million through
the acquisition of Fort Worth National Bank. At December 31, 2007,
$123.4 million of these brokered CDs had maturities from approximately one to
four years and had calls that we control, all of which are currently six months
or less. The $9.5 million acquired through the Fort Worth National
Bank transaction do not have calls and have a maturity of approximately one
year. At December 31, 2007, we had $132.9 million in brokered CDs
that represented 8.7% of deposits compared to $123.5 million, or 9.6% of
deposits, at December 31, 2006. During 2006, we utilized long-term
brokered CDs to a greater extent than long-term FHLB funding as the brokered CDs
better matched overall ALCO objectives due to the calls we
controlled. Our current policy allows for a maximum of $150 million
in brokered CDs. The potential higher interest cost and lack of
customer loyalty are risks associated with the use of brokered CDs.
38
The following table sets forth our deposit
averages by category for the years ended December 31, 2007, 2006 and
2005:
|
COMPOSITION
OF DEPOSITS
|
||||||||||||||||
|
Years Ended
December 31,
|
||||||||||||||||
|
2007
|
2006
|
2005
|
||||||||||||||
|
(dollars in
thousands)
|
||||||||||||||||
|
AVG
BALANCE
|
AVG
YIELD
|
AVG
BALANCE
|
AVG
YIELD
|
AVG
BALANCE
|
AVG
YIELD
|
|||||||||||
|
Noninterest
Bearing Demand Deposits
|
$
|
328,711
|
N/A
|
$
|
314,241
|
N/A
|
$
|
280,036
|
N/A
|
|||||||
|
Interest
Bearing Demand Deposits
|
414,293
|
3.17
|
%
|
349,375
|
2.73
|
%
|
313,815
|
1.74
|
%
|
|||||||
|
Savings
Deposits
|
52,106
|
1.30
|
%
|
50,764
|
1.27
|
%
|
50,502
|
1.04
|
%
|
|||||||
|
Time
Deposits
|
564,613
|
4.90
|
%
|
467,174
|
4.39
|
%
|
354,360
|
3.17
|
%
|
|||||||
|
Total
Deposits
|
$
|
1,359,723
|
3.05
|
%
|
$
|
1,181,554
|
2.60
|
%
|
$
|
998,713
|
1.72
|
%
|
||||
Average short-term interest bearing
liabilities, consisting primarily of FHLB advances and federal funds purchased
and repurchase agreements, were $278.0 million, a decrease of $98.7 million, or
26.2%, for the year ended December 31, 2007 when compared to the same period in
2006. Interest expense associated with short-term interest bearing
liabilities decreased $3.3 million, or 19.8%, while the average rate paid
increased 38 basis points to 4.77% for the year ended December 31, 2007, when
compared to 4.39% for the same period in 2006. The decrease in the
interest expense was due to a decrease in the average balance which was more
than offset the increase in the average yield for short-term interest bearing
liabilities.
Average long-term interest bearing liabilities
consisting of FHLB advances decreased $59.7 million, or 38.5%, during the year
ended December 31, 2007 to $95.3 million as compared to $155.0 million at
December 31, 2006. Interest expense associated with long-term FHLB
advances decreased $2.0 million, or 31.7%, while the average rate paid increased
45 basis points to 4.57% for the year ended December 31, 2007 when compared to
4.12% for the same period in 2006. The decrease in interest expense
was due to a decrease in the average balance of long-term interest bearing
liabilities that more than offset the increase in the average rate
paid. FHLB advances are collateralized by FHLB stock, securities and
nonspecific real estate loans.
Average long-term debt, consisting of our
junior subordinated debentures issued in 2003 and August 2007 and junior
subordinated debenture acquired in the purchase of Fort Worth Bancshares, Inc.,
was $35.8 million and $20.6 million for the years ended December 31, 2007 and
2006, respectively. During the third quarter ended September 30,
2007, we issued $36.1 million of junior subordinated debentures in connection
with the issuance of trust preferred securities by our subsidiaries Southside
Statutory Trusts IV and V. The $36.1 million in debentures were
issued to fund the purchase of Fort Worth Bancshares, Inc., which occurred on
October 10, 2007. Interest expense increased $1.1 million, or 65.7%,
to $2.8 million for the year ended December 31, 2007 when compared to $1.7
million for the same period in 2006 primarily as a result of the increase in the
average balance during 2007 when compared to 2006. The interest rate
on the $20.6 million of long-term debentures issued to Southside Statutory Trust
III adjusts quarterly at a rate equal to three-month LIBOR plus 294 basis
points. The $23.2 million of long-term debentures issued to Southside
Trust IV and the $12.9 million of long-term debentures issued to
Southside Trust V have fixed rates of 6.518% and 7.48%, respectively, for a
period of five years. The interest rate on the $3.6 million of
long-term debentures issued to Magnolia Trust Company I, assumed in the purchase
of Fort Worth Bancshares, Inc., adjusts quarterly at a rate equal to three-month
LIBOR plus 180 basis points.
