UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Form 10-K

(Mark One)

For the fiscal year ended December 31, 2004

Commission file number 0-12247

Southside Bancshares, Inc.

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, $1.25 PAR VALUE
(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 þ       NO o

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 o.

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

The aggregate market value of the common stock held by non-affiliates of the registrant as of June 30, 2004 was $179,434,395.

As of February 18, 2005, 10,859,519 shares of common stock of Southside Bancshares, Inc. were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s Proxy Statement to be filed for the Annual Meeting of Shareholders to be held April 21, 2005. (Part III)

Table of Contents

PART I

ITEM 1. BUSINESS

FORWARD-LOOKING INFORMATION

     The disclosures set forth in this item are qualified by the section captioned “Forward-Looking Information” in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of this Annual Report on Form 10-K and other cautionary statements set forth elsewhere in this report.

GENERAL

     Southside Bancshares, Inc. (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 184,000 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, 2004, the Company had total assets of $1.6 billion, total loans of $624.0 million, deposits of $941.0 million, and shareholders’ equity of $104.7 million. The Company had net income of $16.1 million and $13.6 million and fully diluted earnings per common share of $1.39 and $1.22 for the years ended December 31, 2004 and 2003, 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 non-profit 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 for 1-4 family residential and commercial real estate.

     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 certificates of deposit (“CDs”). 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, 2004, the Bank’s trust department managed approximately $413 million of trust assets. Through its 25% owned securities brokerage affiliate, BSC Securities, LLC, the Bank offers full retail investment services to its customers.

     The Company and the Bank are subject to comprehensive regulation, examination and supervision by the Board of Governors of the Federal Reserve System (the “Federal Reserve”), the Texas Department of Banking (the “TDB”) and the Federal Depository Insurance Corporation (the “FDIC”), and are subject to numerous laws and regulations relating to internal controls, 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 (the “SEC”) may be obtained free of charge at either the Company’s website or the SEC’s website, www.sec.gov, as soon as reasonably practicable after filing with the SEC.

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MARKET AREA

     The Company considers its primary market area to be all of Smith, Gregg, Cherokee and Henderson Counties in East Texas, and to a lesser extent, portions of adjoining counties. During 2004, the Bank opened one branch in Chandler, in Henderson County, and one branch in Jacksonville, in Cherokee County. The Company opened a loan processing office in Gresham, in Smith County, during January 2005. The Company intends to expand into Seven Points, a city located approximately 60 miles Northwest of Tyler in Henderson County, during 2005. The Company expects its presence in the Gregg, Cherokee and Henderson County market areas to continue to increase in the future, however, the city of Tyler in Smith County presently represents the Company’s largest 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, the industry base includes conventions and tourism, as well as retirement relocation. These economic activities support a growing regional system of medical service, retail and education centers. Tyler and Longview are home to several nationally recognized health care systems that represent all major specialties.

     The Company serves its markets through twenty-two branch locations, thirteen of which are located in grocery stores. The branches are located in and around Tyler, Longview, Lindale, Jacksonville, Bullard, Chandler 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, Gregg, Cherokee and Henderson counties. We anticipate that continued advertising combined with strategically placed branches should expand the Bank’s name recognition.

     The Company also maintains six motor bank facilities. The Company’s customers may also access various banking services through 34 ATMs owned by the Company and ATMs owned by others, through debit cards, and through the Company’s automated telephone, internet and electronic banking products. These products allow the Company’s customers to apply for loans from their computers, access account information and conduct various other transactions from their telephones and computers.

LENDING ACTIVITIES

     One of the Company’s main objectives is to seek attractive lending opportunities in East Texas, primarily in the counties in which it operates. Substantially all of the Company’s loans are made to borrowers who live in and conduct business in East Texas, with the exception of municipal loans. Total loans as of December 31, 2004 increased $34.9 million or 5.9% while the average balance was up $34.5 million or 6.1% when compared to 2003.

     Real estate loans increased $31.7 million or 10.0% from December 31, 2003 to December 31, 2004. Municipal loans as of December 31, 2004 increased $7.8 million or 8.1% from December 31, 2003 and commercial loans increased $4.9 million or 6.0% from December 31, 2003. Loans to individuals decreased $9.5 million or 10.2% from December 31, 2003.

     The increase in real estate loans was due to the economic growth in the Company’s market area, the continued strong commitment to real estate lending and less refinancing of real estate loans on the Company’s books during 2004 when compared to 2003. The growth of loans made to municipalities in Texas was a result of the Company’s continued strong commitment in this lending area combined with the Company’s ability to close these transactions in a timely manner. The increase in commercial loans is reflective of the growth in the Company’s market area. The decrease in loans to individuals reflects the difficulty the Company has competing against extremely low interest rates offered by automobile manufacturers combined with the fact that home equity loans have replaced some of the traditional loans to individuals. In the loan 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.

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     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, 2004 was $12 million. The Bank’s largest loan relationship at December 31, 2004 was approximately $9.7 million.

     The average yield on loans for the year ended December 31, 2004 decreased to 6.11% from 6.50% for the year ended December 31, 2003. This decrease was reflective of the repricing characteristics of the loans, interest rates at the time loans repriced, and the competitive loan pricing environment.

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.

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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, 2004, the majority of the Company’s real estate loans were collateralized by properties located in Smith and Gregg Counties. Of the $349.3 million in real estate loans, $168.8 million or 48.3% 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 or charged off 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 $144.8 million of commercial real estate loans, $1.2 million of loans secured by multifamily properties and $1.7 million of loans secured by farm land. The Commercial Real Estate portion of Other will be discussed in more detail below.

     1-4 Family Residential Mortgage Loans

     Residential loan originations are generated by the Company’s loan officers, in-house origination 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 the Company’s market area. Historically, the Company has originated a portion of its residential mortgage loans for sale into the secondary market. These loans are reflected on the balance sheet as loans held for sale. 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 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’s 1-4 family residential mortgage loans are made at both fixed and adjustable interest rates.

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

     Included as part of the 1-4 Family Residential Mortgage Loans, the Company also makes home equity loans and at December 31, 2004, these loans totaled $52.4 million.

     Construction Loans

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

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     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 facilities and offices, warehouse facilities, hotels and churches.

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. Medical loan types include all loan types listed above for commercial loans. Collateral for these loans varies depending on the type of loan and financial strength of the borrower. The primary source of repayment for loans in the medical community is cashflow from continuing operations. The medical community represents a concentration of risk in the Company’s Commercial loan and Commercial Real Estate loan portfolio (see “Market Area”). We believe that risk in the medical community is mitigated because it is spread among multiple practice types and multiple specialties. Should the government change the amount it pays the medical community through the various government health insurance programs, the medical community could be adversely impacted which in turn could result in higher default rates by borrowers in the medical industry.

