SOUTHWEST BANCORP OF TEXAS INC - 10-Q Quarterly Report

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the Quarter Ended June 30, 2003

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

Commission file number: 000-22007

Southwest Bancorporation of Texas, Inc.

(Exact Name of Registrant as Specified in its Charter)


Texas (State or Other Jurisdiction of Incorporation or Organization)		76-0519693 (I.R.S. Employer Identification No.)

4400 Post Oak Parkway

Houston, Texas 77027

(Address of Principal Executive Offices, including zip code)

(713) 235-8800

(Registrant’s telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ No o

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act.) Yes þ No o

There were 34,116,926 shares of the Registrant’s Common Stock outstanding as of the close of business on July 31, 2003.

SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES

INDEX TO FORM 10-Q


		Page

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
	Report of Independent Accountants		2
	Condensed Consolidated Balance Sheet as of June 30, 2003 and December 31, 2002 (unaudited)		3
	Condensed Consolidated Statement of Income for the Three and Six Months Ended June 30, 2003 and 2002 (unaudited)		4
	Condensed Consolidated Statement of Changes in Shareholders’ Equity for the Six Months Ended June 30, 2003 (unaudited)		5
	Condensed Consolidated Statement of Cash Flows for the Six Months Ended June 30, 2003 and 2002 (unaudited)		6
	Notes to Condensed Consolidated Financial Statements (unaudited)		7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			12
Item 3. Quantitative and Qualitative Disclosures about Market Risk			32
Item 4. Controls and Procedures			32
PART II. OTHER INFORMATION
Item 1. Legal Proceedings			33
Item 2. Changes in Securities and Use of Proceeds			33
Item 3. Defaults upon Senior Securities			33
Item 4. Submission of Matters to a Vote of Security Holders			33
Item 5. Other Information			33
Item 6. Exhibits and Reports on Form 8-K			33
Signatures			35

PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Shareholders

Southwest Bancorporation of Texas, Inc.:

We have reviewed the accompanying condensed consolidated balance sheet of Southwest Bancorporation of Texas, Inc. and Subsidiaries (the “Company”) as of June 30, 2003, the related condensed consolidated statement of income for the three-month and six-month periods ended June 30, 2003 and 2002, the condensed consolidated statement of changes in shareholders’ equity for the six-month period ended June 30, 2003, and the condensed consolidated statement of cash flows for the six-month periods ended June 30, 2003 and 2002. These interim financial statements are the responsibility of the Company’s management.

We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with generally accepted auditing standards, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our review, we are not aware of any material modifications that should be made to the accompanying condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

We previously audited, in accordance with auditing standards generally accepted in the United States of America, the consolidated balance sheet as of December 31, 2002, and the related consolidated statements of income, of changes in shareholders’ equity, and of cash flows for the year then ended (not presented herein), and in our report dated February 28, 2003, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet information as of December 31, 2002 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

/s/ PricewaterhouseCoopers LLP

Houston, Texas

July 31, 2003

SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEET

(unaudited)


			June 30,			December 31,
			2003			2002


			(Dollars in thousands, except
			per share amounts)
ASSETS
Cash and due from banks			$	270,711		$	472,257
Federal funds sold and other cash equivalents				274,117			63,107

		Total cash and cash equivalents		544,828			535,364
Securities available for sale				1,303,613			1,201,200
Loans held for sale				91,757			101,389
Loans held for investment				3,277,684			3,117,951
Allowance for loan losses				(38,723	)		(36,696	)
Premises and equipment, net				97,402			92,227
Accrued interest receivable				19,131			20,160
Other assets				146,440			140,362

		Total assets	$	5,442,132		$	5,171,957

LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits:
	Demand — noninterest-bearing		$	1,343,749		$	1,290,323
	Demand — interest-bearing			31,479			36,222
	Money market accounts			1,659,319			1,618,417
	Savings			107,499			97,119
	Time, $100 and over			662,329			518,108
	Other time			335,078			351,860

		Total deposits		4,139,453			3,912,049
Securities sold under repurchase agreements				235,557			275,443
Other borrowings				554,436			515,430
Accrued interest payable				1,322			1,654
Other liabilities				31,448			21,858

		Total liabilities		4,962,216			4,726,434

Commitments and contingencies
Shareholders’ equity:
	Common stock — $1 par value, 150,000,000 shares authorized; 34,059,928 issued and 34,057,022 outstanding at June 30, 2003; 33,856,065 issued and outstanding at December 31, 2002			34,060			33,856
	Additional paid-in capital			90,704			87,651
	Retained earnings			341,795			310,758
	Accumulated other comprehensive income			13,360			13,258
	Treasury stock, at cost — 2,906 shares and 0 shares, respectively			(3	)		—

		Total shareholders’ equity		479,916			445,523

		Total liabilities and shareholders’ equity	$	5,442,132		$	5,171,957

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

SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF INCOME

(unaudited)



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

			2003		2002		2003		2002


			(Dollars in thousands, except per share amounts)
Interest income:
	Loans		$	46,988	$	44,767	$	92,143	$	88,149
	Securities			11,489		14,629		23,440		29,008
	Federal funds sold and other			284		186		491		377

		Total interest income		58,761		59,582		116,074		117,534

Interest expense:
	Deposits			9,535		12,174		19,641		24,867
	Borrowings			2,050		2,503		4,176		5,300

		Total interest expense		11,585		14,677		23,817		30,167

		Net interest income		47,176		44,905		92,257		87,367
Provision for loan losses				3,000		3,250		6,000		5,750

		Net interest income after provision for loan losses		44,176		41,655		86,257		81,617

Noninterest income:
	Service charges on deposit accounts			10,389		9,466		20,915		18,159
	Investment services			2,430		2,395		4,725		4,812
	Other fee income			2,886		3,089		5,624		5,969
	Other operating income			2,113		1,716		4,671		3,342
	Gain on sale of loans, net			1,146		1,008		2,246		1,586
	Gain on sale of securities, net			1,115		1		1,150		2

		Total noninterest income		20,079		17,675		39,331		33,870

Noninterest expenses:
	Salaries and employee benefits			24,076		21,487		47,902		42,460
	Occupancy expense			6,885		5,631		13,384		11,116
	Professional expense			2,147		2,238		4,214		4,056
	Other operating expenses			8,055		7,871		15,174		15,794
	Minority interest			—		24		—		49

		Total noninterest expenses		41,163		37,251		80,674		73,475

		Income before income taxes		23,092		22,079		44,914		42,012
Provision for income taxes				7,129		6,897		13,877		13,285

		Net income	$	15,963	$	15,182	$	31,037	$	28,727

Earnings per common share:
		Basic	$	0.47	$	0.46	$	0.92	$	0.87

		Diluted	$	0.46	$	0.44	$	0.90	$	0.84

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

SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

(unaudited)


												Accumulated
			Common Stock				Additional					Other						Total
							Paid-in			Retained		Comprehensive			Treasury			Shareholders’
			Shares		Dollars		Capital			Earnings		Income			Stock			Equity

BALANCE, DECEMBER 31, 2002				33,856,065	$	33,856	$	87,651		$	310,758	$	13,258		$	—		$	445,523
	Exercise of stock options			150,363		150		2,460											2,610
	Issuance of restricted common stock, net of shares forfeited into Treasury stock			53,500		54		(51	)							(3	)		—
	Deferred compensation amortization							644											644
	Comprehensive income:
		Net income for the six months ended June 30, 2003									31,037								31,037
		Net change in unrealized appreciation on securities available for sale, net of deferred taxes of $996											1,846						1,846
		Reclassification adjustment for gains included in net income, net of deferred taxes of ($940)											(1,744	)					(1,744	)

		Total comprehensive income																	31,139

BALANCE, JUNE 30, 2003				34,059,928	$	34,060	$	90,704		$	341,795	$	13,360		($	3	)	$	479,916

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

SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS

(unaudited)



				Six Months
				Ended June 30,

				2003			2002


				(Dollars in thousands)
Cash flows from operating activities:
	Net income			$	31,037		$	28,727
	Adjustments to reconcile net income to net cash provided by operating activities:
		Provision for loan losses			6,000			5,750
		Depreciation			5,460			4,308
		Provision for mortgage servicing rights in excess of fair value			234			—
		Realized gain on securities available for sale, net			(1,150	)		(2	)
		Amortization and accretion of securities’ premiums and discounts, net			5,118			1,740
		Amortization of mortgage servicing rights			2,594			1,671
		Amortization of computer software			2,203			1,722
		Other amortization			644			163
		Minority interest in net income of consolidated subsidiary			—			49
		Gain on sale of loans, net			(2,246	)		(1,586	)
		Origination of loans held for sale			(108,125	)		(78,172	)
		Proceeds from sales of loans			118,976			95,087
		Income tax benefit from exercise of stock options			864			4,604
		(Increase) decrease in accrued interest receivable, prepaid expenses and other assets			(3,170	)		24,812
		Increase in accrued interest payable and other liabilities			9,258			207
		Other, net			(11	)		245

			Net cash provided by operating activities		67,686			89,325

Cash flows from investing activities:
	Proceeds from maturity and call of securities available for sale				44,174			20,117
	Proceeds from sale of securities available for sale				212,700			—
	Principal paydowns of mortgage-backed securities available for sale				277,537			175,885
	Purchase of securities available for sale				(640,297	)		(270,174	)
	Purchase of Federal Reserve Bank stock				—			(118	)
	Proceeds from redemption of Federal Home Loan Bank stock				—			5,699
	Purchase of Federal Home Loan Bank stock				(339	)		(12,630	)
	Net increase in loans held for investment				(167,081	)		(145,722	)
	Proceeds from sale of premises and equipment				36			801
	Purchase of premises and equipment				(12,863	)		(34,461	)
	Purchase of mortgage servicing rights				(249	)		(423	)
	Other, net				(110	)		—

			Net cash used in investing activities		(286,492	)		(261,026	)

Cash flows from financing activities:
	Net increase in noninterest-bearing demand deposits				53,426			54,375
	Net increase in time deposits				127,439			72,743
	Net increase in other interest-bearing deposits				46,539			27,731
	Net decrease in securities sold under repurchase agreements				(39,886	)		(90,549	)
	Net increase (decrease) in other short-term borrowings				(60,802	)		34,215
	Proceeds from long-term borrowings				100,000			—
	Payments on long-term borrowings				(192	)		(177	)
	Net proceeds from exercise of stock options				1,746			5,663

			Net cash provided by financing activities		228,270			104,001

Net increase (decrease) in cash and cash equivalents					9,464			(67,700	)
Cash and cash equivalents at beginning of period					535,364			345,456

Cash and cash equivalents at end of period				$	544,828		$	277,756

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

SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(Unaudited)

1. Basis of Presentation

The unaudited condensed consolidated financial statements include the accounts of Southwest Bancorporation of Texas, Inc. (the “Company”) and its direct and indirect wholly-owned subsidiaries. The 2002 consolidated financial statements also include the accounts of First National Bank of Bay City, a 58% owned subsidiary of the Company, through November 1, 2002. On this date, the Company sold its interest in this subsidiary. All material intercompany accounts and transactions have been eliminated. In the opinion of management, the unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal and recurring adjustments, necessary for a fair presentation of the Company’s consolidated financial position at June 30, 2003 and December 31, 2002, consolidated net income for the three and six months ended June 30, 2003 and 2002, consolidated cash flows for the six months ended June 30, 2003 and 2002, and consolidated changes in shareholders’ equity for the six months ended June 30, 2003. Interim period results are not necessarily indicative of results of operations or cash flows for a full-year period.