39
AVERAGE BALANCES AND YIELDS
The following table presents average
balance sheet amounts and average yields for the years ended December 31, 2007,
2006 and 2005. The information should be reviewed in conjunction with
the consolidated financial statements for the same years then
ended. Two major components affecting our 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.
|
AVERAGE
BALANCES AND YIELDS
|
||||||||||||||||||||||||||||||||||||
|
(dollars in
thousands)
|
||||||||||||||||||||||||||||||||||||
|
Years
Ended
|
||||||||||||||||||||||||||||||||||||
|
December 31,
2007
|
December 31,
2006
|
December 31,
2005
|
||||||||||||||||||||||||||||||||||
|
AVG.
BALANCE
|
INTEREST
|
AVG.
YIELD
|
AVG.
BALANCE
|
INTEREST
|
AVG.
YIELD
|
AVG.
BALANCE
|
INTEREST
|
AVG.
YIELD
|
||||||||||||||||||||||||||||
|
ASSETS
|
||||||||||||||||||||||||||||||||||||
|
INTEREST
EARNING ASSETS:
|
||||||||||||||||||||||||||||||||||||
|
Loans(1)
(2)
|
$ | 809,906 | $ | 58,002 | 7.16 | % | $ | 722,252 | $ | 48,397 | 6.70 | % | $ | 657,938 | $ | 40,927 | 6.22 | % | ||||||||||||||||||
|
Loans Held
For Sale
|
3,657 | 191 | 5.22 | % | 4,651 | 246 | 5.29 | % | 4,469 | 212 | 4.74 | % | ||||||||||||||||||||||||
|
Securities:
|
||||||||||||||||||||||||||||||||||||
|
Inv.
Sec. (Taxable)(4)
|
52,171 | 2,580 | 4.95 | % | 54,171 | 2,498 | 4.61 | % | 51,431 | 1,978 | 3.85 | % | ||||||||||||||||||||||||
|
Inv.
Sec. (Tax-Exempt)(3)(4)
|
43,486 | 3,065 | 7.05 | % | 43,931 | 3,134 | 7.13 | % | 66,023 | 4,696 | 7.11 | % | ||||||||||||||||||||||||
|
Mortgage-backed and
related
Sec.(4)
|
852,880 | 43,767 | 5.13 | % | 891,015 | 44,401 | 4.98 | % | 773,973 | 34,584 | 4.47 | % | ||||||||||||||||||||||||
|
Total
Securities
|
948,537 | 49,412 | 5.21 | % | 989,117 | 50,033 | 5.06 | % | 891,427 | 41,258 | 4.63 | % | ||||||||||||||||||||||||
|
FHLB stock
and other investments, at cost
|
20,179 | 1,193 | 5.91 | % | 27,969 | 1,409 | 5.04 | % | 28,099 | 1,032 | 3.67 | % | ||||||||||||||||||||||||
|
Interest
Earning Deposits
|
769 | 41 | 5.33 | % | 692 | 35 | 5.06 | % | 644 | 24 | 3.73 | % | ||||||||||||||||||||||||
|
Federal Funds
Sold
|
2,933 | 144 | 4.91 | % | 1,148 | 57 | 4.97 | % | 995 | 30 | 3.02 | % | ||||||||||||||||||||||||
|
Total
Interest Earning Assets
|
1,785,981 | 108,983 | 6.10 | % | 1,745,829 | 100,177 | 5.74 | % | 1,583,572 | 83,483 | 5.27 | % | ||||||||||||||||||||||||
|
NONINTEREST
EARNING ASSETS:
|
||||||||||||||||||||||||||||||||||||
|
Cash and Due
From Banks
|
42,724 | 42,906 | 42,280 | |||||||||||||||||||||||||||||||||
|
Bank Premises
and Equipment
|
35,746 | 33,298 | 31,504 | |||||||||||||||||||||||||||||||||
|
Other
Assets
|
51,968 | 42,716 | 45,625 | |||||||||||||||||||||||||||||||||
|
Less: Allowance
for Loan
Loss
|
(7,697 | ) | (7,231 | ) | (6,945 | ) | ||||||||||||||||||||||||||||||
|
Total
Assets
|
$ | 1,908,722 | $ | 1,857,518 | $ | 1,696,036 | ||||||||||||||||||||||||||||||
|
(1)
|
Interest on
loans includes fees on loans that are not material in
amount.