     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 has a specific lending department 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. Municipal loans made without a direct pledge of taxes are usually made based on some type of collateral that represents an essential service. Lending money directly to these municipalities allows the Company to earn a higher yield than it could if it purchased municipal securities. Total loans to municipalities and school districts as of December 31, 2004 increased $7.8 million when compared to 2003. At December 31, 2004, the Company had total loans to municipalities and school districts of $104.0 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 $51.8 million or 62.0% of total loans to individuals at December 31, 2004. The Company’s loans collateralized by titled equipment declined during 2004 due to extremely low interest rates offered by the automobile manufacturers. Should this type of low financing continue the Company may see additional decreases in this portfolio. Home equity loans have also replaced some of the traditional loans to individuals. In addition, 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.

     Management believes that the economy in the Company’s market area appears to reflect stable growth. One area of concern is the personal bankruptcy rate in the Company’s market area. Management expects the personal bankruptcy rate could 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 Company’s exposure 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

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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.

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, 2004, 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.

LOANS TO AFFILIATED PARTIES

     In the normal course of business, the Company makes loans to certain of its own executive officers and directors and their related interests. As of December 31, 2004 and 2003, these loans totaled $4.3 million in both years or 4.1% and 4.2% 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.

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. 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, the internal loan review department for the Company is responsible for an ongoing review of the Company’s loan portfolio with specific goals set for loans to be reviewed 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 allowances. A list of loans or loan relationships of $50,000 or more, which are graded as having more than the normal degree of risk

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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 allowances 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 allowances), and geographic and industry loan concentration.

     As of December 31, 2004, the Company’s review of the loan portfolio indicated that a loan loss allowance of $6.9 million was adequate to cover probable losses in the portfolio.

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

LOAN LOSS EXPERIENCE AND ALLOWANCE FOR LOAN LOSSES

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

See “Consolidated Financial Statements - Note 6. Loans and Allowance for Probable Loan Losses.”

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NONPERFORMING ASSETS

     Nonperforming assets consist of delinquent loans 90 days or more past due, nonaccrual loans, other real estate owned, repossessed assets and restructured loans. Nonaccrual loans are those loans which are 90 days or more 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 probable 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. The dollar amount of OREO is based on a current evaluation of the OREO at the time it is recorded on the Company’s books, net of estimated selling costs. Updated valuations are obtained as needed and any additional impairments are recognized.

     Total nonperforming assets at December 31, 2004 were $3.5 million, up $1.2 million or 54.4% from $2.3 million at December 31, 2003. Other real estate owned increased $19,000 or 9.7% to $214,000 from December 31, 2003 to December 31, 2004. Of the other real estate owned, 56.3% are residential dwellings and 43.7% are commercial properties. The Company is actively marketing all properties and none are being held for investment purposes. From December 31, 2003 to December 31, 2004, nonaccrual loans increased $701,000 or 45.3% to $2.2 million. Of this total, 6.3% are residential real estate loans, 5.3% are commercial real estate loans, 69.2% are commercial loans and 19.2% are loans to individuals. Approximately $1.3 million of the nonaccrual loans at December 31, 2004, are loans that have an average SBA guarantee of approximately 75%. Restructured loans decreased $26,000 or 11.9% to $193,000. Loans 90 days past due or more increased $555,000 or 204.0% to $827,000. Loans 90 days past due include four residential mortgage loans that total approximately $600,000. Repossessed assets decreased $7,000 or 14.6% to $41,000.

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

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     Nonperforming assets as a percentage of total assets increased 0.06% from the previous year and as a percentage of loans increased 0.17%. Nonperforming assets represent a drain on the earning ability of the Company. Decreases in earnings 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, 2004 in the opinion of management, the Company had $516,000 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:

     The balances of impaired loans included above with no valuation allowances were $58,000 and $162,000, respectively, at December 31, 2004 and 2003, respectively.

     For the years ended December 31, 2004 and 2003, the average recorded investment in impaired loans was approximately $1,492,000 and $1,771,000, respectively.

     The amount of interest recognized on loans that were nonaccruing or restructured during the year was $125,000, $104,000 and $160,000 for the years ended December 31, 2004, 2003 and 2002, respectively. If these loans had been accruing interest at their original contracted rates, related income would have been $186,000, $155,000 and $205,000 for the years ended December 31, 2004, 2003 and 2002, respectively.

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

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 current 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 quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices for similar securities or estimates from independent pricing services. Unrealized gains and losses are excluded from earnings and reported net of tax as a separate component of shareholders’ equity until realized.

Purchase of premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines in the fair value of HTM and AFS securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.

     Management attempts to deploy investable funds into instruments which are expected to provide a reasonable overall return on the portfolio given the current assessment of economic and financial conditions, while maintaining acceptable levels of capital, interest rate and liquidity risk. At December 31, 2004, the securities portfolio as a percentage of total assets was 54.4% and was larger than net loans which were 38.1% of total assets. For a discussion of the Company’s strategy in relation to the securities portfolio, see “Leverage Strategy” in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

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     The following table sets forth the carrying amount of investment securities, mortgage-backed securities and marketable equity securities at December 31, 2004, 2003 and 2002:

     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 Freddie Mac, the Federal National Mortgage Association (the “FNMA”) and the Government National Mortgage Association (the “GNMA”). Government sponsored enterprises are not backed by the full faith and credit of the United States government. Freddie Mac, FNMA and Federal Home Loan Bank are the primary government sponsored enterprises with which the Company purchases securities. 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.

     Mortgage-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 mortgage-backed pass-through security thus approximates the term of the underlying mortgages.

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     The Company’s mortgage-backed securities include collateralized mortgage obligations, which include securities issued by entities that have qualified under the Internal Revenue Code of 1986, as amended, 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 FNMA, Freddie Mac, GNMA, or whole loans which, in the Company’s case, are all currently 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 $880.9 million at December 31, 2004, compared to $759.5 million at December 31, 2003, an increase of $121.4 million or 16.0%. Mortgage-backed securities increased $129.6 million or 21.9% during 2004 when compared to 2003. State and Political Subdivisions decreased $17.6 million or 17.3% during 2004. U. S. Treasury securities decreased during 2004 compared to 2003 by $17.0 million or 81.0%, U. S. Government agency securities increased $18.9 million or 89.8%. Other stocks and bonds increased $7.5 million or 30.4% in 2004 compared to 2003 due to increases of $435,000 in FHLB stock dividends, increased purchases of FHLB stock of $2.7 million and an increase in trust preferred securities of $4.4 million. Of the $4.4 million increase in trust preferred securities, $4.0 million are adjustable rate securities.

