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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
-------------------
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 or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1201 S. Beckham, Tyler, Texas 75701
- --------------------------------------- --------------------------------
(Address of principal executive offices) (Zip Code)
903-531-7111
--------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X . No .
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes X . No .
The number of shares outstanding of each of the issuer's classes of capital
stock as of July 31, 2003 was 8,571,398 shares of Common Stock, par value $1.25.
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(in thousands, except share amounts)
June 30, December 31,
ASSETS 2003 2002
----------- -----------
Cash and due from banks ................................... $ 39,339 $ 49,607
Federal funds sold ........................................ 3,150 --
Investment securities available for sale .................. 118,438 151,509
Mortgage-backed and related securities available for sale . 567,927 489,015
Marketable equity securities available for sale ........... 22,682 22,391
Loans:
Loans, net of unearned discount ........................ 577,092 582,241
Less: Allowance for loan losses ........................ (6,605) (6,195)
----------- -----------
Net Loans ............................................ 570,487 576,046
Premises and equipment, net ............................... 29,699 30,100
Interest receivable ....................................... 8,349 8,930
Other assets .............................................. 22,125 21,588
----------- -----------
TOTAL ASSETS ......................................... $ 1,382,196 $ 1,349,186
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest bearing .................................... $ 216,240 $ 193,305
Interest bearing ....................................... 628,871 621,181
----------- -----------
Total Deposits ....................................... 845,111 814,486
Short-term obligations:
Federal funds purchased ................................ -- 15,850
FHLB Dallas advances ................................... 176,628 153,422
Other obligations ...................................... 2,283 2,500
----------- -----------
Total Short-term obligations ........................ 178,911 171,772
Long-term obligations:
FHLB Dallas advances ................................... 223,763 231,140
Junior subordinated convertible debentures ............. 12,460 14,225
Junior subordinated debentures ......................... 20,000 20,000
----------- -----------
Total Long-term obligations ......................... 256,223 265,365
Deferred tax liability .................................... 2,805 3,631
Other liabilities ......................................... 12,357 11,765
----------- -----------
TOTAL LIABILITIES .................................... 1,295,407 1,267,019
----------- -----------
Shareholders' equity:
Common stock: ($1.25 par, 20,000,000 shares authorized,
9,839,369 and 9,557,598 shares issued) ................ 12,299 11,947
Paid-in capital ........................................ 46,057 44,050
Retained earnings ...................................... 35,240 29,805
Treasury stock (1,358,587 and 1,198,787 shares at cost) (15,481) (12,714)
Accumulated other comprehensive income ................. 8,674 9,079
----------- -----------
TOTAL SHAREHOLDERS' EQUITY .......................... 86,789 82,167
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY .......... $ 1,382,196 $ 1,349,186
=========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
1
SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(in thousands, except per share data)
Quarter Ended June 30, Six Months Ended June 30,
---------------------- -------------------------
2003 2002 2003 2002
------- ------- ------- -------
Interest income
Loans .......................................... $ 9,186 $ 9,433 $18,204 $19,024
Investment securities .......................... 1,074 1,765 2,379 3,639
Mortgage-backed and related securities ......... 4,990 6,130 10,177 11,987
Marketable equity securities ................... 140 165 290 336
Other interest earning assets .................. 47 16 61 32
------- ------- ------- -------
Total interest income ...................... 15,437 17,509 31,111 35,018
Interest expense
Deposits ....................................... 2,926 4,100 6,425 8,383
Short-term obligations ......................... 1,543 1,468 3,082 2,671
Long-term obligations .......................... 3,094 3,500 6,271 7,486
------- ------- ------- -------
Total interest expense ..................... 7,563 9,068 15,778 18,540
------- ------- ------- -------
Net interest income ............................... 7,874 8,441 15,333 16,478
Provision for loan losses ......................... 525 601 1,054 1,051
------- ------- ------- -------
Net interest income after provision for loan losses 7,349 7,840 14,279 15,427
------- ------- ------- -------
Noninterest income
Deposit services ............................... 3,094 2,643 6,071 5,123
Gain on sales of securities available for sale . 1,388 799 3,579 1,043
Mortgage servicing release fees ................ 786 513 1,461 905
Trust income ................................... 244 227 475 481
Bank owned life insurance ...................... 301 326 492 495
Other .......................................... 366 261 670 466
------- ------- ------- -------
Total noninterest income ................... 6,179 4,769 12,748 8,513
------- ------- ------- -------
Noninterest expense
Salaries and employee benefits ................. 6,028 5,420 11,947 10,598
Net occupancy expense .......................... 977 978 1,950 1,915
Equipment expense .............................. 177 141 350 325
Advertising, travel & entertainment ............ 454 482 938 878
ATM and bank analysis fees ..................... 229 225 441 433
Supplies ....................................... 169 178 314 366
Professional fees .............................. 157 184 363 331
Postage ........................................ 143 123 279 241
Other .......................................... 1,177 968 2,374 1,879
------- ------- ------- -------
Total noninterest expense .................. 9,511 8,699 18,956 16,966
------- ------- ------- -------
Income before federal tax expense ................. 4,017 3,910 8,071 6,974
Provision for federal tax expense ................. 590 549 1,287 847
------- ------- ------- -------
Net Income ........................................ $ 3,427 $ 3,361 $ 6,784 $ 6,127
======= ======= ======= =======
Earnings per common share - basic ................. $ 0.41 $ 0.40 $ 0.81 $ 0.74
======= ======= ======= =======
Earnings per common share - diluted ............... $ 0.34 $ 0.34 $ 0.68 $ 0.62
======= ======= ======= =======
The accompanying notes are an integral part of these consolidated financial
statements.