These financial statements and the notes thereto should be read in conjunction with the Company’s annual report on Form 10-K for the year ended December 31, 2002.

New Accounting Pronouncements

On January 17, 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 46 (“FIN No. 46”) Consolidation of Variable Interest Entities, which addresses consolidation by business enterprises of variable interest entities. FIN No. 46 clarifies the application of Accounting Research Bulletin No. 51 (“ARB No. 51”), Consolidated Financial Statements, to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN No. 46 applies immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies in the first fiscal year or interim period beginning after June 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. The Company does not expect the requirements of FIN No. 46 to have a material impact on its financial condition or results of operations.

Reclassifications

Certain previously reported amounts have been reclassified to conform to the 2003 financial statement presentation. These reclassifications had no effect on net income or stockholders’ equity.


	Stock-Based Compensation

The Company applies the intrinsic value method of accounting for its stock-based compensation plans in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, (“APB 25”). In 1995, the FASB issued SFAS No. 123, Accounting for Stock-Based Compensation, (“SFAS No. 123”) as amended by SFAS No. 148, which requires pro forma disclosures of net income, stock-based employee compensation cost, and earnings per share for companies not adopting its fair value accounting method for stock-based employee compensation.

SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

The pro forma disclosures below use the fair value method of SFAS No. 123 to measure compensation expense for stock-based compensation plans.



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

		2003		2002		2003		2002

Net income
	As reported	$	15,963	$	15,182	$	31,037	$	28,727
	Pro forma	$	15,430	$	14,658	$	29,762	$	27,430
Stock-based compensation cost, net of income taxes
	As reported	$	237	$	56	$	445	$	112
	Pro forma	$	770	$	580	$	1,720	$	1,409
Basic earnings per common share
	As reported	$	0.47	$	0.46	$	0.92	$	0.87
	Pro forma	$	0.45	$	0.44	$	0.88	$	0.83
Diluted earnings per common share
	As reported	$	0.46	$	0.44	$	0.90	$	0.84
	Pro forma	$	0.44	$	0.43	$	0.86	$	0.80

The effect of applying SFAS No. 123 in the above pro forma disclosure are not indicative of future amounts. The Company anticipates making awards in the future under its stock-based compensation plans.


2.	Comprehensive Income

Comprehensive income consists of the following:



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

	2003			2002		2003			2002

Net income	$	15,963		$	15,182	$	31,037		$	28,727
Net change in unrealized appreciation on securities available for sale, net of tax		2,400			12,430		1,846			9,616
Reclassification adjustment for gains included in net income, net of tax		(1,704	)		—		(1,744	)		—

Total comprehensive income	$	16,659		$	27,612	$	31,139		$	38,343


3.	Mortgage Servicing Rights

The Company originates residential and commercial mortgage loans both for its own portfolio and to sell to investors with servicing rights retained through its ownership of Mitchell Mortgage Company, LLC. (“Mitchell”). Mitchell also purchases mortgage servicing rights. Mitchell is an approved seller/servicer for Federal National Mortgage Association (“FNMA”) and Federal Home Loan Mortgage Corporation (“FHLMC”) and an approved issuer of Government National Mortgage Association (“GNMA”) mortgage-backed securities.

The Company periodically evaluates the carrying value of its mortgage servicing rights in relation to the present value of the estimated future net servicing revenue based on management’s best estimate of remaining loan lives. Any excess carrying value would be recorded as a valuation allowance with the provision recorded as a component of other fee income in the accompanying statement of income.

SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

The following table summarizes the changes in capitalized mortgage servicing rights for the periods indicated:


		Six Months
		Ended			Year Ended
		June 30,			December 31,
		2003			2002

Balance, beginning of period		$	10,628		$	12,008
	Originations		1,027			1,996
	Purchases		249			804
	Scheduled amortization		(401	)		(1,176	)
	Payoff amortization		(2,193	)		(3,004	)

Balance before valuation allowance			9,310			10,628
	Less: Valuation allowance		(2,605	)		(2,371	)

Balance, end of period		$	6,705		$	8,257

Loans serviced for others totaled $978,729 at June 30, 2003 and $1,068,000 at December 31, 2002. Capitalized mortgage servicing rights represent 69 basis points and 77 basis points of the portfolio serviced at June 30, 2003 and December 31, 2002, respectively.

4. Earnings Per Common Share

Earnings per common share is computed as follows:



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

		2003		2002		2003		2002

Net income		$	15,963	$	15,182	$	31,037	$	28,727

Divided by average common shares and common share equivalents:
	Average common shares		33,965		33,345		33,877		33,152
	Average common shares issuable under the stock option plan		764		1,067		763		1,096

	Total average common shares and common share equivalents		34,729		34,412		34,640		34,248

Basic earnings per common share		$	0.47	$	0.46	$	0.92	$	0.87

Diluted earnings per common share		$	0.46	$	0.44	$	0.90	$	0.84

Stock options outstanding of 207 and 87 for the three months ended June 30, 2003 and 2002, respectively, and 508 and 103 for the six months ended June 30, 2003 and 2002, respectively, have not been included in diluted earnings per share because to do so would have been antidilutive for the periods presented. Stock options are antidilutive when the exercise price is higher than the current market price of the Company’s common stock.

5. Segment Information

The Company has two operating segments: the bank and the mortgage company. Each segment is managed separately because each business requires different marketing strategies and each offers different products and services.

SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

The Company evaluates each segment’s performance based on the revenue and expenses from its operations. Intersegment financing arrangements are accounted for at current market rates as if they were with third parties.

Summarized financial information by operating segment for the three and six months ended June 30, 2003 and 2002 follows:



	Three Months Ended June 30,


	2003									2002

	Bank		Mortgage		Eliminations			Consolidated		Bank		Mortgage		Eliminations			Consolidated

Interest income	$	56,261	$	3,904	$	(1,404	)	$	58,761	$	57,229	$	3,982	$	(1,629	)	$	59,582
Interest expense		11,585		1,404		(1,404	)		11,585		14,677		1,629		(1,629	)		14,677

Net interest income		44,676		2,500		—			47,176		42,552		2,353		—			44,905
Provision for loan losses		2,686		314		—			3,000		3,168		82		—			3,250
Noninterest income		18,505		1,574		—			20,079		16,041		1,634		—			17,675
Noninterest expense		38,494		2,669		—			41,163		34,909		2,342		—			37,251

Income before income taxes	$	22,001	$	1,091	$	—		$	23,092	$	20,516	$	1,563	$	—		$	22,079



	Six Months Ended June 30,


	2003									2002

	Bank		Mortgage		Eliminations			Consolidated		Bank		Mortgage		Eliminations			Consolidated

Interest income	$	111,099	$	7,803	$	(2,828	)	$	116,074	$	112,633	$	8,102	$	(3,201	)	$	117,534
Interest expense		23,817		2,828		(2,828	)		23,817		30,167		3,201		(3,201	)		30,167

Net interest income		87,282		4,975		—			92,257		82,466		4,901		—			87,367
Provision for loan losses		5,604		396		—			6,000		5,586		164		—			5,750
Noninterest income		36,008		3,323		—			39,331		30,898		2,972		—			33,870
Noninterest expense		75,416		5,258		—			80,674		68,848		4,627		—			73,475

Income before income taxes	$	42,270	$	2,644	$	—		$	44,914	$	38,930	$	3,082	$	—		$	42,012

Total assets	$	5,413,743	$	297,093	$	(268,704	)	$	5,442,132	$	4,524,452	$	259,379	$	(235,304	)	$	4,548,527

Intersegment interest was paid to the bank by the mortgage company in the amount of $1,404 and $1,629 for the three months ended June 30, 2003 and 2002, respectively. For the six months ended June 30, 2003 and 2002, intersegment interest was $2,828 and $3,201, respectively. Advances from the bank to the mortgage company of $268,704 and $235,304 were eliminated in consolidation at June 30, 2003 and 2002, respectively.


6.	Off-Balance Sheet Credit Commitments

In the normal course of business, the Company enters into various transactions, which, in accordance with generally accepted accounting principles, are not included in its consolidated balance sheet. These transactions are referred to as “off-balance sheet commitments.” The Company enters into these transactions to meet the financing needs of its customers. These transactions include commitments to extend credit and standby letters of credit, which involve elements of credit risk in excess of the amounts recognized in the consolidated balance sheet. The Company minimizes its exposure to loss under these commitments by subjecting them to credit approval and monitoring procedures.

SOUTHWEST BANCORPORATION OF TEXAS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

are contingent upon customers maintaining specific credit standards at the time of loan funding. Management assesses the credit risk associated with certain commitments to extend credit in determining the level of the allowance for loan losses. Commitments to extend credit totaled $1,672,593 at June 30, 2003 and $1,644,722 at December 31, 2002.

Standby letters of credit are written conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The Company’s policies generally require that standby letters of credit arrangements contain collateral and debt covenants similar to those contained in loan agreements. In the event the customer does not perform in accordance with the terms of the agreement with the third party, the Company would be required to fund the commitment. The maximum potential amount of future payments the Company could be required to make is represented by the contractual amount of the commitment. If the commitment is funded, the Company would be entitled to seek recovery from the customer. Standby letters of credit totaled $208,084 at June 30, 2003 and $167,771 at December 31, 2002. As of June 30, 2003 and December 31, 2002, $228 and $139, respectively, has been recorded as a liability for the fair value of the Company’s potential obligations under these guarantees which represents the unamortized portion of the fee collected. Management believes this amount to be the fair value of the guarantees.


