SOUTHSIDE BANCSHARES INC - 10-K Annual Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM _____ TO _____

COMMISSION FILE NUMBER 0-12247

SOUTHSIDE BANCSHARES, INC.
(Exact name of registrant as specified in its charter)

TEXAS 75-1848732
(State of incorporation) (I.R.S. Employer Identification No.)

1201 S. BECKHAM AVENUE, TYLER, TEXAS 75701
(Address of Principal Executive Offices) (Zip Code)

Registrant's telephone number, including area code: (903) 531-7111

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

COMMON STOCK
(Title of Class)

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [X]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). YES [X] NO [ ]

The aggregate market value of the common stock held by non-affiliates of the
registrant as of June 30, 2002 was $92,347,273.

As of February 28, 2003, 8,382,420 shares of common stock of Southside
Bancshares, Inc. were outstanding. The aggregate market value of common stock
held by nonaffiliates of the registrant as of January 31, 2003 was $103,635,495.

DOCUMENTS INCORPORATED BY REFERENCE

Registrant's Proxy Statement to be filed for the Annual Meeting of
Shareholders to be held April 17, 2003. (Part III)

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PART I

ITEM 1. BUSINESS

FORWARD-LOOKING INFORMATION

Certain statements of other than historical fact that are contained in
this document and in written material, press releases and oral statements issued
by or on behalf of the Company may be considered to be "forward-looking
statements" as that term is defined in the Private Securities Litigation Reform
Act of 1995. These statements may include words such as "expect," "estimate,"
"project," "anticipate," "should," "intend," "probability," "risk," "target,"
"objective" and similar expressions. Forward-looking statements are subject to
significant risks and uncertainties and the Company's actual results may differ
materially from the results discussed in the forward-looking statements. For
example, certain market risk disclosures are dependent on choices about key
model characteristics and assumptions and are subject to various limitations.
See "Item 1 - Business" and "Item 7 - Management's Discussion and Analysis of
Financial Condition and Results of Operations." By their nature, certain of the
market risk disclosures are only estimates and could be materially different
from what actually occurs in the future. As a result, actual income gains and
losses could materially differ from those that have been estimated. Other
factors that could cause actual results to differ materially from
forward-looking statements include, but are not limited to general economic
conditions, either nationally or in the State of Texas, legislation or
regulatory changes which adversely affect the businesses in which the Company is
engaged, changes in the interest rate environment which reduce interest margins,
significant increases in competition in the banking and financial services
industry, changes in consumer spending and bankruptcy rates, borrowing and
saving habits, technological changes, the Company's ability to increase market
share and control expenses, the effect of compliance with legislation or
regulatory changes, the effect of changes in accounting policies and practices
and the costs and effects of unanticipated litigation.

GENERAL

Southside Bancshares, Inc. (the "Company"), incorporated in Texas in
1982, is a bank holding company for Southside Bank (the "Bank" or "Southside
Bank"), headquartered in Tyler, Texas. Tyler has a metropolitan area population
of approximately 175,000 and is located approximately 90 miles east of Dallas,
Texas and 90 miles west of Shreveport, Louisiana. The Bank has the largest
deposit base in the Tyler metropolitan area and is the largest bank based on
asset size headquartered in East Texas.

At December 31, 2002, the Company had total assets of $1.35 billion,
total loans of $582.2 million, deposits of $814.5 million, and shareholders'
equity of $82.2 million. The Company had net income of $13.3 million and $11.7
million and diluted earnings per share of $1.34 and $1.20 for the years ended
December 31, 2002 and 2001, respectively. The Company has paid a cash dividend
every year since 1970.

The Bank is a community-focused financial institution that offers a
full range of financial services to individuals, businesses and nonprofit
organizations in the communities it serves. These services include consumer and
commercial loans, deposit accounts, trust services, safe deposit services and
brokerage services.

The Bank's consumer loan services include 1-4 family residential
mortgage loans, home equity loans, home improvement loans, automobile loans and
other installment loans. Commercial loan services include short-term working
capital loans for inventory and accounts receivable, short and medium-term loans
for equipment or other business capital expansion, commercial real estate loans
and municipal loans. The Bank also offers construction loans primarily for
owner-occupied 1-4 family residential and commercial real estate.

1

The Bank offers a variety of deposit accounts having a wide range of
interest rates and terms, including savings, money market, interest and
noninterest bearing checking accounts and certificate accounts. The Bank's trust
services include investment, management, administration and advisory services,
primarily for individuals and, to a lesser extent, partnerships and
corporations. At December 31, 2002, the Bank's trust department managed
approximately $307 million of trust assets. Through its 25% owned securities
brokerage affiliate, BSC Securities, L.C., the Bank offers full retail
investment services to its customers. Countywide Loans, Inc. ("Countywide"), the
Company's former consumer finance subsidiary, was closed during the fourth
quarter of 2002 due to the Company's inability to penetrate this market in a
profitable manner.

The Company and the Bank are subject to comprehensive regulation,
examination and supervision by the Board of Governors of the Federal Reserve
System (the "FRB"), the Texas Department of Banking (the "TDB") and the Federal
Depository Insurance Corporation (the "FDIC"), and are subject to numerous laws
and regulations relating to the extension of credit, making of loans to
individuals, deposits, and all facets of operations.

The administrative offices of the Company are located at 1201 S.
Beckham Avenue, Tyler, Texas 75701, and the telephone number is 903-531-7111.
The Company's website can be found at www.southside.com. The Company's public
filings with the Securities and Exchange Commission may be obtained free of
charge at the Company's website.

MARKET AREA

The Company considers its primary market area to be all of Smith and
Gregg Counties in East Texas, and to a lesser extent, portions of adjoining
counties. During the first quarter of 2002, the Bank opened one branch in Gregg
County and one branch in Smith County. The Bank opened three additional
branches, all in Smith County, during the second quarter of 2002. The Company
expects its presence in the Gregg County market area to continue to increase in
the future, however, the city of Tyler in Smith County presently represents the
Company's primary market area.

The principal economic activities in the Company's market area include
retail, distribution, manufacturing, medical services, education and oil and gas
industries. Additionally, Tyler's industry base includes conventions and
tourism, as well as retirement relocation. All of these support a growing
regional system of medical service, retail and education centers. Tyler is home
to several nationally recognized health care systems. Tyler hospitals represent
all major specialties and employ approximately 7,800 individuals.

The Bank serves its markets through eighteen full service branch
locations, eleven of which are located in grocery stores. The branches are
located in and around Tyler, Longview, Lindale and Whitehouse. The Company's
television and radio advertising has extended into these market areas for
several years, providing the Bank name recognition throughout Smith and Gregg
counties. Continued advertising combined with strategically placed full service
branches have expanded the Bank's name recognition.

The Bank also maintains six motor bank facilities. The Bank's customers
may also access various banking services through 29 ATMs owned by the Bank and
ATMs owned by others, through debit cards, and through the Bank's automated
telephone, internet and electronic banking products. These products allow the
Bank's customers to apply for loans from their computers, access account
information and conduct various other transactions from their telephones and
computers.

2

LENDING ACTIVITIES

One of the Company's main objectives is to seek attractive lending
opportunities in East Texas, primarily in Smith and Gregg Counties.
Substantially all of the Bank's loans are made to borrowers who live in and
conduct business in East Texas, with the exception of selected municipal loans.
Total loans as of December 31, 2002 increased $44.3 million or 8.2% while the
average balance was up $41.9 million or 8.2% when compared to 2001.

Municipal loans as of December 31, 2002 increased $22.3 million or
41.1% from December 31, 2001. Real estate loans as of December 31, 2002
increased $20.1 million or 6.4% from December 31, 2001 and commercial loans
increased $6.1 million or 7.9%. Loans to individuals decreased $4.1 million or
4.3% from December 31, 2001.

The growth of loans made to municipalities in Texas was a result of the
Company's continued strong commitment in this area. The increase in real estate
loans is due to a stable real estate market, lower interest rates and a strong
commitment by the Company to residential mortgage lending. In the portfolio,
loans dependent upon private household income represent a significant
concentration. Due to the number of customers involved who work in all sectors
of the local economy, the Company believes the risk in this portion of the
portfolio is adequately spread throughout the economic community, which assists
in mitigating this concentration.

The aggregate amount of loans that the Bank is permitted to make under
applicable bank regulations to any one borrower, including related entities, is
25% of unimpaired certified capital and surplus. The Bank's legal lending limit
at December 31, 2002 was $12 million. The Bank's largest loan relationship at
December 31, 2002 was approximately $10.3 million.

The average yield on loans for the year ended December 31, 2002
decreased to 7.17% from 8.17% for the year ended December 31, 2001. This
decrease was reflective of the repricing characteristics of the loans and the
decrease in lending rates during 2002.

LOAN PORTFOLIO COMPOSITION AND ASSOCIATED RISK

The following table sets forth loan totals net of unearned discount by
category for the years presented:

For purposes of this discussion, the Company's loans are divided into
four categories: Real Estate Loans, Commercial Loans, Municipal Loans and Loans
to Individuals.

3

REAL ESTATE LOANS

Real estate loans represent the Company's greatest concentration of
loans. However, the amount of risk associated with this group of loans is
mitigated in part due to the type of loans involved. At December 31, 2002, the
majority of the Company's real estate loans were collateralized by properties
located in Smith and Gregg Counties. Of the $331.3 million in real estate loans,
$156.2 million or 47.1% represent loans collateralized by residential dwellings
that are primarily owner occupied. Historically, the amount of losses suffered
on this type of loan has been significantly less than those on other properties.
The Company's loan policy requires an appraisal or evaluation on the property
based on the size and complexity of the transaction prior to funding any real
estate loan and also outlines the requirements for appraisals on renewals.

Management pursues an aggressive policy of reappraisal on any real
estate loan that is in the process of foreclosure and potential exposures are
recognized and reserved for as soon as they are identified. The slow pace of
absorption for certain types of properties could adversely affect the volume of
nonperforming real estate loans held by the Company.

Real estate loans are divided into three categories: 1-4 Family
Residential Mortgage Loans, Construction Loans and Other. The Other category
consists of $138.6 million of commercial real estate loans, $1.4 million of
loans secured by multi family properties and $0.7 million of loans secured by
farm land. The Commercial Real Estate portion of Other will be discussed in more
detail.

1-4 Family Residential Mortgage Loans

Residential loan originations are generated by the Company's loan
officers, in-house originations staff, marketing efforts, present customers,
walk-in customers and referrals from real estate agents, and builders. The
Company focuses its lending efforts primarily on the origination of loans
secured by first mortgages on owner-occupied, 1-4 family residences.
Substantially all of the Company's 1-4 family residential mortgage originations
are secured by properties located in Smith and Gregg Counties. Historically, the
Company has originated a portion of its residential mortgage loans for sale into
the secondary market. These secondary market investors typically pay the Company
a service release premium in addition to a predetermined price based on the
interest rate of the loan originated. The Company warehouses these loans until
they are transferred to the secondary market investor, which usually occurs
within 45 days.

The Company's fixed rate 1-4 family residential mortgage loans
generally have maturities ranging from five to 30 years. These loans are
typically fully amortizing with monthly payments sufficient to repay the total
amount of the loan or amortizing with a balloon feature, typically due in
fifteen years or less.

The Company reviews information concerning the income, financial
condition, employment and credit history when evaluating the creditworthiness of
the applicant.

The Company also makes home equity loans and at December 31, 2002,
these loans totaled $32.5 million.

Construction Loans

The Company's construction loans are collateralized by property located
primarily in the Company's market area. The Company's emphasis for construction
loans is directed toward properties that will be owner occupied. Occasionally,
construction loans for projects built on speculation are financed, but these
typically have secondary sources of repayment. The Company's construction loans
to individuals have both adjustable and fixed interest rates during the
construction period. Construction loans to individuals are typically made with
the intention of granting the permanent loan on the property.

4

Commercial Real Estate Loans

In determining whether to originate commercial real estate loans, the
Company generally considers such factors as the financial condition of the
borrower and the debt service coverage of the property. Commercial real estate
loans are made at both fixed and adjustable interest rates for terms generally
up to 20 years. Commercial real estate loans primarily include commercial office
buildings, retail, medical and warehouse facilities, hotels and churches. The
majority of these loans, with the exception of those for hotels and churches,
are collateralized by owner occupied properties.

COMMERCIAL LOANS

The Company's commercial loans are diversified to meet most business
needs. Loan types include short-term working capital loans for inventory and
accounts receivable and short and medium-term loans for equipment or other
business capital expansion. Management does not consider there to be any
material concentration of risk in any one industry type, other than medical, in
this loan category since no other industry classification represents over 10% of
loans. The medical community represents a concentration of risk in the Company's
Commercial loan and Commercial Real Estate loan portfolio (see "Market Area").
Risk in the medical community is mitigated because it is spread among multiple
practice types and multiple specialties.

In its commercial business loan underwriting, the Company assesses the
creditworthiness, ability to repay, and the value and liquidity of the
collateral being offered. Terms are generally granted commensurate with the
useful life of the collateral offered.

MUNICIPAL LOANS

The Company formed a special lending department during 1998 that makes
loans to municipalities and school districts throughout the state of Texas. The
majority of the loans to municipalities and school districts have tax or revenue
pledges and in some cases, are additionally supported by collateral. Total loans
to municipalities and school districts as of December 31, 2002 increased $22.3
million while the average balance was up $25.4 million when compared to 2001. At
December 31, 2002, the Company had total loans to municipalities and school
districts of $76.6 million.

LOANS TO INDIVIDUALS

One of the Company's goals is to be a major consumer lender in its
market area. The majority of consumer loans outstanding are collateralized by
titled equipment, primarily vehicles, which accounted for approximately $75.0
million or 81.7% of total loans to individuals at December 31, 2002. The
Company's loans collateralized by titled equipment declined during 2002 due to
the zero interest auto financing and other low interest financing offered by the
automobile industry. Should this type of low financing continue the Company may
see additional decreases in this portfolio. Additionally, the Company makes
loans for a full range of other consumer purposes, which may be secured or
unsecured depending on the credit quality and purpose of the loan.

At this point, the economy in the Bank's market area has shown some
signs of slowing. Two areas of concern are the slow growth of the national
economy and the personal bankruptcy rate. Management expects these two events to
have some adverse effect on the Company's net charge-offs. Most of the Company's
loans to individuals are collateralized, which management believes should limit
the exposure in this area should current bankruptcy levels continue.

Consumer loan terms vary according to the type and value of collateral,
length of contract and creditworthiness of the borrower. The underwriting
standards employed by the Company for consumer loans include an application, a
determination of the applicant's payment history on other debts, with the
greatest weight being given to payment history with the Company, and an
assessment of the borrower's ability to meet existing obligations and payments
on the proposed loan. Although creditworthiness of the applicant is a primary
consideration, the underwriting process also includes a comparison of the value
of the collateral, if any, in relation to the proposed loan amount.

5

LOAN MATURITIES AND SENSITIVITY TO CHANGES IN INTEREST RATES

The following table represents loan maturities and sensitivity to
changes in interest rates. The amounts of total loans outstanding at December
31, 2002, which, based on remaining scheduled repayments of principal, are due
in (1) one year or less*, (2) more than one year but less than five years, and
(3) more than five years*, are shown in the following table. The amounts due
after one year are classified according to the sensitivity to changes in
interest rates.

* The volume of commercial loans due within one year reflects the
Company's general policy of limiting such loans to a short-term
maturity. Loans are shown net of unearned discount. Nonaccrual loans
totaling $2,238,000 are reflected in the due after five years column.

LOANS TO AFFILIATED PARTIES

In the normal course of business, the Company's subsidiary, Southside
Bank, makes loans to certain of the Company's, as well as its own, officers,
directors, employees and their related interests. As of December 31, 2002 and
2001, these loans totaled $8.0 million and $8.1 million or 9.8% and 11.8% of
Shareholders' Equity, respectively. Such loans are made in the normal course of
business at normal credit terms, including interest rate and collateral
requirements and do not represent more than normal credit risks contained in the
rest of the loan portfolio for loans of similar types.

6

LOAN LOSS EXPERIENCE AND RESERVE FOR LOAN LOSSES

The loan loss reserve is based on the most current review of the loan
portfolio at that time. Several methods are used to maintain the review in the
most current manner. First, the servicing officer has the primary responsibility
for updating significant changes in a customer's financial position.
Accordingly, each officer prepares status updates on any credit deemed to be
experiencing repayment difficulties which, in the officer's opinion, would place
the collection of principal or interest in doubt. Second, an internal loan
review officer from the Company is responsible for an ongoing review of the
Company's entire loan portfolio with specific goals set for the volume of loans
to be reviewed on an annual basis. Independent Bank Services, L.C., a partially
owned subsidiary of the Bank, supplements the internal loan review officer's
process by performing additional loan reviews designed to achieve overall goals
of penetration. Third, Southside Bank is regulated and examined by the FDIC and
the Texas Department of Banking on an annual basis.

At each review of a credit, a subjective analysis methodology is used
to grade the respective loan. Categories of grading vary in severity to include
loans which do not appear to have a significant probability of loss at the time
of review to grades which indicate a probability that the entire balance of the
loan will be uncollectible. If full collection of the loan balance appears
unlikely at the time of review, estimates or appraisals of the collateral
securing the debt are used to allocate the necessary reserves. A list of loans
or loan relationships of $50,000 or more, which are graded as having more than
the normal degree of risk associated with them, is maintained by the internal
loan review officer. This list is updated on a periodic basis, but no less than
quarterly in order to properly allocate necessary reserves and keep management
informed on the status of attempts to correct the deficiencies noted in the
credit.

Industry experience shows that a portion of the Company's loans will
become delinquent and a portion of the loans will require partial or entire
charge-off. Regardless of the underwriting criteria utilized, losses may be
experienced as a result of various factors beyond the Company's control,
including, among other things, changes in market conditions affecting the value
of properties and problems affecting the credit of the borrower. Management's
determination of the adequacy of allowance for loan losses is based on various
considerations, including an analysis of the risk characteristics of various
classifications of loans, previous loan loss experience, specific loans which
would have loan loss potential, delinquency trends, estimated fair value of the
underlying collateral, current economic conditions, the views of the regulators
(who have the authority to require additional reserves), and geographic and
industry loan concentration.

In addition to maintaining an ongoing review of the loan portfolio, the
internal loan review officer maintains a history of the loans that have been
charged-off without first being identified as problems. This history is used to
assist in gauging the amount of nonspecifically allocated reserve necessary, in
addition to the portion which is specifically allocated by loan. The internal
loan review officer also uses the loan portfolio data collected to determine the
allocation of reserve for loan loss appropriate for the risk in each of the
Company's major loan categories.

As of December 31, 2002, the Company's review of the loan portfolio
indicates that a loan loss reserve of $6.2 million is adequate to cover probable
losses in the portfolio.

7

The following table presents information regarding the average amount
of net loans outstanding, changes in the reserve for loan losses, the ratio of
net loans charged-off to average net loans outstanding and an allocation of the
reserve for loan losses.

LOAN LOSS EXPERIENCE AND RESERVE FOR LOAN LOSSES

Allocation of Reserve for Loan Loss (dollars in thousands):

See "Consolidated Financial Statements - Note 6. Loans and Reserve for
Possible Loan Losses."

8

NONPERFORMING ASSETS

Nonperforming assets consist of delinquent loans over 90 days past due,
nonaccrual loans, other real estate owned, repossessed assets and restructured
loans. Nonaccrual loans are those loans which are more than 90 days delinquent
and collection in full of both the principal and interest is in doubt.
Additionally, some loans that are not delinquent may be placed on nonaccrual
status due to doubts about full collection of principal or interest. When a loan
is categorized as nonaccrual, the accrual of interest is discontinued and the
accrued balance is reversed for financial statement purposes. Restructured loans
represent loans which have been renegotiated to provide a reduction or deferral
of interest or principal because of deterioration in the financial position of
the borrowers. Categorization of a loan as nonperforming is not in itself a
reliable indicator of potential loan loss. Other factors, such as the value of
collateral securing the loan and the financial condition of the borrower must be
considered in judgments as to potential loan loss. Other Real Estate Owned
(OREO) represents real estate taken in full or partial satisfaction of debts
previously contracted.

Total nonperforming assets at December 31, 2002 were $3.4 million, up
$983,000 or 40.9% from $2.4 million at December 31, 2001. Other real estate
owned increased $459,000 or 706.2% to $524,000 from December 31, 2001 to
December 31, 2002. Of this total, 7.3% consist of a residential dwelling, 52.5%
is the construction of a residential dwelling and 40.2% is a commercial lot and
building. The Company is actively marketing all properties and none are being
held for investment purposes. From December 31, 2001 to December 31, 2002,
nonaccrual loans increased $1.3 million or 149.8% to $2.2 million. Of this
total, 9.7% are construction and land development loans, 30.8% are residential
real estate loans, 7.9% are commercial real estate loans, 30.1% are commercial
loans and 21.5% are loans to individuals. Restructured loans increased $42,000
or 14.8% to $325,000. Loans 90 days past due or more decreased $658,000 or 69.6%
to $287,000. Repossessed assets decreased $202,000 or 94.8% to $11,000.

The following table of nonperforming assets is classified according to
bank regulatory call report guidelines:

NONPERFORMING ASSETS

9

Nonperforming assets as a percentage of total assets increased 0.06%
from the previous year and as a percentage of loans increased 0.13%.
Nonperforming assets represent a drain on the earning ability of the Company.
Earnings losses are due both to the loss of interest income and the costs
associated with maintaining the OREO, for taxes, insurance and other operating
expenses. In addition to the nonperforming assets, at December 31, 2002 in the
opinion of management, the Company had $538,000 of loans identified as potential
problem loans. A potential problem loan is a loan where information about
possible credit problems of the borrower is known, causing management to have
serious doubts about the ability of the borrower to comply with the present loan
repayment terms and may result in a future classification of the loan in one of
the nonperforming asset categories.

The following is a summary of the Company's recorded investment in
loans (primarily nonaccrual loans) for which impairment has been recognized in
accordance with FAS114:

For the years ended December 31, 2002 and 2001, the average recorded
investment in impaired loans was approximately $1,562,000 and $801,000,
respectively. During the years ended December 31, 2002 and 2001, the amount of
interest income reversed on impaired loans placed on nonaccrual and the amount
of interest income subsequently recognized on the cash basis was not material.