2
SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(UNAUDITED)
(in thousands, except per share amounts)
Accumulated
Other
Compre- Total
Compre- hensive Share-
hensive Common Paid in Retained Treasury Income holders'
Income Stock Capital Earnings Stock (Loss) Equity
------ ----- ------- -------- ----- ------ ------
Balance at December 31, 2002................. $ $11,947 $44,050 $29,805 $(12,714) $9,079 $82,167
Net Income................................... 6,784 6,784 6,784
Other comprehensive loss, net of tax
Unrealized losses on securities, net of
reclassification adjustment (see Note 3).. (405) (405) (405)
------
Comprehensive income......................... $6,379
======
Common stock issued (281,771 shares)......... 352 1,875 2,227
Dividends paid on common stock............... (1,349) (1,349)
Purchase of 159,800 shares of
common stock............................... (2,767) (2,767)
Tax benefit of incentive stock options....... 132 132
------- ------- ------- -------- ------ -------
Balance at June 30, 2003..................... $12,299 $46,057 $35,240 $(15,481) $8,674 $86,789
======= ======= ======= ======== ====== =======
Balance at December 31, 2001................. $ $10,917 $35,195 $25,133 $ (8,511) $5,851 $68,585
Net Income................................... 6,127 6,127 6,127
Other comprehensive income, net of tax
Unrealized gains on securities, net of
reclassification adjustment (see Note 3).. 735 735 735
------
Comprehensive income......................... $6,862
======
Common stock issued (283,804 shares)......... 354 2,082 2,436
Dividends paid on common stock............... (1,260) (1,260)
Purchase of 222,600 shares of
common stock............................... (3,372) (3,372)
Tax benefit of incentive stock options....... 108 108
------- ------- ------- -------- ------ -------
Balance at June 30, 2002..................... $11,271 $37,385 $30,000 $(11,883) $6,586 $73,359
======= ======= ======= ======== ====== =======
The accompanying notes are an integral part of these consolidated
financial statements.
3
SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
(UNAUDITED)
(in thousands)
Six Months Ended
June 30,
------------------------
2003 2002
--------- ---------
OPERATING ACTIVITIES:
Net income .............................................................. $ 6,784 $ 6,127
Adjustments to reconcile net cash provided by operations:
Depreciation ........................................................... 1,187 1,135
Amortization of premium ................................................ 6,507 4,882
Accretion of discount and loan fees .................................... (161) (203)
Provision for loan losses .............................................. 1,054 1,051
Decrease (increase) in interest receivable ............................. 581 (453)
(Increase) decrease in other assets .................................... (774) 568
Increase in deferred tax asset ......................................... (617) (241)
Decrease in interest payable ........................................... (378) (357)
Increase in other liabilities .......................................... 753 13,457
Loss on retirement of premises and equipment ........................... 149 --
Gain on sales of premises and equipment ................................ (5) (12)
Impairment of other real estate owned .................................. 62 --
Gain on sales of other real estate owned ............................... (26) (28)
Gain on sales of available for sale securities ......................... (3,579) (1,043)
--------- ---------
Net cash provided by operating activities ............................ 11,537 24,883
INVESTING ACTIVITIES:
Net increase in federal funds sold ...................................... (3,150) --
Proceeds from sales of investment securities available for sale ......... 54,181 68,860
Proceeds from sales of mortgage-backed securities available for sale .... 119,556 66,527
Proceeds from maturities of investment securities available for sale .... 50,135 7,515
Proceeds from maturities of mortgage-backed securities available for sale 117,424 112,645
Purchases of investment securities available for sale ................... (66,366) (63,620)
Purchases of mortgage-backed securities available for sale .............. (324,152) (214,047)
Purchases of marketable equity securities available for sale ............ (291) (780)
Net decrease (increase) in loans ........................................ 3,808 (17,308)
Purchases of premises and equipment ..................................... (938) (4,030)
Proceeds from sales of premises and equipment ........................... 8 19
Proceeds from sales of other real estate owned .......................... 358 79
Proceeds from sales of repossessed assets ............................... 540 977
--------- ---------
Net cash used in investing activities ................................ (48,887) (43,163)
The accompanying notes are an integral part of these consolidated financial
statements.
4
SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW (continued)
(UNAUDITED)
(in thousands)
Six Months Ended
June 30,
----------------------
2003 2002
-------- --------
FINANCING ACTIVITIES:
Net increase in demand and savings accounts ............................... $ 44,655 $ 20,520
Net (decrease) increase in certificates of deposit ........................ (14,030) 10,368
Net decrease in federal funds purchased ................................... (15,850) (10,800)
Net increase (decrease) in FHLB Dallas advances ........................... 15,829 (5,176)
Net decrease in junior subordinated convertible dentures .................. (1,765) (1,880)
Tax benefit of incentive stock options .................................... 132 108
Proceeds from the issuance of common stock ................................ 2,227 2,436
Purchase of common stock .................................................. (2,767) (3,372)
Dividends paid ............................................................ (1,349) (1,260)
-------- --------
Net cash provided by financing activities ............................ 27,082 10,944
Net decrease in cash and cash equivalents .................................. (10,268) (7,336)
Cash and cash equivalents at beginning of period ........................... 49,607 52,681
-------- --------
Cash and cash equivalents at end of period ................................. $ 39,339 $ 45,345
======== ========
SUPPLEMENTAL DISCLOSURE FOR CASH FLOW INFORMATION:
Interest paid ............................................................. $ 16,156 $ 18,897
Income taxes paid ......................................................... $ 1,600 $ 1,000
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Acquisition of other repossessed assets and real estate through foreclosure $ 698 $ 1,837
The accompanying notes are an integral part of these consolidated financial
statements.
5
SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
1. Basis of Presentation
The consolidated balance sheet as of June 30, 2003, and the related consolidated
statements of income, shareholders' equity and cash flow for the quarter and
six-month periods ended June 30, 2003 and 2002 are unaudited; in the opinion of
management, all adjustments necessary for a fair presentation of such financial
statements have been included. Such adjustments consisted only of normal
recurring items. Interim results are not necessarily indicative of results for a
full year. These financial statements should be read in conjunction with the
financial statements and notes thereto in the Company's latest report on Form
10-K. All share data has been adjusted to give retroactive recognition to stock
splits and stock dividends.