7.	Merger Related Activity

On July 1, 2003, the Company completed its merger with Maxim Financial Holdings, Inc. (“Maxim”), whereby Maxim merged into the Company. Maxim is the parent company of MaximBank located in Galveston County, Texas. The merger was an all-cash transaction valued at $63,000. At June 30, 2003, MaximBank had total assets of approximately $312,400 and total deposits of approximately $241,200. The operational merger is expected to be completed in the third quarter of 2003.

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

SPECIAL CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS

Certain of the matters discussed in this document and in documents incorporated by reference herein, including matters discussed under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” may constitute forward-looking statements for purposes of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, and as such may involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of the Company to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. The words “expect,” ‘’anticipate,” “intend,” “plan,” “believe,” “seek,” “estimate,” and similar expressions are intended to identify such forward-looking statements. The Company’s actual results may differ materially from the results anticipated in these forward-looking statements due to a variety of factors, including, without limitation: (a) the effects of future economic conditions on the Company and its customers; (b) governmental monetary and fiscal policies, as well as legislative and regulatory changes; (c) the risks of changes in interest rates on the level and composition of deposits, loan demand, and the values of loan collateral, securities and interest rate protection agreements, as well as interest rate risks; (d) the effects of competition from other commercial banks, thrifts, mortgage banking firms, consumer finance companies, credit unions, securities brokerage firms, insurance companies, money market and other mutual funds and other financial institutions operating in the Company’s market area and elsewhere, including institutions operating locally, regionally, nationally and internationally, together with such competitors offering banking products and services by mail, telephone, computer and the internet; and (e) the failure of assumptions underlying the establishment of reserves for loan losses and estimations of values of collateral and various financial assets and liabilities. All written or oral forward-looking statements attributable to the Company are expressly qualified in their entirety by these cautionary statements.

Overview

Total assets at June 30, 2003 and December 31, 2002 were $5.44 billion and $5.17 billion, respectively. Gross loans were $3.37 billion at June 30, 2003, an increase of $150.1 million, or 5%, from $3.22 billion at December 31, 2002. Shareholders’ equity was $479.9 million and $445.5 million at June 30, 2003 and December 31, 2002, respectively.

For the three months ended June 30, 2003, net income was $16.0 million ($0.46 per diluted share) compared to $15.2 million ($0.44 per diluted share) for the same period in 2002, an increase of 5%. For the six months ended June 30, 2003, net income was $31.0 million ($0.90 per diluted share) compared to $28.7 million ($0.84 per diluted share) for the same period in 2002, an increase of 8%. Return on average assets and average common shareholders’ equity for the three months ended June 30, 2003 was 1.25% and 13.60%, respectively, as compared to 1.39% and 15.60% for the three months ended June 30, 2002. For the six months ended June 30, 2003, return on average assets and return on average common shareholders’ equity was 1.24% and 13.54%, respectively, as compared to 1.33% and 15.20% for the six months ended June 30, 2002. Return on average assets is calculated by dividing annualized net income by the daily average of total assets. Return on average common shareholders’ equity is calculated by dividing annualized net income by the daily average of common shareholders’ equity.

Results of Operations

Interest Income

Interest income for the three months ended June 30, 2003 was $58.8 million, a decrease of $821,000, or 1%, from the three months ended June 30, 2002. This decrease in interest income is due to a decrease in the average yield on interest-earning assets to 5.10% for the three months ended June 30, 2003, a decrease of 91 basis points when compared to the same period in 2002. This decrease is partially offset by a $645.0 million increase in average interest-earning assets to $4.62 billion for the three months ended June 30, 2003, a 16% increase from the same period last year. For the six months ended June 30, 2003, interest income was

$116.1 million, a decrease of $1.5 million, or 1%, from the same period a year ago. This decrease in interest income is due to a decrease in the average yield on interest-earning assets to 5.16% for the six months ended June 30, 2003, a decrease of 86 basis points when compared to the same period in 2002. This decrease is partially offset by a $601.8 million increase in average interest-earning assets to $4.54 billion for the six months ended June 30, 2003, a 15% increase from the same period last year.

Interest income on securities decreased $3.1 million to $11.5 million for the three months ended June 30, 2003. This decrease was due to a 162 basis point decrease in the average yield on securities to 3.77% for the three months ended June 30, 2003, compared to 5.39% for the same period last year. This decrease is partially offset by a $133.2 million increase in average securities outstanding to $1.22 billion for the three months ended June 30, 2003, a 12% increase from the same period a year ago.

For the six months ended June 30, 2003, interest income on securities was $23.4 million, a decrease of $5.6 million, or 19%, from the same period a year ago. This decrease was due to a 144 basis point decrease in the average yield on securities to 3.97% for the six months ended June 30, 2003, compared to 5.41% for the same period last year. This decrease is partially offset by a $108.5 million increase in average securities outstanding to $1.19 billion for the six months ended June 30, 2003, an increase of 10% from the same period a year ago.

Interest income on loans increased $2.2 million to $47.0 million for the three months ended June 30, 2003. This increase was due to a $463.2 million increase in average loans outstanding to $3.30 billion for the three months ended June 30, 2003, a 16% increase from the same period a year ago. This increase is partially offset by a 62 basis point decrease in the average yield on loans to 5.70% for the three months ended June 30, 2003, compared to 6.32% for the same period last year.

For the six months ended June 30, 2003, interest income on loans was $92.1 million, an increase of $4.0 million, or 5%, from the same period a year ago. This increase was due to a $456.0 million increase in average loans outstanding to $3.26 billion for the six months ended June 30, 2003, a 16% increase from the same period a year ago. This increase is partially offset by a 64 basis point decrease in the average yield on loans to 5.69% for the six months ended June 30, 2003, compared to 6.33% for the same period last year.

Interest Expense

Interest expense on deposits and borrowings for the three months ended June 30, 2003 was $11.6 million, a decrease of $3.1 million, or 21%, from the three months ended June 30, 2002. This decrease in interest expense was attributable to a decrease in the average rate on interest-bearing liabilities to 1.37% for the three months ended June 30, 2003, a decrease of 59 basis points when compared to the same period in 2002. This decrease is partially offset by a $405.6 million increase in average interest-bearing liabilities to $3.40 billion for the three months ended June 30, 2003, an increase of 14% from the same period last year.

Interest expense on deposits and borrowings for the six months ended June 30, 2003 was $23.8 million, a decrease of $6.4 million, or 21%, from the six months ended June 30, 2002. This decrease in interest expense was attributable to a decrease in the average rate on interest-bearing liabilities to 1.42% for the six months ended June 30, 2003, a decrease of 59 basis points when compared to the same period in 2002. This decrease is partially offset by a $349.4 million increase in average interest-bearing liabilities to $3.37 billion for the six months ended June 30, 2003, an increase of 12% from the same period last year.

Net Interest Income

Net interest income for the three months ended June 30, 2003 was $47.2 million compared to $44.9 million in 2002, an increase of $2.3 million, or 5%. The increase is primarily attributable to growth in average interest-earning assets and to a decrease in rates paid on interest-bearing liabilities. Average interest-earning assets, primarily loans and securities, increased $645.0 million, or 16%, for the quarter ended June 30, 2003 when compared to the same period last year. This increase in interest-earning assets contributed $9.3 million to net interest income and almost completely offset the effect of lower yields on net interest

income for the quarter. The average rate on interest-bearing liabilities was 1.37% for the quarter ended June 30, 2003, a decrease of 59 basis points from 1.96% for the same period last year.

For the six months ended June 30, 2003, net interest income was $92.3 million, compared to $87.4 million for the same period last year, an increase of $4.9 million, or 6%. Yields on average interest-earning assets, primarily loans and securities, were 5.16% for the six months ended June 30, 2003, a decrease of 86 basis points from 6.02% for the same period last year. The decrease in yield resulted in a decrease in net interest income of $19.0 million when compared to the same period last year. Partially offsetting this decrease is the growth in average interest-earning assets from $3.94 billion for the six months ended June 30, 2002 to $4.54 billion for the six months ended June 30, 2003. Rates paid on interest-bearing liabilities decreased 59 basis points to 1.42% for the six months ended June 30, 2003, compared to 2.01% for the same period last year.

For the three months ended June 30, 2003, the net interest margin, defined as annualized net interest income divided by average interest-earning assets, declined to 4.09%, compared to 4.53% for the three months ended June 30, 2002. This decrease resulted from a decrease in the yield on interest-earning assets of 91 basis points, from 6.01% for the three months ended June 30, 2002 to 5.10% for the three months ended June 30, 2003. This decrease in yield was partially offset by a decrease in the cost of funds of 59 basis points from 1.96% for the three months ended June 30, 2002 to 1.37% for the three months ended June 30, 2003.

For the six months ended June 30, 2003, the net interest margin declined to 4.10%, compared to 4.48% for the six months ended June 30, 2002. This decrease resulted from a decrease in the yield on interest-earning assets of 86 basis points, from 6.02% for the six months ended June 30, 2002 to 5.16% for the six months ended June 30, 2003. This decrease in yield was partially offset by a decrease in the cost of funds of 59 basis points from 2.01% for the six months ended June 30, 2002 to 1.42% for the six months ended June 30, 2003.

The following table presents for the periods indicated the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates. No tax equivalent adjustments were made and all average balances are daily average balances. Nonaccruing loans have been included in the table as loans carrying a zero yield. Interest on nonaccruing loans is included to the extent it is received. The yield on the securities portfolio is based on average historical cost balances and does not give effect to changes in fair value that are reflected as a component of consolidated shareholders’ equity.