The net amount of interest recognized on loans that were nonaccruing or
restructured during the year was $160,000, $70,000 and $122,000 for the years
ended December 31, 2002, 2001 and 2000, respectively. If these loans had been
accruing interest at their original contracted rates, related income would have
been $205,000, $113,000 and $138,000 for the years ended December 31, 2002, 2001
and 2000, respectively.

The following is a summary of the Allowance for Losses on Other Real
Estate Owned for the years presented:

10

SECURITIES ACTIVITY

The securities portfolio of the Company plays a primary role in
management of the interest rate sensitivity of the Company and, therefore, is
managed in the context of the overall balance sheet. The securities portfolio
generates a substantial percentage of the Company's interest income and serves
as a necessary source of liquidity.

The Company accounts for debt and equity securities as follows:

Held to Maturity (HTM). Debt securities that management has the
positive intent and ability to hold until maturity are classified as
HTM and are carried at their remaining unpaid principal balance, net of
unamortized premiums or unaccreted discounts. Premiums are amortized
and discounts are accreted using the level interest yield method over
the estimated remaining term of the underlying security.

Available for Sale (AFS). Debt and equity securities that will be held
for indefinite periods of time, including securities that may be sold
in response to changes in market interest or prepayment rates, needs
for liquidity and changes in the availability of and the yield of
alternative investments are classified as AFS. These assets are carried
at market value. Market value is determined using published quotes as
of the close of business. Unrealized gains and losses are excluded from
earnings and reported net of tax as a separate component of
shareholders' equity until realized.

Management attempts to deploy investable funds into instruments which
are expected to provide a reasonable overall return of the portfolio given the
current assessment of economic and financial conditions, while maintaining
acceptable levels of capital, interest rate and liquidity risk.

The following table sets forth the carrying amount of investment
securities, mortgage-backed securities and marketable equity securities at
December 31, 2002, 2001 and 2000:

11

The Company invests in mortgage-backed and related securities,
including mortgage participation certificates, which are insured or guaranteed
by U.S. Government agencies and government sponsored enterprises, and
collateralized mortgage obligations and real estate mortgage investment
conduits. Mortgage-backed securities (which also are known as mortgage
participation certificates or pass-through certificates) represent a
participation interest in a pool of single-family or multi-family mortgages, the
principal and interest payments on which are passed from the mortgage
originators, through intermediaries (generally U.S. Government agencies,
government sponsored enterprises, and direct whole loans) that pool and
repackage the participation interests in the form of securities, to investors
such as the Company. U.S. Government agencies and government sponsored
enterprises, which guarantee the payment of principal and interest to investors,
primarily include the Federal Home Loan Mortgage Corporation, the Federal
National Mortgage Association and the Government National Mortgage Association.
The whole loans the Company purchases are all AAA rated collateralized mortgage
obligations and real estate mortgage investment conduit tranches rated AAA due
to credit support and/or insurance coverage.

Mortgaged-backed securities typically are issued with stated principal
amounts, and the securities are backed by pools of mortgages that have loans
with interest rates that are within a range and have varying maturities. The
characteristics of the underlying pool of mortgages, such as, fixed-rate or
adjustable-rate, as well as prepayment risk, are passed on to the certificate
holder. The term of a mortgaged-backed pass-through security thus approximates
the term of the underlying mortgages.

The Company's mortgaged-backed derivative securities include
collateralized mortgage obligations, which include securities issued by entities
which have qualified under the Internal Revenue Code as real estate mortgage
investment conduits. Collateralized mortgage obligations and real estate
mortgage investment conduits (collectively collateralized mortgage obligations)
have been developed in response to investor concerns regarding the uncertainty
of cash flows associated with the prepayment option of the underlying mortgagor
and are typically issued by governmental agencies, government sponsored
enterprises and special purpose entities, such as trusts, corporations or
partnerships, established by financial institutions or other similar
institutions. A collateralized mortgage obligation can be collateralized by
loans or securities which are insured or guaranteed by Federal National Mortgage
Association, Federal Home Loan Mortgage Corporation, the Government National
Mortgage Association, or whole loans which, in the Company's case, are all rated
AAA. In contrast to pass-through mortgage-backed securities, in which cash flow
is received pro rata by all security holders, the cash flow from the mortgages
underlying a collateralized mortgage obligation is segmented and paid in
accordance with a predetermined priority to investors holding various
collateralized mortgage obligation classes. By allocating the principal and
interest cash flows from the underlying collateral among the separate
collateralized mortgage obligation classes, different classes of bonds are
created, each with its own stated maturity, estimated average life, coupon rate
and prepayment characteristics.

Like most fixed-income securities, mortgage-backed and related
securities are subject to interest rate risk. However, unlike most fixed-income
securities, the mortgage loans underlying a mortgage-backed or related security
generally may be prepaid at any time without penalty. The ability to prepay a
mortgage loan generally results in significantly increased price and yield
volatility (with respect to mortgage-backed and related securities) than is the
case with non-callable fixed income securities. Furthermore, mortgage-backed
derivative securities often are more sensitive to changes in interest rates and
prepayments than traditional mortgage-backed securities and are, therefore, even
more volatile.

The combined investment securities, mortgage-backed securities, and
marketable equity securities portfolio increased to $662.9 million at December
31, 2002, compared to $634.2 million at December 31, 2001, an increase of $28.7
million or 4.5%. Mortgage-backed securities increased $34.9 million or 7.7%
during 2002 when compared to 2001. State and Political Subdivisions decreased
$14.8 million or 11.7% during 2002. U.S. Treasury securities increased during
2002 compared to 2001 by $15.8 million or 142.7%, U. S. Government agency
securities decreased $8.4 million or 39.4%. Other stocks and bonds increased
$1.2 million or 5.4% in 2002 compared to 2001 due to increases of $1.1 million
in FHLB Dallas stock purchases and dividends. During 2002, interest rates
declined and the yield curve remained steep. The Company used this low interest
rate environment to reposition the securities portfolio in an attempt to reduce
the overall duration and minimize prepayment of premium mortgage-backed
securities. Higher coupon premium mortgage-backed securities with high selling
prices or with a potentially greater prepayment exposure were replaced with
mortgage-backed securities that had characteristics which potentially might
reduce the prepayment exposure. In some cases, higher coupon premium 30 year
mortgage-backed securities with prepayment exposure were replaced with lower

12

coupon premium 15 year mortgage-backed securities which lowered the overall
duration and potentially reduced the prepayment exposure. Specific lower coupon
or long duration municipal securities were sold and partially replaced with
higher coupon municipal securities. The decrease in the municipal securities
portfolio was due partially in response to the growth of the Company's municipal
loan portfolio and the amount of tax free income the Company can support without
being subject to alternative minimum tax long-term.

On January 1, 2001, the Company adopted Financial Accounting Standard
No. 133, "Accounting for Derivative Instruments and Hedging Activities,"
(FAS133). As allowed by FAS133, at the date of initial application of this
statement, the Company transferred held to maturity securities into the
available for sale category and the trading category. The Company sold the
securities transferred into the trading category during the first quarter of
2001. The effect of selling the securities in the trading category is shown as a
cumulative effect of a change in accounting principle and reduced net income by
$994,000 (net of taxes) during the first quarter of 2001. During 2001, the
Company sold available for sale securities which resulted in realized gains of
$4.1 million or an after tax gain of $2.7 million. These separate transactions
allowed the Company to reduce the overall duration of and reposition the
securities portfolio.

During the second quarter ended June 30, 2000, the Company issued $54.6
million of long-term brokered CDs with one-year call options and additional call
options every six months thereafter, until the CDs mature. The average yield on
these CDs was 8.19% with an average life of 10.8 years. Obtaining this long-term
funding enabled the Bank to take advantage of the higher interest rate
environment, during the first half of 2000 primarily through the purchase of
securities without incurring significant additional interest rate risk. The
options associated with these CDs provided the Bank with valuable balance sheet
opportunities. The higher cost associated with these callable CDs had a negative
impact on the net interest spread during the five quarters ended June 30, 2001.
In conjunction with the issuance of these long-term brokered CDs, securities
were purchased with an overall duration and yield approximately that of the
brokered CDs.

During March 2001, the Company notified CD holders that $24.6 million
of brokered CDs were being called April 12, 2001. The Company recorded $195,000
of additional interest expense associated with the call of the CDs during the
first quarter ended March 31, 2001. Gains on sales of securities were used to
offset this expense. During April 2001, the Company notified CD holders that the
remaining $30.0 million of brokered CDs would be called May 24, 2001. An
additional $357,000 of expense was incurred during the second quarter ending
June 30, 2001, associated with the call of the brokered CDs. These CDs were
replaced with long-term advances from the FHLB at an average rate of
approximately 5.40%. As a result, the Company's interest expense on this $54.6
million declined after the CDs were called. The Company's current policy allows
for a maximum of $100 million in brokered CDs. The potential higher interest
cost and lack of customer loyalty are risks associated with the use of brokered
CDs. At December 31, 2002 and 2001, the Company had no brokered CDs and brokered
CDs represented zero percent of deposits.

The market value of the securities portfolio at December 31, 2002 was
$662.9 million, which represented a net unrealized gain on that date of $14.1
million. The net unrealized gain was comprised of $14.8 million in unrealized
gains and $0.7 million of unrealized losses. Net unrealized gains and losses on
AFS securities, which is a component of shareholders' equity on the consolidated
balance sheet, can fluctuate significantly as a result of changes in interest
rates. Because management cannot predict the future direction of interest rates,
the effect on shareholders' equity in the future cannot be determined; however,
this risk is monitored closely through the use of shock tests on the AFS
securities portfolio using an array of interest rate assumptions.

During the month ended January 31, 2000, the Company transferred
securities totaling $91.7 million from AFS to HTM due to changes in market
conditions. Of the total transferred, $21.2 million were investment securities
and $70.5 million were mortgage-backed securities. The unrealized loss on the
securities transferred from AFS to HTM was $2.6 million, net of tax, at the date
of transfer. There were no sales from the HTM portfolio during the years ended
December 31, 2002 or 2001. There were no securities classified as HTM for the
years ended December 31, 2002 and 2001.

13

The maturities classified according to the sensitivity to changes in
interest rates of the December 31, 2002 securities portfolio and the weighted
yields are presented below. Tax-exempt obligations are shown on a taxable
equivalent basis. Mortgage-backed securities are classified according to
repricing frequency and cash flows from street estimates of principal
prepayments.

DEPOSITS AND BORROWED FUNDS

Deposits provide the Company with its primary source of funds. The
increase of $56.5 million or 7.5% in total deposits during 2002 provided the
Company with funds for the growth in loans. Time deposits decreased $828,000 or
0.2% during 2002 compared to 2001. Noninterest bearing demand deposits increased
$21.5 million or 12.5% during 2002. Interest bearing demand deposits increased
$27.5 million or 13.0% and Saving Deposits increased $8.4 million or 28.3%
during 2002. The latter three categories, which are considered the lowest cost
deposits, comprised 57.6% of total deposits at December 31, 2002 compared to
54.4% at December 31, 2001. The increase in total deposits was reflective of
overall bank growth and branch expansion.

The following table sets forth the Company's deposits by category at
December 31, 2002, 2001 and 2000:

14

During the year ended December 31, 2002, total time deposits of
$100,000 or more increased $1.2 million from December 31, 2001. Total time
deposits of $100,000 or more not including State of Texas time deposits
increased $5.7 million or 5.7% during 2002 compared to 2001, while State of
Texas time deposits decreased $4.5 million or 11.3%.

The table below sets forth the maturity distribution of time deposits
of $100,000 or more issued by the Company at December 31, 2002 and 2001:

Short-term Obligations, consisting primarily of FHLB Dallas advances
and Federal Funds Purchased, increased $29.2 million or 20.5% during 2002 when
compared to 2001. FHLB Dallas advances are collateralized by FHLB Dallas stock,
nonspecified real estate loans and securities.

(1) The average amount outstanding during the period was computed by
dividing the total daily outstanding principal balances by the number
of days in the period.

(2) The weighted average interest rate during the period was computed by
dividing the actual interest expense by the average balance outstanding
during the period.

15

Long-term Obligations of FHLB Dallas advances decreased $29.6 million
or 11.3% during 2002 to $231.1 million when compared to $260.7 million in 2001.
The decrease was primarily the result of a reclassification of long term
advances to the short-term category based on their respective maturity dates.
This reclassification more than offset the new long term advances obtained
during 2002.

Long-term junior subordinated debentures decreased $2.7 million during
2002 to $34.2 million or a 7.4% decrease when compared to $36.95 million in
2001. During the year ended December 31, 2002, 272,464 convertible trust
preferred shares were converted into the Company's common stock. The total
convertible trust preferred shares converted to date represents 16.1% of the
initial convertible trust preferred issue.

On November 2, 2000, the Company through its wholly-owned subsidiary,
Southside Capital Trust II (the "Trust II Issuer"), sold 1,695,000 cumulative
convertible preferred securities (the "junior subordinated convertible
debentures") at a liquidation amount of $10 per convertible preferred security
for an aggregate amount of $16,950,000. These securities have a convertible
feature that allows the owner to convert each security to a share of the
Company's common stock at a conversion price of $9.07 per common share. These
securities have a distribution rate of 8.75% per annum payable at the end of
each calendar quarter.

On May 18, 1998, the Company through its wholly-owned subsidiary,
Southside Capital Trust (the "Trust Issuer"), sold 2,000,000 preferred
securities (the "junior subordinated debentures") at a liquidation amount of $10
per preferred security for an aggregate amount of $20,000,000. These securities
have a distribution rate of 8.50% per annum payable at the end of each calendar
quarter.

THE BANKING INDUSTRY IN TEXAS

The banking industry is affected by general economic conditions such as
interest rates, inflation, recession, unemployment and other factors beyond the
Company's control. During the last ten years the East Texas economy has
diversified, decreasing the overall impact of fluctuating oil prices, however,
the East Texas economy is still affected by the oil industry. During 2001 and
2002 the economy in the Bank's market area has shown some signs of slowing. The
two areas of concern are the slow growth of the national economy and the
personal bankruptcy rate. Management expects these trends to have some effect on
the Company's net charge-offs. Management of the Company, however, cannot
predict whether current economic conditions will improve, remain the same or
decline.

16

COMPETITION

The activities engaged in by the Company and its subsidiary, Southside
Bank, are highly competitive. Financial institutions such as savings and loan
associations, credit unions, consumer finance companies, insurance companies,
brokerage companies and other financial institutions with varying degrees of
regulatory restrictions compete vigorously for a share of the financial services
market. Brokerage companies continue to become more competitive in the financial
services arena and pose an ever increasing challenge to banks. Legislative
changes also greatly affect the level of competition the Company faces. During
1998 federal legislation allowed credit unions to expand their membership
criteria. This allows credit unions to use their expanded membership
capabilities combined with tax-free status to compete more fiercely for
traditional bank business. Because banks do not enjoy a tax-free status, credit
unions have a competitive advantage. Currently, the Company must compete against
several institutions located in East Texas and elsewhere in the Company's market
area which have capital resources and legal loan limits substantially in excess
of those available to the Company and Southside Bank. The Company faces
competition from institutions that offer products and services the Company does
not or cannot currently offer. Some institutions the Company competes with offer
interest rate levels on loan and deposit products the Company is unable to
profitably offer. The Company expects the competition to increase.

EMPLOYEES

At December 31, 2002, the Company employed approximately 442 full time
equivalent persons. None of the employees are represented by any unions or
similar groups, and the Company has not experienced any type of strike or labor
dispute. The Company considers the relationship with its employees to be good.

EXECUTIVE OFFICERS OF THE REGISTRANT

The executive officers of the Company and Southside Bank as of December
31, 2002, were as follows:

B. G. Hartley (Age 73), Chairman of the Board and Chief Executive Officer of the
Company since 1983. He also serves as Chairman of the Board and Chief Executive
Officer of the Company's subsidiary, Southside Bank, having served in these
capacities since the Bank's inception in 1960.

Sam Dawson (Age 55), President, Secretary and Director of the Company.
President, Chief Operations Officer and Director of the Company's subsidiary,
Southside Bank since 1996. He became an officer of the Company in 1982 and of
Southside Bank during 1975.

Robbie N. Edmonson (Age 70), Vice Chairman of the Board of the Company and the
Company's subsidiary, Southside Bank. He joined Southside Bank as a vice
president in 1968.

Jeryl Story (Age 51), Executive Vice President of the Company. Senior Executive
Vice President - Loan Administration, Senior Lending Officer and Director of the
Company's subsidiary, Southside Bank, since 1996. He joined Southside Bank in
1979 as an officer in Loan Documentation.

Lee R. Gibson (Age 46), Executive Vice President and Chief Financial Officer of
the Company and of the Company's subsidiary, Southside Bank. He is also a
Director of Southside Bank. He became an officer of the Company in 1985 and of
Southside Bank during 1984.

All the individuals named above serve in their capacity as officers of
the Company and/or Southside Bank and are appointed by each entities' Board of
Directors.

17

SUPERVISION AND REGULATION

Banking is a complex, highly regulated industry. Consequently, the
Company's growth and earnings performance can be affected not only by decisions
of management and national and local economic conditions, but also by the
statutes administered by, and the regulations and policies of, various
governmental authorities. These authorities include, but are not limited to, the
Board of Governors of the Federal Reserve System (the "Federal Reserve"), the
Federal Deposit Insurance Corporation, the Department of Banking of the State of
Texas, United States Department of Treasury (the "Treasury Department") the
Internal Revenue Service and state taxing authorities.

The primary goals of the bank regulatory scheme are to maintain a safe
and sound banking system and to facilitate the conduct of sound monetary policy.
In furtherance of these goals, Congress has created several largely autonomous
regulatory agencies and enacted numerous laws that govern banks, bank holding
companies and the banking industry. The system of supervision and regulation
applicable to the Bank and the Company establishes a comprehensive framework for
the Company's operations and is intended primarily for the protection of the
Federal Deposit Insurance Corporation's deposit insurance funds the Bank's
depositors and the public, rather than the Company's shareholders and creditors.
The following is an attempt to summarize some of the relevant laws, rules and
regulations governing banks and bank holding companies, but does not purport to
be a complete summary of all applicable laws, rules and regulations governing
banks and bank holding companies. The descriptions are qualified in their
entirety by reference to the specific statutes and regulations discussed.

The Company

Bank Holding Company Act. As bank holding companies under the Bank
Holding Company Act of 1956, as amended, the Company and Southside Delaware are
registered with and subject to regulation by the Federal Reserve. The Company
and Southside Delaware are both required to file annual and other reports with,
and furnish information to, the Federal Reserve, which makes periodic
inspections of the Company and Southside Delaware.

The Bank Holding Company Act provides that a bank holding company must
obtain the prior approval of the Federal Reserve (i) for the acquisition of more
than five percent of the voting stock in any bank or bank holding company, (ii)
for the acquisition of substantially all the assets of any bank or bank holding
company or (iii) in order to merge or consolidate with another bank holding
company. The Bank Holding Company Act also provides that, with certain
exceptions, a bank holding company may not engage in any activities other than
those of banking or managing or controlling banks and other authorized
subsidiaries or own or control more than five percent of the voting shares of
any company that is not a bank. The Federal Reserve has deemed limited
activities to be closely related to banking and therefore permissible for a bank
holding company. As discussed below, the Gramm-Leach-Bliley Act, which was
enacted in 1999, established a new type of bank holding company known as a
"financial holding company" that has powers that are not otherwise available to
bank holding companies.

The Bank Holding Company Act restricts the extension of credit to any
bank holding company by its subsidiary bank. Federal regulatory agencies also
have authority to regulate debt obligations (other than commercial paper) issued
by bank holding companies. This authority includes the power to impose interest
ceilings and reserve requirements on such debt obligations. A bank holding
company and its subsidiaries are also prohibited from engaging in certain tie-in
arrangements in connection with any extension of credit, lease or sale of
property or furnishing of services.

The Federal Reserve has cease-and-desist powers over bank holding
companies and their nonbanking subsidiaries where their actions would constitute
a serious threat to the safety, soundness or stability of a subsidiary bank.

Gramm-Leach-Bliley Act. Traditionally, the activities of bank holding
companies had been limited to the business of banking and activities closely
related or incidental to banking. The Gramm-Leach-Bliley Financial Services Act
of 1999 ("GLBA"), which became effective on March 11, 2000, amended the Bank
Holding Company Act and removed certain legal barriers separating the conduct of
various types of financial services

18

businesses. In addition, GLBA substantially revamped the regulatory scheme
within which financial institutions operate.

Under GLBA, bank holding companies meeting certain eligibility
requirements may elect to become a "financial holding company." A financial
holding company may engage in activities that are "financial in nature," as well
as additional activities that the Federal Reserve or Treasury Department
determine are financial in nature or incidental or complimentary to financial
activities. Under GLBA, "financial activities" specifically include insurance,
securities underwriting and dealing, merchant banking, investment advisory and
lending activities.

A bank holding company may become a financial holding company under
GLBA if each of its subsidiary banks is "well capitalized" under the Federal
Deposit Insurance Corporation Improvement Act prompt corrective action
provisions, is "well managed" and has at least a "satisfactory" rating under the
Community Reinvestment Act. In addition, the bank holding company must file a
declaration with the Federal Reserve that the bank holding company elects to
become a financial holding company. A bank holding company that falls out of
compliance with these requirements may be required to cease engaging in some of
its activities.

In a similar manner, GLBA expanded the types of activities in which a
bank may engage. Generally, a bank may engage in activities that are financial
in nature through a "financial subsidiary" if the bank and each of its
depository institution affiliates are "well capitalized," "well managed" and
have at least a "satisfactory" rating under the Community Reinvestment Act.
However, applicable law and regulation provide that the amount of investment in
these activities generally are limited to 45% of the total assets of the bank,
and these investments are not aggregated with the bank for determining
compliance with capital adequacy guidelines. Further, the transactions between
the bank and this type of subsidiary are subject to a number of limitations.

Under GLBA, the Federal Reserve serves as the primary "umbrella"
regulator of financial holding companies, with supervisory authority over each
parent company and limited authority over its subsidiaries. Expanded financial
activities of financial holding companies generally will be regulated according
to the type of such financial activity: banking activities by banking
regulators, securities activities by securities regulators and insurance
activities by insurance regulators. GLBA also imposes additional restrictions
and heightened disclosure requirements regarding private information collected
by financial institutions. The Company has not elected to become a financial
holding company and to conduct the broader activities permitted under GLBA.
However, there can be no assurance that the Company will not make such an
election in the future.