2. Earnings Per Share
Earnings per share on a basic and diluted basis has been adjusted to give
retroactive recognition to stock splits and stock dividends and is calculated as
follows (in thousands, except per share amounts):
Quarter Ended June 30, Six Months Ended June 30,
---------------------- -------------------------
2003 2002 2003 2002
------- ------- ------- -------
Basic Earnings and Shares:
Net income ........................................ $ 3,427 $ 3,361 $ 6,784 $ 6,127
======= ======= ======= =======
Weighted-average basic shares outstanding ......... 8,437 8,323 8,408 8,259
Basic Earnings Per Share:
Net income ........................................ $ 0.41 $ 0.40 $ 0.81 $ 0.74
======= ======= ======= =======
Diluted Earnings and Shares:
Net income ........................................ $ 3,427 $ 3,361 $ 6,784 $ 6,127
Add: Applicable dividend on convertible debentures 180 218 381 462
------- ------- ------- -------
Adjusted net income ............................... $ 3,607 $ 3,579 $ 7,165 $ 6,589
======= ======= ======= =======
Weighted-average basic shares outstanding ......... 8,437 8,323 8,408 8,259
Add: Stock options ................................ 616 628 620 604
Convertible debentures ....................... 1,473 1,678 1,517 1,772
------- ------- ------- -------
Weighted-average diluted shares outstanding ....... 10,526 10,629 10,545 10,635
======= ======= ======= =======
Diluted Earnings Per Share:
Net income ........................................ $ 0.34 $ 0.34 $ 0.68 $ 0.62
======= ======= ======= =======
6
3. Comprehensive Income (Loss)
The components of accumulated comprehensive income (loss) are as follows:
Six Months Ended June 30, 2003
-----------------------------------------------------
Before-Tax Tax (Expense) Net-of-Tax
Amount Benefit Amount
------- ------- -------
Unrealized losses on securities:
Unrealized holding gains arising during period $ 2,965 $(1,008) $ 1,957
Less: reclassification adjustment for gains
included in net income .................. 3,579 (1,217) 2,362
------- ------- -------
Net unrealized losses on securities ......... (614) 209 (405)
------- ------- -------
Other comprehensive loss ........................ $ (614) $ 209 $ (405)
======= ======= =======
Quarter Ended June 30, 2003
-----------------------------------------------------
Before-Tax Tax (Expense) Net-of-Tax
Amount Benefit Amount
------- ------- -------
Unrealized gains on securities:
Unrealized holding gains arising during period $2,130 $ (724) $1,406
Less: reclassification adjustment for gains
included in net income .................. 1,388 (472) 916
------ ------ ------
Net unrealized gains on securities .......... 742 (252) 490
------ ------ ------
Other comprehensive income ...................... $ 742 $ (252) $ 490
====== ====== ======
Six Months Ended June 30, 2002
-----------------------------------------------------
Before-Tax Tax (Expense) Net-of-Tax
Amount Benefit Amount
------- ------- -------
Unrealized gains on securities:
Unrealized holding gains arising during period $2,157 $ (733) $1,424
Less: reclassification adjustment for gains
included in net income .................. 1,043 (354) 689
------ ------ ------
Net unrealized gains on securities .......... 1,114 (379) 735
------ ------ ------
Other comprehensive income ...................... $1,114 $ (379) $ 735
====== ====== ======
Quarter Ended June 30, 2002
-----------------------------------------------------
Before-Tax Tax (Expense) Net-of-Tax
Amount Benefit Amount
------- ------- -------
Unrealized gains on securities:
Unrealized holding gains arising during period $ 3,779 $(1,284) $ 2,495
Less: reclassification adjustment for gains
included in net income .................. 799 (271) 528
------- ------- -------
Net unrealized gains on securities .......... 2,980 (1,013) 1,967
------- ------- -------
Other comprehensive income ...................... $ 2,980 $(1,013) $ 1,967
======= ======= =======
7
4. 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 the intrinsic value method of APB Opinion 25 and related
Interpretations in accounting for the Plan and discloses the pro forma
information for the value method required by FAS 123 and 148.
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 June 30, 2003, there were no stock options available for grant.
At June 30, 2002, there were 22,489 stock 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
27,500 incentive stock options granted in 2003. There were no incentive stock
options granted in 2002. 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 Opinion 25,
the Company has not recognized any compensation cost for these stock options.
A summary of the status of the Company's stock options and the changes during
the periods ended on those dates is presented below:
Quarter Ended June 30
----------------------------------------------------------
2003 2002
-------------------------- --------------------------
Weighted Weighted
# Shares of Average # Shares of Average
Underlying Exercise Underlying Exercise
Options Prices Options Prices
------- ------ ------- ------
Outstanding at beginning of the period .............. 1,027,768 $ 6.67 1,130,865 $ 6.25
Granted ............................................. -- $ -- -- $ --
Exercised ........................................... (25,483) $ 5.65 (45,029) $ 6.12
Forfeited ........................................... (348) $ 6.70 -- $ --
Expired ............................................. -- $ -- -- $ --
Outstanding at end of period ........................ 1,001,937 $ 6.69 1,085,836 $ 6.25
Exercisable at end of period ........................ 724,500 $ 6.27 703,902 $ 5.87
Weighted-average fair value of
options granted during
the period ended June 30 ............................ N/A N/A
Six Months Ended June 30,
--------------------------------------------------------
2003 2002
------------------------ --------------------------
Weighted Weighted
# Shares of Average # Shares of Average
Underlying Exercise Underlying Exercise
Options Price Options Prices
------- ----- ------- ------
Outstanding at beginning of the period .............. 1,049,750 $ 6.29 1,160,070 $ 6.22
Granted ............................................. 27,500 $ 16.10 -- $ --
Exercised ........................................... (70,891) $ 4.28 (71,649) $ 5.80
Forfeited ........................................... (4,422) $ 6.65 (2,585) $ 6.69
Expired ............................................. -- $ -- -- $ --
Outstanding at end of period ........................ 1,001,937 $ 6.69 1,085,836 $ 6.25
Exercisable at end of period ........................ 724,500 $ 6.27 703,902 $ 5.87
Weighted-average fair value of
options granted during
the period ended June 30 ............................ $ 4.91 N/A
The fair value of each stock option granted is estimated on the date of grant
using the Black-Scholes method of option pricing with the following
weighted-average assumptions for grants in 2003: dividend yield of 1.93%;
risk-free interest rate of 4.93%; the expected life of 6 years; the expected
volatility is 28.90%.
8
The following table summarizes information about stock options outstanding
at June 30, 2003:
Options Outstanding Options Exercisable
--------------------------------------------------- ------------------------------
WEIGHTED AVG.