			Three Months Ended June 30,


			2003								2002

			Average			Interest		Average			Average			Interest		Average
			Outstanding			Earned/		Yield/			Outstanding			Earned/		Yield/
			Balance			Paid		Rate			Balance			Paid		Rate


			(Dollars in thousands)
Assets
Interest-earning assets:
	Loans		$	3,304,819		$	46,988		5.70	%	$	2,841,618		$	44,767		6.32	%
	Securities			1,222,798			11,489		3.77			1,089,573			14,629		5.39
	Federal funds sold and other			96,204			284		1.18			47,671			186		1.56

		Total interest-earning assets		4,623,821			58,761		5.10	%		3,978,862			59,582		6.01	%

Less allowance for loan losses				(39,930	)							(33,142	)

				4,583,891								3,945,720
Noninterest-earning assets				526,301								424,419

		Total assets	$	5,110,192							$	4,370,139

Liabilities and shareholders’ equity
Interest-bearing liabilities:
	Money market and savings deposits		$	1,810,986			4,035		0.89	%	$	1,493,217			5,161		1.39	%
	Time deposits			964,980			5,500		2.29			929,548			7,013		3.03
	Repurchase agreements and other borrowed funds			627,729			2,050		1.31			575,363			2,503		1.74

		Total interest-bearing liabilities		3,403,695			11,585		1.37	%		2,998,128			14,677		1.96	%

Noninterest-bearing liabilities:
	Noninterest-bearing demand deposits			1,208,477								954,006
	Other liabilities			27,349								27,560

		Total liabilities		4,639,521								3,979,694
Shareholders’ equity				470,671								390,445

		Total liabilities and shareholders’ equity	$	5,110,192							$	4,370,139

Net interest income						$	47,176							$	44,905

Net interest spread									3.73	%							4.05	%

Net interest margin									4.09	%							4.53	%



			Six Months Ended June 30,


			2003								2002

			Average			Interest		Average			Average			Interest		Average
			Outstanding			Earned/		Yield/			Outstanding			Earned/		Yield/
			Balance			Paid		Rate			Balance			Paid		Rate


			(Dollars in thousands)
Assets
Interest-earning assets:
	Loans		$	3,263,820		$	92,143		5.69	%	$	2,807,782		$	88,149		6.33	%
	Securities			1,190,491			23,440		3.97			1,081,950			29,008		5.41
	Federal funds sold and other			83,829			491		1.18			46,650			377		1.63

		Total interest-earning assets		4,538,140			116,074		5.16	%		3,936,382			117,534		6.02	%

Less allowance for loan losses				(39,078	)							(32,824	)

				4,499,062								3,903,558
Noninterest-earning assets				558,490								453,874

		Total assets	$	5,057,552							$	4,357,432

Liabilities and shareholders’ equity
Interest-bearing liabilities:
	Money market and savings deposits		$	1,772,488			8,327		0.95	%	$	1,490,339			10,325		1.40	%
	Time deposits			965,123			11,314		2.36			923,749			14,542		3.17
	Repurchase agreements and other borrowed funds			633,512			4,176		1.33			607,675			5,300		1.76

		Total interest-bearing liabilities		3,371,123			23,817		1.42	%		3,021,763			30,167		2.01	%

Noninterest-bearing liabilities:
	Noninterest-bearing demand deposits			1,190,533								929,278
	Other liabilities			33,799								25,265

		Total liabilities		4,595,455								3,976,306
Shareholders’ equity				462,097								381,126

		Total liabilities and shareholders’ equity	$	5,057,552							$	4,357,432

Net interest income						$	92,257							$	87,367

Net interest spread									3.74	%							4.01	%

Net interest margin									4.10	%							4.48	%

The following table presents the dollar amount of changes in interest income and interest expense for the major components of interest-earning assets and interest-bearing liabilities and distinguishes between the increase (decrease) related to outstanding balances and the volatility of interest rates. For purposes of this table, changes attributable to both rate and volume which cannot be segregated have been allocated proportionately to the change due to volume and the change due to rate.



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


		2003 vs. 2002								2003 vs. 2002


		Increase (Decrease) Due to								Increase (Decrease) Due to

		Volume		Rate			Total			Volume		Rate			Total


		(Dollars in thousands)
Interest-earning assets:
Loans		$	7,297	$	(5,076	)	$	2,221		$	14,317	$	(10,323	)	$	3,994
Securities			1,789		(4,929	)		(3,140	)		2,910		(8,478	)		(5,568	)
Federal funds sold and other			189		(91	)		98			300		(186	)		114

	Total increase (decrease) in interest income		9,275		(10,096	)		(821	)		17,527		(18,987	)		(1,460	)

Interest-bearing liabilities:
Money market and savings deposits			1,098		(2,224	)		(1,126	)		1,955		(3,953	)		(1,998	)
Time deposits			267		(1,780	)		(1,513	)		651		(3,879	)		(3,228	)
Repurchase agreements and other borrowed funds			228		(681	)		(453	)		225		(1,349	)		(1,124	)

	Total increase (decrease) in interest expense		1,593		(4,685	)		(3,092	)		2,831		(9,181	)		(6,350	)

Increase (decrease) in net interest income		$	7,682	$	(5,411	)	$	2,271		$	14,696	$	(9,806	)	$	4,890

Provision for Loan Losses

The provision for loan losses was $3.0 million for the three months ended June 30, 2003 as compared to $3.3 million for the three months ended June 30, 2002. The provision for loan losses was $6.0 million for the six months ended June 30, 2003 as compared to $5.8 million for the six months ended June 30, 2002. Changes in the provision for loan losses were attributable to the recognition of changes in current risk factors. Although no assurance can be given, management believes that the present allowance for loan losses is adequate considering loss experience, delinquency trends and current economic conditions. Management regularly reviews the Company’s loan loss allowance in accordance with its standard procedures. (See “— Financial Condition — Loan Review and Allowance for Loan Losses.”)

Noninterest Income

Noninterest income for the three months ended June 30, 2003 was $20.1 million, an increase of $2.4 million, or 14%, from $17.7 million during the comparable period in 2002. Noninterest income for the six months ended June 30, 2003 was $39.3 million, an increase of $5.5 million, or 16%, from $33.9 million during the comparable period in 2002. The following table shows the breakout of noninterest income between the bank and the mortgage company for the periods indicated.



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


		2003								2002						2003								2002

		Bank		Mortgage			Combined			Bank		Mortgage		Combined		Bank		Mortgage			Combined			Bank		Mortgage		Combined

Service charges on deposit accounts		$	10,389	$	—		$	10,389		$	9,466	$	—	$	9,466	$	20,915	$	—		$	20,915		$	18,159	$	—	$	18,159
Investment services			2,430		—			2,430			2,395		—		2,395		4,725		—			4,725			4,812		—		4,812
Factoring fee income			1,072		—			1,072			1,087		—		1,087		2,078		—			2,078			2,307		—		2,307
Loan fee income			667		1,049			1,716			302		852		1,154		1,079		1,780			2,859			647		1,402		2,049
Bank-owned life insurance income			1,195		—			1,195			1,207		—		1,207		2,385		—			2,385			2,395		—		2,395
Letters of credit fee income			656		—			656			363		—		363		1,178		—			1,178			703		—		703
Mortgage servicing fees, net of amortization and impairment			—		(922	)		(922	)		—		91		91		—		(1,241	)		(1,241	)		—		121		121
Gain on sale of loans, net			—		1,146			1,146			467		541		1,008		—		2,246			2,246			467		1,119		1,586
Gain on sale of securities, net			1,115		—			1,115			1		—		1		1,150		—			1,150			2		—		2
Other income			981		301			1,282			753		150		903		2,498		538			3,036			1,406		330		1,736

	Total noninterest income	$	18,505	$	1,574		$	20,079		$	16,041	$	1,634	$	17,675	$	36,008	$	3,323		$	39,331		$	30,898	$	2,972	$	33,870

Banking Segment. The largest component of noninterest income is service charges on deposit accounts, which were $10.4 million for the three months ended June 30, 2003, an increase of $923,000, or 10%, from $9.5 million for the same period last year. Service charges on deposit accounts were $20.9 million for the six months ended June 30, 2003, an increase of $2.8 million, or 15%, from $18.2 million for the same period last year. Several factors contributed to this growth. First, the Bank’s treasury management group continues to grow, with service charges from commercial analysis up $495,000, or 14%, for the three months ended June 30, 2003 when compared to the same period last year. For the six months ended June 30, 2003, such charges were $8.9 million, an increase of $1.0 million, or 14%, from $7.9 million for the six months ended June 30, 2002. This success at winning new business results from the Company’s ability to design custom cost-effective cash management solutions for middle market and large corporate customers. Second, net non-sufficient funds charges on deposit accounts were $4.4 million for the three months ended June 30, 2003, an increase of $171,000, or 4%, from $4.2 million for the same period last year. For the six months ended June 30, 2003, net non-sufficient funds charges on deposit accounts were $8.4 million, an increase of $1.1 million, or 15%, from $7.3 million for the six months ended June 30, 2002. Additionally, the total number of deposit accounts grew from 158,057 at June 30, 2002 to 166,259 at June 30, 2003.

Investment services income was $2.4 million for the three months ended June 30, 2003, unchanged from the same period a year ago. For the six months ended June 30, 2003, investment services income was $4.7 million, a decrease of $87,000, or 2%, from $4.8 million for the six months ended June 30, 2002. The relatively low level of growth in investment services activity is reflective of industry experience resulting from consumer uncertainty over the financial markets.

Gain on sale of securities, net, was $1.1 million and $1.2 million for the three months and six months ended June 30, 2003, respectively. This gain resulted from the sale of investment securities with a book value of $162.4 million during the three months ended June 30, 2003. Securities were sold during 2003 as part of the ongoing portfolio management process. There were no such transactions in the prior year.

Mortgage Segment. Gain on sale of loans, net, was $1.1 million for the three months ended June 30, 2003, an increase of $605,000, or 112%, from the same period last year. For the six months ended June 30, 2003, gain on sale of loans, net, was $2.2 million, an increase of $1.1 million, or 101%, from $1.1 million for the six months ended June 30, 2002. This increase is attributable to the declining rate environment in the current year. The market value of loans held for sale is impacted by changes in current interest rates. An increase in interest rates results in a decrease in the market value of these loans while a decrease in interest rates results in an increase in the market value of these loans. The principal balances of mortgage loans sold were $65.2 million and $33.6 million during the three months ended June 30, 2003 and 2002, respectively. For the six months ended June 30, 2003, the principal balances of mortgage loans sold were $116.7 million compared to $89.6 million for the same period last year.