|
|
(2)
|
Interest
income includes taxable-equivalent adjustments of $2,289, $2,230 and
$2,287 for the years ended December 31, 2007, 2006 and 2005,
respectively.
|
|
(3)
|
Interest
income includes taxable-equivalent adjustments of $953, $995 and $1,515
for the years ended December 31, 2007, 2006 and 2005,
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, 2007, 2006 and 2005, loans totaling $2,913, $1,333 and
$1,731, 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.
|
40
|
AVERAGE
BALANCES AND YIELDS
|
||||||||||||||||||||||||||||||||||||
|
(dollars in
thousands)
|
||||||||||||||||||||||||||||||||||||
|
Years
Ended
|
||||||||||||||||||||||||||||||||||||
|
December 31,
2007
|
December 31,
2006
|
December 31,
2005
|
||||||||||||||||||||||||||||||||||
|
AVG.
BALANCE
|
INTEREST
|
AVG.
YIELD
|
AVG.
BALANCE
|
INTEREST
|
AVG.
YIELD
|
AVG.
BALANCE
|
INTEREST
|
AVG.
YIELD
|
||||||||||||||||||||||||||||
|
LIABILITIES
AND
SHAREHOLDERS'
EQUITY
|
||||||||||||||||||||||||||||||||||||
|
INTEREST
BEARING
LIABILITIES:
|
||||||||||||||||||||||||||||||||||||
|
Savings
Deposits
|
$ | 52,106 | $ | 676 | 1.30 | % | $ | 50,764 | $ | 645 | 1.27 | % | $ | 50,502 | $ | 524 | 1.04 | % | ||||||||||||||||||
|
Time
Deposits
|
564,613 | 27,666 | 4.90 | % | 467,174 | 20,516 | 4.39 | % | 354,360 | 11,221 | 3.17 | % | ||||||||||||||||||||||||
|
Interest
Bearing Demand Deposits
|
414,293 | 13,116 | 3.17 | % | 349,375 | 9,529 | 2.73 | % | 313,815 | 5,476 | 1.74 | % | ||||||||||||||||||||||||
|
Total
Interest
Bearing Deposits
|
1,031,012 | 41,458 | 4.02 | % | 867,313 | 30,690 | 3.54 | % | 718,677 | 17,221 | 2.40 | % | ||||||||||||||||||||||||
|
Short-term
Interest Bearing
Liabilities
|
278,002 | 13,263 | 4.77 | % | 376,696 | 16,534 | 4.39 | % | 282,283 | 9,892 | 3.50 | % | ||||||||||||||||||||||||
|
Long-term
Interest Bearing Liabilities - FHLB
|
95,268 | 4,357 | 4.57 | % | 154,983 | 6,379 | 4.12 | % | 274,673 | 10,004 | 3.64 | % | ||||||||||||||||||||||||
|
Long-term
Debt (5)
|
35,802 | 2,785 | 7.78 | % | 20,619 | 1,681 | 8.04 | % | 20,619 | 1,305 | 6.24 | % | ||||||||||||||||||||||||
|
Total
Interest Bearing Liabilities
|
1,440,084 | 61,863 | 4.30 | % | 1,419,611 | 55,284 | 3.89 | % | 1,296,252 | 38,422 | 2.96 | % | ||||||||||||||||||||||||
|
NONINTEREST
BEARING LIABILITIES:
|
||||||||||||||||||||||||||||||||||||
|
Demand
Deposits
|
328,711 | 314,241 | 280,036 | |||||||||||||||||||||||||||||||||
|
Other
Liabilities
|
20,997 | 12,403 | 14,649 | |||||||||||||||||||||||||||||||||
|
Total
Liabilities
|
1,789,792 | 1,746,255 | 1,590,937 | |||||||||||||||||||||||||||||||||
|
Minority
Interest in SFG
|
151 | – | – | |||||||||||||||||||||||||||||||||
|
SHAREHOLDERS'
EQUITY
|
118,779 | 111,263 | 105,099 | |||||||||||||||||||||||||||||||||
|
TOTAL
LIABILITIES AND
SHAREHOLDERS'
EQUITY
|
$ | 1,908,722 | $ | 1,857,518 | $ | 1,696,036 | ||||||||||||||||||||||||||||||
|
NET INTEREST
INCOME
|
$ | 47,120 | $ | 44,893 | $ | 45,061 | ||||||||||||||||||||||||||||||
|
NET YIELD ON
AVERAGE
EARNING
ASSETS
|
2.64 | % | 2.57 | % | 2.85 | % | ||||||||||||||||||||||||||||||
|
NET INTEREST
SPREAD
|
1.80 | % | 1.85 | % | 2.31 | % | ||||||||||||||||||||||||||||||
|
(5)
|
Represents
junior subordinated debentures issued by us to Southside Statutory Trust
III, IV and V in connection with the issuance by Southside Statutory Trust
III of $20 million of trust preferred securities, Southside Statutory
Trust IV of $22.5 million of trust preferred securities on August 8, 2007
and Southside Statutory Trust V of $12.5 million of Trust Preferred
Securities on August 10, 2007 and junior subordinated debentures issued by
Fort Worth Bancshares, Inc. to Magnolia Trust Company I in connection with
the issuance by Magnolia Trust Company I of $3.5 million of trust
preferred securities, which we assumed on October 10,
2007.