Interstate Banking. Federal banking law generally provides that a bank
holding company may acquire or establish banks in any state of the United
States, subject to certain aging and deposit concentration limits. In addition,
Texas banking laws permit a bank holding company which owns stock of a bank
located outside the State of Texas to acquire a bank or bank holding company
located in Texas. This type of acquisition may occur only if the Texas bank to
be directly or indirectly controlled by the out-of-state bank holding company
has existed and continuously operated as a bank for a period of at least five
years. In any event, a bank holding company may not own or control banks in
Texas the deposits of which would exceed 20% of the total deposits of all
federally-insured deposits in Texas. The Company has no present plans to acquire
or establish banks outside the State of Texas but has not eliminated the
possibility of doing so.

Capital Adequacy. The Federal Reserve monitors the capital adequacy of
bank holding companies, such as Southside Delaware and the Company, and the
Federal Deposit Insurance Corporation monitors the capital adequacy of the Bank.
The federal bank regulators use a combination of risk-based guidelines and
leverage ratios to evaluate capital adequacy and consider the Company's and the
Bank's capital levels when taking action on various types of applications and
when conducting supervisory activities related to the safety and soundness of
the Company and the Bank.

The Federal Reserve's capital adequacy regulations are based upon a
risk based capital determination, whereby a bank holding company's capital
adequacy is determined in light of the risk, both on- and off-balance sheet,
contained in the company's assets. Different categories of assets are assigned
risk weightings and are counted at a percentage of their book value.

19

The regulations divide capital between Tier 1 capital (core capital)
and Tier 2 capital. For a bank holding company, Tier 1 capital consists
primarily of common stock, related surplus, noncumulative perpetual preferred
stock, minority interests in consolidated subsidiaries and a limited amount of
qualifying cumulative preferred securities. Goodwill and certain other
intangibles are excluded from Tier 1 capital. Tier 2 capital consists of an
amount equal to the allowance for loan and lease losses up to a maximum of 1.25%
of risk weighted assets, limited other types of preferred stock not included in
Tier 1 capital, hybrid capital instruments and term subordinated debt.
Investments in and loans to unconsolidated banking and finance subsidiaries that
constitute capital of those subsidiaries are excluded from capital. The sum of
Tier 1 and Tier 2 capital constitutes qualifying total capital, and the Tier 1
component must comprise at least 50% of qualifying total capital.

Under regulatory capital guidelines, the Company must maintain a
minimum Tier 1 capital ratio of at least 4.0% and a minimum total capital ratio
of at least 8.0%. In addition, banks and bank holding companies are required to
maintain a minimum leverage ratio of Tier 1 capital to average total
consolidated assets (leverage capital ratio) of at least 3.0% for the most
highly-rated, financially sound banks and bank holding companies and a minimum
leverage ratio of at least 4.0% for all other banks. As of December 31, 2002,
the Company's total risk-based capital ratio was 17.73%, the Company's Tier 1
risk-based capital ratio was 15.17% and the Company's leverage capital ratio was
7.29%.

The guidelines also provide that banking organizations experiencing
internal growth or making acquisitions will be expected to maintain strong
capital positions substantially above the minimum supervisory level, without
significant reliance on intangible assets and that the Federal Reserve will
continue to consider a "Tangible Tier 1 Leverage Ratio" in evaluating proposals
for expansion or new activities. The Tangible Tier 1 Leverage Ratio is the ratio
of Tier 1 capital, less intangibles not deducted from Tier 1 capital, to
quarterly average total assets. As of December 31, 2002, the Federal Reserve had
not advised us of any specific minimum Tangible Tier 1 Leverage Ratio applicable
to the Company.

Dividends. As a bank holding company that does not, as an entity,
currently engage in separate business activities of a material nature, the
Company's ability to pay cash dividends depends upon the cash dividends it
receives from the Bank through Southside Delaware. The Company's sources of
income are dividends paid by the Bank. The Company must pay all of its operating
expenses from funds the Company received from the Bank. Therefore, shareholders
may receive dividends from the Company only to the extent that funds are
available after payment of the Company's operating expenses. In addition, in
November 1985 the Federal Reserve adopted a policy statement concerning payment
of cash dividends, which generally prohibits bank holding companies from paying
dividends except out of operating earnings, and the prospective rate of earnings
retention appears consistent with the bank holding company's capital needs,
asset quality and overall financial condition. The Company is also subject to
certain restrictions on the payment of dividends as a result of the requirement
that the Company maintain an adequate level of capital as described above.

Change in Bank Control Act. Under the Change in Bank Control Act,
persons who intend to acquire control of a bank holding company, either directly
or indirectly, must give 60 days prior notice to the Federal Reserve. "Control"
would exist when an acquiring party directly or indirectly has control of at
least 25% of the Company's voting securities or the power to direct the
management or policies of the Company. Under Federal Reserve regulations, a
rebuttable presumption of control would arise with respect to an acquisition
where, after the transaction, the acquiring party has ownership control or the
power to vote at least 10% (but less than 25%) of the Company's voting
securities.

The Bank

The Bank is subject to various requirements and restrictions under the
laws of the United States and the State of Texas, and to regulation, supervision
and regular examination by the Texas Department of Banking and the Federal
Deposit Insurance Corporation. The Texas Department of Banking and the Federal
Deposit Insurance Corporation have the power to enforce compliance with
applicable banking statutes and regulations. These requirements and restrictions
include requirements to maintain reserves against deposits, restrictions on the
nature and amount of loans that may be made and the interest that may be charged
thereon and restrictions relating to investments and other activities of the
Bank.

20

Regulation of Lending Activities. Loans made by the Bank are subject to
numerous federal and state laws and regulations, including the Truth-In-Lending
Act, Federal Consumer Credit Protection Act, the Texas Finance Code. The Texas
Consumer Credit Code, the Texas Consumer Protection Code, the Equal Credit
Opportunity Act, the Real Estate Settlement Procedures Act and adjustable rate
mortgage disclosure requirements. Remedies to the borrower or consumer and
penalties to the Bank are provided if the Bank fails to comply with these laws
and regulations. The scope and requirements of these laws and regulations have
expanded significantly in recent years.

Dividends. All dividends paid by the Bank are paid to the Company, the
sole indirect shareholder of the Bank, through Southside Delaware. The general
dividend policy of the Bank is to pay dividends at levels consistent with
maintaining liquidity and preserving applicable capital ratios and servicing
obligations. The dividend policy of the Bank is subject to the discretion of the
board of directors of the Bank and will depend upon such factors as future
earnings, financial conditions, cash needs, capital adequacy, compliance with
applicable statutory and regulatory requirements and general business
conditions.

The ability of the Bank, as a Texas banking association, to pay
dividends is restricted under applicable law and regulations. The Bank generally
may not pay a dividend reducing its capital and surplus without the prior
approval of the Texas Banking Commissioner. All dividends must be paid out of
net profits then on hand, after deducting expenses, including losses and
provisions for loan losses. The Federal Deposit Insurance Corporation has the
right to prohibit the payment of dividends by the Bank where the payment is
deemed to be an unsafe and unsound banking practice. The Bank is also subject to
certain restrictions on the payment of dividends as a result of the requirements
that it maintain an adequate level of capital in accordance with guidelines
promulgated from time to time by the Federal Deposit Insurance Corporation.

The exact amount of future dividends on the stock of the Bank will be a
function of the profitability of the Bank in general, applicable tax rates in
effect from year to year and the discretion of the board of directors of the
Bank. The Bank's ability to pay dividends in the future will directly depend on
the Banks future profitability, which cannot be accurately estimated or assured.

Capital Adequacy. In 1990, the federal Banking regulators promulgated
capital adequacy regulations to which all national and state banks, such as the
Bank, are subject. These requirements are similar to the Federal Reserve
requirements promulgated with respect to bank holding companies discussed
previously. At December 31, 2002, the Bank was well-capitalized and had a total
risk-based capital ratio of 16.84%, a Tier I risk-based capital ratio of 15.87%
and a leverage capital ratio of 7.63%.

Prompt Corrective Action. Banks are subject to restrictions on their
activities depending on their level of capital. The Federal Deposit Insurance
Corporation's "prompt corrective action" regulations divides banks into five
different categories, depending on their level of capital. Under these
regulations, a bank is deemed to be "well capitalized" if it has a total
risk-based capital ratio of 10% or more, a core capital ratio of six percent or
more and a leverage ratio of five percent or more, and if the bank is not
subject to an order or capital directive to meet and maintain a certain capital
level. Under these regulations, a bank is deemed to be "adequately capitalized"
if it has a total risk-based capital ratio of eight percent or more, a core
capital ratio of four percent or more and a leverage ratio of four percent or
more (unless it receives the highest composite rating at its most recent
examination and is not experiencing or anticipating significant growth, in which
instance it must maintain a leverage ratio of three percent or more). Under
these regulations, a bank is deemed to be "undercapitalized" if it has a total
risk-based capital ratio of less than eight, a core capital ratio of less than
four percent or a leverage ratio of less than four percent. Under these
regulations, a bank is deemed to be "significantly undercapitalized" if it has a
risk-based capital ratio of less than six percent, a core capital ratio of less
than three percent and a leverage ratio of less than three percent. Under such
regulations, a bank is deemed to be "critically undercapitalized" if it has a
leverage ratio of less than or equal to two percent. In addition, the Federal
Deposit Insurance Corporation has the ability to downgrade a bank's
classification (but not to "critically undercapitalized") based on other
considerations even if the bank meets the capital guidelines.

If a state nonmember bank, such as the Bank, is classified as
undercapitalized, the bank is required to submit a capital restoration plan to
the Federal Deposit Insurance Corporation. An undercapitalized bank is
prohibited from increasing its assets, engaging in a new line of business,
acquiring any interest in any company or insured depository institution, or
opening or acquiring a new branch office, except under certain

21

circumstances, including the acceptance by the Federal Deposit Insurance
Corporation of a capital restoration plan for the bank.

If a state nonmember bank is classified as undercapitalized, the
Federal Deposit Insurance Corporation may take certain actions to correct the
capital position of the bank. If a bank is classified as significantly
undercapitalized, the Federal Deposit Insurance Corporation would be required to
take one or more prompt corrective actions. These actions would include, among
other things, requiring sales of new securities to bolster capital, improvements
in management, limits on interest rates paid, prohibitions on transactions with
affiliates, termination of certain risky activities and restrictions on
compensation paid to executive officers. If a bank is classified as critically
undercapitalized, the bank must be placed into conservatorship or receivership
within 90 days, unless the Federal Deposit Insurance Corporation determines
otherwise.

The capital classification of a bank affects the frequency of
examinations of the bank and impacts the ability of the bank to engage in
certain activities and affects the deposit insurance premiums paid by the bank.
The Federal Deposit Insurance Corporation is required to conduct a full-scope,
on-site examination of every bank at least once every twelve months.

Banks also may be restricted in their ability to accept brokered
deposits, depending on their capital classification. "Well capitalized" banks
are permitted to accept brokered deposits, but all banks that are not well
capitalized are not permitted to accept such deposits. The Federal Deposit
Insurance Corporation may, on a case-by-case basis, permit banks that are
adequately capitalized to accept brokered deposits if the Federal Deposit
Insurance Corporation determines that acceptance of such deposits would not
constitute an unsafe or unsound banking practice with respect to the bank.

Community Reinvestment Act. Under the Community Reinvestment Act, the
Bank has a continuing and affirmative obligation consistent with safe and sound
banking practices to help meet the needs of its entire community, including low-
and moderate-income neighborhoods served by the Bank. The Community Reinvestment
Act does not establish specific lending requirements or programs for financial
institutions nor does it limit the Bank's discretion to develop the types of
products and services that it believes are best suited to its particular
community. On a periodic basis, the Federal Deposit Insurance Corporation is
charged with preparing a written evaluation of the Bank's record of meeting the
credit needs of the entire community and assigning a rating. The bank regulatory
agencies will take that record into account in their evaluation of any
application made by the Bank or the Company for, among other things, approval of
the acquisition or establishment of a branch or other deposit facility, an
office relocation, a merger or the acquisition of shares of capital stock of
another financial institution. An "unsatisfactory" Community Reinvestment Act
rating may be used as the basis to deny an application. In addition, as
discussed above, a bank holding company may not become a financial holding
company unless each of its subsidiary banks have a Community Reinvestment Act
rating of at least satisfactory. The Bank was last examined for compliance with
the Community Reinvestment Act on October 9, 2001 and received a rating of
"outstanding."

Deposit Insurance. The Bank's deposits are insured up to $100,000 per
depositor by the Bank Insurance Fund. As insurer, the Federal Deposit Insurance
Corporation imposes deposit premiums and is authorized to conduct examinations
of and to require reporting by the Bank. The Federal Deposit Insurance
Corporation assesses insurance premiums on a bank's deposits at a variable rate
depending on the probability that the deposit insurance fund will incur a loss
with respect to the bank. The Federal Deposit Insurance Corporation determines
the deposit insurance assessment rates on the basis of the bank's capital
classification and supervisory evaluations. There is currently a 27 basis point
spread between the highest and the lowest assessment rates, so that banks
classified as strongest were subject in 2002 to 0% assessment, and banks
classified as weakest were subject to an assessment rate of .27%. In addition to
the insurance assessment, each insured bank was subject in 2002 to an assessment
on deposits to service debt issued by the Financing Corporation, a federal
agency established to finance the recapitalization of the former Federal Savings
and Loan Insurance Corporation. Under these assessment criteria, the Bank was
required to pay annual deposit premiums to the Bank Insurance Fund in 2002. The
Bank's deposits insurance assessments may increase or decrease depending upon
the risk assessment classification to which the Bank is assigned by the Federal
Deposits Insurance Corporation. Any increase in insurance assessments could have
an adverse effect on the Bank's earnings.

22

USA PATRIOT Act. Following the events of September 11, 2001, President
Bush, on October 26, 2001, signed into law the United and Strengthening America
by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act
of 2001. Also known as the "USA PATRIOT Act," the law enhances the powers of the
federal government and law enforcement organizations to combat terrorism,
organized crime and money laundering. The USA PATRIOT Act significantly amends
and expands the application of the Bank Secrecy Act, including enhanced measures
regarding customer identity, new suspicious activity reporting rules and
enhanced anti-money laundering programs. Under the Act, each financial
institution is required to establish and maintain anti-money laundering
compliance and due diligence programs, which include, at a minimum, the
development of internal policies, procedures, and controls; the designation of a
compliance officer; an ongoing employee training program; and an independent
audit function to test programs. In addition, the Act requires the bank
regulatory agencies to consider the record of a bank or bank holding company in
combating money laundering activities in their evaluation of bank and bank
holding company merger or acquisition transactions.

On April 24, 2002, the Treasury Department issued regulations under the
USA PATRIOT Act. The regulations state that a depository institution will be
deemed in compliance with the Act provided it continues to comply with the
current Bank Secrecy Act regulations.

Transactions with Affiliates. Transactions between the Bank and any of
their affiliates (including the Company) are governed by Sections 23A and 23B of
the Federal Reserve Act. An affiliate of a bank is any company or entity that
controls, is controlled by or is under common control with the bank. A
subsidiary of a bank that is not also a depository institution is not treated as
an affiliate of a bank for purposes of Sections 23A and 23B unless it engages in
activities not permissible for a national bank to engage in directly. Generally,
Sections 23A and 23B (i) limit the extent to which a bank or its subsidiaries
may engage in "covered transactions" with any one affiliate to an amount equal
to 10% of such institution's capital stock and surplus, and limit such
transactions with all affiliates to an amount equal to 20% of such capital stock
and surplus, and (ii) require that all such transactions be on terms that are
consistent with safe and sound banking practices. The term "covered transaction"
includes the making of loans to an affiliate, the purchase of or investment in
securities issued by an affiliate, the purchase of assets from an affiliate, the
issuance of a guarantee for the benefit of an affiliate, and similar
transactions. Most loans by a bank to any of its affiliates must be secured by
collateral in amounts ranging from 100 to 130 percent of the loan amount,
depending on the nature of the collateral. In addition, any covered transaction
by a bank with an affiliate and any sale of assets or provision of services to
an affiliate must be on terms that are substantially the same, or at least as
favorable, to the bank as those prevailing at the time for comparable
transactions with nonaffiliated companies. The Bank is also restricted in the
loans that it may make to its executive officers, and directors, the executive
officers and directors of the Company, any owner of 10% or more of its stock or
the stock of the Company, and certain entities affiliated with any such person.

On October 31, 2002, the Federal Reserve issued a new regulation,
Regulation W, effective April 1, 2003, that comprehensively implements sections
23A and 23B of the Federal Reserve Act, which are intended to protect insured
depository institutions from suffering losses arising from transactions with
affiliates. The regulation unifies and updates staff interpretations issued over
the years, incorporates several new interpretative proposals (such as to clarify
when transactions with an unrelated third party will be attributed to an
affiliate) and addresses new issues arising as a result of the expanded scope of
nonbanking activities engaged in by Bank and bank holding companies in recent
years and authorized for financial holding companies under GLBA.

Branch Banking. Pursuant to the Texas Finance Code, all banks located
in Texas are authorized to branch statewide. Accordingly, a bank located
anywhere in Texas has the ability, subject to regulatory approval, to establish
branch facilities near any of our facilities and within our market area. If
other banks were to establish branch facilities near our facilities, it is
uncertain whether these branch facilities would have a material adverse effect
on the business of the Bank.

23

In 1994 Congress adopted the Reigle-Neal Interstate Banking and
Branching Efficiency Act of 1994. That statute provides for nationwide
interstate banking and branching, subject to certain aging and deposit
concentration limits that may be imposed under applicable state laws. Texas law
permits interstate branching in two manners, with certain exceptions. First, a
financial institution with its main office outside of Texas may establish a
branch in the State of Texas by acquiring a financial institution located in
Texas that is at least five years old, so long as the resulting institution and
its affiliates would not hold more than 20% of the total deposits in the state
after the acquisition. In addition, a financial institution with its main office
outside of Texas generally may establish a branch in the State of Texas on a de
novo basis if the financial institution's main office is located in a state that
would permit Texas institutions to establish a branch on a de novo basis in that
state.

The Federal Deposit Insurance Corporation has adopted regulations under
the Riegle-Neal Act to prohibit an out-of-state bank from using the interstate
branching authority primarily for the purpose of deposit production. These
regulations include guidelines to insure that interstate branches operated by an
out-of-state bank in a host state are reasonably helping to meet the credit
needs of the communities served by the out-of-state bank.

Enforcement Authority. The federal banking laws also contain civil and
criminal penalties available for use by the appropriate regulatory agency
against certain "institution-affiliated parties" primarily including management,
employees and agents of a financial institution, as well as independent
contractors such as attorneys and accountants and others who participate in the
conduct of the financial institution's affairs and who caused or are likely to
cause more than minimum financial loss to or a significant adverse affect on the
institution, who knowingly or recklessly violate a law or regulation, breach a
fiduciary duty or engage in unsafe or unsound practices. These practices can
include the failure of an institution to timely file required reports or the
submission of inaccurate reports. These laws authorize the appropriate banking
agency to issue cease and desist orders that may, among other things, require
affirmative action to correct any harm resulting from a violation or practice,
including restitution, reimbursement, indemnification or guarantees against
loss. A financial institution may also be ordered to restrict its growth,
dispose of certain assets or take other action as determined by the ordering
agency to be appropriate.

Governmental Monetary Policies. The commercial banking business is
affected not only by general economic conditions but also by the monetary
policies of the Federal Reserve. Changes in the discount rate on member bank
borrowings, control of borrowings, open market operations, the imposition of and
changes in reserve requirements against member banks, deposits and assets of
foreign branches, the imposition of and changes in reserve requirements against
certain borrowings by banks and their affiliates and the placing of limits on
interest rates which member banks may pay on time and savings deposits are some
of the instruments of monetary policy available to the Federal Reserve. Those
monetary policies influence to a significant extent the overall growth of all
bank loans, investments and deposits and the interest rates charged on loans or
paid on time and savings deposits. The nature of future monetary policies and
the effect of such policies on the future business and earnings of the Company,
therefore, cannot be predicted accurately.

Annual Audits. Every bank with total assets in excess of $500 million,
such as the Bank, must have an annual independent audit made of the bank's
financial statements by a certified public accountant to verify that the
financial statements of the bank are presented in accordance with United States
generally accepted accounting principles and comply with such other disclosure
requirements as prescribed by the Federal Deposit Insurance Corporation.

All of the above laws and regulations add to the cost of the Company's
operations and thus have a negative impact on profitability. You should note
that there has been a tremendous expansion experienced in recent years by
financial service providers that are not subject to the same rules and
regulations as are applicable to Southside Delaware and the Company. The
Company's management and the Bank's management cannot predict what other
legislation might be enacted or what other regulations might be adopted and the
effects thereof on the Company and the Bank.

24

CAPITAL GUIDELINES

Southside Bank is regulated by the TDB and the FDIC. The FDIC requires
minimum levels of Tier 1 capital and risk-based capital for FDIC-insured
institutions. The FDIC requires a minimum leverage ratio of 3% of adjusted total
assets for the highest rated banks. Other banks are required to meet a leverage
standard of 4% or more, determined on a case-by-case basis.

On December 31, 2002, the minimum ratio for qualifying total risk-based
capital was 8% of which 4% must be Tier 1 capital. Southside Bank's actual
capital to total assets and risk-based capital ratios at December 31, 2002 were
in excess of the minimum requirements.

Also see discussion of "Capital Resources" under Item 7.

USURY LAWS

Texas usury laws limit the rate of interest that may be charged by
state banks. Certain Federal laws provide a limited preemption of Texas usury
laws. The maximum rate of interest that Southside Bank may charge on direct
business loans under Texas law varies between 18% per annum and (i) 28% per
annum for business and agricultural loans above $250,000 or (ii) 24% per annum
for other direct loans. Texas floating usury ceilings are tied to the 26-week
United States Treasury Bill Auction rate. Other ceilings apply to open-end
credit card loans and dealer paper purchased by Southside Bank. A Federal
statute removes interest ceilings under usury laws for loans by Southside Bank
which are secured by first liens on residential real property.

ECONOMIC ENVIRONMENT

The monetary policies of regulatory authorities, including the FRB,
have a significant effect on the operating results of bank holding companies and
their subsidiaries. The FRB regulates the national supply of bank credit. Among
the means available to the FRB are open market operations in United States
Government Securities, changes in the discount rate on member bank borrowings,
changes in reserve requirements against member and nonmember bank deposits, and
loans and limitations on interest rates which member banks may pay on time or
demand deposits. These methods are used in varying combinations to influence
overall growth and distribution of bank loans, investments and deposits. Their
use may affect interest rates charged on loans or paid for deposits.