Mortgage servicing fees, net of amortization and impairment, was ($922,000) for the three months ended June 30, 2003, a decrease of $1.0 million when compared to $91,000 for the same period last year. For the six months ended June 30, 2003, mortgage servicing fees, net of amortization and impairment, was ($1.2) million, a decrease of $1.4 million when compared to the same period last year. The loss on mortgage servicing activity in the current year was due to the level of refinance activity that prevailed during the period. The mortgage industry is experiencing high levels of prepayment activity as a result of lower interest rates. Capitalized mortgage servicing costs are expensed against the related fee income as the underlying loans are paid off.

Amortization of capitalized mortgage servicing costs for the three months ended June 30, 2003 was $1.5 million, an increase of $665,000, or 83%, from $800,000 for the three months ended June 30, 2002. In addition, during the quarter ended June 30, 2003, the Company recognized a non-cash, pretax, write-down of the carrying value of the mortgage servicing asset of $234,000 in accordance with the quarterly revaluation of the capitalized mortgage servicing costs. For the six months ended June 30, 2003, amortization of capitalized mortgage servicing costs was $2.6 million, an increase of $923,000, or 55%, when compared to $1.7 million for the same period last year.

Noninterest Expenses

For the three months ended June 30, 2003, noninterest expenses totaled $41.2 million, an increase of $3.9 million, or 11%, from $37.3 million for the three months ended June 30, 2002. For the six months ended June 30, 2003, noninterest expenses totaled $80.7 million, an increase of $7.2 million, or 10%, from the same period in 2002. The increase in noninterest expenses was primarily due to salaries and employee benefits and occupancy expenses.

Salaries and employee benefits for the three months ended June 30, 2003 were $24.1 million, an increase of $2.6 million, or 12%, from the three months ended June 30, 2002. For the six months ended June 30, 2003, salaries and employee benefits were $47.9 million, an increase of $5.4 million, or 13%, from $42.5 million for the same period last year. This increase was due primarily to hiring of additional personnel required to accommodate the Company’s growth. Total full-time employees were 1,556 and 1,391 at June 30, 2003 and 2002, respectively.

Occupancy expense for the three months ended June 30, 2003 was $6.9 million, an increase of $1.3 million, or 22%, from $5.6 million for the three months ended June 30, 2002. For the six months ended June 30, 2003, occupancy expense was $13.4 million, an increase of $2.3 million, or 20%, from $11.1 million for the six months ended June 30, 2002. Major categories within occupancy expense are building lease expense, depreciation expense, utilities, and maintenance contract expense. Building lease expense decreased $264,000, or 18%, to $1.2 million for the three months ended June 30, 2003, compared to $1.4 million for the same period last year. For the six months ended June 30, 2003, building lease expense was $2.4 million, a decrease of $728,000, or 24%, when compared to the same period last year. This decrease was primarily due to the discontinuation of rental payments on the downtown operations center purchased by the Bank in May 2002. This cost savings was partially offset by increased building maintenance and utility costs on the same property. Depreciation expense increased $592,000, or 26%, to $2.9 million for the three months ended June 30, 2003. For the six months ended June 30, 2003, depreciation expense was $5.5 million, an increase of $1.2 million, or 27%, from $4.3 million for the same period last year. This increase was due primarily to

additional depreciation resulting from the purchase of the downtown operations center and capitalized leasehold improvements associated with renovations at the Company’s headquarters. In addition, depreciation on computer equipment has increased in the current year for expenditures made to support the Company’s growth. Maintenance contract expense for the three months ended June 30, 2003 was $1.2 million, an increase of $378,000, or 43%, compared to $871,000 for the same period last year. For the six months ended June 30, 2003, maintenance contract expense was $2.4 million, an increase of $722,000, or 44%, from $1.6 million for the same period last year. The Company has purchased maintenance contracts for major operating systems throughout the organization.

Income Taxes

Income tax expense includes the regular federal income tax at the statutory rate, plus the income tax component of the Texas franchise tax. The amount of federal income tax expense is influenced by the amount of taxable income, the amount of tax-exempt income, the amount of nondeductible interest expense, and the amount of other nondeductible expenses. Taxable income for the income tax component of the Texas franchise tax is the federal pre-tax income, plus certain officers’ salaries, less interest income from federal securities. For the three months ended June 30, 2003, the provision for income taxes was $7.1 million, an increase of $232,000, or 3%, from the $6.9 million provided for in the same period in 2002. For the six months ended June 30, 2003, the provision for income taxes was $13.9 million, an increase of $592,000, or 4%, from the $13.3 million provided for in the same period in 2002. The Company’s effective tax rate was 31% for the three and six months ended June 30, 2003 and 2002.

Financial Condition

Loans Held for Investment

Loans held for investment were $3.28 billion at June 30, 2003, an increase of $159.7 million, or 5%, from $3.12 billion at December 31, 2002.

The following table summarizes the loan portfolio of the Company by type of loan as of June 30, 2003 and December 31, 2002:



			June 30, 2003					December 31, 2002

			Amount		Percent			Amount		Percent


			(Dollars in thousands)
Commercial and industrial			$	1,327,581		40.51	%	$	1,296,849		41.59	%
Real estate:
	Construction and land development			744,601		22.72			748,272		24.00
	1-4 family residential			501,079		15.29			447,534		14.35
	Commercial			527,204		16.08			458,033		14.69
	Farmland			9,561		0.29			7,679		0.25
	Other			35,462		1.08			21,693		0.70
Consumer				132,196		4.03			137,891		4.42

		Total loans held for investment	$	3,277,684		100.00	%	$	3,117,951		100.00	%

The primary lending focus of the Company is on small- and medium-sized commercial, construction and land development, residential mortgage and consumer loans. The Company offers a variety of commercial lending products including term loans, lines of credit and equipment financing. A broad range of short- to medium-term commercial loans, both collateralized and uncollateralized, are made available to businesses for working capital (including inventory and receivables), business expansion (including acquisitions of real estate and improvements) and the purchase of equipment and machinery. The purpose of a particular loan generally determines its structure.

The Company’s commercial loans are generally underwritten on the basis of the borrower’s ability to service such debt from cash flow. As a general practice, the Company takes as collateral a lien on any available real estate, equipment or other assets and personal guarantees of company owners or project sponsors. Working capital loans are primarily collateralized by short-term assets whereas term loans are primarily collateralized by long-term assets.

A substantial portion of the Company’s real estate loans consists of loans collateralized by real estate, other assets and personal guarantees of company owners or project sponsors. Additionally, a portion of the Company’s lending activity consists of the origination of single-family residential mortgage loans collateralized by owner-occupied properties located in the Company’s primary market area. The Company offers a variety of mortgage loan products which generally are amortized over five to 30 years.

Loans collateralized by single-family residential real estate are typically originated in amounts of no more than 90% of appraised value. The Company requires mortgage title insurance and hazard insurance in the amount of the loan. Although the contractual loan payment periods for single-family residential real estate loans are generally for a 10 to 30 year period, such loans often remain outstanding for significantly shorter periods than their contractual terms.

The Company originates residential and commercial mortgage loans to sell to investors with servicing rights retained. The Company also provides residential and commercial construction financing to builders and developers and acts as a broker in the origination of multi-family and commercial real estate loans.

Residential construction financing to builders generally has been originated in amounts of no more than 80% of appraised value. The Company requires a mortgage title binder and builder’s risk insurance in the amount of the loan. The contractual loan payment periods for residential construction loans are generally for a six to twelve month period.

Consumer loans made by the Company include automobile loans, recreational vehicle loans, boat loans, home improvement loans, personal loans (collateralized and uncollateralized) and deposit account collateralized loans. The terms of these loans typically range from 12 to 84 months and vary based upon the nature of collateral and size of loan.

The contractual maturity ranges of the commercial and industrial and funded real estate construction and land development loan portfolio and the amount of such loans with fixed interest rates and floating interest rates in each maturity range as of June 30, 2003 are summarized in the following table:



		June 30, 2003

				After One
		One Year Or		Through		After Five
		Less		Five Years		Years		Total


		(Dollars in thousands)
Commercial and industrial		$	896,417	$	380,027	$	51,137	$	1,327,581
Real estate construction and land development			293,104		291,695		159,802		744,601

	Total	$	1,189,521	$	671,722	$	210,939	$	2,072,182

Loans with a fixed interest rate		$	510,385	$	129,062	$	176,531	$	815,978
Loans with a floating interest rate			679,136		542,660		34,408		1,256,204

	Total	$	1,189,521	$	671,722	$	210,939	$	2,072,182

Loans Held for Sale

Loans held for sale of $91.8 million at June 30, 2003 decreased from $101.4 million at December 31, 2002. These loans are carried at the lower of cost or market and are typically sold to investors within one year of origination. The market value of these loans is impacted by changes in current interest rates. An increase in interest rates would result in a decrease in the market value of these loans while a decrease in interest rates

would result in an increase in the market value of these loans. The business of originating and selling loans is conducted by the Company’s mortgage segment.

Off-Balance Sheet Credit Commitments

The Company enters into contractual commitments to extend credit, normally with fixed expiration dates or termination clauses, at specified rates and for specific purposes. Customers use credit commitments to ensure that funds will be available for working capital purposes, for capital expenditures and to ensure access to funds at specified terms and conditions. Substantially all of the Company’s commitments to extend credit are contingent upon customers maintaining specific credit standards at the time of loan funding. Management assesses the credit risk associated with commitments to extend credit. Commitments to extend credit totaled $1.67 billion at June 30, 2003 and $1.64 billion at December 31, 2002.

Standby letters of credit are written conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The Company’s policies generally require that standby letters of credit arrangements contain collateral and debt covenants similar to those contained in loan agreements. In the event the customer does not perform in accordance with the terms of the agreement with the third party, the Company would be required to fund the commitment. The maximum potential amount of future payments the Company could be required to make is represented by the contractual amount of the commitment. If the commitment is funded, the Company would be entitled to seek recovery from the customer. Standby letters of credit totaled $208.1 million at June 30, 2003 and $167.8 million at December 31, 2002. As of June 30, 2003 and December 31, 2002, $228,000 and $139,000, respectively, has been recorded as a liability for the fair value of the Company’s potential obligations under these guarantees which represents the unamortized portion of the fee collected. Management believes this amount to be the fair value of the guarantees.