     During 2004, interest rates remained relatively low and the yield curve remained steep during the first half of the year but began to flatten during the second half of 2004. The Company used this low interest rate environment to reposition a portion of 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. Specific low selling yield and, or long duration municipal securities were sold and, in some circumstances, partially replaced with better call protected 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.

     The market value of the securities portfolio at December 31, 2004 was $883.1 million, which represented a net unrealized gain on that date of $7.6 million. The net unrealized gain was comprised of $10.5 million in unrealized gains and $2.9 million of unrealized losses. To the best of management’s knowledge, none of the securities at December 31, 2004 had an other than temporary impairment. 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.

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     On January 1, 2004, the Company transferred mortgage-backed securities totaling $44.4 million from AFS to HTM due to overall balance sheet strategies and potential changes in market conditions. The unrealized loss on the securities transferred from AFS to HTM was $319,000, net of tax, at the date of transfer based on the fair value of the securities on the transfer date. During the second quarter of 2004, the Company transferred mortgage-backed securities totaling $197.1 million from AFS to HTM. The unrealized loss on the securities transferred from AFS to HTM was $2.6 million, net of tax, during the second quarter based on the fair value of the securities on the transfer dates. There were no securities transferred from AFS to HTM during the third and fourth quarters of 2004. The Company has a significant amount of long-term Federal Home Loan Bank of Dallas (“FHLB”) fixed rate liabilities and determined it was appropriate that a portion of the Company’s securities portfolio should be designated HTM. At December 31, 2004, the Company did not have any plans to transfer additional AFS securities to HTM. Should conditions change, the Asset/Liability Management Committee (“ALCO”) may consider additional transfers in the future. There were no sales from the HTM portfolio during the years ended December 31, 2004, 2003 or 2002. There were $241.1 million and $6.4 million of securities classified as HTM for the years ended December 31, 2004 and 2003, respectively.

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     The maturities classified according to the sensitivity to changes in interest rates of the December 31, 2004 securities portfolio and the weighted yields are presented below. Tax-exempt obligations are shown on a taxable equivalent basis. Mortgage-backed securities are included in maturity categories based on their stated maturity date. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations.

DEPOSITS AND BORROWED FUNDS

     Deposits provide the Company with its primary source of funds. The increase of $68.5 million or 7.8% in total deposits during 2004 provided the Company with funds for the growth in loans and provided partial funding for the increase in the securities portfolio. Deposits increased during 2004 primarily due to branch expansion and increased market penetration. Time deposits decreased $2.2 million or 0.7% during 2004 compared to 2003. Noninterest bearing demand deposits increased $34.2 million or 14.9% during 2004. Interest bearing demand deposits increased $32.3 million or 11.7% and saving deposits increased $4.2 million or 9.2% during 2004. The latter three categories, which are considered the lowest cost deposits, comprised 66.0% of total deposits at December 31, 2004 compared to 63.1% at December 31, 2003.

     The following table sets forth the Company’s deposits by category at December 31, 2004, 2003, and 2002:

During the year ended December 31, 2004, total time deposits of $100,000 or more increased $6.2 million, or 4.5% from December 31, 2003.

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     The table below sets forth the maturity distribution of time deposits of $100,000 or more issued by the Company at December 31, 2004 and 2003:

     In previous years, the Company utilized brokered CDs as a funding source. At December 31, 2004, 2003 and 2002, the Company had no brokered CDs and brokered CDs represented zero percent of deposits. 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.

     Short-term obligations, consisting primarily of FHLB advances and federal funds purchased, increased $11.2 million or 5.6% during 2004 when compared to 2003. FHLB advances are collateralized by FHLB stock, nonspecified loans and securities.

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     Long-term Obligations of FHLB advances increased $78.6 million or 31.2% during 2004 to $330.7 million when compared to $252.1 million in 2003. The increase was primarily the result of additional funding obtained to fund security purchases made during 2004.

     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 had a convertible feature that allowed the owner to convert each security to a share of the Company’s common stock at an adjusted conversion price of $8.64 per common share any time prior to the redemption date. These securities had a distribution rate of 8.75% per annum payable at the end of each calendar quarter. On December 31, 2003, Southside Capital Trust II, a subsidiary of the Company redeemed 6,571 shares of its 8.75% Cumulative Convertible Trust Preferred Securities and all of its 8.75% Common Securities which totaled $678,000. Prior to the redemption date, December 31, 2003, all other convertible trust preferred shares were converted into the Company’s common stock. This increased the Company’s number of shares of common stock outstanding to 10,358,880 at December 31, 2003, which is not adjusted for the 5% stock dividend in 2004.

     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 had a distribution rate of 8.50% per annum payable at the end of each calendar quarter. On October 6, 2003, Southside Capital Trust, a subsidiary of the Company redeemed all of its 8.50% Cumulative Trust Preferred Securities and 8.50% Trust Common Securities which totaled $20,618,560. The Company funded the redemption through the issuance of $20,000,000 of trust preferred securities and $619,000 of trust common securities that adjust quarterly at a rate equal to the three month LIBOR plus 294 basis points. During 2004, the average interest rate on the adjustable rate trust preferred securities averaged 4.40%, providing an interest savings when compared to the 8.50% fixed rate trust preferred issue redeemed during 2003.

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 2004, the economy in the Company’s market appeared to reflect stable growth. As described above, an area of concern to the Company is the personal bankruptcy rate. Management anticipates this could 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.

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COMPETITION

     The activities engaged in by the Company 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. The Company expects the number of financial institutions in the Company’s market area to continue to increase. Brokerage and insurance companies continue to become more competitive in the financial services arena and pose an ever increasing challenge to banks. Legislative changes also greatly affect the level of competition 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. Additionally, 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. 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 unwilling to offer due to interest rate risk and overall profitability concerns. The Company expects the competition to increase.

EMPLOYEES

     At February 15, 2005, the Company employed approximately 450 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, 2004, were as follows:

B. G. Hartley (Age 75), 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 Bank, having served in these capacities since the Bank’s inception in 1960.

Sam Dawson (Age 57), President, Secretary and Director of the Company. He also serves as President, Chief Operations Officer and Director of the Bank since 1996. He became an officer of the Company in 1982 and of the Bank during 1975.