REMAINING
RANGE OF NUMBER CONTRACT LIFE WEIGHTED AVG. NUMBER WEIGHTED AVG.
EXERCISE PRICES OUTSTANDING (YEARS) EXERCISE PRICE EXERCISABLE EXERCISE PRICE
--------------- ----------- ------- -------------- ----------- --------------
$ 4.07 to $ 6.70 660,531 4.7 $ 5.98 481,112 $ 5.71
$ 7.26 to $ 16.10 341,406 6.0 $ 8.08 243,388 $ 7.38
--------- ---------
$ 4.07 to $ 16.10 1,001,937 5.2 $ 6.69 724,500 $ 6.27
========= =========
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 FAS 123, the Company's net income
and net income per common share would approximate the pro forma amounts below
(in thousands, except per share amounts, net of taxes):
Quarter Ended June 30 Six Months Ended June 30,
--------------------------------------------------- ---------------------------------------------------
2003 2002 2003 2002
----------------------- ----------------------- ----------------------- -----------------------
As Reported Pro Forma As Reported Pro Forma As Reported Pro Forma As Reported Pro Forma
----------- --------- ----------- --------- ----------- --------- ----------- ---------
FAS123 Charge $ -- $ 43 $ -- $ 47 $ -- $ 83 $ -- $ 98
Net Income $ 3,427 $ 3,384 $ 3,361 $ 3,314 $ 6,784 $ 6,701 $ 6,127 $ 6,029
Net Income per
Common Share-Basic $ 0.41 $ 0.40 $ 0.40 $ 0.40 $ 0.81 $ 0.80 $ 0.74 $ 0.73
Net Income per
Common Share-Diluted $ 0.34 $ 0.34 $ 0.34 $ 0.33 $ 0.68 $ 0.67 $ 0.62 $ 0.61
The effects of applying FAS123 in this pro forma disclosure are not
indicative of future amounts.
9
5. Accounting Pronouncements
In April 2003, the Financial Accounting Standards Board (FASB) issued Financial
Accounting Standard No. 149, "Amendment of Statement 133 on Derivative
Instruments and Hedging Activities" (FAS 149). FAS 149 amends and clarifies (1)
the accounting guidance on derivative instruments (including certain derivative
instruments embedded in other contracts) and (2) hedging activities that fall
within the scope of FASB Statement No. 133, "Accounting for Derivative
Instruments and Hedging Activities" (FAS 133). In addition, FAS 149 amends FAS
133 to reflect decisions made as part of the Derivatives Implementation Group
(DIG) process that effectively required amendments to FAS 133, in connection
with other projects dealing with financial instruments, and regarding
implementation issues related to the application of the definition of a
derivative. The changes in FAS 149 improve financial reporting by requiring that
contracts with comparable characteristics be accounted for similarly and
clarifying when a derivative contains a financing component that warrants
special reporting in the statement of cash flows. The guidance is to be applied
prospectively. FAS 149 is effective for contracts entered into or modified after
June 30, 2003, with certain exceptions, and for hedging relationships designated
after June 30, 2003. The Company does not believe FAS 149 will have a material
impact on its consolidated financial statements.
In May 2003, the Financial Accounting Standards Board (FASB) issued Financial
Accounting Standard No. 150, "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity" (FAS 150). FAS 150 improves the
accounting for certain financial instruments that, under previous guidance,
issuers could account for as equity and requires that those instruments be
classified as liabilities (or assets in certain circumstances) in statements of
financial position.
FAS 150 affects the issuer's accounting for three types of freestanding
financial instruments:
1. Mandatorily redeemable shares are required to be redeemed at a
specified or determinable date or upon an event certain to occur. A
financial instrument is deemed mandatorily redeemable if it embodies
an obligation outside the control of the issuer and the holder to
redeem the instrument by transferring cash or other assets and the
obligation is required to be redeemed at a specified or determinable
date or upon an event certain to occur. No entity would be exempt
from classifying MRIs as liabilities. Further, those entities that
have only one class of stock and that stock is considered
mandatorily redeemable would be required to specifically distinguish
those instruments within the financial statements from other
instruments classified as liabilities.
2. Put options and forward purchase contracts, which involves financial
instruments embodying an obligation that the issuer must or could
choose to settle by issuing a variable number of its shares or other
equity instruments based solely on something other than the issuer's
own equity shares.
3. Certain obligations that can be settled with shares, the monetary
value of which is fixed, tied solely or predominantly to a variable
such as a market index or varies inversely with the value of the
issuers' shares. FAS 150 does not apply to features embedded in a
financial instrument that is not a derivative in its entirety.
FAS 150 also requires disclosures about alternative ways of settling the
instruments and the capital structure of entities -- all of whose shares are
mandatorily redeemable. FAS 150 is generally effective for all financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June 15,
2003. The Company does not believe FAS 150 will have a material impact on its
consolidated financial statements.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - Six months ended June 30, 2003 compared to June 30, 2002.
The following is a discussion of the consolidated financial condition, changes
in financial condition, and results of operations of Southside Bancshares, Inc.
(the "Company"), and should be read and reviewed in conjunction with the
financial statements, and the notes thereto, in this presentation and in the
Company's latest report on Form 10-K.
The Company reported an increase in net income for the quarter and six months
ended June 30, 2003 compared to the same period in 2002. Net income for the
quarter and six months ended June 30, 2003 was $3.4 million and $6.8 million
compared to $3.4 million and $6.1 million for the same period in 2002.
All share data has been adjusted to give retroactive recognition to stock splits
and stock dividends.
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 2 - 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 and may impact prepayments on the
mortgage-backed securities portfolio, changes effecting the leverage strategy,
significant increases in competition in the banking and financial services
industry, changes in consumer spending, 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.
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
11
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.
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 in the Company's latest report on Form 10-K filed March 7,
2003 for a detailed description of the Company's estimation process and
methodology related to the allowance for loan losses.
Estimation of Fair Value. The estimation of fair value is significant to a
number of 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 States require disclosure of the fair value of
financial instruments as a part of the notes to the consolidated annual
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.
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 Federal Home Loan Bank (FHLB) of 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. During
the first six months ended June 30, 2003 quality loan growth was not available
at a market price the Company was willing to accept. 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 the Asset Liability Committee (ALCO) scenarios
modeled.