|
41
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):
|
Years Ended
December 31,
|
||||||||||||
|
2007 Compared
to 2006
|
||||||||||||
|
Average
|
Average
|
Increase
|
||||||||||
|
Volume
|
Yield
|
(Decrease)
|
||||||||||
|
INTEREST
INCOME:
|
||||||||||||
|
Loans
(1)
|
$
|
6,131
|
$
|
3,474
|
$
|
9,605
|
||||||
|
Loans Held
For
Sale
|
(52
|
)
|
(3
|
)
|
(55
|
)
|
||||||
|
Investment
Securities (Taxable)
|
(85
|
)
|
167
|
82
|
||||||||
|
Investment
Securities (Tax Exempt) (1)
|
(32
|
)
|
(37
|
)
|
(69
|
)
|
||||||
|
Mortgage-backed
Securities
|
(1,934
|
)
|
1,300
|
(634
|
)
|
|||||||
|
FHLB stock
and other investments
|
(434
|
)
|
218
|
(216
|
)
|
|||||||
|
Interest
Earning
Deposits
|
4
|
2
|
6
|
|||||||||
|
Federal Funds
Sold
|
88
|
(1
|
)
|
87
|
||||||||
|
Total
Interest
Income
|
3,686
|
5,120
|
8,806
|
|||||||||
|
INTEREST
EXPENSE:
|
||||||||||||
|
Savings
Deposits
|
17
|
14
|
31
|
|||||||||
|
Time
Deposits
|
4,598
|
2,552
|
7,150
|
|||||||||
|
Interest
Bearing Demand Deposits
|
1,923
|
1,664
|
3,587
|
|||||||||
|
Short-term
Interest Bearing Liabilities
|
(4,615
|
)
|
1,344
|
(3,271
|
)
|
|||||||
|
Long-term
FHLB
Advances
|
(2,670
|
)
|
648
|
(2,022
|
)
|
|||||||
|
Long-term
Debt
|
1,184
|
(80
|
)
|
1,104
|
||||||||
|
Total
Interest
Expense
|
437
|
6,142
|
6,579
|
|||||||||
|
Net Interest
Income
|
$
|
3,249
|
$
|
(1,022
|
)
|
$
|
2,227
|
|||||
|
Years Ended
December 31,
|
||||||||||||
|
2006 Compared
to 2005
|
||||||||||||
|
Average
|
Average
|
Increase
|
||||||||||
|
Volume
|
Yield
|
(Decrease)
|
||||||||||
|
INTEREST
INCOME:
|
||||||||||||
|
Loans
(1)
|
$
|
4,173
|
$
|
3,297
|
$
|
7,470
|
||||||
|
Loans Held
For
Sale
|
9
|
25
|
34
|
|||||||||
|
Investment
Securities (Taxable)
|
110
|
410
|
520
|
|||||||||
|
Investment
Securities (Tax Exempt) (1)
|
(1,576
|
)
|
14
|
(1,562
|
)
|
|||||||
|
Mortgage-backed
Securities
|
5,572
|
4,245
|
9,817
|
|||||||||
|
FHLB stock
and other investments
|
(5
|
)
|
382
|
377
|
||||||||
|
Interest
Earning
Deposits
|
2
|
9
|
11
|
|||||||||
|
Federal Funds
Sold
|
5
|
22
|
27
|
|||||||||
|
Total
Interest
Income
|
8,290
|
8,404
|
16,694
|
|||||||||
|
INTEREST
EXPENSE:
|
||||||||||||
|
Savings
Deposits
|
3
|
118
|
121
|
|||||||||
|
Time
Deposits
|
4,196
|
5,099
|
9,295
|
|||||||||
|
Interest
Bearing Demand Deposits
|
679
|
3,374
|
4,053
|
|||||||||
|
Short-term
Interest Bearing Liabilities
|
3,785
|
2,857
|
6,642
|
|||||||||
|
Long-term
FHLB
Advances
|
(4,796
|
)
|
1,171
|
(3,625
|
)
|
|||||||
|
Long-term
Debt
|
–
|
376
|
376
|
|||||||||
|
Total
Interest
Expense
|
3,867
|
12,995
|
16,862
|
|||||||||
|
Net Interest
Income
|
$
|
4,423
|
$
|
(4,591
|
)
|
$
|
(168
|
)
|
||||
|
(1)
|
Interest
yields on loans and securities that 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.