Robbie N. Edmonson (Age 72), Vice Chairman of the Board of the Company and the Bank. He joined the Bank as a vice president in 1968.

Jeryl Story (Age 53), Executive Vice President of the Company. Senior Executive Vice President - Loan Administration, Senior Lending Officer and Director of the Bank, since 1996. He joined the Bank in 1979 as an officer in Loan Documentation.

Lee R. Gibson (Age 48), Executive Vice President and Chief Financial Officer of the Company and of the Bank. He is also a Director of the Bank. He became an officer of the Company in 1985 and of the Bank during 1984.

     All the individuals named above serve in their capacity as officers of the Company and the Bank and are appointed annually by the Board of Directors of each entity.

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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 Federal Reserve, the FDIC, the TDB, 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 FDIC’s deposit insurance funds, the Bank’s depositors and the public, rather than the Company’s shareholders and creditors. The following summarizes 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 businesses. In addition, GLBA substantially revamped the regulatory scheme within which financial institutions operate.

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     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 FDIC Improvement Act prompt corrective action provisions, is “well managed” and has at least a “satisfactory” rating under the Community Reinvestment Act. In addition, the bank holding company must file a declaration with the Federal Reserve that the bank holding company elects to become a financial holding company. A bank holding company that falls out of compliance with these requirements may be required to cease engaging in 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 age and deposit concentration limits. In addition, Texas banking laws permit a bank holding company that owns stock of a bank located outside the State of Texas to acquire a bank or bank holding company located in Texas. This type of acquisition may occur only if the Texas bank to be directly or indirectly controlled by the out-of-state bank holding company has existed and continuously operated as a bank for a period of at least five years. In any event, a bank holding company may not own or control banks in Texas the deposits of which would exceed 20% of the total deposits of all federally-insured deposits in Texas. 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.

     Sound banking practice. Bank holding companies are not permitted to engage in unsound banking practices. For example, the Federal Reserve’s Regulation Y requires a bank holding company to give the Federal Reserve prior notice of any redemption or repurchase of its own equity securities, if the consideration to be paid, together with the consideration paid for any repurchases in the preceding year, is equal to 10% or more of the bank holding company’s consolidated net worth. The Federal Reserve may oppose the transaction if it believes that the transaction would constitute an unsafe or unsound practice or would violate any law or regulation. As another example, a bank holding company could not impair its subsidiary bank’s soundness by causing it to make funds available to non-banking subsidiaries or their customers if the Federal Reserve believed it not prudent to do so.

     The Financial Institutions Reform, Recovery and Enforcement Act of 1989, or FIRREA, expanded the Federal Reserve’s authority to prohibit activities of bank holding companies and their non-banking subsidiaries that represent unsafe and unsound banking practices or which constitute violations of laws or

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regulations. FIRREA increased the amount of civil money penalties which the Federal Reserve can assess for activities conducted on a knowing and reckless basis, if those activities caused a substantial loss to a depository institution. The penalties can be as high as $1,000,000 for each day the activity continues. FIRREA expanded the scope of individuals and entities against which such penalties may be assessed.

     Anti-tying restrictions. Bank holding companies and affiliates are prohibited from tying the provision of services, such as extensions of credit, to other services offered by a bank holding company or its affiliates.

     Capital Adequacy. The Federal Reserve monitors the capital adequacy of bank holding companies, such as Southside Delaware and the Company, and the FDIC 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 bank holding company’s assets. Different categories of assets are assigned risk weightings and are counted at a percentage of their book value.

     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% and a minimum total capital ratio of at least 8%. 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% for the most highly-rated, financially sound banks and bank holding companies and a minimum leverage ratio of at least 4% for all other banks. As of December 31, 2004, the Company’s total risk-based capital ratio was 18.60%, the Company’s Tier 1 risk-based capital ratio was 17.61% and the Company’s leverage capital ratio was 7.93%.

     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, 2004, the Federal Reserve had not advised the Company 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 receives 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

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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 and serve as a source of strength for the bank.

     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 TDB and the FDIC. The TDB and the FDIC have the power to enforce compliance with applicable banking statutes and regulations. These requirements and restrictions include requirements to maintain reserves against deposits, restrictions on the nature and amount of loans that may be made and the interest that may be charged thereon and restrictions relating to investments and other activities of the Bank.

     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 FDIC 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 FDIC.

     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 Bank’s 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

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discussed previously. At December 31, 2004, the Bank was well-capitalized and had a total risk-based capital ratio of 17.50%, a Tier 1 risk-based capital ratio of 16.51% and a leverage capital ratio of 7.43%.

     The 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, 2004, 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, 2004 were in excess of the minimum requirements.

     Also see discussion of “Capital Resources” under Item 7.

     Prompt Corrective Action. Banks are subject to restrictions on their activities depending on their level of capital. The FDIC’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 6% or more and a leverage ratio of 5% 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 8% or more, a core capital ratio of 4% or more and a leverage ratio of 4% 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 3% or more). Under these regulations, a bank is deemed to be “undercapitalized” if it has a total risk-based capital ratio of less than 8%, a core capital ratio of less than 4% or a leverage ratio of less than 4%. Under these regulations, a bank is deemed to be “significantly undercapitalized” if it has a risk-based capital ratio of less than 6%, a core capital ratio of less than 3% and a leverage ratio of less than 3%. Under such regulations, a bank is deemed to be “critically undercapitalized” if it has a leverage ratio of less than or equal to 2%. In addition, the FDIC 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 FDIC. 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 circumstances, including the acceptance by the FDIC of a capital restoration plan for the bank.

     If a state nonmember bank is classified as undercapitalized, the FDIC may take certain actions to correct the capital position of the bank. If a bank is classified as significantly undercapitalized, the FDIC 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 FDIC 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 FDIC 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 FDIC may, on a case-by-case basis, permit banks that are adequately capitalized to accept brokered deposits if the FDIC determines that acceptance of such deposits would not constitute an unsafe or unsound banking practice with respect to the bank.

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     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 FDIC 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 April 26, 2004 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 FDIC imposes deposit premiums and is authorized to conduct examinations of and to require reporting by the Bank. The FDIC assesses insurance premiums on a bank’s deposits at a variable rate depending on the probability that the deposit insurance fund will incur a loss with respect to the bank. The FDIC determines the deposit insurance assessment rates on the basis of the bank’s capital classification and supervisory evaluations. 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 2003 to 0% assessment, and banks classified as weakest were subject to an assessment rate of 0.27%. In addition to the insurance assessment, each insured bank was subject in 2004 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 2004. 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.