Loan Review and Allowance for Loan Losses

The Company’s loan review procedures include a credit quality assurance process that begins with approval of lending policies and underwriting guidelines by the Board of Directors, a loan review department staffed, in part, with Office of the Comptroller of the Currency experienced personnel, low individual lending limits for officers, Senior Loan Committee approval for large credit relationships and a quality control process for loan documentation. The Company also maintains a monitoring process for credit extensions in excess of $100,000. The Company performs quarterly concentration analyses based on various factors such as industries, collateral types, business lines, large credit sizes, international credit exposure and officer portfolio loads. The Company has established underwriting guidelines to be followed by its officers. The Company also monitors its delinquency levels for any negative or adverse trends. The Company continues to invest in its loan portfolio monitoring system to enhance its risk management capabilities.

The Company’s loan portfolio is well diversified by industry type but is generally concentrated in the eight county region defined as its primary market area. Historically, the Houston metropolitan area has been affected both positively and negatively by conditions in the energy industry. It is estimated that approximately 32% of economic activity currently is related to the upstream energy industry, down from 69% in 1981. Since the mid 1980’s, the economic impact of changes in the energy industry has been lessened due to the diversification of the Houston economy driven by growth in such economic entities as the Texas Medical Center, the Port of Houston, and the Johnson Space Center, among others, and government infrastructure spending to support the population and job growth in the Houston area. As a result, the economy of the

Company’s primary market area has become increasingly affected by changes in the national and international economies.

The Company monitors changes in the level of energy prices, real estate values, borrower collateral, and the level of local, regional, national, and international economic activity. Recently, several major employers in the Houston market have either experienced financial difficulties or reductions in employment due to changes in the energy trading markets, corporate consolidations, or political events affecting the global economy. For the twelve-month period ended June 30, 2003, the local economy recorded a net job loss of approximately 14,300 or 0.7% of the employment base. As of June 30, 2003, these events have had no material effect on the Company’s loan portfolio. For the six month period ended June 30, 2003, annualized net charge-offs to average loans was 0.25%. The comparable average for all FDIC insured commercial banks was 0.92% for the three month period ended March 31, 2003. There can be no assurance, however, the Company’s loan portfolio will not become subject to increasing pressures from deteriorating borrower credit due to changes in general economic conditions.

The allowance for loan losses is established through a provision for loan losses based on management’s evaluation of risk inherent in the loan portfolio. The allowance is increased by provisions charged against current earnings and reduced by net charge-offs. Loans are charged off when they are deemed to be uncollectible; recoveries are generally recorded only when cash payments are received. Based on an evaluation of the loan portfolio, management presents a quarterly analysis of the allowance for loan losses to a committee of the Board of Directors, indicating any changes in the allowance since the last review and any recommendations as to adjustments in the allowance. In making its evaluations, management considers both quantitative and qualitative risk factors in establishing an allowance for loan losses that it considers to be appropriate at each reporting period. Quantitative factors include historical charge-off experience, delinquency and past due trends, changes in collateral values, changes in energy prices, changes in the level of borrower covenant violations, the level of nonperforming loans, changes in the risk classification of credits, growth and concentrations of credit in the loan portfolio, the results of regulatory and internal loan review examinations, and changes in the loan portfolio’s composition by both industry and by borrower.

Qualitative factors include an evaluation of the economic factors affecting the Company’s primary market area, changes in the type and complexity of credit extensions, the experience levels of its lending and loan review staff, new lending products, the age of the loan portfolio, and other factors.

In order to determine the adequacy of the allowance for loan losses, management performs periodic reviews of the loan portfolio, either individually or in pools. Generally, commercial and real estate loans are reviewed individually and consumer and single family residential loans are evaluated in pools.

The allowance for loan losses is established based upon (i) the historical loss experience by loan type; (ii) management’s internal grading of the loans resulting in an allowance based upon the historical loss experience by grade applied to the outstanding principal balance of the adversely graded loans; and (iii) certain subjective factors such as economic trends, performance trends, portfolio age and concentrations of credit. In addition, specific allowances may be established for loans which management believes require greater reserves than those allocated based on the above methodology. Future changes in economic conditions, circumstances, or other factors could cause management to increase or decrease the allowance for loan losses as necessary.

Management believes that the allowance for loan losses at June 30, 2003 is adequate to cover losses inherent in the portfolio as of such date. There can be no assurance, however, that the Company will not sustain losses in future periods, which could be greater than the size of the allowance at June 30, 2003.

The following table presents, for the periods indicated, an analysis of the allowance for loan losses and other related data:



			Six Months Ended
			June 30,

			2003			2002


			(Dollars in thousands)
Allowance for loan losses, beginning balance			$	36,696		$	31,390
Provision charged against operations				6,000			5,750
Charge-offs:
	Commercial and industrial			(656	)		(3,762	)
	Real estate:
		Construction and land development		—			(108	)
		1-4 family residential		(23	)		(57	)
		Commercial		(568	)		(7	)
		Farmland		—			—
		Other		(2,741	)		(64	)
		Consumer		(385	)		(469	)

Total charge-offs				(4,373	)		(4,467	)

Recoveries:
	Commercial and industrial			85			190
	Real estate:
		Construction and land development		—			—
		1-4 family residential		48			—
		Commercial		—			—
		Farmland		—			—
		Other		—			—
		Consumer		267			162

Total recoveries				400			352

Net charge-offs				(3,973	)		(4,115	)

Allowance for loan losses, ending balance			$	38,723		$	33,025

Allowance to period-end loans				1.18	%		1.17	%
Net charge-offs to average loans				0.25	%		0.30	%
Allowance to period-end nonperforming loans				204.70	%		249.04	%

The following table reflects the distribution of the allowance for loan losses among various categories of loans for the dates indicated. The Company has allocated portions of its allowance for loan losses to cover the estimated losses inherent in particular risk categories of loans. This allocation is made for analytical purposes and is not necessarily indicative of the categories in which loan losses may occur. The total allowance is available to absorb losses from any category of loans.



			June 30, 2003					December 31, 2002

					Percent of					Percent of
					Loans to					Loans to
			Amount		Total Loans			Amount		Total Loans


			(Dollars in thousands)
Balance of allowance for loan losses applicable to:
	Commercial and industrial		$	16,402		40.51	%	$	15,637		41.59	%
	Real estate:
		Construction and land development		7,044		22.72			6,825		24.00
		1-4 family residential		4,908		15.29			4,014		14.35
		Commercial		6,861		16.08			5,868		14.69
		Farmland		56		0.29			53		0.25
		Other		1,963		1.08			1,037		0.70
Consumer				1,489		4.03			3,262		4.42

Total allowance for loan losses			$	38,723		100.00	%	$	36,696		100.00	%

Nonperforming Assets and Impaired Loans

Nonperforming assets, which include nonaccrual loans, accruing loans 90 or more days past due, restructured loans, and other real estate and foreclosed property, were $22.3 million at June 30, 2003, compared to $15.7 million at December 31, 2002. This resulted in a ratio of nonperforming assets to loans and other real estate of 0.68% at June 30, 2003 and 0.50% at December 31, 2002. The increase in nonperforming assets is primarily due to an increase in accruing loans 90 or more days past due of $2.4 million to $4.3 million at June 30, 2003 when compared to $1.9 million at December 31, 2002 and an increase in other real estate and foreclosed property of $2.6 million to $3.4 million at June 30, 2003 when compared to $760,000 at December 31, 2002. Of the $2.4 million increase in accruing loans over 90 days past due, three loans totaling $1.1 million have subsequently been paid in full and five loans totaling $632,000 have been reclassified to performing status subsequent to June 30, 2003 due to principal payments received. The increase in other real estate and foreclosed property is primarily caused by the April 1, 2003 foreclosure on a multi-family loan with a net carrying value of $2.7 million at June 30, 2003. Nonaccrual loans, the largest component of nonperforming assets, were $14.6 million at June 30, 2003, an increase of $1.5 million from $13.1 million at December 31, 2002.

The following table presents information regarding nonperforming assets as of the dates indicated:


		June 30,			December 31,
		2003			2002

Nonaccrual loans		$	14,609		$	13,113
Accruing loans 90 or more days past due			4,308			1,876
Other real estate and foreclosed property			3,398			760

	Total nonperforming assets	$	22,315		$	15,749

Nonperforming assets to total loans and other real estate			0.68	%		0.50	%

Loans on which the accrual of interest has been discontinued are designated as nonaccrual loans. Loans are designated as nonaccrual when reasonable doubt exists as to the full collection of interest and principal. When a loan is placed on nonaccrual status, all interest previously accrued but not collected is reversed against current period interest income. Income on such loans is then recognized only to the extent that cash is

received and where the future collection of interest and principal is probable. Interest accruals are resumed on such loans only when they are brought fully current with respect to interest and principal and when, in the judgement of management, the loans are estimated to be fully collectible as to both principal and interest. Gross interest income on nonaccrual loans that would have been recorded had these loans been performing as agreed was $605,000 and $394,000 for the six months ended June 30, 2003 and 2002, respectively.

The Company regularly updates appraisals on loans collateralized by real estate, particularly those categorized as nonperforming loans and potential problem loans. In instances where updated appraisals reflect reduced collateral values, an evaluation of the borrower’s overall financial condition is made to determine the need, if any, for possible writedowns or appropriate additions to the allowance for loan losses.

A loan is considered impaired, based on current information and events, if management believes that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. All amounts due according to the contractual terms means that both the contractual interest payments and the contractual principal payments of a loan will be collected as scheduled in the loan agreement. An insignificant delay or insignificant shortfall in the amount of payment does not require a loan to be considered impaired. If the measure of the impaired loan is less than the recorded investment in the loan, a specific reserve is established for the shortfall as a component of the Bank’s allowance for loan loss methodology. All nonaccrual loans are considered impaired at June 30, 2003 and December 31, 2002.

The following is a summary of loans considered to be impaired:


		June 30,		December 31,
		2003		2002


		(Dollars in thousands)
Impaired loans with no SFAS No. 114 valuation reserve		$	8,805	$	9,957
Impaired loans with a SFAS No. 114 valuation reserve			11,103		13,089

	Total recorded investment in impaired loans	$	19,908	$	23,046

Valuation allowance related to impaired loans		$	3,055	$	3,646

The average recorded investment in impaired loans during the six months ended June 30, 2003 and the year ended December 31, 2002 was $21.5 million and $22.1 million, respectively. Interest income on impaired loans of $126,000 and $206,000 was recognized for cash payments received during the six months ended June 30, 2003 and 2002, respectively.