Also see discussion of "Banking Industry in Texas" above.

25

ITEM 2. PROPERTIES

Southside Bank owns or operates the following properties:

o Southside main branch at 1201 South Beckham Avenue, Tyler,
Texas. The executive offices of Southside Bancshares, Inc. are
located at this location.

o Southside Bank Annex at 1211 South Beckham Avenue, Tyler,
Texas. The Southside Annex is directly adjacent to the main
bank building. Human Resources, the Trust Department and other
support areas are located in this building.

o Operations Annex at 1221 South Beckham Avenue, Tyler, Texas.
Various back office lending, training facilities and other
support areas are located in this building.

o Southside main branch motor bank facility at 1010 East First
Street, Tyler, Texas.

o South Broadway branch at 6201 South Broadway, Tyler, Texas.

o South Broadway branch motor bank facility at 6019 South
Broadway, Tyler, Texas.

o Downtown branch at 113 W. Ferguson Street, Tyler, Texas.

o Gentry Parkway branch and motor bank facility at 2121 West
Gentry Parkway, Tyler, Texas.

o Longview main branch and motor bank facility at 2001 Judson
Road, Longview, Texas.

o Lindale main branch and motor bank facility at 2510 South Main
Street, Lindale Texas.

o Whitehouse main branch and motor bank facility at 901 Highway
110 North, Whitehouse, Texas.

o Twenty-nine Automatic Teller Machines (ATM's) located
throughout Smith and Gregg Counties.

Southside bank leases the following locations:

The Company currently operates full service banks in leased space
in eleven grocery stores in the following locations:

o One in Lindale, Texas

o One in Whitehouse, Texas

o Three in Longview, Texas

o Six in Tyler, Texas

26

ITEM 3. LEGAL PROCEEDINGS

Southside Bank is party to legal proceedings arising in the normal
conduct of business. Management of the Company believes that such litigation is
not material to the financial position or results of the operations of the
Company or Southside Bank.

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

During the three months ended December 31, 2002, there were no
meetings, annual or special, of the shareholders of the Company. No matters were
submitted to a vote of the shareholders, nor were proxies solicited by
management or any other person.

PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS

MARKET INFORMATION

The Company's common stock began trading on the Nasdaq National Market
on May 14, 1998 under the symbol "SBSI." Prior to that the Company's common
stock was not actively traded on any established public trading market. The
high/low prices shown below represent the daily weighted average prices on the
Nasdaq National Market for the period from January 1, 2001 to December 31, 2002.
During the third quarters of 2002 and 2001, the Company declared and paid a 5%
stock dividend. Stock prices listed below have been adjusted to give retroactive
recognition to stock splits and stock dividends.

See "Item 7. Capital Resources" for a discussion of the Company's
common stock repurchase program.

STOCKHOLDERS

There were approximately 1,090 holders of record of the Company's
common stock, the only class of equity securities currently issued and
outstanding, as of February 28, 2003.

DIVIDENDS

Cash dividends declared and paid were $0.33, $0.25 and $0.225 per share
for the years ended December 31, 2002, 2001 and 2000 respectively. Stock
dividends of 5% were also declared and paid during each of the years ended
December 31, 2002, 2001 and 2000. The Company has paid a cash dividend at least
once every year since 1970. Future dividends will depend on the Company's
earnings, financial condition and other factors which the Board of Directors of
the Company considers to be relevant. For additional discussion relating to
restrictions that limit the Company's ability to pay dividends refer to
"Supervision and Regulation" and "Capital Guidelines" in Item 1. Business and
"Capital Resources" in Item 7. Managements Discussion and Analysis of Financial
Condition and Results of Operations.

27

ITEM 6. SELECTED FINANCIAL DATA

The following table sets forth selected financial data regarding the
Company's results of operations and financial position for, and as of the end
of, each of the fiscal years in the five-year period ended December 31, 2002.
This information should be read in conjunction with "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations," as
set forth in this report.

28

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The following discussion and analysis provides a comparison of the
Company's results of operations for the years ended December 31, 2002, 2001 and
2000 and financial condition as of December 31, 2002 and 2001. This discussion
should be read in conjunction with the financial statements and related notes.
All share data has been adjusted to give retroactive recognition to stock splits
and stock dividends.

CRITICAL ACCOUNTING POLICIES

The accounting and reporting policies of the Company and its
subsidiaries conform with accounting principles generally accepted in the United
States and general practices within the financial services industry. The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates. The Company considers its
critical accounting policies to include the following:

Allowance for Losses on Loans. The allowance for losses on loans
represents management's best estimate of probable losses inherent in the
existing loan portfolio. The allowance for losses on loans is increased by the
provision for losses on loans charged to expense and reduced by loans
charged-off, net of recoveries. The provision for losses on loans is determined
based on management's assessment of several factors: reviews and evaluations of
specific loans, changes in the nature and volume of the loan portfolio, current
and anticipated economic conditions and the related impact on specific borrowers
and industry groups, historical loan loss experience, the level of classified
and nonperforming loans and the results of regulatory examinations.

Loans are considered impaired if, based on current information and
events, it is probable that the Company will be unable to collect the scheduled
payments of principal or interest when due according to the contractual terms of
the loan agreement. The measurement of impaired loans is generally based on the
present value of expected future cash flows discounted at the historical
effective interest rate stipulated in the loan agreement, except that all
collateral-dependent loans are measured for impairment based on fair value of
the collateral. In measuring the fair value of the collateral, management uses
assumptions (e.g. discount rates) and methodologies (e.g. comparison to the
recent selling price of similar assets) consistent with those that would be
utilized by unrelated third parties.

Changes in the financial condition of individual borrowers, in economic
conditions, in historical loss experience and in the conditions of the various
markets in which collateral may be sold may all affect the required level of the
allowance for losses on loans and the associated provision for loan losses.

Estimation of Fair Value. The estimation of fair value is significant
to a number of the Company's assets, including available for sale investment
securities and other real estate owned. These are all recorded at either fair
value or at the lower of cost or fair value. Furthermore, accounting principles
generally accepted in the United Sates require disclosure of the fair value of
financial instruments as a part of the notes to the consolidated financial
statements. Fair values are volatile and may be influenced by a number of
factors, including market interest rates, prepayment speeds, discount rates and
the shape of yield curves.

Fair values for most available for sale investment securities are based
on quoted market prices, where available. If quoted market prices are not
available, fair values are based on the quoted prices of similar instruments.
The fair values of other real estate owned are typically determined based on
appraisals by third parties, less estimated costs to sell.

Refer to Item 1 entitled Loan Loss Experience and Reserve for Loan Loss
and Notes to Financial Statements No. 1, Summary of Significant Accounting and
Reporting Policies for a detailed description of the Company's estimation
process and methodology related to the allowance for loan losses.

29

FORWARD-LOOKING INFORMATION

Certain statements of other than historical fact that are contained in
this document and in written material, press releases and oral statements issued
by or on behalf of the Company may be considered to be "forward-looking
statements" as that term is defined in the Private Securities Litigation Reform
Act of 1995. These statements may include words such as "expect," "estimate,"
"project," "anticipate," "should," "intend," "probability," "risk," "target,"
"objective" and similar expressions. Forward-looking statements are subject to
significant risks and uncertainties and the Company's actual results may differ
materially from the results discussed in the forward-looking statements. For
example, certain market risk disclosures are dependent on choices about key
model characteristics and assumptions and are subject to various limitations.
See "Item 1 - Business" and "Item 7 - Management's Discussion and Analysis of
Financial Condition and Results of Operations." By their nature, certain of the
market risk disclosures are only estimates and could be materially different
from what actually occurs in the future. As a result, actual income gains and
losses could materially differ from those that have been estimated. Other
factors that could cause actual results to differ materially from
forward-looking statements include, but are not limited to general economic
conditions, either nationally or in the State of Texas, legislation or
regulatory changes which adversely affect the businesses in which the Company is
engaged, changes in the interest rate environment which reduce interest margins,
significant increases in competition in the banking and financial services
industry, changes in consumer spending, and bankruptcy rates borrowing and
saving habits, technological changes, the Company's ability to increase market
share and control expenses, the effect of compliance with legislation or
regulatory changes, the effect of changes in accounting policies and practices
and the costs and effects of unanticipated litigation.

FINANCIAL CONDITION

Total assets increased $72.4 million or 5.7% to $1.35 billion at
December 31, 2002 from $1.28 billion at December 31, 2001. The increase was
primarily attributable to a $44.1 million increase in net loans and a $28.7
million increase in the securities portfolio. At December 31, 2002, net loans
were $576.0 million compared to $532.0 million at December 31, 2001. The
securities portfolio totaled $662.9 million at December 31, 2002 compared to
$634.2 million at December 31, 2001. The increase in loans and securities was
funded primarily by increases in deposits and FHLB Dallas advances.

Nonperforming assets at December 31, 2002 totaled $3.4 million,
representing 0.25% of total assets, compared to $2.4 million or 0.19% of total
assets at December 31, 2001. Nonaccruing loans increased to $2.2 million and the
ratio of nonaccruing loans to total loans increased to 0.38% at December 31,
2002 as compared to $896,000 and 0.17% at December 31, 2001. Other real estate
owned increased to $524,000 at December 31, 2002 from $65,000 at December 31,
2001. Loans 90 days past due at December 31, 2002 decreased to $287,000 compared
to $945,000 at December 31, 2001. Restructured loans at December 31, 2002
increased to $325,000 compared to $283,000 at December 31, 2001.

Deposits increased $56.5 million to $814.5 million at December 31, 2002
from $758.0 million at December 31, 2001. FHLB Dallas advances were $384.6
million at December 31, 2002, a $9.7 million increase from $374.9 million at
December 31, 2001. Short-term FHLB Dallas advances increased $39.2 million to
$153.4 million at December 31, 2002 from $114.2 million at December 31, 2001.
Long-term FHLB Dallas advances decreased $29.6 million to $231.1 million at
December 31, 2002 from $260.7 million at December 31, 2001. Other borrowings at
December 31, 2002 and 2001 totaled $52.6 million and $65.4 million,
respectively, and at December 31, 2002 consisted of $18.4 million of short-term
borrowings, $14.2 million of Long-term Junior Subordinated Convertible
Debentures and $20.0 million of Long-term Junior Subordinated Debentures.

On November 2, 2000, the Company through its wholly-owned subsidiary,
Southside Capital Trust II (the "Trust II Issuer"), sold 1,695,000 cumulative
convertible preferred securities (the "junior subordinated convertible
debentures") at a liquidation amount of $10 per convertible preferred security
for an aggregate amount of $16,950,000. These securities have a convertible
feature that allows the owner to convert each security to a share of the
Company's common stock at a conversion price of $9.07 per common share. These
securities have a distribution rate of 8.75% per annum payable at the end of
each calendar quarter.

30

On May 18, 1998, the Company through its wholly-owned subsidiary,
Southside Capital Trust (the "Trust Issuer"), sold 2,000,000 preferred
securities (the "junior subordinated debentures") at a liquidation amount of $10
per preferred security for an aggregate amount of $20,000,000. These securities
have a distribution rate of 8.50% per annum payable at the end of each calendar
quarter.

Shareholders' equity at December 31, 2002 totaled $82.2 million
compared to $68.6 million at December 31, 2001. The increase primarily reflects
the net income recorded for the year ended December 31, 2002, an increase in the
accumulated other comprehensive income of $3.2 million and common stock issued
of $3.7 million as a result of conversions from the Company's junior
subordinated convertible debentures into the Company's common stock, the
Company's incentive stock option and dividend reinvestment plans. These
increases were partially offset by the repurchase of 278,210 shares of the
outstanding stock at an average price of $15.10 per share and the payment of
cash dividends.

During 2002 the economy in the Bank's market area has shown some signs
of slowing. The two areas of concern are the slow growth of the national economy
and the personal bankruptcy rate. Management expects these trends to have some
effect on the Company's net charge-offs. Management of the Company, however,
cannot predict whether current economic conditions will improve, remain the same
or decline.

LEVERAGE STRATEGY

In May 1998 the Company implemented a leverage strategy designed to
enhance its profitability with acceptable levels of credit, interest rate and
liquidity risk. The leverage strategy consists of borrowing long and short-term
funds from the FHLB Dallas and investing the funds primarily in premium
mortgage-backed securities, and to a lesser extent, long-term municipal
securities. Although premium mortgage-backed securities often carry lower yields
than traditional mortgage loans and other types of loans the Company makes,
these securities generally increase the overall quality of the Company's assets
by virtue of the securities' underlying insurance or guarantees, are more liquid
than individual loans and may be used to collateralize the Company's borrowings
or other obligations. In addition, in low interest rate environments the
amortization expense for premium mortgage-backed securities is associated with
substantially higher prepayments experienced and reduces the overall yields of
the premium mortgage-backed securities portfolio. While the strategy of
investing a substantial portion of the Company's assets in premium
mortgage-backed and municipal securities has resulted in lower interest rate
spreads and margins, the Company believes that the lower operating expenses and
reduced credit risk combined with the managed interest rate risk of this
strategy have enhanced its overall profitability. At this time, the Company does
not maintain the leverage strategy for any other reason than to enhance overall
profitability . One of the risks associated with the asset structure the Company
maintains is a lower net interest rate spread and margin when compared to peers.
This asset structure, spread and margin increases the need to monitor the
Company's interest rate risk.

The Company will attempt to adopt a balance sheet strategy going
forward to gradually reduce the securities portfolio as a percentage of earning
assets assuming quality loan growth is available in the Company's market area.
On the liability side, the Company will attempt to gradually reduce FHLB Dallas
borrowings as a percentage of total deposits assuming deposits can be retained
or acquired at a lower overall cost. The intended net result is to increase the
Company's net interest spread. The leverage strategy is dynamic and requires
ongoing management. As interest rates, funding costs and security spreads
change, the Company's determination of the proper securities to own and funding
to obtain must be re-evaluated. Management has attempted to design the leverage
strategy so that in a rising interest rate environment the interest income
earned on the premium mortgage-backed securities may increase to help offset the
increase in funding costs. As interest rates decrease, the interest income on
the premium mortgage-backed securities may decrease due to increased prepayments
on these securities as funding costs decrease. Due to the unpredictable nature
of mortgage-backed securities prepayments, the length of interest rate cycles,
and the slope of the interest rate yield curve, net interest income could
fluctuate more than simulated under ALCO scenarios modeled.

31

RESULTS OF OPERATIONS

The Company's results of operations are dependent primarily on net
interest income, which is the difference between the income earned on its loan,
securities and investment portfolios and its cost of funds, consisting of the
interest paid on deposits and borrowings. Results of operations are also
affected by the Company's noninterest income, provision for loan losses and
noninterest expenses. General economic and competitive conditions, particularly
changes in interest rates, prepayment rates of mortgage-backed securities and
loans, repricings of loan relationships, government policies and actions of
regulatory authorities, also significantly affect the Company's results of
operations. Future changes in applicable law, regulations or government policies
may also have a material impact on the Company.

COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDING DECEMBER 31, 2002
COMPARED TO DECEMBER 31, 2001

OVERVIEW

During the year ended December 31, 2002, the Company's net income
increased $1.6 million or 13.6% to $13.3 million, from $11.7 million for the
same period in 2001. The increase in net income was primarily attributable to an
increase in noninterest income and net interest income due to the increase in
earning assets. Noninterest income increased primarily due to the increases in
deposit services income, bank owned life insurance income, mortgage servicing
release fees income, and other noninterest income. These increases were
partially offset by an increase in noninterest expense and provision for loan
losses. The majority of the increase in noninterest expense was a result of bank
growth and the costs associated with the opening of five new branches. Earnings
per share of $1.34 represented an increase of $0.14 or 11.7% over the year ended
December 31, 2001.

NET INTEREST INCOME

Net interest income is the principal source of a financial
institution's earnings stream and represents the difference or spread between
interest and fee income generated from interest earning assets and the interest
expense paid on deposits and borrowed funds. Fluctuations in interest rates as
well as volume and mix changes in interest earning assets and interest bearing
liabilities materially impact net interest income.

Net interest income for the year ended December 31, 2002 was $32.9
million, an increase of $2.2 million or 7.3% compared to the same period in
2001. The overall increase in net interest income was due to the fact that
decreases in interest income from loans and securities were more than offset by
decreases in interest expense from deposits and other borrowings which increased
the net yield on average interest earning assets. Average interest earning
assets increased $46.8 million or 4.1%, and the net yield on average interest
earning assets increased from 2.96% at December 31, 2001 to 3.11% at December
31, 2002. During the fourth quarter ended December 31, 2002 the Company's net
interest margin was 2.87% and the net interest spread was 2.36% which reflected
a decrease when compared to the same quarter in 2001. The net interest margin
and net interest spread for the quarter ended December 31, 2001 was 3.19% and
2.62%, respectively. The decrease in the net interest margin and spread during
the fourth quarter of 2002 was due in part to lower mortgage interest rates and
the lower overall interest rate environment which led to substantially increased
residential mortgage refinancings nationwide and in the Company's market area
combined with substantially increased repricings of all of the Company's other
loan types. Increased prepayments associated with the Company's mortgage-backed
securities, residential mortgage loans and the substantial increase in
repricings of other loan types may continue to impact the Company's net interest
margin during the first half of 2003 or until overall interest rates increase.
This may be partially offset by fee income from the sale of mortgage loans into
the secondary market due to the volume of refinancings that the Company is
currently handling in its market area or changes in its balance sheet mix.

As interest rates decreased during 2002, the Company's yield on premium
mortgage-backed securities decreased as prepayment speeds increased. This
decrease in yield, along with the decrease in the yield on average loans,
combined to decrease the net yield on average earning assets.

32

During the year ended December 31, 2002, average loans, funded by the
growth in average deposits, increased $41.9 million or 8.2%, compared to the
same period in 2001. The average yield on loans decreased from 8.17% at December
31, 2001 to 7.17% at December 31, 2002, reflective of an overall decrease in
interest rates. As interest rates have declined, especially short-term interest
rates, loan customers are increasingly requesting floating rate loans, which
lowers the overall yield on loans. In addition, the Company has experienced a
large number of loan customers requesting loan repricings due to lower interest
rates offered to them by competing financial institutions. If interest rates
remain low or move lower the Company anticipates it will be required to meet
lower interest rate offers from competing financial institutions in order to
retain quality loan relationships, which could impact the overall loan yield.
The decrease in interest income on loans of $2.6 million or 6.4% was the result
of the decrease in interest rates partially offset by the increase in average
loans.

Average investment and mortgage-backed securities increased $4.2
million or 0.7% for the year ended December 31, 2002 when compared to the same
period in 2001. This increase was primarily a result of a slight increase in the
Company's leverage strategy. The overall yield on average investment and
mortgage-backed securities decreased to 5.39% during the year ended December 31,
2002 from 6.36% during the same period in 2001, due in part to increased
prepayment speeds on mortgage-backed securities which led to increased
amortization expense and increased cash to reinvest in a lower interest rate
environment. During 2002 the repositioning of the securities portfolio in an
attempt to lower duration also decreased the overall yield on the securities
portfolio. Interest income on investment and mortgage-backed securities
decreased $6.0 million in 2002 or 16.6% compared to 2001 due to the decrease in
the average yield of securities during 2002, which more than offset the increase
in the average balance.

Interest income from marketable equity securities, federal funds and
other interest earning assets decreased $299,000 or 29.8% for the year ended
December 31, 2002 when compared to 2001 as a result of lower interest rates in
2002.

During the year ended December 31, 2002, the mix of the Company's
interest earning assets reflected an increase in loans compared to the prior
year end as loans averaged 46.4% of total average interest earning assets
compared to 44.6% during 2001, a direct result of loan growth. Securities
averaged 53.4% of the total and other interest earning asset categories averaged
0.2% for December 31, 2002. During 2001 the comparable mix was 55.1% in
securities and 0.3% in the other interest earning asset categories.

Total interest expense decreased $11.2 million or 23.5% to $36.4
million during the year ended December 31, 2002 as compared to $47.6 million
during the same period in 2001. The decrease was attributable to a decrease in
interest rates partially offset by an increase in average interest bearing
liabilities of $42.1 million or 4.3%. Average interest bearing deposits
increased $40.2 million or 7.2% while the average rate paid decreased from 4.49%
at December 31, 2001 to 2.73% at December 31, 2002. Average time deposits
increased $6.8 million or 1.9% while the average rate paid decreased 204 basis
points. Average interest bearing demand deposits increased $24.9 million or
13.9% while the average rate paid decreased 115 basis points. Average savings
deposits increased $8.5 million or 32.1% while the average rate paid decreased
87 basis points. Average noninterest bearing demand deposits increased $16.9
million or 10.1% during 2002. The latter three categories, which are considered
the lowest cost deposits, comprised 54.4% of total average deposits during the
year ended December 31, 2002 compared to 51.7% during 2001 and 52.0% during
2000. The increase in average total deposits is reflective of overall bank
growth and branch expansion.

During the second quarter ended June 30, 2000, the Company issued $54.6
million of long-term brokered CDs with one-year call options and additional call
options every six months thereafter, until the CDs mature. The average yield on
these CDs was 8.19% with an average life of 10.8 years. Obtaining this long-term
funding enabled the Bank to take advantage of the higher interest rate
environment, primarily through the purchase of securities without incurring
significant additional interest rate risk. The higher cost associated with these
callable CDs had a negative impact on net interest spread during the five
quarters ended June 30, 2001. The options associated with these CDs provided the
bank with valuable balance sheet opportunities. In conjunction with the issuance
of these long-term brokered CDs, securities were purchased with an overall
duration and yield that approximated the brokered CDs.

33

During March 2001, the Company notified CD holders that $24.6 million
of brokered CDs were being called April 12, 2001. The Company recorded $195,000
of additional interest expense associated with the call of the CDs during the
first quarter ended March 31, 2001. Gains on sales of securities were used to
offset this expense. During April 2001, the Company notified CD holders that the
remaining $30.0 million of brokered CDs would be called May 24, 2001. An
additional $357,000 of expense was incurred during the second quarter ending
June 30, 2001, associated with the call of the brokered CDs. These CDs were
replaced with long-term advances from the FHLB Dallas at an average rate of
approximately 5.40%. As a result, the Company's interest expense on this $54.6
million declined after the CDs were called. The Company's current policy allows
for a maximum of $100 million in brokered CDs. The potential higher interest
cost and lack of customer loyalty are risks associated with the use of brokered
CDs. At December 31, 2002 and December 31, 2001, the Company had no brokered CDs
and brokered CDs represented zero percent of deposits.