     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

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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 banks 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 the Bank’s facilities and within the Bank’s market area. If other banks were to establish branch facilities near the Bank’s facilities, it is uncertain whether these branch facilities would have a material adverse effect on the business of the Bank.

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

     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

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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 FDIC.

     All of the above laws and regulations add to the cost of the Company’s operations and thus have a negative impact on profitability. It should be noted that there has been a tremendous expansion experienced in recent years by financial service providers that are not subject to the same rules and regulations as are applicable to 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.

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 the Company. A federal statute removes interest ceilings under usury laws for loans by the Company that are secured by first liens on residential real property.

ECONOMIC ENVIRONMENT

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

     Also see discussion of “Banking Industry in Texas” above.

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ITEM 2. PROPERTIES

     Southside Bank owns or operates the following properties:

	•	Southside main branch at 1201 South Beckham Avenue, Tyler, Texas. The executive offices of Southside Bancshares, Inc. are located at this location.
	•	Southside Bank Annex at 1211 South Beckham Avenue, Tyler, Texas. The Southside Annex is directly adjacent to the main bank building. Human Resources, the Trust Department and other support areas are located in this building.
	•	Operations Annex at 1221 South Beckham Avenue, Tyler, Texas. Various back office lending, training facilities and other support areas are located in this building.
	•	Southside main branch motor bank facility at 1010 East First Street, Tyler, Texas.
	•	South Broadway branch at 6201 South Broadway, Tyler, Texas.
	•	South Broadway branch motor bank facility at 6019 South Broadway, Tyler, Texas.
	•	Downtown branch at 113 W. Ferguson Street, Tyler, Texas.
	•	Gentry Parkway branch and motor bank facility at 2121 West Gentry Parkway, Tyler, Texas.
	•	Longview main branch and motor bank facility at 2001 Judson Road, Longview, Texas.
	•	Lindale main branch and motor bank facility at 2510 South Main Street, Lindale, Texas.
	•	Whitehouse main branch and motor bank facility at 901 Highway 110 North, Whitehouse, Texas.
	•	Jacksonville main branch at 1015 S. Jackson Street, Jacksonville, Texas.
	•	Thirty-four Automatic Teller Machines (ATM’s) located throughout Smith, Gregg, Cherokee and Henderson Counties.

Southside Bank currently operates full service banks in leased space in thirteen grocery stores and one lending center in leased office space in the following locations:

	•	One in Bullard, Texas
	•	One in Lindale, Texas
	•	One in Flint, Texas
	•	One in Whitehouse, Texas
	•	Three in Longview, Texas
	•	Five in Tyler, Texas
	•	One in Chandler, Texas
	•	Gresham mortgage lending center at 16637 FM 2493, Tyler, Texas.

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     All of the properties detailed above are suitable and adequate to provide the banking services intended based on the type of property described. In addition, the properties for the most part are fully utilized but designed with productivity in mind and can handle the additional business volume the Company anticipates it will generate. As additional needs are identified, individual property enhancements or the need to add properties will be evaluated.

ITEM 3. LEGAL PROCEEDINGS

     The 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 the Bank.

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

     During the three months ended December 31, 2004, 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.

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PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND

MARKET INFORMATION

     The Company’s common stock trades on the Nasdaq National Market under the symbol “SBSI.” The high/low prices shown below represent the daily weighted average prices on the Nasdaq National Market for the period from January 1, 2003 to December 31, 2004. During the third quarters of 2004 and 2003, 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.

     On February 10, 2005, the Company declared a 5% stock dividend payable to shareholders of record March 8, 2005. The stock prices shown above were not adjusted to reflect this stock dividend.

     See “Item 7. Capital Resources” for a discussion of the Company’s common stock repurchase program.

STOCKHOLDERS

     There were approximately 1,100 holders of record of the Company’s common stock, the only class of equity securities currently issued and outstanding, as of February 18, 2005.

DIVIDENDS

     Cash dividends declared and paid were $0.42, $0.36 and $0.33 per share for the years ended December 31, 2004, 2003 and 2002 respectively. Stock dividends of 5% were also declared and paid during each of the years ended December 31, 2004, 2003 and 2002. 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. The cash dividends were paid quarterly each year as listed below.

Quarterly Cash Dividends Paid

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STOCK-BASED COMPENSATION PLANS

     Information regarding stock-based compensation awards outstanding and available for future grants as of December 31, 2004, is presented in Item 12 of this Annual Report on Form 10-K.

UNREGISTERED SALES OF EQUITY SECURITIES, USE OF PROCEEDS AND ISSUER SECURITY REPURCHASES

     Set forth below is certain information regarding repurchases of our common stock during the fourth quarter ended December 31, 2004:

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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, 2004. 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.

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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, 2004, 2003, and 2002 and financial condition as of December 31, 2004 and 2003. 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 declared and paid prior to January 1, 2005. On February 10, 2005, the Company declared a 5% stock dividend payable to shareholders of record March 8, 2005. The share data presented in Item 7. is not adjusted to reflect this stock dividend.

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 Southside Bancshares, Inc., (the “Company”) a bank holding 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,” “believe,” “could,” “should,” “may,” “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 in the State of Texas, nationally or globally, legislation or regulatory changes which adversely affect the businesses in which the Company is engaged, adverse changes in Government Sponsored Enterprises (the “GSE’s”) status or financial condition impacting the GSE’s guarantees or ability to pay or issue debt, economic or other disruptions caused by acts of terrorism or military actions in Iraq, Afghanistan or other areas, changes in the interest rate yield curve or 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 ESTIMATES

     The accounting and reporting estimates of the Company 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.

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     The loan loss allowance is based on the most current review of the loan portfolio at that time. The servicing officer has the primary responsibility for updating significant changes in a customer’s financial position. Each officer prepares status updates on any credit deemed to be experiencing repayment difficulties which, in the officer’s opinion, would place the collection of principal or interest in doubt. The internal loan review department for 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.

     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 allowances. 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 allowance and keep management informed on the status of attempts to correct the deficiencies noted in the credit.

     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.

     As of December 31, 2004, the Company’s review of the loan portfolio indicated that a loan loss allowance of $6.9 million was adequate to cover probable losses in the portfolio.

     Refer to Item 1 entitled Loan Loss Experience and Allowance 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.

     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.

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     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 or estimates from independent pricing services. The fair values of other real estate owned are typically determined based on appraisals by third parties, less estimated costs to sell.