Securities

At the date of purchase, the Company classifies debt and equity securities into one of three categories: held to maturity, trading or available for sale. At each reporting date, the appropriateness of the classification is reassessed. Securities that are bought and held principally for the purpose of selling them in the near term are classified as trading and measured at fair value in the financial statements with unrealized gains and losses included in earnings. Securities not classified as trading are classified as available for sale and measured at fair value in the financial statements with unrealized gains and losses reported, net of tax, as a component of accumulated other comprehensive income (loss) until realized. Gains and losses on sales of securities are determined using the specific-identification method. The Company has classified all securities as available for sale at June 30, 2003 and December 31, 2002.

The amortized cost and approximate fair value of securities classified as available for sale is as follows:



		June 30, 2003									December 31, 2002


				Gross Unrealized									Gross Unrealized
		Amortized									Amortized
		Cost		Gain		Loss			Fair Value		Cost		Gain		Loss			Fair Value


		(Dollars in thousands)
Available for sale:
U.S. Government and agency securities		$	181,354	$	2,003	$	—		$	183,357	$	142,032	$	1,323	$	—		$	143,355
Mortgage-backed securities			943,471		12,403		(836	)		955,038		869,872		18,077		(1,194	)		886,755
Municipal securities			107,487		8,253		(63	)		115,677		105,143		3,634		(190	)		108,587
Federal Reserve Bank stock			4,433		—		—			4,433		4,431		—		—			4,431
Federal Home Loan Bank stock			27,526		—		—			27,526		27,188		—		—			27,188
Other securities			17,427		155		—			17,582		30,777		107		—			30,884

	Total securities available for sale	$	1,281,698	$	22,814	$	(899	)	$	1,303,613	$	1,179,443	$	23,141	$	(1,384	)	$	1,201,200

Securities totaled $1.30 billion at June 30, 2003, an increase of $102.4 million from $1.20 billion at December 31, 2002. The yield on the securities portfolio for the six months ended June 30, 2003 was 3.97% compared to 5.41% for the six months ended June 30, 2002.

Included in the Company’s mortgage-backed securities at June 30, 2003 were agency issued collateral mortgage obligations with a book value of $323.7 million and a fair value of $325.9 million and non-agency issued collateral mortgage obligations with a book value of $90.8 million and a fair value of $91.6 million.

At June 30, 2003, $828.6 million of the mortgage-backed securities held by the Company had final maturities of more than 10 years. At June 30, 2003, approximately $14.5 million of the Company’s mortgage-backed securities earned interest at floating rates and repriced within one year.

The following table summarizes the contractual maturity of investments and their weighted average yields at June 30, 2003. The yield on the securities portfolio is based on average historical cost balances and does not give effect to changes in fair value that are reflected as a separate component of other comprehensive income.



		June 30, 2003


							After One Year					After Five Years
							But Within					But Within
		Within One Year					Five Years					Ten Years					After Ten Years

		Amortized					Amortized					Amortized					Amortized
		Cost		Yield			Cost		Yield			Cost		Yield			Cost		Yield			Total		Yield


		(Dollars in thousands)
U.S. Government securities		$	19,909		5.54	%	$	161,445		2.97	%	$	—		—	%	$	—		—	%	$	181,354		3.25	%
Mortgage-backed securities			1,012		5.18	%		27,435		3.89	%		86,392		4.34	%		828,632		3.90	%		943,471		3.94	%
Municipal securities			1,886		4.48	%		6,404		4.54	%		8,415		4.64	%		90,782		5.69	%		107,487		5.52	%
Federal Reserve Bank stock			4,433		6.00	%		—		—			—		—			—		—			4,433		6.00	%
Federal Home Loan Bank stock			27,526		2.50	%		—		—			—		—			—		—			27,526		2.50	%
Other securities			14,082		1.07	%		665		6.14	%		1,149		3.14	%		1,531		4.57	%		17,427		1.70	%
Federal funds sold			238,440		1.47	%		—		—			—		—			—		—			238,440		1.47	%
Securities purchased under resale agreements			30,000		1.04	%		—		—			—		—			—		—			30,000		1.04	%
Interest-bearing deposits			5,677		1.30	%		—		—			—		—			—		—			5,677		1.30	%

	Total investments	$	342,965		1.82	%	$	195,949		3.16	%	$	95,956		4.35	%	$	920,945		4.08	%	$	1,555,815		3.48	%

Other Assets

Other assets were $146.4 million at June 30, 2003, an increase of $6.1 million from $140.4 million at December 31, 2002. This increase is primarily attributable to increases in the cash value of Bank-owned life insurance policies and other real estate and foreclosed property. The cash value of Bank-owned life insurance policies was approximately $89.9 million at June 30, 2003, an increase of $2.4 million, or 3%, from $87.5 million at December 31, 2002. This increase resulted from the interest earned on these policies. Other real estate and foreclosed property was $3.4 million at June 30, 2003, an increase of $2.6 million, or 347%, from $760,000 at December 31, 2002. This increase resulted from the April 1, 2003 foreclosure of a multi-family loan with a net carrying value of $2.7 million at June 30, 2003.

Deposits

The Company offers a variety of deposit accounts having a wide range of interest rates and terms. The Company’s deposits consist of demand, savings, interest-bearing demand, money market and time accounts. The Company relies primarily on its product and service offerings, high quality customer service, advertising, and competitive pricing policies to attract and retain these deposits. Deposits provide the primary source of funding for the Company’s lending and investment activities, and the interest paid for deposits must be managed carefully to control the level of interest expense.

The Company had $260.7 million and $149.4 million of its deposits classified as brokered funds at June 30, 2003 and December 31, 2002, respectively. The growth in brokered deposits is attributable to growth in a major new treasury management relationship whereby the Bank provides banking and treasury management services to mortgage companies throughout the United States. Under this relationship, a referring source, whose business is to lend money to mortgage companies, introduces its customers to the Bank. Deposits garnered as a result of those introductions are classified as brokered deposits for financial and regulatory reporting purposes. In spite of this classification, management believes that the deposits are stable and relationship-based and that they do not have the characteristics or risks normally associated with brokered deposits.

The Company’s ratio of average noninterest-bearing demand deposits to average total deposits for the periods ended June 30, 2003 and December 31, 2002 was 30% and 29%, respectively.

The average daily balances and weighted average rates paid on deposits for the six months ended June 30, 2003 and the year ended December 31, 2002 are presented below:



		June 30, 2003					December 31, 2002

		Amount		Rate			Amount		Rate


		(Dollars in thousands)
Interest-bearing demand		$	35,250		0.22	%	$	34,409		0.23	%
Regular savings			104,764		0.40			94,388		0.88
Premium yield			828,679		1.09			830,690		1.61
Money market savings			803,795		0.90			593,691		1.04
Time deposits less than $100,000			275,926		2.92			293,752		3.63
Time deposits $100,000 and over			609,846		2.02			553,666		2.69
IRA’s, QRP’s and other			79,351		3.07			78,583		3.73

Total interest-bearing deposits			2,737,611		1.45	%		2,479,179		1.97	%

Noninterest-bearing deposits			1,190,533					994,113

	Total deposits	$	3,928,144				$	3,473,292

The following table sets forth the maturity of the Company’s time deposits that are $100,000 or greater as of the dates indicated:


		June 30,		December 31,
		2003		2002


		(Dollars in thousands)
3 months or less		$	446,009	$	285,071
Between 3 months and 6 months			63,469		56,087
Between 6 months and 1 year			44,926		68,934
Over 1 year			107,925		108,016

	Total time deposits, $100,000 and over	$	662,329	$	518,108

Borrowings

Securities sold under repurchase agreements and other borrowings generally represent borrowings with maturities ranging from one to thirty days. The Company’s long-term borrowings generally consist of borrowings with the Federal Home Loan Bank maturing within one year. Short-term borrowings consist of federal funds purchased and overnight borrowings with the Federal Home Loan Bank. Information relating to these borrowings is summarized as follows:


		June 30,			December 31,
		2003			2002


		(Dollars in thousands)
Securities sold under repurchase agreements:
	Average	$	242,216		$	271,304
	Period-end		235,557			275,443
	Maximum month-end balance during period		290,650			323,815
Interest rate:
	Weighted average for the period		1.01	%		1.45	%
	Weighted average at period-end		0.98	%		1.15	%
Long-term borrowings:
	Average	$	106,953		$	42,162
	Period-end		206,857			107,049
	Maximum month-end balance during period		206,857			107,172
Interest rate:
	Weighted average for the period		2.30	%		2.83	%
	Weighted average at period-end		1.68	%		2.28	%
Short-term borrowings:
	Average	$	284,343		$	326,675
	Period-end		347,579			408,381
	Maximum month-end balance during period		402,017			501,736
Interest rate:
	Weighted average for the period		1.23	%		1.74	%
	Weighted average at period-end		1.25	%		1.26	%

Liquidity and Capital Resources

Liquidity management involves maintaining sufficient cash levels to fund operations and to meet the requirements of borrowers, depositors, and creditors. Higher levels of liquidity bear higher corresponding costs, measured in terms of lower yields on short-term, more liquid earning assets, and higher interest expense involved in extending liability maturities. Liquid assets include cash and cash equivalents, loans and securities maturing within one year, and money market instruments. In addition, the Company holds securities maturing after one year, which can be sold to meet liquidity needs.

The Company relies primarily on customer deposits, securities sold under repurchase agreements and shareholders’ equity to fund interest-earning assets. The Federal Home Loan Bank (“FHLB”) is also a major

source of liquidity for the Bank. The FHLB allows member banks to borrow against their eligible collateral to satisfy liquidity requirements.

Maintaining a relatively stable funding base, which is achieved by diversifying funding sources, competitively pricing deposit products, and extending the contractual maturity of liabilities, reduces the Company’s exposure to roll over risk on deposits and limits reliance on volatile short-term purchased funds. Short-term funding needs arise from declines in deposits or other funding sources, funding of loan commitments and requests for new loans. The Company’s strategy is to fund assets to the maximum extent possible with core deposits that provide a sizable source of relatively stable and low-cost funds. Core deposits include all deposits, except certificates of deposit and other time deposits of $100,000 and over. Average core deposits funded approximately 73% of total interest-earning assets for the six months ended June 30, 2003 and 71% for the same period in 2002.