The following table sets forth the Company's deposit averages by
category for the years ended December 31, 2002, 2001 and 2000:

Average short-term interest bearing liabilities, consisting primarily
of FHLB Dallas advances and federal funds purchased, were $156.7 million, a
decrease of $13.5 million or 7.9% for the year ended December 31, 2002 when
compared to the same period in 2001. Interest expense associated with short-term
interest bearing liabilities decreased $1.6 million or 21.5% and the average
rate paid decreased 63 basis points for the year ended December 31, 2002 when
compared to the same period in 2001. Average long-term interest bearing
liabilities consisting of FHLB Dallas advances increased $17.0 million or 7.9%
during the year ended December 31, 2002 to $232.7 million as compared to $215.7
million at December 31, 2001. Interest expense associated with long-term FHLB
Dallas advances decreased $762,000 or 6.25% and the average rate paid decreased
74 basis points for the year ended December 31, 2002 when compared to the same
period in 2001. The long-term advances were obtained from the FHLB Dallas
primarily to fund long-term securities and to a lesser extent long-term loans.
FHLB Dallas advances are collateralized by FHLB Dallas stock, securities and
nonspecific real estate loans.

Average long-term junior subordinated convertible debentures were $15.3
million for the year ended December 31, 2002 compared to $16.95 million for the
same period in 2001. During the year ended December 31, 2002, 272,464
convertible trust preferred shares were converted into the Company's common
stock. The total convertible trust preferred shares converted to date represents
16.1% of the initial convertible trust preferred issue. Interest expense
associated with the junior subordinated convertible debentures decreased
$149,000 or 10.0% and the average rate paid decreased 4 basis points for the
year ended December 31, 2002, when compared to the same period in 2001.

Average long term junior subordinated debentures remained the same at
$20 million from December 31, 2001 to December 31, 2002. Interest expense and
the average rate paid were the same for the years ended December 31, 2002 and
2001.

34

RESULTS OF OPERATIONS

The following table presents average balance sheet amounts and average
yields for the years ended December 31, 2002, 2001 and 2000. The information
should be reviewed in conjunction with the financial statements for the same
years then ended. Two major components affecting the Company's earnings are the
interest earning assets and interest bearing liabilities. A summary of average
interest earning assets and interest bearing liabilities is set forth below,
together with the average yield on the interest earning assets and the average
cost of the interest bearing liabilities.

(1) Loans are shown net of unearned discount. Interest on loans includes
fees on loans which are not material in amount.

(2) Interest income includes taxable-equivalent adjustments of $1,494, $991
and $494 for the years ended December 31, 2002, 2001 and 2000,
respectively.

(3) Interest income includes taxable-equivalent adjustments of $2,630,
$2,287 and $2,363 for the years ended December 31, 2002, 2001 and 2000,
respectively.

(4) For the purpose of calculating the average yield, the average balance
of securities is presented at historical cost.

Note: As of December 31, 2002, 2001 and 2000, loans totaling $2,238, $896 and
$630, respectively, were on nonaccrual status. The policy is to reverse
previously accrued but unpaid interest on nonaccrual loans; thereafter,
interest income is recorded to the extent received when appropriate.

35

ANALYSIS OF CHANGES IN INTEREST INCOME AND INTEREST EXPENSE

The following tables set forth the dollar amount of increase (decrease)
in interest income and interest expense resulting from changes in the volume of
interest earning assets and interest bearing liabilities and from changes in
yields (in thousands):

(1) Interest yields on loans and securities which are nontaxable
for Federal Income Tax purposes are presented on a taxable
equivalent basis.

NOTE: Volume/Yield variances (change in volume times change in yield)
have been allocated to amounts attributable to changes in volumes and
to changes in yields in proportion to the amounts directly attributable
to those changes.

36

PROVISION FOR LOAN LOSSES

The provision for loan losses for the year ended December 31, 2002 was
$2.1 million compared to $1.7 million for December 31, 2001. For the year ended
December 31, 2002, the Company's subsidiary, Southside Bank, had net charge-offs
of loans of $1.8 million, an increase of 138.9% compared to December 31, 2001.
For the year ended December 31, 2001, net charge-offs on loans were $774,000.

The increase in net charge-offs for 2002 is reflective of the increase
in total charge-offs and the decrease in total recoveries. Total charge-offs for
commercial loans increased $285,000 from December 31, 2001 due to the increase
in small business loans charged off resulting from the slower economy in the
Company's market area. Total charge-offs for loans to individuals increased
$120,000 from December 31, 2001 reflective of increased consumer bankruptcies.
Total charge-offs for real estate loans and construction loans increased
$135,000 and $215,000, respectively from December 31, 2001 primarily due to
charge-offs associated with one builder and one of his clients. Total recoveries
decreased $320,000 from December 31, 2001 primarily as a result of two
recoveries on old charge-offs the Company received during 2001 that totaled
$230,000.

As of December 31, 2002, the Company's review of the loan portfolio
indicates that a loan loss reserve of $6.2 million is adequate to cover probable
losses in the portfolio.

NONINTEREST INCOME

Noninterest income consists of revenues generated from a broad range of
financial services and activities including fee based services. The following
schedule lists the accounts from which noninterest income was derived, gives
totals for these accounts for the year ended December 31, 2002 and the
comparable year ended December 31, 2001 and indicates the percentage changes:

Total noninterest income for the year ended December 31, 2002 increased
17.5% or $2.9 million compared to 2001. Securities gains decreased $220,000 or
5.4% from 2001. Of the $3.9 million in net securities gains from the AFS
portfolio in 2002, there were $340,000 in realized losses and $4.2 million in
realized gains. The Company sold securities out of its AFS portfolio to
accomplish Asset Liability Committee and investment portfolio objectives aimed
at repositioning and reducing the overall duration of the securities portfolio
in an effort to maximize the total return of the securities portfolio. Sales of
AFS securities were the result of changes in economic conditions and a change in
the desired mix of the securities portfolio. During 2002, interest rates
declined and the yield curve remained steep. The Company used this interest-rate
environment to reposition the securities portfolio in an attempt to lower the
overall duration and minimize prepayment of the premium mortgage-backed
securities. Higher coupon premium mortgage-backed securities with high selling
prices or with a potentially greater prepayment exposure were replaced with
mortgage-backed securities that had characteristics which potentially might
reduce the prepayment exposure. In some cases, higher coupon premium 30 year
mortgage-backed securities with prepayment exposure were replaced with lower
coupon premium 15 year mortgage-backed securities which lowered the overall
duration and potentially reduced the prepayment exposure. Specific lower coupon
or long duration municipal securities were sold and partially replaced with
higher coupon municipal securities.

37

The increase in deposit services income of $1.3 million or 14.3% was a
result of increases in overdraft income, increased numbers of deposit accounts
and increased deposit activity. Bank owned life insurance income increased
$857,000 or 786.2%. During the fourth quarter ended December 31, 2001, the
Company purchased Bank Owned Life Insurance in the amount of $15 million on all
of its eligible Bank and Company officers at the level of Vice President and
above. The net increase in cash surrender value is shown as a component of
noninterest income. Mortgage servicing release fees income increased $987,000 or
93.4% due to the significant increase in mortgage loan refinancings the Company
handled during 2002 as a result of the lower interest rate environment. Trust
income increased $70,000 or 7.3% due to growth in the Trust department. Other
noninterest income decreased $120,000 or 10.9% primarily as a result of
decreases in Travelers Express income combined with an increase in the loss
associated with BSC Securities and Countywide.

NONINTEREST EXPENSE

The following schedule lists the accounts which comprise noninterest
expense, gives totals for these accounts for the year ended December 31, 2002
and the comparable year ended December 31, 2001 and indicates the percentage
changes:

Noninterest expense for the year ended December 31, 2002 increased $5.4
million or 18.5% when compared to the year ended December 31, 2001. Salaries and
employee benefits increased $3.9 million or 22.3% due to several factors. Direct
salary expense and payroll taxes increased $3.1 million or 22.1% as a result of
branch expansion, overall bank growth and pay increases. Retirement expense
increased significantly by $389,000 or 27.3% for the year ended December 31,
2002 due to a change in the actuarial present value assumption which decreased
from 7.25% for the year ended December 31, 2001 to 6.75% for the year ended
December 31, 2002, a lower return on plan assets than projected and an increase
in the number of participants. Retirement expense for 2003 could increase
significantly due to a possible low return on plan assets, the continued low
discount rate or a possible decrease in this rate, increased funding required
and the increasing numbers of participants. The Company is currently using a
9.0% assumed long-term rate of return. Due to the decline in major stock market
indexes for three straight years combined with low interest rates the Company's
rate of return on plan assets did not achieve a 9.0% return. The Company will
continue to evaluate the assumed long-term rate of return of 9.0% to determine
if it should be changed in the future. If this assumption were decreased the
cost and funding required for the retirement plan could increase. Health and
life insurance expense increased significantly by $394,000 or 19.8% for the year
ended December 31, 2002 due to increased health claims expense and reinsurance
costs. Health insurance costs are rising nationwide and we anticipate these
costs may increase in 2003.

Net occupancy expense increased $545,000 or 16.2% for the year ended
December 31, 2002 compared to the same period in 2001, largely due to branch
expansion, higher real estate taxes and depreciation expense.

ATM and Bank analysis fees increased $47,000 or 5.8% for the year ended
December 31, 2002 compared to the same period in 2001 due primarily to overall
deposit growth.

38

Supplies expense increased $91,000 or 14.8% as a result of bank growth
and branch expansion. Professional fees increased $49,000 or 7.9% due to
additional internal audit, loan review and data processing related fees. Postage
expense increased $83,000 or 18.3% for the year ended December 31, 2002 compared
to the same period in 2001 due primarily to increases in postage rates.

Other expense increased $680,000 or 19.4% during the year ended
December 31, 2002 compared to 2001. The increase was due primarily to increases
in dues to directors, liability insurance, auto expense, other losses, losses on
other real estate owned, legal fees and bank examination fees.

INCOME TAXES

Income tax expense was $2.2 million for the year ended December 31,
2002 and represented a $1.3 million or 38.1% decrease from the year ended
December 31, 2001. The effective tax rate as a percentage of pre-tax income was
14.1% in 2002, 21.7% in 2001 and 21.3% in 2000. The decrease in the effective
tax rate and income tax expense for 2002 was due to the increase in tax free
income for the year ended December 31, 2002 when compared to December 31, 2001.
The Company decreased its municipal securities portfolio during 2002 and has
further decreased it during the first quarter of 2003 to reduce the overall
level of tax free income from the securities portfolio and to allow the Company
the opportunity to grow its municipal loan portfolio.

DECEMBER 31, 2001 COMPARED TO DECEMBER 31, 2000

OVERVIEW

During the year ended December 31, 2001, the Company's net income
increased $1.9 million or 19.4% to $11.7 million, from $9.8 million for the same
period in 2000. The increase in net income was primarily attributable to an
increase in noninterest income and net interest income due to the increase in
earning assets. Noninterest income increased primarily due to the gain on
securities available for sale and increases in deposit services income. These
increases were partially offset by an increase in noninterest expense, provision
for loan losses and the cumulative effect of change in accounting principle due
to the implementation of FAS 133 in 2001. The majority of the increase in
noninterest expense was a result of bank growth and the costs associated with
the opening of several new branches. Earnings per share of $1.20 represented an
increase of $0.08 or 7.1% over the year ended December 31, 2000.

NET INTEREST INCOME

Net interest income increased $1.3 million or 4.6% for the year ended
December 31, 2001 compared to the same period in 2000.

Interest income for the year ended December 31, 2001 increased $2.8
million or 3.7% to $78.2 million compared to the same period in 2000. The
increased interest income in 2001 was attributable to the increase in average
interest earning assets during the year.

Average interest earning assets, totaling $1.1 billion at December
31, 2001, increased $145.0 million or 14.5% over December 31, 2000 primarily as
a result of increases in average loans and, to a lesser extent, average
investment and mortgage-backed securities. During the year ended December 31,
2001 the mix of the Company's interest earning assets reflected an increase in
loans compared to the prior year end as loans averaged 44.6% of total average
interest earning assets compared to 43.5% during 2000, a direct result of
significant loan growth. Securities averaged 55.1% of the total and other
interest earning asset categories averaged 0.3% for December 31, 2001. During
2000 the comparable mix was 56.1% in securities and 0.4% in the other interest
earning asset categories.

The overall yield on investment, mortgage-backed and marketable equity
securities decreased 108 basis points to 6.29% during 2001 compared to the same
period in 2000.

39

The average yield on average interest earning assets decreased 72 basis
points during the year ended December 31, 2001 as compared to 2000 primarily as
a result of the decrease in the average yield on loans and securities. The
average yield on loans for the year ended December 31, 2001 decreased to 8.17%
from 8.45% for the year ended December 31, 2000. This decrease was reflective of
an overall decrease in interest rates.

Interest income on loans increased $4.5 million or 12.3% compared to
2000 due to the increase in average loans during 2001.

Interest income on securities decreased $0.9 million in 2001 or 2.4%
compared to 2000 primarily due to the decrease in the average yield on
securities during 2001.

The increase in interest expense for the year ended December 31, 2001
of $1.4 million or 3.1% was attributable to an increase in average interest
bearing liabilities of $110.5 million or 12.8%. Average interest bearing
deposits increased $58.3 million or 11.8% while the average rate paid decreased
from 4.81% at December 31, 2000 to 4.49% at December 31, 2001. Average time
deposits increased $40.5 million or 13.2% while the average rate paid decreased
29 basis points along with an increase in average interest bearing demand
deposits of $13.6 million or 8.2% and an increase in average savings deposits of
$4.2 million or 18.8%. Average noninterest bearing demand deposits increased
$20.9 million or 14.4% during 2001. The latter three categories, which are
considered the lowest cost deposits, comprised 51.7% of total average deposits
during the year ended December 31, 2001 compared to 52.0% during 2000 and 56.6%
during 1999. The increase in average total deposits is reflective of overall
bank growth, brokered CD issuance, branch expansion, and with the exception of
the brokered CDs issued, was the primary source of funding the increase in
average loans.

Average long-term junior subordinated convertible debentures were
$16.95 million for the year ended December 31, 2001 compared to $2.4 million for
the same period in 2000. The increase is a result of the sale of 1,695,000
Convertible Preferred Securities on November 2, 2000 at a liquidation amount of
$10 per Convertible Preferred Security for an aggregate amount of $16,950,000.
These securities have a distribution rate of 8.75% per annum payable at the end
of each calendar quarter.

Average long term junior subordinated debentures remained the same at
$20 million from December 31, 2000 to December 31, 2001.

Average long-term and short-term interest bearing liabilities other
than deposits increased $52.2 million or 14.1%, a direct result of replacing the
long-term brokered CD's called during the second quarter ended June 30, 2001
with long-term FHLB Dallas advances. This increase contributed to the higher
interest expense in 2001, as well as providing the primary source of funding for
the increase in average investment, mortgage-backed and marketable equity
securities.

PROVISION FOR LOAN LOSSES

The provision for loan losses for the year ended December 31, 2001 and
2000 was $1.7 million and $1.6 million, respectively. For the year ended
December 31, 2001, the Company's subsidiary, Southside Bank, had net charge-offs
of loans of $774,000, a decrease of 30.3% compared to the year ended December
31, 2000. For the year ended December 31, 2000, net charge-offs on loans were
$1.1 million.

The decrease in net charge-offs for 2001 is reflective of the decrease
in charge-offs and the increase in recoveries. Net charge-offs for commercial
loans decreased $428,000 from December 31, 2000 more than offsetting the
increase in net charge-offs for loans to individuals of $81,000 from December
31, 2000. Part of the decrease in net charge-offs for commercial loans was due
to two large recoveries on old charge-offs during 2001, which totaled $230,000.
As of December 31, 2001, the Company's review of the loan portfolio indicated
that a loan loss reserve of $5.9 million was adequate to cover probable losses
in the portfolio.

40

NONINTEREST INCOME

The following table sets forth the accounts from which noninterest
income was derived, gives totals for these accounts for the year ended December
31, 2001 and the comparable year ended December 31, 2000 and indicates the
percentage changes:

Total noninterest income for the year ended December 31, 2001 increased
63.1% or $6.4 million compared to 2000. Securities gains increased $4.6 million
or 861.3% from 2000. Of the $4.1 in net securities gains from the AFS portfolio
in 2001, there were $6.2 million in realized gains and $2.1 million in realized
losses. The Company sold securities out of its AFS portfolio to accomplish Asset
Liability Committee and investment portfolio objectives aimed at repositioning
and reducing the overall duration of the securities portfolio and maximizing the
total return of the securities portfolio. Sales of AFS securities were the
result of changes in economic conditions and a change in the desired mix of the
securities portfolio. During 2001, interest rates declined and the yield curve
steepened as short-term interest rates decreased significantly more than
long-term interest rates. The Company used this interest-rate environment to
reposition the securities portfolio in an attempt to lower the overall duration.
Several lower coupon, longer duration mortgage-backed securities were replaced
with higher coupon or shorter duration mortgage-backed securities. Long duration
U. S. Government agency securities were replaced with long duration municipal
securities. Specific municipal securities with greater than twenty years and
larger blocks of long-term municipal security zero coupon bonds were replaced
with thirteen to twenty year coupon municipal securities.

The increase in deposit services income of $1.3 million or 16.6% was a
result of the overdraft privilege program, increased numbers of deposit accounts
and increased deposit activity. Trust income increased $235,000 or 32.4% due to
growth in the Trust department. Mortgage servicing release fees income increased
$432,000 or 69.1%. Bank owned life insurance income increased $109,000 or
100.0%. During the fourth quarter ended December 31, 2001, the Company purchased
Bank Owned Life Insurance in the amount of $15 million on all of its eligible
Bank and Company officers at the level of Vice President and above. The increase
in cash surrender value is shown as a component of noninterest income. Other
noninterest income decreased $267,000 or 19.5% primarily as a result of
decreases in income from BSC Securities, Travelers Express income, credit life
income and check printing income.

41

NONINTEREST EXPENSE

The following schedule lists the accounts which comprise noninterest
expense, gives totals for these accounts for the year ended December 31, 2001
and the comparable year ended December 31, 2000 and indicates the percentage
changes:

Noninterest expense for the year ended December 31, 2001 increased $3.9
million or 15.4% when compared to the year ended December 31, 2000. Salaries and
employee benefits increased $2.7 million or 18.2% due to several factors. Direct
salary expense and payroll taxes increased $1.4 million or 10.9% as a result of
branch expansion, overall bank growth and pay increases. Retirement expense
increased $850,000 or 148.6% for the year ended December 31, 2001 due to
increased number of participants, actuarial assumptions and a lower return on
plan assets. Health and life insurance expense increased $464,000 or 30.4% for
the year ended December 31, 2001 due to increased health claims expense and
reinsurance costs.

Net occupancy expense increased $411,000 or 13.9% for the year ended
December 31, 2001 compared to the same period in 2000, largely due to higher
real estate taxes, depreciation expense and branch expansion.

Equipment expense increased $75,000 or 11.4% for the year ended
December 31, 2001 when compared to 2000 due to additional locations. Supplies
expense increased $52,000 or 9.2% as a result of bank growth and branch
expansion. Professional fees increased $72,000 or 13.2% due to additional
internal audit, loan review and data processing related fees.

ATM and bank analysis fees increased $211,000 or 35.1% for the year
ended December 31, 2001 compared to the same period in 2000 due primarily to
overall deposit growth.

Other expense increased $332,000 or 10.4% during the year ended
December 31, 2001 compared to 2000. The increase was due primarily to increases
in dues to directors, trust expense and costs associated with the Bank's website
and online banking. Also, costs associated with the Company's junior
subordinated debentures increased.

INCOME TAXES

Income tax expense was $3.5 million for the year ended December 31,
2001 and represented an $864,000 or 32.5% increase from the year ended December
31, 2000. The effective tax rate as a percentage of pre-tax income was 21.7% in
2001 and 21.3% in 2000. The increase in the effective tax rate and income tax
expense for 2001 was primarily a result of higher taxable income.

42

CAPITAL RESOURCES

Total shareholders' equity at December 31, 2002 of $82.2 million
increased 19.8% or $13.6 million from December 31, 2001 and represented 6.1% of
total assets at December 31, 2002 compared to 5.4% at December 31, 2001.

Net income for 2002 of $13.3 million was the major contributor to the
increase in shareholders' equity at December 31, 2002 along with the net
increase in the accumulated other comprehensive income of $3.2 million and the
issuance of $3.7 million in common stock (428,822 shares) through conversions
from the Company's junior subordinated debentures into the Company's common
stock, the Company's incentive stock option and dividend reinvestment plans.
Decreases to shareholders' equity consisted of $2.6 million in dividends paid
and the purchase of $4.2 million in common stock (278,210 shares). The Company
purchased common stock pursuant to a common stock repurchase plan instituted in
late 1994. Under the repurchase plan, the Board of Directors establishes, on a
quarterly basis, total dollar limitations. The Board reviews this plan in
conjunction with the capital needs of the Company and Southside Bank and may, at
its discretion, modify or discontinue the plan. During the third quarter of
2002, the Company issued a 5% stock dividend, which had no net effect on
shareholders' equity. The Company's dividend policy requires that any cash
dividend payments made by the Company not exceed consolidated earnings for that
year. Shareholders should not anticipate a continuation of the cash dividend
simply because of the implementation of a dividend reinvestment program. The
payment of dividends will depend upon future earnings, the financial condition
of the Company, and other related factors.

The Bank is subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the Bank's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the Bank
must meet specific capital guidelines that involve quantitative measures of the
Bank's assets, liabilities, and certain off-balance-sheet items as calculated
under regulatory accounting practices. The Bank's capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weightings, and other factors.

Quantitative measures established by regulation to ensure capital
adequacy require the Bank to maintain minimum amounts and ratios (set forth in
the table below) of Total and Tier 1 capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average
assets (as defined). Management believes, as of December 31, 2002, that the Bank
meets all capital adequacy requirements to which it is subject.

43

To be categorized as well capitalized, the Bank must maintain minimum Total
risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the
following table:

(1) Refers to quarterly average assets as calculated by bank
regulatory agencies.