     Defined Benefit Pension Plan. The plan obligations and related assets of the defined benefit pension plan are presented in Note 12 of the Notes to Consolidated Financial Statements. Plan assets, which consist primarily of marketable equity and debt instruments, are valued using market quotations. Plan obligations and the annual pension expense are determined by independent actuaries and through the use of a number of assumptions. Key assumptions in measuring the plan obligations include the discount rate, the rate of salary increases and the estimated future return on plan assets. In determining the discount rate, the Company utilizes the yield on high-quality, fixed-income investments currently available with maturities corresponding to the anticipated timing of the benefit payments. Salary increase assumptions are based upon historical experience and anticipated future management actions. Asset returns are based upon the anticipated average rate of earnings expected on the invested funds of the plan. At December 31, 2004, the weighted-average actuarial assumption of the Company’s plan were: discount rate 5.75%; long-term rate of return on plan assets 8.5%; and assumed salary increases 4.50%. Material changes in pension benefit costs may occur in the future due to changes in these assumptions. Future annual amounts could be impacted by changes in the number of plan participants, changes in the level of benefits provided, changes in the discount rates, changes in the expected long-term rate of return, changes in the level of contributions to the plan and other factors.

     Impairment of Investment Securities and Mortgage-backed Securities. Investment and mortgage-backed securities classified as available for sale are carried at fair values and the impact of changes in fair value are recorded as an unrealized gain or loss in “Accumulated other comprehensive income (loss),” a separate component of equity. In addition, securities classified as available for sale or held to maturity are subject to the Company’s review to identify when a decline in value is other than temporary. Factors considered in determining whether a decline in value is other than temporary include: whether the decline is substantial; the duration of the decline; the reasons for the decline in value; credit event or interest rate related; the Company’s ability and intent to hold the investment for a period of time that will allow for a recovery of value; and the financial condition and near-term prospects of the issuer. When it is determined that a decline in value is other than temporary, the carrying value of the security is reduced to its estimated fair value, with a corresponding charge to earnings.

OVERVIEW

OPERATING RESULTS

     During the year ended December 31, 2004, the Company’s net income increased $2.5 million, or 18.7%, to $16.1 million, from $13.6 million for the same period in 2003. The increase in net income was primarily attributable to an increase in interest income and a decrease in interest expense. Interest income increased primarily from increases in interest income on mortgage-backed and related securities. Interest expense decreased primarily from decreases in the interest expense on deposits and long-term obligations. These increases were partially offset by decreases in noninterest income and increases in noninterest expenses and income taxes. The decreases in noninterest income were primarily a result of decreases in gain on sale of securities available for sale and decreases in gain on sale of loans. The majority of the increase in noninterest expense was a result of increases in salaries and employee benefits due to normal payroll increases, staff increases due to opening new branches, and higher benefit costs. There was also a significant increase in professional fees. Earnings per fully diluted share were $1.39 and $1.22, respectively, for the years ended December 31, 2004 and 2003.

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FINANCIAL CONDITION

     Total assets increased $164.7 million or 11.3% to $1.62 billion at December 31, 2004 from $1.45 billion at December 31, 2003. The increase was primarily attributable to a $121.4 million increase in the securities portfolio and a $34.4 million increase in net loans. The securities portfolio totaled $880.9 million at December 31, 2004 compared to $759.5 million at December 31, 2003. At December 31, 2004, net loans were $617.1 million compared to $582.7 million at December 31, 2003. The increase in securities and loans was funded by increases in deposits and FHLB advances.

     Nonperforming assets at December 31, 2004 increased to $3.5 million, and represented 0.22% of total assets, compared to $2.3 million or 0.16% of total assets at December 31, 2003. Nonaccruing loans increased to $2.2 million and the ratio of nonaccruing loans to total loans increased to 0.36% at December 31, 2004 as compared to $1.5 million and 0.26% at December 31, 2003. Approximately $1.3 million of the nonaccrual loans at December 31, 2004, are loans that have an average SBA guarantee of approximately 75%. Other real estate owned increased to $214,000 at December 31, 2004 from $195,000 at December 31, 2003. Loans 90 days past due at December 31, 2004 increased to $827,000 compared to $272,000 at December 31, 2003. Loans 90 days past due include four residential mortgage loans that total approximately $600,000. Restructured loans at December 31, 2004 decreased to $193,000 compared to $219,000 at December 31, 2003.

     Deposits increased $68.5 million to $941.0 million at December 31, 2004 from $872.5 million at December 31, 2003. FHLB advances were $529.6 million at December 31, 2004, an $84.9 million increase from $444.7 million at December 31, 2003. Short-term FHLB advances increased $6.3 million to $198.9 million at December 31, 2004 from $192.6 million at December 31, 2003. Long-term FHLB advances increased $78.6 million to $330.7 million at December 31, 2004 from $252.1 million at December 31, 2003. Other borrowings at December 31, 2004 and 2003 totaled $31.6 million and $26.7 million, respectively, and at December 31, 2004 consisted of $11.0 million of Short-term borrowings and $20.6 million of Long-term debt.

     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 had a convertible feature that allowed the owner to convert each security to a share of the Company’s common stock at an adjusted conversion price of $8.64 per common share any time prior to the redemption date. These securities had a distribution rate of 8.75% per annum payable at the end of each calendar quarter. On December 31, 2003, Southside Capital Trust II, a subsidiary of the Company redeemed 6,571 shares of its 8.75% Cumulative Convertible Trust Preferred Securities and all of its 8.75% Common Securities which totaled $678,000. Prior to the redemption date, December 31, 2003, all other convertible trust preferred shares were converted into the Company’s common stock. This increased the Company’s number of shares of common stock outstanding to 10,358,880 at December 31, 2003, which is not adjusted for the 5% stock dividend in 2004.

     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 had a distribution rate of 8.50% per annum payable at the end of each calendar quarter. On October 6, 2003, Southside Capital Trust, a subsidiary of the Company redeemed all of its 8.50% Cumulative Trust Preferred Securities and 8.50% Trust Common Securities which totaled $20,618,560. Southside Bancshares funded the redemption through the issuance of $20,000,000 of trust preferred securities and $619,000 of trust common securities that adjust quarterly at a rate equal to the three month LIBOR plus 294 basis points. During 2004, the average interest rate on the adjustable rate trust preferred securities averaged 4.40%, providing an interest savings when compared to the 8.50% fixed rate trust preferred issue redeemed during 2003.