The following table compares the Company’s and the Bank’s leverage and risk-weighted capital ratios as of June 30, 2003 and December 31, 2002 to the minimum regulatory standards:



													Minimum to be Well
													Capitalized Under
								Minimum Capital					Prompt Corrective
			Actual					Requirement					Action Provisions

			Amount		Ratio			Amount		Ratio			Amount		Ratio


			(Dollars in thousands)
As of June 30, 2003
	Total Capital (to Risk Weighted Assets):
		The Company	$	501,244		11.61	%	$	345,260		8.00	%	$	N/A		N/A	%
		The Bank		484,710		11.26	%		344,252		8.00	%		430,315		10.00	%
	Tier I Capital (to Risk Weighted Assets):
		The Company		462,521		10.72	%		172,630		4.00	%		N/A		N/A	%
		The Bank		445,487		10.35	%		172,126		4.00	%		344,252		8.00	%
	Tier I Capital (to Average Assets):
		The Company		462,521		9.06	%		153,206		3.00	%		N/A		N/A	%
		The Bank		445,487		8.77	%		152,314		3.00	%		253,856		5.00	%
As of December 31, 2002
	Total Capital (to Risk Weighted Assets):
		The Company		465,545		11.68	%		318,794		8.00	%		N/A		N/A	%
		The Bank		450,853		11.33	%		318,418		8.00	%		398,023		10.00	%
	Tier I Capital (to Risk Weighted Assets):
		The Company		428,849		10.76	%		159,397		4.00	%		N/A		N/A	%
		The Bank		413,643		10.39	%		159,209		4.00	%		318,418		8.00	%
	Tier I Capital (to Average Assets):
		The Company		428,849		9.43	%		136,389		3.00	%		N/A		N/A	%
		The Bank		413,643		8.59	%		144,524		3.00	%		240,873		5.00	%

Critical Accounting Policies

The Company has established various accounting policies which govern the application of accounting principles generally accepted in the United States in the preparation of the Company’s financial statements.

Certain accounting policies involve significant judgments and assumptions by management which have a material impact on the carrying value of assets and liabilities; management considers such accounting policies to be critical accounting policies. The judgments and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances. Because of the nature of the judgments and assumptions made by management, actual results could differ from these judgments and estimates which could have a material impact on the carrying values of assets and liabilities and the results of operations of the Company.

The Company believes the allowance for loan losses is a critical accounting policy that requires the most significant judgments and estimates used in the preparation of its condensed consolidated financial statements. In estimating the allowance for loan losses, management utilizes historical experience as well as other factors including the effect of changes in the local real estate market on collateral values, the effect on the loan portfolio of current economic indicators and their probable impact on borrowers and increases or decreases in nonperforming and impaired loans. Changes in these factors may cause management’s estimate of the allowance to increase or decrease and result in adjustments to the Company’s provision for loan losses. See the Company’s Annual Report on Form 10-K, “— Financial Condition — Loan Review and Allowance for Loan Losses” and “Note 1 — Nature of Operations and Summary of Significant Accounting Policies” for a detailed description of the Company’s estimation process and methodology related to the allowance for loan losses.

Mortgage servicing rights assets are established and accounted for based on discounted cash flow modeling techniques which require management to make estimates regarding the amount and timing of expected future cash flows, including assumptions about loan repayment rates, credit loss experience, and costs to service, as well discount rates that consider the risk involved. Because the values of these assets are sensitive to changes in assumptions, the valuation of mortgage servicing rights is considered a critical accounting estimate. See the Company’s Annual Report on Form 10-K, “Note 1 — Nature of Operations and Summary of Significant Accounting Policies” and “Note 7 — Mortgage Servicing Rights” for further discussion on the accounting for these assets.

Other Matters

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes since December 31, 2002. See the Company’s Annual Report on Form 10-K, “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Financial Condition — Interest Rate Sensitivity and Liquidity.”

ITEM 4. Controls and Procedures

During 2002, management dedicated extensive time, resources, and capital into the development and implementation of a comprehensive enterprise-wide risk management system (“ERM”). The process placed all activities of the Company into 14 processes with 12 process owners. In the initial assessment, a catalogue of the key risks in the Company were identified for ongoing monitoring. Detailed risk assessments were then conducted to determine the risk profile. Infrastructure supporting the ERM includes a Board Risk Committee,

an internal Risk Management Committee, and centralized Risk Management supervision. An automated application, Enterprise Risk Management System (“ERMS”), has also been developed to facilitate execution of this methodology. The basic ERMS system has been implemented and is updated on a regular basis. Management is in the process of developing measurement criteria and risk performance indicators for the various risk processes.

The Company’s chief executive officer and chief financial officer have evaluated the Company’s disclosure controls and procedures (as defined in Rule 13a-14(c) and Rule 15d-14(c) under the Exchange Act) as of June 30, 2003 and concluded that those disclosure controls and procedures are effective.

There have been no changes in the Company’s internal controls or in other factors known to the Company that could significantly affect these controls subsequent to their evaluation, nor any corrective actions with regard to significant deficiencies and material weaknesses.

While the Company believes that its existing disclosure controls and procedures have been effective to accomplish these objectives, the Company intends to continue to examine, refine and formalize its disclosure controls and procedures and to monitor ongoing developments in this area.

With respect to the unaudited financial information of Southwest Bancorporation of Texas, Inc. for the three and six month periods ended June 30, 2003 and 2002, included in this Form 10-Q, PricewaterhouseCoopers LLP reported that they have applied limited procedures in accordance with professional standards for a review of such information. However, their separate report dated July 31, 2003 appearing herein states that they did not audit and they do not express an opinion on that unaudited financial information. Accordingly, the degree of reliance on their report on such information should be restricted in light of the limited nature of the review procedures applied. PricewaterhouseCoopers LLP is not subject to the liability provisions of Section 11 of the Securities Act of 1933 for their report on the unaudited financial information because that report is not a “report” or a “part” of the registration statement prepared or certified by PricewaterhouseCoopers LLP within the meaning of Sections 7 and 11 of the Act.

PART II — OTHER INFORMATION

ITEM 1. Legal Proceedings

None.

ITEM 2. Changes in Securities and Use of Proceeds

None.

ITEM 3. Defaults Upon Senior Securities

None.

ITEM 4. Submission of Matters to a Vote of Securities Holders

(a) The Company’s Annual Meeting of Shareholders (the “Annual Meeting”) was held on April 23, 2003.

(b) The following Class I directors were elected for a three-year term at the Annual Meeting: John B. Brock III, J. David Heaney, Barry M. Lewis, Andres Palandjoglou and Stanley D. Stearns, Jr.. The following Class II and III directors also continued in office after the Annual Meeting: Carin M. Barth, Ernest H. Cockrell, Paul W. Hobby, John W. Johnson, Walter E. Johnson, Fred R. Lummis, Paul B. Murphy, Jr., Adolph A. Pfeffer, Jr., Wilhelmina E. Robertson, and Thomas F. Soriero, Sr.. No votes were cast against any of the directors. The votes cast for and withheld for each director were as follows:


Director	For		Withheld

John B. Brock III		27,525,071		189,769
J. David Heaney		27,535,259		179,581
Barry M. Lewis		27,535,187		179,653
Andres Palandjoglou		27,518,599		196,241
Stanley D. Stearns, Jr.		27,526,251		188,589

(c) At the Annual Meeting, the Company also ratified the selection of PricewaterhouseCoopers LLP, as the Company’s independent auditors for the year ending December 31, 2003. A total of 27,521,571 votes were cast in favor of such proposal with 190,221 votes cast against the proposal and 3,048 votes abstaining from voting on the proposal.

ITEM 5. Other Information

None.

ITEM 6. Exhibits and Reports on Form 8-K

a.) Exhibits:


*15	.1	Awareness Letter of PricewaterhouseCoopers LLP.
*31	.1	Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
*31	.2	Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
*32	.1	Certification of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
*32	.2	Certification of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

b.) Reports on Form 8-K:

Three reports on Form 8-K were filed by the Company during the three months ended June 30, 2003:

i.) A Current Report on Form 8-K dated April 21, 2003 was filed on April 24, 2003; Item 7(c) and Item 9.

ii.) A Current Report on Form 8-K dated April 23, 2003 was filed on April 24, 2003; Item 7(c) and Item 9.

iii.) A Current Report on Form 8-K dated April 18, 2003 was filed on May 6, 2003; Item 5 and Item 7(c).

* Filed herewith

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.


Signature	Title	Date

/s/ PAUL B. MURPHY, JR. Paul B. Murphy, Jr.	Director, President and Chief Executive Officer (Principal Executive Officer)	August 4, 2003

/s/ RANDALL E. MEYER Randall E. Meyer	Executive Vice President and Chief Financial Officer (Principal Financial Officer)	August 4, 2003

/s/ LAURENCE L. LEHMAN III Laurence L. Lehman III	Vice President and Controller (Principal Accounting Officer)	August 4, 2003

EXHIBIT INDEX


Exhibit
Number			Description


	*15	.1	Awareness Letter of PricewaterhouseCoopers LLP.
	*31	.1	Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	*31	.2	Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	*32	.1	Certification of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
	*32	.2	Certification of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

* Filed herewith


(a)	The Company’s Annual Meeting of Shareholders (the “Annual Meeting”) was held on April 23, 2003.

(b)	The following Class I directors were elected for a three-year term at the Annual Meeting: John B. Brock III, J. David Heaney, Barry M. Lewis, Andres Palandjoglou and Stanley D. Stearns, Jr.. The following Class II and III directors also continued in office after the Annual Meeting: Carin M. Barth, Ernest H. Cockrell, Paul W. Hobby, John W. Johnson, Walter E. Johnson, Fred R. Lummis, Paul B. Murphy, Jr., Adolph A. Pfeffer, Jr., Wilhelmina E. Robertson, and Thomas F. Soriero, Sr.. No votes were cast against any of the directors. The votes cast for and withheld for each director were as follows:


(c)	At the Annual Meeting, the Company also ratified the selection of PricewaterhouseCoopers LLP, as the Company’s independent auditors for the year ending December 31, 2003. A total of 27,521,571 votes were cast in favor of such proposal with 190,221 votes cast against the proposal and 3,048 votes abstaining from voting on the proposal.


	i.)	A Current Report on Form 8-K dated April 21, 2003 was filed on April 24, 2003; Item 7(c) and Item 9.

	ii.)	A Current Report on Form 8-K dated April 23, 2003 was filed on April 24, 2003; Item 7(c) and Item 9.

	iii.)	A Current Report on Form 8-K dated April 18, 2003 was filed on May 6, 2003; Item 5 and Item 7(c).