12
Net Interest Income
Net interest income for the six months ended June 30, 2003 was $15.3 million, a
decrease of $1.1 million or 6.9% when compared to the same period in 2002.
Average interest earning assets increased $48.9 million or 4.2%, while the net
interest spread decreased from 2.66% at June 30, 2002 to 2.34% at June 30, 2003
and the net margin decreased from 3.17% at June 30, 2002 to 2.84% at June 30,
2003. Net interest income decreased as a result of decreases in the Company's
net interest margin and spread during the first six months of 2003 when compared
to the same period in 2002, which was due in part to lower mortgage interest
rates and the lower overall interest rate environment. This led to substantially
increased residential mortgage refinancing nationwide and in the Company's
market area combined with substantially increased repricing 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 repricing of other loan types may continue to impact the Company's
net interest margin during the third quarter of 2003 or until overall interest
rates increase. This may be offset by several factors including deposit
repricing strategies fully implemented during the second quarter, $61.5 million
of fixed rate FHLB advances currently at an average rate of 4.42% that will
reprice during the last two quarters of 2003 and continued fee income from the
sale of mortgage loans into the secondary market due to the volume of
refinancing that the Company is currently handling in its market area. The
Company's net interest margin and spread increased slightly during the second
quarter ended June 30, 2003 to 2.87% and 2.37%, respectively, when compared to
2.80% and 2.30%, respectively, for the first quarter ended March 31, 2003.
During the six months ended June 30, 2003, average loans, funded primarily by
the growth in average deposits, increased $36.2 million or 6.7%, compared to the
same period in 2002. The average yield on loans decreased from 7.37% at June 30,
2002 to 6.73% at June 30, 2003 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 repricing due to lower interest rates offered
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 $820,000 or 4.3% was the result of the decrease in
interest rates partially offset by the increase in average loans. During the
first six months ended June 30, 2003, loans decreased $5.1 million or 0.9% when
compared to the year ended December 31, 2002 primarily as a result of a decrease
in sold mortgage loans in the process of funding.
Average securities increased $4.3 million or 0.7% for the six months ended June
30, 2003 when compared to the same period in 2002. This increase was a result of
the increase in average deposits. The overall yield on average securities
decreased to 4.39% during the six months ended June 30, 2003 from 5.58% during
the same period in 2002. This decrease is reflective of overall lower interest
rates, increased prepayment speeds on mortgage-backed securities which led to
increased amortization expense and a restructuring of a portion of the
securities portfolio in an effort to lower duration, reduce tax-free income
derived from the securities portfolio and reposition some of the mortgage-backed
securities coupons in an attempt to reduce prepayments.
Interest income from marketable equity securities, federal funds sold and other
interest earning assets decreased $17,000 or 4.6% for the six months ended June
30, 2003 when compared to 2002 as a result of the decrease in the average yield
from 3.04% in 2002 to 2.16% at June 30, 2003, due to lower interest rates, which
were partially offset by an increase in the average balance.
Total interest expense decreased $2.8 million or 14.9% to $15.8 million during
the six months ended June 30, 2003 as compared to $18.5 million during the same
period in 2002. The decrease was attributable to a decrease in interest rates
partially offset by an increase in average interest bearing liabilities of $15.6
million or 1.5%. The average yield on interest bearing liabilities decreased
from 3.69% at June 30, 2002 to 3.09% at June 30, 2003.
Average interest bearing deposits increased $40.0 million or 6.8% while the
average rate paid decreased from 2.88% at June 30, 2002 to 2.04% at June 30,
2003. Average short-term interest bearing liabilities, consisting primarily of
FHLB Dallas advances and federal funds purchased, decreased $15.2 million or
9.6%
13
as compared to the same period in 2002. Interest expense associated with
short-term interest bearing liabilities increased $411,000 or 15.4% and the
average rate paid increased 94 basis points for the six month period ended June
30, 2003 when compared to the same period in 2002 due to long-term advances
rolling into the short-term category and overnight advances decreasing. Average
long-term interest bearing liabilities consisting of FHLB Dallas advances
decreased $6.9 million or 3.0% during the six months ended June 30, 2003 to
$224.3 million as compared to $231.1 million at June 30, 2002. Interest expense
associated with long-term FHLB Dallas advances decreased $1.1 million or 18.4%
and the average rate paid decreased 82 basis points for the six months ended
June 30, 2003 when compared to the same period in 2002. 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 decreased from
$16.1 million at June 30, 2002 to $13.8 million at June 30, 2003. During the six
months ended June 30, 2003, 176,600 convertible trust preferred shares were
converted into 194,697 shares of the Company's common stock. During the second
quarter ended June 30, 2003, 146,400 convertible trust preferred shares were
converted into 161,403 shares of the Company's common stock. Subsequent to June
30, 2003, an additional 66,231 convertible trust preferred shares were converted
into 73,018 shares of the Company's common stock. Cumulative to date, 515,295
convertible trust preferred shares were converted into 556,703 shares of the
Company's common stock. The total convertible trust preferred shares converted
to date represents 30.4% of the convertible trust preferred issue. Interest
expense decreased $122,000 or 17.5% as a result of conversions of the
convertible trust preferred shares into shares of the Company's common stock.
Average Long Term Junior Subordinated Debentures remained the same at $20
million from June 30, 2002 to June 30, 2003. Interest expense and rate paid were
the same for the six months ended June 30, 2003 and 2002. Effective June 30,
2003 these $20 million Junior Subordinated Debentures are eligible to be called
at the Company's discretion with proper notice. As of June 30, 2003 the Company
had $1.0 million in unamortized origination cost that would have to be expensed
should the Company call these debentures.
14
The analysis below shows average interest earning assets and interest bearing
liabilities together with the average yield on the interest earning assets and
the average cost of the interest bearing liabilities.