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     Shareholders’ equity at December 31, 2004 totaled $104.7 million compared to $100.4 million at December 31, 2003. The increase primarily reflects the net income recorded for the year ended December 31, 2004, and the increase in the common stock issued of $1.6 million as a result of the Company’s incentive stock option and dividend reinvestment plans. These increases were partially offset by the repurchase of 64,600 shares of the outstanding common stock at an average price of $20.27 per share, the payment of cash dividends and a decrease in the accumulated other comprehensive income (loss) of $8.1 million. The decrease in accumulated other comprehensive income (loss) is composed of a $5.3 million, net of tax, unrealized loss on securities, net of reclassification adjustment (see Note 3) and a $2.8 million, net of tax, minimum pension liability adjustment.

     During 2004 the economy in the Company’s market area appeared to reflect stable growth. One area of concern is the personal bankruptcy rate. Management expects the personal bankruptcy rate could 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.

     Key financial indicators management follows include but are not limited to, numerous interest rate sensitivity and interest rate risk indicators, credit risk, operations risk, liquidity risk, capital risk, regulatory risk, competition risk, yield curve risk, and economic risk.

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LEVERAGE STRATEGY

     In May 1998 the Company implemented a leverage strategy designed with the potential to enhance its profitability by maximizing the use of the Company’s capital with acceptable levels of credit, interest rate and liquidity risk. The leverage strategy consists of borrowing a combination of long and short-term funds from the FHLB 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 over the last several years. At this time, the Company maintains the leverage strategy for the purpose of enhancing overall profitability by maximizing the use of the Company’s capital. Risks associated with the asset structure the Company maintains are a lower net interest rate spread and margin when compared to its peers, changes in the yield curve, and increased interest rate risk. During 2004 and continuing into the first two months of 2005, the yield curve has flattened significantly. During this flattening curve cycle, there has been a combination of increasing short-term interest rates combined with relatively flat to decreasing long-term (10 years and out) interest rates. Should this trend in the yield curve continue, the Company may not see prepayment speeds on its mortgage-backed securities slow and could see prepayment speeds increase. In addition, at the same time the Company could see its funding costs rise. Increased prepayment speeds and rising funding costs would most likely squeeze the Company’s net interest margin. The Company’s asset structure, spread and margin increases the need to monitor the Company’s interest rate risk. An additional risk is the change in market value of the AFS securities portfolio as a result of changes in interest rates. Significant increases in interest rates could impact the Company’s equity capital significantly.

     The Company will attempt to adopt a balance sheet strategy going forward to manage the securities portfolio as a percentage of earning assets in combination with adequate quality loan growth available in the Company’s market area. If adequate quality loan growth is not available to achieve the Company’s goal of enhancing profitability by maximizing the use of the Company’s capital, as described above, then additional securities will be purchased if they can be purchased at what the Company believes are acceptable margins. If acceptable securities are not available to purchase, the Company could reduce the level of securities through maturities of securities, principal payments and, or sales of securities. During 2004, sufficient quality loan growth was not available at a market price the Company was willing to accept. As a result, the securities portfolio as a percentage of total assets increased to 54.4% at December 31, 2004 from 52.2% at December 31, 2003. On the liability side, the Company will continue to utilize a combination of advances and deposits to achieve its strategy of minimizing cost while achieving overall interest rate risk objectives as well as ALCO objectives. During the 2004 interest rate environment, long-term deposits necessary to balance ALCO objectives, as a result of long-term assets added to the balance sheet, were not available in the Company’s market area at a market price the Company was willing to accept. As a result, FHLB borrowings as a percentage of deposits increased to 56.3% at December 31, 2004 from 51.0% at December 31, 2003. The increase in FHLB advances were primarily long-term advances. The intended net result of the overall balance sheet strategy is to increase the Company’s net interest spread. The leverage strategy is dynamic and requires ongoing management. As interest rates, yield curves, funding costs and security spreads change, the Company’s determination of the proper securities, proper amount of 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. If the flattening yield curve cycle trend discussed above continues, the overall yield on the mortgage-backed securities may not increase and could decrease. If all interest rates were to 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

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the slope of the interest rate yield curve, net interest income could fluctuate more than simulated under the ALCO scenarios modeled.

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 and securities 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, changes in interest rate yield curves, prepayment rates of mortgage-backed securities and loans, repricing of loan relationships, government policies and actions of regulatory authorities, also significantly affect 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, 2004
COMPARED TO DECEMBER 31, 2003

NET INTEREST INCOME

     Net interest income is one of the principal sources of a financial institution’s earnings stream and represents the difference or spread between interest and fee income generated from interest earning assets and the interest expense paid on deposits and borrowed funds. Fluctuations in interest rates or interest rate yield curves as well as 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, 2004 was $39.4 million, an increase of $8.0 million or 25.7% compared to the same period in 2003. The overall increase in net interest income was primarily the result of increases in mortgage-backed and related securities and taxable investment securities combined with a decrease in interest expense on deposits and long-term obligations. During the year ended December 31, 2004, total interest income increased $6.0 million or, 9.8% as a result of an increase in average interest earning assets of $143.9 million or 11.4%, which more than offset the slight decrease in average yield on average interest earning assets from 5.15% at December 31, 2003 to 5.05% at December 31, 2004. Total interest expense decreased $2.0 million or 6.9% to $27.6 million during the year ended December 31, 2004 as compared to $29.7 million during the same period in 2003. The decrease was attributable to a decrease in the average yield on interest bearing liabilities December 31, 2004, to 2.41% from 2.82% for the same period in 2003 which was partially offset by an increase in average interest bearing liabilities of $93.0 million or 8.8%.

     Net interest income increased during 2004 as a result of increases in the Company’s net interest margin and spread during the year ended December 31, 2004 to 3.08% and 2.64%, respectively when compared to 2.80% and 2.33%, respectively for the same period in 2003, which was due to several factors. The higher overall interest rate environment during 2004 when compared to 2003, contributed to a decrease in residential mortgage refinancing nationwide and in the Company’s market area. This decrease in prepayments on mortgage loans combined with a restructuring of the securities portfolio reduced overall amortization expense which contributed to the increase in interest income. A return to long-term interest rate levels experienced in May and June of 2003 could impact the Company’s net interest margin in the future due to increased prepayments and repricings. Other factors that impacted the Company’s net interest margin and spread included a reduction in interest expense on the Company’s trust preferred securities during the year ended December 31, 2004 of $1.5 million or 61.7% and a decrease in the interest expense on the Company’s interest bearing deposits of $1.3 million or 11.6%. Partially offsetting these decreases in interest expense was an increase in interest expense on long-term FHLB advances of $782,000 or 8.4% due to the increase in the average balance outstanding.