The table below summarizes key equity ratios for the Company for the
years ended December 31, 2002, 2001 and 2000.

44

ACCOUNTING PRONOUNCEMENTS

In June 2001, the Financial Accounting Standards Board issued Financial
Accounting Standard No. 143, "Accounting for Asset Retirement Obligations" (FAS
143). FAS 143 requires liability recognition for retirement obligations
associated with tangible long-lived assets. The obligations included within the
scope of FAS 143 are those for which a company faces a legal obligation for
settlement. The initial measurement of the asset retirement obligation is to be
at fair value. The asset retirement cost equal to the fair value of the
retirement obligation is to be capitalized as part of the cost of the related
long-lived asset and amortized to expense over the useful life of the asset. FAS
143 is effective for all fiscal years beginning after June 15, 2002. The Company
does not believe that FAS 143 will have a material impact on its consolidated
financial statements.

In April 2002, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standard No. 145, "Rescission of FAS 4, 44,
and 64, Amendment of FAS 13, and Technical Corrections" (FAS 145). This
statement updates, clarifies and simplifies existing accounting pronouncements
with respect to the accounting for gains and losses from the extinguishments of
debt. FAS 4 required all gains and losses from extinguishments of debt to be
aggregated and, if material, classified as an extraordinary item, net of related
tax effect. As a result of the rescission of FAS 4, the criteria in APB Opinion
No. 30 will now be used to classify those gains and losses. The provisions of
this statement are applicable to transactions occurring after January 1, 2003.
The adoption of FAS 145 will not have a material impact on the consolidated
financial statements.

In June 2002, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 146, "Accounting for Costs Associated with
Exit or Disposal Activities" (FAS 146). This Statement addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." The principal
difference between this Statement and Issue 94-3 relates to its requirements for
recognition of a liability for a cost associated with an exit or disposal
activity. This Statement requires that a liability for a cost associated with an
exit or disposal activity be recognized when the liability is incurred. Under
Issue 94-3, a liability for an exit cost as defined in Issue 94-3 was recognized
at the date of an entity's commitment to an exit plan. A fundamental conclusion
reached by the Board in this Statement is that an entity' commitment to a plan,
by itself, does not create a present obligation to others that meets the
definition of a liability. Therefore, this Statement eliminates the definition
and requirements for recognition of exit costs in Issue 94-3. This Statement
also establishes that fair value is the objective for initial measurement of the
liability. The provisions of this Statement are effective for exit or disposal
activities that are initiated after December 31, 2002, with early application
encouraged. The Company does not believe that FAS 146 will have a material
impact on its consolidated financial statements.

In October 2002, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standard No. 147, "Acquisitions of Certain
Financial Institutions" (FAS 147). This statement is an amendment of FAS
Statements No. 72 and 144 and FAS Interpretation No. 9. FAS Statement No. 72,
"Accounting for Certain Acquisitions of Banking or Thrift Institutions", and
FASB Interpretation No. 9, "Applying APB Opinions No. 16 and 17 When a Savings
and Loan Association or a Similar Institution Is Acquired in a Business
Combination Accounted for by the Purchase Method", provided interpretive
guidance on the application of the purchase method to acquisitions of financial
institutions. Except for transactions between two or more mutual enterprises,
this Statement removes acquisitions of financial institutions from the scope of
both FAS 72 and Interpretation 9 and requires that those transactions be
accounted for in accordance with FAS 141, "Business Combinations", and FAS 142,
"Goodwill and Other Intangible Assets." Thus, the requirement in paragraph 5 of
FAS 72 to recognize (and subsequently amortize) any excess of the fair value of
liabilities assumed over the fair value of tangible and identifiable intangible
assets acquired as an unidentifiable intangible asset no longer applies to
acquisitions within the scope of this Statement. In addition, this Statement
amends FAS 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets," to include in its scope long-term customer-relationship intangible
assets of financial institutions such as depositor- and borrower-relationship
intangible assets and credit cardholder intangible assets. Consequently, those
intangible assets are subject to the same

45

undiscounted cash flow recoverability test and impairment loss recognition and
measurement provisions that FAS 144 requires for other long-lived assets that
are held and used. The Company does not believe that FAS 147 will have a
material impact on its consolidated financial statements.

In December 2002, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standard No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure" (FAS 148). This Statement is an
amendment of FAS Statement No. 123, "Accounting for Stock-Based Compensation,"
to provide alternative methods of transition for voluntary change to the fair
value based method of accounting for stock-based employee compensation. In
addition, this Statement amends the disclosure requirements of FAS 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. FAS 148 permits two additional
transition methods for entities that adopt the preferable method of accounting
for stock-based compensation. This Statement requires disclosure of comparable
information for all companies regardless of whether, when, or how an entity
adopts the preferable, fair-value based method of accounting. In addition, FAS
148 prescribes a specific tabular format and requires disclosure in the "Summary
of Significant Accounting Policies" or its equivalent. The Company has complied
with the required disclosures in the notes to the consolidated financial
statements.

On November 25, 2002, the Financial Accounting Standards Board ("FASB"
or the "Board") issued FASB Interpretation No. 45 ("FIN 45" or the
"Interpretation"), Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others, an
interpretation of FASB Statements No. 5, 57, and 107 and Rescission of FASB
Interpretation No. 34. FIN 45 clarifies the requirements of FASB Statement No.
5, Accounting for Contingencies (FAS 5), relating to the guarantor's accounting
for, and disclosure of, the issuance of certain types of guarantees. The
Interpretation covers guarantee contracts that have any of the following four
characteristics:

Contracts that contingently require the guarantor to make payments to
the guaranteed party based on changes in an underlying that is related
to an asset, a liability, or an equity security of the guaranteed party
(e.g., financial and market value guarantees),

Contracts that contingently require the guarantor to make payments to
the guaranteed party based on another entity's failure to perform under
an obligating agreement (performance guarantees),

Indemnification agreements that contingently require the indemnifying
party (guarantor) to make payments to the indemnified party (guaranteed
party) based on changes in an underlying that is related to an asset, a
liability, or an equity security of the indemnified party, such as an
adverse judgment in a lawsuit or the imposition of additional taxes due
to either a change in the tax law or an adverse interpretation of the
tax law, and

Indirect guarantees of the indebtedness of others, as that phrase was
used in FIN 34 (FIN 45 supersedes FIN 34 by incorporating in it,
without change, that guidance).

For guarantees that fall within the scope of FIN 45, the Interpretation requires
that guarantors recognize a liability equal to the fair value of the guarantee
upon its issuance.

In addition to the disclosures required by current GAAP related to guarantees
(e.g., FASB Statement No. 5, No. 57, Related Party Disclosures, and No. 107,
Disclosures about Fair Value of Financial Instruments), this Interpretation
requires entities to disclose the following information about each guarantee, or
each group of similar guarantees, even if the likelihood of the guarantor's
having to make any payments under the guarantee is remote:

a. The nature of the guarantee, including the approximate term of the
guarantee, how the guarantee arose, and the events or circumstances
that would require the guarantor to perform under the guarantee.

46

b. The maximum potential amount of future payments (undiscounted) the
guarantor could be required to make under the guarantee. That maximum
potential amount of future payments shall not be reduced by the effect
of any amounts that may possibly be recovered under recourse or
collateralization provisions in the guarantee. If the terms of the
guarantee provide for no limitation to the maximum potential future
payments under the guarantee, that fact shall be disclosed. If the
guarantor is unable to develop an estimate of the maximum potential
amount of future payments under its guarantee, the guarantor shall
disclose the reasons why it cannot estimate the maximum potential
amount.

c. The current carrying amount of the liability, if any, for the
guarantor's obligations under the guarantee (including the amount, if
any, recognized under paragraph 8 of FAS 5), regardless of whether the
guarantee is freestanding or embedded in another contract.

d. The nature of (1) any recourse provisions that would enable the
guarantor to recover from third parties any of the amounts paid under
the guarantee and (2) any assets held either as collateral or by third
parties that, upon the occurrence of any triggering event or condition
under the guarantee, the guarantor can obtain and liquidate to recover
all or a portion of the amounts paid under the guarantee. The guarantor
shall indicate, if estimable, the approximate extent to which the
proceeds from liquidation of those assets would be expected to cover
the maximum potential amount of future payments under the guarantee.

The Interpretation's provisions for initial recognition and measurement should
be applied on a prospective basis to guarantees issued or modified after
December 31, 2002, irrespective of the guarantor's fiscal year-end. The
guarantor's previous accounting for guarantees that were issued before the date
of FIN 45's initial application may not be revised or restated to reflect the
effect of the recognition and measurement provisions of the Interpretation. The
disclosure requirements are effective for financial statements of both interim
and annual periods that end after December 15, 2002. The Company does not
believe that FIN 45 will have a material impact on its consolidated financial
statements.

On January 17, 2003, the Financial Accounting Standards Board (FASB or
the "Board") issued FASB Interpretation No. 46 (FIN 46 or the "Interpretation"),
Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.
The primary objective of the Interpretation is to provide guidance on the
identification of, and financial reporting for, entities over which control is
achieved through means other than voting rights; such entities are known as
variable-interest entities (VIEs). Although the FASB's initial focus was on
special-purpose entities (SPEs), the final guidance applies to a wide range of
entities. FIN 46 has far-reaching effects and applies to new entities that are
created after the effective date, as well as applies to existing entities. Once
it goes into effect, FIN 46 will be the guidance that determines (1) whether
consolidation is required under the "controlling financial interest" model of
Accounting Research Bulletin No. 51 (ARB 51), Consolidated Financial Statements,
or (b) other existing authoritative guidance, or, alternatively, (2) whether the
variable-interest model under FIN 46 should be used to account for existing and
new entities. The effective dates and transition provisions of the
Interpretation are as follows:

Public companies will be required to apply the Interpretation
to preexisting entities as of the beginning of the first
interim period beginning after June 15, 2003.

All enterprises should apply the Interpretation to VIEs with
which they become involved beginning February 1, 2003.

All enterprises will be required to apply the transition
disclosure requirements in financial statements issued after
February 1, 2003.

The Company does not believe FIN 46 will have a material impact on its
consolidated financial statements.

47

EFFECTS OF INFLATION

The consolidated financial statements of the Company, and their related
notes, have been prepared in accordance with generally accepted accounting
principles, that require the measurement of financial position and operating
results in terms of historical dollars, without considering the change in the
relative purchasing power of money over time and due to inflation. The impact of
inflation is reflected in the increased cost of the Company's operations. Unlike
many industrial companies, nearly all of the assets and liabilities of the
Company are monetary. As a result, interest rates have a greater impact on the
Company's performance than do the effects of general levels of inflation.
Interest rates do not necessarily move in the same direction or to the same
extent as the price of goods and services.

MANAGEMENT OF LIQUIDITY

Liquidity management involves the ability to convert assets to cash
with a minimum of loss. The Company must be capable of meeting its obligations
to its customers at any time. This means addressing (1) the immediate cash
withdrawal requirements of depositors and other funds providers; (2) the funding
requirements of all lines and letters of credit; and (3) the short-term credit
needs of customers. Liquidity is provided by short-term investments that can be
readily liquidated with a minimum risk of loss.

Cash, interest earning deposits, federal funds sold and short-term
investments with maturities or repricing characteristics of one year or less
continue to be a substantial percentage of total assets. At December 31, 2002,
these investments were 25.0% of total assets, as compared with 20.1% for
December 31, 2001, and 15.5% for December 31, 2000. Liquidity is further
provided through the matching, by time period, of rate sensitive interest
earning assets with rate sensitive interest bearing liabilities. The Company has
three lines of credit for the purchase of federal funds. Two $15.0 million and
one $10.0 million unsecured lines of credit have been established with Bank of
America, Frost Bank and Texas Independent Bank, respectively.

The Asset/Liability Management Committee of the bank closely monitors
various liquidity ratios, interest rate spreads and margins, interest rate shock
reports and market value of portfolio equity with rates shocked plus and minus
200 basis points to ensure the Company a satisfactory liquidity position. Market
value of portfolio equity is defined as the net present value of an
institution's existing assets, liabilities and off-balance sheet instruments.
Market value of portfolio equity analysis is one of the general measures used by
regulatory authorities for assessing an institution's interest rate risk. The
extent to which assets will gain or lose value in relation to the gains or
losses of liabilities and/or interest rate contracts determines the appreciation
or depreciation in equity on a market value basis. Such market value analysis is
intended to evaluate the impact of immediate and sustained parallel interest
rate shifts of the current yield curve upon the market value of the current
balance sheet. In addition, the bank utilizes a simulation model to determine
the impact on net interest income under several different interest rate
scenarios. By utilizing this technology, the bank attempts to determine changes
that need to be made to the asset and liability mix to minimize the change in
net interest income under these various interest rate scenarios.

The table on page 50 shows the expected maturities for interest earning
assets and interest bearing liabilities as of December 31, 2002.

48

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

In the banking industry, a major risk exposure is changing interest
rates. The primary objective of monitoring the Company's interest rate
sensitivity, or risk, is to provide management the tools necessary to manage the
balance sheet to minimize adverse changes in net interest income as a result of
changes in the direction and level of interest rates. Federal Reserve Board
monetary control efforts, the effects of deregulation and legislative changes
have been significant factors affecting the task of managing interest rate
sensitivity positions in recent years.

The interest rate risk inherent in assets and liabilities may be
determined by analyzing the extent to which such assets and liabilities are
"interest rate sensitive" and by measuring an institution's interest rate
sensitivity "gap." An asset or liability is said to be interest rate sensitive
within a defined time period if it matures or reprices within that period. The
difference or mismatch between the amount of interest earning assets maturing or
repricing within a defined period and the amount of interest bearing liabilities
maturing or repricing within the same period is defined as the interest rate
sensitivity gap. An institution is considered to have a negative gap if the
amount of interest bearing liabilities maturing or repricing within a specified
time period exceeds the amount of interest earning assets maturing or repricing
within the same period. If more interest earning assets than interest bearing
liabilities mature or reprice within a specified period, then the institution is
considered to have a positive gap. Accordingly, in a rising interest rate
environment in an institution with a negative gap, the cost of its rate
sensitive liabilities would theoretically rise at a faster pace than the yield
on its rate sensitive assets, thereby diminishing future net interest income. In
a falling interest rate environment, a negative gap would indicate that the cost
of rate sensitive liabilities would decline at a faster pace than the yield on
rate sensitive assets and improve net interest income. For an institution with a
positive gap, the reverse would be expected. The table on page 52 shows interest
sensitivity gaps for four different intervals as of December 31, 2002.

In an attempt to manage its exposure to changes in interest rates,
management closely monitors the Company's exposure to interest rate risk.
Management maintains an asset/liability committee which meets regularly and
reviews the Company's interest rate risk position and makes recommendations for
adjusting this position. In addition, the Board reviews on a monthly basis the
Company's asset/liability position. The Company primarily uses two methods for
measuring and analyzing interest rate risk: Net income simulation analysis and
market value of portfolio equity modeling. Through these simulations the Company
attempts to estimate the impact on net interest income of a 200 basis point
parallel shift in the yield curve. Policy guidelines limit the estimated change
in net interest income to 10 percent of forecasted net income over the
succeeding 12 months and 200 basis point parallel rate shock. Policy guidelines
limit the change in market value of equity in a 200 basis point parallel rate
shock to 20 percent of the base case. The results of the valuation analysis as
of December 31, 2002, were within policy guidelines. This type of stimulation
analysis requires numerous assumptions including but not limited to changes in
balance sheet mix, prepayment rates on mortgage-related assets and fixed rate
loans, cash flows and repricings of all financial instruments, changes in
volumes and pricing, future shapes of the yield curve, relationship of market
interest rates to each other (basis risk), credit spread and deposit
sensitivity. Assumptions are based on management's best estimates but may not
accurately reflect actual results under certain changes in interest rates.

49

The following table provides information about the Company's financial
instruments that are sensitive to changes in interest rates. Except for the
effects of prepayments and scheduled principal amortization, the table presents
principal cash flows and related weighted average interest rates by the
contractual term to maturity. Callable FHLB Dallas Advances are presented based
on contractual maturity. Nonaccrual loans totaling $2,238,000 are not included
in the Loan totals. All instruments are classified as other than trading.

50

Residential fixed rate loans are assumed to have annual prepayment
rates between 7% and 35% of the portfolio. Commercial and multi-family real
estate loans are assumed to prepay at an annualized rate between 8% and 40%.
Consumer loans are assumed to prepay at an annualized rate between 8% and 30%.
Commercial loans are assumed to prepay at an annual rate between 8% and 45%.
Municipal loans are assumed to prepay at an annual rate between 6% and 15%.
Fixed and adjustable rate mortgage-backed securities, including Collateralized
Mortgage Obligations ("CMOs") and Real Estate Mortgage Investment Conduits
("REMICs"), have annual payment assumptions ranging from 6% to 50%. At December
31, 2002, the contractual maturity of substantially all of the Company's
mortgage-backed or related securities was in excess of ten years. The actual
maturity of a mortgage-backed or related security is less than its stated
maturity due to regular principal payments and prepayments of the underlying
mortgages. Prepayments that are faster than anticipated may shorten the life of
the security and affect its yield to maturity. The yield to maturity is based
upon the interest income and the amortization of any premium or discount related
to the security. In accordance with generally accepted accounting principles,
premiums and discounts are amortized over the estimated lives of the loans,
which decrease and increase interest income, respectively. The prepayment
assumptions used to determine the amortization period for premiums and discounts
can significantly affect the yield of the mortgage-backed or related security,
and these assumptions are reviewed periodically to reflect actual prepayments.
Although prepayments of underlying mortgages depend on many factors, including
the type of mortgages, the coupon rate, the age of mortgages, the geographical
location of the underlying real estate collateralizing the mortgages and general
levels of market interest rates, the difference between the interest rates on
the underlying mortgages and the prevailing mortgage interest rates generally is
the most significant determinant of the rate of prepayments. During periods of
falling mortgage interest rates, if the coupon rate of the underlying mortgages
exceeds the prevailing market interest rates offered for mortgage loans,
refinancing may increase and accelerate the prepayment of the underlying
mortgages and the related security. At December 31, 2002, of the $489.0 million
of mortgage-backed and related securities held by the Company, an aggregate of
$486.4 million were secured by fixed-rate mortgage loans and an aggregate of
$2.6 million were secured by adjustable-rate mortgage loans.

The Company assumes 70% of savings accounts and transaction accounts at
December 31, 2002, are core deposits and are, therefore, expected to roll-off
after five years. The Company assumes 30% of money market accounts at December
31, 2002 are core deposits and are, therefore, expected to roll-off after five
years. The Company does not consider any of its Platinum Money Market accounts
as core deposits. No roll-off rate is applied to certificates of deposit. Fixed
maturity deposits reprice at maturity.

In evaluating the Company's exposure to interest rate risk, certain
limitations inherent in the method of analysis presented in the foregoing table
must be considered. For example, although certain assets and liabilities may
have similar maturities or periods to repricing, they may react in different
degrees to changes in market interest rates. Also, the interest rates on certain
types of assets and liabilities may fluctuate in advance of changes in market
interest rates, while interest rates on other types may lag behind changes in
market rates. Additionally, certain assets, such as adjustable rate mortgages,
have features which restrict changes in interest rates, prepayment and early
withdrawal levels may deviate significantly from those assumed in calculating
the table. Finally, the ability of many borrowers to service their debt may
decrease in the event of an interest rate increase. The Company considers all of
these factors in monitoring its exposure to interest rate risk.

51

The following table sets forth certain information as of December 31,
2002 with respect to rate sensitive assets and liabilities and interest
sensitivity gap (dollars in thousands):

- ----------

(1) Amount is equal to total loans net of unearned discount less nonaccrual
loans at December 31, 2002.

(2) Gap equals Total RSA minus Total RSL.

The Asset Liability Management Committee of Southside Bank closely
monitors the desired gap along with various liquidity ratios to ensure a
satisfactory liquidity position for the Company. Management continually
evaluates the condition of the economy, the pattern of market interest rates and
other economic data to determine the types of investments that should be made
and at what maturities. Using this analysis, management from time to time
assumes calculated interest sensitivity gap positions to maximize net interest
income based upon anticipated movements in the general level of interest rates.
Regulatory authorities also monitor the Bank's gap position along with other
liquidity ratios. In addition, the Bank utilizes a simulation model to determine
the impact of net interest income under several different interest rate
scenarios. By utilizing this technology, the Bank can determine changes that
need to be made to the asset and liability mixes to minimize the change in net
interest income under these various interest rate scenarios.

52

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The information required by this item is set forth in Part IV.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Certain of the information required under this item appears
beginning on page 2 of the Company's definitive proxy statement for the
Annual Meeting of Shareholders to be held April 17, 2003, and is
incorporated herein by reference.

ITEM 11. EXECUTIVE COMPENSATION

The information required under this item appears beginning on
page 9 of the Company's definitive proxy statement for the Annual
Meeting of Shareholders to be held April 17, 2003, and is incorporated
herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required under this item beginning on page 2
of the Company's definitive proxy statement for the Annual Meeting of
Shareholders to be held April 17, 2003, and is incorporated herein by
reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required under this item beginning on page 12
of the Company's definitive proxy statement for the Annual Meeting of
Shareholders to be held April 17, 2003, and is incorporated herein by
reference.

PART IV

ITEM 14. CONTROLS AND PROCEDURES

Within the 90 days prior to the date of this report, the
Company carried out an evaluation, under the supervision and with the
participation of the Company's management, including its Chief
Executive Officer and Chief Financial Officer of the effectiveness of
the design and operation of the Company's disclosure controls and
procedures. Based upon the evaluation, the disclosure controls and
procedures are effective in enabling it to record, process, summarize
and report information required to be included in the periodic SEC
filings within the required time period. There have been no significant
changes in the Company's internal controls or in other factors that
could significantly affect internal controls subsequent to the date the
Company carried out its evaluation.

53

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a)

1. Financial Statements

The following consolidated financial statements of
Southside Bancshares, Inc. and its subsidiaries are filed as
part of this report.

Consolidated Balance Sheets as of December 31, 2002 and 2001.
Consolidated Statements of Income for the years ended
December 31, 2002, 2001 and 2000.
Consolidated Statements of Shareholders' Equity for the years
ended December 31, 2002, 2001 and 2000.
Consolidated Statements of Cash Flow for the years ended
December 31, 2002, 2001 and 2000.
Notes to Consolidated Financial Statements.