SUMMARY OF INTEREST EARNING ASSETS AND INTEREST BEARING LIABILITIES
-------------------------------------------------------------------
AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE INTEREST YIELD BALANCE INTEREST YIELD
--------------------------------------------------------------------------------------------
(dollars in thousands)
Six Months Ended June 30, 2003 Six Months Ended June 30, 2002
------------------------------------------ ------------------------------------------
INTEREST EARNING
ASSETS:
Loans (1)(2) $ 575,628 $ 19,205 6.73% $ 539,408 $ 19,714 7.37%
Investment Securities (3)(4) 113,247 3,301 5.88% 154,400 5,019 6.56%
Mortgage-backed Securities (4) 505,506 10,177 4.06% 460,090 11,987 5.25%
Other Interest Earning
Assets 32,840 351 2.16% 24,412 368 3.04%
----------- ----------- ----------- -----------
TOTAL INTEREST EARNING
ASSETS 1,227,221 33,034 5.43% 1,178,310 37,088 6.35%
----------- -----------
NONINTEREST EARNING
ASSETS:
Cash and Due from Banks 36,356 35,202
Bank Premises and Equipment 29,906 29,445
Other Assets 46,238 39,276
Less: Allowance for Loan Loss (6,476) (6,069)
----------- -----------
TOTAL ASSETS $ 1,333,245 $ 1,276,164
============ ===========
INTEREST BEARING LIABILITIES:
Deposits $ 627,690 $ 6,425 2.06% $ 587,672 $ 8,383 2.88%
Fed Funds Purchased and
Other Interest Bearing
Liabilities 2,082 13 1.26% 4,083 39 1.93%
Short Term Interest Bearing
Liabilities - FHLB Dallas 141,418 3,069 4.38% 154,618 2,632 3.43%
Long Term Interest Bearing
Liabilities - FHLB Dallas 224,272 4,844 4.36% 231,138 5,937 5.18%
Long Term Junior Subordinated
Convertible Debentures 13,751 577 8.39% 16,077 699 8.70%
Long Term Junior
Subordinated Debentures 20,000 850 8.50% 20,000 850 8.50%
------------ ----------- ----------- -----------
TOTAL INTEREST BEARING
LIABILITIES 1,029,213 15,778 3.09% 1,013,588 18,540 3.69%
----------- -----------
NONINTEREST BEARING
LIABILITIES
Demand Deposits 197,523 179,279
Other Liabilities 21,403 11,463
------------ -----------
Total Liabilities 1,248,139 1,204,330
SHAREHOLDERS' EQUITY 85,106 71,834
------------ -----------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $ 1,333,245 $ 1,276,164
============ ===========
NET INTEREST INCOME $ 17,256 $ 18,548
=========== ===========
NET MARGIN ON AVERAGE
EARNING ASSETS 2.84% 3.17%
===== =====
NET INTEREST SPREAD 2.34% 2.66%
===== =====
(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 $1,001 and $690
as of June 30, 2003 and 2002, respectively.
(3) Interest income includes taxable-equivalent adjustments of $922 and $1,380
as of June 30, 2003 and 2002, respectively.
(4) For the purpose of calculating the average yield, the average balance of
securities is presented at historical cost.
15
Noninterest Income
Noninterest income was $12.7 million for the six months ended June 30, 2003
compared to $8.5 million for the same period in 2002. Deposit services income
increased $948,000 or 18.5% for the six months ended June 30, 2003. Deposit
services income increased primarily as a direct result of increases in overdraft
income, increased numbers of deposit accounts and increased deposit activity
from June 30, 2002 to June 30, 2003. Mortgage servicing release fee income
increased $556,000 or 61.4% to $1.5 million for the six months ended June 30,
2003 from $905,000 for the same period in 2002 due to significant increases in
mortgage loan refinancing the Company handled during the first six months of
2003 as a result of the lower interest rates. Other noninterest income increased
$204,000 or 43.8% for the six months ended June 30, 2003 primarily as a result
of increases in other fee income, income from check sales and income from
subsidiaries. During the six months ended June 30, 2003, the Company had gains
on the sale of securities of $3.6 million compared to $1.0 million for the same
period in 2002. The Company sold securities out of its AFS portfolio to
accomplish Asset Liability Committee and investment portfolio objectives aimed
at repositioning 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 the first six months ended June 30, 2003, interest rates
remained low and the yield curve remained steep. The Company used this
interest-rate environment to reposition the securities portfolio in an attempt
to reduce tax free income derived from the securities portfolio and minimize
prepayment of the premium mortgage-backed securities.
The market value of the entire securities portfolio at June 30, 2003 was $709.0
million with a net unrealized gain on that date of $13.5 million. The net
unrealized gain is comprised of $15.7 million in unrealized gains and $2.2
million in unrealized losses.
Noninterest Expense
Noninterest expense was $19.0 million for the six months ended June 30, 2003,
compared to $17.0 million for the same period of 2002, representing an increase
of $2.0 million or 11.7%.
Salaries and employee benefits increased $1.3 million or 12.7% during the six
months ended June 30, 2003 when compared to the same period in 2002. Normal
payroll increases and higher benefit costs were the primary reasons for the
increase. Direct salary expense and payroll taxes increased $1.0 million or
11.5% as a result of bank growth and pay increases for the six months ended June
30, 2003 when compared to the same period in 2002. Retirement expense increased
$380,000 or 43.9% for the six months ended June 30, 2003 when compared to the
same period in 2002, primarily as a result of the increase in the number of
participants, level of performance of retirement plan assets and actuarial
assumptions. 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 the
previous 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
insurance expense decreased $19,000 or 1.7% for the six months ended June 30,
2003 when compared to the same period in 2002. The Company has a self-insured
health plan which is supplemented with stop loss insurance policies. Health
insurance costs are rising nationwide and these costs may increase during the
last two quarters of 2003.
Net occupancy expense increased $35,000 or 1.8% for the six months ended June
30, 2003 compared to the same period in 2002, largely due to branch expansion
during 2002, higher real estate taxes and depreciation expense.
Advertising, travel and entertainment expense increased $60,000 or 6.8% compared
to the same period in 2002 primarily as a result of increases in direct media
costs. Professional fees increased $32,000 or 9.7% compared to the same period
in 2002 due to increased consulting fees. Postage expense increased $38,000 or
15.8% compared to the same period in 2002.
Other expense increased $495,000 or 26.3% for the six months ended June 30, 2003
compared to the same period in 2002 primarily due to the retirement of assets in
a grocery store branch, losses on other real estate owned, liability insurance,
personnel placement fees and other losses. The retirement of assets in the
grocery store branch was a result of relocating the branch within the store
prior to fully depreciating the original lease improvements.