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     During the year ended December 31, 2004, average loans, funded by the growth in average deposits, increased $34.5 million or 6.1%, compared to the same period in 2003. The average yield on loans decreased from 6.50% at December 31, 2003 to 6.11% at December 31, 2004. The decrease in the yield on loans was reflective of the repricing characteristics of the loans, interest rates at the time the loans repriced, and the competitive loan pricing environment. If interest rates remain low or move lower the Company anticipates it will be required to continue to meet lower interest rate offers from competing financial institutions in order to retain quality loan relationships, which could continue to impact the overall loan yield. The decrease in interest income on loans of $518,000 or 1.5% was the result of the decrease in the average yield on loans which was partially offset by the increase in average loans.

     Average investment and mortgage-backed securities increased $110.3 million or 16.9% for the year ended December 31, 2004 when compared to the same period in 2003. This increase was primarily funded by an increase in FHLB advances and an increase in average deposits. The overall yield on average investment and mortgage-backed securities increased to 4.35% during the year ended December 31, 2004 from 4.13% during the same period in 2003, due in large part to decreased prepayment speeds on mortgage-backed securities which led to decreased amortization expense. Interest income on investment and mortgage-backed securities increased $6.6 million in 2004 or 26.3% compared to 2003 due to an increase in both the average yield and the average balance on securities during 2004.

     Interest income from marketable equity securities, federal funds and other interest earning assets decreased $56,000 or 9.2% for the year ended December 31, 2004 when compared to 2003 primarily as a result of lower average interest rates paid on FHLB stock during 2004.

     During the year ended December 31, 2004 securities increased more than loans. As a result, the mix of the Company’s average interest earning assets reflected a decrease in average total loans as a percentage of total average interest earning assets compared to the prior year end as loans averaged 43.3% during 2004 compared to 45.7% during 2003, a direct result of less loan growth when compared to the growth in securities. Securities averaged 56.1% of average total interest earning assets and other interest earning asset categories averaged 0.6% for December 31, 2004. During 2003 the comparable mix was 53.7% in securities and 0.6% in the other interest earning asset categories.

     Total interest expense decreased $2.0 million or 6.9% to $27.6 million during the year ended December 31, 2004 as compared to $29.7 million during the same period in 2003. The decrease was attributable to a decrease in the average yield on interest bearing liabilities partially offset by an increase in average interest bearing liabilities of $93.0 million or 8.8%. Average interest bearing deposits increased $22.2 million or 3.5% while the average rate paid decreased from 1.82% at December 31, 2003 to 1.56% at December 31, 2004. Average time deposits decreased $12.6 million or 3.8% and the average rate paid decreased 33 basis points. Average interest bearing demand deposits increased $30.1 million or 12.0% while the average rate paid decreased 3 basis points. Average savings deposits increased $4.8 million or 10.9% while the average rate paid decreased 19 basis points. Average noninterest bearing demand deposits increased $39.2 million or 18.9% during 2004. The latter three categories, which are considered the lowest cost deposits, comprised 64.4% of total average deposits during the year ended December 31, 2004 compared to 60.2% during 2003 and 54.4% during 2002. The increase in average total deposits is reflective of overall bank growth and branch expansion.

     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, 2004, 2003 and 2002, the Company had no brokered CDs and brokered CDs represented zero percent of deposits.

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     The following table sets forth the Company’s deposit averages by category for the years ended December 31, 2004, 2003 and 2002:

     Average short-term interest bearing liabilities, consisting primarily of FHLB advances and federal funds purchased, were $181.8 million, an increase of $22.5 million or 14.1% for the year ended December 31, 2004 when compared to the same period in 2003. Interest expense associated with short-term interest bearing liabilities decreased $15,000 or 0.2% and the average rate paid decreased 51 basis points for the year ended December 31, 2004 when compared to the same period in 2003 due primarily to higher interest bearing FHLB advances rolling off and being replaced by lower interest rate advances. This more than offset the increase in the average balance of short-term FHLB advances. Average long-term interest bearing liabilities consisting of FHLB advances increased $61.1 million or 26.3% during the year ended December 31, 2004 to $293.5 million as compared to $232.4 million at December 31, 2003. Interest expense associated with long-term FHLB advances increased $782,000 or 8.4% and the average rate paid decreased 57 basis points for the year ended December 31, 2004 when compared to the same period in 2003. The long-term advances were obtained from the FHLB primarily to fund long-term securities and loans. FHLB advances are collateralized by FHLB stock, securities and nonspecific loans.

     Average short-term junior subordinated debentures decreased $1.8 million or 100% during the year ended December 31, 2004 when compared to same period in 2003. There were no short-term junior subordinated debentures outstanding at any time during 2004. On September 4, 2003, the Company announced it would redeem on October 6, 2003 the $20.0 million of long-term junior subordinated debentures the Company originally issued during 1998. The average balance in 2003 reflects the reclassification of the long-term junior subordinated debentures to short-term until they were redeemed.

     Average long-term junior subordinated convertible debentures decreased $11.7 million or 100% during the year ended December 31, 2004 compared to the same period in 2003. On December 31, 2003, Southside Capital Trust II, a subsidiary of the Company redeemed 6,571 shares of its 8.75% Cumulative Convertible Trust Preferred Securities and all of its 8.75% Common Securities which totaled $678,000. Prior to the redemption date, December 31, 2003, all other convertible trust preferred shares were converted into the Company’s common stock. This increased the Company’s number of shares of common stock outstanding to 10,358,880 at December 31, 2003, which is not adjusted for the 5% stock dividend in 2004. Interest expense associated with the long-term convertible debentures decreased $834,000 or 100% for the year ended December 31, 2004, when compared to the same period in 2003 due to the fact the debentures did not exist during 2004.

     Average long-term junior subordinated debentures (the “Cumulative Trust Preferred Securities”) decreased $20 million or 100% from December 31, 2003 to December 31, 2004. Interest expense decreased $1.4 million or 100% for the year ended December 31, 2004 when compared to the same period in 2003. On October 6, 2003, Southside Capital Trust I, a subsidiary of the Company redeemed all of its 8.50% Cumulative Trust Preferred Securities and 8.50% Trust Common Securities which totaled $20,618,560. The Company funded the redemption through the issuance of $20,000,000 of trust preferred securities and $619,000 of trust common securities that adjust quarterly at a rate equal to the three month LIBOR plus 294 basis points. During 2004, the average interest rate on the adjustable rate trust preferred securities averaged 4.40%, providing an interest savings when compared to the 8.50% fixed rate trust preferred issue redeemed during 2003.

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RESULTS OF OPERATIONS

     The following table presents average balance sheet amounts and average yields for the years ended December 31, 2004, 2003 and 2002. 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 .