2. Financial Statement Schedules

All schedules are omitted because they are not
applicable or not required, or because the required
information is included in the consolidated financial
statements or notes thereto.

3. Exhibits

- ----------

* Filed herewith.
** Compensation plan, benefit plan or employment contract or arrangement.

(b) Reports on Form 8-K

None.

57

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

SOUTHSIDE BANCSHARES, INC.

BY: /s/ B. G. HARTLEY
--------------------------------------------
B. G. Hartley, Chairman of the Board
and Director (Principal Executive Officer)

/s/ LEE R. GIBSON
--------------------------------------------
Lee R. Gibson, CPA, Executive Vice President
and Chief Financial Officer (Principal
DATED: March 7, 2003 Financial and Accounting Officer)

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

58

CERTIFICATION

I, B. G. Hartley, Chairman of the Board and Chief Executive Officer of Southside
Bancshares, Inc. (the "Company"), certify that:

1. I have reviewed this report on Form 10-K of the Company;

2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading as with respect to the period covered by this
annual report;

3. Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly
present in all material respects the financial condition,
results of operations and cash flows of the Company as of, and
for, the periods presented in this annual report;

4. The Company's other certifying officers and I are responsible
for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14 and
15d-14) for the Company and have:

a) designed such disclosure controls and procedures to
ensure that material information relating to the
Company, including its consolidated subsidiaries, is
made known to us by others within those entities,
particularly during the period in which this report
is being prepared;

b) evaluated the effectiveness of the Company's
disclosure controls and procedures as of a date
within 90 days prior to the filing date of this
annual report (the "Evaluation Date") ; and

c) presented in this annual report our conclusions about
the effectiveness of the disclosure controls and
procedures based on our evaluation as of the
Evaluation Date;

5. The Company's other certifying officers and I have disclosed,
based on our most recent evaluation, to the Company's auditors
and the audit committee of the Company's Board of Directors:

a) all significant deficiencies in the design or
operation of internal controls which could adversely
affect the Company's ability to record, process,
summarize and report financial data and have
identified for the Company's auditors any material
weaknesses in internal controls; and

b) any fraud, whether or not material, that involves
management or other employees who have a significant
role in the Company's internal controls; and

6. The Company's other certifying officers and I have indicated
in this annual report whether there were significant changes
in internal controls or in other factors that could
significantly affect internal controls subsequent to the date
of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material
weaknesses.

Date: March 7, 2003 By: /s/ B. G. HARTLEY
------------------------------
B. G. Hartley
Chairman of the Board and
Chief Executive Officer

59

CERTIFICATION

I, Lee R. Gibson, Executive Vice President and Chief Financial Officer of
Southside Bancshares, Inc. (the "Company"), certify that:

1. I have reviewed this report on Form 10-K of the Company;

2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading as with respect to the period covered by this
annual report;

3. Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly
present in all material respects the financial condition,
results of operations and cash flows of the Company as of, and
for, the periods presented in this annual report;

4. The Company's other certifying officers and I are responsible
for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14 and
15d-14) for the Company and have:

a) designed such disclosure controls and procedures to
ensure that material information relating to the
Company, including its consolidated subsidiaries, is
made known to us by others within those entities,
particularly during the period in which this report
is being prepared;

b) evaluated the effectiveness of the Company's
disclosure controls and procedures as of a date
within 90 days prior to the filing date of this
annual report (the "Evaluation Date") ; and

c) presented in this annual report our conclusions about
the effectiveness of the disclosure controls and
procedures based on our evaluation as of the
Evaluation Date;

5. The Company's other certifying officers and I have disclosed,
based on our most recent evaluation, to the Company's auditors
and the audit committee of the Company's Board of Directors:

a) all significant deficiencies in the design or
operation of internal controls which could adversely
affect the Company's ability to record, process,
summarize and report financial data and have
identified for the Company's auditors any material
weaknesses in internal controls; and

b) any fraud, whether or not material, that involves
management or other employees who have a significant
role in the Company's internal controls; and

6. The Company's other certifying officers and I have indicated
in this annual report whether there were significant changes
in internal controls or in other factors that could
significantly affect internal controls subsequent to the date
of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material
weaknesses.

Date: March 7, 2003 By: /s/ LEE R. GIBSON
------------------------------
Lee R. Gibson, CPA
Executive Vice President and
Chief Financial Officer

60

Report of Independent Accountants

To the Shareholders and Board of Directors of
Southside Bancshares, Inc.:

In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income, shareholders' equity and cash flows present
fairly, in all material respects, the financial position of Southside
Bancshares, Inc. and its subsidiaries at December 31, 2002 and 2001, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2002, in conformity with accounting principles
generally accepted in the United States of America. These financial statements
are the responsibility of the Company's management; our responsibility is to
express an opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with auditing standards
generally accepted in the United States of America, which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

As discussed in Note 5 to the financial statements on January 1, 2001, the
Company changed its method of accounting for debt and equity securities.

/s/ PRICEWATERHOUSECOOPERS LLP

PricewaterhouseCoopers LLP
Dallas, Texas
February 21, 2003

61

SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)

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

62

SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share data)

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

63

SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(in thousands, except share amounts)

(continued)

64

SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (continued)
(in thousands, except share amounts)

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

65

SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
(in thousands)

(continued)

66

SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW (continued)
(in thousands)

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

67

NOTES TO FINANCIAL STATEMENTS Southside Bancshares, Inc. and Subsidiaries

1. SUMMARY OF SIGNIFICANT ACCOUNTING AND REPORTING POLICIES

The significant accounting and reporting policies of Southside
Bancshares, Inc. (the "Company"), and its wholly owned subsidiaries,
Southside Delaware Financial Corporation, Southside Bank (the "Bank")
and the nonbank subsidiary, are summarized below.

Organization and Basis of Presentation. The consolidated financial
statements include the accounts of the Company, Southside Delaware
Financial Corporation, Southside Bank and the nonbank subsidiary, which
did not conduct any business in 2002. Southside Bank offers a full
range of financial services to commercial, industrial, financial and
individual customers. All significant intercompany accounts and
transactions are eliminated in consolidation. The preparation of these
consolidated financial statements in conformity with generally accepted
accounting principles requires the use of management's estimates. These
estimates are subjective in nature and involve matters of judgment.
Actual amounts could differ from these estimates.

Cash Equivalents. Cash equivalents, for purposes of reporting cash
flow, include cash and amounts due from banks.

Loans. All loans are stated at principal outstanding net of unearned
discount. Interest income on installment loans is recognized primarily
using the level yield method. Interest income on other loans is
credited to income based primarily on the principal outstanding at
contract rates of interest. Loans receivable that management has the
intent and ability to hold for the foreseeable future or until maturity
or pay-off are reported at their outstanding principal adjusted for any
charge-offs, the reserve for loan losses, and any deferred fees or
costs on originated loans and unamortized premiums or discounts on
purchased loans. A loan is considered impaired, based on current
information and events, if it is probable that the Company will be
unable to collect the scheduled payments of principal or interest when
due according to the contractual terms of the loan agreement.
Substantially all of the Company's impaired loans are
collateral-dependent, and as such, are measured for impairment based on
the fair value of the collateral.

Loan Fees. The Company treats loan fees, net of direct costs, as an
adjustment to the yield of the related loan over its term.

Reserve for Loan Losses. A reserve for loan losses is provided through
charges to income in the form of a provision for loan losses. Loans
which management believes are uncollectible are charged against this
account with subsequent recoveries, if any, credited to the account.
The amount of the reserve for loan losses is determined by management's
evaluation of the quality and inherent risks in the loan portfolio,
economic conditions and other factors which warrant current
recognition.

Nonaccrual Loans. A loan is placed on nonaccrual when principal or
interest is contractually past due 90 days or more unless, in the
determination of management, the principal and interest on the loan are
well collateralized and in the process of collection. In addition, a
loan is placed on nonaccrual when, in the opinion of management, the
future collectibility of interest and principal is in serious doubt.
When classified as nonaccrual, accrued interest receivable on the loan
is reversed and the future accrual of interest is suspended. Payments
of contractual interest are recognized as income only to the extent
that full recovery of the principal balance of the loan is reasonably
certain.

Other Real Estate Owned. Other Real Estate Owned includes real estate
acquired in full or partial settlement of loan obligations. Other Real
Estate Owned is carried at the lower of (1) the recorded amount of the
loan for which the foreclosed property previously served as collateral
or (2) the fair market value of the property. Prior to foreclosure, the
recorded amount of the loan is written down, if necessary, to the
appraised fair market value of the real estate to be acquired, less
selling costs, by charging the reserve for loan losses. Any subsequent
reduction in fair market value is charged to results of operations
through the Reserve for Losses on Other Real Estate Owned account.
Costs of maintaining and operating foreclosed properties are expensed
as incurred. Expenditures to complete or improve foreclosed properties
are capitalized only if expected to be recovered; otherwise, they are
expensed.

68

Securities. The Company uses the specific identification method to
determine the basis for computing realized gain or loss. The Company
accounts for debt and equity securities as follows:

Held to Maturity (HTM). Debt securities that management has the
positive intent and ability to hold until maturity are classified
as HTM and are carried at their remaining unpaid principal
balance, net of unamortized premiums or unaccreted discounts.
Premiums are amortized and discounts are accreted using the level
interest yield method over the estimated remaining term of the
underlying security.

Available for Sale (AFS). Debt and equity securities that will be
held for indefinite periods of time, including securities that may
be sold in response to changes in market interest or prepayment
rates, needs for liquidity and changes in the availability of and
the yield of alternative investments are classified as AFS. These
assets are carried at market value. Market value is determined
using published quotes as of the close of business. Unrealized
gains and losses are excluded from earnings and reported net of
tax in Accumulated Other Comprehensive Income until realized.

Premises and Equipment. Bank premises and equipment are stated at cost,
net of accumulated depreciation. Depreciation is computed on a straight
line basis over the estimated useful lives of the related assets.
Useful lives are estimated to be twenty to forty years for premises and
three to ten years for equipment. Maintenance and repairs are charged
to income as incurred while major improvements and replacements are
capitalized.

Income Taxes. The Company files a consolidated Federal income tax
return. Deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities
and their respective tax bases. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in
the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities
of changes in tax rates is recognized in income in the period the
change occurs.

Stock Options. The Company applies the provisions of Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" and related interpretations, in accounting for its
stock-based compensation plans. Under Opinion 25, compensation cost is
measured as the excess, if any of the quoted market price of the
Company's stock at the date of the grant above the amount an employee
must pay to acquire the stock. The Financial Accounting Standards Board
(FASB) published Statement of Financial Accounting Standard No. 123,
"Accounting for Stock-Based Compensation" (FAS123) on January 1, 1996
which encourages, but does not require, companies to recognize
compensation expense for grants of stock, stock options and other
equity instruments to employees based on new fair value accounting
rules. Companies that choose not to adopt the new rules will continue
to apply existing rules, but will be required to disclose pro forma net
income and earnings per share under the new method. The Company elected
to provide the pro forma disclosures for 2000, 2001 and 2002.

Pro Forma Net Income and Net Income Per Common Share

Had the compensation cost for the Company's stock-based compensation
plans been determined consistent with the requirements of FAS123, the
Company's net income and net income per common share for 2002, 2001,
and 2000 would approximate the pro forma amounts below (in thousands,
except per share amounts, net of taxes):

The effects of applying FAS123 in this pro forma disclosure are not
indicative of future amounts.

69

Accounting Pronouncements. In June 2001, the Financial Accounting
Standards Board issued Financial Accounting Standard No. 143,
"Accounting for Asset Retirement Obligations" (FAS 143). FAS 143
requires liability recognition for retirement obligations associated
with tangible long-lived assets. The obligations included within the
scope of FAS 143 are those for which a company faces a legal obligation
for settlement. The initial measurement of the asset retirement
obligation is to be at fair value. The asset retirement cost equal to
the fair value of the retirement obligation is to be capitalized as
part of the cost of the related long-lived asset and amortized to
expense over the useful life of the asset. FAS 143 is effective for all
fiscal years beginning after June 15, 2002. The Company does not
believe that FAS 143 will have a material impact on its consolidated
financial statements.

In April 2002, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standard No. 145, "Rescission of FAS
4, 44, and 64, Amendment of FAS 13, and Technical Corrections" (FAS
145). This statement updates, clarifies and simplifies existing
accounting pronouncements with respect to the accounting for gains and
losses from the extinguishments of debt. FAS 4 required all gains and
losses from extinguishments of debt to be aggregated and, if material,
classified as an extraordinary item, net of related tax effect. As a
result of the rescission of FAS 4, the criteria in APB Opinion No. 30
will now be used to classify those gains and losses. The provisions of
this statement are applicable to transactions occurring after January
1, 2003. The adoption of FAS 145 will not have a material impact on the
consolidated financial statements.

In June 2002, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" (FAS 146). This Statement
addresses financial accounting and reporting for costs associated with
exit or disposal activities and nullifies Emerging Issues Task Force
(EITF) Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring)." The principal difference
between this Statement and Issue 94-3 relates to its requirements for
recognition of a liability for a cost associated with an exit or
disposal activity. This Statement requires that a liability for a cost
associated with an exit or disposal activity be recognized when the
liability is incurred. Under Issue 94-3, a liability for an exit cost
as defined in Issue 94-3 was recognized at the date of an entity's
commitment to an exit plan. A fundamental conclusion reached by the
Board in this Statement is that an entity's commitment to a plan, by
itself, does not create a present obligation to others that meets the
definition of a liability. Therefore, this Statement eliminates the
definition and requirements for recognition of exit costs in Issue
94-3. This Statement also establishes that fair value is the objective
for initial measurement of the liability. The provisions of this
Statement are effective for exit or disposal activities that are
initiated after December 31, 2002, with early application encouraged.
The Company does not believe that FAS 146 will have a material impact
on its consolidated financial statements.

In October 2002, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standard No. 147, "Acquisitions of
Certain Financial Institutions" (FAS 147). This statement is an
amendment of FAS Statements No. 72 and 144 and FAS Interpretation No.
9. FAS Statement No. 72, "Accounting for Certain Acquisitions of
Banking or Thrift Institutions", and FASB Interpretation No. 9,
"Applying APB Opinions No. 16 and 17 When a Savings and Loan
Association or a Similar Institution Is Acquired in a Business
Combination Accounted for by the Purchase Method", provided
interpretive guidance on the application of the purchase method to
acquisitions of financial institutions. Except for transactions between
two or more mutual enterprises, this Statement removes acquisitions of
financial institutions from the scope of both FAS 72 and Interpretation
9 and requires that those transactions be accounted for in accordance
with FAS 141, "Business Combinations", and FAS 142, "Goodwill and Other
Intangible Assets." Thus, the requirement in paragraph 5 of FAS 72 to
recognize (and subsequently amortize) any excess of the fair value of
liabilities assumed over the fair value of tangible and identifiable
intangible assets acquired as an unidentifiable intangible asset no
longer applies to acquisitions within the scope of this Statement. In
addition, this Statement amends FAS 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets," to include in its scope long-term
customer-relationship intangible assets of financial institutions such
as depositor- and borrower-relationship intangible assets and credit
cardholder intangible assets. Consequently, those intangible assets are
subject to the same undiscounted cash flow recoverability test and
impairment loss recognition and measurement provisions that FAS 144
requires for other long-lived assets that are held and used. The
Company does not believe that FAS 147 will have a material impact on
its consolidated financial statements.

70

In December 2002, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standard No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure" (FAS 148). This
Statement is an amendment of FAS Statement No. 123, "Accounting for
Stock-Based Compensation," to provide alternative methods of transition
for voluntary change to the fair value based method of accounting for
stock-based employee compensation. In addition, this Statement amends
the disclosure requirements of FAS 123 to require prominent disclosures
in both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the
method used on reported results. FAS 148 permits two additional
transition methods for entities that adopt the preferable method of
accounting for stock-based compensation. This Statement requires
disclosure of comparable information for all companies regardless of
whether, when, or how an entity adopts the preferable, fair-value based
method of accounting. In addition, FAS 148 prescribes a specific
tabular format and requires disclosure in the "Summary of Significant
Accounting Policies" or its equivalent.

On November 25, 2002, the Financial Accounting Standards Board ("FASB"
or the "Board") issued FASB Interpretation No. 45 ("FIN 45" or the
"Interpretation"), Guarantor's Accounting and Disclosure Requirements
for Guarantees, Including Indirect Guarantees of Indebtedness of
Others, an interpretation of FASB Statements No. 5, 57, and 107 and
Rescission of FASB Interpretation No. 34. FIN 45 clarifies the
requirements of FASB Statement No. 5, Accounting for Contingencies (FAS
5), relating to the guarantor's accounting for, and disclosure of, the
issuance of certain types of guarantees. The Interpretation covers
guarantee contracts that have any of the following four
characteristics:

Contracts that contingently require the guarantor to make payments to
the guaranteed party based on changes in an underlying that is related
to an asset, a liability, or an equity security of the guaranteed party
(e.g., financial and market value guarantees),

Contracts that contingently require the guarantor to make payments to
the guaranteed party based on another entity's failure to perform under
an obligating agreement (performance guarantees),

Indemnification agreements that contingently require the indemnifying
party (guarantor) to make payments to the indemnified party (guaranteed
party) based on changes in an underlying that is related to an asset, a
liability, or an equity security of the indemnified party, such as an
adverse judgment in a lawsuit or the imposition of additional taxes due
to either a change in the tax law or an adverse interpretation of the
tax law, and

Indirect guarantees of the indebtedness of others, as that phrase was
used in FIN 34 (FIN 45 supersedes FIN 34 by incorporating in it,
without change, that guidance).

For guarantees that fall within the scope of FIN 45, the Interpretation
requires that guarantors recognize a liability equal to the fair value
of the guarantee upon its issuance.

In addition to the disclosures required by current GAAP related to
guarantees (e.g., FASB Statement No. 5, No. 57, Related Party
Disclosures, and No. 107, Disclosures about Fair Value of Financial
Instruments), this Interpretation requires entities to disclose the
following information about each guarantee, or each group of similar
guarantees, even if the likelihood of the guarantor's having to make
any payments under the guarantee is remote:

a. The nature of the guarantee, including the approximate term of the
guarantee, how the guarantee arose, and the events or circumstances
that would require the guarantor to perform under the guarantee.

71

b. The maximum potential amount of future payments (undiscounted) the
guarantor could be required to make under the guarantee. That maximum
potential amount of future payments shall not be reduced by the effect
of any amounts that may possibly be recovered under recourse or
collateralization provisions in the guarantee. If the terms of the
guarantee provide for no limitation to the maximum potential future
payments under the guarantee, that fact shall be disclosed. If the
guarantor is unable to develop an estimate of the maximum potential
amount of future payments under its guarantee, the guarantor shall
disclose the reasons why it cannot estimate the maximum potential
amount.

c. The current carrying amount of the liability, if any, for the
guarantor's obligations under the guarantee (including the amount, if
any, recognized under paragraph 8 of FAS 5), regardless of whether the
guarantee is freestanding or embedded in another contract.

d. The nature of (1) any recourse provisions that would enable the
guarantor to recover from third parties any of the amounts paid under
the guarantee and (2) any assets held either as collateral or by third
parties that, upon the occurrence of any triggering event or condition
under the guarantee, the guarantor can obtain and liquidate to recover
all or a portion of the amounts paid under the guarantee. The guarantor
shall indicate, if estimable, the approximate extent to which the
proceeds from liquidation of those assets would be expected to cover
the maximum potential amount of future payments under the guarantee.

The Interpretation's provisions for initial recognition and measurement
should be applied on a prospective basis to guarantees issued or
modified after December 31, 2002, irrespective of the guarantor's
fiscal year-end. The guarantor's previous accounting for guarantees
that were issued before the date of FIN 45's initial application may
not be revised or restated to reflect the effect of the recognition and
measurement provisions of the Interpretation. The disclosure
requirements are effective for financial statements of both interim and
annual periods that end after December 15, 2002. The Company does not
believe that FIN 45 will have a material impact on its consolidated
financial statements.

On January 17, 2003, the Financial Accounting Standards Board (FASB or
the "Board") issued FASB Interpretation No. 46 (FIN 46 or the
"Interpretation"), Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51. The primary objective of the
Interpretation is to provide guidance on the identification of, and
financial reporting for, entities over which control is achieved
through means other than voting rights; such entities are known as
variable-interest entities (VIEs). Although the FASB's initial focus
was on special-purpose entities (SPEs), the final guidance applies to a
wide range of entities. FIN 46 has far-reaching effects and applies to
new entities that are created after the effective date, as well as
applies to existing entities. Once it goes into effect, FIN 46 will be
the guidance that determines (1) whether consolidation is required
under the "controlling financial interest" model of Accounting Research
Bulletin No. 51 (ARB 51), Consolidated Financial Statements, or (b)
other existing authoritative guidance, or, alternatively, (2) whether
the variable-interest model under FIN 46 should be used to account for
existing and new entities. The effective dates and transition
provisions of the Interpretation are as follows: Public companies will
be required to apply the Interpretation to preexisting entities as of
the beginning of the first interim period beginning after June 15,
2003.

All enterprises should apply the Interpretation to VIEs with which they
become involved beginning February 1, 2003.

All enterprises will be required to apply the transition disclosure
requirements in financial statements issued after February 1, 2003.

The Company does not believe FIN 46 will have a material impact on its
consolidated financial statements.

General. Certain prior period amounts have been reclassified to conform
to current year presentation and had no impact on net income or equity.

72

2. Earnings Per Share

Earnings per share on a basic and diluted basis as required by Statement of
Financial Accounting Standard No. 128, "Earnings Per Share" (FAS128), has been
adjusted to give retroactive recognition to stock splits and stock dividends and
is calculated as follows (in thousands, except per share amounts):

73

3. COMPREHENSIVE INCOME

The components of accumulated comprehensive income as required by Statement of
Financial Accounting Standard No. 130, "Reporting Comprehensive Income" are as
follows (in thousands):

4. CASH AND DUE FROM BANKS

The Company is required to maintain cash reserve balances with the Federal
Reserve Bank. The reserve balances were $250,000 as of December 31, 2002 and
2001.

74

5. INVESTMENT, MORTGAGE-BACKED AND MARKETABLE EQUITY SECURITIES

The amortized cost and estimated market value of investment, mortgage-backed and
marketable equity securities as of December 31, 2002 and 2001 are reflected in
the tables below (in thousands). There were no securities classified in the HTM
category at December 31, 2002 and 2001.