16
Provision for Income Taxes
The provision for the income tax expense for the six months ended June 30, 2003
was 15.9% compared to 12.1% for the six months ended June 30, 2002. The increase
in the effective tax rate and income tax expense is due to the overall increase
in income before income taxes and decrease in tax free income for the six months
ended June 30, 2003 when compared to the six months ended June 30, 2002 as the
decrease in the average investment in tax free municipal securities more than
offset the increase in the average tax free municipal loans.
Capital Resources
Total shareholders' equity for the Company at June 30, 2003, of $86.8 million
increased $4.6 million from December 31, 2002, and represented 6.3% of total
assets at June 30, 2003 compared to 6.1% of total assets at December 31, 2002.
Net income of $6.8 million was the major contributor to the increase in
shareholders' equity at June 30, 2003 along with the issuance of $2.2 million in
common stock (281,771 shares) through conversions from the Company's junior
subordinated debentures into the Company's common stock and the Company's
incentive stock option and dividend reinvestment plans. Decreases to
shareholders' equity consisted of a decrease of $405,000 in the accumulated
comprehensive income, $1.3 million in dividends paid and the purchase of $2.8
million in common stock (159,800 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. 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.
Under the Federal Reserve Board's risk-based capital guidelines for bank holding
companies, the minimum ratio of total capital to risk-adjusted assets (including
certain off-balance sheet items, such as standby letters of credit) is currently
eight percent. The minimum Tier 1 capital to risk-adjusted assets is four
percent. A portion of the $32.5 million trust preferred securities is considered
Tier 1 capital by the Federal Reserve Bank. The Federal Reserve Board also
requires bank holding companies to comply with the minimum leverage ratio
guidelines. The leverage ratio is a ratio of bank holding company's Tier 1
capital to its total consolidated quarterly average assets, less goodwill and
certain other intangible assets. The guidelines require a minimum average of
four percent for bank holding companies that meet certain specified criteria.
Failure to meet minimum capital regulations can initiate certain mandatory and
possibly additional discretionary actions by regulation, that if undertaken,
could have a direct material effect on the Bank's financial statements. At June
30, 2003, the Company and the Bank exceeded all regulatory minimum capital
requirements.
The Federal Reserve Deposit Insurance Act requires bank regulatory agencies to
take "prompt corrective action" with respect to FDIC-insured depository
institutions that do not meet minimum capital requirements. A depository
institution's treatment for purposes of the prompt corrective action provisions
will depend on how its capital levels compare to various capital measures and
certain other factors, as established by regulation.
It is management's intention to maintain the Company's capital at a level
acceptable to all regulatory authorities and future dividend payments will be
determined accordingly. Regulatory authorities require that any dividend
payments made by either the Company or the Bank not exceed earnings for that
year.
Liquidity and Interest Rate Sensitivity
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 June 30, 2003, these investments were 25.4% of total assets.
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 overnight
federal funds at prevailing rates. 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.
17
Interest rate sensitivity management seeks to avoid fluctuating net interest
margins and to enhance consistent growth of new interest income through periods
of changing interest rates. 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 (MVPE) with
rates shocked plus and minus 200 basis points to ensure a satisfactory liquidity
position for the Company. 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.
On November 2, 2000, the Company through its wholly owned subsidiary, Southside
Capital Trust II, (the "junior subordinated convertible 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.
The debentures have a distribution rate of 8.75% per annum payable at the end of
each calendar quarter.
The proceeds received by the Company from the Trust II Issuer were used for
general corporate purposes, which included, capital contributions to the Bank to
support growth, for working capital and, the repurchase of shares of the
Company's common stock.
Composition of Loans
One of the Company's main objectives is to seek attractive lending opportunities
in East Texas, primarily in Smith and Gregg counties. Total average loans
increased $36.2 million or 6.7% from the six months ended June 30, 2002 to June
30, 2003. The majority of the increase is in loans to municipalities and real
estate loans. The increase in municipal loans is due to a strong commitment in
municipal lending. The increase in average real estate loans is a result of
increases in commercial real estate loans and home equity loans.
Loan Loss Experience and Allowance for Loan Losses
The loan loss allowance is based on the most current review of the loan
portfolio at that time. The Internal Loan Review department of the Company is
responsible for an ongoing review of the Bank's entire loan portfolio with
specific goals set for the volume of loans to be reviewed on an annual basis.
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 department. This list is updated on a periodic basis
but no less than quarterly by the servicing officer in order to properly
allocate necessary allowances and keep management informed on the status of
attempts to correct the deficiencies noted in the credit.
While management is aware of certain risk factors within segments of the loan
portfolio, allowance allocations have been made on an individual loan basis. An
additional allowance is maintained on the remainder of the portfolio that is
based on tracking of the Company's loan losses on loans that have not been
previously identified as problems and anticipated problems using historical
data and current economic valuations.
For the second quarter and six months ended June 30, 2003, loan charge-offs were
$580,000 and $915,000 and recoveries were $161,000 and $271,000, respectively,
resulting in net charge-offs of $419,000 and $644,000. For the second quarter
and six months ended June 30, 2002, loan charge-offs were $828,000 and
$1,172,000 and recoveries were $60,000 and $166,000, respectively, resulting in
net charge-offs of $768,000 and $1,006,000.
Net charge-offs decreased for the six months ended June 30, 2003 compared to the
six months ended June 30, 2002. The necessary provision expense was estimated at
$1.1 million for the six months ended June 30, 2003.
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
18
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 June 30, 2003 were $2.9 million, down $506,000 or
14.9% from $3.4 million at December 31, 2002. From December 31, 2002 to June 30,
2003, nonaccrual loans decreased $575,000 or 25.7% to $1.7 million. Of this
total, 22.0% are residential real estate loans, 7.2% are commercial real estate
loans, 54.8% are commercial loans and 16.0% are loans to individuals. Other real
estate decreased $291,000 or 55.5% to $233,000 at June 30, 2003 from $524,000 at
December 31, 2002. Of this total, 10.3% consist of residential dwellings,
81.1% consist of commercial real estate and 8.6% are construction and land
development loans. The Company is actively marketing all properties and none are
being held for investment purposes. Loans 90 days past due or more increased
$333,000 or 116.0% to $620,000. Repossessed assets increased $55,000 or 500.0%
to $66,000 compared to an unusually low level of repossessed assets at December
31, 2002 of approximately $11,000. Restructured loans decreased $28,000 or 8.6%
to $297,000.