42
PROVISION FOR LOAN LOSSES
The provision for loan losses for the year
ended December 31, 2007 was $2.4 million compared to $1.1 million for December
31, 2006. Approximately $933,000 of this increase is related to the
loans that were purchased by SFG during 2007. Approximately $152,000
of this increase is provision expense of Fort Worth National
Bank. For the year ended December 31, 2007, net charge-offs of loans
decreased $277,000, or 28.4%, to $700,000 when compared to $977,000 for the same
period in 2006.
The decrease in net charge-offs for 2007 was
due to a combination of an increase in total recoveries of $52,000 and a
decrease in total charge-offs of $225,000. Net charge-offs for
commercial loans decreased $161,000 from 2006 primarily as a result of an
overall decrease in charge-offs and increase in recoveries. Net
charge-offs for loans to individuals decreased $46,000 during 2007 due to an
overall increase in recoveries and decrease in charge-offs when compared to
2006.
As of December 31, 2007, our review of the loan
portfolio indicated that a loan loss allowance of $9.8 million was 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, 2007 and the comparable year ended December 31, 2006 and
indicates the percentage changes:
|
Years
Ended
|
||||||||||||
| December 31, |
Percent
|
|||||||||||
|
2007
|
2006
|
Change
|
||||||||||
|
(dollars in
thousands)
|
||||||||||||
|
Deposit
services
|
$ | 17,280 | $ | 15,482 | 11.6 | % | ||||||
|
Gain on
securities available for
sale
|
897 | 743 | 20.7 | % | ||||||||
|
Gain on sale
of
loans
|
1,922 | 1,817 | 5.8 | % | ||||||||
|
Trust
income
|
2,106 | 1,711 | 23.1 | % | ||||||||
|
Bank owned
life insurance
income
|
1,142 | 1,067 | 7.0 | % | ||||||||
|
Other
|
3,071 | 2,661 | 15.4 | % | ||||||||
|
Total
noninterest
income
|
$ | 26,418 | $ | 23,481 | 12.5 | % | ||||||
Total noninterest income for the year ended
December 31, 2007 increased 12.5%, or $2.9 million, compared to
2006. During the year ended December 31, 2007, we had a gain on AFS
securities of $897,000 compared to $743,000 for the same period in
2006. The market value of the AFS securities portfolio at December
31, 2007 was $837.5 million with a net unrealized gain on that date of $5.9
million. The net unrealized gain is comprised of $8.7 million in
unrealized gains and $2.8 million in unrealized losses. We sold
securities out of our AFS portfolio to accomplish ALCO and investment portfolio
objectives aimed at repositioning a portion of the securities portfolio in an
attempt to maximize the total return of the securities portfolio and reduce
alternative minimum tax. During 2007, we primarily sold selected
mortgage-backed securities where the risk reward profile had
changed. We recorded an impairment charge of $58,000 on $4.8 million
of whole loan collateralized mortgage obligations ("CMOs") at December 31,
2007. After the sale of these CMOs during January 2008, all of our
remaining mortgage-backed securities are agency mortgage-backed securities
("MBSs").
Deposit services income increased $1.8 million,
or 11.6%, for the year ended December 31, 2007, when compared to the same period
in 2006, primarily as a result of increases in overdraft income, an increase in
the number of deposit accounts and an increase in debit card
income.
43
Trust income increased $395,000, or 23.1%, for
the year ended December 31, 2007, when compared to the same period in 2006 due
to growth experienced in our trust department.