Interest income recognized on securities for the years presented:

75

During the month ended January 31, 2000, the Company transferred securities
totaling $91.7 million from AFS to HTM due to changes in market conditions. Of
the total transferred, $21.2 million were investment securities and $70.5
million were mortgage-backed securities. The unrealized loss on the securities
transferred from AFS to HTM was $2.6 million, net of tax, at the date of
transfer. There were no sales from the HTM portfolio during the years ended
December 31, 2002 or 2001. There were no securities classified as HTM for the
year ended December 31, 2002 or 2001.

On January 1, 2001, Southside adopted Financial Accounting Standard No. 133,
"Accounting for Derivative Instruments and Hedging Activities," (FAS133). As
allowed by FAS133, at the date of initial application of this statement,
Southside transferred held to maturity securities into the available for sale
category and the trading category. Southside sold the securities transferred
into the trading category during the first quarter of 2001. The effect of
selling the securities in the trading category is shown as a cumulative effect
of a change in accounting principle and reduced net income by $994,000 (net of
taxes) during the first quarter of 2001. During 2001, Southside sold available
for sale securities which resulted in realized gains of $4.1 million or an after
tax gain of $2.7 million. These separate transactions allowed Southside to
reduce the overall duration of and reposition the securities portfolio.

Of the $3.9 million in net securities gains from the AFS portfolio in 2002,
there were $4.2 million in realized gains and $340,000 in realized losses. Of
the $4.1 million in net securities gains from the AFS portfolio in 2001, there
were $6.2 million in realized gains and $2.1 million in realized losses. Of the
$535,000 in net securities losses on sales from the AFS portfolio in 2000, there
were $1.5 million in realized losses and $1.0 million in realized gains.

The scheduled maturities of AFS securities as of December 31, 2002 are presented
below. Mortgage-backed securities are presented in total by category.

Investment securities with book values of $401.5 million and $376.2 million
were pledged as of December 31, 2002 and 2001, respectively, to collateralize
FHLB Dallas advances, public and trust deposits or for other purposes as
required by law.

76

6. LOANS AND RESERVE FOR POSSIBLE LOAN LOSSES

Loans in the accompanying consolidated balance sheets are classified as follows:

The following is a summary of the Reserve for Loan Losses for the years ended
December 31, 2002, 2001 and 2000:

Nonaccrual loans at December 31, 2002 and 2001 were $2.2 million and $896,000,
respectively. Loans with terms modified in troubled debt restructuring at
December 31, 2002 and 2001 were $325,000 and $283,000, respectively.

For the years ended December 31, 2002 and 2001, the average recorded investment
in impaired loans was approximately $1,562,000 and $801,000, respectively.
During the years ended December 31, 2002 and 2001, the amount of interest income
reversed on impaired loans placed on nonaccrual and the amount of interest
income subsequently recognized on the cash basis was not material.

The amount of interest recognized on nonaccrual or restructured loans was
$160,000, $70,000 and $122,000 for the years ended December 31, 2002, 2001 and
2000, respectively. If these loans had been accruing interest at their original
contracted rates, related income would have been $205,000, $113,000 and $138,000
for the years ended December 31, 2002, 2001 and 2000, respectively.

77

The following is a summary of the Company's recorded investment in loans
(primarily nonaccrual loans) for which impairment has been recognized in
accordance with FAS114:

7. BANK PREMISES AND EQUIPMENT

Depreciation expense was $2.3 million, $2.0 million and $1.7 million for the
years ended December 31, 2002, 2001 and 2000, respectively. Rent expense was
$532,000, $468,000 and $447,000 for the years ended December 31, 2002, 2001 and
2000, respectively.

Future minimum rental commitments under noncancelable leases are (in thousands):

2003 $ 436
2004 368
2005 350
2006 324
2007 88
--------
$ 1,566
========

78

8. OTHER REAL ESTATE OWNED

The following is a summary of the Allowance for Losses on Other Real Estate
Owned (OREO) for the periods presented:

For the year ended December 31, 2002 and 2001, provision and other expense from
ORE properties exceeded income by $126,000 and $21,000, respectively. For the
years ended December 31, 2000, income from OREO properties exceeded the
provision and other expenses by $2,000.

9. INTEREST BEARING DEPOSITS

For the years ended December 31, 2002, 2001 and 2000, interest expense on time
deposits of $100,000 or more was $4.5 million, $8.2 million and $7.9 million,
respectively.

At December 31, 2002, the scheduled maturities of certificates and other time
deposits are as follows (in thousands):

2003 $246,668
2004 43,378
2005 20,980
2006 15,995
2007 and thereafter 17,933
--------
$344,954
========

The aggregate amount of demand deposit overdrafts that have been reclassified as
loans were $1.3 million and $1.9 million for December 31, 2002 and 2001,
respectively.

79

10. SHORT-TERM BORROWINGS

Information related to short-term borrowings is provided in the table below.

FHLB Dallas advances are collateralized by FHLB Dallas stock, nonspecified real
estate loans and mortgage-backed securities.

81

In April 1998, the Company formed a wholly-owned non-banking subsidiary
Southside Capital Trust (the "Trust Issuer"). The Trust Issuer was created under
the Business Trust Act of Delaware for the sole purpose of issuing and selling
Preferred Securities and Common Securities and using proceeds from the sale of
the Preferred Securities and Common Securities to acquire Junior Subordinated
Debentures (the "Debentures") issued by the Company. Accordingly, the Debentures
are the sole assets of the Trust Issuer and payments under the Debentures are
the sole revenue of the Trust Issuer. All of the Common Securities are owned by
the Company.

On November 2, 2000, the Company through its wholly-owned subsidiary, Southside
Capital Trust II (the "Trust II Issuer"), sold 1,695,000 cumulative convertible
preferred securities (the "junior subordinated convertible debentures") at a
liquidation amount of $10 per convertible preferred security for an aggregate
amount of $16,950,000. These securities have a convertible feature that allows
the owner to convert each security to a share of the Company's common stock at a
conversion price of $9.07 per common share. These securities have a distribution
rate of 8.75% per annum payable at the end of each calendar quarter.

On May 18, 1998, the Company through its wholly-owned subsidiary, Southside
Capital Trust (the "Trust Issuer"), sold 2,000,000 preferred securities (the
"junior subordinated debentures") at a liquidation amount of $10 per preferred
security for an aggregate amount of $20,000,000. These securities have a
distribution rate of 8.50% per annum payable at the end of each calendar
quarter.

The Company's obligations under the Debentures and related documents, taken
together, constitute a full and unconditional guarantee by the Company of the
Trust Issuer's obligations under the Preferred Securities. Although the
Debentures are treated as debt of the Company, they currently qualify for Tier 1
capital treatment subject to a limitation that the securities included as Tier 1
capital not exceed 25% of total Tier 1 capital. The Securities are callable by
the Company on or about June 30, 2003, or earlier in the event the deduction of
related interest for federal income taxes is prohibited, treatment as Tier 1
capital is no longer permitted or certain other contingencies arise. The
Preferred Securities must be redeemed upon maturity of the Debentures in year
2028.

82

12. EMPLOYEE BENEFITS

Southside Bank has a deferred compensation agreement with eight of its executive
officers, which generally provides for payment of an aggregate amount of $4.1
million over a maximum period of fifteen years after retirement or death.
Deferred compensation expense was $236,000, $369,000 and $13,000 for the years
ended December 31, 2002, 2001 and 2000, respectively.

The Company provides accident and health insurance for substantially all
employees through an insurance program funded by the Company. Health insurance
benefits are offered to retired employees who pay a premium based on cost as
determined by a third party administrator. Substantially all of the Company's
employees may become eligible for those benefits if they reach normal retirement
age after fifteen years of employment with the Company. The cost of health care
benefits was $2,266,000, $1,897,000 and $1,451,000 for the years ended December
31, 2002, 2001 and 2000, respectively. There were eight retirees and ten
retirees participating in the health insurance plan as of December 31, 2002 and
2001, respectively.

The Company has an Employee Stock Ownership Plan which covers substantially all
employees. Contributions to the plan are at the sole discretion of the Board of
Directors. Contributions to the plan for the year ended December 31, 2002 were
$100,000. Contributions to the plan for the years ended December 31, 2001 and
2000 were $0 and $100,000, respectively. At December 31, 2002 and 2001, 225,590
and 226,129 shares of common stock were owned by the Employee Stock Ownership
Plan, respectively. The number of shares have been adjusted as a result of stock
splits and stock dividends. These shares are treated as externally held shares
for dividend and earnings per share calculations.

The Company has an Officers Long-term Disability Income Plan, (the "Disability
Plan"), which covers officers of the Company and Southside Bank in the event
they become disabled as defined under its terms. Individuals are automatically
covered under the plan if they (a) have been elected as an officer, (b) have
been an employee of the Company and Southside Bank for three years and (c)
receive earnings of $50,000 or more on an annual basis. The Disability Plan
provides, among other things, that should a covered individual become totally
disabled he would receive 66-2/3%, not to exceed $10,000 per month, of their
current salary. The benefits paid out of this plan are limited by the benefits
paid to the individual under the terms of other Company sponsored benefit plans.

The Company and Southside Bank have a defined benefit pension plan pursuant to
which participants are entitled to benefits based on final average monthly
compensation and years of credited service determined in accordance with plan
provisions. All employees of the Company and Southside Bank who have worked
1,000 hours or more in their first twelve months of employment or during any
plan year thereafter are eligible to participate. Employees are vested upon the
earlier of five years credited service or the employee attaining 60 years of
age. Benefits are payable monthly commencing on the later of age 65 or the
participant's date of retirement. Eligible participants may retire at reduced
benefit levels after reaching age 55. The Company contributes amounts to the
pension fund sufficient to satisfy funding requirements of the Employee
Retirement Income Security Act. Plan assets included 153,137 shares of Southside
Bancshares, Inc. stock purchased at fair market value at December 31, 2002 and
2001. The number of shares have been adjusted as a result of stock splits and
stock dividends.

83

The weighted average discount rate and rate of increase in future compensation
levels used in determining actuarial present value of the projected benefit
obligation was 6.75% and 4.50% and 7.25% and 4.50% at December 31, 2002 and
2001, respectively. The assumed long-term rate of return on plan assets was 9.0%
at December 31, 2002 and 2001.

Net periodic pension cost for the years ended December 31, 2002, 2001 and 2000
included the following components:

84

The Company has a nonfunded supplemental retirement plan (restoration plan) for
its employees whose benefits under the principal retirement plan are reduced
because of compensation deferral elections or limitations under federal tax
laws.

The weighted average discount rate and rate of increase in future compensation
levels used in determining actuarial present value of the projected benefit
obligation was 6.75% and 4.50% and 7.25% and 4.50% at December 31, 2002 and
2001, respectively. The assumed long-term rate of return on plan assets was 9.0%
at December 31, 2002, 2001 and 2000.

85

Net periodic postretirement benefit cost for the years ended December 31, 2002,
2001 and 2000 includes the following components:

Incentive Stock Options

In April 1993, the Company adopted the Southside Bancshares, Inc. 1993 Incentive
Stock Option Plan ("the Plan"), a stock-based incentive compensation plan. The
Company applies APB Opinion 25 and related Interpretations in accounting for the
Plan and discloses the pro forma information required by FAS123.

Under the Plan, the Company is authorized to issue shares of Common Stock
pursuant to "Awards" granted in the form of incentive stock options (intended to
qualify under Section 422 of the Internal Revenue Code of 1986, as amended).
Awards may be granted to selected employees and directors of the Company or any
subsidiary. At December 31, 2002 and 2001, there were 23,531 and 19,904 options
available for grant, respectively. At December 31, 2000, there were 19,324
options available for grant.

The Plan provides that the exercise price of any stock option may not be less
than the fair market value of the Common Stock on the date of grant. There were
no incentive stock options granted in 2002 or 2001. The Company granted
incentive stock options in 2000. These stock options have contractual terms of
10 years. All options vest on a graded schedule, 20% per year for 5 years,
beginning on the first anniversary date of the grant date. In accordance with
APB 25, the Company has not recognized any compensation cost for these stock
options.

A summary of the status of the Company's stock options as of December 31, 2002,
2001 and 2000 and the changes during the year ended on those dates is presented
below:

The fair value of each stock option granted is estimated on the date of grant
using the Black-Scholes method of option pricing with the following
weighted-average assumptions for grants in 2000: dividend yield of 2.95%
risk-free interest rate of 5.95%; the expected life of 6 years; the expected
volatility is 23.21%.

86

The following table summarizes information about stock options outstanding at
December 31, 2002:

13. SHAREHOLDERS' EQUITY

Cash dividends declared and paid were $0.33, $0.25 and $0.225 per share for the
years ended December 31, 2002, 2001 and 2000, respectively. Future dividends
will depend on the Company's earnings, financial condition and other factors
which the Board of Directors of the Company considers to be relevant. The
Company's dividend policy requires that any dividend payments made by the
Company not exceed consolidated earnings for that year.

The Bank is subject to various regulatory capital requirements administered by
the federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory and possibly additional discretionary actions by
regulators that, if undertaken, could have a direct material effect on the
Bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's assets,
liabilities, and certain off-balance-sheet items as calculated under regulatory
accounting practices. The Bank's capital amounts and classification are also
subject to qualitative judgments by the regulators regarding components, risk
weightings, and other factors.

87

Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the table
below) of Total and Tier 1 capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average
assets (as defined). Management believes, as of December 31, 2002, that the Bank
meets all capital adequacy requirements to which it is subject.

As of December 31, 2002, the most recent notification from the Federal Deposit
Insurance Corporation categorized the Bank as well capitalized under the
regulatory framework for prompt corrective action. To be categorized as well
capitalized the Bank must maintain minimum Total risk-based, Tier 1 risk-based,
and Tier 1 leverage ratios as set forth in the table. There are no conditions or
events since that notification that management believes have changed the
institution's category.

(1) Refers to quarterly average assets as calculated by bank
regulatory agencies.

Payment of dividends by the Bank is limited under regulation. The amount that
can be paid in any calendar year without prior approval of the Bank's regulatory
agencies cannot exceed the lesser of net profits (as defined) for that year plus
the net profits for the preceding two calendar years, or retained earnings.

88

14. DIVIDEND REINVESTMENT AND COMMON STOCK REPURCHASE PLAN

The Company has a Dividend Reinvestment Plan funded by stock authorized, but not
yet issued. Proceeds from the sale of the common stock will be used for general
corporate purposes and could be directed to the Company's subsidiaries. For the
year ended December 31, 2002, 37,374 shares were sold under this plan at an
average price of $14.98 per share, reflective of other trades at the time of
each sale. For the year ended December 31, 2001, 37,894 shares were sold under
this plan at an average price of $10.96 per share, reflective of other trades at
the time of each sale.

The Company instituted a Common Stock Repurchase Plan in late 1994. Under the
repurchase plan, the Board of Directors establishes, on a quarterly basis, total
dollar limitations and price per share for stock to be repurchased. The Board
reviews this plan in conjunction with the capital needs of the Company and
Southside Bank and may, at its discretion, modify or discontinue the plan.
During 2002, 278,210 shares of common stock were purchased under this plan at a
cost of $4.2 million. During 2001, 314,025 shares of common stock were purchased
under this plan at a cost of $3.2 million.

15. INCOME TAXES

The provisions for federal income taxes included in the accompanying statements
of income consist of the following (in thousands):

89

The components of the net deferred tax liability as of December 31, 2002 and
2001 are summarized below (in thousands):

A reconciliation of tax at statutory rates and total tax expense is as follows
(dollars in thousands):

90

16. COMMITMENTS AND CONTINGENCIES

In the normal course of business the Company buys and sells securities. At
December 31, 2002 and 2001, the Company had recorded in its balance sheet
commitments to purchase $5.3 million and $800,000 in securities, respectively.
There were no commitments to purchase securities at December 31, 2000.

The Company, or its subsidiaries, is involved with various litigation which
resulted in the normal course of business. Management of the Company, after
consulting with its legal counsel, believes that any liability resulting from
litigation will not have a material effect on the financial position and results
of operations and the liquidity of the Company or its subsidiaries.

17. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK

In the normal course of business the Company is a party to certain financial
instruments, with off-balance-sheet risk, to meet the financing needs of its
customers. These off-balance-sheet instruments include commitments to extend
credit and standby letters of credit. These instruments involve, to varying
degrees, elements of credit and interest rate risk in excess of the amount
reflected in the financial statements. The contract or notional amounts of these
instruments reflect the extent of involvement and exposure to credit loss the
Company has in these particular classes of financial instruments.

Commitments to extend credit are agreements to lend to a customer provided that
the terms established in the contract are met. Commitments generally have fixed
expiration dates and may require payment of fees. Since some commitments are
expected to expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements. Standby letters of credit are
conditional commitments issued to guarantee the performance of a customer to a
third party. These guarantees are primarily issued to support public and private
borrowing arrangements. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loan commitments to
customers.

The Company had outstanding unused commitments to extend credit of $55.4 million
and $46.9 million at December 31, 2002 and 2001, respectively. Each commitment
has a maturity date and the commitment expires on that date with the exception
of credit card and ready reserve commitments which have no stated maturity date.
Unused commitments for credit card and ready reserve at December 31, 2002 and
2001 were $8.3 million and $8.5 million, respectively and are reflected in the
due after one year category. The Company had outstanding standby letters of
credit of $1.1 million and $775,000 at December 31, 2002 and 2001, respectively.
The scheduled maturities of unused commitments are presented below as of
December 31, 2002 and 2001.

The Company applies the same credit policies in making commitments and standby
letters of credit as it does for on-balance-sheet instruments. The Company
evaluates each customer's credit worthiness on a case-by-case basis. The amount
of collateral obtained, if deemed necessary, upon extension of credit is based
on management's credit evaluation of the borrower. Collateral held varies but
may include cash or cash equivalents, negotiable instruments, real estate,
accounts receivable, inventory, property, plant, and equipment.

91

18. SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK

The economy of the Company's market area, East Texas, is directly tied to the
oil and gas industry. Oil prices have had an indirect effect on the Company's
business. Although the Company has a diversified loan portfolio, a significant
portion of its loans are collateralized by real estate. Repayment of these loans
is in part dependent upon the economic conditions in the market area. Part of
the risk associated with real estate loans has been mitigated since 47.1% of
this group represents loans collateralized by residential dwellings that are
primarily owner occupied. Losses on this type of loan have historically been
less than those on speculative properties. Many of the remaining real estate
loans are collateralized primarily with owner occupied commercial real estate.

The mortgage-backed securities held by the Company consist solely of Government
agency pass-through securities which are either directly or indirectly backed by
the full faith and credit of the United States Government.

19. RELATED PARTY TRANSACTIONS

Loan activity of executive officers, directors, and their affiliates for the
years ended December 31, 2002 and 2001 were (in thousands):

Other indebtedness of officers and employees as of December 31, 2002 and 2001
was $5.0 million and $4.3 million, respectively.

The Company incurred legal costs of $202,000, $145,000 and $134,000 during the
years ended December 31, 2002, 2001 and 2000, respectively, from a law firm of
which a director of the Company is a partner. The Company paid
approximately $117,000, $88,000 and $69,000 in insurance premiums during the
years ended December 31, 2002, 2001 and 2000, respectively, to a company of
which a director has a related interest.

92

20. DISCLOSURES ABOUT THE FAIR VALUE OF FINANCIAL INSTRUMENTS

Statement of Financial Accounting Standard No. 107, "Disclosures about Fair
Value of Financial Instruments" (FAS107), requires disclosure of fair value
information about financial instruments, whether or not recognized in the
balance sheet, for which it is practicable to estimate that value. In cases
where quoted market prices are not available, fair values are based on estimates
using present value or other estimation techniques. Those techniques are
significantly affected by the assumptions used, including the discount rate and
estimates of future cash flows. Such techniques and assumptions, as they apply
to individual categories of the Company's financial instruments, are as follows:

Cash and due from banks: The carrying amounts for cash and due from
banks is a reasonable estimate of those assets' fair value.

Investment, mortgage-backed and marketable equity securities: Fair
values for these securities are based on quoted market prices, where
available. If quoted market prices are not available, fair values are
based on quoted market prices for similar securities.

Loans receivable: For adjustable rate loans that reprice frequently and
with no significant change in credit risk, the carrying amounts are a
reasonable estimate of those assets' fair value. The fair value of
other types of loans is estimated by discounting the future cash flows
using the current rates at which similar loans would be made to
borrowers with similar credit ratings and for the same remaining
maturities. Nonperforming loans are estimated using discounted cash
flow analyses or underlying value of the collateral where applicable.

Deposit liabilities: The fair value of demand deposits, savings
accounts, and certain money market deposits is the amount on demand at
the reporting date, that is, the carrying value. Fair values for fixed
rate certificates of deposits are estimated using a discounted cash
flow calculation that applies interest rates currently being offered
for deposits of similar remaining maturities.

Federal funds purchased: Federal funds purchased generally have an
original term to maturity of one day and thus are considered short-term
borrowings. Consequently, their carrying value is a reasonable estimate
of fair value.

Commitments to extend credit: The carrying amounts of commitments to
extend credit and standby letters of credit are a reasonable estimate
of those assets' fair value.

FHLB Dallas advances: The fair value of these advances is estimated by
discounting the future cash flows using rates at which advances would
be made to borrowers with similar credit ratings and for the same
remaining maturities.

Junior subordinated debentures and junior subordinated convertible
debentures: fair values for these securities are based on quoted
market prices.

93

The following table presents the Company's assets, liabilities, and unrecognized
financial instruments at both their respective carrying amounts and fair value:

As discussed earlier, the fair value estimate of financial instruments for which
quoted market prices are unavailable is dependent upon the assumptions used.
Consequently, those estimates cannot be substantiated by comparison to
independent markets and, in many cases, could not be realized in immediate
settlement of the instruments. Accordingly, the aggregate fair value amounts
presented in the above fair value table do not necessarily represent the
underlying value of the Company.

94

21. QUARTERLY FINANCIAL INFORMATION OF REGISTRANT
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)

95

22. PARENT COMPANY FINANCIAL INFORMATION

Condensed financial information for Southside Bancshares, Inc. (parent company
only) was as follows:

CONDENSED BALANCE SHEETS

96

CONDENSED STATEMENTS OF INCOME

CONDENSED STATEMENTS OF CASH FLOW

97

INDEX TO EXHIBITS

- ----------

* Filed herewith.
** Compensation plan, benefit plan or employment contract or arrangement.

(b) Reports on Form 8-K

None.