Expansion
Currently the Company has no definitive expansion plans in place. The Company
continues to evaluate new opportunities for branches but will continue to be
very selective about the opportunities it pursues.
Accounting Pronouncements
See "Basis of Presentation" and "Accounting Pronouncements" in Note 1 and Note 5
to the Company's financial statements in this Form 10-Q.
ITEM 3. 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.
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 June 30, 2003, were within policy guidelines. This type of simulation
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 repricing 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.
19
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. Adjustable rate student loans totaling $3.3 million are
classified in the one year category. These loans reprice annually and are not
retained by the Company when they enter repayment status. Nonaccrual loans,
totaling $1,663,000, are not included in the loan totals. All instruments are
classified as other than trading.
EXPECTED MATURITY DATE
(dollars in thousands)
Twelve Months Ending June 30,
--------------------------------------------------------------------------------------------------
Fair
2004 2005 2006 2007 2008 Thereafter Total Value
---- ---- ---- ---- ---- ---------- ----- -----
Fixed Rate Loans $197,351 $ 90,415 $ 51,376 $ 28,849 $ 16,004 $ 68,280 $ 452,275 $ 476,650
6.92% 7.07% 6.92% 6.78% 6.52% 5.36% 6.69%
Adjustable Rate Loans 41,487 5,027 6,628 15,105 13,317 41,590 123,154 123,154
4.53% 4.76% 4.60% 4.66% 4.54% 4.75% 4.63%
Mortgage-backed
Securities 262,036 146,403 80,729 43,218 21,872 13,669 567,927 567,927
3.88% 3.79% 3.69% 3.56% 3.39% 3.44% 3.78%
Investments and Other
Interest Earning Assets 49,898 300 1,123 380 394 92,728 144,823 144,823
1.67% 7.70% 8.71% 7.77% 7.77% 7.08% 5.23%
Total Interest
Earning Assets $550,772 $ 242,145 $ 139,856 $ 87,552 $ 51,587 $ 216,267 $1,288,179 $1,312,554
4.82% 5.04% 4.96% 4.83% 4.69% 5.86% 5.05%
Savings Deposits $ 4,425 $ 2,211 $ 2,211 $ 2,211 $ 2,211 $ 30,961 $ 44,230 $ 42,821
0.41% 0.41% 0.41% 0.41% 0.41% 0.41% 0.41%
NOW Deposits 26,545 4,676 4,676 4,676 4,676 65,456 110,705 106,629
0.62% 0.10% 0.10% 0.10% 0.10% 0.10% 0.22%
Money Market Deposits 21,733 7,244 7,244 7,244 7,244 21,732 72,441 73,386
0.82% 0.82% 0.82% 0.82% 0.82% 0.82% 0.82%
Platinum Money Market 49,399 5,293 5,293 5,293 5,293 -- 70,571 71,806
0.88% 0.88% 0.88% 0.88% 0.88% -- 0.88%
Certificates of Deposit 238,654 43,888 14,616 23,395 10,178 193 330,924 339,585
2.11% 4.02% 4.26% 5.04% 3.82% 6.50% 2.72%
FHLB Dallas Advances 126,798 104,926 47,660 22,422 15,278 83,307 400,391 414,187
3.56% 3.16% 4.24% 4.64% 4.12% 5.38% 4.00%
Other Borrowings 2,283 -- -- -- -- 32,460 34,743 47,557
0.88% -- -- -- -- 8.60% 8.09%
Total Interest
Bearing Liabilities $469,837 $ 168,238 $ 81,700 $ 65,241 $ 44,880 $ 234,109 $1,064,005 $1,095,971
2.21% 3.09% 3.38% 3.59% 2.54% 3.27% 2.77%
20
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 annualized rate between 8% and 45%. Municipal loans are
assumed to prepay at an annualized 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 June 30, 2003, 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 June 30, 2003, $567.9 million of
mortgage-backed and related securities held by the Company were collateralized
by fixed-rate mortgage loans.
The Company assumes 70% of savings accounts and approximately 60% of transaction
accounts at June 30, 2003, are core deposits and are, therefore, expected to
roll-off after five years. The Company assumes 30% of Money Market accounts at
June 30, 2003 are core deposits and are, therefore, expected to roll-off after
five years. The Company does not consider any of its Platinum Money Markets
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.
ITEM 4. CONTROLS AND PROCEDURES
An evaluation was carried out under the supervision and with participation of
the Company's management, including its Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of its
disclosure controls and procedures (as defined in Rules 13a-14 and 15d-14 under
the Securities Exchange Act of 1934). Based upon that evaluation, the Chief
Executive Officer and Chief Financial Officer concluded as of June 30, 2003 that
the disclosure controls and procedures were effective. No significant changes
were made in the Company's internal controls or in other factors that could
significantly affect these controls subsequent to the date of their evaluation.
21
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is a party to certain litigation that it considers routine and
incidental to its business. Management does not expect the results of any
of these actions to have a material effect on the Company's business,
results of operations or financial condition.
ITEM 2. CHANGES IN SECURITIES
Not Applicable
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable
ITEM 5. OTHER INFORMATION
Not Applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits -
Exhibit
No.
---
* 31.1 - Certification Pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002
* 31.2 - Certification Pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002
* 32.1 - Certification Pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002
* 32.2 - Certification Pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002
(b) Reports on Form 8-K - Earnings release dated July 18, 2003
- ---------
* Filed herewith.
22
SIGNATURES
Pursuant to the requirements 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.
(Registrant)
BY: /s/ B. G. HARTLEY
---------------------------------
B. G. Hartley, Chairman of the
Board and Chief Executive Officer
(Principal Executive Officer)
DATE: August 13, 2003
/s/ LEE R. GIBSON
--------------------------------
Lee R. Gibson, Executive Vice
President (Principal Financial
and accounting Officer)
DATE: August 13, 2003
23
Exhibit Index
Exhibit
Number Description
------ -----------
31.1 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002
31.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002
32.1 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
32.2 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
24